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Low taxes, inflation and other demons

by das monde Thu Oct 30th, 2008 at 11:37:29 PM EST

The libertarian ideology is suffering quite a few setbacks amidst the ongoing financial crisis. Say, the governments just can't stop expensive stimulations. Maestro Greenspan acknowledged that reliance on everybody's self-interest was a mistake. And what other way is there to prevent fools to bank everyone all in than some regulation?

But one of libertarian recommendations is still never criticized: Low taxes are always good, as they encourage economic activity, job creation and what not. No one ever tells how low the taxes eventually must be, but many insist that tax cuts are always wonderful.

But do low taxes really work that wonderful way under any circumstances? Are there not any ill side effects? Any theory, however nice, has its limits of application. Whoever looked for limits of tax cut benefits?

Here below I share some thoughts, how Bush-led tax cuts might had actually fueled the current economic crisis.


Lower taxes leave more money to people. But more money circulating is not always a good thing. You have heard of scenarios of "too much money chasing too few assets". That's a definition of a bubble. And the Real Estate bubble (in particular) was a key component of all this financial mess.

Surely, lax credit practices were most instrumental in blowing the gargantuan Real Estate bubble. But what pushed banks to make so many crazy subprime loans? This is rarely voiced fortissimo, but it was Wall Street investors who were eager for more mortgage derivatives. And they had more money to "invest" (or leverage) thanks to tax cuts as well.

It all depends on how most of the tax cuts are really spent. Does most of the extra money indeed go into creation of quality jobs, better services, investments into future? Or do they go into Ponzi-lite schemes of asset and commercial paper manipulation?

It is not a big secret that most of the tax cuts benefited a rather small but already very wealthy portion of population. The "trickle-down" theory is nice, but there is little evidence that it really worked so wonderfully. Many self-help advices told that hard work and direct venture are not the best way to "get most of your money". You rather invest and let others work. And what are the best investments in bubble times? Theoretically, nothing can beat a Ponzi scheme in the short term. Surely, all those games of hedge funds and with CDOs looked most attractive. No wonder if not much of the extra money trickled down to the real eco-nomy.

Let me encapsulate in four points:

  1. Tax cuts may fuel bubbles as bubble investments appear to offer best profit.

  2. Tax cuts may increase leverage volume. With more money you can do more stupid things.

  3. Tax cuts may fuel inflation after a bubble bursts. With no reliable assets to invest in, wealthy people like to spend, and they do not mind if the prices get too high for regular folks.

  4. Equality of tax cuts does matter. Not only "trickle down" may work or not work. Bush tax cuts disproportionally empowered wealthy individuals and bigger companies. Smaller businesses got their modest cuts, but were often crushed or swallowed by giants' competition. Advocates of small-scale businesses should tell more precisely, what tax cuts are needed.

Of course, tax cuts might work as wonderfully as prescribed as well. Say, they might decrease inflation, if the value created by boosted economic activity clearly exceeds the extra monetary volume. But if tax cuts have their own way of self-interest, anything else may happen.

What are your thoughts of whether the modern fashion of tax cuts fueled the ongoing crisis? Do low tax policies keep making things worse? Couldn't things actually improve with higher taxes?  

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Systemic Fiscal Reform

is an interesting new site.

I met one of its protagonists, a Tory councillor called Robin Smith, at the recent Claverton Group conference. It appears to me that the most natural home politically for these ideas is in fact the LibDems - who narrowly failed to introduce a Land Tax in 1908 - but I don't think that it is possible to pigeonhole them as conventionally Left or Right

I am also engaged in a dialogue with Dr Adrian Wrigley - the intellectual source of the site - in relation to my thinking re Community Land Partnerships and consensual alternatives to taxation, among other things.

In particular I think that they lack a narrative, and for me the underlying theme underpinning such Systemic Fiscal Reform is the taxation of the privilege of exclusive use of Commons.

I therefore suggested to them that in addition to taxing land rental value and carbon use they should also be looking at taxation of limitation of liability.

