subject: Taxes, Jobs, and Deficits: Are We Doomed To Repeat History? [print this page] Taxes, Jobs, and Deficits: Are We Doomed To Repeat History?
UPDATED 12/11/2010
The Wall Street Journal reported in early 2009 that President Bush was leaving office with the worst record for job creation since 1939, the year government payroll records began. Although his hallmark tax cuts were intentionally tilted toward "job creators" in top tier tax brackets, the workforce expanded overall by barely 2.3% on his watch or only 375 thousand jobs per year. His abysmal record compared poorly to a 12.5% average for 10 previous presidents but most starkly to his immediate predecessor. Bill Clinton had the best overall performance with 21.1% growth or 2.9 million jobs added per year. So much for the theory that giving rich people tax breaksis the surefire better way to create jobs, you might think.
Yet, not two years later, frustrated by stubbornly high unemployment, mid-term voters have given control of the U.S. House of Representatives to Republicans, whose plan to get Americans back to work is focused on two things, making the Bush tax rates that are set to expire this year permanent even for the top 2% of taxpayers and reducing government spending to 2008 levels.
How simple their plan seems is a big part of its appeal. But some perplexing questions go unanswered. In a study by the non-partisan Congressional Budget Office of 10 ways to stimulate the economy reducing taxes was found to be the least effective. Beyond that, lowering taxes and cutting spending at the same time is the economic equivalent of turning up the heat and opening the windows in winter.Cutting spending would exacerbate an anemic economy counteractingintended beneficial effects of lower taxes. At the same time, their tax plan would add almost $4 trillion to the deficit over the next 10 years off-setting any conceivable spending cuts. This conundrum should concern us but more troubling is lower tax rates for the richest people perpetuate pernicious long-term socio-economic trends.
Extending the Bush tax rates for the top 2%, the main difference between the President's and Republican's tax plans, would add in the neighborhood of $700 billion in debt over 10 years by itself. His argument opposing this part of the Republican plan is simply that there are better ways to use borrowed money than makingrich peoplericher still with little benefit to anyone else. From 1980 to 2005, 80% of the total increase in income in the U.S. went to the top 1%. According to the Internal Revenue Service, the share of national income going to the richest Americans grew more than 10 times faster over the last 30 years than middle and low-income workers' stagnant real wages after inflation. On the face of it, that fact belies the notion that when the few who can afford to save and invest most of their income are doing well everyone shares in the inevitable rising tide of prosperity that creates. It mostly depends obviously on what they do with their money. In this instance the resulting massive upward redistribution of wealth has not been used in ways that have produced widespread benefits for most Americans but, to the contrary, it has become one of the major factors prolonging the U.S. economy's malaise.
The rich getting richer while everyone else is treading water creates a drag on the economy. That situation reduces what economists call the velocity of money, basically how fast it is spent again and again, first by one party and then the next, and so on. Up to 70% of the U.S. economy is driven by consumer spending. Middle and low-income consumers spend most of their income as soon as they get their paychecks but as a larger share resides in wealthy hands money normally circulates in the economy more slowly with a lower multiplying effect.
The drag on the economy is currently more severe while consumer debt, which has helped Americans sustain middle-class lifestyles, lingers at the all time high, people worried about their jobs are paying down their debt or stashing away all they can, and, with the end of easy credit, no one can borrow money they badly need, no longer even by mortgaging their homes. With a record 3 million homes in foreclosure in 2010, Deutsche Bank grimly forecasts that up to 48 percent of home owners in the U.S. will be under water in 2011. We assume the worst of the financial crisis of 2008 that sent the global economy into a tailspin is past history and the U.S. recession officially ended last year, but many millions still face a steep uphill climb trying to get their lives back on track.
The widening gap between the rich and everyone else has profound implications for the kind of society we live in. Overall, while this trend has persisted over decades, the U.S. has slipped to number 26 among the 100 top industrial nations on a broad index of the quality of life including education, health, business vitality, and political environment, as reported by Newsweek in August 2010. In 1988 only 1 in 4 Americans responded to a survey by the Pew Research Center that they felt Americans were divided along economic lines. Today, twice as many are of that opinion and less than one-half the people in our country now believe they are among the haves versus the have-nots.
Watching excessively inflated corporate executive compensation packages with golden parachutes that protect them from their own failures and outlandish, if not to say outrageous, Wall Street bonuses lavishly handed out year after year, it is hard to placate people downsizing and worrying meanwhile whether the American Dream of middle-class affluence is at least over for them. The feeling is the rich have been spared lasting consequences but after sliding downhill they fear the rest of the country will be stuck with a new normal of higher unemployment and lower wages.
