CBO Report: 'Back Through A Time Warp' to 'Discredited' Economic Theory

July 7, 2008 - 7:28 PM

Capitol Hill (CNSNews.com) - A new report by the Congressional Budget Office (CBO) is being hailed by liberals as vindication of their proposals to increase government spending and to allow only temporary tax cuts targets at low-income individuals. Conservatives, meanwhile, say they've seen this approach fail too many times before.

The report entitled "Economic Stimulus: Evaluating Proposed Changes in Tax Policy" examines nine proposed tax "cuts" and their purported effects on the economy. It says that to stimulate the economy, Congress must get money back into the hands of people who will immediately spend it.

"Tax cuts to stimulate economic activity in a recession do so by spurring additional demand," according to the analysis.

The report concludes that proposed payroll tax or sales tax "holidays" would have the greatest stimulative effect on the economy. The next most effective proposal, it claims, would be extending the 2001 tax "rebates" to individuals who did not originally qualify because they paid little or no income taxes.

Those proposals would put money directly into the hands of the consumers most likely to spend it, according to Peter Orszag, senior fellow in the economic studies division of the Brookings Institution.

Orszag says three features are crucial to any good economic stimulus package.

"One is that it maximizes its 'bang for the buck' in the short run so that you get the most stimulus you can for a given budgetary cost," he said. "Secondly that the costs are only short-run, that there are no long-run costs, or the long-run costs are minimized. And, third, that it adjusts automatically to economic conditions."

New tax cuts proposed by House leaders and the administration, Orszag believes, miss the mark on all three counts.

"The CBO report just ranked those proposals so low, I mean, it wasn't even close," he said. "These really were flunking grades for the major components of the House and administration stimulus packages."

The only pro-business proposals thought to have any significant effect on the economy by CBO are the temporary investment incentives, which include accelerated depreciation, expensing, and investment tax credits.

The remaining incentives, including deferral of taxes on subpart F income, repeal of the corporate alternative minimum tax, and reductions in capital gains taxes, "would be least likely to generate significant stimulus," the report concludes.

Dr. Daniel Mitchell, the McKenna senior fellow in political economy with the Heritage Foundation, says he's not surprised to see liberal economists promoting "demand-side economics," but he is amazed that CBO is supporting the theory.

"I'm very disappointed that CBO is trotting out discredited Keynesian economics," Mitchell said. "Consumer spending isn't what drives the economy, it's a reflection of a strong economy."

He says both history and current events prove that the Keynesian theory of boosting consumer spending at the expense of investment spending always fails.

"If Keynesian economics was successful," he added. "Japan should have boomed in the last ten years instead of being an economic basket case."

Mitchell says demand-side economics fails to address the fundamental source of growth within an economy: an increase in national income. Tax rebates and holidays, he says, merely redistribute the income already present in a society without any increase in spending power.

"The only way to increase national income is to encourage more work, saving, investment, risk-taking, and entrepreneurship. This is why incentive-driven supply-side economics has a successful track record," Mitchell concluded in his report entitled "Essential Conditions for a Pro-Growth Stimulus Package."

"When tax rates are reduced, people have more motivation to be productive and create wealth," he said. "And when they earn more income, they are able to spend more and save more."

An effective economic stimulus package, according to Mitchell, should:

- Permanently reduce all personal income tax rates, effective immediately;
- Limit the growth of domestic spending by the federal government;
- Reject tax holidays or rebates;
- Reject any temporary tax cuts;
- Eliminate the corporate alternative minimum tax; and
- Reform expensing and depreciation provisions to encourage investment.

"Proponents of economic recovery in the administration and on Capitol Hill should insist that the stimulus package meet these conditions," he added, "and reject any proposal that does not."

Mitchell is astounded that the CBO report didn't reach the same conclusion.

"CBO has gone through a time warp back to 1975," he said. "I'm embarrassed for them."