Category Archives: Micro

Student Debt + Stagnant Real Wages = Colleges Need to Focus On Student Success

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Today’s post is an excerpt of something I wrote for another site.  This year, in addition to my teaching duties at the college, I’m leading a project to update our college strategic plan.  As part of that project I’m writing and editing a series of “briefing papers” (long blog posts, actually) about issues of strategic importance to the college’s future.  When those papers cover a topic that I think might be of interest to econproph readers I’ll cross-post them. Last week I wrote the following about the student debt explosion in the U.S., the stagnation in hourly wages for those for with less than college degrees/credentials, and the implications for those of us who work in higher education.  The full original post is here.

America has a student debt problem.

And it’s growing. According to the statistics assembled by the New York Federal Reserve Bank, theU.S. Dept. of Education, and other sources, total student loan debt outstanding is nearing $1 trillion, easily exceeding the $791 billion in total credit card debt.  As disturbing as the total might seem, the growth rate of student debt is even more distressing.  This graph, first published by The Atlantic last summer from NY Federal Reserve Bank statistics shows the relative growth  (not amounts) of outstanding student debt since 1999 compared to total household debt including mortgages. FromThe Atlantic:

The red line shows the cumulative growth in student loans since 1999. The blue line shows the growth of all other household debt except for student loans over the same period.

crazy student loans 2011-q2.png

This chart looks like a mistake, but it’s correct. Student loan debt has grown by 511% over this period. In the first quarter of 1999, just $90 billion in student loans were outstanding. As of the second quarter of 2011, that balance had ballooned to $550 billion.

The chart  is striking for another reason. See that blue line for all other debt but student loans? This wasn’t just any average period in history for household debt. This period included the inflation of a housing bubble so gigantic that it caused the financial sector to collapse and led to the worst recession since the Great Depression. But that other debt growth? It’s dwarfed by student loan growth.

Roots of the Problem

The student loan debt problem has many roots, most of which [colleges] cannot change or directly affect.  Causes of the explosion in student debt include:

  • A long-term shift in U.S. political opinion away from thinking of higher education as a public good with direct funding support from government toward thinking that students should pay for their own educations with loans guaranteed by the government.
  • Tuition and fee increases in higher education (particularly at 4 year schools and especially at private schools) have outpaced inflation for at least 3 decades, driven by cost increases, stagnant productivity, and reduced government direct funding.
  • Middle class real incomes have been largely stagnant or only modestly increasing for those same 3 decades, limiting the ability of families to pay dependent students’ tuitions.
  • The collapse of the housing price and mortgage bubble in 2006-07 which limited the ability of many middle- and working-class families to finance college education through home equity loans.
  • High unemployment rates since 2008 have limited the ability of students to work while in college and have also sent increased numbers of unemployed back to college.

… most community colleges can be a partial solution to the nation’s growing student loan burden.  After all, [community colleges are] one of the most cost-effective providers of the first 2 years of a college education.  Indeed, students can graduate with a bachelors’ degree with less total indebtedness if they take their first two years at community college and then transfer.

But the growing student loan problem when combined with another trend has even more significant implications the community college mission.

The Long Term Trend on Real Incomes – A Closing Middle Class

Long term trends in incomes in the U.S. including increasing income inequality have become a news headline topic in recent months.  …  Cumulative Growth in Hourly Wages, 1979-2009, by Level of EducationAs this graph from  the Congressional Budget Office (via Paul Krugman) shows, over the past 30 years the clear trend in hourly wages for workers with less than high school or only high school education has been negative. A high school graduate now earns 10% less per hour in inflation-adjusted dollars than they did 30 years ago.  Even workers who only have some college but haven’t completed a formal degree or credential are either negative or at best, even with 30 years ago.  The data in the graph is from 2009 and labor market conditions have not improved since then.  Indeed, most labor market economists, myself included, expect little to no improvement in wages or employment rates for many years to come.

So what does this mean?  It’s clear that for young and middle-aged people, the route to a rising income and participation in the middle class requires either a college credential or advanced degree.  Yes, anecdotal exceptions are always possible such as the stellar young person who becomes a big success in sports or entertainment. But the numbers are clear – for virtually all, membership in the middle class in the future requires succeeding at college not just attempting college.

Implications for LCC and It’s Mission

The mission of LCC and community colleges in general since they were created has been to provide access.  The great post-World War II expansion of community colleges in the U.S., of which LCC was a part, was based on the idea that broad, democratic access to higher education was important.  Community colleges provided access to college for millions who otherwise couldn’t attend, either because of costs, lack of family support, family/work obligations, location, lack of preparation, grades, or other circumstances.  Over time community colleges have expanded programs to help  increase access to even more individuals.  Indeed, this open-door, democratic access mission is a large part of the motivation for many who work at LCC.  Providing access is something we could feel good about.

But let’s consider how access has traditionally worked.  LCC, like most community colleges, has focused on providing the same basic instruction and learning that was available at 4 year institutions.  The difference was we had an open-door. We provided access.  We provided a chance at college and greater income and success in life. But it was always considered up to the student to succeed. The historical model is the college provides the student a chance at success. If they didn’t succeed that was their problem.  We measured our success by our enrolments as an indicator of the number of people to whom we had provided access.  Thirty years ago, if a student attempted college and didn’t succeed it didn’t carry the consequences it does today.  Thirty and forty years ago, a student who failed at college or simply didn’t complete could always get a job in a factory or a trade. They could still make a middle-class life despite not succeeding at college.

Now the trends tell a different outcome.  If a student doesn’t attempt college at all, they are likely not going to stay in the middle class at all and will likely experience declining real incomes.  The big change is if the student does attempt college but simply doesn’t succeed or complete, today their prospects for staying in the middle class are slim.  Successful completion of a college degree or credential has become a requirement now for a middle class future. It’s necessary for young people in particular to attempt and succeed at college now.

But now let’s add the student loan issue.  Suppose a person attempts college today but doesn’t succeed. Not only are they faced with the prospect of flat to declining real income, they have a significant burden – their student debt. Under current law there are really only two ways to discharge student debt – either pay it or die. Student loans cannot be discharged in bankruptcy. There’s no asset to sell or foreclose. So today’s student is facing a higher risk environment than their predecessors did in previous generations.  Instead of access to college being a chance at a better life, it’s now a high-risk necessity.  So it’s not just access; it’s success that matters.

