On Tax Cuts for the Middle Class and the Wealthy

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It is a known fact today that extreme conservatives push for tax cuts (but just for the wealthy) and extreme liberals are against all tax cuts, believing that we need higher taxes to pay for government programs … and that taxes somehow won’t create any drag on the economy.

I believe both extremes are wrong.

In the real world, tax cuts for the middle class and poor stimulate the economy, but tax cuts for the wealthy hurt the economy.

Look at the facts: Taxes were cut in 2001, 2002, 2003, 2004 and 2006.

It would have been one thing if the Bush tax cuts had at least bought the country a higher rate of economic growth, even temporarily. They did not. Real G.D.P. growth peaked at just 3.6 percent in 2004 before fading rapidly. Even before the crisis hit, real G.D.P. was growing less than 2 percent a year…

According to a recent C.B.O report, they reduced revenue by at least $2.9 trillion below what it otherwise would have been between 2001 and 2011. Slower-than-expected growth reduced revenue by another $3.5 trillion….and spending was $5.6 trillion higher than the C.B.O. anticipated for a total fiscal turnaround of $12 trillion. That is how a $6 trillion projected surplus turned into a cumulative deficit of $6 trillion.

If you recall, it was George W. Bush’s father, GWH Bush, who, when campaigning against Reagan, called supply side economics’ claims that tax cuts pay for themselves Voodoo Economics. And Bush was proved right when deficits spiraled out of control and both Reagan and Bush were forced to raise taxes. In fact, the Bush tax cuts accrued disproportionately to the wealthy. The Tax Policy Center shows that 65 percent of the dollar value of the Bush tax cuts accrued to the top quintile, while 20 percent went to the top 0.1 percent of income earners.

If you want to talk about redistribution, there it is.

Bottom Line?

First, the rich spend a smaller proportion of their wealth than the less-affluent, and so when more and more wealth becomes concentrated in the hands of the wealth, there is less overall spending and less overall manufacturing to meet consumer needs.

Second, in both the Roaring 20s and 2000-2007 period, the middle class incurred a lot of debt to pay for the things they wanted, as their real wages were stagnating and they were getting a smaller and smaller piece of the pie. In other words, they had less and less wealth, and so they borrowed more and more to make up the difference. Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled. Total mortgage debt was almost three times higher in 1929 than in 1920. Eventually, in 1929, as in 2008, there were “no more poker chips to be loaned on credit,” in [former Fed chairman Mariner] Eccles’ words. And “when their credit ran out, the game stopped.”

And third, since the wealthy accumulated more, they wanted to invest more, so a lot of money poured into speculative investments, leading to huge bubbles, which eventually burst. Reich points out:

In the 1920s, richer Americans created stock and real estate bubbles that foreshadowed those of the late 1990s and 2000s. The Dow Jones Stock Index ballooned from 63.9 in mid-1921 to a peak of 381.2 eight years later, before it plunged. There was also frantic speculation in land. The Florida real estate boom lured thousands of investors into the Everglades, from where many never returned, at least financially. Tax cuts for the little guy gives them more “poker chips” to play with, boosting consumer spending and stimulating the economy.

Besides, small businesses are responsible for almost all job growth in a typical recovery. So if small businesses are hurting, we’re not going to see much job growth any time soon. On the other hand (despite oft-repeated mythology), tax cuts for the wealthiest tend to help the big businesses … which don’t create many jobs.

In fact, economics professor Steve Keen ran an economic computer model in 2009, and the model demonstrated that giving the stimulus to the debtors is a more potent way of reducing the impact of a credit crunch [than giving money to the big banks and other creditors]. And as discussed above, Reich notes that tax cuts for the wealthy just lead to speculative bubbles … which hurt, rather than help the economy.

Indeed, Keen has demonstrated that “a sustainable level of bank profits appears to be about 1% of GDP” … higher bank profits lead to a Ponzi economy and a depression. And too much concentration of wealth increases financial speculation, and therefore makes the financial sector (and the big banks) grow too big and too profitable.

