Refuting Reaganomics, Part 4 – Shifting Perspectives, and Factual Proof

(Return to the Contents Topics page.)

Google Lava Lamps – Plunderguide 

The game fixers maintain a worldview that justifies using every tool at their disposal to perpetuate and expand their wealth.  Most believe they are the engines of the economic train, creating enterprises and wealth that pull everyone else along. This worldview is well captured in the introduction to the 2010 Forbes 400 survey:

“Who cares whether somebody is worth $2 billion or $6 billion? We do.  That personal stash is a critical barometer of how well the nation — and to a degree, the world — is doing. * * *”

They conflate extreme wealth with virtuous actions that are beneficial to society as a whole.  They believe government should step aside and not interfere with their actions — or better yet, steer subsidies and tilt the rules in their favor. Some genuinely believe this serves the greater good. Others don’t think much about the bottom 99 percent and through their inaction perpetuate the unequal status quo.

Unfortunately, three decades of rule changes in favor of the 1 percent, as we shall discuss, have almost destroyed the economy and the ecology of the planet and shattered the lives of billions around the world. * * *  — Chuck Collins  [1]

Introduction

As illustrated by the lava lamps, wealth drifts up.  To maintain a stable inequality (and some degree of prosperity for any but the very rich) it must be taxed back down at an adequate rate.  No single factor is more crucial to the economic survival of the United States, and other countries as well.  Unfortunately, awareness even of the fact of increasing income and wealth inequality, much less its implications, is relatively brand new, revealed only a few years ago in the important work of a small handful of economists.

Meanwhile, for over thirty years the “trickle-down” Reaganomics myth discussed in this series of posts has been intentionally and firmly entrenched in the public consciousness. Most people, under the general impression that economic theories are controversial and unproven, have no clue what to believe.  Lacking proof and a workable rationale (or the time to present one), reporters and analysts are reduced to rejecting “tax cuts for the rich” with conclusory statements like “We tried that, and it didn’t work.”  To the general public, that must seem like just more contentious controversy.  Most of them have yet to learn that “trickle-down” economics, even with its pejorative intent, is a term far too neutral and positive.  As my colleague Skip has recently suggested, Reaganomics should be renamed “siphon-up economics.”  That’s how these policies actually work.

But there’s another problem: We’re only just discovering and learning about the massive income and wealth inequality caused by Reaganomics.  Even in a Keynesian-based analysis of the American economic decline, such as Nobel Prize winning economist Paul Krugman’s The Return of Depression Economics (2008 edition, entire text on-line), there is no reference to the economic implications of inequality – the inequality data had not yet been produced – nor is there in his conclusions (see Ch. 10) a discussion of the role of taxation.  Krugman concludes with this (pp. 190-191):

As readers may have gathered, I believe not only that we’re living in a new era of depression economics, but also that John Maynard Keynes – the economist who made sense of the Great Depression – is now more relevant than ever.  Keynes concluded his famous masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: “Soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

We can argue about whether that’s always true, but in times like these, it definitely is.  The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain.  Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work.  The true scarcity in Keynes’ world – and ours – was therefore not of resources, or even of virtue, but of understanding.

We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead.  Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.  

Yes, Keynes is indeed more relevant today than ever.  In a depression, where labor and resources are idle, scarcity is not the issue.  But what is?  This is important: As good as he is, Krugman in 2008 did not yet have the tools he needed to “follow his thoughts wherever they lead,” and so his own 2008 work is unfortunately limited, to a degree, by his reliance on “obsolete” doctrines.  When we follow Keynesian economics to its logical conclusions, we will all arrive soon at something I think deserves to be called by a new name: the economics of inequality.

In a recent post, Why the Buffet Rule Sets the Bar too Low, Robert Reich has it right: “The rich should be paying far more.”  Reich understands the economics of inequality.  Also, see an excellent discussion from the Democratic Underground, The Economics of Destruction, where the broad premise of what I undertake to explain and prove in these posts is summed up this way: “General prosperity goes together with income equality, whereas income inequality goes with economic downturns.”  For his part, Krugman continues energetically to denounce Reaganomics. In the recent New York Times op-ed  Debunking the Reagan Myth he concluded:

Now progressives have been granted a second chance to argue that Reaganism is fundamentally wrong: once again, the vast majority of Americans think that the country is on the wrong track. But they won’t be able to make that argument if their political leaders, whatever they meant to convey, seem to be saying that Reagan had it right.

While a small group of knowledgeable experts moves gradually toward explaining why Keynes is correct, this exact debate rages front and center in the political arena. It is, by far, the most important substantive issue in this election year, as America’s economic future depends on getting it right.  An ideological barrage from the political right will continue to insist that Reagan did have it right: If ever the substantive basis for Reaganomics is to be thoroughly aired in public, the proper time is now.

