This policy, which Altman terms the "neoconomy" is a monstrous gamble based on a few radical economic assumptions. "Following the path chosen by the neoconomists," says Altman, "could indeed lead to a period of untold prosperity, with living stands rising faster than ever before. It could also lead to nothing less than the collapse of the capitalist system -- a real revolution in which the nation's tax-paying laborers rise up against a class of wealthy free-riders." This gamble largely depends on whether or not the neoconomists' model is a sound one, and whether the economic upside of their vision can outweigh the downsides of increased inequality of income, ballooning deficits, and painful cuts in spending. As Altman argues, it's not at all clear that they can.
Altman, who has written regularly for the New York Times and the Economist, recently spoke with MJ.com by phone to discuss the origins of the neoconomy vision, it's successes and failures thus far, and what we might expect from a second Bush term.
MotherJones.com: Now your basic premise is that the Bush administration's economic policy is directed by a radical vision that aims to end taxation on savings in order to boost the economy's rate of growth permanently. Can you just explain briefly how this is supposed to work?
Daniel Altman: Sure. In the 1960s economic theorists started developing models showing that if you could increase the savings rate in the economy, you could attain a one-time burst of economic growth -- a one-time leap in living standards. Later on, in the 1980s, some other theorists decided that they weren't satisfied with some of the assumptions of those models. So these later theorists decided that they would make technological innovations part of the model -- by saying that if you made more money available to the corporate sector, it would spend more on research and development, and that would result in technological innovation. Then you would, according to the theorists, not only get a one-time leap in living standards, but also increase the rate of innovation, which helps to raise living standards faster and faster over time.
MJ.com: Can you do a quick run-through of who, exactly, the neoconomists are?
DA: They were the economists in the Bush administration who adopted these ideas because they thought the models had direct policy implications. This includes [former chairman of Bush's Council of Economic Advisers] Glenn Hubbard, [former director of the National Economic Council] Larry Lindsey, [former assistant Treasury Secretary] Richard Clarida, and to some degree [current assistant Treasury Secretary] Mark Warshawsky. I think there's little doubt that Glenn Hubbard, who was the architect of most of the economic policy in the first several years of the Bush administration, was especially receptive to these ideas.
MJ.com: So how far along are we in the neoconomy process after the first three Bush tax cuts?
DA: Well I'd say we've made a good start. The elimination of the estate tax is a small part of it. The tax cuts on dividends and capital gains are a larger part. Making it easier for companies to pay less corporate income tax is another. And, by lowering the income tax rates -- which for the most part affects wealthy people with more savings -- helps to take away some tax on saving.
MJ.com: Let's talk about the selling of the tax cuts. You argue that the Bush administration basically used the 2001 recession, along with 9/11, to sell the next batch of tax cuts—the cuts after the 2001 package.
DA: Well, each one of those tax cuts did offer some economic stimulus to the economy. But it was very plain to economists that stimulus was not their main goal, that in fact the main goal was a long-term change in the economy, and any stimulus that would be offered was something of a side effect.
MJ.com: But then after Enron and the other corporate scandals in early 2002, the neoconomists had to be a lot more timid about how they cut taxes?
DA: I think it required them to make certain choices. For instance, many economists would probably agree that if you wanted to get rid of the double taxation of dividends, it was much better to get rid of the tax on the corporate side than on the individual side. It's much less complex as well. But officials in the administration said that that just wasn't legislatively feasible, and a big reason for that was that the corporate sector was in the doghouse with the American public.
MJ.com: Now the neoconomist vision assumes that if you end taxation on savings, people actually will save more. Is that a good assumption or is that sort of a leap?
DA: Well, if you take a very simple economic model, it is not necessarily the case that people will save more. Economists have basically been looking at the data for the last year or so, trying to see if the cuts in the dividend and capital gains tax rates have actually resulted in more savings, and though there is a lot of other stuff that could affect the savings rate, there certainly wasn't the big increase that people were expecting. A number of economists believe that the relationship just doesn't exist -- that there are other things that affect savings more, like culture, or incentives that come from things other than taxes.
MJ.com: I noticed a study by the Cato Institute recently showing that dividend payouts were up 20 percent after the 2003 tax cut, and the stock market gained about $2 trillion in value after the cuts. Could this be considered a success?
DA: In a way, part of the stock market gain could have been merely mechanical. If you cut the tax rates on dividends, it means that a stock is instantly worth slightly more, because investors will be able to keep more of the returns on that stock. However, I would be very reluctant to attribute any stock market gain over a long period of time to one policy or change in the economy, because there are so many things that affect the stock market.
MJ.com: The Bush administration hasn't actually released a proposal for tax reform in the second term. But given what we know about the first term, what do you expect the next steps to be?
DA: Well, step number one will be to make all their previous tax cuts permanent. Step two is that they want to see some simplification of the tax code. And that could be anything from getting rid of loopholes to completely redesigning the income tax or even replacing it with a national sales tax. There's a huge range of options here. I think that other things on their agenda include a vast expansion of tax-free savings accounts. In addition they probably want to get rid of the dividend tax completely, and I suspect they may try to lower the capital gains tax rates as well, which has been part of the Republican platform for a long time. All of these steps would advance the general neoconomy goals.
MJ.com: What about corporate taxes? Would they aim to eliminate corporate taxes altogether?
