Do We Need a New School of Economics?

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“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.
CaptureMr. 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!

The Long Run and the Short Run

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“I agree with you that something must be done now. The trick is what will work the best in the short term to trigger the agreement between the fiscal conservatives and the modern liberals to cut costs and balance the budget that we both agree on. We can agree to disagree on the solution details but I hope you are successful in achieving the short term goals you are working tirelessly on.
Just as big a question is what will work the best in the long run to prevent it from happening again. I will continue to work on changing the intellectual environment that I see as a precondition to solidifying your short-term gains and preventing a re-occurrence.”
CaptureThese are the words of my Omaha libertarian friend, David Demarest, with whom I have an ongoing dialogue.  He wants to cut back and limit the scope of government.  I’m willing to have a more expansive government as long as we’re willing to pay for it.
The secret to solving many of our current problems (stagnant economy, high unemployment, massive debt, increasing inequality) is to grow our economy faster.  The best way to accomplish this is by boosting investment and entrepreneurship with broad-based tax reform, by lowering tax rates for both individuals and corporations, paid for by eliminating deductions and closing loopholes.
But some people think that lowering tax rates means lower taxes on the rich.  To counteract this perception, and at the same time to raise additional tax revenue to lower the deficit, I propose to  levy a new wealth tax of 1% of assets with an exemption of $10 million per person to make sure that the tax only applies to the “truly wealthy.”
I believe that a program along these lines is the best way to get our economy back on track.  But, at the same time we need to figure out how to avoid falling back into another slow growth, high debt trap anytime soon.
A good way to achieve long run protection is with a balanced budget amendment.  It would need to be flexible, allowing for emergencies, and also phased in over several years to allow citizens and legislators time to make the necessary adjustments to spending and taxes.

Do We Really Need a Wealth Tax?

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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.

Considering a Wealth Tax for the U.S.

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What should a country do when it has

  • Massive accumulated debt and annual deficits predicted to grow indefinitely.
  • A rapidly growing population of retirees heavily dependent on expensive entitlement programs such as Social Security and Medicare.
  • A national Congress which is unwilling to make significant spending cuts for fear of offending powerful constituent groups.
  • Growing income inequality and wealth inequality.
  • A stagnant economy and high unemployment which makes inequality worse.
  • An inefficient income tax system which does not take in enough tax revenue to pay the bills.

The best response by far is to implement broad-based, pro-growth, tax reform.  I have often discussed how to make major changes to our current income tax system.  I have also described an attractive way to introduce a consumption tax, the so-called Graetz Plan.
CaptureAnother way to reform taxes is to introduce a wealth tax.  The economist Ronald McKinnon has described a way to do this in a Wall Street Journal column, “The Conservative Case for a Wealth Tax”.  His plan is to implement a federal wealth tax in addition to the federal income tax.  It would consist of a flat tax of about 3% imposed on household wealth in excess of a $3 million exemption which would exclude 95% of the population.  In addition to bringing in a significant amount of new revenue each year, which is its principal objective, it would serve the purpose of making a flatter, pro-growth, income-tax system more palatable to people who are concerned about inequality, and therefore to a much wider audience.
The economics journalist, Daniel Altman, recently reported in the New York Times, “To Reduce Inequality, Tax Wealth, not Income” that American household wealth totaled more than $58 trillion in 2010.  The most recent issue of Forbes Magazine reports that there are now 492 billionaires in the U.S. with a total wealth of $2.3 trillion.  A 2% tax on the wealth of just these billionaires alone would raise $46 billion.  A 0.5% tax on the wealth of all Americans would raise $290 billion annually.  These examples show that a “moderate” wealth tax could bring in a significant amount of new tax revenue which would make a big dent in shrinking our annual deficit.
We have to do something and do it quickly.  The problem will occur when interest rates return to their normal level as they surely will before long.  When this happens, interest payments on our national debt will sky rocket.  It’s going to be painful regardless, but let’s try to head for the softest landing we can manage!

Wealth and Taxation

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As I reported in my last blog post a few days ago, wealth inequality in the United States and the rest of the developed world is growing rapidly and is likely to get much worse in the foreseeable future.   This is happening because income from wealth, i.e. the return on investment, typically grows faster than wages and GDP.  As income inequality also grows, and top wage earners have more and more money to invest, then the gap between investment income and wage income will become even wider.  There is nothing wrong with this and the more money that is reinvested in our economy, the faster it will grow and the more jobs that will be created.
At the same time that huge new wealth is being created we have an archaic tax system in the U.S. which is not only incredibly complicated and inefficient, but also discourages investment because the top individual and corporate rates are so high.  And it doesn’t collect enough tax to pay our bills.  We have huge deficits already and the CBO says that they’ll just keep getting worse.
Making government operate more efficiently with less spending is highly desirable but will only go so far.  Every government program has a constituency of supporters who complain when their own program is targeted for cuts.  And the biggest and most expensive, the entitlement programs of Social Security and Medicare, have the largest constituency of all, over 50 million retirees at the present time and growing rapidly as the baby boomers retire at the rate of 10,000 per day.
This huge crunch can only be resolved by fundamental tax reform.  Several different ways have been proposed to do this:

