So we avoided the fiscal cliff. Forgive me if I am less than impressed with our political leaders.The temporary Bush tax cuts passed in 2001 and 2003 are now permanent for incomes less than $400,000 per year. The increase in taxes on incomes over this threshold is expected to net $617 billion over ten year. To be exact, that is $617 billion more in revenue than would have been collected had tax rates on higher incomes remained unchanged. On the spending side, automatic across-the-board cuts that would have gone into effect on January first will be delayed for two months.
Recently in political economy Category
An excellent case study in rent seeking:
"In the 1960s, Louisiana made it a crime to sell "funeral merchandise" without a funeral director's license. To get one, the monks would have to stop being monks: They would have to earn 30 hours of college credit and apprentice for a year at a licensed funeral home to acquire skills they have no intention of using."
Then there are the gas shortages. These are primarily the result of storm damage. But they've been made worse by New Jersey Governor Chris Christie's effort -- joined by New York Attorney General Eric Scheiderman -- to crack down on "price gouging." This politics hurts victims. It's elementary economics that holding prices down depresses supply. If you could sell gasoline for $15 a gallon, lots of people would load pickup trucks with gas cans and drive to the storm area, alleviating shortages. (And at that price, people wouldn't buy more than they needed.) If doing that risks arrest, they won't. Political posturing over "gouging" leads to gas lines, further economic disruption and possibly lost lives.
You may have noticed there is a presidential election coming up. The Republican Party met this past week in Tampa, Florida and officially nominated Mitt Romney as their candidate. Democrats are meeting this week in Charlotte, North Carolina to renominate President Barack Obama. Of course all that really matters is the counting of electoral college votes, and those will be decided on November 6th.
In the meantime, however, it is at least entertaining to try and predict which candidate will win. There is no shortage of opinion, of course. In the past week I have read that an Obama win is a sure thing, that Romney is sure to win, and that the election is too close to call.
On June 4th, President Barack Obama delivered a campaign speech at the New Amsterdam Theatre in New York City. In that speech he noted that his Republican rival in the upcoming election, Mitt Romney, "has a theory of the economy that basically says, if I'm maximizing returns for my investors, for wealthy individuals like myself, then everybody's going to be better off."
We could debate whether this statement accurately reflects
Mitt Romney's views on capitalism, but for the sake of this article let's
assume it does. So what? Is it really that bad to believe that people
motivated by self-interest, even selfish and greedy self-interest, can
collectively arrive at an efficient and equitable outcome?
The Greek financial system is in big trouble right now. The fundamental problem is that the Greek government has been on a bit of spending bender over the past few years and has borrowed a lot of money to pay for this, all of it denominated in euros. It has become frighteningly clear that this level of debt is unsustainable and the Greek government needs truly radical fiscal reform to avoid defaulting on its outstanding debt. Much of that debt is held in the form of Greek government bonds by Greek banks, but a large amount is also held by various financial institutions outside of Greece.
By itself this is not really a very interesting or important situation. There are a large number of countries in the world and inevitably, some of them get into fiscal trouble. Some sort of financial crisis of this sort happens on a fairly regular basis. Greece is, however, a member of a monetary union. And its financial health could have an effect on the financial health of other members of that union.
The euro is a unique currency because it is issued by a collection of sovereign states, rather than by a single country as is usually the case. The currency was formally introduced into circulation in 2002 and replaced the national currencies of the participating countries. Control of the euro money was given to the European Central Bank (ECB), which was created with the sole purpose of managing the euro. When the euro was created it was very clear that all member countries would be using a single currency and would therefore be unified monetarily. It was not clear, however, how unified these countries would be in fiscal terms, however. There is no governmental equivalent to the ECB. There is a European parliament, but there is no central government with authority to tax and spend for the European Union as a whole. Fiscal matters are, in theory, left entirely to the individual member countries. This means there is no natural central source of funds to "bail out" the Greek government. The two bailout packages worked out so far have been hammered out via complex negotiations between Greece, the ECB, and other European governments.
Suppose Greece decides it is going to default on its government bonds. Does this necessarily mean that the euro as a currency is in trouble? Not necessarily. In fact, if there is no expectation that Europe is a fiscally united, then there should be no issue at all. Greek bonds, though denominated in the same currency as German bond, already pay higher interest rates due to their higher probability of default. If the Greek government decides to default, things could get really bad for Greece, but it need not affect other European countries. The fact that German and other European banks hold Greek government bonds could lead to increased stress on the banking sectors in those countries, but it need not lead to dissolution of the euro as a currency.
