The Misdiagnosis Of Our Economic Malaise

A comparison of tax rates, economic growth, and unemployment rates over the last 50 years has allowed me to reach the following conclusions regarding the tax cuts that are the core of Mitt Romney’s economic plan:

  • Tax cuts have little effect on either unemployment rates or the economic growth rate in the long run.
  • Making either the Bush tax cuts permanent, or worse, enacting new tax cuts now will significantly increase the deficit.

However, their approach towards taxes also illuminates a more fundamental difference between Romney and Obama, and it pertains to what each candidate has diagnosed as the problem with our economy today. And understanding this difference is key to making a decision on whose policies now are more likely to spur economic growth in the long run.

So what is the rationale for additional tax cuts? The essence of Romney’s argument as outlined throughout the presidential debates and during the primaries is as follows – cutting taxes will free up the money that businesses would normally pay the government, and they would instead use this money to expand their operations and create more jobs. The underlying implication is that a heavy tax burden and government hindrance is preventing businesses from acquiring sufficient capital to expand and create more jobs. Are there economic indicators that we can we look at to verify whether this claim is actually true?

As a first step, I looked at how the various US stock market indices have fared under Obama. As an example, I have included a chart depicting the value of the S&P 500, which is an index of the top 500 publicly traded US companies, over the last 5 years:

At its lowest point on March 2, 2009, the S&P500 closed at 683.38. Four days ago, it closed at 1411.94, indicating an almost complete recovery to the highs in 2007. This suggests that businesses have gradually accumulated value over the last 4 years. However, this has not translated into a corresponding increase in employment.

To further understand whether corporations have the resources to expand and hire new employees, I looked at cash reserves of US corporations over the last 5 years:

As of 2010, companies were sitting on more than a trillion dollars in cash, yet they had not utilized that money to significantly increasing their hiring. In addition to this, the federal reserve has cut interest rates to almost zero and intends maintain low interest rates until at least mid-2015. This allows companies to borrow the money they need to expand at much lower interest rates than they normally would. Furthermore, as I mentioned before, Obama has maintained all the Bush tax cuts during his first term. So businesses haven’t been burdened by higher taxes during the last 4 years.

Together, these economic indicators suggest that companies already have abundant resources to expand their operations, if they wish. For the same reason, it is improbable that freeing up more money by cutting taxes further will stimulate companies to hire more workers. So why aren’t companies hiring? Answering this question requires us to first ask why companies hire in the first place. Companies hire only when they see that there is a demand for their products and that meeting that demand requires them to hire more people. And what determines demand? Our incomes do – we shop when we have the money and when our incomes grow, we tend to shop more. Likewise, when incomes shrink, as they do in a recession, we hold back. Demand falls. Why then would companies increase their payrolls? They wouldn’t. So the problem with the economy has to do with demand. Can/Should government do anything to boost demand? And has Obama done enough? We shall examine this in the next post.

3 thoughts on “The Misdiagnosis Of Our Economic Malaise”

  1. I’d love to hear a specific company interviewed about their cash reserves and see whether this really holds true in their case. Hmm, know any small business owners?

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