The Great Jobs Debate
by PETER HUESSY
August 9, 2012
The United States is having a major debate about how to get the economy going and create millions of new jobs. On one side advocates call for greater government spending on such things as roads and bridges, ("infrastructure") and higher "taxes on the rich" to pay for the spending and also bring down the debt. On the other side are those who believe that keeping tax rates low and restraining government spending and regulation will spur the necessary investment to create jobs.
The problem with the debate is that if no deal is struck before the end of the year, a fiscal train wreck of massive tax increases and spending cuts happens automatically.
But you might say, Democrats want tax increases and Republicans want spending restraint, so is not this the best of both worlds?
Excellent question, grasshopper. To answer it, we have to first explain how this happened, and then second, go back to first principals as what makes an economy grow. Then we can answer your question.
HOW DID WE GET INTO THIS MESS?
First, how did this happen?
In 2010, with the 2001-2003 tax rate cuts and reforms scheduled to expire, the administration and the lame-duck Congress agreed to extend the tax rates through the end of 2012.
In 2011, with the House now under the control of the Republican majority, the looming European debt crisis and the growing US debt put into stark relief the central concern that had propelled much of the change in the 2010 elections. We were spending too much.
The US Treasury told the new Congress that the US could not borrow any more money unless its debt ceiling limit was extended some time in spring or early summer. The debt limit had been raised repeatedly and was considered "no big deal". But the Republicans, especially their Tea Party supporters, and some Democrats said, "Not So Fast". If we were going to increase our borrowing, at least offset the borrowing with an equal amount of long-term spending restraint or debt relief, they said. (1)
Well, the two sides could not agree whether there should be spending restraint or tax increases, or both, so they come up with a interim deal that threatened financial Armageddon unless they came up with a new deal by the end of 2012.
So in August 2011, the administration and Congress agreed that failing to come up with a deal, automatic spending cuts would occur beginning in 2013, reaching $1.5 trillion over ten years. Part of this were automatic across the board cuts of $100 billion a year starting in 2013, equally divided between defense and non-defense discretionary spending.
The debt deal also cut spending by $1 trillion immediately. Defense was cut $487 billion (a number the OMB simply pulled out of thin air!), which meant 14% of the Federal budget (DOD spending) had to come up with nearly half of all the immediate budget cuts.(2) At the same time, unrelated to the debt ceiling deal of August 2011, taxes in 2013 would go up on everyone--at $500 billion a year--as the tax reform of 2001 and 2003 would expire. So Washington faces both massive spending cuts and major tax increases in January 2013 if nothing is done to alter this coming fiscal train wreck.
Now we have to return to our narrative. Why not simply increase taxes and cut spending? Well, that is hard when a lot of Washington is talking about spending more--stimulus and entitlements--while simultaneously talking deficit reduction--primarily taxes and defense spending cuts. One choice--some stimulus spending and keeping our promise on entitlements and welfare--is universally assumed to grow the economy and be morally necessary.
The other choice--cutting defense spending and increasing taxes--is assumed to cut the deficit and raise enough revenue to allow "good spending". But the defense cuts have largely been baked into the deficit cake so to speak, except $50 billion a year slated for cuts under sequestration. And as for tax cuts, the President of Federal Express put it best: "How can anyone be serious about a trillion dollar deficit by proposing to increase taxes $150 billion?" Another way to look at it: there are $150 billion in new taxes in the President's budget or $1.5 trillion over a decade to pay for over $45 trillion in new spending of which a projected $10.6 trillion will be borrowed.
DOES MORE GOVERNMENT SPENDING MEAN MORE JOBS?
Now we come to the second part of the question. What makes an economy grow?
Let's look at the facts. Since 2009, we have spent trillions on new spending to make the economy grow. What happened? The Wall Street Journal of Monday, August 6, 2012 has an answer to the question: Has government "stimulus" created jobs and growth?
