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 July 2004 There's No Debate
How else can you explain some of the charges from the political hustings? It will only get worse as Election Day draws closer. The economy, which impacts every voter every day, has drawn more than its share of distortions. The purportedly unfair nature of tax cuts, the "Middle Class Squeeze", and the evil deficit constantly fill the headlines. But how much of this is good economic theory and how much is just political spin? Some issues just take a little thought instead of rhetoric. Tax CutsPerhaps no economic issue has gotten more press than President Bush's tax cuts. Are they fair? Have they made the divide between the richest and poorest Americans even greater? Are they responsible for the current national deficit? Did they spur a recurrence of inflation? Are they they source of all that is bad in the world?OK, we made that last one up, but from some of the things quoted in the press, you'd think that was the result. The facts, while not nearly as exciting as some of the sound bites, are really fairly easy to discern. •Tax cuts are unfair. Not to sound too much like ex-President Clinton, but this all depends on your definition of the word "fair". If by "fair" you mean everyone getting exactly the same benefit, then no, the President's tax cuts weren't fair. But if you define "fair" as equitable, then they were as fair as they could be. To see why, consider a simple example. Suppose you and I have just finished dining at a fine restaurant. The check arrives and you graciously pick up the tab. Before we can leave however, the waiter stops us and informs us he accidentally over-charged us and returns $50 to you. After he leaves, I ask you for $20 since the money he returned was based at least in part on the cost of my meal, too. Would you hand over the money? Wouldn't that be the fair thing to do? Of course it wouldn't! You paid the bill, you were over-charged, and you are entitled to the entire refund. It's preposterous that I could feel slighted in this transaction. So why isn't it equally preposterous when politicians claim that the President's tax cuts unfairly favor the rich? They are, after all, the ones paying the majority of the taxes just like you paid the whole tab in the example. The benefits of tax cuts are inherently unequal since they favor those who pay more. How could they be otherwise?
As we've pointed out before, the politicians who use this approach are generally trying to gain from stirring up an us-vs.-them type fervor, a class warfare, if you will. They're assuming you'll confuse tax policy with income redistribution. That's the only way I could possibly think you owe me anything from your dinner bill refund. No doubt about it, income redistribution and other types of social spending are legitimate issues but they should be debated on their own merits, not as an aspect of tax policy. As former IRS Commissioner Donald Alexander says, "The tax system should be designed to impose and to collect taxes, not to administer social programs." So once you distinguish between these two issues, there really is no question about the "fairness" of tax cuts. It's as ridiculous as my demand for a cut of your refund in the restaurant example. •Tax cuts have contributed to a growing disparity in wealth between the richest and poorest Americans. This is another way to sneak the class warfare argument into a political speech. After all, any policy that makes the rich richer at the expense of the poorest of the poor has to be bad, right? Politicians making this argument often offer support from government statistics. The typical report divides the U.S. populace into quintiles (20% divisions) based on income or wealth. Over the past twenty years, the difference between the highest and lowest quintile has, indeed, increased. Some statistics actually show the lowest losing ground. But this is one of those instances where figures don't lie, but lies figure. The underlying presumption is that the same individuals remain in the same quintiles over time. This is mistaken. Think of your own situation: When you first started out was your income or net worth as high as it is now? Probably not. Throughout their working years, most people see their incomes and worth rise as they gain more experience and skills. With promotions, savings, and investments, they move up from the lower wealth quintiles. They may not make it all the way to to the top, but many do move up the scale.
Immigration helps stock the lower quintile. It's not the foreign millionaires who come to this country seeking work, but rather the poor. It's not hard to see how the lower quintile can lose ground yet the average individuals still enjoy an increase in wealth. In order for the class warfare-mongers' argument to work, comparisons from different time periods must assume the same people are in the same quintiles, but the world simply isn't such a static place. •Tax cuts have sent the U.S. a from surplus to a deficit. During the Clinton years, the U.S. moved from a federal deficit to a federal surplus. After years of running a deficit, many believed it was impossible to not to, but they were (happily) mistaken. As you'll notice from the blue line on Chart 1, shortly after President Bush came into office, the U.S. swung back to deficit status. Democrats blame this on the President's tax cuts which reduced incoming revenue but not spending. They charge it was irresponsible to cut government receipts without making them up elsewhere. Suddenly the "tax-and-spend" Democrats are taking the high road as fiscal conservatives. Of course the loss of incoming revenue can be offset not only by alternate receipts, but by spending cuts as well. Spending cuts were never really considered by Congress -- they never are. Instead, as you'll also notice from Chart 1, government spending has actually been on the increase since early in the Clinton presidency and has spiked up under President Bush. The Democrats also cite this as evidence of the current administration's fiscal irresponsibility. But this isn't just profligate spending -- at least not all of it. You can see this from Chart 2 which compares government outlays for defense spending versus non-defense spending. What you'll notice is throughout the 1990s after the fall of the Berlin Wall and the end of the Cold War, defense spending dropped dramatically. The decline is even more pronounced in light of the defense buildup during the Reagan years. Unfortunately, the so-called "peace dividend" was really fools gold. While domestic spending increased and defense spending languished under President Clinton, al Qaeda and terrorist nations were plotting attacks on America. The events of September 11 brought this home in more ways than just the obvious. Realizing the need to respond, President Bush sharply increased defense spending.
