Opinion

The Great Debate

2013: The year of tax reform

By Grover G. Norquist and Patrick Gleason
November 1, 2012

Policy and political circles are now both talking about the prospect of comprehensive federal tax reform next year. From Capitol Hill to Wall Street to Main Street, people are asking how this reform will be structured. They should look to states across the country for their model. Many are due to embark on sweeping overhauls, even complete rewrites, of their tax codes in 2013.

Lawmakers in numerous state capitals are now poised to introduce major tax reform when they come back into session early next year. As we’ve seen with other policy matters, reforms that percolate in the states often make their way to Washington. More than half of all state governments are controlled by one political party, so it’s likely that state lawmakers will move far more quickly than the folks on Capitol Hill. What these state legislators do will provide a preview of and parallel the debate in the new Congress.

Consider North Carolina. Republicans took control of the General Assembly in 2010 for the first time since Reconstruction, and next month the Tar Heel State is likely to become the 26th state where Republicans control the governor’s mansion and both chambers of the state legislature. The Republican gubernatorial nominee, former Charlotte Mayor Pat McCrory, has said that tax reform will be a top priority if he is elected, which appears likely given his double-digit lead in the latest polls. The state now has one of the nation’s least competitive tax regimes. But based on proposals being discussed at the capitol, North Carolina lawmakers next year could enact one of the boldest and most pro-growth state tax reforms in history.

Reducing and possibly eliminating the state personal and corporate income tax, both now the highest in the Southeast, is also a top priority for many in the legislature. In North Carolina’s final gubernatorial debate last week, McCrory reiterated his intention to provide personal and corporate income tax relief. Legislative leadership and McCrory have made clear that any tax reform would be revenue neutral.

This is the same commitment that Republican presidential nominee Mitt Romney has made at the federal level. It’s an important marker to lay down, since it tells spending interests that tax reform will not be used as a Trojan Horse for raising taxes.

North Carolina is not alone in pursuing pro-growth tax reform next year. Louisiana Governor Bobby Jindal is also planning for it. And, as a governor, when Jindal sets out to do something, he gets it done. This year, for example, school choice and pension reform were his top priorities. By the end of session, he had signed bills that improved the solvency of the state pension system and created the nation’s second-largest school voucher program.

Jindal has already announced that his top priority for the 2013 legislative session will be tax reform.

Though details of the plan are still coming together, in recent public statements Jindal has sketched an outline for reform that would lower rates and broaden the base by eliminating some preferential tax treatment. The direction that Jindal would like to take the tax code could, like the reforms being discussed in North Carolina, make for a more efficient tax code and also improve Louisiana’s economic competitiveness.

As Jindal’s Departments of Revenue and Economic Development explained in a joint report last month, “A broad base with low rates and few exemptions makes it easier for taxpayers to understand and comply with the tax system and for the state and local governments to administer it.”

While personal income tax relief puts more money in the pockets of individuals and families, it also increases the job-creating capacity of small businesses, many of which, as sole proprietors or partnerships, file under the personal income tax system.

At the same time, it is wise for states to reduce and move to eliminate their corporate income tax, one of the most economically damaging levies, and one that doesn’t even generate that much revenue for states.

On average, states get a paltry 3 percent of general fund revenue from corporate income taxes. Most states could easily offset the elimination of their corporate tax through broadening of the sales tax base or modest spending restraint. Both would make a state more attractive to potential employers and investors.

It’s not just Louisiana and North Carolina. Lawmakers in a host of other states, including Oklahoma and Mississippi, are also developing plans for major tax reform in 2013.

It could help their economies. As Harvard economist Dale Jorgenson recently explained to Congress, rate-lowering federal tax reform would provide an economic boost, increasing long-term U.S. output by $7 trillion, he approximates. Similarly, state lawmakers can stoke economic growth where they live by crafting revamped tax codes that make their states more competitive regionally, nationally and globally.

While a number of states are due to compete next year to see which can implement the most pro-growth tax reform, Democratic-dominated states — including Illinois, California and Connecticut — are moving in the opposite direction. They are raising rates and shrinking the tax base, with disastrous results for their state coffers and economies.

It might appear as though Governors Jerry Brown of California and Pat Quinn of Illinois are driving their state economies off a cliff. But remember that no governors or states are total failures — some just serve as bad examples.

The tax reform battle on Capitol Hill next year will get most of the media attention. But keep an eye on the states: Major tax showdowns are set to take place in numerous state house Gucci gulches in 2013.

