Paul Ryan’s new budget blueprint released this week — details to follow, as usual — will only intensify the partisan warfare over the deficit. In truth, the deficit is just a cover story here, since the real debate is over the scope and role of government itself. Ryan at least is more upfront about it than most – he includes large new tax cuts as well as draconian spending reductions in what is ostensibly a plan to “balance the budget.” In his fervor to miniaturize Washington’s domestic role, however, he cannot provide the resources to maintain the core commitments of Social Security and Medicare.
The ideological core of this debate also explains why most of the proposals and agreements of the past year have paid so little heed to the needs of the economy. There is no doubt that the spending cuts and tax hikes of the last six months have weakened economic growth — and as a result, deficits actually could be larger over the longer-term than they otherwise would have been. The additional spending cuts contemplated for the next six months under the sequester — and under most of the grand bargains being floated to supersede the sequester — would inflict more damage. In this regard, Ryan stands at the extreme with a plan that would drive us back into recession.
Nonetheless, a major deal that includes entitlement reforms and tax-loophole closings remains possible. In the politics that could determine the relative weights of those two factors, Republicans will have less maneuvering room on taxes than Democrats will enjoy on entitlements. That’s because primary challengers from the far right already have taken down a number of conventional Republicans, heightening the GOP’s resistance to more revenues. By contrast, there have been no successful attacks so far on centrist Democrats for supporting the cutbacks in federal programs now in place. This political difference suggests that more of the burden in any grand bargain will likely fall on entitlements than on revenues. The next question is, what entitlement changes could Democrats accept and still preserve the essential missions of those programs.
Let’s consider Social Security and its core guarantee of basic economic security for more than 40 million retirees (plus nearly 9 million people with disabilities). Unfortunately for Ryan and his fellow supporters of austerity for the elderly and disabled, no change that would trim the benefits of all Social Security recipients is compatible with the program’s central mission. To begin, while countries such as Germany, France and Italy provide monthly pension checks equal on average to 75 percent or more of a person’s average monthly wages over a lifetime, this “replacement rate” for Social Security is only about 40 percent. That translates into an average monthly benefit of $1,230, or less than $15,000 per-year. Moreover, these bare benefits comprise at least 90 percent of the total income for more than one-third of all current Social Security recipients.
Let’s do the math. The terms just described translate into an annual income of less than $16,300, which amounts to a very bare minimum. After all, the average cost today of a small apartment (rent and utilities) is over $7,000 per-year. Even if elderly people pay 20 percent less than the average, their rent and utilities still claim an average of $5,600 per-year or nearly 40 percent of all their income. Add to that at least $335 per-month for food at a poverty level ($4,000 annually) and another $310 per-month for Medicare Part B and Part D premiums and other out-of-pocket medical expenses ($3,700 annually). That leaves tens of millions of elderly and disabled Americans with about $130 per-month ($1,600 per-year) to cover all other expenses such as clothes, transportation, recreation, state and local taxes, and any unexpected expenditures.
These data suggest that any across-the-board benefit cut today is incompatible with Social Security’s essential mission. That takes off-the-table changes in the annual inflation adjustment or the retirement age. Given current benefits, the only reforms consistent with the program’s central commitment are ones based on means-testing. For example, Congress could apply a smaller annual cost-of-living adjustment to the benefits of the top tier of retirees. And if Congress is set on guaranteeing the system’s solvency for the next 75 years, in the same spirit they should think about applying the payroll tax to the capital income of the top tier of workers. Not that there is an enormous rush, given the actuaries estimate that the system’s solvency is secure for at least another quarter-century.
Much like George W. Bush’s proposal to privatize part of Social Security, the 2013 Ryan budget is simply uninterested in the missions that animate federal entitlement programs. Democrats would commit a grave mistake, as a matter of both social policy and politics, if they also sacrificed those commitments in search of Republican acquiescence to more revenues.
This week’s bout over federal spending pits Tea Party militants, conservative pundits and most Republican office holders against the President, his congressional allies and most economists who pay attention. But behind the politics, there is simply no economic basis for the immediate spending cuts that would follow the sequester – or immediate tax increases for that matter. The economy is still fragile enough that GDP went negative in the last quarter, when inventory purchases and federal spending both slowed more than usual. And just last weekend, Moody’s credit rating agency stripped the United Kingdom of its AAA rating -- not because UK deficits are too high, but because Britain’s premature austerity policies are leaching away the growth required to make its deficits manageable. Moody’s decision only echoed recent warnings from the IMF and World Bank against just such precipitous moves to bring down cyclical deficits.
