“The misfortune of a republic is when intrigues are at an end; which happens when the people are gained by bribery and corruption: in this case they grow indifferent to public affairs, and avarice becomes their predominant passion. Unconcerned about the government and everything belonging to it, they quietly wait for their hire.” — Montesquieu, ‘The Sprit of laws’
Locke (Two Treatises on Government), Hobbes (Leviathan) and Montesquieu, each in their own way influenced the writing of the American Constitution, but it was Montesquieu and his immortal ‘Sprit of Laws’ that motivated James Madison, the father of the American Constitution, to adopt a more intertwined division of powers, when it came to the three wings of the government, namely the legislative, the judicial and the executive wing, which is better known as the approach of checks and balances.
Montesquieu, in this great book, The Spirit of Laws, while highlighting many of the important learning that he derived from Hobbes, never missed to point out the inherent deficiency in Hobbes, “The natural impulse or desire which Hobbes attributes to mankind of subduing one another is far from being well founded. The idea of empire and dominion is so complex, and depends on so many other notions, that it could never be the first which occurred to the human understanding. Beside the sense or instinct which man possesses in common with brutes, he has the advantage of acquired knowledge; and thence arises a second tie, which brutes have not. Mankind have therefore a new motive of uniting; and a fourth law of nature results from the desire of living in society.”
He took from Cicero and Spinoza the essence of what the Roman nobility and aristocracy failed to deliver, which finally led to their downfall, “The natural ignorance of the nobility, their indolence and contempt of civil government, require that there should be a body invested with the power of reviving and executing the laws, which would be otherwise buried in oblivion. But easy as it may be for the body of the nobles to restrain the people, it is difficult to restrain themselves. Such is the nature of this
constitution, that it seems to subject the very same persons to the power of the laws, and at the same time to exempt them.”
But Montesquieu’s greatest contribution comes in the identification of two very important elements that coalescence the power of the laws to that of democracy, in the concept of Virtue and that of Frugality, in his words, “There is no great share of probity necessary to support a monarchical or despotic government. The force of laws in one, and the prince’s arm in the other, are sufficient to direct
and maintain the whole. But in a popular state, one spring more is necessary, namely, virtue.”
“A love of the democracy is likewise that of frugality. Since every individual ought here to enjoy the same happiness and the same advantages, they should consequently taste the same pleasures and form
the same hopes, which cannot be expected but from a general frugality.”
In the Constitution of United States of America, as the founding fathers envisioned, there is a subtle allegiance to the concept of shared power, between the various wings of the government, as they had a mild fear that concentration of power would belittle the rights of the commoner in shaping public opinion towards common good, the very root of all causes of failures of erstwhile systems of government. The checks and balances provide the necessary fillip to restore order between the executive and legislative when it came to enactment of policies and their execution, and erasing some of the pitfalls that could accrue, which Montesquieu rightly summarized as “In aristocratic governments there are two principal sources of disorder: excessive inequality between the governors and the governed; and the same inequality between the different members of the body that governs.
From these two inequalities, hatreds and jealousies arise, which the laws ought ever to prevent or repress.”
The genius of Montesquieu lies in also pointing out that taxation could well be the bone of contention, “This inequality occurs likewise when the condition of the citizens differs with regard to taxes, which may happen in four different ways: when the nobles assume the privilege of paying none; when they commit frauds to exempt themselves; when they engross the public money, under pretence of rewards or appointments for their respective employments; in fine, when they render the common people tributary, and divide among their own body the profits arising from the several subsidies.”
My current essay would try to look at how the current partisanship demonstrated by a divided polity resemble some of the passages that Montesquieu warned us more than two hundred and fifty years ago.
The Origin of the Divide: The debate on Tax-cuts and the dubious interpretation of the Supply Side Economics
Jimmy Carter left office in 1981 and left with a National debt touching $2.3 Trillion dollars. When he assumed office in 1977, he inherited a National Debt of $2.5 Trillion. This denouement between the starting debt and ending debt had actually remained quite unchanged from the time of Kennedy, to Johnson, Nixon and Ford and finally to Carter. In these years from 1961 to 1981, the National debt never changed much, $2.0 Trillion to $2.3 Trillion.
