Mar 10 2008

Advice to Republican presidential nominee on taxes – “raise ’em!”

What McCain Could Do About Taxes – New York Times

McFlation?

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John McCain admits that economics is not his strongest suit. He recently claimed that he  wished “interest rates were zero.” Perhaps the fallacy of this policy position is over his head, but I think there are at least 74 AP Econ students here in Shanghai who could explain to Mr. McCain the inflationary impact zero percent interest rates would have.

Regardless, the article above is not about interest rates (thankfully, interest rate and monetary policy decisions will never be his to make even if he does end up in the White House, granted Fed independence remains intact!), rather, tax policy, which would be within McCain’s powers as the designer of the US federal budget. Ben Stein, economist, actor, and humorist, writes a letter to Mr McCain offering his advice on tax policy.

Let’s start with the obvious. Almost everyone dislikes taxes. No sane person enjoys writing out a big check to Uncle Sam when he could spend that money or bank it for retirement. By the same token, almost everyone likes the phrase “tax cuts” for the same reason.

The problem, and it’s a killer, is that over the years we have obligated ourselves as a nation to spend truly staggering sums. These sums are growing rapidly. They consist mostly of entitlements, like Social Security and Medicare; fixed obligations like interest on the national debt, pensions for federal and military employees and various subsidies that have already been enacted; and morally mandatory expenses like those for national security.

All politicians campaign on the promise to cut federal spending by identifying hitherto unfound waste, fraud and corruption. None of them ever do so in a meaningful way. Total federal spending has not once fallen noticeably since 1954, no matter the party or the promises of the incoming chief executive.

That is the first thing you need to know. The next thing is that the Republican Party (my party and yours) has for the last 30 years or so been operating under a demonstrably false and misleading premise: that tax cuts pay
for themselves by generating so much economic growth that they replace the sums lost by tax cutting.

Ben Stein refers here to a macroeconomic theory embraced starting under Reagan in the 1980’s known as “trickle-down” economics. This is a supply-side theory proposed by Reagan economic adviser Arthur Laffer proposing that tax cuts would “pay for themselves” through stimulating new investment and spending, shifting both aggregate demand and aggregate supply outward, increasing national income, and thus income tax receipts, resulting in continued (or even greater) tax revenues even as taxes are lowered. Laffer even got his own curve, which was originally posted to this blog last September.

The problem is, according to Stein, as average tax rates have fallen in the US since the 1980s, government spending has ballooned to new heights. Even though in the long-run, tax revenues did eventually reach their pre-tax cut levels (often after six or seven years), they could never again catch up with the levels of spending the government was doing (except during three years at the end of Clinton’s administration,when the US ran its only budget surpluses since the 1960s).

So how has the government been able to increase spending, even as tax revenue has fallen? And by the way, why is this a bad thing? It seems that more spending and less taxes should make all Americans better off, as we get to keep our hard earned salaries and still get lots of public goods provided by the government. Unfortunately, all debts eventually come due, and America’s debt-financed deficit spending of recent decades is starting to put a financial pinch on the American people, as tax-payer dollars are being funneled ever-more towards paying off past debt.

Certainly, they are not worthless. They make taxpayers feel good and they generate growth. But basically, they shift the tax burden from us to our progeny and add immense amounts of interest expense to the federal budget. At this point, taxpayers shell out about $1 billion a day just for that item.

Moreover, immense federal deficits in modern life are financed largely by foreign buyers of our debt. This means that the American taxpayer must work a good chunk of the year to send money to China, Japan, the petro-states and other buyers of United States debt. In effect, we become their peons.

$1 billion a day of tax-payer money goes towards paying the interest on past government debt. Granted, some of this is going right into American’s pockets, since it is primarily American banks, businesses, households, and government agencies that own 70% of our $9.3 trillion debt; but that still leaves over $3 trillion held by foreigners (China alone holds around $1.3 trillion of US government securities). When the government pays interest on all the debt held by foreigners, it signifies a transfer of income from Americans to foreigners.

So what is to be done? Mr. Stein offers the obvious, yet politically unpopular, solution: raise taxes. But aren’t Americans already feeling the pinch of an economic slowdown, rising unemployment figures, and inflation? Yes. But one group of Americans is doing just fine… the rich.

It would be lovely if we did not have to tax them. Many have worked hard for their money. Many have created useful businesses. Many of them are fine people.

But as Willie Sutton said when asked why he robbed banks, “Because that’s where the money is.” By definition, the truly rich have a lot more money than they need. If they don’t, then they are not rich by my standards. The first step toward putting our house in order, once we are past the seemingly looming recession, is much higher taxes on the truly rich and serious enforcement to prevent offshore tax evasion.

