An update on some developments on the fiscal-trap front:  After a Levy brief on fiscal traps was issued in November, events continue to bear out the fears expressed therein that budget cuts and tax increases being implemented in Europe and the US would lead to disaster.  For example, recent news coverage of events surrounding the announcement of the UK budget confirm that the trap can hit nations that possess their own currencies, particularly in a region such as Europe where recessionary forces are dominating at the moment. Martin Wolf notes that owing to disappointing growth figures, the UK deficit surprised again on the high side. As the fiscal-trap theory asserts, governments implementing austerity policies have run into unexpectedly low growth in their attempts to reduce government debt.

Meanwhile, despite the warnings of macroeconomists, including those here, the austerity measures that together make up the fiscal cliff in the US were only partly averted.  Among these policy changes are the loss of the 2-percent partial payroll-tax holiday and the sequester cuts to discretionary spending. The latter unfortunately went into effect at the beginning of this month, following a two-month Congressional reprieve. Based on unofficial data from the Bipartisan Policy Council in this New York Times article, which are similar to those in a recent and more detailed CBPP report, the cuts for the remainder of the fiscal year are large as a percentage of planned spending, as seen in Table 1:

Dollar amounts shown in billions.

continue reading…

We expect the unexpected at the Levy Institute. As followers of Keynes, most economists here, including this author, believe that one cannot assign exact probabilities to most important economic outcomes even, say, six months into the future.

On the other hand, thinking about the economic debate on job creation, and the recent release of new jobs data, I have not been very surprised at the gradual pace of progress in reducing the unemployment rate. In fact, we on the macro team have consistently called for more fiscal stimulus rather than less. The reason is that unemployment is a relatively slow-moving variable. As the chart at the top of this post shows, the unemployment rate (shown as a blue line) fell only rather gradually after each of the previous three recessions (shown as shaded areas in the figure). (Here, we count the double-dip recessions of 1980 and 1981–82 as one.) Hence, once the recovery began, we knew that with the unemployment rate at very high levels, it needed to fall unusually fast to be at reasonable levels by this point in the Obama administration.  Hence, since 2007, the team has advocated an easing of fiscal policy. Instead, especially after the 2009 ARRA, little action was taken by the government to stimulate the economy. Partly as a result of inaction on fiscal stimulus, government employment as a percentage of the civilian workforce (red line in the figure above) peters out after 2010.

At this point, we hope for legislation to moderate January’s expected “fiscal cliff”—which will lead to perhaps a $500 billion in reductions in the federal deficit in 2013 unless laws are changed, by CBO estimates.  (In its current form, the cliff would probably have a serious impact on all economic and demographic groups. Lately, I’ve been working on a model that incorporates the larger effects of an additional dollar of income on spending at lower income levels—not a simple task.)

In the figure, both lines are shown in the same units, namely percentages of the civilian labor force age 16 and above, though the two lines use different scales, one on each side of the figure.  For example, a one-unit change in the blue line represents the same number of workers as a move of one unit in the red line. A hypothetical jobs program or another spending measure that gradually increased government employment (red line) by, say, 1 percent of the total US workforce might easily have led to an unemployment rate (blue line) for last month of 1 to 3 percent less than the actual reported amount. But government does not seem to be expanding; in fact, the red line shows that government employment shrank at a time when more hiring from that sector would have been of great help to the economy. (The figures include employees of local and state governments, as well as those of the federal government. The smaller governmental units have seen the biggest cuts in payrolls.) continue reading…

The cliff approaches, and politicians and pundits in Washington are pondering how to deal with it. For those who have forgotten, recent nontechnical summaries of the legislative issues and amounts of money at stake can be found here , here, and in this old post. But essentially, the term “fiscal cliff” refers to a massive group of tax increases and spending cuts due to take effect on or around January 1 of next year. President Obama and some Congressional Democrats are seeking to take a stand for distributional fairness and deficit reduction at the same time by pushing for a renewal of the Bush tax cuts, but only for those with incomes less than perhaps $250,000 for a couple. On the other hand, some long-time fiscal conservatives are seeking to cushion the blow by delaying the impact of the spending cuts and tax increases and by seeking a less indiscriminate choice of program cuts. They emphasize that in any case, draconian measures must in their view be taken eventually and committed to now.

From the point of view of Keynesian macroeconomics, what the fiscal conservatives fail to understand is that the economy requires even more fiscal ease than they have been willing to contemplate so far; otherwise, like Spain and many other European nations (see the FT and the WSJ on the European austerity debate), this country will experience such weak economic performance that even the goal of reducing the deficit will be elusive—let alone feeding the hungry, keeping states and localities from going broke, maintaining an adequate defense, or funding scientific research.

The automatic spending cuts (known also as sequesters) due to take effect soon are designed to hit almost every discretionary defense and nondefense spending item—to the tune of 10- to 15-percent cuts in what the federal government spends each day on average on these items. continue reading…

Mark Thoma has posted the English transcripts of a three-part interview of James Galbraith by the German website NachDenkSeiten.

