In my opinion the two most serious problems facing the U.S. at the present time are 1) stagnant growth and 2) massive debt. As discussed by William Galston in yesterday’s Wall Street Journal, the U.S. presidential campaign is now beginning to address the first of these issues. For example:
Bernie Sanders rejects “growth for the sake of growth” and says that “our economic goals have to be redistributing a significant amount back from the top 1%.”
Hillary Clinton says that we have to build a “growth and fairness” economy. “We can’t create enough jobs and new businesses without more growth, and we can’t build strong families and support our consumer economy without more fairness.”
Jeb Bush argues that there is nothing wrong with household incomes that 4% growth wouldn’t solve.
The readers of this blog will have little difficulty figuring out where I stand on this continuum of economic values. My view is illustrated by the chart just below from the World Bank which shows that countries with the fastest growing economies also have the least amount of inequality. Let’s be more specific. Mrs. Clinton would achieve more fairness by:
Raising the minimum wage.
Guaranteeing child care and other family friendly policies.
Encouraging profit sharing.
Encouraging more innovation by increasing public investment in infrastructure, broadband, energy and scientific research.
These are attractive goals but how do we achieve them? The best way to raise wages is to get the economy growing so much faster that it creates a labor shortage. Then businesses will be competing for labor and wages will go up. This is exactly what is happening in Omaha NE where I live and the unemployment rate is down to 2.9% (2.6% in Nebraska as a whole).
Furthermore, in a tight labor market, businesses will automatically try harder to keep good employees by providing extra benefits such as childcare and profit sharing.
Public investment in infrastructure, etc. will be more easily affordable with the higher tax revenue generated by a faster growing economy. Conclusion: faster growth is the best way to create a more fair and equal society!
In the national elections this year four states: Alaska, Arkansas, Nebraska and South Dakota raised their state minimum wage rates above the national rate of $7.25 per hour and, at the same time, elected Republicans to the U.S. Senate, in three cases replacing Democratic incumbents. Does this represent contradictory behavior by the voters? The American Enterprise Institute’s James Pethokoukis recently reported (see above) that the U.S. has the third highest rate of billionaire entrepreneurs behind only Hong Kong and Israel, as well as by far the most billionaires over all. These are the high-impact innovators like Bill Gates, Steve Jobs and Mark Zuckerberg and the Google Guys.
These observations are put in context by the Manhattan Institute’s Scott Winship who recently reported that “Inequality Does Not Reduce Prosperity.” Here is a summary of his findings:
Across the developed world, countries with more inequality tend to have higher living standards.
Larger increases in inequality correspond with sharper rises in living standards for the middle class and poor alike.
In developed nations, greater inequality tends to accompany stronger economic growth.
American income inequality below the top 1 percent is of the same magnitude as that of our rich-country peers in continental Europe and the Anglosphere.
In the English-speaking world, income concentration at the top is higher than in most of continental Europe; in the U.S., income concentration is higher than in the rest of the Anglosphere.
With the exception of a few small countries with special situations, America’s middle class enjoys living standards as high as, or higher than, any other nation.
America’s poor have higher living standards than their counterparts across much of Europe and the Anglosphere.
Conclusion: Americans are fair-minded and would like to help the working poor do better. But Americans also appreciate the value of innovation and entrepreneurship. When there is a tradeoff between increasing prosperity and reducing inequality, greater prosperity comes first.
Most people agree that income inequality and wealth inequality are increasing in the U.S. Likewise anyone who’s paying attention is aware of our slow rate of GDP growth, averaging 2.2% per year, since the end of the recession five years ago. Is there a connection between inequality and slow growth? Maybe! First of all, it is important to note that income inequality in the past 30 years has been greatly offset by federal taxes and transfer programs as shown in the October 2011 chart (above) from the Congressional Budget Office. Secondly, the Economist discusses this situation in the article “Inequality v growth”. The economists Jonathan Ostry, Andrew Berg and Charalambos Tasangarides have shown (see above chart) that a large amount of redistribution affects growth more negatively than a smaller amount of redistribution.
