when you’re not standing on the brink. Karl Smith has published a very thought-provoking post in which he proposes a complete, temporary tax holiday:
So what happens if we simply suspend taxation for a few years and then pay it back later?
I know, I know there are issues about market freak out and the signals that such a move would create. Some will also object that such a move would alter interest rates based on sheer volume but I doubt that actually.
Even still lets put all that aside for the moment.
If the government suspends taxation and then tries to raise the money later to repay what it borrows it will actually be extracting less real resources from the economy.
Hat tip: Alex Knapp
Dr. Smith goes on to discuss interest rates, growth rates, and deadweight loss.
The reason I find this post interesting is that Dr. Smith has almost but not quite introduced a very new topic into the discussion of the economy and how to make it grow. He assumes that we will pay back the extra trillion or so per year that is the difference between what we’re raising in taxes and what we’re spending. Why?
We presently finance our government by a combination of taxes, borrowing, and currency expansion. What is the optimal mix? Does it change over time?
We have a fiat currency. Let’s assume, arguendo, that we are in a liquidity trap. That’s what any number of economists, notably Paul Krugman, have been saying for some time. A liquidity trap is a situation in which the sovereign is unable to debase the currency whatever it does. Given those circumstances, isn’t the best solution with the least deadweight loss to suspend taxation and finance the government solely via currency expansion? We could even pay down the debt a bit to improve our cashflow situation when conditions return to normal (if ever).
Horrifying, isn’t it? But is the suggestion wrong or right?