Jul 13

Keynesian economics, that economic theory that is once again running the country, was shown to be a complete sham this past Tuesday by a fifth grade student in small Midwestern town during a routine math assignment.    The student’s teacher and school principal were impressed enough to issue a press statement, excerpted below:

“I was working on my decimal and percentage multiplication for homework”, the student said, “and I could hear my dad complaining about how his paycheck was smaller because of all the taxes they take out.  He said his check was about 75% of what he earned.   I asked him where the other 25% went and he said to the government, but that the government was spending a bunch of that money to stimulate the economy.”

“So I thought some more about that, and it occurred to me that they can’t simply take whatever they tax from my dad and spend it somewhere else, because some other moms and dads working for the government have to get paid, too.    Of my dad’s taxes, I bet they can probably only spend maybe half of that on stuff they think will grow the economy.   I know they can actually spend all of it, but then to pay for the government workers and the things they do, they have to get even more money, which is probably what all the borrowing and debt is for that I’ve seen in the papers.”

Johnny (not his real name) described his thinking in mathematical terms to his teacher:

“If they take $1000 in taxes from my dad, but can then only put $500 to work on the stimulating stuff, then to break even that stimulus would somehow have to double the $500.  That would be a 100% rate of return.    And if they don’t get everything back that they took from my dad, then why bother taking it?   It seems like that would just create other problems.

Sometimes I see my parents watching CNBC and on that station they’ll brag about people who’ve made like 18% or more, on their investments,  for a long time.    It seems to me like the government is trying to do more than five times better than that!

I went back to my math, and said, well, what if they just wanted to match the 18% like the guys on TV?   Let’s start with the $1000 they take from my dad:  If they invested about $847 dollars (1000 divided by 1.18) from my dad, and then earned 18%, they’d get the $1000 back. Using $847 is $347 more to spend on stimulus than my guess of the $500 they spend now.  That leaves $153 (1000 – 847) of my dad’s money to pay for themselves and whatever else they do, or about 15%.

But earning 18% only gets back what they take from my dad.  They’re still not matching what my dad would have done with the money.   Say my dad can do 7% (he’s not on TV), so that one year later, his $1000 is now $1070.  That means the government actually needs to make about 26% on the $847 ((1070/847)-1), which is harder still.

Something doesn’t jive though, with the government only needing 15% for themselves, because they take more than that from my dad, and way more than that from some other people.   That wouldn’t be fair if they took more than they need, so they must need more than 15%, which means they have to earn way more than 18%, or 26%, with that stimulus to match my dad.

I think if they were that good, people would be rushing to have them manage all of their money, except I never see that in the papers, or on TV.   I can’t even find stories about that with Google, and there’s no Facebook Page for it either (although I did find the opposite.)

I know that the government spends money on a lot of other stuff, like the military and schools and roads, so that just means that of my dad’s money, maybe my first guess of them spending 50% of it for stimulus is still much too high.   That means even less money can go to stimulus, which means they have to earn even more than 100% for the stimulus to have worked!

So in the end, I don’t think they ever get all of my dad’s original $1000 back, let alone beat him, which just seems bad all around.   They should just let my dad keep his money and do what he wants with it, even if he never gets on TV.

John Maynard Keynes

My teacher said that what I was describing, with the government taking money from some people and spending it to help the economy was kind of like the theory of a famous economist named John Maynard Keynes.  I Googled him and came up with a whole bunch of things.

An economist who writes for the New York Times named Paul Krugman was basically wanting the government to spend a ton more money.  He seemed kind of angry about it too, like people weren’t listening to him.   His basic idea is that because the people aren’t spending their money, the government has to do it instead.   I think he’s forgetting that they have to take the money from the people first, which seems a little like my dog chasing his tail.

Then I found another story from a guy who responded to some make-believe assignment from another economist named Robert Reich, who also wants the government to spend a lot of money.   That story was kind of silly, talking about sand diggers — I had one of those and hit my brother in the head with it — but it kind of made sense, too.   Where a lot of people made reference to a Keynesian Multiplier, that sand digger story made a good case that it was actually a ‘Government Subtractor’, and it’s pretty obvious that my math shows that.   At least, it is to me and my teacher.   Maybe to you, too.”

As it turns out the teachers had a good discussion about Johnny’s homework assignment as well.   The head of the social studies department had this to say:

“The staff got to talking about the issue, and it begged the question, ‘Given that the math, and actual experience itself, shows that it basically can not work, why does Keynesianism live on?’   The really simple answer is that it is an economic theory tailor made for government, and big government in particular.   It empowers the politicians to act with a cloak of intellectual authority as they repeatedly attempt to ‘do something!’ about every this-and-that in the economy.

Several years ago I sat down with my state assemblyman to talk about the state’s budget crisis, which is now much worse.   I was impressed by his willingness to meet and talk, even though going in I knew we wouldn’t see eye to eye.   He told me how even cutting something as innocuous-sounding as a bus route can be impossible, as politicians are supposed to give things to people, not take them away.   When I suggested that by cutting spending, he’d be giving people their long-term financial security, he just smiled.

