Saving the System

 

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.
Capture1“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.

Is America Falling Behind?

 

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.
CaptureThe 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.

The Resurrection of Karl Marx

 

The French economist Thomas Piketty is creating a huge stir with the publication in English of his new book “Capital in the 21st Century.”  Mr. Piketty develops a very simple idea, with reams and reams of data.  Namely that income from wealth, i.e. investment income, typically grows faster than income from wages and GDP.  This means that the value of private capital is growing steadily as a percentage of national income.  This trend has been occurring ever since 1950, at the end of WWII, and is likely to continue indefinitely absent new mega shocks to the global economy such as another world war.
CaptureIn other words, wealth inequality is rapidly increasing just as is income inequality.  Today’s New York Times has an interesting article “Taking on Adam Smith (and Karl Marx)”  discussing Mr. Piketty’s background and how it has influenced his research.  “No revolutionary, Mr. Piketty says that inequality by itself is acceptable to the extent it spurs individual initiative and the generation of wealth.  But extreme economic inequality, he contends, will have a deep and deleterious impact on democratic values,” says the reporter.
Now that income inequality and wealth inequality are clearly well documented, the question is how our democratic society will respond through the political process.  First of all, we need to agree to take the problem seriously.  Equality of opportunity and economic mobility still exist but it is getting harder and harder to move up the income ladder. What our country badly needs right now is an economic program that will get our economy growing faster in order to create more jobs as well as bringing in more tax revenue to pay for government.
One way to accomplish this is with

  • Broad-based tax reform to lower rates in order to put more money in the hands of people who will spend it on basic necessities as well as business expansion. Lower rates can be paid for by closing loopholes and deductions which primarily affect the wealthy.
  • A low percentage (1% or 2%) tax on wealth (i.e. financial assets) with a fairly high personal exemption of perhaps $10 million in order to only include the most wealthy. This would raise about $200 billion per year which could be used to fund a wide scale infrastructure renovation program which would provide employment to millions of people.

Such a wealth tax would be a highly visible means of addressing economic inequality in a way which would greatly benefit to the economy at the same time.

Is Capitalism in Crisis?

 

The economist and public lecturer, Richard Wolff, gave an address in Omaha NE last night, entitled “Capitalism in Crisis: How Lopsided Wealth Distribution Threatens Our Democracy”.  His thesis is that after 150 years, from 1820 – 1970, of steadily increasing worker productivity and matching wage gains, a structural change has taken place in our economy.  Since 1970 worker productivity has continued to increase at the same historical rate while the median wage level has been flat with no appreciable increase. This wage stagnation has been caused by an imbalance of supply and demand as follows:
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  • Technology has eliminated lots of low skill and medium skill jobs in the U.S.
  • Globalization has made it less expensive for low skill jobs to be performed in the developing world at lower cost than in the U.S.
  • At the same time as jobs were being replaced by technology and disappearing overseas, millions of women entered the labor force.
  • A new wave of Hispanic immigration has caused even more competition for low skilled jobs.

In addition, stagnant wages for the low skilled and medium skilled worker have been accompanied by an increase in private debt through the advent of credit cards and subprime mortgage borrowing.  This enormous increase of consumer debt led to the housing bubble, its bursting in 2007-2008, and the resulting Great Recession.
Five years after the end of the recession in June 2009, we still have an enormous mess on our hands: a stagnant economy, high unemployment, massive and increasing debt and a fractious political process.  How in the world are we going to come together to address our perilous situation in a rational and timely manner?
Mr. Wolff believes that capitalism’s faults are too severe to be fixed with regulatory tweaks.  He also agrees that socialism has proven to be unsuccessful where it has been tried.  He proposes a new economic system of “Workers’ Self-Directed Enterprises” as an alternative.
I agree with Mr. Wolff that capitalism is in a crisis but I think that it can be repaired from within.  The challenge is to simultaneously give our economy a sufficient boost to put millions of people back to work and to do this while dramatically shrinking our annual deficits in order to get our massive debt on a downward trajectory as a percent of GDP. How to do this is the main focus of my blog, day in and day out!

Wealth Inequality vs Income Inequality

 

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.”
CaptureWe 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)!

Response to a Persistent Critic

 

You keep saying that we need lower tax rates to boost the economy but what makes you think this will help? Businesses are sitting on piles of cash. They have plenty of money to invest in expansion. What they need are more customers. The basic problem is not enough demand for more goods. This is what is holding back the economy. It doesn’t much matter what the tax rates are. If the demand and customers are there, businesses will spend their own money or borrow as much money as they need, at low interest rates, to produce all the products they can sell.                                                                                                                Anonymous Critic

I have several responses to this criticism:

  • First of all I want to make it clear that all cuts in tax rates must be offset by shrinking or eliminating tax preferences.   So there will be no loss of tax revenue. Two thirds of all taxpayers take the standard deduction and will therefore automatically benefit from lower tax rates. This will put tens of billions of new dollars into the hands of middle class wage earners who will spend most of this money because they have tight budgets. This will give the economy a big boost.
  • As I discussed in my blog post from October 26, 2013 “Where are the Jobs? II. How to Create More of Them,” most net new job creation comes from businesses less than one year old, the true “startups.” New business owners are typically not wealthy, with lots of personal tax deductions. They need all the financial resources they can muster. Lower tax rates will save them money and therefore help them get their new business going.
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  • In general, tax deductions such as for mortgage interest, municipal bond interest payments, state and local taxes, etc. benefit the wealthiest tax payers.  Therefore the lowering of tax rates, offset by shrinking tax deductions, represents a shift of funds from the wealthier to the less wealthy. This will at least slow down the increase of inequality which afflicts the modern world.

Conclusion: Lower tax rates will put more money in the hands of people who will spend it, thereby boosting the economy by creating more demand, provide support for entrepreneurs starting new businesses (which will create more jobs) and lessen income inequality. All in all this represents major progress!

Soaring Profits, Too Few Jobs and Low Interest Rates

 

“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.”
Capture“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.