Support for tax hikes relies on economic fallacies

Spending restraint was always the superior option

By Geoffrey Lawrence
  • Wednesday, June 17, 2009

Economists frequently disagree with each other on nearly every issue. Often, it seems there are nearly as many economic paradigms as there are economists. Yet most economists can be characterized as belonging to one of the major schools of economic thought — whether Austrian, monetarist, Keynesian or Marxist. A recent article by Elliott Parker of the University of Nevada, Reno, in which he advocates for increases in state taxes and government spending, places him neatly in the Keynesian mold.

Parker's analysis recognizes that the current recession has impacted some sectors more negatively than others, high unemployment in the construction industry being a prime example.  Yet, in typical Keynesian fashion, his analysis fails to probe deep enough to reveal the cause of this disparate impact.

As Austrian Business Cycle theory clearly demonstrates, recessions are more pronounced in particular industries precisely because of government — and specifically central bank — action.  The Federal Reserve consistently publicly misrepresents the amount of savings available within society by manipulating interest rates downward through the creation of new money. While this policy can create an artificial boom period, it is equally responsible for the bust that follows.  That's because the artificial credit inevitably leads to an economy-wide misallocation of resources as the signals sent by manipulated interest rates cause a malinvestment of real capital. 

In the current case, real-estate development was the "bubble" market into which an overabundance of capital was invested. As such, it is this same industry that must scale back in order for the economy to return to sound fundamentals. The problem is not that the industry has suffered some devastating and unexplainable collapse. The problem is that government policy first encouraged that industry to grow to an entirely unsustainable level.

After failing to properly diagnose the problem, Parker proceeds to offer the typical Keynesian policy prescriptions. He acknowledges that taxes have an adverse impact on private spending because individuals have less disposable income with which to provide for their families. Yet he proceeds to contend that government spending can be superior to private spending — meaning, in practice, that compelling struggling families to forego food so that unionized government workers can enjoy pay raises is really in the struggling families' best interest. 

Keynesians often adopt this posture from a fear that private individuals might, if they were allowed to keep their income, save or invest a portion of it in lieu of spending gratuitously in the present. The critical concept of time preference and the importance of capital accumulation to economic growth are routinely dismissed by Keynesians who notoriously have no foresight beyond the immediate present.

The type of runaway government spending for which Keynesians advocate during a recession aims, as an explicit goal, to prevent the overall economy from returning to sound fundamentals.  It aims to subvert the market's ability to adjust to the failure of government policies, which the market would do by shifting productive resources back into the industries where output reflects true demand. While this is the essence of a recession, it is also the necessary healing process following the subversive effects that specific government policies have wrought upon the economy.

Government spending programs that seek to prevent recession simply prolong a misallocation of resources and undermine long-term economic growth while expanding the power and size of government. Indeed, the true measure of success for a government "stimulus" program under Keynesianism is that sustainable growth is never restored.

Parker predictably references the "glory days" of Keynesianism, the Great Depression — a time when government spending grew irresponsibly and unabashedly in order to subvert the market's ability to recover by reallocating resources. Unsurprisingly, the Depression dragged on for an entire decade. 

Parker even goes so far as to suggest that "when the federal government is trying to stimulate the economy, the states are unintentionally making it worse because they are generally constrained to balance their budgets." He quotes Keynesian poster-boy Paul Krugman, who refers to this so-called "problem" as "50 Herbert Hoovers." (This statement is as factually inaccurate as it is conceptually inaccurate. Hoover, who believed that high wages led to prosperity and not the other way around, grew federal spending by 49 percent in order to prevent a market correction.)

The presumption made by Parker's analysis is that the new 20 percent increase in the state tax burden will be a boon to Nevada's economy, because spending by government bureaucrats is somehow better than spending by families. 

Parker specifically points to higher education as a "good that the private sector can't provide in sufficient amounts" and, therefore, as a desirable target for large state subsidies (from which he, of course, personally benefits). Yet, according to US News and World Report rankings, the top 20 undergraduate universities in the United States are all private. 

Indeed, economists from all schools of thought can agree that education is a critical component of long-term growth. However, the best universities in the nation are private precisely because they are held responsible to the consumer for the full cost of attendance and must offer a quality of education consistent with that cost. Because subsidized universities shift the cost onto third parties, consumers are not forced to weigh the full cost of attendance against the potential benefits, and university management is not held to the same level of market discipline.

The Freedom Budget offered by the Nevada Policy Research Institute as an alternative state budget would have addressed Nevada's shortcomings in higher education by creating a tiered system. It would have fully funded the state's community colleges in order to make job training programs easily accessible, but it also would have addressed the state's lack of elite educational opportunities by forcing UNR and UNLV to operate at market standards. This is an approach that should only be feared by underperforming university workers. Those who successfully help students gain the skills to be genuinely successful would actually see their wages increase in direct proportion to their productivity.

If Dr. Parker and others of like mind would truly like to address the problems facing Nevada, they should embrace a more reasoned and consistent school of economic thought than the very narrow and flawed Keynesian approach. 

The truth is that specific, defective government policies caused the current economic crisis, and that further government action aimed at preventing the market from adjusting will only further exacerbate the problem — regardless of whether that action comes at the federal or state level.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute.

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