Solving the Problem of Excess Consumption by More Consumption:
Robert Reich is "Totally Spent"
13 Feb 2008 in Regulatory Economics, Regulatory Policy
We don't normally wade into macroeconomics, but today is an exception. Former
Secretary of Labor Robert Reich diagnoses today's economic problems in
a intriguing manner and offers an interesting prescription. He begins
from the premise that the U.S. economy has been stagnant for a
generation, and lower- and middle-income households already spend
everything they earn and do not save. "America’s median
hourly wage is barely higher than it was 35 years ago, adjusted for
inflation," he writes. "{M]iddle- and lower-income Americans found ways
to live beyond their paychecks," he continues, "[b]ut now they have run
out of ways."
His prescription: subsidize additional
consumption by middle- and lower-income households. This is an unusual
proposal given the prevailing view that Americans do not save enough.
Reich's says in his op-ed that the only way to sustain the U.S. economy in the long run is to increase spending by lower- and middle-income households:
[Today's] problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going.We looked at data from the Bureau of Labor Statistics and focused on two categories in which middle- and lower-income workers are likely to reside: "Office and administrative support," and "blue-collar occupations." Instead of looking at hourly wage rates, however, we looked at the BLS' employment cost index (ECI). This index captures the cost of both wages and benefits, and there are at least two good reasons for doing this. First, the ECI includes the full cost of labor, not just take-home pay. Second, it is misleading to focus only on hourly wages if benefits have been rising.
The only lasting remedy, other than for Americans to accept a lower standard of living and for businesses to adjust to a smaller economy, is to give middle- and lower-income Americans more buying power — and not just temporarily.
In recent years, employment costs rose 7% in inflation-adjusted dollars for office and administrative support workers from 2001 to 2007, and 5% for blue collar workers from 2001 to 2006. Similar increases occurred in other occupational classifications where middle-income workers are found: Elementary and secondary schools (7%), health care and social assistance (8%), hospitals (11%), nursing and residential care facilities (7%), public administration (11%).
The graph below from BLS illustrates what has occurred over the past several years. Real increases in wages have occurred throughout the period, though at a higher rate in the early years and since 2006. Meanwhile, there were large increases in the inflation-adjusted cost of benefits, especially during the 2003-2006 period. It is hard to square these data with Reich's implied assertion that middle- and lower-income household incomes are "stagnant."
Reich proposes to subsidize additional consumption by middle- and lower-income households by increasing the Earned Income Tax Credit, "financed by a higher marginal income tax on top earners." His explanation for how the EITC is generally correct:The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. The current supplement for a worker with two children who earns up to $16,000 a year is about $5,000. That amount declines as earnings increase and is eliminated at about $38,000. It should be increased to, say, $8,000 at the low end and phased out at an income of $46,000.Reich does not acknowledge, however, that "reverse income taxes" also create perverse disincentives to work and advance up the economic ladder. Under his proposal, for every $1,000 in additional income a low-income worker earns, she loses $375 in reverse income tax benefits. That's a {$8,000 / ($46,000 - $16,000) =} 27% marginal tax rate. Instead of rewarding them for improving their economic position, Reich's proposal penalizes them slightly. (The current marginal income tax rate is ($5,000 / ($36.000 - $16,000) = } 25%.)
Reich's proposal is all about increasing consumption, not rewarding investment. He would increase the marginal tax rate on higher-income households in hopes of generating the income to pay for increasing the Earned Income Tax Credit., the logic being that higher-income households don't consume as much. To the extent that higher-income households did not actually pay these higher taxes, such as by working less, the higher Earned Income Tax Credit would be paid for by borrowing -- that is, by future taxpayers.
This is an intriguing irony. Reich is concerned that Americans have been consuming beyond their means, yet his remedy consists of consuming even more.
UPDATE
February 13, 2007 @ 1245
A reader has commented privately that Reich appears to be aware of the disincentive effects on work caused by high marginal tax rates. His proposed revision of the Earned Income Tax Credit would raise both the maximum EITC and the phase-out income level. If the EITC were raised from $5,000 to $8,000 but the phase-out income level were kept constant, the marginal income tax rate would be {$8,000 / ($36,000 - $16,000) =} 40%.
If the maximum EITC were kept constant but the phase-out income level increased to $46,000, the marginal income tax rate would be reduced to {$5,000 / ($46,000 = $16,000) = } 17%. By opting to increase both as he has done, Reich seems to be concerned that the proposal not increase the marginal tax rate on the working poor too much, knowing that it will deter their incentive to work.
Bureau of Labor Statistics
Employment Cost Index (December 2005 = 100)
Office and administrative support
YEAR MARCH
2001 93.8
2002 96.4
2003 97.0
2004 99.3
2005 99.8
2006 99.4
2007 100.3
Blue-collar occupations
YEAR MARCH
2001 94.6
2002 96.7
2003 97.4
2004 99.8
2005 99.9
2006 99.1
