The Hypocrisy of the Deficit Squawks

I think the entire congress needs to spend the rest of its summer in a remedial economics course. If the sky is falling from the future size of the deficit, then why are we getting calls from the same folks to extend the Bush tax cuts to the rich? (This includes taxing things like dividends.) Why are they being deliberately inconsistent? It’s VooDoo economics again. The supply side Zombies will just not die. What’s worse is that some democrats are joining them.

My question is which is it boys? You can’t have it both ways. Is the source of all evil deficit or tax increases on the very rich? If the 80s and the naughts proved anything to us,it’s that lowering the tax rates on the rich does lead to a increase in the deficit and it does not stimulate the economy or investment as much as good old fashion government spending. It mostly leads to speculative asset bubbles that burst in every one’s face. Why does the middle and working class get the “let them eat cake” while the rich “get to have their cake and eat it to?” Where’s the economic theory and the common sense in that?

Top Republicans called on Democrats in Congress and the White House to extend all the tax cuts that are set to expire at the end of this year.

Sen. Judd Gregg (N.H.), the top Republican on the Senate Budget Committee, joined House Minority Whip Eric Cantor (R-Va.) in pushing for the extension of a series of taxes set to expire at the end of this year, including a series of cuts for households making more than $250,000 per year.

“If you want to do something to stimulate the economy, you could make clear that tax rates aren’t going to go up at the end of the year,” Gregg said during an appearance on CNBC. “If this administration really wants to stimulate, say they’re going to continue those tax rates — all those tax rates.”

The tax cuts on income and dividends that Republican Congresses had approved during the administration of President George W. Bush are set to expire at the end of 2010.

Senator Jon Kyl had to twist himself into a illogical pretzel to justify the position. I’ve always been amazed by the Republican ability to hold completely contradictory positions without having complete brain failure. For example, they demand the government be smaller and get out of peoples lives while wanting to control the domestic arrangements of GLBTs and women seeking reproductive health. That’s another one of those issues where the contradictions are painful to watch. Thinking you can lower the deficit while not taxing the people with the incomes and assets just boggles the mind. Don’t forget, that prescription also includes approving every military toy and adventure that comes across their desk save helping veterans.

Here’s a description of Kyl’s appearance on Fox from Ezra Klein.

“[Y]ou should never raise taxes in order to cut taxes,” Jon Kyl said on Fox News Sunday. “Surely Congress has the authority, and it would be right to — if we decide we want to cut taxes to spur the economy, not to have to raise taxes in order to offset those costs. You do need to offset the cost of increased spending, and that’s what Republicans object to. But you should never have to offset cost of a deliberate decision to reduce tax rates on Americans.”

What’s remarkable about Kyl’s position here is that it appears to be philosophical. “You should never have to offset cost of a deliberate decision to reduce tax rates on Americans,” he said. Never! This is much crazier than anything you hear from Democrats. Imagine if some Democrat — and a member of the Senate Democratic leadership, no less — said that as a matter of principle, spending should never be offset. He’d be laughed out of the room.

All of this comes about as the Democratic co-chair of Obama’s cat food commission calls the growth of the deficit a ‘cancer’. Why is it that congress seeks to balance the budget on the backs of those least able to pay for it and those who have benefited the least from the excessive spending?

Bowles said that unlike the current economic crisis, which was largely unforeseen before it hit in fall 2008, the coming fiscal calamity is staring the country in the face. “This one is as clear as a bell,” he said. “This debt is like a cancer.”

The commission leaders said that, at present, federal revenue is fully consumed by three programs: Social Security, Medicare and Medicaid. “The rest of the federal government, including fighting two wars, homeland security, education, art, culture, you name it, veterans — the whole rest of the discretionary budget is being financed by China and other countries,” Simpson said.

“We can’t grow our way out of this,” Bowles said. “We could have decades of double-digit growth and not grow our way out of this enormous debt problem. We can’t tax our way out. . . . The reality is we’ve got to do exactly what you all do every day as governors. We’ve got to cut spending or increase revenues or do some combination of that.”

Bowles pointed to steps taken recently by the new coalition government in Britain, which also faces an acute budgetary problem, as a guide to what the commission might use in its recommendations. That would mean about three-quarters of the deficit reduction would be accomplished through spending cuts, and the remainder with additional revenue.

Most Republicans in Congress are opposed to any tax increases, which has made the work of the commission far more difficult. Bowles and Simpson appealed for support to the governors, who have been forced by their states’ constitutions to balance their budgets with deep spending cuts and, in many cases, tax increases.

