tax cuts

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Upside Down Financial Crisis

I had the misfortune to read an article by William Cohan in the New York Times. It was about the impending fiscal crisis. It was about how we all have to tighten our belts. It was awful, and a testimony to the upside down group think now dominating our debate about the budget.

It made me think the following:

It’s funny, or distressing depending on your point of view, to see how the financial crisis has morphed from a private sector implosion based upon egregious risk taking, into a public sector implosion based upon assumed entitlement overreach. That this entire episode began in the bowels of Wall Street banks and was fed by insane risk models built around orthodox economic theory is now glossed over. We have moved beyond that into a period of hand wringing and soul searching about unaffordable pensions and health care benefits we have lavished on ourselves – against the better wishes of those conservative voices who railed against social safety nets all along. This is their moment. This is their glorious opportunity to hack away at those awful social programs and to inject a good old fashioned dose of pre-Dickensian sensibility. We have traveled back in time to the Victorian era when writers like Samuel Smiles could produce a best seller – called “Self Help” – full of those beloved Puritanical virtues of individualism and self-reliance that the ruddily healthy rich always seem to want to foist on the poor, elderly, or sick.

Along the way we are supposed not to notice the desperation, the social unrest, and the oppressive poverty that characterized the society into which folks like Smiles poured their class ridden homilies.

We have returned to those days.

Or at least we run the risk of it.

The entire discussion has been turned upside down. Instead of an insistence on reflating the economy and instituting sufficient limits on the banks to prevent another melt down, we are going in exactly the opposite direction. We are lashing away at our own backs with a fury those religious zealots of yore must be proud of.

But we didn’t cause this problem.

Why is it that we should bear the entire brunt of the fix?

Why is it that we should listen respectfully to the credit agencies warning us of potential sovereign debt downgrades when these are the same people who sold illusory AAA ratings during the go-go bubble years? Are they not for sale any longer?

Why is it that the credit markets, fresh from destroying trillions of dollars of wealth, have the gravitas and experience to dictate how we deal with the current phase of the mess they created?

With respect to the much debated tax deal in Congress: why is it that we should accept a reduction in payroll tax, which is the source of revenue for Social Security, as a good compromise in order to get a “backdoor” stimulus when, [a] stimulus should be both front door and self evidently sensible, and [b] the lost revenue from the Social Security fund will surely come back to haunt us as further evidence of a crisis in the entitlement programs? Where, exactly, is the compromise in giving away the store?

And if I read one more story about fiscal responsibility by a writer who previously defended the Bush tax cuts I think I will have to scream. What nonsense is that? Defunding the government is a well known right wing agenda item. Grover Norquist and his fellow conservative advocates have been beating that drum for years. Anyone who went along with those tax cuts knew their impact. They were destabilizing. They were meant to be.

Add that attack on the safety net to the extraordinary appropriation of wealth by the top tier of income earners over the last three decades and the picture becomes clear. The transformation of America into a 1920’s style plutocracy is nearly complete. The remaining step is a final attack on entitlements.

Which is why it has become necessary for them to invert the conversation.

Those who look forward to plutocracy have decided that the public needs to be told, incessantly, that the root cause of our fiscal problems is the entitlement burden. A burden that, suddenly, we can no longer afford. The astonishing ferocity with which the right wing defended the Bush tax cuts for the very wealthy is a sign that they are well aware of the nature of the society they want to create. What saddens me is how quickly a consensus has been built around the inevitability of cuts to the safety net. Only a few or our more zany left wingers lined up in its defense. The so-called independent voters, those muddled thinking centrists who have no clear world view, have been quickly coerced into capitulation. With the center lost to communal action, what hope do we have of avoiding a return to the era when people like Samuel Smiles could lecture us all about the efficacy of self help?

In this upside down financial crisis those who caused the problem are those who will save us. The innocent will pay reparations to the villains. The CEO’s, bankers, lawyers, accountants, and other hangers on who constructed the toxic empire, whose irresponsibility has never been called to proper account, and whose disproportionate reward has skewed our social values as well as our incomes, are about to force us to settle for even less.

Apparently we are not entitled any longer.

