A little something about you, the author. Nothing lengthy, just an overview.
Barack Obama exhibited this week what Machiavelli called the essential quality of a successful statesman, "virtu," or the capacity to advance a society's vital interests while respecting the constraints of conditions beyond his control. The vital interest at stake here is a decent economic expansion that improves the circumstances of the vast majority of Americans, and the critical condition beyond the President's control was the Republicans' ability to block any tax increase for a very small minority of high-income households. While this week's tax deal isn't nearly enough to drive a robust recovery, it should be good economic news for most Americans.
Yes, the President agreed to two more years of the Bush tax cuts for very well-to-do people, covering their overall incomes, dividends and capital gains, and sheltering all but the very richest estates from inheritance taxes for two years. But those were concessions to conditions beyond his control, since without them, there would have been no action at all. Moreover, in return the President won the GOP leaders' acquiescence to some significant help for nearly everyone else. Beyond two more years of lower tax rates for average Americans, he secured expanded tax credits for parents putting their children through college, a one-year payroll tax reduction for working people, an expanded Earned income Tax Credit for working poor families, and an additional year of unemployment benefits for millions of out-of-work Americans.
To be sure, that won't be enough to drive a strong expansion. That still requires difficult measures to correct the distortions that brought on the original financial crisis and still continue to dampen the expansion. A strong revival of consumer spending, of the sort that powers most early expansions, still depends on steps to stabilize housing prices. And while this week's deal includes another dose of tax breaks for business investment, a surge in business spending will have to wait for consumers to begin spending freely again and for lenders to clear their books of billions of dollars in real estate-related investments that continue to deteriorate. Nevertheless, the deal passes the basic test of sound economic policy by moving the economy in the right direction, and should help nudge the jobless rate down a bit.
The temporary nature of these measures also provides intriguing opportunities for Democrats. The payroll tax reduction would expire one year from now, just as the 2012 campaigns get going. Ultimately, neither party would let that happen, but the President could use its prospect to drive progressive social security reforms. For example, the 2 percent cut in the payroll tax rate for employees could be phased out very gradually, and the lost revenues could be offset by raising the cap on the wages subject to the tax. The 1983 social security reforms set the cap to cover 90 percent of all wages, rising each year at the same rate as average wages. But since the wages of those at the top have grown much faster than the average, today the cap covers only 85 percent of wages. Push it back to 90 percent, as the Bowles-Simpson Commission has proposed, and we could phase out the "temporary" tax rate reduction over a decade's time and take a big step towards guaranteeing the system's long-term solvency.
Moreover, the tax cuts for high-income Americans could be more vulnerable politically two years from than they are today. It's safe to say that the deficit will be a hot-button issue in 2012, and with the Bush tax cuts now set to expire in January 2013, the election-year deficit debate will include heated arguments over who should have to pay higher taxes. According to current polls, at least, the public's answer is those high-income folks.
While the loudest complaints about the deal have come from progressive Democrats, the real question is why the Republicans agreed to it. For all of the GOP's talk about jobs and deficits, the deal exposes their real bottom line: Preserve at almost any cost lower taxes on the incomes of the top 2 percent of Americans and on the estates of the top 0.5 percent. The deal equally highlights the President's priorities "” tax relief for the middle class, and help for the unemployed and the poor. And if the economy finally begins to gather steam by 2012, the contrast embedded in this week's deal might well boost the President's prospects.
The political struggle over how the federal budget will shape American government is now in full swing and likely to dominate Washington for the next two years. This week, the President joined the battle by proposing a two-year freeze on federal pay, his symbolic version of Bill Clinton's maxim that "the era of big government is over." In doing so, he aligns himself with growing public skepticism about the value of much of what Washington does. Yet, the anger driving the public debate isn't really about federal spending much less federal pay. It's about continuing high unemployment and stagnating incomes, because if Washington can't get that right, what credibility does it have to manage everything else the public pays for?
