It’s not structural unemployment, it’s the corporate saving glut
Mark Thoma rightly points out the hypocrisy of the deficit hawks’ intent to cut spending while approving military spending in the same sentence. Ryan Avent furthers the dicussion by stating that Washington has used the ‘dire fiscal’ rhetoric to sell short-term cuts that were unwarranted, given that the fiscal problems are structural in nature.
Me, I’d argue that the fiscal deficit is simply the consequence of corporate America’s excess saving: the corporate saving glut – no I didn’t mean the ‘global saving glut’. Furthermore, the corporate saving glut is manifesting itself into the labor market, creating high and persistent unemployment. Some economists are wrongly referring to this as higher structural unemployment.
Exhibit 1: The 3-sector financial balance model demonstrates that elevated excess private saving (firms and households) keeps the government deficit in the red. For a discussion of the 3-sector financial balances, see Scott Fullwiler and Rob Parenteau; and I’ve written on this as well.
The excess saving rate for the public sector, external sector, and household sector is constructed using the Federal Reserve’s Flow of Funds accounts as: (Gross Saving – Gross Investment)/GDP. The excess corporate saving rate is the residual of the Current Account (external saving) net of government and household excess saving. If the corporate excess saving rate is positive, then investment spending falls short of asset purchases (financial or tangible).
* In Q4 2010, the household excess saving rate dropped to +3.5% of GDP
* In Q4 2010, the government excess saving rate dropped to -10.4% of GDP
* In Q4 2010, the current account deficit dropped to -3% of GDP
* In Q4 2010, the corporate excess saving rate jumped to 3.9% of GDP – this is the Corporate Saving Glut because while firms are investing, they’re saving more, thereby breaking the positive feedback loop.
The positive feedback loop remains broken: higher demand increases sales rates, revenues and production which grows firm profits that are translated into wage and income gains, only to drive demand further upward. It’s broken right between ‘grows firm profits’ and ‘translated into wage and income gains’.
The funny thing is, too, that economists sell this broken feedback loop as rising structural unemployment. Actually, unemployment is not structurally higher, it’s that when firms do not reinvest corporate profits, the lack of income flow manifests itself into the unemployment rate.
Exhibits 2 and 3. It’s not structural unemployment, it’s the corporate saving glut!
The chart below illustrates a simple univariate regression of the unemployment rate on the corporate saving glut. The correlation is very strong, 85%, and suggests that the structural unemployment rate is less than 5.8%. Furthermore, while the unemployment rate seems to be perpetually higher than normal (the upper-right circle), that perfectly coincides with a high corporate saving glut.
If the corporate excess saving glut just equaled zero, i.e., firms invested and saved at the same rate, the unemployment rate would be 5.8%. Now, if the corporate saving glut fell below zero to -2%, i.e., firms reinvested in the economy by way of capital investment in excess of saving, the simple model implies an unemployment rate of 4.7%.
The government doesn’t need to add jobs, per se, the government needs to figure out how to get corporate America to drop the saving glut and re-invest in the economy.
Rebecca Wilder
“The government doesn’t need to add jobs, per se, the government needs to figure out how to get corporate America to drop the saving glut and re-invest in the economy.”
How Excellent! So Simple!
So, all we do is reduce the taxation on the returns from investing capital, meaning that we’ve increased the incentive to invest, not hoard, said capital, and everything will be fine!
So ‘Becca, you will indeed be fighting in the streets for a reduction in corporate and dividend taxation then, yes? I look forward to this quite as much as you do.
Many thanks, Rebecca. 🙂
Especially for the chart showing the correlation between corporate saving and unemployment.
A couple of nits about the other chart.
First, GDP has not been all that steady in recent years, so apparent movement can be distorted, as the movement of the GDP denominator is hidden.
Second, the chart obscures an important relationship:
“* In Q4 2010, the household excess saving rate dropped to +3.5% of GDP
* In Q4 2010, the government excess saving rate dropped to -10.4% of GDP
* In Q4 2010, the current account deficit dropped to -3% of GDP
* In Q4 2010, the corporate excess saving rate jumped to 3.9% of GDP”
You have three savings and one deficit. That obscures the fact that the savings sum to zero. (3.9 + 3.5 – 10.4 + 3.0 = 0.) Better to show the current account surplus than the deficit. No?
“So, all we do is reduce the taxation on the returns from investing capital, meaning that we’ve increased the incentive to invest, not hoard, said capital, and everything will be fine!”
