Friday, February 17, 2012

A Birthday, and my War on Debt continues

Apart from all else, happy birthday to my son Jerry!

It is occasionally said that fighting the supply of illegal drugs has failed to stem the drug trade, and fighting demand would give better results. If people were somehow convinced not to buy illegal drugs, the drug trade would wither away.

I see the same solution for a different problem, another four-letter word that starts with "d": Debt. If we can somehow convince people to borrow less, and pay back more, then debt need never again accumulate into the kind of problem it has become for us. If we cut demand in half, the business of lending will shrink, and creditors will have to find better things to do with their money. Productive things, perhaps.

Don't get me wrong. I don't blame borrowers for the mess we're in today. I don't even blame lenders. I blame policy. (You... you can blame lenders if you want. But if you want lenders to change, you still have to change policy.)

All Hills and Valleys

The unlimited deduction for corporate interest payments originated in 1918. Since then the history of our economy has been a long ride up the hill of debt accumulation, down the hill of global depression and war, and up the hill of economic recovery and debt accumulation again. You can see that, here:

Graph #1: Debt per dollar of Income Generated with that Debt
It is easier to see the hills and valleys here:

Graph #2: Debt per dollar of Spending Money
The second graph also, I think, better conveys the scale of the current problem.

A tax deduction for corporate interest payments means that corporations don't pay income tax on the income they use to pay interest. It makes borrowing money a way to avoid paying income tax.

Of course, businesses can also deduct the money they spend paying their employees. Wages are a deductible cost, just like interest. But for the cost of interest you get money to spend. For the cost of wages, you get attitude.

But I guess if you borrow money and use it to pay wages, you get to deduct the wages and the interest payments from your taxable income!

The tax deduction for interest expense encourages businesses to borrow. That's good for economic growth -- or it would be, if there was not already too much debt in our economy. Still, it should be clear that increased borrowing has not been a very great boost for economic growth for a decade or more. Forty years, more like.

Follow the Money

Consider the years after World War Two, up to the end of the time before Reagan. This period, some three decades, includes both the Golden Age and the Great Inflation.

Interesting: The Great Inflation begins around 1965 -- basically in the middle of those decades before Reagan. And more and more, I am coming to think that the Golden Age ends around 1965, though it is often said to run into the 1970s. One might say this period encompasses both the Keynesian era and the death of the Keynesian era.

Graph #3: Interest Costs Rise as Employee Compensation Falls
All through those years, corporate interest costs increased as a portion of total corporate income tax deductions, and corporate compensation of employees fell. Corporate interest costs absorbed corporate income, making that money unavailable for wages and salaries, and unavailable for profits.

Graph #4: Interest costs eat into Wages
By 1965, interest costs were starting to push up prices. In the 1970s, the news reported a "wage-price spiral". But wages were not the problem. Wages were not a rising share of corporate costs. Wages were a falling share.

The cost of interest was the problem. And it was fully deductible.

// UPDATE 2:44 AM 2/19/2012

Graph #1 was developed on Sheet1 and Graph #2 on Sheet7 of my Debt-to-GDP spreadsheet (Google Docs).

Graphs #3 and #4 come from Sheet1 of the Components of Corporate Cost spreadsheet. This sheet is a copy of the one linked in my comment below.

// UPDATE 6 October 2015

Due to changes in Google Docs, the graphs in this post were not being displayed. So instead of trying to use "interactive" graphs I just did screen captures of the four graphs and stuck them in the post in place of the empty rectangles that were being displayed. Too many words.

I fixed it.


Jazzbumpa said...

Happy birthday Jerry! Sorry I'm late.

This is an interesting post. Where did you get the interest and compensation as a % of deductions data?

I've never seen anything like that before.


The Arthurian said...

Thanks, Jazz.

"I've never seen anything like that before."

Since the time that we first needed explanations for the rise of inflation in the 1960s, the generally accepted explanations have been incorrect. That's how far back the problem goes.

I'm updating the post to link to the spreadsheets.

See also my Components of Corporate Cost. Graphs #3 and #4 here are based on that older post.

The graph for the older post was generated in this Google Docs spreadsheet.

The data identified there: NIPA Table 1.13 for Employee Compensation, and NIPA Table 7.11 for Interest Deductions. For "Total Deductions" I refer only to "HS & SA" -- Historical Statistics of the United States (Bicentennial Edition) and various issues of the Statistical Abstract.

The Arthurian said...

The list of NIPA tables is here.