Tax Cuts for the Rich Hurt the Middle Class

One of the rationalizations often given for reducing taxes on upper incomes is to promote investment. That investment would then “stimulate economic growth and create jobs.” This, however, is arguing in a vacuum. Two points immediately come to mind:

1. Lack of capital for investment (until the last few weeks) has not been a problem for quite awhile. Many companies (such as MS, GE, Google, and until a couple of years ago even GM!) have been sitting on billions of dollars in cash (equivalents). Venture Capitalists were also sitting on hundreds of millions of dollars that they needed to invest. In 2005-2007 many companies began returning money to shareholders through large dividends and stock buybacks (I’m sure that the effect this had on the executive’s stock options was merely coincidental). The problem all these firms faced was that there was little in the way of promising investments. There were, and are, many promising ideas waiting for funding, but investors did not believe there to be sufficient demand for the potential product or service. This brings we to my second point.
   
2. Cutting tax rates on high incomes places moderate and low income groups at a disadvantage that reduces overall consumption. The rich, by definition, have more than enough to meet all their needs, and also more than enough to meet most (or all, depending on how voracious their appetites) of their wants. Cutting taxes on the rich has little effect on their consumption, so does little to affect aggregate demand or boost the overall economy. For the rich, tax cuts end up as investments (possibly after a trip to Europe or some other treat); this is a point on which the Right is actually... correct. But this is where the problem creeps in. People make investment decisions based on where they expect the largest (and surest) return. To a large extent, this turns out to be real estate. Both the Reagan and Bush terms were times with large run-ups in real estate investing*. The rich bought larger houses, and second houses. The increased demand for housing drove up both housing and construction costs. This squeezed the moderate and low income demographics by raising their housing costs, and as a result, low and moderate income groups had less disposable income, which the nation observed as a weakening in aggregate demand. A cascading effect was to make investments in goods and service producing industries less attractive and real estate more attractive, creating a vicious feedback loop.
   

*Rising real estate values during the Bush years were further fueled by Greenspan’s free money policies at the Fed.

The point is that investments are productive only if there is a market for the product in which the investment is made. The problem with supply-side tax cuts is not that the investment incentive is wrong, it is that the tax cuts (on the top marginal rates) weaken demand and destroy the rationale for investing.

Tax Policy and Personal Income

My friend Deanna’s supply-side economics tribute had it’s share of whoppers. But she did set an interesting metric: “The real test of an economic policy is whether or not it can produce a rising tide that lifts all boats.” This is a a great way to judge recent history and shed some light on what a McCain or Obama tax policy might mean for our futures.

Let’s look at annual changes in average personal income (constant dollars) by quintile -- plus the top 1, 5, and 10 percent of incomes -- for the Reagan, Clinton, and G.W. Bush terms.

Average annual percent change in average income

Percentile	Reagan (1981-1988)	Clinton (1993-2000)	GW Bush (2001-2005*)
1st Quintile (0-20)	-0.4%	1.2%	-0.8%
2nd Quintile (20-40)	0.04%	1.9%	-0.4%
3rd Quintile (40-60)	0.8%	1.6%	0.3%
4th Quintile (60-80)	1.2%	2.2%	0.6%
5th Quintile (80-100)	4.3%	5.6%	3.7%
Top 10 percent	5.5%	7.0%	4.7%
Top 5 percent	7.0%	8.8%	6.1%
Top 1 percent	11.3%	13.1%	8.7%

*The latest year with available data.

Personal earnings grew faster during the Clinton presidency than during either the Reagan or George W. years. But more importantly, that increased prosperity was shared by all income groups. The Clinton tax policy, which raised the top marginal rates, created both higher growth and a more even income distribution.

Source Congressional Budget Office (http://www.cbo.gov/ftpdocs/88xx/doc8885/Appendix_tables_toc.xls)

Tax Rates and Tax Revenue

Supply-side economics is a dead, rotting corpse of a theory; yet despite the odoriferous off-gassing, the right refuses to give it a proper burial. Even Greg Mankiw, former Chairman of Bush’s Council of Economic Advisors, described it as the work of "charlatans and cranks" (in his textbook Principles of Economics).

My friend Deanna recently raised this stinking corpse in a post arguing against Barak Obama’s tax proposals. The Right’s justification for lower tax rates on high incomes, is basically the supply-side rationalization that lower marginal tax rates spur investment which then creates growth that pays for the tax cuts. Deanna adds an additional argument that raising tax rates on the wealthy will also reduce investment. The implication being that rich people will only invest if bribed. I disagree.

Deanna mixes up tax effect changes to overall revenue with income distributions and then spiced things up with revisionist history. In our recent history, tax cuts have reduced both the amount of tax revenue collected and the subsequent growth in tax revenue that followed. Here are a few statistics.

