Instead of expanding entitlement programs like unemployment benefits, the government should cut taxes on small business to bolster the economy.
Michele Walk, Associate Editor
Ideology: Moderate | Writing From: Boston, Massachusetts
As my fellow Politicizer writer Malcolm-Wiley Floyd recently pointed in his article “Extend Unemployment Benefits Now,” the recession has left many Americans either unemployed or underemployed due to the struggling economy and government assistance could help improve this situation. While the markets have recently experienced a surge and some analysts have speculated that the economy is on its way to recovery, the unemployment rate is still worryingly high and now sits at 9.7 percent, which is shockingly high compared to the pre-recession rate in 2007 of 4.6 percent. Unfortunately, it is almost impossible to determine how soon the recession will end. Economic downturns can be self-perpetuating: consumers have less disposable income, which in turn leaves businesses (employers) with less revenue, which then need to reduce costs to stay afloat (layoffs), which leads to less disposable income, which decreases profits – ad nauseam.
Government assistance, though not a panacea, can be helpful in breakinging that cycle. Extending unemployment benefits, however, is not the answer. While the intent behind entitlement programs is pure – to assist those in need – in practice they are often a bane rather than a benefit to society. Unemployment insurance, much like welfare, does assist those in need but it only artificially props people up and does not solve their problems in the long term. During a more stable economic climate in which jobs are more plentiful, unemployment benefits are helpful in assisting those affected by job loss with temporary relief until they find employment at another company. However, today’s economic problems are pandemic and, unlike before, are not localized to one specific area or company. Every city, town, and business across this nation has been affected by the recession, and sending more paychecks to laid-off workers for not working is not going to bring real relief. It’s just a band-aid.
Almost every industry has been affected, and many, such as automobile manufacturing, are undergoing restructuring. Underlying Floyd’s avocation of extending unemployment benefits is the assumption that once the recession is over, people will be able to return to the same jobs as before. This flaw in the argument is truly the breaking point, for many of the jobs in these restructuring industries simply may not be available or exist as they did before the recession. Workers must adapt as the economy changes, and giving them a year of government pay for not working would de-incentivize this, as well as job seeking in general. Furthermore, while providing more generous unemployment insurance would ease the pain of job loss, unemployment benefits alone will never create jobs – and isn’t the eventual goal to put people back work?
What the government should do instead is create incentives for individual economic contribution; put more simply, encourage economic growth through tax breaks. More specifically, the federal capital gains and small businesses taxes should be temporarily reduced to zero to encourage investment and job creation.
While reducing the capital gains tax is often criticized from the left as benefitting the wealthy more than the poor, it is crucial to note that the majority of money subject to capital gains is eventually re-invested into the economy, and it is therefore in the best interest of the entire economy, even during boom periods, to have low capital gains taxes. Raising the capital gains tax, as Obama promised to do during his campaign but thankfully has not, discourages investment in the economy. Therefore, it follows that to temporarily reduce the capital gains tax to zero would greatly encourage investment in new and existing businesses. It may be the rich doing all of the investing, but slashing capital gains would re-energize the market and greatly increase investment in both the markets and businesses – effects that would help the entire economy.
Businesses, however, are the crucial factor in this recovery plan; more specifically, new small businesses. If the government were to temporarily suspend federal taxes on small businesses, which face an average effective rate of 19.8 percent, this would greatly encourage the creation and expansion of new companies (i.e., new employers). The unemployed, instead of being encouraged not to work, would then be encouraged to “hire themselves” by starting their own businesses and get the economy moving again. The United States has perhaps the easiest incorporation process of any country (see Thomas L. Friedman’s The World Is Flat for more details), and the cost of a designing a business plan is only the time consumed to create it. The average six-month period in which one can receive unemployment benefits provides ample time for the jobless to design and start their own small businesses. While one business on its own would not jump-start the economy, the ripple effects of entrepreneurship would be much more beneficial than those of unemployment insurance. If small businesses taxes were temporarily suspended, existing proprietors would have more money to invest in their companies and in turn increase their payroll, which would in turn increase consumption, which would increase production – ad nauseam.
