Taxing, Borrowing, and Eating Your Seed Corn

Robert Samuelson, my favorite economist/pundit, has a pleasant tax day piece arguing that higher taxes are in our future.

Almost all the pressures on taxes are in the same direction: up. It will be hard for President Obama to keep his promise not to raise taxes on households with incomes below $200,000 (for singles) and $250,000 (for couples). It will be hard for economic conservatives or the tea party to achieve meaningful tax reductions. Just about everyone will be tempted to deplore federal budget deficits—and do nothing about them. But this escape route may close; many economists warn that endlessly large deficits risk big jumps in interest rates. Someday, higher taxes may be unavoidable.

So, the lesson for tax day 2010 is simple: enjoy it while you can. It's not going to get any easier.

I strongly recommend the whole essay, where he lays out the reasons that tax increases are inevitable. Reluctantly, I must agree. It would be a good idea, however, to be clear about what we are really doing when we tax.

Economies produce two things: goods, like iPods and hearing aids, and services, like repair work and treatment for hearing problems. There are in turn two things you can do with the economy's productive capacity: consume it or invest it in future production. The primary purpose of the economy is consumption, but you have to invest to provide for future consumption. The big question is whether we are providing enough investment to insure future growth.

Government spending is largely about consumption. To be sure, the government takes a portion of the productive economy in order to provide things that make economic production possible, like policemen and courts. That is investment of a sort. Mostly, however, it moves wealth from productive parts of the economy, like family breadwinners, to less productive or unproductive people like retirees.

Government can finance its spending by taxing or borrowing. Taxing depresses consumption among some in order to increase it among others. Borrowing likewise increases consumption, now, in return for a promise that the loans will be paid for by future production. Give us the productive capacity you control now (by your ownership of capital) and we promise you control over more capital in the future.

Samuelson points out that about half of Americans pay no Federal income tax. That doesn't mean that they pay no Federal Taxes. Everything we buy is more expensive because of Federal taxation. Some people believe that the Administration will propose a Value Added Tax, or VAT, to cover its enormous expenditures. That would add a series of taxes to the production of anything valuable at every stage where the product is refined and made more valuable: when wood is cut into lumber, where lumber is assembled into a chair, etc. All this is about hiding the real cost of government from the consumer.

When government borrowing gets out of hand, as surely is happening now, that threatens the financial system. At some point, lenders will suspect that the promise of future returns is fraudulent, and that's when the currency collapses. For that reason, taxation has to keep up with borrowing.

But taxation is still just another way of shifting wealth from one place to another. When government is mostly shifting wealth to consumption, which is what our gargantuan social programs are about, that means less wealth is available for investment.

That is the real worry. We may be at the point where we are eating our seed corn. The American economy has driven the world economy for most of the last hundred years. It has done so because our investment to consumption ratio has been a lot higher than the rest of the developed world. We seem to be where Europe was decades ago, when high salaries, long vacations, and early retirement began to suck the life out of economic growth.

Increasing taxation might help to stave off financial collapse, but it doesn't do anything to shift wealth away from consumption toward investment. That is the real crisis we face.

Comments

[George Mason]

KB old boy allow me to simplify further. Government cannot create wealth it can only destroy wealth. The greater the wealth the government extracts from the citizens the less opportunities for the citizens to create wealth. Ultimately this not only makes the country poorer but less free. We are approaching a time when the government will consume 50% of our nations wealth. When that occurs we will no longer be a free people we will be slaves.

[Stan Gibilisco]

We are headed toward a society controlled more by the public sector and less by the private sector. This change may offer us somewhat more fiscal stability, but will drag down our economic performance.

Within a few decades, China and India will lead the world economically, and we'll lag behind along with Europe. I cannot say, however, that I'd rather move to China or India even then.

In light of the current scenario in Greece, one might argue that even the European model can provide no guarantee against economic demise. You don't pay your bills, and sooner or later the devil will come a-knockin'.

I found an excellent piece on the CNBC Web site:

http://www.cnbc.com/id/36422316

I think that this little article tells it all. As the raindrop goeth, so goeth the storm. Until we can "get our stuff together" in an individual as well as a collective fiscal sense, things can only get worse until we are figuratively eating our own livers to survive.

[KB]

George: I think you are a little bit harsh on government. It consumes wealth but also protects the conditions under which wealth is created. It also kills Nazis. But I certainly agree that Government can become a drag on the economy, hence my 'seed corn' metaphor.

Stan: Both India and China have immense obstacles to surmount before they take charge of the world economy. India looks like a better bet than China. China's one child policy has put them in the same demographic sinking ship as the rest of the developed world, without as much development.

Thanks to both of you for the comments.

[George Mason]

KB; You are correct up to a point. That point is reached when the government creates the conditions where Nazi's (or Communists) become attractive and can take over the government. At the moment we are on a trajectory towards financial collapse (a condition where the radicals may gain power). We Americans are fortunate that every 2 years we can accomplish a major political change in our government. The question then becomes will we accomplish true change by electing people willing to reduce the rate of government spending and the overall size of the government.