Aftershock: The Next Economy and America’s Future

    Excerpt from Aftershock: The Next Economy and America’s Future, by Robert B. Reich (Vintage, 2010). Reprinted with permission from the author.

    From Part III: The Bargain Restored

    Chapter 1: What Should Be Done: A New Deal for the Middle Class

    I could have grounded my argument in morality: It is simply unfair for a handful of Americans to take home such a large share of total income when so many others are struggling to make ends meet. Or I could have based it on traditional American values: Such a lopsided distribution is at odds with the nation’s history and its ideal of equal opportunity—especially when the deck seems stacked in favor of those at the top. I could have talked about how this degree of inequality undermines the nation’s moral authority and its standing in the world.

    I have chosen instead to base my argument on two tangible threats that such inequality poses to everyone—including even the wealthiest and most influential among us. One is economic: Unless America’s middle class receives a fair share, it cannot consume nearly what the nation is capable of producing, at least without going deeply into debt. And debt on this scale is unsustainable, as we have seen. The inevitable result is slower economic growth and an economy increasingly susceptible to great booms and terrible busts. The other threat is political: Widening inequality, coupled with a growing perception that big business and Wall Street are in cahoots with big government for the purpose of making the rich even richer, gives fodder to demagogues on the extreme right and the extreme left. They gain power by turning the public’s economic anxieties into resentments against particular people and groups. Isolationist and nativist, often racist, and willing to sacrifice overall prosperity for the sake of achieving their ends, such demagogues and the movements they inspire can cause great harm.

    As I’ve shown, the Great Recession has accelerated both troubling trends. With the bursting of the housing bubble, many middle-class homeowners who can no longer use their homes as piggy banks must face the reality of flat or declining wages. The downturn also has forced—or given a ready excuse for—firms to increase profits by shrinking their payrolls, laying off millions of workers and reducing the pay of millions more. It has simultaneously induced firms to ratchet up the pay of their “talent”—the executives and traders who drive the profits. At the same time, the Great Recession has starkly revealed the political power of big business and of Wall Street. Both have been able to enhance their profits by exacting money and other favors from government—even from one under the nominal control of the Democratic Party.

    Unless these trends are reversed, the financially stressed middle class will not have the purchasing power to keep the economy growing. This will hurt even those who are well-off. A political backlash could generate a similar result, or worse. Margaret Jones and her Independence Party are fictional, but the anger on which she bases her appeal is not.

    I cannot pretend that the following measures would remedy these problems altogether, but they represent important steps. They would help restore the basic bargain. As such, they would fill the gap in aggregate demand, and would preempt a politics of resentment. Some of these reforms would be costly, but I suggest ways to pay for them so they would not increase the national debt. To the contrary, they are likely to produce a budget surplus. And because they would generate stronger and more sustainable growth than the policies we now have, they would shrink the debt as a proportion of the national economy in years to come. The costs of inaction are far greater. An economy functioning well below its capacity is a terrible waste of all our resources, especially of our people; a society riven by resentment is potentially unstable.

    A reverse income tax. The most immediate way to reestablish shared prosperity is through a “reverse income tax” that supplements the wages of the middle class. Instead of money being withheld from their paychecks to pay taxes to the government, money would be added to their paychecks by the government.

    A similar idea was proposed by the prizewinning economist Milton Friedman, and we now provide this for low-income workers through the Earned Income Tax Credit. The EITC has not only helped reduce poverty but has also increased the incomes of families most likely to spend that additional money, and thereby create more jobs. In 2009, the EITC was the nation’s largest anti-poverty program. Over 24 million households received wage supplements. Given what’s happened to middle-class incomes, the EITC should be expanded and extended upward.

    Under my plan, full-time workers earning $20,000 or less (this and all subsequent outlays are in 2009 dollars) would receive a wage supplement of $15,000. This supplement would decline incrementally up the income scale, to $10,000 for full-time workers earning $30,000; to $5,000 for full-time workers earning $40,000; and then to zero for full-time workers earning $50,000.

    The tax rate for full-time workers with incomes between $50,000 and $90,000—whether the source of those incomes are wages, salaries, or capital gains—would be cut to 10 percent of earnings. The taxes for people with incomes of between $90,000 and $160,000 would be 20 percent, whatever the income source.

