Taxes and business

* Joe White, in the Nov 25 Letters to the Tennessean, argues that financial incentives to lure a business to a county or state are analogous to reductions of income-tax and capital-gains tax to enrich the already rich. He claims that the economic benefits for the rest of us outweigh the economic costs to the rest of us.
* I wonder whether an honest accounting of losses and gains in our business-luring programs would support his thesis. What about American Airlines, Dell, the arena, the stadium, etc. My property-taxes have increased painfully since these deals were made. It would be rational for all sub-national governments to agree on a federal law forbidding financial incentives to influence locating of businesses among states and counties. Then businesses would go where their prospects are best, not to where they have been bribed to go. HCA would almost certainly stay in Nashville without a bribe, since its founders, owners and officers have deep roots here.
* Anyone or any business that could naturally be in Nashville but chooses to go elsewhere is giving up the opportunity to be in the most interesting place in the US--an island of intellectual and cultural ferment in a State that rivals paradise.
* Ethically speaking, it doesnn't matter where a business moves. God (ie an objective observer of good will) might care about per capita happiness, not where that happiness happens.
* The idea that tax-paying employees of a business will improve local revenues is flawed, in that those employees must be provided infrastructure and services that consume revenues. Nashville is already too crowded. Try driving on any of our arteries, especially Woodmont Blvd or Harding Pl most hours of the day.
* The prosperity of a community depends on its products and services that are bought by ousiders. Competing for such businesses could be in the self interest of locals.
* Finally, the fees collected from businesses by brokers/consultants for negotiating their tax breaks are obscene, about 30% of the tax break. That offends me.
* I wonder whether Joe White is parroting the Reagan/Laffer narrative or has studied the economic data bearing on his claims about tax cuts.
* The data show that Kennedy's economic boom began in 1968, 3 years before Kennedy took office and 5 years before his tax cut, which had no discernible effect on revenues. After the Reagan tax cuts, revenues abruptly fell about 20% below their pre-Reagan trajectory, continued drifting down from that trajectory until 1993, then began rising when the top income-tax rate rose from 30% to 40%. This revenue rise was broken in 2001, due to financial turmoil following the 9/11 attacks, then returned in 2004 after the 2003 tax cuts but in fact due to a housing bubble that popped three years later. We have little to show for tax cuts except our ballooned government debt.

US Macroeconomic History

I've been assembling macroeconomic data to explore influences of independent variables (tax rates, government spending, oil prices, interest rates, regulations) on dependent variables (inflation, prosperity, employment, government debt, wealth distribution). They are presented in this essay. What do you see?

* GDP grew in three main phases, slow, fast and slow, corresponding to phases of CPI growth, inflation being the dominant component of GDP growth. The GDP growth in excess of inflation and population growth represents supra-subsistance purchase of goods and services, ie prosperity or life style.  US prosperity in the present decade (2002-2012) is about twice that in the 1950s.  Why aren't we grateful?  Probably because most of the increased prosperity was for the richest citizens; little of the increased prosperity was shared by average workers -- this shown in the Top 1% Income Share plot of Fig 4.  The dynamics of wealth distribution are examined by Robert Reich.
* Comparing Figs 1 and 2, one sees that prosperity declined between 1978 and 1982, when oil prices and interest rates were highest and GDP growth was fastest; and prosperity improved between 1982 and 1988 when oil prices and interest rates were falling, government spending was elevated and GDP growth was slowing. Given these data, one cannot attribute the Reagan prosperity to tax cuts, and one cannot look to GDP growth as a measure economic health. Do economists, pundits and politicians know this?

