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

2013 and All That

There is continued discussion of how fiscal tightening in the first quarter of 2013 (the fiscal cliff in January and Sequestration in March) was followed by decent growth in the second half of 2014. I have already written much more than enough about this, but I have two more thoughts.

First 2013 was not just a year of Federal fiscal austerity, it was also the year of the taper tantrum when interest rates jumped up immediately following a press June 19 2013 conference where Ben Bernanke said that the Fed would taper it’s asset purchases. This means that there was a contractionary fiscal shock (really mainly the fiscal cliff tax increase January 1 2013 not sequestration) in the first quarter and a contractionary forward guidance of monetary policy shock in the second. No matter what one’s view of the relative effectiveness of fiscal policy and of non standard monetary policy at zero lower bound, one would expect disappointing growth. Also growth remained very disappointing compared to forecasts of rapid growth reducing the output gap as all past US output gaps have shrunk.

Second the lags people use are getting extremely long and variable. The debate was triggered by the surprisingly high growth in the third quarter of 2014 (the rapid growth from the first to the second quarter could be ascribed to the economy thawing after the polar vortex froze 2014q1). This is six quarters after the contractionary fiscal shift and five quarters after the contractionary non-standard monetary shift. This is very odd data analysis, especially since those who believe that fiscal policy works believe it works mostly without long and variable lags.

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How About Pegging a Long Term Interest Rate ?

As often, Paul Krugman has an extremely interesting thought. Discussing the sudden end of the Swiss Franc Eur peg he wrote

This in turn helps us put the explicit exchange rate target into the right slot: it was about making QE effective through commitment, so that you got the maximum impact on expectations. Actually, the success of the currency program suggests that other central banks might want to try things like setting a ceiling on some long-term interest rate.

I think the paragraph is pretty clear but will try to explain a bit more. There are two huge advantages of a peg. First the rule for maintaining one is very simple — just sell at a price as much as people want to buy and buy as much as they want to sell at that price. Also, whenever markets are open, people can see if it is being maintained . We can see that the Fed is sticking to its declared target federal funds rate immediately. It always does. I’m sure the Federal funds rate is perceived by some (of the those who know what it is) to be an instrument under the administrative control of the Fed.

The Fed could declare that the 10 year constant maturity treasury rate shall be no higher than 1% and then make it so by buying enough notes and bonds.

I see two questions. First which long term interest rate ? Second, what might go wrong ?
The interest rates the Fed would most like to set are interest rates on risky assets such as mortgage bonds or at least low grade corporate bonds. The problem here is that the say the Baa corporate bond rate is an average of the rates on many different bonds. If the Fed were to promist to buy any of them at a yield of 2% say, then it would buy the worst Baa bonds. Pegging one price for a bunch of different things is the perfect way to achieve adverse selection. I think that it is much more practical to set a long term Treasury rate.

Now the 10 year constant maturity rate isn’t the return on a particular note or bond. It is an index calculated with a complicated formula. However, it is calculated with a standard formula and can be recalculated very quickly. All the different Treasury securities the returns on which are involved in the calculation are equally safe.

To simplify, I am now going to consider a silly but simple target in which the Fed puts a ceiling on the return of a particular bond which I will call the target bond. That is equivalent to setting the price of that bond and this can be achieved buy buying or selling unlimited amounts at that price.
OK so what could go wrong ? Here I think the problem is that it might be that to keep the price of the target bond at the desired floor (so the yield at the desired ceiling) the Fed would have to buy exactly 100% of the target bonds that have been issued. Then the market for the target bond would freaze with the Fed offering to sell it for a price higher than anyone is willing to pay.
The effect of the simple policy would be to eliminate an asset. Returns on very similar assets which are not bought and sold by the Fed might be very different.

This silly result is partly due to my considering the silly so simple I could do it policy. But I think that it illustrates a real problem with setting a ceiling on a long term interest rate -the yield curve is flexible and pushing on one part of it doesn’t have to move all of it. I think there is a tradeoff between setting a simple well defined long term interest rate target the monetary authority can actually reliably hit and influencing a large part of the huge set of long term interest rates which matter.

I think there is a lot of devil in the detail of choosing “some long-term interest rate”.

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Obama’s Populist Tax Reform Proposal

Barack Obama has released the details of a fairly radical proposal to increase tax progressivity which he will make in his state of the union address.

The political impact will dwarf that of Chris Van Hollen’s proposal (which I am sad to say, has been quite dwarfish already). I am very enthusiastic about this. Even Romney is trying to sound populist. I am sure that politicians must have convincing evidence of a populist mood from polls and focus groups even aside from the public polls which, as always, show strong support for soaking the rich. I don’t see how Republicans can win this debate or even avoid debating with each other over whether Obama is a socialist class warrior or not a true economic populist like Republicans.

