Can Tax Cuts Grow the Economy Without Spending Cuts?

Frank Shostak recently wrote an article for the Mises Institute titled “Tax Cuts Without Spending Cuts Won’t Grow the Economy“.

I wholeheartedly endorse the spirit and main point of his article, but I do want to dig deeper into the main argument.

I recently wrote a post about the Trump/ Republican tax plan.  There are some positive aspects about it, along with some negative ones.  In some ways, it really is like rearranging the deck chairs on the sinking Titanic, except that some will make out better than others.

In my post, I wrote the following, “But this tax proposal does not really deal with our high tax burden. The reason is because it doesn’t address spending. Regardless of whether this thing passes, the federal government will still be spending about $4 trillion this year. This is money coming out of our pockets one way or another.”

This is basically the whole point of Shostak’s article.  Still, I might take exception to the title of his piece, along with one sentence within the article.  He writes, “Contrary to what the followers of supply-side economics claim, it is not possible to strengthen economic growth by lowering the tax rates whilst keeping the size of government outlays intact.”

He is basically correct in this, but we have to make a caveat.  This is only true to the point where tax cuts are not so confiscatory as to severely hamper economic activity.

While I do not endorse much of what supply siders say, I do think they are correct to a certain extent on the Laffer Curve.  It is not anything brilliant that Arthur Laffer came up with.  It simply says that there is some tax rate (or tax rates) in which tax collections to the government will be maximized.  This is easy to confirm when you take the rates to either extreme.

If tax rates are zero, then the government is not going to collect anything, unless it is voluntarily handed over.  If marginal tax rates are 100%, then almost nobody is going to work above the income threshold that puts them in this bracket.  They are not going to work for free.  Of course, in a country of 325 million people, you can almost always find a few exceptions.  There would be a few people who would work just to send all of their earnings over to the government.

The point is, tax rates at zero and 100% would yield the government virtually nothing.  Therefore, the maximum collections would be somewhere in between these two rates.  The Laffer Curve doesn’t claim to know the exact rate, although it doesn’t stop us from speculating.  The maximum tax collections might happen at 20% or 80% or whatever.

Therefore, if marginal tax rates are really confiscatory so as to severely hamper production, then a cut in rates could actually yield more tax collections for the government.  We must also figure that taxes could be cut so as to yield approximately the same tax collections.

For example, let’s say the government could maximize its revenue with a top marginal rate of 50% to collect $4 trillion.  Let’s say the current top rate is at 60% and the government is collecting $3.5 trillion.  Let’s also say that the rate could be lowered to 42%, which would yield the same collections as the 60% rate due to the increased economic activity.

Therefore, in this example, the government could cut the top rate from 60% to 42% and it would still yield the same revenue of $3.5 trillion.  In this scenario, it would be hard to argue that tax cuts would not be beneficial for economic growth, even if government spending remained the same (regardless of whether the government is running a deficit).

I don’t want to overemphasize the Laffer Curve as is done by the supply siders.  Of course, at least for any libertarian, the goal is not to maximize the government’s collection of taxes.  In addition, not knowing which side of the curve we are on, it is hard to justify tax cuts on the basis of increased government revenue, or even a revenue neutral tax cut.

The major problem here, which is rarely discussed by supply siders, is the existence of a central bank that can create money out of thin air.  This enables the government to run high deficits and accumulate huge amounts of debt that wouldn’t be possible otherwise.  If you cut taxes at the state or local level, you really can starve the beast.  In the case of the federal government, they can just issue more debt.

In addition, the whole idea of increasing government tax collections by decreasing tax rates is clouded by monetary inflation.  When tax cuts were pushed and implemented by the Reagan administration in the early 1980’s, there was ultimately an increase in tax collections.  (Despite what the left often claims, the larger deficits/ debt were not a result of tax cuts.  They were a result of increased spending.)

But the increase in tax collections was also partially a result of the monetary inflation.  The Fed had a tight policy in 1979 and the very early 1980’s, but the Fed started to loosen up again.  In order for government tax revenue to increase that much over a period of time, there almost has to be monetary inflation.

To summarize, I do think it is possible to strengthen economic growth by lowering tax rates in certain situations, even if government spending remains intact.  But that is not likely the scenario we are in now, with the possible exception of the corporate tax rates.  The corporate rates are very high, especially as compared to the rest of the planet, and lower corporate rates could bring more businesses to be headquartered in the United States.

