Special Report

Economic Growth and the Working Class

If the latter does not benefit from the former, there's no way for the Republican Party to escape political minority status.

By 7.9.08

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For decades, conservative Republicans could not consistently climb out of their political minority status based on their limited government philosophy alone. That changed fundamentally for the long run in 1980, when Ronald Reagan embraced supply-side economics and the Kemp-Roth tax cuts, and campaigned on a vision for robust economic growth. The focus on economic growth and tax cuts transformed national politics into at least a 50-50 battle between liberals and conservatives, and even majorities for Republicans and conservatives by the mid-1990s.

Some neoconservatives are now arguing that Reagan's success was based on his support for maintaining the New Deal rather than a devotion to small government ideology. But Reagan clearly communicated to every voter over and over throughout the 1980 campaign that his "national economic recovery plan" was based on four components -- tax cuts, spending cuts, removing unnecessary regulatory burdens, and sound monetary policy to stop inflation. That was all explicit, up front, and central. Reagan bowed only to pledge never to cut Social Security.

The economic growth component enabled Republicans to appeal consistently to a substantial majority of voters, because economic growth is the most progressive program possible. Growth is the most effective anti-poverty program in world history, shattering the whole notion of poverty over time. The Heritage Foundation publishes reports every year showing the standard of living of the poor in America today is comparable to the standard of living of the American middle class a few decades ago, and of the European middle class today.

Growth creates new jobs and rising wages that pull more and more of the poor out of poverty altogether, and more and more of the working class into the middle class. The poor in America today are almost all either recent low skill immigrants or those who dropped out of high school, bore out of wedlock children as teenagers, or suffer from alcohol or drug abuse. Over time, economic growth will pull these folks out of poverty as well.

Economic growth spreads broader and broader benefits across society. More rapid growth means more rapid development and wider use of breakthrough technologies such as the Internet. It means better health care and medical technology. It means more government revenue to help the poor enjoy these medical breakthroughs as well. It means more resources can be devoted to improving and maintaining the environment.

THIS PROCESS WAS was recently recognized by Barron's editorial page editor Thomas G. Donlan in his book, A World of Wealth: How Capitalism Turns Profit Into Progress. Donlan writes,

Two centuries ago, even a wealthy man such as George Washington did not have central heating. A hundred years ago, the indoor toilet, the electric light, and the telephone were found in only a few homes that could afford to install them. These inconveniences became middle class necessities and now are commonplace items in virtually every American home, even the poorest.

Donlan's no-nonsense book explains basic economics in terms the average person can understand. He starts by explaining,
There are two kinds of economists. Those who think the free market always works, except when the results don't suit them; and those who think the free market never works, except when the results do suit them. In my view, the free market always works. Whether the results suit me or you is a matter of taste....The best thing about economics is the free market, and the best thing about the free market is freedom.
This is why social goals can always be better achieved by peeling away big government burdens rather than adding new ones.

Donlan explains the process of economic growth starting with taxes, saying:

Oddly, if you really want to raise taxes on the rich, you should cut their tax rates the way Congress and President Bush did in 2001, 2002, and 2003. It sounds like a joke but it's the most sensible way to read the results of the Bush years in U.S. tax policy. After the Bush Administration and Congress reduced the top marginal `rates, the people with the highest incomes shouldered a larger share of the tax burden because they made so much more money....Of more importance, the expanding economy generated more revenue from income taxes, sales taxes, corporate income taxes, and social insurance taxes....By fiscal 2007, higher economic growth and lower tax avoidance covered the loss of revenue from lower rates.

But the Left argues that economic growth doesn't work anymore for low and moderate income workers, defined as the working class, and the poor. That is because in recent years wages seem to have stagnated among these workers. Historically, wages have grown when productivity has grown, but since 2000 continued productivity growth does not seem to have been reflected in rising wages for working people.

The Left has seized on this as an excuse for more government power, arguing that the market is obviously failing working people. But the Left offers this same response on every issue and development, including the weather (or more precisely its theories about the weather).

Unfortunately, some putative conservative intellectuals are now effectively taking this same position as well. They are arguing that conservatives and Republicans are losing their appeal to working class voters because of this wage stagnation. As a result, conservatives should drop their focus on limited government, free-market Reaganism, which, they say, is failing these voters. They should embrace instead a modern, big government conservatism with Republicans offering the working class government redistribution that will recognize their economic difficulties and their pain, and so win their votes.

How these intellectuals can fail to understand that this is socialism not conservatism is unfathomable. What they are saying is no more than that the free market has failed their politically favored interest group, but look at them in their central planning genius, they know the perfect government intervention to fix it.

THERE IS A REASON why wages for unskilled and lesser skilled labor have fallen behind in recent years. That is because the market for this labor is increasingly global, as modern technology allows the work forces of the emerging economies of China and India, and the liberated economies of the former Soviet bloc, to compete in the world market. This is a radical increase in the supply of basic labor, which naturally holds its price in terms of wages down. What should be surprising is that it hasn't had an even bigger effect.

But this is not a reason to abandon the free market. Quite to the contrary, this increased global competition means that there is even less margin for error, or big government fat and waste. We must adhere even more closely to free market policies, and seek even more ardently to maximize economic growth. This is the way, the only way, for American workers to keep earning the highest wages in the world.

