Wednesday, September 16, 2009

Is the Obama Administration Thinking Tax Hikes?

Nouriel Roubini writes that it is important that the White House timing on raising taxes is right. Raising taxes? Who else has said anything about raising taxes? Remember, Roubini is buddies with Larry Summers and Timothy Geithner, and he seems to make comments out of the blue that turn into reality. In other words, pay attention to Roubini comments that seemingly come out of the blue. If Roubini is talking tax hikes, they are talking tax hikes in the White House. Here's what he wrote:

[T]he key issue for policy-makers is to decide when to mop up the excess liquidity and normalize policy rates – and when to raise taxes and cut government spending, and in which combination.

The biggest policy risk is that the exit strategy from monetary and fiscal easing is somehow botched, because policy-makers are damned if they do and damned if they don't. If they have built up large, monetized fiscal deficits, they should raise taxes, reduce spending and mop up excess liquidity sooner rather than later.

The problem is that most economies are now barely bottoming out, so reversing the fiscal and monetary stimulus too soon – before private demand has recovered more robustly – could tip these economies back into deflation and recession. Japan made that mistake between 1998 and 2000, just as the United States did between 1937 and 1939.

But if governments maintain large budget deficits and continue to monetize them as they have been doing, at some point – after the current deflationary forces become more subdued – bond markets will revolt. When that happens, inflationary expectations will mount, long-term government bond yields will rise, mortgage rates and private market rates will increase, and one would end up with stagflation (inflation and recession).
Even more scary is what Roubini writes is the alternative to higher taxes:
...the temptation for governments to use inflation to reduce the real value of public and private debts may become overwhelming. In countries where asking a legislature for tax increases and spending cuts is politically difficult, monetization of deficits and eventual inflation may become the path of least resistance.


  1. I don't find inflation to be more scary than taxes (though inflation really is a tax). I can always trade better than the government can tax, but if they tax away my trading profits I'm screwed.

    What I find really scary is the government's systematic closing of our borders to outgoing cash. Rather than competing for our capital, they are simply going to prevent its departure. And once that is accomplished, they can tax us as much as they want. Pretty soon Washington will be known as "Pyongyang on the Potomac".

  2. Sean, that's a shallow way of looking at inflation. It's not just about you, but about the entire economy. After all, even if you are able to avoid dollars, it's not likely that the whole country can.

    Markets are hobbled by an unpredictably-inflationary environment, and trade breaks down. As bad as taxes are, it's possible to calculate exactly what they're going to be. With inflation, it's not always clear whether an investment is sound or not.

  3. Stewart, I read into your comment that taxes spread the tyranny more evenly. True. But if I were in the White House facing the reality of one or the other, I'd give strong consideration to inflating my way out of it. After all, the base (private sector and government unions) can simply demand a cost of living increases.

    In the end I think they do both as the unions can recoup most of the inflationary losses and income taxes are so heavily waited toward the top tier. And the top tier guys that Obama needs to keep as friends (Buffet, Soros) take only a small amount of earnings as ordinary income.

  4. No, Sean, it's not an egalitarian concern. The overall economic damage of funding a deficit through inflation is worse than that from a similar level of taxation. The reason is that individuals can more-or-less account for how much they're being taxed, and they can plan they're businesses accordingly.

    You can't always plan for inflation. The value of money becomes unpredictable; savings is destroyed; and markets break down to the extent that inflation is destroying the currency they are denominated in.

  5. The lesser of evils may be taxation but I want all evils in excess, i.e., the kill or cure situation. The people will revolt or the little freedom left will perish.