The European economy is in trouble. After a few years of slow growth it is now making a turn for the worse. EurActiv reports:
The eurozone economy shows little sign of recovering before the year-end despite an easing of financial market conditions, European Central Bank Mario Draghi said on Thursday (8 November) after interest rates were left at a record low. The ECB held its main rate at 0.75%, … “Economic activity in the euro area is expected to remain weak although it continues to be supported by our monetary policy stance and financial market confidence has visibly improved on the back of our decisions,” Draghi told a news conference.
That monetary policy is basically the open-ended commitment that the ECB has made to print unlimited amounts of money to buy treasury bonds from troubled euro-zone welfare states, from Greece to Portugal. By promising to flood the euro zone with fresh cash, the ECB intends to keep interest rates down, in the hope that their policy will combine two things:
- Low investment financing costs for private businesses, intended to stimulate business growth; and
- Low financing costs for government deficits aiming to keep debt service costs – i.e., current government expenditures – down.
The low interest rates will not help on either front. Businesses do not make major investment decisions based prmarily on their funding opportunities, but instead on the so called marginal efficiency of capital. Simply put, that is their expectations of what they can earn on their investments. The higher their expected earnings, the more inclined they are to invest. Since earnings are defined primarily by sales, a low interest rate won’t help if the economy as a whole is in the tank.
Simple Keynesian macroeconomics.
As for government deficits, a low interest rate will only encourage them to borrow more. By making its open-ended bond purchasing promise, the ECB has effectively destroyed the market mechanism for risk management. Governments that will never be able to pay down their debt (hello Greece?) can continue to rake up debt more or less with impunity.
Sadly, it seems like more expansive monetary policy – pushing for lower interest rates – is the only economic-policy instrument that the Europeans are willing to use to revive their economy. EurActiv again:
Gloomy data this week indicated the eurozone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates. Recent survey evidence gave no sign of improvement towards the end of the year and the risks surrounding the euro area remain on the downside, Draghi said. He signalled the ECB would downgrade its GDP forecasts next month, describing “a picture of weaker economies”, and said inflation would remain above the ECB’s target for the rest of the year, before falling below two percent during in 2013. Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the eurozone, a mechanism that has been broken by the bloc’s debt crisis.
It is not entirely clear what he is saying here, but he is probably referring to where the new money supply is going. It is not replenishing the balance sheets of banks willing to lend to the public, but instead padding the pockets of governments. The mechanics of monetary policy are more complicated than this, but if this is how the ECB thinks, they are essentially correct: government spending, and the credit funding it, is absorbing resources that would otherwise have benefited the private sector. (For those who are familiar with the “crowing out” effect of the IS-LM model, this is somewhat different. But that’s a story for another day.)
Another aspect to the debt crisis is that a long, gloomy recession has weakened the finances of private citizens. In many instances this is leading to a new private-sector debt crisis. Sweden is steaming toward a housing bubble, and in Germany an increasing number of families can no longer afford their mortgages, car loans, credit cards, etc. German Creditreform.de reports (including an informative chart) that “overindebtedness” – defined as more debt than someone can handle – has grown notably since 2009:
Die Zahl der überschuldeten Bürger hat sich in Deutschland wieder erhöht. Gegenüber dem Vorjahr erreicht die Schuldnerquote 9,65 Prozent (2011: 9,38 Prozent). Damit sind 6,59 Millionen erwachsene Bundesbürger überschuldet – im Vorjahr waren es 6,41 Millionen.
This is a small but important sign that the German economy is not going anywhere but down over the next six to nine months. That in turn means less money from German taxpayers to bail out the crumbling welfare states down south of the Alps. And that, in turn, spells even more trouble for politicians in Athens, Rome, Madrid and Lisbon who are trying desperately to keep their sinking welfare states afloat.
So where does this new European recession come from? It’s quite simple: austerity. When governments take more and give less, they drain the private sector of resources while discouraging productive business activity through higher taxes. Businesses and households have less money to spend, which leads to less productive economic activity – and a shrinking tax base. As the tax base shrinks, governments fail in their attempts to balance their budgets. That means more deficits.
And more austerity.
And more recession.
Take note, America. It’s time to change course before it is too late.
We have all heard about the now-infamous video where Governor Romney talks about the 47 percent of Americans who supposedly support Obama as dependent on government. The video made quite a splash in the duck pond that is the GOP establishment. Panic erupted. Republican cocktail-party goers on the Tenderfoot Coast between Times Square and Tyson’s Corner whipped themselves for having even pondered voting for Romney. Jonah Goldberg and his buddies over at National Review are all up in arms. Media “conservatives” like Megyn Kelly at Fox News are trembling with fear. Shoot-from-the-hip columnist Josh Barro over at Bloomberg just can’t jump ship fast enough, declaring to the world that the election is now over.
Leading the scramble away from Romney is of course Bill Kristol, editor of the allegedly conservative Weekly Standard. It is not surprising that Kristol’s coat is turning left: like most people in the mainstream media, Kristol is an ardent Obama supporter (see, e.g., here, here and here).
Unlike these Cocktailers, Mainstreamers and Beltwayers, we at the Liberty Bullhorn don’t have tender feet. We are not addicted to schmoozing with liberals and we are certainly not afraid of either principles or good analysis. Therefore, we don’t panic when Governor Romney says something that is deemed politically incorrect by thin-skinned news pundits and campaign consultants.
What Romney meant is very easy to understand for anyone who cares to spend more time on the issue than it takes to read a tweet. But to make sure that even those with a short political attention span can follow the reasoning, let us sum up what the issue is all about in five easy steps:
1. The federal budget is in deep deficit.
2. About four in ten Americans are net takers of government services and entitlements.
3. About four in ten Americans are net givers of government services and entitlements.
I know these two points can be difficult to grasp for cocktail conservatives, but bear with me. I will explain in a moment.
4. To close the deficit we need to move people from being net takers from government to being net givers to government.
5. (This is the last point – hang in there, tenderfooters!) If you depend on government, you get addicted to the easy money.
From these five points, Romney concludes that:
a) it is likely that those who depend on government will vote to perpetuate their own dependency; and
b) this presents us with a formidable challenge – provided of course that we want to close the budget deficit without killing the American economy.
The best road forward, Romney says, is again to move people from the column of net takers from government to the column of net payers to government. However, the longer people depend on government, the more institutionalized they become (my term, not Romney’s). Even though you can convince people rationally that self determination is better than dependency on government, experience from Europe shows that most of the net takers of government services and entitlements aren’t going to listen to that rational argument. Comfort appeals to a lower level of the human mind than self determination, and therefore has a tendency of prevailing.
Anyone who wants to study the effects of this kind of dependency can look at how Europeans respond when austerity-minded governments try to take away their allowance. They protest wide and loud even though the unsustainability of their welfare state is staring them in the face.
This is the short version of what Romney said – hopefully it is short enough for the cocktail conservatives on the tenderfoot coast to understand. (If you still don’t grasp Romney’s point, and if the following analysis is too complex for you, do feel free to e-mail me and ask for clarifications. I have successfully educated people with little or no high school background on more complex issues than this.) Now, let’s take a more comprehensive look at the problem.
There is a very good way to illustrate the difference between a net taker from government and a net giver to government. It is called the Earned Income Tax Credit (EITC). This welfare program is one of the most obvious candidates for turning people from net taxpayers to net government takers. In fact, it is the single largest welfare program in the country: in 2009, 27.4 million families received a total of $55.1 billion in Earned Income Tax Credit, averaging $2,206 per family.
The EITC is nothing more than a low-income trap. It gives a substantial infusion of cash to eligible taxpayers but combines that infusion with effective marginal tax rates that exceed what people pay who make ten times more.
