This may be hard for anyone under age 40 to believe, but at one time in the recent past the Republican Party was the party of ideas. While older generations of Democrats simply repeated nostrums from the 1930s, and younger generations of Democrats chanted slogans from the 1960s, Republicans were examining evidence of what did and did not work, and proposing solutions. And many of those solutions were implemented during the 30 years of Republican political dominance, often with the support or at least acquiescence of Democrats who couldn’t come up with anything better.
Times sure have changed. Some of those Republican/Conservative/Free Market ideas worked as promised. But most others have failed miserably, except as means to redistribute income upward, and from worse off younger generations to older generations that voted Republican, which is NOT what was promised. So, are Republicans examining the evidence and proposing alternatives? Hardly. They are simply saying the same things over and over, but shouting instead of speaking reasonably. I’m not just talking about Tea Party fools, and spinning candidates for office. I’m talking about think tanks and PhD’s, such as R Glenn Hubbard and Greg Mankiw. Those with conservative leanings but open eyes, such as David Frum, are no longer welcome. This isn’t an ideology anymore. It’s a cult. Since they won’t, let’s get in the wayback machine, look at some of the promises, and some of the results.
Back in 1980 the economic system that had been put into place in response to the New Deal, with some expansion during the 1960s, was falling apart. In major industries, unions had pushed up wages but also held down productivity, to the point where many American made goods were both declining in quality and increasingly expensive to those not in the deal. Expansionary monetary policy meant more and more money, promises that you can buy something, was chasing not enough goods and services, the stuff actually available to buy. Regulations and price controls discouraged production and competition in industries such as natural gas and the airlines. The top federal income tax rate was 70.0%, with state and local taxes on top of that. For those anywhere near the top, there was little incentive to work more or invest – after taxes and inflation everyone was coming out behind.
What you had, in other words, was a crisis of supply. Yes people held pieces of paper that said they were entitled to things, and those pieces of paper were much more equally distributed that they are today. But people were less and less motivated to work diligently to produce the goods and services that the pieces of paper could then buy, and produce them well. Japanese products were much less likely to break. And there was much less interest in using some of those pieces of paper to invest in the plant, equipment, infrastructure, and research and development that would allow even more goods and services to be produced better in the future. The U.S. savings rate was a miserable 8.0%, far less than our economic partners/competitors, and their plant, equipment and infrastructure was far more up to date.
The Reagan Republican solution – tax cuts, to encourage work, savings and investment, and deregulation to allow economic innovation to take place faster. Some may remember that this was called “supply side economics.” It was claimed this would lead to more production and productivity in the United States, and therefore higher wages, and therefore greater tax revenues, despite the lower tax rates. The latter point, pushed by Arthur Laffer, made it seem as if tax cuts for those at the top would either cost nothing, or even benefit, everyone else. (Just as 20 years later the public employee unions claimed that their retroactive pension enhancements would cost, or even save money.)
Another influential right winger of the 1970s was Edward C. Banfield, author of The Unheavenly City. Banfield argued that older central cities were in decline due to the presence of many poor people, and poor people were poor because of their moral failures. They were “present-oriented,” and unwilling or unable to restrain their biological urges for their own future benefit and the benefit of their children. If they felt like screwing they screwed. If they felt like stealing they stole. If they didn’t feel like studying or working, they didn’t. When they realized their mistake later, it was too late for themselves and their offspring. This, he claimed, was the “culture of poverty.”
The middle class, according to Banfield, was more moral – able and willing to work for, study for, save for their own future, and restrain their sexual desires and other appetites for the benefit of their futures and their families. The real moral people, however, were the rich, who were not only capable of considering their own futures in the present, but also to make short term sacrifices for the long-term good of society as a whole. They were the ones who would advocate fiscal responsibility, to leave a positive collective legacy for future generations, and build vibrant new industries with high paying jobs, if only they were allowed to control more of society’s resources.
The first supply side policy, and perhaps Ronald Reagan’s biggest congressional victory, was the Kemp-Roth Tax Cut of 1981, which among other things cut the top federal income tax rate from 70.0% to 50.0%. The rate would be cut as low as 28.0% in 1988, before being increased to 31.0% as part of the deficit cutting deal by George Bush I, breaking his “read my lips” pledge. It is 35.0% today, but would be 39.6% if the George Bush II tax cuts expired – the level reached after tax increases in the Democratic Clinton Administration. Critics claimed the tax cuts mostly benefitted the rich. But in response, Republicans claimed that the benefits would “trickle” down to everyone else as the rich saved and invested, and productivity and wages rose. Kemp-Roth passed even though the Democrats still controlled the House of Representatives, due to gerrymandering and the benefits of incumbency, despite Republican ascendance. (The same reasons, the only reasons, that the Republicans control the House today).
