Keynes, Today, Obama, the VAT, and the Future of Prosperity

By Tom Pallow of Third Way Progressives, 2/24/11

For almost a century now the US and the rest of the developed capitalist world has relied on Keynesian economics as a way of increasing consumer demand and job growth in the economy. The understanding of the need for something like a Keynesian stimulus in order to increase consumer demand dates back to the writings of Karl Marx in 1864 with Das Kapital. Marx did not invent the concept of Surplus Value, but he did popularize the concept. Surplus Value points to the fact that, in aggregate in an industrial economy, in order for businesses to make a profit, they must charge more for their products than what they pay their employees. Marx’s fix to the problem of Surplus Value was so absurd that only the poorest, least literate, least democratic, and lacking of a fourth estate, countries of the world accepted his fix. Yet the problem of Surplus Value is why, once the most developed economies of the world became primarily industrial by the early 1900’s due to the mechanization of farm equipment, railroad expansion, and the electrification of industry, that these economies all enacted progressive income taxes between 1910 and 1915. The progressive income tax was needed to redistribute income from the wealthy to the poor and middle class in order to compensate for Surplus Value and keep consumer demand up.

Economists around the turn of the century popularized the idea of the progressive income tax. In America it was enacted into law in 1913, yet with a modest rate of 7%. It was up to John Maynard Keynes with his General Theory of Employment, Interest, and Money in 1935 that brought forward the intellectual framework that allowed the top progressive income tax rate to stay so high until the 1980’s.

The primary dynamic leap in understanding that Keynes genius brought to the world of economics and policymaking was his description of his, Greater Propensity to Save. This, Greater Propensity to Save is simply a more detailed description of Surplus Value. It points to the fact that very wealthy people have a propensity to save a much higher percentage of their income then do the poor and middle class, and that through this Greater Propensity to Save consumer demand is slowly pulled out of the economy. As consumer demand is pulled out of the economy businesses will lay employees off. This will further depress consumer demand, and the cycle will continue downward. An example of the Greater Propensity to Save is the fact that, in the US today the top 5% of income earners save on average of about 30% of their income, while the bottom 95% of earners save on average about 3% of their income. The top 1% of US income earners generally save about 50% to 60% of their income.

Keynes argued that it is up to the government to help increase consumer demand via the government borrowing, then spending, then paying for that borrowing via a progressive income tax. This was a strong enough argument during the economic chaos of the Great Depression, which had just fallowed the roaring 20’s, to greatly increase the height and base of the progressive income tax. Keynes had the right tax solution for his time only to the extent that his sole intellectual rival on the political/economic right were the followers of the 120 year old Say’s Law and conclusions typically derived from that law. Say’s conclusions in simplest form stated that the natural and quickest way for a recession to end is to have an economies workers except less pay. This idea had always been painful to accept, but in the economic chaos of the 1930’s, with no farms for workers to go back to and live off of, this solution was unacceptable.

So Keynes eliminated in the developed world the ability of a government to rely on followers of Say’s Law as the only way to get out of a recession. However, it now can be said that, with the current British government and the Republicans here, such ideas are coming back. They are now only beginning to look like an alternative because the Keynesian, New Deal coalition that has guided the left since the New Deal appears to be falling apart. Further, due to our new, highly competitive, high tech, global economy, there exists no traditional Keynesian method of stopping this deterioration. Therefore, President Obama appears that he might now be trying to transform and add to our Democratic coalition, but he is moving far to slow and not in any clear and workable direction.

This transformation is needed for the survival of the Democratic Party, but most importantly, for the prosperity of our people! In order to understand how best to achieve this transformation, it is very helpful to see the shortcomings of Keynes’s analysis, but most importantly we must understand how Keynes’s solutions are no longer applicable given our highly competitive, high tech, global economy that has seen an effective 20 fold increase in global trade since Keynes’s day.

One of two primary shortcomings of Keynes’s work as it relates to today is that, in his needed zealotry while lobbying for government stimulus spending, he advocated for absolutely any type of government spending as a way to increase consumer demand. Keynes used to make the somewhat humorous argument that, during a recession, it would be better for a government to bury money in the ground and have unemployed people dig it up so that they could spend that money to stimulate the economy, than it would be for the government to do nothing. Such thinking has influenced Keynesianism over the past almost 80 years. Yet today, in our highly competitive, high tech, global economy, we can no longer afford the degree of economic inefficiency that comes with such thinking.

The other shortcoming of Keynes’s work has also become even more problematic with the increasing competitive nature of our global economy. This shortcoming deals with Keynes analysis of the wealthy’s savings that is not detailed enough to have use within the realities of our global economy. This shortcoming exists because Keynes did not distinguish between wealthy income that was produced by individuals through employing fellow citizens so that this income is more likely to be invested in ways that employ more fellow citizens, and wealthy income that is not generated via employment and is therefore more likely to be saved in ways that do not increase employment and/or will only go into purchasing luxury goods for wealthy individuals.

