Targeted Tax Cuts and Government Lead Economic Recovery: A Recipe for Disaster

Lost in the haze of high sounding rhetoric and a laundry list of policy proposals within Barack Obama's speech was the idea that he believes that the way to move the economy from weakness to strength is through targeted tax cuts and stimulus through government spending. Here is how he summarized his economic policy proposals.

Change means a tax code that doesn't reward the lobbyists who wrote it, but the American workers and small businesses who deserve it.Unlike John McCain,

I will stop giving tax breaks to corporations that ship jobs overseas, and I will start giving them to companies that create good jobs right here in America.

I will eliminate capital gains taxes for the small businesses and the start-ups that will create the high-wage, high-tech jobs of tomorrow.

I will cut taxes - cut taxes - for 95% of all working families. Because in an economy like this, the last thing we should do is raise taxes on the middle-class.

...

As President, I will tap our natural gas reserves, invest in clean coal technology, and find ways to safely harness nuclear power. I'll help our auto companies re-tool, so that the fuel-efficient cars of the future are built right here in America. I'll make it easier for the American people to afford these new cars. And I'll invest 150 billion dollars over the next decade in affordable, renewable sources of energy - wind power and solar power and the next generation of biofuels; an investment that will lead to new industries and five million new jobs that pay well and can't ever be outsourced.

To understand why this won't work first I think we must look at the make up of Gross Domestic Product, the leading measure of economic health.

The most common approach to measuring and understanding GDP is the expenditure method:GDP = consumption + gross investment + government spending + (exports − imports), or,GDP = C + I + G + (X-M).

Now, what Barack Obama wants to do is cut taxes for the middle class while increasing taxes on the wealthy, capital gains and corporations. At the same time he will increase government spending.

So, what will this do to do GDP. It may or may not increase consumption (because some taxes will go up while others go down), but let's just say it will. At the same time gross investment will go down because of the increase in both capital gains taxes and corporate taxes. It is unclear what would happen to exports over imports though an increase in government spending puts downward pressure on the dollar which actually helps exports. At the same time, government spending will go up because Obama wants to increase it.

Now, the first problem is that an economy can't sustain growth if consumer spending increases at the same time capital investment decreases. Barack Obama foolishly thinks that he can creates sustainable economic growth by increasing growth in parts of the economy at the EXACT same time other parts of the economy are shrinking. That doesn't work. If businesses don't spend, any consumer spending will be temporary. Soon enough, businesses will begin cutting jobs and consumer spending will go to the exact same place that business spending has already gone to. Thus, the economy will be driven entirely by government spending.

Any economy that grows driven by government spending becomes addicted to government spending. Let's, just for the sake of argument, say that Obama actually will create millions of new jobs through government spending. Those jobs will only be around as long as the government continues to spend to keep them around. All this really does is balloon an already excessively large bureaucracy. How long can the economy sustain growth if that growth is being fueled by a ballooning bureaucracy?

The last fallacy in such a plan is the fallacy that raising taxes on wealthy folks and businesses has no negative consequence on the economy. Just because wealthy folks are still wealthy even if their taxes are 3% higher, doesn't mean that the wealth that is taken away from them won't stunt the economy. Let's just use one person that makes $250,000 per year as an example. Let's even say that this person simply puts about $60,000 that they save every year in the bank in nothing more than a checking account. Now, they will have to pay an extra $7500 in taxes. That means that this person will put $7500 less in the bank. That bank will now have $7500 less to invest and lend. Think that isn't such a problem. Multiple that by billions if not trillions and you will see the potential corrossive effect on the economy of raising taxes ONLY on the wealthiest. Now, imagine if some of those folks give up hiring an extra person, investing in equipment, or buying an extra luxury item along with simply putting said money in the bank. Every single dollar earned moves the economy forward. Every single dollar taken away from any individual stunts the economy. It is just that simple.

The fallacy of Obama's plan is the naive idea that just because someone has a lot of money that not all of their money contribute to moving the economy forward. It certainly helps the average family making $50,000 per year to get an extra thousand dollars, but it doesn't help the economy if their gain is made at the expense of someone else who is wealthier. An economy's growth that is built because one class prospers while another suffers is NOT sustainable. While Obama's plan certainly pushes all the right buttons of the middle class, it is a recipe for disaster.