Our Govt Must Do As We Do

Most of us know what it's like to have to spend money to make money. So why do so many find it counter-intuitive that our nation might have to do the same? We should all know that need from our own lives. Perhaps it's just that our personal vocational spending strikes us as more obvious because we know so directly that we need it.

Oil draining during auto maintenance

We live with many ways we must spend money to maintain our income, let alone increase it. For many, we start by taking out loans for a college degree, but that's only the beginning. Some of us have to purchase training or educational materials every year to keep current. And some must pay annual license or certification fees. Commuters, the vast majority of Americans, must travel to work to keep earning a paycheck, so the car payments must go out every month, the tank must be filled, and the maintenance must be done. Those in snow-prone states must buy shovels and often find ice-melting products an income-preserving investment. Telecommuters have a different set of bills for virtually getting to work, but the costs are no less necessary. Various craftsmen must spend significant amounts on raw materials. Often, the total annual material cost dwarfs the profit from the craft after covering material costs. Most shopkeepers know that story well, as it's a lucky business indeed whose net profits from selling products are significantly larger than the wholesale costs paid year after year.

What's this have to do with our government? Our government's income comes from the economy at large. That economy at large has needs just as we do individually. Commerce grows on better roads and stagnates on worse roads. Businesses thrive on an availability of healthy, qualified workers who can concentrate on their work confident that govt services such as fire and police protection will be there for their homes. And some of those workers are available during the day because after decades of honest work their parents were able not only to retire and get by in a reasonably dignified manner but also with basic medical needs covered. These things cost money. Without them, our nation's commerce would stagnate, reducing tax revenues. We can only maintain our federal income by spending on a variety of national necessities that keep our system of commerce working.

How much spending to make money is reasonable? Individually, that depends on the profession. But the simple answer is: that which at least covers what's necessary to get by but beyond that is not so much we can't profit. With all the attention on our debt, one might think we've been spending more than we can call profit. But there's more than one way to profit. The masters of finance and investment don't focus just on leveraging costs alone but also consider rates of return as well as inflation when deciding where to place bets and for how much. As Ezra Klein pointed out recently, negative real yields on Treasuries can mean "the government is getting paid to keep money safe." This implies that our safe-haven status could -- at least for a while -- mean we're profiting from our borrowing even before considering what we might be doing with that money to increase commerce. But then add in what we can be doing with the money to improve infrastructure, access to healthy, qualified workers, and more. If we do the basic maintenance on our economy plus some efforts at improvement, we should generally expect better growth. If that spending helps national income growth outpace the growth of the debt, what more justification should it need? After all, most of us invest in increasing our own incomes even when it's an ongoing cost.

But how much debt can we manage to juggle to keep oiling the gears? While that's a difficult question to answer, one might consider that historically the full faith and credit of the US govt has been more stable than houses, especially recently. Let's imagine our national govt were looking for a new home loan. We're currently taking what amounts to a voluntary pay-cut with the temporary tax cuts. Given the 2010 GDP of $14.5 trillion and our historical average revenue of 18% of GDP, we should theoretically have had a 2010 revenue around $2.61 trillion. For 2010, playing it safe by using a conservative 28% payment-to-income ratio for affordability, our theoretical govt-as-homeowner loan could have been around $14.5 trillion. In 2010, our debt was $13.5 trillion, around 7% lower than we could have afforded by traditional home purchase standards. And that's not even accounting for the full faith and credit being more solid than houses.

The Second Paradox of Thrift

We generally consider savings good for individuals as a matter of common sense. One would naturally think it would be good for the nation as well. As it was put to me at one point, "But if a household gets ahead by saving, not spending, why don't a million households?" The question requires different answers depending on whether you're concerned with those million households as an aggregate of individual spenders or as a unified spender through a national government.

The traditional answer considering the aggregate of individual spending hails as the paradox of thrift. The typical increase in savings by the average consumer comes via reducing spending rather than from an increased income. Given level income, as one consumer spends less in order to save more, that consumer increases his personal net worth. However, the decrease in spending lowers that individual's contribution to demand. If decreased spending by half the potential spenders is offset by increased spending from the other half, then there's a break even for the overall economy. But if every spender in an economy spends 1% less in an effort to save more, then overall demand for goods and services would be diminished by roughly 1%. When supply and demand happen to be matched, that reduced demand doesn't require as many employees as before to fill the orders. The resulting layoffs mean fewer people can save thus ironically causing reduced aggregate savings from a too aggressive (or panicked) shift towards individual savings.

On the other hand, if we're talking about those million households in the unified sense of a national government, we need to look at a different aspect of the question. At that point, we can shift our focus to that first part about "gets ahead". Almost no household truly ever gets ahead by saving rather than spending in real life. Saving is how households that are already ahead maintain that being ahead. Households get ahead in the first place by spending on tools to increase income (such as job training, education for higher-wage jobs, tools for trades, goods to improve and sell, etc.). Saving foolishly can be far worse than spending wisely.

In that sense that recognizes that certain debts can increase future income by more than the debt, what's good for households can be good for nations. For a nation that's already doing great, saving could do a wonderful job of steadying the already rolling wealth. For a nation that's not doing well, investments in improving the national potential will tend to do much better. In that sense, it's just like an individual. Your high-income CEO would be wise to put enough money into safe investments that he no longer has to have his job to pay the bills and just does it for personal satisfaction. Your broke high-school graduate would be better advised to get an engineering degree on loans than to try to save up from working at a gas station or other low-wage job. A nation in steady growth (or a boom) mirrors the situation of the well-paid CEO or engineer. A nation in low growth (or recession) mirrors the situation of the low-paid laborer who can't quite afford the basic cost of living and will never be able to save up enough to make a difference without taking on debt to achieve a higher income.

Simply put: If you have a high income (strong growth), it is wise to save. If you have a low income (weak or negative growth), it is more wise to spend on increasing your income. The second paradox of thrift: for an individual or nation, you have to already be doing well before thrift makes as much sense as spending wisely.

We Could Pay Off The Debt. But Should We?

We could do it. If we wanted to, we could eliminate the deficit with taxes alone. The real question is whether we should.

Debt in perspective

Yes, you've probably heard that we can't. You've probably heard the claim that the deficit is unmanageable. You've probably heard the claim that the debt is some grand, unapproachable amount that we already can't possibly hope to pay off. You've probably heard the claims that our debt is so high there aren't enough assets or income in the country to cover it.

They're flat-out false. The only question is whether they believe what they're saying or they're purposefully lying.

Here are the numbers from the census data, the treasury, the fed, and the standard deficit projection:

• Number of households in 2010: 118,682,000
• Mean 2010 household income in 2010 dollars: $67,530
• 9/23/2011 current debt: $14.7 trillion
• Projected 2011 deficit: roughly $1.3 trillion
• Household 2010 net worth: roughly $57 trillion

So take those numbers above and we can see that:

• Net worth / household: $480,275
• Federal debt / household: $123,861
• Net worth after US debt / household: $356,414 (far higher than median net worth)
• National income / household: $67,530
• Federal deficit / household: $10,954
• Net income after deficit: $56,574 (significantly higher than median income)
• Deficit / income / household: 16.2%

The particular items of interest here are: 

• $356,414 dollars left over if we were to pay all all federal debt from all household net worth today
• 16.2% as the mean increase required to eliminate the deficit with tax increases alone

As $356,414 is far above the median net worth, most people would say that's far from broke. There would be lots of problems with actually liquidating private net worth, of course, so that's strictly hypothetical. The fact remains, however, that there is enough household net worth in the US to do it and still have quite a bit of wealth. Just because it isn't something we want to do doesn't mean it couldn't be done.