In regards to a deeper analysis of the savings of the wealthy, for example, only about 19% of all of the income that is made by the top 2% of income earners in the US is the profits of any private business that is taxed as personal income that has one or more employees in the US (1,2&3). This means that today, we can lower taxes on American employing, private businesses through our US Employee Tax Credits, while we raise personal income tax rates on the wealthy who do not employ in the US. Since 19% is so much smaller than the remaining 81%, taxes can be raised on this 81% of the top 2% of US income earners and much new federal revenues can be raised. Meanwhile, effective personal income tax rates on the 19% of the top 2% of incomes who employ in the US can go down. Very importantly to remember, the greater the difference in effective tax rates between those who employ fellow citizens, and those who do not, all else being equal, the greater there will be an incentive to employ in that economy and the more tax revenue will be raised! It is only increases in the demand for labor in the private sector, along with increases in productivity or quality of production that raises real incomes for the poor and middle class. The specifics of this personal income tax plan can be found at our website, ThirdWayProgressives.org.

In regards to the wealthy’s savings that effect a capital gains tax, Keynes did not distinguish between savings that go into the four primary investments that create jobs, and all other investments that are simply speculative paper trades. These four primary investments are: One, venture capital funds and projects. Two, stocks bought at IPO or secondary offering. Three, bonds bought at first issue. Four, the underwriting of any of the above three investments.

Once again, like with the personal income tax data, the math works for us. Generally, only about 3% to 12% of all financial gains within our financial markets are generated from these four investments (4&5). Very importantly, with our capital gains tax plan, that can also be found at ThirdWayProgressives.org, the businesses invested in as part of these financial investments would have at least 5% of their total global expenditures consisting of US employee expenses that would qualify for our US Employee Tax Credits. Also, just like with our personal income tax, the greater the effective tax rate difference that exists between those engaged in simple speculative savings, and our four financial investments that drive job growth in the US, the more jobs will be created in the US and the more government revenues will be raised! The higher the capital gains tax rate is on gains from speculative, paper investments, and the lower is the tax rate on gains from the four primary investments, with our minimum employment qualifications, the more the government will raise in tax revenue, and the faster the economy will grow and the more jobs in the US will be created! This added economic growth, along with an increase in fiscal stability that our capital gains tax plan will bring to the federal government and those state governments that also enact our capital gains tax plan, will add even more to government tax coffers.

Our FICA tax plan would also increase government revenues throughout the US while greatly increasing American jobs and economic growth. We also have a C Corporation tax plan that would do the same. Both plans can also be found at ThirdWayProgressives.org in the Weekly Blog section. The reality is that today, in our new global economy, we still have to compensate for Surplus Value and the Greater Propensity to Save, and the most efficient way to do this is through the progressive income tax because all other forms of taxation are much more regressive. However, in today’s highly competitive global economy the progressive income tax must be contoured to the realities of this type of economy.

For many of the reasons stated above, the VAT tax is a very bad idea. A VAT raises the cost of doing business and the cost of capital for businesses. Very importantly, it does not take long for businesses to learn how to pass the cost of the VAT onto consumers, which makes the VAT very regressive and pulls consumer demand out of the economy. Then, if many VAT exceptions are made to try to make the VAT less regressive, the tax raises much less revenue, and an already bureaucratic and hard to enforce tax becomes even more bureaucratic and hard to enforce.

Yet, even though our overall tax plan is much more efficient than a VAT, and even though it raises more government revenues than President Obama’s or the Deficit Commission’s tax plan, $1.25 trillion over 10 years versus $700 billion and $9.25 billion over 10 years respectively just when statically scored and four to five times the revenues when dynamically scored, our federal, state, and local governments cannot be as inefficient with future Keynesian stimulus’s as has been too often the case over the past 80 years. In several ways President Obama appears now to be trying to make our government spending more effective and efficient while trying to build a broader Democratic Party coalition. Given these new efforts, we must encourage him, support him, and guide him to those extra steps that will ensure that his entire program will be successful.

The Obama budget does begin to move in this correct direction of directing government spending towards those investments that greatly increase private sector jobs growth and productivity. His idea to greatly increase to $148 billion in 2012 the governments R&D assistance to among other things, “create transformative technologies”, is a very positive move, as is his proposed “Manhattan Project” for critical clean energy research.

However, given that the administration has said that their budget plan is a starting point for negotiations, given that the President’s 2012 budget will be 9.5% more than the Democrats proposed 2011 budget, and given that the Republicans now control the House, the final 2012 budget will need to have much less spending than what the President has offered. Therefore, the future cuts in the President’s budget should not come from areas that either most adversely affect the poor and middle class, or are those areas that most increase private sector job growth and productivity. Things like the Home Heating Oil Assistance Program should not be cut. Such a cut will create actual pain for many poor, and/or it would lower demand in the economy because many poor would have to restrain current spending to purchase oil.

