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Cut, Cut, Cut, and More Cuts (Part II)

By       Message Seymour Patterson       (Page 1 of 1 pages)     Permalink

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Two classes of people populate the national environment: the one-percenters who garner the lion's share of the income and the rest of us. Each class is a beneficiary (so to speak) of some form of special treatment by the government. The former benefits from tax cuts and the latter from cuts in benefits.

When top marginal tax rates are above 50 percent, there can be more economic stability. In fact, some economists believe top marginal tax rates should be 90 percent. Surely, a 90 percent tax will cause some income to shy away to foreign shores as happens now because 'nobody likes to pay taxes'. Hence, some capital will take flight due to malfeasance, no matter the tax rate. Yet a 90 percent marginal tax rate might not discourage work in highly motivated people with unique talents and skills in the creative arts and applied sciences. Perhaps, more importantly though, a top marginal tax rate of 90 percent might also increase domestic investment as a way to circumvent paying the tax. The investment expenditure enters the company's ledger as an accounting cost, thereby reducing pretax profits, leading to more sustainable long-term economic growth. Second, when the Gini coefficient is above 50 percent there tends to be more civil unrest inasmuch as workers cannot be euphoric as profits rocket to the stratosphere while wages remain trapped in Antarctic like glacier permafrost. As the divergence between wages and profits keeps expanding, the likelihood of political instability also escalates: notably various unmooring or displacements in the nation some social fabric--strikes, riots; others economic--recession/depression; and still others political--coup d'etats that disrupt peoples' lives and well-being.

Nevertheless, budget spending cuts rule the day in sequester and in aspiration. The advocates believe spending cuts can somehow spur economic recovery in a time of economic crisis. Lest anyone clamors for evidence, please refer to Wisconsin's Scott Walker and Louisiana's Bobby Jindal both of whom have publicly declared plans to cut spending on education by the tune $300 million. There is nothing especially innovative about spending abatement proposals: Sam Brownback rammed through some of these cuts in Kansas with adverse results.

The statement that "deficits don't matter" is attributed to Vice-president Dick Cheney. On its face, the utterance is of course naïve. However, there is more to what he said ten years ago. Mr. Cheney also said that the high deficit was leverage to do things that they could not do before ". . . in terms of insisting on policies that will be painful, . . . " namely, cuts in programs that hurt the least advantaged among us. On the other hand, some countries think deficits matter. For instance, the European Monetary Union maintains that "In the European Monetary Union (EMU), the Stability and Growth Pact (SGP) imposes medium-term budgetary objectives to achieve and maintain a status close to balance or surplus, and a ceiling on fiscal deficits at 3% of GDP." (See OECD 2008)

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When the US borrows large sums from the rest-of-the-world, the value of the dollar falls, making imports more expensive in terms of dollars, and domestic interest rates and prices will tend to rise. In the long term, higher interest rates will reduce investment and slow economic growth and increase the deficit. Deficits do matter!!

Carmen Reinhart and Kenneth Rogoff in "Growth in a Time of Debt" argue that when a country's debt-to-GDP ratio is above 90 percent, its growth would slow by one percent. This assertion is tautological. When an economy is slowing (or in a recession), its debt-to-GDP ratio will rise, and in good times, its debt-to-GDP ratio will fall. Obviously, cutting government spending through layoffs of government workers will reduce this ratio, but not necessarily improve the economy for the decline in the ratio will not be due to an improvement in GDP growth.

The distribution of the post-Great Recession growth in income has been extremely skewed in favor of the top one percent of income earners. The following quote makes the point:

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"The recovery that officially began in mid-2009 hasn't arrived in most Americans' paychecks. In 2010, the top 1 percent of U.S. families captured as much as 93 percent of the nation's income growth, according to a March paper by Emmanuel Saez, a University of California at Berkeley economist who studied Internal Revenue Service data." (Source: Bloomberg.com)

This information is a bit dated, but it points to a trend in income inequality (i.e. higher Gini coefficient) that now plagues the U.S. and the rest-of-the-world. The figure below depicts the upward trend in the U.S. Gini coefficient.

Source: US Census: www.economicpopulist.org

By way of interpretation, the Gini index (coefficient) is a measure of distribution. The figure immediately above depicts the U.S. case of income distribution. The Gini coefficient has a range of 0 to 1, where 0 means perfect income equality, and 1 perfect income inequality. The U.S. seems to be trending in the direction of--about 0.47 in 2011. Economists believe that a number above 0.5 (as it means the economy's income distribution is skewed in favor of inequality) can lead to internal social unrest.

The final inference has to be that high deficits (and huge debts) can have an insidious effect on economic performance depending on where in the business cycle the country finds itself. High deficits, indeed, can reduce the availability of loanable funds and cause interest rates to be higher--although in the current business cycle this has not been the case. However, this would be of little concern if we found ourselves in the trough of the business cycle where unemployment was high and economic output was low. Further, if the deficits were financed through transnational borrowing, the value of the dollar would suffer reverses, making imports more expensive. Nevertheless, this scenario hardly justifies deliberate efforts to exacerbate the inequality gap by inflicting more pain on the poor, and favoring the rich with tax cuts--and easy money as the Federal Reserve Banking has been doing. So what to do? The policymakers have the reins of policy choices in their in hands--economists are mere advisers.

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Moving an operation offshore or opening bank accounts in the Cayman Islands to evade taxes or environmental regulations increase a company's profitability. One could argue that is good for shareholders and that the company has no responsibility to the country. Yet, these activities harm the country: they hurt U.S. employment while increasing employment abroad; government revenues decline, thereby worsening the deficit. Tax evasion robs the country of the revenue needed for public works and social programs: roads, bridges, dams; Social Security, Medicare, and SNAPs.

How does a country redress the unpatriotic profit-seeking behavior of U.S. companies that display no concern for America, only stockholders' profits? One answer is to reduce the corporate tax rate: if we assume that high taxes drive companies offshore, then lowering those taxes should bring the home. Another possibility is an import tariff on U.S. companies that produce goods abroad that they want to sell in the U.S. market. Problem: the U.S. is a signatory to international agreements that rule that out. The U.S. could put a value-added tax (VAT) in place. This works most effectively if the VAT raises the price of imports up the domestic price. In this case, a U.S. company would have no incentive to produce offshore.

Higher top marginal tax rates or tariffs or a VAT in general is remedial action the government might implement to correct business practices that hurt employment and income in the country. If a company refuses to contribute to a country's growth and development, but prefers to use its market to sell its products, then the country should bar that company's goods or tax them.


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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)

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