 

PHOTO: Louisiana Governor Bobby Jindal, speaking during the Republican Leadership Conference in New Orleans,  is planning a major state income tax overhaul next year.  Sean Gardner / Reuters

 

Comments
15 comments so far | RSS Comments RSS

As long as taxes are compulsory, it’s still legalized theft. Want real tax reform? Make it voluntary. Then see if other countries are willing to lend to us or if our legislators are forced to operate within a budget. If, they are financially supported at all. People seem to think that we would crumble without a Federal tax system. History tells us otherwise.

Posted by LysanderTucker | Report as abusive
 

Why is Reuters giving editorial space to Grover Norquist? Article 1 Section 8 of the U. S. Constitution states “The Congress shall have Power To lay and collect Taxes.” Implicit in this authority is the duty to do so when necessary, to ” common Defence and general Welfare of the United States.” However, in order to be a Republican in good standing, you must forsake your Constitutional duty and pledge allegiance to Norquist instead. Dereliction of duty under the Constitution is arguably treason. Every politician who signs on with Norquist should be removed from office.

Posted by Fishrl | Report as abusive
 

Mr. Norquist,

Your “tax reform” is nothing more than a euphemism for eliminating ALL taxes from the wealthy and shifting it to the middle class, which would inevitably result in the total economic collapse of the US economy as we know it today.

I was going to state virtually the same position as Fishrl’s comment above, but he stated the issue quite well. Except I would have gone further to state openly what he did not.

Your activities as a private citizen constitute a massive covert, and increasingly overt, attempt to overthrow the US government by enticing US government officials to openly sign allegiance directly to you in violation of their oaths of office to serve the American people.

As such you, and anyone who has supported you, should be charged with treason.

ALL of your activities constitute an ongoing pattern of sedition against this nation.

For example, your classic statement that you would “shrink it down to the size where it could be drowned in a bathtub” is not a figure of speech, but a direct threat to do exactly that.

Such statements and your seditious acts, especially by someone who has the means to carry out those actions, constitute a direct threat to the stability of the US government.

Let there be no mistake about what I mean. I am not using these words lightly, nor should your actions be treated as such. Let us be clear as to my intent by charging you with treason and sedition against the US and the American people by giving the dictionary definitions of treason and sedition:

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“Treason, sedition mean disloyalty or treachery to one’s country or its government.

TREASON:

1. the offense of acting to overthrow one’s government or to harm or kill its sovereign.
2. a violation of allegiance to one’s sovereign or to one’s state.
3. the betrayal of a trust or confidence; breach of faith; treachery.
4. any attempt to overthrow the government or impair the well-being of a state to which one owes allegiance.

SEDITION:

1. incitement of discontent or rebellion against a government.
2. any action, especially in speech or writing, promoting such discontent or rebellion.
3. speech or behaviour directed against the peace of a state
4. an offence that tends to undermine the authority of a state
5. an incitement to public disorder
6. any act, writing, speech, etc., directed unlawfully against state authority, the government, or constitution, or calculated to bring it into contempt or to incite others to hostility, ill will or disaffection”

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ALL of your actions have been taken to undermine and overthrow the legally-elected government of the United States.

You are guilty of both treason and sedition and the government should move to charge you as such, otherwise it is open dereliction of its duty to preserve and protect this nation from its enemies, both foreign and domestic.

Freedom of speech does not give one to right to shout “fire” in a crowded theater. You have been abusing the right of free speech that many others died to give you.

It is sad to realize that this government is so corrupted that it cannot realize, nor react appropriately, against sedition and treason.

Unless the federal government is willing to apply its laws uniformly without regard to a person’s wealth, we will ALL suffer for it.

Posted by Gordon2352 | Report as abusive
 

Nice to hear from the “American Operator” of all our tea party Congressmen… a fitting nod to “The Manchurian Candidate”.

On a patriotic gut level I agree with all that Fishrl and Gordon said above. Enough then about the gravity of this un-elected influence now allied with a few like-minded gazillionair donors…

There are important questions to decide if Mr. Norquist offers America a path to the 21st, or the 19th century:

1) Job Creationism needs a Monkey Trial.

Federal income tax rates now are roughly half what they were 50 years ago, top brackets having dropped from 70% to 36%, and capital gains that apply more to rich superpac donors dropped from 25% to 15%. Most of that change occured over the last 30 years since Reagan was elected. Since the Job Creators had almost twice as much otherwise taxed money for decades now, where are all the jobs they created? I see deficits – where are the jobs?