There's another, more subliminal factor feeding the public's anger about taxes and spending, and the only accurate term for it is economic class. Most Americans are fine with rich people getting richer, even when they get richer faster than everyone else "” as long as the rest of us make progress too. But that's clearly and painfully not the case today "” the stock market and corporate profits are way up and multi-million-dollar Wall Street bonuses are back; while high unemployment won't budge, wages are down, and the value of most people's homes keep falling. On top of that, it was middle-class Americans who financed a recovery, through taxpayer bailouts and emergency spending, which so far seems to benefit only the wealthy. These factors alone should give Republicans pause as they prepare to block the extension of unemployment benefits and hold tax cuts for the middle-class hostage to preserving the tax cuts for the well-to-do.
The bigger political question is how most Americans would feel about the GOP's hard-line positions, if they realized how much the economy in recent years has tilted to favor the wealthy. Recent data from the Federal Reserve document this tilt. In 2007, for example, the top one percent of Americans owned about 35 percent of all of this country's assets or wealth "” including houses, stocks, bonds, businesses, and so on "” and the top 10 percent owned 70 percent of those assets.
The distribution of financial assets is even more skewed: In 2007, the top one percent owned 43 percent of the total value of all bank accounts, stocks and bonds, business equity, mutual funds, pensions, and retirement savings; and the top 20 percent of Americans owned an astonishing 93 percent. Ownership of only one type of asset is still spread around fairly broadly: With 70 percent of Americans being homeowners, the bottom 90 percent owned 40 percent of the total value of all residential real estate in 2007. But that fact is no longer evidence for the conservative trope that good times for the wealthy presage good news for everyone else: Since 2007, the housing bust has destroyed about 30 percent of the value of American homes, and it was triggered by Wall Street geniuses who took the taxpayer bailouts and now are pocketing multi-million dollar bonuses.
The tilt towards the wealthy is also much less steep in most other societies. While the top 10 percent of Americans own 70 percent of this country's wealth and assets, the top 10 percent of Britons own only 56 percent of the wealth of their nation, the top 10 percent of Canadians own just 53 percent of their country's assets, and the top 10 percent of Germans hold but 44 percent of the assets of their nation.
The gap in incomes also has grown substantially over the last generation, and that suggests that the wealth disparities will only continue to increase. From 1982 to 2006, for example, the share of all annual income claimed by the top one percent of Americans increased from 13 percent to more than 21 percent; and the top 20 percent of us took home more than 61 percent of all the income earned here in 2006. Put another way, 80 percent of Americans have to divvy up about 38 percent of all the income generated in our economy. To be sure, a modestly progressive tax system ensures that the top one percent and the top 20 percent both contribute slightly larger shares of all federal revenues than they collect as income. But their share of federal revenues is also much smaller than their fast-growing share of the nation's wealth.
These disparities have grown not from our politics, but from the way the economy is evolving. For example, our economy is increasingly capital-intensive "” just consider, for example, how much more technology-dense most offices and workplaces are today, compared to just 20 years ago. Since capital is the source of more wealth creation than before, the wealth of those who own most of it has been growing faster. Incomes also are linked closely to the ability to work with all of that capital, increasing the income share of the top 20 percent of Americans with the most advanced skills and education. It is certainly not the burden or responsibility of government to alter the economy's natural course. But when that course precludes meaningful economic progress for most people and creates profoundly undemocratic disparities in wealth and incomes, it surely becomes the government's responsibility to ensure that the majority can genuinely thrive in that economy.
That's a budget battle that President Obama could champion with confidence. For example, a good handful of subsidies for various industries would pay for low-cost access to college and graduate training for any young American with the drive and ability to see it through "” as Britain, Germany and other countries, all with much smaller disparities of wealth and incomes, do. A small tax on financial transactions could float a new program of low-cost loans for homeowners with troubled mortgages, and so help stabilize the housing values that comprise the only asset of most Americans. Even a modest reform of the "carried interest" tax preference for hedge funds and private equity funds could more than pay for grants to community colleges to provide free computer training for any working person who wants it. And surely it's time for the new realities of wealth and incomes in the United States to provide part of the framework for reforming our taxes and entitlements.