Americans faced similar budget issues after World War 2 and a lot of it was paid off by economic growth. However, growth seems elusive in the current environment. This is especially true because there has been no fundamental change in the systemic causes of the current financial crisis and deficit debacle. This policy choice we’re given now is ridiculous! Investment bankers who made bad bets get a blank check but we can’t extend unemployment insurance to the 2 million long term unemployed that just lost their benefits? Who is most likely to actually become a customer to businesses? Is it A, an unemployed person that needs to pay the rent and buy groceries or or B, Goldman Sachs that will take the cheap loan and game the market by arbitraging self-created paper?

Also, go back to the tax rates during that same booming period of post World War 2. Obviously, taxing the rich does not kill an economy. Here’s some examples of tax rates from the Eisenhower years.

The highest tax bracket on earned income today is 35%. During Ike’s administration, the highest tax bracket was 92% in 1953, and 91% thereafter [1]. Yes, taxes on the Rich were almost three times higher under the Republican Eisenhower compared to our current President, or compared to the Democratic administration of Bill Clinton!

Here’s the capital gains treatment for the Eisenhower period.

It is considered to be almost the gospel today that capital gains should be taxed at a far lower rate than earned income. Today the maximum capital gains tax rate is a whopping 15% on assets that have been held for at least a year since purchase. This is why the middle class, who are dependant on earned income, effectively pay taxes at a higher rate than do the wealthy.

In Ike’s day, capital gains were not treated differently from earned income, so the rich paid 91% tax on capital gains. From 91% to 15% – another reason why it’s good to be rich!

Note that in 1955, in the middle of Ike’s presidency, the typical (median) family paid less than 20% in all taxes [2]. By 2003, the total of all taxes paid by a typical family had more than doubled, to almost 40% of income.

So in Ike’s day, the rich paid a lot of taxes, the middle-class paid a little taxes, and somehow it all worked out.

Right now, there is a need for money to be given to the people who are mostly likely to spend it. State governments and poor to middle class people are the ones that come to mind. Banks are not lending out money. Businesses are sitting on money and not investing. They’ve got the lowest real interests rates possible now and they’re not expanding capital. Why would they if they have no customers walking through their doors?

Investors aren’t particularly happy with the market either. There appears to be a massive pay down of debt as a way of savings rather than money heading for the markets. Most of the market money is not coming from the individual investor. It’s coming from pension funds and such. That’s why Wall Street is so hungry for Social Security dollars. There’s very little new money coming into the market. They have nothing they can use to build new pyramid schemes asset bubbles. So where does stimulus come from if the government does not do it itself? It has to come from people that are most likely to be customers of business. Only the increase in customers will make a business expand its production. Either way, you have to get the money to the right people.

Here is a prelimary study out by Corsetti et al (May 2010) that empirically studies the impact of fiscal policy multipliers during financial crisis. (h/t to Paul Krugman) It basically reinforces the idea that fiscal stimulus in the right places is necessary to create a multiplying impact for federal dollars spent on sustaining the economy. Don’t try to read the analysis part, it’s extremely technical. Here’s the conclusion which is the part that policy makers need to understand. Corsetti is some one I follow a lot because of his work on exchange rates. There are some important findings for that. However, this last statement is germane to our conversation.

A second key finding relates to the marked increase in fiscal multipliers during times of financial crisis. On the one hand, this may be taken as evidence in support of fiscal stimulus during financial crises. On the other hand, our empirical results also suggest that many countries have historically cut back government spending during financial crises, presumably out of concern over debt sustainability. In this sense, a large conditional multiplier also provides a stark warning about the costs of financial turmoil, and an argument in favor of building up fiscal buffers in normal times so as to avoid fiscal retrenchment when it is most painful.

This is something that most economists that have a real feel for Keynes have being saying for years. Keynes didn’t recommend endlessly running budget deficits. He believed they were necessary during times of crisis. He recommended balanced budgets and surpluses during good times which is exactly what Bill Clinton’s administration did. He handed a surplus to Dubya Bush who immediately threw it away. A similar situation happened down here in Louisiana. The first year of the Jindal administration, Jindal was handed a surplus and a big rainy day fund. Rather than sitting on it, Jindal wanted to eliminate income taxes. This kind of behavior leads to future deficit problems.

Where are these deficit squawks when the government is running surpluses and in a good situation? Well, they generally throw caution to the wind and spend like crazy or rebate like crazy. You can’t do this and then turn around and complain about high deficits and demand tax cuts to the folks with wherewithal a few years later during recessions without sounding contradictory, crazy, and callous. But that’s the way with these Supply Side Zombies, they entice the middle class with the idea that they pay too much in taxes when the real motive is to stuff the pockets of the Bonus and the political donor class.

This financial crisis and the resulting deficit problems were not caused by the poor and working class. They are as much victims since they did not participate in the lavish incomes and tax cuts that came from the last asset bubbles fueled by low interest rates and low capital gains taxes. Why then, ask us to bear the burden of this sudden onset of restraint?