Reports from the Economic Front

The economist Ed Dolan sums up the current state of the U.S. economy in a recent blog post with the following headline: “Latest US GDP data show economy weak at year’s end but corporate profits near record high.”

The chart below, taken from that post, illustrates the steady rise in corporate profits.  As Dolan comments, “both before-tax and after-tax profits, stated as a percentage of GDP, reached their second highest level ever recorded, falling just short of their all-time highs of Q4 2011.”

One reason for this trend has been the ability of corporations to squeeze labor.  Fred Magdoff and John Bellamy Foster highlight this corporate success in their Monthly Review article “Class War and Labor’s Declining Share.”

The following four charts are taken from the article.  The first chart looks at total labor compensation as a percent of GDP.  The downward trend is visible but the extent of the attack on workers is somewhat masked since the data includes all workers and total benefits.  The second chart looks just at wages and salaries, again for all workers.

Chart 3 looks just at production and nonsupervisory workers.  These workers account for approximately 80 percent of all private sector workers.  We can see that while their share of total employment has remained relatively constant, their share of payroll has dramatically fallen.  Chart 4 compares wage and salary trends for production and nonsupervisory workers with trends for management, supervisory, and other nonproduction employees.

These last two charts make clear that the war on labor has been focused on production and nonsupervisory workers, and has been going on for decades.  And it doesn’t take much of a stretch of imagination to connect these trends with the growing suffering of most working people, the explosion in income inequality, and the rise in corporate profits.

But what are corporations doing with their profits?  As it turns out they are using their gains not to strengthen the economy but rather to reward their already wealthy stockholders (with dividends) and managers (with higher bonus boosting stock prices).

As the Wall Street Journal reports: “Firms Send Record Cash Back to Investors.” The article explains the headline as follows:

U.S. companies are showering investors with a record windfall in the form of dividends and share buybacks, helping to propel the stock market’s rally.  Companies in the S&P 500 index are expected to pay at least $300 billion in dividends in 2013, according to S&P Dow Jones Indices, which would top last year’s $282 billion. . . .

American corporations also announced plans to buy back $117.8 billion of their own shares in February, the highest monthly total in records dating back to 1985, according to Birinyi Associates Inc. a Westport, Conn.-based market research firm. Home Depot Inc., General Electric Co. and PepsiCo Inc. are among a number of large companies that announced plans last month to scoop up large amounts of their own shares. . . .

In returning money to shareholders, companies by and large are tapping into cash piles they have accumulated in the past few years by cutting costs or taking advantage of low interest rates to borrow funds. . . .

“Corporations are flush with cash and that cash sitting in the corporate coffers is earning next to nothing,” said Rob Leiphart, an analyst at Birinyi. “Companies have to do something with it.”

Clearly, all is well for those at the top.  And that is the problem for those of us opposing austerity.

While some austerity advocates really fear (although incorrectly) the consequences of deficit spending, the strongest proponents are actually only concerned with slashing government programs or the use of public employees to provide them.  In other words their aim is to weaken public programs and/or convert them into opportunities for private profit.

One measure of their success has been the steady decline in public employment.  Floyd Norris, writing in the New York Times notes:

For jobs, the past four years have been a wash.

The December jobs figures out today indicate that there were 725,000 more jobs in the private sector than at the end of 2008 — and 697,000 fewer government jobs. That works into a private-sector gain of 0.6 percent, and a government sector decline of 3.1 percent.

In total, the number of people with jobs is up by 28,000, or 0.02 percent.

How does that compare? It is by far the largest four-year decline in government employment since the 1944-48 term. That decline was caused by the end of World War II; this one was caused largely by budget limitations.

The chart below, taken from the same post also reveals just how weak private sector job creation has been over the past 12 years.

What follows is a screen shot of a graphic in a New York Times Business Day post.  It highlights just how significant the decline in public employment has been in this business cycle compared with past ones.  Each line shows the percentage change in public sector employment for specified months after the start of a recession.  Our recent recession began December 2007 and ended June 2009.   As you can see, what is happening now is far from usual.

