by Paul Craig Roberts, Paul Craig Roberts:
The last time the US economy received a helping hand from policymakers was the Reagan tax rate reductions. The high tax rates on inflated nominal incomes by the “guns and butter” Vietnam war policy reduced the after tax earnings of labor and new capital investment, and the economy was experiencing the “malaise” of stagflation. The Reagan tax rate reduction, which I drafted and saw through to passage, indexed the tax system for inflation, so that inflation, if properly measured, could not push purely nominal incomes into higher brackets. This was the last achievement of American economic policy. Everything that followed contributed to the decline of the once powerful US economy and the dismantling of its ladders of upward mobility that had brought growing prosperity to Americans.
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The supply-side policy also corrected the outdated theory of the cost of capital. The theory predated the income tax and was never adjusted for it. The theory attributes the cost of capital to the interest rate. The higher the interest rate, the higher the cost of capital. Thus, according to the theory, government budget deficits drove up interest rates and crowded out investment, while high rates of saving lowered the interest rate and the cost of capital.
I brought taxation into the theory. What I was able to show together with Treasury economists Aldona Robbins, Gary Robbins, and David Brazil, with review and input from others acknowledged in the publication–“The Relative Impact of Taxation and Interest Rates on the Cost of Capital,” published in Technology and Economic Policy, edited by Ralph Landau and Dale Jorgensen, (Ballinger, 1986)–is that taxation as part of the service price of capital is a higher cost than interest rates. This result has never been challenged to my knowledge, but it has not, to my knowledge, been incorporated into the body of economic knowledge.
Here is the statement of our finding:
“The chapter calculates the relative impact of interest rates, taxes, and technology on the cost of capital. The results show that the cost of capital is highly inelastic with respect to changes in the interest rate. Taxation, however, substantially affects the cost of capital, raising it by 43 percent for the economy as a whole. Increases in the cost of capital due to tax changes raise the rate of return required from real productive assets, which translates into fewer viable investment opportunities.
“The results of this chapter dispute the policy prescription implied by the view that federal deficits cause high interest rates, which in turn, crowd out investment. The view that higher taxes would reduce crowding out and raise the investment rate is inconsistent with our findings that taxation has significant adverse effects on the rate of capital formation.”
Since President Reagan’s revival of the US economy, many greed-driven economic responses have appeared in response to changing foreign policy events. When the Soviet Union collapsed in 1991 as a result of Soviet Politburo house arrest of Soviet President Michael Gorbachev, China and India, witnessing the collapse of communism and socialism as an economic system, opened to foreign investment. This made vast amounts of labor available to US capital at throwaway wages.
American executives who did not quickly capitalize on low labor costs in Asia by moving their prodution for US markets offshore were informed by Wall Street to get there quickly or Wall Street would finance takeovers of the corporations and move their manufacturing to China.
With the offshoring of US manufacturing jobs to Asia (and Mexico) went blue collar middle class incomes and the tax bases of US cities and states.
The growth of US consumer incomes stopped in its tracks, and the values of municipal bonds in the abandoned cities and states declined. Social support budgets rose as the tax base declined.
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