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The Fiscal Cliff Won't Live Up to the Hype Print
Tuesday, 25 September 2012 05:26

That's what Brad Plumer tells us. As we like to say here at BTP, if everyone in Washington agrees, it's got to be wrong.

 
Work Sharing: The Hidden Secret of Germany's Economic Success Print
Tuesday, 25 September 2012 05:03

The NYT had an article that reported on Germany's relative economic success and attributed it to the labor market reforms that reduced benefits for unemployed workers and took other steps to weaken workers' bargaining power. While these reforms undoubtedly had the effect of reducing Germany's labor costs and thereby allowing it to accumulate a large trade surplus in the euro zone (which meant that countries like Greece, Spain, and Ireland would have large trade deficits), this is only part of the story of Germany's success in lowering its unemployment rate.

The fact that Germany has persuaded employers to reduce work hours rather than lay off workers has been at least as important in bringing down Germany's unemployment rate. Germany's growth rate since the downturn began has been almost identical to the growth rate in the United States. While the unemployment rate in the United States has risen by 3.6 percentage points over this period, from 4.5 percent to 8.1 percent, the unemployment rate in Germany has fallen by more than 2.0 percentage points from the 7.6 percent to 5.5 percent. It would have been worth noting the policy of promoting work sharing in this discussion.

germany-us-since-downturn-09-2012Source: OECD.

The NYT article also wrongly refers to the official Germany unemployment rate of 7.0 percent instead of the OECD harmonized rate. The official German rate counts people who are working part-time but desire full-time employment as being unemployed. It therefore is not directly comparable to the U.S. unemployment rate. The OECD harmonized unemployment rate uses the same methodology as the U.S. Labor Department.

 
All Economists Do Not Agree that Mitt Romney's Tax Rate Should be Low Print
Monday, 24 September 2012 14:15

Any time you hear anyone tell you that "all economists agree," get out your gun. Unless the question pertains to the shape of the earth, this is almost certainly not true.

It is most definitely not the case that economists agree that Mitt Romney should be paying his current 14.1 percent tax rate or less as Washington Post readers were told by Dylan Matthews today. Matthews rests his case on some arguments in the literature concerning scenarios in which we both look to an infinite future horizon and we have identically situated individuals, meaning that we all have the same wealth and the same opportunity to gain income. When these assumptions are relaxed, the case for preferential treatment of capital income becomes considerably weaker, as argued in a recent Journal of Economic Perspectives article by Peter Diamond and Emmanuel Saez, two of the most prominent public finance economists in the world.

The second point here is probably the more important. If we have some individuals who inherit immense wealth so that they can live entirely off their capital income and other individuals who must work for their income, a policy that subjects capital income tax to a lower rate of taxation than labor income means that we are taxing the rich at a lower rate than the middle class and poor. It is difficult to see how this is either efficient (we are giving disincentives to work for middle class people as a result of a higher than necessary tax rate) or fair.

Furthermore, as a result of having a lower tax rate on capital income than labor income we are giving people an incentive to game the tax code by concealing labor income as capital income. While most workers may not have much opportunity to play such games, higher end workers, such as doctors or lawyers with their own practices would have ample opportunities for such gaming. This is both unfair and leads to a waste of resources as these people employ accountants to rig their books.

In fact, Mitt Romney and his firm Bain Capital were experts at such gaming. They routinely negotiated deals that changed management fees, which would be taxed as normal income, into carried interest which would be taxed at the capital gains tax rate. Few, if any, economists would agree that allowing for such deals is good policy.

Finally, even if economists might in general agree that it makes sense to have a lower tax rate on capital income than labor income, it does not at all follow that they think that Mitt Romney was paying enough in taxes. The article by Diamond and Saez suggests a top marginal tax rate of around 70 percent. In this case, a 50 percent tax rate on capital gains would still provide a substantial benefit to earners of income from capital. That rate would be more than three times the tax rate that Mitt Romney paid on his income.

So when you get your score card out remember to put down that many, perhaps most, economists believe that Mitt Romney should pay more money in taxes. Don't let the Washington Post fool you.

 
Robert Samuelson Wants the Government to Stop Trying to Help People Into the Middle Class Print
Monday, 24 September 2012 04:55

His piece today notes that many people who start college don't finish and that many people got themselves into bad mortgages that they could not afford in the housing bubble years. He therefore concludes that government really cannot do much to ensure low income people a path to the middle class:

"What also cannot be wished away are on-the-ground realities that impede middle-class status for more Americans. Only one-third of children born to the poorest fifth of Americans graduate high school with at least a 2.5 grade-point average and without having become a parent or been convicted of a crime, reports a Brookings Institution study. Brookings economist Isabel Sawhill notes that gaps have widened between the children of poor and well-to-do families on school test scores, college attendance and family formation. In his book “Coming Apart,” conservative scholar Charles Murray makes similar points.

