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USA - Taxation: Tax Cuts Versus Government Growth	sand-@wwdb.org
	Jun 06, 2003 07:53 PDT

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Tax Cuts Versus Government Growth

By Frank Shostak

[Posted June 4, 2003]

On May 28 President Bush signed into law a $350 billion
package of tax cuts and state aid. Millions of Americans
will begin to see the effect of the package within weeks, in
the form of bigger paychecks. Also, in July some 25 million
families will receive up to $400 per child in tax credits.

With more money in their pockets, the President believes
Americans will be able to spend more and this will speed up
economic recovery. According to President Bush,

"By ensuring that Americans have more to spend, to save
and to invest, this legislation is adding fuel to an
economic recovery. We have taken aggressive action to
strengthen the foundation of our economy so that every
American who wants to work will be able to find a job."

The belief that putting more money in consumers' pockets
will revive the economy is based on the popular view that a
given dollar increase in consumer spending will lift
economic activity in terms of gross domestic product (GDP)
by a multiple of the increase in consumer expenditure. An
example will illustrate the magic of this multiplier.

Let us assume that on average individuals spend 90 cents and
save 10 cents of each additional dollar they receive. Thus
if consumers raise their spending by $100 million, this will
boost retailers' revenues by this amount. Retailers in turn
will spend 90% of their new income, i.e. $90 million on
various goods and services. The recipients of the $90
million will in turn spend 90% of $90 million, i.e. $81
million and so on. At each stage in the spending chain
people spend 90% of the additional income they receive. This
process eventually ends with GDP rising by $1 billion, i.e.
(10*100 million).

In short, all that is required is to give every American
more money to spend and this in turn should set in motion
increases in consumer expenditure, which in turn will
trigger increases in the production of goods and services.
Observe that within the framework of 'the multiplier'
savings are actually bad news. The more people save the
smaller the multiplier.

The magic of 'the multiplier' however, is just wishful
thinking. Every activity in an economy has to be funded and
therefore it is always in competition with other activities
for scarce real funding. Hence if more is spent on
consumption goods, less is left for capital goods. An
increase in retailers' activity will be offset by a decline
in the activity of capital goods producers.

It is therefore not possible to lift the pace of general
economic activity without an increase in the sources of
funding. In other words, for a given pool of real funding
any increase in some activities must mean less funding for
other activities. Now if it would have been otherwise then
by the magic of the multiplier we could have generated an
almost unlimited prosperity.[1]

The proponents of the tax cuts are, however, of the view
that tax cuts generate incentives to work harder and provide
incentives for businesses to expand their activities. Again,
without an expanding pool of real funding irrespective of
tax cuts announcements no general expansion in economic
activity can emerge. For every expansion in activity of some
businesses, some other businesses will not have the required
funding to embark on expansion.

But surely the individuals who will be receiving checks
would be able to spend more and thus lift the economy? Yes,
they will be able to spend more at the expense of those
individuals who will not get the checks.

A major driving force behind the increase in the pool of
real funding is the real savings that fund the buildup of
tools and machinery, which in turn makes possible an
expansion in the production of final goods and services.
With a greater pool more can be allocated towards
consumption and savings.[2] With more savings it would be
possible to enhance the production structure further, which
in turn permits the expansion of the production of final
goods and services-this is what economic growth is all
about.

Now, what does it mean to lower taxes? It means that
Americans should have greater access to the pool of real
funding. The only way this can be made possible is if
government access to the pool is reduced. After all, in
similarity to all other activities, government activities
must also be funded.

Thus when government decides to promote a particular
activity, this means that the government will supply various
individuals that are engaged in this activity with money.
The received money in turn will permit individuals in that
activity to access the pool of real funding.

Since government is not a real wealth generator it relies on
its sources of funding from the private sector. This in turn
means that the more government spends the less real funding
will be available for the wealth generating private sector.
Obviously this will impede the creation of real wealth and
impoverish the economy as a whole. Observe that if
government could generate real wealth, it wouldn't need to
tax the private sector.

The effective level of tax then is dictated by government
outlays. The more government plans to spend the more real
funding it will divert from the wealth generating private
sector. The mode of diversion of real wealth from the
private sector is, however, of secondary importance. What
matters is that real funding is diverted. The method of
taking real funding can be through direct taxes or indirect
taxes and by means of monetary printing.