Could anyone question that these two decades were very ordinary decades that did not bring America to the threshold of prosperity through advancements in the frontiers of knowledge and technology? Were the growth rates significantly different from the other decades that followed later or preceded? The data is indifferent to any of the claims as there were many macro-economic factors that influenced as well as the changes that shook the world and made the center of gravity shift slowly but steadily to the East.
Enter Reagan in 1981 and the situation changed quite dramatically. He inherited a debt of $2.3 Trillion and when he left in 1989, the U.S. National Debt touched $4.9 Trillion. The same dramatic rise happened twenty years later when George W. Bush assumed office n 2001, when he took the national debt from $7.1 Trillion to $11.9 Trillion (thanks to tax cuts) and the momentum never got lost when Obama raised it further to $14.2 Trillion in just three years (he saved his presidency by continuing with the tax cuts to forge an alliance in a Republican dominated House), but many would attribute it to the financial crisis that struck and to the consequences that followed.
The divide in the policies that we have seen between the two major political factions that had dictated the political debate is in the area of Supply Side Economics Vs stimulating the job growth through investments in the social sectors in moderation. But the recent times have seen this divide be singled out on one single attribute of the Supply Side Economics, the issue of the Tax Cuts, and not even in the original contention, Big Vs Small government.
Sad but true that the entire nation is today divided on the issue of Tax cuts, as if that is one magic wand that would stimulate the economy. I am reminded of Gregory Minkew, when he wrote in his famous book, ‘Principles of Economics’ that this was like, ‘snake oil salesman selling a miracle cure’. But first let us examine whether the tax cuts indeed did any good in the Reagan era, that it was instrumental in increasing the National debt is never in doubt. But before that let us look at Supply Side economics in general and see what it prescribes when it comes to tax cuts.
Supply Side Economics deconstructed
The origin of the idea is embedded in Say’s Law that ‘Supply creates its own demand’, meaning that if there is a production of any goods or service it automatically creates a demand either of it or its constituent, thus meaning that supply is the independent variable, while demand is dependent.
During the decade of the seventies, when growth rates slowed down, the Supply Side Economics grew credence through the Laffer curve, which pointed out that when marginal tax rates increase, beyond a certain point the revenues starts to decrease, but it was very clear that before this point any decrease in tax rates would not increase the revenue.
There was however a subtle message in this curve that if marginal tax rates close to the threshold point were lowered it would create an incentive to spur capital formation that would in turn create consumption and growth. It also went on to advocate that such rate cuts would incentivize people towards more work and that would in turn increase the aggregate tax revenues at the end, although the rates remained lower.
This was far more credible in the area of marginal rate cuts on capital gains, as capital was then allocated more efficiently to those sectors of the economy that created better returns on investments.
But if one delves into the numbers that followed such application of supply side economics, it would be clear that there was one very simple outcome in the immediate term, which is fiscal deficit, and this therefore is no different from Keynes as this means that we are trying to stimulate demand by the multiplier effect. But by any standard if one sees the tax revenues as a percentage of GDP, it is clear that the supply side economists failed to prove their point that the lower marginal tax rates in any manner increased the aggregate tax revenues even in the short term as is evident in this graph from the Congressional Budget Office:
But this needs to be seen from the ideological stand point and here we come to the center of the debate, between the conservatives on one side and the liberals on the other, it is all about economic re-distribution of wealth and this simply cannot be left as a ‘trickling down’ hypothesis.
If we assume that capital is free to move without any impediments, it would move to the highest bidder who by virtue of his efficiency would put it to the best use. The returns from such endeavor must be shared in the right proportion so that such a result could be replicated again and again and again, gainfully. The question is if too little is left for the constituency like the government and too much is left to the efficient industry, if I can call this, then the fruits of such an industry cannot be recycled as there are so many common goods that would have to be provided for that industry cannot, like education, like health for the old people, like defense, and more.