Back home, President Obama’s odds of prevailing on the sequester would be greater, if those who have made careers out of fetishizing a balanced budget were not receiving quiet support from much of Washington’s split-the-difference political pros, including a clutch of Democrats. Looking out a few weeks, a chorus of self-described centrists and a few liberals could nudge the President into accepting a “compromise package” of substantial, immediate spending cuts and what Ronald Reagan used to call “revenue enhancers.” If it stops there, the economic damage will be contained. But the scenario could turn worse if, as seems likely, such a compromise also becomes embedded in a Continuing Resolution that will cover the rest of the fiscal year and create a new, lower baseline for 2014.
This premature austerity inescapably will weaken the economy, raising deficits even more down the line. Worse, such a bipartisan agreement could reinforce both parties’ natural resistance to contain Medicare spending and build up the tax base, especially over the long-term. And that could finally convince global financial markets that the United States has lost its way economically. The result would be higher interest rates, which in turn would mean even slower growth and higher deficits. What the markets want and have long expected from us is just fiscal common sense. That means, first, sidestep the sequester trap and instead increase federal investments in infrastructure, basic R&D along our technological frontiers, and access for all adults to upgrade their skills. Then follow it up with serious steps to contain long-term Medicare spending and expand the national tax base.
The American Dream is a precious and curious thing. According to the basic narrative, if you work hard, opportunities will present themselves – which, to be sure, usually involve working even harder. And if you do this long enough, you’ll be able to raise a family in conditions that prepare your children, like you, to work hard for the opportunities to work harder. It should be said that the aspirations of most modern societies do not revolve around a lifetime of work. What makes the American dream something precious is the freedom to choose the work you do, especially if you’ve worked hard, and the prospect that your hard work will lead to a better life. Americans believe in this dream, because it generally has delivered as promised -- at least until the last decade.
The next four years will test whether Mr. Obama can do something meaningful about the economic forces which recently have blocked access to that dream for most Americans. In fact, a vivid statement of this very problem hung in the Chicago campaign office of David Simas, who headed up polling operations for the President’s reelection. As it happened, the chart came from research and analysis which I did for NDN. That research showed how productivity and per-capita GDP grew fairly steadily from 1992 to 2009, while average incomes grew at nearly the same rates only until 2000, and then flat-lined for the past decade. Simas and David Axelrod, the president’s chief strategist, dubbed the chart the “North Star” of the campaign, and Time Magazine has called it, “The Most Important Chart in American Politics.”
The chart was meant to remind the campaign staff that the rewards (income gains) of working hard (productivity and per capita GDP gains) have largely stopped for most Americans. From this came the campaign’s central theme of growth based on progress by the middle class, in contrast to Mr. Romney’s shopworn Republican faith in growth spurred by tax breaks for the wealthy. The theme has even gone trans-Atlantic: NDN’s Simon Rosenberg and I made the same case to leaders of Britain’s Labour Party, and last week the Guardian reported that the analysis is now informing that party’s new agenda.
The realization that the long-time link between incomes and productivity gains and the link between job creation and growth had both weakened, came originally from research I had done for Futurecast, a book I published in 2008. Rosenberg and I had sounded the first alarm even earlier in an NDN report in 2005. By June 2007, NDN issued a long essay I did on how certain elements of globalization could hold down income progress and job creation even as productivity and GDP increase. From that point on, we returned again and again to this new challenge to the American Dream. It was the subject of five of these blog essays in 2012, for example, as well as a Washington Post op-ed published just last week.
Now, we are developing additional analysis to gauge just how broad and deep the problem has become. Using new Census Bureau data, I recently tracked the income progress of every one-year age group – those born, for example, in 1950, 1951, or 1955, and so on -- as it aged through recent expansions and recessions. Looking across all of the age cohorts, I found that people’s incomes grew an average of 1.5 percent per-year in the 1983-1989 expansion, followed by income losses of 2.6 percent per-year in the 1990-1991 recession. So, the entire 1983-1991 business cycle produced average, net income gains of 5.3 percent. Things got even better in the 1990s: Across all age groups, the incomes of Americans grew an average of 1.6 percent per-year from 1992 to 2000, followed by the brief and modest recession of 2011 which brought income losses averaging just 0.2 percent. Across all ages, then, the 1992-2001 business cycle produced average net income gains of 14.2 percent. That’s the American Dream truly paying off.
From that point on, however, all of the data point to the grim conclusions of the “most important chart in American politics.” Tracking all age groups as they aged through the 2002-2007 expansion, we find that people’s incomes grew an average of zero percent per-year over those six years, followed by income losses averaging 1.7 percent per-year in the 2008-2009 recession. So, the 2002-2009 business cycle produced net income losses averaging 3.4 percent across all age groups. For the first time in America’s postwar history, most people lost ground over the course of an entire business cycle. And the early signs for the current expansion are even more discouraging: In its first two years, 2010-2011, incomes across all age groups continued to fall at an average rate of 1.0 percent per-year.
