Voodoo Economics

Did the Reagan Tax Cuts boost Federal Government tax revenue?

See the big peak on the left of the graph? That was 1981 Q4. The cuts were implemented in 1981 Q3. As you can see, tax revenue never reached the same level before 1996. Revenue eventually hit 20.38% in 2001 Q1, but has dropped since, bottoming out at 15.44% in 2009 Q3 (in the midst of the GFC) and is around 19% at present.

So in terms of the whole "Tax cuts increase tax revenue", it certainly didn't grow as fast as the rest of the economy.

Schiff vs Laffer

This video clip is just incredible (19mb, nearly 9 minutes long). It shows a debate between economic pessimist Peter Schiff and the over-optimistic Arthur "Supply Side" Laffer. It was recorded on 28 August 2006 - over two years ago.

In this clip, Schiff argues that the housing market will eventually pop and a recession is around the corner. He argues that America has borrowed and spent too much and needs to return to producing things and saving money.

Arthur Laffer argues that the economy is going fine, thank you very much, and that there is no need to worry.

Laffer, it must be said, is the intellectual basis of Supply Side Economics and popularized the "Laffer Curve".

Schiff is an Austrian Economist, a school of economic thought that I respect and have much in common with (though I disagree with some of it).

McCain, Money and Mondale

Anyone who reads this blog regularly knows my distaste for the US Republican Party. This distaste has been present ever since George W. Bush won the 2000 election. This does not mean that I am a partisan Democratic supporter, but it does mean that, at present, I honestly believe that the best choice America has in November is Obama and Biden.

The fact is that I will support whatever party has the better policies or the better record or a combination of both. Back in 1996 I voted for John Howard and the Liberal Party (which is, ironically, Australia's conservative party) because the Labor Government under Paul Keating was philosophically bankrupt and, despite 13 years of economic reform, had not been fiscally responsible. My support for John Howard evaporated after 2000 when he began to implement racist policies and use the fear generated by 9/11 for political gain. Joining in the 2003 invasion of Iraq was another problem for me.

So my support for the Democratic Party and Obama has nothing really to do with partisanship. I am sure that I would support the Republican Party at other times if their history since 1981 was different. Having said that, I will state now that a McCain/Palin victory in November may possibly end in disaster.

I personally have no beef with John McCain, and the only thing that really worries me about Sarah Palin is whether or not she is capable of being America's president in case McCain goes to meet his maker. The policies of John McCain, though, are problematic - specifically his tax cutting program.

I have seen a comparison of Obama's and McCain's tax plan and McCain gives the biggest tax cuts by far. Obama gives bigger tax cuts to lower income earners than McCain, while increasing the taxes of those on higher incomes, with the end result being a small net tax cut.

For many conservatives, the idea of a tax cut is wonderful news. The problem is that McCain, along with Obama, has yet to explain how such a tax cut will impact government spending. I am of the belief that any tax cut should be met by a corresponding cut in government spending. I am also of the belief that if anyone wants to increase government spending, then taxes must rise as well.

The problem is that, for the last 25 years, the Republican Party has been dominated more or less by Supply-side economics, a form of "voodoo economics" which believes that tax cuts fund themselves by stimulating economic growth and generating more tax revenue. While there is some truth to be found in the more intellectual corners of this economic system, it has resulted in a simplistic and effective myth -  that the government should just keep cutting taxes.

After 25 or more years, popular supply-side economics has resulted in nothing but large federal government deficits. Ronald Reagan's big tax cuts in the 1980s were followed by increased tax revenue but also a corresponding increase in public debt. It was not until George H.W. Bush raised taxes after his "read my lips" promise that Supply side economics began to lose its influence. But by that stage, the damage had been done and the US government was deeply in debt.

Such was the loss of standing of Supply side economics that Republicans during the 1990s returned to a more traditional economic stance. Whatever I may have disliked about the Republican Congress under Newt Gingrich and their government shutdowns and impeachments, the fact was that they worked with the Clinton administration to balance the budget - a process that eventually led to surpluses near the end of Clinton's presidency.

