Economic Growth



If your income is $100,000 you pay $10,000. Now this is the least unjust income tax. It means that the tax burden increases in proportion to your income. Your income is 10 times as large your tax is 10 times as high $1000 for $10,000 $10,000 for $100,000. On the diagram there are two mutually exclusive scenarios. Table 8 A and B will demonstrate what happens with the effect of governments taxes.

A will demonstrate what happens if households earn and keep a 100 billion; then, B what happens if the government collects a 100 billion with a proportional income tax, and spends it. There is no significance to the shapes, and, or designs of these charts. So over on the left hand side is the government, on the right is financial markets, on the bottom is consumer goods and services, and in the middle is households; that rectangle inside of households represents $100 billion in household income. The two alternatives I want to consider is that (A) households get to keep it, and spend it, or (B) the government takes it and spend it. Now the average saving rate in the United States today is about 5% according to Buechner so across the entire population people save about 5% of their personal income.

(Recording) So that means for every $100 dollars income on average people save $5, and that means since Im taking the same percentage of everybodys income; that percentage should be reflected in this $100 billion. So Im going to leave this in the peoples hands-$5 billion will be saved, and $95 billion would be spent on consumption. And that is the way I have indicated here. The $5 billion is saved all the arrows represent flows of money. The $5 billion in saving is going into the financial markets, and $95 billion in household income is spent on consumer goods and services.

If instead the government collects the $100 billion via a proportional income tax the whole thing flows to the government $100 billion in taxes, and government spends that $100 billion on consumer goods and services. So the effect here is of this collection of $100 billion by the government is to reduce saving by $5 billion dollars. Reducing saving by $5 billion is a net increase in consumption spending in the economy. Although this is not good I think an argument can be made that the effect on economic growth will be relatively small assuming the tax rate is kept within reasonable limits. Now what people think is reasonable changes over time, but obviously if the government uses a proportional tax to take 90% of peoples income thats going to be a disaster.

If it stays around 20 or 30% which is what people are finding acceptable today. I think best the way to describe this is as follows. According to Buechner what we end up with is a substitution of consumer spending by government for consumer spending by households. (Recording) Essentially that is what this tax does. Instead of the people buying the consumer goods they want there money is used to buy consumer goods the government wants, and the net affect on the allocation of capacity between adding capacity and consumer goods I think would be relatively minor.

Now looking at a progressive tax its worse. Table 9 Now everything here is the same except the saving. Im now assuming the $100 billion is left in households hands this saving is $10 billion. Now why is it higher? This is because a progressive tax takes a larger percentage of higher incomes. A progressive tax going back to the example I was using before maybe the rate is 10% for a $10,000 so you pay a $1000 if your income $10,000, but if youre making a $100,000 your rate maybe is 40% so you pay $40,000 in taxes.

Your income is 10 times higher, but your tax burden is 40 times higher. Now this system is an outrage on its face, and according to Rand it has never been justified in anything short of total egalitarian level down and destroy the rich. (622) The effect is also bad for economic growth because a progressive tax takes more money from people with higher incomes. People with higher incomes save more, and that means that the amount of money that is diverted from savings to consumption through the government is going to be greater with a progressive tax. Thats what this represents. Whatever the numbers the progressive tax is worse for saving than a proportional tax.

I should make it clear I made this number up, I dont know what the right number would be here, I dont think anybody knows, I dont know how it would be possible to find out. “It would be impossible for even the cleverest statistician to know”(Hazlitt 78) All I can say is that clearly a progressive tax is worse for economic growth than a proportional tax. The corporate profits tax. Table 10 The corporate tax structure in the United States is more complicated than the individual tax structure. It goes up to from 15% to 39% as a top bracket; then, after that it goes down again to 35% on any profits over approximately 18 million dollars.

Now corporate profits are divided into two parts. One part is retained earnings and the other part is dividends. So those are the two things a corporation can do with its profits. The corporation can either retain the profit, or reinvest in the business or it can pay all or a portion of the profit out as dividend to its stockholders. If the corporation pays does decide to pay out profits as a dividend to its stockholders those stockholders are typically among the more wealthy individuals of the population; theyll save some portion of the dividends they receive.

