Distributism and the Current Crisis, Part 2: You Say You Want a Devolution?

[Part 1] Conservatives express great frustration with the egregious violations of the Constitution by the legislatures and the courts, violations which ensure that power gravitates to the federal government, while the states become mere bureaucratic subdivisions of the federal apparatus rather than partners in a political union. In response, they call for a devolution, a return of power to the states.

Devolution as a Fiscal Problem

Many historical, political, and philosophical reasons could be advanced for the centralization of power, but at base this turns out to be a fiscal problem. Power follows property, as Daniel Webster noted. The political equivalent is that power follows funding, that it gravitates towards that level of government that has the most money to spend. When the federal government acquired the power to tax incomes with the 16th Amendment in 1913—a source of funds with no natural limit—the rest of the constitution gradually became irrelevant.

The income tax makes the feds the most important source of funds, and hence the source of power. Local and state officials tend to kick problems “upstairs” to the largest funding source. Thus it comes as no surprise that a senator can run for vice-president on the claim that he “put 11,000 cops on the beat”; that is, that he did a job the city councilman should have done. But the councilman was happy to kick the job up to the senator, since the senator controlled the money. If you want the councilman and the senator to do their proper jobs, then you must cut the funding of the one and enhance the funding of the other. You cannot change the powers without changing the funding.

Income taxes are paid by capital and labor. Now, the more you tax a thing, the less you get of it. Yet labor and capital are things we want more of, not less. They should be taxed the least, if at all. Further, income taxes tend to degenerate into labor taxes, with the burdens shifted down the income scale, or forward to the next generation. The rich may claim that they pay the majority of incomes taxes, but this number is reached only by excluding the social insurance taxes, which only apply to the first $100,000 of income, and certainly don’t include the taxes they shift onto their children and grandchildren.

In order to implement subsidiarity in government, we must also have subsidiarity in the funding of government. That is, funding must start at the local level and be dispersed upward, rather than the other way round. Further, we must tax that which has no economic value, that is, the tax should fall primarily on economic rent and externalities. Economic rent can be confiscated with no negative economic consequences (except for the rentiers) and many positive ones. Externalities (the costs of a transaction charged to a third party not involved in the transaction, e.g., pollution) should be charged with the full cost of their mitigation. With any luck at all, the government will be sufficiently inefficient at mitigating externalities that businesses will prefer to perform the mitigation themselves and not pay the tax.

Economic rent is primarily embodied in ground rents. Treated as a tax, ground rents are most efficiently collected at the local level, and indeed the bureaucracy to do so already exists. Obviously, there has to be national agreement on the methods used to value and assess ground rents and on the “split” between local, state, and the federal governments. But lower levels of government will then have an incentive to accept more responsibilities, rather than kick problems upstairs, because this justifies claiming a larger portion of the revenues, revenues which they themselves collect. Politically, the problem with a “ground rent tax” is that it sounds like a “property tax,” and that scares people. However, once it is understood that we are trading off the income tax for the ground tax, most people, I suspect, will see the advantage. They will have a tax easily predicted, easily collected, local, and all without the government prying into the details of their lives.

This would not entirely eliminate labor taxes, since there are still the social taxes. However, these taxes should be used solely for direct services to workers and their families, mainly unemployment and medical insurance, welfare, and old-age pensions. They should not be, as they are now, over-collected and used to subsidize the general fund, which requires that in a very few years the general fund will be required to subsidize the social funds, and this will prove to be impossible under the current system; the general fund is already broke and destined to get broke-er.

The social taxes are efficiently collected (at least in regard to wages) because they are a flat tax paid by businesses in behalf of the employees and which require no complex filings. The income limitations ought to be removed, and the tax made steeply progressive for the top 2% or 3% of incomes (since there is an implied economic rent in these cases), but otherwise, there is surprisingly little that needs to be done. The problem is a bit more complex when dealing with non-wage income, but I believe those problems can be solved efficiently.

