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Low Inflation Causes Consumer to Delay Purchases and Undercuts Profits and Jobs Print
Friday, 29 August 2014 04:55

In an article discussing the drop in the year over year inflation rate in the euro zone to 0.4 percent, the New York Times told readers that the inflation rate could fall further, turning into deflation, which it told readers:

"causes consumers to delay purchases and undercuts corporate profits and jobs."

That is true of deflation, but it is also true of very low inflation. The reported inflation rate is an average of the inflation rate seen in millions of different goods and services being sold at millions of different outlets. At any point in time roughly half of these inflation rates are more rapid than the average inflation rate and half are less. This means that the prices of a large number of goods and services are already falling. Insofar as this is a factor causing a delay in the purchase of goods, we would already be seeing it. A further drop in the overall rate of inflation to make it negative would change the picture little.

In terms of the impact on corporate profits and jobs, the issue here is the real interest rate, which is the nominal interest rate minus the inflation rate. Any drop in the inflation rate means a higher real interest rate and therefore provides a disincentive for investment. Whether the inflation rate crosses zero and turns negative really has no consequence in this story.

The point here is important. The euro zone is already suffering from an inflation rate that is way too low, causing real interest rates to be far higher than would be desired given the weakness of its economy. The problems of deflation are not something that it may have to worry about in the future. Those problems are here now. The situation worsens anytime the inflation rate falls further, but crossing zero and turning negative has no particular economic significance.

I should probably also mention that there is huge error in measurement. The Boskin Commission, to the widespread applause of most elite economists, said that our consumer price index overstated the annual inflation rate by 1.1 percentage point. After some changes in the index were made, they said it still overstated inflation by 0.8 percentage points. There is no reason to think the euro zone measure is more accurate than the U.S. measure, which means if people follow our elite economists then they should believe that the euro zone already is facing deflation.

I should probably also mention that the Boskin Commission's estimates were pushed as part of an effort at the time to cut the annual cost of living adjustment to Social Security benefits. For some reason no one seems to mention their work anymore, even though the Bureau of Labor Statistics has not addressed most the sources of bias they identified.

 

Note: Typo corrected, "inflation" changed to "deflation." Thanks kea.

 
NYT and Alan Krueger Discover that Some People Don't Respond to Employment Surveys Print
Wednesday, 27 August 2014 11:38

It's always nice when a prominent economist and the NYT pick up on a line of work that we started at CEPR. That is why we are all happy to see David Leonhardt's piece on a new paper by Alan Krueger, the former head of President Obama's Council of Economic Advisers.

The gist of the piece is that Krueger has discovered that many people do not respond to the Current Population Survey (CPS), the main survey used to measure the unemployment rate. Krueger discovered that the unemployment rates are higher for people the first month that they are in the survey than in later months. (People are in the survey for four months, then out for eight months and then back for four months.) The implication is that people who are not responding may be more likely to be unemployed than people who are responding.

This fits well with analysis done by John Schmitt and me nine years ago. That work noted a sharp gap between the employment rates reported in the 2000 Census and the employment rates reported in the CPS for the overlapping months, with the CPS rates being much higher. (The Census has a response rate close to 99 percent, whereas the coverage rate for the CPS is under 90 percent overall. It is under 70 percent for young black men.) The analysis focused on employment rates because employment is much more well-defined than unemployment.

The analysis also noted that the gap was largest for the groups with the lowest coverage rates. In particular the gap was largest for young black men, with the CPS showing an employment rate that was 8.0 percentage points higher than the Census data for the same month. Our conclusion was that the people who respond to the survey are more likely to be employed than the people who don't respond. It's good to see that Krueger appears to have concurred in this finding nine years later.

 

Note: Link and president corrected.

 
Headline Writer at Washington Post Gets Budget Story Backward Print
Wednesday, 27 August 2014 11:29

The headline of the Washington Post piece on the new budget projections from the Congressional Budget Office (CBO) told readers, "CBO: Deficit falls to $506 billion in 2014, but debt continues to rise."