It is also worth noting that despite claims that most Americans want to see cuts in major federal government programs, the survey data show the opposite.  For example, see the following graphic from Catherine Rampell’s blog post.

As Rampell explains:

In every category except for “aid to world’s needy,” more than half of the respondents wanted either to keep spending levels the same or to increase them. In the “aid to world’s needy” category, less than half wanted to cut spending.

Not surprisingly, this assault on government spending and employment will have real consequences for the economy and job creation.  Binyamin Appelbaum writes in the New York Times:

The federal government, the nation’s largest consumer and investor, is cutting back at a pace exceeded in the last half-century only by the military demobilizations after the Vietnam War and the cold war.

And the turn toward austerity is set to accelerate on Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government’s contribution to the nation’s gross domestic product by almost 7 percent in the last two years. . . .

Over the last two years, federal consumption and investment declined by 6.9 percent. Including state and local consumption, a larger category that has declined more slowly, the inflation-adjusted reduction since 2011 was 4.9 percent.

But Alec Phillips, an economist at Goldman Sachs, estimated that federal consumption could fall by another 11 percent over the next two years. Mr. Phillips also noted that those earlier rounds of cuts in the 1970s and the 1990s came primarily from the military budget. The sequester is designed to be indiscriminate, cutting everything from air traffic control to nursery schools.

That could increase the resulting pain, because economic research suggests that military cuts are less painful than other kinds of spending reductions.

“It is cutting some of the best spending that government does,” Professor Cowen said of the cuts that would fall on the domestic side of the ledger.

All of this takes us back to the starting point–we are talking policy here.  Whose interests are served by these trends?

There is general agreement that the economy is not growing fast enough to boost employment.  The question: What to do about it?

The response, at all levels of government, seems to be: increase corporate subsidies and lower corporate taxes in hopes that corporations will boost investment and, by extension, employment.  Those who promote this response no doubt reason that corporations must be struggling along with workers and need additional incentives and support to become successful “job-creators.”

The chart below, taken from a Paul Krugman blog post, certainly raises questions about this rationale and response.  It shows trends in corporate profits (in red) and business investment (in blue), both measured as shares of GDP.

As you can see, profits have clearly been trending upwards over time, especially during our current recovery.  At the same time, business investment, although improving, remains historically quite low.  It is hard to see a poor profit performance as the root cause of our slow growth and job creation.

Moreover, banks are sitting on record amounts of money.  The chart below, from the St. Louis Federal Reserve, shows that banks are holding approximately $1.5 trillion in excess reserves.  In the past, excess reserves averaged roughly $20 billion.  In other words, our banks just aren’t motivated to make loans.  And, instead of taxing these excess reserves to encourage loan activity, the Federal Reserve is actually paying the banks interest on their holdings.

Now, as noted above, it would not be fair to say that governments are not actively trying to create jobs.  It is just that they are going about it in the wrong way, the wrong way that is, if their aim is to actually create jobs.

Governments continue to shovel huge subsidies and tax breaks at our major corporations.  This, despite the fact that most studies find little evidence that they help promote investment or employment.  What they do, of course, is enhance corporate profits.  They also force cutbacks in public spending, which does have negative effects on the economy and social welfare.  Ironically, these negative effects then cause corporations to shy away from investing.

The New York Times recently ran a good series on state and local tax deals and subsidies written by Louise Story.  She wrote:

A Times investigation has examined and tallied thousands of local incentives granted nationwide and has found that states, counties and cities are giving up more than $80 billion each year to companies. The beneficiaries come from virtually every corner of the corporate world, encompassing oil and coal conglomerates, technology and entertainment companies, banks and big-box retail chains.

The cost of the awards is certainly far higher. A full accounting, The Times discovered, is not possible because the incentives are granted by thousands of government agencies and officials, and many do not know the value of all their awards. Nor do they know if the money was worth it because they rarely track how many jobs are created. Even where officials do track incentives, they acknowledge that it is impossible to know whether the jobs would have been created without the aid. . . .