Unfortunately, the Republican congress under Bush enthusiastically returned to the populist appeal of tax cutting. The result has been astounding, with public debt increasing dramatically. The recent Fannie Mae and Freddie Mac bailout will see a substantial increase to this level of debt. The current recession in the United States will also result in lower tax revenues.

So, fiscal irresponsibility + Fannie and Freddie Bailout + recession equals a federal government with a massive debt burden that will most likely exceed any comparative level of net debt in peacetime US history.

Of course, for regular readers, this warning of mine is nothing new. So why am I repeating the fiscal alarm all over again? It is because I believe that a McCain/Palin administration will continue the fiscal irresponsibility started under Bush. Moreover, the inaction of the Democratic-party dominated congress (elected in 2006) has allowed the situation to deteriorate. If the White House continues to be Republican, there is little chance that a Democratic Congress will have the testicular fortitude to stand up to him and pass economically sensible bills.

The only real chance for fiscal responsibility to return to Washington is for a Democratically controlled Congress and White House. Republicans have proven themselves too attached to Supply side economics for the past 25 years (with the notable exception of the Gingrich years) while the Democrats have not.

This is not to say that the Democrats (Obama and congress) won't make a hash of the economy between 2009 and 2012 - I'm just saying that they are less likely to ruin the economy than one in which Republicans control the White House during that period.

Hard decisions must be made in 2009 about the federal budget. Loaded down with increasing amounts of debt, congress and the president must pass spending bills that will ensure that revenue exceeds spending - or at least a bill that will return the budget to surplus over a number of years. In order to do this, taxes must be raised or spending must be cut or some combination of both.

But herein lies the problem. If taxes are to be raised, won't that hurt the economy? And if spending is to be cut, which government departments should suffer the most cuts? Given the massive expansion in military spending since 2003 and the inefficiencies that run through it, and also given the fact that other federal government departments are so small in comparison (completely closing down NASA and the Department of Education won't be enough to stop a big deficit), then whoever sits in the White House next year will have a very unenviable task. What should next year's president do?

Given the nature of the Republican Party, it is unlikely that McCain and Palin will raise taxes or cut military spending. At most, they will probably cut back on other expenses (like NASA or Education), a process that will simply not be enough to return the federal government to a fiscally sound position - to say nothing for the damage that such cuts would make to important government services. The result of a McCain/Palin White House is therefore likely to be one in which the federal debt gets larger and larger - a process that will lead America further into economic decline.

On the other hand, an Obama/Biden White house along with a Democratic Congress is far more likely to make painful but necessary decisions. I'm not saying that this is a given, but I am saying that it is more likely.

Which brings to mind the prophetic words of 1984 Democratic presidential candidate Walter Mondale. When discussing the Reagan tax cuts and the deficits that had resulted from them, Mondale said these fateful words:

By the end of my first term, I will reduce the Reagan budget deficit by two-thirds. Let's tell the truth. It must be done, it must be done. Mr. Reagan will raise taxes, and so will I. He won't tell you. I just did.

Reagan won the election in a landslide, mainly due to the perception that Mondale was a "tax and spend" Democrat. Yet, in hindsight, Mondale's words have come back to haunt the Republican Party and the memory of Reagan. Supply side economics was still in its ascendency during the Reagan years and people had not yet begun to suffer its negative effects. Now that Supply side economics has been proven beyond reasonable doubt to be unworkable and ultimately damaging to an economy, the time has come to pay the price for political expediency and financial stupidity.

It was over ten years ago that The Simpsons episode "Trash of the Titans" was aired. In that episode, Homer becomes Springfield's sanitation commissioner, defeating the incumbent Ray Patterson (voiced by Steve Martin), and promises a lot of crazy things for the people of Springfield. Homer's policies soon end up bankrupting his department and completely ruining the city. When Ray Patterson is unanimously voted back in as sanitation commissioner, he gives this wonderfully short speech:

Oh gosh. You know, I'm not much on speeches, but, it's so gratifying to leave you wallowing in the mess you've made. You're screwed, thank you, bye.

