The Case for Stimulating Profits
By Arnold Kling
I am going to endorse the idea that Bryan Caplan called smart stimulus.
if you cut employers’ share of the payroll tax, this puts money in employers’ hands, not workers’. But the indirect effect is to reduce the labor surplus; employers want to hire more workers (or lay-off fewer) when labor costs are lower.
Standard economic analysis says that the employer’s share of the payroll tax is borne by workers. With flexible wages and prices, one would expect a cut in the employer’s share of payroll taxes to result in higher wages, not higher profits.
However, as Bryan points out, we are in a recession, in which wages are probably too high to begin with and there is unemployment. Under these circumstances, workers are unlikely to press for still higher wages.
Given that we are in a recession, Bryan’s smart stimulus really would, as he says, put more money in employers’ hands. That is, it would create profits and stimulate investment.
If you are a folk Marxist, then profits are bad. Your instinct is to oppose any policy that raises profits and instead always support redistribution toward labor.
However, if we ever needed higher profits, the time is now. Profits are much more cyclical than wage income. We will not have data for another month, but my guess is that the decline in profits over the four quarters of last year will turn out to be more then ten times the decline in labor income.
We especially need profits because the financial sector is contracting. I have referred a number of times to Hyman Minsky, who pointed out that investment is particularly sensitive to profits when the availability of credit is low. From that perspective, now indeed is a “Minsky moment.”
Another unhelpful framework is what I have called folk Keynesianism. I wrote,
Regardless of the state of scholarly belief about Keynes, folk Keynesianism is dominant. For example, most people believe that we should worry about whether “the consumer” will spend freely. Everyone fears that if consumers tighten their belts then this will “weaken” the economy…Instead, Keynes himself focused more on business investment as a determinant of economic fluctuations.
Tax cuts that go to consumers will be saved. Government spending, including infrastructure projects will take years to have an effect. Right now, the biggest multiplier for any fiscal stimulus would come from stimulating profits.
UPDATE: Alberto Alesina and Luis Zingales have two other stimulus proposals geared toward investment. One is to eliminate capital gains taxes for investments made in 2009 (I think that would cause much more trading than actual new investment). The other is to allow firms in 2009 to expense investment rather than have to use depreciation. However, if companies continue to lose money, the value of tax deductions is not going to matter.