A portrait arises of mayors and governors who are desperate to create jobs, outmatched by multinational corporations and short on tools to fact-check what companies tell them. Many of the officials said they feared that companies would move jobs overseas if they did not get subsidies in the United States.

Over the years, corporations have increasingly exploited that fear, creating a high-stakes bazaar where they pit local officials against one another to get the most lucrative packages. States compete with other states, cities compete with surrounding suburbs, and even small towns have entered the race with the goal of defeating their neighbors.

These subsidies can dominate state budgets.  The Times reports that they were equal to approximately one-third the budgets of Oklahoma and West Virginia and almost one-fifth of the budget of Maine.

Here in Oregon, we continue to struggle with budget shortfalls.  And, fearful of losing corporate investment, the state legislature is doing what it can to keep corporate costs down.  In December 2012, Governor John Kitzhaber called the state legislature into special session to pass a bill specially designed to help Nike.

Nike had privately told the Governor that it planned to spend at least $150 million in an expansion which it claimed would create at least 500 jobs over a five year span.  If the state wanted that expansion and those jobs to be in Oregon, it had to reassure the company that its current favorable tax treatment would remain unchanged far into the future.

Although state legislators were not pleased to be presented with a major tax bill with little if any time to study its terms, they passed it.  The new bill guarantees Nike that the state of Oregon will not change how it calculates the company’s state taxes for the next 30 years, regardless of any future changes in the state’s tax policy.  More specifically, it gives the Governor power to offer such a deal to any major company that plans to invest at least $150 million and create at least 500 jobs over a five year span.  It just so happened that Nike is the only company, at least for the moment, receiving this benefit.

To appreciate what is at stake in this deal a little background on how Oregon taxes multi-state corporations like Nike is helpful.  Prior to 1991, Oregon taxed Nike using a formula that considered the state’s share of Nike’s total property, payroll, and sales, with each weighted equally.  In 1991, Oregon double weighted the sales component.  This greatly reduced Nike’s state tax bill, since while its property and payroll are concentrated in Oregon, only a small share of its sales are made in the state.

Then in 2001, Oregon began introducing a “single-sales factor” formula.  As Michael Leachman of the Oregon Center for Public Policy explains:

Under this formula, only in-state sales relative to all US sales matter in determining how much of a company’s profits are apportioned to and thus taxable by Oregon; it doesn’t matter how much of their property or payroll is based in Oregon. The Legislative Assembly in 2005 cut short the phase-in process and fully phased-in the “single-sales” formula for tax years starting on or after July 1, 2005.

The Oregon Department of Revenue estimates that using the single-sales factor formula instead of the double-weighted sales formula is costing Oregon $77.6 million in the current 2005-07 budget cycle, and will cost another $65.6 million in the upcoming 2007-09 budget cycle. The projected decline in the cost of “single-sales” in the upcoming budget cycle is temporary. It is due primarily to a corporate kicker that will slash corporate tax payments by two-thirds this year. In subsequent budget cycles, the revenue hit from “single-sales” will return to a higher level. . . .

Take Nike, for example. Nike lobbied for the switch to single-sales factor apportionment and it’s easy to see why. At the Oregon Center for Public Policy, we conservatively estimate that Nike’s 2006 tax cut from “single-sales” was over $16 million. Other prominent, profitable firms such as Intel also received a massive tax break from “single-sales.”

As Michael Munk points out:

The governor’s deal is also particularly cynical when at a time of declining public services desperate politicians are dragging out a regressive sales tax out of mothballs and The Oregonian’s “fact checker finds “mostly true” a finding that Oregon’s existing tax breaks (including almost $900B a year in corporate welfare) exceed tax collections.

