Wednesday, September 21, 2011
Saturday, September 10, 2011
Mamata’s folly
BZ KHASRU
During the Indo-Pak talks in New Delhi on April 8, 1974, the Pakistani delegation leader suggested to the Indians inclusion of aphrase – “on the basis of sovereign equality” – in the agreement they were about to sign, which reiterated the two nations’ resolve to work toward achieving durable peace in the subcontinent.
In marking the proposal, Aziz Ahmed, then Pakistan’s state minister for foreign affairs, pointed out that sovereign equality was the phrase India used repeatedly when it raised the subject of possible discussions between Pakistan and newly-independent Bangladesh.
To Pakistan’s surprise, Kewal Singh, then India’s foreign secretary, brushed off the idea, saying he was “sick” of hearing this phrase. Swaran Singh, then India’s external affairs minister, dismissed it as mere platitude.
Pakistan, which negotiated from a point of weakness just after suffering a crushing defeat in the Bangladesh Liberation War, dropped the subject, not wanting to hinder the adoption of the pact over this one point.
India’s reluctance to include the phrase suggested to the Pakistanis that their giant neighbour considered itself more than equal to Pakistan. This episode continued to trouble Pakistan for quite some time.
West Bengal Chief Minister Mamata Banarjee’s decision to boycott Prime Minister Manmohan Singh’s just-concluded visit to Bangladesh over the Teesta River water sharing might also continue to trouble her neighbour for a long time. Bangladesh might reflect back on this even more acutely, given the Bengalis on both sides of the border share a common heritage.
Mamata’s decision would adversely affect the Bengali mind not just because she wanted more water for her state. Of course, as the chief executive of the state she must protect her people’s interest. What will bother Bangladesh is that she found it prudent to stay away, instead of engaging in talks to resolve the matter to both sides’ satisfaction.
Her decision not only holds the potential to cause wrinkles in Indo-Bangla relations, it has also dealt a blow to the central government’s image, causing a negative perception about its authority to conduct foreign policy in the interest of the entire country — and the region as a whole. India is not merely a country in South Asia, but also a regional superpower and a potential global player. A veto power by a state over its foreign policy is certainly a matter into which the external affairs ministry needs to look closely.
Mamata’s pulling out of the prime minister’s entourage embarrassed Singh. Her dramatic protest dealt a severe blow also to Prime Minister Sheikh Hasina, who had expected India to reciprocate her bold steps in addressing New Delhi’s security concerns and its long-time request for transit through Bangladesh.
The Teesta fiasco also killed two other key potential deals: Sharing of the Feni river water and letting India use Chittagong and Mongla seaports to carry goods through Bangladesh.
To India’s credit, it has tried to reassure its neighbours by being correct and even generous in its official dealings with them. But its specific security considerations, its self-image as the dominant power in South Asia, domestic political pressures and bureaucratic differences within the government continued to create tensions between India and its smaller neighbours.
The largest and most important of these smaller neighbours – Bangladesh – went through ups and downs in its relations with Delhi, thanks to some imprudent steps by India and political upheavals in Bangladesh. As a result, problems left over from the period of confrontation under Pakistan were not proving amenable to a quick solution.
Since 1971 India has sought to reassure its smaller neighbours, Bangladesh included. Indian officials have been visiting, discussing, explaining and giving assistance. Discussions with Bangladesh have been almost continuous.
Singh prudently reinforced India’s policy in Dhaka when he declared: “India will not, I repeat and assure you, India will not take steps that will adversely affect Bangladesh.” It will be sweet music not just for the Bengali ear, but for others as well — far away. It will reassure not only Bangladesh, but also others beyond the Himalayas.
India’s main interest in its smaller neighbours is its security against China. This is particularly true in the case of Nepal, Bangladesh and Bhutan, any of which would provide China with strategic access to the southern side of the Himalayas.
The linkages between India and her smaller neighbours have created groups within India with a special interest in Indian relations with these countries. Despite occasional clashes of interests, some West Bengalis and other Indian businessmen have both real and sentimental interests in forging a beneficial relationship between Kolkata and Dhaka.
Regional differences and bureaucratic inefficiencies play a big role in India’s behaviour to its neighbours. The correct posture represents the position of the external affairs ministry. On important issues, it can usually impose its view on other ministries. But parochial interests come into play and tend to undermine the good intentions of the foreign office. Regional politicians may be well advised to remember they are not just Bengalis or Punjabis, they are also Indians.
