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America’s Choice: Winner-Take-All or Social Democracy

Image result for social democracy america

The 2018 midterm elections, which saw significant gains for the Democratic Party, were in many ways a rejection of President Trump’s policies and worldview. But while the American people seemingly know what we don’t want, do we know what we do want? Those are the questions to be answered leading up to and by the 2020 elections, campaigning for which is already underway.

Ultimately we cannot have the “economic populism” many Americans across the political spectrum seem to want with our current tax code. Insufficient tax revenue means the government cannot provide what is needed to develop the next generation of Americans while simultaneously addressing more immediate concerns. In order to fulfill these two key responsibilities of governing, it is time to seriously consider ideas that have, for a while, been outside of mainstream political discourse.

One such idea is that taxes can be significantly higher at higher income levels. The vast majority of Americans believe that the wealthy and corporations do not pay their fair share of taxes (and these survey results are from before the new GOP tax code went into effect, which even further reduced taxes for the wealthy and corporations).

Alexandria Ocasio-Cortez has recently brought this idea to the forefront, proposing top income tax rates upwards of 70%. Nobel prize winners have said optimal rates may be as high as 80+%. I do not know what a politically viable top rate is, that’s for the American people to decide. I do know that it should be significantly higher than it is today.

Here are three things to consider regarding taxes in America:

  1. Marginal Income Tax Rates

    Whatever tax brackets we choose to have, they will work within the marginal tax rate system we currently use. What are marginal tax rates you ask? Well, imagine there are 3 tax brackets:

    10% for those making > $10,000
    20% for those making $10,000-$100,000
    30% for those making > $100,000

    If I got a raise from $90,000 to $110,000, only the $10,000 over 100,000 would be taxed at 30%. Dollars 1-9,999 would still be taxed at 10%, and dollars 10,000 – 100,000 would still be taxed at 20%. My income would not all now be taxed at the highest rate, only the amount over that top bracket threshold.

    The idea that people will work less hard because of higher marginal rates is silly–people typically can’t control their earnings that much (without the help of high priced accountants at least). Your average American works as hard as they can in hopes of earning as much as they can–they do not calibrate their level of effort based on what is typically a small tax increase that results from entering a higher bracket.

    Now having high marginal tax rates is admittedly harder in a globalized world than it was in the mid 20th century, because people can move themselves and their money around much more easily today. Having said that, and feel free call me a “homer” if you like, but I think that America is pretty unique and special place. If our leaders prioritized curtailing tax avoidance by coordinating with other countries and international organizations, I believe that people would still choose to live, operate businesses, and park their wealth here even if we had higher tax rates.

    In other words, if the choice was pay your fair share or leave, I believe that most wealthy people would choose to pay their fair share.

  2. Income as a Measure of Hard Work, and Inequality in the Age of Globalization

    Think about entrepreneurs in the 1950s. They brought their products mainly to domestic markets, which relied primarily on domestic infrastructure, court systems, and public goods to function. At the time, the government was able to provide these goods without running huge deficits, in large part by adequately taxing the rich.

    Now think about entrepreneurs in the 2010s. They bring their products to a global market. If it’s a popular product, global capital chases it, expanding operations and profits. Maybe they decide to sell their company to foreign firm for a huge pay day.

    The 1950s millionaire entrepreneur can easily be today’s billionaire. Does today’s billionaire work that much harder? Generally speaking, not really–both work(ed) very hard, and there are only so many hours in a day. The same is true of today’s business executives versus those of decades past. Today’s greater earnings, rather, are largely an effect of the global economy we operate in, not harder work–there are billions of potential customers out there instead of millions.

    The global economic system is expensive to maintain. Today the U.S. government needs to not only finance domestic infrastructure and institutions, it also has to help finance international institutions and (perhaps most importantly and expensively) global defense.

    The U.S., as a global leader, naturally pays a large portion of this global economic infrastructure. While it is impossible to quantify piece-by-piece, overall this is a good deal for Americans–just look at the world as it currently is as proof! America is leading the way in almost all macroeconomic metrics (despite what Trump may say about us getting “taken advantage of”, “losing”, or “not being respected”).

    Where America is lacking is in social cohesion, social mobility, and general optimism and happiness. This is not an accident, but rather a feature of our current winner-take-all economic system. This is not just a liberal “bleeding heart” speaking, just ask Fox News host Tucker Carlson.

    It is not difficult to understand the anger of Americans displaced by globalization. Over the past few decades, middle class workers have seen their incomes stagnate, even as their productivity has risen. Why should the wealthy see gains well beyond their hard work, while the average person doesn’t even see the gains their work should rightfully earn them?

