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Trumping Incomplete Models on Financial Speculation Taxes Print
Monday, 02 January 2012 03:00

An NYT article on changes in governance rules in the European Union (EU) referred to the United Kingdom's opposition to a financial speculation tax supported by other members of the EU. The article noted that the UK cited a study done by the European Commission that found such a tax could lower GDP by 1.76 percent.

It is worth noting that this projected drop in GDP was derived from a model was intended as a work in progress, not a well developed forecasting technique. This model did not incorporate potentially beneficial effects of a tax such as diverting resources from the financial sector to more productive sectors of the economy.

The model also has several implausible implications. For example, it implies that much of the productivity growth in the last three decades was attributable to the decline in transactions costs in financial markets. This is not a factor in standard growth models, nor do any official projections assume a slowdown in productivity growth based on the fact that it will be impossible for transactions costs to decline as much in the future as they did in the past (because they are so close to zero already). The model also implies that the UK could raise its GDP by almost 10 percent if it eliminated the 0.5 percent tax that it imposes on stock trades.

 
Non-Payment of Credit Default Swaps on Greek Debt Print
Monday, 02 January 2012 02:48

Gretchen Morgenson noted the fact that credit default swaps (CDS) on Greek debt are not being paid off despite the fact that many investors are only getting 50 cents for each dollar of debt. This issue is a bit more complicated than presented in the column.

Major European banks essentially had their arms twisted to "voluntarily" accept a partial write-down on Greek debt. The ruling on the swaps hinged on the fact that no one who held Greek debt did not actually get a payment that they were expecting. The argument was that when the Greek government failed to make a payment, then they should move to collect on their credit default swaps.

This outcome suggests that CDS may not provide as much protection as their purchasers had expected. It also suggests that CDS may not be a good way to speculate on the prospect that a government will face a debt crisis.

 
There Was No Bowles-Simpson Commission Report #4567 Print
Monday, 02 January 2012 02:25

For some reason many people in the policy community feel the need to assert that the deficit commission chaired by Morgan Stanley director Erskine Bowles and former Senator Alan Simpson produced a report. It did not. The two co-chairs produced a report, which was never submitted for a formal vote since it did not have the support of the necessary majority.

Therefore Christine Romer, the former head of President Obama's Council of Economic Advisers (CEA), was mistaken when she referred to the report of the commission. This is simply the report of the co-chairs. 

 
Robert Samuelson, Wrong Again Print
Friday, 30 December 2011 06:47

To his credit, in his column today Robert Samuelson apologized for a mistake in an earlier column. In the prior column he claimed that if Keynes saw the level of indebtedness of countries today, he would not be arguing that governments should be running deficits to stimulate the economy. The problem is that the level of indebtedness in the UK, where Keynes was writing, was far larger in the 30s than the level of indebtedness currently faced by the United States and every other wealthy country, except Japan. 

However, he makes up for this apology by making several new mistakes or misrepresentations. In the former category he repeats what he said in the prior column:

"I was arguing that today’s highly indebted governments have less leeway to adopt massive 'Keynesian' stimulus programs of spending increases or tax cuts without triggering a backlash from bond markets — higher interest rates that undermine the stimulus. I still believe that’s true; the evidence is Greece, Ireland, Portugal, Spain and Italy."

Spain certainly cannot belong on this list since it was not and is not heavily indebted. It was running budget surpluses before the crisis and even now its debt to GDP ratio is still under 70 percent. Ireland also had surpluses and low debt before the crisis, but had its debt surge as a result of assuming the debt of private banks that it rescued.

Samuelson again refuses to note the fact that these countries are in a fundamentally different situation than the United States because they are on the euro and therefore do not issue their own currency. Countries with greater debt burdens, like the UK and Japan, pay far lower interest rates than these euro zone countries. This presumably has something to do with the fact that they have central banks that can buy up their debt if there is a panic in the market. 