BZ Khasru, based in New York, is the author of a bestselling book,
Myths and Facts: Bangladesh Liberation War - How India, U.S., China, and the USSR Shaped the Outcome (Rupa & Co., 2010)
During the Indo-Pak talks in New Delhi on April 8, 1974, the Pakistani delegation leader suggested to the Indians inclusion of aphrase – “on the basis of sovereign equality” – in the agreement they were about to sign, which reiterated the two nations’ resolve to work toward achieving durable peace in the subcontinent.
In marking the proposal, Aziz Ahmed, then Pakistan’s state minister for foreign affairs, pointed out that sovereign equality was the phrase India used repeatedly when it raised the subject of possible discussions between Pakistan and newly-independent Bangladesh.
To Pakistan’s surprise, Kewal Singh, then India’s foreign secretary, brushed off the idea, saying he was “sick” of hearing this phrase. Swaran Singh, then India’s external affairs minister, dismissed it as mere platitude.
Pakistan, which negotiated from a point of weakness just after suffering a crushing defeat in the Bangladesh Liberation War, dropped the subject, not wanting to hinder the adoption of the pact over this one point.
India’s reluctance to include the phrase suggested to the Pakistanis that their giant neighbour considered itself more than equal to Pakistan. This episode continued to trouble Pakistan for quite some time.
West Bengal Chief Minister Mamata Banarjee’s decision to boycott Prime Minister Manmohan Singh’s just-concluded visit to Bangladesh over the Teesta River water sharing might also continue to trouble her neighbour for a long time. Bangladesh might reflect back on this even more acutely, given the Bengalis on both sides of the border share a common heritage.
Mamata’s decision would adversely affect the Bengali mind not just because she wanted more water for her state. Of course, as the chief executive of the state she must protect her people’s interest. What will bother Bangladesh is that she found it prudent to stay away, instead of engaging in talks to resolve the matter to both sides’ satisfaction.
Her decision not only holds the potential to cause wrinkles in Indo-Bangla relations, it has also dealt a blow to the central government’s image, causing a negative perception about its authority to conduct foreign policy in the interest of the entire country — and the region as a whole. India is not merely a country in South Asia, but also a regional superpower and a potential global player. A veto power by a state over its foreign policy is certainly a matter into which the external affairs ministry needs to look closely.
Mamata’s pulling out of the prime minister’s entourage embarrassed Singh. Her dramatic protest dealt a severe blow also to Prime Minister Sheikh Hasina, who had expected India to reciprocate her bold steps in addressing New Delhi’s security concerns and its long-time request for transit through Bangladesh.
The Teesta fiasco also killed two other key potential deals: Sharing of the Feni river water and letting India use Chittagong and Mongla seaports to carry goods through Bangladesh.
To India’s credit, it has tried to reassure its neighbours by being correct and even generous in its official dealings with them. But its specific security considerations, its self-image as the dominant power in South Asia, domestic political pressures and bureaucratic differences within the government continued to create tensions between India and its smaller neighbours.
The largest and most important of these smaller neighbours – Bangladesh – went through ups and downs in its relations with Delhi, thanks to some imprudent steps by India and political upheavals in Bangladesh. As a result, problems left over from the period of confrontation under Pakistan were not proving amenable to a quick solution.
Since 1971 India has sought to reassure its smaller neighbours, Bangladesh included. Indian officials have been visiting, discussing, explaining and giving assistance. Discussions with Bangladesh have been almost continuous.
Singh prudently reinforced India’s policy in Dhaka when he declared: “India will not, I repeat and assure you, India will not take steps that will adversely affect Bangladesh.” It will be sweet music not just for the Bengali ear, but for others as well — far away. It will reassure not only Bangladesh, but also others beyond the Himalayas.
India’s main interest in its smaller neighbours is its security against China. This is particularly true in the case of Nepal, Bangladesh and Bhutan, any of which would provide China with strategic access to the southern side of the Himalayas.
The linkages between India and her smaller neighbours have created groups within India with a special interest in Indian relations with these countries. Despite occasional clashes of interests, some West Bengalis and other Indian businessmen have both real and sentimental interests in forging a beneficial relationship between Kolkata and Dhaka.
