Tuesday, November 8, 2011

Bob Murphy: It's Not Austrian Business Cycle Theory That Counts, It's Depreciation Rates

Bob Murphy, along with Thomas F. Landstreet, have an odd column out at Forbes, which seems to diss Austrian Business Cycle Theory and promote depreciation rates as the key to the economy.

M and L write (my bold):
The hopes for a general rebound are misplaced, however, because temporary depreciation rules may be driving the apparent upswing. The generous bonus depreciation and small business deduction rules begin to drastically phase out in January 2012, which will likely cause a dramatic reversal in investment and other indicators.
Say what? Depreciation is driving the upswing? I have been one of those forecasting a general (manipulated) rebound because of Fed money printing, based on ABCT. I don't see anyway that depreciation is the major driver in this economy.

ABCT holds that central banks print money which generally first goes to the capital goods sector. This flow of funds results in a (manipulated) boom in the capital goods sector. Federal Reserve Chairman Bernanke is now printing money (M2) at a rate of 15% plus. That is a lot of money to be hitting the system. In fact, over the last 12 months, it is nearly a trillion dollars. M and L apparently want to ignore this trillion dollars and hang their hat on depreciation changes.

Now, admittedly, tax laws do cause distortions in an economy, but that doesn't mean you can ignore the trillion dollars Bernanke is shoveling into the mix. Further, a tax distortion is not the same thing as a business cycle distortion. A business cycle distortion confuses all businessmen, as the interest rate is distorted and no one knows with absolute certainty what it would be otherwise, assuming one  knows that it is distorted in the first place.

M and L when they discuss depreciation are specifically referring to IRS code Section 179 and Section 168(k)d. They write:
Under Section 179, a business can immediately deduct the full expense of qualifying investments within certain limits. There is a cap on the maximum deduction that can be taken, and additionally there is an upper limit of expenses beyond which the Section 179 deduction is phased out, dollar for dollar. Because of this structure, the Section 179 deduction is considered applicable to small businesses. The so-called bonus depreciation rules are available under Section 168(k) of the IRS code, and typically apply to qualified property with no limits.
As M and L note:
Investors need to realize that the generous depreciation rules are set to fall back by 75% and 50% respectively in January 2012, and will be virtually phased out completely in 2013. Specifically, the Section 179 maximum deduction drops from $500,000 down to $125,000 in January 2012, while the bonus depreciation rate drops from 100% to 50%. Then a year later, the 179 maximum deduction drops to $25,000, while bonus depreciation completely disappears.
In other words, businesses are going to be hit with a big new tax burden.What does this have to do with a general rebound? If you know that you are getting business because of a depreciation law that is about to expire, are you going to crank up your business for a demand that is not going to be there in a year? Of course, not. Do glove makers continue to crank up sales for the summer months? Should we send out an alarm saying, "Hey glove makers, coat makers and sweater makers are going to get smacked when summer hits. The economy is going to tank." ? Of course not. Expected changes are planned for.

The depreciation change is not fooling anyone. M and R admit this:
Anecdotally, we know many businesses have been rushing to get their capital purchases “placed in service” before the 2011 deadline passes
Do M and R think that the businessmen on the sell side of these transactions aren't aware of this? Do they think the sellers are idiots?

What's going on with the depreciation laws is much different from a money printing inspired general rebound, when no one knows when it will end, or exactly how.

In addition, if the depreciation rules are to be much harsher, it doesn't mean that the  money that was once spent on investment disappears. Harsher depreciation rules mean more government tax revenues. So it should be made clear that the money ends up with the government, which will bid for goods and services, and we will see manipulated GDP growth from that end.. So there may be a shift from some capital goods spending to government spending. But, again, this is not the broad based impact that M and L are suggesting. And, most important it does not surprise anyone--which is much different from a business cycle downturn which surprises most. In addition, there is that bearded man in the room pumping trillions.

