One More Time, the Government Is NOT Like a Household or a Business

Ron Dzwonkowski of the Detroit Free Press ran a column today urging people to participate in various “town hall” discussions to help figure out the US can deal with it’s “deficit” and the “debt” that must “lead to collapse”.

Mr. Dzwonkowski adopts the posture of  “reasonable, practical man” – not that of an ideologue.  In fact he appeals to “basic math and logic”.   But again, we see that Keynes was right:   Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Mr. Dzwonkowski is the slave of defunct economists from the late 1800’s and early 1900’s when gold and bankers reigned supreme.  This is not the world we live in today.  The following is the text of the email I sent him.

I was most disappointed in your column on Sunday, June 20. There are many reasons for my disappointment, but the greatest is your repetition of economic nonsense that is flatly, factually wrong.

I quote your opening:

Basic math — and logic — says you can’t keep spending almost $2 for every $1 in your pocket. However, neither rules in Washington, where our national government now adopts budgets that authorize spending more than $1 trillion beyond tax collections and has accumulated a debt in excess of $13 trillion, a simply incomprehensible number…..This can’t go on; it’s a formula for collapse.

Actually basic math and accounting (and “logic”) brings the exact opposite conclusion. I believe you have fallen prey to a very common error, an error that is promoted by people who know better (or should) but have reasons to keep people believing the error. The error is simple:

You assume that the national government is the same as any household or any business or any corporation. It is not.

Households, businesses, corporations, and even state governments are all “financing-constrained”. This means that before they can spend, they must raise the funding through either revenue (income or taxes depending on the entitity), borrowing, or selling assets. SImply put, they must have something in the checking account before writing the check to spend.

A national government is NOT the same as these other entities. A national government CAN and DOES spend without any restriction on raising the funds first.

For these purposes, I’m using a “national government” to mean one that is:

a. sovereign in it’s money (in other words, it is the sole source of determining what is money/legal tender inside it’s territory)

b. let’s it’s money float in exchange rate and doesn’t promise a fixed conversion rate into any other currency or gold

c. borrows money in it’s own currency (when it chooses to borrow) and not a foreign currency.

Who fits this definition? The U.S., Japan, Canada, the U.K., Australia, India, among many (most) others. Who doesn’t fit? Anybody in the Euro Monetary Union (Greece, Spain, Italy, France, Germany, etc). Who else doesn’t fit? Anybody that borrows in foreign currencies (Russia & Argentina in the 1990’s).

What I am explaining is not “an economic theory” – it is basic, fundamental national income accounting and fundamental banking procedures.

The blunt truth is that the U.S. can indeed continue to run deficits. The same people who claim that we are on the verge of collapse (as you claim is obvious) said exactly the same thing about Japan in the mid-1990’s. A decade and a half later Japan is still running “high deficits” and has no problem with either it’s budget or “solvency”.

The blunt truth is that when unemployment is well in excess of 9% nationally, any attempt to reduce deficit spending now by cutting spending or raising taxes will only further contract the economy, reduce actual tax collections and make the actual deficit bigger (see Ireland over the last 2 years).

The fundamental economic reality (again, basic math and accounting, not “theory”) is that if the private sector, you and me and private businesses, want to get financially richer, that is if we want to see our bank balances and 401K’s get bigger over time, the government, the public sector, must run a deficit. It is simply impossible for the private sector to net save money AND have the government run a surplus at the same time. (technically, there is one situation where it is possible, but that can ONLY happen if net exports is so large – think 20% or more of GDP – Chinese scale. Such large net exports cannot happen in all countries at once).

These are not the thoughts of sole “crank professor”. I could provide plenty of support for everything I’ve said. In fact, if you are interested, I would be happy to discuss it further and help you learn.

I am distressed because I work so hard to educate students to think critically, evaluate the evidence, and make sound “logical” conclusions. But I can only reach maybe 150 students per semester. You, however, reach thousands of people and you repeat what are eggregious errors of math, logic, and accounting, while repeating these fallacies while posturing as a neutral adult voice of reason. I could leave it at that, except that this epidemic of illogical thinking about government budgets has consequences. Social services will be sacrificed on an the alter of 1800’s economics theory where governments were constrained by what gold the bankers would lend them.

Interesting Stuff – Good Stuff This Week

  • Bruce Bartlett (a Republican) does a pretty good job defusing myths and fears about the federal debt at  What is the National Debt? He still misses how a deficit is necessary to ensure an adequate money supply without forcing the private sector to go into increasing debt, but overall good job.  No monsters here, so let’s move along.
  • Bill Black, one of very few criminologists to study how corporations commit crime, on Top Ten Ways to Crack Down on Corporate Financial Crime.

Supply Side Arguments for Tax Cuts for the Rich Ignore both Theory and Evidence

One of the political-economic legacies of the late 1970’s and early 1980’s was a belief in  supply-side theories of tax cuts as an “engine of growth”.   Republicans have claimed this as  a legacy from Ronald Reagan.  In fact, however, the cutting of top marginal income tax rates was started by Jimmy Carter.  Under Carter’s administration the top marginal tax rate (MTR) was reduced from 70% to 50%.   Under the first of the Reagan cuts, the top MTR was cut further to 38%, and then later to 33%.  The claim had been (and still is by some) that reducing the MTR’s improves the incentives to work resulting in more people working harder & longer & making more income (thus more GDP).  The inverse has also been argued as a reason why MTR’s can never be increased, particularly on upper-income brackets.

This logic, carried to an extreme under the Bush II administration brought us the first attempts to fight two major (in $ terms) wars and finance them with tax cuts instead of taxes.  It hasn’t worked.  Part of the reason is because such supply-siders ignore part of the logic and theory of why people work.  Yes, higher tax rates reduce my incentive to work longer because they reduce the take-home pay rate I get for longer hours.  But the lower income also motivates me to work longer and harder to maintain the same absolute dollar income.   Theory is indeterminant about which effect dominates.  However, experience is not indeterminant.   MTR’s as incentive mechanisms are very weak.

Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. In their familiar rhetorical flourish, they insist that a more progressive tax system would kill the geese that lay the golden eggs. On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the time-honored belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less, as trickle-down theorists claim. As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.

If economic theory is unkind to trickle-down proponents, the lessons of experience are downright brutal. If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

via In the Real World of Work and Wages, Trickle-Down Theories Don’t Hold Up – New York Times.

One implication is that the U.S. could raise MTR’s on upper income taxpayers without slowing growth.  In particular, a top candidate should be hedge fund managers and other Wall St. traders that use loopholes introduced in 2001 to pay a lower tax rate than on their high six and seven-figure incomes than someone earning $60,000 pays on theirs.   This could go a  long way to paying for universal healthcare, reducing the long-term structural deficit, and even paying for those wars Washington just can’t seem to let go of.

Why We Really Need to End the Empire: “We Can’t Cut Spending – Forbes.com”

Bruce Bartlett explains why a “balanced budget” for the US federal government is an impossibility.  Unfortunately, most people who strenously object to the deficit and want a balanced budget simply don’t understand the realities.  They often confuse “millions” and “billions” (it takes 1000 millions to equal a billion).  They further operate from greatly distorted ideas of just where the actual federal spending goes.

Domestic discretionary spending amounted to $485 billion last year. With a deficit last year of $459 billion, we would have had to abolish virtually every single domestic program to have achieved budget balance. That means every penny spent on housing, education, agriculture, highway construction and maintenance, border patrols, air traffic control, the FBI, and every other thing one can think of outside of national defense, Social Security and Medicare.

via We Can’t Cut Spending – Forbes.com.