Saturday, May 26, 2012

Yesterday, my friend Ben Yee posted this infographic on facebook with the comment, “It’s called investment.”

In response, one commenter wrote,
So all we have to do to get money is just spend more of it. Oh wow, and can I eat my cake and have it too?! Come on. This is totally disingenuous. Let's not pretend we are trying to optimize government fiscal health here. We're not going to consider the cost-cutting measure of executing this kid for his first misdemeanor because it's immoral. And the people who make posters like these would not be at all interested if it could be established that total tax revenue might actually increase if you just slashed programs and taxes and let successful business people keep more of the wealth they generated so as to provide bigger incentives to innovate. By all means, make an argument for statist social planning if you want, but don't peddle snake oil.
This is a classic example of reductio ad absurdum. What's actually being argued via the infographic is that prevention, in the form of social investments enabling the development of marketable skills, is much more cost-effective than denying such investments & dealing instead with the long-term consequences of such neglect. Underlying that is the standard economic concept of the multiplier effect--the process by which money spent by me in a store, for example, is then re-spent by the merchant on supplies, salaries, rent, utilities, etc., in each case then being spent again further on down the line. In this way, my spending contributes to stimulation of the economy.

Mark Zandi, chief economist at Moody's Analytics & former economic adviser to John McCain's 2008 campaign, ranked the various tools available to the government for use in stimulating the economy. 

The most effective? Food stamps, unemployment insurance & infrastructure spending, because they provide direct funding (the latter in the form of salaries to workers) for people in an economic position where they need to spend it immediately, thus contributing to the multiplier effect. The least effective? Accelerated depreciation allowance & making the Bush tax cuts permanent. Why is that? There are several reasons.

Recall that the financial crisis led to a freezing up of commercial credit. When businesses became unable to get short-term credit via the so-called shadow banking system, they became unable to meet payroll, pay rents & utilities, and began laying people off in droves. When Obama took office, we were losing 750,000 jobs per month. In that context, people across all income brackets began cutting their own spending in a perfectly understandable reaction to the worsening economy. Unfortunately, this had the unintended consequence of worsening the recession, as a balance sheet recession in which not enough money was flowing through the system combined with a drastic reduction in demand, further reducing the amount of money flowing through the system. Making the situation even worse was the fact that the states, mandated (in all but one case) by law to balance their budgets every year, began laying off thousands of public sector workers &cutting spending, again reducing the amount of money flowing through the system. By the way, all those laid-off workers were no longer paying taxes on their former salaries, further reducing the amount of federal revenues. Note that in addition to reduced federal revenues caused by a reduction in the number of taxpayers, the recession has been characterized by lack of demand, as explained above. Contra GOP claims that uncertainty is the main cause of continued economic doldrums, repeated quarterly business surveys have shown that businesses rate low demand as the main reason they're not hiring & expanding. Neither the Bush tax cuts or accelerated depreciation allowance will compensate for lack of demand.

The commenter also stated that "...if it could be established that total tax revenue might actually increase if you just slashed programs and taxes and let successful business people keep more of the wealth they generated so as to provide bigger incentives to innovate." This is a repetition of the by now all-too-familiar supply-side argument for austerity budgeting combined with tax cuts for the wealthy. But in a way, the wording above is more accurate than the commenter may have realized. Contra supply-side claims that high tax rates are depressing the incentive to create and expand businesses, James Kwak notes that a recent study by Christina & David Romer shows that "you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates." What actually happens when you lower the taxes of the wealthy in a recession is that, not being forced to spend the fruits of such largess (since their costs are already covered very well, thank you very much), they simply pocket the money. They're willing to pay lawyers & accountants more to hide their wealth from the taxman, but they don't invest in growing businesses. In short, they just get richer. 

