Wednesday, January 31, 2018

Stockman, Cutting Taxes and the Deficit

Mitch Black emails:
Regarding Mr. Stockman's correlating the receipt of plunder (taxes) and the federal deficit: I don't and never have observed much of a correlation at all. These sanctimonious, tunnel brained, greedy politicians will spend regardless of receipts.

Is there any evidence that Mr. Stockman's assertion about this is correct?

Even if it was correct, I have always felt (as Cavuto mentioned) that ANY money in the hands of politicians and bureaucrats is dangerous and at the very least, wasteful. That money kept in private hands, much better spent. But Stockman felt differently about this as well. He's a smart guy, so I am wondering if I'm missing something.
RW response:

I am not sure Stockman was making a correlation. He is simply looking at the fact that government spending is not being cut but taxes are. This means that the deficit will have to go up. That's his point with the further point that the spike in the deficit is not going to be small, it is going to explode.

Under these circumstances, when government spending isn't cut, the money is taken out of the economy via a much more circuitous route--but it is taken out. Either the government borrows on the open market, thus crowding out private sector borrowing (so less goods are produced) or the Fed monetizes the debt (meaning the Fed prints more money for the government to bid goods away from those of us in the private sector.)

Think of it this way.

Say there is an economy with a GDP of $10 million.

The government taxes 30% and spends the $3 million which leaves $7 million for the private sector.

Now along comes Trump. he cuts taxes by $500,000.

So things look like this: Government takes $2.5 million which leaves $7.5 million for the private sector.

But the government still spends $3 million. This will result in a deficit of $500 000.

 If the government goes to the open market to borrow the money to finance the deficit, it will crowd out $500,000 in private sector borrowing, so the $7.5 million in the private sector shrinks to the same $7 million that existed before the tax cut and government funding goes back up to $3 million/.

Things get quite a bit more complicated if the $500,000 is monetized by the Fed. There are a series of rounds that take place in the monetization scenario. The government will get back, in phase one, to $3 million because the Fed buys $500,000 to support the government debt issuance to cover the deficit. But because of the fractional reserve system even more money gets created pushing the number of dollars in the private sector above $7.5 million. Thus a bidding price war will develop with the explosion in the money supply. This will mean a further shortfall in government funds to finance budgeted activities as costs rise, which will explode the deficit further and we are caught in what Hayek pointed out in a slightly different context was a tiger by the tail situation---that makes it very difficult for the private sector to save or plan. As more funds are funneled to the government by even more Fed deficit monetization (or the crowding out of the private sector).

I do not find any of these alternatives attractive. A cut in government spending is the only sound solution, a tax cut without spending cuts is just getting hit by a train that you don't hear until it hits you.


  1. I agree the impact of a deficit financed tax cut is reduced purchasing power for us.
    Nonetheless, given the choice between no tax cut and a deficit financed cut, Rothbard favored the latter. Perhaps someone can locate the reference.
    Perhaps we should go the whole hog ie suspend all taxes, finance govt spending by money creation and publicize the consequences.

  2. Incidence of taxation changes. Right now a small business llc in NYC gets hit terribly. If it is financed by inflation, treasury bond holders and other dollar asset holders like China, Buffet, insurance companies get hit.

    Since taxation is theft, I want the least theft from me.

  3. This has been asked before but I don't recall ever seeing an explanation. If the federal government can and does print all the money it wants, why do we need to pay federal taxes?