Monday, December 19, 2016

Capital and Money Are Not The Same Thing

The word "capital" is bandied about as if the word had a concrete, common, well understood meaning. But does it?

For economists, capital is the third fundamental category of scarce resources --- as in land, labor, and capital --- categories that every faithful student of ECON 101 no doubt memorized. On this account, capital includes factories, equipment, and tools. On another account also used by economists, people are said to be investing in and building "human capital" when they go to college or invest time and money to learn new skills. On both accounts, capital is said to be the fundamental source of rising productivity of labor, without which, rising labor income is not possible.

In financial contexts, the word capital most often seems to mean simply "money." On this account, capital is said to "flow" to its highest valued use, if markets are free, to flow between countries, if unrestricted by governments and their central banks, and to be the life blood and wellspring of economic growth and prosperity. Businesses are sometimes said to be "capital constrained" or "under capitalized." Countries are sometimes said to restrict capital outflows (e.g., China), or to attract capital inflows (e.g., America).

Researching the etymology of the word, we find that an early meaning of the word "capital" is from the medieval Latin capitale, meaning a "stock" of something. On this account, one could have capital in the form of grain, cattle, gold or just about anything of value --- including a stock of money.

But on all accounts, the word "capital" really means something beyond simply money. To accumulate a stock of anything requires saving, as opposed to consuming or using up the thing. Hence, money can be capital, but not all money is capital. How so?  Income that is saved in the form of money is capital. But newly created money --- which is to say money created from "thin air" by commercial banks and the Fed --- is not capital.

The world is awash in money these days. But the world is not awash in capital. Is it mere coincidence that the substantial slowdown in growth of GDP in America over the most recent eight years correlates substantially with rapid growth in newly created money, much of which now resides in reserve accounts of commercial banks? Or is it a slowdown in accumulation of real capital --- which requires saving --- that better explains the slowdown in economic growth?

A second early meaning of the word "capital," also from medieval Latin, is capitalis pars, which designated the principal sum of a money loan. In medieval days the principal sum of a loan of money pretty much had to come from money saved. In those days, it was easy to understood that one could not borrow money that had not first been saved. Consequently, if one borrowed, one would typically be borrowing capital.

Not so in today's world of commercial banking, central banks, and money created from nothing. So called "quantitative easing" does not create capital; it just creates new money. In the United States, the Fed purchased Treasury bonds with that money, enabling the federal government to continue increasing its spending.

If some of that spending finds its way to you, you probably don't mind. And since none of that increased spending requires reduced spending by someone else, no worry, right? It's rather like a free lunch, right? Except, there ain't no such thing.

Yes, here I am, beating an old dead horse once again. You can't borrow that which has not first been produced and saved, an idea I've written about before, here.  But you can borrow newly created money, which amounts to a kind of counterfeiting. Here's how it works.

You deposit $1 in your bank account, say a dollar of income you earned by working. By law, the bank is allowed to lend 90 cents of your dollar to Tim. The bank must hold only about 10 cents in its reserve account with the Fed. Now you have $1 that you can spend, and Tim has 90 cents that he can spend. Where did the 90 cents of purchasing power come from? Thin air, as they say.

You created your $1 dollar claim over goods and services by providing a service called labor. But Tim created no goods or services in return for his newly created command over goods and services. Does Tim's new claim on goods and services somehow seem bogus?  You decide.

When Tim spends the 90 cents, that 90 cents shows up in another bank pretty quickly. The second bank is allowed by the Fed to lend 81 cents to Bob. If you like math, you can see where this is going. If the banking system as a whole does all the lending its allowed to do, retaining only 10 percent of deposits in reserve, your original $1 deposit into the banking system can result in up to $10 additional money created from thin air.

The federal government would consider it a grievous crime if Tim were to counterfeit 90 cents on his own and spend it, but it's somehow not a crime if the commercial banking system does what amounts to the same thing.  To add insult to injury, the banking system earns interest on its loans of your dollar to Tim, Bob, and so on. If you have an interest bearing account with your bank, the bank pays a small fraction of that interest to you and keeps a larger fraction for the bank's owners.

Through the magic of fractional reserve banking, people are able to borrow money that has not been saved by its owner. It's a kind of alchemy, seemingly generating something from nothing.

Some folks worry that money creation from thin air will ultimately lead to price inflation. If it does, then the counterfeiting we call fractional reserve banking turns into outright theft, since price inflation robs you, the original owner of the $1, of purchasing power. If you had saved a dollar in 1913, the year the Fed was created, today that dollar would purchase perhaps 9 cents worth of goods and services at today's prices. You might be forgiven if that loss of purchasing power seems to you a little like theft of 91 cents of your saved dollar.

When it is the federal government that borrows your $1, we get an even more insidious outcome. The federal government doesn't repay its debt, since it just creates additional debt to pay you back plus interest. Worse still, government acquires purchasing power over goods and services without taxing.  If government is building roads and protecting us from foreign despots, that's okay by me. But of course, federal spending isn't limited to road building and national defense.

Central banks around the world, especially the Fed, are making sure that the world is awash in money. But that money is not capital. It's just newly created claims over goods and services generated as if by magic from thin air.  Some believe that central banks around the world have built a house of cards. Let us hope that the wind does not blow too hard in the coming months.

