Freedom's Fidelity

Thursday, January 29, 2004

Bush, Curves, Cuts and Deficits

You probably wouldn't know it from reading this site, but I do have some serious criticisms for President Bush. Yeah, I like the tax cuts, I like the proposed immigration policy, and obviously he scores the most points with me on issues of national security and the way he led the county in the aftermath of September 11. But the federal budget just keeps growing.

I have no problem with defense spending, at this time we need more of it. But Bush is exploding the budget everywhere else. (Where have all the fiscally responsible Republicans gone?) In fact, when it comes to government spending Bush looks more like a Democrat in Republican clothing. As the market has been correcting itself from the overvaluation of the 90's companies and individuals alike have made sacrifices and cuts on costs and spending to avoid falling into massive debt. Why should the federal government be any different?

Cutting taxes is a good start to combating deficit. When Reagan (and Kennedy before him) cut taxes government revenue actually increased or held steady. How can this be? Do a simple mind exercise with me and you'll see. If the government were to increase the income tax rate to 100% how many hours a week would you work? Assuming you are not a sucker, the answer is none, and the government would collect $0 in tax revenue. Now lets pretend that government has a new tax rate of 0%, how much would you work if you got to keep all that you earned? The answer should be (again suckers excluded) something like "a hell of a lot more than none!" Those two points (0% and 100%) are the book ends of what's known as the Laffer Curve:




They reflect two very different tax rates that lead to the exact same result - the government collects $0. It follows then that somewhere between 0 and 100 represents the "optimal rate." (T*) If an economy is at (T*) then a lower than optimal rate will bring less revenue, and a higher than optimal rate also will bring in less revenue. Where the United States is on that scale can be debated.

People respond to incentives though and taxes change those. A world where taxes are cut means a greater incentive to be more productive as the worker takes home higher compensation. (Looked at another way, the cost of NOT working - the cost of taking an hour off - has increased. Therefore some individuals will choose to use those leisure hours that are on the margin in a more productive way, i.e. with tax cuts my hourly wage increases to a point where now I'd rather work an extra hour than watch another bad re-run) As a general rule if the government wants less of some behavior, it should tax it. If it wants more, it should do the opposite. Work and productivity are no exception.

As mentioned above though, the Laffer Curve does not suggest that a tax cut will always increase revenue. That is why I put "optimal rate" in scare quotes. The problem with giving more money to politicians is that it gives politicians more money. Most elected officials see fiscal restraint as little more than a campaign promise. Money in the hands of a politician vanishes faster than a Howard Dean poll lead. That is why while more money may be "optimal" for politicians it is decidedly less so for the economy. The government tends to spend money in areas that are less beneficial and less valued by society than consumers would. If certain expenditures were so beneficial the free market would have already provided them. Compounding this is the fact that so much money is wasted in the absence of competitive market pressures. The practice of spending $10 to get something only worth $7 is a recipe for deficit, and one the government continually repeats. We'd all be better off if the bureaucrats left it to us when it comes to spending our own earnings.

Bush and the Republican controlled Congress apparently see things differently, for after the tax cuts, they have decided to spend, spend and then spend some more. His laundry list of micro-initiatives during the SOTU was Clintonesque - no problem is too small or too personal for the federal government to throw money at. What is paramount to deficit reduction is tax cuts and spending cuts, so far Bush and Congress have demonstrated a clear reluctance on the latter. This issue is one he could be vulnerable on come election time. At the very least he risks alienating the libertarian/fiscal conservatives that support him. If a candidate comes forward that convinces me he'll continue to aggressively fight the war on terror, cut taxes and spending he would get my vote. Alas, though he really risks nothing, as according to The National Taxpayers Union, each one of the Democrat's platforms would raise, not lower, the budget deficit. It's a quite informative and thorough piece, the spending projections range from an increase of $169.9 billion (Lieberman) to an absolutely absurd $1.33 trillion (do I even need to say? Sharpton). Democrats, Republicans, Politicians will continue to put the budget in the red until cutting it becomes a salient issue. In the 2004 election any "reduce the deficit" rhetoric will be just that.

Is Harry Browne running this year?

posted by Paul  permalink | |