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Real Compensation in 2005: Helping Sec. Snow with the Data

Bruce Bartlett and Brad DeLong note that even the Washington Times is challenging the credibility of our Treasury Secretary:

According to Mr. Snow’s own numbers, which Mr. Frank had to drag out of him, over the past 12 months average nominal wages, for production and nonsupervisory employees, who account for 80 percent of private-sector employment, have increased by 3.8 percent, while consumer prices have increased by 5.1 percent. That would mean that average real wages as adjusted for inflation had declined by about 1.3 percent. That can’t illustrate “how broadly the benefits of this strong growth impact Americans,” as Mr. Snow tried to suggest. Nor, actually, is it quite as bad as the Treasury secretary grudgingly conceded. The relatively good news is that average real wages over the past 12 months actually increased by one-tenth of 1 percent, as the Labor Department announced in a companion report, “Real Earnings in April 2006,” which was issued at the same time as April’s consumer price index numbers. That’s better than the 1.3 percent decline Mr. Snow was forced to acknowledge.

So which is it – did real compensation rise or fall? The Bureau of Labor Statistics reports a series entitled Employer Costs for Employee Compensation, which reports a series for nominal wage and a series for nominal fringe benefits as well as the sum of these two or total compensation. At the end of 2004, reported wages were $18.07 per hour and reported fringe benefits were $7.50 per hour so total compensation was $25.57. At the end of 2005, reported wages were $18.59 per hour and reported fringe benefits were $7.87 per hour so total compensation was $26.46. Also – consumer prices rose by about 3.4% during 2005. With nominal wages rising by only 2.9% – real wages fell. But fringe benefits rose by 4.9% resulting in an overall increase in nominal compensation of 3.5%.

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Misrepresenting the Economic Views of Liberals

Mark Thoma shared with me in an email some very odd rant from Jan Larson:

The third in a potentially never-ending “liberals are” generalization series focuses on how liberals are economically ignorant … Liberals don’t understand economics, but that doesn’t stop them from following a “liberal economic theory.” This theory is fallacious in its assumptions that the “rich” (who, according to liberals, are evil) only got that way at the expense of the poor, that government can actually pay for things and that businesses are no different than rich people, that is they are evil and must be punished. Liberals abhor the concept of profit, especially “excessive” profit. Just what is excessive profit? Any profit that is more than a liberal thinks it should be. Surprisingly, I’ve never heard of a case where a liberal sold his or her house for less than market value or took less than the maximum profit. Liberals get the vapors just thinking about “tax cuts for the rich.” Liberal economics dictates that you take money from the rich and give it to the poor. Most wealthy people didn’t get rich by accident nor did many poor people get there by accident either. People largely achieve their economic status by the decisions they make. Wealthy people start companies and create jobs. Poor people don’t. Who would you rather work for, a poor person or a rich one? The recent run up in gasoline prices has gotten liberals in a lather about oil company profits. Too much profit! Those fat, greedy, cigar-smoking oil company executives must be laughing it up as they just keep raising prices higher and higher.

Like Mark, I would not have much to say about this rant given that I don’t consider rich people to be evil and I certainly don’t abhor the concept of profits. But Mark bailed us both out with his link to an oped from George McGovern:

I HAVE NEVER wavered in my support for policies that relieve poverty and improve the standard of living of American workers. As a lifelong liberal, I supported Medicare and Medicaid, civil rights, Social Security and workplace safety requirements. Today, I strongly support universal healthcare … The current frenzy over Wal-Mart is instructive. Its size is unprecedented. Yet for all its billions in profit, it still amounts to less than four cents on the dollar. Raise the cost of employing people, and the company will eliminate jobs. Its business model only works on low prices, which require low labor costs. Whether that is fair or not is a debate for another time. It is instructive, however, that consumers continue to enjoy these low prices and that thousands of applicants continue to apply for those jobs.

I’m sure that some of my fellow economist bloggers might find some reasons to be concerned about the economics inherent in how Wal-Mart runs its business. For now, I’ll just point out that perhaps the most liberal Democrat to win our nomination for the Presidency (at least in my lifetime) does not abhor profits. Incidentally, Mr. Larson holds an MBA – not a Ph.D. in economics.