In the first interview there is a brief exchange with Roger Strassburg in which Galbraith discusses the idea that the 1986 tax reforms, which followed the “lower the rates, broaden the base” mantra that we’re still hearing from lawmakers, may have contributed to dramatic increases in executive salaries:

JG: In the U.S. In the 1980′s, the progressive reform which was developed by Bill Bradley and Dick Gephardt in Congress was to reduce the top tax rates by extending the base, because the system of very high marginal rates was so riddled with loopholes and exemptions that top earners by and large didn’t pay it unless they were of a very peculiar type, for example a celebrity athlete like Bill Bradley himself or Jack Kemp, who was also in the Congress at the time. They paid very high rates on that sort of straight salary income that they had. But if you were in any kind of business activity, you had a depletion allowance or timber allowance or some other damn thing that got you out of that.

RS: That seems to kind of be the way that things always run, though, that wages and salaries end up getting taxed higher than anything else. It seems to happen in every country.

JG: That may very well be, but the point of the ’86 act was to reduce the rates at the top, but to expand the base such as to be revenue-neutral, which it largely was. I think the long-term implications of the ’86 act are only now being recognized in the economics profession. A major thing that it did was to – and that’s true also of the earlier Reagan cuts – was to create a strong incentive for corporations to shift income directly to their chief executives. I think the CEO boom was partly an artifact of the reduction of marginal tax rates, and that had very pernicious effects on corporate governance in the United States. I wrote about this in a previous book, in The Predator State, and I’m now beginning to see some commentary. I know that Thomas Piketty has come to the same conclusion.

… [I]f you have a high marginal rate, then you have an incentive to retain earnings in the corporation and pay the corporate tax rate and then to use the retained earnings in ways that add indirectly to the consumption of your top executives. You build a skyscraper with lovely penthouses in it, you have corporate aircraft, you have the whole aspect of this that characterized the way the big corporations presented themselves in the 50′s and 60′s in the United States. And they stopped building skyscrapers – when was the last time one was built? Probably the World Trade Center in 1970. There was very, very little after that, and corporations started building basically campuses, which are much cheaper, and instead funneling the money directly into the pockets of their chief executives.

Jens Berger then plays devil’s advocate and offers up the familiar alternative theory that these compensation increases are simply a “normal market effect”: continue reading…

Randall Wray has been engaged in a back-and-forth with John Carney of CNBC.  Their latest exchange touched on the question of the “real” economic burdens of Social Security (distinct from issues of affordability).  Wray responds:

“John Carney agrees with me that supporting our elderly is not an ‘affordability’ problem, but he claims that I fail to see the ‘real’ burden—the dependency ratios and all that. Actually I’ve been writing about that since the early 1990s. The ‘real’ burden is the only thing that matters.

Here’s just a short list of easily accessible things I’ve written at www.levy.org:

The Case Against Intergenerational Accounting: The Accounting Campaign Against Social Security and Medicare [2009]

Global Demographic Trends and Provisioning for the Future [2006]

The Burden of Aging [2006]

Social Security’s 70th Anniversary [2005]

Killing Social Security Softly with Faux Kindness [2001]

More Pain, No Gain [1999]

Does Social Security Need Saving? [1999]

… There are two important issues here. continue reading…

Some indigestible food for thought:  there is not a single state in the Union—not one—in which the top 1% of income earners pay a higher rate of state taxes than the bottom 20%.  For the majority of states, it’s not even close:  the poorest 20% pay somewhere between double and six times the tax rate of the richest 1%.  In Florida, those who make the least pay 13.5% of their income in state taxes, while those who make the most pay 2.1%.

This comes to us from Mother Jones’ Kevin Drum, who dug into the comprehensive “Assets and Opportunity Scorecard” recently produced by the The Corporation for Enterprise Development.

In the course of an interview by Alan Minsky from a couple of weeks ago, Michael Hudson discussed a proposal for setting up a public option for banking (following the “Chicago Plan” of the 1930s and, says Hudson, Dennis Kucinich’s recent NEED Act):

Instead of relying on Bank of America or Citibank for credit cards, the government would set up a bank and offer credit cards, check clearing and bank transfers at cost. …

Providing a public option would limit the ability of banks to charge monopoly prices for credit cards and loans. It also would not engage in the kind of gambling that has made today’s financial system so unstable and put depositors’ money at risk. …

The guiding idea is to take away the banks’ privilege of creating credit electronically on their computer keyboards. You make banks do what textbooks say they are supposed to do: take deposits and lend them out in a productive way. If there are not enough deposits in the economy, the Treasury can create money on its own computer keyboards and supply it to the banks to lend out. But you would rewrite the banking laws so that normal banks are not able to gamble or play the computerized speculative games they are playing today.

Hudson also argues that distortions in our tax system that encourage debt leveraging are contributing to the fragility of the financial system and worsening inequality:

Over the past few decades the tax system has been warped more and more by bank lobbyists to promote debt financing. Debt is their “product,” after all. As matters now stand, earnings and dividends on equity financing must pay much higher tax rates than cash flow financed with debt. This distortion needs to be reversed. It not only taxes the top 1% at a much lower rate than the bottom 99%, but it also encourages them to make money by lending to the bottom 99%.