In particular, for American workers to succeed in this global marketplace, we must equip them even more with the latest, the best, and the most in advanced, high-tech capital. Such capital investment, enabling workers to produce more, is the key to higher wages and incomes. Taking into account the huge increase in the global supply of basic labor, we need even more of this to get wages for the working class moving up again.

This means that we need even more urgently to rid our tax system of outdated, neo-Marxist, multiple tax burdens on capital investment. Every educated person needs to know by now that the biggest problem in our tax system is the multiple taxation of capital. The returns to a typical capital investment today are taxed once by the corporate income tax. If any of that return is paid to the stockholders, it is taxed again by the individual income tax. When the stock is sold, the returns to investment are taxed again by the capital gains tax. When the investor dies, the capital returns saved over a lifetime are taxed a fourth time by the death tax.

Then investment expenses are not treated fairly either. Every other business expense is deducted in the year it is incurred. But capital investment expenses must be deducted over many years according to arbitrary IRS depreciation schedules.

High tax rates are a problem as well. America now suffers the second highest corporate tax rate in the industrialized world, averaging about 40% counting state corporation taxes. The average in the European Union is now 24%, down from 38% 10 years ago. Ireland's corporate tax rate has now long been 12.5%, and Irish workers are progressing towards higher wages on average than American workers. Individual investors can also now find lower tax rates than America's top Federal rate of 35%

Facing this tax gauntlet, investors, at home and abroad, are not going to provide American workers with the latest, best, and most in capital equipment. If Ireland and Estonia offer tax systems that are more hospitable for capital investment, there is no reason why their workers cannot eventually earn more and enjoy a higher standard of living than American workers. We need a reformed tax system that taxes the returns to capital once at a single low rate, allows immediate expensing for capital investment, and maintains low rates for individual investors as well as wage earners.

ANOTHER ESSENTIAL WAY to maximize long-term economic growth is to reduce the soaring cost of energy for our economy. Plentiful, low cost energy supplies will naturally support higher economic output and growth over time than scarce, high cost supplies. But to achieve this result, we need to sharply reduce the wildly excessive regulation that is choking off our energy supplies. The government needs to allow us to drill for more oil and gas on the mainland, in the frozen, lifeless, dark, Arctic moonscape of ANWR, and offshore. It needs to allow us to build more refineries and nuclear power plants. The resulting sharply increased energy supply would reduce energy costs, with the same effect on our economy as a major tax cut.

To the extent we can reduce unnecessary government spending, that along with the resulting lower taxes would further boost our economy. And we need to restore sound monetary policies to short-circuit budding inflation. Contributing to that is the central planning ethanol boondoggle that is harmfully increasing food prices at home and abroad, while contributing much more to runaway government spending through ethanol subsidies than to solving our energy problems. Abolishing the Federal government's ethanol adventure would reduce inflation and unnecessary government spending.

These are the policies that would maximize our economic growth, and do the most to raise wages for the working class, and the poor, and everyone else. Remarkably, we are back to the Reagan economic recovery strategy of cutting taxes, cutting spending, deregulating, and restoring sound monetary policies.

In terms of politics, the working class would respond to such a vision for economic growth as it did in 1980, if the message is explained and driven home. Polls and focus groups show that working people would respond to such a message. When American voters are given a choice on election day between economic growth on one hand and redistribution on the other, they always choose growth.

IN ADDITION, Republicans and conservatives should emphasize their enormous achievement in abolishing income taxes on the working class and the poor. Again, the bottom 40% of income earners pay no income tax on net. Instead, they receive net payments from the income tax system. This started with Ronald Reagan's proposal for the Earned Income Tax Credit (EITC) in the 1970s. Another important factor was the Child Tax Credit proposed by the Heritage Foundation, now maxed out at $1,000 per child. The tax rate cuts over the years culminating with President Bush's 33% reduction in the lowest rate in 2001 hasve ended with this result. These policies have also cut the share of Federal income taxes paid by the true middle class, as well as minimizing income taxes for thethe middle 20% of all income earners,class as well atto less than 5% of all income tax payments, another major achievement that should be trumpeted.

Republicans and conservatives should emphasize as well that they next plan to phase out payroll taxes on the poor, the working class, the middle class, and everyone else, as well, replacing the tax instead with personal savings and investment accounts that would eventually take over payment of all the benefits that are financed by the payroll tax today. This would transform the payroll tax into an engine of personal family wealth for every family in America, an enormous achievement. Working class families would accumulate hundreds of thousands of dollars in such accounts by retirement, an historic breakthrough in the personal prosperity of working people. Those family funds would provide a new foundation for the future prosperity of working class children as well.

Republicans and conservatives should also promote the idea of eliminating state income taxes as well, on the poor, the working class, and everyone else. Nine states survive today perfectly well without any state income tax, including the large, prosperous, booming states of Texas, Florida, and Tennessee. Working people are voting with their feet by migrating to these states in large numbers, fleeing the high tax states. States without an income tax have higher economic growth, and higher growth in jobs, wages, and incomes.

Now that's an agenda to appeal to the working class. Add to that a pro-growth energy policy sporting lower prices for gas and electricity, the defense of traditional family values, and strong national defense policies that will keep families safe, and conservatives and Republicans should have more than enough appeal to win the votes of the working class.


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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.