Disposable Income and GDP Growth

Posted by PITHOCRATES - February 25th, 2013

Economics 101

With less Disposable Income there will be less New Economic Activity Created

The key to economic growth is disposable income.  For when we live from paycheck to paycheck economic growth is flat.  It’s when we have disposable income that we can spend money beyond our basic needs.  Such as on a vacation.  A new car.  A television.  New windows, carpeting, appliances, furniture, etc.  Movies, ball games, dinners, the theater, etc.  New clothes, jewelry, shoes, accessories, etc.  Tennis rackets, skis, baseball gloves, hiking boots, fishing gear, etc.  Smart phones, MP3 players, iPads, laptops, etc.  Jet skis, boats, motorcycles, mountain bikes, etc.  Radio-controlled cars/helicopters/planes, Game Boys, Xboxes, Wiis, PlayStations, multiplayer role-playing computer games, etc.

Buying these things creates a lot of economic activity.  But we can’t buy any of these things unless we have disposable income.  So the only way to increase economic activity is to increase disposable income.  Which means there is a direct relationship between GDP and disposable income.

There’s been a lot of talk about real incomes being flat.  Even falling during the Obama presidency.  Which is bad.  For if median incomes are falling people will have less disposable income.  And with less disposable income they will be buying less of all those things that create new economic activity.  The things we enjoy.  That make our lives more fun.  More enjoyable.  And less miserable.  Those things that increase our standard of living.  And the quality of life.  So a flat and falling median income reduces our standard of living.  And our quality of life.  As we live from paycheck to paycheck.  Making barely enough to meet our living expenses.  And sometimes not even making enough for that.  Having to turn to government assistance to make up the difference.

We add Disposable Income and Discounted Government Spending to get the Net Add to GDP

The key to disposable income and GDP growth is jobs.  And the more jobs the better.  So job creation is very important.  Which means we need a business-friendly environment.  With a minimum of costly regulations.  And low taxes.  To encourage employers to hire more people.  So more people have jobs.  Those who do use their income to meet their living expenses.  And use their disposable income to create new economic activity.  The more disposable income they have the more new economic activity they can create.  So what’s the best way to increase their disposable income?  The same way we encourage employers to hire more people.  Low taxes.  We can illustrate this in the following table which is based on assumptions and approximations.

GDP Discounted Required and Average Calculations

The effective tax rate a person pays includes all taxes he or she will pay.  Property tax, sales tax, gas tax, telecommunication tax, liquor tax, cigarette tax, import tariff, dog license tax, fishing license tax, luxury tax, watercraft registration tax, vehicle sales tax, state income tax, federal income tax, Social Security tax, Medicare tax, capital gains tax, etc.   Median income and living expenses are constants.  We subtract taxes from median income to get net income.  Subtracting living expenses from net income gives us disposable income.  We then calculate these numbers for additional effective tax rates that are multiples of 4%.

We add disposable income and stimulus together to get the net add to GDP.  What we call ‘stimulus’ is a percentage of all those taxes reentering the economy through government spending.  In our example 80% of those taxes find their way back into the economy.  While 20% is lost through waste and inefficiency.  This stimulus can pay for a government worker, a government contractor or a direct government benefit that helps people meet their living expenses.  This redistributed income is money that the income earner would have spent had it not been taxed away.  Instead, someone else will spend it.  But not as efficiently.  As it must first pass through an inefficient government bureaucracy.

Giving People Benefits does not Replace Disposable Income

We extend the table out to an effective tax rate of 52% and graph the results.  We see that as the effective tax rate increases disposable income falls.  As does GDP growth.  Showing that increasing taxation reduces GDP.  That said, average GDP growth has been approximately 3% during the latter half of the 20th Century.  Despite increasing taxation reducing GDP.  So how do we reconcile a falling GDP and a 3% GDP growth?  With aggressive increases in productivity.  And investments in capital equipment.  Allowing business to produce more with less.  Resulting in a rising real GDP growth rate.  As shown in the following graph.

GDP Discounted Required and Average

In order to maintain a 3% growth rate in GDP we need a rising real GDP growth rate (in one America doing very well despite government) to offset the falling discounted GDP growth rate due to falling disposable income (in another America not doing well because of government).  When we add the real and the discounted GDP growth rates together we get the constant 3% of average GDP growth.  Which is why businesses have never been more profitable despite stagnant economic growth during President Obama’s time in office.  They’re doing well because they’re producing more with less by exchanging people for new capital equipment.  Hence the higher profitability along with chronic high unemployment.  With more unemployed workers than available jobs there is a downward pressure on median income.  That combined with higher personal effective taxes has greatly reduced disposable income.  And new economic growth.  Which subtracts a lot away from that real GDP growth.

