Read How Capitalism Will Save Us Online
Authors: Steve Forbes
How Capitalism Will Save Us (68 page)
So which is it—inflation or delation? That depends on how the government finances spending, as well as on what the Fed does. We won’t get inflation if the government borrows the money on the open market; the money supply will remain constant. But if the Federal Reserve creates money out of thin air to cover the government’s deficit, the money supply will expand. With more dollars in circulation, prices will eventually go up. Interest rates will go up immediately.
However, if the Fed doesn’t create enough money for the economy—which is what happened between December of 2008 and the spring of 2009—deflation will result. The shortage of money will mean tighter lending; consumers and businesses will sell assets to generate cash. This wave of distress sales will put downward pressure on prices. The problem will be compounded by Uncle Sam’s profligate spending, at levels never seen before in peacetime, and the time bomb of entitlements. These could suppress investors’ appetite for U.S. government bonds. (After all, would you lend money to a guy who’s not only broke but hopelessly overextended?)
What next? Real interest rates will soar. The higher cost of money will further cripple the private sector. The higher taxes needed to finance the interest payments and spending will only increase the pain—raising the cost of productive activity, draining people and companies of capital and savings. There will be less money in the economy to buy and invest. The result: falling asset values and prices.
It’s very possible that we might actually experience both inflation and deflation—inflation in prices and deflation in wages. We’ve already seen a wage deflation during the 2008–2009 recession. Commodity prices went down. Credit was unavailable. People and businesses scrambled to get cash. Millions lost their jobs and millions of others had to take wage cuts. If, to finance spending, the administration lets the capital gains taxes go up by 33 percent and personal dividend taxes to more than double, as they are scheduled to do at the end of next year, housing prices and stocks will be adversely affected. Moreover, the administration is toying with substantially increasing taxes on personal incomes by removing the cap on wages eligible for the 12.4 percent Social Security tax. Not only that, it wants to add a 5.4 percent surcharge to high-income partners to help pay for health-care “reform.” The highest effective federal tax rate could jump from the current 35 percent to well over 50 percent. The joblessness and hardship this would produce could be as disastrous as Argentina’s currency chaos.
REAL WORLD LESSON
Heavy government spending and the excessive printing of money produce inflation—but they can also produce equally disastrous deflation if the government taxes heavily to finance spending
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Q
D
OESN’T A DEMOCRATIC CAPITALIST SOCIETY NEED GOVERNMENT SAFETY NETS?
AS
URE, BUT THERE ARE RIGHT WAYS AND DESTRUCTIVE WAYS TO PROVIDE THEM
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Y
es, Virginia, even believers in free markets see the need for safety nets. The disagreement, however, centers on the size and scope of such government programs to help those who cannot help themselves.
Even the Founding Fathers, with their basic belief in limited government, felt government should assist the needy. But they thought the primary purpose of such aid should be to provide a lifeline at a time of crisis—to get people back on their feet.
Austrian school free-market economist Friedrich von Hayek considered meeting “the extreme needs of old age, unemployment, sickness” a “duty” in a democratic capitalist society.
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Milton Friedman supported certain programs, such as the Earned Income Tax Credit (EITC), which basically transfers income to society’s lowest earners. In his book
Against the Dead Hand: The Uncertain Struggle for Global Capitalism
, Brink Lindsey of the Cato Institute has written:
There is no inherent conflict between the principles of economic liberalism [i.e., free-market economics] and a decent provision for the needy and unfortunate…. It is perfectly consistent with liberal precepts for government to supplement the charitable efforts of civil society with a more comprehensive and systematic safety net. Whether provided privately or by the government, social assistance lies outside the market, in the realm of public goods. That realm is not in conflict with the market; it is in addition to the market.
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However, helping the poor and sick at their time of need is different from what we have today; giant antipoverty bureaucracies that provide ongoing subsidies, and not just to the poor. In the case of Medicare, everyone has to accept assistance, needed or not. The program is mandatory.
