The Theodore Newsletter

August 1, 2016

Most governments do not know how to spend capital wisely because they do not understand or consider basic economics.  They treat money as something in a budget to be spent.  There is no consideration whether the expenditure will generate a return of the capital spent.  Even if there were such consideration, there is no mechanism to measure performance or punish incompetence. There are benefits to society if government is small but a lot of downside if government just keeps growing larger and larger.

The primary reason for a government to exist is to provide law and order, defense of the country, regulations to insure public safety, regulations for suitable use of land and the environment, a stable currency, and an infrastructure for the common good.  If government limited itself to these responsibilities, then the tax burden on those who work would be quite low. However, most governments go way beyond this primary purpose.

Taxation eats away the capital able for job creation and eats away at the spending power of the population.  There are two other options available to governments to operate instead of more taxation.  One is to borrow money.  The second is to inflate the currency and eventually devaluate it.  This is the mode of operation for many governments of the world. But borrowing is very risky because an economic downturn jeopardizes the ability to pay money back and inflation can rapidly increase interest costs which also make it harder to pay money back. Bankruptcy is another solution when there is too much debt but this is terribly painful as many countries have found out.  The United States is a late joiner to this club but it is already seeing much of its capital wasted by uneconomic projects and concepts.

The fundamental problem of socialistic government is that there is no desire by those in control to be governed by basic economics.  Money is spent for causes, i.e., reduce poverty, provide welfare, provide pensions, provide medical care, provide jobs, etc. But monies spent for so-called “good causes” usually are not effective because the fundamental cause of the problem is not addressed or solved. The usual result is that problems get worse, not better. Much government money is spent to buy votes and to reward friends and vested groups.

There are two ways to reduce income inequality between those who are rich and those who are poor. One way is by wealth transfer. This means taking money from those who have money and giving it to those who have little. This may sound like a noble and wise thing to do on behalf of poorer people but it doesn’t work well. It doesn’t make the poor richer for very long. Instead, everyone becomes poorer except for the elite in government who control the wealth transfer.  The wise thing to do is to create a mechanism whereby everyone who can and wants to work can get a good job (i.e., one that is productive and contributes to capital generation) at a living wage. Almost all good jobs come from the private sector from businesses that make a profit. Of course, some jobs in government are essential for it to carry out its key responsibilities. But “make work” jobs and those created by unnecessary regulations destroy capital and lead to a failing economy; they are not a solution to reducing inequality.

If creating jobs in the private sector is the key to reducing inequality, then it behooves us to find ways to maximize the number of people employed in the private sector.  Here are some suggestions.

The first priority should be to help young people. If young people are to succeed and lead productive lives, they must have basic skills and have a positive attitude and behavior so they will be worth hiring.  But government must also decrease the costs they impose upon businesses and employees that make it too costly to hire young people and pay them a livable wage.  How can this be done? Suppose that up through age 28, young people would have no deductions from their pay stubs: no tax withholding, no deductions from pay for Social Security or medical insurance. They could take home all that they earn which would help them to get a place to live, pay off debts and to begin thinking about having a family one day. The government would not lose too much revenue because new hires have low salaries. The loss in revenue to government would be quickly made up once the young people are over 28. Then they will begin to pay taxes and have deductions but they will be paid more because they will have gained experience and be of more value to their employer.

The second priority must be for government to reduce the cost to businesses for hiring, training and maintaining a young person on the payroll. Remember that every business has to work hard to be profitable. So businesses are very concerned whether a new employee will add to profitability or take away from profitability. Every cost that government adds to a business for paper work, regulations, benefits, litigation, penalties, etc., adds to the cost of having an employee on their payroll and their ability to contribute to profitability. This is especially problematical for a new employee because they have the fewest skills and ability to contribute to profitability.  When government or other factors, such as unions, add too much to the cost to having an employee, businesses turn to automation so they can use machines rather than people. If they don’t, other countries with lower costs will take away the business.

The third priority is that government payments to individuals not working must be significantly less (not just less) than what one could earn by working. What is the incentive for a young person to learn a skill or be industrious or responsible if he or she knows they can scheme to get the government to give them more money than they could earn by working at a job?

