Santa Claus vs. the Cost Disease

Taxing the future is harder than advertised.

Previously, I put forth the idea that Austrian Economics is the foundation for true Sustainable Economics. I went even further and chastized Supply Side Economics as being Keynesian Economics' retarded brother and incompatible with both traditional values and nationalism.

This produced some pushback:

If I was a Sigma Male, I would have had a manly temper tantrum and banned Mr. Nier for his impertinence. But being a Circuit 3 dominant¹ semi-Vulcan, I found his objections to be interesting -- fascinating even -- and so I interrupt my original intended series to answer Mr. Nier's quite valid objections.

So, Why Not Rely on Economic Growth?

Progress happens. If progress happens faster than per capita resource depletion, society becomes truly richer. So why pay taxes now while poor? Why not run up some debt and pay when richer? It makes sense on the surface. It's progressive taxation applied to time.

Let's first try modeling this with a simplistic but somewhat real scenario. Televisions used to be expensive. When I was a young child, my family had a flaky black and white television. We didn't upgrade to color TV until I was in something like third grade -- and we were not poor. My father was a country lawyer.

When transistors replaced most of the vacuum tubes in televisions, and manufacturing moved overseas, TV prices plummeted. By the time I was in grad school, there were televisions on sale at the local Albertson's grocery store.

So, let's run an alternative economic scenario where the price of televisions drops in half while the rest of the economy stays roughly the same. Furthermore, to keep this scenario simple, let's pretend that the federal government is funded by a national sales tax. (I'll add fidelity later.)

Under these assumptions, to first order the government loses tax revenue, since the price of televisions drops by 50% and so sales tax from television sales drops by 50%. First order thinking is obviously wrong; however, since people would buy more televisions thanks to the price drop. Furthermore, those who don't buy extra televisions have money they could spend on other things.

But there is no reason to think that this progress would increase total spending, and thus tax revenue. Some kind of intervention is required to turn that progress into more government funding.

The government could cash in on the drop in TV prices while still leaving Joe Sixpack better off. Suppose the government were to levy a new excise tax on televisions equal to half the price drop. Joe Sixpack gets to buy a television at 25% off and the government gets a 50% tax on hot selling televisions. It's win-win all around.

But it would make Reaganites cry.

The Club for Growth approach would be to inflate the currency and call it Growth. Let's run some simple numbers. Suppose Joe Sixpack's family budget was 10% for televisions. With TV prices cut in half, Joe can continue buying the same basket of goods and services for 95% of his old budget. Therefore, the government can increase the amount of currency in circulation to inflate prices by nearly 5.3% overall and put Joe back where he was even if he doesn't get a pay raise. With this Growth, government sales tax revenues go up by over 5% without having any new taxes or official inflation. Keynesians and Supply Siders are dancing and blowing bubbles. No tax hikes. More revenue. Wheeeeee!

But not so fast! What happens to government expenditures due to this non inflationary inflation of the currency? While this currency debasement helps pay older debt, ongoing spending might need to go up. We'll explore this in greater detail later.

Excise vs. Sales Tax

So fare we've looked at the scenario as if we had a national sales tax just to keep things simple. I'll get to our real tax system presently, but first I want to run it under the federal tax regime originally proposed in our Constitution: tariffs and excises. Under such a system televisions would be taxed like alcohol. Television is a luxury good and arguably more addictive than alcohol. A television tax would be approved of by our Founding Fathers.

So what happens to federal government revenues when television prices drop and there is a television excise tax instead of a national sales tax? Answer: government revenues go up! Automatically! The excise tax would be per television, and so with people buying more televisions due to the price drop, the government collects more TV excise tax without having to alter the tax rate.

And Joe Sixpack is still better off despite paying more taxes, since Progress. And we get to stay on a gold standard since there is no need to inflate the currency. Indeed, the excise tax dampens the natural deflation which comes with Progress.

There is one other big difference between tariffs and excises vs. price based consumption taxes. Under the former, the tax burden shifts towards the sectors of the economy which got cheaper. Under the latter, the tax burden shifts to those sectors which did not experience Progress. And by Growing the economy, we get to see inflation in just those sectors.

Welcome to Baumol's Cost Disease, where prices explode in everything which cannot be automated, outsourced, or replaced by computers.

Back to the Real World

In the pre Trump era, the federal government was financed primarily by deficit spending and taxes on labor. FICA and Medicare were overt labor taxes. But the regular income tax was also a tax mainly on domestic labor, thanks to accelerated depreciation schedules and a long term capital gains rate that was well below the individual income tax for high wage earners.

When we throw in inflation, we also got a federal property tax on some land and capital, since inflation creates fake capital gains. But this was more of a factor for real estate and stock market investments. When a business fully depreciates capital equipment and scraps it, the inflation applies only to the scrap.

So, under the pre Trump federal tax system, the tax shift to the non improved sectors of the economy was even worse than if we had a national sales tax. Prices drop mainly from automation or outsourcing. With accelerated depreciation and low capital gains tax rates, government favors automation over human labor. And before Trump, tariffs amounted to a few percent.

So under the pre Trump system, government was aggressively moving the tax burden to those sections of the economy which resist automation and outsourcing. The government was magnifying Baumol's Cost Disease, where clothing, smart phones, and injection molded plastic items at Walmart are dirt cheap, but only the upper classes can truly afford legal services and healthcare without government help.

Donald Trump began dampening the Cost Disease by raising some tariffs. He didn't go far enough. Free Trade…isn’t.

When Government Taxes Itself

Imagine a Congress that's really, really stupid -- even stupider than the one we have. This extra stupid Congress decides that national defense is a real drag: all those soldiers and weapons are really expensive. So this bunch of clowns decides to recoup the government's expenses by levying special taxes on soldiers and weapons.

