As the end of the year draws nearer, the expiration of tax cuts passed in 2001 and 2003 also begins to creep over the horizon. As this happens, our federal government continues to spend what seems to be an infinite line of credit. Recent financial and health care reforms bring with them cost estimates that undoubtedly understate true costs. The same can be said about unemployment extensions.

The egregious amount of deficit spending is leaving taxpayers with a sizable bill. The federal government would like the “rich” (those that make more than $200,000 in pre-tax income) to pay a higher proportion of that bill, making them the lucky recipients of a tax rate increase. The politics of the tax cuts have already begun. It seems like an impossible task for Washington to divorce the economics from the politics. At this point in history I’m betting that that those individuals and families in the highest tax brackets will certainly see a tax increase come January.

The president recently said, “There will be no more taxpayer-funded bailouts. Period.” But, as Dan Henninger of the Wall Street Journal points out, “Raising taxes to cut the deficit is a bailout for the spenders.”

I’m beginning to think that an effective training regimen for politicians would include an undergraduate degree in linguistics.

Maybe I am missing something. Maybe classical microeconomics has become outdated and doesn’t adequately reflect decisions in the real world anymore. Maybe the nuance of their arguments is too much for me. Or maybe they’re wrong.

Economists have been developing mathematical equations since the days of Adam Smith, attempting to ascribe reality to a system of variables that can be changed and tweaked to more accurately reflect what economists empirically see. The problem with these equations is that they are not reality. That being the case, it is best to avoid needless complication.

Someone best illustrated this to me using the game of billiards as an analogy. Hitting the cue ball into the eight ball in an effort to send the eight ball into a corner-pocket requires skill and accuracy. Ricocheting the cue ball off the rail into the three ball which then will kiss the nine ball on its way into the two ball which will subsequently fall into the pocket is an entirely different problem. The more complex the system gets, the more accuracy is required, and initial mistakes are magnified further down the line.

Intertemporal decision making can be a complex problem to study, but most of the world makes such decisions intuitively — we are all practicing economists. The amount available for future consumption is future income plus savings plus the amount of interest earned on savings. If savings are negative, the person is borrowing and must pay back the amount borrowed plus the interest in the second period. This has the effect of reducing future consumption.

Future Consumption: P₂C₂ = M₂ – M₂t + S + iS

This means that today’s purchases change tomorrow’s parameters.

Current Consumption: P₁C₁ = M₁ – M₁t – S

Reality is an integration of these two equations. We do it constantly, and instantaneously most of the time. Income (M₁ & M₂) is a function of spent spent in leisure and work, and wages. People often decide how much they will work based on how much they plan to consume and how long it will take them to achieve the desired amount of income for that consumption (this also allows income to implicitly represent labor decisions in these micro equations).

Enter government, with a budget constraint that looks very similar. What is different is that the government doesn’t have to make labor decisions; it makes taxing decisions, and consumes through expenditures.

Government Expenditures: p₁E₁ = M_G + S

Government Revenue: M_G = M₁t (this form represents an income tax)

Taking from the income produced by others is the government’s only real source of revenue. This has two very obvious implications: 1) Taxation has an obvious impact on private consumption decisions, because it subtracts from real income (this also affects savings and consumption patterns, both now and later); and, 2) tax rates and government expenditure choices signal to the public the likely outcome of future taxation and expenditure decisions. This model of the aggregate economy suggests that eliminating the tax cuts will have deleterious effects on output and employment.

For some reason, Keynesian economists believe they have the power to affect the M₁ variable in this equation on a massive scale. The government is just adding pool balls to the equation. When the government decides to increase expenditures, it also has to increase revenue, by increasing the tax rate (t) now or in the future (after borrowing). This will have a negative effect on personal income, which translates to a decrease in personal consumption. The government has also decided to implement a progressive income tax structure. This means that, as M₁ increases, so does t. Because people tend to make decisions based on marginal welfare at their original consumption pattern, the last unit of consumption is roughly equal to the leisure that a person gives up to work that extra little bit so they can afford that last bit of consumption. With a progressive income tax, or an increase in the tax rate on any person, production is decreased at a marginal rate. When this happens to 300 million people at the same time, we begin to see problems.

