The pundits and politicians on the left and on the right have been
amazingly consistent in their analyses of our budget crisis as well as
the proposals they each subscribe to for fixing the economy. Since
most of us do not have the time or inclination to corroborate the
validity of the "facts" or the reasonableness of the proposals
presented by each side of this debate we tend to agree with the
analyses of the party we have affiliated with in the past. But – if
you listen carefully and take the time to do some basic fact-checking
– you will find some serious flaws in both the Republicans' and the
Democrats' facts and proposals.
Here are the theses so consistently offered by each party it is
practically guaranteed they will be repeated by the politicians and
pundits in any conversation about the economy.
• Republican: If tax rates were reduced for individuals and
corporations the economy would flourish as individual and corporate
taxpayers alike would have additional money in their pockets to spend;
as a result consumer spending would increase and corporations would
use the additional funds to hire more employees. This worked when
Reagan was president and will work today.
• Democrat: Instead of worrying about the deficit and debt we need to
focus on jobs. (Often this is left hanging without explanation of how
these jobs will be created – because even Democrats are wary of openly
suggesting more government spending. But when an explanation is given
– here are the talking points…) Our [choose from the following;
infrastructure, education system, unemployed] need improvement or
assistance and if the government spends to improve or benefit
[infrastructure, children, unemployed] then jobs will be created and
private sector spending will increase, boosting our economy to new
heights.
On the surface both arguments seem plausible. However, if the facts
are presented – including a basic analysis of the current economic
situation – then both arguments fall flat. To appreciate how truly
wrongheaded either of these proposals are we need to understand where
our economy is now and how we got here.
Budget History and Current Economy
During our post-WWII economy only two administrations produced a
budget surplus – Truman's and Clinton's. All other administrations
during this 60+ year period operated in the red – realizing budget
deficits. Not a record to be proud of. More important than the basic
deficit versus surplus status is the trend over time – which can be
seen from the chart below.
Average (AVG) Annual Budget and GDP Amounts During Post WWII
Presidential Terms
Plus 2010 and 2011 Annual Budget and GDP Amounts – Barack
Obama
President (term*) AVG GDP $Billion AVG Receipts% of GDP AVG
Spending% of GDP AVG Surplus/(Deficit)
Harry S. Truman (1947-54) $306.58 16.96%
16.55% 0.41%
Dwight Eisenhower (1955-62) $480.08 17.33%
17.88% (0.55)%
John F. Kennedy (1963-64) $620.35 17.67%
18.52% (0.85)%
Lyndon B. Johnson (1965-70) $847.08 18.28%
19.04% (0.76)%
Richard Nixon (1971-75) $1,313.16 17.78%
19.62% (1.84)%
Gerald Ford (1976-77)** $1,390.33 17.62%
21.03% (3.41)%
Jimmy Carter (1978-81) $2,625.03 18.85%
21.26% (2.41)%
Ronald Reagan (1982-89) $4,264.80 18.00%
22.14% (4.14)%
George Bush (1990-93) $6,123.58 17.69%
21.92% (4.23)%
William J. Clinton (1994-2001) $8,520.68 19.38%
19.28% 0.10%
George W. Bush (2002-09) $12,681.51 17.03%
20.52% (3.49)%
Barack Obama, FY 2010 $14,660.40 14.08%
23.60% (9.52)%
Barack Obama, FY 2011 (est) $15,079.60 14.40%
25.30% (10.90)%
*The budget fiscal year begins October 1 of the previous year. For
example Fiscal Year 2009 began October 1, 2008. For this reason,
budget years appear to not correspond with a president's term. For
example George W. Bush took office January 2001 but the FY 2001 budget
was prepared by the Clinton Administration and authorized by Congress
in 2000.
** The fiscal year changed from ending June 30 to September 30 during
Ford's administration.
Aside from the interest you might have in a particular president or
party, the theme of a trend of increasing deficits over time should be
troubling. But this trend is also instructive in that it strongly
supports the theory that democracies tend to reward politicians
willing to rob Peter to pay Paul while also rewarding those who
deliver on the promise lower taxes; two policies on a collision course
heading for bankruptcy.
Also instructive in regards to a more positive statistic is the
possibility of reversing this trend – as can be seen for the Clinton
administration. So the question I hope you are asking is how the
Clinton administration was able to buck the trend and produce a
surplus (and how can this be replicated today!) The short answer is a
contentious political battle followed by compromise.
In his first year, Clinton increased the tax rates as well as passed
through a then Democratic controlled Congress other significant tax
and spending legislation. Not surprisingly, this law change improved
future receipts but the government outlays did not move much.
However, in 1994 the Republicans won over both houses in the midterm
elections. Following that there was definitely a divided government.
The ensuing years saw plenty of political theater with the Republicans
demanding cuts in government spending (and being labeled as heartless
functionaries of the rich) and the Democrats resisting this (and being
accused of being irresponsible and profligate). In the end the
Republicans were able to enact deficit reduction legislation which
Clinton signed into law. The result was a significant reduction in
spending, a fairly stable experience of receipts being collected,
annual surpluses, and a healthy growth in the economy. And this good
outcome for the economy came to be because both sides were able to
meet in the middle. Is there a lesson here?
