Texting, Marginals, and Tax Rates on the Rich

When I was in the fourth grade my teacher said I was marginal. Being confused I immediately took out my ipad and went to Wikipedia. No not really – at that time the wheel had not been invented yet and fire was a new concept. But we did have a huge paper weight in our house that was called a Dickshunary so I asked my mom to help me research marginal. At that time little did I know how much would be riding on something called marginal tax rates. This post explores the importance of marginal tax rates and concludes that little good can come from increasing marginal tax rates on the rich. Raising average tax rates for the rich might be better in economic terms. Unfortunately politics seems to matter more than economics these days.

MY exploration in the dictionary didn’t help much . One definition said that marginal is something found only at the outer limits and therefore is not of central importance. Another definition referred to something on the edge. A third applied the term to apparently less important words written in the margins of a page. Since I had not yet taken on the habit of JD I had little to relieve my marginal headache. I felt even worse when I found the following example of the use of the word marginal – “having reviewed the test, there are two students below the required standard and three more who were marginal.” I wondered who those other students were.  The confusion is that while marginal often refers to things that are not very important – when you have been branded "marginal" like these students – that seems pretty important. It might mean the difference between moving on to the next grade or staying another year with the same mean, ugly, and hateful fourth grade teacher at Coconut Grove Elementary School.

When I took my first economics course at Georgia Tech, Professor Schaffer told me that marginal was critical to understanding decisions. Marginal helps to concentrate the most important factors when making a decision. So let’s suppose we are trying to decide whether or not to walk down the street while texting. On the one hand, there are benefits from this course of action. I can walk down the sidewalk and Tweet to all my friends about how wonderful I feel walking down the street. Let’s call that the marginal benefit of the decision. On the other hand, there are also new costs associated with this decisions. It is quite possible that while I am texting I might walk into a tree or a parked Vespa. Then I would have to go to the hospital. 

Hospitals are costly. Let’s call that the marginal cost of the decision.  I can’t speak for you but let’s say I believe the MB is greater than the MC. Then I make the decision to go ahead and text while walking. Of course if the MC is greater to you than the MB, then you decide not to text while walking. Advanced math explanation:

·         MB > MC then do the action

·         MB< MC then do not do the action

·         MC is an important concept despite the marginal stuff written about it in the dictionary

Last week my post was critical of plans to increase marginal tax rates on the rich. After 396 pages of detailed and insightful analysis, I left out a couple of things. I mentioned that an increase in the marginal tax rate for the upper 2% might not be good for the economy. I suggested it could lead to another recession in the USA as soon as 2013. But I didn’t explain why. So let me carry on that argument.  

Let’s suppose on some planet that resembles Earth that the marginal tax rate for incomes above $200,000 per year was 100%. Let’s call that planet Obiden. The marginal tax rate for incomes equal to or less than $200,000 on Obiden is 35%.  Jim lives on Obiden and runs a manufacturing company that makes Obiden T-shirts. Jim loves to surf on the Han River in his spare time and also enjoys spending time with his family playing checkers and Mass Effect 2.

Jim’s business is doing well and he is thinking of hiring more people and adding a new manufacturing location in a right-to-work state named Michi on Obiden. Michi looks a lot like the outline of my left foot. Anyway, Jim has a crack accountant named Kilt who explains over a couple of Heffe Weitzens that if his income goes above $200,000 he will not get a penny of the increase. With the 100% marginal tax rate on incomes above $200,000 any income he earned above $200,000 would all go to the government for good deeds.  Jim would pay 35% of $200,000 (=$70,000) as his tax. If he made, for example $250,000, he would pay the $70,000 in tax plus another $50,000.Thus his average tax rate would increase to 48%. In this example the government raises revenue, it raises the average tax rate, and it does it by increasing the marginal tax rate.

My liberal friends who are still awake would scream – Larry – no one is proposing a marginal tax rate of 100%. Then they would call me a lot of names and hang up on me. But extremes are often used to make legitimate points. For example, Democrats often depict rich people as selfish and beyond any real empathy for the poor. That extreme view of rich people makes it easier for them to want to punish rich people and confiscate their income and wealth.