Regional differences and bureaucratic inefficiencies play a big role in India’s behaviour to its neighbours. The correct posture represents the position of the external affairs ministry. On important issues, it can usually impose its view on other ministries. But parochial interests come into play and tend to undermine the good intentions of the foreign office. Regional politicians may be well advised to remember they are not just Bengalis or Punjabis, they are also Indians.
BZ Khasru, based in New York, is the author of a bestselling book,
Myths and Facts: Bangladesh Liberation War - How India, U.S., China, and the USSR Shaped the Outcome (Rupa & Co., 2010)
TAX EVASION AS CORRUPTION
From Business Standard September 10, 2011
INDIA’S social fabric has been dented in the past month over the issue of corruption. Corruption has many faces, one of the more important of which is tax evasion. Tax evasion can be unilateral, on account of taxpayers alone, or bilateral, through collusion between taxpayers and the tax collector, thus robbing the state of its due revenue, or multilateral, where a society participates in it through resistance to remedial measures.
Tax evasion leads to inefficient and inequitable outcomes. Because tax evasion erodes tax revenue, the lost revenue is attempted to be made up through high tax rates. An example is real property tax rates in India that range around seven per cent, as opposed to developed countries where it approximates one to two per cent. Note, therefore, that paradoxically, an estimate of tax evasion based on this elevated or artificial or compensating tax rate would yield an exaggerated number. That is, if the tax rate were lower, tax evasion could also be lower. Thus, the consequence of those who get away with it is an extra burden of taxation on those who pay tax. This is an inequitable impact across taxpayers.
The sectors or activities that are amenable to tax evasion will fetch more investment, which would be redirected from other areas. And this reallocation of resources takes place often from more to less productive sectors. Thus, if investment in land is prone to evasion, more resources would go into construction than in the production of rail engines or food. Construction as an activity ends when a building or bridge is completed. Manufacturing and agriculture, by contrast, are more long-term and generate a longer time horizon of employment and supply of the product. Economists call this the outcome of inefficient allocation of resources.
Through time, scholars and governments have attempted to measure tax evasion. Estimation methods have used national accounts or expenditure survey information to assess the size of economic activity and compared it with reported activity. The difference between estimated and reported activity could then be related to the loss of tax revenue associated with it.
In India, tax evasion has not been directly estimated. In Latin America this was carried out widely in the 1980s and 1990s (Aguirre and Shome for Mexico, Serra for Chile, Shome for Colombia, and others). In the case of individual income tax, the following method would apply.
To personal income declared for tax purposes, adjustments should be made for those components of income that are included in the concept of income in the national accounts but are deductible for tax purposes, for example, personal exemptions, deductions, savings incentives. Adjustments need to be made for individual tax brackets if the tax structure is progressive. The resultant series of gross taxable declared income (by income class) should then be compared with gross taxable income from the national accounts to obtain an estimated undeclared income.
Similarly, for corporate income tax, adjustments to national accounts-based income for deductions for the array of tax incentives that are legally applicable, as well as for special conditions for small and medium industry, would have to be made, and then compared with declared taxable income from returns. To simplify the exercise, instead of national accounts, data by the Centre for Monitoring Indian Economy could be used to obtain more reliable conclusions, albeit from a more truncated information base.
For the VAT and CENVAT (or central excise), using an input-output table for the economy would be the ideal option. The widest theoretical VAT base is all purchasable goods and services, or GDP plus imports minus exports. However, given that the VAT base usually has a plethora of exemptions for not just the supply of outputs but also for the inputs of exempted outputs, it is not sufficient to use only GDP data. Instead, one has to go upstream and start with production data against which taxable inputs would have to be credited out since the VAT base is value added, or output minus input.
Tax evasion should be estimated in India. Another matter is how to limit tax dodging (Tanzi and Shome). The first means should be to focus on those taxes that the tax administrator can monitor more cheaply or easily. For example, to begin, it may not be fruitful to spend a lot of administrative resources on monitoring small taxpayers. Thus, the service tax did away with 80 per cent of taxpayers from the bottom. The second is to design taxes intelligently. The VAT has a good design since input tax credit is matched between buyer and seller, and allowed only on the basis of physical invoices. The third is to use third-party information for individual income tax as has been introduced in India through Annual Information Returns (AIR) for third parties such as mutual funds, credit cards, property transactions and others who must report transactions they carry out with customers (using PAN numbers) above stipulated thresholds. However, it is crucial that such information is correctly used and interpreted by the tax administration so that a taxpayer does not suffer from erroneous matching of such information.
