The Price of Inequality: How Today's Divided Society Endangers Our Future (35 page)

Greece can be convicted of overspending—though, again, there is some culpability of the financial sector; one of America’s banks helped an earlier government hide its fiscal positions both from its citizens and the EU by using derivatives. But other crisis countries cannot be accused of fiscal profligacy: Ireland and Spain had fiscal surpluses before the crisis.

One of the big differences between the United States and Greece (and those other countries) is that while those other countries owe money in euros, over which they have no direct control, U.S. debt is denominated in dollars—and the United States controls the printing presses. That’s why the notion that the United States would default (suggested by one of the rating agencies) borders on the absurd. Of course, there is some chance that, to pay off what’s owed, so many dollars would have to be printed that they wouldn’t be worth much. But then the issue is
inflation
, and at present the markets just don’t think that inflation is a significant risk. One can infer that both from the very low interest rate that the government has to pay on its long-term debt and even more from what it has to pay for inflation-protected bonds (or more accurately, the difference between the returns on ordinary bonds and inflation-protected bonds). Now, the market could be wrong, but then the rating agencies giving a downgrade to the United States should have explained why the market was wrong, and why they believed that there is a much higher risk of inflation than the market believed. The answers have not been forthcoming.

Before the euro, Greece owed money in drachmas. Now it owes money in euros. Not only does Greece owe money in euros, but control of the central bank is vested in Europe. The United States knows that the Fed will buy U.S. government bonds. Greece can’t even be sure that the European Central Bank (ECB) will buy Greek bonds owned by its own banks. In fact, the ECB continually threatens not to buy the sovereign bonds of the countries of the eurozone, unless they do as it says.

The Right’s alternative

Europe’s crisis is not an accident, but it’s not caused by excessive long-term debts and deficits or by the “welfare” state. It’s caused by excessive austerity—cutbacks in government expenditures that predictably led to the recession of 2012—and a flawed monetary arrangement, the euro. When the euro was introduced, most disinterested economists were skeptical. Changes in exchange rates and interest rates are critical for helping economies adjust. If all of the European countries were buffeted by the same shocks, then a single adjustment of the exchange rate and interest rate would do for all. But different European economies are buffeted by markedly different shocks. The euro had taken away two adjustment mechanisms, and put nothing in its place. It was a political project; politicians thought that sharing a currency would move the countries closer together, but there wasn’t enough cohesion within Europe to do what needed to be done to make the euro work. All they agreed upon was not to have too large deficits and debts. But as Spain and Ireland so aptly showed, that wasn’t enough. There was hope that over the years, the political project would be finished. But when things were going well, there was no momentum to do anything further; and after the crisis, which affected different countries so differently, there was no will. The countries could agree only on further belt tightening, which forced Europe into a double-dip recession.

Looking across Europe, among the countries that are doing best are Sweden and Norway, with their strong welfare states and large governments, but they chose not to join the euro. Britain is not in crisis, though its economy is in a slump: it too chose not to join the euro, but it too decided to follow the austerity program.

Unfortunately, many members of Congress want the United States to join that same “austerity and small government” bandwagon—to cut back taxes and expenditures. We saw that balanced increases in taxes and expenditures stimulate the economy. By the same token, balanced cutbacks in expenditures and taxes will lead to a contraction in the economy. And if we go one step farther, as the Right wants to do, to cut back expenditures even more, in a valiant if possibly fruitless attempt to reduce the deficit, the contraction will be even greater.

U
NMASKING THE
D
EFICIT
A
GENDA:
P
RESERVING AND
E
XTENDING
I
NEQUALITIES

It might seem strange, in a country where tax rates at the top are already lower than they are in most of the other advanced industrial countries, to have a
deficit reduction program
emphasize the reduction of top tax rates and tax rates on corporations, but that’s exactly what the Bowles-Simpson Deficit Reduction Commission did.
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It proposed limiting the top marginal tax rate to between 23 percent and 29 percent, part of its broader agenda of limiting the size of government, capping overall tax revenues at 21 percent of GDP. Indeed, about three-fourths of the deficit reduction is achieved by cutbacks in government spending.

Reagan supply-side economics, which held that lowering tax rates would increase economic activity, so much so that tax revenues would actually increase, has (as we noted in chapter 3) been disproved by what happened after both the Bush and the Reagan tax cuts. Today individual tax rates are much lower than they were in 1980, suggesting that further reductions in tax rates would lower tax revenues even more.

The argument that the corporate tax rate should be lowered (to between 23 percent and 29 percent, from the current 35 percent)
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was even less convincing, though the Bowles-Simpson commission’s proposals to close the myriad loopholes, if actually implemented, would mean that many corporations would pay more taxes even though the official rate was lowered. We noted in chapter 3 that the effective tax rate—the fraction of their income that corporations actually pay in taxes—is much less than 35 percent, with some of the country’s premier corporations, like GE, paying no taxes. But while there is a compelling case for closing the loopholes, even focusing simply on investment and job creation, there was little case for an across-the-board lowering of the corporate tax rate. After all, with the tax deductibility of interest, the tax lowers the cost of borrowing and the return proportionately. There is no adverse effect on investment for any investment financed through borrowing, and once one takes into account the favorable rates at which capital could be depreciated (businesses are allowed to deduct from their income an amount to reflect the fact that their machines are wearing out), the tax code actually encourages investment.
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If the commission was concerned about the tax’s effect on investment, there were more precise ways to tweak the tax code than an across-the-board cut: it could have suggested lowering the tax on firms that created jobs and invested in America and raising taxes on those that didn’t. Such a policy would raise revenues and provide incentives for more investment and job creation in the United States.