But the general point is made. When it comes to the decision to expand Jim’s factory and hire more people on Obiden, it is the marginal tax rate that matters the most.  The definition of marginal is what Prof. Schaffer taught us smelly freshmen – the marginal tax rate is critical for making decisions since it applies to MORE or NEW incomes – not to all our income. When we raise the rate of taxation on wage income, on dividends, or on capital gains on the highest or last income earned – we are directly impacting decisions that involve change.  Changing average tax rates has no such extreme effect.

We don’t know what the critical marginal tax rate is for the USA. Maybe the current rates are already too high for economic expansion. Maybe they are too low. Maybe 39% is too high. No one knows for sure. But you are definitely flirting with danger when you raise these rates at a time when most people are predicting a slowdown in the US economy in the coming months.

When we say rich people we have some idea that these super rich individuals (with incomes over $200,000????) can easily and gleefully absorb the marginal tax increase. And maybe some would or could. But this defies Prof. Schaffer’s lessons. Marginal tax rates impact decisions. Raising MC relative to MB is never a good thing for output and employment. Think of the kinds of decisions that might be made as those with incomes above $200,000 react to the new and higher marginal tax rates:

·         Cut or do not expand output and employment

·         Delay output and employment to a future time when marginal rates might be lowered

·         Work less and take more leisure

·         Move output and employment to another location in Mexico or Canada

·         Consume less as you prefer to not sell stocks or bonds so as to postpone capital gains

·         Consume less as you move from dividend stocks to non-dividend stocks deferring gain to the future

·         Sell your worst stocks at a loss – the benefit of capital losses against taxes is now higher. This reduces your wealth and your desire to spend

These are a few behaviors to note but certainly there are more. The general idea is that raising marginal tax rates reduces the incentives to work, to produce, and to invest. Use the comment section on the blog to tell me what I missed. How else do increases in marginal tax rates cause negative effects?

The main idea should not be lost in the details – raising marginal tax rates create perverse incentives for economic growth. It is possible to raise revenues in such a way that these perverse impacts are minimized. If part of the political solution to current deficit/debt challenges is raising tax revenues on the wealthiest Americans, then more thought should be given as to how to do this. Capping deductions and similar schemes can impact the rich more than others and might have smaller undesirable impacts on economic growth. It goes without saying, however,  the more we restrain unbridled government spending the less has to be done in the way of tax revenues. But that’s another topic and you have shopping to do. So let’s carry this on later.

Uncle Vinny, Uncle Sam, and the proverbial rock/hard place

When people with responsibility and power make stupid public statements on film the press usually goes wild sort of like a swarm of bees after you just bumped into their nest.  Remember when Dan Quayle misspelled potato and when candidate Romney said something about the lower 47%. But when a prominent US Senator, Tammy Baldwin, explained in front of rolling cameras why Social Security could not be part of the coming budget negotiations because it was separate and fully funded until 2037, no one said a peep. The press looked like Marcel Marcaeu as Bip the Clown.

So pardon old Lar if he takes a big swig of JD and takes his chance to spout off a bit. Remember when our leading intellectual Al Gore mentioned the nation’s lock box a few years back? It is the same kind of disinformation. Is it stupidity or a clear attempt to mislead the public? Guys – there is a lock box. But unlike a real lock box that keeps the family treasures and a few naughty photos of grandma when she was 16, the USA lock box is full of a bunch of IOUs from the Federal government. Let’s suppose the Davidson family has a lock box with an IOU for a million dollars from Cousin Vinny. Vinny is in prison serving 90-100 years for financial fraud. Cousin Vinny owes a lot of people a lot of money.  What is that IOU worth to the Davidsons? Right! Zero, Nada, Zilch, Yung.  

