Economics for The Rest of Us

August 08, 2011

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I get tired constantly repeating myself to my fine friends who are on the Left side of the political spectrum when it comes to economic, fiscal, and business realities. It’s not their fault. I used to be the same way. However, following up on a good article about economics for dummies, I thought I’d add some basic concepts that everyone should understand — regardless of political beliefs.

This stuff isn’t that hard to understand. My old high school math teacher would just drill me over and over on something until I got it.

Risk, Reward, and Investment

A rich person makes all his income, more than $250,000 each year, from investment income only.
Investment involves taking a risk. In exchange for that risk, an investor is rewarded.

The greater the risk, the greater the reward.

Imagine two cups. Under one is a dollar. You bet one dollar and choose one cup. The odds of picking the right cup are 1-1. If you are right, you win one dollar.

Imagine ten cups. Under one cup is ten dollars. You bet one dollar but choose only one cup. The risk of choosing the right cup has gone up to 9-1 against you. Don’t you think you deserve a higher reward for choosing that one right cup?

If you don’t think so, I have a bridge I’d like to sell you.
Investment works the same way.

The IRS charges a capital gains tax on investment income. If Mr. Rich Person makes an investment, and sells it in less than one year, he gets taxed at the highest rate (35%). If he holds it longer than a year, he is taxed 15%. Why? Because 1) holding an investment for a longer period of time is riskier than for a short period of time, and 2) the government wants to encourage people to invest for long periods of time in things that build the economy, instead of speculating on short-term profits.

If that lower tax rate were raised or eliminated for long-term investments, what do you think Mr. Rich would do? Think about it for a moment. What would you do?

Would you make the investment anyway? Maybe, but the stock market would see even more volatility, since more people might speculate rather than invest, moving money in and out, buying and selling. Volatility creates uncertainty. Uncertainty encourages people to keep their money on the sidelines, where it does not contribute to the economy’s growth.

Some investors would be less likely to sell their profitable investments and trigger the higher capital gain tax. That keeps money in investments that grow the economy. But then the government collects no taxes, so tax revenue would fall, creating a wider federal budget deficit. Furthermore, never selling increases risk, and you may not be inclined to invest in the first place, keeping your money again on the sidelines.

Instead of investing, would you spend it instead? No. Why? Remember, you make all your income from investments, and now you’re not investing, so you have no income. So instead, your money sits on the sidelines.


Why Government Spending Usually Fails

If rich folks won’t invest, why can’t government fill the gap?

Here’s an idea! The government gives big tax credits to solar manufacturing and installation companies for every worker that is hired for a period of 3 full years. These people are trained to manufacture solar panels, and to install them on residences in areas of the U.S. that receive the highest number of sunny days each year. The panels are offered at an affordable rate to homeowners, and even subsidized by the government. Not only are thousands of jobs created, but the solar company makes a fortune, pays less taxes on them thanks to the credits, homeowners see energy savings, and we’ve reduced our dependence on foreign oil.
That would really be something.

And it could never happen. Because government spending doesn’t create many jobs, and the ones it does create cost more than just paying someone off the street a regular salary. Why? Government spending wastes taxpayer money because politicians are self-serving.

By every single metric, stimulus money was wasted. Visit The “most expensive” items went to states for “government services” and “education funds”. What does that mean? Who got that money? Where are the jobs? Why was this money just thrown to the states without any oversight whatsoever?

Were any jobs created? From late 2009 through mid-2010, private sector employment increased 1%. Government jobs increased 2.5%. Those gains have since been lost.

How much money has been wasted? The national debt went from $5.3 trillion on the day Bush took office to $10.6 trillion the day Obama came in — an increase of $5.3T. As of July 31, the debt was $14.3 trillion — Obama has increased it 70% of the amount Bush did in 30% of the time.

How can anyone believe the idea that government spending creates jobs, given how much has been spent, and where unemployment and the economy are today?

Who Cares About The Debt?

A credit rating agency just downgraded the quality of US debt for the first time in history. Why? Because there is concern that the US must spend so much money just to pay interest on its debt, that there is just that much more concern about certain debts not getting paid. The cost of borrowing (interest) for the US goes up because it is riskier to loan to us.

That’s bad for you and me. Why? Investors will be that much more afraid about buying or holding U.S. bonds. So they will sell those bonds. When the price of a bond goes down, the interest rate goes up, because you must incentivize new investors to take on greater risk and earn those greater rewards.

When U.S. bond interest rates go up, all interest rates go up — mortgages, credit cards, car loans. etc. Now it’s harder for businesses to borrow money to hire people and expand. It’s harder for people to borrow money to buy a house (as if the banks weren’t tight enough).


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