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Saturday, July 24, 2004

Battle Tax Cuts - Challenger - Closing

From: stirling.newberry@xigenics.net
Subject: Closing Statement
Date: July 24, 2004 1:13:02 AM EDT
To: thechairman@onlinerp.net

Lionel Robbins, libertarian economist and supporter of FA Hayek, defined economics as the study of choices between scarce resources that have alternate uses. Alfred Marshall, who literally did write the book on Principles of Economics argued that economics is the social science that focuses on what is measurable.

Measurable trade offs then, are at the heart of any discussion or debate about an economic policy. To fail to lay out the trade offs of an economic policy is to engage in bad faith.

I would like to start with an example of how to propose a series of tax reductions, from Kennedy's two speeches, first in 1961, and then in 1963.

First, in both addresses, note his continual laying out of the balancing alternatives. His 1961 tax plan includes, not only extensions of existing taxes, but decisions not to back tax increases which had been proposed, and closing of loopholes, including the use of Social Security Numbers to track income tax.

Second, not how he connects with each proposal, exactly how it is to produce expected gains. For example, he points out that commercial aviation produces benefits in the economy beyond those captured by the companies themselves, and that therefore during the transition to broader use of jets, aviation fuel should not be taxed as heavily, but that the tax on fuel would be raised, gradually until “the entire cost is recaptured".

Finally, note that he does not ask that the Congress count these chickens before they hatch. Instead, he labels losses in revenues where they occur, and balances them with exactly how the new tax structure should produce effects:

But continued confidence at home and cooperation abroad require further administrative and legislative inroads into the hard core of our continuing payments deficit-- augmenting our long-range efforts to improve our economic performance over a period of years in order to achieve both external balance and internal expansion-stepping up our shorter run efforts to reduce our balance of payments deficits while the long-range forces are at work--and adding to our stockpile of arrangements designed to finance our deficits during our return to equilibrium in a way that assures the continued smooth functioning of the world's monetary and trade systems.

Before turning to the specific measures required in the latter two categories, I must emphasize once again the necessity of improving this Nation's over-all long-range economic performance--including increased investment and modernization for greater productivity and profits, continued cost and price stability and full employment and faster growth. This is the key to improving our international competitiveness, increasing our trade surpluses and reducing our capital outflows.

In otherwords, even if the Federal Budget is to run a deficit, it will improve the gold flight problem, which would undermine the US trade position. He is saying that his trade off, even if the tax plan does not work as well as hoped, is domestically held federal deficit for foreign held trade deficit, and that over time high yielding investments overseas would return more than domestic investment. Bush, in contrast, has allowed the trade deficit to explode, making the devaluation argument, while forgetting that much of our trade deficit is for oil, and the Saudis don't buy our consumer goods, no matter how cheap they are.

Particularly in the 1963 address, he relentlessly underlines the particular economic condition that prompts his action, namely the need to maintain the gold peg of the dollar, and slow the outflow of gold from the United States. He underlines the need for the United States to undertake these agreements.

The Council of Economic Advisors at the time realized that the tax cut had inflationary implications, and felt that, under the then commonly held view of how the Phillips Curve worked, that they could allow a certain amount of price inflation, in return for wider employment. The wider employment would then bring down prices because of economies of scale, if, there were enough investment in automation to provide those economies of scale. So the demand side, tax reductions, linked to the supply side through, as Kennedy put it, automation improving productivity. But note as well that he is committed to making sure that the losers of the automation advancement would be caught, rather than simply dumped into unemployment. Even when the trade off is generally positive, the costs are recognized.

History has seen that the Kennedy tax bill helped sustain expansion in the 1965-1968 period, but that it had the effect of creating pressure on the dollar and increased pressure on oil supplies. It was Nixon's inability to deal with these pressures that caused him to lift oil import quoats in 1973, and to go off gold in 1971. The lesson is that tax policy cannot be set on autopilot, but must constantly be reexamined in the light of the market's response to incentives. Kennedy himself points out a tax provision of 1954 which, despite reasonable arguments for its passage, should be repealed.

The standard set here, for what a tax package should look like, is not met by the various tax bills which taken together form the revenue reductions. The underpinnings of these bills are either the “starve the beast" hypothesis of Grover Norquist. Which is to say that one cuts revenues, and then nasty effects force people to cut spending. This is based on the work of Robert Mundell. Or one can believe “Ricardan Equivalence Hypothesis" of Robbert Barro and argue that people will get a tax windfall, and then save all of it to pay for the tax increase they know is coming. But even Barro admits that the particulars of a tax policy have an impact, and therefore should be looked at.