It is the same thing with the US lock box. But in this case Uncle Vinny has been replaced with Uncle Sam. For years and years the Social Security system received more in revenues from tax payers than it paid out to prune-eating elderly. Did  Social Security invest those surplus dollar in GE stocks? In a portfolio of stocks? In anything that might come close to looking like an investment? Of course not.  Every year since I can remember SS lent the money to Uncle Vinny – er I mean Uncle Sam. Why? Because the US government has gone more than a half century spending more than it earned in the non-SS part of the government budget. That part of the budget is called "on-budget." That terminology makes no intuitive sense because all government spending, including SS, is included in the budget. 

For example, in 2012 the so-called on-budget part of the US budget had a deficit of approximately $1.4 trillion dollars. In that year the Off-Budget (mostly SS) had a surplus of $67 billion. So in 2012 SS loaned approximately $67 billion to the US government for its on-budget deficit. In return the SS system got another IOU to add to approximately a half a century of similar IOU’s. Those IOUs were stacking up like hotcakes at Denny’s on Sunday morning. Now please tell me what the probability is of the US government paying SS back so it will be solvent through 2037? Can you say zero?

As the surplus in SS soon diminishes – it is expected to be down to $22 billion by 2017, the government will begin paying from the on-budget part of the budget money to cover the deficits in social security.  This is like Uncle Sam getting a loan from Greece.   Since the on-budget will be in deficit too – that just means that we borrow more money from the public.

So when anyone tells you that SS is solvent and does not need to be part of the government fiscal cliff deliberations, please grab your wallet and whatever other valuables you might have with you and run for the hills. These people are either ignorant or the evil man Mini-Me. Either way, get out of town fast.

I feel better now. But I still have another page to ruin so why stop now when we are having so much fun? Let’s talk next about the President’s insistence that marginal tax rates be increased for the millionaires or those in the top 2 percent of the income distribution. First, the overwhelming majority of those in the top 2% are not millionaires – so quit saying that. It is just plain wrong and totally misleading. STOP IT. Aim I yelling?

Second, the top 2% account for approximately (I had to extrapolate from the top 1% and top 5% data) 18% of all income earned in the USA and pay 47% of all income taxes. Okay – so these folks make about a fifth of the income and pay almost HALF of the taxes. So quit saying that don’t pay their fair share. This is bullcrap. Just say they should pay more. If you think they should pay more – just say it that way. Don’t disparage the people who pay for nearly half of all income taxes collected? Don’t bite the hand that feeds you. Just explain why you want them to pay more. Is that so much to ask?

Finally, if some folks are willing to sock it to the upper 2% then why won’t you come off your high horse and work with them? To most of us the difference between a marginal tax rate and an average tax break is the like the difference between nuclear fusion and nuclear fission.  Most of us don’t have a clue about the difference without a quick trip to Wikipedia. To a nuclear physicist about to build a bomb, the difference is pretty critical. To an economist about to promote a policy to strengthen economic growth the difference between marginal and average tax breaks is also very important. So let’s work on this a minute.

One party says they want the rich to pay more. So let’s suppose we agree that the rich paying even more than 50% of all taxes is okay.  Let’s assume the other party says they are ready to sock it to the upper 2% by increasing the average tax rate paid by rich people. The rich will pay more dollars AND the rich will pay more dollars as a percent of their incomes. You would think the first party would be elated. But NOOOOO, that  party sticks up its nose and calls the other party a bunch of stupid poopie-heads.

Why isn’t that party willing to accept an increase in average income tax rates paid by the upper 2%? Why is the ONLY WAY they want to impact the rich through raising the marginal tax rates or brackets of the upper 2%? There is no economic answer. You can sock it to the rich equally with average or marginal approaches yet the President and some in his party insist that it has to be one way and not the other.  I heard Charles Krauthammer the other night explain on television while visibly gritting his teeth the reason for his focus on marginal rates is that President Obama wants to cripple the Republican Party. He thinks by sticking with the very intuitive marginal tax bracket approach that he fulfills his election mandate and sticks up for the average American by raising marginal rates.

