Saturday, November 13, 2004

The Benefit of Tax Cuts

Most conservatives nowadays do not think clearly, and so don't develop a complete picture of things.
One example: tax cuts.
Most people think of tax cuts as good because they give us more money. It's a little more complicated than that.
As long as there are deficits, tax cuts themselves do not reduce the amount of money the government takes out of the world economy. Spending cuts do. Tax cuts simply alter how the government takes the money out. (When there is a surplus, spending cuts do not reduce the amount of money taken out of the economy, but tax cuts will, for reasons I will explain shortly).
Basically, if the government wants to spend more money thatn it has, it has four choices:
(1) Raise revenues with taxes
(2) Borrow money from its citizens
(3) Borrow money from foreigners.
(4) Print money to pay its bills (i.e. inflation).

Option (1) obviously takes money out of the economy, in a way that most taxpayers have only slight control over (e.g. they can, to varying degrees rearrange their investments and alter their spending and earning habits to reduce the burden).
Option (2) is somewhat better in the short run because while it still takes money out of the economy, people have much more freedom to choose whether or not they will loan the government money (e.g. buy bonds). To the extent that lowering taxes and making up the difference by domestic borrowing helps the economy, it is because of the fact that the citizens have more control over who loans and so it is more similar to a fre market. The downside of course is that bonds need to be paid back, so there has to be a constantly willing supply of creditors to keep covering the repayment of old bonds, or else eventually, options 1,3, or 4 will have to be used to pay back the bonds.
Option (3) has the benefit of option 2 as well as the added benefit that the money won't come out of the domestic economy, but the same drawbacks as #2, and the additional drawback that it puts the country at the mercy of foreign creditors.
Optiuon (4) is more destructive than taxes, because it destroys paper wealth and thus the incentive to save. If you believe that saving capital rather than unbridled consumption is the key to long-term economic growth, than this is a dismal opion indeed - especially seeing as it also will pretty much dry up any reliance on Options 2 and 3 (who will lend to someone if the interest they get is eaten up by inflation?)

Spending cuts, on the other hand, allow money not to be borrowed or devalued, keeping resources in the private sector.

With a surplus, things go in the opposite direction; extra money goes to a wealth transfer to the government's creditors (although in the long run it will decrease the amount of money given to the creditors by reducing the principle and thus future interest charges) or if the government is a creditor, to whatever projects the government wants to invest in. Therefore, in times of surplus, reducing spending will just shift the government's control of revenues from consumptive spending to investment (e.g. loaning to other countries or actually becoming an investor in private businesses in some way, or maybe buying land).

Of course, the best course of action is to reduce both spending and taxes, which will always reduce the government control of the economy.

What's my point here, you may ask? Simple. Until Bush decides to cut spending somewhere, his tax cuts are only minimally fiscally conservative.

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