A Comedy of Myths

Peter Ferrara is a graduate of Harvard Law School and holds various positions including Senior Advisor for Entitlement Reform and Budget Policy at the National Tax Limitation Foundation and Senior Fellow at the National Center for Policy Analysis. He served in the Reagan administration and the first Bush administration.  He’s also clueless.

In a recent column a Forbes dot com http://tinyurl.com/cwt7kay Ferrara sets out to debunk what he believes are fiscal policy myths.  Some of the myths Ferrara claims to debunk were never really myths in the first place. Maybe Nancy Pelosi passed some of them on to her constituents in a lame attempt to smear an opponent. It is true that both parties have a few Todd Akins and Louie Gohmerts who are clueless, classless and beyond correction and hold some wacky beliefs, but for the most part, the so-called myths debunked [sic] by Ferrara are hardly widely embraced.

One such myth is the notion that Keynesian policy includes a belief that increased government spending stimulates the economy during recession. This is not true.  Keynesian theory does not hold that Government spending stimulates the economy, but fiscal policy can and does stabilize the economy.

The Obama stimulus [sic] is a good example of this. It stopped a freefalling economy. It prevented a lot of people from losing their jobs. Did it stimulate economic growth? No way. Take a look at the cash-for-clunkers program. During the program, sales of new cars jumped noticeably, but when it ended sales of new cars tanked again. The program had an undeniable effect. However, it didn’t stimulate any economic growth.

Another myth propagated by Ferrara is the blatantly ignorant belief that the money supply is fixed. Ferrara nails this one: “If the government spends more, where does the money for that increased spending come from? Either from increased borrowing, or increased taxes, which both take an equal amount of resources and spending out of the private economy as they finance in increased government spending.” This is ridiculous. The Fed can and does create money out of thin air. Everyone knows this except those that fell asleep during Intro to Monetary Policy class.

[There is the threat of inflation when the Fed does this. However, the Fed’s actions only increase the monetary base. In a recessionary deflationary economy, that doesn’t lead to inflation. There is a risk of inflation in the future, but that can be easily addressed when the time comes.]

Here’s another one: “Demand can never be inadequate in a market economy. If the demand for any product or service is not strong enough, the price of the good or service will fall, until demand equals supply.” The actual statement is theoretically true (except for the Jessica Simpson Christmas CD a few years ago – they couldn’t lower the price enough to sell them so they ended up shit-canning tens of thousands of dollars of product), but Ferrara uses it to argue that a shift in aggregate demand does not affect economic growth.

In fact, in 2007 the aggregate demand curve began a long migration to the left, and it is this low aggregate demand that is the primary reason the economy isn’t growing. People are too indebted with underwater mortgages, student debt and consumer debt. This reduced the quantity of goods and services they can purchase at any given price level thereby affecting the quantity of goods and services supplied. I mean come on. Why produce more cars, houses or other products when consumers can’t or won’t purchase them?  This is actually a widely held belief among supply-siders and appears in a 2004 book written by Stephen Moore and Arthur Laffer.

And another: “The people can never spend more than they produce…” This is stupid because the U.S. has been spending more than they produce for nearly the past 3 decades. We’ve gone from the world’s largest creditor nation to the world’s largest debtor nation using mortgage debt, credit card debt and other borrowings to finance the appearance of prosperity. As I mentioned earlier, the major factor holding back the economy is the overwhelming consumer debt.

Ferrara continues (he’s on a roll, baby): “And they will never spend less than they produce, leaving demand inadequate, for they will either consume or save every dime that they earn or produce. The consumption goes into consumer spending, and the savings goes into capital spending.” The fact is that not all savings goes into capital spending especially right now. Banks and businesses are sitting on assets. The reason they’re sitting on cash and not investing was already mentioned above. With consumers so deeply in debt from spending more than they produced for so long, investment in new production is not expected to reap a high return.

One thing that Ferrara does get right is this: “Another myth is that raising tax rates will not harm the economy”. But this is another one of those things that everyone really does agree with. Raising taxes can have a significant adverse effect on the economy. In dispute is the degree of the effect. Reducing a marginal tax rate from 70% or to 28% has a significant effect. When people raise the argument that raising a tax rate from 35% to 39% might not have such a dramatic effect on the economy, they have a valid point.

Good Tax Policy

In a recent column posted at Forbes http://tinyurl.com/d3pg4eo, Peter Ferrara argues that President Obama is a socialist.  What label one wishes to place on another is of little importance to me.  Whether you want to call the President a socialist or a liberal is of little importance to me.  I think name-calling is immature.  Someone called me “Big Nose” once.  It hurt my feelings, but it didn’t facilitate an informative discussion of the issues.

