Author: Lawrence

Lawrence C. Marsh is professor emeritus in the Department of Economics.  He taught graduate and undergraduate economics in the department for 30 years beginning in 1975. Marsh's "Optimal Money Flow" book was released on June 16, 2020. His latest book "Money Flow in a Dynamic Economy" was released on July 4, 2023. In 1990 he co-founded the Midwest Econometrics Group (MEG), which he directed for 15 years.  He served as the director of the graduate program in economics for 13 years. He served in 2010 as visiting professor of econometrics and statistics at the University of Chicago's Booth School of Business and in 2016-2017 at Avila University in statistics and research methods in psychology. In teaching he won the James A. Burns award for excellence in graduate teaching in 1990-1991 and was an O’Malley Award Nominee for undergraduate teaching in 1995-1996.    In 2002-2003 he was selected as a Kaneb Faculty Teaching Fellow for excellence in teaching. He has served on 80 Ph.D. dissertation committees and has given several thousand lectures in graduate and undergraduate statistics, econometrics, mathematical economics, microeconomic theory and research methods in psychology. In quasi-retirement he spends his time writing and editing a variety of articles, books and newspaper columns.  His latest book is "Optimal Money Flow: How a Dynamic-Growth Economy Can Work for Everyone" published by Avila University Press.  Professor Marsh will forgo author royalties and donate the entire book price to student scholarships for books purchased through Avila University Press at  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh .

Stop Inflation Without Causing Recession

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Don’t repeat our historically dysfunctional approach to stopping excessive price inflation. The Federal Reserve uses a supply-side tool to stop excessive inflation by raising interest rates that works by constraining business enough to cause a cutback in working hours and layoffs that suppresses consumer demand. But postal bank accounts could be created to provide the Federal Reserve with a demand-side tool to directly reduce demand pressure to stop inflation without throwing the economy into recession.

When the Federal Reserve raises interest rates, it suppresses supply for seasonal, cyclical and other businesses that depend on short term liquidity to maintain and establish inventory and cash flow.  It suppresses business.  For example, farmers borrow money from the financial system to pay for seed, fertilizer and irrigation in the spring and to pay workers to harvest the crop in the fall, and pay it back after the harvest is sold. 

But production is cut back when borrowing costs increase as interest rates rise. This traditional approach suppresses both supply and demand as workers find less work and their incomes fall. High interest rates also cause businesses to put off long-term investments in plant and equipment that would increase supply. The economy slides into recession.

Inflation occurs when too much demand for goods and services is chasing too little supply. The financial markets exist to offer liquidity to businesses to maintain or expand the supply of goods and services. Countering the rapidly rising prices requires increasing supply while reducing demand. Current supply shortages call for encouraging supply. But the traditional Federal Reserve policy approach will do the opposite of what is needed.

Sure, suppressing business to lay off workers to reduce demand will work if you slam on the brakes hard enough. But trashing our economy to stop inflation is not necessary. What the Federal Reserve is missing is a demand-side tool to ratchet down demand when markets for goods and services become overheated.  

Under the Postal Savings Act of 1910, our post offices served as banks for 56 years from 1911 to 1966. You could go to any of our 34,000 post offices to cash a check or set up a savings account. The Public Banking Act, which was recently introduced in the Congress to create postal bank accounts, could be modified to provide the Federal Reserve with a demand-side tool to curb excessive inflation without throwing our economy into a recession.

Demand can be tamped down and supply encouraged by recreating the postal savings accounts and offering high interest rates in those savings accounts on balances up to some specified limit, such as $10,000 (with no interest earned on amounts above that limit), while leaving the rates in the New York financial markets relatively low to stimulate, not suppress, supply. 

Higher interest rates will encourage savings. Saving more and spending less is obviously what is needed when too much money is chasing too few goods. If we offer high enough interest rates in postal bank accounts dispersed in our 34,000 post offices around the country, excess demand can be reduced enough to stop inflation without forcing the economy into an unnecessary recession. This approach withdraws money from the economy by offering a return on investment, not by taxation. People will still be able to purchase their necessities, but will be motivated to delay or cut back on luxuries until the economy cools off and postal bank interest rates return to normal. 

This will especially benefit the elderly who need a good return on their savings to help finance their retirement. Having more people save more money will also serve as an automatic stabilizer by providing people with the savings they need to ride out economic downturns, which, in turn, will make such downturns shorter and less extreme.