    The yearly cost to the federal government of these wage supplements would be $633 billion. The cost of the tax cuts for middle-income families would be billions more. But these lost revenues would be replaced by the following two initiatives: a carbon tax, and higher taxes on the top 5 percent of incomes.

    A carbon tax. We should tax fossil fuels (coal, oil, and gas), based on how many tons of carbon dioxide such fuels contain. The tax would be collected at the mine or port of entry for each fossil fuel, and would gradually rise over time in order to push energy companies and users to spew less carbon into the atmosphere. (A yearly auction for the “right” to pollute under a certain maximum cap that tightened year by year would theoretically have the same effect and generate about the same amount of money—but only if permits were not handed out to politically powerful polluters free of charge or exchanged for imaginary and unverifiable “offsets” that a company might claim by, say, planting trees in Brazil.)

    If initially set at $35 per metric ton of carbon dioxide or its equivalent, such a tax would raise over $210 billion in its first year alone. By the time it reached $115 per ton, it would yield about $600 billion per year. The public wouldn’t pay this tax directly, but indirectly as the prices of goods rose in proportion to how much carbon was used in their production. For example, a tax of $115 per ton would add about $1 to the price of a gallon of gasoline and 6¢ per kilowatt-hour to the price of electricity.

    If the revenues from the carbon tax went into wage supplements, middle- and lower-income Americans would still come out far ahead. A carbon tax would have two additional advantages. First, it would push energy companies and businesses to invest in new ways to reduce greenhouse gases, and in lower-carbon fuels and products; it could thereby lead to the development of cheaper and more efficient sources of energy. Second, by stimulating such investments, the carbon tax would also boost aggregate demand.

    Higher marginal tax rates on the wealthy. In a nation facing a widening chasm between the very rich and everyone else, it is not unreasonable to expect those at the top to pay a higher tax on their incomes, from whatever source (wages, salaries, or capital gains). I propose that people in the top 1 percent, with incomes of more than $410,000, pay a marginal tax of 55 percent; those in the top 2 percent, earning over $260,000, pay a marginal tax of 50 percent; and those earning over $160,000, roughly the top 5 percent, pay 40 percent. These taxes, when added to the modest amounts contributed by taxpayers who earn between $50,000 and $160,000 under my plan, would raise $600 billion more than our current tax system per year. Added to the $210 billion generated by the carbon tax just in its first year, the total new revenues would be $810 billion initially and would increase as carbon tax revenues increased. These would more than pay for the income supplements and tax cuts I propose. I would use the surplus for additional initiatives listed in the following pages that require funding, and for reducing the federal deficit.

    Under my proposal, income from capital gains would be treated no differently from income derived from wages and salaries. Someone with a total income of between $50,000 and $90,000 would pay 10 percent, even if a majority of that income is from capital gains. That is substantially less than the 15 percent tax rate on capital gains today. By the same token, someone with a total income of several million dollars would pay a marginal tax of 55 percent on all income, regardless of how much of it came from capital gains. (The four hundred highest-income taxpayers in 2007, each with an average income of over $300 million, paid only 17 percent of their total incomes in taxes that year, because most of their incomes were treated as capital gains. This makes a mockery of the ideal of a progressive tax system.)

    Furthermore, these tax rates are not out of line with most of our history over the last century, during which time the nation’s productivity and overall economy grew quickly. As noted, from 1936 to 1980, the top marginal tax rate was 70 percent or more. Since 1987, the official top rate has remained below 40 percent, and the effective rate, after all deductions and credits, between 20 percent and 25 percent. Yet higher taxes on top earners have not correlated with slower growth, the claims of so-called supply-side economists to the contrary notwithstanding. During the almost three decades spanning 1951 to 1980, when the top rate was between 70 percent and 92 percent, average annual growth in the American economy was 3.7 percent. Between 1983 and the start of the Great Recession, when the top rate ranged between 35 percent and 39 percent, average growth was 3 percent.

    So-called supply-siders are fond of claiming that Ronald Reagan’s 1981 tax cuts caused the 1980s economic boom. There is no evidence to support their claim. In fact, that boom followed Reagan’s 1982 tax increase. The 1990s boom likewise was not the result of a tax cut; most of it followed Bill Clinton’s 1993 tax increase.

