Income Inequality Does Matter And It Makes Us Worse Off

Posted by Jim Luke — November 6, 2011

There is viewpoint that asserts that income inequality and wealth inequality are necessary, that they are the differences that motivate people to work and get ahead. This viewpoint often implies that without wide income disparities that our economy’s growth would slow. Supporters of such a viewpoint seem to suggest that the only choices we have are either: a society of dramatic differences in income distribution or a society where everybody is equal but also poor. This viewpoint is wrong. Absolutely wrong. A simple review of U.S. history in the 20th century demonstrates the wrongness. US GDP real growth in the 3 decades of 1950′s, 1960′s and 1970′s was much stronger than the 3 decades since 1980. In the high-growth decades, income distribution was more equal and more fair. Income distribution since 1980 has gotten worse. But there’s more data to disprove the idea of “income inequality is good”.

Richard Wilkinson is a British researcher who has spent his life studying income inequality and the consequences for societies. I strongly urge you to view in it’s entirety his TED talk on this subject.

Here are some excerpts from the transcript:

You all know the truth of what I’m going to say. I think the intuition that inequality is divisive and socially corrosive has been around since before the French Revolution. What’s changed is we now can look at the evidence, we can compare societies, more and less equal societies, and see what inequality does. I’m going to take you through that data and then explain why the links I’m going to be showing you exist.

…I want to start though with a paradox. This shows you life expectancy against gross national income –how rich countries are on average. And you see the countries on the right, like Norway and the USA, are twice as rich as Israel, Greece, Portugal on the left.And it makes no difference to their life expectancy at all. There’s no suggestion of a relationship there.But if we look within our societies, there are extraordinary social gradients in health running right across society. This, again, is life expectancy.

…Now I’m going to show you what that does to our societies. We collected data on problems with social gradients, the kind of problems that are more common at the bottom of the social ladder.Internationally comparable data on life expectancy,on kids’ maths and literacy scores, on infant mortality rates, homicide rates, proportion of the population in prison, teenage birthrates, levels of trust, obesity, mental illness – which in standard diagnostic classification includes drug and alcohol addiction – and social mobility. We put them all in one index. They’re all weighted equally. Where a country is is a sort of average score on these things.And there, you see it in relation to the measure of inequality I’ve just shown you, which I shall use over and over again in the data. The more unequal countries are doing worse on all these kinds of social problems. It’s an extraordinarily close correlation. But if you look at that same index of health and social problems in relation to GNP per capita, gross national income, there’s nothing there,no correlation anymore.

…What all the data I’ve shown you so far says is the same thing. The average well-being of our societiesis not dependent any longer on national income and economic growth. That’s very important in poorer countries, but not in the rich developed world. But the differences between us and where we are in relation to each other now matter very much.

…This is mental illness.

…This is violence.

…This is social mobility. .

The other really important point I want to make on this graph is that, if you look at the bottom, Sweden and Japan, they’re very different countries in all sorts of ways. The position of women, how closely they keep to the nuclear family, are on opposite ends of the poles in terms of the rich developed world. But another really important difference is how they get their greater equality. Sweden has huge differences in earnings, and it narrows the gap through taxation, general welfare state, generous benefits and so on. Japan is rather different though.It starts off with much smaller differences in earnings before tax. It has lower taxes. It has a smaller welfare state. And in our analysis of the American states, we find rather the same contrast.There are some states that do well through redistribution, some states that do well because they have smaller income differences before tax. So we conclude that it doesn’t much matter how you get your greater equality, as long as you get there somehow.

I am not talking about perfect equality, I’m talking about what exists in rich developed market democracies. Another really surprising part of this picture is that it’s not just the poor who are affected by inequality. There seems to be some truth in John Donne’s ”No man is an island.”

…

I should say that to deal with this, we’ve got to deal with the post-tax things and the pre-tax things.We’ve got to constrain income, the bonus culture incomes at the top. I think we must make our bosses accountable to their employees in any way we can.I think the take-home message though is that we can improve the real quality of human life by reducing the differences in incomes between us.Suddenly we have a handle on the psychosocial well-being of whole societies, and that’s exciting.

The Economy Has Caused Riots Before – In the Great Depression

Posted by Jim Luke — October 30, 2011

Washington’s Blog reminds us that things got ugly during the last prolonged depression in the United States. This interesting historical footage from the Great Depression shows what happens when large numbers of people are unemployed for years at a time, get desperate, and perceive that the game is rigged to the benefit of Wall Street.

This depression isn’t as deep or severe as the Great Depression – the bank bailouts and the 2009 Obama stimulus spending/tax cut bill (ARRA) made sure of that. But as this week’s GDP numbers show, we simply aren’t growing enough to fully recover. For workers, the nightmare is real. With the #OccupyWallStreet movement (#OWS) growing stronger, spreading, and continuing now for well over 6 weeks, perhaps the Wall Street banks are having nightmares of their own about such scenarios as what happened in the video. Could that be why JP Morgan Chase bank is making such large ~~payoffs~~ donations to the New York City Police department? Yves Smith at Naked Capitalism fills us in:

Is JP Morgan Getting a Good Return on $4.6 Million “Gift” to NYC Police? (Like Special Protection from OccupyWallStreet?)