Here are a few thoughts on the breaking news from the FCC on net neutrality, a matter I've written about repeatedly for several years.
Today, FCC Chairman Julius Genachowski spelled out his proposal for new rules for the regulation of broadband networks. They won't satisfy everybody, and some outspoken advocates of so-called network neutrality are already throwing their stones, but the truth is, they're pretty balanced and reasonable. Mr. Genachowski wants the Commission to vote before the year ends, so they can use 2011 to focus on critical issues such as universal broadband. Progress in that area "” the key to digital equality "” has been slowed by the telecom community's focus on the neutrality rules.
In brief, the Chairman's proposal outlined at a press conference today (December 1st, 2010) would bar service providers from blocking any consumer's access to any legal websites and applications of their choosing, and from unreasonable discrimination in delivering Internet traffic. Net neutrality advocates may not acknowledge it, but that's a big win for them "” it directly addresses their fears that the large service providers will become gatekeepers to the web, deciding what consumers can do online. For their part, the companies have always insisted that they have no interest in being gatekeepers, and this proposal should make that part of the debate moot.
On the other side, Mr. Genachowski's framework shouldn't interfere with the incentives that the providers need to invest an estimated additional $300 billion or more in broadband infrastructure, to handle the sharp recent and projected increases in bandwidth demand coming largely from video applications. The Commissioner did just the right thing by confirming the service providers' right to manage their networks for congestion and offer specialized services to boost their bottom line. And the best news is that it also should help the economy in coming years.
Most of Washington is stuck “in what we call the reality-based community . . . people who believe that solutions emerge from your judicious study of discernible reality. That’s not the way the world really works anymore. . . . When we act, we create our own reality." Karl Rove, 2004.
Rove's famous comments came to mind this week as President Obama and his political rivals launched new policy offensives. Hop-scotching across Asia, the President nudged the center of U.S. foreign policy towards international economic interests and concerns. From Delhi and Jakarta to Seoul and Tokyo, he has focused on the predominant economic realities that inform the decision-making of our major allies and competitors. In the process, he has begun to recast our critical relationships around issues that allow the United States to draw on its greatest advantages, a market four times larger than China's, and our capacity to develop the advanced technologies and business methods driving modernization across the world.
Back in Washington, congressional Republicans launched their own offensive, trumpeting their plans to use their majority in the House of Representatives and expanded numbers in the Senate. But their agenda seems to draw less on the hard realities that drove most of those who went to the polls two weeks ago "” jobs and incomes "” than on the full-throated ranting of the more extreme elements in their political base. As if saying so will make it so, they are uniting around non-negotiable demands to repeal health care reform, cut taxes for high-income people, and slash domestic spending in unspecified ways.
These dueling offensives recall the 1990s even more than the Bush era. Bill Clinton came to office on the heels of the collapse of global communism, and so happily refocused American foreign policy on international economic matters. Barack Obama was less fortunate, with two wars and worldwide economic turmoil dominating his early foreign policies. But less than two years later, the Iraq conflict is winding down, the Afghan war has a new course, and global markets are more stable. So for now, he can concentrate on the economic concerns "” currency values, trade barriers, debt, and worldwide demand "” that once again are central factors in our real relations with other nations. And as in the 1990s, real movement on these international issues can help build a foundation for the progress on jobs and incomes at home that dominates the President's domestic agenda.
Appropriately, the President chose the world's most economically-consequential region, Asia, to quietly launch his new foreign-policy offensive. His agenda began with new commercial openings and investment arrangements with India and with Indonesia, two of the world's fastest-growing and most protected large markets. Next, he turned to the G-20 summit in Seoul, where he fended off Chinese criticism of our monetary stimulus and called for measures to address the global imbalances that set the stage for the 2008 global meltdown. He will wind it up in Japan, the world's third largest economy, where he will lead discussions on currency, trade and economic growth at the Asia Pacific Economic Cooperation forum. Whatever the outcomes of all of these meetings and agreements, the President is subtly shifting the focus of American influence to the real matters that drive our relationships with most other countries.