Both parts of this are wrong if the comparison is the most recent prior set of projections. The deficit projected for 2014 is actually somewhat higher in the most recent projections, $506 billion compared to $492 billion in the projections made in April. Both figures are below last year's deficit of $680 billion. Measured as a share of GDP the deficit fell from 4.1 percent in 2013 to 2.9 percent in the most recent projections for 2014.

However the debt numbers in the new projections are lower than the debt numbers in the prior set. CBO now projects that the debt will be 77.2 percent of GDP at the end of the projection period in 2024. It previous had projected a debt to GDP ratio of 78.1 percent.

The article got both of these points right.

 
Jared Shoots Back on the Corporate Income Tax Print
Wednesday, 27 August 2014 08:54

Jared has a few more points in response to my least post -- certainly very reasonable concerns. As far as his comparison of me to Mr. Burns, I'll just say "excellent!"

 
The Mostly Good News on Housing Print
Wednesday, 27 August 2014 07:02

Neil Irwin had a good post on the latest Case-Shiller house price data. he argued that the flat, or even modestly declining house prices are good news. This means that prices are now more or less following a normal pattern where they move pretty much in step with the economy.

This is right, with one important qualification. The Case-Shiller tiered price indexes show some worrying numbers in some cities for the bottom third of the housing market. Prices for the bottom tier fell by 0.7 percent in San Francisco in June. In Atlanta, the index showed a drop of 1.3 percent and in Minneapolis the decline was 4.0 percent. This may just be a monthly blip, but there is a real risk that in some areas this could be the beginning of another plunge in low-end house prices.

House prices for the bottom tier have been on a real roller coaster ride for some time. They were inflated in the bubble years by subprime loans and then plummeted when this source of lending collapsed. Then they were propped up by one of the most hare-brained policies of all-time, the first-time homebuyers tax credit. Predictably, prices in the bottom tier plummeted again when the credit ended. (Typical of the honesty people came to expect from Timothy Geithner, his book had a chart (p 304) which showed the uptick in house prices caused by the credit, but ends before the subsequent fall.) 

Price recovered again and began to rise rapidly through the first half of 2013. There was a real danger of a new bubble forming, but then Bernanke's famous taper talk took the wind out of the market. The concern now is that with investors leaving the market prices in the bottom tier in some cities will take another major hit. This is not likely to have much of an effect on the national economy but could be bad news for moderate income homeowners that bought in near a temporary peak.

 
Subverting the Inversions: More Thoughts on Ending the Corporate Income Tax Print
Tuesday, 26 August 2014 20:08

I see that my friend Jared Bernstein has some more thoughtful (if mistaken) arguments on ending the corporate income tax. I recognize his concerns about giving more money to the people who have the most (hey, it’s the American Way), but I still think this is a policy that could be a big winner in the battle against the enemies of the people.

I will quickly address two issues Jared raised, the extent to which any of the savings will be passed on in wages and the ability to replace the revenue. However my main focus is the nature of the corporate tax avoidance industry. This is a pernicious drain of economic resources. It is also a major source of upward redistribution. I consider its elimination an enormous benefit – even if on net we give up some government revenue to do it.

First, I followed the Tax Policy Center in assuming that 20 percent of the benefits would go to workers in higher wages. Jared rightly pointed out that this will depend on workers bargaining power. However, it is worth noting that even in the worst of times workers have gotten some fraction of productivity gains. And if we look at the last year, the data show that average real hourly compensation increased almost as much as productivity growth (1.0 percent rise in real compensation versus a 1.2 percent increase in productivity). So the Tax Policy Center’s 20 percent pass back to wages hardly seems out of line.

The second question is how we would make up the lost revenue. The Congressional Budget Office (CBO) projects we will get $351 billion or 2.0 percent of GDP from the corporate income tax in 2014 (Table 4-1). This is the average for the next decade as well. Much of this can be gotten back from eliminating the special treatment of dividend and capital gains income. The major rationale for their special treatment was the argument that it amounted to double taxation since profits were already taxed at the corporate level. Since the corporate income tax will have been eliminated, there is no rationale for special treatment.

