Monday, November 17, 2008

Comment: Why tax cuts won't solve economic crisis

UK Prime Minister Gordon Brown today claimed world backing for the idea of tax cuts as a means of addressing the current economic turmoil.

However, tax cuts even if just for the middle class are unlikely to solve the current situation. Low taxes, especially on the rich, are instead one of the contributing factors to the current debacle.

Many nations of the world have followed the US lead on lowering taxes over the last few decades. Such low taxes generally did not mean also lower spending especially in America's case.

Lowering taxes on the wealthy to levels not seen since just before the Great Depression has contributed to the steep divide between the rich and poor, something that must be studied to understand the current problem.

Hoarded capital is not efficient

While it may sound "socialist," the concentration of such wealth in so few hands is not an efficient distribution of capital.

America faced a similar situation before the Wall Street crash of 1929. Taxes on the wealthy were only 25 percent. What actually lifted the country out of the Great Depression and into the strongest recovery in the nation's history was very high tax rates on the rich!

During World War II, the highest tier tax rates stood at 91 percent, and continued at no less than 88 percent until 1963 when they were lowered to 70 percent. This period represented the strongest boom period in American history.

Prior to the Depression, the concentration of wealth in the hands of a few led to many schemes to make the rich even richer. Generally, this is a great waste of resources.

In modern times, hedge funds and derivatives are examples of "fixed" securities designed to benefit the wealthy by allowing them to make more money, or at least 'paper money,' through risky, non-productive investments.

Rather than circulating this money to consumers, the hoarded money just gets tied up into these greedy schemes until they start collapsing on their own non-productive weight. In order to prevent this collapse, Wall St. calls on DC for greater debt spending and bailouts.

However, eventually things reach a crest. Credit can no longer keep up with demand as produced by this bubble system. A type of "peak credit" is reached similar to the predicted "peak oil" when resources begin to decline.

We can already see this happening now. Credit cards are cracking down and increasing rates and penalties. Many credit card companies are axing cards that are seen as going into "desperation mode" i.e., paying for groceries and other living expenses. Even large banks are having trouble borrowing money from other banks.

Now world governments are still trying to cover the corporate fat cats by deficit spending, but it will not be enough.

Just to save the banking system in the United States alone from complete collapse is thought by many economists to require at least US $2 trillion on top of what has already been allocated. And this is just to prevent a collapse much less get those institutions back into sound working order.

There are still as many bad mortgages out there as caused the current financial mess, and the current mortgages now seem to be put on the back burner. And its hard to find an analyst out there who does not think that the hedge fund market will eventually melt down.

Govt needs to circulate money into economic infrastructure

Let's face it, this is the government's job. That's partly what taxes are for.

Corporations do not build freeways, repair bridges, regulate the economy, etc.

Instead of sitting in hedge funds allowing billionaires to see their assets grow into shadow assets, capital must be recirculated into the economy through the instrument of government taxation. The money is funneled into programs that create jobs, improve business infrastructure, increase efficiency, etc.

As money flows into the hands of ordinary consumers, it is used more efficiently and productively, and the system flourishes with a more equitable distribution of resources.