Courtesy Reuters

What Occupy Wall Street Gets Wrong About Inequality

A Better Way to Think About the Bailout, Jobs, and Taxes

The protestors taking part in the Occupy Wall Street demonstrations around the country, despite their disparate backgrounds, seem to have settled on a recurring theme: fairness. It is not fair that Wall Street employees got a bailout and still have their jobs while so many workers in the United States have neither. It is not fair that the rich are not taxed at higher rates. It is not fair that some people are far richer than others.

Complaints about the bailout and jobs are ironic, because it did not have to be this way. Indeed, it is a tribute to the bad execution, not the bad intent, of policy that the Occupy Wall Street movement exists in the first place.

In 2008, when it was first conceived, the Toxic Asset Relief Program (TARP, now simply referred to as "the bailout") was supposed to save jobs across the economy -- not by bailing out banks but by solving the problem of toxic assets, the mortgage-backed securities at the heart of the financial crisis. This did not mean handing taxpayer dollars to banks. At the time, Senator Christopher Dodd (D-Conn.), then the chair of the Senate Banking Committee, called the proposal "stunning and unprecedented in scope and lack of detail." He went on, "It would allow the Secretary of the Treasury to intervene in our economy by purchasing at least $700 billion of toxic assets. It would allow the Secretary to hold on to those assets for years and to pay millions of dollars to hand-picked firms to manage those assets." Notice that there is no mention of a bailout: the focus was not banks but toxic assets anywhere in the system.

Congress held hearings to consider the TARP proposal, during which Henry Paulson, then Secretary of the Treasury, testified that "the $700 billion program we have proposed is not a spending program. It is an asset purchase program, and the assets which are bought and held will ultimately be resold, with the proceeds coming back to the government." Ben Bernanke, chair of the Federal Reserve, concurred, saying, "The Federal Reserve supports the Treasury's proposal to buy illiquid assets from financial institutions."

At the time, I was the director for domestic and economic policy for John McCain's presidential campaign; I remember the words, intentions, testimony, legislative language, press releases, and promises that Bush administration officials made as to what the Treasury Department needed to counter the shock to the economy. In short, they said that the Treasury Department needed to buy toxic assets to stop the free-fall, not to direct infusions of taxpayer money into the banks that were teetering on collapse.

But this, unfortunately, is exactly what happened. Shortly after TARP was passed into law, Paulson abandoned purchases and elected to direct equity injections into banks. The bailout began. And once the Obama administration took office and Timothy Geithner became Treasury Secretary, Washington announced plans to address toxic assets but then abandoned them. In short, TARP was hijacked by Paulson and Geithner and turned into a bailout for bankers, with no discipline for either the banks or the bankers. This unfairness of bailouts was not the original intention.

Similarly, unemployment -- another central grievance of Occupy Wall Street -- did not have to be so dismal. The 2009 stimulus bill was poorly crafted, with few "shovel-ready" infrastructure jobs, too much waste, and a bevy of ineffective pet programs. In the aftermath of the stimulus, the Obama administration took its eye off job creation and instead prioritized its social agenda (health care reform), green objectives (Waxman-Markey and EPA regulations), labor priorities (National Labor Relations Board agenda), and other legislative and regulatory initiatives that were damaging to economic growth. And as the coup de grâce the administration placed the U.S. government on a dangerous, explosive debt trajectory that invites a return to the worst days of the financial crisis.

The Obama administration should have pushed for reforms to existing tax policy that would have created incentives for businesses and entrepreneurs to base their operations in the United States and to spend at a faster rate on innovation, workers, repairs, and new plants and equipment.

The place to start is the corporate income tax, which harms the United States' international competitiveness in two important ways. First, the current 35 percent rate is far too high: when combined with state-level taxes, U.S. corporations face the highest tax rates among developed countries. The rate should be reduced to 25 percent or lower. Second, the United States remains the only developed country to tax corporations based on their worldwide earnings. Other states follow a territorial approach in which, for example, a German corporation pays taxes to Germany only on its earnings in Germany, to the United States only on its earnings there, and so on. If the United States were to adopt the territorial approach, it would place U.S. firms on a level playing field with their competitors.
 
Proponents of the worldwide approach used by the United States argue that because it does not let U.S. firms enjoy lower taxes when they invest abroad, it removes a possible incentive to send jobs overseas. Imagine two Ohio firms, they say: one invests $100 million in Ohio, the other $100 million in Brazil. The worldwide approach treats the profits on these two investments equally -- both are taxed at U.S. rates -- giving the company that invests in Brazil no advantage over its competitor that invests in the United States.
 