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On “Starve the Beast” Regressions and Feckless Politicians

Mark Thoma provides a working link to and comments on a 2004 paper by William A. Niskanen and Peter Van Doren:

The first conclusion from these tests is that there was no significant effect on the relative level of federal spending … The more important conclusion, consistent with my prior estimate of this equation, is that there was a very strong negative relation between the relative level of federal spending and the relative level of federal revenues in the sample 1981-2000 … What happened in federal fiscal politics that might explain the substantial difference in the estimates from these two samples? We do not know, but we suspect that the growing influence of the “supply siders,” who have a strong case that high marginal tax rates significantly reduce economic growth, undermined the influence of the traditional fiscal conservatives’ commitment to a balanced budget…

Mark cautions us not to put too much faith in these regressions. While I agree with Mark, maybe we can provide an answer to this question about fiscal politics by reviewing the ratios of revenues (Rev) and expenditures (Exp) to GDP over the 1949 to 2005 period. My view is that we have had four fiscal regimes since World War II ended. The regime that extended from President Truman to President Carter – which included Democratic and Republican Administrations – was one of general fiscal responsibility. Over such a regime, it would not be surprising that revenues and expenditures would tend to be correlated. Despite the general upward trend in the size of the Federal government, however, there was little variation in these ratios.

As Niskanen and Van Doren note – we had a change in fiscal regimes after 1980 with a pack of free lunch supply-siders telling President Reagan that we could have more defense spending and lower tax rates at the same time. The third fiscal regime combined two virtuous features. One was the good fortune of having political leaders with what Brad DeLong called “feck” (as Brad was drinking his morning can of diet Pepsi). The other was the peace dividend. So we should not be surprised the revenue/GDP and expenditure/GDP ratios moved in opposite directions.

Unfortunately, the last five years have been dominated by feckless politicians as well as a reversal of the peace dividend. One would think President George W. Bush would have paid for the Global War on Terror with either a tax increase or reductions in Federal spending. Yet, we see him today passing out free money to seniors in the form of that prescription drug benefit as he advocated more tax cuts. We don’t need regression equations to tell us that we will one day have to enter into a fifth fiscal regime that hopefully resembles what we saw during the 1990’s.

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Another Supply-Side Claim: This is Not Einstein Economics

Perhaps macroeconomic professors should assign the latest from Cesar Conda & Ernest S. Christian (C&C) as reading material with an attached essay question designed to let their students find the various flaws in the argument:

The recipe for high GDP growth in the future is the same as it was in 2003-04, when the combination of lower tax rates and “bonus depreciation” caused a spurt in investment that helped lead the economy out of recession and toward its current strong standing … Standard neoclassical econometric models confirm what common sense and experience suggest: Replacing old-fashioned tax depreciation with immediate first-year expensing would add more than $200 billion to GDP, boost wage incomes, and add upwards of 750,000 jobs. Because the static revenue cost of first-year expensing quickly phases out after four years, it is also in the long term the cheapest, most bang-for-the-buck, and most growth-oriented tax change the Congress could make. When you use dynamic scoring that takes into account induced economic growth, first-year expensing costs nothing.

The essay question could be posed in terms of several aspects of C&C’s “argument”, which they are very unclear about. First, C&C do not tell us the size of the alleged direct impact on investment demand from this accelerated depreciation treatment for tax purposes. Secondly and more importantly, any neoclassical presumes full employment so an outward shift of the investment demand schedule would increase interest rates so as to reduce consumption demand. The net impact on investment demand must equal the decline in consumption and would tend to be much less than the direct impact. One would have to make assumptions to the elasticity of investment demand and the elasticity of saving (the supply curve if you will).

Even after one ascertained the (likely very small) net increase in annual investment spending, the premise of the neoclassical growth model is that output per capita grows very slowly over time when an economy engineers a capital deepening policy. The short-run impact on tax revenues would be negative, which begs the question – how is the government making up for the loss of tax revenues? Is there some offsetting reduction in government spending? If not, can we even be sure that national savings increases?

But I digress – so back to the dynamics. C&C are suggesting that this change in tax policy will (someday) increase output by $200 billion. Since that is clearly not the immediate impact, how many years will we have to wait to realize this alleged increase in output?

Bonus Question: Begin by taking a look at the fourth diagram of The Nation’s Fiscal Outlook, which is part of OMB’s Budget of the United States Government – Fiscal Year 2007, and then explain what Edward Lazear was trying to say (hint: I can’t explain it).