Presidents Define the Debate

This past Tuesday (4/10/12), President Obama and former President GW Bush both delivered speeches that pin-pointed this crucial  issue.  In a speech in Boca Raton, the President stumped on Keynesian grounds for American prosperity:

When we guarantee basic security for the elderly, or the sick, or those who are actively looking for work, that doesn’t make us weak.  What makes us weak is when fewer Americans can afford to buy the products that businesses are selling, when fewer people are willing to take risks and start their new businesses, because if it doesn’t work out, they worry about feeding their families. 

What drags our entire economy down is when the benefits of economic growth and productivity go only to the few, which is what’s been happening for over a decade now, and the gap between those in the very, very top and everybody else continues to grow wider and wider and wider and wider.  In this country, prosperity has never trickled down from the wealthy few. Prosperity has always come from the bottom up, from a strong and growing middle class.

In this speech, Obama gives a clear description of the demand-side prerequisites for general prosperity and opportunity, and it is knowledgeably linked to inequality growth. President Obama gets it.

In sharp contrast, former President Bush argued for a Reaganomics tax policy in introductory remarks at a conference at the New York Historical Society. On the tax policy issue, he did start off on the right foot when he said: “Aggregate demand of citizens determines what is produced,” and when he added:

Seventy percent of new jobs in America are created by small business owners. . . . Most small businesses pay tax at the individual income tax level. If you raise taxes on these so-called “rich” you are really raising taxes on the job creators.

Here, Bush seems to be saying “don’t raise taxes on people who are not really rich,” and if Obama had been there, not down in Florida delivering his own speech, he would have agreed.  In the first paragraph quoted above, Obama emphasized that Americans need more income so that they can afford to buy what businesses sell,  helping small businesses (those that according to Bush provide 70% of America’s jobs) become more successful.

Beyond that point of potential agreement, however, Bush’s argument derails:

And if the goal is private sector growth, you’ve got to realize that the best way to create that growth is to leave capital in the treasuries of the job creators.  If you raise taxes, you’re taking money out of the pockets of consumers. And it’s important for policy makers to recognize that all the doubt about taxes causes capital to stay on the sidelines.

Bush opposes any tax increases. He supports the very wealthy when he opposes raising the top income tax rate (e.g., reversing the Bush tax cuts for the rich) or taxing capital gains at the top rate. This view confuses the effect of taxing very high incomes with that of taxing lower incomes.  Raising taxes on the very wealthy does not, in the aggregate, take money out of the pockets of consumers, as explained in Part 3 of this series.  What nearly everyone overlooks is that not taxing the rich means leaving money in the hands of people with a very low propensity to consume, instead of increasing aggregate demand by putting it in the hands of people with a much higher propensity to consume. [2]

Bush’s supply-side position ignores the factor that is Obama’s focal point – the growing income gap between “those in the very, very top and everybody else.” Bush says he wants 4% growth, but Obama counters that he can’t get that by cutting taxes on incomes of the very rich: “What drags our entire economy down is when the benefits of economic growth and productivity go only to the few,” adding that “In this country, prosperity has never trickled down from the wealthy few.”

It comes down to this: Tax cuts for the rich reduce aggregate demand and, consequently, their investments (in jobs and production), serving only to depress the economy and increase income inequality, as explained in Part 3 of this series.  Only the income tax cuts for lower-income consumers, and for small business owners (who will spend, and invest in response to higher demand), increase aggregate demand and investment.

The main reasons supply-side advocates ignore these realities, lumping all tax brackets together conceptually as if like changes in all of them have the same effect on the economy, are: (1) they are ideologically opposed to government taxation and spending, and especially opposed to  the government employing Keynesian fiscal policy for stimulus; and (2) they want to protect the growing incomes and wealth of the very wealthy.

Many supply-side advocates may not realize that the theory is wrong.  It is crucial for the rest of us, however, to understand not only that supply-side theory is wrong, but why it’s wrong.

Gaining a New Perspective

So we must update the way we think about macroeconomics to incorporate the new focus on inequality.  That aggregate demand determines investment and production is the main lesson of Keynesian economics, so it is not surprising to see Bush acknowledge that.  But he and the other advocates of “siphon-up” economics work tirelessly and shamelessly to trash aggregate demand, sending the U.S. economy reeling into depression. Bush’s only argument for this agenda is that higher taxes “cause capital to stay on the sidelines,” the supply-side, Laffer-curve claim refuted in Part 1 and  Part 2 of this series.

“So it’s crucial to appreciate where we are,” Paul Krugman concludes in the epilogue to his 2008 book: “We may have avoided a repeat of the Great Depression, but we’re still very much living in a world in which the usual rules of economic policy don’t apply.” Understanding depression economics, he says, “is our only defense against economic disaster.” And I would add: Understanding the economics of inequality. 

