Debt Ceiling Deal: Wrong Diagnosis Leads to Wrong Treatment for What Ails the Economy by Dr. Eileen Appelbaum,

by Aug 10, 2011All Articles

The stock market’s decline as the debt-ceiling deal was sealed says it all. Wall Street doesn’t buy the reliance on magical thinking behind this deal ñ that it will ward off the bond market vigilantes, get the confidence fairies back on the job, and let business expand. Even Wall Street knows that cutting spending now threatens jobs, growth and profits in what has been a very weak recovery. The diagnosis of the run-up in debt ñ out-of-control spending by the federal government ñ is wrong, and the ‘cure’ is likely to make economic recovery more difficult.
The real budget problem facing the US is the fall-off in tax revenues. From 20 percent of GDP in 1998 through 2001 ñ the four years in the last forty in which the federal government had a budget surplus ñ tax revenues have fallen steadily. They averaged just 17 percent of GDP from 2002 through 2008, and then fell below 15 percent of GDP in 2009 and 2010.

This precipitous drop in the government’s income is due to cyclical factors ñ the collapse of the housing bubble and the deep recession that followed, as well as to structural factors ñ tax breaks for the wealthy and cash-rich companies that have shifted taxes onto the middle class.

The sharp increase in the deficit ñ to $1.4 trillion in 2009 and $1.3 trillion in 2010 ñ was divided between expenditures to shore up the weak economy and help the unemployed make it through the recession and a decline in tax receipts as employment and incomes fell. There is absolutely no truth to the claim that a run-up in government spending is at the root of our problems. Deficits in the years from 2000 to 2007, the last year before the Great Recession, never exceeded 3.5 percent of GDP and were usually below 2 percent. The national debt held steady at about a third of GDP ñ far lower than it had been in the 1990s.

The real problem is that economy is producing far less and creating far fewer jobs than it is capable of doing. A laser-like focus on job creation would reduce the need for public spending to help workers through a period of prolonged high unemployment. Tax receipts in 2009 and 2010 were more than $400 billion below receipts in 2007, and only 14.9 percent of GDP. Higher employment and incomes would allow tax receipts to recover to pre-recession levels and would help eliminate the cyclical decline in government revenue.

Longer term, structural problems with taxes need to be fixed to address revenue shortfalls, guarantee that everyone contributes their fair share, and reduce the national debt. Corporations that license intellectual property (IT companies, pharmaceuticals) or manage investments make extensive use of offshore entities and convoluted strategies like the ‘double Irish, Netherlands sandwich’  to avoid paying US profits taxes. US corporations are estimated to hold roughly $1.43 trillion overseas and are lobbying for a tax holiday to bring these profits home. Ending these offshore tax havens would eliminate these tax avoidance strategies. So-called ‘carried interest’ – pay tied to the performance of financial investments that is paid to private equity and other financial services managers ñ is taxed at the long-term capital gains rate of 15 percent rather than as ordinary income at 35 percent. This tax break for the highest earners is estimated to cost the Treasury $20 billion over the next 10 years. The tax code needs to be changed so that this pay, like other bonuses employees receive, is taxed as ordinary income. Letting the Bush tax cuts for the wealthy expire would bring the tax rate on dividends and long-term capital gains back to 20 percent, where it stood in 2002. It would also raise the marginal tax rate on the wealthiest income earners from 35 to 38.6 percent.

The key fiscal problem facing the US is a shortfall in revenue, not out-of-control spending. Tax receipts are lower in relation to income than they have been in 60 years. Getting jobs growing again is the number one priority for eliminating the cyclical decline in federal revenue. A tax system that discourages tax avoidance by the wealthy and in which everyone ñ individuals and corporations ñ pays their fair share will speed the reduction of the national debt as a share of GDP.

The Center for Economic and Policy Research | Op-Ed
Friday 5 August 2011
by: Dr. Eileen Appelbaum,

Dr. Eileen Appelbaum is a senior economist at the Center for Economic and Policy Research. She previously served as director of the Rutgers Center for Women and Work. During her tenure, Dr. Appelbaum built the Center into a major locus for research on women’s advancement in the labor market and at the workplace. The Center undertook numerous projects that were aimed at understanding and improving the lives of working women at all income levels. Prior to taking over the Center at Rutgers she was the research director at the Economic Policy Institute. She previously had been a professor of economics at Temple University.

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