The 16.2% seems like a massive tax increase. But then consider that we've had higher taxes than that before. It wouldn't be all that bad if such an increase were done in a progressive manner. For the bottom 50% of taxpayers, losing 16.2% more of income would be catastrophic. But together they only make about 12.75% of total AGI, so managing without the bottom 50% isn't so hard. For the top 1% such an increase would be easily survivable and still far below what folks with such incomes would have paid in the 1950s and 60s. Based on the AGI's if we taxed the top 1% an additional 40%, that alone would cover over half the deficit. Just for a rough example, if we were to raise effective tax rates by 40% on the top 1%, 15% on the rest of the top 5%, 10% on the rest of the top 10%, 5% on the rest of the top 25%, and 2% on the rest of the top 50%, that would net us an additional $1.38 trillion. That'd be well more than enough to cover the deficit. Whether we want to do something like that or not, the fact remains that it could be done. If we collectively wanted to, we clearly could close the deficit with tax increases alone.

If you don't believe my numbers, please look them up yourself. If you don't believe these basic calculations, please pull out your calculator or spreadsheet and run them yourself. You'll find the same thing. We could cancel out the deficit if we wanted to. And we could pay off the debt if we really wanted to. That's part of why our debt is an international safe-haven investment at very low interest rates. But there's another side to the story. Do we really want to have no national debt?

2010 Intragovernmental Holdings

Of that $14.7 trillion, $4.6 trillion is intragovernmental holdings. Over $2.6 trillion is held by the Social Security trust fund alone. Social Security needs someplace secure to hold that cash till it's needed. We don't want them gambling it on stocks or volatile commodities like gold or oil. Even if the rest of the world weren't seeing lots of instability, U.S. Treasuries are the only reasonable option. That means our federal govt must borrow at least enough to be able give the Social Security trust fund a safe place to invest. The same holds true for at least most of the rest of intragovernmental holdings, many of which are insurance or retirement accounts. We don't want them anywhere less safe; and anywhere else is less safe.

So far, we've identified roughly $4.6 trillion of debt that we want right where it is. It would be senseless to force ourselves to find alternatives less secure than the full faith and credit of our own government for those holdings.

Holders of debt, Dec 2010

The rest? As of the end of 2010, there was $802 billion in pension funds. Shall we tell all the pensioners their funds have to be less secure because our debt hawks don't want us to have govt debt anymore? There's $517 billion held by state and local govts. Shall we force our other levels of govt to engage in risky speculation? Depository institutions (i.e., banks) hold $323 billion. Didn't we already get burned by letting banks increase their risk? Do we really want to go there? Wouldn't that be exactly the opposite direction from where we've been trying to push the financial industry? Insurance companies hold $244 billion. Guess why they've put it into Treasuries ... because they need the stability in order to keep insuring us without entirely relying on risky sources to back up our claims. Then there's another $2,046 billion held among mutual funds, savings bonds, and other investors. All of whom look to Treasuries for low-risk investments to balance out our riskier investments with some safe, guaranteed income. Shall we deny all our investors -- both wealthy folks and the grandmother nearing retirement -- the opportunity to choose additional investment beyond Social Security that's backed by the full faith and credit of our govt? To stop issuing federal debt would be to say, "No, you may be ready to retire and seeking to move your funds out of risky assets, but we're not going to let you have this guaranteed income option." Do we really want to say that? Seriously?

What's that leave? The foreign portion, under a third of our debt. That's the part we could seriously consider. That's the part we could pay off without forcing our own govt institutions, companies, and individuals to shift all of their investments into riskier options. But what does that part mean to us? Foreign investments aren't invested in our debt because of attractive rates to them. Quite the opposite; they could easily choose any number of investments with higher rates. But those higher rates all come with more risk. We're the place nations stow cash in case everything else fails, safer than burying it. It isn't about making money off us; it's about making sure they've got enough money socked away where it is more certain to be available than any other option. It's about stability. That means we're issuing debt at very low rates, lower than ordinary inflation. After factoring for inflation, all the world is literally paying us to hold their money safely for them. Why should we turn that down instead of using it to improve our infrastructure and lower our domestic cost of doing business?

Bastiat's Fallacy In The Parable Of The Broken Window

Frédéric Bastiat

The Broken Window may be the most popular story among today's Libertarians and disciples of Mises. Discuss government spending, and they will almost assuredly bring up Bastiat's parable of the Broken Window as if its mere mention should ward off all thought of govt spending. Unfortunately for Broken Window devotees, Bastiat's bases his conclusion on a false assumption.

For anyone not already familiar with the story, Bastiat presented us with a citizen whose son had broken his window. Bystanders consoled the citizen with the thought that at least some good would come of the broken window in that it would mean business for the glaziers. Bastiat, however, argued that had the citizen not needed to pay six francs to the glaziers to fix the window, then those six franks would have been spent on new shoes or a new book. As such, according to Bastiat's telling, the additional work for the glazier came only at the cost of work for the cobbler, the bookbinder, or some other profession. Bastiat offered up his story as an argument against the trade restrictions of protectionism, although today it is more commonly used as an argument against figures showing an increase in economic activity in the wake of a disaster. It's also rolled out against any govt project on the basis of the opportunity cost of what might have happened otherwise.

Bastiat's fallacy: The six francs would not necessarily have been spent. The shoes might not have been bought. Nor the book. His six francs might well have sat buried in his mattress, his house fell down, and someone built over it. Bastiat and all those who call out "the parable of the Broken Window" depend upon an assumption that does not hold, namely that the citizen must certainly have spent that six francs. Clearly that is not the case. The citizen may or may not have spent the six francs. If they were not spent at that time, the six francs may have been lost or forever stored in a static asset (such as cash or gold physically kept in a safety deposit box). Even if it were spent, there is no guarantee that it would be spent in the region of the window and employ a local cobbler or bookbinder.

The safe or safety deposit box are among many options for static assets representing inactive money for our economy. For a domestic economy, any store of assets outside of that economy (e.g., in a foreign nation) will generally spur no activity whatsoever in the domestic economy while those funds remain outside. If the citizen must withdraw funds from a foreign investment to fix the window and those funds would have otherwise stayed in the foreign investment indefinitely, then activity has been added to the domestic economy. Likewise, funds that the citizen would otherwise have invested in foreign assets can not be said to cause the domestic bookbinder to lose a sale because of those funds going into fixing a window. An event that diverts funds back into the domestic economy has increased the domestic economy from funds that would not otherwise have been put to use in the domestic economy.

In Bastiat's example, this obviously means the son breaking the window did not necessarily hurt the cobbler or bookbinder. That would only be the case if the citizen was sufficiently impoverished by the replacement of the window as to be unable to afford the shoes or the book. That may have been the case for Bastiat's citizen, but will not necessarily be the case whenever a citizen's window is broken by his son. Some citizens will have spare gold in the vault or spare funds in foreign investments that they will bring into the economy in order to replace the window and still get the new shoes or book.

Beyond Bastiat's example, at least some of the funds used to rebuild after a disaster will normally have been sitting in static assets. For the region being rebuilt, it doesn't matter what those static assets were so long as they were not otherwise going to be spent in that region. That's how regions get an economic boost from disaster recovery, such as fixing windows. Of course, recognizing this effect does not mean celebrating the disaster. No reasonable person is happy to see damage just because of the effects of the rebuilding. Among other reasons for non-celebration, the additional activity for repairs will not always be sufficient to more than make up for jobs lost or suspended because of damages. Still, deploring the damage doesn't mean we can't recognize the economic effects of the rebuilding itself.