As for the cash, a taxpayer who qualifies can get up to $5,030 per year. Since the “credit” is refundable, and thus de facto a welfare program, it cancels out and in many instances exceeds what eligible taxpayers pay in federal income taxes. Three out of four EITC recipients got at least as much from the government as they paid in federal income taxes, making them net consumers of government. This is not counting any other government entitlement program; if we add all other cash that government hands out or provides in the form of services, we find – as demonstrated by the Heritage Foundation - that the upper half of all income earners pay virtually all federal income taxes.
It is a big moral problem when people are net takers from government. They are not contributing their fair share – which obviously would be a fixed, equal percent for everyone, as in the Herman Cain 9-9-9 plan – and since they are not paying their fair share it is ethically questionable whether or not they should have the same influence over government as those who actually bankroll government.
However, there as also economic problems that are at least as important as the moral ones. Established economic theory says that steep marginal income taxes discourage increases in labor supply and labor effort. Since the EITC suffers from precisely that – steep marginal tax rates – it discourages self determination and pursuit of prosperity.
To make this point, let us perform a little experiment. Suppose that Jack and Jill are married, have no children and no other deductibles file their taxes jointly. They qualify for the EITC, with an amount determined by the EITC eligibility calculator provided by the Internal Revenue Service. (Federal income tax amounts are taken directly out of the IRS 1040 tax table.) Suppose, also, that their income increases by $10,000 per year, starting at $10,000. Their net between the federal income tax and the EITC will be as follows:
|Taxable Income||Federal Income Tax||EITC||Net||Effective Rate|
|$ 10,000||$ 1,003||$ 5,030||$ (4,027)||-40.3%|
|$ 20,000||$ 2,166||$ 5,030||$ (2,864)||-14.3%|
|$ 30,000||$ 3,666||$ 2,700||$ 966||3.2%|
|$ 40,000||$ 5,166||$ 1,120||$ 4,046||10.1%|
The marginal rates are even more startling than the effective rates reported above. Suppose Jack and Jill make a combined $30,000 per year. Jack is offered a better job which would increase his income by $5,000. Their combined federal income taxes would increase by $750, indicating a 15-percent marginal tax on the new income. But their higher income also reduces their EITC eligibility from $2,700 to $1,640. This loss is now equivalent to a tax on the last $5,000 they make. The actual tax on that income increase is therefore $1,810 – a 36-percent effective marginal tax rate.
This effective marginal rate prevails through a wide income bracket: from $22,500 to $40,000. These numbers are, again, calculated under the assumptions outlined above, which makes them somewhat artificial. Nevertheless, they do highlight the fact that taxpayers who qualify for the EITC are taxed more heavily on the margin than high-income earners.
There is plenty of anecdotal evidence of what happenes to families who go from a low-paying part-time job to full-time employment. I know a family where the breadwinner had endured the recession earning just over $20,000 and was happy to accept a full-time job paying $50,000. He and his wife were amazed to discover that once they had made the transition, they saw no noticeable change in their disposable cash every month. They were penalized by the welfare state who kicked them off income-dependent welfare programs, including but not limited to the EITC. In addition, of course, they had to pay a much higher federal income tax on the last earned dollar.
You work more every day, take on a lot more responsibilities – but you are not better off. Romney’s point is that when faced with this kind of choice, too many people fall for the temptation to remain on welfare.
And just to put another angle on his comment, consider the fact that in 2009 almost 68 million tax returns declared an income of less than $30,000. That was 48 percent of all personal income tax returns. The vast majority of these filers qualify for one tax-funded entitlement or another, transforming them from net taxpayers to net takers of government services and entitlements.
To make this point yet another way: according to individual income tax return data from the IRS, tax filers with an income between zero and $30,000 earned 3.8 percent of the total adjusted gross income – but they paid only 0.1 percent of all federal income taxes.
Put bluntly: their income share is 38 times higher than their share of the taxes.
This imbalance between income and tax payments remains strong as we move up the income ladder. A full 64 percent of all tax filers make less than $50,000 per year. They earn 10.5 percent of all income but pay only 3.9 percent of the federal income taxes. This makes their income share 2.7 times bigger than their share of the total tax burden.
Do you think these people want to increase their share of the taxes? Thought so. And that’s precisely Romney’s point: now that we have placed half of the American people in a tax-and-entitlement comfort zone, how do we get everyone onboard when we try to close the federal budget gap?
This past week we learned that the Chairman of the Federal Reserve, Ben Bernanke, is going to put his money printing presses into overdrive:
The Federal Reserve said it will expand its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month in a third round of quantitative easing as it seeks to boost growth and reduce unemployment. “We’re looking for ongoing, sustained improvement in the labor market,” Chairman Ben S. Bernanke said in his press conference today in Washington following the conclusion of a two-day meeting of the Federal Open Market Committee. “There’s not a specific number we have in mind. What we’ve seen in the last six months isn’t it.” Stocks jumped, sending benchmark indexes to the highest levels since 2007, and gold climbed as the Fed said it will continue buying assets, undertake additional purchases and employ other policy tools as appropriate “if the outlook for the labor market does not improve substantially.”
I am not a fan of Austrian economics, and I have my concerns when it comes to monetarism. There is enough evidence out there to suggest that both theories have it wrong, at least generally, when it comes to the destructive consequences of printing money. However, when it comes to the new strategy by the Federal Reserve I am on the side of the monetarists.
My reason, though, is not primarily that I worry about inflation – for reasons I will explain in a moment, you can print a lot of money without causing inflation. My concern is instead that this happens at the same time as the European Central Bank (ECB) has decided to provide an infinite guarantee for the deficits of EU member states.
The Federal Reserve has two policy objects: to keep inflation down and to contribute to the growth of the U.S. economy. The ECB has only one policy object, namely to keep inflation down. Neither of the two central banks has a directive to bankroll a government deficit. That is, however, precisely what is happening: the Federal Reserve has been buying treasury bonds for a very long time, and the ECB has now gotten into the same business.
We could stop here and simply note that both these central banks are breaching their policy boundaries – and probably their charters as well – but that would not be of much consequence. The fact that something is wrong in principle has rarely stopped a politician or a government agency; what matters here is instead that both the Fed and the ECB are getting into policy territory that is very risky from an economic viewpoint.
When a central bank makes an open-ended promises to buy treasury bonds from the fiscal government of that country - which is precisely what the ECB has done for Spain and thus by implication for any other troubled welfare state in the euro zone – it effectively nullifies any effort by that same government to end a budget deficit. From the viewpoint of those who create the deficit, namely the legislators, the money printed by the central bank is the perfect solution: they don’t have to raise taxes to pay for their spending, nor do they have to schmooze foreign investors. As far as they can see, they can keep on spending ad infinitum.
For a while, they can. Short-term, there is no immediate penalty to expansive monetary policy. (There is later on; let’s get back to that in a moment.) On the contrary, the combination of sustained government spending and low interest rates is appealing to many mainstream policy makers. They can continue to run a deficit without having to support politically painful spending cuts or even more politically painful tax increases. Furthermore, they can make the case that private-sector activity is stimulated by low interest rates, from household spending on durable goods to businesses making investments at low cost.
Over time, though, two dark clouds rise on the horizon. The first is a downward macroeconomic spiral, driven by a relentless growth in government spending. Due to what legislators consider to be easy money, government will continue to spend on its entitlement programs, and do it essentially as if the deficit did not exist. Such government spending has negative effects on many fronts, one being that people reduce their workforce participation and live more on entitlements. This reduces the tax base and deprives the welfare state of some of the revenue it needs to pay for that same welfare state. It is this revenue gap that the central bank fills with freshly printed money.
By perpetuating this replacement funding the central bank thus perpetuates the spending that erodes the tax base and perpetuates people’s dependency on entitlements. It perpetuates the need for its own printing presses.
But this situation is not static. Over time, more and more people depend more and more on entitlements, and the increasing demand for taxes that comes with growing entitlement spending falls on fewer and fewer shoulders. Not only do people who are not working depend on government, but in a welfare state more and more working people get at least as much in entitlements from government as they pay in taxes.