* There are some (but not enough) negative-feedback loops from dependent variables back to independent variables, antagonizing departures from a steady state--in the face of economic disturbances such as technological advances, international trade, educational outcomes, wars, resource variations, immigration, social justice, labor movements, etc. The feedbacks may be market forces (prosperity back to oil price), interventions (inflation and employment rate back to interest rates, government debt back to tax rates and government spending), regulatory (resource reserves and environment back to exploitation). Political doctrines distort these feedbacks.
* Employment rate (inverse of unemployment rate shown in Fig 2) is seen as a more sensitive and reliable index of economic health than prosperity shown in Fig 1. Nevertheless, comparing the two, one sees that the prosperity plot is meaningful. For example, the long employment recovery from 1958 to 1968 corresponds to a steeper prosperity rise from 1960 to 1969, likewise for 1982 to 1988 and other intervals.
* The unemployment plot looks almost like a delayed version of the interest-rate plot (CMT = Constant Maturity Treasury), and it looks almost like a delayed version of the oil-price plot in direction though not in amplitude. One can even see a correlation between government spending and economic health. Given these apparent dynamics regardless of tax rates, I conclude that the 1980s recovery would surely have occurred without the tax cuts, whose undeniable effects were massive government debt and social imbalance.

Prior to the tax cuts and spending increases of the 1980s, government debt relative to GDP declined. During the 1980 presidential campaign, Reagan (reportedly based on Laffer's theory) claimed that he could balance the budget while cutting taxes and increasing military spending. Fig 3 shows that his claim was false. Today's irrational national conversation about taxes and spending is the Reagan/Laffer legacy.

* As seen in Fig 4, Reagan's tax/spending policies increased the income share of the already wealthy, the richest 1% of Americans now getting 18% of income, a 2.25x increase from pre-Reagan years. The average 1%er now receives 25x what the average 99%er receives, ie the average 1%er receives about $500/hour or $4000/day. (Is this correct?) This was a deliberate policy to increase capital formation for the sake of entrepreneurialism. My experience is that businesses start and grow when paying customers have unmet needs and desires. More capital sloshing among the hedge funds contributes little if anything to economic health.
* Rich people don't know what's good for them. When they take power and rig tax rates to enrich themselves at the expense of budget balance, they don't feel satisfied, since their increased wealth gets them little they couldn't already afford and their social peers grow richer with them as a cohort. If at the same time they do nothing for average citizens, they are condemned as greedy. With all that power, they failed to arrange a just sharing of the benefits of technology with and among laborers. Now that everyone has smart phones and social media, there is a growing risk of civil unrest. Carried interest could become the cause celebre of unemployed and demoralized workers demanding restoration of economic justice.
* Laborers don't know what's good for them. They blackmail managers into wages and benefits that may not be sustainable. They should accept a base-pay/profit-sharing formula that ensures that their jobs endure as long as possible, in America.

* Fig 5 shows reveneues and expenditures causing the debt seen already in Fig 3. In passing, it is worth noting that we got through the Korean War, Vietnam War and the Great Society with modest revenues, modest expenditures, modest deficits, relatively good employment and declining debt/GDP. It seems to me that Reagan's tax cuts might have been a simple-minded response to more people earning into the highest bracket and complaining about it to their government buddies, top rate being 70%, this resulting in revenues 20% of GDP. It would have been better to leave the tax rates unchanged and to index the tax brackets to CPI so as to move revenues toward 20% of GDP, where it would have prevented the unbridled growth of debt. Any scientist or engineer could accomplish this if so commissioned, but Congress cannot be trusted to do it. The effects of this fine tuning are shown in the green Debt plot, where it is seen that our debt/GDP today would be a manageable half what it actually is, less than twice what it was in 1980. Without the housing-bubble collapse of 2007, government debt would be only 30% of GDP as it was before Reagan's tax cuts.
* Now, what about that Fiscal Cliff. As argued above, the 1980s recovery could be explained by falling interest rates, falling oil prices and increased spending, one or more of these initiating every recovery. While tax cuts might have contributed to the recovery, there is no evidence that they did. The even bigger recovery of the 1990s was again anticipated by falling interest rates, falling oil prices and some extra spending. The increases of income tax rate and capital-gains tax rate of the late 80s and early 90s clearly did not constitute a fiscal cliff. And the tax cuts of the early 2000s did not prevent the economic collapse of 2007. Since government debt is getting to be a serious problem and since there is no evidence that tax cuts ever had a beneficial effect or that tax hikes ever had a harmful effect on economic health, we should let the Bush tax cuts expire for all earning more than $100k/y or for everybody.
* With a model accounting for the influence of independent variables on dependent variables, one could estimate the sensitivity of any dependent variable to any independent variable. The above considerations support the view that economic-health measures (employment, prosperity) are extremely insensitive to tax rates. Any detrimental effect of the expected tax hike on economic health could be easily compensated by a modest regulatory or spending adjustment.
* The looming economic threat is not a tax hike; it's the European cash-flow imbalance that might lead to a sudden drop in European buying power.
Update: A 2017 expert analysis essentially agrees with the above, as does a more recent one.
David M Regen
Recreational Utopian
xmsdavidr@gmail.com

