Bad economics, worse politics

Robert Kuttner

October 05, 1990|By Robert Kuttner

THE HOUSE did what it should have done in scrapping the budget deal. It was bad economics and worse politics.

First, the economics: The Bush administration and Congress waited about three years too long to get serious about cutting the deficit, and the entire exercise has now been overtaken by events. A big deficit cut might have been sensible while the economy was booming. But now the country is teetering on the edge of recession, which a massive cut in the buying power of the middle class will only deepen.

Supposedly, that effect will be offset because a deficit cut will allow the Federal Reserve to cut interest rates and thereby stimulate the economy. But this assumption also has been overtaken by events.

Today the Fed is entirely hemmed in by America's dependence on borrowed foreign capital. Right through 1989, European and Japanese investors were buying U.S. Treasury debt, to the tune of about $80 billion a year. But in the first six months of 1990, foreign investors withdrew a net $20 billion.

The Japanese, defending their shaky money market against a financial meltdown, have raised prime rates five times since last year. Interest rates in Tokyo are now slightly higher than in New York, so investing in U.S. Treasury debt is no longer a good deal for the Japanese. The Germans, meanwhile, are sending their spare money east, not west across the Atlantic.

As a result, the Fed has very little running room to lower rates. The dollar has already dropped substantially in value against other currencies and the Fed will need to shore it up with higher interest rates to prevent further outflow of foreign capital.

As for the politics, the details of the package were yet another gift for the very rich, a soaking of the working middle class, and a neutering of the Democrats as a credible opposition party.

The federal budget has been chronically out of whack since the early 1980s for one very simple reason: the massive fraud of supply-side economics. In theory, tax cuts for the rich would so stimulate the economy that the lost revenues would be more than made up. That, of course, didn't happen. What happened was a permanent budget crisis.

The only conceivable way to reduce the budget deficit without taking further resources from the great middle class is to restore taxes on the wealthy to something like their level before Reagan took over.

The Democrats' first mistake this year was even to sit down at the bargaining table as long as President Bush insisted that higher tax rates for the rich were out of the question.

When Bush said "Read my lips -- no new taxes," it turned out that he meant only no new taxes on the wealthy. His attempt to further reduce taxes on the well-off through yet another supply-side capital gains tax cut only added insult to injury. But the Democrats convinced themselves that by blocking a capital gains cut, they had won a great victory. In fact, the rest of the package was a disgrace too.

The package raised taxes on middle-income families by about 3.3 percent, according to the Congressional Joint Tax Committee. It raised taxes on households with incomes over $200,000 a year by just 0.3 percent.

The big cuts in Medicare, which accounted for about half of all the spending cuts, also operated as a tax on the middle-income and low-income elderly, who would have had to pay hundreds of dollars a year more out of pocket for medical bills, or do without.

During most of the postwar era, the income share of the very rich was fairly stable. In 1977, before Reagan's supply siders got hold of the tax code, the richest 1 percent of Americans had 9.2 percent of the total national income. Last year, the richest 1 percent had nearly 13 percent.

Changing the tax code to restore the income share of the top 1 percent to its historic average would solve the federal deficit problem, without touching the middle class, the poor, the moderately wealthy or Social Security and Medicare! Restoring taxes on the top 5 percent would produce new revenues for child care, education, environmental clean-up and long-term health care.

The long, slow boom of the 1980s was a boom only for the well-off. It was not built on supply-side incentives: It was built on a decade-long reduction in the price of oil and a decade-long willingness of foreigners to finance American debt. On both counts, the game is over.

Back at the drawing board, the Democrats, if they have an ounce of political sense and a shred of principle left, will remember why people occasionally vote for them. People vote for Democrats because Democrats sponsor and defend programs like Social Security and Medicare to help ordinary families cope with life's vicissitudes. People vote for Democrats so that society retains a modicum of balance between the private pursuit of wealth and our common purposes as a nation.

The budget deal was a travesty, but especially with Democrats' fingerprints on it. The Democrats need to begin again -- this time with clearer vision.

Robert Kuttner writes regularly on economics.

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