Im assuming the division is fifty-fifty so on a $100 billion in corporate profits $50 billion is retained earnings, and $50 billion goes to dividends. Of the $50 billion in dividends $10 billion is saved $40 billion is spend on consumption. So the total savings here is the $50 billion in retained earnings that the corporation reinvests in its business plus the $10 billion in savings that the stockholders would save. So $10 billion plus $50 billion equals $60 billion that will go into the financial markets as long as it is not collected in taxes. The remaining $40 billion in consumption spending by the stockholders would go into the consumer goods market.

Now if the government collects it in taxes by means of a corporate tax of course it take the whole thing and spends all it on consumers goods and services. I think this a significantly more destructive tax even than the progressive income tax for economic growth because these retained earnings are the most powerful source of potential increases in capacity. These are funds that the business keeps, and can put directly back into the business. Actually this use to be worse than it is today back in 1960 23% of the federal governments revenues came from the corporate profits tax; today its down around 9%. According to the United States Department of Treasury in 1960 the corporate rate was 48% and for all practical purposes thats like 50% percent of all corporate taxes went to the government; today it averages something like 35% percent.

(Online) Thats a very bad tax for economic growth its bad for a long list for other reasons not the least of which, no body knows who pays this tax, nobody knows where the burden of this tax falls. Now all this was under the heading of reducing the amount that people are able to save. It also very helpful if you can reduce the amount they want to save that is if you want to reduce economic growth. How can you reduce the amount they want to save? Well why do people save? Or why did they save? In the 19th century the primary motive for saving by people up until the 1930s the reason people saved fundamentally was for there retirement for there old age, so they would not be destitute in there old age, so they wouldnt be a burden on there children they saved. They dont do that today, or they certainly dont do it the way they did 100 years ago.

Why not? Well today the government is saving for you. That system is called social security according to Franklin D. Roosevelt the government will provide for your old age you dont need to worry about it anymore. (Online) Now if in fact the government were saving it wouldnt be so bad, but the governing is not saving; the social security system is a simple “transfer system from the young to the old” there is no saving going on. (Hazlitt 53) This totally undermines the fundamental personal motive that people have to save in the absence of a welfare state. What is the second motive for saving? The secondary most important personal motive people would have to save used to be called saving for a rainy day. Saving for hard times, saving in case of loss of employment, saving for in case somebody gets sick, saving for a rainy day; I dont know whether young people are even familiar with that expression anymore.

Well what happens on a rainy day? Well there is a safety net a whole welfare system of constructing a safety net. On a rainy day you just fall into the net you dont need to provide for yourself anymore the government will pick it up. Again the personal motive is destroyed or at least is seriously undermined by the whole welfare system, and in the case of the safety net there is not even the pretence of safety. Reduce the amount people want to save – inflation is great for this. Inflation reduces the real return on savings. The reward you get for savings is the interest that you are paid if you invest a $1000 dollars at 5% interest at the end of the year you will have $1050; that $50 dollars is your reward for saving, for making those funds available for productive purposes. What if the inflation rate is also 5%? If the inflation rate is 5%; then, at the end of that year you will need $1050 to buy what you could have of bought at the beginning of the year with a $1000.

So the 5% interest return in real terms is 0% you need a $1050 to purchase the same amount you could buy with a $1000 at the beginning of the year. If the interest rate and the savings rate are the same percentage you are making no interest. Without real interest your money is just retaining its value. What happens if the inflation rate goes above the interest rate? Youll end up having negative interest, therefore the value of your savings are shrinking over time-you can buy less. Suppose inflation rate is 7% is, and the interest return on your savings is 5%.

