The Debt Crisis: Compromise is Not an Option

July 29th, 2011 by Roy W. Spencer, Ph. D.

We are used to politicians having to compromise in Washington. Compromise is viewed as a good thing. Both sides get some of what they want. What our country is facing with the current budget crisis, however, is a totally different situation.

We are not discussing how much this constituency gets out of tax revenue versus that constituency. We are instead dealing with the very real possibility that our economy will collapse due to excessive levels of debt and overspending, at which point no one is going to get much of anything they want.

An Example from the Real World

Let’s say a large family has gotten in the habit of spending more than it earns, borrowing more and more each year to the point where they are now spending 40% more than they are earning (which is where the federal government is now).

The family has loaded up its credit cards, and even opened up new credit card accounts each year in order to pay off the interest owed on the previous cards, as well as to support their lavish spending.

To make matters worse, creditors are about to raise the interest rates on those credit cards because they see the family as a high risk for not being able to pay off their cards. As it is, the parents in this family already know their children will be inheriting the problem they have created, since it will take many years of sacrifice to fix the problem.

What should they do? Should the family keep on the current path? Or, should they start to reduce their rate of spending, rather than increase it year after year?

The husband and wife agree there is a problem, but disagree about what they should do. One wants to start decreasing their rate of spending, even if it is painful in the short run. But the other wants to continue spending more than they earn…after all, the rest of the family has grown accustomed to clamoring for more and more cash to support their lifestyle. It would be cruel to not allow them to continue as before.

On an Unsustainable Path

The following chart dramatically illustrates that the situation our country is in right now, and it is far worse than any financial situation we have ever experienced before (the data come from here). True, almost every year the U.S. Federal Government has run a budget deficit (spending more than it takes in), but the last few years have seen an astronomical growth in that deficit due to the housing bubble, multiple wars being fought, “stimulus” spending, and an increasing proportion of the population willing to just sit back and live off their neighbors’ tax dollars: (click for the full-size version)

The brake this puts on economic growth is now making the budget deficit even worse because the amount of tax revenue coming in is a “percent of the action”, and the “action” (economic activity) has slowed to a trickle.

Clearly, the path we are on is unsustainable. I fear we will soon find ourselves in the same situation as Argentina, whose unsustainable rate of borrowing finally culminated in what amounted to economic collapse around 2001. Much of the country was suddenly poverty stricken, with rampant crime as people were just trying to survive.

Banks either closed, or only allowed customers to withdraw very small amounts of cash each week. Inflation skyrocketed. Many of the ruling elite fled the country with great amounts of wealth, since they saw the crisis coming.

In a matter of a couple of years, Argentina became virtually a Third World country.

Unfortunately, just like the family that could not rein in its spending, so much of our population has become dependent on government handouts (which means, taking from those taxpayers who help keep our economy going) that it will be difficult for politicians to do what needs to be done to put us back on a path toward prosperity.

We must reduce wasteful spending, and we must reduce the governmental tax and regulatory burdens on businesses which are keeping those businesses from growing. Politicians must make tough decisions that will save the country without regard for whether they will be re-elected or not.

The problem cannot be fixed by “taxing the rich more” because (1) there is not nearly enough money there to fix the problem, and even more importantly, (2) unless there is at least some incentive for people to financially benefit in proportion to their good ideas, there is no motivation to take the risks involved in bringing new and better products and services to market. After all, most of those attempts fail, and people who want more of what “the rich” have, are not willing to share in the failures of those who tried and failed.

Remember, “the rich” have kept only a small fraction of the total wealth they have provided to our country in the form of a higher standard of living with innumerable products at reduced prices, along with the millions of jobs provided to bring those products to market.

We need to celebrate the rich, not demonize them.

We are now at a crossroads, and it is our way of life that is at stake. If you want to see what the future looks like, just look at surviving in Argentina.


54 Responses to “The Debt Crisis: Compromise is Not an Option”

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  1. Christopher Game says:

    Dr Spencer writes: “take the risks involved in bringing new and better products and services to market”. That is the only way to ‘stimulate the economy’; academic economists, I believe, call it Say’s Law. The method attributed to Keynes, government spending, does more harm than good. Christopher Game

    • Kevin O'Neill says:

      Christopher:

      The military. Public roads. Public Universities. Police. Firemen. Hospitals. Senior citizens NOT reduced to eating dogfood. The modern airplane. The internet. Transistors. Computer chips. Cellphones. Vaccines.

      Should I go on? The list of services and products that would either not exist or be outside the economic reach of most citizens if not for government is endless. We are all socialists – it’s just that many of us don’t wish to acknowledge it.

      Do a little research on ‘privatized profit, socialized risk.’ Many of our most significant inventions were developed on the government dime – then turned over to business royalty-free. Remember, Al Gore *DID* help to create the internet (by passing the deciding vote that gave DARPA funding) – despite everything the political right would have you believe.

      • The vast majority of the value that the “dimes” the government uses comes from the private sector. I agree there are some services best coordinated by a large organizations like the government. But the private sector still pays for it all…it’s a matter of who coordinates it and whether they are efficient or inefficient. The incentives for success in government service are exactly opposite what is needed to increase prosperity.

        Our prosperity has been in spite of government, not because of it.

        • Kevin O'Neill says:

          Dr. Spencer,

          If Our prosperity has been in spite of government, not because of it. then shouldn’t we have countries with virtually no government doing much better than we are? Instead what we see are countries with the weakest governments are usually the poorest and most lawless.

          Every measure of healthcare spending and outcomes shows that socialized medicine produces more bang for the buck. Are you advocating a government takeover of healthcare?

