The ideals of the revolutions in Poland, Hungary, Czechoslovakia, and even Bulgaria owe much to the American model, with its combination of political freedom and an economic system that seems to guarantee an ever-rising standard of living. It is important to recognize that it is a version of American political democracy, and not Japanese discipline or German efficiency, that the new leaders of these countries say they are striving for. Whether and how they will succeed is impossible to predict; their struggle will be long and may not always be peaceful. It is worth examining, however, whether the American system is all that they think it is, or whether they are seeing the light of a distant star which, some time ago, may have ceased to shine so brightly.
Clearly, military power is no longer the ultimate test of influence in the world. As the Soviet Union struggles simply to survive, the main competition for the US is no longer communist ideology or military expansion, but European and Japanese financial and economic power. The so-called American century lasted barely twenty-five years. We are still, in many ways, the richest and most powerful country in the world. However, since the mid-1970s, the competitive position of many of our industries has steadily eroded, our position as the world’s largest creditor has turned into the world’s largest debtor, and our dependence on foreign capital has become worrisome to many. It is ironic that, as one country after another seeks freedom from foreign domination, our own economic independence is more and more constrained as a result of our needs for borrowing.
Americans are smug in claiming that “we beat communism.” To some extent, the strength and steadfastness of the western Alliance account for the recent changes; but if the command economies have failed, our own experiment with the free market and a deregulated economy is far from a success. Communism destroyed itself because it is philosophically and psychologically untenable and economically unworkable in the modern world. In many ways, communism was defeated by people who believed in the ideal possibilities of both democracy and the “social market” rather than by the American reality; the real question for the US is whether it can become what these countries think it is.
First, as these Central European countries are striving to do, we should have a real multiparty political system. At the least, we should have two functioning political parties. This is no longer the case today. I have been a Democrat ever since I came to the US in 1942, at the age of fourteen, from Occupied France. There was never any question in my mind whether to support FDR, Truman, Stevenson, Kennedy, or Johnson. They stood for what I believed in: internationalism, the defense of freedom, equality of opportunity, fairness in the distribution of wealth. The Republican party, it seemed to me, was a party of the status quo, of isolationism, and of the simple, unadulterated pursuit of wealth.
Today the political choice, if there is any, is quite different. The Republican party is internationalist and expansionist, both militarily and economically; it is conservative, not to say reactionary, on social issues such as abortion, school prayer, and gun control; it is dedicated to the pursuit of wealth through lower taxes and the absence of regulation, without any seeming concern for the appropriate role of government. But what does the Democratic party stand for, in opposition to this program? It is exceedingly hard to tell because the Democrats are not an opposition party; they share power, they do not seek it. Seeking power requires putting forward alternatives to the voters and competing for their allegiance; sharing power is an entirely different matter. The Democratic leaders in the Congress are excellent men, but they are part of the existing political power structure, and have formed something close to a coalition government with a Republican administration. Congressman Dan Rostenkowski’s proposal to cut the federal budget deficit and to eliminate the Gramm-Rudman law is a courageous exception to this situation. However, in the main, we no longer have a true multiparty system, certainly not at the national level.
The legacy of Ronald Reagan, which has entirely paralyzed the Democratic party, is twofold:
1) The conviction, throughout America, that the country is overtaxed, with a 28 percent top income tax rate; and
2) The conviction that government is the enemy, especially when it intervenes in the economy to control the social consequences of excess or to protect the poor.
The result of these convictions is that two important notions have been wholly eliminated from American political discourse. The dread of taxes means that no rational discussion of resource allocation or of fairness can take place; and the dread of being associated with “liberalism” means that no rational discussion of an active policy of government intervention in economic life can take place either.
The Republican administrations of the 1980s, together with the Democratic Congresses, are jointly responsible for the present situation. Excessive tax cuts together with steep increases in defense spending created huge deficits, which were financed with $2 trillion of debt. The low domestic savings pool resulted in a growing foreign debt, high real interest rates, and the sale of more and more domestic assets abroad. A haphazard policy of deregulation under the Reagan administration brought about the fiasco of the S&Ls, as well as the tendency of the securities industry to act like a gambling casino, the demise of half of the US airlines, and the increasing destruction of the environment.