We started with the fact that the touted effects of Bush era tax cuts on job creation have never materialized. Naturally bewildered by complicated economic problems experts in charge are finding hard to unravel and the slow progress they're making, it's not surprising so many seem to have been afflicted with amnesia about all the foregoing. People who are hurting and apprehensive naturally want simple reassuring answers promising quick results, or as they say on Saturday Night Live, for someone to just "fix it." With people becoming more and more disillusioned by the sluggish economic recovery and finding little consolation in the idea that without the stimulus things would be worse, Republicans have had unmitigated gall to keep repeating their same tiresome old charades about taxes and jobs.
Saying they won't compromise, if the President refuses to go along with extending the Bush tax rates across the board, Republican leaders threaten to let them expire for everyone at year end. Staunch Democratic partisans want the President to take Republicans on during the lame duck session, but it appears virtually impossible for party leaders in the Senate to cobble together enough Democratic votes to break a filibuster and pass his own tax plan extending lower rates for everyone except people with taxable income over $250,000. The President is talking about finding a bipartisan approach instead, but how well has that worked for him so far? He's signaled he might concede to a one year extension. Nothing, however, will have changed a year from now except that Republicans will be in control of the House and, if this year is any indication, the next election campaign will be in full swing. How will it be any more opportune time for his plan to win out? A temporary extension provides some political cover by postponing the threat of higher taxes across the board and accomplishes little more. Some hybrid approach, such as extending lower rates temporarily for the top 1 or 2% while extending rates for everyone else permanently,is also a possibility, but Republicans have not shown any sign that would be acceptable.
Letting all of the Bush tax cuts expire might actually be the better idea. It's a bitter pill to swallow but would get us back on a more sustainable footing and create an opportunity to take a fresh look at how to stimulate the economy and job growth without locking in perpetual out-of-control deficits. Extending tax cuts for the top 2% alone costs more over the next 75 years than the entire Social Security shortfall. Going back to the prior tax rates could also be the less regressive approach, better for middle and low-income people, compared to draconian spending cuts and similarly radical tax proposals suggested by co-chairs of the President's own bi-partisan National Commission on Fiscal Responsibility and Reform. Ironically, the commission's preliminary plan would reduce the deficit by exactly the same amount extending all the Bush tax rates would add, resulting in no net reduction at all.
Before accepting as self-evident conventional wisdom that not extending lower tax rates would stop the nation's recovery dead in its tracks, remember that the economy did better comparatively and jobs were created at a 50-year record pace in the decade before tax rates were cut to their current levels. Lower tax rates, on the other hand, didn't save the economy from 7 years of meager growth and anemic job creation before nose diving into the worst recession since the Great Depression losing over 8 million jobs in the process.
Explanations are multifarious but these coincidences are notjust aberrations. Overall, there has been a year to year positive correlation between higher, not lower, top tax rates and economic growth since 1950. Correlation isn't the same as causation, of course, but the trend is exactly the opposite of what we are told over and over to expect.We might understand this outcome betterbearing in mind that a decade ago the Federal Government had a surplus and the country briefly enjoyed a sense of confidence about the future. Growing overconfidence, however, led to the decision to cut taxes with most of the savings going to those on top. We found ourselves living beyond our means again. The housing bubble allowed the mirage of general prosperity to continue even while we were fighting two wars, but as problems in the sub-prime mortgage market inevitably got worse the financial house of cards collapsed.
Economist Richard Koo's insightfully drawn parallels between our present situation and Japan's 15-year Great Recession from 1990 to 2005, brought on by their own real estate crash when prices in commercial centers dropped 87%and corporate balance sheetswere left deep in the red, are helpful. Koo distinguishes between typical recessionary cycles when corporations' primary goal continues to be maximizing profits and "balance sheet recessions" when restoring balance sheets to presentable condition becomes their paramount concern.
Koo contends politiciansobsessing about temporary deficits and cutting spending will aggravate the economy's contraction in the latter situation. If, for example, U.S. corporations and individuals disposed to repair balance sheets devastated from collapse of the American housing bubble and related losses in financial derivatives that spread the damage globally are also cutting costs and paying down their own debt, a fallacy of composition known as the Austerity Paradox exits. That is, behavior that makes sense for anyone over their head in debt leads to a negative overall result when everyone does the same thing. The imbalance of supply over demand leads to a deflationary spiral. Monetary stimulusthat increases banks' liquidity is ineffective in this case, rather likefeeding out a rope when no one is on the other end taking up the slack.