To some degree, this increase is making up for the fall-off during the previous administration. Tax cuts or not, increased defense spending was necessitated by current geopolitical events. So no, tax cuts didn't single-handedly lead the country into deficit. Spending is to blame, too, perhaps even more so. But then, no politician -- Democrat or Republican -- wants to cut spending. Unlike some (or is it most) of the government's social spending, the tax cuts actually helped the economy. Some might even say they helped too much. Artificial StimulusThe enactment of the Bush administration's tax cut proposals made fiscal policy as accommodative as the Federal Reserve's monetary policy. Together they helped take the edge off the post-equity bubble recession and fostered the current recovery. Of course this doesn't keep politicians from seeing a dark cloud surrounding the silver lining.•The current fiscal and monetary stimulus will ultimately lead to another major bout of inflation. Monetary and fiscal policymakers always walk a thin line when they tinker with the economy. Tighten too much and they run the risk of recession, but be too lax -- as some charge now -- and unleash another round of inflation. With the Fed Funds rate at a microscopic 1.25% and the largest tax cuts since the Reagan years, there's no doubt the combined economic policies have been and are still extremely accommodative. That's what it takes when the economy slows. But it's not slow anymore; in fact it's taken off in the past three quarters. Even a monetarist will tell you in a booming economy an easy money policy won't lead to more production, just higher prices.
Indeed, that's already happening. May's Producer Price Index (PPI) jumped 0.8%, the most in 14 months. The Consumer Price Index (CPI) climbed 0.6% and 1.7% on a year-over-year basis, its biggest increase in 3-1/2 years. That's not only scaring some politicians, it's scaring some economists as well. The rising price of oil also adds inflationary pressure. As the Iraq engagement drags on and terrorist threats persist, not only is the supply of oil disrupted, the price includes an uncertainty premium. Chart 3 shows how crude oil has led the recent increases in the CPI. The fear is that in trying to assure the recovery is truly self-sustaining (and perhaps also the attempt not to influence the coming elections) the Fed has waited too long to act. By the time they do, the inflation genie will already be out of the bottle and be much more difficult to put back in. To their credit, the Fed's not insensitive to this. "[W]e must continue to be vigilant in monitoring developments that pose a risk," says Chicago Fed President Michael H. Moskow. "Currently, the federal-funds rate is very low, and this degree of policy accommodation cannot be maintained indefinitely. Sifting through the data and analyzing them from a variety of perspectives will continue to be an important input into our assessment of the appropriate stance of monetary policy."
The first action came at the conclusions of the June 29-30 FOMC meeting. As expected, the increase was 1/4 point, the "measured response" that had been promised. More are likely to follow. Yet even Fed Chairman Alan Greenspan remains sanguine. "[I]nflationary pressures are not likely to be a serious concern in the period ahead," he said on June 15. "We seem to be on track, but as duffer golfers like to say, 'It's not a gimme putt.' " He may be correct to the extent that there's already some indication that inflationary threats are waning. For example, the final reading for the first quarter's GDP showed it growing at a 3.9% clip, not only lower than anticipated but also the slowest since the third quarter of 2002. June's employment report showed only 112,000 jobs being created during the month, considerably less than in the three prior months and below the 150,000 level many economists believe is necessary to establish sustainable job growth. So maybe the economy really isn't in danger of overheating. Commodity prices are also showing signs of easing. After a 9-month run-up, the CRB Commodity Index (Chart 4) peaked in March and is now moving back towards its 200-day moving average. The 50-day average has already turned negative so perhaps inflation at the producer level -- and ultimately at the consumer level -- will begin to taper off. Regardless, the Federal Reserve has started a tightening process that will -- if history is a guide -- include several increases. Again, relying on history, the Fed is probably a little late getting started and will eventually raise rates a little too far. Contrary to what the pols will have you believe however, none of this is because of over-stimulating the economy or because of the impending election, but rather it's just what always happens at this point in the economic cycle. Conspiracy TheoriesA little inflation is actually good in some instances. Rising prices give manufacturers more leeway in increasing the prices of their finished goods while workers have more clout when demanding higher wages. This is also the source of political fodder.•Under the present administration, workers are not benefiting along with businesses. This charge has been around for a long time. Up until earlier this year, it was primarily leveled at the so-called "jobless recovery" but once strong job growth took hold in March, it's changed to focus on wages. At this point, the Bush administration is the first since Herbert Hoover's to experience net job losses throughout its term. While this situation reversed course in March, as of early July it's still negative. But, according to the opposition, it's more than just lost jobs, it's lost earning power. The jobs being created are lower paying than those that have been lost. Workers may be back on the job, but they're finding they're earning less. Government statistics bear this out. Chart 5 compares employment growth and the wage cost index. As you'll notice, employment growth actually began declining in the final year of the Clinton presidency. At that same time, the wage cost index began to decline. The two went their separate ways in early 2002.