But what I want to discuss here is a statement made by Ferrara that illuminates a common error in thinking among many economic hacks.

Tea Party Patriots national coordinator Jenny Beth Martin, right, with Reps. Michele Bachmann, left, and Louie Gohmert this March. (Chip Somodevilla / Getty Images)

 “Good tax policy is not guided by ‘need.’  It is guided by what is needed to establish the incentives to maximize economic growth.”

This is a good illustration of how pop-economics has deteriorated over the years.  This guy thinks that tax policy should be guided on incentives to maximize economic growth.

Tax policy should actually be guided towards allocating the costs of government services to those that benefit from them.  Ideally, all expenses should be matched against the revenue.  If this doesn’t happen, then resources can be misallocated resulting in a net loss to society.  For example, there was a sitcom where a boy was making burritos and selling them to his friends.  He would buy the ingredients at the grocery store and charge them to his mother’s account.  Then he’d sell the burritos for $1 each.  When the expenses were paid by his mom, he thought he was making a profit.  Thus, resources were allocated towards an unprofitable endeavor thereby resulting in a net loss to society.

The same for a business.  Part of the expenses of a business are the roads that the delivery trucks drive on, the cost of the court system to enforce contracts and the CIA agent in Afghanistan preventing terrorist attacks.  A perfect tax policy would allocate the costs of all government services to the individuals and businesses that benefit from them.  A toll booth or a gas tax allocates costs to those that use roads.  An entrance fee allocates costs of public parks to those that enjoy them.  However, a lot of services (like national defense, police protection and cutting the grass on the National Mall) are more difficult to allocate to those that benefit, but the objective should be the same.

But what’s been happening these past few decades is that mom, or perhaps I should say “Mǔqīn”, has been picking up a lot of the bill.  This is where tax policy can establish incentives to maximize economic growth.  The government can establish trade relations with foreign nations, spend billions to protect shipping lanes, build roads and bridges, and provide a judicial system to enforce contracts.  But if these costs are not appropriately passed on to those that benefit (i.e. consumers and businesses), then the costs are not included in the prices of the products and services generated thereby resulting in misallocation of resources resulting in a net loss to society as a whole.

Tell me.  Who should pay for your latte?  Should you pay for it?  Who should pay to protect us from terrorists?  You think you’re paying for it.  Truth be told you are paying for some of it, but a portion of it is being paid by whoever is going to inherit the national debt, most likely your children and grandchildren.

Let’s go back to the boy who was making so much money selling burritos.  Who should pay for the ingredients?  If the boy can convince his mom to make his little sister pay, then the boy can reap profits and enjoy a lavish lifestyle.  Meanwhile the boy’s mom struggles to pay her bills, and the little sister gets screwed.

Another result is that society produces more burritos than it wants.  Suppose it costs more to produce a burrito than a taco.  But because the boy’s mom picks up the costs, the boy can sell the burrito for less than the taco thereby putting the taco boy out of business.

A real world example of this would be transportation.  People want gasoline.  Americans like to drive their cars, and they want the gasoline to be inexpensive.  In addition, gasoline diesel fuel and gasoline are used to ship goods to market.  If the price of gasoline and diesel fuel go up, then the prices of many goods will increase from tomatoes to lumber.  What would cheap gasoline be without roads on which to drive.  Americans want pothole free roads.

The government spends hundreds of billions on securing shipping lanes and making deals with oil producing nations.  Seemingly uncountable amounts of money are spent by federal, state and local governments on road construction, repairs and maintenance.  When Bob Hamilton gets into his car to drive to the Starbucks to get a cup ‘o jo, he pays, let’s say, one dollar for the cost of the round trip in addition to his coffee.  However, if all the costs were included, it might cost, let’s say, ten bucks.  Thus the government is subsidizing this lifestyle.  If Bob had to pay the total cost, he might reconsider his plan.  He might pick up the coffee on the way home from work or combine his daily errands thereby reducing his costs.  To go to his job he might consider taking public transportation.  And he might buy a more fuel-efficient car instead of that Hummer.

Do Americans like their cars?  Yes, they do.  Should the government subsidize it?  That’s the question.  If you want to drive your car, then drive your car.  Get a Ford Excursion or a Hummer and drive just for the fun of it.  But should part of the cost be paid by someone else?

