Higher Taxation As An Economic Solution
Jenson Hagen
Money Supply x Velocity = Total Money = GDP
This equation should be singed into the brain of every representative. Within it lies the power to understand our economic situation and derive meaningful solutions.
Money Supply: Our economic turnaround will not take place until we find balance in how we trade internationally. We are in an unsustainable cycle whereby, as consumers, we buy imports from countries that do not readily buy an equal amount of our exports. This imbalance sends money overseas and prevents us from churning through that money and increasing our overall purchasing power. As well, the banking sector needs to remain solvent, but we should not ignore the need to regulate the banking sector since it does indeed allow for the vital production of money supply.
Velocity: With $100, you can allow the purchase of $800 of goods and services if the velocity of money equals 8. Velocity is defined as the number of times money changes hands in a year. Money cannot change hands within this country if we continue to send it overseas as part of our larger effort to buy cheap imports and sink our own economy. Good job folks! You might want to check where stuff is made maybe. Nor can money change hands if it sits idle in the stock market or unproductive investment vehicles.
Total Money: Money supply and velocity work in tandem. The financial sector is having a rough time keeping money supply up. The government is trying to keep the financial sector solvent while boosting velocity. The Oregon Legislature wants a $175 million stimulus package to help create 3,000 jobs. There should be a Buy Oregon provision in that package in order to keep the money supply here in Oregon. No sense in spending money if we kill both the money supply and velocity by sending it overseas.
GDP: Having wealthy investors hold onto money is important since entrepreneurs can access that money to fund profitable ventures. At the peak of the economy, there was a definite lack of profitable business ventures. We call this oversupply of money an unproductive asset, and it manifested in high oil prices for example. Excess money was simply chasing a pyramid of price increases. Going forward, excess money is better taxed since it will reduce the overall systematic risk all investors face and it will prevent the manifestation of bubbles. The potential for future ventures to show profitability is also somewhat based off the risk free rate, which will rise if the U.S. government and municipalities overdose on debt.
Real Stimulus: As a society, we tend to favor letting wealthy individuals keep their money. But their money is created first by the banking sector and then grown through velocity. A long-term, mindful solution realizes that money vanishes if the banking sector fails or if velocity dwindles. Higher taxation of "idle money" will help to ensure velocity remains high and that money is available for the purchase of goods and services for all members of this society, including the wealthy. Taxation of productive money can decrease economic activity if it slows velocity, but we are not talking about that. Money acquired (not created!) by the government to use for economic stimulation is by definition idle money for which an investor has no other productive use. An investor will not loan money at 4% when productive ventures offering 15% exist. Those ventures simply don't exist at the present. In our current economic climate, there is definite idle money that should be taxed in order to boost velocity of that money. Instead of using this money on loan, taxation would be more appropriate since it is the government's use of that money that is ultimately trying to suspend GDP, reinvigorate productive ventures and ensure that wealthy individuals have access to money in future periods.
Is it better to lose $5 million in the stock market or provide the government with $3 million through taxation in an effort to suspend the remaining $2 million? A short sided person will not realize that the $2 million can only grow in future periods in a sound economic climate. We are short sided if we allow $5 million to fail because of an aversion to taxation. Let us tax idle money, put it to work here in Oregon, put Oregonians to work in the process and allow wealthy citizens to regrow any foregone wealth.
PS. I was the 2008 winner of the CFA Society of Oregon's forecast contest. I have a massive bottle of Apolloni Pinot Noir as proof as well as some other gifts. Our future looks incredibly bleak and unemployment will only worsen. Three thousand jobs are nothing and we are trying to create them using borrowed money! We need meaningful solutions as well as political will. We need to stomach higher taxes so long as those taxes move money along right here in Oregon.
To our future!
Feb 13, '09
Let's see: Unemployment levels are in double digits in many counties in Oregon. The state's numbers could easily be 12-15% before it's all over; people have less money to spend; many are losing their homes, and filing for unemployment at record levels; businesses are struggling to meet payroll, and senior citizens are losing their retirement.
Yep, sounds like the perfect recipe for raising taxes. Let's just add more salt to the wound.
Feb 13, '09
Jenson, While you have accurately captured a number of key economic principles, I'd point out that the $175 million stimulus package approved by the Legislature last week is the FIRST PHASE of the state stimulus plan, and that there will be additional projects approved as the session continues. These projects were chosen because they were ready to go and will put people to work within the next 45 days. The second point I woould make is that the while Legislature clearly indicated its preference to buy from Oregon companies and to hire Oregon workers, Federal commerce law prohibits Oregon from requiring that as a part of contracts.
