THE BLOG
04/27/2011 11:36 am ET Updated Jun 26, 2011

Message to Washington: Fix the Economy Already

Apparently those inside the Beltway, and those who report on what goes on there, haven't heard - the economy sucks, still. Government spending is third on the list of public concerns. Number one, for three years running, is jobs and the economy. In Washington, whether to fix it or not has become the real partisan issue for the first time since the Great Depression, when business and the GOP were admitted Social Darwinists. Instead of working to create jobs, the GOP, led by Tea Party neophytes, seek to leverage the national debt in order to cut spending and therefore taxes at a time when both are sorely needed to, literally, keep America a Superpower. So, for the first time in 80 years, the GOP is NOT working with Democrats to fix the economy during a recession.

The idea of getting more money circulating in our economy should be a bipartisan objective. Leaving aside the fact that the GOP is acting as if they don't want an improving economy for the moment, how getting more money into the economy is best done is the issue on which jobs most hinge. Conservatives insist that it is best done by cutting taxes for the rich, the "job creators." Liberals are pretty sure that doesn't work given 30 years of "trickle down" theory pay stagnation, record un/under employment, and that a 25% top tax rate was in place leading into and during the first leg of the Great Depression.

Analytically, both conservatives and liberals are or can be right under given circumstances. Ideally, both taxes and profits take money from one point in the economy and redistribute it to another point in the economy. Profits build capital that is ostensibly reinvested and taxes tap some of that capital to be reinvested in public programs. Both recycle dollars into the economy. It is the efficiency with which tax dollars and profit dollars are recycled into the economy that matters.

In an ideal sense, the very reason that we have preferred capitalism over socialism in economic policy is that capital investment tends to leverage macro economic growth through enhancing productivity. Many government tax funded programs are aimed at long term structural needs of the economy and so enhance growth as well. We'll talk about the big three of government taxation and spending, Social Security, Medicare/Medicaid and defense later.

Government spending on non-defense discretionary programs is pretty straightforward; so is the concept of taxation, if not the rules. Money comes in and is spent, tapping what would otherwise be discretionary spending or capital formation in the private sector. It is economically neutral in the sense that 100% of it is flowing back into the economy in some way 100% of the time, excluding foreign affairs and wars.

Charting out the flow of capital and GDP factors shows a different story for capital formation and investment.

gdpfactor

Percent changes in GDP and consumer spending, the bars, closely track each other in small changes relative to capital formation and investment factors that influence GDP. Swings in Fixed Investment (Investment label in the chart), a component of the GDP including purchases of business equipment, residential and commercial real property, is more exaggerated in every cycle of growth and recession than is swings in other GDP components. Saving swings wildly too. While not an actual component of GDP calculation, Saving is capital that is being formed and is from which Fixed Investment is ostensibly drawn. Savings includes stock and bond purchases by individuals and institutions.

Captured, in this unusual chart view, are four distinct periods of economic movement powered by four distinct confluences of macro economics and finance.

First, the Reagan tax cuts seem to have powered a two year growth spurt in 1983-85, in both Saving and Investment. This is partially exaggerated by the historic changes to CPI factors, authored by the Reagan administration, that lowered the impact of CPI as a deflator to GDP, but still illustrates that in a decent economy where there is expansion opportunity, tax cuts can spur Saving (capital formation) and Investment.

The second period of interest is 1995-2000 where year over year growth was achieved with higher tax rates on the books. Consumers led this expansion, shown as increases in consumer spending leading growth in GDP for those 5 years. Again, the economy offered good prospects for investment and so Saving was drawn down by Investment, Investment helping fuel growth. Part of that growth is attributable to higher taxes tending to spur Fixed Investment as a way to defer taxes.

Third, 2000-07, post dot com crash, exhibits a spike in Saving from Bush's tax cuts that did not see a more typical following bump in Investment, this despite a huge speculation-driven surge in housing. Saving growth ebbed away, but was not Invested in the U.S. economy. It went off shore instead, following the new conventional wisdom of investing where the growth is, China. So Bush's tax cut was not made in an economic period where it could be made use of by our own economy due to widespread acceptance of global free market ideology. The benefit of the Bush tax cuts went off shore. Incidentally, a substantial share of the Obama stimulus bill spending went off shore as well.

Fourth, and most interesting, is the enormous spike in saving in 2007-09 Great Recession. Paired with the utter collapse of Investment, it's obvious that money was being held back from investment while business consolidated operations. There's no reason to invest, not even off shore for purposes of re-importation, if the world's largest consuming economy is in trouble.