I don’t know if Krauthammer is right or wrong. But I do think the President is being disingenuous – and that is a hard word to type if you don’t actually know how to type according to the correct method. On one hand Obama says it is all about math – that you cannot raise enough money from the rich by changing their deductions and thus raising their average tax rates. But that is highly debatable. Furthermore he recently did a complete flip-flop and now says that changing deductions will hurt charities too much. He said exactly the opposite a few years ago. Aside from the flip flop this signals the real reason he doesn’t want to go in the average tax rate direction – he has finally admitted that tax loop holes exist for a purpose. Each loophole was legislated for an important purpose. If you close loopholes then someone gets hurt. He says one day that the tax code and the entitlement system must be restructured. But he is not being honest. Every so-called restructuring will hurt one group or another. Obama does not want to get into all that. It is much easier and politically more fun to go after the rich and rich only via marginal tax rates.

But of course it is a big lie. If he raises his $1.6 trillion mostly from the rich do you really believe that won’t create another economic tailspin? Do you really believe that the 2013 recession will be short and modest? Do you really believe this won’t affect the average person greatly? No way Jose. One way or another – the US has to fix a half-century mess of living like Uncle Vinnie. This is the proverbial rock and a hard place. There are no easy solutions. To me we are better off starting down the path in the right direction with average tax rates. Marginal tax rates on the rich is a path to nowhere. 

Wealth, Income, and Keynesian Boobs

As I write the politicians of both parties are again throwing spears at one another with respect to a cliff.  Rather than complicate that mess further, I thought it might be a nice change of pace to focus on the difference between two economic concepts – income and wealth. Most of us would be happier if the economy grew faster. Faster growth would make solving the financial crisis a little easier. Our Keynesian predilection is to seek policies that aim at income and economic growth. Most of the stimulus policies focus on income. That’s the way we think because many of us were nursed on Keynesian boobs. Apparently we still aren’t weaned. A look at wealth might be more nourishing. 

Income is an intuitive concept. My Dad said that if I would do my chores I would get an allowance. The allowance was my income and while paltry it was worth a lot more than what he got out of me in the way of washing his car and drying the nightly dinner dishes. As an assistant professor at the Kelley School of Business in 1976 I earned a handsome sum of $15,000 in return for a year of confusing students and doing research that led to me to this glorious blog. We all know that we have to pay income taxes on what we earn and what is left to either spend or save is what we call disposable income. Let’s write that in big letters – DISPOSABLE INCOME. I write it in all caps to see if you are still awake. Also because it is the key to Keynesian economics. 

If the economy is weak, then Keynesian fiscal policy aims its bazookas at something that would increase disposable income. The government could give you a tax cut. Or perhaps the government could build a nice new and shiny bridge and pay construction company workers for the work – thereby increasing their take-home pay. A Keynesian monetary policy pours hot money into the financial system with the intent of lowering interest rates – causing homes, autos, and other interest-sensitive goods to be purchased and  produced – enriching with income those who produce all that stuff. So whether it is fiscal or monetary in nature, Keynesians are all about raising spending and disposable income.

That leads us to the four-letter word of the day – Wealth. Okay it is actually 4 letters with a “th” added to the end. Who am I Euclid? 4 letters 6 letters who cares? What matters is that wealth has become an ugly word. It has become an ugly word because most of the wealth – like much of the income -- is owned by a very small group of really rich people who live in castles and eat snails and sit in vaults and count their money over and over. Some even have their own television shows.

But what is wealth and why does it matter? It matters because there is more to economic growth than Keynesian preoccupations with income. Wealth is basically what must of us try to accumulate by earning income. My Dad gave me my allowance each week and said – Son, do not spend all your money and someday you will be a wealthy man. I laughed as I bought enough gum (and the enclosed free baseball cards) to make my dentist a wealthy man. Yes, as a young man I didn’t save a penny and my baseball collection didn’t amount to a hill of beans.