However, a problem does arise with one the way that Greece might choose to default on its debt. Rather than default outright, the Greek government could choose to drop out of the euro zone and reintroduce their previous national currency, the drachma. They could do this by initially trading all euro amounts in Greece one-for-one with drachma, for example, and legally rewriting all contracts in euro to contracts in drachma. Then the Greek central bank could drastically increase the number of drachma in circulation and repay its nominal debt with this new money. The result would be a devaluation of the drachma. Greek assets would be worth less on the world market, just like a default, but a formal default would be avoided. In effect, Greece would be solving its fiscal problems by imposing an inflation tax and at least some of the burden of that tax would fall on non-Greek holders of Greek government bonds.
Now suppose you had a time machine and knew for certain that this was going to happen on Dec. 31st 2011. What should you do today? You should sell any Greek assets you hold today to avoid the inevitable loss in their value when the drachma is devalued. If you are a savvy investor you might take profits by short-selling Greek debt. Even if you don't have the time machine and are uncertain what is going to happen, you might still find it prudent to sell. When all or most investors do this, the result is a worsening of the financial crisis.
If investors feel that Greek devaluation is becoming more and more likely, it is only natural that they begin to look at other European countries with similar fiscal problems. These countries include Ireland, Spain, Portugal, and perhaps even Italy & France. If enough countries choose to withdraw and devalue their currencies - particularly if either of the latter two do - then the euro as a multinational currency will effectively be dead.
Greek fiscal problems don't automatically mean the euro is doomed, but it is very easy to see why policy makers in Europe and elsewhere are worried that events are moving in exactly that direction.
After months of wrangling and weeks of brinksmanship, the U.S. congress passed a bill raising the debt ceiling and President Obama signed it into law. The compromise calls for an immediate increase in the legal limit on federal borrowing by 2.4 trillion dollars and imposes reductions in federal spending by the same amount over the next 10 years.
It will be interesting to see how congress interprets the word "reduction." For most of us a reduction is an absolute drop. Congress, however, reduces spending by comparing the new forecast level of spending with the amount that was forecast before the agreement was reached, the so-called "baseline". There is no legal reason for using this baseline as opposed to some other measure. Some proponents of spending reform prefer a "zero baseline", where any change in policy is compared to a case where all future spending is assumed to remain at this year's levels. This latter baseline is a more accurate measure of how spending will actually change over time, but the former is a better reflection of the impact of a particular act of legislation.
If this was the only difference, baselines would not matter all that much. But when congress actually begins to implement the mandated spending cuts, the definition used will become very important. For example, if spending were forecast to rise by 10% per year over the next ten years, and we slowed that growth to only 5%, then (ignoring inflation) by the first definition we would have achieved a savings of just over 21%, but we would still have increased spending almost 26% from a zero baseline.
Credit agencies and financial markets are unimpressed by the debt-limit agreement. It is a good start; probably preferable to having the U.S. Treasury default on its debt payments. It may even be the best possible agreement one could hope for with a divided government. But it is only a start.
One of the more pithy, but accurate, descriptions of the deal came from Senator Rand Paul, who said, "The current deal to raise the debt ceiling doesn't stop us from going over the fiscal cliff. At best, it slows us from going over it at 80 m.p.h. to going over it at 60 m.p.h."
To the extent that the debt ceiling debate had focused the attention of the political class on the issue of spending it has done some good. But in a broader sense, the debt ceiling is a red herring. As I learned years ago from my college professor, Jim Kearl, the government has three fundamental ways of raising revenue: it can tax, borrow, or create money. And the effects of each of these, while not exactly identical, is roughly the same. In all cases the government extracts real resources from people in the economy which it then uses to buy goods and services and/or spend as transfer payments.
When it taxes the government uses the threat of force to extract resources. Failure to pay required taxes can result in imprisonment. When it borrows the government cajoles people into voluntarily surrendering resources by offering a sufficiently high repayment in the future. Of course, far enough in the future the government will be forced to raise taxes to pay for these interest payments, so the repayment is not as high as it may seem. Finally, when the government (via the Federal Reserve, in the case of the U.S.) creates money it taxes unilaterally without an explicit threat by reducing the real value of existing money holdings.