When a central bank steps into this situation and makes an open-ended money-printing commitment, it only reinforces the destructive erosion of the tax base and of people’s ability to support themselves through work. A vicious circle becomes a vicious downward macroeconomic spiral. This is where Greece, Spain, Portugal and Italy find themselves today – and it is where America is heading.
The second dark cloud on the horizon is inflation. However, it does not kick in as early as Austrian and monetarist economists claim: the monetary printing presses in America have been running on overtime for years without causing the kind of inflation that those theories foresee. But that does not mean there is no connection whatsoever between an expanding money supply and the general price level in the economy.
The key is a set of so called “transmission mechanisms” between the monetary sector of the economy and the real sector (the one where production, consumption, investment and work take place). During the 1990s there was a lively debate in the academic economics literature about these transmission mechanisms, and one of the front figures in the related research was - you guessed it - Ben Bernanke. He was one of the economists involved who pointed out that there was insufficient research as to how these transmission mechanisms actually work.
This is important because prices are not monetary phenomena: they are real-sector value equivalents that happen to be denominated in a certain currency. When monetarists and others claim that prices rise as a direct consequence of expanding money supply, they assume – implicitly – that prices are monetary phenomena. They claim that a one-percent rise in the supply of money will cause a one-percent rise in prices, all other things equal. But all other things are neither equal nor irrelevant. A price does not rise just because there is more money in the economy.
Austrians and monetarists are missing a mechanism, namely that which makes the increased money supply change the real-sector value equivalents. Prices, for short.
What could possibly change real-sector value equivalents? Well, this is where government-provided entitlements enter the picture. In an economy without entitlements, all products produced are priced relative people’s workforce participation. You buy what you need and want by means of what you earn through work (current or accumulated in the form of investment dividends). When government provides entitlements it allows some people to pay for their goods without working, which increases demand for a given production. Since the entitlements also discourage workforce participation, there will be less labor available to produce in order to meet the extra demand. This has an inflationary effect on consumer prices.
So long as government pay for entitlements through taxes, it somewhat mitigates the imbalance by reducing demand among those who are net taxpayers. That way the inflationary effect on consumer prices is moderated or eliminated. However, when government decides to pay for some of its entitlements with newly printed money, it removes the inflation moderation that comes with taxes. When a sufficiently large share of consumer spending is driven by entitlements, and when a sufficiently large share of those entitlements are funded by money supply, consumer prices will start to rise. And when they do, there will be little in the way to stop them from rising further.
These mechanisms have been at work in many countries at different points in time. Weimar Germany is a classic example; some Latin American countries have a history of hyper inflation, driven by out-of-control entitlements. Zimbabwe has long suffered from a similar problem. Therefore, we know what this problem looks like and we have a good idea of what its causes are. However, what we do not know is just how far you can push a welfare state by funding its entitlements with freshly printed cash, without causing hyper inflation.
I would rather we don’t try to find out. But both the ECB and the Federal Reserve appear all too eager to test the limits of monetary sanity.
Let’s hope someone puts a foot down before these two central banks have caused consumer prices to spiral out of control in the world’s two largest economies.
The resistance to more austerity is growing across Europe. From Greece to France to the Netherlands, anti-austerity politicians are turning the political tide away from a destructive combination of tax hikes and spending cuts. But their solution is just as destructive: their idea is to keep raising taxes – in the French case to a ridiculous 75-percent marginal income tax – but to spend even more on entitlements and government projects. In other words, a return to the very policies that brought about the current fiscal disaster in the first place.
Politically, this is even more absurd. The socialists built Europe’s over-spending welfare states; when spending ran out of control and deficits became a real threat to the fiscal survivability of the EU member states, voters handed over power to center-right parties; once in power, the center-right parties tried their best to save the welfare states that had caused the fiscal problems in the first place; but since their rescue method by pure necessity involved austerity, voters think things were better before the fiscal problems began.
Which, superficially, is correct. You are always better off in a car right before it crashes than right after.
Europe’s increasingly destructive spiral of socialist welfare spending and conservative austerity is painfully visible in Spain. The Iberian nation is being torn between harsh austerity measures, put into place to supposedly save the country from a Greek disaster, and a determined counter-reaction from left-leaning local politicians and activists. The Spanish trajectory, so to speak, is worrisome and tells us a great deal about where Europe is heading. In a matter of speaking, Spain is the canary in the European coal mine.
Let’s go back to July, when the Spanish government announced another round of tough spending cuts:
Spain has announced a drastic series of spending cuts and tax increases in the face of an ultimatum by the EU, as the country struggles to reduce its deficit while negotiating a bailout for its banks. “These are not pleasant measures but they are necessary,” Prime Minister Mariano Rajoy told parliament referring to a programme designed to bring in €65 billon in savings by the end of 2014. “We have very little room to choose. I pledged to cut taxes and now I’m raising them. But the circumstances have changed and I have to adapt to them,” he addded, according to Bloomberg.
If he had chosen tax cuts, he would have given the economy a chance of a moderate recovery. If he had also chosen tax cuts and structural reforms to eliminate the welfare state, he would have given his country a new, prosperous future. But this libertarian “third option” to the socialist spend-and-tax strategy and the conservative cut-and-tax austerity alternative, is not on the political radar screen in Europe.
So what was in the Spanish July austerity package, and what were they trying to accomplish?
The measures include a hike in valued added tax from 18 to 21 percent, a reduction in unemployment benefits and a reform of the public administration. The move is an attempt by Madrid to reassure markets and bring its borrowing rates down to more sustainable levels. It is also part of a quid pro quo deal with its eurozone partners, which have given it an extra year to bring to [sic] its deficit to below the three percent of GDP required by EU rules. It is expected to reduce its budget to 6.3 percent this year, to 4.5 percent in 2013 and to 2.8 percent a year later. “This is a challenging but achievable objective,” said EU monetary affairs commissioner Olli Rehn said at the beginning of the week, while noting that Madrid will have to commit to the “rapid adoption of additional measures.”
Mr. Rehn is wrong. The combination of higher taxes and lower government spending is going to make it harder for the Spanish government to close the deficit gap. This austerity strategy:
- shrinks the tax base when higher taxes reduce consumer spending and force more layoffs in the private sector; and
- increases demand for government-provided entitlements when more people are unemployed and poor.
Not only is austerity a self-defeating proposal, but if pushed far enough it puts social and economic stability in jeopardy, something that the EU Observer noted already in July:
The new cuts have caused anger among many of Spain’s citizens, with the country already suffering from a high unemployment rate, particularly among its youth. On Wednesday, thousands of miners made their way to Madrid to protest the government. They were joined in the Spanish capital by anti-austerity demonstrators.
This was only the beginning. In August, as the national government started putting its austerity package to work, some regional governments refused to cooperate:
An escalating dispute between Madrid and Spain’s regional authorities risks undoing its austerity pledge to EU authorities. The conflict erupted on Tuesday (31 July) when Jose Antonio Grinan, the President of the Andalucia region, walked out of a meeting of Madrid’s Council of Fiscal and Financial Policy when it told him to cut another €3 billion from his 2012 budget. Catalonia boycotted the meeting in the first place, saying it already cannot pay some hospital, child-care and elderly-care centre workers.
There are still those who deny that austerity is taking place in Europe. Then there are those who think it is desirable to import this to America. Fortunately, there is a third alternative, as mentioned earlier. More on that later; back now to the rising tensions in Spain:
Asturias and the Canary Islands voted against the council’s demands. The Basque region also raised heckles. Regional spending was the main reason why Spain last year missed its deficit targets under EU rules: Andalucia and Catalonia between them have a GDP of €346 billion, or 32 percent of the country’s total economy. Andalucia’s Grinan renewed his attack on the government on Wednesday. He said at a press conference in Seville, the Andalucian capital, that he would challenge Madrid’s demands in Spain’s Constitutional Court if need be.