For govt projects in general, the fallacy shows us that govt spending will generally defy its Broken Window critics and add to the economy so long as the spending draws a sufficient portion from outside the active, domestic economy. Unless too much of the funding comes from taxing those on a tight budget, building a new or expanded road and hiring a construction worker should not be expected to impoverish the taxpayer even before we consider the long term benefit of the road to the taxpayer. Only taxes on those who have the least will necessarily withdraw money from the economy. Upper-bracket taxes can simply mean somewhat less being stored in static assets such as foreign investments that would not benefit the domestic economy anyway. And issuing T-Bills at today's extraordinarily low rates to pay for expanding and improving infrastructure will not tend to divert funds from business investment either. My choice of how much to invest in risky start-ups with high potential return will be determined by my risk tolerance rather than how many bonds the Treasury issues. It's a safe bet that's the case for most other investors too. That risk tolerance isn't likely to increase until we have a credible boost for the economy -- not just some half-hearted nod to the idea. Let's fix some windows. And make those "windows" big infrastructure improvements and lot's of 'em.

No, World War 2 Didn't End The Depression

There's a common myth out there that goes, "the Great Depression was finally ended by World War 2". It has some slight variations, such as "the Great Depression lasted 15 years" or even "the market didn't recover until govt spending stopped".

All of these are complete misunderstandings of history if not outright lies.

While there may not be as accepted a definition for depression as for recession, there's a good bit of consensus along the lines of these two criteria for an economic depression:

1. real GDP decline beyond 10%
2. period of decline lasting more than three years

Year	2005 Real GDP
1929	977,000
1930	892,800
1931	834,900
1932	725,800
1933	716,400
1934	794,400

Real GDP declined every year from 1929 through 1933. By 1934, the economy had been pushed back into growth again. There you have it: the end of the Great Depression. It was 1929-1933, far short of 15 years. One can not be in a depression and have real GDP growth because a depression is defined by GDP decline. One can note other factors peculiar to depression, such as deflation. But a depression only exists while there is a declining economy as measured by real GDP. One can debate what ended the Great Depression, whether it was a combination of monetary and fiscal policy, deficit spending alone, monetary policy alone, or some other set of factors. But there is no reasonable debate that the Great Depression ended years before World War 2 when the economy returned to growth.

Some effects of the Great Depression -- though mostly diminished -- did linger somewhat until World War 2. That much is true. Although unemployment had been drastically reduced before the war, it was still high until the war. Yet while it took quite a while to achieve full recovery, it did not take all that long to achieve renewed growth. Unemployment peaked in 1933. By 1936, the New Deal had kicked the economy into rolling again and -- though unemployment was still high -- the main economic indicators were back in gear. In early 1937, industrial production reached a level above that of 1929. But then pressure picked up to balance the budget, and FDR and Congress cut back spending. Although unemployment had been dramatically reduced from its peak, it was still too high for the economy to be self-sustaining. With the fiscal and monetary tightening of 1937, production dropped and unemployment went back up. Seeing the mistake, they stoked spending back up in 1938 and the recovery resumed.

Unemployment remained problematic throughout the 1930s and into the start of the 1940s. But even that measure declined every year that the New Deal was fully in force. The recession of 1937-1938 showed the effect of govt cutbacks pushed by Republicans overzealous to balance the budget at the wrong time. The cuts interrupted the full weight of the New Deal to push the economy forward. The unemployment rate continued to drop right up until the start of the war. We were already growing towards full recovery before the war. Admittedly, the massive increase of spending for the war -- far beyond that of the New Deal -- did push unemployment to very low levels far more rapidly than we would have achieved without the focus of a war effort. But the war boom runs quite the opposite of a case against spending. The extreme, focused spending for the war effort rocketed our economy higher. It was a finale to the New Deal, like a burst of fireworks at the end of a good 4th of July show. It couldn't be further from the truth to say that "the market didn't recover until govt spending stopped". When govt cut spending while the economy was still weak, the economy suffered. Except for the disastrous cut-backs that brought us the recession of 1937-1938, government didn't stop spending until the markets had recovered.

Cure For Economic Blindness: Why The Wealthy Should Want To Be Taxed

"No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable." - Adam Smith

To see poverty as good for the economy requires blindness to the effect on commerce if those starving citizens were to have even a few dollars to spend on food. If those dollars would otherwise have been idle, then ignoring the benefit of putting that money to use embodies the economic equivalent of sticking our fingers in our ears and screaming "Nyah, nyah, nyah, I don't hear you!" Rich and poor alike, all benefit from the poor having money to spend. How can anyone miss the benefit to the wealthy of more customers for their business? If it must come by filtering some larger portion from what's headed into the deep pockets of the wealthy, why worry for their pockets as long as they're still being filled? With thriving commerce, wealth grows. Expansion requires sufficient circulating money. Money sitting idly in stockpiles doesn't increase wealth but merely stores it. If the wealthy have smaller amounts after taxes to add to their stockpiles in the short term -- as long as they're left their assets and more than enough income to cover costs -- they'll gain even more by that money being put to use to generate ever more money down the road. After all, we're not talking about removing their accumulated assets that they use to reap money from the system. We're just talking about skimming a portion of what they'd be adding to the hoard (via higher marginal upper-bracket taxes) so that we can put it to active use.

Should we just cut checks to the poor then? No, there are far more beneficial ways to put the money to active use. Bring back the WPA to build new roads, bridges, and parks. Perhaps invest in a few additional backhoes and such -- especially for the road and bridge work. But for the parks, skip as much of the modern machinery as possible and issue the workers a bunch of shovels, hammers & nails, and materials and build 'em the old-fashioned way. We have a shortage of decent paychecks. We can use investments in infrastructure to fix that. And when the economy picks up and unemployment lowers, we wind down projects to ordinary levels and gradually release those workers back into the ordinary system. The infrastructure improvements will remain and keep helping business. It's a win for everyone.

Reaganomics Author Sees The Light: Bruce Bartlett's Call For Higher Taxes On The Wealthy

That's not just anybody. Bruce Bartlett called for tax increases on the wealthy. Bruce Bartlett! Bruce Ron-Paul-Staffer Bartlett. Bruce Supply-Side-Author Bartlett. The man wrote one of the first books advocating Reaganomics. Advisor to President Reagan. Senior fellow at the Heritage Foundation. Treasury official under President Bush I. Worked at the Cato Institute. We're talking about a major figure in tax reduction efforts in the 80s and 90s, responsible for convincing many to support lower taxes.

But here we are now with the lowest taxes in 60 years. We've got lax demand. The supply-side approach clearly failed for the past decade that we've had tax cuts. As Mr. Bartlett put it in answer to the question "Are Taxes in the U.S. High or Low?", "The truth of the matter is that federal taxes in the United States are very low. There is no reason to believe that reducing them further will do anything to raise growth or reduce unemployment." With tax rates already low and the economy not doing as well as it was under higher rates, there's no reason to think it'll do any better with even lower tax rates.