They are.

How upside down is that?

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Unemployment and Interest Rate Confusion: What Next?

If we ever needed evidence that economic forecasts can be confusing, the reaction to this week’s reported numbers is more than enough. One day the fact that lone term interest rates are rising is cited as a warning that the deficit is a major problem. The next those rates are rising because we have stimulated the economy by keeping taxes low and thus bulking up the debt. Then today we have the weekly figures for new applications for unemployment assistance, which despite being fairly good, is blithely ignored by everyone. It makes my head spin.

First that unemployment claims number.

During the middle months of the year we saw clear evidence that the economy’s progress had stalled. These weekly claims figures started to edge back up rather than continuing to fall. If ever there was a time for us all to realize that this recovery was going to be a long slow slog that was it. From the low to mid 400,000 level per week claims rose steadily and even above 500,000 for a short while. The consensus is that a weekly claims figure of between 325,000 and 375,000 signals a very healthy economy, while anything below 400,000 is considered good and illustrative of near normal growth. So today’s report of a 17,000 improvement to 421,000 is good news. Especially as it brings the four week moving average – always a better measure – down to 427,500. So we are approaching, albeit after far too many months, a better job market. Couple this news with the fact that unfilled job postings are also rising, and it looks as if the truly dire part of the unemployment cycle will be past us sometime in the new year.

Why the markets didn’t focus on this is anyone’s guess.

Now a word of caution: this improvement in no way implies that the unemployment rate is about to drop quickly. The economy is simply not expanding fast enough for that to happen. Instead we can confirm our view that the long shallow curve of the cycle will play out as forecast many times. All that today’s report tells us is that we are still on that track.

But what of those bumpy interest rates? Is the sky falling? Or are we onto more solid ground?

The best way to look the rise in rates is that the markets took the tax deal and factored it into their GDP forecasts. The result was that most people now peg 2011 growth 0.5% to 1.0% higher than previously thought. One ramification of that is the Fed’s ability to move short term interest rates away from the zero boundary where they now languish increases. So those same forecasters saw rates ticking up in 2011 a bit earlier than they had thought before. A more rapidly growing economy implies rising rates more often than not. Couple this with the ongoing impact of QE2 on medium to long term rates and suddenly we seem to be looking at a yield curve both stepper and generally higher than today’s. So the market bid up rates in a flurry of self-fulfilling expectations.

Of course there is another view. There always is. That is the deficit hawk view. In this interpretation rates are rising because the market fears the tax deal does nothing to impose austerity on us all, and thus adds to our long term budget woes. Inevitably, according to this perspective, the credit markets will start to impose both an inflationary and credit quality penalty on US debt. This implies bidding up bond rates, not in anticipation of higher growth, but in anticipation of collapsing confidence.

What are we sensible folk supposed to think?

Well, in a way they are all correct. What emphasis you decide to place depends on your faith rather than on your analysis.

There is no doubt that the tax deal failed to address the long term budget problem, such as it is. Remember, there is only a problem to the extent that the economy grows less quickly than the debt itself. Debt per se is not a problem. It is our ability to pay for it we need to worry about. Faster growth lessens the debt burden and so shrinks the so-called problem away. Plus, the fiscal imbalance we are all focused on has two very different components. One is the result of projected outlays growing faster than projected income, especially as health care and defense spending remain uncontrolled. The other is the permanent reduction in income created by the ill advised tax cuts back in 2001 and 2003.

Those tax cuts were justified – I use the word loosely – by the fact that we had accumulated a large annual surplus at the end of the Clinton era, and were apparently going to run surpluses for a while longer. So reducing income to get back into balance was both reasonable and politically sensible. Also, after the 2001 recession kicked into gear, another justification was that a tax cut would spur growth. In other words the Republican mantra of the day was that we needed a massive stimulus to shore up GDP. That seems like a long time ago.

Those tax cuts were a total fiscal disaster. They opened up a vast funding gap without providing any substantial stimulus.

You will notice that I am ignoring a third cause of our current deficit: the recession itself. This is because as we look into the future to rebuild a sound fiscal balance we must assume the recession will fade and that any cyclical fiscal imbalance it caused due to the drop in revenues, inevitable during a downturn, will also fade.