This mans is a socialist, a fact worth keeping in mind:
The Socialist also fired a political broadside against conservative Prime Minister Mariano Rajoy. “This … could close 19 hospitals, all of the Andalucian health service, or get rid of 60,000 public workers, one in four of the local governments workforce,” he said at the press event, according to local news agency Europa Press. “We are taking resources away from health care and education to save the banks, that is intolerable.”
This is the same kind of ideological mantra that carried the French socialists to both presidential and parliamentary victories this summer. The Dutch socialists are also beating the “unfairness” drum, but more in the traditional sense of income redistribution and having government give things to people for free.
As the national government has continued to push through its austerity package, resistance among the general public has only grown stronger. The situation is in fact getting desperate, to a point where the Spanish prime minister is now – predictably – finding himself in the same situation where his Greek colleague was before the May parliamentary election:
Spanish Prime Minister Mariano Rajoy on Tuesday (28 August) said his government has not yet taken a decision on asking for European help in refinancing its debt, pending a key meeting of the European Central Bank next week. Speaking alongside EU council chief Herman Van Rompuy, who interrupted his vacation in Spain to meet the Prime Minister, Rajoy re-stated his commitment to “take all necessary measures” to get the country out of the worsening crisis. “We’ve already taken complicated, painful decisions, but they were required in this situation. We have to lower our public deficit, we can no longer continue in this situation where refinancing is so difficult,” he said. Fresh data published on Tuesday by the country’s statistics office showed that recession is now at 1.3 percent of GDP, compared to previous estimates that suggested the economy would contract by one percent.
Austerity is working. Higher taxes are depressing private-sector spending; government spending cuts are depressing government spending.
You don’t need to have a Ph.D. in economics to see that this is going in the wrong direction. But you probably have to have an appreciation for Keynesian macroeconomics.
On the same day, the country’s most economically important region, Catalonia, said it would need a €5 billion bailout from the central government to refinance its debt. Rajoy brushed off questions about the sustainability of the country’s public finances and said Catalonia was not the first region to be bailed out. Yet the worsening data and the soaring borrowing costs for both the central and the regional governments have fuelled speculation that Spain will need a bigger bailout, on top of the €100bn earmarked for its troubled banks.
To misquote Yogi Bera, it’s the Greek deja vu all over again.
Nothing says Spain is going to come out of its current round of austerity measures in any better shape than Greece, where authoritarian or totalitarian political parties captured 40 percent of the votes in the second election round in June. Spain could easily go the same way. While socialist madmen like this small-town mayoral crazeball are still an exception, it is very important to keep in mind that Spain was a fascist dictatorship for a longer period of time in the 20th century than it was a democracy. Let’s also not forget the country’s recent and very bloody history of terrorism.
More than almost any other country in the euro zone (where austerity pressure is crushingly high) Spain is a catalyst for how far a welfare state can be pushed by austerity, before it breaks. Spain is more than four times larger than Greece and at least in the eyes of Europe’s fiscal and monetary policy makers Madrid runs a stronger and more reliable economy than Athens does. This means that they will give Spain more credit, politically and financially, but it also means that once austerity pushes Spain beyond the breaking point, the turmoil that follows will in all likelihood be of a magnitude not seen in Europe since Weimar Germany.
Now: should anyone be interested in the libertarian alternative between the socialist welfare state and conservative austerity, there is a very important book that I would strongly urge you to read.
I have been predicting a Greek exit from the euro for a while now. I have also noted that other countries with much better credit rating, primarily Finland, have been floating the idea of leaving the euro because they don’t want to be contaminated by the Greek mess. This has, as I have explained, put a lot of tension on the euro, and essentially forced pro-euro nations like Germany to choose whether or not they want to be part of a weak currency, or a strong one.
It looks like the Germans have now made up their minds. According to the EU Observer the Germans have already begun engineering the Greek secession from the common currency:
Greek prime minister Antonis Samaras has called on EU politicians to stop unhelpful speculation about his country’s exit from the eurozone but his plea comes as it emerged that German officials have set up a ‘Grexit’ working group.
Not surprisingly, this does not sit well with the Greek prime minister, who says that…
efforts to undertake the tough reforms demanded by Greece’s lenders are being undermined by regular negative statements about Athens’ euro future. “How can we privatise when, every day, European officials speculate publicly about a potential exit of Greece from the common currency? This has got to stop.” Samaras said an exit from the eurozone would be “devastating” for Greece as no democracy could survive such a drop in living standards but also for other eurozone countries who would feel sharp knock-on effects.
Well, to begin with the Greeks have not exactly been working to build their own standard of living. Their idea of “standard of living” has been to milk as much as they could out of government and then use a German-backed credit card called the common currency to get cheap loans for their lavish fiscal self-indulgence. Mr. Samaras is not the right person to lament about a drop in the standard of living.
Beyond that, he does have a point in that the speculations about a Greek exit contradict his efforts at putting austerity to work in his country. From an outsider’s viewpoint this looks like the EU and Germany don’t believe in their own deal to save Greece. But this contradiction is problematic only to the extent that one believes that the austerity imposed by the EU actually could save Greece. It can’t. In fact, the austerity measures are pushing Greece closer and closer to a breaking point where the country will ditch both the euro and its parliamentary democracy.
Therefore, Mr. Samaras’ complaints, while valid within a narrow context, are more reflective of his overall frustration of where his country is going than part of a genuine effort to save Greece. If he really wanted to save Greece he should end the austerity bombardment of the country’s economy and focus on structural reforms that will permanently roll back the welfare state.
As the EU Observer notes, Samaras is in Berlin to negotiate easier terms on the austerity programs demanded by the EU and Germany, but his reason for doing so has nothing to do with getting time to reform away tax-funded entitlement programs. His only goal is to avoid uncontrollable escalation of an already tense political and social situation in Greece:
Samaras will meet Chancellor Angela Merkel in Berlin Friday (24 August) to put the case for more flexibility around the austerity programme demanded by creditors in return for the second €130bn bailout. He said the meeting would not be about discussing the goals of the programme but how to achieve them while maintaining “social cohesion.” However his visit coincides with news that the German finance ministry has established a special working group to discuss how to deal with a potential Greek exit from the eurozone. Financial Times Deutschland revealed that the group … is considering the “financial consequences” of an exit and how to prevent a “domino effect” to other states, the newspaper quotes a ministry official as saying.
The German government is strongly pro-euro, and its overall attitude is that Greece is an anomaly within an otherwise well working currency union. That is not the case: once Greece goes, it will be proof that the efforts to stabilize fiscally troubled countries within the euro zone do not work. Spain is currently undergoing the same treatment as Greece, though at an earlier stage. If Greece secedes, it will ony be a matter of time before a Spanish exit becomes reality.
What makes this situation so delicate is that the only way to save the euro is to kick out countries like Greece and Spain. But if that becomes the norm, it will set an entirely new and very low tolerance level toward fiscal problems in the remaining euro countries. It will reinforce the calls for a common fiscal union for the euro countries – a federal government running the entire welfare state in all nations with the euro as their currency. This new level of “integration” does not sit well with EU critics and those who want to preserve national sovereignty in Europe. It should therefore come as no surprise that a new, anti-euro movement has seen the light of day in Austria. EurActiv reports:
Billionaire auto parts magnate Frank Stronach has burst into Austrian politics with a call to abandon the euro, probably turning parliamentary elections due next year into a de-facto referendum on the country’s role in Europe. The man who emigrated to Canada as a 22-year-old pauper and made a fortune by building the Magna automotive supply empire has come home with a bang, insisting it is time to restore the schilling national currency as quickly as possible. Stronach’s party is so new that it still has no name and its support remains so far in single figures, but the 79-year-old is already drawing on the discontent about the cost of eurozone membership which is spreading in the bloc’s wealthier members.
