As my last post last week commented on how the lower class Americans cannot afford healthy food, I wanted to shift gears and commented my views on the economy. It is no rocket science that our economy is in trouble. It seems to me lately the stock market is PMSing harder than a lady going through menopause. (no offense to any woman experiencing menopause but you have to admit your mood swings are out of control)
The George W. Bush tax cuts end at the end of 2012 so Obama's administration has the duty whether to keep the tax cuts or reverse them. Without getting into a debate of what Obama should do, I always wondered, who advises the presidents to make these kind of decisions? Are they politicians with a background in economy? Are they economist intellectuals? Are they economists pulled from scholastic institutions?
I ask this question with a purpose. Within the study of macroeconomics, there is an idea, the Ricardian Equivalence Proposition. Stated simply, the Ricardian Equivalence proposes that in the long run, all government purchases must be paid for by taxes. So cutting taxes without decreasing government spending does not help anyone. By prolonging these payoffs, it is only increasing the amount we have to pay. Knowing that everything has to be paid off eventually, does not give the consumers of America any incentive to change their current consumption. (which the purpose of tax cuts is to try to increase GDP, or Gross Domestic Product, by giving consumers "more" money to spend) With a temporary increase in income (i.e. a tax cut), history shows that consumers do not go and spend it, but rather save it for the future.
So why does the government keep cutting taxes if it doesn't seem to help us short term and definitely does not help us long term? Obviously I am not as well versed on all of our economic policies so maybe I am missing something key. Clearly I am not in the White House, but maybe someone who remembers the basics should be.
Like me, I feel like a lot of America is just as confused.
I noticed in your post you state that "With a temporary increase in income (i.e. a tax cut), history shows that consumers do not go and spend it, but rather save it for the future."
ReplyDeleteMaybe this is really technical, but every consumer has a "propensity to consume" (rather than save) that differs based on their income, and economics research has shown that lower-income citizens have a greater propensity to consume than others. The reason that the government would propose cutting taxes is that, if done correctly it would help stimulate consumption and investment (there are all sorts of really complex equations to demonstrate how this works but the idea is the same). But only at the lower levels of income, which is why tax cuts to the rich don't work (if they recieve more disposable income, they are inclined to save a greater portion of it). Obviously there are those that will disagree with that idea, but they aren't economists. In my eyes economics is a science and you really can't disagree with the facts, math, and research that accompanies these core ideas.
Also, just another note...cutting government spending is what needs to be done to reduce the budget deficit. If we are trying to stimulate the economy, which is the focus of your post, we should actually be increasing government spending (along with tax cuts) which adds to aggregate demand and increases output. But that's where the problem lies...we have no money to be spending on stimulus funds as it is because we have dug ourselves into such a deep hole. The conflict now is basically whether we want to help fix the recession (and create an enormous deficit), or cut spending and raise taxes which will only further erode at the economy. No matter what Washington does there will be major consequences and we're gonna have to accept that this problem isn't gonna go away anytime soon.