Matt Yglesias has an excellent (as usual) explainer at Vox. Basically the proposal is to increase the capital gains tax, close tax loopholes used by the rich, tax borrowing by huge banks and then use the proceeds to make permanent and expand various tax breaks for the non rich.

Of course, the proposal is politics not policy — there is no chance of Congress seriously considering it, let alone, passing it. I don’t have a problem with making political gestures when actual policy making is blocked by partisan gridlock. However, good policy and good political gestures are not identical. My one thought is that the tax cuts are much too complicated. I think it would have been much wiser to propose just cutting taxes of the non rich by some fixed amount as in the ARRA (and Obama’s successful 2008 platform) [update: and pay for this with the tax increases which I support as proposed]..

The proposal will be discussed but not implemented. It is therefore much more important that for it be simple and easy to understand than for it to be optimal policy. And to be frank, I think it is important that the proposal give money to almost everyone.

In other words what Lord said about the Van Hollen proposal.

Lord
January 12, 2015 12:41 am
Needlessly complicated. Simply raise the exemption level.

update: just to be clear, my proposed proposal would be to keep the fairly complicated loophole closing and tax increases, but to replace the proposed targetted tax cuts with a broad simple tax cut. The quote of Lord from comments should have been paraphrased to “the tax cut parts are ‘Needlessly complicated. Simply raise the exemption level’ and close the loopholes”.

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My GASB comments

Well, I should have taken my own advice and not waited until the last minute to submit my own comments on the proposed standards for government accounting of subsidies. But, at long last, they are in. Below please find them in their entirety.

Director of Research and Technical Activities

Project No. 19-20E

Government Accounting Standards Board

January 14, 2015

Dear Director:

I am writing to comment on the proposed standards for reporting the “tax abatements” given by state and local governments as part of their Comprehensive Annual Financial Reports (CAFRs). Let me begin by saying that I welcome this proposal and want to urge the Board to be sure these standards are truly comprehensive.

I write from a unique vantage point because my best-known academic work consists of making estimates of the value of subsidies given to companies by state and local governments. This includes two books: Competing for Capital: Europe and North America in a Global Era (Georgetown University Press, 2000) and Investment Incentives and the Global Competition for Capital (Palgrave Macmillan, 2011). In my latter book, I estimate that in 2005 state and local governments gave just under $50 billion in business attraction subsidies and perhaps another $20 billion in subsidies not tied to making an investment. In addition, I have written numerous journal articles and book chapters on tax incentives and other forms of subsidies to attract investment. The proposed standards, if done correctly, would put me out of the estimation business, and that would be a great thing. In the United States, there is a terrible lack of transparency in the use of these incentives, which makes informed policy analysis very difficult and, in some cases, impossible. Not only that, the lack of transparency hinders the ability of bond and other financial analysts to determine the true long-term financial position of a government entity that may be seeking to borrow through the bond market.

I am regularly interviewed by, and have my work cited in, well-known publications such as The Wall Street Journal, Bloomberg, The St. Louis Post-Dispatch, Los Angeles Times, etc. I have consulted on these issues for the Organization for Economic Cooperation and Development (OECD), the International Institute for Sustainable Development, the North Carolina Budget and Tax Center, and the Missouri chapter of the Sierra Club. I hold the position of Professor of Political Science at the University of Missouri-St. Louis, where I have taught for 23 years. Let me note for the record that the comments which follow are my own personal recommendations and my views are not necessarily shared by my employer or consulting clients.

Let me begin by highlighting an important terminological problem caused by the Board’s use of the term “tax abatement” as its catch-all term for the policies under discussion. In fact, a “tax abatement,” properly so called, is only one form of subsidy to attract investment to a state or locality, and most likely not the most important one, depending on the governmental entity in question. A true tax abatement relieves its recipient from having to pay certain taxes that would otherwise be due, most usually the local property tax. It is merely one form of a broader category of support for business investment that I generally call an “investment incentive,” “location incentive,” or “location subsidy.” I define all three of these terms as “a subsidy to affect the location of investment.”

What, then, is a “subsidy”? To answer this question, we can turn to the “Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, April 15, 1994,” which was adopted into U.S. law via Public Law no. 103-465. Thus, the definition of a “subsidy” established in the Uruguay Round’s “Agreement on Subsidies and Countervailing Measures” (SCM) is in fact a provision of U.S. law. This is important to keep in mind in the discussion that follows.