Note that the Federal Reserve is independently financed from its bank fees and investments, which produce enough revenue such that the Federal Reserve donates more than $80 billion to the U.S Treasury each year. The Federal Reserve, not the taxpayers, can pay for setting up and operating the postal banks. The Federal Reserve could also help pay for postal employee pensions. This will reduce, not increase, the overall tax burden. 

With reasonable limits on the savings and loan amounts restricted to one account per person or small business, these postal banks can avoid interfering with the normal functioning of the commercial banking industry. Of course, banks will oppose any intrusion onto their turf, but the broader benefit to the country as a whole must be taken into account.

When the opposite conditions develop with low demand, high unemployment, and the start of a deflationary cycle, postal banks could offer small loans at relatively low interest rates to individuals and small businesses. Such a loan program has already been proposed in bills formulated in both the Senate and the House in the last few years such as Senator Kirsten Gillibrand’s Postal Banking Act as Senate bill S.2755 or Representative Rashida Tlaib’s Public Banking Act as House bill H.R.8721. These bills are aimed at helping unbanked and underbanked people who live paycheck to paycheck and suddenly face job loss, a medical emergency, an automobile accident, or some other event that forces them to go to loan sharks, pawn shops, payday loan dealers, or “cash now” providers who typically charge exorbitant interest rates.

Postal bank savings accounts offering high interest rates could attract middle-class and working-class people, and those with high marginal propensities to consume who tend to spend most of their income except when offered an exceptionally high interest rate on savings. This will provide the Federal Reserve with a demand-side tool to directly impact Main Street instead of relying on indirectly influencing demand through a supply-side tool aimed at Wall Street.  Targeting demand through postal bank accounts to stop excessive inflation or, alternatively, to stimulate demand in a weak economy will be much more cost effective in offering more bang for the buck, will be more direct and have a more immediate impact, use less money and be less disruptive of our economy than current Federal Reserve supply-side stabilization strategies. 

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Use More Creativity in Funding Government

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USE MORE CREATIVITY IN FUNDING GOVERNMENT
Get your name on buildings, streets, programs and positions.

How did America create and pay for the best teaching and research universities in the world? What can government learn from this success story? When both carrots and sticks are known to motivate, why restrict funding to sticks (tuition or taxes) when carrots (donations and endowed chairs) could also provide money?

In my recent book (“Optimal Money Flow”) I proposed the taxpayer appreciation program (TAP), which would allow the naming of a taxpayer supported institution or edifice after those who pay an especially high estate tax. For example, at some point in the future, and with the approval of the appropriate board, a primary school in Omaha, Nebraska might be named “The Warren Buffett Elementary School.” Of course, you only get to die once so under TAP you could only get one institution or edifice named in your honor.

However, there is no reason that such naming should be limited to estate taxes or taxes in general. Universities allow donors to have their names attached to campus buildings, programs, scholarships and professorships. Whatever people are willing and able to fund might be considered for approval. Why shouldn’t the public sector explore this approach as well? Voters or their representatives could approve a particular donor to have their name attached to a building or road. You might be able to pay to have “Union” in Union Station or “Country” in Country Lane replaced with your name.

But what about funding actual government positions as endowed chairs? A donor named John Smith could donate a few million dollars to make Mayor Bill de Blasio the John Smith Mayor of New York City. If several wealthy people want to bid for naming an official government position, the naming of the position could be auctioned off. Of course the funding for these positions need to be large enough to pay both the future salaries and operating expenses of the named position. This would free up tax money to pay other expenses, or that tax money could be earmarked for a reserve fund to be used in an economic downturn instead of cutting back services or going into the red.

If having individual donors pay to have their names associated with key positions seems unseemly, with the approval of her family and next of kin why not create a “Go Fund Me” page to create a Ruth Bader Ginsburg Justice of the Supreme Court? The nation as a whole could show their respect and appreciation along with that of her important and wealthy friends and colleagues by funding a Supreme Court position in her honor. One of Georgia’s senators could be named the John R. Lewis Senator of Georgia. Endowed positions could eventually be created for every position in the Congress of the United States.

As the wealthiest Americans accumulate more and more money, they may wish to use their money more creatively than just investing it all in the stock market. Not every wealthy person has the ability and ambition to create an Amazon or a Tesla so offering them another way to get their name out there may be just what they were looking for. Alternatively, a “Go Fund Me” page for honoring our fallen heroes may be exactly what we need to reestablish our sense of commitment and unity as a nation. Let’s hope that our leaders will have the courage to give it a try. It has got to be more popular than raising taxes or running up the national debt.