The opponents of tax cuts often ask: What is the difference between swelling the public sector and cutting taxes, in terms of the federal government’s deficit? The answer is that they have different compensation structures and lead to different production decisions. Public money doesn’t force firms (whether they are public firms, or private firms contracted by the government) to make marginal decisions that maximize efficiency. Unfortunately, this means that public money is attached to inefficiency margins for anyone accepting it. Raising taxes therefore has a double whammy effect: Private production slows based on marginal decisions, and when it is converted to public money, it integrates inefficiency into each dollar.

Does this sound like a good prescription for an ailing economy?

As the president tries to ramp up education reform with the administration’s new Race to the Top funding structure, he is receiving blow-back from the NAACP and a number of other groups. Their major critique of this most recent outreach program is that a funding structure based on competitive incentives during a recession cannot help the massive education problems that exist in the nation’s low-income communities.

The statement that the civil rights and other activist groups produced at the end of July suggested as a solution more of the status quo — or, at least, more for the status quo. It seems that their position is to give current schools more money (with no qualifier) and trust them to fix the problems.

Unfortunately, the economic reality is that money doesn’t grow on trees. Whether or not this attempt at ensuring that the dollars devoted to education are spent effectively actually achieves all the program’s goals, competition for the grants will hopefully create change in a stagnant system.

One of the criteria in this system that the civil rights groups oppose is the use of charter schools. Today, an article in the Wall Street Journal pointed out that minority support for these institutions is on the rise, and the numbers suggest that nearly 50 percent of African Americans and Hispanics support the formation of charter schools, while only 14 percent of African Americans and 21 percent of Hispanics oppose them. It is time for these groups to stop playing politics in education. The current system doesn’t work.

The Show-Me Institute’s most recent policy study shows that superintendents in school districts across the state are receiving compensation based not on performance factors, but rather correlated with school district characteristics, such as population size.

The time to reform education is now; competition and a fundamental change in how schools are funded have a far better chance of helping the kids that need it most. Although Missouri is not on the short list to receive any of the grants, we should pay close attention to this new federal market-based funding structure and track its results.

Eminem released a new CD in June. There is a track on the album titled “Talkin’ 2 Myself.” Sometimes I feel the exact same way:

Can anybody hear me yeah, I guess I keep talking to myself
Feels like I’m going insane, am I the one who’s crazy?

The president recently signed the Improper Payments Elimination and Recovery Act. I might favor this type of reform if the fraudulent payments it intends to target were recovered in a cost-effective manner. But is this law even needed?

Here’s a quote from the White House Blog:

Last year, improper payments by the Federal Government added up to $110 billion.

If a publicly owned corporation misplaced $110 billion dollars, it would be more than reprimanded — it would be bankrupt and out of business.

This legislation shows in unadulterated clarity the inherent flaws of government. The federal agencies responsible for this irresponsible behavior will be fined and face “penalties and other repercussions,” but I wonder who exactly the federal government thinks pays for penalties levied on federal agencies.

And people wonder why consumer confidence is low.

The Kansas City Star recently wrote that the Power and Light redevelopment project in downtown Kansas City will cost more than originally planned. The city originally lent the project $295 million, but now estimates that it will cost taxpayers another $230 million by 2033.

The project, cast as a “self-sustaining venture,” has had trouble occupying its 511,000 square feet of retail space. City planners blame the vacancy on the downturn of the economy. Without a fully occupied site, the project is having trouble recapturing the tax dollars originally allocated to finance the project.

This is not to say that the project was a failure, but rather to point out the difficulty in predicting its success. Of the original $295 million, $212 million was used to rebuild infrastructure around the project area (which could more readily be considered a legitimate expense). Many of my friends love the Power and Light District as a weekend hangout, but rosy projections and rationalization won’t save taxpayers any money.

A perfect example of the inherent fallacy of utilizing a centralized plan is found in Nassim Nicholas Taleb’s book The Black Swan. He writes:

The inability to predict outliers implies the inability to predict the course of history, given the share of these events in the dynamics of events.

Governments who believe they have a better chance than individuals of predicting future events have the tendency to be vastly irresponsible, and the bill almost always lands at the feet of the taxpaying public.

As plans like Kansas City’s Power and Light District come together, they are sold to the public in the most favorable light with the most favorable projections. Unfortunately, those projections almost never translate in the real world. Public projects usually cost more than expected and produce less.