In order to create a façade of fiscal respectability, the administration and the Congress enacted the Gramm-Rudman-Hollings Act, which pretends to limit the yearly budget deficit to $100 billion. The act is really an accounting fantasy, at once cynical and grotesque, since, to avoid the automatic effects of the act, the government, among other bookkeeping devices, claims contributions to Social Security as assets and fails to show its bailout of the S&Ls as liabilities. It is as if a private company used its employee pension funds to offset operating losses, while not reporting the huge debts one of its branches had incurred. The directors, management, and auditors of such a company would be indicted and convicted. But each year the US government solemnly performs this charade, which gives the administration and the Congress the excuse to borrow another $150 to $200 billion, and to pretend that they are reducing the deficit. The Gramm-Rudman-Hollings Act provides a convenient excuse to do nothing about our real problems, other than to suggest that state and local governments deal with them. The most recent example of this policy is the suggestion by Secretary of Transportation Skinner that the states pay a larger proportion of the federal highway program through increases in local fuel taxes. The US did not become a great power through such evasions.
The events occurring in the world today can give the US a unique opportunity to deal with its internal needs and, by doing so, to maintain the strong international position that is rapidly slipping away from us. These needs include large new domestic investment, both in the private and the public sectors; a significant reduction in the cost of capital to American businesses; and a willingness on the part of the federal government to deal with many urgent social and economic problems, in partnership with local governments as well as with business.
A few weeks ago, I watched former French Prime Minister Jacques Chirac on television talking about the world of the 1990s. He spoke of the dominant role of a Europe of 500 million people, East and West, educated, skilled, increasingly well-to-do, and cohesive. He spoke of the Pacific rim, of Japan, Korea, Taiwan, Singapore, with their economic power, discipline, and high growth. I waited to hear what he would say of the US and where we fit into his vision of the future. It never came; neither we nor the Soviet Union were mentioned as having any international influence or presence. I do not believe that this is a correct analysis, but more and more, in Europe and in Japan, the US is seen as a marginal country. Sooner or later, perception will become reality.
With or without the addition of Eastern Europe, the Western European countries will together be an increasingly formidable competitor. With a unified market, a common currency, financial institutions more powerful than ours, more investment in public facilities, higher and higher educational standards, and strong social welfare institutions acting as a safety net, Europe will be a powerhouse in the twenty-first century. So will Japan and the Pacific rim nations, as their often interconnected financial institutions and manufacturing enterprises continue to grow swiftly. And, unless we begin to change, we will gradually slip permanently into the position of a large, less than first-rate economic power, still strong militarily, but less and less competitive, burdened by huge levels of debt, the sagging leader of a continent whose southern nations are also burdened by debt and declining living standards. This does not have to happen but it will, unless there is a growing consciousness that a national effort must be made. The leaders of the Democratic party, the Congress, and state governments should be trying to conceive of programs to remedy such failures. This will mean that they will have to defy the conventional political wisdom.
The US today has gigantic problems. These include a decaying infrastructure, whether in roads, bridges, or transport, as well as inadequate public education, increasing use of drugs, greater numbers of deaths from AIDS, and a lack of adequate housing—and these are only a few. Dealing with these problems is now hampered by the claims of the federal deficit and the need for the budget to remain within the artificial arithmetic limits of the Gramm-Rudman law. Even though the social, physical, and economic problems that we face are daunting, our fiscal problems, centering as they do on insufficient public revenue and excessive federal deficits, need not be. To deal with our fiscal problems would require relatively little real sacrifice. I was a member of the National Economic Commission created by the Congress to make recommendations to solve such problems, and a decisive bipartisan majority of the Commission was ready to propose a program of budget cuts and new taxes that would have increased revenues and steadily reduced the deficit. The administration was not interested in such a program; the Congressional leadership was not willing to endorse it without presidential support, and so the Commission was disbanded. But such a program, consisting of budget cuts, particularly in military spending, but also in entitlement programs, and a relatively small increase in taxes, should not be difficult for American citizens to absorb. Dan Rostenkowski’s recent propopsal would certainly be one way to do it. Certainly the sacrifices involved would be derisory compared to those that are being accepted in Western and Eastern Europe today.
