McCain: cut taxes to pay for infrastructure!!

John McCain's solution our economic woes is tax cuts, a plan not atypical of Republicans of any stripe. But will tax cuts build a single bridge, fill a single pothole, pay a single teacher or create a single new job? No, absolutely not!

UNLESS

You believe that tax cuts alone lead to increased economic activity. This is the justification we have heard from Republicans since Ronald Reagan embraced economist Arthur Laffer's theory that reducing tax rates leads inexorably to increased economic activity. The theory is that reducing taxes reduces the cost of doing business to such an extent that businesses, especially small businesses, will expand operations, hire more employees, increase inventory and profits. This expanded economic activity will generate so much additional profit that government revenue, even at the lower tax rate, will actually increase.

GHW Bush (Bush 41) famously called this "voodoo economics" when he was campaigning against Reagan. However, after Reagan chose him as VP candidate, Bush senior embraced the theory.

Republicans point to the economic recovery since 2001, anemic as it was, as proof of the theory. But let's look at that assumption carefully. What else was going on economically during that period between 2001 and about 2005? The most obvious is that Fed interest rates were the lowest in modern history, less than 2% for three full years between December, 2001 and Dec 2004.

Now imagine you're a small business owner and business is not bad, but it could be better. You're considering increasing inventory, maybe starting a new line of products. Or you're a construction contractor and you want to bid on a big job, but you need to buy some equipment and hire more workers. Which do you think would make you more comfortable in that expansion, cutting your tax rate from 30% to 25%, or being able to get a loan at 1.5% instead of 5%? There is no question that taxes are a significant expense for a business, and figure into business decisions. However, taxes are due only if you're making a profit. The ability to get a low cost loan is crucial to a small business. Tax considerations come 'way down in the list of concerns.

What kind of businessman makes a serious business decision based upon tax rate alone? Certainly not a small businessman. Now, for a large corporation, tax rates are very important. A huge international corporation might give its top executives a bonus if tax rates decrease (and therefore quarterly profits increase).

Cutting taxes panders to the economically unsophisticated and the selfish, but does very little to drive an economy, at least at the tax levels extant in the USA for the past several decades. Far more conducive to expanding business, and therefore the economy, is the interest rate.

The effect of tax cuts on budget deficits, however, is enormous. The largest peace-time budget deficits in history (as a per cent of GDP) happened under Ronald Reagan and his supply-side tax cuts. The second highest (highest in actual dollars) happened under our current president. It is no coincidence that both these presidents embraced Laffer economics and the magic quality of tax cuts.