The Boston Tea Party on December 16, 1773 was a powerful protest by a freedom-loving group called the Sons of Liberty against the British government’s decision to impose a tax—a tariff—on tea imported from China to the Colonies. The protestors opposed an arbitrary government action, which they saw as an infringement on their rights as Englishmen.
We know the story. England responded with violence, and the Revolutionary War was initiated. Later, after a long and costly struggle, a new nation was formed, one dedicated to the notion that ordinary people had the right to pursue happiness. Even, one might say, if that means buying a consumer good from China without paying an arbitrarily imposed tariff.
The preamble to the Declaration of Independence reminds us:
“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”
Yes, these beautiful words are well-known, but do we understand the full implication?
Thomas Jefferson, the Enlightenment thinker who penned them, saw this new nation as an experiment in liberty, one where free people—endowed by their creator with rights—could pursue happiness. And how might they go about doing so? By cooperating and engaging in mutually beneficial exchange in the world’s marketplace. These free people would not be inhibited by government, but assisted by it in their happiness pursuits.
Mr. Jefferson explains:
“That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.”
Somehow, much of this seems to be forgotten. A November 6 Wall Street Journal story tells us that just in the month of September, the United States “collected a record $7 billion in import tariffs … as new duties kicked in on apparel, tools, electronics and other consumer goods from China.” Tea is not mentioned.
Seen through the lens of Enlightenment thinking as reflected in the Declaration of Independence, the $7 billion tariff revenues are a tax on the right of ordinary Americans to pursue happiness. To the extent that the current tariffs represent undebated actions taken by the executive branch of government—no taxation without representation—the tariffs are a tax on freedom and should therefore not be allowed to stand.
Yes, all this seems to be forgotten. Instead of talking about happiness, we hear discussions of another country’s arbitrary regulatory policies, which some dislike. So now, we have imposed freedom taxes on timber from Canada, steel and aluminum from France and Germany, and yes, on consumer goods and more from China.
Freedom goes down when tariff revenues go up. It’s high time we revisited the Declaration of Independence and renewed our commitment to freedom.
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AIER’s Leading Indicators index held steady in October, remaining slightly above neutral. Slow growth continues as economy remains vulnerable.
AIER’s Business Cycle Conditions Leading Indicators index was unchanged in October, staying slightly above neutral at 54. The Roughly Coincident Indicators index rose to 92 while the Lagging Indicators index remained unchanged at 67 for the third consecutive month (see chart).
Third quarter real gross domestic product rose at a modest 1.9 percent rate, slightly below the 2.0 percent pace of the second quarter. Over the last four quarters, real gross domestic product is up 2.0 percent, the slowest pace since 2016. Consumer spending accounted for the entire gain in real gross domestic product in the third quarter as other sectors had small offsetting contributions.
A strong labor market remains the primary support for consumer spending and consumer confidence. Uncertainty about trade policy, monetary policy, immigration policy and fiscal policy has the potential to undermine consumer and business confidence. Furthermore, extreme partisanship in Washington is likely to worsen as impeachment proceedings ramp up and the 2020 election cycle gains momentum. Overall, the economy continues to expand but at a slow pace, and remains vulnerable to continued erratic policies and extreme partisanship.
Leading indicators index remains slightly above neutral in October
The AIER Leading Indicators index suggests continued economic expansion, but caution is warranted.
The AIER Leading Indicators index was unchanged at 54 in October. The index has been range bound between 25 and 75 for 11 consecutive months, posting an average over the period of 47. Fluctuating around the neutral 50 level is consistent with the overall mixed performance of many economic reports. The general message is continued economic expansion albeit at a slow pace and with a heightened degree of uncertainty.
The tally of the leading indicators was the same as the prior month. Six of the 12 leading indicators had positive trends in October, with 5 trending lower and 1 indicator was neutral. However, three indicators changed direction with offsetting impact on the final index. Positive trends were seen in real retail sales and food services, real new orders for consumer goods, total heavy-truck unit sales, real stock prices, the 10-year–1-year Treasury yield spread, and housing permits. Among those, the positive trend in total heavy-truck unit sales was an improvement over the prior month when that indicator was in a down trend.
A neutral result came from initial claims for unemployment insurance. This indicator was in a favorable trend in the prior month. Initial claims for unemployment insurance is a bound indicator, meaning it can not go below zero and in practical terms is about as low as can be expected. Therefore, it’s not surprising to see the indicator move to a flat trend. It’s not as worrying to see this indicator move to neutral compared to an unbound indicator such as sales or orders. If the initial claims indicator turns to an unfavorable trend, it will be more concerning.
