Tuesday, November 30, 2010
Home prices continued downward. Prices in November fell 1.5% versus year ago prices. The Case Schiller Report covers 20 major metropolitan areas. The index is set with January 2000 equal to 100. The index for Boston is 156.28 which indicates that prices are 56% higher than they were in January 2000. This compares with cities like Detroit which has a current index of 71. Prices fell in most cities year to year but they increased .04% in the Boston area.
In general, the rate of decline has decreased nationally but some cities still show substantial price declines. Along with Boston, there are other bright spots with DC at the top of the list. K Street keeps growing.
An alternative view of how to deal with the household debt problem. His view is that we should save the economy and not the creditors who made the bad loans. He feels that the bad loans should be written off by the banks who made the loans to restore household balance sheets. He has a radical view of the financial sector in which it is viewed as a parasite on the real economy. The parasite extracts nourishment from the host but it also takes over the host and tricks it into thinking that it is part of the host. A very interesting video.
Monday, November 29, 2010
This graph (via Brad DeLong's website) shows that Medicare's cost for delivering a common benefit is less than that for private insurers. Moreover, the trend for cost reductions is steeper over time with Medicare. These data run counter to GOP claims that Medicare is unable to control its costs.
Actually, the inability of private insurers to control costs and premium growth makes it more difficult for Medicare to control costs. One of the problems with a mixed private and public insurance system is that doctors prefer to provide services to those who will pay the highest price. As long as private insurers are willing to pay higher prices, Medicare must limit its cost controls or doctors will reduce services to Medicare patients. That is one of the reasons why Canada has a single payer insurance system. Government in Canada is better able to control costs without the threat from higher paying private insurers.
This is the famous hockey stick published by Michael Mann. It shows the rapid growth in global warming subsequent to the industrial revolution and the recent trend in warming which gains momentum and accelerates in the 21st century.
Joe Barton, a representative on the House Energy Committee from Texas, commissioned a study to the Mercatus Center at George Mason University to discredit the hockey stick. It is well known that many in the oil industry believed that the hockey stick graph was compelling evidence for global warming that the average person could understand. The Mercatus Center is funded, among others, by the Koch brothers who have been active deniers of global warming and very large contributors to ultra conservative causes. The Wall Street Journal editorialized on the data provided by the Mercatus Center to build its critique of the scientific evidence for global warming. It frequently uses experts at the Mercatus Center to provide academic cover for its positions.
Joe Barton picked a good place to find problems with the hockey stick. The Mercatus Center has been a vocal critic of government regulation and 14 of George Bush's targets for deregulation came from Mercatus Center input. The economics department at GMU is also known for its conservative approach to economics.
Unfortunately, the work of the Mercatus Center and other organizations with connections to the fossil fuel industry, has accomplished its goal. Global warming deniers in the Tea Party, and in other conservative organizations, have been given enough ammunition to make the overwhelming consensus in the scientific community on the human contribution to global warming to appear to be a subject of intense debate and uncertainty among scientists.
Tom DeLay, the former GOP majority leader in the House, who was recently convicted in Texas for money laundering, was often called the representative from Enron. Joe Barton, like many politicians from Texas, understands how his bread is buttered.
Japanese economist from Nomura Securities explains Japan's "lost decade". He explains how Japan reacted to their bubble burst and financial crisis. It created a balance sheet recession that he describes very well. He points out that fiscal policy stimulus was attempted but it was not enough to fix the problems. Interest rates fell to zero but it did not stimulate spending because there was more interest in paying down debt (which is savings) than in increasing private borrowing and spending. His major point is that government borrowing must compensate for the lack of private borrowing and spending. This increased deficits in Japan and caused the government to withdraw the needed fiscal stimulus.
Krugman explains how Spain's recovery from recession is made difficult because it cannot take actions to devalue the euro. Consequently, it must undergo internal devaluation to lower its cost structure so that it can export its way out of recession. That means a long process of wage compression and slow growth until its products are cost competitive.
The US and the UK have their own currencies and they can use monetary policy to devalue their currencies and build up their export base. The attack on the Fed by conservatives may restrict the use of monetary policy to make US exports price competitive. The result would be the "Spanish Trap". That is, wage compression to make our products less expensive to sell overseas.
This link is to a video by Mark Blyth from Brown University who offers an explanation of the debate between those who focus on deficit reduction and others who focus their attention on growing the economy in order to reduce deficits.
There are also links to articles on the debate.
Sunday, November 28, 2010
Under current law our income tax system is progressive. The rate increases as income increases. However, all of the progressiveness of the income tax stops after we reach the top bracket with an income of $363,650. The difference between upper middle income families at the bottom of the top bracket and families with multimillion dollar incomes, in the same tax bracket, is like living on a different planet, but they are subject to the same tax rate. Timothy Noah explains why we need to extend the progressiveness of the tax system above the current maximum income of $363,650. He points out that under Richard Nixon and Jerry Ford the tax rate for incomes equivalent to $1 million today was 70%. This is a 50% reduction in the tax rate for those with incomes over $1 million.
This article describes how the Great Depression was understood as a moral response to our sins. We are going through the same "cleansing" exercise today. I think that the psychology of resentment, which DeLong attributes to Nietzsche, aptly describes the psychology of the Tea Party. It is a powerful motive that Hitler exploited to perfection.