Thursday, February 25, 2016

The FairTax Is No Fantasy

The editorial below was published originally in The Roanoke Times, April 10, 2006. With all the presidential candidates laying out their ideas for tax reform, one wonders why none of them are proposing the FairTax.

The FairTax Is No Fantasy

By David L. Kendall

Kendall is professor of economics and finance at the University of Virginia's College at Wise.

Some critics of the FairTax, HR 25, such as Christian Trejbal in his March 22 column, "FairTaxers pitch a fiscal fantasy," call it a fantasy and a crackpot idea. But benefits of the FairTax are no fantasy.

If enacted as written, HR 25 would eliminate all federal income taxes for individuals and corporations. It would eliminate oppressively regressive payroll withholding taxes, now the cruelest burden on the working poor. The FairTax would replace all federal income and payroll taxes with a simple, progressive and efficient national retail sales tax.

Because the FairTax would eliminate all individual tax returns, April 15 would be just another pleasant spring day. HR 25 would eliminate the Internal Revenue Service and its annual abuse of our Fourth and 14th Amendment rights. A small federal agency would be needed to administer the FairTax, but the IRS as we know it would be abolished.

The FairTax would collect federal sales tax from every retail consumer in the country, including foreign visitors and even underground criminals, greatly enlarging the federal tax base. With a larger base, the average tax rate paid would go down, while the U.S. Treasury Department collects the same federal revenue.

The monthly prebate paid to all households under the FairTax would not be a new entitlement program. The prebate would simply keep income in the hands of the people who earned it. The HR 25 prebate is to the FairTax what the personal exemption is to the income tax, just sooner and fairer.

Recent studies estimate that the underground economy is about $1 trillion per year, all of it untaxed. That's tax evasion on a scale that simply could not happen with the FairTax. Significant evasion of the FairTax would require retailers like Wal-Mart, Kroger and your local dentist to help consumers avoid the sales tax; very unlikely. Potential tax evasion with the FairTax pales compared to the massive income tax evasion already happening.

The FairTax would bring greater accountability and visibility to federal tax collection. All Americans would understand clearly how much federal taxes they pay. People could even plan for taxes they would pay in the future, removing the mystery we face now.

With the FairTax, Congress would be compelled to be up front about tax increases. That's not the case now. When Congress changes tax law now, it takes years to sort out who won, who lost and how tax revenues changed.

The FairTax offers still more. Eliminating the federal income tax would attract more foreign investment to the United States. It would also give U.S. firms incentives to keep new manufacturing capacity in the United States. That means more jobs and faster economic growth.

Our federal tax code gives corporations enormous incentives to export jobs, money and manufacturing off shore. Studies suggest that replacing the federal income tax with a national retail sales tax could cause as much as $10 trillion to flow back into our economy from abroad to finance new plant and equipment. The long-run economic benefits for our children are obvious.

Businesses and other organizations spend more than 6 billion hours each year complying with the federal tax code. That's time and expense wasted. Economists estimate that compliance costs top $250 billion annually. Although out of sight and mind, those costs are real, and consumers are paying them now.

Through competition, the FairTax would compel businesses to lower retail prices. For corporations, taxes and compliance costs are like any other cost of doing business; they must be recovered in prices. With the FairTax, consumers would see retail prices drop by 20 percent to 25 percent.

So, if the national sales tax were 30 percent, the retail cost of the $100 iPod shuffle plus tax would not be $130. Instead, it would be more like $80 plus a $24 sales tax. Because consumers would have their whole paycheck to spend, instead of their "after withholding" paycheck, the $104 iPod, including tax, looks pretty reasonable.

The current federal income tax code is widely regarded by just about everyone as unfair, wasteful and mind-numbingly complex. It's time for dramatic, real change. It's time we demand that Congress pass HR 25.

Thursday, June 25, 2015

The Law Means Nothing in 21st Century America

Here, Michael F. Cannon, an expert on the economics of health care and the provisions of the Patient Protection and Affordable Care Act (PPACA), remarks briefly on the June 25th, 2015 decision of the Supreme Court to allow the IRS and the Obama administration to ignore the law.

Here, you may read a few succinct words from the dissent of Justice Antonin Scalia, who along with Justices Clarence Thomas and Samuel A. Alito Jr., voted to uphold the law, as written by Congress. Six justices, Sotomayor, Kagan, Ginsburg, Breyer, and Kennedy, and Chief Justice John Roberts, voted to ignore the words Congress specifically wrote into the Obamacare Act.

Given the completely clear language of the Act, and given the well-known, express intention of Congress to deny Obamacare subsidies for citizens of states that chose not to establish their own exchanges (a provision of the PPACA that Congress fully intended to entice states to establish their own exchanges), today's Supreme Court decision in King v. Burwell makes a complete and absolute mockery of the rule of law and the Constitution of the United States.

How can Americans be anything but ashamed of our President and the six members of the Supreme Court responsible for today's ruling?

It's now completely clear that Americans live by the rule of a few privileged and powerful men instead of the rule of law, men who are able to ignore completely---evidently with impunity---the Congress of the United States and the laws it passes.  Forget about the Constitution; it means nothing.  Forget about laws passed by Congress and signed by the President; they mean nothing.  Forget about liberty; forget about the principles of law and justice that once made America great.

