The Magic Formula for Prosperity
December 2, 2012
(This item originally appeared at Forbes.com on December 2, 2012.)
I sometimes refer to the Magic Formula for economic prosperity. Here it is:
Low Taxes, Stable Money
It’s only four words. That’s so it is easy to remember.
The United States was founded on the principles of the Magic Formula. Until the introduction of the income tax in 1913, taxation was almost nonexistent. The principle of a gold-based currency was defined in the Constitution. The result was magical: the United States was the most successful country of the 19th and 20th centuries.
We seem to have forgotten the Magic Formula today. Despite Republicans’ staunch efforts, we are drifting towards “austerity” in the U.S., which means: higher taxes, and some efforts at reducing spending, which typically don’t amount to much. The results of “austerity” have been shown repeatedly now in Europe. The higher taxes cause the economy to deteriorate, and don’t produce the expected revenue. A worsening economy increases the demands on the government to provide welfare assistance, and also leads politicians to attempt to shore up their dwindling support by handing out more cash.
We abandoned the principle of Stable Money when the U.S. left the gold standard system in 1971. Today’s dollar changes value chaotically. It is supposed to do that – it is a floating currency in principle. Floating currencies normally don’t “float” for very long; they sink. The value of the dollar has already fallen to about 1/50th of its value before 1971, when it was worth 1/35th of an ounce of gold. It will probably fall a lot further from here.
Over the next five or ten years, the combination of higher taxes and unstable money will cause problems. This policy trend is happening not only in the U.S., but even more so throughout Europe and Japan. An intense debate will likely emerge, focusing on raising taxes more and some sort of even-more-unstable money. Thousands of pages will be written, and a thousand conversations ensue, among policymakers and the horde of professional economists surrounding them.
Throughout this cacophony of opinion, the Magic Formula is typically forgotten completely. Even as higher taxes are repeatedly shown to debilitate the economy – Europe’s “austerity” — the idea that lower taxes would help the economy is considered irrational and not suited for serious discussion. The economic decline is typically blamed on spending cuts, which don’t actually exist. 
Republicans in the U.S. actually understand these ideas fairly well. Unfortunately, they lost the recent presidential election. This was not due to their inferior economic plan, in my opinion – Romney generally led in polls on economic issues – but rather the Republican Party’s long list of other activities, including a cozy relationship with their crony capitalists in the banking industry, a history of police-state measures characterized by the Patriot Act, and enthusiasm for starting new wars on flimsy pretexts.
Yes, the Democrats are also cozy with the banking industry. But, not quite as cozy as Mitt Romney.
Today, the Magic Formula is best exemplified by Hong Kong and Singapore. Both have very modest tax rates. Both provide a full spectrum of government services, including universal healthcare. Both adhere to the principle of Stable Money. They don’t use a gold standard – that would introduce an intolerable degree of instability of exchange rates and the conditions of trade – but they have a policy of maintaining their currencies’ value at a stable and predictable level with major international currencies.
In Hong Kong, this is done by way of a currency board arrangement with the dollar. In Singapore, it is done by way of a currency-board-like arrangement with a basket of major currencies. The result is that both governments abandon any significant form of discretionary “domestic monetary policy”.
You can do that? Yes, you can. In fact, most countries do.
In recent years, the Magic Formula team has grown to include the flat-taxers of Eastern Europe, led by Estonia and then Russia. These countries also abandoned any “discretionary monetary policy,” opting instead to keep their currencies as stable as possible with the euro.
The problems the U.S. faces, along with much of the rest of the world, are generally conservative problems: Getting the budget in balance. Reducing government as a share of GDP, from 30%+ to perhaps the levels of Singapore (14%) or China (17%). Tax reform, with much lower rates. Reforming senior income insurance and healthcare to some much more sustainable and productive framework. Returning U.S. monetary policy to the principle of Stable Money, which, historically, has always been a conservative point.
This isn’t going to happen right away. It certainly won’t happen if Republicans continue to make themselves unelectable. However, through whatever turmoil may come, remember the Magic Formula.
It’s only four words. That’s so you don’t forget it.