So then I said, ‘Why don’t you just agree to not take anything away, but not give anything new, either?’  — the whole ‘when you’re in a hole, stop digging!’ approach — and that with the right pro-growth policies, the state could grow its way out.   I’ll never forget: he just slumped back in his chair speechless, but with a look that was some bizarre combination of ‘Why didn’t I think of that?’ and ‘Truly you must be joking.’   In any case, it was a very eye-opening experience for me, seeing the mindset of someone with the power to actually make a difference.   I mean, he gets to vote on legislation, and I don’t.

When you combine that mindset with a voting population that is — and this is just the unvarnished truth — increasingly economically illiterate, you have the recipe for a real mess.   I mean, the textbooks spend so much real estate on FDR and LBJ’s Great Society, and with the teachers unions being puppets of the state, or visa-versa depending on who you ask, they’re not going to rock any boats with the curriculum.   A bunch of Johnny’s dad’s stimulus money is just keeping them employed.  You know I couldn’t even say that if we were a public school — no tenure for me, thank you.”

I suspect Professor Krugman is getting increasingly agitated by the current situation because he’s realizing his gig is up.   The snake oil isn’t selling the way it used to.   It’s getting increasingly clear to most people that his beloved theory of Keynesian economics, with all of its manifestations and applications, rather than running the country, is in fact running it into the ground.

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65 Responses to “Fifth Grader Discredits Keynesians!”

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  8. Michael says:

    Hmm, well it’s nice to see that little Johnny Anonymous is taking an interest in economics, it should come as no surprise that the kid knows not of whence he speaks.

    The Federal government, as the issuer of the currency, has neither need nor want to take Daddy’s money in order to spend. There are reasons that the IRS insists that Daddy’s taxes be paid (upholding the laws duly enacted by the representatives of the people in congress assembled, chief among them) but there is no functional requirement that taxes be collected in order for the government to spend its own currency. Unlike Daddy, who must earn and collect pay in order to spend, Uncle Sam faces precisely the opposite situation: the US can hardly expect people to pay taxes unless it has first created the dollars needed to pay them, by spending.

    Little Johnny, unworldly youngster that he is, also doesn’t seem to realize that government employees, like his own parents, actually spend their paychecks, purchasing goods and services from the private sector merchants that produce them. So in no way can their pay be considered a loss of national income, any more than that of any other employees. When US workers are paid more, regardless of who they work for, the national income increases. Even an average fifth grade math student should be able to grok that.

    It will surprise no one who knows anything of economics that a 10 year old boy is entirely ignorant of the subject. What is more alarming however, is that any adult reader, and Johnny’s teachers of social science in particular, would find anything approaching merit in his uninformed and understandably childish “rebuttal” of the General Theory of Employment Interest & Money, which he is alleged to have absorbed by Googling Keynes.

    If the readers of this blog would take the time to actually read the work of Mr Keynes, perhaps they too could gain some insight into the subjects (again, Employment, Interest & Money) that are discussed therein. Certainly no economist would assert that this book, easily the most influential publication in the field of the last century, has been discredited. Least of all not by some kid.

    • Patricia says:

      But little Johnny most likely sees the government as the big bad guys, sitting on their thrones drawing big fat paychecks. He sees only what his father makes and how much the GOVERNMENT IS TAKING AND SPENDING! He’s a fifth grader, think about it. You have had history classes, just how much do you think the book reveals and just how much truth is told by reporters on TV?

    • Andy says:

      Too funny: someone who doesn’t know the difference between “wealth” and “currency” lecturing about how others are economically stupid! The idea that wealth flows from the government printing fiat currency is “priceless”, if you’ll excuse the pun.

      Here’s a book that any of you out there can read that will teach you most of what you need to know about economics in simple form http://www.amazon.com/How-Economy-Grows-Why-Crashes/dp/047052670X/ref=sr_1_1?s=books&ie=UTF8&qid=1291158778&sr=1-1

  9. Joseph says:

    The people working for federal agencies, bureaucracies, are dammed by the
    walls of redundancies and useless regulations.
    The creative free flow of capital that moves goods and services is retarded.
    When the creative souls of individuals are allowed freedom, then true
    prosperity will result. The varied talents can be expressed. This is directed not
    by some government dictate, but by the Spirit that was fused in the individual
    by the Creator.
    The energy department, established in the 70’s did not solve the problem:
    dependence on foreign oil.
    The education department, established around the same time, did not improve
    schooling in America.

    • ed says:

      wow, God loves capitalism.

      as a person who is talking about God, you probably know about that doctrine of Sin. or the sin of greed. or the fact that a lot of kids whose parents don’t happen to be wealthy never get the chance to develop the talents they could if someone would cut their parents a break. this kid wants his dad to pay less taxes so they can spend more at the store. i would want my dad to pay MORE in taxes so that other kids might have had a chance to go to college.

      i grew up pretty bourgeois and i never heard the end of my dad complaining how the government took his money which he was going to spend which would be “Good for the Economy.” however, after living on my own i realized that other kids in other families weren’t growing up with the advantages i had and that no amount of consumer spending on my family’s part is going to do anything but create more demand for more low-wage service sector jobs and cheap goods from China.

      • Andy says:

        No one has hurt the poor more than government, who continually tax the poor disproportionately, e.g. farm subsidies and import tariffs drive up the price of food; food represents 70% of a poor person’s expenditures, but a much smaller percentage for wealthier people.

