Monday, September 20, 2010

Industrial Policy Fails

President Obama has proposed another $50 billion for infrastructure, full deductions for investments in capital goods during 2010 and 2011, a permanent tax credit for research. These measures will do little to revive the economy.

The new infrastructure spending would be small, relative to the size of the economy. If a bridge here and a road there need repairing, then do it, but not to create jobs or stimulate the economy. These projects pull resources away from other activities, and they take some time to plan and implement. The government has already spent billions of dollars for stimulus, and unemployment is still high, and growth sluggish.

If the economic problem is lack of demand, why have the budget deficits of over a trillion dollars not provided sufficient demand? Because the problem is not a lack of demand. The government of Japan tried for a dozen years after 1990 to stimulate demand, and the economy remained flat.

Business can already deduct the cost of investments from their tax liabilities, so a full deduction just moves the tax deductions from the further future to the nearer future. That will provide a little help to business, but they will not expand so much if other taxes rise and reduce their profit.

The tax credit for research, experimentation, and development, is rather selective. Some types of research, such as new applications for programmable devices, are not eligible. Credits for particular activities are an example of industrial policy, in which government seeks to push economic activity in particular directions. But the chiefs of government cannot know which types of investment will be the most productive for the future. Industrial policy ends up distorting the economy and creating waste by arbitrarily subsidizing some activities and penalizing others.

Tax credits for research do little to reduce unemployment, because few workers are involved in such activity. Tax advantages for capital goods skew the economy against labor. When a company hires more labor, it is slapped with payroll taxes and medical costs, whereas if they buy machines, they get lower taxes. Thus it pays for firms to substitute capital goods for labor. The US government’s industrial policy pushes firms into labor-saving investments. If the goal is to reduce unemployment, this industrial policy is senseless.

The best policy for employment and economic growth is permanently low or zero marginal tax rates, and no subsidies. A “marginal tax rate” is the tax rate on additional income. The top marginal tax rate on dividend income is scheduled to rise from 15 percent to 39.6 percent in January 2011. The capital gains rate will jump from 15 to 20 percent.

So with one hand the government provides tax credits and deductions for particular activities, but with the other hand it takes away more of the profits from enterprise and investment. Some firms which have had profits in 2010 are paying these to the shareholders in dividends in 2010 when they would have used the funds for research and investment. It makes financial sense to pay the dividends now, before their steep rise in 2011. But it may have made greater economic sense to invest the funds if not for the tax increases.

The chiefs of government today seem to have a bias against low marginal tax rates for higher incomes. To get revenue, they could have proposed taxes on pollution or land value. They don’t seem to believe that the law of demand applies to the rich. They think that they can just take income from the wealthy with little economic impact. But that is not the way the world works.

After the transition, taxes on land value would have no economic burden, because by lowering the price of land, the tax would replace the mortgage interest that would otherwise be paid. The government seeks high taxes on the rich, which they then rebate implicitly with the rent generated by governmental infrastructure and rebate, but with a deadweight loss on the economy.

Not one in a million persons, and not one in a thousand economists, understand that much of taxation is at the expense of land rent. Production has a surplus that gets paid in land rent. Taxes reduce the surplus, as taxed enterprise bids down the rent. So taxes already take land rent, but in an indirect and hidden way, with a deadweight loss punch to the economy.

Once you understand the tax cat, you see that the current tax policy and tax proposals are economic madness. But the chiefs will not let the cat out of the bag.