When it is the last borrower standing, to keep the money supply in circulation constant and the economy from shrinking the national treasury has to sell bondsat least equal tobanks' current idle excessreserves and insertthe money directly in the real economy. Koo shows how generally following this approach Japan slowly dug itself out the economic crisis that was relatively more severe in terms of financial losses equaling 3 years of GDP than 60 years earlier at the beginning of the Great Depression when losses in the stock market were about 1 year of GDP but the U.S. economy cascaded into a deflationary spiral and GDP fell by 46% after austere fiscal policies were imposed. Over the 15 years it took to recover from their much deeper "balance sheet" recession, Japan's GDP never fell below its peak before the crash of commercial real estate began and continued growing at 24% per year.
Everything about the scenario isn't rosy, of course. After all the spending, Japan has a current debt to GDP of 174%, the second highest ratio among 129 sovereign states. It is notable, however, that as problematic as Japan's debt ratio might become, with prospects causing the IMF to call for Japan's government to take measures to reduce the deficit, the sky hasn't fallen yet. Their grace period has been extended while interest rates of 1-2% have kept their cost of debt service in line with most other countries with lower national debts but higher interest rates.
Coming out the recent recession the U.S. debt to GDP is 94% after the cost of the stimulus is added. There are mitigating differences in the comparison of the two cases, such as how much of Japan's debt is held domestically, but overall the comparison with our current situation, including our own nominal interest rates, suggests that making U.S. deficit reduction a priority so critical it overrides all other economic concerns overstates how urgent the problem is.
We face other challenges too. Our principal future global competitors are building infrastructure for 21st century communications, transportation, and smart grid power distributions systems and concentrating on rapidly expanding higher education accessibility and building their own middle-class consumer markets. In this context, objections to additional fiscal stimulus to rebuild America's aging public infrastructure and to replace lost public financing for all levels of education are short-sighted. Jump-starting the "new energy economy" is another forward lookingideahindered by a myopic focus on deficits. The accelerated decline of the American middle class brought on by the housing and financial crisis and the prolonged jobless recovery from the consequential economic recession is a domestic calamity of greater significance than anything we have faced since the Great Depression. Taking a miserly approach to these challenges puts the country on the road toward bleaker prospects for generations to come whether deficits are reined in or not.
It would be a different matter if the private sector was responsive but the Federal Reserve reports banks are sitting on nearly $1 trillion of excess reserves and, after a record breaking 3rd quarter with $1.7 trillion in corporate profits, non-financial U.S. corporations are hoarding $1 trillion in cash instead of hiring more workers. Reemerging corporate prosperity is still based mostly on short-term financial speculation that largely benefits the corporate elite, certainly not most American workers.
Middle-class tax cuts and targeted tax policies such as tax credits for companies hiring unemployed U.S. workers would be more effective stimulating the real economy than across the board lower tax rates. To the contrary, Republican opposition to taxing off-shore accounts of companies shipping jobs overseas, has shown their singular determination to look out for large corporate interests. Until corporate balance sheets are repaired and hiring resumes healthy expansion, we should also heed Moody's Analytics findings that $1.61 of economic activity results from every dollar of unemployment benefits. Republicans blocking efforts to extend temporary benefits for 2 million long-term unemployed whose benefits are expiring and justifying their indifference to the misery this causes by exaggerating the effects on the deficit - insisting at the same time on permanent extension of the Bush tax cuts for the rich that have had negligible benefits for job creation and add $700 billion to long-term structural deficits - underscores their double standards.
Asking people to make sacrifices is never an easy sell and there is normally a political price to pay. In this case, Republicans know there's little risk in their threatto let all of the Bush tax cuts expire as scheduled if the top 2% don't get a permanent extension. Even less likely than the Bush tax cuts having any more beneficial effects on job growth than before is that Democrats will quit fighting among themselves and, beginning with the President, show the courage of their convictions or a spirit of bi-partisanship to help solve the nation's problems taking hold among Republicans.
The President has announced an agreement with Republicans conceding to a two year extension of all the Bush tax cuts in exchange for their support for a 13 month extension of unemployment compensation telling Democrats in Congress the plan is take it or leave it To get Republicans on board the deal was sweetened with a controversial $68 billion break on estate taxes for the super rich and an accelerated one-year write-off of capital investments by businesses estimated to let them defer paying $200 billion taxes adding $30 billion to the long-term deficit. Workers also get a one year payroll tax holiday of 2% that might become a stalking horse for making future cuts in Social Security benefits. Democrats in the House want to fix some of the problems they see with the plan but knowing Republicans can run out the clock puts them in a difficult negotiating position. It is likely Republicans will get their way on extending the Bush tax cuts sooner or later. Not taking lessons from history dooms the country to repeat it.