Temporarily suspending taxes on new small businesses would, unlike extending unemployment benefits, encourage the jobless to not only participate in the economy but contribute to its recovery. Unemployment benefits, though helpful in the short run, are just that: a short-run solution. Tax breaks, however, for small businesses would encourage entrepreneurship, lead to job creation and economic growth, and could truly be a remedy for our ailing economy.
“While reducing the capital gains tax is often rightly criticized from the left as benefitting the wealthy more than the poor”
This is at best partially true, and probably completely false.
The last time we slashed the “Capital Gains Tax,” (which, in reality, should be referred to as the “Long Term Capital Gains Tax,” because short term capital gains are taxed as income), we had a drastic increase in revenue. This would seem to indicate that slashing the capital gains tax results in higher capital investment (as you suggest) which means higher employment. Formerly unemployed people, rich or poor, gain from this, in addition to the person who has made a 2+ year investment in a firm. To suggest that this is regressive, and benefits the “rich” disproportionally is most likely, therefore, not correct. A rich person invests, which employs many more “poorer” people. Two years (or more) later, if/when he/she chooses to sell his/her ownership stake in the firm, and profits as a result, he/she is responsible for a capital gains tax. Dividends earned while the person is an “owner” of the firm (by owning stock) are taxed as “income.” It is only by his/her choice to divest–to sell–shares of his/her ownership stake and move from one business to, presumably, another business (or cash) that subjects him/her to the “Capital Gains Tax” to which you refer. And, so, to suggest that capital gains are the rich man’s only “profit” from investment is false (because dividends are income) and to suggest that he gains more than those who formerly did not have a job but for his investment is dishonest, as this is not something that is necessarily true (and my intuition suggests that it is actually false).
If the real goal was to help the poor and stimulate the economy, cutting other taxes might also have a greater effect. Corporate taxes in this country, which cripple our firm’s ability to compete worldwide, are something that should definitely be in the public eye right now. It can actually be measured as to what proportion of these taxes are paid by consumers and what portion comes from the owners’ equity. Consumers often lose more than the owners.
But, to suggest that cutting income taxes to stimulate the economy will do a better job than government spending is ambiguous at the very least, to those who believe in Keynesian theory. I am not a Keynesian (in fact, as a monetarist, I tend to question fiscal stimulus in general), but I recognize that IF they are right, and IF the “multiplier” is greater than one (at least on economist has published that he believes it to be less than one), then cutting taxes will have less of a stimulative effect than simply spending more. Although I do not agree with this (because its historical effectiveness has been very low compared to monetary effects), it is unquestionable that it is a legitimate macroeconomic theory that has widespread acceptance.
Cutting taxes will also raise deficits, and the current existence of severely underfunded entitlement programs makes this irresponsible at the very least without massive reform of said programs.
The policies you are proscribing are idealistic and quite obviously based on ideology, rather than the perceived theoretical consequences of such policies. This is not analysis–it is simply fundamentalism.
Michelle, if you really want real economic growth, it’s time to just scrap the current income tax system and start all over again with a taxation system that -encourages- personal savings and capital investment staying in the USA.
We current have a HUGE problem where income taxes cause serious amounts of tax evasion, especially with around US$2 trillion involved in the nearly untraceable “underground economy” based on cash and the legal funneling of American-owned liquid assets through tax loopholes to “offshore financial centers” estimated somewhere between US$12 and US$17 TRILLION (not a misprint!) just to avoid income taxes on these assets. It’s also why corporate headquarter and manufacturing operations are leaving the USA at a record pace.
Maybe it’s time that the FairTax consumption tax system replaces our current income system. FairTax effectively ends all taxes on -earning- money, and that could result in a land rush of liquidity into the USA from all that repatriated liquidity and new investments for foreigners discovering the USA has become the world’s largest legal tax haven. The prospect of injecting as much as US$20 TRILLION in liquidity in the the US financial system would immediately turn our economy around for strong, solid economic growth.
Tim,
Thank you for your comments on my article. Your in-depth critique is highly appreciated. Because of the unpredictable nature of economics, it is important to have discussions on the different approaches to solving economic problems and makes the science a bit less dismal, if you will.