Back home, economic reality for many of the President's opponents "” John Boehner is a lonely exception "” is being redefined by the likes of Glenn Beck and Rush Limbaugh. Somehow, hundreds of billions of dollars will be cut from the budget without touching the defense programs and entitlement benefits which account for most spending. Next, all of the Bush tax cuts must be extended forever, even in the face of the GOP's sky-is-falling rhetoric on the deficits. And any compromise on the tax cuts in the lame duck session, before they expire on December 31st, is off-the-table "” despite GOP attacks on the President for allegedly fostering "economic uncertainty." Prominent Republicans this week also attacked the Federal Reserve's "quantitative easing" program to support growth, as if the prescription for jobs and incomes in a weak economy is to end monetary as well as fiscal stimulus. Ironically, this last offensive echoes China's position that the new Fed policy will make U.S. exports "unfairly competitive."
These implacable opponents' latest gambit involves the debt ceiling, which will come up in the early months of next year. Some Republicans in both the House and Senate now threaten to block this normal procedure on the principal that's already too high for their comfort, while others propose to let it go through only if the President agrees to $300 billion in budget savings "” again without specifying any real cuts they would support. This one is dangerous even as just a threat, since any serious suggestion that the United States might find itself legally unable to pay the interest on its' Treasury notes and bonds would sharply drive up interest rates. In the real world, that would cut off the fragile recovery and possibly send the entire world economy into a tailspin.
Politics always involves a good deal of posturing and shenanigans. But these escapades, at this moment, have real consequences, not least of all for millions of struggling Americans who apparently hope that divided government will restore their jobs. By definition, divided government can produce the results that voters want only through reasonable compromise. And much as when Newt Gingrich and his fantasy-fueled followers took power, if the radicals leading the offensive this time continue to deny that fact, they too will find themselves bested by a reality-based president.
This week's seismic shift in the Congress will not change the problems facing its members and the President. This is the third consecutive election to bring large losses for the party in power, all for the same reason. For a decade, neither party has been able to deliver the rising incomes and economic security that matter most for average Americans. For all of the stark differences between the Bush and Obama presidencies, these economic results and the political outcomes that have followed are less surprising than one might think. That's because the Obama administration, despite its rhetoric and efforts, finds itself backed into a version of the same, failed trickle-down economic model that its predecessor embraced openly.
Yes, the last two years of Democratic dominance produced small gains in jobs, especially compared to the massive job losses at the close of Bush's term, and modest gains in incomes compared to stagnating wages under the Republicans. Like his predecessor, however, Obama now presides over an economy that continues to produce much greater gains for those at the top. While most Americans are struggling, corporate profits are up sharply, and the stock market has recovered all of the ground it lost in the financial crisis and its aftermath. Perhaps most galling, Wall Street is preparing to hand out another round of mega-bonuses, dismissing the fact that they were the ones who brought down the economy for everyone else, and that the average people who bailed them out aren't sharing in their private boom.
Most Americans accept, at least intuitively, that the financial bailout ultimately saved everyone from a much worse economic fate. But the public's anger tells us that voters also sense that Wall Street's rapid return to good times wasn't accidental. They're right: Once again, Washington made the restoration of big profits for Wall Street the lynchpin for a broader recovery. The key was the administration's decision, once further stimulus to directly support average people seemed to be off-limits, to embrace the indirect approach of massive, ongoing monetary stimulus. Its principal element was open access at the Fed for big finance to borrow funds at near-zero interest rates, which the administration's economic team hoped would jumpstart business investment and large consumer loans.