Does not follow. Why invest in something if there are no customers?
Not that I am recommending it, but right now it would make more sense to tax away the excess corporate savings and give it to people who will spend it.
I see the label is “current account”. “Negative of the current account” sounds awkward, though.
Min, Yes the same equation has many faces. Yours is definitely easier to visualize, and usually the way that the 3-sector financial balances model is presented.
But you say “to show the current account surplus than the deficit”
it’s not a surplus, per se. I make this very important distinction because part of the reason that some of the other balances are in deficit is because we do run current account deficits. They can’t all be in surplus.
But the identity is just a rearrangement of the following uses equals spending identity:
C + S + T = GDP = C + I + G + (X – M)
where X-M approximates the CA deficit for the US (X-M < 0), so
(S-T) + (T-G) = CA, where (CA<0 deficit and CA>0 surplus)
(S-T) + (T-G) – (X-M) = 0
But Tim that corporate hoard of cash is in large measure the result of very limited taxation. Doesn’t it then stand to reason that further reductions in corporate taxes would lead to a yet greater hoard of cash. Besides, don’t most corporations operate in accordance with the free market concept of investing returns in the most profitable and productive manner rather then based on exogenous considerations such as taxes? On top of which, if they’re not paying taxes now why would any additional reduc tions in taxes make any difference to their decision making process?
Macro is music to my ears…thanks for staying on topic Min.
It does not follow Tim…an ironic statement is not macro. thanks Min.
“But you say “to show the current account surplus than the deficit”
Thanks, Rebecca. 🙂
I realized later that “Negative of the current account” is “Current account deficit”. I. e., a positive number for the current account deficit is the same as a negative number for the current account. 🙂
Why the Federal Reserve would put out a graph that obscures the relationship between the variables in the graph is beyond me.
“Besides, don’t most corporations operate in accordance with the free market concept of investing returns in the most profitable and productive manner rather then based on exogenous considerations such as taxes?”
Anyone who has had a college level intro to finance class knows that you use AFTER TAX cash flows in DCF analysis.
Company A has a project to invest $1 billion today that will return $0.3 billion (pre tax) each year for the next 5 years. The firm’s WACC is 10%. Under the current tax regime, the project will increase tax liabilities by $0.04 billion each year. With a lower tax rate the project will increase tax liabilities by $0.03 billion each year. The terminal value of the project is $0.
Which tax regimes do you invest in this project?
And anyone actually investing in business enterprise would know that effective tax rates are subject to change with little notice. The profitability of an enterprise is likely to be calculated on a long term basis which cannot rely on a potentially fluctuating tax rate to decide the value of the investment. Otherwise, put your money into triple munis.
The fact remains that reducing taxes to induce investment is self defeating unless there is an intention to eliminate all business taxes by means of a Constitutional amendment. Better to tax capital accumulation if you want to encourage better use of cash by business entities.
BTW, was it college level intro to finance that encouraged the development of arcane derivatives based on sub-prime mortgages? Or was that taught at the graduate level in advanced financial manipulation? The economy is still reeling from the results of all the knowledge dispersed in those college level finance classes.
My contention is that corporations have permanently increased their cash reserves, because the old meme about being able to borrow when you needed to was proven not to hold in late 2008 (and to some extent earlier). The goal appears to be to be able if necessary to go some extended period with no borrowing, just in case the capital markets (commercial paper in particular) freeze up again. If you know that it could take 2 months to sell commercial paper in a frozen market then it makes sense to keep 2 more months of reserve just in case it happens again. Yes you won’t get much roi on the cash, but conversly if the markets freeze up you won’t have to file chapter 11 if you can’t borrow what you need to stay solvent.
In one sense then its a return to the older way of doing business since the go-go version of the market of minimal cash was proven be potentially unstable.
Well, maybe they’re saving cash for M&A. Like ATT.
Maybe they’ll increase dividend payouts to investors on a regular basis or a one-time deal.
Companies just finished letting folks go after the last recession. They are probably reluctant to add resources until there is more demand for their goods and services. There isn’t much wage pressure due to the higher unemployment rate.
So Tim Worstall is saying we should start to tax corporate savings more (increase the undistributed corporate income tax)? Or did I understand that wrong?
