Tax cuts are inflationary? You're dreaming, Mr Cullen

A long post this morning, but I believe the length is commensurate with the subject's importance. After all, this is our money we're talking about.

The idea of tax cuts appearing in the next Budget or in any Budget delivered by the Clark Government has always been summarily dismissed with the claim that "we" can't afford tax cuts now, or tomorrow or next week or next year. Well, maybe next year. There's an election next year and they're behind in the polls. So maybe. Just maybe. But we still can't afford them, says Cullen.

Now, the reason repeatedly given for spurning tax cuts is that "tax cuts are inflationary" -- more money in people's hands will supposedly just generate a big spend-up. (Meanwhile Cullen and Clark continue to peddle the illusion that the billions spent on Welfare for Working Families, student loan interest write-offs, and the Clark Government's annual $20 billion spend-up aren't inflationary. No, no no.) This "reason" was repeated as recently as yesterday in Questions in the House.

The reason is nonsense.

THE FALLACY BEING PEDDLED HERE obscures the simple economic fact that if tax cuts were implemented, total spending wouldn't change. All that would change is who spent it.

You see, the argument that tax cuts would be inflationary rests on the premise that tax cuts would "overheat demand." But the flaw in that premise is that the total amount that is spent in the economy now is no less under the Cullen/Clark status quo scenario of tax and tax and spend and spend than it would be if we could all keep what is rightfully ours; instead it is just transferred from the individuals who produced it and it is spent instead by the Wastemaster General on things you never said you wanted. The total amount spent either way is no more; all that changes is what your money is spent on, and who decides.

In other words, if taxes were cut as they should be, then the total amount being spent in the economy would be no more than it is now. To say it again: All that would change with, say, a billion-dollar tax cut is what it's spent on, and who's spending it.

With any sort of proper and substantial tax cut there would be a drop in demand for everything inflated by government spending. There would be reduced pressure on, for example, Wellington commercial property, where demand has increased exponentially to house the exploding number of bureaucrats employed since 1999; there would be reduced upward pressure on the salaries of consultants and higher-level bureaucrats; and there would be reduced upward pressure (hopefully) on the spin doctors who have to spin untruths to sell the lie that tax cuts cause inflation.

And since taxpayers would now have more of their own money back, there would undoubtedly be increased demand for a host of other products and services than those holes down which the Wastemaster General presently pours our money -- but that increased demand for those products and services would be balanced out by the commensurate reduced demand for the drainholes down which our money is presently poured.

The immediate effect of this shift of demand would be to depress prices in the already over-inflated sectors of the economy in which government largesse is the order of the day (you'd see a fall for example in the prices of Wellington commercial property, high-rent advertising agencies, state health care, state education provision, and in the salaries of consultants and bureaucrats) and a transfer of production to other goods that people actually want and that previously had to go unsatisfied (a newer or better car or computer, extra education, health insurance, better and more nutritious food, paying off the mortage).

Unless you're either a Wellington commercial property owner or a consultant or bureaucrat, that would be a good thing.

A SECOND POINT TO MAKE is that if tax cuts of $1 billion were implemented, then that would actually be less of a threat to inflation than is the status quo because unlike the tax and spend status quo, part of this $1 billion returned to taxpayers would be saved by those taxpayers. It's true. In fact if Treasury is correct, and there's no reason to suggest they aren't, "the proportion saved could be expected to be higher if they were focused mainly on reductions to the 39 and 33 percent tax rates." The bigger the tax cuts, the bigger the savings. (By contrast, all of the $1.6 billion spent on Welfare for Working Families is spent on increased consumption --and that includes the "consumption" costs of the extra parasites to administer the welfare -- pushing up prices; meanwhile Transit's shortfall of $600 million is caused mainly by the increased cost of construction caused by the roading industry working at capacity due to the inflated demand of Cullen's roading budget; and the same cost inflation is reflected in the state's die-while-you-wait health system, where both spending and prices have increased by about 8% a year for the last ten years, and in the state's factory schools where spending has increased by 6% a year for the last ten years, with consequential increases in prices.)