To put it even more starkly, the government — which is us — needs the money to keep old people alive, to pay for their dialysis, to build fighter jets and to pay our troops and pay interest on the debt. We can get it by indenturing our children, selling ourselves into peonage to foreigners, making ourselves a colony again, generating inflation — or we can have some integrity and levy taxes equal to what we spend.

So there you have it. If you asked me, I’d say Ben Stein knows a bit more about economics than any president of the last three decades. If Senator McCain wins the White House, it would be not only in his, but in America’s best interest to take this advice.

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

17 responses so far

17 Responses to “Advice to Republican presidential nominee on taxes – “raise ’em!””

  1. optional.xuon 16 Mar 2008 at 12:58 am

    Yeah. This is true. Tax the rich, but too bad the rich are so influential that to tax the rich would be to commit political suicide.

    Nobody likes increasing taxes. But increase the tax rates of the people who have to fund your campaign and pay for the lobby groups in the Capitol and you are looking a ton of problems.

    Although this seems feasible, it just doesn't seem possible for any politician to do it. Maybe they should give tax-power to the Fed as well… who cares about taxation without representation.

    Just kidding.

  2. Jeewonon 17 Mar 2008 at 12:02 am

    I agree that taxing the rich would be a political suicide, but it's better than owing $3 trillion to foreigners!! If all Americans knew that increased government spending and tax cuts signify more debt and therefore a transfer of income from Americans to foreigners, they will agree with Ben Stein's proposal. If the rich people are unaffected by tax raises because they have more money than what they really need, why not tax them and continue government spending instead of a debt-financed spending?

  3. andyxuon 17 Mar 2008 at 6:40 pm

    "he wished “interest rates were zero.”"

    McCain probably said that with a political purpose.

    It's also notable that although taxes have been lowering over the years, the progressive tax system is still generating trillions of money.

  4. Alex Goldmanon 17 Mar 2008 at 9:03 pm

    Ben Stein's argument sounds very reasonable. I don't like sounding reductive, but it seems to me that the demand "levy taxes equal to what we spend" is the crux of his argument. If more Americans were economically savvy (McCain included), they would realize that Stein's proposed plan would help them more than the often used and dangerously facile platform "lower taxes."

  5. Nicole Wongon 17 Mar 2008 at 11:14 pm

    If the government were to spend more than they earned in tax revenue, this would create a budget deficit, which could then accumulate into debt. If lowering taxes is continuously going to cause debt for the country, some politician is going to have to gather the courage and come forth, saying he/she is going to raise taxes on the rich. Whoever does that will not be a widely popular guy, but at least he or she would have the support of the economics-savvy public…

  6. Margaret Liuon 18 Mar 2008 at 9:52 am

    We're doing fine not taxing the rich, don't tax them. We can continue off the "trickle down" effect.

  7. Annie Sungon 18 Mar 2008 at 4:58 pm

    Taxes are necessary in order for the country to stay in function, for government to generate revenue – without taxes, how would the government get money for public services like highways, parks, etc.? It's true that some revenue goes to fund war, but like Nicole said, if the government spends more than its tax revenues, the country will be in deep debt, and the government would eventually be forced to tax heavily anyway.

  8. Cassy Changon 18 Mar 2008 at 5:09 pm

    if interest rate is zero, then there is no incentive to lend money…

  9. Chris Seahon 18 Mar 2008 at 6:09 pm

    I will not have this turn into a flame thread against John McCain. I will not.

    I suppose that's what hiring economic advisors is for. I fully agree with Andy's above statement that if this was not some sort of grave misunderstanding it was really just some effective rhetoric; bear in mind that the general public that McCain is aiming for is largely uneducated in terms of economics and only extend their suport to him.

  10. Rebecca Sungon 18 Mar 2008 at 6:42 pm

    Like Annie and Nicole said, deep debt would not be a good thing for the economy. In class, it was shown that approximately 25% of the national debt is money owed to foreigners. With even more debt, probably even a higher percentage is owed to foreigners.

  11. Dana Y.on 20 Mar 2008 at 6:19 pm

    What a naive man McCain is. As many before already have said, if interest rate was zero, the whole financial factor would screech to halt as banks wouldn't loan any money anymore. Thus, I believe Stein's solution to lowering the exorbitant sum of $9 trillion debt America owes by taxing the rich more would be an effective masure. Even if it's not, it certainly sounds better than Bush administration's "cut all budgets for federal programs money" at least!

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