Relevant and even prescient commentary on news, politics and the economy.

Obama’s FY 2011 Budget

by Linda Beale

Obama’s FY 2011 Budget

The Obama Administration released its FY2011 Budget proposals today which assumes a substantial amount of tax cuts (making the 2001-2003 Bush cuts permanent for most Americans costs about $3.75 trillion over ten years) and some tax increases to cover important programs (about $1.9 trillion), resulting in a substantial net tax cut of almost $2 trillion over ten years. See press release and Green book.

The press release claims that the Administration’s plan covers “short-term tax incentives to create jobs and encourage business investment, …proposals to deliver tax relief to middle class families and small businesses, and its blueprint for restoring fiscal discipline and responsibility to our tax code.”

Personally, I think most of the tax cuts are stupid and will do very little to create jobs. Passing a law to permit modification of home mortgage loans in bankruptcy would do more than any item in the bill. And many of the famlies offered “tax relief” are not really middle class–they are the upper middle/lower upper class. They aren’t the ones the Administration should be focussing on. The best way we could help ordinary Americans is to get more people at the lower end spending more. That would let the businesses thrive that are threatened by the drop in spending as people face difficult times, and letting businesses thrive means creating new job opportunities. And the best way to do that would be to use the money wasted in these tax cuts on real programs to create jobs–public infrastructure and public education. And how can you claim that a bill that includes even more tax expenditures for businesses that have been proven not to work except that they give managers and owners more money to spend on themselves (or invest overseas) is a bill that “restores fiscal responsibility”. Nah. I don’t think so.

Naturally, the media are plugging this as a tax hike. See, e.g., Donmoyer, Obama Seeks $1.9 Trillion Tax Rise on Rich, Business, BusinessWeek (Feb. 1, 2010). The Donmoyer story starts out with “the Obama administration wants to increase tasxes on Americans earning more than $200,000 by almost $970 billion.” But of course that’s achieved by letting the law Congress passed in the Bush adminstration play out as the law was written to play out–eliminating the tax cuts which were described as “temporary” measures that were expected to stimulate the economy. Now, if tax cuts really worked as economic stimulus, we should expect to have seen robust job creation over the entire Bush administration. But even though Bush began two wars of choice (Iraq and Afghanistan), which tends to make the military-industrial complex happy and sometimes also creates more jobs as soldiers go to war and others have to fill in back home, neither the war machine nor the temporary tax cuts managed to crank up the economy past weak growth.

The Obama administration takes as a given extending the Bush tax cuts to everybody earning less than $250,000. Most people in government probably think of that as an average wage, but folks making $250,000 are actually quite well to do. The Administration also proposes continue to “patch” the AMT to protect the upper middle class from paying that tax. The media keep repeating that “originally it was intended to ensnare millionaires and now it gets people at lower incomes” but they never read the history. For a long time, the AMT has been intended to get people who have quite high income ($250,000 to $500,000 qualifies) and who have lots of “preferences” that reduce the amount of tax they pay too much. Instead, the AMT expands the base and taxes it at a nearly flat rate. We need to make some corrections to the AMT, but we don’t need to protect the $250,000 to $500,000 group from its impact.

The Obama administration has scaled back its proposals aimed at companies that shift profits offshore. It won’t include a proposal to drop the check-the-box rules–an administrative change that facilitated all kinds of offshore gamesmanship by the big multinationals. Instead, the administration proposes to crack down more on transfer pricing. My view–it will be hard to make the crack down effective, because this is a place where businesses have the facts and can manipulate the results. It’s clear, though, that the transfer pricing changes are targeting the right area–the transfer of intangible properties that are created in the US, so that future profits are offshore. But will the concept of “excessive returns” do the trick? Not sure.

Obviously, big businesses lobbied with complaints about their “competitiveness” to get these watered down provisions. This is just whining–but whining that works on vulnerable congresspeople who don’t want to recognize that the US, after all, is a tax haven, with lower effective corporate tax rates than most OECD countries. It isn’t the tax structure that is keeping US corporations –like Campbell Soup, GE, and Caterpillar–from competing. It may be their over-paid management that has lost the ability to think lean and act smart.

