After the Crash: Designing a Depression-Free Economy

Mason Gaffney

[ GroundSwell, November-December 2010]

(The following was prepared for a Jan. 26, 2011 talk to the Citizens-University Committee, U.C.Riverside. This is not an outline for a short talk, but more like an appendix. In speaking I will just hit a few high spots.)

FOREWORD

These proposals will seem too radical to some, but consider:

A. We have been radically, spectacularly wrong, and so we need to change radically. Bush I, Bush II, and now Obama have demonstrated their incompetence. If Clinton and Gingrich's Congresses were better it was only marginally. They have used the same set of economists, the same paradigms with the same astigmatic limits. They narrow their vision to money, its quantities and flows, without reference to real events and resources, not even the synchronized symbiosis of real estate collateral and the volume of demand deposits. They look only at ancient "in-the-box" policies, ever leaving us with dismal choices.

In Washington it is "inflation or unemployment, take your pick". In Sacramento with successive Governors it is "regressive taxation or kill incentives, take your pick". In either case it is our fault, not theirs, if the side-effects are bad. They offer no "win-win" solutions, except where two private rivals may both win at the expense of the amorphous general taxpayer.

B. Many changes proposed here are returns to older traditions that prevailed when California policies made us a magnet for capital and labor, and the U.S. was the hope of and model for the world. Returning to tradition is not "radical" in the sense of untried or frightening or unpredictable. 40 years ago, California was the most successful case of "economic development" in history – not the basket case of today.

C. Some proposals here entail State and local action; some entail Federal action. I have not, in the time available, distinguished sharply between them, but left that to the listeners to infer.

I. Premises.(These go back at least to A-R. J. Turgot, the tutor both of Adam Smith and several of the Founding Fathers of the U.S.A..)

A. Investing is the healthy circular flow thatanimates most of the work of society. Capital is a Great Revolving Fund: the faster any fixed quantity of it revolves, the more work it animates. More capital may be better, but we can always make do with what we have.

B. Politicians and popular thought today (and for centuries past) have seen "consumption" as the key driver of circular flows, with magical "multiplier" effects as consumption creates more incomes which create more consumption, and so on. Actually, consumption per se only takes goods off the shelf; REPLACEMENT is what creates new incomes. Replacement anticipates liquidation, and by anticipating it creates the incomes that make it happen. Consumption is mainly a passive function of income, but Investing is the autonomous variable that regulates the circular flow. See appendix, "Replacement anticipates liquidation".

C. "A" applies only to NET new investing, income-creating and job-creating. It does not apply to buying existing assets like land and old buildings. It MAY apply to IPO's, depending on how the new capital is expended. It does not apply to M&A. Since the beatification of "uniformity" in and after the tax reform of 1986, Washington, the academies and even the labor movement have lost consciousness of this principle.

D. Walter Heller demonstrated one way to downtax net new investing without losing revenue from the income of old assets (Investment Tax Credit; fast writeoff of NEW capital). Since his time his policies have been abandoned and reversed; wage rates and the demand for labor have steadily fallen, probably partly in result.

E. Land available in the right place at the right time at the right price is the necessary venue for "A". With Prop. 13 cum urban sprawl it has been available in the wrong places, freezing up precious capital in attenuated infrastructure, while also invading pristine environments.

F. Taxes and other charges based on giving and receiving jobs are directly and obviously job-killers. They have risen steadily and inexorably over the last century.

II. Our present economic problem summarized We have a shortage of liquid capital; a shortage of available land and resources; and a surplus of labor.

III. Solution Summarized A solution should be obvious to any reasonably bright 12-year old -- lower the coefficients of capital and land per worker. Get capital moving (turning over); get land in use. Those will put labor to work.

IV. Capital: turning too little capital into enough Capital may be a Great Revolving Fund, but some capital revolves much faster than other. To simplify, there are two kinds of capital: fixed and working. We have lots of fixed capital just now, but capital in empty buildings, mothballed ships and airplanes and bridges-to-nowhere do not make jobs by themselves. We need more working capital, or "Capital in motion", capital that keeps returning to be reinvested (revolving, or turning over) to meet the next payroll. Two parts of solution to capital shortage:

i. When down in the hole, stop digging Avoid new "economic pyramids", e.g. proposed tunnel under The Delta of the Sacramento-San Joaquin Rivers. Long building periods swallow up capital, first in construction costs; then in compound interest on the funds (Allowance for Funds During Construction); and then in slow recovery, for capital costs interest every month until you recover it.