Government has only limited power to offset these disadvantages. The appeal of the American Dream is that it’s disconnected from nasty facts and choices."

Of course many of the realities on the ground reflect deliberate government policy to redistribute income upward. In the last three decades the government has done everything possible to remove barriers that obstruct manufactured goods from entering the United States. This policy coupled with the over-valued dollar threw millions of manufacturing workers out of work and put downward pressure on the wages of less-educated workers. Instead the government could have pursued a "free trade" policy that focused on reducing the barriers that prevented foreign professionals (e.g. doctors, lawyers, economists) from training to U.S. standards and working in the United States. This would have had the effect of driving down the wages of U.S. professionals. That would reduce the cost of health care, legal services, university education and many other items, thereby raising real wages and producing large economic gains.

The government could have eliminated the special low tax status that the financial industry enjoys, thereby allowing it to grow as parasite on the rest of the economy. It is also the source of many of the highest incomes in the country.

And, the government need not have strengthened patent and copyright protection. These monopolies redistribute several hundred billion dollars a year from consumers to drug companies, software companies and the entertainment industry. (Yes, this upward redistribution is the topic of my book, The End of Loser Liberalism: Making Markets Progressive.)

In short the government could have done a lot to improve the plight of lower income people just by not pursuing the policies that have worsened their plight. Of course it could have also raised the minimum wage in step with productivity growth, as it had done in the quarter century following World War II. If this had been the policy, the minimum wage would be close to $18 an hour today. That might make a difference to the middle class aspirations of many workers.

 
The Fed Has Always Sought to Counteract Recessions Print
Monday, 24 September 2012 04:21

The Washington Post has a piece on how Federal Reserve Board Chairman Ben Bernanke transformed the Fed so that it now has an active role in boosting the economy. In fact it is difficult to see anything qualitatively different about the role that Bernanke has set for the Fed. As the piece notes, high employment is part of its mandate. In past recessions, the Fed has sharply reduced the federal funds rate to help boost the economy.

FRED Graph

As can be seen, the Fed lowered the federal funds rate from 19 percent to 8 percent to boost the economy following the 1981-82 recession. It dropped the rate from 12.5 percent to 5.0 percent following the 1974-75 recession. The difference in this case is that the downturn is more severe and with inflation very low, the Fed has hit the limit of what it can do by lowering the federal funds rate since it is already zero. This has forced it to pursue extraordinary measures like quantitative easing and long-term commitments to keeping interest rates low. It is more the conditions which have changed rather than the Fed's role in the economy.

This piece also includes a line about the risks of the Fed's expansionary policy:

"The most significant [risk] is that the Fed’s efforts heat up economic growth in a way that unleashes inflation, which would eat away at middle-class incomes."

Actually it is very difficult to imagine inflation taking a form that would "eat away at middle-class incomes." If the economy heats up in the way described, it means that unemployment would fall sharply, leading to more rapid wage growth. This rapid wage growth would be the factor driving inflation. Since most middle income people get most of their income from wages, if wages are rising rapidly, it is unlikely that their income would be eroding. Most middle income retirees get most of their income from Social Security which is indexed to inflation, so these people would be largely protected as well.

The big losers from higher than expected inflation would be lenders, like the Wall Street banks, who have large amounts of loans outstanding that would suddenly be worth much less in a higher inflation environment. This is a reason why Wall Street is generally a forceful lobby against higher inflation.

At one point the piece refers to Bernanke's "grueling" years at the Fed. It is worth pointing out that the main reason the years have been grueling is that Bernanke and Greenspan failed to recognize the housing bubble (Bernanke was a Fed governor from 2002 to 2005) and to take steps to deflate it before it grew large enough to do so much damage to the economy. In other words, he is cleaning up his own mess.

 
Another Post Editorial on the Budget Runs in the News Section Print
Sunday, 23 September 2012 07:51

The Washington Post has long felt that the distinction between news reported and editorializing was outdated. Hence it had no compunctions about running a piece on the budget that begins:

"Senior Republicans say they will be forced to retreat on taxes if President Obama wins a second term in November, clearing the biggest obstacle to a deal with Democrats to defuse a year-end budget bomb that threatens to rock the U.S. economy."

