Robert Reich and others have pointed out that income inequality was at a maximum both in 1928 just before the Great Depression and again in 2007 just before the Great Recession. In both cases the share of the nayional income going to the top 1% was greater than 23% as the following graph shows.
If you superimpose a graph of the top income tax rate, you can see that it is almost the inverse of the graph of the share of income going to the upper 1%. In the 1920s the top tax rate was 25%. In the period which Reich calls the Great Prosperity, roughly from 1945 to 1980 the top tax rate was high, 91% under Eisenhauer, 70% under Nixon and 39.6% under Clinton as the following graph shows. Roughly the peaks in the first graph correspond to valleys in the second and vice versa.
We can conclude from these two graphs that income inequality increases as top marginal tax rates decrease. There is almost a direct correlation. But in addition to that government revenues diminish when top tax rates are lowered and increase when they are raised. So lowering taxes produces more income inequality and diminished government revenues. Reagan and the first Bush lowered taxes and quadrupled the national debt from $1 trillion to $4 trillion. The second Bush lowered taxes and doubled the national debt from $5 trillion to $10 trillion. Fiscal responsibility as defined by government revenues exceeding government spending has been achieved by every Democratic President since Johnson and by no Repuiblican President since then as shown by the following graph.
Clinton ran budget surpluses four years in a row, a feat not achieved since the 1920s. Even though top tax rates were low in the 1920s, the government still ran surpluses for all those years. This was because the economy was booming so a lower tax rate was sufficient to produce ample revenues. Supply side economics promised the same result but didn't deliver. Instead lowering taxes produced huge government deficits which added huge sums to the national debt. In the 1930s, when the Great Depression hit, the government started running deficits, but it had built up a relative surplus in the 1920s so it could better afford to run deficits than it can today since such huge deficits were run up during the Bush administration.
Keynsian economics says that the government should spend more and run deficits during recessions and save more and run surpluses during expansions. That theory made some sense during the 1920s and 1930s when the surpluses of the 20s were somewhat balanced by the deficits of the 30s although the deficits were about triple the surpluses. Today, however, we have a dual problem: the need for the government to spend money to stimulate the economy and the need not to add more to the national debt. One way the government can do this is to raise income taxes on the wealthy which would solve two problems. It would reduce income inequality and it would decrease government deficits. Since the wealthy don't add greatly to aggregate demand especially after a certain amount of wealth has been accumulated, this will not affect the economy negatively. Also, as has been proved by the Bush administration, increasing the wealth of the already wealthy does not create jobs.
Another way the government can solve the deficit problem is to find other sources of revenue. Up until approximately the First World War most government revenues were derived from excise taxes (mainly on cigarettes and alcohol) and tariffs. By the 1920s these sources had been largely replaced by the income tax. Excise taxes are taxes on particular products produced and sold within the US. They are similar to the VAT tax which is used in Europe. But the VAT tax applies to all products not just certain selected ones. The VAT tax is basically a national sales tax. Excise taxes could be reinstated and applied to speculative financial products in the form of a Financial Transactions Tax (FTT). This would net hundreds of billions of dollars a year. Hundreds of billions more could be gotten from collecting taxes on profits illegally parked offshore. Tariffs could be applied selectively to certain countries and/or certain products in order to equalize the trade balance which has been running huge deficits. This would mean abandoning free trade in favor of fair trade.
Keynsianism is outmoded today because the government can't afford to go into debt to stimulate the economy. However, the government can raise revenues by instututing increased taxes on the upper 1% and other forms of taxation such as a FTT that won't affect the purchasing power of the middle class. Royalties on oil and minerals extracted from the US by corporations could also be taxed at rates similar to what other countries are taxing their oil. Today the US is practically giving away its natural resources. The problem in today's economy is lack of demand so purchasing power must be increased among those who are in a position to increase demand, namely, the middle class. Government spending that is offset by government revenues is deficit neutral. One of the greatest problems in the currrent economy is lack of job creation. Government spending that directly and indirectly creates jobs will do much to ameliorate the current lack of demand, and if that spending is balanced by increased revenues, the national debt can be paid down at the same time.