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  11. […] through logic and math. Awesome article and one genius of a kid. Probably a future Mises. Fifth Grader Discredits Keynesians! "Only government can be capable of missing the irony of ordering people at gunpoint to be […]

  12. Jeff says:

    Wow. Nice find. I cant believe he is in fifth grade. This wasnt even brought up in my high school! I think we may have a future Austrian on our hands.

  13. RUFUS LEVIN says:

    But…..what ever happened to “trickle down voodoo economics”.

    Or guns vs. butter

    or beggar thy neighbor

    or damn the torpedos, full speed ahead?

    All I hear today is stimulating black liberation theology and how stupid the Cambridge police force are.

    • Patricia says:

      BLACK LIBERATION THEOLOGY, what does this have to do with the main topic? Come on speak on the issue not the color of it.

  14. […] Fifth Grader Discredits Keynesians! "But earning 18% only gets back what they take from my dad. They’re still not matching what my dad would have done with the money. Say my dad can do 7% (he’s not on TV), so that one year later, his $1000 is now $1070. That means the government actually needs to make about 26% on the $847 ((1070/847)-1), which is harder still." (tags: economics libertarian) […]

  15. Michael says:

    Maybe this is what a smart 5th grader sounds like when he’s not being drugged with Ritalin. Who remembers anymore? Still, after all the blah about who wrote it, it still makes the point. Keynes was a tool whose bent economics has hurt far more people than it ever helped. Copy and paste everywhere. Yoink!

  16. […] read an article linked at Real Clear Markets about a fifth grader who reasoned and worked his math through why Keynes can’t possibly […]

  17. Kletus McLoving says:

    This is BS and probably a hoax by tea-baggers. No 5th grader would have that kind of understanding. The hitting-his-brother-with-shovel story makes it obvious. Where is the screening for these things?

    • Andrew says:

      This is satire.

      And Jonathan Swift didn’t really want people to eat babies.

    • Adminstrator says:

      Is the “understanding” of the 5th-grader wrong in some way? Was the math incorrect? Should I use the same screening that sites like, oh, dailykos use?

  18. David says:

    Of course the whole point isn’t that Keynes said “raise taxes to increase stimulus!” That’s not Keynesian. Instead, the formula is: LOWER taxes on consumers, RAISE taxes on producers, LOWER interest rates to produce inflation, RAISE government spending on infrastructure projects and public welfare. It’s not supposed to work because of straight ROI, it works because of introducing strong structural changes to the economic forces at play and letting them move forward of their own accord. Let us see our little 5th grade genius work that one out. Or is he and his dad too much in the pocket of big business to consider more taxes on the rich?

    • Andrew says:

      How will raising taxes on producers help, and how is it Keynesian? When I took Macro 101, I was told that Keynes preferred government to issue debt and increase spending. This debt, of course, must be paid for by investors who then choose not to invest in private firms. If the Keynesian activist policymaker instead resorts to raising taxes to pay for spending, this again takes money out of the economy to spend. The only way government can actually increase growth is if it creates goods that people or firms (and thus eventually people) benefit from.

      Keynes himself said to dig a ditch and fill it again would suffice, but this benefits no one. And the Keynesian ditch is why Keynsianism fails.

      • David says:

        First, I literally just went to the wikipedia page on Keynes and read about what was proscribed. Actually, it’s not so clear what is meant by “Keynesian Economics” anyway because there’s Keynes, Keynesians, and New Keynesians. But regardless, the general notion isn’t so much *particular policies* as it is freeing up more money for consumers to spend while using government spending to make access to credit and access to goods more favorable. The worry of providing more money to the producers is that they may not be as likely to spend the money and help the economy.

        But whatever. Maybe it works, maybe it doesn’t. What I’m more concerned with is the preposterous notion that somehow Keynesianism has been “disproved” because of a single ROI calculation. What this “kid” calls Keynesian doesn’t necessarily sound like Keynesian, but does somehow sound like the eternal drumbeat of “lower my taxes!” Since many advocates of stimulus would like to finance it with higher taxes on the wealthy, it doesn’t pass the smoke test. It smells like shilling for big interests once again. Doesn’t matter if it works or not. What matters is that we allow billionaires to be taxed like millionaires!

        • Dean says:

          Ha ha, thanks for trying to argue economics using wikipedia…
          Moniterism, Rational Expectations, Neo Classicalism, and the Austrian School, as well as history, have all disproved Keynes, Keynesism, and New Keynesism.

          I’m not really sure how raising taxes on producers helps, considering that always results in firms reducing costs, i.e. firing workers, searching for new cheapers areas to produce, i.e. Japan and China, passing the incidence of the tax along to consumers in the form of higher prices, or lowering savings, i.e. investment and innovation, resulting in retarded growth in both the short and the long run, thus prolonging any recession.

          Government is also much more inefficent at “spending” money than consumers are, as the 5th graders argued, and taking resources and workers out of the private sector and forcifully redistributing them to the public sector merely points out how more efficiently the private sector could be allocating such resoources with the price system, aka the free market. Now, lets not get into a discussion of institutional economics, witch deals with how government and buisness institutions, by colluding together, manipulate the market to create artifical monoplies and certain benefits to specific companies, industries, while harming other firms that didn’t have the chance to persuade government to change the rules to help themselves out. This can only occur when government opperates outside of its consitutional restrictions.

          Of course, any idiot would agree that lowering taxes is a good thing for consumers and the economy, so Keynes or a hobo basically could have sneezed and that logic would have appeared on the paper.