Ranked-Choice Voting Blocks Extremists From Power

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New York City has joined Maine in recognizing the danger of traditional plurality voting methods and has embraced ranked-choice voting. Ranked-choice voting is not new. Australia started using it in state elections in 1918, and Ireland started using it in presidential elections in 1937. Commentators have frequently pointed out that ranked-choice voting eliminates extremist candidates who are not favored by a majority of the electorate and allows a more moderate candidate to get elected. But the best way to understand the pitfalls of our traditional plurality voting system and the advantages of ranked-choice voting is with some simple examples.

Suppose that there are only three candidates. Candidate A gets 35 percent of the vote, Candidate B gets 33 percent, and Candidate C gets 32 percent. Without a runoff election, Candidate A wins even if most of those who voted for Candidate C would have preferred candidate B. In the extreme case, Candidate A was preferred by only 35 percent of the voters with 65 percent opposed, yet Candidate A wins, while a majority of the voters favor Candidate B. With Ross Perot running as a third party candidate in 1996, neither Bill Clinton nor Bob Dole was able to get a majority of the votes. We will never know who would have won if Ross Perot had not been in the race.

A runoff election could solve the problem, but only with an expense that would be unnecessary if the original ballots had allowed each voter to rank the candidates as first choice, second choice, and third choice. In a three-candidate race under ranked-choice voting, if none of the candidates received 50 percent or more of the votes in the first round, the third-choice candidate would be eliminated and the ballots of all those who had ranked that candidate as their first choice would be recounted, moving their second choice candidate up to first place. In the extreme example above, this ranked-choice voting procedure would enable Candidate B to win with 65 percent of the vote without requiring an expensive runoff election.

In the 2000 election both in Florida and nationally, George Bush beat Al Gore, but failed to get a majority of the votes, with Ralph Nader as the spoiler candidate. If ranked-choice voting or a runoff election had been used in Florida in 2000, Al Gore might have won the presidential election, but we will never know. In November of 2018 in the Australian state of Victoria in a race with several candidates, a Green’s party candidate, who came in third in the first round of voting, won the election under the ranked-choice voting system. In other words, ranked-choice voting can sometimes make a dramatic difference in an election outcome.

Now consider an election with 13 candidates as in the June 22 Democratic primary for New York City mayor where ranked-choice voting was used with voters ranking up to five candidates. First suppose that the traditional plurality voting method was followed. Imagine that an extreme left-wing candidate got 17 percent of the vote and an extreme right-wing candidate got 17 percent of the vote, and each of the 11 moderate candidates got 6 percent. Even in a runoff election between those top two extremist candidates, the winner might be truly favored by only 17 percent of the electorate with a majority of the voters preferring any of the more moderate candidates. In other words, in the extreme case, a candidate with just over 17 percent of the vote could get elected under traditional plurality voting even with almost 83 percent of the electorate strongly opposed to that candidate. If ranked-choice voting had been used instead, the most likely outcome would be the election of one of the more moderate candidates. In other words, under traditional plurality voting, even in the case of a runoff election between the top two candidates, one of the extreme candidates would win, but under ranked-choice voting, a more moderate candidate, preferred by a majority of the electorate, would ultimately win.

Maine is the first state to mandate ranked-choice voting in federal elections. Losing Republican incumbent Bruce Poliquin from Maine’s Second Congressional District challenged the use of ranked-choice voting in federal court. He was in the lead in the first round, but lost after the votes of third-party candidates were reassigned under the ranked-choice voting procedure. After losing the recount and after a federal judge rejected the claim that ranked-choice voting was unconstitutional, Poliquin ceased his challenges to the outcome of the election.

In Maine and several cities throughout the United States, ranked-choice voting has been successfully implemented without much confusion or disruption. Once the voters get used to it, they will see how easy it is and the advantages of ensuring that only candidates with widespread support get elected. The delay in the New York City tabulation is not due to the use of ranked-choice voting, but because of the need to wait until all the votes, including all those mailed-in ballots, are received. Once all the votes are in, it only takes a few nanoseconds for the computer to determine the winner under ranked-choice voting.

We like to think of the United States as that “shining city on a hill” as President Reagan said, yet our democracy has serious drawbacks and disadvantages. A combination of our traditional plurality voting system, especially as used in primary elections to defeat more moderate candidates, along with gerrymandering, influencing politicians through massive campaign contributions, and other aspects of partisan politics, has produced a much less attractive version of democracy. The widespread use of ranked-choice voting could be one step in the right direction toward correcting these deficiencies.

