By Ken Libbey

Periods of history are never as clearly defined and delineated as we make them out to be. Nonetheless, American economic history can be visualized in terms of centuries.

Emerging from a colonial, agrarian, tradesman beginning, we spent much of the 19th century claiming the continent, discovering its resources, and building the infrastructure to access them. Except during the civil war, the federal government consumed little of the country’s output. It did, however, play an important role in creating a national market. First under the Whigs, and then under their successors the Republicans, federal power and resources were used to (a) protect growing industries with high tariffs, (b) push the railroad network across the continent, and (c) confine the natives to ever-shrinking reservations. The preservation of the Union itself was in no small way motivated by the desire of northern industrialists to preserve the South as a captive market.

Having begun the extraction of vast oil reserves and mineral deposits, along with the harvest of midwestern grain and northwestern timber, we set out in the 20th century to enjoy a seemingly endless bounty of natural resources. The American way of life, centered on the house and the automobile, became a national religion. Government obliged nearly every desire in this exploitation, interfering only to provide a regulatory framework for competition and a modest safety net for those that had been used and discarded by the capitalist economy.

Not until the shock of the first Arab oil embargo, in 1973, did the political establishment give serious thought to conservation of resources. For the rest of the century, we flirted with the notion of managing our use of energy while the market alternated between ominous warnings and blithe reassurances. The end of cheap oil was one factor in the decline of our manufacturing base, as countries with desperate workers supplied an ever-increasing share of our consumer products. Still, a modest redistribution of income and a boom in technology spurred a decade of prosperity to end the century. Our economic future was hazy.

It is not hazy now. The fate of the American way of life in the 21st century will depend on our determination to make the most of ever-scarcer resources. We have picked the low-hanging fruit – our own and that of the Middle East. From now on, the resources we have traditionally used will be more expensive to exploit and more coveted by a growing world population. Let not the short-term fluctuations of commodity prices fool us. We will need a national policy of conservation and reuse, one that makes a real difference rather than nibbling at the edges.

I wrote a few months ago about the problem of replacing manufacturing jobs that have fled to Asia. The only solution, in my opinion, is for the federal government to become a greater consumer of labor than it has been, through contracting for the reconstruction of our national infrastructure. In addition, we need a new public service jobs program at the local level to combat hard-core unemployment and crime. Government at all levels will have to increase its share of gross domestic product.

President Obama talks about creating green jobs in the production of alternative energy, but his plans are small-scale compared to what we will need in this century. We will need public investment and government policy that encourages renovation of houses and buildings and maximum reuse of materials from demolition. We will need stronger standards for energy conservation in all forms. We must put a new value on labor that saves resources, rather than seeing labor only as a cost. Government must assure that there is a market here, and not only in Asia, for household recycling.

In short, government will have to take a greater role in determining the demand for goods and services in our economy. This is not a matter of ideology, it is a matter of national survival. Market forces will still determine the makeup of consumer products, but we can no longer allow the market to allot seventy percent of GDP to consumer spending. To do so would drive up our international debt and so weaken the dollar that we would lapse into austerity without any alternative plan.

This will, of course, require greater federal revenue. The middle class can afford to share in this burden, but the major source would have to be a partial restoration of the progressive tax rates of the past. We are struggling now to emerge from an orgy of speculation fueled by the wealth accumulated by the corporate executive class. Recycling a portion of that excess income into the economy would not only meet public investment needs, it would create purchasing power and increase tax revenue from lower- and middle-income households.

In the 21st century, Americans will have to get used to scarcity and a lifestyle that relies less on the constant purchase of new products. We can stumble our way to this and suffer economic crises along with greater social dysfunction. Or we can elect leaders with the vision to steer us in the necessary direction. We do not need socialism. We do need a government that, with a variety of policies, matches our workforce to the opportunities and imperatives of a changed national situation.

I think President Obama knows this, and I think it is part of the eight-year plan that he reveals a little at a time. I hope so.

By Ken Libbey

Most commentators opine that President Obama is sticking his neck out in his budget by promising higher taxes on corporations and high-income households. In truth, however, he has retreated somewhat from his campaign position of repealing the Bush tax cuts that primarily benefited the wealthy. Bowing to the “don’t raise taxes during a recession” crowd, he has proposed to let the Bush cuts die a natural death, expiring after 2010. Score another message victory for the Republicans.

