dollar_bills

The most direct way to eliminate waste in the financial sector is with a financial transactions tax, effectively a sales tax on shares of stock and other financial assets, similar to the sales tax that we pay on clothes, cars, and most other things we buy. (Photo: Getty Images/Stock Photo)

Successfully Fighting Inflation Starts at the Top

The Fed's high interest rate approach to stemming inflation is about reducing the bargaining power of workers, and especially workers at the lower end of the wage ladder.

Center for Economic and Policy Research

With the high rate of inflation reported for March, the chorus for strong measures from the Federal Reserve Board is growing louder. The idea is that the Fed needs to substantially accelerate its pace of rate increases. This will slow economic growth, increase unemployment and then put downward pressure on wages.

It is worth noting that wages have not been driving inflation, unlike in the 1970s wage-price spiral. Wage growth has been lagging price growth, as there has been a shift from wages to profits since the pandemic.

A slower pace of wage growth should help to slow inflation, since wages are a major cost of production. In this respect, it is worth noting that wages have not been driving inflation, unlike in the 1970s wage-price spiral. Wage growth has been lagging price growth, as there has been a shift from wages to profits since the pandemic.

It is also worth noting that the Fed rate hikes will disproportionately hit workers who are most disadvantaged in the labor market. The people who will lose their jobs will be disproportionately, Black, Hispanic, people with disabilities, and people with criminal records.

One of the ironies of much reporting on inflation is that it has claimed that lower income people have been hit hardest by inflation. In fact, wage growth has been most rapid in the lowest paying industries, such as restaurants and convenience stores. It will be interesting to see if news stories tell us if these low-paid workers are doing better when the rate of inflation has slowed, but they've lost their jobs.

The Origins of the Current Inflation

It is fashionable among Republican politicians, and political reporters, to blame the upsurge in inflation on President Biden's policies. This is hard to reconcile with a simple fact, inflation has risen pretty much everywhere. Our year over year inflation rate was 8.5 percent as of March, the year over year inflation rate in Europe over this period has been 7.5 percent.

Needless to say, no one here would be celebrating if our inflation rate was 7.5 percent. There are reasons why our economies, as well as our measures of inflation, differ, but the point is that most of the jump in the inflation rate over the last year had little to do with anything the Biden administration did or did not do. The rise in the inflation rate was the result of difficulties associated with reopening from a worldwide pandemic, as well as Russia's invasion of Ukraine.

Blaming Biden for high inflation, without noting the pandemic and the war, would be like blaming Louisiana's governor for the housing shortage in 2006, without mentioning that the most populated part of the state had been devastated by Hurricane Katrina. Unfortunately, this level of seriousness is pretty much the norm in current policy discussions.

Stemming Inflation at the Top

The Fed's high interest rate approach to stemming inflation is about reducing the bargaining power of workers, and especially workers at the lower end of the wage ladder. (To be clear, some increase in interest rates does make sense, given the current strength of the labor market. The Fed had pushed its overnight interest rate to zero with the idea the economy needed stimulus in the pandemic recession. With 3.6 percent unemployment, this is no longer true.) Instead of having a policy focused on reducing the bargaining power of workers at the middle and bottom, we can attack inflation by reducing the bargaining power for those at the top.

Prescription Drugs and Medical Equipment

My favorite place to start is with prescription drugs. We will pay over $500 billion this year for drugs that would almost certainly sell for less than $100 billion in a free market, without government-granted patent monopolies and related protections.[1] The $400 billion difference would come to almost $3,300 per family a year.

The federal government has some tools it could use to directly bring about most of these savings. Section 1498 of the US Commercial Code gives the government broad power to override patents. It does have to compensate the patent holder, but it could immediately act to suspend drug patents and then allow the drug companies to fight out in court how much they should be compensated.

The Bayh-Dole Act, which allows drug companies to take advantage of government research in their patented products, has a provision which allows the government to demand a lower price. Many, if not most, drugs rely on research financed through the National Institutes of Health, or other government agencies. These "march in" rights can be used to force lower prices on a wide array of prescription drugs.

There is a similar story with medical equipment and devices. In almost all cases, the high prices charged for scanning machines, dialysis machines, and other cutting-edge medical equipment is due to patent monopolies and related protections. The same tools can be used to push down these prices, potentially saving another $100 billion a year.

The industry will scream bloody murder if the government were to take these paths to lowering prices for drugs and medical equipment. They would say that they would not have the money or incentive to develop new drugs and medical equipment.

The obvious answer is to simply increase public funding to make up for the lost patent supported funding. As should be apparent, these are substitutes. The industry spends roughly $100 billion a year developing drugs. This compares to more than $50 billion than the government spends through the National Institutes of Health and other government agencies. Even if the federal government had to replace the industry's funding in full, we would still be far ahead.

The impact of these measures on inflation will be both direct and indirect. The direct impact will be lower drug prices. The weight of prescription drugs is just over 1.0 percent in the Consumer Price Index. This means that if drug prices fall by 50 percent (a good target), it would knock 0.5 percentage points off the annual rate of inflation.