What could have been done by the National Economic Commission in 1989, with relatively little pain, can be done even more readily in 1990 in view of the new world situation. Therein lies our greatest opportunity. The so-called peace dividend, however, is not something that will magically appear. The peace dividend will become reality only when it is decided upon and planned for over a period of years, as a matter of national policy, and enacted into laws. Furthermore, the peace dividend will not by itself provide for the needs of new public investment in America; nor will cutting the deficit, by itself, do the job; they should, however, form an important part of an ambitious three-part strategy: to invest an additional $1 trillion (in today’s dollars) in America by the year 2000; to cut the costs of capital—particularly interest rates—significantly; and to reduce the tax burden of state and local government.
Such objectives are not as far-fetched as they sound. Military spending, if sustained at current levels in constant dollars, would amount to $3 trillion between 1990 and the year 2000. Reducing this expenditure by $500 billion, or slightly over 15 percent, does not appear to be excessively ambitious. In addition to savings in defense spending, another $500 billion over ten years can easily be raised by a combination of gasoline taxes (50 cents per gallon alone would accomplish it); a small increase in the maximum income tax rate, to 33 percent at the most; and a moderate slowing of the growth of some entitlement programs, for example health care costs, which are growing at three times the rate of inflation and must be brought under control. Our increasing dependence on foreign oil alone would justify a small gasoline tax as a conservation measure; it would still leave American fuel costs at less than half of Europe’s and Japan’s. Appropriate safeguards would be provided to the poor.
Of such a trillion-dollar program, one half could be allocated to reducing the borrowing of the federal government, and one half could be returned to state and local governments for repairing infrastructure and for other urgent needs. Reduced federal borrowings would result in lower interest rates. The costs of a tax increase would be offset to a large extent by the reduction in interest costs to the individual and corporate borrower, and by the increased value of assets ranging from securities portfolios to real estate, which would come about as a result of lower interest rates.
Is it excessively bold to suggest investing an additional $1 trillion in our economy over the next decade? Not if you look at European countries investing $100 billion in high-speed railway transportation alone. Not if you look at the savings rate of the Japanese economy—at least double our own—and at the fact that the cost of capital to Japanese companies is about half of our own capital costs in real terms. Or if you look at the state of our infrastructure, with an estimated need for $2 trillion to restore to an acceptable condition interstate roads, city facilities such as bridges and waterworks, and airports; or if you take account of the fiscal condition of state and local governments, which have in many cases reached the fiscal limits of their capacities to deal with many of the problems I have mentioned. One trillion dollars is probably a minimum.
To talk seriously about such goals involves two subjects that are currently taboo in American political discourse. The first is active government. When a significant reduction in military spending takes place, the consequences of that reduction must be carefully worked out if it is to produce the hoped-for savings and, at the same time, avoid serious industrial and social dislocations. This requires some kinds of coordination and planning among the federal government, local communities, and the existing defense industries. Defense companies should be encouraged, through tax benefits or direct contracting, to convert to nonmilitary activities such as rapid rail and mass transit systems, large-scale waste disposal systems, or large supersonic commercial airplanes, to mention only three of many possibilities. The antitrust laws should be reviewed to permit mergers among large defense contractors facing significant cutbacks. Reductions in jobs should be planned far ahead of time and cushioned by retraining and relocation programs. If any of this smacks of another dreaded phrase, i.e., “industrial policy,” it is time for the US to outgrow such slogans and observe how other industrial transitions have successfully been carried out in such different capitalist countries as Japan, France, and Austria.
The second political taboo is a rise in taxes. The resistance to tax increases is all the more understandable when the money seems to be wasted in fraud, corruption, and political waste. However, taxes are also the price we pay for a civilized society, for clean and safe streets, a decent system of education, a workable health care system, and a genuine protection of poor and incapacitated citizens from degradation. No other advanced Western industrialized democracy functions today with a top income tax rate as low as 28 percent or with gasoline prices less than double our own. And yet Japan and West Germany are more productive than we are in many industries, and save more than we do, while producing at least as much security for their citizens. We must break out of the trap we have created by purely reflexive reactions to tax policy.