But now he's gone even further and, like Warren Buffett, Mr. Bartlett called for tax increases on the wealthy. That's major. That's fresh facing of reality from one of those who sold us the lower taxes idea in the first place. Even Bruce Bartlett -- an architect of Reaganomics -- has apparently seen the light. Given enough such calls for rationality, maybe we can get past the "starve the beast" insanity and start doing what needs to be done. All those folks who bought Grover Norquist's bill of goods can take Mr. Bartlett's realization as a wake-up call. It's not too late to get a grip on our situation, fix up our ridiculously low tax rates, rebuild our infrastructure, and get the American economy back in gear.

The Wealthy Don't Create Jobs; Good Jobs Create The Wealthy

What came first, the wealthy or the building blocks of wealth? This is no idle "chicken or the egg" question. Major political players base real policies with serious impact on their own answer to the question. What if most of them are getting it wrong? What if getting it wrong could wreck the system and ransack wealth?

To get the answer, the GOP base are obviously looking at wealthy investors. Our tax-cutting crowd clearly thinks they're the starting point. They say that getting more money to them will mean more jobs. The idea runs that investors bet their capital on starting or expanding a company that can then hire folks, thus jobs. This seems to pass for unquestionable truth among the "starve the beast" set. They figure that the more money the wealthy have the more they'll put into creating jobs. Even leaving aside the question of whether they'd likely choose to invest their money elsewhere, the anti-tax set need to reconsider two questions: 1) Is that usually how jobs are made? and 2) Where'd the capital come from in the first place? These two questions are necessarily linked. You can't explain where the capital came from without considering ways to make jobs without capital.

So where'd the first capital come from? Unless you think it was somehow handed over to man by divine intervention -- capital raining down from heaven or appearing from nothing -- it had to come from work. We can set aside the factor of inherited wealth, since somebody had to collect it in order to pass it down to lucky heirs. That first capital accumulating work -- whatever it was -- was collecting and/or making something that could be sold or traded. In short, it was a job. It may not have been a modern job, but close enough for our question. Somebody did some work. It may have been all on his own. Or the work may have been getting others to do things for him. But whatever it was, somebody did some work that produced a surplus. Perhaps that surplus was then -- directly or through heirs -- reinvested by getting other folks to do more work to produce more surplus. At root, the workers involved still created the surplus. The worker-created surplus was then used to spur more work to create more surplus. The job came first. The assets produced were just a product of the job that lets that job contribute to even more jobs. Get together a lot of surplus produced from a lot of jobs, and you've got wealth. Even if you then use that wealth to spur more work that creates more wealth, the wealth still didn't create itself but rather came as the sum effect of the work ... the jobs.

"Labour was the first price, the original purchase - money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased." -- Adam Smith 

Ultimately, the idea that wealth comes from somebody investing in business is a myth. If I build a factory and hire 50 people to make widgets, I'm not going to get any return on my investment unless there are people who can be interested in widgets and have enough money to spend on my widgets. If my widgets aren't essentials, those people will only have enough money to spend if they're making a surplus beyond the cost of living. Even if the widgets are essential, folks who don't have an income aren't going to be buying many widgets. If I don't have enough potential customers to break even, I'm not going to be employing those 50 widget makers for long. But if I have enough customers to make a profit, I'll keep employing them. And if I have too many customers for them to keep up, I'll hire more. Then who really created the wealth I reap from my factory? Sure, I made the factory investment that allowed me to sell widgets. But without the customers, that investment would have just been a foolish building that couldn't support long term jobs. It's the customers who really make the difference.

Jobs further wealth in two ways. Obviously there's the surplus collected by the initial business owner. But there's also the circulation of resources wherein the worker's share of surplus is spent at other businesses. The worker's paycheck allows him to be a customer contributing to other jobs that yield other surpluses for other business owners. The paychecks from those other jobs may in turn be spent at yet further businesses or even end up winding back to the initial business. Jobs have no choice but to create wealth, even when they fail to do so directly for a specific employer. Unless they're inefficient jobs, they'll create a surplus. And even if they're inefficient jobs they'll mean money for workers to spend at efficient businesses yielding surplus. The job just can't hold itself back from contributing to the creation of wealth. Wealth, on the other hand, can sit idle. It can be stored in some valuable thing that'll sit collecting dust. Sure, wealth may be further invested in jobs and help yield more wealth. But it can also hang on the sidelines for years or even centuries and do nothing productive.

Clearly it's the job that creates the wealth. We can use that answer to figure out what to do to get our economy rolling again. We want wealth and jobs. We need to push the one that creates the other. If we change our tax structure to get more money to the wealthy, we're just tinkering with accelerating redistribution of income to the rich who may just sit on it. That risks having it grind to a halt if too much money is removed from the system to just sit idly in the stockpiles of the wealthy. I'm all for building wealth, but not at the cost of having all the money locked down to the point where it no longer flows from business to business through employees and customers. Since wealth ultimately comes from jobs, those of us who want both more jobs and more wealth need to focus on jobs in order to get both. With more wealth, there doesn't necessarily have to be more jobs. With more jobs, there will be more wealth.

Now we've got a situation where there isn't enough demand for products and services to spur widespread hiring. Too many people don't have enough money to spend. And unemployment causes much of that current lack. Private industry can't fix the situation because it won't make any sense for them to hire until there's demand for products and services. There's only one credible way out: govt must step in to fill the void. Govt must stop hiding their heads in the sand and pretending that we can count on the wealthy to hire out of the goodness of their hearts -- without enough demand causing it to make sense as an investment -- if we just help a bit more money stick in their accounts. Govt must stop laying off workers and start hiring so there will be more paychecks to spend on goods and services. And to do that, govt is going to have to start leveling with us and facing that we'll have to rack up a future bill in order to make things work here and now ... and for the future.

What Can We Really Learn From Estonia?

S&P Downgrade of U.S. and Upgrade of Estonia Inspires Misguided Admiration

In the wake of a few recent S&P decisions, fans of budget cuts are practically waving the Estonian flag. They point to Estonia's recent austerity measures and it's Q1 2011 growth as some sort of vindication. "Look, look ... we've got a positive example!" Ah, but if only it were that simple. There's more to Estonia's austerity and growth than meets the eye of the starve the beast crowd who would have us emulate their example. Estonia chose "internal devaluation," including wage cuts. So keep in mind what following the Estonian script would mean: big wage-cuts and a lower standard of living. Who really wants to sign up for that?

But more importantly, one should take a closer look at the impact on the Estonian economy before declaring them a model that everyone should copy. I'd swallow some short-term pain if it made the overall situation better for my country in the long run. But in the case of Estonia, the trouble didn't entirely end with the turn-around from the -13.9% plummeting GDP in 2009 to the 1.8% growth in 2010 and varying more-or-less positive growth forecasts for their future. While Estonia has returned to GDP growth, they're doing so on the backs of their neighbors. The one bright-spot in their economy is exports, which were up 43% from a year earlier in June. (Although June's figures showed a drop from the previous month.) Their unemployment remains high. Their retail sales and non-govt construction are both still down significantly. The domestic market isn't looking so good there. But in Sweden, Russia, and Finland demand is rising. All three of Estonia's biggest foreign markets saw significantly higher GDP growth in 2010 than Estonia. The strong growth continues in Sweden in particular ... plenty to explain why Estonian producers have still had a market in the face of lower internal demand. Having growing trading partners is great. But in the long run it's a poor substitute for steady internal demand. Estonia's internal devaluation has made them even more dependent on their neighbors. Should the growth in Sweden, Finland, and Russia cease or even slow down significantly, Estonia could find itself in deep trouble with no fuel for its economy. That sort of dependence on -- and vulnerability to -- foreign trade partners has lots of drawbacks. Sacrificing domestic demand to gain foreign demand means a weakened domestic economy.