Nobody does a better job of describing our current culture and political disarray than Frank Rich. Maybe we should make all of our political candidates go on "Dancing with the Stars" and send the winners to Washington.
Meet the inquisitor general in the new House of Representatives. It won't be long before his name will be household and he will be on all of the Sunday AM talking point shows. He will claim that he wants to eliminate waste in government in order to dismantle it. The recession, and the budget deficit that it produces, provides the cover for "starving the beast". Anyone familiar with the budget knows that it can't be brought into balance by eliminating waste. Of course, he understands that his base believes otherwise.
The so called deficit hawks won't help out the unemployed unless we extend the Bush tax cuts which blow the deficit sky high. They argue that the unemployed choose to be unemployed in order to collect benefits. The fact that there are 5 job seekers for every job opening is just another inconvenient fact that can be safely ignored. The Dem's have to put a line in the sand on this or they will see more erosion in their base.
Justin Fox (via Manan) has more on where the corporate profits are going. They aren't going to Main Street.
Saturday, November 27, 2010
The Medea Hypothesis suggests that the success of a species on Planet Earth leads to predictable disaster. For example, plant life expanded to the point that it produced the Ice Age. Plants lack intelligence so there was nothing that they could do about it. The success of the human species is causing irreversible damage to our ecosystem. This raises the fundamental question about whether we are smarter than plants. Recent scientific evidence from biology has introduced a new problem in addition to the evidence that the human species is responsible for global warming. Plant plankton produce 50% of the earth's oxygen. One degree of ocean warming has destroyed 40% of the plant plankton. The question is no longer whether we face disaster according to the linked article. The issue is whether we face disaster or catastrophe.
Unfortunately, the Copenhagen Conference was a failure. The coming Cancun Conference gives us another shot at developing a response to the scientific evidence that is overwhelmingly validated by the scientific community. Apparently, we are intelligent enough to understand the problem of human contribution to ecological disaster or catastrophe. The real question is whether we will listen to the scientific community or to experts like Karl Rove and Rush Limbaugh who claim that the purported threat of ecological disaster is "so 70's"
Friday, November 26, 2010
This graph illustrates the effect of the recession on growth in wages. Prior to the recession wages were growing at over 3%. Since the recession wage growth is less than half of its prior rate of growth. The implications on the economy and on deficits is clear. Tax revenues decline with falling wages and high unemployment to promote deficits, and household spending must also decline with falling income to exacerbate recession.
Ireland's financial crisis was similar to that in the US. Bankers and land developers took big risks to earn big profits while government looked the other way. The government response to the crisis has been to punish those who had nothing to do with the crisis. The government decided to guarantee the debt of the Irish banks to foreign investors who provided the funds for the real estate bubble. The result has been huge budget deficits, due to the guarantees to foreign investors, and to the loss of tax revenues from high unemployment. This led to huge cuts in public spending, which along with the decline in private spending, has depressed the Irish economy even further. Since Ireland is part of the Euro zone, it does not have the option of using monetary policy to deal with its fiscal problems. The population will suffer for a long time for the sins of the bankers and the Irish government.
Galbraith's critique is devastating. It is not about fixing deficits by figuring out the best way to cut spending or by changing the tax system. I don't know why his critique has been ignored by the media. If nothing else, it is certainly more interesting and newsworthy. I have summarized the report which he delivered to the Commission below.
He cited a study by the IMF which laid the cause of the world wide recession to the financial crisis which slowed economic growth and led to high unemployment rates, and consequently, lower tax revenues and a rise in transfer payments to the unemployed. The conclusion is that only 10% of the budget deficits are due to increased public spending for economic stimulus. Therefore, the only way to reduce deficits due to unemployment, is to take the steps necessary to reduce unemployment. Cutting public spending or raising taxes cannot reduce deficits due to unemployment.
He then argues that since high unemployment is due to the financial crisis, we must remedy the financial crisis to increase private credit, instead of relying on government and public debt. He asks the Commission why fixing the financial system was not on its agenda while entitlements, which are not the root cause of our deficits has been placed at the top of the agenda. He states that debt restructuring for households would restore private credit, and that reconstruction of the banking system by purging it of toxic assets, and replacing the management which caused the crisis, as well as the compensation system which provided the incentive for poor risk management, would fix the financial system. He went on to show that private credit was the cause of the boom in the Clinton administration which led to budget surpluses. The use of public credit to restore employment is only necessary when the private credit system is not working.
He then moves to the Commission's focus on entitlement spending. His major point is that entitlements, like Social Security and Medicare, are not regarded as government spending in the calculation of GDP because they do not consume resources. They are transfer programs which are irrelevant to deficit reduction. As transfer programs, they reallocate income from one consumer (taxpayers) to another (retirees). One could argue the merits of income reallocation on questions of fairness etc. but it is false to argue that the programs can become insolvent. The are just like any other government program funded with tax revenues, and they can only become insolvent if the government becomes insolvent. Since the revenues from payroll taxes are not sequestered, and are used for any purpose decided by government, it doesn't make any more sense to talk about entitlement insolvency than it does to refer to defense spending and insolvency. From Galbraith's perspective, the attack on entitlement spending is merely an attack on income redistribution and the so called welfare state. This is a perennial target of attack by conservatives.
