Economic Reporting Review
By Dean Baker
January 21, 2003


California's Budget Deficit

Calif. Faces Harsh Budget Action
Rene Sanchez
Washington Post, January 11, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A40357-2003Jan10.html 

Californians Hear Grim Budget News
John M. Broder
New York Times, January 11, 2003, Page A1
http://query.nytimes.com/gst/abstract.html?res=F70E10FA3D550C728DDDA80894DB404482 

      These articles both report on California's budget shortfall, which is now projected to be $34.6 billion, or more than 30 percent, in the 2004 fiscal year. California's governor, Grey Davis proposes to address the shortfall with a series of spending cuts and tax increases.  Both articles include a statement from James L. Brulte, the Republican Senate leader that, raising taxes in a sluggish economy is counterproductive.

      It is worth noting that spending cuts are at least as counterproductive. The immediate effect of tax increases is to pull money of the economy, thereby leading to less spending, which would be expected to lead a loss of jobs and output in the short-run. Similarly, a reduction in state spending also pulls money out of the economy. In some cases this will mean a direct loss of jobs, as when the cuts involve layoffs of teachers and firefighters. As with tax increases, there will also be an indirect effect, as the people who no longer receive state money (either workers who lose their jobs or individuals receiving a transfer payment – such as a health care subsidy), cut back their spending since they have less money in their pocket. Since spending cuts can directly cost jobs, and also pull money out of people's pockets, during a recession they are at least as harmful to the economy as a tax increase.

Bush Tax Cuts

Key GOP Senators Object to Bush Plan
Dana Milbank and Jim Vanderhei
Washington Post, January 11, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A40552-2003Jan10.html 

      This article reports on the reaction of several Republican senators to President Bush's tax plan. At one point it quotes comments from Vice President Dick Cheney, in which he said that the tax cut would spark enough growth to actually increase tax revenue. While it is plausible that the tax cuts could lead to some increase in growth, it is not plausible that the increase in growth due to the tax cuts would be large enough to offset the lose revenue. In order to offset an annual lose of revenue equal to 0.6 percent of GDP (approximately the size of the tax cut), GDP would have to rise by 3.0 percent.

       The Congressional Budget Office estimated than an increase in national saving of 2.5 percent of GDP would eventually lead to an increase in output of 1.6 percent of GDP. Evidence from past tax cuts, and statements from administration officials, make it questionable whether this tax cut will lead to any increase in national saving whatsoever. Given its limited impact on national saving, it is implausible that the Bush tax cuts could increase GDP by even one tenth of the amount needed to offset the loss revenue.

Some CEOs Would See A Windfall
Ben White
Washington Post, January 12, 2003, Page H1
http://www.washingtonpost.com/wp-dyn/articles/A41461-2003Jan11.html 

      This article reports on the gains in after-tax income that many CEOs will enjoy if the Bush tax cut is approved, since the dividends on the stock they hold will then be tax free. It is worth noting that many CEOs will also get large windfalls on stock options if the tax cut is approved. The tax cut is likely to lift stock prices since investors will value tax free dividends more than taxable dividends. As a result, many stock options that had strike prices set below the market price for the stock may suddenly become "in the money" as the stock price rises above the strike price. In this way, the tax break could provide a large windfall by giving value to otherwise worthless stock options.

      This is yet another example of how stock options can lead to large profits for reasons that have nothing to do with firm performance. If the strike price on executive options was indexed to movements of comparable stocks (e.g. the stock prices of other firms in the same industry), it would substantially reduce the probability that executives would enjoy large gains simply due to good luck.

December Employment Report
Economy Lost 100,000 Jobs in December
John M. Berry
Washington Post, January 11, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A40497-2003Jan10.html

     This article reports on the Labor Department's release of employment data for December. It notes that the economy lost more than 100,000 jobs in December and comments that this pushed payroll employment to the lowest level "since the recession began in early 2001." Actually, the December data showed the number of jobs 1,673,000 below its January 2001 level. The number of jobs is lower than at any point since December of 1999.