I would, however, like to clarify a few points you brought up.
First: “To suggest that this is regressive, and benefits the “rich” disproportionally is most likely, therefore, not correct… And, so, to suggest that capital gains are the rich man’s only “profit” from investment is false (because dividends are income) and to suggest that he gains more than those who formerly did not have a job but for his investment is dishonest, as this is not something that is necessarily true (and my intuition suggests that it is actually false).”
I understand your frustration to those who say that cutting capital gains only helps the rich. I intended to make the argument that while on the surface it is the rich who are mostly subject to the capital gains tax, they often re-invest it in the economy. I quote myself, “it is therefore in the best interest of the entire economy,” by which I meant the poor as well as the rich. I could have made this point much more clearly and I do apologize for the confusion. And to clarify: never, ever, did I say, imply, or mean to imply that it is dishonest for the rich to benefit from their investments. I believe in that excerpt I have quoted after the ellipses you are more standing on your own soap-box and not specifically responding to the content of my article. Investment helps the entire economy, most certainly including the out of work and the disadvantaged.
Second: With regards to your speculation about my macro ideology, I do not subscribe to Keynesian nor Monetarist theories; I am more in the Edward Prescott/RBC line of thought. You will notice in the article that I said nothing regarding cutting income taxes and once again I believe you have left the argument at hand for your apparently rather tempting soap box.
Third: “Cutting taxes will also raise deficits, and the current existence of severely underfunded entitlement programs makes this irresponsible at the very least without massive reform of said programs.” You will notice in the first line of my article I explain that I am writing a rebuttal to a piece written by another author on the Politicizer in which he argued in favor of expanding entitlement programs. To double unemployment benefits, as he suggested, would also certainly raise the deficit; in this case, however, I am firm in my belief that cutting taxes and encouraging investment would be the much better option in a situation in which we are left with two deficit-causing evils. Given the choice between expanding entitlement programs that discourage economic growth and pro-growth policies, my optimal “policy” bundle (if you will) would certainly include the latter. And with regards to your last rather snippy comment: I prefer to emphasize the practical consequences of policy.
Raymond, I agree that the current tax system is due for a much-needed overhaul.
Tim, this is the first time I’ve ever agreed with you.
First of all, thank you Michelle for continuing our discussion on how the Obama administration might cap off the rescue of the economy. In your support of a capital gains tax “holiday”, you claimed that:
“…the majority of money subject to capital gains is eventually re-invested into the economy…”
I actually have a hard time defending the capital gains tax with anything but a moral argument, and this point makes sense. However, you ignored the fact that fiscal stimulus to the poor is often more effective at stimulating the economy because they have higher marginal propensities to consume, i.e. they save less. Since most people who collect UI immediately spend it on essentials such as food, rent and gas, the money they receive is pumped through the economy. Since the capital gains tax is normally applied to richer Americans, a tax break is more likely saved.
Also, it’s important to note that high taxes aren’t the big thing keeping people from starting businesses. Instead, it is the credit crunch. Because banks are still worried about giving out a loan for a risky venture. However, there’s no real solution for this problem, besides waiting for the economy to turn around, and injecting stimulus in other places, hopefully through government spending and tax breaks to people that will spend, not save.
M-W, thank you for your response. I agree that the credit crunch is probably the biggest issue right now. Say Congress was going to spend that 1 trillion on economic stimulus regardless of the plan, I would have much rather seen it go towards growth-causing investments such as easier access to education & small business loans/grants.
“Since most people who collect UI immediately spend it on essentials such as food, rent and gas, the money they receive is pumped through the economy.”
This is the crux of my disagreement: UI is only temporary, and it doesn’t help them in the long term (or even after their unemployment runs out).
“However, you ignored the fact that fiscal stimulus to the poor is often more effective at stimulating the economy because they have higher marginal propensities to consume, i.e. they save less.”
I absolutely agree with that point. However, extending UI continues that cycle and, in a sense, locks them in poverty. However, if they had access to microloans, they could help themselves, save money, and be self-employed (and therefore contribute to, and not be a drain on, the rest of the economy).