Other business tax changes proposed here don’t make much sense. Making the research & development credit permanent is another one of those crazy giveaways that will reward drug companies for developing a tweak to a patent that keeps them in monopoly profits a little longer and raises our medical care costs even faster. We should instead be investing that tax expenditure money in funding basic research at universities. The expensing writeoff for businesses investing in equipment is just another concession to the lobbying–nobody has shown that it works, and it probably doesn’t work to create jobs. But we keep doing it anyway.

So is there anything I like. Yes. The proposal to ensure that carried interest is characterized appropriately as compensation income. The managers of big equity funds have been playing a game with their wages for years–one that is not clearly sustainable under the Code as written. They claim they earn capital gains, and then they defer their income “to boot” by claiming to work for offshore companies that are essentially mailboxes in the Caribbean run by people in the US. That tax dodge shouldn’t work to start with. And the Congress surely should make sure it doesn’t with a clear statement clarifying the law that such items are 1) compensation and 2) earned currently.
crossposted with ataxingmatter

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How Big Must a Bubble Be to be Dangerous

Robert Waldmann

This is a brief follow up on my post on measuring bubbles. The amount lost due to sub-prime mortgages in default is tiny compared to the damage done. How large can the ratio of damage to losses be ?

My answer is it can be infinite — that it is possible for irrational investing to destroy the financial system, even if the financial system looses nothing on average when reality bites.

Let’s imagine a case in which big money center banks secretly bet each other tens of billions on the flip of the coin. Average gains and losses must be zero. However, if counter-parties don’t know who bet on heads and who bet on tails, the financial system will seize up as the solvency of all the gambling banks is in doubt.

In the real world, the coin flips were called CDSs. It was known that investment banks and hedge funds had huge positions in CDSs, but it wasn’t known who was long and who was short. When the price of CDSs written on CDOs made up of MBSs shot up there were winners and losers. However, unless and until a firm went bankrupt it was unclear who the winners were (after bankruptcy it is clear that the winners are lawyers and everyone else loses on average).

That’s enough to disrupt finance and cause a huge worldwide recession. I think that’s what did it. Not the average loss but the immense variance of losses across banks.

It’s true that banks lost on average. Partly the lost to some hedge funds. This hurts the system because hedge funds don’t provide financial services. However, I think the banks could have failed in their role in the economy by making stupid investments even if their losses had added up to zero.

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Ads were in the works, but their appearance today caught me not preparing readers for this event except for Bears. Sorry. Angry Bear is trying out the notion of a small revenue stream to help take care of expenses instead of our personal income. The time involved to keep the blog running involves much time, so a small stipend may emerge if the ads prove capable of producing income.

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Transfer Deadline Day and Poor Incentive Alignment

The big news of Transfer Deadline Day was that Nathaniel Clyne turned down a move from The Eagles to The Wolves.*  As The Guardian noted:

[This] will please everyone at Crystal Palace who isn’t an administrator.

Let’s look at the timeline and the reality.

  1. Palace was ninth in the Premier Championship [thanks to Tim in comments] League at the time they were put into Administration. (Owners could not pay bills.)
  2. Being put into Administration carries with it a 10-point penalty on the team. This moved them from ninth to twentieth—from in contention for the FA Cup Coca Cola Championship playoffs [ibid. to Tim] and possible Promotion to the borderline of Relegation.

    UPDATE 2: The Eagles’s current FA Cup matchup—being one of five remaining Championship League teams in the Round of 16—is a replay today (3:00pm EST) with…the Wolves. Yes, the same team to which Clyne declined a transfer. Looking at the economics of today’s game (h/t My Loyal Reader), there is 90,000 quid to get through to the next round, and an expectation of 247,500 in additional revenues from that round. So the proposed 1.5MM transfer fee for Clyne and Moses has to be adjusted by the decrease in probability (from positive to virtually zero) of receiving that 337,500. Even if you assume only a 40% chance of winning at home, that’s an immediate 135,000 quid—9%—decline in the value of the sale.

  3. Note that the team itself did not change in the least at that point.
  4. This puts two factors into play: a relegated Eagles squad would be worth less, but the Administrators are looking for short-term cash flow that can best be achieved by selling top players. (We should call this a “borrowing constraint,” perhaps, save that it was the lack of an initial borrowing constraint and the resultant overextension that led to the situation in the first place, so perhaps it is a resource allocation issue.)