We sometimes forget that if industry were so efficient, why does it so much depend on the government to bail them out once in every decade when the cycles force them to approach the door steps of the government to ask for special incentives, or for recapitalizing banks and businesses through special assistance? Also how can one ignore that even in the richest of countries of the world like the United States we have 14% living below the poverty line, which need to be provided for through social security programs? How can we ignore that as a follow through of many upturns downturns follow and the severe brunt of such downturns fall on the under-privileged sections who run out of jobs and must be given help through unemployment benefits? Is there any doubt that without food stamps millions of American households would be living in utter misery and without medical assistance through government sponsored programs the aged above seventy simply stand no chance of any decent medical care, when the need for such care is the highest?
The debate thus gets reduced to few against the many, and here one needs to also look at the conservative side of the story, especially with respect to ‘Bigger Government’. Any government that moves into areas that better be left to private industry is only making the wrong step of allocating capital in areas where the returns would be less efficient. Supposing in the name of government spending, we move into programs that simply drain revenues earned through tax receipts that do not intend to make long term investments in education, Science and Technology absorption in the economy or improvement in that part of the infra structure which cannot be taken up by private industry because of the nature of the public good, then such a government would be committing to wasteful fancy of a spending drive that would only augment the fiscal deficit. There cannot be any supporter of this line of government.
But there have been so many government programs that have consumed tax payer funds, some of them do not fall under the scheme of Big Government spending, but they could actually qualify easily for them like the greatly publicized War of the recent decade that took away $1 Trillion, or even more. Or the bail out of the auto industry, or the bail out of the banks, do they not fall under the same public scrutiny as the ‘Big Government’, programs? Why do we need such spending if there are so many regulatory bodies looking after the well being of the overall good?
So the debate once again goes back to a form of conservatism that points at fiscal rectitude where the brunt of the actions would fall on those who need the most of government support. But let us first see how certain myths are wrong.
America and Taxes
There is a common belief that tax rates are very high in U.S., in fact they are the highest in the world. On the contrary data shows that tax receipts as a percentage of the GDP is the lowest amongst all developed nations, thanks to the tax cuts over the several decades. The Federal tax rates are also historically low for average families, but the effect has been quite dramatic amongst the wealthiest.
The taxes thus have only one direction to go, and by reverting to the other direction, we enter into a debate that has no logical basis other than prolonging the irrational argument that a magic wand would stem the tide of defaults that would ensue.
Timothy R. Homan’s September 14th 2010 report in Bloomberg sighted many of the Moody’s Economists report how the rich actually respond to tax increases and tax cuts. Contrary to the popular belief, the rich actually start saving when tax cuts happen and spending when taxes increase. This is clear from the data from Clinton’s tax increases and Bush’s tax cut programs. The more revealing point is that the for every dollar of tax cut only 29 cents comes back as a growth driver in the economy, so it is only one of the many drivers that could kick start the current sluggishness of the economy, not the only.
The debate actually takes our eyes away from the root of the problem that the economy is based on a consumption spree and is structured in a manner that any delta change in consumption makes the economy reel under its effect and not on investments that could actually create the foundation for growth. Such extreme reliance on consumption makes the case weak, that tax cuts for the rich in effect could have not such strong one to one correlation with the growth to be desired. If there was economic redistribution of wealth, such tax cuts in effect would have had better results when orchestrated over a larger base of consumers, who would have in effect used such cuts for spurring consumption.
Lack of investment, as has been pointed by McKinsey, instead of consumption holds the true trump card. Any action that creates the incentive for investment in the economy could actually go a long way in solving many problems. Tax cuts have not in the last decade been converted into investments as is evident in the following data for U.S., as the data shows that U.S. followed all the other developed economies in terms of lack of investments. The slowing down of the real GDP growth is only a consequence of this.
What does it leave for the polity?
The founding fathers of the constitution wanted every wing of the government to create checks and balances through a deep scrutiny of the social impacts that policy decisions bring. This also needed to be orchestrated through rigorous debate amongst the various wings that would bring in the consensus needed for any proposal to finally fructify. This was the unstated goal as seen by the founding fathers. There was a strong belief that giving extreme authority to the executive wing for formulating as well as executing proposals could in effect bring in absolute power to be more concentrated. Here is where the American constitution triumphs but gets defeated as well, as we see so much in evidence in the manner ‘interest’ groups today take the better off democratic institutions.