…The governments, both state and federal, are paying increasing attention to success rates.  As mentioned in the first briefing paper, state governments, including Michigan, are increasingly looking at funding for higher education in terms of how many successful credentials or degrees does it produce, not just how many seats in classes were offered.

Beyond what the government is requiring, the success issues pose a challenge to our understanding of our core mission and how we measure our institutional success. In today’s environment, providing access to large numbers of students without regard for their success is playing a cruel joke on them.  It’s teasing them with dreams of a future many of them won’t achieve and then punishing them with a burden of debt.  For those of us in the institution, that’s not the motivator that the original access mission was. We need to adjust our sense of the mission.  Yes, access is important, but it needs to be successful access.  Successful access as a mission changes many things.

It changes our most basic metric of institutional success. Instead of simply enrollment growth showing institutional success at providing access, we now need to consider whether that access was successful. …But measuring success and access are one thing. Improving them is another. The shift to successful access calls for many changes in the organization, it’s processes, systems, the curriculum, teaching methods, support services, and attitudes. It is not easy or simple. It is very challenging.


Religion, The Stock Market, and the Search for Meaning

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People want to understand phenomena.  We want explanations for what happens. Journalists, especially TV and radio journalists, want explanations that can be summarized in 1-2 sentences in a sound bite.  Randomness is pretty scary.  And anything that’s too complex to understand easily looks a lot like randomness.

So what triggered this little nugget of metaphysical social observation in an economics blog?  Reporting on the stock market!  Everyday we (those of us who read, listen or watch the news) are treated to not only reports of what the major stock market averages have done that day, but we’re always given a simple and easy explanation.  Just look at today in the NYTimes.  I’m not trying to pick on The Times, it was just the first thing showing on Google Finance as I wrote this – any source, any time and you’ll get similar simplistic explanations.

The move announced by central bankers on Wednesday to contain the European debt crisis led to euphoria in global stock markets…

Krugman posted this evening that he didn’t understand it.  But he approached it from the standpoint of “does this action by ECB make economic sense that should improve stock prices?’.  I think he’s right that it doesn’t make sense, but I think he misses a bigger point.  It’s foolish to try to attribute the movements of stock market averages on any given day to the any particular sentiment of investors or any particular logic of rational investors.

The markets are huge.  We’re talking hundreds of billions and trillions of dollars in trades. Daily volume is in the billions of trades everyday. It’s complex, folks. The reasons these trades happen and why they happened at the prices they did are really, really complex.   It’s kind of like ancient peoples trying to understand the stars and without even a telescope or any calculus! Unfortunately, like them, we want simple explanations.  So we invent them.  And like ancient peoples we make sure our explanations support and reinforce whatever religious or superstitious beliefs we have.  [readers are advised not to try to decide what my spiritual beliefs are based on that sentence - it's complicated].

There is a belief that supports much of this daily “this is what the market did and why” reporting. It’s actually based on the theory that markets are rational and “efficient”.  There’s an economic theory that holds that prices in financial markets accurately reflect the current state of all known information and news regarding the future flow of earnings and profits from firms.  It’s demonstrably false, but it has quite a following among neoclassical economists.  It cannot be proven and evidence exists to contradict the hypothesis (see Quiggin’s Zombie Economics), yet it’s taken as article of faith among many, many economists.  So much so that some non-believing economists have begun to refer to neoclassical economics as theo-classical.

The whole idea that there’s a single sentiment or key piece of news that drives the stock market each day is made even more absurd when we realize that most trading isn’t even being done by humans!  The significant majority of all trades are done by computers based on algorithms such as “buy this if the price has moved x in the last y seconds”.  Even more of the trading is done by casino-oriented short-term trading by large banks and hedge funds who are only trying to figure out what they think the other traders are going to do a few seconds before they do it. (also known as Keynes’ beauty contest).

Markets are the collective, sum judgement of lots of complex decisions.  Even if all the individual decisions were rational, there’s still no reason to believe the aggregate outcome can be represented as the decision of some hypothetical rational being.  So next time you hear or read some talking head pontificate that “the markets are saying…..”, just remember there’s little difference between that modern commentator and some ancient priest in long gown claiming that “the gods are saying….”

Is The Fed Corrupt or Captured?

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Yesterday I responded to a reader who asked if “The Fed is out of control”.  In short, I said no, not in the sense that critics have charged them with “out of control printing of money” that could produce inflation.  But I left the post with an acknowledgement that the secrecy of The Fed carries some risks.  I said:

…it is unseemly for The Fed to be able to make large loans on favorable terms to banks, loans that save those banks’ managers from failure, without any sunshine or transparency.  It makes fertile ground for corruption.

Today I want to look at the question of whether The Fed, as it is currently constituted, is corrupt.  The Fed has generated a lot of populist anger.  A quick Google search for “end the fed” turns up over 8 and 1/2 million results.  A lot of people seem to feel there’s something wrong here with The Fed, even if they can’t pinpoint what it is.  Typically the charge has been that The Fed has been guilty of creating (“printing”) money too fast and producing inflation.  We’ve seen that’s not true.  Inflation is not our problem and hasn’t been for 20-30 years. Nevertheless, many people feel there must be something wrong.

I tend to agree. First, let’s define corrupt.  From Webster’s online, we see two possible meanings for corrupt:

1…   b : characterized by improper conduct (as bribery or the selling of favors) <corrupt judges>…

3.  : adulterated or debased by change from an original or correct condition <a corrupt version of the text>

Going by this definition, The Fed is corrupt.  It’s characterized by improper conduct and it’s debased from a correct condition (although the original condition wasn’t much better).  Let’s take a closer look to understand problems better.

