BrianGarst.com

This post from Pejman Yousefzadeh on the tax deal is a few days old, but it’s worth talking about because it illustrates a trap into which conservatives too often fall. His point is that the temporary extension of the tax rates likely will not help the economy. I don’t dispute this, as whatever benefit the tax rate extension provides comes from the fact that it means taxes won’t be going up. It’s good only insofar as it prevents politicians from doing something really bad, at least for another 2 years.

What I take issue with is his reasoning. Here’s what he says:

The thing is, a temporary extension of the Bush tax cuts will not be enough to stimulate the economy. Per Milton Friedman’s permanent income hypothesis, consumption patters (sic) even in the aftermath of a temporary extension of the Bush tax cuts will be tempered by long term expectations that eventually, the tax cuts may be allowed to expire. As a consequence, consumers are more apt to save money that comes from a temporary tax cut, rather than spending it in order to offer the economy any kind of economic stimulus.

My problem is his implication that the primary benefits from cutting taxes comes from increases in consumption.  This is essentially the Keynesian view of economic growth. It is this consumption-based view of growth which has led both Bush and Obama to try “stimulating” the economy through gimmick rebates and handouts. Each attempt has failed more miserably than the last.

Just to be clear, I’m not disputing Friedman’s permanent income hypothesis (that personal decisions on spending are based not on current income, but long-term expectations),  just its relevance to this situation. It’s not germane here because even if it were not true and consumption would increase in response to a temporary extension, it wouldn’t have any significant pro-growth impact. Otherwise, the other stimulus attempts would have worked.

The benefit from lowering tax rates, particularly those on capital, comes when it reduces government disincentives to savings, investment and entrepreneurship. Increased consumption is just the consequences of growing the economy. To see it as something to try to increase in its own right is to implicitly admit the validity of the Keynesian, interventionist approach which has never worked.

economic theory economics Keynesian Milton Friedman