It is a commonly accepted fact that our government is a bloated beast that, left to its own devices, will consume us all. It is also commonly accepted that it is essential to shrink the size of Big Government, and the way to do that is to "starve the beast" by cutting taxes.
But what if there is evidence to the contrary? What happens when commonly accepted "facts" are shown to not be facts at all? Will the public still believe in those statements? Unfortunately, most of the time they will.
As author Thom Hartmann recently pointed out in his book "Rebooting the American Dream", William A. Niskanen, a key architect of Reaganomics "figured something out that would make Reagan's head explode." There is a strong inverse correlation over the 24 year period from 1981 to 2005 between tax rates and the overall size of government. That is to say, when tax rates go up, government shrinks. When tax rates go down, the size of government gets bigger.
But how can this be? Not only is this counter intuitive, but it flies in the face of what the public accepts as common fact. The reason for the inverse correlation between tax rates and the size of government is actually quite simple, and is within the intellectual grasp of anyone who possesses even the most basic knowledge of the laws of supply and demand.
When taxes go down, you would expect the size of government to shrink. But in the short term, the government's size stays the same, namely because there are essential services that cannot be immediately cut. This is called "tax cuts that are not paid for." The government proceeds as it did before the tax cuts (without making spending cuts), and then borrows or prints money to make up the shortfall.
What happens next is where the supply and demand curve comes into play. Because the public gets the same services but pays less in taxes for them, the cost of these government services is effectively reduced. Tax cuts without spending cuts have the overall effect of reducing the tax payer's cost of government, and therefore encouraging its growth. According to Niskanen, "You make government look cheaper than it would otherwise be."
So what happens when you reduce the price of something, but continue to sustain the supply? The answer is obvious. The demand for that commodity or service goes up. In this case, cheaper government services (because the government subsidizes the shortfall from the tax breaks with borrowed or printed money) leads to an increased demand for government. The supply then increases to meet the demand. This in turn grows the size of government.
On the other hand, in the cases where tax rates were increased, government became "expensive." Once again - the supply and demand curve is in play, as it always is. The price of the commodity or service was increased, while the supply was uninterrupted. This decreases the demand for government services, and in turn, caused the size of government to shrink, i.e. the supply is reduced to meet the lower demand. The tipping point in terms of how tax rates affect spending seems to be right around 19 percent of the GDP. Tax rates above that level tend to decrease spending, and thus reduces the size of government. Tax rates below that level increases spending (and borrowing) and ultimately results in a bigger government.
This seems to contradict the accepted notion that the more money we send to Washington, the more government will increase in size. The flawed idea being, no matter how much money we send to Washington, it will all get spent. They will always grow the government accordingly to a larger and larger size. The historical data shows the opposite. The extra revenue from higher taxes leads to smaller government, and the surplus can be used to balance the budget, and eventually reduce the national debt.
This is an amazing irony, yet it also makes so much sense. Historically, we are in a period of relatively low tax rates (revenues have been well below 19 percent since 2002), and the size of government is large. But yet the answer from the right and from libertarians (and, increasingly so from average middle class Americans) is to cut taxes in order to reduce the size of government. It is in fact these tax cuts that were not paid for during the Bush II administration that grew the size of government to the size that it is today.
Thursday, March 17, 2011
Wednesday, March 9, 2011
The state of the state - Wisconsin style
There has been much written lately about the current situation in the state of Wisconsin. While some say that the Democrats in the Senate should have come back (or never have left) to do their job, others say that Walker has broken the bargain, being too dictatorial in his refusal to make any compromises. The Democrats have done whatever is necessary to draw attention to this issue, and defend the rights that have been fought for by the state workers for so long, even if it means potentially breaking the law to make that case. A right is being taken from the workers. Some may claim that the workers should not have that right to begin with, but they do, and have had for over 50 years. Adjusting budgets and bargaining for benefits and pay is part of the process, and having that stripped away permanently in order to shore up a short term budget crisis (partially of Walker's own making by giving big corporate tax cuts) is a very serious matter. Even people that voted for Walker in November of 2010 are experiencing a case of "buyer's remorse."
But rather than continue to focus on that specific situation in Madison, I prefer to comment on the much broader perspective on what is ultimately in play. This battle is much bigger than what is going on in Wisconsin. This is why the issue has taken such a big place on the national stage.
It's not about the senators fleeing to avoid a quorum, nor the amount of protesters camping out at the State Capitol that is garnering this level of national interest, but rather the fundamental place that we are at in American Politics.
The bottom line is that 30 years of supply side economics have failed our nation's economic interests. Cutting the tax rates on the top earners does nothing for the economy, other than steer it into the greatest economic downturn since the great depression.
