Faith-Based Tax Policy

The justification behind tax cuts as stimulus is derived from the laissez faire argument and the Laffer curve. While the Laffer curve was made popular by Arthur Laffer on the Reagan administration Economic Policy Advisory Board, it was first described by 14th century Muslim intellectual Ibn Khaldoun. The idea of tax cuts as stimulus was also proposed by John Maynard Keynes though its current proponents appear to be unwilling to associate themselves with Keynesians.

The laissez faire argument states that any transfer of wealth from the state to the people is positive for economic growth since government is always detrimental to the economy. This is a philosophical belief that does not take into account the current state of the world and the limits of short-term change. In the short and medium term, the size of government will not be changed substantially due to the checks and balances that exist in government. Unless there is a national consensus on what must be done, the conflict in competing political interests will prevent large changes from occurring quickly. As this pertains to tax policy and the size of government, unless proponents of smaller government can match tax cuts with spending cuts, government debt will increase creating a larger tax burden on the future economy.

Proponents of tax cuts counter that the Laffer curve proves that tax cuts will not produce deficits because the economic growth produced by the tax cuts will increase total tax revenues. In order for this tax elasticity effect to occur, the current tax rate must be above the rate at which taxes are a disincentive to productivity. Since there is little empirical evidence to support an objective tipping point, the effectiveness of the Laffer curve is dependent on the subjective assessment of whether current taxes are too high. As tax policy is linked to philosophical arguments on the proper size of government, those who believe in smaller government will likely use the Laffer curve to justify lowering taxes without consequence relative to any given rate.

Risk Aversion and Job Creation

The current consensus view is that the economy will remain weak until consumers start spending again. In the near-term, consumers will increase spending as they become more confident about their job situation and in the long-term, they will need to repair their balance sheets before returning to the level of spending we were accustomed to. This is what many people refer to as “New Normal” since consumers are unlikely to be capable of returning to the old level of spending without another debt bubble. Many people believe that jobs will be created as economic activity increases but this circular argument is being refuted as the largest public companies accumulate cash and continue to grow profits. This is where politics complicates the narrative as analysts attribute the lack of job creation to uncertainty about taxes, healthcare or some other partisan issue. The bottom line is that we still live in a capitalist system regardless of the marginal tax rate or the method of healthcare care administration and business is only rewarded for successfully taking on risk.

Business risk is largely borne by small business since large company employees are rewarded for maintaining the status quo in order to protect their existing competitive advantage. (When you make buggy whips, it doesn’t matter if you’re a fox or a hedgehog and every business eventually enters the buggy whip stage.) As more of our economic activity is dominated by large companies, there is a decreasing impact from real entrepreneurs that are willing to take risk and we should not be surprised when the risk aversion of the entire economy increases. While tax cuts certainly increase profits, there is no direct connection to wealth creation as opposed to wealth transfer. Jobs will be created when businesses are willing to show some leadership and take on risk. Everything else is just politics.

Reflections on the 2008 CES

This was my first visit to the Consumer Electronics Show in Las Vegas, NV. I spent everyday wandering through the endless displays of gadgetry goodness but was hard pressed to find any truly innovative products. I found the presentations to be the most useful for understanding how the industry thinks and what they can realistically deliver. Paul Otellini’s presentation was a good show but couldn’t deliver details on how or when the translation and GPS capabilities could be incorporated into real products because the whole thing was a simulation run on servers located backstage. Jerry Yang’s keynote was exciting but I doubt that the full platform will be released on time as presented. After a depressing presentation by several private equity investors, I realized that no one is interested in building a consumer centric company which is why Apple will probably continue to succeed in the consumer electronics space despite their rushed product life cycles and lack of respect for early adopters. It seems that consumer electronics firms succeed more on marketing and management capability than technological innovation.