34 comments:

  1. Did you ever think the trillion dollars could be used to SHORT stocks?

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  2. I cannot say that I didn't see this one coming....
    I'll just ease back in my chair for the inevitable Murphy-Wenzel showdown.
    Should be interesting, indeed.

    Oh wait, I guess that I do have something to contribute to a portion of this article (regarding government spending). From Mr. Miller's blog (halfway down the page)...
    http://millergd.blogspot.com/2011/05/hoppe-on-argumentation-ethics-doug.html

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  3. I have to agree with Bob, I am about to do some major capital improvements in my business to capture that depreciation. Without it I'm not sure I would purchase the capital goods. I would just hold on to the cash in form of gold.

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  4. I don't see how its a "dis" of ABCT but just an article on the impact that depreciation laws can have on the economy. Having been a corporate tax guy many years ago, what they wrote is pretty accurate when it comes to year end tax planning where some of your 2012 purchases get placed into 2011 to take advantage of the very favorable tax savings.

    I agree with you that sellers would know that this is going on but they would have a hard time determining how much of it is driven by closing out unspent budgets and taking advantage of tax law changes. Generally a business in my experience would never buy more then 6months early, so I doubt that this would have such a profound impact on the economy as to create a massive drop off, but it will have an impact. If businesses believed that things were going to tank next year, they would never make these purchases and just pay the additional taxes which leaves a lot more cash in their coffers for better times. Only idiots and governments buy things they may not ever use.

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  5. Oh come on RW, Murphy isn't trying to replace ABCT with depreciation changes.

    He's only saying that the recent increase depreciation deductions the last few years MAY have had some impact on the upsurge in activity in recent years, and that investors should be wary come January 2012 because the rules are going to change for the worse.

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  6. @Major_Freedom

    Did you read what Murphy wrote. He didn't write as you state:

    "...the recent increase depreciation deductions the last few years MAY have had some impact on the upsurge in activity in recent years."

    He wrote:

    "The hopes for a general rebound are misplaced.."

    Wenzel is saying that there might be some impact from depreciation changes. Murphy is the one talking about impact on a "general rebound". When you are talking general rebound, you are talking ABCT.

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  7. Doesn't a decrease in tax revenue increase the deficit, which is being monetized to keep short-term interest rates between 0 and 0.25%? Won't the rate of monetization slow when the taxes are raised afterwards and the deficit closed (ceteris paribus), and therefore contribute to the down side of the business cycle?

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    Replies
    1. In theory yes, but in practical terms I think not. You assume increasing taxes will actually lead to closing the deficit but an unintended consequence of higher tax rates is slower business growth. It will backfire because now the government will collect less in revenue on lower returns for businesses. Is it better to collect revenue at a 35% tax rate with diminished investment income or to collect it at 25% with a higher volume of investment returns? My point is that higher tax rates will not necessarily reduce the deficit but actually increase it causing slower business growth and hence less income to tax. Regardless I believe the real problem in fiscal policy is spending and this administration will continue spending more while increasing taxes. A recipe for disaster. I believe Murphy and Wenzel agree on the general outlook and just disagree on the sequence of events. Murphy seems to believe we are headed for a downturn much sooner where as Wenzel believes we will be in the boom phase for a more extended period of time. Love the debate between these Scholars.

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  8. @Practical

    Read Murphy's article again. He wrote:

    "temporary depreciation rules may be driving the apparent upswing."

    In other words, he said what I paraphrased him as saying, which was:

    "...the recent increase depreciation deductions the last few years MAY have had some impact on the upsurge in activity in recent years."

    The importance of:

    "The hopes for a general rebound are misplaced.."

    is that the depreciation deductions that were put into effect the last few years, which Murphy says may have had an effect in the recent upswing, are going to be phased out in January 2012. Hence, sentiments of a general rebound are misplaced in his opinion.

    Wenzel is saying that there might be some impact from depreciation changes.

    That's what Murphy is saying.

    Murphy is the one talking about impact on a "general rebound".

