On Stiglitz: Part Eight

The next chapter in Stiglitz's book, The Price of Inequality, is called "The Battle of the Budget." Written around the time of the 2011 budge battle (see also: When the Right Lost the 2012 Election Due to Moonbattery), it's frustrating that in 2013 we are still having the same fight and have not progressed.

This budget brinksmanship obscured the real economic challenges facing the country: the immediate problem posed by the high level of unemployment and the gap between the economy's potential output and its actual output, and the long term problem of growing inequality. The brinksmanship shifted attention away from these fierce problems to the issues of deficit and debt reduction.

Stiglitz describes this shift as being caused by what he terms " debt and deficit feitishists." Ironic that these people ignored the actual causes of our debt and deficit and, instead, ascribed the cause to their emotional feelings (see: psychosis) about government spending. I'll get to spending later but as he notes correctly, the four main causes of our debt and deficit are: the Bush Tax Cuts, the wars in Iraq and Afghanistan, the Medicare D (a huge rent for the drug companies) and the underperformance of the economy itself due to contraction. The figures for each of these causes are: $3.3 trillion dollars, $2.5 trillion dollars, $500 billion dollars, $900 billion dollars. Given that we have made some small improvements in the tax structure earlier this year, these numbers aren't quite as bad anymore but they still illustrate the need for improvement.

But we still have a fundamental and systemic problem with our tax structure. The people that contribute the least to our economy (the financial sector) are taxed at a ridiculously low rate for the amount of money they make. As Stiglitz notes, the lower tax rates on capital gains did not lead to higher, sustainable growth but rather, two speculative booms (1997, early 2000s) in the technology sector and the housing sector.

Bush argued successfully in 2003 for a (temporary) cut on the tax on dividends, to a maximum of 15 percent, less than half the rate paid by someone who receives a comparable income in the form of wages and salaries. The claim was that it would lead to more investment by firms in plant and equipment, but it didn't. Arguably, it may have had the opposite effect. Firms were, in effect, encouraged to pay out dividends while the tax rates were low, leaving fewer funds inside the corporation for a good investment project, should have turned up.

Stiglitz goes on to argue the need for stiffer taxes on rents and how we need to put more taxes on the toxic things in our economy. He makes a very interesting point that considering the fact that the financial sector nearly brought down the world economy, they are "polluters" and need to be taxed accordingly. For those of you unfamiliar with basic economic theory, taxing good things distorts markets and can do harm. Taxing bad things corrects the erosion of consumer surplus and inefficiency of markets due to the public expense of something like pollution. The public has born a great deal of expense as a result of the financial collapse and the people in those markets should be taxed at a higher rate.

In addition, the financial sector (along with many other sectors of our economy ), no longer need subsidies. It continually amazes me that the Right argues vociferously for less social welfare but wants corporate welfare to continue in earnest. The tax breaks we give to the multi-billion dollar oil industry are ridiculous.

So, Stiglitz has six action items in regards to our tax system'

1. Raise taxes on the people at the top
2. Eliminate loopholes and special treatment for upper incomes
3. Eliminate subsidies
4. Tax rents at higher rate
5. Tax pollution
6. Tax the financial sector similar to the ways we tax pollution given the costs they impose on the rest of society.

As I stated above, the deal on the budget reached earlier this year is a beginning down this path but it's not enough.

Now, seeing the word "tax" is sure to cause the mouth foamers' blood to rise. They will caterwaul and bloviate about how it hurts businesses and they won't hire people but they are pushing a myth, which is a polite way of saying they are lying, as Stiglitz notes on page 225. Suppose you own a business and calculate that hiring a worker will yield you a return of $100,000. $50,000 of that will go to costs the firm has to pay (including taxes, salary, other costs etc). This leaves a profit of $50,000. Now, you had to pay an extra tax of $2500 (5 percent) on that employee, would you still hire? Of course you would. Taxes don't prevent people from hiring if there is profit involved. What prevents people from hiring is a lack of demand (discussed many times on this site) which would push that $100,000 figure downwards. If they don't have the business coming through the door, they won't hire.

Moving past the issue of revenue, let's turn our attention to spending. Stiglitz argues for more spending to really get the economy going again. He dismisses the deficit/debt fetishes and notes...