I’m not accusing The Fed or Fed officials of outright petty bribery.  I don’t think anybody has directly paid off Fed officials or promised personal gains in return for Fed decisions.  It’s more complex than that.  The Fed has become the subject of regulatory capture.  Regulatory capture occurs when an agency of the government is initially established to regulate or control the excessive behavior of some industry.  But then, over time, the industry captures the hearts, minds, and ideologies of the regulators.  The regulators come to function as the protectors and servants of the industry they were supposed to regulate.  Regulatory capture is common anytime the industry involved is complex and technical.  Experts have to be hired as regulators but the best source of experts on the industry is the industry itself.  The problem is made worse when the regulated industry is able to pay much higher salaries than the regulatory agency.  Wikipedia tells of a few examples from The Fed:

Federal Reserve Bank of New York (New York Fed)

The Federal Reserve Bank of New York is the most influential of the Federal Reserve Banking System. Part of the New York Fed’s responsibilities is the regulation of Wall Street, but its president is selected by and reports to a board dominated by the chief executives of some of the banks it oversees.[39] While the New York Fed has always had a closer relationship with Wall Street, during the years that Timothy Geithner was president, he became unusually close with the scions of Wall Street banks,[39] a time when banks and hedge funds were pursuing investment strategies that caused the 2008 financial crisis, which the Fed failed to stop.

In the wake of the financial meltdown, Geithner became the “bailout king” of a recovery plan that benefited Wall Street banks at the expense of U.S. taxpayers.[39] Geithner engineered the New York Fed’s purchase of $30 billion of credit default swaps from American International Group (AIG), which it had sold to Goldman Sachs, Merrill Lynch, Deutsche Bank and Société Générale. By purchasing these contracts, the banks received a “back-door bailout” of 100 cents on the dollar for the contracts.[40] Had the New York Fed allowed AIG to fail, the contracts would have been worth much less, resulting in much lower costs for any taxpayer-funded bailout.[40] Geithner defended his use[40] of unprecedented amounts of taxpayer funds to save the banks from their own mistakes,[39] saying the financial system would have been threatened. At the January 2010 congressional hearing into the AIG bailout, the New York Fed initially refused to identify the counterparties that benefited from AIG’s bailout, claiming the information would harm AIG.[40] When it became apparent this information would become public, a legal staffer at the New York Fed e-mailed colleagues to warn them, lamenting the difficulty of continuing to keep Congress in the dark.[40] Jim Rickards calls the bailout a crime and says “the regulatory system has become captive to the banks and the non-banks”.[41]

Regulatory capture isn’t limited to only the possibility that a regulators’ decisions might be influenced by their personal future employment prospects.  It also involves ideology and group think.  The regulators spend their time, both professional and personal, mixing with the regulated.  They come to think alike.  Professor Steven Davidoff writes at Deal Book:

Instead, we have ideological and social capture of the top regulators. This is an issue that trumps what can be a model regulator at the bottom where the line people are quite competent, able and uncaptured, but the message from the top skews their effectiveness….

For an example of social capture at the top, one need only look at the publicly available calendars of Treasury Secretary Timothy F. Geithner and his predecessor, Henry M. Paulson Jr. The people regulating the financial industry largely come from that industry or look to that industry for their social interactions. They play squash with them and dine with them, and these are the peers they look to when they have issues to discuss. Jo Becker and Gretchen Morgenson of The New York Times documented this ably in their April 2009article on Mr. Geithner’s social interactions during his time as head of the Federal Reserve Bank of New York.

Lawrence H. Summers may not be as social, but even he worked at a hedge fund in the year leading up to his current position in the White House.

Among these people, there is no evil or nefarious plot to regulate in favor of the banks. These men and women may believe they are doing their best, but their worldview is affected by the people they interact with. This is a problem that can be exacerbated by a revolving door between finance and regulators.

This social influence can be affected by an additional factor: ideological capture also at the top. This occurs when regulators are appointed who share the same beliefs and ideas as their industry. A prime example of this is Alan Greenspan, the former Federal Reserve chairman, who was a devotee of Ayn Rand and objectivism and a fierce devotee of free markets. He no doubt was acting in good faith and true belief; the financial industry benefited from the fact that he shared their ideology

James Kwak and Simon Johnson, the authors of the book 13 Bankers, have written extensively about the regulatory capture of The Fed and the resulting improper conduct and debased condition of the world’s largest central bank. The book is worth checking out, as is their blog The Baseline Scenario.  Bill Moyers interviewed them for PBS on these topics. You can watch the video or read the transcript here.

The evidence is extensive that The Fed has become captured by the very banks it is supposed to regulate.  The Fed now sees it’s mission as first and foremost as protecting Wall Street, the banks, and the financial system.  The audit of The Fed in July 2011 confirmed that problems existed with conflicts of interest:

The audit also found that the Fed mostly outsourced its lending operations to the very financial institutions which sparked the crisis to begin with, and that they delegated contracts largely on a no-bid basis. The GAO report recommends new policies that would eliminate such conflicts of interest, and suggests that in the future the Fed should keep better records of their emergency decision-making process.

It was evident before that.  I March 2010 I recounted how Nobel-prize winner Joseph Stiglitz accused The Fed of being corrupt and said if a developing nation had a central bank like The Fed, we’d pressure them to change.  So, yes, The Fed is corrupt because it has been captured.

 

Banks Want to Do To Student Loans What They Did to Mortgages

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On the heels of yesterday’s post about student loans and their growth.  I want you to know that Wall Street is hot on the problem.  They’ve made a quiet proposal to the “supercommittee” that’s supposedly addressing government deficits to have the government subsidize the banks via fees without creating any more student loans or taking on any risk.  The essence of the whole proposal is to leave the government on the hook for student loans but to use accounting tricks to “take them off the books”.  It’s similar to the ways the big banks prior to the crisis would take debt and obligations they had and hide them in “special purpose entities” so they wouldn’t have to show them on their books.  There’s no benefit to investors, students, or the government from the proposal. Only the banks benefit.  But maybe that’s why they aren’t talking about the proposal in public but instead try to get it passed quietly through lobbyists.

Jason Delisle of New America Foundation’s Higher Ed Watch explains (bold emphases are mine):

The investment banking industry – and its friends in Congress – have cooked up a scheme they are pitching to the “supercommittee” that they say would reduce the federal debt and cut federal spending. Supposedly, the plan would take the government’s $555 billion direct student loan holdings off of its books. In reality, the plan, which would allow the bankers to earn fees on a $555 billion deal, plus $100 billion more every year, would not reduce the debt or cut spending. But that hasn’t stopped Wall Street from trying.

