Wednesday, January 28, 2009

The Stimulus Package and the Crash


Almost all economists will tell you we need some sort of stimulus to have a chance of getting out of the amazing economic mess we find ourselves in. The biggest controversy on the stimulus is the Republican plan to use tax cuts, and only tax cuts, as opposed to the combination of spending and tax cuts that Obama proposes. Our economy was greatly shaped by the two big tax cuts of the early 2000s and there was a $160 billion tax cut last year to stimulate the economy. We are in this mess anyway. This suggests that pure tax cuts will not be effective. It seems time to change direction.


In a previous post (It's the Debt, Stupid) I identified excessive debt as a root cause of our economic problems, and briefly noted that excessive compensation to people not doing a particularly good job may also be at fault. There is some support for this view in "The Great Crash 1929" by John Kenneth Galbraith. On page 177 he identifies excessive concentration of wealth, 1/3 of all income going to the top 5%, as a primary cause of the Great Depression. He notes that people living paycheck-to-paycheck will reliably spend all their money, whereas wealthier individuals can stop buying luxuries and investing whenever they choose; thereby creating a big drop in demand. This is, among other things, exactly what happened in the Great Depression; in part because this group lost a great deal of money in the crash. Here's the scary part, take a look at the income data at Summary of Federal Individual Income Tax Data 1980-2006. In particular, examine Table 5, Adjusted Gross Income Shares, 1980-2006. There you will see that in 1980 the top 5% of earners took in 8.46% of all personal income. By 2006 this had risen to 36.66% -- well over 1/3, the level partly responsible for the Great Depression.

This concentration of wealth confirms a prediction I heard way back in 1979. That year I read a book called "Global Reach" about the rise of transnational corporations driven solely by profit. Although it was meticulously researched, I didn't buy most of their argument. However, I remember their prediction: that America would begin to resemble a banana republic: heavily in debt, militaristic, questionable elections, and, most important for our purposes, characterized by a few very wealthy people surrounded by a sea of poor folks. A very real trend in this direction is clear from the tax data.

No one really knows what will or won't get us out of this fix short term, but long term I think we need to substantially reduce debt and flatten incomes. During one of the primary debates, Ron Paul tried to made the case that our accounting system is out of whack, excessively rewarding a small fraction of the population at the expense of everyone else; based not on productivity, but rather who controlled the accounting system. There's very little that Ron Paul and I agree on, but this is one of them.

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