Art Laffer explains that 33 of 34 countries that make up the Organization of Economic and Community Development, (the industrialized countries of the world outside of China and Russia), dramatically raised their government spending between 2007-9 by up to 18%. But their economic growth rates in every instance actually fell in 2008-2009 compared to 2007-2008. The US fell 8%; Germany 12%; Switzerland 7%; Japan 11% and Greece 11%. Ireland 21%.
In the United States, Laffer notes government spending went from 21.4% of our GDP in 2007 to 27.3% in 2009, which included greater spending on "housing and agriculture, the tax rebate in 2008, the TARP expenditures, the bail outs of Fannie Mae and Freddie Mac, mortgage relief, cash for clunkers, and the stimulus package of $860 billion".
In the last five years we spent $4 trillion on "stimulus". In addition, some of the stimulus spending went to tax rebates, and current stimulus spending includes the temporary payroll tax cut. But "Where are the jobs?", Americans rightly ask. What happened to all that money?
WHAT DID HAPPEN TO ALL THAT MONEY?
What are we missing? Let us look at the current financial balance sheet of the United States.
The President's newly revised long term budget plan was just analyzed by the Congressional Budget Office. It projects $10.6 trillion in new debt over the next decade with spending increasing from today's (FY2013) $3.8 trillion to $5.5 trillion (FY2022).
Most everyone agrees such spending and debt is not sustainable. So naturally, people turn to raising tax rates to get more revenue and reduce the growth in spending to close to budget gap. But Democrats want to both spend more on roads, social welfare and entitlements (good stuff) while cutting defense spending (bad stuff), while Republicans have no problem with smart infrastructure spending and reasonable defense spending, but see entitlements growing out of control (which they are).
On taxes, there remains a huge divide; Democrats want the rich to "pay their fair share" while Republicans say the upper income folks are already paying their fair share. In addition, tax increases cannot begin to pay but for a fraction of the new spending projected for the next decade. And tax increases have historically been a useful tool by spending enthusiasts as leverage to hide plans to expand social welfare spending.
The administration's latest budget updates has increased taxes, increased spending and increased debt, apparently confirming the fears of many. The problem is we are trying to grow the private economy but taxing it more will make it contract. And we are trying to reduce the deficit and at the same time increase stimulus spending.
GOVERNMENT BUILT THAT, SO LETS KEEP BUILDING!
Richard Cohen of the Washington Post says we should love government spending because it built the Erie Canal and our highways. (3) In a recent column he cites the Economist from across the pond to explain the deadlock in Washington. "Tax cuts are always right" even if they inflate the deficit seems to be the view of conservatives, they complain. He concludes the "refusal of the Republican party to acknowledge the role of for government is linked to an illogical determination never to raise taxes". So Cohen is only arguing about how to pay for more government spending he likes!
He is not alone, however. All government spending to tax hiking enthusiasts is not the same. The Simpson-Bowles deficit commission,, appointed by the administration and Congress, recommended not only to raise taxes by trillions of dollars, they proposed that defense spending be curtailed by over $1 trillion and be coupled with some modest entitlement reforms.
But they left intact the biggest entitlement program of all--the Affordable Care Act--which the Congressional Budget Office says will spend $2.7 trillion over the next 10 years, while the legislation raised taxes by only $514 billion to pay for it. (Including a 3.8% tax on the sale of your home and a similar tax on your gross revenue if you sell medical equipment).
DID WE CUT DEFENSE TOO MUCH?
Could one of the reasons the economy is not producing jobs is that defense has been cut by $1 trillion already since 2009? Many assessments such as the AIA project that future sequestration cuts in defense will eventually lose the economy 1.2 million jobs, hardly the means of increasing economic growth and with it revenue to the US Treasury. A new Brookings Institution report says such job losses won't happen. They assert the AIA report exaggerates the impact, arguing that the AIA report implies that fully a third of all aerospace workers would lose their jobs, and since such defense spending is not being cut by a third, such job losses are unlikely.
