A Response: Why Levi prefers Direct Government Spending

Let's start with a question... What is more stimulative, tax cuts or food stamps.  The answer may surprise you.  It's food stamps, and the same is true when it comes to tax cuts for people below a certain income level.  When you give rich, upper middle class or even middle class people a tax cut generally they save it or put it on debt, which doesn't have a multiplier.  In order for any money put into the economy, either through tax cuts or direct social investment it must be spent.  

Let's take the Bush tax cuts for example...  $300.00 or $600.00 per couple.  What did I do with my $300... I paid off a credit card and then closed it.  That did nothing for the economy...  What did my parents do with their $600.00.. they put an extra payment on the house... which did nothing for the economy.  But what did my friends who were just making ends meet do?  They went out, and bought food, and an Xbox to provide the family with entertainment.  I didn't adjust my spending habits at all, but they did and bought a luxury and therefore stimulated the economy.  So it would have been better stimulus, to give me and those who make an income higher than me nothing and double or triple my friend's tax cut.  OR as many poor people don't make enough to pay any taxes, perhaps double their food stamp allowance, or increase the earned income tax credit, or... I could go on.  The point is tax cuts for the rich are of limited stimulative effect.

Pivoting to direct government investment. When the government pumps money into an economy directly it had multiple benefits.  Large government infrastructure investments employ people... the workers, the suppliers, the food vendors nearby... and allow for greater economic activity.  Adding light rail between Seattle and Tacoma will increase the flow of people and therefore the flow of money.  Adding lanes to I-5, finishing 167 or the cross-base highway will allow goods and services to flow more effectively across the region.  Paying states not to lay off teachers will have the net benefit of smaller class sizes, improved education (which will pay long term benefits), and oh yeah, keeping a skilled and specialized workforce employed and spending money.  The benefits of direct government spending are large, but hidden.  How do you know the state worker who lives next door to you kept his job due to the stimulus?  But you do see that $300.00 that you ended up using to pay off that credit card.  Tell me, what has a higher long term economic benefit.. a $40,000 a year job as a teacher... or $300?

Tax cuts to billionaires will go into savings accounts, or hopefully stock portfolios to increase capital available for investment, but we really can't say because as a society we have no control over what people will do with that money.   Additionally, there is a lag time.  You can cut taxes, but it will take people a while to realize they have more money and spend.  A $1,000 a year tax cut comes down to an extra 83.00 a month... what will you use it for?  Will you even notice? 

Pivoting to local issues - Why Levi opposes I-1098.

In Washington State we have an initiative this election cycle called I-1098.  This initiative would impose an income tax in the state, while at the same time reducing the state property and B&O tax.  In a move that has put me in the minority with my more liberal friends, I personally oppose this.  This is not to say I don't agree with the general point that Washington's tax structure is regressive and that it does not serve the needs of a state to have a reliable means of income.

Washington State is primarily funded by property and sales taxes with some money being provided by a B&O tax.  With this structure it is very difficult for the state to accurately anticipate tax revenues and budget accordingly.  The result is that during good times, we have a surplus (and as a result start hearing from republican politicians that we need a tax cut), and and bad times we have a deficit.  What compounds the problem is that we do all of our budgeting on projections.  When this is based on sales tax, that creates a major problem.  It's much easier for a consumer to get spooked and stop spending, which drives down sales tax revenues, than it is for them to stop working.  Certainly, when the economic situation gets bad enough you'll have job losses, but it's not the same kind of volatility you get with sales tax revenues.

Additionally, when I was unemployed for a period of time last year, I took the initiative to try to start my own business.  Imagine my surprise when I learned that not only do I have pay state B&O taxes on my profit, no, I have to pay them on everything!  It was frightening and confusing and stopped me from trying to expand my business.  The B&O tax is a major hurdle to building a business in Washington State and must be replaced.