That means at the end of the year you need $1070 to buy the same things you could have bought with a $1000 at the beginning of the year, but the with the interest return you have $1050 your $20 dollars short you can buy less with the additional money. This is depressing. From roughly 1978 to 1981 when the inflation rate was the highest in this country there was three years of almost continuous negative interest where everybodys saving became less and less valuable over time. According to Buechner this lead to a near permanent decline in the savings rate in the United States before that period the saving rate in the United States was around 7 or 8% which, is half of what it was in Japan, but at the end of the period around 1982 the saving rate was around 3%. (Recording) It takes people a while to learn but eventually they get the idea you know this is not a good deal. Now its crept up since then very slowly according to Angel were up around 5%, which is still a pathetic savings rate.

(Online) Even better you combine inflation with a tax on your interest income. You know a tax which, doesnt recognize that most of that interest income is necessary to just to stay even, and to make up for the inflation rate. Thats what the government does for the people. I used to live in New York City, and I can personally testify the total tax rate if you add up the federal rate of almost 40%, and the income tax rate of the city, and the state tax its over 50%. In New York City the income tax rate over 50%! Suppose that your making an interest return of 5% on your savings. The government takes more than half of that.

Lets say they take only half that reduces your interest return to 2.5% the according to Angel consumer prices for the last half year have been running around 3% (Online) so you got a 2.5% percent rate of return after you pay taxes. The prices youre paying are increasing at a 3% rate. What is your real interest return? Minus .5% its a negative real return. Now I think this is worth doing everybody should do this. When you take account of the inflation rate, and taxes you pay the odds are pretty good that you will find yourself very close if not in the negative range. You may be asking yourself why should I save. The point of this is not that you shouldnt save; there are reasons to save even if the value of your saving is slowly shrinking over time.

You can still increase you wealth by savings, but talk about discouraging you get nothing out of the interest. The third way of reducing the rate of economic growth is “divert savings from financing production to financing consumption”. (Buechner Recording) Anything that can be done which, can divert savings away from financing, investment, production, additions to productive capacity-anything at all along those lines of taking savings, and instead giving them to people to finance consumption purchases will reduce the rate of economic growth. In an effort to further clarify a subheading anything that you can to do that will increase borrowing for consumption, and anything that you could do to encourage people to borrow for consumption purposes. Now suppose you really wanted to do that one really good way might be to give people a tax break on the funds that they borrow for consumption we could let them say deduct the interest they pay on there consumer debt.

Now up until fairly recently in fact you could do that with credit card interest run up a huge credit card bill the interest was horrifying on credit cards but all the interest payments you paid on your credit card installment debt were deductible from your taxable income. So you got a little plus going along with that debt. Now that has been eliminated and that is one small step in the right direction but there is still a huge factor that is still working in a huge way. That is called mortgage interest. You can deduct all the interest you pay on your mortgage from your taxable income.

A house is a consumer good its not a part of the economies productive capacity, and by this tax deduction for the interest you pay on your mortgage debt the government encourages people to incur that debt, and increases the demand for the particular type of consumption item. All of the labor, and the materials that go to build houses lumber, bricks, motor, concrete, pipes, all of it, that labor could all be used to add productive capacity in the economy instead it is being used to build houses. Now is that necessarily terrible? No its not necessarily terrible. But it does reduce the rate of economic growth. Another move in this direction the opposite not a plus is you reduce the penalties for bankruptcy.

In the last five years the laws past significantly reduce the penalties for bankruptcy. So you declare yourself bankrupt you can keep your house, car, furniture, pool, and, the other house in Florida. What do you lose? I have family member that has just went through bankruptcy as far as I can tell nothing has changed in her life. But in terms of diverting saving this is the champion government deficit financing. The deficit is: the deficit is the “difference between what the government spends, and what the government collects in tax revenues”. (Buechner Recording) If the government spends $900 billion, and it collects $800 billion in taxes the deficit is $100 billion the government is spending $900 billion, and only has tax revenues of $800 billion.

Its important to grasp this the government is actually spending $900 billion. The government only got $800 in tax revenues where is it getting that extra $100 billion since is really spending $900 billion. There really only two alternative places the government can get that extra $100 billion. One-way is to print the money. Print the money and spend it. Now if the government does that- that takes goes back to the first thing I discussed under the heading of how to reduce economic growth, and you have the government spending new money on consumer goods.