The obvious happens: the price of national defense goes up at the same rate as the new taxes bring in revenue. Doh!

Well guess what: thanks to Baumol's Cost Disease, our real world government is doing just about the same thing. Our government is taxing itself!

Look at the things that our governments (federal, state, and local) purchase and produce: education, healthcare, taking care of the aged and severely handicapped, road building, policing, national defense... These are areas which cannot -- or should not -- be outsourced, and the opportunities for economical computerization and automation are limited.

They aren't zero. The federal government saves a boatload on printing costs by using PDFs. Tax collection, census tallying, vote counting, and the like have been economized thanks to computers. Computers sort mail, and now one can search patents online instead of flipping through packs of stapled pages at the Patent Office.² And electronics helped us win the Cold War! There is a reason why so many spy films in the 60s featured top secret microchips. We had a serious edge in electronics and when we threatened to use it to build a missile defense system in space, it forced the Russians to realize that they had top open up their society to keep up.³

Reagan's tech based military buildup was a rare example where deficit spending made sense. We could have used the resulting Peace Dividend to pay down some debt before the Baby Boomers started retiring, but instead we blew the budget surplus with tax cuts, unnecessary wars in the Middle East and ObamaCare.

Progress is no longer our best friend when it comes to national defense. Thanks to environmental lawsuits, DEI, and inviting foreigners to attend our graduate schools, our electronic edge is shrinking rapidly. Economic trends are not in our favor. Expect military spending to go up in the future even if we scale back our empire.

The other major portions of our government bills are heavily subject to Cost Disease. Education has been notoriously resistant to improvement through technology despite attempts going back to before I was born.

Yes, there are thousands of educational videos available on the Internet. Yes, it is possible to browse historic documents and read old literature on a tablet. For a motivated older student, the Internet is a valuable educational resource. But for the unmotivated student, computers provide clickbait, addictive videos, video games, and porn. Computers and the Internet are making people dumber on average.

Fast Food for the Mind

A huge chunk of government spending is devoted to medical care. While high technology does help with developing pharmaceuticals and with medical imaging, the human touch isn't going away, and some of those humans are expensive. It still takes a dentist to fill a tooth, a nurse to change a bedpan, and a janitor to sanitize a hospital room. I do expect some costs to drop. Eventually, high temperature superconductors are going to make the price of MRI machines plummet. Liquid nitrogen is cheap. But old age will always be expensive unless we just plain stop trying to stretch out the last year. Antibiotics breed resistant bacteria. Novel chemicals have created epidemics of autism, allergies, and infertility. The power to cure genetic diseases is the power to create new diseases. And we may well have passed the point of diminishing returns for vaccines.

It may be possible to make medical care cheaper by altering regulations and incentives. Having a true market for medical care vs. putting even the upper classes on welfare by using insurance for ordinary care would help.

Likewise, it is possible to provide decent educations for less by returning to phonics for reading and by using some of the reforms listed in Rule 5.

But in both cases, the cost reductions come from changes of management, law, technique, and goals. They do not stem from the progress of the economy as a whole. Running deficits now in anticipation of future reforms is silly. Make the reforms now.

When Cheaper Government is Bad

The government is enlisting technology to make law enforcement cheaper. We have stoplight cameras automatically issuing tickets. We have the NSA snooping on the Internet. Our cell phones are personal tracking and surveillance devices. The combination of Smart televisions and artificial intelligence makes George Orwell's nightmarish telescreens a real possibility.

Throw in electronification of the financial system and No Fly lists, and the government can punish those it dislikes at the touch of a button -- or the opinion of an AI. No trials needed. The Chinese are doing this openly. Our government is using back doors.

I'd rather pay the tax for less efficient government.

The government could imitate industry by outsourcing as well. Instead of using expensive American labor to fight in third world hellholes, tap into that vast pool of military age men who are bravely crossing our border. Have an American Foreign Legion. And when they are done fighting abroad they could serve as a Praetorian Guard here, and do battle with those pesky rednecks with bad Social Credit Scores.

Hmmm, I'd rather pay the tax for a less dangerous government.

Conclusions

Progress can make paying for government more affordable, but the Reaganite dream of Growth and regressive income taxes will not deliver us from deadly debt. The combination is causing the government to tax itself.

It's also making the more socialistic welfare states of Western Europe look good. We expect aspiring doctors to run up massive debt and then pay it down with high salaries -- salaries in high tax brackets. In some of the welfare states of Europe doctors get a free education so they need less income to justify the career. And all the welfare states of Europe have a Value Added Tax, so cheap stuff from China isn't as cheap as here. Furthermore, there is no VAT on medical care for those countries with full on socialized medicine. (And maybe not in some of the other countries. I haven't researched VAT exemptions.)

Is the American healthcare system really that much more expensive? Or are we seeing an artifact of the tax system? This would be a good subject for a think tank study...

To use tomorrow's Progress to pay for today's government spending we would need to actually tax the Progress. This would require a much more Hamiltonian approach to tax policy: give infant industries a tax break and then hit them pawith special excise taxes when they take off.

Ugly? Interventionist?

Yes.

But we have big ugly government now, and the money has already been spent. It's past time to deal with it. The future was yesterday.

1. From Timothy Leary’s 3 Circuit model of the mind. Leary studied male hierarchy behavior in the ultimate psychlotron: prison.

2. Although for image searching, I like the old system of flipping through paper patents better.

3. I think it was Jerry Pournelle who wrote that mimeograph machines were highly regulated in the Soviet Union in order to prevent illegal publication. Personal computers are publishing devices, so the only way to go high tech was to implement Glasnost.