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The Democrats' anti-tax cuts lunacy

Gerard Jackson

Monday 22 March 2010

The Democrats' opposition to tax cuts borders on the hysterical. Apart from their insincerity (the only kinds of tax increases they support are those their fabulously rich supporters can easily avoid) there is the utter bankruptcy of their so-called economic arguments, one of which is that the rich — meaning merely the better off and not their super rich pals — will save the additional income rather than spend it. The effect of this, according to these brilliant economic thinkers and their advisors, would be to worsen the economic situation.

The real reason, however, is that more and heavier taxes buy more political control and hence power over the people, irrespective of the appalling cost in jobs and living standards. Hence the monstrous bill that they and their media stooges have the outrageous audacity to call universial healthcare.

(It's a sad reflection on the general level of thinking in the US among a sufficently section of the population — thanks to the success of the leftwing-controlled teachers' unions — that millions of Americans now think that a corrupt mob of greedy politicians can really provide them with all the healthcare they need whenever it will be needed. That Obama can indeed bring "Christmas everyday".)

Nevertheless, the corrupt shenanigans of the power-hungry Democrats should not deter us from examining the savings argument against tax cuts: As David Ricardo pointed out about 200 years ago "to save is to spend"1. (The Works and Correspondence of David Ricardo, Edited by Piero Sraffa, Royal Economic Society, 1973, p. 449.)

Apart from devastating insights of the classical economists (Malthus later dropped his forceful approach to the boom-bust cycle) there is also the absurd logic of this anti-tax argument. If those who used it were genuinely sincere they would propose a 100 per cent tax on all savings. That means, of course, the confiscation of all 401(k) funds. (Now that Obama and his socialist supporters have virtually declared the Constitution obsolete. . . who knows what's next?)

But one must be fair, even to politicians as despicable as Pelosi and Reid. Economic fallacies, even the most absurd, can receive a warm welcome in the strangest of places. For instance, some years ago Marvin Goodfriend, a senior vice president at the Richmond branch of the Fed, suggested that dollars should contain a magnetic strip carrying information about when the notes entered the banking system, allowing the government to impose a "carry tax" on notes whose expiration date had passed.

This is the sort of silliness that one would normally treat as an aberration. Unfortunately Greg Mankiw has given a sympathetic hearing to this lunacy (Reloading the Weapons of Monetary Policy), clear evidence that he has failed to totally free himself from Keynesian thinking. Irrespective of what he believes using a negative interest rate to try and restore full employment is extremely dangerous and reveals a gross misunderstanding of the nature of recessions.

The ludicrous idea of a carrying tax originated with monetary crank Silvio Gessel2. Believing that savings and hoarding were destructive of prosperity he proposed a currency that would lose a proportion of its value each month. This would be done by having people literally pay the post office to stamp their notes.

The longer people kept their notes the more they paid the government. This is because unstamped money would lose part of its purchasing power each month. Either way, people had their purchasing power reduced unless they spent their incomes within four weeks of receiving them. Gessel argued that this process would abolish savings and stimulate consumption, thus maintaining prosperity.

One would imagine only an idiot would be stupid enough to swallow Gessel's economics. But Keynes apparently did. So taken was he with Gessel's absurd proposal he was almost in raptures. Calling Gessel a "strange, unduly neglected prophet" he gave this crank's proposal a glowing recommendation (The General Theory, Macmillan-St. Martin’s Press, 1973, chap. 23.) This section is so embarrassing — or used to be — to Keynesians that they chose to ignore it. Now, however, this misbegotten idea is once again being resurrected

The thinking behind the scheme is based on the concept of underconsumption, one of the oldest fallacies in economics. This has it that consumption drives an economy. Therefore if consumption lags behind production the economy will sink into recession. So it appears that the proponents of Gessel's policy of taxing purchasing power in order to accelerate velocity and destroy savings have got it into their heads that Americans may have decide to hoard dollars and hence retard recovery.

Though a significant increase in the demand to hold money (hoarding) would set off a tendency to lower prices it would still not be deflationary as that requires an absolute monetary contraction. In any case, I know of no instance in which a sudden rise in the demand to hold money preceded a depression. In fact, it has always been the reverse as people tried to protect themselves against hard times.

Moreover, if the underconsumptionists were right then the consumption goods industries would be hit first and hardest with falling demand working its way up the production structure. But as genuine students (some going back to the early days of the Industrial Revolution) of the boom/bust cycle observed, the reverse is true as the recent recession demonstrated.

It is important to understand that savings fuel free economies and entrepreneurship drives them. Savings are transformed into investment which then raise the marginal value of labour's product. It is this process that raises real wages and living standards. Increased consumption is its obvious result. Anything that directs spending away from investment into consumption will therefore eventually lower living standards, including real pensions.

1The classical economists could distinguish between cash balances and savings just as they could distinguish between real savings and forced savings.

2Other monetary cranks had similar ideas but Gessel's seems to have been the most detailed and popular.

Gerard Jackson is Brookesnews' economics editor

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