What now can this President and future presidents not do?  What principles now limit the power of  American presidents?  What law cannot be broken, if the President chooses to break it? Evidently, the President of the United States can do whatever he wishes to do.  Today is a very dark day in American history.

Monday, April 13, 2015

Who Bears the Burden of the Income Tax on Corporations?

Who Bears the Burden of the Corporate Income Tax?

No other question in the arena of public finance is as controversial as “who bears the burden of the corporate income tax.  Economists who specialize in public finance simply don’t know.  So, if you encounter an economist who says he does know, you will know you have found an economist who says more than he knows!

The first fact to get on the table right at the beginning is that only people pay taxes.  Corporations remit taxes, of course, based on income that they earn (a.k.a., net income or profits), but that does not mean that corporations (which are not persons) bear the burden of taxation of corporate income.  By now in this course, we are familiar with the difference between tax incidence and tax liability. 

Whoever it is that bears the burden of taxation of corporate income, those persons will get to spend (or save) less each year than they otherwise would, if the United States did not tax income earned (a.k.a., earnings or profits) by businesses registered with the IRS as C corps.   Only persons from three broad categories could possibly bear the burden.  They are (1) shareholders of a corporation (owners of the corporation), (2) owners of the factors of production (land, labor, and capital), which the corporation pays to use, (3) persons who buy goods or services from the corporation (consumers).  Consequently, I am absolutely certain that I do not bear any burden of the income tax paid by GM, since I am not a shareholder, I do not sell GM factor services that I own, and I do not buy GM products. 

Students of public finance will recall that people who have few options to avoid a taxed activity (such as earning income or buying cigarettes or buying insulin) will end up bearing all or part of the burden of any tax, regardless of who actually has legal liability to collect and remit the tax.   Economists say that such persons have “inelastic” demand (or supply) curves for the activity.  Perfectly inelastic demand or supply curves result in complete bearing of the burden of a taxed activity in which one engages.  

So, if I must work to live, and if the politicians tax wage income, then I will bear nearly all the burden of a tax on my wages.  On the other hand, if I am independently wealthy, and the politicians tax wage income, I can avoid bearing part of the burden of a tax on wage income by reducing the hours I work for pay, up to and including not working for wages at all!

I am really confident that shareholders bear the immediate burden of a new or a raised tax on corporate income in the economic short run.  They do so because the corporation will remit money to the government that would otherwise have gone directly to shareholders equity (retained earnings) or would otherwise have been paid directly to the shareholders as dividends.  Following the imposition of a new or a raised tax, corporations will not have time to raise the price of their products to shift the tax forward to consumers, nor will they be able to shift the tax backward to employees by reducing their wages and salaries, nor will they be able to shift the tax backward to owners of land they are renting by negotiating a lower rent, nor will they be able to reduce what they are paying for any other factor of production.

But in the economic long run (after people make all the adjustments to a new tax they care to make), I think that consumers of goods and services sold by corporations bear most of the burden of taxation of corporate earnings.  I cannot be sure, though, because the lived world does not allow economic researchers to conduct an experiment that can appropriately hold everything else constant while we impose a new tax and measure everyone’s income before and after the new tax, after an appropriate amount of time has passed to allow everyone to make all the adjustments they care to make.

 But we can be sure that given enough time, shareholders (who are supplying capital to finance activities of corporations) will reduce the quantity of money (capital) they supply, if the rate of return to holding shares of corporations is lower than the rate of return such savers (a.k.a., investors) can earn through some other activity.  Alternatives to holding shares of stock in a corporation abound.  One can buy gold, paintings by Monet, farm land in the Midwest, corporate bonds, silent partnerships in non-corporate forms of business, etc.  Investors (a.k.a., savers) do not have to buy shares of stock in  C corporations in the United States.  Capital always flows to the highest bidder (of equal risk), given enough time, just like water seeks the lowest level.  So, owners of capital have options for avoiding the corporate income tax.  It’s hard to imagine how shareholders will end up bearing the burden in the economic long run.

What about employees of corporations?  Can owners of a corporation (shareholders) push the burden of the corporate income tax backward to its employees, by reducing their pay (or by withholding future raises as inflation occurs)?  Or, can employees just work somewhere else, should owners of the corporation try to shift the tax?  Do employees have options to avoid the backward pushing? 

At this point, I want to point something out.  Shareholders do not meet somewhere and vote whether or not to try to shift the income tax levied against their corporation.  Moreover, employees have no way of knowing whether their wages and salaries are not rising fast enough to avoid getting some of the burden pushed back to them.  The very language that economists use to talk about shifting tax incidence is actually a little silly, since any tax shifting that occurs is completely hidden from view and takes an unknown amount of time to occur, if it does occur.

What about consumers who purchase the products of corporations?  In the economic long run, can corporations simply raise their prices to shift the burden of their income tax forward to consumers?  I think that corporations can and do just that.  After all, businesses must be able to recover all the costs of production, plus a competitive profit to compensate owners of the business, in the economic long run.  Businesses that cannot cover all the costs of production will quit producing, in the economic long run.

