We’ve covered quite a bit on why a consumption tax might
not be the best way to go in this short series.
We have one more reason, and it might not be one that occurs to most
people simply because it is highly technical and gets into economic and
financial theory.
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| Consumer demand drives the economy. |
It is a basic rule of taxation that if you want to
discourage a form of behavior, you tax it.
This is why most of the price of cigarettes and alcohol isn’t profit to
the seller or the cost of manufacture, it’s taxes to the government.
So, logically, if you want to cut consumption, you tax
it. And that creates a BIG problem.
You see, it’s demand for consumption goods that drives
any economy. If there is no demand for
widgets (economists always talk about
widgets), then there is no demand for widget makers. If there is no demand for widget makers,
there is no demand for widget making machinery.
If there is no demand for widget making machinery, there is no demand
for machines or people that make widget making machinery . . . .
And so on. In the
end, it’s the consumer who drives everything in the economy, one way or
another. If you divert consumption
income away from consumption and into taxes or reinvesting, then you’ve reduced
consumption and thus the reason for producing in the first place, and thus
eliminated jobs (and more consumption income) from the economy, reducing demand
even further.
This is where the
problem comes in. Mainstream economists,
especially Keynes, insisted that new capital can only be financed by
restricting consumption below production levels (“saving”).
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| Dr. Harold Glenn Moulton |
Dr. Harold G.
Moulton, president of the Brookings Institution, however, pointed out something
that contradicted Keynes’s assertion about cutting consumption in order to save
being essential to finance new capital formation. It creates what Moulton called an “economic
dilemma”:
The dilemma may be summarily stated as
follows: In order to accumulate money savings, we must decrease our
expenditures for consumption; but in order to expand capital goods profitably,
we must increase our expenditures for consumption. . . . [W]hen the managers of
modern business corporations contemplate the expansion of capital goods they
are forced to consider whether such capital will be profitable. . . . Now the
ability to earn interest or profits on new capital depends directly upon the
ability to sell the goods which that new capital will produce, and this
depends, in the main, upon an expansion in the aggregate demand of the people
for consumption goods. . . . if the aggregate capital supply of a nation is to
be steadily increased it is necessary that the demand for consumption goods
expand in rough proportion to the increase in the supply of capital. (Harold G.
Moulton, The Formation of Capital.
Washington, DC: The Brookings Institution, 1935, 28-29.)
In short, no
producer will invest in additional capital until and unless there is an
increase in consumption to warrant and justify the investment. Instead of a decrease in consumption prior to
new investment in order to provide the financing, what Moulton found for the
preceding century was an increase in
consumption accompanying every period of significant investment in new
capital. As Moulton concluded,
The traditional theory that an
expansion of capital construction and consumptive output occur alternatively
. . . finds no support whatever in the facts of our industrial history. . . .
We find no support whatsoever for the view that capital expansion and the
extension of the roundabout process of production may be carried on for years
at a time when consumption is declining.
The growth of capital and the expansion of consumption are virtually
concurrent phenomena. (Ibid., 47-48.)
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| Investment banks help "float" new issues of stock |
This finding
raised another question. If periods of
rapid capital expansion are not preceded by periods of saving to finance new
capital instruments, but instead by dissaving to finance the increase in
consumption, how is new capital financed, especially on such a vast scale? The answer is, By the proper use of the
commercial banking system (invented for just that purpose) backed up with a
central bank:
Funds with which to finance new capital
formation may be procured from the expansion of commercial bank loans and
investments. In fact, new flotations of
securities are not uncommonly financed — for considerable periods of time,
pending their absorption by ultimate investors — by means of an expansion of
commercial bank credit.” (Ibid., 104.)
If, therefore,
all current income is used either for consumption purposes, or to retire loans
made out of expanded commercial bank credit for capital formation, production
and consumption will be in balance, and there will always be enough effective
demand to purchase all production. If,
however, income that should be spent on consumption is diverted to
reinvestment, there will be insufficient demand to clear all the goods and
services produced.
The bottom line
here? Cut consumption, and you kick the
economy in the teeth. A consumption tax
is a direct incentive to cut consumption, and therefore is harmful to the
functioning of a sound and sustainable economy.
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