Sunday, September 30, 2012

On Tax Increases and Spending Cuts

"The liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic state itself."
-- Franklin D. Roosevelt

In this lamentable election season there is no end to the tired refrains, "raise taxes" (as in, income taxes) and "cut spending."  And it's peculiar that Americans are willing to rally around either of these messages. But that's just how effective parties and politicians are at fooling people.

The American people don't have the luxury of believing what the party bosses are telling us. These days, it's not just mortgages that are underwater. It's the entire United States of America.

The idiom "underwater" refers to owing more for an asset than the asset is worth.

Why do some Americans want their taxes to be raised? They are taking notice of the monstrous public debt and conclude that a tax increase is the only solution. They're the ones who don't realize how much Americans are being taxed already. Some of these taxes are not called "taxes." A savings account that only gets a quarter of a percent interest is a tax. It's a decision made by people in government to stimulate banks by allowing them to keep money that they'd otherwise have to give back to consumers in the form of interest on savings. And when the interest rate is less than the rate of inflation, people who save money are in fact losing money, little by little, and seeing it fall into the hands of bankers. A fine time to be talking about privatizing Social Security.

Other Americans take notice of the public debt and want the government to cut spending -- and sure, there's plenty of spending that ought to be cut, but it's a sure bet that what's most in need of cutting won't be cut, and the things that shouldn't be cut will be cut. When the cuts arrive, children will get less education and a greater number of our elderly will struggle to stay warm and fed. But rest assured, money will still be spent on military jets that can't fly and bridges that don't go anywhere and subsidies for financial firms that are making record profits.

In reality, raising taxes will not reduce the public debt. Cutting spending will not reduce the public debt. Austerity measures will usher in austere living conditions, but they won't reduce the public debt. Allowing the sanctity of contracts to be violated without redress, that will only lead to the ruin of our country, and it won't reduce the public debt.

So, what will succeed at reducing the public debt? After studying this question for a while, I've discovered that there is a tried-and-true method for lowering the public debt and even generating surpluses. To explain how this works, let's start by discussing the idea of twin deficits.

It turns out that public debt and trade deficits go hand in hand. For a while, economists had doubted this and argued against this conclusion, but recent research using more sophisticated methods shows that this is a robust and reliable relationship (source). When America has a trade surplus, chances are, America will also have a budget surplus.

The last time this happened was during the early 1990's. America's advances in information technology resulted in increased exports, and the trade deficit shrank. It didn't last for very long because, in no time at all, Asian companies began to compete in the electronics sector. Now, years after the horse has escaped the barn, politicians are worried about intellectual property rights. But the point here is that the early 1990's was also the last time the United States enjoyed a budget surplus. This had nothing to do with Bill Clinton's leadership. To the contrary, he promoted high-risk mortgages and ill-conceived free trade agreements. His administration was instrumental in creating the dire situation that Americans are facing today.
Increased technology exports in the 1980's reduced the trade deficit.
Since the 1990's, things have been going south (source)

There are many historical examples of the positive relationship between a favorable balance of trade and reduced debt. But, rather than try the reader's patience with a recitation of these examples, it suffices to say that there is nothing mysterious about why there's a relationship between the two. When America is exporting at a rapid pace, unemployment rates shrink. When more Americans have jobs and industries are growing, the government earns more revenue from taxes. And you may have noticed that, right now, China is benefiting from a favorable balance of trade and by all accounts their economy is doing pretty well.

Each time a United States company pulls up its roots and hires people in China, that company is increasing the trade imbalance between the U.S. and China. Companies like Dell Computers have single-handedly contributed billions of dollars to the size of our trade deficit. Fewer Americans are employed; thus, they are not only too poor to pay taxes but they are receiving government aid in the form of unemployment and Medicaid.

There are two reasons for China's success that are worth noting. First, the Chinese government makes it nearly impossible for its citizens to make foreign investments. This has the effect of keeping currency within the country. Secondly, the Chinese government taxes imports. When American goods enter China, a 35% corporate tax and a 17% Value Added Tax (VAT) are imposed, making American goods more expensive. When Chinese goods enter the United States, there are no taxes at all on the imports. Not a penny (source).

The liberals' argument that public debt is irrelevant, and both parties' loving embrace of so-called "free trade" policies, are both mistaken. And conservatives -- being famously tax-averse -- won't want to hear this, but it is about time that the United States instituted a VAT on imported manufactured goods. A VAT will increase the cost of Chinese imports, encourage businesses to return manufacturing to America, keep currency at home, and reduce unemployment. By reducing unemployment and increasing revenue through the VAT, the public debt won't be a problem.  The only reason that neither of the two parties is willing to champion a VAT is because the people who pay for their campaigns benefit from the situation being the way that it is now.


  1. So I like the idea of a VAT, tarriff, or tax on imports, whatever you want to call it. But I have a question, one of the reasons we have out sourced and off shored production is to reduce costs to a consumer which demands ever lower prices, if we place a tax, some (or all?) of the increased cost will be passed on to the consumer. What can we do to balance this shift in cost? Do we print less money to reduce inflation and raise the value of the dollar? Do we then fiddle with interests rates and what not, to make sure existing property (homes) are not devalued? I am not an economist, but I have been trying to figure out this complex equation to make sure the whole thing won't go out of wack if we return to a tarriff system (which we used to have to protect American interests) in the modern global world. I would think this would have to be managed constantly and different tarriff placed on goods from every country in the world, to in essence create a equivilient cost of manufacturing world wide (or maybe make it a little cheaper for the US).


  2. Hello Alan!
    The way I look at it, the American people pay a dear price for supposedly "low-cost" goods from China. Americans face record unemployment, a crumbling infrastructure, and the loss of essential programs like Social Security and Medicare. That is what Americans pay for the privilege of buying stuff cheap at Walmart.

    Also, if America loses its manufacturing capacity to low-cost countries, there is a genuine danger of tyranny or oligarchy. This may sound alarmist, but history shows us that this is true.

    If America becomes a production-oriented rather than a consumption-oriented economy, the effect will be greater purchasing power and global competitiveness.

    I think there is a natural upward pressure on the price of homes because our population is growing. The only restraining force is that people don't have the income to buy homes. OF course, given that the housing prices were inflated by Wall Street malfeasance, I am not opposed to plans that would forgive a portion of mortgages taken out during the bubble years, provided that Wall Street pays and not the taxpayer.

    Lastly, I think you know this, but I want to emphasize that a VAT is not a tariff. Tariffs are meant to regulate trade, whereas VATs are meant to regulate consumption. China already has a VAT so if we were to institute one, they could hardly use that as a pretext to start a trade war.