A Letter to the Next President

by komal sri-kumar and masood sohaili

komal sri-kumar is an economist who heads Sri-Kumar Global Strategies, a California-based consultancy specializing in risk analysis.

masood sohaili is a Los Angeles-based partner in the law firm DLA Piper.

Published September 30, 2019


Dear Mr./Ms. President-elect:

We have two objectives in writing. First, we think it would be possible to raise the pace of sustainable growth of the U.S. economy, which monetary and fiscal stimulus policies have been unable to achieve since the end of the Great Recession in 2009. Second, we’d like to persuade you that the way the economic pie is divided can be as important to the nation’s well-being as the size of the pie. The issue is one of great urgency because, in spite of very low measured unemployment, income inequality has increased significantly in the past decade, leaving the U.S. as one of the OECD nations with the greatest disparity in incomes.

The growth that we have experienced since the Great Recession has largely been driven by fiscal and monetary stimuli, and less obviously by the failure to account for the costs of environmental damage linked to air and water emissions. Permissive emissions policies merely borrow from future growth. They also tend to exaggerate business cycles. So it is hard to avoid the conclusion that the growth since the Great Recession has not only been tepid but also unsustainable. And it has come at a steep social cost in terms of the ongoing widening of income inequality.

The critique of capitalism is a distraction from a deeper issue. We believe that the fairest and most effective way to accelerate growth and reduce income inequality is to move away from a system that creates incentives for the powerful to profit by avoiding the discipline of markets.

Capitalism per se isn’t the problem. Relatively free, decentralized markets are essential to creating sustainable growth. And there is no dispute that capitalism has managed to lift billions out of abject poverty worldwide in the past four decades. Neither China nor India was able to achieve rapid, largely continuous economic growth until they adopted free market practices in the 1980s and early 1990s.

Indeed, the critique of capitalism is a distraction from a deeper issue. We believe that the fairest and most effective way to accelerate growth and reduce income inequality is to move away from a system that creates incentives for the powerful to profit by avoiding the discipline of markets. For the invisible hand to fulfill its promise, those acting in the market need to have equal opportunity and enough bargaining power to offset the leverage of the giant players.

Yet government has not been an impartial referee working to level the playing field. Rather, as Jeremy Grantham, the widely respected fund manager, concluded: “The capitalist beast is out of control. … Steadily increasing corporate power over the past 40 years has been the defining feature of the U.S. government.”

We would like to see an end to government measures that subtly increase benefits to “winners” while further hurting “losers” — America’s lite version of the more obvious crony capitalism that undermines growth and equality in unsuccessful economies around the world.

It would be instructive to examine why we are where we are today. In responding to the 2008 financial crisis, Ben Bernanke, then the chair of the Fed, cited what economists call the “wealth effect,” stemming from losses in asset values as the justification for lowering interest rates to near-zero levels and for Fed purchases of bonds of all sorts on an unprecedented scale. Monetary easing did, indeed, boost wealth for investors who were prescient enough, or just plain lucky enough, to have stayed in the markets after the financial meltdown. The S&P 500 Index rose by 265 percent between January 2009 and June 2019.

Low- and middle-income households, by contrast, did not enjoy this wealth effect because they had few securities to appreciate. Wages did rise a bit in the same period — but only by 21 percent.

What about all the job creation over the past decade and the record-low unemployment rate recently? Did that not make wage earners better off despite the slow pace of earnings growth?

Two inconvenient facts complicate the story of a healthy labor market. The labor force participation rate for Americans age 25 to 54 (the prime working age group) is still below the level of 2008. Furthermore, 8.3 million U.S. workers held multiple jobs in July 2019 — a record number. This would suggest that a single job is becoming ever less adequate to support a household.

$379 billion in income shifted from workers’ wages to business’ profits in 2018 alone.

One consequence of the diverging fortunes of the wealthy and the rest of us is a drop in the share of wages and salaries as a portion of national output. In 2008 earned income represented 45.1 percent of income. A decade later the figure was 43.3 percent. Not a big change, you say? It amounts to $379 billion in income shifted from workers’ wages to business’ profits in 2018 alone, compared with what would have been the case if the division had remained unchanged over the decade.

We believe that smaller government — not larger — is the key to righting the imbalance. The idea here would be to strip away policies, including tax policies, that tilt the playing field. Case in point: the 2017 year-end changes in the tax law. 

The new law imposed no restriction on what corporations could use the tax cut for. And unsurprisingly — at least to anyone who understands how easy it was to raise business capital in the past decade — a significant portion of the windfall was used to repurchase shares rather than to invest. Note, moreover, that the percentage increase in after-tax income that went to higher-income payers was more than that gained by the bottom 20 percent of income earners during 2018 and 2019.

The unequal distribution of goodies stemming from the 2017 tax cuts is likely to have a longer-term negative impact as well. It has further shifted the balance of political and economic power toward the affluent.

To move the economy a little closer toward a balance of opportunity among market participants, we offer a short list of high-priority initiatives. All would face fierce political opposition — but change in the face of difficult odds is what leadership is all about.

True Tax Reform

Both equity and efficiency would get a big boost from the gradual elimination of tax preferences and deductions that distort markets and favor specific groups and households. One goal here would be to tax income at the same rate regardless of whether it arises from capital gains or ordinary income. Broadening the tax base in this way would make it possible to divert enough revenue to eliminate the separate levies to fund Social Security, Medicare and unemployment benefits, reducing current incentives to work less and employ less labor.

We would also propose — as Milton Friedman did — the flat-out elimination of the corporate income tax. Instead, corporate income tax liability would be proportionately allocated to shareholders, the way we tax partnerships now. This, by the way, would also greatly simplify the tax code and reduce the resources needed to enforce compliance.

Last but hardly least on the tax front, we would tax carbon emissions at the source — the smokestack, the pump, etc. — at a rate equal to the damage done by the emissions. This would serve three functions, making markets more efficient, slowing the pace of climate change and generating a lot of revenue that could be used to pare budget deficits or reduce taxes on capital and labor.

Universal Basic Income

The anti-poverty safety net in America is inefficient (it penalizes work), inconsistent (benefits vary greatly by locality) and stigmatizing (nobody wants to be on welfare). Substituting a “universal basic income” — say, $10,000 per year for every adult — would tackle all three problems, reducing disincentives to work, creating a uniform benefit and removing the welfare stigma. A UBI would go a long way, especially at lower income levels, in adjusting the balance of power in a market-friendly manner and reduce the size of government by eliminating welfare and support payments.

Public Education Reform

Revamping education, with an emphasis on basics that adults need to make informed decisions and on vocational training that is tied to labor market demand, would go a long way toward giving the bottom third of the income distribution the tools to hold their own in a society in which they have little economic or political voice. It would likely also increase the labor force participation rate, especially for those in their prime working years. We would especially emphasize vocational training for young adults of the kind that was so successful in integrating Germany’s two economies in the aftermath of reunification.

• • •

We’re aware that none of this would come easily, in no small part because it would undermine a power structure that is more successful operating in the zero-sum environment of the political marketplace than in the growth-oriented environment of competitive free markets. But think of the alternatives. The failure to address the encroaching problems of inequality fed by crony capitalism is unthinkable. And if not now, when?

main topic: Economy: U.S.
related topics: Social Safety Net, Tax Policy