Tax Compact – My Take

Here is my take on a tax compact and the four questions from the November 13 post.

Who should pay an income tax and who should be exempt from it?  My take is that anyone who is not classified as officially poor should be obligated to pay income tax.  This is about 85% of our population.  Compared to the 85% of the non-poor, only 68% of Americans actually paid US income tax in 2006.  My belief is that anytime the Government wants to expand services, then everyone who can pay an income tax should feel some part of the pain whether that pain is 1% or 40%.  In my view, this is necessary to maintain a responsible working social and electoral structure.  All classes will bear their share of the burden.

How much tax is too little?  None.  I don’t know if the minimum tax should be 1% or more, but I would settle for a minimum tax of 1%.  

How much tax is too much?  I believe that no one, no matter how rich, should pay more than 50% of his or her income as a tax.  That is a total income tax and that includes both Federal, state, and local.  In California, the maximum tax is 10.3%.  If the liberals ever succeed in setting the maximum tax at 39.6% or higher, then the highest combined income tax would be 49.9%.  Now that would work with me if that is all there was, but there’s more.

The reason why 50% of income should be the maximum combined income tax is that economic freedom was part of our revolution from the British, and that pursuing economic self-interest in the Adam Smith sense is central to that freedom.  If anyone spends one hour of any day making more money for the Government then for him or herself, then we are in tyranny.  That is why I believe in a maximum tax rate.

If Republicans are going to argue that 39.6% is too much tax and 35% isn’t, then they need a better explanation then “class warfare”.  No one even knows what that means.  They also need to justify it on a basis other than the Laffer Curve, which was discussed in the previous post.  It cannot be used to prove 35% will produce more tax revenue than 39.6%. 

There is a case to be made that small business owners would use the 4.6% difference hiring more workers and generating more overall government revenues.  However, conservatives are not proving the point with data.  The data is there.  Go find the data and make the point.

Okay, so 39.6% fits, except that when Social Security taxes are added, which I consider an income tax.  It is becoming a pure transfer tax from the younger generations to the older ones.   It can no longer be considered an investment.  It is simply, correctly, and honorably, a response to a promise from one generation to another that should not be broken. 

If we add Obama’s 39.6% to Social Security’s 7.65% and California’s 10.3%, then the total rate climbs to 57.55%.  This is 7.65% into the tyrannical range for income taxes.  Some would point out that Social Security taxes max out at $106,800 a year.  Well, as suggested in a previous post, the ceiling should be lifted to convert Social Security from a regressive tax to a flat tax, a move that would go a long way to solving its funding problem.

All of these changes would result in a maximum Federal Income Tax of 32%.  That would be a just tax………..unless the Fed’s challenged California to get its fiscal house in order and lower its maximum tax rate in order for the Fed’s to raise its maximum tax. Let’s see, California would respond that the Federal government should take back some of the responsibilities it has passed down to the states to fund, and it would go on from there.  It would be two behemoths pushing each other around, similar to watching sumo wrestling in Japan.  Now, that would be interesting.

Tail of Two Ideologies - The Laffer Curve

The Republican fiscal ideology is wrapped in something called “supply side economics”.  The concept is based on the concept that individuals work harder when they can keep more of what they earn.  As individuals work harder, the increase in work results in additional jobs.   It is somewhat reminiscent of Adam Smith and his views on self-interest. 

This idea has been taken further.  From a national perspective, there is an optimum tax rate that is low enough to motivate workers while generating the maximum tax revenues to the government.   This curve that theoretically identifies the optimum tax is called the Laffer Curve.

There are some who may confuse the Laffer Curve with supply side economics.  They are related but not the same.  First, let’s discuss supply side economics.

There are several events that supply-siders cite when advocating lower income tax rates.  One is when President Kennedy lowered the highest tax rate from 91% to 70%, and the second is when President Reagan lowered the highest rate from 70% to 30%.  Both actions are credited with causing long economic recoveries for their times.  By lowering tax rates, the economies grew and tax revenues grew.  Unfortunately, government expenditures grew as well, and deficits continued. 

This most recent downturn in the economy occurred just as the census was happening, which was a prelude to Congressional reapportionment among the states.   A recent study compared states that will be adding to their Congressional representation with those that are losing Congressional seats.  The states losing seats are high tax states and have the average of their personal income tax rates is 6.05%, and those gaining seats have average rates of 2.8%. There is the view that when a state lowers taxes, it basically draws economic resources from neighboring states.  In other words, people walk, or even vote, with their feet. 

  

So, Texas and Virginia are growing state economies and California is not.  These experiences do not necessarily support the idea that lower tax rates create more economic growth.  These states are really drawing businesses from other states, and the situation does not support the argument that businesses within these states are growing by themselves due to lower rates.

These are the main arguments that supply-siders cite when stating their case.  However, one of them, namely Arthur Laffer, in the early 80’s fascinated President Reagan with what has come to be known as the Laffer Curve.  This says that tax revenues will increase as rates increase up to a point, after which as rates increase, tax revenues will fall.  Supply-siders are left with the question of where is this optimum point in the tax rate structure? 

Well, I know of one mainline economic textbook that says that the theory sounds great, but there is no evidence that supports the curve.  Supply-siders cite Kennedy and Reagan, but leave out Clinton, who took Reagan’s highest rate and raised it back up to 39%.  G.W. Bush lowered it to 35%, and we had good economies under both.  Now, Obama wanted to raise it back up to the Clinton rate, and the supply-siders became upset again.  The problem is that they have no data upon which to argue their point. 

And when a group argues a theoretical point without the data, they are being ideological.  Hence, the classification of the Laffer Curve as ideology.

Tail of Two Ideologies – Keynesian Economics

The previous post framed the question of a tax compact around the fact that each party has their respective ideologies.  The Democratic ideology is based in Keynesian economics.  Republican fiscal ideology is wrapped in something called “supply side economics”.  So, let’s take Keynes first.  In the next post, I will review the supply siders.

