Wednesday, February 18, 2009

The Stimulus, Part Three: Global Coordination

The G7 finance ministers and central bankers—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States—held their annual meeting in Rome on February 14-15, 2009. Their closing communiqué called for “stabilizing the global economy and financial markets.” To that end, the participants emphasized the need for global coordination, urging each country to stimulate its economy and oppose protectionism. The same conclusions will doubtless be reiterated at the larger G20 meeting, which includes another 13 emerging economies, to be held in London on April 2, 2009.

Assume the G7 and G20 can agree to coordinate their fiscal and monetary policies and that they choose a constructive course of action. What is the likelihood of success in carrying them out?

Let’s start with the U.S. The fiscal stimulus pass by an almost 100% partisan vote, with only 3 Republicans defecting in the Senate to enable its passage. Since the crisis erupted, the U.S. Treasury has wandered all over the map, changing its use of TARP funds on several occasions, and is likely to do so again. Securing passage of further stimulus measures is sure to be more difficult.

The United Kingdom faces a general election in 2010. The economic crisis in the U.K. has put the Conservative party (the Tories led by David Cameron) in position to win control of the House of Commons and establish the next government. The Tories are unlikely to support Prime Minister Gordon Brown’s efforts to stabilize the banks and the economy.

Italian politics are always fractious. Japan is running through prime ministers and finance ministers at a torrid pace. The governments of France, Germany, and Canada face internal opposition to their measures. France, Italy and Spain have granted subsidies to sustain national industries, threatening a rise in protectionism. Democratic politics, government versus opposition, in all 7 countries virtually assures that coordinated action will fall victim to partisanship inside the G7. Coordinating fiscal and monetary policies across the G20 is a pipedream. The best that can probably be hoped for is that G7 and G20 members do not work at cross purposes.

Tuesday, February 17, 2009

The Stimulus, Part Two: The Real Issue

The debate over the stimulus during the past few months focused on two big issues: (1) the composition of the stimulus, the shares for tax cuts and spending and (2) the size of the stimulus, $700 billion, $800 billion, $900 billion, or more.

First, the composition of the stimulus. The ratio of tax cuts to spending is about 40:60. But this greatly exaggerates the fraction going to tax cuts. The tax cuts consist largely of credits for low- and middle-income households, an increase in the earned income tax credit, and other credits (credits are cash payments or subsidies for low- and middle-income households, not real income-tax cuts). The law also raises the exemption in the Alternative Minimum Tax to keep millions of middle-income households from paying higher taxes. Tax incentives for business are a much smaller portion of the stimulus. Republicans and conservatives favor tax-rate reductions while Democrats and liberals prefer tax credits, which means the latter secured the vast bulk of the “tax cuts.”

Few Republicans and conservatives are happy with any part of the spending package, whereas Democrats are generally pleased with the mix and timing of the proposed expenditures. Apart from the merits of specific expenditures, they are disproportionately directed at traditional Democratic constituencies. The largest are Medicaid health care for the poor ($87 billion), direct aid to the states for local public schools ($45.6 billion with teachers’ unions the beneficiaries), infrastructure ($61 billion, labor unions), greater unemployment benefits (workers), more food stamp benefits (the poor), job training (workers), science (professors in leading universities), and investment in green technology (environmentalists).

Second, the size of the stimulus. To secure passage, Democrats required three Republican votes in the Senate to prevent a filibuster. The process that achieved the final result was a charade. The House bill was a tad over $800 billion. The Senate added a number of measures to raise the package past $900 billion. The “gang of three,” Maine’s Olympia Snowe and Susan Collins and Pennsylvania’s Arlen Spector, that provided Democrats with the required 60 votes, postured as fiscal conservatives, insisting that the stimulus be cut by $100 billion or more. The Democrats were ready to grant the threesome this gesture because the final $787.5 billion package was quite close to the original numbers in both houses. Moreover, the Democrats will likely be able to restore some of the deletions in supplemental bills or clauses attached to other appropriations.

Many economists and analysts criticized the stimulus as too small, too large, lacking incentives, failing to address pressing infrastructure and social needs, the timing of spending, and others. None of these concerns was particularly important in the architecture of the final package. The purpose of the stimulus was not so much to halt the economic decline as it was President Obama’s and the Democratic party’s payment to the various constituencies that helped them get elected and to support their re-election bids in 2010 and 2012.

Monday, February 16, 2009

The Stimulus: Part One

Gallons of metaphorical ink have been shed on the stimulus bill, H.R. 1, that President Obama signed into law on February 17, 2009. The stimulus will occupy this blog for several weeks. Before delving into its tax and spending details, it’s interesting to observe the discord that the law has generated among economists. Prominent economists of the left and right completely disagree on the “stimulus” effect of the measure. Some on the left argue that a dollar in stimulus will give the economy a substantial boost, as much as a dollar fifty in additional economic activity. Some on the right argue that it will provide no net benefit.

Two of the leading antagonists in the debate over enacting a stimulus have become increasingly uncivil. They are Princeton’s Nobel Laureate Paul Krugman, who received his prize for integrating international trade and economic geography, and Harvard’s Robert Barro, a leading macro-economist and possible future prize winner. Krugman insists that a large stimulus is essential to create jobs and avoid years of stagnation; indeed, he has repeatedly argued for a larger package than Congress approved. Barro argues that the stimulus will create no new net jobs. Barro has charged Krugman with abandoning serious economics in his New York Times columns in favor of political advocacy for Democrats and opposition to Republicans. Barro asserts that he, despite Krugman’s Nobel prize, is more qualified to comment on macroeconomic matters. Krugman has completed rejected Barro’s use of World War II to make Barro’s point as “boneheaded.” Neither man wins on charm.

