In my retirement, I have devoted myself to the investigation of income and wealth inequality, and in the process acquired a distributional perspective on how modern market economies actually work. When I began this project, I soon realized that it would involve tracing through the history of “political economy” the emergence of some very harmful, and very wrong, ideas. Consistently nurtured over more than 150 years of modern “neoclassical” economics, these are ideas that have come to control the perspectives and thinking of most economists, and of politicians and the mainstream media.
It seems not only surprising, but also quite remarkable, that bad ideas — that is, ideas that do not stand up under scientific scrutiny — have consistently favored the interests of wealth and power. For this reason, perhaps, it seems less surprising that these bad ideas now dominate economic theory and doctrines: Sadly, mainstream economics has become less a social “science” and more an elitist discipline dedicated, in effect, to the cultivation of inequality and the preservation of the interests of wealth.
Yes, there are pockets of “heterodox” dissent, but you have to dig to find them. Happily, the voices of dissent are growing louder as conditions worsen, but throughout history societies have reacted too late, and suffered enormous damage, and then had to learn hard-won lessons all over again, as ably recounted by Thom Hartman in his latest book, The Crash of 2016.
It has not always been that way. A period of significant objective scientific inquiry in economics got underway with Adam Smith, who published Wealth of Nations in 1776, and his immediate successors T. R. Malthus and David Ricardo. This period of “Classical Economics” continued on into the mid-19th Century through the work of the German Karl Marx, the British philosopher/economist John Stuart Mill, and the American Henry George, but began a rapid decline with the emergence of neoclassicism in the last decades of 1800s.
Unlike classical economics, which was concerned with the overall welfare of society, neoclassicism promoted private gain. It made gigantic and often creative leaps to assume away unpleasant and morally troublesome aspects of reality, chief among them the fact that one party could gain wealth only at the expense of others. Alfred Marshall’s Principles of Economics (1890) made explicit one of the biggest neoclassical leaps of faith ever, namely, the idea that an economy can somehow always recover from the consequences of the accumulation of concentrated wealth. Forty-five years later, in what would be the last gasp of rational classicism, John Maynard Keynes took on Marshall and the neoclassicists, exposing the weaknesses in their thinking in The General Theory of Employment, Interest, and Money (1936).
The last word of that title is revealing: Keynes’s target was neoclassical supply-side idealism, and modern neoclassicism has continued to ignore the role of the money supply in providing effective demand, and the constraint the finite money supply imposes on growth and recovery. Keynes emphasized the “principle of effective demand,” which essentially means that there must be a sufficient supply of money distributed throughout society to provide for the growth of demand, income and investment. An important ingredient missing from Keynes’s analysis was the Quantity Theory of Money (QTM), a theory developed by the American economist Irving Fisher and a few others in the late 1890s that expresses a mathematical truism: The amount of an economy’s annual income (GDP) is determined by the average size of the money supply and the average velocity of its circulation. The supply and velocity of money are the ultimate constraints on effective demand.
Intent on denying Marx’s prediction that inequality gradually grows over time in capitalist economies, neoclassical economics has consistently cultivated the “trickle-down” fantasy that wealth and income could be increasingly concentrated in the hands of a few with no adverse consequences for the less wealthy. To prop up this trickle-down fantasy, neoclassicists like Paul Samuelson and Milton Friedman marginalized the Keynesian emphasis on the sufficiency of “effective demand.” Today, Keynesian “demand-side” theory has been almost entirely discarded in favor of the “supply-side” approach Keynesian macroeconomics repudiated. Likewise, the QTM has been overlooked: Growing income concentration at the top reduces the amount of spending and demand below top incomes (which Keynesian theory requires for economic recovery) and that represents a decline in the velocity of money. That stagnation and recovery fundamentally depend on the velocity of money was completely overlooked by mainstream economics after Milton Friedman presumed a constant velocity of money in his famous theory of the Great Depression.
Trickle-down and the QTM
It is fairly easy to explain why the perpetuation of the trickle-down myth requires overlooking the realities imposed by the QTM: The trickle-down argument requires that when the wealthiest get richer there is enough stimulation and growth so that the entire economy will do better as well: The losers, as always, are those who are not trying hard enough to succeed. The QTM, however, demolishes that fantasy, for it establishes that when the wealthiest get richer, everyone else is worse off.