So, back to interest rates.

The fact that we did not address the deficit is a good thing. That’s what we need to do as we continue to provide support to the economy. When we view the tax deal as a form of stimulus because it continues to flood the economy with government money, then we can project higher growth and thus higher rates. And, yes, the larger deficit will require funding through the issuance of more debt, so the markets will occasionally get a little skittish in the run up to big US bond auctions. But this week is ample evidence that the markets are less worried about the rising debt than they are about the lack of growth. However temperamental, nutty and short term focused we may accuse our creditors of being they have the same goal as we do: getting the economy humming again.

So long term rates have risen because our prospects have improved and the stimulus is perceived to be beneficial. Everyone is happy except the deficit hawks who openly focus on the debt side of the effort. Oh, and don’t get carried away about rates. They are merely back where they were before the onset of the midsummer gloom. They haven’t suddenly exploded out of control. In fact today’s successful bond auction set them back a little.

I hope that straightens out your confusion.

But.

Of course I would be remiss were I not to throw my own version of confusion into the ring. Those more upbeat forecasts for 2011 have to include a counter movement in 2012. The tax deal may well produce a slow down in growth as we head into the election year. Why?

Because none of the fundamental conditions change and thus once the extra demand created by the deal ebbs away we will be left with some version of our current economy chugging along, still in debt reduction mode, and still with high unemployment. It is not until the de-leveraging has run its course and demand has picked up that we can forecast solid growth. That is still a long way off. Tinkering with the supply side by reducing business taxes or encouraging investment just won’t work. We need to fix the demand side of our economy. That takes time if you don’t plunge into the effort with gusto. And gusto is in short supply in Washington.

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The Tax Deal

We knew that there had to be some kind of deal on those Bush tax increases. Nobody wanted to be responsible for the planned tax hike going into effect, especially while the economy is still sluggish. So, despite all the silly posturing, a deal was always the most likely outcome. The question now becomes: is this particular deal any good?

As usual the answer is muddled.

I find it sad that we cannot legislate transparently sensible things such as extended unemployment assistance without a behind the scenes political brawl over making sure the wealthy folks get some benefits as well. Quite what our horde of unemployed fellow citizens and Wall Street bankers have in common I am not sure. Nonetheless it became necessary to lavish gifts on the rich in order to secure their support for the needy. We are incapable of doing the right thing for its own sake. We have to bargain away at everything. Oh well.

So the Bush tax increase was averted for a couple of years. Big deal. According to the Congressional Budget Office that will pump up GDP growth by all of 0.1% in 2001 and 2012. OK, let me be honest: the CBO gave a range of 0.1% to 0.3% for the boost to GDP. Frankly that’s not much of a boost at all, especially considering all the huffing and puffing needed to acquire it. Then again, as I have said many times here, tax cuts are not very good at generating economic growth. Especially when people are still paying down debt. I have a suspicion that the average family will not notice any change. Why not? Because there isn’t any. We seem to forget that this entire discussion has been about avoiding a tax increase, not about getting an actual tax cut. That’s why the terminology was wrong. The projected boost to GDP is more theoretical than actual. Since analytical models had to take into account the existing law, which had the Bush tax increase coming into effect, the postponement of that increase alters the models more than it alters actual cash flows in the economy.

Thus far: no big deal.

However, the compromise worked out does have some real stimulative content. It includes three such components: a modest change in business tax deductions for investment; an extension of unemployment payments; and a temporary 2% cut in employee payroll taxes.

The first of these, the business investment tax credit, will have minimal effect. At least I don’t see how it can. With businesses awash with profits and cash, this $40 billion or so credit will hardly encourage investment. Besides, the economy is knee deep in excess capacity making additional investment foolhardy at best.

