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Maybe Gov. Vilsack Should Teach Economics to Thomas Nugent

I don’t know if Gov. Vilsack has taken any courses in economics, but Thomas Nugent is attacking a “Vilsack Manifesto” that looks like it was co-authored by John Kasich (a conservative Republican). Nugent scoffs at the following proposals: (1) declare war on pork; (2) end corporate welfare; (3) cut oil and gas subsidies; and (4) trim government waste.

Even Nugent scoffs at cutting subsidies to this company, he accuses us Democrats of “wealth redistribution schemes”. Nugent is also defending massive Federal deficits, which shift our tax burden onto our children.

But let’s put aside his defense of fiscal irresponsibility, and imagine that we joined Vilsack in a macroeconomic lecture given by Professor Nugent – that was also attended by some pesky student.


The question that should be asked in response to this accusation is: “Governor, what might you have done to avoid a major economic decline in the face of the technology-sector collapse and an overly tight monetary policy?”

Pesky student: Mr. Nugent – we did have an investment led recession in 2001, but I hope that you are aware of the fact that interest rates were falling even before President Bush took office. So I don’t understand why you believe monetary policy was overly tight.

Since Nugent’s focus was on fiscal policy, he went on:

If I read the governor’s comments correctly, he would have preferred to preserve the budget surplus, raise taxes, and cut spending – all actions that could have lead to an even greater economic decline. Come to think of it, that’s just what Herbert Hoover did.

Pesky student: The governor was not endorsing procyclical – or Hooverian fiscal policy. Rather he was talking about long-run fiscal restraint. As I read the General Theory by Lord Keynes, recessions are not permanent features of the economy so do not need the type of long-term fiscal stimulus that we are endorsing.

Nugent again ignores this student and continues:

First of all our economy is strong, not fragile. If GDP growth in excess of 3 percent, record employment and housing starts, $100 billion in unexpected tax revenues in fiscal 2005, and low interest rates are a sign of fragility, you could fool me.

Pesky student: Now you are just contradicting yourself. If we are at full employment as you suggest, is this not the perfect time to reverse the current fiscal irresponsibility?

At that point, we and the governor decided to invite this pesky student to join us at the local pub. After all, drinking a few beers with her and chatting economics would provide us more understanding of economics than listening to Professor Nugent.

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The NeoCon’s Political Exit Strategy

Howard Fineman writes about the “Conservative Crackup”:

President George W. Bush may have no military exit strategy for Iraq, but the “neocons” who convinced him to go to war there have developed one of their own – a political one: Blame the Administration. Their neo-Wilsonian theory is correct, they insist, but the execution was botched by a Bush team that has turned out to be incompetent, crony-filled, corrupt, unimaginative and weak over a wide range of issues.The flight of the neocons – just read a recent Weekly Standard to see what I am talking about – is one of only many indications that the long-predicted “conservative crackup” is at hand.

The execution was botched, but the theory was also incorrect.

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Inflation Watch

The headline inflation numbers in the estimates of consumer and producer price inflation during September were pretty spectacular; in fact, yesterday’s PPI report showed a one-month increase in producer prices that was the highest in 31 years.

But most of the inflation indicated by these headline numbers was caused by one thing alone: sharply higher energy costs. The ‘core’ rate of inflation, excluding food and energy, has remained roughly constant over the past year, as the chart below indicates, despite the recent rise in energy costs.

As I’ve argued before, economists tend to focus on the core rate of inflation because it is much less volatile, and generally does a better job of revealing the underlying trends in the economy, than the overall inflation rate. Since the core rate hasn’t budged in recent months, does this mean that we don’t have to worry about the energy price spike causing a more general inflation problem in the US? Not necessarily.

The problem is that a high overall inflation rate due to energy costs could very easily spill over into a higher core inflation rate. There are two important ingredients needed for that to happen.

First, since all types of businesses are seeing their costs rise rapidly (which is what the overall PPI rate shows), they would like to pass on these higher costs to their customers. If demand is strong enough (or competition weak enough) to allow them to raise prices without losing customers, then we would expect to see them pass on higher energy costs. We haven’t seen that happen yet, but it could – if demand is strong enough.

Secondly, individuals are finding that the purchasing power of their paychecks have been sharply eroded, as the price for the average bundle of goods that they buy has risen by nearly 5% over the past year. If workers can successfully demand higher nominal wages to compensate for this loss in purchasing power, then we might start to see nominal wages rising faster, which in turn would increase business costs further and lead to even greater pressure on businesses to raise prices for all types of goods and services. However, this depends crucially on the ability of workers to extract wage increases from their employers, which in turn depends largely on the strength of the labor market.

