Ad Majorem Dei Gloriam

Essential thinking for reading Catholics.

Thursday, November 08, 2012

A quick bit of explanation I need to drop on you.

One of the truisms we hear a lot -- because it's true, incidentally -- is that it is very unwise to raise taxes in, or facing, a recession.

It seems very, very likely this advice will be ignored.

"But why is it bad? Rich people can afford to pay more."

Here's why, and keep in mind I am giving you a FEROCIOUSLY abbreviated version of things.

We have had a recession and "recovery" (ponder that we had higher unemployment during the recovery than during the recession) that was characterized by a near-evaporation of liquidity. People had "stuff" (i.e., goods and services) but they were not liquid (i.e. people had no cash and the stuff they did have wasn't so simple to turn into cash). In a normal situation that's not a very big deal because financial institutions provide the cash (i.e. liquidity) to compensate.

But for a whole bunch of reasons we shan't discuss today, the banks weren't providing that lubrication and the system really, really broke down. So the Fed steps in to "inject liquidity" or "provide monetary easing" into the system. But here's the problem with that: The money (again for a whole textbook's worth of reasons) gets stuck in the banks where it has remained. The analogy of a clogged hose is apt.

So what does that have to do with taxes?

Simple.

When you increase taxes -- and we're using only for the sake of simplicity, because it's otherwise loathsome and useless, a static analysis model -- you get money that was otherwise coursing through the private sector, and put into the government sector. The problem with that is that there is a multiplier differential between what $1 does in the private economy and what $1 does in the government pipeline. The last time I checked, the difference was a +/- 1.78 for private and +/- 1.21 for government. That means that for every $1 that goes into the private sector's pipeline, at the other end emerges $1.78. In the case of the government, you get $1.21.

The logic is simple, if you start with Person A and $1, you see that $1 buys goods and services as it goes through the private sector and changes hands. Stuff gets made. Not so with the government. (It still has a multiplier -- albeit a very diminished one -- because as government employees all along the chain get paid they then buy goods and services. But keep in mind that it costs $40K to give $20K in assorted benefits.)

In other words, think of that innumerate limousine progressive (but I repeat myself) such as Stephen King. He can afford to pay, say, an extra $X dollars. And so he does. Fine. What would have he done with that $X? "Wasted it on ____." would be the reply of the self-styled bien pensants. But let's examine that. Let's say he chose to "waste" it on, oh, a custom suit. Those $X pay for that suit, in turn pay for the rent on the store, pay for the needles, thread, fabric, etc. The landlord, needlemaker, spinner, weaver all, in turn, pay for assorted goods and services, and so economic activity is generated, leaving us with the 1.78 multiplier. But that $X in the government coffers? It doesn't pay rent, it doesn't buy supplies, it doesn't buy needles, thread, fabric or any other economic-generating goods or services...which brings only a 1.21.

This is where it gets hairy. IF we're having an economy starving of capital (again, setting aside the "why" of that) the last thing you want to do is starve it further. Increased government spending cannot hope to compensate because its multiplier effect is simply too bloody low. (The spending would have to be almost 3¾ times higher to have the same effect and, while that may have been a viable option in the salad days of Keynesianism, the towering debt -- however you want to measure it -- we face now makes that a practical impossibility.)

So you have a double whammy at a time when the global economy is very, very fragile. Siphoning capital from the private side and putting it in a labyrinthine system that almost four times less efficient at generating economic growth.

This in turn, petrifies the holders of the remaining capital. Anything they invest into stands a good chance of failing or being delayed in bringing a return.

...oh, and it doesn't take much of a tax spike, especially in combination with other shocks (one of the clearest examples would be 9/11/01) to send the economy into a tailspin.

But!

Kindly note the following. Until now, recessions were cushioned by the expansion of the preceding recovery. Now, if you just yelled at your poor, innocent screen "WHAT recovery????!!!!!????" you win a prize. This is why this is so worrisome this time around, because we have had, functionally, no recovery. Much of what has been ascribed to same is statistical misdirection or simply flatlines unadjusted for population growth. So:
There's essentially no cushion. Worse: Germany, which has been bailing out the Eurozone is staring into recession itself (three guesses what that does for the bailout-ees?) and their economy has much better fundamentals than ours.

Sleep well.

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