Obama Gets Tax Cuts Right

WASHINGTON--The times they are a'changin, as Bob Dylan sang in 1964, the year Congress passed the Kennedy tax cuts. And yesterday President Obama called for firms to be allowed to expense - deduct in full in the year of purchase - all their investment in plant and equipment through the end of 2011. In The New York Times on Tuesday, President Obama's former budget director, Peter Orszag, called for extending all current income tax rates through 2013.

Congratulations to Mr. Orszag on his new-found wisdom. Would that he had persuaded the Obama team before he left the White House.

Democrats are turning to tax cuts because, after almost two years of trying to cure economic woes through a loose monetary policy and over $1 trillion of government spending programs, GDP growth slowed to a 1.6% annual rate in the second quarter and unemployment reached 9.6% last month.

This is because the stimulus money is not free. It comes from people in the form of higher current tax payments, or higher future tax payments for repaying future government debt. Higher levels of taxation reduce people's ability to shop, save, and invest. The stimulus might have some positive effects, but these effects are offset by negative effects elsewhere. That's why the recovery is slowing down.

Republicans, running on a platform of extending current tax rates, are predicted to win back the House of Representatives and make substantial gains in the Senate. Another reason Democrats are in favor of tax cuts is that they want to minimize their electoral losses.

To be sure, the Democrats have not abandoned public investment as a socially desirable path and a short-term remedy for the economy's woes. In a Labor Day speech in Milwaukee, President Obama proposed to spend an additional $50 billion now on roads, rail, and runways to create jobs. He declared, "This will not only create jobs immediately, it's also going to make our economy hum over the long haul."

The $50 billion expenditure would be funded by raising taxes on oil and gas companies - which make the fuel to power the cars, trains, and planes that use the transport infrastructure - likely resulting in job losses in that sector.

The president also proposed replacing congressional earmarks with the creation of an Infrastructure Bank to direct private and public capital in partnerships for transportation projects, and making permanent the research and experimentation tax credit, which has already been extended 13 times.

How might the president's proposals help the economy?

Take business expensing of investments, a long-time favorite of Republicans. This allows firms to deduct 100% of investment costs immediately, lowering taxable income, rather than deducting the cost of these investments over several years. An immediate short-term period of expensing - through 2011 - encourages more investment, because firms know that the benefit will expire.

However, American Enterprise Institute senior fellow Kevin Hassett told me, "It makes no sense to lower cost of capital with one measure (expensing) while lifting it with another measure (letting tax cuts expire). This sends the message that Democrats are confused. But expensing plus a tax extension would be fine."

Perhaps the president needs to talk to Mr. Orszag, who proposed extending the current tax rates through 2013, rather than letting them rise on January 1, 2011, as scheduled under current law. Reacting coolly, the White House said Tuesday that Mr. Orszag had not offered such a proposal while on the Obama team. Mr. Obama might take the opportunity to comment at his scheduled Friday press conference. A groundswell of Democratic support in Congress and further deterioration in the economy might persuade him, however reluctantly, to acquiesce.

Expensing business investment and extending the research and experimentation credit would help the economy build capital, but if the costs of hiring labor are still high, the economy won't create jobs, especially low-skill jobs. Firms are facing a federal minimum wage that has risen from $5.15 to $7.25 per hour over the past three years, affecting low-skill workers and teens. The teen unemployment rate exceeds 26%.

Employers with more than 50 workers are preparing for new annual penalties of $2,000 per worker in 2014 if they don't offer the right kind of health insurance. Firms with fewer than 50 workers won't want to hire more to exceed the statutory level, and those in the 55 to 60 worker range are now likely considering how to shed labor.

In addition, one of Mr. Obama's first actions, in February, 2009, was to sign an executive order encouraging the use of union labor for federal government construction contracts over $25 million. The majority, or entirety, of the labor component of the $50 billion of infrastructure spending would go to union jobs.

Will the $50 billion in transportation spending create more short-term jobs? Not according to Florida Republican John Mica, ranking Republican on the House Transportation and Infrastructure Committee and likely chairman if the Republicans win back the House.

Rep. Mica announced that he would not support the bill, "While proposing to spend more on infrastructure in another stimulus effort may sound like the Administration is doing something about jobs, in fact only 32 percent of the infrastructure funding approved 18 months ago in the first stimulus has been spent. Projects continue to be bogged down by bureaucracy and red tape."

As Mr. Mica and even Senate Majority Leader Harry Reid have signaled, with only a few legislative weeks before the election, it's unlikely that President Obama will get his infrastructure bill, or his tax cuts.

Back in 1964, when Bob Dylan was singing, tax cuts passed by Democrats ushered in the economic expansion of the late 1960s. It's good news that now Democrats are proposing lower taxes on income and investment. Combined with removing employer disincentives to hiring, tax cuts could do the same today.