How Laffer Inadvertently Prophesies The Limits of Capitalism

Arthur Laffer famously took the trouble to draw a curve to describe the following. If taxes are zero, zero taxes are collected. If taxes are 100% of everything, zero taxes are collected because nobody has anything left to tax. Somewhere in between zero and 100% taxes is just right. Genius.

What poor Arthur did not intend was to inadvertently model the effect of profits on an economy. If there are zero profits, an economy cannot exist. Who would even go to work if they gained nothing from it? If there are infinite profits on everything, no product will be bought and the economy will not exist. Who would buy anything if it took everything they owned to buy it, other than the ultimate commodity, health care? " Somewhere between zero and infinite profit is just right" - Goldilocks.

The Berkeley Professor Emmanuel Saez reveals more than meets the eye in the Huffington Post Income Inequality Is At An All-Time High: STUDY. You will notice that a highly irregular build up of personal wealth is coincident with the crash of '29 and the crash of '08. What is not so evident is that the wealth of top tiers of society is severely corrected as a consequence of those securities crashes. It's gone, flown overnight, vanished. What is exhibited here, in stark raw data, is the limitations of capitalism.

This is no idle curiosity. It transcends politics as a phenomenon, but is itself, nevertheless, the foundation of the American political debate. As it is a rare occurrence, and goes without much thought like a hundred year flood, but it literally defines the outcome of any economy overburdened by profit, in the same vein as Laffer intended to illustrate in how tax burdens necessarily limit government. No economy can survive that is overtaxed by either of literal taxation or, in its effective equivalent to the public, profit.

Government spending, discounting deficits, roughly equals income tax receipts, and is spent as soon as or sooner than it is received. It is therefore economically neutral except for channeling effects. Taxes may be spent on public schools to the exclusion of nail spas or concert tickets, but it is spent, and admonitions that taxes are somehow removed from the economy, excepting certain foreign exchanges, are entirely crap. Spending, of any sort, is the stuff of which a paycheck, and by extension, an economy is made. Investment alone can't do it.

Private investment channels economic activity as well, generally toward profit making ventures. Government reinvests tax dollars for the public good and private investment reinvests profits to grow the economy through innovation in product and productivity. Government does what it does best, invest in public goals, and private capital does what it does best, enable individuals to push the limits of conventional thinking. Both for better of for worse.

What is seldom examined, because of the rarity of the condition, is that too much profit is one of only two means of removing money from an economy. Trade imbalance, foreign aid and competing currency valuations are one way. The other way is to make the top earners of society very, very rich. The two means have intersected to compound the problem here lately, but that negative synergy is another story. Excess wealth, you see, pulls money out of the economy, harmful in itself, and sets it on a path to further harm the very economy on which it depends for its own value. We really are all in this together, like it or not.

As the very rich have increased the gulf between their wealth and that of the average citizen, two patterns have emerged. One, the average citizen is making less money and therefore the economy is shrinking in relative terms. Two, the very wealthy have increasingly fewer productive ways in which to invest their wealth and get a decent return. Prior to the crash of 2008, the amount of capital in the U.S., as measured by M2 and (now abandoned) M3 of the Central Bank, exceeded total yearly capital investments in this country by a factor of 10. Another perspective, 10 times as much money was fallow as can be used by the U.S. economy for product and production investment. Indeed, overcapacity is the plague of America's industries, and capital injection can't cure that.

What you would have to call excess wealth then, is channeled into unproductive "investments", speculation. The overvaluations of the stock market in 2000 and 2007 were driven by this excess wealth. The housing bubble was driven by speculation, as were gas prices in 2008. And for those of you that believe the stock market will not recover for decades, consider that there is no place else for all that money to go but the stock market, except into increasingly risky derivatives. Derivatives were, in fact, an invention to ameliorate the risk of speculation. The fact that they don't work is another issue.

So excess profits are responsible for two things that have afflicted the American economy for a decade. The no growth, or as some have suggested, false growth, of a jobless Bush recovery. And the distortions of the economy that resulted from speculation fueling valuation bubbles, more so than at any time since 1929. The "real", underlying economy, has not grown in this decade and, in fact, is running at a deficit in job creation.

With so much fallow money out there, the incidence and severity of market "corrections" are growing. And the wealthy seem oblivious to the fact that speculation does not create sustainable prices, only the "real" economy can. The market "correction" is a reflection of that unavoidable fact, as prices and values tend to follow the trajectory of and are inexorably bound to the "real" economy.

What will happen to all that wealth is not pretty. It will, substantially, be lost in a series of bursting speculative bubbles, decreasing in frequency and severity as the excesses in wealth are bled away. So in a fundamental sense, all wealth is tied to the health of the economy and growth of the underlying economy's ability to support valuations.

In summary, excess profits, as they lead to excess wealth, actually does what the conservatives falsely accuse the government and taxation of doing, it removes money from the economy. Just as bad, excess wealth fuels speculation that distorts the economy to the detriment of the economy and the public welfare. Tens of millions of citizens who were lured into and subscribed to speculative investments have seen their 401k valuations crater along with their home values. Millions of jobs have been lost, with little prospect for new job creation. Profit is, if anything, potentially more dangerous to an economy, by far, than taxation.

The rich complain more about taxes than do the average American. They do, in fact, shoulder the lion's share of tax burdens. But the whole argument is a deception cast to have a semblance of arguing for fairness. If America's median income were higher, then the average American could shoulder more of the tax burden. As it is, the system is weighted on the wealthy in recognition of the fact that the rich must pay taxes for the poor if they are not willing to pay higher wages. Simple as that Mr. Laffer.