    That's what RW is arguing, and has been arguing since around July 2008 when M2 started to really get going.

    When you are talking general rebound, you are talking ABCT.

    No. ABCT is a theory of booms. A general rebound could be inflation financed (although destructive) or it could be market driven, so ABCT is not necessarily implicated.

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  9. @Wenzel

    In addition, if the depreciation rules are to be much harsher, it doesn't mean that the money that was once spent on investment disappears. Harsher depreciation rules mean more government tax revenues. So it should be made clear that the money ends up with the government, which will bid for goods and services, and we will see manipulated GDP growth from that end.. So there may be a shift from some capital goods spending to government spending. But, again, this is not the broad based impact that M and L are suggesting. And, most important it does not surprise anyone--which is much different from a business cycle downturn which surprises most. In addition, there is that bearded man in the room pumping trillions.

    The economy is not instantly capable of absorbing such large shifts in demand that will result in no general downturn. Yes, removing the depreciation deductions will lead to more government tax revenues and thus a boost in GDP from that end. But this doesn't mean that the entrepreneurs will instantly be able reallocate labor and capital away from the companies that have been stimulated on account of the depreciation deductions, and towards those companies that are stimulated on account of government spending.

    I mean, time needed to absorb changes is one of the cornerstones of ABCT.

    Do entrepreneurs know exactly where the government is going to spend money once they take more tax revenues on account of depreciation changes? Sure, entrepreneurs may be able to anticipate which companies are going to be dinged by the depreciation rule changes the most, but it's not as if they will know all this instantly. The market process will take time to produce the required information for entrepreneurs to know where the new value judgments are being made, in both private and public sectors.

    By your logic, if I were to take everyone's money tomorrow, and then spend on whatever I want, thus leading to unchanged spending and GDP, then entrepreneurs are somehow going to be able to instantly know and anticipate the changes, thus leading to no general economic downturn. That's silly.

    Aren't we forgetting regime uncertainty?

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  10. @Major_Freedom

    I really thought you had much better persuasive skills than you are demonstrating here. Or is it just because you have an impossible case to defend?

    You are switching the emphasis of my point. It is not that Murphy said MAY, it is that Murphy said the depreciation may be "driving" the upsurge. Wenzel's point is that Bernanke has printed a trillion dollars in the last year and that should be where the focus is.

    From this confusion, you go to the totally absurd when you write:

    "The economy is not instantly capable of absorbing such large shifts in demand that will result in no general downturn."

    The second part of the sentence doesn't make any sense. But the first part is wrong. As Wenzel points out, if a drop in demand is expected in the future, than it can be adjusted for and Wenzel uses the example of winter clothes. The economy frequently adjusts for known changes in demand. It is the business cycle shifts where the economy is fooled.

    Wenzel has Murphy trapped on this one.

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  11. I used to think like Wenzel, that surely all government policy changes are accounted for well in advance. But, they're not. For example, homebuilders stocks rose and then tanked before and after the expiration of the $8,000 tax credit for homebuyers. You would think the stock market would have "efficiently" priced all that in, but it apparently didn't.

    It is funny that sometimes, Wenzel rails about Keynesian forecasters who just follow trends, and yet when it suits his rhetorical purposes we have a market composed of forward looking rational calculators who are apostles of supply-side economics.

    The last bit of irony is that Wenzel only knows about this post because I sent it to him. See? Expectations are often wrong. What the heck was I thinking?

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  12. Compare "winter clothes" to "bottled water post-Katrina" and it becomes clearer. Some firms will anticipate the shift, but the majority will not. Therefore, they will misallocate capital because they think the downturn is transitory or not serious. They get caught with their pants down, and end up selling capital equipment at a discount higher than their depreciation via tax law. That capital is still available for use, but any loans against it are depreciated (faster than any tax law) and bad debts weigh on the economy.