In his response to the President’s State of the Union address, Marco Rubio gave the GOP’s current prescription for the American Dream: Cut federal spending now, because incomes and jobs can come back only if Washington does less of everything. It’s the Romney platform without the tax cuts. It’s also the game plan which conservative governments in Britain and Germany followed faithfully until it brought on double-dip recessions in both countries.
Mr. Obama’s program starts in a more reasonable place economically. For example, it focuses on research and development by promoting “advanced manufacturing,” and on a variety of efforts to upgrade people’s skills. The Census data do show that since 2000, people with graduate degrees have seen their incomes rise pretty steadily, although more slowly than in the 1980s and 1990s. However, recent evidence also suggests that a college degree no longer guarantees healthy income progress. A more comprehensive response also would involve, for example, steps to reduce certain business costs that come out of people’s wages and salaries, such as employer-provided medical coverage.
The President’s approach, by itself, may not restore the American Dream. Like his senior campaign staff, however, he clearly recognizes the challenge we all face and its pivotal role in American life.
This morning’s disappointing report that GDP actually declined by 0.1 percent in the fourth quarter of last year is a lesson in how government and serendipity can shape our economic path, especially in the short-term. The basic elements of economic prosperity are in place. To begin, Americans are spending again: Personal consumption accelerated from a 1.6 percent increase in the July-August-September quarter to 2.2 percent in October-November-December. Even better, spending on durable goods – autos, appliances, and so forth – increased at nearly a 14 percent rate. That should be no surprise, since disposable personal income rose at a strong and healthy 8.1 percent rate in the fourth quarter. Firms looking to the future are spending, too: Business investment expanded more than 8 percent, and investments in equipment and software were up more than 12 percent, a rate reminiscent of near-boom times. Housing is back as well, with residential investments growing at a rate of more than 15 percent.
How does all this good news translate into a flat quarter? For one thing, our exports fell faster than our imports. One reason for that was the economic slowdown in the huge European and Japanese markets. The other was Hurricane Sandy, which disrupted shipments in and out of the huge, New York and New Jersey ports. The hurricane also disrupted inventory purchases, which slowed by two-thirds compared to the preceding quarter. But the biggest single drag on the economy was Washington: Federal spending fell 15 percent, led by defense which declined at the fastest quarterly rate, 22 percent, in 40 years. Those declines were fueled entirely by politics, especially planning for the spending sequesters threatened for January 1.
We cannot influence the weather, but we can control the impact of government on the economy. This report should remind us that the economy remains vulnerable to precipitous, additional budgetary austerity. And given the progress we’ve already made on deficits -- $1.2 trillion in cuts over 10 years enacted in 2011 and $700 billion in new revenues enacted late last year – we can now proceed in a very measured way with the final stage of long-term reforms for entitlements and defense, plus some additional revenues. And to assure everyone that grown-ups who understand the economy are in charge again in Washington, Congress should cancel the sequesters and enact a clean, long-term increase in the debt limit.
For decades, fiscal conservatives have used congressional debates over raising the debt ceiling to vent their frustrations with big government. But almost no one seriously questioned the need to raise the ceiling, not until a band of Tea Party uber-conservatives in 2011 resolved to use the debt limit as a bargaining chip in budget talks. They ignored the fact that the debt limit simply allows the Treasury to borrow the funds to finance spending that past Congresses and Presidents already have undertaken. In other words, it has no effect whatsoever on future spending or taxes. Raising the debt ceiling, in short, is a ministerial act that grants the government the technical legal authority to maintain the full faith and credit of the United States. And since the Treasury securities that comprise that credit underpin much of the operations of the American economy, withholding that technical authority could have devastating economic effects.
To understand how and why, start with the basics. When Washington runs a deficit, the Treasury has to borrow from investors not only to fund the deficit, but also to cover interest payments on the government’s existing debt and the regular refinancing of much of that debt, all on a continuing basis. A failure to raise the debt limit, as some Tea Party denizens in Congress recently called for, could therefore force the Treasury to default on those obligations.
Now, sovereign debt defaults have well-known and very unpleasant consequences. Interest rates spike, stock and bond markets fall sharply, the value of the currency declines dramatically, and the country quickly falls into a deep recession. Given those consequences, no government with sane leadership would ever default voluntarily. Rather, the only reason any country has ever found itself unable to pay the interest on its bonds or issue new government debt is that domestic and foreign investors won’t lend it the funds to do so.