So what can we really learn from Estonia? Mainly that it's good to have trading partners who have money to spend on what you're making. That's not a lever we (or anyone else) can control. It's up to our trading partners to keep their economies moving. Aside from maybe lending the occasional wrench, we can only look to get our own engine revving again. But we can also learn that worrying too much about increasing our exports can cause a nation to become export dependent -- at the mercy of the whims of foreign markets. While that may be nice when those markets are thriving, do we really want to count on them completely and make ourselves export dependent? Wouldn't you rather we fixed our domestic shortage of demand instead of sacrificing what's left of it in the vague hope for an uncertain boost to exports?

Tax Me!

I want patent protections for my business to keep an advantage from its inventions. Patent registration and enforcement costs money. Tax me!

I want my company to be able to hire qualified workers. That means education can't put students in such debt that education isn't a worthwhile investment. Subsidizing education costs money. Tax me!

I want quality schools for my business to have competent workers. That costs money. Tax me!

I want quality schools for MY CHILDREN to be able to compete in the global market. That costs money. Tax me!

I want safe foods. Maybe most farmers mean well, but agribusiness has demonstrated time and again that it does not always do a good enough job of safeguarding food without govt oversight. That costs money. Tax me!

I want safe cars. Reputation helps motivate good engineering, but not enough. Govt standards have made a huge difference. Developing and enforcing good standards costs money. Tax me!

I want good roads on which I don't have to pay per trip. Private industry won't give me that. Roads cost money. Tax me!

The same goes for bridges and tunnels. Tax me!

I want to be able to breath clean air. Developing and enforcing air pollution controls costs money. Tax me!

I want to be able to drink clean water. Developing and enforcing air pollution controls costs money. Tax me!

I want at least basic flood control measures built around rivers. Private industry has no profit motive to give me that. Tax me!

I want police protection, both for my company's assets and my own personal assets. Tax me!

I want military protection so that I have no worry that some despotism beyond the reach of my vote might try to mess with us. Tax me!

I want military protection so that pirates -- who are quite active in parts of the world these days -- will expect that attacking our ships would mean that massive naval force would be breathing down their necks. I want them to expect that attacking American citizens in any waters anywhere would soon result in Navy Seals jumping up out of the water into their boats -- after the Seals finished snacking on great white sharks -- to teach 'em a lesson about picking on innocent folks. Training Seals costs money. Tax me!

I want veterans who risked their life & limb to defend my country to be well care for, medically and otherwise. Tax me!

I want to be able to say my govt was largely responsible for finding the cure(s) for cancer. Tax me!

I want to be able to say my govt was largely responsible for finding the cure for AIDS. Tax me!

I want to be able to say my govt was largely responsible for finding the cure for anything else horrible. Tax me!

I want there to be no hunger from poverty in my nation. Private charities haven't managed to cover that alone. And private industry isn't either. Tax me!

I want there to be nobody in my nation who can't find shelter when they need it. It doesn't have to be nice, but it has to keep 'em dry and not too cold. Tax me!

I don't want monopolies eliminating all competition, driving up prices, and reducing my product/service choices. I particularly don't want my company to have no chance to compete on the quality of our output just because some other company has 99.9% of the market. Anti-trust efforts cost money. Tax me!

I don't want various industries dumping dangerous chemicals into my drinking water, crop land, playgrounds, parks, etc. And by the way, without govt interference, lots of industries do that. Tax me!

I want violent crimes to be investigated and the criminals to be prosecuted. Tax me!

I want the innocent to be protected from unreasonable prosecution, even if they don't have the money to defend themselves. Tax me!

I want diplomats on the task of making sure American companies can compete fairly abroad. Tax me!

I want consular services making sure that when I travel abroad -- whether for business or pleasure -- I can expect my govt to be looking out for my interests even there. Tax me!

When I take a domestic flight, I want to be able to expect the air traffic to be well coordinated. Tax me!

I want investment in research and development that will grow American business. Tax me!

I want to be able to say my govt recently built things as impressive as the Hoover Dam, the federal highway system, and all those other great things of the past. No -- strike that -- I want to be able to say we built and did things far better than anything done before. Tax me!

The Keynesian Home-owner vs the Austrian School Home-owner

The Austrian School of economics would have us leave our hands off the economy. Get govt out of the picture, they say, and everything will tend to itself better. Let's explore what that would mean from the perspective of a home-owner's lawn.

Under laissez-fair lawn care, no amendments could be applied to the lawn, no fertilizer and not even water. Should there be a drought, the grass will be left to brown. There would certainly be some benefit to this in areas with a water supply shortage, but it could lead to soil erosion if the grass is not replaced quickly enough. If the Austrian School home-owner had pets that left "presents" on the lawn, that raw manure would be left to sit and create patches of dead grass. Through natural secondary succession, soon most of the grass will be replaced by shrubs and trees. Eventually it will become a forest instead of a lawn. While that's great for harvesting timber and for woodland habitat, it's not much good for having space for kids to play in the grass, for a place to set up your grill for the 4th of July (as overhanging trees would be dangerous), or for much else of what most of us want to have and do right outside our houses.

The Keynesian neighbor, on the other hand, does not share the Austrian's faith that a hands off approach is always best no matter what's going on with the lawn. Instead, the Keynesian will consider whether there's some way to help the lawn stay a nice, green area in which to grill, read, work, or play. Depending on his experience -- or means -- the Keynesian will start with some test to determine the health of the lawn. It might be just looking at whether the grass is green and the soil is dark. Or it might involve testing pH and nitrogen levels. When the soil lacks nutrients, opinions will vary among such home-owners whether it is best to use organic fertilizer or manufactured amendments. But most will have studied the options at least enough to know to avoid raw manure, as that will tend to burn the grass. Some will find that all they need to do is spread some extra seed -- perhaps drought resistant varieties -- where the grass is looking a little thin. Some will worry about every little weed, while others will be content to enjoy the dandelion blooms as long as the lawn is more grass than weed. While the occasional such home-owner will experience setbacks, extremely few end up doing their lawn more harm than good. Most will end up with a lush, enjoyable, robust lawn on which their kids may play and they may eat their hot-dogs and hamburgers in satisfaction. Some will even improve their landscape enough to raise the market value of their house.

"But wait,", you might say, "what's this have to do with economics? After all the economy isn't just a lawn." Yes, and there have been metaphors that shot and missed at capturing economic truth. But consider: life lacks perfection. If the base, natural state of humanity were a perfectly functioning economy without government, governments would never have been able to compete with the raw anarchy before that first tiny government. That first bumbling govt meant the group that formed it obviously out-competed neighboring anarchism. Govt is our means to seek the greener economy in which we wish to see our children play. We develop rules that help us succeed.

Beyond that, aside from its competitive ability, govt is our means to push our economy to look the way we want. Without govt, what happens? Some industries left on their own will do the right thing because they're run by someone with a sound moral compass. Others are run by those who care only about wealth. And these -- absent govt -- will do things like Sinclair described in The Jungle and others have recorded elsewhere of the dark days of unfettered industry. Absent child-labor laws, there would again be five year old girls working 12+ hour days in sweat shops. Absent work-safety laws, those same kids would once again very rarely make it to adulthood without being mangled in a workplace accident. Absent food and drug regulation, we would once again have reason to expect not just the occasional problem but rather frequent death and debilitation from our food and the snake-oil that would pass for medicine. These are the dark and dangerous plants that would invade our lawn if it were not for govt regulation and oversight. Were the Austrian School to fully succeed in their nightmarish dream of entirely unfettered markets, we would likely soon see our economic lawn overwhelmed by poison ivy and thorny trees. If we're to have a place to grill safely and for our children to play on fields of grass, we need to tend our lawns.