In arguing for cuts to Social Security and Medicare, Samuelson continues to ignore the fact that retirees pay for these benefits. Older people get a disproportionate share of government spending just as rich people do. In the latter case the reason is that rich people own a disproportionate share of government bonds and therefore get a disproportionate share of the interest paid out by the government each year. It would make as much sense to say that we should cut interest payments to rich people because the money could be better spent on children as it does to say that we should cut Social Security benefits to wealthier beneficiaries. The point is the same in both cases: they paid for these income flows.

Also Samuelson pulls a cheap trick in trying to make his case by telling readers that:

"among the richest fifth, Social Security accounts for slightly less than a fifth of total income."

This is true only because it refers to an average for the top quintile. This average includes the incomes of people like Peter Peterson and Warren Buffet. Ninety percent of Social Security benefits go to individuals with non-Social Security income of less than $40,000 a year. Eliminating the Social Security of people like Peter Peterson will not affect the program in any visible way. The only way to achieve notablyesavings is by reducing benefits for people who by any definition are very middle class. (Remember, for tax purposes people are not rich until their income crosses $200,000 a year.)

The main source of the country's projected long-term budget problems is Medicare and Medicaid. The costs of these programs are driven by our broken health care system. We pay more than twice as much per person for health care in the United States as people in other wealthy countries with little to show in the way of outcomes.

This is not a problem of seniors getting too much in benefits. It is a problem of paying too much for the health care that they and others receive. The answer to this problem is to fix the health care system, not to deny care for seniors. (One obvious route is to rely on increasing trade in health care services, but unfortunately hard-core protectionists dominate public debate so this is rarely even raised as an issue.)

 
Social Security Is NOT Selling Government Bonds Print
Friday, 30 December 2011 06:31

In an article discussing the implications of the extension of the payroll tax cut, the Washington Post told readers:

"This year, the Social Security system projects that it will pay out $46 billion more in benefits than it will collect in cash. It made up for the shortfall by redeeming Treasury bonds bought in years when there were cash surpluses."

This is not true. The Social Security trust fund is projected to earn $114.9 billion in interest on the bonds it holds. It will use a portion of these earnings to pay current benefits. It will not be redeeming its bonds.

 
When Companies Write Off Stock Options Is It an Unfair Tax Break? Print
Friday, 30 December 2011 06:02

The NYT had an interesting piece on a provision in the tax code that allows companies to write off the value of exercised options as employee compensation. This is deducted from profits and reduces their taxes accordingly.

It is not clear that this treatment is improper. In principle, the value that the company is paying the executives getting options is the value of the option at the time it is issued. For example, if a company's stock is current valued at $10, an option to buy the stock at any point in the next five years for $10 a share, may be worth $5. In principle, an award of 1 million options would then be worth $5 million. This is what the company should deduct from its profit at the time the options are issued.

However, the story described in this piece is that companies don't make any deduction from profits when they issue the options (meaning they pay more in taxes in the year of issuance then they actually should), but then deduct the value of options when they are redeemed. This means that if the stock price rises to $30, in this case the company would deduct the $20 million gain on the options (one million $30 shares being sold to the executive for $10) from its taxes. As the piece notes, this is not very different from a situation in which the company just paid the executive with $20 million in stock.

In principle, this tax treatment should be symmetric with the tax treatment where the value of the options is deducted from profits at the time they are issued. The article notes many cases with executives getting large windfalls and companies thereby getting large write-offs due to bounceback from the low stock prices of 2008-2009. While this is true, there were many options issued in the years 2005-2007 that ended up being worthless since the current value of the stock is below the strike price. 

There is an issue that many executives were rewarded for a run-up in strike prices that had nothing to do with their performance, however this is a problem of corrupt corporate governance, not the tax code. It is easy to write contracts that would only reward executives for their performance relative to a reference group so that they do not benefit from an economy-wide improvement. However, this is rarely done because corporate boards are often appointed by top management and have little incentive to reduce their pay.

It is likely that stock options cause problems in national income accounting, since this is one of the ways in which capital gains income is likely to end up being recorded as normal income, leading to an overstatement of the income side measure of GDP when the stock market rises rapidly.