It is possible, by clever redefinition of terms to avoid a debt limit in the short run by turning debt into taxes. For example, suppose the government were to impose a surtax on households this year based upon estimated income from 2012. Tax revenue would rise, and the government debt would fall (or rise more slowly). But over time, everyone will end up paying the same amount as if the surtax had never been imposed.
The pressing problem with federal government finances is not the amount of money that is borrowed, but rather the size of the real resources the government extracts; in other words, the size of government. Right now there is no national consensus on how big the government should be. Until a consensus is reached and ultimately communicated to our political leaders, problems will continue to loom regardless what has happened or will happen to the debt limit.
In mid-May the trustees of the U.S. Social Security system issued their annual report. The conclusion of the report is stated clearly and succinctly: "Projected long-run program costs for both Medicare and Social Security are not sustainable under currently scheduled financing and will require legislative corrections if disruptive consequences for beneficiaries and taxpayers are to be avoided."
One bit of information from the report that got some attention was that the total payouts in benefits have finally surpassed the collection of revenue from payroll taxes. This was not unexpected; we have known for a long time that the retirement of the baby boomers would eventually cause this to happen. What was surprising is that it happened this year and that it is projected to remain this way for the foreseeable future. Last year's report projected this flipping point would occur in 2015.
The Social Security system is a pay-as-you-go system. Revenue collected from workers is used primarily to pay for the benefits of retirees. Only a small fraction of revenue (about 8.5 percent this year) goes into the trust fund. This is in contrast to most other retirement plans, where most or all of the revenue collected goes into holdings of financial assets earmarked specifically for future benefits.
Social Security is still generating net surpluses today because it earns interest on the $2.7 trillion held in the trust fund. The system is expected to start generating net deficits starting in 2022. From that point on, the balance in the trust fund will begin to fall until it drops to zero in the year 2035.
Once this milestone is reached, the system faces a conundrum. Since the Social Security trustees do not have the legal authority on their own to raise taxes or lower promised benefits and cannot issue debt obligations, they will have no choice but to pay only some portion of promised benefits. That will initially be about 80 percent.
The scenario laid out above is true as far as it goes, but it also misrepresents how our fiscal system actually works.
The Social Security trust fund holds all its assets in the form of U.S. Treasury securities. Since these are normally very safe assets, this might actually be prudent, but it also means that the trust fund is effectively a fiction. The trust fund is a set of government assets that is backed by the same government's debt. This means the public debt is not as big as reported, and it also means there is no nest egg tucked away in a secure vault somewhere. In truth, the trust fund is backed by the government's ability to tax its citizens in the future. Workers today who are interested in receiving their promised benefits when they retire should therefore be very concerned about the size of the public debt and the U.S. budget deficit.
The trustees' report assumes that in 2035 they will need to reduce benefits so that total benefits outflows equal the total inflow of tax revenues. Politically, this seems highly unlikely. Rather, Congress would likely borrow more money to pay the full promised amounts to retirees. This accumulation of debt could conceivably go on for a very long time, but eventually the government would be unable to issue any more debt. No one knows for certain what the limit is, but we do know there is one. In fact, the limit may appear unexpectedly -- just ask the Greek government.
To avoid long-run bankruptcy, we need to realign the mismatch between promised benefits and expected tax revenues. The Social Security Administration is well aware of this problem. There are many viable options that would move us in the right direction. For example, there is talk of changing the way Social Security benefits are calculated so that future benefits are not so large a proportion of lifetime earnings. But change cannot occur unless Congress enacts it.
Since Social Security is pay-as-you-go, and workers pay the benefits of retirees, one way to make the system more sound is to increase the ratio of workers to retirees. In the past a high ratio was maintained by a high birthrate. But birthrates have fallen dramatically in the U.S. in the past few decades, and life expectancy has risen at the same time. We are transitioning from a retirement age of 65 to 67 in an attempt to adjust this ratio, but it is unlikely to be sufficient. Increases in legal immigration are one way to correct the imbalance. For fiscal purposes it doesn't matter if the birthrate rises and we have more young workers, or if they immigrate from other countries. More workers supporting the existing retirees reduces the tendency to draw down the trust fund balance.