No matter how you look at this development, it does not smell right. From JP Morgan’s website, hat tip Lisa Epstein:

JPMorgan Chase recently donated an unprecedented $4.6 million to the New York City Police Foundation. The gift was the largest in the history of the foundation and will enable the New York City Police Department to strengthen security in the Big Apple. The money will pay for 1,000 new patrol car laptops, as well as security monitoring software in the NYPD’s main data center.

New York City Police Commissioner Raymond Kelly sent CEO and Chairman Jamie Dimon a note expressing “profound gratitude” for the company’s donation.

“These officers put their lives on the line every day to keep us safe,” Dimon said. “We’re incredibly proud to help them build this program and let them know how much we value their hard work.”

…

But what, pray tell, is this about? The JPM money is going directly from the foundation to the NYPD proper, not to, say, cops injured in the course of duty or police widows and orphans…

And look at the magnitude of the JP Morgan “gift”. The Foundation has been in existence for 40 years. If you assume that the $100 million it has received over that time is likely to mean “not much over $100 million” this contribution could easily be 3-4% of the total the Foundation have ever received.

Now readers can point out that this gift is bupkis relative to the budget of the police department, which is close to $4 billion. But looking at it on a mathematical basis likely misses the incentives at work. Dimon is one of the most powerful and connected corporate leaders in Gotham City. If he thinks the police donation was worthwhile, he might encourage other bank and big company CEOs to make large donations.

And what sort of benefits might JPM get? It is unlikely that there would be anything as crass as an explicit quid pro quo. But it certainly is useful to be confident that the police are on your side, say if an executive or worse an entire desk is caught in a sex or drugs scandal. Recall that Charles Ferguson in Inside Job alleged that the use of hookers is pervasive on Wall Street (duh) and is invoiced to the banks.

Or the police might be extra protective of your interests. Today, [Oct 5] OccupyWallStreet decided to march across the Brooklyn Bridge (a proud New York tradition) to Chase Manhattan Plaza in Brooklyn. Reports in the media indicate that the police at first seemed to be encouraging the protestors not only to cross the bridge, but were walking in front of the crowd, seemingly escorting them across…

The wee problem is that the police are in the street, and part of the crowd is also on the street (others are on a pedestrian walkway that is above street level). That puts them in violation of NYC rules that against interfering with traffic. Note the protest were aware fo the rules; they were careful to stay on the sidewalk on the way to the bridge.

…some (many?) the protestors who used the walkway and got across the bridge were also corralled and not permitted to proceed to the Chase plaza. Greg Basta, deputy director of the New York Communities for Change, told me by phone, based on multiple reports from people who participated in the march, that as soon as protestors got to the Brooklyn side of the bridge, they were kettled. Greg was under the impression that there were construction barricades at the foot of the bridge which made it impossible for the marchers not to walk on the street. Because the focus has been on the what happened on the bridge, the coverage of what happened to the rest of crowd is sparse.

Some confirmation in passing comes from MsExPat at Corrente (apparently some of the very first off the bridge were permitted to proceed):

My friends and I made it to the Brooklyn side okay–we ended up with about 350 other marchers in Cadman Plaza, a lovely 19th century park. What I didn’t find out until later is that several hundred people behind me also got kettled and barred from going all the way to Brooklyn. So I was among the lucky marchers in the middle.

But notice even then that the procession to Chase Manhattan Plaza [correction, Cadman Plaza} was effectively barred. [Note JPM may have operations nearby, Bear Stearns had much of its back office there, and if the leases were cheap, JPM may have kept the space].

We simply don’t know whether the police would have behaved one iota differently in the absence of the JP Morgan donation. But it raises the troubling perspective that they might have. …

So far, the JP Morgan donation is an isolated example. But the high odds of continuing deep budget cuts at the state and local level open up the opportunity for corporate funding of preferred services, and with it, much greater private sector influence on the apparatus of government. This is a worrisome enough possibility to warrant a high degree of vigilance by all of us.

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

Posted by Jim Luke — October 28, 2011

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.

Some Other Interesting Perspectives on OccupyWallStreet

Posted by Jim Luke — October 26, 2011

I’ve already mentioned my initial thoughts on the Occupy Wall Street movement (#OWS). Here’s some snippets from a couple of others with some interesting insights. First, historian William Hogeland writes at his blog Hysteriography. He notes how the #OWS movement is a deeply American movement. It has roots in the American revolutionary period as much as any Tea Party. He also reminds us that the Revolution wasn’t simply Americans vs. the tyrannical English. It was just as much about pure economic equality and fairness. It was also about elitist rich Americans vs. populist American farmers and workers oppressed by taxes, foreclosures, and debts.

… I write about the deep, founding roots of rowdy, American populist protest and insurrection, often visionary and even utopian, yet informed and practical too, specifically over money, credit, and the purpose and nature of public and private finance. …most people still don’t connect the American founding period with a rugged drive on the part of ordinary people for equal access to the tools of economic development and against the hegemony of the high-finance, inside-government elites who signed the Declaration and framed the Constitution and made us a nation.