That way they will be addressing the privilege of private ownership of all three of the principal Commons: Land; Non-Renewable Energy; and Knowledge.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Oct 31st, 2008 at 05:49:47 AM EST
they should also be looking at taxation of limitation of liability

That is interesting.

What about taxing ability to limit others?

by das monde on Fri Oct 31st, 2008 at 06:23:24 AM EST
[ Parent ]
das monde:
What about taxing ability to limit others?

Could you give an example?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Oct 31st, 2008 at 08:00:34 AM EST
[ Parent ]
You may call it taxation of power. Say, I do not really like a business environment where you (realistically) either have to become a big shark or go bust. I do not wish to take everything it takes to get sharky. The problem is to restrict or impede the power of sharks to take over my little business. One way is to make laws and rules; other way is to tax their power - let them roam, but impede their freedom with a taxing compensation. As wealth correlates with power in this world, and wealth is easily measurable, we come close to an interesting justification of taxing wealth (as a first approximation).
by das monde on Sat Nov 1st, 2008 at 11:35:29 AM EST
[ Parent ]
A political contribution tax that commences above, say, 2x median net worth or 3x median income, depending on how is best to proceed, might be one approach. Have the bracket go up 10% for each additional multiple.  There could be an exemption of the equivalent of, say, the first $100/ candidate or issue.

Another possibility would be a merger and acquisition tax that scales according to the size of the merged entity.  Then we could let the magic of the market determine just  what was the economy of scale.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Nov 2nd, 2008 at 01:31:24 AM EST
[ Parent ]
Thanks

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Oct 31st, 2008 at 06:42:59 PM EST
Could you give a second demonstration based not on the US tax cuts but Lithuanian flat tax?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Oct 31st, 2008 at 07:31:35 PM EST
I am sick of tired of Ltihuanian commentators glorifying necessity to cut govenment spending and ever more "flat" taxes. There is now significant inflation and slow down, despite the governments going that direction on every occassion. The slowdown is less acute than in the other two "Baltic sisters", but they assure that without "real" reforms we will be there just as fast. I would say that Lithuania is not worse off yet because (rather than despite) of the half-heartiness of reforms. Falling behind in real estate and finansial instrumentalization is clearly a blessing.

One of joys of Lithuanian big corporate initiatives is that nothing gets started unless 6-7 digit profits are in sight.

by das monde on Sun Nov 2nd, 2008 at 01:39:42 AM EST
[ Parent ]
Tax cuts may fuel bubbles as bubble investments appear to offer best profit.
When high taxes are legitimized (not as money for value but as good in themselves) the public sector might get a carte blanche for inefficiency. Things don't work? Just ask the government for more "free money" via higher taxes. Indeed, you could argue certain nations at certain times have suffered from "public sector bubbles".

Tax cuts may increase leverage volume. With more money you can do more stupid things.
Freedom includes the freedom to be stupid (often known as the crucial societal need called "putting all your eggs in one basket" or "entrepenurship").

This doesn't mean we shouldn't strictly regulate finance.

Tax cuts may fuel inflation after a bubble bursts. With no reliable assets to invest in, wealthy people like to spend, and they do not mind if the prices get too high for regular folks.
Wealthy people won't affect the aggregate spending by much if you live in a reasonably equal society (ie not the US), and even if you do, inflation in the price of Champagne, Beluga caviar and luxury yachts won't affect the price of bread and milk much. Paris Hilton obviously doesn't eat 100 kg of bread every day just because she can afford it.

Equality of tax cuts does matter. Not only "trickle down" may work or not work. Bush tax cuts disproportionally empowered wealthy individuals and bigger companies. Smaller businesses got their modest cuts, but were often crushed or swallowed by giants' competition. Advocates of small-scale businesses should tell more precisely, what tax cuts are needed.
True.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Sat Nov 1st, 2008 at 01:46:43 PM EST
OK.