The other two pieces of the deal make more sense and are truly stimulative. Keeping a flow of cash into unemployed worker’s pockets will be expansionary. They need the cash and are likely to spend it. So the economy benefits from this. Similarly, the cut in payroll taxes gets extra money into worker paychecks and is also likely to get spent. While most right wing politicians want to deny it, money given to the average or below average household is much more likely to be spent than the same money given to the more affluent. This is not only intuitive it is proven. So these two parts of the deal will provide a boost to growth next year. Depending on your view of the “multiplier” or knock-on effect, this boost will be between 0.5% and 0.7% of GDP. Not a whole lot, but better than nothing.

So overall the deal will have a modest benefit next year before tapering off during 2012. Which is odd, since this implies the boost declines just as we are cranking up for yet another election. By the way, that increase in GDP will lower unemployment only by a small amount. A good rule of thumb is to look for a reduction in the unemployment rate of about half the addition to the GDP growth rate. So, taking the entire deal as a whole, we can expect extra growth of between 0.6% and 1.0% next year, thus cutting unemployment down by about 0.5% at best. Not a huge return on such a vast output of political effort.

One last thing. Nowhere in the brouhaha about this deal have I seen anyone ask what it means for the deficit of the debt. I can only wonder why this is. Up until now we have been bombarded by right wing stories of gloom and doom based upon apocalyptic visions of the wave of debt supposedly about to wash away the republic. Apparently maintaining the tax reductions that caused over 50% of our current deficit is not a problem to the deficit hawks. Which makes them either liars or hypocrites. Maybe both. It’s easy to see where this is now headed. With the tax cuts for the rich safely protected we will all be asked to sacrifice the safety net in order to balance the books.

But that’s after the New Year. When the hawks will be hawks once more.

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The Election and Economic Policy

Those of you who have read this blog since it started will recall that I set out to express my objection to the economic policies of the Bush regime. They were misguided, ill informed, and fiscally reckless. The Bush legacy is the single largest reason for our current Federal deficit. Remember his reasoning? That the Federal surplus he inherited from Clinton was a misuse of the citizen’s tax dollars. The government should not be taking in more than it spent, so he cut taxes to cure the “problem” of a surplus. Boy did he ever. It was a monumental mistake. Instead of using the healthy economy of the late 1990’s to pay down our national debt, we engaged in a gamble of epic proportions. In effect we bet that the economy would never turn down, and that we would not need to use fiscal policy to save ourselves from a recession any time soon.

Whoops.

History will record the Bush tax cuts as one of our most egregious mistakes.

What made it worse was the cynical way in which it all occurred. The Republicans did not have to courage to balance the budget, as was required if the lost revenue was deemed permanent. That would have meant going to the voters with huge cuts in entitlement and defense spending. So they punted. They made the tax cuts temporary. They were designed to expire slap in the middle of the first term of the next president, long after Bush had faded back to his ranch. Can we all admit this was cowardly and cynical?

What’s that to do with the election of 2010?

Because the entire tone of the election is set against the backdrop of the grand clean up of the Bush chaos. The Democrats failed miserably to deal with the collapse of the economy. That collapse happened on the Bush watch, but the clean up only started in full gear after Obama took office. The bank bail out was a Bush policy, getting unemployment under control fell to Obama. Voters are about to lash out at the failure of Washington to react in proper proportion to the problem. The Democrats were divided and timid. The Republicans obstinate and unrepentant. Policy became a tussle between “No” and “Can’t”. Dither and muddle took hold as inequality soared and unemployment stayed stuck at unacceptable levels. Someone has to pay for the malaise. That means whoever is thought to run the place.

So here we are in 2010 with the likelihood of a return to power of the very party whose policies led to the crisis. During the last two years the Republicans have not uttered one policy statement to suggest they have any ideas what to do. They are simply driven by anti-Obama sentiments. A stalemate is almost inevitable. Obama can prevent any further market magic nonsense, but he will have no power to enact any meaningful remedial policy.

This is a recipe for disaster.

The next clear opportunity for strong economic policy action therefore appears to be 2013 in the first year of the nest presidential term. By 2014 we will be electioneering again, and between now and then I predict a stand off.