If low capital gains tax rates catalyzed economic growth, you’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series.  The correlation is 0.12, the wrong sign and not statistically different from zero.  I’ve tried lags up to five years and also looking at moving averages of the tax rates and growth.  There is never a statistically significant relationship.
Does this prove that capital gains taxes are unrelated to economic growth? Of course not. Many other things have changed at the same time as gains rates and many other factors affect  economic growth. But the graph should dispel the silver bullet theory of capital gains taxes.  Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.
Low capital gains tax rates do accomplish one thing: they create lots of work for lawyers, accountants, and financial geniuses because there is a huge reward to making ordinary income (taxed at rates up to 35%) look like capital gains (top rate of 15%).  The tax shelters that these geniuses invent are economically inefficient, and the geniuses themselves might do productive work were the tax shelter racket not so profitable.  And the revenue lost to the capital gains tax loophole adds to the deficit, which also hurts the economy.  

"Optimiz[ing] government fiscal health" is an interesting concept. What constitutes optimization? A balanced budget? Modern societies rarely achieve that; rather, there's ongoing fluctuation in levels of spending & income, dependent on numerous factors including tax receipts, the state of the economy, the state of imports & exports, inflation, interest rates, exogenous factors like wars, natural disasters, demographic changes, etc. A balanced budget amendment, which Paul Ryan, the Tea Party & Romney have proposed to bring the federal budget into balance, ignores all such things. By setting an arbitrary mechanism to achieve balance, a BBA (especially in combination with an automatic spending cap of 20% of GDP, also advocated by the same sources), would condemn the government (especially given the GOP's resistence to the raising of taxes under any circumstances) to perpetual budget cuts. In the context of the worst recession since Herbert Hoover, the combined effects of budget cutting & additional tax cuts would be to push us back into recession, possibly a depression. Here's the most recent analysis by the CBO of the massive cuts due to take effect at the end of 2012 (thanks to the debt ceiling fiasco), making the same point.

One last point. The reference to "statist social planning" implies a libertarian frame of reference. At root, libertarianism rests on the notion that the only unit of analysis in studying society with any validity is the individual & the only allowable focus is on the rights of the individual. But the answers we reach depend on the nature of the questions we ask, and excluding everything larger than the individual (i.e., the social & historical context within which each individual lives) obscures the influence of those larger phenomena on the individual, making it impossible to see those influences & therefore to create solutions to problems involving such influences. With that in mind, let's not pretend that individual entrepreneurs have been solely or even mostly responsible for the results of their efforts. The development of canals, railroads, highways, the electrical grid, the internet & the GPS technology underlying the functioning of your cell phone have all been central to the growth of technological & social change in the US, as they have been in other countries. Thomas Edison, Henry Ford & Mark Zuckerberg would never have been able to develop their businesses in the first place if not for technologies made possible by (gasp) the government.

The influence of thepernicious anti-government ideology promoted by Ronald Reagan, Ayn Rand et al has been central to the galloping inequality our society has been experiencing. It has also been the underpinning of the thinking that brought on the global financial & economic crises that started in 2007. As noted in a recent Guardian editorial,

At the heart of this calamitous strategy is a wholesale misdiagnosis of how the market economy functions and a complete failure to understand why the financial crisis took place, the profundity of its impact and its implications for policy. For a generation, business and finance, cheered on by US neoconservatives and free market fundamentalists, have argued that the less capitalism is governed, regulated and shaped by the state, the better it works. Markets do everything best – managing business and systemic risk, innovating, investing, organising executive reward – without the intervention of the supposed dead hand of the state and without any acknowledgement of wider social obligations.
The lesson of the financial crisis is that this is complete hokum that serves the political and personal interests of the very rich. It has been an intellectual carapace to permit the creation of dynastic personal fortunes while dismantling the social contract that underpins the lives of millions...

The lesson of the financial crisis is unambiguous. Risk – the existence of incalculable unknowns – cannot be handled by markets alone. It has to be socialised by the state, otherwise we encounter chronically low levels of investment and innovation, along with periodic systemic crises, the core message of John Maynard Keynes.

What we've had up to now is privatized profits & socialized risk. And the GOP politicians, who have been decrying federal spending to counteract the effects of the deepest recession since the Great Depression, are now campaigning on a program including repeal of efforts, however inadequate, to attempt to correct that situation. While we're on the subject of snake oil.