However, while a third of the defense budget is not being eliminated, $30 billion of the $50 billion a year in projected defense cuts could be coming out of acquisition and research and development, according to the DOD comptroller. Other analysts put the number higher. Such spending now totals $166 billion a year. A twenty percent cut would implicitly lose 650,000 jobs according to Brookings logic, although the secondary effects on defense industrial suppliers and the ripple effect of such job losses certainly would make that figure escalate. And this does not include the employment effects of the other defense spending cuts.
WHY COHEN IS OUT TO LUNCH.
Cohen wants to pay for greater government social spending but he knows the resulting budget deficits cannot be sustained. So he seeks both tax increases to convince the American public he is serious about debt reduction, and defense spending cuts because he knows its an easy sell to tell liberal Americans a smaller military means we are withdrawing from the world. The former British Prime Minister Clement Atlee said it well: "Big ships make big wars; small ships make small wars; and no ships make no wars".
THE RED APPLE LOOKS ENTICING
Like the witch with her bright red apple in Disney's Snow White, this sure looks enticing. Raise taxes, take care of social spending, come home from fighting overseas, and cut defense spending which is no longer needed. Such a deal!
But it is illusory and false. Everything is wrong with it.
Let us start at the top. A US retreat from the world will only encourage our adversaries to expand their presence and hostility. Between 1932 and 1939, defense spending remained at $700 million a year. During these years of the Great Depression, overall government spending grew from $3 billion to over $9 billion. Tax rates were raised to over 90% on top earners.
Did the restraint in defense spending guarantee the piece Roosevelt promised? No, we got World War II as the gathering storm about which British Prime Minister Churchill repeatedly warned broke upon us. Sixty million people perished.
Similarly, after Vietnam, a failure to support our military and the development of a hollow Army saw the advance of the Soviet empire everywhere. Eighteen countries fell to Soviet tyranny, and others, such as Iran, fell to a new Islamic totalitarianism. America was in retreat. Inflation reached 14% at the end of the decade after Vietnam, interest rates hit 21%, oil prices reached $37 a barrel, (from $4 in 1974) and unemployment climbed to over 8%. "Stagflation" it was called---high inflation and low growth combined. So obviously whether we look at the pre-WW II period or the post Vietnam period, low defense spending neither helps our economy or our security!
OUR PLAN WORKED!
So how do we get out of this mess? The administration has said we cannot look at the "last thirty years" for solutions. They have said "none of that worked". They implied the Reagan economic recovery "didn't work" and that "we tried that and it did not work". Only recently the administration has changed its tune, saying the Clinton years of the past thirty "worked" and they are trying only to emulate the job creation of the 1990s by claiming their policies are similar.
Well, as President Truman used to say, let's look it up. What worked in the past 30 years and what didn't?
In 1981, President Reagan cut tax rates across the board by 30%. The money supply had to be curtailed to wring inflation out of the economy, but by September 1983 the US economy produced 1.3 million jobs in a single month, recovering from a recession of $200 billion deficits and over 10% unemployment.
But in those same Reagan boom years, revenue to Uncle Sam increased $65 billion a year. Why? Jobs. Between 1983-88, jobs increased 21 million, or 3.5 million a year. But between those same years, government spending as a percent of our GDP declined 2%.
In the next boom period, 1991-2000, revenue climbed an average of $104 billion a year and 24 million jobs (2.4 million a year) were created. And government spending declined nearly 3% of GDP to roughly 20%.
Interestingly, after the capital gains tax cuts of 1997, US government revenue climbed an extra $200 billion between 1998-1999 over the previous period.
Now what about between 2003-7? We had a recession in 2001, the collapse of the Dot-Com bubble and the attacks of 9/11. By 2003, however, jobs were being created. Between 2003-7, we increased Federal revenue by $800 billion, or by $160 billion a year on average, but with one year between 2005-6 revenue climbing a spectacular $245 billion. And in 2003-7, jobs increased 8 million, implying 16 million over an eight year period.