Therefore, what is left to be cut are those investments that do not hurt the poor or economic mobility and that are not yet proven to add to the nation’s productivity. More accurately, we should first cut those investments that have not been proven to pay for themselves over time above the rate of inflation, and are not sustainable without future federal moneys. Such an expenditure would be the President’s high speed rail proposal that has a price of $56 billion over six year. In this time of possible austerity, much unbiased research would have to be made that showed that the high speed rail system would pay for itself once it was built in order for such an expenditure to be justified. After all, if the middle class and wealthy are not willing to pay high enough fares to pay for a high speed rail system, and meanwhile the poor will still opted for much less expensive bus rides, then why should a new rail system be built? At this time it would be much more efficient to increase the amount that is put into the new, Infrastructure Bank. The Infrastructure Bank would be more likely to fund projects that wind up paying for themselves.

Putting off high speed rail might depress and anger some of the special interest groups that support us, but favoring them over the supporters of cheaper home heating oil or public/private R&D collaborations that will bring high paying private sector jobs to the US will only mean many Democratic Party losses in 2012.

President Obama has a long way to move regarding several aspects of the 2012 budget. How he handles these questions this year will greatly determine if he has a second term. That is, how President Obama adjusts Keynesian economics to the realities of the global economy will determine, in regards to domestic policy, whether he is considered a transformative and successful president, or a failure. Our version of Keynesianism for a global economy has long been called qualityism.

Keynesianism for a global economy, or qualityism, can be explained in a simple way by differentiating between how traditional Keynesianism taxes and spends, versus how qualityism taxes and spends. Old Keynesianism uses a blunt ax to tax all of the wealthy equally. It spends in ways that do increase consumer demand, but not optimally. It does not spend optimally because it does not demand that it’s investments pay for themselves and too often it makes the decision on how moneys are spent when that is not desired. Too often over the past almost 80 years Keynesian spending has created government projects that have to be perpetually funded with little return, and too often the government chooses how to spend stimulus moneys when the poor and middle class would rather make these spending decision on their own via a tax cut or an increase in the Earned Income Tax Credit.

Qualtyism believes that the wealthy should be taxed using the precision of a scalpel. Wealthy income that is hiring employees in the US and investing in ways that employ in the US should receive a lower tax rate. All other wealthy income should have its tax rate go up. Regarding spending, qualityism suggests that, unless government spending generates an overall financial return above inflation, the stimulus spending should be left to the poor and middle class via lower taxes and/or the EITC. Other government stimuli should be left for investments that produce a return and create real technological advancements for the economy, or education expenses that empower people to generate more revenue than the cost of the education. For example, many of our federal expenditures in the area of basic medical research have been shown to reproduce three dollars in the economy for every dollar spent. History is full of, and developed economies have always relied upon, government assisted technologies that have greatly added to the prosperity of the private economy. Most often war was the motivator for these achievements. We cannot afford to, nor should we have to or want to, rely on war for this motivation in the future!

Qualityism is different in many ways from capitalism. For one, qualityism acknowledges that wealth needs to be redistributed to the poor and middle class, both for the economy to be more prosperous and to make incomes more egalitarian. Qualityism believes that the best and most efficient way to do this is through the progressive income tax, but a progressive income tax that is contoured to a global economy. Using tax incentives through progressive income, capital gains, and C Corporation taxes, businesses will be incentivized to create more and higher paying jobs. The higher the demand for labor in the private sector and increases in productivity will, for all classes in the economy, bring more prosperity, a higher quality of life, and the freedom to have more time off with friends and family. Unlike laissez faire capitalism, qualityism believes that government spending can add to the economic prosperity of a nation, and that this is best done through the advancement of new technologies. The government can do this best through fully financing basic research and coordinating with the private sector in applied R&D. Along with our environmental tax plans that can also be found at ThirdWayProgressives.org, this government R&D assistance will make the economy more environmentally sustainable, prosperous, and egalitarian. The economy and society will be of higher quality!

When the economy first moved from primarily agricultural to primarily industrial, new social and economic thinkers had to arise to solve new problems. Today, we live in an entirely different economy compared to what existed just 40 years ago. With the fall of the Soviet Union and communism, the developed world has been opened to a new cheap labor market of 4 billion people. Add in new technologies that make outsourcing as fast as the speed of light and increased productivity in manufacturing, and we have experienced an effective 12 fold increase in global trade in the US and for the rest of the developed world since 1967. This has been every bit the change that occurred when the developed world moved from primarily agricultural to primarily industrial. With this change, new social and economic thinkers must arise to solve new and unique problems. Consider qualityism the first attempt at doing so.

  1. Emmanual Saez and Thomas Piketty, “The Evolution of the Top Incomes: A Historical and International Perspective,” National Bureau of Economic Research, working paper no. 11955, January 2006.
  2. The World Top Incomes Database, Facudo Alvaredo, Tony Atkinson, Thomas Piketty, January 2011.
  3. US Census Bureau, Statistics of US Businesses: 2008 : All industries US.
  4. “Recent Changes in US Family Finances” Federal Reserve Bulletin.
  5. Jay R Ritter, University of Florida, “Initial Public Offerings”

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