Isn’t it ridiculous that billionaires like Bill Gates or Ross Perot are forced to take Medicare or Medicare Part D, rather than government and taxpayer resources being focused on the 20 percent of the population that truly needs this insurance?
We have repeatedly noted that experts of all political stripes agree that Medicare and Social Security “entitlements” are not sustainable. Faced with unprecedented demands by the retiring baby boomer generation, today’s government health-care system, even if it is not expanded, as well as Social Security, is in danger of collapse.
Social Security and Medicare were sold to the public not as welfare, but rather as government-run insurance programs. The idea was that you would put in money as you would into a 401(k) or annuity during your working lifetime. Then you’d draw the benefits when you retired. The problem is that the cost of these programs continues to go up. Despite several extensions of Medicare coverage, millions of elderly Americans still need to buy more supplemental insurance.
Social Security and Medicare were supposed to be self-financing, just like your private health insurance and pension plan. But the government is not an insurance company. It didn’t finance Social Security, for example, the way a private company would. There are no reserves. More and more taxes will be needed to finance these programs unless, as we have suggested, they are systemically reformed.
Medicare and Medicaid don’t fully reimburse doctors and hospitals. So their costs are shifted to the private sector, which ends up subsidizing them in excess of $90 billion a year. And then there are those Fannie-and Freddie-sized distortions and the bureaucratic rigidities they create in the markets for health insurance and medical care. They also breed corruption, including fake claims and billing estimated to be in the billions of dollars.
These programs—and others—have become so big because government spending all too often lacks the market discipline, accountability, and transparency you’d normally have in the private sector. Funding is propelled by politics—i.e., who screams the loudest—and not by actual need.
This is true not only of the big entitlement programs. Writing in the magazine
City Journal
, Steve Malanga presented a compelling account of the little-scrutinized world of government-funded nonprofits. In New York City, they are a major part of the economy.
At one time, Malanga writes, such organizations were privately funded. They focused on serving the poor and did so without the help of
government. All of this changed with the Johnson administration’s War on Poverty:
The feds allocated billions of dollars to nonprofits through direct grants or via money funneled through state and local government agencies. In the process, the federal government paid nonprofits to do everything from running homeless shelters and rehabilitation programs for drug addicts to opening job training centers and designing and operating preschool programs. In just a few years, the money turned many charities into government contractors, reliant on public funding and serving an agenda set by Washington or local governments. The sudden availability of so much government money also prompted enterprising individuals to get into the public-contracting game and create new nonprofits of their own….
Today, though the city’s population has increased only slightly since the mid-1970s, social-services jobs number more than 160,000, making them one of the fastest-growing sectors. Indeed, private social services [even before the crash] now rival Wall Street as one of Gotham’s biggest employers; three times as many people work in private social agencies as in publishing. But while these service jobs are counted as part of the private sector, they’re financed almost entirely with government money. The industry continues to rely for its growth on expanding government budgets, fueled by tax collections.
Once narrowly focused on serving those in need, the social-services sector, Malanga writes, is today a government-supported industry. Inevitably politics enters the picture.
[M]any nonprofits have become political power bases, replacing the local political clubhouses of the 1960s. Executives and founders of nonprofits have used their agencies as launching pads for political careers, so that today a job in the nonprofit sector is as likely a route to the City Council or the state legislature as being a lawyer and member of a local political machine once was. And
channeling money into nonprofit groups is a sure way for a legislator to win friends and influence people.
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Funded as they often are by pork-barrel spending, organizations have resisted reforms—like being made subject to competitive bidding to win government grants. Some have become enmeshed in scandal, Malanga says: “City Council staffers have created phony nonprofit groups and allocated money to them as a way of parking cash that could be dispensed later.”
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One wonders if this is the kind of safety net the Founding Fathers or anyone else had in mind.
Occasionally, it is possible to scale back and reform counterproductive government programs. President Bill Clinton realized the unsustainability of welfare in 1996 when he signed into law the Personal Responsibility and Work Opportunity Reconciliation Act. Welfare rolls dropped by nearly two-thirds. What happened? Sixty percent of the welfare mothers who left the program found employment.