The fact remains that the project has been undertaken, and I believe City Manager Troy Schulte put it best:

“20-20 hindsight is always good, but I’d tell taxpayers to come down and enjoy downtown, because you’re paying for it,” he said.

Please join the Show-Me Institute and the John Cook School of Business at Saint Louis University in the fourth annual Friedman Legacy of Freedom event. The event will take place on Friday, July 30, from 11:30 a.m. to 1:30 p.m., and will feature a panel of economists from the region who will discuss Friedman and his lasting impact on economics. Economists Dr. Michael Podgursky from the University of Missouri–Columbia, Dr. Susan Feigenbaum from the University of Missouri–Saint Louis, and Dr. Daniel Thornton from the Federal Reserve Bank of Saint Louis will convene to discuss Dr. Friedman’s contributions and their continued relevance to our economy and our lives.

Click here to register online.

A recent article in the St. Louis Beacon posed a question to local economists that is being tossed around globally:

Given the current state of the economy and the deficit, is this the time to pull back on stimulus spending and pay more attention to the deficit, or should Washington worry more about the short term and let the long term take care of itself?

The Paul Krugman camp, consisting of those economists wanting to stimulate the
recovery through expansive government spending, are — like the spending they are advocating — lost in their own arguments.
In the article, Steve Fazzari, a professor of economics at Washington University in St. Louis, states, “One person’s spending is someone else’s income.” I absolutely agree. But then, in a quick turn of events, he goes on to say, “When the government cuts spending, it’s cutting income to someone.” This is also true, strictly speaking, but the implications of his first statement are more important.

I used to mow lawns, and if my employer had told me that he would give my payment to my brother after I finished my work so that my brother could do some weeding, I would have immediately walked away and taken my labor elsewhere.

If that same employer had given me $10 the week before I was supposed to mow the lawn, two things might have resulted: (1) With cash already in hand, my attention to detail would have suffered considerably; and, (2) I would not have been in any hurry to finish the job.

Historically speaking, capital evolved before credit, and for most of the real world, that is how personal finance is understood — you largely only spend what you have. The problem that got us into this recession was egregious spending beyond our means. If mortgage lenders hadn’t been so eager to hand out money — apart from the fact that home loans were implicitly backed by the federal government’s approval — this last recession most likely could have been avoided.

Without the possibility of high default rates at the micro level, the financial instruments that impregnated the system with risk may never have been implemented on such a large scale. Now, after the crisis, we see the world’s top economists trying to formulate a plan to fix the system. In practice so far, that has involved injecting liquidity into the economy through massive government spending. The Krugman camp claims this is more responsible than private investment, because the Fed can print more money to increase the flow of capital rather than bearing the risks of default. There’s no need to worry about the deficit now, they say; we can take care of that later.

Yet few are buying the empty promises of the government. And why should they? With an aging population and massive health care overhauls on the way, everyone can see that entitlement spending is about to skyrocket. Higher taxes are almost certain. Increasingly larger numbers of the American people are holding onto their money in an effort to maintain liquidity in anticipation of the expiring tax cuts at the end of the year. Stimulus money is falling into the same trap; it’s not multiplying the way Keynesians had hoped because investors are wary of the uncertain economic conditions that may be brought about by still more government spending and higher taxes.

We cannot extricate ourselves from the hole we are in until we stop digging. Americans need to see the sunlight before they are willing to buy an expensive ladder to climb out.

LeBron James recently announced that he will be moving to Miami. This is great news for Miami, but terrible news for the rest of the cities courting him.

An economic impact study commissioned by the mayor of New York City concluded that the LeBron effect would likely inject $60 million per year into the local economy. Not surprising, given that ticket sales, advertising revenues, and team retail in Cleveland had increased dramatically since James’ rookie year.

Because of the way the free-agent landscape worked out, and overall team salary cap requirements, Miami was not able to offer James a competitive contract, while both New York and Cleveland were. But Miami did possess a wild card that the other suitors couldn’t match: tax-relief. No, not in the form of direct incentives, in the form of a healthier tax climate.

Interestingly, Florida does not impose a personal income tax, whereas both Ohio and New York levy personal income taxes of 6 percent and 12.6 percent, respectively, in their highest brackets. On a deal said to be worth around $100 million, that 12.6 percent tax on income wipes out the economic comparative advantage that New York may have had. However, the 6-percent income tax would level the playing field for Miami and Cleveland were it not for Cleveland’s pesky earnings tax. The 2 percent of James’ income that the city of Cleveland could claim was enough to give Miami the fiscal residual it needed to land its new money-making machine.

