Greenspan Paradox on Recovery

September 20, 2010

by Chidem Kurdas

Alan Greenspan exemplifies an inconsistency that appears to be widespread. He reportedly said that the stimulus has fallen far short of expectations and the government should get out of the way and allow businesses to power the recovery. At the same time, he’s so worried about budget deficits that he supports higher taxes.   

Threatening more taxes is not exactly the way to encourage economic activity. This is not a new point, but judging by the chorus advocating higher taxes – Mr. Greenspan is far from alone – the argument needs to be repeated. Raising tax rates will create a vicious cycle of slowing growth, fewer jobs, lower income and less tax revenue, leading to more deficits.

Robert Barro estimates that if all the 2003 Bush tax cuts are allowed to expire for 2011, the growth of gross domestic product for 2011-12 would be reduced by 1.1 percentage points.  Mr. Greenspan favors letting the Bush tax cuts expire, but not just that. Out-of-control government spending implies even higher taxes.

So the end of the Bush cuts may be just the first step of a comprehensive new plan to rob America. This mugging looks to knock down the economy by creating incentives against investment and work.

Yes, the taxes we’re discussing are in the future and right now there may be other uncertainties that delay recovery. But people think of long-term prospects when deciding to hire more staff or start a new business. Those prospects are increasingly impaired. There are the higher future taxes. Then there are healthcare costs due to the mammoth new medical entitlement. Add to all that, there are regulations that pullulate like bed bugs. 

A vicious cycle is already discernable. Consider the demand for more “stimulus” to accelerate the recovery. This is like knocking somebody down and then offering them stimulant drugs to help with their wooziness. The Obama administration handicaps businesses every which way and then uses the slow economy as an excuse to add more pork—while the prospect of taxes to pay for the yawning deficits further worsens the outlook, hindering recovery.

Mr. Greenspan does not favor additional stimulus, but the tax increases he and others advocate in the name of fiscal responsibility are potentially a blight upon jobs and incomes.

To be sure, market economies can generate jobs and incomes in the face of adverse conditions.  The American economy is recovering despite the shadow cast by government bloat. But it will have to drag along a limitless burden of taxes and bureaucratic edicts. That’s a substantial encumbrance for even a very dynamic economy.  

It makes no sense to advocate higher tax rates to cure deficits—the resulting sluggish growth will pull down total tax revenue in the long run. So why this insistence on taxes? You can argue, following conventional neoclassical economics, that government borrowing will eventually push up the cost of capital, crowding out investment. By this textbook reasoning, tax hikes are needed to avoid higher interest rates in the future. But that argument ignores the direct impact of tax hikes on output and income.

Anyway, there is a better solution. The way to tackle the deficit is to cut government spending. If you really want to improve prospects and encourage the economy, make a commitment to reduce spending over time. To make the commitment credible, cut taxes now.

6 Responses to “Greenspan Paradox on Recovery”

  1. Boy Plunger Says:

    Mr. Kurdas, with all due respect, it seems rather obvious that you have a strong bias towards one side of the issue failing to balance different alternatives. For example, the issue of raising taxes by the government cannot be considered merely as such but in relation to how they will use the new funding. This is key, as this administration has been working on redistributing income in many different ways, either through legislation or fiscal policies. Looking at big business cycles, that time may be upon us again. A time when there is no other alternative but to redistribute. The last time when massive redistribution took place was after 1930. Think of it as a readjusments of excesses in many diverse sectors of the economy.

    On this note, Obama has expressed his desire to double exports in 5 years as well as his favoritism to certain sectors. Higher taxes will aid in this redistribution and as some sectors -that were beneficiaries of policies that have been in place for more than 2 decades- get a hit, other sectors may rise and start to prosper. To someone’s dislike, obviously.

    Raising taxes and government intervention has not been the american way since Reagan. But that does not mean, it has never been.

  2. Jerry O'Driscoll Says:

    Good post, Chidem. Paul Volcker was defending the administration yesterday as being friendly to business. He couldn’t understand why people perceive it as anti-business.

    He then proceeded to discuss the options for new taxes. It was a complete disconnect. It happens I was asked to comment on what he said.

  3. Bill Stepp Says:

    Paul Volcker was defending the administration yesterday as being friendly to business.

    To use a Richard Kostelanetz-ism, “Am I the only person who” [his favorite phrase] thinks that Volcker’s reputation is way overblown?

  4. chidemkurdas Says:

    Jerry, I like your comments on Volcker’s remarks. Amazing, really, this zeal to find more ways to tax. Is it something in the Beltway air or water that makes people obsessed with increasing taxes?

  5. chidemkurdas Says:

    Bill, I wish someone would explain what makes Volcker say these things. Can’t say I have a clue. It’s bizarre.

  6. Brandon Adams Says:

    What do income taxes have to do with business decisions like hiring and capital expenditures?

    Every time I read an article like this it makes me think that either the author doesn’t know how businesses are taxed, or the author assumes that decision makers in businesses do not know how businesses are taxed.

    Even if taxes on business profits were being considered – and they aren’t – why would that lead a business owner to make fewer expenditures? Greater expenses will lead to lower accounting profit, which will lead to a lower tax bill.

    On the micro level it seems that only complete irrationality would lead a business to change its behavior based on marginal income tax rates. You may argue that some business owners would choose to hold off on expansion just to spite the tax man, but even that doesn’t work. If you want to spite the tax man, you should increase expenditures, lowering your profits, which will lower your your tax bill.


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