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High Oil Prices Aid Anti-American Regimes in Russia, Iran, and Venezuela.

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Some key anti-American governments are highly dependent on oil revenues. A large portion of the budgets of Russia, Iran, and Venezuela depend on money from oil and natural gas. The United States consumes the most oil of any country in the world. If demand for oil and other fossil fuels in the United States were cut dramatically, their prices would fall, and that would sharply curtail the activities of our adversaries. Should we send more troops overseas to curb the bad behavior of these regimes, or, instead spend that money on switching our economy from fossil fuel dependency toward an economy built on renewable energy, and thereby deprive these regimes of a substantial part of the revenues they need to continue their anti-American activities?

Transitioning the American vehicle fleet from using fossil fuels to electricity will be a major step in that direction. Ford made news last month when it announced it will begin production next year of the F-150 Lightning, all-electric truck. As an added plus, the truck’s batteries will be able to power your house during an electric outage. There are also plans to integrate its Intelligent Backup Power system with a solar company to provide solar power to both charge the truck as well as your home.

At the moment, one of the drawbacks of an electric vehicle is the limited range of its batteries, which typically provide a range of 250 miles on a single charge. One solution already under way is the creation of a network of fast-charging vehicle battery stations by Tesla, local utilities (such as Evergy in Kansas City) and a growing number of private providers such as EVgo.

Another solution is to buy the electric vehicle, but rent the batteries. This significantly reduces the price of the car, but requires a rental payment. The advantage is that when your battery power runs low, you just stop at the highway service station for ten minutes to swap out the low-power batteries for renewed fully-charged ones. This greatly extends the driving range of your electric vehicle. This battery rental plan has worked well in Israel and other countries that have tried it. It may work even better in the USA where we often drive great distances, especially on holidays.

Economists generally tend to oppose most tariffs in favor of free trade. However, in matters of national defense some tariffs may play an important role. In particular, a tariff on imports of crude oil and gasoline could substantially reduce American demand for these commodities. This would drive down their prices on world markets and deny our adversaries the revenues they need to continue their anti-American campaigns. It would also increase the demand for electric vehicles in the United States.

Even if you believe that global warming is a hoax, but care about national defense, taking advantage of our adversaries’ weakness is just common sense. A tariff on crude oil and gasoline imports would be a good start. Tax breaks for wind, solar and other renewables could create new, higher-paying jobs and contribute to economic growth, instead of sending more soldiers to fight in those never-ending Middle Eastern conflicts. Vladimir Putin doesn’t want you driving an electric vehicle. He needs you to keep driving your gas-guzzling car or truck. Putin will be very annoyed and disappointed with you if you purchase one of those recently announced electric Ford F-150 Lightning trucks or any other fully-electric vehicle.

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Exactly what would happen if federal debt got very big?

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The cash in your wallet used to be government debt. What the government owed you before 1971 was an ounce of gold for $35.  In 1971 President Richard Nixon took the United States off of the gold standard. Now the government owes you absolutely nothing for $35 or any amount of money. If you are nervous about using money that is backed by nothing, don’t use it.

Question: But what about US Treasury bills and bonds? Doesn’t the government owe you for the principal and the interest on those bills and bonds?  Answer: they owe you the interest payment, but if you want to redeem any of those bills and bonds, you go into the New York financial markets and sell them for whatever price they are currently selling for.

Question: Does that mean that the government never has to pay back the debt that it has issued?  The answer: as long as there is a market for government bills and bonds, the government doesn’t have to worry about it. As long as there is someone else willing to buy the debt, then it isn’t a problem.

Question: How do we know when a government debt problem might be developing? Answer: when people start losing faith in government debt, the interest rates on government debt will begin to rise.  Safe and secure debt offers a low interest rate. Risky debt requires that the issuer pay a high interest rate. If the interest rate on government debt starts rising above that offered on corporate bonds, then it would be time to start worrying, mainly because the government would need to sell more and more debt to get the money to pay the interest rate on the increasing debt load. It is very unlikely that the government would let this get to the point where they couldn’t keep up. In an emergency the Federal Reserve would monetize some of the debt (buy up enough of it to alleviate the crisis) to bail out the government just as it bailed out the banks on Wall Street in 2008-2009.

