by Caleb Nelson
TAXES DISCOURAGE PRODUCTION
Taxes inevitably affect the actions and incentives of those from whom they are taken. If a business must be responsible for 100% of its losses, but through taxation only gets to keep forty cents of every dollar it earns, its policies are affected. It will expand more slowly taking on considerably less risk (risks such as new locations, new employees, and new products). Would-be entrepreneurs who recognize this may be discouraged from starting their own new enterprises. Improved machinery comes about more slowly than it would otherwise. Consumers are prevented from getting better and cheaper products than they otherwise would.
[115] A small business owner may decide to do more work himself rather than hire another assistant.
The opposite is also true if taxes are lowered or removed. If you have a greater potential to gain from an endeavor, you will work harder, think harder, and try longer, because your successes will pay off better.
GOVERNMENT MONEY DIVERTS PRODUCTION
Government assistance rewards bad or failing companies, and penalizes good or profitable ones. For example, the housing and mortgage crisis that began around 2007 and crashed the economy was both preventable and predictable. It’s always possible when one knows true principles. Here is Hazlitt’s explanation from 1946 which eerily sounds like it applies, not decades ago, but today:
“Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to ‘buy’ houses that they cannot afford. They tend eventually to bring about an oversupply of houses as compared with other things. They temporarily over stimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly over-expansion [known as a ‘bubble’]. In brief, in the long run they do not increase overall national production but encourage malinvestment.”
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Yes, a simple look at cause and effect not only predicted the 2007 economic crisis sixty years early, but could have prevented it. Principles get violated through greed, ignorance, a denial of reality, ambition for power, or even a misguided desire to help; and we all suffer the consequences. Even after the consequences are seen and exposed, politicians have shown that they care more about assigning blame and seizing more power than in learning and correcting the true causes of the disaster.
Here is more recent proof that the housing market crash of 2007-2008 was both foreseen and preventable when one thinks according to principle. Read what U.S. Representative Ron Paul predicted two years before the crash, in 2005:
“The connection between these government sponsored enterprises [GSE] and the government helps isolate their management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement at Fannie Mae and Freddie Mac. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand assurance that Fannie and Freddie follow accepted management and accounting practices. Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market.
“Despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policy of diverting capital into housing creates a short-term boom in housing. Like all artificially created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have been had government policy not actively encouraged over-investment in housing.
“[This bill] further distorts the housing market by artificially inflating the demand for housing through the creation of a national housing trust fund. This fund further diverts capital to housing that, absent government intervention, would be put to a use more closely matching the demands of consumers . . .
“Perhaps the Federal Reserve can stave off the day of reckoning by purchasing the GSEs’ debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary and painful market corrections will only deepen the inevitable fall. The more people are invested in the market, the greater the effects across the economy when the bubble bursts.”
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Government incentives diverted production and capital into a housing market where, if such incentives had not been in place, the free market would have spread such productivity to other safer and more profitable ventures.
PRODUCTION GROWS THE ECONOMY
In response to a troubled economy, President George W. Bush issued “stimulus” checks to most people in America. The idea was to spend it, thus driving the economy forward through (false) consumption and demand. What happened? Things got worse.
President Obama’s stimulus, which didn’t go to the American people, but to big failing businesses (and campaign donors), also failed in its aims. Giving out a stimulus check is artificial and useless because it is a false and temporary increase in demand. There is no ability to continue to consume at that level. It is an unsustainable bubble. When it bursts, everyone is worse off than before.
A basic principle was ignored. Economist Peter Schiff stated it simply, explaining that economies don’t grow because people consume more—people consume more because the economy grew.
[118] Only by increasing supply can people get more of what they demand.
While consumption and production is a reciprocal cycle, this is not a case of the chicken or the egg. There is a definite beginning because people cannot consume what does not exist. A thing must be created before it can be sold. An iPad must exist before a buyer even knows he can demand one.
In the beginning of this cycle, a producer must sacrifice, work harder, go without, and/or take out loans so that they can raise the level of their productivity. If they are producing goods that others find valuable, they will be able to trade and be successful. The increased amount of production lowers prices and allows for greater consumption. How? In general, every product is in competition with every other product in the marketplace. Because consumers have finite amounts of money to spend, they must choose which of all the options they would like to purchase the most. If you spend your money on a round of golf, that may mean going without the 40 oz. porterhouse steak. Production is what gives people a greater ability to consume collectively and individually. Greater production means greater wealth. As people create and trade more, their wealth increases, in turn giving them the ability to consume more. As long as production lags, so does income.