That said, I am completely opposed to I-1098.  First and foremost, it's unfair.  If you are going to levy an income tax, something that I support for a variety of reasons, you do so across the board, not just on the rich.   AND more importantly you remove other taxation.  All 1098 does is reduce other taxation, it reduces B&O but does not eliminate.  It reduces the state portion of the property tax but does nothing for the local portion.  It reduces the state sales tax but does not remove.  So now we have 4 different tax schemes as opposed to 3 and due to the idiotic targeting, we encourage higher income earners to leave the state.  Washington has to do something with it's regressive tax structure that doesn't allow the state to adequately predict income... but this... isn't it... and this is from a liberal!

Income's Effect on Happiness

I previously claimed that the often sited growth in the income gap in the US is not really an issue since the dollar's ability to improve quality of life rapidly diminishes as you increase in wealth.

A recent article in the Chicago Tribune discusses study which looked into part of that effect.  The study was looking into how income affects happiness.  They concluded that income increases up to around $75,000 impacted happiness, but that income increases above that level did not significantly increase it.  Of course, they are quick to state that there is a short term increase from any raise in income or windfall of cash, however, they found that non-income factors were the primary constrains on happiness above $75,000.

While happiness is just one aspect of quality of life, it is very interesting that the effective benefit of income to happiness is so low.  I suspect that much of the reason for that due to the limits in the power of the dollar for higher prices items as I discussed in the previous post.

The largest impact on people is not the difference between rich and poor, but the difference between poor and middle class.  No one, however would be willingly to openly state that they want to take money from the middle class and give it to the poor (though that is often a result of their attempts to take money from the rich as I discuss here).

So the question really should not be about the income gap between the rich and the poor.  A far more valuable measure, though still not a wholly accurate one would be to measure the income gap between the poor and the middle class.

I have not been able to find a more recent graph, but this one shows that this gap is increasing very slowly even looking at purely dollar terms.

The article that accompanies the image is here.  It, of course, focuses on the gap between the rich and the poor which shows a huge percentage change in income.  Looking at the middle to bottom fifth shows very similar rates of change.  

So again, while the rate of change in income is certainly widening at a very high rate, it is only rapidly widening  at income levels which have a very diminished impact on quality of life.  In the article it states that the top 1 percent in 2007 had an average income of $1.3 million and that the increase from the year before was an average of $88,800.  How much of an impact does a salary increase from $1.21 million to $1.3 million really make in a person's quality of life?  Is that change really greatly different in quality of life impact than the average increase of $800 from $16,900 to $17,700 that the bottom fifth attained?  I know that when I was making under $20k a year, $800 was a lot of money which would allow me to have something like a much more reliable car.  I could accept that some believe that $88k means as much to someone making $1.3 million as $800 dollars does to someone making under $18, but I hardly find it credible to believe that it means significantly more.   I mean how do you even spend $1.3 million a year?

When looked at in those terms, doesn't the income comparison between the top 1% and the bottom fifth seem to be the wrong one to look at?  Certainly it's draws attention, but it is a statistic that has very limited value and is used often to mislead people into the view that the poor in this country are worse off now then they were in the past.  When the truth is nothing of the sort.  

The above chart and article are discussion inflation adjusted dollars, so the poor have increased in wealth by 16% from 1979 to 2007.  This is compared to the slightly higher increase of 25% for the middle and 23% for the second bottom fifth.  That means that there is very little increase in the dollar income gap for roughly half the population. Even the next fifth showed only a 35% average increase.  The only large gaps come into play with the top 20% of the country where you are talking about incomes over $200k per year.  That is far above the 75k per year (over 40% of the country was at or above that income level in 2007), and it above the income level where you have very diminished increases of quality of life per dollar.

I'm not arguing that we should not have welfare programs and charity to help those in the bottom incomes.  I believe we should.   I even believe that the tax system should be a progressive one where the more wealthy pay a greater percentage share.  What I don't believe is that things are getting worse, quite the contrary I think the numbers (when you look at the right ones) show that things are getting much better.  

