Monday, September 13, 2010

Why We Should Leave The Tax Cuts In Place

September 13, 2010. Being an economist or a meteorologist is a good job: you can be wrong all the time and still get paid. In undergrad school, I chose to major in accounting: it was hard, it was interesting, but importantly (to me), it had a finite result (well, sort of finite). I had my minor in economics, which had a similarity to taking either religion or political science: everybody had a theory, and sometimes they were right.

Nevertheless, I’d like to take a stab at economic theory and how to fix our economy and the rest of the world’s economies. The first and foremost notion for every economic entity (with the possible exception of the Taliban) is to ‘Provide economic growth’. Simplistic? Yes, but you can’t argue its merit. So the question of economic growth comes down to this: How? The answer is again, even by economic standards, almost universal: ‘Putting money into an economic system stimulates economic growth’. Again, simple. So how do you put money into the system?

Here’s where the arguments start and the similarities to religious and political conflict begin. One school of thought (called the Keynesian school) says ‘put money into the system by providing jobs through fiscal stimulus’. This notion is to build roads, bridges, parks, whatever; get people working, even on government dollars. Provide unemployment benefits, keep wages up and the money will flow into the system from the bottom up. This ‘bottom-up’ approach suggests that money into a worker’s hands will flow into goods and services that the worker buys, putting money into the system. This method has worked before, most notably in the 30’s. During the 60’s and 70’s, not so much. Currently, the government has thrown the entire fiscal stimulus playbook at the economy. Unemployment is still high. The problem with fiscal stimulus is that it takes time to work. In fact it usually starts working after you need it.

Another idea (called the Monetarist school) says ‘put money in the system by increasing the money supply, and banks will lend it out and stimulate the economy, providing jobs and expansion’. This notion is that money is self-regulating and by increasing the amount of money, you’ll increase the amount of activity. It’s worked before (most of the 90’s), and then again, it hasn’t (the late 70’s, it was a total bust). This ‘top-down’ approach believes that money flowing from the top will work its way into jobs by companies expanding and hiring. The government has not only thrown in the entire monetarist playbook, but created new pages, tools and weapons and tossed them in too. The result is that we have the biggest money supply in history, with about the lowest velocity of money (the amount actually making its way into the system). In other words, tons of money, going nowhere, sitting on the sidelines.

So fiscal stimulus isn’t really working, and monetary stimulus isn’t really working. What’s my magic bullet? I’d like to see some ‘Behavioral stimulus’. What’s behavioral stimulus? It’s letting the participants in the economic engine have some confidence that they can make good decisions. It’s reducing uncertainty. We advise about 700 families on what to do with their money. On the estate tax law, you know what we have to say? “We don’t know what the government is going to do”. On the capital gains rates for next year, we have to say “We don’t know what the government is going to do”. On the upper tax brackets, we have to say “We don’t know what the government is going to do”. How in the heck can an investor, taxpayer, businessperson or even an advisor function in uncertainty?

So here’s a grand idea: ‘put money into the system by allowing taxpayers to keep more of their money and have a stable system in which to plan their finances’. In the early 80’s the fiscal stimulus approach had failed, the monetary approach had failed, the Dow was at 870, and interest rates were at 16% on the 30 Year Treasury. The President cut taxes, and the economy took off, with the stock market rising about 1900%. By the end of that wave, the government had a surplus. We should leave the tax cuts in place. We should have a stable environment for people and businesses to do business, not a cloud of uncertainty to keep us on the sidelines. Give us a stable tax system and the economy will do what it wants to do: grow. Then you can have more tax revenue by taxing higher incomes. What a novel idea.

Reduce uncertainty.