What is so interesting about fiscal policy? This week I learned how the federal government's fiscal
policies effect the macroeconomic model I talked about last week. This is the model that describes
the total output of the economy equaling the incomes of households, which is then "leaked"
through savings and taxes (adding the Government into the picture). The taxes are reinjected
through government spending, and the savings are used as investment by businesses, all of which is
added to consumption by households to equal aggregate demand.
So, in Norm's post this week on the looming "fiscal cliff" I think we can apply this new fiscal policy
lens. Norm is talking about an article from the New York Times by Paul Krugman which explore's
the upcoming automatic reduction in government spending and tax cuts which was agreed upon in
2011 in response to the debt ceiling discussion. In the article, Krugman argues that President
Obama should not allow the tax cuts for the wealthy to be exempted from the bill as the
Republican Party is pushing for. Norm notes that this will be hard to accomplish as Obama wants to
exempt the middle class tax cuts from the bill, which is what is allowing the Republicans to bid for
the wealthy tax cuts exemption. Krugman says that if Obama cannot exempt the middle class tax
cuts, then he should let the bill move forward and take effect as planned. Many argue that this would
throw us back into further recession.
So this change in fiscal policy would increase taxes and decrease government spending to reduce
the government debt. In our macroeconomic model, this would decrease aggregate demand overall,
thus slowing the recovery through a decrease in consumption of output which then decreases total
income to households. I would argue, after reading Richard Coo's comments on Japan's failed and
successful efforts to end their very similar recession of the late 90's, that we need to increase
government spending right now as the most effective means of increasing aggregate demand. We are
experiencing a "balance sheet recession" according to Koo, which means that even with interest
rates from the FED of 0%, companies are not able to create new jobs because they are stuck paying
down their debts (as their liabilities currently exceed their assets, this is a must). Also, because
government spending is much more direct and effective at increasing aggregate demand than is
cutting taxes, and has a higher economic multiplier effect, government spending is what we need.
We also learned that even increasing taxes while increasing government spending, increases
aggregate demand.
The most effective way out of this recession then, is to increase government spending both on
social programs to help the multitude currently in need, and on direct job creation programs. I
would also keep some attention paid to our issue of government debt by partially financing all of
this increased spending with the elimination of tax cuts on the wealthy and on capital gains. It was
the very wealthy which maneuvered the financial sector into the role of grand casino in the housing
boom which caused this recession in the first place, and made them large sums of money, which
were then taxed at a much lower than fair rate. Thus, financing the recovery with increased taxes
on those at the top, is the the least our country could do to even be allowed to speak the word
"justice" with any kind of authority again. This method would also be very effective since, as I
discussed last week, tax cuts for the wealthy really have not led to faster or better economic
growth ever in our history.
I want to end by throwing in another little snip-it of reality which complicates our economic
models and is painfully absent from mainstream discourse. I was just reading a report from the New
Economics Foundation called, "The Economics of Oil Dependence: A Glass Ceiling to Recovery."
This report discusses the link between the rapidly decreasing stock of the finite resource we are so
heavily dependent on in the U.S. and the global recession. They define Economic Peak Oil as, "The
point at which the cost of incremental supply exceeds the price economies can pay without
significantly disrupting economic activity at a given point in time." This concept is very important as
all data point to us reaching Economic Peak Oil around 2014-2015. This is due to the complete lack
of new sources of crude oil in general, and in terms of low cost sources--as is evident by the recent
scaling up of oil extraction from the Alberta Tar Sands and subsequent need for the new Keystone
pipeline, which is a highly inefficient and costly source of oil. Technology only increases our usage
efficiency of oil products by 2-3% per year, a snails pace compared to the speed at which global
consumption of oil is increasing.
I bring this into the discussion not just because it is not being talked about, but also because we
have an opportunity to make a significant and lasting recovery effort. If we did increase government
spending, financed in part by allowing tax cuts on the wealthy to expire, and directed it all to a
Citizen Conservation Corps style jobs program focused entirely on the creation and
implementation of green energy projects, then we would be doing something more impactful and
worthwhile for future generations than simply reducing government debt.