    Wealth did not trickle-down as promised (no surprise there, it never does). People who could not afford the increasingly expensive baseline goods needed take advantage of the global economy (early childhood development, higher education, job [re]training) became disgruntled, believing politicians from neither party cared about them. They then went out and voted for any “outsider” offering simple solutions to complex problems, and we ended up with President Trump.

    The truth is that America’s economy has become unfair. In order to restore that fairness we need to provide certain public goods–like affordable (if not free) higher education and healthcare. In order to provide these things, we need more tax revenue, and that tax revenue has to come from the ever-wealthier wealthiest Americans.

    There are many types of taxes, aside from income tax, that are also in play. Some are currently part of the U.S. tax code, while others are not. Examples include corporate taxes, capital gains taxes, financial transaction taxes, carbon taxes, estate taxes, sales taxes and gasoline taxes. 2020 Democratic Presidential candidate Elizabeth Warren has proposed a first-of-its-kind-in-America wealth tax, which has certainly gotten people’s attention.

    Some of these taxes fall mostly on the rich, while others hit everyone. This is an important consideration when trying to address inequality through the tax code. There are also countless tax loopholes, some of which are useful but many of which should be closed.

    The appropriate top marginal income tax rate is a function of the overall tax code.

  3. Adequately Fund and Reprioritize the IRS

    “The [budget] cuts are depleting the staff members who help ensure that taxpayers pay what they owe. As of last year, the IRS had 9,510 auditors. That’s down a third from 2010. The last time the IRS had fewer than 10,000 revenue agents was 1953, when the economy was a seventh of its current size…the IRS conducted 675,000 fewer audits in 2017 than it did in 2010, a drop in the audit rate of 42 percent. But even those stark numbers don’t tell the whole story, say current and former IRS employees: Auditors are stretched thin, and they’re often forced to limit their investigations and move on to the next audit as quickly as they can.

    Corporations and the wealthy are the biggest beneficiaries of the IRS’ decay. Most Americans’ interaction with the IRS is largely automated. But it takes specialized, well-trained personnel to audit a business or a billionaire or to unravel a tax scheme — and those employees are leaving in droves and taking their expertise with them. For the country’s largest corporations, the danger of being hit with a billion-dollar tax bill has greatly diminished. For the rich, who research shows evade taxes the most, the IRS has become less and less of a force to be feared.

    The story has been different for poor taxpayers. The IRS oversees one of the government’s largest anti-poverty programs, the earned income tax credit, which provides cash to the working poor. Under continued pressure from Republicans, the IRS has long made a priority of auditing people who receive that money, and as the IRS has shrunk, those audits have consumed even more resources, accounting for 36 percent of audits last year. The credit’s recipients — whose annual income is typically less than $20,000 — are now examined at rates similar to those who make $500,000 to $1 million a year. Only people with incomes above $1 million are examined much more frequently.

    [Former IRS Commissioner Koskinen, in testimony about the IRS budget] told the Senate, “I don’t know any organization in my 20 years of experience in the private sector that has said, ‘I think I’ll take my revenue operation and starve it for funds.’”

    The idea that a resource-strapped IRS is auditing EITC recipients instead of millionaires and multinational corporations is as absurd economically as it is cruel morally. No wonder most Americans hate the tax man and think the wealthy don’t pay their fair share–they are right.

Being a “Competitive Economy” Need Not Be a Race to the Bottom

A friend recently shared a Breitbart article about America being “the world’s most competitive economy”. While this is good news, it definitely needs some context.

First, America wasn’t a slouch before Trump; we placed 2nd, 3rd, and 3rd in 2017, 2016, and 2015 respectively. I don’t feel like going further back, but I’m sure we’ve never been low on this list.

Second, look at the countries right after us. “Singapore, Germany, Switzerland, and Japan [make up the rest of the] top five. The top ten includes the Netherlands, Hong Kong, the U.K., Sweden, and Denmark.”

These countries almost all have higher levels of taxation, stronger safety nets, and stronger worker protections than the U.S. Some were the “most competitive” countries in past years. A country does not have to “race to the bottom” in order to be competitive.

Being first on this list, as opposed to being second or third, really doesn’t gain us anything other than a nice headline. Companies do not decide where to build plants or hire employees based on “most competitive” indexes, they do it based on their complex internal calculus (cost of labor, cost of moving goods around their supply chain, level of employee expertise needed, infrastructure needs, tax rates, etc.). In some cases this will be the U.S., in others it will not, regardless of meaningless titles.

Jobs and the “Green New Deal”

I am actually a fan of how Trump uses his bully pulpit to make hiring American workers an important consideration for companies–I like his tough rhetoric here. While I am not a fan of protectionism in general, in some cases the credible threat of tariffs is needed in order to show these are not just empty words. This is particularly true when another country isn’t playing fair on trade, which is certainly the case in some instances.