Fiscal Cliff or Fiscal Reform?

* I've been examining the past half century of macroeconomic data, because the national conversation about tax rates, economic health and employment seemed suspect.
* I've come to believe that gross domestic product (GDP) is not a valid measure of economic health, and its growth is not universally desirable. To a good approximation, GDP growth in recent decades is 15% population growth, 67% inflation, and 18% prosperity growth--as seen in this graph:

Those of us who care about the planet don't cheer for population growth. Those of us hoping for some dignity in retirement don't cheer for inflation. And since Republicans took power in 1980, essentially all prosperity growth has gone to the advantaged, this not to be praised by laborers, minorities and those of us wishing for more justice and balance.
* I've come to believe that the only macroeconomic variable worth cheering for is employment rate. There have been four substantial employment-rate recoveries in the past half century and two minor ones, these depicted in the over-struck phases of the unemployment plot in following graph:

Three substantial recoveries began during long periods of constant tax rates (income, capital gains, inheritance). One of them began after tax-rate reductions but also after large reductions of oil price from a stifling $100/barrel and of constant-maturity-treasury (CMT) interest rate from a stifling 20%, at a time when we still made much of what we consumed and so were hungry for credit. In fact, all employment recoveries followed interest-rate reductions and/or oil-price reductions. Interest rates are now negligible, so we need to explore new actions to increase employment rate without harmful side effects.
* In passing, note that the prosperity curve declined between 1978 and 1982, the period of peak oil price and peak CMT interest rate. It also declined between 2007 and 2009, when oil price again peaked and the housing bubble popped. Prosperity trends would be hard to identify in real time. It is interesting also that the CPI curve shows a phase of high inflation between 1968 and 1982, especially after 1973. Back then I attributed this to a strong labor movement and OPEC.
* There is not a scintilla of evidence supporting the hypothesis that cutting income, capital-gains and inheritance tax rates benefits average Americans. Tax cuts increased national budget deficits, increased national debt and enriched the rich--claims from the Business Round Table, Heritage Foundation, Cato Institute and local economists notwithstanding. This transfer of wealth from treasury to the privileged can be appreciated from the following two graphs:
*From http://www.usgovernmentspending.com:

Observe the climb of government debt relative to GDP following Reagan's reductions of income and capital-gains tax rates and his increase of spending relative to GDP.
*From Fred the Oyster at commons.wikipedia.org:

Observe the climb of Top 1% income share after Reagan's tax-rate reductions and spending increases. Both government debt and Top 1% income share rose again after Bush II's tax cuts.
* Next time someone claims economic benefits of tax cuts, please insist that they show you the data!
* Two recommendations emerge from these considerations: 1) Since the Bush tax cuts transferred money from the US Treasury to already rich people without improving economic health, Obama should let them all expire during the lame-duck period regardless of protests from the business world and regardless of his own four-year-old campaign rhetoric. 2) By decree or statute, all multistate retailers should be required to increase their US manufacturing labor expenditure by 1% of their foreign manufacturing labor expenditure after any year in which our unemployment rate averages above 7%--this constituting a walmartization-limiting negative feedback loop. There are several other innocuous tweaks that would improve the US employment rate.

