Eric Cantor's Temporary Tax Cuts Are Bad Economics

Cantor's proposal is temporary and only caters to a special interest group rather than everyone.

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House Majority Leader Rep. Eric Cantor
House Majority Leader Rep. Eric Cantor speaks during a news conference on Capitol Hill in Washington, D.C. Rep. Cantor and other House Republicans held a news conference to unveil the "Small Business Tax Cut Act of 2012."

Veronique de Rugy is a professor and a senior research fellow at the Mercatus Center at George Mason University.

In January 2013, the 22 million small business owners who pay their taxes through the personal income tax will see their top marginal tax rate increase to 41 percent.

Most people don't want to pay more taxes.

Everyone loves small businesses.

Take these three sentences, shake well, and you get the legislation backed by Majority Leader Eric Cantor, Republican from Virginia, to cut taxes on small business by 20 percent.

[See a collection of political cartoons on the economy.]

By design, the GOP plan would cut the top marginal rate from the current 35 percent to 28 percent and avoid reverting to the pre-Bush tax cuts rate of 39 percent for firms that have fewer than 500 employees.

While I am all in favor of lowering marginal rates and tax burden of businesses, this bill is a terrible idea. In fact, it is the perfect example of how not to cut taxes. It is temporary and it only caters to a special interest group rather than everyone.

A temporary tax cut is precisely the sort of half-baked intervention that accomplishes little more than injecting even more uncertainty into an already murky economic situation. Reducing tax rates can help spur investment and job creation, but "temporary" tax cuts never have that effect precisely because producers and consumers know a change is coming soon.

[Read the U.S. News debate: Is Obama's Corporate Tax Plan A Good Idea?]

Do Republicans really believe that companies that benefit from the reform will invest and hire new employees based on a reduction in rate that may go away a year later? Shouldn't they have learned by now that temporary tax rebates, tax credits, and tax cuts don't work?

Take the Bush administration Tax Relief Act of 2001 and the Economic Stimulus Act of 2008, two similar packages with similar effects on the economy. Which is to say, not much. In 2008 the major component was sending $100 billion in cash to Americans so they would have more to spend and thus jumpstart the economy. It failed. People spent little if anything of the temporary rebate, and consumption did not recover. In fact, formal statistical work by Joel Slemrod, a professor of tax policy at the University of Michigan, has shown that rebates generally produce no statistically significant increase in consumption because of their temporary nature. The same is true with temporary tax cuts, and temporary anything for that matter.

In fact, it is their tendency to pass temporary tax cuts—shared by Democrats—that explains the uncertainty taxpayers face today. Think about the extension of the Bush tax cuts and the payroll tax set to expire in 2013. Do they really want to add to it?

[See a collection of political cartoons on the budget and deficit.]

Now, making tax cuts permanent would be a different story. But why contain it to firms with fewer than 500 employees? If I were cynical, I would argue that it is because that particular number allows them to call it a "small business bill" since that's the main way the Small Business Administration defines small businesses. It also allows them to show that they aren't doing a favor to big business.

But no matter how much marketing matters, this is still bad economics, because it picks winners (arbitrarily defined "small" firms) and losers (larger firms).

Larger employers face an important tax burden too. The U.S. corporate tax rate of 35 percent now holds the record as the highest of all the Organization for Economic Cooperation and Development countries. It is true that larger firms doing business abroad have ways to lower their effective tax rates by keeping their foreign income outside of the country. However, making business decisions based on tax rates is hardly the best way to run a business.

Republicans should stop playing favorites and give fundamental tax reform a try. That means a broader base and lower rates for all.

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