Borrowing, Taxes & Deficits – A Discussion

In my last post "Soaking the Rich” – A discussion" I set forth a discussion with various subscribers to my blog, which was initiated by an article written by Christopher Caldwell, a senior editor at The Weekly Standard the magazine founded by William Kristol, and a response thereto by a professor at the University of Warwick, Coventry UK.

One of my subscribers, Professor Robert Malchman of Brooklyn, NY has now prompted me into another discussion by sending me a post to his own blog I Am Not Bob.

I urge the reader to go that site and read both his post and the comments, which were exchanged between him and a reader who identified herself (I think it was a she) as bunny42. 

After reading those exchanges I found myself in disagreement with both of them, and accordingly wrote:

I find myself in disagreement with both the post by Robert Malchman and the comments posted by “bunny,” whoever she might be.

Professor Malchman posits a beautiful theory under which the US government is better off the more it borrows and “deficits don’t matter.” This is the first time I have heard this theory since VP Cheney declaimed this sentiment. See here.

Of course Cheney had no basis for his claim, since Reagan neither proved this, nor believed it. After a huge cut in taxes, Reagan worried enough about the deficit that resulted, that he instituted the biggest tax increase in history, “the Tax Equity and Fiscal Responsibility Act of 1982. TEFRA — which was designed to raise $214.1 billion over five years, and took back many of the business tax savings enacted the year before.” See here.

But Professor Malchman points out that conditions are now so unusual that the ordinary rules don’t apply. He points out that with interest rates below the rate of inflation, the government actually makes money by borrowing. But what Malchman overlooks is that if the funds obtained by this borrowing are spent, it will not be possible to pay back the T-Notes, except by further borrowing when they fall due. If at that time the present unusual situation no longer holds then the government would be forced into borrowing at a rate not advantageous. The only way new borrowing can be justified is because it is necessary to cover existing debt, or it is to be invested in projects that by the time the notes become due return a larger return than the cost of long range borrowing, not on the basis of temporary conditions. Investing in infrastructure, undoubtedly, meets this test, and other projects might, but this has to be the test, not temporary deviations from the norm.

Now Bunny is even more off base! She misinterprets Professor Malchman’s comments as recommending that people should buy these instruments. Just the opposite is true. Malchman is pointing out that people who buy these instruments are making a bad investment, since rather than making money, they are losing it. She then goes into a rant about the CRA, which I assume refers to the Community Reinvestment Act, passed in 1977, and which provides among other things, that loans “should be undertaken in a safe and sound manner, and does not require institutions to make high-risk loans that may bring losses to the institution. See here.

In any case there is no evidence that the agency required the type of predatory lending that brought about the housing crisis. All the available evidence indicates that banks and credit facilitators made and encouraged stupid loans, because they believed that with housing prices going up ad-infinitum, the real risk was much smaller than the apparent risk, and with the high rates of return, it was a very profitable business. “They made me do it” is a children’s excuse, and not one for adult sophisticated bankers. In any case if they felt they were being made to do something they didn’t want to do, no one ever heard their protests, Congressman Paul’s allegation notwithstanding.

Malchman then makes an unfortunate comment that has nothing to do with lending, i.e. that if the deficit needs to be cut (according to Malchman it need not be cut) it should not be “cut by eliminating spending (but) by raising taxes on millionaires.” My main concern with this is that it does not define millionaires. Is a millionaire one who has net assets over a $1million, or one who has an annual income of over $1 million? That makes all the difference in the world. But Bunny never raises this question. Instead she goes into a rant saying, “Historically, taxing the rich (the numbers I heard started at $250K) has caused them to circle their wagons and save their shekels.” for which she offers no evidence. In fact the evidence is just the opposite.

“… across the board, today's tax rates are low by historical standards--and for the rich they're very low.” See here. 