Article 1 of the SCM defines a subsidy as follows:

1.1 For the purpose of this Agreement, a subsidy shall be deemed to exist if:

(a)(1) there is a financial contribution by a government or any public body [note that his means this section applies to all state and local governments within the United States] within the territory of the Member (referred to in this Agreement as “government”), i.e. where

(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);

(ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits); [footnote omitted]

(iii) a government provides good or services other than general infrastructure, or purchases goods;

(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments; [an anti-evasion rule]

Or

(a)(2) there is any form of income or price support in the sense of Article XVI of GATT 1994;

And

(b) a benefit is thereby conferred.

To sum all this up, the Agreement on SCM establishes a definition of “subsidy” that includes any potential subsidy mechanism, carried out by any level of government (for example, the Washington B&O tax reduction that was a major element of the European Union’s complaint against subsidies to Boeing, a case the EU won), one not evaded by simply claiming that it was a private body carrying out the subsidy. In effect, if the subsidy exists in law or in fact, the subsidy rules come into play.

This principle that a subsidy existing in law or in fact must be counted is an important one when examining the Board’s proposed rules. Some tax measures that are obviously subsidies under the SCM definition (again, something incorporated into U.S. law) might not be considered “tax abatements” using a strict reading of the definition of that term. Consider the case of tax increment financing (TIF). In the states with which I am most familiar, a TIF recipient is legally considered to have paid its property tax even though its payment flows immediately back to its own benefit. If the entity has legally paid its property tax, how can one say that government has “foregone” the revenue? The answer, of course, is to look at the facts as well as the law. GASB’s rules must ensure that they follow the facts and ignore legal fictions. Otherwise, huge swathes of tax-based subsidies will not be counted, and bond analysts and other researchers will not have the facts they need to establish the true financial situation of a government. This is similarly true of situations where the tax foregone is not due from the subsidy recipient. For example, many states allow companies to keep personal income tax withholding from their employees. In Missouri, local taxing districts called transportation development districts collect an extra sales tax from customers, but keep the money until they have received the entire subsidy they negotiated from a municipal government. It does not matter whose taxes are foregone; the rules must capture the subsidy itself in order to be useful. These are not small programs, either. In California, by 2010 TIF was generating $8 billion a year in tax increment for local governments, which was largely plowed back into paying the subsidies they were tied to (or equivalently, paying off bonds which funded the subsidies). In the much smaller Missouri economy, both TIF and transportation development districts see hundreds of millions of dollars of new subsidies committed annually by municipal governments.

In light of the fact that investment incentives may not be entirely tax-based, I believe it to be important to at least cross-list cash grants paid to companies with the “tax abatement” they receive. From anecdotally talking to reporters calling me about various incentive packages they are covering, it appears to me that there is an increasing trend for cash to make up a significant chunk of these packages. If the new rules require such cross-listing, we can then see in one place how much money a state or local government is committing in subsidies to attract businesses. This information gives us important clues about future fiscal trends from a government, as heavy users of incentives tend to remain such well into the future; however, there is no telling from one year to the next what the split will be between cash and tax-based subsidies.

On a related point, the rules absolutely need to include future amounts committed for tax incentives. Once again, without such transparency it is impossible for bond or other analysts to derive a true financial picture for a particular government.

Last, I would urge that the reporting of location subsidies be made on a firm-specific basis. If a single company is receiving tens of millions of dollars in tax breaks per year from a given municipality, with many more tens of millions committed in the future, it could signal that the municipality is highly vulnerable to anything which adversely affected the recipient. A city like Flint, Michigan, was devastated when the numerous subsidized General Motors facilities in the city began to go out of business in the 1980s.

In summary, then, the most important principle to consider is that transparency must be comprehensive. If the rules have loopholes allowing governments to not report certain types of subsidies, those subsidies will not be reported, and everyone relying on data reported under the new rules for accurate financial information – from citizens to investors – will be misled by numbers that don’t reveal a government’s true financial situation. Please require the most comprehensive reporting possible, for your efforts to live up to their potentially game-changing value.

Sincerely,

Kenneth P. Thomas

Professor of Political Science

University of Missouri-St. Louis

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Social Security Defender Shared Files

Who or what is ‘Social Security Defender’? Well it is basically a G-mail account controlled by me: socsec.defender@gmail.com . Which is kind of pretentious and vainglorious on my part but does allow a platform for some attached products including the blog Social Security Defender and a Google Drive. In which as an experiment I have created a Public Folder called Social Security Defender Shared Files into which I plan to save any number of official SSA and CBO Reports and tables and figures extracted from them. So if this works you should be able to Bookmark/Favorite the link and have a one stop location for lots of Social Security resources.