     At another point the article infers an increase in manufacturing output in December based on a reported increase in manufacturing hours and an increase in productivity. The relationship between monthly hours and output is actually not very close since there is a large amount of error in both measures. Often the two move in ways that are implausible. For example, in August, manufacturing hours were reported as rising by 0.2 percent, while output was reported as being unchanged. This implies that productivity was falling at a 2.5 percent annual rate in August. Since manufacturing productivity has been rising at a 4.0 percent annual rate, this sort of decline in August is implausible. (The Federal Reserve Board's Report on industrial production in December was released on Friday and showed a 0.2 percent decline.)

Lieberman Presidential Race

Lieberman Announces He'll Seek Presidency
Dan Balz
Washington Post, January 14, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A51842-2003Jan13.html

Lieberman Announces Run For the White House in '04
Adam Nagourney
New York Times, January 14, 2003, Page A24
http://query.nytimes.com/gst/abstract.html?res=F40C14FD39550C778DDDA80894DB404482

      These articles report on Senator Joe Lieberman's announcement that he will seek the Democratic presidential nomination in 2004. In discussing Senator Lieberman's career, neither article mentions his successful effort to overturn the Financial Accounting Standards Board's (FASB) ruling on the accounting of stock options. In 1993 FASB ruled that stock options should be treated as an expense at the time they are issued and deducted from profits.  

      Senator Lieberman insisted that firms not be required to deduct the cost of stock options, and threatened to revoke FASB's status as the arbiter of accounting rules, if it did not reverse its ruling. As a result of this pressure, FASB agreed to a much weaker provision that required that options be listed in financial statements as a footnote. The failure to deduct the expense of stock options from profits contributed to the mania surrounding tech stocks in the late nineties and also to the corporate accounting scandals that have recently come to light. Senator Lieberman's role in this matter has probably had more impact than anything else he has done in his political career. 

Welfare Reauthorization
Bush Presses Lawmakers to Back Welfare Changes
Amy Goldstein
New York Times, January 15, 2003, Page A4
http://www.washingtonpost.com/ac2/wp-dyn/A56925-2003Jan14?language=printer

Bush Urges Congress to Extend Welfare Law, With Changes
Richard W. Stevenson
New York Times, January 15, 2003, Page A19
http://www.nytimes.com/2003/01/15/politics/15BUSH.html

      These articles report on President Bush's plans for a new welfare bill. Both articles refer to the fact that he intends to freeze annual spending over the next five years at its current level of $17 billion. He also proposes freezing child care assistance at $4.8 billion a year. It is worth noting that this implies cuts in real spending in both areas, since spending will not be keeping pace with inflation. If inflation follows the path projected by the Congressional Budget Office, then the value of these value federal grants will have declined by more than 13 percent in 2008, the last year covered under the proposed re-authorization.

The Budget
Spending Bill to Test Senate G.O.P.
Dan Morgan and Eric Pianin
Washington Post, January 16, 2003, Page A1
http://www.washingtonpost.com/wp-dyn/articles/A63422-2003Jan15.html

      This article discusses Republican plans to pass a 2003 budget bill. At one point it reports on a Republican proposal to cut large areas of non-defense spending by 1.6 percent. The article does not indicate whether the cut is before or after taking account of the effects of inflation. If this cut is nominal dollars, then it implies a cut of approximately 4.0 percent in real spending in the affected areas.

       At one point, the article notes that the Bush administration supports most of the proposed cuts, commenting that it "has been adamant about maintaining fiscal discipline." Given the deficits that will be created by its proposed tax cuts, it is inaccurate to describe the Bush administration as adamant about maintaining fiscal discipline, although it may be adamant about cutting non-defense spending.

