How to Know When to Tax and When to Spend

Let’s talk economics 101. Capitalism has cycles of bust and boom. They’re normal, and they’re called the “business cycle.”

From the George Washington administration to the Ronald Reagan administration, when the business cycle is in decline, we increased government spending to fill in the holes created by the loss of private sector revenue.

That government spending during times of declines in the business cycle not only softened the blow for business and average working people, but also stimulated the economy and got things back on track.

On the other hand, government behavior should be very different at the high points of the business cycle.

That’s when there’s nearly full employment and lots of money sloshing around in the private sector. So it’s the right time for government to dial back spending and to raise enough revenue through taxes to pay off the money spent during the business cycle downturn.

President Harry Truman, for example, knew that, during times of prosperity, when the business cycle was on the upswing as it was just after World War II, less government spending was needed, and modest increases in taxation would help to reduce the national debt.

And, as we saw during the earlier Republican President Hoover presidency, failing to follow this commonsense principle can be a disaster for the economy, and, thus, for the nation. In 1929, after the great stock market crash, President Hoover and his Republican Congress refused to significantly increase government spending. As a result, the economy continued to collapse, day after day, for more than three years.

In fact, economists know that there is even a multiplier effect when it comes to government spending. During downturns in the business cycle, government spending produces a lot more bang for the buck, because it goes directly into people’s pockets and they then spend it into the economy. When the business cycle is up, government spending doesn’t have as much impact or make as much sense, but collecting taxes makes a lot of sense.

The average American has always known this. It was such obvious, common knowledge that when President Truman gave his presidential nomination acceptance speech in 1948 he didn’t have to explain it, he just made a passing reference to it. He told the crowd in Philadelphia, “Now everybody likes to have low taxes, but we must reduce the national debt in times of prosperity.”

Think about it like this.

Being unemployed is like being in a business cycle downturn. While a person may not be making a salary, they still need to survive. You can’t just pack up, live on the street, and stop eating. Instead, people typically rely on credit – whether it’s actual credit or goodwill from others – to get by until you get another job. This is the same with the business cycle. During times of downturn, it’s necessary to borrow and spend, to get the economy back on track.

Now say you get a new job, and once again have an income. This is the time to essentially tax yourself to pay down your debt, and set a bit aside for a future time of unemployment. It’s an imperfect analogy, because our nation can borrow easily and print its own money if necessary and generally we can’t, but it shows how it works.

So here we are today, as America and much of the world are in the middle of a downturn in the business cycle. Those countries like Greece, Italy, and Spain that are following Herbert Hoover’s 1929 strategy of austerity are experiencing a disaster. And countries like Germany, China, and Sweden that are using government spending to bridge the business cycle downturn are doing great.

Even Federal Reserve Chairman Ben Bernanke is saying America should be using this common-sense principle. During testimony on Capitol Hill earlier this week, Bernanke told lawmakers that, “A substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery.”

In plain English, he’s saying that, given the state of our economy, we need to be borrowing and spending more to give the economy a boost.

Bernanke went on to say that, “Besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.” Or, again in layman’s terms, cutting back on government spending during times of economic downturns by following austerity policies, does more harm than good.

Unfortunately, Republicans in Congress fail to understand the Economics 101 principle that Bernanke was explaining.

Republicans want us to cut government spending in the middle of a business cycle downturn. Or, to use the person-with-a-job analogy again, Republicans want us to move out onto the street, become homeless, and stop eating food after we lose a job, rather than use our credit cards to help us survive and get by.

Ever since Reagan, and his “government can’t solve problems” mentality, Republicans have either forgotten or just ignored these common-sense Econ 101 principles that have guided our nation for hundreds of years.

It’s time to return to economic sanity and basic Econ 101 principles, and make sure that this Hoover-Reagan nonsense is debunked once and for all.