Devolution and Deficits

A ground rent tax would collect about 20% of GDP on the best estimates. However, current government expenditures at all levels total closer to 35%. Hence there will be a shortfall under a ground rent scheme. Whether this is an advantage or not depends on whether the budget can be cut. We cannot use the “starve the beast” strategy that has characterized Republican Party policy. Such a strategy does not curtail the growth of government: it enables it. Cut off from any fiscal restraints whatever, it breeds a “deficits don’t matter” mentality that divorces the budget from any fiscal reality. Further, tax cuts without spending cuts are not really tax cuts at all; they are tax shifting, mainly from the current to the future generation. Spending our children’s money is both economically unsound and morally reprehensible.

Moreover, it is not just the problem of getting government to live within reduced means, there is also the problem of the enormous debt that must be paid off (or significantly reduced) if both sanity and subsidiarity are to be restored. The federal debt is, as I write this, $11.8 trillion and rising rapidly. The interest on that debt exceeds half a trillion dollars; after the defense budget, it is the largest expenditure of the federal government and will soon be the largest. These are monies that must be paid out before a single bullet is bought or a single bridge rebuilt. Thus, we seem to face intractable problems. On the one hand, we would like to reduce both taxes and the expenditures of government, and on the other we must pay a seemingly insurmountable debt from these reduced revenues. Nor is that all. Our infrastructure is aging and much of it needs to be rebuilt, at enormous expense. The freeway system, for example, was begun in the 1950?s, and many parts are nearing the end of their useful life. And the same goes for many other parts of the infrastructure, such as levees and dams. This will put enormous pressures on any attempts to rein in the budget.

To add to the problems, we are about to face the retirement of the post-war baby boom generation, which will arrive like a fiscal tsunami on the Social Security and Medicare budgets. In the face of all these problems, it would seem that we need not lower taxes, but higher; not a devolution to the states, but an even more powerful central government empowered to tackle these enormous and growing problems. However, this would be to gorge on the medicine that made us sick in the first place, which can only make us sicker. How then should we confront these problems?

In regard to the federal budget, not only would it be relatively easy to cut one third or more from the general fund, it could be done without reducing (and usually enhancing) any essential services. I will not here rehearse that argument, but only mention that some of the measures are obvious, such as abolishing pointless departments like education and ending subsidies, recalling the military to our shores (do 700 overseas bases really enhance our security?) and shifting from taxes to fees wherever there is an easily identifiable group of users for a service.

Eliminating the Debt

But the largest line item, after the defense budget, is the interest on the debt. No real progress can be made if this debt is not eliminated, or at least substantially reduced. In thinking about the debt, one has to think about money itself. The creation of money is the private monopoly of the banks. This money is created out of thin air, and represents no prior savings or production. Yet, it forms a claim against things that have been produced. In the case of government debt, the banks lend money they invent, but demand payment in the equivalent of real goods and services. Hence, the government must tax real goods and services and turn over the money to the creditors. But this will become increasingly less of a possibility in the near future.

About 41% of the debt ($4.3 trillion) is owned by agencies of the government, mainly the Social Security Trust Fund. This portion of the debt can simply be monetized over a ten to fifteen-year period. That is, the government will print the money to pay off the debt to the trust funds. Some may be shocked by the suggestion that the government be allowed to simply print money into being, but this is certainly preferable to having the banks lend it into being. Will it be inflationary? It might be mildly so, but if done over ten to fifteen years, it will be no more than simply converting the current interest payments into principle and eliminating both.

There isn’t much else that you can do with this debt. The only alternatives (other than just reneging on the commitment) are to raise taxes or increase borrowing. Up until now, the social security taxes have formed a vast subsidy to the general fund, with IOUs being placed in the fund. But in just a few years, the cash flow will go the other way: from the general to the trust funds; but the general fund does not have, and will not have, enough money to pay the trust fund. In order to pay off these IOUs, there would have to be a vast tax increase over and above the high social security taxes we now pay. Our children—and the economy—simply cannot tolerate that burden. Or we can simply borrow more money, but that is problematic, to say the least.

The next portion is the 29% owed to foreign governments, banks, and individuals. This portion of the debt could be monetized, but likely shouldn’t be. My belief is that paying this debt should be the responsibility of the financial sector. A small tax, about 0.25%, on the transfer of financial instruments such as stocks, bonds, CDOs, CDSs, etc. should be levied and placed in a sinking fund to pay the interest and principle on these debts. Such a small tax would be sufficient to pay off the foreign debt over a term of five to ten years.

