“When the Athenians finally wanted not to give to society but for society to give to them, when the freedom they wished for most was freedom from responsibility, then Athens ceased to be free.”
Edward Gibbon, 1737 – 1794, The Decline and Fall of the Roman Empire
In my last blog, “The Government We Deserve,” I reported on a new book “Dead Men Ruling” by Eugene Steuerle, which shows how “Dead and retired policymakers have put America on a budget path in which spending will grow faster than any conceivable growth in revenues.” Our country is clearly in a huge predicament. We can get out of this jam by:
Restoring Balance: our legislators should only appropriate spending for one year at a time.
Investing in our future: i) opportunity is a more optimistic goal than adequacy ii) policies to assure adequacy often reduce opportunity by creating negative incentives (e.g. food stamps, disability programs, housing vouchers) iii) means-tested programs are often anti-family (i.e. discourage marriage)
Building a Better Government: our main goal today should be to restore fiscal freedom by allowing future generations to create the government they need and want. i) constrain the automatic growth in big federal tax subsidy, health and retirement programs ii) reorient government towards investment, children, opportunity and leanness
“Both parties talk the talk about deficit reduction but fail to see that the deficit is but a symptom of a much broader disease – the extent to which both have tried to legislate far too much of what future government should look like.”
Here are the kinds of fixes which are needed:
Eschew Constitutional Fixes (i.e. a balanced budget amendment, term limits).
Require Presidents to propose budgets which balance over a business cycle.
A True Grand Compromise (end automatic growth of entitlements, generate revenues needed to pay current bills).
As Mr. Steuerle says, “If the obstacles to progress are considerable, the payoffs are enormous.”
“As for the future, your task is not to foresee it, but to enable it.”
Antoine de Saint-Exupery, 1900 – 1944
An important new book, “Dead Men Ruling,” by the Urban Institute’s C. Eugene Steuerle, has just been published. Here is the flavor of its message: “Dead and retired policymakers have put America on a budget path in which spending will grow faster than any conceivable growth in revenues. … The same policy makers also cut taxes so much below spending that they created huge deficits, which have now compounded the problem with additional debt.”
“Both sides have largely achieved their central policy goals – liberals have expanded social welfare programs, conservatives have delivered lower taxes. Both now cling tenaciously to their victories.”
In short, “our central problem is the loss of fiscal freedom.” There are “four deadly economic consequences of this disease:
rising and unsustainable levels of debt,
shrinking ability of policymakers to fight recession or address other emergencies,
a budget that invests ever less in our future and is now a blueprint for a declining nation, and
a broken government, as reflected in antiquated tax and social welfare systems.”
In addition there are “three deadly political consequences:
a decline of ‘fiscal democracy’ depriving current and future voters of the right to control their own budget,
a classic ‘prisoner’s dilemma’ where both left and right leaning elected officials conclude that they will suffer politically if they lead efforts to impose either spending cuts or tax hikes, and
rising hurdles to changing our fiscal course because, to do anything new, requires reneging on past promises of rising benefits and low taxes, that voters have come to expect.”
In other words the U.S. is in a very difficult predicament. Mr. Steuerle thinks it will take a major “fiscal turning point” to escape from the present danger. Both sides will have to make big concessions in order for us to get out of this jam. But how is this possibly ever going to happen? More next time!
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.
The House Committee on Financial Services recently held a hearing on the topic “Why Debt Matters.” One of the speakers was David Cote, CEO of Honeywell International. He pointed out that the percentage of world GDP generated by the developed countries (the U.S., Western Europe, Canada and Japan) is predicted to decline from 41% in 2010 to 29% by 2030. High growth developing economies are expected to grow in GDP from 33% in 2010 to 47% in 2030. In order to compete in this new world we need an “American Competitiveness Agenda.”
Mr.Cote suggests eight components: debt reduction, infrastructure development, better math and science education, immigration reform, tort reform, stronger patent support, more energy generation and efficiency, and trade expansion. “To compete effectively on the increasingly competitive world stage, we have to have a strong balance sheet. We don’t have a strong balance sheet today and it will worsen over time with our current plan. … In 2025, just 11 years from now, we will be spending a trillion dollars a year just in interest.” And this is assuming no more recessions in the meantime! Our public debt level today, at 72% of GDP, is higher than at any time in our nation’s past, except for during World War II when the survival of the free world was at stake. And while public debt will be 78% of GDP in 2023, which might not sound much worse than today, it is also projected to be much higher, 99% of GDP, by 2033. Is this really the legacy that we want to leave for our children and grandchildren? Some people say that we should run even bigger deficits right now until we are fully recovered from the Great Recession. But this is what we’ve been doing for the past five years and it’s not working. How much longer do we wait until we change course?
It’s possible to shrink our deficits and speed up the growth of our economy both at the same time. This is what Mr. Cote is saying and what I am constantly talking about on this website!
“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!
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 Brookings Institution social economist, William Galston, has an interesting column in yesterday’s Wall Street Journal, “The U.S. Needs a New Social Contract”, deploring the fact that worker compensation (i.e. wages + benefits) has not kept up with gains in worker productivity since the 1970s. Here is a chart published by the Economic Policy Institute showing the divergence between productivity and compensation for a “typical” ( i.e. in the middle) worker beginning in the 1970s: The Heritage Foundation’s James Sherk has addressed this same question in a recent report “Productivity and Compensation: Growing Together” and shows that the “average” compensation of an American worker does track productivity very closely as shown in the chart below: What is the explanation for this apparent discrepancy? In fact, it is the difference between the average earnings of U.S. workers and the earnings of the median or middle worker. The very high earnings of the top 10% and the even higher earnings of the top 1% raise average worker compensation way above the income level of the median worker. In other words it is the result of the skewed and unequal distribution of incomes which is heavily weighted toward those at the top of the scale. The typical or median worker is falling behind and is not benefitting from the steady rise in the overall productivity of the American economy. This is what income inequality is all about.
The question is what to do about it. Faster economic growth will create more opportunity by creating more jobs and better paying jobs. Raising high school graduation rates as well as creating high quality technical training programs will also help.
Mr. Galston insists that this is not enough. Too many workers will continue to lag farther and farther behind. We could raise the Earned Income Tax Credit for low income workers but this would be very expensive in our currently tight fiscal situation which is likely to continue indefinitely.
Do we need a new social contract? If so, what form will it take? How will we pay for it? These are indeed very difficult questions to answer!
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?
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!