A proposal that could only have been be cooked up by investment bankers is circulating on Capitol Hill. It would refinance the $555 billion direct student loan portfolio with new debt backed 100 percent by the federal government. But this new debt would not be called U.S. Treasury debt, despite the 100 percent guarantee, and therefore not counted as part of the national debt. In other words, the new debt would be used to pay off the old debt (Treasury bonds) that the government issues to finance direct student loans. To be sure, the mechanics of the proposal are more complicated than that, but the effect of the proposal would be to move all outstanding and future student loans from bonds backed 100 percent by taxpayers to another set of bonds backed 100 percent by taxpayers but not counted as part of the national debt. …

The proposal would increase federal spending because the new securities the government would issue to finance direct loans would have higher interest costs than the Treasury bonds they would replace, effectively increasing the cost of every direct loan. Investors would view the new securities as slightly less desirable than Treasuries (even though they still carry a 100 percent guarantee from the federal government) because they will not be as liquid (easily bought and sold among investors). The new securities would also be subject to prepayment risk…Then there are the fees that the government would have to pay to investment banks (the “syndicate of underwriters”) to put the new securities on the market each year. Those fees could cost taxpayers tens or even hundreds of millions of dollars every year.

Apparently the supporters of the proposal claim that it would “diversify funding sources”.  In other words, if someday, somehow, some investors wouldn’t want to buy U.S. Treasury bonds (something is emphatically NOT happening now since interest rates are at record lows), then maybe they might be interested in something that’s backed by the U.S. but isn’t called a Treasury bond.  In other words, there’s a slight chance that pigs might someday fly away from the farm so let’s have a bunch of hogs that well call “pink cows”.  Jason speaking again:

Some members of Congress – particularly Republicans – would simply feel better if the direct loan program were funded with “private capital” rather than U.S. Treasury bonds….[but] the securities would be sold in the same markets as Treasury bonds and the capital raised to finance direct student loans would be no more or less “private” than it was before.

If the Wall Street proposal to refinance direct student loans doesn’t actually reduce the debt, increases the federal budget deficit, and doesn’t make the program’s financing any more dependent on the private market than it already is, what does it do? It effectively addresses what some see as the direct loan program’s biggest shortcoming; it doesn’t allow Wall Street to make a ton of money off of it.

So Wall Street wants to do to student loans what it’s done to home mortgage finance.  Have somebody else, such as the federal government, guarantee that they cannot lose any money.  Then, they want to bundle them and re-sell them solely for the purposes of making more fees – just like they did with mortgage-backed securities and credit default swaps and other derivatives.  If I recall correctly, that didn’t really work out too well now did it?  Well it worked out for the banks, but not for the rest of us.

Oligopoly and the Costs of Higher Education – Journals Edition

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There are many reasons why costs in higher education have been rising faster than inflation for many decades.  A fundamental reason is because education is so labor-intensive and (so far) has been resistant to improved productivity via capital investment or technology.  This is called Baumol’s Cost Disease.

But there are other reasons too.  One is that historically higher education has been a non-profit industry but it is like healthcare in that much, if not all, of the costs are paid for by a third-party such as government instead of the consuming customer themselves.  There’s another similarity to healthcare in that in both it’s the seller, the doctor or the professor/university, that tells the consumer, the patient or student, what specifically they need to consume.  The consuming customer, the student or patient, doesn’t have all the information to know what they need.  This 3-way or 4-way transaction arrangement isn’t the standard buyer-seller arrangement of micro-economic texts about markets.  When a 3-way arrangement exists where there’s a seller, a consumer and a separate payor, conditions are ripe for abuse.  Basically, the seller tells the consumer to buy more at higher prices.  The consumer doesn’t object because somebody else is paying.

Historically, the arrangements never got out of hand because doctors in healthcare and universities in higher education were non-profit “professionals”.  But when for-profit entities entered, the dynamics shifted.  Higher education still consists of a a strong majority of non-profit institutions.  But they are surrounded by a several supplier industries that are very definitely profit-maximizers such as book publishers.  Publishers have long pursued a process of competing on features and making textbooks more expensive because the person who selected the book, the professor, didn’t have to pay.  Students paid through their student loans and they didn’t have much choice.

Eliminating choice is the key to higher profits.  That’s why monopolies and oligopolies make economic profits while firms in pure price competition don’t.

Now courtesy of a lecture by Hal Abelson at the Educause 2011 conference, passed our way by George Siemens at elearnspace.org, we see why prices of academic journals have risen so much that many libraries can’t afford them.  It’s the trend towards concentration and oligopoly.  The government could do something about it via antitrust enforcement, but for several decades antitrust enforcement has been weak except for blatant conspiratorial price-fixing.  This image below (from this article – .pdf) demonstrates:

The Fraudulent Flat Tax Pitch – A Rich and Powerful Tactic

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Power and riches go together. But nowadays, they need political spin. Throughout history the very rich have usually also been the very powerful.  And usually the very rich use that power to both protect themselves from the less well-off and to figure out ways to further enrich themselves.  Often the enrichment comes at the expense of the less well-off.  When you’re powerful, redistribution of income away from the poor towards yourself is often a lot easier and more lucrative than trying to be productive and creative.  It’s been this way largely since the start of history.  But getting the poor and middle classes to go along it can be a challenge.  Of course blatant power, threats, and coercion were the means of choice for centuries.  The pure power dynamic gave way over the centuries to class, the idea that somehow the rich were different people, better people. The poor and middling classes were taught that it was the natural way of things.

Then the American and French revolutions brought out that dangerous idea: people really are fundamentally the same and they should have the same political rights.  It was a very dangerous idea for the rich and powerful classes. It leads to questioning why the rich are rich and the poor aren’t.  More importantly, this equality idea gave rise to a democratic governments.  Democracy is a challenge for the rich and powerful.  As historian William Hogeland has powerfully explained, the U.S. Constitution was actually created as a reaction by the rich and powerful against democratic finance well after the American Revolution.

