The $300 billion tax cut: Let’s do it right

January 8, 2009

Diana Furchtgott-Roth – Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. The views expressed are her own. –

President-elect Obama announced on January 8 that he is planning to use $300 billion of his $700 billion two-year stimulus package for tax cuts—but we should not celebrate too soon. Obama is proposing a series of temporary tax cuts, not permanent cuts that would hasten economic recovery.

For two years only, Obama wants to give a tax cut of $500 a year to individuals and $1,000 a year to families, at a cost of about $145 billion over the two years.  Rather than mail out U.S. Treasury checks, as was done last spring in an effort to ward off a recession, he would lower withholding rates so that the tax cut would be spread over the year.

Obama and his advisers evidently believe that a temporary tax cut spread out over 52 weeks would induce more extra spending than one delivered all at once.  The problem is that tax cuts that are temporary have limited effects on spending behavior.  Milton Friedman won a Nobel Prize for his permanent income hypothesis, which showed that spending decisions are made not by the amount of money in consumers’ pockets, but by their expectations of future income.

Businesses with losses in 2008 or 2009 would also receive temporary tax cuts. They would be allowed to convert those losses to cash by applying them to taxes paid in earlier years.  Treasury checks for the losses would give them additional cash for new investments.

As an incentive to spend the money, businesses would be allowed to expense—deduct in full—up to $250,000 of equipment in 2009 and again in 2010, up from the present limit of $125,000 a year.

Firms do tend to respond to temporary incentives, boosting current GDP. But they often do this by advancing investment projects from future years to the present, lowering GDP in the future. If a firm, to take advantage of the extra write-off, invests more this year or next, then some additional projects would be advanced from 2011 and 2012, reducing investment and employment in those years.

Businesses would also be given a one-year tax credit to hire new workers, or prevent layoffs, valued at $3,000 per worker, at a cost of $40 billion.  This provision is so murky that it will obviously be abused.  A company could fire workers and rehire them to get the credit, or announce plans for layoffs in order to qualify.

The goal of tax systems, in addition to raising revenues that governments need, should be to encourage work and investment, and thereby production of national income.  Income effects are critical when it comes to assessing the effects of changes in tax rates on government revenues and the inefficiencies associated with different taxes.

The most effective measure would be a permanent cut in individual tax rates and an increase in business expensing, paid for by a permanent cut in spending when the recession is over.  The tax cuts of 2001 through 2003 would have been more effective if spending could have been cut in subsequent years.

Economists such as Professor Jonathan Gruber of MIT have found that households earning more than $100,000—typically containing two middle-class professionals—are highly responsive to changes in tax rates. When tax rates rise, their work declines.

Others, such as Professor William Gentry of Williams College, found that higher marginal tax rates discourage entrepreneurs from starting new businesses, which involves much risk.  Additional investment in new ventures creates jobs, encourages innovation, and enables people to reap further benefits from economic creativity. (Click here for Gentry’s report.)

An efficient tax system is a vital tool for restarting American growth.  Improvements in our tax system can help us outgrow the recession and keep up with the rest of the world.  If we’re planning tax cuts of $300 billion, let’s do it right.

For previous columns by Diana Furchtgott-Roth, click here. The author can be reached at dfr@hudson.org.

34 comments

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The problem with this is that on April 15th you will either pay a portion of this money back or get less of a return. Your tax bracket did not change, you just pay less taxes. So, when the tax man cometh

Posted by watchyourback | Report as abusive

Mr Obama,

9.61 a week. Thank you……for the slap in the face.

Posted by John | Report as abusive

As a guy working two jobs with three kids two cars a house in the burbs and a stay-at-home wife, I’ll take the 9.61 a week and that’s fine, thanks.

Posted by Tom | Report as abusive

It might make more sense to increase the $3,000 limit that people can deduct of capital losses aginst ordinary income to a much larger amount, say…$100,000. then after that one time change, increase the $3,000 figure to $15,000. Very few other changes to the personal income tax code would be necessary.

Posted by david | Report as abusive

If we renew the excess profits tax of old and invest in rail transportation for people (a spoonful of oil moves a man one mine on rails) then the US economy might be able to afford the greedy fools that we have all become. Oh! we must also fix the quality of “made in the USA goods” before we can compete with “foreign made”. Good luck Mr. Obama and good luck fat butted, lazy ,greedy Americans.

Posted by A Over | Report as abusive

People seem to forget that the govt. can’t stimulate anything, all it can do is take and reallocate dollars. Dollars that ultimately must be paid for through taxation. So for people to continue to argue that this urgent stimulus is necessary and that it will save the economy is ridiculous.

The problems we have are linked to excess spending and consumption. To conclude that we need to spend and consume more is absurd. We need to quit consuming and save, that’s where the only real capital for the economy comes from, it doesn’t come from capital created by the govt with a printing press.

If the govt. continues to intervene and prevent the market from making the corrections it needs to we’ll have a prolonged and protracted decline consistent with the Great Depression.

Govt. needs to get out of the way and let the market work.