Of course, this stance towards the needs of Oregonians is nothing new for Nike.  In 2010, Oregonians voted in favor of two measures (66 and 67) which temporarily raised taxes on the very wealthy and corporations.  Phil Knight, the Nike CEO, not only gave $100,000 to the anti-Measures campaign, he also wrote an article published in the Oregonian newspaper in which he said:

Measures 66 and 67 should be labeled Oregon’s Assisted Suicide Law II.

They will allow us to watch a state slowly killing itself.

They are anti-business, anti-success, anti-inspirational, anti-humanitarian, and most ironically, in the long run, they will deprive the state of tax revenue, not increase it.

The current state tax codes are all of those things as well. Measures 66 and 67 just take it up and over the top.

Knight even threatened to leave the state.  He didn’t, but I guess the last laugh is his, now that his company’s tax situation is secure for the next 30 years.

So—what lies ahead—more counterproductive state policies and head scratching about why things are going poorly for working people, or a change in strategy?

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.

The following two charts taken from a Center for Economic Policy and Research Center study by John Schmitt and Janelle Jones highlight the distressed nature of the U.S. labor market and the need for raising the minimum wage and strengthening union organizing.

Schmitt and Jones define low wage work as that work paying $10.00 an hour or less in 2011 dollars.  As the charts show, low wage workers are far more educated and older in 2011 than in 1979.    Said differently, education and experience are not sufficient to ensure a living wage.

Not surprisingly, growing numbers of low wage workers at Walmart and at chain fast food restaurants have begun engaging in direct action for higher wages and better working conditions.   They deserve our support.

With the election over, the news is now focused, somewhat hysterically, on the threat of the fiscal cliff.

The fiscal cliff refers to the fact that at the end of this calendar year several temporary tax cuts are scheduled to expire (including those that lowered rates on income and capital gains as well as payroll taxes) and early in the next year spending cuts are scheduled for military and non-military federal programs.  See here for details on the taxes and programs.

Most analysts agree that if tax rates rise and federal spending is cut the result will be a significant contraction in aggregate demand, pushing the U.S. economy into recession in 2013.

The U.S. economy is already losing steam.  GDP growth in the second half of 2009, which marked the start of the recovery, averaged 2.7% on an annualized basis.  GDP growth in 2010 was a lower 2.4%.  GDP growth in 2011 averaged a still lower 2.0%.  And growth in the first half of this year declined again, to an annualized rate of 1.8%.

With banks unwilling to loan, businesses unwilling to invest or hire, and government spending already on the decline, there can be little doubt that a further fiscal tightening will indeed mean recession.

So, assuming we don’t want to go over the fiscal cliff, what are our choices?

Both Republicans and Democrats face this moment in agreement that our national deficits and debt are out of control and must be reduced regardless of the consequences for overall economic activity.  What they disagree on is how best to achieve the reduction.  Most Republicans argue that we should renew the existing tax cuts and protect the military budget.  Deficit reduction should come from slashing the non-military discretionary portion of the budget, which, as Ethan Pollack explains, includes:

safety net programs like housing vouchers and nutrition assistance for women and infants; most of the funding for the enforcement of consumer protection, environmental protection, and financial regulation; and practically all of the federal government’s civilian public investments, such as infrastructure, education, training, and research and development.

The table below shows the various programs/budgets that make up the non-security discretionary budget and their relative size.  The chart that follows shows how spending on this part of the budget is already under attack by both Democrats and Republicans.

Unfortunately, the Democrat’s response to the fiscal cliff is only marginally better than that of the Republicans.  President Obama also wants to shrink the deficit and national debt, but in “a more balanced way.”  He wants both tax increases and spending cuts.  He is on record seeking $4 trillion in deficit reduction over a ten year period, with a ratio of $2.50 in spending cuts for every $1 in new revenue.

The additional revenue in his plan will come from allowing tax cuts for the wealthy to expire, raising the tax rate on the top income tax bracket, and limiting the value of tax deductions.  While an important improvement, President Obama is also committed to significant cuts in non-military discretionary spending.  Although his cuts would not be as great as those advocated by the Republicans, reducing spending on most of the targeted programs makes little social or economic sense given current economic conditions.

