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Wednesday, July 06, 2005

Sometimes We Have a Funny Feeling That Maybe X < 1 

Ancient joke: A professor stands before a blackboard covered from top to bottom with abstruse mathematical formulae. To his class he says, "Now if X represents a number greater than one, it's perfectly obvious that . . . "

He stops in mid-sentence, a look of mild panic on his face. "Please excuse me," he says, and races out of the classroom.

Half an hour later he returns, greatly relieved. "I was right!" he announces to his bewildered students. "It is obvious!"

We wish we had taken more courses in economics. The logic of the argument below (by Cornell economist Robert H. Frank) strikes us, in our ignorance, as perfectly obvious. Yet plainly it is not, for if it were, how could Mr. Bush have sold the country on tax cuts for the rich?
[T]he president portrayed his tax cuts as the linchpin of his economic stimulus package. He argued that because most new jobs are created by small businesses, tax cuts to the owners of those businesses would stimulate robust employment growth. His policy thus rests implicitly on the premise that if business owners could afford to hire additional workers, they would. But whether owners can afford to hire is not the issue. What matters is whether hiring will increase their profits.

The basic hiring criterion, found in every introductory textbook (including those written by the president's own economic advisers), is straightforward: If the output of additional workers can be sold for at least enough to cover their salaries, they should be hired; otherwise not. If this criterion is met, hiring extra workers makes economic sense, no matter how poor a business owner might be. Conversely, if the criterion is not satisfied, hiring makes no economic sense, even for billionaire owners. The after-tax personal incomes of business owners are irrelevant for hiring decisions . . . .

In brief, the president's claim that tax cuts to the owners of small businesses will stimulate them to hire more workers flies in the face of bedrock principles outlined in every introductory economics textbook.

Had the dollars required to finance the president's tax cuts been used in other ways, they would have made a real difference. Larger tax cuts for middle- and low-income families, for example, would have stimulated immediate new spending because the savings rates for most of these families are low. And their additional spending would have been largely for products made by domestic businesses - which would have led, in turn, to increased employment.

Grants to cash-starved state and local governments would have prevented layoffs of thousands of teachers and police officers. And many useful jobs could have been created directly. For instance, people could have been hired to scrutinize the cargo containers that currently enter the nation's ports uninspected.

Economists from both sides of the political aisle argued from the beginning that tax cuts for the wealthy made no sense as a policy for stimulating new jobs. And experience has proved them right. Total private employment was actually lower in January 2005 than in January 2001, the first time since the Great Depression that employment has fallen during a president's term of office.

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