“Economic Recovery – Where’s the Beef?”

Sydney M. Williams

Thought of the Day

“Economic Recovery – Where’s the Beef?”

March 27, 2012

One observation; one fact: Yesterday, Federal Reserve Chairman Ben Bernanke acknowledged that the economy is not growing fast enough to produce enough jobs to bring down the unemployment rate – an observation difficult to counter. Unless the President and Congress grapple with the issue of taxes in the next nine months, the United States will experience the largest tax rate increase in its history – a fact that must be addressed, if we don’t want to double dip.

Granted, the recession of 2008-2009 was more severe than any previous in the post-war period, in terms of depth and duration; though, interestingly, not in terms of unemployment. (The dubious victor of that contest goes to the 1982 recession when unemployment remained above 10% for ten months – September 1982-June 1983. In the recent recession, unemployment topped 10% only once, in October, 2009.) But, what is most notable about the recent recession has been the feebleness of its recovery. Two years after its last negative quarter of GDP (Q4 2009), the economy was expanding at 1.6%. Two years after the final negative quarters in the 1974-1975 and the 1982 recessions, the economy was growing at 4.2% and 5.6%, respectively. If the current economy were growing at rates closer to those previous periods, it would have meant dollar additions to GDP over the past two years of $700 billion to $1.2 trillion! Whatever the federal government has been doing to spur economic growth, it is not working.

No matter if one is liberal or conservative, we should be able to agree on one thing – whatever size government we want, it should be paid for. It hasn’t been, other than a few years in the late 1940s and 1950s and then again in the period 1998-2001. Last year receipts were 14.4% of GDP, while spending was 25.3%, an obviously unsustainable situation. Republicans and Democrats are both at fault. For the last three years, as a percent of GDP, the shortfall (the deficit) has been the largest since World War II.

There are areas of disagreement, but two stand out. The first is the size of government desired – most liberals suggest government should represent about 22.5% of GDP, the number being forecast by the Brookings Institute for the next five years. Most conservatives would prefer a number closer to the 19.5% that was common during the 1990s through 2007. (Waste in government spending is acknowledged by both parties, but is recognized to be so embedded that reforms seem all but impossible. In part that is because waste supports the livelihood for tens of thousands of government employees.) The difference between 19.5% and 22.5% amounts to about $500 billion in annual federal government spending.

The second area of disagreement involves how federal revenues should be generated. Liberals believe the answer lies in increasing taxes. They enthusiastically speak of raising taxes on the wealthy, yet know that to achieve their spending goals they will have to raise taxes on middle class. Conservatives believe in making the tax code more conducive to economic growth, with lower nominal rates and a simplified code embodying fewer deductions and credits – the purpose: spur economic growth, with the goal of generating more employment and higher tax revenues.

Presidents have a relatively short window in which to dramatically impact change. (Though it appears Mr. Obama feels that he will have “greater flexibility” once he wins re-election.) Mr. Obama, with control of both the House and the Senate at the time, used his honeymoon period to increase federal spending via an $850 billion stimulus that did little other than keep some union workers employed and, more impactful, signed a national healthcare plan, with the illusory name Affordable Care Act, a government managed program that will only be affordable if tax rates become confiscatory – rates so high they will destroy what feeble recovery we already have. He could have easily chosen a much more fiscally responsible path. In February 2010, a year into his Presidency, he appointed former Senator Al Simpson and Erskine Bowles to head a Commission charged with addressing the growing problem of debt – a problem that can most realistically be addressed through tax reform and deficit reduction: both recommendations of the Simpson-Bowles report, which was ignored.

The expiration on December 31, 2012 of the tax cuts enacted in 2001 and 2003 will cause rates for all five brackets to rise; the largest percent increase will be for the lowest bracket – from 10% to 15%. The highest bracket would increase from 35% to 39.6%. Currently, the death (inheritance) tax is 35%, with an exemption of $5 million ($10 million for couples.) The price for dying in 2013 is scheduled to rise to 55% on all estates over a million dollars. Investment income will be treated as earned income. The tax on capital gains will rise from 15% to 23.8%. Additionally, the Affordable Care Act includes an investment surtax of 3.8%, which means that the tax on dividends next year will rise from 15% to 34.6% for those making $80,000, and to 43.4% for those in the highest bracket. In all, the Affordable Care Act includes twenty new or higher taxes. According to Americans for Tax Reform, the Alternative Minimum Tax (AMT) will ensnare 28 million families in 2013, up from 4 million in 2011.

An increase in any tax is injurious to economic growth, as it removes a needed stimulus. The increase in dividend and capital gains taxes is particularly notable, and affects especially the elderly – the retired and near-retirees. As savers, these are people who already have been negatively impacted by the Fed’s policy of very-low interest rates. Warren Buffett has made a lot of noise regarding the “unfairly” low tax rate he pays; so has been vociferous in his support for higher taxes, including those on capital gains and dividend income – an opinion oft cited by President Obama. From Mr. Buffett’s perspective, a higher tax on dividends is no big thing; he has no dog in that fight. Berkshire Hathaway pays no dividends, so would be unaffected, and Mr. Buffett has made it clear that he doesn’t believe in selling his stock. But it will affect millions of people with much smaller net worths.

Moreover, dividends are a critical component of investor return. Data from Ibbotson Associates show that between 1926-2005 dividends accounted for over 40% of total return from stocks. And there is little question that companies will have less incentive to increase, or even maintain, dividends.

With baby boomers reaching retirement age at the rate of 10,000 a day, while retirement plans – both public and private – remain underfunded and with Social Security on life support, one would think that common sense would argue: don’t mess with dividends or capital gains! As I have pointed out on numerous occasions, there is not enough capital to pay for the needs of our aging population. (And most of the developed world is in far worst shape than are we, because they are aging at a far faster rate.) Government should be encouraging investment and capital formation, not discouraging it.

There are still five million fewer people working today than when the recession began. There are too many people subsisting below the poverty line. These people need whatever assistance government and the private sector can reasonably provide, but government must be careful that what they do today does not create far more poverty in the years ahead. Policies that focus on improving entitlements and not on the seeds necessary for economic growth will most assuredly endanger the enervated recovery we are experiencing. Where’s the beef?