  • Reform the current income tax system by broadening the base, lowering rates and eliminating deductions and loopholes to pay for it.  The problem with this approach is that no one wants to give up their own deductions (for mortgage interest, charitable contributions, employer provided healthcare, state and municipal taxes, etc.)
  • Introduce a consumption tax such as the Graetz Plan which I described in my January 7, 2014 post.  It would establish a 14% Value Added Tax on consumption, supplemented by a lower but still progressive tax on incomes over $100,000.  It would avoid being regressive on low wage workers by using an Earned Income Tax Credit to offset the Payroll Tax.
  • Introduce a wealth tax.

Sorry, I’m over my (self-imposed) word limit already.  I’ll describe a possible wealth tax in my next post!

Wealth Inequality I. What Is It?

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The subject of income inequality has generated much interest and concern in recent months.  Now we will also be hearing a lot about wealth inequality, based on the highly credible new work, “Capital in the Twenty-First Century” by the French economist, Thomas Piketty.  The New York Time’s Eduardo Porter, summarizes the basic message in his recent column “A Relentless Widening of Disparity in Wealth”, which is clearly displayed in the two charts below.
CaptureThe value of private capital as a percentage of national income worldwide has been growing steadily since about 1950 and Mr. Piketty predicts that this trend will continue indefinitely.  The trend is equally true, not only in the U.S., but also in other developed countries as is illustrated in the chart.  It happens because the income from wealth, i.e. return on investment, typically grows faster than wages and GDP.
As Mr. Porter says, “It means future inequality in the United States will be driven by two forces.  First of all, a growing share of national income will go to the owners of capital.  Of the remaining labor income, a growing share will also go to the top executives and highly compensated stars at the pinnacle of the earnings scale.”
This trend has now been in effect ever since 1870, with the exception of the period between World War I and World War II, when a massive amount of wealth was destroyed.  The forces of globalization and growth of technology are contributing to both types of inequality, especially in the developed world (see my post of January 23), and these forces will almost surely continue unabated.  So the wealth and income inequality gaps are just going to keep getting worse.
How much inequality can exist in a democracy?  The number of losers (the low income, the poor, and even the struggling middle class) will gradually get bigger and bigger and will become more and more frustrated and express their discontent at the ballot box.  This threatens the future of capitalism and free enterprise, the economic principles on which our way of life is founded.
Something has to be done!  Stay tuned for my next post!

A Balanced and Sensible Anti-Poverty Program

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The American Enterprise Institute’s Robert Doar recently testified before the U.S. Senate Committee on the Budget with ”Back to Work: How to improve the prospects of low-income Americans”.  His recommendations are based on the four principles:

  • Work requirements as a condition of public assistance.  The work first approach has been shown to have better outcomes with regard to attachment to the labor force than even approaches which focus on training and education.
  • Robust work supports for those who are working at low wages.  The Earned Income Tax Credit accomplishes this and should be extended to childless adults.
  • Business growth and investment.  Policies that raise the cost of doing business and deter growth do little to create what the poor need most: jobs.
  • Foster married, two-parent families.  We need to mitigate marriage penalties in public assistance programs and we need to be honest about the consequences for children of single parenthood.

Mr. Doar points out that 10.2 million American’s are unemployed at the present time, 3.6 million have been jobless for more than 27 weeks, 7.3 million are involuntarily working part-time and 837,000 workers are so discouraged that they have stopped looking for work.  Labor force participation has dropped from over 66% in 2007 to 63% today while the poverty rate has risen from 12.5% to 15%.
CaptureRaising the minimum wage will not help the job prospects of most poor Americans.  Only 11.3% of individuals who would benefit from raising the minimum wage are living below the poverty line.  The Congressional Budget Office estimates that raising the minimum wage to $10.10 per hour would lead to 500,000 people losing their jobs.  CBO also estimates that the Affordable Care Act will reduce full-time employment by 2.3 million by 2021.  Given the strong anti-correlation (see the above chart) between labor participation and poverty, this means that the poverty rate may go higher yet.
The conclusion to draw from this excellent poverty synopsis (with lots of references) is that there are intelligent and effective ways to fight poverty and also much poorer ways to try to do it.  Good intentions are not enough!

Does Tax Reform Have a Future?

