The Proposed New “Tax Deal” is More of the Same Washington Bait and Switch

According to a report published on the front page of the December 6, 2010, Wall Street Journal, Congress is close to negotiating a compromise in which the so-called Bush tax cuts will remain in place temporarily (for two years) in return for an extension of yet unknown duration in federal benefits for the long-term unemployed. The pending legislative deal also proposes continuing existing tax breaks for private businesses, students and low-income Americans (under the Orwellian program known as “Making Work Pay”).

Given that the national unemployment rate now stands at 9.8 percent and job creation in the private sector remains moribund, acting to extend current corporate and personal income tax rates is a no-brainer. But continuing current rates for two years only will do nothing to cure America’s economic woes. As Nobel laureate Milton Freidman observed long ago, the spending plans of consumers and, what is more important, the investment decisions of business firms, hinge on expectations of permanent after-tax incomes, not year-to-year fluctuations in them. At best, therefore, the pending congressional compromise will shift some spending initiatives forward in time, but chill them again as yet another expiration date looms two years hence.

It is well-established in the economics literature that acceptance of offers of employment increase significantly after unemployment benefits end. Beforehand, workers are paid to remain idle. Afterwards, even if those unemployed currently take jobs paying less than what they had earned previously, many are willing to reenter the labor force as active participants.

In order for markets to adjust in today’s economic environment, wages and asset prices, including those of real estate, must be allowed to find their bottoms. Rather than continuing to pay jobless people to take vacations from the workforce and to prop up other prices, it would be far better to allow market forces to operate. If government gets out of the way by, for example, restoring predictability to the income tax code, the U.S. economy will recover and prosperity will resume.