A final word. Tax evasion is not the only form of corruption. Corruption has more tentacles. According to Transparency International, India’s Corruption Perception Index (CPI) ranking worsened from 72 in 2007 to 87 in 2010 amongst 180 countries. It is worse than Brazil at 69 and China at 78, but better than Mexico at 98 and Russia at 154. Though CPI does have flaws, it gives an indication of impediments to economic and social growth and equity. A worsening index is detrimental to attracting foreign investment and political stability. On a broader canvas, it is important to investigate what has been motivating and sustaining corruption before designing draconian measures to combat it. If the cart is put before the horse, the outcome may remain shy of success.
References:
Aguirre, Carlos and Partho Shome (1988), “Mexican VAT: Methodology for Calculating the Base”, National Tax Journal, Vol. 41
Serra, Pablo (1991), “Estimación de la Evasión Tributaria en el IVA", Servicio de Impuestos Internos, Publicación No. 91/05/C, Universidad de Chile
Shome, Partho (1995), Colombia: Fundamental Tax Reform, IMF Occasional Paper No. 123
Tanzi, Vito, and Partho Shome (1993), “A Primer on Tax Evasion”, IMF Staff Papers, Vol. 40.
The author is director and chief executive, Icrier. Opinions are exclusively those of the author. His book, Modernising Tax Administration: Championing Analysis and Specialisms, is forthcoming in the autumn
India needs to develop ways to estimate the cost of tax dodging, says PARTHASARATHI SHOME
INDIA’S social fabric has been dented in the past month over the issue of corruption. Corruption has many faces, one of the more important of which is tax evasion. Tax evasion can be unilateral, on account of taxpayers alone, or bilateral, through collusion between taxpayers and the tax collector, thus robbing the state of its due revenue, or multilateral, where a society participates in it through resistance to remedial measures.
Tax evasion leads to inefficient and inequitable outcomes. Because tax evasion erodes tax revenue, the lost revenue is attempted to be made up through high tax rates. An example is real property tax rates in India that range around seven per cent, as opposed to developed countries where it approximates one to two per cent. Note, therefore, that paradoxically, an estimate of tax evasion based on this elevated or artificial or compensating tax rate would yield an exaggerated number. That is, if the tax rate were lower, tax evasion could also be lower. Thus, the consequence of those who get away with it is an extra burden of taxation on those who pay tax. This is an inequitable impact across taxpayers.
The sectors or activities that are amenable to tax evasion will fetch more investment, which would be redirected from other areas. And this reallocation of resources takes place often from more to less productive sectors. Thus, if investment in land is prone to evasion, more resources would go into construction than in the production of rail engines or food. Construction as an activity ends when a building or bridge is completed. Manufacturing and agriculture, by contrast, are more long-term and generate a longer time horizon of employment and supply of the product. Economists call this the outcome of inefficient allocation of resources.
Through time, scholars and governments have attempted to measure tax evasion. Estimation methods have used national accounts or expenditure survey information to assess the size of economic activity and compared it with reported activity. The difference between estimated and reported activity could then be related to the loss of tax revenue associated with it.
In India, tax evasion has not been directly estimated. In Latin America this was carried out widely in the 1980s and 1990s (Aguirre and Shome for Mexico, Serra for Chile, Shome for Colombia, and others). In the case of individual income tax, the following method would apply.
To personal income declared for tax purposes, adjustments should be made for those components of income that are included in the concept of income in the national accounts but are deductible for tax purposes, for example, personal exemptions, deductions, savings incentives. Adjustments need to be made for individual tax brackets if the tax structure is progressive. The resultant series of gross taxable declared income (by income class) should then be compared with gross taxable income from the national accounts to obtain an estimated undeclared income.
Similarly, for corporate income tax, adjustments to national accounts-based income for deductions for the array of tax incentives that are legally applicable, as well as for special conditions for small and medium industry, would have to be made, and then compared with declared taxable income from returns. To simplify the exercise, instead of national accounts, data by the Centre for Monitoring Indian Economy could be used to obtain more reliable conclusions, albeit from a more truncated information base.
For the VAT and CENVAT (or central excise), using an input-output table for the economy would be the ideal option. The widest theoretical VAT base is all purchasable goods and services, or GDP plus imports minus exports. However, given that the VAT base usually has a plethora of exemptions for not just the supply of outputs but also for the inputs of exempted outputs, it is not sufficient to use only GDP data. Instead, one has to go upstream and start with production data against which taxable inputs would have to be credited out since the VAT base is value added, or output minus input.