Since the economy appears to be headed into a prolonged malaise of weak growth and high unemployment, a political gridlock could not come at a worse time. This means that we will have no response to the rapid rise of Chinese economic power; to lingering unemployment; to inadequate growth; to our festering infrastructure issues; to the imbalances inside our entitlement budget; and to our apparent decline as an economic powerhouse. The American economy will remain the world’s largest and most wealthy, but it will also remain sick. That represents a problem not just for us: we will forgo wealth at an alarming rate, but for the world as a whole: the rest will have to put up with our inertia and endless quarreling.

The impoverishing of our middle class that was set in motion by Reagan and which was accelerated by the Bush tax cuts, will thus continue unabated. Inequality will rise further; profits will be robust; we may fall into deflation; the malaise will be prolonged and painful.

We will pay a huge price for the so called anger about to be expressed in this election. Like a petulant child we are about to lash out and make matters worse instead of being responsible and setting things right.

I remember being vilified by conservatives when I argued that Reagan’s budget deficits would damage our future. I was similarly called out for opposing the Bush calamity. Running deficits is just fine as long as GDP grows more quickly than the debt. Indeed permanent deficits are no problem in that case. But the Reagan and Bush deficits that haunt us now were utterly and cynically destructive. They undermined growth and gutted out our economy. If we want to get angry we should at least get angry at the perpetrators of the problem. They are the ones [Cheney] who told us that deficits don’t matter. And they are the ones about to regain control of Congress on the backs of our anger at the mounting debt they created.

There’s something juvenile about that.

I hope I am wrong.

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The Republican Pledge … Not!

It must be election season.

We know this because we are being honored with another Republican Party pledge to reduce the size of government. Like all such seasonal arrivals it wears a bit thin over the years, but is greeted with enthusiasm and interest by the media whose responsibility it is to keep all the seasonal joys fresh, perky, and shiny-like-new for the children.

Bah humbug.

I do not have any quarrels with as sensibly thought through, politically mature, and internally consistent plan to reduce the role of government in an economy. I don’t agree with it, especially now, but I recognize that it is a long established and honorable, ideologically sound idea. The current UK government is implementing just such a policy, and looks as if it will achieve a very significant reduction in both the UK budget deficit and the intervention of the government in everyday economic life.

Again: this is not my preferred approach to economic policy management. But it is a clear and very coherent alternative to the more interventionist Keynesian policies I advocate here.

So hats off to those who advocate such a position. They form a worthy opposition. More to the point: voters benefit from having such a clear distinction between the two major parties. Choice is a good thing.

You already know where I am going with this …

Simply put: the Republicans don’t mean it. They haven’t actually meant it for years. This is why the Tea Party presents such a big threat to the mainstream GOP. The Tea Party folks do mean it.

For at least three decades it has been a perennial claim of the Republicans that they stand for smaller government and fiscal conservatism. They throw rude epithets at “tax and spend” Democrats with monotonous regularity. I think that voters have bought the line that the GOP stands for smaller government than the Democrats do.

That maybe the case in a rhetorical sense.

But substantively?

Not so much.

Actually, the opposite is true.

Ever since Reagan threw the country into enormous peacetime debt – remember Dick Cheney’s claim that deficits don’t matter? – the Republicans have backed away from any practical attempt to reduce government. In fact they have presided over the fastest growth of government since Johnson.

Both parties advocate big government. Either explicitly, as the Democrats do, or implicitly, as the GOP does.

So every election cycle we are treated to some form of The Pledge; and every post election period is characterized by a quick burst of forgetfulness by Republican leaders. They love spending on their districts as much as anyone.

Plus they know full well that American voters are very happy to receive government largesse. Whether it be Social Security, Medicare, or mortgage interest tax relief, Americans love receiving goodies. It would be political suicide to eliminate any of these deeply embedded programs. Last I looked, opinion polls show between 65% and 75% of Americans absolutely loving Social Security.

This helps explain why the Republicans are always making up stories about how close to the edge of disaster the Social Security program is. It has become tiresome to have to pint out how inaccurate that claim is. Frankly it gets boring having to do the very trivial math that shows how minor the tweaks are that would preserve Social Security forever. In all honesty, the problem for Social Security comes more from the Democrats who seem not to be willing to recognize that we should raise the retirement age or get rid of the payroll tax cap. Either would end the discussion once and for all, but both seem a problem for the left.