Posted by steve | Report as abusive

Diana,
The title of your Article caught my attention because I´m wondering for days how I could channel my idea to President Obama and/or his Economy Team; Hope, in case you find it worth enough, you have the tools to reach them.
America has to waiste less energy, American People will have a tax cut so, let´s make it simple: energy spent in each american house (or business)in the last twelve months (electricity/gas) less energy to be spent in the next twelve months (in watts and m3)multiplied by average market values of these comodities, to be deducted from next year tax of actual business company, house holder either the actual house owner or the house renter. This connects the welcomed tax cut to the decisive incentive American People need to moderate their energy consumption reaching in a few years, the percapita levels say, of the European Union (taking in account climate considerations). I believe Americans will change, having the double perspective of spending less on energy plus paying in consequence less tax; they will look, as we Europeans already do, on our own, for ways to reduce our consumption, namely, reduce house inside temperature, stop openinng windows to compensate, use a pullover inside, buy a thertmostate, isolate better, automatic connect/disconnect heating/cooling system through internet/phone, etc..etc…it´s fresh money in their pockets! The Government may decide to finance these investments to help the change.
Thus the above make sense (Let´s do it right!) or, is just another one fool/idiotic idea?
With my Best Regards,
Pedro Spohr

Posted by Pedro Spohr | Report as abusive

Where’s Huckabee?

Posted by Donna | Report as abusive

I would not want to be a young American. Their future income -and much more- is being spent to try to save the lifestyle of the rich greedy frauds that have sucked the US economy dry doing nothing but spinning hot air, starting wars and destroying the US manufacturing base. Frightening to see a whole generation that can’t control its materialism living off of their children.

Posted by fbertinotti | Report as abusive

Govt. needs to get out of the way and let the market work.

- Posted by steve

Steve, while I agree that savings equals investment, what’s especially amusing is that the economic wreckage we see before us today is in fact the handiwork of the Randian dimwits who’ve become endemic to conservative economics.

Exhibit A: Longtime Fed Chairman Alan Greenspan, who was a Big Randian from back in the day.

Of course, Greenspan now admits this approach may not have worked out so well. Especially the bit about letting the true economic geniuses/captains of industry have their unfettered way. In fact, it all turned out to be a big fat fraud, didn’t it?

Greenspan wasn’t alone, of course. George W. Bush’s entire approach to governance, especially in the economic sector, was fundamentally Randian: Bush never met a tax cut for the wealthy or deregulation scheme he didn’t chase like a fox after a chicken. Even the Democrats who succumbed to the “era of profound irresponsibility” did so because they were harkening to the siren song of the right-wing Randians.

Watching Randians at work trying to convince themselves of their essential rightness in the face of the global wreckage pile of evidence to the contrary would be funny were the consequences of their historical muckup not so devastating and so far-reaching for so many of the ordinary schlubs for whom the Randians have at best a guarded contempt. It all reminds me of a bit of wisdom passed along to me: “Watch out for ideologues. Ideas are more important to them than people.”

I agree let’s do it right! Let’s cut government payroll and benefits starting with the president, congress and they’re spending accounts. Then some of our military spending abroad. We need a real tax cut here not more loop holes in tax code. And you will not have a cut if they don’t get rid of something or else they’re just going to print more money to cover it or borrow it from someone else.

Posted by jason | Report as abusive

Any fix that does not create or re-create non-government jobs will not work. Repairing the manufacturing base and the jobs it provides is the only way to quickly turn around our economy. Trace every other job in the US back to it’s source and you will find it supported by manufacturing money. How many people can be supported here in the US by someone buying foreign product, marking it up and selling it to the people? Only a few people at the upper management level and whoever it takes to sell it from a store will be supported by that system. People need to understand the sheer numbers of a manufacturing process creates almost too many jobs to count. Every tiny part of any product creates at least two jobs – one to make the tiny part and one more to assemble it. Think about your toaster – 50 little parts = 100 jobs. The manufacturing companies are sending all those jobs overseas just to make the product more profitable. All those jobs disappearing for the last 30 years is why we have finally crossed the tipping point and our economy collapsed.
It won’t be easy but the trade imbalance needs to be fixed.
The quality of US product is not the issue – it’s always price.
We need to steer our highly educated people towards finding ways to make our manufacturing more competitive.
We need to get union wages back in line.
The only guaranteed fix is to make our manufacturing industries strong again. If that happens – everything else will work.

Posted by Ted Ryfiak | Report as abusive

getplaning,
Whatever you were talking about, I don’t get it. What
Steve was saying is just perfectly right, purely right and utterly right. Saving is key, especially after a period of over-consumption.

Do you have any source or references that the economic wreckage now is caused by Randians?

The idea of of anti-Randian (whom the society regards to as “hedonists”) that the economy can grow by having people consuming more and more until one type of resource is depleted and then move one another type of resource and repeat is simply absurd.

Posted by Trevor H | Report as abusive

why not!

Posted by CrazyDude | Report as abusive