But Republicans wanted everyone to have an incentive to “save and invest.” So they created a number of subsidized savings vehicles that in effect cut the federal income tax on money that was saved, at least for the middle class in the short term, to zero. In 1981 the Individual Retirement Account (IRA), previously available only to those who did not have pensions, was made available to everyone. The 401K, and 529 for college savings, followed. And to discourage borrowing even as savings were encouraged, the deductibility of consumer interest on federal income taxes (except for mortgages) was eliminated in 1986. Critics complained that this favored the rich, with money to save and invest, and hurt the less well off, who borrowed, but the “supply side” argument carried the day.
But the rich wanted even lower taxes. They made the case that lower taxes on capital gains (the increase in the value of investments that was not actually paid out to investors) would encourage even more investment, and thus even more economic growth. Not only that, they claimed that taxes on capital gains amounted to “double taxation.” You work, get paid, and get taxed on your “ordinary income” at the regular federal tax rate. But what if instead of just blowing the money on your short term wants, like people raised in the “culture of poverty,” you nobly save it and invest it? Perhaps you lose it, but if the value of your investments goes up, you are taxed a second time on the gain. So under the Clinton Administration, the federal income tax rate on capital gains was cut to just 15 percent.
The payroll tax rate on capital gains, of course, is zero. While the income tax, which includes investment income and falls more heavily on the affluent, was going down, the payroll tax, which only falls on work income and falls more heavily on the middle and working classes, was going up. In fact the massive Reagan payroll tax increase of 1983, to “Save Social Security,” was the largest tax increase in U.S. history.
After the stock market bubble burst in 2000, the Republicans found that corporations had stopped paying dividends. After all, why pay dividends taxed as ordinary income when they could keep the money and increase the value of the firm, or use it to buy back stock? The value of the remaining stock would rise, and investors would receive capital gains taxed at just 15 percent! Or at least that was the excuse the corporations who stopped paying dividends used. Then the capital gains never came. So to encourage the payment of dividends, the Republicans decided to only tax them at just 15 percent too!
So did all these tax cuts deliver savings and investment, higher productivity and thus higher wages, more incentive to work, and higher tax revenues as a share of the economy? Was Social Security saved? After all these years we know the answer, and the answer is “no” “no” “no” “no” no!”
Despite the removal of the tax incentive to borrow, and the creation of lots of tax incentives to save, the U.S. personal savings rate fell from 8.0% in 1980 to 6.0%, then 4.0%, then 2.0%, and finally in 2007 to zero. No net savings by U.S. households at all, despite the “supply side” policies to encourage saving. Why? No one seems to be asking that question, which is why no one is providing answers.
But my guess is that this big surprise proves that economic incentives are not the only thing that drives what people do. Culture matters more. And with real religion (not including the Prosperity Gospel) in retreat, what has been driving American culture for 30 years has been advertising. People felt a need to spend more and more to have the life they felt entitled to. The message, over and over and over, was spend, spend, spend. Not save. And like sheep, they spent. This “present orientation” isn’t the “culture poverty. It is the culture of consumerism, and it goes right to the top.
At the time, the idea of rewarding savings and not borrowing made sense to me. But that is because of my own values and lifestyle. I didn’t do anything different because of all the differences in taxes. And neither did anyone else.
With savings was supposed to come investment. How did that work out? Well we did have some investment in some sectors, mostly in information technology, software and telecommunications. Think about what aspect of life has gotten substantially better in recent years, and what type of work can be done much faster and easier. Yup, that’s it.
But what about U.S. investment as a whole? Has it been higher or lower than it was before supply-side economics? You may have heard that after 30-plus years of supply-side economics, 70 percent of our GDP is consumption, more than most developed nations. Gross domestic private investment accounted to 18.3% of GDP in 1981, according to the Statistical Abstract of the United States. It has been that high only once since, and has generally been far lower. Gross domestic private non-residential investment was 13.4% of GDP in 1981. It has been far lower ever since. Despite all the corporate tax incentives, the lower capital gains tax, and the lower taxes on the affluent overall.
Either investment wasn’t induced by all those supply side policies. Or the only investment the supply-siders achieved was conspicuous consumption of overbuilt houses, investment abroad, and speculation in zero-sum derivatives wages that are just pieces of paper and create nothing. Why was this? Why did all those tax breaks, deals, incentives and cuts yield less U.S. investment rather than more? Perhaps because if most workers have less and less money to spend, generation by generation, because wages are going down, there less of a market for goods and services. So investment to produce more goods and services makes less and less sense. More on that in a minute.
We cut the tax on capital gains to get investment, and we didn’t get investment and investors didn’t get capital gains. We cut the tax rate on dividends and didn’t get dividends. The S&P 500 dividend yield is currently 2.10%, less than half the historical (1932 to present) median level of 4.38%. Either dividends would have to double, or stock prices would have to fall by half, to get to that historical average. But wages are at an all time low as a share of the economy, and profits are at an all-time high, so where are all those profits going? Higher executive pay. No where else.
How about the incentive to work? This “supply side” argument sort of made sense to me at the time. Let’s say you are the lower earning spouse in a two-income household with two college-educated workers. Not an unusual situation in metro New York. Your income is low enough that every extra dollar you earn is subject to the 15.0% payroll tax. But your combined income is high enough that every extra dollar you earn is taxed at a high federal and state income tax rate. Adding it all up, perhaps the extra dollars earned would be taxed at more than 50 percent. And at that rate, perhaps some work wouldn’t get done.