How do you Stimulate an Economy? Part 4 - Taxing to Spend

In light of my previous post on the benefits of government spending, you might wonder why I claim that reducing taxes is the better option in an even earlier post.

The problem is that both are necessary for a healthy economy.  Government spending is beneficial to the economy, but low tax rates are also beneficial.  The problem is that one requires the opposite of other (though you can delay the taxation by increasing debt).  So if you increase government spending (good), you have to increase taxes (bad) or if you decrease taxes (good) you have to decrease spending (bad).  Either extreme is bad so it isn't a question of which is better for the economy, the question is what is the correct balance point.

In both cases the benefit is diminishing as you increase the levels.  Increased spending when spending is very low has a much higher benefit than it does when spending is high.  The same is true for taxes, the lower the rate the less benefit you have from lowering it further.

For me it is less a question of which is better and more of a question of where the balance point is.  There have been times when using spending would offer benefit despite the necessary raise in taxes and others where the reverse is true.

As for where we are at in the US today, I don't believe that increased spending is going to have an overall positive effect.  The outstanding debt is far to high and is rising far too quickly in an unsustainable way, which means taxes will have to increase to cover the cost.  The concern on what that increase will be, who it will affect, and when it will happen is having a hugely detrimental effect on the economy already. While there are many positive aspects to the spending programs which have been put in place in the past year, they also come with that significant negative.

That negative is compounded by the uncertainty of how the deficit will be handled, especially in light of how much debt the US has and how quickly it has risen.   The ability of the US government to continue spending on credit has a limit and there are signs that limit is approaching.  Further spending is going to exacerbate the problem even as it provides the benefits I have mentioned.

If the US had limited or no debt, then spending might be a good answer, though it does come with some risk.  With spending levels already high and debt levels very high, I believe that the overall effect of increased spending not only doesn't help the economy, but I believe there is overall harm being done.

Why you can't increase taxes only on the rich.

It is common for politicians, when talking of raising taxes to promote the idea that they will be either taxing only the rich or taxing the rich more heavily. The idea being that they can raise the necessary revues by passing the costs only on those who can afford it.

Is that a something that any part or whole of the US government can do?  I don't think so.

Certainly, they can raise the tax rates on only those with incomes in a certain range, or they can tax only goods and or services that only the wealthy are likely to use.  But does that cost truly come from the wealthy?  Again, the answer usually is no.

The problem is that, as I say with nearly everything, it is more complicated. You cannot simply isolate one part of our economy.  When you make a change to one aspect, there are naturally changes to other parts.

Let us start with income taxes.  If you raise taxes on these high earners, what will be the result?

First you must look at what you have done.  What you have effectively done is increased the disparity between the business cost and the personal reward for the highest income labor.  To help that make sense, let's put some numbers in there.  Say we are talking about a $300,000 salary.(For now lets ignore other taxes, fees and benefits, since their impact is roughly the same before and after an income tax change).  With our current tax rate, the employee would pay about 33% of that income in federal income tax.  This means that it costs the company $300,000 to provide that employee with $201,000 in compensation (again excluding other taxes and benefits).  If you were to increase the tax rate to 40% it would then cost the company $335,000 to provide the same $201,000 in compensation or alternatively the company can pay the same $300,000 and the employee with now earn only $180,000.

If the latter result above is what happens, then the tax would primarily affect the rich.  Why is that considered to be even a likely outcome, much less the expected one?  If you were to suddenly have a permanent pay decrease for performing the same job, how would you react?  Would nothing change?  People who earn high incomes are able to do so, because they have skills which are in high demand, they have a willingness to work at a higher level than most, and/or they are willing and able to take a much higher level of responsibility.  If you decrease their compensation, most people are either going to move on to a place where they are better compensated or they are going to work less.  Either way, what you have actually taxed is not the wealthy employee, but the business.  It will have to either increase salaries to compensate to the taxes, or it will have to hire more people to do the additional work.  Essentially, employees pass on the much cost of their taxes on to their employers. Though we negotiate gross salaries, it is the net salaries that really concern employees.  Someone isn't going to do the same work for $7 an hour in take home pay that they will do for $9 an hour, even if the gross pay is $12 in either case. The same is true (perhaps more so) for those earning much higher wages.