So, how do we scale the fiscal cliff in a responsible way?

We need to start with the understanding that we do not face a serious national deficit or debt problem.  As Jamie Galbraith notes:

. . . is there a looming crisis of debt or deficits, such that sacrifices in general are necessary? No, there is not. Not in the short run – as almost everyone agrees. But also: not in the long run. What we have are computer projections, based on arbitrary – and in fact capricious – assumptions. But even the computer projections no longer show much of a crisis. CBO has adjusted its interest rate forecast, and even under its “alternative fiscal scenario” the debt/GDP ratio now stabilizes after a few years.

Actually, as the chart below shows, the deficit is already rapidly falling.  In fact, the decline in government spending over the last few years is likely one of the reasons why our economic growth is slowing so dramatically.

As Jed Graham points out:

From fiscal 2009 to fiscal 2012, the deficit shrank 3.1 percentage points, from 10.1% to 7.0% of GDP.  That’s just a bit faster than the 3.0 percentage point deficit improvement from 1995 to ’98, but at that point, the economy had everything going for it.

Other occasions when the federal deficit contracted by much more than 1 percentage point a year have coincided with recession. Some examples include 1937, 1960 and 1969.

In short, we do not face a serious problem of growing government deficits.  Rather the problem is one of too fast a reduction in the deficit in light of our slowing economy.

As to the challenge of the fiscal cliff—here we have to recognize, as Josh Bivens and Andrew Fieldhouse explain, that:

the budget impact and the economic impact are not necessarily the same. Some policies that are expensive in budgetary terms have only modest economic impacts (for example, the 2001 and 2003 tax cuts aimed at high-income households are costly but do not have much economic impact). Conversely, other policies with small budgetary costs have big economic impacts (for example, extended unemployment insurance benefits).

In other words, we should indeed allow the temporary tax rate deductions for the wealthy to expire, on both income and capital gains taxes.  These deductions cost us dearly on the budget side without adding much on the economic side.  As shown here and here, the evidence is strong that the only thing produced by lowering taxes on the wealthy is greater income inequality.

Letting existing tax rates rise for individuals making over $200,000 and families making over $250,000 a year, raising the top income tax bracket for both couples and singles that make more than $388,350, and limiting tax deductions will generate close to $1.5 trillion dollars over ten years as highlighted below in a Wall Street Journal graphic .

However, in contrast to President Obama’s proposal, we should also support the planned $500 billion in cuts to the military budget.  We don’t need the new weapons and studies are clear that spending on the military (as well as tax cuts) is a poor way to generate jobs.  For example, the table below shows the employment effects of spending $1 billion on the military versus spending the same amount on education, health care, clean energy, or tax cuts.

And, we should also oppose any cuts in our non-security discretionary budget. Instead, we should take at least half the savings from the higher tax revenues and military spending cuts–that would be a minimum of $1 trillion–and spend it on programs designed to boost our physical and social infrastructure.  Here I have in mind retrofitting buildings, improving our mass transit systems, increasing our development and use of safe and renewable energy sources like wind and solar, and expanding and strengthening our social services, including education, health care, libraries, and the like.

Our goal should be a strong and accountable public sector, good jobs for all, and healthy communities, not debt reduction.  The above policy begins to move us in the right direction.

There is growing talk that the economy is finally on its way to recovery—“A Steady, Slo-Mo Recovery”—in the words of Businessweek.

Here is how Peter Coy, writing in Businessweek, explains the growing consensus:

Job growth is poised to continue increasing tax revenue, which will make it easier to shrink the budget deficit while keeping taxes low and preserving essential spending. All this will occur without any magic emanating from the Oval Office. It would have occurred if Mitt Romney had been elected president. “The economy’s operating well below potential, and there’s a lot of room for growth” regardless of who’s in office, says Mark Zandi, chief economist of forecaster Moody’s Analytics.

