Tuesday, October 19, 2010

Aftershock: The Next Economy and America’s Future by Robert B. Reich

Robert Reich’s new book, Aftershock, provides a concise description of the economic and social conditions that he believes caused what he refers to as the Great Recession. These conditions arose both from historical changes and from 30 years of mismanagement of the economy and of society. He suggests a path forward that would correct this mismanagement and get the economy back on a firm footing.

Reich breaks up U.S. economic history into eras. The first would be the pre-Depression period, which he will compare with the period before the Great Recession (1980-2007). The intervening period between World War II and 1980 he refers to as the Great Prosperity. It is this period of prosperity that we need to study in order to understand why the economy drifted into such a weakened and unstable state.

Reich’s explanation for this economic cycle is quite simple. Most economic activity has to come from the majority of the people. This majority will be referred to as the “middle class” for simplicity. If the fraction of the income that goes to the middle class declines, then economic activity will diminish. Accumulating wealth in the hands of the very wealthy is economically inefficient and cannot compensate for the income lost by the middle class. The consumption of the wealthy is much less than that which would have occurred if the income had “trickled down” into the lower wage groups.
“Their savings are hoarded, circulated in a fury of speculation, or, especially these days, invested abroad.”
The growth of income inequality is then the driver for increased speculation, lower consumption and lower investment—clearly an unstable situation. Reich argues, compellingly, that this was the root cause of the Depression and also the Great Recession.

His justification for this thesis lies in his description of the almost universally prosperous post-war decades. Everyone’s wages grew. Unions were strong and they negotiated with managers who considered themselves to be employees also. This was a period of high government spending and high government income. Much of the spending went to reinforcing the social safety net and to building the infrastructure industry needed. Middle class incomes grew and so did the economy. Taxes on the wealthy were high, but they and the middle class thrived.
“The top marginal tax rate during the war ranged from 79 percent to 94 percent. In the 1950s, under President Dwight Eisenhower, whom few would call a radical, it was 91 percent. In 1964, the top rate dropped to 77 percent. It was 77 percent again when Richard Nixon became president. Even after exploiting all possible deductions and credits, the typical high-income taxpayer during the Great Prosperity paid a federal tax of well over 50 percent of his earnings.”
Reich refers to the treatment of the middle class during this period as “the basic bargain.” By this he means that the middle class was guaranteed a proportionate share of economic growth. This balance is necessary to maintain stability in the economy.

A number of factors entered into the breaking of this bargain. Around 1980 the globalization of the economy became a significant factor. About this time automation also became more efficient and more widespread. Both of these developments tended to eliminate jobs and drive workers into lower paying positions. It should have been possible to arrive at a plan to respond in some positive way to this economic evolution.
“....government could have enforced the basic bargain. But it did the opposite. Starting in the late 1970s, and with increasing fervor over the next three decades, it deregulated and privatized. It increased the cost of public higher education, reduced job training, cut public transportation, and allowed bridges, ports and highways to corrode. It shredded safety nets—reducing aid to jobless families with children, and restricting those eligible for unemployment insurance so much that by 2007 only 40 percent of the unemployed were covered. It halved the top income tax rate from the range of 70 to 90 percent that prevailed during the Great Prosperity to 25 to 39 percent; allowed many of the nation’s rich to treat their income as capital gains subject to no more than 15 percent tax; and shrank inheritance taxes that affected only the topmost 1.5 percent of earners. Yet at the same time, America boosted sales and payroll taxes, both of which took a bigger chunk out of the pay of the middle class and the poor than of those who were well-off.”
Reich concludes that the middle class tried to maintain the standard of living to which they felt they were entitled. They did this by putting their wives to work, by working longer hours, and by drawing down savings and borrowing as much as they could. There are limits to all these measures. These limits have been reached.

Reich thinks that the economy can be salvaged. He presents a multipoint plan that he projects would restore the basic bargain—and with no net new costs. The major component of his plan includes a reverse income tax and higher marginal taxes on the wealthy.

Reich would extend the Earned Income Tax Credit (EITC) and put all classes of income on the same tax basis.
“Under my plan, full-time workers earning $20,000 or less....would receive a wage supplement of $15,000. This supplement would decline incrementally up the income scale, to $10,000 for full-time workers earning $30,000; to $5,000 for full-time workers $40,000; and then to zero for full-time workers earning $50,000.”

“The tax rate for full-time workers with incomes between $50,000 and $90,000—whether the source of those incomes are wages, salaries or capital gains—would be cut to 10 percent of earnings. The taxes for people with incomes of between $90,000 and $160,000 would be 20 percent, whatever the income source.”

“I propose that the people in the top 1 percent, with incomes of more than $410,000 pay a marginal tax of 55 percent; those in the top 2 percent, earning over $260,000, pay a marginal tax of 50 percent; and those earning over $160,000, roughly the top 5 percent, pay 40 percent.”

“...under my plan, would raise $600 billion more than our current tax system.”
Reich would also impose a carbon tax, both for environmental and revenue purposes. This would bring in, initially, $210 billion. He states that there would be sufficient funds to cover the income subsidies and the lower tax rate on the middle class—with money left over to recast society.

The author’s numbers indicate just how much society gives up in order to shelter the wealth of a few percent of the population.

I have no problem with what Reich is attempting to do. My only reservation is with his method of redistributing income. If you have a job earning $20,000 a year, your income is actually $35,000. If you work hard and train yourself to get one of those better jobs paying $30,000 per year, your income will increase to $40,000. The system gives away half the incentive to improve one’s self. An employer could look at this situation and tell himself that lowering his employees’ pay $2 per hour is really only lowering it $1. I would expect many employers to employ this logic.

I would be intrigued by schemes which enforce an increase in wages rather than an income subsidy. It might be more popular politically, and it would be healthier psychologically for the workers. Reich’s approach has the advantage of being instantaneously implementable. A wage-based approach would have to be phased in to attain the level of change required without disrupting the economy.

Reich has big plans for what could be done with the remaining funds. They include modifying our unemployment compensation by adding wage insurance and long-term retraining support. He would provide school vouchers to all with the amount based on family income. Similar vouchers would be available to cover early childhood education. He would make tuition free at all public colleges and universities. If a student took out a school loan he would have to repay a fixed fraction of his salary for no more than ten years. Reich would also provide Medicare for all at a huge cost savings. Presumably this last step helps pay for some of the other initiatives.

Except for his plan for school vouchers these are all good progressive proposals. One may agree with them or not, but we all should be struck by the amount of freedom to operate that becomes available if we revert to a more traditional progressive tax code.

I have a hard time seeing much of this happening anytime soon, but it is certain that it will never happen at all if people like Reich aren’t out there beating the drum.

1 comment:

  1. Robert Reich has his chance to fix the economy, and we must say he failed. He also had his chance to become a "wheel," and he succeeded. His approach to economics is simplistic and designed to appeal to the utterly dumb. For those of you familiar with complexity economics, I call Reich's approace "survival of the laziest."


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