Thursday, September 02, 2010

Thus Spake Geothustra, Episode 4

Geothustra was now old, with white hair, and word had spread in the region that there was a wise, though odd, guru who lived on the mountain. Now Geothustra had a stream of visitors who climbed up to tap his wisdom.
“I have become a caricature,” huffed Geothustra to himself. “A cartoon guru that people climb up to for one-liner answers. If such must be, then I shall be cartoon squared!”
Word spread that Geothustra wandered about the mountain naked, not caring if others were male or female. Often he was naked when visitors arrived. “This is how I assert and express my sovereignty,” he would explain to startled visitors.
There was a knock on the door, the 5th visitor for the day. “How can I get rich?” asked the visitor. “Compound interest,” replied Geothustra.
A young man came and asked, “How can I get a date?” “Ask a hundred women. One will say yes, although she may be the one you like the least.”
“How can I achieve peace on earth?” asked a young lady.
“Put in your will that you wish to be buried in soil,” replied Geothustra.
Another asked, “What is the true religion?”
Replied Geothustra, “Why do you think there is one?”
A teacher asked him, “What makes you so wise?”
Geothustra replied thus: “I go to the ground of things.”
A college student asked, “Is money the root of evil?”
Geothustra: “Why do you speak of money? You are not going to the ground of things!”
“What is the ground?” asked the student.
“The ground is the ground!” exclaimed Geothustra.
Another visitor overheard this. “Oh, Geothustra, you hit hard with your truths! From whence do you get your truths?”
“When one is in touch with the universe” explained Geothustra. “Truth comes to one of its own accord.”
A member of parliament asked, “What advice do you have for law makers?”
Replied Geothustra, “Will nothing beyond your capacity.”
Asked the legislator, “And what is my capacity?”
Geothustra: “Your capacity is exceeded when you believe you are more sovereign than others.”
One day there were a dozen visitors. Geothustra thought it would be appropriate to have a party. “This evening at my place, there will be dancing!” he said. There was an odd assortment of people gathered. Sitting together were two kings, an old magician, the brother of the pope, a beggar, a man afraid of his shadow, a woman who claimed to be spiritual but not religious, a soothsayer, a man voted the ugliest in the valley, and a donkey.
“Tell us a story,” said the magician.
Thus replied Geothustra: “I once met a woman whose name was Eternity. I loved her, but she did not reciprocate. I then realized that in seeking Eternity, I was willing beyond my capacity. Later I met a woman whose name was Destiny. I sought her too, but she could not love me, and I realized that again I willed to power beyond my capacity, as Destiny is simply what must be. Now I ask only for my sovereignty.”
Geothustra turned towards the woman who was spiritual but not religious.
“What is your name? If I may ask.”
She replied, “My name is, indeed, Sovereignty.”
“Oh!” exclaimed Geothustra. “Who here besides her is sovereign?”
The two kings raised their hands. “They call us the sovereigns.”
“You are all sovereigns,” said Geothustra. “But people give away their sovereignty, even while they over-reach into the sovereignty of others. Thus is it said, the law is an ass.”
The donkey went “Yee haw!”
“Is the donkey also sovereign?” asked the ugly man.
“Usually not,” answered Geothustra. “But then suddenly the donkey will refuse his load.”
“Now let’s dance!” said Geothustra. “Lift up your legs!”
“I don’t know how to dance,” said the pope’s brother.
“Then stand on your head and kick your legs,” answered Geothustra.
The kings were too embarrassed to dance. “We must maintain dignity,” they explained. What if one of our subjects were to visit here?”
“They are kings,” thought Geothustra, “yet they have heavy feet. They are slaves of custom and pomposity.”
“Keep dancing” exclaimed Geothustra. “Your very souls should be dancing!”
Geothustra’s cave was full of laughing and dancing. Except for the solemn kings.
Then late in the evening, out of the forest came a loud roar. They all looked towards the direction of the bellow, and there emerged a large yellow beast. The lion shook its head and roared out again, and then he came running towards the cave. Everybody except Geothustra and Sovereignty fled down the mountain.
“Everyone who hosts a party should have such a lion on hand,” said Geothustra.
“Oh, Sovereignty,” exclaimed Geothustra. “You are all I desire. I have been seeking the higher man, and now I have found the higher woman. Please, will you stay with me?’
“Yes, Geothustra, I will stay. For you have taught me to love the earth!”
“The higher man should ask for nothing more than his Sovereignty,” said Geothustra. “Accept nothing less, and demand nothing more.”
“You shall have your Sovereignty!” she said.
“I have fulfilled my destiny, for eternity.”
Thus spake Geothustra.
(This has been a deconstruction and reconstruction of Thus Spoke Zarathustra by Friedrich Nietzsche, Cambridge University Press, 2006; Fourth Part.)