Mr. Obama’s Most Recent "2%" Sellout is his Worst Yet

by Michael Hudson

Now that President Obama is almost celebrating his willingness to renew the tax cuts enacted under George Bush for the super-rich ten years ago, it is time for Democrats to ask themselves how strongly they are willing to oppose an administration that looks increasingly like Bush-Cheney III. Is this what they expected by his promise of an end to partisan politics?

It is a reflection of how one-sided today’s class war has become that Warren Buffet has quipped that “his” side is winning without a real fight being waged. No gauntlet has been thrown down over the trial balloon that the president and his advisor David Axelrod have sent up over the past two weeks to extend the Bush tax cuts for the wealthiest 2% for “just” two more years. For all practical purposes the euphemism “two years” means forever – at least, long enough to let the super-rich siphon off enough more money to bankroll enough more Republicans to be elected to make the tax cuts permanent.

Mr. Obama seems to be campaigning for his own defeat! Thanks largely to the $13 trillion Wall Street bailout – while keeping the debt overhead in place for America’s “bottom 98%” – this happy 2% of the population now receives an estimated three quarters (~75%) of the returns to wealth (interest, dividends, rent and capital gains). this is nearly double what it received a generation ago – while the rest of the population has been squeezed, and foreclosure time has now arrived.

One would not realize that the financial End Time is here from today’s non-confrontational White House happy-talk. Charles Baudelaire quipped that the devil wins at the point where he manages convince the world that he doesn’t exist. We might paraphrase this today by saying that the financial elites win the class war at the point where voters believe it doesn’t exist – and believe that Mr. Obama is trying to help the middle class, not reduce it to debt peonage and a generation of victimhood as the economy settles into debt deflation.

The first pretense is that “two years” will get us through the current debt-induced depression. The Republican plan is to make more Congressional and Senate gains in 2012 as Mr. Obama’s former supporters “vote with their backsides” and stay home, as they did earlier this month. Why vote for a politician who promises “change” but this is merely an exclamation mark for the Bush-Cheney policies from Afghanistan and Iraq to Wall Street’s Democratic Leadership Council – the party’s right wing, one of whose leaders was Mr. Obama’s own beloved Senate mentor Joe Lieberman. So “two years” means forever in politician-talk.

The second pretense is cutting taxes for the super-rich is a trade-off to get Republican support for extending the tax cuts on the middle class. It is as if the Democrats already have lost their plurality in Congress. It’s all “to create jobs,” headed by employment of shipyard workers building yachts for the nouveau riches and foreclosing on the ten million Americans whose mortgage payments have fallen into arrears. It sounds Keynesian – or at least, reminiscent of Thomas Robert Malthus’s claim (as lobbyist for Britain’s landed aristocracy) that landlords would use their rental collection to hire footmen, carriage-makers and butlers to keep the economy going.

It gets worse. Mr. Obama’s “Bush” tax cut is Part I of his one-two punch program to shift taxes onto the middle class that elected him. Congressional economists have estimated that extending the tax cuts to the top 2% will cost $700 to $750 billion over the next decade or so. “How are we going to go out and borrow $700 billion?” Mr. Obama asked Steve Croft on his Sixty Minutes interview on CBS last week.

It was a rhetorical question, for whose answer the President has appointed a bipartisan commission (right-wingers on both sides of the aisle) to “cure” the federal budget deficit. The National Commission on Fiscal Responsibility and Reform, known as the Deficit-Reduction Commission” among media friendlies, might better be called the New Class War Commission to Scale Back Social Security and Medicare Payments to Labor in Order to Leave more Tax Revenue Available to Give Away to the Super-Rich. A longer title, but sometimes it takes more words to get to the heart of matters.

The heart of the matter is “Big fish eat little fish.” There’s not enough tax money to continue swelling the fortunes of the super rich while making even a pretense of saving enough to pay the pensions and related social support that North American and European populations have been promised. Something must give. And the rich have shown themselves sufficiently foresighted to seize the initiative. For a preview of what’s in line for the United States, watch neoliberal Europe’s fight against the middle and working class in Greece, Ireland and Latvia.