If beyond all reason or economic necessity, Congress were to force our own government to default on our national debt, the results would be particularly nasty. Trillions of dollars in U.S. Treasury securities are held by financial institutions here and abroad, so the default would quickly freeze capital markets around the world. In other words, private lending to businesses and households here and in many other nations would halt. The reserves held by many of the world’s central banks include more trillions of dollars in U.S. Treasuries, so a U.S. default also could quickly bring on a global financial crisis that would dwarf the chaos of late-2008. And even if the debt-limit debate merely increases the concerns of investors that a U.S. debt default somehow might occur, their heightened apprehension could have serious effects on interest rates, the dollar, and the stock and bond markets.
Even before a technical debt default could set in, however, the government would be forced to drastically cut current federal spending. Federal borrowing today covers between 35 percent and 40 percent of all federal spending. If Congress prevents the Treasury from legally borrowing any more funds, the government will be forced at once to slash spending by 35 percent to 40 percent. Such truly unimaginable cuts -- more than ten times those contemplated under the sequester provisions of the 2011 budget Act -- would force the President to shut down many parts of the federal government, including some national security operations, and even cut income support programs for tens of millions of retired Americans. And since the President and the Treasury would determine the distribution of these cuts, failure to raise the debt ceiling would effectively shift the power of appropriations from Congress to the Executive.
Conservatives have serious and sincere differences with progressives over certain federal programs and functions. Whether Republican leaders recognize it or not, putting at risk the government’s legal authority to issue new bonds as a lever to press their budgetary preferences is a form of political nihilism. It dismisses the costs of wrecking the operations of government, because it places little value on government itself. As such, this new political nihilism is as far from genuine conservatism, which seeks to preserve traditional political arrangements, as it is from a progressivism that uses government to reform those arrangements. Nevertheless, by vowing to block any increase in the debt limit until the administration accedes to their budget demands, congressional conservatives have embraced this new nihilism.
Nor, as some Tea Partiers would have it, should a failure to raise the debt limit be seen as a “preemptive default” intended to head off a real one. Global investors continue to lend the United States whatever funding we require – and judging by the low interest rates they accept, they are eager do so. Nevertheless, a handful of radical members would have the Congress refuse to raise that limit, knowing that the country would face another recession as government programs are slashed, followed by the chaos of a sovereign debt default. Republican leaders have no reasonable alternative but to join the President in rejecting such nihilism.
One argument nearly entirely absent in the debate over the fiscal cliff issues is the effect on the economy. True, some diehard conservatives warn that without drastic steps to privatize part of Social Security and much of Medicare, our national debt will soon make us pariahs in global capital markets, on the Greek model. But there was never any economic evidence or reasoning behind their feverish scenario. In fact, throughout our long fiscal debate, worldwide investors have been eager to lend the Treasury virtually unlimited funds in 10-year tranches and accept annual yields of less than 2 percent.
Based on that, some diehard liberals insist that we do not have to cut spending at all, especially when there are plenty of well-heeled Americans around who can afford to pay higher income taxes. Their position ignores economic history – namely, that whenever our deficits have climbed and the national debt has threatened to soar, we earned the confidence of global investors by addressing those problems in measured ways. The only genuine economic imperative in this entire dismal fight is not that we should raise taxes on the wealthy or cut domestic spending, but simply that we once again have to take care of our fiscal business in a reasonable manner.
Despite the protestations of partisan economists, the economy is largely indifferent to whether we address these imbalances by cutting spending or raising taxes. The first stage of this effort, in 2011, brought $1.2 trillion in spending cuts over 10 years. The verdict of the markets was, “well done.” And despite the heated rhetoric of last year’s campaign, the 2011 deal was followed by a generally strengthening economy. Stage two was resolved in this week’s agreement to raise nearly $700 billion in new revenues over 10 years, including substantially higher taxes on capital income. The markets are satisfied with that, too, and the economy almost certainly will continue to strengthen.
Stage three will come in a few months, when the President and Congress will likely agree to modest entitlement changes in exchange for additional revenues raised through some version of corporate tax reform. The economy will be fine with that resolution as well.
In fact, this process has been a quiet refutation of the slash-the-deficit chorus. That includes those of the Paul Ryan variety who would upend entitlements to finance more tax cuts, and “responsible budget” types who would hike taxes and slash spending as much as possible to reduce the cost of business borrowing in years to come. The truth is, the economy does not usually cotton to drastic measures that confound the expectations of investors and consumers. For all of the complaints that rather than make a meal of the deficit, we take a nibble here, another nibble there and then a third nibble somewhere else, this tortured course allows businesses and households to adjust little by little. And that is the best course for the economy.