Sometimes people even ascribe democratic ideas to the famous upscale American Revolutionaries, who to a man actually hated democracy and popular finance. Paine, the exception, was ultimately rebuked and scorned by all of the others. [UPDATE: Anyway, Paine wasn't one of them; I threw him in defensively because consensus-history types like to "include him in" on the basis of "Common Sense," while including his social/economic radicalism out.]

The difficulty in dealing with our founding battle for democratic economics arises in part because the movement was not against England but against the very American banking and trading elites who dominated the resistance to England. That complicates our founding myth, possibly unpleasantly. Also, it was a generally losing battle. With ratification of the Constitution, Hamiltonian finance triumphed, and people looking to Jefferson and Madison for finance and economic alternatives to Hamilton are barking up the wrong tree, since what those men knew, or even really cared, about finance could be written on a dime. (Anyway, in pushing for creating a nation, Madison supported Hamiltonian finance down the line. Their differences came later.) When Occupy Wall Street protesters say “It’s We the People!” they’re actually referring to a preamble, intending no hint of economic democracy, to a document that was framed specifically to push down democratic finance and concentrate American wealth for national purposes. Not very edifying, but there it is.

…Amid horrible depressions and foreclosure crises, from the 1750′s through the 1790′s, ordinary people closed debt courts, rescued debt prisoners, waylaid process servers, boycotted foreclosure actions, etc. (More on that here and here.) They were legally barred from voting and holding office, since they didn’t have enough property, so they used their power of intimidation to pressure their legislatures for debt relief and popular monetary policies. Their few leaders in legit politics included the visionary preacher Herman Husband, the weaver William Findley, and the farmer Robert Whitehill.

They had high hopes for American independence. In the 1770′s, their “out-of-doors” collaboration with the famous elites was critical to enabling the Declaration of Independence — even though none of their names appears there (well, Benjamin Rush’s does, but by then he’d become unradicalized). Their democratic, egalitarian hopes dashed, in the 1780′s, in western Massachusetts, they marched on the state’s armory in Springfield to reverse regressive finance policies that had again plunged ordinary people into debt peonage and foreclosure while bailing out rich creditors (elites called that populist action, reductively, Shays’s Rebellion). In the 1790′s, with the Constitution in force, and Hamilton’s economics the law of a powerful new nation (partly in direct reaction to the Shays action), populists took over the militia and debt-court system throughout western Pennsylvania and western counties of neighboring states, flew their own flag, and tried to secede from the United States and form an economically egalitarian country. Hamilton dubbed that action, again in a successful effort to reduce it, the Whiskey Rebellion, and he and President Washington responded, naturally enough, by occupying western Pennsylvania with federal troops.

It is my possibly vain hope that reading up on such historical matters might inspire efforts like Occupy Wall Street to greater cogency and a deeper, more solid foundation in longstanding (if embattled and problematic) American values than they now seem to possess. You don’t have to look as late as the 19th-century Populists and the 1930′s labor movement, for example, to find an American left deeply immersed in both economic issues and an ambitious vision of a better country. Those things were present at the creation.

Hogeland also recommends an “Occupy Wall Street” Reading List.

Next up is John Quiggin at Crooked Timber. He first observes that much of the eventual outcome of the #OWS movement depends on the “19%” – the folks that are in the top quintile, the top 20%, but aren’t part of the top 1%. As we know powerfully from a graph I posted a few days ago:

First, economix at the New York Times reported on the basic income distribution data recently:

The graph below shows how much income is earned by a household at any given percentile in the income distribution, based on these new numbers for 2011:

Tax Policy Center

Incomes grow much, much faster at the top end of the income distribution than in the middle or at the bottom end. That is, the disparity in income between one percentile and a consecutive percentile is bigger among the very rich.

The top quintile, the top 20% may be rich compared to the rest, but not very much. It’s really the top 1% and the top 0.1% where the income scale is truly distorted and outrageous. Quiggin makes the point that the 19% is politically influential and powerful. Perhaps not as powerful as the 1%, but clearly politically influential. To keep the redistribution of income to the top game going, the top 1% has to keep the 19% on their side. Without them, there’s clearly no legitimacy. [bold emphases mine]

The top quintile as a whole commands the great majority of US income, and virtually all financial wealth – few households outside this group own much beyond their homes and perhaps some money in a pension fund….

The 19 per cent also have a disproportionate political weight, since they are much more likely than Americans in general to register, vote and engage in political activity. So, it makes a big difference whether, as as implied by ‘We are the 99 per cent’ their interests are aligned with the mass of the population or with the top 1 per cent…

The top quintile as a whole has done very well over the past few decades, and (despite some silly claims to the contrary), high-income earners have mostly voted Republican, in line with their economic interests. Certainly there are plenty who don’t vote their interests, but that is also true of many people in the top 1 per cent, not to mention bona fide billionaires like Buffett and Soros. [but]… a closer look at income growth figures suggests that, while the 19 per cent have enjoyed rising incomes, they’ve only barely maintained their share of national income. The redistribution of the past three decades has gone from the bottom 80 per cent to the top 1 per cent.

That suggests the possibility of a policy response in which the main redistributive thrust would be to reverse this process. This would almost certainly involve higher tax payments, but this would be offset by the restoration of public services, which are in economic terms a ‘superior good’, valued more as income rises. The top 1 per cent can buy their own services, and are largely unaffected by public sector cutbacks, but that’s not true of the 19 per cent.