 Social Security and Medicare

 Fight Looms Over Who Bears the Biggest Tax Burden
Edmund L. Andrews
New York Times, January 14, 2003, Page C1
http://query.nytimes.com/gst/abstract.html?res=F10D15FA39550C778DDDA80894DB404482

      This article examines the distribution of the tax burden as well as the benefits of the tax cut proposed by President Bush. At one point the article notes that Social Security and Medicare expenditures are projected to rise rapidly in the near future as a result of the retirement of the baby boom generation. It then raises the possibility that these costs might be met by raising payroll taxes. It notes that these taxes are extremely regressive, since they are only paid on wage income, and the Social Security tax is capped at $87,000.

       There is no obvious reason that there would be a payroll tax increase to fund these programs anytime in the near future. Social Security has built up a reserve of more than $1.4 trillion of government bonds. This reserve is projected to rise to more than $6 trillion by 2015, when the program is projected to first need any money in addition to the payroll tax. Medicare has also been building up a reserve in recent years. It would only be necessary to increase payroll taxes if the Federal government defaulted on the bonds held by these trust funds. The U.S. government has never defaulted on any debt since it came into existence. There is not likely to be much public support for a default on these bonds. Given these facts, this does not seem to be a scenario that deserves serious attention.

Social Security Faces Changes
Associated Press
Washington Post, January 16, 2003; Page A17
http://www.washingtonpost.com/wp-dyn/articles/A62935-2003Jan15.html

      This article reports on the Comptroller General's assessment of the Social Security program's long-term prospects. The article concludes by noting that the program is projected to begin paying out more money in benefits than it collects in payroll taxes in 2017.

      Under the law, this date has no relevance whatsoever for the program. In 2017 the program is projected to have accumulated a surplus of more than $6 trillion in government bonds in its trust funds. It will be able to draw on the interest and principal from these bonds to meet all benefit payments until 2041, according to the Social Security trustees' most recent projections. This makes the program more financially sound than it was at any point in the first four decades of its existence. The article should have noted the 2041 date, which does have meaning for Social Security, rather than 2017, which does not.

Africa and Trade

Bush Says He Will Ask Congress To Extend Africa Trade Benefits
Elisabeth Bumiller
New York Times, January 16, 2003, Page A4
http://www.nytimes.com/2003/01/16/international/africa/16AFRI.html

      This article reports on President Bush's plans to ask Congress to extend a bill that allows many African exports to enter the United States without paying any tariffs. The article refers to President Bush's comments about the benefits of the bill for Africa. It also quotes the head of the Institute for African Development at Cornell, who approved of the bill, but argued that eliminating U.S. farm subsidies would have great benefits for Sub-Saharan Africa.

       In standard economic theory, U.S. farm subsidiaries have a mixed effect on countries such as those in Sub-Saharan Africa. While they lower the world price of goods that some African farmers may produce, they also lower the price of food for consumers in sub-Saharan Africa. The net effect may be either positive or negative. A recent World Bank study concluded that these effects were largely offsetting, so that if the United States eliminated all tariffs, quotas, and subsidies on goods traded with Sub-Saharan Africa, there would be no net gain or loss to the nations of Sub-Saharan Africa (http://econ.worldbank.org/files/1715_wps2595.pdf).

 Education

Schools Ending Year Early Among Efforts to Cut Costs
Sam Dillon
New York Times, January 12, 2003, Page A14
http://query.nytimes.com/gst/abstract.html?res=F4061EFC3C550C718DDDA80894DB404482

      This article reports on plans to shorten the school year, and other school spending cuts, that state and local governments are implementing to address budget shortfalls. It is interesting to note that these cuts are occurring just after Congress and the Bush Administration passed federal legislation to increase support for education. It appears that the current state and local budget crises may more than offset the increases in funding provided under this legislation.

Green Construction
Not Going Green Is Called a Matter of Economics
Michael Brick

New York Times, January 15, 2003, Page C5
http://www.nytimes.com/2003/01/15/business/15BRIC.html