Posts Tagged ‘taxes’

Is MMT neutral concerning income equality / inequality?

Now the last of the row of re-posts…

23 Aug 2011 21:46

One of the main points of MMT is that a monetary sovereign government can always spend enough to allow full capacity utilization.

How does this affect equality / inequality?

If deficit spending closes the demand gap, this results in the economy running at full capacity, and this means that all available labor force will find employment, so the economy will as well run at full employment.
What influence has full employment on total and median wages? At full employment, workers can easily find new employment. This gives the workforce significant leverage against companies, and allows them to bid the wage level up. So we should see a strong rise in the median wage, and an even stronger raise in the lower wage segments. Wages above the median wage will have to rise somewhat slower than the average wage, or the general rise of the wage level would lead to a very strong rise in the wage share of GDP. But generally, the wage share will rise, and the profit share will decline. Thus, income distribution will tend towards equality, and the purchasing power of ordinary middle and lower class workers will rise sharply, increasing consumer demand.

Some companies might dislike the falling profit share, and will try to hike their prices significantly. But if they are not in a quasi monopolistic situation – or a cartel – they will lose market share to competitors who sell at lower prices, so their attempt should usually fail.

Of course, under full employment, there will be a significant risk of inflation. So, what should the government do to keep inflation in check? It has to reduce the deficit – either by reductions in spending or by increased taxation. Some of that will happen more or less automatically – in a booming economy, sales and income taxes will go up – and unemployment and other welfare payments should decline.[the so called automatic stabilizers]. But if the previous slump has been large, this will not be enough.

So, what should it be – cut spending – or increase taxes?

Much of the government spending usually happens in fields that should be a natural domain of governments – like the military, public pensions[1], infrastructure, utilities[2], healthcare[3]and education. So, significant cuts in those sectors might undermine the public wellbeing rather soon, and provoke the next recession.

If we don’t want significant cuts, we’ll have to look at tax hikes. General sales taxes, flat-rate income taxes and contributions to pension plans reduce the purchasing power of the middle and lower classes and therefore, work against equality. So they will reduce aggregate demand (if they are hiked), but it’s quite likely that they will not be lowered soon enough to avoid a new recession.

OTOH, taxes on capital gains, corporate profits and very high incomes will not lower demand very fast, but if they are mostly taxed away (above a certain threshold), the incentive for corporations, and potential high income earners to hike prices / top level wages will be low, and this should limit inflation.
So, the most sustainable approach, almost certainly, is, to spend a lot in bad times and then to rise top tax rates / taxes on economic rent – and push for a very egalitarian income distribution.

Austerity, of course, is just the opposite.

The proponents of government austerity intend to widen the demand gap. This results in even more excess capacity, and higher unemployment. As higher unemployment, as weaker the bargaining position of labor. If this goes hand in hand with the dismantling of social safety nets, the effect on the median wages and the general wage level is clear. The median wage will decline, and the lowest wages for workers without special skills or previous experience will drop fastest. If some wages might rise at all, it would only be the top salaries.

Income distribution will get more and more unequal – the wage share of GDP falls, and the profit share rises. With falling wage incomes, (and – may be – falling government transfers), the purchasing power of the middle and lower classes will decline. They might cope for some time by taking on more and more debt – but sooner or later they will be overleveraged. So, the economy should enter a downward spiral – falling prices (to little demand), falling wages (resulting in lower demand), many bankruptcies. Normally – if some automatic stabilizers would still exist, government spending should slow the fall, but this would mean a sharply increasing deficit.

For true austerians, deficits are anathema. So, the government would have to balance the budget by spending cuts (cutting pensions, health care spending, infrastructure, education, and yes, even defense). Thus, the downward spiral will accelerate fast – if the government cuts keep the pace of the shrinking economy, the profit share (as ratio to GDP) might still rise, but for most businesses, absolute profits (in money units) will still fall, and many will go bankrupt.

Can there be full employment without more equality?