So how do the rich and powerful today attempt to overcome democratic impulses and further enrich themselves at the expense of the others?  In other words, how do the rich and powerful get the poor and middle classes to go along with proposals that ultimately are only in the interest of the rich and powerful? 

One tactic is to simultaneously promote the idea that anybody can get rich and that success is purely a function of individual merit and effort.  One blatant example of this is Republican presidential candidate Herman Cain’s statements that “If you don’t have a job and you’re not rich, blame yourself.”   The unstated, but necessary assumptions behind such a statement are that sufficient opportunities exist instead of an economy where there is only 1 job opening for every 4+ job seekers.  It also assumes that all power is benign and that the rules are truly fair and balanced.  There’s a pernicious micro-economic theory called marginal resource productivity pricing (the MRP=MRC idea) that falsely provides a patina of cover for such ideas.  I won’t deal with that here but I hope to in a future post.

A second tactic is political spin.  Proposals that are really attempts to use the government to further entrench the rich and powerful at the expense of the 99% are dressed up in language that is carefully chosen to sound like it’s fair and populist.  But it’s a faux populism.  It’s an attempt to fool voters. Flat tax proposals are just such attempts to fool voters into supporting proposals that will hurt them. Let’s look at how and why flat tax proposals are neither “fair” nor beneficial to the majority of voters, workers, or taxpayers.

Inevitably, all flat tax proposals represent an attempt to raise taxes on the poor and middle classes while reducing taxes on the extreme rich, the top 1%. I’ve already analyzed and explained just how much Herman Cain’s “flat tax” proposal, the “9-9-9″ plan would raise taxes on at least the 80% while providing a huge tax cut for the top 1% and even more for the top 0.1%.  If there were truth in political advertising, Cain’s plan should be described as the “9+9+9=27% tax plan”.

Why are all flat tax proposals some kind of tax increase on the poor & middle class while providing tax cuts for the rich?  It’s because we already have a mildly progressive tax system.  Progressive means that the higher your income is, the higher your tax rate is.  In other words, under a progressive system, the rich pay higher rates and the poor lower rates.  Under a regressive system, the poor pay higher rates than the rich.  In the U.S., the federal income tax system is moderately progressive, although it’s been flattened a lot in the last the 33 years.  The progressiveness of the federal income tax system is offset partially by the regressive nature of a lot of other taxes like Social Security and Medicare payroll taxes, state and local sales taxes, and some property taxes.  The net effect is a mildly progressive tax system.  I quote from a post I made about this topic last spring:

 the folks at  Citizens for Tax Justice  used 2008 data for all federal, state and local taxes combined to do the analysis.  Here’s their analysis (via New York Times - warning paywall):

It found that the average effective tax rate is 29.8 percent, and that including state and local taxes makes the tax curve look much  less steep:

INSERT DESCRIPTION
Source: Citizens for Tax Justice Horizontal axis shows the income group. Vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

So what do we learn from this?  It shows us that if we look at the overall tax system in the U.S., the complex patchwork system of federal-state-local income taxes, payroll taxes, property taxes, sales taxes, etc., we are pretty close to having a flat tax system.  The poorest, lowest income folks pay 18.7% of income as some type of tax while the the richest 5% do pay more, but they only pay 32.2%.

What is really stunning is how the top 1%, the really-really rich multi-millionaires actually pay less average tax rate than the those who are only rich enough to make the top 5%.  It must really be nice to be so rich that Congress tweaks the tax code just for you.

So the system is very, very mildly progressive.

Flat tax advocates don’t make this “tax increase on the poor/middle class with tax cut for rich” aspect clear.  They try to hide it and obfuscate it.  They use terms like “flat” and “fair”.  They are really trying to tap into our collective memories of childhood when the idea of everybody getting the same percentage of the birthday cake seemed like an obvious “fair” solution.  They don’t want us to pay attention to the actual numbers.

But even a “flat” tax rate isn’t really fair. There’s a phenomenon that’s described in economics as the “diminishing marginal utility of money”.  In plainer English, it simply means that the richer you are, the more income you have, the less valuable any particular increase in income is to you.  The reverse is also true, when you’re poor and don’t have much money, the value or utility of money is very, very high.  An obvious example is to consider two extremes and look at the value or utility of having an additional dollar bill.  To an unemployed person with no assets and no money, a dollar bill is very, very valuable.  It may well represent eating vs. not-eating today. Life is dependent upon it.  Now contrast that to a hedge-fund manager who has a tens of millions of dollars in income each year and even more cash in the bank.  A single additional dollar doesn’t mean much.  If a strong wind blows the dollar out of the hand of the unemployed, they will no doubt chase it.  If it blows it out of the hand the hedge-fund manager, they’re much less likely to chase it.

But some critics may point out that my example is using dollar amounts not percentages.  Surely percentages would be the same.  Not really.  This time let’s consider someone working full-time at minimum wage.  They earn $296 per week – gross. But after payroll taxes they’re closer to $275.  That’s close to $1100 per month. One percent of that is $11.  That one percent could easily represent the difference between bus fare or gasoline and not having it.  In other words, that 1% represents the very ability to get to work and earn their income.  It’s extremely valuable.  It can be the difference between making it and not making it.  For many seniors on social security, 1% is the difference between life-maintaining prescriptions and not. But let’s look at that hedge-fund manager again.  The one with the $16 million dollar a year income.  The monthly income is $1.33 million.Now yes, 1% for our hedge fund manager is $13,333 each month. It seems like a huge amount of money to us (I’m assuming not many of the 1% read my blog), is how big of a sacrifice will it mean to the hedge fund manager?  Would paying an additional $13,333 per month really change the hedge fund manager’s life much?  Not likely.  It’s not likely to change the choice of first or second house.  I’ll grant it might affect the choice of whether to have a third home or how big it would be. The point is that the sacrifice represented by 1% of income is greatly different depending upon your income.  A flat tax does not represent equal sacrifice.  

