:: Some thoughts... ::

:: Tuesday, October 22, 2002 ::

Economic Fallacies:

The Democrats, especially and other commentators are quick to jump to faulty conclusions based on suspect data regarding what’s good for the economy. Let’s look at these arguments one by one.

Tax Cuts are Bad: The argument from the Democrats and others are that the tax cuts passed in 2001 are fiscally irresponsible because they have decreased government “revenue” and “stolen” from the Social Security “trust fund.” In addition because of the increased borrowing, interest rates have been forced to rise as government spending “crowds out” the private sector. I will say right now that the tax cuts were bad in some respects but not for any of the reasons the Democrats and others argue. All in all, the benefit of the tax cuts outweighed the negative effects. First, let us look at the issue of fiscal “irresponsibility.” The tax cuts are not an issue here; it is the outrageous increases in government spending. Government spending, even before September 11, was increasing at far faster rates than inflation. The other argument concerns “revenue.” The income tax in the United States takes in about 1 trillion dollars. That is a rough estimate and it varies depending on the economy. The “revenues” the Federal government takes come directly from your pocket especially if you make the median income and above. It is not revenue, the government did not earn this money, it simply took it. The government is not a company involved in making widgets. The tax cuts simply mean more of your money ends up in your pocket. The idea of “revenue” being lost or money “stolen” is false. The fact is that even if we rescinded the tax cuts, they would be a drop in the bucket compared to the long term deficit the Social Security plan faces. The whole idea of a “lock box” and the like is just plain misleading and an accounting fiction. The government puts WorldCom and Enron to shame. Social Security is part of the general government “revenue.” It is financed by an income tax of 12.5% up to $84,990. If you are self employed the tax is 15.3% and you pay the entire amount. In contrast, Social Security is split 50/50 with the employer. One can argue that if there wasn’t a Social Security tax at least a goodly portion of that tax your employer pays would end up in your pocket. The idea of separate fund for Social Security is a fiction because no matter how the taxes are collected, the Federal government is responsible for the benefits that accrue to Social Security recipients. The Social Security tax is even more atrocious as it primarily falls on “low income” taxpayers and is what we call a “regressive” tax as opposed to a proportional or a “progressive” tax. The long term deficit, that starts accumulating for Social Security, was last I checked estimated at $38,000,0000,000,000. In contrast the current budget of the United States is roughly $2,000,000,000,000. In other words, the long term deficit for Social Security is an estimated 19 times the current budget, and nearly 4 times our current GDP of $10 trillion. Who is going to pay for this? The “save Social Security” crowd, from the tax cuts doesn’t have an answer. Their idea of constructive criticism is to create a cartoon of an old lady being pushed off a cliff. Eventually scare tactics such as this won’t work. Something must be done about Social Security. That is for another discussion, but I believe that the only effective way is to create an entirely privatized (meaning that benefits are transferable upon death, and the property of the individual) system with a minimum benefit, for those of low lifetime income. This should be phased subsidy that creates every incentive to work and save rather than depend on government handouts. The great myth of Social Security is prolonged by the media and the politicians who refuse to engage in a serious discussion, but rather rely on sound bites and cartoons. The last argument against the tax cut is the only argument of any sort of substance. The idea actually originates from the 1970’s. It died for a while during the Reagan years, as the deficits went up and interest rates went…. down.
The lack of any empirical proof for this year had made it irrelevant until the 1990’s when Robert Rubin was Secretary of the Treasury under FPOTUS Bill Clinton. In the 1990’s, largely thanks to a soaring economy and divided government, deficits turned into surpluses, and interest rates went…. up. The biggest proponent of “crowding out” these days is none other than Robert Rubin. Sorry, Bob empirical evidence does not back up this theory, so back to the trash bin it goes. Actually, is not so much that it is wrong, per se, there is an argument to be made for “crowding out,” but its proponents ignore two things. First, the US government and American companies borrow from a global pool of funds, meaning that we are not limited in “supply” as much as the “crowding theorists” suppose. Secondly, they misunderstand the fundamental reason for interest rates. Interest are not a function so much of the supply of money, but also more importantly of the risk of the borrower and the opportunity cost of investing that money elsewhere. The pool of savings is not just everyone who buys bonds, but all investors. In other words, with a society with trillions of dollars in wealth, the $150 billion the government may borrow this year has little effect.
One last note on the idea that tax cuts “benefit” the “wealthy.” One thing to look at is the percentage change in the tax brackets themselves rather than total amounts involved. For instance, the tax cuts of 2001 lowered the lowest tax bracket from 15-10%, a 5% reduction and 33% reduction in total tax taken without any deductions for the lowest income earners. That is huge. In contrast, the top rate was reduced over the life of the tax cut from 39% to 36%. That is a 3% reduction in actual amount taken, and an 8% reduction from tax taken from the top income bracket. It is disingenuous at best to suggest that the “wealthy” are getting the primary benefit from the tax cut. Already, as of 2001, the bottom 50% of all income earners in the United States paid just 4% of all taxes while earning 13.3% of all income. In contrast, the upper 50% paid 86% of all taxes and earned 86.7% of all income. The higher you go up the income scale the greater this disparity becomes. No wonder there is great pressure for higher spending because only a select few get the “privilege” of paying for it. The idea that the tax cuts “benefit” the wealthy is another example of rhetoric trumping facts. If you want further insight into the tax system, please contact me and I can send you my short (slightly longer than 10 pages) paper on what to do about the current tax system.

