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There once was a family that sat down to do its taxes. The family usually overwitholds a small amount each year – not enough to make it a real economic cost, but enough so that it is unlikely they will have to make tax payments at tax time each year. In 2010, when they were expecting a small tax rebate, they found that they would be getting an additional $2,800 than they had planned on when they had make their consumption, saving, withholding choices a year earlier. $800 of this comes from a new “Making Work Pay” credit that I get just for being good enough to remain employed. $2,000 comes from a new child tax credit which may or may not expire at the end of this tax year. My irrationality led me to forget about the $2,000 we got last year from that credit, but the $800 credit is entirely new.

What did we do with this extra $2,800? We are sitting on it. Why? Because we have no clue whether or not these credits will be there in the future. If I knew that both would be there every year in the future, I would immediately reduce my withholding from my monthly paycheck – so that I’d be taking home roughly $150 more after-tax each and every month. We would probably save half of this and spend the other half. This savings would be channeled into discretionary retirement contributions.

However, we cannot count on these being here in the future. With the tax-loving and suddenly deficit conscious corporatists in office, we are sure to see the child tax credits expire (they are evil relics of the hack Republican-corporatists that preceded the current regime) and we have no idea about the Making Work Pay credit. My expectation is that it will go away, and beyond that, I expect my taxes to increase in order to pay for the entitlement growth and pending health reform and energy initiatives. So my wife and I are sitting on that money. We want it to be able to make our future tax payments if I get my withholding estimates wrong. We want it as a rainy day fund just in case something unexpected happens to us. We certainly are not going to spend it. We certainly are not going to use it to engage in any long-term planning or “investment” project. For example, we could sign ourselves up for memberships in various clubs or organizations that we have long wanted to do – but we do not wish to go through the work of getting into these organizations, only to have to withdraw from them later on. We may pay down some debt with it – but we really only have a 5% mortgage and a small amount of tax-favored college loan payments¬† – so we are better off sitting on the cash.

In short, we really have no clue what to do with this $2,800 windfall, because we have no clue what will become of it in the future. And I do not think that my behavior is crazy or irrational. Now imagine a business trying to make similar decisions, but when the stakes for them are extraordinarily higher. Perhaps they made a decent profit this year. Should they expand and hire more? Maybe, but what if a payroll tax levy to pay for national health programs is instituted? That could eliminate profitability pretty quickly, and also get the business tied up in long-term investment projects and employment relationships that are costly to turn back on. Maybe corporate income taxes will increase? After all, that was a direct suggestion in the State of the Union? But maybe my industry will get favorable tariff protection? Or maybe my industry will be susceptible to increased unionization efforts? Or maybe the minimum wage laws will significantly change over my planning horizon? Or maybe environmental regulations will change during my planning horizon (e.g. so, should I build my new office to burn gas heat, where should I build it, etc.?). Do I finance my new expansion with debt or equity or via merger or other strategic partnerships (and how will the inflationary environment affect this, or anti-trust law?). These and thousands of other decisions face employers every single day. And nothing in the current policy environment is providing any sign that stability and clarity is coming any time soon.

Aside from the frictions that you would expect in a labor market when the “economy” is reallocating resources away from housing and finance and into other more valuable sectors, the regime uncertainty is, in my view, a bigger worry for those folks who worry about high and persistent unemployment.

One Response to “Parable for the Macroeconomy”

  1. Harry says:

    Exactly, Wintercow. Next time you are on the shuttle with Chuck Schumer, I expect you to explain this to him. I hope the event occurs shortly after his next speech about “disgorging profits.”

    While we are on the subject of demagoguery, I’d like your thoughts on a different topic, namely the simmering fear of China holding so many treasury securities, which they recently said they planned to sell.

    The reason China holds so much debt is that we have paid them dollars voluntarily for goods we think are worth the price. Those dollars are actually federal reserve notes or other sorts of promises to pay in Federal Reserve Notes.

    What the hell we expect the Chinese to do with these notes?

    Evidently for whatever reason they have chosen to convert these notes due immediately for other notes, like t-bills or t-bonds, and suddenly it is revealed we are indebted to the Chinese. Big surprise.

    I bet they also have chosen to exchange many dollars for Australian coal, too.

    Recently the Chinese have been getting antsy about holding t-bills and bonds, figuring that maybe it is time to cut their losses. Maybe they have been secretly been watching the Gordon Liddy commercials on Fox, and have figured an annual return of .987% might not be a good deal, even if they decide not to convert their dollars to gold. What they do announce is that they will be sellers of dollar promises.

    This should be good news to investors who are also stuck with dollars, since interest rates should rise, and the Chinese are among the first to run for the door.

    It also is bad news for our country, a big debtor, which will face rising costs to refinance its debt, which invariably will burden all of us. Running any business financed by debt will be tougher, and whatever might be paid to employees and owners will be less, resulting in less tribute being paid to our government masters, who will want to disgorge more from us.

    In this arena the Chinese are no more our enemies than the
    Australians who sell the Chinese coal, or Costa Ricans who sell us golf shirts and bananas.

    Come to think of it, after you talk to Chuck on the plane, why don’t you ask him to lunch to discuss this? I’d be happy to pay even if I could only make it for dessert and coffee.

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