But at least the Democrats are being honest with their supporters. That’s more than the GOP is.

The Republicans have absolutely no intention of cutting government spending sufficiently to make the Federal budget balance. They cannot without cutting deeply into entitlements or defense [offense] spending. Both are hallowed. So the GOP is stuck on its rhetoric. And that’s not a happy place to be.

The current debate over the imminent Republican tax increase is a great example of the mess that the GOP creates for itself. It slashed government revenues back in 2001 when it had a firm grip on the entire government machinery. It ran Congress and it had the White House. If ever it was going to follow through on its pledge, it was back then.

But it chickened out.

It had a bad case of the willies.

So cowardly was it that it punted the entire issue forward. Hence the debate now going on. The tax cuts were temporary. Why? Because the rule back then required permanent tax cuts to be balanced by equally permanent spending cuts. Gulp! No can do. So the GOP only did the easy bit: it slashed taxes. The voters went nuts and applauded loudly. Lost in the hoopla was the minor detail that not one penny was cut from spending. Not one. On the contrary spending rose at an accelerated rate. Forget “tax and spend”. Please welcome “Borrow and spend”.

Bush thus emulated Reagan by doing a total U-turn on the cut government platform. So much for fiscal conservatism. Fiscal recklessness has become the watchword for the Republicans.

Which is why this week’s retread of the Pledge produced such a yawn from the public. And, surprisingly, was attacked the loudest by the right wingers within the conservative think tanks. The Tea Party people just laughed.

The fact is that Republican assurances that they will cut spending are worthless. They don’t mean it. They never announce a program of actual proposed cuts. They just position themselves as fiscally sound, as opposed to that other bunch. You know the other bunch: the ones who reduced the deficit and achieved a surplus back in the late 1990’s. Now that’s embarrassing.

One way of telling how annoying it must be to be a Republican hewing to the party line is the constant claim that the Clinton surplus was a result of Reagan policies. This elides the point. Clinton raised taxes in order to cut the Reagan deficits. The GOP howled bloody murder at the thought. They claimed that such tax increases would force the economy into ruin.They were wrong. But they continue to shout as if they were right. Never let facts muddy your argument.

All this is by way of saying that I remain highly skeptical of the newly released Pledge. It is mightily short on detail, and it has produced nothing but laughter and scorn on the right wing. Conservatives don’t like it, so I imagine it will be gently retired before the split in the Republican ranks develops further.

The country is ill served by this. We need choice. We need clear alternatives. We need to be able to assess the facts in the context of those choices. Smoke and mirrors merely obscures choice and makes it difficult to make that assessment.

We have just run through about three decades of highly right wing economic policy. We have also smashed ourselves onto the rocks. Those too phenomena are related. We should be discussing how to reverse course and how much government we can all tolerate. To do that properly we need both context and competing thoughts on how to go forward.

The one arena in which the Republicans followed through on their mantra was in deregulation. Like cutting taxes, cutting red tape is easy and popular. They also de-funded the IRS and a couple of other agencies. At least those moves are in line with their platform. The problem is that they piled on the spending in other areas. For instance Bush oversaw the biggest increase in Medicare since it inception. Hardly a conservative move, and one that is hated by right wingers to this day. The only problem with this is that they exposed the flaws of their own argument. The awful response to hurricane Katrina was directly a result of that de-funding. And the Bush era efforts to outsource defense spending – there were upwards of 140,000 private contract troops in Iraq – raised rather than lowered the cost of the war.

So the GOP record is not good. They are not a party of small government. They are party of small government revenues. The spending side … not so much.

They don’t have the fortitude to go to the voters with actual spending cuts. So they continue to publish Pledges that have no meaning. And they continue to mutter about privatizing Social Security and undoing health are reform without actually offering an alternative.

They just don’t mean it. Why anyone takes them seriously I don’t know.

And, as I said, that’s a shame. We need credible choices. Especially in difficult times.

This latest Pledge isn’t credible. We should all ignore it and demand proper policy suggestions instead. More importantly: if they are hell bent on avoiding a tax increase, what, precisely, are they proposing to cut? And, by how much?

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