I seldom use the New York Times sociological columnist, David Brooks, as a source for my blog posts because I am focused primarily on economic and fiscal issues. But his column today, “Saving The System,” is highly pertinent to my message. “All around, the fabric of peace and order is fraying. The leaders of Russia and Ukraine escalate their apocalyptic rhetoric. The Sunni-Shiite split worsens as Syria and Iraq slide into chaos. China pushes its weight around in the Pacific. … The U.S. faces a death by a thousand cuts dilemma. No individual problem is worth devoting giant resources to. But, collectively, all the little problems can undermine the modern system.”
In addition to all of these pesky worldwide problems, our free enterprise economic system is under siege. Wages have been largely stagnant since the early 1970s and income inequality is growing as the top 1%, and perhaps the top 10 or 15% as well, do much better than everyone else. And just lately we have also learned from the French economist, Thomas Piketty, that wealth inequality has been growing steadily ever since about 1950 and is likely to get substantially worse in the future.
In other words, western civilization is under threat in more ways than one. What are we going to do about it? At the risk of oversimplifying, I believe that the single best thing we can do is to undertake fundamental tax reform to make our economy stronger. Cut everyone’s tax rates and pay for it by closing loopholes and deductions which primarily benefit the wealthy.
Lower tax rates will put more money in the hands of the two thirds of Americans who don’t itemize their tax deductions. These are largely the same people with stagnant wages and so they will spend this extra income they receive.
The resulting increase in demand will put millions of people back to work and thereby increase tax revenues which will help balance the budget. This shift of income from the wealthy to the less wealthy will reduce income inequality.
Although harder to implement politically, a low (between 1% and 2%) wealth tax on financial assets above a threshold of $10 million per individual, would be a highly visible way to address wealth inequality. The substantial sum of revenue raised by this method could be used to fund national priorities as well as paying down the deficit.
I don’t want to leave the impression that I consider this program to be a panacea for strengthening our country. But it would help and we need to make some big changes to maintain our status as world leader.
Yesterday’s New York Times has a very interesting article, “U.S. Middle Class No Longer World’s Richest”, demonstrating that from 1980 -2010 the median wage in many other developed nations has grown faster than in the U.S. The chart below does show that the U.S. median wage is still growing but just not as fast as elsewhere. The authors suggest three reasons to explain what is happening:
Educational attainment in the U.S. is growing more slowly than in the rest of the industrialized world.
A larger portion of business profits in the U.S. is going to top executives meaning less for middle and low income workers.
There is a higher degree of income redistribution (through taxation) in Canada and Western Europe than in the U.S.
The data presented in this article is more elaborate but nevertheless consistent with what other studies are showing. We are still on top but we need to make some major changes in order to stay there. For example:
Most states have adopted the national Common Core curriculum for K – 12 schools. In today’s highly competitive global environment, this will enable a more rigorous evaluation of educational attainment between the states and should, therefore, improve overall academic achievement.
The best way to raise salaries for middle and low-income workers is to boost economic output overall. Fundamental tax reform, with lower tax rates for everyone, offset by closing loopholes and lowering deductions for the wealthy, will put more money in the hands of the people most likely to spend it. This will increase demand and make the economy grow faster.
As a highly visible way of addressing economic inequality in the U.S., institute a relatively small, i.e. 1% or 2%, wealth tax on the assets of individuals with a net worth exceeding $10 million. This would raise up to $200 billion per year which could be used for an extensive infrastructure renewal program, creating lots of jobs and further boosting the economy, with a lot left over to devote to shrinking our massive federal deficits.
A program like this encourages everyone to work hard and reach their highest potential, including accumulating as much wealth as they are able to. But the people at the very top, i.e. the superrich, will be required to give back a little bit more in order to benefit the entire country.
This morning’s Wall Street Journal has a book review by the New York fund manager, Daniel Shuchman, “Thomas Piketty Revives Karl Marx for the 21st Century” of Thomas Piketty’s new book “Capitalism in the Twenty-First Century.” As I recently discussed, Piketty makes the simple observation that income from wealth, i.e. investment income, grows faster than income from wages or GDP. He then provides a large quantity of data showing how this has played out since the end of WWII. He plausibly predicts that the value of private capital as a percentage of national income will continue to grow indefinitely into the future. This much is straightforward. The question is how we should react to a steadily increasing and very large concentration of wealth in the hands of a small percentage of people. Mr. Piketty’s own idea is, for example, to establish an 80% tax rate on incomes starting at “$500,000 or $1,000,000” in order “to put an end to such incomes.” Mr. Shuchman attempts to discredit Mr. Piketty by focusing in on such socialistic views for dealing with the problem rather than discussing the intrinsic merit of Piketty’s basic thesis about the buildup of great wealth in the first place.