A lot of potential corporate expenditures – on labor-saving automation, executive compensation, dividends, relocating facilities overseas – would be macro-losers. If you consider the rational response of individual companies and the capital-management decision-makers to a demand-constrained economy, isn’t that how you’d respond to any penalization of retained corporate cash?
Why is there a corporate savings glut?
The risk premium for expansion increases as demand drops. As demand returns, the risk premium for expansion and investment drops.
Companies need to time their production to meet demand. They need to keep cash so they can time their expansion.
This dynamic creates spirals. As demand decreases, risk premiums increase. As risk premiums increase, investment drops. The drop investment further decreases demand. Companies end up sitting on cash because there are no investments with a low enough risk premium compared to anticipated future investments.
The spiral reverses only with sufficient demand. Insufficient demand can be met with current capacity and does not change the risk premium. It is only once demand crosses a threshold that risk premium begins to moderate.
The key to recovery is to increase demand enough to require capacity increase, lowering the risk premium for expansion, thereby increasing investment that leads to increasing demand and reversing the spiral.
The fault in this presentation is an ideological perspective, and that it’s assigning, cause-and-effect, twixt symptoms. One does not cause the other. At best, it’s a chicken-n-egg deal. Is unemployment high because corporations are sitting on cash, or are they sitting on cash because their customers are unemployed ? The answer is: yes.
Ideology becomes apparent when solutions are discussed. Should we make the market more inviting to investment ? Or should we re-distribute corporate cash ?
Rebecca’s last sentence is profound: “The government doesn’t need to add jobs, per se, the government needs to figure out how to get corporate America to drop the saving glut and re-invest in the economy“.
But, the government doesn’t need to figure out anything. It just need to re-learn its appropriate role… IOW, become less involved and burdensome, not more of both. The very thought that government is in a position to, and has a duty to, and the ability to directly, “add jobs“, is at the root of all these problems. That’s how government has evolved into something whose very purpose, is to gobble up as much of the GDP as possible, and then borrow/spend significantly beyond even that. The services we expect and require from the federal government are counter-productive when in total, they’re 1/4 of the entire GDP.
As for using tax-rates for social-economic engineering (re-distributing corporate cash)(as oppose to just funding government).. the rates themselves are almost arbitrary when the feds spent it all, and them just borrow more. Deficit-spending (or quantitative-easing) is a tax increase, as surely as credit card purchases are real spending. The same tax-payers are on the hook for the deficit/debt (plus interest). Whatever it is that they could do with confiscated, corporate cash, they can do too, via deficit-spending -and we see how well that worked in a dollar-per-benifit outcome.. ala stimulus- ..
If we want honestly-low unemployment, and a healthy economy, with a sustainable future.. we can skip the GDP references, and stop fretting about a company’s (or person’s) bank account (it’s no more the business of the feds, than it would be a municipality that would audit a pizza shop, and then tax it based on net-worth).. and get right to the point. The per-household share of federal spending (not just taxes) needs to be well south of 50% of the average household income. THAT will free up capital. As it sits today.. well.. you do the math
Federal budget = $3.7T
Total households = ~ 100M (3.3 people per)
Avg Houseld income = ~ $60,000
“Or was that taught at the graduate level in advanced financial manipulation?”
For the record, if home prices had continued to rise from 2005 to 2010 do you believe that RMBS returns would have reflected a Aaa rating or a Baa rating? It is not manipulation when the faulty underlying assumption was disclosed to investors. Just lazy investors.
RweTHEREyet: “Deficit-spending (or quantitative-easing) is a tax increase, as surely as credit card purchases are real spending.”
As far as deficits are concerned, spending is equivalent to tax cuts. Whether they will lead to future tax increases is a question. That they will is plausible, but the historical record does not provide much support for that. Look at the failure of the current Congress, abetted by the President, to increase taxes. This at a time when both agree on reducing the deficit. If they don’t raise taxes when they say they want to reduce the deficit, when will they? (Not that I think that they should have raised taxes.)
RweTHEREyet: “Whatever it is that they could do with confiscated, corporate cash, they can do too, via deficit-spending -and we see how well that worked in a dollar-per-benifit outcome.. ala stimulus- ..”
Yes, we can see how well that worked out. Sorry, I do not have the stats at hand, but as I recall, the most effective gov’t spending (or maybe it was number 2), which produced the most bang for the buck, was unemployment insurance, one of the automatic stabilizers already in place, not the stimulus. The stimulus could have put more money in the hands of people who would spend it. That would have been more effective.
