It Must Be the Drinking Water

I am referring to the behavior of the folks in Washington, D.C.  They are clearly bipolar.  They profess to want to achieve a specific goal but every action they take is designed to thwart it.  Specifically, I’m talking about the avowed goal of creating jobs that this administration has bleated on about incessantly.  It says it wants to increase private sector jobs, especially in small businesses.  It and the Congress’ actions, however, will do exactly the opposite.

We had the spectacle on the Sunday morning talk shows of Larry Summers saying on ABC that the recession is over, while on NBC, Christina Romer said that it wasn’t .  Where is Harry Truman’s onehanded economist when you need him?  At least, they weren’t proposing policies that were in direct conflict with each other, although if each believes their position to be correct they will ultimately have to.

As an aside, in the late 1970s, inflation was driving up interest rates and devastating the housing market (something is always screwing up the housing market, it seems) because of the restrictions on the maximum rate that could be charged for mortgages.  At the time, six-month CDs paid more than a bank could lend the funds at.  You can’t make this up on volume.  The Carter administration, in particular the Secretary of HUD, Patricia Harris, was going to present to Congress their plan for getting mortgages flowing again.  The economists at HUD proceeded to draft a position paper that said, in essence, that what was needed to get long-term interest rates down was for inflation to be brought under control.  The way to do this was to slow the growth of the money supply which would reduce both inflation and expectations of future inflation.  Unfortunately, Mrs. Harris had taken a fancy to the views of Leon Keyserling, one of the first members of the Council of Economic Advisors back in the late 1940s.  Being an unrepentant Keynesian, his advice was to increase the rate of growth of the money supply thereby driving interest rates down, which would make mortgages affordable and available again.  The lawyers at HUD who assembled her testimony strung these two totally incompatible views into one document.

You get the picture: one paragraph would say that the growth of the money supply should be slowed, while the next countermanded that advice.  It went on like this through the whole document. Fortunately for the Carter Administration, Stuart Eizenstat read the testimony late on a Friday afternoon, it was to be given the following Monday morning, blew a gasket and had her appearance cancelled.  This type of nonsense unfortunately occurs all the time down there.

But getting back to today.  Open any graduate macroeconomics textbook and it is clear that in order to increase per capita consumption we need to increase per capita levels of capital, that is, we need to expand investment.  Can anybody name any actions taken by this Administration or Congress that would encourage firms to invest?  I say encourage because it needs to be made clear that the government cannot create jobs, it can only create an environment in which entrepreneurs will be willing to undertake risks.  The government can, and usually does, take actions that severely reduce the incentives to undertake risks and create jobs.

The most obvious current deterrents to job creation are the health care bill and the cap and trade legislation.  Both will have the effect of causing jobs to be located overseas, whether by American firms or foreign domiciled ones.  The U.S. will be viewed as offering firms fewer opportunities to earn their cost of capital while at the same time imposing severe financial burdens that will have to be met irrespective of the levels of output.  Both the costs for health care, and they are going to be much higher, and for cap and trade can be viewed as quasi-fixed costs.  These are costs that must be paid if a firm wants to open its doors.  By raising the hurdle, on the margin, firms will opt not to expand in the U.S. or opt not to locate here to start with.  Clearly, both will be job killers, especially for small businesses who don’t have the ability to absorb upfront costs such as these.

There is another job killer stalking the land, I’m afraid to report.  In the 1980s, Ronald Reagan reduced the capital gains tax from 70% to 28%.  The U.S. economy surged in that time period, growing by a third.  In the 1990s, Bill Clinton, against his wishes, signed legislation reducing it further to its current 15%.  Tax revenue poured into Washington’s coffers to such an extent that we actually had a budget surplus for a fleeting moment.  The clear evidence is that a low capital gains tax rate is good for capital formation.  The President wants to increase the rate which is clearly counterproductive if he wants to increase jobs.  And by jobs, I mean well-paying ones.  If our sole goal is to drive the reported unemployment rate to zero, including discouraged workers, a two sentence law could accomplish that.  To wit:

All foodstuffs sold in the U.S. shall be produced here.  No mechanized equipment can be used in the production of foodstuffs.

While this will guarantee full-employment, it probably won’t guarantee full bellies.  Our standard of living would revert to that of the early 1800s.

Congress recently voted to extend the inheritance tax at its current rate through 2010 after which it is to return to its pre-2001 level of 55%.  Say what you will about the inheritance tax, it acts like a capital gains tax.  If it is increased, capital formation is reduced.  In this case it is a bit more insidious because it takes the form of allowing the existing capital stock to disappear via lack of reinvestment.  Further, small businesses, those that are impacted by this legislation, will divert resources to tax and estate attorneys to devise ways to protect at least a portion of their life’s work.

I recognize that there are some very vocal opponents of eliminating this tax, Warren Buffet and Bill Gates, Sr. being quite prominent.   I don’t understand Mr. Gates problems with it. Nothing by the way prevents anyone from writing the U.S. Treasury a check for more than legally obligated amount of taxes if they feel that they under-taxed.  I do understand Buffet’s.  His companies sell life insurance which is one of the preferred means of dealing with the tax bill.  If the tax bite is reduced, so is the demand for life insurance.  He also has another incentive for keeping it high.  His firm acquires many privately-held firms.  He offers shares in his firm in payment and is able to split, if you will, the tax saving from postponing its due date (the 3 Ls of taxes: least, latest, and legal.) The higher the tax rate, the more there is to split.  If the tax rate was zero, these firms would opt for the highest cash offer which would mean Buffet might have to compete harder for these acquisitions.

Unfortunately (for me), the inheritance tax is pretty much of a non-issue.  As a matter of public policy, though, it is of great importance.  The firms most affected by the tax are those that are most likely to invest in the U.S.  They are the largest job creators, by a long shot, in our economy.  I find it sad that our politicians will opt for a tax that really doesn’t generate that much revenue, while its impact is concentrated on some of the most productive people in our society.  It garners headlines; it is making those “fat cats” pay their fair share, whatever that means (other than shilling for votes.)

As the economy slowly grinds forward in the coming year or so and one asks why aren’t things improving faster, one need look no further than the impact of health care legislation, cap and trade, and the increases in the capital gains tax, including the inheritance tax.

Posted by Jim

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