The great political debate of late is over whether or not to extend the current payroll tax cut that cuts into the social security trust fund… The proponents cite Barclays Bank Economists who say if it’s allowed to expire we’re looking at a 1+% hit to next year’s GDP… The opponents say it hasn’t produced squat thus far and blows another $300 billion hole in the budget – and that the proposed offsetting permanent tax-hike on high-earners will result in a net long-term hit to the economy…

Milton Friedman’s Permanent Income Hypothesis suggests that the opponents would have it right…. Its central idea being that people base consumption on what they consider their “normal” income. I.e., they maintain a fairly constant standard of living even when their incomes vary from month to month or from year to year. Therefore temporary increases in income would have minimal effect on their spending…

While I’m a huge fan and ardent student of the late Mr. Friedman, his hypothesis is, to me, unconvincing… My experience (with clients) has been that long-term allocations of income (mortgages, retirement savings, etc.) tend to be based on “normal” income… And that consumption spending (other than on essentials, i.e., discretionary) is based on discretionary income… Therefore, when an individual realizes a temporary increase above “normal” income, he/she is every bit as (if not more) likely to spend it as he/she is to save it…

Now, to the payroll-tax-cut-opponent’s point; I entirely agree that, at this juncture, it hasn’t worked… But I wonder if that hasn’t been simply the result of fear (inspiring people to save the extra, or pay down debt). And that, in a period of greater consumer confidence (that survey having improved of late), the consumer wouldn’t indeed spend every dime (record-setting Black Friday) of that temporary pick up in income…

I’m afraid the opponents, this time around, may be barking up the wrong tree… Simply stating that it hasn’t worked thus far, and therefore won’t this time, is very likely to bite their credibility come this time next year…

They would be wiser to focus on the strikingly obvious problem with “temporary” tax cuts – the fact that they’re temporary… Think about it; how can we expect anything but temporary (election-aiding) results from a temporary tax cut? And how can we expect anything but a weaker economy and larger deficits (more gov’t spending) from a permanent tax increase on any consumer/producer, regardless of his/her level of income?

And I don’t care what side of the aisle you lean to; if you don’t work for the government (politicians [especially] included), if you’re not on [or do not enjoy being on] welfare or unemployment, or if you believe that giving a man the opportunity to fish is better than giving him a fish, you cannot, with a straight face, argue that capital is better allocated by bureaucrats than it is the private sector…

As for the pending vote; look for the Republican Congress, those supposed fiscal champions, knowing it’s a fundamentally bad idea for the country, to go right along with the payroll tax cut extension anyway… I’m guessing it would be too politically risky for the dubbed “Party of No” to do the right thing… In the end, they’re all just a bunch of politicians…