Tuesday, January 31, 2012

The letter the New Yorker didn't want you to read!

To the Editor:

In “Private Inequity” (January 30), James Surowiecki proposes addressing private-equity’s “financial gimmickry” by capping the deductibility of corporate debt and closing the carried interest loophole. That sounds complicated and politically challenging. Reformers would be better-served by a policy that simply coupled an increase in the capital gains and dividends tax rates with an offsetting reduction in corporate income taxes. It may seem counterintuitive to lower corporate income taxes, but doing so will reduce corporate debt levels because it makes debt more expensive (the lower the tax rate, the lower the value of a deduction). The benefits extend beyond this, however, as it instantly improves the business case for every potential domestic corporate investment, generating immediate stimulus to our economy and permanently tilting the balance away from offshoring jobs.  Meanwhile, the offsetting, tax revenue-neutral nature of this approach leaves shareholders unaffected by the change, preempting the Republican concern that higher taxes on capital gains and dividends dampens investment. Moreover, it complements Democratic efforts to raise taxes on wealthy individuals because, to the extent that it encourages businesses to organize as corporations, it disarms the well-worn Republican charge that raising marginal tax rates on individuals hurts otherwise job-creating businesses filing under the individual tax code. For all of these reasons, offsetting higher taxes on capital gains and dividends with lower taxes on corporate income is good policy.

Saturday, January 21, 2012

why we work

"Now is the time to make an adequate income a reality for all God's children. Now is the time for City Hall to take a position for that which is just and honest."
     - Dr. Martin Luther King, Jr., addressing striking sanitation workers in Memphis, March 18, 1968 

The living wage movement uses MLK's words as a rallying cry to require employers to pay enough for people to get by. A noble aim, but it's an example of how a simplistic view of our role in the economy leads to self-defeating policy. Unfortunately, you shoot yourself in the foot when you target wages.

We should consider why we work in the first place: to pay for the things we need to get by. I can tell you that if everything were free, I wouldn't be a worker at all (if only!). It follows, then, that our interests as consumers should take precedence over our interests as workers, and that we are better served ensuring the adequacy of our income by focusing our efforts on reducing the cost of living rather than increasing our means to meet it. Not only would we more directly address the essential problem at hand, we would avoid the self-defeating aspect of increasing aggregate income, a scenario where the benefit of higher wages is offset by the inflationary pressure pay raises put on production expenses. Your standard of living doesn't improve if your raise is offset by price increases. Lazy people like me appreciate how this dynamic sends us in the wrong direction.

Perhaps this sounds uncomfortably similar to the supply-side economics championed by the right since the days of Reagan. Still, we can't ever let partisanship triumph over reason, and it's a valid observation that we should prefer cutting costs to raising income (if food were free, wouldn't you join me in a life of leisure?). The distinction we need to draw is in the policy implications of this simple insight. While events have thoroughly discredited the Republicans' sloppy and simplistic tactic of making rich people richer, a smarter, more precise approach would achieve the ultimate goal of broadly shared prosperity. As I will argue in future posts, in order to do so, the left will need to reconsider its take on some of its favorite villains, including corporations and globalization.

Sunday, January 8, 2012

Household debt, part III: The road ahead, or I can't drive 55

My 3rd -and for now, final - post on household debt concerns its implications on our future. If we continue on our current trajectory, it could take people a decade or more to pay down their debts to a sustainable level. Perhaps Washington will do something to help speed this up, such as enacting a more effective mortgage modification program, but I'm not holding my breath. Meanwhile, the deleveraging process places a drag on our macro growth prospects as people will need to live below their means in order to repay their debts. (As an aside, while this may seem intuitive, it's not as broadly accepted as you may think. However, this fairly readable study from the Federal Reserve Bank of San Francisco makes a compelling argument).

Despite this, I'm optimistic. While we have a huge hole to dig out of, things are actually going better than I expected. For example, the chart below depicts the portion of after-tax household income that goes to servicing debts. It should first be noted that this data is very sketchy and is useful more for trend analysis than as an absolute measure. Still, incredibly, and no doubt aided by the Fed's maintenance of extraordinarily low interest rates, households are now operating at a level not seen since the mid-90's.

