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Kimberly Amadeo

Economic Growth Edges Up

By October 27, 2011

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The nation's economic growth is stabilizing from the effects of cutbacks in government spending in the first quarter (.4%) and the Japanese tsunami and debt ceiling crisis in the second quarter (1.3%).  The BEA's advance estimate for third quarter (July-September) is a reassuring 2.4%.  It's edging closer to the minimum of  3% growth needed reduce the 9.1% unemployment rate.

What's driving growth? Exports are helping manufacturers, as evidenced by yesterday's durable goods report. Another is increased consumer spending. Despite less reliance on credit cards, shoppers are hitting the stores more than ever to celebrate Halloween this weekend. Forecasts for increased retail spending for this year's holiday season are also optimistic this year.

Another boost was that Federal government spending balanced cutbacks in state and local government spending.  GDP suffers whenever budget cuts are implemented. (GDP is short for the nation's gross domestic output, which is how economic growth is measured.)

That's why further tax cuts probably won't boost economic growth at this phase of the business cycle. According to the theory of supply-side economics, tax cuts provide more income to consumers and businesses. This allows them to shop more and hire more, creating further economic growth. In time, it will expand the tax base enough to offset any immediate losses to government spending.

This theory was based on the Laffer Curve. Its creator, Arthur Laffer, warned that the success of tax cuts in stimulating economic growth depended on six factors. One of them is how fast the economy is growing already, and another is how low taxes are already. In fact, the Laffer Curve will tell you that if taxes are already low, then further cuts will only lower government revenues without boosting economic growth.

What It Means to You

I've always said that the economy is the only game where you can't sit on the sidelines. If you don't understand the rules, you're apt to be pummeled by those that do. Tax policy can be confusing (maybe on purpose?) but the theory behind it is pretty straightforward (and, if you're like me, fascinating). Take ten minutes to read about the Laffer Curve and supply-side economics. Then, tell us what you think.

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