He ends his critique by showing the flaws in the claim that we will be punished by the bond market with higher interest rates if we do not balance the budget. He points out that the current yield on long term government bonds is very low. The bond market does not seem to be concerned about the risk of default on government debt. It can be argued that the bond market can be fickle and change its mind. But in that case, the assumption must be that the bond market is not rational, and that it is impossible to predict what it will do under any circumstance. Moreover, the assumption used to forecast large increases in future interest rates, which is responsible for substantially higer interest payments relative to GDP by 2050, is not consistent with the assumption that inflation will be only 2%. We don't have high interest rates when investors do not price in an inflation premium.
He points out that there is a risk to dollar depreciation but that might reduce our trade deficit. His last point is that there is a strong relationship between our trade deficits and the amount of US debt held by international investors. As long as we have large trade deficits, international investors will have to find a way to invest the dollars that they accumulated along with their trade surplus with the US. If we want to reduce our dependence on foreign lending we will have to reduce our trade deficits.
Thursday, November 25, 2010
Most recent data are not encouraging. Fed has kept interest rates low and inflation is almost non-existent. Industrial production is steady at a low rate of growth which is reflected in slow growth in payrolls and the unemployment rate stuck above 9.2%.
This is not your father's recession. The economy seems to be stuck in low gear. The longer it persists at this level, the more difficult the recovery.
Wednesday, November 24, 2010
"Let us clear from the ground the metaphysical or general principles upon which, from time to time, laissez-faire has been founded. It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. There is no ‘compact’ conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately. We cannot therefore settle on abstract grounds, but must handle on its merits in detail what Burke termed: "one of the finest problems in legislation, namely, to determine what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion..."
This quote provides a good perspective on the economist most reviled by those who have never read him. Keynes was a pragmatist who understood the problems inherent in a society in which private interests were not balanced with the public interest. It is important to figure out the proper role of each in terms of the practical problems that we face. In other words, the doctrine of private supremacy is an ideological approach that can impede social progress. He was totally opposed to the notions of a corporatist or a statist society. Of course, his belief that the public interest might be served by the state was heresy to economic fundamentalists who preferred a society without a counterbalancing role for the state. Most forms of fundamentalism are primarily an impediment to careful thought about how to deal with social issues. They are an alternative to the use of mind.
Krugman sounds much like Stockman in the article posted below. According to Krugman, Obama's assumption was that he could change the way that Washington works. The GOP and the Democrats would come together to deal with the enormous problems that he inherited. I guess he didn't learn much from watching what happened to Clinton after he assumed the presidency. The GOP immediately did everything that it could to discredit the president and his wife in the eyes of its conservative base. Today, Hillary bashing has been replaced by Michelle bashing, and Obama bashing produced calls for impeachment before he was even sworn into office.
The GOP has depended upon a solid South ever since Nixon developed the southern strategy in response to the civil rights movement. Obama's success in several southern states, paralleled Clinton's success. They realized that this could not continue or they would be the minority party again for a long time. The majority party controls all of the congressional committees and, as a result, has greater access to campaign contributions because it has more influence over policy. What we are seeing today is simply the battle to regain control over key committees by becoming the majority party. Fixing our national problems is not a priority.
"Obama’s presidency is a profound disappointment. So far, he’s proven that when Republican’s start elective wars, Democrats can’t end them; when Republicans empty the Treasury, Democrats can’t replenish it; when Republicans put a middle-class destroying money printer at the head of the Fed, Democrats reappoint him; and when the Republicans unleash an orgy of dangerous speculation on Wall Street, Democrats pass a contentless, 2,300 page, enabling act which will do nothing to protect Main Street from another financial meltdown, even as it keeps K Street fully employed."
What's interesting about his answer is that he faults the GOP for creating the mess that we are in and he faults Obama for not taking the necessary steps to clean up the mess. This is the kind of criticism that we typically hear from progressive Democrats and not from influential Republicans. I think that this wing of the GOP has been purged from the party.
A good explanation of what the Fed is doing and the likely impacts.
It has a chance of improving the economy through two channels. It will keep long term interest rates low which might encourage business investment. It may also cause the dollar to depreciate relative to foreign currencies and stimulate US exports. The chances that this will work are not high. Interest rates are low today and business is not investing. Furthermore, our trading partners will take actions to fend off appreciation of their currencies relative to the dollar.
The primary benefit may come from warding off price deflation. Price deflation is dangerous for several reasons. If prices for goods fall, wages will fall even faster. Consumers will have less money to spend and they will have less money to pay down their debts which will not fall. Falling prices also make it more likely that businesses will sell their products for less than they paid for them. The Fed understands that price deflation is very bad for the economy and hard to correct once it gains momentum.
It is possible that the Fed's policy can lead to inflation if they don't take steps to control it after the economy strengthens. The Fed understands this and it is better at controlling inflation than it is in beating back price deflation.
The Fed would like Congress to supplement its monetary policy with fiscal stimulus but it understands that this is politically unlikely given that campaign 2012 has stared already.
Tuesday, November 23, 2010
Corporate profits last quarter were the highest in 60 years of history. They were due partially to higher productivity, which means higher output per hour worked, and to investments in faster growing markets overseas. Since output increased with a smaller workforce, corporations have little incentive to add employees, and the unemployment rate is unlikely to fall.