Still, I agree with the general spirit of Shostak’s article.  We would see much greater economic growth if the government were to significantly cut spending.  Government spending diverts real resources away from their most efficient use as determined by consumer demand in the market.  Government spending is a misallocation of resources that makes us poorer.

While seemingly everyone is discussing tax cuts, we desperately need government spending cuts.  That is what would significantly improve the lives of middle class Americans.

Consumer Prices Jump, But Less Than Expected

The latest numbers for the Consumer Price Index (CPI) were released on October 13, 2017.  The CPI rose for September by 0.5% after going up by 0.4% in August.  However, the September rise was actually less than the forecast for a 0.6% increase.

The year-over-year CPI jumped up to 2.2%.  Meanwhile, the more stable median CPI is also at 2.2% from the previous 12 months.  The median CPI increased by 0.2% for September.

One of the main reasons that consumer prices were expected to jump was because of the higher gasoline prices in the wake of the hurricanes.

Still, it is not as if these higher numbers are irrelevant.  The soaring gas prices make sense during the hurricanes and shortly after, as supplies are diverted to the hard hit areas.  But they have not fallen back to the levels seen before the hurricanes hit.  Therefore, it is a legitimate expense for most people that has increased.

If you look at the CPI just for August (0.4%) and September (0.5%), it is nearly a jump of 1% over the course of two months.  This is significant when compared to the relatively low price inflation numbers over the last several years.

In our world of finance, the markets react based on the difference between reality and expectations.  We didn’t hear any dire warnings of inflation when the forecasts were made.  But when the actual CPI numbers come in 0.1% less than expected (0.5% versus 0.6%), then all of a sudden there are questions about whether the Fed should follow through with its plans for a rate hike and a slow draining of its balance sheet.

I don’t know about the rate hike that is expected in December.  It will have some impact on the financial markets just because of investor expectations.  But overall, this rate is not that meaningful right now.  It is a reflection of the rate paid by the Fed on bank reserves.  Banks get free money (more bailouts) for simply not lending depositors’ money.

The federal funds rate is not being driven by the Fed’s balance sheet at this point.  The Fed could engage in monetary inflation or monetary deflation and it wouldn’t much impact the target rate, unless the deflation were really significant.

The bigger deal at this point is the Fed’s balance sheet.  Assuming the Fed keeps reducing its balance sheet slowly as it has stated that it will, then the void will have to be filled by investors.  I haven’t heard of any plans to reduce the annual deficit, so someone has to buy the bonds to finance it.

Investors have already been funding the deficit for the last three years since the end of QE3.  Now they will have to finance the deficits, plus an additional $10 billion per month that the Fed is draining from the monetary base.

While I don’t think Trump is going to make it to 2020 without a recession, we might still have some legs left in the mini-boom.  It is not a boom for most middle class Americans, but it is a boom for stock investors and some real estate sectors.  The high CPI numbers for August and September tell me that we may still have a little bit of boom left to go.

I expect the CPI numbers to decelerate in the coming months.  If, however, they continue to come in high, then the good times (for some) will keep on rolling for a little while longer.

Cash is King, Even in a Permanent Portfolio

I have been a strong proponent of the permanent portfolio as described by Harry Browne.  While it is defensive in nature, it also typically provides growth above price inflation in the long term.  Of course, there are no guarantees of anything, but I consider the permanent portfolio as the best strategy for long-term passive investing.

There are probably better investments for those with an entrepreneurial spirit.  Your best investment is in yourself in almost any situation.  But from a monetary standpoint, someone with a profitable business that does not require an exorbitant amount of time to be spent by the owner is probably the best investment there is.

Real estate investors can also do quite well, at least for those who are savvy.  If you can own rental properties and have them managed by a dependable management company, then this is close to passive income.

Still, for anyone with a significant amount of wealth, I think having some assets in a permanent portfolio is a good idea.  It is a matter of diversification.  Even a long-time business owner or real estate investor can run into problems.  Even Bill Gates sells off some of his Microsoft holdings to diversify in other investments.

In the past, I have made suggestions for tweaks you can make to your own permanent portfolio.  The most common objection is owning government bonds, especially with interest rates so low.  It is still an important piece of the puzzle because bonds will do well in a depression/ deflationary type situation.  They will probably do well even in a more mild recession.  If you really hate bonds, I have suggested putting a slight percentage into paying down mortgage debt.