Which again should not surprise anyone. The Finns have, as mentioned, already voiced the possibility of them returning to their national currency, the markka, if the euro continues to weaken from the perpetual problem countries down south. Austria is also a well-managed country, by European comparison, and, like Finland, a relative newcomer in the EU (the two joined in the mid-’90s together with Sweden). Being a strong economy, Austria finds itself…
having to fund bailouts for the eurozone’s weaker members. There is increasing evidence of bailout fatigue in the well-off countries, so having solidly pro-Europe Austria waver in its commitment would be an ominous sign for the currency. Finland’s foreign minister said last week that officials had prepared for the possible collapse of the single currency. Dutch voters go to the polls next month in an election dominated by the eurozone debt crisis and austerity measures. “Clearly this is not just an Austrian development but more representative of the so-called stronger countries which have the highest credit rating,” said Zsolt Darvas, research fellow at the Brussels-based Brugel think tank. “In Germany, Finland or the Netherlands you see exactly the same or similar movements.”
Interestingly, EurActiv reports that the concept of a euro rollback has set roots in national politics:
[Austrian] FPÖ leader Heinz-Christian Strache, whose party is off highs but still gets around 21% in polls, is calling for the eurozone to be reduced to a group of strong members such as Germany, Austria and the Netherlands. Even ÖVP leader and Foreign Minister Michael Spindelegger, a pro-Europe stalwart, has backed treaty changes to let the eurozone evict members that do not live up to financial commitments.
Whenever the Greek exit from the euro happens, it is going to be a tumultuous moment. It may turn out to be a bit of a fiscal blessing for the rest of Europe who can experience some easing of austerity policies – which they should use to start phasing out their welfare states, not rebuild them – but the problems in Greece will not go away. Their return to the drachma will in all likelihood cause a dramatic plunge of the currency, which in turn will lead to a serious spike in import-price inflation. The country will have scant opportunities to borrow on its own, which will force them to yet again choose between austerity, the welfare state – and ultimately the very democratic system of governance.
Other European countries are not that close to the abyss. Spain is experiencing political turmoil and some signs of social instability, though not yet at the level we can see in Greece. Nevertheless: the Greek experience is a stark warning to the rest of Europe: it’s time to wake up and do something about the welfare state – or else, you will follow in the Greek footsteps.
One of the fundamental ideas behind the European currency union was to create a central bank that would always, at all times, take a hard line on money supply. The euro architects assigned one, and only one, duty to the European Central Bank: keep inflation under control by means of a very strict monetary policy. Under absolutely no circumstances was the ECB supposed to veer from this path of tight money.
This hard-line monetarism earned the ECB a lot of credibility. During the early stages of the Great Recession international investors and lots of economists opined that the euro was going to replace the U.S. dollar as the international standard currency, primarily because of the vast difference in monetary policy. The Federal Reserve was printing money on over time while the ECB was running a very tight ship.
Now the euro is in deep trouble. The dollar is not yet returning as the international standard bearer, but at least the euro crisis has shifted the balance dramatically in the dollar’s favor. What is scaring investors more than anything at this point is investments in euro-denominated treasury bonds. The fear is two-fold: that countries like Greece and Spain are going to exit the euro, re-issue their own currencies and then print money through the wazoo to pay for their deficits; or that, in order to prevent secessions from the euro, the ECB is going to do whatever it takes to save the euro – including printing money like there is no tomorrow.
An article in English in the German magazine Der Spiegel reveals that this is exactly what the ECB is now planning to do:
Interest rates on Spanish sovereign bonds have been rising to dangerous levels in recent weeks. Now, SPIEGEL has learned that the European Central Bank plans to use a new instrument to stop the trend: The bank is considering setting yield targets on the bonds of euro-zone countries. Should interest rates exceed those levels, the ECB would intervene by buying up their debt.
This is nothing short of promising an endless supply of money to the euro zone. In addition to the distorting effects this is going to have on the interest rate as a “risk signal”, this endless credit line is also going to effectively neutralize the austerity demands that the EU, the ECB and the IMF have put in place on, primarily, Greece and Spain. While those programs are destructive in nature, the alternative is not to flood the euro zone with freshly printed money. Which, again, is exactly what the ECB is planning, according to Der Spiegel:
As part of its efforts to fight the euro crisis, the European Central Bank (ECB) is considering establishing caps on interest rates for government bonds in individual countries as part of its future bond-buying program. Under the plan, the ECB would begin purchasing government bonds from crisis-hit countries if yields for those bonds exceeded the interest rates for benchmark German sovereign bonds by a predetermined amount. This would signal to investors which interest rate levels the ECB believes to be appropriate.
This means that the ECB, not the free market, will determine the risk premium on Spanish treasury bonds. Investors will no longer get the return they deem appropriate for putting their money at risk. As a result, demand for bonds from, e.g., Greece and Spain will decline. That in turn will force the Spaniards and the Greeks to raise interest rates even more – which under this new rate cap means that the ECB will have to step in even earlier than desired. They will have to print even more money to keep the troubled euro member states afloat.
In short: the solution exacerbates the problem. As Der Spiegel explains, the ECB does not seem to see it that way:
Given that it can print money itself, the central bank has access to unlimited funds, which could make it extremely difficult for speculators to continue driving yields up beyond the amount stipulated by the ECB. By engaging in bond buying, the ECB not only wants to get the financing costs of crisis-plagued countries under control — it also wants to ensure that the general interest-rate levels across the euro zone do not drift too far apart.
When the euro zone was created the architects of the economic unification wrote a paragraph into the Maastricht Treaty that banned budget deficits beyond three percent of GDP. That paragraph they said, would guarantee that no country ended up with runaway deficits. But as Greece, Spain, Portugal et c have proven, the words in that paragraph were not worth more than the ink they were printed with.
As a result of this fundamental architectural flaw in the currency union, neither the board of the ECB nor the EU leadership is equipped to deal with the crisis. That is why they are now forming a circular firing squad: the EU leadership continues to demand austerity measures from Spain and Greece, intended to close their deficit gaps; the harsh and misguided austerity policies, in turn, are slowly but steadily pushing Greece and Spain toward the euro exit door; simultaneously, the ECB will now do its best to keep these countries in, by flooding them with stacks of freshly minted euros. As a result, Greece, Spain and Italy can use the new money supply to continue to borrow, i.e., to escape the austerity policies and stay in the euro. Instead of them seceding from the euro or closing their deficits through structural reforms to their welfare states, they now have an opportunity to stay in and live off an endless cash commitment from the ECB.
Der Spiegel reports that the ECB leadership appears to be aware of the consequences of their own open-ended commitment:
In an interview with state-owned news agency EFE, Spanish Economics Minister Luis de Guindos called for the ECB to purchase unlimited amounts of Spanish sovereign bonds on the capital markets. He argued that that would be the only way to effectively reduce interest rate pressure on Spanish sovereign bonds and to eliminate doubts about the euro. ECB President Mario Draghi has signaled the prospect of the ECB undertaking that kind of step, but only under the precondition that countries such as Spain or Italy first make a formal request for EU aid, which would involve agreeing to the conditions attached to that assistance. The question of what a country would have to do in return for the ECB buying its bonds is expected to be discussed at a meeting of Euro Group finance and economics ministers that is scheduled for the second week of September, de Guindos said.
This is interesting, because it means that Spain and other troubled euro countries would be able to negotiate more lenient deals with the ECB under this plan than they currently have with the EU. In other words, they would be able to relax their austerity policies and get a virtually unlimited line of credit at the same time.
If this actually becomes the policy standard for the euro zone, it means that its member states have surrendered to the fiscal behemoth that caused the deficit crisis in the first place: the welfare state. They will de facto have admitted that the only solution to the fiscal problems in countries like Spain and Greece is politically too difficult to deal with. Instead they choose to slowly but steadily erode their common currency and to replace destructive austerity policies with an even more destructive open monetary commitment.