What is needed to put Mr. Obama’s sell-out in perspective is the pro-Wall Street advisors he has chosen – not only Larry Summers, Tim Geithner and Ben Bernanke (who last week reaffirmed his loyalty to Milton Friedman’s Chicago School monetarism), but his Deficit Reduction Commission. Its majority is stacked with outspoken advocates of cutting back Social Security, Medicare and other social spending so as to “free” the budget for “non-discretionary” spending. Within a decade, interest on the public debt (that Reagan-Bush quadrupled and Bush-Obama redoubled) will amount to $1 trillion annually. As for military spending in the Near East, Asia and other regions responsible for much of the U.S. balance-of-payments deficit, the Commission is confident that Congress will always rise to the occasion and defer to whatever foreign threat is conjured up requiring new armed force.

The public is told of the nightmare of $1 trillion deficit to pay retirement income over the next half century – as if the Treasury and Fed have not just given Wall Street $13 trillion in bailouts without blinking an eye. President Obama’s $750 billion tax giveaway to the wealthiest 2% is mere icing on the cake that the rich will be eating when the bread lines get too long.

It’s all junk economics. Running a budget deficit is how modern governments inject credit and purchasing power to enable economies to grow. When they do not run deficits – e.g., when they run surpluses, as they did under Bill Clinton (1993-2000) – credit must be created by banks, at interest. And the problem with bank credit is that most is lent against collateral already in place. The effect is to inflate real estate and stock market prices. This creates capital gains – which the “original” 1913 U.S. income tax treated as normal income, but which today are taxed at only 15% (when they are collected at all, which is rarely in the case of commercial real estate).

The giveaway: the Commission’s position on tax deductibility for mortgage interest
The Deficit Reduction commission spills the beans with its proposal to remove the tax subsidy for high housing prices financed by mortgage debt. The proposal is only to move against homeowners – “the middle class” – not absentee owners, not commercial real estate investors, and not corporate raiders or other prime bank customers.

The IRS permits mortgage interest to be tax-deductible on the pretense that it is a necessary cost of doing business. In reality it is a subsidy for debt leveraging as opposed to equity investment (using one’s own money). This tax bias for debt rather than equity is largely responsible for loading down the U.S. economy with debt, encouraging corporate raiding with junk bonds, adding interest to the cost of doing business, and hence causing the debt deflation that is locking the economy into depression. This subsidy for debt leveraging also is the government’s largest giveaway to the banks. And it also happens to violate every precept of the classical economic drive for “free markets” in the 19th-century.

Table 7.11 of the National Income and Product Accounts (NIPA) reports that in 2009, total monetary interest paid in the U.S. economy amounted to $3,240 billion. Homeowners paid just under a sixth of this amount ($572 billion) on the homes they occupied. Mr. Obama’s commission estimates that removing the tax credit on this interest would yield the Treasury $131 billion in 2012.

Defenders of stopping this tax credit make the valid point that the mortgage-interest tax deduction does not really save homeowners money at all. It is a shortsighted illusion. And this argument is right – absolutely right. What the government gives to “the homeowner” on one hand is passed on to the mortgage banker by “the market” process that leads bidders for property to pledge the net available rental value to the banks in order to obtain a loan to buy the home (or an office building, or an entire industrial company, for that matter.) “Equilibrium” is achieved at the point where whatever rental value the tax collector relinquishes becomes available to be capitalized into bank loans.

This means that what appears at first as “helping the homeowner” afford to pay mortgages turns out merely to enable them to afford to pay higher more interest to their bankers. The tax giveaway uses homebuyers as “throughputs” to transfer tax favoritism to the banks.

It gets worse. By removing the traditional tax on real estate, state, local and federal governments need to tax labor and industry more, by transforming the property tax onto income and sales taxes. For banks, this is transmuting tax revenue into gold – into interest. And as for the home-owning middle class, it now has to pay the former property tax to the banker as interest, and also to pay the new taxes on income and sales that are levied to make up for the tax shift.

I support removing the tax favoritism for debt leveraging. The problem with the Deficit Commission is that it does not extend this reform to the rest of the economy – to the commercial real estate sector, and to the corporate sector.

The argument is made that “The rich create jobs.” After all, somebody has to build the yachts. What is missing is the more general principle that wealth and income inequality destroy jobs. This is because the wealthy soon reach a limit on how much they can consume. They spend their money buying financial securities – mainly bonds, which end up indebting the economy. And the debt overhead is what is pushing the economy into deepening depression today.

