Are we all happy with the lower withholding rates and federal tax cuts? This means more money in our paychecks. And that certainly seems good. Otherwise we’d just be giving more money to the government. And for most of us giving Uncle Sam more of our hard earned tax dollars is not something we’d choose to do voluntarily.
And clearly that extra money in our paychecks will probably get spent. That can only help, not hurt the economy, right? But most of us are aware that what the government gives with one hand it often takes away with the other hand. For instance: here in Fairfax County state money to the counties has been reduced due to reduced collections. Revenues from sales taxes are also flat. The pressure on counties is to increase local taxes to make up the difference. I live a desirable spot: close to high paying jobs where land is at a premium. My assessments increase every year. Even though the county cuts the tax rate I end up paying more property taxes every year. This year it will amount to a couple hundred dollars, as it usually does. I don’t particularly like it, but I understand it. Unlike some of my tax phobic neighbors I’m not willing to let the roads deteriorate or to shove fifty kids in a classroom in order to save a couple hundred dollars in taxes.
So most of us understand this painful necessity even if we don’t like it. But a lot of us are unaware of hidden taxes. The best example I can think of happens at the gas pump. And I’m not talking about those federal, state and local taxes tacked on to the price of gasoline.
Doubtless you are aware that gas prices are at record highs. I paid $1.88 a gallon for 87 octane last weekend. Ten years ago, according to the EPA, the average price of a gallon of gasoline was $1.04. Now it is $1.88. Arguably gas prices are still a bargain. It’s hard to find a country in the world where it can be procured so cheaply. To have an accurate comparison today’s prices need to be adjusted for inflation. In 1968 gas cost about 35 cents a gallon. Add inflation and that would be about $1.90 a gallon today. So overall gas costs about as much in real dollars as it always has. The notion that OPEC has us over a barrel of oil is somewhat fallacious. Oil prices have proven to be very inelastic, to use an economics term. Naturally we don’t tend to think of gas prices in those terms. We can spend $3.50 for a cafe latte at Starbucks without giving it a second thought. But we will go out of our way to save a couple pennies a gallon for gas, particularly when prices are as high as they are today. I suspect that the cost of gasoline is actually a much smaller percentage of our budget today than it was in 1968.
But you may have read that OPEC wants to increase its benchmark price for oil. Actually OPEC doesn’t really set prices; that is determined by supply and demand. But they do try to encourage member nations to price their product in a range. And the current benchmark range is $22-$28 a barrel. However with demand high as economies recover the average price of a barrel of crude oil is hovering around $34 at the moment — about as high as it has ever been. Certainly this has an effect on the price you pay at the pump.
But here’s the kicker: oil prices in Europe are steady. How is that possible? Have vast new deposits been found off the coasts of France and Spain? Is OPEC cutting Europe a special deal? The answer is they are paying the same rates as everyone else. But they have an advantage. Oil is traded in U.S. dollars. And the U.S. dollar has been sinking against all major currencies, including the Euro. When George W. Bush assumed office one U.S. dollar bought 1.07 Euros. Today, one U.S. dollar buys .82 Euros.
Taxes on gasoline are much higher in Europe than in the United States. No doubt about that. But let’s assume that taxes were the same. That would mean that the gallon of gas I bought last weekend for $1.88 a gallon could be purchased in Europe for the equivalent of $1.45 in Euros.
In short because our dollar is now weak we pay a penalty. If the dollar had the same exchange rate with the Euro as it did at the start of the Bush presidency, that gallon of gasoline I bought would be priced at $1.55 a gallon instead of $1.88 a gallon. In these terms then the penalty for a weak dollar is thus currently $.33 a gallon. Now of course all things are never equal and currency rates are always fluctuating. But assuming you put 12 gallons into your automobile once a week this adds up. That’s $205.92 per car per year. If you have two cars, that’s $411.84. All because of a weak dollar.
Now you’re probably asking yourself “How did our dollar get so weak?” Again there are lots of factors that influence exchange rates but in this case there is the 800-pound gorilla that makes the other factors rather moot. And that is the United States continues to live beyond its means. To finance our needs, including government, we need money we don’t have. So we get it from overseas. Other countries lend us hundreds of billions of dollars annually. Certainly not all of the federal debt is financed from overseas, but with federal deficits running $300B to $500B a year that’s a lot of dough crossing the ponds so you can have that tax cut. So I think there is a clear link between deficit spending and the fall of the U.S. dollar. Arguably more deficit spending will just make the dollar weaker.
So what does this have to do with taxes? In this case a weak dollar is a hidden tax. A weak dollar has some positive economic effects in making our products cheaper to buy. But it also means that imports cost a lot more than they otherwise would. The current grumbling from oil producing countries is that they are losing gobs of money because oil is traded in dollars. In effect oil-producing countries are selling oil at a considerable discount. This sucks when they want to exchange those oil dollars for their local currency.
But actually we are benefiting. If OPEC decided suddenly to stop selling oil in dollars and demanded, say, Euros instead we’d be in a hell of a fix. That gallon of gas might cost us $2.50.
My point is that deficits do matter, as much as Dick Cheney would argue otherwise. Consequently balanced budgets matter. They drive low inflation and increase confidence in the United States. That’s exactly what happened during the Clinton years. The economy became a self-sustaining proposition. Why? Because that economy was built on the solid foundation of fiscal discipline. (The end of the Cold War certainly didn’t hurt either.)
So maybe if you’ve been to college you are thinking, “Hey this isn’t news. I studied economics. Inflation is a tax.” This is true. It’s also very abstract. We just don’t think of it as a tax. And sometimes, particularly in times of historically low inflation like now, inflation is still there although it may not be obvious.
The Federal Reserve is seeing signs that inflation is making a come back, spurred in part by the rising cost of foreign good and oil prices. We now see that much of this is a result of the low value of the U.S. dollar. As a result the Fed is likely to raise interest rates at its next meeting. And this will be a tax too. Anyone who borrows money will feel the ripples. Money that would otherwise go to buy things will instead go to creditors, the majority of which will probably be overseas. The Fed is trying a little medicine here. Their interest rate increases are designed to keep cause mild short-term inflation at the benefit of reducing the long-term inflation. In the short term the effects may be higher unemployment. It may mean higher mortgage payments. It may mean some won’t be able to buy that first home at all.
My conclusion: there is no free lunch. As much as the Bush Administration would like us to believe it we cannot spend ourselves into true prosperity. We can perhaps live high on the hog for a while, but the piper will have to be paid. If we can stop this foolish deficit spending habit perhaps those glorious economic days of the Clinton 90s can return. But first we need to put people in power again who truly understand economics. It is time to stop buying into the lie that Democrats are big spenders. Republicans, particularly George W. Bush and today’s Republican Party with their lock on all branches of government are the true big spenders. They are charging our national charge card to the maximum and don’t want to pay back any principle.
If you truly value your economic future you should pull the lever for Democrats this fall.