And you are right, the Federal gov’t can spend without taxing corporate savings. 🙂
“As far as deficits are concerned, spending is equivalent to tax cuts“
Only if government spending is as carved in stone as the laws of physics. .. that a percentage of the GDP is already owned by the government, and that it HAS to spend it all. It’s as though cutting spending to match revenue is a fantasy.
And never forget (plenty of historical proof), that when you let the entire tax burden hover near the top of the Laffer Curve; tax cuts will result in revenue INcreases. And on that note we find another root problem. Taxation has become some sort of device to extract every possible penny from the private sector, tied in no direct way to budget items (even FICA became bastardized) right up to where it becomes destructive.. and then spend even beyond that. It’s all back-assward. We now work to support a government that grows for its own needs against our will and consuming more of our labor-fruit than we do.., as opposed to the private-sector growing, and then allowing the government to grow as WE need it to grow.
The buck-bang from unemployment spending, is like the pitcher of bloody marys after the party. Sure, it eases the pain now, but it just puts off the inevitable hangover, and makes it worse. No matter how well-intentioned any spending.. when you’re in debt 100% of GDP, and it’s 100% borrowed/printed, it does more harm than good… making it no different than the stimulus spending. We could be two years into recovering from whatever the ultimate “bottom” of this mess might be.. but instead, we’re trillions deeper in debt, and the bottom yet seen, will be even deeper.
“And you are right, the Federal gov’t can spend without taxing corporate savings“
As far as I know, they aren’t taxing them yet -aside from any captital gain- .. not just a tax on the value of the assets. That would be a scary line to cross. Tax on income/profit is one thing (poor residents of Massachusetts, and personal property tax aside).. literally taking accumulated cash is another.
And as far as taxing corporations go.. they really don’t pay it. If you don’t like the argument that they’re just conduits that pass the tax on in the price of their product (which is a silly as saying renters don’t have property tax built into their rent); those taxes end up coming out of SOMEbody’s pocket.. be it a business owner, or its stock-holders… it comes out of a household income, one way or another.
Or when you cite manipulation maybe you mean this…
“BasePoint Analytics LLC, a recognized fraud analytics and
consulting firm, analyzed over 3 million loans originated between 1997
and 2006 (the majority being 2005–2006 vintage), including 16,000
examples of non-performing loans that had evidence of fraudulent
misrepresentation in the original applications. Their research found that
as much as 70% of early payment default loans contained fraud
misrepresentations on the application.”
http://www.mortgagebankers.org/files/News/InternalResource/58467_TheImpactofPoorUnderwritingPracticesandFraudinSubprimeRMBSPerformance.pdf
RweTHEREyet: “And never forget (plenty of historical proof), that when you let the entire tax burden hover near the top of the Laffer Curve; tax cuts will result in revenue INcreases.”
And how does that happen? Deficits stimulate the economy. 🙂
Actually, dividend payments would be macro-gainers. It would be a transfer of wealth back to the shareholder (the consumer in aggregate).
bakho,
The problem is that the household burden to increase demand has risen as corporations keep employment low, don’t expand business, refinance at record low rates, and add back temporary workers and (some) hours in lieu of secure jobs.
As you see in the first chart, the household excess saving has been declining. Is that what fiscal and monetary policy should be pushing? Households to lever up again, only to see financial asset prices crash again? I think not.
Big tax breaks on all sides would get this economy going…Short-term expansionary fiscal policy is still needed! In aggregate, corporates have the cash – policy should be guided to improve sentiment!
Rebecca
Well, of course technically that would be even more true of executive compensation. But if you consider not only the pattern of stock ownership skewed to the welathy, but even the method of ownership (e.g., in retirement plans) for those likely to spend, you’ll see what I mean.
RweTHEREyet,
“The very thought that government is in a position to, and has a duty to, and the ability to directly, “add jobs“, is at the root of all these problems.”
Apparently it does. There is a large stock of resources that can be used. This recession was not about an adjustment in the supply of goods and services, it’s about demand. Government can supplant that demand while households and firms save.
Min, “And you are right, the Federal gov’t can spend without taxing corporate savings.”
Yes, the government CAN spend without taxing corporate savings. It just draws funds from the banking system and issues bonds! Apparently they’ve not breached any limit because the 10-yr Treasury bond remains at record lows!
As soon as they stop saving, government revenues will rise. The challenges to the government finances is structural, not cyclical.
