Monday, July 20, 2009

Trickle Down

In the 1980s, opponents to President Reagan’s policy of cutting taxes to stimulate economic growth coined the term “trickle down” economics. His policies were also popularly known as “voodoo” economics. Reagan’s belief in tax cuts was ultimately justified as the US economy began a long period of strong economic growth.

Today we are seeing a trickle down of a different sort. Our current economic crisis began with a banking crisis last fall. Bad mortgages led to a rise in foreclosures. As these bad loans metastasized like a cancer throughout our financial system, banks were unable to borrow or lend and the economy was in danger of grinding to a halt.

Several prominent banks failed or were forced to merge to avoid failure. Thousands of Wall St. financial workers lost their jobs. At this point, many Americans believed that the crisis was a Wall St. crisis that did not affect them.

Over the next few months, this belief was shattered as the economic pain trickled down. At the same time that the credit markets froze, the stock market crashed. Companies could not find financing to expand and, in many cases, could not even make their payroll. 401(k), pension trust funds, and other retirement accounts were halved in value.

As demand for goods and services plunged, companies began to lay off workers. A friend who is an architect was one of the first victims after it became difficult to fund construction projects. Almost a year later, he still out of work. As layoffs increased, there were more foreclosures and demand dropped further.

My own industry provides a good example of the economic carnage of the past year. I work in the fractional aviation industry. My company sells shares of private jets to individuals and companies who need to fly, but don’t want the hassle and expense of owning their own airplane. We manage the airplane and provide crews for the owners. All the owners have to is let the company know when and where they want to fly… and make sure they pay their ownership fees. Before last fall, this was a thriving and quickly growing business.

After the onset of the crisis, paying the fees became a problem for many owners. Many had lost their shirts in the calamity and could no longer afford even part of an airplane. Owners began selling back their shares. Prospective owners, worried about the state of the nation and the markets, elected not to buy into an airplane. To top it off, government officials began demonizing corporate aircraft as a waste of investor’s money. Suddenly, we had too many airplanes and not enough flying to do.

Not surprisingly, my company decided that it had to lay off employees. As the economic situation continued to deteriorate, approximately one quarter of the company’s pilots were laid off, furloughed in aviation parlance, along with a large number of office employees. The most recent furlough was announced last week. Older airplanes were grounded and deliveries of new airplanes were canceled or deferred to a later date.

Similarly, other general aviation companies were also ravaged. Cessna, a manufacturer of private jets, shut down many production lines and laid off over 8,000 workers, over half of the company. FBOs, private aircraft terminals, also went out of business, or laid-off employees. Charter companies that depended on companies like mine for much of their business folded or downsized. Startup companies like small jet manufacturer, Eclipse, and air-taxi operator, Day Jet, went completely out of business. The aircraft market, both new and used, collapsed.

As employees of these and other companies lost their jobs or portions of their income, other businesses and workers were affected. They weren’t able to buy cars, leading GM and Chrysler into bankruptcy. When they couldn’t pay their mortgages any longer, more banks failed. Their lack of disposable income meant that other businesses, from restaurants to boutiques, had to lay off employees or close their doors entirely.

As the economic situation spiraled out of control, the government passed a stimulus bill. Four months later, the unemployment rate has continued to rise and will continue to rise even further in coming months as more workers, my friends among them, lose their jobs. In fact, many believe that the real unemployment rate is much higher than the official 9.5% because many unemployed workers have dropped off the rolls after not finding a job even after their unemployment insurance runs out. If many companies had not cut pay and hours, many other workers would be totally out of a job.

So trickle down economic theory has worked several times in recent years. Under Presidents Reagan and George W. Bush we saw examples of positive trickle down in which wealthy people and businesses had more money. They used this money to invest in other businesses and buy things. This created more jobs and wealth for the middle and lower classes.

Under President Obama, we are witnessing a negative example of trickle down. The wealthy and businesses have lost millions of dollars in a matter of months. They are frightened of the future and, in any case, have little money left to spend. Consequently, lower and middle-income workers are suffering.

If we can acknowledge the reality of trickle down, then we can make appropriate choices that will enable good things, rather than bad, to trickle down in the future. The option that Presidents Reagan and Bush chose was to put more money in the hands of the American people. They cut taxes. With the government withholding less of each worker’s pay in taxes, they had more money to spend. As businesses paid less money in taxes, they had more money to grow and hire new workers. In both cases, the economy grew, jobs were created, and the government collected more money in spite of taxing at a lower rate. Presidents Harding, Coolidge, and Kennedy also successfully used this strategy.

In contrast, the Obama Administration is taking the opposite tack. President Obama had said last January that without the stimulus bill unemployment could exceed 10%. In reality, the stimulus bill passed shortly after Obama took office, but unemployment is still at 9.5% percent (citation). Much of the stimulus money has not been dispersed. Much of the money that has been spent has been wasted on pork barrel projects. Even worse, the American public has become alarmed at the ballooning deficit.

People realize that the Obama spending spree has a hefty price tag. The money to pay for all of this spending has to come from somewhere. It is widely expected that taxes will be increased on 100% of Americans to pay the bills. In recent weeks, members of Congress have been discussing the possibility of a national value-added tax, which is similar to a national sales tax. The administration is also proposing a national health plan and a cap-and-trade energy tax. Both of these plans would add new taxes that would ultimately be borne by American consumers.

As taxes rise to pay for the increased government spending, consumers find themselves with less money to spend. Businesses find themselves with less capital with which to expand, hire new workers, pay shareholders, and develop new products. As a result, the economy inevitably contracts and more people lose their jobs.

To turn the economy around, we need to put more money in the hands of the private sector. Tax cuts for everyone is the easiest way to do that. If workers and businesses have more money, they will spend and invest more. Banks will, in turn, have more money to loan and credit will become easier to get. Demand for cars and other consumer items will increase and companies will need more workers.

To put it in real terms, if tax cuts for the wealthy enable them to buy an airplane share from my company, then that will put people back to work throughout the economy. Pilots and office staff will need to be recalled to meet the increased demand for flights. Aircraft manufacturers like Cessna will need to reopen production lines to build more airplanes. FBOs around the country will need to hire more workers to service the increased numbers of airplanes flying in. And that is just the immediate impact.

Beyond the aviation industry, the affect would be felt throughout the nation. Newly recalled or rehired workers would need new houses and cars. They would need work clothes and food. They would have more money to spend on entertainment. And their increased income would mean that they would pay more income taxes and sales taxes, helping all levels of government. People would also have more money to donate to charity.

The future depends on President Obama and Democratic majorities in Congress since the Republicans are not able to introduce and pass legislation. Neither do they have the votes to stop the spending and taxes without help from Democratic defectors.


Newark NJ

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