Economic Dynamics

* The Republican propaganda machine has spent much of every day and night for three years blaming Obama for the slow economic recovery. I would argue that presidents deserve little praise or blame for economic swings during their terms. In case of the latest downturn, conventional tools for economic stimulation had been spent before Obama's tenure.
* Time courses of several economic swings are beautifully illustrated in a couple of graphs published on the web by Bill McBride. Seen in his graphs, the Great Depression was by far the deepest and longest period of job loss. Downturns between 1948 and 1980 were rather short lived. Then each subsequent downturn (1981, 1990, 2001 and 2007) was longer than the previous one. The first three of these were shallow, reflecting the responsiveness of economic activity to reductions of Federal Reserve interest rates. We grew complacent with the apparent ability of the Fed to prevent large recessions.
* Then came the catastrophic recession of 2007, which involved several bank failures. After several desperate actions to stop the bleeding, employment slowly improved and continued improving slowly until the present.
* The slowness of employment recovery in the present recession is due primarily to two facts: 1) Interest rates were already so low that lowering them had little effect, and 2) Businesses won't borrow to expand with fewer than normal customers and orders. In other words, economic actors weren't in a position to respond to a push from slightly easier borrowing. The economy hasn't been capital limited for decades.
* There is reason to fear an interruption of our slow recover, ie a second dip. This is due to imbalance among European countries, who are experiencing bail-out fatigue, and to maturing of the Chinese economy, which can't go on with infrastructure projects forever.
* Most of these factors are out of the president's control. However, there are outside-the-box policies that could get our economy back to a satisfactory steady state.

Economic growth and economic health

* Almost every day a current-events broadcast has someone prescribing more economic growth as a cure for some of America's troubles. I wonder whether there is a definition of economic growth that authorities can agree on. I'll bet that most pundits think that economic growth is GDP growth and that GDP growth is a measure of economic health.
* In fact GDP growth is largely a product of population growth and inflation, neither of which is universally desired. Those of us who feel an ethical obligation to future generations should be imagining, discussing and seeking a society that functions satisfactorily without population growth and with minimal inflation.
* GDP is a normalizing reference or denominator for numerous macroeconomic variables, such as tax revenues, government spending, market indices and especially national debt. For example, lenders' confidence in government bonds depends on (national debt)/GDP. But GDP and its growth is not economic health. In a developed society, one that produces plenty of what it needs, the most reliable expression of economic health is employment rate which is: 100 minus unemployment rate as percentage. In my opinion, this measure of economic health can be nudged to a satisfactory value by several small tweaks in public policy.
* Since GDP growth is mostly population growth and inflation, I postulate that growth of GDP/(population x CPI) should be a pure expression of what's desirable about economic growth. Population is measured only once per decade, so one must interpolate population to estimate this index annually. As seen in Fig 1, 0.1*GDP/(Pop*CPI) passes through 1.0 in 1960, so it is named "Prosperity relative to that in 1960". I calculated this "Prosperty rel 1960" for the past 6 decades and found something interesting.

Over this period, 0.1*GDP/(Pop*CPI) increased 2.47x (from 0.88 to 2.17).
* The important result is that Americans on average have well over twice the buying power of their grandparents. That is, we average people could save over half our incomes if we kept our appetites for stuff down to that of our grandparents, or we could use over half our incomes for nonessentials. Everybody who feels that rich hold up your hands. The increased buying power is due to technology and exploitation of poor foreigners holding down inflation.
* The problem is that this extra wealth has gone to the top 10% of Americans, none of it went to the bottom 90%, and the bottom 30% are poorer. If the increase of average buying power was indeed confined to the top 10%, then their buying power would have increased 25 fold. What did they do to deserve that? The wealth is obvious in southwest Davidson Co and Williamson Co. Perfectly good homes were razed to make way for McMansions, and new homes are super mansions--drive down Tyne Blvd, Hillsboro Rd and Franklin Rd.
* Should we discuss the ethical implications of the modern distribution of wealth? Is it right to leave the bottom fifth of our population out of productive employment when we are awash in money? Is failure to share life's satisfactions sinful? Is greed on the rise? What happened to noblesse oblige? This ain't my Utopia. Is it your Kingdom of God?