Another important factor is the growth of economic insecurity. The myth of the US as a land of opportunity for upward mobility has been replaced by Barbara Ehrenreich’s Fear of Falling (another good source on this is High Wire by Peter Gosselin). Even if people in the top 19 per cent are doing well, they are less secure than at any time since the 1930s, and their children face even more uncertain prospects.

Finally, there is the alliance of the 1 per cent with the forces of rightwing cultural tribalism. The 1 per cent can only rule by persuading lots of people to vote against their interests, and that requires a reactionary and anti-intellectual agenda on social, cultural and scientific issues. As a result, educated voters have increasingly turned against the Republican Party.

I don’t want to make too much of this last point. As Allan Grayson said during his memorable takedown of PJ O’Rourke recently, the 1 per cent own the Republican Party outright, but they also own much of the Democratic Party, and can rule satisfactorily through either. Also, having a college degree isn’t the same as being educated – Tea Party supporters are more likely than the average American to have a degree, and college-graduate Republicans are even more prone to various delusional beliefs on issues such as climate change.

Nevertheless, taking account of all the factors listed above, even the most comfortably affluent members of the professional class, looking at the alliance of plutocrats and theocrats arrayed to defend Wall Street could reasonably conclude that it was in their own interests to support the 99 per cent and not the 1 per cent.

We are therefore (surprisingly to me) suddenly back in a situation where a progressive movement can reasonably claim to act in the interests of a group that is:..
(a) the overwhelming majority of the population
(b) responsible for nearly all the productive activity (as against the 1 per cent’s incomes drawn from a parasitic financial sector)
(c) economically desperate or at risk of becoming so.

Can all of this be sustained? I don’t know, any more than anyone else. But #OWS has already achieved things that most people would have regarded as impossible a month ago, and for the moment at least, the momentum is still growing.

The #OWS movement appears to be spreading and growing in a way the Tea Party never did. It’s clearly, as Hogeland points out, deep in the tradition of American politics. And as Quiggin points out, the 19%, the top quintile folks have had income gains in recent years but they’ve also had a dramatic increase in economic insecurity, diminished prospects for their children, and a reduction in the public services they value such as top-notch public universities and infrastructure. It’s interesting times, especially since no presidential candidate from either party appears to align with the interests of the #OWS movement.

Warning: More Bank Bailouts Possible

Posted by Jim Luke — October 24, 2011

One area I haven’t commented on much is the ongoing European “debt crisis”. The Greek debt crisis is a part of it, but it’s only the tip of the iceberg. The roots are much deeper. One reason I haven’t commented is because it’s fairly complex and requires a lot of background explanation which I haven’t had time to write. Nonetheless, it’s something worth mentioning. In particular because it’s likely to mean more big bank bailouts.

In short, the crisis involves the way the Euro currency zone is constructed. Countries that use the Euro have surrendered their sovereignty on monetary policy – that’s now the purview of the European Central Bank (ECB). This means that government debt levels do matter for countries in the Euro. They can default because they don’t have control over their own currency. The U.S., Japan, UK, Canada, Australia, and others can’t default because they control their own central bank and currency. But Euro countries can. In the case of Greece and Ireland this means a high likelihood of default. When the global economy crashed three years ago, it sent the economies of most countries down. This raised the debt-to-GDP level by reducing the denominator, the GDP number. But a country in a recession needs to increase government spending and deficits to stimulate growth. Instead, the construction of the Euro agreement and pressures from the ECB forced these countries to pursue an austerity-based policy of cutting government programs. But the cutting of government spending has only worsened the recession and shrunk their GDP even more, reducing tax collections. It’s made default more likely.

In the Greek case, default appears inevitable. The question is how much of a loss do bondholders take and when. Therein lies a problem. The people who own the Greek debt are largely big French and German banks. These banks themselves aren’t exactly robust. If Greece defaults at a level that will actually help Greece find it’s way out instead of simply delaying the crisis, then these banks will likely take very heavy losses. The losses are large enough to jeopardize the solvency of the banks themselves. So Greek default also means figuring out how to recapitalize these big banks. These are so-called “too big to fail banks”.

Currently there are negotiations going on about how to structure a Greek default, simultaneously prop up the Euro banks, and stop a possible contagion effect from spreading to Ireland, Portugal, Spain, Italy, and Belgium. But there have been negotiations over this crisis for nearly two years now with much successs. The German and French leaders have promised a comprehensive solution later this week. It was supposed to be today, but it’s been delayed to mid-week.

What does that have to do with the U.S.? Nobody really knows. The devil is in the details. At first pass, big U.S. banks aren’t supposed to have much exposure to Greek debt, so they shouldn’t be endangered by a large Greek default. But, the big U.S. banks like Citi, JP Morgan Chase, BofA, and Goldman Sachs have large stakes in the big Euro banks. A failed Euro bank could have repercussions. Of greater concern are derivatives, particularly Credit Default Swaps. The U.S. banks, particularly Goldman are known to have been active in selling these derivatives. Since the derivative markets and positions are largely secret and non-transparent (a failure of the Dodd-Frank Financial Reform bill), we don’t know if a Greek default will trigger significant liabilities for these banks.