Saving is defined as the part or residual from your disposable income that you don’t spend. That’s easy. While it is true that much of the nation’s savings belongs to the wealthier people – most of us save or at least say we are going to save.  For example, much of our saving is done to provide for times when we no longer work – for bouts of unemployment and for our retirements. The saving that we and/or our employers do for our retirement is called a pension. 

As of 2011 the Federal Reserve estimated that Americans had about $13 trillion in pension reserve funds. We also save through our houses. We often think of the mortgage payments we make each month but the other side of the equation is that our homes are worth something.  The FRB estimates in 2011 U.S. households having homes worth a little more than $18 trillion. Of course we also hold our wealth in many other forms including bank deposits of about $8.6 trillion, equities or stocks worth about $9 trillion and various credit market instruments of almost $4 trillion. In total, the FRB estimates our total assets or wealth to equal about $73.6 trillion. Wealth data comes from the Federal Reserve Board Flow of Funds Accounts published in September 2012:  http://www.federalreserve.gov/releases/z1/Current/annuals/a2005-2011.pdf

Are you feeling rich? Want to buy a used hot tub? Don’t get too crazy. While we own all these assets we also incur a lot of loans or liabilities. If you borrow $1,000 to buy a cool new Fender electric guitar, your wealth has not really increased. You own a guitar but you also owe $1,000. When you pay off your loan in 47 years and your guitar is worth $35 dollars then you have some real wealth. When you subtract the liabilities from the assets, we get something called NET WEALTH. It is in caps because that is the important concept comparable to disposable income and because my Caps Lock key sticks sometimes.

Like disposable income, NET WEALTH gives you spending power. When all of our homes seemed to be worth a ton of money in 2006 because housing prices were making homes more valuable, we felt very wealthy and so we went out and bought groovy  pipes, sweaters with patches on the elbows, and we hired drivers for our all electric cars. NET WEALTH can have powerful impacts on the economy – just like disposable income.

That brings us back to now. US Net Wealth peaked at $66 trillion in 2007 and then subsequently fell to $53.5 trillion in 2008. That’s a decrease of almost $13 trillion or 19%. We felt a lot poorer! Even if a decrease in Net Wealth of $100 decreased spending by only $1, then this impact alone would have decreased GDP by more than $100 billion dollars in 2008. For that you can buy a lot of stinky fish and bindaetteok in Seoul. Much of that decline came from real estate and equities but pension funds and other asset values tumbled. When you see all your wealth vanishing you don’t run out and buy the most expensive Galaxy Note II.

So Net Wealth contributed to the recession we had in the USA in 2009 and 2010. As Einstein said, what goes down must come up. Or something like that. But the point is that Net Worth recovered and by 2011 it was estimated to have increased to about $60 trillion. Net Wealth recovered about half the value it lost after 2007 and was a positive force in the economic recovery. But we all know the recovery has been weaker than usual and we remain concerned that we are stuck at lackluster economic growth rates and high unemployment to boot.

Keynesians want to kick start disposable income. Since 2008 they have been stoking the fires of demand and disposable income and today Keynesians are pushing programs to keep government spending growing strongly and to pay for these increases by impaling rich people, or in modern terminology raising taxes on the rich. Vlad the Impaler would have been proud.  These programs have not been working and yet they keep asking for more taxes to support them.

An alternative approach is to think about New Wealth. If Net Wealth had already increased to its earlier value of $66 trillion it would have had a much bigger impact on the economy. Why didn’t Net Wealth return to its former value? To answer that we need to know a little more about the current market or the replacement value of wealth. Let’s suppose Aunt Lucy gave you some things when she passed in 1990. You received a house worth about $40,000, some stocks valued at about $2,000, and some long-term bonds worth $8,000. Is all that stuff worth a total of $50,000 today? Probably not – inflation has pushed the value of that house to about $120,000. Lower interest rates boosted bond prices so your bonds are now worth about $6000, and the growth in the overall stock market means that your stocks might be worth $24,000. 

Your wealth in this illustration increased to about $150,000 – an increase of $100,000. The point is that many factors can and do affect the prices of the assets we own.

