Washington Embraces Keynes, Investors Shrug

Last Friday concluded a week in which a bipartisan collection of allegedly wise legislators sought to outdo one another in terms of who could offer up the biggest economic “relief” packages. Global investors of course voted on Monday and Tuesday, and the sight was not a pretty one as increasingly interconnected world markets sold off on further evidence of resurgent Keynesianism in our nation’s capital.

Markets continue to blanch in response to stimulus plans for the simple reason that they mock basic economic logic pertaining to growth. For lawgivers here to assume that investors might be fooled by their compassion is for them to also assume investors are so obtuse as to buy the notion that Washington can tax with one hand, while giving back with the other in ways that might create economic growth.

To witness the policy crack-up in Washington without any historical perspective is to assume the last thirty years did not happen; thirty years in which Keynesianism was largely discredited in favor of tax cuts, stable money, and laissez-faire economics. Investors are understandably scared because just as the world mostly followed our lead in the direction of free markets and low taxes, it could just as easily follow us back down the path toward more rigid economic management from the Commanding Heights.

Irrespective of their political affiliation, establishment economists continue to feed Washington’s heightened self-image when it comes to managing the economy. Fueled by editorials and studies suggesting the U.S. economy is merely experiencing a collapse in what elite thinkers term “aggregate demand,” politicians float all manner of temporary proposals meant to stimulate the near-term buying of “things.”

Forgotten here is the simple economic truth that our supply is our demand. We work and produce so that we can consume, and so rather than pushing redistributionist plans that in no way impact incentives to produce, Washington should be reducing penalties on production if it truly seeks to increase real economic activity.

From there, the answers are pretty simple. The 2003 tax cuts surely reduced penalties on work and investment. Those cuts are set to expire in 2010, but with stimulus in mind, should be made permanent. If Congress and the President think the economy needs something more, they should build on the aforementioned reductions with even greater marginal relief. Economies require work and investment in order to grow, so Washington should reduce the penalties on both.

Some say that due to the deliberate pace of legislation in Washington, major tax legislation would take too long to pass, and so short-term stimulus plans are the only answer for an economy needing relief now. That might be a realistic point if showering lower-income Americans with the dollars of others actually worked, but since it does not, the easy answer when it comes to timing stares us in the face.

Indeed, while tax cut legislation may take months to pass, an outline of what a future package might look like would not. To insure that Americans in no way delay increased economic activity with lower future rates in mind, Congress and the President should agree now that any tax cuts will be retroactive to January 1, 2008. A retroactive guarantee would give all productive Americans (and those on the sidelines too) assurance that growth-enhancing work will be taxed at the lower, more stimulative rates still to be determined.

Thanks to aggressive and at times more fitful moves toward incentive and market-driven economic policies over the last thirty years, the United States has provided a template for other countries to follow which has lead to a worldwide economic renaissance, and which has happily integrated economies the world over ever more tightly. Simply put, what our politicians do here matters both for our influence on non-U.S. economic policy, and for the size of our economy relative to the world’s integrated whole.

And so long as our political class embraces the discredited policies of decades past, investors will continue to shrug in ways that will make today’s perceived economic sluggishness seem tame by future comparison. If the economy really needs fuel to fix what our leaders deem a slowdown, then the time to cut marginal tax rates is now.