Progressive Keynesian Myths Debunked: The Coming Redistribution of Political and Economic Power Among the States

Progressive Keynesian Myths Debunked: The Coming Redistribution of Political and Economic Power Among the States
April 17, 2013

Peter Ferrara

Peter Ferrara is senior fellow for entitlement and budget policy at The Heartland Institute, a... (read full bio)

Ongoing effective economic experiments among the 50 states are sharpening, and definitive results will pour out in the real world, editorial and opinion fallacies to the contrary notwithstanding. That sharpening is the result of the increasing political segregation among the states, with 25 now in complete control of Republicans in the Governor’s office and in majorities in the state legislatures, and 15 in the same complete control by the Democrats.

That sharpening is further exacerbated by the overconfidence of so-called “progressives” in reaction to the election of 2012, which they are certain heralds the greening of America – the abandonment by rising American majorities of the foundations of traditional American prosperity and success, in favor of European concepts of social justice and neo-Marxism. That overconfidence is leading the Democrat controlled states to embrace more radical left nostrums.

Hence we see accelerating tax rate increases in California, New York and Illinois, combined with overregulation driving out dramatic, emerging, real world opportunities in resource development and other market prospects.

The likely outcome of these economic experiments is carefully presented in the recent publication by the American Legislative Exchange Council (ALEC) of Tax Myths Debunked, authored by economists Eric Fruits and Randall Pozdena. That publication wields both meticulous logic and authoritative empirical support to definitively grind to dust economic myths advocated by “progressives” with religious fervor.

One such myth is the hopelessly outdated Keynesian notion that increased government spending stimulates the economy during recession. As the authors note, “The Obama Administration and its liberal allies in Congress forgot the dismal performance of Keynesian-type deficit spending as a stimulus of growth in the 1960s and 1970s and embarked on an aggressive deficit spending policy anyway.”

That was the nearly $1 trillion dollar so-called “stimulus” that Obama and the Democrats waived through Congress as the first major act of the Obama Administration in February, 2009. Keynesian policies failed so thoroughly in the 1970s, leading to both double digit inflation and double digit unemployment, that it is puzzling as to why Obama returned to them, as if he is ignorant not only of what happened then, but of everything that happened after then, from 1980 on. Ronald Reagan explicitly scraped Keynesian nostrums, embracing instead the new, modern supply side economics, which focuses on incentives for increased production to restore economic growth and prosperity, rather than increased demand. Inflation was quickly subdued, shocking the Washington Establishment, and the economy took off on a generation long, 25 year, economic boom from 1982 to 2007, which Art Laffer and Steve Moore called “the greatest period of wealth creation in the history of the planet,” in their 2008 book, The End of Prosperity.

That is why I have called Obama’s economic policies Rip Van Winkle economics, because Obama seems to have slept through that 25 year economic boom, and to be totally unaware of everything that happened then, in his own country.

The myth of Keynesian economics is based on a failure to take into account basic double entry bookkeeping. If the government spends more, where does the money for that increased spending come from? Either from increased borrowing, or increased taxes, which both take an equal amount of resources and spending out of the private economy as they finance in increased government spending. So not only can there not be a net increase in aggregate, or total, demand from these policies, the spending is in truth a net drag on growth, as the private economy spends money more productively and efficiently than the government. That is why this Keynesian nostrum never worked in the 1930s, as the recession of 1929 extended into the decade long Great Depression, and it hasn’t worked anywhere else since.

But most fundamentally, economic growth is not driven by increasing demand, which is insatiable, but by increased production or output (supply), which is driven by incentives for productive activity. In other words, just as an individual cannot spend himself rich, neither can a nation. Prosperity is determined by production, just as an individual increases his or her income by becoming more productive.

Demand can never be inadequate in a market economy. If the demand for any product or service is not strong enough, the price of the good or service will fall, until demand equals supply. The people can never spend more than they produce, and so increase “aggregate demand.” And they will never spend less than they produce, leaving demand inadequate, for they will either consume or save every dime that they earn or produce. The consumption goes into consumer spending, and the savings goes into capital spending (which is actually what makes us richer and more prosperous over the long run, as discussed further below).