What can Missouri learn from all this?

Simply put, our current economic development plans may not be able to compete against states with lower taxes. New York may offer James lots of incentives to coax him to the state, but the simple ability to keep the money you’ve earned is a strong incentive in itself.

Right now, our country is in the process of passing legislation that many see as badly needed reform in the financial industry. The reform comes as a reaction to the most recent banking crisis, which sent the world economy into a tailspin.

As we climb our way out of this recession, the last thing we need is monetary policies that would stagnate private capital flow. The second-to-last thing (but if anyone would like to convince me it should at the top of my list, I’d be willing to listen) we need is a rise in the costs of necessary consumer products. Financial products like savings and checking accounts exhibit relatively inelastic demand trends, which gives the producers of those products, the banks, better pricing power. If the proposed regulations are enacted, financial institutions across the nation will incur new costs. My bet is that at least a substantial proportion of those costs won’t come out of their profit margin — they will come out of our pockets.

A recent article in the St. Louis Beacon debates the pros and cons of the proposed regulations. In the article, Dr. Joseph Haslag, the Show-Me Institute’s chief economist and an economics professor at the University of Missouri–Columbia, points out that the proposed regulations miss the mark.

“It’s not the derivatives or the swaps or any of the other complicated financial contracts that are problems by themselves,” said Haslag, who holds the Kenneth Lay chair in economics at Mizzou. “They are mechanisms that parcel out risk. People see these as ways to make big gambles, and there are risks in the world. If you line up your gambles all in one direction, and the risks come out in a certain way, you can lose a lot of money.”

As people in the finance industry seek to maximize their profits, they will find ways around the new regulations. It may very well be the case that these regulations force bankers into even riskier behavior that is outside the scope of presently foreseeable action. The government has no way of knowing or policing the instruments that may be developed next. In fact, by mandating this type of regulatory environment they might very well cause a new variant of the type of behavior they were trying to quash.

As regulatory protocols are activated, the banks with the best chance to survive the rough waters are the the same banks that were implicated in the financial crisis in the first place. On the other hand, small community banks that keep capital localized will have a tough time staying afloat. This is all trouble for consumers.

Yesterday, the Wall Street Journal ran a piece titled “The End of Community Banking. From the article:

What does all this mean for our customers? Less credit will be available, costs will increase, and we will be less able to make loans to regular people who were creditworthy in the past. This is the perfect storm for the small retail banking customer.
[...]
Small community financial institutions care about the people in their communities. Unfortunately, the new financial regulatory reform bill will greatly inhibit our ability to help them.

Good news for Missouri. In a recent press release, Unisys announced that its forthcoming Application Modernization Center of Excellence is expected to create 300 IT jobs right here in St. Louis. And it only cost Missouri taxpayers more than $5 million dollars.

This means someone in Jefferson City thought that it was a good idea to award more than $5 million dollars in tax credits to a Fortune 500 company. Although tax credits aren’t a direct transfer of funds from taxpayers to industry, if a targeted company receives such credits and government spending is not also reduced by that same amount, the marginal tax rate increases for everybody else. Shifting the tax burden in this way is in itself a form of corporate welfare.

There must be a mistake. Someone must have thought that Unisys’ $4.6 billion in revenue last year was a typo. I mean, sure, if the “b” in “billion” were an “m” instead, I would say, “Why not? They are obviously struggling for survival. Last time I checked, kids didn’t need that money for scholarships, the elderly sure don’t need it for health care, and our roads are in pristine shape everywhere I drive. Yep, go ahead and give our $5 million dollars to Unisys; we don’t need it around here.” Unfortunately, in immediate retrospect, I realize that a similar thought had to go through someone’s mind — and what may be even scarier is that this individual has the ability to shift hundreds of millions of dollars in tax burden away from whomever he or she deems worthy.

I’m glad we have safety nets for companies like Unisys; you never know when one of those multinational companies (whose revenue stream is more than half of Missouri’s revenue for last year) might just slip through the cracks.

Let’s call it what it is: a handout, a freebie, a bailout.