Added Bonus: Charles Wheelan mocks the Laffer Curve nonsense with this analogy:

Can’t Lose Weight by Eating More: Neither the Reagan nor the George W. Bush tax cuts were “self-financing,” as the Laffer disciples like to argue. According to The Economist – my former employer and no bastion of left-wing thought – the current Bush Administration’s top economist, Gregory Mankiw, estimated that decreasing taxes on labor would generate enough growth to recoup only about 17 cents for each lost dollar; a tax cut on capital is better, paying for more than half of itself. Still, the bottom line from the Bush Administration itself is that tax cuts reduce Uncle Sam’s take. So why does Laffer’s sketch on Dick Cheney’s cocktail napkin rank near the top of my list of bad economic ideas? Because, when applied to the U.S., it’s intellectually dishonest. The Laffer Curve offers the false promise that we can cut taxes without making any sacrifice on the spending side, and that’s simply not true. It’s the economic equivalent of arguing that you can lose weight by eating more … Whether it’s tax policy or dieting, you can’t have your cake and lose weight, too, which is why America currently has huge deficits and a lot of fat people.

Dr. Lazear flunks, while Mr. Wheelan aces the test!

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Paul Krugman on the 2003 Tax Cut and the Recent Recovery

Mark Thoma has started an interesting discussion beginning with a Q&A with Paul Krugman:

Alan Gertler, Reno, Nev.: I’m a scientist, not an economist, so I’m fairly naive when it comes to what drives the economy. My question is this: Have the tax cuts stimulated the economy as claimed (which I don’t believe given the past cases of Reagan and Bush senior), or has it been the willingness of the government to continue massive spending by increasing our debt that has led to the growth of the economy?
Paul Krugman: It’s actually neither. About the Bush tax cuts: the tax cuts of 2001 evidently didn’t do the job; these days, the Bush people talk about the economy as if history began in the middle of 2003, after their SECOND wave of tax cuts. But while the economy did start growing, finally, in 2003, the growth wasn’t at all of the form you’d expect if tax cuts were responsible. The main tax cuts were on dividends and capital gains; supposedly this would make it easier for businesses to raise funds and invest. But business investment hasn’t been the main driver of growth; in fact, businesses have been sitting on huge piles of earnings, reluctant to invest. Instead, the big driver was housing construction and consumer spending.

I think Paul is generally right here but I had a wee bit of a problem with the last two sentences that was very ably addressed by a comment to Mark’s blog from Spencer. Mark had kindly provided an update with a chart of growth rate for non-residential investment, which my chart below does using annualized growth rates and includes real GDP growth, consumption growth, and residential investment growth. The simple empirical point is that non-residential investment growth has been strong since 2003. To which Spencer says:

In the major econometric models business investment is driven by corporate profits. Given the increase in profits we have seen this cycle the rebound in capital spending is disappointing. But it is like so many other things, what we are seeing is a fairly normal cyclical development and there is little evidence that the tax cuts made a significant difference. Another point that relates to this is to break capital spending down into information technology and software vs. all other, or traditional capital spending. If you look at real investment as a share of gdp what you find is that traditional capital spending is still about the same as it was in the late 1960s early 1970s. All the growth in capital spending since 1980 has been in the high technology sectors. If tax policy played a major role in the increase in capital spending shouldn’t it hav impacted all sectors. the fact that the growth has been contrasted in one sector implies that the driving force are factors within that sector — like falling prices — rather then economy wide factors like taxes.

Well said so all I had to add was:

If one only looked at investment spending since the 2003 tax law change … and if one was silly enough to do the Post Hoc Ergo Propter Hoc nonsense they teach over at the economics department of National Review University, one might go “wow – the tax cut worked”. But as you have so eloquently noted, one would have to look at a real model that would include various factors that would explain variation in investment demand. If the other factors fully explain the increase, then the marginal impact of this tax law change is from modest to zero – at least per our model.

Simply put – recessions come and go without tax cuts. Beyond that – classical economists have the long-term properties right: if you give people their money back so they can consume more but then do not cut government purchases, national savings decline.

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Starve the Beast Theory with a Lag

That didn’t take long. When William Niskanen produced a regression that suggested years in which taxes were low also tended to be years in which spending was high, one had to expect that the National Review would have some comment:

While Niskanen has accounted for the effects of the business cycle, he has not taken account of the possibility that tax cuts cause spending cuts after a few years. It may be, for example, that Ronald Reagan’s tax cuts helped doom Bill Clinton’s push for socialized medicine.