I can't help but think of comparing Walter Mondale to Ray Patterson here. Twenty-four years after his abysmal failure in the 1984 presidential election, Mondale could probably be justified in repeating Ray Patterson's short speech.

This is why I don't hate John McCain

I'm not a fan of John McCain. I think he decided a few years ago to pretty much align himself with George W. Bush and has been happy to parrot right wing boilerplate ever since he announced his candidacy for the 2008 election. His economic policies are dangerous and he seems to have little idea what his actual positions are on issues.

Having said that, with all the standard rumours entering the various echo-chambers making it hard to think, I have decided to reject some of the more standard attacks.

First of all, I think that his service for the US Navy as a Skyhawk pilot was brave. He was certainly braver than George W. Bush who managed to avoid the war by defending the Republic of Texas as part of the Air National Guard. As a pilot McCain may have been a bit of a jerk, but then a lot of fighter pilots are. He did his job, bombing targets during the Vietnam war, a war which I think was a big mistake for America to get involved in but I blame the leaders at the time (Johnson, McNamara and 1st term Nixon) not those who fought in it. I think he did stellar service and anyone who is happy to point out his shortcomings as a navy aviator needs to understand that many of them aren't perfect. McCain did get shot down and was imprisoned and was tortured. That, of course, was a horrible thing, but I'd wish he'd used his experience of being tortured to explain to the American people why those in Guantanamo Bay, who underwent similiar treatment, were being tortured as well. Nevertheless I don't think McCain's service in Vietnam - as pilot and as prisoner of war - was anything but brave. Along with Vietnam Veterans such as Al Gore and John Kerry, we should recognise his service.

Secondly, it is true that McCain committed adultery while his first wife was sick in hospital. As a result of this infidelity he left his first wife and married the woman he committed adultery with - which is his current wife. McCain's actions were definitely immoral in a Christian sense, but there's no way I would describe McCain as being a Christian anyway. Having said that, a public official's private life should only be of importance if he or she has broken the law and disqualified himself or herself from public office. McCain, like many politicians (including Bill Clinton and John Kerry), has had marital difficulties and/or problems with adultery. Just as it was not enough to disqualify others from public office, so too is it not enough to disquality John McCain.

Thirdly, John McCain was one of the Keating Five, a group of US Senators who were involved in a corruption scandal in 1989. McCain admitted his wrongdoing to Congress but none of the five were jailed. Had voters been up in arms about McCain, he would not have been re-elected by the state of Arizona as their Senator in 1992. Obviously Arizonans know McCain and have been happy with his service in the Senate both before and since the Keating Five scandal.

Fourthly, a lot of mention has been made lately about McCain not knowing how many houses he owns. As a rich man, McCain's inability to remember his personal assets is understandable. Okay, he is not "like ordinary people" and maybe if he has been presenting himself that way then that would be a bit problematic. I don't have any problem with a rich man in public service. John Kerry and his wife had multiple properties as well, and John Edwards probably did spend a lot of money on a haircut. McCain spent a lot of money of his shoes. This is not a reason to portray someone as being elitist of out of touch as it can probably be said that 99% of all members of congress are elitist and "out of touch", even right wing politicians who have convinced their voters that they aren't. Besides, I agree with Jon Stewart on this one - not only do I want an elite president, but I want someone who is embarrassingly superior to me.

So, is John McCain a horrible person? A lying liar who has managed to cover up his incompetent past in order to progress politically? Definitely not. I think if he were to become president he would be better than many of his predecessors (Bush 2 and Nixon for starters).

