You know, sometimes, I don't know why
But this old town just seems so hopeless
I ain't really sure, but it seems I remember the good times
Were just a little bit more in focus
-Tom Petty
It's difficult to deny the divide in Washington these days. It
seems perhaps the divide wasn't so wide long ago. But then it's
easy to rewrite history as romantic and the grass always does seem
greener in hindsight.
For my entire adult life I've been told that Americans need to
consume less and save more. I've also been told that income taxes
need to be either increased or decreased. Many also have argued for
more government spending, while others believe government should be
as small as possible.
It's funny, but the arguments align consistently along political
party lines, no matter the state of the economy (though it is true
politicians don't always "do" as they "say").
It is interesting the consumer savings rate reached 6.9 percent in
May for the first time since December 1993. However, this is most
likely a reflection of fear on the consumer's part rather than a
decided and ongoing change in behavior.
Regarding taxes, arguing for ever-increasing tax rates is as silly
as arguing for ever decreasing tax rates. Instead, we must realize
the "appropriate" tax revenue rate adjusts over time. As the
economy weakens, tax revenue becomes less important than turning
the economy around. As the economy strengthens, we must pay for
previous shortfalls by increasing tax revenue.
Notice I am targeting tax revenue and not tax rates.
Reaching back to our high school economics class (they still teach
this stuff in high school, don't they?) we recall a concept called
"utility." Utility is the total satisfaction received at a certain
level of activity. Remember the old clich
é of the
child caught smoking whose father then locks him in a closet with a
carton of cigarettes until they are gone? Fire safety aside, his
parents certainly teach him a lesson by increasing the quantity of
product until the utility received from smoking becomes negative.
In the nearby chart, you can see a possible utility curve for the
marginal tax rate. In this illustration, utility is the revenue
government receives for a certain level of taxation. You can see
the curve is sloped on both sides, meaning that to get to the top
of the utility curve you may have to either increase or decrease
the marginal tax rate depending upon where you start.
Source: SVB Asset Management
In this specific graph it seems the tax rate should be
lowered in order to maximize tax revenue. However, this is entirely
dependant on
where the utility curve lies.
For example, take a look at Possible Scenario #2. If
this
utility curve is correct, then an
increase in taxes may be
in order.
Source: SVB Asset Management
The crux of the "tax" discussion should be where the curve lies
today. Are we on the up slope or the down slope? Instead, the issue
is obscured by emotion and selfish viewpoints.
Government spending is a topic for another day. But consider this:
The last time income taxes covered such a small portion of
government spending was 1945. In fact, the only times taxes were
less effective in addressing spending than today were the end of
World War I, the Great Depression and the end of World War II.
Simply put, raising tax revenue alone will not significantly drive
the budget deficit towards zero. There will have to be cutbacks in
spending at some point.
Key Developments
Consumer confidence declined in June to 49.3 after spiking from
40.8 in April to 54.8 in May. Much of the recent increase is due to
improvement in the "expectations" index as opposed to the "present
situation" index. The recent market rally has surely driven
consumers' feelings toward the positive.
Construction spending fell in May by 0.9 percent after unexpectedly
rising 0.8 percent in April. The effects of the federal stimulus
package on this sector are making it quite difficult to forecast.
The bounceback expected in May has now been pushed forward.
Nonfarm payrolls decreased by 467,000 in June, over 100,000 more
than expected on the Street. The unemployment rate rose slightly to
9.5 percent, up 70 percent from 12 months ago. Total net job losses
in this downturn now total close to 6.5 million since January 2008.