Last Friday's issue of the Wall Street Journal carried an interesting piece by Stephen Moore on how the current government spending spree might be halted. The idea was that Congress should mandate a legally-binding limit on how much the federal government could spend, then raise taxes on wage incomes.
The problem is that the article left out the possibility of taxing dividends and capital gains as regular income, presumably in the belief that financing new capital formation requires the accumulations of the rich in order to be viable. That is not, in fact, the case, as anyone familiar with the basic theory behind banks of issue and central banking can tell you. Here is the text of the letter we sent to the Journal on the subject, with a sentence or two added for clarification:
Mr. Stephen Moore's editorial in last Friday's Journal ("It's Time to Legislate a Spending Cap," WSJ, 08/07/09, A11) is a step in the right direction, but it goes at the problem from the wrong direction. Politicians can always justify spending what they've been given. A legal limit on spending, binding or not, can be circumvented by passing another law.
It may be time to consider an alternate approach: don't try to figure out how much we can afford to surrender to the State, but how much the State needs to function effectively. The federal government should be required to prepare a budget and, when the budget is approved, set a single tax rate at a level sufficient to cover all current expenditures and begin retiring the debt. Government figures prior to the current spending spree suggest that a tax rate of approximately 46% on all income from whatever source derived (including dividends tax deductible at the corporate level and capital gains) above $30,000 per adult and $20,000 per dependent would balance the budget and retire the debt as of 2006 in 17 years.
This still leaves us, however, with the presumed necessity of using existing accumulations of savings to finance capital formation, and the reason behind giving preferential tax treatment to dividends and capital gains. The question becomes, are existing accumulations of savings necessary to finance new capital, and thereby provide jobs for non-owning workers?
Capital formation (and thus job creation) need not be financed out of existing accumulations of savings, as Dr. Harold Moulton of the Brookings Institution pointed out in his 1935 monograph, The Formation of Capital. Instead, the commercial banking system can provide investment capital for all financially feasible projects by discounting qualified industrial, commercial, and agricultural paper at the Federal Reserve. This would back the currency with liens on hard assets instead of government debt. By extending the credit in ways that create new owners who will use the income from their investments first to pay for the assets and then for consumption instead of reinvestment, effective demand and the tax base will increase, enabling the federal government to cut entitlements and lower taxes.
The Federal Reserve has proved it can create money for massive non-productive government spending. It's time to return the institution to its original purpose and provide adequate liquidity for private sector growth and development.