Economists generally agree that the recovery has been slowed down by a lack of demand by consumers for more goods. So the recovery should speed up as less affluent consumers feel secure enough to spend more money. Two things, to start with, can make this happen. One is a restoration of the housing market so that homeowners have more equity (which can be borrowed and spent). Another way to accomplish this is with government redistribution programs, such as food stamps and Medicaid, for low income people.
But there is an even better way to put money in the hands of people who will spend it, and at no cost to the government. I am talking about broad based tax reform, whereby tax rates are lowered for everyone, offset by closing tax loopholes and shrinking deductions, which primarily benefit the wealthy. For the two-thirds of taxpayers who do not itemize deductions, and who tend to be the less affluent, such a tax rate cut will put money in their pockets, most of which they will spend.
Such a tax program as this would be a direct shift of resources from the wealthy to everyone else, thereby lessening inequality. It would stimulate the economy, creating millions of new and higher paying jobs, and thereby increasing tax revenue and lowering the deficit. Win, win, win, win!
On the eve of the President’s State of the Union address, the New York Times gives an answer to this question in today’s paper, “Obama’s Puzzle: Economy Rarely Better, Approval Rarely Worse”. The charts below do show the basic trends all moving in the right direction. But is this good enough? The unemployment rate is moving steadily downward but it is still a high 6.7% almost five years after the recession ended in June 2009. And this is with a labor participation rate of only 58.6%, which is historically very low.
The budget deficit is dropping but is still unsustainably high. In the five years, 2009 – 2013, deficits have totaled $6 trillion dollars. As soon as interest rates return to their historical average of 5%, interest on this $6 trillion in new debt alone will total $300 billion per year, forever! Furthermore, the Congressional Budget Office, the most credible source of budget information, predicts that the deficit is likely to resume an inexorable climb within a few years as baby boomers retire in ever greater numbers, rapidly driving up entitlement costs.
Economic growth was stronger than expected in the last quarter of 2013 and this is a good sign. But it has averaged only about 2% since the recession ended which is very low by historical standards, in a post recessionary period.
The point is, do we really need to settle for such mediocre performance: a stagnant economy, high unemployment and massively accumulating debt? Should we just declare that in a highly competitive global economy with an ever higher premium on information and technology, that we just can’t do any better than we already are? Isn’t there some way to make our economy grow faster in order to provide more and higher paying jobs?
I think that the answer to this last question is an emphatic yes! In fact, this is what my blog is all about. Just read some of the other recent posts and let me know if you disagree with what I am saying!
In his usual provocative fashion, New York Times columnist Paul Krugman says that Republicans are “Enemies of the Poor” because “they’re deeply committed to the view that efforts to aid the poor are actually perpetuating poverty, by reducing incentives to work.” But the Heritage Foundation’s Robert Rector has recently pointed out in the Wall Street Journal, “How the War on Poverty Was Lost”, that “the typical American living below the poverty line in 2013 lives in a house or apartment that is in good repair, equipped with air conditioning and cable TV. He has a car, multiple color TVs and a DVD player. The overwhelming majority of poor Americans are not undernourished and did not suffer from hunger for even one day of the previous year.” In fact we are now spending $600 billion a year of our $3.4 trillion federal budget and another $230 billion by the states to fight poverty. The poverty rate was 19% in 1964 and is 16% today (when government benefits are included).
Mr. Rector reminds us that “LBJ’s original aim (in initiating his antipoverty program) was to give poor Americans ‘opportunities, not doles’. It would attack not just the symptoms of poverty but, more important, remove the causes. By that standard, the war on poverty has been a catastrophe. The root ‘causes’ of poverty have not shrunk but expanded as family structure disintegrated and labor force participation among men dropped.”
So what should our poverty agenda look like going forward? We are already providing the basic necessities of life. Our future efforts should therefore be focused on improving the quality of life for the poor. This means more effective education and job training. It means more effort to keep families together by reducing marriage penalties. But most of all it means providing more opportunities for employment and job advancement. This requires faster economic growth. There are many ways to accomplish this. Back to square one!
The true enemies of the poor are those who refuse to accept the progress which has been made in the War on Poverty and the need to change our approach in order to make further progress.