The strange thing is that, without the penalty, the incentives of the Administrators would be better-aligned with the long-term goals of the team: putting the best possible product on the field and selling an attractive commodity.**

Note, however, that the previous owners suffer no incremental reputational risk as the team is sold, even though they failed to prepare the firm team for those next steps. (Think Sandy Weill and The Big C or Neutron Jack and the DoD-subsid[iar]y/mortgage lender.) The damage after their departure is borne solely by the players.  In this particular case, Nathaniel Clyne’s move of support for the Eagles should be a stronger symbol for potential acquirers of the F.C. than the 1.5 million quid would have been.

*Dissent on this point from Tottenham supporters is understandable, if wrong.  Yes, it was a boring day on the transfer front.

**This doesn’t mean that they might not still be trying to sell players, just that there wouldn’t be a “Fire Sale” sign on their foreheads, which should produce marginally better deals, i.e., those that are more closely aligned with the longer-term interests of the team.

UPDATE 1: Tim in comments notes, correctly, that Administration does, at least, pay the players, leaving transfer fees a possibility. The purpose of Administration remains, however, (1) keeping the League orderly and (2) being able to sell the franchise to other buyers for as much as possible. Since transfer fees are based on negotiation, and Administration (“fire sale”) prices seem by definition to be below those that would be negotiated if it were One’s Own Money.

So assuming one expects the Eagles to remain a Going Concern—that is, that Selhurst Park next season won’t be being developed into a Harrod’s—taking the transfer fee upfront is at best a wash, and more likely a reduction in the franchise’s value. Especially in a case where there is risk of Relegation.

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Corporate Inefficiency When the Costs Are Imposed on Third Parties

by cactus

Corporate Inefficiency When the Costs Are Imposed on Third Parties.

Long time readers may recall that I had some issues with Norton Anti-Virus, which led to my uninstalling the thing from every computer I own (plus my mom’s computer) back in 2007. Planned obsolescence in the computer world being what it is, I don’t even have those computers any more.

In the process, I discovered its very, very difficult to get Norton to understand you have cancelled your service. There’s no phone number to call (unless you want to pay for tech support), no e-mail address where anyone responds. So I got a bill a year later, in late ’08. And again, in late ’09, according to AmEx bill. Now AmEx has strict instructions not to accept any charges from any Symantec organization again. If I get charged for anything from Norton again, I’m cancelling my AmEx card. But what incentive does Norton have not to bill me? They seem to have set up a structure where its cheaper for them to continue billing me for services they are not providing me than to stop. Put another way – it is cheaper for them commit fraud than it is for them not commit fraud. Of course, the costs get imposed on others, in this case, me.

A similar example – we recently bought a house, and are planning to install a home security system. So we got a land-line, after being a cell-phone only household for a few years. At present, we leave the landline with a ringer off.

See, Darnell is getting something on the order of 3 to 10 calls an hour. Now, you may be wondering: who is Darnell? Sadly, I couldn’t tell you. But someone thinks he owes someone money (Norton perhaps?) and I guess there are several collection agencies on the case. Now, the first hour (and I mean, the first hour) we connected up, we were telling the collection agencies that called, politely, that we had just gotten a new number from Time Warner. A few hours later we were later we were literally yelling at them to stop calling. That evening, we hooked up an old answering machine the old owner of the house had left behind. Most of the callers don’t leave messages, but a few do. Every so often, I simply erase the entire lot without listening to them.

Darnell keeps getting calls all the time despite the fact that we’ve had this number for a few weeks. Now, before the phone number was assigned to us, it had to lay fallow for a while (30 days? 60?). The collection agencies spent that time dialing and getting messages from the phone company indicating the number was no longer in service, and apparently it didn’t occur to any of them to take the number off of their list. The reps that call here get an answering machine that indicates someone other than Darnell is at the number, but it doesn’t occur to any of them to take the number off the list either. Or more likely, it does occur to them, but the incentive structure set up by the firm discourages them from doing so, assuming they even have the freedom of movement to do it.

Its easier and cheaper, apparently, for these companies to engage in a denial of service attack of indefinite duration on third parties like us than it is for them to do the right thing, which would involve taking up issues they might have with Darnell with Darnell. As an aside – I just hope no previous resident of this home has ever skipped bail as I really don’t want any bounty hunters breaking in at 2 in the morning. Someone is very likely to get shot if that were to happen.

