Washington Fiddles, Productivity Burns

You know the country is in trouble when Congress starts running against Michael Milken. The financier’s name was used repeatedly in the budget debate last week as a symbol for the 1980s. The proposed surtax on incomes over $1 million, for example, was called the “Mike Milken tax.” Sen. David Boren, (D-Okla.), defended a proposed tax cut on long-term capital gains by saying “this is not a quick profit for Mike Milken and Ivan Boesky.”

Milken, who made $550 million one year at Drexel Burnham Lambert--and who now faces sentencing on securities law violations--has become a battle cry for politicians who say they’re going to reduce the deficit by taxing the rich while protecting the middle class.

But it’s all political eyewash.

The problem in this country--and the reason for the budget deficit--is not that the rich are passing the tax burden onto the middle class. And it’s not that most people aren’t paying high taxes--the average American pays between 35% and 40% of his or her income, if Social Security and state taxes are added to federal. The trouble is not even that government budgets are in the hands of wild-eyed spendthrifts.

The problem is lagging economic growth, causing tax revenue to be insufficient to pay for all the needs of a complex society--from defense at nearly $300 billion a year to Social Security payments at $241 billion. Social Security payments will go up 5.4% as of January just to keep pace with inflation, but tax revenue in a recessionary economy won’t go up.

The tax bite has already grown faster than the pie: In this fiscal year, tax revenue of the federal government will be 21% of the nation’s output of goods and services; 10 years ago they were 19.5%.

The simple truth is that U.S. industrial growth and gains in productivity have been less than they should be for almost 20 years. From 1973 to 1989, real gross national product grew at an average annual rate of 2.5%, compared to 3.5% a year from 1955 to 1973. It is indeed correct to remember the 1950s and 1960s as times of abundance. But they were followed by a big decline, with fully 25% less national wealth created--one-fourth less to pay for everything from social benefits to advanced research.

Why growth slowed remains a disturbing mystery, and attempts to revive it with taxes have been frustrating. The 1981 tax law contained incentives for business investment--which worked up to a point. Capital investment, particularly in computers, rose sharply in the early 1980s. “And don’t forget, the nation was able to come through an awful recession in 1982,” notes Professor Aaron Wildavsky, of UC Berkeley, co-author, with Joseph White, of “The Deficit and the Public Interest.”

Still, growth lagged. So a new approach, in 1986, was to eliminate the distortion of tax shelters and reduce 14 income tax brackets to two. That approach has produced no miracles, and now it’s being criticized for creating a “bubble” in which the rich pay taxes at a lower rate than the middle class--which, by the way, isn’t true.

The bubble is a statistical anomaly, the result of the Internal Revenue Service efforts to hit Americans earning between $50,000 and $100,000 with a little more in taxes than the average working person pays. But despite all the shouting, these high earners still pay a lower overall rate than the very rich. The effective rate is always lower, says an IRS spokesman.

Nonetheless, the snarling about rich and poor is a bad omen. With the pie not getting larger, the fight for pieces is getting nastier. And the problem is spreading beyond the federal government. According to the National Governors Assn., 33 states actually had budget deficits in 1990--despite balanced budget laws in every state. No state admitted to a deficit, preferring to paper things over with bookkeeping. But those tactics soon lead to where the federal deficit is today--the point at which it must be cut.

And that’s why you’re seeing politicians shout about “soaking the rich” while slapping taxes on gasoline and beer. The taxes may be necessary if the country is to reduce the defict and move on to other matters. But we shouldn’t kid ourselves, the taxes will do nothing to aid productivity and economic growth.

What could? Hard to say. Some experts, such as Stanford University economist John Shoven, point out that “taxes are one-third of a business’ cost of capital. Lowering them could make U.S. companies more competitive internationally.”

“No doubt of that,” agrees economist Allen Sinai of Boston Co., the investment firm. “But there’s no chance of tax cuts for business this year. The rich-poor issue is too politically heated in Washington.”

More heat than light is typical for Washington, a place influenced by the latest bad book on popular economics. At the beginning of the 1980s, all Washington was reading George Gilder’s “Wealth and Poverty,” which argued that reducing taxes on the wealthy would improve the economy. That turned out to be a false promise.

So now all Washington is reading Kevin Phillips’ “The Politics of Rich and Poor,” which argues that raising taxes on the wealthy will improve the economy. When that turns out to be a false promise, maybe Washington will stop reading and start thinking about a cure for our lagging economic growth.

But don’t get your hopes up. Washington politics is like baseball, as described by announcer Vin Sculley at the World Series. Informed by co-announcer Johnny Bench that Cincinnati pitcher and Rice University graduate Norm Charlton was a genuine intellectual, Sculley agreed, but quipped: “You know what baseball calls an intellectual, don’t you? A guy who carries a hardback book.”

The same holds for Washington.