Politically, that is the safe play. Obama can have the reasonable and effective tax rates of the Clinton Administration back by simply refusing to sign anything else. And let’s be honest – higher tax rates on capital gains and corporate profits would not raise much revenue right now, since hardly anybody has any. Obama is taking advantage of this political opportunity to propose some changes: reasonable taxes on hedge funds, cap-and-trade taxes on carbon emissions, and stricter limits on itemized deductions by high-income taxpayers. These have a good chance of passing, because the budget reconciliation process is not subject to filibuster in the Senate.

With everything else that is going on, trying for significant tax reform this year is probably not realistic. Next year, however, with the Bush cuts expiring, a rationalization of our tax code should be considered. I am not talking about the so-called flat tax or fair tax touted by conservatives in hopes of pushing more of the tax burden onto the middle- and low-income classes. I am talking about tax policy that raises enough revenue to meet 21st century obligations while workers’ purchasing power and encouraging broadly based savings and investment.

The most illogical policy left by the Bush Administration is the taxation of earned income at higher rates than investment income. Money earned by work is generally taxed more heavily than money earned by money. Now, there is some justification for encouraging people to save for education and retirement. Hence I propose replacing the current privileged treatment of investment income with a zero percent rate on the first $2,000, 10 percent on the next $8,000, and ordinary income rates on investment income above $10,000 in a year.

This could be accomplished in the following manner. All investment income (capital gains, dividends, and interest) should be combined and $2,000 then deducted on page one of the Form 1040, thus excluded from adjusted gross income. In the tax calculation on page two, up to $8,000 of remaining investment income should be deducted from taxable income. After tax has been calculated, additional tax should be added on the $8,000 at a rate of 10 percent.

A further break for investors could come with an increase in the limit on deductible capital losses. This is unreasonably capped at $3,000 per year, which means that many people have been unable to deduct much of their losses from the market downturns of the past eight years. The limit should at least be raised to $10,000, and perhaps phased out over time.

With the expiration of the Bush tax cuts, the top rate on marginal income above $250,000 would return to the 39.6 percent rate of the Clinton Administration, still far below the rate imposed after the Reagan tax cut of 1981. While the Clinton rates were enough to produce a surplus in the prosperous 1990s, they will not be adequate in the wake of the spiraling national debt under the Bush Administration. Congress should consider higher rates on income over $1 million. Recycling more of this excess income would create jobs and spur a higher rate of economic growth.

If Congress is not willing to take this political risk, it should at least enact a balanced-budget surtax across the board. This should be 5 percent of the final tax liability, moderated, however, by a credit for each personal exemption. This would not be a permanent tax, but rather would apply only when the federal government finishes the previous fiscal year in the red. Designed like this, it could be enacted this year as part of the budget reconciliation process.

Corporate income taxes have been the subject of pervasive manipulation. Special write-offs for various businesses abound in the tax code, amounting to a system of corporate welfare. Tax lawyers have found myriad ways to reduce their clients’ tax liabilities, including offshore protection of income. The result has been a host of inequities, and effective tax rates that bear little relation to the profitability of companies. A company that actually tries to pay its taxes honestly is at a competitive disadvantage, and the net revenue accruing to the government is substantially lower than it should be.

A rational replacement for the current system would be a gross receipts tax on all revenue from sales within the United States. This would be owed by foreign and domestic companies alike. It would be difficult to evade, and would be a more stable source of revenue than the volatile profits tax.

Some deductions would be in order, however. To encourage small businesses, the first $1 million of revenue each year could be excluded. To encourage domestic employment, compensation and payroll taxes paid to and for American citizens and legal residents could be deducted from revenue, limited to $500,000 for any employee. Finally, to allow for slowdowns in the economy, a company that suffered an operating loss for two or more consecutive quarters would be allowed a credit for the losses.

The IRS would still need a vigorous audit program to assure compliance with these rules, but the task would be much simpler than the current byzantine system. Moreover, the incentives for companies would be clear and would not encourage the kind of dubious expenditures that are commonly written off under current rules.

