Tax Cuts: a Painful Way to Keep Bleeding

The Co-Chairmen of the bipartisan commission to reduce the deficit released a proposal for the commission members and general public to consider as to what is needed to reduce the national debt.  In their comments they bluntly make it clear the reduction can only come with pain to the American people; there is no other way.  Of course Americans have never taken kindly to pain when it comes to economics and thus politicians who vote on policies which affect the nation’s economy tend also not to make the hard decisions in fear of being voted out of office. 

The U.S. Congress is going to take up the issue of making permanent the Bush era tax cuts.  This is being done while simultaneously there are calls to shrink the national debt.  These are the tax cuts that Mike Kimel and Michael Kanell in PRESIMETRICS characterize in this way:

Consider, for instance, that less than two months after taking office GW laid out a plan to aggressively pay down the debt while simultaneously cutting taxes and boosting military spending.  The plan was titled, ‘A Blueprint for New Beginnings: A Responsible Budget for America’s Priorities.’  One can only wonder what an irresponsible budget might have looked like to GW’s advisors. 

According to what I’ve read, making the Bush-era tax cuts permanent will add $4 Trillion (that’s $4,000,000,000,000.00) to the national debt.  One wonders whether any Americans are really fiscally responsible or conservative who can advocate this right now.

Christmas is a time when kids tell Santa what they want and adults pay for it.  Deficits are when adults tell government what they want and their kids pay for it. (Richard Lamm)

The push for the tax cuts at this point seem to be the usual American nearsightedness when it comes to fiscal issues: we want immediate gratification and don’t want to be troubled by the fact that what we do today will have  future repercussions.  

“… a president who cuts taxes while at the same time driving up the debt is not really ‘cutting taxes.’  He is merely transferring taxes from now until some later date.”  (Mike Kimel & Michael Kanell, PRESIMETRICS)

A president who cuts the national debt, on the other hand, saves you from having to make interest and principal payments on that debt in the future, and therefore reduces you tax bill later. Unfortunately, most people don’t seem to make the connection between fiscal irresponsibility today and increased taxes later on.  (Mike Kimel & Michael Kanell, PRESIMETRICS)

We would do well to remember how we got into the national fiscal mess we are in and not perpetuate those same mistakes and then magically hope for a different result.  We might consider the words of U.S. founding father James Madison

“… war should not only be declared by the authority of the people, whose toils and treasures are to support its burdens, instead of the government which is to reap its fruits: but that each generation should be made to bear the burden of its own wars, instead of carrying them on, at the expense of other generations.”

It is we the people, or at least we through our elected political leaders, who got US into the current financial mess.  It is the current and past president and the current and past congresses which have made the decisions to  bury us in debt.

Somehow, some keep singing the song to reduce taxes, as if that is the panacea for all that ails the American economy.  Yet the national debt also ails the economy and we are not going to reduce the national debt by reducing taxes,  anymore than someone can reduce their credit card debt by reducing their income.  If we are serious about reducing the national debt, we are going to need a different remedy than reducing taxes to pay down the current debt.

I do not know where the idea that reducing taxes is the best way to grow the economy comes from – but if PRESIMETRICS  measures the data right, then reducing taxes isn’t the panacea needed.  Consider the following based on Kimel and Kanell’s analysis of the data available from 1952-2008 (Presidents Eisenhower to GWBush):

“in recent decades, higher tax burdens have been associated with faster, not slower, economic growth.” (p 120)

“there doesn’t seem to be any evidence here for the proposition that lower taxes result in higher incomes  … lower taxes- at least by themselves- are not the way to increase economic growth.”   (pp 124-125)

“The numbers are pretty compelling.  Lower average tax burdens do not produce faster economic growth, or more jobs, or bring in more tax revenues.  Similarly, tax cuts also do not produce faster economic growth, faster income growth, or more jobs, or bring in more tax revenues.  … Unexamined faith in a principle that is demonstrably false is no way to run a country.”  (pp 129-130)

So, is the idea that tax cuts are beneficial to the economy based upon intuitive assumptions rather than on any statistical analysis?    It seems like it should be true that lowering taxes would benefit tax payers in every way, but the data which PRESIMETRICS studies doesn’t uphold what is a cornerstone of political beliefs for many.

This may be a case where we need to stop believing what we think, and actually examine the data to see what in fact will bring down the national debt and help the economy.  Maybe we actually are going to have to do some of the painful things the bipartisan commission is considering, including both raising taxes and cutting spending.  Ouch!

Or maybe we will continue to pretend there is some magical and painless way to reduce the budget deficit and keep doing all the things we currently are doing. 

Any magic left in these contenders?

In the Harry Potter books and movies, ultimately it is not magic that saves the day and defeats evil, but rather the courage and persistence of its “all too human” heroes to do the right thing despite their weaknesses, even when it is very painful.

Our politicians need to learn a bit of that magic called courage.

6 thoughts on “Tax Cuts: a Painful Way to Keep Bleeding

  1. Brian

    Take a look at this blog entry… http://blogs.marketwatch.com/fundmastery/2010/07/02/does-hiking-tax-rates-raise-more-revenue/ … especially the chart showing “Hauser’s Law”. It shows the top individual tax bracket and the revenue as a percentage of GDP over time. From this chart it is evident that a higher top tax bracket does not significantly increase the tax revenue as a percentage of GDP. I believe the marketwatch blog author is pointing out that as the economy grew, actual revenue into the government had tripled (since 1965). During which time top marginal tax rates were falling. (see the next chart) This is in direct contradiction to the Presimetrics book. (I suspect an agenda ;-) )

    I remember reading your previous post about this book and thinking that their arguments did not seem to correlate the increases in congressional spending during the same tax cutting eras. Reagan did cut taxes, but also increased military and social program spending. George W decreased taxes, but at the same time both congresses (Republican-led and then Democratic-led) dramatically increased spending.

    It is interesting on the chart in the marketwatch blog titled “Under the Current Policy Baseline, Spending is Causing the Deficits” you see that during the late Clinton era revenue went well above the 18% average while spending fell below the 20.3% avg. But again that is when Newt Gingrich and the Republican led congress had implemented the “Contract with America” plan; something I’d bet Presimetrics didn’t mention.

    Personally, I’m pretty concerned with how the Fed is trying to keep things afloat by printing more money (QE2). It sounds like a recipe for high (hyper?) inflation to me!

    1. Fr. Ted

      True PRESIMETRICS is following statistics as they relate to each President rather than how it relates to congress, though the book does mention congress at a few points. But it does in an appendix address the issue that maybe it was congress that made the difference. They note for example that during the Clinton administration that federal spending decreased faster before the GOP took control of congress. Also while Clinton was in office federal tax collections as a share of of GDP increased every single year including once the GOP took control of congress. This is what ultimately enabled the debt to be paid down while Clinton was in office. So if it was the GOP congress that made a difference it did so by continuing the increase in federal tax collections. Also according to their statistics when the GOP controlled congress, “not only did the tax bite go up, it went up by more than when Democrats were in control of Congress. … the biggest average increase in the tax burden occurred in the years following the Republican Revolution.” I’m only quoting what they are showing from the data. You can read the book to see if you can find fault with their data or their interpretation.

      As for the relationship of the top tax brackets and tax revenue as a percentage of GDP, their claim is that the top tax bracket is a bogus issue to begin with since the top tax rates affect such a small percentage of people and even at that only a portion of their income. So they say pointing to the top tax rates to prove anything is dicey – those top tax rates don’t have any correlation to what is actually collected in taxes because it is a tiny portion of the tax base.

      If cutting taxes were the panacea for helping the economy, GW cut them as much as anyone and yet by the end of his term in office the country was in a severe recession. Cutting taxes couldn’t stave off the economic collapse.