          Yes, the dimes ultimately come from the taxpayer, but if the government didn’t launch satellites for scientific research – who would? There’s no guarantee in pure science that the results will lead to a profit.

          It’s always easy to talk about government waste – until you actually have to start showing where the money can be cut – and explaining how we’ll deal with the consequences of each cut.

          Zero out the military? Fine. We can save trillions in a few years. Hey, I just solved the budget crisis!

          • coturnix19 says:

            countries with the weakest governments are usually the poorest and most lawless.

            It is forcing and feedback problem. What comes first? You do not notice time lag between contry getting rich and only then government increasing in size.

          • coturnix19 says:

            if the government didn’t launch satellites for scientific research – who would?
            — No one would. For as long as rockets use chemical fuel, rockets are – and always will be a net negative on economy. USSR was the first to launch spootnick (that’s how it is pronounced), but half of its citizens shat into a barrel in a flimsy wooden huts, even when it was -30C outdors. Measuring earth temperature to a 0.1C degree is nice, but is it really worth for 150000000 people shitting outdoors?

        • Kevin O'Neill says:

          Dr Spencer,

          It should be noted that nowhere in your post did you draw a distinction between operating budgets and capital budgets. As Bill McBride writes over at Calculated Risk:

          I get really frustrated with politicians comparing the Federal budget to a family budget. The government does not have a capital budget, so if they spend money on R&D or roads, that is just included in the budget.

          If a family buys a car with 5 year financing, they usually just budget the monthly payments. If they budgeted like the government, they’d have to include the entire purchase of the car the year it was bought (same with a house – they’d have to enough to pay cash to buy the house).

          Some people compare to the states too. Hey the states are supposed to have balanced budgets. But states have separate capital and operating budgets. I think people just don’t understand.

          A politician can say “We should have a balanced budget”. It sounds good, but why aren’t they challenged about operating vs. capital budgets? And about business cycle spending (obviously revenue falls during a recession – and spending increases)?

          What they really want is a balanced operating budget over the business cycle. You can’t put that in the Constitution. It requires effective government and constant vigilance.

          Of course in 2001, when the politicians were concerned about paying off the debt too soon, that nonsense went mostly unchallenged too. Very frustrating.

          I need to think about how to explain it. “Balanced budget” sounds so good, and is so wrong.

  2. Andrew says:

    Those who constantly call for “compromise” on any and every issue, ought to answer the simple question, how do you compromise between good and evil, right and wrong, truth and falsehood? There is this irritating faith amongst so many of the elites, and sadly among many ordinary people, that the answer is always “inbetween” or “in the middle”. Anyone who has ever learned any elementary logic ought to immediately recognize this as the fallacy of the golden mean.

    Currently our society is on a trajectory to spend itself into oblivion. A compromise between oblivion and not is what, exactly? Partial oblivion? As a society, we end up only mostly bankrupt? Clearly those who call for compromise have no sense of what the sakes are.

    • Kevin O'Neill says:

      Andrew:

      Good or evil. WWJD?

      The morality of public policy has long been co-opted by the political right in the USA. It’s really too bad. The economic policies of the conservative right is the antithesis of Christianity and the teachings of Jesus Christ.

      Where Christ disdained material things and urged his followers to give them up, the GOP glorifies the accumulation of earthly possessions. Where Christ said that a rich man had a snowball’s chance in hell of reaching Heaven, the political right somehow thinks rich men are MORE moral than the weak or the poor. Dr Spencer echoes that same GOP misguided view.

      Capitalism is an amoral economic system. Please note I said ‘amoral’ – not ‘immoral’ – there’s a difference. Good or evil does not enter into the computation of most businesses or corporations. Profit does. You really can’t get much further from the teachings of Christ.

  3. Andrew says:

    Sorry, that should have been “what the stakes are”, realized it only once I clicked submit.

  4. RB says:

    But Argentina was a currency user and the United States is a currency issuer. And the foreign debt is in dollars and therefore there is no ‘sudden stop’ debt explosion due to the plunge in the value of the currency. And since the Federal government has been in debt continuously since 1837, it should be pretty obvious from 174 years of history that a Federal balance sheet is nothing like that of a household.

  5. Dan Pangburn says:

    When the issue is jumping out a window on either the first floor or the 40th floor, jumping out a window on the 20th floor is not a compromise.

    • Kevin O'Neill says:

      Tea Partiers believe the correct compromise in this situation is jumping out the 41st floor. Their 40 and your 1 put together.

      Keep your government hands off my MEDICARE!

  6. BlueCollarCritic says:

    “But Argentina was a currency user and the US Is a currency issuer……it should be obvious from 174 years of history that a Federal Balance Sheet is nothing like that of a household”. ~RB

    The US is an issuer but that will not, cannot last if we continue down this path. Our ability to print money is not a magical ability to print our way out of debt; it is a fairy tale.

    Other nations will tolerate only so much of this fake money printing before taking measures that will force us to be more honest about our money. Each time the government prints more money (virtual or real money) without increasing what backs up that money they reducing what existing dollars are worth.

    Look at it like this, when corporations increase their stock do they double the number of stocks and then say we now have twice s much value as before the change? Of course not that would be foolish. They do this gis stock splits which allows for distributing the stock’s value over more stocks so that the net sum is the same. Even if they wanted to double their company’s value by doubling the stock, other so would not recognize each new stock as being equal to the old stock. The company could issue a doubling of stocks and claim each is worth as much as the original stock but this would simply not hold up in the market, those who trade would say each stock is now worth half of its prior value, at least until the company white stock represent increase its value.