So, do we need to worry about inflation spreading into other sectors of the economy? The answer depends on how strong you think the labor market is, and on how strong demand is more generally. If the labor market is weak, so that workers can’t demand nominal wage increases to keep up with high consumer price inflation, or if overall demand in the economy is weak, so that firms can’t raise prices, then it could well be the case that the rise in overall inflation will be a temporary blip. But if the economy is strong enough so that workers and firms can effectively pass on the higher prices that they’re facing, we may soon see the core rates of inflation moving up.


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Kauffman Index of Entrepreneurial Activity

Jerry Bowyer of NRO Fuzzcharts fame found something interesting:

President Bush’s economic policies have created an environment that is highly conducive to the prosperity of racial minorities. BuzzCharts knows this assertion might shock some people, even those who are supporters of President George W. Bush. The Bush administration clearly is better at helping African Americans and Latinos become more prosperous than it is at telling the country what it has done to make these minority groups more prosperous. BuzzCharts doesn’t do PR; we do data. And here’s what the data says: During the last five years of President Clinton’s term – as far back as the data for this analysis goes – entrepreneurial activity among blacks increased 0.02 percent. Since the beginning of the Bush presidency, it has increased 0.04 percent – twice the Clinton growth rate for the available data. Meanwhile, entrepreneurial activity among Latinos increased 0.1 percent during the last five years of Clinton’s term. Since Bush has taken office, entrepreneurial activity among Latinos has jumped 0.12 percent.

The problem with Mr. Bowyer is that he is incapable of honestly reporting on anything he reads. So let’s check with another source on what the Kaufman index data said versus Bowyer’s PR:

KANSAS CITY, Mo., Sept. 22, 2005 (PRIMEZONE) – More than half a million new businesses are started each month with the number of businesses started by immigrants and Latinos showing strong start-up activity and the rate for African-Americans growing, according to a new national assessment of entrepreneurial activity launched by the Ewing Marion Kauffman Foundation. The Kauffman Index of Entrepreneurial Activity is the first study to measure business start-up activity for the entire U.S. adult population at the individual owner level. The data are derived from the monthly Current Population Survey (CPS), a national population survey conducted by the U.S. Bureau of the Census and the Bureau of Labor Statistics.

Two especially surprising findings from the study are: (a) that the Latino rate of entrepreneurship increased from 0.38 percent in 1996 to 0.48 percent in 2004, which was higher than the white, non-Latino rate of 0.39 percent; and (b) that immigrants have substantially higher rates of entrepreneurship than native-born individuals. The average rate of entrepreneurship for immigrants was 0.46 percent compared to 0.35 percent for the native-born.

The Kauffman Index of Entrepreneurial Activity finds that over the period from 1996 to 2004, an average of 0.36 percent of the adult population created a new business each month, representing approximately 550,000 new businesses per month. The rate of overall entrepreneurship activity remained relatively constant over the period despite major changes in the economy, with the rate of business creation generally between 0.3 and 0.4 percent. The average rate of entrepreneurship was 0.36 percent in 1996, 0.35 percent in 2001, and rose to 0.4 percent in 2004. It is too early, however, to know whether the recent increase in the entrepreneurship is due to cyclical or structural factors … Entrepreneurship activity is much lower for African-Americans than other ethnic/racial groups; however, rates appear to be increasing. The average rate of entrepreneurship for blacks was 0.29 percent in 1996 and 0.35 percent in 2004.

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Tax Reform

It appears that the President’s commission studying fundamental tax reform is nearing its final recommendations. From the NYTimes:

WASHINGTON, Oct. 18 – President Bush’s tax advisory commission agreed today to recommend two alternative tax plans, both of which would limit or eliminate almost all tax deductions, including the ones for state and local income and property taxes.

…The plans are quite sketchy. There is no written summary, much less legislative language. But the basics could be gleaned from a three-hour discussion this morning at the commission’s last public meeting before a final recommendation is written.

For individuals, the two plans are almost identical. These are some of the main elements:

  • The alternative minimum tax, a steep levy faced by an increasing number of middle-income taxpayers, would be abolished.
  • The tax break on home mortgages would be sharply limited, especially for expensive houses.
  • No deduction would be allowed for state and local income and property taxes.
  • Employer-paid health insurance premiums above $5,000 a year for an individual and $11,500 for a family policy would be treated as income to workers and taxed accordingly.
  • All taxpayers could deduct charitable donations, but only to the extent they exceeded 1 percent of a taxpayer’s income.
  • Personal exemptions and deductions and credits for children would be eliminated and replaced by a credit of $1,600 for a single person, $3,200 for a couple, $1,500 for each child and $500 for each other dependent.
  • The myriad savings vehicles available now like individual retirement accounts and 401(k) plans would be replaced by three streamlined savings plans and a refundable savings credit for low-income workers.
  • The six tax brackets in the existing law would be replaced by four, with a low bracket of 15 percent and a top rate of 33 percent. The top rate now is 35 percent.
  • The two plans differ on the way they would treat investment income. One would eliminate taxes on dividends entirely, lower the top capital gains rate to 8.25 percent on the sale of stock in American corporations and tax interest income at the same rate as wages and salaries. The other plan would have a 15 percent rate on dividends, interest and capital gains. The rate now is 15 percent on dividends and capital gains, and interest payments are taxed like earned income.
  • One of the biggest changes would be the limits on tax breaks for homeowners. Now, all interest payments on mortgage loans smaller than $1 million are deductible.
  • Both plans would lower the limit to the maximum mortgage the Federal Housing Administration will insure. That level changes each year and varies depending on housing costs in each county, with a maximum loan limit now of $312,895 in communities where housing is most expensive and a national average of about $244,000.
  • The commission would raise to $600,000 from $500,000 the amount of profits from home sales that would be excluded from capital gains taxes.
  • Another big change would be the elimination of the tax deduction on state and local taxes.

In principle, I’m a fan of tax simplification. The tax code has accummulated layer upon layer of complexity with recent tax changes, and I would welcome a real step in the direction of tax simplicity. And the only way to get true tax simplification is to eliminate some deductions, so in that dimension these proposals make sense.

However, the devil is in the details, of course. We’ll have to wait for more specifics about this plan to fully understand the distributional impact that these changes to the tax code would have. The plans are touted as being roughly revenue- and distribution-neutral, but I don’t really believe that; I find it impossible to believe that such dramatic changes in the tax law would leave everyone paying the same tax as before.

Of course, in some sense this is a moot discussion anyway. Given the Bush administration’s disarray, its numerous other priorities, its weakening power to influence the Congress, and Congress’ current penchant for district-level gratification at the expense of the national good, I think that real tax simplification has about as much chance of happening in 2006 as I do being named Greenspan’s successor.


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Economic Security: A Couple of Good Op-eds

The funds for retirement for many workers will come from a variety of sources including Social Security (a publicly run defined benefits plan), private defined benefits plans, defined contribution plans, and even bank accounts. Just as FDIC and FSLIC were designed to provide insurance for bank accounts, PBGC was designed to provide insurance for private defined benefits plans. The National Review ran a very good discussion of the problems facing PBGC by John Boehner. I wish we had more principled conservatives in Congress such as Mr. Boehner.

On the general issue of economic security and how some in the GOP are proposing ways to undermine the protections of Social Security, see Jonathan Cohn who echoes some of the wisdom on these issues that have been provided by Mark Thoma. Alas, the National Review had to run a weak attempt to rebut Mr. Cohn from Michael Cannon:

Which would you rather have, freedom or security? … Social Security privatization, school vouchers, and deregulating healthcare would expand the menu of choices available to ordinary people … From whom would you rather buy bread: a government monopoly, a private monopoly, or one of a number of competing grocery stores? It’s really not much of a contest. The government and private monopolies would have consumers right where they want them … In essence, health-insurance regulation is a product.

Insurance is not the product, it’s the means to pay for the product. The health care debate is complicated and not all liberals are advocating socialization of prescription drugs and doctors. But it would be hard to argue that the current market system in the U.S. provides health care efficiently. Also notice that Mr. Cannon fails to address the issue of equity, that is, how to address the health care needs of the poor.

I also noticed he spent very little time on retirement savings. The government monopoly canard belongs to George Will who seems to think we would get a better deal from private brokers even though their only potential advantage – lower transaction costs – does not fit what most observers see as the facts. In the Cato & Club-for-Growth view, the issue is all those extra expected returns from stocks as they ignore the extra risk from holding stocks. What this crew fails to appreciate is that households can already pursue higher expected returns in their private defined contribution plans to combine with the low risk, modest returns from bonds held in the public defined benefits plan we call Social Security. Of course, Mark Thoma would remind us of longevity risks, which are one of the reasons why putting some of one’s retirement savings into a defined benefits plan might be optimal. In theory, the private sector could provide such mechanisms, but for some reason – private markets have not done so.

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LA Times Endorses Proposition 75

I oppose Proposition 75, which is mislabeled paycheck protection. My local newspaper endorsed it:

IN 1998, THIS PAGE OPPOSED Proposition 226, the so-called paycheck-protection measure that sought to bar labor unions from spending a member’s dues for political activities in the absence of that member’s consent. We considered that initiative a disingenuous “good government” move aimed at diminishing the voice of only one side on public policy debates, and we would oppose such a proposition again if it were on this year’s ballot. But contrary to some of the arguments being mustered both for and against Proposition 75, this election’s version of “paycheck protection” is significantly different than Proposition 226: It applies only to public employee unions.