So, setting aside politics and social policy, the economic imperative remains that Washington must manage to take care of its fiscal business in measured and reasonable ways, whether through taxes or spending cuts of almost any variety. Looking ahead, this means that the debt limit can never again become a negotiating chip in fiscal politics. The last time that House and Senate hyper-conservatives went down that path, it cost the U.S. government its triple-A rating from one of the three major credit-rating agencies. A government capable of letting lapse its own legal authority to issue new debt and pay interest on its existing debts is one that, by definition, cannot take care of its basic business. And that is especially so in the current circumstances, when there are no market pressures on the government to default and when the government’s debt securities comprise much of the reserves of most of the world’s central banks.
Global investors would be anything but indifferent to such contempt for predictable economic consequences. A technical sovereign debt default triggered by a debt-ceiling stalemate would be a calamity for the U.S. and world economies. Any political leader or party that helps to bring about such a catastrophe will prove themselves unfit to govern for a very long time.
Thank goodness for the fiscal cliff. Without it, most of Washington would be home for the holidays, happy to put off the unpleasantness of raising taxes and cutting spending. But the truth is, the only part of the cliff that really matters right now is the Bush tax cuts. Yes, much has been made about triggering large, across-the-board cuts in defense and domestic spending. But nobody in Washington wants them to happen – not the administration, and not either house of Congress. And whenever there’s a bipartisan consensus not to do something, it doesn’t happen.
Of course, there is no such consensus about most parts of the Bush tax cuts. There is, however, tacit bipartisan agreement that all of them shouldn’t simply expire. So even at this late hour, we can be pretty certain that they won’t. Unhappily for Speaker John Boehner and his party, the part with virtually universal support is also the only part the President wants to extend unchanged -- the lower tax rates for the 98 percent of Americans earning less than $250,000. That leaves the rest of George W. Bush’s vanishing economic legacy up for grabs. And that includes not only the current 35 percent and 33 percent top rates that everyone talks about, but also, and frankly more important, the special 15 percent tax rates on capital gains and dividends.
So, thank goodness for fiscal cliff, because it produced a sense of urgency that now seems likely to lead Congress, ultimately, to rebuild part of the government’s tax base. The big question to settle before New Years is whether that will include a top rate that goes all the way back to 39.6 percent or only part of the way back to, say, 37.5 percent, plus some additional revenues from limiting the deductions claimed by the same well-to-do people.
As a matter of social policy, the top rate is much less important than what happens to capital gains and dividends. Successful lawyers, doctors, consultants and small business people care how high the top rates go. But those rates are matters of indifference to rich people, because most of their seven- and eight-figure incomes come through capital gains and dividends. Since George W. Bush, they’ve gotten away with rates lower than the middle-class. And if their 15 percent rates expire and they jump up to normal income tax rates, early next year the President can trade off, say, a 25 percent rate on capital income for Republican agreement to smaller cuts in entitlements.
But what about the economics of all of this? There is some debate among economists about whether higher tax rates on capital income matter much. But the only genuine economic imperative today is that the two parties cut a budget deal. Over time, yes, we need to take serious steps to both slow the growth of entitlements and further rebuild the tax base. That’s what Congress and the President did in the 1980s and again in the 1990s; and both times, it took several years of haggling and incremental measures. For now, global investors believe the United States will do that again, which is why 10-year Treasury bonds yield less than 2 percent. What the economy needs most over the next several months, then, is a deal that’s significant enough to confirm their confidence, even if it doesn’t solve the whole problem.
As to the content of that deal, that matters much less economically, especially for the short-term. In terms of overall investment, consumption, growth and employment in 2013 and 2014, it really won’t matter much whose taxes go up. Nor will the overall economy care whether the spending cuts come from Medicare, Medicaid, national parks or national defense. Of course, different sectors and businesses will care, as will those whose taxes increase. But what will count for global investors and the economy is that something substantial gets done. If the deal includes serious steps to slow future entitlement spending, all the better. But economically, it just has to get done sometime over the next several years.
Other things, however, could shake our economy. The European sovereign debt crisis remains a serious threat, but not because a collapse of Greek, Spanish or Italian debt would infect confidence in U.S. Treasuries. The real issue is that such a crisis would threaten the solvency of many major French and German banks. That would affect us, because our banks are closely linked with them through thousands of deals and other transactions, and through credit default swaps guaranteeing the corporate paper of the big European banks as well as Italian and Spanish sovereign bonds.
Here’s a practical step for the Administration: The Treasury and Fed should conduct new stress tests of large U.S. financial institutions to establish how well each of them would weather a broad European banking crisis. Such a public accounting would help insulate us from the shock of a Eurozone meltdown and ensure that our financial system will withstand it.