In separate news, Bank of America, is on a death-watch by some analysts. Yves Smith at Naked Capitalism clues us in:

If you have any doubt that Bank of America is in trouble, this development should settle it. I’m late to this important story broken this morning by Bob Ivry of Bloomberg, but both Bill Black (who I interviewed just now) and I see this as a desperate (or at the very best, remarkably inept) move by Bank of America’s management.

The short form via Bloomberg:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation…

Bank of America’s holding company — the parent of both the retail bank and the Merrill Lynch securities unit — held almost $75 trillion of derivatives at the end of June, according to data compiled by the OCC. About $53 trillion, or 71 percent, were within Bank of America NA, according to the data, which represent the notional values of the trades.

That compares with JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives, the OCC data show.

Now you would expect this move to be driven by adverse selection, that it, that BofA would move its WORST derivatives, that is, the ones that were riskiest or otherwise had high collateral posting requirements, to the sub. Bill Black confirmed that even though the details were sketchy, this is precisely what took place.

Part of BofA’s problems, well, actually a very large part of it’s problems stem from the loose and possibly illegal banking practices at Countrywide Mortgage which it took over in 2008. Yves updates us on this here.

Bottom-line on all this: expect more big bank bailouts of some kind in coming months. It might only be big Euro banks. It might only involve Bank of America. But there’s significant,if less than probable, chance that we’ll have to see another round of bank bailouts.

The Fraudulent Flat Tax Pitch – A Rich and Powerful Tactic

Posted by Jim Luke — October 23, 2011

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:

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.

Herman Cain’s 9-9-9 Plan and the 99%

Posted by Jim Luke — October 20, 2011

In the constantly churning pool of Republican Presidential candidates, a seemingly political newcomer has risen to the top (for now): Herman Cain. Mr. Cain, the former CEO of Godfather’s Pizza where he engineered a leveraged buy-out from Pillsbury, isn’t really a political newcomer or outsider, though. He only appears to be because he personally has never won an election despite several attempts. (see Wikipedia biography). In fact, he’s been a campaign insider and advisor for many Republican candidates going back to at least Bob Dole in 1996. He also played a key role in defeating President Clinton’s attempts to reform healthcare in the 1990′s.

Herman Cain has risen to the top (some recent polls show him essentially tied with Mitt Romney) largely because of his “9-9-9″ tax plan. So what’s it all about and what are the likely consequences? Let’s explore what the plan is first.

I will summarize here. A more in-depth analysis (pdf) is available from the Tax Policy Center. The Cain campaign’s page on the plan is here. Cain is proposing to eliminate the existing corporate income tax and payroll taxes. I assume that this includes eliminating the Social Security tax and Medicare taxes, although the Cain campaign avoids saying that clearly by referring only to “payroll taxes”. He then proposes to radically reform the existing individual income tax system and adding two new taxes. The result is that the existing triad of corporate income tax, payroll tax, and individual taxes is replaced by a triad of three taxes which each have a 9% tax rate, hence the name for the plan.

Change existing Individual income tax system – charge a flat 9% on gross income with the only deduction allowed being for charitable contributions. Home mortgage interest deduction is gone. Personal exemptions are gone. This means a single person with no dependents and $50,000 income pays $4,500 (9%), the same exact amount as a family of four with two small children and a $50,000 income. It is unclear whether deductions for the expense of earning income are allowed or not such as sales representative deducting business expenses. I presume they are not. Only earned income from employment is taxed, not dividend income. It is unclear whether Cain would tax pension income or Social Security benefits. He doesn’t clarify those. My guess is they would be taxed.
A new national sales tax of 9% on everything. Although most states currently exempt food and other essentials from sales tax, Cain does not. Plan to add 9% to whatever you buy. The consumer pays the sales tax directly at the time of purchase.
A new national business tax of 9%. This is a modified form of value-added tax (VAT) commonly called a business transfer tax. It essentially means that all businesses pay a 9% tax on everything they sell minus a deduction for whatever purchases they have made, not counting purchases of labor. I find the enthusiasm among Republicans for this part for the tax kind of strange. The state of Michigan had a similar business transfer tax called the Michigan Business Tax (MBT) in recent years and it was the #1 target of Republicans to repeal when they came into office. The MBT was absolutely hated. That makes me skeptical that Cain either could actually get a a national business tax or that it would survive for longer than a year or so. I expect that in implementation, the national business tax would soon be eliminated in favor of a higher individual income tax and/or higher sales tax and/or larger deficit. A business transfer tax like Cain’s proposed national business tax requires significant accounting and record-keeping. Businesses would no doubt attack such a tax as a “heavy regulatory and reporting burden”.

Overall, estimates of the immediate effect of the 9-9-9 plan on tax revenues to the government show it would be largely neutral. That is, the plan, when applied to today’s economy this year, should produce approximately the same revenue as today’s tax system produces. In that sense, the plan represents neither a tax cut nor a tax increase in the overall macro sense. At the individual level, though, it’s a different story. The 9-9-9 plan is either a really heavy tax increase or a really huge tax cut depending upon how high your income is.

For people who are in the lower 80% of the income distribution, meaning the poor, the working class, and the middle class, Cain’s plan represents a very, very serious tax increase. Even households in the lowest 20% of the income distribution would pay an average of $1,854 more in taxes than they do currently each year. The typical or normal household, the folks that are in the middle, the 60% of us that are neither in the top 20% or the bottom 20% (which most likely means you!), would pay more than $4,000 more each year in taxes. That’s a serious tax increase. How? Why? Currently people in these brackets, the majority of us, pay around 23-30% of our income in the form of all taxes to the all levels of government. Of those 23-30% points, approximately 10% points are taxes for state and local government. Those taxes remain under Cain. So currently the middle income ranks pay between 13-20% of their incomes to the federal government. That initially sounds like it’s higher than Cain’s 9%. But remember, Cain’s plan is a 9-9-9 plan. You will pay a 9% income tax. You’ll also pay 9% sales tax on everything you buy. Let’s say you’re fortunate and prudent and only spend 90% of your income, that sales tax still equates to being 8% on your income. But the sales tax is being applied to goods that have already been marked up in price by 9% by the retailer to pay for the business tax. In effect, you’ll pay an 18% sales tax. That means that your real tax burden for the federal government will be closer to 9+9+9. I expect the effective federal taxes paid by individuals in the middle income ranges under the Cain plan to be 24-27% depending on how much you save vs. spend. Add in the 10% for state and local and you’ve got an individual tax burden in the 34-37% range – much, much higher than today. The Tax Policy Center graphs out the actual expected change in your taxes in dollars by income quintile here:

Now what about the top 20%? They come out ahead. The average household in the top 20% gets a $14,442 tax cut. If you’re not one of these fortunate rich people to get this large tax cut from the 9-9-9 plan, remember Herman Cain says it’s your fault you’re not rich.

In summary, the Cain 9-9-9 is a massive redistribution of the tax burden away from rich households onto the backs of poor and middle-income households. As Jared Bernstein notes:

Conclusions:

–to implement the 9-9-9 plan would truly be the most dramatic and regressive shifting of the tax burden in the history of our nation;

–based on this policy, Herman Cain’s campaign is deeply out of touch with the challenges facing the American middle class;

But we haven’t really looked at the impact on the top 1% or the top 0.1%, the really, really rich folks, the Wall Street CEO’s and big hedge fund managers, the ones who have gotten large bonuses in recent years paid for by government bank bailouts. The top 1% (which includes Herman Cain himself) will save on average $238,422 in taxes. The top 0.1%, the 150 thousand or so households that are really, really rich and powerful, will get even more. They will see an average cut of $1,356,078 in their taxes. I also have a properly scaled graph to show this too, but it’s only after the jump for formatting reasons. So click and take a look to see what Herman Cain calls making the tax system more fair. It should add fuel to the Occupy Wall Street fires.

Continue reading →

On the Occupy Wall Street (and Everywhere Else) Movement

Posted by Jim Luke — October 19, 2011

I’ve been asked what I think of the Occupy Wall Street Movements. I say it’s about d*** time. The anger and discontentment that the movement has tapped into is real and has been building for a long time. The mass numbers of people – like say the 99% - have good reasons to be angry. The U.S. economy is very sick and it’s not really recovering. For at least three decades now the rules in the economy have gradually been changed. The overwhelming net effect of all these institutional and structural changes has been to transfer income and wealth from the bottom 80% of the income scale (odds are that means you!) to the upper 1%. What about the other 19%, the ones in the top 20% but not the top 1%? They haven’t really lost in number terms but they’ve struggled to hold on. Their security is greatly reduced. And now, the politicians that have been bought by the top 1% are coming for everybody’s Social Security and Medicare.

The American poor, working, and middle classes have been like the proverbial frog put into tepid water and then heated to boiling (note, yes, I know there’s evidence that frogs don’t behave that way in real life – it’s a metaphor, folks). Gradually the rules were changed. The banking and finance industries were deregulated – not all at once, but in a series of steps. Despite massive (for that time) bailouts and bank rescues in the 1980′s savings and loan crash, we continued. Union power was reduced. Antitrust enforcement languished under a philosophy of “markets will self-enforce”. The tax codes were changed to favor hedge fund managers and bankers. Median household incomes began to stagnate while incomes at the top continued to grow and even accelerate. A loud chorus of anti-”liberal” media, politicians, and think tanks constantly pounded an anti-government theme. Meanwhile economic growth gradually slowed. We lowered our expectations. Instead of demanding the growth rates of the 1950′s, 1960′s, and even much of the 1970′s, we began to settle for less but pretended it was more. We shifted more and more of the cost of a college education away from government and to students in the form of student loans. For a long time, the working and middle classes were distracted from what was really happening. The leaders blamed the people themselves. It was getting harder and harder to keep up, let alone get ahead economically. We were distracted for a while by dreams of riches in an Internet dot-com bubble (“just pick the right start up and get rich”) or later in a housing bubble (“your house will make you rich ‘cuz home prices never drop”) or by endless wars and obsessions with terrrorism.

