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Tax and Spend, or Face The Consequences

By Gregory Clark
Sunday, August 9, 2009

At some point, the Great Recession will end. Newsweek even says it's already over. Whenever it happens, we will see that the downturn was but a minor blip in the long story of the economy.

In the next chapter, abundance beckons -- for some. Advances in technology drive economic growth, and there is no sign that they are slackening. The American economy is likely to continue unabated on the upward path that began with the Industrial Revolution.

No, the economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

The battle will be over how to get the economy's winners to pay for an increasingly costly poor. Last weekend Treasury Secretary Timothy Geithner and Lawrence Summers, the director of the White House's National Economic Council, refused to rule out raising taxes. Despite the White House's subsequent denials, this may be an early acknowledgment of an inexorable trend. In a future with higher taxes, the divide between rich and poor would be the central economic challenge.

For much of the past 200 years, unskilled workers benefited greatly from capitalism. Before the Industrial Revolution, for example, skilled construction workers earned 50 to 100 percent more than unskilled laborers; today, that premium has fallen to 33 percent in the United States. The era of the two world wars, 1914 to 1945, was one of particularly sharp gains for the wages of unskilled workers, relative to the rest.

Why have the unskilled fared so well? After all, machines -- whether steam engines, internal combustion engines or electric motors -- have replaced people as deliverers of brute force. But even today they cannot replace many of people's manipulative abilities, language skills and social awareness. The hamburger you eat at McDonald's is still put together and delivered to you by human hands; even a fast-food "associate" deploys an astonishing repertoire of spatial and language skills.

But in more recent decades, when average U.S. incomes roughly doubled, there has been little gain in the real earnings of the unskilled. And, more darkly, computer advances suggest these redoubts of human skill will sooner or later fall to machines. We may have already reached the historical peak in the earning power of low-skilled workers, and may look back on the mid-20th century as the great era of the common man.

I recently carried out a complicated phone transaction with United Airlines but never once spoke to a human; my mechanical interlocutor seemed no less capable than the Indian call-center operatives it replaced. Outsourcing to India and China may be only a brief historical interlude before the great outsourcing yet to come -- to machines. And as machines expand their domain, basic wages could easily fall so low that families cannot support themselves without public assistance.

With the march of technology, the size of a future American underclass dependent on public support for part of its livelihood is hard to predict: 10 million, 20 million, 100 million? We could imagine cities where entire neighborhoods are populated by people on state support. In France, generous welfare has already produced huge suburban housing estates, les banlieues, populated with a substantially unemployed and immigrant population, parts of which have periodically burst into violent protest.

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners -- those with the still uniquely human skills, and those owning the capital and land -- to provide for the losers.

Modern society seems comfortable with the rich and poor living in vastly different housing, eating disparate qualities of food and facing radically dissimilar crime risks. No one pickets four-star restaurants because they feed only the rich, or the Waldorf Astoria because only the wealthy can afford to sleep there. But when it comes to medical care, Americans display strong ethical resistance to having the poor receive a substantially inferior product. (Just recall the outrage a few years ago when news reports emerged of Los Angeles hospitals discharging poor patients onto city sidewalks.)

Rising health spending -- from 5 percent of U.S. annual income in 1960 to 16 percent today -- is no tragedy. Thanks to such spending, we can all live longer. But as medical advances allow us to live far beyond our working years, with the average American adult living to 78, the burden on the public purse will rise. Of the 47 million currently uninsured Americans, most will need public assistance to get adequate care.

Adult-onset diabetes, for example, estimated to afflict more than 21 million Americans, is a chronic condition associated with a lifestyle occurring at high rates among lower-income people. Modern medicine allows the average person diagnosed with diabetes to live more than 15 additional years, but at a cost typically exceeding $100,000. (Twenty-one million times $100,000 is $2.1 trillion, and that's just one disease.)

The United States was founded, essentially, on resistance to taxes, and to this day, an aversion to the grasping hand of the state seems fundamental to the American psyche. The share of total income collected in taxes by all levels of government in the United States is 27 percent, compared with 51 percent in Sweden, at the other extreme. The conflicts to come are foreshadowed in California, where popular anti-tax sentiment has forced substantial reductions in medical care for the state's poorest children.

How can we avoid or minimize such conflicts? The Obama administration seeks to do so in part through a more cost-effective health-care system. With luck, the United States could reduce health-care expenditures closer to the 9 to 11 percent of annual income typical in Canada and Europe. But health-care spending as a share of income has been increasing everywhere, so this will at best buy time before an inevitable crunch.

Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I'm skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. We can certainly arrange to have everyone "graduate" from high school, but whether they will have the skills needed to make it is doubtful.

The last great hope may be to design a more efficient tax system. Much of the present system takes from people with one hand then gives back with the other, after bureaucracy eats its share. Taxes for Social Security, Medicare and roads all show elements of such recycling. A more efficient system would tax only where there is a need for some specific public good or a transfer to the poor.

Unfortunately, such measures are only stopgaps. In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

gclark@ucdavis.edu

Gregory Clark, a professor of economics at the University of California at Davis, is the author of "A Farewell to Alms: A Brief Economic History of the World."

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