My previous post, “Fundamental Tax Reform Is the Key to Solving Our Economic and Fiscal Problems II. The Graetz Plan”, describes a tax reform plan which establishes a 14% national consumption (VAT) tax, exempts families earning under $100,000 from paying any income tax and also reduces the Corporate Income Tax to 15%. All of this is done in a revenue neutral manner while also preserving all of the progressivity of our current income tax system. A recent Op Ed column in the New York Times, by the economist Lawrence Kotlikoff, “Abolish the Corporate Income Tax”, makes the case that such a proposal “might sound like a gift to the rich, but it would actually help workers. … Apple’s tax return says it all: The company, according to one calculation, paid only 8% of its worldwide profits in United States corporate income taxes, thanks to piling up most of its profits and locating far too many of its operations overseas.”
Our corporate income tax rate, at 35%, is one of the highest in the world and this is what encourages American multinational companies to move their business to other countries. Whether we abolish the corporate income tax entirely, or just reduce it to 15%, is less important than recognizing the need to overcome popular prejudice about big business and make fundamental changes in our tax structure.
Solving our country’s many problems, from rising inequality at home to projecting adequate strength around the world, requires that the U.S. have a strong economy. An annual growth rate of 2% of GDP is not nearly good enough to end our current economic stagnation. To accomplish this will require overcoming the strong headwinds of increasing global competition and the replacement of people with machines. We will need innovative thinking and initiative to break out of the old ways of doing things which are holding us back.
Are the American people “exceptional” enough to accomplish this challenging task?
The Yale Tax Law Professor, Michael Graetz, has proposed a new tax system “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States” which would do wonders towards straightening out the huge fiscal and economic problems now facing our country. How do we rev up the national economy in order to put more people back to work and, at the same time, raise the revenue needed to operate the government in the 21st century without mountains of debt? Mr. Graetz’s basic idea is to tax consumption rather than relying totally on an income tax. Under his plan both savings and investments will be taxed at a lower rate which will encourage more of both. The Plan has these features:
A broad based Value Added Tax of about 14% is enacted on goods and services. The U.S. is the only advanced economy without a VAT.
Families earning less than $100,000 are exempted from the income tax. For incomes between $100,000 and $250,000, the tax rate would be 15%. For income over $250,000, the rate would be 25%.
The corporate income tax rate is lowered to 15%.
The Earned Income Tax Credit (EITC) is used to provide relief from the VAT burden to low-income families by using payroll tax offsets.
The plan is designed to be revenue neutral as verified by the Tax Policy Center.
This plan has many advantages including:
Taxing consumption and lowering the corporate tax rate to 15% from its current level of 35% would dramatically encourage investment in the U.S. thereby stimulating the economy and creating both new jobs and higher wages for American workers.
It would eliminate more than 100 million of the 140 million U.S. tax returns.
With many fewer Americans paying income taxes there would be far less temptation for Congress to use income tax exclusions, deductions and credits to try to address social and economic problems.
The plan retains all of the progressive features of our current tax system whereby higher income earners pay higher tax rates.
The point of describing the Graetz Plan in some detail is not to suggest that it is the best way to implement tax reform but rather that here, at least, is one attractive way to do it. The purpose is to move the discussion forward. We badly need to make changes along these lines!
Many political commentators have been complaining recently about the financial difficulties of the American middle class. For example, a recent report from Bill Moyers and Company, “By the Numbers: The Incredibly Shrinking American Middle Class”, has a chart showing that the median middle class salary, adjusted for inflation, is now no better than it was in 1989 and not much higher than in 1979: But there is another point of view, very well described by the two economists, Donald Boudreaux and Mark Perry, in the Wall Street Journal just about a year ago, “The Myth of a Stagnant Middle Class”. They make several pertinent points:
The Consumer Price Index overestimates inflation by underestimating the value of improvements in product quality and variety.
Wage figures ignore the rise over the past few decades in the portion of worker pay taken as (nontaxable) fringe benefits. Health benefits, pensions, paid leave, etc. now amount to almost 31% of total compensation according to the Bureau of Labor Statistics.