So let’s use this understanding of net wealth in the context of recent policy to see why Net Wealth has not risen more in today’s policy environment.

·        

Explosions of monetary policy contributed to an environment of lower interest rates and that has helped to stimulate housing and autos. But what if the increase in money also contributed to an increase in expectations about future inflation? Bonds and stocks do not do well in an inflationary environment so this contributed to lower expected future Net Worth. 

·         Furthermore, with interest rates so low and the economy recovering that means interest rates will likely rise – and will likely increase a lot. That will not be good for valuations of bond wealth. 

·         Policies that intend to hurt the rich by raising taxes on dividends and capital gains clearly are not good for stock market wealth.

·         A thicket of new regulations on companies specializing in housing, finance, nonrenewable energy, and health are not the best ways to increase the values of the stocks of those companies.

·         Finally, lackadaisical approaches to government deficit and debt moderation a la Europe clearly portend bad things for both bond and stock markets.

Keynesians and other macroeconomic policy liberals ignore the value of national Net Wealth to their peril. It seems fair to them to pay for more government spending for the middle class by taxing the rich. It seems like business as usual to keep middle class taxes low to stimulate disposable income to create growth.  An unrelenting force to redistribute income from the rich to the poor may well accomplish what they want in the short-term but the reality is that this will be bad for National Wealth and for the economy. As in other attempts to do such things, if these folks with their apparent mandates accomplish their policy goals – we as a nation might find fleeting equality but at a much lower level of wealth and income! It is like the guy with one bad foot who prayed that one day both his feet would again be equal. He got his wish and now both of his feet are bad!

The Government Spending Scam

Last week I wrote about the fiscal gap and implications for tax revenues and income tax rates. This week I focus on federal government spending and the fiscal gap. I call the spending discussion a scam because much of the wording describing the course of future spending is all about cuts. And while there are some cuts and the overall message suggests smaller deficits in the future, the truth is that spending will increase at very strong rates and it does not appear that much is being accomplished with respect to the fiscal gap on the spending side. Thus either debt or tax revenues will have to cover the spending.  The data show also that by taking some of the bigger spending programs out of the discussion we purposely and unnecessarily jeopardize the great majority of government services and therefore put even more stress on taxes and debt.

This is not an easy project to do right now. I get my data for federal government spending from the White House web site. It comes from what the President calls the 2013 budget. Fiscal year 2013 started about two months ago on October 1, 2012. The problem is that the budget projection numbers for 2013 and beyond are being estimated based on so-called spending caps legislated in something called the Budget Control Act. I could have used another version of spending produced with a different set of assumptions published by the Congressional Budget Office but that just adds more speculation about what budget changes will be made in the next month or two or longer.

So I am sticking with what is published on the White House site because it is the only official budget right now.  (http://www.whitehouse.gov/omb/budget ) This budget version exaggerates how much spending restraint there will be – assuming that some of the caps will be removed in new legislation. So if spending looks like it is growing in the White House budget – then it will probably grow even more under a new compromise bill. So let’s at least see what is in store for us at the moment.

To create some basis of comparison let’s start by identifying what might be normal changes in federal government spending. From 1992 to 1997 spending increased by $220 billion. In five years the level of spending increased from $1.38 trillion in 1992 to a level of $1.6 trillion in 1997. In the next five years, 1997 to 2002, the level of spending rose by $400 billion. The increase in five years was about double the five years before. From 2002 to 2007 spending increased by $720 billion. So let’s stop there. You can see a progression of government spending increases over five years periods – expanding by $220 billion, then $400 billion, then $720 billion. I am not sure what you would call normal. Focusing on increases you can see a rapidly rising curve of federal spending.

One would expect a significant yet temporary increase in government spending during the recession and slow economic recovery that followed. And we got it. From 2007 to 2012 federal government spending increased by a little more than $1 trillion. Federal spending went from $2.73 trillion in 2007 to $3.8 trillion in 2012. So the change curve was  not dented and simply continued. The President’s budget –- with spending caps in place – has government spending rising from $3.8 trillion in 2012 to $4.53 billion in 2017. That amounts to another five year increase of $730 billion. How do we interpret that increase?

