A Better Stimulus for the Economy

The problem with our economy is not weak spending, which is just a symptom of our predicament. The root problem is lack of confidence in the future. We already know that spending is not the cause of economic prosperity. In fact, profligate spending is exactly what got us into the tight spot we are in. Borrowing even more from the Chinese and adding that on top of our already bloated budget is monumentally irresponsible, especially given that the Chinese might not be forever willing to extend us credit at low interest rates.

In addition, by launching spending programs, bailouts and subsidies to private enterprise, we effectively make all of us poorer. Wholesale government intervention creates the most unintended consequences: in the 1930s, the New Deal's artificially high wages kept unemployment up for a decade. In the 1970s price controls created shortages.

Forcing the American tax payer to subsidize this parlous state of affairs is not smart policy. Sure, adjustments brought about by capitalism are not pleasant, but they make the system more transparent, more efficient and more fair, because they weed out the unworthy and incompetent.

But there is a better way to create stimulus. Professor Russell Roberts of the economics department at George Mason University has proposed a more efficient way to stimulate the economy, by eliminating the payroll tax.

The payroll tax (15%) is a regressive tax, which means it disproportionately burdens low income earners. It is also mischievously deceiving, which is not becoming of an administration that promises to be transparent: while most people wrongly believe half the payroll tax is paid by employers, the fact is the tax effectively lowers employees' compensation. Therefore, eliminating the payroll tax will create jobs and spur stimulative spending by the private sector.

If you are worried about the impact on the deficit, you should know that the payroll tax currently generates about $700 billion, less than President Obama's stimulus plan that cleared the House last week. And keep in mind that if we cut just 10% of all departments in government -- nothing draconian, simply bringing them to the same level they were two years ago -- we save $250 billion annually.

If you are worried about the future viability of Social Security, remember that the current payroll tax is not used towards future social security payments, but to pay current entitlements and other ongoing government expenditures. Either way, Social Security and Medicare are not practical solutions. Those are fake pension and insurance programs that have been effectively bankrupt for a long while. It is better, Professor Roberts perspicaciously suggests, to make Social Security and Medicare a safety net program for the people who really need it, and let richer Americans who can afford it handle their own retirements.

We should recall Thomas Jefferson's famous maxim: "a government big enough to give you everything you want, is strong enough to take everything you have", and choose tax reduction as a superior solution to another growth spurt for Washington D.C., in a futile effort to jump start the economy using the very same methods that got us into this crisis.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at [e-mail].

Comments

[Sundialsvc4]

While you make an interesting point, Alan, I suspect that "the solution" to our economic difficulties will not come so much from government as from stern reforms to the consumer-lending industries. People are paying vastly too much money in interest on loans of all types. There are also billions of dollars' worth of loans that should never have been made.

The financial industries ought not to be permitted to "walk away" from any of this, to any degree nor in any respect. You (Mister Banker... Mister Scrooge) can't foreclose on those loans and dump families out into the winter night with no place to go ... and with a warm, snug home that you can't sell (especially when homeless families start squatting in it). You have to make them work. Not for you... for them. You have to be compelled to do business in a way that actually helps your millions of customers, because you do not yet comprehend (and maybe have just become too jaded and too "rich" (sic)...) that what is good for them IS good for you.

"IF he relents..."
"He is past relenting, Caroline. He is dead."
"But to whom shall our debt be transferred?"
"I do not know. ... It would be bad fortune indeed to find so merciless a creditor in his successor..."

[DuganS1]

Too much on interest? Interest rates have been historical low for a decade and a half. Plus, mortgage interest is tax deductible and many folks moved their auto loans and high interest credit cards onto their low rate mortgages during the housing boom. There was a huge amount of refinancings again in the past two months so people are still reducing interest payments to record low rates.