Rebecca
I see some hyperbole involved in some of the above comments. And some common claims on deficits, public private spending etc. Lets be more specific if we can.
You are missing a lot of money by focusing on household income.
US total GDP – 14.12 trillion
US total households 100,000,000 (we’ll go with your figure – haven’t validated)
GDP / household – 141,200
Fed Budget – 3.7 trillion
Fed Budget/household – 37,000 (26% of GDP/houshold)
Seems the bigger question is – why is houshold income (if 60,000) only 42% of GDP/houshold?
Unemployment insurance was an automatic stabilizer already in place, but extending unemployment insurance was part of the stimulus (and other subsequent expenditures). And there is significant evidence, as evinced in a number of studies, that the stimulus did work and prevented a deeper recession.
The problem is that a 1.6 trillion fall in aggregate demand can not be adequately made up for with a 700 billion stimulus, and most of the stimulus was offset by state and local spending cuts, so total government spending actually went down.
John
Fed expenditure are
“And how does that happen? Deficits stimulate the economy“
Of course not.. When you pull back to the “good” side of the curve, the money ends up back in the private-sector.. and investment/expansion/hiring grow the economy. It’s that co-dependency tipping point. Free-markets can’t function sans government.. and government counts on the free-market for funding.. if one side gets too far ahead of the other, they both falter.
John,
First, to your final paragraph, I say make the stimulus bigger!
To your first point, I did not use household income. The household excess saving is constructed from aggregate data, not net saving as released by the BEA (in the personal income statement). The BEA in their income statement shows net saving – this calc here looks at gross saving less domestic investment (by households).
You can see the data on table F.8 in the Fed’s flow of funds. http://federalreserve.gov/releases/z1/
Line 7 plus line 17 minus line 28 and divide by GDP (not personal income).
Rebecca
“You are missing a lot of money by focusing on household income. “
I’m not trying to focus on all of the money (M3). Just using what’s in the hands of the citizens vs what’s in the hands of the governemnt. At any given time, a large percentage of the GDP can be in transit, in a warehouse, or at any stage yet to be useful, have multiple owners.. etc… not being spent, taxed or put to use (until we get a VAT tax, that is).
“US total GDP – 14.12 trillion
US total households 100,000,000 (we’ll go with your figure – haven’t validated)
GDP / household – 141,200
Fed Budget – 3.7 trillion
Fed Budget/household – 37,000 (26% of GDP/houshold)
Seems the bigger question is – why is houshold income (if 60,000) only 42% of GDP/houshold? “
You’re comparing different denominators. I used, per-household-spending / household-income (61%) … You used per-household-spending / per-household-GDP .. apples and oranges.
Try: All-household-income ($6T) as a percentage of GDP (42%) compared to the budget ($3.7T) percentage of GDP (26%), and it looks about the same for the taxpayer (26/42)= 62%.
All I’m doing is referencing what people earn, and what the governemnt spends as a percentage of that. Or more directly.. How the heck did the federal budget reach a numer equal to 61% of ALL household incomes ? And that’s just the feds **sigh**
So yes.. the big question is: How come hosehold income is only 42% of household GDP ?
..hint.. subract 42 from 100 and you’ll see a number in proportion to another familiar number ; )
Solution: Get government spending back under 20% of GDP.
As for extending unemployment (and stimulus spending), we agree.. it staved off a depression.. but only in the bloody-mary, delay kinda way.. It’s still coming, and we’ll go into it trillions further in debt. Any demand created by governemnt borrowing/spending was us, as an an economy, literally livng off a credit card.
So your claim is that there is historical evidence that cutting taxes and reducing gov’t spending by the same amount increases tax revenues? That sounds quite interesting. When and where did that happen? Thanks. 🙂
RweTHEREyet: “Free-markets can’t function sans government.. and government counts on the free-market for funding.”
Isn’t that gold standard thinking? The Federal gov’t is the ultimate source of its money, not the market. Treasury bonds are subsidies to bondholders, offering them (virtually) safe investments, not a source of funds.
Rebecca – I am with you completely. My comments were aimed at RWEThereYet and his analysis that government spending was more than 50% of personal income. I should have been more clear – I thought the reply button would sort out the post hierarchy.
