Sunday, July 31, 2011

While similarities exist, Obama is no Ronald Reagan

Published in The Tennessean, Sunday, July 31, 2011

by Richard J. Grant

In recent days, President Barack Obama has become quite fond of quoting his esteemed predecessor, President Ronald Reagan. We all know the dangers of quoting out of context and of misunderstanding quotes, but it is also rumored that Obama has been studying Reagan's career.

Perhaps he came across this 1986 Reagan quote: “Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” Given President Obama's record so far, it seems that he mistook this for advice.

Superficially, the two men do have some similarities. Both share the same job title and both inherited very poorly performing economies. Both saw unemployment rise during their first two years in office.

At no time during Reagan's two terms did Republicans control both houses of Congress. The Republicans never had a majority in the House of Representatives. The “Reagan revolution” occurred despite this, and sometimes despite the Republican establishment. We never did get to see what Reagan would have done with a less hostile Congress, but we were never in doubt as to which direction he wanted to go.

President Obama began his term with Democrats controlling both houses of Congress. But after 22 months of experience, voters decided to take away that luxury. If we are still in doubt about which direction he wishes to take us, then it is only because it is so hard to believe. He is no Reagan.

Reagan understood that there is pain even when healing from a wound. The transition from bad management to good management means change; it means disruption. To the untrained eye, the initial stages of making things better will appear little different from making things worse. This explains the superficial resemblance between the first two years of the Reagan and Obama administrations.

President Obama uses the nice-sounding words “balanced” and “compromise” as often as possible. By focusing on the budget deficit rather than the total size of government, he implies that tax increases are somehow needed to “balance” spending cuts. By emphasizing compromise, he implies a moral equivalence where there is none. He likes to remind us that President Reagan compromised and agreed to raise taxes on occasion.

In 1982, the Democratic leaders in Congress promised Reagan three dollars in spending cuts for every dollar in tax increases. Reagan agreed. The tax rates increased, but the spending cuts never happened.

Later, President Reagan achieved significant tax-rate reductions. By 1986, the income-tax base had been broadened and the top tax rate had been reduced by over 40 percentage points to 28 percent. He also continued to push deregulation, which allowed oil prices to fall and businesses to serve customers and to grow accordingly. The economy boomed, unemployment fell, and tax revenues increased.

Our current president should study this.

He, and we, might also think about the universal applicability of these words that Reagan spoke in 1983: “I urge you to beware the temptation of pride, the temptation of blithely declaring yourselves above it all and label both sides equally at fault, to ignore the facts of history and the aggressive impulses of an evil empire, to simply call the arms race a giant misunderstanding and thereby remove yourself from the struggle between right and wrong and good and evil.”


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, July 24, 2011

Higher tax rate won't guarantee more revenue

Published in The Tennessean, Sunday, July 24, 2011

by Richard J. Grant

It is often said that business taxes, such as the corporate income tax, are simply passed on to consumers through higher prices. But it is not that simple. If companies could just raise prices to cover their higher costs, why didn't they just put their prices that high in the first place?

When a company raises its prices, some customers stop buying and others cut back on the quantities that they purchase. This is especially true if competitors do not raise their prices. But even if all businesses are affected by rising tax rates, or any other cost, the company cannot assume that it can raise its prices without losing sales. This is why companies don't like taxes: it hurts them. It hurts their owners by reducing profits, and it hurts their customers because they pay more for less.

Just because a company sets its price does not mean that customers will come forth with the predicted levels of spending. The sales of some products are less sensitive to price than others, so companies might be able to pass more of the burden of rising costs on to customers. But if customers are not willing to pay what the company needs to cover its costs, then that company will need to change or it will go out of business.

The point is that a company cannot raise its prices and expect everything else to stay the same. Customers and competitors react to the changes. The company can set its price, but it cannot set its revenue. And the same is true for a government.

Congress can set a precise dollar debt limit on the U.S. Treasury. Congress can also appropriate a precise number of dollars that serves as an upper limit for total federal government spending. But Congress cannot levy a precise number of dollars in tax revenue.

What Congress does is to designate a tax base and to specify a schedule of tax rates associated with that base. The base might be personal income, corporate income, imported goods, capital gains, or a gallon of gasoline. Although the tax rate and the nature of the base can be specified in advance, the size of the base cannot be known with precision until after the taxable activities occur and incomes are earned.