Unpatriotic Reaganomics

* A mature and intelligent person inquired of my bumper sticker, "No more Republican/Reaganomic Kool Aid". I discovered that most people don't realize that the economic paradigm under which we struggle is a contrivance of Ronald Reagan and Margaret Thatcher beginning after 1980, an economic experiment with a dubious rationale, not the natural order.
* The pillars of Reaganomics are: 1) deregulation to unleash commercial activity; 2) globalization to combat inflation; 3) tax cuts for the rich to stimulate investment; 4) faith in market forces to provide what society needs; 5) privatization of basic services for better efficiency and incentives. Each of these pillars might be helpful in small doses, but suicidal in large doses.
* Swallowed whole they translate to environmental degradation, resource depletion, loss of American jobs, Walmartization, idle mill towns, blighted cities, broken rungs on the economic ladder, anemic middle class, diffuse disaffection, transfer of wealth to foreign corporations and sovereign wealth funds, sequestration of wealth among corporate executives and Wall Street paper pushers, large and relentless government budget deficits hence rapid expansion of government debt now equal to the gross national product, epidemic corporate and personal bankruptcies, over-expansion of the military-industrial complex, toxic self-righteousness among those who compete successfully, neglect of infrastructure and utter failure to prepare for future inevitabilities.
* Reaganomics seems unpatriotic.

Obama & Robert Reich

* Since 1980, I've suspected that Reaganomics (tax cuts for the rich, globalization, deregulation, faith in market forces, privatization) would decimate our middle class, bankrupt the nation, deplete essential resources and pollute the world's support systems. We're 'bout there.
* Since 1980, corporate bankruptcies have been rampant, oceans and air are irreparably polluted, the lower rungs of the economic ladder are missing and the national debt has increased 10 fold, doubling under Bush II and now equaling the gross national product. Owing to corrupt election financing, our government has subsidized many industries that didn't need it and failed to incentivize industries essential for the nation's survival, specifically solar and hydrogen energy.
* Now joblessness and homelessness are at or near 50-year highs. With so many of us in this together, perhaps there will be fewer people groveling in self-righteousness.
* Sadly, Obama seems to accept much of the Reaganomic paradigm. It was somewhat encouraging to see Robert Reich among his economic advisers. He is best suited to steer our economy back to something widely satisfactory and sustainable.

Economic Crisis

Almost a decade ago, it seemed clear to me that a great deal of sadness would issue form home loans exceeding home values and homeowners using such loans to support unearned lifestyles. Home buyers were cynically encouraged to speculate with borrowed money, governments welcomed this phony contribution to economic activity, and the whole economy became more brittle.
I did not predict how contagious foreclosures would be, each foreclosure resulting in devaluation of neighboring homes hence foreclosures there and so on. Banks now hold massive numbers of foreclosed and devalued properties vulnerable to destruction by copper thieves.
Banks and governments should have recognized this epidemic at least three years ago and formed a plan to nip it in the bud. Up front, they might have outlawed variable-rate loans, liar loans and greater-than-value loans, they might have restricted loans for new construction, they might have regulated mortgage backed securities, etc.
When defaults started increasing, delinquent homeowners should have immediately been offered restructured loans according to an industry-wide agreed-upon formula arranged by government. For example, each delinquent loan might be converted to a 30-year mortgage with principal and interest appropriate for the time of the original purchase, then with interest adjusted annually in proportion to the change of property value since that time. That would reduce the bank's income for a few years, until housing inventory is brought into balance, but bank's principal would be salvaged. This is a modest, more flexible variation of the THDA plan, which is coming too late.