To start, Keynes says that government can correct a recession by expanding government. This expansion is financed through debt.  Governments are supposed to repay the debt during good economic times.  In the posts on David Stockman, it was noted that the United States has run a deficit in 38 of the past 40 years.  Additionally, the overall amount of national debt will equal the Gross Domestic Product in the next few years.  In 2010 the interest on the national debt will be $209 Billion or 6 percent (up from 1 percent in 2009) of the Federal budget. 

With regard to Keynes, the real question is whether it can and should be used in all economic downturns.  It is in its overuse that it serves as a candidate for ideology status.  In this blog, I raise two questions about it.   First concern, can it be expected to work in a recession resulting from a structural downturn?  In our case, the balance sheet of most American households have been hit hard by the mortgage crisis causing people to increase their saving by abnormally high amount, which, according to Keynes, lowers the multiplicative effect of government expansionary efforts (or in other words, more savings means less expansion).

In the posts on the Stimulus Program it was noted that it failed to stimulate.  One possible explanation is that the program was designed incorrectly and relied too much on some of Keynes’ main ideas.   I speculated that the type of recession was structural in that it was tied to the mortgage crisis (this reduced assets levels), and not tied to consumption, as Keynes would suggest.  One concern that follows from this is the view that the United States may be approaching its maximum debt level that it can carry before the benefits of expansionary borrowing become diluted and less effective.

Another concern is whether government deficit spending has been overused to the point that its beneficial effects have been diluted and is not as effective as it once was.  In other words, is there some inelasticity in the economic tool that was not considered by our policy makers in this most recent crisis?  The answer is ‘maybe’ as David Brooks reported on a recent National Bureau of Economic Research that examined stimulus efforts in 44 countries.  The report argued that fiscal stimulus can be quite effective in low-debt countries with fixed exchange rates and closed economies, and countries like the United States with high debt and floating exchange rates, are generally not as effective with stimulus measures.

The main reason for calling Keynesian ideas an ideology is that they are over used.  Paul Krugman, a Nobel Prize winning economist, advocates that the size of the stimulus was inadequate and should have been significantly larger in order to stimulate the country out of a recession.  Not only would the proposal complicate the country’s problems with debt, but it also would increase the risks of inflation, which is anti-stimulative.

The point is that the evidence does not exist to support Krugman’s proposal.  People who advocate this solution for this particular recession are essentially acting on faith, and that fact alone qualifies it as ideology. 

Keynes’ ideas are tools.  As a tool, people need to understand when Keynes’ ideas should be used and when they should not be used.  The election was not about ideology, but about making the country work, and for that we need tools.

A Tax Compact – No One Will Ever Agree on One

What our country has been subject to is two political parties trying to stimulate the economy using their respective formulae for Kool-Aid.  The ideology of each party doesn’t necessarily work as advertised.  Each party should go back to the laboratory and find out what really works.  Our economy lurches this way and that way without real focus.  Republicans stimulate with tax cuts, and then the Democrats stimulate with spending, and we are in a mess.  We need a new approach.

I suggest a new compact between the citizens of the United States and their politicians.  Each party should define how much service government should provide for how much tax.  Make it simple.   For the Republicans, how about basing tax cuts on a set of tax principles, not “yang” the economy from the Democratic “ying” direction?

To create a tax compact with the citizens, the Republicans should answer the following questions.

1. Who should pay taxes?  50% of the citizenry?  80%?  90% 
2. Who should be exempt from taxes?
3. How much tax is too much?
4. How much tax is too little?  

Answer these like Reagan would.  I am going to give my take on these questions in future postings.  If we establish a baseline based on a set of principles, and if we have to simulate, then we will know the point to which we have to return once growth has been achieved.

Timing is Everything – The Deficit Commission

The news as of late (apologies for the style, but I just finished watching my almost favorite new show, which is from Britain, and is called Top Gear.   They do outlandish things to cars while speaking dry English wit.  I just saw a tank chase a Land Rover.)

Anyway, let me start again.  I need to get back into my regular American style of writing.  Okay, I’m ready.

There is news that the U.S. deficit commission has recommended some severe cuts in Social Security.  Now that it is clear that the Social Security fund will start to pay out funds as it takes them in around 2016, there is a need to adjust the payout in benefits so that they do not exceed what is being paid in.  In other words, Social Security needs to balance the inflows with the outflows.  Cuts in benefits are being proposed to achieve this calibration. 

One proposed benefit cut is to extend the age when a person can start receiving the full regular benefits from 66 to 68 in 2050.  Of course, Eric Cantor, the House of Representatives soon to be Majority Leader has recommended that a person eligible for Social Security should be able to take a tax credit in lieu of the regular payments.  This would apply to those people who can afford to take such an option.  There are several articles on the commission’s report, but I am providing a link to the Barron’s article. 

The article also discusses fiscal spending cuts as well as ending of some of our most treasured tax deductions, including the most beloved home mortgage deduction.  Since the next two posts will be on taxes, I thought the article would serve as a good transition to the next topic.   

(By the way, for those interested, the tank caught the Land Rover and blew it up.  The host commented that the Land Rover was an excellent off-road vehicle, but was not well suited for invading a country.)

Hey Republicans! You Can’t Get There From Here!

Besides It Was A Bad Idea Anyway.  The “it” is the Republican proposal to privatize Social Security.  Ever since President Bush based his second term on this idea, I had sincere doubts.  Since the recession started, it has become obvious to me that the idea will never work without burdening our economy with a lot more debt, and since we just celebrated an election where a mandate for less debt was embraced by the voters, well, you get the idea.  Anyone want to be a one-term hypocrite?

Before talking about debt and Social Security, lets discuss a few facts about the program.  When Social Security was adopted in the 1930’s the average life expectancy was 63.6 years.  Today it is 77.5.  In the 1930’s only 5.4 percent of the population were age 65 and above.  Today it is about 12.4 percent.   These statistics say that when Social Security was established, there was a larger population of workers supporting a relatively small number of retirees.  Today, the burden is far greater because there are not just more retirees per capita, but the average retiree is living longer, a lot longer.