Tax evasion should be estimated in India. Another matter is how to limit tax dodging (Tanzi and Shome). The first means should be to focus on those taxes that the tax administrator can monitor more cheaply or easily. For example, to begin, it may not be fruitful to spend a lot of administrative resources on monitoring small taxpayers. Thus, the service tax did away with 80 per cent of taxpayers from the bottom. The second is to design taxes intelligently. The VAT has a good design since input tax credit is matched between buyer and seller, and allowed only on the basis of physical invoices. The third is to use third-party information for individual income tax as has been introduced in India through Annual Information Returns (AIR) for third parties such as mutual funds, credit cards, property transactions and others who must report transactions they carry out with customers (using PAN numbers) above stipulated thresholds. However, it is crucial that such information is correctly used and interpreted by the tax administration so that a taxpayer does not suffer from erroneous matching of such information.
A final word. Tax evasion is not the only form of corruption. Corruption has more tentacles. According to Transparency International, India’s Corruption Perception Index (CPI) ranking worsened from 72 in 2007 to 87 in 2010 amongst 180 countries. It is worse than Brazil at 69 and China at 78, but better than Mexico at 98 and Russia at 154. Though CPI does have flaws, it gives an indication of impediments to economic and social growth and equity. A worsening index is detrimental to attracting foreign investment and political stability. On a broader canvas, it is important to investigate what has been motivating and sustaining corruption before designing draconian measures to combat it. If the cart is put before the horse, the outcome may remain shy of success.
References:
Aguirre, Carlos and Partho Shome (1988), “Mexican VAT: Methodology for Calculating the Base”, National Tax Journal, Vol. 41
Serra, Pablo (1991), “Estimación de la Evasión Tributaria en el IVA", Servicio de Impuestos Internos, Publicación No. 91/05/C, Universidad de Chile
Shome, Partho (1995), Colombia: Fundamental Tax Reform, IMF Occasional Paper No. 123
Tanzi, Vito, and Partho Shome (1993), “A Primer on Tax Evasion”, IMF Staff Papers, Vol. 40.
The author is director and chief executive, Icrier. Opinions are exclusively those of the author. His book, Modernising Tax Administration: Championing Analysis and Specialisms, is forthcoming in the autumn
India needs to develop ways to estimate the cost of tax dodging, says PARTHASARATHI SHOME
Thursday, September 8, 2011
Monday, September 5, 2011
The Limping Middle Class - From NYT
September 3, 2011
The Limping Middle Class
By ROBERT B. REICH
Robert B. Reich is the former secretary of labor, a professor at the University of California, Berkeley, and the author of “Aftershock: The Next Economy and America’s Future.”
THE 5 percent of Americans with the highest incomes now account for 37 percent of all consumer purchases, according to the latest research from Moody’s Analytics. That should come as no surprise. Our society has become more and more unequal.
When so much income goes to the top, the middle class doesn’t have enough purchasing power to keep the economy going without sinking ever more deeply into debt — which, as we’ve seen, ends badly. An economy so dependent on the spending of a few is also prone to great booms and busts. The rich splurge and speculate when their savings are doing well. But when the values of their assets tumble, they pull back. That can lead to wild gyrations. Sound familiar?
The economy won’t really bounce back until America’s surge toward inequality is reversed. Even if by some miracle President Obama gets support for a second big stimulus while Ben S. Bernanke’s Fed keeps interest rates near zero, neither will do the trick without a middle class capable of spending. Pump-priming works only when a well contains enough water.
Look back over the last hundred years and you’ll see the pattern. During periods when the very rich took home a much smaller proportion of total income — as in the Great Prosperity between 1947 and 1977 — the nation as a whole grew faster and median wages surged. We created a virtuous cycle in which an ever growing middle class had the ability to consume more goods and services, which created more and better jobs, thereby stoking demand. The rising tide did in fact lift all boats.
During periods when the very rich took home a larger proportion — as between 1918 and 1933, and in the Great Regression from 1981 to the present day — growth slowed, median wages stagnated and we suffered giant downturns. It’s no mere coincidence that over the last century the top earners’ share of the nation’s total income peaked in 1928 and 2007 — the two years just preceding the biggest downturns.
