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Thoughts from the Frontline

The Direction of the Compromise

September 15, 2012

Choose your language

"How did you go bankrupt?"
"Two ways. Gradually, then suddenly."
– Ernest Hemingway, The Sun Also Rises

We are often told that the current election is the most important in recent history. I think I have heard that in about ten presidential cycles, ever since I first voted, for McGovern, as a young man. And looking back, only about one of those elections actually qualified on that score. I think this election does have the potential to be one of those rare times, at least in terms of economic outcomes. In Thoughts from the Frontline we cover economics and investments, money and finance. We only rarely stray into the political world, and then only glancingly. Today, we cross that gray line, but at a somewhat different angle, as we look at the economic consequences of the political decision that will come with the choices we make in November in the US.

But it is not as simple as suggesting that choosing one party over the other will solve the nation's economic ills. If that were the case, we would not be facing the momentous challenge we now do, because both parties have had firm control of the levers of power in recent years, and both have failed to deal with what has become, at least for this economic analyst, the burning issue of the day. Indeed, both have made it worse. Today we look at what the choices are and the impacts of those choices.

The Economic Consequences of a Political Decision

The preview of economic consequences depends on your view of what the most important issues are that need to be decided (in terms of economics). Let me list my top ten.

1.  The Deficit

2.  The Deficit

3.  The Deficit

4.  The Deficit

5.  The Deficit

6-10. Everything Else

I am only being mildly flippant.…

Discuss This


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Peter J Taylor

Sep. 21, 2012, 3:48 p.m.

You write: “Government jobs depend on taxes, which come from the private sector.”
Don’t public servants in the USA pay any taxes?
OK, you can argue that, since public servants’ incomes are mostly derived from taxes, the taxes they pay back are recycled taxes from the private sector. That’s a fallacious argument.
If a military officer, say, receives a salary of, $100,000, and he or she has deducted, say, $20,000 in tax, then the cost to the public purse is only $80,000.
If you are going to ignore taxes returned to the state by public servants, then you need to quote all public expenditures net of such tax receipts. Otherwise you are guilty of double-counting.

Arlis Stone

Sep. 21, 2012, 8:54 a.m.

I have to admit that I didn’t read every word but - we have been blessed with newly found abundant sources of energy just when we thought we were running out and now you want to be able to export this energy?  Let this energy, and the relatively low price we are paying in the US, continue to be the catalyst for bringing back American manufacturing jobs now and for a prolonged time and don’t concentrate on seeing how quickly we can deplete these new resources by exporting them.  I depend on O&G for some of my income but I do not like the idea of sending our economic life’s blood out of the Country.
Also, I remember reading an article in a very old magazine, 1918ish, concerning the income tax and how it was going to kill the Oil and Gas industry in the US.  You and I both know that income taxes in the US have been much, much higher than they are today.  Throughout the 1950s, a time of general economic health, the top income tax rate was 91% to 92%.
The EPA is what we have to worry about.

Carl Bechgaard

Sep. 19, 2012, 11:47 a.m.

Some comments (including my own on Sep 17) ask why the Government just can’t carry on and expand their borrowing from the Fed. Financing from foreign lenders would not be necessary then, and there may be good reasons why it won’t cause increased inflation. In the Wall Street Journal of Sep 17 there was a letter to editor which I think answers the question well (in addition the reason put forward in the article which the letter addresses). Here is the letter:

Regarding Phil Gramm and John Taylor’s “The Hidden Costs of Monetary Easing” (op-ed, Sept. 12): It is unduly censorious to reproach the architects of fiscal policy for abrogating their responsibilities when we live in an era where monetary policy is fiscal policy. As Messrs. Gramm and Taylor point out, the monetary policy of the Federal Reserve has made the marginal cost of borrowing for the federal government effectively zero. When cost is zero, demand is infinite, and the government’s demand for borrowed funds becomes, if not infinite, much greater. Current monetary policy thus enables, even compels, only one possible fiscal policy, one of dramatically increased borrowing and additional spending made possible by the borrowing.

However, with the marginal cost of borrowing at zero, the real danger is that the marginal cost of public goods provided by the government is perceived to be zero. At zero marginal cost, the demand for public goods becomes infinite and government, as the provider of the public goods, expands its role accordingly. The government thus becomes very activist, intrusive and interventionist. Expansion of government necessarily entails a restriction in the scope of private action and private decision-making; this is the true hidden cost of monetary easing.
Joseph Annunzio
Antioch, Ill.

End of letter

As the writer points out, zero cost of borrowing will probably grow government considerably, which in addition to the negative effects mentioned in the letter would probably increase inflation significantly: a large increase in government spending combined with a reduced output from the private sector is likely to increase demand much more than supply which I assume is the fundamental cause of high inflation. There may also be problems on the current account since increased government spending will grow imports while the private sector probably can’t produce increasing exports.

