The Case For Lower Taxes

In theory, big spending on public investment projects could make sense. But around the world, the track record of these experiments is dismal. Governments and parliaments tend to waste precious time devising the programs, which often fall prey to special-interest groups, resulting in "bridges to nowhere" that offer no help to the economy. In the 1970s for instance, German cities used generous federal aid offered to stave off a recession to build splashy new swimming pools, but soon after had to close many of them because they couldn't afford to pay the lifeguards and other operating costs.

Tax cuts can be passed quickly, leaving special-interest groups less time to interfere. A temporary income-tax reduction, for instance in the form of tax-rebate checks, can help to bridge the time gap before interest-rate cuts start to work. The best tax cuts could also enhance the long-term incentives to work and invest.

The formula will vary by country. Many should cut payroll taxes to put extra spending power into the pockets of workers and businesses immediately. In Germany and France, where payroll taxes raise total wage costs by about 40 percent, with the burden shared by employers and workers, a big cut should have a huge impact.

Because payroll taxes don't apply above certain income thresholds—for example, usually €65,000 per year in Germany—payroll-tax cuts benefit ordinary workers more than the rich. Lower payroll taxes would also reduce the wage bill of each company, helping them to cope with the economic downturn, alleviating the need to fire and making it more profitable for them to hire again once they sense an uptick in demand.

Of course, lower taxes now have to be coupled with future spending restraint. The time to make tough decisions will not end when the economy turns up again. But rarely before has the case for tax cuts to make a recession shorter and shallower been stronger than in today's credit crunch.

© 2008