The reforms outlined above would simplify tax accounting for individuals and businesses alike. They would restore needed government revenue and make it possible to realistically address the long-term financial issues of the Social Security program. They would provide a foundation for prosperity by diminishing the drag on the economy that has resulted from growing inequality. If reforms like this prove politically impossible, it would be better just to let the Bush cuts expire and return to the Clinton tax laws.

By Ken Libbey

The gross domestic product of the United States fell by at least 3.5 percent in the final quarter of 2008, and is likely to continue falling for a few more quarters. In light of the record federal deficit and the boost in spending from President Obama’s stimulus plan, federal government spending could reach 23 percent of GDP in 2009, up from 20.5 percent in the final year of the Bush Administration. Since World War II, government has consumed that much of the economy only in Ronald Reagan’s first term, when he ratcheted up military spending coming out of a recession.

Franklin Roosevelt’s New Deal expanded the role of government in the economy, but never higher than 10.5 percent of GDP. That was dwarfed by the command economy of the war, when federal spending reached 43.6 percent of GDP in 1943 and 1944. As the country returned to normalcy, the federal government’s share of the economy settled into the high teens. It would recede a little when the economy was growing and rise a little when the economy slowed down, thus following a modest Keynesian pattern despite Washington’s aimless economic policies.

Slow economic growth in the 1970s pushed the government share above 20 percent, and Reagan’s obsession with the Cold War pushed it higher. Coming out of the 1990-91 recession, federal spending was 22.9 percent of GDP. The trend was reversed under Bill Clinton, however, as a robust economy and restrained military spending brought the government share steadily lower to 18.4 percent in 2000. Under George W. Bush, wars and sluggish economic growth brought the federal budget back to 20.5 percent of GDP in 2008.

Whether the current crisis will be just another recession or a prolonged slump is not clear at this time. Obama is putting Keynesian economics to the test, and hopefully will be able to kick-start a recovery. If the trend of rising unemployment and falling GDP is reversed, however, Obama and the Democratic leadership will have to face a more basic question – how can the United States sustain a gradual improvement in living standards in a global economy where the cost of production disfavors us and imported oil drains our purchasing power?

With international trade relatively unfettered, it has proven nearly impossible to preserve American manufacturing industries in which importation is feasible. For a while, it seemed that service jobs and high-tech professions were safe, but outsourcing has now undermined some of those sectors. Spending on consumer products and services, which once drove the growth of our economy, has supported fewer and fewer American jobs. With this decline has gone a growing reluctance of corporations to invest capital in the U.S. Despite heavy accumulations of corporate cash, capital spending grew not at all under the Bush Administration.

From where, then, is to come a demand for American labor? How are we going to support a middle class lifestyle? How are we going to provide opportunity to the poor? How are we going to pay for the baby boom’s retirement? These questions will not go away with the current recession.

To answer such questions, we must remember some basic principles. First, the economy grows and prosperity spreads when money circulates faster. It slows when money languishes in accounts or circulates among a narrow stratum at the top of society. Second, money circulates fastest when it becomes purchasing power for the lower half of society. If this part of the population can buy used cars, starter homes, haircuts, fast food, movie tickets, etc., the effect ripples up through the economy, eventually becoming better corporate profits and better returns for the investor class.

It follows that the more wealth is concentrated at the top of a society, the less robust will be its economy. This has in fact been borne out in U.S. history, as well as in that of societies around the world. In recent decades, economic growth slowed during both the Reagan-Bush and Bush Administrations, when tax policies favored the concentration of wealth. The economy grew rapidly under the modest redistribution of wealth achieved by Clinton’s tax package.

The combination of global competition and greater inequality of income has weakened the job market in the U.S. Only the federal government can counteract this trend. The option of erecting trade barriers is essentially not available. It would disrupt treaties, invite retaliation, and reduce the availability of inexpensive goods to low and moderate income consumers. Rather than try to isolate ourselves, we must try to use our strengths to compete better.

At a minimum, we need a strong government commitment to energy conservation and alternatives to crude oil, in order to reduce the outflow of petrodollars. We also need to reduce the export of dollars supporting our overseas military presence and paying interest on foreign debt. Accomplishing the latter goal will require tax policies that restore the loss of federal revenue.