From the point of view of a business owner, paying taxes is just like paying the electric bill.  Taxes can be thought of as a slip of paper that says “you paid your taxes,” which slip of paper is required to produce and sell, and which is just another cost of doing business.  Consequently, I think that in the economic long run, prices of goods and services produced by corporations adjust upward to include the complete burden of the corporate income tax, thereby shifting the burden of the tax to people who buy those products. 

But, I will conclude by repeating that I cannot know for sure, nor can any other economist.         

Saturday, April 11, 2015

Redistributing Income

As you may have noticed, one of the two major political parties in the United States is all about redistributing income.  According to supporters of that particular political party, the distribution of income that results before redistribution is not equal enough and is not fair.  Consequently, much of the legislation supported by this political party is designed to take income away from Peter (who evidently has more income than would be fair) and give it to Paul (who evidently has less income than would be fair).

Members of this political party also complain that the top 1% of income earners in the United States earn way, way too much more than 1% of total income, and the lowest 20% of income earners earn way, way too much less than 20%.  Some people agree with the claims of this political party; some people do not. 

The word "fair" has no clear, settled meaning.  Yet, we all use the word as if we all know exactly what it means.  In my judgment, the word "fair" cannot be used in any logical way in talking about the distribution of income. 

Some people say that "fair" means "equal."  But it's hard to see how equal income for engineers and restaurant servers could be thought fair by anyone.  Moreover, I've never met anyone who thought engineers and restaurant servers should earn equal income.  Some people say that "fair" means "deserved."  Perhaps, but if so, what will we want to say "deserved" means?  Does Tiger Woods deserve his enormous income, just because he possesses athletic abilities particularly suited to hitting golf balls into small holes?  Does Bill Gates deserve his enormous income, just because his mind is so structured that DOS made sense to him for a computer operating system?  Don't we all "deserve" prosperity?

The distribution of income in the United States is unequal because the capabilities of people are unequal and because all people do not want the same goods and services.  Equal income cannot and will not come about in a society of people who have different capabilities and who have different wants. 

Attempts to redistribute income in the United States, which have been ongoing on a major scale since the "War on Poverty" initiated by President Lyndon Johnson in the early 1970s, have scarcely changed the real distribution of income in the United States.  Today, through a variety of transfer payment programs, government transfers about $1 trillion per year from someone who earned the income to someone who did not.  The simple truth is that if somehow overnight, income were distributed exactly equally among the nation's 125 million households, within just a few weeks, income would once again be distributed unequally.  Until people all have the same capabilities and the same economic wants, the distribution of income will remain unequal.

Human prosperity is not the same thing as the distribution of income.  As an observable matter of fact, human prosperity around the world has been rising dramatically over the past 250 years. Perhaps people would benefit by focusing more on the causes of human prosperity and less on the distribution of income.  But try telling that to the political party that favors redistribution of income.

P.S.  I am personally not a member of a political party.  I am not a partisan, so please don't disparage my simple observation of obvious truth for political argument.

Thursday, March 12, 2015

What Is the Burden of Federal Debt?

"We owe it to ourselves" was the common refrain that I heard from my professors as an undergraduate and graduate student about federal debt. Here are some questions that might help clear up whether growing federal debt is a serious problem.
  1. Does outstanding federal debt ever have to be repaid?
  2. If federal debt were repaid, who would do the paying, and who would receive the payment?
  3. If federal debt does not have to be repaid, the U.S. Treasury still has to pay interest to whoever holds Treasury bills and bonds.  What are the economic implications of interest on the debt?  Who bears the burden of paying the interest and who benefits from receiving those interest payments?
So far, federal debt has not been repaid.  In fact, federal debt has been growing for decades.  You and I could not continuously expand our debt, but the U.S. Treasury is different.  Because Congress can tax and because the Fed can create new money, the U.S. Treasury has a much larger capacity to repay debt (if it had to) and to pay interest on outstanding debt (which it must do to avoid default).  As long as the real economy continues to grow, federal debt does not have to be repaid, and it seems quite unlikely at present that all federal debt will ever be retired by repayment of principal.

If federal debt were repaid, repayment could come from only two possible sources: (1) taxes collected in excess of federal spending and (2) money creation.  If taxes in excess of federal spending were the case (a federal budget surplus), tax payers would be the payers and holders of maturing Treasury bonds would be the recipients.  I pay taxes, but I don’t own much in the way of Treasury bonds, so I guess I would be a payer, not a receiver.  How about you?

If federal debt does not have to be repaid, the Treasury still has to pay interest on outstanding debt.  Interest on outstanding debt can be paid from one of three sources: (1) taxes collected in excess of federal spending, (2) money creation, and (3) additional debt.  Obviously, people who own Treasury bonds are the beneficiaries of interest payments.  It isn’t obvious at all who bears the burden of making those interest payments.

Tax payers are not currently bearing a burden to pay interest on outstanding federal debt, because federal spending continues to exceed tax collections.  That fact means that interest is paid through money creation (when the Fed buys U.S. Treasuries) and by issuing additional debt, which expands outstanding debt, of course. 

The real burden of federal debt is the value forgone by using scarce resources in ways they would not have been used, aside from the government’s borrowing.  If government’s use of those scarce resources also creates value, then what we are getting is a transfer of value from Bobby to Annie, with maybe a net loss and maybe a net gain.  Transfers of value from one person to another cannot be objectively measured to see if we got a net gain.