The United States is an especially good position to pursue this strategy, both because returns to public investments are so high, as a result of underinvestment for a quarter of a century, and because it borrow so cheaply long term. Unfortuneately, especially among the Right (but, even, alas, among many in the center) deficit fetishism has gained ground. The ratings agencies-still trusted despite their incredibly bad performance in recent decades-have joined in the fray, downgrading US debt. But the test of the quality of debt is the risk premium that investors demand. As the book goes to press, there is a demand for US T-bills at interest rates near zero (and, in real terms, negative)

Exactly right. The fetishists don't get to determine the quality of our debt. The free market does. It simply isn't justified on the basis of economic principles. Stiglitz goes on to note that economic stimulus can be achieved through a long standing principle called the balanced budget multiplier (increasing taxes and expenditures simultaneously while taking care to not add any more to the current deficit). He argues that if this happens, GDP would increase two to three times the rate of spending. This growth would decrease the national debt over the intermediate term (pages 217-218).

But won't all this spending make us "like Greece?" No, says Stiglitz...and everyone else who doesn't let their emotions about spending dictate policy (side note: why is it that the Right cite power hungry human nature as the reason why people in the government should not be allowed to spend money yet believe, in the same head, that people are little angels when they make financial decisions privately?). Greece owes money in euros of which they have no direct control. US debt is in dollars and we control the printing presses. The idea that we would default is pure moonbattery. Sure, you'll hear bloviating about inflation but, again, the free market does not see that happening.

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.

Likely because it was politically motivated. The United States knows that the Fed will buy government bonds. Greece has no idea if the ECB will buy their bonds at all. Essentially what's going on here is that the adolescents are playing make believe and saying that there is less faith in the US government than there actually is. Considering they are big believers in the free market, this makes no sense to me.

Some other bits from the chapter...

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 era tax cuts.

Ah, but we should never let reality get in the way of a good fantasy, right?

No deficit reduction group suggested a frontal attack on corporate welfare and the hidden subsidies (including the financial sector) that we've stressed in this book, partly because the Right has succeeded in convincing many Americans that an attack on corporate welfare is "class warfare." 

Of course, when Reagan said it, it was okey-dokey.

Regarding Social Security and Medicare...

In the most hopeful scenarios, the Right would privatize both services. Privatization, of course, is based on yet another myth: that government run programs must be inefficient, and privatization accordingly must be better. In fact, the transaction costs of Social Security and Medicare are much, much lower than those of private sector providing comparable services. This should not come as a surprise. The objective of the private sector is to make profits-for private companies, transaction costs are a good thing; the difference between what they take in and what they pay out is what they want to maximize. 

Social Security and Medicare can be fixed quite easily with very simple adjustments phased in over time (increasing retirement age, means testing etc). Unfortunately, no one in Congress seem willing to move towards that end. Privatization is absolutely the wrong answer and we all know the real reason why the Right wants to get their hands on that money. As Stiglitz notes..

The agenda for privatization of Social Security was not about providing more money to America's retirees or more security or about increasing efficiency. It was about one thing only: providing more money to the 1 percent at the expense of the 99 percent-more money to Wall Street. The magnitudes involved are potentially enormous. Think of the $2.6 trillion in the Social Security Trust fund. If Wall Street could get just 1 percent per year for managing that money, that would be an extra bonanza for the managers of $26 billion dollars a year.

It's about as obvious as the smell of pig shit.

Stiglitz round out the chapter with a discussion of how the Right likes to blame the victim (in this case, the middle class) for our economic woes. Cuts in wages reduce economic demand so, again, it makes no sense to blame your average worker, especially considering how well the wealthy have done despite the contraction. On the last few pages of the chapter he offers a scathing indictment of austerity (pages 230-231) as well as an evisceration of the myth of the failed stimulus (page 232)., explaining in detail just how awful it would have been had we not had it and how the Obama administration failed to note just how deep the hole was that we dug ourselves.

He challenges anyone to find historical examples of austerity actually working in more than just rare cases in countries that are small and had trading partners experiencing a boom. He blows apart the myth of how a government budget should be like a household budget. Considering that the former can change the macro-economy and the latter counter, one would think the differences are obvious.

So, as this latest round of budget battles gets underway, Stiglitz is correct when he says government spending can be very effective. Funds directly spend on high productivity, structural reform, and basic infrastructure will increase productivity which will include an increase in demand. One need only look at examples from the past like Grand Coulee Dam or the current return on government investment in research to see that this is true.

(Note: the link to The Price of Inequality in the first line of this post takes you to Amazon.com where you can look inside and read the entire book and source material)