At least insofar as it concerns the domestic economy, the modern Republican is simply uncomfortable with government. There is an instinctive feeling in him that government – despite being by far the largest single actor in the economy at any given time – deserves no credit for anything good that might be happening and is probably to blame for anything bad. One would think that such intrinsic feelings would be quite awkward for those Republicans who ask us, the voters, to hire them as executives in the very government they so distrust. After all, it is quite rare that someone applies for a job while expressing outright contempt for his/her would-be employer. But they manage it somehow, and those of them inclined to engage intellectually, also manage to articulate a set of ideas to explain their instincts.
In so doing, broadly speaking, Republicans overemphasize the disincentive impact of taxes, fail to acknowledge the positive economic impacts of government activity, and tend to promote the notion that being a private sector businessman is in and of itself a virtue. They claim often to be “pro-market” and in favor of “free market capitalism”, but their rhetoric does not seem to recognize that free, fair and competitive markets do not crop up in the midst of anarchy.
Government is a necessary element for the development and maintenance of free, competitive markets. Along the same vein, there is a puzzling tendency of Republican economic thinkers to decry government action aimed at preserving competition. For evidence, survey the reaction of some noted Republican commentators to the DOJ opposition to the AT&T and T-Mobile merger. You will hear that AT&T should be allowed to acquire T-Mobile because this will benefit the consumer in the form of lower prices and higher quality service presumably due to economies of scale. That may or may not be true, but if you think it is true, are you not acknowledging that sometimes a market with greater competition is NOT what’s best for consumers and that your ideology is NOT necessarily centered on free, fair and competitive markets? Possibly, it is centered on whatever will result in greater value to consumers (even if that, in this case, is economies of scale which are not generally found in a fragmented, highly competitive market), or more likely I suspect, it is centered on allowing business people in the private sector to do whatever they want to do regardless of how that impacts upon the character of the markets they operate in. The alternative – any form of government action – is after all, instinctively not palatable.
Leaving a deeper discussion of government regulation of markets for another day, let’s focus on the visceral repulsion Republicans feel toward the government as an entity that transacts in the economy – by taxing, borrowing and spending. Those Republicans articulating a case for what is really an anti-government instinct, say that it is largely based on a concept that government action in the economy illogically harms and disincentivizes creative and productive people and benefits only unimaginative and unproductive people. The philosophy, part Randian objectivism and part neo-liberal economic theory is built on the basic idea that the government unduly harms society’s achievers in three significant ways and on three separate occasions:
1. At the time of tax collection – a progressive income tax system penalizes success by imposing a higher rate of tax at the margins
2. Upon government’s expenditure of funds – the “goodies” that government provides are more likely to benefit the unsuccessful than the successful and thus reward failure
3. By crowding out private investment in the economy – government investment with borrowed money drives up the cost of investment for the private sector and also, everything the government invests in or consumes is something that the private sector loses the opportunity to invest in or consume.
Before even addressing these points, it is important to note that of course, one fundamental unspoken assumption belying this way of thinking is that the most “successful” (high income earners, the wealthy) are such because they are more creative or productive than anyone else and that the least “successful” (low income earners, the poor) are such because they are less creative or productive. Any people in between are where they are on the spectrum of “success” as a perfectly linear function of their ingenuity, productivity, work ethic, etc.
In order to believe we actually have this perfect economic meritocracy, the following things must all be assumed away – or at least their aggregate impact must be assumed to be negligible:
• Inherited or family wealth
• Privilege: legacy or current personal connections that open doors which then close on more talented individuals; protection of particular industries or trades which enable earnings that are not economically justifiable
• Caste pluralism or systemic discrimination
• Dumb luck: being in the right place at the right time or the wrong place at the wrong time
• Deception
• Unproductive arbitrage: taking advantage of temporary market disconnects to attract income or accumulate personal wealth whilst not actually producing anything of tangible value; being victimized by such disconnects despite producing something of tangible value
Of course anyone who lives in the real world as opposed to a classroom at the University of Chicago or George Mason University, knows that the above things DO exist in abundance, and that they likely DO significantly impact economic results in our society, but for the sake of moving on in this discussion, let’s just give them one and assume that the above things do not exist. As such, high income earners and the wealthy are a perfect proxy for the most industrious people in society, and low income earners and the poor are a perfect proxy for the least productive people in society, with the bulk of people falling somewhere in between. Now let’s look at those three points about government.