That leaves only the 31% of the debt held by American citizens and institutions. This portion of the debt could be partially monetized (as financial conditions dictate), partially paid off by the sinking fund, or simply left in place and allowed to shrink as a proportion of the economy. What is critical, however, is that the debt not be allowed to grow. And this requires abolishing the Fractional Reserve System, whereby the banks get to create money for nothing. This is the fiat money that is “lent” to the treasury. Its origin is thin air and a legal monopoly, a monopoly that must be abolished.

Monetary Reform

One of the greatest forces for the unjust accumulation of property is this fractional reserve banking system, which grants a monopoly privilege to a small group of people, namely the bankers and their allies. These private citizens have the power to create out of thin air nearly all the money in circulation. Such a system is intolerable on both moral and economic grounds, and must result in periodic credit crises, as greed and necessity moves bankers to create more money than the economy needs or can be reasonably “repaid.” That last word is in quotes because you can’t “repay” what was never paid in the first place, to repay in real goods a “debt” that was only an accounting entry on the books of some bank.

I do not believe that an ownership society can be reconciled with such a money system. The creation of money is a public power, and the public ought to take it back. Coining money into being ought to be the sole authority of the federal government, or even the states that wish to do so (although this is not currently allowed in the Constitution).

There is no reason why the federal government should not create its own money and spend it into circulation for capital projects. Capital projects, in the main, create more wealth then they cost, hence there would be little inflationary effect. The Federal Government could also act as a banker to the states and cities to lend them money, at little or no interest, to finance their own capital needs. This would shift the power inherent in capital projects back to the states and cities. In any case, control of the money supply should not be in private hands; it is a public power, and the public should take it back.

John Médaille is an adjunct instructor of Theology at the University of Dallas, and a businessman in Irving, Texas. He has authored the book The Vocation of Business, edited Economic Liberty: A Profound Romanian Renaissance and just completed Toward a Truly Free Market: A Distributist Perspective on the Role of Government, Taxes, Health Care, Deficits, and More.

This article courtesy of The Distributist Review.

  • John,

    Please run for Congress.

    I am confused on one point. I thought the Federal Reserve had the sole power to create money, but you are saying that banks have that power. Do you mean ordinary banks like the one where I have my checking account, or the big banks on Wall Street, or the Federal Reserve banks?

    My proposal for helping the nation’s economy rests on the observation that true wealth comes out of the ground. We are a wealthy nation. We should mine, drill, farm, timber, and fish our way back to prosperity. A national campaign to use our resources, it seems to me, would generate considerable income. What do you think about that idea?

  • HomeschoolNfpDad

    PrairieHawk, one of the fundamental consequences of a fiat monetary system is that the circulating monies have zero intrinsic value. Circulating money acquires an extrinsic value when someone trades the money for goods or services or both. The goods and services require actual time, labor, and material resources in order to produce and deliver. The person providing the good or service does so in exchange for money, and the money becomes a proxy for the value of the goods and services provided in exchange. So far, so good.

    At some point, our producer of goods or provider of services needs to do something with the monies he has received. One option would be to exchange that money with another producer for other goods or services. But a producer may acquire a surplus of money, all of which acts as a proxy for the value of goods and services provided by the producer in the past. The producer would like something to come from this money. So he searches for someone who needs access to value in order to develop some other good or provide some other service. If our original producer hands his surplus over to the new producer in exchange for a promise of some future payment (usually secured by contract), then our original producer becomes an investor, and the accumulated surplus value of his past labors goes to fund what is hoped to become a new enterprise, which will further contribute to the surplus. Now a real enterprise, if successful, produces real net gain, and the surplus proxy value of provided goods and services (proxy because it is money) is real value. Again, so far, so good.

    There is, however, another option. Our original producer can place his money in trust with a third party, in exchange for interest. An older term for interest provides us with some idea of what interest really is: usance. Interest is the fee charged by the provider of proxy value (in the form of money) to another who makes use of that proxy value for a period of time, in exchange for a promise to return the original sum in the future, plus regular usage fees over the term of use.

