Whiting column: The policy embedded in the budget
First of two parts.
President Trump recently presented his budget to Congress. Beyond the obvious, what are the economic motivations and implications?
A budget involves identifying the source and amount of both income and expenses. Theoretically, income must equal if not exceed expenses. In a business or household, there isn’t a choice. We prioritize our expenses to reflect what we need and value. The government, however, has the alternative of deficit spending. It provides additional funds, at the cost of interest, which must be paid in the future.
In our economic system, besides this identification process, the budget takes on additional importance because it’s a significant component of fiscal policy. In December, when the Fed started a series of interest rate hikes, we discussed the role of monetary policy.
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Fiscal policy utilizes tax rates (income) and spending (expenses) as an economic tool. It is the purview of the president and Congress. Either can initiate, but, in practicality, both must approve.
The same as monetary policy, fiscal policy is used to flatten the peaks and valleys of a capitalistic economy. It is termed either expansionary or contractionary fiscal policy. If the goal is expansionary (boosting) the economy, the president and/or Congress can:
• Lower tax rates, leaving more money in the hands of people and business. It will be spent over and over, increasing business, profits and the most significant long-term result: job creation.
• Increase spending, which also puts more money in the hands of people and business.
If the goal is to slow the economy, tax rates will be increased and spending will be decreased. Why would slowing the economy be a desired goal? Remember, economic theory says and history supports that our economy is never stagnant. Up and down cycles are natural, but the higher the highs, the lower the lows. It’s not the highs that concern us, but the extreme lows with its loss of employment. Consequently, we try to knock down the highs and boost the lows to make the fluctuations less dramatic.
An accompanying characteristic of an economy growing too fast is increased inflation. More and more money is being spent, increasing demand and consequently price. The concern is that higher prices will eventually mean less spending, turning the economy downward. Fiscal policy can moderate inflation by slowing the economy.
There are truisms, implications, ramifications and possibilities to fiscal policy. Lowering taxes will benefit the economy — always. Raising taxes will harm the economy — always. In the short term, it will reduce tax revenue — always. It doesn’t matter the source of the taxes: income, property, sales, social security, Medicare, capital gains, estate, excise, specialty (gasoline). Any tax reduces dollars in the hands of individual and business spenders.
Given the myriad taxes, in addition to amount, a decision must be made as to which tax to raise or lower. The greatest immediate benefit from a tax decrease will occur when:
• It reduces the taxes of the entity most likely to spend as opposed to save: typically, those with the lowest income. That is why reducing the income or property taxes of an entrepreneur will have a greater effect than one for a corporation.
• It reduces the tax affecting the largest number of people. Generally, federal income, then sales, then gasoline.
• It reduces the taxes affecting the largest number of dollars. Generally, federal income, then sales. That is why reducing the income taxes of a corporation can have a large effect and one reason President Trump is contemplating decreasing the corporate tax rate to 15 percent.
• The savings will be spent on consumer goods that wear out and require repurchasing. This is why some economists disagreed with President Obama’s recession stimulus strategy of giving various businesses a total of $836 billion. They argued that giving each citizen older than 18 (231 million people), $3,620 would have had greater impact.
• The savings is spent in the jurisdiction it is generated. Federal income tax savings isn’t of any value if spent in a foreign country or on foreign products. State income tax savings isn’t of value in Colorado if it is spent in Florida.
The greatest long-term benefit from a tax decrease will occur when:
• The savings will be spent on an income producing asset: cropland, apartments, an entrepreneur or corporation opening another store, adding another manufacturing plant, warehouse facility, equipment such as trucks, planes, drilling rigs, tractors or an individual earning a college degree.
• The savings brings additional money to the United States. The 15 percent corporate tax rate is an example by motivating the repatriation of the $1.7 trillion of U.S. corporate profits currently on deposit in foreign countries, avoiding the higher corporate tax rate.
• The savings are “saved.” To the economist, savings facilitates future consumption. If the economy goes downhill, it enables either an individual or a business to continue spending, facilitating a quicker rebound.
To the economist, it also doesn’t have to be a formal tax to be fiscal policy. Any fee reduces spending, whether it be license plates, business license, driver’s license, building permit, workers compensation or any governmentally generated fee. They can be raised or lowered to affect the economy.
To be fair, other economic possibilities should be considered. In the long term, it is theoretically possible for a decrease in tax rates to bring about an increase in revenue. For that to occur, the additional spending must result in economic growth at a level sufficient to produce additional income that when taxed results in revenue greater than previously generated.
For example, $1 million in income at a 25 percent tax rate produces $250,000 in taxes.
Reducing the tax rate to 15 percent would reduce tax revenue to $150,000. The $100,000 in tax savings would need to generate additional income of $667,000 to produce total tax revenue of $250,000. Given the multiplier effect of 3-5 times and an inflation rate of 2-3 percent, it is possible. Historically, economists debate whether that has ever occurred.
Because of fiscal policy, tax rates take on a more complex role in our economy. Tomorrow, we will discuss the role of spending, which isn’t any less complex.
Bryan Whiting feels most of our issues are best solved by personal responsibility and an understanding of nonpartisan economics rather than by government intervention. He is retired after 40 years of teaching marketing, entrepreneurship and economics. Comments and column suggestions to: email@example.com.
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