Another instrument for the diversion of real funding is by
means of borrowing. But how can this be? After all if a
lender transfers his real funding to a borrower surely this
is done voluntarily? Furthermore, a lender should actually
be seen as an investor. He commits his real resources in
order to make a gain. This in turn implies that the borrower
must be a wealth generator in order to be able to repay the
original loan plus an interest.

This is however, not so as far as government is concerned.
For government is not a wealth generator, it only consumes
wealth.[3] So how then can the government as a borrower,
which produces no real wealth, ever repay the debt? The only
way it can do this is by borrowing it again from the same
lender-the wealth-generating private sector. In short, it
amounts to a process wherein government borrows from you in
order to repay to you.

It is therefore not possible to have an effective tax cut
without a cut in government outlays. A so called tax cut
while government spending continues to increase is just an
illusion.

Looking at the history of government outlays shows
relentless increases. For 2004 the President's budget
outlays stand at $2.229 trillion[4]. This is an increase of
19.8% on the outlays in the 2001 budget, which President
Bush inherited from President Clinton (see chart). Per
capita government outlays since 2001 increased by 17.2% (see
chart).

So long as the pool of real funding is expanding various
fiscal tricks appear to work-the multiplier seems to be the
real thing. It is only once the flow of savings disappears
all together on account of reckless fiscal and monetary
policies that the facts of reality begin to assert
themselves. Once this happens, irrespective of loose
policies the economy falls into a severe slump.

In this regard, the government-compiled data indicates that
the pool of real funding may be in trouble. Since 1986 real
disposable income adjusted for imputations was below real
consumer outlays. Consequently real personal savings, which
are the difference between real disposable income and real
consumer outlays, have been negative since 1986. In 2002
real personal savings stood at -$321 billion against -$363
billion in 2001 (see chart). The personal savings rate stood
at -8.3% in 2002 against -9.8% in 2001 (see chart).

In addition to this, the widening in the state and local
government budget deficit means that Americans will be
paying more taxes to state and local governments, which are
legally not supposed to have deficits. In Q1 the state and
local government budget deficit stood at $66.9 billion
against a deficit of $50.6 billion in the previous quarter
(see chart).

Luckily for the U.S. however, some important contributors to
government funding are foreigners. Out of the total federal
debt outstanding of $6,198 billion in 2002 (see chart)
foreigners held $1,106 billion (see chart), i.e. 17.9% of
the total debt. There is a growing possibility that
foreigners might lower their exposure towards the U.S.
government debt implying that the American private sector
would be forced to provide a greater portion of real funding
to the government. For instance, according to the
government's own estimates the Federal debt will jump to
$7.3 trillion by 2004, an increase of 17.7% from 2002 and by
2008 the debt is expected to stand at $9.4 trillion, an
increase of 51.6% from 2002.

We can thus conclude that as a result of ever growing
government outlays and the reckless monetary policies of the
Fed, it is mission impossible to have an effective cut in
taxes. That the intention is to grow rather than shrink the
size of the government was demonstrated by President Bush's
signing the increase in the Federal debt limit from $6.4
trillion to $7.384 trillion on the day he signed into law
the tax cuts.

------------------------------------------------------------
--------------------

Frank Shostak is an adjunct scholar of the Mises Institute
and a frequent contributor to Mises.org.

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<DIV>
<DIV><A
href="http://www.mises.org/fullstory.asp?control=1243"></A></DIV></DIV>
<DIV>Tax Cuts
Versus Government Growth </DIV>