The 2001-08 period started and ended in recession, but not due to tax rate cuts or regulatory reform or cheap energy. In fact, many now acknowledge the Sarbanes-Oxley "reforms" of July 2002 put a dramatic stranglehold on investment, making job growth difficult. On top of which, as Art Laffer's article explained above, the huge spending increases in 2007-8 along with the oil price spike toppled the US into a serious recession.
Today there are roughly 142 million Americans working, some 4.5 million less than were working in December 2007, the peak of employment. Then revenue to Uncle Sam hit $2.6 trillion. Revenue today, some 5 years later, has only reached $2.3 trillion, having been adjusted downward recently.
Why? Fewer people are working because obviously there is less investment. But US government spending is some $1 trillion a year higher, but we are taking in less revenue and fewer Americans are working. So obviously, their plan did not work! If anything, their planned spending and regulatory policy on energy is in danger of repeating the very government mistakes that topped the US economy into recession in 2008 in the first place!
HOW TO PUT PEOPLE TO WORK
The point? We should be talking about how to put people to work in the US economy, especially how to increase investment in new companies and expanding current ones. While previous efforts to reduce the deficit were almost all centered on the idea that once deficits were curtailed, interest rates would fall and thus spur borrowing and grow the economy, that in the short term is now irrelevant. Interest rates are at historical lows even as deficits are at historical highs! If interest rates were once a barrier to borrowing, they certainly are not today.
The debt is now ten times what it was under both President Reagan and George Bush's last full year in office even though interest rates today are near rock bottom. And the solution for job growth hardly appears to be based on MORE federal government spending, as we are spending $3.8 trillion today compared to $3 trillion in 2008 and $2 trillion in 2000.
Let us examine where we have been and where we are.
Well, in December 2007, the peak of the economy prior to the recession, the top tax rate was 35%, defense spending was $549 billion, overseas contingency spending was $148 billion, the debt was $161 billion a year and 145.5 million Americans were employed, and unemployment was 4.4% in May 2007 (the low point).
Today, the top tax rate remains at 35%, defense spending is $525 billion plus the Overseas Contingency Operations of $118 billion, the budget is $3.8 trillion and the deficit $1.275 trillion. Unemployment is 8.3%, nearly twice as high as the May 2007 number.
So the annual debt has ballooned over $1 trillion while defense spending has declined and tax rates remained stable. So why do we think cutting defense even more, adding more debt and contracting the private sector by raising tax rates will help?
The key is putting more Americans to work. And the administration has recently said--perhaps inadvertently-- this will come about not due to government spending but because of expanded private investment. This is a formidable task, but many Americans seem to have decided that no solution is at hand, that the gloomy economic statistics that dominate their televisions will simply continue. The new bad economy has become the new "normal".
It is not acceptable and is not moral. What right to we have to throw up our hands, admit defeat and hope America's decline doesn't affect us too badly? How can we face our children and say, well, for you guys, there is no American dream? And how can we allow politicians and other leaders to convince us that they cannot do much about all this as other factors are overwhelming us--hurricanes, tsunamis, the European debt crisis, new technologies?
Add the number of Americans out of work but looking for work, those underemployed, and those having given up looking for work, and the unemployment rate approaches 12+%. Americans in need of jobs is thus approaching 20 million. The debate should thus be, how do we put to work 20 million fellow Americans as soon as possible.
From fiscal years 1983-89, 1993-2001, 2003-2007, the US generated 52 million jobs. What were the common elements of these growth years?
They were low tax rates, especially on investment. Two, regulatory reform, although the most recent period saw regulatory excess. Three, investment in new technologies and new companies. Fourth, energy production and low oil prices, which again occurred due to fracking but was offset completely by OPEC. And fifth, restraint in government spending, again which occurred between 2003-7 but ended in 2008-9.
Let us look at the record.