Something could still go wrong, but the median prediction of 37 economists surveyed by Blue Chip Economic Indicators is that during the next four years, economic growth will gather momentum as jobless people go back to work and unused machinery is put back into service. “The self-correcting forces in the economy will prevail,” predicts Ben Herzon, senior economist at Macroeconomic Advisers, a forecasting firm in St. Louis.

Before we get lulled to sleep, we need some perspective about the challenges ahead.  How about this: we face a 9 million jobs gap, and this doesn’t even address the low quality of the jobs being created.

The chart below, taken from an Economic Policy Institute blog post, illustrates the gap.

As Heidi Shierholz, the author of the post, explains:

The labor market has added nearly 5 million jobs since the post-Great Recession low in Feb. 2010. Because of the historic job loss of the Great Recession, however, the labor market still has 3.8 million fewer jobs than it had before the recession began in Dec. 2007. Furthermore, because the potential labor force grows as the population expands, in the nearly five years since the recession started we should have added 5.2 million jobs just to keep the unemployment rate stable. Putting these numbers together means the current gap in the labor market is 9.0 million jobs. To put that number in context: filling the 9 million jobs gap in three years—by fall 2015—while still keeping up with the growth in the potential labor force, would require adding around 330,000 jobs every single month between now and then.

Unfortunately, our “job creators” only created 171,000 net jobs in October. And that was considered a relatively good month.   The chart below, from the Center on Budget and Policy Priorities,  gives a sense of what we are up against.

Of course, weak job growth in the past doesn’t mean that we cannot have strong job growth in the future.  On the other hand, such a change would require consensus on radically different policies than those currently being discussed and debated by those in power.

The good economic news, which got plenty of attention, is that the U.S. economy added over 170,000 new jobs in October.  The largely unreported negative news is that average real hourly wages in the private sector declined that month, and have been in decline for most of the past year.

It is hard to remember that the economy has been in expansion since June 2009.

Jeffrey Sparshott, in a Wall Street Journal blog post, offered the following chart of the trend in hourly earnings in private industry, with each point showing the change from a year earlier.

Citing a Labor Department report, Sparshott noted that:

hours worked were flat [in October] for the fourth straight month. Meanwhile, average hourly earnings for all employees on private payrolls fell by 1 cent to $23.58 in October. Over the past 12 months, earnings have risen a scant 1.6%. That’s not enough to keep up with inflation. The consumer price index was up 2% in September from a year earlier.

It’s even worse for blue-collar workers. Average hourly earnings of private-sector production and nonsupervisory employees edged down by 1 cent to $19.79, only a 1.1% increase over the past year.

The blog post quoted the HSBC’s chief U.S. economist who said:

This is the smallest increase in wages on record for the data going back to 1964. The persistently high level of unemployment over the past few years is clearly restraining wage gains and suppressing any inflationary pressures that might have possibly emanated from the labor market.

It also quoted the chief U.S. economist at J.P. Morgan Chase who said:

This pace of labor income growth may be quite acceptable for corporate profits, but it does pose headwinds for consumer spending growth.

Consumer spending did rise last quarter, helping to boost third quarter U.S. GDP, but this was largely because of a decline in the personal savings rate, which fell from 4.0% in the second quarter to 3.7% in the third.

We clearly don’t have a foundation for a sustained economic recovery, certainly not one that brings benefits to the majority of workers.  Instead of talk about austerity we need a real debate about the best way to strength worker bargaining power.

Presidential candidate Mitt Romney’s low federal tax rate—14.1%—has called attention to the fact that our tax code favors people who make their money from investments rather than labor.  According to the conventional wisdom, this is as it should be.  It encourages people, like our job creators, to invest their money, thereby boosting growth and the well-being of all working people.  Sounds plausible but the facts don’t support the policy.