    I don't know fully where this input leaves the article in question and the ongoing debate (I'll have to re-read it a few times to get the nuance) but I hope it's a helpful interjection!

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  13. @Bob Murphy

    2 points. First, I see you are ditching Austrian methodology, also, by attempting to use empirical data (the housing stock prices) to prove your point.

    Second, I go back to your post, where you are basically saying that buyers of investments are moving their investments up in anticipation of the end of the depreciation allowance, but apparently sellers of the equipment are not aware of this.

    So is your position that buyers get it and sellers are idiots?

    Further, do you not think there is some rational calculation that goes on in markets? Do you think winter clothes makers continue to make winter clothes for delivery in the summer?

    This is, as I note in my post,much different from central bank interest rate manipulations, where it is impossible to know what rate levels would exist without the manipulation.

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  14. C'mon fellas, there are like 20 of us in the sheep pen of the United States who actually believe in economic liberty. Could we not do the People's Front of Judea vs. the Judean People's Front? Keep it technical - don't erode my admiration for the two of you by making this personal.

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  15. @Practical

    I really thought you had much better persuasive skills than you are demonstrating here. Or is it just because you have an impossible case to defend?

    Practical, comments like that only REINFORCE the convictions I have in my statements.

    You are switching the emphasis of my point. It is not that Murphy said MAY, it is that Murphy said the depreciation may be "driving" the upsurge.

    Holy bonkers. I'm supposed to read "may be driving the upsurge as" as "may be driving the upsurge"?

    MAY be driving the upsurge is not driving the upsurge.

    This is just a disagreement on whether or not inflation is dominating depreciation rules. I myself tend to saying yes, inflation is more than likely dominating depreciating rules, but I will not rule out depreciation rules. I thought that made a pretty good case.

    Wenzel's point is that Bernanke has printed a trillion dollars in the last year and that should be where the focus is.

    Everyone knows that. We all know that Wenzel has been pushing that story as the correct one. For what it's worth, I think that story is more correct than the depreciation story.

    From this confusion, you go to the totally absurd when you write:

    Wait, there is no confusion about this on my part. I understand both Wenzel's and Murphy's point.

    "The economy is not instantly capable of absorbing such large shifts in demand that will result in no general downturn."

    The second part of the sentence doesn't make any sense. But the first part is wrong.


    No, the second part makes sense. The second part is "result in no general downturn." That makes sense.

    The first part is right, not wrong. The economy is not capable of instantly absorbing shifts in demand. The time delay is, like I said, a cornerstone of ABCT. It is precisely because inflation from the Fed system enters the economy at certain parts first, and not everywhere instantly, that is part of the reason why the business cycle is generated.

    If there is a large shift in demand away from the private sector, towards the government sector, then this is equivalent to a rise in taxes. A rise in taxes HARMS economies, it doesn't act as some sort of neutral redirection of spending. By that logic, there should be no economic downturn if the government increased taxes to 99% and then spent all the taxes on whatever they like.

    You're ignoring, actually you seem to be rejecting, basic economic theory.

    As Wenzel points out, if a drop in demand is expected in the future, than it can be adjusted for and Wenzel uses the example of winter clothes.

    But people cannot predict just how much demand will fall and where it will fall, nor can people predict where the government will spend the money once their revenues go up. Maybe political insiders can know, but not the average businessman.

    The economy frequently adjusts for known changes in demand. It is the business cycle shifts where the economy is fooled.

    You're begging the question. Saying "known" changes in demand already presupposes the conclusion you are making. I am challenging you on the "know" part.

    Wenzel has Murphy trapped on this one.

    Perhaps, but not for the reasons you seem to think.

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  16. @RW

    This is, as I note in my post,much different from central bank interest rate manipulations, where it is impossible to know what rate levels would exist without the manipulation.

    It is different, but not as different as you surmise, such that neither general upsurges nor general downturns could take place.

    Higher and lower taxes have depressing and upswinging effects on general economic health.

    General upswings and downturns are not SOLELY due to inflation/deflation.