By rejecting automotive bailout funds in 2008 and 2009, Ford managed to shield itself from the political hit that was sure to result. As an article in the Columbia Missourian points out, now Missouri politicians are looking to find room in the budget for a $15 million per annum tax incentive program to provide the Claycomo Ford Plant with income tax breaks to reinvest in the plant. This time, the remuneration coming under the guise of tax incentives. As Show-Me Institute scholars have pointed out in the past, when the tax burden is reduced for one targeted business or industry, but overall government spending does not simultaneously decrease, the marginal tax rate for other taxpayers necessarily increases. In this way, Ford would be the beneficiary of taxpayer money.

This illustrates another flaw of the tax credit system, adding to an already long list of inadequacies. Public disapproval of the auto industry bailout in December of 2008 was well documented. This disapproval most likely stemmed from the general public’s disdain of using taxpayer funds to shore up profits for big business. The tax credit system does much the same, except that politicians and recipients of the tax incentives have figured out how to have their cake and eat it too. Missouri’s tax credit system effectively funnels money to a business or group of the government’s choosing while at the same time serving as a buffer to shield the politicians involved from losing political capital.

I understand the importance of keeping jobs at home in a competitive nationwide market, but empowering the government to play favorites through the use of tax credits and incentives is not the most effective way to accomplish this goal (if it’s a successful strategy at all). There are many other potential solutions that would not only help the Ford Claycomo plant stay afloat, but would also help in attracting other businesses to the state. Earlier this year, Show-Me Institute policy analyst David Stokes suggested that lowering the large commercial property tax surcharge in Clay County would help Missouri businesses located in that county retain more of their profits for reinvestment. Policies like this allow all businesses in an area to benefit, spurring reinvestment, stimulating growth, and widening the tax base. By improving the economic climate in general, benefits accrue to far more than just those lucky few businesses that government officials deem worthy.

I guess the news has finally reached Washington. In a recent post on the Political Fix blog, Bill Lambrecht pointed out that the political heat around subsidies is increasing, and this time it is fueled by ethanol. Almost two years to the date after the Show-Me Institute’s release of its case study of the E-10 ethanol mandate in Missouri, another nonprofit research organization has published a study about the inefficiencies of federal ethanol subsidies. The Environmental Working Group’s analysis of the ethanol subsidies concluded:

Americans have spent $17 billion since 2005 to achieve reductions in gasoline consumption that could have been achieved for free.

Today, proponents of ethanol are attempting to piggyback on the recent oil crisis in the Gulf of Mexico in order to gain support for their most recent push to increase the amount of ethanol in the U.S. gasoline supply and keep their subsidies. In a Post-Dispatch article yesterday, Jeffrey Tomich pointed out:

The ethanol industry is also lobbying Congress to extend a tax credit for blending ethanol with gasoline and maintain a tariff on imported ethanol — measures implemented years ago to help a fledgling industry grow. Both the tax credit and tariff are set to expire at the end of the year.

Letting the tax credits and tariffs expire wouldn’t be such a bad thing. Who knows, besides saving the American taxpayers $17 billion dollars, we might actually come up with an alternative energy idea that works.

Earlier this week, the Kansas City Business Journal reported:

Missouri Gov. Jay Nixon has signed legislation that would enhance tax benefits for the state’s higher education savings program.

On Monday, Nixon approved Senate Bill 772, which eliminates a 12-month holding period for contributions made to the Missouri Higher Education Savings Program.

Well, not exactly. This bill may indeed be an effort to promote more savings by Missouri families for their children’s future education, but it doesn’t entirely eliminate the holding period for contributions made into a Missouri 529 savings plan. Instead of providing contributors with more freedom pertaining to the control of their accounts, it allows the Missouri higher education savings program board to establish a “minimum length of time that contributions and earnings must be held by the savings program to qualify” for the state tax exemption. Eliminating the language that sets the minimum length of time at 12 months, but keeping the provision that allows the board to set minimum limits, doesn’t provide contributors with more information.

Proponents of the bill suggested that eliminating the mandate would allow the Missouri Higher Education Savings Program to be more competitive with similar programs in other states. Had the legislation eliminated a minimum holding period altogether, it may have accomplished that goal. In reality, it only muddies the water.

I am all in favor of eliminating government mandates, whether it be in health care, energy, or any other area in which the government attempts to control the market, but the removal of this language does not return the pie-slicer to the marketplace — rather, it keeps control in the hands of the people who cut the pie the first time around.