By Frank Shostak
[Posted June 4, 2003]
<IMG src="http://www.mises.org/images2/taxcut.gif" align=right
border=0 NOSEND="1">On May 28 President Bush signed into law a $350 billion
package of tax cuts and state aid. Millions of Americans will begin to see the
effect of the package within weeks, in the form of bigger paychecks. Also, in
July some 25 million families will receive up to $400 per child in tax
credits.
With more money in their pockets, the President believes
Americans will be able to spend more and this will speed up economic recovery.
According to President Bush,
<BLOCKQUOTE dir=ltr style="MARGIN-RIGHT: 0px">
"By ensuring that Americans have more to spend, to save and to
invest, this legislation is adding fuel to an economic recovery. We have taken
aggressive action to strengthen the foundation of our economy so that every
American who wants to work will be able to find a
job." </BLOCKQUOTE>
The belief that putting more money in consumers' pockets will
revive the economy is based on the popular view that a given dollar increase in
consumer spending will lift economic activity in terms of gross domestic product
(GDP) by a multiple of the increase in consumer expenditure. An example will
illustrate the magic of this multiplier.
Let us assume that on average individuals spend 90 cents and
save 10 cents of each additional dollar they receive. Thus if consumers raise
their spending by $100 million, this will boost retailers' revenues by this
amount. Retailers in turn will spend 90% of their new income, i.e. $90 million
on various goods and services. The recipients of the $90 million will in turn
spend 90% of $90 million, i.e. $81 million and so on. At each stage in the
spending chain people spend 90% of the additional income they receive. This
process eventually ends with GDP rising by $1 billion, i.e. (10*100
million). 
In short, all that is required is to give every American more
money to spend and this in turn should set in motion increases in consumer
expenditure, which in turn will trigger increases in the production of goods and
services. Observe that within the framework of 'the multiplier' savings are
actually bad news. The more people save the smaller the
multiplier. 
The magic of 'the multiplier' however, is just wishful thinking.
Every activity in an economy has to be funded and therefore it is always in
competition with other activities for scarce real funding. Hence if more is
spent on consumption goods, less is left for capital goods. An increase in
retailers' activity will be offset by a decline in the activity of capital
goods producers. 
It is therefore not possible to lift the pace of general
economic activity without an increase in the sources of funding. In other words,
for a given pool of real funding any increase in some activities must mean less
funding for other activities. Now if it would have been otherwise then by the
magic of the multiplier we could have generated an almost unlimited
prosperity.<A title=""
href="http://www.mises.org/fullstory.asp?control=1243#_ftn1" name=_ftnref1>[1]</A>
The proponents of the tax cuts are, however, of the view that
tax cuts generate incentives to work harder and provide incentives for
businesses to expand their activities. Again, without an expanding pool of real
funding irrespective of tax cuts announcements no general expansion in economic
activity can emerge. For every expansion in activity of some businesses, some
other businesses will not have the required funding to embark on
expansion. 
But surely the individuals who will be receiving checks would be
able to spend more and thus lift the economy? Yes, they will be able to spend
more at the expense of those individuals who will not get the checks.
A major driving force behind the increase in the pool of real
funding is the real savings that fund the buildup of tools and machinery, which
in turn makes possible an expansion in the production of final goods and
services. With a greater pool more can be allocated towards consumption and
savings.<A title=""
href="http://www.mises.org/fullstory.asp?control=1243#_ftn2" name=_ftnref2>[2]</A> With more savings it would be possible
to enhance the production structure further, which in turn permits the expansion
of the production of final goods and services-this is what economic growth is
all about. 
Now, what does it mean to lower taxes? It means that Americans
should have greater access to the pool of real funding. The only way this can be
made possible is if government access to the pool is reduced. After all, in
similarity to all other activities, government activities must also be
funded. 
Thus when government decides to promote a particular activity,
this means that the government will supply various individuals that are engaged
in this activity with money. The received money in turn will permit individuals
in that activity to access the pool of real funding. 
Since government is not a real wealth generator it relies on its
sources of funding from the private sector. This in turn means that the more
government spends the less real funding will be available for the wealth
generating private sector. Obviously this will impede the creation of real
wealth and impoverish the economy as a whole. Observe that if government could
