Analysis of the Myths Regarding Government Debt Pt 1

Anthony Davies, Phd has taken the time to make a video regarding the Myths regarding Government Debt. As promised, I will provide some deeper insight on some of the points that Dr. Davies makes in his video. My insights will not be in order of the listing that he provides in the video, I will simply touch on some of them.

The Printing of More Money

Some individuals will state to solve the multi Trillion dollar debt issue, the solution of prininting more money will suffice. Albiet it may sound reasonable, it will actually make matters worse. The inflationary effects of the expansion of the money supply are well documented, on this blog as well in the video done by Dr. Davies. As prices rise, due to the devaluation of the currency, the illusion of increased tax revenues will occur. Public Policy analysts will remark a record number of tax revenues have flowed into the treasury. Yet, this is misleading. The tax rates will be based upon the PRICES of goods(this also includes the WAGES of labor). The inflationary impact, as stated in the video, impacts both PRICES AND WAGES. The impact of the increase of the money supply creates this effect, along with the depreciation of capital(savings). As an aside, this is why politicians love lower interest rates for monetary policy–this action encourages consumption in the present, and discourages savings for future consumption.

Since the revenues will increase to the treasury, politicians will spend more money, creating a wider short fall(deficit). This deficit will be “balanced” by the sale of Government securities or debt. Once those securities are sold, this action also expands the money supply, creating more inflationary impact on prices and wages, while concomitantly wiping out individual savings. More could be stated about his effect on savings, but that shall wait for another blog entry. In short, the debt will be never balanced by simply “printing more money”.

Raising Taxes

This battle cry is highly popular with politicians and their supporters: ” We can simply raise taxes on the rich, and this will help us balance the budget.” Like many of these proposals, they *sound* reasonable, at first. Once deeper analysis is performed, it is revealed these sort of proposals are meaningless and fallacious. A thought exercise: Suppose your local grocery story raises its prices on your favorite name brand cereal. Let us suppose it raises it by $10. Before the price was $5 for a box of Raisin Brand, now the retail price is $15. Will you continue to purchase this cereal? In most cases, the answer is no. You will seek alternatives to paying $15 for cereal. Yes, I know cereal is not the same as paying taxes, but the underlying human behavioral concept is the same: Price elasticity. Humans will purchase goods relative to their price elasticity–if the price of that good rises too high, actors in the free market will seek other means to satisfy their wants that were normally fulfilled from that particular good. If tax rates are raised up too high, individuals will seek out means to offset the tax risk or avoid paying on the tax increase. This economic phenomenon will occur if taxes are raised: Tax payers will seek alternatives(price elasticity) to paying the higher tax rates. Since this is the case, tax revenues will not increase when tax rates are increased. Historically, this has been proven to be true. When tax rates are lowered, tax revenues are increased. Also, regardless of what the tax rates are, taxes collected typically are around 17% of GDP.

More will be covered on another blog entry…

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