Beyond that, we may have to accord the federal government a larger role in creating jobs for American workers. The progressive income tax, which has always been an engine of prosperity by recycling excess wealth back into the economy, will have to assume a greater role than was assigned to it under Clinton. The federal government will have to take the lead in a long-term modernization of the country’s infrastructure. A good example would be a twenty-year partnership with local governments and utilities to put wires underground in older neighborhoods and communities, thus avoiding the misery of extended power outages. There are plenty of other examples. The American Society of Civil Engineers has a five-year list amounting to $2.2 trillion.

Except for the military, very little of the money the federal government spends leaves the country, instead going directly into job creation. While strict Buy American requirements would run afoul of trade agreements, the government can prescribe a form of affirmative action for contractors and subcontractors. A contractor would have to certify that he has made a good faith effort to use American suppliers, even at modestly higher cost. And of course he would have to certify to using only American citizens or legal residents as employees.

The bottom line is that the federal government is going to have to be a greater consumer of American goods and services than it has been, and to do so, it must recycle wealth at a faster pace than it has for the past 25 years. We should get accustomed to the federal government accounting for 25 to 30 percent of GDP indefinitely. Even at that level, we would remain below the average of countries in the Euro currency zone. The resulting employment growth would then generate upward economic momentum, just as a slack labor market generates downward momentum. The combination of more robust growth and more progressive taxation will reverse the spiral of national debt, strengthen the dollar, and make it possible to support Social Security and health care.

I hope President Obama realizes that his stimulus package is just a shot across the bow, and that the fundamental changes lie ahead and must be confronted.

By Ken Libbey

Osama bin Laden put out another tape recently calling for renewed Jihad against Israel. It was, as one astute observer noted, his attempt to keep Al Qaeda relevant in the Muslim world. In a typical cable news interview, experts were asked if we can prevent another terrorist attack. One of them said what should have been said long ago. If suicidal terrorists, local or foreign, are determined to carry out an attack, there are too many targets for us to protect. What is more important is how we react to another attack. Will we once again multiply its damage to our way of life?

The aftermath of the 9/11 attacks was infinitely more harmful to America than the attacks themselves. Whether out of deliberate political calculation or uninformed blundering, the Bush Administration made the “war on terror” the central concern of American life, at least until the 2006 elections. Behind this façade, the administration and Republican congress pursued an agenda of upper class and corporate tax cuts, lax enforcement of regulatory laws, and dismissal of scientific evidence. It lavished spending on the military, running up huge budget deficits. It diverted hundreds of billions of tax dollars to the Middle East to finance its supposed solution to the terrorist threat.

How has this affected our country? The unnecessary tax cuts for wealthy households have made us dangerously dependent on foreign governments (increasingly China) to finance our deficits. The dismissal of energy conservation has meant that huge amounts of dollars go to oil-producing countries, contributing to our chronic trade deficits. Military spending abroad has further unbalanced our accounts. All of these have undermined the value of the dollar and the confidence that foreign governments have in our economy. It has forced us to sell assets, companies and real estate, to cover our debts.

At home, we have allowed economic and social problems to fester and worsen. The labor market has deteriorated to the point that anxiety is widespread. Crime waves are vexing cities that thought they had turned the corner by the end of the last century. We have slipped backward in our efforts to manage our energy and environmental problems. Urban schools are struggling to survive and be relevant to the young people they serve. In the name of mindless security, we have diminished the appeal of flying, attending sporting events, and travelling abroad. In deference to religious zealots, we have denied young people the services they need to control their reproductive lives and give themselves a fair chance in life.

Our response to 9/11, rather than the terrorist threat itself, has left the American people less secure, less prosperous, and in less control of our destiny. This is, of course, exactly what bin Laden wanted, although he could not have imagined the extent to which he succeeded. Before the attacks, bin Laden and his movement were falling out of favor in the Muslim world and were in danger of being marginalized. The Bush Administration put bin Laden back in the game, greatly increasing his prestige while diminishing our own.

