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Obama Tax Proposals Historically Sound

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I've been thinking about this Wall Street Journal article ("Their
Fair Share") since I read it. It seems to be very convincing. However, when you view economic policy through a Keynesian vs. Chicago School paradigm you find that Barack Obama's tax proposals contain historically heavyweight arguments.

The article led me to do some quick, light reading on the whole Keynesian-Chicago economic split and I found some interesting things. Granted, I know the danger of laying history on top of contemporary events and saying, "Eureka!" But, I will say there are some interesting parallels. And, of course, much of the argument between the two schools is on theory, not on practical policy issues, but much of what they were discussing is still applicable to the current campaign and/or larger scope of US Economic Policy.

The Keynesians enjoyed heavy influence in the United States Government, post World War II, particularly under President Franklin D. Roosevelt. They advocated heavy government spending with a decrease in tax rates across the board. Their idea was that government needed to incur heavy deficits in order to prop up economic institutions that would spur economic growth (i.e., Public Works Projects, Fannie and Freddie, etc., as well as War Production).

The cut in taxes was necessary so that once the public works programs began to run soundly and provided jobs for people they would have that income in-pocket and would then have the purchasing power necessary to drive new investing. The increase in personal income would make up for the deficit in the long run because, although the government would be taxing at a lower rate, the increased domestic wealth spread out amongst many individuals would generate more revenue than the previous taxing structure.

I found this long quote from Marriner Eccles, FDR's Chairman of the Fed:

"As mass production has to be accompanied by mass consumption; mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.

That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans and foreign debt.

The stimulation to spending by debt-creation of this sort was short lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.

The time came when there were no more poker chips to be loaned on credit. Debtors were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but what was in reality under-consumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.

Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear which required economies of all kinds in the wages, salaries, and time of those employed. And, thus again, the vicious circle of deflation was closed until one third of the entire working population was unemployed with our national income reduced by fifty percent. The aggregate debt burden was greater than ever before, not in dollars but measured by current values and income that represented the ability to pay. Fixed charges such as taxes, railroad and other utility rates, and insurance and interest charges clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.

This then, was my reading of what brought on the depression."

The Chicago School, in opposition to the Keynesians, gained influence in the 1950s and 60s under neoliberalism and then changed their mode in the 1980s to monetarism. They generally advocated laissez-faire economics. Milton Friedman is perhaps the most famous of the Chicago schoolers. He argued that less government intrusion in economic policy was best because active monetarism (easy credit) and fiscal (tax and spend, i.e. PAYGO) policy was detrimental to the money supply. A naturally expanding money supply, to Friedman, was the most important thing. If a country's money supply was to grow organically it theoretically would reduce the causes of inflation and devaluation of currencies.

Now how do I get all of the above information into an argument about tax policy? First, I find great wisdom in what Mr. Eccles says to initiate his quote, "As mass production has to be accompanied by mass consumption; mass consumption, in turn, implies a distribution of provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery."

I think we are seeing the negative of this statement playing out now. Much has been written not only of the housing crisis and a credit crunch for investment banks but also much has been written about the increasing level of credit usage by average consumers. I think Eccles' reference to a poker game is very apt -- only right now there are very few additional chips to buy for the average American. Not only that, but while credit is running out and average Americans are more indebted (therefore have very limited discretionary funds) their dollars are being devalued by a previous era of active monetarism by the Federal Government (i.e., their focus was on how to make credit easily available).

Now, the arguments against tax hikes is that increased tax rates on high-net individuals -- through income tax rates and capital gains -- will lower re-investment. And that may be true but I think it may be good to stop and consider what those people would be investing in. Is there enough buying power in the middle class for these investments to be successful, profitable, and contributing towards an overall growth of the economy? I believe this is a serious question investors must ask themselves.

As for the taxation part, currently the income gap is the widest it has been since 1928 right before the Great Depression. Under the Obama plan, the Bush tax cuts for those in the middle class will actually be extended and actually offer a further cut while the Bush tax cuts for those in the top income bracket (the top 1% of earners) would expire. Those same folks, the top 1%, will also see a rise in terms of capital gains.

The point here is that taxes for the middle and lower class, the consumer class if you would, will decrease -- putting more discretionary funds in-pocket. Those in the highest tax bracket will be asked to endure a slight increase in rates (no higher than they were under Clinton) in order to make up the revenue lost in giving the middle class cuts. The argument here is that more Americans will have money to spend and will increase the dividend yields on stocks because the stock index will rise due to rising corporate sales and profits. This, Obama argues, is the best way to incentivize investing -- make it more profitable than the current conditions.

Essentially, this is government run wealth redistribution. Many people may disagree with that but it is important to know why Obama would attempt wealth redistribution especially in the manner he is proposing. He seems to have an underlying agreement with the Keynesians in saying that purchasing power needs to increase in line with investments.

But underlying all of this is an agreement with the Chicago school of thought. Consider the fact that a good deal of Obama's Economic team is University of Chicago schooled -- his head Economic advisor is Austen Goolsbee, economics professor at the University Of Chicago Graduate School Of Business. The Chicago school's line of thought is that governments need to have a neutral monetary policy.

Following this line of reasoning Obama would be opposed to more adjustment of the interest rate by the Fed. This would be a move that seeks to make credit more available to consumers or investors. Instead, Obama seems to be advocating what I would consider the more sound policy of organically growing both purchasing power and investment capital (the grassroots mentality apparently filters through to his governing style as well). The way he seems to be doing this without the federal government engaging in active monetary or fiscal policy (as opposed to laissez-fair monetary and fiscal policy) is through wealth redistribution by tax restructuring.

While some may disagree with these conclusions there is no doubt that there is heavy intellectual and rational thought going into the formation of Democratic economic and tax policy. It is not just populist rhetoric, as some Republicans claim. Here is a list of Obama's economic advisors with links to their profiles and other articles just in case you'd like to see what their theoretical backgrounds are.