[DennyCrane]

People have no confidence in the future. They've either lost their jobs or they're worried they're going to. Giving people more money won't solve anything. Just like businesses, people save money they get from tax cuts. People won't start spending again unless they're sure they'll have job safety. The goal should be getting the credit markets to function again. Banks are being too strict now because of what happened when they were too lenient. The pendulum has swung too far in the other direction and now no one can borrow money.

[Binckeslaw]

The core problem with the American economy is wages. Wages is a taboo subject that the corporate pundits never touch although America's wage crisis is quite clear. When the salaries and wages of employees fall they can't buy what they could buy before. A microcosm of the wage crisis includes - cutting the wages of American auto workers from $28 per hour to $14; bringing back outsourced work with employees getting 60% of their former wage to do it; requiring employees to pay a greater percentage of their health insurance premium so that their wages, after the health care contribution, actually decline; and implementing pay cuts to keep workers employed while not reducing the hours that they work to keep from laying workers off. Americans who have been victimized by the wage slashing models can't afford homes at 2006, 2008 or 2009 prices because their wages reflect 1990's wage scales. American households are already giving up "the extra car" - the one that is more of a convenience than actual necessity - because they need to slash household expenses in a big way to keep their homes. Car sales won't rebound until Americans feel secure in their homes. They won't feel secure in their homes as long as their wages are being eroded by regressive wage models that were implemented to increase corporate profits.

[DuganS1]

Wages vary tremendously across geographical regions and houses are priced according to wages per that region. During the housing boom there were, of course, areas where home prices far exceeded affordability per local wages (ie California, Florida, Vegas, Phoenix) but in the vast majority of areas within the country home prices haven't exceeded affordability to that great an extent. Note, that while the median real wage for a male worker hasn't increased since 1973, real household income per family member has continued to increase substantially because more family members are working and household sizes are smaller. Also note that interest costs are now much lower than ever before, which frees up income for other purchases, prices for a large number of consumer goods have gone down over the past 25 years so consumers can buy more of certain things, and the "real" wage numbers are distorted by housing inflation which people who bought their homes before the huge increase in home prices didn't see (as banks can't increase the amount of your mortgage just because the value of your home has increased). So in summary, the problem isn't wages. Wages are fine. The problem is that too many people bought homes near the peak of the housing boom and are sitting on negative equity or have adjusted loans where payments increase to a point they can no longer afford.

[Erdgeist]

Indeed there are regressive taxes -- nobody disputes that. But that there has not been sufficient *investment* in the U.S. on the part of the private sector -- including the government in the way of infrastructure for quite some time is pretty much our problem right now. Our chickens have come home to roost, in other words.

Fundamental also to maintaining an adequate level of employment is exactly the amount of investment. When domestic investment falls off or is, so to speak, offshored to China or the Philippines layoffs occur as does under employment (chump-wage service sector jobs).

During World War II when the federal government heavily invested in setting up factories to produce war materials, employment proportionally grew.

Neither an increase in consumption nor lowering taxes can be counted as investment. In this regard, one would err to suppose that the arsenal of democracy in World War II grew to its might by lowering taxes and by getting American workers to buy lots of cotton candy. The point I am making is that right now we need to invest in America the way we did when we were the arsenal of democracy. Only then will this crisis end.

[BelieveInAmerica]

And one more thing:

WHY IS IT THAT Republican Economists always think that lower wages -- meaning a lower standard of living -- is the solution? These economists seem to think that shipping jobs to low paid workers in other countries is an end on to itself.

They will look to higher efficiency (less wages per hour) and higher world production (with no accounting for the negative impact of environmental damage) as the measure of a healthy economy. How about a healthy distribution of wealth to ordinary workers? How about clean air and clean water and healthy food and healthy world ecology? They don't even make the list.

[research]

And they can't explain How Ford succeeded by paying his workers TWICE the going rate.

[BelieveInAmerica]

For many years, Ford did succeed. Ford and GM are now burdened by the consequence of being so successful for so many years, meaning that they have a larger retired workforce than their competition. Addition factors in Ford's current problematic state include the health insurance burden (Japanese and European car manufactures can rely on the government program), and frankly this country's attitude towards fuel economy ("a virtue" rather than a matter of national security).