But this line of reasoning is misguided and out of date. For starters, because firms all over the world pay lower taxes than the two Ohio-based companies, the likeliest outcome is that both firms would have trouble competing with global rivals. Moreover, when U.S. multinational firms invest in and expand employment abroad, they tend also to invest in and expand employment in the United States. In the end, healthy and competitive firms grow and expand, while uncompetitive firms do not. Washington's goal should be to make sure that U.S. companies do not end up overtaxed, uncompetitive, and eventually out of business. And finally, because the United States is the only holdout still using a worldwide approach, it is less attractive as a headquarters for large global firms. As the United States loses these headquarters, it will also lose the employment, research, and manufacturing that are typically located nearby.
 
Related to their grievances about both jobs and taxes -- and indeed, to the very notion of fairness as they see it -- the Occupy Wall Street protesters would like to deal with the fallout of the economic collapse by having the rich pay higher taxes. After all, the incomes of the country's wealthiest have continued to rise when much of the labor force is idle. Moreover, they say, the wealthy get much of their current income in the form of capital gains, which are more lightly taxed.
 
But these arguments ignore the fact that capital gains are already taxed once, when the income is originally earned. And beyond that, the arguments of Occupy Wall Street are especially misleading because they focus only on annual tax payments and ignore the larger picture of federal finances.
 
The largest tax that most Americans pay each year is the payroll tax, which is dedicated to funding Social Security and Medicare. The vast majority of them will get much more out of these programs than they will ever pay in. In effect, these individuals are subsidized by the payroll and income taxes of the remainder of U.S. taxpayers.
 
More important, they get their federal government for free. Everything the country's original framers envisioned for the federal government -- national security, infrastructure, basic research, and so on -- is paid for largely by income taxes. Nearly one half of Americans pay no income tax, and the top five percent pay well over 50 percent of the income taxes.
 
Put another way, when a tiny fraction of Americans is paying for many of the federal services that every American enjoys, why is it fair to make them pay even more? Stepping back further, the major injustice is not who pays what tax rate but that, unless the United States changes course, future generations will inherit broken social safety-net programs, enormous debt, and a crippled economy. Focusing the fairness debate on the income taxes of a handful of Americans simply distracts from the greater injustices in federal fiscal policy.
 
Finally, some in the Occupy Wall Street movement and its sympathizers question the fundamental fairness of the capitalist system. And indeed, regardless of whether one focuses on the well-being of the least affluent (caring about the social safety net) or on the gap between them and the rich (caring about inequality per se) there is legitimate concern for the outlook for the bottom of the U.S. income distribution.
 
The solution, however, is to rely more on capitalism. The seminal economic event of the early twenty-first century is not the financial crisis and the recession but the entry to the global labor market of billions of workers in China, India, and elsewhere. The simplest economics suggest that this added competition will lower the relative market earnings of unskilled laborers and raise the return to higher-skilled workers and capital investment.
 
This is bad news for poor wage-earners and an advantage to those with human and financial capital. Progressives have reacted by calling for pure redistribution, empowering unionized labor, or attempting to close U.S. borders to the flows of goods, capital, and labor. But global market forces will overwhelm such ill-conceived government attempts to reverse economic fundamentals.
 
A better strategy would be to harness those very market forces by building human and financial capital. Fundamental reforms to the K-12 education system that would emphasize parental choice and reward teacher performance would be a good place to start; among other pluses, Republicans and Democrats now agree on the basic merits of such changes.
 
But Washington will also need a more thoroughgoing focus on building human capital at every stage of a person's career.
From a budgetary perspective, the United States should not only rein in the over-promises of existing entitlements but also reverse the underlying strategy of focusing more on a person's needs at the end of life than at the beginning. Instead of just providing entitlements for retirement income, health care, and elder assistance, the U.S. government should prioritize entitlements for pre-K schooling, primary education, nutrition, and preventive care.
 
Similarly, the U.S. government should move away from making unemployment insurance, food stamps, and other low-income programs conditional on low cash flows. Instead, it should integrate those programs with individual accounts that can be managed to accumulate wealth. Such a structure would provide strong incentives for reliance on work and on a timely exit from support.

Occupy Wall Street may be right about one thing: fairness is and should be at the heart of debate over financial policy and economic well-being. But the solution to these questions of fairness -- and to the United States' economic woes -- is to use the capitalist system, not to destroy it.

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