Friday, September 3, 2010

Payroll tax holiday

Depressions. There are people today, mostly in their nineties, who experienced the last one that commenced in 1929 and ultimately ended because of huge government expenses and deficits to fight the second world war. There is no one alive today who can remember the other one that was also precipitated by a monetary crisis in the mid 1890's. While the cause for both can be traced to liquidity, the availability of loans, the underlying reasons are different.

In the 1890s the money supply was gold. For fifty years the country had increasing amounts of this commodity from California, Alaskan and Yukon gold mines. The supply of new gold began to dry up in the 90s, but not the need for it to fund expansion.

The capricious spending of the 1920s came to an abrupt end when speculators realized that the value of the stocks they owned was ethereal. The banks that lent money on what they thought was market value, suddenly found that their collateral had no substance. They could not lend and business could not find funds to continue growth.

In 2008 the basis for growth was not gold nor stocks, but the consumer's appetite for big houses funded by what was perceived to be a never-ending increase in value of their investment. Americans began to use their homes as ATMs. Again, the banks went along with this fantasy, fueled by the guru of the Federal Reserve, Alan Greenspan.

Consumers could not afford their mortgages and cut back on spending. Business saw inventories increasing and cut back on both hiring and making additional product. Banks stopped wild loans of 100% or more of value. While the basis was different (houses as collateral versus stocks as collateral) the problem was the same. Loss of liquidity.

In 1935 along came John Maynard Keynes who wrote The General Theory of Employment, Interest and Money. He basically said that there are three components of any economy: What consumers spend, what business invests, and what Government spends (or invests). These three items comprise the Gross Domestic Product (GDP). Reduce any one of them and GDP decreases.

The deficits caused by our participation in World War II brought an end to the Great Depression and convinced some that Keynes was right, that government must step in when the other elements of GDP are not viable.

A moratorium on the Employment Tax (FICA) that funds Social Security is now being considered. In fact, Senator Scott Brown (R. Mass) had indicated his support of this idea in January. This tax goes into a Trust Fund that is then borrowed by the Government to fund deficit spending and may be the largest lender to the General Revenue. Stopping this tax does not add to the general deficit. It is not part of the federal budget.

What does a moratorium do? First, we do not have a problem for funding Social Security until about 2037 under current actuarial calculations. By allowing current employees to use these funds that would otherwise be a tax, consumer spending will increase immediately. Secondly, business who will save their portion of FICA will have funds to both increase investment and incentive to hire additional workers since the cost of wages will be reduced by the elimination of the FICA tax.

The placement of funds in the hands of consumers and business will be the fastest way to improve the GDP. Keynes would be smiling.

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