Rather than take a position on these theories, I've laid out a practical case: namely that energy prices have jumped, that as a result real wages have been squeezed. That the chances for genuinely new businesses dropped, and that new company formation has fallen through the floor. These are the root problems in the economy: rising energy costs and falling chances for new business. The tax reductions have not addressed this problem, nor can they – because even under their own theory of REH, they have to be poured into investment. Investment that must produce efficiencies to pay for itself and remain neutral. But investment isn't remaining neutral, on the contrary, it is over inflated by historical norms – that's the Price to Earnings graph.

In other words, for the deficits “not to matter", even under their own theory, they can't be of any help in paying for the current squeeze, and they can't be used to get us out of recession. Because that would be spending, and not saving.

What this means, even under their own theory is:

1. The tax reductions are going to be paid by higher taxes down the line. Not saying what these taxes are – means that we have people buying lottery tickets on their not being around to pay the results.

2. The tax reductions have to be shown to be increasing investment that will specifically drive down the cost of scarce resources. They have to do this without buying signals from the demand, because, under their own theory, there can't be any demand. This is “getting from the demand side to the supply side". They haven't done this either. I have pointed out that Iraq was an attempt to ease they supply side energy problem, but there is nothing in the tax bill that would do this.

3. For the REH to hold, all the money has to be investment, and all the investment has to be effective. Leaving aside Stiglitz and others who deal with imperfect information, investment has a supply and a demand. New investment demand, which under REH government deficits have to be, will eventually saturate investment supply. This is why I talked about P/E ratios in investing: because if investment is saturated, which by every historical measure it is, more money will not produce more efficiency, merely asset inflation.

So that is the case: we have energy and asset inflation already, before Bush was inaugurated in fact. Cutting general revenues exacerbates these problems, regardless of whether you want lower taxes or not, regardless of whether you want smaller government or not. As with Kennedy and the problem with gold flight, it is these problems that are hindering our economy: the cost of energy, and the paucity of chances for genuinely new areas of business. We see these hit the average citizen in the cost of gasoline, falling real wages, and stagnant employment. That these conditions have remained true, even after the tax bills is a practical indication that they have failed to deal with the very problem that forced Greenspan to raise interest rates quickly in 2000, and then slash them to historical real lows in 2001-2002.

If people are getting tax reductions and spending them, even under the theory that is advanced to say deficits don't matter, then tax reductions will be their borrowing against having to pay higher taxes later. And one way or the other, through higher interest rates, higher taxes or higher inflation, they will lose out. This was the point of the investment in the S&P - that the best case family that Republicans crow about as "getting more money", would have to turn around and invest all of it in the Standard and Poors, and still be behind what the tax package would have to charge them. Even under the conservative assumptions, best case, the middle class tax payer is behind. Thus, when someone says "deficits don't matter", the reply is "they don't matter only to people who don't need to spend the money".

Finally, if the argument is that a tax policy is meant to stimulate the economy, then it should be as cheap as possible. This way the later tax burden is small, and does not need to be paid by large cuts to expenditures, or large tax increases. The chance that the savings of people's lives and capital and the social fabric will offset most of the costs is higher, if the later costs are lower. In short, if you are going to be liberal, be cheap. It's Machiavelli's old advice from The Prince

And that is why I say, focus on the real bottom line. If government policy isn't dealing with the real present dangers to the economy, regardless of what the nominal dollars do, then it will fail as a policy. This may sound like a harsh standard, and it is. It also refutes many policies that you will hear from the Democratic side of the aisle as well – because they too do not address the root problems. The present tax policy will make worse the problems faced, because it dumps inflationary dollars into the system and those dollars do not address why we aren't getting ahead. Perhaps some other tax policy would do this.

I've attempted to make this complex case, and refrence this more complex material because it is essential for the public to know the words being thrown around on the inside. Instead of accepting the sound bite debates, the internet, and forums like this one in particular, give us a chance to deal with matters as they are, even if it takes longer to do so. The readers of this forum should congratulate themselves, they've read more on the tax debate than the average American will see and hear during the entire 4 years of Bush's tenure in office, and more than they will hear during the campaign.

But it is not time to rest on those laurels. Because the root problems, of lack of chances for new business, and increasing energy cost pressures, are going to be with us for sometime to come. And while the current tax bill has been a miserable failure in dealing with those problems, it is not enough to know what not to do, it is important to know what must be done, and to hold congress' collective feet to the fire to make sure that the solutions that are proposed meet the problems we actually have.


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