Saturday, January 14, 2012
Gold Bonds - Taxing Matters
However, in deference to people's sensibilities, the normal humn reluctance to accept unpleasant truths, and all the nonsense in the media, I think I should support that thesis rather solidly. That will require more graphs, although I hate them. So:
Most of the media does not define terms and in some cases willfully obscures the problem.
This graph shows four indicators.
Indexed on the left as percent change over the year are:
A) Thin blue line = Gross Federal Debt. That is rather meaningless, but it is the number often cited.
B) The thin green line = Real GDP.
C) The red line = Federal Debt Held By The Public. This is "real" federal debt. It is debt that has been issued, on which interest is paid, and which has been sold to ex-government entities. As you can see, it took a wild hop upward as a result of the Great Recession, but it does take a big hop up in every recession.
The black line, which is indexed to the RIGHT, is a long time series of Federal Debt Held By The Public divided by Real GDP. This is the important number going forward. Until you have to float your debt, creditors are not bothered by it. Creditors could not care less about theoretical debt, because they are not competing with it for repayment. As of the end of Q3 2011, it was about 77-78% of Real GDP. What matters is not so much the level of FDHBTP, but the ratio to Real GDP.
It is important to compare publicly-issued debt to real GDP rather than nominal GDP, because interest has to be paid on that debt, and the ratio of debt to GDP plus interest rate demanded determines when it becomes difficult to pay interest on it.
Inflating the dollar, regardless of what numerous hopeful idiots write, is of little use when a high proportion of public expenditures are spent on funding basic needs of the population. As inflation goes up, so do those expenditures, and worse yet, inflation-adjusted social spending tends to rise faster than real incomes of the working population, which gets you in fiscal trouble damned quick. Real incomes for the working population drop, real consumer expenditures go down, and the ratio of public spending to tax collections tends to rise. This is one reason the Germans are so afraid of inflation.
Whether inflation is a cure for high levels of government debt depends on several variables, most specifically demographics, the health of the economy (will drops in real income induced by higher real taxation produce more workers seeking to earn more or reduced real spending by workers, and thus a decline in GDP?), the ratio of social spending to total government spending (including interest), the ratio of "easily cut" government spending to total government spending (including interest), the ratio of social benefits available without working or by working minimally to real income increase potential by working, and the total societal debt-to-income ratio. As society-wide debt-to-income ratios rise, the ability to withstand higher real levels of taxation declines - there is, to state it simply, less money to spare to invest and to potentially lose. The need to save rises.
Let us proceed further:
This graph shows the previous black line, which is the ratio of Federal Debt Held By The Public to Real GDP, two employment levels.
The two employment levels are indexed to the right and include (blue) total employment as a number, and (green) not in labor force as a number.
The red line - deeply significant - is the ratio the total number of employed persons to the persons not in the labor force. These persons may not be in the labor force because they are too young, too old, are disabled, have enough resources to live without working, or because they cannot find work.
Please note that I did not use the more accurate level indicator for persons working full time. Those persons are essentially those who can support themselves from their labor plus pay significant total taxes (federal, state and local) - most of the part-time workers are receiving significant government transfer benefits, and are net subtractions. The red line would look much worse if I had used full-time number, and I really should have used it, but I've recently referred to it and I don't want to be accused of being alarmist. So what you are looking at here is not just grim reality, but grim reality viewed with a rose-colored lens. Please be aware of this as you continue. The error bars are all to the negative (more fiscally insecure).
If you will double click on this graph or open it up in a larger detail, you will notice that the red line has trended downward for over a decade, but took a big drop associated with the recession. Since, it has not recovered. This is substantially due to demographics (retirements) plus poor employment opportunities. It is reducing our official unemployment rate without greatly improving our economic structure.
This red line is also very important, and so both it and the black line will travel with us to our final graph in this series. I call this one the Trinity of Taxing Terror:
The final member of the trinity is the orangish/burnt umber line sort of traveling in wavy fashion straight across this graph.
I included the other lines to show total state, local and federal receipts.
The last member of the trinity is nominal total US government receipts (at all levels) divided by nominal GDP.
BURNT umber indeed. Despite all the chatter about lower taxes, the ratio of total taxes/GDP just hasn't moved much in four decades. In fact, it only takes one glib glance at this thing to see that the strong bumps seem to be associated with (cough) bubbles. Do we need more bubbles? No, because they keep causing more recessions.
I strongly encourage readers to view a larger version of this graph and look carefully at the non-bubble inflections. Put on your non-Krugman lenses and really look at this thing. Look carefully at all the lines on this graph. Lookat how they move together.
If your non-Krugman lenses are working, you should see:
A) Taxes at the state and local level didn't drop like like federal taxes did as the result of the recession. Instead, they rose. Now if you are Krugman, you can totally ignore this fact and wail loudly about the horrible effects of states cutting real spending, but it appears obvious that they were forced to do so, and not cutting real spending would have forced them to raise taxes even more, and raising taxes is just as much a subtraction from the economy as cutting spending, and may be more of one.
B) The 1970s were considered to be a high-tax era, but if you look at the ratio of taxes to GDP now compared to then, you see it is actually the same or higher. This is largely because of state and local real tax increases, and it therefore the pension problem at the state and local level is just about impossible to solve without cutting vested pension benefits and/or cutting promised medical benefits in many plans.
C) If we made all those changes in tax policy and never succeeded escaping from the 30-32% bound, we are not suddenly going to jack up taxation to 40% of GDP and see growth in the economy. No, instead we would see a collapse in the economy, which the graph tells us reduces the ratio of tax receipts to GDP. Also, if we enter a recession we have to expect Federal Debt Held By The Public to jump up, so raising taxes too much appears to be a self-defeating strategy. For further detail on that, we can refer to Spain, Greece and Italy. Call them laboratories of dire debt in action.
The last piece of this Gordian knot is of course social spending by governments. That will be the next post in this series.
The belief that the social and economic costs of
Free Trade would be minimal, while at the same time
believing Free Trade would be beneficial to the bottom
80 percent has been proven wrong.
A net tax increase will almost always affect the production side of the economy. That means the young and labor. In other words, the tax burden never SHIFTED to the young and labor because it has ALWAYS been on the young and labor. The burden was merely INCREASED on the young and labor.
Not only has the overall increase in taxation over the last 40 years reduced productivity, it has also played a role in causing the birth rate to drop (affecting the demographics for social programs) and created further incentives for black-market labor (illegal immigration).
Forty years ago government labor was priced below the private sector, and now it is priced above the private sector. And further increase in taxation will only further divide society.
Wow! Thanks as always for the analytical feast. I look forward (or rather, I don't!) to seeing the next installment. So much in these charts debunks what the conventional or complacent wisdom is saying.
BTW, my take is the missing piece is growth. The only way to produce growth is to increase returns to total private investment. The only way to do that is better mousetraps or lower asset prices. We'll get the former someday; we need the latter now. This is known as "liquidationist thinking", which means its just plain mean and unhelpful (even if its true). Or, I suppose we could increase public investment by having a war. TPTB seem to be always working to maintain that option!
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