Projections can be made, but these are based on assumptions about the future. If economic growth is lower than expected, then incomes will be lower than expected. Gasoline sales might also be lower than expected. That means that the projections will turn out to have overestimated the revenues received from income taxes and gasoline taxes.

Taxes always hurt economic growth. The question is whether an increase in the tax rate will bring in more revenue per dollar taxed than is lost due to the shrinking number of dollars in the tax base.

High U.S. corporate tax rates cause businesses to produce less here and to produce more in other countries where the conditions are more favorable. Increases in capital-gains tax rates tend to result in lower tax revenues.

Within the United States, people tend to move to lower-tax states. This might be to protect their personal incomes, or it might be to go where the jobs are.

Raising tax rates is not the same as raising tax revenues. Sometimes more means less.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, July 17, 2011

President lets truth slip out about Social Security

Published in The Tennessean, Sunday, July 17, 2011

by Richard J. Grant

Did President Barack Obama just admit that Social Security adds to the deficit? In an interview about the debt ceiling with CBS News last week, the president said, “I cannot guarantee that those checks go out on August 3rd if we haven't resolved this issue. Because there may simply not be the money in the coffers to do it.”

Clearly it was not the president's intention to admit that Social Security payments are inextricably entwined with the federal budget. His intention was to score political advantage by scaring a politically active voting bloc, composed largely of seniors, into pressuring Republicans to raise the debt limit unconditionally.

There never has been any chance that Social Security payments to current recipients would be missed or even reduced. Although Congress is not legally bound to continue such payments indefinitely, it has a strong political motivation to do so. Over the past 70 years, people have made retirement plans based on a promise, however vague, that they would receive certain payments. No congressman wants to be the first to stand in the way of those payments.

That is precisely why President Obama brought it up. There was no threat to Social Security, so he had to invent one. The hoped-for political payoff would be to panic seniors, a large portion of whom vote Republican, to put pressure on their congressmen to acquiesce in a debt-limit increase.

For many months, Republican House leaders have made it clear that they are willing to raise the debt limit provided that there would also be budget cuts of at least the same magnitude. They even passed a budget that included a deficit, but reduced projected spending. If anything, they have been too soft.

The president's words demonstrate the real political purpose of Social Security. No, it is not to make the elderly more financially secure – and it doesn't really do that. The real effect has been to make the elderly dependent, to some degree, on the political class.

Throughout their working lives, people are required to pay the FICA tax, which is really an income tax paid on the same base as the official income tax. For most people, the FICA payments are at least as large as the income-tax payments. These payments are then channeled into the same uses as any other tax.

Had the working people been allowed to put their FICA payments into personal investment accounts, they would almost certainly have entered their retirement years with much greater and more dependable financial security. A reader, who has the aptitude to make the financial calculations, has provided details showing that private investment of his FICA payments would have yielded him a monthly retirement income over three times larger than the Social Security payment he is now eligible to receive. He is not alone.

Had everyone been allowed to invest privately, then the economy would now be much larger and retirement incomes would be far more than three times current Social Security payments. If President Obama were serious about fulfilling the intent of Social Security, he would give future generations a private option. Instead he is squandering their inheritance with current government spending that is 60 percent higher than revenues.

President Obama has run out of our money, and now he is trying to scare us into giving him more.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, July 10, 2011

Ignored cost of stimulus negated any benefits

Published in The Tennessean, Sunday, July 10, 2011

by Richard J. Grant

One reason that big government is associated with weak economies is its inability to consider adequately the costs of its actions. This is why the various “stimulus” packages have failed to achieve their stated goals. They did succeed in bailing-out particular companies and classes of investors, but the American economy has been slow to adjust and is showing signs of continued weakness.

Big-spending governments can always point to big results. But these results look good only when some of the costs are ignored. When the federal government spent hundreds of billions of dollars specifically on “stimulus,” the burden on taxpayers and the private sector was greater than that. Taxpayers hand over the levied amount of dollars to the government, but they also bear the burden of tax-compliance costs and the adjustments to maximize after-tax profits.

That is just fiscal policy – the effects of government spending, taxing, and borrowing. But monetary policy is also a tool of first resort in stimulus efforts. Control of the money supply gives influence over the level of interest rates and asset prices.