Huh? Employees in the public sector deserve fewer rights than employees in the private sector? An odd way to start its case.

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More Free Lunch Economics from Michael Mandel

Michael Mandel replies to James Hamilton:

Moreover, he also doesn’t point that the real consumption per person is actually reduced by the amount of additional savings … The pro-savings people are asking us to accept a sure decline in living standards today, in exchange for the possibility of a moderate increase in income somewhere off in the future … Hamilton says he doesn’t know a policy for increasing productivity growth. I’ve got a simple one – how about increasing government spending on basic research …

An increase in government-sponsored R&D might be a very nice thing as Mandel suggests, but he seems to dodge the question as to how we pay for this extra expenditure. Do we cut some form of private or government consumption? If so, then I’d call this saving.

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CAL’s Propositions: “Just Say No”

Kevin Drum provides us California voters who may be confused by the lies we hear on TV a couple of favors. The point of his post is to alert us to the very good analysis from Brad Plumer as to why Proposition 77 is not reforming how we do redistricting as much as it is Trojan Horse designed to favor the GOP. The other favor is to let us know about this group who provide their analysis of what is behind each of the California propositions.

Given the interest in health care issues that my colleagues have, AB readers might take a look at their discussion of Propositions 78 and 79 – especially the link Lies My TV Told Me. Propositions 74 and 76 involve our public education system and the BuyBlue folks note:

At the median pay rate of $55,300, a California public school teacher gets high pay relative to all public school teachers nationwide, but her money does not go as far as it does in less expensive states. Typically, a California public school teacher stays in the job 3 years, and then moves to another profession. California students rank near the bottom nationwide, in large part because Californians have allowed public education funding to lag behind needs. The state needs schools, textbooks, educational materials, facilities, scholarships, reduced costs and increased professional assistance for distressed schools. The Prop 74 logic of blaming teachers for the failure of California students is like a corporate officer reducing the sales division’s budget and then threatening to fire the salespeople for not making enough sales. It doesn’t address the central issue, which is that California public education needs vastly more funding.

Ever since ARNOLD told Warren Buffet to keep quiet about property tax reform, I have suspected he’s been in the pocket of certain rightwing special interest groups. My view on these propositions steals a line from Nancy Reagan – “Just Say No”.

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Housing: Ready for the Fall

Fall is in the air. For us Southern Californians that means the first rains of the season. For the seasons of the housing market, it means falling real prices.

Although we will not know for sure until the Q3 OFHEO House Price Index is released on December 1st, it is very likely that real housing prices declined in Q3 2005; the first significant real decline since the end of the last housing downturn in 1996. A combination of slowing nominal price gains (from anecdotal evidence) and higher inflation will most likely lead to declining real prices. Friday’s BLS CPI report showed ‘CPI less shelter’ increased 3.3% in the 3rd quarter (a 13.9% annual rate), a high hurdle for nominal prices.

It is true that most observers only care about nominal prices, but in the previous housing slowdowns, negative real prices were an excellent leading indicator for falling nominal prices.

And looking at the overextended American consumer, the housing market is ready for a fall. The Federal Reserve’s Financial Obligations Ratios report shows consumers are dedicating a record percentage of disposable income to housing. Here are some interesting numbers from the Flow of Funds report:

From 2000 to 2005 (Q2 annual rate), Personal Income increased from $8.43 Trillion to $10.2 Trillion, a real increase of 5.1% over 5 years. However mortgage obligations(1) increased from $662 Billion to $951 Billion; a real increase of 24.4% over the same period. Even with low interest rates, Americans have dedicated a substantially larger portion of their income to housing.

(1) Mortgage obligations include mortgage payments, homeowners insurance and property taxes.

The following chart shows the growth of US Households mortgage obligations. Part of this increase is due to the sharply higher property taxes.

Click on graph for larger image.

And mortgage obligations are posed to increase substantially in the near future as many mortgages become adjustable. From the NY Times in June: The Trillion-Dollar Bet

This year, only about $80 billion, or 1 percent, of mortgage debt will switch to an adjustable rate based largely on prevailing interest rates, according to an analysis by Deutsche Bank in New York. Next year, some $300 billion of mortgage debt will be similarly adjusted.

But in 2007, the portion will soar, with $1 trillion of the nation’s mortgage debt – or about 12 percent of it – switching to adjustable payments, according to the analysis.

With record mortgage obligations, rising interest rates combined with a large number of mortgages becoming adjustable, and other stresses on the US consumer (like fuel costs), it appears Housing’s Fall is nigh.

Best Regards, CR Calculated Risk

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