Monday, December 31, 2012

On the Eve of the Fiscal Cliff

It is New Year's Eve and still no resolution to the fiscal cliff.  I had thought there would be a resolution but it seems unlikely now.  As I have written before, I don't think it will be a cliff since things will change slowly and Congress can still act in January to change things. The extent to which one views the changes tomorrow as a cliff depends on how Keynesian one is. Since I am not a Keynesian, I don't see it as dramatic as many others do. John Cochrane has a post on his blog that puts the cliff in perspective. He calls it a molehill.  As he notes, the key question involves incentives and we have to look much more broadly at things than just the tax rates in the tax code.

The fiscal cliff can lead to positive things if President Obama and Congress use the next couple of months to work out a long-term solution to the budget deficits that includes true tax reform, i.e., a tax structure that raises revenue in line with needed spending, that minimizes disincentives for work and investment, and eliminates most of the portions of the budget and tax codes that engage in industrial planning.

Greg Mankiw's article in the New York Times yesterday pointed out some basic facts that both political parties tend to ignore.  Any long-term solution to budget deficits requires that the middle class pay substantial taxes.  Alternatively, cuts in entitlements have to be large and our entitlement programs basically are for the middle classes. 

New Year's Eve is supposed to be a time of optimism--hopes for the new year. Fortunately, as people we can have a good year even if the macroeconomy is not great.  Life consists in more than wealth and consumption goods. I prefer to rely on God's grace than on my 401k plans or on social security.

Saturday, December 29, 2012

The Whole Nine Yards

An interesting piece in today's NY Times on the origin of the term, "the whole nine yards." It turns out that this has fascinated people interested in word origins for a number of years. A number of explanations have been offered, including the length of ammunition belts in WW II aircraft or the amount of cubic yards produced by a cement mixer. Recently, discoveries of the term "the whole six yards" in the early 1900s in some Kenucky papers means the other explanations are false.  A definitive answer has not been offered yet, but many options have been eliminated.

On another note, the article referred to the origin of the Windy City for Chicago. I had thought it originally came from New York politicians complaining about Chicago's lobbying for the 1892 World's Fair, and the fact that Chicago is windy helped make the term stick. That, too, is wrong. Newspaper accounts from the 1860s used the term because of Chicago's weather.  For economists, the big mistake on origins was economics as the dismal science. Most thought that Thomas Carlyle was referring to Malthus, whose vision was rather dismal. But actually Carlyle was referring to John Stuart Mill and his opposition to slavery in the British colonies.

Countdown to the Fiscal Cliff

As January 1 approaches so does the fiscal cliff. A couple of days ago, I was sure that the government would not come to an agreement. Now, things look slightly better. Negotiations are now going on in the Senate to come up with a compromise.  If it passes the Senate, Speaker Boehner has said he will bring it to a vote in the House.  Perhaps some congressmen will not want to go on record as voting against a package to a vert the fiscal cliff. Of course, there are Tea Party Republicans who want to be on record as voting against an increase in taxes. So, I don't think the odds are high that a deal will be found.

As I have written before, I am not convinced that going over the cliff will be that negative since a bill can be passed in the new congress to avert much of the impact. It could also be retroactive to Jan. 1. The fact that many will gladly vote for a tax reduction after Jan. 1 means that most of the Bush tax cuts would be reinstated. Ultimately, I don't see anything happening that will address the long-term problems.  The short-term mentality still prevails in Washington and, unfortunately, on Main Street.

Monday, December 24, 2012

On the Fiscal Cliff and the Long Term

So far there is no resolution to the fiscal cliff. Perhaps we will go over it. In the long run, I don't think it much matters if we do or not. If we go over, I am sure that there will be legislation proposed to cut taxes on all except the top 2 percent. I posted several days ago about an article in the St. Louis Fed Review about the increase in the deficit since the early 1970s.  We have also known since before then that the "Baby Boom" generation was a phenomenon that impacted things when they hit certain ages--the need to build more schools when boomers reached school age, expansion of colleges and universities when boomers hit college age, more houses as boomers began family formation, and so on. In  the same way, we have known that boomers would impact social security and medicare when they hit retirement age.

If we look at voting in this country since the early 1970s, we can say that the people have wanted more from the government but have not wanted to pay for all of it.  Whenever any politician has broached the subject of social security or medicare reform, he or she has been slapped down by voters. Social security taxes do not go into funds set aside for the persons, but are used to pay social security benefits of current retirees. Instead of having boomers pay more on the grounds that they ultimately will collect more, we end up forcing younger generations to bear more of the burden. The alternative is to reduce benefits to some extent. The debt levels will not fall significantly by only making cuts in discretionary spending unless taxes rise substantially.

