How Stimulating. . .

Let’s continue our rebuilding the Republican Party series by explaining how stimulus plans should be done. With GDP crashing, unemployment soaring, and a double dip recession knocking on the door, it’s time for the Republicans to suggest a plan to stimulate the economy. Not more spending, as Obama proposes, but a genuine stimulus plan. Here it is. . .

About a week ago, we explained why conventional stimulus plans never work, and why Obama’s was worse that most. We noted that most stimulus plans try to increase demand, either by getting consumers to spend more money or by having government spending replace falling consumer spending. But this is problematic.

Getting consumers to spend more simply shifts economic activity from the future to the present. This can stimulate the economy now, but it depresses the economy in the future. Government “stimulus spending” is even worse, because the money the government spends must first be taken from consumers. Thus, the government depresses the economy at the same time it tries to stimulate it. . . unless the government borrows the money, in which event it depresses the future.

Just thinking about this logically should be enough to give us pause. If stimulus spending really could increase the overall economic activity of a country, wouldn’t it make sense to start spending wildly and to keep spending until we were all rich. Yet, even the most wild-eyed proponents of stimulus spending don’t think that’s a good idea.

Moreover, by directing spending (e.g. cash for congressmen. . . er, clunkers), the government creates distortions in the market, where money is spent on projects that are less beneficial to society than those upon which the money would otherwise have been spent. This causes the economy to be less efficient and can lead to significant problems down the road (like housing bubbles).

The goal of a stimulus plan should be to encourage people to generate more wealth. More wealth means a greater capacity to spend without stealing from the future. Stimulus spending does not do that, it only shifts money around from savers to spenders or from the future to the present. So what would do this? Here are two proposals:

Proposal 1: Cut The Payroll Tax

Our first proposal is to cut the payroll tax. Why? Because that will encourage people to work more and it will encourage employers to hire more.

Human beings value leisure. It’s true. When the value of working exceeds the value of leisure, they will work. When it does not, they goof off. Want proof?

Ok, would you come work in the Commentarama file room on Sunday for one hour for free? Probably not. Why? Because you value your leisure time more than you value what you would get from working for us. . . a big old goose egg. But what if I offered a crisp fiver? Still nothing? Ok, what if I offered $500. Suddenly, you’re starting to think about it. Some of you will accept this, some won’t. If I offer $1,000, more of you will jump at the offer. At some point, each of you will jump. . . like lemmings. The point where you would jump is the value that you place on one hour of leisure.

To get you to work more, our stimulus plan needs to increase the value of working to the point that it exceeds the value you place on your leisure time. Fortunately, people don’t value all of their leisure hours at the same rate. Indeed, it takes a lot less to get someone to agree to work 41 hours instead of 40, than it does to get them to agree to work 70 hours instead of 40. So even minor changes to the value of work can get people wanting to work more.

The easiest way to increase the value of working is to cut the payroll tax. By decreasing the amount the government takes from your paycheck, the government makes each hour of work more profitable. This gives you an incentive to convert some of your leisure time into work time. As millions work more, they generate vast amounts of economic activity. They can then turn the extra money they earn into spending, i.e. stimulus, without the normal negative effects of stimulus spending because they generated that new wealth rather than merely shifting it from the future to the present. Basically, cutting the payroll tax encourages people to convert their leisure time into stuff.

But will the work they seek be available? Yes, especially if you cut the employer contribution as well. Cutting the payroll tax decreases the cost to the employer of employing you. Think about a company that employs 50 people at $20,000 per year each. That company has a payroll of one million dollars per year. A two percent reduction in the employer portion of the payroll tax results in cost savings to the company of $20,000 a year. That means the company can hand out more overtime, increase salaries, or hire one new employee without any increase in overall payroll costs.

This effect will be repeated across the economy as a whole (because all workers are affected by the payroll tax), leading to increased incomes and increased employment opportunities. And, best of all, nothing is stolen from the future to make this happen.

Interestingly, several European governments have experimented with this and found it to be highly effective in reducing unemployment. I have also see estimates that a 1% cut in payroll taxes would generate three million new jobs.

Proposal 2: Decrease The Capital Gains Tax

Wait, don’t hit that mouse button. I can explain this in a way that makes sense and that won’t have you trying to slice your wrists. Here’s why a capital gains tax rate cut will spur economic activity.

First, I’m not talking about stock sales when I say capital gains. What I’m talking about here are the gains that companies experience when they sell capital equipment, like bulldozers or computers. What gains you ask? Well, when you buy something like a bulldozer, each year you write off a portion of its value as depreciation. If you then sell it for more than the value at which it sits on your books, you have a gain. . . a capital gain.

If we reduce the capital gains tax, we will increase the incentive for companies to replace their capital equipment sooner. That means more jobs for the makers of the equipment, as more people are needed to make those computers or bulldozers.

With more companies trading up sooner, this also means that there will be more (better/newer) equipment available in the "used equipment" market. This will help smaller companies who can’t afford to buy new equipment. These companies can then replace their own bulldozers/computers and pass what they have into the used market quickly as well, which helps someone else down the line. This improves the efficiency of each of these companies, which usually means more money to expand.

The same effects will occur in any capital equipment market.

Interestingly, the Democrats hate this idea. This shows their inability to give up on class warfare. A capital gains cut generates jobs and stimulates the economy, there is little serious debate about that. BUT, it also benefits people with money, and that is intolerable to the left. They would rather that no one benefit, than run the risk that a rich person might benefit more than a poor person.

So far, the Republicans have been unable to explain to the public why the Democrats are wrong. Part of it lies in an inability to explain why this tax cut works. For example, it was obvious that McCain didn’t have a clue when the issue arose in the debates. But equally importantly, the Republicans usually focus on a generic capital gains cut, which includes the profits from the sale of stock. This allows the Democrats to paint this as a plan to let a thousand Scrooge McDucks sell their stock and use the gains to buy more gold for their money piles. To counter this, the Republicans should propose limiting the capital gains tax cut solely to the sale of capital equipment (or eliminating the capital gains on the recapture of depreciation). This would allow the Republicans to paint the Democrats as opposed to workers.

Conclusion

Cutting the payroll tax and the capital gains tax would truly stimulate the jobs market, would stimulate people to work more, and would result in overall increased economic activity. The effect from both would be immediate, so there’s no need to wait for the spending to kick in, and neither suffers from the problem of stealing from the future. With the economy in such a poor state today, and Obama out of answers, now is the time for the Republicans to put forward this plan.