Saving, by the way, is a good thing. Private saving, that is, since in a very real sense it's saving that fuels wealth. Here's how: You see, saving doesn't just reduce demand. Savings don't go into a hole in the groun. In fact, as all non-Keynesian's understand, saving is simply the flip-side of investment.

Saving is not hoarding: saving one's income does not take it out of production; rather, it makes 'seed capital' available to build and grow productivity in areas in which entrepreneurs see opportunity. Savings don't just go into a hole in the ground, savings is where capital comes from, and it's capital that makes us all more productive. And paradoxically, it's tax cuts for rich people that would help most in the long term!

Rich people who like to remain rich do not consume the majority of their wealth on champagne, caviar, nights out with Paris Hilton and large donations to global warming skeptics -- more's the pity -- instead they invest their money, producing new capital goods. Explains Reisman:

The truth, which real economists, from Adam Smith to Mises, have elaborated, is that in a market economy, the wealth of the rich—of the capitalists—is overwhelmingly invested in means of production, that is, in factories, machinery and equipment, farms, mines, stores, and the like. This wealth, this capital, produces the goods which the average person buys, and as more of it is accumulated and raises the productivity of labor higher and higher, brings about a progressively larger and ever more improved supply of goods for the average person to buy.

Now, as you'll have heard before, the chief reason for the lack of productivity of New Zealand workers is the relative lack of productive capital invested here; more tax cuts allowing more saving is one very simple way to change that, and to make investment capital available.

But there's more!! If tax cuts do increase demand, then the increased demand caused by tax cuts will be met by the increased production brought about by this increase in capital -- the new capital allows producers to meet the new demand for goods that people actually want (or in reducing demand on mortage credit), which reduces any rise in prices caused by that increased demand.

It just keeps getting better. Tax cuts are not inflationary -- tax cuts are good! Good for strong non-inflationary growth! You want some of that?

IT MAY BE THAT Cullen is honestly mistaken in claiming that tax cuts would cause inflation, rather than just mendacious. That's possible. After all, there are supposedly eminent economists (starting perhaps with the supposedly eminent John Maynard Keynes) who fail to understand how production and consumption are related economically, causing them to completely misunderstand inflation, or even real-life economics.

If inflation is to be kept down, according to this mistaken view, then "purchasing power" must be kept either level with or below the level of production. In order to do that governments must mop up "surplus" purchasing power and put it under the mattress for a rainy day. That's what Cullen thinks he's doing. It's a view that fails to realise that just as savings and investment are two sides of the same coin, so too are production and "purchasing power. It's an error that Michael Cullen repeated in the House yesterday. It's a kind of Social Credit A+B theorem that finance ministers tend to subscribe to because it makes them look important.

They're not, except in a destructive sense.

The fact is, as Jean Baptiste Say and James Mill [pdf] pointed out many decades ago, is that it doesn't need a finance minister however highly paid to keep purchasing power and production in line. They don't need to because in reality they're part of the same thing: purchasing power grows out of production. As I say, they're two sides of the same coin.

Economist Benjamin Anderson explains the point in a way that even Keynes and Cullen could surely grasp if they put heir minds to it:

... purchasing power grows out of production. The great producing countries are the great consuming countries. The twentieth-century world consumes vastly more than the eighteenth-century world because it produces vastly more. Supply of wheat gives rise to the demand for automobiles, silks, shoes, cotton goods, and the other things the producer wants. Supply and demand in the aggregate are thus not merely equal, but they are identical [italics added], since every commodity may be looked upon as either supply of its own or as demand for other things. But this doctrine is subject to the great qualification that the proportions must be right; that there must be equilibrium [ in other words, that there must be a proper relationship between different kinds of production and different kinds of services that hasn't already been dislocated by government, but that is set by the relationship between prices and costs, and prices and wage-rates].

