Feeding the Kitty for Katrina

The Washington Times (Washington, DC), September 21, 2005 | Go to article overview

Feeding the Kitty for Katrina


Byline: Richard W. Rahn, SPECIAL TO THE WASHINGTON TIMES

Assume you were a regular blood donor but had an accident in which you lost a considerable amount of blood. Do you think you should increase or decrease the size and frequency of your blood donations until you recover?

Though most politicians are smart enough to answer, "decrease the blood donations," many seem not smart enough to understand that, when you take an economic hit, you don't want to unnecessarily add burdens to the economy. I refer to the call from some politicians to increase taxes or not extend President Bush's tax cuts to "pay" for New Orleans. (Note: Not making the tax cuts permanent is the same as a tax increase because tax rates therefore would be higher than now.)

The tax increase proponents seemingly cannot grasp that taxes reduce our economic vitality. When taxes rise, the economy slows. When taxes are reduced, job creation and economic growth accelerate. Those who do not understand the role of incentives are always surprised when tax revenues increase, as they did after the Reagan and recent Bush tax cuts, and fall or stagnate when tax rates increase. (For instance, the capital gains tax now - at a maximum 15 percent - produces many times the tax revenue it did when the rate was 40 percent, even after adjusting for inflation and the economy's size.)

Raising tax rates can increase government revenue over the long run, if the rate is low enough to only have a minimal effect on incentives to work, save and invest. Unfortunately, almost all major U.S. taxes are at rates where the disincentive effects of any rate increase eventually swamp any short-term revenue gains. Almost any tax rate increase can augment revenues in the very short run (the next week or month), before people and businesses have time to adjust their behavior, which most often result in lower long-term tax revenue.

Given it would be foolish to raise tax rates, and given the government will spend several hundred billion dollars (advisably or not), and the private sector probably much more, how should recovery from Katrina be paid for?

Before answering, we need to understand the real problem. The economy lost many productive assets - factories, stores, bridges, schools, etc. These assets need to be replaced, along with the workers' homes to give us the same potential GDP as the economy had before the storm.

To minimize the burden, we should begin by looking at where resources are now wasted in our economy. If we cut waste by the amount we need to replace what was lost, there would be no net loss to the economy either in jobs or productive assets. …

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