Neither government spending nor tax cuts automatically provide an economic stimulus. But President Obama has continued to make this mistake. Take a look at much of what he insisted be included in his tax cut deal with congressional Republicans.
So what makes the economic pie bigger? There are two sides to this. The supply side: lower marginal tax rates mean the more that people get to keep from each additional dollar that they earn, the harder that they will work and the more that they will produce.
The other view, the Keynesian view, also often called "the demand side view" or "the multiplier," is that giving the money to the right people to spend which will create wealth. Democratic House Speaker Nancy Pelosi made this claim earlier this year when she advocated more unemployment insurance benefits: "it injects demand into the economy and is job creating. It creates jobs faster than almost any other initiative you can name. Because again it is money that is needed for families to survive and it is spent."
We see this line of reasoning in the proposed 13-month extension of unemployment insurance benefits to continue paying out benefits for up to 99 weeks.
It is also the basis for the president's proposed expansion of the earn income tax credit and items such as the college-tuition tax credit for relatively lower-income families.
The problem with this multiplier claim is pretty simple. First, the money has to come from some place.
Second, everyone spends their money one way or another. This claim of some people "spending" their money while others are "saving" it really assumes that saving is the equivalent of burying one's money in a hole in the backyard. In reality, if you don't spend your money, you are putting it in the bank or you are putting it in stocks or bonds, which means you are giving it to someone else to spend.
Even when a poor person spends his money at the local grocery store, that business is going to either spend it or put it in the bank. Taking money from wealthy people and giving it to poor people doesn't create more spending. It just alters who gets to choose where the money is spent.
President Obama keeps pointing to the tax cuts that he supports, but his tax cuts actually discourage work for one simple reason: they increase marginal tax rates. Obama's tax cuts increase marginal tax rates because they are phased out as people make more income. You get the earned income tax credit or the college tuition credit but as you earn more money more of those credits are taken away from you. Those lost tax benefits are on top of the unchanged official marginal tax brackets.
There is never a good time for the country to have increased penalties resulting from harder work but surely this is not the time for it, when so many people are already hurting.
Of course, far from stimulating the economy, the increased unemployment insurance benefits also discourage people from working. People only receive the unemployment insurance as well as assistance paying their mortgages and health insurance as long as they are unemployed. -- There is a real dollar penalty as soon as they take a job.
Disappointingly, so many members of the media measure the stimulus by just counting up the money that is spent. Take the New York Times’ David Leonhardt, who writes the paper's "Economix" column. On Monday, he wrote about the stimulus in terms of "the amount of money pumped into the ailing economy," not in terms of the incentives created for work. And how about last Friday, December 3, when he included an extension of unemployment insurance benefits are among the measures "that are more likely to create jobs."
All that said, there is one new proposal pushed by President Obama that does lower marginal tax rates, that is the one-year, 2 percentage point reduction in Social Security taxes. But it lowers the marginal tax rates for most people by much less than his proposal to phase out the different tax credits will raise the rates.
Increased marginal tax rates will clearly be bad for the economy. But President Obama just can't let go of the old Keynesian arguments that have failed so spectacularly over the last two years.