For risk takers, I have also suggested a more aggressive version of the permanent portfolio in which you reduce your cash portion.  For example, you could put 30% in stocks, 30% in gold, 30% in long-term government bonds, and 10% in cash.

This portfolio is more aggressive and would have bigger ups and downs.  It would do much worse in a recessionary environment, as cash tends to help in this situation.  But over a long period of time, there is a greater chance for greater returns.

This is just my own suggestion for someone looking to be more aggressive.  I haven’t seen this suggested by others.  I never heard any such suggestion from Harry Browne.  He would have said to keep a separate portfolio for speculations.

Of course, most people out there are either too conservative (too much cash) or they are too aggressive (too heavy in stocks).  It is more the latter.  One thing you can be sure of is that almost nobody owns any significant portion of gold investments.

Right now (October 2017), all asset prices seem to be on the high side.  The permanent portfolio has not done that great because interest rates have been low for quite a long time now.  The bond and cash portions have put off low returns in the low interest rate and relatively low price inflation environment.

Stocks make me nervous with them hitting all-time new highs, seemingly almost every day.  Gold does not make me quite as nervous, but it could still take a decent dive if we hit a bad recession.

Bonds are a good protection for a recession, but they carry their own risks.  With the Fed threatening to decrease its balance sheet (albeit slowly), who knows if private investors will pick up the slack?

Despite past suggestions of decreasing the cash portion for those who want to be aggressive, I don’t think now is the time to do it.  You want to have a good cash portion if we hit a recession, and I believe the risks of a recession are greater now than they have been in a while.  During down times, cash is king.  There is a caveat to this.  It is only king if we are not in an environment of high price inflation.

With that said, even in the 1970s, while cash was a loser, it wasn’t horrible either.  The interest rates went into the double digits, so you could put money in a money market fund and make a good nominal return.  It would lag behind inflation, meaning the real return would still be negative, but it wasn’t really bad.

It is always important to have cash (which includes cash equivalents like checking accounts, savings accounts, and money market funds).  It is not just for emergencies though.  It can be used to buy assets when they are cheap.  Assets become cheap in a recession.  This is why cash is king.  In a recession that is not accompanied by high price inflation, cash is in high demand.

Until the Federal Reserve starts another round of massive monetary inflation, I don’t expect price inflation to take off.  You may lose a little bit with your cash holdings, but it will be minimal.  At this stage, it is better to have liquid funds to buy cheap assets in a recession.

In terms of major asset classes, stocks have been king for the last several years.  But kings get overthrown all the time.  Cash will rule once again, at least for a period of time.

Who Loses With the Trump/ Republican Tax Plan?

With Trump and the Republican’s failure to repeal Obamacare, they have moved on to tax reform.  I could say tax cuts, but that might be misleading, as there are also tax hikes in the plan too.

For a libertarian, there are things to cheer, and there are things to denounce.  We should cheer virtually any reduction in taxes, especially when it comes to tax rates.  I do not count tax credits in which some people actually receive money for the year, as this is another form of welfare.

We should denounce tax hikes, but this should also generally apply to the removal of tax deductions and most tax credits.  While the complicated tax code is far from ideal, it is better to have most deductions than to not have them, as it ultimately results in some people paying less in taxes by having these deductions available.

If we could have a law that would just raise taxes on bureaucrats and politicians, then maybe I could make an exception, but even here I would just assume that the law would be written so as to result in the exact opposite of its stated intention.

Here are a few things to cheer about the Trump/ Republican tax proposal:

  • Reduces corporate tax rates
  • Reduces corporate taxes through a change in how companies can claim depreciation
  • Reduces the tax on S corporations, partnerships, and sole proprietorships
  • Eliminates the federal estate tax
  • Eliminates the alternative minimum tax
  • Possible repeal of the 3.8% investment tax through Obamacare
  • Possible opportunity for companies to repatriate money from overseas and pay a one-time tax

Unfortunately, we don’t know all of the details yet.  It is possible a few of these things could end up being negative too.  We all know that once the legislators, lobbyists, and administrators get going, there is some crazy language in these bills.