The flat tax advocates also make much of the idea that a flat tax would simplify the tax code. Again the reason for claiming simplification is to get middle class voters to support  something that isn’t  It won’t.  First, while some flat tax proposals start out as recommending the elimination of all deductions, exemptions, and tax credits, they rarely do in practice.  Even Herman Cain has backtracked from his original proposal of eliminating all exemptions.  It’s the personal exemption that gives the current federal income tax system much of it’s progressiveness.  When push comes to shove, the political pressures and special interests that pushed for the deductions and credits originally rise up and force some kind of inclusion in the new proposal.  Herman Cain, I understand has now already backtracked and decided to add back personal exemptions.  That ends the “flatness” of his flat tax.  Now it’s just a tax cut for the rich proposal. In the real world of politics and special interests, no flat tax proposal will stay that way.  There are too many legitimate reasons why we don’t have a flat system now and they will inevitably reassert themselves.  Charitable deductions (think churches and universities, not homeless shelters) and home mortgage deductions have powerful interests behind them. Besides, much of the complexity in tax forms comes from simply trying to determine what’s income and what isn’t.  That won’t change.  Simplicity is just false promise to make flat tax proposals attractive to the middle class.

Flat tax advocates also claim it would treat all taxpayers the same.  But the current system already does that. As Robert Reich points out:

The truth is the current tax code treats everyone the same. It’s organized around tax brackets. Everyone whose income reaches the same bracket is treated the same as everyone else whose income reaches that bracket (apart from various deductions, exemptions, and credits, of course).

For example, no one pays any income taxes on the first $20,000 or so of their income (the exact amount depends on whether the person is married and eligible for tax credits like the Earned Income Tax Credit of the Family Tax Credit.)

People in higher brackets pay a higher rate only on the portion of their income that hits that bracket — not on their entire incomes.

So when Barack Obama calls for ending the Bush tax cut on incomes over $250,000, he’s only talking about the portion peoples’ incomes that exceed $250,000. He’s not proposing to tax their entire incomes at the higher rate that prevailed under Bill Clinton.

Republicans have tried to sow confusion about this. They want Americans to believe, for example, that if the Bush tax cut ended, small business owners with incomes of $251,000 a year would suddenly have to pay 39 percent of their entire incomes in taxes rather than 35 percent. Wrong. They’d only have to pay the 39 percent rate on $1,000 – the portion of their incomes over $250,000.

Get it? We already have a flat tax – flat within each bracket.

Flat tax advocates also deceive by only focusing on federal income taxes.  Payroll taxes, the Social Security and Medicare taxes, are regressive.  People with incomes over $104,000 don’t pay any tax on the income above that threshold.  People whose income comes from capital gains and not wages don’t pay any Social Security or Medicare taxes.  Yet they are eligible for Medicare.  State sales taxes are highly regressive.  Flat tax advocates don’t want to change those systems because the real objective is to shift taxes to the poor and middle class and give tax cuts to the top 1%.

Finally, the biggest deception in most flat tax proposals is that capital gains, dividend income, and hedge fund management fees (called “carried interest”) are usually still provided special treatment.  Herman Cain does this.  He claims to want all income taxed at 9%, but in reality he proposes that capital gains and dividend income be totally exempt from taxes.  In other words, the way that the top 1% generally earns most of their money would be tax free.  How fair is that?  It’s the current loopholes about taxing capital gains, hedge fund managers, and dividends at lower rates that results in the top 1% paying less than anyone else in the top 10% (see graph at top).

Flat tax proposals aren’t about flattening tax rates. They’re about flattening the majority of taxpayers.  But that doesn’t sell politically so they have to be wrapped in political spin to be something they aren’t.

 

 

 

 

 

Too Big to Fail Should Be Too Big to Exist

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Against Monopoly has a great graphic that shows a big part of the problem with our financial sector and our economy.

How the Too Big to Fail Banks Got So Big

How the Too Big To Fail Banks Got So Big

The four banks shown above are the four largest banks in the U.S.: JP Morgan Chase, Citi, BofA, and Wells Fargo.  Together they dominate the financial industry. If you add in Goldman Sachs and Morgan Stanley, the domination is near complete.  They all received large bailouts in the 2008-09 crisis.  Today they are much larger than when we entered the crisis. As the graph shows, none of these banks grew so large by “natural” or “organic” means.  They didn’t grow because they offered better or more efficient services to customers.  They didn’t “win in the marketplace” by competing better.  They simply bought the competition.  It’s domination by merger.  The U.S. banking system which at one time was very competitive and decentralized with literally thousands of very competitive banks is now dominated by a few.  We call it oligopoly on the way to monopoly.

When very, very large banks get too big, they become “Too Big To Fail”.  That means, if the banks were allowed to fail because of bad decisions, bad management, or bad investments, it would set off a domino effect throughout the economy and financial system.  That would punish all of us and not just the bank’s owners.  This, of course, is what happened in 2008 when Lehman Brothers was allowed to fail.  It set off a financial panic where banks wouldn’t / couldn’t loan to each other (or anyone else).  Result:  big bailouts of big banks.

But it doesn’t have to be this way.  Yes, once we have a “too big to fail” bank and it fails, then there’s pretty much no choice but to bail them out.  There are choices about the structure of the bailout. We could have set up the bailouts in a way that the economy wins and the failed managers and bank owners suffered.  We didn’t.  The Federal Reserve, the Bush administration, and then the Obama administration made it a priority to keep the bank managers and bank owners whole.  The economy has suffered from a slow recovery partly as a result.

But bailouts shouldn’t be necessary because we shouldn’t allow the banks to become this big in the first place.  Again, we have a choice.  We could have prevented some or all of these mergers.  The laws are on the books to do it.  Washington, following the failed anti- antitrust philosophy of the Chicago school since the 1980′s simply doesn’t challenge many mergers these days.  It’s bad for campaign contributions.  Besides we’re supposed to believe that a market fairy will make it all right.  Instead of challenging and stopping some of these mergers, both the government and The Federal Reserve have actually facilitated and acted as match-maker for many of the mergers.  In March 2008, when Bear Stearns failed, The Federal Reserve offered a deal to JP Morgan Chase.  If Chase would buy Bear Stearns, The Fed would reimburse Chase for any losses over a set amount.  Heads Chase wins. Tails Chase wins.  Nice deal.