The power to create base money gives the Federal Reserve the ability to increase liquidity and hold down interest rates. Since mid-2008 the Fed has tripled the quantity of base money, an increase of almost $2 trillion. Its stated intention is to reduce the cost of borrowing and to encourage the purchase of big-ticket items such as cars, houses, and appliances.

Policymakers also quietly hope that the resulting weakness in the dollar relative to other currencies will make American-made goods appear cheaper to foreign buyers while making foreign goods more expensive to Americans. The goal is to encourage exports while discouraging imports in order to create a greater demand for American-made goods.

The Fed buys bonds with newly created money. This bids up the prices of the bonds and reduces their interest rates. Seeking higher returns, many investors switch to the stock market, thereby bidding up stock prices. With bond and stock prices rising, the experience of increased wealth induces many investors to spend more.

Policymakers hope that all this will stimulate production and employment. But they seem to ignore the burden borne by those, especially seniors, who are dependent on income from low-risk interest payments. Fed policy has severely reduced their incomes below what they would have received in a normal post-recession recovery.

Such income reductions have real effects on the economy. Recently published estimates by William F. Ford, a professor of finance at Middle Tennessee State University and former president of the Federal Reserve Bank of Atlanta, and Polina Vlasenko, a research fellow at the American Institute for Economic Research, show reductions in consumption, gross domestic product, and employment that more than cancel out even the most generous claims on behalf of the fiscal stimulus.

By their most conservative estimate for 2010, Ford and Vlasenko found that the Fed's artificially low interest rates caused “$256 billion of lost consumption, a 1.75 percent loss of GDP, and about 2.4 million fewer jobs.” Had these jobs not been lost, the May unemployment rate would have been 7.5 percent instead of 9.1 percent.

When they include more assets in their calculations, the adverse impact of the low-interest-rate policies on employment can be almost double the conservative estimate. Perhaps this helps explain why neither fiscal nor monetary stimulus policies really work.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, July 03, 2011

We pay for Social Security at cost of liberty

Published in The Tennessean, Sunday, July 3, 2011

by Richard J. Grant

About a year before the Declaration of Independence, Benjamin Franklin wrote the oft-quoted sentence, “They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety.”

Mr. Franklin and his colleagues famously lived up to the admonition implied in his words. But he was not confident that future Americans would consistently do so. When he emerged from the Constitutional Convention a dozen years later and offered his storied description of the result, “A republic, if you can keep it,” he was worried less about physical dangers than democratic dangers.

It has become easy to believe that we can vote ourselves into financial security, but there is no substitute for work and saving. It is easy to believe that we can force people to save for their old age and to administer those savings through governmental programs even though we know that centrally planned economies are less prosperous and less secure than those that are free from governmental interference.

Several American generations have traded their liberty to save and invest for the hoped-for safety of the Social Security system. In so doing, they have made themselves dependent on the benevolence and financial competence of Congress and have imposed an economic burden on future generations. This burden consists of wealth that was never produced, economic progress that was never made, and a moral obligation that is increasingly less likely to be accepted.

For most of its history, the Social Security system has been seen as in need of reform. As the number of beneficiaries has grown relative to the number of taxpayers, the tax rate legally associated with Social Security has grown sixfold. But this is only part of the cost.

Although the rising FICA tax rate has enabled the Social Security program to show operating surpluses for most of its history, this does not mean that it creates net benefits. As the FICA tax rate has increased, and shifted resources from private to government control, it has increasingly distorted the labor market and reduced national saving. As a result, each succeeding generation has earned less from both its labor and investment income than it would have in the absence of the pay-as-you-go Social Security system.

Fifteen years ago, Harvard University professor Martin Feldstein estimated this “deadweight loss” to be the equivalent of an “annual loss of more than 4% of GDP as long as the current system lasts.” If Feldstein's estimate was a fair reflection of reality, then over the past 15 years GDP (gross domestic product) would have grown to a size 80 percent greater than it is now.

Those who claim that Social Security pays for itself clearly fail to take all this into account. They also fail to see how it adds to the federal budget deficit.

Every dollar paid out as Social Security benefits increases the unified budget expenditures by $1 and “uses up” $1 of combined tax revenue. Therefore, the trust fund has one dollar less to lend to the Treasury. That dollar must be borrowed from the public.

This has always been true, even when FICA tax revenues were greater than Social Security outlays. The “surplus” existed only in an accounting sense. The trust fund is an internal account that shows how much one segment of the government “owes” to another. Taxpayers pay it all.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011