Fortunately, there is some resistance within the euro zone to this from-bad-to-worse kind of policy shift:
In Germany, however, leading politicians within Chancellor Angela Merkel’s coalition government — which includes the conservative Christian Democratic Union (CDU), its Bavarian sister party the Christian Social Union (CSU) and the business-friendly Free Democratic Party (FDP) — reject any additional bailout packages for Greece beyond the two that have already been approved. Volker Kauder, the head of the joint CDU and CSU party group in the federal parliament, the Bundestag, told SPIEGEL: “The Greeks must abide by what they’ve agreed to.” And on Saturday, German Finance Minister Wolfgang Schäuble also rejected further financial aid for Greece. “We can’t put together yet another new program,” he said. “It is not responsible to throw money into a bottomless pit.”
We will have to see where this ends. Clearly, the ECB has its own skin in the game – in fact, its very survival is on the line. If the euro starts falling apart, then where will it stop? That government entity will do everything in its power to survive. Which means, it will do a lot. Eventually, this may actually come down to a political showdown between the ECB and the German government, though that is still a bit far down the road. But with growing resistance in Germany toward more Greek bailouts, there will also be increasing resistance toward any ECB mismanagement of the euro. The Germans will return to the Deutsch Mark before they let the ECB print money and reduce the euro to drachma standards.
At any rate, the European crisis is not over yet. On the contrary: the biggest drama is yet to come.
There is one principled issue when it comes to government spending that is gaining far too little attention in the public policy arena. Our governments, especially at the local level, often sit on large rainy-day funds that they built as a financial cushion for those days when the economy goes into a recession and tax revenues fall short of spending obligations. Interestingly, now that the economy is indeed in a recession and there is very much need for the deployment of those rainy-day funds, states and cities tend to refuse to use them.
A good example is the city of Lawrence, Indiana. This is a slice of traditional, American heartland. Located on the north-east outskirts of Indianapolis with its 45,000 residents, Lawrence matches the national average in almost every way: income, household size, crime rate, education… and of course the recession. It comes as no surprise, then, that the city is running a budget deficit: it can only fund $19 million of its $21 million (general fund) budget with current revenues.
And, true to the American Heartland character of their city, the elected officials in Lawrence are wrestling with the question of whether or not to spend the city’s rainy day fund to cover the deficit. The Indianapolis Star reports:
Lawrence is considering deep cuts from its public safety fund to bridge the city’s budget gap for 2013. Mayor Dean Jessup is proposing to slash about $600,000 from the Lawrence Fire Department budget. This entails eliminating 24 civilian EMT positions and replacing them with firefighters. Jessup’s budget proposal also includes a $30,000 cut from the Lawrence Police Department budget.
The city does not publish its budget online. This makes it difficult for the general public – including the city’s taxpayers – to see what their elected officials are doing with their money. But assuming that there is no unusual levels of waste going on, the city’s budget situation is representative of what most local governments are going through these days.
Which brings us to the question: what do you do about it? Unlike a state or the federal government, a city is relatively limited in its options when it comes to improving its economy. This is especially true for a city like Lawrence where many of the residents are commuters and thus depend on jobs outside of the economic jurisdiction of the city.
Still, the city does have some options. One of them is to put its rainy day fund to use:
City Controller Kim Diller said if Lawrence were to use its rainy day fund to shrink the $2 million deficit, the city will be a little more than $1 million in the hole for 2013. “That’s not what the mayor wants to do,” Diller said. “It’s not fiscally sound.”
This is an issue of principle. The city has obviously over-taxed its residents for a number of years in order to build the rainy-day fund, for the very purpose of having some margins available when the economy is weak. Now, the economy is weak. Should not taxpayers be allowed to enjoy the benefits of having over-paid for city services in better times?
Apparently, city officials in Lawrence don’t think so. They believe that it is “not fiscally sound” to use the rainy day fund. But even thoguh I am not a taxpayer in Lawrence, I do have to ask: how it is fiscally sound to cut city services for taxpayers who have been over-paying for them for years (taxes for current expenditures plus taxes to build the rainy day fund) and have money sitting uselessly in the bank?
The Indianapolis Star again:
Keith Johnson, Jessup’s deputy chief of staff, said the mayor thinks cutting EMT positions is a viable solution because that would enable to [sic] city to keep the same number of fire stations, fire engines and ambulances. But City Councilwoman Linda Treat said she does not support the mayor’s proposal. “Public safety has always been a top priority for the council,” Treat said. “It’s the one thing we cannot afford to lose.”
Councilwoman Treat has a very good point: public safety is a core government function. Since, again, the city does not publish its budget online, it is difficult for an outside observer to assess what else the city could cut down on. However, if it is spending money on economic development – which it appears to be doing, given that the city has an economic development director and a redevelopment commission – this would be a good time to consider short-term priorities. Such priorities could include scaling back economic development spending while using rainy-day funds to save core government functions.
That said, it is also important to recognize that the city, ccording to the Indy Star story, has a history of making relatively sound budget priorities. But the city has also fallen for the temptation to take temporary federal money for permanent expenditures:
History indicates that Lawrence had spent a huge chunk of its budget on public safety. But that spending appears to be why the city is now in a deep budget hole. In 2010, Lawrence hired 18 firefighters and bought a fire station from Lawrence Township in a merger with the Indianapolis Fire Department. As a part of the deal, the city acquired $1.5 million to pay for salaries and benefits of those firefighters. That, however, was a one-time federal grant that was depleted in 2011. “The former mayor and the former council never put in place a permanent source of revenue (to pay for the firefighters),” Johnson said. Diller said the city continued paying for the firefighters by taking $1.6 million annually from its reserves with not enough outside revenue coming in.
If the city is over-spending, that does not necessarily mean that it is over-spending on its core functions. This is a good time for Lawrence to review its spending structure, especially in departments outside of public safety. Economic development tends to be an inefficient way to spend taxpayers’ money – it is rare that economic development spending pays for itself – but regardless of what priorities the city council ends up making, it owes its taxpayers to use all of its rainy day funds before cutting core government functions.
This is, again, a matter of principle. Rainy-day funds do not grow out of thin air. They grow from deposits made out of current tax revenues. To afford to build these funds, governments must tax us in excess of its current operating costs. We as taxpayers – whether in Topeka, Kansas or Lawrence, Indiana – deserve to enjoy the benefits of that rainy-day fund before being asked to accept cuts in government services. Let’s keep in mind that when government makes its cuts, it does not cut the cost of government to taxpayers: the residents of Lawrence still pay the same taxes even as the city cuts public safety services.
If the city is not going to use rainy-day funds to protect its core functions – then what is the city going to use those funds for? So long as they prefer spending cuts in core functions to the use of those funds, they are shortchanging taxpayers. That is neither fiscally nor morally sound.
There is this myth going around among America’s “big tent libertarians” (predominantly concentrated to the Tenderfoot Coast between Baltimore and Tysons Corner) that we here in America need to look to Sweden in order to figure out how to do things right. The latest example is an article by Matt Kibbe in the Forbes Magazine, where Kibbe, the president and CEO of Freedom Works, raises the highest-taxed nation on Earth to the skies.
I, for one, thought Freedom Works wanted more economic freedom in America, not less, but since I am not paying Kibbe’s salary I will concentrate on dispersing the mythologically rosy clouds upon which he serves his vision of adopting Swedish policies in America.
The headlines from across the pond read “Europe Rejects Austerity” as the French and Greeks elected socialists and even some neo-national socialists to office. These new officials have promised tax rates as high as 75 percent on millionaires, and have vowed to continue government spending unabashed in the wake of staggering levels of debt and anemic economic growth and persistent double- digit unemployment. However, there is one finance minister in one European nation that is bucking the trend, and, instead of ridicule and failure, he’s been named Europe’s best finance minister by the Financial Times. … His name is Anders Borg and he’s Swedish. That’s right, the European nation famously stereotyped for having aggressive taxation to fund an omnipresent state has actually decided that in response to the Eurozone crisis and the continued effects of the global economic downturn, or “Great Recession”, that it’s time to ease up on taxes and reduce the size of government.