And as a bonus, it may well increase our property value.

Pawlenty vs FDR

Sustained five percent growth? One might ask when we could possibly find an example of that sort of growth in American history.

From "Pawlenty’s 5 Percent Growth Solution Makes Historical Sense"

"So, yes, the U.S. economy has indeed shown an ability to grow at an average of five percent over a 10-year period. The problem for Pawlenty, and for many other modern-day politicos who believe they know the secret to rapid growth, is that all this growth came under Franklin Delano Roosevelt.

In the 1930s, as Roosevelt and his allies saved American-style capitalism from its own gaudy excesses and pathetic failings, Republican opponents, business interests and trade groups stomped their feet. They accused FDR of being a Socialist, of burdening the economy with regulations, of scaring investors by fomenting uncertainty, of hampering investment by instituting a new safety net, of placing restrictions on a bankrupt Wall Street and banking system. These crazy Keynesian schemes would never work. Why, they would turn the U.S. into a weak clone of the U.S.S.R., unable to compete in global markets, lead, or stand up to external enemies. (Plus ca change. . .)

Of course, the exact opposite happened. In the 1930s and 1940s, the U.S. economy (and its stock market) got back on its feet, rediscovered its capacity to grow, expanded and then led the world to victory over Fascism."

Sadly, Pawlenty is no FDR. Despite all the Republican grumbling about President Obama, sadly, President Obama is no FDR either. But who knows? Maybe there's a chance we voters will get our act together in 2012 and elect a Congress full of FDRs in response to what the Republicans have been trying to do. That's the only way we'd be likely to see that sort of sustained growth any time soon.

Gross Govt Impact

The idea that we should make huge govt budget cuts is premised on the notion that our economy would be better off that way, wouldn't be hurt by it, or at least would soldier on about the same. Sometimes the best insight into that notion comes from people who weren' even discussing budget cuts directly. Daniel Gross's recent article about whether to buy bonds or not didn't touch on the idea of budget cuts at all. It's one and only focus was on whether US govt bonds are still a safe-haven investment compared to stocks. To explain that, he covers the impact on stocks if the US runs up against the debt ceiling and stops spending to not default on bonds.

"The U.S. government occupies a pretty large footprint in the economy. It employs 2.85 million people directly. Next, think of all the businesses, many of them publicly held, that rely on the government  for a big chunk of their business. For-profit education companies, defense contractors, the entire health care industry, Wal-Mart and other retailers that cater to people who depend on federal benefits to help pay their grocery bills. Every large consulting firm, every large tech firm (from Microsoft to IBM) has a large unit that provides services and products to the federal government.

Should the U.S. bump up against the debt limit without resolution, it's possible the Pentagon would delay indefinitely the signing of new contracts for fighter jets. Or agencies would cancel or slowdown payment on IT projects. Or Congressmen and their staffers would see their wages reduced. Or fewer people would get food stamps. The cumulative impact would be less demand, less economic activity, more uncertainty."

In pointing this out, Mr. Gross was ostensibly more concerned with explaining why bonds seem a relatively safe investment at this point. He says, "government reliance on debt to fund of operations and investments is so great that they'd rather alienate workers and citizens and taxpayers than anger the bond market." So all the explanation of what they'd have to do to avoid angering the bond market just explains why stocks are the more risky bet despite debt ceiling fears.

Yet there's a far more important take away than Mr. Gross's surface question of whether it makes more sense to invest in bonds versus stocks. Those payments we'd have to avoid making? They're a lot like the cuts the GOP wants to make. If the Republicans got their way -- the whole thing for which they're playing chicken with the debt ceiling -- we'd see most of those cuts. No wonder they don't care about the debt ceiling, if what they figure we'd avoid paying to avoid default are the things they don't want to fund anyway. And "Of course, all these moves would be contractionary — they'd help slow economic growth."

Contraction, by the way, is more or less a general term for things like recessions and depressions. Mr. Gross didn't speculate on whether those non-payments (or cuts, if de-funded in a relatively orderly manner) would cause a mere recession or a full-fledged depression. But that's really the remaining question for anyone who might be paying attention to where the Republicans goals would shove us. If the Republicans get their massive budget cuts, the question isn't whether it'll hammer the economy, the question is only how hard ... and whether we've ever seen it hammered that hard before.

Why Business Hires, and the Deficit Isn't It

Why would you hire a new employee for your business assuming you had one? All of the answers generally come down to one root: to make the company better.

Better could be a lot of things: producing more products/services, reducing vulnerability to some risk, producing better products/services, improving public image, broadening supply resources, strengthening relationships with vendors/clients/customers, etc. They all more or less seek the same goal. You want your company to bring in more income and do so more reliably.

What's this have to do with the deficit? Nothing.

Seriously, how many businesses can you name that consider the deficit when making a hiring decision? A few financial companies may occasionally see some impact from really big deficit changes on the need to create or eliminate positions related to bond trading. That's most of the jobs that are impacted by the deficit in any real way. Ordinary businesses hire because they need more employees to cover their production or to pitch their products, with absolutely no factoring in the size of the deficit.

None the less, Republicans want us to focus on cutting the deficit despite that many of them campaigned on the idea that they would improve the job situation. So now they're trying to make people think there's a connection between what they promised and what they're trying to do.

"Cutting the federal deficit will create jobs" -- Rep. Cantor (R-VA)

That's completely and utterly divorced from any sort of reality on where we get jobs. The GOP have begun spinning elaborate stories to try to pretend there's a connection. Why is Rep. Cantor making that claim? Voters are concerned about jobs. The Republicans know that right now there's no better pitch for anything than jobs. And they wants to eliminate any govt program they can get their hands on. There's no way to get more support for their plans to ransack govt than to convince voters that it'll help what voters really care about: jobs. Unfortunately, the truth is quite the opposite. The truth is that -- during a troubled economy -- the sort of cuts the Republicans are pushing are worse than doing nothing at all.

Cutting the deficit won't give businesses more customers. Cutting govt spending takes customers away from businesses that provide goods and services to the govt. That's most businesses. Indirectly, that's all businesses. During good times, when the economy is humming along at a fast pace, a govt cutback wouldn't necessarily be a big problem. With the economy struggling to recover from the massive credit crunch and layoffs that were the finale of the Bush II administration, we can't afford so many businesses losing demand from govt purchases. The most obvious reason to hire is to handle greater demand. The most obvious reason for layoffs is because of a drop in demand. There's no more surefire way to drive ourselves back into recession -- or worse -- than massive budget cuts. That's a recipe for even higher unemployment.

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On a related note, for a decent catalog of the Republican record as far as jobs, see ""Where Are The Jobs?":The GOP's Two-Year Campaign Against Job Creation and Economic Growth"

The Sprint Towards Insanity

Wow. And we thought things were getting a bit nutty in the 2010 elections. One has to wonder, since the Democrats have adopted so many of the Republican ideas (e.g., cap-n-trade, etc.) years after the Republicans brought them up: For 2016 will the Democrats also embrace something like what's going on in the Republican party today?