If government’s use of scarce resources did not create value for anyone, but nonetheless caused a loss of value for someone, we end up with inefficiency and a net loss.  But most government spending benefits someone, somehow, and once again, because interpersonal comparisons of value are not really possible, we are hard pressed to say much more.

If government control of scarce resources diverts resources away from production of capital goods that would otherwise have occurred, it is possible that growth of the real economy could be retarded.  If growth of the real economy is retarded, that reduces future consumption opportunities below what they otherwise could have been.  Economists who study this phenomenon have been unable to reach what everyone takes to be conclusive, persuasive evidence about this issue.  In other words, no one has been able to persuade lots of economists one way or the other about whether government control of scarce resources has retarded growth of the economy, although any number of economists make statements about it one way or the other.

The expression “we owe it to ourselves” is pretty silly, really.  Some part of federal debt (about 40%) is debt held by private citizens of America.  Interest payments on that internal net debt amounts to a transfer of purchasing power to the owners of that debt.  Although the payers of that interest are Americans, as are the recipients of those interest payments, “we” are not “ourselves.”  In other words, growing federal debt means growing transfer of purchasing power over goods and services to people who lend to the federal government.  So, even internally held federal debt may pose some issues about which people will have normative opinions. 

For that part of federal debt that is held externally (by Japanese citizens in large measure, and by other citizens of the rest of the world), interest payments on U.S. federal debt enlarge their consumption opportunities.  But it is far from clear that those interest payments reduce the consumption opportunities of Americans.  The evidence so far is that the standard of living of nearly all Americans continues to rise.

So, should we worry about growing federal debt?  Yes, if the real rate of growth of our economy is retarded, and no, if it is not.  I am persuaded that we do not really know, but nearly everyone has a normative opinion about the wisdom or stupidity (whichever it is) about growing federal debt.   

Friday, January 23, 2015

Whither the Welfare State?

Here, George Will provides an accurate and succinct description of the growth of the welfare state in America over the past three or four decades.  As usual, Mr. Will gets it right and offers entirely thoughtful comments.

Unless I misread his intent, Mr. Will is less than happy about the growth of transfer payments now received evermore broadly by Americans who would not be considered "needy."  Although I rarely find myself at odds with the ideas of George Will, I will offer a different perspective for explaining continuing growth in the welfare state in America and in other developed countries of the world.

The American economy continues to grow at a modest pace (about 2% per year over the long haul), which is far more impressive than pundits seem to think.  Our GDP weighs in at about $17 trillion per year, which is really a huge economy.  China is second at about $9 trillion per year.  Japan is third these days at about $5 trillion per year.

Even a small rate of growth for something as large as the American economy generates impressive gains in income per household.  Two percent of $17 trillion is about $340 billion.  If that $340 billion were divided equally among the approximately 118 million households in America, just 2% growth in GDP per year would bring an additional $2,800 per year to each household.  Or, examined on a 10-year period (which government types are fond of doing), a $31,500 increase in household income over the 10-year period, accounting for compound growth.

Of course, annual gains in GDP are not earned equally across all 118 million American households.  The widening gap between annual income of the top quartile and the bottom quartile of households in America is frequently the topic for hand wringing by those who call themselves progressives.

Mr. Will writes in his essay,
"America’s national character will have to be changed if progressives are going to implement their agenda. So, changing social norms is the progressive agenda."  
He is correct, of course.  But I propose that we all might as well get used to a sea change in America's national character and its social norms.  Let me explain.

In a word, "technology."  The widening income gap between the top and bottom of the statistical income distribution in the United States (and in other developed countries) is pretty much a direct result of advances in technology, in my judgment.

People who own income streams generated by creating technological advances (e.g., Bill Gates), or by owning income streams generated by astute use of technology (e.g., many IT employees across the nation), enjoy high and rising income.  People who own only their labor, made evermore obsolete by advancing technology, suffer from low and falling income.  Hence, the expanding income gap between those who benefit from advancing technology and those who don't.

Tyler Cowan has written a book Average is Over: Powering America Beyond the Age of the Great Stagnation   that explores many implications of the truth that advancing technology is making common labor obsolete for production of goods and services in our economy.  But people who own nothing other than common labor services must somehow keep body and soul together.

The answer is not "work harder," as any number of pundits on the right are wont to expound.  Nor is the answer "get more education," as any number of politicians and academicians have advised.  The simple truth is that an ever-rising number of people are not now capable of and will not become capable of inventing advanced technology, or becoming astute users of advanced technology.

Advancing technology makes it ever more possible to produce greater quantities and better qualities of goods and services with less human labor.  In the United States, our creation and use of advancing technology has already enabled us to transfer about 14% of annual GDP from people who earn it to people who did not earn it each year.  Although many lament such expansive transfer payments, the amazing thing is that it is possible to make such transfers while the standard of living for the payers of those transfers continues to rise!

Think for a minute of all the people who have jobs that literally could be done without.  I can easily think of tens of people I know whose job falls into that category.  Even what I do, which is teach economics and finance to college students, is quick on its way to falling into that category!  Yes, even college teachers will be replaced in the fullness of time with advanced technology.