The problem is that Trump gets headlines for the jobs his policies creates or keeps, but not for the ones they lose. For example, job losses have exceeded gains when it comes to iron and steel tariffs and solar panel manufacturing tariffs. Aside from jobs, there is also the increasing prices of imports to consider, which make up about 15% of U.S. GDP–the American consumer likes options, including ones made abroad.

As I have said before, Trump’s worldview is too zero-sum and short-term. Specifically, he views addressing climate change only as a cost (which he always inflates), and not an opportunity for the U.S. to be a leader in emerging industries. Unfortunately, due to the 2013 sequester budget cuts, the Bureau of Labor Statistics stopped tracking “Green Jobs”, making it much more difficult to quantify the benefits of being a leader in these emerging industries.

Take electric vehicles (EVs) for example. General Motors is begging Trump to support a Nationwide Zero Emissions Vehicle program, to no avail. It’s like private sector lobbyists always have Trump’s ear, unless they are promoting something environmentally friendly.

ev investments by country

Credit: Reuters

Over the next decade car companies will invest over $300 billion in EVs, with the largest chunk going to China due to government incentives (Germany is second, while the U.S. is a distant third). As you can see from the image above, Trump’s stance towards EVs has resulted in us leaving other countries investment dollars on the table. It’s like Trump always wants to be tough on China and promote investing in the U.S., unless it has to do with something “green”.

Meanwhile, over in Germany, the government is paving the way for Volkswagen to position itself as a future leader in EVs. In fact, Ford just announced a partnership with VW on EVs. American automakers now need to look abroad for support because our President won’t help them–sad. Hey, remember when Obama saved the U.S. auto industry just a decade ago? That was pretty cool, but I guess Trump wants to undo that part of Obama’s legacy as well…

Auto companies are starting to reach a 200,000 vehicle sale threshold that triggers a gradual elimination of consumer tax credits for buying electric vehicles. Under normal circumstances, either a Republic or Democratic President would seriously consider extending these credits. Instead, the Trump administration has signaled it wants to eliminate the credits altogether.

The shift to a global economy was done on the backs of the commoner–global wealth soared, but so did wealth inequality. “Yellow Vest” protests in France show that regular people will not let the next major shift–from a fossil fuel based economy to a “green economy”–be solely placed on their backs as again (and rightly so!). Rather, this shift will need to be part of an “all hands on deck” approach, with everyone (rich, poor, and all those in between) contributing their fair share towards a greener, fairer, and more dynamic economy. This is the spirit of the “Green New Deal”.

America’s Choice: Social Democracy vs. Unbridled Capitalism

“Supply-side” GOP economics has always relied on questionable math (“magic asterisks“), Trump is just faster and looser with the rules. To Trump, numbers (and the truth in general) are things to be manipulated to promote his agenda. Lies about the value of the Saudi Arabian arms deal, the costs of addressing climate change, and the costs of illegal immigration are prime examples of this.

It is amazing how a man who casts doubt on so many things he disagrees with can speak with such confidence about things that actually are uncertain, like economic outcomes. But then again, humility and honesty have never been Trump’s forte.

Living in a democracy, the shape of our economic system is a choice we collectively make. In American democracy the means justify the ends, as long as the debate is honest and people can make informed decisions. To date, the debate on the structure of our economic system has been anything but honest. Those supporting wealthy interests pretend that any tax increases would ruin our economy, while simultaneously painting any social program as communism.

A choice does not have to be made between having a competitive economy, an environmentally sustainable economy, and a fair economy that promotes equality of opportunity–that is a false trichotomy. We can have all of those things with the right mix of public policy, hard work, and American ingenuity.

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Economic Outlook: “Starve the Beast”, MMT, Debt Sustainability and the Debt Limit

I have, like many an economist, been preoccupied by the possibility of a U.S. debt default. How could our politicians willingly do something that is so obviously detrimental to American and global economic interests? Is there any precedent or historical clue which may shed some light on this phenomenon? It is possible, I would argue, that such a default is the current (and most heinous) manifestation of “starve the beast” political theory:

Starving the beast” is a political strategy employed by American conservatives in order to limit government spending[1][2][3] by cutting taxes in order to deprive the government of revenue in a deliberate effort to force the federal government to reduce spending. The short and medium term effect of the strategy has dramatically increased the United States public debt rather than reduce spending

On July 14, 1978, economist Alan Greenspan gave testimony to the U.S. Finance Committee: “Let us remember that the basic purpose of any tax cut program in today’s environment is to reduce the momentum of expenditure growth by restraining the amount of revenue available and trust that there is a political limit to deficit spending.”[5]