Even if Barro is the more distinguished macro-economist of the two as he claims, it’s hard for the typical college-educated person to fathom how two such brilliant economists can take radically opposing views on the stimulus. Evidently the application of economic theory and evidence is unable to resolve their differences. A survey of the top several hundred economists in the nation would also likely reveal wide differences on the benefits of the stimulus. Economists have presented different interpretations on what measures ended the Great Depression and whether tax-rate reductions in the past, or other factors, were responsible for economic recoveries and growth. If this division persists throughout Obama’s presidency for the next 4 or 8 years, how can Members of Congress decide the best course of action to ameliorate the current crisis and other issues that will arise in the future, other than vote along partisan lines to maximize their prospects for re-election.

Tuesday, February 10, 2009

“Making Work Pay” Credit: The Flawed Tax Cut in the Stimulus Bill

The final stimulus bill will almost certainly include President Obama’s “Making Work Pay” tax credit of $500 for an individual and $1,000 for a family in 2009 and 2010. The credit, included in both the House and Senate versions of the bill, is to be refundable, which means that individuals without any income tax liability will also receive the tax credit as an offset of an employee’s share of the first $8,100 of the social security payroll tax levied on wages and salaries. The full credit will be limited to individuals making $70,000-75,000 (double that for two-earner households) or less, gradually phased out for higher incomes. Some prominent economists on both the right and left are calling for this tax cut to be made permanent.

There is danger lurking in this measure. The vast majority of federal income taxes is being paid by fewer and fewer households. The share of federal income taxes paid by the top 20% of all households has increased from 64.9% in 1979 to 86.3% in 2005. (That of the top 1% rose from 25.8% to 39.4% during 1986-2005, the top 5% from 43.9% to 59.7%, and the top 10% from 55.7% to 70.3%.) The share paid by the bottom 40% fell from 4.1% to -3.8% (negative tax) during 1979-2005. Negative tax means that the government is topping up household incomes with an earned income tax credit, cash, payable to low-income households. The share of the top 60% declined from 10.7% to 4.4%.

In 2003, there were 138,959,000 tax unit households in the United States. Of these, 18,131,000 (13%) were non-filers. Nontaxable returns including those with refunds, amounted to 33,544,000 (24.1%). The two categories sum to 37.1%. Those subject to income tax of $500 or less numbered 8,372,000 (6%), of which single heads of households constituted the bulk at 5,985,000.

The shares of social insurance taxes rose or fell less dramatically during 1979-2005 because social insurance taxes are paid from the first dollar of earnings. The share paid by the bottom 60% fell from 36% to 31.1% while that of the top 20% rose from 35.9% to 43.6%.

On these numbers, a refundable tax credit against employee social insurance earnings would remove more than another 8 million tax units (5.8%) from federal tax liabilities, putting the share of non-taxpaying units around 49%.

If the “Making Work Pay” credit were to become permanent, and if Congress were to raise the offset to a higher percentage of the payroll tax, the 49% of households without any federal tax liability will quickly surpass 50%. When that happens, a non-taxpaying political majority will find itself in the enviable position of being able to vote tax increases on a minority of taxpayers (thereby financing benefits for themselves) without having to pay any of the increase. The models used by economists to estimate the economic gains of making the “Making Work Pay” tax credit permanent do not include this political outcome and its implications for U.S. democracy.

Friday, February 6, 2009

Capping Pay: How Far Should it Go?

Those banks and firms which accept government funds in the future will be subject to annual executive compensation limits of $500,000. What’s good for the goose should be good for the gander.

Take Tom Daschle and Leon Panetta. Daschle earned $5 million in two years and Panetta $700,000 in one. Did they produce any goods or services other than influence peddling? Not really. They were paid to consult or speak on the basis of their past and prospective political influence.

A better example is White House chief of staff and former Member of Congress Rahm Emanuel, who served as an advisor to President Bill Clinton. He resigned from his position in the Clinton administration in 1998 and went to work as an investment banker at Wasserstein Perella (now Dresdner Kleinwort), where he worked until 2002. In 1999, he became a managing director at the firm’s Chicago office. According to Congressional disclosures, Emanuel made $16.2 million in his two-and-a-half-year stint as a banker, a profession in which he had no prior experience.

Public service is supposed to be serving the public, not working a stint in the White House, an executive branch or agency, and Congress, and then cashing in big time in the market for influence peddling. So, for the sake of symmetry, let’s cap post-public service earnings at $500,000 a year for at least five years. All income over $500,000 would be subject to a 100% tax rate.

How far might we extend the cap? How about professors who have outside earnings from royalties, speaking, consulting, or business? Let’s cap them too. After all, almost every academic institution is either funded by state governments, and/or receives federal grants, and accepts tax-deductible (tax expenditure) contributions. Ditto for every other business, profession, or line of work that receives government support.

It’s one thing for a person of means to use his or her own money to run for office and then return to private life so long as their subsequent economic activities have no connection to government. That’s real public service. But all too many individuals do a stint in government and then make millions in a few short years peddling influence. Let’s stop using the word public service for these persons. Perhaps some enterprising person might set up a web site that posts the annual earnings of those who convert public service into private fortunes.