Still, the fundamental problem with the system is that the benefits levels are too high relative to the taxes. Lawrence Kotlikoff of Boston University recently calculated the gap between the net present value of promised benefits from all government programs (which are dominated by Social Security and Medicare in the long run) and the net present value of all taxes likely to be collected. He calls this figure the "fiscal gap" and comes up with a number of $202 trillion! This means that in order to meet the promised obligations from our current fiscal system, we need to find the equivalent of more than a decade's production of all the goods and services in the entire U.S. economy.
Clearly, unless we can reduce promised benefits relative to taxes imposed, the system will go bankrupt. It is not too late to fix the Social Security system, but the longer we wait, the more difficult the fix will be.
Here is a fun little video parody from Reason.tv. (Thanks to Jason for the link.)
|The Daily Show With Jon Stewart||Mon - Thurs 11p / 10c|
|Home Crisis Investigation|
Well, I just came across a fund that is taking a like-minded strategy. The fund is called the Congressional Effect Fund. The fund's basic strategy is to capture the above average returns on the stock market on those days when Congressmen are on vacation. A great idea and much easier to implement than my strategy. The average annualized return to the S&P 500 when congress is in session (1965-2009)? 0.31%. The average annualized return to the S&P 500 when congress is out of session? 16.15%.
Hat tip to DoL'er (and fellow Georgian) Frank Stephenson.
However, adding an exclamation point to the Geithner appointment is now the Daschle appointment to head the Department of Health and Human Services.
And it looks like the stimulus package leaves little hope that there has been a change in rent seeking behavior.
(Upton Sinclair, I, Candidate for Governor: And How I Got Licked, (1935) repr. University of California Press, 1994, p. 109.)
Paul Krugman used this quote in his blog post Sunday (Nov. 30, 2008) as the final word in his plea for policy makers to get on board with a big Keynesian fiscal stimulus plan.
Old definition of "chutzpah": (n) nerve, gall, audacity, insolence, impertenence.
New definition of "chutzpah": CNNMoney.com reported on a Congressional hearing in which "Skeptical lawmakers grill[ed] auto execs... [and] portrayed the Big Three as both short-sighted... and devoid of vision."
When Democrats have had control of both Houses and the Presidency (1932-1946, 1949-1950, 1961-1968, 1977-1980, 1993-1994), government expenditures as a fraction of GDP have averaged 23.5%. On the other hand, when Republicans have had control (1929-1931, 1953-1954, 2003-2006), spending as a fraction of GDP has averaged 21.1% (not statistically different). Divided government spending averages 23.9% of GDP. The graph below shows the size of government over time by party in control. The most prominent trend is the fall in the size of government since the late 1960s, which is evident under Democratic or Republican controlled government and divided government over this time period.
But the "power of the purse" resides in Congress, so does party matter in Congress?
I'm tempted to start off the discussion by reading Don Boudreaux's letter to an Obama supporter. As with most of Boudreaux's writing this one has some great lines: "Very few of them [politicians] have any knowledge of the subject [economics], and even fewer of them are courageous enough to speak about it honestly."
If not that, I'd like to make a case for not voting at all, but maybe George Carlin has already done this better than I ever could.
But I think I'll be more PC. Below are my summaries of the candidates stances on taxes and trade as well as some opinions about fiscal policy in general and the chances the candidates will push us into the next Great Depression.
(Joseph Sobran, syndicated political columnist and former National Review writer. Quote is from his chapter in the book The Economics of Liberty (Mises Institute) entitled "Back to First Principles.")
"That's terrible!" he gasps. "I'm going to check out communist hell!" He goes over to communist hell, where he discovers a huge queue of people waiting to get in. He waits in line. Eventually he gets to the front and there at the door to communist hell is a little old man who looks a bit like Karl Marx. "I'm still in the free world, Karl," he says, "and before I come in, I want to know what it's like in there."
"In communist hell," says Marx impatiently, "they flay you alive, then they boil you in oil, and then they cut you up into small pieces with sharp knives."
"But... but that's the same as capitalist hell!" protests the visitor, "Why such a long queue?"
"Well," sighs Marx, "Sometimes we're out of oil, sometimes we don't have knives, sometimes no hot water."
(Taken from the website of Jeffrey Parker at Reed College)