Question: What if there was a situation (such as the current situation) where wealthy people and wealthy corporations had a huge amount of money in the financial markets and there were no reasonable real investment opportunities (except maybe overseas) so the money just drove up stock and bond prices and drove down interest rates? Answer: Yes, this is the current situation. There is a huge amount of money in the financial markets that is sitting idle. Corporations are using the money they get to issue stock buybacks and increased dividends and driving up stock and bond prices. Right now the chances that the interest rates on government debt are going to spike are next to none. It is definitely not an immediate problem. The inflation that has resulted is primarily in stock and bonds, which are not well represented in the market basket of goods and services that the government uses to generate the consumer price index (CPI), because most consumers don’t own many stocks and bonds.

Question: But what if the government went wild by issuing a huge amount of government debt? Answer: that would be a problem, because eventually all market interest rates would start to rise and private investment would be choked off. This is what is sometimes referred to as “crowding out.” But a moderate amount of “crowding out” is not a bad thing if the money is being used for important public investments such as infrastructure repair and other important priorities that voters have determined are more important than what the private sector would spend the money on. The term “crowding out” is prejudicial in that it implies that private spending is good and government spending is bad, but that is not always the case. Some reasonable amount of government spending is needed.

Question: What if the government issued the debt but didn’t spend the money?  Answer: Although the chance that this would happen is absolutely zero, it is an interesting question. It would mean that the government was reducing the money supply. Controlling the money supply is supposed to be the responsibility of the Federal Reserve. But if the treasury department did it the effect would be the same as the Fed purchasing securities in the financial markets. It would reduce the money in the economy and slow the economy, and, if extreme enough, cause a recession.

The real question is how much money is flowing through our economy and where is that money going? Right now, there is too much money flowing into Wall Street and too little money flowing to the people on Main Street. The people on Main Street don’t have enough money to buy back and goods and services they are creating so the federal government has to use deficit spending to make up the difference to keep the economy from falling into a recession. The problem is that the wealthiest one percent don’t spend enough of their enormous fortunes, and they put so much money into the stock and bond markets in New York City that there aren’t enough investment projects to use all that money. In others words, the wealthy have a low marginal propensity to consume and make financial investments that trigger increased dividends and stock buybacks, but not enough real investment in the real (Main Street) economy. The Wall Street economy has become more and more separated from the Main Street economy. Deficit spending is here to stay until we correct the money flow problem where too much money is flowing to the wealthiest people and biggest corporations on Wall Street and too little money is going to everyone else back on Main Street. Of course, if too much money flowed to Main Street, it could trigger real inflation in the real economy and not just stock and bond inflation on Wall Street. I will leave the inflation discussion for another column.

Lawrence C. Marsh is professor emeritus in economics at the University of Notre Dame and author of the 2020 book “Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone.”

The “Inflation Dilemma” and How to Solve It

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Fiscal conservatives claim that President Biden’s $1.9 trillion stimulus proposal surely will lead to excessive inflation. However, in Congress the recently proposed Public Banking Act opens the door to a new policy tool that could quickly and painlessly stop excessive inflation in its tracks were it to develop. 

Economists such as Stephanie Kelton in her book “The Deficit Myth” argue that although we must avoid excessive inflation, deficit spending is not inherently a problem. The key point in her argument is that interest rates have remained low.  Low interest rates make larger deficits manageable because they keep interest payments on the debt low.  Moreover, low interest rates are a sign that investors have not lost faith in the soundness of U.S. Treasury securities. Although the interest rate on 10-year government bonds has risen to around 1.5 percent, it has not yet approached levels that would be of any real concern.

But already we have seen the prices of gasoline, lumber and some foods rising significantly. What if President Biden’s $1.9 trillion COVID stimulus package were to push us into an upward inflationary spiral? Biden supporters argue that this is unlikely, but what if it did?  Would the Federal Reserve have the policy tools to stop excessive inflation quickly without throwing the economy into recession?

In the past the Federal Reserve has stopped inflation by significantly raising interest rates in the New York financial markets. Most notably in the early 1980s after inflation soared to 13.5 percent, Chairman Paul Volker led the Federal Reserve to raise rates and throw the economy into a deep recession. Could the Biden stimulus bring this upon us once again?

The key to solving this problem is in understanding “The Inflation Dilemma.”  The fundamental cause of excessive inflation is when too much money is chasing too few goods which drives up prices. In the face of excessive inflation, high interest rates are needed to encourage consumers to divert more of their money to savings to earn the higher interest rate and, therefore, cut back on unnecessary expenditures.  This reduces the demand for goods and services.