Then the crunch came in 2008. The economy collapsed. But it wasn’t workers that crashed the economy – it was largely the banking and finance sector. But the fall out hit just about everybody. For 5-6 months we were on a trajectory to repeat the Great Crash and Great Depression of the 1930′s. The same depression that conservative ideologue economists like Robert Lucas had claimed in 2003 was permanently “solved for all practical purposes” . President Obama promised change and entered office in the midst of the collapse. He wasn’t really prepared for this situation. The change Obama had originally envisioned was a more conservative, polite cutting back of social programs like Social Security. The change we needed wasn’t the change that originally motivated him to run.

In response to the crisis and collapsing economy, the government responded – both the Bush and Obama administrations. And they both pursued rather similar policies: bailout the banks without even requiring sacrifice by the bank managers or the bank share and bond holders, and meanwhile offering some mild (relative to the problem) stimulus with much of the stimulus being in the form of tax cuts. It hasn’t worked. Well, I should be more precise. It worked for the top 1% – the really, really wealthy and for Wall Street and the banks. For the rest of us, it’s grim. The economy stopped it’s free fall. That was good. But it has never substantially begun a real recovery. Unemployment is stuck at over 9%. The reality is worse than that number, though since large numbers have dropped out of the labor force and simply abandoned the hope of finding a job for now. It’s been over 3 years since the crunch on Wall Street and there’s no recovery. Instead, politicians, both Democrat and Republican, have been spent the past year trying to cut spending, cut social programs, and make things worse for the 99% while cutting taxes further for the 1%. It makes for anger and confusion. We are now in a workers depression.

The Tea Party movement of the last couple years had initially tapped into some of that populist anger. But the Tea Party wasn’t/isn’t really a broad-based populist grass-roots movement. It’s more of an Astroturf, faux populist movement with a lot of funding from very, very rich sources like the Koch brothers. What’s more, it has become clear in the last year in Congress that the Tea Party doesn’t really have any solutions. Last summer it was clear that some Tea Party people in Congress would rather have the U.S. default reach any kind of do-able compromises. The vast majority of the 99% do not think a default by the U.S. government is a good thing. The anger and frustration remains.

To make things worse, recent years have seen an increase in the power of large corporations. The Supreme Court has ruled that corporations are “people” and that we the people cannot put any limit on political speech or spending by corporations. Campaigns have become extraordinarily expensive. The result is that politicians, even more so than ever, basically listen to and do the bidding of people on Wall Street and large corporations. The average American has been frozen out of their own political processes.

I observed last winter during the uprisings in Tunisia and Eqypt that two ingredients of revolution are an educated population that learns or knows that a better condition is possible, and a political economy where there is no prospect for improved living standards. Hopelessness turns to frustration which turns to anger. That produces protest and demands for change. As John F. Kennedy famously said, “Those who make peaceful revolution impossible will make violent revolution inevitable.” I also observed last winter that the inequality in income is worse in the U.S. than it was in Tunisia, Eqypt, or the other Arab spring nations. I also noted that for now demography was keeping the U.S. from breaking out in mass protest. Basically the U.S. population is older and revolutionary protest is usually a young people’s phenomenon. But there are limits. The U.S. also has a very extensive history of protest-driven social and political change. It’s really the last few decades of quiet between the civil rights & Vietnam protests of the 1960′s-70′s until recently that have been the unusual phenomenon. The longer the U.S. persists in pursuing austerity policies that keep the economy from growing and transfer more wealth and power to the top 1%, the more the nation is playing with fire.

As it stands now, I stand with the Occupy Wall Street movement. The lack of clear “leaders” and “demands” is a good thing. I will contribute my help in the coming weeks by trying to further illuminate the issues involved.

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

Posted by Jim Luke — September 22, 2011

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.

Obama’s So-Called Keynesian Stimulus Efforts Aren’t Very

Posted by Jim Luke — September 22, 2011

The simple version of Keynesian economics suggests that if the economy is suffering from too little economic activity and high unemployment there are some policy options. Specifically Keynes suggests there are three general kinds of policy options:

The central bank (The Fed in the case of the U.S.) could lower interest rates and create money by buying bonds on the open market. This is called stimulative monetary policy. It is supposed to work by making private sector borrowing more attractive and more profitable so that businesses in particular increase their spending on business investment goods like equipment and factories.
The government could increase it’s budget deficit by borrowing more money and cutting taxes. This is fiscal policy by tax cuts. It works by putting more cash in the hands of households and firms (increases their after-tax income) who then increase their spending.
The government could increase it’s budget deficit by borrowing more money and directly spending the money itself, either by direct transfer payments to needy individuals, or by buying things like new dams or construction projects, or by hiring the unemployed itself. This is fiscal policy by spending.

There’s nothing to stop a country from pursuing all the above options simultaneously if it chose. But not all of these options are equal in either effectiveness.

NOTE: This is old-style John Maynard Keynes style Keynesianism, not the ”New Keynesian” theories that have dominated some academic circles in the last couple decades. It’s also based on the real thing, not the caricature that it’s opponents paint which is usually without foundation.

NOTE 2: It’s really not a good idea to try to simplify Keynes. When you do, you’re likely to over-simplify and really miss powerful insights and nuances. Nonetheless, I will plunge ahead with full knowledge of the risk.