Roberto Pavan

Sep. 18, 2012, 7:58 p.m.

Just sayin’.

Tax Cuts Don’t Lead to Economic Growth, a New 65-Year Study Finds:

Kathleen Page

Sep. 18, 2012, 4:30 p.m.

Thank you for a very cogent and timely analysis. However, your suggestions about going to a flat tax or VAT tax approach sound good on their face, but doesn’t anyone remember giving up tax deductions for a “top” rate of 28% under Reagan, only to have the “top” rate keep going up? The only way anyone can have comfort in a flat tax or fixed VAT is if it’s locked into the Constitution—otherwise, we will give up our deductions only to have the rates rise at the continuing whim of our elected officials…and then just to keep it “fair”, the top earners will get hit with tax surcharges to make them pay more, and we are back to the same, progressive rates, but then with no deductions at all. Frankly, I’d rather take my chances with the current tax code.


Sep. 17, 2012, 7:37 p.m.

I like the VAT tax, lower income tax rates, and getting rid of almost all income tax deductions, corporate and individual.  The VAT tax can eliminate payroll taxes.  There can be a credit for low income taxpayers, but they should pay some tax.  Will strong special interests stop Congress from acting?  I still do not understand where the money will come from to pay off the “Social Security Trust Fund” (that is really not there?), when the payroll tax is not enough to pay Social Security benefits.  I do not like either of the candidates that well.  I wish I could vote for someone else.  Most of the attack ads are nonsense.  Will the debates be any better?  One party said it wants smaller government.  But is increased military spending and involvement in personal, social issues really small government?  There are those who want to start more wars.  By borrowing more money?

Joe Hagedorn

D. Max Williams

Sep. 17, 2012, 2:13 p.m.

A simplified tax system would come quickly if 5% of our congress were selected at random each year, seated in a large room on April 10th, and given eight hours to complete their own Form 1040’s.

Jim Buslepp

Sep. 17, 2012, 12:36 p.m.

In a sense this time is different. It’s a major deleveraging which hasn’t been seen since the 1930s. The study sited used only post WWII data. The last time we saw this sort of situation it was massive government spending, first in the form of public works projects and then in the form of a massive war that got us out of it.

Taxes only reduce economic activity if they divert money that would otherwise be spent or invested productively. There’s little incentive to invest in productive capacity currently with demand as low as it is. Under these conditions higher taxes at the top won’t significantly reduce productive investment.

Our current choice is between one candidate who says he wants to raise taxes at the top of the income scale and spend on public works and another who wants to lower taxes at the top and spend more on the military.

If we stop to read the plaques we see many things built by the WPA and CCC still in productive use, not to mention those socialist interstate highways. How many commercial airports were built by private companies? I’ve never seen one. On the other hand, military spending is unproductive if we don’t use what’s built and destructive if we do.

Perhaps we can have both. Bring the troops home and put them to work insulating homes, building high speed rail and other transit systems, fixing crumbling roads, etc. After all it was the “National Defense Highway Act” that built the interstates.

Allan Hotti

Sep. 17, 2012, 10:20 a.m.

Thank you for summary ... Love to join fixthedebt but “committee” does not represent 99% of the stakeholders. We need to have partners/advocates from all sectors of society so that real political pressure can be applied to Party-run politicians. Don’t exclude strong stakeholders from the 99%.

Carl Bechgaard

Sep. 17, 2012, 7:41 a.m.

John, this was a very interesting letter. The letters you write yourself are usually the best. Until I read about the Romers’ paper on the effects of tax changes on the national economy I have been slightly skeptical about the benefits to the economy of lowering already low taxes. But from your letter is seems that their work is so thorough that maybe there is something to it.

The deficits and debt are indeed very worrying. However, let me put something on table to be contradicted, as I am surely wrong. I just can’t see where I go wrong. Here it is:

As is generally known, the Fed bought about 77% of government debt during the fiscal year ending Sep 2011. Yet, the sky hasn’t fallen, inflation is still modest, ECRI’s leading indicator for inflation is flat, and in one of your recent letters the writer argued convincingly that deflation is more likely that inflation as the population grows older and therefore spends less (mind you, my wife doesn’t seem to get that point, even though I keep telling her that a retired husband means half as much money and twice as much husband).

The German experience with hyper inflation in the 1920s as a result of government spending being financed by their central bank is certainly scary, but perhaps this time is different. And does it make any difference to inflation whether the government’s spending is financed by loans from foreigners or by the Fed? Either way extra money is coming into the economy.

So, my heresy it to ask: if foreigners won’t lend to the government, can’t the fed then take over all of the financing? The difference from last year’s 77% financing isn’t so great. And as an added benefit to the government it would effectively be interest free, as the Fed pays their earnings back to the Treasury.

I am only putting this forward as the devil’s advocate, as it goes against my own conviction: live within your means. I hope someone will put me right.

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