BusinessWeek lays out the background and political context for our current low taxation rates on investment income as follows:  

Since 1950 capital gains have generally been taxed at a lower rate than income, to spur investment. The rate under President George W. Bush went from 20 percent to 15—the lowest ever—and was billed as a way to stimulate the economy. (If nothing’s done by Jan. 1 to change tax and budget provisions already passed by Congress, the rate will snap back to 20 percent, a scenario both parties hope to avoid.) Mitt Romney wants to ditch capital gains tax altogether for people earning less than $250,000. President Barack Obama, in his Affordable Care Act, increased the rate by 3.8 percent for high earners beginning in 2013, and has proposed the so-called Buffett Rule, which would among other things end an accounting interpretation that allows private equity and hedge fund managers (and Romney) to save money by paying tax on their earnings at the capital gains rate. Neither candidate, though, contests the Bush administration’s basic logic: that a lower capital gains rate encourages investment, which creates jobs and helps the economy grow. That doesn’t mean they’re right.

Leonard E. Burman, a tax expert, took on this issue in recent testimony before the House Committee on Ways and Means and the Senate Committee on Finance.   A good place to start is with who benefits from lower capital gains taxes.  

Not surprisingly, as the figure below (which is taken from Burman’s testimony) shows, the benefits are extremely concentrated.  As Burman noted:

In 2010, the highest-income 20 percent realized more than 90 percent of long-term capital gains according to the TaxPolicyCenter.  The top 1 percent realized almost 70 percent of gains and the richest 1 in 1,000 households accrued about 47 percent. It is hard to think of another form of income that is more concentrated by income.

Moreover, as the next figure shows, the concentration of capital gains has grown over time.  Given that the rich fund political campaigns, this certainly helps to explain why both political parties are so determined to keep the rate low.

But, to the main question—do lower capital gains taxes actually boost growth? This is what Burman had to say in his testimony:

The heated rhetoric notwithstanding, there is no obvious relationship between tax rates on capital gains and economic growth. Figure 4 [below] shows top tax rates on long-term capital gains and real economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, we’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series. The correlation is 0.12, the opposite sign from what capital gains tax cut advocates would expect, and not statistically different from zero. Although not shown, I’ve tried lags up to five years and using moving averages, but there is never a larger or statistically significant relationship.

Burman notes that he posted this figure on his blog and offered the data to anyone interested, challenging readers to find support for lower rates.  “A half dozen or so people, including at least one outspoken critic of taxing capital gains, took me up on the offer, but nobody to my knowledge has been able to tease a meaningful relationship between capital gains tax rates and the GDP out of the data.”

As reported in a previous post, Thomes L. Hungerford, writing for the Congressional Research Service, came to the same conclusion about the lack of any relationship between the capital gains tax and GDP.  In fact, he concluded raising the top income and capital gains tax rates would likely reduce income inequality without causing harm to the economy.  

So, if we are really concerned with the budget deficit, rather than slashing spending on social programs lets raise the top tax rates.  Wonder if this will come up during our presidential debates?

Politicians always seem to be talking about the middle class.  They need some new focus groups.  According to the Pew Research Center, over the past four years the percentage of adult Americans that say they are in the lower class has risen significantly, from a quarter to almost one-third (see chart below). 

Pew also found that the demographic profile of the self-defined lower class has also changed.  Young people, according to Pew, “are disproportionately swelling the ranks of the self-defined lower classes.”   More specifically some 40% of those between 18 to 29 years of age now identify as being in the lower classs compared to only 25% in 2008.

Strikingly the percentage of whites and blacks that see themselves in the lower class is now basically equal.  The percentage of whites who consider themselves in the lower class rose from less than a quarter in 2008 to 31% in 2012.  This brought them in line with blacks, whose percentage remained at a third.  The percentage of Latinos describing themselves as lower class rose to 40%, a ten percentage point increase from 2008.

And not surprisingly, as the chart below shows, many who self-identify as being in the lower class are experiencing great hardships.   In fact, one in three faced four or all five of the problem addressed in the survey.

 In short, there is a lot of hurting in our economy.