Economic Common Sense – Government Debt & Taxes

Perhaps you’ve heard the term “Keynesian Economics” but aren’t sure what it means. Well, the basic idea of Keynesian Economics was around way before Maynard Keynes and can be illustrated by a couple of well known stories, one of them from the Bible.

Simply put, the most basic idea is that one should save during fat times so one can spend during lean times. This is so common sense that it almost seems silly to restate it, but unfortunately US economic policy in recent years seems to have forgotten this basic lesson.

Back to those two stories. In one, the Ant and the Grasshopper, the grasshopper spends the summer hopping around eating all the leaves he can and mocking the ant for working so hard to gather and store food for the winter. Of course, come winter, the grasshopper is starving, and the ant kindly shares some food with him.

The other story is the Biblical tale of Joseph in ancient Egypt. Joseph interprets a dream for the Pharaoh: seven fat cows come out of the Nile, followed by seven skinny ones. The seven skinny ones turn on the seven fat ones and eat them. Joseph interprets this to mean that there will be seven years of plenty followed by seven years of famine and that Pharaoh should appoint a discerning and wise man to arrange that a portion of the crops will be gathered during the fat years so that food can be distributed during the lean years and famine avoided. Joseph is appointed, crops are taxed, the extra food stored, and famine during the lean years is avoided.

The story of Joseph is a particularly good illustration of the central idea of Keynesian economics. Keynes was concerned with the economic booms and busts that were a regular feature of the economy prior to, and including, the Great Depression, and he proposed that government could smooth these highly unpleasant business cycles by taxing during the good times and spending during the bad times. And indeed, Franklin Roosevelt implemented a drastic program of government spending during the Great Depression, and of course during World War II, which brought us out of the slump. After World War II the implementation of Keynesian policies in the US and Europe led to greatly smoothed business cycles. During economic downturns individuals like you and me tend to cut our spending because we’re worried about our income and jobs, and only the government can “pump up” spending to reinvigorate the economy. But this should be followed by taxing and saving during the fat years. Unless you believe in free lunches.

So, have we forgotten this simple common-sense lesson? Recent history suggests so. During the boom years buildup to the Great Recessing of 2008, Bush pursued a highly expensive war in Iraq and we put the entire bill on the tab. In short, we did not raise taxes to pay for the war, we just added that cost to the deficit during the good times.

When the Great Recession hit, the story of Jacob and Keynesian economics both say the Government should pump up spending to reduce the depth of the downturn and save important industries. And in the end we did, although there was much screaming from some quarters about the deficit and it took tremendous political will to get even a somewhat inadequate response. Since we hadn’t saved anything during the “fat years”, we had to add the cost of saving the economy to the tab.

Now the fat years are back, and we have a $20 trillion deficit. We should be saving up for the lean years to come, or at least paying back some of the enormous amounts we’ve borrowed. And what did we do?  We passed a major tax cut that will instead add at least an additional $1.5 trillion to the deficit.

Now I personally think a corporate tax cut was long overdue, it will help make our companies more competitive and encourage them to keep more money in the country. But we should have paid for that tax cut on corporations by making sure all of them pay it – get rid of all the loopholes and tax giveaways – and by raising taxes on individual income whether in the form of dividends, employment, or capital gains. Most, or all, of that additional tax should be paid by the wealthy since they have received most of the benefit from the tax cuts and are far better able to absorb the cost than the middle class. We’re not talking about anyone paying more on the first, say, million dollars of annual earnings, just a higher marginal rate after that. Like it was during Eisenhower’s Presidency when the economy boomed at several times today’s rate.

Some of you might say we should reduce costs, and indeed there are places where I see major cost savings possible. However, some might be for reducing the military budget and ethanol subsidies and others might be for doing away with Social Security and Medicare, but in the end the big-ticket items on the budget aren’t going away, in fact they’re increasing. The single biggest contributor to a rising budget is simply the cost of servicing the national debt itself. As a percentage of Gross Domestic Product, the Federal budget has been remarkably stable for the last 30 years at about 35% of GDP. That pays for Social Security and Medicare, the military, Veterans benefits, and Homeland Security. All the other activities of the government are a miniscule 5% of GDP and falling.

So, the problem really hasn’t been on the spending side, it’s been on the paying side. Taxes have been reduced, especially on the rich, and we’re putting increasingly more on the credit card. With the aging of the baby boomers, our kids will have to assume the burden of our retirement as well as medical care. And now we’ve saddled them with at least another $1.5 trillion in debt to pay for a tax cut. This at a time when the economic prospects for young people are worse than any time in recent history.

It is time for us to start paying for what we consume even while we continue to argue about spending priorities. Not only should we be paying for current consumption, but we should be taxing to reduce the deficit instead of passing the IOUs on to the next generation. It says so in the Bible as well as in Keynes’ “The Wealth of Nations”. Insist that your representatives, whatever their party, get this message or vote for someone else who does!