The Right Stuff

Eighteen months later and billions of dollars spent have not resulted in the new jobs that the stimulus program was intended to create. Private-sector employment has actually declined an estimated two million additional persons since the inauguration of the program. The elusive goal of creating private-sector jobs is the subject of much commentary among economists, and many suggestions for a cure have been offered. The Obama Administration has offered a solution in the form of an additional stimulus package, and congressional leaders have enthusiastically endorsed a renewed spending program.

There is no reason to believe that a new stimulus program will be any more successful than the former. The reasons for the failure of the stimulus are many and varied. Funds were parceled out by different departments and agencies to a bewildering array of areas and grants, which in many cases increased the purview of government departments but had little or no influence on creating jobs. Tax credits, such as the $500-per-year grant to each tax filer in 2009 and 2010, were heavily in the mix of early distributions. Since there were strict income limits on eligibility applied to the tax credits, they became, in effect, income redistribution schemes from which the majority of taxpayers did not benefit. States also received a large portion of the initial grants and, in some cases, now face even more dire conditions. Infrastructure projects such as road repair, now in full swing, came later and were a minority of the total stimulus.

Taken together, the stimulus represented a partial expansion of favorite social programs, partial income redistribution, partial bailout of states, and partial infrastructure. At a time when the focus is on the scale and cost of unfunded government liabilities, it is not hard to understand why the American public is so jaded about the prospects for more government spending.

Private-capital investment is the key to productivity and a higher standard of living. Only the private sector is capable of generating the investment required to create new jobs, and only the private sector can offer incentives for growth, reward for hard work, creativity, and advancement based on merit. The stimulus was based on a vast increase in government spending and in government control of the economy: Incentives for private investment and spending were avoided, and corporations were vilified.

Our financial history provides many examples of successful fiscal policy efforts to regenerate economic growth. An early example is the tax reductions engineered by Treasury Secretary Andrew Mellon. When the federal income tax was enacted in 1913, the top rate was 7 percent and grew to 77 percent by 1919. Real Gross Domestic Product declined sharply immediately after the war, falling a total of 16 percent by 1921. Fearing a more prolonged recession as the United States turned from wartime toward a peacetime economy, Mellon succeeded in reducing tax rates across the board beginning in 1921, including sharp reductions in the top brackets. Federal tax receipts initially declined, but then grew strongly as the economy stabilized and grew. A study of that era concluded that total tax payments rose sharply during the 1920s, and the percentage of taxes paid by the top income earners soared, from one-third of total income tax receipts in the early 1920s to almost two-thirds by 1929.

The Revenue Act of 1964, popularly known as the Kennedy Johnson Tax Act, radically reduced corporate and individual taxes. It is generally viewed as providing the impetus for the prosperity enjoyed by the United States in the late 1960s and early 1970s. Like the Mellon tax cuts of the early 1920s, personal income after taxes rose every year, the use of tax shelters declined, business investment increased, and unemployment declined in the years immediately following the cuts. Similar results were obtained from tax programs of later administrations.


Taxes are a complicated subject. Because of their extreme complexity, discussions of their use and effectiveness often dissolve into ideological preferences. Studies of previous eras of financial stress, however, clearly point to universal results from changes in tax policy. Tax changes cause industries and businesses to alter their behavior. As tax rates rise, individuals and businesses scale back plans to spend, invest, and start or expand business. At the margin, individuals tend to retire earlier, work less, and seek out tax-avoidance schemes when faced with the prospect of higher taxes

Financial behavior also changes radically when permanent tax cuts are instituted. Individuals spend and invest more as discretionary income expands. The use of tax avoidance schemes tends to decline, exposing more income to taxation. Corporations gain confidence and execute plans to expand and invest. As spending increases so too does production, and new jobs are created. Permanent tax reductions unleash the full potential of our entrepreneurial economy, resulting ultimately in higher employment, higher federal income-tax receipts, and a larger share of taxes paid by upper-income persons. Numerous studies illustrate that one-shot tax rebates do not have the same beneficial impact as permanent tax cuts.

In today’s environment, an overall sense of caution and anxiety characterize financial decisions. It is evident in the hoarding of cash and reluctance to commit to large-scale expansion projects by corporations, the careful attitude toward spending and debt by consumers, and the extreme sensitivity of the financial markets to pronouncements by government officials. Most people accept that our economy has exited the recession, but their personal finances in many cases have not recovered. For the consumer, concern about jobs, financial security, and increased taxes conflict with the administration’s goals of radical social change. For corporations, an onslaught of expensive new regulations, fear of taxes, and a hostile attitude from the public (as reflected by numerous public bashings) draw an inward response

The economy is clearly in a recovery mode, but confidence is needed for it to achieve its potential. An aggressive monetary policy remains supportive of private-sector growth, but it is not capable alone of creating the number of jobs needed for the economy to reach full employment. The large tax increases sought by the administration would place a physical barrier in the path of recovery. Changes in fiscal policy by permanent, across-the-board tax reductions, combined with meaningful cutbacks in government spending (including entitlements), would very quickly restore confidence and unlock the enormous underlying potential of the American economic machine.

Alfred A. Lagan


Alfred Lagan is the founder and chairman of Congress Asset Management Company, a respected investment management firm in Boston, MA. Prior to starting Congress in 1985, he held senior investment positions in several financial services firms. Mr. Lagan holds an MBA from New York University with distinction, and a BA in economics from Iona College. He was born in New York City of Irish immigrant parents, and served four years in the Navy.

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