I expect this to be sustainable because the employment picture has been getting better recently and the Fed has been going out of its way to set expectations that it won't touch interest rates for at least another year. These two factors could also be somewhat inflationary, which would be helpful, despite what you hear from some corners. This is because wages generally track inflation, so, since the face value of the outstanding debt is fixed, higher inflation makes it easier for people to manage their debts.

Another cause for some optimism here relates to the actual impact the deleveraging is having on our growth. This chart indicates the rate of consumption growth after inflation over the last 15 years. We only have 2011
data through November, but still what we have shows that personal spending is now growing at more or less the same rate as it was before the recession.

Moreover, as the next chart shows, even after accounting for inflation personal spending is not only back above where it was at the start of the recession, but other than flat-lining during the "double dip" scare earlier in the year, it's been on a
pretty consistent uptrend
for a while now. When you
consider how much better
the employment picture has gotten recently, it would be reasonable to expect this trend to have legs.

Economic forecasts are generally horrible (what Obama would give to be able to take back "recovery summer"!). While we can project out from current trends, unforeseeable influences will undoubtedly emerge and could easily overwhelm the status quo. Still, while we know about threats from Europe's sovereign debt crisis and China's growth deceleration, to name two of the bigger ones grabbing headlines, it's perhaps harder to predict positive surprises, such as the potential for constructive action from Washington, or the impact of the human capital upgrade as people left the labor force to go back to school. Also, growth can be self-reinforcing -in a manner equal and opposite to the recession's vicious cycle- and we may already have enough momentum to make it more difficult for bad news to derail us.

However, in the interest of full disclosure I should point out that my optimism is far from the consensus view. Many economic forecasters are predicting a slow-down in the first half of 2012, with some even expecting a recession. I don't see it in the data I'm looking at but who knows; or as Sammy Hagar once sang for Van Halen, only time will tell if we'll stand the test of time.

Wednesday, January 4, 2012

Dirty money

Are you in the mood for some Occupy-style outrage? Let's look at this household debt chart again, highlighting the Reagan and Bush II Presidencies, eras which featured tax policy aimed at disproportionately benefiting our wealthiest:

You'll note that both periods featured rapid escalations in the growth rate of debt relative to the ability to repay it, and it's no coincidence. It's a tragic case of keeping up with the Joneses: people see their wealthier neighbors spend more, so they have to spend more so as not to lose position in the pecking order. This explanation is reinforced by the fact that the mix of who held this debt changed during this period, as the top 10% income earners actually managed to reduce their share 8% between 1989 and 2007 (source: Federal Reserve 2007 Survey of Consumer Finances). In other words, trickle down debt.

What does this mean? A friend of mine characterized it as a matter of regressive government handouts, where the rich got the clean money provided by tax cuts and the regular people got the dirty money facilitated by interest rate cuts, as both the 1980s and 2000s saw some aggressive monetary policy. A conspiracy theorist may interpret this as an attempt to repress the lower classes by inducing them into indentured servitude. The less conspiratorially-minded would point out that those rate cuts were reasonable responses to events such as the end of early 80's inflation, the 1987 and 2000 market crashes and the post-9/11 recession. 

Indeed, it misses the point to seek retribution. The takeaway is simply that we shouldn't allow the politicians who still support these policies - including every GOP Presidential contender and most of their colleagues on Capitol Hill - to come within 1,000 yards of the corridors of power. You don't need a grand conspiracy theory to be concerned about the oppressive nature of carrying a high personal debt burden, or to be outraged at this result of the now-obviously ridiculous notion that making the rich richer would benefit us all. 

Sunday, January 1, 2012

one number to rule them all

There is already a bookshelf full of analysis picking apart the wreckage of the economic calamity to determine why it happened. Tons of blame has been passed around - incompetent or unethical bankers, Fannie & Freddie's structural flaws, unscrupulous mortgage brokers, trickle-down economics - and I don't doubt that there's some validity to all of it. To me, the debacle exposed flaws in every link of the chain.

Still, I think the whole mishegas can ultimately be boiled down to one thing: the consumer debt surge that preceded the disaster. I'll have more to say about this in future postings, including why it happened and its implications on how we move forward, but if a picture tells 1,000 words, it's worth taking a moment to consider the chart below, which depicts the debt burden of American households since WWII:

Two conclusions you can easily draw from this:

1. In retrospect, it's hard to imagine a soft landing to what built up over the last 25 years.

2. Despite the relative thriftiness of the last 3 years, we still have a long way to go.