After this bombastic set-up, Kibbe has a lot to deliver on. But already here we can see that he has not bothered to read Remaking America: Welcome to the Dark Side of the Welfare State, a book about the disaster waiting for us if we here in America were to copy the Swedish welfare state.
While Sweden is not technically in the Eurozone, as it does not use the Euro as currency, it has been drawn into the financial mess of the Eurozone by sheer proximity. Unemployment in 2011 was north of 7.5 percent and GDP growth was anemic at .4 percent projected for 2012.
If Kibbe checked his facts, he’d see that the only sector that has been growing in Sweden for the past 20-odd years is the export industry. Private consumption growth rates were at one third to one half of American levels for the last three decades of the 20th century. Since then the parity has been smaller, but only because America’s private consumption has grown more slowly.
Gross exports is the largest category of Sweden’s GDP. What does that mean? That households are living a very poor life while an isolated corporate sector is making good money. There is virtually no tricke-down from the export-oriented manufacturing industries to the rest of the economy.
In the Spring 2012 Economic and Budget Policy Guidelines, the Swedish Government and its Finance Minister, Anders Borg, have laid out a plan that is focused on lowering taxes. Their rationale? “When indviduals and families get to keep more their income, their independence and their opportunities to shape their own lives also increase.”
These “tax cuts” consist almost entirely of an Earned Income Tax Credit, which has increased the already steep marginal effects in the Swedish income tax system. That system, which starts at a 30-percent local income tax rate and tops out north of 60 percent, is now even more discouraging toward hard work, career-advancement and the pursuit of higher education. The more you make, the more government will take on the margin. All the Swedish version of the EITC does is encourage people to take low-paying jobs – and stay there.
Borg also wants to lower the corporate tax rate as a way of meeting the government’s goal of “full employment”. The government has already cut property taxes and other luxury taxes on the rich to lure investors and entrepreneurs back to Sweden.
The corporate income tax is about six percent of total tax revenues. Largely insignificant, in other words. Property taxes barely even register on the government revenue radar screen. Government revenues depend predominantly on personal income taxes and consumption-based taxes, such as but not limited to the value added tax. Besides, the property tax reform was initiated long ago and really has nothing to do with some kind of overall strategy by the current administration.
The government has also slashed spending across the board, including on the welfare programs that used to be Sweden’s claim to fame.
Every Swedish government over the past 20 years has executed spending cuts. Between 1995 and 2005 the socialized health care system laid off 21 percent of its staff. Between 2000 and 2006 the general income security system cut spending by tightening eligibility requirements to such a degree that they were running 15-percent surpluses year in and year out.
Did this benefit the economy? Of course not. Taking people’s money in the form of taxes and then refusing to spend it is not a policy for smaller government. Standard of living has remained virtually flat since the big crisis in the early ’90s, and the total tax burden on Swedish families and businesses is still the highest in the world.
They’ve also installed caps on annual government expenditures: real and enforceable limits that the Swedes believe are pivotal to economic stability. They explain in their Policy Guidelines that “the expenditure ceiling is the Government’s most important tool for meeting the surplus.”
Kibbe is wrong. These spending cuts were put in place in the late ’80s and reinforced by reforms to the national government’s budget appropriations process in the mid-’90s. Has this changed the role that government plays in the Swedish economy? Only for the worse: government now takes in on average 102 krona in taxes for every 100 krona it spends. Does Freedom Works really endorse that kind of government budgeting??
Imagine that, a government that stays within its limits.
And taxes are still the highest in the world. Freedom Works has to make up its mind: does it want a balanced budget or less government?
Then Matt Kibbe spins the no-austerity-here wheel one more turn, repeating the fiscal mythology that Veronique de Rugy marketed earlier this year (and I responded to here):
We have now seen that attempts at austerity within the Eurozone have met a similar fate: none of it was serious. As spending increases have been squandered, spending cuts have been a charade, failing to target the big government programs at the core of the debt crisis.
[What] Sweden is doing is working. And it’s working better than even Minister Borg expected. Despite slow projected growth for 2012, Sweden is expecting annual GDP growth of over 3 percent starting next year, projected out through 2016 by which time their unemployment is expected to slide down to just about 5 percent.
Pure accounting trickery. Sweden has enormous general income security programs where people can participate for a variety of reasons. With the exception of unemployment benefits, when government stashes away a person in one of these programs that person vanishes from the unemployment rolls. Sweden also has Europe’s highest youth unemployment rate.
Kibbe’s praise of Sweden’s superficial fiscal achievements…
During this time the Swedish gross debt is expected to drop from 37.7 percent/GDP to 22.5 percent/GDP as a result of government surpluses.I don’t think Kibbe could even imagine that this is what is going on in Sweden. But from now on I hope he studies up on the practices of the world’s largest, most authoritarian welfare state before he raises its superficial fiscal achievements to the skies.
…is overshadowed by his ignorance of the actual workings of the world’s largest, most authoritarian welfare state. One example of how the Swedish government balances its budget is from the general income security system, run by a government agency funded by very high payroll taxes. This agency forces sick people back to work by simply refusing to recognize their doctor’s notes on their medical condition. I report in detail on this practice in my aforementioned book Remaking America.
Long story short: the fiscal responsibility that Matt Kibbe sees and praises is actually achieved on the backs of cancer patients who are forced back to work because the government can no longer afford to pay their benefits.
Hopefully, Freedom Works is not in the business of generally handing out accolades to the world’s largest welfare states. But regardless of why Freedom Works is suddenly so interested in the big Swedish government, the real story here is that any attempt at keeping the welfare state will always fail in the end. In Sweden’s case the “salvage operation” has come in the form of massive austerity programs – in the ’90s government executed net spending cuts equivalent to nine percent of GDP – while still maintaining the world’s highest taxes.
There is only one sustainable solution: end the welfare state.
As if the presidential election campaign, the tensions in the Middle East and the escalating welfare-state crisis in Europe were not enough, FoxBusiness.com reports this morning:
Taking a cue from Europe, the markets are tumbling deep into the red as anxiety over the eurozone debt crisis boils back to the surface. The Dow is down 210 points, or 1.7%, the S&P 500 is off 1.6% and the Nasdaq is 2.2% to the downside. Economically-sensitive sectors, including materials, energy, technology and consumer discretionary, are taking the steepest losses.
This will probably translate into bad GDP numbers for the third quarter, numbers that will be released just before the November election. But there is a far more urgent matter related to this: the eurozone crisis itself. And that is an escalating crisis that refuses to die down, obviously because the underlying welfare-state crisis remains unsolved. The tensions between countries in at different stages of the crisis are growing almost by the day, which puts enormous stress on the common currency. The latest news is that some of the best-performing euro countries might leave the currency. GoldMoney.com has the scoop:
Within the eurozone there are great stresses. At one extreme there are punitive costs of borrowing for Greece, Cyprus, Portugal, Ireland, Spain and Italy; at the other there is zero or negative interest rates for Germany, the Netherlands and Finland. Doubtless the first group begets the second, as captive investors in euros have to buy government bonds, and this requirement is being funnelled away from risk into safety. This is the opposite of the convergence intended behind the creation of the euro.
Precisely. When Greece entered the euro they effectively got hold of a credit card cosigned by Germany and other less debt-prone nations. The original idea was that Greece would use this credit card very responsibly and not max it out. In return, their credit rating would be guaranteed by first-tier Germany and other well-behaving euro countries. But in order to refrain from using that credit card, Greece would have had to do something structural about its welfare state – ideally dismantle it altogether – something that was totally unpalatable to them. Instead, they paid their way through several years of continuous, lavish entitlement spending and refused to see the rapidly approaching end of the credit line.