Tuesday, May 15, 2012

Mitt Romney's Supposed Moderation

On May 11, Scott Lemieux wrote, in re claims by some on the left, that Romney is a moderate:
“He’ll govern as the head of a very right-wing Republican coalition and will be working with a Republican Congress that will send him plenty of terrible legislation. He’ll be working with the Republican foreign policy apparatus that will be urging him to attack Iran and will probably succeed. We don’t even want to think about what will happen to the federal courts. What Romney really thinks about this stuff is beside the point. John Tyler isn’t a successful leadership model for someone who wants to run for re-election.” []
And I would like to elaborate on Scott’s elaboration. Mitt Romney’s economic proposals include:
  1. Making the Bush tax cuts permanent;
  2. Cutting tax rates across all brackets by 20%;
  3. Eliminating the Alternative Minimum Tax (AMT);
  4. Eliminating the Estate Tax;
  5. Cutting the corporate tax rate from 35% to 25%;
  6. Offsetting (D) by eliminating corporate tax loopholes;
  7. Changing the US tax system to a territorial one, meaning that corporate earnings from overseas would be exempt from US taxation;
  8. Repealing the Affordable Care Act;
  9. Repealing the Dodd-Frank financial regulatory reform law;
  10. Setting minimum defense spending at 4% of GDP & taking funding for wars back off the books, as was done by George W. Bush;
  11. Capping federal spending at 20% of GDP;
  12. A balanced budget amendment to the constitution.
The proposals above would reduce federal revenues by $10.7 trillion over 10 years & eliminate any US government flexibility in spending that any modern government would need in emergencies such as wars, natural disasters, or (ahem) recessions and depressions.

Economist Menzie Chinn has guesstimated the scale of across-the-board spending cuts Romney will need to balance the budget by 2022 (no one can do more than that, since Romney has stated publicly that he’s not going to say what he’ll cut until after he’s elected).

Excluding defense, Romney would have to cut every other federal program by 20% to achieve a balanced budget. Under that scenario, Social Security would be cut by $186 billion by 2016, and by $2 trillion in 2022. Three million people would be forced into poverty.

If Social Security is excluded from the cuts, every other federal program would have to be cut by 28%. Medicare, under this scenario, would be hit with $176 billion in cuts by 2016, and $1.9 trillion in cuts by 2022. There would be a sharp increase in premiums and changes in cost sharing. Medicaid and CHIP would be cut by $1.3 trillion as of 2022. SNAP, formerly the food stamp program, would have to drop 12 million recipients, overwhelmingly poor families with children, the disabled and the elderly. Discretionary programs (aside from defense, of course) would lose $166 billion by 2016 and $1.6 trillion by 2022. To put discretionary cuts in perspective, almost all other major industrialized nations spend about 10% to 12% of GDP on such programs as agriculture, commerce, education, energy, environmental protection, food safety, justice, labor, scientific research, disease control, transportation/infrastructure and veterans affairs. The Romney plan would (again, assuming across-the-board cuts) reduce total funding for those programs from the current 30-year average rate of 3.7% of GDP to 2.3% of GDP in 2016 and 1.7% of GDP by 2022–the lowest rate ever recorded.

Thus far, we’ve only considered the implications of the above cuts for specific government programs and the people they benefit directly. What about the broader economic picture? Recall that the immediate consequence of the run on the shadow banking system in September 2008 was the seizing up of the commercial credit market. With credit no longer available, businesses began massive layoffs, lacking the short-term funding needed for things like payroll. And as the layoffs mounted, people around the country began responding in a commonsensical way, by sharply reducing spending. With demand drastically reduced, businesses saw no need to expand or to hire. Four years later, that is still the case, although the recession is technically over and some hiring has resumed. Recent business surveys have borne this out. Despite GOP claims that the cause of reduced hiring is lack of business “confidence” supposedly due to the possibility of higher taxes, businesses have reported that the number one reason for lack of expansion is low demand. To put it another way, not enough money is flowing through our economic system from one transaction to another, boosting economic growth in the process. This is reflected in an unemployment rate of 8.1% and GDP growth under 3%, in a country with a historical average GDP growth rate of 3.4%.

Given the above mentioned situation, what are the likely economic results of withdrawing $10.7 trillion from the economy over 10 years? And does the combination of budgetary, economic and human consequences described above strike you as moderate?