Finally, any honest observer would have to acknowlege that Ford and its UAW workforce have brought some of this about by the poor choices they have made.

[DuganS1]

Ford's margins went up dramatically in the first few decades of the 20th century because costs went down. He increased pay because turnover was so huge in his factories that he had problems keeping enough workers to build enough cars to meet demand. Ford strongly opposed the New Deal,despised FDR , and fought unions tooth and nail despite making periodic concessions (like the standard five day work week). Even when he raised workers wages in 1929 he also cut large number of employees and began sub-contracting a large amount of work out to sweat-shops.

http://findarticles.com/p/articles/mi_m1132/is_n10_v39/ai_6323610/pg_1?tag=content;col1

[BelieveInAmerica]

Let no University of Chicago economist forget: Mortgage backed securities endangered the world and they were invented in the private sector.

You might remind these people with their degrees in philosophy backed economics, that most of the bad mortgages are *not* classified as "sub-prime". Many more loans were given to those with excellent (prime) credit ratings, but who's income didn't match their magnificent homes, or to developers (read: speculators) whose capital reserves didn't match the risk of multiple loans.

An economy is money in motion. Today, as in the Great Depression, money stopped moving due to the human element. When you have the unhealthy situation where wealth is allowed to accumulate in the hands of the few, as per the Republican policies, the economy becomes hostage to the fears and greed of this superior (meaning privileged) group.

When you have a anti-regulation party nominating an anti-regulation president who named anti-regulation regulators, then truly there is no one to watch the dangerous devices -- such as mortgage backed securities -- that can threaten everyone's well being.

The solution to economic depression is two fold: 1. Give all people, not just the wealthy, a reason to believe in a better future. 2. Take the wealth from those in whose hands it sits idle and put it to work.

A NEW ECONOMY where we use renewable, American sources of energy, where we are no longer hostage to foreign oil potentates. That is something to hope for, something to work for.

[Mildmannered]

these mortgage backed securities were probably bought/sold by Wellcap Partners too.

[Mildmannered]

Alan -- how many employees has Wellcap had to lay off the past six months?

[grateful4thedead]

The author is correct....slash payroll taxes and people will not lose jobs.

Slash corporate taxes and there will be lots of extra jobs out there within 12-15 months. gov't revenues will go up as well.

worked in new zealand (go research it, i won't do your homework for you).

seems i recall another young Democratic President who was elected for change and a breath of fresh air and he took the tax cut route and it worked quite well....hmmmm, anybody else recall that man???

[kennethjkranz]

oh no...not another...­kennedy/di­llon cut taxes and the economy expanded post. this isnt 1960. america doesnt have a labor movement or a 10% savings rate. inflationary pressures in the economy then were demand driven. Tax cuts designed to expand capacity in that environment can relieve inflationary pressures and expand the economy.2 great things. Unfortunately those aren the pressures we have today. They are much easier to deal with. Kennedy and Dillon also realized that of the economy were to slow further from the point they were at when they enacted the tax cut it would have been ineffective. I got that from Kennedy/Dillon transcripts I dug up online a few years ago.

In today's economy wages stagnated, consumer debt ballooned stimulated by a housing equity bubble. Pressures are deflationary. and for fans of Friedman. we rescued the money supply. we backed the banks and guess what. they stil arent lending. simply cutting business taxes isnt going to get it done. corporate tax receipts are down 45% ytd. 4% on the personal side and that is where most small businesses are. they arent making money and not paying taxes. Id back a payroll tax holiday for starters though. Its quick. we still need a longer term plan.

[grateful4thedead]

banks won't lend for 2 reasons: 1. every loan makes a hit on their capital position and this must be rectified whether an aggregator bank, ring fence, fair value/mark to market amendments. 2. the fear of bad loans is real, which can be overcome by the confidence of businesses having more money in their pockets to repay the loans if their corporate tax rates were reduced.

we agree on payroll tax holiday, great thing!