Now that they are there, they have called their co-signers, primarily Germany, and asked them to chip in toward the credit card bill. (That’s what the “bailout” is all about.) Germany in turn is now in the unfortunate situation that its credit rating is now increasingly being determined by Greece, not the other way around as was originally the plan. The same is happening to small, well-behaving euro countries like Finland, as explained in the GoldMoney.com story:
Launched in January 1999, the original members of the eurozone bent the entry rules to qualify with respect to budget deficits and the level of outstanding government debt. This was not an auspicious start, but hey, governments bend the rules all the time, don’t they? Greece then joined two years later, and would have had a severe funding crisis if it hadn’t. This was bending the rules at a new level. There followed what economist Philipp Bagus aptly called the tragedy of the commons. Eurozone members, who on their own would have had difficulty accessing affordable credit, used the low interest rates on the back of Germany’s rating to borrow, borrow, borrow. This was not a problem until the financial crisis of 2008, when the borrowing became progressively more difficult, and insolvency beckoned.
In other words, the euro allowed welfare states that had already taxed-and-spent their economies into the tank to stay afloat and continue to spend as if there was no tomorrow. Which, in a matter of speaking, there won’t be if they stubbornly stay in the euro. But it is important to remember in this context that Europe’s banks own a lot of government debt, more than half of total national debt in some countries. This has led to a vicious downward spiral now that the welfare states are desperately trying to honor their current debt levels and even attempting to borrow more.
These are the euro’s backers. On a rough rule of thumb, measured by the commitments behind the European Financial Stability Facility, 41% of the euro’s backers have requested, or are likely to request a bailout themselves.
As I explained in early May, one quarter of the eurozone GDP is under austerity pressure. This raises the stakes in saving the euro, but so does the absence of eurozone-wide government bonds. The individual member states still issue their own treasury bonds, which means that there is no single government at the helm the euro when the sea gets stormy. Crisis-ridden countries have basically expected Germany to take that role, and thus far Germany has indeed done that. But their commitment is not endless – far from it.
GoldMoney.com notes this and moves on to explain that:
In this case we have 17 governments, some of them insolvent, and the solvent governments unwilling to underwrite the lot. And one of the solvent governments, Finland, is quite likely to desert the sinking euro ship: Finland is Scandinavian firstly, and European secondly. She only participates in bailouts if she obtains extra collateral. It is unlikely that she will remain committed to the eurozone project if it continues to deteriorate.
Apart from the erroneous remark about Finland being Scandinavian (it is not) the suggestion that Finland would be the first country to exit the euro is a credible one. The Finns have so far “managed” their welfare-state crisis by means of exceptionally high taxes, a long series of spending cuts (slow-progressing austerity) and government perks to large export-oriented corporations whose wealth has brought in enough taxes to make up for an otherwise rather paltry economy. They have pretended that their welfare state is of a different breed than the Greek one, but down to the core – when it really matters – they are very similar.
This is beginning to show: recent macroeconomic data hint that the Finnish economy is slowing down from government overload. If this turns into a lasting trend the Finns would be very wise to back out of the euro and concentrate on their own macroeconomic problems.
Time will tell. But we do know one thing: all it takes is for one highly credit-rated country to leave and the gate has been left open for others to follow. In theory, the Finns and other euro countries with good credit will use their own pending exit as a threat to force Greece and Spain out. However, that is unlikely to work because it would be an admission that the welfare state is too heavy a burden for some European countries to carry. France, with its new socialist government, will not allow such blackmail against Greece and Spain.
Only one option remains for good-credit euro countries: get out now and save your credit line for your own welfare-state crisis.
If you were a Senator, would you be willing to plunge the American economy into a depression just to try to save the welfare state? The Democrats in U.S. Congress are apparently willing to do just that. From the Washington Post:
Democrats are making increasingly explicit threats about their willingness to let nearly $600 billion worth of tax hikes and spending cuts take effect in January unless Republicans drop their opposition to higher taxes for the nation’s wealthiest households. Emboldened by signs that GOP resistance to new taxes may be weakening, senior Democrats say they are prepared to weather a fiscal event that could plunge the nation back into recession if the new year arrives without an acceptable compromise.
So the Democrats want $494 billion in tax increases and $100 billion in cuts to our national defense. Taking $600 billion out of the economy at this point is of course complete madness: the tax hikes alone are big enough to send us spiraling into a depression. (See this article for an analysis of its effects on just one state, Oregon.) Apparently, as the Washington Post reports, the Democrats are willing to let that happen unless they get to raise taxes on America’s small business owners:
In a speech Monday, Sen. Patty Murray (Wash.), the Senate’s No. 4 Democrat and the leader of the caucus’s campaign arm, plans to make the clearest case yet for going over what some have called the “fiscal cliff.” “If we can’t get a good deal, a balanced deal that calls on the wealthy to pay their fair share, then I will absolutely continue this debate into 2013,” Murray plans to say, according to excerpts of the speech provided to The Washington Post. If the tax cuts from the George W. Bush era expire and taxes go up for everyone, the debate will be reset, Murray is expected to say.
All of this, and a severely crippled military, just to protect – what? Well, let’s go back to the Democrat counter-proposal to the Paul Ryan budget earlier this year. Back then the Democrats in the House had this to say:
This budget firmly rejects the Republican budget’s proposal to end the Medicare guarantee and strengthens the program instead of dismantling it. It also ensures that the social safety net remains intact. The growing costs of health care and retirement programs pose long-term challenges that need to be addressed in a way that puts the budget on a sustainable path, reduces the cost of health care for families, and improves our competitiveness. This budget supports the goal of making Medicare sustainable by making the health care system more efficient overall.
Medicare is just one of a myriad of entitlement programs that Congress has created over the decades. The Democrat attitude toward it – save at all cost – is telling of how they approach all parts of the welfare state. There is not a single entitlement program that the Democrats would like to dismantle: on the contrary, they want to go in the opposite direction. In their budget they adamantly defend the Affordable Care Act which obviously is the latest pile-on to the already fiscally obese stack of government-run schemes to redistribute income and wealth between Americans.
Back to the Washington Post story:
[Senator Murray's] speech comes less than a week after Obama assured Hill Democrats during a White House meeting that he would veto any attempt to maintain the Bush tax cuts on income over $250,000 a year, according to several people present. It also echoes the dismissive response by Senate Majority Leader Harry M. Reid (D-Nev.) to Republicans seeking to undo scheduled reductions in Pentagon spending that even Defense Secretary Leon E. Panetta has said would be “devastating” to national security.
In other words, the Democrats would rather devastate our military and our economy than give up a single entitlement program.
But even if they get their tax increases on higher incomes, this would only add $96.8 billion per year to the federal coffers. And that is from a generously slanted estimate. That would barely pay for the extra funds to the states that the National Governors Association called for when they began to see the end of the Stimulus Bill gravy train. Since Democrats only know how to create and grow entitlement programs, and nothing about shrinking, let alone terminating them, they would dispose of this extra revenue in a heartbeat.
The budget deficit would still be at least as big as it is today – and that is if the Democrats “only” get to raise taxes on high income earners.
But far more ominous is the Democrats’ determination to plunge the economy into the dungeon dug out for us by Taxmageddon and the Pentagon spending cuts. If they do this, it will make every aspect of our already urgent fiscal crisis far more urgent and a far bigger crisis. Consumer spending would tailspin, business investments – already disturbingly low – would plummet, unemployment would rise dramatically, and tax revenues for the federal budget would fall significantly. As a direct consequence, the budget deficit would explode to fiscally cataclysmic proportions.
The only thing that could emerge from such a disaster would be a new America, reduced to nothing more than a bleak version of austerity-ridden Europe, stuck in permanent industrial poverty.
It is unconscionable that anyone elected to U.S. Congress would ever consider doing this to our country. Most of the Democrats who would cast votes or otherwise act to make Taxmageddon happen probably would do so only because their leadership tells them to. But that does not liberate them of their legislative responsibility.
As a direct consequence of what Congressional Democrats are willing to do to the American economy, I would like them and their supporters across the country to answer two questions:
1. Is the welfare state more important to you than America?
2. When is government big enough for you?