8:53 a.m.
Feb 13, '09
What slows the velocity of money when we buy overseas (or from Florida, for example)? Doesn’t the money come back to us either as payment for our exports or as investments or as loans (as in China financing our various bailouts)? Wouldn’t trade barriers create inflation as many Made-in-the-US (Oregon) items would cost more than those made outside the trade protected zone?
I do worry and wonder whether there is any way we (US or Oregon) can maintain our relatively higher incomes/wages to the rest of the world as billions of new middle class people with many of the same skills and abilities as us are trained and education all over the world. Is this deflationary pressure on incomes/wages part of the problem we are in? Can trade barriers protect us? At what costs now and in the longer term? I’ve explore the issue a bit on my own blog here. But, if you have thoughts, I’d be interested.
Feb 13, '09
Yep, sounds like the perfect recipe for raising taxes. Let's just add more salt to the wound.
Top marginal rate on income taxes was 63%, going as high as 79% during most of the 1930s. Bottom marginal rate was 4%, going as low as 1.125%. I'm pretty sure we can stomach more taxes. It's just a question of who we tax.
9:06 a.m.
Feb 13, '09
Sorry, Jenson, you just flunked basic economics. You have hopelessly confused our current account and our capital account in foreign trade, you have no conception of what the velocity of money actually means, and the idea that taxing "idle" money will force it into circulation was one of the failed experiments of the New Deal.
Winning a bottle of pinot noir for guessing the future could make you the next Jeane Dixon but not the next Paul Krugman. I suggest you go back to the textbooks and keep studying.
Feb 13, '09
Mr. Hagen,
With respect, your economics are very confused and, frankly, incorrect. Rather than go through a long list of corrections, I'll just point out the fundamental problem - you have mistaken an accounting identity with an economic model.
You also messed up the identity, it is MV=PY so if I just increase M, guess what, P increases - inflation. Y (GDP) increases, or growth, comes from productivity not from the money supply. Decreasing investment and increasing government spending does not increse productivity unless you can argue that the government can invest in more productive assets than the market will. Generally not true - though sufficient investment in public goods, like health and education, is necessary for growth.
I think the correct argument is that the government is doing too little of this.
Feb 13, '09
failed experiments of the New Deal
Sounds like you've been getting your facts from reliable sources such as Rush Limbaugh and Sean Hannity. Explain in what way did the New Deal fail Jack?
Feb 13, '09
Jenson, My God, is there anybody on this planet capable of polishing a complete sentence on a blog who is more clueless than you? This is downright scary. Let's see what you seem to be saying here: The stock market is idle money? So let's abolish the capital markets and see how far that takes us! Manufacturing workers will have a great time without any equipment to increase productivity. One reason we run a trade deficit is because the average American worker requires about $50K in capital to optimize our productivity. Hint: Optimization is usually a good thing. International trade reduces our wealth? Okay, there is this old story about Portuguese wine and British wool - read it and try to comprehend the power comparative advantage. Now try growing bananas commercially in your backyard. Oh, and that lithium used in those fancy car batteries? Almost all of it comes from Peru - how are we going to have electric cars without a source of lithium?
In your casual use of economic equations, you seem to be ignoring several key elements. One is causality: What creates wealth? Moving numbers around in an equation isn't how an economy functions. Two - Nominal vs. real: GDP = money x velocity is expressed in nominal amounts. What counts is real GDP. You appear to believe that this equation means an increase in money and/or velocity increases well-being. Tell that to the people of Zimbabwe! Gosh, I could go on, but I don't think anyone is taking you seriously. Now that you've demonstrated your complete lack of understanding of economics, is there a way we can get Congress to claw back your bottle of pinot noir?
10:55 a.m.
Feb 13, '09
I appreciate the comments. They remind me why I never became an economist. A true economist gets is wrong the first time but has a wealth of nerdy formulas to understand why. Let me know when you guys are able to capture the main point of an argument without getting sucked into the inane detail. When you do, I'll show you my investment account.
Bottoms Up!
Feb 13, '09
Shorter Jenson, Eat the rich.
Which I wholeheartedly agree with.
12:10 p.m.
Feb 13, '09
Sounds like you've been getting your facts from reliable sources such as Rush Limbaugh and Sean Hannity. Explain in what way did the New Deal fail Jack?