ii. Some dreadful cases in point: "high-speed rail" with low-speed construction, the 65-mile "first leg" of the dreamy 500-mile line from San Francisco Bay to San Diego ; the Washington Public Power Supply System ("WHOOPS"); the Tenn-Tom Canal, begun when Andrew Jackson was President and finished only recently; The Chunnel; The Seikan Tunnel (Honshu-Hokkaido); empty mansions; Louis XIV's long-a-building Canal du Midi; 1846 work-relief in starving Ireland, building roads for the next century while people died of hunger; etc. ad inf.

iii. Generic case: urban sprawl, continental sprawl, and our worldwide sprawl swallow up massive capital and keep it from recycling. We do not need "shovel-ready" projects so much as sales-ready or use-ready projects from which we recover capital fast to meet the next payroll.

iv. Solve problems in other ways than building monuments and pyramids, e.g. by using local waters economically. In the Kaweah Delta, little local economies would have obviated the massive Friant-Kern Canal (Gaffney, 1960); in southern California, reasonable local economies would have obviated the massive, energy-gobbling California Water Plan.

D. Restructure income tax system, drastically – yet by returning to tradition

i. Reallocate undistributed profits

ii. Downtax quick profits, a la Heller; uptax slow profits and capital gains

iii. Downtax both giving and receiving jobs.

iv. Forget "shovel-ready" slogan, replace it with "sales-ready"

v. Recover that capital

a. It takes working capital to thaw out frozen capital. Use empty buildings, remove mothballs.

b. Complete half-finished work before starting new projects: "full-funding" vs. trading earmarks

V. Solutions to land and resource shortage

1. Repeal or amend Prop. 13; recreate the magnetic tax system that made early California flourish: no sales tax, no state income tax, heavy taxes on land

2. Note that property taxes based on land values are both progressive and pro-enterprise. This is one of the best-kept secrets of modern economic orthodoxy.

3. Note that the prospect of steady annual tax rates levied on the base of land values will have a tempering effect on the present high amplitude of cyclical swings in the price of land, which in turn is the collateral behind wild swings in bank credit. This is a central part of "Designing a Depression-free Economy".

4. Use new funds from property tax to lower other taxes and fees, that now "shoot anything that moves", suppress local enterprise, and, sarcastically, "welcome, strangers".

5. Stop water and other subsidies to farmers who produce the least value per acre-foot of water: rice, alfalfa, pasture, sugar beets. Reallocate water to higher uses. The market would do it, if we had a market, but we hardly do. Give high priority to creating new institutions to facilitate water marketing. This could be "California's new frontier" (Gaffney, 2006).

VI. Making jobs by untaxing labor, replacing revenues from resource and environmental taxes and charges

1. Remove FICA tax, and various state taxes and charges that vary with jobs. Replace revenues from:

a. Higher property taxes Raise rates to 1977 levels, 3% or more. It worked for a century before then; why not now? 40 years ago California was El Dorado, a magnet for both labor and capital at the same time. It was expressed as "the continental tilt" of interest rates, but not at the expense of labor, for wage rates , too, were higher here – a double continental tilt. Sunset preferential assessments:

1. ) Timber Preserve Zone (TPZ)
2. ) Williamson Act
3. ) Golf courses

b. Raise taxes or charges on various natural resources that are now tax-free, and often heavily subsidized Assets held by licenses, which are not taxable property. E.g. liquor licenses; taxi licenses; utility franchises; licenses to preempt the electromagnetic spectrum, a valuable part of the public domain; Water: "Turn Negabucks into Megabucks". The State Constitution declares that "The waters of California belong to the people of California", so charge for it instead of subsidizing people to waste it, as now. Oil and gas,

1. ) Severance taxes, common in every state but ours
2. ) Administer leasing on State and some city lands more aggressively Timber and timberlands, private and public Charge for curb parking on public streets (Shoup, High Cost of Free Parking)

c. Charge for road use by moving vehicles

1. ) Crudely, by raising gas taxes that have fallen since 1920
2. ) Gradually introduce more sophisticated methods as practiced in Singapore and some other pioneering cities Effluents in air and water: estimates of enormous revenue potential in carbon taxes (Barnes) Coastal access: slips and Moorings ix. Fisheries, fin and shell x. "Sweetheart" leases, e.g. on Federal lands ("possessory interests") xi. Eleemosynary institutions

d. Close loopholes in sales taxes and income taxes (if we must have them). Long lists of loopholes are available on request.

e. Assert State ownership using Public Trust Doctrine potentially covering vast areas, e.g. the entire Delta and that half of the original San Francisco Bay that has been filled in.