So, when Social Security was established, the administrators could pay for the retirees of their time as well as pay the excess into a separate fund for future retirees.  Payments out of the fund are projected to exceed payments into the fund by 2016, and it is projected that the fund will be depleted by 2037 if no other action is taken, including the Federal Government paying back what it has borrowed from the fund over the years (remember the Al Gore “Lock Box”  - remember to say it slowly with a deep voice) after which the year of depletion will extend to 2052. 

Compare this to my previous post on creating a savings account.  We are not collecting enough Social Security revenues.  We have avoided insuring that the fund has enough inflows over time to pay out the funds it is obligated to payout.   We soon will be paying out more than we can without maintain the fund’s balances.  The amount of funds will not cover all the plan’s obligations. 

The significant thing is that beginning in 2016, the amount we pay in will now begin to go out directly to our retirement generation.  In this context, the Republicans want to come along and privatize Social Security.  That means taking the payments that are going directly out to retirees and putting them aside in investment accounts.  This raises the question of if we take moneys that go directly to retirees and divert them, how do we pay for current obligations?  The answer is debt – we borrow it. 

In a time when the public wants public debt to go away, Republicans want to increase debt to restructure Social Security, and they ran on reducing the debt.  As I said in the title, you cannot get to a place where we privatize Social Security from our country’s tenuous financial position. 

In our country, Social Security is a promise from each generation to the next.  We have a promise to keep.  For this reason and this reason alone, any idea that endangers this promise is a bad one.

Prepare Ye Thy Republican Bashing

In this blog I have spent a number of posts going after the Stimulus, and by association, the Democrats who crafted it and sold it, particularly President Obama.  In each, I promised to balance the scales and bash some Republicans.  Oh, yes, I did agree with Joel Klein on his opinion of Christine O’Donnell, but I really haven’t balanced the scales.  Well, it’s almost time to pay-up.

Before I do, can we spend some time together and discuss some terms that I want to use in next post’s bashing?   (Yes, this is the paragraph where I attempt to persuade you to read on in spite of the fact that the bashing will be in the next post.  I promise you it will be worth the effort.  The terms are on public finance.   Work with me here.  You will be a hit at parties discussing terms many of your friends don’t know.)   Seriously, part of my purpose in this blog is to help educate, which makes this post as important as one that goes after any particular politician or party.

Let’s start with taxes.  Let’s define progressive, regressive, and flat taxes.  Basically, a progressive tax is one that taxes people who have low income with a small tax rate, or even no tax.  As income rises, the rate of taxation increases as well.  Our income taxes at the Federal and state levels are examples of progressive taxes.   Regressive taxes are just the reverse.  As income shrinks, the rate of tax increases.  Social security is an example of a regressive tax.  A person making $100,000 pays 7.65% in Social Security and Medicare taxes.  This rate applies up to a $106,800 ceiling after which there is no tax.  That means a person making $200,000 pays about 4% overall for the same tax.  A flat tax is a simple tax rate that applies to everyone regardless of income.  A sales tax is a good example of a flat tax.

Some related tax terms are transfer taxes and tax incidence.  A transfer tax has two definitions.  One is a real estate document tax, which is not my purpose here.  Another is consistent with my purpose and it is a general term for a type of tax designed to transfer funds from one class of people to another.  I submit that Social Security taxes have become transfer taxes, but I will elaborate on this in the next post. 

Tax incidence is a term for which class of income bears the tax burden of government.  Many opponents of increasing individual income tax rates argue that people in the high rates pay most of the tax, and that increasing tax rates also increase their tax burden.  This is a tax incidence argument.  Wikepedia has a good discussion on tax incidence.

So much for tax terms.  Now let’s discuss funds.  Most of us have a checking account and a savings account.  Funds are a little bit like this.  Sometimes government sets up a fund to collect funds and put them in their own account.  We call this a fund, except that the fund is associated with laws that say the money can only be used for a designated purpose.  The moneys are then isolated in the funds and reserved.  All interest payments on balances are also returned to the funds.

Okay, one last concept that I find a little tough to summarize, but let’s see what I can I do with it.    It is about investments and annuities.  When we setup a savings account and designate a specific sum to be deducted from our payroll check to be deposited in the account, we notice that over time, the savings earns interest, and the interest earns interest.  This interest compounding effect works in our favor.  It means having more funds on which to retire at 65.  When approaching retirement, we may approach a bank or financial advisor to set up an annuity, which is somewhat like a reverse mortgage.  The bank will arrange for a series of payments from the fund taking into account interest earnings on the remaining balances of principal.  The first payment has more interest that the second payment.  Principal in the first payment is less than the second.  This downtrend in interest and uptrend in principal will continue with each successive payment until the principal runs out.  The Social Security fund works like this.

One final term.  “Gnashing” (pronounced nashing, unless one prefers the Monty Python pronunciation of gah-nashing) is defined as grinding one’s teeth.  It is often used to describe scenes where people are freaking out in mass at some ugly thing.  It is also found in Biblical passages, sometimes associated with beheadings or killings or some such thing.

Now, we are ready for the Republican bashing.  I can see some of them now ….. fearful.  Their teeth are clenched and a few are trembling.  Imagine dark music in the background.  Will it be a gnashing of a bashing? 

Read the next post on “Slightly Right of Center”.  (Dark music swells.)

 

 

Barbara Billingsley

Barbara Billingsley Died last week.  She was 95.  To me, she made a contribution.

She was known for her role of Beaver’s mom in “Leave It to Beaver”.  She was the archetype of the perfect ‘mom’.  She, Jane Wyatt of ‘Fathers Knows Best’, and Harriet Nelson of ‘The Nelsons’ represented this 50’s image.  To sons and daughters of my generation, she was the mom we wanted to have, and to our mothers who had to put up with us, she was the impossible standard.  It was great entertainment for its time.   It was like tapioca pudding, a favorite desert of the 50’s.

