A proven method to prevent both deep recessions and rapid inflation

Progressive taxes help stabilize the economy and budget

by Richard Schiming
Published in the Mankato Free Press, Sunday, March 20

The author teaches economics at Minnesota State University Mankato.

What if a macroeconomic tool existed that could protect an economy from both deep recessions and rapid inflation? What if, as a bonus, this tool could help balance the federal budget?

We already have such a fiscal tool: a progressive tax system.

A progressive tax structure has numerous tax brackets with increasing marginal tax rates.

When the economy and income expand, people move into higher tax brackets. This movement reduces aggregate demand and inflationary pressure while increasing tax revenue. When the economy and income are slowing, a progressive tax structure automatically moves taxpayers into lower tax brackets, reducing their taxes without the necessity of waiting for Congress to act. Aggregate demand doesn’t fall as far and as fast, moderating any recession.

Since World War II, a more progressive federal tax system correlates with good federal budget outcomes.

If we count federal budget surpluses and small federal budget deficits (defined as less than 2 percent of U.S. gross domestic product) as fiscal successes, there is a clear difference between the budgetary impacts of a more progressive or a less progressive tax structure.

With a more progressive tax structure (the 27 fiscal years from 1946 to 1963 and from 1994 to 2002), we had 11 federal budget surpluses and 13 small federal budget deficits, a 90 percent success rate.

With a less progressive tax structure, (the 39 fiscal years from 1964 to 1993 and from 2002 to the present), we ran 1 surplus and had 12 small deficits, only a 33 percent success rate.

Since 1981, we have had a schizophrenic federal tax policy: We use the correct Keynesian pol icy of cutting taxes during bad times to help the economy recover but use supply-side tax policy to cut taxes during good times. Our federal tax structure is becoming progressively less progressive, and our deficits over the last 30 years reflect the consequences of that trend.

From 1946 to 1981, our federal budget deficit averaged 0.88 per cent of GDP. Since 1982, the aver age deficit has been 3.1 percent of GDP.

Some believe that, by cutting taxes during good times, we are only giving the public’s money back to them. Yet if that foregone federal budget revenue was used to reduce the national debt, the nation and the public would benefit in the long run by lower inter est payments on the debt and lower interest rates.

The missing piece of fiscal sanity is running a surplus in good years. If you want a balanced budget over the course of the business cycle, you must accumulate surpluses in the fat years to prepare for deficits in the lean years.

There is a lesson here for Minnesota as well. A more progressive tax system, by providing surpluses in good times, would help avoid the need for drastic fiscal medicine of budget cuts and tax increases during bad times.

Real fiscal discipline recognizes that good times do not last forever and government should tax accordingly. Even a modest increase in the marginal tax rate for the highest income individuals would add some needed progressivity to our federal tax structure and reinvigorate the usefulness of this key fiscal tool.

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The Republicans' class war

July 1, 2010

By Tom Maertens
Mankato Free Press

For many years now, Republican economic policy has been built around two principles: “trickle down” and “starve the beast.”

Trickle down is a broad justification for policies favoring the wealthy: Cut taxes on the rich, the theory says, and they will invest, create jobs, and generate more tax revenue. David Stockman, Reagan’s budget director, famously acknowledged that “supply-side economics” is simply trickle down by another name.

John Kenneth Galbraith referred to this as the horse and sparrow theory: "If you feed the horse enough oats, some will pass through to the road for the sparrows."

So how did trickle down work for George W. Bush?

The tax cuts successfully achieved their main purpose: Redistributing the wealth upward to the richest 1 percent, who, not coincidentally, fund the Republican party. The April edition of Business Insider (http://www.businessinsider.com/15-charts-about-wealth-and-inequality-in-america-2010-4) gives details.

Thanks to those policies, the richest 1 percent now control 33.8 percent of the wealth while the bottom 50 percent control only 2.5 percent. The same 1 percent now gets about 190 times the median income — far greater inequality than in virtually any other developed country.

As Warren Buffett observed in 2008, “There’s class warfare — but it’s my class, the rich class, that’s making war, and we’re winning.”

If the rich fared well under Bush, the country did not. Bush’s policies resulted in no net new jobs for eight years, ballooning deficits, an unfunded entitlement program, soaring unemployment, falling tax revenues, and a $1.2 trillion deficit for his successor. Middle-income families had a lower net worth and made less at the end of his administration (inflation adjusted) than at the beginning, according to the Washington Post.

The second factor behind Bush’s economic policies was to “starve the beast,” an effort led by The Club for Growth, Americans for Tax Reform and other conservative groups to use tax cuts to create huge budget deficits, thereby forcing cuts in Social Security and Medicare. Grover Norquist is the godfather of the group: “My goal is to cut government in half in 25 years, to get it down to the size where we can drown it in the bathtub.”

In short, Republicans want to bankrupt the government to force it to default on Social Security and Medicare. Dick Cheney encouraged starve-the-beast by declaring that “Reagan proved that deficits don’t matter,” thus bestowing his personal imprimatur on crackpot economics.

Ronald Reagan began the process with a ruinous tax cut in 1981 and a huge military buildup. The result was that he tripled the debt from $994 billion to $2.9 trillion in eight years. Reagan also shifted the tax burden onto working people by dramatically raising the Social Security tax while decreasing the taxes on dividend and interest income for the wealthy.

George H.W. Bush increased the debt by another 33 percent, largely because of Reagan’s tax cuts, to $4.3 trillion.

By contrast, the Clinton administration’s policies reduced the debt by 10 percent. The key was the Deficit Reduction Act of 1993, which every Republican in Congress voted against as “job-killing” tax increases, but almost 23 million jobs were subsequently created during Clinton’s two terms. Fiscally sound policies pay off.

The undisputed champion of borrow-and-spend, however, was George W. Bush. According to the conservative CATO Institute, he presided over an 83 percent increase in overall federal spending while simultaneously turning Clinton’s projected $5 trillion surplus into $5.6 trillion more debt.

He left the country in an economic death spiral that risked another great depression, requiring extraordinary expenditures to rescue the financial system. Had not Obama done so, the country faced a deflationary trap like the one which led to Japan’s “lost decade.”

The stimulus package may be the difference between a severe recession and a full-blown depression; a May CBO report said it preserved as many as 2.8 million jobs through March.

As for the “deficits-don’t-matter” crowd, they seem to have suddenly morphed into deficit hawks, opposing any action at all, even Obama’s tax cuts, in the apparent belief that a bad economy helps them in November.

They are also shedding crocodile tears about the deficits they created, which have run the national debt up so high that nervous Democrats are apparently going to do their dirty work for them. Obama’s commission on the deficit has ten Democrats and eight Republicans, all of them wealthy and several of whom have already stated publicly that they are looking to cut the social safety net.

Ronald Reagan, who got his start in politics campaigning against “socialized medicine” (Medicare), would be pleased.

The rest of us, not so much.

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