I showed how that reduced economic growth. The other alternative is for the government to sell debt in the financial markets. For government to print up government securities, promises to pay-promising a certain interest return the principal due at a certain date, and sell these to people. These are very eagerly sought in the financial markets. This is a little different from the other three diagrams I have shown.

Table 11 As you can see I have added in producer goods and services. I have included again these two mutually exclusive alternatives A is the financial intermediaries loan out $100 billion in savings accumulated from all the savers. There are two possible ways these loans can go. They can be loaned for productive purposes to business, or they can be loaned to consumers I have divided this up goings to production increases in capacity going to consumers to finance consumption purposes. I have no idea what proper division is according to Buechner I am pretty sure that as a rule more of it goes for production.

(Recording) The alternative however is that all it-the whole $100 billion goes to the government, and all of it is spend on consumer goods and services. This is a giant net sucking of wealth out of financial markets funds, which could and would be used to finance additions to productive capacity in the economy, but instead it goes to finance government purchases of consumer items. Now the statistics are very confused on this general subject of whats been happening but the in general there seems to be a consensus that the real wage rate in the United States hasnt risen since about 1974 the real wage rate. That doesnt mean that households standard of living hasnt risen because since that time we have had a massive movement into the labor force by the female population. The prosperity of the 1980s which is attributed to Reagan statistically does not seem to be meaningful, and I think that has to be understood at least in part because according to Buechner Reagan multiplied the federal deficit by a factor of three or four, and we went from a $1 trillion dollar national debt- the national debt is a summation of all the deficits in the past added onto each other to where we are now approaching $6 trillion dollars. (Recording) This is pretty horrifying, but nonetheless the other side of this is anything you can do to discourage borrowing for production.

The governments regulations and controls in the economy are “extremely discouraging for people to borrow for productive purposes” or for people to produce anything. (Hazlitt 687) The whole environmental movement has not just increased regulations it has erected absolute prohibitions all over the place in the economy. Among other things for example its illegal to drill for oil wells in what the oil companies have identified, as the best locations where they might find oil you just cant do it. In addition the “government has done many things to increase the risk of loss which also discourages borrowing for production” inflation makes the whole economy more uncertain, thus; increasing risk, together with the possibility of new regulations, and controls descending on you at anytime to destroy the product of your effort is also very discouraging. (Buechner Recording) Conclusion None of these methods none of the things I have discussed not one existed in the 19th century. There was no government spending out of new money in 19th century.

Money was gold, and it was limited by the gold supply. There were no phantom goods in the 19th century. There was no phantom labor in the 19th century. There was no income tax in the 19th century. There was no corporate profits tax, or at least at the federal level.

There was no social security. There was no inflation in fact Buechner points to a period which I would like to emphasize when the United States had 30 years out of this 40 plus year period when we were growing over 5% a year when the economy was actually deflating thats when the average price level was falling 1 or 2% a year. (Recording) There were no taxes on interest income, there were no tax breaks on consumption debt because there was no income tax, there was no safety net you had to build your own net. Bankruptcy was a disaster to go bankrupt was a true horror at that time. There was no federal deficit, there were no federal government regulations and controls, and very little on the state level.

So if you want to increase economic growth I believe we need to move in that direction. I believe as a matter of political realism there is very little that is possible politically today. There is some significant concern about the deficit, and if the deficit could really be eliminated I think that would positive move. For today I believe it is much more important to fight for the philosophic preconditions which I have mentioned in the beginning on the paper which we are also losing, and if we lose those philosophical preconditions nothing originating in economics will make any difference at all. As Henry Hazlitt so aptly puts it “only minds corrupted by generations of misleading propaganda can regard this conclusion paradoxical.” (80) Bibliography Angel, Wayne D., John Ryding, Melanie Hardy and Conrad DeQuadros. Global Economic Watch.

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Atlas Shrugged, 1957-1992, By Rand. Ed. Signet. New York: Penguin Group, 1957. 1075-84.

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