Thursday, January 29, 2009

THE TROUBLE WITH TAX CUTS

Yesterday, the House of Representatives passed a massive $819 billion economic stimulus bill. The bill provides massive cash infusions to public agencies in an effort to jolt the economy from recession--or depression, depending on who defines the terms. Every single House Republican voted against the measure. Some representatives even labeled it "insane." Why? "Because it does not contain enough tax cuts for businesses."

Our economy is in ruins. People are starving. They are going homeless. Their life savings are evaporating. They are losing their health coverage. If the government does not act soon--and boldly--they will suffer even more. Just as Franklin Roosevelt had to act fast in 1933, so too must President Obama act fast today. Roosevelt understood that modern crises demand radical programs, even if those programs ruffle conservative feathers. Republicans in the 1930s, for instance, believed that the government had no power to create a social security office or regulate the stock markets. But national crisis shunted their pedantic criticism aside. Seventy years later, no one would argue that social security or stock market regulation are bad. At the time, however, critics said the government was "going too far" and "exceeding its powers."

Republicans are putting up a similarly doomed fight now. They do not recognize the magnitude of the crisis we face. They apply reasoning that might be sound in a stable economy, not in a depression. Rather than take bold steps, they cling to economic slogans and talismans. I often use the word "talisman" to describe hypnotic allegiance to concepts, even when it does not make sense to apply those concepts. Republican resistance to sweeping economic reform is a perfect example of a talisman at work. This is the talisman: "Government spending is bad. Tax cuts are good." If government action violates this simplistic formula, Republicans start crying bloody murder and threaten to vote against it. They reason that job creation, wealth and prosperity result when private enterprise gets to keep more money, on the assumption that rich people will use it to spend on the rest of us. On the other hand, they reason that government spending does not create "real wealth" because it results in waste and mismanagement. Republicans want low taxes all the time. That is their talisman.

That is why Republicans voted against the Obama stimulus plan to a man. It violated the talisman: Too much government spending; not enough tax cuts. Perhaps they are also just a little spiteful that a Democratic black man is so popular among the populace; and this is their chance to "sock it to him" in whatever institutional way they can. Motivations aside, Republican critics all say the same thing: "This plan is insane because there is not enough tax relief for business." They ignore the fact that the bill sends billions to Americans who need mortgage relief, health care, unemployment benefits and social help. In the Republicans' view, these desperate people don't matter; only tax cuts matter. That's it. There is nothing subtle about it. No tax cut, no vote. Too much government spending, no vote. That's how Republicans think when it comes to economic legislation.

In theory, businesses should create jobs and invest more money in the public when they do not have to pay as many taxes. After all, if a company has gross receipts of $15 million and must pay $6 million in taxes, one would think the company could hire more workers if it only had to pay $4 million in taxes. But there is a fatal assumption here, namely, that companies and wealthy individuals will spend their savings on others, rather than on themselves. In the preceding scenario, what if the company owner preferred to take his $2 million tax savings and redo his living room? What would make him hire 5 more employees, withhold their taxes and pay their health benefits? Why not enrich himself with the money? In other words, tax cuts do not necessarily lead to the public good. They could lead to reinvestment and job creation. Or they could lead to mere self-aggrandizement and personal consumption. I would venture that human beings are more likely to spend extra money on themselves than on others. Admittedly, this is a cynical view. But experience confirms that it is usually true.

Republicans are right that government spending can result in waste and mismanagement. But they are incorrect that tax cuts are a magic potion that automatically cures economic ills. In our private enterprise system, people do not spend money to help others; they want money to enrich themselves. What is the point of success if you must take your winnings and give them to others? That defeats the whole point of capitalism. The whole point is to get richer and richer, not to diffuse your money to others. Charity might be a reason to spend money on others, but that ultimately inures to the capitalist's benefit, since it lets him pay fewer taxes at year's end. Self-interest does nothing selflessly. Yet Republicans assume that tax cuts will make business owners act selflessly voluntarily. That is a pipe dream. If you give more money to a rich man, he will not transform into a saint. He will go buy a new house.

We need government spending now, not tax cuts. Government must approach this economic crisis the way Roosevelt approached the Depression in 1933. Government must take a more active role. In the 1980s, Ronald Reagan said that "government is the problem." That is not the case today. Unfettered private enterprise created this mess; winking government lassitude only exacerbated it. In 2009, we need strong government to rein in cowboy capitalism. Tax cuts will only worsen current problems. If anything, the government needs more revenues to rebuild the economy. This may chafe against Republican virtues--"it's wealth redistribution, by God!"--but rigid allegiance to private enterprise will lead only deeper into Depression. Tax cuts may be appropriate when the economy is relatively stable and the government does not need to intervene. But today the economy is not stable, and government must intervene. In crisis, people turn to the government. Government cannot ignore them. After all, despite all the technical squawking about whether we are in a "recession" or a "depression," economic strength really depends on popular faith. When people panic, lose their savings and go homeless, they think they are in a depression, no matter what the numbers say on CNBC. In the 1930s, government intervention restored public faith. Today, government must do the same.