2) is anti-tax really pro-growth?

Lower taxes force choices. Less emergency response, including disaster relief; less road and bridge construction and maintenance; less grade school education and more expensive college or trade school; fewer libraries; and on.

If low tax = pro-growth, then why are lowest-tax states like Nevada lagging behind, instead of leading the recovery? is it because a lot of modern employers need a trained workforce (a public education investment) and competitive workers want more amenities where they raise their families?

An editorial cartoon that ran here for a school referendum showed an older man challenging a schoolboy: “Why should I pay for your school? You’re not my son!” to the reply “No, but I might become your doctor.” This shows the selfish and short term aspect of Norquist’s ideology. To save a buck now (and save much bigger bucks for the mythical “job creators”), we set ourselves up to pay more later. We’ll pay with less competitive workforce in a global economy, less public-funded research lifitng up U.S. industry, a bigger bill for infrastructure later as repairs rob from new facilities. In management terms, Mr. Norquist ignores the “life-cycle cost” and only looks at the sticker price.

Mr. Norquist and his handful of Trump/Koch/Adelson, etc., backers are a modern incarnation of H. L. Hunt, the oil tycoon who railed at Eisenhower to dismantle the New Deal. Ike said there are people on the outer fringe who don’t understand that some roles are appropriate for government, and Ike expanded social security while he continued the personal and corporate taxes used to pay for the Korean War for some time after the cease-fire, to balance the budget. Ike dismissed single-issue people like Mr. Norquist.

I agree with David Brooks’ editorial hoping for more moderation and less ideology; more compromise to find practical solutions; instead of stonewalling that sees failure as superior to bipartisanship. Mr. Norquist is the poster boy for the ideology-based stalemate in Congress created by ‘his’ tea party house members. It’s time to vote them out and stop paying attention to this guy before we blow the recovery that’s underway and erode our global leadership.

Mr. Norquist has turned the GOP from my father’s party of America-building, anti-deficit Eisenhower Republicans into a narrow-minded anti-tax and anti-government force that is hurting America and costing us money now (loss of AAA) and costing us in the long term too. The sooner we catch on and look at long term growth for the 21st century, and ignore his selfish, fast-buck message, the better.

Posted by Decatur | Report as abusive
 

Grover Norquist is not an elected official and does not write legislation. Unfortunately what the voters do not realize and do not see is the behind the scenes of lobbyists pounding on regulators and elected officials to deregulate and bend things in their favor that suits the agenda of the lobbyist employer, and not for the good of the citizens of the United States.

Posted by mmcg | Report as abusive
 

And it’s kind of creepy that Reuters would even give space to a non representative of the citizens of the United States

Posted by mmcg | Report as abusive
 

I posted two comments to anther Reuters article today, but I think they are worth repeating in this one also.

The other article is:

Inequality is more relevant than ever this election

http://blogs.reuters.com/great-debate/20 12/11/02/inequality-is-more-relevant-tha n-ever-this-election/#comment-65524

——————————-

I agree with your statement that “rather than talking about the underlying causes of increased inequality, the presidential candidates have focused on dealing with its consequences, particularly over taxes and welfare.”

However, I am disappointed that you, as an economist, do not seem to understand those causes either.

It is no accident that this dramatic shift in income inequality began in the late 1970s.

The REAL underlying reason, which no one seems to understand, is that the primary cause was the beginning of “free trade” with China that is responsible for this massive surge in the wealth of the 1%.

Since then ALL the trade, tax and banking legislation has been shifted towards capital investment in China (and other Asian nations) without ANY restrictions whatsoever.

As an economist you should know the US is NOT practicing Adam Smith’s version of free trade in which both nations benefit, but a twisted neocon version that is EXACTLY what Adam Smith warned us against in his Wealth of Nations.

————————

From Wikipedia solely for the convenience of those who, like you, don’t understand what I am referring to by that comment.

“Smith’s belief (was) that when an individual pursues his self-interest, he indirectly promotes the good of society.

Self-interested competition in the free market, he argued, would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services.

Nevertheless, he was wary of businessmen and warned of their “conspiracy against the public or in some other contrivance to raise prices.”[80]

Again and again, Smith warned of the collusive nature of business interests, which may form cabals or monopolies, fixing the highest price “which can be squeezed out of the buyers”.[81]

Smith also warned that a true laissez-faire economy would quickly become a conspiracy of businesses and industry against consumers, with the former scheming to influence politics and legislation.

