Reality and Fantasy: The Economic Pie

All governments have certain financial obligations.  Which obligations they ought to have is a matter for political philosophy.  How they most prudently meet their obligations is, at least in part, an economic question.  It’s an important topic right now because if things don’t change pretty significantly, the U.S. may not be able to meet all of its projected expenses.  

There are essentially three views as to how we can satisfy those obligations, and they segregate into two camps: the size of the American economic pie is fixed, or the economic pie can grow.

The Occupy Wall Street crowd is the clearest example of fixed-pie thinking.  The very act of labeling citizens by their income percentile betrays a fixation on current wealth / income and ignores the implications of future economic growth.  Can you imagine any self-respecting OWSer arguing that in order to wring more money out of the 1% we should figure out how to incentivize them to deploy their wealth more productively?  Their rhetoric is entirely confiscatory.    

Reality is not on their side—economies grow.  The basic equation for macro-economic growth is a rising population + increasing productivity.  Both of those trends are intact globally and show no signs of letting up in the next several decades.   

Some fixed-pie folks may claim to have a right to a larger piece of that growth, but that is a question for political philosophy--and hopefully, the rule of law--not economics.  

The other group believes that the economic pie can grow.  They believe that taking money out of the public sector allows it to be put to work more productively in the private sector, which raises taxable incomes and which in turn leads to higher tax receipts.    

Growing pie proponents include “supply-siders”.  Supply-siders argue that that there is no limit to the amount of economic benefit realized through cutting taxes, and that because of this, the more taxes are cut, the more tax money will be raised through taxes.

Ultimately it’s a view that reduces to the absurd: if we were to cut total federal tax receipts from $1 to $0, would we really somehow then take in more money?  Reality is on their side, but only to a point.   

  

The other growing-pie sub-group—we’ll call them the “optimal tax” group—says to the fixed pie-ers and the supply-siders, “Wait a minute, there must be a tax structure that engenders economic growth through private sector profit retention, and maximizes tax receipts to meet government obligations.”

One challenge—especially difficult in an election year—is to distinguish whether popular arguments pertain to political philosophy, or to economics.  Another challenge is to decide which economic arguments are reasonable.  

The fixed-pie crowd has a tough time distinguishing between philosophy and economics and when they do, they make poor arguments like: “redistributing wealth will allow ‘middle-class families’ to spend more money and, thus, increase economic growth.”  Hmm.  How do we know that consumers will spend money more productively than hirers?  Empirically, we’re seeing the limits of that notion right now: far from spending their FICA tax holiday money, consumers are paying down debt.

Supply-siders also frequently blur economics and philosophy.  They desire a less pervasive federal government and thus support all tax-cutting initiatives, often times without actually doing the work to figure out the real economic implications.

The place to spend our intellectual energy is optimal tax structure.  Optimal tax proponents agree with research which suggests that high marginal income tax rates act as a drag on incentives to produce.  They also know that we can’t simply cut our way to paying off our debts.  

Backing optimal tax rate policies does not limit you to one political philosophy.  It just means you’re thinking rationally about government income and expenditures, and tax payer incentives and disincentives.  In other words, optimal tax structure is the land of grown-up fiscal management—the domain of economic reality. 

 

So, OWSers and blind-faith supply-siders, pull up a chair!  The pie is delicious—and capable of growth—and the price ain’t so bad, in reality.

C'mon, John, Just Say it!

If you didn’t happen to catch House Speaker John Boehner’s summary of why congressional Republicans caved on their earlier demands to pay for the payroll tax cut with spending cuts, here it is.  His accusation that Democrats are playing political games isn’t at issue, rather it’s the insinuation that he and his cadre are taking the high road and not playing games.   

Really, Mr. Speaker?  Blech!

How refreshing would it have been to hear the Speaker say instead: “Look, everybody, we did our level best to force these spendthrift redistributionists to pay for their economically-ineffective-but-politically-popular, vote-buying tax cut with spending cuts elsewhere, but we failed.  And, in case you numbskulls hadn’t noticed it’s a rather big election year; it would’ve been political suicide for us to try to take the high-fructose corn syrup laden lollipop away from the diabetic toddler.”  

 

People love free stuff.  OK, the stuff’s not really free, but they don’t have to pay for it now and if we finance the purchase of the stuff with debt, chances are pretty good that eventually someone else will have to cover the tab.  Over time, people come to believe that the free stuff should always be free to them.  It becomes something to which they feel entitled.     

The Democrats clearly get that restoring taxes during a weak economic expansion won’t help anything.  But, surely, they also must know—deep down—how ineffective a temporary FICA tax holiday is, right?  I don’t know, maybe they’ve never been exposed to permanent income theory, but I'm inclined to give them the benefit of the doubt. Maybe that's too much to assume: our last president didn't seem to get that one and he was, a 'conservative'. Still, Democrats are always saying how much smarter they are than Republicans, so I think I'm safe.

Anyway, assuming Democrats do actually understand how silly tax holidays are, then we should expect them to propose a date or set of economic conditions as a trigger for restoring the tax to pay for Social Security’s obligations. 

On the other hand, when will it be politically feasible for Democrats to raise taxes on 'middle class families'?  Might the underlying strategy be a permanent shift of financial obligation for funding Social Security—from the beneficiaries to the 'rich'?

There’s one way to tell.  Someone should ask the Democrats at what point it makes sense to fully reinstate payroll taxes, and see what they say.  What kind of response would Rep. Boehner get if he asked that question?