generate real wealth, it wouldn't need to tax the private sector.
The effective level of tax then is dictated by
government outlays. The more government plans to spend the more real funding it
will divert from the wealth generating private sector. The mode of
diversion of real wealth from the private sector is, however, of secondary
importance. What matters is that real funding is diverted. The method of taking
real funding can be through direct taxes or indirect taxes and by means of
monetary printing.
Another instrument for the diversion of real funding is by means
of borrowing. But how can this be? After all if a lender transfers his real
funding to a borrower surely this is done voluntarily? Furthermore, a lender
should actually be seen as an investor. He commits his real resources in order
to make a gain. This in turn implies that the borrower must be a wealth
generator in order to be able to repay the original loan plus an
interest.
This is however, not so as far as government is concerned. For
government is not a wealth generator, it only consumes wealth.<A title=""
href="http://www.mises.org/fullstory.asp?control=1243#_ftn3" name=_ftnref3>[3]</A> So how then can the government as a
borrower, which produces no real wealth, ever repay the debt? The only way it
can do this is by borrowing it again from the same lender-the wealth-generating
private sector. In short, it amounts to a process wherein government borrows
from you in order to repay to you. 
It is therefore not possible to have an effective tax cut
without a cut in government outlays. A so called tax cut while government
spending continues to increase is just an illusion. 
Looking at the history of government outlays shows relentless
increases. For 2004 the President's budget outlays stand at $2.229
trillion<A title=""
href="http://www.mises.org/fullstory.asp?control=1243#_ftn4" name=_ftnref4>[4]</A>. This is an increase of 19.8% on the outlays
in the 2001 budget, which President Bush inherited from President Clinton (see
chart). Per capita government outlays since 2001 increased by 17.2% (see
chart).
<IMG src="http://www.mises.org/images2/Shostak/1243/1.gif"
border=0 NOSEND="1"><IMG src="http://www.mises.org/images2/Shostak/1243/2.gif"
border=0 NOSEND="1">
So long as the pool of real funding is expanding various fiscal
tricks appear to work-the multiplier seems to be the real thing. It is only once
the flow of savings disappears all together on account of reckless fiscal and
monetary policies that the facts of reality begin to assert themselves. Once
this happens, irrespective of loose policies the economy falls into a severe
slump.
In this regard, the government-compiled data indicates that the
pool of real funding may be in trouble. Since 1986 real disposable income
adjusted for imputations was below real consumer outlays. Consequently real
personal savings, which are the difference between real disposable income and
real consumer outlays, have been negative since 1986. In 2002 real personal
savings stood at -$321 billion against -$363 billion in 2001 (see chart). The
personal savings rate stood at -8.3% in 2002 against -9.8% in 2001 (see
chart).
<IMG src="http://www.mises.org/images2/Shostak/1243/3.gif"
border=0 NOSEND="1">
<IMG src="http://www.mises.org/images2/Shostak/1243/4.gif"
border=0 NOSEND="1">
In addition to this, the widening in the state and local
government budget deficit means that Americans will be paying more taxes to
state and local governments, which are legally not supposed to have deficits. In
Q1 the state and local government budget deficit stood at $66.9 billion against
a deficit of $50.6 billion in the previous quarter (see chart).
<IMG src="http://www.mises.org/images2/Shostak/1243/5a.gif"
border=0 NOSEND="1">
Luckily for the U.S. however, some important contributors
to government funding are foreigners. Out of the total federal debt outstanding
of $6,198 billion in 2002 (see chart) foreigners held $1,106 billion (see
chart), i.e. 17.9% of the total debt. There is a growing possibility that
foreigners might lower their exposure towards the U.S. government debt implying
that the American private sector would be forced to provide a greater portion of
real funding to the government. For instance, according to the government's own
estimates the Federal debt will jump to $7.3 trillion by 2004, an increase of
17.7% from 2002 and by 2008 the debt is expected to stand at $9.4 trillion, an
increase of 51.6% from 2002. 
<IMG
src="http://www.mises.org/images2/Shostak/1243/5.gif" border=0
NOSEND="1">
<IMG
src="http://www.mises.org/images2/Shostak/1243/6.gif" border=0
NOSEND="1">
We can thus conclude that as a result of ever growing government
outlays and the reckless monetary policies of the Fed, it is mission impossible
to have an effective cut in taxes. That the intention is to grow rather than
shrink the size of the government was demonstrated by President Bush's signing
the increase in the Federal debt limit from $6.4 trillion to $7.384 trillion on
the day he signed into law the tax cuts.
<DIV>
<HR align=left width="33%" SIZE=1>
</DIV>
Frank Shostak is an adjunct scholar of the Mises Institute and a
frequent contributor to Mises.org. </BODY></HTML>

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