Giving people benefits does not replace disposable income.  For government assistance helps people meet basic living expenses.  While having a job offers the ability to earn disposable income.  Which is key for new economic growth.  If we bring the effective tax rate down the discounted GDP growth graph will flatten out.  As this happens the gains in productivity would remain.  Leaving real GDP growth unchanged.  With real GDP growth unchanged and discounted GDP growth decreasing the average annual GDP growth would therefore increase.  And approach real GDP growth.  With double digit GDP growth tax revenues would soar even at lower effective tax rates.  Requiring less borrowing.  Which would give us smaller deficits.  While reducing the growth in the federal debt.  Perhaps even reducing the debt.  Solving all of our financial problems.  By simply cutting taxes.  And the spending those taxes fund.

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Jimmy Carter, Malaise, Ronald Reagan, Austrian Economics, Morning in America, Barack Obama, Keynesian Economics and Great Recession

Posted by PITHOCRATES - September 4th, 2012

History 101

It was Morning in America again because Ronald Reagan reduced the Misery Index by 42.7%

Ronald Reagan was a supply-sider when it came to economics.  Of the Austrian school variety.  In fact, one of his campaign promises was to bring back the gold standard.  A very Austrian thing.  The Austrian school predates the Keynesian school.  When the focus was on the stages of production.  Not on consumer spending.  These policies served the nation well.  They (and the gold standard) exploded American ingenuity and economic activity in the 19th century.  Making the U.S. the number one economy in the world.  Surpassing the nation that held the top spot for a century or more.  Perhaps the last great empire.  Great Britain.

Following the stagflation and misery (misery index = inflation rate + unemployment rate) of the Seventies Reagan promised to cut taxes and governmental regulations.  To make it easier for businesses to create economic activity.  Easier to create jobs.  And he did.  Among other things.  Such as rebuilding the military that the Carter administration severely weakened during the Seventies (it was so bad that the Soviet Union put together a first-strike nuclear option.  Because they thought they could win a nuclear war with Jimmy Carter as president).  During the 1980 campaign Reagan asked the people if they were better off after 4 years of Jimmy Carter.  The answer was no.  Four years later, though, they were.  Here’s why.  (Note:  We used so many sources that we didn’t source them here to save space.  The inflation rate and unemployment rates are for August of the respective years.  The dollar amounts are annual totals with some estimates added to take them to the end of 2012.  The debt and GDP are not adjusted for inflation as they are only 4 years apart.  Gas prices and median income are adjusted for inflation.  There may be some error in these numbers.  But overall we believe the information they provide fairly states the economic results of the presidents’ policies.  (This note applies to both tables.))

Reagan entered office with some horrendous numbers.  The Carter administration was printing so much money that inflation was at 12.9% in 1980.  Added to the unemployment rate that brought the misery index to 20.6%.  A huge number.  To be fair Carter tapped Paul Volcker to be Fed Chairman and he began the policy of reigning in inflation.  But Carter did this far too late.  The only way to cure high inflation is with a nasty recession.  Which Volcker gave Ronald Reagan.  But it worked.  By 1984 inflation fell 8.8 points or 66.7%.  Even with this nasty recession the unemployment rate fell 0.2 points or 2.6%.  Which shaved 8.8 points off of the miserable index.  Or reducing it by 42.7%.  This is why it was morning in America again.  The Left to this day say “yeah, but at what cost?” and point to the record deficits of the Reagan administration.  Saying this is the price of tax cuts.  But they’re wrong.  Yes, the debt went up.  But it wasn’t because of the tax cuts.  Because those tax cuts stimulated economic activity.  GDP rose 12.6% by 1984.  And tax receipts even increased with those lower tax rates.  Because of the higher GDP.  By 1984 Reagan’s policies increased tax revenue by 28.9%.  And on a personal level the median income even increased 0.4%.  And this following a very bad recession a few years earlier.  Finally, gas prices fell 22.2%.  And the way Americans feel about rising gas prices this was truly morning in America again.

To Top off the General Malaise of the Obama Economy Gas Prices Soared while Median Income Fell

Barack Obama is a Keynesian through and through.  A believer in pure demand-side economics.  To that end his administration focused everything on increasing consumer spending.  Tax and spend policies.  Income redistribution.  Deficit spending.  Anything to make America ‘more fair.’  Raising taxes on the rich so the poor can spend more money.  With the Keynesian multiplier they believe this is the path to economic prosperity.  Just doing everything within their power to put more spending money into the hands of poorer people.  Increasing government regulation, fees and fines as well as taxes to bring more money in Washington so they can redistribute it.  Or spend it directly on things like roads and bridges.  Or solar power companies.  Even paying people to dig a hole and fill it back in.  Because these people will take their wages and spend them.  Creating economic activity.

