The Economics of Tax and Spend

In the closing days of the presidential campaign, it is a good time to sort through the piles of rhetoric that get shoveled our way. You hear a lot of talk about taxes and expenses. Some candidates complain about cutting taxes--how will the government pay its bills? Other candidates talk about raising taxes--how will people afford it?

It just doesn't work that way. We need to talk about how taxes and expenses are going to either stimulate or deflate the economy. That is the better way to look at it. You can have a situation where you lower taxes but the government actually ends up with more revenue in taxes--the lower taxes stimulate the economy enough to pay for itself. Raising taxes can also do the same! What's the right thing to do? The key is to figure out where the money is being invested, as I'll show below.

The Police Effect

Let's say the government raises taxes to hire more police officers. As a result, your city puts in a new precinct in a rough part of town. Folks are a little grouchy, since taxes went up to pay for it, but more jobs are created. The cops are spending their money in that neighborhood. The gas stations and donut shops are doing better business. Eventually, some enterprising people notice that there is a safe neighborhood where there used to be a rough one. They decide to open a business right across the street from the new police station. Soon enough, a second person opens another shop right next to them. Suddenly, a neighborhood that was once lacking in resources has new businesses, increased stability and a more vibrant economy.

Having the police around reduces risk in a neighborhood. Businesses are not as worried about break-in's or theft, anymore. People don't have to spend so much money buying bars for the windows or limiting their operations. Risk is one of those key indicators in an economy. When risk goes down, productivity goes up. Other folks who are less enterprising take the jobs that these folks left vacant, and some people come off of unemployment.

All this happened because we put a few more cops in a neighborhood? Yes! Sure, we paid more money for more police, but if it plays out right, you could have a small renaissance where we all benefit. All of this increased activity just turns into more tax revenue for the government.

You could follow all the possible ripple effects even further: There is more supervision for kids so they can be productive members of society rather than rotting away in a cell somewhere. If folks feel safer they might spend more money on their yard or their cars, knowing they will be protected. People might take more pride in their neighborhood which could be a boost of morale for everyone. Cops have special training, so that means there is a more educated workforce out there. The ripples keep going on and on.

The Teacher Effect

Let's say we raise taxes to put more teachers in the classrooms. All the same applies: There is an immediate boost as new jobs are created, and those teachers spend their money back into the economy. It also means that universities increase enrollment to train new teachers. More teachers also means that schools can hire art and gym instructors, hire more counselors and host more extra-curricular activities. All of these just turn into more opportunities for students to learn more and get more support. They also provide ways for kids to be connected who may not get that connection in a pure classroom setting. It also provides more mentors in different capacities, who may encourage kids to stay in school, stay out of crime and be successful. Violence should go down in schools, as well.

The result? Not only did we boost the economy by hiring more teachers, but through their work they help foster a smarter, safer, more stable population. Not only are teachers an immediate benefit to the economy, but the product of their work keeps reaping benefits as the years go on.

Just like lowering risk in the police example, innovation in the market is also another key indicator of growth. New ideas, education and technology are reliable factors for growth. We can expect long-term economic growth with a smarter, more experienced population.

The Military Effect?

Some say we should spend more on the military because it will stimulate the economy. At the outset, this is true. It follows the same initial pattern as if you hired more cops or teachers. The government will hire people to work in the weapons factories and in research and development. These people, in turn, will support the gas stations and convenient stores. Eventually, real estate agents start selling again so they feel comfortable enough taking their family out to dinner at a fancy restaurant, for example. It goes on and on, just like the previous examples.

The problem with military spending is that it doesn't create anything with a life of its own. If you make a bomb, then that bomb sits somewhere in a warehouse. You stimulated the economy in the short term by making the bomb, but once that money is spent, it is gone. The bomb has no further use to society, other than to blow up someone else's country--which you may rebuild but I wouldn't count on that, nor would I want an economic strategy based on bombing and rebuilding other countries! Admittedly, some innovation has come through military engineers, but I would rather have that innovation enter the economy directly and not in a small way as an after-thought of military research.

People: The Real Deal

So as you can see from the above examples, the real deal is not just a simple statement of who is raising or lowering taxes. There are good and better ways to stimulate the economy. Pay a guy to build a bomb, and the bomb sits in a warehouse and the guy sits in a factory. Pay a guy to teach our children, and not only do you have an active, vital teacher but he is also hard at work sculpting the next generation of innovators and productive members of society. That is the kind of investment that pays out for years and years.

So my advice: It is good to know how the government is taxing and spending. But look deeper: Think of all the expenses as investments. Are we spending our money on projects that are going to pay out dividends for years to come? Or are we throwing our money into things that have a limited impact? The government can stimulate the economy by hiring all sorts of people--we should be hiring people who, in turn, also perform a service that betters society.

Investing in people is the way to go: Police, education, social work, these are the kinds of things that build up the infrastructure of a society. These people all work to improve on key macroeconomic factors: reducing risk and increasing innovation. One person out of jail and into the workforce makes us all happier, smarter, safer and richer. This is really an extension of FDR's New Deal: building roads, bridges and dams not only puts people to work in the short run, but it also creates a transportation system which increases commerce and cuts cost, thereby continuing to support business in the years to come. It's a double pay-off.

These Democratic policies are not anti-capitalistic at all--in fact, they are entirely capitalistic. They support the system of capitalism so that it can run more smoothly. They function like the traffic light system: Businesses are more profitable when there is a well-policed environment. Businesses can innovate with a more educated workforce. Good social work can help people develop the social skills to work through difficult circumstances in their life--circumstances which keep people from being productive in society. A good counselor can help an angry teen find healthy ways to channel his feelings--instead of one more kid in jail, you have a potential role model in the making.

So not only should we ask our politicians how they are going to tax and spend--we need to ask them how they are going to invest in the future of this country. Some ways of investing can have an exponential impact while others just a linear one.

There are still scientists around today who were inspired and put to work by John F. Kennedy's science initiatives. For the last 40+ years, our nation has benefited from his prophetic investments into our future. Just think how another leader may set in motion the next generation of leaders and innovators who will continue to help us long after the job of that leader is done.