Tuesday, January 13, 2009

How not to improve the economy

Perhaps the centerpiece of Obama’s “tax cut” plan is the proposal to give everyone except high income Americans a $500 refundable tax credit, paid for by higher taxes on “the rich”, or by borrowing. What few people realize is that the tens of billions of dollars in total payouts under this scheme will reduce the sum of American investment and production by that same amount. In effect, America will become that much poorer overall.

The reason is that this money is not being paid for producing anything – people are getting it just for being there. If that same money were spent or invested by the taxpayers from whom it came, it would be spent on goods and services.

Those in favor of this scheme would argue that the money will be spent by the recipients, so there will be no difference in spending, but that is an invalid comparison. Think of the flow of this money through the economy as a chain of transactions, one after another. The tax transaction extracting this money from taxpayers results in zero production whereas their spending on other things would have produced goods and services.

The next transaction in the chain is the spending by the recipients of the tax credit, but this would have been matched by the spending of the vendors the taxpayers would have purchased goods and services from if their money had not been taxed away.

Not only are the taxpayers hurt, but their suppliers are also hurt. Instead of the suppliers being paid for their products, the money is instead directed to other people for producing nothing. Many of the employees of the suppliers are on lower rungs of the economic ladder themselves. The same amount of money given to people for not working is being taken away from other people for working – and producing.

Sometimes economics gets so wrapped up in theories and formulas that it’s easy to lose sight of the fact that it’s ultimately about real goods and services. The money is just a means to an end. In this case, the tax credit will result in a reduction of real goods and services by the same amount as the total payments.

Only a politician, or an economist, can believe the economy would be improved by reducing the total production of goods and services.

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