My own view is that Mr. Piketty has clearly identified a weakness of capitalism and that it behooves supporters of free markets and private initiative to address this problem in a constructive way, for example, as follows.
We need fundamental broad-based tax reform, i.e. lower tax rates in exchange for closing loop-holes and lowering deductions, in order to boost the economy and create more jobs. As part of a major tax overhaul, we could also establish a relatively small wealth tax, of about 1% or 2%, on assets over $10,000,000, which would raise as much as $200 billion per year. This much money could be used to begin a large scale program of infrastructure renewal as well as leaving a lot left over to make significant payments on reducing our annual deficit.
Such an overall plan would address both income inequality and wealth inequality in a highly visible manner while simultaneously helping our economy.
The Yale Economist and Nobel Prize winner, Robert Shiller, has an article in today’s New York Times, “Better Insurance Against Inequality”, proposing that “taxes should be indexed to income inequality so that they automatically become more progressive – meaning that the marginal tax rate for the highest income people will rise – if income equality becomes much worse.” We do know, of course, that income inequality is steadily increasing in the U.S. It is in fact essentially folklore that the top 1% of Americans is collecting a larger and larger share of the national income. Furthermore the French economist, Thomas Piketty, has recently shown that there is also “a relentless widening of disparity in wealth”.
Our democratic political system will surely respond in some way to this increasing gap between the rich and the poor. It is important to our future wellbeing to respond in a constructive manner. Today’s top tax rate of 39.6% is already very high and Mr. Shiller admits that the top rate would have to rise well over 75% in his plan.
Our biggest economic problem today is a stagnant economy. We badly need faster economic growth, in order to put people back to work and to bring in more revenue to shrink the deficit. Today what we need is lower tax rates, to put more money in the hands of people who will spend it, including potential entrepreneurs who will invest it in new businesses. Raising tax rates to address rising income inequality is therefore self-defeating as an economic strategy.
Rather let’s tax people’s financial assets after they have earned their money. A 1% wealth tax with a relatively high $10,000,000 personal exemption would bring in approximately $200 billion per year. $200 billion per year would enable us to pay down our deficit at a much faster rate as well as having a lot left over to begin an extensive infrastructure renewal program (for example)!
“Low interest rates aren’t working, but we need a debate about what will,” declares The Wall Street Journal’s William Galston yesterday in “Soaring Profits but Too Few Jobs”. “Corporate profits after taxes in the fourth quarter of 2013 rose to an annual level of $1.9 trillion – 11.1% of GDP, a postwar high. Meanwhile, total compensation – wages and benefits – fell to their lowest level of GDP in at least 50 years.” “Businesses are sitting on tons of cash . . . and they’re choosing to invest their capital in hardware, rather than hiring. The reason: they believe that investing in technology is likely to have a better effect on sales than hiring more people.” Furthermore, “today’s (low) interest- rate regime lowers the cost of capital – and therefore of capital investment relative to labor.”
Meanwhile,” Republicans are banging away at the Affordable Care Act while Democrats are busy scheduling votes on a grab bag of subjects designed to boost turnout from the party’s base in the fall elections. The economic problems we face are getting lost in the partisan din.”
We are in a very tough situation. Raising interest rates might give a marginal boost to hiring more workers over capital investment but it will also greatly increase interest payments on our massive and rapidly increasing national debt. And meanwhile we have a stagnant economy with millions of people either unemployed or underemployed. What should we do? How about
Boosting the economy with lower individual and corporate tax rates, paid for by cutting back on tax preferences. This will especially help small businesses grow and hire more employees. It will also encourage multinational corporations to bring their foreign profits back home for reinvestment.
Addressing rising income and wealth inequality by establishing an annual 1% wealth tax on individual assets in excess of $10 million. This will raise about $200 billion per year and could be used to set up a huge infrastructure improvement program to put millions of people back to work.
Interest rates will eventually return to normal levels of 5% or so and this will create a big squeeze on the federal budget. So we also need to get federal spending under control as soon as possible. But this is a separate issue.
Just boosting the economy and putting people back to work while addressing inequality in a very visible way will get us started on a path to recovery.
“Consider the following scenario. You are an airline pilot charged with flying a planeload of passengers across the Atlantic. You are offered the choice of two different aircraft. The first aircraft has been prepared by chief engineer Keynes and the second by chief engineer Hayek.