Starting in the late 1970s, the middle class began to weaken. Although productivity continued to grow and the economy continued to expand, wages began flattening in the 1970s because new technologies — container ships, satellite communications, eventually computers and the Internet — started to undermine any American job that could be automated or done more cheaply abroad. The same technologies bestowed ever larger rewards on people who could use them to innovate and solve problems. Some were product entrepreneurs; a growing number were financial entrepreneurs. The pay of graduates of prestigious colleges and M.B.A. programs — the “talent” who reached the pinnacles of power in executive suites and on Wall Street — soared.
The middle class nonetheless continued to spend, at first enabled by the flow of women into the work force. (In the 1960s only 12 percent of married women with young children were working for pay; by the late 1990s, 55 percent were.) When that way of life stopped generating enough income, Americans went deeper into debt. From the late 1990s to 2007, the typical household debt grew by a third. As long as housing values continued to rise it seemed a painless way to get additional money.
Eventually, of course, the bubble burst. That ended the middle class’s remarkable ability to keep spending in the face of near stagnant wages. The puzzle is why so little has been done in the last 40 years to help deal with the subversion of the economic power of the middle class. With the continued gains from economic growth, the nation could have enabled more people to become problem solvers and innovators — through early childhood education, better public schools, expanded access to higher education and more efficient public transportation.
We might have enlarged safety nets — by having unemployment insurance cover part-time work, by giving transition assistance to move to new jobs in new locations, by creating insurance for communities that lost a major employer. And we could have made Medicare available to anyone.
Big companies could have been required to pay severance to American workers they let go and train them for new jobs. The minimum wage could have been pegged at half the median wage, and we could have insisted that the foreign nations we trade with do the same, so that all citizens could share in gains from trade.
We could have raised taxes on the rich and cut them for poorer Americans.
But starting in the late 1970s, and with increasing fervor over the next three decades, government did just the opposite. It deregulated and privatized. It cut spending on infrastructure as a percentage of the national economy and shifted more of the costs of public higher education to families. It shredded safety nets. (Only 27 percent of the unemployed are covered by unemployment insurance.) And it allowed companies to bust unions and threaten employees who tried to organize. Fewer than 8 percent of private-sector workers are unionized.
More generally, it stood by as big American companies became global companies with no more loyalty to the United States than a GPS satellite. Meanwhile, the top income tax rate was halved to 35 percent and many of the nation’s richest were allowed to treat their income as capital gains subject to no more than 15 percent tax. Inheritance taxes that affected only the topmost 1.5 percent of earners were sliced. Yet at the same time sales and payroll taxes — both taking a bigger chunk out of modest paychecks — were increased.
Most telling of all, Washington deregulated Wall Street while insuring it against major losses. In so doing, it allowed finance — which until then had been the servant of American industry — to become its master, demanding short-term profits over long-term growth and raking in an ever larger portion of the nation’s profits. By 2007, financial companies accounted for over 40 percent of American corporate profits and almost as great a percentage of pay, up from 10 percent during the Great Prosperity.
Some say the regressive lurch occurred because Americans lost confidence in government. But this argument has cause and effect backward. The tax revolts that thundered across America starting in the late 1970s were not so much ideological revolts against government — Americans still wanted all the government services they had before, and then some — as against paying more taxes on incomes that had stagnated. Inevitably, government services deteriorated and government deficits exploded, confirming the public’s growing cynicism about government’s doing anything right.
Some say we couldn’t have reversed the consequences of globalization and technological change. Yet the experiences of other nations, like Germany, suggest otherwise. Germany has grown faster than the United States for the last 15 years, and the gains have been more widely spread. While Americans’ average hourly pay has risen only 6 percent since 1985, adjusted for inflation, German workers’ pay has risen almost 30 percent. At the same time, the top 1 percent of German households now take home about 11 percent of all income — about the same as in 1970. And although in the last months Germany has been hit by the debt crisis of its neighbors, its unemployment is still below where it was when the financial crisis started in 2007.
How has Germany done it? Mainly by focusing like a laser on education (German math scores continue to extend their lead over American), and by maintaining strong labor unions.
THE real reason for America’s Great Regression was political. As income and wealth became more concentrated in fewer hands, American politics reverted to what Marriner S. Eccles, a former chairman of the Federal Reserve, described in the 1920s, when people “with great economic power had an undue influence in making the rules of the economic game.” With hefty campaign contributions and platoons of lobbyists and public relations spinners, America’s executive class has gained lower tax rates while resisting reforms that would spread the gains from growth.