The fiscal cliff provided an opportunity for serious thought and discussion about the long term if that discussion had begun early in 2012. There is not enough time between Christmas and New Years for such a conversation to occur. The track record of the Congresses and the presidents we have had is settle for short-term patches and not to tackle the longer term issues such as the unsustainability of the entitlement programs as they exist today. But, I have come to realize that the Congresses and presidents we have had merely provided what the electorate wants.  We want more but we don't want to pay for it.  But who do we get the "more" from?  Many years ago my father suggested that a law should be passed that said that any future laws had to substitute the term "taxpayers" for government, as in "the taxpayers will provide the funds for defense, or for building highways, or for medicaid payments." I don't know if it would make a difference but it might be worth a try.

Political Freedom versus Freedom in Christ

The Wall Street Journal runs an editorial every Christmas Eve that first appeared in 1949. The sentiment is good and one that I could agree with for the most part.  But it also misuses Scripture in a way totally  contrary to what Paul was thinking. The title of the editorial is "In Hoc Anno Domini," and begins with Saul of Tarsus on his journey to Damascus. Tyranny in the form of the Roman Empire dominated the Mediterranean region. But into that world came light in the form of a man from Galilee. Several gospel quotations are provided and the idea that the truth would set us free. But, darkness can always return. (This was written not many years after World War II and while the iron curtain was descending). What if humankind returns to a new Caesar?

The editorial concludes with, "And so Paul, the apostle of the Son of Man, spoke to his brethern the Galatians, the works he would have us remember afterward in each of the years of his Lord:
'Stand fast therefore in the liberty wherewith Christ has made us free and be not entangled again with the yoke of bondage.'"

Paul was not writing about political freedom. He was writing about spiritual freedom. While I value political freedom a great deal, I do not confuse it with our freedom in Christ. Paul typically introduced himself as a slave of Jesus Christ. In his view, all human beings are slaves--either to Christ or to sin and death. From this perspective, it mattered little whether one was a literal slave or master; the slave who was free in Christ was blessed while his master, if he was a slave to sin, was not.

As Paul said to the Corinthians, "If for this life only we have hoped in Christ, we are of all people most to be pitied." (I Cor. 15:19, NRSV).

Wednesday, December 12, 2012

Will Munis Lose Their Tax Exemption?

According to an article in today's Wall Street Journal, President Obama and Speaker Boehner are willing to consider deductibility limits on municipal bonds. Municipal bonds are bonds sold by state and local governments.  For many years, the interest earned on municipal bonds were exempt from federal income taxes. The idea was to reduce the costs of borrowing for state and local governemnts. Investors are willing to accept lower yields on municipal bonds because the interest is tax-exempt.  Investors care about their after-tax return, so an investor in the top tax bracket can recieve a lower interest rate on municipal bonds than on equivalent corporate bonds because of the tax difference.  One can argue that munipical bonds should or should not be treated differently. I suspect many people would like to see the interest on school bonds remain relatively low. But the rationale offered by politicians, according to the article, is interesting. Clearly, one goal is to increase federal government revenue. The article quotes a portion from the administration's budget documents arguing that limiting interest and other tax breaks for the higher-income households would, "reduce the benefit that high-income taxpayers receive...and help close teh gap between the value of these [breaks] for high-income Americans and the value for middle-class Americans."

I would have hoped there would have been some discussion about the impact on state and local governments and their ability to raise money for capital projects.  In general, I favor removing tax breaks across the board. Favoring some groups over others distorts capital markets. But if decisions are made based on income-redistribution concers only, then I don't see that as an improvement.

Fed extends bond buying.

The Fed is extending buying bonds. See WSJ article

Tuesday, December 11, 2012

On the Ethics of a Shepherd

I am currently reading a book by Yoram Hazony entitled, The Philosophy of Hebrew Scritpture.  I am finding it interesting concerning the Old Testament, but surprisingly also found some ideas that connect with some of the political debate in the last election. In a chapter, "The Ethics of a Shepherd, Hazony discusses differences between Abraham and his great-grandson, Joseph, and argues that the ethical system of the great eastern empires (partially represented by Joseph)--Egypt and Babylon--contrasted with he ethical system developed in the Hebrew Scriptures (as represented by Abraham and Moses). He then compared the ethic of the empires with the Athenian ethic coming from Plato and Aristotle, finding them similar. Hazony writes, "...[Athenian philosphy] continued to find it difficult to think of the ethical life of man as having reference to anything outside the common life of members of the political community constituted by the state. In this respect, the thought of Plato and Aristotle is still much like that of the great empires of the ancient Near East, accepting it as a given that if we are to make sense of the moral order, we must begin with the individual as part of the state that governs him." (p. 130, emphasis in the original). Havony quotes from Plato and then concludes, "The state, then, is to be held sacred, and more revered than one's parents." (p. 131).

Havony also looks at Aristotle, concluding, "Aristotle does not seem to think that the end of man--the highest purposes for the sake of which the individual acts and lives his life--can even be distinguished from the end of the state." (p. 131).  Havony claims that the view was the a child would be mistaken to think his parents provided his life and education because actually the laws and the state protect his parents, so ultimately are responsible for the child's life and education.