John
“…if home prices had continued to rise from 2005 to 2010,…”
And if my grandmother had balls she’d have been my grandfather. That’s one big if. And who is to say that the explosion in the mortgage market didn’t cause the home prices to dive rather than vice-versa. Just lazy investors? No collusion on the part of the rating agencies and the banks turning a blind eye on all the subterfuge. You’re beginning to sound like some of the narrow vision characters that have been an annoyance here lately.
Forget my claim; just acknowledge the Laffer curve…..
Do you agree that at a total tax-rate of zero, there is zero revenue for the government ?
Do you agree that from there, a gradually increasing tax-rate yields gradually increasing revenue ?
Do you agree that there’s a point where an overall tax-burden reaches a revenue apex, and beyond that revenue starts falling ?
It’s that simple.
Co-inciding spending cuts, and their effect remain an unknown. Review the federal budget for modern history.. there have never been meaningful reductions in spending. What you’ll find is a trend dating back to the onset of federal income tax itself: As the economy grows, the government grows. When the economy slows or recedes; the government still grows. A near century of this cycle has taken us to where a per-household share of government spending is now 60-plus percent of a per-household income. As recently as 1970 it was only 32% (60,000,000 families.. $200B budget… avg income= $10,000).. And the scary thing is, that in 2011 there are far more households with TWO incomes.
Heck.. as we stare at deficits that will add 10% ($1.5T) to the debt PER YEAR, we can’t get political leaders to agree to cutting that would even DENT those deficits.
Rwe- Government’s ‘appropriate role’ is providing public goods- the infrastructure on which both businesses and individuals rely, the education that provides businesses with the trained talent it needs and individuals with the opportunity to develop their abilities, the basic research which provides the foundation on which private research can build, the security and rules of law without which no individual and no business can thrive. Private enterprise’s “appropriate role” is providing private goods. Now we are in a situation in which neither is doing it job. Infrastructure, education and basic research are badly decayed and the -already greatly reduced- expenditures in these areas are under attack. You are right to identify this problem as ideological, however: a minority of individuals- and what may be a majority of large corporations- have decided that being taxed to help pay for public goods they depend on is somehow unfair (even as many of those same corporations have made huge claims on the public coffers)- and that government’s already enfeebled ability to enforce existing law and protect the public from fraud needs to be castrated entirely. To these people I can only say, be sure to call me next time you need a lifeline. I want to be there to laugh and point.
“Isn’t that gold standard thinking?”
No.. not a gold-standard thing. Just pointing out that without the infra-structure; laws; general civil order from government, the free market can’t do its thing. And it’s the wealth generated by the market that funds the government.
How and why money enters the market as the economy grows; is a blog debate unto itself. Let’s start one called, “The Federal reserve and you” .. lol
Hi Sarah,
If you look back.. a made a point to mention that co-dependency.. specifically that the market can’t even function without government infra-structure, and support. My ideological view is that the government has grown beyond the private sector’s ability to support it.
As for things like education funding.. over the last 40 years; the per-student, adjusted for inflation expenditures have sky-rocketed.. and we all know what’s happened to quality of that service in the mean time. And look at many other aspects. As the cost of government per-household grows and grows.. things get worse and worse.. significantly… and all the while, we’ve built a national debt now 100% of GDP.
Ponder this… The per-household share of the national debt is $140,000. Our children will inherit that burden, as surely as any personal estate we leave them.
Ideology aside, for good and for bad.. we’ve left the time for debate, and are up against the reality wall. Debating the debt problem when it was $5T in a $10T economy left lotsa room for theory. now ? not so much.
Nobody knows the maximum point of the Laffer curve. It could well be around 95%. If tax cuts are followed by revenue gains, it is because of increased economic activity. I. e., stimulus. If the deficit has increased at the same time, then it is hard to say that the tax cuts were responsible. The clearest tests are when both tax rates and the deficit increase or decrease at the same time.
“Government’s ‘appropriate role’ is providing public goods. . . . Private enterprise’s “appropriate role” is providing private goods. Now we are in a situation in which neither is doing it job.”
Well said! 🙂
“Nobody knows the maximum point of the Laffer curve. It could well be around 95%.”
Correct.. it’s as nebulous as any ecomonic theory (I think there’s a new topic RE: economics as science).. We may have gone well past it, long ago .. which would explain why; as government spending stays within a relatively constant range as a percentage of GDP, household income has fallen.. ie.. the government keeps getting a realtively bigger piece of the pie.
“Government’s ‘appropriate role’ is providing public goods. . . . Private enterprise’s “appropriate role” is providing private goods. Now we are in a situation in which neither is doing it job.”