The 20th century was one of American ascendancy. Whether we are attacked again or not, it is important to prevent the 21st century from being one of American decline. We will not have the easy advantages we had in the past. We will not have an abundance of cheap energy. We will not have again the luxury of enjoying postwar prosperity while other nations were recovering from terrible destruction. We do not have a strong dollar based on a trade surplus and a modest national debt. Instead of an economy growing from the surge of a baby-boom generation, we have an aging boom generation that will strain our retirement and health care resources.

If we are to find answers to these challenges and persist in addressing them, we cannot allow terrorists to dictate our political agenda. Of course we should seek to foil terrorist plots through intelligence and international cooperation. But we cannot again let the threat of terrorist attacks distract us from the tasks of economic recovery, health care rationality, sustainable resource management, and strengthening the foundation of our civil society.

I believe Barack Obama understands this. Still, some of his obligatory rhetoric worries me. An attack may occur, and he will have to choose between magnifying it or defying it. He has the credibility and the oratorical gifts to do either; I hope he chooses the latter. I worry even more about his pledges to pursue victory in Afghanistan. I hope that instead he will quietly put this misadventure to rest. No foreign nation has been able to change the intractable culture of Afghanistan. It has all the potential of being Obama’s Vietnam. Moreover, nothing is more crucial to restoring the economic health of the United States than systematically reducing the outflow of dollars from this country.

Barack Obama’s election has already gone a long way toward restoring American prestige and influence in the world. He seems to understand how to build on this beginning with low-key, more sophisticated diplomacy. Equally important will be his success in restoring the economic and social health of this country. If we are to command respect and admiration throughout the world, we must be able to set an example of prosperity, solvency, and effective, humane government.

We have veered off track, and we must not do so again.

By Ken Libbey

Democrats have an historic opportunity to get America back on track, and in the process to consolidate their recent victories. Whether they do so or not will depend on their ability to stay focused on results, despite the slings and arrows of the opposition. For it is results on which they will judged in 2010 and 2012.

Employment

Nothing is more important than reversing the spiral of unemployment and underemployment. It is clear by now that the Paulsen approach of injecting capital into the credit markets is floundering. Moreover, providing credit to the automobile industry may stave off disaster, but it will not bring customers back to dealer lots. Bad economic news is piling on bad economic news.

It is no wonder. Stopgap measures that treat the economy from the top down are logical extensions of the misguided “supply-side” economics that has served as religion to the Bush Administration and congressional Republicans. The capital markets seized up because underlying demand declined, demand for houses, cars, consumer products, and services. Demand declined because the unrelenting cost-cutting pressure of global capitalism had eliminated jobs and depressed incomes to the point that much of wage and salaried America became insecure and less willing to take risks. Easy credit kept things going for a while, but eventually just made the fall worse.

An economic recovery will require a return of consumer confidence, and this will only come with an improvement of job security and prospects. Government policy must be directed toward job creation and increasing purchasing power in the lower half of the population. Prosperity has never trickled down in this country; it has always rippled up. The top priority of a Democratic Congress should be tax policy that recycles idle wealth back into the economy, at least as much as the Clinton policies did. Given the more serious situation we face now, it may be necessary to go further than Clinton went.

Extensions of unemployment and food stamp benefits are necessary to ward off hardship, but are also needed to support consumer demand. Equally important is a further increase in the minimum wage, which was raised modestly in 2007 for the first time this century. Adjusted for inflation, the minimum wage had sunk so low that even Wal-Mart was complaining of its depressing effect on purchasing power.

Energy

Close behind economic policy must be energy policy. One thing we should be clear about: while alternative energy technologies need steady long-term support, they are not the answer to our energy dependency in the foreseeable future. Oil will remain the backbone of our transportation system for decades to come, but we cannot continue to send the volume of dollars abroad that we have been. Unless we adopt serious conservation measures, we will progressively sell off our country to pay for oil, and we will be at constant risk of price spikes that disrupt our economy.

The high gasoline prices of Spring and Summer 2008 got everyone’s attention and people began changing their habits, at least temporarily. But prices like those are not the solution we need. To begin with, they do not last. The historical volatility of the oil market promotes complacency following panics, dissipating the political will for reform. Moreover, high gasoline prices are a hardship for low- and middle-income families, and reduce their ability to support our domestic economy.