In practice, Wall Street didn't use much of more than $1 trillion in nearly-free money to expand business lending. With consumer spending sidelined by high unemployment and the still-falling housing market, demand for business loans remained slow. Moreover, once the big financial institutions were safely bailed out, they used their unlimited and nearly-free funds from the Fed to buy U.S. and foreign government securities and other safe instruments, generating the large profits that now fund their bonuses.
This trickle-down approach has been further amplified by the Fed's "quantitative easing" program. That's their latest effort "” the second time in two years "” to get the trickle going by buying up to $1 trillion in nearly any long-term assets that Wall Street wants to unload. It hasn't worked yet: Last week, the report on third quarter GDP showed that most of the tepid, 2.0 percent growth came from inventory buildup, while final sales slumped. So long as the trickle doesn't reach most Americans, the Fed's efforts won't work politically either.
In fact, there were alternatives "” and there still are. A more effective approach, for both the short and long terms, would link immediate new spending and tax reductions for most Americans with long-term entitlement changes to control deficits down the line. Given the scale of the economy's current troubles, this is an opportunity for the administration to think big "” for example, a multi-year payroll tax holiday and new light rail systems for the nation's 30 largest metropolitan areas; new research initiatives on the scale of the moon shot for green fuels and technologies and medical breakthroughs; or free tuition at public colleges for students from families earning less than $120,000, an approach now in place at Harvard and other elite universities.
Perhaps most important, the economy needs a federal loan program for families with mortgages in trouble to help stabilize housing prices by keeping foreclosure rates in check. Such a measure could short-circuit much of the "negative wealth effect" from falling housing prices, which continues to hold down consumer spending and, with it, business investment. Yet, when one loudmouth on cable TV ignited a rightwing cry against direct federal assistance to keep people in their homes, who among the Democrats had the gumption to refute him?
What approaches can we expect from the Republicans who will run the House of Representatives? Their leading proposition is to extend the Bush tax cuts, on the view that you don't raise taxes in a weak economy "” and they're basically right. Of course, they also want to cut current spending, which would slow the economy more than restoring the Clinton-era tax rates for high-income people. The truth is, most Republicans are all talk on the deficit. Apart from Paul Ryan and his handful of true-believers, the GOP is probably no more willing today to pull back current pending for any sizable group or interest than they were under George W. Bush, when federal spending grew at the fastest rate since LBJ.
Yet, there may be opportunities to agree on something beyond the expected, temporary extension of the Bush tax cuts. President Obama can begin by going beyond trickle-down and pressing for major initiatives to directly help average Americans, including payroll tax relief and mortgage loans, linked to long-term spending reforms for the entitlement programs. If the Republicans refuse, that's a debate the President should welcome as he prepares his run for reelection.
The French statesman Georges Clemenceau famously called war "too serious a matter to entrust to military men"; and in the same spirit, national budgets in a democracy are too important to leave to economists. But no sensible government would wage war without listening to generals and admirals, and the National Commission on Fiscal Responsibility and Reform "” aka the National Deficit Commission "” would be equally well served to consider basic economics more carefully. This week's leaks from the Commission include reports that its members are leaning towards cutting back the deductions for mortgage interest and employer health insurance payments. This approach could certainly raise a lot of money in the short run. But for an economy suffering as ours is from weak demand, a fragile housing market, and a decade of slow hiring and income gains, these proposals are economically illiterate.
Listen up, National Deficit Commission. This is the wrong time "” maybe the worst time "” to target the mortgage deduction. Falling housing values have been the single largest force holding down consumer demand, and with it investment and growth, because their decline leaves the 70 percent of Americans who own their homes poorer. That has created a classical, negative wealth effect which dampens spending. On top of that, these falling housing values sharply raise the ratio of most people's debts to their assets, moving most people to reduce their debt. And that has meant fewer large purchases and less credit-card buying.