    It is a judgment call here, which by the way I tend to side with your explanation more.

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  17. @RW

    First, I see you are ditching Austrian methodology, also, by attempting to use empirical data (the housing stock prices) to prove your point.

    That's uh, kind of what you are doing by using price and employment statistics, inflation from the Fed, and CPI/PPI to prove your point.

    Further, do you not think there is some rational calculation that goes on in markets? Do you think winter clothes makers continue to make winter clothes for delivery in the summer?

    Weather can be predicted in ways that future human choices cannot.

    Did you expect that the massive inflation from the Fed since 2008 wouldn't result in higher prices that you are seeing now? You expected everything exactly the way it happened? Come on.

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  18. Wenzel, you are starting to get ridiculous with your bad-mouthing of fellow Austrians. Just stop it. Murphy and Schiff are on OUR side. Either you have a serious chip on your shoulder, or you are trying to leech some fame from them. Either way, its getting old.

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  19. If Wenzel wasn't such a great news aggregator, I would have stopped reading this blog a long time ago because of this type of feuding.

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  20. @Major-Freedom

    Listen. Don't you have a day job? I don't have time to answer every one of your idiotic defences of Murphy. I'm surprised Wenzel hasn't banned you for spamming.

    Let me point out just one of your absurdities, then I am going back to watching The Three Stooges. You say "Weather can be predicted in ways that future human choices cannot."

    1.So are you saying the tax rules that Murphy is referencing may not end the way he states so that Murphy may be even more wrong than Wenzel states, because "Weather can be predicted in ways that future human choices cannot"?

    2.Do you really honestly believe that the firms benefiting to any significant degree aren't going to notice the end of the tax depreciation rules and they are going to plow producing product where demand disappears because "Weather can be predicted in ways that future human choices cannot"?

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  21. I get a chuckle out of the pantywaists who can't bear the discord. They fail to see that it's actually a good thing.

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  22. I've been sitting back on this one, but I do have something to say about it generally.

    Does Wenzel call people out if he doesn't agree with them? Yep and I see no problem with this. In fact, this is how we get to the bottom of particular things and ideas. Without debate, there can be no mutual understanding. Sure, that mutual understanding doesn't always present itself, but that is the goal of debate (I don't think the goal of debate is to call the other side an idiot).

    When Wenzel called out Schiff for using a completely supply-side argument everybody threw a hissy fit. Even though there was some disagreement on particular details of Austrian theory, every Austrian agreed that Schiff was wrong (an agreement was eventually made between Austrians on the particular details). I won't get into the details, but Schiff certainly was not interested in debating the topic to come to an understanding.

    Now, Wenzel is calling out Bob Murphy on what he feels is a disregard for the ABCT with regard to the current increases in investment, etc. Unlike Schiff, Murphy does care about coming to an understanding on the subject and will debate with Wenzel on the subject (though, I imagine most of this will be behind the scenes). If Murphy is shown that he is wrong, he will admit it (he's isn't a little girl about it). I don't know as much about Wenzel, but I would hope that he would do the same in the event that he is proven wrong on something.

    People have to stop thinking that disagreements are the same as attacks, they're not. This is how we root out the bad ideas in favor of the good ones; debate is a healthy thing for knowledge. Nobody ever complains when an Austrian calls out, say, a Keyenesian; so, why is it different if it is an Austrian calling out an Austrian?

    If you think Wenzel or Murphy are wrong, then come out and show us why they are wrong. But, don't piss and moan just because their is a disagreement.

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  23. @Practical

    Listen. Don't you have a day job? I don't have time to answer every one of your idiotic defences of Murphy. I'm surprised Wenzel hasn't banned you for spamming.

    Wonderful. When you can't defend your position or refute mine, you resort to this childish nonsense.

