Tuesday, August 31, 2010

A Remedy to Our Economic Troubles

Two years after the economy plunged into crisis, it has still not come close to recovering. Last month’s unemployment numbers bear witness to that sobering fact. Instead of bemoaning the dire situation, or predicting a bad economy for the foreseeable future, I wish to propose a solution.

While the economy may have gone south, there is still no shortage of capital to invest. American companies are sitting on over $1.24 trillion. The reason they are hoarding the money instead of spending it is that they are unsure about what the future will hold. This is certainly true when it comes to public policy. Taxes on the wealthiest 1% might rise, or they might not. Obamacare might impose sweeping changes on the healthcare system, or it might be repealed when Republicans take control of Congress. There is only so much public policy can do to secure a good economic future. But it could in theory promise stability.

So to give investors and businesses a sense of stability, we could freeze tax rates on income, capital gains, and dividends for the next five years. Because of the deficits we are currently running, tax rates would revert back to Clinton era levels for the next five years. Businesses and investors would know exactly what is going to happen for the next ten years, and this sense of stability might be enough to get them lending and spending again.

Of course, a strong recovery in a consumer economy like ours will only come when regular Americans feel comfortable spending again and that will likely take a while. Still, freeing up banks and businesses to grant more credit and hire more people could only lead to a virtuous cycle.

The main problem would be getting political leaders to agree on a solution. If Republicans take over Congress, they will have to pursue tax cuts and repeal of Obamacare to please their base. The same logic will cause Democrats to pursue the opposite agenda. But there may yet be hope as David Cameroon’s coalition government which includes both Conservatives and Liberal Democrats shows. One of the first pieces of legislation the coalition put forward was to make each parliament stand for five years before elections. Hence, investors and businesses can make the reasonable assumption that there will not be wild swings in terms of public policy if a Labor government were to win election in a year.

Something tells me this all might be a pipe dream though.

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