Achieving that understanding won’t be easy.  Almost no one in the media understands where we are.  We are presented with analyses drawn from a dream world of assumed economic normalcy.  When overall economic trends are reviewed by “experts” we hear discussions of  the “business cycle,” and predictions of when we can expect the recession to “end” with consumer spending and employment returning to normal.  We routinely hear superficial reports of stock market performance, or trends in housing or unemployment, that fail to appreciate that the economy of the bottom 99% continues to shrink.  The new “normal” is  assumed to be pretty much the same as the old “normal,” but it is not.

Crucially, these assessments overlook the growth of income and wealth inequality, and the creation of what Chuck Collins calls the “inequality death spiral” for the bottom 99%: “As wealth concentrates in the hands of the 1%, they use their power to rig the rules to their benefit.  This leads to a downward spiral in the quality of life for the bottom 99%.” [3]

The following two graphs illustrate this phenomenon. The initial hypothetical example illustrates the “normal” case of “business cycle” changes in aggregate 99% income assuming constant, stable income inequality.  The top 1% is represented as taking in about 10% of U.S. income, as was the case in the ’60s and ’70s in the U.S., and the hypothetical assumes (for comparative purpose) no annual GDP growth:

It is this “normal” case of stable inequality that virtually everyone presumes exists today. If we have a recession, we presume, the economy will bounce back after it recovers to a situation resembling the situation that existed at the beginning of the recession.  But since the 1970s, it has not. What we now know is that ever since the Reagan tax cuts inequality has been growing, with wealth constantly transferring to the top 1%, leaving the bottom 99% worse off after a recession than before, as illustrated in the next graph:

This graph illustrates continuous inequality growth, in this example to some future point where the top 1% has close to 50% of all incomes. (The top 1% share of all income has grown to about 25% today.)  Of course, the death spiral by that point would have long since descended into a serious depression.  Total income is shown to decline (relative to the base case), because growing inequality stunts overall growth, as confirmed by history since 1979. Bottom 99% income declines (relative to the base case) even faster than total GDP, because the top 1% share of total income is continuously growing.

Any time income inequality is growing, the bottom 99% loses.  Incomes in the bottom 99% remain stagnant even in “business cycle” recovery periods, and as inequality grows the top 1%’s share of any new “recovery” income increases.  This graph illustrates the fact that recovery from a recession can still leave the bottom 99% in decline, if inequality is increasing rapidly enough.

This has been the U.S. experience ever since the excessive Reagan tax reductions started the “death spiral” thirty years ago, and especially over the last decade.  Since the Crash of 2008, President Obama has been remarkably successful in stimulating private sector job growth, in the face of increasing state-level public sector unemployment — but bottom 99% incomes have continued to decline.

There are other “structural” problems contributing to the decline of bottom 99% incomes, like the rise of global competition in the labor market, and the profiteering of Wall Street and the global banking cartel, but the primary structural problem that has led to inequality growth has been the depressive effects of the excessive reduction of taxes on top U.S. incomes.  Some will argue that globalization of labor and finance “caused” the decline in 99% incomes, but my perspective is that the regressive taxation of Reaganomics (whose practitioners have set government policies for most of the last 30 years and benefited from globalization) has denied the bottom 99% the opportunities and economic stimulation needed to develop and strengthen domestic productivity while avoiding rising inequality.

What the Data Show

In a  study of top incomes in five Anglo-Saxon countries released in May 2010 by A. B. Atkinson (Nuffield College, Oxford) and Andrew Leigh (Australian National University and IZA), the researchers concluded:

We find that top income shares are highly correlated across Anglo-Saxon countries. The share of the very rich appears to be extremely responsive to changes in marginal tax rates.

As reported by  VOX this past December, there have been additional findings on income taxes and income inequality, for all OECD countries and in particular for the United States:

CEPR DP8675 investigates the link between skyrocketing inequality and top tax rates in OECD countries.  The authors find a strong correlation between tax cuts for the highest earners and the income share of the top 1% since 1975. 

In their discussion paper (DP8675) issued November, 2011, economists Thomas PikettyEmmanuel Saez and Stefanie Stantcheva review their studies of the top 1%’s income response to changes in the top tax rate, as a function of three factors (elasticities) that would cause top 1% incomes to change beyond the arithmetic effect of tax rate changes.  They found:

[No] study to date has been able to show convincing evidence in the short or medium-run of large actual economic real economic activity responses of upper earners to tax rates. * * * [I]nter-national evidence shows a strong correlation between top tax rate cuts and increases in top income shares in OECD countries since 1975. Interestingly, the link between top rate cuts and top income share increases is strong in English speaking countries but much smaller in other countries such as Japan or Sweden which also experienced large top tax rate cuts.  (DP8697, p. 2)