Fruits and Pozdena recount the consequently all too predictable, dismal results, from Obama’s Rip Van Winkle, 2009 “stimulus,”

“The president’s economists predicted that by the fourth quarter of 2010 the stimulus would have led to employment of 137.5 million. Instead, actual employment was 7.3 million lower than the administration’s projections, and unemployment rates reached 10 percent. They projected that 2012 unemployment would be only 5.75 percent. Instead, unemployment is hovering around 8 percent, with much of that ‘improvement’ coming from individuals leaving the labor force unable to find employment.”

The only reason that Keynesian economics has survived for so long in western thinking is not because it works, or even makes any sense, but because it justifies what liberal politicians already want to do – spend with reckless abandon, run bigger and bigger deficits so they don’t have to explicitly pay for it with higher taxes today, and run up the national debt, which will be someone else’s problem later. The truth is, as Fruits and Pozdena explain, “A large and long-standing body of literature finds that increased or higher government spending tends to reduce economic growth rather than increase it.”

They cite Baumol, W. J. (1967), “Macroeconomics of unbalanced growth: The anatomy of urban crisis.” American Economic Review, 57(3): 415–426 as showing 45 years ago that shifting resources from high productivity growth sectors to low productivity growth sectors, such as government services, will cause the growth rate of overall productivity to decline. They cite Barro, R. J. (1991), “Economic growth in a cross section of countries.” Quarterly Journal of Economics, 106(2): 407–443 as showing that government consumption has no effect in increasing private productivity, or in other words in restoring economic growth. Instead, Barro found that increased government consumption lowers saving and growth through the distorting effects of taxation or government expenditure programs.

A review of data from the G-7 countries by E. Hseih and K. Lai (1994) found no evidence that increased government spending increases the rate of growth of per capita GDP. Barro, R. J. (1996), “Determinants of Economic Growth: A Cross-Country Empirical Study.” Working Paper No. 5698, National Bureau of Economic Research found that most government spending does not increase productivity, and that increased government spending relative to the economy reduces investment and growth.

Harvard Professor Alesina, A., along with Perotti, R. in “Fiscal Expansions and Adjustments in OECD Countries.” Economic Policy, n.21, 207-247 (1995) found based on a cross-country analysis of OECD studies that reducing the share of public spending in the economy would increase economic growth by increasing investment. Alesina A., Ardagna, S., Perotti, R., and Schiantarelli, F. (2002), “Fiscal Policy, Profits, and Investment,” American Economic Review, Vol. 92, no. 3, June 2002, 571-589 argue that government spending cuts are the most stimulative policy for economic growth in a recession.

The bottom line is that Keynesian economics has long been refuted by experience, empirical evidence, and logic, and the failed doctrine now needs to be put to bed, in American colleges and universities, and throughout the councils of government. Moreover, Obama should have known better, given that Keynesian economics has failed so badly every time it has been tried, from the 1930s to the 1970s, and all around the world since then. He had a responsibility to the American people to know better.

Another “progressive” myth debunked by Fruits and Pozdena is that raising tax rates will not harm the economy. Often cited is that tax rates were very high in the 1950s, yet the economy still grew. Perhaps if we bombed to smithereens all our economic competitors, as had recently been done in the 1950s, high tax rates would not be as harmful. But Kennedy did not think those high 1950s tax rates were harmless. He campaigned in 1960 against what he saw as the weak Eisenhower economy, and advocated an across the board 30% cut in tax rates. After that was mostly enacted after his death, the economy boomed, and revenues actually soared.

More recently, Fruits and Pozdena note that ironically, Professor Christina Romer, Obama’s own [former] head of his Council of Economic Advisors, has provided (along with her husband David Romer), some of the strongest evidence that higher tax rates depress economic growth, with their work concluding that each 1% increase in taxation lowers real GDP by 2 to 3 percent. That works primarily through the effect of tax rates on incentives. Lower rates increase the incentives for productive activity, such as savings, investment, business start ups, business expansion, job creation, entrepreneurship and work, resulting in more of each, which adds up to increased economic growth. Higher rates do the opposite.