However, at the same time, low interest rates are needed to encourage producers to supply more goods and services to help drive prices back down. Businesses would like to respond to excessive demand by supplying more. But high interest rates discourage them from borrowing the money they need to add another line of production. 

When faced with rising prices, we need to cut back on demand and raise supply.  Raising interest rates enables the former, but discourages the latter. This inflation dilemma can be overcome only by providing high interest rates for consumers, motivating them to increase their savings and reduce demand, and at the same time providing low interest rate to companies to increase supply.  

The Public Banking Act opens up the opportunity to solve this inflation dilemma.  From 1910 to 1966 the post offices throughout the United States offered banking services. You could go to any post office to cash a check or set up a savings account.  A resumption of these services as currently proposed in the Public Banking Act would be particularly beneficial to low-income, disadvantaged people, who, after a job loss, car accident or uninsured medical emergency, need to borrow money but have to go to loan sharks, pawn shops or “cash now” opportunists and end up paying high interest rates. Under the Public Banking Act they could apply for a small loan at a relatively low interest rate at any post office. 

But the Public Banking Act could also serve to defeat the threat of excessive inflation and solve the inflation dilemma. Limiting postal savings accounts to individuals based on their Social Security numbers and placing a limit on how much of the savings in their accounts could earn interest, the accounts could offer a high interest rate when excessive inflation threatened. Limiting interest payments to accounts with $10,000 or less would keep wealthy individuals from transferring large amounts of money to these savings accounts from the private banking system. At the same time, the Federal Reserve could keep interest rates low in the New York financial markets enabling both the payments on the federal deficit to remain low and encouraging businesses to employ more workers, not less, as they expanded supply in the face of rising prices. Thus, the inflation dilemma would be solved by offering consumers high interest rates to reduce demand and businesses low interest rates to increase supply. The combination of less demand and more supply could slow or stop price increases without entering a recession.

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Please provide your insights and comments on The Inflation Dilemma and How to Solve It.
Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
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You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
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For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer courtesy of your local public library via Hoopla at:  https://www.hoopladigital.com/artist/7090137015 
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Please provide your insights and comments on “The Inflation Dilemma and How to Solve It” at:
https://sites.nd.edu/lawrence-c-marsh/ 
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For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS___________________________________The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
Link to my Notre Dame webpage

Minimum Wage Promise and Pitfalls

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One aspect of the minimum wage that has been widely ignored is not the impact on overall employment, but on the actual low-wage workers themselves. The question that has been largely ignored is what happens to low-wage workers who are not as good as alternative workers who do not enter the labor force to displace the low-wage workers until the minimum wage is raised?  

Think of a local McDonald’s where at a low minimum wage the workers may not be those with the best social skills. They may not get along well with their colleagues or be very nice to the customers. They do only the minimum required to keep their jobs. Not all low-wage workers have poor social skills, but for obvious reasons workers with poor social skills are over-represented in low-wage jobs. 

Then the minimum wage is raised. A stay-at-home parent may decide that the increased pay makes it worthwhile for them to work when their children are at school. Elderly retired workers may be willing to come back to work when offered higher pay. A college student may decide that the wage is high enough to make it worthwhile to take that McDonald’s job after all. Workers with better social skills may get along better with one another and with the customers, and they may be more willing to pick up trash in the parking lot and keep the restaurant looking nice by cleaning and straightening chairs, etc.  

What the debate about the minimum wage is missing is an analysis of what happens to the original, low-quality workers when better workers show up? With the higher minimum wage, it may be worth the while of the higher-quality workers to enter the labor force and take the jobs away from the low-quality workers. But the low-quality workers are the very ones that need the most help.  

We are fooled into thinking that the minimum wage has no effect when the level of employment does not fall. McDonald’s may employ just as many people for just as many hours as before. But the low-quality workers may have lost their jobs nonetheless. Yet these are the workers who typically are the poorest and need the most help.  

The problem is that we tend to analyze one economics policy tool at a time. But there are times when two tools need to be used in concert with one another to solve a problem. When you try to tighten a bolt and it just goes around and around without tightening, you take a wrench to hold the nut while you use the screwdriver to screw in the bolt. In the same way it is sometimes necessary in economics to use more than one tool at a time. Raising the minimum wage may work well if at the same time unemployment insurance is increased to help the lowest-quality workers.  