However, McCain is a Republican, and Republican politicians are more to blame for America's current economic problems than Democrats are, and Republicans are more to blame for America's loss of standing in the world than Democrats are. If he follows through with his economic promises he will continue America's stupid fascination with Voodoo Eocnomics (aka Supply side economics). Moreover, while I don't think Barack Obama is the Messiah I certainly don't think he's the antichrist either, and I think he represents a far better choice for both America's present and future.

AAAAAAAAA

A blog post with every single category marked (I'm doing this for scribefire)

Advantage Australia?

From the department of slightly:

Commodity exports from Australia, the world's biggest shipper of coal, iron ore and wool, are forecast to gain to a record for a fifth straight year driven by demand for steelmaking raw materials led by China.

Sales may reach A$189.1 billion ($178 billion) in the year ending June 30, 2009, the Canberra-based Australian Bureau of Agricultural and Resource Economics said today in a statement. That compares with a revised A$145.6 billion this fiscal year.

Prices for the nation's top five commodity exports, iron ore, coking and thermal coals, gold and crude oil have risen to records this year, benefiting producers including BHP Billiton Ltd. Robust economic growth is expected in China this year along with strong demand for Australia's resources, the bureau said in a report.

``China is far and away the biggest underlying force'' driving sales, Peter Arden, an analyst at Ord Minnett Ltd., an affiliate of JPMorgan Chase & Co., said by phone from Melbourne. ``The outlook is very, very rosy.''

This is obviously good news, not just because it is "good" that people overseas want our commodities, but because it will help to reverse one of Australia's economic imbalances - the current account deficit. This will, however, be a case of "I'll believe it when I see it" because the current account deficit is one of Australia's most intractable economic problems.

Australia's economy, like all modern economies, buys goods from overseas. It also sells goods overseas as well. The problem is, however, that Australia buys more than it sells. So where does it get the money to buy overseas goods? It borrows it from overseas lenders. In the September quarter last year, Australia borrowed a total of US$49.9 billion. This is called a current account deficit, and that figure represents some 5.4% of GDP. Australia has been borrowing money from overseas for a long time, and the amount of money Australia owes to overseas lenders is now around 53.5% of GDP - over US$610 billion.

Now I'm a great believer in balance when it comes to economics. A deficit is not "bad" but continual deficits are "bad". Similarly, a surplus is not "good" but continual surpluses are, in fact, just as "bad" as continual deficits. The idea is to get things in balance.

In order to reverse Australia's net debt and reduce it to zero, the current account must, at the very least, be reduced to zero as well. In short, this means that Australia needs to export more and import less, to save more and borrow less, to produce more and to consume less.

Since Australia's economy is heavily dependent upon commodities (like coal, iron, gold, copper, etc) as well as agriculture (like wheat and rice), the current commodities boom and increase in grain prices will act to increase the price of the goods we sell. This will, in turn, act to reduce Australia's current account deficit.

One of the more fortunate results of a conservative government that wasn't influenced by voodoo economics is that Australia's public debt (the amount of money all of Australia's governments owe) has basically been erased. Eleven years of fiscal prudence by Howard and Costello has meant that the government can now actually afford to do things like cut taxes and/or increase spending. This is where Australia and America differ.

Nevertheless, there are some weaknesses in Australia's economy.

The first is that inflation is increasing. It is expected that the Reserve Bank of Australia will raise rates to 7.25% today. Australia's economy, unlike America, is still showing signs of strength so our central bank is right to increase rates. Moreover, this increase in rates will do exactly what is needed to reverse the current account deficit - it will curb domestic spending, making us less likely to consume and more likely to save. If things work out okay (and they probably won't), this decrease in domestic spending will be balanced out by the increase in overseas exports mentioned in the news report quoted above.

The second is that, while Australia does not have the same subprime mess that the US has, our housing market is still significantly overvalued - perhaps more so than the US market ever was. I am astounded that housing prices here in Australia have remained stratospheric while they have been crashing in America for over 12 months now. Today's interest rate rise will, at the very least, deflate the bubble slightly. Hopefully it will pop it, and an Australian economic downturn is a possibility.