Empirical analysis today has extended to the process of voting and selection of representatives for forming the government and economists have delved into the issues of how efficient this process is in terms of selecting what is best for the common good. It is clear that there is no efficient market pricing mechanism for votes, although many of the earlier aberrations have been removed starting with the Ballot Act of 1872, in Great Britain, which for the first time introduced secret ballot that eliminated the purchase of votes and this followed suit in the United States in the period 1888 to 1910. Garry M Anderson and Robert D Tollison in their seminal analysis ‘Democracy, Interest Groups and Price of Votes’ have summarized, “Because of laws preventing the exchange of votes in markets, votes represent an unpriced resource. While various laws against bribery of votes function both to reduce the quantity of votes supplied and to increase the price, the institutions that acts effectively to prohibit the emergence of a competitive vote market altogether is the secret ballot, which prevents enforceable contracts between buyers and sellers. Voters consequently have only a negligible incentive to allocate their votes efficiently. The various paradoxes of voting and the instability phenomena associated with democratic decision making result from this fact. If votes could be freely traded across markets, voters will act purely as agents of interest groups who bid competitively for these scarce resources.”
The analysis in this treatise brings out the fundamental point that in a democracy like America, every election provides an opportunity for economic redistribution; when one type misses to deliver greater good the next takes over. But this entails the very important role played by the interest groups in securing for themselves a major part of the benefits, which comes at a price. When this price is too much it calls for a change in distribution, but does not leave the vanquished any better.
This process of redistribution through the intermediation of the interest groups is an acceptable form of democracy as in the United States, the only question that remains is whether this redistribution debate takes into account all the major elements of economic progress, like inter-generation transfers, or the issue of the under-funded programs for the future, as interest groups for such elements hardly exist.
On the other hand there could be excesses in form of interest groups or lobbyists becoming too powerful or too big to stymie, like the Oil interest groups, or the Gun groups, or Wall Street for example, where they represent significant portion of the GDP and wealth associated with it. Industry groups by and large although fragmented could still operate in the State jurisdictions although some of them could still be strong in the Federal structure; there is enough information available in the public domain about some of the abnormalities related to either tax exemptions or other forms of subsidies that many of these industries enjoy that sharply contrasts the true equity that these measures are supposed to bring in for the general good.
The proliferation of interest groups and the increase of the size of the government in modern democracies like America leave us with some doubt that the checks and balances as provided by the founding fathers have been misdirected to some extent to create the veneer of separation of powers. What we can see is that such checks and balances have little served the real purpose of democracy as advocacy groups have known how to transfer certain vital issues to the back burner of all debates thus screening the ones that serve the interests of certain groups to a higher priority. This stems from the very deficiency of the structure, namely, the federal system, the bicameral legislature, judicial review, presidentialism, and the electoral college system.
Our belief in the legitimacy of the constitution and the legitimacy of the democratic principles can only be put to test in reviewing whether some of the fruits of democracy have better prospered in America, like racial integration, economic equality or the rights of women and whether the needs of the current generation are kept in fine balance with the needs of the future generation.
It leaves us with a mixed feeling that it would depend on the interest groups to stand up to these vital needs of the peoples, and the debate on tax cuts is just one of the many that are unwinding, that want to delve into the challenges of the future; economic redistribution must usher a higher purpose, that of bringing in greater resilience for the future generations to grow the equity, not be rent collectors of the little remnant of wealth that we would leave behind.
Montesquieu was right in pointing out that, “A love of the democracy is likewise that of frugality. Since every individual ought here to enjoy the same happiness and the same advantages, they should consequently taste the same pleasures and form the same hopes, which cannot be expected but from a general frugality. The love of equality in a democracy limits ambition to the sole desire, to the sole happiness, of doing greater services to our country than the rest of our fellow-citizens. They cannot all render her equal services, but they all ought to serve her with equal alacrity. At our coming into the world, we contract an immense debt to our country, which we can never discharge.”
The question is whether America believes in the love of frugality and equality, as true reflection of the democratic principles. America is greatly indebted, but what about debt to the country that each individual has to discharge, at the end, to the country?
20th April, 2011