We have other choices as well.  In other industries historically when the private competition in the market led to monopoly or near-monopoly outcomes, the government chose to regulate the industry as a public utility.  We did it in the 1920′s and 1930′s with the electrical industry.  Your local electrical company wasn’t always a regulated utility.  At one time it was ravenous and rapacious private monopoly just like these banks are becoming.  When Standard Oil became a monopoly over a hundred years ago, we sued and broke it up into a bunch of other companies.

This complicity in allowing the big banks to become Too Big To Fail is among the types of policies that the protesters of #OccupyWallStreet want changed.  Me, too.

John Stossel Fails an Education Test and Demonstrates That He’s Economically Illiterate

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John Stossel is a Fox Business News reporter.  Stossel is an unabashed “libertarian” with a strong Austrian orientation on economics who focuses on economic issues.  He’s made a living out of being indignant and disgusted by “liberals” and “big government” which he sees as the root of all economic problems.  He’s been quite successful over the years, first at ABC News and now at Fox.   He also writes a blog to go with his Fox News show.

In other research I was doing recently I stumbled upon a post of his from Sept 15 called “Stupid in America” in which he asserts that schools have gotten too expensive and don’t deliver the goods.  In Stossel’s own words and graph:

School spending has gone through the roof and test scores are flat.

While most every other service in life has gotten faster, better, and cheaper, one of the most important things we buy — education — has remained completely stagnant, unchanged since we started measuring it in 1970.

It looks appalling right?  Scores have increased by 1% but the cost of an education appears to have increased by approximately 246% ($43,000 up to $149,000).  Except it’s very deceptive and the obvious product of an economic illiterate.  There’s two clear, elementary economic errors here.

First, he’s comparing test scores, a measure that’s in absolute terms on fixed scale to dollars spent in nominal terms over a 40 year period.  Dollars are not fixed units of measure.  They change value over time because of inflation.  If you want to compare test scores to dollars spent “buying” those test scores, then you need to use real dollars with the inflation taken out.

So let’s do that.  Using the Bureau of Labor Statistics CPI Inflation Calculator, we find that what $43,000 purchased in 1970 would require $241,660. in 2010.  Yes, inflation has changed purchasing power that much.  Inflation compounds so even a 2% annual inflation rate would more than double nominal costs in 40 years.  In the late 1970′s we had some years of inflation in the double-digits.  So really, the graph is telling us the opposite of what Stossel wants us to believe.

The second big problem is that Stossel is assuming that the all money spent on education goes to buying improved test scores in math, science, and reading.  He also is assuming that the inputs, the students being educated are the same in 1970 as in 2010.  They aren’t.  He ignores that we might be paying for something else in addition to math, reading, and science test scores.

Stossel then goes on the attribute all of the problems to education being a government monopoly.  Again, he ignores facts. Facts are inconvenient for Stossel.  Competition has been brought to K-12 education in many areas. Maybe not as much as he would like, but it’s a significant change since 1970.  As his test scores indicate, it hasn’t helped much.

Finally, I want to note that it’s poor practice to not cite your sources and more precisely define your data series.  The graph is labeled “Source: NCES”.  NCES is a huge website and archive of a lot of data.  Stossel doesn’t give a source. Is it because he wants us to take him at his word and not verify or check it out for ourselves? He doesn’t even label what the spending series is to which he refers.  I am assuming it is a “spending per pupil over 12 years” type of series.  A search of NCES for a series labeled as he has it turned up nothing.

I find it enormously ironic that Stossel would make such elementary errors as to not deflate a data series or to not label his measures precisely.  That’s what we demand in principles of economics courses.  What makes it ironic is that on August 23 Stossel takes Congress to task for being “economic illiterates” and not having degrees in economics or business.  Pretty rich stuff from a guy with only a psychology degree who makes elementary economic errors.

Where Are or Were The Jobs?

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With the all the alleged concern in Washington now from both parties about job creation, there’s something that’s missing in much of the debate: facts.  So let’s take a look at some.  I really like graphics like the one below.  They’re complex and take quite some time to read and fully absorb what’s there, but they pack a lot of information into a small space.  They’re info-dense.

We hear from the left a lot of talk about “good” vs. “bad” jobs.  Often what they are referring to is the relative wage level of the jobs.  In general, manufacturing and government jobs are “good” because they tend to have slightly higher than average wages*.  Education and health services jobs are a mixed bag with a lot of variation.  Doctors, nurses, and admins do very well.  Home health aides and assisted living workers not so much.  Teachers are either good or bad depending on the state. Leisure and hospitality are generally panned as below-average.

From the right we hear claims that heavily unionized sectors like motor vehicles, parts and manufacturing are holding down growth and killing jobs.  We also hear political conservatives claiming that excessive growth of the government sector has somehow prevented the private sector from adding jobs.

We also hear from the left that it’s lack of demand that is keeping unemployment high.  The right like to claim the unemployment is structural – we have the wrong workforce with the wrong skills.

But what’s really happened?  How have the different policies of Bush and Obama (to the degree they’re different – they aren’t as different as some think) affected the employment picture?  Let’s look a this graph from David Altig, Senior VP at the Atlanta Federal Reserve Bank as posted at macroblog.  It helps to click and enlarge the graph in a new window/tab.

Click to Enlarge

First, let’s examine how the graph is structured.  As always, it’s important to make sure we understand a graph’s axes first.  Horizontally, we have the average monthly change in employment in percentage between Dec. 2001 and Oct. 2007.  This period covers all of the non-recession portion of the G.W. Bush administration.  Industries to the reader’s right grew strongly and thrived under the Bush administration’s policies.  Industries to the reader’s left shrunk. No growth is the zero or mid-line. Next, the vertical axis shows a similar measure, average monthly percent increase in employment, but it’s for the period of July 2009 through Aug. 2011.  This is the non-recessionary months of the Obama administration.  Industries located high up grew under the Obama recovery. Industries low on the scale shrunk and cut jobs during Obama’s recovery.  There’s no tricks here of cherry-picking time periods – both axes cover only the “recovery” portion of each president’s respective time in office.

