Archive for January, 2013
The British economy is a disaster. Oddly enough most analysts find it difficult to explain why.
Actually the reason is quite simple. The British government responded to its own Great Recession by cutting spending and raising taxes. The result, which is anything but mysterious, is that the county remains in deep recession.
Matthew O’Brien, writing in the Atlantic, describes the situation as follows:
public net investment — things like roads and bridges and schools, and everything else the economy needs to grow — has fallen by half the past three years, and is set to fall even further the next two. It’s the economic equivalent of shooting yourself in both feet, just in case shooting yourself in one doesn’t completely cripple you. Austerity has driven down Britain’s borrowing costs even further, but that’s been due to investors losing faith in its recovery, rather than having more faith in its public finances. Indeed, weak growth has kept deficits from coming down all that much, despite the higher taxes and slower spending. In other words, it’s economic pain for no fiscal gain.
Below is a chart taken from the Atlantic article. It shows that:
Britain’s stagnating economy has left it in worse shape at this point of its recovery than it was during the Great Depression. GDP is still more than 3 percent below its 2008 peak, and it hasn’t done anything to catchup in years. At this pace, there will be no recovery in our time, or any other time.
In other words, while the British economy suffered a deeper decline during the Great Depression period of 1930 to 1934 than to this point in the Great Recession which started in 2008, the economy recovered far more quickly then than now. In fact, it doesn’t seem to be recovering now at all.
Perhaps the most surprising thing about the situation is that political leaders appear determined to stay the course.
Considering the enormous time spent debating tax policy, it is easy to imagine that the U.S. must have one of the high tax rates in the world. Well, that is not the case.
The following graph is one of them. It shows the personal tax rate paid by people making the equivalent of $100,000 a year in 2012. The U.S. is the 55th ranked country out of 114 in terms of tax rates.
The next graph shows the same thing but for those earning the equivalent of $300,000 a year. The U.S. ranking is similar for this upper income group, 53rd highest out of 114.
Moreover, as Derek Thompson, the author of the Atlantic post, notes:
But these numbers might understate how low taxes have been in the U.S. Unlike most advanced economies, the U.S. don’t supplement personal income taxes with a national sales tax, or value-added tax (VAT). Consumption taxes accounted for about a fifth of total U.S. revenue in 2008 (mostly at the state and local level) compared to an OECD average of 32 percent. In other words, the U.S. relies uniquely on personal tax rates to raise revenue — and we have relatively low personal tax rates.
Finally, here is a look at the U.S. ranking among OECD countries for taxes as a share of GDP in 2008.
So, given that the U.S. doesn’t seem to be a high-tax rate country, why is tax policy so contentious? No doubt the answer has a lot to do with who actually pays the taxes and, perhaps even more importantly, what the revenue is used for.
The media continues to direct out attention to deficits and debt as our main problems. Yet, it does little to really highlight the causes of these deficits and debts.
The following two figures from the Center on Budget and Policy Priorities help to clarify the causes. It is important to note that the projections underlying both figures were made before the recent vote making permanent most of the Bush-era tax cuts.
Figure 1, below, shows the main drivers of our large national deficits: the Bush-era tax cuts, the wars in Iraq and Afghanistan, and our economic crisis and responses to it. Without those drivers our national deficits would have remained quite small.
Figure 2, below, shows the main drivers of our national debt. Not surprisingly they are the same as the drivers of our deficits.
Significantly, the same political leaders that scream the loudest about our deficits and debt have little to say about stopping the wars or reducing military spending and are the most adamant about maintaining the Bush-era tax cuts. That is because, at root, their interest is in reducing spending on non-security programs rather than reducing the deficit or debt.
Some of these leaders argue that the tax cuts will help correct our economic problems and thereby help reduce the deficit and debt. However, multiple studies have shown that tax cuts are among the least effective ways to stimulate employment and growth. In contrast, the most effective are sustained and targeted government efforts to refashion economic activity by spending on green conversion, infrastructure, health care, education and the like.
While Republicans and Democrats debate the extent to which taxes should be raised, both sides appear to agree on the need to reign in federal government spending in order to achieve deficit reduction. In fact, federal government spending has been declining both absolutely and, as the following figure from the St. Louis Federal Reserve shows, as a share of GDP.
In reality, our main challenge is not reducing our deficit or debt but rather strengthening our economy, and cutting government spending is not going to help us overcome that challenge. As Peter Coy, writing in BusinessWeek explains:
It pains deficit hawks to hear this, but ever since the 2008 financial crisis, government red ink has been an elixir for the U.S. economy. After the crisis, households strove to pay down debt and businesses hoarded profits while skimping on investment. If the federal government had tried to run balanced budgets, there would have been an enormous economy wide deficit of demand and the economic slump would have been far worse. In 2009 fiscal policy added about 2.7 percentage points to what the economy’s growth rate would have been, according to calculations by Mark Zandi of Moody’s Analytics. But since then the U.S. has underutilized fiscal policy as a recession-fighting tool. The economic boost dropped to just half a percentage point in 2010. Fiscal policy subtracted from growth in 2011 and 2012 and will do so again in 2013, to the tune of about 1 percentage point, Zandi estimates.
If we were serious about tackling our economic problems we would raise tax rates and close tax loopholes on the wealthy and corporations and reduce military spending, and then use a significant portion of the revenue generated to fund a meaningful government stimulus program. That would be a win-win proposition as far as the economy and budget is concerned.