Why Tax Cuts Aren’t Inflationary

There are plenty of myths and legends in economics and politics.

One that has gained a lot of support – thanks to bureaucratic propaganda – is that tax cuts are inflationary.

Needless to say, this downright lie has been lapped up by the political hacks in the mainstream press. Largely because, well that’s what the bureaucrats and politicians have told them, so it must be true.

The reality is that tax cuts are no more inflationary than a tax increase is deflationary. In fact it’s probably more likely that the reverse is true.

The argument the bureaucrats like to use is that if taxes are cut, or if surpluses are given back to taxpayers, people would go out and spend all the money and therefore push up prices.

Of course, this is a complete furphy. But it’s a useful one for governments as it gives them a seemingly valid reason not to cut taxes, and for them to spend your money for you – because apparently that won’t cause prices to rise!

Er, a quick look at the spiralling costs of healthcare and education and defence will tell you that’s not true. But anyway…

What about the argument that a tax cut is the equivalent of an increase in the money supply or the increase in bank credit?

Well, that’s not true either.

Let’s see if we can completely cover this off in today’s Money Morning. But before I do, a quick note on the long awaited National Housing Supply Council 2010 report. You can download the full report by clicking here.

If you recall, this was the report we exposed last year for using the number of homeless people to justify the existence of the fictitious housing shortage.

We notice the report includes the numbers again to show how there is a chronic housing shortage in Australia. And your editor notices again just how crazy and nonsensical the argument is.

Here’s the table from the current report highlighting how they arrived at the housing shortage number last year:

As we pointed out last year, the idea that you can draw a straight line between the number of homeless people and a housing shortage is just plain ridiculous.

In fact, we’re prepared to claim it’s an insult to the homeless. The report does quietly mention that there are other reasons for homelessness aside from a housing shortage but that’s disingenuous to say the least.

We’re pretty sure that if you ask any social worker or psychologist to name the top three reasons for homelessness, they won’t say it’s because of the so-called chronic housing shortage.

So to use people that have suffered mental breakdowns or broken marriages or domestic violence as evidence of a housing shortage is pretty shameful in our opinion.

Besides, we’ve taken a quick look at what our friends at the University of Wikipedia have to say on homelessness in the United States. It turns out:

“[T]here were 664,414 sheltered and unsheltered homeless persons nationwide on a single night in January 2008. Additionally, about 1.6 million persons used an emergency shelter or a transitional housing program during the 12-month period between October 1, 2007 and September 30, 2008. This number suggests 1 in every 190 persons in the United States used the shelter system at some point in that period.”

We don’t know if that’s a direct comparison to the homeless numbers used by the National Housing Supply Council, but it wouldn’t be too far off the mark.

But either way, the 2.2 million homeless people in the US didn’t stop house prices from falling, and it didn’t provide an accurate indicator on the perceived housing shortage either.

Because as we all know, the US didn’t have a housing shortage despite what their property spruikers said at the time. It was only after the housing market collapsed that that became obvious.

Based on these numbers, 0.7% of the US population is deemed to be homeless over a one-year period. In comparison, 0.27% of the Australian population is deemed to be homeless – about one-third of that in the US.

It just doesn’t make sense that homelessness equals housing shortage. But aside from that, we love the idea that you can take the long term average rental vacancy rate, deduct the current vacancy rate, and then claim that the difference represents a shortage of housing.

It’s ludicrous. It would be like saying a baker has a bread shortage if he normally has 10 loaves of bread left over at the end of the day, but recently he’s only hold 7 loaves of bread left over.

Using the National Housing Supply Council’s methodology, our baker friend would have a bread shortage of three loaves! As I say, it’s ludicrous.

But at least the National Housing Supply Council has acknowledged our criticism. Even though it doesn’t mention Money Morning specifically we know it’s aimed at us because this is the only place that has dared to point out the idiocy of using homelessness as a measure of a housing shortage.

The report states:

“Some recent commentary about the National Housing Supply Council’s demand-supply gap disputes the conclusion that there is an undersupply of housing. Other critiques question the statistical evidence underpinning the gap, particularly questioning the homelessness and vacancy rate measures used to calculate the gap in the 2008 report.
The Council’s 2008 report acknowledged the crudeness of the gap estimate and its
underpinning assumptions. The limitations of the underlying data are also noted.”

OK, well done for mentioning it. But then the report follows up with:

“However, the Council is not alone in projecting a housing shortage. The Reserve Bank of Australia has estimated a 40,000 annual shortage. Industry analysts have also estimated shortages. The ANZ estimates a shortage of over 200,000 homes in 2009 and 250,000 properties by 2010, with a shortfall per annum of 30,000 dwellings. Westpac estimates a shortage of 190,000 for 2009 and BIS Shrapnel estimates 160,000 by 2010. The Housing Industry Association has estimated a current shortfall of 109,200.”