My point was not that the New Deal failed. Parts of it were successful, parts of it weren't. That, in fact, was why FDR talked about trying a variety of approaches to see what works. He was pragmatic, not ideological, in his approach to the depression.
The excess profits tax they tried was roundly criticized by liberals as well as conservatives for having the perverse effect of discouraging entrepreneurial activity while encouraging tax avoidance behavior, such as investing in municipal bonds and other low interest, low return instruments. It is generally regarded as one of the failed experiments. That's why we should learn from it and not repeat it.
Believe it or not, there are sources of information out there other than talk radio and cable news shows. In fact, there are entire buildings called libraries filled with things called books (sort of like magazines, only thicker, often with hard covers).
It's amazing the information that is stored in those things. Who knows, they could end up putting the internet out of business. (Okay, that's a pipe dream, but you really might want to give it a try.)
Feb 13, '09
Jenson says Let me know when you guys are able to capture the main point of an argument without getting sucked into the inane detail. When you do, I'll show you my investment account.
Spoken like a true economist... Instead of insulting your audience, tooting your own horn, and trying to present yourself as the second coming of Alan Greenspan, perhaps you could spare us the inane details and learn how to communicate your ideas better.
The true worth of a person is not measured by their investment account.
P.S. and the word is 'short-sighted'... not 'short-sided'
Feb 13, '09
Jensen,
I dunno if you're being quite fair to your detractors. Some of them are behaving poorly, and most of them are harping on things that may be peripheral to the main argument (which is... ?), but I think that you wrote the article to get your views out there and understood by more people. If that's true, perhaps remembering that they all felt strongly enough to post would prompt you to address some of their concerns and disagreements. Or perhaps you have bigger fish to fry. That having been said, I, too, have some comments.
Your article, as far as I can see, is saying that spending extant money on production/consumption needs to happen for an economy to thrive, and that the gov't should step in to do this--especially at a time when the rich have prevented this from happening by drawing in the purse strings.
It amazes me how anybody could think that your argument implies inflating the money supply. That's what's happening far worse today (spending by borrowing/inflating rather than taxing). It amazes me how anybody could think you're suggesting we tax poor Americans harder. Or that having foreigners invest/loan us money yields as much velocity as buying locally. And that's just touching a fraction of the comments that amaze me. Hey. I'm easily amazed.
In an ideal world, we'd all understand the value of playing nice. We wouldn't need much of a government at all. However, our greedier sides won't allow this. So an ideal government in today's world, I'd think, would be one that set out to enforce a minimum standard of fair play and then met that standard by contracting and expanding in proportion with our financial powers' degree of refusal to meet that standard on their own.
Well, hope you appreciate all your comments, both against and for. And, really, doesn't Dave's 2nd paragraph pose a fascinating question? The optimist would say that innovation, hard work, and fair play could let us all live nicely. I just don't see it happening.
Feb 13, '09
Dismissing your audience for failing to understand your argument (explained using inane detail) is a cop-out. A number of readers have pointed out fundamental flaws in your logic until you can adequately respond to these criticisms, you have no business insulting those that comment on your ideas. There are some very smart and serious readers of BlueOregon and you would do well to respect those that communicate thoughtfully.
That aside, you may have noticed that the government is doing something like you suggest in that it is taking in huge amounts of capital through banks buying US Treasuries, which the government is using to fund the stimulus and the bailout plans. This is a response to a liquidity trap - a well known aspect of crises in the literature. The taxation to pay for it all will come later and no economist believes that this will not create a drag on economic growth once the recovery is underway. Most believe the trade-off is worth it.
If you want to make the general argument that government can direct capital to more productive uses you really have to appeal to the public goods argument.
Feb 13, '09
William, I did not think the argument was about increasing the money supply, I was simply pointing out the mistake in nominal v. real GDP in his accounting identity.
Feb 13, '09
Well Jensen the thing to do might be to repeal many of the barriers that have been erected by local government in the last couple of decades. Permits to build a house should be simplified if not repealed. Afterall the costs of the permits are worked into the mortgage and since many mortgages are held by overseas companies that just means more money leaving the state and country thanks to local government regulations.
Not higher taxes; lower the barriers to production. Local barriers restrict trade just as did the Smoot-Hawley tariffs. Maybe the magnitude is smaller, but the restriction exist just the same.
TLG
Feb 13, '09
You've definitely passed the Ted Turner litmus test for a good idea (if the average person understands/likes it, it's worthless). In all the detail nit-picking, I don't hear anyone saying the goal is questionable, so I guess that's agreement. I just wanted to say that one kind of investment that stimulus plans should be careful to attract, perhaps penalize if it sits idle, is what will be the result of the largest transfer of wealth in US history, as baby boomers' parents die.
