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        Economics, Taxes and Wailing Speakers

        December 2nd, 2010 by Alexei Zoubov

        Let us start with the “wailing speakers”.

        You may have witnessed it at a concert or a club performance: when a singer comes too close to the speakers, the whole sound system goes crazy and produces an intolerable awful scream that, in the worst case, could damage the speakers.

        This is an example of so called “positive feedback loop“. Even the slightest noise is amplified, then fed back into the mike, then amplified again, until the whole system locks up or breaks down. The word “positive” in the name is not a value statement, it just means that a part of the output signal is added to the input and so increases the output.

        As a rule, to keep any system in balance and prevent it from going into uncontrollable oscillation, we need to introduce a”negative feedback loop“, feeding part of output back into the system with a negative sign, thus working against the changes in the output.

        Negative loops are all around, as well as inside you. Most air conditioners, shock absorbers, automatic speed controls, quality amplifiers, etc. have negative feedback implemented; your body maintains its healthy temperature the same way.

        Avalanches, explosions, wailing speakers and, I’d say, economic crashes are the resultsĀ  of negative influences of positive feedback loops.

        Feedback loops are often mentioned as important factors in economics, unfortunately very often the “positive” and “negative” are applied the wrong way. Here is an example by financial risk consultant Sean Harkin:

        On unemployment, significant job losses lead to reduced spending, harming additional firms, causing more job losses and causing prices to fall in a way that makes those who still have an income hold back on spending because they expect things to be even cheaper in future.

        In the press this situation is usually presented as an example of negative feedback loop just because the results have negative value. But, this is a typical positive feedback loop!

        Now to the main topic of this post:

        What does the growing imbalance of the distribution of wealth in America says about feedback loops in the system?

        Firstly, here is a quote from the post by Robert Creamer:

        Two-thirds of the nation’s total income gains from 2002 to 2007 flowed to the top 1 percent of U.S. households, and that top 1 percent held a larger share of income in 2007 than at any other time since 1928, according to an analysis of newly released IRS data by economists Thomas Piketty and Emmanuel Saez..

        During those years, the Piketty-Saez data also show, the inflation-adjusted income of the top 1 percent of households grew more than ten times faster than the income of the bottom 90 percent of households.

        In fact, in 2006 dollars, the income of the top 1% increased from $337,100 in 1979 to $1.2 million in 2006. That trend has continued since.

        In fact, according to the Center on Budget, “During the last economic recovery, from 2001 to 2007, poverty actually increased and the median income of working-age households declined, even as income at the top of the income scale continued to rise.

        Let’s put aside a “fairness” issue and try to be as logical and rational as we can.

        There is no question that the natural evolution of our economic system results in a built-in positive feedback, benefiting the wealth holders the most. It was and is natural for a simple reason that the money has the most influence on this evolution, bending the system in such a way that those who already have more money would get the most rewards.

        Harkin again:

        Advantage in wealth leads to advantage in the marketplace and this, in turn, leads to further advantage in wealth, with no converse process arising naturally from the market to cause the gap to narrow.

        There is no surprise that The Wealth always resisted any measures that would work against the upward flow of money. But, if left unregulated or not compensated by some negative feedback, the built in positive feedback will lead to uncontrollable oscillations or complete collapse. We’ve seen it happening.

        There are basically two forces that could provide the needed negative feedback: trade unions – on the level of the particular industry, and the government – on the state level. Both of these could have good and bad sides to them, but there’s just nothing else out there that could help the situation.

        The most important negative feedback the government can apply is taxation. Flat tax is not a workable solution because it doesn’t provide the needed negative feedback, only progressive tax can do the job. How progressive should be determined not by elusive “fairness”, but as being enough to insure that the gap of income and wealth between the upper layer and the rest doesn’t grow to insane levels, as it was growing lately.

        Talking about “fairness” is really counterproductive here. Both sides, the one that wants to tax the rich more, and the other that wants them taxed less, are shouting about what is fair and what is not. The system as it is now is obviously unfair, the taxes by definition are also always unfair to somebody. The goal should be practical – either have feedback loops sufficient to maintain some level of equilibrium, or have endless crashes of the system.

        The rate of growth of the progressive tax with income, sufficient for well balanced system, but not “over-dumping” it, is not easily calculated – economy is a so called “non-linear” system, described best by “chaos” theory (just like the weather).

        At least, based on the factual data on growing disparity in wealth distribution that accelerated exactly after the tax cuts, it’s clear that the present rate of “progressiveness” of the tax is not enough.

        And regarding “fairness”, I think Teddy Roosevelt said it really well:

        No man should receive a dollar unless that dollar has been fairly earned. Every dollar received should represent a dollar’s worth of service rendered – not gambling in stocks, but service rendered. The really big fortune, the swollen fortune, by the mere fact of its size, acquires qualities which differentiate it in kind as well as in degree from what is possessed by men of relatively small means. Therefore, I believe in a graduated income tax on big fortunes, and in another tax which is far more easily collected and far more effective, a graduated inheritance tax on big fortunes, properly safeguarded against evasion, and increasing rapidly in amount with the size of the estate.

        Posted in Ideas & Ideologies, Thoughts