So President Obama put Keynesian economics to work.  Beginning with a $787 billion stimulus bill.  Investments into green energy and the jobs of the future.  Like a Department of Energy loan of $528 million to the now bankrupt Solyndra.  Which was only one of many loans.  The bailout of the UAW pension fund (aka the auto bailout).  The government poured $528 million into GM.  And President Obama touted the Chevy Volt, boasting that GM would sell a million each year bringing his green goals to fruition (GM is struggling to sell 10,000 Volts a year).  A lot of malinvestment as the Austrians would say.  But a Keynesian sees any government expenditure as a good investment.  Because if all the people who receive this government money spends at least 80% of it (while saving only 20%) the Keynesian multiplier will be five.  Meaning that the net gain in GDP will be five times whatever the government spends.  So how has that worked for the president?  Well, here are his numbers:

The government spent so much money that the federal debt increased by $5.4 trillion.  Trillion with a ‘T’.  That’s over a trillion dollar deficit each of the president’s 4 years in office.  And his last year isn’t even a whole year.  Unprecedented until President Obama.  And what did all of that federal spending get us after about 4 years?  An unemployment rate 2.1 points higher.  Or 33.9% higher than when he took office.  Inflation fell but it did nothing to spur GDP growth which grew at an anemic 3.1%.  Which is less than a percentage point a year.  Which is why the Great Recession lingers still.  Meanwhile the Chinese are having a bad year with a GDP growth of 7.8%.  So all of that spending didn’t help at all.  In fact, it made things worse.  The economic activity is so bad that even tax receipts fell 2.2% after four years of President Obama.  Which has many in his party saying that we need to raise tax rates.  Contrary to what Ronald Reagan did.  And to top off the general malaise of the Obama economy gas prices soared 107.6% under his presidency.  While the median income fell 7.3%.  One has to look hard to find any positive news from the Obama economy.  And there is one.  Inflation did fall.  But even that really isn’t good.  As it may be an indicator of a looming deflationary spiral.  Giving America a lost decade.  Like Japan’s Lost Decade.

The Flaw in Keynesian Thinking is that it Ignores the Layers of Economic Activity above the Consumer Level

So there you have an Austrian and a Keynesian.  Both entered office during bad economic times.  Although things were much worse when President Reagan took office than when President Obama took office.  The misery index was 20.6% in 1980.  It was only 11.6% in 2008.  About half as bad for President Obama than it was for President Reagan.  It came down 16.4% under Obama.  But it came down 42.7% under Reagan.  Which is why it isn’t morning in America under President Obama.  Reagan increased tax receipts by 28.9 % by the end of his first term.  They fell 2.2% under Obama.  Adjusted for inflation Reagan averaged annual deficits of $348 billion.  That’s billion with a ‘B’.  Obama averaged $1.324 trillion.  That’s trillion with a ‘T’.  Or 280% higher than Ronald Reagan.  Gas prices fell 22.2% under Reagan.  They rose 107.6% under Obama.  Median income barely rose 0.4% under Reagan.  But it fell 7.3% under Obama.  In short there is nothing in the Obama economic record that is better than the Reagan economic record.

And why is this?  Because Obama’s policies are Keynesian.  While Reagan’s policies were Austrian.  Reagan focused on the stages of production to improve economic activity.  Cutting taxes.  Reducing regulatory compliance costs.  Creating a business-friendly environment.  A system that rewarded success.  Whereas Obama focused on consumer spending.  Tax, borrow and print (i.e., quantitative easing).  So the government could spend.  Putting more money into the pockets of consumers.  Which stimulated only the last stage in the stages of production.  So while some consumers had more money it was still a business-unfriendly environment.  Where tax, regulatory and environmental policies (as well as the uncertainty of Obamacare) hindered business growth everywhere upstream from retail sales.  From raw material extraction to industrial processing to construction to manufactured goods.  Where these Obama’s policies punish success.  For the bigger you get the more you pay in taxes and regulatory compliance costs.

The greatest flaw with Keynesian economics is that it looks at aggregate supply and demand.  With a focus on consumer spending.  And ignores the layers of economic activity that happens before the consumer level.  The Austrian school understands this.  As did the British when she became one of the greatest empires of all times.  As did America during the 19th century.  No nation became an economic superpower using Keynesian economics.  Japan grew to be a great economic power during the Fifties and Sixties.  Then went Keynesian in the Eighties and suffered their Lost Decade in the Nineties.  Some Keynesians like to point to China as an example of the success of Keynesian economics.  But they still have a fairly restrictive police state.  And their economic policies are hauntingly similar to Japan’s.  Some have even posited that it is very possible that China could suffer the same fate as Japan.  And suffer a deflationary spiral.  Resulting in a lost decade for China.  Which is very plausible considering the Chinese practice state-capitalism where the state partners closely with businesses.  Which is what the Japanese did in the Eighties.  And it hasn’t been great for them since.  As it hasn’t been great in America economically since the current administration.

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