The third is that it is China and Japan that are buying all the commodities we produce... and both Japan and China turn those commodities into goods that are then sold to America. With the American dollar now low and its economy in recession (face it, it is), it is only a matter of time before Chinese and Japanese industry is affected by America's recession... which will, in turn, reduce the need for Australian commodities. It is this last point which is important because it assumes that the commodities boom will eventually end, leaving Australian mines and mine workers with less work and money.

Regardless of what happens - whether the commodities boom pops earlier or later - the right thing to do is to discourage domestic spending and to reduce the current account deficit accordingly. This will result in, hopefully, higher interest rates over the medium term. Over the long term, however, it will be dependent upon tighter monetary policy which targets inflation at a lower rate - something which has yet to become policy anywhere, mainly because it is my proposal for Absolute Price Stability.

In short, Australia is probably more likely to weather the brewing economic storm than America, but still has some serious shortcomings that need to be addressed sooner rather than later. The current account deficit is the key - reduce that and you will reduce a whole range of economic problems. Increasing interest rates and cooling the economy down is exactly what is needed at this point, even with a global recession heading our way.

Austerity - the solution to America's economic ills

As many commentators have predicted, America is in an economic recession. Although it can't be declared "official" yet - the most popular definition of a recession is two quarters of economic decline - all the signs are there that a serious economic realignment is taking place. Consider the following facts:

1. The share market is volatile, reacting to good news and bad news wildly. Moreover, important indices show a long term decline in share prices. If you look at this graph of the S&P 500's performance in the last year, you'll see that the share market, while not officially "bearish" is certainly in the process of declining.


2. House prices in the US have been in marked decline for some time now, and sales figures show that the amount of houses sold in January 2008 has dropped to an eight-year low.


3. The Service Sector is contracting sharply, with many employers laying off staff.


4. Unemployment has increased to around 5%. This is still pretty good by historical standards, but the rate has been hovering around 4.5% for a few years now, so the latest figures show an upward trend.
   

There are many other indicators, to be sure, and some are contra. However the majority of stats point in a downward direction.

The reason for the recession is to be found in the over-heated property market, which popped last year and is now responsible for the overall decline in house prices and the subprime mortgage fiasco that is battering the share market.

But there are other reasons. The over-heated property market was, I believe, the result of expansionary fiscal policy by the Bush administration and expansionary monetary policy by the Federal Reserve Bank for the past few years - both unwarranted.

Greenspan's loose monetary policy ensured that the Federal funds rate remained very low from 2002 to 2004. This encouraged the already forming property bubble. Cheap money was flowing into the housing market, and house prices were sky-rocketing. Had Greenspan and the Fed kept interest rates higher during this period, it would have helped prevent the crash from occurring. It would have also stunted economic growth during that period as well, but, in hindsight, slow growth then to prevent a recession now would be more than worth it.

During the same period, Bush and congress enacted tax cuts. Advocates of "Voodoo Economics", that tax cuts pay themselves (aka Supply Side economics), would argue that such a cut was deserved and would boost growth.

Of course, one problem with any expansionary policy - whether fiscal or monetary - is that they have a short-term positive effect which is eventually balanced out by a long-term negative effect. In other words, higher growth now leads to lower growth later. Conversely, contractionary policy - both fiscal and monetary - has the opposite effect - low growth now and higher growth later.

Nevertheless, because of political reasons, many governments choose to run continual government deficits and to cut taxes - which is expansionary fiscal policy - during periods of economic growth. This goes against the grain of those schooled in Keynesian economics, who would argue that, during periods of economic growth, policies must be contractionary while they should be expansionary during downturns. Whatever the faults that Keynsians have, they know their stuff at this point. What Bush and Greenspan essentially did from 2002-2004 was to implement expansionary fiscal and monetary policy during a period when it was inappropriate. The current downturn has its roots in these bad decision.