Debit balances in customers’ margin accounts moved to a downtrend in October, joining real new orders for core capital goods, the ratio of manufacturing and trade sales to inventory, the University of Michigan index of consumer expectations, and the average workweek in manufacturing.
Overall, the Leading Indicators index remains slightly above 50, indicating continued expansion is likely. However, the fluctuation around the neutral level over the past 11 months combined with the other mixed economic data and erratic policy suggest a high degree of caution is warranted.
The roughly coincident indicators index rose to 92 in October from 83 in September. The industrial production indicator improved from a negative trend to a neutral trend in the latest month. The improvement may be short-lived as other data suggest a very difficult environment for the manufacturing sector. Overall, there were five indicators trending higher and one, industrial production, now neutral.
AIER’s Lagging Indicators index was also unchanged in the latest month, holding at 67 for the third consecutive month in October. The index has been above neutral for four months following a pair of 42 readings in May and June. Among the six lagging indicators, four indicators are trending higher, two are trending lower, and none are neutral.
The economy slowed in the third quarter
Real consumer spending was the only major contributor to third quarter growth.
Real gross domestic product rose at a 1.9 percent annualized rate in the third quarter, down from a 2.0 percent pace in the second quarter. Growth was driven primarily by a moderate gain in consumer spending. Housing investment and government spending made small positive contributions while business investment, net trade, and inventory change made small negative contributions in the calculation of gross domestic product.
Consumer spending decelerated in the third quarter, rising at a moderate 2.9 percent pace compared to a 4.6 percent growth rate in the second quarter. The deceleration was broad-based across the major segments of consumer spending, with durable-goods spending rising 5.5 percent versus 8.6 percent in the second quarter, nondurable-goods spending up 4.4 percent versus 6.5 percent, and services gaining 1.7 percent versus 2.8 percent. Consumer spending contributed all 1.9 percentage points of the 1.9 percent real GDP growth rate versus 3.0 percentage points in the second quarter.
Investment in business structures and equipment fell
Business fixed investment fell at a 3.0 percent annualized rate in the third quarter versus a 1.0 percent pace of decline in the second quarter. At annualized rates, the drop was led by a 15.3 percent fall in spending on structures while spending on equipment declined 3.8 percent. Investment in intellectual property products rose 6.6 percent continuing a run of 11 consecutive quarters of growth. Real business investment deducted 0.40 percentage points from overall real GDP growth versus a 0.14 percentage-point deduction in the second quarter.
Housing posts a gain
Residential investment, or housing, rose at a 5.1 percent pace in the third quarter compared to a 3.0 percent decline in the prior quarter. The gain breaks a string of six consecutive declines for residential investment. Housing had benefited from a drop in mortgage rates over recent months. However, future activity continues to face a challenging environment with interest rates starting to rise again and home prices continuing to rise, albeit at a slowing pace.
Altogether, business and residential investment declined at a 1.3 percent pace in the third quarter, subtracting 0.22 percentage points from total GDP growth compared to a 0.25 percentage-point deduction in the second quarter.
Inventories and trade had little impact in calculation of GDP
The pace of inventory accumulation by businesses was little changed in the third quarter, slowing to a $69.0 billion pace in real terms, from $69.4 billion in the second quarter. The decelerating in inventory accumulation reduced real GDP growth by .05 percentage points in the third-quarter after subtracting 0.91 percentage points in the prior quarter.
Net trade also had a small negative impact in the calculation of overall GDP growth in the third quarter, subtracting 0.08 percentage points. Exports rose at a 0.7 percent pace while imports grew at a 1.2 percent rate. The outlook for trade remains highly uncertain given erratic trade policy and slowing global growth.
Government Spending rose
Government spending rose at a 2.0 percent annualized rate in the third quarter compared to a 4.8 percent increase in the second quarter, contributing 0.35 percentage points to growth versus a 0.82 percentage-point contribution in the prior quarter. Government spending rose in nearly every category, with federal defense spending up 2.2 percent, federal nondefense spending up 5.2 percent, and state and local spending up 1.1 percent. Exploding federal deficits remain one of the most significant risks to the medium- and long-term outlook for the economy.
The labor market has softened
Job creation has slowed, and openings have fallen recently.
Job creation was better than expected in October and disappointing gains in September and August were revised higher. Furthermore, October employment was held down by the strike at General Motors. Overall, job gains over the past few months appear significantly stronger than initially estimated. However, the pace of gain is still slower than the strong gains in 2018.