The economy grew at an annual rate of 2.5%. This was higher than forecast but it is not enough to reduce the risk of deflation. Ordinarily, the economy grows more rapidly coming out of a recession.
This is because businesses draw down their inventories during the recession and they must rebuild them during the recovery. Consumption often expands rapidly as well because households have delayed spending during the recession and there is latent demand to be satisfied. However, this is not a typical recession and recovery. Recessions are usually deeper and recovery is slower when a recession is accompanied with a financial crisis and households have high debt levels to draw down.
Lack of demand from major investors, such as university endowments, and shrinking pipeline, worry Facebook founder who is now a VC. Investors have become more risk averse after major losses from risky bets and there are fewer opportunities to fund companies seeking long-term viability and IPO for payout. Most are looking to flip the companies to larger companies seeking technology. He is very negative about the big bets that VC's have made on green technology start ups. Most will not pay back investors. This raises the general question about where our growth will come from in the future.
This is a long read but it does an excellent job of describing how Wall Street has evolved from a system that creates value by allocating funds to their most productive use, to a system that makes most of its money by making bets that provide little social value but huge benefits for bankers.
Monday, November 22, 2010
Frank Rich tells the Palin story well. I am reminded of the movie Citizen Kane which was about William Randolph Hearst's attempt to win political office by using his newspaper empire to promote his cause. Hearst also used his papers to turn his mistress into a star. Murdock is smarter than Hearst. He is using his media empire to create a star that has real charisma. And he is smart enough to know that she has a better shot at winning political office than he would have. She already has the support of 80% of the GOP base and she has only just begun. Moreover, the larger her base the better it is for his bottom line. He must have a great time laughing his way to the bank.
The Fed has changed its forecast for the US economy. It expects unemployment to be higher and longer in duration than previous forecasts. It also forecasts the inflation rate to be below 2% for the next few years. This forecast provides the rationale for its plan to use monetary policy to prevent deflation. Sarah Palin disagrees with Fed's plan. She claims that it is inflationary and she uses a different method than the economists at the Fed to measure inflation. Its best called the ordinary person's method of analysis. She claims that she went to the super market at found some of the prices of groceries had increased. Who needs the Fed?
It wasn't too long ago that the GOP pushed the Bush tax cuts through Congress. Their argument, at that time, was that a slight downturn in the economy required strong medicine. Essentially, they were advocating a Keynesian approach to cutting unemployment. The tax cuts, combined with increased government spending, produced budget deficits and helped to stimulate economic growth. Today, the same party that invoked Keynesian economics to bolster the economy has declared that Keynesian economics is socialism, or perhaps it is Fascism, or maybe its Islamic economics, or maybe its anything that will help them win back the presidency in 2012. Most of their base does not understand the difference between these things anyway. As Sarah Palin proclaims in her revival tour of her homeland: "Give us our guns and our religion", or let them eat guns.
Sunday, November 21, 2010
This graph shows the enormous rise in US household debt, with the most rapid increase beginning in the early 2000's with development of the housing bubble. Household debt was 60% of income as recently as 1985. It increased rapidly during the housing bubble to almost double the 1985 percentage by 2007.
Ordinarily, economic growth is a response to rising average household income. Since average income growth has been flat, our economy was driven by debt which is unsustainable. Households have begun to pay down their debt and they are saving more. This is one of the reasons for a slowly growing economy. The American consumer is no longer driving the US economy and the US is no longer the consumer of last resort for the world economy. This has created problems for countries dependent upon the US consumer. One of the consequences of slower growth in the world economy is that savings are flowing from slow growth economies to more rapidly growing economies. This creates inflation problems in those countries and it causes them to take actions to keep their currencies from rising in relation to the dollar. Another problem is that investors have become risk averse. They have been purchasing safer assets instead of investing in productivity enhancing assets that might provide the basis for future economic growth. The world economy has not only depended upon the US consumer. It has always looked for the US to provide leadership. This has not been forthcoming.
In order for the US government to lead the world economy it must have the support of the American people. One of the results of the US financial crisis, and the government's response, has been a loss of trust in government. This is reflected in the Tea Party movement, but is also evident among liberals. Too many Americans viewed our response to the financial crisis as an indication that government no longer serves the average American. It will take a long time, and it will take actions instead of words, to convince Americans that the government is on their side.
One of the categories in measuring the economy is government spending. We add spending by households along with investment spending by business and subtract our trade deficit to get GDP. Since GDP rises and falls in response to changes in the business cycle, this graph shows government spending as a percent of potential GDP which assumes full-employment and negates the effect of business cycles on GDP.
We only count government spending on the delivery of government services as part of GDP. The red line shows that discretionary government spending as a % of potential GDP has declined since the sixties. The green line shows mandatory government spending on transfer payments. This includes entitlements such as Medicare, Medicaid, Social Security, Veterans Health Care etc. This line shows that most of the growth in government spending has been mandatory spending and that discretionary spending, which is controlled by Congress, has been shrinking as a percent of GDP. The blue line shows what current government expenditures would look like as a percent of GDP over time. Current government expenditures as a percent of GDP are slightly elevated by transfer payments and about the same as they were in the 80's under the conservative icon Ronald Reagan. Our current budget deficits are primarily due to rising transfer payments, lower tax revenues from the Bush tax cuts and from the recession. They are not the result of large increases in discretionary spending.
