Economic Reporting Review
 By Dean Baker
April 18, 2005

In This Issue:

•  Outstanding Story of the Week

•  Social Security

•  The Estate Tax

•  Trade

•  China

•  Germany

•  Wage Growth


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Outstanding Story of the Week

Report Says Financial Firms Are at Less Risk of Tax Audits
David Cay Johnston
New York Times, April 11, 2005, Page C2

This article reports in audit rates among different types of companies. It reports that large financial firms are only one-fifth as likely to be audited as large manufacturing companies. It also notes that many audits are incomplete, since auditors face pressure to complete them quickly. 

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Pensions: Big Holes In the Net
Mary Williams Walsh
New York Times, April 12, 2005, Page E1 

This article examines the structure of pension regulation in the United States, pointing out many of its inadequacies. 

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Disparities Found in Sub-Prime Lending
Kirstin Downey
Washington Post, April 11, 2005, Page A2

This article reports on a new study that shows that African Americans were nearly three times as likely as whites to have a high interest sub-prime mortgage. 

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Social Security

Bush to Shift His Social Security Focus to Solutions
Richard W. Stevenson and Robin Toner
New York Times, April 10, 2005, Page A19

This article reports on President Bush’s new strategy to push his Social Security agenda. At one point the article reports that Bush plans to start discussing ways to put Social Security “on a sound financial footing.” It later refers to the “painful steps” necessary to improve the system’s finances.

It is worth noting that according to the Congressional Budget Office (CBO), the system is fully solvent for the next 47 years, with no changes whatsoever. Most people would probably consider this to be “sound financial footing.”  The CBO also shows that the measures needed to bring Social Security into balance over its 75-year planning horizon are only 40 percent as painful as the measures needed to pay for the rise in annual defense spending since 2000. Filling the projected Social Security shortfall will only be 20 percent as painful as paying for President Bush’s tax cuts. 

Recent polling data shows that public has been badly misled by reporting on Social Security’s finances. For example a New York Times poll reported this week that most workers under age 45 do not believe that the program will pay them a benefit when they retire. 

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A Safety Net With Some Holes
Monte Reel
Washington Post, April 11, 2005, Page A11

For Many, It’s Back to the State
Glenn Frankel
Washington Post, April 11, 2005, Page A11

These articles report on the privatized Social Security systems in Chile and Britain, two countries that have often been held up as models by proponents of Social Security privatization. Neither article gives a clear discussion of the administrative costs of these systems, which is probably the most important issue in comparisons with the current system. (The returns in these countries don’t provide any special insights – in the same way that score in two random basketball games will not provide us with any useful insights into the score in the last game in the NBA championships.) The annual administrative costs of both systems have been between 15 to 20 percent of the annual flow of money into the system. By contrast, the administrative cost of Social Security is just 0.5 percent of the money that flows into the system. 

There are also substantial fees associated with converting accounts into annuities – lifelong streams of income. The private financial system typically charges between 15-20 percent of the amount accumulated in these accounts. 

At one point the article claims that “like many western countries, Britain faces a pension crisis fueled by demographics.” Actually, the projected increase in the cost of paying for an aging population is not any greater at present than it would have been 40 years ago. Western societies have been aging for the last 100 years due to improvements in medical technology and growing wealth. It would have been as accurate to say that these countries faced a pension crisis in 1965 as in 2005. 

It is also important to note that there is no scenario in which the additional expense of supporting a growing population of retirees will require more than a small fraction of the increase in wages that will be obtainable due to productivity growth. In other words, if productivity growth allows for 1.5 percent real wage growth, it is possible that rising public sector pension costs could reduce wage growth to 1.3 percent a year. It is not clear why this should be viewed as a “crisis.”

The article on Chile reports at one point that only about 50 percent of Chile’s workforce participates in its privatized pension system. It is worth noting that this is virtually the same as the participation rate in the unreformed system in 1980. One of the main stated motivations for introducing privatized systems in the developing world was to increase participation. They have largely failed in Chile and elsewhere by this measure.

The article on Chile reports that returns have averaged 10 percent annually. This was primarily due to the fact that, in the 1980s, the interest rate on Chilean government debt (the primary asset held in these accounts at the time) was very high in the first years of the system. Such returns would only be transferable to the United States if the interest rate that the United States paid on its debt soared. 

While the article does report that the Chilean system was put in place during the Pinochet military dictatorship, it would have been worth noting that the military opted to keep its pre-existing defined benefit system. 

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Pros vs. Cons: A Guide to the Debate
Edmund L. Andrews
New York Times, April 12, 2005, Page E10

This article summarizes some of the key issues in the debate over Social Security privatization. At one point it discusses the finances of Social Security from a cash flow perspective, noting that the Social Security trustees project that benefit payments will exceed annual tax revenue in 2017. 

This date actually has no meaning whatsoever from the standpoint of Social Security, although proponents of privatization have sought to highlight this date in order to promote their agenda. In 2017, the program is projected to hold more than $3.5 trillion (in 2005 dollars) in U.S. government bonds. Under the law, Social Security will draw on the interest and principal from these bonds, just as the Medicare program is doing today. 

To use the analogy in the article – this is exactly like Paris Hilton drawing on her inheritance, if her inheritance happens to be in the form of U.S. government bonds. The government will have to repay one type of bond (the bonds held by the trust fund), which can be done either by raising taxes, cutting spending, or simply issuing new debt to replacing the existing debt. 

At one point the article discusses the possibility that “add-on” accounts outside of Social Security will be created as a result of the current debate. It claims that these accounts would add to national savings. This is not necessarily true. If the accounts included subsidies that were paid by a larger deficit, then they may have no effect whatsoever on national savings. 