And yet the rich “are savi(ng) shekels”. Using Bunny’s logic they should have been spending it. Yet they sent us into the worst recession since the ’29 depression. When Clinton became President (1993) he raised the marginal tax rate from 31% to 39.6% for those making over $194,000, and from 31% to 36% for those making over $108.696. See here. The economy boomed, coming out of a recession that led to the slogan “It’s the economy stupid.” Now I don’t believe that the tax increase caused the boom by itself - but the tax increase reduced the deficit, causing the Fed, under Allen Greenspan, to lower interest rates. Now interest rates are at an all time low, so reducing the deficit would not have the same beneficial effects, but neither would it do any harm if we returned to the rates under Ronald Reagan at say the beginning of his second term, in 1985 when they were 50% for those making over $169,000. Ibid.

As even Bunny should be able to see there is no correlation between taxes and economic expansion. After 1985 taxes went down drastically, and yet we had an economic slowdown, which was not addressed adequately until Clinton.

Bunny says: “So, just tax more? Why not just print more money. You'll get the same result.” No Bunny, printing money, frequently, though not always, leads to inflation, increasing taxes never does. But as you say, “whadda (you) know?

Let me see Bunny – in your second post you posit that increasing taxes on the rich would not make your life easier. No it wouldn’t – but cutting spending in many areas would make your life harder. Would you like your food to be unsafe, the water you drink unsafe, or have your children play with unsafe toys. Would you like your elderly parents to have no income, unless they made enough money to have a big 401K, or to be denied health care because they weren’t wealthy enough to afford the incredibly expensive health insurance at market rates? Or if they are younger, and they have health insurance through their employer, would you want them to go bankrupt because they got sick, lost their job and with it their health insurance. I could go on ad infinitum. Yes, our so-called entitlements are out of whack and need reform, and Ronald Reagan made Social Security reforms that saved the program, and we need to do something like that again. But Ryan’s plan would effectively do away with it, and still increases the deficit by $6 trillion over ten years. See here.

Bunny, you talk about “the self-made millionaires, … having worked for their success” - yes some have, but most inherited money, which they invested and made more from, and paid less taxes than people who actually do work. The people who work the hardest are the ones who make low wages and work on two jobs to make ends meet, and don’t have health insurance or pensions from their employers.

Please understand, Bunny, that employers aren’t hiring, not because taxes are too high, or because regulations are onerous, those have been around through good times and bad, they aren’t hiring because there is no demand. If you had a business and you couldn’t sell the goods you made, would you hire people to make more goods? It wouldn’t matter how cheap that labor is, or how much taxes are lowered, you wouldn’t hire until the demand was there. And if the demand was there you would hire regardless of taxes or regulations. If you double your gross, and taxes were 40% you would still be ahead of the game. If taxes were 40% and you made 10% more you would still be ahead of the game. You would simply have less of an increase. If you make $10,000 more and you pay 40% of that to the government you still have $6,000 more. Would you forgo that $6,000? I am all for cutting. God knows there are many places where we spend money foolishly, on our war on drugs, on subsidies for ethanol, etc. etc. etc. But we have to have enough revenue for the country's legitimate needs, and we have to get that money from those who can afford it – not because we hate them, but because they can afford it. Even half of 250,000 isn’t bad, half of a million isn’t bad. And half of a billion, I only wish. But nobody is advocating anything anywhere near an effective tax rate of 50%. Even a marginal tax* rate of 50% doesn’t amount to anywhere near an effective tax rate of 50% and nobody is advocating a marginal tax rate anywhere near 50%, though in 1945 the marginal tax rate was 94% on all incomes over $200,000. See here.

 A slightly higher marginal tax rate than we have now, would not hurt those who have so very much, and the point is not to hurt anyone.

*Marginal Tax rate is the tax owed on income above a certain amount. Thus taking the Clinton tax rates as of 1993 on someone making $300,000, we find that the marginal tax rate is 39.6%, which according to the table comes to 39.6% on all incomes over $250,000. With an income of $300,000 that comes to $50,000, or a tax of $18,800; 36.0% on all income over $140,000 but below $250,000 which comes to $110,000 at 36% and a tax of $39,600; 31% on all income over $89,150 but below $140,000; 28% but on all income over $36,900 but below $89,150 and 15% on the remaining income. If my arithmetic is correct, the marginal tax rate is 36.9%, but the effective tax is 31.86%.

Comments are welcome and will be distributed with attribution, unless the writer requests that he/she not be identified.