The reason for this is simple. Capitalism starts out great when people have the opportunity to succeed. But over time, the invisible hand of capitalism is guided by a visible hand that ultimately concentrates the wealth into the tiniest corners of society. The reason being that once a certain group of people start making a lot more than the rest, they then use their wealth to gain power and influence in government (such as tax loopholes and subsidies, aka "corporate welfare"), and thus continue to tilt the playing field in their direction.
This results in the perpetual cycle of a smaller and smaller group of people controlling more and more of the nation's wealth. The argument that I am about to make is not a political one of left vs. right, liberal vs. conservative, or even of the haves vs. the have-nots. It is simply an argument of mathematics and basic supply and demand economics.
When the wealth is concentrated into the hands of the few, the middle class simply can no longer afford to purchase the goods and services that they are capable of producing, and that leads to economic stagnation. The demand cannot meet the supply. The demand has to come from the middle class, because the small number of people that control most of the wealth spend only a small percentage of their earnings.
This is where the "supply siders" come in. The idea is that the people at the top will eventually have so much money to invest that they will increase the supply chains by expanding their businesses and hiring more people. Then the demand will be forced to meet up with the supply, and everyone is happy. But the problem is, economies cannot be supply driven. They must be demand driven, and the demand has to come from the people that spend most of their earnings - the middle class. Once the business owners realize that the middle class doesn't have any more money to spend (and cannot borrow any more, after the bursting of credit and then real estate bubbles), it does not take them long to figure out that expanding their businesses would be foolish. The whole "supply side" process then gets stalled, and so does the economy.
Specifically in the case of the state of Wisconsin, cutting working class wages (by increasing the cost of benefits to the workers, and ultimately rescinding their collective bargaining rights) to solve a short term budget crisis is going to do much more damage to the state's economy - and its ability to balance the budget - in the long term.
The damage done by the concentration of wealth into the highest percentile of the population is three-fold:
The second point is that sacrificing long term goals (such as educating future generations) for the purpose of solving short term budget gaps is only going to create more crises in the future. It is imperative that we provide quality education for our citizens so that we can compete in a global economy - one in which the world is increasingly handing our asses to us with regards to educating future generations.
The third point is that the ultra wealthy do not spend the extra money they get to keep when they get a huge tax cut. Do they save all that money? No, not in a conventional sense.
The middle class has been duped into thinking that the ultra-wealthy really do spend more when they get a tax cut, and ultimately, that money goes into the general economy, and "trickles down" into the hands of the middle class. But what really happens is that the ultra-wealthy spend only a tiny fraction of their income - with or without the tax cuts.
The reason for that is because, even though $80 an ounce caviar and $350 bottles of wine looks to the average person like a lot of money being spent, in actuality, it really is only a tiny fraction of what the ultra-wealthy keep for themselves. They are spending money like it is going out of style - as fast as they can. But when you are talking about 700 million dollar stock options for a health insurance company CEO, or 1 Billion dollars in fees for a hedge fund manager (who only pays 15% tax on his income because of a loophole that allows him to count those earnings as long-term capital gains, rather than ordinary income), the fact is, no one can really spend that much money.
Never mind the fact that more of the money would get spent if it were divided amongst a larger number of people. (One Billion dollars for one hedge fund manager equals a $50,000 annual salary for 20,000 people.)
The real point is that there is a great deal of unspent money left over, and that money does not get saved either. The money ends up fueling speculative bubbles, which causes bank failures, stock market crashes, and ultimately only serves to create a tremendous amount of market volatility in general.
Is this class warfare? In some ways it is not, but it should be. The billionaires that are gaming the system are pitting the middle class against one another. This results in a disproportionate amount of middle class people voting against their own economic interests. After all, if an economic policy that only benefits the top 1% of wage earners or less is going to be politically viable, it requires that roughly half the population be duped into shooting itself in the foot. As I always say, the self-inflicted wound is always the most painful.
The real solution is for the middle class to unite and stand together. A rising tide lifts all boats, which has been used in the past to claim "when the rich do well, so does everyone else." But in this case the meaning is, when the unions get a good deal, so does the rest of the middle class. Better wages for public union workers and a more reasonable progressive tax structure benefits all working people.
But what if the taxes were raised not just on the wealthy, but on everyone? Still a better deal for the middle class. In the short term, higher taxes means less money in the pocket of the average worker, but in the long run, higher tax rates actually hurt the wealthy more than the middle class. More revenues can be raised, budgets can be balanced, schools, health care and infrastructure can be funded, and middle class wages will actually go up.
Think about it - if you are a private sector employee that is not getting this "sweet pension deal" that the public sector union workers get, who do you have more in common with? The teacher, policeman or firefighter? Or the Wall Street hedge fund manager that makes a billion a year and does not even pay their fair share due to Washington lobbying (aka bribery) that enables them to get special loopholes written into our laws?