[research]

WRONG WRONG WRONG!

Stop the FDR REVISIONISM!

FDR save the economy.

You derivatives Gamblers crashed it.

Do exactly the opposite of what you recommend:

REMOVE THE CAP on social security.

Invest in green energy.

Regulate the banks and wall street.

Invalidate the 643 TRILLION dollar Derivatives debt.

Not a penny for banks till the regulations and audits are done.

[texastrixie]

It appears that Obama will give in to the Republicans much more than anyone expected. I don't know if this 4% mortgage idea will work, but I'm game to try that. As to tax cuts, we will save every penny this year. Except for medical care (and I'm going to have to use a lot of that this year), I won't be buying anything. I still plan on buying shoes on the internet, but they are only 60-70% off so far, and I am waiting for 80% and free shipping!

Throw out all the taxes you want! If there aren't jobs, and the promise of jobs in the future, people will not buy. And with the banks refusing to loan unless you have a golden credit rating, many who might buy won't be able to.

Rich people are using this crisis to extract more concessions from the govt so that they can enjoy the benefits of this country without contributing their fair share. Cut all these taxes and we will be asking in 3 months, "We did away with all these business taxes, and the unemployment rate continues to go up and seems to be accelerating. Where are the jobs that business promised?" The same place as those bonuses the bankers got!

I think people ought to start saying the truth - that rich people are inherently unpatriotic, and their actions over the last decade has been traitorious.

[joebaggadonuts]

It's MONEY that is inherently unpatriotic. It bribes rich people to become traitors.

[jeffrey678]

Why should we pay for the military defense of Korea,Japan, Taiwan, and the countries of Europe. We trade with China, Russia, and most of these so called enemies. Make them all pay for their own way. We could save trillions of dollars. It's insane to spend trillions of dollars for nonexistent enemies.

[Christian]

"in the 1930s, the New Deal's artificially high wages kept unemployment up for a decade."

Have you looked at the economic growth graphs from the 30s & 40s? The numbers say something different from what I can see. I agree that we should let bad companies die but government spending in areas that create jobs works and grows and improves our country from what I read from the historical record. They talk about private jobs as good ones and government jobs as bad ones, jobs that don't last, etc., but construction jobs are temporary for the job at hand, once built, they need to find new work. I just don't get this argument that government jobs are bad and private jobs are good. They say that the cost of government jobs is to high and the private sector can do it better and cheaper but is that what we have seen with Blackwater and other private firms that contract government jobs? No, often times they cost 2 or 3 times more. Look at the VA hospitals once private contractors moved in, services went to crap. I think you need to rethink your positions.

[DuganS1]

Unemployment remained extremely high throughout the entire decade of the 1930s, even after federal spending was more than tripled. The 1940s unemployment was low because nearly every able bodied man in the country was drafted into the military. Unemployment finally went down to normal levels in the late 1940s when federal spending was massively cut. VA hospitals by the way have been in crappy condition for a long long time. Many of those hospitals have had more employees than patients for long periods until recently.

[Raphi]

You're absolutely correct about the New Deal programs. They worked! How else could people have lived from from Nov. 1929 to Jan. 1943? The '38 downturn was FDR testing the advice of the conservative economists. Claims to the contrary are part of the current wave of anti-New Deal propaganda. Like the unsubstantiated but often heard "history shows the New Deal didn't work" coming from Fox news. Same for Social Security. Which has incredibly low admin. costs compared to the private sector; it is also sound. The figures used to say otherwise assume a sluggish economy, then insist that somehow stock market investment would be better. Yeah, for those getting broker fees. And what does "free markets" really mean? An end to corporations having the same rights as real people? It's really about whom the laws and the regulators serve.

[DuganS1]

The New Deal didn't work because unemployment remained incredibly high despite a three fold increase in govt spending. The "FDR taking the advise of conservative economists caused the nasty 1937-1938 depression in the depression argument" is simply misguided. Govt fiscal spending was only moderately cut in 1938 and the economy nosedived, yet the economy grew dramatically when govt spending was cut just as much in the 20s and cut much more substantially in the late 40s.