She was also known for a very small role on “Airplane”.  She played a passenger who volunteers to help the airline stewardess to communicate with two passengers who only spoke ‘jive’.   Imagine a perfect mom with the 50’s image breaking the mold and reaching across to others of a different culture, helping the situation, and encouraging us to not just laugh but also to reach across ourselves.

The world changes, and we keep up.

Of course, I still like tapioca pudding.

Democracy, Reason, and Listening

In the previous post, I noted how a politician on the right was deemed by the a journalist on the left as ignorant of the issues, and I noted how a leader on the left appears, in my opinion, to be ignoring relevant facts in revisiting policy on the major issue of our time.   I concluded with the question of whether our politics has evolved to a situation where we must choose politicians based on the facts they consider relevant, and those that they ignore in their reasoning process.

Reason requires the same set of facts.  For me to reason based on these facts and you to reason on those facts is similar to me dismissing you and you dismissing me.  Neither of us likes to be depersonalized.

People may weigh some facts over others in the reasoning process.  Why a particular fact is not important and others are is part of the debate.  The other person deserves to know.  If we all commit to reason, fairly and legitimately, then we can survive as a democracy.

In order to discuss the same set of facts, we must listen for them – to each other for them.  So, for that period of time we should stop talking and listen.  Second, we must acknowledge what we heard.

For those who are ignorant of the issues, education is the answer.

For those who insist on building policy without acknowledging the facts advocated by the other side, then that is what elections are all about.   The public will decide which set of facts will prevail.

I was concerned when I wrote the previous post, but I was depressed when I heard this week of a Republican Congressional candidate in Texas who said that violent revolution was not off the table.  I hope he looses.  I hope he doesn’t get a vote, even his own.

President Obama and Christine O’Donnell

What do two politicians who are so diametrically different have in common? They both have significant intellectual blind spots. 

The New York Times reported that President Obama said that there is no such thing as shovel ready projects in a recent interview in the New York Times.  Shovel ready projects were one of three major pieces of the stimulus package that the Congress passed early in 2009.   The other two are limited term tax cuts, which fail to be effective about two quarters after they expire, and payments to states to maintain existing government workers, which is not stimulus. 

Of the three parts of the stimulus, the one that had some potential to stimulate was the shovel ready projects part.  Had it been known at the time the stimulus package was being considered that there are no shovel ready projects, then we as a nation would have looked for other ways to work ourselves out of the recession. The skeptical observer would cite something called a ‘time lag’ as the period between the point in time when a economic policy is adopted and the time it’s effects are felt.  Skeptics predicted that the time lag would be years to feel the effects of the stimulus because they doubted that there were shovel ready projects.  Now, we learn that the skeptics were right.

The statement invited a chorus of criticism.  Some commentators said he lied.   Others, like Derek Thompson of the Atlantic Monthly, said he is intellectually dishonest.  I come down close to the latter, though with a nuance, because intellectual dishonesty can be seen as someone not being honest with himself.  It is not a criticism of character, but rather one of a person’s ability to reason, especially in the area of self-evaluation.  Sometimes we lie to ourselves.  I don’t believe that Obama knew that his policy choice was ineffective and misrepresented the situation, but that leaves the situation where he may not have the good sense to question the major assumptions on which his policies are built.  It makes him look incompetent, or worse.   Had he doubted the realism of a shovel ready project in February 2009, his administration could have drafted something that could have worked.

Andrew Sullivan, a liberal blogger, likes the fact that the President is smart and brings his intellectual honesty to the task of policy making.  Why did Obama fail at it when it comes to the economy?  From the Times interview Obama still believes he made the right choice and that those un-shovel ready projects will ultimately work us out of our bad economic times.  The current state of the economy is sufficient evidence that his approach on the economy is wrong, and his apparent desire is to continue along a discredited path. 

The President went to Massachusetts to campaign for its Governor and proclaimed that Republicans stood by while he tried to fix the economy insisting that he was doing it wrong.  If events have proven the President wrong and his opponents right then why not reexamine the policy and set a new course consistent with good policy making?  We are paying the price for the President trying to prove that his approach to fixing the economy actually works in spite of the evidence.

Joel Klein wrote a column in Time about Delaware Senate candidate Christine O’Donnell and questioned why we, the public, seem fascinated with candidates like her, who are ignorant of the issues.  When asked, she could not name a single Supreme Court case with which she disagreed.  We like “Mr. Smith Goes to Washington”.  We, the public, like candidates who are like us.   But why must these candidates be ignorant of the issues?   Good point.  I agree.

Ignoring the facts should also be avoided.  To persist on a policy approach that is intellectually bankrupt when people are hurting may or may not be intellectually dishonest, but it is grossly inadequate.  Change is required.

What do these two politicians have in common?  They have major intellectual blind spots.  They cannot see what others see.

So, are we left with a choice between politicians who ignore certain relevant facts versus others who ignore different but relevant facts?   

More On TARP, GM, and the Stimulus

Here are a some updates on a few of my favorite topics. 

The White House has announced recent studies indicating that TARP will cost less than anticipated, specifically, no more than $50 billion, and perhaps zero when all the repayments are in.  Even if it turns out that TARP costs $50 billion after the final accounting, I still think TARP was worth it considering the personal havoc it avoided.  Yes, it was flawed and, yes, it was not executed as planned, but it protected us from a very ugly downside.  Banks are very different from normal businesses.  They have our money.  They play with our money.  We need to remember that.

On another matter, the White House announced that taxpayer losses from the auto bailouts are estimated at $17 billion.  In fact, because the new GM has not yet reached its goal of 19% market share, some speculate that the IPO may not happen, which will leave the American taxpayer holding the bag for a while longer.  Car companies are different from banks.  They don’t have our money, or at least they are not supposed to.

