Taxes – A Nation’s Tiller

Printing money is merely taxation in another form. – Peter Schiff

 

August 12, 2018

by Steve Stofka

The Federal government does not need taxes to fund its spending, so why does it impose them? Taxes act as a natural curb on the price pressures induced by Federal spending. Taxes can promote steady growth and allow the government to introduce more entropy into the economic system.

During World War 2, the Federal government ran deficits that were 25% of the entire economy (Note #1) and five times current deficit levels as a percent of the economy. Despite its monetary superpowers, the government imposes a wide range of taxes. Why?

Using the engine model I first introduced a few weeks ago (Note #2), taxes drain pressure from the economic system and act as a natural check on price inflation. During WW2, the government spent so much more than it taxed that it needed to impose wage and price controls to curb inflationary pressures. Does it matter how inflation is checked? Yes.

When price pressures are curbed by law, people turn to other currencies or barter. During WW2, the alternative was barter and do-it-yourself. Because neither of these is a recorded exchange of money, the government collected fewer taxes which further increased price pressure in the economic engine. After the war was over and price controls lifted, tax collections relieved the accumulated price pressures. As a percent of GDP, taxes collected were 50% more than current levels.

For the past fifty years, Federal tax collections have ranged from 10-12% of GDP, but they are not an isolated statistic. What matters is the difference between Federal spending and tax collections, or net Federal input. During the past two decades Federal input has become a growing share of GDP.

FedSpendLessTaxPctGDP

During the past sixty years, that net input has grown 8% per year. The growth rates have varied by decade but the strongest rates of input growth rates have occurred when the same party has held the Presidency and House. Neither party knows restraint. The lowest input growth has occurred when a Republican House restrains a Democratic President (Note #3).

FedNetInputGrowth

Let’s compare net Federal input to the growth of credit. As I wrote last week, the Federal government took a more dominant role in the economy in the late 1960s. By the year 2000, net Federal input grew at an annual rate of 10.3%, over one percent higher than credit growth. During all but six of those years, Democrats controlled the House and the purse. During those forty years, inequality grew.

FedNetInputCreditGrowth

During the 1990s and 2010s, government should have increased its net input to offset the lack of credit growth. To increase input, the government can increase spending, reduce taxes or a combination of both. When GDP growth is added to the chart, we can see why this decade’s GDP growth rate has been the lowest of the past six decades. It’s not rocket science; the inputs have been low.

FedNetInputCreditGrowthGDPGrowth

A universe with maximum entropy is a still universe because all the energy is uniformly distributed. At a minimum entropy, the universe exploded in the Big Bang. Too much clumping of money energy provokes rebellion. Too little clumping hampers investment and interest and condemns a nation to poverty. As an act of self-preservation, a government adopts redistributive tax policies. Among the developed nations, the U.S. is second only to France in the percent of disposable income it redistributes to its people (Note #4).

A nation can either tax its citizens directly, or add so much net input that it provokes higher inflation, which taxes people indirectly through the loss of purchasing power. Of the two alternatives, the former is the more desirable. In a democracy we can vote for those who spend our tax dollars. Inflation is both a tax and an unmanaged redistribution of money from the poor to the rich. How so? Credit is money. Higher inflation rates lead to higher interest rates which reduce access to credit for lower income households, and give households with greater assets a higher return on their savings.

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Notes:
1. Federal Income and Outlays at the Office Management and Budget, Historical Tables

2. The “engine” was first introduced in Hunt For Inflation, and continued in Hunt, Part 2 , Engine Flow , and Washington’s Role.

3. Federal spending less tax collections grew at a negative annual rate during the Clinton and Obama administrations. Both had to negotiate with a hostile Republican House in the last six years of their administrations.

4. “U.S. transfer payments constitute 28.5% of Americans’ disposable income—almost double the 15% reported by the Census Bureau. That’s a bigger share than in all large developed countries other than France, which redistributes 33.1% of its disposable income.” (WSJ – Paywall) The OECD’s computation of the GINI coefficient is based on disposable personal income, which is calculated differently in the U.S.

Miscellaneous:

Average GDP growth for the past sixty years has been 3.0%. The average inflation rate has been 3.3%. The 60-year median is 2.6%. The average inflation rate of the past two decades have been only 2.1%.

A good recap of the after effects of the financial crisis.

 

Washington’s Role

“The rich are much better placed to feed at the public trough. The poor get crumbs.” – Steve Hanke, American Economist, 1942 –

August 5, 2018

by Steve Stofka

In the past fifty years, the increasing role of the Federal government in the economy has been the chief contributor to inequality. In the last years of the Bush administration, America became a socialist economy. Credit growth under the Trump administration has not changed from the levels during the Obama administration. On this score, Trump is Obama II.

Since the Great Recession, the federal government has far surpassed the role of banks in net input into the economic engine. In the post WW2 period, the annual growth in credit outstanding (see Notes #1) to households, corporations, state and local government surpassed the net input of the federal government, its spending less the taxes it drained out of the engine. The blue line in the graph below is the growth in bank credit.

CreditGrowthvsFedInput1953-1970

The Great Society and the escalation of the Vietnam War in the 1960s marked a changing role for the Federal government. Bernie Sanders marked the early 1970s as the beginning of the increase in inequality. Bernie suggested that the Federal government should have a greater role in the economy to correct the problem. Bernie has it backwards, as I will show. It is the greater role of the Federal government in the economy that has contributed to inequality. The hand that feeds the poor becomes the hand that feeds the rich.

Under subsequent presidents after 1968, both Republican and Democratic, the Federal input into the economy dominated the net – loans minus payments – input of bank credit. When the Federal government spends more than it taxes, it becomes a proxy debtor for individuals, state and local governments who cannot borrow enough to meet their needs. As the net credit input into the economy sank in the last two years of the Bush administration, 2007-2008, the role of the Federal government approached the levels of western European socialist governments.

CreditGrowthVsFedInput

The Obama Administration and super-majority Democratic Congress of 2009-2010 simply held that input level established earlier by the Bush Administration and a Democratic House. When Republicans took control of the House in 2011, they fought with the Obama Administration to reduce the input level. From 2012 through 2015, the growth in credit eclipsed the net input of the Federal government. Since early 2016, the growth in Federal input has once again dominated the role of the banks in the private economy. After the tax cuts passed last year, the Federal government will drain less taxes out of the economy and further cement its dominant role as an input into the engine.

For the past 65 years, quarterly credit growth has averaged 1.9%. In the last ten years, it has averaged .4%. From April 2017, two months after Trump took office, through March 2018, quarterly net credit growth averaged the same .4% as it did during the Obama years. Banks may express confidence in the Trump presidency, but their credit policies indicate that they have as little confidence in Trump’s Washington as they had in Obama’s Washington. Unless Trump can turn that sentiment, his administration will suffer the same lackluster growth as the Obama administration. If the Federal government continues to dominate economic input, Trump’s pledge to drain the swamp will be broken. Federal economic power only feeds the K-Street crocodiles lurking in the swamp waters.

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Notes

  1. The growth of credit outstanding (net input) is a function of new credit issued (input), debtors’ payments on existing loans (drain) and the write-off of non-performing loans (drain).

K-Street in Washington is the location of many of the nation’s most powerful lobbying firms.