I don’t know about you, but I find most of the recent debate about renewing the “Bush” tax cuts disturbing. There is a certain class of liberals out there who frame their discussion on two themes, and when someone challenges one theme, they switch to the other, but neither are well thought out. But the conservative opponents of these tax-a-holics miss the point as well.
Let us look at the two arguments of those who want the tax cuts to expire. They start out by saying that the rise in taxes is needed to try to close the budget deficit. They appeal to people’s correct instinct that the massive budget gap and the accumulated debt are severe problems, which will adversely affect generations if not drastically lowered. When their conservative opponents ask, “Why not cut spending?”, the liberals switch to the other argument. This one appeals to the greed of the ordinary person. They say these tax cuts were for the wealthiest 2% of the population, and just continuing them allows them to enjoy life even more than before.
The conservatives then give their argument: you shouldn’t increase taxes in a recession. What has happened is that the liberals have fallen into the socialist envy trap with their top 2% argument. Who owns businesses? Who starts businesses? Who employs people? Not me. The wealthy do. The wealthy are not to be the victims of envy and hatred, they are to be thanked. They are not like the lords of old, sitting around on old money, and getting more as the peasants work for subsistence food. Today’s entrepreneurs work very hard for their income, not quitting at 5 PM. They take giant risks to start and run a business; the ordinary person just takes home his salary because he did what he was expected to do. Taxing those people takes the food out of the mouths of the workers because it discourages the wealthy person from doing more of the same.
But the conservatives fall into the Keynesian trap by repeating exactly what Keynes believed: that government should deficit spend in recessions and tax in prosperity. Now the conservatives do not buy the spending line but the whole argument is based on the presumption that government should be doing fiscal policy.
For the sake of the conservatives, let us return to principle. The original Constitution explicitly prohibited “capitation” taxes, that is, taxes on people (caput is Latin for head). There were not supposed to be any income taxes, and all government revenue would come from the states apportioned by population. The states had to raise the money, which means that they had to hear the complaints about high taxes. Since the senators were appointed by the state legislators, the states had a direct line into Congress. If the tax bill given to the state was too high, the senators would vote against it. Note how this would strictly limit the spending of the government. It could not reach into your pocket and just take the money it wanted for whatever project it wanted, or to “regulate the economy.”
Along came the progressive movement and with it the income tax. I remember my grandmother, who was born in 1880, telling me that “they” promised that the income tax would only be something like ¼ of one percent, and would apply only to the rich. Well, she said that that changed very soon as the rate went up and the threshold of minimum income came down. She felt that the income tax was “sold” to the people on false pretenses. Look what we have today! The average American spends half of his working life working to give the government money, which means he works half-time for the government.
The principle that liberals and conservatives miss is not the pragmatic one about whether we should raise taxes during a recession, or how to close the budget gap, or should we punish the rich for their success. The principle is, “Does government have the right to tell you what to do with your income?” The founders would say, “NO.” Things like sales taxes or tariffs, aside from their economic inadvisability, are voluntary, because you can decide not to buy the product or service. Income tax is not voluntary. To test this theory, just don’t pay your taxes and see what happens.
In one of my own undergraduate classes in the 1960s I was arguing the same point in class, and after class a fellow student said to me, “What’s the matter, don’t you want to pay your taxes?” I responded “NO!” Even as an undergrad I knew it was wrong to just take people’s money.
Lastly, look at the mischief that has come from it: gigantic increases in the size of government, in Federal enforcement agencies, military, and national debt.
Ideas have consequences, as the title of Richard Weaver’s book points out. We are in the current financial mess not only because of the government spending money it does not have, but because we have accepted the “end justifies the means” principle, and forgot that people have a right to the fruits of their labor. Case closed.
The other day, I was watching the news on television and the news anchor was interviewing an economist who was defending the government stimulus. The conversation was occasioned by the continued bad economic reports we have so learned to expect. The economist was telling the anchor that the stimulus was the right way to go, and then made the following statement with positive excitement: “There is so much liquidity in the system [this means so much cash put in by Federal deficit spending and the printing of money by the Federal Reserve Bank] that the economy should be really chugging along!” But the conversation was about the fact that the economy was clearly not “chugging along.” It should be noted, if I did not make it quite clear, that the economist said this in a positive vein. He definitely was NOT saying that the economy was not chugging along and I cannot figure out why it is not. He was saying that his paradigm says that we have done what we should have done, and any second it will be chugging along.
Let us take a silly yet analogous story. Say that you were told that to lose weight to need to eat five of the big Hershey chocolate bars every day. After getting off the scale where you see that you gained ten pounds this week, you say, positively, “I ate so much candy this week that I should be losing a ton!” Your paradigm predicted a weight loss and, since you followed the plan, any second you should see a significant weight loss.