From the supply-side point of view, giving money to unemployed workers just encourages them to remain unemployed. But demand-side economics sees workers differently. From the demand-side point of view, more money going to unemployed workers is a good thing, especially if it causes them to hold back on taking a job until a higher wage is offered. The unemployment insurance check helps ensure that workers will not sell out for too low a wage. Even in the absence of a union, a higher unemployment insurance payment can lead to higher wages relative to profits.  

When aggregate demand is too weak relative to aggregate supply, higher unemployment payments will help divert the money flow from the financial markets where it piles up inflating stock and bond prices and depressing interest rates to money flowing to workers who have higher marginal propensities to consume than the investors on Wall Street. When demand is weak, Wall Street investors can’t find real business projects to invest in. In such circumstances diverting profits to worker paychecks through a combination of a minimum wage increase and an increase in unemployment insurance helps create real business opportunities by increasing the demand for goods and services. This produces a healthier economy with greater economic growth from which we all benefit. 

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Listen to audiobooks for free via University or Public Library via Hoopla

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Public libraries now allow free 21-day access to audiobooks via Hoopla. Now you can listen to “Optimal Money Flow: How a Dynamic-Growth Economy Can Work for Everyone” on your smartphone for free when you exercise, drive or just hang out. Here is the Hoopla link for free audiobook (click on book image for book description): https://www.hoopladigital.com/title/13557352

The Deadweight Loss of Christmas (revisited)

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Economics is about the efficient allocation of resources. But gift giving is anything but efficient. From a purely transactional point of view, wouldn’t Uncle Jim be better off if you just handed him $50 than spending that $50 on another ugly sweater for him?  Why guess what the other person wants?  Perhaps a $50 gift card from Walmart might work, but what if what Uncle Jim really wants is not sold at Walmart?  Instead, what if you just give him $50 and he gives you $50?  Wouldn’t that be the most efficient gift exchange of all? 

Joel Waldfogel presented and analyzed this problem in the December 1993 issue of The American Economic Review in an article entitled: “The Deadweight Loss of Christmas.” For close relationships such as a good friend or significant other, the loss of efficiency from gift giving may average about one-tenth of the value of the gift; whereas, for more distant relatives or friends, the loss of efficiency may average closer to a third of the value of the gift. 

It is clear that social relationships are different from economic relationships. The problem is that economics students are taught to view the world from a purely transactional point of view. This doesn’t mean that we don’t care about other people, but just that economists don’t generally consider “intent” as important. But it is important. Meaning may be imbued into a gift by virtue of the fact that the gift-giver meant well, even if the gift was not optimal to the recipient given the amount paid for the gift. Gift giving is associated with good intent, but behavior can also be distorted by bad intent. Having your car dented in a hail storm is much less upsetting that someone denting it with a hammer. 

How about all those great Thanksgiving dinners your mother-in-law made in years past? As you left, did you give her a tip, or pull $50 out of your wallet to pay her for the great meal? People who are trying to build or strengthen a relationship don’t want to be simply paid off for their efforts in some sort of quid pro quo manner. Social (noncognitive) skills are often more important than technical (cognitive) skills in navigating the real world. Unfortunately, most economic textbooks in the past have tended to ignore such considerations.

Economists create a fantasy world where everything is about money and market relationships. In the past economics professors have tended to ignore aspects of life that cannot be measured or understood in terms of money. But this ignores the most important relationships of all. The problem boils down to prediction. Neurologists frequently point out that the primary purpose of the human brain is prediction. In primitive times knowing what to expect in different circumstances was often a matter of life or death. Even today, accurate prediction is often the key to success or failure. If people are motivated by things other than money, then an economic prediction methodology based primarily on money may lead us seriously astray if people tend to deviate from gaining the highest monetary return because they are willing to sacrifice money for other less tangible and less measurable objectives. 

Remember over this holiday season, that it is not the gift that counts, but the thought behind it that matters. (And that there is sometimes more truth in old cliches, than in that Principles of Economics textbook.)

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Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. 
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You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
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For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer from here:  https://www.hoopladigital.com/artist/7090137015 
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Please provide your insights and comments on the Deadweight Loss of Christmas (revisited) at:
https://sites.nd.edu/lawrence-c-marsh/ 
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To sign up for this free monthly Money Flow Newsletter =>  click here.
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For additional details see the Optimal Money Flow book website at:
http://optimal-money-flow.website or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS___________________________________The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh

Should the income tax be replaced with a progressive consumption tax?