    This is show it should work with the US dollar but the interference of the Federal Reserve combined with the governments force of its military allows it to bully other countries into accepting each new dollar being equal in value to the old dollar. The government can maintain this bully like charade for a while but eventually others will start refusing to deal in dollars or will devalue each dollar in turn forcing us to either print more to drive back up the net some or increase the wealth of what backs up those dollars. This game of one-upping , with vendors devaluing our dollars and our government printing more to push the net sum back up is in essence theft of our wealth and the economists know this.

    The way to prove this is to look at what dollar buys now and what it bought a 100 years ago. You say that we can’t do this because of inflation but you would be wrong. Inflation is the devaluing of purchasing power of a currency. While the perceived value of gold fluctuates some, in the end a gold coin can still by today what it could 100 years ago, 500 years ago and even 1000 years ago. If it took 1 gold eagle dollar to buy a complete suit in 1901 you can bet that the same gold eagle dollar would still buy a complete suit today or at least come very close it doing so; much more so then the dollars it took to buy the suit in 1901.

    This is because gold does not change its natural value. We may change our perception of what gold is worth but the gold itself is not diluted by the printing of more gold coins because the value is in the coin and not what it represents. A US Federal Reserve note (aka the US dollar bill ) is a promise to pay off a debt; it’s a promissory note. As faith in the ability to pay that goes down the value of that note also goes down. As the government has gotten more and more reckless with its spending and borrowing the faith of that note to be paid has gone down thereby reducing the buying power of it.

    Had we stayed on the gold standard as was outlined by the founding fathers we could NOT have been but into this situation because the faith in gold does NOT change.

    The drive to move away from real money like gold and solver coins and to paper money as promissory notes was a necessary step of the elite and powerful of the world were to eventually take over the country’s wealth. While we’ve been placing our faith in the US dollar they have been using it to transfer true wealth in the form or tangible assets like land and precious metals thereby taking from us in a voluntary fashion that which our ancestors fought and died to secure. Get your head out of the sand and see the world for how it really is.

    • Kevin O'Neill says:

      BlueCollarCritic:

      This is because gold does not change its natural value.

      Ummm…. gold doesn’t have a natural value. The value of any mineral, metal, commodity, product, or service is a social construct. It’s only value is what someone else is willing to pay you in exchange for it.

      Which is intrinsically worth more, a pound of gold or a pound of rice? Well, if you and I are stranded on a desert island, I’ll take the pound of rice. In this case the ‘natural value’ of rice is infinitely greater than that of gold.

      If the public suddenly decided that gold was a metal with some important industrial uses, but no more special than silver or copper, then the price of gold would plummet. There’s no ‘natural value’ to prop up its price.

      • coturnix19 says:

        The value is determined by supply and demand. Gold is always limited supply. One day, alchemistry will be able to create gold out of lead, but not today. paper dollars are unlimited in supply. That’s why paper dollars are worth as much as there are carriers floating in the gulf or elsewhere.

    • MRW says:

      Gold is fiat money. It was initially worth one cow. The cow was the value: provided food, transportation, value in the fields, and when dead: more food.

      Gold in either 315 or 350 grain (can’t remember) coins equalled one cow. You couldn’t trade cows if you exhausted them by enormous treks to trading places, so you took gold coins instead. That coinage and what it meant existed for hundreds and hundreds of years on all contients. But you have to study history to know the real history of money. There is nothing inherently valuable about gold except that it was chosen as fiat for its properties (malleability, easy to strike marks on it, metal ubiquitous, and constancy).

      You need to study the issuance of the Greenbacks in Lincoln’s time. The government that issues its own currency controls its own destiny, and it is backed by the full faith and credit of the government. (I don’t have time to go into the full explanation of this.) Right now we sorta issue our own currency via the Fed. The government, the Treasury, should be doing it. That will aright more ills than anything.

      The problem with these Tea Partiers deciding our economic future is that they are woefully ignorant of monetary history, have zero understanding of how money evolved over the millennia, and couldn’t distinguish economic theories if they tried. I’vv even heard some of them say that “Adam Smith was right” which goes to show you the profound level of ignorance we are dealing with.

      And none of them know what happened to the economy in 1938 when FDR did what this debt deal just did in 1937. It’s called the ‘depression with a depression’. But hey, history is for comic books, right?

  7. RB says:

    “The way to prove this is to look at what dollar buys now and what it bought a 100 years ago. ”

    Sorry, I don’t know if you are trying to educate me about inflation, but this is no argument. Average salaries are also not what they used to be 100 years ago. The rest of your post is a detour into the gold standard, which I will engage in, although this has nothing to do with invalid comparisons with Argentina and on a post about the tea partiers is probably going to bring out the Ron Paulites out in full force.
    [
    The depression era of the 1930s and the Long Depression period made it clear how oppressive and economy-crushing deflation can be for debtors.

    An excerpt from Bush advisor Greg Mankiw's textbook:

    The redistributions of wealth caused by unexpected changes in the price level are often a source of political turmoil, as evidenced by the Free Silver movement in the late nineteenth century. From 1880 to 1896 the price level in the United States fell 23 percent. This deflation was good for creditors, primarily the bankers of the Northeast, but it was bad for debtors, primarily the farmers of the South and West. One proposed solution to this problem was to replace the gold standard with a bimetallic standard, under which both gold and silver could be minted into coin. The move to a bimetallic standard would increase the money supply and stop the deflation.