 
The Over-Valued Dollar as Class War Print
Friday, 30 December 2011 05:47

This piece reports on a growing trend among major manufacturers to bring factory jobs back to the United States, but at much lower wages than what they had formerly paid. The article shows clearly how the over-valued dollar that was deliberately engineered by Robert Rubin in the late 90s has put downward pressure on wages of large segments of the U.S. workforce. With the dollar having reversed most of its gains from the 90s, U.S. manufacturing wages can again be competitive with wages in China and other developing countries. Further declines in the dollar will allow manufacturing workers to get higher wages and create more jobs.

Most professionals (doctors, lawyers, economists etc.) are largely protected (by policy) from the sort of competition that manufacturing workers face. For this reason they are likely to benefit from a higher valued dollar since it means that they can get cheaper manufacturing goods and pay less for overseas vacations.

 
Spain Did Not Run Up High Public Debt Print
Thursday, 29 December 2011 05:43

In an article discussing the current budget situation in Italy the NYT told readers:

"Germany has adamantly opposed what it sees as rewarding the bad behavior of southern rim countries like Italy, Greece, Spain and Portugal, which amassed high public debts and where tax evasion is rampant."

Actually, of this group only Greece was consistently experiencing a rise in its debt to GDP ratio. In Portugal there was some increase in the debt to GDP ratio in the years prior to the recession, but Italy's debt to GDP ratio actually had been trending downward since 2000. Spain was running budget surpluses and had a considerably lower debt to GDP ratio than Germany.

The article also asserts that the market is forcing Italy to reform its budget. This is somewhat misleading since the European Central Bank (ECB) has played a major role in creating current market conditions. The ECB has been considerably less expansionary than the Fed during the downturn, even raising interest rates last spring, ostensibly to fight inflation. In addition to pushing up interest rates on government debt, the ECB's policy has reduced growth and employment, worsening the budget situation of euro zone countries.

 
The Daily Beast Acts Up on the Economy Print
Wednesday, 28 December 2011 14:15

Sometimes a little kid will deliberately be bad just to get attention from her teacher or parents. This seems to be the philosophy of a Daily Beast column by Zachary Karabell, which uses what seems to be some deliberately bad economic analysis to tell us things are really pretty good.

The piece begins with the incredible assertion:

"years from now, when we look back at 2011, it may be remembered as one of the best worst years of the early 21st century. You’d be hard-pressed to come up with an extended period where people were more negative, yet remarkably, in the United States at least, not much actually happened."

No, 2011 looks better than 2009 and 2010 and certainly better than ending of 2008, but most of the country would be hard-pressed to find a reason to put 2011 ahead of any of the years prior to the crash. The unemployment rate for the year is likely to average above 9.0 percent. The number of people who are involuntarily underemployed has generally been 8.5 and 9.0 million, close to double the pre-recession level. Millions more have given up looking for work altogether. Real wages have been stagnant or falling for the last 4 years, with little prospect of turning around any time soon as the high rate of unemployment continues to depress wages.

In addition, tens of millions of baby boomers are approaching retirement with almost nothing to support themselves other than their Social Security. According to a recent study by the Pew Research Center, the median older baby boomer (ages 55-64) had just $162,000 in wealth. This is roughly enough to buy the median home. This means that if this household took all of their wealth, they can pay off their mortgage. They would then be completely dependent on their Social Security to support them in retirement. And, half of older baby boomers have less wealth than this.

In short, most of the country is looking at a situation where they are desperate for work or fearful about losing their job. Older workers are looking at a retirement where they are not far above the poverty level, even after spending a life working in middle class jobs. The bad attitudes toward this situation are not the result of "groupthink" as the column asserts, they are the conclusion of people better able to understand the economy than Karabell.

For extra credit in the acting up department Karabell throws in a few broad assertions that are simply wrong. For example he tells us that:

"Overall growth for the next year is shaping up to be 2 percent, give or take. That is pretty lame compared to the heady days of the 1990s or even the mid-2000s. But those seemingly halcyon periods benefited from bubbles, whether the stock market and telecom spending in the 1990s or the housing and debt-inflated growth of the mid-2000s. So while activity now doesn’t look so good by those comparisons, it is actual economic activity undistorted by bubbles. It’s as if the economy of the past 20 years was wearing platform shoes ('Wow, she’s like 6 feet tall'); it looked a lot bigger than it was."