VII. SUMMARY Please go back over headings I through VI. Consider how they just scratch the surface; use your imagination to fill in the blanks. Many companies invest in excess of depreciation. A company can do that—by tapping others. An economy cannot, except by new saving. It is a closed system with a zero sum of capital transfers. To meet the national payroll the economy must deliver the goods, or cut the payroll.

The national capital is indeed a Great Revolving Fund. The fund receives inputs from labor and delivers to consumers. Labor and consumption set limits on the throughput, as we know. But so does turnover of the fund—and economists neglect this. Meeting the national payroll has two sides: spending money for work, and delivering real goods to back up the money. Turnover generally balances the two sides nicely. Replacement anticipates liquidation. The keepers of the fund—capitalists—anticipate the maturity and sale of their goods, and pay workers to replace them. This gives workers the income to buy the ripe goods. (Along with turnover there are net saving and investment, but these are small next to turnover—too small a tail to wag so big a dog.)

Note well that Replacement, not consumer demand, is the autonomous causative variable here. The latter is a passive function of income. It is investing that is discretionary, hence autonomous, hence the key to starting and sustaining the circular process. Ordinary macro models take care only of the spending side, the money demand. Their fault is to assume that delivering the goods then takes care of itself. Turnover is assumed mutable, totally accommodating in response to the touch of spending. The fact is that turnover itself controls spending, since replacement anticipates liquidation. If we perceive the problem as how to remove surplus goods from the market, the doctrines and policies that result will welcome investments with only deferred benefits. These create money incomes and no consumer goods. The result has to be inflation, and has been for many years.

We have traded on the symbol and denied the substance until the symbol has lost its power to command. Neoclassical macro models do not omit turnover from their equations. Rather they bury and obscure it by keeping it implicit. This occurs when one treats "consumption" as an income-creating expenditure. Now really, consumer spending as such does not create much income; it takes off the shelf goods already produced. Replacement is the spending that creates income. There is disinvestment and reinvestment. In macroeconomic logic these two transactions are netted out, so consumption creates income, and only the uncleared balance shows up as net investment—which is what "investment" means in current macroeconomic lingo.

The great mass of gross investment is called consumption. The turnover of capital required is assumed to occur passively, automatically, accommodatingly. Only it doesn't. Turnover has its own set of determinants, including the tax biases we have surveyed. Furthermore, since replacement anticipates liquidation, and the time for liquidation depends largely on the physical character of the capital in question, turnover plays a strong role in determining income and consumer spending, rather than the other way around. It is the pacer, not the paced. Consumer spending is the result, not just the cause of the ripeness and sale of goods. It is this that keeps balance between aggregate demand and supply. This is the missing link in neoclassical macro models enmeshed in consumer determinism.

Actually it is replacement, mainly, that determines gross investment which generates most income. Replacement in turn is determined by the schedule of maturity of capital in being. That analysis would seem to explain better than neoclassical macro models our current predicament. In it, replacement spending falls short because of a shortage of ripe goods, not a surplus. If there are not enough jobs to go around it results from too few goods flowing out the pipeline, not too many. A shortage of ripe goods requires that they be rationed, and unemployment is the rationing agent. If there is not enough consumption to employ all workers, it is because there is too little to consume.

What's happening is that turnover is too slow. A lot of good capital is simply wasted and lost forever too, which is worse in the long run but not very different in the short from freezing it up for twenty years. This means slow delivery of final goods, and slow recovery of capital to reinvest. How can capital be short when there is so much, and you can buy it so cheap? Easy. There is plenty of capital stuck in the ground. The shortness is of readily recoverable capital for reinvestment. The shortness raises discount rates and devalues common stock, but cannot transmute concrete into peaches or recycle 'phone poles into sugar. The moving finger has written. We have gone astray by thinking that what is good for capital is good for labor. It is a half truth, and we are now having to face up to the other half.

The microeconomic solution to unemployment is lowering the coefficient of capital and land per worker. This also contains a macroeconomic solution. An important aspect of substituting labor for capital and land is to apply labor to land more often and recover and reinvest capital more often. This increases replacement demand, which is almost all of aggregate demand, and does it without any inflation. The key to good macroeconomic policy is not net new investment and growth of capital, but turnover, recovery and reinvestment of capital. Favors to capital are not favors to labor unless they come in such form as to accelerate the cycling of capital. APPENDIX: "Replacement Anticipates Liquidation, and Causes it." Excerpt from Gaffney, "Towards Full Employment with Limited Land and Capital"