    The silver issue dominated the presidential election of 1896. William McKinley, the Republican nominee, campaigned on a platform of preserving the gold standard. William Jennings Bryan, the Democratic nominee, supported the bimetallic standard. In a famous speech, Bryan proclaimed, "You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.'' Not surprisingly, McKinley was the candidate of the conservative Eastern establishment, whereas Bryan was the candidate of the Southern and Western populists.

    The story ended happily when new gold was discovered.

    ]

  8. janama says:

    10 years ago if I gave you an Australian dollar you’d give me back US$0.45 – today you’d give me US$1.10.

  9. RB says:

    DEspite which the Federal Reserve and the Treasury have been fighting deflation.. while 10-year treasury yields have fallen from 5.1% in July 2001 to 2.8% today – maybe the bond market vigilantes seem to grasp that things are a little more complicated than is within the reach of blogospheric pundits.

    Doom… banana republic, I tell you.

  10. Sun Spot says:

    You can look to Canada to see what had to be done to get a balanced budget, a) Increase taxes b) cut spending.

    How is an America who refuses a tax increase any different than Greek who refuses to pay taxes, both result in huge debts and economic collapse. Greek socialist extremism or American capitalist extremism get you to the same place !

    P.S. we’ll all celebrate the rich when they start acting responsibly and pay taxes not avoid taxes.

  11. KevinK says:

    Dr. Spencer, well this topic at first seems quite a bit “off course” from your usual topics.

    But I must say I agree fully with your analysis. The spouse (a.k.a. the “manager”, I’m just “labor”) and I attended several of the first Tea Party demonstrations here in our environs back in 2009. When interviewed by the local “free press” I stated that the “new” government was borrowing 40 cents out of every dollar they spent. My simple question was; “how long can that go on?????” I got a blank stare, and the paper reported the next day that the “Era of Reaganomics” was OVER. And magically everybody was going to get; free gasoline, houses, new kitchens, jobs…… and a unicorn that poops dollar bills whenever you need them…

    I have to fully agree with you.

    Cheers, Kevin.

  12. Bill says:

    True dat, federal spending as a percent of GDP is at the highest since WWII. But at 25.1% of GDP estimated for 2011 not that much higher. for example, spending averaged 22.7% of GDP for the final two budget’s signed by Bush II, and during the 8 years of Ronald Reagan spending as a percent of GDP was 23.1, 23.5, 22.2, 22.8, 22.5, . The GAP (40% spending over intake) is a function of the spending PLUS the fact that federal revenues are also at a 50 year low at about 16% of GDP. Coincidentally, Federal tax rates in 2009 and 2010 resulting from a combination of the Bush tax cuts plus the additional tax cuts which made up 40% of the stimulus bill are also are at a 50 year low.

    Seems to be that the hypothetical family you describe is going to be a LOT worse off if its chosen solution for the problem you outline is to simply stop paying the bills (e.g. mortgage) that are due from past decisions (e.g. buying that big house) rather than looking at both their revenue options (let’s get rid of laws restricting child labor laws and put the children to work too for the family good) and their spending. They really should try to sell the house before simply defaulting on their mortage if increasing revenues is not an option. In any event, the wise family can (and does) choose to look at options for reducing their spending and/or increasing their earnings completely separate from deciding whether to put that mortgage payment in the mail.

  13. Norman says:

    I have to disagree with the content of Dr. Spencer’s article above.

    I think he is missing a very important problem with money. It is called greed. It consumes people. Please reread your Bible.

    “Often misquoted as ‘money is the root of all evil’. Originates in the Bible, Timothy 6:10 (King James Version):

    For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.”

    The rich class in America is creating jobs but most overseas and for very low pay and poor working conditions.

    Please also read some Dickens novels to understand that History repeats for those unwilling to learn from it. It was not the rich class that created a prosperous middle class. It was workers sticking together and demanding better working conditions, safer, more money, less hours that created the middle class. Now companies can outsource and seek the lowest cost labor to try and recreate the world Charles Dickens wrote about (Scrooge for one).

    I think most people are not thinking the issue through if they neglect to understand the destructive nature of greed. It is and unsatisfiable lust for more money and power. There is no limit to how much money a person can have.

    As for the spending. If you look at the budget the big three expenses are Military, Medicare and Social Security. The only solution to not increasing taxes is to round up all people who have retired and put them in camps to die. If the young generation is unwilling to pay for the elderly then there is no other solution.

    And here is a graph of how wealth has gone recently. Please try to understand greed and what it is. It is a cancer. It is very destructive. It consumes all the energy of a living system, or Nation in this case. If we continue to feed the rich, the cancer will only grow faster and stronger until all the other citizens of the nation have nothing.

    For any reasoning person I cannot see why this would make a superior thought process. I cannot see how a Roy Spencer economy would be better. I see it as a Charles Dickens world of most people living in poverty, working long hours and a very small amount of the population living like kings. Why should I celebrate this system???

    Here is a link to a graph.

    Graph of how wealth is concentrating in the hands of a few.

    Source article for graph link.

  14. George Crews says:

    Hi Roy,

    I respectfully disagree. We should no more celebrate the rich than demonize them.

    Your more careful wording in other places leaves me hopeful you are mindful that we must *increase* the governmental tax and regulatory burdens on those businesses and institutions that got us into this financial mess. I also hope you would agree that these people, who have clearly “gamed the system”, should not be allowed to continue to game it. Raising their taxes and aggressively regulating their financial activities would seem the appropriate and responsible thing to do.

    The underlying issue I have with your line of reasoning is the seeming lack of appreciation of how easy it is, in our complex modern world, to separate those who are burdened with the negative consequences of risk from those who will realize the positive benefits from taking risk. Economic risk consequences and benefits are not scalars, but vectors.