Finally, President Obama told the New York Times this week that there is no such thing as a shovel ready project, a major component of the stimulus package.  Well, this has opened a Pandora’s box of criticism.  The next post will examine the mess that the President has unleashed. 

(Tease?   That’s what my wife said.  She wanted some meat on this last subject, somewhat like the old Wendy’s commercial, “Where’s the beef?”  Well, it’s coming.  I actually started writing the stimulus part of this post and it just grew and grew and grew.  I read a little and wrote a little and suddenly it was bigger and being bigger it deserved its own post.  Okay?.........Remember when Walter Mondale tried to use the Wendy’s beef line in a joke during his 1984 debate with President Reagan?   Didn’t go anywhere then either….)

“What’s the News Across The Nation?”

“We have got the Information!”  Well, this is a little homage to Laugh-In, my generation’s SNL Weekend Update.

In the past week we have heard that House Speaker Nancy Pelosi announced that unemployment and food stamps increase job creation.  The problem is that these payments are known as transfer payments and are not counted in the calculation of our national GDP.  Her statement got an almost universally negative reaction.  Normally, this type of statement would go unnoticed, but it came from a person in power who was a major player in the creation of the stimulus package. 

Richard Blumenthal, the Democratic nominee for the U.S. Senate from Connecticut took almost two minutes in a debate to explain how a job is made, and the reviews are practically unanimous that he got the answer wrong. 

Now even though these two news items are about Democrats, the Republicans have nothing to brag about either.  I am planning a few choice bashings of their “misunderstandings” in future posts.  There will be balance.

The point is the same one I made in a previous post.  Politicians who are making economic policy in this country seem not to have a sufficient knowledge of economics to pass an introductory course in the subject.  Quiz them in finance, same result.  And we wonder why we are in the mess we are in.

My second reaction to Richard Blumenthal’s inability to explain how a job is created is that it is obvious to me that he was never unemployed.  He appears never to have gone through the experience, and had he done so, he probably would have found himself in a church or a community center that sponsored support groups for people looking for work.  The first group lecture is why a job is made.  The explanation is that employers create so much demand for products and services that they create jobs to do work that they cannot do themselves.  I know, because I have heard the lecture. 

How can he feel the pain of people who ARE out of work when he was born economically secure?  I mean how can he really identify with people who have had to stand in line to file for unemployment?  It is an intensively leveling experience.  I met a senior defense engineer and a construction worker in the same line.  There were men and women, people in suits and people in jeans, and people of all races and ages and backgrounds.  The pride of a job flows out of you in the line no matter who you are. 

They were great laughs, Dan and Dick, …… George too.  

What if David Stockman is Right?

Okay, the David Stockman interview mentioned in the previous post wasn’t pretty.  It depressed me.

I can’t believe I am writing this.  I need to entice readers into looking at what he says.  Yes, he says very important things.  Yes, there are warnings that should be taken seriously.  But wow!   Talk about speaking loudly and carrying a toothpick.

Here are just a few of his observations.

Over the past 40 years, we have had only 2 years in which we had a surplus.  That is 38 years of adding to the National debt.

If we elect a Republican Congress, we will have 2 years of gridlock with a split White House and Congress.  Nothing will get done, including deficit reduction.  Once we can be in a position to reduce the debt, perhaps as early as 2012, we will have added an additional $16 trillion in total debt with state and local debt added in.  That will surpass the nation’s GDP.

After 40 years of deficit spending, we no longer have the balance sheet to support the budget cuts that Republicans want to extend.  There is a 10% gap between revenue and expenditures in the National budget, and Republicans are “faking it” when it comes to budget cuts, and that means raising taxes.  When there is no will to cut spending, then raising taxes must be used to balance the budget.

The recovery is over.   The news flash is that we had a short recovery and we are now in a new normal of slow 1% to 2% growth with 9%, perhaps 10%, unemployment for years.  (See, I told you he was depressing.)

This is a bad environment to work on the deficit problem but we can’t wait.  We must start now.   We have excessive debt at all levels, and we must de-lever at all levels, including our personal individual debt.

He was asked about going back on the gold standard.  Before the Nixon Presidency, the dollar was tied to gold before Nixon let it float.  Stockman did not advocate returning to it, though he did advocate getting positive in our current accounts internationally.  Hmmmm….sounds like a future post on this subject.

I had to turn it off.

But if David Stockman is right, what should we be thinking about?  First, we have a long way to go to get into a growth economy.  Second, deficit reduction will be tough.  Third, we are so over leveraged with debt that we can no longer stimulate the economy through debt.

Stimulus programs don’t work, but tax cuts may not work either?  Well then, what will?

David Stockman is Coming! David Stockman is Coming!

I saw David Stockman being interviewed the other day.  Well, like the rest of us, he has aged.

For those who don’t remember, Stockman was a Congressman when President Reagan tagged him to be his first Director of the Office of Management and Budget.  Stockman was impressive.  He knew the Federal Budget inside and out.  He would identify budget cuts better than any OMB Director before or since.  His influence in the Reagan Administration fell in December 1981 when an article was published in the Atlantic Monthly in which he was quoted as saying "Kemp-Roth [Reagan's 1981 tax cut] was always a Trojan horse to bring down the top rate.... It's kind of hard to sell 'trickle down.' So the supply-side formula was the only way to get a tax policy that was really 'trickle down.' Supply-side is 'trickle-down' theory."

Yes, we owe the term “trickle-down economics” to David Stockman.  But what does this really mean?  Is there a rational approach that allocates resources efficiently?   Not in the sense that Stockman was implying.   I am not aware of a government centralized resource allocation mechanism that works.   Government is not designed around a win-win approach based on individuals advocating their self-interest economically.  By the way, the top tax rate when Reagan took office was 70%.

Regardless of which tax theory one advocates and as a future post will suggest, the first question is to determine what’s fair.

TARP and the Church Lady

Will I harp on TARP again?  Well, I will….one last time…….at least for now.  But this time, let’s have some fun with it.  Imagine the Church Lady from Saturday Night Live.  What would she say about TARP?