The indirect impact would be that we would be reducing the money going to top executives, highly paid researchers, and shareholders in the drug companies. This would likely curtail their consumption. These people would be less likely to own second or third homes, and the ones they do own would likely be smaller. They would also be spending less money on a wide range of goods and services, from cars and hotel rooms to restaurants and gyms. The reduction in demand should help to put downward pressure on prices in many sectors of the economy.

Eliminating Waste in Finance

Our bloated financial sector is an enormous source of waste in the economy. It also has created many of the country's biggest fortunes. That should make it a prime target for inflation fighters, but we all know about US politics.

Anyhow, as is the case with the pharmaceutical industry, there is both a direct effect on inflation and an indirect one. The direct one is interesting because it is not actually picked up in the Consumer Price Index (CPI) or other measures of inflation.

The most direct way to eliminate waste in the financial sector is with a financial transactions tax, effectively a sales tax on shares of stock and other financial assets, similar to the sales tax that we pay on clothes, cars, and most other things we buy. The rates usually proposed for such taxes are in the range of 0.1 to 0.2 percent on stock sales, with equivalent rates on trades of bonds, options, futures, and other derivatives.

While the financial industry hates the tax, most countries around the world, including the United States, either currently have such a tax or had one in the not distant past. The United Kingdom has had a tax of 0.5 percent on stock trades for more than three centuries.

The direct effect of such a modest financial transactions tax in the United States would be to eliminate a huge amount of wasteful trading. Many people have retirements accounts, which shuffle stock back and forth, without any gains to them. Most trades in fact end up losing money because people don't cover the commissions and other trading costs. If we cut trading volume in half (saving us over $100 billion a year in commissions and fees), returns on 401(k)s and other retirement accounts would not be harmed.

The same story applies to pension funds and other pools of wealth. Of course, this one is difficult politically because most people do not want to believe that they are throwing their money in the toilet by trading. Also, for pension fund managers it is very embarrassing to admit that they were handing workers' money to rich people in the financial industry for nothing.

But here are Beat the Press, we don't have to worry about the politics. If we imposed a modest financial transactions tax it, it would leave most investors unharmed. It could raise around $100 billion a year for the government by eliminating waste in the financial industry. However, the reduction in spending on trades would not lower the CPI because the trades themselves are counted as being valuable, even if they do not benefit the investor.

The same applies to my other favorite reform of the financial industry: universal bank accounts at the Federal Reserve Board. People could save tens of billions of dollars annually on bank fees and penalties if the Fed created a system of accounts for every individual and corporation. These accounts could be used to make costless transfers. This means that workers could have their paycheck automatically deposited in their account, have their mortgage or rent paid from the account, and pretty much do any sort of financial transaction they like.

This would save low- and moderate-income households tens of billions of dollars that they now pay banks and other financial institutions to make these payments, as well as penalties that they frequently incur due to overdrafts. Needless to say, these savings are money out of the pockets of the financial industry. These savings also don't show up as a reduction in the CPI, rather they would be counted as a reduction in services provided by the financial industry.

These changes would also have the same indirect effect as the changing our policy on patent monopolies. There would be many rich people in the financial sector who would be considerably less rich. That would mean fewer second and third homes and other forms of luxury consumption. That would free up more resources for the rest of the country.

Other Routes to Reducing Inflation

There are other areas where we can look to reduce inflation pressures by hitting those at or near the top of the income distribution. We can subject doctors and dentists to more competition, both nationally and from increasing access to qualified foreign professionals. Bringing their pay more in line with their counterparts in other wealthy countries could save us more than $150 billion a year on our tab for their services.

We can also change the rules of corporate governance to get CEO pay in line with their actual contribution to their companies. If the ratio of CEO pay to the pay of an ordinary workers was 20 or 30, like it was back in the 1960s and 1970s, CEOs would get $2 million to $3 million a year, instead of $20 million or more. This would have a huge impact on pay structures at the top throughout the economy, pulling tens of billions a year out of the pockets of some of the richest people in the country.

These and other policies could dampen inflation by directly lowering the price of many goods and services and reducing the purchasing power of the rich and very rich. I discuss these policies in more detail in Rigged (it's free).

The point is that if we want to reduce inflationary pressures, there are a whole set of policies that we can look to implement that would lower the incomes of people at the top of the income ladder. Unfortunately, we are not likely to go this route, because rich people have enormous political power and will likely beat back any effort to reduce their income.

In short, when it comes to fighting inflation, it is too politically difficult to go high. Instead, policy types look to go low and have the Fed reduce the purchasing power of those workers at bottom of the income distribution.

[1] Data on spending on prescription drugs can be found in the Bureau of Economic Analysis, National Income and Product Accounts, Table 2.4.5U, Line 121. Calculations for the gap between patent protected prices and free market prices can be found here.

This work is licensed under a Creative Commons Attribution 4.0 International License