Most people in America today have lost their faith in unfettered private enterprise. That is why they voted in Obama and an overwhelmingly Democratic Congress. They want economic reorganization, even if that means "more government spending." It is no coincidence that the Republicans--who want tax cuts--are in the minority. Congress reflects the popular will better than any other national institution. The stimulus bill is an aggressive push for change. That is what the people wanted. They have no more faith in pure private enterprise for economic strength. Only strong action will restore national faith in the economy. The stimulus bill is a good measure to begin that work. Like it or not, economic strength is as much about perception as it is about numbers. When people feel that their government is doing something about the economy, their perception will improve. That is the first step to recovery.

5 comments:

SteveW said...

You attack the fatally simplistic arguments of the Republicans with your own fatally simplistic arguments.

Example: you argue that the tax cut theory only works because we assume altruism. In truth, it is the exact opposite, and it is your model depends upon altruism. The tax cut theory is, if the government allows people to reap the benefits of their own economic activity, more economic activity will occur. The tax cut theory assumes that if you take a higher percentage from someone's earnings, that is a disincentive for them to earn beyond their required standard of living, and less economic activity occurs. Those who believe the government can stimulate the economy must believe that if you take from Peter to pay Paul, that Peter will continue to produce at the level he would have before, i.e. that he will "altruistically" donate his labors to Paul and continue to produce at the previous pace. Your own example is a perfect one if you will read it again. If a guy takes his $2 million and remakes his living room, he just provided employment for about 50,000 contractor hours, or employed 25 people for a year. That is stimulus.

Let's pretend, instead, that the government took that $2 million. First, they have to collect and disseminate it, creating $100,000 of work between his accountants (trying to minimize what they get) and their accountants to make sure they get it. Of the remaining $1.9 million, about 15% will be sent to made up beneficiaries of the thing the government was trying to subsidize (i.e. corruption), and that $150,000 will be spent on the living rooms of the folks that tricked the government into giving them the money. Of the remaining $1.75 million, $175,000 will disappear in government oversight to ensure that the people receiving the money are in fact the people who should receive the money. The remaining $1.575 million will probably be distributed to the intended recipients who will probably spend some of it on the intended stimulus item.

You may think you know where I'm going with this, but I doubt it at this point. Does $2 million taken from Mr. Rich Bags yield net economic spending of $1.575 in the above scenario? NO. It is $2 million spent in both scenarios.

This is the fallacy of both sides, yours and theirs, - it doesn't matter if the government takes it, he spends it, he saves it, he buys stock with it, etc. The only thing he can do to substantially affect the equation is to hide the money under his mattress - and rich people DON'T do that. Anything else anyone does with that money puts the money into the economy, and it is utilized. He may not spend it, but through distribution of risk it will be spent (e.g. he puts it into a low-risk savings account which is then loaned downstream by a bank).

Therefore, the difference between stimulus on the spending side is zero, even assuming 25% of the government dollars seemingly go "poof" because those accountants and grafters are part of the economy as well. So what is the stimulus difference? It is on the wealth creation side.

There is not a fixed quantity of money in the world, and either you have it or I have it. Rather, the amount of money in the world is the total sum of goods and services provided that matched up with goods and services wanted. If you can provide a good, but no one wants it, there is no transaction and that is not measured as an economic event. Likewise, if I want a good but no one can provide it, there is no transaction and that is not measured as an economic event. If I provide too many goods for what people want, but they will take them if they are cheap enough, the economy is diminished because the price of fewer goods would have been higher, leaving leftover production that could have been better utilized. Likewise, if I produce to few of a type of goods that are wanted, the economy is diminished because, although I sold the few I had at a high price, somebody else could have stepped in and made more of these goods at a higher price than they did something else that they probably did at a lower price.

(continued...)

SteveW said...

So now the question is, are tax cuts better for economic stimulus or is the government better for economic stimulus. Now that we know what economic stimulus is, the answer is quite clear (you believe that, right? :-) ).

We have to match a production event with a consumption event to produce an economically measurable transaction. Further, that transaction has to occur in the daylight or it will not be measurable. Taxes distort the economic picture in several ways.

First, they create a want for goods and services that, in the absence of taxes would not be desired (namely, accountants and attorneys to reduce tax burdens, and to follow and enforce tax laws) (diminishing event).

Second, they deprive producers of some of the value of the goods they produce, not related to the merits of the transaction making producers less likely to create as many such production events (diminishing event).

Third, they cause the recipients of the tax money to spend with limitations that would not be present in the absence of the government stipulating how the tax money is spent. This means they may be buying something they don't want very much, they may be spending just to avoid losing the money, and in any event they are not spending the money exactly the way they would want to spend the money (diminishing event).