    In the old frontier days, individuals and groups took risks and they got the benefits or consequences. Nowadays IMHO, to a significant degree, the risk takers have been able to assign the negative consequences of taking risks, and only the negative consequences, to others.

    I only mention this because I would think this issue could be resolved by careful analysis of the actual facts. I don’t dispute the rich take risks. I do dispute they bear all the consequences. Financial examples abound. But in other areas too. For example, were the people who profited most from the Fukushima Nuclear plants the same as those who suffered the most from its eventual negative consequences? Obviously, no. And that is not right. And let’s not compromise about that either.

  15. kuhnkat says:

    Dr. Spencer,

    the majority of the responses show little understanding of human nature, supply and demand, inflation/deflation issues, and economics in general is an excellent example of how the US got where we are. People simply are being taught socialistic Utopian propaganda. Sadly there probably isn’t a solution and they will be screaming about how the greedy bankers stole their future after the economic collapse, similar to Argentina’s, makes paupers out of most of us.

    On my Facebook page I had a gentleman absolutely outraged with the idea that there are only so many resources available to spread around. He soundly rebuked me that there is always enough money. He was totally oblivious to the fact stated above by another poster that printing too much money is simply devaluing it.

    I tried to use the example of everyone being given a trillion dollars. Would everyone get what they wanted?? Uh, no. Most people would stop working and live on the money. With few working the production and distribution of goods would quickly stop. With a suddenly severely limited supply of goods the bidding would soon start on a loaf of bread to the point the trillion dollars wouldn’t even feed them.

    Another example is, with a trillion dollars we would all want the beach house and the ski chalet… There are simply not 1 billion oceanside plots or ski locations. Again, the bidding war would be ferocious until all of them were gone and a new value set for these areas. Similar action would happen for simply getting your plumbing fixed. Why work with a trillion dollars. Who is going to fix it??

    The monetary system is how we ration goods. It is a poor system, but, better than every other system tried so far. I challenge everyone to show me where there is a WORKING system that shows better results in real life!!!

  16. Ray says:

    Andrew says:
    “Currently our society is on a trajectory to spend itself into oblivion. A compromise between oblivion and not is what, exactly? Partial oblivion? As a society, we end up only mostly bankrupt?”
    Ultimately, economic growth is only made possible by credit and debt. The it becomes a problem when debt increases to unsustainable levels, in order to fund unsustainable growth. Bankruptcy is an essential part of a free-market, capitalist economy. Since without credit, it is impossible for all businesses in an economy to make a profit simultaneously, it is necessary for some businesses to default on debt and go bankrupt. I am not saying that this is a good thing, or a bad thing, but it is inevitable.

  17. Andrew says:

    Ray, I agree that bankruptcy is not something wrong in general. However, the way I look at it is we are like dutiful employees of the company, and I can see the bankruptcy coming. I think we can prevent it. In the individual case, should not the members of a company try to save their company from going under? I am not asking that the US get a bailout to be “rescued” from bankruptcy, I am hoping we can get our act together to prevent it in the first place. If we reach the point of inevitability it’s too late.

  18. Kevin O'Neill says:

    Dr. Spencer – the U.S. has increased spending and cut taxes to the lowest level in modern history resulting in large deficits and increasing debt. What does your economic theory say should happen to interest rates and inflation under these conditions?

    Every Republican economist claimed these policies would result in a dramatic rise in both interest rates and inflation. Many of the libertarian economists claimed we’d see hyperinflation. The reality? Quite the opposite.

    There are plenty of economists who predicted that we would NOT see a rise in inflation or interest rates. Since they seem to actually understand macroeconomics shouldn’t we be listening to the people who got it right – as opposed to those who got it all wrong?

    Here’s a sampling from the list of those who got it right: Baker, Krugman, Shiller, Delong. Perhaps you should try to understand why they were right and continue to be right before you mislead any more readers.

  19. RW says:

    I think a lot of people here are not seeing the forest through the trees. They’re either unaware of or neglecting the fundamental parasite/host relationship between the government and private sector economy (the ultimate source of gov’t revenue). It’s inescapable.

    The so-called ‘rich’ that you think need to be soaked to generate more revenue to are mostly the entrepreneurs and job creators in the private sector. Sure some are inherently wealthy, but they are mainly the super rich, as opposed to majority of the so-called ‘rich’ – those making over 250K a year.

    By increasing taxes on the ‘rich’ (or any income bracket for that matter), you’re also reducing the amount of money available to go back into the private sector economy, thereby weakening the private sector – the ultimate source of the revenue. Also, by increasing taxes, you’re ‘de-incentivising’ entrepreneurship and business risk taking because the reward or potential pay off or profit for the risk is reduced. In the long run, this weakens economic growth and productivity, which ultimately reduces revenue to the government.

    Also, as economic growth and the private sector decline or stagnate, more and more citizens are unable to provide for themselves through employment in the private sector, so more and more are forced to turn to the gov’t for ‘help’. This in turn requires the gov’t to keep growing, requiring more and more revenue through higher taxation, which only further weakens the economy, reducing revenue to the gov’t, creating more and more citizens in need of ‘help’ from the government. This requires the gov’t to keep raising taxes and so on and so forth.

    This process continues until eventually the parasite kills the host and some form of collapse ensues.

    This is not only where we are headed, it’s being done on purpose right in front of everyone’s face. Apparently the vast majority of Americans are too naive to see it.