Actually 2.0 percent annual growth would look bad compared to the 80s, the 70s, the 60s, and the 50s. It is simply a very bad growth rate. Trend productivity growth in the U.S. is between 2.0 and 2.5 percent. Labor force growth is averaging around 0.7 percent. This means that we need growth of around 2.5 -3.0 percent just to keep even with the growth of the labor force. At a 2.0 percent growth rate unemployment will be rising, not falling. This has nothing to with platform shoes, it's arithmetic.

Furthermore, given the severity of the downturn we should be seeing growth in a 5-8 percent range to get the economy back to its potential level of output. People should be outraged at the thought that the economy might only grow at a 2.0 percent rate.

Karabell also tells readers:

"It is also true that we have a structural jobs issue, but not an issue of making things and innovating."

If we had a structural jobs issue then there would be sectors of the economy where large numbers of jobs are going unfilled, workers are putting in long hours, and wages are rising rapidly. This would be the result of the labor shortages in these areas.

We don't see any major sectors that fit this bill. That implies that the problem is not one of structural unemployment but simply a lack of demand. We just need the government to spend more money, the Fed to be more aggressive in pushing down long-term interest rates or boosting inflation, or a decline in the value of the dollar to boost exports. We can also put more people to work by having people work shorter hours through work sharing. Saying the problem is structural is simply wrong and points people away from the obvious solutions.

 
Washington Post Runs Another Front Page Editorial About the Deficit Print
Wednesday, 28 December 2011 08:03

The Washington Post used a front-page, above-the-fold article, to complain that Congress and President Obama had not done as much as it would have liked to reduce the deficit. Every person interviewed for the piece shared the complaint. The piece did not present the views of a single person pointing out that more progress on deficit reduction could have led to even more unemployment than what the country is already experiencing.

Nor did the Post present the views of anyone pointing out the fact that the deficit is large because the economy collapsed. The article likely led readers to believe that the country has large deficits because we have out of control spending or massive tax cuts. Anyone with access to the Congressional Budget Office's projections knows that the deficits would have been relatively modest in the last few years had it not been for the downturn caused by the collapse of the housing bubble.

It is remarkable that the Post never makes this point in its budget reporting. Of course, mentioning this fact would call attention to its unbelievable level of incompetence in ignoring the housing bubble. While the Post devoted endless and editorial space to the modest deficits of the bubble years, it completely ignored the growth of the housing bubble that eventually sank the economy and caused the large deficits of the present. 

Nor did it present the views of anyone applauding the fact that the Super Committee failed in its efforts to cut Social Security and Medicare. The Super Committee, a group with a guarantee of a special fast-track vote on its budget proposal, has been a longstanding dream of the many groups funded by Wall Street investment banker Peter Peterson. The fact that they finally realized this dream and were able to do nothing with it is very noteworthy. Many people around Washington and across the country applauded this failure as a great victory. Their views should have been presented in the article.

The article includes several other misleading or simply false statements. In the latter category are several references to proposals from Simpson-Bowles deficit commission. This commission produced no proposals. The co-chairs, former Senator Alan Simpson and Morgan Stanley director Erskine Bowles, produced a proposal, however this proposal was not approved by the commission. 

The piece also includes several comments to the effect that Social Security and Medicare will break the budget. In fact, Social Security's costs are rising very gradually. Furthermore, its projected benefits are fully paid for through the year 2038 with no changes whatsoever in the program. Even after that date, if Congress does not change the law, Social Security cannot contribute to the deficit. It would only be able to pay out about 80 percent of scheduled benefits (roughly 10 percent more than the average benefit received by today's retirees).

Every budget analyst knows that the real source of the country's projected long-term deficit problem is the projection that health care costs in the United States will continue to explode. However this fact was never mentioned in the article. 

 
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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