You Decide!, by Dr. Mike Walden

You Decide!

By DR. MIKE WALDEN William Neal Reynolds Distinguished Professor Emeritus N.C. State University

You Decide: Should Economic Growth Be A Goal? Although today we live in a fractious political environment, there is one area of widespread agreement among individuals and groups of differing political perspectives. It is that economic growth is good.

Administrations and elected officeholders of both major political parties praise economic growth, especially when it happens on their watch. Cheers are heard, and positive statements to the press are released when job growth is strong, the unemployment rate plunges, and companies’ production and sales are good. When the opposite occurs – fewer jobs, higher unemployment, or weak production – worries are heard, and economists are asked what can be done to put the economy back on track.

It’s easy to understand why economic growth is the accepted goal. Growth means more jobs and more income for many workers and companies. Additionally, firms with higher sales will be more willing to hire and offer higher pay to workers. For investors, economic growth usually leads to higher stock values.

However, there are critics who point to problems resulting from economic growth. Waste, rising prices, pollution, more traffic and congestion, and the psychological negatives from being pushed to be bigger and better are some of the downsides raised by doubters. Those who question economic growth have often been heard in North Carolina’s fast growing metropolitan regions.

So, who’s correct, the growth supporters or the growth doubters? Or is there a middle ground?

Growth supporters argue boosting the size of the economy is necessary for a country increasing in population and desiring higher standards of living for its residents. With more people, more jobs are needed, additional products and services must be provided, and consequently, more spending will occur. Plus, to improve their lifestyles, workers will pursue occupations with higher salaries, which in turn generates even more spending.

Growth supporters reply to some of the complaints of the growth doubters by pointing to one simple fact. Countries with higher standards of living tend to spend more creating pollution abating technology, developing improvements in health care, contributing to charities, and providing larger “social safety nets” for struggling individuals.

This makes sense. As economic growth pushes standards of living higher, societies can move away from focusing mainly on staying alive to worrying about broader issues like pollution and the environment. Plus, richer societies will have more available income and wealth to devote to these problems.

While growth doubters may acknowledge these benefits from faster economic growth, they say it isn’t enough. In rich countries, roads are still congested, pollutants continue to be released into the air and waters, landfalls are clogged with thrown away products, and open fields are being replaced with subdivisions. Growth doubters worry the future is still threatened by economic growth.

Economists are trained to recognize these issues. Indeed, economists have a term for these by-products of growth – “negative externalities.” A negative externality occurs when I do something that benefits me – like purchasing a new washing machine – yet doing so creates harm for society – such as adding my discarded washing machine to a landfall.

Fortunately, economists have created an approach for addressing negative externalities, and using it can create a middle ground between the growth supporters and the growth doubters. The idea from economists is simple – have the generator of the negative externality recognize it by paying a fee for the harm it creates.

Imposing such a fee can have two beneficial results. For those who still engage in the activity or purchase the product that causes the negative externality, the fees will create funds to help mitigate the adverse results.

However, others may react by deciding the additional fee makes the activity or product too costly, thereby encouraging them to use alternatives that do not produce negative externalities.

Examples of these “negative externality” fees are fees on fuels that generate carbon dioxide, fees to drive in congested areas, disposal fees added to the purchase price of limited life products like electronics and appliances, and development fees to purchase and preserve open space. While these fees make the cost of living higher today, they can make the harmful by-products of a prosperous and growing economy lower both today and tomorrow.

Hence, there can be three alternative approaches to economic growth: promote it, curtail it, or promote it but have policies in place to deal with growth’s potential negative consequences. You decide which is the best!

You Decide: What Will the Fed Do? During my 43 years of teaching economics at N.C. State University, my favorite part of the introductory economics class was the topic of the Federal Reserve. I’d open the lecture by asking students if they’d like to buy things without deducting any funds from their financial accounts. Heads would nod, “yes.” Then I’d follow up by asking if they knew of a person, company, or institution that could do that. Perplexed stares signaled “no.”

Happy I now had their attention, I would tell the students there actually is an institution that can buy things without deducting an account. Effectively, the institution does so by printing money. Its name – the Federal Reserve System, or “Fed” for short. The Fed is the central bank of the country. In this role, the Fed has many important duties, such as supervising banks.

But the most important power of the Fed is monetary policy. The Fed uses its ability to create money – paper in the old days, digital today – to expand or contract spending in the economy and to raise or lower key interest rates. Using this power, the Fed has the ability to move the $24 trillion national economy.

We can see the Fed at work during the COVID-19 pandemic. A large part of the $6 trillion the federal government has appropriated to help households, businesses, and institutions get through the pandemic was financed by the Fed.

How was this done? The federal government issued debt, called Treasury securities, to pay for the various COVID-19 relief programs. The Fed bought large amounts of these Treasury securities by creating more money. Indeed, the nation’s supply of money almost doubled in the past two years.

In effect, the Fed enabled the federal government to rescue the economy from the pandemic. The statistics show the results. After plunging during the Spring of 2020, the economy came roaring back in the summer and fall. Amazingly, median household income was higher in 2020 than in 2019, and the poverty rate was lower after this aid was included.

Although COVID-19 is still with us, some measures show the economy has fully recovered. Indeed, attention has now turned to issues typically seen in a strong economy, specifically higher inflation rates and tight labor markets.

To contain inflation and labor costs, the Fed would put its current policy in reverse. The Fed would sell Treasury securities and pull money out of the economy, and it would also nudge interest rates higher.

The current Federal Reserve governing board has indicated it may be ready to turn monetary policy around. This means the Fed would be de-stimulating, or slowing, the economy. While this may be good for containing inflation that can be caused by too much money creation, there’s also the possible downsides of slower job growth and higher unemployment.

