by Gary North
Recently by Gary North: Lincoln’s Gettysburg Address, If He Had Been More Honest
Have you ever heard this phrase? “Starve the beast!” It refers to starving the Federal government. It argues that if Congress cuts taxes, spending cuts will necessarily follow.
The problem with this metaphor is that it conjures up a mental image of an overweight person who cannot bring himself to stop eating. He has no inner Richard Simmons, longing to get out.
The problem is this: this obese person has an inheritance that he can tap into whenever money runs short: the Federal Reserve System. He just keeps getting fatter.
The metaphor of the obese person is the wrong one. The correct metaphor is a city council filled with drunks. Only one of them has remained stone cold sober for 30 years. He keeps telling the voters that his colleagues can’t sober up on their own. The voters pay no attention. That is because the council members keep buying free drinks for the party-loving folks who live in their districts. “Barkeep, another round for my friends!”
Where does the city council get the money? From the voters. The voters who remain sober say they don’t like it when council members keep buying drinks for their neighbors and then put it on the city’s tab. But, drink by drink, household by household, most residents are becoming steadily addicted to booze.
It is always hard to persuade a lone drunk to head for Alcoholics Anonymous. It is impossible when they are all together at the bar, with half a dozen constituents each. “Set ’em up, barkeep! Put it on my tab!”
POLITICAL RESENTMENT BY SOBER VOTERS
There is no possibility that such a city council will ever head for AA as a group. Why should they? Parties are fun. Everyone loves a good party. But what’s a party with only lemonade? That would be a Baptist party, with some Mormons invited, just to be sociable.
But, insist the fiscal Baptists, one of these days the taxpayers are going to find themselves incapacitated. The broad mass of taxpayers are going to find it difficult to remain productive. Revenues will fall. Then the city council will find that the till is depleted. No more parties!
That sounds plausible, but there is a problem: bonds. The voters keep passing bond issues. And why not? When you are dealing with a room full of drunks who are three hours into the party, you will not find a lot of concern about the borrowing cost of putting more booze on the tab. Parties make for short-run thinking. “There’s always more where that came from! Let the good times roll!”
The bartender knows that the city council is good for the money. What’s a little extra debt? The owner of the bar will submit his bill at the end of the month, and it will be paid. It has always been paid. It’s easy money for him. He tells the barkeeper, “Keep filling up those glasses. The city is good for the debt.”
The remnant of voters who are both sober and productive now see what is going to happen. The bonds must be paid off. The sober voters will have to pay the bills. They don’t have the votes to lower taxes. They can at best hold taxes level. But the tab keeps getting larger. The tavern owners in the city keep extending credit. The tax base will not cover this indefinitely.
It is obvious to the voters who are not participants at the party that, at some point, the city is going to default on the bonds. The losers will be the dolts who kept lending money to a city whose council members were, with one lone exception, drunks. The tavern owners will hit the skids themselves. The fiscal Baptists prepare for the great “we told you so” opportunity that is surely coming. “Sorry, guys, but you knew your customers were a bunch of drunks. You will now have to go into another line of work. And your customers will all be suffering from hangovers and depleted bank accounts.”
The problem is, when the city defaults, there will be a lot of services cut. The parties will cease, but then money for all of the other services will be hard to come by. The city council will find it difficult to collect taxes. It will find it more difficult to attract future lenders. When it’s “in God we trust; all others pay cash,” there will not be much cash.
CONGRESS IS NOT A CITY COUNCIL
Here is where the analogy breaks down. Yes, they are all drunks: voters and council members. That part holds up. What doesn’t hold up is the analogy of the city council. Drunks with an unlimited tab are in Congress.
Unlike a city council, which faces a potential revolt by bond investors – the famous vigilantes – Congress has a central bank in reserve. That’s why it’s called the Federal Reserve. The FED keeps buying the debt of the U.S. Treasury. Congress, unlike a local city council, can keep running up the tab. “Another round for my guests, barkeep!”
