Senator Romney Versus The Wall Street Journal

The bigger story

Raising taxes on the wealthy will likely be part of plans to manage our increasing debt, but it won’t succeed without efforts to encourage wealth-building among everyone else.

Senator Mitt Romney recently argued that raising taxes on people like himself should be a key part of restoring fiscal responsibility. Unsurprisingly, the Wall Street Journal (WSJ) editorial page felt compelled to respond. For decades, the WSJ has promoted the extreme supply-side view that nearly any tax cut, especially on capital income, benefits the economy.

One can easily reduce this debate to the classic and long-standing one between populists and business special interests, but that would overlook what history and economics tell us. Moreover, Senator Romney is not a populist, and, in making a “declaration against interest,” deserves the additional credibility that courts, dating back to early English Common Law, ascribe to such statements.

As I’ve explained elsewhere, Congress, especially Congressional Republicans, has spent nearly fifty years successfully lowering taxes on capital income, while taxes on labor earnings have largely been maintained. In many ways, Republicans have long achieved their goal. By cutting tax rates on high-income individuals, directly or through businesses, by about half since 1980, economic theory suggests that these reductions have reduced the inefficiency of these taxes by much more than half. (More technically, the “welfare loss” from a tax rises with the square of the tax rate.) Romney suggests that higher-income individuals can now share some of the additional burden needed to address our massive budget problem.

But that’s not the whole story.

Though not my primary focus here, Congressional Democrats over the same period have effectively continued their own juggernaut of allocating ever-higher shares of our national income and federal budget to Social Security and health care. The combination of these dominant tax and social policies has several deleterious consequences.

• A massive surge in federal debt relative to GDP.

• A significant increase in the share of wealth held by the wealthy, those most likely to benefit from the tax cuts.

• An intense government focus on consumption among the non-wealthy, financed primarily through significantly higher transfers of income and expensive healthcare over extended periods of retirement.

• A squeezing out of most programs, at least as a share of our national income, that promote upward mobility, opportunity, and wealth building by the non-wealthy.

These ongoing trends have become mutually reinforcing. The government’s efforts to boost consumer spending, primarily through transfers, make most of us increasingly dependent on it. Meanwhile, the government relies ever more on the wealthy to invest and expand the capital stock. Because no political party wants to fund its priorities, Congress continues to borrow more.

However, taking some wealth away from the wealthy can easily reduce the nation’s total investment unless simultaneous efforts are made to build wealth, including knowledge or human capital, for the rest of the population. This is where both Republicans and Democrats have entirely missed the mark. As my wise friend Rudolph Penner, a former Congressional Budget Office director and colleague at the Urban Institute, once pointed out to me, the rich tend to save at much higher rates than others. Billionaires earning hundreds of millions of dollars each year find it almost impossible to spend most of that money on consumption. They can only use so many yachts and servants. Many may live extravagantly, but their efforts largely go toward acquiring yet more power and wealth. Transfer more money to them, and savings and investments in the economy will increase.

If we reduce wealth-building opportunities for the wealthy, then we must increase them for those who are less affluent. To do this, we need to limit unsustainable growth rates in programs that primarily support higher levels of consumption, while encouraging, rather than discouraging, the saving, education, and work efforts necessary for wealth building.

And all of this must be done while addressing the debt situation that Senator Romney criticizes.

Unfortunately, neither Congress nor the Executive Branch conducts the detailed analyses, much less builds the organizational structure, needed to address these simultaneous problems. When they are not spending much of their time on social media and cultural battles, they keep budget policy on the well-beaten and unsustainable path developed over the past half-century—more wealth for the wealthy and consumption for the masses.