Monday, November 17, 2008

It’s Only a Matter of Zeros

In the mid-1990s I was conducting research on the operations of local stock exchanges in the Caribbean. Sitting in the office of an individual I was interviewing, he interrupted our conversation to place an order for U.S. government bonds.

The company for which he worked was an offshore pension fund of a major multinational energy firm with headquarters in the United States. The reason for the funds location in a Caribbean jurisdiction was the absence of a corporate income tax, which enabled the fund to earn a pre-tax return on its investments until money was repatriated as required to pay the pensions of the firm’s retirees.

Returning to his phone call, he placed an order for $150 million of U.S. government bonds. My jaw dropped. I was not then used to hearing instructions to purchase financial assets in such large amounts. Looking at my discomfiture, he casually remarked “It’s only a matter of zeros.”

Fast forward to late 2008. Millions are so small as to no longer constitute a rounding error on government expenditures, tax cuts, or the creation of credit by the Federal Reserve Board. The same applies to most of Western Europe. The U.S. federal budget deficit in fiscal 2009-10 could well amount to $1 trillion ($1,000,000,000,000). The Congressionally-enacted TARP program authorized $700 billion ($700,000,000,000) for the purpose of preventing an implosion in U.S. financial markets. Additional appropriation of funds if needed could propel that above $1 trillion ($1,000,000,000,000). The Fed’s increase in credit since the financial crisis unfolded is estimated at $2 trillion ($2,000,000,000,000). The federal government’s public debt has surpassed $10 trillion ($10,000,000,000,000) and will grow rapidly during the next few years.

Will these subsidies, loans, credits, and deficits be repaid? Perhaps, but not in the short run. Perhaps only indirectly through inflation. As I noted in a previous post (March 6, 2008), the time may soon come for the fresh printing and circulation of $500 and $1000 bank notes, as the existing $100, $50, and $20 notes come to buy less.

Tuesday, November 11, 2008

Saving Detroit’s Big Three

Labor unions played an important role in helping get out the vote for President-elect Obama, and expect a payback for their efforts. In addition to the $25 billion appropriated by Congress for retooling by General Motors, Ford, and Chrysler, the big three are seeking another $50 billion lest they run out of cash in 2009 and declare bankruptcy. If President Bush refuses to go along with Congressional support for additional aid, it is almost certain that the new Obama administration will place such financial assistance at the top of its agenda.

Additional federal funds for the automakers is principally directed at keeping their employees on the job and sustaining the benefits that labor unions have extracted for their members. However, Obama will need to make clear that both auto executives and assembly-line employees will have to accept harsh measures to keep from facing the same problem in the next year or two. Unless Obama makes explicit that the additional $50 billion might be the last tranche of aid, the unions are likely to hold out for higher wages and benefits, instead of accepting the necessary reductions in jobs and compensation to make the automakers competitive with imports and domestically-produced foreign brands.

It’s hard to imagine the United States of America without General Motors, Ford, and Chrysler. But then again, the current financial crisis is a once-in-a-century event, and many long-standing, reputable financial houses are no more.

Monday, November 10, 2008

Sales Tax Hike in California

To close the state of California’s large budget deficit, Governor Arnold Schwarzenegger has proposed a combination of spending cuts and a (temporary) increase in the sales tax of 1.5 cents. Without new tax revenue, the state cannot meet its proposed budgetary expenditures.

This situation raises the question that few public officials are willing to confront. How can the people meet their budgetary commitments if the state takes more money from their pockets? Homes are being foreclosed, wages and benefits are being frozen or reduced, workers are being laid off or having their hours reduced, medical and food costs are rising, yet the governor’s solution of higher taxes would put even greater stress on strapped household budgets.

Before we ask how the state and local governments can get by with less money, we first need to ask how the people can get by with less money.

Thursday, November 6, 2008

Fixing Social Security—An Obama Priority

President-elect Obama has proposed to fix Social Security by transforming it from a partial contribution-linked, old-age benefit program into a more explicit tax-and-transfer regime. The transformation will further shatter the myth that payroll taxes represent an individual’s contribution to his old-age government pension by further breaking the link between contributions (payroll taxes) and benefits. The transformation will be done in a few short steps.

First, Obama has proposed to create a “Making Work Pay” tax credit, the principle source of giving middle-class Americans a tax cut. Workers will be provided with a refundable tax credit equal to their share of the Social Security payroll tax (6.2 percent of payroll) on the first $8,100 of earnings. Those earning up to $8,100 would receive $500 each or $1,000 per family. The credit would be completely refundable against personal income tax, offsetting that amount in income tax liabilities, but would likely be phased out for high income earners. Refundable also means that individuals or families would receive a government check for $500 or $1,000 even if they have do not owe any income tax. The refunds would ostensibly come from general revenue, but that is a mere accounting notion, as the money has to be borrowed in any case.

Second, currently projected to start in 2018 or later, Obama would impose additional Social Security tax on persons earning more than $250,000 a year, at an initial rate between 2 and 4 percent, split between employer and employee. He has yet to specify if the tax would apply to capital income (dividends, interest, capital gains) or whether those paying the tax would receive larger benefits (unlikely).

Once in place, the size of the refundable tax credit could be increased, the rate of additional tax on those making over $250,000 could be increased, and the $250,000 threshold could be lowered.

With these changes, the Social Security payroll tax would morph into a much more explicit income redistribution scheme. Nor would it take much effort to extend Obama’s transformation of Social Security to Medicare, and then combine the two.

Wednesday, November 5, 2008

Some for the Love of Ireland, More for Hatred of Peel

Sir Robert Peel held office as Conservative (Tory) prime minister of Great Britain during 1841-46. Seeking to foster economic growth in heavily protectionist Britain, he undertook two revisions of the tariff in 1842 and 1844-45 to free up trade. Although tariff revenue declined £192,000 and £204,473 respectively, the corresponding value of trade due to lower duties rose £410,000 and £835,760. Peel compensated for the lost revenue, in part, with an income tax of about 3 percent (7d./£) on annual incomes over £150. Despite lower tariffs, revenue actually increased on some goods due to the expansion in trade.

As a Tory, Peel came into office committed to the principle of agricultural protectionism. The long-standing Corn Laws restricted grain imports. However, the potato famine in Ireland forced him to open Irish ports to food imports in 1845, which represented an unplanned extension of his movement towards free trade.

To prevent future famines, in 1846 Peel proposed repeal of all grain duties to take effect on February 1, 1849. The measure passed both houses of Parliament by June 25, 1846, and received royal assent the following day. However, Peel was not to escape the wrath of the landed Tory interests. Famine was followed by disorder in Ireland, which compelled him to propose an Irish Coercion Bill for parliamentary approval. In this, Peel was defeated by a combination of Irish, Whigs, and Protectionist Tories, “some for the love of Ireland, more for hatred of Peel.” Peel served in opposition in Parliament until his death in 1850 by a fall from his horse.

John McCain was soundly defeated in his quest for the presidency, “some for the love of Obama, more for hatred of _____.” (Bush? Spendthrift Republicans? Other reasons?).