Do We Need to Spur More Consumption?

Bob Williams over at the Tax Policy Center’s blog brings up an interesting question: why do fiscal conservatives claim that allowing the Bush “tax cuts for the rich” to expire will hurt the economy while ignoring the lower and middle-class tax relief Obama included in his stimulus plan? Williams argues that allowing programs like the Making Work Pay tax credit to expire will mean less money in the pockets of the vast majority of taxpayers, leading to less consumption and a slower return to economic growth.

It’s a good point. Indeed, when talk of stimulus first arose at the beginning of 2009, it was fiscally conservative economists and policymakers that pushed for tax cuts over government spending projects to help spur economic activity. The Obama tax cuts are certainly the least objectionable part of the stimulus plan, and there is a reasonable argument that they should continue. But the push to extend them is also tied up in the Administration’s misguided fascination with boosting aggregate demand through greater and greater spending, despite the failure of demand-pumping policies to produce reliable growth.

Programs like Making Work Pay were specifically designed to spur consumption and, consequently, return us to economic health. The problem is that increasing consumer spending has not revived the economy; in fact, consumption has been quietly rising all year, even as growth and employment remain tepid. As statistics from the Bureau of Economic Analysis show, real consumption expenditures hit an annual rate of $9.35 trillion in September, only slightly lower than their pre-recession peak of $9.56 trillion in December 2007.

Another prime marker of demand, vehicle sales, is still down from pre-recession levels, but has steadily increased from its 2009 trough. It’s curious, then, why the Administration and its backers continue to insist that we need to continue to raise demand. If consumption is already almost at a record high, except for an ongoing and necessary correction in the housing market, why hasn’t the economy turned around?

The real problem lies on the other side of the equation: limpid investment by businesses. As BEA numbers demonstrate, though private investment has recovered from its nadir in late 2009, it’s still fallen 18.5 percent from its Q1 2006 peak. Why? Besides market uncertainty and risk aversion created by the vague, still incomplete Dodd-Frank financial regulation reform and the upheaval wrought by Obamacare, there’s the opportunity for riskless returns by borrowing essentially free money from the Fed and using it to buy Treasury bills.

Williams is right that we should focus on tax cuts, but it seems unlikely that there is much more mileage to be gained from trying to goose consumer spending. Congress should consider reauthorizing both the Obama (and Bush) tax cuts to avoid a painful drop in consumer confidence that could further jolt the business community. But in the long term, rather than using fiscal policy to artificially pump demand (hmm… sounds familiar), the government should make sure work actually pays by continuing to cut corporate income and capital gains tax rates. This will allow the private sector to do what it does best: innovate, grow and create real value for society.