(1) The Tax Case
The disincentive to work or innovate caused by progressively higher taxation of income sounds vaguely plausible in theory, but in the real world, no one turns down a promotion because of the resulting higher taxes on the incremental income. Have you ever heard of anyone rejecting a raise on the grounds that the incremental income would be taxed at a higher marginal rate? No entrepreneur turns down funding for a new business because, if successful, she would pay higher taxes. No one says, “I’m not going to work hard, or pursue this idea, because if I do so successfully, then I’ll make too much money and thus owe more to Uncle Sam” – that is, no one except right wing commentators posturing for low tax policy, but somehow I think if he were called on his bluff, O’Reilly would not only not quit, but step up his activities.
Perhaps things would be different if we really had excessive confiscatory tax rates in our country, but we really don’t. Far from it. At times in the past, we HAVE had confiscatory headline tax rates for the top brackets of income (90%+ tax rates in the 1950s for example) but during a lot of those times the American economy – at a macro level - boomed, so the allegation that the tax-related disincentive to work will singularly stifle economic growth doesn’t seem to be consistently borne out by the historical data, even from eras when there were truly confiscatory rates.
The tax-related disincentive is a theoretical psychological phenomenon, one that as I mentioned, those of us in the real world do not see playing out all that often – if ever. As such, economists who promote the idea try to use macroeconomic data to prove their theoretical psychology. A lot of the empirical case for the disincentive argument comes from tax multiplier analysis done by people like the Romers (the President's former Chair of the Council of Economic Advisers and her husband). This analysis, like a lot of economic analysis, is flawed because the limited available data contains a lot of noise which has to be assumed away in one direction or the other to reach a final conclusion. This injects subjective ideas that tilt the conclusions. They try in this way to convince us that people will cut off their noses to spite their faces – that workers and investors are so averse to paying more taxes that they will forgo opportunities for additional income well in excess of those taxes. However, this is just not something that’s observed very often in the real world.
An additional point…our so called “progressive” income tax system is only progressive if you look at the published headline rates for wage earners at different income levels. But everyone knows that those rates have hardly any relationship to the actual rates paid by people in the upper income brackets. This is important because it is the allegedly progressive nature of the income tax system that is attacked by Republicans as “penalizing achievement”. If you look at effective taxation instead of the theoretical rates for wage earners in the IRS booklet, then the case is strong that the actual collection of income tax is not entirely progressive – something Warren Buffet has pointed out multiple times over the years even before his most recent August NY Times editorial. The average effective tax rate of the top 400 income earners in America is around 18% (primarily due to the much lower tax rate applied to long term capital gains, but even wage earners tend to have the ability to utilize a number of deductions that reduce their tax burden, and upper income people are more likely to make use of these). Years ago, Warren Buffet issued an offer of $1 million to any of his fellow Forbes 400 who could prove that they have higher effective tax rates than their secretaries. His money is still unclaimed. People complaining about our existing tax system on the grounds that it, as a whole, penalizes success are living in a world of theory. Reality looks a lot different.
(2) The government spending case
The notion here is that the U.S. Government mostly spends money in a way that benefits poor people rather than rich people.
Let’s look at the current state of government expenditure. What are the heads of account in the federal government budget?
• Social Security and Medicare are not entitlements that pay out to low income earners more than high income earners. In fact, the more years you earned income at or exceeding the FICA threshold (currently $106,800), the more benefits you will get in retirement (and the greater your income is over that cap the lower your effective payroll tax rate will be...not very “progressive”). Though there is an element of the benefit formula that kicks a little extra to those in great need, benefits are not denied to the rich on the grounds that they have independent means to sustain themselves. Thus Social Security and Medicare together account for 34 cents of every federal dollar spent which cannot be accurately characterized as goodies for the poor. (Now, an economist could make the case that if people live long enough after retirement to receive benefits that exceed what they paid in plus a reasonable rate of interest, then in those cases these programs start to reward unproductive retirees- whether rich or poor- at the expense of productive working age people, but even most Republicans would not touch an argument that rebrands all of our seniors as “the unproductive”.)