Government policy has accelerated the growing inequality. It has encouraged American companies to move their facilities, resources and paychecks abroad. And some of the biggest companies in America have a negative tax rate … that is, not only do they pay no taxes, but they actually get tax refunds. Indeed, instead of making Wall Street pay its fair share, Congress covered up illegal tax breaks for the big banks.

For those who still claim that tax cuts for the rich help the economy, the proof is in the pudding. The rich have gotten richer than ever before, and yet we have Depression-level housing declines, unemployment and other economic problems.

No wonder Ronald Reagan’s budget director David Stockman called the Bush tax cuts the “worst financial mistake in history”, and said that extending them will not boost the economy.

What do you say?

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

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Have we learned anything from the Financial Crisis of 2007?

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I would say nothing at all…. In fact, instead of changing their behavior to prevent another crisis, the Powers-that-be seem to be doubling down on the strategies that Caused the Financial Crisis in the First Place

Liberals blame deregulation and reckless Wall Street greed for the economic crisis. Conservatives blame bad government policy.

What are they doing? Well here again…. they are:

  1. Pushing banks to make home loans to people with weaker credit (sound familiar?)
  2. Deregulating and even promoting insane levels of derivatives (ring a bell?)
  3. Following policies which lead to rampant inequality (that didn’t work out so well last time)
  4. Letting white collar criminals know that they have free rein to do whatever they want, and they won’t be prosecuted (once again)
  5. Letting the giant banks get bigger and bigger (the government helped them get big in the first place)
  6. Bailing out the banks with hundreds of billions of dollars a year (which creates dangerous “moral hazard” – just like before the 2007 crisis – and once again destroys sovereign nations). Indeed, crony capitalism has gotten worse than ever (even though heroes have been fighting it for 100 years)
  7. Enacting policies which suck money out of the U.S. economy … and ship it abroad (as they’ve been doing for 50-plus years now)
  8. Enacting policies which discourage people from even trying to find work
  9. Giving the Federal Reserve more power than ever (while a neutral government agency says that the Fed is riddled with corruption, and economists say the Fed caused many of our problems in the first place, and has too much power for the good of the economy)
  10. Blowing insanely large speculative bubbles (when they burst in 2007, that caused the last crisis)

As to the big banks and financial institutions, looks like nothing has changed for them too as they are still engaged in the same risky behavior which got us into the 2007 crisis in the first place by:

  1. Trading even more risky derivatives than at the height of the financial crisis
  2. Taking insanely risky bets with the money that we deposit into our bank accounts. When some of their risky bets blow up, they will either look to the government – once again – for a bailout, or to our bank deposits
  3. Getting back into “synthetic” financial instruments – which are even more disconnected from real assets than regular derivatives
  4. Doing no-document mortgage loans

What could possibly go wrong?… Go figure

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How stupid does Wall Street think we all are? – Financial Policy Council

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While the big boys try to sell the “dumb money” on a recovery under a “greater fool” theory, the smart money knows the score.While the snake oil salespeople at the retail investing level selling financial channels have been saying for years that we’re in a “recovery” (albeit a slow one), we all know that nothing has changed and that we’ll soon have another crash.

Why am I so confident this crash will happen sooner than later and is inevitable?

  1. It is because the causes of the previous financial crisis haven’t been resolved and the government hasn’t done anything to fix the basic problems in our economy.
  2. It is because we still have a quadrillion dollar derivative overhang which dwarfs the size of the total global GDP by a factor of 10 to 1
  3. It is because derivatives still haven’t been regulated and are still growing strong.
  4. It is because creditors and investors are still at the behest of a central bank (Federal Reserve) and policymakers that are robbing them of their money every day.
  5. It is because complacency is coming back and we are losing momentum every passing day.
  6. It is because regulators and lawmakers who needed to impose rules so failing banks could be shut down, allowed those incompetent banks to operate indefinitely with taxpayer support. They clearly have taken all the wrong steps in terms of the structural underpinnings of our capital markets.

In the meantime, Utah has declared gold and silver to be legal tender – with the value of the coin determined by the weight of precious metal it contains.

The law is the first of its kind in the United States. Several other states, including Minnesota, Idaho and Georgia, have considered similar laws.

Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.

