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Tuesday, Aug 14 2012 11:03 PM

ANOTHER VIEW: Don't sail to Fantasy Island with Martinez

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    Frank Colatruglio

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By FRANK COLATRUGLIO

The Aug. 9 Community Voices rant from Cal State Bakersfield political science professor Mark Martinez, "Time to sail away from GOP's 'Trickle Down Island,'" is just one more in a long line of biased, one-sided ideological diatribes written from a less-than-objective or scholarly perspective. A perusal of Martinez's 2009 book, "The Myth of the Free Market," reveals a singular interpretation of the greatest economic expansion in U.S. history (1982-2007) as a primarily government-spending-led expansion, aided by cracks in OPEC, a tight monetary policy (crediting only Fed Chairman Paul Volcker, ignoring his reappointment in 1983 by Ronald Reagan, and macroeconomic disinflation), and misguided deregulation of banking, insurance and real estate.

Of course, if Keynesian-led stimulus spending was effective in creating economic prosperity and new jobs, then since 2009, when government spending suddenly jumped to a structurally permanent 25 percent of GDP, we should by now have experienced a sharp rebound in employment. Instead, unemployment is stuck above 8 percent, a level the current president said we would not even reach under his administration.

Oh, that's right, based upon Franklin D. Roosevelt's ill-fated attempts to bring down unemployment with the same types of policies from 1932 through 1940, what did we expect? By 1940, the rate was still 14.6 percent, and we endured a serious economic downturn in 1937-38 largely due to FDR's efforts to raise taxes in a deflationary economy attempting to balance the budget and vilify the rich on moral grounds. Sound familiar?

Martinez asserts that innovation and creativity are human constants, owing to curiosity, art, professional achievement, etc. Fair enough, but the psychology of risk-taking tells us that it takes more than creativity and innovation to maintain vibrant markets and high employment. Steve Wozniak was the real technological innovator of the original Apple Computer, but without Steve Jobs being a liaison between engineering and the end-user marketplace, commercial success would not have happened. And, inevitably, Jobs needed Wall Street risk capital in order to fully realize the potential of his vision.

Martinez claims inventions happened all through the 1940s and '50s even though the top tax rate at the time was 90 percent. True enough, though the effective tax rate during this period was much lower due to the deductibility of non-cash items like depreciation and depletion against ordinary income. In fact, during the past 60 years the effective tax rate on top earners has remained relatively stable compared to the statutory top rate contained in the code. Professionals who worked during the 1950s tell me that without real estate and other tax-advantaged offsets to ordinary income, they simply didn't see clients after August or September. Talk about lost productivity.

Speaking of the 1950s, according to the Office of Management and Budget, the federal revenue share of GDP from personal income taxes averaged 7.4 percent in those years. From 2000 to 2009, in spite of the much lower tax rates in effect after abandoning the archaic New Deal-era tax brackets, federal revenue from personal income taxes averaged 8.04 percent, a not-inconsequential 8.64 percent increase. Unfortunately, the high level of government spending since the early 1970s has always been the problem, not the solution. Although we consistently generated 18 percent of GDP in federal revenue for many years, we consistently spent 20 to 22 percent. In the 1970s, average tax receipts were 17.93 percent of GDP and outlays were 20.02 percent. From 2000 to 2009, revenue was 17.64 percent and outlays were 20.01 percent, meaning the problem has not been revenue, it has been a lack of fiscal restraint. The real issue is that we have never established contingency plans in anticipation of the inevitable economic downturn.

As a self-proclaimed JFK Democrat, Martinez should study the speech John F. Kennedy gave in 1962 proposing a reduction in taxes to avoid another recession and to eventually generate additional federal revenue. Unfortunately, the Johnson, Nixon, Ford and Carter administrations followed a Keynesian model, which produced low growth, with high inflation and high unemployment. Under both Kennedy and Reagan the deployment of a classic economic model of sound money and free enterprise produced strong growth with low inflation and unemployment.

Hopefully, the next president will optimize (not maximize) effective tax rates for economic growth and low unemployment that will result in optimal federal revenue, and at the same time we should impose a 20 percent cap on the federal spending share of GDP barring unforeseen national emergencies.

Frank J. Colatruglio is a local financial adviser and portfolio manager who manages assets for private clients, retirement plans and endowments. Another View presents a critical response to a previous editorial, column or news story.

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