    My proposal is not a Robin Hood–like redistribution. The wage supplements and tax reductions I’m proposing for the middle class would enable them to spend more, and their spending would help move the economy to full capacity and sustained growth. Consequently, companies would enjoy higher profits, and the stock market would rise. Although the rich would pay higher taxes and thereby receive a somewhat smaller share of the economy’s overall gains, those overall gains would be much larger than they would be otherwise. Hence, richer Americans are very likely to come out ahead compared to where they were before—as they did during the Great Prosperity, when they paid substantially higher taxes but enjoyed the fruits of faster growth.

    A reemployment system rather than an unemployment system. The old unemployment insurance system was designed to tide people over until they got their jobs back at the end of a downturn. Nowadays, most job losers never get their jobs back, and the ranks of the long-term unemployed are extraordinarily high. People who are unemployed for long periods have difficulty getting back into the job market, and they drain family assets. High levels of long-term unemployed strain our social safety nets. What’s needed is a reemployment system that speeds and smoothes the way for those who become unemployed to find new jobs.

    One piece of such a reemployment system would be wage insurance. Any job loser who takes a new job that pays less than his or her former job would be eligible for 90 percent of the difference, for up to two years. After two years, many workers would have acquired enough on-the-job training to render them sufficiently productive to warrant wages nearly as high as the wages they formerly had on the job they lost. Wage insurance would speed the movement of laid-off workers into new jobs because it would induce them to take jobs that pay less rather than wait for ones that pay as much as the job that was lost. It would thereby save the costs of unemployment benefits and would generate added revenues as reemployed workers pay income taxes earlier than otherwise.

    For workers who need additional skills, income support of 90 percent of the former wages would be provided for up to a year while a worker is engaged full-time in approved training or education programs. Longer-term training has been shown to be more effective than short-term, especially when it gives people the basic tools they need to continue learning on the job. If job seekers choose to enroll in programs that prepare them for fields in which labor is likely to be in short supply, such as nursing or teaching, they would receive income support for an additional year of training and education. As participants acquire the kinds of skills that are rewarded in the new economy and fill positions for which there are labor shortages, we could all expect to reap the benefits of this program in the longer term through stronger economic growth, higher tax revenues, and less dependence on social safety nets.

    I estimate the total new costs of a reemployment system to be $3 billion a year over and above the $2.35 billion that the federal government now spends on unemployment insurance in an average year. In time, however, the costs of the reemployment system would drop as the skills of the labor force improved and the rate of long-term unemployment declined.

    Any remaining shortfall in revenues to cover this program would be made up by a severance tax on profitable corporations that lay off their workers. Under the current system, employers do not pay the social costs of layoffs—including additional unemployment benefits and the extra needs of families in distress. It stands to reason that companies would be less inclined toward layoffs if they had to pay these costs. What is needed is a one-time severance tax on any layoff equal to 75 percent of the full cost of the laid-off worker’s yearly salary, for all workers under the median wage, and 50 percent for all workers above it, up to 200 percent of the median. Such a tax would not only give employers more incentive to keep workers on, but would also help pay for the wage insurance and skill upgrades of the reemployment system.

    Excerpted from Aftershock by Robert B. Reich. Copyright © Robert B. Reich, 2010. All rights reserved.

    Robert B. Reich is Chancellor’s Professor of Public Policy at the Richard and Rhoda Goldman School of Public Policy at the University of California, Berkeley. He has served in three national administrations, most recently as secretary of labour under President Bill Clinton. In 2008, Time magazine named him one of the Ten Best Cabinet Members of the century, and The Wall Street Journal in 2008 placed him sixth on its list of the “Most Influential Business Thinkers”. He was appointed a member of President-elect Barack Obama’s economic transition advisory board. He has written thirteen books, including The Work of Nations, which has been translated into twenty-two languages, and the best seller Supercapitalism. His articles have appeared in The New Yorker, The Atlantic, The New York Times, The Washington Post, and The Wall Street Journal. He is also cofounding editor of The American Prospect magazine and provides weekly commentaries on public radio’s Marketplace. He lives in Berkeley and blogs at

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