The entire issue of growth and prosperity is intimately linked to the distribution of wealth and income, as I have emphasized over the past several years. Mainstream economics has steadfastly refused to admit that inequality growth has any macroeconomic implications at all. That denial has become impossible to maintain: The many trillions of dollars of net worth that has accumulated within the top 1% since 1979 was overlooked for decades, and is only now being discovered. But with the acceleration of inequality growth since the Crash of 2008, the reality of wealth concentration has become difficult to overlook. For example, Paul Buchheit reported in Nation of Change on November 14, 2014 (here), that “American wealth has been sucked away from the middle to a greater extent than in any major country except Russia.” Moreover:
A revealing study from the Russell Sage Foundation found that: — Median wealth has dropped, stunningly, by 43 percent since 2007 — Only the richest 10% of the country gained wealth since 2003.
Ignoring these facts is to ignore QTM: It is not just a “theory,” it is a mathematical certainty. Even more stunning is the high concentration of income redistribution, which economist Emmanuel Saez has reported is consistently moving higher and higher within the top 1%, and is locating somewhere near or within the top 0.1%.
This leads to enormous levels of confusion and misinformation. An excellent example can be found in the recent New York Times article “As Economies Gasp Globally, U.S. Growth Quickens” by Nelson D. Schwartz, dated August 28, 2015 (here). This was a tremendously optimistic report:
The latest evidence of this shift came on Thursday, as the Commerce Department revised sharply upward its estimate of economic growth in the second quarter to a healthy annual pace of 3.7 percent, from an initial estimate of 2.3 percent. At the same time, the Labor Department, in reporting another drop in weekly unemployment claims, provided further evidence that the job market was on the mend. * * * With markets remaining on edge, investors are already turning their attention to coming data about the economy’s course, which will help determine whether the Federal Reserve will make its long-awaited move to raise interest rates in September or wait until later meetings.
To project growth at an annual rate of 3.7% for any length of time is a classic example of neoclassical trickle-down optimism. The annual rate of GDP (income) growth has been around 1% since 2008, and that includes the income at the top. And the job market cannot really be mending at such a pace with median incomes drastically falling, as dictated by the QTM (Craig Roberts, July 8, 2012, (here):
And while median income is falling, quite naturally, household borrowing must increase to keep up effective levels of effective demand. The following graph (reproduced from azizonomics blog, here) shows private sector debt as a percent of GDP over the last century. Americans were relatively cash rich after WW II, a condition that persisted until the depression-era 1930 debt/GDP ratio returned in the late 1990s:
Meanwhile, as reported by the St. Louis Fed (here), corporations “are holding record amounts of cash,” and cash holdings have grown rapidly since 1995:
In 2011, cash holdings amounted to nearly $5 trillion, more than for any other year in the series, which starts in 1980. The increases in cash holdings grew steeper from 1995 to 2010, with an annual rate of growth of 10 percent (from $1.22 trillion to $4.97 trillion).
Here is their graph of the growth of the aggregate cash and equivalents of U.S. firms:
And here is their graph of the ratio of cash to net corporate assets:
According to the attached report “Why are Corporations Holding So Much Cash?” by Juan M. Sánchez and Emircan Yurdagul (here):
A close look at the balance sheets of publicly traded U.S. firms shows that their cash holdings have increased dramatically since the mid-1990s except for a slowdown around the financial crisis. The two explanations most frequently given for the growth in cash pertain to fiscal policy and structural factors.
Fiscal policy affects cash holdings in two ways, both of which involve taxes. First, public firms are seeing their profits rise elsewhere in the world; if these firms were to bring these profits from overseas operations back to the U.S., the profits would be relatively heavily taxed. Second, uncertainty about future taxes is on the rise.
Ah yes, taxation! We’ll get to that shortly. But first, we need to ask ourselves a couple of questions emerging from the Schwartz article: (a) How can the rate of GDP growth be expected to increase with median incomes in constant decline? (b) Doesn’t the ominous rise of private household debt portend further GDP decline? and (c) What does the huge increase in corporate holdings of idle cash tell us about why this is happening?
The answer to the last question clearly lies in the growing inequality of income and wealth distribution. When U.S. corporations are sitting on $5 trillion of cash, in tax-avoidance mode, it is obvious that they have far too much money which is not being invested and circulated throughout the economy. In terms of the QTM, this is a glacial pace of the velocity of money. This money obviously has not trickled down — and these are the conditions of incipient depression.
Trickle-Down and the Laffer Curve
It’s all about avoiding taxation, and the trickle-down propaganda assault has come from both directions: As just discussed, the entire weight of neoclassical ideology is thrown behind the assertion that cutting income taxation of the rich investment class is good policy, because they will “work” harder and can obtain limitless additional wealth without hurting anyone else. Regardless whether that idea seems silly on its face, the QTM demonstrates its absurdity.
