The Paradox of Thrift

This is the last post for awhile on why we need spending, so let's look at the clearest possible case: a village of three people who trade only with each other.

If some hold back on their spending, they all suffer. Why?

Suppose they each buy $5 of goods from the others, spending and earning $10. Peter bakes bread, Paul grows grapes, and Mary cooks casseroles, and everyone buys - and sells - two items each month.

This works fine until Peter begins to worry about the future and wants to save. He decides he can do without Paul's grapes for now, so he buys nothing more than the $5 casserole from Mary.

Paul now has just $5 to spend, since only Mary bought his grapes. Paul must cut back on his own spending as a result, and once he buys one loaf of bread from Peter - and nothing from Mary, since he has no more money - all trade is finished.

How much money does Peter now have to save?

Nothing. Zero. Zip. No one has more money in this situation, yet everyone has less to enjoy. How can that be?

This is what economist John Maynard Keynes called "the paradox of thrift." When people move too drastically to save, they can all end up saving less than if they were less thrifty. The problem results from a sluggish economy when everyone pulls back at once from their spending.

What can be done to get this village economy moving again?

Someone has to have confidence that things are improving, enough to promise purchases from both other merchants. Then the whole chain can begin moving again at full capacity. 

Saving isn't inherently evil. But if people leap too quickly to increase their saving habits, they can end up with less on the table and in the bank.

Who Laughs at the Laffer Curve?

You've found me: the one and only person in America who believes in the Laffer curve.

Ever since Reagan championed the idea that the government can earn more from lower taxes, liberals have shunned the concept.

Oddly, conservatives have, too, though they love part of the idea. You can read some near-religious praise for part of the Laffer curve at FreeRepublic.com, a site whose crazy fervor used to tickle me until they kicked me off for suggesting there's a role for good government.

One poster says, 'its logic continues to elude the class-warfare lobby' and another insists, 'Laffer curve should be pasted on the ceiling above every child's bed.'

But they don't really want a Laffer curve. They want a Laffer bulge, a curve with no left side.

Look closely at that left side: at that point, government receipts fall with further tax cuts. That fits both our historical data and plain logic. If you cut taxes to 0%, we'll clearly have no government revenue.

So where are we on the curve?

For us to expect more revenue by cutting taxes to 10%, from 40%, we'd have to expect that people would work four times as many hours. That's simply not possible, and the tax change does not imply any leap in productivity to fill the gap.

Could people work twice as many hours to compensate for a cut to 20%? Since the average employed American works between 46 and 50 hours per week, doubling their time would be exceptionally hard. Remember, that's an average. Yes, some people already work 100 hours a week, but they can't double their time to 200.

Then here's where we are on the Laffer curve: we're close to the optimum level for receipts. We can't cut the top tax rate to 20% and expect people to double their work week, nor should we hike it to 60% while hoping it doesn't reduce hours. Neither is reasonable.

We can argue over whether we should shift 5% one way or another, but we're no longer at the punitive 80% top tax rate that existed when Reagan took office. The level now is close to where it needs to be.

So let's put away the Laffer bulge and call a spade a spade: lowering taxes now is liking taking medicine for last year's cold.

Making Sense of Really Big Numbers

Pundits had laser-like criticism of Louisiana Gov. Bobby Jindal and his televised address on Tuesday.

They focused on his "folksy" style and his wobbly command of facts when criticizing parts of the stimulus bill, particularly those for 'volcano monitoring' and 'magnetic trains.' Of course, here in the Northwest, we don't find monitoring of volcanoes any more wasteful than a hurricane watch in the South, but much worse than Jindal's ridicule is his math.

$140 million for volcano monitoring is less than one tenth of one-percent of the spending bill. It doesn't deserve any greater portion of our attention.

Then what about the 'MagLev' train in Las Vegas? Its aim of linking working-class neighborhoods with jobs deserves better than Jindal's jibes, as you might expect given its support by the chairman of California's portion of the long rail line, Quentin Kopp.  Kopp, who served for years as San Francisco's most conservative council member, is whip-smart and one of my favorite politicians. He's been called a lot of things, including "biting," and "a force of nature," but he's never been accused of being a dreamy liberal.