Smith states that the interest of manufacturers and merchants “…in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public…

The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.”[82]

————————–

As an economist you should also know that China is not and never has been practicing free trade but MERCANTILISM.

The ugly truth, which you are perpetuating, is that the US has been at war with China for over 30 years — an economic and trade war that has devastated this economy, just so the wealthy class can profit at the expense of the 99%.

This is NOT “rocket science”, nor is it difficult to explain to the American people IF one chooses to do so. But the wealthy class cannot afford to have the American people understand what they have done.

And thanks to the insane “economics” of the Bernanke Fed, is STILL doing.

My ONLY conclusion after reading this article is that you are either a fool or a liar.

Posted by Gordon2352

———————-

I meant to explain my comment about mercantilism, as well as a connection between it and capitalism (i.e. free trade) today that no one “seems” to understand, which is very convenient for the wealthy class who profit from a neocon — neocon by 1987 being used as an abbreviation for the neo-conservative movement in the U.S. political sense — version of the worst of both economic theories.

(1) I explained capitalism above and mentioned it is a twisted version of the real free trade proposed by Adam Smith in his monumental economic treatise the “Wealth of Nations” (1776) in which he laid out a plan by which not only nations and the ruling class could become wealthy, but that free trade (if properly controlled) could also “spread the wealth” to ALL classes.

This was not by charity or taxes. “Smith’s belief (was) that when an individual pursues his self-interest, he indirectly promotes the good of society.”

HOWEVER, and this is the “catch”, when free trade is NOT controlled, it soon devolves into the nightmare economic conditions for the poor as the wealthy begin to collaborate to create “a conspiracy of businesses and industry against consumers, with the former scheming to influence politics and legislation”.

Unfortunately, the neocon (i.e. neoconservative movement in the US) has become EXACTLY what Adam Smith warned us about in 1776.

Human nature does not change and excess power must be guarded against or we will lose everything we have to the wealthy class.

(2) The best example of the type of conditions that results from an economic system that completely fails to care for its poor, that treats them as less than animals, is that of England in the period of the 1700-1800s — for example, think of an unrepentant “Ebenezzer Scrooge”, an image that lives on long past it accurately described the bankers of the era — which was a country of debtors prisons, workhouses and forced exportation of its “excess” population to overseas colonies like Australia.

THAT is mercantilism!

It is a political, economic and philosophical theory that is based on “survival of the fittest” (i.e. Social Darwinism).

In economics, mercantilism is the doctrine that government control of foreign trade is of paramount importance for ensuring the military security of the state.

In particular, it demands a positive balance of trade.

Mercantilism dominated Western European economic policy and discourse from the 16th to late-18th centuries.[1]

Mercantilism was a cause of frequent European wars in that time and motivated colonial expansion.

Favours for powerful interests were often defended with mercantilist reasoning.

British mercantilism — the best example of mercantilist philosophy — meant that the government and the merchants became partners with the goal of increasing political power and private wealth, to the exclusion of other empires.

The government protected its merchants—and kept others out—by trade barriers, regulations, and subsidies to domestic industries in order to maximize exports from and minimize imports to the realm.

The goal of mercantilism was to run trade surpluses, so that gold and silver would pour into London.”

Now, of course, fiat money has replaced gold and silver, thus creating even more power by simply printing money whenever the wealthy class destroys the economy — which it has quite often if you care to look up the history of financial panics and crashes in the US alone — just like Bernanke is doing for them now.

I want to make a final point below, so I would ask you look up the Opium Wars:

http://en.wikipedia.org/wiki/Opium_Wars

THIS is the greatest example of mercantilism in action by the European nations in vying for each other for power.

Basically, because Britain refused to pay China in silver for the trade goods they bought, the British tried to destabilize the Chinese government by getting the Chinese people hooked on opium.

They succeeded after many years of war with China, and that is why China is “communist”.

(3) What is worse even worse than either than neocon capitalism or mercantilism?

Why, a combination of the two of course!

THAT is what we have in the US right now.

THAT is why the US since WWII has pursued an aggressive military policy (i.e. the “Military/Industrial Complex” President Eisenhower warned us about in his final speech), just as the British Empire did when they ruled the world.

THAT is why all the US jobs have been outsourced to overseas locations — the “new” US colonies.

