Thursday, March 26, 2009

The Economics of Conservatives and Liberals

The Economics of Conservatives and Liberals
From a forthcoming book by Dr. John B. Buck entitled Understanding Macroeconomics.

Traditional conservatives believe government, and thus taxes, should be relatively small. They also tend to think it is fair for the tax burden to be distributed more broadly across people of various incomes than liberals do. They justify this belief by focusing on the progressivity[1] of individual income tax rates. Conservatives tend to believe either that market failures[2] are relatively small or that the government is ineffective at correcting them. Both are justifications for small government. Conservatives favor smaller government welfare programs and less redistribution of income. Thus, critics of traditional conservatives claim they are less concerned with issues of equity or fairness than liberals. Conservatives respond that people already have relatively equal opportunities (e.g., everyone has access to public education) or that it is not the government’s role to provide such opportunities. Conservatives point out that the waste and abuse of the welfare system is both inefficient and unfair. Conservatives are sometimes accused of being selfish and inconsiderate of others in society. However, wealthy Americans engage in a myriad of charitable activities and donate vast amounts of wealth to agencies that benefit others. They argue that private organizations tend to be more efficient at providing assistance to those in need than the government.

Traditional liberals believe government, and thus taxes, should be relatively large. Most liberals think it is fair for the tax burden to be borne primarily by the rich. They justify this belief using a philosophy known as the ability-to-pay principle.[3] Liberals claim conservatives ignore the regressivity[4] of social insurance and sales taxes and that tax breaks and shelters provide the most benefits to the wealthy. They also point out that middle and lower-income families already pay a larger share of taxes than they are given credit for[5] and argue the total tax burden is already relatively proportional. Liberals tend to believe that market failures are relatively large, that the government is fairly effective at correcting them, or that issues of fairness are more important than economic efficiency. Liberals are accused of being selfish when they want government benefits to be paid by other taxpayers. Critics of traditional liberals claim they lack sufficient concern for economic efficiency and have an exaggerated sense of fairness. Liberals are often accused of recklessly and wastefully spending other people’s money and promoting handouts that undermine the incentive to work. Liberals tend to think Americans do not have equal opportunities or that some citizens suffer from past inequities. Thus, they are more likely than conservatives to favor affirmative action programs or similar projects.

Compassionate conservatism is the phrase used by President George W. Bush to describe his belief in bigger government and lower taxes. Compassionate conservatives argue either that lower taxes will lead to such dramatic economic growth that future tax revenues will be sufficient to pay for today’s government spending and future government expenses, or they argue that deficits and government debt do not matter and debts can be passed to future generations without the need to ever be paid. Traditional conservatives and most economists think compassionate conservatives use flawed logic.[6] Budget deficits and increasing public debt place higher demands on government revenues in the form of interest payments to those who have loaned money to the government. While these may be tolerable in the short-run, they have the potential to be crippling to the U.S. economy when interest rates rise and the baby-boom generation progresses from being a significant source of revenue for the government[7] to being a significant expense[8].

[1] With a progressive tax, people with higher incomes pay a higher percentage of their income than people with lower incomes. The structure of the U.S. individual income tax system is progressive because high-income people face a higher marginal tax rate than those with lower incomes. This is often referred to as being in a higher tax bracket.
[2] Market failures occur when the market system fails to provide the socially desirable outcome. If the market system is left completely alone, it creates too much of some things (e.g., pollution, poverty, and market power) and not enough of other things (e.g., national defense, education, and basic research).
[3] The ability-to-pay principle states that taxes should be paid by those who are best able to pay them. A contrasting idea, the benefits principle, states that taxes should be paid by those who receive the benefits from the services provided by the government. Both principles are used in the U.S. tax structure. Fuel taxes are designed to generate revenue for the construction and maintenance of highways and roads. Since the people who use the highways and roads the most also buy the most fuel, fuel taxes are based on the benefits principle. Since welfare programs redistribute income, they cannot be based on the benefits principle. The people who receive the transfers of income cannot also pay for them.
[4] With a regressive tax, people with lower incomes pay a higher percentage of their income than people with higher incomes. Payroll taxes for Social Security and Medicare, often referred to as social insurance taxes, are regressive because high-income people pay these taxes on only a portion of their income while low-income people pay these taxes on all of their income. Sales taxes are also regressive because they are a represent a higher percentage of income for the poor than for the rich.
[5] Individual income taxes provide about 50% of the federal government’s revenues. Payroll taxes provide about 35% of the federal government’s revenues.
[6] Wishful thinking is probably part of it, too.
[7] Workers tend to earn the most income, and thus pay the most tax revenue, in the years just prior to retirement.
[8] Baby-boomers will add significantly to the Social Security and Medicare expenses of the federal government.


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