The major potential economic gain of a new system of add on accounts would be the drastic reduction in administrative waste that would be achieved if the government created a centralized system, like that envisioned by Bush’s Social Security commission, that could compete with the private financial system. The lower administrative costs of a centralized system could increase retirement savings by 10 to 15 percent. In addition, according to the Bush commission’s assessment, workers could increase the size of the annuities generated by an account by as much as 10 percent, if they were allowed to use a centralized system for buying annuities instead of relying on the insurance industry.

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The Estate Tax

The Erosion of the Estate Tax Is a Lesson in Politics
Jonathan Weisman
Washington Post, April 13, 2005, Page E1

This article details the success of the Republicans in winning support for the repeal of the estate tax. At one point it asserts that the “repeal movement's success has been its appeal to principle over economics.” 

This claim is questionable. The repeal movement consistently held up small business owners and family farmers as victims of the estate tax. In fact, the overwhelming majority of small business owners will absolutely nothing under the estate tax due to its high exemptions ($1.6 million for a couple, prior to the 2001 tax cut). Even when the estates of small business owners crossed threshold level for the tax, their liability would generally limited, since the tax is only paid on the increment over the threshold, not the entire estate.

At this point, a very small segment of the public realizes how little small business owners and family farmers are actually affected by the estate tax. The repeal movement’s success probably owes at least as much to its ability to deceive the public on who is affected by the estate tax as to any appeals to principles. 

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True to Ritual, House Votes for Full Repeal of Estate Tax
David E. Rosenbaum
New York Times, April 14, 2005, Page A19

This article reports on the House’s approval of a bill that would permanently repeal the estate tax. At one point it presents the argument of proponents of repeal that the estate tax harms family farms and businesses. It would have been helpful to note that only a tiny fraction of family farms and businesses are affected by the estate tax because of the large exemptions. In reality, only a small number of very wealthy estates are subject to the estate tax. 

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Trade

Sugar Sours CAFTA Hearing
Paul Blustein
Washington Post, April 14, 2005, Page E1

This article reports on the congressional debate over the approval of the Central American Free Trade Agreement. The article repeatedly refers to the agreement as a “free-trade” agreement and its supporters as proponents of “free trade.”

This is not accurate. While the agreement reduces some trade barriers it also increases some types of trade protection, most importantly by increasing copyright and patent protections. The agreement also leaves in place many protectionist barriers, most notably the professional and licensing barriers that protect highly paid professionals in the United States (e.g. doctors and lawyers) from foreign competition. Most proponents of free trade agreements are strong supporters of measures that protect this segment of the labor force.

Proponents of recent trade agreements use the term “free trade” because of its positive connotations with large segments of the public, in the same that opponents of the estate tax refer to it as the “death tax.” News stories should not adopt inaccurate labels used by one-side in a political debate. 

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Demand for Oil Helped Push U.S. Trade Deficit to $61 Billion in February
Eduardo Porter
New York Times, April 13, 2005, Page C6

This article reports on the Commerce Department’s release of trade data showing that the deficit had hit yet another record in February. The article reports comments of several analysts that the cause of the trade deficit is the under-valuation of China’s currency and the currency of other East Asian countries. It then counters this view with the claims of some economists that the problem is that the United States does not save enough.

In fact, this is the same argument. The mechanism through which low savings leads to a trade deficit is by raising the value of the dollar. In principle, low savings leads to higher interest rates in the United States, which leads more foreign investors to buy U.S. financial assets. The increased demand by foreign investors for U.S. financial assets drives up the value of the dollar, thereby making U.S. exports more expensive for foreigners and making imported goods cheaper for people in the United States. Therefore, those who believe that the main factor leading to the U.S. trade deficit is inadequate saving also believe that the problem is an over-valued dollar. 

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China

China Builds a Smaller, Stronger Military
Edward Cody
Washington Post, April 11, 2005, Page A1

This article reports on China’s modernization of its military. In discussing China’s military potential, the article reports that the country has a $1.3 trillion economy that is growing at the rate of 9 percent a year. 

While this is the size of China’s economy using a currency conversion measure of GDP, virtually all economists would agree that a purchasing power parity (PPP) measure (which applies the same set of prices to goods and services produced in the United States and China) is a more accurate basis for international comparisons. By the PPP measure, China’s GDP is already more than $7 trillion, more than 60 percent of the size of the U.S. economy.

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Germany

Nation That Once Drew Guest Workers Now Sends Them
Richard Bernstein
New York Times, April 14, 2005, Page A4

This article reports on a recent trend among young German workers, primarily those if former East Germany, to travel to other countries for jobs. The article reports that Germany has a 12.5 percent unemployment rate. This is the measure of unemployment using the German government’s definition. This definition treats anyone working less than 15 hours a week as being unemployed. Using the OECD’s standardized measure, which is similar to the U.S. measure, Germany’s unemployment rate is about 9.5 percent. The unemployment rate if the part of the country that was formerly West Germany is approximately 8.0 percent.  

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Wage Growth

Falling Fortunes of the Wage Earner
Steven Greenhouse
New York Times, April 12, 2005, Page C1

This informative article reports on the fact that real wages have been falling in the last year and a half, in spite of extremely good productivity growth. At one point the article quotes an economist who terms this surprising since the unemployment rate is close to 5.0 percent, a relatively low level.

While the unemployment rate is currently fairly low, it is important to realize that it may not currently be a good measure of the tightness of the labor market. The ratio of employment to population (EPOP) is still near its recession low, 2 full percentage points below its 2000 level. In the last four years, millions of people have simply dropped out of the labor force, reporting on surveys that they are neither working nor looking for work. If the EPOP were the same today as in 2000, it would imply that another 4 million people had jobs. 

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