THAT is why the US economy has spiraled out of control and crashed in 2007-08. The housing bubble was due ENTIRELY to excessive speculation driven SOLELY by Alan Greenspan and his ilk (including Bernanke, who was his assistant) in order to keep the US economy expanding beyond what it could sustain so the wealthy could continue to profit at the expense of the American people.

THAT is why our “entitlement” programs are broke. The government “borrowed” the money and never bothered to repay it. So, yes, you baby boomers out there, you have NO money for retirement. The country is BROKE.

THAT is why the US is reduced to printing money to survive. Bernanke is committed to the same insane QE policies — to protect the wealthy class, all at our expense when clearly they don’t work — except for the wealthy class, of course, which is why the stock markets are now at or near the same identical level they were just before their greed caused them to crash in 2007-08.

THAT is why the US economy will NEVER recover.

ETC., ETC. ETC. …

(4) Around 1980, when their communist government experiment had run its course China figured out how to get revenge on the European nations who had devastated their country and tried to totally destroy their culture.

They began a new policy of “free trade” with the US, except it has never been free trade at all, just a “revived” version of mercantilism.

In their greed, our wealthy class fell for it “hook line and sinker”, and now we are nearly bankrupt because of it.

It is ironic, if you think about it, that the Chinese used the same lessons of European greed that nearly destroyed them to destroy us.

And that, folks, is the REAL truth!

Posted by Gordon2352

Posted by Gordon2352 | Report as abusive
 

“Republicans need to be making deals with the American people right now, not signing little pledges for Grover Norquist.”

-Joe Biden, 2012 Vice Presidential Debates

Posted by AlkalineState | Report as abusive
 

LysanderTucker writes: “People seem to think that we would crumble without a Federal tax system. History tells us otherwise.”

Yes, those parts of history where we had a 60% tariff on imported goods. Not the 1.3% we have now. The Constitution provides for two ways the U.S. Government can raise money. Domestic taxes, or tariffs on foreign goods. For most of our history, we were a tariff nation. That’s why we had so many factories here. And the tariffs generated direct revenue for our government. But slowly, the multi-national business lobbies like the oddly named “U.S. chamber of commerce” have been doing their best to drop our tariffs so that they can dump their Chinese and Guatemealan goods here, turning us into a nation of walmart customers instead of producers.

So…..Raise the tariffs? Yes.

Posted by AlkalineState | Report as abusive
 

Please stop telling us you’re for tax “reform”, Grover; we all know you’re really just for lower taxes, especially on the wealthiest whether or not they really create jobs.

Posted by borisjimbo | Report as abusive
 

Ah.. Jindal and these Harvard economists.. “rate-lowering federal tax reform would provide an economic boost, increasing long-term U.S. output by $7 trillion”.

We tried all that and more – all it did was reduced the receipts by $6T+. No brainer.

These folks still seem to live in the times of Thacher/Reagan/Bush and these ideas are quite outdated in current times.

Posted by Mott | Report as abusive
 

For those of you out there who think the US economy is in recovery and the best Rx is to begin cutting our deficit spending without raising taxes, you may be interested in this article from the Prudent Bear.

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Mr. Global Economy – The Economic & Psychological Prognosis

by Satyajit Das
October 11, 2012

As requested, I have undertaken an extensive examination of Mr. Global Economy, both physical and psychological.

Patient History

The patient’s history includes a seizure in 2007/2008 – financial losses, banking problems, a major recession, etc. Liberal injections of taxpayer cash avoided catastrophic multiple organ failure assisting a modest recovery.

Governments ran large budget deficits in the period after the crisis. Interest rates around the world were reduced to historic lows, zero in many developed countries.

With interest rates constrained at zero, central banks have adopted “innovative” treatments, referred to as quantitative easing; the fashionable appellation of a more old-fashioned procedure – printing money. Balance sheets of major central banks have increased from around $6 trillion to $18 trillion, an unprecedented 30% of global gross domestic product (GDP).

As evident from the anticipation of and reaction to decisions by the U.S. and European central bank to provide further support, the global economy is now addicted to monetary heroin. Increasing doses are necessary for the patient to function at all.

Lifestyle Changes

Mr. Economy has also not made the recommended changes necessary for a return to full health. He seems to have taken rock star Steven Tyler’s advice: “Fake it until you make it.”