If the wage share doesn’t rise again, domestic consumer demand will remain to weak for full employment. So full employment would have to come from an export surplus (but not everyone can be a net exporter) or from a higher government deficit. But if the economy runs at full employment, the bargaining power of workers would rise in any case – the only way to avoid this would be political oppression – Fascism and / or slavery. And the only way such a system could run at full employment under this condition would be deficit spending – either for a huge military, or infrastructure projects.

Where will this all lead to?

If we follow the full employment path, we have to take some other aspects in to consideration – demography, and resource constraints.

Many leading industrialized countries (and soon China as well) have a fast growing share of elderly people. Unless they take in a lot of immigrants, the dependency ratio – and especially the costs for healthcare, will continue to rise sharply. Is this a problem? Not really – as long as there is productivity growth, there can still be growth with a shrinking work force, or at least constant output with a shrinking workforce.

And as many of the elderly don’t consume that much, there should be a shift from consumption expenditures to healthcare. This, of course, requires a rising government share as part of the economy – the savings ratio might go up, (thus the deficit has to rise to keep demand constant), and with pensions and healthcare a rising segment of the economy, most of the growth will have to be absorbed by the government sector.

And then there are the resource constraints – rising prices for raw materials will likely beat up imported inflation in many countries rather soon. So the governments should tax away the economic rent that oil-importers etc might gain, and invest heavily in alternate energy sources, energy saving devices and the like..

What if austerity prevails?

As long as austerity is maintained, shrinking expenditures should lead to a shrinking economy, more inequality, more misery, and more bankruptcies. Eventually, the fabric of society will break down. There might be fascist regimes, or areas where warlords take over, entire nations turning in to failed states, or a combination of the above. If the fascist keep to austerity, there will be no recovery unless the misery will have reduced the surplus workforce (starvation, lack of healthcare, crime, etc), and a significant part of the survivors have returned to subsistence farming. Only then will wage levels be so low that formerly leading industrial countries that neglected their infrastructure will once again be able to become net exporters. Many people might de facto (if not the jure) have fallen back to the status of slaves. Only if the new fascist regimes will deficit spend for a huge military – and some infrastructure – (and thus have ended austerity) will there be a remnant of a growing economy. If they don’t, further disintegration, back to micro fiefs as in the European middle ages, or – in less populated and more open areas, to a culture of warring horse nomads, will finally become inevitable.

Anyhow – austerity – if it rules long enough, will destroy capitalism, and will destroy civilization.

Why should pensions, utilities, and health care be natural domains of government?

1] Pensions: Private pension schemes try to build a stock of capital at present to pay for pension in the future, but future retirees will need goods and services that are available in the future, there can’t be a transfer of this goods, because there are not part of a finite stock. By increasing present savings, private pension plans reduce aggregate demand at T1(present), and therefore weaken the growth of the economy, so , the future economy is likely to be weaker (the pie is smaller) at T2(future). So, to ensure maximal growth, reliable public pensions systems – without ex ante funding – are required, so that people don’t need to forego consumption at present.

2] Many utilities, like gas, electricity, water, sewage [and public transport] are best operated as a natural monopoly [duplication of infrastructure by competing utilities will just result in higher prices] – while private monopolies will likely result in abuse (high prices, low quality of service, minimal investment) – public monopolies – with tight supervision, should do the trick..

3] Health care is not really a consumer market. Very few consumers pay most treatments out of pocket. Most patients carry insurance, and the insurance pays for (most of the) treatment. So, in a triangular market, no one has a real interest in maximal efficiency – the patients want the best treatment, the doctors want high wages, the pharmaceutical industry wants high profits, and the insurance company would like to pay as little as possible, but earn high premiums. So both providers and payers have not necessarily the best interest of patients in their mind, and most patients can’t do a real quality check. This drives up cost, but not so much effect. So many people can only afford healthcare if the government either pays for the care, or subsidizes the insurance. Therefore, a single payer health care system – where all services are bought by a monopoly intermediary – e.g. the government, which has leverage in price bargaining against suppliers, seems the most effective. And if there is no price bargaining, but just government funding, excessive profits of pharmaceutical companies and super high wages of some specialists should be subject to high taxes, to remove the monopoly rent.