This is not a new dilemma for the Fed. Congress has given the Fed two mandates: maintain full employment but also achieve low inflation. Unfortunately, the two goals don’t necessarily go together. Full employment often leads to a tight labor market and faster rising costs and prices. To achieve low inflation, sometimes slower economic growth has to be tolerated. The two goals can be reached together, but getting there may be hard.

There’s also the matter of timing. A risk of continuing rapid money creation and low interest rates is that higher inflation rates will become deeply embedded in the economy. Then, lowering those high inflationary expectations becomes tougher and can require the hard medicine of a severe recession.

The country went through this scenario 40 years ago, in the early 1980s. Rising inflation rates were left unaddressed for several years, ultimately reaching double digit annual rates for two straight years. Then, under a new Fed chairperson whose orders were to end rampant inflation, the Fed slammed on the monetary brakes. A deep, multi-year recession resulted in lost jobs and incomes. However, the upside was that high inflation rates disappeared.

There are some economists who fear we are at a similar point to where we were forty years ago. While much higher than in recent years, today’s annual inflation rate is still half of what it was in the early 1980s. Hence, the goal of reducing inflation to where it was before the recent rise - one percent to two percent annually - is within striking distance. But if the Fed waits too long and inflation continues to spike, then the task - and the cost in jobs and incomes – will be much greater.

The Fed is an amazing institution. That’s why I loved teaching about it to students. The Fed has the ability to change the course of our economic ship, and rather quickly. Right now, the Fed is debating its future course. Its decision will have profound impacts on the entire economy and every individual and business.

Paraphrasing an old ad, “When the Fed speaks, we should listen.” You decide if this is good advice to follow, especially now.

You Decide: Is A Wealth Tax In the Future? Trillions of dollars were added to the national debt during the COVID-19 pandemic as the federal government poured money into the economy to avoid a long and deep collapse. Now national legislators are considering spending trillions more to address physical and social infrastructure issues.

To avoid putting all this new spending on the national financial tab, some are advocating new federal taxes. One idea is to enact a national wealth tax.

How would a wealth tax differ from the existing federal income tax? To use a little economics lingo, income is a “flow” whereas wealth is a “stock.” Income is earnings over a period of time, usually a year. For persons, income is what they derive from working and from payments from their investments. For a company, income is mostly receipts from sales. In short, income is what “flows” to a person or business.

In contrast, wealth is the value of investments on a specific date after subtracting debt. All kinds of investments are included, such as savings accounts, stock and bond holdings, ownership of real estate, and anything else that has value. Just like when I took inventory in the furniture store where I worked as a youth, evaluating wealth means “taking stock” of your investments on a specific date.

The value of wealth is much larger than annual income. The Federal Reserve estimates private wealth in the U.S. in 2021 at $140 trillion. In contrast, annual income in 2021 is expected to be $20 trillion. So, one reason why a wealth tax is being considered is it is a very, very large, mostly untapped source of financial value.

Another reason some favor a wealth tax is inequality. Wealth is more concentrated among higher income households than is income. For those who want higher income households to pay a larger share of taxes than other households, a wealth tax would accomplish this goal.

We already have some wealth taxes in the country, mainly at the local level. Property, such as the value of homes and commercial structures, is commonly taxed by cities and counties. For many local governments, property tax revenues are the largest single source of their public spending.

How would a wealth tax work? Conceptually, implementation of a wealth tax would be straightforward. Once a year, the value of a person’s wealth would be identified. A tax rate would be applied to that wealth to calculate the tax amount.

For example, using the total national private wealth of $140 trillion this year, a tax rate of one percent would yield $1.4 trillion of revenues to the federal government. If all current federal taxes are kept, such a wealth tax would increase federal tax revenues by 37 percent. Just like the current income tax, households would likely pay their estimated wealth tax in monthly or quarterly payments, with adjustments for over-payments or under-payments done annually.

Although a wealth tax appears to be simple, it has many issues and questions. While there are specific measures for many forms of wealth – stocks, bonds, and bank savings accounts are examples – there aren’t for all types. Real estate, including homes, is a case in point. Unless your home has been sold recently, there are only estimates of its value. Local government offices make official estimates, but these usually aren’t done every year. So, for homes, a process would need to be developed to generate annual values.

Accessing all wealth could also be an issue. Many U.S. citizens have investments in foreign countries. The IRS would have to develop processes and protocols to improve reporting of those assets.

A practical problem of wealth is it can be much more volatile than other economic measures, such as income and spending. Just think about the big downs and ups of the stock market during the height of the pandemic in 2020. This characteristic makes forecasting tax revenues from wealth more challenging.

Then there’s the controversial question of who should pay a wealth tax. Like taxing homes in local jurisdictions, should everyone who owns wealth pay the tax? Or should only wealth holders above a certain level of income pay? Indeed, most of the current proposals for a wealth tax would apply the tax only to very rich people. Alternatively, should a wealth tax be set up like the income tax, where there are lower tax rates for lower income households, as well as deductions that reduce the amount of a person’s wealth subject to the tax?

Some economists also worry about the broader economic impacts of a wealth tax. Would the tax discourage saving and investing, which are crucial for supplying the funds for building homes, starting businesses, and financing new innovations? If the answer is yes, then a wealth tax could slow economic growth and curtail improvements in our collective standard of living.

I predict we’ll hear more about a wealth tax – especially at the national level – in the coming weeks and months. Like most important matters, it’s worthwhile to think about the details of any wealth tax before you decide to be pro or con.