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US economy, deficits, taxes and Democrats
Gerard Jackson
Democrats have been sending me emails full of praise for the brilliant Robert Rubin. Although I’m not at a loss to understand Mr Robert Rubin’s confusion about the interconnectedness of taxes, surpluses, booms, recessions and fiscal discipline — how ‘New Democrats’ wear that slogan with pride — I was puzzled as to why so many so-called informed people could be so dumb as to take the former Treasurer’s views seriously, until I quickly realised nearly all of them were Democrats. Not only do they believe this nonsense will serve them well politically, I fear they may even believe in it themselves.
What are we to think of you, Mr Rubin? A Wall Street financial wizard who preaches that Clinton’s 1993 tax hike generated the 1990s boom is clearly not a person who shines in the field of economics or economic history, even of the most recent kind.
Now where could a man of Rubin’s incredible intelligence have picked up this economic absurdity? Well, according to his logic, raising taxes to raise a surplus raises government savings which lowers interest rates which in turn stimulates investment. Tax cuts that generate deficits have the reverse effect.
Now if we rigidly adhere to Rubin’s reasoning we arrive at the absurd conclusion that interest rates could be driven down to zero, or even made negative, if the government built up a sufficiently large surplus through taxation. I think it’s more than reasonable to assume that absurd conclusions suggest badly flawed arguments.
Firstly, there is no correlation between interest rates and deficits. (This is not to suggest, however, that deficits do not influence interest rates). A country with a deficit can have lower interest rates than a neighbouring country which is running a surplus.
Secondly, surpluses are not savings. The former country can have high real interest rates in a period when it’s running a surplus, and in another period have low real interest rates when it’s running deficit. And this can occur without any changes in the money supply and in the absence of a boom-bust cycle.
If we assume, as Rubin does, that surpluses are not spent then they become cash balances or hoardings, if you like, a situation that Keynesians are supposed to abhor in a recession. So what are savings? They are a process by which present goods are transformed into future goods.
In other words, to save is to direct resources from consumption to the production of capital goods that in the future will produce a greater flow of consumer goods. This is what classical and some preclassical economists meant when they said that to save is to spend. I think it’s therefore fair to deduce that governments save when they cut back on expenditure, not when they increase it or increase surpluses.
Let us take a situation in which a government takes Mr Rubin’s advice and see what happens. If it suddenly raised taxes that significantly lowered disposable incomes, this would have a deflationary effect that would have to be offset by prices and costs adjusting themselves to the new level of total spending.
Moreover, the likes of Rubin never seem to give any thought to the simple and obvious fact that people save out of disposable incomes. Therefore reducing net incomes could very well cause savings to fall and interest rates to rise even as the government accumulates a surplus.
Now there is nothing in economics that says people will save less; we can only say that it is likely that this will be so. However, if they decided to maintain their savings rate then their “propensity to consume”, as Keynesians put it, would fall. And as a good Keynesian, Mr Rubin certainly wouldn’t like that.
That the Clinton-like tax hikes did not have a deflationary effect is explained by the fact that they took place in the presence of monetary expansion. (From January 1991 to December 1994 M1 grew by about 40 per cent). Once we realise that we should come to understand that the tax hikes were being underwritten by a loose monetary policy.
The Fed forces down the rate of interest through credit expansion. This induces firms to borrow in the belief that more real savings have become available. These borrowings eventually resolve themselves into high nominal incomes. It’s this process that not only explains why Clinton’s tax hikes did not immediately depress economy — though in my opinion they did contribute to the 1996 slowdown — but also what triggers off booms.
What this amounts to is that Rubin’s economic advice to Clinton only served to raise taxes. It did nothing to increase the level of real savings and so expand America’s capital structure.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 25 April 2005