For example, while S corporations, partnerships, and sole proprietors may end paying a lower tax instead of the top marginal tax rate of 39.6%, the proposal also says that measures will be taken to prevent the reclassifying of personal income to business income so that wealthy individuals do not avoid paying the high marginal tax rate.  You can see where this thing could get messy quickly.

For the overall tax rates, we also can’t really say whether this will be positive or negative.  Unfortunately, while we have been told that the reform will contain three rates of 12%, 25%, and 35%, we have no idea what the income thresholds are.

It is rather foolish, if not devious, of Trump to lay out this proposal without identifying the income thresholds for the different tax brackets.  There isn’t much point on telling us the different rates if we don’t know how they apply.  If the top rate of 35% kicks in after you make just $50,000, then this would be a horrible plan.  It would be a massive tax hike.  On the other hand, if the 25% rate didn’t kick in until an individual makes over $100,000, then this would be great, as most middle income people would be looking at a big reduction in overall taxes.

One of the big negatives about this plan that we do know about is the reduction in deductions.  While the mortgage interest deduction would still be there, more people would not be claiming it because the standard deduction would go up significantly.  And while we should seemingly cheer for the increase in the standard deduction, we don’t know if this will be much of a benefit because we have no idea about the income thresholds for the various rates (see paragraph above).

We do know that deductions for state taxes are likely to go away if this plan becomes reality.  This has a lot of people upset, especially those in “blue” states.  It seems that Trump is trying to get his revenge on those who live in states that did not hand him electoral votes in November.  While it is not a perfect correlation, the blue states tend to be states that have higher living costs, higher incomes, and also higher taxes.  By eliminating deductions for state taxes on the federal income tax return, it will disproportionately hurt those in the blue states.

Of course, for conservatives, and even libertarians, it is tempting to cheer this on, especially for those living in red states.  After all, if the blue state people don’t like it, then they should lower their taxes.  They are the ones who cheer for higher taxes, especially on the wealthy, so that is what they are getting.

Both sides can make the argument that the other side is being subsidized. On the one hand, the high tax states are being subsidized because they get to claim more deductions on their federal tax returns, which could come at the expense of lower tax states.

On the other hand, low tax states are being subsidized because they tend to also be states with overall lower incomes.  Therefore, the people in these states are paying lower taxes than those with higher incomes.

With all of that said, there are still many people living in New York, California, and other high tax states who did not vote for Hillary Clinton.  They already have my sympathy because they live in these high tax states, and now they may be paying even more if this tax proposal passes as it is.  Of course, if it really bothers them, they could always move to a different state.

Overall, there is no question that this tax plan would tend to help those in lower income and lower tax states, while doing the opposite for higher income and higher tax states.

The cut in corporate taxes would be very positive for almost everyone.  It has been needed for a long time.  While people don’t see it directly benefitting them, it will help them in the long run.  It will mean more competition, more products coming to market, and ultimately higher wages and cheaper prices, all else being equal.

If I could pick one tax to cut or eliminate, I think it would be the employer portion of the payroll tax.  This is rarely discussed because people want to live under the illusion that Medicare and Social Security are like insurance programs in which you pay premiums.

The employer portion of the payroll tax is highly burdensome on independent contractors and small business owners.  In addition, by eliminating this tax, it would help increase wages, as the cost of hiring for employers would drop.  Unfortunately, I think we are a long way off from this tax even being reduced.

There is one more key thing to discuss in all of this.  It is something that even most conservatives ignore.  This tax plan, whether or not it is supposedly “revenue neutral” (I really don’t like that term), is not addressing the fundamental financial problem that we have.

Our problem is that we are highly regulated and highly taxed.  We also deal with a central bank that distorts the price of money.

But this tax proposal does not really deal with our high tax burden.  The reason is because it doesn’t address spending.  Regardless of whether this thing passes, the federal government will still be spending about $4 trillion this year.  This is money coming out of our pockets one way or another.

I know the whole theory about the Laffer Curve and how tax reductions can lead to higher tax collections.  If taxes are burdensome enough, this can certainly be true.

But again, the government is still spending $4 trillion per year.  These are resources being consumed and allocated that are not in accordance with consumer demand.  Government spending is typically a misallocation of resources.  Almost all spending that is not being used strictly to enforce contracts or protect property rights is spending that is misallocating resources.  Therefore, most government spending makes us poorer.

If we really want to increase our living standards, we should be calling for massive cuts in spending by Congress.  Unfortunately, there aren’t many calls for this.  Instead, we get more tinkering with the tax code.

