Thursday, April 21, 2011

What Money Does

We're in the midst of a very contentious fight over the right way to close the budget deficit;  one the one side, it is believed that simply reducing taxes on the rich will eventually accomplish the feat.

This is the belief of the conservatives, and I understand what it is based on.  It is based on the nature of an industrial economy.  Unfortunately, we are no longer an industrial economy.

In 1952 (to pick a year at random) if you gave a tax break to a wealthy person (which means, essentially, giving them extra money to spend) and given that they would obviously want to find a way to make more money from this windfall, they would invest it in something that was likely to grow.  They would expand their business, or build a new one, or invest in the expansion of someone else's business.  This would create jobs that, ultimately, would expand the tax base and contribute to the shared coffers that pay for our social programs.

In other words, putting money in "at the top" would mean growing the economy.  In 1952.

Today if you give a wealthy person "extra money", what are they likely to do with it?  Their goal would be the same; grow the money into more money.  This is only natural, you or I would probably do the same.  But is the best way to do that still investing in a business?  Probably not.

In most cases the windfall will be invested in complex, "innovative" financial instruments: CDO's, credit-default swaps and the like.  It will be invested in the financial sector itself.  Or, it will be invested in overseas endeavors where the economies are emerging (like China, India, and the like).  It will rarely create jobs here at home.

The Bush era proved this.  The Bush tax cuts invested massively in the upper end of our economy and we lost jobs, lost tax revenue, and exploded the deficit.  It did not work because it cannot work in an economy such as ours.

So, it is not that the conservative "trickle down" theory is baseless, it is that it is obsolete.  Put money in at the top of an economy based on the financial sector, and you grow the financial sector.  Into a bubble.  Eventually the bubble pops, and all that wealth simply disappears, or gets recycled back into financial products. 

Prior to 1985 the financial sector had never represented more than 16% of the US economy (in 1947 it was 2.5%).  In the current decade it represents more than 40%, and is growing steadily.*

We are a consumer based economy, like it or not.  Jobs are created by consumption of goods.  The only way to grow the job base, and thus the tax base, and thus the economy itself is to inject money into consumption.

In other words, the middle class is where the tax breaks should go, and the only way to make that workable is to shift the burden upward.  This does not have to constitute class warfare, it's just a realization of how the modern US economy works, and making policy based on reality.

The problem, of course, is that rich people own our politicians, and they naturally don't want to be burdened with higher taxes.  The problem, of course, is money distorting our political process.  What we should do about that is another subject.

-Scott Bain-