Voodoo Economics Redux

First, an apology. A couple of readers have commented that this blog's posts often get a bit long-winded, and I wholeheartedly concur. I'll try to do better. But please understand the reasons for my wordiness. First, sometimes I'm responding to a subject that is itself long-winded, as was the case with the last post. And second, I'm often trying to explain macroeconomic issues, which I find are understood by few but misunderstood by many. And I realize that there are some people reading who, while they're highly knowledgeable about many things, may not be that well-versed in these topics. So I try to explain things in terms that anyone can understand, which requires thoroughness.

On to the topic at hand. As the debate rages over whether tax cuts alone are sufficient to reverse this recession (they're not, and nothing else is, either), the talk inevitably turns to "trickle-down economics," popularized as "Reaganomics" under that President's administration, which were famously called "voodoo economics" by his primary foe, George H.W. Bush, who would later become his veep, then his successor.

First, a partial defense. Trickle-down economics holds that if you cut taxes for corporations and the wealthiest Americans, the economy gets the most benefit. Corporations can use those tax cuts to invest and grow, providing much-needed jobs, which provide more income for people to spend, thus stimulating the economy. And those in the higher tax brackets are often small business owners operating out of their own personal balance sheets, so they too can use the tax savings to grow and hire people.

In addition, those at lower income levels are more likely to save or pare down debt during lean times, so cutting their taxes doesn't stimulate spending as much. Higher-bracket people have more savings, and more discretionary income, and thus are more likely to spend their tax savings.

Now, readers of this blog know that I don't buy into the notion that consumption is the engine of economic growth. But trickle-down still works under my view, as it provides jobs that will allow people to save, not just spend. And the higher-bracket beneficiaries of a tax cut will invest in stocks, which gives companies more capital to invest and expand and create jobs.

Now, trickle-down isn't an end-all, be-all. It's a theory, and like all other economic theories, it works very well - in theory. But theories work because they make basic assumptions that are held constant - for example, the assumption that if the government enacts those tax cuts, it will exercise fiscal responsibility and restraint to avoid building deficits.

That, of course, didn't happen under Reagan. Part of the reason was the significant build-up in defense spending, which helped end the Cold War and bring down the Iron Curtain - a significantly positive outcome. And an outcome that paved the way for President Clinton to balance the budget, largely through reduced military spending since the threat of the Cold War had ended, and aided by low interest rates throughout his two terms that reduced the funding cost on the federal debt dramatically, after Paul Volcker had tamed hyperinflation in the early '80s.

But President Reagan's two terms also coincided with a Democratic majority in the House of Representatives for both terms, and in the Senate for two of his eight years in office. So compromises were made, as is always the case in Washington, between tax cuts and spending, and deficits resulted. I'm not finger-pointing here; such compromise is business as usual in Washington when power is divided between the parties in terms of control of the executive and legislative branches.

So far all we know, the Reagan era might have resulted in the same, or worse, deficits had his party controlled Congress all eight years. But by the same token, that scenario could have proved trickle-down economics to be a smashing success. We'll never know, and that's the problem with applying economic theories to the reality of American politics and its influence on government - the variables can't be controlled, so we can't really test the theories.

Now, Poppy Bush was no fiscal conservative in my view, nor was his son. Bill Clinton appears to have been, but again, his balancing of the budget was aided by the framework laid before his terms, and the GOP controlled both the House and the Senate for six of his eight years in office.

Here's my point regarding trickle-down economics: it's back, raised to an exponent. Now, before you call me crazy, this is my premise.

In my view, the federal government is at the top of the pecking order, economically speaking. It sits above both corporations and the wealthy, even though elections are too heavily influenced these days by both.

My rationale is simple: the government has taxing authority; it can regulate businesses; and it can print money. Corporations and rich people can't do those things. They are at the mercy of the government, which, as Gerald Ford wisely observed, is big enough to take away everything you have if it's big enough to give you everything you want.

So throwing money at the federal government to undertake massive spending is trickle-down economics on the highest order. We expect it to trickle down to businesses, the wealthy and the not-so-wealthy alike, the states, our schools, and so on. It's trickle-down theory from the top, instead of from the second and third tiers.

Can it work? Maybe. But only if it's applied prudently and responsibly, and only if we have the money to spend anyway. If we don't, we create larger problems down the road than we can possibly solve in the short-term. And if it's spent on the wrong things, we solve nothing in the short-term, and still create the long-term problems of higher interest rates, higher taxes, and a devalued currency, which leads to higher inflation.

Given the current proposed massive deficit spending bill, and the items therein, I'll leave it to you to draw your own conclusions as to whether it's going to work this time.