Unfortunately we are not in the same environment today – politically
or economically. Looking at the 2011 budget it is anticipated that
receipts will be 14.40% of GDP and spending will be 25.30% of GDP.
Either figure should scare the crap out of anyone aware of the history
shown in the chart above. Put simply…
• If we proposed to fix this problem strictly by cutting spending that
would require a decrease of around 43% of the 2011 estimated spending
– a laughable goal at best.
• If we proposed to fix this problem strictly by increasing taxes that
would require a 76% increase in taxes – a solution no one who
currently pays taxes would vote for.
So before pondering anyone's solution to this budget mess – and the
problems it has caused in our economy in general – can we agree that
the answer must include corrections to both spending and taxation, not
relying on one to the exclusion of the other? Based on the current
situation and the historical information shown in the chart it is not
realistic to make a proposal to solve our problems by focusing
exclusively on the spending side or exclusively on the taxation side
of the equation.
Republican Argument
The Republican assertion that reducing the highest tax rates will fix
the budget problem is presented with another assertion: that this
approach worked successfully during the Reagan administration. To the
Republican's credit – they also call for a significant reduction in
government spending (at least in speech, if not in deed). However
doubtful one might be about any politician's seriousness about really
reducing spending the concept seems to have been adopted in theory by
both those on the left as well as those on the right; a positive
development in itself.
If we give the Republicans the benefit of the doubt regarding their
sincerity for reducing spending we are then left with the question of
the validity of their claim that tax rate reduction will spur economic
growth and job creation. Let us begin by testing the validity of the
claim that it was successful when Reagan was president. This claim is
framed based on the dollar amount of tax collections; i.e., that tax
receipts increased for the year tax rates were reduced as compared to
the previous (pre-reduction) year. This statistic is misleading in
that during the entire 37 year post-WWII period up to and including
the first year Reagan was responsible for the budget (1946 to 1982)
there were only 5 years where government receipts were less, in
absolute dollar terms, than the previous year. An expected nominal
dollar increase year-to-year is easily explained in that the growth of
GDP provides a larger base to be taxed each succeeding year. Even
using this misleading nominal dollar yardstick, in 1983 (following
Reagan's 1982 reduction in the top individual tax rate from 70% to
50%) government collections fell by $17 billion as compared to 1982.
In any case, the relevant statistic for measuring year-to-year
fluctuations in tax receipts is the percentage of GDP collected as
compared to the previous year. Based on this statistic the history of
the relationship between tax rate reductions and the government's
receipts will be seen in a very different light.
• In 1946 the highest individual income tax rate was reduced to 91%
from 94%; in 1964 Kennedy reduced the rate to 77% from the previous
91%; in 1965 LBJ reduced the rate to 70% from the previous 77%; and in
each of those years of rate reduction, tax collections decreased
compared to the previous year as measured by the percentage of GDP so
collected. By today's standards these rates seem punitive but keep in
mind that coming out of WWII our nation was still spending
considerable funds on defense (e.g.; in 1966 defense spending amounted
to 8.84% of GDP as compared to 2011 defense spending of 6.40% of GDP)
and the wealthy were indeed providing a greater share of tax revenue
as compared to today – thus the much touted rise of the middle class
from the 1950s through the early 1970s. Whatever one thinks of the
tax policy during this period the inescapable conclusion is that
reductions in the highest individual tax rate led to reductions in tax
collections in the year the rate change occurred. And no one would
question that this period includes our golden years in terms of
economic growth and stability.
• And regarding the Reagan years: the highest individual tax rate was
reduced from 70% to 50% in 1982; from 50% to 38.50% in 1987 and ended
up at 28% in 1988. For each of these years that rates were reduced,
excepting 1987, the government's receipts declined as measured by
percentage of GDP.
So the "history" that reducing tax rates increases revenue is
nonexistent. Quite the opposite is the case whether you look at the
Reagan years specifically or the post-WWII period in general.
Moreover, when considering the post-WWII period prior to Reagan –
where the highest individual income tax rate was never less than 70% –
it simply seems implausible to expect that reducing the current top
rate of only 35% (to what??) would boost the economy or government
receipts. This is so especially in recognition of the fact that the
2010 receipts amounted to the pathetically sorry statistic of 14.8% of
GDP and it appears 2011 will not be much different. (Compare this to
the 17%-19% of GDP figure for government receipts during the 1950s –
1970s and rise of the middle class that occurred then as well as an
economy growing at rates we can only dream of today.)
The Republican dialogue does distinguish between business and
individual income tax rates. Their belief is that decreasing
corporate rates will lead to job creation (which we are all for) based
on the theory that the additional available cash to corporations will
be applied to the hiring of more workers. In fact – it is often
repeated by the politician or pundit speaking on this issue that they
have firsthand knowledge from the powers that be (corporate managers)
that reducing the corporate tax rate will lead to hiring. I hope not
to be taken as the ultimate cynic – but I would expect most anyone
asked if they want their taxes reduced would whole heartedly support
the notion – even to the extent of promising to help fix our economy
in return for the favor. More importantly, whether such conversations
have happened or not there is a major fact that belies this supposed
quid pro quo that corporate tax reduction will lead to jobs:
corporate balance sheets reflect an historical high point in cash.