    • Kevin O'Neill says:

      RW:

      Your ideology may lead you to believe this is how the world works. The reality is far different. Just examine the history of computers. For example:

      A recent report by the National Research Council states that in 1996, $1.7 billion was invested in research by computer manufacturers, most of which was carried out in their own facilities. In contrast, federal expenditures for computer research reached almost $960 billion …

      So, who were the risk takers that created all the innovations, technological advances, and jobs? The government. Industry accounted for less than 1% of the research funding.

      It is almost impossible to find an industry that hasn’t been built on R&D paid for by the taxpayer. Now, you can argue we’re not getting the right bang for the buck, but that’s a totally different argument. The rich are NOT risking their money in new R&D to bring us innovative products and services.

      40% of domestic corporate profits come from the financial sector. Obviously they weren’t risking anything – except the health of the country’s economy. After we bailed them out they’re once again making record profits. How many jobs are they creating?

      • RW says:

        I was referring more to the aggregate, such as small businesses, which employ most people in this country. If all you can do is site like one arbitrary example, you’re as I said – not seeing the forest through the trees.

        You’re also confusing alleged dollars spent with actual productivity. Just because the gov’t spent more doesn’t mean it was spent efficiently or resulting in significant advances in technology. Also, ‘computer research’ is an extremely vague thing. The implication is it was the same type of ‘computer research’ but we don’t know. Virtually everything is done on computers now, so an awful lot could be lumped into the catagory of ‘computer research’. I suggest you be a little more dubious with claims like this.

  20. Steve Kettle says:

    The USA needs to replace a good chunk of the “Income Tax” with a “Consumption Tax”. This is the case in Canada, Japan and most of Europe.

    Taxing Income is the same as taxing productivity. The more income a person makes, generally the more productive they are. For example the most productive baseball players get paid the most income. The most productive lawyers get paid the most income. The most productive salespeople get paid the most income etc.

    There taxing income is like taxing productivity – BAD for economy.

    A consumption tax also puts a stake in all citizens paying for government. If all citizens pay then these people have a stake in keeping government as efficent as possible.

    There is some bi-partisan support for a federal consumption tax but I doubt it will get passed. We are not talking about increasing taxes here. We are talking about replacing one type of tax with another type of tax.

  21. Zealander says:

    Raising debt limit does NOT increase spending!

  22. Kevin O'Neill says:

    Dr Spencer – It’s a strange analysis that proclaims we have a debt crisis today.

    Zachary Karabell write in TIME

    Yes, the federal debt has grown by nearly $3 trillion dollars in the past three years. And yes, the dollar amount of that debt is quite large (in excess of $14 trillion and headed toward $15 trillion should the ceiling be raised). But large numbers are not the problem. The U.S. has a large economy (slightly larger than that debt number). And, crucially, we have very low interest rates.

    Because of those low rates, the amount the U.S. government pays to service its debt is, relative to the size of the economy, less than it was paying throughout the boom years of the 1980s and 1990s and for most of the last decade. The Congressional Budget Office estimates that net interest on the debt (which is what the government pays to service it) would be $225 billion for fiscal year 2011. The latest figures put that a bit higher, so let’s call it $250 billion. That’s about 1.6% of American output, which is lower than at any point since the 1970s – except for 2003 through 2005, when it was closer to 1.4%.

    Under Ronald Reagan, the first George Bush, and Bill Clinton, payments on federal debt often got above 3% of GDP. Under Bush the second, payments were about where they are now. Yet suddenly, we are in a near collective hysteria.

    So, as an imaginary household, we’ve cut our interest payments in half (relative to income) since the 1980s.

    By the way, who is responsible for the current mess? I remember having surpluses just a decade ago. Then there were some large tax cuts, two wars, unfunded Medicare Part D, deregulation of the financial industry …. must have been those anti-free market liberal socialists.

  23. Steve Kettle says:

    Most people I think would be okay with increasing taxes if they could be convinced the money was not being wasted. Many think there is fraud and waste in medicare and the military.

    If congress can make a good effort removing the waste they could get tax increases past. And these tax increases need to be in the form of a VAT, so that every person has a stake in government efficiency. Best policy that Canada ever put in was the VAT.

  24. Joe Bastardi says:

    Its quite simple, burden anyone too much, and they will break down. Taxes are called that for a reason , they are burdens The most hideous thing about the tax system is it does not allow freedom of choice, At least a consumption, rather than mandatory tax would give you freedom to decide

    People should be taxed on CONSUMPTION not PRODUCTION. Essentials, such as food would not be taxed, and the arguments on the tax scale should be over how much sales tax to level on items consumed. A large thriving middle and upper class would naturally pay more given they would buy more, BUT THEY WOULD HAVE THE FREEDOM TO DO WHAT THEY WISH FIRST. The tax and spend policy of the US is an affront to the people of the US, but guess what, its our fault. We chose this for ourselves.

    As it is more people are now depending on government than government depends on them, so government by consent of the people is on the way out. Each dollar taken before it is in your hand eliminates a choice, a freedom. In addition, taking money from people leaving them less able to give on their own simply outsources the responsibility for those less fortunate to the government, rather than where it should be, on you and me.

    A Value Added Tax is fine, if it REPLACES the income tax completely. Again the arguments can be over how much tax should be charged for items.. ranging from none on food, to perhaps very high values on luxury items. You can sock it to the rich then, for those who dont think they pay their fair share( They do, look who is paying all the taxes) and we will at least have the chance to choose before hand what we do with the fruits of our labor.
    And you will have enough taxes. People naturally spend when they have more in the first place

  25. Tim Lambert says:

    So the US future’s is like Argentina unless you do something? Sounds like things are looking up. Here’s the WSJ on Argentina:

    “BUENOS AIRES (Dow Jones)–Argentina’s unemployment rate declined further in the first quarter thanks to a booming economy, according to the national statistics agency, Indec.