Now if all currencies are moving up or down together, the question is: relative to what? Gold is the canary in the coal mine. It signals problems with respect to currency markets. Maybe central banks should pay closer attention to it.

On the same note, China just recently edged out India to become the world’s largest buyer of investment-grade gold products, according to a World Gold Council report.

In the first quarter, Chinese consumers purchased 90.9 metric tonnes in gold bars and coins, valued at $4.1 billion.

That’s more than double the amount Chinese consumers were buying a year ago.

With virtually all of the world’s countries printing money like mad, it is not gold – but rather fiat currencies themselves – which are in a bubble. In that light, maybe gold is not really overpriced as some Wall Street analysts are leading us to believe.

So maybe it is time to stop listening to the supposed “Wall Street gurus”, since all that we’ve been hearing from them, for a decade now, is disinformation, stupidity and ideas that only fit their narrow agenda and bottom line.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

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Wreckonomics: America’s Fiscal Policy in Action

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“The Moment of Truth” is upon us or so proclaims the title of the report issued by the bi-partisan National Commission on Fiscal Responsibility and Reform. The report correctly identifies the fiscal mess we now find ourselves: deficit spending that is unsustainable and entitlement programs that can’t possibly keep their promises without massive tax increases. To the Commission’s credit, its proposals likely would find broad support from economists. But for political reasons, little or nothing is likely to be done, at least until a crisis develops. The same factors that put us into this mess are the ones blocking reform: politicians prefer policies that provide benefits now and costs later. The Commission’s proposals would do just the reverse.

The behavior of politicians reminds me of a personal experience with a troublesome bear in Minnesota. The big bear appeared at my cabin porch one day drawn by aromas of some steaks cooked the night before. The bear tried to enter the cabin by rearing on its hind legs and trying to push in windows and doors. Finally I resorted to banging pots and pans to drive the beast off, but not before he knocked over a few things in the yard. I called the Department of Natural Resources to report the bear. I had hope of getting someone to come out to move the bear further into the wilderness. The DNR officer asked me to explain what had happened. After doing so, the officer said: “So he was just doing bear things?” It was obvious the DNR was not riding to the rescue.

Politicians are a lot like bears in that they just do “politician things.” It is just the nature of the beast. To get elected, successful politicians know that they must provide benefits to constituents who can provide votes and/or money. These constituents are usually members of special-interest groups who receive substantial individual benefits while costs get dispersed over a large numbers of taxpayers. Some years back, a study on the milk-price support program showed the program raised milk prices about a penny per quart. Benefits to the milk producers were in the hundreds of millions of dollars. Few government programs can stand up to a rigorous benefit-cost study. Far too frequently, the benefits of the programs are less than the costs to taxpayers.

The “cash for clunkers” program in 2009 provides a nice illustration. Billed as a program to help save the environment and put autoworkers back to work, the government gave people with “clunkers” up to $4500 to trade in their old vehicles for new more fuel efficient vehicles. The “clunkers” that were traded in had to have their engines and transmissions destroyed. I and a fellow economist, George Parsons, put the clunker program under a cost-benefit analysis and concluded that for every $4000 spent by taxpayers there was a $1,000 net loss in value, even after including environmental benefits. Imagine a private business that took $4000 worth of inputs to produce a product worth $3,000. How long would this business survive? But politicians seem to flourish.

On a much larger scale, the Medicare, Medicaid and Social Security systems already have provided or promised benefits far in excess of any reasonable ability for us to pay for them. Economists have estimated that, if these programs were actuarially sound, they would have amassed an additional $60 trillion or so in financial assets. One prominent economist and past President of the St. Louis Fed has said that the future tax rates needed to finance these programs with their current promises would “produce tax rates inconsistent with a market economy.” Obviously promised benefits are going to be cut, but which politician is going to step up to the plate? It likely will require a monumental crisis before a solution is seriously sought.

Is there any way to improve government governance? This is a key question, but one with no easy or obvious answers. Improving government governance is arguably even more difficult than improving corporate governance. I’m working with a colleague on a book and we plan to explore some possibilities. But don’t expect any magic solutions.

Transcript of Research Presentation given on February 24, 2011 at the New York Historical Society

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