This leads to an obvious conclusion – If corporations are currently
drowning in cash (and clearly not hiring) why would an additional
infusion of cash by way of a tax reduction suddenly change the
behavior toward hiring?
A plausible theory of why all this cash sits in corporate coffers but
hiring has stagnated is that corporate managers are worried – just as
most of the rest of us are – about the implications of a government
incapable of doing anything constructive in the face of bankruptcy.
Is consumer demand going to really dry up when the country goes
broke? Is inflation going to become so extreme that corporate margins
will suffer? If these issues are on their minds, I do not blame
corporate managers for keeping their powder dry until this either gets
fixed by a more competent government or the new reality unfolds to the
point that path forward becomes clear. In the meantime, reducing
corporate tax rates seems to be a red herring as a solution to our
economic problems.
On the subject of being able to convince the government to reduce your
taxes, here is a strange twist: Bill Gates and Warren Buffett have
made public their opinion that anyone earning over $1 million should
be subject to a higher tax rate than currently exists. These are
smart guys and, not to take away from their spirit of generosity, if
this were followed up on they would likely benefit from such a tax
increase in the long run. If you are worth $50 billion or so (we can
dream) and earn say around $100 million a year (probably less is my
guess – but let us be generous), a 15% increase in tax rates will cost
you $15 million of additional tax. (Under current law with ordinary
income taxable at 35% this presumes those earning more than $1 million
will be taxed at 50% instead – which of course presumes capital gains
and dividends also get taxed at a higher rate for these fortunate
few.) Why would anyone agree to this – patriotic motivations aside?
Simple answer: If tax receipts continue on their current pathetic path
and spending is not curtailed the economy as a whole is headed for
serious trouble – which would be a much bigger nominal dollar loss for
someone with $50 billion in stocks, bonds, etc. than the average
taxpayer. Thus if Berkshire Hathaway or Microsoft stock plus other
assets Bill or Warren hold lost 10% of their value (hardly a stock
market crash – it could be much worse) the $50 billion of previous
holdings for each would shed $5 billion of value. Test question:
What would you rather do; pay $15 million additional tax per year
(knowing other wealthy people are doing the same to increase the
likelihood of a more balanced budget) or lose $5 billion or more in
net worth when the economy fails?
So however troubling it might be to have to raise taxes the outcome of
doing so will be much more beneficial than imagining our way out of
the current budget crisis by attacking the spending side of the
equation alone. I hope anyone promoting the idea that reducing taxes
will achieve anything beyond propelling a misinformed or disingenuous
politician into office will think otherwise after reviewing the
facts. And for those who think they can embarrass me because I am
calling for "raising taxes on the rich" you should know that I also am
for the proposition that all but the poorest should pay taxes – in
reaction to the fact that around 50% of households pay no tax. Such a
tax system would reduce the negative consequences of the robbing of
Peter to pay Paul philosophy of current politics.
Democrat Argument
The argument offered by Democrats indicates they are in denial of the
necessity to cut spending. As their argument goes, if we just spend
more money on infrastructure or education or the unemployed this will
spur the economy. They find authoritative support for this – and
often refer to – the late economist John Maynard Keynes. Keynes
promoted his economic theories during the 1930s – a time when a very
different economic environment existed. In 1930 our government spent
3.4% of GDP and the national debt was 17.75% of GDP and these figures
climbed by 1934 (this was the Great Depression) to spending at a then
outrageous 10.6% of GDP and debt at 40.98% of GDP. If Keynes was
alive today I do wonder if he would be so keen on the idea of more
spending to spur the economy given the current situation of spending
at 25.3% of GDP and the debt soon to exceed 100% of GDP; not to
mention an expected 10+% of GDP budget deficit – greater than total
annual spending that occurred during the 1930s.
However you may view the theories of Keynes, in today's world with the
current out of control spending and monumental debt it seems
preposterous to believe we can spend our way to prosperity.
Furthermore, as long as the Democrats try to promote such policies it
would surely be viewed by business leaders as a government digging a
deeper hole and rational businesses would be reluctant to risk
expansion or hiring in such a dangerous environment. Sadly the only
businesses that would likely prosper if such policies were pursued
would be those employed by the government – not the best approach for
allocating resources or building a vibrant and competitive economy in
the global market we must now compete in.
So whether these spending proposals are motivated by an attempt at
buying votes or something less nefarious the results will be the same
– accelerating our march toward the cliff of bankruptcy.
Now What?
Though I do not expect anyone to change their political party after
exposing these fallacies each party supports and since "none of the
above" is not a viable option when casting your vote I do however hope
to encourage the reader to seek out and support those (rare) leaders
who put common sense ahead of party dogma.
Since we live in a democracy we are free to complain and criticize.
Given the current situation we have good reason to do so. But now is
a critical time in our history and finding leaders that deserve our
support and taking the time (and money if you can afford it) to keep
or get them into office is the best use of our energy.
--
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