The average hourly wage has been held down by the great increase of women and immigrants into the workforce over the past three decades. Because the economy was (before the Great Recession) so strong, it created millions of jobs for the influx of often lesser skilled workers into the workforce.
Messrs. Boudreaux and Perry point out several other improvements in the quality of life which Americans enjoy:
Life expectancy has increased to 79 years for an American born today, five years longer than in 1980. And the gap in life expectancy between whites and blacks has narrowed.
Spending by households on the basics of food, housing, utilities, etc. has shrunk from 53% of income in 1950, to 44% in 1970 to 32% today.
Although income inequality is rising when measured in dollars, it is falling when measured in terms of our ability to consume. For another example, air travel is now as common as was bus travel in an earlier era. And another: the latest electronic products are available to even middle class teenagers.
Conclusion: We should stop complaining about inequality and thank our lucky stars for the free enterprise system which has been so successful in improving our quality of life.
In yesterday’s Wall Street Journal, the economist Robert Grady addresses “Obama’s Misguided Obsession With Inequality”. The basic problem is that an important Congressional Budget Office report in 2011, “ Trends in the Distribution of Household Income Between 1979 and 2007”, is easy to misrepresent and misinterpret. Here are three basic pieces of data from the CBO report: The first chart shows that yes, between 1979 and 2007 the rich did indeed get richer relative to the rest of the population. The second chart shows, however, that median household income increased by 62% during this same time period. And the third chart shows that all five income groups made substantial gains at the same time.
As Mr. Grady says, “Here is the bottom line. In periods of high economic growth, such as the 1980s and 1990s, the vast majority of Americans gain and have the opportunity to gain. In periods of slow growth, such as the past four and a half years since the recession officially ended, poor people and the middle class are hurt the most, and opportunity is curbed. … The point is this: If the goal is to deliver higher incomes and a better standard of living for the majority of Americans, then generating economic growth – not income inequality or the redistribution of wealth – is the defining challenge of our time.”
So then, what is the best way to address income inequality? Should we concentrate on raising taxes on the rich and increasing spending on social programs like we have done in the last five years? Or should we rather concentrate on speeding up economic growth, as Mr. Grady says, in order to create more jobs and more opportunities for advancement?
Compare the enormous growth in the period from 1979 to 2007 with the stagnation of the past five years. Isn’t it obvious which is the better way to proceed?
The economist Joseph Stiglitz has an Op Ed column in today’s New York Times, “In No One We Trust”, blaming the financial crisis on the banking industry. “In the years leading up to the crisis our traditional bankers changed drastically, aggressively branching out into other activities, including those historically associated with investment banking. Trust went out the window. … When 1 percent of the population takes home more than 22 percent of the country’s income – and 95 percent of the increase in income in the post-crisis recovery – some pretty basic things are at stake. … Reasonable people can look at this absurd distribution and be pretty certain that the game is rigged. … I suspect that there is only one way to really get trust back. We need to pass strong regulations, embodying norms of good behavior, and appoint bold regulators to enforce them.” Mr. Stiglitz is partially correct. Although the housing bubble, caused by poor government policy – loose money, subprime mortgages, and lax regulation – was the primary cause of the financial crisis, nevertheless, poorly regulated banking practices made the crisis much worse. But this is all being fixed with Dodd-Frank, a just recently implemented Volker Rule, and a soon coming wind-down of Fannie Mae and Freddie Mac. Mr. Stiglitz concludes, “Without trust, there can be no harmony, nor can there be a strong economy. Inequality is degrading our trust. For our own sake, and for the sake of future generations, it is time to start rebuilding it. But how do we reduce the inequality in order to restore the trust which is necessary for a strong economy? Mr. Stiglitz doesn’t say! What we need is faster economic growth in order to create more new jobs. The last four years have demonstrated that the Federal Reserve can’t accomplish this with quantitative easing. It needs to be done by private business and entrepreneurship. Tax reform and the easing of regulations on new businesses is what we need. It’s too bad that ideological blinders prevent so many people from understanding this basic truth!