Month: July 2011

Economy is Worse Than We Knew; Uncertainty Still Reigns

Tim Kane at the Kauffman Foundation is out with his latest survey of economics bloggers (full disclosure: I am both an adviser to the survey and a participant in it).

In light of today’s abysmal GDP report, the results for one question are particularly relevant:

The latest revisions shows that GDP growth in recent quarters was much lower than previously reported (e.g., only 0.4% in the first quarter versus the prior estimate of 1.9%). So score this one for the 44% of economics bloggers who answered “worse”. (I wrongly answered “same”.)

As always, it’s also fun to look at the word cloud of adjectives the bloggers used to describe the current state of the economy:

Uncertainty still dominates the middle of the nation, but weakness, vulnerability, and fragility have, unfortunately, being gaining territory.

For results from previous surveys, see this earlier post.

Why Do Half of Americans Pay No Federal Income Tax?

You may have heard the claim that about half of Americans pay no federal income tax. That’s a true fact. My Tax Policy Center colleagues estimate, for example, that 46% of households either will pay no federal income tax in 2011 or will receive more from the IRS than they pay in.

Today, TPC released a new study that examines why these people end up paying no federal income tax.

The number one reason should come as no surprise. It’s because they have low incomes. As my colleague Bob Williams notes:

A couple with two children earning less than $26,400 will pay no federal income tax this year because their $11,600 standard deduction and four exemptions of $3,700 each reduce their taxable income to zero. The basic structure of the income tax simply exempts subsistence levels of income from tax.

Low incomes (or, if you prefer, the standard deduction and personal exemptions) account for fully half of the people who pay no federal income tax.

The second reason is that for many senior citizens, Social Security benefits are exempt from federal income taxes. That accounts for about 22% of the people who pay no federal income tax.

The third reason is that America uses the tax code to provide benefits to low-income families, particularly those with children. Taken together, the earned income tax credit, the child credit, and the childcare credit account for about 15% of the people who pay no federal income tax.

Taken together, those three factors — incomes that fall below the standard deduction and personal exemptions; the exemption for most Social Security benefits; and tax benefits aimed at low-income families and children — account for almost 90% of the Americans who pay no federal income tax.

For further details and info about the other 10%, please see the study.

P.S.: The true fact — about half of Americans do not pay federal income taxes — often gets transmogrified in public discourse into the decidedly untrue claim that half of Americans pay no taxes. That simply isn’t so. There are many other taxes in our fair land, including payroll taxes, excise taxes, sales taxes, state income taxes, and property taxes. Most people who don’t pay federal income taxes still encounter some of these other taxes.

Ranking U.S. Economic Recoveries

The Wall Street Journal has a lovely graphic this morning illustrating the strengths and weaknesses of U.S. economic recoveries since World War II.

No surprise, the current recovery is long on weaknesses and short on strengths:

The graphic is based on a very similar one the IMF included in its recent overview of the U.S. economy (officially known as the 2011 Article IV Consultation).  I’ve pasted the original IMF graphic below.

Continue reading “Ranking U.S. Economic Recoveries”

Fedspeak on Quantitative Accommodation

In case you haven’t heard of him, let me introduce Brian Sack. As Executive Vice President at the New York Fed, he’s the guy in charge of implementing the Federal Reserves’s monetary policy efforts including all the purchases of agency securities and Treasury bonds in QE1 and QE2  (LSAP1 and LSAP2 in Fedspeak, where they are known as large-scale asset purchases).

Sack gave an interesting speech last week on the Fed’s $2.654 trillion portfolio. Among other things, he reiterated the Fed view that the impact of the portfolio comes from the owning, not just the buying:

Lastly, I should note that the market seems to have adjusted fairly well so far to the end of the purchase program. The pace of the Desk’s purchases fell back sharply at the end of June, as we moved from expanding the portfolio to simply reinvesting principal payments. In particular, our purchases slowed from an average pace of about $100 billion per month through June to an anticipated pace of about $15 billion per month going forward. We do not expect this adjustment to our purchases to produce significant upward pressure on interest rates or a tightening of broader financial conditions, given our view that the effects of the program arise primarily from the stock of our holdings rather than the flow of our purchases. While there has been considerable volatility in Treasury yields over the past several weeks, we attribute those movements primarily to incoming economic data and to broader risk events. However, we will continue to watch the markets and assess their adjustment to the end of the purchase program.

…

As noted earlier, the current directive from the FOMC is to reinvest principal payments on the securities we hold in order to maintain the level of domestic assets in the SOMA portfolio. This approach can be interpreted as keeping monetary policy on hold. Indeed, one can generally think of the stance of monetary policy in terms of two tools—the level of the federal funds rate, and the amount and type of assets held on the Federal Reserve’s balance sheet. The FOMC has decided to keep both of these tools basically unchanged for now. (Emphasis added)

In short, quantitative easing is over, but quantitative accommodation is still boosting the economy.

