Explaining the economy to kids (or yourself)

 

HERE’S HOW TO EXPLAIN ECONOMICS TO YOUR KIDS

Not hard, here’s a graph

I
I    government revenue ^
I

I                               5

I                             x        6

I                      3                 x

I             2       x  

I            x

I1                                                          4

x-------------------------------------------------x

0       tax rate>                                      100%   

 

We are going to plot various tax rates and see how much government revenue is gotten. Start with an empty plot. Now ief the tax rate is zero how much money does the government get? Where shall I put an ‘x’?  Well it is at zero%, zero revenue, right? But it the rate is raised to a little there’s more revenue and it comes out at 2.  Higher tax rate and it comes out at 3.  Going up! Well, suppose the tax rate is 100%, where do I put my x? Well, that’s confiscation!  Nobody will willingly show any income so they don’t get taxed. We are at point 4, essentially zero revenue.  But the graph, 1,2,3 is going up, yet ends at 4, back down to zero.  That means it must have a peak somewhere and then go down.  Thus we might run an experiment of tax rates going up and start seeing a plot like 5 and 6.  If the government wanted to maximize their money they would tax at rate giving 5.

     This is the research done by Arthur Laffer.  He noticed that the Swedes kept raising and raising rates until the tax system broke down raising less and less with each increase. The maximum of the curve was surprising—at about 20%.  So he came back to USA after doing this analysis in 3 European countries and started looking at our tax rates. We were on the far side of the curve. So he told Reagan to lower tax rates and we’d get more revenue. It didn’t raise more the first year and every Democrat started hooting.  But the 2^nd year and thereafter the government revenue rocketed up to double by his 8^th year in office. And the economy grew like gangbusters. Why was that? Well when government taxes a lot most of it goes into redistribution, “robbing Peter to pay Paul.” But if you tax Peter more, does he have more or less incentive to work harder? Less! He just grumbles about paying so much tax and he looks for ways to work around paying more. And does Paul have more or less incentive to work harder? Less! He is taking it easy. Less work=poorer economy.

     Now another graph.  We are going to plot economic growth and national debt.

 

I

I

I                                      x

I                              x                         Economic growth rate^

4%     x     0  x       x         0         0

I  x            x                      x         x

I

I      x                 x

I

I                                                   x   x

I

I

I                                                             x          1          x

I                                                                          x                         2

1%                                                                                                 x                               3

I                                                                                                                                       x

 I

I
0%----------------------------------------------------------------------------------------------------------------

    National Debt as a % of GDP>  90%                                                                         200%

 

This is something of a scatter plot you would get if you plotted how much each country’s debt was compared to their GDP vs. how much they grow. (sorta schematic) 0’s are USA when the debt was 40%, 60%, then 80% of GDP when Clinton and W. Bush were President. So can you just keep increasing the debt without consequence? 1 is when Obama and now Biden was/is President, 2 is Italy.  3 is Japan. You can easily draw a line through the general trend.  Countries without much debt grow about 3-4% each year. But if the debt is 100% growth declines.  At very high amounts, the country is almost moribund.  Why?  When debt is small, it is no big deal to pay the interest, and the rest of the country grows.  When it gets about 90% of GDP, debt service suctions up most of investment monies. When it goes way bigger, default is near.

      There are arguments about this scatter plot.  Some countries had a bad recession during the time period, others didn’t. Nobody’s debt stays the same. And the reason Japan manages some meager growth? Most of the debt is held by their own citizens, not outsiders.  It’s like savings bonds where people do it for patriotism, not so much gains.  This research was Reinhardt and Rogan, then altered again and again by others who thought better methodology.  What both plots say is that too much taxation and deficit spending leads to dysfunctionality.  Government needs to be limited and stay out of people’s way.  As Reagan said, “Govt is not the answer to the problem, Govt is the problem.”  

Inflation is too much money chasing too few goods.  Suppose the government printed twice as much money.  What would happen? Well it would make everything twice as high in price.  But it takes time for this to happen since the businessman says, Well I made money last year so this year I'll just raise prices a little since my supplies went up just a little.  Eventually things will approximately double in several years. Now if we have too much money, we can't take it back.  What can we do to stop inflation? We could raise interest rates so businesses have a hard time borrowing money they need to make more stuff.  But that still leaves too few goods.  So then what? We could double the amount of goods, but that only comes with economic growth.  We can lower taxes, lower regulations to make it easier to produce things.  That's really the only way to solved inflation.