It's time for America to choose sides, and that entails defining who is one one side, and who is on the other. It is time for middle class Americans to stop being duped into letting the people at the top game us into fighting amongst each other based on ideological grounds. It's time to look at the real mathematics and economics of the situation and stand together against the big corporations, Wall Street, billion dollar hedge fund managers, and 700 million dollar CEOs.
But rather than continue to focus on that specific situation in Madison, I prefer to comment on the much broader perspective on what is ultimately in play. This battle is much bigger than what is going on in Wisconsin. This is why the issue has taken such a big place on the national stage.
It's not about the senators fleeing to avoid a quorum, nor the amount of protesters camping out at the State Capitol that is garnering this level of national interest, but rather the fundamental place that we are at in American Politics.
The bottom line is that 30 years of supply side economics have failed our nation's economic interests. Cutting the tax rates on the top earners does nothing for the economy, other than steer it into the greatest economic downturn since the great depression.
The reason for this is simple. Capitalism starts out great when people have the opportunity to succeed. But over time, the invisible hand of capitalism is guided by a visible hand that ultimately concentrates the wealth into the tiniest corners of society. The reason being that once a certain group of people start making a lot more than the rest, they then use their wealth to gain power and influence in government (such as tax loopholes and subsidies, aka "corporate welfare"), and thus continue to tilt the playing field in their direction.
This results in the perpetual cycle of a smaller and smaller group of people controlling more and more of the nation's wealth. The argument that I am about to make is not a political one of left vs. right, liberal vs. conservative, or even of the haves vs. the have-nots. It is simply an argument of mathematics and basic supply and demand economics.
When the wealth is concentrated into the hands of the few, the middle class simply can no longer afford to purchase the goods and services that they are capable of producing, and that leads to economic stagnation. The demand cannot meet the supply. The demand has to come from the middle class, because the small number of people that control most of the wealth spend only a small percentage of their earnings.
This is where the "supply siders" come in. The idea is that the people at the top will eventually have so much money to invest that they will increase the supply chains by expanding their businesses and hiring more people. Then the demand will be forced to meet up with the supply, and everyone is happy. But the problem is, economies cannot be supply driven. They must be demand driven, and the demand has to come from the people that spend most of their earnings - the middle class. Once the business owners realize that the middle class doesn't have any more money to spend (and cannot borrow any more, after the bursting of credit and then real estate bubbles), it does not take them long to figure out that expanding their businesses would be foolish. The whole "supply side" process then gets stalled, and so does the economy.
Specifically in the case of the state of Wisconsin, cutting working class wages (by increasing the cost of benefits to the workers, and ultimately rescinding their collective bargaining rights) to solve a short term budget crisis is going to do much more damage to the state's economy - and its ability to balance the budget - in the long term.
The damage done by the concentration of wealth into the highest percentile of the population is three-fold:
- not enough revenue flowing into the state to balance the budget
- deterioration of education and other critical services
- creation of speculative bubbles that lead to a variety of market volatility
The second point is that sacrificing long term goals (such as educating future generations) for the purpose of solving short term budget gaps is only going to create more crises in the future. It is imperative that we provide quality education for our citizens so that we can compete in a global economy - one in which the world is increasingly handing our asses to us with regards to educating future generations.
The third point is that the ultra wealthy do not spend the extra money they get to keep when they get a huge tax cut. Do they save all that money? No, not in a conventional sense.
The middle class has been duped into thinking that the ultra-wealthy really do spend more when they get a tax cut, and ultimately, that money goes into the general economy, and "trickles down" into the hands of the middle class. But what really happens is that the ultra-wealthy spend only a tiny fraction of their income - with or without the tax cuts.
The reason for that is because, even though $80 an ounce caviar and $350 bottles of wine looks to the average person like a lot of money being spent, in actuality, it really is only a tiny fraction of what the ultra-wealthy keep for themselves. They are spending money like it is going out of style - as fast as they can. But when you are talking about 700 million dollar stock options for a health insurance company CEO, or 1 Billion dollars in fees for a hedge fund manager (who only pays 15% tax on his income because of a loophole that allows him to count those earnings as long-term capital gains, rather than ordinary income), the fact is, no one can really spend that much money.
Never mind the fact that more of the money would get spent if it were divided amongst a larger number of people. (One Billion dollars for one hedge fund manager equals a $50,000 annual salary for 20,000 people.)
The real point is that there is a great deal of unspent money left over, and that money does not get saved either. The money ends up fueling speculative bubbles, which causes bank failures, stock market crashes, and ultimately only serves to create a tremendous amount of market volatility in general.
