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After the deficit reduction supercommittee, back to school

Now that the Deficit Reduction Supercommittee has apparently failed to reach a consensus on how to cut the trillion-dollar federal budget deficit, the field is open for new ideas.  Locking six Republicans in a room with six Democrats was never going to be a very good way to solve the country’s economic problems.  Much better to go back to school.

The solution to our current situation can be found in any first-year economics textbook.  Think of it as a final exam question.  You’ve just finished a semester of Economics 101.  Your professor gives you the following scenario.

A country has extraordinarily low taxes on its wealthy citizens.  It’s wealthy citizens are wealthier than at any time in history.  Its poor and working-class citizens, however, are suffering from low wages and high levels of unemployment.  They haven’t had a raise in 40 years and now their unemployment rate is over 10%.  The economy as a whole is stagnant.  What should the government do?

The solution is straightforward.  The government should raise taxes on the wealthy and use the money to employ the poor and working-class.  Tax and spend.  It really is that simple.

It all comes down to multipliers.  We know that taxing the rich tends to hurt the economy — just a little.  It only hurts the economy a little because rich people almost by definition have excess income that they don’t have to spend every month.  When they do spend their income, they spend it on luxury goods, which are often imported.  They don’t put a lot of people to work at your local nursing home or grocery store.  In economics-speak, taxes on the rich have a very low multiplier effect.

On the other hand, government spending can have a very high multiplier effect.  Increase the benefits paid to unemployed people, and they spend it immediately — on groceries, not on imported luxuries.  Hire additional nurses to care for the elderly and disabled and the multiplier is even greater.

For the highest multiplier effects, the government can make investments that directly contribute to the nation’s overall productivity growth, for example by paying for daycare workers so that mothers can more easily work outside the home or by paying for unemployed people to go back to community college to upgrade their skills.

By taking money out of the economy in a way that reduces employment a little (taxing the rich) and putting it back into the economy in a way that increases employment a lot (spending on jobs) government can rapidly reduce the unemployment rate.  This in itself will bring down the deficit by generating new tax revenue.  For additional deficit reduction, just raise taxes enough to more than cover the spending.

If it’s so simple, why aren’t we doing it?  Economics 101 isn’t very popular among the people with high incomes who lobby Congress (or, for that matter, sit in Congress).  Campaign contributors don’t need Economics 101 — they’re doing just fine under the current system.  As for economists: well, there’s no excuse for them.  They should read their own textbooks.

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Sydney-based globalization expert Salvatore Babones is available to speak on the Chinese economy (demographics, growth, technology), the Belt & Road Initiative, global trade networks, and Australia-China relations. Contact: