Jason Lewis: There are better economic tools in the box

What we need is more production -- real production. And what encourages that is permanent tax reduction.

By JASON LEWIS

Last update: January 25, 2008 - 6:22 PM

In any economy, growth is a function of people and productivity. An increase of labor or capital will always result in higher levels of output. Unfortunately, the stimulus package being fast-tracked by Washington these days provides little incentive for increasing either.

One would have thought by now that the mere escalation of government transfer payments -- whether in the form of rebates (the key element of a tentative agreement announced Thursday) or larger food-stamp and unemployment checks (a Democratic idea that's out of the plan for now) -- would be seen for what it is: an old-fashioned Keynesian attempt to inflate the economy without increases in real production.

Of course, in the case of tax rebates, it's always a good idea when government returns money to its rightful owner. But this can only be done if rebates are matched with spending cuts. Otherwise, government simply taxes (or borrows from) one set of individuals in order to subsidize another, as in the Democratic plan denying rebates to taxpayers earning more than $85,000 per year. Moreover, no one is suggesting the $140 billion scheme be paid for. So much for the deficit. It's the spending that counts anyway, whether part of it is financed by borrowing or not. And in this way, not all deficits are alike. Those that come from spending increases are bad; those temporary deficits that result from permanent tax reduction are generally quite harmless.

Permanent tax reduction rewards both labor and capital; government spending does not. No doubt, federal borrowing diverts capital from more productive uses in the private sector, but taxes are worse. While they consume scarce resources, just like deficits, they also crowd out labor by reducing its rate of return. Especially if such taxes are aimed at the so-called wealthy -- who not only save more but can most afford to change their behavior based upon the tax code.

Understanding all of this helps to explain the economic growth experienced during the Reagan boom, as well as after the Bush tax cuts of 2003. Deficits may have initially grown, but a robust economy fueled by tax reduction resulted in even larger amounts of savings and investment -- including foreign capital. That put downward pressure on interest rates and eventually the deficit itself -- now hovering just above 1 percent of GDP, or half the average of the last 50 years, making it a political talking point at best.

It's hard to see how Bush's tax reduction had much to do with the deficit at all, since federal revenues have gone up $785 billion in the last four years. Of course the same cannot be said of spending. But without the willingness to cut taxes, even in the face of deficits, private-sector growth would have remained anemic in an economy shackled by record government budgets and still recovering from 9/11.

This silly stimulus package seems to be the latest attempt to increase aggregate demand at the expense of long-term saving. Government's task should be to encourage the factors of production, not to hand out checks in the hopes that someone might still produce something in spite of diminishing investment and incentive.

What's really had the markets spooked lately is the ominous specter of massive tax increases on the horizon if the 2003 tax cuts are allowed to expire, which would wipe out any stimulus-package relief in the span of a few months. Couple that with an inscrutable monetary policy from a Fed that thinks it can bail out Wall Street's mal-investment in a housing bubble, and today's generation may start to see what Jimmy Carter-style stagflation is all about.

Jason Lewis hosts a weekday talk show from 4 to 7 p.m. on 100.3 KTLK-FM in Minneapolis-St. Paul.

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