You have to choose which plane to use, so naturally you ask the advice of the two engineers. Keynes urges you to use his aircraft, offering a convincing explanation of why Hayek’s plane will crash on take-off. Hayek urges you to use his aircraft, offering an equally convincing explanation of why Keynes’s plane will crash on landing. At loss as to which plane to choose, you seek the advice of two leading independent experts – Karl Marx and Adam Smith. Marx assures you that it does not matter which aircraft you choose as both will inevitably suffer catastrophic failure. Similarly, Smith also reassures you that it does not matter which aircraft you choose, as long as you allow your chosen craft to fly itself.”
Thus begins a fascinating new book, “Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a true science,” by the fund manager and economist, George Cooper. Mr. Cooper sets up a circulatory model of democratic capitalism whereby rent, interest payments and profits flow from low income people at the bottom of the pyramid to the wealthy at the top. And then tax revenue (collected mostly from the wealthy) is redistributed downward in the form of government programs.
According to Mr. Cooper, the financial crisis was caused by a combination of lax regulation and excessive credit and monetary stimulus. The question is what to do about it. Mr. Cooper says:
Stop adding to the problem. High student debt and high mortgage debt are still being supported by government programs.
Change the course of the monetary river. Quantitative easing does not work because it just puts money into the hands of the wealthy and they have no incentive to spend it.
Change the course of the fiscal river. Instead put money into the hands of the people at the bottom of the pyramid with expanded government spending on infrastructure (paid for by taxing the wealthy).
Without endorsing all of Mr. Cooper’s suggestions, he nevertheless has many good ones and expresses them in a highly entertaining style!
Our dire fiscal and economic problems are crying out for a bold solution. We need to simultaneously stimulate our economy to grow faster and create more jobs, raise sufficient tax revenue to pay for our growing spending commitments, and address a widening inequality gap which threatens to undermine the basic principles of a free and just society. How are we going to accomplish all of these tasks at the same time?
It seems to me that the best way is to thoroughly reform our income tax system based on the following principles:
Lower tax rates on marginal income to encourage more investment and entrepreneurship. Such changes can be made revenue neutral by eliminating deductions, loopholes and other tax preferences. This would apply to corporations as well as individuals.
Establish a new low percentage (1% – 2%) wealth tax with a relatively high personal exemption ($5 million – $10 million). This would bring in approximately $200 billion per year to be used for reducing the deficit. Equally as important it would be a visible sign that the wealthy are making a significant contribution towards solving our fiscal problem. This will make it more acceptable to lower marginal tax rates on income in order to boost economic growth.
Fiscal conservatives often oppose any increase in tax revenue because, they think, it is likely to be used for new spending rather than for lowering the deficit. One way to overcome this concern is to pass a Balanced Budget Amendment to the Constitution. This would make it much harder to increase spending. The problem is that it will be very hard for Congress to pass such an amendment and have it ratified by ¾ of the states.
But something has to be done. The longer we wait and the more debt we build up, the more painful it will be to extract ourselves when the next crisis occurs as it surely will.
Two of my favorite columnists are the Brooking Institution’s William Galston, a social economist who has a weekly column in the Wall Street Journal and the economics journalist Robert Samuelson who writes for the Washington Post. Most people agree that income inequality in the U.S. is steadily getting worse. Mr. Galston make a good case (see my last post) that it is primarily caused by the large gap between the rising productivity of American workers and the stagnant level of their pay which has developed since 1973. He thinks that we need a fundamentally new social contract which links worker compensation to productivity. This, of course, is a tall order and it is not at all clear how such a new order would be achieved. Mr. Samuelson has a different perspective: “Myth-making about Economic Inequality”. For example:
The poor are not poor because the rich are rich
Most of the poor will not benefit from an increase in the minimum wage because only 6% of the 46 million poor people have full time jobs
All income groups have gained in the past three decades, even though the top 1% has gained the most (see the above chart from the CBO, December 2013)
Widening economic inequality did not cause the Great Recession
These two perspectives on inequality are quite different but not contradictory. Basically what Mr. Samuelson is saying is that we have to be careful in how we address this problem or we’ll just make it worse. Raising taxes on the rich is unlikely to help and might hurt if it slows down the economy. Raising the minimum wage will only raise a fairly small number of people out of poverty and may cause a lot of unemployment along the way.
My solution: focus on boosting the economy to create more jobs in the short run (tax reform, immigration reform, trade expansion) and improved educational outcomes for the long run (early childhood education, increasing high school graduation rates, better career education).
But I agree with Mr. Galston that it is imperative to lessen income inequality, one way or another. Otherwise as a society we’ll have big trouble on our hands.
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!
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?