[EinChicago]

Any cut in teh payroll tax has ot be matched by an abolition of the ceiling. Sure, make the payroll tax 7.5% instead of 15%.

And make it 7.5% of every dollar earned, not just the first $100K. Do away with teh arbitrary ceiling. Just institute a flat 5% payroll tax on every dollar earned with no maximum.

That'll fix it.

[DuganS1]

Theoretically you get back what you pay in, right? Since upper income folks don't need it, why should they pay more? If the entire system in its current form was to be scrapped (which I strongly favor) then lower income/poor retirees could receive payments (subsidies) which could be funded through the federal income tax codes (of which wealthy folks pay the vast majority of).

[EinChicago]

" the federal income tax codes (of which wealthy folks pay the vast majority of)."

Baloney. I pay less tax now than I did when I was 25... and my income is more than 10 time snow what it was then.


The more you earn the less federal income tax you pay because teh more deductions become available.

[Aaror]

Social security is a problem, but for a different reason than most people know. It works by taxing today's workers to pay yesterday's. The reason for this was necessity, FDR wanted to set up a retirement plan immediatly, not one that kicked in in 1965 or so. So instead of mandating that people save for retirement he taxed the workers of the day and paid the elderly with those taxes. Today many people mistakenly believe that they are getting back what they paid in. In practice people get a lot more out of the program than they put in, and this is an unsustainable system. Eventually, perhaps when Gen X and Gen Y are getting ready to retire, it will collapse. That is why the government has been encouraging personal savings for retirement.
In the long run, mandated savings for our own retirement are probably the way to go, perhaps coupled with an employer funded national pension system modeled on the existing unemployment insurance system.

[Aaror]

Payroll taxes for dummies:
The payroll taxes consist of two tax programs, FICA and Medicare. FICA is a 6.2% tax on the employee and employer that pays for social security payments. This tax has a "cap," at about $100,000 a year, so the wealthy don't pay 6.2% like the rest of us, but pay a much lower rate as a percentage of income (if you pay 6.2% on the first 100K, and 0% on the next 900K, you pay .62% on a million dollar income, similar calculations show that the higher your pay the lower your tax rate).
Medicare is 1.45% for employee and employer, and has no cap.
These taxes are not paid into the general fund and are not reflected on the deficit, except in certain reports that net the social security/medicare surplus against the federal debt.
The author makes some good points, social security taxes on the employer do depress the funds available for wages, though I have a bridge to sell anyone who thinks a holiday or repeal of this tax will result in wage increases. Of course, eliminating this tax would be very similar to the stimulus Bush made, and would have the same effect (none). Increasing the money in taxpayer pockets won't fix a big recession/small depression like what we are in. Only creating jobs will.

[DuganS1]

It's debatable whether wealthy folks should pay payroll tax at all considering they don't need social security when they retire, so I see no reason that folks should pay the tax over a certain level of income. In my opinion the entire system should be scrapped like the author of the article said and a new program of subsidizing old folks who need it via the federal income tax (of which upper income earners pay the vast majority of) makes a lot of sense. Aaror, I disagree that eliminating this tax would have no effect on the economy. I think it would increase disposable income for lower income folks and would eliminate an incentive for mult-national corporations to hire foreign workers over American workers since companies don't pay the payroll tax for workers abroad.

[USBrit]

When does this country get past the tax cut mania which has never, ever in this country resulted in a budget surplus? Tax cuts are not economic viagra, many of the wealthy do not go out of their way with the extra funds to create new jobs, but rather to buy up more fixed assets or other already present assets. Tax cuts do nothing to help the unemployed pay their bills immediately, nor keep their homes from being foreclosed on. Someone I know personally who is very well off is at this time going around buying up land because it is so cheap. Number of jobs created? 0.