First, let’s imagine that the Church Lady has a $200,000 house with an $180,000 mortgage right before the fall of 2008.  This means that she has $20,000 in equity.  She has no credit card debt (I mean, would anyone think that the Church Lady would have credit cards?), and she has $50,000 in savings.   So, her total assets are $250,000 from the house and the savings account.  Weighed against a liability of $180,000 for the mortgage, her personal net fortune is $70,000. 

Most readers will probably recognize the basic accounting relationship of assets equal’s liabilities and equities here.  This is the basic balance sheet formula.

Imagine also that during the crisis, the Church Lady’s neighbor had an identical house with a higher mortgage.  Both houses went down in value by $50,000, except that her neighbor defaulted on her mortgage, and the bank had to write off the mortgage as well as those of many others.  Well, the balance sheet of the bank went from a positive equity position to a negative equity position.  It had more liabilities than assets.   

Though the Church Lady has lost $50,000 in net equity, she continues to support the house.  The bank, however, is not as fortunate.  The government through the Federal Reserve Board has set a minimum reserve level, which the bank can no longer meet.  The bank goes bankrupt.  It can no longer give loans to people who want houses or businesses that employ people who buy houses.  Other banks raise loan requirements because they have bad loans on their books and they cannot afford acquiring any more.

The government passes a law called the Toxic Assets Relief Program in which the government will buy the banks’ bad loans.  The bad assets go away in exchange for cash, and miraculously, the banks balance sheet is healthy.  The banks can lend money again. 

The Treasury changes its mind.  It buys stock in the banks.  The balance sheets are better, but not as healthy and credit is still difficult to come by. 

What would the Church Lady say?  Well, first, she would say that the Congressmen and Senators who voted for the original program were lied to.  She would note that despite the lying, the Treasury department did make money on the bank investments.  She also noted that despite the change in plans, banks closures did slow and that gradually, people began to get the credit they deserved.  The devastating losses decelerated, and the bottom was within reach.  This was TARP. 

To answer the question, I personally believe the Church Lady would have refrained from ranting at the program and the Congressmen and Senators who voted for it.  Something had to be done.  The destructive cascade had to stop.  Their motives were in the right place.    Execution?  Well…  We all can improve that.

However, she would note one particularly bad government bailout.  Oh, how would she say it?  Maybe something like “Who, after being bought by the Federal government, sold the government assets, assets purchased with taxpayer money, at a loss to corporate investors, some from China who demanded it to share its technological advancements?  Who could it be?  Who could it?  Could it be …… General Motors?”

Okay…I bashed GM again.  I couldn’t resist.

TARP! The Sequel?

The period from late 2008 through 2009 was frightening.  In the previous post I talked about small investment firms that went bankrupt due to the fall of Lehman.  But genuine fear ran through me when a relative’s business went under in early 2009, again, as an after effect of the failure of the investment banks from the previous fall.

Let’s call this relative Jane, who is an MBA with a great track record.  She wanted to develop a small restaurant idea into a business.  She developed a business plan, searched for the right location, developed a theme, leased space, retained an architect, paid attention to every detail from food to drink to ambience, AND the result was spectacular.  Every time my wife and I visited we were awed at the accomplishment. 

So Jane got up early every day and got home late every night.  She always looked tired, as well as proud, deservingly proud. 

And then one day we got an email saying that Jane was closing her restaurant.  She could no longer get credit.  The standards had changed.  The effects of the investment crisis cascaded down again.

How many times would this story have repeated itself across this country without TARP?

So, You Want to Vote Out Politicians Who Voted for TARP?

I observed some interesting behaviors in the investment industry following the collapse of Lehman Brothers in September 2008.  There are many small investment firms that went out of business as a result of the fall.

Investment firms often leverage funds. Downside risk can be mitigated by a series of investments that go up as others go down and vice-versa. When Lehman Brothers went bankrupt they denied these firms a source of funds for leveraging.  As Lehman went under, calls against all of its investments funds drew down the values of their funds to fire sale levels.  Hence, a number for firms went under through no fault of their own.

Imagine working all of your life in a small investment firm.  You put all of your capital in the firm.  You work long hours.  You don’t make the megabucks of the big firms.  You make enough like everybody else, and whatever good fortune you get goes back in your firm.  And suddenly, it is all gone.  Your life’s work gone over night.  And it was not your fault.

Had TARP or something like it been in place when Lehman went under then the cascade would have been prevented and many of these small firms could have been saved.

The conclusion is that TARP was intended to provide a firewall around some of the innocent investors who did nothing wrong.  These are the people who responsibly managed the retirements of lots of small investors whose retirements are now either gone or severely impaired.  The impact could have been disastrous for so many.

For the Tea Party to advocate that voting for TARP was a wrong idea – well – find someone who was washed out by the Lehman collapse and make your case.   Remember that real people got hurt.  Now imagine that the situation of many of these small firms is replicated to the large firms because TARP was not available, and think about how many jobs, jobs like yours and mine, are really dependent on the success of these larger firms who received TARP.  Now think about risk and whose job you are willing to risk by not voting for TARP. 

To me, TARP was a necessary evil.  The recession would have become a depression without it.  I don’t blame a politician who held his or her nose while voting for it.

The Smartest Guy in the Room

Wait!  There is one explanation to the deeply critical question raised in a previous blog of how could those smart people have failed us?

They can’t forecast!  They can’t forecast the economy!

At least that is what Nassim Nicholas Taleb says.  He is one of those financial engineers that could have been an economist.  He is not just a financial engineer, but he is a teacher of financial engineers at New York University.  So, he is the smartest guy in the room, at least today.

He says that the investment crisis could have been forecasted.  He also says that the Obama stimulus made things worse, and that the proper course of action would have been to pay down debt. 

So, we have administration officials saying that as many as 3 million jobs were helped from the stimulus.  While there is great difficulty finding supporting data to their claims, there is at least one leading financial engineer who says the stimulus hurt the recovery.