Is this class warfare? In some ways it is not, but it should be. The billionaires that are gaming the system are pitting the middle class against one another. This results in a disproportionate amount of middle class people voting against their own economic interests. After all, if an economic policy that only benefits the top 1% of wage earners or less is going to be politically viable, it requires that roughly half the population be duped into shooting itself in the foot. As I always say, the self-inflicted wound is always the most painful.
The real solution is for the middle class to unite and stand together. A rising tide lifts all boats, which has been used in the past to claim "when the rich do well, so does everyone else." But in this case the meaning is, when the unions get a good deal, so does the rest of the middle class. Better wages for public union workers and a more reasonable progressive tax structure benefits all working people.
But what if the taxes were raised not just on the wealthy, but on everyone? Still a better deal for the middle class. In the short term, higher taxes means less money in the pocket of the average worker, but in the long run, higher tax rates actually hurt the wealthy more than the middle class. More revenues can be raised, budgets can be balanced, schools, health care and infrastructure can be funded, and middle class wages will actually go up.
Think about it - if you are a private sector employee that is not getting this "sweet pension deal" that the public sector union workers get, who do you have more in common with? The teacher, policeman or firefighter? Or the Wall Street hedge fund manager that makes a billion a year and does not even pay their fair share due to Washington lobbying (aka bribery) that enables them to get special loopholes written into our laws?
It's time for America to choose sides, and that entails defining who is one one side, and who is on the other. It is time for middle class Americans to stop being duped into letting the people at the top game us into fighting amongst each other based on ideological grounds. It's time to look at the real mathematics and economics of the situation and stand together against the big corporations, Wall Street, billion dollar hedge fund managers, and 700 million dollar CEOs.
Monday, March 7, 2011
Misconceptions about the S&P 500 index
Let's start by looking at some fun facts about the S&P 500 Index:
The index was down 5.77% over the 10 year period.
That is an annualized rate of -0.56% for 10 years.
However, if one had invested $10,000 in the S&P at the end of 2000, then as of Dec 31, 2010, they would have had $11,507. That's a 10 year total return of 15.1%, which comes out to a 1.41% return annually for 10 years.
So what?
The S&P is a free floating market capitalization adjusted index. So it is true that whenever a company pays dividends, then S&P adjusts the weighting of that company in the S&P 500 accordingly, because the dividend distribution changes the market cap. However, the dividends that those companies actually pay out are NOT reflected in the S&P index, even though most investors of S&P 500 index funds do reinvest the dividends.
So it's the reinvested dividends that account for the discrepancy. S&P 500 index does not reflect those dividends, but "growth of 10,000" figure does.
It is misleading to say that the S&P 500 index is adjusted for dividends. Only the weighting of the company based on market cap is adjusted. The dividends themselves are counted as a distribution OUT of the S&P 500, and therefore not reflected in the index itself.
Basically, I am just sick of the distortion of the facts in the case of so many reports of the S&P being lower now than it was 10 years ago. That part is true, but then they usually go on to say that you would have lost money in the S&P over the past 10 years, which is NOT true.
Now granted, a 1.41% annualized return is pretty dismal, but making $1,507 profit on every $10,000 invested is a far cry from being a loss.
I guess I feel like this type of distortion makes the average person feel like stocks are not a good investment by making them feel like they will lose money.
- S&P 500 index closed at 1334 at the end of 2000
- S&P 500 index closed at 1257 at the end of 2010
The index was down 5.77% over the 10 year period.
That is an annualized rate of -0.56% for 10 years.
However, if one had invested $10,000 in the S&P at the end of 2000, then as of Dec 31, 2010, they would have had $11,507. That's a 10 year total return of 15.1%, which comes out to a 1.41% return annually for 10 years.
So what?
The S&P is a free floating market capitalization adjusted index. So it is true that whenever a company pays dividends, then S&P adjusts the weighting of that company in the S&P 500 accordingly, because the dividend distribution changes the market cap. However, the dividends that those companies actually pay out are NOT reflected in the S&P index, even though most investors of S&P 500 index funds do reinvest the dividends.
So it's the reinvested dividends that account for the discrepancy. S&P 500 index does not reflect those dividends, but "growth of 10,000" figure does.
It is misleading to say that the S&P 500 index is adjusted for dividends. Only the weighting of the company based on market cap is adjusted. The dividends themselves are counted as a distribution OUT of the S&P 500, and therefore not reflected in the index itself.
Basically, I am just sick of the distortion of the facts in the case of so many reports of the S&P being lower now than it was 10 years ago. That part is true, but then they usually go on to say that you would have lost money in the S&P over the past 10 years, which is NOT true.
Now granted, a 1.41% annualized return is pretty dismal, but making $1,507 profit on every $10,000 invested is a far cry from being a loss.
I guess I feel like this type of distortion makes the average person feel like stocks are not a good investment by making them feel like they will lose money.
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