The Middle Class and the Economy

In the next few months we will be hearing a lot about the economy; why the country is in the condition that it is in; whether or not improvements have been made; where we are going; and who can do the best job at recovery and a return to prosperity. 

There are two basic theories on how the economy works; Supply Side Economics and Demand Side Economics.  Supply side economics championed by the political right employs the Trickledown Theory in which the wealthy, or top five percent, drive the economy.  Demand side economics, championed by the political left, purports that the economy is driven by the demand created by the middle class.

Under Trickledown Economics, it is the belief that if the wealthy and businesses are taxed less, they will invest more in business infrastructure and equity markets.  This will, in turn, lead to more goods at lower prices and create more jobs for middle and lower class individuals.  The term “Trickledown Theory” was coined by Jack Kemp, borrowing from the old “Supply Side Theory” and the concept was employed by Ronald Reagan and known as “Reaganomics”.  In short they put into policy the concept that    “Tax Cuts for the wealthy will create jobs”   The Reagan Administration made additional cuts to business taxes, excise taxes, capital gains taxes etc.  David Stockman, President Reagan’s budget Director, championed the tax cuts originally but then quickly became skeptical of them after the effects of their administrations cuts were realized.

Data found in the National Income and Product Accounts, which are produced by the Bureau of Economic Analysis of the Department of Commerce, collected over the past fifty years shows that there is no statistical correlation between tax cuts and job creation.  Cutting the top tax rate does not lead to economic growth and does not lead to job creation. These cuts have been proven to only increase the deficit.

Reduced taxes for the wealthy, and equity investments can initiate economic conditions that may encourage a demand for products and services, thus stimulating job growth.  However, a demand component must be evident before job growth, can and will, take place.  Demand results in job growth which will, in turn, produce more demand. 

Remember from the first paragraph I have said that “Demand Side” economics postulates the theory that the middle class generates the demand that sparks and drives the economy.  So let’s look at the middle class and see who they are; 

A December 2010 issue of CBS News Watch defined Middle Claus households as having a median income of $50,000. And for married households was $71,830.  The Conservative PEW Research Center claims that 53% of the households are Middle Class.

Nick Hanauer, founder of the Seattle based venture capital firm Second Avenue Partners, and original investor in Amazon.Com, argues that having a clear sense of demand from a strong middle class is how businesses get a clear signal regarding profitable opportunities to invest in.

Mr. Hanauer states: “The conventional wisdom that the rich and businesses are our nations ‘job creators’ is false.  Only consumers can set in motion a virtuous cycle that allows companies to survive and thrive and business owners to hire.  An ordinary middle class consumer is far more of a job creator than I ever have been or ever will be.”

Nick Hanauer further points out that businesses and private equity investors will only invest if they are confident that they will be able to sell their products at a profit.  Families will not be able to make investments and create demand if they do not have sufficient income or are financially insecure.  The Center for American Progress, a bi-partisan non-profit think tank, points out that 86% of the U.S. economy comes from domestic demand generated by the middle class.

From 1947 to 1979, when the middle class received 54% of the nation’s total income on average, the economy grew at a rate of 3.7 % per year.  In the time frame of 1980 to 2010, the middle class received 46% of the income and the economy grew at only a rate of 2.7%.  America is becoming less of a middle class society. Income inequality has made us less trusting and less willing to make investment that others might benefit from.  Income inequality makes us less tolerant of government spending and thus less supportive for the needs of the public at large.

BusinessInsider.org tells us that 83 percent of US stocks are in the hands of 1% of the people.  In addition, 61% of Americans live paycheck to paycheck, up from 43% in 2007.  And ,most disturbing, Business Insider tells us that 66% of the income growth from 2001 to 2007 went to 1% of all Americans

If the economy is to get out of first gear, the American middle class is in need of a boost A temporary increase in the deficit may be necessary. However, in the long term, with an economy in a virtuous cycle of growth, the deficit will decrease.  Job creation will occur, demand will increase, consumer confidence will grow, and the housing market will again be strong The government will again be encouraged to fund social programs that benefit all of the people.

Paul Krugman, economist and New York Times columnist, says “such low taxes on the very rich are indefensible.  The economic record certainly does not support the notion that super low taxes on the superrich are the key to (American) prosperity”. During President Bill Clinton’s first term, 11.5 million jobs were created when the long term capital gains tax was 29%.

A boost to the middle class which will create jobs and economic growth could come from Government spending cuts in the form of reductions in the Department of Energy, National Institute for Health, and Department of Education, the functions and responsibilities of which should be State and local responsibility.  The application of an increased long term capital gains tax rate would provide an additional income and allow all citizens’s to share in the wealth of our nation’s output. 

Dick Desrosiers

Hampton