By Chriss Street

The Great Recession was primarily caused by the collapse in economic demand as 70 million baby boomers born between 1946 and 1964 moved out of their peak spending years in their mid-30s to mid-50s and into retirement in their late 50s and early 60s.  The U.S. government over the last five years squandered $7.6 trillion on Keynesian demand-side stimulus programs, trying to resuscitate this demographically shrinking demand.

With only 23 million born between 1995 and 2012 in Generation Z, this population is just too small for demand-side stimulus to revive the economy.  America is now deep in debt, facing 23 million unemployed, and needs to fund the baby boomer’s retirement.  Consequently, politicians are being forced to abandon demand-side stimulae and re-embrace supply-side economics.

The Revolutionary War was sparked by Great Britain’s demand that the American Colonies pay increasingly higher taxes to support England’s expanding national debt.  Once independent, the new U.S. Constitution’s Commerce Clause established a free-trade zone among the states and passed the Sinking Fund Act of 1795 to require a significant amount of tax revenue be set aside each year to quickly pay off any outstanding national debt.  These policies created an economic boom that allowed the United States to be debt-free by the 1830s.

This concept of encouraging long-term economic growth by lowering taxes on income and reducing regulatory burdens that serve as barriers for people to produce goods and services is referred to as “supply-side economics.”  The Founding Fathers understood that a greater supply of goods and services produced increases demand by lowering prices for consumers.

But during the Great Depression, Washington politicians abandoned supply-side and imported Keynesian “demand-side” economics from Great Britain.  Demand-side economics argues that, in the “short-run,” productive activity is influenced by aggregate demand (total spending in the economy) and that aggregate demand may not always equal aggregate supply (the total productive capacity of the economy), because private-sector decisions often lead to “inefficient market outcomes.” Therefore, government should create demand through targeted spending.  Armed with this smoke screen, U.S. short-term spending has risen every year since 1948, as politicians always found some inadequate market demand that needed more spending.

California revival

California’s own President Ronald Reagan revived supply-side economics in the 1980s with Reaganomics.  The policy ended the oil windfall profits tax to stimulate oil production, passed the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986 to cut taxes and eliminate deductions, and instituted a payroll tax to begin a “sinking fund” to reduce the accumulated liability of Social Security and Medicare.  Although Reagan was never able to reduce total spending, he did start a huge economic boom that lasted until 2001 and led to huge United States Treasury surpluses in the late 1990s.

Most Americans do not realize that Reagan’s biggest ally for his supply-side encouragement of economic growth was the demographics of the baby-boomers.  Studies demonstrate that 50 percent of all durable (cars and houses) and non-durable (food and clothing) expenditures are directly related to household demographics.  Spending tends to peak as families grow and people reach their mid-30s to mid-50s.  Then spending declines rapidly after the mid-50s.

When Reagan began Reaganomics in August 1981, the first baby-boomers born in 1946 were just turning 35 years old.  By the time those first baby-boomers hit 55 in 2001, the NASDAQ over-the-counter index of growth stocks had risen from 190 to more than 5000, a jump of 2,600 percent.  As the boomers hit 55 and begin to retire through 2019, only 30 percent as many Generation Z members will replace them in the work force.

Politicians love demand-side economics because they get to look busy spending lots of money creating “demand” for their crony capitalist friends.  On the other hand, a part-time Congress could manage a supply-side economic policy, because the policy is set once to encourage long-term economic growth.

But as we have been observing, the United States government will go bankrupt long before politicians can “create” enough demand to replace the shrinking consumption spending as the baby-boomers continue to rapidly retire.  Having tripled the national debt since 2001 and recently suffering a credit downgrade, Congress has no other viable option than supporting a return to supply-side economics to encourage growth.

I expect Congress to soon update President Reagan’s playbook for supply-side growth.  The United States has the world’s largest oil and gas reserves and last year those proven reserves rose by the highest amounts ever recorded.  Much of the un-tapped oil is on federal land and Congress will begin deregulating the energy market to capture huge royalty payments on higher energy production.