Borrowing levels remain unsustainable. Debt levels for 11 major nations have increased from 381% of GDP in 2007 to 417% of GDP in 2012. Debt has increased in Canada, Germany, Greece, France, Ireland, Italy, Japan, Spain, Portugal, the UK and the U.S.

There has been a shift of debt from private borrowers to governments. There has also been a change in the identity of the lender – governments and central banks have heroically stepped in to take over debt from commercial lenders and investors.

Global imbalances – major current account surpluses and deficits – remain. Large exporters like China, Japan and Germany remain resistant to abandoning their export-based economic model.

Little progress has been made in bringing the banking system under control. Regulatory initiatives involve activity if little achievement. New regulations of stupefying complexity run to thousands of pages.

The process provides continuing employment to thousands of needy policy advisors, regulators, lawyers and lobbyists, who would otherwise struggle to gain productive employment. Without their heroic efforts and stoic acceptance of privations (first class travel, 5-star hotels, constant conferences and symposiums etc), the recovery would be even more tepid.

Major Organs – U.S.

Physical examination revealed that the U.S. is in marginally better condition than other organs – the “cleanest dirty shirt” is the expression. Despite a $1 trillion annual budget deficit (6% of GDP) and zero interest rates, growth is a tepid 2%.

The housing market’s rate of descent has been arrested but prices remain 30-60% below highs. New housing starts have stabilized, at around 50% below peak levels. Benefiting from a weaker dollar, manufacturing has improved. Lower oil and natural gas prices have benefited the economy.

Employment remains weak. If discouraged workers who have left the workforce and part-time workers seeking full-time employment are included, then unemployment is over 15%, well above the headline 8% rate. The total number of Americans now employed is around 140 million, well below the peak level above 146 million.

Consumer spending remains patchy. Job insecurity, lack of earnings and wealth losses are causing households to reducing spending and repay debt.

Record corporate profits have been achieved mainly through cost reductions and minimal revenue growth. Investment is weak due to the lack of demand.

Bank lending is sluggish due to lower demand for credit and problems of financial institutions.

Federal public finances remain unsustainable. Hardening of the political arteries means that there is little resolve to deal with deep-seated problems. There is risk of a “fiscal cliff” episode.

If there is no political resolution, then automatic tax increases (non-renewal of tax cuts) and spending cuts equivalent to about 5% of GDP, mandated under the 2011 increase in the national debt ceiling, will automatically occur. This would mean a contraction equivalent to more than $600 billion in the first year and $6.1 trillion over 10 years. This would improve the budget deficits and slow the growth in debt, but adversely affect growth.

State and municipal finances are also under stress, with an increasing number of borrowers filing for bankruptcy.

Other Developed Organs

Many European countries have high debt levels, budget and trade deficits, social spending inconsistent with tax revenues, poor industrial competitiveness (with some exceptions), a rigid monetary system and inflexible currency arrangements. This is compounded by weaknesses of the European banking system with large exposure to sovereign bonds issued by peripheral nations.

Intellectually and institutionally, Europe is unable to deal with its debt crisis. Europeans believe stabilization and recovery can be achieved through greater integration. Even if issues of national sovereignty can be overcome, integration will not work. Unsustainable levels of debt do not magically become sustainable by changing the lender or guarantor. The monetary arithmetic of European debt problems is that the EU and Germany, its main banker, does not have enough funds to rescue the beleaguered euro-zone members.

Austerity dooms Europe to a prolonged and severe recession as the debt burden is worked off. The alternative, a debt write-off, would result in significant loss of wealth for the mainly Northern European lenders triggering an economic contraction and prolonged period of economic stagnation.

Japan is in a state of advance atrophy, despite decades of therapy. The temporary rebound, mainly the result of the recovery from the tragic tsunami and government spending, is running out of steam. The political system is even more blocked than that of the U.S., allowing only a trickle of oxygen to circulate, impairing function.

Japan’s primary investment merit is that almost all possible manmade and natural disasters have happened and the worst is factored in.

Emerging Parts

Mr. Economy’s physicians originally hoped that the BRIC (Brazil, Russia, India, China) nations would offset weakness in more developed and weaker elements. Unfortunately, China’s growth is slowing rapidly. India and Brazil have also lost momentum, with growth weakening. Russia is dependent on high energy prices.

BRIC weakness is a function of lower demand from developed countries reducing exports and weaker commodity prices.

