Monday, June 13, 2011

Modern Economics & Its Evil Basis: The Pareto Distribution(2)

In the last instalment, I examined the evil nature of the Pareto distribution and how it skews priorities toward the wealthy. I invoked Vifredo Pareto's original quote on the collectivity comprised of a sheep and a wolf and how it was to remain happy. Probing deeper, given pasture with only food the sheep can consume, the wolf is rendered miserable by not being able to eat the sheep. At least if he can eat the sheep he can remain happy for a bit!

I now pursue the issue of what qualifies Pareto efficiency by examing the madness of tax cuts, the worst idea to perhaps ever infect economics. The kind of pivotal event was the invention of the "Laffer curve" (see diagram) on napkin and on the fly, by one Arthur Laffer in 1974. Laffer was then an economist at the University of Chicago and traveled to Washington, D.C. to meet with Donald Rumsfeld, Gerald Ford's then chief of staff.

Laffer had a new theory on why tax rates were inefficient and high, or one might say "inefficiently high" and one interested nabor from the WSJ asked Rumsfeld to meet with Laffer on the issue. As it happened, Rumsfeld had other committments so dispatched Dick Cheney instead to a bar, where the meeting took place. (See, e.g. Economics for the Rest of Us by Moshe Adler, Ch. 6) Laffer then proceeded to sketch his infamous fiagram on a napkin on why the rich could be said to be "over taxed".

As drawn, it was totally convincing! Especially for a guy like Cheney with minimal math skills. Note the line defining the highest marginal tax rate of 70% for Gerald Ford's presidency. What Laffer's curve sought to show is that by cutting that rate down, say to 50%, one could increase the revenues by nearly 35%! Of course, the 50% turned out to be wholly arbitrary and in fact after Reagan became President in 1980 the rates were cut down to 50 by 1981, then to 28% (by 1988). After all, if one could increase revenues by cutting taxes 20%, imagine what one could do by cutting them more than 40%!

Thus did Laffer's curve become the basis of Reagan's tax cuts and the whole tax cut meme ever since, despite the fact that in reality no community or even human body has mamanged to GROW by virtue of starving! But try to tell the bulk of Americans, who continue to buy into this codswallop at a mind-boggling rate! Despite the fact there's never been evidence it's actually worked!

A Financial Times Analysis (9/15/10, p. 24) of the Bush tax cuts found:

The 2000s- that is the period immediately following the Bush tax cuts – were the weakest decade in U.S. postwar history for real, non-residential capital investment. Not only were the 2000s by far the weakest period but the tax cuts did not even curtail the secular slowdown in the growth of business structures. Rather the slowdown accelerated to a full decline

For reference, the top marginal tax rate during the Bush years (for income tax) was reduced to 36% from the 39.5% during the 1990s Clinton Years. Over the 1950s and into the 1960s (until about 1964) the top marginal rate was at 91%, going down to 65% by the mid -60s. The lower level of 50% wasn’t hit until Reagan arrived in 1980, and passed his tax cuts. And we've been piling up deficits ever since.

The FT conclusion was blunt:

“Business investment data demonstrate the Bush tax cuts failed to achieve their goal of spurring productive U.S. investment and that failure has contributed to the poor performance of U.S. stocks”

So why are so many Americans (50%) still attracted to the "fun house math" of the GOP, to use the words of one TIME writer (June 20) who is nonplussed that so many have bought (and evidently taken) the kool aid that the Reeps are selling: that the only way out of our economic malaise is to further lower taxes on the wealthy and businesses, and cut "entitlements". Can this be a disease?

The question arises: when Laffer's crappola was first presented to the Reaganites and then budget maven David Stockman (who now argues for higher taxes)how did he manage to sell the meme that HIGHER tax rates cause revenues to decrease? That's like saying or arguing that the more gas I put into my tank the less distance I will be able to travel! It makes NO sense!