Though this dialogue could have been forecasted, there is an ongoing issue here that has been a recurring theme in my blog.  There are those who believe in Keynesian economics that more government spending yields greater overall consumption, and those who take more of a balance sheet view that excessive levels of debt may restrict increased consumption.   We will revisit this tension in future posts.

We ARE smart people! Yes! Yes! We ARE!!

Then why are our best minds failing us?   Why is the economy in the toilet and there is not good sign of recovery anytime soon?

I just think our economists have it wrong.  This is from a guy who may become an economist one day.  My thought is that our recession is not in a normal business cycle recession which says that manufacturers build up inventories until demand fails off, at which point manufacturing pulls back until inventories fall back to normal levels and consumption increases.   Keynesian expansion was made for this type of downturn. 

This is an accountant’s view of the problem.  This is a balance sheet recession.  There was not an over supply of inventories in September 2009.  Instead we devalued our assets over night, and we had a leverage problem.  When banks have fewer assets on their balance sheets to leverage against our loans, they have less to loan, and business contracts.  When we have less equity in our houses and our neighbors are moving out of theirs, we become more conservative, pay off our own individual debt, and restrict our buying.  So, if the Government stimulates the economy, we won’t respond as normal.  The Federal Reserve can flood the banks with cash and the cash will just sit there, especially after the banks raises the criteria for borrowing.  

The entire balance sheet of the country has been devalued, when our country borrows for the stimulus, we accelerate sovereign debt problems. 

What this adds up to is that there are no easy fixes to the recession.  Knee jerk reactions won’t work.  We may be in this thing for a long period of time.

Michael Hirsh says that our best minds are no longer becoming economists.  They are AWOL and have become financial engineers.   Ugh!

Incompetence is a Political Risk

One of the gifts that President Bush gave President Obama is that he made incompetence a political risk.  Simply because President Obama avoids terms like “strategery” and “lock box” does not put him in a position where he can avoid looking incompetent.

To solve a problem, President Obama likes to get the best minds in the country in one room and select the policy that represents a consensus.  He does not necessarily know the subject matter at hand, but if everyone else in the room agrees, it must be right.  Right?  Wrong!  A President must know the subject matter enough to recognize bad alternatives and get them out of the room.  If he doesn’t do it, know one will.  Those smart people are afraid of speaking truth to power and will not speak up.  The result will be bad policy.

If, as the previous post suggests, that some basic college level education would help, especially in economics, then the President would have known that short term tax cuts have limited usefulness.  Even his predecessor had a tax rebate in his final year and it benefited the economy for only two quarters.  We all should have learned from that.  He would have also known that fiscal stimulus projects of two to three years in length severely dilute the impact needed today to reduce unemployment.  Even people on the street would have told him that incentives for home and car purchases merely move demand up in time, but don’t really create additional demand, which explains why home and car sales are down now that those rebates are over. 

A basic course in project management would have helped the President in the gulf oil spill.  It would have told him to identify all his potential solutions on day one of the crisis, and crash, or expedite, them all.  Instead, he took them one at a time, including the berm designed to protect the wetlands.  I am quite sure that some of the President’s competition in 2012 will point out lots of ways for him to have shortened the 80 days it took him to stop the leak.  

I have spent my life around some of the most brilliant and overeducated minds in a host of industries and some of them could not lead you to a restroom.   Yes, they could after studying the matter, but many of them are so consumed with their own thoughts that they fail to notice where the restrooms are when the walk through the building.  They are often arrogant and self-absorbed to the point that they fail to listen and understand the self-interests of those who are affected by the policies they create.  Now that I possibly alienated some of my friends, I lay myself open for the same criticism.

There is a political risk brewing for the President in health care.  There is a case that is moving up to the Supreme Court that seeks to declare the new health care law unconstitutional on two grounds, namely that it violates the commerce and taxation clauses of the Constitution.  The health care law has a provision in it that says if the Court voids any part of the law, the entire law will be voided.  This is unusual, and if voided, as some predict, it will bring questions of to why the President took more than a year to put our country through the national exercise of adopting this law during a severe economic recession, and the law was not even competently constructed?

Now I have to find a restroom.

Educate!

I turn on the TV and I turn to Fox and I get one interpretation of public policy.   I turn on MSNBC and I get a different view.  I turn on CNN and I am not sure what I get.  But common to all three of these news outlets is that none of them really concentrate on educating the audience as to the basics of how things work.   To the reader of this blog, the following may seem tedious, but work with me here, please.  This is an educational piece that explains one of the key themes of this blog.  Or, you can skip this and move on to the next post.

During the Enron crisis, the stock market was crashing and President Bush stabilized it by making it a criminal offense to put forward financial statements that misrepresented the financial condition of a public company.  Instead, the press concentrated on the Sarbanes-Oxley bill.  But if one reads the first few chapters of a basic text in financial management, one will learn that information risk is a major factor that has to be controlled in order to stabilize market values and lower interest rates.  History has proven Bush right in that instance and the Sarbanes-Oxley bill has proven to be excessive.  The press could have educated the public on something important, but they focused on the wrong thing.  We, as a public, could have learned something important.

During a debate on Social Security, one Democratic Representative, said that a bankrupt Social Security Fund was okay.  It would pay out 40% of its commitments.  The press did not jump on this and they should have.  Just the mere thought of a 40% payout is offensive, but another education opportunity was lost.  A basic first year text in accounting would explain that bankruptcy is the inability of a company to pay current obligations with current cash.  Again, a major opportunity to educate all of us was lost. 

During the debate on General Motors and Chrysler, no one in the press talked about public versus private goods.  Many of our freedoms and responsibilities as an electorate are present in a discussion on this subject.  The freedom to own property is embedded in this right.  A basic text in economics discusses this.  Again, the press was silent on this subject, and the Government went ahead without an educated electorate to help with the decision.  