How about 0% estate tax, IF funds are used for green projects, or are invested in T-Bonds? And how about, oh, 50%, if it goes into a hedge fund, commodity, junk paper, or real estate? OK; let's take off 1% for every percentage point of equity over 50% they put into the initial purchase. If they want to buy a new house with their inheritance, fine, but it's a cash deal, no leveraging, to get the 0% rate.
There. That should attract a few of the "you don't know economics" crowd! Being an economic theorist must be the most frustrating task in the world. Seems to be something about human cognition where inspiration and creativity are diametrically opposed to sound economic thinking. Maybe that's why artists are always broke.
Feb 13, '09
I think Jenson should set an example for the rest of us by following through on his own wisdom and send 60% of his "idle money" investment account to the US Treasury. After all, trusting the infallible government to put that 60% to proper use will no doubt help "suspend(?)" the remaining 40% that by his own theory he's going to lose anyway.
5:32 p.m.
Feb 13, '09
DJ,
Well said. Beautiful even. Someone finally gets it!
If you looked at my portfolio account you would see . . . drumroll . . . idle money. Why? Because there are no good investments. If I keep this money on the sidelines to wait until the economy improves, that is idiotic. Why? Because the economy needs the money that is sitting on the sidelines in order to improve. Use it or get taxed. The problem is that too many conservative ideologues live in their own personal economic "bubble."
If anyone is wondering why the first couple of posters are nitwits, it's because they rant on and on about how I don't know anything about economics, yet they offer no solid conceptual theory themselves. In what way is my understanding of economics off? Is it because I did not make the distinction between nominal and real GDP? Is it something else? What exactly is it? Evolve the argument or you're going to get backlash from me.
Has anyone ever heard of Occam's Razor by the way?
Feb 13, '09
Patrick, when I read "You also messed up the identity, it is MV=PY so if I just increase M, guess what, P increases - inflation. Y (GDP) increases, or growth, comes from productivity not from the money supply," I thought you were suggesting that Jensen was talking about increasing the money supply, and that he was not talking about increasing productivity. I think he was talking about increasing productivity, but not the money supply. I misinterpreted you, though that's still how I read it.
That having been said, I think it's not uncommon for somebody well-versed in a field to simplify things to the degree that he imagines most of his audience to be comfortable with. In short, I don't think Jensen is confused about nominal vs real GDP, which I think he's telling you with his Occam's Razor comment.
Jensen,
How would you address the person who's aware that idle money doesn't help the economy, but it's important to hold some just the same. Calamity may befall us, and will society then take care of us if we no longer have any savings? Of course not. At least not to the standards many of us would like.
The wealthy hold money through greed and irrational fear. The middle class hold money through greed and rational fear. The poor hold none. The only person to tax harder is the rich person.
Feb 13, '09
Jensen PS: And given the government's track record of spending money poorly (unjust wars, crony payoffs, the first round of our bailouts, etc), I really couldn't blame a person for thinking that increased taxation wouldn't help much. Implicit in your argument is the belief that government will effectively spend money. Higher taxation will only work if the gov't works.
Feb 13, '09
If Jenson could bottle up his ego (and sell it), he may well become a millionaire.
Of course he won't be so forgiving of tax increases if he achieves that level of personal wealth.
Feb 14, '09
Sorry, Jenson ... But I still can't quite get your arguments on excess money, idle money and productive money and how taxing various categories of money can be achieved. Are you proposing a wealth tax? How could this be implemented? And why would this help? The economy is suffering from a malinvestment crisis (housing and other assets) brought about by easy money, misguided policies, a public mania, international imbalances, and the nature of banking (money, after all, is the ultimate commodity which means any efficient banking system will be fragile). We are fixing the banks and the TARP has been effective in restoring confidence in the remaining major banks (although dozens or more regional banks still must be eliminated to reduce the overcapacity in the industry - hence, use of TARP funds for mergers should be encouraged, not discouraged). The malinvestment, primarily in real estate and its derivatives, means some backpedaling by the economy is unavoidable, but this blow will be softened by inflation - while real estate may stagnate, price declines will be lessened by raising the the price of everything else, hence the Fed's monetization of debts. As a net debtor nation, this works to our advantage if we can pull it off without a currency crisis, but as the only game in town there is no reason it shouldn't work. In other words, I think you have misdiagnosed the problem (focusing on the monetary side effects rather than the root causes), you have proposed an unworkable reaction that would likely harm the economy. And you have indicated that you not only don't comprehend the benefits accruing from international trade, you would undo one of America's greatest strengths by seeking to undermine our large, national market with your "Buy Oregonian" clause. Wow.