Even though some people lose more than others with this tax plan, most Americans lose because the federal government keeps spending $4 trillion per year.

Would Mark Cuban Make a Good President?

It’s possible that there may be a second billionaire running for the U.S. presidency in 2020.  Mark Cuban, owner of the Dallas Mavericks and a shark on Shark Tank, said in an interview that he is considering a run.

Cuban said he is an independent all the way through, but this seems to contradict his support for Hillary Clinton in the 2016 election.

Cuban has a strong Type A personality that is very similar to Donald Trump.  I think that may be part of the reason that Cuban has been so anti Trump.  There is not enough room for both of their egos in the same room.

There aren’t that many billionaires in the world, yet we face the possibility that we could have two running in the 2020 election.  If Cuban runs as a third-party candidate or as an independent, then maybe we could have three billionaires if Oprah decides to throw her hat in the ring as a Democrat.  It would certainly be a race of outsiders.  Trump would be the only one who could not be considered an outsider at that point.

I see nothing wrong with a billionaire running for president.  It isn’t the money that got Trump elected, as his campaign spent far less than others.  The only significant role that money played was that it got him the prestige and notoriety in the first place.

Some people think it is better for a rich person to be a politician because they aren’t as likely to sell out.  If the person is already rich, then they are not in it for the money.  They are less likely to be bought.

Unfortunately, this theory went out the door in the first six months of the Trump presidency.  They don’t need to buy him.  They (the establishment) just has to pressure him.

That is Trump, but what about Mark Cuban?  Would Cuban make a good president from a libertarian perspective?

Cuban would be 62 years old for the 2020 election.  He looks young for his age.  There is little question that he would hold his own against other candidates.  While Kevin O’Leary (Mr. Wonderful) is probably known as the toughest shark on Shark Tank, I think he is just more sarcastic and funny.  Cuban can actually be the toughest one.  Sometimes he can be downright mean.

I heard suggestions years ago that Cuban is a libertarian or has libertarian leanings.  On a few things, this might be true.  But he is certainly not any kind of principled libertarian.

The man supported Hillary Clinton in 2016.  That is enough said.  He clearly has very poor judgement.  He doesn’t have bad judgement when it comes to business decisions, but he is obviously not a very good judge of character.  He is obviously not very bright when it comes to political issues, unless he is just evil, which I don’t think is the case.

The SEC tried to nail Cuban several years ago for insider trading.  He could have landed in federal prison.  He fought them hard and won.  It was probably his best moment.  And he was proud of beating the charges.  But does he not realize that Hillary Clinton and the establishment that he supports is the very system that almost locked him away for many years?

I hope that all libertarians realize now that things are probably not going to change based on who is sitting in the Oval Office.  Unless the person is a radical libertarian with a long history of sticking to principles, then it won’t matter.  But if the country were to elect someone like Ron Paul, then things would be changing anyway, as it would demonstrate a radical shift in public opinion.

Cuban would not be much different from Trump.  You can’t go into the presidency and make radical changes unless you are prepared for an all-out battle with the establishment.  Trump still faces a huge battle against the establishment even as he has fallen in line.

Unless Cuban is going to withdraw all troops from foreign lands and dismantle all of the so-called intelligence agencies, then nothing significant will change, or at least it won’t change because of who is in office.  Things could change because of a massive depression or other events, but that could happen with anyone in office.

If the spy agencies and the foreign policy don’t significantly change, then nothing significant will change.  Cuban could tinker around the edges with tax rates, just as Trump is trying to do.  He could repeal a few executive orders or make some new ones.  But overall, not much would be different.  He would be corrupted by the establishment very quickly, just as Trump has been.  He would be another billionaire sellout.

Barring a major recession or depression, the federal budget is going to stay above $4 trillion per year.  This is why our living standards have not been advancing at a pace of previous generations.

If we see Trump and Cuban go head to head in 2020, it would make for some good entertainment.  But that is all it would be.  A Cuban presidency would not result in any more change than a Trump presidency.

There are really only two ways we are going to move towards liberty.  One is through changing public opinion.  The other is by having a severe economic downturn, coupled with the broken promises of so-called entitlements.  This will force Congress to reduce spending.  Until this happens, the presidential race and other political races are mostly for entertainment purposes.