    Now, sometimes the third party who accepts money in trust in exchange for usance fees is called a “bank.” And this bank has, essentially, three options:

    1) It can take the money received in trust and invest it in a real enterprise. This, of course, entails a great deal of risk for the bank and the provider of the funds (our original producer). Historically, this was dealt with via the instrument of contract law, whereby the trust holder (the bank) asserts what it will do with the funds held in trust, and the provider of the funds (the original producer) agrees to the associated risk. This risk can be quite high. Enterprises fail, and funds used to fund them are lost. If all parties agree on the risk, however, this is one thing a bank can do (at least in the historical sense).

    2) It can pool the monies received in trust and place them all in the possession of a larger holder, which latter pays a slightly higher usance fee for the privilege of holding all the pooled proxy value (i.e. money) from several real producers. Now the larger holder has the problem of what to do next, but the smaller holder now possesses a contract whereby it can pay all the usance fees it is obligated to pay and collect a differential fee for itself.

    3) It can make the proxy value (i.e. the money) available to others at a slightly higher usance fee. This is commonly called a “loan.” It differs slightly (but significantly) from option #1 in that the recipient of the loan takes on all the risk associated with disbursing the money in such a way that it can be paid back, along with the usance fee, over some period of time. The bank simply asserts via contract the money, plus usance, must be paid.

    Now options #1 and #2 generally don’t create much of a problem (except that option #2 requires the larger trust holder to figure out what to do with all its proxy value). Option #3 is where mischief can be made – and mischief is readily made here. The holder of proxy value must be able to do something with that proxy value, or else it cannot pay off the usance fees to which it has obligated itself. But there is no expectation of shared risk, so the holder has to pawn the risk off onto someone else. Once the shared risk is eliminated, it becomes possible to lend out the proxy value (i.e. the money) while still making the legal claim that the original amounts of proxy value are still readily available. This is where we get the term, “reserve requirement.” The reserve is the amount of proxy value the bank is required to keep readily available in order to validly assert the claim that it actually possesses the full value – even though much of that full value is floating around in the form of loans. Now this is not bad per se, but it can be problematic. Just watch the shuffling that goes on in It’s a Wonderful Life while George Bailey makes his bank work. Money moves from one depositor to another and so long as they do not all ask for their money at the same time, it is possible.

    The real source of money, however, comes from the ratio of total deposits to total deposits kept in reserve. If a bank receives $100,000 in total deposits and keeps $20,000 on hand while lending out $80,000, the bank has actually created $80,000 that did not exist before. This is because of the bookkeeping fiction wherein the bank asserts $100,000 of deposits but only has access to $20,000.

    Now, recipients of this excess $80,000 will do something with it. The money will move from person to person in the real economy, acquiring new proxy value of its own. Ultimately, though, this money will find itself back in another institution which holds it in trust. This institution (or collection thereof) will keep 20% in reserve and lend out the remaining $64,000. And so the cycle continues until all the money lands in some banks’ reserve somewhere. By then, the original $100,000 exists on the books of many banks in a total that is equal to $500,000 ($100,000 / 0.2). The excess $400,000 was never issued by the government, never printed. It originated as a fiction in order to allow the first bank to do something so that it could pay for the use of its depositors’ funds. As soon as it was issued, though, it acquired the perception of real value, as if it had, in fact, been used as a proxy to represent actual goods and services. But note that none of the banks actually did anything. They just made it up. This process is called the multiplier effect of money. The multiplier effect depends upon the reserve requirement, which is traditionally set in contract but is now set in law in most countries. It is important to understand that the original $100,000 in this example was printed by a government, but the other $400,000 was created by the banking system itself. Thus, most money in circulation comes from the banks, not the government. In effect, the government has outsourced the printing of 80% of the money in circulation.

    Note that the real enabler of the multiplier effect is the separation of risk from the original producer when he looks for a place to put his surplus money. The contract or legal mechanism whereby usance is paid also includes a provision wherein the original depositors’ risk exposure is reduced (or eliminated), either via contract or law or both. But in fact, when spread over all producers in an economy, even the reduced risk is a fiction because ultimately, the money must do something. If that something is a really bad something – like paying $500,000 for $100,000 worth of real estate – then somebody loses out. If these bad decisions happen here and there, there is no problem, but if everybody makes bad decisions, then everybody reacquires and shares all of the original risk. Thus, the losses, eventually, are real.