By far, the most effective conservation policy has been the Corporate Average Fuel Economy (CAFE) standards, which required auto companies to sell a mix of vehicles that average 27.5 miles per gallon. These standards went unchanged for many years until Congress recently passed a modest increase. The CAFE standards achieved a significant reduction of imported oil when they were first enacted, and they could do so again. Congress should set more ambitious targets and phase in the inclusion of sport utility vehicles, which have hitherto been excluded as light trucks.

Education

Everyone talks about education, but no one seems to know what to do about it. It has been a political football, used more to get politicians elected than to help young people find a way in life. Current federal policy, enshrined in the grossly misnamed No Child Left Behind Act, has made American education even more rigid and less enlightening than ever. It has condemned many urban schools to chronic failure and dwindling commitment. Dropout rates have continued high or gone higher, while unruly behavior has demoralized teachers. NCLB has left more children behind than ever.

American education needs fundamental rethinking, with an emphasis on how to accommodate the diversity of ethnic backgrounds, aptitudes, and motivation with which it must contend. We are kidding ourselves if we think that accountability sanctions and batteries of standardized tests are going to bring order out of this chaos. We should abandon our obsession with “one size fits all” education and try to offer a variety of quality options to young people, options that will help them transition to adult life.

Social Security

The long-term financial problems of Social Security cannot be ignored. It is true that conservatives have exaggerated the extent and immediacy of the problems, but the impending growth of the rolls with baby boom retirements does require action. The first order of business should be the separation of the trust funds from the rest of the federal budget, as they were before 1965. They must be viewed as genuine trust funds, and the Treasury’s obligation to them treated the same as to private bondholders.

The cavalier dismissal of the trust fund surpluses by George Bush and other conservatives is the greatest threat to the future of Social Security. When social security taxes cease generating surpluses, sometime around 2018, the federal government will have to raise enough revenue from other taxes to cover its needs. The temptation will be great to disregard the sums owed the trust funds, which would allow them to pay benefits for another 30 years. Legislation protecting the funds should be a prerequisite to any changes in social security taxation.

Some changes in trust fund financing will be needed, the most obvious being a progressive increase in the income ceiling for payroll taxes. Even more critical, however, will be realistic income tax rates that allow the government to cover its general fund deficits and honor its obligations to the trust funds. We cannot continue to allow the national debt to spiral out of control. Unless there is an unusual will to reduce defense spending, the answer will have to come from additional revenue. Any other approach would aggravate our economic and social problems.

Health Care

Health care reform has been on the national agenda for many years, with no significant improvement in a system characterized by excess cost, inefficiency, evasion, large gaps in coverage, and dissatisfaction among both providers and consumers. Fundamental simplification of the system has been and will continue to be politically impossible. All of the reforms under consideration are attempts to plug holes in the dike.

Congress and the administration will sort through these schemes and some hybrid will emerge. I am not going to offer another imperfect solution for the mix. There are, however, some fundamental principles that should guide the process. The value of insurance is achieved to the extent that risk is spread across the widest possible population. The greatest failing of our current system is fragmentation of risk, and the consequent elaborate game of cost shifting that follows. A second principle is that the provision of services to the hitherto uninsured must be done in the most cost-efficient framework possible. Finally, the federal government should in some fashion underwrite the huge costs of chronic care, so that the burden is spread as widely as possible.

Crime and Poverty

A final comment about crime, which has been rising for four years and is a much greater threat than terrorist attacks. Certainly, renewal of the assault weapons ban and new support for community policing would help. The fundamental problem, however, has been the steady growth of poverty during the Bush Administration. President Clinton signed a Republican welfare reform in 1996 that greatly weakened the safety net for families on the margin. For a time, the robust job market of the late 90s masked its effects. With the deteriorating economy, desperation and alienation are growing and crime is increasing at an alarming pace.

Redesigning our income-support programs is a complex undertaking, and would warrant a separate column. It needs Congress’ immediate attention. President Obama can make a good beginning, however, by reversing the government’s hostility to emergency contraception and realistic pregnancy counseling. Family planning and income support must be the intertwined pillars of an assault on poverty.

There is a lot to do.