          Medling with the interest rates casue great disequilibirum in the supply and demand of loanable funds, and since the interest rate is argueablely the “price of money” or the cost of holding money compared to investing it (which is influence by time prefernce). Does no one remember that low interest rates (below equillibirum ) spurn too much investment, (a boom!) which is accompayned by a bust, where the market compensates for the low rate by individuals refusing to supply loanable funds for such a low amount of return, and an inevitable rise above the equillibrium interest rate. Same thing happened in the housing market.

          So there, I’ve just disproved Keynes for you, using ideas from varing other economic schools of thought, or you can argue that animal spirits do really control the entire economy, or go on to try to justify the ISLM curves and the supposed government spending multiplier.

          • Adminstrator says:

            Note that ‘Dean’ is not the author of the piece.

          • Andy F says:

            Could somebody show me where Keynes ever advocated a tax increase given our current situation?

          • David says:

            That’s a pretty smug answer. And it makes smug assertions that don’t necessarily constitute proof. And it smugly misses the point, in that I wasn’t trying to make an argument for or against Keynes. The point is that there are always thousands of people who provide justifications like yours for cutting government services and lowering taxes on the wealthy, and the most ascinine usually involve claims that it’s for the public good. This cute little parable about a boy’s calculations on government spending seems to fall into that realm. It’s an overly simplistic, overly moralistic fable.

            By the way, the government can be inefficient, yes – but so can businesses. A business can be super-efficient at creating profit, which often means that customers, employees, and the general public good all get shafted in the process. Large corporations would love to step in and do what the government does because it would give them an opportunity to siphon off so much more cash. But out of the other side of their mouth they have this drivel about how they’re 9000 times more efficient. Like hell they are.

          • Adminstrator says:

            David,

            No business can be so “super-efficient at creating profit” that all other parties that deal with them get “shafted”. How many private-sector businesses do you routinely tolerate getting shafted by? Not many, I hope. So therefore, such businesses don’t last for long, and get replaced by those that provide the best products and services to their customers, as defined by the customers.

            Conversely, you can’t opt out of dealing with the government. They can shaft you every time and you still have to deal with them.

    • Adminstrator says:

      Just curious, what role should “big business” play in lowering the unemployment rate?

    • xavier says:

      Well as any business owner will tell you, when taxes go up they just bypass the cost to the consumer. Its easy to say “lets raise taxes on big business” but the truth is that they will offset the tax by increasing prices shifting the cost to me and you.

    • Marc says:

      Unfortunately the rich do are not going to get taxed nor do they ever get taxed. How much do you think David Rockefeller and George Soros pay in taxes? Nothing..

      The whole idea that we are doing something different is a facade. It is the same corporate fascism we have seen for the past two decades. The poor get poorer and the rich get bailed out on our tab. Even if they did raise taxes on the super elite they have already made off with trillions of our dollars, which we printed out of thin air, which will severely debase our currency. There is no escaping that

    • John says:

      David,

      Sorry, but I just have to call you on your claim Keynes’ economic thinking “it works because.” Please cite specific periods of history in the US that proves “It works.”

      As I said in another post if you read Domitrovis’s Econoclasts there is no time from 1913, when Keynes ideas have been proven to have worked when tried. Domitovic’s historical review of economic growth or lack thereof from 1913 to the present is the among the most comprehensive that I have found. He found just the opposite to be true, success in taking the country out of economic down turns can only be attributed to periods of planned across the board tax reductions being enacted, be under Democratic or Republican leadership.

  19. […] July, 2010 The Civil Society has a fifth grader explain why Keynesian economics, the spendthrift supply-side […]

  20. JJTV says:

    This is an excellent example of how a person (It is obvious a fifth grader did not write this article) completely misunderstands our modern monetary system. The major arguments against fiscal stimulus assume either that the US is under a commodity based monetary system or that the economy is operating at full employment.

    The first error the author makes is in assuming that tax dollars go to pay for goods and services in the economy. The point of taxes, in a modern fiat system, is to regulate aggregate demand. When the government wants to decrease aggregate demand it raises taxes and when it wants to increase aggregate demand it lowers them. (I agree, along with most economists, that taxes should be decreased or there should be a payroll tax “holiday”). The government is not revenue constrained when it comes to spending in its own currency. When the government wants to spend it credits reserve accounts at the Fed and debits bank accounts. If there are too many dollar reserves in the system the government issues Treasury securities to absorb the reserves and increase the interest rate.

    When Ben Bernanke was poised the question “what are you doing with our tax dollars” by a US senator he replied in a nutshell “Nothing, we are simply changing numbers up and down in federal accounts”. In a fiat system, stimulus is paid for by increasing dollar reserves, and it is never determined by tax revenues. In the face of decreased effective demand the government has two policy options: decrease taxes and increase government spending. Neither one on its own will effectively work….there needs to be a mix of both GOOD spending and tax cuts.

    • Adminstrator says:

      I’m glad it was obvious that indeed, the fifth grader is fictitious.

      There’s only so much one can write without people clicking away out of boredom. I think you’ve missed a main point of the Keynesian debate, which is that there is no basis for the government to try to divine what the appropriate level of “aggregate demand” is, or to make any attempts to “regulate” it.