Fourth, they cause some transactions to occur out of the daylight. This puts an overhead on the transaction for efforts to hide it, and further the transaction itself is no longer a measurable event. (diminishing event)

There is only one possible stimulating effect from taxes. The distribution of the taxes creates liquidity for the need event of a person to be met by a production event where that person may lack money to otherwise effect the transaction. However, we must subtract out the value of the transaction that would have occurred with that money previously. It's clear that we took the money from someone who was good at meeting needs and gave it to someone who was not good at meeting needs. Therefore, even though a need is now met that was not met before, it is likely that this is still a diminishing event, but it is not as clear as the above points and I think it would be fair to say that some individual transactions probably would be stimulating rather than diminishing.

Therefore, from the perspective of growing the economy, taxes are a loser every time. Taxes can create the above benefit - namely helping those who cannot have a need met due to lack of liquidity, however we must accept overall diminishment to do so. Therefore, where the need of someone is great, and their individual ability to produce a benefit for someone else is small, there is a case to be made that taxes should be utilized to meet that need. The case would have to compete with a competing private charity case, but that is much more back in the realm of opinion then as to which is better for meeting those types of needs.

(one more - on Social Security...)

SteveW said...

I have to take issue with "no one would argue that social security ... [is] bad"

Social Security is not just bad, it's a form of social insanity. The Social Security system takes 12.4 % of your income - which most financial planners will tell you is enough of your income to fully fund a comfortable retirement - and they basically destroy that money. They provide current seniors with maybe 30-40% of their reasonable cost of living, and this from 12.4% of the income of a larger pool than the seniors themselves!

Social Security is the largest Ponzi scheme ever operated, and the evidence for that is public and clear. Yet somehow, it is now revered in the public conscience as a social good that is untouchable. I will never buy that, just as if the public conscience decided that day was night or the earth was flat I wouldn't buy that either. Sorry, no can do.

Social Security is an admission to our grandchildren that we just can't plan and they're going to have to foot the bill. Of course, there will be more of us than them by then, and like all Ponzi schemes this one will collapse at that time. It will collapse, despite our current vast capacity for collective suspension of disbelief.

Even as a charitable enterprise for the poor elderly, Social Security is awful. It's our one regressive tax that the poor pay and the rich don't. The poor will not live as long as the rich, so they won't even collect as much. Further, the elderly (as a group) are the wealthiest segment of our society, so the scheme is already set to pay the rich. If it were really intended for the stated purposes, all of the above problems could be fixed with some simple corrections. Uncap the upper limit, put in a wealth/income test to collect, have a large deduction at the low end that does not pay, and just like property taxes at the local level have the rate variable to zero out every year. There is no need to run a deficit or surplus in Social Security, it's supposed to be a pay-as-you-go system. I wouldn't support even a corrected social security system, but I would at least believe them that it was intended for the stated purposes in that case.

I'm convinced the purpose of the actual Social Security system is to create a Congressional liquidity fund where they can get their hands on some unmarked bills that can be spent without either raising taxes or reporting large deficits. So, yeah, I argue that Social Security is bad. :-)

Balthazar Oesterhoudt said...

Steve, I can tell simply by the volume of your response that I touched a nerve with this one! As usual, I must start by saying that my essays always make sacrifices in detail for easily understandable rhetoric (which is always simplistic). Here, my main goal was not to justify taxation or even to utterly reject tax cuts. Rather, I really wanted to criticize "talismanic" arguments. It just seems to me that Republicans take a categorical stance on this issue. They never list all the beneficial arguments about tax cuts (as you did...and they are compelling). Instead, they simply say: "Tax cut good; federal spending bad." I think that is funny. That is why I wrote about it. I do not know enough about economics to offer detailed solutions to our crisis. All I know is that I have a sense that people are fed up with Bush-era policies and want more government intervention. Even during the New Deal, plenty of people criticized interventionism. Yet history remembers the era for interventionism. However well-intentioned the conservative arguments may have been back then, they did not prevail. I think the same thing will happen under Obama. The New Deal is historically analogous to our situation.

Thanks for your detailed analysis. I think it is a good supplement to the article itself... which is admittedly more parts rabble-rousing than cogent economic policy. But I am just an agitator, nothing more.

SteveW said...

Balthazar,
Just to be clear - I engage in a bit of reverse satire by generally presenting my comments with a more serious nature than they deserve and than I actually intend. But I am having as much fun as you are.

It's tough work defending Republicans, because they may say tax cuts and reduce spending, but where is the reduced spending? At the time, President Clinton set records for the rapid rate of growth of the government. Those records were exceeded only by Bush (and probably will be exceeded yet again by Obama). Where is a Libertarian girl to turn?

So, when defending Republicans, I often end up defending some idealized Republican-like position that doesn't actually exist. Real-life politicians always seem to be ideologically confused, and most real Republicans could not actually explain what some undesirable characteristics of a tax might be - only that they are "bad."