Not so original. Haven’t these fellows already suggested that the 1981 tax cut caused the 1990’s peace dividend? Besides, the 2001 and 2003 tax cuts were followed by that bloated prescription drug benefit that Bush is now using to brag about passing around free money.

But it is the rest of this paragraph that defies reality:

And even if it were the case that tax cuts do not, by themselves, make it easier to cut spending, that would hardly negate the economic case for cutting taxes that punish saving, investment, and work.

Yes, St. Reagan’s “work, saving, and invest” slogan. Only problem was that national savings FELL after the 1981 tax cut and national savings are lower today than they were in 2000.

Update: Nick Schulz takes this Niskanen regression in a different direction suggesting that we should raise taxes in order for Americans to demand spending cuts too. What I found interesting was his link to the latest from Jagadeesh Gokhale and Kent Smetters:

the nation’s fiscal imbalance has grown from around $44 trillion dollars as of fiscal yearend 2002 to about $63 trillion, mostly due to the recent adoption of the prescription drug bill (Medicare, Part D). The imbalance also grows by more than $1.5 trillion (in inflation adjusted terms) each year that action is not taken to reduce it. This imbalance now equals about 8 percent of all future GDP and it could, in theory, be eliminated by more-than doubling the employer-employee payroll tax from 15.3 percent of wages to over 32 percent immediately and forever – assuming, quite critically, no reduction in labor supply or national saving and capital formation. Equivalently, massive cuts in government spending would be required to achieve fiscal balance: The total federal fiscal imbalance now equals 77.8 percent of non-Social Security and non-Medicare outlays.

Of course, part of the solution might also be to repeal the income tax cuts enacted in 2001 and 2003 and to repeal the prescription drug benefit or otherwise find some means for paying for it.

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Greenspan on the Real Fiscal Problem

Alan Greenspan makes an important point:

NEW YORK (MarketWatch) — Former Fed chief Alan Greenspan sent a message to Washington policymakers: Don’t think about naming him to another commission seeking to untie the Gordian knot of Social Security reform.

…Greenspan warned that retirement health-care costs are more of a problem for the federal government than fixing Social Security.

“Social Security will get resolved. The real fiscal problem is Medicare,” Greenspan said. “I’m fearful we have already committed more that we can afford.”

So it is time for a “Medicare commission?” the moderator asked, breathlessly.

Please no, Greenspan replied. “I could write the [commission’s] report in 20 minutes,” he said.

I’m sure that I would disagree substantially with the report that Greenspan would write about how to solve to the Medicare crisis. But he’s quite right that Medicare is the real fiscal problem, and that there are obvious solutions that do not take a rocket scientist (or even an economist) to figure out: Medicare benefits could be cut (that would be Greenspan’s 20-minute commission report), or, if that is not a popular option (which it won’t be, and shouldn’t be), then taxes could be increased to close the enormous Medicare funding gap.

My preferred solution to the Medicare crisis is different, though: I would advocate a complete overhaul of the nation’s health insurance system, for example by moving to a single-payer system. Properly done, such a move could generate enormous savings that would enable us to afford decent health insurance without large tax increases. Why not try for the best of both worlds?


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Real Wages for Production or Nonsupervisory Workers and the 2006 Credit Crunch

Kash’s post on the latest consumer price inflation news allows us to raise a couple of additional points. Our first graph provides the latest on real wages for production or nonsupervisory workers, which have generally been declining over the past two years as nominal wage increases have not kept pace with consumer price inflation. While most students who have taken a couple of principles of economics classes understand the difference between nominal wage increases versus changes in real wages, apparently John Snow does not:

To which Frank said: “OK, because you’ve got hourly earnings going up 3.8%, and I believe…that’s not adjusted for inflation. So my understanding is that even in the past 12 months, which are your best 12 months, hourly wages have barely kept up with inflation….. But you would acknowledge that 3.8% increase in wages you’re talking about is nominal, not adjusted for inflation, correct? Snow, who has a Ph.D. in economics, was a bit flummoxed at first. “I’ll have to go back, Congressman, and check these numbers,” he said.

Our second graph shows the recent increase in real interest rates, which Kash attributes to the tightening of monetary policy in order to avoid an acceleration of inflation.