2010 showed an increase in domestic Investment for the first time in seven years. The large-seeming changes are not cause for celebration yet, as they are large relative to an already severely shrunken base of Investment. It's possible that renewed domestic Investment is driven by expectations of Chinese inflation and U.S. monetary policy driving an upward revaluation of the yuan, making domestic Investment more attractive. Then too the U.S. economy needs to be growing in order to warrant more investment in offshore production capacity.

As the chart shows, Fixed Investment by business and individuals is highly correlated with GDP and consumer spending growth. Money is spent on tangible goods and real property, fueling the economy. Savings growth is fairly inversely correlated with Fixed Investment. Capital is built and expended when opportunity arises, otherwise it waits for opportunity to arise before being spent. The good news is that plenty of it has been built as of 2009. The bad news is that it was not spent in 2008-09.

Absent a trending opportunity business and investors will just sit on cash. There's nothing irrational about it in an individual sense. It's just that business is not in the business of governing economies. In macroeconomic terms, business is in the business of exploiting economies for profit that will then create the potential for growing economies through Fixed Investment. Business does not lead, business, in general, follows identifiable trends.

Business doesn't lead macroeconomically because the risk is too great on an individual basis. No one business has the ability to move economies through its spending alone. It takes aggregated business thinking or governments to move economies, and poor quality of that aggregated business and government thinking has led us to where we are now. Apparently that thinking has been wrong in terms of long term benefit to either of business or labor, the state of which is already bad for labor and is becoming precarious for most business outside of energy and health care.

So, capital is just not there when the economy needs it. Creating more of it through tax cuts is pointless. It will just go into saving, stocks, bonds and futures, and create bubbles that will distort and damage the economy.

Taxing some of that wealth will put money into the economy, lower the deficit or in effect indirectly channel money into Investment in order to defer taxes which then boost the economy and creates jobs. So taxes work not only to directly inject money in the the economy and lower deficits, but indirectly as well. Taxation is in a sense therefore, more reliable, controllable, and twice as effective as tax cuts for spurring economic growth. Cutting government spending will decrease the amount of money in the economy, making it less likely that capital will be employed as Investment.

Mounting deficit/debt used to achieve an economic a turnaround is becoming a problem, but the public has it in the right perspective. Fix the economy first and it will help balance the budget in just the way getting a job will help balance your own budget. Fixing the budget first will not help the economy any more than not buying food will help you live long enough to get a job.

The big three of government outlays, Social Security, Medicare/Medicaid and defense are not equal drains on the economy and therefore budget. The economy powers the tax revenues from which the budget is balanced. Whatever is not a drain on the economy is not a drain on the budget.

Self-funding Social Security is not an economic drain at all. All it collects from FICA withholding is dispersed back into the economy and any tax revenues that go to repaying the Social Security Trust Fund will recycle as well.

Medicare/Medicaid costs have outstripped inflation by double digits for years now and therefore the ability of payroll taxes and recipient copays to fund them together and separately. They now cost twice what dedicated taxes for them bring in. Had they not gone off the profit reservation, they, like Social Security, would not be a drain on the economy and budget. Profit has driven the explosion of health care cost. Were that profit recycled into the economy it would be economically and budget neutral, but we are in an extraordinary situation where it is not. Profit margins on Medicare Advantage, the privatized part of Medicare spending cut out to help fund the Affordable Car Act, were exploitatively high. Medicare Part D also comes at exploitative profit margins for business. The solution is definitely not in making Medicare/Medicaid more expensive by privatizing them as the profit will not be recycled as investment.

Some part of defense spending is economically neutral and therefore budget neutral. Wages paid and materials bought domestically by defense contractors remain in the economy. The markup of those wages and material purchases goes to the very high profit margins on defense products and research and is economically damaging and therefore budget damaging.

Cutting spending where it most damages the economy and budget is the place to start. However, even cutting defense or health care costs will do some harm to the economy and therefore budget. Cutting Social Security is absurd as there's no profit in it to cut. The only avenue open to solving the budget problem in this economic climate of outsourcing and the highest relative concentrations of capital since 1929 is to raise taxes on profit and impose tariffs. Raising taxes will even help curb runaway health care and defense costs. There will be less loot to take from either sector, better to reinvest.

Taxes are, right now, the only way to get money back into our economy as capital is not interested in playing. Money in the economy creates jobs. Those jobs will become permanent in conversion from government spending to private investment should the economy regain traction. Capital does not and never has provided the decisive traction needed to for job and economic growth. Traction comes from labor and democratic government living up to the covenant of the welfare clause.

We the People... to promote the general Welfare... ordain and establish this Constitution for the United States of America.

The only real flaw of capitalism is that it does not know when enough profit turns into too much profit. There is no stewardship in it by its nature.