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Sakmongkol ak 47

Tuesday 9 December 2008

Tax Cuts and the Economy(2)

It is often said that to keep this economy growing and delivering prosperity to more Malaysians, we need leaders in Putrajaya who understand the importance of letting you keep more of your money, and making the tax relief we delivered permanent. This step of course would be politically popular, but maybe, economically, not responsible. Again using the US economy as an example, researchers at the Joint Committee on Taxation, the Congressional Budget Office, and the Brookings Institution have all found that large unpaid-for tax cuts reduce economic growth over the long run. For example, a study by Brookings Institution economist William Gale and then-Brookings economist Peter Orszag concluded that making the 2001 and 2003 tax cuts permanent without offsetting their cost would be likely to reduce, not increase, national income over the long run. Similarly, in a study in which it examined the economic effects of reductions in individual and corporate tax rates and an increase in the personal exemption, the Joint Committee on Taxation found, Growth effects eventually become negative without offsetting fiscal policy [i.e. without offsets] for each of the proposals, because accumulating government debt crowds out private investment.

The reason behind these results is that, even if tax cuts have modest positive effects on work and savings decisions, those effects are outweighed by the negative consequences of higher budget deficits. In claiming that tax cuts will boost savings, investment, and GDP growth, supporters often seem to forget that national savings has two components: private and public (i.e., government) savings. Tax cuts could positively affect private savings, although, studies have failed to find large effects. But when the federal government runs a deficit, it pays for the deficit by borrowing money from the private sector, which reduces national savings. By adding to deficits, unpaid-for tax cuts thus generally reduce national savings.

Making the tax cuts permanent would add billions to deficits over the next decade, when the additional interest costs on the national debt are included. The resulting decrease in national savings would mean fewer funds available for investment, reducing the size of the capital stock (the total supply of equipment, buildings, and other productive capital in the economy). With less capital available, future workers would be less productive, and as a result, national income over the long run would be lower than it otherwise would be.

It has been argued that progressive tax cut would be one that raised after-tax incomes for those at the bottom of the income spectrum by a larger percentage than for those at the top, increasing their share of total take-home pay. This is a favourite argument with the crowd. But in the US, their tax policies, however, have widened the differences in take-home pay between high- and low- and middle-income households, according to Tax Policy Center estimates. When the tax cuts are fully in effect, households with incomes above $1 million will receive tax cuts equivalent to an increase of 7.5 percent in their after-tax income. Households in the middle of the income spectrum will receive tax cuts equal to only 2.3 percent of their income.

Put another way, households with incomes over $1 million will hold a larger fraction of total U.S. after-tax income than they would have received without the tax cuts, while households in the middle and bottom quintiles will hold a smaller share. The tax cuts thus have widened, rather than narrowed, income gaps, making them regressive.

Another argument for tax cuts is the contention that tax cuts have made the tax system more fair to small business owners. We cut the taxes on the small business owners to let small businesses keep more of the money they make. Let us see.

The problem with claims that all taxpayers are winners tax cuts rest on the false assumption that the government can provide billions in tax cuts without anyone ever footing the bill. As noted earlier, the tax cuts so far have been financed by deficits, and most proposals to extend them include no measures to offset their costs. In the long run, however, it is widely recognized that deficit-financed tax cuts eventually must be paid for. Simply stated, funds that are borrowed must eventually be paid back.


de minimis 9 December 2008 at 16:33  

bro Sak

I agree with your central thesis. Tax cuts and deficit spending appear to be antithetical. So, how does one reconcile the irreconcilable?

Perhaps the answer lies in the fact that all modern economies are hybrids. Mixed economies. Capitalistic in character with central govt intervention in the form of activist fiscal policies.

Tax cuts for the corporate sector is justifiable on the ground that economic activities should be private-sector led.

Govt deficit spending is justifiable on the ground that the private sector can get carried away with over-committing resources into certain sectors at the expense of a broader expansion of the economy. Active fiscal deficit spending tempers this distorting effect.

But, I hasten to add that, deficit spending must be directed at social and economic fairness.

By "fairness" I mean balancing the needs of society such as education with the needs of the economy such as economic sectors that can provide useful employment to graduates.

This is where we can join with etheorist in being sceptical about the property development sector as one of the main drivers of the Malaysian economy instead of locally-owned manufacturing and technology-driven businesses.

If the deficit (I believe the RM7 billion stimulus package falls into this category) is used to support economic sectors that do not contribute to socio-economic fairness in terms of providing employment opportunities to Malaysians at fair wages.

Otherwise, a tax cut will be a fairer policy :D

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