The fiscal situation in 2006 is reminding me more and more of the 1966 fiscal situation and the resulting Credit Crunch. As we noted, the economic advisors to President Johnson warned him that continued fiscal stimulus would crowd-out investment. I hope (and suspect) that the Council of Economic Advisors are saying similar things to President Bush. I fear (and suspect) that the President refuses to listen to his own economists. Why? He and his political hacks are too busy telling us his fiscal fiasco is good for long-term growth even though most economists argue just the opposite.

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Responsibility for the Federal Budget Deficit

I’ve taken the liberty of composing a picture that addresses the implausible notion that the Federal government’s budget deficits are the result of “ungoverned forces”.

The graph below shows the on-budget federal budget balance – that is, the budget balance excluding the Social Security Trust Fund surplus – and the ways in which various deliberate policy choices have contributed to it. The lower-most heavy red line shows the actual budget deficit that we’ve seen over the past several years, as well as the forecast for the remainder of the Bush presidency from the CBO (see the January 2006 report: Budget and Economic Outlook), including the recently-passed extension of the cut in capital gains taxes and AMT relief. Excluding the Social Security surplus, the deficit will be around $550bn this year, and will remain at that level for the rest of Bush’s time in office. (Though it’s worth noting that if there’s a recession any time in the next three years the deficits will grow to be much larger.)

This deficit is then decomposed into various components that correspond to specific legislative changes made by the Bush administration and the Republican Congress over the past five years. The CBO estimates the cost of each change to tax laws and spending legislation, and provides those estimates in their regular “Budget Outlook” reports. I’ve compiled all of those cost estimates and put them together to make this graph.

So for example, in 2005 the actual on-budget deficit was $494bn. But many of the choices made by the Bush administration and Congress over the years have contributed substantially to this figure. Spending on Iraq was about $80bn during 2005; all of the various tax cuts deferrals over the past five years cost about $211bn in 2005; specific decisions to increase defense spending over the past five years, excluding the costs of the war in Iraq, cost about $142bn in 2005; legislative changes to various entitlement programs cost about $32bn in 2005; and specific changes made to non-defense discretionary spending over the past five years cost about $49bn in 2005.

If none of these deliberate changes to taxes and spending had happened – in other words, if tax laws had remained the same as they were in Clinton’s last year in office, discretionary spending had simply grown at the rate of inflation, Iraq had not been invaded, and entitlement programs had remained unchanged by new legislation – then the federal budget balance would have followed the top-most blue line instead of the bottom-most red line. Rather than a budget deficit of $494bn in 2005, the federal government would have run a surplus of $18bn. Rather than facing a future of massive and growing deficits as far as the eye can see, the US would be enjoying the prospect of being able pay down some of its national debt in preparation for the looming retirement costs of the baby boomers.

(If you’re worried that this analysis omits the positive revenue feedback effects of the tax cuts, you’re quite right – but as I’ve demonstrated before, those feedback effects are really tiny so we can safely ignore them.)

There are two crucial points to take from this picture. First, the Bush tax cuts are alone responsible for close to half of the Bush administration’s chronic and massive budget problem. The decision to dramatically increase defense spending, including the war in Iraq, accounts for most of the rest of the problem. As I’ve emphasized previously, increased non-defense discretionary spending is only a tiny contributor to today’s budget problem.

Second, it is quite clear that the deficit is entirely due to specific decisions made by the Bush administration and Congress. External, “ungoverned” forces have not caused our budget mess. That honor belongs entirely to our policy-makers in Washington.


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David Altig Defends Karl Rove

My friend David Altig does his best to defend that speech from Karl Rove that we attacked here. David’s defense of Mr. Rove goes like this – the growth rate of real GDP and employment started to slow in late 2000, which is factually true.

At the risk of repeating myself, let me kindly suggest why this defense really does not justify the often heard claims that the recession started before Bush took office by copying my second comment to David’s post:

As I re-read your evidence for a “downturn” that occurred before 2001, I have to cry FOUL. A reduction in the GROWTH RATE of real GDP is not the same thing as a decline in real GDP. I don’t think any economist would have found it prudent to maintain a growth rate in aggregate demand that was in excess of the growth rate of potential GDP past mid-2000. Unless you believe – which I’m sure you don’t – that we were below full employment as of 2000QII, one would have welcomed some slowing of real GDP growth.

I’ll concede that Rove was more guilty of extreme spinning than lying – given that modern political correctness almost rules out the possibility that anyone is ever guilty of lying no matter how they twist facts in order to deceive. But I have no clue why a sensible and honest conservative economist like David Altig feels the need to defend the free lunch supply-side spin from this White House. David?

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