The Federal Reserve, unlike a bond vigilante, is not using its own money to pay Congress for its perpetual party. It creates money out of nothing to buy the IOUs of the party-goers. It’s a two party system. The Democrats invite their constituents to the party, and the Republicans invite theirs. They sit at different ends of the bar. Nobody is in favor of calling it a night and going home.
What this means is that the party can go on a lot longer in Washington than it can locally. The presence of the Federal Reserve makes the tavern-owners happy. The revelry will go on indefinitely.
Or can it? As they say, “drunks are drunks.” The behavior has the same debilitating effects, whether locally or in Washington, D.C. The revelers stagger home at dawn, only to start up again in the evening.
Good time Charlie Wilson is the model. So is Carl Albert, who was Speaker of the House from 1971 to 1977. He was an alcoholic. The public did not know or care. His colleagues knew, but a lot of them suffered from the same affliction. (http://bit.ly/DCbooze) It is “don’t ask, don’t tell.” People who live in dirty glass houses don’t hire window washers, let alone throw stones.
When you are dealing with people who are long-term alcoholics, you need to intervene to get them to stop. The problem is, almost everyone seems to be at the party, allowing Congress to run up a huge tab at the bar. The vast majority of voters do not want intervention. They may complain about too much beer being consumed by teenagers and other uninvited guests whose IDs are never checked by the bartender, but the hard stuff – Medicare, Social Security, and the Department of Defense – is untouchable. “Let’s party!”
The dwindling number of sober voters look at this and conclude: “Something’s got to give.” They are correct. This raises several questions.
3. With what consequences?
4. For whom?
5. In what order?
And, of course, the big one:
6. How can I get out of the way?
The last time that the Federal Government had no debt was in 1836. That was the only fiscal year in American history when the condition of cold turkey sobriety prevailed. This tells us that the problem of irresponsible drinking is not going to be solved at fiscal AA meetings: no booze at all.
Americans are not fiscal Baptists. We are, at best, sneakin’ deacons.
For 35 years, conservatives have witnessed a continuing debate that has raged on the sidelines of the conservative movement.
Should the Federal government balance the budget by (1) raising taxes or (2) cutting spending, so that economic growth can replace the forfeited revenues?
This is the debate over the Laffer Curve. Arthur Laffer presented his famous curve to Dick Cheney and Donald Rumsfeld on a napkin. That was in 1974. He argued that, when taxes are too high, people will find ways of cutting back on their official, easily taxable production. The government will not collect all of the tax revenues that Keynesian economists had promised.
The solution, Laffer argued, is to cut taxes: especially high marginal income tax rates. Then production will increase and tax revenues will rise. Presto: Less is more! Less taxation on the books brings more revenue. That will balance the budget.
Wikipedia has a cogent article on the Laffer Curve.
The argument is formally correct, but it rests on an assumption: the marginal tax rates really are on the far side of the curve. This assumption is true most of the time.
The argument makes another assumption, which is never true for long: “Congress will not spend more money than is collected from any increased revenues.” This assumption is not correct politically. (When Laffer drew his curve, it was not politically correct, either.) Here is what it misses.
No matter how much revenue is collected, Congress will always pass more spending bills, so that the deficit will inevitably reappear, assuming that it ever goes away.
Put succinctly: “Federal government deficits are inevitable.” This law has remained unbreakable ever since 1837.
Mainstream economists make false assumptions. There is only one assumption with respect to taxation that is in fact a law of politics: “Assume the position.” Politics determines only who will assume which position and for how long.
DAVID STOCKMAN’S SOLUTION
Stockman was Ronald Reagan’s budget director from 1981 to 1985. He did not believe that Laffer’s solution would work. He said so in cabinet meetings. Reagan had promised to pressure Congress to pass a law lowering marginal tax rates. He also promised to increase military spending. He did both.
Stockman kept saying that the increased revenues would not be sufficient to overcome the increase in expenditures. He was correct. Reagan vetoed no big spending bills that Congress got to his desk for a signature. Spending kept rising.
Meanwhile, Volcker’s policy of dramatically reduced rate of growth in the monetary base produced back-to-back recessions: one under Carter in 1980, which lost the election for him, and one under Reagan in 1981-82, which cut revenues. In 1983, the Federal Deficit went over $200 billion. I had predicted this figure in my newsletter and my book on price controls in 1977, at the beginning of Carter’s Administration. I had said it would hit in 1984. I missed.