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My post on February 27, “A Breath of Fresh Air” praises the new tax reform proposal from the House Ways and Means Committee which both lowers and consolidates tax rates in a revenue neutral way as well as greatly simplifying the tax code.  It would be a big step in the right direction.  But the Washington Post’s Robert Samuelson makes a good case in ”Does Tax Reform Have a Future?” that the House bill does not go far enough.
CaptureMr. Samuelson argues that if we’re going to eliminate tax deductions and loopholes, and thereby alienate lots of special interest groups, in order to get lower tax rates, then we should avoid half measures and eliminate virtually all deductions in order to get the lowest possible rates.  In other words, eliminate the mortgage interest deduction rather than just limiting it, eliminate deductions for charitable contributions as well as deductions for state and local taxes.  Eliminate the deduction for employer provided healthcare (which by itself would go a long way towards reforming healthcare.)
Mr. Samuelson would retain only the Earned Income Tax Credit (which encourages low-income people to work) and also the tax preference for contributions to retirement accounts (without which most Americans wouldn’t save for retirement.)
We badly need broad based tax reform to stimulate our economy.  Douglas Holtz-Eakin, the former director of the Congressional Budget Office, has estimated “Reforming Taxes, Goosing the Economy”, that even the imperfect House tax reform proposal would raise GDP by .5% annually for 10 years and create 500,000 new jobs each year over this time period.
Full-fledged tax reform, a la Samuelson, would provide an even greater stimulus but let’s at least do something to put the millions of unemployed and underemployed people back to work and reduce our staggering budget deficits!

Trash Talk from the New York Times

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The Budget Committee of the House of Representatives has just issued a report “The War on Poverty: 50 Years Later”, providing an excellent summary of federal antipoverty programs and their cost at the present time (budget year 2012).  Highlights are:

  • The federal government spent $799 billion on 92 different programs to combat poverty
  • Over $100 billion was spent for 15 different food aid programs
  • Over $200 billion was spent on cash aid
  • Over $90 billion spent on education and job training (over 20 programs)
  • Nearly $300 billion spent on healthcare
  • Almost $50 billion spent on housing assistance

The report also points out that many low-income households face very high effective marginal tax rates, approaching 100%, if any members are employed, because making more money means losing welfare benefits.  This discourages low-income individuals from working at a time when the labor-force participation rate has fallen to a 36-year low of 62.8%.
CaptureHere’s the situation: we have a rapidly growing federal budget with huge deficit spending (see above chart), a stalled economy with low labor-force participation, and an inefficient welfare system which encourages people not to work. Surely our goal should be to motivate welfare recipients to become productive citizens by returning to the workforce.  So doesn’t it make sense to revamp our welfare system to be more efficient as well as to create more incentives for recipients to get and hold a job?
Apparently this does not make sense to the New York Times.  Two days ago they ran an editorial “Mr. Ryan’s Small Ideas on Poverty”, castigating Paul Ryan for “providing polished intellectual cover for his party to mow down as many antipoverty programs as it can see.”  The editorial goes on to say that “it’s easy to find flaws or waste in any government program, but the proper response is to fix those flaws, not throw entire programs away as Mr. Ryan and his Party have repeatedly proposed. . . . For all their glossy reports, Republicans have shown no interest in making these or any other social programs work better.”
Putting it as charitably as possible, the NYT is being unhelpful.  It is a beacon of progressive thought for millions of Americans.  But it is apparently unwilling to give any credence to a sincere effort by fiscal conservatives to reform a major government program to make it operate more efficiently and effectively.

Where Have All the Raises Gone?

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In yesterday’s New York Times an editorial asks the question “Where Have All the Raises Gone?”, pointing out that wages for college graduates have been stagnant since 2001 (see the chart below.)  A report referred to in the NYT editorial suggests that as the information technology revolution has matured, employer demand for cognitive skills has waned and so some college graduates have had to take lower paying jobs, displacing less educated lower skilled workers in the process.  This makes sense and, of course, new hiring has slowed down even more as a result of the recession.
CaptureThe question then becomes, what, if anything can government do to counteract and overcome this trend?   According to the NYT, “what’s needed to raise pay are policies like a higher minimum wage, trade pacts that foster high labor and regulatory standards, and more support for union organizing.”
Of course there is another point of view and it is expressed very well in yesterday’s Wall Street Journal by Mortimer Zuckerman, the Chairman and Editor-in-chief of U.S. News and World Report, “Fight Inequality With Better Paying Jobs”. Mr. Zuckerman declares that “income inequality isn’t so much the problem as income inadequacy.  A more robust economy, stoked by growth-oriented policies from Washington, would help produce the jobs and opportunities that millions of Americans need to climb the economic ladder.”  He suggests that what is needed is:

  • Lower corporate tax rates so that American multinational companies will bring their foreign earnings back home.
  • Get healthcare costs under control (Obama Care doesn’t do this).
  • Cut back on unnecessary regulations to encourage more business investment.
  • Train more skilled workers.  The National Federation of Independent Businesses reports that 38% of its members have job openings they can’t fill.
  • Restore H1-B visa levels to the higher levels of earlier years – 195,000 per year compared to only 65,000 today.  Skilled immigrants start many new businesses and this is the biggest source of new job creation.

In other words there are lots of things the federal government can do to boost the economy.  As Mr. Zuckerman says, “The political system is failing us.  Washington doesn’t seem to be listening as our political parties are focused more on ideological conflict than the good of the country.”