Tax Cuts Should Create Growth, Not Junk Spending: Amity Shlaes

Feb. 23 (Bloomberg) — Payroll-tax cut equals growth. Consumer spending equals growth. Consumer spending is 70 percent of the economy. All growth is equal.

These are the axioms that motivated lawmakers to secure an extension of a payroll-tax cut this month. They felt like heroes for passing and signing a temporary break allowing citizens to skip Social Security payments.

President Barack Obama, too, was pleased. He trumpeted the payroll-tax news when he was visiting a Boeing Co. plant in Washington. An aim of that trip was to persuade American companies to do more business in America. In fact, by even going to Washington, Obama was highlighting what the administration believes is Boeing's shame: Boeing does business offshore. But Obama took the time to go off message and praise Congress on the payroll-tax issue.

"It is amazing what happens when Congress focuses on doing the right thing," the president said. Heed the axioms, he was saying. Even if doing so costs $93 billion, as the most recent extension does.

Axioms and Evidence

But perhaps the axioms are wrong. Maybe payroll-tax cuts don't equal growth. Perhaps they don't matter to growth. Perhaps other steps generate better growth. Perhaps the evidence is right there before us, even at Boeing. Look at the data, then look at what else the administration is up to this season, and you'll see the case for new axioms.

The Tax Foundation, a Washington-based nonprofit group that focuses on state, federal and international taxes, surveyed the 34 nations in the Organization for Economic Cooperation and Development for the period from 2000 to 2010. The foundation looked at rates for pension taxes and growth. It found no relationship. None.

The average OECD payroll tax for pensions and health was 27.9 percent, whereas the U.S. levy was 16.3 percent. (The OECD includes unemployment insurance in its basic reckonings of payroll taxes, so the numbers may look slightly different.) By those traditional axioms, that means we should be growing faster than other countries. Instead we grew significantly slower than the OECD average.

Some countries featuring very high or regressive payroll-tax rates, such as the Slovak Republic, with taxes in the mid-40 percent range, grew fast over the decade. The Czech Republic has high payroll taxes and high growth; Chile combined low payroll taxes and high growth. There was no pattern.

A different picture emerged when the Tax Foundation got to a levy that the administration began to talk about after the Boeing trip: corporate income-tax rates. The corporate rates did correlate heavily to increases in gross domestic product. Tax Foundation author William McBride found that if you cut a corporate tax rate by 10 percentage points, you get a cumulative 11 percentage points of GDP over 10 years. The seven fastest-growing countries had below-average corporate-tax rates, whereas the seven countries with the highest tax rates grew at below-average rates.

That means the new administration plan to lower corporate rates really is the right thing. "Corporate rate cuts are good" is a worthy axiom.

Personal income-tax rates also seem to matter, especially top rates. Countries with heavily progressive tax structures have slower long-term growth. The Slovak Republic may have a high pension tax, but its personal income tax is a flat rate of 19 percent, hence the growth. Low tax rates at the bottom of the schedule, by contrast, don't seem to track growth.

Junk Growth

These results — payroll-tax cut "no," corporate tax "yes" and personal income-tax cut "yes" — are consistent. The axioms notwithstanding, growth is not equal. There's such a thing as junk growth — GDP increases that are all about people buying two cars or two phones instead of one. That growth tends to be sporadic. And it doesn't tend to yield productivity gains. Buying a new piece of factory equipment or new software that helps your company make twice as many phones or planes yields more enduring growth.

For better quality growth, it is the availability of capital that matters. So tax changes should be ranked by how much capital they free. By this measure, payroll taxes rate a "C" or a "D": Putting money into consumers' hands means they may — and may is the word — buy something that is already invented. By the productivity criterion, corporate-tax and individual-rate cuts at the top perform well. The money from tax cuts on top rates for corporations and individuals tends to flow to new investments, the kind that allow factories to make more jet planes an hour.

"If lawmakers want to have the biggest impact on boosting long-term economic growth in the U.S.," McBride said, "they should turn their attention to cutting tax rates on corporate and individual income." Perhaps soon, since Japan and Canada are both cutting corporate rates, putting the U.S., which features high corporate taxes, at a greater disadvantage.

If corporate taxes were consistently lower here, companies such as Boeing wouldn't spend so much jetting around the world playing the tax-arbitrage game that irritates Obama. One reason the tax status of big companies like Boeing is so complex is that they receive targeted breaks for, say, research and development rather than a simple low basic corporate rate.

The old axioms endure for political convenience. Keynesianism, their basis, provides window dressing for the spending and stimulus that please voters. In a non-election year, the economists who serve the politicians are willing to acknowledge the limits of rebate checks. In an election year, they will pooh-pooh as second-rate economics any idea but spending.

Still, even in 2012, even if it offends, it's worthwhile to say it aloud: Ladies and gents, look at the evidence. And, like President Obama, try out some new axioms.

(Amity Shlaes is a Bloomberg View columnist and the director of the Four Percent Growth Project at the Bush Institute. The opinions expressed are her own.)

© Copyright 2012 Bloomberg

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To book Amity Shlaes for a speaking engagement, contact Jamie Brickhouse at the Red Brick Agency, 646.281.9041.
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