U.S. nonfarm payrolls added 128,000 jobs in October, after an increase of 180,000 new jobs in September and 219,000 in August. Government census workers helped boost August and September payrolls.
For the private sector, nonfarm payrolls added 131,000 in October following a gain of 167,000 in September and 163,000 in August. October private payrolls were also held down by 46,000 striking workers at GM. With those workers included plus the upward revisions to prior months, the three-month average gain for private payrolls was 169,000, a solid result but well below the 215,000 average for 2018.
Goods-producing industries lost 26,000 jobs in October. Construction led on the upside with the addition of 10,000 new employees, while durable-goods industries lost 41,000, though 46,000 were striking workers who will return to payrolls in November.
Within private service-producing industries, which typically account for the lion’s share of job creation, payrolls rose by 157,000 workers, led by a 61,000 gain in leisure and hospitality industries. Health care and social assistance added 34,200, while professional and business services posted a gain of 22,000 jobs. Financial services added 16,000 and retail employment rose by 6,100. Information industries eliminated 4,000 positions.
Public sector employment fell by 3,000 in October after adding 130,000, or an average of 32,500 per month, over the prior four months.
Average hourly earnings rose 0.2 percent in October, pushing the 12-month change to 3.0 percent, down from a cycle peak of 3.4 percent in February. Combining payrolls with hourly earnings and hours worked, the index of aggregate weekly payrolls rose 0.3 percent in October and is up 4.3 percent from a year ago. This index is a good proxy for take-home pay and has posted relatively steady year-over-year gains in the 3 to 5 percent range since 2010 but has now been decelerating after hitting a 5.7 percent pace in January. Continued gains in the aggregate-payrolls index are a positive sign for consumer income and spending, and are likely to support continued economic expansion.
Federal government deficit worsened in latest fiscal year
Worsening deficits are unprecedented at this stage of an economic expansion. Rising debt may be a disaster waiting to happen.
The federal government continues to run massive deficits. For fiscal year 2019, the deficit totaled $984 billion, $205 billion more than in the prior fiscal year, a 26 percent jump. As a percentage of gross domestic product, the federal deficit for fiscal year 2019 totaled 3.8 percent, the third consecutive year of worsening and the worst deficit since 2013. The deficit as a percentage of gross domestic has never worsened for three straight years this late in an economic expansion.
Total public debt outstanding as October 31, 2019 was $23 trillion, the highest ever. The latest projections by the Congressional Budget Office show deficits are expected to continue to run between 4.5 and 5.0 percent of gross domestic product every year over the next 10 years, adding significantly to total debt outstanding and increasing interest expense.
Health care spending continues to rise
Total spending on health care is estimated to be $3.6 trillion in 2018, a 4.4 percent increase over 2017. Projections from the Center for Medicare and Medicaid Services show spending is expected to average 5.5 percent through 2027, pushing the share of gross domestic product from 17.9 percent in 2017 to 19.4 percent in 2027.
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As the debate over wealth taxation rages on, journalists have assumed a central role in the dissemination of empirical claims about the distribution and historical trajectory of U.S. tax policy. Unfortunately several leading media outlets have approached this task by engaging in political advocacy on behalf of Elizabeth Warren and Bernie Sanders’ tax plans, sacrificing factual accuracy in the process.
A recent statement by the New York Times editorial board reveals just how politically distorted the coverage has become.
Promising to set “a few things straight” about wealth taxation, the Times advanced an astounding claim:
“The wealthiest Americans are paying a much smaller share of income in taxes than they did a half-century ago. In 1961, Americans with the highest incomes paid an average of 51.5 percent of that income in federal, state and local taxes. In 2011, Americans with the highest incomes paid just 33.2 percent of their income in taxes, according to a study by Thomas Piketty, Emmanuel Saez and Gabriel Zucman published last year. Data for the last few years is not yet available but would most likely show a relatively similar tax burden.”
As with previous editorializing by the Times, this piece relied upon controversial empirical work by Piketty, Saez, and Zucman. Over the last several weeks this group of left-leaning economists has cluttered the U.S. tax debate with a veritable French “Reign of Error” of deeply misleading and perhaps intentionally manipulated statistics to prop up the case for the Warren tax plan. By continuing to rely upon the PSZ triumvirate without acknowledging the substantial criticisms of their data, the American press has ventured into the territory of journalistic malpractice.
But the Times’ most recent editorial took this ongoing politicization of economic data reporting even further, giving a false impression that tax rates on the wealthy have dropped by over 18 percentage points in the last 50 years.