There are certainly other factors that influence production however. The uncertainty that you will be able to sell more goods might very well be enough to discourage more production. When there is a recession, when confidence is low, or when the future looks uncertain, consumers tend to save more and spend less. And reciprocally, this causes production to slow. In this way, markets can enter self-perpetuated downward spirals until something interrupts the circuit and causes a change.
The solution to uncertainty in a market? Remove the most uncertain element—arbitrary government interference (which means: actions that do not protect individual rights). Aside from bureaucratic meddling, the only other real threat to long range planning, production, and prosperity is natural disaster (assuming of course that the government is doing its job in protecting rights). But even natural disasters can often be mostly mitigated through proper insurance. Unfortunately, there is no insurance policy that can protect against government seizures.
LUDDITISM: THE BELIEF TECHNOLOGY CREATES UNEMPLOYMENT
“There are some structural issues with our economy where a lot of businesses have learned to be
come much more efficient with a lot fewer workers. You see it when you go to a bank and you use an ATM; you don’t go to a bank teller. Or you go to the airport, and you’re using a kiosk instead of checking in at the gate.”
[119] - Barrack H. Obama, reasoning through continued high unemployment rates
The belief that technology creates unemployment, when examined logically, leads to pretty crazy conclusions. Taken to its logical extreme it means that cavemen first started creating unemployment when they invented the wheel. While new machines may put a few people temporarily out of work, they open up entire new fields of labor full of employment opportunities.
Consider farming. Before any technology greater than the scythe, flail, and winnowing fan, farmers had a tremendous amount of back-breaking reaping, threshing, and winnowing to do by hand. All that work was just to have grain, not to mention all the time and effort required to further process the grain. The amount they were able to produce, even working sixteen hour days was not very far above bare subsistence, especially if they had no children to help them.
With the invention of labor saving devices like the combine harvester, what used to take weeks of toil now only took hours. This increase in productivity, along with other equivalent advances, had the effect of making food abundant and cheap. Instead of a large portion of a town having to farm to survive, with food more available, a greater division of labor was possible. Where before those who would prefer to be bakers, artists, tailors, carpenters, and barbers had to farm, now they or their children were able to give up farming entirely and work in their chosen fields of labor. Having so much labor opened up to specialization meant increasing the availability and affordability of goods and services for everyone.
The gift of technology is time—our very lives. With our time freed up by the diminished requirement for labor, we have the option of engaging in other activities—productive and recreational. Prosperity is eternally bound to productivity; it is thanks to labor-saving technology that the western world enjoys the opulence it does.
New technology may cause short term unemployment as the economy adjusts to the changes, but these growing pains are wholly positive. The automobile may have crushed the horse-and-buggy industry much as airplanes nearly crushed the railroads, but how many hundreds of thousands are now employed in these new industries? How many more industries has mankind yet to explore? When men are free to work and create, they will invent new products which not only will provide new areas of employment, but will also raise the aggregate quality of life for all. Those put out of business by the invention of the car were now freed up from antiquated and less-effective labors in order to work somewhere else which would be more productive. As machines and new inventions make life easier for everyone, man’s productive capability is free to be put to better uses.
Yet, this idea is ignored in the creation of hundreds of make-work rules by unions: electricians who refuse to install equipment made out of the state unless it is disassembled and reassembled at the job site; plumbers who insist on cutting the pre-threaded ends off pipes and re-threading them themselves; theater unions insist on the use of scene shifters even in shows in which no scenery is used; postal workers who can’t clean up the equipment used by others of a different craft because it isn’t part of their job, etc.
Nobel Prize-winning economist Gunnar Myrdal opposed the introduction of labor-saving machines in underdeveloped countries on the grounds that they “decrease the demand for labor”!
[120] Mr. Myrdal might be pleased, it seems, with a remote Amazonian or African tribe where employment is 100%, from sunup to sundown.
There is an anecdote told of an American businessman who visited China. He approached a work site with hundreds of people hard at work with shovels, moving earth to build a dam. The man approached the foreman and said, “If you employed the use of a tractor to move this earth, you could have done in a day what it will take these men three weeks to accomplish.”