The problem now, however, is what is the US going to do in order to solve their current problem? Since careless expansionary fiscal and monetary policy caused the current crisis, should we assume that expansionary fiscal and monetary policy can solve it?

Bush and the Fed (now under Bernanke) certainly think so. Bush is trying to push through a "rescue package" bill in congress that would attempt to provide much needed fiscal stimulus to the different markets in America that need it most (mainly, I believe, the housing market). Meanwhile, Bernanke at the Fed has been lowering rates as though it were going out of style. In fact, the rate cuts have been so substantial that the market is getting spooked by them.

I do not think, though, that these will work. US Federal government debt is already so high that interest repayments on government debt now exceed 3% of GDP. A continual and growing deficit has already begun to eat up federal spending to such a degree that the interest charges alone rival defence spending and health care costs. A fiscal stimulus package of the sort that Bush is proposing will simply result in higher deficits. Whatever growth such a package could encourage would be sucked up by the downturn that high deficits would have later.

Similarly, Bernanke's cutting of interest rates is problematic. I have argued elsewhere on this blog that the declining US currency, now dredging the bottom of historical lows, will have an inflationary effect upon the economy. Oil, now at $100 per barrel, is spreading inflation too. The question is, though, whether the inflationary effects of a declining currency and high oil prices will be balanced out by the deflationary effects of an economic downturn. I doubt it, for the simple reason that other countries who have suffered currency devaluations and/or high oil prices always ended up in the mire of stagflation - high inflation mixed in with economic stagnation. Bernanke's cutting of rates, during a period in which inflation is already eating into the value of people's wages and savings, is a dangerous move.

So, if the solution is not through expansionary policies, then it can only come through contractionary ones - Austerity. Put simply, this involves an increase in saving money - and by money I mean cash in bank accounts, not money invested in shares or property that can lose value. Moreover, such saving needs to be protected from the ravages of inflation.

For an Austerity program to run in America, both the government and the Federal Reserve need to do the exact opposite of what they are currently doing. Instead of spending money and creating deficits, the government needs to run a fiscal surplus and pay back debt owed. This would involve raising taxes or cutting spending (mainly on health care or military costs) or a combination of both, in such a way that tax revenue exceeds expenditure, thus allowing earlier retirement of government debt (which is essentially paying off the principal earlier).

Instead of creating money and stirring inflation through lower interest rates, the Federal Reserve needs to increase rates to encourage household savings and control inflation (higher interest rates will make saving money more attractive to households and businesses, while at the same time killing off inflation, thus making money more valuable to keep rather than spend).

Of course, such actions are clearly contractionary. In other words, the austerity program I am proposing will, in effect, make the recession worse. Such an austerity program would cause a significant economic downturn that will result in high unemployment. Is it worth it?

Yes. It is. At some point in the future, an austerity program will be tried. It may occur next year, it may occur next decade. The issue is that the sooner such a program can be implemented, the easier it will be to recover from its shocks. Leave it too long, however, and the shocks will take longer to recover from, and the more potential damage such inaction will cause.

The shock of running an austerity program will be deep but, as Keynsian economists would point out, a recovery will eventually arrive. Not only that, but increased tax revenues from this recovery will make it easier for governments to pay off debt (assuming they remain fiscally restrained) thus making it easier for future governments to avoid the mess the current generation is in.

Sadly, however, I do not believe that such an austerity program is likely in the short to medium term. The price that politicians would have to pay for such a downturn would be too high for many of them, which will prove, yet again, that the structure of modern politics does not encourage men and women to be willing to do the right thing, no matter what the cost (apologies to The Big Lebowski). Instead we will see a period of stagflation and rising public debt, both of which will result in confused and angry politicians and a reduced standard of living amongst ordinary Americans.

There is one glimmer of hope, however - Paul Volcker could become chairman of the Federal Reserve again.



© 2008 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/

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