Let me just say that I am surprised. I have previously stated that Romney really needed to shine in the debate simply because Obama is a proven master orator. Well, Romney not only shined but in many instances controlled the debate. While the debate covered many issues from the economy to healthcare, in my opinion, the key to the economic future really comes down to one thing - jobs. In this regard I think that Romney clearly "got it."
Both Obama and Romney discussed lowering the corporate tax rate and closing the tax loop holes to make the U.S. more competitive globally on a taxing basis. However, the two were clearly divided when it came to taxes. Obama's mistake has been to aggressively focus on "big business" as the evil that plagues the American economy - yet ignores the impact that his tack will have on the small business enterprises that create more than 2/3rds of all the jobs in the country.
Obama kept repeating that we need to go back to the tax rates that existed during the Clinton administration. Obama's argument is that during Clinton's term the economy created 28 million jobs and the government ran a surplus. That is a true statement if taken solely at surface value. However, the economic environment at that time was vastly different. During the late 90's the economy was driven by a revolution in technology and finance. The economy was surging on the back of falling inflation, declining interest rates, and surging consumer debt which instilled a belief that the "good times would never end." This euphoria gave birth to excess job creation as businesses ramped up operational capacity to fill the never ending future needs that were surely coming. Unfortunately, those excesses have come back to haunt us horribly.
Today, there is no massive innovation ramp occuring. Interest rates and inflation are already exceedingly low, regulations on business are on the rise, the consumer is wrestling with a balance sheet recession and the finance market is in contraction mode. Simply put the economic environment today is exactly the opposite of the wave that Clinton was able to ride on during his administration. The economy was able to survive a tax increase at that time due to the perceived economic strength.
The chart below shows the corporate tax rate versus employment back to 1946. There are two big things to note about this chart. First, the corporate tax level creates employment change at the margin. If you look at the chart you will notice that when corporate tax rates are reduced - employment increases, and vice versa, initially.
However, employment adjusts over time to respond to the strength and direction of the economy rather than the movements in tax rates. The chart below shows economic growth versus employment.
Do not misunderstand me. Tax rates do make a difference in the short run particularly when coming out of a recession as it frees up capital for productive investment. However, in the long run, it is the direction and trend of economic growth that drives employment. The reason I say "direction and trend" is because, as you will see by the vertical blue dashed line, beginning in 1980 both the direction and trend of economic growth in the United States changed for the worse.
As the next chart shows, as economic output declined - the consumer turned to debt to sustain their standard of living which reduced personal savings and productive investment. The Austrian Business Cycle Theory predicted that the current economic malaise would be caused by "...the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings."
In other words, the proponents of Austrian economics believe that a sustained period of low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. Low interest rates tend to stimulate borrowing from the banking system which in turn leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money and, therefore, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities. Finally, the credit-sourced boom results in widespread malinvestments.
Does any of this sound familiar? This is why the economic "boom" of the 80's and 90's was really not much more than a debt driven illusion that has now come home to roost. (More discussion on this problem here and here)
It's Jobs Stupid
What Obama has clearly failed to grasp is that the state of the current economy is more akin to that of the "Great Depression" rather than the Clinton era. Obama wants to increase tax revenue by raising taxes. The problem is that by raising taxes, which there are 22 new or higher taxes starting next year from ObamaCare that will directly impact the middle class, is that it reduces the real disposable incomes of families which is on the decline. Personal savings rates are already near historic lows and consumer debt is near its all-time peak.
Romney, however, understands that by focusing on job creation first that higher tax revenue will come later. Not surprisingly when employment has increased federal receipts and economic growth have followed. With an economy that is currently greater than 70% based on consumption - higher levels of employment leads to higher levels of consumption.
Consequently, increasing taxes on "the rich" has the exact opposite effect. In a weak economic environment, where aggregate end demand is low, businesses remain on the defensive. Increasing productivity to suppress employment and wage growth, combined with extensive cost cutting, are the primary weapons of choice to protect profitability. By threatening to increase taxes, or actually doing it, businesses and individuals become more defensive in order to combat higher taxation which reduces consumptive capabilities and stifles end demand.
The chart above shows the top marginal tax rate (the rate that the rich would pay) going back to Calvin Coolidge. There are two important points to be made: 1) Tax rate adjustments have a very limited impact on economic growth as the economy very quickly absorbs and adjusts to the rate and; 2) tax revenue is much more correlated with economic growth. The first point is critical. When tax rates are adjusted, either up or down, there is an immediate, but brief, reaction to the adjustment. In every instance where tax rates were increased - tax revenue and domestic growth were negatively impacted as businesses and individuals adjusted spending to accommodate for lower incomes. Secondly, as I stated, tax revenue growth is much more closely associated with economic growth as shown in the next chart.
It will surprise most people that over the last 50+ years regardless of the level of tax rates - tax receipts as a percentage of GDP have remained mired between 16 and 21%. Why? Because when you raise taxes; you lower economic growth and less revenue is collected. When economic growth slows, or slides into a recession, tax revenue also slows. This is why during recessions tax collections are at the lowest and during periods of economic growth they are at their highest.
While the current administration continues to demonize "the rich" for not paying their fair share - the real culprit is the administration itself. The continued lack of actions to provide fiscal policy measures to promote economic growth, a health care plan that has guaranteed higher taxes in the coming year and continued expansions of federal debt to GDP continues to stifle both economic and employment growth. With the level of federal debt rising - the increasing levels of debt service continues to rob from future economic growth as revenue is diverted from productive uses.
The chart shows the Federal Debt to GDP overlaid with tax revenue and economic growth. When debt to GDP was on the decline both economic growth and tax revenue were on an increasing trend. However, as debt to GDP began to climb the economic growth rate began to deteriorate.
Today, what is not understood by the current administration, is that we are mired in a "balance sheet" recession. The deleveraging process is compounded by a sub-par growth economy and high levels of unemployment. Dependency ratios on government welfare incentivizes individuals to be less productive leading to lower productivity and reduced demand.
It is this lack of final demand from consumers that keeps businesses from creating jobs or expanding. The NFIB (National Federation of Independent Business) has continually reported that "poor sales" are a major concern of those surveyed. Furthermore, those saying this is a good time "expand" their businesses remains at recessionary levels. This isn't the type of backdrop that you need to create jobs or economic growth which would increase tax revenue for the government in a "healthy" manner. Raise taxes in this type of environment and you guarantee that economic growth will be reduced even further.
Romney clearly understands this issue and made his point abundantly clear. More importantly it rings home with the voters who are the average middle class Americans that are struggling to make ends meet in an environment, at least for them, that is still mired in a recession.