And again, the best perspective of all comes from looking at the numbers. $8 billion for the train is just over 1% of the spending package.

When is the last time you saw any large project, public or private, that was more than 99% efficient?

Does Jindal really mean to imply that he agrees with nearly all of it? If not, why doesn't he address the big-number items?

I expect it's because it is hard to disagree with most of the stimulus package (whose components you can see clearly laid out in my earlier post, Components of the Stimulus.

Complaining about waste in 1% of the bill is like complaining about "pork" in politics. Yes, it's there, but only as a small fraction of the total (see my earlier post,  Where Do Taxes Go? ).

Let's call a spade a spade: $785 billion in stimulus is a lot of money, no doubt. But it's not too much to keep in proper perspective.

Components of the $825 billion stimulus package

Item                                                 Amt ($billion)

Tax Cuts                                        275

  $500/person, plus expansion of business loss writeoffs

Aid to States 119

   $87bn Medicaid, $25bn public safety, $7bn law enforcement

Education                                 117

   $41bn low-income support, $39bn secondary, $22bn college

Unemployment Aid                  106

  $43bn  jobless benefits extension, $39bn health coverage

Infrastructure                                                                  90

  $30bn highways, $31bn building repair, $19bn water, $10bn transit

Energy Investments                     54

$32bn grid upgrade, $22bn housing weatherizing

Investments in Science and Technology 16

  $10bn research facilities, $6bn rural broadband Internet expansion

Other 48

You can see more detailed figures in the actual proposal (.pdf document hosted by the Wall Street Journal).

Note how conservative this is - 'conservative' in the political sense. Tax cuts are not only the largest portion of the package, they're twice the size of the next largest item. More than twice the size.

And look at where the other big expenditures are: public safety, law enforcement, infrastructure. Even some of the liberal-sounding titles actually house conservative projects. 'Energy investments' isn't going toward solar-powered smiley buttons. It's primarily for upgrading the nation's electrical grid.

Good for President Obama for reaching across the aisle. Let's see how it works.

Where do Taxes Go?

Here's where your tax money goes:

Item ('07 unless noted)         Amt ($billion)

Social Security Payments       586

Defense (minus Iraq, Afghan.) 548

Medicare      395

Unemployment          294

Interest on nat'l debt '08        244

Medicaid '08        202

Iraq and Afghan wars                186

Stimulus rebates '08 168

Foreign tax loophole discovered Sept '08              100

Education                      89

Transportation                                77

Veterans benefits        73

Justice Dept                                   44

Food Stamps         39

Foreign Affairs                             32

NASA                                  17

Earmarks '08                                                                  16

National Parks                       2

What does this tell us?

Three things. First, the media attention given to issues doesn't accurately reflect their real size in the budget. There are headlines over every wasteful 'bridge to nowhere' pork project, and while they're awful, they're also a small part of the budget.  In fact, a tax loophole the IRS just announced is more than eight times the size of all 'pork' projects combined. We aren't going to balance the budget just by trimming pork.

Second, our National Parks are being shamefully squeezed. We could quadruple its budget and it would still be one of the smallest  national programs. Ditto for NASA. If you think the money we spend on NASA would be better spent on schools, you're looking at the wrong source. NASA is small (half the size it was in 1965, by inflation adjusted dollars), and it's the big items we need to debate.

Third, if we want to balance the budget, it's going to be through defense cuts or tax hikes.

Yes, Social Security, Medicare, and Medicaid are big parts of the budget, but they also have their own tax sources. Social Security is currently in surplus, and while that will change, that's a topic for another time. For now, the items funded by your general income taxes are dominated by defense spending.

Take every other program in this chart - education, transportation, food stamps, and yes, NASA - and add them together. That's less than we spend on defense and the wars in Iraq and Afghanistan. Throw in unemployment expenses. It's still less.

I believe in a strong national defense, but I also believe in fiscal responsibility, and if we don't want higher taxes, we're going to need to rein in spending where it counts. Trimming the National Parks program won't balance the budget, but a careful look at defense just might.