Sack also offered a rule of thumb equating each $250 billion in asset purchases to a 25 basis point reduction in the federal funds rate. By that metric, the $1.6 trillion in asset purchases has been the equivalent of lowering short-term rates by about 1.6 percentage points. (Over at Econbrowser, however, James Hamilton suggests that impact may be significantly smaller.)

Does the Gang of Six Cut Taxes or Raise Them?

Here’s a quick multiple choice quiz about the Gang of Six’s new budget proposal.

Over the next ten years, would the proposal:

a. Cut taxes by $1.5 trillion

b. Increase taxes by $2.0 trillion

c. Increase taxes by $1.2 trillion

d. All of the above.

If you answered (d), you have a fine future as a budget watcher (or you peeked at the answer from the last time we played this game).

The answer depends on the yard stick you use to measure changes in tax revenues. Unfortunately, people now use at least three different yard sticks.

The first, known as the current law baseline, assumes that Congress doesn’t change the tax laws on the books today. That means every temporary tax cut expires in the next two years, including the individual tax cuts enacted in 2001/2003 and extended in 2010, the “patch” that limits the growth of the alternative minimum tax, and the current estate tax.

The second, known as the current policy baseline, assumes those three temporary tax cuts all get permanently extended.

The third, known variously as the Fiscal Commission’s plausible baseline or the alternative fiscal scenario of 2010, assumes that those three temporary tax cuts all get extended with one big exception: the tax cuts that benefit “high-income” taxpayers expire.

With three different yard sticks, we get three different measures of the impact of the Go6 proposal.

Relative to the current law baseline, the Go6 plan would be a $1.5 trillion tax cut. In other words, the Go6 plan would raise $1.5 trillion less in revenue over the next ten years than if Congress did nothing, and all the temporary tax cuts expired. That’s an important number because the Joint Committee on Taxation and the Congressional Budget Office are required to use current law in preparing official budget scores.

Relative to the Fiscal Commission’s baseline, the Go6 plan is a $1.2 trillion tax increase. That includes three pieces: $1.0 trillion from reducing tax preferences (some of which may be the moral equivalent of cutting spending), $133 billion in new revenues for the highway trust fund (but not from higher gas taxes), and about $60 billion from using a lower measure of inflation – the chain CPI – to index the tax code.

Relative to current policy, finally, the Go6 plan is roughly a $2 trillion tax increase. In addition to the $1.2 trillion in tax increases noted above, it assumes an additional $800 billion in revenue – equivalent to what would be raised by allowing the “high-income” tax cuts to expire.* The Go6 plan would thus raise about $2 trillion more in revenue over the next ten years than if Congress simply kept in place the tax policies that apply in 2011 (except the payroll tax holiday, which everyone assumes will eventually expire).

Bottom line: You should expect to hear the plan characterized as anything from a $1.5 trillion tax cut to a $2 trillion tax hike.

P.S. For a similar discussion comparing two of the three baselines, see this nice piece by David Wessel of the Wall Street Journal.

P.P.S. What really matters, of course, is the plan itself, not how it scores against some possibly arbitrary baselines. Bob Williams makes that point here.

* I revised this sentence to emphasize that the plan includes revenue equivalent to letting the “high-income” tax cuts expire; it doesn’t actually let the rates expire – instead, it includes a wholesale reform that includes lowering the top rate to no more than 29 percent. 

Let’s Eliminate the Debt Limit

My latest column at the Christian Science Monitor:

America’s leaders need to get to yes on a budget deal – one that marries substantial deficit cuts with a much-needed increase in the debt limit.

But that’s not enough. Rather than merely increasing the debt limit, we should eliminate it.

I realize that sounds strange. With all the Sturm und Drang in the budget talks, you might think that the debt limit is essential to controlling Washington’s profligate ways. It’s not.

Washington has other tools for managing its finances. The annual budget process includes a series of steps by which Congress decides how much to spend and to collect in taxes. Those decisions determine the size of America’s deficits and debt.

That simple fact often gets lost in the debate, so let me say it again: When Congress decides how much to spend and how much to tax, it is also deciding how much to borrow.

Unfortunately, the debt limit allows lawmakers to pretend that they can separate the two. Members routinely try to wrap themselves in the flag of fiscal responsibility by voting against debt limit increases. In most cases, though, those members have also voted for spending and tax policies that make those debt increases necessary.

Votes on the debt limit thus usually reflect raw politics, not substantive policy differences. Everyone knows that the debt limit has to rise. But they also know that voters hate debt. So law-makers jockey to see who can win the right to vote no and who must bear the burden of voting yes.

