In the 1960s and ‘70s, the US and UK economies gyrated along what became described as the political business cycle or partisan business cycle. The idea was that before each election, looser fiscal and monetary policy caused a surge of expansion that was then curtailed after the election so as to keep a lid on inflation. Alternatively alternate governments of differing hue would alternately focus on controlling inflation or on expansion. Our current political wariness of fiscal policy and over-reliance on monetary policy dictated by unelected central bankers is a sorry legacy born from that experience. Currently fiscal policy is typically only deployed in an automatic way. If we are in a boom period, then tax revenue tends to increase because more taxable economic activity takes place whilst in slumps, welfare payments tend to increase and tax revenues drop. These counter-cyclical effects are termed the “ automatic stabilisers”. I consider many of the economic policies of recent decades to have been deeply misguided. However, I’m wondering whether an entirely automatic, non-reactive, form of fiscal automatic stabilisers could be consistent with economic democracy.

Economic democracy is a movement hoping for a reformed economic structure. I’ve tried to make the case that the best way to achieve economic democracy might be to replace all current taxes with a tax on gross assets and to replace all means tested benefits with a citizens’ dividend. People advocating for a broadly similar argument have made the case for using a variable blend of different types of taxes and transfer payments to fine tune fiscal policy so as to supposedly steer along an optimal macro-economic course. This post is an argument in favour of instead setting up an automatically self-correcting fiscal framework and then leaving things to take their course.

Imagine that a gross asset tax was set at say 5% per year, all other taxes were abolished and a citizens’ dividend was paid at say £7000 to all citizens of all ages. No active attempt was subsequently made to balance the budget or provide fiscal stimulus or to moderate inflation. The government just left the economy to it and concentrated purely on doing stuff that only the government was well placed to do (such as policing, maintaining infrastructure etc), endeavouring to provide such government services for the best value with no regard to job creation or such like. If a consequence was that government spending outpaced taxation, then the increased stock of government issued money would soon provide a larger source of revenue for the asset tax (the details about the proposed tax are in this pdf). If asset values increased greatly due to economic growth (or bubbles) such that taxation was greater than government spending, then the asset tax demands would cause asset price deflation so increasing the real value of the citizens’ dividend to the point where it stayed proportional to the expanded economy. Government employees could have pay scales proportional to the fixed citizens’ dividend. If everyone became lazy and just lived off the citizens’ dividend, then supply shortfalls would soon push up consumer prices to the point where it was easy to make lots of money by working and harder to live off the citizens’ dividend. It would be a self-correcting system. The key point is that the government has unlimited ability to maintain the nominal size of the citizens’ dividend, the pay of government employees and the asset tax. The government also has the unlimited capacity to electronically “print” the money to pay for it and to automatically electronically deduct the asset tax from that money.

The great advantage of such an automatic system is that it does not obscure price signals and allows firms to plan long term on the basis of how they predict the economy is going to be based on a long term fixed system rather than the fickle whims of political expediency. It provides no scope for gaming the system around reactive government interventions because there aren’t any. The only way to make money is by providing customers with what they want to pay for. Speculators would know that a credit fuelled asset bubble would never become a “new normal” because the consequent asset tax would bring everything down to earth. Conversely investors could see that genuinely useful new productive capacity would provide earnings that could not be matched by speculative asset bubbles.

Monetary policy would be permanently set to “maximum looseness” with a zero interest treasury rate (as it has been in Japan for many years) and no issuance of anything but the shortest term treasury debt. However the gross asset tax would cause credit to be something that required careful consideration by those taking it on.

Deflation is the great fear of current economic planners and much of current economic planning is focused on ensuring that it never occurs. Much of that fear is because currently deflation would encourage money hoarding and because our economy is so indebted that deflation would cause a severe debt crisis. A gross asset tax would cause money hoarding to be much less attractive and would favour equity financing over debt financing. We do currently have spectacular levels of deflation in the prices of certain high technology products such as computers and DNA sequencing and that is celebrated rather than being seen as a problem. In an economy with minimal debt, deflation need not be at all distorting; it can be simply providing accurate price information leading to rational economic planning by the real economy. If the economy was growing strongly such that all prices were deflating in the way that the cost of computing has, then great.

Related stuff on the web (I added this link on 11May2013):

Monetary policy for the 21st century- Interfluidity