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The financial sector facilitates private sector deficit spending that helps sustain output.

Without it, the government has to increase its deficit spending to sustain output.

Bottom line, all else equal, a less effective financial sector means lower taxes.


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12 Responses

  1. I am trying to figure out this plays itself out in the “real” economy:

    Taxes are necessary to attract resources away from the private sector toward the public sector. The more demand for resources from the private sector (for example to build 15,000 sq. ft. mansions in Greenwich, CT), the higher taxes must be in order to compete for the resources. With a lower level of private investment, higher levels of public investment can be sustained with lower levels of taxation. The paradigmatic example would be WWII, when much of the private economy was shut down and taxes, while increasing, didn’t go up nearly as much as government debt…

  2. Taxes are necessary to attract resources away from the private sector toward the public sector.

    SORT OF, IT’S THE ACTUAL GOVT SPENDING THAT MOVES THE REAL RESOURCES

    TAXES CREATE THE NEED TO SELL REAL GOODS AND SERVICES TO THE GOVT TO GET THE FUNDS TO PAY THE TAXES

    The more demand for resources from the private sector (for example to build 15,000 sq. ft. mansions in Greenwich, CT), the higher taxes must be in order to compete for the resources.

    NO. REMEMBER, THE FUNDS TO PAY TAXES COMES FROM GOVT SPENDING. GOVT IS ‘PRICE SETTER’ IN THAT SENSE.

    NOT THAT I WOULD RECOMMEND IT, BUT GOVT COULD LEAVE TAXES ALONE AND CUT THE PRICES IT PAYS FOR EVERYTHING. THAT WOULD TRIGGER A GENERAL DEFLATION AS THE PRIVATE SECTOR IS FORCED (BY MARKET FORCES) TO SELL GOODS AND SERVICES TO GOVT AT LOWER PRICES TO AVOID TAX DEFAULTS.

    With a lower level of private investment, higher levels of public investment can be sustained with lower levels of taxation. The paradigmatic example would be WWII, when much of the private economy was shut down and taxes, while increasing, didn’t go up nearly as much as government debt…

    LOWER DOMESTIC DEMAND FOR A VARIETY OF REASONS (INCLUDING RATIONING, PATRIOTISM, SAVINGS INCENTIVES ETC) ALLOWED HIGHER GOVT DEFICIT SPENDING WITH LIMITED INFLATION.

  3. Ok, let me try again. (Hmm, I’ve been studying this stuff literally for years, and I still have trouble getting “in paradigm”…)

    In a hypothetical economy with a 0 foreign sector balance and no deficit, there can be no “net” savings – all savings that one person accumulates must be balanced by some other person’s debt – and taxes must equal govenment outlays. If you have an “efficient” financial sector that can securitze, slice and dice loans, and keep the credit card apps going out, you can keep one portion (the larger portion) of the population accumulating enough debt to balance out the fortunes being accumulated by the Wall Street types. Basically debt peonage, 21st century style.

    But if the financial sector can no longer “efficiently” increase private sector debt, and we now increase the public sector debt, then it is possible for there to be growth while a significant portion of the population can actually accumulate financial assets, all the while lowering the need for taxes to soak up government spending.

    Is that more-or-less it?

  4. But if the financial sector can no longer “efficiently” increase private sector debt, and we now increase the public sector debt, then it is possible for there to be growth while a significant portion of the population can actually accumulate financial assets, all the while lowering the need for taxes to soak up government spending.

    Is that more-or-less it?
    YES!

  5. Seems to me this comes down to an efficiency question: whether collective vs private services can best manage populace motivation and collective productivity .
    Graft, fraud, non-transparency, efficiency could all be handled well by either model – the deeper question is how to maintain adequate population knowledge throughput regardless of which “tribal” management method is pursued .
    To answer that you need to look a few layers deeper into the processes used in both methods . If we can invent mechanisms for maintaining such scrutiny, the macro differences may not be rate limiting. [e.g., the PRC Communist Party may CURRENTLY be outdoing both our Congress & our Wall St., but Governments can just as easily do poorly.]
    The only objective, appropriate review process I’ve heard of is the “force readiness” and war games reviews in military doctrine (an ongoing prediction market with test simulations). Maybe formal, ongoing “force readiness” reviews should be required of all staff in all 3 branches of local, state & Fed governments? What happens if “citizenry readiness” isn’t strong enough to demand productivity? We get superficial, maladaptive policy management regardless of private or gov debt management.

  6. As always, the crux of the matter is how you allocate capital. The Soviets did a pretty good job of proving the failures of the centralized planning approach, but what I think many have missed is how much the last 20 years of securitization and financial consolidation have done to replicate the worst features of the Soviet system: no accountability, no feedback mechanisms to limit gross misallocations, and vast inefficiency. The only difference is the apparatchicks are better dressed and live in bigger dachas. It seems to me we need to move back toward the “neighborhood banking” system we used to have, perhaps with a zero interest rate policy like Warren has been advocating…

  7. Roger, Jim:

    A tax cut doesn’t increase public control of anything. Instead the larger resulting govt deficit gives the private sector more financial income and equity to spend to ‘replace’ ‘borrowing to spend.’

    It’s not about public vs private- the absolute amount of govt spending and control/ownership determines that.

  8. Jim, Warren,

    No quibbles with your argument, only with implementation realities. Paraphrasing Socrates, “the un-executable hypothesis is not worth positing”.

    Kinetics of the decision process for implementing a particular tax or monetary policy is dependent upon how cumbersome the decision process is. That typically boils down to whether the decision process is concentrated, and then whether it is concentrated in private or public channels. Either way, the perspective, honesty and personal/institutional experience determines whether and when we get a particular tax/monetary policy (or not), and how long it takes to execute follow-on course corrections.

    Simply put, an informed electorate gets what it deserves. An uninformed electorate depends on luck. Given house rules, the odds are against the latter helping most people. Ensuring an informed electorate is a policy. Maintenance of an informed electorate involves strategies. Enacting a given tax/monetary decision is a tactic. +100K yrs of human history tells us that these processes cannot be usefully managed in isolation.

    If you want a given equilibrium condition to be maintained in N% of iterations (i.e., not be enacted, repealed, re-enacted), the easiest way to ensure that outcome is to subtly alter policies and strategies at least 5 levels prior to enactment of the context where the tactic comes up … because maintenance costs are the dominant factor in sustaining all complex systems. Managing by suggesting tactics is, like whack-a-mole, practicing costly repairs. It doesn’t scale. Asking what preparation would get a quorum to want zero interest rates is all that matters. Then, you’d better hope a quorum is also ready to closely monitor and manage any unexpected outcomes.

  9. “Managing by suggesting tactics is, like whack-a-mole, practicing costly repairs. It doesn’t scale. Asking what preparation would get a quorum to want zero interest rates is all that matters. Then, you’d better hope a quorum is also ready to closely monitor and manage any unexpected outcomes.”

    Not sure Japan had a strategy, quorum or tatics towards reaching the zero bound. Given flexible fiscal policy and weak monetary policy they reached a fairly stable equilibrium. The drive towards the zero bound seems to be a ‘natural’ progression as financial sector strategic failures lead to a loss of political support for outright bailouts. Perhaps the zero bound will not be reached this cycle or even the next, but the education of those that control fiscal and monetary policy continues.

    Paulson is politically running out of time, it will be interesting to see if he attempts to slow, halt or enhance the progression.

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