From the other direction, the argument is made that attempts to increase taxation of the rich capitalists will backfire, because they will lose the will to “work” for more money. When that happens, the argument goes, these wealthy “job providers” will invest less, pick up their marbles and get out of the game.
This argument is perhaps even less credible than the first. Warren Buffett has underscored the obvious point: “People invest to make money, and potential taxes have never scared them off.” (“Stop Coddling the Super-Rich,” by Warren E. Buffett, The New York Times, Op-ed, August 14, 2011, here). From the accumulation of trillions of idle cash just discussed, it is evident that it doesn’t take an actual tax increase to cause the hoarding of financial wealth at the top.
Lest it escape our attention how unimaginably huge the incredible $3.75 trillion growth of idle corporate wealth between 1995 and 2010 really is, consider this: The distance light travels in a year is about 5.86 trillion miles, and the closest star to our sun is Alpha Centauri, about 4.37 light years away. For a hypothetical trip to Alpha Centauri, at a cost of $1/mile, that idle wealth would be enough get you about 1/7 of the way there. The fastest spacecraft ever launched, Voyager 1, “would take well over 70,000 years to reach Alpha Centauri” (Paul Gilster, Centauri Dreams, here). Thus, in our hypothetical, the idle cash would finance about 10,000 years of space travel at the speed of Voyager 1! Even with that analogy, the scope of this problem remains virtually unimaginable.
In an attempt to provide a patina of legitimacy to the argument, University of Chicago economist Arthur Laffer unveiled, at a 1974 Washington, D.C. dinner party with Jude Wanniski, Donald Rumsfeld, and Dick Cheney. a graph that has become known as the “Laffer Curve” (“The Laffer Curve: Past , Present and Future,” by Arthur Laffer, The Heritage Foundation, June 1, 2004, here). Here is a frequently published version of the curve:
This symmetrical bell-shaped government revenue curve is based on the argument that no government revenue will be collected if the top marginal income tax rate is zero (which is obviously true) or if the top rate is 100% (which is essentially untrue, since CEOs reaching the top income tax rate in a tax year probably would not decide to shut down their corporations until the following year).
Since the top income tax rate has never been at 100% in U.S. experience, this is entirely a matter of fanciful speculation. Moreover, to suggest as this formulation of the government revenue curve does, that optimum revenues are achieved at a 50% top tax rate ignores the U.S. experience between 1945 and 1982, when the middle class grew and flourished and there was steady growth and prosperity, and the top rate was at 91% and 70%.
Econometricians have estimated the optimal tax rate for the United States at over 80%. Here is an optimum revenue curve generated by British economist Sir Tony Atkinson and Australian economist Andrew Leigh, from the Twentieth Century income tax data of five Anglo-Saxon income tax systems: Australia, Canada, New Zealand, the U.K., and the U.S. (here):
Focusing solely on the United States, the French economists Emanuel Saez and Thomas Piketty, together with Stephanie Stantcheva, developed a complex “three elasticity” model, and though they published a revised paper in 2013 (“Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva, revised March 2013, WP 17617, here), their conclusions remained the same. Although their model was different, and they isolated the U.S. experience, they too estimated an optimal top income tax rate of 83%. Their substantive conclusion (“Taxing the 1%: Why the top tax rate could be over 80%,” by Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, VOX CEPR’s Policy Portal, December 8, 2011, here) is unequivocal:
The top 1% of US earners now command a far higher share of the country’s income than they did 40 years ago. This column looks at 18 OECD countries and disputes the claim that low taxes on the rich raise productivity and economic growth. It says the optimal top tax rate could be over 80% and no one but the mega rich would lose out.
This post provides only a sampling of the ideology generated by neoclassical economics to defend the interests of wealth. The primary threat perceived to wealth, naturally enough, has always been taxation. It is sobering to confront the array of truly bad arguments that have been advanced in the successful effort to oppose the taxation of wealth and top incomes. The “trickle-down” fantasy has been the most successful of these bad ideas, and it controls taxation policy in the United States today.
Unfortunately, as is becoming increasingly apparent each year, the downside of regressive taxation is decline and, ultimately, collapse. Without significant tax reform in the U.S., and in some other major industrialized countries, the U.S. and global economies are not too many years away from a truly disastrous collapse.
JMH – 9/7/2015