The earliest use of the actual term “starving the beast” to refer to the political-fiscal strategy (as opposed to its conceptual premise) was in a Wall Street Journal article in 1985 where the reporter quoted an unnamed Reagan staffer.[7]

Since 2000

The tax cuts and deficit spending of former US President George W. Bush‘s administration were attempts to “starve the beast.” Bush said in 2001 “so we have the tax relief plan […] that now provides a new kind—a fiscal straightjacket [sic] for Congress. And that’s good for the taxpayers, and it’s incredibly positive news if you’re worried about a federal government that has been growing at a dramatic pace over the past eight years and it has been.”[8]

Historian [Economist] Bruce Bartlett, former domestic policy adviser to President Ronald Reagan, has called Starve the Beast “the most pernicious fiscal doctrine in history”, and blames it for the increase in US government debt since the 1980s.[18]

For a historical look at government revenue and expenditure, please see here. The most useful number (IMO), is the % GDP comparisons.

But what is the connection between “starve the beast” and the “debt limit”? The answer lies in a simple analysis of Modern Monetary Theory:

A pivotal issue in our discussion turns out to be whether the central bank can or should hold the nominal rate of interest on government debt, R, below the rate of growth of nominal GDP, G. (We could frame the discussion in real terms instead by subtracting the rate of inflation, ΔP, from both sides; it makes no difference.) If R is held below G, then essentially any level of the government’s budget deficit is “mathematically sustainable,” a term we have been using to mean that the debt-to-GDP ratio does not grow without limit over time. On the other hand, if R exceeds G, the budget balance must show a primary surplus, on average over the business cycle, to achieve mathematical sustainability of the debt. (See the first of the posts referenced above for a detailed discussion of the conditions for mathematical sustainability.) 

The essential argument of MMT is that if growth rates are greater than interest rates, debt is sustainable and a government can run a budget deficit indefinitely (governments, unlike households, do not die). Japan, with its Debt/GDP ratio almost twice as high as the U.S., is a primary example the difference between debt sustainability versus total debt. Many of Europe’s “trouble countries” have trouble with much lower debt / GDP ratios (than Japan); without control of printing money, they are at the mercy of markets to borrow. These markets have been charging troubled countries a higher “risk premium”, pushing these countries into damaging austerity policies in the face of depressed demand. It is not the level of debt, but the interest that needs to be paid on it, that determines debt sustainability in a MMT model. 

In order to truly starve the beast, it is not enough to deny the U.S. government of tax revenue; the obstructionist must also increase the governments borrowing cost. This is exactly what a debt default would do, lead to higher borrowing costs. In fact, one of the main arguments by liberal economists for stimulus spending–other than the social and economic benefits of employing a substantial portion an idle workers and stimulating demand–is that the cost for doing so is for all intents and purposes the same as if we were running a government surplus! True the Fed can set the interest rate it pays by expanding it’s balance sheet, but this is an extraordinary role for the Fed to use only the most dire liquidity trap, not a viable long-term policy (due to inflationary effects of increasing the money supply when the economy is near or at full capacity).

There is certainly no proof that this is specifically anyone’s agenda. However, the same ideologies are behind “starve the beast” policies are behind holding the debt-limit hostage for fiscal concessions. We have to at least question the motives of these politicians; they are “rational” people, and until now I have heard no rational reason for such an unprecedented default. If the goal is to convince their opponents, who are likely to have Post-Keynesian if not MMT views of political economy, that certain policies are unsustainable, a default is–an irreversible way–to achieve such goals.

As the self-proclaimed party of fiscal responsibility, the GOP is leading America down the road of ballooning interest payments. Interest payments  already make up a substantial portion of total expenditure (8% and growing, twice as much as the federal government spends on education). A default would cause these payments to be substantially bigger, further constricting fiscal space for important social programs. We wouldn’t be getting more for less, or even the same for the same amount, we would receive less services for the same levels of expenditure. It is not fiscally responsible, but then again “starve the beast” and their contemporary “Tea Party” advocates were never really about fiscal responsibility.

Furthermore, follow a debt default the ensuing global recession would greatly raise the unemployment rate, driving up the spending on “automatic stabilizer” welfare programs that would otherwise be trending downwards in tandem with a growing economy.

You may say that no elected official would ever act so heinously and against the interests of the government and the American people; I would say read up on the history of the “starve the beast” political philosophy. It should also be noted that a default does not actually need to pass in order to result in higher borrowing costs / lower growth (making borrowing unsustainable based on a MMT framework); the specter of a default is enough to achieve these goals (the next debt-limit debate is set for February 2014).