Popular Economics Weekly

It should be obvious by now that the Romney-Ryan program of fiscal austerity—cutting government spending, while cutting taxes in the hope businesses and their investors will invest more of their wealth—can’t work. Latest evidence is the just out IMF 2012 World Economic Outlook (WEO) report that confirms European austerity policies over the past year have made things worse.

So how can Romney say he will create 12 million jobs during his tenure by cutting government spending while lowering taxes? He has said his blueprint is Paul Ryan’s House passed budget bill that drastically downsizes safety net programs, and cuts some $5 trillion in taxes over 10 years, without specifying where he will raise additional revenues to pay for those tax cuts. Since no expert believes it can be done without removing such favored tax shelters as the home mortgage interest deduction, it will create the same austerity trap Europeans now find themselves in.

For instance, we know from the IMF study Great Britain has fallen back into recession over the past 3 quarters by explicitly following Conservative PM Cameron’s austerity program. Ireland and Greece are also in recession because of draconian spending cuts, with Italy and Spain soon to follow.

Chapter One of the WEO report stated that current European policies that demand a reduction of debt as the path to recovery without job creation programs were wrong. In fact, “…IMF staff research suggests that fiscal cutbacks had larger than-expected negative short-term multiplier effects on output, which may explain part of the growth shortfalls,” said the report.

This only confirms what Keynesian economists such as Paul Krugman have been saying for years. The only path to increasing economic growth is to literally create more jobs. Only then will there be sufficient revenues to grow the economy and thereby reduce debts, both in the private and public sectors.

As Lord Keynes famously said, jobs can be digging ditches and then filling them up again, or, how about repairing some of the $2 trillion in needed U.S. infrastructure repairs being put off, which will only increase their costs? Roosevelt’s New Deal created WPA projects that grew the economy by putting people back to work—such as building Hoover Dam, planting trees and the like.

The reason austerity has been ruling economic policies of late is bond vigilantes have been in control, a relic of Germany’s fears of a repeat of their 1920s inflation rate, and U.S. creditors’ fears of inflation that eats away at bond prices. Republican conservatives have used this argument to demand lower taxes, though it has done nothing to reduce government debt. Republican Presidents Reagan and GW Bush created the largest budget deficits since World War II, as I have said.

In fact, other studies, such as by acknowledged budget experts Peter Diamond and Emanuel Saez, conclude that “the revenue-maximizing top federal marginal income tax rate would be in or near the range of 50-70 percent (taking into account that individuals face additional taxes from Medicare and state and local taxes). Thus we conclude that raising the top tax rate is very likely to result in revenue increases at least until we reach the 50 percent rate that held during the first Reagan administration, and possibly until the 70% rate of the 1970s”.

And does it significantly lower economic growth? In the postwar U.S., higher top tax rates tend to go with higher economic growth—not lower, said the study. Indeed, according to the U.S. Department of Commerce’s Bureau of Economic Analysis, GDP annual growth per capita (to adjust for population growth) averaged 1.68 percent between 1980 and 2010 when top tax rates were relatively low, while growth averaged 2.23 percent between 1950 and 1980 when top tax rates were at or above 70 percent.

Neither does international evidence support a case for lower growth from higher top taxes, say Diamond and Saez. “There is no clear correlation between economic growth since the 1970s and top tax-rate cuts across Organization for Economic Cooperation and Development countries.”

It is only recently that historical evidence has been able to examine so-called supply-side economic theory that says lowering taxes promotes growth, which it turns out is just a theory not borne out by the facts.

Harlan Green © 2012