Reaganomic Debt

Reaganomics (tax cuts for rich, deregulation, globalization) has increased government debt 10 fold during 1/10 of our nation's existence, despite two world wars and several other wars during the other 9/10 of our existence. Thus, Reaganomics has increased the rate of debt accumulation to almost 100 times the previous average, with little to show for it.
I wonder who celebrates the economic trajectory that we are on, a vortex in which debt service is a large, growing and self-augmenting line item of the federal budget--this accompanied by the largest redistribution of wealth in history, from workers to wealthy.
Now we see that Reagan's deregulation and globalization were bad not only for Main Street but also for Wall Street. Record-breaking bankruptcies and bailouts are now commonplace. Business-friendly governance kills businesses.
We are flirting with bankruptcy, selling production assets, property and debt paper to sovereign wealth funds etc to finance ongoing operations of both government and business.
We may have already drunk too much Republican Cool Aid; but, with Sarah Palin in the race, chances are we'll elect to drink some more. We wouldn't be in this shape if a rag-tag bunch of Iranian students hadn't held our embassy personnel hostage back in the late 70s, thereby weakening Carter's image. Chaos theory is not just for butterflies any more.

Brittle Economy

The US economy is out of balance, hence the US way of life is unsustainable. We are too addicted to low consumer prices, high stock prices and convenience. Can a free society act rationally? We need to experiment with new ways to get things done.
1) We consume too much that we don't produce, so we spend much more on imports that we receive in revenues from exports. Our debts to foreign countries are huge and growing faster. Addiction to oil contributes much to this trade imbalance. Driving fuel-inefficient cars and living far from work are self destructive. Our building codes don't insist on high-R thermal envelopes and low surface/volume ratios. We have failed to support non-carbon (renewable, local) energy production. We have allowed too much of our manufacturing capacity to leave. These choices were political, not inevitable. As a result we are deep in debt to the more productive nations, most of which are not our friends.
2) US taxes are not sufficient to pay for federal programs. Our government spends much more than it takes in, with the result that national debt is huge and growing faster. Interest on that debt has become a very large component of the federal budget, which robs from programs and increases the debt even faster - the miracle of compound interest in reverse. Left as is, debt service will eventually consume the entire budget, ie it will be the only item in the budget. Debt service contributes to the negative trade balance. Cutting tax for economic stimulation is inefficient, temporary, undesirable. Satisfied, Grover Norquist & GW Bush?
3) Our culture and educational system don't sufficiently respect labor, encourage work ethic, teach trades, insist on work, reward hard labor. Fat, lazy & entitled are norms. We import workers at most levels: intellectuals, nurses, hospitality workers, builders, food producers and processors (We still grow inventors and entrepreneurs.) Many drop out of school early but don't have skills, work ethic or self respect to do needed work, and that work is so undercompensated that many who might be in that work force end up choosing crime while we import their replacements. The process is self augmenting. Some say that the massive import of laborers is necessary for several industries and to support our social-security system (which could be balanced by modest tweaking). One might ask whether an industry that needs massive imported labor is in need of more fundamental alteration to make it attractive to native citizens. There is no end of foreigners who would love to immigrate, but our population is already too big by some measures. The US will become like those places where the workers are coming from.
4) We believe that most problems can be solved by a growing economy. But economic activity is already bigger than the earth can support. Competition for energy, limitations of water, displacement of wildlife, pollution of air, water and land are consequences of expanding population and expanding economy. We are close to the maximal sustainable average world prosperity. It is hypocritical to pretend that a happier world will result from development of now small-footprint societies. The march for more economic activity is unsustainable. Time will come when Milton Friedman will be seen as the midwife of doom.