Thought of the Day
“The Debt Problem – Is Government a Help or a Hindrance?”June 30, 2010
Growing up in northern New England in the 1950s, two of my favorite characters were “Bert and I”, recorded by Marshall Dodge and Robert Bryan, both students at Yale Divinity School. Bert, considered “dumb as a hake”, once when asked how to get to Millinocket, responded: “Come to think of it, you can’t get there from here!”
That is how many of us feel looking at the extraordinary debt load of our federal, state and local governments. Is there a way out? The answer must include a combination of reduced spending and increased revenues. Printing our way out, a possibility for the federal government, would have devastating consequences as we well know from reading the history of the Weimar Republic.
To assume Congress will reduce spending is about as likely as my seeing sixty again. Nevertheless the resulting deficits are unsustainable and, unless addressed, will lead to an extended period of stagflation or inflation. Spending won’t be cut, so the focus must be on revenue growth. The question becomes, how best to grow revenues.
Again, there are two choices: raise taxes or generate economic growth. The immediate temptation is to increase taxes, especially on easy and soft targets like the “rich” and corporations. The problem, though, is that those two segments are responsible for most of the job growth in our economy. Common sense suggests that government should encourage businesses, especially small ones, to invest and hire – something lower, not higher, taxes will do.
The tax cuts of the early 1920s, 1960s and 1980s kicked off several years of economic growth. But when stimulus is mentioned it is generally spoken of in terms of what government can do. However, stimulus comes in many forms. Going to the barber is a form of stimulus; an auto company investing in a new factory line is another. A study done by the U.S. Office of Management and Budget in 1996, which argued there is no evidence that tax cuts increase tax collections, belied its stated conclusion. The study used the Reagan tax cuts as an example. While tax receipts, in constant dollars, did decline for two years following the cuts (1982 was a recession year), the study neglected to mention that for the following six years receipts rose – 20% higher in constant dollars and 65% higher in nominal dollars by 1988. The evidence seems irrefutable – tax cuts promote economic growth.
Additionally, the personal tax cuts of 1981 (a 25% across the board tax reduction) had the effect of increasing the share of total taxes paid by the top 10% of all tax payers, from 48% in 1981 to 57.2% in 1988. A similar experience occurred in the 00s. By 2006, three years after the Bush tax cuts, tax receipts were at 18.4% of GDP, above the 20-year, 40-year and 60-year levels. Long term capital gains tax rates were reduced from 20% to 15% in 2003; three years later revenues from this source had more than doubled. Those same Bush tax cuts – purportedly benefitting the rich – had the effect of raising the share of taxes paid by the top quintile from 81% in 2000 to 85% in 2004. Tax cuts are positive for economic growth. Tax increases are not, and that is what will happen in 2011.
The stock market (the S&P 500) is at an eight-month low, down 14% from the high on April 23, having given up 173 of the 550 points gained after the March ’09 lows. Explanations abound as to why the market is behaving so abysmally – China’s slowing growth, problems in Europe, sovereign debt, inflation, deflation, unfunded public pension funds, a possible double dip in the economy, the spill in the Gulf, the U.S. housing market, tax increases and Afghanistan.
But as much as anything, the market, in my opinion, reflects concern over a spreading, pernicious and increasingly indebted federal government – a beast that exercises more control over our lives, reduces individual initiative and needs to be fed (higher taxes.) The uncertainty created by Obamanomics regarding health and financial reform, the consequences of cap-and-trade, the refusal to sign free trade agreements, the takeover of FNM, FRE and AIG and auto bailouts that ignored the rule of law is worrisome. (The irony of yesterday’s decision – a Treasury decision – to appoint as AIG’s compliance officer the former compliance officer from Lehman, a decision which causes one of those “you’ve got to be kidding!” moments, will not go unnoticed.) This apparent refusal on the part of government to acknowledge the seriousness of its rapidly deteriorating financial condition concerns investors.
Providing (temporary?) cover to the President, Treasuries have continued to rally. The yield on the Ten-Year, at 2.97% is the lowest since April 2009, while the yield on the Two-Year at 59 basis points is at a new low. The safety of a fiat currency has presumably driven investors toward the Dollar and Treasuries, but if current trends persist that will prove but a brief respite.
The answer is ‘yes’, we can get there from here, but it requires a sea-change in Washington that recognizes the limits to government and reflects the importance of the private sector to the economy. America is fortunate in its people, its laws and its resources. To restore growth, which more than anything else will re-fill federal coffers, the animal spirits endemic to our economy must be unleashed.