In 2012, the most recent year for which data is available, the Internal Revenue Service reported $260.4 billion in taxable dividend income and $2.217 trillion in capital gains distributions. If we assume an average increase of 10 percentage points in the tax rate on dividends and 5 percentage points in the effective tax rate on realized capital gains, this gets us $137 billion in tax revenue (26.0 billion from dividends and $111 billion from taxing capital gains). If we adjust this figure up by 10 percent to account for nominal growth from 2012 to 2014 we are up to $151 billion.

In addition, eliminating the corporate income tax will cause both sources of income to increase, which would imply a further increase in revenue. If half of profits are paid out in dividends (a bit less than the historic average) then we would see dividends increase by $175 billion (using the 2014 numbers), which at a 30 percent average tax rate gets us $53 billion in tax revenue.

The ending of the corporate income tax would increase after tax profits by around 25 percent, which presumably would lead to a corresponding increase in stock prices. That would lead to a one-time windfall for both stockholders and also the government in the form of capital gains tax revenue. However going forward stock prices should rise on average at the same pace but at base that is roughly 25 percent higher. In 2011 (sorry, most recent year I could find) the CBO projected capital gains income for 2014 of $103 billion. If we up that by 25 percent, it gets $26 billion.

This brings the total from additional capital income to $79 billion. Adding that to $151 billion from raising the tax rate, get us to $230 billion. Suppose we raise the top marginal rate by three percentage points. CBO projected that the ending of the Bush tax cut for high end individuals would raise $109 billion in 2014 (Table 3), so a three percentage point hike should get around half that, or $55 billion. That gets us to $285 billion, still a bit short of the $351 billion in lost corporate tax revenue, but it is within spitting distance.

Read more...

 

 
How to Think About the Corporate Income Tax Print
Tuesday, 26 August 2014 07:06

My friend Jared Bernstein had a piece in the NYT warning against plans to eliminate the corporate income tax. He argues that the corporate income is paid primarily by owners of capital, who in turn are primarily wealthy people. Therefore, if we eliminate the corporate income tax we will be giving a big tax break to the wealthy.

This is largely true. Eliminating the corporate income tax without some major increases in the personal tax rates for high income people would be a big gift to the wealthy. And as much as we would all like to help our favorite billionaires, they are probably not the ones most in need of a hand at the moment.

But the story on elimination may be a bit brighter than Jared implies. First, it is important to remember that not all of the corporate income tax comes out of corporate profits. Due to feedback effects (less investment), some portion will come out of wages. The model used by the Tax Policy Center of the Urban Institute and Brookings Institution put the split at 80 percent profits and 20 percent wages. This means that if we lose $100 billion in corporate income taxes we are effectively losing $80 billion in revenue from rich people.

But even this is somewhat of an overstatement. If companies had $80 billion in additional after-tax profits, then they would pay roughly half of this out in dividends, or $40 billion. If we assume for simplicity that all of this is paid to high end individuals, then we will tax back 20 percent of this amount or $8 billion. (Dividends are taxed at roughly half of the rate of normal income. This would presumably change if we eliminated the corporate income tax.) This means the net loss of revenue from rich people is $72 billion.

Now let's consider the tax evasion industry that is created by the corporate income tax. The corporate income tax use to raise close to 4.0 percent of GDP. In recent years it has been less than 2.0 percent even though corporate profits are at a record high as a share of income. Part of the drop is explained by a drop in the top tax rate from 50 percent to 35 percent. However most of this decline is explained by more effective forms of tax avoidance or evasion. (Avoidance is legal.)

The question is, how much will a company pay to avoid paying $100 in income taxes? The answer is up to $99.99. There are a lot of companies that are paying lots of money to avoid paying corporate income taxes. It is likely that a very substantial portion of that lost 2.0 percentage points of GDP in corporate income taxes ($350 billion a year in today's economy) is instead being paid to the income tax avoidance industry (a.k.a. the financial sector).

