Fundmastery Blog

Kurt Brouwer July 1st, 2009

Martin Feldstein is a distinguished economist who has studied business cycles for many years at the National Bureau of Economic Research.  Professor Feldstein is also a member of President Obama’s Economic Recovery Advisory Board.  Martin Feldstein has been accurate in his appraisal of this recession and, unfortunately, I suspect his predictions from this Bloomberg interview will be pretty close to the mark as well [emphasis added]:

Feldstein Sees Renewed U.S. Slump After ‘Improvement’ (Bloomberg, July 1, 2009, Vincent Del Giudice)

The U.S. economy will grow for a few quarters and then contract again, said Martin Feldstein, a professor of economics at Harvard University.

“I think we’re going to see a temporary substantial improvement,” Feldstein, the former head of the National Bureau of Economic Research and a Reagan administration adviser, said today in an interview on Bloomberg Radio. “I emphasize the words temporary and substantial.”

Feldstein — a member of the private panel that dates the start of recessions and recoveries — suggested the economy will contract into next year, and that the pattern of economic turnaround will be more of a seesaw than what he called “a beautiful symmetrical W.”

The National Bureau of Economic Research Business Cycle Dating Committee said the current recession, the worst in half a century, started in December 2007. Since then the economy has lost about 6 million jobs, and gross domestic product contracted in the final quarter of 2007, the third and fourth quarters of last year and the first quarter of this year.

After the economy shrank at a 5.5 percent annual pace in the first quarter of the year, the change in GDP will be “closer to zero” or “even a small plus” for the April-to- June period, Feldstein said.

“We’ll get a bounce for a few quarters and then it will fade out,” Feldstein said. “We’re now going through the getting-better phase for a while.”…

Professor Feldstein does not get into the thinking behind his prediction, but it is pretty clear from other sources that he thinks we are making grave economic errors, primarily in raising taxes during a severe economic recession.  These errors are reminiscent of similar mistakes that were made in the 1930s.

In a piece written for the Wall Street Journal [emphasis added], he expands on what we are doing wrong:

Tax Increases Could Kill the Recovery (Wall Street Journal, May 14, 2009, Martin Feldstein)

The barrage of tax increases proposed in President Barack Obama’s budget could, if enacted by Congress, kill any chance of an early and sustained recovery.

Historians and economists who’ve studied the 1930s conclude that the tax increases passed during that decade derailed the recovery and slowed the decline in unemployment. That was true of the 1935 tax on corporate earnings and of the 1937 introduction of the payroll tax. Japan did the same destructive thing by raising its value-added tax rate in 1997.

…Mr. Obama’s biggest proposed tax increase is the cap-and-trade system of requiring businesses to buy carbon dioxide emission permits. The nonpartisan Congressional Budget Office (CBO) estimates that the proposed permit auctions would raise about $80 billion a year and that these extra taxes would be passed along in higher prices to consumers. Anyone who drives a car, uses public transportation, consumes electricity or buys any product that involves creating CO2 in its production would face higher prices…

…The next-largest tax increase — with a projected rise in revenue of more than $300 billion between 2011 and 2019 — comes from increasing the tax rates on the very small number of taxpayers with incomes over $250,000. Because this revenue estimate doesn’t take into account the extent to which the higher marginal tax rates would cause those taxpayers to reduce their taxable incomes — by changing the way they are compensated, increasing deductible expenditures, or simply earning less — it overstates the resulting increase in revenue.

…The third major tax increase is the plan to raise $220 billion over the next nine years by changing the taxation of foreign-source income…The purpose of the tax change is not just to raise revenue but also to shift overseas production by American firms back to the U.S. by reducing the tax advantage of earning profits abroad.

The administration is likely to be disappointed about its ability to achieve both goals. Bringing production back to be taxed at the higher U.S. tax rate would raise the cost of capital and make the products less competitive in global markets. American corporations would therefore have an incentive to sell their overseas subsidiaries to foreign firms. That would leave future profits overseas, denying the Treasury Department any claim on the resulting tax revenue. And new foreign owners would be more likely to use overseas suppliers than to rely on inputs from the U.S. The net result would be less revenue to the Treasury and fewer jobs in America…

The level of economic illiteracy or innumeracy in our policy makers is simply astounding.  If you raise taxes on Americans with incomes over $250,000, those people will do their best to change behavior and avoid higher taxes.

Or, if you pass the cap and trade legislation, then businesses will simply pass on higher costs to consumers where they can.  So, the net result will be higher costs for consumers and a transfer of wealth to the government.

Finally, if you tax corporations doing business overseas, they are not just going to line up and take their punishment? They will try to lobby Congress for special dispensations and, failing that, they will re-align their businesses as Professor Feldstein points out.  As a result, the Treasury will lose and so will our economy.

As we posted earlier, the great Winston Churchill pointed out the fallacy of this many years ago:

We contend that for a nation to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.

Professor Feldstein is simply making the same point.  If we raise taxes during a recession, we have to expect negative consequences.

• Business , Economy , Geopolitics , Money , debt
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