Recently, Senator Moynihan attempted to do so by suggesting a cut in the Social Security payroll tax. Moynihan was trying to point out a long-concealed reality: since 1981, the United States has cut income taxes and increased military spending by a combined total of about $3 trillion. We have financed this program with (1) increases in Social Security payroll taxes, (2) domestic and foreign borrowing of $2 trillion, and (3) increases in state and local taxes to make up for federal cutbacks. This has been an economically self-destructive means of financing, and a socially regressive one as well—its burdens have not been allotted according to people’s ability to pay. Moynihan and the Democratic leaders were, however, inhibited from stating the logical conclusion from the reality Moynihan pointed to; if payroll taxes are to be cut, income taxes or other taxes must be increased. No leading politician today seems able to say this.
Proposals for tax increases, if they are to be accepted, should be presented as part of a long-term domestic public investment program that will simultaneously lower the cost of capital to American business and reduce the fiscal pressure on local governments. The high cost of capital in America is caused, in large part, by the huge borrowing requirements of the government and by the general propensity of American private business to make use of debt during a period of low national savings. This country’s overall debt structure is a financial San Andreas fault which puts the entire economy at risk. The tendency to borrow was compounded in the 1980s by financial deregulation, high levels of speculation, and the extensive use of junk bonds and other forms of credit in takeovers and corporate restructurings. Financial deregulation of the thrift industry, together with lax oversight and widely tolerated corruption, produced the scandal of the S&Ls. The use by unscrupulous bankers of federally guaranteed deposits to rescue a savings and loan industry that should have been liquidated a decade ago will ultimately cost the taxpayers between $300 and 500 billion; ten years ago, the costs could have been limited to perhaps $10 billion. The colossal amounts of money wasted by the savings and loan industry in investments in worthless real estate, in junk bonds, in speculation and corruption of all kinds, could have been invested in new, productive investments. Instead, half a trillion dollars were diverted from productive investment to the most blatant kind of fraud. The enormous capital drain caused by the S&Ls is one reason for our high cost of capital.
Another reason for the high cost of capital is the more general trend of the 1980s to substitute debt for equity. The invention of junk bonds, the relaxation of credit regulation, and the rush for high immediate returns by financial institutions led to the huge wave of debt-financed takeovers, leveraged buyouts, and corporate restructurings of the last decade. During the last five years alone, some $500 billion of equity disappeared—as companies were acquired or bought back their own shares—and was replaced by debt. The leading instrument for promoting this debt was the junk bond, which, because of its lack of covenants or any real restrictions on the borrower, for the first time gave almost any raider, no matter how small, the ability to acquire almost any company, no matter how big. All that was needed to create an ocean of debt was large-scale institutional demand for junk bonds, a demand that was stimulated by very high interest rates (quite often beyond any realistic prospect of profitability by the business that would be responsible for the payments) and the promise of something like a functioning market. The S&Ls, banks, pension funds, and insurance companies rushed to acquire over $200 billion of this junk paper, and together with the commercial banks largely created the financial boom of the 1980s.
A slowing economy, an increasing number of large bankruptcies, the collapse of the junk-bond market, and the demise of Drexel Burnham brought the world back to harsh reality. First, there is no real junk-bond market, only a collection of financial institutions holding questionable paper; second, far from being the new way to finance American growth, the excessive use of junk bonds, particularly for LBOs and takeovers, is now destroying both borrowers and lenders, at great cost to the US economy. It was a destructive experiment which also had, as one of its principal effects, that of raising the cost of capital to American business. But it was not the free market alone that belatedly started the demise of junk bonds. It was regulation by the Federal Reserve and other federal agencies that tightened the use of bank credit; and it was federal legislation that took the S&Ls out of junk bonds. These actions were long overdue.
Additional regulation and legislation is probably required to reduce the cost of capital by making equity financing more attractive than acquiring debt. Making dividends tax-deductible should be studied as an alternative to reductions in the capital gains tax, which offer no real overall economic benefits. Such changes in tax policy should obviously be related to their effects on the budget. In addition, to restore full confidence in our financial institutions, regulation of the financial markets should be tightened by increasing the capital requirements of the securities firms and adopting the initial recommendations of the Brady Commission, for example, raising margin requirements on options and futures trading as well as making the Federal Reserve the overall regulator of the adequacy of capital in the securities industry.
