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August 24, 2008

Why Obama's Tax 'Rebate' Plan Cannot Succeed
by Gerard Jackson

On the advice of Jason Furman, Austan Goolsbee and Warren Buffet Obama has proposed a tax 'rebate' scheme to get the economy moving. Critics have pointed out that these one-off 'rebates' would go to people who pay little or no federal income taxes. This makes the so-called 'rebate' largely a transfer payment. (Even a Keynesian will admit that transfer payment have no stimulatory value). Where the recipient pays taxes, the amount he pays would be deducted from the 'rebate'. Hence, if the maximum rebate is $1,000 and he pays $500 in taxes he would then get a rebate of $500.

Now many of those who oppose Obama's tax-and-spend policies do not in principle object to the view that tax refunds or rebates can stimulate the economy by increasing the demand for consumer goods, even if it is a one-off effect. But this is really dreadful economics and derives from the fallacy that the demand for labour derives from the demand for consumer goods. Therefore, using fiscal or monetary policy to encourage consumption will expand GDP until the central bank feels the need to slap on the monetary breaks. (In fact, fiscal policy is usually code for monetary expansion).

The fact that monetary policy must eventually be tightened should have signalled to economists that there is something seriously wrong with a fiscal or monetary policy the end result of which is a recession. But no, they continue to blindly accept the orthodox and erroneous view that the trade cycle is a natural part of capitalism instead of being the bitter fruit of a fractional reserve system.

Although the monetary angle may seem to be a digression it is a crucial part of the problem. One hears from the economic commentariat and ignorant politicians that tax cuts have to be frequently forgone otherwise they will create excessive demand that will drive up inflation. But inflation could only follow if the tax cuts are being funded out of an expanding money supply, which is frequently the case. Unfortunately this fact is invariably overlooked in debates about the beneficial effects of tax cuts. It certainly appears to me that Obama's economic advisors are completely ignorant of this line of thought.

Like the rest of their colleagues they fail to see that whether the tax rebates are genuine or not their effects on investment will be virtually nonexistent, especially so where they are directed to consumption. Consumption springs from production: it is a truism that what has not been produced cannot be consumed. In turn production comes from investment which is fuelled by savings. It is obvious that if the whole of the rebate were saved then the savings pool would rise by the same amount.

However, once the rebate has been invested the savings pool would return to its previous level. This is why rebates can -- at best -- have only a negligible effect on aggregate investment and hence future living standards. It follows that a lasting effect can only be produced by permanent tax cuts. Opponents of this policy -- not all of whom are Obama supporters -- would argue the need to target consumption because it is about 70 per cent of aggregate economic activity.

This is false. Any accurate figure for total economic activity would have to include spending among firms. Once this is done statistics suggest that the GDP figure would at least double, bringing consumer spending down to about 33 per cent of total spending. We then see that it is business spending that drives the economy and not consumption. Mill was presenting the classical view on this matter when he wrote:

What a country wants to make it richer, is never consumption, but production. Where there is the latter, we may be "sure that" there is no want of the former. (John Stuart Mill, Essays on Economics and Society 1824--1845, Liberty Fund, 2006, p. 263).

The above tells us that the last thing the US economy needs -- or any other economy -- is an Obama tax and spend policy, which would be better named tax and destroy. Nevertheless, the real problem is not Obama but economic illiteracy and entrenched Keynesian fallacies. Until these have been permanently uprooted and the true nature of capital, savings and production fully grasped we are going to continually have to confront dangerous economic policies whose short run effects are such that they will always attract the support of cynical politicians.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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