Another thing holding back a stronger expansion next year is everyone’s experience from 2010 and 2011, when the economy gathered strength and then petered out. There were good reasons in both of those cases – especially in falling housing prices and a continuing drive by American households to pay down their debts. Those reasons, happily, no longer apply. Still, a lot of hesitation remains out there, by businesses about investing and hiring and by households about how much they can spend without getting nervous. So, the economy could use a little push. That’s what the Fed is trying to do through QE3. That’s what the President wants to do with a little more stimulus next year. And this should remind Congress that that it needs to slowly phase-in its tax increases and spending cuts, as the economy gathers strength.
Finally, Congress and the President need to show global investors that they take seriously America’s responsibility as the nation whose currency is the medium for world reserves, by passing the ministerial legislation that raises the legal debt ceiling. Some members will be tempted to use the debt ceiling once again as leverage for spending changes they sincerely believe in. But there would be no clearer demonstration that America has lost its political capacity for economic leadership than to make that authority hostage to a political argument.
And in the end, an amicable resolution of the fiscal cliff and debt ceiling issues just may be enough to support a stronger expansion next year than most people expect — and everyone can share the credit.
The fiscal cliff is more of a cascade – or a game of dominoes. First, the President and congressional Republicans have to make a deal on the terms for renewing the Bush tax cuts. That appears to very possible, since GOP leaders seem to have conceded that additional revenues are inevitable. So, the most basic deal to be struck is how precisely to raise $800 over 10 years from higher-income households. John Boehner can probably get his caucus to agree with those revenues, especially since the President has recently talked about raising twice that total, and so long as it does not involve a new, 39 percent tax rate. The only way to raise $800 billion without hiking the top rate is to increase instead the tax rate on capital gains, dividends and interest. So, look for a new, 25 percent tax rate on capital income for the top 2 percent – a change that will hit some 25,000 very wealthy households more than some three-to-four million well-paid professionals.
If the two sides can manage to compromise on the initial high-end tax increase, they get to move on to the next stage: Some broad understanding about how much can be cut from defense, other domestic programs, and entitlements over the next 10 years – and perhaps, how much additional revenues can be raised from business. As Republicans will have to concede more substantively on the initial, high-end tax increases, the administration will have to concede more here, especially on entitlements and almost certainly on business tax increases too. But, any broad agreement on principles should be enough to let them delay the automatic across-the-board cuts in defense and non-defense spending now scheduled for January 1.
And, if they can manage to compromise on the broad terms of a big budget deal, they get to move to stage three -- actually negotiating what to cut and by how much. As Republicans are effectively going to dictate the terms of the tax increases on higher-income people which they’ve been fighting – i.e., no new 39 percent rate – the Democrats will get to dictate the terms of the cuts in Medicare and Medicaid which they’ve been resisting. In the end, all of the changes will probably add up to less than everyone talks about today – perhaps $3 trillion over 10 years rather than $4 trillion, including the $1 trillion in cuts agreed to in the last debt-ceiling fight as well as the initial, $800 billion in new revenues. But, it will be enough to get sufficient GOP support to raise the debt ceiling in April, and the economic expansion should be able to continue on its course.
With the fiscal cliff now in sight, the nation’s pundits are breathing as heavily as they collectively can over the prospect of political warfare over the Bush tax cuts. Yet, a compromise between President Obama and congressional Republicans over taxes for the top 2 percent is already clear. We extend the Bush tax rates but also cap the value of tax preferences for those two-percenters – an idea borrowed from Mitt Romney – so they pay the same additional taxes they would have if the top rates had gone back to 36 percent and 39.6 percent. The President meets his commitment to ensure that well-to-do Americans pay more taxes, and congressional Republicans get to boast that they held the top rates at 33 percent and 35 percent. And if we do it right, it could also be the first real step in a generation to address growing income inequality.
Yes, the President has called on Congress to re-enact the Bush tax cuts without the rate cuts for the top 2 percent. But he has also said, sensibly enough, that compromise will be required to move away from the fiscal cliff, so we can assume that that his current position is not final. Similarly, House Speaker John Boehner has said no to new taxes, but yes to additional revenues. This compromise builds on that foundation, extends Romney’s idea of capping deductions to cover all tax preferences, and uses the revenues to pay down the deficit rather than fund more cuts in tax rates.