The more people there are who are creating a useful product or service, the better off the society will be.  The more people not working or creating something useful, the poorer is the quality of life in a society. Why are some cities so decrepit and full of crime? Because there are not enough people there doing useful work and creating capital for investment. Instead, too many people in these decrepit cities are skilled at destroying what has been created by others.

There is an axiom that every person should understand. It explains where wealth comes from. The wealth and the creation of capital for investment by a society is generated from the sum of each individual’s creation of a useful product or service.  In other words, people who work and do something useful, create a society’s wealth. People who do not produce something useful, consume society’s wealth.

A forth priority is that taxes on business profits should be eliminated because this tax directly destroys capital, increases the cost of products that people buy and increases the cost of having workers on the payroll. What do taxes on profits of a business do? Do they make the business more responsible? Probably not. Do they reduce high salaries of the top executives?  Probably not. Do they increase the amount of money businesses spend on lobbying Congress.  Definitely yes. Does it increase the cost of products.  Definitely yes. Does it increase the pressure on a business to cut costs unmercifully to try to maintain profitability? Definitely yes. The ultimate payer of taxes on businesses is the consumer. They pay the tax in the form of higher prices. Politicians try to keep taxes hidden from those who really pay them because you, the consumer, really pay them in the form of higher costs. When I was a boy, a postage stamp cost 3 cents and a loaf of bread was 15 cents. Today costs are 15 to 20 times higher. A major part of this increase is due to business taxation, excess paper work and the extensive printing of new money (another form of taxation).

Consumers are led to believe that taxing businesses is a way to shift a tax burden from them to someone else. They are wrong. They are paying the tax anyway. On the other hand, when taxes on business profits are reduced or eliminated, then it becomes easier to pay higher wages to employees and keep product prices from rising. It is a way to reduce income inequality and raise the quality of life for the poorest.

Everyone knows that it is desirable in a society for people to find jobs that will provide them enough income so they can survive, raise a family and have a good quality of life.  We often heat politicians claim that they can create jobs. But this raises a key principle. “Creating a job is simple but creating a “good” job is difficult”. What is the distinction?  Once again, a “good” job is one that produces something of value and service or a useful product.  It must be something that someone is willing to pay for. But there is a caveat. If a wage for a job is more than the value it creates, then the cost for a business will rise. The business must then increase its prices or else it will be harmed. If we agree that it is desirable to create “good” jobs, then it means that the more wages that an employee can keep will help the employee and the more skills the employee; and, has makes him more valuable.

Bottom line:  A job that is created for the sake of a job but which creates nothing useful but waste and “red tape” hurts everyone but mostly the poor and the young.

Politicians use charisma and promises to get you to vote them into power. Some are ethical and honest but many use the communistic “Saul Alinsky” campaign strategy which is to lie like crazy and castigate your opponent unmercifully. These unethical candidates usually promise lower income voters all kinds of freebies and benefits. They may look like a good deal for these voters but the reality is that most of these freebies are so-called Ponzi schemes. This is a scheme where the initial recipients get something good but then the money runs out.

It is time to recognize that economics counts when it comes to reducing income inequality.  The poor are not going to be helped in the long term by government spending which wastes capital. The poor will be helped by understanding that capital must be spent wisely to create good jobs and by making it easier for businesses to make a profit and hire the young.

I close with a comment on income redistribution.  Unfortunately, income redistribution is an employed strategy for cultivating the favor of large blocks of voters.  In this manner, voters maintain loyalty to those who promise to take from Wall Street and the “evil rich” to support the government.  Since voters with lower incomes have the incentive to vote for higher taxes on the wealthy.  The end result is a smaller tax base that supports a financial burden that increases exponentially with time.

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NEXT POSTINGS:  (tentative):

SEPTEMBER 1:         On the Nesmith Basketball Hall of Fame

OCTOBER 1:             On the OHI Day IV

NOVEMBER 1:         On “THE” Election

DECEMBER 1:          On the 2016-17 Hofstra Basketball Season

JANUARY 1:             One Purely Chaste, Pristine, and Random Thoughts XXIV