The real richness of Keynesian theory though lies not just in these prescriptions, but the analysis of when to use which one, whether it is likely to work, and under what conditions. The first option, monetary policy, is to be preferred in cases of mild recessions when interest rates are “normal” and the slowdown is largely for mild, temporary factors such as an outside economic shock. Monetary policy is quick and easy to implement. It’s also relatively easy to reverse course when the time comes.

Keynes had two key insights about monetary policy though that are highly relevant to our present situation. Monetary policy can be become impotent if interest rates drop to near zero and we get into a liquidity trap. This is when people and firms become fearful of the future and come to expect continued weakness or even GDP declines and deflation. In a liquidity trap, people just sit on money rather than spend or invest it. Monetary policy is relatively ineffective in such cases. We have been in a liquidity trap since late 2008 and that’s why the record 3 years of a virtually zero Fed Funds interest rate and The Fed’s QE1 and QE2 programs haven’t worked. Liquidity traps aren’t common, but they do exist and they aren’t extinct. We were in one in the 1930′s Great Depression and Japan has struggled with one for the last 15+ years.

Keynes also had insights about the two fiscal policy approaches, tax cuts vs. increased spending. In particular, tax cuts will only be effective to the degree that households and firms actually spend the money. If they use the money to pay down debts or to save, then it really won’t improve conditions. Later research in the 1950′s and 1960′s strengthened these insights. Later research showed that it also makes a big difference who gets the tax cuts and whether they think the tax cut is permanent. Temporary tax cuts are much less effective than permanent ones because people tend to save them more. Also, high-income individuals tend to save more of the tax cut (proportionally) than more desperate lower-income folks. Finally, later research showed that when a recession comes about because private debt got too high, then tax cuts are least effective. Notice a pattern here?

The fiscal policy “stimulus” efforts that we have pursued since the Great Recession began have been very, very heavily tax-cut oriented. Bush’s original stimulus effort in early 2007 in an effort to “nip the recession in the bud” was all tax cuts. The Feb. 2009 stimulus bill of Obama (the ARRA) was between 40% and 50% tax cuts. The meager effort passed in Dec 2010 was all tax cuts. And now, the proposal is again very tax cut heavy. Not only have the fiscal stimulus efforts been heavily tax cut-based, but the cuts have temporary cuts targeted at either high-income folks or only offering a meager amount to low-income folks. Further, we still have a huge private sector debt overhand that people want to pay down before they spend more. In sum, the dominant response which many have labeled as “Keynesian” really hasn’t been what John Maynard Keynes suggested. Many have asserted that “Keynesian policies don’t work” and cite our weak economy despite several fiscal policy stimulus attempts as proof. But that’s not really a valid test. It’s like claiming some physician is a total quack because you took pills like he recommended but you didn’t take the exact same pills as he recommended. You took something else. Now you’re still sick. It’s not the physician’s prescription that failed, it’s your refusal to follow the prescription and the diagnosis that failed.

Critics will counter with a “yes, but there was still some spending stimulus in the Obama bills and our failure to fully recover is proof the fiscal spending as stimulus prescription is quackery.” But have we really had an increase in government spending anywhere near large enough to fill the gap? Let’s look at some trends (courtesy of Brad Delong):

We simply have not expanded government purchases as a share of potential GDP in this downturn:

The graph shows the relative changes in share of GDP of four key portions of GDP: exports, business equipment investment, government purchases, and residential construction. (everything in the graph is scaled relative to 2005 -that’s why the lines all meet at o in 2005). The whole Keynesian idea is that if exports, business equipment investment, or residential construction go down then government purchases should go up and vice versa. That hasn’t happened at all. Instead, government purchases has consistently declined since 1995!. In other words, actual changes in government purchases have not only not been a stimulus, but they have been contractionary. Government spending policy has been contractionary for over 15 years! We didn’t notice it because strong increases in business equipment investment and housing were doing the stimulating prior to 2006. In the period 1995-2000, it was probably appropriate in a Keynesian sense to have declining government purchases and a contractionary policy – it was countercyclical to the dot-com boom and the housing boom.

But after 2007, residential construction collapsed. For awhile in 2009 both business equipment investment and exports declined sharply. The only appropriate Keynesian response would have been a very, very large government purchases program. But we didn’t do that. Instead, the so-called 2009 stimulus bill was barely enough new spending at the federal level to offset the declines and cuts at the state and local levels. Overall, government spending did not increase. It went neutral for a couple years. But in late 2010, we resumed the march to contractionary policies. The ARRA wound down. State and local governments accelerated their budget cuts. And Washington became pre-occupied with imaginary threats of impossible debt crises at some point 10 years from now.

To continue the earlier physician and disease metaphor, we did try a little of the prescription but we took too little. It’s as if we went to the doctor, the physician diagnosed a very severe infection and prescribed heavy doses of anti-biotics. We went home took a lot of aspirin instead and only a couple of the anti-biotic tablets. Now folks want to blame the doctor and his “failed prescriptions” when we didn’t take them. None of this is what Keynes or 1960′s style Keynesians would have recommended. To conclude that Obama has tried Keynesian policies and they have failed is dead wrong. The policies have largely failed to stimulate and re-ignite growth, but they weren’t Keynesian.

EconProph

Category Archives: Political Economy