A radio show I listen to had a conservative financial commentator on this morning, Jim Pethokoukis from US News. He was all worked up about the decisions President Obama was making, specifically running huge deficits, spending money on health care and raising taxes on the rich. After an over the top tirade, he was asked what we should do instead. His proposal was to invest a very small amount in infrastructure ("which is a problem") and then put the rest towards tax cuts, not mentioning how that will address the deficit he was previously so upset about. Backing up his argument, he referenced what Reagan did in 1981, which absolutely did stimulate the economy. If you want the basic argument, listen to the first radio show caller in this segment here. Anyways, this whole incident made me realize what a truly terrible job the press is doing in explaining the situation to the public. I decided that I could do better. Today I will explain why this argument is so off and then describe what the current President is attempting.
A quick history lesson is in order, the top tax rate in 1981 was 70% (yes, 70!), which Reagan’s cuts reduced to 50% (they were later reduced further under Reagan, and the top rate was 39% by the time President Clinton left office). In 2001, President Bush cut the top rate to 35%, an unprecidented tax cut during a time of war. As far as corporate tax rates go, they currently sit at the same 35%. You constantly hear they are the highest in the world, but there are so many loopholes in the tax code, that is a difficult factual argument to make (For example, look at Lockheed Martin’s actual 2007 tax rate of 30%). The corporate tax rate in 1981 was 46% and was also reduced reduced to 34% by Reagan's tax cuts.
So the Republican argument right now is that the deficit is out of control and we should stimulate the economy by cutting taxes across the board. Keep in mind that when you cut taxes while you are running a deficit, that IS spending. We will need to borrow the money from the Chinese to pay for them, just like we are going to do to pay for the stimulus bill. However, instead of the government deciding where to invest, they are just giving the money back to the public and businesses. That makes sense if the tax cuts go to people who will spend and invest that money wisely or when tax rates are so high that they stifle growth like in 1981. Yet after 8 years of doing exactly that (cutting taxes and running deficits), we have nothing to show for it: horribly inefficient healthcare, a deteriorating education system, volitle energy costs, and a dying infrastructure. This is because while running huge deficits, we were cutting aid to states for infrastructure, education, and healthcare programs. Clearly, the last 8 years have shown that there is a difference between a cut from 70% to 50% and cut from 39% to 35%. You should ask yourself why another cut from 35% to say 30% would change anything? Amazingly, the "conservative" leadership is literally saying, "Let’s do the same exact thing we’ve done since 2001" and all the commentators on CNBC are chirping right along. Hopefully the insanity of this clear, but it will become more so after the next paragraph.
Now the approach that President Obama is taking, is that our economy is fundamentally broken. I’m not just talking about the banking system, but the fact that business is being stifled, just like in 1981, but this time by skyrocketing healthcare costs and volitle energy prices. At the same time, looking to the future, the administration has recognized that our infrastructure and education systems are growing more and more inadequate every day. For example, our broadband availability is ranked 15th in the world and our water systems and energy grid were built decades ago. This makes it difficult to compete with China and India to attact business investment when they offer cheaper labor and are building entire cities with brand new infrastructures. So the President, has chosen to put the majority of money right now towards those four things, two that will free up business (energy and healthcare) and 2 that will position us for long term growth (education and infrastructure). At the same time, this money will create jobs immediately, and make us the world leader in energy technologies, technologies that developing countries like China and India will want. This isn’t bad or irresponsible spending, it is smart and targeted, and if executed properly, exactly what we need to do.
Now there are two caveats to this, first the banking system needs to be fixed for anything to work. Secondly, the deficit must be drastically reduced once we have stable economy again to ensure the long term strength of our currency and borrowing power. I’ll touch on those in future posts.