DA: Well they've already cut corporate taxes somewhat with their 2002 tax cut, which had a lot of bonusing and expensing rules to help companies lower their tax burdens. In addition, when you talk about double taxation on dividends, the "double tax" is basically the corporate tax added to the personal tax on dividends. So if you take away one or the other, you've cut corporate taxes.
MJ.com: How does Social Security privatization fit into the neoconomist vision?
DA: By transforming Social Security into a system of private portfolio accounts, we're essentially taking a huge amount of money out of the government's coffers and putting it straight into the private sector. So this would be a huge step forward in achieving the neoconomy. We're talking about trillions of dollars, and increasing our stock of financial capital by that much makes a big difference to the stock market. But that's part of what's problematic about the plan—you have to ask yourself, who's going to choose where we could put the money. Would we have been able to invest in Enron? Would we be able to invest in foreign securities? Because if we could, they wouldn't help our corporate sector to spend or invest in R&D.
The other problem is that we don't know how to fund the transition. If we take money out of the current system as the president has proposed, we just leave ourselves with a bigger debt to retirees, and a bigger tax burden. The last problem is that you bear the risk of a crash in the financial markets. As Chile showed -- and Chile has been an example that the president has cited as a model -- in 2001 their stock market crashed, and some of their retirees saw their benefits drop by as much as 7 percent.
MJ.com: Now what will happen if a neoconomist—say, Martin Feldstein or Glenn Hubbard—becomes chairman of the Fed when Alan Greenspan retires in 2006, as rumored? How will that change things?
DA: Well, it's an interesting question, because Glenn Hubbard is not really a monetary economist. Alan Greenspan made his name as a forecaster. But you would think if they're going to pick an academic economist, the president might go with someone like John Taylor, the undersecretary of the Treasury for international affairs, because he's one of the biggest names in monetary policy. But I don't really know how Glenn Hubbard would manage monetary policy, and I don't think there are many people who do.
MJ.com: What about deficits? If you increase deficits basically you're not doing anything for national savings, and only shifting taxes onto later generations.
DA: This is a critique that Marty Feldstein made of the Reagan administration in fact. Even though the Reagan tax cuts may have encouraged some economic activity, Feldstein worried they were creating unsustainable deficits. I think the same worry is justified now. The explanation or gloss that the White House has put on it is that these tax cuts will improve the business climate so much in the long term that the deficits, which the administration views as a temporary problem, will just drift into distant memory.
Now they have also said they will cut the deficit, but if they're cutting taxes at the same time, they will have to make very deep cuts in spending. Yet neither they nor Congress has shown any real inclination to do that.
MJ.com: You float the theory that part of this strategy could be to tie the hands of future administrations—so that they can't increase spending any further.
DA: I think it's pretty well known that if you spend a lot and cut taxes a lot, the next administration will have very little room to maneuver. And I think that the second Bush administration may have to come to grips with that problem. If you look carefully at the president's economic policy during the campaign, he did advocate making some tax cuts permanent, but that would not have affected budget balances in the large part for several years. Most of his economic policies were mandates, which would cost the federal government nothing, but might impose significant costs on the private sector.
MJ.com: It seems that the neoconomists in the Bush administration believe that it's better to offer tax cuts for investment than to actually have the federal government invest in things like research and training. But you argue that this isn't always true?
DA: That's right. There are very high and proven returns to government investment in basic research, and to the subsidization of higher education. The problem is that both of those things take a long time to pay off, and it's hard to get politicians interested in things that may not pay off during their terms or before their next election.
MJ.com: You also touch on the fact that the effect of increase in capital stock is somewhat dulled if the government isn't investing in training and education for labor.
DA: Sure. You can throw more and more capital at the same workers, and eventually -- in fact very quickly -- you get into the problem of diminishing returns. You need to help the workers become skilled at the same time, in order to make best use of that capital.
MJ.com: Now let's touch on some of the effects of the neoconomist vision. By now we all know that Bush's tax cuts go primarily to the wealthy. But in your book you press even further than that—noting that basically the neoconomists are talking about a taxation on wages.
DA: Yes, I think that's pretty clear. If you're getting rid of the other sources of income taxation, then all you're left with is wages and salaries.
Now if you save more than $3,000 a year, then you would benefit to a large degree, but there are a large percentage of Americans who don't save at all; they certainly won't benefit. Of course the people who have the most saving benefit the most, and I think we know who they are.
MJ.com: What do you think are some of the negative effects of increasing these sorts of disparities?
DA: I think there are two, maybe three big risks associated with that. First is that because we don't live in a meritocracy, the wider the gap between incomes, the more likely it is that someone who is wealthy but not so bright will take a place away—whether it's at college or in government or in some other area where opportunities are limited—from someone who is poor but talented. This is a really crucial problem for our economy, because we're heading into a period where the labor force is not going to grow very much. So in order to keep our economy expanding, we will need to use all the potential and all the talent of every one of our workers. If we allow income equality to increase, then it's more likely that we will waste the potential of part of our population.
The other risk is that the gap in taxation will create a political backlash. If wage-earners see that high-earning executives are able to avoid paying any tax at all, they may decide to make a change in the system. And if they decide to reverse the policies of this administration, we may wonder why we ever had them in the first place.
The third effect of increasing inequality has to do with the people themselves who are losing out on these opportunities. It's been shown that there's a discouragement factor where if you can't own the fruits of your labor, you won't work as hard, and you won't indulge your creativity. That's another way in which we risk missing out on some of the great things that people can do.