Sunday, November 11, 2012
Sunday, November 4, 2012
Taxes and a Healthy Economy
The
relation of tax rates to the health of our economy is and has long been
contentious. I was interested to see a recent post by Norm Becker which
contained the summary remarks of the Congressional Research Service
report on tax policy. A key finding was that, “the real GDP growth rate
averaged 4.2% and real per capita GDP increased annually by 2.4% in the
1950s. In the 2000s, the average real GDP growth rate was 1.7% and real
per capita GDP increased annually by less than 1%.” They compare these
rates of GDP growth to the income tax rates from those two periods to
make the point that, “analysis of such data suggests the reduction in
the top tax rates have had little association with saving, investment,
or productivity growth.” This is important because the income tax rates
from 1945 through 1970 were significantly higher than they have been in
the last 40 years, and yet real GDP growth, and particularly GDP growth
per capita, have slowed with the decreasing tax rates on the top income
earners in this country. Why is this and why all of the heated debate
about income tax rates in recent years?
I have several proposed reasons which, oddly enough, come from a study of neo-classical macroeconomics, or the very school of thought that those in the U.S. who argue for reduced tax rates for the wealthy are supposed to be champions of. First, let me sketch out the basic model: the production of goods and services by firms (output) creates payments to households (income). This income is put towards either consumption or Savings. Savings create the capital stock which firms can use as investment in their production operations (intended investment). Total consumption by households and intended investment by firms equals spending or aggregate demand. If there is full employment and if all savings are efficiently used as investment by firms, then the aggregate demand should equal output, where we started.
One very important thing to understand about all economic models and schools of thought is that they are theoretical. That is to say, not necessarily representative of what really ends up happening in an economy. For instance, taxes and government spending are not represented in this model. So, proponents of lowering taxes in general argue that taxes just reduce the income of households which then decreases the overall level of spending which can result from consumption and investment. This would be unhealthy for the economy because then aggregate demand would not be sufficient to meet the total output of producers, which would then ripple through the whole cycle causing unemployment, recession, and reduced or negative growth. The other argument used for lowering taxes specifically for the top income earners in society is that the savings of those top earners becomes the investment stock of firms and is also directly invested to create jobs and increase spending, thus increasing the health of the economy.
To respond firstly to the issue of government taxes in general, we must realize that if taxes and government spending were properly represented in this theory, all monies diverted to the government from incomes, also end up both as incomes for government employees and as consumption and investment in the economy through government services and programs. Thus, taxes still work through the cycle to increase aggregate demand. In fact, all taxes get spent in the economy unlike some of household income which is diverted to savings (called a leakage in the model).
More importantly, when we look at the incomes of top earners in the U.S. we find several reasons why the argument for diverting less and less of their income to taxes as a policy for a healthy economy, holds no water. Leakages as savings from the incomes of the wealthy can create the investment stock for business expansion, operation or creation. However, this does not happen when a large share of their income is stored in off-shore bank accounts for the purposes of avoiding taxes. The money in those accounts is not accessable as the capital stock for investment in job creation or expansion in our economy and it is not available to be spent by the government if it had been taxed. Also, when the untaxed incomes of top earners is used extractively through investment in venture capital endeavors which require rapid growth of industries through measures of austerity and reckless abandon (low paid employees, turning quick profits through risky activities, tax avoidance) the long-term health of the economy is decreased. As we saw in the lead up to the recent crash and recession, much of the untaxed incomes of the wealthy were invested in derivatives and other clever financial instruments which do not play any part in aggregate demand or the actual production of goods and services. Often now the excess wealth of top income earners is invested in private equity firms spurring mergers and acquisitions which succeed through rapid and extensive off-shoring of more expensive U.S. jobs and outsourcing company functions to the lowest bidder globally.
John Maynard Keynes had a slightly different, but still limited take on the classical macroeconomic model. In his line of thought, households do not just automatically direct all of their incomes to savings and the rest to consumption. They automatically consume at a level called “autonomous consumption” which would account for basic necessities regardless of their income. Then they also have a “marginal propensity to consume” which changes with their income level and confidence in the health of the economy. In line with this theory I would argue that we could more effectively stimulate aggregate demand by raising the incomes of the majority of folks who cannot even meet their required autonomous consumption levels (ie. a living wage) let alone a very significant marginal propensity to consume. Plus the majority of households in our economy which have low to moderate incomes, spend all of their income, contributing directly to aggregate demand thus increasing aggregate demand. So, it would be much more effective to tax a larger share of the incomes from top income earning households in the U.S. in order to stimulate aggregate demand. The decrease in their excess income which would would have been put towards the detrimental activities described above, would instead be spent in the economy by the government.
Even if my argument and logic make sense, you may then wonder why this argument to lower taxes overall and specifically those of the top income earners seems so loud. In an Economist article called “The Rich and the Rest,” they state that, “one analysis suggests that 80% of the total [campaign spending] comes from fewer than 200 donors.” They also point out that 90% of the income gains since the recession have gone to households in the top 1% of income earners. This paints a very clear picture of where power in our society lies. If there are 200 people at the top that control 80% of the financial sway in elections, and are part of the small group which not only caused the recession, but now are the only ones recovering from it, then it would be in their direct but narrow self-interest to reduce taxes on the wealthy.