Feb 14, '09
What exactly is it?
They've got a text and your words don't appear verbatim in it.
Has anyone ever heard of Occam's Razor by the way?
The principle of parsimony, while never greatly loved, has been dead for years. Even scientists are finding theories that are utterly unfalsifyable, and multiply terms, to be sexy, eg., string theory, n=12 universe. Occam was even dissed by his fellow Franciscan thinkers, during his life, which is hard to do by being too progressive, though he succeeded on a regular basis. Government is positively hostile to the notion. Business is following suit, led by the software industry. Do you know how much functionality in most application software is completely unnecessary toward accomplishing the task? The amount of junk added in to pad resumes, "be cutting edge", increase the development budget, and sell new hardware, is scandalous. We are becoming a deliberately inelegant society. It's the natural follow-on to our wasteful mindset.
Honest thinkers consider it a law, though. It's a simple one. One must not posit entities without necessity. If two theories account for the observed data equally well, and one has fewer terms, it is the better theory.
Feb 14, '09
Reading material for Jenson:
Oregon exports hit record $19.4B in 2008 by Richard Read, The Oregonian Wednesday February 11, 2009, 10:59 AM Canada remains Oregon's biggest foreign customer, but its purchases remained flat at $2.8 billion while mainland China's imports from the state rocketed 73 percent to $2.5 billion. When exports to Hong Kong are included, China has overtaken Canada to become Oregon's biggest foreign customer.
Feb 14, '09
William,
My bad, clarity was lost for brevity's sake. But the same argument can be made for velocity - if one could magically increase velocity all we would see is inflation unless it changed something else fundamental to the economy. Which is to say, once again, an accounting identity is not an economic model.
Jensen,
There are hundreds of endogenous growth models which highlight the importance of investments in human capital, technology and infrastructure. The book "Endogenous Growth Theory" by Aghion and Howitt is not a bad place to start. This is where I think the best argument for increased government expenditure can be made.
Finally, it is not clear that there are lots of good investments to be made right now with the level of economic uncertainty and the frozen credit markets. So the idle funds in your investment account don't represent your failure to find the good investments (and thus was should not expect government to do better) rather that such good investments don't exist. But I assume that your idle money is sitting in a savings account somehwere, so the money is not idle but available to investors. The problem, in other words, is the non-functioning credit markets and the post-bubble downturn. Said another way money is not idle due to supply, but demand.
4:47 p.m.
Feb 14, '09
Everyone,
Thank you for valid input instead of just browbeating (except that Jennifer W lady). I learn something when people input ideas instead of merely pointing out mine are wrong.
Feb 14, '09
Patrick,
Your claim is entirely correct. People could buy and sell debt all day long and the velocity could approach infinity what with all the automated systems we have. I can imagine a hypothetical world where greatly increased velocity would yield plenty of inflation and nothing of value.
However short we are of an ideal world, we live in a world where not all gov't spending is wasteful. I think it's demonstrable that increases in taxation (matched by increases in spending under a sane stimulus policy) will result in increased consumption and production, and will do so better than leaving the money under the control of the ultra-wealthy.
I am in general agreement with Jenson. Raising taxes and spending wisely is a legitimate prescription for our economic ills. I'm not going to sweat it if Jenson lists an equation that isn't complete so long as the right factors are on the proper side of the equation and decently approximate reality (ie as long as we see that an increase in X will lead to an increase in Y). And I'm not going to sweat the reality that an increase in velocity could hypothetically do nothing for the bad economy as long as I see a spending plan where it will do good.
I think it's clear in this discussion that we don't want to aimlessly inflate the money supply, but we do want to increase our production. Thus, I'd say that increasing velocity is a great place to start. After all, what happens as velocity approaches zero? We sure don't want that!
Said another way money is not idle due to supply, but demand.
<h2>Are you suggesting that the demand of investors is logical? I would suggest it isn't. It's geared towards making money over a fairly short span rather than bettering our collective economic health. What investor is going to spend money on improving our education system? But is improving our education good for the economy? What investor would spend money on a citywide network of streets? But is it important to our economy to have them? I can think of many more examples. Increasing taxes will help if the money is spent well, and there are PLENTY of good places to spend it.</h2>