Saturday, November 20, 2010
I also suspect that it may be due to the way in which we compensate executives. Top executives receive a large share of their wages from stock options. This provides an incentive for them to manage the stock price. This requires constant growth in profits to please Wall Street.
In any case, wage deflation in the US means that consumers in the US will have to reduce consumption. Since consumption is around 70% of the economy, economic growth in the US will slow going forward and multi-national corporations will continue to expand into emerging markets that provide better opportunities for growth. They don't care where their profits come from. Wall Street, and apparently the US government, share this perspective.
There are three PowerPoint presentations available from the above link that reflect the issues in the world economy and the role of monetary policy in stimulating the US economy. This is a summary of the issues as I see them. The basic problem is that we have a balance sheet recession. Businesses and households took on too much debt and they are saving more and paying off their debt. The result is what we call the paradox of thrift. If everyone increases savings at the same time, spending collapses and we have a recession. This is reflected in the presentations by very weak private demand for loans despite extremely low interest rates. The only way to fix this problem is for the public sector to absorb the flow of savings by borrowing and spending. In other words, we need to use fiscal policy to stimulate the economy. Unfortunately, it is politically impossible to use fiscal policy in the US because of the fixation that conservatives have on federal budget deficits and the longer term problem of the national debt burden. Frankly, I believe that their concern with budget deficits is both misplaced and politically motivated. It fits into the "starve the beast" tactic advocated by many conservatives, which uses the deficit as an excuse to cut spending on social programs. Also a poor economy will increase GOP chances to win back the presidency in 2012. In other words, the public interest is being sacrificed for party interest.
Friday, November 19, 2010
The article that I linked to above was published in a blog operated by a libertarian who is both a Senior Fellow at the libertarian Cato Institute and the Director of Undergraduate Instruction at Harvard. I thought that it would be interesting to get a libertarian perspective on tax policy from someone whose views were considered publishable by a distinguished libertarian who works in one of our elite universities.
I was really disappointed by the article. The rationale used to argue against a progressive tax system is typical of the arguments used by those without the benefit of an expensive education.
The article begins by telling us that the battle between the rich and poor has been going on for thousands of years and there is nothing new about the current battle. The poor will always be envious of the rich, and the poor will always be with us, so the battle over tax policy is boring and useless. He then provides us with an analysis of the issues which demonstrates either ignorance or duplicity. One of his tactics is to show that the rich pay a greater share of the federal income tax than the poor. This would be expected since those with more income are bound to pay more income taxes than those with less income. He also provides data to show that the share of taxes paid by the top income earners is larger than their share of income. This demonstrates only the obvious point that the federal income tax is progressive. Critics of the current income tax argue that it has become less progressive even as income inequality has increased. Nobody needs to be told that the income tax is progressive; critics want it to be more progressive.
Another problem with his analysis is that the income tax is not our only tax on income. Everyone with income under $105,000 pays 15.6% of their income to the payroll tax. Half of this is paid for by the employer, who deducts this cost from the wages that would otherwise be paid, and the remainder is paid by the individual. Since the tax is only applied to the first $105,000 it is very regressive. For example, the tax rate for someone who earns $210,000 is only 7.8%, and the tax rate get progressively lower as income increases. The payroll tax is just another income tax. The revenue goes into the same pot as income tax revenue, and it is spent on anything that government wants to use it for. Since payroll tax revenues exceed payouts to social security beneficiaries, the Treasury puts an IOU into the social security trust fund to cover the money that it has "borrowed" from the surplus payroll tax revenues. When the regressive payroll tax is combined with other regressive taxes, such as the sales tax, the total US tax system is only slightly progressive. It is very close to the flat tax system that many conservatives seem to like.
To make matters worse, we are told that we should not be punishing success with a progressive income tax that discourages wealth creation and hard work which has made us a great nation. A quick look at the history of the income tax will show that it was substantially more progressive prior to the Reagan tax cuts in the 80's and our economy did quite well compared to its growth rate in the last 30 years. In other words, there is no reason to believe that there is negative relationship between income tax progressiveness and wealth creation. If it were not for the progressive income tax, the combined tax rate for high income earners would be less than that of lower income earners.
We have been looking at the federal budget deficit and the implication of health care costs (which means higher prices from suppliers) on the national debt in the long-term. We have also been discussing the health care reform bill and the reasons why there has not been as much support for health care reform. One of the problems is that a lot of people receive insurance benefits from their employers and they do not believe that reform will serve their interests. They think it primarily benefits the poor who do not have employer provided insurance. This graph should cause all of us to think twice about the need for reform. It shows that spending by households, less spending on health care, has been pretty flat since 1960 while consumption as a percent of GDP has risen dramatically, especially since the 80's. As a nation, we are spending an increasing amount of our income on health care because prices have been rising twice as fast as GDP (or income). Lets consider why this is a problem.
In the first place, the rising costs are a burden to employers who have been providing the insurance. This makes those who compete in global markets less competitive against firms in countries with less expensive health care and in countries in which the cost is borne by the government. This is one of the reasons why multi-nationals have moved much of their production off-shore. Furthermore, the trend has been to pass more of the cost of insurance on to employees. This is done by purchasing coverage with higher deductibles and co-payments but it has also been done by capping employer contribution to the cost and shifting the burden of price increases to employees. If health care prices continue to rise at twice the rate of income we will all be forced to spend an increasing share of our income on health care.