Deficits Suddenly Matter

In his column “Don't Cave GOP, This Time Deficits DO Matter” posted at Forbes.com on December 14, 2012, Jerry Bowyer argues that deficits do matter.  This is a sudden departure from his previous position.  Let’s take a look.

On page 60 of his book “The Bush Boom” Bowyer argues to forget the deficit.  In the column referred to above, he admits that he has in the past “downplayed the importance of deficits” thinking that a budget deficit is rendered harmless if GDP growth exceeds the growth of the deficit.  The problem was that (except during the mid to late 1990s) GDP growth did not exceed the growth of the deficit.

Bowyer argues that now the debt has grown “to the point where it really is unsustainable”.  He points out that the national debt as a percentage of GDP is “over 100% and rising” and that “for the past few years the deficit has hovered around nearly 10% of GDP”.  So basically the reason for Bowyer’s sudden change in position is that the debt and deficit have gotten bigger.

A little background: A key statistic in evaluating a nation’s financial position is the Debt/GDP ratio which compares the national debt to the nation’s growth domestic product.  Nations with higher incomes are more capable of handling higher amounts of debt than nations with lower incomes.  For the United States, a debt of $1 trillion is a small amount.  For Cuba, a $1 trillion debt would be unmanageable.  A person with an income of $500,000 could easily afford to pay the mortgage on a $1 million house.  But for a person with an income of $25,000 per year… I mean, forget about it.

The U.S. Debt/GDP ratio has historically been much lower than it currently is.  It reached as high as 30% after WWI.  Then after the Great Depression and WWII the U.S. Debt/GDP ratio peaked at 112%.  It was necessary to accumulate that debt to win the war.  But after WWII the nation was responsible and little by little year by year the ratio decreased back to below 30%.

Then along came the supply-siders telling us that deficits don’t matter.  We can grow our way out of it, they argued.  The only problem is that we didn’t grow our way out of it.  The Debt/GDP ratio nearly doubled during the Reagan/Bush years.  The W Bush years returned to increasing Debt/GDP ratio during what Bowyer refers to as the “Bush Boom”.  Debt kept piling on with a brief respite during the Clinton administration.

Bowyer and people like him who kept saying “Forget the deficit,” and “Deficits don’t matter,” are the principle cause of the dire situation that we’re in today.  Spending beyond our means and borrowing to finance the appearance of prosperity for three decades has resulted in this nation going from the world’s largest creditor to the world’s largest debtor nation and being told to “forget it”.  When the financial crisis hit and the inevitable Great Recession, we were not in a financial position to properly address it.  Instead of drawing on savings, we had to borrow even more to prevent the economy from collapsing.

Now suddenly Bowyer wants to change his position, and he does a song and dance to convince himself (he’s not fooling anyone else) that his original position was justified.  But his original position was wrong.  We didn’t grow out of the debt.  Deficits do and always did matter.  Unnecessary irresponsible spending and debt accumulation accompanied by accumulation of off-balance sheet unfunded obligations for three decades is not and never was a good policy.

Thomas Sowell, Clueless on Capital Gains

http://www.nationalreview.com/blogs/print/329110 

A lot of pop-economics writers have little to no education in the field of economics.  Think of Lawrence Kudlow, history major, Jerry Bowyer, accounting major and Bruce Bartlett, also a history major.  Thomas Sowell actually has an education in the field of economics as well as decades of relevant experience which is why it’s so strange that he is so clueless with respect to capital gains.

In a recent column about capital gains, Sowell reveals that he doesn’t even really know what a capital gain is.

Sowell describes a scenario where he spends ten years writing a book thenceforth selling it to a publisher for $100,000.  He argues that this constitutes a capital gain because there is no guarantee that the publisher will pay him after ten years.  In another scenario he describes a builder who spends ten years creating a housing development.  When he sells the houses, Sowell argues that the income constitutes capital gain because of risk.

When you write a book and sell it for royalties, it’s not a capital gain.  It’s compensation for the work you performed.  The fact that there is risk involved doesn’t render it a capital gain.  Yes, I agree that holding an asset with the hopes that the value will increase and thereby reaping a gain on the sale involves risk, but that does not mean that all income subject to risk is a capital gain.  When you build a house and sell it, any income is ordinary operating income.  If you sell the house at a loss, then it’s an ordinary operating loss.

There are legitimate arguments for taxing capital gain income below that of ordinary income.  But for crying out loud, educate yourself with respect to what constitutes capital gain income before you enter into the discussion.