Deregulation:

I don’t have the time to go in depth here but the poster child for “deregulation” gone bad is California. The Californian energy market was never “deregulated in any meaningful sense. To use California as a punching bag to support “re-regulation,” consider some of the following. The price consumers paid was set by the California PUC. It was never allowed to fluctuate and was set artificially high. The PUC responded by tacking on a 10% mandatory discount. (If you live in California, check your bill, it’s there) Demand for energy soared in California and there wasn’t a corresponding increase in supply. If I remember correctly demand soared 31% and supply increased 4%. Secondly, in the supposedly “deregulated” wholesale market, the market was conducted entirely on a spot price basis. In addition, the highest bid for power was the price that all bidders received. This was just plain dumb. In any event, it was not a “free market” nor was it “deregulated” but in fact highly regulated. To argue otherwise is to argue in contradiction to the facts. Real de-regulation and a decreased incidence of NIMBY (Not in My Backyard) would go a long way toward alleviating any future “crises.”

401(k) Plans:

As a 401(k) Plan Administrator myself, I have a certain amount of experience in this area. The common mistake of most participants is not to diversify. The fact that the idiots at Enron did not diversify and lost all their money is not a knock against retirement plans in general. Did you know that Enron employees had 96% of the assets in their 401(k) plans invested in Enron stock? They are entirely at fault for their losses and I have no sympathy for them. Yes, that is shame Enron went bankrupt and there were certain parts of their plan that prevented them from selling their stock. The whole point is they should have never invested their own money in Enron stock in the first place. They are taking a double risk. The first risk is that their company might fail and they would lose their job, and the second risk is that all their retirement savings would be lost also. They didn’t diversify and paid the price. I don’t mean to be cold hearted but people must take responsibility for their action. The ex-Enron employees are a good example to many others who have their entire 401(k) plans invested in company stock or in one or two mutual funds. Diversify!!! Further government regulation to force people to diversify is completely unnecessary, education would be better. Diversity also doesn’t mean, picking three different tech funds, because that is like eating three steaks and calling it a balanced meal. One needs steak, potatoes and a salad for a balanced diet. Further regulation for 401(k) plans does nothing but make them more complicated, and therefore harder to understand. People are highly unlikely to invest in things they don’t understand.


More to come....
:: Nathan 2:33 PM [+] ::
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