During the debate on health care reform the GOP scared lots of people by claiming that the bill was designed to ration health care. A lot of folks on Medicare believed the "granny scare" tactic employed by the GOP and its media outlets. What people don't understand is that pricing is a form of rationing. Many of us would like live in a million dollar house and drive an expensive luxury car. Most of us cannot do so because the high prices ration these luxuries for those on moderate incomes. Health care works the same. As prices rise it becomes less affordable and it is rationed by the pricing system. The GOP approach to health care reform is to let prices do the rationing. They are not interested in limiting price inflation. They would rather collect campaign contributions from the health care providers by" keeping government off of their backs".
Thursday, November 18, 2010
Bloomberg reported on Bernanke's defense of monetary policy at a closed meeting with senators. The response from senators was predictable and uninteresting. Buried at the end of the report was the most important piece of information. They reported that the core inflation rate in the US was only .6% year to year in October. This is the lowest post war inflation rate recorded in the US. We call the reduction in the inflation rate disinflation. If it falls into negative territory it is call deflation. That, of course, is what the majority in the Fed are worried about. The goal of monetary policy is to avoid deflation. The Fed is skilled at controlling inflation. Deflation is much more difficult to control once it gets started. After all, we have a recession when there is not enough spending in the economy to absorb the output of a full-employment economy. That is why we have unemployment. Business investment is targeted to create the output consumers intend to purchase. The problem with deflation is that money becomes more valuable when prices fall. Consumers hold on to money instead of spending it. It also affects debtors negatively. They have to pay back their mortgages with more valuable dollars. This would not be good for the housing market.
Its easy to understand why the public has been so poorly informed about the health care reform bill that many detest. The insurance industry contributed $86.2 million to the US Chamber of Commerce which led the disinformation campaign by stressing the negative impact it would have on small businesses. I was rather surprised that the insurance industry would lobby so hard to protect small businesses rather than their own interest.
The usually moderate voice of the Washington Post op-ed staff raises another critical comment on the Billionaire Populism championed by Jim DeMint. With the help of many of our distinguished leaders in the Senate the lobbyists for the hedge fund industry have protected the outrageous tax benefit that they enjoy. Their income is taxed at the capital gains rate of 15% instead of the ordinary income rate for the top earners of 35%. This means that the top hedge fund CEO, who earned over $4 billion last year paid only 15% on that income. The Tea Party crowd, thanks to leaders like Jim DeMint, defend this policy on the grounds that Americans would not put in the effort to create wealth if they were taxed for the effort. That would be punishing success. We should be punishing the losers in society by ending government programs that unfairly benefit them by taxing the unfortunate rich.
Jim DeMint, the purported leader in the Senate of the Tea Party segment of the Senate, will have to find some new reasons for opposing the government bailout of GM. The 1.4 million jobs that are estimated to have been created by the new GM and its suppliers are not in the capital of the Tea Party republic in S.Carolina.
In the 1940's the top 1% in Argentina had more than 20% of the national income. Their share in Argentina was more than twice that in the US. Many will be pleased to learn that we have more than closed that gap. The top 1% in the US has taken the lead. They have 24% of the income while the top 1% share in Argentina has dropped to 15%. I'm sure that we are well on our way to increasing our lead, USA USA USA
Even more good news. By extending the Bush tax cuts the top 0.1% will get an average of $370,000 in tax cuts. Our after tax lead over Argentina will be even better.
Uwe Reinhardt is an economist from Princeton and one of the most respected experts on the economics of health care. He discusses the choices that he would make and his rationale for each choice. There are value judgments in his selections of things to cut but his rationales have more reasoning behind them that those of the less informed.
He makes the point, that most everyone agrees with, that politicians have spoiled us by providing government services and benefits without paying for them with taxes. His graph which shows that the US has the lowest percentage of tax payments as a percent of GDP than any industrialized country in the world may surprise you. It will certainly give your conservative friends another good reason not to be confused by facts. I tend to agree with the comment of a famous GOP senator from another era: "Everyone has a right to their own opinion. They are not, however, entitled to their own facts".
Wednesday, November 17, 2010
You may enjoy the dialogue between the conservative columnist David Brooks and the more liberal columnist Gail Collins. They both played the budget cutting game and came up with different solutions. Their interchange was good humored but they did a good job of making some of the trade offs more apparent. The both pointed out that the big elephants in the room are the Bush tax cuts and Medicare. Without dealing with these issues we don't get very far.
A thoughtful article in the Post on the beginning of the 2012 campaign. This time the Fed is under attack for its efforts to use monetary policy to fight price deflation and high unemployment. This may not work the way the Fed intends but they have already reduced interest rates as far as they can and they are running out of ammunition. Unfortunately, political opportunists in the GOP have decided that they can cash in on their love affair with the growing segment of their base that hates government and particularly the "eastern elitists" in the Fed. Consequently, Fed bashing has substituted for rational debate. The Fed is required, by law, to manage price stability and to use its tools to encourage reasonable economic growth and full-employment. GOP leaders want to restrict the Fed's role to managing price stability. What they don't understand is that this is exactly what the Fed is doing when it attempts to prevent price deflation. Moreover, the only way they can fight price deflation is to use monetary policy to encourage economic growth and lower unemployment.