As of this moment the folder includes a PDF of the 2014 Report, folders containing TIFFs and PNGs of the various Figures from that Report, plus maybe a copy of my 2014 SocSec Report Tables Workbook which might or might not open for you in Excel or be able to be saved to your own Google Drive to open in whatever. I have been wanting and planning to ramp up Social Security Defender into an integrated product supporting the blog, a Google+ site, and file sharing for about four years but given that the enemies of Social Security had simply gone on hiatus recently put the project on the back burner. Well THEY’RE BACK!!! and attacking via the Disability program. So here we go.

Feedback and advice can be left in comments or sent to the g-mail address. Thanks.

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Interest Rates, Mortgage Refinancing and Consumption

This is a discussion in a comment thread which I think is worth pulling back. I claimed (as I often do) that interest rates do not have noticeable effects on consumption. Please notice the “noticeable” — it is an appeal to standard econometric analysis of aggregate time series.

OK the discussion

EMichael
January 16, 2015 10:14 am

Reason,

One other thought while readily admitting I am out of my element here.

A couple of weeks ago I did a private refi for a buddy of mine. He was at 7.5% on 300gs, paying PI of $2084 a month. Now he is at $1578 while keeping the term the same at 4%.

That is $500 a month of potential consumption caused by low interest rates. And knowing my buddy, he will spend it. 🙂

part of my reply

I will claim that consumption (as officially defined) is not noticeably correlated with interest rates. The key word is “noticeably”. I assume that EMichael’s friend’s consumption will increase. However, as far as I know, the effect of such events on aggregate consumption is so small that it doesn’t show up in the aggregate data.

The correlation between the achieved 3 month real interest rate and the consumption disposable income ratio is -0.13. OK I should look at the mortgage rate, but this is a blog comment.

Always I am discussing how to model the economy. I don’t claim that my story is a complete description of everything which happens in the economy. I am discussing which effects are small enough that they can be neglected when modelling.

Coberly
January 16, 2015 6:07 pm
Robert

i would guess that while emichael’s friend’s consumption would increase
(unless paying interest is “consuming” a financial product), the guy collecting the interest would decrease his consumption…. unless he got paid off and so increases his consumption with the money he now has “not lent.” in that case maybe the new mortgage holder would have less consumption than the first…

update: the interesting comments continue. Marko knows a lot more on the topic than I do.

Marko
January 17, 2015 4:38 am

You might have better luck seeing an effect if you looked at durables – and , more specifically , auto sales. A common use of a sizable windfall via mortgage refi seems to be splurging on a new set of wheels. Another common use is paydown of high-interest debt , like credit cards , which doesn’t increase current consumption , but bodes well for consumption in the future ( assuming that lower debt load households will tend to consume more than higher debt load hhs ) .

Also , you have to consider the after-tax impact of lower mortgage payments – you probably only get about 70-75% bang for the buck after tax , which makes for a pretty good hit to “noticeability”.

A couple of recent papers :

http://www.nber.org/papers/w20561

http://www.voxeu.org/article/low-interest-rates-can-boost-households-consumption

– See more at: http://angrybearblog.com/2015/01/interest-rates-mortgage-refinancing-and-consumption.html#comment-2538304

End update

My long confused and confusing reply to Coberly after the jump (and down in the thread)

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Social Security Report Tables & Figures: a Project Sample – Table V.B2

Table V.B2: Additional Economic Assumptions
Well I am back and working on a new project in anticipation of the release of the 2015 Report this late Spring. The project involves extracting the Tables and Figures from the Social Security Trustees Report, in this case the 2014, and having them individually web accessible as spreadsheeets or images or both. This first attempt is to present the Table that has projections for Unemployment going forward both over the short run and in ultimate terms. Since this is mostly a test of concept I will just let people see if they can actually access the data. I would point out however that under the Intermediate Cost Alternative (i.e. standard and supposedly median projection) Unemployment for 2014 was projected at 6.9% and then staying above 6% until 2017 after which it would settle quickly to 5.6% in 2020 and ultimate 5.5% by 2025. When we turn to the more optimistic Low Cost Alternative (which in toto would have Social Security self-fund under current formulae) we see that even there 2014 UI was set to be 6.7% in 2014 and 6.1% in 2015 before settling fairly quickly to ultimate 4.5%.

Now what does it mean that actual UE in 2014 came in under both Intermediate and Low Cost and projects to do the same in 2015? Well hard to say, in order to make some judgement you would have to look at all the economic and demographic variables in Tables V.A1-A4 and V.B1-B2 over the ten year window while keeping an eye on ultimate numbers and then examine the various Sensitivity tables for each of those variables. And what would help with that is someone compiling all those Tables and Figures into individual files as opposed to just linking to a ginormous HTML or PDF of the whole Report. Of which this is a sample. Comments on either the project or the unemployment numbers welcome in Comments.

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