| The Myth of Tax Stimulus |
| I have the unfortunate duty to inform you of a tragedy.
The paper that I was going to write for isn't going to happen. Quite understandably, the editor decided that she had better things to do. So, I'm going to post the two articles I had written for it on here (and maybe on my website, too). So, enjoy! The Myth of Tax Stimulus In his recent State of the Union address, President Bush informed us that his tax cuts are working. Indeed, preliminary reports (which are nearly always adjusted downward later) do say that GDP has increased rapidly during the last couple quarters. However, as all (good) statistics classes point out, correlation and causality are two very different concepts. After learning this, most economists and nearly all politicians quickly forget it. Yet, based on the correlation between temporary tax cuts and increases in GDP, President Bush would have us believe that tax cuts are the solution to economic downturns. This idea is only half true, at best. How can tax cuts not cause economic growth? In order to answer this question, we should first ask: Why do taxes decrease economic growth? The answer is simple (at least to most conservatives and libertarians): taxes remove resources from the productive private sector, and places them in the hands of the inefficient, unproductive government sector. President Bush and his supporters have accurately stated that people know how to spend their money better than the government does. This statement brings up the real point: government spending is what drags down the economy. Simply put, all spending, public or private, must be paid for somehow. Private individuals have two (basic) options: income and borrowing. The government has four options: taxation, monetary inflation, borrowing domestically, and borrowing internationally. When taxation decreases without a decrease in spending (note: “4% increase in discretionary spending” is still not a decrease), the other three financing options must be used to a greater extent. If the government decides to finance through monetary inflation, then price inflation follows. In the end, the tax is shifted from a statutory income tax to a “de facto” income tax. While earners have more dollars, each dollar buys less. But, that’s not to say that the tax cut does nothing. It has definite income distribution effects. Specifically, those people on fixed incomes are hardest hit as their incomes do not adjust upward over time to compensate for the higher prices. For every dollar that the government prints to cover its deficit, the actual incomes of our elderly and poor are being eroded. If government chooses the common option of domestic borrowing, government is taking resources out through the loan market. This demand increases interest rates above what they would be (not necessarily above what they were in the previous quarter), thereby increasing the cost for businesses to invest in productive projects that increase economic well-being. It is no wonder that this recovery is “jobless”. As long as businesses are being prevented from investing in projects, employment in the private sector will probably not increase. Even an interest rate of 3% can be prohibitively high if the available investments only yield 2%. But we have not seen price inflation. Also, we have not seen increasing interest rates. Both of these are evidence that the government may be resorting to the final option, which, unlike the others, is potentially a security risk on top of being an economic hardship. Whenever a person or a government borrows money from another, the debtor gives up a certain degree of his power to the lender. When our government starts issuing its debt to foreign governments, we are selling our freedom and security to them. For every US bond that the Saudi government buys, we are that much less able to demand that the Saudi’s stop funding fundamentalist Islamic schools. For every bond that Red China buys, we are that much less able to demand that they stop looking at Taiwan as a runaway child that needs to be beaten. Every bond that a European nation holds makes the United States that much less able to demand that Europe’s horrendous system of agriculture subsidies is abolished. Every dollar that other nations spend on US government debt makes our government less able to disagree with our allies when they are out of line and stepping on our sovereignty and, even worse, makes us less able to attack those that seriously threaten the United States of America and its citizens. However, the economic effects are also not to be ignored. Every dollar that a foreigner spends on government debt is a dollar that is not being spent on American exports. Because of borrowing internationally, fewer foreigners are eating wheat grown by American farmers. Fewer foreigners are driving cars made by American manufacture workers. Our potential exports are being lessened, American jobs are being lost, and some of our businesses are hard pressed to make ends meet simply because the government is accepting dollars held abroad in exchange for little bits of the sovereignty of the United States. But, I would be misguiding you if I said that I did not support the tax cuts. I do. But, I support the tax cuts for a reason other than stimulus (I need another reason since that one does not stand): tax cuts create deficits. I know, the view that deficits are a good thing is usually associated with John Maynard Keynes and his plans for fiscal stimulus. However, there is an entirely different reason, one that Milton Friedman points out, that I think deficits have the potential to be a good thing. As long as the voting public is convinced that deficits should be small, if existent at all, and as long as tax cuts are politically unacceptable, deficits create a political incentive for restraining spending. This, my conservative and libertarian friends, is key to having a smaller government. A government that is less a burden on the economy. A government that is less a burden in our personal lives. Estimates say that the budget deficit for 2003 will be in excess of $300 billion. That is a total of over $300 billion dollars of purchasing power being taken from our grandparents, private investment being blocked by unprofitable interest rates, and American exports being lost along with American sovereignty. But, if that $300 billion keeps the over $2 trillion total for federal government spending from growing as quickly as it has been, then it very well may be money well spent. |
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