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Elections & Economics: Understanding the Relationship Between Government and the Economy

Elections & Economics: Understanding the Relationship Between Government and the Economy

August 15, 2023

Election season is right around the corner! Can’t you just feel the excitement?!

All kidding aside (for now), it’s most likely not lost on anyone that our politics are currently and particularly contentious—don’t worry, we won’t be jumping into that viper pit.

Instead, we can use politics, which might be best understood as the drama that surrounds governmental policy, as an entry point to delve into the talking points that typically surround policy. In particular, the main concern here is the fact that elected leaders like to take credit for the positive outcomes of policy and distance themselves from the negative outcomes—after all, that’s how marketing works in politics if someone hopes to get re-elected.

Government and the Economy

If you’re not familiar with Reaganomics, then maybe you’ve heard of Bidenomics. I have to be honest and say that I don’t know what these terms are supposed to mean, if not that the person whose name is being invoked has discovered some secret economic sauce. The problem is that economics are economics, and no amount of marketing can change that. In other words, there is no such thing as a secret sauce—there are only those leaders who embrace sound economic principles and those who don’t.

Broadly speaking, it’s probably no secret that governmental policy can go a long way toward determining how well the economy functions. What governmental policy cannot do, however, is explain the simple fact that an economy exists, nor can it substitute its own factors for the ones that fundamentally drive the economy.

It should be no secret, but the individual arrived on this Earth prior to government—after all, the government is comprised of individuals. If the individual preceded the government, then so did the needs and wants of the individual. The needs and wants of the individual are the fundamental factors that drive economic activity—e.g., the whole reason anyone works is that there are things individuals need and want. If the individual, his/her needs and wants, and his/her economic activity all precede government, then the individual must be the essential component that explains the fact that economies exist and why the health of an economy matters.

If an individual has needs and wants, then this means he/she does not already possess the things that are needed and wanted—otherwise, they wouldn’t have a need or a want. It follows, therefore, that the individual must interact with others to obtain that which is needed or wanted. The primary means of interacting involves the exchange of something an individual does possess for something he/she does not. What this establishes is the simple fact that economic activity must involve two parties, with the interaction between two people commonly known as a transaction.

Transactions and Taxes

Maybe the most important consideration about a transaction, though, is that if an exchange is taking place, then this means that negotiation is involved. In one sense, individuals negotiate with themselves: what I am willing to supply for what I demand? Alternatively, what do I demand for what I am willing to supply? The most conspicuous negotiation that takes place, though, is the one between the two individuals involved in a transaction.

Fundamentally, the purpose of a negotiation is to establish an agreement. The agreement in an economic transaction centers around what will be exchanged: If price is what you pay and value is what you get, then this means that one way to understand a transaction is that it is evidence of an individual’s perception of value—i.e., it defines the value that the individual believes he/she is receiving.

Something else that should be understood about a transaction is that it is the unit upon which income and sales taxes are built. To put it another way, in order for an income or sales tax to be levied, a transaction must take place. When it comes to income taxes, it might not be so obvious what transaction is taking place. Well, if a transaction is an exchange, then an employed individual is giving their time in exchange for a paycheck.

By far, taxes related to income, or employment, represent the bulk of the tax revenue that the government collects. Between 1945 to 2019, individual income taxes comprised 40%-50% of all tax revenue collected, and the majority of the time it was closest to 50%. Payroll taxes, which tax the exact same transaction of employed individuals, have grown to represent about 30%-35% of all tax revenues collected. So, between those two sets of taxes, they comprise about 70%-85% of all tax revenues collected.

An enlightening fact about the taxes that are levied on transactions is the fact that losses are not taxed. The implication of this is that the impact that most transactions have on an individual’s wealth is at least neutral. If most transactions resulted in losses, again with income and sales taxes not being levied against loss transactions, then that would be a poor way to generate tax revenue. Further, if a transaction defines value, and if most transactions resulted in losses, then it would be difficult to discern why someone would participate in most transactions.

Can't We Just Print Money?

Now, some of you might be reading this and saying, the government doesn’t need to tax us to ensure it has money—it can just print it, like it’s been doing, for however many years. In case it’s not obvious, the reason someone might say this is because of the myriad programs the government has rolled out that have resulted in the significant growth of our money supply. While the statement about the government “printing” money is not necessarily a complete falsehood, it’s also not necessarily a complete fact, either.

The reason why it’s not a complete fact is that the government cannot, and does not, simply print money that it immediately spends on goods and services, in a similar sense as to what we probably understand an individual to do with income from a paycheck when they are acting as a consumer. This obviously begs the question of how, exactly, the government gets its hands on the money it “prints”.

Well, what it must do first is use mechanisms and facilities to distribute the “printed” money into the general economy. Two quick examples to serve as evidence of how these work are quantitative easing (QE) and the Paycheck Protection Program (PPP).

Principally, QE was a program whereby the Federal Reserve purchased bonds in the open market—a.k.a., the secondary market. The basic objective of this program was to increase liquidity, directly and indirectly. Direct liquidity was provided in the form of the cash received by investors, from whom the government purchased bonds, while indirect liquidity came in the form of loans with cheaper interest rates. Theoretically, an increase in liquidity leads to an increase in economic activity—i.e., transactions, which the government taxes.

PPP was a loan program aimed at small businesses, including sole proprietors. The CARES Act created the PPP Liquidity Facility, which was the official program through which funds were loaned to Small Business Administration (SBA) approved commercial lenders, who then loaned money to small businesses. A forgiveness element was included, and later enhanced, that served to maximize liquidity for some because any amounts forgiven did not have to be repaid. Again, the objective was to stimulate economic activity with increased liquidity, which ultimately leads to tax revenue.

Even though these types of programs mainly involve the interaction of government and business, that would seem to be more a matter of efficiency, let’s say, as opposed to a bias that the government holds, favoring businesses over individuals. The reason for that is because, in the case of QE, it is much more cumbersome to cobble together a grouping of 1000 individual investors who hold one bond than it is to simply interact with one institutional investor who holds 1000 bonds. It is only through purchasing large quantities of bonds, by the way, that a program like QE can achieve its liquidity goals—a few bonds here or there just won’t have the desired impact.

PPP presents a similar story, though it is one that is more focused on the individual. While only 12% of businesses are sole proprietorships, every business on Earth must ultimately be designed to meet the needs and wants of individuals. We know this for the same reasons that apply to the government: the individual preceded business and businesses are comprised of individuals.

So, not only is it beneficial to the individual for their employer to be in good shape, but PPP was expressly crafted with the individual in mind. The reason we know this is because its entire purpose was to create a way to help businesses meet payroll, thus ensuring that individuals could remain employed. This proved to be a necessity for many businesses and individuals because no matter how essential they might have viewed themselves and their income, large numbers of people were forced to stay home because of governmental policies related to Covid that deemed them “non-essential”.

If programs like QE and PPP stimulate the economy, then why doesn’t the government enact legislation to create these kinds of programs more frequently? In addition to the simple fact that those programs are more exceptions than rules, another important fact to consider would be that these programs tend to come about during periods of significant economic distress. What this would seem to indicate is that there are negative consequences that can result from these programs, thus they are saved for when they are absolutely necessary.

If the government cannot establish such programs more frequently, or even in perpetuity, then this must mean that the government can only stimulate the economy on a temporary basis. In contrast, the needs and wants of an individual will never cease, as long as there is one person that inhabits the Earth. What this means is that the government cannot be the ultimate savior of the economy—only the individual can claim that mantle. It would seem to follow that governmental policy should be evaluated on the basis of its impact on the individual.