      For example, as people have been recently shocked into saving more and spending less, including demanding less credit, on what basis does the government declare that that activity is wrong or bad and must be corrected? What group of people in government are collectively smart enough to get that right, and what damage do they do to the economy as a whole as they try to figure it out?

      I’ll leave it at that.

      • ed says:

        i think it’s good that people are spending less and saving more, but this behavior has actually caused a drop in consumer demand meaning that it is taking away jobs from workers who are no longer necessary since demand for goods and services have decreased.

        entrepreneurs, businesses etc. probably don’t see any point then in using their existing capital to increase levels of production or start new business ventures since there is less spending going on. this means that unemployment and underemployment is not likely to decrease.

        i guess what i would say is outside of the government then raising taxes on the wealthy (who currently don’t have a lot of incentive to use their wealth to create new jobs since people aren’t spending and aren’t likely to return to prior levels of spending) and then using that revenue to say, pay workers to do useful jobs (like all the hundreds of thousands of teachers who have been laid off) i don’t see a way that unemployment is going to decrease.

        this isn’t exactly Keynesian or anything, just the notion that if we leave things as they are we won’t put a dent in unemployment nor do we do anything about the fact that yes, the government does do some important things like provide education, law enforcement and road maintenance. all of those have been cut in many areas at present which isn’t going to help the present or the future be any brighter.

    • John says:

      JJTV, have you read Domitovic’s “Econoclasts?” History would surely point to tax cuts as being the principle driver of boosting growth. And lets not forget the individual, with the fruit of a tax cut, will most likely spend most all of it. And all of the tax spenders spending is GOOD, as you agree. If fact what makes the Government stimulas spending anymore good than what the individual decides to spend?

      What we have seen this past year is principly so called stimulas spending with minimal tax cutting. In fact what is being promised is increased taxes on all fronts much of it being justified as penalties for past abuses on the part of business. Why would the institutions of business want to invest and spur growth faced with this damaging outlook and policy promised by the current leaders of our Government?

      The pendulum has to swing greatly to the tax cutting side if we are to get our economy moving forward. History says this is how things work in fact. It is not theory, it is fact and today those in charge prefer to spout theory and ignore facts, causing great harm to all of us.

      • AndyF says:

        Does the benefit from these increased tax cuts come in the form of increased consumption or increased investment spending? On one hand John says that people will spend “most all of it”, which infers increased consumption expenditures, and on the other hand John says that “what is being promised is increased taxes on all fronts”, which implies that individuals and firms would save today (the “Ricardian Debt equivalence theorem”) to offset increased tax liabilities tomorrow; which means both decreased investment and consumption spending. Both of which would amount to decreased saving (and supposedly investment); assuming that investment is what drives sustainable economic growth. So, I guess I’m confused, please let me know exactly what kind of tax cuts (income, capital gains, or maybe investment credits? all of which have different economic effects) are we talking about and exactly how are individuals (firms and households) responding?

      • Terry Karney says:

        “History” does not so point, and neither do the facts one see if one looks at the historical record.

        As I do not know about html here, I shall just give the url for a refutation of the claim.

        http://www.presimetrics.com/blog/?p=92

        Some relevant quotations:

        “The graph shows that Presidents who cut the tax burden produced slower growth, on average, than Presidents who increased the tax burden. ”

        This, of course, seem counterintuitive, esp. to those who have an almost religious fetishisation of “lower taxes”

        More to the point, there is also the myth of the “marginal tax rate”, which I first encountered when I was in about the fifth grade. The idea that if one made more money, one lost more money. It is, of course, not true. The more money one makes, the smaller the overall bite gets, as a percentage of income. Warren Buffet has, not so famously as it might be known, offered a prize to any member of the Forbes 400 who can show they pay a larger percentage of their income in taxes than their secretary pays.

        No one has yet claimed that million dollars. Even if it were a function of good accountants finding deductions, the point still stands, the greater burden of paying taxes is not on the rich, even when they “suffer” an increase in taxes.

        And the economy has, historically, been in better shape when the taxes are higher. Why? Because the gov’t isn’t really that bad at dealing with money. Contra Reagan, and his descendents, the gov’t is actually pretty good at moving money to places it can do well, and even do good. The idea that somehow the gov’t (of, by and for the people) is somehow a faceless mass of of heartless, soulless automatons, is one of the most corrosive ideas going, and it’s spread has done more to polarise, and jeapardise, the grand experiment which is the United States than any other in our lifetime.

        External threats, even the Soviet Union at its most aggressive have not done as much damage to the body politic as the idea that the Gov’t is an evil entity, completely incapable of doing what it is constituted to do, “promote the general welfare, ensure domestic tranquility, and secure the blessing of Liberty to ourselves and our posterity.” As Heinlein said, “There ain’t no such thing as a free lunch,” and taxes are the way we pay for it.

        As to the idea that debt is no way to fix anything… it’s like refinancing a house. You can do it one of two ways, take out the second mortgage, and fix the roof, the foundation, and all the other things which time and lack of ready money have done to the house, pay off the note on the cars, and the credit cards, etc., and be in a better place than you were when all you had was the first mortgage, or… you can tighten your belt, not take on new debt and hope a couple of bags of quick-crete, and a bit of tar, will keep things together until you can, “afford it.”

