3 Huge Economic Misconceptions From Election Season
We're down to nine weeks until the presidential election. That means we're heading into a period of what will no doubt be a breathless display of rhetoric and nonsense winning out over facts and reason. Here are three that always get me.
1. Lower taxes lead to faster economic growth
It makes a lot of sense: Take money out of the hands of the most productive members of the private sector and give it to some bumbling bureaucrats, and growth will slow, and vice versa. It makes so much sense that few take the effort to look at the historical facts to see how the argument holds up (the most dangerous form of certainty).
Here's the scorecard:
Sources: Tax Policy Center, Federal Reserve.
Do you see the trend? I hope not. Because it doesn't exist.
Since the Sixteenth Amendment was ratified in 1913, America has had every combination of taxes and growth you can think of. High taxes and blistering booms, low taxes and crushing depressions, and everything in between.
Why is this?
First, there's a difference between the top statutory tax rate and the top effective tax rate. Statutory is the rate that's advertised; effective is the rate people actually pay. Because of deductions, write-offs, loopholes, and high marginal barriers, the difference between the two can be huge. Since 1979, the top statutory tax rate has been as high as 70% and as low as 28%, but the average effective income tax rate for the top percentile of households has hovered between and 18% and 24% -- much less variance. A spike in effective tax rates would almost certainly thump the economy, but we simply haven't seen that despite big changes in statutory rates.
More importantly, taxes are just one piece of this enormously complicated thing we call the economy. Other factors like education, population growth, and the ideas of entrepreneurs play a much larger role in economic growth than taxes alone. It's not that taxes don't matter, but that other things matter so much more. Take an economy of 300 million people, 27 million businesses, and 6.7 billion other people on the planet in hot pursuit, and very rarely can you say, "Do X and Y will happen." It's just a lot more complicated than that.
2. We eventually need to pay off the national debt
Let's just get this out there: We will never, ever pay off the national debt. And frankly, that's fine.
A popular way to put U.S. debt in perspective is to compare it to household finances. This makes the numbers more comprehensible, but it turns the comparison into apples and oranges.
Households have a fairly short window of money-making potential (40-50 years), and pass away 10-20 years after that. All debts have to be repaid by that time for creditors to get their money back.
Countries are different. Their lifespans are indefinite, and they can remain indebted indefinitely. The same is true for corporations. General Electric and Ford have likely been indebted for over a century, and they'll never become debt-free. Nor should they, and nor should our country. Rather than being paid off for good, debt that comes due is replaced with new debt, and on and on. What matters for organizations with indefinite lifespans is not the raw amount of debt, but the cost of carrying that debt.
Yes, sometimes the cost of carrying debt becomes excessively expensive. When interest rates rise, our nation's $16 trillion debt surely will. How will we deal with it then? Ideally the same way we did after World War II: We grew out of it.
As a percentage of GDP, debt after the second world war was more than a third higher than it is today. But it was never much of a problem. For the following three decades, debt to GDP fell consistently and like a rock before settling at just 31% in 1981, three-quarters lower than it was at the end of the war.
Interestingly though, from 1945 to 1980, there were only eight years when the government actually ran a surplus, and most were irrelevantly small. Think about that: The debt burden fell dramatically even as we ran deficits almost 80% of the time.
How? Because those deficits were small and the economy grew like a weed.
As long as nominal GDP growth is higher than the annual deficit, a government can run in the red forever while actually lowering its debt load. This isn't intuitive because it doesn't apply to households, but that's the point: Governments aren't households.
3. It matters who wins the presidency
Can we all admit one thing? Evidence that if one party wins, the economy will tank, or if another party wins, it will boom, is mindlessly weak. Just as with taxes, we have had every combination of political party and economic growth you can think of. Democrat and high growth, Democrat and deep recession. Republican and high growth, Republican and deep recession.
There is very little a U.S. president can do to the economy unilaterally. If a single person does have inordinate sway over the economy, it's the president of the Federal Reserve, not the president of the United States.
Almost without exception, politicians get too much credit for the economy when things are good, and are burdened with too much blame when it slows. In their world, a successful economy reflects their decisions, and a poor one reflects the decisions of the person they're running against. In the real world, the economy is built on the decisions of businesses and consumers, most of whom go about their day making personal choices while blissfully unaware of what's happening in Washington.
This is not a declaration that the Oval Office has no impact on the economy -- surely it can have. But its impact is way out of proportion with the amount of blame and credit we often give it. The 1990s boom probably would have happened with a Republican president, the 2000s probably would have been just as miserable with a Democratic president, and the budget deficit would have been massive over the last four years even with a Republican president. For the vast majority of Americans, the most important business stories of the next decade will have nothing to do with who wins the next election. You reject that at your own peril.
Bank lobbyist (of all people) Andrew Lowenthal made a good point a few years ago: "Every election I've ever been involved with has been 'the most important election in history.' At some point, it's not. It's just the path of history."
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
The article 3 Huge Economic Misconceptions From Election Season originally appeared on Fool.com.Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Ford Motor. Motley Fool newsletter services have recommended buying shares of Ford Motor. Motley Fool newsletter services have recommended creating a synthetic long position in Ford Motor. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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