The Times did so by cherry picking its numbers from the 2018 iteration of the PSZ statistics in the Quarterly Journal of Economics, which is less controversial than newer revisions released by Saez and Zucman. This study at least has the benefit of having undergone peer review, and attempts to estimate the overall tax rate of the top 0.1% of earners over time.
The problem with the Times’ accounting arises from the years they chose to bookend their claim, 1961 and 2011.
Let’s consider each in turn.
First, their 1961 figure purporting to show a rate of 51.5% on the top 0.1% of earners comes from a section of the PSZ study that is almost certainly unreliable. In 1962 the IRS introduced microdata reporting of its tax statistics – a more refined set of numbers that allows researchers to dig deep into distributional questions about the federal tax burden. No such numbers existed however in 1961, which means the PSZ study had to rely on a series of imputations taken from an older estimate of the income share distribution published by Piketty and Saez in 2003.
Yet as my own investigation of these data has shown, the older Piketty-Saez 2003 study is marred by several data quality issues prior to the introduction of IRS microdata in 1962. It systematically overestimates top income shares across the board from 1917 to 1961 by erroneously adjusting for tax code discrepancies in this period, and by underestimating the total amount of tax-eligible income earned in each year. It is therefore unreliable to use as a baseline for estimating top tax shares.
We may see this problem directly in the PSZ-2018 numbers where a clear discontinuity exists. According to the PSZ series, the average total tax rate on the top 0.1% dropped from 51.5% in 1961 to 43.6% in 1962, even though the main federal tax rates were not changed during those years. Indeed, from 1950 to 1961 the PSZ estimates consistently place this rate around 50%, whereas after the microdata estimates become available it drops instantaneously to the low 40s.
By selecting the last year before the better microdata files became available, the Times thereby artificially inflates the tax rate paid by top earners in this period.
Second, turning to 2011 reveals that it is an equally bizarre choice for the Times to use while bookending its argument. Contrary to what the editorial claimed, 2011 is not the most recent year with available data – 2014 is. And further contradicting the Times’ argument, the PSZ statistics for 2014 show a higher tax rate on the wealthy (39.8%) than the 2011 number (33.2%) quoted in the editorial.
The reason for the discrepancy may be found by digging deeper into the underlying data. 2011 reflected a temporary trough in overall effective tax rates across the board, likely attributable to the wake of the 2008 financial crisis and recession.
These events appear to have disrupted the normal revenue yields from capital gains taxation, which is historically sensitive to business cycle events. As a result, the overall tax rates paid by the wealthy temporarily dipped from 2009 to 2012. In 2013 they returned to their pre-recession norm of about 40%, as the highlighted image below from the PSZ data files shows.
Source: Piketty-Saez-Zucman (2018) data appendix file
In short, the Times appears to have selected 1961 and 2011 to create the illusion of an 18 percentage point decline in the average overall tax rate paid by the wealthiest earners. The actual decline, measured from the earliest microdata year 1962 to the most recent available year in 2014 shows a top average tax rate change from 43.6% to 39.8% – or only 3.8 percentage points in 50 years.
We may see further evidence of the severity of the Times’ misleading portrayal by looking to how top rates held up over the last half-century. For his own part, Zucman recently tried to lend credibility to a Times-style contention by tweeting claims of a dramatic double-digit drop in tax rates over this same period.
In reality, even the PSZ estimates reveal only an exceedingly modest cut in taxes on the top earners during this period.
Let’s consider the average top tax rate for the two decades prior to 1980 – the year Ronald Reagan was elected, allegedly portending a dismantling of the progressive tax system according to the Times, Saez and Zucman, and Elizabeth Warren. From 1962 to 1980 the overall tax rate on the wealthiest earners averaged 43.1% per year.
Compare that with more recent decades. From 1981 to 2014 the rate on the same category of earners averaged 38.6%. And if we further limit that group to just the period between 2000 and 2014, it averaged 37.7%.
So according to the PSZ series used by the Times, overall tax rates on the wealthiest earners did decline in the last half-century – but only slightly. The tax cut amounted to no more than about six percentage points, or less than a third of what the Times editorial board claimed.
When debating tax policy it is important to use empirical evidence to inform the discussion of what rates the top earners currently pay and what rates we would like them to pay, or if a rate change is even warranted at all. We cannot have that discussion, however, when academics such as Saez and Zucman put their fingers on the scale of their own measurements, and when top journalism outlets that claim to be papers of record present such blatantly distorted and politicized picture of what the empirical evidence reveals.
Phil Magness is a Senior Research Fellow at the American Institute for Economic Research. He is the author of numerous works on economic history, taxation, economic inequality, the history of slavery, and education policy in the United States.