Cutting the mortgage interest deduction would only intensify these dynamics, because the value of that deduction is incorporated or "capitalized" in housing prices. When prospective home buyers try to figure out whether they can afford the monthly payments on a particular house, they naturally factor in the value of the deduction. Buyers are willing to pay more than they would without the deduction "” and sellers demand more than they could without it. Reduce the deduction, and buyers will be able to afford less, sellers will have to accept less, and housing values will fall further.
There are reasonable arguments for paring back this deduction, since it channels so much investment into housing. Of course, that's its explicit intention, so home ownership can be part of the American dream. And yes, a smaller deduction would raise considerable revenues. But doing it would inescapably further drive down housing values, and doing it now could lock in years more of slow economic growth.
This is an equally ill-timed moment to cut back the deduction for employer-provided healthcare insurance. Once again, there are reasonable arguments for rethinking this deduction, but shrinking the deficit under current conditions isn't one of them. Limit this deduction for employers, and hiring costs will go up at a time when job creation is already historically weak. Worse, the change would raise the cost of retaining people working today, creating new pressures for more layoffs. The Commission may be talking about taxing workers, not businesses, on some share of the value of their employer-provided health insurance. That seems no more sensible economically at this time, since it would reduce most people's after-tax incomes at a time when their consumer spending is historically weak.
The truth is, this is not the time for any short-term deficit reduction. We tried fiscal tightening in 1937, at the early signs of recovery from the Great Depression, and it bought us four more years of slow or negative growth. Japan tried it too in the mid-1990s, during the early stages of their recovery from a financial meltdown, and it set off another half-decade of economic stagnation. Now Britain's new conservative-coalition government is trying budget austerity, and the results almost certainly will be similar.
Yet, it also would be foolish for the Commission to squander this rare public support for deficit reduction, so long as its members focus on the long term and consider the economic fallout from their various brainstorms. The place to begin is with the two forces driving the long-term deficits "” prospective, fast-rising entitlement spending, and taxes that raise sufficient revenues only when the economy booms. On the spending side, Social Security could be the relatively easy part, because its budget gap remains comparatively small for many years "” if Americans are prepared to accept smaller benefits down the line. Experts figure, for example, that we could close one-third of that gap by using the CPI for the elderly, rather than the higher overall CPI, to calculate future cost-of-living adjustments. And much of the rest of the problem would fade away if we tied the annual increase in people's initial benefit to a combination of wage gains and inflation, rather than just wage gains.
The harder part involves Medicare and Medicaid costs. As with Social Security, the main difficulty lies not in figuring out how one could slow annual cost increases in health care, but rather in marshalling majority support for such measures. In fact, the President's health care reform already included a catalogue of approaches to slow the growth of medical costs, albeit on a limited scale or in weak form. The Commission could urge Congress to scale up and strengthen those measures. If those reforms work, they not only would generate large budget savings down the line. The same approaches also would support jobs and incomes, since fast-rising health care costs have significantly slowed job creation and wage progress.
The Commission purportedly has agreed to use additional revenues to close one-third of the long-term deficit. Assuming that additional taxes would go into effect only once the economy fully recovers, higher taxes for wealthy Americans would raise revenues without severely damaging demand, since they don't spend nearly all that they earn. The same idea could even be applied to industries which, by economy-wide standards, earn abnormally high profits. By this measure, the leading candidate is finance. A small tax on financial transactions, for example, would raise substantial revenues for the deficit with little adverse effect on the overall economy if other advanced countries follow suit "” and Germany, France and the United Kingdom all have indicated interest.
And if the Commission wants to tackle broader tax reform, the top candidate should be a carbon-based fee on energy. A tax on greenhouse gas emissions not only would restore U.S. leadership on climate change. It also could turbo-charge the development and deployment of green fuels and technologies, a potential source of exports; and reduce our dependence on foreign oil and the consequent distortions in our foreign policy. And if Congress set a carbon tax high enough to sharply reduce CO2 emissions, a good share of the revenues could go to reduce payroll taxes, spurring job creation and income gains.
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