Ultimately, to reduce significantly the cost of capital will require a significant decrease in real interest rates. This can only occur if US government borrowing requirements are reduced—an outcome that will be made all the more difficult to achieve by the huge international demands for capital for the development of Eastern Europe. As a result of our own capital constraints we will, in my view, unfortunately have to leave the financing of development in Eastern Europe largely to West Germany, the European Community and Japan, and to private investors.
We must concentrate on putting our own house in order. If the US were to make available $1 trillion in new resources over the next decade through a combination of new taxes and cuts in expenditures, roughly one half, or $500 billion, should be dedicated to bringing down the deficit and to reducing the borrowing requirements of the government. This should allow the Federal Reserve System to bring interest rates down significantly. Such a decrease in the real cost of capital would have a dramatic effect on US economic growth; our objective should be a prime rate of interest of 5 percent within two years. In addition, such a reduction would reduce significantly the costs of (1) the government in bailing out the S&Ls, (2) US banks in carrying shaky third world and real estate loans on their books, and (3) companies that must, if they are to continue, struggle with high interest payments.
The current arguments about including or excluding Social Security pension funds from the federal budget are missing the central issue. Social Security is, and always will be, a pay-as-you-go system; the level of payroll taxes and benefits will be set by future Congresses, and there is no way of insuring exactly what they will be. We should not become fascinated by the accounting dodges of the Gramm-Rudman law. The one public financial obligation of decisive importance is the net borrowing requirement of the government. For the five years from fiscal year 1986 through fiscal year 1990 the national debt held by the public grew by about $900 billion despite the existence of the Gramm-Rudman restrictions. It will probably continue to increase at between $150 and $200 billion per year as a result of continued deficits together with greater financial requirements for the S&L bailout. The growth of the national debt must be contained. The likely result of doing so could be a rise in the securities markets, which would in turn lower the cost of capital further and help to stabilize the dollar. Both our balance of trade and our ability to invest abroad would be strengthened.
Of the one trillion dollars in new resources that is needed, the balance of about $500 billion should, as I have noted, be returned to the states. One half of this $500 billion should, in my view, be devoted entirely to rebuilding decaying infrastructure; the other half should directly augment the budgets of state and local governments. If some $250 billion of the $500 billion were devoted to rebuilding infrastructure over the decade, it would still only represent a fraction of our total needs. New York City alone estimates that between $40 and $50 billion will be required for the next decade. However, annual increases in investment in the infrastructure by the states would be of significant help to the general economy. The federal funds returned to the states for investment in infrastructure should be deposited in state trust funds adapted to such purposes.
The reasons for allotting $250 billion for direct assistance to local governments should be clear. Enormous pressure has been put on state and local governments to deal with social problems that are national in scope: education, medical care, crime, drugs, housing, the environment, etc. With a slowing national economy and continuing federal cutbacks, local governments have had to raise taxes and cut services time and time again. The new federalism of the Reagan years has mainly consisted of transferring responsibilities to local governments and having them financed locally. This is being continued by the Bush administration and has been extremely destructive. A national investment program would assist local governments by making it possible for them to finance vital social services and/or reduce their own taxes—including local sales taxes, property taxes, and income taxes—by an amount equal to the federal contribution that they receive. Such a program—a different kind of revenue sharing—would stimulate local economies and allow them to devote more resources to deal with national problems, while causing a rollback in some of the more regressive local taxes. It is not enough for the President and the nation’s governors to set ambitious goals for public education by the year 2000. The states have to be given the means to carry out those goals.
If we continue on our present course of borrowing and spending and selling our national assets; of neglecting our environment, our cities, and our children; of giving up one industry after another to foreign competition, we will surely see a decline in America’s position in the world, whether or not we have a financial crisis. We will see a steady erosion in our standard of living and an increasing polarization of our society.
None of this is necessary; dealing with our budget problems should not be difficult if we stop acting like a poor country that cannot afford taxes that are proportionally equivalent to those of other advanced industrial countries. But for a change to occur, more imaginative political leadership will have to come forward. The Democratic party should produce that leadership by proposing to invest in the United States, by defining how the government can act in partnership with other forces in society, and finally by showing how both a balanced program of reduced military and entitlement costs and moderate federal tax increases are needed to save both public and private institutions from deterioration. It is time for the Democrats to raise their sights and to make real for Americans the ideals that other countries still ascribe to us.
April 12, 1990