Stockman looked at the politics of budget-cutting and concluded, “No way.” He was correct. There was no way that Reagan would reduce spending sufficiently to bring the budget into balance.
The question was this: “Could he have cut spending?” That was the most important domestic policy question in the entire post-War world.
The thrust of bipartisan Keynesian politics, 1946 to today, has been to resist all attempts to cut spending, or even hold it steady. Reaganites promised a Reagan revolution. “Let Reagan be Reagan.” But Reagan was a big spender. He never lost his taste for the New Deal, which he favored domestically all of his life. He was never in the camp of the Taft Republicans.
Reagan had the votes to get marginal tax rates cut. He had the votes to build up the Defense Department. But he never bothered to test the political waters on the question of domestic spending.
In 1983, Social Security technically went bankrupt. That was Reagan’s moment of truth in domestic politics. Would he let the thing go under, or would he implement the Greenspan’s Commission’s recommendation to hike taxes? He did not hesitate. He backed Greenspan.
Then in 1986 he signed TEFRA into law: a major tax increase.
There was no Reagan revolution. There was only a Laffer revolution, and then only on the taxing side.
Stockman wanted a balanced budget. He saw that Reagan would not provide it by vetoing spending for domestic programs. So, he opposed tax cuts. He opposed the Laffer revolution. Conservatives never gave Stockman credit for having warned Reagan that this would happen. When he resigned, there were no cries of “Good show, Dave!”
Had I been Stockman, I would have resigned. But I would have resigned over Reagan’s refusal to cut spending, not his decision to cut taxes. My motto is this: “If you’re going to commit political suicide, do it on behalf of cutting spending.”
“ALL HAIL THE DEFICIT!”
Here are the political choices available in a national political system that is based on this slogan: “Another round for my friends, barkeep.”
1. Cut taxes (deficit rises).
2. Leave taxes alone (deficit rises)
3. Raise taxes (deficit rises)
This means that the deficit will rise. Now the debate shifts. From the point of view of American voters, who should buy Treasury debt?
1. Private investors
2. Foreign private investors
3. Foreign central banks
4. The Federal Reserve
There is no question which I am in favor of: #3. Let foreign central banks buy all of it – every last dime of it. Why? Because American voters will accept this slogan: “Stiff China!”
Somebody is going to get stiffed. There is no way out. This can be American investors. It can be Asian central banks. It can be American citizens, who will be wiped out because of
1. Piecemeal default by hyperinflation
2. Piecemeal default by mass inflation and price controls
3. Immediate default by open declaration of Federal bankruptcy
4. Piecemeal default by means-testing of benefits
5. Piecemeal default by the boom-bust cycle, repeated forever
The deception can go on and will go on. But the question of who bears most of the costs of the default is a political question.
Raising taxes will not help. Congress will spend every dime and borrow against the future.
Cutting spending is not politically possible. Reagan had his chance. He never considered it.
The deficit will delay the day of sobriety.
The day will come when Congress will not have any more credit. The bar’s owner will send a note to the bartender: “Don’t let these guys run up the tab. It’s cash on the line.”
If the FED inflates, prices will rise, until the bar’s owner tells the bartender: “Silver coins or gold coins only.”
Congress will then sober up.
Tens of millions of Americans will then go through forced de-tox at that point. It will be pink elephants on parade.
Pink elephants are the inevitable result of red ink.
So, my goal is to increase the supply of red ink. I want to keep more of my income, so that I can invest in asset categories that will protect me from the drunks, both when they are drunk and when they have the DT’s. This means lower taxes now, capital accumulation now, and buying up the distressed property of drunks after they finally sober up. Cut taxes and cut spending. But if it’s one or the other – and it surely is – cut taxes.
I wish to be remembered by this poem:
North marched up the Laffer curve,
And said to all his men:
“Let’s cut the rates till income falls,
And then let’s cut again.”
December 1, 2010
Copyright © 2010 Gary North