Dean Baker
Debate Club (U.S. News & World Report), July 31, 2012

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What's wrong with 4.0 percent unemployment, and 4.0 percent GDP growth?

That's what the world looked like the last time the wealthy paid the higher tax rate they would face under the Senate tax plan. The unemployment rate averaged 4.0 percent as the year-round average for 2000 with several months coming in at 3.9 percent. The economy grew at more than a 4.0 percent annual rate for four consecutive years from 1997 through 2000. Is this the world that we are supposed to be afraid will return if the wealthy have to pay the same tax rates they did when President Bill Clinton was in the White House?

Of course no one can seriously claim raising taxes on the wealthy will restore the prosperous days of the late 1990s. The reality is that we are still recovering from the collapse of an $8 trillion Wall Street-fueled housing bubble. This bubble had been driving the economy ever since the recovery from the 2001 recession. Record high house prices led to near record levels of housing construction. The home equity created by bubble-inflated house prices led to an unprecedented consumption boom as millions of people spent against the equity in their homes.

When the bubble burst, we lost close to $600 billion in annual construction demand as the housing boom turned to a bust. We also lost close to $600 billion in annual consumption, as the home equity that was fueling spending vanished.

This loss of $1.2 trillion in annual demand has created an enormous hole that the economy cannot easily replace on its own. The stimulus was an effort to fill this gap, but at its peak in 2009 and 2010 it could at best replace one-quarter of the demand lost from the collapse of the bubble. For this reason, we are not likely to soon see a return to the prosperity of the 1990s, barring a much larger stimulus.

In this context, the additional tax revenue from the wealthy may end up being used to finance additional spending to build infrastructure, improve education, or improve the environment. That would provide at least a modest boost to the economy.

The prosperity of the 1990s shows that the scare stories over higher taxes are just silly. The job creators from 15 years ago had no problem expanding their companies and the economy even when they faced higher tax rates. Is there something wrong with the current crew?