The foreman was stunned and sputtered, “But think of all the unemployment that would cause!”
“Oh, I’m sorry,” the American responded. “I thought you wished to build a dam. If it’s employment that you want, take all their shovels away and make them use spoons.”
All those men were wasting hundreds of hours of labor doing something inefficient. If they did bring in a tractor to do the work, what could those men be doing instead? Instead of one dam, maybe two? Maybe an entirely different line of production making life better for all? If they hadn’t been wasting their time there, they could have accomplished so much more, and more production means better quality of life—cheaper goods and services of a higher quality and in greater abundance. Production grows the economy.
GOVERNMENT PRICE CONTROLS
“Let vigorous measures be adopted, not to limit the price of articles, for this I believe is inconsistent with the very nature of things and impracticable in itself.”
[121] - George Washington, 1779
There’s always a “well-intentioned” reason for government price controls. If prices are to be kept artificially low, it’s because government officials want to “protect” the public from price gouging and exploitation. If prices are to be kept artificially high, it’s to make sure the producers get “fair” market value.
According to the principle of supply and demand, the “natural” price of an item on the open market fluctuates constantly depending on a few factors.
SUPPLY: How much of a product is available? Is it plentiful or scarce? Is it easy to produce? Or is it difficult or costly with lots of time, skill, or resources involved? Is it a unique and hard to find item, or are there hundreds available to compete and bring the price down? An item will tend to cost less the more there is of it and the easier it is to come by. People may refuse to buy it when they know they can get it easily elsewhere for less.
DEMAND: How much do people desire and value the product? Is it rare?
The phenomenon of eBay is a great study in the law of supply and demand. It is easy to see how much an item is valued by people looking for it at any given time. They get to set the price themselves, and the item justly goes to whoever valued it most during the auction time.
What happens if government keeps prices artificially low? An almost immediate shortage results. People’s demand increases as the price drops, people buy more than they normally would—more than they can utilize effectively. Demand soon exceeds the supply and then the government decides it has to institute rationing. Producers no longer want to produce an item that may not have a sufficient profit margin anymore to make it worthwhile. The government then tries to subsidize the producers for the difference. So in essence, the government is taxing all the people to make prices lower for the few who purchase the product.
How can a government keep prices artificially high? The government has been known in the past to intentionally decrease the supply of an item to raise its value. One such time was when farmers in the late 1930’s such as Roscoe Filburn, who had grown more wheat than the law allowed, were ordered to destroy their crops and pay a fine because the government was trying to raise and “stabilize” the price of wheat.
[122] People were lined up for food at soup kitchens and our government was burning food to make sure that it wasn’t “too cheap.”
Another method to keep prices high is by taxing the item to make it more expensive. A major consequence to this is that black markets grow to the extent that an item is made more expensive through taxes. A black market is an “underground” market that operates outside the confines of the law. The most famous black market in U.S. history occurred during the era of Prohibition when alcohol was made illegal. Unfortunately, people like alcohol. The result was bootleggers, mobsters, crime lords, just as today’s prohibition against drugs has created cartels, gangs, kidnappings, trafficking, and murders.
Now what if the item itself isn’t illegal, but just discouraged and made expensive through excessive taxation? You still get a black
market to avoid paying the tax and obtain the desired item for less. See New York’s cigarette industry for proof. As of this writing, there’s more than a $4.00 per pack tax on cigarettes in New York. But, people still smoke, and the crazy part is, they buy their cigarettes somewhere cheaper. According to one article in 2007, one in three packs were purchased via untaxed Indian smoke shops (resulting in a loss of nearly $1 billion in potential tax revenue).
[123] The New York Times reported that one legitimate vendor saw his sales in 2002 decreased 75% after the recent tax increase.
[124] The USPS also put a ban on shipping cigarettes in large quantities through the mail, presumably to help cut down the black market sources.[125]
After World War II, some countries in Europe saw their black markets grow at the expense of the legally recognized markets until the former became, essentially, the market. Everyone used it. But, you can’t suppose no harm was done merely because the black market was widely used. The harm was both economic and moral. Not only were goods on the black market generally inferior and dishonest, but the long-established “honest” firms suffered economically, and demoralization spread into all business practices.