• Reagan’s “Economic Recovery Tax Act of 1981”
• Reduced Federal revenues by more than $575B (constant 1992 $) during the next four years.
• Resulted in Federal revenue growth (constant dollars) of 2.1% per year for the remainder of the Reagan term (1.7% for the combined Reagan-Bush terms). For comparison, the growth rate during Carter’s term averaged 5.9% per year.
• G.W. Bush’s “Economic Growth and Tax Relief Reconciliation Act of 2001”
• Reduced Federal revenues by nearly $170B (constant 1992 $ - around $350 in current dollars) during the next four years.
• G.W. Bush’s “Jobs and Growth Tax Relief Reconciliation Act of 2003”
• Reduced Federal revenues by more than $390B (constant 1992 $ - around $490 in current dollars) during the next four years.
• Federal revenues grew at a rate of 0.9% per year (so far) for the Bush years. Even if we ignore the troubled year 2001 and instead start with 2002, the growth rate still averaged only 1.8% per year

Compare that with the Clinton years, which started with a tax rate hike: 

• Revenues increased almost $170B (constant 1992 $) higher during the next four years.
• Federal revenue growth averaged 5.9% per year during the Clinton Presidency.
  

The Right's faith in supply-side tax cuts is wrong and misplaced. Tax cuts do not pay for themselves; nor do they generate faster growth in Federal revenue streams.

Source: The Tax Policy Center (http://www.taxpolicycenter.org/taxfacts/index.cfm)

McCain-Obama: Debate Number 1

Much of the discussion on Friday’s debate focuses on “who won the debate?” as if there are clear, well known criteria for scoring points and determining a winner. For what it’s worth, I thought the debate was very even, with no clear winner on “points.” McCain did relatively well on the economic issues, and Obama demonstrated a command of foreign policy issues. Initially, based on a strictly audio experience, I gave McCain a slight edge for three reasons:

1. McCain was more aggressive. While Obama capably countered all of McCain’s attacks and demonstrated both breadth and depth of knowledge, it was McCain who usually controlled the topics. Where Obama addressed McCain attacks, McCain avoided responses to Obama’s assertions, usually changing the subject
   
2. As an Obama supporter, I was disappointed that he failed to pounce upon McCain when McCain’s (mis-?) statements left a clear opening, three examples include:
   
• McCain clearly mixed up, an perhaps does not understand the difference between, the financial crisis and fiscal issues.
• McCain's fabrication that Obama’s plans to hand “the health care system over to the federal government.”
• McCain misstating the difference between strategy and tactics.
• McCain describing Pakistan as a “failed State.”
3. While Obama’s answers included more substance and made more factual sense, McCain had better sound bites. I thought McCain’s answers and non-answers revealed a lack of knowledge on many issues, I doubt that most people 
   

After then watching video of the debate, however, I give Obama a (slight) edge, not because I am a partisan (I am) but because I think: 1) Obama better achieved his objectives, and 2) McCain’s demeanor was overly negative and off-putting.

But overall, both candidates did (relatively, neither are great debaters) well in the first debate. Neither made any big mistakes. So partisans’ previous opinions were likely reinforced. The question then becomes how ell did each candidate do in achieving their own objectives.

What Did Obama Need To Do?

Obama’s principal need was to demonstrate a command of foreign policy and give let voters get comfortable with the idea Obama as Commander in Chief. A secondary objective was to reinforce the public’s opinion that the Democratic Party in general, and Obama specifically had a better understanding of economic issues and offered superior solutions to the problems faced by the country.

During the foreign policy portions of the debate, Obama displayed a thorough knowledge of the issues and held his own with McCain on supposedly McCain’s strength. I gave McCain slight edges for Iraq and Iran. I think Obama’s position on Iran is stronger, but McCain did a better job of framing his points. in contrast, Obama did better (again, slightly) on Pakistan. Both Afghanistan (where I felt the discussion dissolved before much had been said) and Georgia seemed even to me. Overall, his performance probably helped with undecided voters who were looking for a reason to support Obama.

On the economy, Obama did not hurt himself, but he also did not deliver a knockout blow to McCain.

What Did McCain Need To Do?

Contrary to many opinions, McCain’s principal need was not to counter Obama and show Obama to be unfit for COF duty (although that would have been very good for McCain). No, McCain needed to demonstrate that he was still relevant after his clown show on Thursday; McCain needed to stop the cratering of his poll numbers if he wanted the chance to rebuild his support.

McCain did well at expressing an ability to express some knowledge of the economic issues. Many of his answers struck me as rather empty (such as asserting that eliminating earmarks would solve all his fiscal issues), but he was very good at dancing away from Obama’s counter-attacks. His suggestion of a spending freeze was a great tactical move for the debate, but will probably cause problems for him in the coming weeks.

On the foreign policy issues, McCain did well, but he was suppose to; other than a few minor gaffes, which probably went unnoticed, there was nothing surprising in his performance. 

While I think most undecided voters will make their decision based upon how they feel about Obama, McCain may have hurt his chances with the grumpy, lecturing style he employed. No one wants to vote for an angry elf!

Update: A new LA Times/Bloomberg poll give Obama the win (OK, they "preferred" Obama over McCain 49% to 44%). But more importantly, and reflecting my thoughts above, Obama did very well with those who were undecided or not firmly committed to a candidate. When asked who appeared "more presidential," Obama was chosen by 44% compared with only 16% who chose McCain.