So looking overall, we have the four quadrants.  The upper right shows industries that have added jobs under both presidents’ recoveries. The lower left are industries that have been cutting jobs under both presidents. Upper left would be winners under Obama but not Bush. Lower right are those sectors that have been cutting employment under Obama but were big growth sectors under Bush.  Finally, the size of each bubble indicates the relative importance of the industry in terms of jobs.

So what can we conclude?  First there are few items that aren’t so surprising.

  • Under Bush, a lot of the employment growth involved construction and financial activities.  Not surprising. This is the Wall Street driven housing and mortgage bubble. Frankly we don’t need that big of construction sector, at least not if it’s focused on housing as it was.  We have too much housing already.  We do have needs for more construction of infrastructure and to the degree that housing construction workers are either in the wrong location or don’t have the skills for infrastructure construction (I don’t know – it’s not my expertise), then the low employment growth under Obama here represents a  structural unemployment problem.  But notice that industry isn’t that big.  Also, we probably don’t want to have Financial Activities come back as big as they were before.
  • The big winners under Bush were Education and Health Services and Professional/Business Services.  In education and health, health dominated.  Not surprising, health care spending has been growing and the population is becoming older and/or sicker.   The growth in professional/business services is probably not really very productive stuff.  A very, very large part of the increase in that area was the huge increase in security personnel and related-security contracting that has arisen from an increasing paranoid insecure society since 9/11.
But there are some items here which are surprising, or at least surprising if you’re believe the normal political rhetoric.
  • First, it was Bush who grew government employment.  Under Obama, government employment has been negative since the recession ended. Shrinking government employment is clearly the single largest drag on the economy. That’s not ideology or belief talking. It’s facts and data.
  • Second, the big reason why the Bush recovery was such a slow recovery for employment, considering the 2001 recession was mild, is that throughout the Bush administration manufacturing shrunk dramatically.  This was the result of globalization policies that provided incentives for U.S. manufacturing firms to locate production overseas or to buy from overseas manufacturers instead of making their own.  Fast growing companies like Apple and other computer companies prefer to design it themselves but to contract with foreign firms for manufacture. Obama has not turned the corner on manufacturing employment, but he has stopped the bleeding. For the U.S. to recover, this sector needs to have positive growth.  Given it’s size, it’s not necessary to rise to the top in percentage terms, but it needs to be positive which it isn’t now.
  • “Manufacturing” does not mean “autos”.  Manufacturing is much worse than Motor Vehicles and Parts.  Too often when politicians talk “manufacturing” they conjure a stereotypical image of auto manufacturing.  In reality, motor vehicles and parts, while not being a source of growth under either, has essentially held it’s own as neutral.
  • The Information industry is the one industry that has shrunk under both recoveries, although it’s not that large.  This largely represents true sectoral, innovation-driven change as the World Wide Web changes information technology.
Finally, let’s see what this graph says about the controversy over is unemployment structural (in which case we need training and incentives to work) or is it a lack of aggregate demand (in which case we need more stimulus spending).  I think the graph is relatively clear in this regard.  We have three very, very large sectors where there is no increase in employment under the current recovery: Manufacturing, Retail Trade, and Wholesale Trade.  These are the three that represent basic total spending.  Retail and wholesale trade are driven by total consumer spending. Period. Retail and wholesale also are very flexible without widespread specialized skills requirements.  When demand exists, they hire. When demand doesn’t exist they don’t hire and may layoff.  To me, the data indicates it’s clearly a lack of demand story that is hurting jobs in this so-called recovery. Reducing government employment right now, like this graph shows is being done, has repercussions in stopping employment growth in retail, wholesale, and manufacturing.

Businesses (and Micro) Refute the Logic of Jobs Tax Credits

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I wrote a few days ago about how I found the President’s American Jobs Act proposal to be less than stimulating and I updated my assessment yesterday.

Much of the proposal involves a lot of complex tax credit ideas that are supposed to provide the incentives for businesses to hire.  The idea is that if a $5000 or so tax credit is dangled in front of businesses, they’ll decide to part with some of the cash they are sitting on and hire.  It’s a dubious idea.  But it’s straight out of the conservative-thinking playbook. See this post for an explanation of the economic theories and thinking behind different types of jobs proposal. The conservative view and theories emphasive the supply-side. They posit that all can be fixed by providing greater financial incentives to businesses and that any form of tax is a disincentive.  The fact that President Obama has embraced these types of proposals is additional evidence, that contrary to the accusations that he’s a socialist or liberal, he is, in fact, quite conservative in his views.  He simply isn’t as conservative as the far-conservative/liberatarian wing of the Republican party would like.

There’s little historical evidence to suggest that tax credits for new hiring is a powerful incentive.  What I’ve always found interesting is that the economists and conservatives who propose these ideas claim that the theory underlying it is based on microeconomics – the idea that firms want to maximize profits.  But, in fact, it ignores basic microeconomic thinking about where profits come from.  Profits come from first selling something.  It makes no difference what your taxes are if you aren’t selling enough.  This is another reason why I think the idea of tax credits for new hiring will be a weak and relatively ineffective way of stimulating employment. It’s an expensive way to not get much results.  What really we need is an economy that spends more money.

To bolster my case, we can read about the reaction from many businesspeople in the New York Times:

The dismal state of the economy is the main reason many companies are reluctant to hire workers, and few executives are saying that President Obama’s jobs plan — while welcome — will change their minds any time soon.

That sentiment was echoed across numerous industries by executives in companies big and small on Friday….[M]any employers dismissed the notion that any particular tax break or incentive would be persuasive. Instead, they said they tended to hire more workers or expand when the economy improved.

Companies are focused on jittery consumer confidence, an unstable stock market, perceived obstacles to business expansion like government regulation and, above all, swings in demand for their products.

“You still need to have the business need to hire,” said Jeffery Braverman, owner of Nutsonline, an e-commerce company in Cranford, N.J., that sells nuts and dried fruit. While a $4,000 credit could offset the cost of the company’s lowest-cost health insurance plan, he said, it would not spur him to hire someone. “Business demand is what drives hiring,” he said.

On the other hand, creating lots of tax credits and tax code complexity will create some additional jobs and hours worked in one particular sector:  tax accountants and laywers.