The Answer to Our Economic Problems: Changing Fiscal Policy

Keep personal income tax rates where they are today. In 2011, we have a massive tax increase coming. Under the permanent income hypothesis theory, Americans are bracing themselves for the onslaught by hoarding cash. Corporations are also increasing cash balances on their balance sheets. Keeping personal income tax rates where they are today would free up a little cash for Americans to spend, and release cash so corporations can invest.

Suspend or cut the payroll tax, putting more money into the pocket of Joe Six Pack. This allows citizens to save more or spend the extra income on wants and needs. This would be a temporary cut, but it would allow breathing room for the economy to work its way back to prosperity.

End the capital gains tax. It is scheduled to rise to 20% next year, and even higher if you happen to be in a higher tax bracket.  This is a tax on productive resources. Chief financial officers (CFO) make decisions on how to build and deploy resources using models like the capital asset pricing model (CAPM). Eliminating this tax would cause them to make different decisions.

Instead of hoarding cash on a balance sheet, the CFO would have to make some hard decisions on how to use the cash. They would build to expand their business, buy another business, or pay dividends to their shareholders. Dividends are not just paid to the rich. They are paid to mutual funds and pension funds as well. Freeing up cash will buoy the stock market. This would not be an artificial event if the tax was suspended permanently.

Hourly wages would be increased by ending capital gains taxes. Old equipment would be retired. Workers would become more productive. Assets would be sold, and the money put into more productive assets.  Significant economic expansion would occur.

Critics say that ending the capital gains tax would blow a gigantic hole in the budget. If simple tit-for-tat accounting is used to look at economic activity, they would be right. However, using simple accounting is not the correct lens to view the cut. The colossal increase in economic activity resulting from tax elimination would create a enormous amount of jobs. This would take many workers off the government dole, saving the government money in transfer payments. More employment causes more people to pay taxes, replenishing government coffers. Using dynamic economic analysis would prove the critics wrong.

Entrepreneurs would have an easier time starting a business and getting funding. The risk parameters that are calculated when funds are put into a start-up change significantly with 0% capital gains. Giving incentives to entrepreneurs is growth positive, since our future economic development depends on them.

Does anyone in Washington, D.C., have the intestinal fortitude to avert disaster?  Or do they want to quietly continue to fall down the black hole of decay?