Laffer argued that higher tax rates on the rich would only cause them to work fewer hours, or if REALLY rich, invest in fewer projects, enterprises, hence create fewer jobs. Thus, revenues over all would decline, first from the working rich because Uncle Sam would get less taxes by virtue of their reduced work, and also from the investing rich because they'd create fewer jobs and thus no workers would be around to pay the taxes Uncle Sam wants. Thus, Laffer argued, the higher tax rates were Pareto Inefficient!

But fortunately, enough economic real indicators existed to test Laffer's curve on an empirical basis. Thus, given the progressive Reagan cut - from 70% to 50% by 1981, then down to 28% by 1988, it should be possible to match the claims against economic reality. Especially, one would expect to find lower debt % of GDP IF Laffer's claims were true.

A first full examination of the empirical effects arrived in James Medoff and Andrew Harless, The Indebted Society, 1995, wherein they found, p. 23:

"For the health of the economy, Reagan's policies turned out to be just about the worst thing that could have happened: investment did not increase, growth continued to stagnate, and the federal deficit ballooned to new dimensions....

In 1981, the year Reagan took office, the public debt was 26.5 % of the gross domestic product (GDP)....In 1993, the year that Bush left office, the public debt was a staggering 51.9 percent of the GDP."

Thus, we have the first evidence that Laffer was plying bare bunkum not sound economic policy! If the debt as percentage of GDP nearly doubled by the end of the Bush Sr. presidency (and recall he kept Reagan's rates for most of his tenure) then we see what a disaster they were.

More impressive yet was Medoff and Harless' analysis in their chapter 'Let The Eat Cake' (p. 84) which looked at actual data(p. 87)and found that "high tax rates are associated with higher productivity growth. There is a consistent and strong relationship.". This was written barely a year into Bill Clinton's imposition of a marginally higher tax rate on the wealthiest, and we saw after the fact more than 20 million jobs created, even as the deficits decreased and a healthy ($600m) surplus was left for Bush Jr. (promptly pissed away in his tax cuts!)

Less well known, but which I can document since I lived there, is that supply side economics was tried in Barbados, in FY 1987. The usually democratic socialist state had just elected a new government (ibn 1986) that was determined to experiment for the first time with 'trickle down' supply side bunkum. They eliminated all taxes totally for those earning under $15,000/ year and also cut marginal rates in most income categories from 20-30%. They were warned by the country's top economists it would lead to disaster, but they took no heed. Finding it more to their liking to pander to a naive (then!) populace to garner votes, they couldn't renege once in power, if they wanted re-election.

The supply side idiocy was implemented for tax year 1987 and beyond and five years later (and the loss of 35,000 (out of 105,000) jobs), with reserves barely at $11 million, the island had to go to the IMF for loans as its cash flow had evaporated. The IMF injected nasty medicine - in the form of across the board pay cuts- and higher taxes, though devaluation of the currency was avoided. The pain is still felt today, as the succeeding government had to also impose VAT or value added taxes, including on foodstuffs.

This also is an object lesson to all who still believe suppply side baloney can work in any venue, or that tax cuts are an answer.

What was the biggest irony of all? That one of Reagan's top professional economists, Martin Feldstein, actually pooh-poohed Laffer's curve. In a 1986 econ article Feldstein admitted he "never believed Laffer" and referred to his "curve proposition" as the "height of supply side hyperbole". The tragedy is that Fedlstein's article was snuffed by the Reaganites, and Feldstein himself never broached it, especially after being given an office in the administration. A pity, because decades of foolishness and pain might have been avoided.

Because of that, the belief that tax cuts for the rich are the best way to apply them remains dogma, especially among Republicans.

But let's never forget the underside of their credo: that tax cuts are pushed not merely to benefit the rich, but to "starve the beast".

If then revenues are drawn down to minimal level, the government will eventually have little choice but to cut the "entitlements" people depend upon. Of course, the pressure builds even further if military spending is also increased (as it was in 2004, from 2.4% of GDP to 3.9%)

No comments: