Why the tax cut is a sham

[rogerashton]

So you think you got a tax cut? So what if there’s a deficit: you got that refund check and deposited it right away, right? But according to right-wing, free market economist Robert Barro, a real tax cut with a government deficit is impossible. His reasoning is like this: regardless of what the tax codes say, when the government purchases more goods and services, those goods and services are not available to the private sector, and somebody is going to pay for that somehow. He goes on to argue that future tax payments for interest and repayment of the government debt are equivalent to the tax payments you don’t make now. (This is called Ricardian equivalence, since Barro got the idea from David Ricardo, a great economist of the early 1800’s). Thus, if people are rational, they will put aside money for the future tax payments, cutting back on consumption in the process, and the consumption cutback just offsets the withdrawal of goods and services from the private sector for government use. That also means, by the way, that a tax cut cannot possible “stimulate” the private economy.

Of course, Barro makes some assumptions, and it is pretty clear that we don’t live in the perfect world he describes. In particular, it is pretty clear that the government deficit has not been offset by reductions in consumer spending. The continuous growth of consumer spending over the last several years is one of the most obvious characteristics of our economy (and one of the hardest for economists to understand.)

But somebody has to pay, somehow, for the goods that are withdrawn from the private sector. What are the alternatives?

Inflation is one. If the withdrawal of goods and services for government use results in excess demand, then prices rise. (Orthodox economists say this can only happen if the monetary authority “accommodates” the inflation by increasing the money supply.) But inflation IS a tax – a tax on all forms of wealth that are fixed in dollar terms. What difference does it make if the purchasing power of your assets are cut by a 15% tax or by a 15% inflation? Either way, you lose – and the tax cut is a sham. But this does not seem to be what has happened. Inflation rates are still pretty low.

Alternatively, maybe people are not as rational as Barro assumes (or the system is “imperfect” in some other way Barro hasn’t accounted for) and people have to be persuaded to put aside money to pay future taxes by greater incentives to save – higher interest rates. We may also get higher interest rates because the monetary authority is trying to prevent inflation by keeping the money supply down. What this means is that investment is reduced by an amount equivalent to the government deficit. That means, in turn, that we will be less productive in the future, and profits and wages will be correspondingly less. That’s politically convenient – you may never notice that you are paying back the tax cut with a lower real income in the future. But that doesn’t seem to have happened in this case either, since interest rates are still pretty low. What are the other alternatives?

Well, if there are people who are involuntarily unemployed, some of them might be hired to produce the goods and services purchased by the government. Therefore, the private sector would not need to be deprived of the goods and services at all, and eventually tax payments by the newly employed might (maybe?) pay for the interest on the federal debt. That’s the centerpiece of Keynesian economics and the one respectable argument why government spending or tax cuts might “stimulate” the economy. Barro rules it out as a possibility, on the grounds that there can be no involuntary unemployment in a world of rational people – and he may be right. But I think this does happen, SOMETIMES, in the world I live in. But it didn’t happen with the tax cuts of the current administration, since job growth has varied between negative and stagnant.

What remains? Perhaps we could get foreigners to pay for our government deficit, by increasing our deficit in international trade. We could import enough goods and services (net) to make up for the goods and services withdrawn from the private sector for government use. And in fact that is what has happened, both in the 1980’s and in the current administration. In the 1980’s, foreigners bought bonds that financed the US government deficit because we offered them very high interest rates. But not this time – as we already noticed, interest rates remain low.

In fact, people around the globe seem to be willing to take our dollars in return for their goods and services, and just hold onto the dollars. Why? Because, in many cases, they see the dollars as being sounder than their own currencies. In many cases, their governments are holding dollars to back up their currencies. We are supplying “liquidity” to the world – and profiting by doing so. It can be very profitable to be the banker, especially the banker to the whole world!

But those dollars are still out there. This works only as long as people see the dollar as sounder than the alternatives. If the time comes when another currency is seen as being sounder than the dollar – the Euro, perhaps, or the British Pound, Swiss Franc, Japanese Yen, renminbi, whatever – then those dollars will come home, with people wanting to buy American-produced goods and services to repay both the goods and services they have sold to us and their patience in the meantime. And continuing government deficits are precisely what could lead them to see the dollar as being unsound.

So that refund check is not really your money. It is a loan from the other countries of the world, and that loan will come due sooner or later. We just don’t know when.

That’s why the tax cut is a sham.

[Paradise]

1. Since the SHAM tax cuts, real estate taxes have skyrocketed,

sales taxes have increased substantially, and the repercussions of the bait and switch tax cuts came back to bite us, across-the-board and comprehensively!

One way or the other, someone has to pay for government spending, and that someone is YOU AND ME!

What we have been handed is TAX INCREASES under the GUISE of tax cuts!

[rogerashton]

2. Right

Increased taxes at other levels are another offset. But those have also been results of the recession/stagnation.

I think my post was pretty long without going into that, though.

[Paradise]

3. your post was excellent and thanks! :) n/t

[Commendatori]

4. Every time I try to explain anything like that, I get hit with

"so what, taxes were at the perfect level before Bush, or should they be raised?" Since I'm not the most left-leaning Democrat economically out there (I do believe we're overtaxed, especially considering the bullshit government we're currently paying for, and would never accept a tax rate of over 49.9% even for Bill Gates), I'm left without anything to say, especially since to my co-workers, since being a registered Democrat means "card-carrying commie."

So would you have cut taxes (if so, directed in which way), left them exactly as they were or raised them? Your answer could help me shut the mouths of a gaggle of assholes, so thanks in advance for any response.

[rogerashton]

5. Well, we did have a surplus

when Clinton was president.

On the logic of what I wrote before, the answer is sustainability. The tax take overall needs to be enough this year so that we are not passing the costs of our benefits on to our future selves or our kids. Given the boom we were in, taxes MAY have been too low in the Clinton administration. If they had been higher then, building up the country's reserves, then they could be lower now and in the future. That would probably make old geezers without kids, like me, worse off, but who cares about us? Everybody else, including your younger colleagues, would be better off in lifetime terms.

Don't let them frame the argument, good buddy. The question to ask them is, "Would you rather pay it now, or next year with interest? Those are your choices. But you will pay."

The direct answer to your question is: nobody knows the "right" level of taxes because it depends on too many other things. But somehow I don't think that will win your argument.

[Commendatori]

6. Nice, and exactly what I was looking for.

The majority of the arguments I get in with these people are based on social issues, not economic, so I'm not really equipped to cut through their memorized talking points. When I brought up the surplus, they hit back with "first of all, it was a PROJECTED surplus, based on projections made before 9/11, blah, blah..," and I don't really know enough to continue from there.

Your last sentence is exactly what I was looking for - something simple and irrefutable. You can't begin to imagine how happy I was to read that. Many thanks! :)