Tuesday, July 26, 2011

Follow the Economic Arrows

Remember the days in Econ 101 when the professor drew the seemingly incomprehensible charts on the board (if you remember it as a black board, it means you are old)?  We should have all paid more attention.  Those arrows are coming back to haunt us now with the federal deficit well beyond the comprehension of most taxpayers.

The lesson went like this.  Consumers are savers.  They supply capital to the market in the form of savings.  Businesses require capital to grow; to produce new products and services.  They present the demand for capital. Here the professor drew an elegant upward sloping curve across the board, the arrow pointing toward the sky as if there would be no end to the supply of money.  Then there was the demand curve, a flat line, pointing sharply downward and making it very clear that as the cost of borrowing increases, businesses will demand less capital.  The meeting point of these two lines, represents “equilibrium” the place where suppliers of capital and those who require it are in harmony on interest to be paid.

Now enters the government  -  an indirect player in the supply-demand conversation.  Government is neither a supplier nor user of capital.  Lurking on the sidelines, government claims to be a disinterested party to the capital tug of war.  Unfortunately, every fiscal and monetary decision shoves either savers or users of capital to the right or left. 

If tax receipts are not enough to support the government’s spending plans, it prints out its own credit card by selling treasury bills and bonds.  We all know this leads to deficits.  John Keynes argued that governments should run deficits during difficult times to make up for slack consumer demand.  Then the government should run a surplus during flush times.  Who could disagree with such a social responsive and considerate view?

The problem is that the U.S. government is simply a spendthrift.  Very few presidents and practically no one in Congress are willing to bring spending under control.  We enter one-war after another.  Indeed, we even pick a few fights without provocation, burning up precious military assets and creating new ranks of wounded soldiers to support.  When was the last time a president made any measurable progress in curing the inefficiencies in federal programs?  Is the postal service operating efficiently?  Has Medicare fraud been eliminated?  Has the rampant duplication of effort between federal agencies been eliminated?  Not lately.  No, no and no.

Some politicians would have us believe that we need to rein in spending on entitlement programs such as social security and Medicare.  After all, these categories represent the largest portions of the U.S. budget.  It makes sense to cut here first.  However, the economic arrows point to a fact that rarely gets mentioned in all the political rhetoric.  Members of Congress comprise a group of “insured” people who have the very best in health care insurance coverage and access to the best physicians in the country.  There is something very disingenuous about that idea.

Some of the same politicians feverishly argue for making permanent the lower tax rates introduced by the second George Bush.  Those with higher incomes benefited the most from this move.  Proponents promised that the tax savings would encourage this class to save more, investing in new business and creating jobs.  It happened just as the Republican administration promised  -  the consumers “saved” more money and invested, creating new jobs.

The problem was that at the same time, the new, lower tax rates went into effect, investment returns were substantially higher outside the U.S. than at home.  It does not take a Nobel Laureate like Keynes to follow that economic arrow.  Advances in electronic trading and communications, was making it ever easier for individuals to invest outside the U.S.  Corporations were already getting very skilled at “outsourcing.”  Indeed, the Bush tax cuts led to job creation  -  just not in the U.S.

Can Congress finally follow the economic arrows that to the rest of us seem so clear?  In the coming weeks all taxpayers will have chance to answer that question for themselves.

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