Saturday, June 30, 2012

Obamanomics: Economics For Dummies

   US President Barack Obama speaks on the econom...

In his Cleveland speech, Obama argued that it was the Bush tax rate cuts that caused the recession somehow. However, there is no economic theory under which tax rate cuts could cause recession. Can America afford a president who is this confused and deluded? (Image credit: AFP/Getty Images via @daylife)
President Obama’s June 14 address in Cleveland presented his foundational economic policy arguments for this fall’s campaign.  We will hear those same rhetorical points over and over this year, at least until his pollsters realize they are doing more harm than good.
The marker Obama himself laid down for judging his economic policies is whether they would serve “to create strong, sustained growth…pay down our long-term debt…[and] generate good, middle class jobs….”  Last week, we discussed how his economic policies would consistently produce the opposite of those results, just as they have in his Presidency so far.  But his speech contained many more fallacies that further illuminate his perverse economic thinking.

Lowering marginal tax rates, not just cutting taxes, expands the incentives for increased production, and consequently increases productive activities, such as saving, investment, expanding businesses, starting businesses, job creation, entrepreneurship, and work.  That expands production and increases GDP, which means economic recovery, growth and prosperity.  Even under Keynesian economic thinking, tax rate cuts promote economic recovery and growth by increasing demand for goods and services, which would in theory increase supply, GDP and growth.
But in his Cleveland speech, Obama argued that it was the Bush tax rate cuts that caused the recession somehow.  He said, “We were told that huge tax cuts – especially for the wealthiest Americans – would lead to faster job growth….So how did this economic theory work out?”
So let’s review how it did work out.  Bush cut the top income tax rate by 11.6%, from 39.6% to 35%, and the second highest rate by about 8%, from 36% to 33%.  But he cut the lower rates by higher percentages, including slashing the bottom rate by 33%, from 15% to 10%.  Then in 2003, he cut the tax rates on capital, reducing the capital gains tax rate by 25% from 20% to 15%, and the tax rate on corporate dividends to 15% as well.
These tax rate cuts first quickly ended the 2001 recession, despite the contractionary economic impacts of 9/11, and the economy continued to grow for another 73 months.  After the rate cuts were all fully implemented in 2003, the economy created 7.8 million new jobs over the next 4 years and the unemployment rate fell from over 6% to 4.4%.  Real economic growth over the next 3 years doubled from the average for the prior 3 years, to 3.5%.
In response to the rate cuts, business investment spending, which had declined for 9 straight quarters, reversed and increased 6.7% per quarter.  That is where the jobs came from.  Manufacturing output soared to its highest level in 20 years.  The stock market revived, creating almost $7 trillion in new shareholder wealth.  From 2003 to 2007, the S&P 500 almost doubled.  Capital gains tax revenues had doubled by 2005, despite the 25% rate cut!
The Bush economy nevertheless did perform subpar because Bush also supported a loose, cheap dollar monetary policy, following Keynesian doctrine that a cheap dollar boosts the economy by promoting exports.  Weak dollar monetary policy discourages critical job creating investment that bids up higher wages, because investors fear the depreciation of their investment returns by a declining dollar or inflation, and the rise of artificial boom bust cycles that might crash their investment in a recession.  That contrasted with the earlier Reagan boom built on anti-inflation, strong dollar policies that promote job creating, wage increasing investment, without fear of a declining dollar, inflation, or boom bust cycles.  As discussed below, the Bush cheap dollar monetary policy did play perhaps the central role in the financial crisis of 2008, as free market critics of Bush’s monetary policy had forewarned.
But there is no economic theory under which tax rate cuts could cause recession.  America cannot afford a President who is this confused and deluded.
Obama said in Cleveland, “Over the last three years, I’ve cut taxes for the typical working family by $3,600.  I’ve cut taxes for small businesses 18 times.”  But Obama’s “tax cuts” have almost all involved tax credits and other loopholes, not reductions in rates, which he is increasing at an historic pace, as discussed last week.  It is reductions in rates that promote economic growth and prosperity, because it is the marginal tax rate, or the rate on the next dollar of income, that determines whether the producer is going to undertake the activity to produce that income.  Tax credits are really no different than welfare checks, particularly the refundable tax credits Obama has favored, which pay the beneficiary the full amount of the credit regardless of tax liability.  But welfare does not promote economic growth and prosperity, Nancy Pelosi to the contrary notwithstanding.

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