For progressives, this approach could also be a lot fairer than simply raising tax rates, if Congress and the President will just allocate a proportionate share of the new taxes to America’s truly rich households, by capping the value of all tax preferences. The key here is that the top income tax rate applies only to the labor income – wages and salaries – that doctors, lawyers, business people, and other well-paid professionals actually earn. Those top rates do not touch the capital gains and dividends that comprise most of the incomes of really wealthy people. In 2008, for example, nearly 75 percent of all capital gains and dividend income went to the top 1 percent – and 80 percent of that was reported by the richest one-tenth of one percent of Americans. That’s how Mitt Romney could legally pay a lower tax rate on his $20 million annual income than an average teacher pays on her annual $50,000 salary. Repeal the top Bush tax rates, and most of the income of the very rich will still be taxed at 15 percent.
Instead, let’s think about how a hybrid Obama-Romney tax reform might work. Repealing the Bush cuts for the top rates would raise about $800 billion over 10 years or an average of $80 billion per-year. (The interest savings would come to another $130 billion.) Our hybrid reform would allocate those additional taxes across the top 2 percent, based on income. For example, in 2008, everyone in America with taxable incomes of $200,000 or more reported a total of $2.06 trillion in taxable income. Some 3,470,000 households with incomes of $200,000 to $500,000 accounted for 38.3 percent of that total. So, they would have to come up with 38.3 percent of the additional $80 billion in annual taxes, or $30.64 billion per-year. That would come to about $9,000 per household.
As it happens, many people earning between $200,000 and $500,000 would still end up ahead, because they would retain an average of $12,000 in tax savings from the extension of the Bush rate cuts on income below $200,000. Now, consider what would happen to the very rich. Those reporting incomes of $10 million or more accounted for 16.9 percent of that $2.06 trillion in taxable income, or $339 billion. So, in fairness, they should bear 16.9 percent of the $80 billion annual tax bill or about $13.5 billion per-year. The 13,401 households responsible for that $339 billion in reported income would face additional taxes averaging about $1 million each.
The alternative – leave the big tax preferences for the wealthy untouched and just roll back the top two Bush rate cuts on labor income – would unfairly shift most of the burden to some 3 million or so affluent professionals. The irony is that according to the supply-side catechism, that would lead them to work less, depriving the economy of some of their valuable labor. Economists are still divided over whether those effects would be significant or modest. What is less controversial is that changes in capital gains taxes have little effect on how much people save and invest. That’s why Ronald Reagan was willing to tax capital gains (and dividends) at the same rate as wages and salaries. This new alternative, inspired by Mitt Romney himself, would leave unchanged the low marginal rates on capital gains and dividends, but limit the value of the benefits wealthy people can claim from those low rates. In the bargain, the President and Congress could cut $1 trillion from our deficits over the next ten years and make the first real progress in a generation towards containing today’s record-high income inequality.
The disappointment and anger many Americans feel about their economic lot has held center stage in this year’s elections. Mitt Romney, of course, blames President Obama. New Census Bureau data, however, tell a different story. The economic problems facing working Americans did not begin with the current slow recovery or even with the financial crisis of 2008-2009 and the subsequent deep recession. A new report issued last week by NDN tracks the earnings of working Americans of various ages, year by year, as they have grown older. It shows that average working people racked up steadily-rising wages and salaries through the economic expansions of the Carter, Reagan and Clinton presidencies. I also found that this progress stopped abruptly in the expansion of 2002-2007, when people’s wages and salaries stagnated through five years of strong productivity gains and reasonable growth.
This new analysis recasts the significance of our current slow recovery. As many economists have pointed out, slow recoveries are the norm when an economy suffers a serious financial crisis, whether it was the United States and Europe in the 1930s, Latin America in the 1980s, or Japan in the 1990s. In fact, the Obama program stopped a dangerous spiral towards a second Great Depression and restored modest job gains that have far outpaced the job growth following the 2001 recession. The economy now seems poised for stronger growth over the next four years. The outstanding question is whether the programs offered by the President or Mr. Romney can address the forces that halted earnings progress in the 2002-2007 expansion. The evidence suggests that Obama’s program comes much closer to that mark than Romney’s proposals.
To answer that question, we first need an accurate picture of how Americans have really fared economically over the last two generations. To capture people’s actual economic experience over that period, I tracked the median wage and salary earnings of various age cohorts as they aged over the last 45 years. We followed the earnings path of working Americans age 25 in 1975 until they reached 55 in 2005, those age 25 in 1985 until they reached age 50 in 2010, and those age 25 in 1995 until they reached age 40 in 2010. A clear pattern emerged. The earnings of working people grew by 2.8 percent a year as they aged through the Carter expansion of 1976-1979, followed by gains of 3.2 percent per year through the Reagan expansion of 1982-1989, and then another 3.8 percent per year in the Clinton expansion of 1992-2000. Then came the expansion of 2002-2007, which produced annual wage and salary gains ranging from 1.7 percent for those in their 20s and early 30s, to negative 1.5 percent for those in their late 40s and early 50s. Across all age cohorts, people’s earnings progress averaged 0.5 percent per year through the Bush expansion, nearly 85 percent less than the average wage and salary gains achieved during the three previous expansions.