Congress will also deregulate the utility industry.  This will encourage up to $6 trillion in private-sector capital spending for new pipelines and refineries across the nation to connect and distribute new production.  Corporate taxes and crony tax deductions will be slashed and individual taxes and deductions will be reduced.

America is on the verge of a huge economic expansion.  Enjoy the ride!

Chriss Street appears on “THE AMERICAN EXCEPTIONALISM RADIO TALK SHOW”
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A Wall Street Journal editorial headline today branded Gov. Jerrry Brown: “Governor 13.3%.” That’s the percentage California’s top income tax rate would be if he finagles voters into passing his tax hike this November.

It’s a great headline. And I’m going to use the phrase to refer to him in the future: Governor 13.3%.

The 13.3 percent tax top tax rate would be by far the highest in the country, well head of the current top states, Oregon and Hawaii’s rate of 11 percent. California’s current top rate is 10.3 percent.

Wall Street comments:

“It’s hard to believe now, but Jerry Brown once ran for President as a reformer who favored a flat tax with a 13% top federal rate. That was 1992. Nowadays in his second stint as Governor, he’s running to give California alone a higher top income-tax rate.”

That’s right. In 1992, presidential candidate Jerry Brown proposed that the top federal rate — the one paid by everybody — should be just 13 percent. (Currently in 2012, the top U.S. rate is 35 percent, although President Obama wants to jack that up to 39 percent.)

People like to say that “California is the world’s 8th largest economy,” but this is ridiculous. In fact, we’re not a country, but a state. And we compete against other states, such as: Nevada, Texas, Washington, New Hampshire and Florida, all of which have zero state income tax.

For Governor 13.3% to propose a state income tax higher than the entire federal income tax he proposed 20 years ago is absurd.

Highest Taxes

Wall Street:

“The top 1% in California pay between one third and half of all state income tax revenues, depending on the condition of the economy….

“So for the privilege of living in California, a millionaire would pay close to $125,000 a year more in income tax than someone in Nevada, Texas or Florida. A Californian earning $10 million would pay an extra $1 million or more than if she moved to a state without an income tax, or nearly $500,000 than an average tax state.

“Even Mr. Brown, in one of his saner moments earlier this year, said that relying on millionaires to pay the bills causes “more volatility” in revenue collections, which has meant “a more or less constant state” of deficits. He was right. Capital gains collections collapsed to $734 million in 2009-10 from $1.6 billion in the boom years. So why would Mr. Brown make that problem worse?”

Wall Street also made the point that Supply Side economists do: That when taxes get this high, people don’t pay them. They leave the state or country. So the government fails to collect not only the tax increase, but the previous tax that the wealthy person was paying.

Paradoxically, that means if California wants to increase revenues to the state it must make this state more enticing to taxpayers — by cutting taxes. Wall Street points this out:

“One of the last states to have a tax rate as high as California is proposing was Delaware in the 1970s. Its rate hit 19.8%. Then-Governor Pete du Pont cut the rate to 10.3% in 1979 and later to 5.95%, and after five years the state’s revenues had nearly doubled and its credit rating went from the worst to one of the best.”

Governor 13.3% used to understand that. He talked to economics Arthur Laffer, the Supply Side economist who designed Brown’s excellent 1992 flat tax proposal. He should talk to Laffer again.

Laffer has produced a new study, “Eureka! How to Fix California,” for the Pacific Research Institute, CalWatchDog.com’s parent think tank. He calls for a 5.8 percent flat-tax for all Californians.

Laffer will be launching his new new book and signing copies at The City Club of San Francisco on March 27, from 5:30 to 7 pm.

And he’ll signing his new book on Wednesday, March 28, at the Pacific Club in Newport Beach.

March 26, 2012