Yup ! .. (se my reference to when one gets ahead of the other, they BOTH falter )
Besides, we know for a fact that higher corporate tax rates are associated with higher growth of the GDP. Look at the 1950s, 60s and 70s. We had outrageous taxes, but high rates of growth. Ever since Reagan, we’ve had lower taxes, but had to settle for slower growth.
Obviously, we should tax away corporate savings. It will probably work the way Sweden’s recent experiment in negative interest rates worked, and get the economy moving again.
“Government’s ‘appropriate role’ is providing public goods.”
And education is obviously a non-excludable and non-rivalrous good (sorry for the wonkish response).
There actually is a pretty easy way to determine if deficits today cause businesses to avoid investment because of fear of future taxation – If that were so, then it would be reflected in the tax rate assumptions that are used in the discounted cash-flow analysis. Someone could do a survey of corporate finance managers asking how they calculate tax-rates for the DCF anal and to what extent changes in taxation are calculated in the sensitivity analysis.
My suspicion is that not many are anticipating general future tax increases, other than perhaps looking at a scenario where the Bush tax-cuts are repealed.
However, the argument that deficit spending does not stimulate the economy because it creates an expectation of future tax increases does not hold from a finance perspective and ignores the time-value of money. Stimulus money now is worth more than higher tax money later. Even if we are talking about a rough equivalence between stimulus now vs taxes later, the value of deferring the taxes is going to make it a net plus.
And I think it’s clear that investors know that – deferring taxes is a standard practise on many levels of investment, from 401Ks to the slew of tax-defferal strategies that high-end investors employ.
It just doesn’t follow that deficit spending would reduce private investment out of fear of future tax increases.
John
I used a different denominator on purpose. The point is that taxes / household misses a lot of economic activity. A lot of GDP is transferred between parties that are not households (though we should make a distinction between assets that are not doing anything, which add to net worth but don’t add to GDP, and assets moving between parties that are neither governments or households. Inventory that does not move does not add to GDP.) Corporate taxes are taxes on economic activity that has not been transferred to households. It could, eventually, get transferred to households, or it could be retained, invested in projects, or sat on (as is the current situation). A significant amount of taxation is on that 32% of GDP that is in businesses, but not transferred to household income.
Related – 1.8 billion of cash that corps are sitting on = 13% of GDP. (and I am not saying that that 1.8 billion is part of GDP – net worth vs GDP again – but consider the scale).
Why should government spending get under 20% of GDP? It ran over 20% of GDP through most of the Eisenhower era, which was a time of dramatic growth for the US. Government expenditures are more than 20% of GDP for most of the OECD countries (more than 30% actually), including those that weathered the great recession better than we. If there is a Laffer curve, and I think we can presume there is, than the evidence would point to the US being on the upslope with plenty of room to move up.
John
For those who haven’t seen it, the NY Times budget puzzle pretty much exposes the flaws in the GOP’s approach both to the short and the long term deficit, in a way that people who don’t know a $Million from a $Trillion can see.
http://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html
The optimal GDP spending percentage, is kinda like the Laffer Curve. It’s not only tough to define, but it’s situational. For a theoretical country just starting out, it HAS to start at near 100% and stay there until the “pump is primed”. Similar for a country who’s economy AND population are exploding (ala the Eisenhower era). If we crash, and have to literally rebuild, we will see near 90% of GDP spending.
But there is good eveidence when it’s too high (likely when we’re on the bad side of the Laffre Curve, too). I’d say that when Gov-spending is over half of ALL the personal income, we’re WAY on the bad side of both.. and as evidence, I’d submit that like today when it takes TWO average incomes to raise a family, that the ratio twixt the gov’s share of the GDP, and the citizens share is totaly out of whack.
Another nebulous reference is, Government Freedom Day (not tax freedom day). Since there’s no disputing that the average house has to somehow generate $37,000 to support the government (and that’s JUST the federal government)… we’re working completely FOR the governemnt, well into August. How can that healthy, when not long ago, it was half of that ?
If, when all is said and done, 2/3 of a citizen’s labor ends up in some level of government’s hands.. the government spending is much too large a percentage of GDP, and the “good” side of the Laffer Curve is well behind us.
Here’s an eye-opener…
I just ran the numbers for the heart of the Eisenhower years (1957).