• Defense and National Security – it is the rich who benefit the most from the national security apparatus of the country because the value of their property is higher than that of poorer people. In economic terms, they have the most to lose from a failure of the nation state due to a breakdown of our defenses. Poorer people not only don’t have as much property to lose, but since lower and middle income people are much more broadly represented in the ranks of soldiers who find themselves in harm’s way in the defense of their country, they are, as a group, sacrificing comparatively more than the rich to uphold the defense establishment. As such, defense and national security spending represents another 20 cents of every federal dollar spent that doesn’t jive with the Republican line about rewarding failure and penalizing success.
• Debt Service – when you borrow money, you need to pay interest to your creditors. Debt service payments on previously accumulated debt now account for 6 cents of every federal dollar spent. It isn’t credible to argue that making these payments in a timely manner benefits the poor or the rich. These payments are what they are. It is the spending that led to the accumulation of the debt in the first place that can be characterized one way or the other.
• Medicaid and CHIP are together, the first bit of spending on this list which is designed specifically to help poor people. An effective argument can be presented that while these programs save the lives and health of lower income people, the direct monetary benefit of Medicaid and SCHIP goes to doctors, hospitals and pharmaceutical corporations. Nonetheless, let’s play along and score this one in the column of “rewarding failure”…so that’s the first 8 cents that goes into that column.
• Safety Net Programs are obviously designed to help lower income people directly. These include the favorite whipping boys of Republican commentators: welfare, food stamps, unemployment insurance, etc. They also include spending through the tax code, such as the portion of the earned income and child tax credits which exceeds the actual income tax liability. In sum total, these programs comprise 14 cents of every dollar the federal government spends.
• Other Non-Defense Spending (including spending through the tax code), represents in aggregate 20% of government expenditure. You will find here some expenditures that may benefit low income people. However, the extent to which poor people are able to take advantage of these “goodies” pales in comparison to the extent to which these items benefit industrialists and corporations:
o Agriculture subsidies
o Oil and gas subsidies
o Other industrial subsidies
o SBA loans and guarantees
o Infrastructure spending
o Research and development
o Technology
o Overseas private investment insurance
o Various tax expenditures for businesses – excise and other types of targeted tax credits that exceed the tax liability incurred through the taxable activity.
Add it all up, and for every dollar of federal government expenditure, only about 22 to 25 cents can be characterized as benefiting poor or low income people directly. That’s a pretty weak case for the notion that government spending as a rule “rewards failure.” Further, since much of the remaining 78 to 75 cents is at least neutral to income and wealth and possibly more favorable to the wealthy and to industrialists, one could easily make the opposite case.
(3) The Crowding Out Case
The third component of the Republican economic case against government takes us into a discussion that can get a bit wonky (for me anyway). It does have some merit depending on the specific circumstances in the broader economy, but it too ultimately falls short when tested by reality – especially at present.
In classic economic terms, “crowding out” is the phenomenon of government borrowing causing an increase in interest rates, which then makes money more expensive for the private sector, and thus prevents people from accessing capital for investment which they otherwise could have accessed. Some commentators employ a broader formulation of the concept of crowding out wherein government consumption of goods and services both raises prices and creates shortages and government investment denies opportunities to private sector investors.
Whether or not crowding out is actually taking place is something that can be tracked if we follow interest rates in the aftermath of significant increases in government borrowing and spending. What such an analysis seems to reveal is that if the government were to significantly increase borrowing at a time when the economy was at full strength – credit flowing, near full employment, production capacity near full utilization – then the problem of crowding out could be a real concern. However, the circumstances in which the government tends to implement a program of increased borrowing and spending tend to be the exact opposite. When unemployment is high and credit is unavailable (and you have what could be described as a “liquidity trap” with private sector money sitting on the sidelines) the evidence suggests that significant government borrowing does not lead to crowding out. No one has emphasized this point more than Nobel Laureate Paul Krugman. As he has pointed out in multiple columns and blog posts, we have not experienced an increase in interest rates on account of the additional government borrowing undertaken recently. Rather interest rates continue to hover at historic lows. Only when demand is intrinsically strong in the economy would this even be an issue, but again, those are not the circumstances in which the government seeks to ramp up borrowing and spending as a matter of policy.
In closing…
The economic religion of Republicans is based on a holy trinity of highly faulty precepts, which have become their mantras. That is not to say that there aren’t some faults in the way Democratic politicians and commentators present ideas on economics, but until we can have a conversation that is steeped in an understanding of reality, we will not be able to move beyond this nonsensical tug of war about government.