Congressional Republicans and Democrats are engaged in a heated debate over which Americans deserve not to have their taxes raised, with both claiming that some form of tax cut will stimulate the economy. The primary point of divergence is what type of cuts will be most likely to get Americans spending, and whether the wealthy will wastefully save their extra cash or use it to create jobs. This debate is academic. If a stronger economy (rather than pre-election posturing) is really the goal, then tax cuts alone will fail.
The real impediment to economic growth is not taxes, but the government spending that makes high taxes necessary in the first place. Given the widespread, but erroneous, belief that spending is the root cause of economic growth (rather than saving and investment), it may shock many to know, especially my fellow Republicans, that of all the three means to finance government - taxation, borrowing, and money creation - taxation is the least destructive over the long term.
Despite the visceral sting on April 15th, taxes have the virtue of being honest, direct, and most importantly, visible. By transferring purchasing power from one group to another, taxes take a pie that has already been baked and change how it is sliced. But taxes do create dangerous disincentives if they are abused. Raise taxes high enough and society's most productive individuals may stop working; keep raising them, and the public may riot. As a result, a government that relies primarily on taxes tends to be one that lives within its means.
Government borrowing, in contrast, doesn't just move money around from one spender to the next; rather, it taps into society's limited store of savings and directs funds away from private investment and towards the public sector. Decreases in the availability of private investment capital, which is where economic growth really comes from, can be extremely destructive over time. Borrowing also adds another cost that taxation doesn't: interest charges. Just as it costs less to buy something with cash than it does to buy it on credit, it costs society less to pay for its government upfront.
Printing is even more insidious. By creating money out of thin air, government debases the currency, stealing from savers and depriving the economy of a stable unit of account. The inflation that results from an expanding money supply distorts all economic activity and discourages the accumulation of future investment capital.
However, borrowing and printing have one huge advantage over taxation: they make it much easier to disguise the true cost of government while surreptitiously pushing the burden onto future generations. So while taxes are political poison, borrowing and printing have always been preferred by Washington.
Make no mistake, I am against raising taxes. I would prefer cuts in government spending. Yet, after years of lowering taxes, with the illusory hope that one day spending cuts would follow, I think it's time we tried another tack. Instead of "starving" government, which has proven to be a disaster, we should look to transfer more of the current cost of government to taxation, which might finally create the political will to actually cut spending.
To really make this strategy fly, we should revise our abominable tax code in a way that is less destructive to the economy. In particular, taxes should not: discourage hard work and risk taking, impede capital formation, impose high costs for computation and enforcement, favor particular groups or activities, or intrude on individual liberty any more than is absolutely necessary. Given these preconditions, I believe a national sales tax would be ideal. If Congress insists on taxing income, then a flat tax (whereby all taxpayers pay the same rate with no special deductions or credits for politically favored expenses) would be best. Unfortunately, we are stuck with the most harmful system of all: a complex, progressive income tax, with lots of politically motivated loopholes, deductions, and credits, that encourages a raft of unproductive activities, and supports an entire class of unneeded service providers to calculate.
By failing to address the spending side of the equation, neither the Democrats' nor the Republicans' current proposals will provide any genuine stimulus. The President's version will temporarily increase the purchasing power of the middle class, but the gains will come at the price of larger deficits, bringing larger tax increases down the road. By bringing down savings, which President Obama ironically touts as a benefit, the plan will diminish private investment, thereby slowing job growth.
While the Republicans' distaste for high taxes is admirable, they fail to see how increased borrowing or printing is worse. Unfortunately, after having been in the majority for twelve years with nothing to show on the cost-cutting side, those Republicans who do advocate for fiscal prudence have little credibility with the voters. Without corresponding cuts in spending, the full benefits of lower taxes - particularly as they apply to the rich - will never be realized. In the current environment, extra savings accumulated by the rich are largely "invested" in government securities rather than private sector ventures. Throwing more money into a government abyss can't help economic growth.
Rather than trying to disguise another misguided round of stimulus in the cloak of a tax cut, we should deliver what the economy really needs - genuinely smaller government. However, to accomplish this, we need leaders who not only understand economics but have the political will to level with the American people about how much government we can really afford.