The Stupidity of Raising Taxes in a Downturn

As I’ve said repeatedly, this crisis will make people’s head spin. The latest mind-boggling move is the rise in Treasuries following S&P’s downgrade. At first this is confusing, but remember this is a global crisis, and if global capital panics, only the Treasury market can handle all that capital. So crudely, Treasuries rise. The talking heads on TV misinterpret these moves as a reflection of global confidence in Treasuries, and by extension the U.S., but it’s pretty much the opposite.

This is such a complex crisis that I’m sure some of my statements are confusing people. For example, I’ve received valid questions about my criticism of both the policy of raising taxes and the policy of cutting spending. Most view this as an either/or type of problem, and I don’t blame them. I’ll try to explain my thought process in the coming days while trying to focus your attention on the true solutions to this crisis.

To give you an analogy, it’s like asking if gold is an inflation or deflation hedge. The answer is both and neither. It depends. Is gold considered money by the government and the people? Is the population confident in its leaders? The answer to this question is nuanced and it depends on the situation.

Today I’ll briefly explain my position on taxes. This topic deserves more time than I’m giving it, but let me make some points to clarify why raising taxes in a downturn is foolish.

The Great Depression and Taxes

Revisionist history tends to minimize the role of taxes during the Great Depression. FDR may have been the interventionalist Democrat, but it was Hoover who first raised taxes on the “rich” in 1932 during the depths of the Depression, a mere 3 years into a decade-long Depression. Taxes rose to onerous levels that would make us blush today, yet there was no robust recovery on our balance sheet. Business leaders were attacked by the government, much as they are today.

FDR magnified Hoover’s folly by raising corporate and personal income taxes even more. Democrats and Republicans were both wrong on this one. There was no relief in employment even though corporate debt did well, just as it is doing well now. People look at corporate debt at new highs and wonder the economy is so weak. They forget that corporate debt competes with government debt and that capital sees corporate debt as more attractive. So again, you can’t analyze the rise in corporate debt in isolation; you’re only seeing half the picture.

The problem with raising taxes is that capital now competes globally, and huge sums of money can change hands at the push of a button. When the U.S. was dominant, Federal taxes were unavoidable and states had to compete with each other for business. We have a similar situation today, except countries now compete with each other for capital. Asia used to be poorer than Africa, but now Asia is attracting large sums of capital and growing at incredible rates. Singapore is a tiny island city-state that happens to be one of the wealthiest nations on a per capita basis in the world. Hmm, I wonder how they pulled this one off. Could it possibly be because they are the most business friendly country in the world?

America is blessed with great resources and a dynamic population; if our government had a clue, our economy would be booming. As it stands, our government is creating an environment of confusion and fear. The big boys in the hotel industry have already moved to Macau; if our government decides to tax them to oblivion, guess where they are taking their business? Our government needs to stop taxing income earned abroad so that we can compete evenly with international companies. There are so many policies we can enact that are virtual guarantees to spur business. Sorry, but raising taxes is not one of them, and if you think raising taxes will at least raise revenue, think again.

Recessions are one thing, recessions where there is no solution in sight are another. Pessimism in America has now surpassed levels seen during the depths of despair in early 2009. Confidence is getting destroyed, and this is going to have significant consequences. You are going to see more young people head to Asia in the years ahead because that’s where the opportunities are. Our leaders will be scratching their heads, but they brought this upon our country. This crisis is fundamentally different from any we’ve ever experienced, which means we need to make more than cosmetic changes. Raising taxes is the worst thing we can do, and this isn’t a right vs left issue, it’s a common sense issue. Get it in your heads: capital competes globally; we cannot raise taxes and get away with it anymore.

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