I have several proposed reasons which, oddly enough, come from a study of neo-classical macroeconomics, or the very school of thought that those in the U.S. who argue for reduced tax rates for the wealthy are supposed to be champions of. First, let me sketch out the basic model: the production of goods and services by firms (output) creates payments to households (income). This income is put towards either consumption or Savings. Savings create the capital stock which firms can use as investment in their production operations (intended investment). Total consumption by households and intended investment by firms equals spending or aggregate demand. If there is full employment and if all savings are efficiently used as investment by firms, then the aggregate demand should equal output, where we started.
One very important thing to understand about all economic models and schools of thought is that they are theoretical. That is to say, not necessarily representative of what really ends up happening in an economy. For instance, taxes and government spending are not represented in this model. So, proponents of lowering taxes in general argue that taxes just reduce the income of households which then decreases the overall level of spending which can result from consumption and investment. This would be unhealthy for the economy because then aggregate demand would not be sufficient to meet the total output of producers, which would then ripple through the whole cycle causing unemployment, recession, and reduced or negative growth. The other argument used for lowering taxes specifically for the top income earners in society is that the savings of those top earners becomes the investment stock of firms and is also directly invested to create jobs and increase spending, thus increasing the health of the economy.
To respond firstly to the issue of government taxes in general, we must realize that if taxes and government spending were properly represented in this theory, all monies diverted to the government from incomes, also end up both as incomes for government employees and as consumption and investment in the economy through government services and programs. Thus, taxes still work through the cycle to increase aggregate demand. In fact, all taxes get spent in the economy unlike some of household income which is diverted to savings (called a leakage in the model).
More importantly, when we look at the incomes of top earners in the U.S. we find several reasons why the argument for diverting less and less of their income to taxes as a policy for a healthy economy, holds no water. Leakages as savings from the incomes of the wealthy can create the investment stock for business expansion, operation or creation. However, this does not happen when a large share of their income is stored in off-shore bank accounts for the purposes of avoiding taxes. The money in those accounts is not accessable as the capital stock for investment in job creation or expansion in our economy and it is not available to be spent by the government if it had been taxed. Also, when the untaxed incomes of top earners is used extractively through investment in venture capital endeavors which require rapid growth of industries through measures of austerity and reckless abandon (low paid employees, turning quick profits through risky activities, tax avoidance) the long-term health of the economy is decreased. As we saw in the lead up to the recent crash and recession, much of the untaxed incomes of the wealthy were invested in derivatives and other clever financial instruments which do not play any part in aggregate demand or the actual production of goods and services. Often now the excess wealth of top income earners is invested in private equity firms spurring mergers and acquisitions which succeed through rapid and extensive off-shoring of more expensive U.S. jobs and outsourcing company functions to the lowest bidder globally.
John Maynard Keynes had a slightly different, but still limited take on the classical macroeconomic model. In his line of thought, households do not just automatically direct all of their incomes to savings and the rest to consumption. They automatically consume at a level called “autonomous consumption” which would account for basic necessities regardless of their income. Then they also have a “marginal propensity to consume” which changes with their income level and confidence in the health of the economy. In line with this theory I would argue that we could more effectively stimulate aggregate demand by raising the incomes of the majority of folks who cannot even meet their required autonomous consumption levels (ie. a living wage) let alone a very significant marginal propensity to consume. Plus the majority of households in our economy which have low to moderate incomes, spend all of their income, contributing directly to aggregate demand thus increasing aggregate demand. So, it would be much more effective to tax a larger share of the incomes from top income earning households in the U.S. in order to stimulate aggregate demand. The decrease in their excess income which would would have been put towards the detrimental activities described above, would instead be spent in the economy by the government.
Even if my argument and logic make sense, you may then wonder why this argument to lower taxes overall and specifically those of the top income earners seems so loud. In an Economist article called “The Rich and the Rest,” they state that, “one analysis suggests that 80% of the total [campaign spending] comes from fewer than 200 donors.” They also point out that 90% of the income gains since the recession have gone to households in the top 1% of income earners. This paints a very clear picture of where power in our society lies. If there are 200 people at the top that control 80% of the financial sway in elections, and are part of the small group which not only caused the recession, but now are the only ones recovering from it, then it would be in their direct but narrow self-interest to reduce taxes on the wealthy.
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