      • ed says:

        i would repeat my above but something to note is that wealthy individuals are the least likely to use their income on products and services – tax cuts for them won’t necessarily be spent in say, the local restaurant or the big box retailer.

        right now wages have been stagnant for many workers for long enough that they don’t have disposable income that entrepreneurs can go after by new business ventures. consumer spending for the past few decades was based on spending on credit at an unsustainable rate.

        public infrastructure and many necessary public functions are suffering right now. if we took some tax money from the wealthy to keep them afloat and functioning this would put more middle class people (like school employees) to work with money they coudl spend in the economy.

        i mean, right now schools and not just public k-12 but universities are hurting for money. give the rich tax breaks and they aren’t going to fill that hole and we certainly can’t afford to let that slide if the US is goign to be compettive in the future.

    • Andrew says:

      Wrong, wrong, wrong, wrong. I am not quite sure you yourself understand the modern monetary system…

      The scenario presented above simply makes no sense. Even though we have a fiat currency, the public still determines to a large extent the effectiveness of that currency and its use. Government must still live within its means, or hyperinflation will set in. To put it simply: laws cannot on their own create wealth. Don’t believe me? Look at Zimbabwe.

      Today in 2010, just like in 1910 when we had a gold standard, the government must collect revenues to lay out expenditures. The government stores the revenues in the treasury, and when Congress appropriates money by law, the government may spend it. When government cannot collect the revenue necessary to cover expenses, it issues debt (Treasury notes, savings bonds, etc.), payable in dollars (fiat money), to investors who are betting that the US will not default. The risk of US default is low, and the dollar has fairly low inflation (we’ll get to that later), so it’s basically a guaranteed bet. Being fiat doesn’t magically make taxation and spending different, it simply means that the currency doesn’t automatically translate to a certain amount of gold or some other commodity, but is backed by government command (the literal meaning of fiat) or faith.

      The Federal Reserve System, or Fed, has nothing to do with taxation or government spending; it controls monetary policy. The Fed has a mandate from Congress to maintain price stability, maintain full employment and keep long-term interest rates close to short-term rates (often, one will hear of a “dual mandate” to curb inflation and keep unemployment low, since long-term rates naturally tend to follow short-term rates). It executes these mandates by buying and selling securities (usually Treasuries) on the open market, which target interest rates, thus targeting inflation by keeping money supply growing at low levels (around the rate of GDP growth).

      Activist policy-makers may use taxes to affect aggregate supply or aggregate demand, just like they use government spending. However, because people have expectations that are somewhere between rational and adaptive, often these changes lead only to inflation in the long run (sometimes this inflation is the result of the Fed “monetizing the debt” and sometimes it is the result of the public’s expectations and the effects of those expectations on bank balance sheets). Expectations are actually a reason why tax cuts seem to help, and why a payroll tax holiday or rebate would likely have no effect on the economy.

      Also, your quotation from Bernanke is nonsense. Bernanke is talking about the Fed balance sheet, which has exploded recently (see http://en.wikipedia.org/wiki/Quantitative_easing). The representative he is responding to likely has no understanding of monetary policy, which is sadly a frequent occurrence in Congress.

      None of what I wrote means that government cannot expand the economy: it can, as long as the benefits (wealth created) exceed the costs (taxation). Don’t believe me? Look at the interstate highway system, the early US canals, or the Internet. However, outside the narrow vein of public goods, such as defense and certain infrastructure where firms can make no profit, government spending is widely ineffective because there is no incentive on part of government officials to spend efficiently.

      If government instead focused on ensuring flexibility and stability in the economy by keeping taxes and regulation fairly low and non-burdensome while providing the necessary public goods and punishing only firms engaging in force or fraud, we would likely be out of this recession by now.

      • JJTV says:

        “To put it simply: laws cannot on their own create wealth. Don’t believe me? Look at Zimbabwe.”

        If I may use your own statement against you “Wrong, wrong, wrong, wrong. I am not quite sure you yourself understand the modern monetary system…

        Anybody who compares a fiat currency system like Zimbabwe to a country like the US, GB, or Japan has clearly not read any history on Zimbabwe or analyzed the country at the most basic level. If you look at Zimbabwe GDP growth from 1980, the date of independence, until 2000 you will see variable yet relatively positive economic growth (excluding the drought years of 1992 and 1993). The problems came when Robert Mugabe introduced land reforms in 2000. While the motive was right the implementation was a disaster. White-owned commercial farms fed the entire population and were the largest employer as well. What ensued was a disaster, unemployment rose to 80%, 45% of the food output was destroyed. The situation continued to grow worse as infrastructure was left to decay and by 2007 only 18.9% of Zimbabwe industrial capacity was being used.
        What caused the inflation and then hyperinflation was increases in net government spending without any changes in productive capacity and they were paying for large amounts of imported goods by using their foreign reserves. Eventually they were creating money to purchase foreign currencies to pay for goods. There is NO empirical evidence proving that a sovereign government, running permanent deficits to pursue full employment, will EVER turn out like Zimbabwe.

        Your second paragraph is wrong as well. You make the novice error of confusing private and government borrowing. Private households/businesses are the USER of a currency and any excess spending must be financed. The only financial constraints, under a fiat monetary system, are self-imposed. Under a fiat monetary system, money is an accepted medium of exchange because the government requires it for tax payments. The only reason the government ever needs to issue treasury securities is to drain excess reserves from the banking system.
        A government operating under a fiat system is never revenue constrained and can spend a virtually unlimited amount first, and if it wishes, conduct a reserve drain by issuing securities. Under a fiat system, for the private sector to have a net surplus the government must have a net deficit equal to or greater than the surplus. Deficits provide net financial assets to the private sector.