The withdrawal of European banks, historically major lenders to emerging markets, has decreased the flow of money to countries needing foreign investment. For example, in 2011 large European banks accounted for 36% of global trade finance, based on a World Bank study. Some 40% of trade credit to Latin America and Asia was provided by French and Spanish banks. As the European banks, besieged by financial problems at home, reduce their international activities, the supply of financing has decreased and its cost has increased.

Emerging markets also show increased susceptibility to the developed world credit virus. A rapid expansion of domestic credit in China, Brazil, Eastern Europe, Turkey and India will result in banking system problems. The combination of external and internal weaknesses threatens emerging economies, naturally prone to serial crises.

Psychological Assessment

As requested, Dr. Freud assessed the psychological condition of Mr. Global Economy.

He concluded that Mr. Economy is delusional, believing complete recovery is imminent. Presented with contrary evidence, he quoted philosopher Friedrich Nietzsche: “There are no facts, only interpretations.”

Like many terminally ill patients, Mr. Economy has embraced faith healing techniques. Keynesian and monetarist regimes, he believes, will boost demand and create sufficient inflation to bring his elevated debt levels under control.

Keynesian Kool-Aid

The Keynesian cure entails government spending financed by taxation or borrowing to restore Mr. Economy’s health. There is no evidence that it can arrest long-term declines in growth.

Government spending boosts activity temporarily, but may create excess capacity in the absence of underlying demand. Nostalgia about President Roosevelt’s infrastructure projects during the Great Depression is misplaced. Excess electricity generation capacity from dam projects was only absorbed by wartime demand for defense equipment.

As tax revenues have fallen due to slower economic activity, governments have already borrowed to finance large budget deficits.

Government ability to borrow to finance further spending is increasingly limited, without resort to the innovative monetary techniques. In recent years, the Federal Reserve has purchased around 60-70% of all U.S. government debt issued. The European Central Bank is now financing governments indirectly by lending to banks to purchase sovereign bonds.

The ability of the U.S. to finance its large budget deficit relies heavily on several unique factors. The Federal Reserve and the banking system flush with central bank funds have been a large purchaser of U.S. government bonds. The status of the dollar as the major trade and reserve currency has allowed the U.S. to find buyers of its securities, even at very low interest rates. The U.S. ability to finance is also underpinned by the balance of financial terror – overseas buyers, such as China, Japan, major oil producers are forced to continue purchasing U.S. government debt to avoid loss of value on existing large holdings.

The limits of government’s ability to borrow and spend are highlighted by the European debt crisis. Investors are increasingly concerned about public finances, becoming reluctant to finance nations with high levels of debt or demanding high interest rates.

Monetary Boosters

Having reduced interest rates to zero, central banks are giving Mr. Economy the modern Monetarist prescription, changing the quantity of money available. Under quantitative easing, they buy government bonds injecting money into the banking system to lower borrowing costs and increase the supply of money to stimulate demand and inflation. Central banks believe they can keep rates low and print money to finance government debt purchases indefinitely.

But greater government spending, lower rates and increased supply of money may not boost economic activity. Crippled by existing high levels of debt, low house prices, uncertain employment prospects and stagnant income, households are reducing, not increasing, borrowing. For companies, the absence of demand and, in some cases, excess capacity, means that low interest rates are unlikely to encourage borrowing and investment.

Loose monetary policies may not also create the hoped-for inflation, needed to lower real debt levels. Banking problems and the lack of demand for credit means the essential transmission mechanism is broken. Banks are not using the reserves created and money provided to increase lending. The reduction in the velocity of money or the rate of circulation has offset the effect of increased money flows. The low velocity of money, the lack of demand and excess productive capacity in many industries means the inflation outlook in the near term remains subdued.

Side effects

The treatments being taken have serious side effects. Low rates entail a transfer of wealth from investors to borrowers, with the lower coupon payment acting as a disguised reduction of the principal amount of the loan. They provide an artificial subsidy to financial institutions, allowing them to borrow cheaply and then invest in higher yielding safe assets such as government bonds.

Low rates discourage savings, creating a disincentive for capital accumulation. They encourage mispricing of risk and feed asset bubbles, such as that for income (high-dividend-paying shares and high-yield low-grade debt) as well as speculative demand for commodities and alternative investments.

Low policy interest rates have created massive unfunded pension liabilities for governments and companies. S&P 1500 companies have aggregate pension deficits of $543 billion, an increase $59 billion in the first half of 2012.

In the long run, economies become dependent on low rates as high debt levels cannot be sustained at higher borrowing costs.