But what about the evidence? Yes the labor force participation rate did rise during the first 20 years of supply side economics. But it has been falling ever since. It reached its peak in 2000, after the Clinton tax increases, at the federal income tax rates the Republicans now say discourage work, savings and investment. It has fallen despite the Bush II tax cuts, and then the Obama cuts to the payroll tax. So why are fewer people looking for work?
Once again, culture and demographics matter more. On the way up for labor force participation, you had the entire Baby Boom generation in the workforce until recently. You had a decision by a large share of U.S. women of that generation that participation in the labor force was important to their financial independence, self esteem and realization of their human potential. More recently, you the Baby Boomers start to reach retirement age. The labor force participation rate followed these social and demographic trends exactly, and the marginal tax rate not at all. In my family, we worked less when we had school age children, and more when those children were older. We’ll probably work less when we reach what used to be retirement age.
So what about tax revenues? The Republicans have endlessly repeated the matra that there is “natural” federal tax revenue level of 18.0% of GDP. If tax rates are cut, the greater incentive to work, save, and invest will nonetheless lift federal tax revenues to 18.0% of GDP, they said. If tax rates are increased, the economic disincentives will cap federal tax revenues at 18.0% of GDP.
So what happened? Federal revenues been at 18.0% of GDP or higher for relatively few years since the Kemp-Roth tax cuts. Despite the increase in the regressive payroll tax. Of the 12 years from 1982 to 2009 with federal revenues at 18.0% of GDP or higher, seven were from 1995 to 2001 when the higher Clinton tax cuts were in effect. And with tax the Bush II tax cuts and the Obama payroll tax cut in effect right now, federal revenues are at a rock bottom level relative to GDP for recent history.
How about higher wages? Well, higher wages were supposed to result from an increase in non-residential investment in the U.S., and as discussed no such investment occurred. But in fact the wages of most American workers have been falling for nearly decades, starting first with high school dropouts, and then high school graduates, then college graduates, and finally just about everyone.
This didn’t affect consumer spending at first, because as baby boomer women flooded the labor force total household income continued to rise on average. Then employers started cutting future income – pensions, 401K contributions, and retiree health insurance. This didn’t affect total consumer spending in the past, because individuals didn’t save on their own to make up the difference. But it will affect total consumer spending into the indefinite future, as millions are forced to retire into poverty. The next phase was a huge surge in consumer debt, to either (depending on your politics) live large or at least live the way similar Americans in older generations used to live. That collapsed in 2007.
The federal government has been borrowing itself into bankruptcy, and the Federal Reserve has been printing money, to keep the debt and consumer driven economy going ever since. With no end-game, and no ideas. The question for America’s overpaid corporate executives and the Republicans is this: now that you have beaten down the serfs, who are you going to sell to? Where is your market? They don’t know. They have no idea what to do, so they just keep paying themselves huge money, piling up cash on corporate balance sheets, and hope to retire to some other country before the whole thing collapses.
This isn’t a crisis of supply. It is a crisis of demand, and it is global.
You want a historical comparison? The industrial revolution brought a huge increase in the productive capacity of what is now called the developed world in the first 30 years of the 1900s. But the resulting income was unequally distributed, with wages falling (among other things) for the half of Americans still on the farm. Demand was supported by an explosion of debt. Then you had a collapse, and the Great Depression. The rich had the value of most of the pieces of paper created in the debt binge wiped out, and the distribution of wealth and income became drastically more equal.
This time around, the industrial revolution has spread to what is now called the developing world, leading to a huge increase in the global productive capacity of humanity. That’s the good news. But the resulting income has been unequally distributed, with most people in younger generations in the developed world facing falling incomes, and many of the gains in the developing world accruing at the top. The shortage of demand had been covered up by yet another debt binge. But rather than allowing another Great Depression, government stepped in – and preserved the wealth of the wealthy.
As far as I’m concerned, whether we would have been better off with Great Depression II remains in doubt. Such a cataclysm, would have wiped out the burdensome debts in a bonfire of bankruptcy, and the excess wealth of the wealthy at the same time, and would have prevented the instant return of arrogance seen in the executive class in a handful of years after their bacon was saved. The wealthy are now holding pieces of paper that say they are entitled to a large share of the fruits of any labor in the future. Those pieces of paper are backed not by productive assets resulting from the investments we were supposed to get, but mere promises that someone else will be poorer in the future due to money borrowed and spent in the past. Someone else less powerful.
The Republicans have no answer to this. So they yell the same failed ideas, louder and louder. They think it’s 1980. The Democrats have no ideas either. They think it is 1930, with the U.S. the world’s biggest creditor with plenty of capacity to create growth by borrowing, rather than the world’s biggest debtor — the reality today.
I’ll talk about some additional past ideas that have reached dead ends, and some that worked but were not applied uniformly, in another post.