What's It Going To Take?

I was chatting with a colleague yesterday who was talking about the tax rates and various aspects of taxation as means of raising revenues or stimulating the economy.  I threw napalm on that discussion by pointing out that splitting hairs over the marginal rate isn't going to do anything.  If we completely eliminated the Department of Defense - which happens to be the largest employer in the world - we would still be running a spending deficit funding everything else.

Later yesterday I was having a heated debate about fiscal policy with someone who is one of the brightest, most well-read people I have ever known, including some highly decorated professors at the University of Chicago.  This person also happens to be a Keynesian/quasi-socialist who believes that the Government can fix things.  It seems impossible to be well-read in general, and about history in particular, and still be a Keynesian, doesn't it?

At any rate, the second person remarked that the Government needs to raise taxes to pay for its spending and that we need to sharply reduce defense spending.   I agree 150% with the latter.  However, I pointed out the bulk of economic growth since we went off the gold standard in 1971 has come from the Fed increasing the money supply and from massive debt accumulation, both private and public.  I also pointed out that studying the effect of changes in tax policy are very difficult because changes in the marginal tax rates are always piggybacked with more loopholes for those who can afford to have the loopholes legislated.  Moreover, just increasing the rate of taxation will primarily affect the shrinking middle class and further depress consumer spending. 

A good example of the uselessness of looking at tax policy would be a quick review of the huge reduction in taxation implemented by Reagan.  The economy did indeed take off in the 1980's after this tax cut.  However, the Reagan tax cuts were accompanied by a massive increase in the money supply and an even more massive increase in private and Government debt accumulation.   So you tell me - did the tax cuts stimulate the economy or did reckless monetary and debt-issuance standards create a "boom?"  Recall that the first two of many financial bubbles were spawned in the 1980's:  junk bonds and real estate/mortgage finance.

As this chart below shows, compiled from data available on the St. Louis Federal Reserve Bank website - which is a fabulous source of data - THE primary drivers of GDP growth have been the unbelievable growth in the amount of both public and private debt outstanding:

This chart shows GDP growth, Government tax revenues and expenditures, money supply and total Government/private sector debt outstanding, where private sector is corporations and individuals.  The red line is the M2 measure of money supply and the bottom two lines are Government receipts/expenditures.

I would actually argue that because debt is created using Fed monetary reserves as its "fractional" basis, that the amount of debt outstanding is actually a "de facto" component of the money supply.  The pieces of paper called "debt" actually circulate in the economy and create the same expenditure effect as do the pieces of paper called U.S. currency.   The only difference between debt and equity (equity is cash in this example) is that debt contains the legal promise to "retract," or repay, the amount borrowed, whereas equity (cash) would have no such legal obligation.  HOWEVER, as we have seen, this legal obligation often gets either restructured and reduced or transferred from the private sector to the Government (i.e. socialized).  Therefore, since this debt never seems to get paid back, except in small amounts by individuals, it functions as a money supply surrogate. 

I'm sure pure Keynesians like Krugman would try to slash my view with fancy arguments.  But put to the test of reality, something of which people like Krugman have NO experience or knowledge of, my view is correct.

As you can see from the chart above, tax receipts (based on the rate of taxation) have almost no correlation with changes in the GDP after 1971 - and really after the U.S. starting bastardizing the Bretton Woods agreement in the 1950's by issuing more debt to foreign creditors than it had gold to back to that debt.

One more chart of note is the one below that shows just the rate in Federal spending and rate of growth in Federal revenues (tax receipts) since 1971:

(click on chart to enlarge)

As you can see the rate of Government spending in excess of revenues has been increasing at a parabolic rate.  I don't want to discuss whether or not the rate of taxation is good or bad for the economy.  But the first graph shows that it is likely irrelevant in a system that is substantially dependent on debt accumulation for its source of "growth."  The second chart shows that in the context of Government spending deficits, the spending side of the equation is the true source of the massive problem with our fiscal policies.

And just for the record, Paul Samuelson, the true icon of Keynesian pornography and the author of the world's best-selling Keynesian academic textbook on macroeconomics, commented in the 1960's that Social Security is a big Ponzi scheme but that it could last forever because he assumed infinite economic growth:  LINK  - (for the record, my macro economic course in college did not use Samuelson's book nor did the professor pay any heed to the Keynesian Fallacy). 

So the REAL problem is the overall level of debt that has accumulated at all levels our system. As the first chart shows, it now requires $5 of borrowing by both the Government and private sector combined to generate a $1 of economic growth.  And in reality that Government-reported $1 of growth is overstated by corrupted data manipulation (that this is true is largely accepted by almost everyone except those who work for the Government or CNBC or Wall Street).

The golden truth is that not only has the accumulated amount of debt become impossible to repay by relying on some kind of real economic growth miracle, but the consequences of rectifying this situation are truly horrific if you think about what it will take and what the implications are for the borrow-and-spend-what-you-can-never-pay-back American way of life...

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