One of the major platforms that John McCain ran on was the elimination of earmarks to reduce the federal budget deficit. Today it is one of the major pleas coming from the Tea Party and acted upon by GOP Senate leadership. Most people will be surprised to learn that it really does little to reduce deficits. Its not a bad idea but we should not be deluded about the implication.
One of the things that amaze me is the similarity of the political and social reactions to the Great Depression and the Great Recession. FDR ran his first campaign with balancing the federal budget as one of his goals. He did this because the depression had eroded tax revenues and put the budget in deficit under Hoover just as it has done under Obama. Some of the programs that were introduced after FDR took office helped the economy to recover but the increased the federal budget deficit. Taxes were increased and spending was cut in response and we had a double dip depression. We know much more about how the economy works today but the politics are not much different. Lets hope that we get lucky.
One of the suggestions in this article linked above is that we simplify the tax code. The basic problem with the tax code is that politicians make it more complex every year because it is one of the ways that they can milk campaign contributions out of the beneficiaries from the changes that they make. As long as politicians are dependent upon large contributions to run campaigns, we will never simplify the tax code and we will never spend government funds in a way that maximizes the public good.
Warren Buffet has a way of putting complex issues into a simple story that everyone can understand. I realize that there are many folks out there who believe that we should have just let all of the banks fail. Its easy to say that if you are a religious fundamentalist and your religion is free market capitalism. Its even easier to take that position if you are not aware of the potential consequences. Warren Buffet understands what the consequences would have been if government had not put its finger in the dike. He also knows that we might have done it better and we might have done more in the aftermath to punish those who brought the world economy to its knees. Frankly, if all of our billionaires were like Warren Buffet the world would be a much better place.
Tuesday, November 16, 2010
This is an excellent follow-up, by a respected economist, on the interactive tool (available from my link on OK You Fix the Budget) that you can use to provide your solutions for fixing the budget. You cannot fix the problem without making value judgments. For example, you have to decide which group might have to pay higher or lower taxes. You have to decide whether to raise taxes, or cut spending (and what spending to cut). Economics cannot answer these strategic questions. It is essentially useful as a tactical tool to help us measure the economic impact of the decisions that are being considered.
A good example of the value issues can be deduced from reactions to Obama's health-care bill. I believe that he had three things that he wanted to accomplish with the bill. One was to expand coverage to the uninsured and another was to reform the insurance industry. A third goal was to reduce the cost of health care, in small steps, because he realizes that rising health care costs are the greatest threat to the national debt in the long term. Opponents to the bill used focus groups to determine how to use turn a decent, but not perfect bill, into Obamacare and produce strong negative reactions to the bill. In the South, it was portrayed as a bill that would extend health care to groups that are perceived negatively. That is, it was going to provide health care to blacks, illegal immigrants and other negatively perceived groups. It was also positioned as socialism and an unnecessary expansion of government, or an intrusion on states rights. Of course, people who are well covered by insurance had no vested interest in expanding coverage or in changing the system. Many in this category, saw no reason to support the bill, but reasons to attack the bill if they believed that it might increase their taxes. This group does not share the president's concern about the long term impact of increasing health care costs on the federal debt. Most don't understand it, and the administration did a poor job in explaining it. In any case, opponents did a better job of creating negative reactions to the bill than advocates did in justifying the bill. It was simply a matter of value judgments, and unfortunately, a very effective misinformation campaign.
CBS poll on results of election and other opinion in above link shows that Cheney was right. He told Bush that "deficits don't matter and that Reagan proved it". What he meant was that Reagan won the election by cutting taxes and increasing spending. This produced big deficits which were funded with debt. Bush took his advice. With a democrat in the White House, deficits seem to matter again.
Monday, November 15, 2010
Orzag was formerly the head of the CBO and the OMB. Nobody knows these numbers better than Orzag. His view is that the proposal on SS reform developed by Obama's budget commission is not a bad start. He understands that SS is not the biggest budget problem that we face long-term but it is something that we can deal with by starting with the recommendations of the commission. He also thinks that its a good idea to build on a system that does not include the privatization of SS that Bush advocated unsuccessfully.
The above link is to an article in today's NYT that lays out many of the issues in fixing the federal budget. The author gives you the choices and asks you to make the decisions. You will discover that many of the choices that can be made involve value judgments. That is, what do you want to do with taxes and what do you want to do with spending. In other words, whose ox is being gored by your choices?
When I think about politics it comes down to answering the above questions. Just follow the money. Government tax policy determines how much revenue that is raised; it also determines the sources of the tax revenue. Government policy also determines how the money will be spent. If everyone understood tax policy and how it is determined, and how spending decisions are made, our system would work pretty well. Unfortunately, these things are poorly understood and our electorate rewards politicians who express concerns over deficits but who are not specific about what they will do to correct them. Heaven for many politicians is to provide government benefits to win votes, while they are also giving voters tax cuts which also wins votes. They do this by paying for benefits with debt instead of with taxes, but they express grave concern about deficits which makes them appear serious about fiscal policy.