In 1981-86, income tax rates were cut from 70% to 50% and then to 28%. Capital gains and dividend taxes were also sharply cut. Reagan reformed the trucking, airline, communications and transportation sectors. He decontrolled the price of oil. Oil fell to $14 barrel by 1986 from $38 in 1980.
In 1997, Clinton and the Gingrich led Congress cut capital gains taxes, established a new child tax credit, and reduced other taxes. [They did raise cigarette taxes]. Welfare reform was approved. And a balanced budget agreement cut spending and created a surplus over four years.
The result? Revenue increased by upwards of $200 billion a year. The internet became free of government control. And oil fell from $28 a barrel in 1990-1 during the build-up to Desert Storm to $16 a barrel by 1994 and then $13 by 1998, further spurring the US economy.(4)
As these policies took hold, venture capital investment soared from $8 billion to $28 billion to $56 billion a year; and welfare reform moved 8 million people from the poverty roles to the employment roles. Jobs increased 24 million beginning at the end of the Bush administration to the end of the decade and Clinton's eight years (1991-2000).
In both periods, US government spending dropped 2-3% of GDP. Investment in new technologies, energy price declines, tax cuts, free trade deals and Federal government spending restraint all boosted employment.
And again in 2003-7, venture capital investment increased, government spending as a percent of GDP declined by 2% again, and 8-9 million jobs were created. More importantly, annual revenue to the government soared $800 billion, from $1.8 trillion to $2.6 trillion.
Looks like our way worked.
WHAT CAUSED THE DECLINE OF 2008?
As I wrote in my July 11, 2012 posting, both Treasury Secretary Geithner and former CEA Chair Goolsby have noted the 2008 financial crisis was precipitated by $147 barrel oil. This is absolutely true. As Robert Zubrin has written: "Every oil-price hike for the past four decades, including those in 1973, 1979, 1991, 2001, and 2008, was followed shortly afterwards by a sharp rise in American unemployment". In this case, the oil spike crashed the economy and with it housing prices, which uncovered the huge indebtedness from subprime mortgages, which in turn turned Wall Street and the banking industry upside down.
Energy prices did increase gradually, from $24 barrel to $74 barrel by mid-decade. But by 2008, prices on July 4 skyrocketed to $145.29 a barrel from $53 in January 2007. Today, despite a world economic decline from the 2007 peak, energy prices in 2009 increased as well from a low of $38 barrel in December 2008 to well over $60 by the late spring 2009 and then back to the $80-100 a barrel. Brent Crude closed today at $103.
One would think given the history of the relationship between growth in the US economy and energy prices, we would be pursuing a policy of production first, technology development second, and ending OPEC's stranglehold on our economy third? Shouldn't we be doing everything possible to expand currently available energy resources now even as we invest in technologies that will deliver us new energy in the future? We hear much about using American energy technology to supply the US economy.
But the administration policy appears to be to invest in future technologies now while curtailing current technologies that will produce energy now.
But there is a better way. For example, with Bush era regulatory reform, leaving things to the states, new fracking technology grew dramatically, and has doubled US natural gas production. Almost entirely on private and state land. Prices have dropped 75%. Seems our way worked.
Yet US government policy, while building roads and bridges, seems determined not to produce the gasoline needed by the trucks and cars driving on the new roads. The Keystone pipeline has not been approved which could bring 700,000 barrels of crude to thirsty US refineries every day. Permits to produce oil and gas on public lands are down 40% as is production, while more than one judge has found the administration guilty of cooking their energy books. Millions of acres of energy resource land has been taken out of production by executive order.
Yet new studies say the US has more energy than the entire Middle East by a factor of 700%. A North American energy cooperative deal says one analysis could by 2030 add $5 trillion to the US economy, 2.5 million jobs and $300 billion annually to our national income. If only the US would develop and produce its own energy!(5)
In addition, instead of seeking regulatory relief, the administration's regulatory and labor policies are shutting down job creation, the most apparent the NRLB attempt to close down a Boeing airplane plant in South Carolina. In the rescue of GM, 20,000 Delphi workers lost their retirement accounts because Treasury knew they were not union organized. Already the administration has added this year 3500 pages to the 85,000 pages of the current Federal register, with 170 major rules on the books or forthcoming that will cost over $100 million each. And people complain there are not enough Federal rules for us to obey!?