To take one important example, much of the bread and butter of the private equity industry is bringing creative tax schemes to smaller businesses that lacked the expertise to do it themselves. To personalize this some, think of Mitt Romney. Much of the story of his wealth was the corporate income tax. By devising clever schemes that allowed businesses his firm took over to escape the tax, he was able to resell these businesses at an enormous profit. In this way, the corporate income tax is not just a way of taking money from rich people, it is also a way to give money to rich people by creating enormous profit opportunities in altogether unproductive areas of the economy.

And Mitt Romney's wealth has direct ramifications for the rest of us. Suppose Mitt Romney spends a big chunk of his wealth building a big new house. In the context of a depressed economy, any spending is good for growth and jobs, so his consumption is a net plus just like anyone else's consumption. However as we start to get to the point where the inflation hawks are bringing enough pressure to bear on the Fed to force it to raise interest rates and slow the economy, Romney's construction project will effectively be crowding out other spending. The Fed will be raising rates sooner than it otherwise would have because of the riches Romney accumulated from designing ways to avoid the corporate income tax.

If we assume that roughly half of the drop in corporate income tax is now income for the tax avoidance industry, then this means that we are giving them 1.0 percent of GDP to raise 1.15 percent of GDP (0.72*1.6 percent of GDP raised in corporate income taxes) in taxes from rich people.

In this fuller context, the corporate income tax is a much more questionable proposition. It seems very plausible that we could design a system that will raise as much money from the rich with an increase in personal tax rates, while at the same time destroying the tax avoidance industry.

 

 

 
NYT Has Determined That Brazil's Neo-Liberal Policies Were Necessary to Allow Growth Print
Tuesday, 26 August 2014 04:48

That's right, you might have thought there was a debate on whether the neo-liberal policies pursued by Brazil and other Latin American countries promoted or retarded growth, but the NYT settled the issue. It refers to the policies put in place by Social Democratic Party from 1994-2002 and then tells readers:

"The measures vanquished galloping inflation, opening the way for the next decade’s growth."

This voice of authority should perhaps explain why it took seven years of moderate inflation before growth could pick up. Inflation fell back to 6.9 percent in 1997 (it had been over 1000 percent), the growth rate crossed 5.0 percent in 2004 and remained at a respectable pace until the world financial crisis led to a recession in 2009.

 

 
Does Competition Really Increase in the Textbook Market When it Becomes More Concentrated? Print
Tuesday, 26 August 2014 04:22

A Vox piece on soaring textbook prices told readers:

"And the college textbook market has changed, too. Publishers used to spread out the cost of a new edition over five years before publishing the next edition and starting the cycle over. Since the publishing industry began consolidating in the 1980s — five major publishers now control 80 percent of the market — competition has become keener, and the window before a new edition has narrowed from five years to three. That means higher prices so that publishers can recoup the costs and make a profit."

Let's see, competition has become keener as the industry got more concentrated, causing prices to rise? That doesn't sound like the textbook economics I learned.

This sounds more like a story where an industry grew more oligopolistic. Rather than competing on price, textbook makers compete on quality (or the appearance of quality -- to keep the analogy to the prescription drug industry used in the piece). There is an implicit agreement not to try to undercut each other on price, since the big five recognize they would all end up losers in that story.

This sounds like a case where a bit of anti-trust action might do lots of good. Alternatively, a small amount of public funding for open source textbook production may wipe out the bastards altogether.

 
The Export-Import Banks Claims Need Not be Taken at Face Value Print
Tuesday, 26 August 2014 04:01

A New York Times article on the role that the debate over the Export-Import Bank is playing in the North Carolina senate race told readers that the bank:

"says it makes a profit and supported more than 200,000 jobs with $37.4 billion in transactions last year."

It would have been worth including the views of someone other than the bank who could have put these claims in context. If companies did not have access to the Bank's loans at below market interest rates, most of these sales would still take place. The companies would just have lower profit margins. As a result, the number of jobs that would be lost is a fraction of the number cited here.

Furthermore, in standard models it would be expected that with fewer exports subsidized by the bank, the dollar would fall in value, which would make other exports more profitable. The net effect on jobs and GDP would be close to zero and quite possibly positive. It would be possible to construct the exact same story about any industry that is subsidized by the government with loans offered at below market interest rates.  

 
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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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