Population=170,000,000
Federal Spending= $77,000,000,000
Household Income= $5,000
Per-houseld cost of federal spending = $450
Their share per household of federal spending was less than 10%
Worthwhile Canadian Initiative’s Nick Rowe took a stab at this a couple years ago.
Hmmmm what happens when the corporates savings glut moves but moves into employing German / Chinese workers to construct US jobs. Has this dynamic always existed, not since Clinton made China a ‘Foreign Friend’. Whilst I like your charts and analysis the structural rate is higher than you suggest due to increased globalisation……Good piece.
Your numbers are just plain wrong. $450 is the PER-CAPITA share of federal spending, not per-household. Avg household size in 1957 was 3.33, so Federal spending per family is about $1,485.
Number of households 1957 = 49,673,000
GDP in 1957 = 461,000,000,000
GDP / Household = $9280(roughly)
Household income as % of houshold GDP = 5000/9280 = 54%
Households received considerably more of a share of GDP than
Federal Expenditure 1957 = 77,000,000,000 = 17% gdp
Total Government expenditure 1957 = 102,000,000,000 = 22% gdp
Per houshold government expenditures = $2053 = 41% household income.
But none of this really gets to the question of why government spending has to be less than 20% of GDP, or less than 50% of household income. Much of government spending goes into household income (from social insurance, government employees, govt economic activity), etc. Your argument is that a greater percentage of houshold income should come from private sources, not public. But that is an a-priori assumption, not backed up by the data that you are presenting.
Most of the OECD countries have govt share of GDP of greater than 30%, some much more. To conclude that there is a general rule that expenditures have to be less than 20% of GDP goes against the reality of most of the developed world. Current total US government spending is about 36% of GDP (5,282 billion / 14,657 bil). That still puts us on the lower end of all developed countries.
As you state, the optimal role of government % of GDP varies. “If we crash, and have to literally rebuild, we will see near 90% of GDP spending.” We did crash, and our GDP is well below our potential output. Now government spending (all) is 36% of GDP. Do we rebuild, or try to maintain an arbitrary percentage of govt/GDP regardless of our potential output? (I know what Hoover would say).
John
Rebecca, just to pound my spoon on the high chair about one of my pet peeves, in the NIPAs this is not called “excess saving.” It’s called saving.
It’s the antithesis of (fixed) investment a.k.a. investement spending — if you do one with a dollar, you by definition do not do the other.
We really need to eradicate the misconception out there, created by confusion re: the S=I identity (and the dual uses of the word “investment), that savings and investment are somehow equivalent.
If you “save” money — store it in financial assets (often called “investing”), you are by definitiion *not* investing in fixed assets, which is what the NIPAs mean by “investing.”
So these shouldn’t be referred to as “excess savings.” Just promulgates the confusion. They’re savings.
In addressing these questions, why do people only tend to look at flows and not stocks? Households can be divided into many different sectors by both income levels and stocks of wealth. Taxing wealth, rather than just income, can turn stocks into a flow, and shift wealth from people with a high propensity to save addtional income and build stocks to those with a higher propensity to spend income.
It seems to me economists tend to ignore wealth and focus too much on income, because transactions are measured more readily than stocks.
Household wealth and income has taken a pounding over the past several years for everyone other than the top 10% in the plutonomy. A combination of deficits and redistributive taxation is needed to fix the pathologies of the Great Income Crash.
Businesses don’t spend when they don’t think there are enough customers with enough dispasable income to make the spending profitable. Call that a “saving glut” if you want. But that’s just the flip side of a demand deficiency.
We really need to eradicate the misconception out there, created by confusion re: the S=I identity (and the dual uses of the word “investment), that savings and investment are somehow equivalent.
Absolutely! It’s worse than a misconception. It’s willful bamboozlement. I imagine confusing these two was less common in a bygone age when people and businesses actually took some of their specie and gold and locked it up in a safe. But given that the means of saving now usually involves purchasing a financial asset, it’s easier to be duped by the myth that saving is all somehow canalized into business purchases on non-financial assets.
Rebecca,
I have a couple of questions / requests:
Can you report standard errors or p-values for your regression (i.e. final graph in OP)?
Why don’t I see any measures of aggregate demand or household spending?
The bigger the government the slower the 10-year growth rate for the economy. The government is an overhead that the private economy must support. The bigger the government the less they have to invest in growth.
http://pair.offshore.ai/38yearcycle/#governments