Each of the deficit reduction groups sought to address distortionary aspects of the tax code—provisions, many of them deliberately placed by special interests, that encourage specific sectors in the economy. No group, however, suggested a frontal attack on corporate welfare and the hidden subsidies (including to the financial sector) that we’ve stressed in this book, partly because, as we saw in chapter 6, the Right has succeeded in convincing many Americans that an attack on corporate welfare is “class warfare.”

Deductions

Many of the advocates of deficit reduction have given particular attention to a set of deductions that have been of special benefit to the middle class—the interest deduction for mortgages and the deduction for health care benefits.
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But eliminating these deductions would be an effective increase in taxation on the middle class, whose income has been stagnating or declining for years. Anyone concerned with the plight of the middle class should have seen that if deductions were eliminated, they—not those at the top—should have been compensated with lower tax rates.

Most economists would have supported the elimination of the home mortgage deduction, which leads to too much spending on housing. Additionally, the mortgage deduction can be faulted for encouraging excessive indebtedness. The government was, in effect, subsidizing debt—another hidden subsidy to the bankers who were among the true beneficiaries. And because richer individuals face higher tax rates, they benefit more from the mortgage deduction than do lower-income individuals. The tax deduction, as currently designed, is both distortionary and inequitable. And it may not even be effective in increasing homeownership in urban areas, where so many lower-income individuals live. In those localities, where the supply of housing is limited, the mortgage subsidies may raise prices, making homeownership less affordable.
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But the timing of the elimination is a concern: eliminating the deduction would have made housing more expensive, depressing housing prices. Because a quarter of all Americans with mortgages owe more on their mortgages than the value of their houses—some eleven million families—the crisis in the housing sector would have become only worse. There would have been more foreclosures, more depressed communities, and this key sector of the economy would have remained in the doldrums for years to come. The longer the housing market stays depressed, the longer the economy remains in its current state of near-recession.

There is a way around the quandary. In 2009 a first-time home buyer tax credit of $10,000 helped to prop up the housing market by providing first-time buyers with
equity
. Renewing and extending this program to all low-income families would simultaneously help stimulate the housing market, help restore the economy to health, and make it possible for lower-income families to afford homes.

More generally, a variety of tax provisions (like special treatment of retirement accounts) are designed to encourage individuals to save more; whether they actually lead to more savings is questionable, but because they are of much greater benefit to upper-income individuals, they do help enrich the rich who do save. But there is nothing comparable for low-income individuals. If the government provided a cashable tax credit for investments by low-income households (that is, supplemented their savings, even if they didn’t pay any taxes), it would provide them with increased incentives to save and might even reduce some of the disparity between the bottom and the top.

An equitable approach to deficit reduction

In short, while deficit reduction is not the major immediate problem facing the economy today, the task of reducing the deficit is not that difficult. Simply reverse the measures that led to the reversal of the government’s fiscal position from 2000 to today; raise taxes at the top; cut out corporate welfare and the hidden subsidies; increase taxes on corporations that don’t invest and create jobs in the United States relative to those that do; impose taxes and charges on polluters; stop the giveaways of our country’s resources; cut back on military waste; and don’t overpay for procurement, whether from the drug companies or defense contractors. There’s more than enough money in this agenda to meet the most ambitious deficit reduction target set by any of the deficit reduction commissions.

Contrasting this agenda with the reforms proposed by the various commissions, one comes to one of two conclusions: either some of them were deliberately seeking to continue the path of restructuring our economy in ways that benefit the top at the expense of the rest; or they were taken in by some of the myths that have distorted rational economic policy making.

M
YTHS

The debate over the budget has been clouded by a set of myths, some of which we have already discussed. The supply-side myth argues that taxing the rich will reduce work and savings and that everyone—not just the rich—will be hurt. Every industry has its own version of this myth: cutting back on military expenditures will cost jobs. Cutting back on tax benefits to the coal or oil industry will cost jobs. Industries that contribute to air or water pollution or that create toxic wastes claim that forcing polluters to pay for the costs they impose on others will cost jobs.

As we’ve explained, history and theory argue strongly against supply-side economics, but today that’s almost beside the point. Today our problem is not supply but demand: large firms at least have the cash on hand to make any investment that they want; but without demand for their products, such investments won’t be forthcoming. To stimulate investment, we must focus on how best to stimulate demand. Getting more money into the pockets of those in the middle and at the bottom would do that. That’s why deficit reduction proposals that would, in effect, impose much of the burden of tax increases on the middle would simply make things worse.
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It is the responsibility of macropolicy—monetary and fiscal policy—to maintain the economy at full employment. When things are going well, and the economy is operating near full employment, excessive military spending and lavish corporate welfare don’t create jobs. They just distort the economy by moving labor from more-productive uses to less-productive uses. It is true that if we correct these distortions, some workers with sector-specific skills will suffer, as their skills will no longer be in demand. But that is not an argument for keeping them in place. It is an argument for robust adjustment assistance for the affected workers—assistance that the Right has typically resisted.

Perhaps the myth that’s been most effective is the claim that raising taxes on millionaires or corporations will hurt small businesses and therefore cost jobs. In reality very few small businesses would even be affected by such taxes—under 1 percent. But it’s only their
profits
that would be slightly reduced. If it were profitable to hire a worker or buy a new machine before the tax, it would still be profitable to do so after the tax. Say hiring a worker yielded the firm a return of $100,000, and the firm had to pay (inclusive of all taxes) $50,000, the firm (small or large) makes a neat profit of $50,000. If the owner now had to pay an extra tax on that profit of 5 percent, it would lower what he netted by $2,500, but it would still be very profitable for him to hire the worker. What is so striking about claims to the contrary is that they fly in the face of elementary economics: no investment, no job that was profitable before the tax increase, will be unprofitable afterward.