    You haven't shown how my "defences of Murphy" (actually they're defenses of an idea) are "idiotic." All your attempts have either been misconstrued characterizations of what Wenzel and Murphy and myself have said, or you have simply asserted claims without substantiation. Now that you're resorting to attacking me personally, it is you who should be banned for spamming.

    Let me point out just one of your absurdities, then I am going back to watching The Three Stooges. You say "Weather can be predicted in ways that future human choices cannot."

    1.So are you saying the tax rules that Murphy is referencing may not end the way he states so that Murphy may be even more wrong than Wenzel states, because "Weather can be predicted in ways that future human choices cannot"?

    Yes.

    2.Do you really honestly believe that the firms benefiting to any significant degree aren't going to notice the end of the tax depreciation rules and they are going to plow producing product where demand disappears because "Weather can be predicted in ways that future human choices cannot"?

    No.

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  24. "Listen. Don't you have a day job? I don't have time to answer every one of your idiotic defences of Murphy. I'm surprised Wenzel hasn't banned you for spamming."

    Case in point. While I know many people try to use the 'ol ruse of calling a person's argument "idiotic" instead of calling the person an idiot, most people see through that.

    I am guessing that Wenzel doesn't ban MF because MF often makes good, solid Austrian arguments. I won't say whether I think MF's arguments presented here are good or bad (once again, I would rather leave this one to Murphy and Wenzel), but if you get around the blogosphere a bit, he does a lot of good for Austrians, even if he (like me) is often long-winded.

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  25. "he's a good man, and thorough"

    name it.... ;)

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  26. @Joseph Fetz

    "every Austrian agreed that Schiff was wrong"

    That is a laughable statement. If by "every Austrian" you mean Wenzel and Rothbard, I guess you're right.

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  27. Anon 8:46,

    Ok, I should not have used the word "every". However, can you name a current Austrian economist that supported Schiff's position on 999? This is with regard to the consumption tax argument (i.e. the supply-side argument), not his (correctly) pointing out the extra 9.

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  28. @Joseph Fetz

    The argument is almost comparing apples to apples. With an income tax, people have less money to spend, therefore they buy less. With a consumption tax, people have more money to spend, but things are more expensive, therefore they buy less.

    Schiff likes the idea of having the consumption tax because people would be able to invest tax-free if they decided not to spend it. Other than that, he doesn't really see too much of a difference.

    One benefit I see about the consumption tax is that, since it would permit people to have more money at one once, lower and middle-class people would have less of a hard time affording the slightly more expensive things in life. This includes buying things in bulk, which provide for a lower price overall.

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  29. @Anonymous

    "Pantywaist" here likes the "feuding"...
    It's called intellectual debate....no problem with it. May the best argument win and may the loser change his mind...find another argument!

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  30. Anon 12:54,

    Yes, one tax is on income on the way in, the other is on income on the way out, but that is besides the point (demand-side vs supply-side). As I said, I haven't seen any Austrians supporting his position, and for good reason, because no Austrian would recommend using a market intervention to nudge people to increase their savings. This is really the main point.

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  31. In other words, the position that Schiff took is an entirely anti-free market position. If you cannot see that, then I don't know what to tell you.

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  32. @Joseph Fetz

    So, allowing people the opportunity to save what they make before the government gets its hands on it is anti-free market, but the government preventing you from ever getting your hands on it isn't? I'd rather be "nudged" towards savings than not have the option at all.

    In deciding between having one option for the allocation of your money (taxes) or two (savings or taxes), I would say having two options is more free market than only having one.

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  33. You aren't gaining anything, which was the larger point, because whether you tax on the demand-side or the supply-side, it still falls on the original factors, thus reducing productivity just the same. Like I said when this debate first occurred, it is like saying, "sure, I'll take I higher cash balance for lower productivity". Of course, both taxes reduce productivity (and thus net utility), but one works on the money coming in, while the other works on it going out. You don't gain a thing but a higher cash balance and the revenue to the government is the same. It's a supply-side ruse.

    Regardless, the 999(9) tax has both of those taxes and then some.

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