Both the Republicans and the Democrats are partially right and wrong on their interpretation and application of key economic factors. The problem is there are 3 major Keynsian factors that have profound impact on the economies health. They are Interest Rates, Tax Rates and Government Spending. There are other economic activities that can enhance or minimize there influence. Lord John Maynard Keynes a preeminent economist in the mid twentieth century espoused the following, somewhat simplified. He said that lower interest rates stimulated the growth of the economy and higher interest rates depressed the growth. He said that lower tax rates stimulated the growth of the economy and higher tax rates depressed economic growth. And, finally the most controversial, government spending. Higher government spending ( often termed deficit spending ) stimulates the growth of the economy and Lowered government spending ( often termed surplus ) depresses the economy’s growth.
Each of these factors have very confusing aspects. The reason is that sometimes Interest Rates should be raised and sometimes they should be lowered. The same holds true for Tax Rates and Government spending.
First, I choose to use the term Redutio Ad Absurdem (means reduce to absurdity). It means propose extremes that are so wide most everyone knows what should be done. The two major extremes are rampant inflation and serious recession or depression.
Rampant inflation occurs when interest rates are very low, tax rates are very low and government spending is too high. Serious recession occurs when interest rates are too high, tax rates are too high and spending is too low. The closest we have had in recent years was Jimmy Carters “Stagflation”. Ronald Reagan spun that around by dramatically lowering tax rates, and increasing spending with massive defense spending and he persuaded Volker’s federal reserves 16 or more interest rates to be reduced.
So the big dilemma here is what should theses factors be targeted at. The truth is that there is a band of cooperative levels of each of these factors where the economy will grow at a sustainable rate. Needless to stay there is considerable disagreement amongst economic thinkers as to what that should be. In my opinion there is a set of economic conditions that could exist that would permit a sustainable growth rate of 4.5%. This is a high figure and will only be achievable if we do a lot of things right and to be totally honest getting all that right is extremely hard to accomplish. A more reasonable and still hard to maintain rate is around 3%. I will later define what needs to be, to permit a sustainable of say 4.5%. All I can say about that is solving many of our economic maladies would occur if we at least chose that growth rate as an optimum target.
Lets diverge and explain how these factors work. Tax rates are the most controversial and the most misunderstood. Fundamentally within a band, difficult to define precisely because it varies when the other factors vary. If you reduce taxes, the government in fact realizes more revenue. And if you raise tax rates the government realizes less revenue. This has occurred many times, so to me not accepting this is the major flaw in reasoning of those supporting raising tax rates to obtain more revenue. Why is that? Lower tax rates seems to stimulate small business growth, which results in more employment. Since more people are working, more people are paying taxes. And the more money they spend, then even more people become employed serving them. And since they are not now on the unemployment, the government spends less on this expense, leaving them with more cash to apply to worthy expenditures.
Interest rates can have a massive impact on economic growth. Let’s just do some simple arithmetic. Assume a $100,000 mortgage at 7% versus 5%. The difference of 2% on $100,000 is $2,000 per year or $167 per month. That amount of money on every mortgage is extremely stimulative to the economy.