I don’t know about you but we’re not about to rely on estimates from organisations that have a vested interest in keeping the housing shortage lie going.

However, according to the National Housing Supply Council, things have just gotten a whole lot worse, because now the shortage has increased from 85,000 to 163,900 in the space of a year!

And if you think it’ll stop there you’re just kidding yourself, because the Council has figured the shortage will reach 640,600 houses by 2029.

The way we see it, this report from the National Housing Supply Council hasn’t provided one grain of evidence to back up claims about a housing shortage. Simply saying that “the banks have said the same thing too” just doesn’t cut it.

And relying on homeless numbers and a below average rental vacancy rate is so far short of being a reliable metric it isn’t funny. But we’re sure the housing shortage myth will continue to run and run, until the almighty housing bubble finally bursts.

We wonder. Could it get as bad as in Ireland where some reports claim “As many as one-in-five houses in Ireland could be empty…”

We don’t know whether that’s true or not. But the Ireland experience just goes to show what happens when everyone realises that there isn’t the massive pent-up demand or undersupply for housing that the spruikers claimed.

Anyway, we’ve spent more time on that than we’d planned. What about this tax cuts are inflationary idea?

It’s simple really. Tax cuts aren’t inflationary. Think about it. A tax cut merely means that you get to keep more of your money instead of having it taken by force by the government.

So, let’s say you get to keep an extra $100 per month as opposed to the government getting its stinking hands on it.

The argument by bureaucrats is that if you’re given back that money then you’ll spend it and cause prices to rise. Of course, what the bureaucrats conveniently forget is that it also means there’s $100 less for the government to spend.

As you can see, there’s no increase in the money supply and therefore no inflation. Easy. Now, that’s not to say that your increased spending won’t have an increase on prices. But it won’t have a general increase across the economy.

Prices may rise for the goods that you purchase due to your extra buying power, but prices may fall for the goods that the government would otherwise have bought.

The point is, you’re able to buy the goods that you previously weren’t able to. And also the bureaucrats fail to point out that an increase in demand may cause producers to produce more goods which could see unit prices fall.

But what about if the government has been running a surplus? That’s still not an argument against tax cuts. And again it doesn’t necessarily mean that prices will rise if surpluses are repaid to taxpayers.

A surplus is where a government has over-taxed (although in our view all taxation is over-taxation regardless of a surplus). It has spent all the money it needs, and is left with extra.

Sure, if the surplus is repaid, it could lead to an increase in spending which could cause some prices to rise. But it’s arguable that some of the repaid taxes would just go into private savings or investments which could then be used by businesses to grow.

In reality the tax cut is inflationary argument is just a cover for the real inflationary culprit. And that’s the banks and central bankers with their issuing of credit.

As we pointed out yesterday, residential borrowing has increased 50% in the last two-and-a-half years. Banks have used depositor’s money and foreign creditor’s to leverage up their balance sheet by creating new money from thin air.

Most of this has then been used to prop up the housing bubble. But it’s also fed through to the wider economy which is why you see prices rising across the board by well over the 2-3% band the Reserve Bank of Australia sets as its target.

But look at the amount of tax revenue the federal government rakes in each year. According to last night’s budget it’s over $320 billion for this year. That’s roughly equal to the increase in residential borrowing over the last two and-a-bit years.

In other words, it’s the increase in credit given by the banks that is the real cause of rising prices, not piddly little tax cuts. If the government abolished income taxes it would save taxpayers $137 billion.

Then, if the government cut $137 billion from budget spending it would still not add one fraction of a percentage point to the consumer price index.

Instead it would be beneficial to the private sector. Because rather than $92.9 billion being spent by bureaucrats on “General government services”, that’s $92.9 billion which individuals could spend or save on items of their own choosing.

That’s $92.9 billion of private money going towards productive industries rather than being wasted on propping up housing insulation firms or dodgy infrastructure projects.

And because individual’s value their own income greater than a government values stolen taxpayer money, the money would be more wisely spent or saved.

Furthermore, if individuals were allowed to keep more of their income instead of having it taken away by the government it would doubtless mean a lower demand for borrowed money from the banks.

However, thanks to taxation and the real cause of inflation, the creation of money from thin air, individuals are forced into increasing their demand for bank credit.

Because if they don’t then they know they’ll be left behind. And that’s exactly why the property bubble continues to expand. Buyers are fearful that if they don’t buy now then they’ll never be able to.

That reader, is the classic sign of a bubble primed for bursting.

Yet, just as the housing shortage myth has been allowed to grow by a compliant mainstream press, we’ve little doubt that the case will continue to be made for the government to create a surplus rather than to cut taxes, all in the name of keeping a lid on inflation.

Cheers,
Kris.

Tagged as: bureaucratic, defence, deflationary, education, healthcare, housing shortage, inflation, inflationary, mainstream press, National Housing Supply Council, propaganda, property spruikers, tax cuts, taxpayer