So what would happen then if the finance minister were to let people actually keep the fruits of their production ... ? Well, you work it out. But I assure you, if the come up with the answer, "It would be inflationary," then you go to the bottom of the class.

NOW, THERE WILL BE some clever dicks who point out that if $1 billion is taken from the "surplus" and devoted instead to tax cuts, and that amount is not presently being spent but is instead just sitting around in the bank, then that does represent a real increase in spending. This argument has more legs but they're just as spindly, and it's impossible to see how anybody on the Government side of the aisle can really run it seriously.

You see, if there were an inflationary impact from" funding" tax cuts out of the enormous surplus that we're all presently paying for, then it would be an impact almost exactly the same as that from a monetary injection, and oddly enough a monetary injection is what we've been getting for the last few years -- a year-on-year 12-15% increase in the money supply -- and no one but the economists calling for tax cuts have been noticing!

That's right: The same people who argue against tax cuts because they are inflationary are the same people who totally ignore the enormous increase in the money supply! As Gerard Jackson says of the very successful Australian tax cuts, "One can only wonder at the intellectual powers of [people] who fear the so-called inflationary consequences of tax cuts while blithely ignoring the Government’s massive monetary expansion."

Reducing that monetary expansion on its own would be a good thing. Reducing it and funding tax cuts would be even better.

THE MAIN POINT TO make here is that tax cuts do not work simply by putting money in people's pockets. If they did, then just having government give money to people could guarantee growth, and we all by now that that doesn't work. But taxing or borrowing money from one group to give to another does not encourage productive economic activity. Quite the opposite. The basic moral fact is that tax cuts give you back your own money. And the basic economic fact (which everyone but Keynesians should understand) is that tax cuts work not by stimulating demand, but by increasing the incentives for new investment, and by providing the capital for that investment to happen.

SO WHY STICK TO $1 BILLION? If all my arguments above are true for $1 billion, then they're just as true for 5 or10 or even $20 billion -- and if $20 billion was slashed off the tax bill, we could all get a decent tax cut.

And it's not like the Goverment has been doing anything productive with the $20 billion per year it spends in real terms over what it spent in 2000. As Phil Rennie convincingly demonstrated recently in his report on New Zealand's Spending Binge, the Clark Government has produced nothing with that spending binge -- nothing at all:

Core government spending is now almost $20 billion a year higher than it was in 2000, a 32% increase in real terms ... [yet t]he available social indicators we have show negligible improvements since 2000. Life expectancy, infant mortality, hospital outputs, literacy, violent crime, suicide, poverty and income inequality have barely changed despite a massive increase in social spending.

"Nothing at all," that is, beyond inflating demand in the sectors down which they've poured our money.

Further, as Rennie points out [check out his report either on the net or in the latest Free Radical], the $20 billion overspend is so much that if this extra $20 billion of expenditure was allocated to tax cuts, nearly all income tax could be abolished, and all remaining public services funded solely by a combination of GST and a low corporate tax rate.

That's something even (or even especially) low-paid and over-taxed Labour voters might care to consider.

SO WHY WOULDN'T YOU DO THAT? Why wouldn't you reduce taxes by at least $20 billion right across the board when it's never been so easy to do it?! Clearly, Cullen's objections to tax cuts are not based on economic sense. His objections are simply his own private ideological burp for which we're all required to pay -- and pay through the nose we have been.

Clark and Cullen tell us their spending binge represents "investment." What nonsense. Contrary to Keynesian myth, government spending is not "investment" at all (a cruel joke) -- unless you want to categorise it as misinvestment, or even malinvestment. In reality, it's not investment at all but plain old-fashioned wasteful "consumption" spending. The "consumers," in this case, are the politicians and government officials who leech off the productive private sector.

Reducing demand for these parasites would be nothing but a good thing for all of us.