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Only real tax cuts stimulate the economy

Created on February 11, 2009

Only real tax cuts stimulate the economy

Economy Boosted by Permanent Reductions in Tax Rates

By Ken McIntyre

There are tax cuts and then there are tax cuts.

That's why conservatives are so concerned about the kind President Barack Obama and Democrats in Congress continue to emphasize in their economic "stimulus" plan.

"It's commendable that President Obama wants a sizable portion of the stimulus package to contain tax cuts," observes Rea S. Hederman Jr., assistant director of The Heritage Foundation's Center for Data Analysis.

"However, the package should have tax cuts that are most likely to boost the economy," Hederman says. "The tax cuts that are part of the stimulus bills and supported by President Obama are a bad deal."

What's at issue?

Any practical plan to prime the economy's pump, Heritage experts assert, must emphasize permanent reductions in income tax rates for individuals and businesses - not, as liberals advocate, one-time or short-term tax rebates and credits combined with upward of $1 trillion in deficit spending.

Reduced income tax rates -- such as the 2003 tax  cuts -- create incentives to work, innovate and invest. The evidence of history and decades of research bear this out.

Obama and most congressional Democrats err when they "rely on increased consumer spending instead of boosting investment and saving," Hederman explains. "Similar proposals that rely on the same thinking failed to boost the economy, and it's unlikely history will change course this time."

Liberals largely pin their hopes on a refundable, two-year tax credit for low- and middle-class Americans that is equal to 6.2 percent of up to $8,100 of earnings. Translation: a credit of $500 per person per year, or $1,000 per couple -- only $10 more per weekly paycheck over the two years.

There's really only one difference between these proposed "tax cuts" and last year's ineffective tax rebates from President Bush and Congress, Hederman says: Rather than wait for a government check in the mail, taxpayers would see a little less of their money withheld from their paychecks for a couple of years. They wouldn't see it as a permanent increase in income to save, spend or invest as they please.

Most taxpayers don't know that the "Make Work Pay" refundable tax credit also would provide up to $500 in cash to low-income adults who don't pay any income taxes. For the first time, the government would hand out money -- $23 billion in the first year -- to able-bodied men and women who don't have dependent children.

But it gets worse, as Heritage welfare expert Robert E. Rector discloses in a new paper: The House and Senate "stimulus" bills would undo the historic welfare reform of 1996 by heavily rewarding states that increase the size of their welfare caseloads.

Beginning with more than  $260 billion, the package would -- if unchecked -- add nearly $800 billion in new means-tested welfare spending over 10 years, Rector calculates.

This welfare "spendathon" amounts to $22,500 for every poor American and would cost, on average, more than $10,000 for each family that pays income tax,  warns Rector, whose work provided the foundation for the '96 reforms achieved by President Clinton and a Republican Congress.

Most American workers, of course, make more than $8,100 a year. So tax credits capped at that amount won't reward them for working more.

Reducing the marginal tax rate would, though, especially for lower-income Americans. By also reducing tax rates on business income, Heritage's analysis shows, President Obama and Congress could curb the recession and spark creation of 1.3 million new jobs by next year, with 4.8 million new jobs by 2013.

Ken McIntyre is the Marilyn and Fred Guardabassi Fellow in Media and Public Policy Studies at The Heritage Foundation.