Posted on by Lawrence

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Conservatives love to complain about the income tax. They say that taxing income undermines incentives and suppresses innovation and economic growth. Why should you work hard if the government is just going to take away a substantial portion of your hard-earned income? 

Instead, some propose the so-called “Fair Tax” which replaces all personal federal taxes with a national sales tax. To raise comparable revenue such a tax would need to be about 30 percent of the pre-tax price. Such a tax would be very regressive. In other words, it would take a much higher percentage of income from low income people than from high income people. Such a tax would be certain to draw the ire of the working class and middle class and be a nonstarter politically. So forget about the “Fair Tax” which imposes tax on purchases directly.

But what about a progressive consumption tax?  This tax would allow all earned income to be nontaxable as long as it went directly into savings and stayed in savings. It would be essentially an unlimited traditional individual retirement account (IRA). In other words, you could put your earned income directly into a savings account, buy certificates of deposit or stocks and bonds without paying income tax.  However, any withdrawal of money from any of these forms of savings would be progressively taxed annually at rates higher than the current income tax rates. Basically, as under the current income tax, you could probably cover a modest monthly rent and essential food expenditures while paying little or no tax. However, a high flying life style of buying exclusive properties, frequently eating out at the most expensive restaurants, and traveling around the world on costly vacations would cost you an arm and a leg in tax payments, because it would require withdrawing a lot of money from your savings. 

In theory there could be some real advantages to a progressive consumption tax. First, it would not undermine work incentives as much as the income tax, at least not directly. It would encourage frugality. You could earn a lot of money and not pay a penny in tax as long as you saved most of it. Since wealthy people have more money than necessary to meet basic needs, they often purchase items that do not involve producing more goods, such as in buying exclusive real estate or rare artifacts such as famous paintings. Their motivation is more in displaying their relative wealth and in accumulating more wealth than other wealthy people. A consistently and evenly applied progressive consumption tax would reduce absolute wealth but not relative wealth so their incentives would not be undermined by a progressive consumption tax. A progressive consumption tax would not bump anyone from their position on the Forbes list of wealthiest people unless they consumed relatively more than their peers. 

Second, a progressive consumption tax would encourage savings. Certainly, getting people to save more would help reduce the severity of recessions. Instead of cutting back dramatically on expenditures with a reduction in overtime pay, a reduction in work hours generally, or a temporary layoff, people could draw on their savings to maintain their basic expenditures when the economy slowed.  Moreover, with more money saved, they would have a more secure retirement. Overall, this would certainly serve as an automatic stabilizer and keep the economy from experiencing deep recessions.  

All this sounds good. If a progressive consumption tax was applied in the decades after World War II when interest rates on savings were higher and consumer demand was very strong relative to aggregate supply, it might have worked, although higher estate and inheritance taxes might have had to be added to maintain adequate revenues.

But there are some serious difficulties with implementing a progressive consumption tax during the current period. In recent decades our money flow has become so distorted that huge amounts of money are being diverted to the financial markets as the wealthy get ever wealthier. In the face of weak consumer demand, most of this money is not going into real investments in our economy, but is instead used to increase dividends and stock buy-backs. So little money is being retained by consumers that they can no longer afford to buy back the value of the goods and services they are producing. The government has had to step in with deficit spending to make up the difference. Stock and bond prices have been driven up, while interest rates have fallen so low that it is hardly worth bothering with a savings account. Under current rates, even a modest level of inflation could significantly reduce the real value of your savings over time. 

What this all boils down to is that to create and maintain a healthy economy, we need to eliminate the tax loopholes and distortions that enable wealthy individuals and corporations from shifting the burden of taxation onto the middle class and pouring huge amounts of money into the financial markets. Instead we need to direct money to working class and middle class people who will actually spend that money on the goods and services they are producing. Higher tax revenues from either a progressive income or consumption tax would enable us to cut back and ultimately eliminate the federal deficit spending. With less money in financial markets, interest rates would rise, which, along with a progressive consumption tax, would encourage people to save more money, which in turn would strengthen our automatic stabilizers in keeping our economy healthy.  

Please add your insights and comments on the potential advantages and disadvantages of the progressive consumption tax below in the comment box.

To sign up for this free monthly Money Flow Newsletter =>  click here.
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Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame
and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone. You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
For a limited time (21 days) listen to Optimal Money Flow for free on your smartphone or computer from here: https://www.hoopladigital.com/artist/7090137015