Democrats opposed debt limit increases when President George W. Bush was in office and Republicans controlled Congress. Republicans returned the favor under President Obama and the Democratic Congress. The only times we’ve seen hints of bipartisanship are when, as now, divided government has placed some responsibility on both parties.

A larger problem is that the debt limit institutionalizes risky brinkmanship. In divided government, both parties must agree to raise the debt limit. If they don’t, the United States can’t pay all its bills. We might even default on our debt. That’s the economic equivalent of driving over a cliff.

Both sides would regret that outcome. But they face very different incentives. The party that holds the White House has to make sure that the government functions. That’s why Treasury Secretary Timothy Geithner has repeatedly warned Congress about the damage that would result if the debt limit isn’t raised in time.

But the opposing party wants to extract the highest possible price for agreeing to more debt. So they have to act as though hitting the limit is no big deal. That’s why many Republicans have been discussing the potential to prioritize payments (putting interest first), and some have flirted with endorsing temporary default.

The problem with that strategy is that negotiations can fail, prioritization might not work, or we might be surprised with a sudden need for funds. In short, we might accidentally go over the brink.

Even if we don’t, dancing on the edge is costly. Alone among major nations, the US talks openly about the possibility of default. Financial markets usually discount that rhetoric as mere politics. As the deadline nears, however, that rhetoric will sow doubt in financial markets, inspire warning shots from credit-rating agencies, and potentially increase our borrowing costs.

There’s no reason to subject ourselves to those needless costs. The debt limit is an anachronism. Congress should eliminate it.

P.S. In conjunction with the eliminating the debt limit, I would strengthen the existing budget process along the line the Bipartisan Policy Center’s SAVEGO proposal. We do need budget procedures to force action, just not the brinkmanship of the debt limit.

P.P.S. Reuters reports that Moody’s is also recommending the elimination of the debt limit.

How Will Colleges Innovate?

That’s the question that Jeffrey Selingo poses over the The Chronicle of Higher Education (ht: Jack B.):

[I]f current economic trends continue, much of traditional academe is going to be forced to change. Families can no longer use their house as an ATM. States are making tough choices about the size of government, and public colleges are often left at the end of the line. And now the federal government is likely to cut back on many of its fiscal promises to deal with an out-of-control deficit.

The bottom line is that we’re likely to face a future where students and their families pay a lot more of the cost of a college education out of pocket. Without grants and loans as a safety net, students are probably going to make different choices than they do now (read: less expensive choices). We’re likely headed toward a future where smaller, struggling colleges need to move to new models of doing business, while elite, wealthy colleges continue to support the current model.

Selingo then summarizes several ideas that were bandied about in a meeting of academic “disruptors” and disruptive innovation guru Clayton Christensen of Harvard Business School. They include:

  • Disaggregated universities, in which colleges would purchase courses from other colleges (or, I suppose, sources like Khan Academy) rather than produce them themselves, and
  • Modular universities, in which colleges would provide much more focused degree offerings.

Also on the agenda: rethinking the often-anachronistic academic year and the scholastic currency known as the credit hour.

To be sure, none of these ideas are particularly earth-shattering. But that may well be the larger point. America’s higher education “industry” might well reap substantial benefits from adopting organizational ideas that are already old hat elsewhere in the economy.

The Supply and Demand for War

Wars are becoming more common. Writing at History Today, Kathryn Hadley reports (ht: The Browser):

New research by Professors Mark Harrison from the University of Warwick and Nikolaus Wolf from Humboldt University has revealed that between 1870 and 2001, the frequency of wars between states increased steadily by 2% a year on average.

“Steadily” might be overstating it, but there is a decidedly upward trend in a graph of their findings (from this paper):

What explains this increase?

Economic growth and the proliferation of borders.

The effect of borders is intuitive: more borders = more potential conflicts. Doubly so, in fact, since the researchers define wars as between separate states. A new border can thus transform a civil war, which isn’t counted, into a war between states, which is.

But why would economic growth encourage wars? Because it makes them cheaper:

In Harrison’s view, political scientists have tended to focus too much on preferences for war (the ‘demand side’) and have ignored capabilities (the ‘supply side’). Although increased prosperity and democracy should have lessened the incentives for rulers to go to war, these same factors have also increased the capacity of countries to go to war. Economic growth has made destructive power cheaper. It is also easier for modern states to acquire destructive power because they able to tax more easily and borrow more money than ever before.

Mark Harrison concluded that: ‘The very things that should make politicians less likely to want war – productivity growth, democracy, and trading opportunities – have also made war cheaper. We have more wars, not because we want them, but because we can.

In short, wars are up for the same reason that our offices aren’t paperless: progress sometimes increases supply more than it reduces demand.