This sounds like the debate that occurred over a speech President Obama gave in which he said, "You didn't build that." How much of a person's success should be attributed to things the person does versus the environment provided by the state? There was also the words of John F. Kennedy, "Ask not what your country can do for you, ask what you can do for your country." One way of asking this is to ask whether the government is there to provide an environment for the individual to thrive, or is the indivual the servant of the state? These are questions Milton Friedman often wrote about, arguing from a libertarian point of view. While I suspect the truth lies somewhere in between, I fear the collectivist tendency implicit in Kennedy's quote and the implication many tried to draw from Obama's statement.

Monday, December 10, 2012

A Longer-Run Look at the U.S. Debt

An article in the most recent Federal Reserve Bank of St. Louis REVIEW by Daniel Thornton offers a long-run perspective on the U.S. Deficit and Debt Problems. It is very interesting and sheds light on what has caused the increase in debt.  Several findings are of interest:
1.   For most of our history, federal debt was associated with war, and during the time after a war, the debt/GDP fell for a number of years.
2.  The exception is the increase in debt associated with the Great Depression, but the increase in debt was not that large.
3.  The increase in annual deficits began in the early 1970s.
4.  Tax revenues as a percent of GDP stayed relatively constant but federal expenditures as a percent of GDP increased.
5.  The increases in government spending are associated with increases in Social Security and Medicare/Medicaid, and other payments to individuals.  That is, to transfer payments.
6.  The two major sources of government revenue are the individual income taxd and social security taxes.
7.  The individual income tax revenue relative to GDP has not been greatly affected by changes in the highest marginal individual income tax rate.
8.  The average individual income tax rate paid by households based on income shows that the highest quintile pays an average income tax rate about four times higher than the lowest quintile.
9.  Since 1979, the lowest income-earners have benefited the most from all the tax law changes.

Different people are likely to draw different inferences from these "facts."  Those who believe that we have to have substantial redistribution will argue that the rise in expenditures is necessary and to close the deficit, more tax revenues need to be raised from the higher-income households.  Those who believe the size of government is too large, will call for reduced expenditures.  But any future plans should at least acknowledge that historical record.

Friday, December 7, 2012

The Fiscal...Cliff...Slope,,,Curb?

The Fiscal Cliff is all they talk about on some of the business channels now, at least by my infrequent watching of the channels. Fiscal policy involves government expenditures and taxes, and both are will be impacted in early January unless Congress and the president come to an agreement about how to change things. On January 1, the Bush tax cuts will expire so rates will return to those that prevailed in 2000.  The lowest rate will increase from 10 to 15 percent, the next from 15 to 25 percent, and the remaining by smaller amounts--mostly by 3 percentage points.  Other tax changes would also take place such as increased in capital gains and taxes on dividends, and a return to the criteria for the Alternative Minimum Tax that prevailed in 2000. According to the non-partisan Tax Foundation, the increased taxes collected would be $514 billion.

Government spending will also be cut.  The law has federal government expenditures falling by $110 billion, divided evenly between defense spending and discretionary non-defense spending, i.e., exclusing Social Security, Medicare, federal pensions and federal salaries.  So, both the tax increases and the cuts in government spending are considered contractionary policies, which most economists would consider unwise in a weak economy.

A simplistic way of looking at the effects would be  to take the components of GDP and see the impact. In the third quarter of 2012, we had: C = $11,149.4 billion, I = $2080.4 billion, G = $3090.1 billion, and net exports = -$522.9 billion. This gives a GDP of $15,797.4 billion. THe fall in G of $110 billioin reduces government spending to $2908.1 billion, which would lower GDP by 0.7%. Assuming the tax changes lead to reductions in consumption spending, we would have C=$10,35.8 and end up with a reduction of GDP of 3.9%.  If spread over a couple of quarters, we would have a recession.

Some argue that the "cliff" is really a "slope" because the changes will occur slowly over the year. People will see lower take-home pay in each paycheck. So, if the new Congress acts, the effects would be minimal.  But since the major players politically are the same as we now have, it is difficult to see how a new Congress will so different from the status quo.

There are also some who argue we should go over the cliff. For example, Howard Dean, the former chair of the Democratic National Committee argues "progressives" should want to go over the cliff because it will generate greater tax revenue to fund programs with.  The tax increases are about five times more than the spending cuts.

Two other issues worth considering. First, most estimates of government multipliers from before the recent recession were that the multiplier on tax changes was greater than the multiplier on expenditure changes, and permanent changes have much bigger impacts than temporary changes.  If so, then the contractionary effects of the tax increases will be much greater than the effects of the spending cuts. Second, tax changes also affect incentives, which would also be a drag on the economy.

On the other hand, if one is not a Keynesian, should one think the effects in the long run may actually be positive?