On the one hand, advancing technology that permits a rising standard of living for everyone on the planet is a good thing.  On the other hand, most of us will not be inventors of that technology, nor will we be astute users of it, which means that most of us will have declining work-based claims on goods and services as technology continues to advance.  Yet, we will still want to eat, be clothed, be sheltered, and enjoy life.

Yes indeed, America's national character and social norms will definitely have to change.  They have been changing for decades, and they will continue to change.  The challenge we and other developed countries around the globe face is how to live in a world of abundance --- a world in which advancing technology makes it possible for an ever-growing percentage of GDP to be transferred from those whose current job generated it to those who either have no job or who have a job that is unnecessary for generating goods and services.

In my own insignificant corner of the world, I continue to add value by what I do because I have been an early adopter of computer technology throughout my teaching career.  I became certified in online teaching, for example.  I am a fairly astute user of technology.  But, still, I am not safe.  I can foresee the day when what I do will be unnecessary, due to a combination of clever computing and clever computer programming.  Call it a fairly meager advance toward artificial intelligence, which I think is not far off.

In a world of abundance --- a world in which scarcity of resources has been greatly attenuated --- we face a disconnect between work, income, and wealth.  I grew up in an era when hard work and education led to higher income.  I grew up in an era when social norms required attention to being a productive member of society.  I grew up in an era when national character and social norms dictated that those who would not work hard and obtain an education should not earn much income.

But what is one to do when what one can do has little productive value?  Which of you reading this essay is capable of inventing advanced technology?  Which of you is capable of even using advanced technology astutely?  And what of technology that is literally just around the corner that we cannot yet even imagine.  If you doubt that advancing technology is likely to be the rule, all you need to do is think about the technological advances that have occurred in just the most recent 50 years. David Hume was right in noting that the future is under no obligation to repeat the past.  Still, I think the future of advancing technology will be very much like its recent past.

Technology is advancing at an advancing rate.  It's not even linear; it's exponential.  Advancing technology is not a bad thing; it is a good thing.  But we humans will have to figure out a way for the fruits of advancing technology to benefit all of humanity, not just the inventors and the astute users.

I will close this essay with an analogy, one that some readers may find offensive, although no offense is intended.  My dogs have limited intellectual capacity,  even though they appear to have unlimited willingness to please.  No amount of hard work or eduction will enable my dogs to learn algebra.  If the material well-being of my dogs somehow depended on their learning algebra, they would be toast.

I submit that George Will and any number of others who lament rising transfer payments in America and around the world may as well get used to a continuing rise.  How else will the masses keep body and soul together?  How else will most of us enjoy the rising abundance of real goods and services available to humanity?

I confess that I have no good answers to the questions I just posed.  But I think they are questions we must grapple with out in the open, because I absolutely believe that technology will continue to mitigate the ravages of scarce resources.  I invite economists around the world to quit talking about scarcity and get on to the challenging business of creating economic theories that embrace abundance and the problems of income distribution in the face of rising abundance --- abundance that is the result of a very small number of persons, compared to the population of earth.

I am a confirmed classical liberal, as readers of EconoBlast have surely noticed. I believe fervently in individual liberty.  My recently published book, Morality and Capitalism, is a testament to that fact. When I note that transfer payments in the United States will be an ever-rising proportion of GDP, it is not because I favor the progressive policies of the current federal administration.  I have not lost my way, but the path is getting harder to see.

Sunday, December 7, 2014

Why Is the Federal Budget Chronically in Deficit?

    The federal government budget of the United States is chronically in deficit.  Almost unimaginably, the federal deficit topped $1 trillion in each of the years 2009-2012.  Total federal debt tops $17 trillion.  Promised federal spending for Social Security and Medicare exceeds projected tax collections by more than $100 trillion!  Since 1940, the federal budget was not in deficit in only eight years.  And in those years of surplus, highly questionable accounting was usually involved.

1)  Why is the federal budget typically in deficit?
2)  What are the real costs and consequences of federal budget deficits?
3)  What could be done to stop systematic deficits and ever-expanding federal debt?

     Democracy, combined with the political institution of majority rule (let's call it MRD for short), has a built-in flaw.  Under MRD, small minorities with much to gain get their way against large majorities with only a little to lose.  The problem is large, concentrated benefits combined with small, dispersed costs.  For example, wheat farmers in Kansas, who each have thousands of dollars in benefits to gain from a wheat price support program, will lobby loud and long for the program, but each of the rest of us, who each have only pennies to lose if wheat support programs become law, will scarcely pay attention at all.  Each of the rest of us won't spend our scarce time and money to fight the farm bill handout to wheat farmers, funded by federal expenditures.  And so it goes with every special interest. 
     Politicians prosper and get reelected by handing out benefits to supporters who finance campaigns.  A wheat farmer in Kansas has every incentive to donate $1,000 to reelect a politician who will vote for wheat price support.  Each of the rest of us are quite unwilling to donate $1,000 to elect a politician who will vote against the program. 

     Politicians also prosper and get reelected by voting for laws and policies that produce highly visible short run benefits, but generate costs that are mostly invisible, dispersed across millions of citizens, and deferred to the distant future.  The most obvious and largest examples of this phenomenon is Medicare and the evolving PPACA (a.k.a., Obamacare). 

