Economics is more about people’s behavior than about money. This is why economic behavior is so difficult to control and often difficult to quantify in a usable way.

A tax rate of 25% is neither high nor low. It is relative to comparative tax rates in other countries; if you can get the same risk adjusted return in a different country with less taxes then capital will move to that country, along with the wealth, social capital, talent and tax revenue that goes with it.

It would be irrelevant to argue that we have not raised our tax in years if during that period other safe countries have substantially lowered their tax rate. Tax generating wealth will still move overseas even if our own tax rate has remained stable.

A 25% tax rate is different if taxes were recently cut to 25% from say 35%. Such a downward change may generate new investment, especially if it is now competitive to rates obtainable overseas. If it is still high compared to overseas rates then such a cut may have very little impact or change in economic behavior.

If we just raised the rate from 20% to 25% then it may have a curtailing effect on economic activity. A 25% rate achieved by a decline in the rates may have the opposite effect.

But our behavior is also determined by our emotions. Lower mortgage interest rates should increase mortgage lending yet many home mortgage holders paid of their mortgage debt when rates were very low. The reason is that there were fewer perceived safe alternatives in the investment world. The best investment was “not paying” 6% or whatever mortgage rate prevailed at the time.

With investment returns slaughtered in the last several months, people are sitting on cash with little return because it is safe. If inflation is expected people will be less inclined to invest and more inclined to spend on longer term items that will likely cost more in the future. We have not seen the second part of that yet because we still sense the deflation of lower fuel and house prices. In fear people are sitting on cash. We are awash in liquidity that every one fears spending.

The government program to force spending through the Stimulus Act will inject the liquidity into the economy, but unless the psychology of fear and lack of confidence is countered the velocity of this money will remain slow and the stimulus effect may be very short lived. If the construction worker and the truck driver and the teachers who benefit from the largess of the so called Stimulus Act do not have confidence in the future they will be less likely to invest for the future. They will hoard cash and pay down debt.

When inflation becomes obvious this behavior may change. People will buy to avoid higher prices later. This means they will invest less and further drain the investment capital.