Yet the rich are now being bitten by their own success. Those at the top would be better off with a smaller share of a rapidly growing economy than a large share of one that’s almost dead in the water.
The economy cannot possibly get out of its current doldrums without a strategy to revive the purchasing power of America’s vast middle class. The spending of the richest 5 percent alone will not lead to a virtuous cycle of more jobs and higher living standards. Nor can we rely on exports to fill the gap. It is impossible for every large economy, including the United States, to become a net exporter.
Reviving the middle class requires that we reverse the nation’s decades-long trend toward widening inequality. This is possible notwithstanding the political power of the executive class. So many people are now being hit by job losses, sagging incomes and declining home values that Americans could be mobilized.
Moreover, an economy is not a zero-sum game. Even the executive class has an enlightened self-interest in reversing the trend; just as a rising tide lifts all boats, the ebbing tide is now threatening to beach many of the yachts. The question is whether, and when, we will summon the political will. We have summoned it before in even bleaker times.
As the historian James Truslow Adams defined the American Dream when he coined the term at the depths of the Great Depression, what we seek is “a land in which life should be better and richer and fuller for everyone.”
That dream is still within our grasp.
The Limping Middle Class
By ROBERT B. REICH
Robert B. Reich is the former secretary of labor, a professor at the University of California, Berkeley, and the author of “Aftershock: The Next Economy and America’s Future.”
THE 5 percent of Americans with the highest incomes now account for 37 percent of all consumer purchases, according to the latest research from Moody’s Analytics. That should come as no surprise. Our society has become more and more unequal.
When so much income goes to the top, the middle class doesn’t have enough purchasing power to keep the economy going without sinking ever more deeply into debt — which, as we’ve seen, ends badly. An economy so dependent on the spending of a few is also prone to great booms and busts. The rich splurge and speculate when their savings are doing well. But when the values of their assets tumble, they pull back. That can lead to wild gyrations. Sound familiar?
The economy won’t really bounce back until America’s surge toward inequality is reversed. Even if by some miracle President Obama gets support for a second big stimulus while Ben S. Bernanke’s Fed keeps interest rates near zero, neither will do the trick without a middle class capable of spending. Pump-priming works only when a well contains enough water.
Look back over the last hundred years and you’ll see the pattern. During periods when the very rich took home a much smaller proportion of total income — as in the Great Prosperity between 1947 and 1977 — the nation as a whole grew faster and median wages surged. We created a virtuous cycle in which an ever growing middle class had the ability to consume more goods and services, which created more and better jobs, thereby stoking demand. The rising tide did in fact lift all boats.
During periods when the very rich took home a larger proportion — as between 1918 and 1933, and in the Great Regression from 1981 to the present day — growth slowed, median wages stagnated and we suffered giant downturns. It’s no mere coincidence that over the last century the top earners’ share of the nation’s total income peaked in 1928 and 2007 — the two years just preceding the biggest downturns.
Starting in the late 1970s, the middle class began to weaken. Although productivity continued to grow and the economy continued to expand, wages began flattening in the 1970s because new technologies — container ships, satellite communications, eventually computers and the Internet — started to undermine any American job that could be automated or done more cheaply abroad. The same technologies bestowed ever larger rewards on people who could use them to innovate and solve problems. Some were product entrepreneurs; a growing number were financial entrepreneurs. The pay of graduates of prestigious colleges and M.B.A. programs — the “talent” who reached the pinnacles of power in executive suites and on Wall Street — soared.
The middle class nonetheless continued to spend, at first enabled by the flow of women into the work force. (In the 1960s only 12 percent of married women with young children were working for pay; by the late 1990s, 55 percent were.) When that way of life stopped generating enough income, Americans went deeper into debt. From the late 1990s to 2007, the typical household debt grew by a third. As long as housing values continued to rise it seemed a painless way to get additional money.
Eventually, of course, the bubble burst. That ended the middle class’s remarkable ability to keep spending in the face of near stagnant wages. The puzzle is why so little has been done in the last 40 years to help deal with the subversion of the economic power of the middle class. With the continued gains from economic growth, the nation could have enabled more people to become problem solvers and innovators — through early childhood education, better public schools, expanded access to higher education and more efficient public transportation.