Sunday, November 14, 2010
Historically, class warfare has been defined as actions taken to redistribute wealth from the rich to the less affluent. The op-ed by Frank Rich, cited above, provides data that suggests that we need to redefine class warfare. The data indicate that in "building a bridge to the 19th century", or to the new gilded age that characterized America at the turn of the last century, the warfare has been conducted by the super-rich against everyone else. It has been accomplished with the assistance of politicians in need of contributions to fund increasingly expensive election campaigns. Even as the income gap between the top earners and the middle class has widened, tax policy has made the after tax income gap even wider. Moreover, the arguments made to preserve tax policies that favor the super-rich, are shown to be specious when we consider the current debate over the extension of the Bush tax cuts which made the federal tax code considerably less progressive.
The administration favors extending most of the Bush tax cuts ; it would reset the top marginal tax rate for households with incomes over $250,000 back to the rate that was in force during the Clinton administration. The GOP calls this class warfare. Their argument is disingenuous at best. They frame it as a war against small business owners, few of whom would be considered as super-rich. In other words they understand that it is easier to defend small business than the super-rich politically, even though the increase only applies to 2% of small business owners who are in that income category. Moreover, even for those with incomes between $200,000 and $500,000, the average tax increase would be around $700 per year. Their hypocrisy is even greater when they make believe that they care about budget deficits and the national debt with full knowledge that maintaining the Bush tax cuts will add $700 billion to the national debt by 2020.
The new gilded age is not about small business owners who are portrayed as the target for the tax increase. It is about the top 1% of Americans who have seen their incomes rise dramatically in recent years. In 1976 the top 1% received 9% of the national income. This group received 23.5% of the national income in 2007 while the incomes of the middle class have barely risen at all. To make matters worse, the tax burden has been shifted from the top 1% to the middle class by changes in tax policy. Tax rates for the top 1% are 33% lower than they were in 1970. This has been done by reducing the top marginal income tax rate dramatically, but also by substantially cutting taxes on dividends and capital gains. Of course, the tax cuts on capital gains and dividends primarily benefit the super-rich whose share of the wealth in America is even greater than its share of income.
In conclusion, there has been class warfare in America for the last 30 years. It has been conducted by the super-rich who have seen their share of income rise at the same time that their taxes as a percent of their income has fallen. We need to understand that there is a difference between tax cuts and a shift in the tax burden. The super-rich pay more in taxes than the middle class because they earn more taxable income but the critical metric is not the amount of taxes paid. The tax incidence for the super-rich has fallen at the expense of the middle class. It is also important to understand that a tax cut has the same impact on the national debt as an increase in government spending. Tax cuts only reduce the national debt when they are paid for with spending cuts. The largest tax cuts occurred in the Reagan and Bush administrations. They were not paid for with cuts in spending, they were funded with debt. Consequently, they are responsible for the most of the increase in our national debt prior to the Great Recession.
Saturday, November 13, 2010
This article illustrates several of the major problems in the global economy and in our domestic economy. President Obama got a cool reception at the G20 meeting which dealt with the important issue of global trade imbalances as well as the role of government in fostering economic growth.
Nations with trade surpluses, such as Germany, China and emerging market countries, expressed concern over the Fed's decision to purchase $600 billion of long-term US treasuries. They believe that efforts to maintain low interest rates in the US will cause investors to seek higher returns by increasing the flow of dollars to surplus nations with higher interest rates and faster growth rates. They worry that this could fuel inflation in their economies and cause their currencies to appreciate relative to the dollar. This could also make their exports more expensive and increase the prices of commodities which are traded in dollars. In short, they believe that the US is worried more about its domestic economy than it is about the global economy
China took the position that the US was not taking its responsibility as the issuer of the world's major reserve currency seriously. Of course, the US has been after China, which pegs its currency to the dollar, to let market forces work to increase the value of is currency to the dollar.
This is a familiar issue that has been with us for some time.
Germany's response was deeper and more telling. It has a trade surplus with the US (as well as with other nations) and it has been able to export its way to economic growth. It suggested that the US should make products that the rest of the world wants to buy instead of trying to devalue the dollar to make US products less expensive in world markets. This raises questions about structural issues in the US economy. Manufacturing wages in Germany are higher than those in the US yet Germany has been able to run a trade surplus while the US has run huge trade deficits. Germany exports manufactured products, which create jobs, while the US has lost its competitiveness in many areas in which it was able to create surpluses. For example, up until 2002 the US ran a trade surplus in many high technology areas. The surplus turned into a $17 billion deficit in 2002 and the deficit increased to $53.6 billion in 2007. This is a trend that should worry us. We may not be able to restore our trade balance by selling financial products or agricultural products to the rest of the world. Besides, these are high productivity sectors which do not create jobs.
There was also a lack of consensus about the role of government to stimulate economic growth. Germany was opposed to government actions that would increase deficits and debt. This may make sense for Germany which is a leading exporter. The UK took a similar stance but for different reasons. Its newly elected conservative government is intent upon using spending cuts to restore fiscal balance. Conservatives in the US would like to take a similar approach by cutting spending, and strangely enough by cutting taxes which will deepen our deficit.
The global financial crisis has exposed major weaknesses in the global economy and in the US. Our domestic economy was fueled by debt instead of by growth in income. Average wages in the US have been relatively flat for 30 years. Growth in consumer spending has depended upon rising debt levels which has been exposed by the bursting of the real estate bubble and a weakening of the banking system. Unfortunately, Obama does not have the full support for taking the necessary actions in his own party and the Republicans will continue their policy of placing the destruction of the Obama presidency above that of restoring the US economy. Things could get worse before they get better.