In both of these scenarios we see a defection from reality. Everyone knows that to lose weight, one needs to eat less candy, not more. But you accepted a cockamamie theory, and then used the theory to color your perception of reality. It is the same with this economist. He accepted the Keynesian paradigm of government involvement in the economy, which says that in times of economic downturn, it is the job of various government agencies to “stimulate” the economy by injections of money, and that will bring the country out of the recession. The economist does not believe the actual data, like you do not really believe the scale, because the theory “predicts” an economic upturn or a weight loss. This is blindness.
It’s not like there is no historical precedent for this. For all that Franklin Roosevelt is touted as the savior of the country from the great depression, he did no such thing. Actual recovery did not come until after World War II. And it came on its own.
Let us examine why pumping money into the economy does not cause it to recover. First of all we have to realize that all macroeconomic theory has to have a microeconomic foundation or it’s just fantasy. One major fault of Keynes is exactly that: he has no microeconomic foundation for his theory. He treats the macroeconomy as if it is a machine. If you press the gas pedal, it pumps more gas and air into the engine, raises the RPM, and the result is an increase in speed. This is like the little kid’s version of economics. We need to ask how the influx of mere cash into the economy will affect the behavior of actual persons.
An increase in actual economic activity begins with savings being available for the purchase of capital goods, which are used to make consumer goods in the long run. Even if there are savings, those saving must be willing to risk their savings investing in projects which over time will result in more consumer goods. All the plans of the entrepreneur for the production of consumer goods come to naught without the savings needed to purchase capital goods. Savings are an indication of savers’ time preferences. All men have a desire for things now, not later. To persuade persons to save, that is, to put off acquiring consumer goods now, their time preference must become lower. In order for a person to lower their time preference, they must be compensated in the future for goods not purchased now. That compensation is called interest or profit. The lower the time preference, that is, the longer that person is going to go without the availability of his money, the higher the interest rate is going to be; that is, the more compensation a person will demand. In economically uncertain times, additional interest that will be demanded is called a “risk premium.” Now the interest paid to the saver becomes the “cost of capital” to the producer. The producer needs to predict that he will make enough money from selling his final product to pay the interest to all those who saved to help him produce the product. The higher the interest rate, the higher the cost of capital; the higher the cost of capital, the higher the cost to bring the product to market. But in an economic downturn, people are not able or willing to pay more for things, but actually look for cheaper things. The result is that the entrepreneur is reluctant to borrow money for his project because he might not be able to sell it.
So the Keynesian-Obama solution is to pump money into the economy from deficit spending and/or money created out of nothing by the Federal Reserve Bank. The theory goes that an increase in liquidity will lower interest rates and make borrowing cheaper, so that business will be more likely to borrow and invest in capital goods, thus picking up production and employing workers again. Problem number one with this theory is that the lower the interest rate, the less people are likely to save, because their return is not worth the lower time preference. Secondly, the Keynesian-Obamaites do not understand that people learn from previous events. The most recent one is the housing boom, which started this economic downturn in the first place. The Federal Reserve, to stimulate interest-sensitive industries like the housing market, pumped money into the economy, forcing interest rates to an artificial low. Many people, who before could not afford to buy a house because the higher interest rates made housing too expensive and increased the requirements for borrowing, now wanted to purchase housing. Seeing this increased demand, the building industry, which wanted to take advantage of the boom, began investing in house-building. Now while the increase of houses for sale would lower the price for borrowers, this artificial boom put strain on all the things needed to build houses. So now wood, plumbing supplies, shingles, construction equipment, and workers are relatively scarce as compared to the previous housing market, which makes the prices and wages go up, which also means that the houses built later on in the boom are no longer cheap. The result is that people who thought they could afford a house due to the artificially low interest rates now cannot afford them because of the price. Builders are now stuck with houses they cannot sell, and now declare bankruptcy.
In addition to this government-caused disaster, the Federal government passed the Community Reinvestment Act, which pressured banks to give housing loans to those who were hardly credit-worthy (in English, this means to those who probably could not afford to pay back the money). Banks, with the help of government corporations like Fannie Mae and Freddie Mac, lost tons of money because of defaults.
So President Obama and his cronies came up with bailouts. And what did the banks do with the money given them by the Federal government? They covered the losses in their balance sheets caused by the widespread defaults, instead of what Obama thought they would do—lend the money out again. “Fool me once, your fault; fool me twice, my fault.” To make matters worse, the Democratic administration has created a period of great uncertainty with the great deficits, threats of soaking the rich (that is, soaking the movers and shakers of the economy), and the massive health care “reform.” So nothing in the economy is moving. Entrepreneurs are afraid to begin projects, savers are unwilling to lend, and people are unwilling to borrow for or buy even a cheap house. In Detroit (that gem of liberal politician successes), there are houses that go for a few thousand dollars—and no one will buy them.
In short, that is why there is no recovery, and Vice-President Biden’s Summer of Recovery tour is a big joke covered with lies about how things are coming back. Bwahahahah! So, to the economist on television the other day, I say, your paradigm is dead wrong, and I knew even as an undergraduate in the 1960s that things like this do not and will never work. Where have you been?