Memo to Washington:
Lower Tax Rates = More Tax Dollars
by Thomas W. Harvey, DBA
Associate Professor of Finance – Ashland University
President and CEO – The Foundation for Ethics in Financial Education
On the day following the 2012 election, Americans became more aware of the phenomenon called the “fiscal cliff,” the major financial events that are scheduled to occur late in 2012 and the beginning of 2013. The “fiscal cliff” includes the expiration of the tax cuts that were implemented during the George W. Bush administration and the elimination of the payroll tax cut of the Middle Class Tax Relief and Job Creation Act of 2012 (MCTRJCA) and other tax-relief provisions. It also includes the beginning of $1.2 trillion reduction in government spending for defense and other discretionary programs as identified in the Budget Control Act of 2011. The net effect would be a 19.63% increase in tax revenue and a 0.25% reduction in government spending. If it happens, the Congressional Budget Office forecasts another recession like the one experienced in 2008 – 2009 or worse. Additionally, Congress is faced with raising the debt ceiling once again which, if like the last time, would trigger another stalemate between Democrats and Republicans.
As I wrote in my commentary about that stalemate in 2011, fighting with each other about political ideology instead of doing what is right for the American people is not what members of the Congress and the administration should be doing. The word “compromise,” apparently, is not in their lexicon even though that is exactly what is needed, and the world’s financial markets will be watching again. They didn’t like what they saw in 2011, and they won’t like what will happen if America does, in fact, go over the fiscal cliff. They showed concern in the week following the election, but it is generally understood that if a compromise is not reached by December 10, 2012, they will get real nervous very soon. That will not be pretty as the volatility that characterized 4th quarter, 2008, and 1st quarter, 2009, will return, with the value of Americans’ 401(k) programs at serious risk.
To prevent the recession and the fallout across the world’s financial markets, Congress must extend the Bush tax cuts permanently. The reason is that a lower tax rate actually means more tax dollars being gathered by the Internal Revenue Service because there will be more people working. Lower taxes are an incentive to entrepreneurs to take the risk to build their businesses and to hire more people who, in turn, will pay their federal, state, and local taxes. That lowers the unemployment rate and increases the Gross Domestic Product which would have a favorable effect on the American stock market. It is an incentive for businesses to grow and expand, an economic principle upon which this country was founded.
If, on the other hand, taxes are increased, profits decline, and the incentive to take risk to grow and expand is eliminated. The unemployment rate increases and GDP decreases and the stock market loses value. With GDP presently at $15,775 billion and the federal debt at $16,2262.7 billion, technically, the United States is insolvent and decreasing GDP will only make it worse. Our children and their children and, perhaps, even their children will be saddled with the debt unless Congress takes action now. It isn’t going to be easy and political reputations may be at stake, but that is why we send our representatives and senators to Washington…to represent us, the American people.
While extending the tax cuts and not touching Social Security or Medicare, Congress can also revisit the health care tax created by Patient Protection and Affordable Care Act of 2010, even though the U.S. Supreme Court ruled it was constitutional and the law of the land. By 2014,every citizen will be required to have health insurance or face a penalty from the Internal Revenue Service. It would take some courage on the part of the Senate and the President to agree with repeal efforts in the House of Representatives, but they could revisit the law from an economic perspective and cut out the items that are really not necessary. For example, the Patient Protection and Affordable Care Act includes a tax increase on dividends, capital gains and interest. First, what does that have to do with health care? Second, that tax increase would prove to be a disincentive to investment in stocks and bonds which is the capital businesses need to grow and create more jobs.
Additionally, Congress and the administration can examine all domestic spending and cut out that which does not add value to the country. The “bridge to nowhere” is a primary example of a project that taxpayers funded but really served no purpose. Or, the $2 million that was spent to determine the reason people don’t ride their bicycles to work. Or, the $33 million that was spent pumping sand onto the private beaches of hotels in Miami. These are just examples but there are, presumably, many more of them which could be carved out of the budget, thus reducing spending and the need for the federal government to continue borrowing and increasing the debt. And, somebody needs to explain why Congress continues to fund programs and projects that the Department of Defense does not want.
This prescription is reminiscent of the economic policies of the Reagan Administration in the 1980s. Congress cut taxes, the government’s spending budget, and useless programs and projects. The Fed kept interest rates low while watching for any signs of inflation. The number of people working for the government was decreased, as well. Consumer and investor confidence was at an all-time high as the country experienced sustained economic expansion, with the Dow Jones Industrial Average actually doubling during that time.
If Congress allows the country to go over the “fiscal cliff,” taxes will be increased, decreasing purchasing power which subsequently causes GDP to decline. Cutting spending across-the-board will also negatively impact the economy as fewer jobs will be created. Fighting over the debt ceiling will not solve anything either as the financial markets watch. I would hope that the President and the Speaker can come to an agreement that puts the country first and deals with the “fiscal cliff” as it would demonstrate to the world that America is still a political and economic force and would provide another sustainable economic expansion for the American people instead of penalizing generations with a debt burden that crushes the American dream. December 10 is not that far away.