     Federal expenditures can be financed in just three ways: taxes, borrowing, and money creation.  Politicians' propensity to favor borrowing and money creation is no mystery.  By the way, borrowing is deferred taxes; money creation is the most insidious, least visible, and most widely dispersed form of taxing.  Pernicious and growing federal debt—in America and around the world—really poses no mystery at all.

     The real costs and consequences of ever-rising federal debt are ever-growing command of scarce resources by a small number of politicians instead of by a large number of private individuals.  In EconoBlast, we have often discussed how voluntary exchange (a.k.a., free markets), generate prosperity and social coordination.  We have also learned how centralized control of scarce resources generates concentrated benefits, dispersed costs, and prosperity for special interest minorities. 

     Systematic federal deficits and ever-expanding federal debt could be stopped.  I offer four proposals that would end the problem.  First, the political institution of MRD could be replaced with SMRD—super majority rule democracy.  SMRD would require that no law could be passed by Congress without a 4/5ths majority.  Second, we could prohibit individuals from serving more than a single term in Congress.  Third, we could give Congress a budget constraint, stipulating that the federal government cannot spend more than 20% of the average of the most recent three years nominal GDP. Fourth, we could end creation of new money under the direction of just seven people—the Board of Governors of the Federal Reserve, replacing discretionary monetary policy with a money growth rule.

      With SMRD, very few if any laws could be passed that concentrate benefits on small minorities, but disperse costs across the rest of us.  With single-term members of Congress, special interest groups would lose their incentive to finance campaigns for politicians who promise to butter the bread of the special interest group.  With a federal budget constraint tied to GDP, politicians would have to make choices about how to spend tax dollars, instead of deferring taxes with debt and money creation.  Finally, with a monetary growth rule, the growth rate of the money supply would be limited to a rate that makes inflation impossible and promotes wide-spread social cooperation based on knowledge instead of deception.

     If we the people do not have the persistence to insist on fundamental changes, such as the four proposed above, we should stop complaining and just get used to federal deficit spending with no end in sight.  Each and everyone of us can enforce term limits simply by not voting for an incumbent politician, regardless of who it is.  It's a start.  

     The other three fundamental changes I propose would require the help of Congress, and perhaps even constitutional amendments.  But politicians who will serve but a single term might just become statesmen, instead of career practitioners of cronyism.  It's worth a try. 

Wednesday, February 5, 2014

Minimum Wage Again? You Must Be Kidding

Below is a reprint of an article that appeared originally in the Austin Business Journal, way back in 1995.  Later, in 2007, I updated the article, because the drums were beating yet again to raise the minimum wage.  Unbelievably, here we are once again with the President pushing an increase in the minimum wage.

Raising the Minimum Wage:  Who Benefits, Who Loses?

by David L. Kendall
January 26, 2007

In 1964 I turned 15 and landed my first real summer job washing dishes in a restaurant.  Somehow, I got the job over several others who also wanted it.  My first wage was 80¢ an hour—45¢ below the $1.25 federal minimum wage that year.
It might take an army of lawyers to figure out whether my employer was breaking federal law by not paying me minimum wage.  But legal or not, I was thrilled to work for 80¢ an hour.  That summer I learned a lot about holding a job, personal responsibility, and forgoing summer fun with my friends.  I even got a raise to 90¢ an hour after the first month.  More important, I earned about $385 over the summer, an enormous sum for me at the time.
Franklin D. Roosevelt sponsored the first federal minimum wage legislation with the National Industrial Recovery Act of 1937.  The Supreme Court declared that act unconstitutional.  But undeterred, one year later Congress legislated a federal minimum wage of 25¢ an hour in the Fair Labor Standards Act.
The 1938 act covered wage earners only in industries involved in interstate commerce.  But over the years, Congress amended the law to increase the federal minimum wage and to extend its reach.  Federal minimum wage law now applies to about 70 percent of the work force. 

The drums are beating again in Washington to raise the federal minimum wage from its current level of $5.15 per hour to $7.25.  With House Speaker, Nancy Pelosi as chief drummer, several legislators and pundits are claiming the moral high ground for wanting to raise the federal minimum wage.  Supporters argue that $5.15 is not a “living wage,” and therefore, the moral, ethical thing to do is raise it.
But is raising the minimum wage the moral high ground?  Should those who oppose the minimum wage hang their heads in ethical shame?  Who will benefit and who will lose?  A closer look and a little reasoning may be helpful.
Myth Number One—unless forced by law to pay higher wages, businesses will exploit workers, forcing them to accept a low wage.  The truth is that fewer than 7 million workers—about 5 percent of the workforce—received wages below $7.25 in 2005.  Conclusion:  most wage earners receive wages higher than minimum wage, even though no law requires it.
Employers are willing to pay more than minimum wage because they are in business to earn profit.  Just as most people are willing to pay costs to earn income—transportation, lunch, and day care expenses, for example—businesses are willing to pay costs to earn income too.  In fact, businesses are willing to pay workers whatever wage will maximize profits. 