In other words, especially in English speaking countries, cuts in the top tax rate since 1975 have not materially affected top 1% economic activity (consumption and investment); they have merely increased income inequality. The following graph (DP8679, p. 49) shows the top 1% income share in the United States, along with the top tax rate and the capital gains rate, over the last century:

We have been posting similar data for about a year.  Here, however, the top tax rate and 1% income share are usefully provided on the same graph, with the capital gains portion of the 1% income share displayed separately, as is the capital gains tax rate.  Among other things, the data show:

(1) Top 1% income share was stable between 1967 and 1980 at (for the most part) a 70% top rate and a 35% capital gains tax rate;

(2) The top 1% share increased quickly in response to marginal tax rate (MTR) and capital gains (KG) tax rate reductions during the Reagan administration;

(3) In 1988, when MTR was decreased from 50% to 28%, and KG tax was increased from 20% to 28%, total 1% income share responded immediately, with the capital gains portion narrowing;

(4) After 1993, the rate of growth of the share of income (excl. KG) accelerated at the 40% MTR, then again when it was reduced to 35% (the “Bush tax cuts”);

(5) After 1993, with the lowering of the KG rate to 20%, then to the current 15%, the capital gains portion of the top 1% share skyrocketed and made the top 1% share more volatile.

This second graph shows income growth for both the top 1% and the bottom 99%. After 1973 the income growth rate of the bottom 99%, that had been steady since WW II, was radically reduced and mostly eliminated. Real income growth per adult in the top 1% increased markedly over the same period — hence, the sharp rise of income inequality since 1980 shown in the first graph.

This analysis reveals that factual history refutes the more subjective analyses presented in support of the supply-side argument over the years.  For example, in a 2004 article for The Heritage Foundation, Arthur Laffer asserted that:

The 1964 tax cut reduced the top marginal personal income tax rate from 91 percent to 70 percent by 1965. * * * The Kennedy tax cut set the example that President Ronald Reagan would follow some 17 years later. By increasing incentives to work, produce, and invest, real GDP growth increased in the years following the tax cuts: More people worked, and the tax base expanded. 

The facts prove otherwise: Following the Kennedy tax cut from 91% to 70%, income growth for the bottom 99% dropped precipitously, ending the aggressive creation of the American middle class, but remaining fairly consistent with top 1% growth.  (We should have the 70% rate today.)  The Reagan tax cuts 17 years later, however, were an entirely different story.  As we noted, decreasing the top rate from 70% to 28% began the process of rapidly growing inequality that has since all but eliminated the middle class.

Conclusion

For three decades, the wealthiest people in the United States have successfully confused most Americans into believing that policies that actually favor the top 1% at the expense of everyone else affect us all the same way.  They have fostered an equality myth that can only be defeated by the truth about the growing inequality of incomes and wealth.

Now we are learning that the supply-side ideology has been consistently disproved by experience, through facts that could only be revealed by studying the long-run growth of inequality between bottom 99% incomes and the top 1% incomes to which the top tax rate applies.  The truth has now been conclusively revealed: Taxes are the mechanism that checks the “siphon-up” process, and there is no “trickle-down” process.

These studies only go to 2008.  Elsewhere on this blog we pointed out that since the 2008 Crash and the descent of the bottom 90% into a depression, there has been no growth except in the top 1%.  The top 1%, through the processes documented here, have siphoned up more than $10 trillion from the bottom 99% from 1979-2007.  Subsequently, the bottom 99% has lost another estimated $8 trillion of real estate wealth, and the median income has fallen by about 10%.

No one aware of the truth about income inequality and its effects should be less than fully alarmed by the Republican agenda, with its plans to cut taxes for the ultra-rich even more while eliminating more jobs (both public sector and private sector), to eradicate government participation in the economy through the social safety net, and to cut virtually everything from the federal agenda but military activities and spending.  Politicians like Paul Ryan, Mitt Romney, Grover Norquist, and Mitch McConnell can only get away with the gross distortions and lies they must tell to support this deadly agenda because they are appealing to a gullible, ignorant electorate.

“We’ve got two very different visions of our future,” President Obama told his audience a few days ago in Boca Raton, “and the difference could not be greater.”

Wake up, America: It’s now or never.

JMH – 4/16/2012 (ed. 4/17,20/2012)

_______

[1] Chuck Collins, “99 to 1: How Wealth Inequality is Wrecking the World and What We Can Do about It,” Barrett-Koehler Publishers, Inc., 2012, pp. 33-34.

[2] If the top rate were to start too low, say at $250,000, the obvious solution is to start the highest bracket at a higher income.  For example, the “Buffett Rule” would start the 30% minimum rate at $1,000,000.  The Buffett Rule would therefore increase aggregate demand.

[3] Id., p. 90.

(Return to the Contents Topics page.)

This entry was posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Reaganomics. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s