Internationally, low interest rates distort currency values and also encourage volatile and destabilizing short term capital flows as investors search for higher yields. Attempts by nations to increase their competitive position by weakening their currency also threaten tit-for-tat currency wars, trade restrictions and barriers to investment flows.

The faith healing cures provide symptomatic relief but do not address fundamental problems – the high debt levels, lack of demand, declining employment, lack of income growth or the problems of the banking system. It is not clear how if at all any of the cures being pursued can create real ongoing growth and wealth to restore Mr. Economy’s health.

Limits to Knowledge

The number of medical advisors involved and variety of drugs – stimulus, austerity, quantitative easing, leeches, cupping, witchcraft – is unhelpful. While doing nothing is politically and socially impossible, the treatments may be doing more harm than good. As French playwright Moliere noted: “More men die of their remedies than of their illnesses.”

Interestingly, these same faith healers until recently oversaw Mr. Economy, prescribing regimes that caused the present financial and economic calamity. Perhaps like writer Samuel Beckett they are keen to fail better next time.

There is no recognition of the limits to knowledge and policy tools. Economic relationships are poorly understood, complex and unstable. Cause and effect is uncertain – does money supply influence nominal income or does nominal income affect velocity and the demand for and thereby the supply of money? The ability of governments and central banks to influence economic activity is overstated. As economist Wynn Godley put it: “governments can no more control stocks of either bank money or cash than a gardener can control the direction of a hosepipe by grabbing at the water jet.”

To paraphrase Voltaire’s observation on doctors, Mr. Economy’s faith healers prescribe medicines of which they know little, to cure diseases of which they know less, in economic and financial systems of which they know nothing.

Prognosis for Mr. Economy

Mr. Economy now has a serious chronic condition with limited prospects of a full cure. He might continue to live but in an impaired state of no or low growth for a prolonged period. The threat of a sudden life threatening seizure cannot be discounted. Constant management will be needed.

Happily, Mr. Economy remains remarkably optimistic. Perhaps he recognizes the truth of Mark Twain’s observation: “Don’t part with your illusions. When they are gone you may still exist, but you have ceased to live.”

© 2012 Satyajit Das

Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money

Views are as of October 11, 2012, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security.

Federated Equity Management Company of Pennsylvania

Posted by Gordon2352 | Report as abusive
 

@AlkalineState

If choosing between the two, then yes, eliminate income taxes and reintroduce the tariffs. If we’re going to think in terms of protectionism, then protect domestic industry against cheap labor while limiting the income potential of the Federal government. In turn, competition would be reintroduced between the individual States and local businesses as they battle for the local labor supply. Wages would raise as a benefit. I understand that costs to consumers would also rise, but product quality would match the rise I’m sure.

I would also suggest a tariff on intellectual labor, not just imported goods. By intellectual labor, I mean the foreign call center employees who have no actual imported product but are paid and employed by US based companies.

Aside of choosing between the two, I suggest ending the currency monopoly and repealing all legal tender laws. Think NORFED here. A responsible currency would maintain its purchasing power better than an irresponsible one, which in turn would force all levels of government to be responsible for their spending so their chosen currency doesn’t become worthless in the domestic market. Competing currencies used to be permitted, though they were heavily taxed and internal tariffs on domestic goods is always a recipe for ruin. If I can choose where I work and where I bank, along with what I drive and eat, then I should be able to choose what currency I am paid in based on the long term performance of it.

Posted by LysanderTucker | Report as abusive
 

The Free Trade agreements are what’s tanking our country. Ross Perot was exactly right…”A giant sucking sound”. Jobs are farmed out and the products made with that cheap labor have free access to our markets. The best example is Apple. ALL Apple products are made in China. Apple enjoys a 27% profit margin and has been struggling in the past two years on what to do with the $100B in cash they are sitting on. Some will call it protectionism, but if we don’t do something (like increasing Tariffs to level the playing field) only the richest in this country will prosper while the country goes down the tubes.

Posted by xyz2055 | Report as abusive
 

To put salt on the wound..Apple has a functional tax rate of 9.8% using a variety of tax loopholes. When people like Grover Norquist and Mitt Romney whine about the 35% U.S. corporate tax rate..shout out a big “BS”. Because that 35% is BEFORE the massive loopholes in our system. Read the article below.

http://news.yahoo.com/apple-dodges-billi ons-taxes-concise-guide-091500039.html

Posted by xyz2055 | Report as abusive
 

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