But willing or not, employers are not able to pay workers more than they’re worth.  The wage workers are worth per hour in business depends on the value of goods or services they produce, and how much they are able to produce each hour.  Fortunately, a huge majority of workers in America produce goods or services each hour that can be sold for far more than minimum wage.
My employer during the summer of 1964 was a good, kind man.  But he was also in business for a living.  Owning and running a restaurant was how he and his family earned their income.  Like any other business—small or large—he had to cover all his costs of doing business, including a profit for his family’s income.  Otherwise, he would soon have been out of business.  He paid me what I was worth that summer.  Had he been forced to pay me minimum wage, the cost to his business would have been about $600 for the summer instead of $385.  Would he have hired me if the law had required him to pay me more than I was worth?  Plain sense suggests no.

Myth Number Two—minimum wage law helps the poorest, least advantaged workers in society.  Belief in this proposition may explain why so many Americans favor raising the minimum wage.  Much closer to the truth is that the minimum wage helps one set of “have nots” at the expense of another set of even poorer “have nots.”  A simple example helps explain why.

Suppose that a company is now paying $5.15 an hour for 400 hours of labor supplied by 10 workers, each working 40 hours per week.  Suppose also that the business is paying 100 other workers various amounts more than minimum wage.  Raising the minimum wage to $7.25 an hour would increase this company’s weekly wage bill for the 10 minimum-wage workers from $2,060 to $2,900, an increase of $840. How will the hypothetical business respond?  Let’s consider several options:  (1) raise prices to consumers, (2) accept lower profits, (3) reduce wages of workers who earn more than minimum wage, or (4) lay off some minimum wage workers. 

Most employers have no ability to “pass it on” to consumers.  If businesses could raise their product prices anytime they wished, why wouldn’t they already have used their hypothetical market power to increase profits?  Raising price to consumers, other things unchanged, has a predictable outcome—a drop in sales. Our hypothetical business can ill afford to lose sales.  After all, its weekly costs of doing business are up $840, due to the increase in minimum wage. 

What about accepting lower profits?  This option seems reasonable to some—particularly to people who think “profit” is a four-letter word.  But keep in mind that profit is someone’s income.  Is it any more reasonable to expect employers to accept lower incomes by decree of law than it would be for you or me to accept lower wages or salaries? 

Which brings us to the third option, reducing wages of workers who already earn more than the new $7.25 minimum wage.  Are you and I ready to be one of those workers?  Paying some workers less than they’re worth to allow paying other workers more than they’re worth isn’t really much of an option.  Remember, what a worker is worth has nothing to do with the worker as a human; only that worker’s worth as a producer of goods or services.
That leaves option four.  Our hypothetical company can keep its weekly wage bill from rising by reducing its use of minimum-wage labor by about 116 hours per week.  Which workers would lose their jobs if the company chooses this option?  They will likely be the least skilled, least productive workers.  Arguably, they will also be the poorest, least educated, least advantaged people—those most in need of even a low-paying job—whether it’s a “living wage” or not.  If low income is bad, no income is worse.
How will real companies all across the nation respond to a higher minimum wage?  Companies who can do so will raise prices to consumers, but competition at home and abroad will severely limit that option.  In the short run, business owners may absorb the increased wage bill through profit reductions.  But in the long run, stockholders and entrepreneurs must earn a normal profit or they move their capital resources elsewhere.  In the long run, higher labor costs will not be paid for with reduced profits. 

Wages of workers already earning more than minimum wage will certainly not decline.  Oddly as it may seem, raising the minimum wage tends in the long run to increase wages of skilled, experienced workers.  Faced with a higher minimum wage for unskilled labor, companies demand even more skilled labor.  It’s really just sensible economics.  A higher minimum wage for unskilled labor makes skilled labor relatively cheaper, other things unchanged.  Savvy business owners always want to use more of a productive input that becomes relatively cheaper—and less of inputs that become relatively more expensive.
In the end, once business firms make long-run adjustments to a higher minimum wage, workers who aren’t worth the higher minimum wage to their employers will lose their jobs.  Minimum wage legislation does not and cannot force employers to hire workers who are not worth the legal minimum wage.
Who gains and who loses if Congress raises the minimum wage to $7.25 and hour?  Supporters in Congress clearly gain by doing what appears to be a highly visible “good.”  Some voters like the idea of guaranteeing higher incomes to low income earners.  But the good comes at the expense of others in the labor force who earn even lower incomes.  The losers are generally willing, hardworking people with the poorest educations, the lowest skill levels, and the least ability to help themselves.  Fortunately for Congress, the harm done is evidently out of sight to most Americans.  Better still for Congress, the losers don’t make campaign contributions, and many of them seldom vote.

Workers who lose jobs or cannot find jobs that pay the higher minimum wage will have even poorer choices than they had before the increase.  They may retreat to the welfare rolls, or they may find a job that can legally pay them less than minimum wage.  Most will choose a job—or perhaps two jobs—that pay less than minimum wage, because most are self-respecting, hard working people.  But if unskilled, inexperienced workers cannot get in on the ground floor, it’s even less likely that they will make it to the second floor.
If a higher minimum wage could somehow transfer income from wealthy “haves” to disadvantaged “have nots,” then raising the minimum wage might be defensible on moral, ethical grounds.  At least it would be debatable.  But to use the force of law to take from really poor “have nots” to benefit slightly better off “have nots” may not be what most people would call ethical behavior.  It no doubt depends on how you look at it, but perhaps there is no moral high ground available to supporters of a higher minimum wage.