295.9 -or- The 2008 Republican National Convention

My Mother asked me yesterday what I thought of the Republican convention, an the only word I could think of was schizophrenic. Contradictions abounded throughout the past week, not just between speakers but also within any given speech. Here are just a few that I observed:

• The campaign of the politician who has received more favorable media treatment than anyone over the past decade attacked the media
  
• A Harvard educated multi-millionare from Boston complains about "eastern elites"
  
• Romney, who once ran a private equity firm that eliminated thousands of jobs in the name of higher profits blames Liberals for employment problems
  
• The ex-mayor of New York complains that Obama is too urban
  
• The GOP candidates told us that change and reform were necessary and that McCain was the man to bring that change by continuing the policies of the last eight years
  
• McCain was celebrated for being a "Maverick" because he bucked his party on a few issues such as immigration reform, positions he has subsequently rejected and repudiated
• Several speakers complained about both extending Constitutional protections and not honoring the Constitution
  
• Campaign representatives and surrogates complained that Obama offered only empty promises with no specifics, then presented four days with no specifics for McCain's plans
  
• GOP leaders claimed that Obama only glorified himself at the Democratic convention* and derided Obama as "The One," then spent four days aggrandizing John McCain culminating with John McCain taking more than half of his speech to talk about John McCain (apparently in the belief that there was someone somewhere unaware that McCain was once a POW).
  
• Tuesday's theme was "community service"; Wednesday saw Guliani and Palin mocking community organizers; on Thursday McCain then asked Americans to volunteer in their communities
  
• Romney told us that opportunities grow when Constitutional freedoms are preserved then complained because we are not allowed to torture Gitmo detainees 
• Speakers behaved as if Republicans were the insurgents, not the incumbants, never once mentioning that it was a Republican President and a GOP controlled congress that got us into this mess.

*In point of fact, about 15% of Obama's speech contained references to himself.

Palin for VP: Smart?

Deanna thinks that McCain's decision to select Palin is smart because the shock and curiosity it generates will force the Obama camp to relinquish the spotlight and allow the McCain camp to connect to voters with a relevant message. She makes no mention as to what that message might be, but then who could?

Last week I wold have told you that the VP choice was neither smart or dumb; that the VP did not much matter in the election because most of us were choosing the President. Looking back, the choice of a VP has little (if any impact). Look at some winning campaigns with less than star VP choices:

• Nixon won two elections with Agnew who was little know (in '68) and not highly regarded for anything other than delivering punch lines. 
• George H. W. Bush won the 1988 election with Dan Quayle. 
  
• George W Bush won reelection in 2004 even though most Americans viewed Cheney as the second coming of Lucifer.

Palin, however, may be the exception. I think she is a bad choice for McCain for the very reason Deanna likes the choice: because it puts the country's focus on the McCain campaign, where it helps him the least. McCain can't win on the issues and he won't win because people like him better than Obama. If McCain does win the election, he will do it the same way he won the Republican nomination: because voters chose not to vote for the other guy. For McCain to win, he needs to drive down Obama's support and make voter's question the wisdom of electing Obama. With the focus off of Obama, voters can't indulge their fears about electing a black man: bad for McCain. 

With the focus on McCain, voters might begin to question his suitability for the office. If the public begins looking into the half-ass process he went through in selecting Palin, they may begin to wonder how seriously he would treat the Presidency. Should any of the Palin allegations gain traction, or if the Alaskan Legislature's investigation completes before the election with an indictment or articles of impeachment, this will be not just a bad choice, it will be a disastrous choice.

I do agree with Deanna on one point: "Bravo McCain and Co.!"

Two Signs of Hope

Two readers wrote Andrew Sullivan with indictments of the current Republican party.

First there was this:

The opportunity to have prospered through hard work and discipline has been destroyed by the party who claims to be the standard bearer for those very attributes.

and then this:
...my party changed.

Where once was a belief in the power of the individual, came a heavy, overbearing government that dared to challenge how people should live their lives...
Where once I viewed the party as one who ended wars and focused on balanced budgets and living the American dream, there was now one that started one and leveraged our dreams with debt...
And then came the loss of privacy. Where once there was the beiief in live and let live, there was now a strange curiosity on the part of the government, to peer into the most private parts of our lives...
Where once was a party with a rather sunny disposition came one that was dark, glowering and saw the future as a threat

Thomas Merton's Prayer

From Counseling Kevin (via Andrew Sullivan)

MY LORD GOD, I have no idea where I am going. I do not see the road ahead of me. I cannot know for certain where it will end. Nor do I really know myself, and the fact that I think that I am following your will does not mean that I am actually doing so. But I believe that the desire to please you does in fact please you. And I hope I have that desire in all that I am doing. I hope that I will never do anything apart from that desire. And I know that if I do this you will lead me by the right road though I may know nothing about it. Therefore will I trust you always though I may seem to be lost and in the shadow of death. I will not fear, for you are ever with me, and you will never leave me to face my perils alone.