Read the whole thing.  An edited transcript of the radio KPFK interview can be found here at NEP (with Hudson adding some post-interview elaboration).

I study the distribution of wealth and income here at the Levy Institute, so I read the first five hundred words of Robert Samuelson’s Washington Post column on inequality (“The backlash against the rich,” Oct. 9^th) with interest and approval. But I knew it couldn’t last. Once Samuelson gets beyond description and attempts explanation and analysis, he is clearly out of his depth.

Samuelson turns his gaze to the proposal to raise income taxes on those with incomes above a million dollars, whom he refers to as “job creators”—a Republican Party talking point that Samuelson repeats uncritically. He makes two mistakes in citing a paper, written by my colleague Ed Wolff, in which the distribution of assets for the top 1% of households by wealth (total assets minus total debt) is compared to the distribution for the bottom 80%. First, Samuelson seems to assume that those people who own privately held businesses are small business owners. Second, not all of the people in the top 1% of household wealth are households making more than $1 million a year in income.

In Ed Wolff’s paper we see that the wealthiest 1% of U.S. households in 2007 held more than half of their net worth in “unincorporated business equity and other real estate,” and only 26% in financial assets such as stocks, mutual funds, bonds, etc. It is clear that Samuelson is translating the former category as “small and medium-sized companies.” This could be an honest mistake. But it is a mistake. There is no evidence in Ed Wolff’s paper that the top 1% contains all (or no) “small business owners.” Just that they hold twice as much wealth in privately held businesses as in publicly traded businesses.  And as Kevin Drum of Mother Jones put it, “[w]e’re talking about people who earn upwards of a million dollars a year, after all. You don’t get that from taking a minority stake in your brother-in-law’s auto shop.”

If we actually look at those U.S. households receiving $1 million or more in income (using the 2007 Survey of Consumer Finances, as Ed Wolff does), we are talking about 0.37% of households. In terms of the composition of their assets, the picture is pretty much the same for them as for the wealthiest 1% of U.S. households.  But only 24% of the top 1% of household wealth are in the million-dollar income club. If you look at the bottom 99.6% or the bottom 80%, the picture is very different. continue reading…

Here is an excerpt from the most important article you will read this year, by George Lakoff:

Here’s how public intimidation by framing works.

The mechanism of intimidation is framing, not just the use of words or slogans, but rather the changing of what voters take as right as a matter of principle. Framing is much more than mere language or messaging. A frame is a conceptual structure used to think with. Frames come in hierarchies. At the top of the hierarchies are moral frames. All politics is moral. Politicians support policies because they are right, not wrong. The problem is that there is more than one conception of what is moral. Moreover, voters tend to vote their morality, since it is what defines their identity. Poor conservatives vote against their material interests, but for their moral identity.

All language activates frames in the brain. Conservative language activates conservative frames, which activate conservative moral worldviews in the brains of those who hear the language. The more those frames are activated, the stronger the conservative moral views get in people’s brains.

Please go to this link, read the article, and then we will discuss it.  (Continued at EconoMonitor…)

The Congressional deficit reduction committee has numerous government programs on the chopping block, and we may soon see some very severe spending reductions. The committee must agree upon, and Congress must pass, $1.2 trillion in spending cuts and/or tax increases by November 23, or automatic, across-the-board spending cuts will go into effect in 2013. I hope that cuts to Social Security are not among the committee’s recommendations, but fiscal hawks are beating the drum harder than ever with their insistence that spending on the program must be reduced soon.

The Social Security issue came to mind a week or two ago, when I read James B. Stewart’s article in the New York Times on possible changes in the way the federal government taxes certain kinds of investment income.  Stewart’s article makes the point that some of the wealthiest taxpayers benefit greatly from the special tax rate of 15 percent that currently applies to capital gains* and dividends:

“The IRS reports that for taxpayers with the top 400 adjusted gross incomes, capital gains in 2008 amounted to an eye-popping average of $154 million for each of these taxpayers…and this in a year when the stock market plunged.”

Suppose the government taxed capital gains at the same rate as “ordinary income” (wages, salaries, most interest payments, etc.). For the 400 ultra-wealthy taxpayers mentioned in the quote above, a marginal tax rate of 35 percent would have applied to this income, instead of the special rate of 15 percent. Hence, if all 400 had been required to count their capital gains as ordinary income for tax purposes, their tax bills would presumably have been about $31 million higher on average than they actually were. It seems that the special, reduced rate for capital gains yields a large amount of tax savings for these 400 income tax filers, along with others who report capital gains on their income tax forms—who make up a fairly wealthy group themselves.

This brings us back to Social Security and to the relatively modest benefits that it offers. Social Security literature available on the web  lists the 2009 primary insurance amounts (PIAs) for covered workers with various income levels. (By the way, 2010 numbers can be found at this link.) This is the monthly payment to which a worker is currently entitled if he or she retires at the current full retirement age of 65 years old (not including Medicare, any applicable spousal benefits, etc.). Here are three examples: continue reading…