We might have enlarged safety nets — by having unemployment insurance cover part-time work, by giving transition assistance to move to new jobs in new locations, by creating insurance for communities that lost a major employer. And we could have made Medicare available to anyone.
Big companies could have been required to pay severance to American workers they let go and train them for new jobs. The minimum wage could have been pegged at half the median wage, and we could have insisted that the foreign nations we trade with do the same, so that all citizens could share in gains from trade.
We could have raised taxes on the rich and cut them for poorer Americans.
But starting in the late 1970s, and with increasing fervor over the next three decades, government did just the opposite. It deregulated and privatized. It cut spending on infrastructure as a percentage of the national economy and shifted more of the costs of public higher education to families. It shredded safety nets. (Only 27 percent of the unemployed are covered by unemployment insurance.) And it allowed companies to bust unions and threaten employees who tried to organize. Fewer than 8 percent of private-sector workers are unionized.
More generally, it stood by as big American companies became global companies with no more loyalty to the United States than a GPS satellite. Meanwhile, the top income tax rate was halved to 35 percent and many of the nation’s richest were allowed to treat their income as capital gains subject to no more than 15 percent tax. Inheritance taxes that affected only the topmost 1.5 percent of earners were sliced. Yet at the same time sales and payroll taxes — both taking a bigger chunk out of modest paychecks — were increased.
Most telling of all, Washington deregulated Wall Street while insuring it against major losses. In so doing, it allowed finance — which until then had been the servant of American industry — to become its master, demanding short-term profits over long-term growth and raking in an ever larger portion of the nation’s profits. By 2007, financial companies accounted for over 40 percent of American corporate profits and almost as great a percentage of pay, up from 10 percent during the Great Prosperity.
Some say the regressive lurch occurred because Americans lost confidence in government. But this argument has cause and effect backward. The tax revolts that thundered across America starting in the late 1970s were not so much ideological revolts against government — Americans still wanted all the government services they had before, and then some — as against paying more taxes on incomes that had stagnated. Inevitably, government services deteriorated and government deficits exploded, confirming the public’s growing cynicism about government’s doing anything right.
Some say we couldn’t have reversed the consequences of globalization and technological change. Yet the experiences of other nations, like Germany, suggest otherwise. Germany has grown faster than the United States for the last 15 years, and the gains have been more widely spread. While Americans’ average hourly pay has risen only 6 percent since 1985, adjusted for inflation, German workers’ pay has risen almost 30 percent. At the same time, the top 1 percent of German households now take home about 11 percent of all income — about the same as in 1970. And although in the last months Germany has been hit by the debt crisis of its neighbors, its unemployment is still below where it was when the financial crisis started in 2007.
How has Germany done it? Mainly by focusing like a laser on education (German math scores continue to extend their lead over American), and by maintaining strong labor unions.
THE real reason for America’s Great Regression was political. As income and wealth became more concentrated in fewer hands, American politics reverted to what Marriner S. Eccles, a former chairman of the Federal Reserve, described in the 1920s, when people “with great economic power had an undue influence in making the rules of the economic game.” With hefty campaign contributions and platoons of lobbyists and public relations spinners, America’s executive class has gained lower tax rates while resisting reforms that would spread the gains from growth.
Yet the rich are now being bitten by their own success. Those at the top would be better off with a smaller share of a rapidly growing economy than a large share of one that’s almost dead in the water.
The economy cannot possibly get out of its current doldrums without a strategy to revive the purchasing power of America’s vast middle class. The spending of the richest 5 percent alone will not lead to a virtuous cycle of more jobs and higher living standards. Nor can we rely on exports to fill the gap. It is impossible for every large economy, including the United States, to become a net exporter.
Reviving the middle class requires that we reverse the nation’s decades-long trend toward widening inequality. This is possible notwithstanding the political power of the executive class. So many people are now being hit by job losses, sagging incomes and declining home values that Americans could be mobilized.
Moreover, an economy is not a zero-sum game. Even the executive class has an enlightened self-interest in reversing the trend; just as a rising tide lifts all boats, the ebbing tide is now threatening to beach many of the yachts. The question is whether, and when, we will summon the political will. We have summoned it before in even bleaker times.
As the historian James Truslow Adams defined the American Dream when he coined the term at the depths of the Great Depression, what we seek is “a land in which life should be better and richer and fuller for everyone.”
That dream is still within our grasp.
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