When high taxes are legitimized (not as money for value but as good in themselves) the public sector might get a carte blanche for inefficiency. Things don't work? Just ask the government for more "free money" via higher taxes. Indeed, you could argue certain nations at certain times have suffered from "public sector bubbles".

This "oranges" argument does not negate the bad "apples" of low taxes. It is close to extreme caricature, as if smart people could not refrain themselves in the middle. I pointed out my own "legitimation" in a parallel thread. The whole point is that high or low taxes are good not "in themselves" but depending on other conditions.

In my view, the public sector is not supposed to be "most efficient". The point is to provide basic level of servises to the whole population. If the private sector can do better (for some, most probably), let it be! What I see is that the private sector likes to find its own level of inefficienties when there is no pressure from the government.

Your point would be clearlier with a particular example of a "public sector bubble".

Freedom includes the freedom to be stupid (often known as the crucial societal need called "putting all your eggs in one basket" or "entrepenurship").

Here I am concerned with the freedom of others to be shamelessly stupid. If my pension depends on what hedge fund nerds are playing, I wish to see some taxation of the "stupidity" privelege.

Wealthy people won't affect the aggregate spending by much if you live in a reasonably equal society (ie not the US), and even if you do, inflation in the price of Champagne, Beluga caviar and luxury yachts won't affect the price of bread and milk much. Paris Hilton obviously doesn't eat 100 kg of bread every day just because she can afford it.

When I try to ponder the Baltic inflations, I just can't buy the theories of higher salaries without "productivity improvement" pushing up all the inflation. For one thing, a salary is just a transaction within the economy, with no change in monetary volume. Secondly, the price reaction should not be so fast, as between the salaries and the prices are the businesses that actually set the latter. Lithuanian salaries are still very low (with the average about 500 euro). The enterpreneurs seem to rise prices for 2 reasons:

(1) to compensate higher labour costs; this ammounts to protecting the profit share of the business;
(2) reorientation to more "able" customers; how else would you rise "productivity" measured in service payments.

Celebrities may not be vying for tons of bread, but quality bread (and other bread) sellers do shift their marketing decisions.

by das monde on Sun Nov 2nd, 2008 at 01:51:10 AM EST
[ Parent ]
Perhaps we should update the old saying: "Idle hands are the Devil's workshop," to "Idle capital is fuel for a bubble."

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Nov 2nd, 2008 at 01:35:48 AM EST
I wrote an essay awhile back where my premise was that conservative (or libertarian) philosophy was concerned with process and not goals.

So, for example, lower taxes, free markets, less regulation are all techniques not goals. One of the reasons to do this is that it is easier to whip up resentment when you focus on such topics. People can always be persuaded that taxes are too high and once they are outraged they become easier to turn into blind followers of your cause.

The whole thing is here:
Free Market Philosophy as Process

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sun Nov 2nd, 2008 at 08:34:00 AM EST
On one hand, it is true that conservatives are skeptical of goals and good intentions. But their ultimate rationalization of "best" practices is still "nothing can be better". Conservativism would not be so appealing without the confidence "this is good, that is bad".

I got some fruitful thoughts on conservative metaphysics while reading Part B here. Quite contrarily, conservatives seem to presume deeply primary (final) causes, as opposed to the interest in mechanical (efficient) causes of post-Enlightenment rationalism. It is rather the liberals that are fascinated by "instrumentalist" approach of living. The liberals usually get optimistic of perceived instrumental powers indeed for achieving goals or solving problems; but they may get so enthusiastic about the mechanisms that they would not care anymore what goals are they achieving (or can be achieved). Once zealousness sets in, there is no distinction between means and goals.

I get an impression that conservatives like to copy much of the success of rational liberalism. They adopt new methods (especially if that suits the hypocrites you refer to), but their metaphysics is still more ancient than rational. What they eventually develop is faith in the methods they adopt. They just (rather genuinely) believe that their methods are for "primary" good of the world. And faith is not easily shaken by "a few" counter-indications.

by das monde on Mon Nov 3rd, 2008 at 09:58:01 PM EST
[ Parent ]


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