But anyway, all this reminds me of what I was taught in my econ classes, much of which I now regard as bull#$%#. I remember having a discussion with one prof about whether there was any need for government regulation at all. I noted that there are times that a company might make a mistake that had irrevocable consequences to their customers – perhaps a company might, in the course of saving money, inadvertently poisoned one customer out of a million. Shouldn’t the government regulate that? The response was that if a company did poison one customer out of a million, the bad press and whatnot would discourage consumers from buying from that company, and their competitors would have an incentive to do better – perhaps killing one person out of ten million, which in turn would lead to other companies killing an even smaller proportion of customers, until we (and this was supposed to happen pretty quickly) ended up with perfectly safe milk. I remember wondering what planet the guy was from, and whether it was an opportune time to switch to another major.

My guess, though, is that had I described the Norton scenario or the phone calls for Darnell, he would have insisted that this couldn’t happen. After all, they don’t fit with the theory.

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What You Measure is What You Try to Manage, FRB edition

For those who were thrilled by the positive general prospects in Rebecca’s post, the WSJ presents words to die/foreclose by:

If that seems at odds with the economy’s recent strength, keep in mind that the unemployment rate is usually one of the last places recovery shows up.

Many of us are having trouble forgetting that, as the “flat” consumer confidence makes clear.

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Consumers around the world are generally more upbeat, but not uniformly so

Last week the IMF released its World Economic Outlook Update for the October 2009 forecast. The global economy is expected to grow 3.9% in 2010, an 0.8% upward revision. In fact, the 2010 growth projections were generally upward with little offset in 2011 (often when you get a surprise and positive economic release, the current period forecast improves at the cost of growth later in the forecast):

  • The 2010 U.S. growth Update is 1.2%-points above the October level, now 2.7%.
  • The Eurozone GDP growth Updated to 1% pace in 2010, up 233% from October’s forecast (driven by the 400% surge of Germany’s GDP growth outlook, now 1.5% in 2010).
  • Canada’s GDP growth forecast got a slight bump, up 0.5%-points to 2.6%.
  • The UK is now expected to grow at a 1.3% annual pace in 2010.
  • Russia’s Update to GDP growth is 3.6% in 2010 (that’s off of a sharp 9% drop in 2009).
  • And the IMF envisages that China maintain 10% growth in 2010, up 1%-point from its forecast just 3 months ago.

The IMF has no crystal ball, but the story is compelling: banking crisis + global recession = weak recovery. However, it is improbable that the IMF is spot on. The short IMF press release stresses the divergent path of economic recovery across the advanced and developing world. In short, much of the emerging and developing world should recover smartly, while key advanced economies, burdened by debt and financial stress, are to see a more muted recovery.

Of note is the IMF’s listed upside risk to the growth forecast (thus inflation, trade, and other related variables):

On the upside, the reversal of the confidence crisis and the reduction in uncertainty may continue to foster a stronger-than-expected improvement in financial market sentiment and prompt a larger-than-expected rebound in capital flows, trade, and private demand.

Confidence, consumer, investor, and business, is key – let’s focus on the consumer. The one that accounts for roughly 17% of global GDP – i.e., the U.S. consumer – remains afflicted by excessive debt burden and record unemployment. In contrast, consumer confidence is rebounding smartly in other parts of the world, developed and developing.

Advanced consumers showing some confidence, but the U.S. consumer confidence index remains 39% below that during the onset of the recession.

The chart illustrates various measures of consumer confidence across a selection of advanced economies (you can see the exact sources here). Consumer confidence in the U.S., U.K., Germany, and Ireland remain well short of their Jan. 2008 levels. Notably, confidence in the U.S. has moved laterally since May 2009 despite recent gains in the fourth quarter of 2009.

Confidence in some emerging economies remains muted as well.

I chose a selection of monthly confidence indicators for select emerging markets. Clearly, some biggies are missing – India and South Korea being the first on the list – but data availability and/or frequency precludes a more thorough analysis.

Consumers in Indonesia are ostensibly more upbeat than those in other emerging economies. In China, consumer confidence hovers below its Jan 2008 level. And in spite of the bubbles and wealth talk in China, confidence hasn’t been this low since 2003. In Brazil, consumer confidence is back to peak levels before the onset of the U.S. recession.

I provided a snapshot of global consumer confidence. Generally consumers do portray the ongoing confidence struggle, especially in the U.S., that plays out in the IMF’s muted growth forecast.

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