During the debate on fiscal stimulus, the press failed to educate on the efficiencies of tax cuts versus direct government programs.  Guess what?  A basic text in economics addresses this.

During the debate on banks and TARP, the press failed to educate on monetary policy.  Again, a basic text in economics discusses this.

I heard people recommend that when writing for the general public, it is best to write to a 10^th grade level of education.  I also heard that we should peg our writing at the 8^th grade level.  We spend so much on education and this is the result?  I am advocating that we raise it to a first year college level of education.  After all, 85% of our fellow citizens have completed high school.  This is just a little higher.  If low expectation is the standard of our press, then no good policy will be the result.  Every smooth politician will think that he or she can sell us anything.

I really don’t care that Fox is conservative and MSNBC is liberal.  I care that they educate and enable us, the electorate, to competently engage in public discussion.  We need some economic education.  Good policies are the result of an educated electorate.

A Numbers Game?

Valerie Jarrett was on “The View” recently defending the stimulus plan on the basis that it helped keep 3 million jobs.  If you visit www.recovery.gov, the Administration’s official website on the stimulus, it says that the stimulus funded 749,779 jobs during the first 15 months of the program.  Last week, the Controller’s Office of Los Angeles reported that $111 million dollars of stimulus funds were used to create 55 new jobs. 

If we project from the City of Los Angeles experience, maybe only 270,000 jobs have been created to date?  If this even begins to approach the truth, where did all the money go?

According to the IBTimes.com, Robert Inman, an economics professor at the University of Pennsylvania, theorized that state governments have been using the money to promote their own selfish agendas and are not using the funds in the best interest of the country.   

GM, TARP, and China

My wife and I proudly own only GM cars.  All told, we have owned eight GM cars, as well as a few Fords, in our combined lifetimes.  To me, it was a patriotic thing to buy an American car and create more American jobs.

So, it pains me to present the following, all of which have been sourced from mainstream financial and auto industry publications.

• The government owns 60.8% of GM. 
• GM is planning to sell a portion of the government’s share in an IPO right after the elections.
• GM needs an estimated $133.78 per share for the government to re-coup its $49.5 B investment.
• Financial press has speculated for months that GM and the government will lose money on the initial sale of shares in the upcoming IPO.  In fact, the latest speculation is that the IPO will yield only $10 B when the initial target was $16 B.
• The new GM CEO has said that it will take years for the American taxpayer to realize a payback.

But wait, there’s more.

• SAIC, a Chinese auto company intends to buy GM shares in the upcoming IPO.
• China has signaled its intent to force US and other automakers operating in China to share its technology.  Rep. Dingell, a Michigan Democrat, has voiced his strong objections.  This means that the new battery technology behind the Volt will be at risk.
• GM recently sponsored a film in China promoting the Chinese Communist Party.
• GM has recently begun giving money to various candidates for the upcoming election, mostly incumbents from both parties.

Just a few more facts. Most Apple, HP, or Dell computers are made in China when the technology was invented here.  China is at the top of the FBI’s list of nations sponsoring industrial espionage? 

My boss’ favorite saying is ‘you can’t make this stuff up.’

I have been visiting the AutoTrader website recently and found myself looking at BMW coupes, 3-series, automatic with paddle shifters, and a sunroof.  White with a tan interior would be nice.

When is a Stimulus Like a Boat?

In an earlier post I reported Christine Romer predicted that the stimulus package would add 1.6% GDP to the economy.  So, let’s have some fun with her prediction. 

When the stimulus bill was passed, the economy was $14,050 B and it has grown to $14,575 B over a year and a half, a difference of $525 B.  Now in the same period of time the Federal Government has spent $512 B of the $787 B in the stimulus bill.  So, what can we conclude?  The stimulus caused the economy to expand by $13 B beyond the stimulus itself?  At 3%, that only covers the first year’s interest on the money borrowed for the stimulus. 

Let’s keep Christine’s Romer’s 1.6% expansion in mind.  We should have grown by $225B more than the stimulus.  But not all of our growth can be attributed to the stimulus.  Let’s assume that half of the $525B is the product of our individual private labor and companies.  Also, we must give some credit to Ben Bernecke and the Federal Reserve’s expansionary money supply policies.  Then we are getting about a 50% return on the dollar from the stimulus. 

Annualized we are growing at something like 2% per year when we should be getting 5-6% in the initial phase coming out of a recession.  We shouldn’t be threatened with slipping back into a second recession.  In Keynesian terms, the multiplier effect of the stimulus is between .5 and 1 when it should be between 2 and 3.

President Obama wants to add $50B for transportation improvements, and he does not want to call it a stimulus.

When I thought about this post, I thought of some very clever things to say, but now that I laid out this information, I think I’ll stop writing.

Republican Tax Cuts

Politicians and their economic policy analysts can engineer the economy. They are not always successful, but they attempt to engineer it.  The Republicans generally do it through tax cuts to stimulate consumption.  Democrats tend to emphasize government purchases.  Any entry-level college text in macroeconomics will say that the GDP is a combination of consumption, government purchases, investments, and expenditures by foreigners. 

Tax cuts have the advantage of working quickly and effectively.  The Bush tax cuts were very successful in stimulating consumption with an average 6.5% per year increase in GDP from 2002 to 2008.  Give people money to consume and they consume.  Unfortunately, a lot of what they consume is foreign.    In 2006, when the Federal Budget deficit was $247 B, the trade deficit was $235 B, and China bought $200 B in US Treasuries alone to finance our deficit.  Where did China get the money?   From us.  So, here are the connections.  The US Government cuts tax rates for people to spend, and they spend a lot of it on foreign goods that transfer wealth to foreign countries that buy up our debt.  This wealth then becomes a basis for them to build up their industries and eventually begin to buy our industries and our wealth creation capabilities.  A case in point is Ford selling Volvo to a Chinese car company. 

As Mr. Spock would say, “This is not logical.”  And I did not even begin to get into structural unemployment.

Next post - equal bashing for the Democrats.