Are We Headed for a Double-Dip Recession?

Originally posted: October 13, 2011

With the headlines about the world’s struggling economies in the news on a daily basis, Questioning Authority decided to ask Professor of Economics James Hartley for his take on the situation and what he sees for the future.

Questioning Authority: Is the United States in a double-dip recession? Or headed toward one?

James Hartley: Actually, looking at the data, we aren’t in a recession at all right now. The recession began in December 2007 and ended in June of 2009. For the last two years, the economy has been growing. In the second quarter of 2011, U.S. gross domestic product (GDP, or the total amount of goods and services produced) was a little over $15 trillion a year. That is not only the highest GDP for any country in the history of the world, it is also more than 8 percent higher than the U.S. GDP was at the lowest part of the recent recession.

QA: With all the financial problems facing Europe and the United States, is the global economy on the verge of a recession?

JH: It’s possible. But the question of whether there is another recession just around the corner (the much-talked-about “double dip”) isn’t the important issue. The much bigger question is why growth rates are not higher than they are. In the first quarter of 2011, GDP grew at a rate of 0.4 percent per year; in the second quarter, it grew at 1.3 percent per year. There is very little difference in the short run between an economy growing 1 percent in a given year and one declining by 1 percent. However, there is a very big difference between a country growing at an average of 3 percent per year over a long period of time and one growing at an average of 1 percent a year. There is also a big difference between an economy with unemployment rates averaging around 10 percent (as many western European countries have had for decades) instead of around 5 percent (similar to what the United States had before 2007). The right question to be asking, then, is why aren’t economies growing at a faster rate two years after the recession ended?

Europe is in bigger trouble that the United States and it isn’t clear how things will turn out there. We are witnessing a historically unprecedented series of events in Europe; this is the first real test for the common currency in Europe. We don’t know, for example, how long the more stable countries will be willing to bail out the less stable countries. We don’t know how many countries at the edge of economic stability will tip into requiring assistance from the stable countries. We have no idea if the European banking system can weather these sorts of disruptions. And we also don’t know how much trouble a collapse of the European banking system would cause in banking systems in the rest of the world. There are a lot of alarmist predictions out there, but it’s hard to see how anyone can form a reasonable guess about such things.

QA: What do you think needs to happen to improve the U.S. economy?

JH: First of all, I think we need a widespread recognition that no policy, no matter how well intentioned, is going to dramatically improve things in the next six months. Failing to realize this has led to quite bit of bad policy since 2007, as government officials scurry around looking for quick fixes. The discussion needs to change to be about long-run trends of GDP growth, such as inflation, unemployment, and so on, instead of the month-to-month variations in those things. If Washington would just settle down and stop rewriting the rules every few months, it would help. With a presidential election next year, however, it is unlikely that this will occur.

Over the longer term, the biggest problem facing the U.S. government is the retirement of the baby boomers. Both Social Security and Medicare are soon to become bankrupt, and there is at present no plan in place to deal with the consequences. Also, banking regulation is a mess right now; it is not clear what rules the banks will be operating under in the foreseeable future, which is making it nearly impossible to imagine a stable banking system emerging anytime soon. Finally, I would rest easier if I were certain the Federal Reserve was going to have the political will to prevent a breakout of inflation.

QA: What do you forecast for the U.S. economy? Where do you see things going from here?

JH: I don’t have an independent forecasting model. Fortunately, the Philadelphia Federal Reserve Bank performs an invaluable service in publishing a consensus forecast from professional forecasters. The most recent survey is from June, and the consensus forecast is that the United States will be growing at about 3 percent over the next year, unemployment will drift down slightly to about 8.5 percent, and inflation will not rise much. Remember though, that’s just the guess of people who are professional guessers. Things can get better or worse in a hurry.

QA: Finally, President Obama says he wants to tax the rich more (which some have called “class warfare”). What are your thoughts about this debate?

JH: The debate on how much the rich do and should pay in taxes is filled with a lack of knowledge of the facts. So here are some details: Using IRS data, the richest 1 percent of Americans earn 20 percent of all income. The interesting question is then: Given that, if we wanted to be fair, what percentage of income taxes should be paid by the richest 1 percent? Or, as President Obama puts it, if the richest Americans should pay their “fair share,” what share of total income tax revenue should they pay? Whether the rich are paying too much or too little depends in part on how one answers the question of what percentage of total income taxes the rich should be paying. Currently, the richest 1 percent pay 38 percent of all income taxes. The percentage of total income tax revenue paid by the richest 1 percent is roughly double the percentage of income they receive. Is that too high or too low?

Also, with all due respect to Warren Buffet, in the current tax code, the rich pay a higher percentage of their income in federal income tax than do the middle class. Breaking taxpayers into five groups by income level, the middle group pays 14.1 percent of income in federal income taxes, the next highest group pays 18.9 percent, and the top 20 percent pays 25.5 percent. Looking more closely at the top group, the top 1 percent pay 28 percent and the top 0.1 percent pay 30.4 percent. It is also important to note that none of the figures here are in any way controversial. I got those numbers from the Tax Policy Center (run by the Brookings Institute and the Urban Institute, both left-of-center think tanks).

One final way to think about the numbers: The top 1 percent of taxpayers collectively earn about $1.7 trillion in income. (To get in the top 1 percent, you need an annual salary around $400,000.) They currently pay almost $400 billion in taxes. So, if you raised income tax rates on the wealthy to 100 percent in an attempt to collect taxes on all of the income of the top 1 percent, and if they still continued earning that income (they wouldn’t, but if they did), you would get an extra $1.3 trillion. This year, the U.S. federal budget deficit will be about $1.3 trillion.

The debate surrounding taxing the rich would be much better if the simple facts were more widely known. Reasonable people will disagree about the proper tax rates on the rich. However, historically Americans have never been keen on demonizing the rich, both because Americans tend to admire the rich (witness the reaction to the death of Steve Jobs) and, probably more importantly, most Americans have dreams of one day becoming rich.

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