    “The unemployment rate was 7.4% in the quarter, down from 8.3% in the first quarter of 2010, but slightly higher than the 7.3% posted at the end of last year, Indec said in a report Friday.

    “The government has forecast an unemployment rate of around 6.6% at the end of the year.

    “The economy is expected to grow more than 6.5% this year, according to the central bank’s latest forecast.”

  26. Bill says:

    History shows that more often people become rich as a result of creating jobs; rather than creating jobs because they are rich. There is virtually no empirical data supporting the Laffer curve (except at the two extremes) or showing a correlation between tax rates on the rich and job creation.

    Just google the reaction to Clinton’s tax bill in 1993 (mostly on the “rich”), and it will be replete with predicions of economic doom and job loss by the WSJ, Newt Gingrich and others. What actually happened? Tremendous job growth over the next decade. This was certainly not BECAUSE of the increase in taxes nor was it in spite of it. It was because – like other job booms – substantail new innovations entered the marketplace. In this case the internet and computer boom. Tax rates were virtually irrelevant to what actually happened. Rather, major job creaters including Michael Dell, Steve Jobs, Bill Gates, Mark Cuban, and many other “pioneers” introduced a new “revolution” – all of whom got rich through their innovations and the subsequent jobs they created. They weren’t the “rich” who were being rhetorically relabeled as “job creaters.” They were job creaters who became rich.

    Similarly, the Bush tax cuts of 2001 preceded rather anemic job growth. The tax cuts did not lead to the anemic growth; they simply accompanied it. Tax rates on the rich were high in the 1950′s a decade that gave rise to a great middle class with many jobs. Why? Many reasons from public sector (i.e. this was the decade we built the great interstate highway system) to the private system (also the decade that gave rise to Holiday Inns and McDonalds that dotted that new interstate highway – an all the opportunity in between from the emerging electronics industy such as TVs and advanced communication systems).

    The trouble with Roy’s thesis is that it he must begin by saying: “sure it (raising taxes to raise revenues as PART of closing the debt gap) works in practice, but how does it work in theory”. Roy’s answer to this question is as predictable as any future conclusion he will draw about climate change in light of new data.

  27. Steveo says:

    The curve tells the story perfectly. It is an exponential curve and illustrates perfectly what is going on. It is the “wonder” of interest. The interest accumulation is designed into the system of banking such that there is no escape for the borrower, ever. The bankers are in bed with the only military power that can kill them. If the people understood the banking system, they would lynch the bankers, that’s why the bankers give the US anything they want, decade after decade it is the bankers-politicians agreement. the bankers know that and that’s why the lies and deceit and low interest rates, etc. we all know the system is corrupt, the politicians give the bankers the monopoly position of printing money with interest and fractional reserve lending (loan sharking) and the bankers give the politicians money to buy votes. The US military pounces on countries who have resources the bankers want or do not agree to the bankers money monopoly. this is all so very clear just looking at the chart. Chris Martinsen, Jim Willie and others point this out daily.

    So the end game can be two ways. The system is saved at much pain for the common man and we all owe the bankers the world as they planned. Or the governments finally chooses to kill the corrupt banking system which has brought this on. Which one do you think will happen and how you prepare is the key.

  28. Alan D McIntire says:

    There were supposedly surpluses during the Clinton years, but the US debt did not decrease during those years, it increased. Either those pushing the “surplus” allegation cannot count or they cannot tell the truth.

  29. Norman says:

    Alan D McIntire,

    I believe the “suplus” comes about when you figure inflation adjusted dollars. I will link to debt and President’s. In Clinton’s last year (with inflation adjusted dollars) the debt did go down. I do not know if this is a falsehood or not. It seems the recent Reupublicans and Obama are the winners of debt increase.

    Scroll down to graph of President’s and debt chart.

    Please check out the % increase in the debt listing. Look at the astonishing debt increase percentages of Reagan and Bush. Then look at the percentage under Clinon. I see a huge difference. Cutting taxes on the rich does not generate prosperity for the United States as so many believe (even though no evidence is available to prove this). It just increases the debt.

    We have had the “trickle down” hypothesis tested. It does increase debt. May or may not create jobs. The wages of the average American worker have only gone up 4.3% from 1990 to 2005 yet Corporate profits have gone up 106.7% in that same time period and CEO pay has gone up 298.2%.

    Graph for above data.

  30. Norman says:

    Joe Bastardi,

    I do think you are an excellent meteorologist and like your articles on WUWT, but I am not sure of how your thinking is working on the economic front.

    From your post “You can sock it to the rich then, for those who dont think they pay their fair share( They do, look who is paying all the taxes) and we will at least have the chance to choose before hand what we do with the fruits of our labor.”

    They pay the most taxes because they have increased their wealth considerably under George W Bush Government.

    Graph of how income inequality has grown.

    What years was the United States most prosperous for the average citizen? It makes sense to me if a small group of people get all the wealth the Nation produces there will be far less for everyone else and your economy will collapse because the vast majority do not have the money needed to purchase the products generated by the economy and factories will shut down and things grind to a halt.

    Do Republicans every study history? The Nation has been there done it. Go back further when Capitalism was the King in England and France. Do you study the living conditions of the average during that time? The only reason Communistic ideas found an audience was because most were very unhappy with their living conditions.

    Joe and Roy seem to want to go back to those conditions. If you are anti=Communist you would be wise to reconsider how your brain processes data. If you recreate the living conditions of Europe in the 19th Century you will invite a Communistic revolution as the vast majority have nothing to lose by supporting people who advocate this.