Michael Tomasky said it well, in "The Lies and Lunacy in Tim Pawlenty's Economic Plan", "The Republicans have lost any connection to earth, and the Democrats are afraid (with a few noble exceptions) to tell the American public the truth."

It is in this context, that perhaps we shouldn't be entirely surprised that among the notable celebrated likely serious contenders for the GOP Presidential nomination are Santorum, Romney, and Gingrich. Santorum is so far right-wing that he's been known to make other conservatives nervous. Romney is best known for a plan from which he's desperately trying to disassociate himself and claim it wouldn't be good for the country. And Gingrich has that remarkable contradiction of championing the "Defense of Marriage" while himself going through wives like tissue during cold-n-flu season.

In a nutshell, the GOP is running a bowl of mixed nuts.

Ah, but there's Pawlenty, right? For quite some time, most of what we heard about Pawlenty was that he might be a bit boring ... that he lacked charisma. Perhaps he's not so boring after all. He's put forward a "plan" that's more or less total fiscal insanity. That's some exciting stuff. You can't be entirely boring when you put forward a plan that ridiculous. Then again, it does rather come across as the natural extension of the direction in which Republican policy has been heading.

As Tomasky put it,

"The lie, which one hears from Republicans on cable television on a daily basis, is that “we spent our way into this crisis.” Yes, federal spending has gone up significantly in the last decade. But increased spending wasn’t as decisive as decreased revenue. The truth can’t be said often enough: We did not spend our way into this crisis; we de-taxed our way into it."

If folks take that lie and base their world around it -- around the madness that cutting taxes would always be good and couldn't possibly be the real cause of deficits -- then they're going to come up with some really absurd plans.

How's that Austerity Going?

Time for an update on how austerity efforts are going.

In Greece, a movement of protesters called Indignados has spread from Spain where signs had taunted, "Quiet, we mustn't waken the Greeks". The effect has reportedly been to transform the previously violent protests into more peaceful protests featuring waving of the Greek flag, much discussion of their situation, and a broad variety of Greeks coming together to reject the Euro plan to shove economy-crushing cuts down their collective throats. In addition to the general protesters, Yannis Palaiologos writes that "more than a dozen of the governing party's deputies are openly expressing their reservations about the new measures, while the main opposition party adamantly refuses to lend its support".

In the U.K., a long list of economics/business profs and other notables wrote a collective letter in the Observer saying, "As economists and academics, we know the breakneck deficit-reduction plan, based largely on spending cuts, is self-defeating even on its own terms. It will probably not manage to close the deficit in the planned time frame and the government's strategy is likely to result in a lot more pain and a lot less gain." They also offered up a rough start of a plan B, though the chances of the Cameron govt accepting their plan B seem low.

In Portugal, Bloomburg reports that "Portugal may have followed Greece into recession even before implementing austerity measures demanded for its European Union bailout that are set to further choke the economic growth needed to tame the country’s debt."

In Ireland, Eamon Quinn reports that, "unemployment has soared from 4.4% in 2007 to 14.8% in May." Their main hope for recovery seems to be an exports boom, although that seems unlikely to overcome the impact of severe austerity measures.

As for Spain, per Sylvia Poggoli, "Under international pressure to cut its deficit, the government imposed sharp austerity measures — cutting public service workers' salaries, freezing pensions and drastically reducing public expenditures. The immediate results: a 20 percent drop in consumption and Europe's highest jobless rate, 21 percent." No wonder they have Indignados.

Cuts Damage: Even for the Body Politic

"For every $1 the government doesn't spend, economic activity shrinks by as much as $2."

from Insights on Stimulus, Thanks to the Mafia

This insight comes from an Italian study showing that when they freeze spending for government project in areas where Mafia corruption was found, the reduction in government spending leads to an even larger decrease in economic activity in the region than the amount of the initial cut. Not only do private sources not step in to make up for whatever the government doesn't spend, but without the government project there is even less private spending than there would be otherwise.

There are, of course, limits to how much the ratios seen in that study will match the ratios one would see elsewhere, such as in the U.K. austerity programs or the massive budget cuts that the GOP is attempting to foist upon the American people. However, the general mechanism will apply. When you're looking at useful infrastructure improvements [roads, rail, bridges, etc.] and/or programs upon which businesses rely for stability -- such as having their healthy, able-to-work labor supply not bogged down with personally looking after their grandparents -- [Social Security, Medicare, etc.], these things will generally hurt economic activity if government significantly cuts spending.

Runaway tax cuts

"The biggest culprit, by far, has been an erosion of tax revenue triggered largely by two recessions and multiple rounds of tax cuts."

- from "Running in the red: How the U.S., on the road to surplus, detoured to massive debt"

This should be old news. But yet people still blame it on spending growth. Why? How is it that the misinformation of yelling "runaway spending" somehow speaks louder than the truth of "runaway tax cuts"? Why is it so hard to look at the drop in revenue and realize that it's the biggest problem?

Speechless

Rep Crowley (D-NY)

US Stimulus vs UK Austerity

"Unlike the US, where rampant 'stimulus' spending and deficits continue apace, the UK opted for 'austerity.' The country sharply cut its spending and raised taxes, in an attempt to get its fiscal house in order.  Unfortunately, this immediately plunged the economy back into recession. 

The US, meanwhile, kept its foot on the gas, racking up massive deficits and debts but also stimulating solid if unspectacular economic growth. The US economy, therefore, continues to grow.  And at least for now, inflation is under control."

from Does The UK’s Lousy Economy Prove It? Were Paul Krugman And Keynes Right?

NGA Speech Highlight

Interesting highlight from today's speech to the National Governors Association:

"All told, the budget cuts I’ve proposed will bring annual domestic spending to its lowest share of the economy since Dwight Eisenhower. Let me repeat that. Under my budget, if it were to be adopted, domestic discretionary spending would be lower as a percentage of GDP than it was under the nine previous administrations, including under Ronald Reagan’s." - President Obama

What is Small Government?

What does small government mean? Those calling for massive cuts say we've got big government and they just want us to get back to small government. They say that whoever disagrees with them wants "big government."

Like pretty much all of my fellow Americans, I want govt to stick to its appropriate role. I want a government that does only what we need it to do. But what if that's what we've got now?

Comparing against other modern, industrialized nations would be one way to put it into perspective. In 2009 we had larger than normal expenditures from stimulus and lower than normal GDP from the Great Recession. That year, we had a GDP of roughly $14,258 billion and total Federal spending of $3,518 billion. That's 24.7%. In the same year, the U.K. central government spent around 32.6% of their GDP. Looking back to the more normal levels of a year that doesn't include stimulus spending, in 2007 our Federal spending was 19.38% of our GDP. That same year, the U.K. central government spent 28.44% of their GDP. That's how the general trend goes. Between 1995 and 2010, the our national govt spending undershot their national govt spending by 8.7% on average.

National govt spending as a share of GDP in the US and UK

The U.K. is far from alone among the other industrialized nations in dwarfing our national govt spending.

Expense (% of GDP) in 2004 from data.worldbank.org

By and large -- though some other countries often run budgets proportionally similar to ours -- we have a relatively small government compared to the other industrialized nations.

Perhaps one could argue that maybe the general trend in the other industrialized nations is to maintain giant governments that dwarf our so-called big government. If that's the case, we should easily be able to find vast, expensive programs that we don't really have any use for in our society ... that few of us would want government to do. Where are those programs?