These findings transcend partisanship. The policies of the Carter, Reagan and Clinton administrations all enabled average working Americans to achieve healthy wage and salary gains as they aged. To begin, this suggests that changes in people’s marginal tax rates – down under Reagan and up under Clinton -- do not materially affect whether their wages and salaries increase as they age. In addition, of course, earnings progress virtually stopped in the last decade, despite the Bush tax cuts. Therefore, there is no historical evidence that the centerpiece of the Romney program, a 20 percent across-the-board cut in marginal income tax rates, will make any difference for people’s wages and salaries.
A serious program to restore earnings progress has to begin by identifying what has changed in the economic landscape, so national policy can respond effectively to an economic environment that stalls that progress. One factor almost surely involves the budget deficit. When deficits ballooned in the 1980s, President Reagan and Congress stabilized them, largely by ending his defense buildup and raising taxes on businesses (1982), payrolls (1983), and energy use (1984). When deficits ballooned again in the 1990s, President Clinton and Congress moved the budget to surpluses largely through defense cuts, Medicare changes and tax increases on higher-income households. Strong gains in wages and salaries in both decades also were crucial to curbing those deficits, by expanding the revenue base for income and payroll taxes. By contrast, when the deficit ballooned in 2001 and 2002, and earnings stagnated, the Bush administration enacted another tax cut in 2003, increased entitlement spending for the new, unfunded prescription drug benefit, and expanded Pentagon spending for the wars in Iraq and Afghanistan.
Obama’s program seems much more likely to address this factor than Romney’s plan. The President’s deficit proposals mirror those of Reagan and Clinton, covering defense cuts, additional revenues, and spending restraints in Medicare and discretionary programs. By contrast, the Romney program begins with large increases in defense spending and big, new tax cuts. In recent weeks, to be sure, he suggested that he would pare back his tax cuts to ensure “revenue neutrality.” But he remains unalterably opposed to the revenues increases that all of his predecessors except George W. Bush used to help control deficits. That leaves his pledge to control deficits entirely dependent on the Ryan budget. He will have to persuade Congress and the public to accept a Medicare program reorganized around vouchers, state-run Medicaid systems with one-third fewer resources, and the deepest cuts ever seen in federal support for education, natural resources, law enforcement, export promotion and everything else. Once again, there is no historical evidence that Mr. Romney’s approach will bring deficits under control.
Another force shaping the new economic landscape is globalization. China’s total imports and exports, for example, jumped from $200 billion in 1994 to $500 billion in 2000 and an astounding $2.4 trillion in 2008. Over the same years, American businesses and workers also have had to face new competition from businesses in many other countries, including India, Korea, Brazil, Mexico, and much of Eastern Europe. This new level of competition has affected the wages and salaries of Americans, because it has made it much harder for American businesses to pass along their cost increases in higher prices. The result is that those companies have cut other costs, starting with the wages and salaries they pay.
Globalization is not going away. So, the only course available to ease this new pressure on the earnings of Americans is to help businesses address some of costs which rose rapidly in the 2002-2007 expansion – namely, health care and energy. Once again, Obama’s program seems more promising than Romney’s plan. For example, Obamacare includes numerous provisions which may help slow fast-rising medical and insurance costs. They range from new prevention programs and active promotion of cost-effective best practices, to mandatory coverage for healthy young people. But Romney is committed to repealing all of these reforms and would depend instead on the current patchwork of private competition which has proved unable to make a dent in these costs.
On the energy front, both candidates pledge to expand our supplies of fossil fuels, which in recent years actually have increased substantially on their own. However, Obama also would continue to actively promote alternative forms of energy. Romney wants to end those efforts. In addition, Obama says he will to continue to use new federal laws and regulations to increase energy conservation and efficiency. For example, he raised fuel mileage standards for new automobiles, which effectively reduce unit energy costs. Romney has suggested he would end these conservation efforts and roll back many existing regulations, undoing some of this progress in containing future energy costs.
The central economic challenge facing the next president is to restore healthy wage and salary gains for average Americans. This challenge will not be met by cutting taxes and rolling back government. Rather, it will take a sustained effort to address the forces which, following 25 years of steady gains, have stalled further earnings progress for the last decade. On this basis, the President’s program offers much more promise than Mr. Romney’s agenda.