        IMPORTANT: In no way does this mean that the government should just create trillions of dollars, rather, it should be understood in the sense that the government never needs to limit its policy options during recessions.

        Here is the Bernanke quote: “Is that tax money the government is spending?” ANSWER: “It’s not tax money. . . we simply use the computer to mark up the size of the account … It’s much more akin to printing money than it is to borrowing.” (Bernanke, 60 Minutes interview, 2009)………you must have been looking at a different paper.

        On the final two paragraphs I couldn’t agree with you more. The government funds projects that would otherwise be un-fundable for the private sector. When the government spends during a recession it should be on projects that benefit the non-government sector and long-term growth (Fully funded schools, healthcare, infrastructure, etc.) and should also include broad based tax cuts.

      • Andy F says:

        I’m not sure Andrew is right, right, right, right. Or that he understands the modern monetary system…
        In regards to Andrew’s understanding of the modern monetary system. Firstly, the Treasury does not “store” revenues from taxes or bond sales, it has accounts at the Fed and private banks. Then to the statement that “government must collect revenues to lay out expenditures”; this requires coordination between the Central Bank (the Fed) and the Treasury, and maybe Congress??. This blows Andrew’s statement that the Fed “has nothing to do with taxation or government spending” to hell, while it is not an active participant in fiscal policy decisions, it plays an integral part in how the system operates. So, let’s see how this works in the real world. The conventional story goes this way: since the government must “collect the revenue necessary to cover expenses” it must spend the money appropriated by tax collections, and should there be a shortfall it must issue debt to fill this shortage. If we look at private banks, the Fed, and the Treasury as a set of interconnected balance sheets a different story emerges as to how this happens operationally. The conventional wisdom holds that tax payments lead to a reserve drain, while treasury spending results in a reserve infusion to private banks. Therefore, the Fed and Treasury, in order to keep from jacking with the level of bank reserves, and therefore interest rates, have developed a clever system to deal with such problems. This solution is necessary, I believe we all would agree, to maintain stability in the banking system. So, if the Treasury can use only the Fed as its sole banker (which is not the case), while running a balanced budget each day, the net effect on bank reserves would net to zero. This is a major problem because the Treasury is typically in deficit, and the majority of tax receipts occur around one day, Tax Day, April 15 so there is no hope of balancing the books daily. This is a problem because spending throughout the year would amount to increasing amounts of reserves, then a huge drain around one day. This has the effect of messing with reserve positions, and therefore interest rates. Therefore, one of the means by which the situation is avoided is allowing the Treasury to keep tax receipts (called “tax and loan accounts”) at specific private banks (Note option banks and remittance-option banks), so tax payments and spending simply move reserves within the banking system. But, while these accounts hold tax receipts, the Treasury continues to spend throughout the year, and these checks are drawn on its account at the Fed. Spending in this fashion amounts to reserve injections, so the Treasury transfers funds from the special TLAs to the Fed as it spends. While this may give the appearance of “covering expenditures”, what is actually happening is that it is attempting to keep reserve positions stable. Since money is an IOU (or “that which is necessary to pay taxes”), and this opens up a whole new can of worms– it is not redeemable for any set amount of specie, etc.–it doesn’t need to get it’s IOU’s back before spending. On the other side, the private sector, the opposite takes place, the PUBLIC needs to get gov’t IOU’s before paying taxes. This is the same thing as saying that the private banks holding money need to have reserves before the reserves can be transferred to the Fed. Furthermore, the reserves must have come in the first instance from the gov’t! All of this is done in the attempt to stabilize the banking system by the Treasury keeping an arbitrary amount (not determined by deficits, bonds, gold, or lunar cycles) of money in its account at the Fed, thus causing a neutral effect on reserves by Treasury spending. If the Treasury spends more than what it holds at the Fed, it simply transfers additional reserves from TLA accounts. Think about it, if the Treasury spent more than it had at its account at the Fed, without transferring money from TLA accounts, it creates fiat money. This money comes from nowhere, it is simply “created” out of thin air. But the treasury doesn’t want to operate in this way since continual (as is the case) deficit spending by the Treasury would amount to an excess of reserves in the banking system, and since banks cannot act quickly enough to undertake actions designed to absorb reserves, the interest rate would be pushed to zero. This is where JJTV argument fits in, that bond sales are to absorb excess reserves in the attempt to hit an interest rate target. So, the sale of bonds simply replaces non interest-earning assets (cash deposits at the Fed) with an interest-earning deposit (Treasuries). And this is accomplished operationally by creating different accounts at the Fed. A bond
        But, can the Treasury–which Andrew supposes holds money I guess like Uncle Scrooge’s money bin; ok in all seriousness the Treasury in conjunction with the Fed–consistently and accurately predict how much money it needs to keep in its account at the Fed so as not to mess with the interest rates? Even if the Treasury is good at this, it cannot control when its checks are deposited by recipients at their member banks. In addition, even in today’s electronic banking world, it does not attempt to sell bonds daily in order to “cover” its expenses. What it has done is implement procedures designed to maintain the stability of the banking system through reserve accounts held by private banks.
        An example: Say the Treasure anticipates that its closing balance will exceed its daily desired level $8 mil. If this happens, the Treasury will attempt to make deposits from its account at the Fed into its TLA accounts. If the banks are unwilling to accept this amount (because they don’t want to pay interest or don’t have the reserves to accept it), the Fed will work with the Treasury by engaging in an open market purchase offsetting the Treasury’s account balance. That’s how gov’t spending happens in the real world, the gov’t is able to spend without issuing debt. Furthermore, every time the Treasury spends in excess of its holdings it creates fiat money. But, why do people accept such money? Like I said, that is a whole ‘nother can of worms.
        A couple other things:
        A government can never default on debt denominated in its sovereign currency. As for high debt to GDP ratios look at what Japan did about twenty years ago, selling massive amounts of debt at low interest rates despite the nasty prognostications of ratings agencies and fiscal fundamentalists. Greece and other Euroland countries are different because they have given up control over monetary policy. They must acquire dollars either by taxing or issuing debt.
        Expectations can’t be both (or in between) adaptive and rational, pick one or the other.
        I could go on, but I’m already sick at my stomach.