Shall we cut infrastructure spending and let our already crumbling roads and bridges decay further, making it harder for our businesses to transport products? Shall we dismantle Social Security and allow elderly citizens to starve in the streets? Should we stop investing in the medical research that has helped make our biomedical industry such a large contributor to our GDP? Shall we stop funding education and fail to foster skills needed to compete in the modern global economy? Shall we stop monitoring our food supply so that producers can get away with cutting corners and contamination runs unchecked? Shall we cut billions by stopping payments for police, fire-protection, and border security?

These things are all quite necessary from the government. A modern society doesn't function as well without any of that. When you look at charts showing a much smaller government hundreds of years back in our history, keep in mind that we had an entirely different economy back then. We didn't have the transportation system that we have today. We didn't have a social safety net to make it so an elderly miner could retire rather than just working till he died nor workplace regulations to make it less likely for him to die of black lung. We didn't have such a thriving biomedical industry both making our health better and enriching our nation. We didn't have a workforce capable of designing high-tech products to sell to the rest of the world. We didn't have most of the great things about our modern economy that require government programs to work smoothly and in many cases to function at all. One can't expect the economy of the 21st century to operate with the government spending levels of the 18th or 19th centuries. When we had significantly smaller government, we also drove horse-drawn carts, used outhouses, suffered polio, and couldn't reasonably expect to have a chance of ever retiring. Should we really be basing our idea of appropriate government spending on a time to which we wouldn't want to go back in any other way?

Govt Bakers: Cutting the Fat? Or Let Them Eat Cake?

Marie Antoinette

Sen. Toomey (R-PA) in the Wall Street Journal claims, "For too many years, Congress has ignored or exacerbated the looming fiscal crisis created by overspending."

Has it? Has it really? We've got a Congress chock full of GOP members telling us we need to cut, cut, cut because we've been "overspending." So where's all this alleged fat to trim?

The Defense Secretary has suggested we may be able to spare about $78 billion from the defense budget, which is a fair slice of savings. For the defense budget that's not all that far over 10% of their piece. As Gates puts it, "not every defense program is necessary". While I'm no military expert, I hear there's some trial and error in designing new programs. That's a low enough percentage that I could imagine chalking up that much in unnecessary projects.

That's nice, but to zero the deficit immediately by cuts alone -- without undoing those tax cuts -- we'd have to cut about a third of our spending ... not just 10% and not just from defense. Various members of Congress have proposed slashing or even eliminating various specific programs. For instance, Rep. Bachmann proposed cutting what we spend on taking care of our loyal veterans, which left a bad taste with just about everybody else. Turns out that for every program they propose chopping, a bunch of people start pointing out good reasons why we need those programs.  There really just isn't that much we can trim from the budget without mayhem.  There may be some waste, but not a full third of everything.

The GOP keeps telling us that if we just charge the wealthy less at the figurative bakery register, they'll buy more cigars, the cigar makers will buy more bread, the bakery will expand, and there'll be more bread to go around. The bakery took in less money and had to borrow money to keep baking our bread. When the Republicans tried to tell us the bakery should just stop supplying whole-wheat to avoid borrowing, we said, "no, the national diet needs whole-wheat". Now the Republicans say the problem is we bake too much cake.

Reagan, Tax Cuts, and GDP

In honor of the 100th anniversary of President Reagan's birth, lets take a look at the effect of his tax cuts for the top marginal rate. When we looked at the course of the past 80 years as a set, it looks as if there isn't a particularly clear correlation between top marginal tax rates and GDP growth. But what if we weren't looking close enough? After all, the last few decades seemed to have a noticeable symmetry.

Where should we look? For President Reagan, whose tax cuts came into play around 1982, we should see those rates working their magic on the economy by two years later in 1984. The rates would continue any effect after President Reagan left office, so lets keep looking up through 1992.

Tax rates on left scale; GDP growth rates on right scale

Inspiring, don't you think? Apparently that GDP growth going down in about the same slope that top marginal tax rates were going down must have been what they meant by "trickle-down."

Of course, that might not be entirely fair. We should probably look at the President's entire term and see what happened in case we can credit the tax cuts immediately with a big initial boost that gradually faded.

Tax rates on left scale; GDP growth rates on right scale

As seen in the chart of 1980 to 1992, there is indeed a big spike in GDP growth immediately after the tax cuts begin. Yet that conflicts with what we see in the rest of the chart. Why would lowering taxes correspond with expansion in one section of the chart and contraction in another? In this case, we need additional data: the Fed rate. The Fed ramped up interest rates brutally high for the early 80s in order to tame massive inflation. The Fed rate had been slowly ratcheted up over 1978 and 1979. The rate for 1979 started at 10% and went up to almost 14%. For 1980, the rate averaged 13%. For 1981, the rate averaged over 16%. The prime interest rate even ventured into the 20s in 1982. These high rates did tame the inflation, but in doing so they brought on the recession of 1981-1982 because they made it much harder to borrow to invest for growth. Naturally, when the brutal interest rates were eased back down in 1982, there was some pent up thirst for financing just waiting for lower interest rates.

What can we draw from 1980 through 1992 as far as taxes and GDP? If these years are indicative of anything, it is that under relatively normal interest rates lowering the top marginal tax rate appears to come with a corresponding drop in GDP. Whereas during a period of extreme high interest rates, there appears to be no correlation between top marginal tax rates and GDP because of the growth-blocking effect of extremely high interest rates.

For the Gipper, unfortunately, that top marginal tax cut play doesn't seem to have been a win.

Chained to Real: Tax Rates, Inflation-adjusted GDP Measures, and the Difference

The question:  what impact (if any) do top marginal tax rates have on GDP growth rates?

Our previous chart of top marginal tax rates versus GDP growth rates utilized "chained dollars," a measure with which not everyone is familiar. That data was drawn from the BEA's Current-dollar and "real" GDP table. While the chained dollars therein are a measure of real GDP, they're not the only measure. There's a slightly different set of data at the BEA's NIPA Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product.

To satisfy those who wonders whether the result would be different if we use another measure of inflation-adjusted GDP:

Left scale for top US marginal income tax rates. Right scale for GDP growth in inflation-adjusted "real" dollars. A 10 year moving average for each figure is also included. GDP data from the BEA. Tax rate data from TruthAndPolitics.org

The results of using this measure of (inflation-adjusted) real GDP are almost the same as using the (inflation-adjusted) chained dollars. From 1951 through 1963 the top tax rate varied between 91 and 92%. During those years, the average rate of inflation adjusted GDP growth (using real dollars) rested at 3.72%, a rather robust growth rate. (GDP growth averaged 3.39% from 1951 through 2007.) By contrast, the GDP growth under the average 37.4% top tax rate from 1986 through 2008 was only 3.2%, 0.52% lower growth than under the much higher 1951 - 1963 tax rate.

Regardless of which inflation-adjusted measure we use, the answer is still the same: Overall, the past 80 years show us a thorough lack of clear correlation between the top marginal tax rate and GDP growth. The data's closest hint of a relationship derives from the slightly more robust average GDP growth back when the top rates were higher, but that closest hint isn't close enough to be sure of an ideal rate. The notion that lowering the top tax rates improves the economy just doesn't hold water. Indeed, these 8 most recent decades show us that increasing the top tax would not necessarily have any impact on the economy, let alone slow it at all.

original chart

Update 02/07/2011:  Replaced original chart with improved version featuring better parity of scales, better visibility of trendlines, and replacement of the poly trend with a linear. The change in scale does suggest an interesting symmetry in the past two or three decades. We'll look at that in more detail later.