The Price of Inequality: How Today's Divided Society Endangers Our Future (33 page)

C
HAPTER
E
IGHT

THE BATTLE OF THE BUDGET

W
ITH THE ONSET OF THE GREAT RECESSION, GOVERN
ment revenues plummeted, and the nation’s deficit and debt soared. A cry soon went out in the United States and Europe that deficits had to be brought under control as soon as possible, typically by drastic cuts in expenditures—in programs referred to as
austerity
.

President Obama set up a bipartisan deficit reduction commission, headed by the former Wyoming senator Alan K. Simpson and President Bill Clinton’s former chief of staff Erskine Bowles.
1
A Washington think tank, the Bipartisan Policy Center, came out with its own proposal.
2
The head of the Budget Committee in the House of Representatives, Paul Ryan of Wisconsin, offered another.
3
By the summer of 2011 debate over the budget had turned rancorous, and House Republicans effectively held the country for ransom, refusing to allow an increase in the debt ceiling, unless it was accompanied by a commitment to substantial deficit reduction—either cutting expenditures or raising taxes.
4

This budget brinkmanship obscured the real economic challenges facing the country: the immediate problem posed by the high level of unemployment and the gap between the economy’s potential output and its actual output, and the long-term problem of growing inequality. The brickmanship shifted attention away from these problems to the issues of deficit and debt reduction.

As the recommendations of the various commissions came in, some actually proposed lowering taxes at the top and increasing taxes in the middle. They ignored how the deficit—the gap between the governments expenditures and revenues—had come about in the first place. If they had focused on the true origins of the deficit, they would have realized that there were more straightforward ways of getting it under control. In this chapter, I seek to recast the debate. I will show how budget, tax, and expenditure policies can actually be used to reduce our country’s inequality at the same time that they promote economic growth and bring the deficit under control.

T
HE
H
ISTORY OF THE
D
EFICITS

It may be hard to remember now, but just a decade before seemingly out-of-control deficits rose to the top of the nation’s policy agenda, the country had large surpluses, some 2 percent of GDP. So large were the surpluses that Fed chairman Alan Greenspan fretted that the entire national debt would soon be repaid, and that would make the conduct of monetary policy difficult. (The way the Federal Reserve increases or decreases interest rates is to sell or buy government Treasury bills, but if there was no government debt, there would be no Treasury bills to buy and sell.) There was (according to him) an answer to this potential crisis: Bush’s proposed tax cut, most of the benefits of which went to the rich. Greenspan’s support for the 2001 tax cut was pivotal.
5

The argument should have been viewed with skepticism: had the forecasts been accurate, with the national debt at some future date in danger of being paid off, he and the president could have appealed to Congress to increase spending or cut taxes. It is inconceivable that they would not have complied quickly enough to avoid the alleged looming disaster of the elimination of the national debt. For the critics of these tax cuts, it seemed that Greenspan’s agenda had less to do with monetary policy and more to do with downsizing government. And for those concerned about the country’s increasing inequality, the combination of tax cuts targeted at the top and weakened social protection programs for lower- and middle-income Americans that would inevitably follow as fiscal constraints tightened was particularly troubling.

It wasn’t long before the surpluses turned to deficits under the influence of four major forces. The first was the tax cuts themselves. The intervening years have shown the magnitude by which they exceeded what the country could afford: by 2010 the Congressional Budget Office (CBO) was predicting that if the tax cuts were extended for the next decade, the budgetary costs for 2011–20 would be $3.3 trillion.
6
Of the 2012 budget deficit, around a fifth is attributed to the Bush tax cuts.
7

The second contributor to the dramatic change in the country’s fiscal position was the expenses incurred in the wars in Iraq and Afghanistan, with budgetary costs (over the long run) estimated to exceed $2 to $3 trillion dollars. The budgetary costs will, in fact, go on for decades: almost 50 percent of returning troops are eligible to receive some level of disability payment, and such payments and health care costs for these veterans are likely to approach or exceed a trillion dollars.
8
Even as the Iraq war was being brought to an end in 2011, war spending still accounted for at least 15 percent of the 2012 budget deficit.
9
Instead of raising taxes to pay for these ventures, we put them on the credit card, with compounding consequences for the debt, especially in the years before the Great Recession. At a 5 percent interest rate, a $2 trillion national debt requires $100 billion to service it (even if no attempt were made to repay), year after year. Right now, that interest bill is low, because interest rates are so low; but it is a bill that will grow much larger when the economy recovers and interest rates return to normal.

While the United States was fighting those wars, it increased its other military spending by hundreds of billions of dollars
10
—including spending for what critics said were weapons that didn’t work, against enemies that didn’t exist. You might not have suspected that the Cold War was over by looking at the Defense Department and CIA spending. America was spending as if it was still ongoing: its military expenditures totaled that of the entire rest of the world put together.
11

While the tens of thousands of Iraqis and Afghanis, and the thousands of young Americans who became disabled or died fighting in these wars have paid a high price, every public expenditure, every venture, has winners as well as losers, and this is the case here too: defense contractors walked away with excess profits, some of which got “recycled” in the form of campaign contributions. Some of this spending took the form of “rents” (as we called them in chapter 2), with government paying prices greater than competitive market rates. The $7 billion Halliburton no-bid contract at the start of the Iraq war was a classic example. We described in chapter 6 the high costs associated with contracting, in which the government pays more than it would if government employees provided the services. The cost of weapons systems has soared even as the government has tried to rein it in: the $382 billion Lockheed Martin F-35 Joint Striker Fighter by itself costs half of the entire Obama stimulus program.
12
(One can understand why so many people are upset with current budget priorities: there is money for a fighter jet that critics say doesn’t help in the types of conflicts the United States finds itself in, and likely will in the future, but there’s no more money to help homeowners stay in their homes.)