Fruits and Pozdena explain that this works “because low marginal tax rates, in effect, raise the after-tax returns to labor and capital,” which “increase[s] the supply of labor, entrepreneurship and capital,” which directly increases production and economic growth. Most important for growth and prosperity directly for working people and labor is capital investment. That produces the tools for workers to be more productive (e.g., digging with computerized, mechanized steam shovels as compared to hand shovels as compared to bare hands). Increased worker productivity provides the increased earnings to pay workers higher wages. The increased investment also means the increased demand for labor that bids wages up to reflect the increased productivity. That reveals the fundamental truth about capitalism that labor and capital are complements, not antagonists, which so-called “progressives” fail to understand. Capital increases the productivity of labor, and labor increases the productivity of capital, which increases the production, and hence growth, of the entire economy.

This is why higher tax rates on investment (which in populist parlance is naturally held by “the rich,” who have the funds to make such investments) are so particularly harmful. This is further confirmed by the work of Romer and Romer, which found a strong negative effect of higher tax rates because “investment falls sharply in response to tax increases. It is very likely that this strong retreat of investment is part of the reason the declines in output are so large and persistent.”

That does not mean that “the rich,” or capital investors, should not pay their “fair share” of taxes. But as explained in this column already ad nauseum, “the rich” already pay far more than their fair share under current tax law, which leaves President Obama’s repeated calls ad nauseum for further tax increases on “the rich” to pay their fair share explicable only on Marxist grounds (“the rich” being unjustifiable per se, regardless of effects on economic growth, and ultimately working people and the poor).

Copious data and research from the increasingly divergent policies at the state level further explode the myth that higher tax rates are not harmful to the economy. As Fruits and Pozdena explain, “The evidence that lowering marginal tax rates grows the economy is voluminous and, because individual states vary so much in the level and type of taxes levied against the backdrop of federal policy, it is relatively easy to demonstrate a causal relationship between lower mar­ginal tax rates and greater employment overall and mi­gration to those states with preferable, low income tax rates.” Besides Tax Myths Debunked, that data and research are thoroughly provided in the annual volumes of Rich States, Poor States also published by ALEC.

The response from “progressives” too often just involves Alinsky style ad hominem attacks, which seems to reflect inadequate public schooling, failing to teach Aristotelian logic, which instructs that ad hominem arguments are logical fallacies.

This data and research are already increasingly affecting tax policy among the states. Nine states prosper perfectly well with no state income tax at all, including Texas, Florida and Tennessee. That policy is starting to spread across the South, from Louisiana to Virginia, and up the Plains states. In contrast, the “progressive” states, from California to Illinois to New York, along with Oregon, Hawaii, and some others, persist in raising state tax rates to record levels.

Political activist organizations posing as media institutions can effectively shield the populations of the “progressive” states from knowledge of the above discussed data, research and analysis. But they can’t shield them from the real world effects of “progressive” tax and economic policies. These redistributionist policies are only redistributing economic and political power among the states, as the American population is migrating from the increasingly stagnant “progressive” states to the increasingly booming growth oriented states.

Political power follows that migration, as the states with growing populations receive more Congressional representatives and electoral votes from the economically stagnant, “progressive” states. Arizona now has as many electoral votes, and Congressional representatives, as Massachusetts, with South Carolina not far behind. Florida now matches formerly dominant New York as well. Georgia now has as many as Michigan. Texas as many as Illinois and Ohio combined. For the first time since the 1849 Gold Rush, California received no additional electoral votes in the 2010 Census.

On our current course, these trends will only accelerate. As the saying goes, “the South will rise again.”

[First Published at Forbes]

Peter Ferrara

Peter Ferrara is senior fellow for entitlement and budget policy at The Heartland Institute, a... (read full bio)