    In some sense, what we are experiencing today is exactly the same thing as occurred in 1929. Late 1920s depositors weren’t demanding their money all at the same time because they felt it prudent to do so. They demanded all their money all at the same time because they perceived that the risk from which their deposit contracts allegedly shielded them was suddenly manifest. Today, there are fewer savers (and less savings), so there’s no run on the banks. But banks are still failing because the risk from which banks have shielded depositors (a shielding now enforced in law rather than contract) was suddenly made manifest. The only real difference today is that banks have lost – and the government has swooped in to cover the losses, thereby charging taxpayers for the cost of shielding the risk. Thus shielding the risk is just a shell game. Low reserve requirements (with a correspondingly high multiplier effect) merely increase the incentive for banks to seek higher usance fees by lending money, thereby increasing the fiction of shielded risk. While things are good, banks do well – but they do well without having done very much because they haven’t produced anything beyond an exchange whereby depositors can find users of their deposits. But again, the problem really is the risk shielding, because there is real value in banks helping people with money find others who need it.

    The risk shielding is always an illusion in the macro economy. The hope is always that the failures will trickle along in a manageable fashion. But any time large amounts of the risk are made manifest, a crisis ensues. One consequence of requiring that government accept direct responsibility for all of its fiat money is that those with excess will be required to recognize the risk of whatever loans or investments they make. The illusion of shielding depositors from risk would thereby be shattered, and the result would be a more prudent management of money by the original producers themselves.

  • HomeschoolNfpDad

    The real problem is always with risk. Note that when the system works, the original $400,000 in value is generated by the real economy after the fact of the loan — and then paid back. The problem is that failures eventually do occur — and the loaned money cannot always be paid back. If the failures are small, then everything is okay, but such a system always bets that the failures will never be large. But those bets are sometimes wrong.

  • HomeSchoolNfpDad,

    I think you should run for Congress too.

    What if the banks kept all of their depositors’ money in reserve and lent out only what the depositors were comfortable risking? The banks would then show on their books that their assets had been reduced by what had been lent out, and there would be no fictional money created.

    Some folks would be comfortable risking large sums, others nothing. Lending would be somewhat contracted but it would continue, and people would still have access to capital they need. I think this would result in a healthier economy with less borrowing and more saving.

    Thank you for the early-morning economics lesson. It was really something to wrap my brain around.


  • HomeschoolNfpDad

    There are no easy solutions. One thing that might happen if banks only invested what their depositors were comfortable risking would be that a boom time would eventually be upon us — and then everyone would be comfortable risking everything. This would mirror the bets that were made in the 1920s: the famous notion of the shoeshine boys owning stock.

    I don’t have a systemic answer to the conundrum. The Gospel actually has something to say about the matter, however, in the Parable of the Talents. But you have to step away from your Catholic upbringing to get at what the parable might be saying. Brought up as a nominal Protestant, I never once heard any parable about any talents. Instead I heard a parable about one servant who was given 5 bags of gold; another who was given 2 bags of gold; and a third who was given 1 bag of gold. An interpretation that falls out of this is that the servants — namely us — do best when we prudently use whatever surplus we have been entrusted with, and it doesn’t matter whether we succeed or fail. What matters is that we do our best — and this applies not just to the gifts of talent that God gives us but to the gifts of money.

    In an economy of love, this is actually possible, because failures are covered by the voluntary generosity of those who have succeeded, and the only outcasts are those who refuse even to try (and even they can get back in if they repent and try again). But once you attempt to enforce generosity, you break the economy of love. Since the human tendency is toward greed on the one hand and retribution on the other, the only way to achieve this may be in Heaven.

    In the meantime, we can only muddle through and do our best.


  • So much of our economy is based on the logic of sin that I often wonder if we wouldn’t be better off scrapping it all and starting over – perhaps adopting the economy of love that you suggest. Problem is, the process of changing to something new will involve a lot of pain and fear for people who didn’t bring it upon themselves.

    My suggestion is, as always, pray to Our Lady, Protectress of the U.S.A.

  • PH, I think we will be starting over soon. And yes, it will take prayer, along with courage and wit.