    Study some history. Why was Hitler and the Nazi party popular and rose to power. They were in Germany long before their final rise. Every time the economy took a downturn the party became popular. As things got better the average citizen lost interest.

    History will tell you having a very small group of people who have all the wealth is highly unstable (use your meteorlogy knowledge…it is like having very cold air aloft over a very warm air mass below…what then happens under such a condition?). A strong and prosperous middle class is like a temperature inversion. Very resistent to radical ideas. So if you two get your wish and have a small group of US citizens that have all the wealth and everyone else is poor, you will see the unwise thought process you are currently advocating. I hope reason can break into your current perspective and you can at least consider the situation.

  31. David says:

    No capital budget at the Federal level? Who is buying the aircraft carriers, planes, government buildings, and lands for highways? Money is set aside for capital expenditures every single year, and actually that is part of the problem. Very seldom is “two-year” money set aside in legislation. Nevertheless, it doesn’t mean there is no capital budget. Dr. Spencer’s analogy of a personal credit card is totally valid. The request for an increase in the debt ceiling is the same as a request to your credit card company to raise your credit limit. It doesn’t mean you are becoming more fiscally responsible, it means you are going to go farther in debt. Some people think as long as you can borrow money, you aren’t broke. Someday that money has to be repaid. Already, something like $2,000 annually is paid by the average taxpayer (remember half the people don’t pay any income taxes) just to service the existing debt. In a few years, it will be $4,000 per taxpayer, etc. That is one reason the Fed keeps printing money because it is easier to pay off debt with inflated dollars. Again, this doesn’t make it right, and also adversely affects everyone by raising the cost of living. The mere thought of having debt is bad, and those that seek it without the full intention of paying it off are criminals. Except at the Federal level it seems….

  32. RB says:

    The debt ceiling is meaningless. Net government deficit increases in a direct relation with the net private sector savings. I’m sure most of the pretend cognoscenti doesn’t realize that, much less be able to draw a supply-demand curve. The only thing that matters is the ability to service the debt, where there is nothing out of the ordinary. Spencer thinks the credit card is about to raise the interest rate. As of now, inflation protected ten-year treasury bonds yield an interest of 0.4%. The Fed understands more about the pernicious effects of deflation than any half-baked pundit who reads the Drudge Report. Their job is to guarantee price stability – neither too high inflation nor deflation – and thus help with the smooth functioning of the credit markets. Unanticipated deflation hurts the borrowers as much as unanticipated inflation hurts the creditors. That’s essentially the problem with the tea-baggers – a little government education would not hurt.

    • MRW says:

      @RB

      “The debt ceiling is meaningless. Net government deficit increases in a direct relation with the net private sector savings. I’m sure most of the pretend cognoscenti doesn’t realize that, much less be able to draw a supply-demand curve. [...] That’s essentially the problem with the tea-baggers – a little government education would not hurt.”

      I could not agree more.

      And of course, look what’s happened since this debt deal went through IN TWO DAYS: markets tank, double-dip recession feared making a comeback. As I wrote above, FDR did the same thing in 1937 and nearly caused the Great Depression all over again by 1938 with unemployment soaring back to 19.5% within a year.

      What is wrong with this these Republican newbies that they can’t read history. You cannot apply business budget thinking to the government. And the family/credit card analogy is 100% completely wrong.

      But I guess it’s going to take destitution before these nincompoops put aside this simplistic thinking and start to read.

  33. RB says:

    I should have clarified that ten-year TIPS yield 0.4% while the regular ones yield 2.8% showing what the market currently anticipates to be the break-even inflation rate for the next ten years.

  34. AlexBPop says:

    “The problem cannot be fixed by ‘taxing the rich more’ because (1) there is not nearly enough money there to fix the problem, and even more importantly, (2) unless there is at least some incentive for people to financially benefit in proportion to their good ideas, there is no motivation to take the risks involved in bringing new and better products and services to market. After all, most of those attempts fail, and people who want more of what ‘the rich’ have, are not willing to share in the failures of those who tried and failed.”

    Neither of these arguments makes sense. In response to (1), nobody’s supposing that we can balance the budget solely by taxing the rich. Obama’s Grand Bargain proposed a split of roughly 85% spending cuts and 15% tax raises. This was quite fair and in fact it’s in line with what the Republicans were proposing a short while back.

    In response to (2), right now tax rates for the rich are around 30%. If we raised them to 40% or even 50%, there would still be plenty of profit motive for the rich to invest.

  35. Dan Pangburn says:

    AB,
    Anyone who is aware that the free market system made the US the greatest country on the planet will recognize that both ‘arguments’ make perfect sense.

  36. AlexBPop says:

    Leaving aside the question of what exactly defines us as “the great country on the planet”, I made specific responses to both arguments. Perhaps you should those responses, rather than just declaring that the arguments make sense.

  37. Dan Pangburn says:

    AB
    Prosperity is defined by the amount of time left for recreation and relaxation after that required to achieve comfort and avoid starvation.

    Prosperity occurs when good new ideas are exploited.

    Exploiting new ideas involves risk which is weighed against potential reward.

    If potential reward is reduced by higher taxes on success, the threshold for allowable risk is lowered.

    With a lower allowable risk threshold, fewer good ideas will be exploited.

    If fewer good ideas are exploited, prosperity will slow.

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  39. Mike O'Connell says:

    This has to be the biggest failure of science to let people like you try to LIE to get your point across. Your data is flawed and your sources debunked. And you NEVER let politics or some screwed up version of god get in the way. Your argument is invalid.