Saturday, May 9, 2009

Are We Growing the Economy or the Government?

Our local Hallmark store is closing at the end of June. Alex, a Russian immigrant, successfully pursued the American Dream for 25 years. This entrepreneur, so typical of small business that creates most jobs in America, invested his blood, sweat, and capital into the store. He employed about a half dozen employees, including a vibrant 80+ year old retiree.

He pays his income taxes, workers comp, unemployment taxes, local business taxes, and generate sales taxes for the state and local community. He receives no special tax breaks or credits in return.

All he does is work hard and provide service. Customers are treated with respect. Alex, like millions of small business owners around the country, is the backbone of the American economy. He creates the jobs while the Detroits shed them.

Alex cannot beat the deteriorating California economy and the escalation in state taxes. How bad is the economy? He still has leftover 2008 Hallmark Christmas ornaments for sale at 60% off.

About 1/3 of the storefronts will be vacant when Alex closes. He will join the clothing store, restaurant, bagel shop, yogurt shop, bank, used bookstore, photography shop, water store, tv repair shop, and others which I cannot remember, which preceded him in calling it quits. An empty Mervyns sits across the street.

Tax increases kill business. They don’t necessarily do it by directly taxing a business out of business. Instead, substantial tax increases suck the discretionary spending out of consumers’ pockets. Studies have shown that these tax increases are essentially regressive with the greatest impact on the economically disadvantaged – the ones most likely to patronize neighborhood merchants.

I remember when Governor Lowell Weicker of Connecticut and the Democrats in the Connecticut Legislature “solved Connecticut’s budget problems” by imposing an income tax on the state. It cost the average family about $2,000 a year in state income taxes. That was $2,000 less to spend on restaurants, hobbies, recreation, movies, dvd’s, travel, newspapers and magazines, electronics, and cars. It also destroyed what was left of the commercial lifeblood of downtown Hartford, Connecticut, the state capitol. The added costs simply didn’t justify state residents in enjoying an evening in the dying downtown. The Hartford Civic Center became a cement mausoleum most days and nights.

Instead of letting individuals spend their money as they wish, and spreading it throughout the economy, the state takes the money and directs it to a few favored recipients in wages, grants, transfer payments, and corruption.

Legislators, Democrat and Republican, have an inherent bias in growing government by dispensing largesse to their constituencies. It’s easier to get elected by promising voters more benefits than by offering them cuts in services. Their solution to deficits is to raise taxes - income taxes, sales taxes, gas taxes, property taxes, vehicle taxes, alcohol taxes, tobacco taxes, and a host of nickel and dime fees and taxes, which can crush the entrepreneur.

Entrepreneurs, retirees, and the youth flee the high tax, slow growth states for the no income tax and low tax states of the Sunbelt. Florida and Texas are especially attractive.

A classic example is William Foley, an astute investor who acquired control of Carl’s, Jr. and Fidelity Title Insurance Company.

He moved his residence to beautiful Santa Barbara, California, but beauty does not outweigh taxes (California has a millionaire’s tax) and bureaucracy. He packed up and moved to Florida, costing California a substantial loss of tax revenue.

California’s unemployment rate is 11.2%, up from 6.9% last summer, as the state races to pass Michigan. At least Michigan has an excuse. It has ridden the vicissitudes of the auto industry for a century. The nation’s and world’s wealth poured into Detroit. The reign of MoTown is over, and the state’s recent tax increases have driven business out of the state.

Fed Chair Ben Bernancke testified to Congress last week that he sees signs of the country’s economy turning around by the end of this year. Wall Street and the government celebrated yesterday when the unemployment report showed only 539,000 jobs disappeared and the nation’s unemployment rate reached 8.9%.

The fine print showed that state and local governments added 6,000 jobs and the federal government 66,000 workers. A host of pink slips to government workers, especially teachers and other education workers, is about to hit as state and especially local governments face fiscal realities.

The Fed Chair has to remain publicly optimistic, but he would be wise to read the tea leaves in California.

California, with 1/8 of the nation’s population, and 13% of the nation’s gross domestic product, sufficient to rank 10th in the world if it were an independent nation, is not expected to bottom out until next year or even 2011. The national economy will not, cannot, turn around without California. Alex is personally facing unemployment.

The big fear is that a second wave of foreclosures may still occur – commercial real estate, such as the neighborhood strip mall, which Alex will son vacate. The financial system has factored in the home foreclosures and home builders failures, but commercial real estate is teetering.

Economists believe that three major causes existed for the Great depression: high taxes, protectionism, and tight money.

States and local governments have raised taxes much greater than the nominal cuts in President Obama’s Stimulus Bill, which also imposed substantial protectionism on the America economy. Money, especially credit, is still tight despite the heroic efforts by the Fed and Treasury to loosen it.

As with the New Deal, government spending, the Stimulus Bill, will not correct the underlying economic problems.

FDR in the New Deal was trying to provide jobs to tens of millions of unemployed Americans. The Obama Stimulus Bill, with all its Congressional earmarks, is really funneling large sums to a relatively few employed Americans. The unemployed are offered extended unemployment benefits.

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