Since the 1980s, for example, corporate raiders have borrowed high-interest “junk bond” credit to take over companies. They make money by stripping assets, cutting back long-term investment, research and development, and paying out depreciation credits to their financiers. Once they take over financially parasitized companies, the new financial managers use corporate income to buy back their stock – thereby supporting its price, and hence the value of stock options that financial managers give themselves – and borrow yet more money for stock buybacks, and even simply to pay out as dividends. And when the process has run its course, they threaten their work force with bankruptcy that will wipe out its pension benefits if employees do not agree to “downsize” their claims and replace defined-benefit plans with defined-contribution plans (in which all that employees know is how much they pay in each month, not what they will get in the end.) By this time the financial managers have paid themselves outsized salaries and bonuses, and cashed in their stock options – all subsidized by the government’s favorable tax treatment of debt over equity investment.

This self-destructive financial policy refined by “shareholder activists” has created consternation among old-fashioned investors – for instance, in the attempted raids on McDonalds and other companies in recent years. So why is the Deficit Reduction Commission restricting its removal of tax favoritism for debt leveraging only to the middle class (homeowners), not to the financial sector across the board?

Two thirds of homeowners do not even itemize their deductions, so the main effect of tax deductibility is on commercial investors. Most other countries do not permit such deductions – not Canada, or even Australia, where bank credit has been fueling a steep property bubble.

If the argument is correct (and I think it is) that permitting interest to be tax deductible merely “frees” more revenue to pay interest to banks – to be capitalized into yet higher loans – then why isn’t this true of the Donald Trumps and other absentee owners who seek always to use “other peoples’ money”? In practice, the “money” in question turns out to be bank credit whose cost to the banks is under 1% these days. The system is siphoning off rental value from commercial real estate investment by partnerships and corporations, increasing the price of rental properties, commercial real estate, and indeed, industry and agriculture.

Alas, the Obama administration has backed the Geithner-Bernanke policy that “the economy” cannot recover without saving the debt overhead. The reality is that it is the debt overhead that is destroying the economy. So we are dealing with the irreconcilable fact that the Obama position threatens to lower living standards from 10% to 20% over the coming few years – making the United States look more like Greece, Ireland and Latvia than what was promised in the last presidential election.

Something has to give politically if the economy is to change course. And what has to give is the underlying favoritism for Wall Street at the expense of the economy at large.

What has made the U.S. economy uncompetitive is primarily the degree to which debt service has been built into the cost of living and doing business. The NIPA report this debt service as a “service” payment for providing credit. But interest (like economic rent and monopoly price extraction) is more in the character of a transfer payment, a quid without quo. The beneficiaries are the super-rich at the top of the economic pyramid – the 2% that Mr. Obama’s tax giveaway will benefit by some $700 to $750 billion.

If the present direction of government is not reversed, Mr. Obama will shed crocodile tears for the middle class as it sponsors the Deficit Reduction Commission’s program for the middle class to suffer cutbacks in Social Security, and cutbacks in revenue sharing to enable states and cities to avoid defaulting on local pensions. The economy is now buckling under pressure of debt deflation. One third of U.S. real estate already is reported to have sunk into negative equity. This is squeezing state and local tax collection, forcing a choice to be made between bankruptcy, debt default, or shifting the losses onto the shoulders of labor, off those of the wealthy creditor layer of the economy responsible for loading it down with debt.

Critics of the Obama-Bush agenda are recalling how America’s Gilded Age of the late 19th century was an era of economic polarization and class war. At that time the Democratic leader William Jennings Bryan accused Wall Street and Eastern creditors of crucifying the American economy on a cross of gold. Restoration of gold at its pre-Civil War price entailed a financial war in the form of debt deflation. Falling prices and incomes received by farmers and wage labor made the burden of paying debts heavier. The Income Tax of 1913 sought to rectify this by only falling on the wealthiest 1% of the population – for they were the only ones obliged to file tax returns. Capital gains were taxed at normal rates. So most of the tax burden fell on finance, insurance and real estate (FIRE) sector.

The vested interests have been fighting back for a century, and now see victory within reach with the perpetuation of the Bush tax cuts for the wealthiest 2%, phase-out of the estate tax on wealth, the tax shift off property onto labor income and consumer sales, and slashing government spending on anything besides more bailouts and subsidies for the emerging financial oligarchy.