What about investment income? The administration proposes tripling dividend taxes and increasing by sixty-seven percent capital gains taxes. Already because of the uncertain and troubling investment environment, we are not attracting the capital needed to create jobs. Only 8.6% of world-wide IPO's took place in the US this past year. The US corporate tax is the highest in the world and yet is levied on already taxed foreign earned income unlike any other modern industrialized country in the world. America has not only lost its high credit rating under this administration, it has dropped significantly in its attractiveness as a place to do business.
LETS TRY OUR WAY
Would not smart tax and regulatory reform, coupled with energy production and budget restraint, duplicate the three previous boom periods? We followed this prescription three times in the past thirty years and created 52 million jobs.
In all of the boom years mentioned here, the defense establishment did well, major new military technologies were adopted, and the US military became the best in the world. So we do not have to choose between continuing US leadership in the world or a growing US economy. The two are not mutually exclusive.
Ironically, a booming US economy, and a treasury flush with cash, can sustain and maintain a strong US military. American retreat and American decline, both feared and wished for by American doubters and detractors, is not a future we need to choose. We increased annual revenue to the Federal government by $800 billion between 2003-7. If we duplicate that in the next eight years, we can bring revenue to $4 trillion a year even with the same tax rates. And produce 28 million new jobs if we sustain the Reagan era job growth for eight years or 16 million jobs if we duplicate the period 2003-7 for eight years, or 24 million jobs if we duplicate the growth from 1991-2000.
At the same time, instead of seeking to sustain the welfare state, we can again replace the poverty roles with the work roles. In 2008, we spent $569 billion on means tested poverty programs. Administration projections are that in 2016, we will be spending $1.1 trillion on poverty programs despite being in the sixth year of economic recovery. That does not make any sense. Just returning to the spending level for poverty programs in the last year prior to the recession would cut such spending--over time, as we did welfare reform-- by nearly half a trillion dollars annually. Added to the growth in revenue from prospective job growth, and the US budget could be near balance.
Reagan was right--America's best days are ahead of her and that "Shining City on a Hill" can remain a beacon to all those seeking freedom and liberty in the 21st century. Throughout our history, the path ahead has been, no doubt, in part, illuminated by our past accomplishments. But if we adopt those things that have worked in the past---spending restraint, technology advancement, regulatory reform, energy production and tax and investment incentives--the creative genius of America will find that path again and with a new light restore America's leadership of the free world and the prosperity that makes the American dream come true.
(1) Nearly 30 years ago, in 1985, at the height of the Cold War, then Senator Biden said there should be no debt ceiling increase unless there was a freeze on defense spending.
(2) This was on top of $505 billion in defense cuts already implemented by the administration in 2009-11. Note also these cuts do not apply to any spending for the war in Afghanistan or the counter terrorism deployments by US forces in Africa and elsewhere otherwise known as Overseas Contingency Operations. Thus conversely, any reductions in such OCO spending could not count toward any deficit agreement. One of the few analysts to identify this OMB sleight of hand is Rebecca Heinrich of the Heritage Foundation and a frequent guest on Fox television. They should make her an anchor.
3. Actually business paid the taxes through their employees and directly to the government to build everything.
4. Robert Zubrin makes a major point of the benefit of declining oil prices: we spend less on gasoline but we send less overseas--upwards of $300 billion stays in America rather than goes overseas. That alone is a major stimulus package that neither has to come from borrowed government spending or taking more income through higher taxes.
5. Solar, geothermal, biomass, wind and hydropower together produce 8 quads of BTU's of energy in the US out of 98 quads used.
Peter Huessy is President of GeoStrategic Analysis of Potomac, Maryland , a defense and national security consulting firm.