      • Andy F says:

        Did you really cite wikipedia to validate your claim?

  21. John says:

    Great article! Recently I happened to hear a talk given by Dr. Brian Domitrovic, a Harvard Ph.D graduate in history, currently teaching history at Sam Houston State Universtiy.

    Studying the US economy historically from 1913 to the present he makes a compelling case that the only period of times when the economy prospered were when there was a determined approach to lower taxes, both personal and business. Included in these times of growth were the Reagan years when the Keynesians of the land tried to discredit his policies calling them “voodoo economics.”

    I would hope that in today’s arena of economic ideas everyone would take the time to read and study this history in his book “Econoclasts” as it does not approach the subject with a right wing or left wing bias, but rather just presents the historical facts. Domitrovic should be invited on every regular business and political TV and radio show to simply explain the historical facts of his study. They speak for themselves.

    Of course Domitrovic is an educated man and far advacned in his formal education than the 5th grader who made the simple economic discovery for himself that Keynesians can not work much earlier in life than most of us.

    Would it not be wonderful to have the 5th grader, along with Domitrovic, as guest panelists on the contemporary progams aired today. What an eye opener it would be for the politicians and the major media networks, who cling to their discredited and historically proven erroneous theories about how to put us on the path to growth once more simply hear the facts and the elementary story told by the 5th grader.

    • Jeff says:

      There are 2 problems with what you write above…The 1950’s and 1960’s showed tremendous economic growth and the top personal tax rates was almost 90%. Second, we have had 0 real wage growth since the early 1980’s – all of the growth in our economy have come from debt. What has happened in the last 2 years with credit unobtainable for most people? The economy has collapsed, we are in a huge recession and we have over 9% unemployment.

      • Sycophant of the Bourgeoisie says:

        Absolute growth is a bad measure. Technology, resources, and hundreds of other factors are drastically different.

        Comparative growth, i.e. how the US did in relation to say Russia or China is a much better measure.

        A recent paper:
        http://www.brookings.edu/papers/2009/01_institutions_henry.aspx

        Examines Jamaica and Barbados and why one is nearly 5 times as wealthy today despite nearly identical times of independence and identical common law systems.

  22. Dani says:

    I bet his dad wouldn’t help him out with the assignment if he had to defend Keynes, nor do I believe there was a discussion of the things his dad ‘could’ spend money on but never would; ie schools, bridges, roads, fire dept, police dept, libraries, etc.

    • Adminstrator says:

      I can tell you with certainty that the dad is not an anarchist.

      • Dani says:

        How is that a logical inference of what I said? I was saying that, for all the items the kid said his dad could pay for by himself, the kid did not even hint at any positive thing the government does with money. This just shows that the title of the article makes no sense because it lacks a broader view of our economy.

      • ed says:

        yeah, but he’s probably a bourgeois republican who would be happy to have another luxury car while making sure none of his tax money goes to educate poor minority students, police bad neighborhoods or fix roads in places where he doesn’t drive or libraries in neighborhoods where he doesn’t live.

        right now we are having a problem even keeping some government functions which nobody but anarchists would argue SHOULD be abandoned funded. SO if this kid’s dad is NOT an anarchist, shouldn’t we – in the light of laying off teachers and cops and such – raise taxes on some people who can afford to pay to keep the ship afloat?

  23. Ben says:

    Can you cite the press release please? This kid sounds too smart to be true.

    • Adminstrator says:

      I don’t have the press release handy, but what “smart” parts about the kid’s observations do you take issue with?

      • Ben says:

        In paragraph 2 the child figures out for himself that government has overhead. He’s also already aware that government cannot spend anything it doesn’t first tax out of someone. In the final two paragraphs he nails Paul Krugman a bit too succinctly.

        It usually takes some unlearning before most people can comprehend that sort of thing. If genuine, I couldn’t be happier for this youngster and his parents.

  24. […] This post was mentioned on Twitter by Nena Espinosa, Civil Society Trust. Civil Society Trust said: Latest essay on the sham mathematics behind Keynesian economics – "Fifth Grader Discredits Keynesians": http://bit.ly/auhw9P […]

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