Wow, a year-end "budget bomb" that threatens to "rock" the economy, that sounds pretty serious. In reality what we are faced with is a situation where taxes will be deducted from paychecks at a higher rate beginning in January and roughly $110 billion in spending reductions will begin to go into place.

If nothing is done by year-end what happens to the economy? Pretty much nothing. If Congress still doesn't do anything for the month of January, so that everyone starts to see larger deductions from their paycheck and government spending is also reduced, then we will start to see a drag on the economy. If Congress does nothing all year, then we would see a serious hit to the economy that would likely throw us back into a recession, as the Congressional Budget Office and others have projected. However this story of slowly strangling the economy, as the Conservative government has done to the U.K. and the European Central Bank is doing to the euro zone economies, is not quite the story of a "budget bomb." or at least probably not to people who don't work for the Washington Post.

The Post also warned that the $55 billion in cuts that would hit the military would "whack" the defense budget. No doubt the paper feels strongly about protecting the defense contractors who advertise in the paper, but there is no obvious reason that the $55 billion in military cuts in any sense involve a greater "whack" than the $55 billion in cuts that will hit domestic discretionary spending at the start of the year.

 
NYT Discovers Retirement Income Problem Print
Sunday, 23 September 2012 07:29

They may have been a bit slow, but better late than never. It is encouraging to see the NYT strongly endorse the proposal to have California offer a state managed retirement plan to workers in the private sector who don't have a pension at their workplace. That fact that it took so long is a bit annoying to those of us who have been working on this issue for the last 15 years or longer, but no one ever accused the NYT of being on the cutting edge of anything. Anyhow, better late than never.

 
Ross Douthat Is at Least Half Right Print
Sunday, 23 September 2012 07:16

Douthat's column today lashes out at the economy of the Washington metropolitan area. Douthat describes it as an economy of exploitation as highly paid lobbyists thrive on efforts to manipulate government policy to advance their interests. Douthat is 100 percent on the mark here. This is a town chock full of 6 and 7-figure buffoons. People who draw paychecks in the hundreds of thousands or even millions but who have no discernible skills other than an impressive contact list.

What he gets wrong is tying this to government spending or the deficit. Many of the most important issues that lobbyists devote themselves to, such as patent and copyright rules, trade agreements (e.g. the Trans-Pacific Partnership), and rules on bank regulation, involve little or no government spending. However the sums of money are often far larger. For example, patent protection on prescription drugs will be worth more than $3.5 trillion to the pharmaceutical industry over the next decade.

Douthat is also wrong as to the reason we have a budget deficit. We have a budget deficit because the collapse of the housing bubble sank the economy. Most people in Washington didn't see the bubble when it was expanding and apparently still haven't noticed it even after it burst and wrecked the economy. The collapse of the bubble cost the economy $1.2-$1.5 trillion in annual demand. The deficit is helping to fill the gap created by the loss of private sector demand. This is primarily due to the fall in tax collections and the increase in payments like unemployment benefits and food stamps that automatically take place in a downturn.

 
David Brooks' Concern for Entrepreneurial Spirit Print
Friday, 21 September 2012 04:09

David Brooks devotes his column today to profiling Elon Musk. Musk emigrated to Canada from South Africa when he was 15, eventually coming down to attend school in the United States. According to Brooks, he was one of the leading figures in PayPal. He later helped finance SpaceX, a space exploration company; Tesla, an electric car company, as well as several other companies.

After describing Musk's extraordinary career and lifestyle, Brooks tells readers:

"Today, grandiosity is out of style. We’ve just been through a financial crisis fueled by people who got too big for their britches. We’ve got an online and media culture that specializes in ridiculing grand people.

Caution rules. The number of jobs created by business start-ups under President Obama is much lower than under the three previous presidents. The World Economic Forum ranks the competitiveness of nations, and the U.S. has lost ground in each of the last four years.

But, if growth is ever going to rebound, the U.S. will need a grandiosity rebound and the policies that encourage rich people with brass: immigration policies that attract people like Musk, tax rates that encourage risk and government policies that boost them along (SpaceX has benefited greatly from NASA, and Tesla received a big government loan).

Most of all, there has to be a culture that gives two cheers to grandiosity."

These comments raise several important points. First, Brooks obviously missed the collapse of the housing bubble. Otherwise he would not have killed trees to tell us:

"The number of jobs created by business start-ups under President Obama is much lower than under the three previous presidents."