The third large source of the increase in the deficit was the new Medicare drug benefit, and while the benefit itself made sense, part of the cost was another huge “rent”—this time not to the military contractors but to the pharmaceutical industry. We noted earlier that a small detail—a provision in the bill providing the drug benefit to Medicare recipients which said that the government, the largest buyer of drugs in the world, couldn’t negotiate prices with the drug companies—was a gift worth, by some estimates, a half trillion dollars over ten years.
13

The biggest difference between the world of 2001, when we expected a large federal budget surplus, and the world of 2011, when we faced yawning deficits as far as the eye could see, though, was the Great Recession. Any recession causes a decrease in revenues and an increase in expenditures (for unemployment insurance and social programs), and a recession of the magnitude of the Great Recession of 2008 causes a major reversal in the fiscal position of a country. Spain and Ireland also had budget surpluses before the crisis and now are on the verge of fiscal collapse. Even as the American economy was supposedly entering into recovery, in 2012 the downturn accounted for almost two-thirds of the deficit—16 percent of the deficit was for measures to stimulate the economy (the stimulus package that included tax cuts, aid to states, and public investment); but almost half (48 percent) of the entire deficit was a result of the underperformance of the economy, which led to lower tax revenues and higher expenditures on unemployment insurance, food stamps, and other social protection programs. These shortfalls reflect the fact that the U.S. GDP in 2012 is predicted to be nearly $900 billion short of its potential.
14

The critical point to bear in mind in thinking about deficit reduction is that the recession caused the deficits, not the other way around. More austerity will only worsen the downturn, and the hoped-for improvement in the fiscal position will not emerge.

K
ILLING
T
HREE
B
IRDS
WITH
O
NE
S
TONE

The
causes
of the reversal in the U.S. fiscal position provide a clear prescription for how to put it on a firm foundation: reverse the Bush era tax cuts for millionaires, end the wars and scale back defense spending, allow the government to negotiate drug prices, and, most importantly, put the country back to work. Restoring the country to full employment would do more than anything else to improve the country’s fiscal position. While all of these actions would help to address current budget woes, improve the distribution of income, and make money available for investments that could improve future growth, there are a few other reforms that would go still further.
15

Making the tax system
fair
is one such reform
.
Right now, as we noted in chapter 3, speculators are taxed at a fraction of the rate of those who work for their living. It’s a prime example of how those in the 1 percent have convinced the rest of society that what is in their interests is in the interests of all. The lower tax rates on capital gains didn’t lead to higher sustainable growth, but rather fed two speculative booms: it’s not an accident that, in quick succession, after the capital gains tax cuts of 1997 and the early 2000s, America experienced both a tech bubble and a housing bubble.
16

So too, Bush argued successfully in 2003 for a (temporary) cut on the tax on dividends, to a maximum of 15 percent, less than half the rate paid by someone who receives a comparable income in the form of wages and salaries. The claim was that it would lead to more investment by firms in plant and equipment, but it didn’t. Arguably, it may have had the opposite effect. As we observed in chapter 4, firms were, in effect, encouraged to pay out dividends while the tax rates were low, leaving fewer funds inside the corporation for a good investment project, should one have turned up.
17

Beyond this, making the tax system not only more fair but more progressive would involve closing loopholes and enacting increases in the tax rates at the top and reductions in tax rates at the bottom. The exemption of interest on municipal bonds is an example of an inefficient “loophole” of far more benefit to the rich than to the municipalities, the
alleged
beneficiaries. The tax deductibility allows cities to borrow at a lower rate—but only slightly lower. If, for simplicity of arithmetic, the interest rate had been 10 percent, the tax exemption might lower the rate that a city could borrow to 9 percent. On a $100 million bond, the city then saves $1 million a year. The bondholders, many of them in the top tax bracket, get $9 million in interest payments and owe no taxes on their interest income. But suppose they had faced a combined federal and state tax of 40 percent. They would have had to pay $4 million in taxes and reaped after-tax returns of $6 million. In our current system they take home $9 million. While it’s true the city saves $1 million, to deliver that $1 million of assistance, the state and federal government have to give up $4 million in tax revenues. Wealthy bondholders get three times the benefit that is received by cities. It would have been far more efficient to give the cities a direct subsidy from the federal government.
18

A basic principle of economics holds that it is highly efficient to tax rents because such taxes don’t cause any distortion. A tax on land rents doesn’t make the land go away. Indeed, the great nineteenth-century progressive Henry George argued that government should rely solely on such a tax.
19
Today, of course, we realize that rents can take many forms—they can be collected not just on land, but on the value of natural resources like oil, gas, minerals, and coal.
20
There are other sources of rents, such as those derived from the exercise of monopoly power. A stiff tax on all such rents would not only reduce inequality but also reduce incentives to engage in the kind of rent-seeking activities that distort our economy and our democracy.