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Friday, December 10, 2010

“First, do no harm.”

As George Washington lay on his sickbed, having caught cold after working outside in freezing weather, doctors were called in, one after another. One of the primary remedies for illness at that time was bloodletting, and each physician in succession provided that remedy. It is now surmised that by the time he died, a day after taken ill, doctors had taken two-thirds of the blood in his body. Washington finally died of his remedy.

With Washington’s doctors to instruct us, it behooves the government, as the economy lies on its sickbed struggling to recover, to make sure that it does no harm. There is not a single economist, Left or Right, who believes that raising taxes during a recession is a prescription for a recovery. Had Washington’s doctors simply stood by his bedside, he may not have recovered, but his death would certainly have been delayed.

Most of what you know about the Obama/Republican compromise legislation is wrong. First of all, it’s not about a tax cut. The rate cuts occurred in 2001 and 2003 in response to an economy in recession, still suffering from the after-effects of 9/11. The tax rates have been in effect for nearly a decade. In return for cutting tax rates, Democrats insisted that the rates should go up at the end of 2010. If the deal that has been described passes, it will simply continue the current tax rates for the next two years. There is no income tax cut in the bill. The bill is designed to keep taxes from rising automatically on January 1, 2011. To go back to our Washington analogy, allowing tax rates to go up would be the same as starting the bloodletting, and you see how well that worked out.

The proposal calls for a temporary reduction in the Social security tax. Social Security taxes have been used to fund other government programs for decades. Will this stimulate the economy either by increased consumer spending or increased hiring? Time will tell, but there are doubts.

The estate tax, which is scheduled to go from 0% to 55% on estates over $1 million as of January 1, 2011 will, according to this accord, be levied on estates over $5 million at 35%. To minimize your taxes, plan to die before the end of the year.

Seriously, I question whether the passage of this plan will do much to stimulate the economy. What it does is give the American people the ability to see their tax burden for two years into the future and removes the current uncertainty for some time. That stability will cause some people who have been holding off needed investments to proceed. The problem facing the policy makers who want to have consumers begin spending again is that the trauma of the last 2 years will not be forgotten soon. People living paycheck to paycheck are going to be taking Dave Ramsey’s advice and are getting debt free. That means that most of the extra money from the reduction on the Social Security tax will be used to reduce debt and put some money aside in an emergency fund. Consumers are getting their financial house in order.

I predict that economic growth over the next decade will be producer-driven rather than consumer-driven. That’s where the cash is, that’s where the profits are and that’s where the real needs are. From a public policy perspective we do not want to encourage the vast majority of the American people to spend and spend, live paycheck to paycheck, always in the brink of insolvency, and retiring with their Social Security checks as their sole source of income. Make no mistake, corporate pensions for private sector workers are a thing of the past and, as governments face the facts regarding their unfunded pension liabilities, they will also disappear for public employees. Demographics do not allow the welfare state to support us at more than subsistence levels; anything above that will have to be provided from our personal resources.

This is the “new normal” and those who want to move the country back to the days before the bills came due in 2008 are simply going to bleed the patient to death.

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