Yes, and agricultural yields fall in a drought. We had a collapse in demand that preceded President Obama coming into office. News for Brooks: businesses expand less in downturns than in upturns. If Brooks wants to tell us that even when we adjust for the collapse of the housing bubble that business start-ups have created fewer jobs under President Obama than prior presidents, let's see the evidence.

The second question is whether Brooks hero, Elon Musk, is really the sort of meek pathetic character that Brooks seems to be describing when he worries that we are discouraging entrepreneurialism. After all he tells us that:

"We’ve got an online and media culture that specializes in ridiculing grand people."

Does this mean that we shouldn't expect to see Musk and his fellow ambitious creative types start new businesses because someone might make fun of them on the web? Are these folks really that sensitive? Should we have a national fund that awards gold stars to bold entrepreneurs that they can wear on their foreheads? Brooks seems to think so. He could be right, I don't know many (any?) of these people, but it would be a bit scary if our bold entrepreneurial types are really this sensitive.

The other point to raise about Brooks paean to Musk is that some of his ideas seem pretty crazy. Brooks tells us:

"Musk also told Businessweek about two other project designs he is working on. The first is something called the Hyperloop, a tube capable of taking people from downtown Los Angeles to downtown San Francisco in 30 minutes. The second is a vertical lift-off supersonic passenger jet that would surpass Boeing. He also hopes to open up a space colony on Mars within 10 or 15 years."

I don't know the details of any of these plans and these certainly are not my areas of expertise, but on the surface they don't sound like viable enterprises. This point is important. Many entrepreneurs, big and small, come up with business plans that don't make sense. In a well-working economy, they don't get funding for these plans.

If entrepreneurs do get funding for nutty ideas, as was the case at the peak of the stock bubble in 1998-2000, then this is wasting resources that could have otherwise been used productively. It has the same effect on the economy as creating a department of waste, fraud and abuse that pays people to write up documents that get passed back and forth to each other and then thrown into the garbage. This creates jobs (people are getting paid to write up documents) but it is a net drain on the economy. 

The idea that more entrepreneurship is always better than less entrepreneurship is ridiculous on its face. More good entrepreneurship is always better, but much entrepreneurship is not good.

In fact, the story is somewhat worse than just wasting resources as an abstract economic issue. Many people are persuaded to leave secure stable jobs to pursue ill-considered business ventures. The vast majority of new businesses fail. These failed entrepreneurs can find themselves mid-career unemployed, with no savings and few good job prospects. (In other words, they could become part of the 47 percent.) That is not a happy situation. It would not be a good thing if we had more people in this situation.

Brooks and many other entrepreneur worshippers don't seem to appreciate the way business works. They seem to have a naive view that having more entrepreneurs or that allowing entrepreneurs to have greater access to capital is always good. This is obviously not true. A well-working economy allows entrepreneurs to get capital when they have good ideas, but it prevents them from raising capital when they are off the mark. If the economy doesn't do the latter, then resources will be wasted, lives will be ruined, and the economy will not maintain good growth rates.

 

 
Robert Samuelson Badly Understates the Size of the Welfare State Print
Thursday, 20 September 2012 04:48

Robert Samuelson used his column today to urge Mitt Romney to make the welfare state the major issue in the presidential race. For some reason Samuelson's indictment of the welfare state missed many of the largest items.

For example, in listing the beneficiaries of government largess, Samuelson missed obvious ones like homeowners who benefit from the mortgage interest deduction, the deduction for property taxes, and the subsidy provided by government guarantees of mortgage debt. He also misses the benefit provided by the tax deduction for employer provided health insurance.

While most people may not have a sufficient understanding of the tax and budget system, Samuelson surely knows that if we give someone a $4,000 tax break by making their mortgage interest tax deductible, it is the same thing as if the government wrote them a $4,000 check as a housing subsidy. In both cases they fit the bill as "takers."

Of course the really big beneficiaries of government largess are the folks who Samuelson neglects altogether. These would be people like the top executives at the Wall Street banks who benefit from the $60 billion in too big to fail insurance that is provided at no cost by the government. He would also talk about the hundreds of billions of dollars that the government transfers to the pharmaceutical industry each year by providing patent monopolies on prescription drugs. A similar amount goes to the tech industry. Samuelson could also talk about the selective protectionism in U.S. trade policy that redistributes income from most of us to highly paid professionals like doctors and lawyers.

These highly distortionary government interventions do not feature prominently on Samuelson's list. He only seems interested in attacking government interventions that primarily benefit lower and middle class people.

 
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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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