Fair enough, businesses that can afford to pay people enough to be wealthy are wealth themselves, so taxing them is till taxing the rich.  Not exactly.

The problem with taxing companies is that you are simply increase their labor costs.  When a company has increased costs they can do many things, but they all boil down into one of two actions.  Either they increase the price of their product or they lower its quality.  This means that the increased costs of the company are felt, not by the employees but by their customers.

This is the same scenario you run into if you increase corporate or business taxes.  Increasing those taxes is simply increasing the cost of the goods or services that the business provides.  The reaction of the business will be to pass on that cost to the consumers.  In some cases this can force a reduction in the size of the company, which can cause layoffs.  The reason for this is probably a topic for another post, but it happens is most cases.

This leaves only investment income as a source of taxing the rich. Here again, you run largely into the same problem.  If you increase taxes on investment gains then you simply reduce the return on those investments.  This forces those seeking investment funds to offer more to get the same investment.  Just because investments are more expensive doesn't mean that investors are willing to risk their funds for a lower return.  The result of this is that starting companies are not able to retain as much revenue to use for growth and expansion as they instead have to use more to repay investors.  It also means that potentially profitable business are not able to get funding as their potential profits are not hight enough to attract investors.

None of what I have outlined above is 100%.  In reality the wealthy individuals targeted will pay some of the tax increases, but they will pay nowhere near all of them and the rest will be paid, indirectly, by the non-wealthy.  So while you can increase taxes on the rich and you can increase how much they pay, you cannot do so without a significant portion of those tax increases actually being paid by the poor and the middle class.

How do you Stimulate an Economy? Part 2 - Why Aaron prefers Tax Cuts

In part 1 I discussed how difficult it is to even know what is the correct course of action to take to help improve an economy.  The is both a remarkably complex system and one in which seemingly small events can have massive impact.  Mathematically speaking it is a chaotic system, which makes it very hard to predict much less guide and control.

That is the primary reason that I prefer using tax cuts to stimulate the economy. While I don't think businesses are inherently any more competent or less corrupt than politicians, the bottom line is that there are many more of them and their methods produce success or failure much more directly for them and much more quickly.  This leads to a system in which many different plans are attempted and ones which lead to success are emulated and refined while ones that lead to failure are discarded.

Now of course, on major drawback is that these plans are not designed for the benefit of the economy, but rather for the benefit of the company, or the company owner/shareholder.  Such actions, however, almost always also increase the overall economy.  Making businesses successful is the key driver in making the economy healthy.

The plan of using the government spending, provides more direct control of things into the hands of fewer decision makers.  That can be a good thing, especially when there is a clear case of something that needs to be done.  A good example of this, and something good that is in the current US stimulus is funding research into non-hydrocarbon energy generation.  While I have some disagreements with the details of how it is being done, overall it is a good program to use government funding to promote this research.  However, that is because even if it isn't something that will directly help the economy overall in the near term (it in help in many ways and hurt in many others) it is something that, if successful, will help the economy greatly in the long term by reducing the costs (either political or economic) of energy.  Because it is clearly beneficial to the economy and may be too long term to be correctly promoted by business it is a good candidate for government funding.  However, those cases are, I believe, limited in number. 

It is far more often that we don't know what the best path to promoting the economy is and when that is the case I prefer, to steal the term from Glenn Reynolds, an Army of Davids to the management of a Goliath.  As we decrease tax burdens it increases profitability and therefore incentive for new players to enter with new ideas.  Yes, we also get old players with old ideas, but failing ideas lead to either abandonment or failing business, successful ideas lead to emulation.  

So while I think that both spending and tax reduction can and to stimulate the economy in some ways and depress it in others, overall I prefer tax reduction because it empowers larger numbers of solutions to a problem that we don't understand well enough to have all the answers for.