  2. Darrell

    One has to bear in mind that the dollar is accepted as legal tender in most countries. Legal tender means that I can use my dollars to buy goods, services, and/or assets in any country that accepts the dollar as legal tender.

    Once a nation accepts the dollar as legal tender then they have no choice but to continue to accept the dollar. And this is why Japan, China, and other nations have continued to increase their dollar holdings with no way of stopping the flow of dollars into their economy.

    There are three uses of the dollar or any other currency: save it, invest it, or spend it. Most foreign dollar holders are saving their dollar by purchasing government debt; what percent of our debt is held by foreign dollar holders? I don’t know but I think we are in a moral abyss when our policy wonks continue to print more dollars to buy the goods, services, and/or assets our economy needs in order to function effectively.

    The economic rule is that you obtain what you need through earnings not buy printing more currency! Our policy wonks use the debt process to print more currency: and this money is used to fund government programs, fund wars, stimulus programs, and foreign aid; whatever.

    Because our debt is dominated in dollars all we have to do is print more dollars to pay off this debt. This is what QE2 is all about.

    During the cold war era the dollar was adopted as global legal tender and France was the most vocal critic of using a national currency as a global currency.

    So our economic problem is more than too much debt and taxpayers unwilling to fork over their income to pay down this debt; the problem is that if the dollar reverts to a national currency only, then we will not have the earnings base to fund government programs let alone pay down debt.

    The cold war era is over and capitalist principles direct economic activity in most countries. Many nations think we have an unfair competitive advantage when our currency is used as a global legal tender and they want to end the practice.

    And I think they will succeed in their quest.

    Below is the Jacques Rueff, French Finance Minister back in the early seventies, take on the dollar’s global status (I picked this up on the internet and I forgot to bookmark the source, so my apologies)

    “It is that when a country with a key-currency runs a balance-of-payments deficit – that is to say, the United States, for example – it pays the creditor country dollars, which end up with the latter’s central bank. But the very same day, they are re-loaned to the New York money market, so that they return to the place of origin. Thus the debtor country does not lose what the creditor country has gained. So the key-currency country never feels the effect of a deficit in its balance-of-payments. And the main consequence is that there is no reason whatever for the deficit to disappear, because it does not appear. Let me be more positive: If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him and my own balance of payments would then be in deficit. Because of this situation, the United States could pay off its balance of payments deficit in paper dollars. (…) As the central banks received dollars, they used them immediately to buy U.S. Treasury Bills or certificates of deposit in New York banks, thus returning the dollars to their country of origin which thus recovered all the assets it had just paid out.”

    Rueff warned that, if this system is continued for long, it would inevitably have 3 consequences:

    1) A permanent deficit would develop in the United States’ balance of payments whose overseas settlements would no longer automatically reduce the amount of credit available at home. (…) Thus the United States was in the privileged position of being able to buy, invest, loan or donate money in other countries without limit since its money markets would not feel any effects from this capital outflow. Having learned the secret of having a “deficit without tears”, it was only human for the United States to use that knowledge, thereby putting its balance of payments in a permanent state of deficit.

    2) Inflation would develop in the surplus countries as they increased their own currencies on the basis of the increased dollar reserves held by their central banks.

    3) The convertibility of the reserve currency, the dollar, would eventually be abolished owing to the gradual but unlimited accumulation of sight loans redeemable in the Unites States gold.”

    (Jacques Rueff: “The Monetary Sin of the West”; New York: Mac Millan, 1972)

  3. Gregory

    I would love for anyone to try applying the GOP’s solution — pay down debt while cutting taxes but ramping up spending on certain things — to their own personal finances. Go ahead, try it: pay down your credit cards, car note and house mortgage while slashing your income but spending more money on home security. Let me know how it works out. (Of course, nobody does it, because to do so would be personal economic suicide…)

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