In essence, the economy is creating new jobs but the wage expense to employers is still falling. The latter enables businesses to increase profits and lessens the need for price increases, helping to keep inflation low. The Democrats charge, however, that these gains come at the expense of the middle class workers who have actually sustained a drop in their standard of living in light of their new lower paying jobs. This "middle class squeeze" argument is basically the "class warfare" approach in a different guise. The rich business owners and investors are benefiting disproportionately at the expense of the middle class. Of course if you ask anyone who is or has been unemployed, a lower paying job is often preferable to no job at all. But even more to the point, businesses aren't cutting wages in existing positions; it's the new jobs that are being created -- the ones that are needed now -- that may actually be lower paying. Manufacturing tends to lead an economy coming out of recession, not upper management. Lower paying jobs are usually the first ones created and wages later rise as the recovery progresses. Take another look at Chart 5 and notice how this pattern held when job growth picked up in 1986 and again in 1991. This is the typical course in an economic recovery. Although lower labor costs have helped fuel corporate profits, businesses haven't been conspiring to underpay their employees. Conspiracy theories may make for good sound bites and TV newsmagazine stories, but at least in this case they aren't appropriate. As in most recoveries, job growth comes before wage growth. •The Bush administration's fiscal policy is geared toward businesses at the expense of the middle class. Here again is the "class warfare" argument in yet another form. Tax incentives for businesses benefit the rich rather than the middle class. As a result, corporate profits have zoomed ahead while the average worker has been left behind. There's no question that corporate earnings have definitely picked up over the past year. Stocks also rallied strongly in 2003 although they're basically flat this year. Again as shown on Chart 5, wages haven't yet kept pace.
However it's still not valid for the Democrats to blame the Bush fiscal policy for favoring one group over another while it's equally unjustified for the Republicans to take credit for the economic turnaround. There are a number of issues being confused here. First and foremost, it's important to realize that corporations never have and never will pay taxes. Although we often speak of companies as if they were living entities, they really aren't. Instead, they are simply representative of their owners, their shareholders. Any benefit granted them or tax imposed on them is simply passed through to their individual shareholders. As a result, any fiscal policy geared toward businesses will actually impact individuals. Secondly, it's not just "the rich" who are shareholders. Of course this again may turn on a definition, in this case what it means to be "rich". If you include the hourly wage earner who contributes 2% to his company sponsored 401(k) or the 12 year-old who has a few shares in a mutual fund, then yes, only the rich are shareholders. But most people wouldn't include these two or millions of others like them who either directly or indirectly have an ownership interest in and benefit from publicly traded companies. Finally, you don't have to be a shareholder to gain when the the stock market's rising. Remember the old adage, "What's good for GM is good for the country"? There's a grain of truth in it, at least in a capitalist society. Nominal GDP and the S&P 500 have tracked fairly closely, especially in the past five years. Chart 6 shows the relation. Over that time, a rising stock market occurred when there was strong GDP growth and just about everyone benefits when the economy is expanding. That, of course, doesn't mean that fiscal policy should be directed toward the stock market since even the data illustrated in Chart 6 don't establish a causal relation between share prices and GDP, only that the two tend to move together. In fact, even though they'll try to, Republicans can't really take credit for the economic or equity market turnaround. As discussed above, monetary policy played a major role in ending the recession and the stock market has responded as it always does at this point in the economic cycle. Politicians on both sides of the aisle frequently appeal to voters' emotions rather than reason. As you can see from these examples, arguments from both sides may at first draw you in, but they ultimately boil down to nothing more than bad economics. With this forewarning, enjoy the debates. Search this site! Just enter you key word or words:
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F SOCRATES WAS ALIVE TODAY and listening to some of the current political arguments -- especially regarding the economy -- he'd probably ask to drink the hemlock. Unlike the ancient Greek philosophers who valued the use of logical debate, today's politicians instead seek the quick sound bite and opportunistic spin. Facts and logic are only secondary considerations if considerations at all.