First, does it look like gut crunching austerity? I don’t think so. The government will be spending more and more and more – as we approach 2017.

Second, how do we evaluate the size of the projected future $736 billion increase? Well it is really big. It is bigger than the increase in the 10 years from 1992 to 2002. It is also bigger than the very rapid period from 2002 to 2007 when spending rose by $720 billion.

Point taken – the government is spending at about as high a rate as it ever has – and by "ever has" we mean more and more and more. I could present all this spending information in real terms or as a percent of GDP and it would show slightly different relative outcomes – but the general point would be the same. There is no austerity. Government spending is not decreasing. Government spending did not take a breather after the recession. What was supposed to be temporary government spending to stimulate a recessionary economy is now permanent.

But the issue is more interesting because we haven’t talked about specific components of spending. Luckily the White House website provides lots of details of spending by year and by program. What we see is very interesting especially in light of Harry Reid’s threat that he will never touch one cent of Social Security, Medicare, and Medicaid.

Recall that total federal spending is projected to increase by $730 trillion between 2012 and 2017. Here are the main* spending categories that account for the increases:

Interest on the debt                                        $340 billion

Social Security                                                 254

Healthcare Services                                          251

Medicare                                                         157

Income Security for Veterans                             29

Federal Employment Retirement/Security            24

Other Income Security                                        24

Higher Education                                                19

Ground Transportation                                       16

     Non-Interest Sub-Total                          $774 billion

Total                                                      $1,114 billion

If we count interest on the national debt the government is planning to spend $1.1 trillion over the next five years on these nine categories. That is, in 2017 we will be spending on an annual basis more than $1 trillion than we did in 2012 in these areas.

Notice that if we focus on the Big Three programs – Social Security, Healthcare Services, and Medicare this accounts for $662 of the planned spending increases. When Harry Reid says he is not going to touch these categories of spending he is basically saying there is no way to control federal government spending. Since he can’t eliminate interest on the debt without a national default, any politician who says he can control government spending and not include all spending categories is involved in a scam. What he really means when he says this is that he either wants higher taxes or higher debt.

One final point. The government does plan to cut quite a few programs. The largest cuts will go to Defense ($126 billion), Commerce and Housing Credit ($114 billion), ), Unemployment Compensation ($56 billion), and Elementary, Secondary and Vocational Education ($46 billion). Quite a few others will be cut by smaller amounts.  Some of those cuts are not real policy changes but are the automatic result of an improving economy.  Others are debatable. A lot of programs will see true cuts so that the Big Three programs can enjoy large increases.

I am not advocating that we cut any particular program but I do see a real scam in operation here. By purposely letting the Big Three programs grow we take a blunt ax to the rest of government AND we raise taxes and probably the debt. It seems to me that putting everything on the table is the only way to make progress on our fiscal gap. We can control government spending but we cannot do it by playing politics as usual. 

*There were other categories that had increased spending but I did not include in this table any increases that were less than $10 billion. 

Taxes 2013

Our government is debating what to do about future tax revenues. This is a big issue because there is a gaping hole or gap between what the government plans to spend and the money it will have to make those expenditures. When I was a teenager is was pretty cool to have a small hole in my Levis. But when the hole got big enough I had to buy a new pair of jeans. As you probably know if you live on the planet Earth the US government is spending more than a trillion dollars each year MORE than what they bring in. When governments have such gaps they have to go into debt. This means that each year they have to sell government bonds to the public of a trillion dollars or more. Selling bonds is usually pretty easy but at some point the public begins to wonder if the government will have the resources to pay the interest each year and then the principal balance when the bonds mature. We see this playing our daily with respect to the bonds of Greece, Ireland, Italy and several other places. The result is not pretty. Bloody street demonstrations are just one visible sign of how painful it becomes when people begin to worry that governments are in financial trouble.

In short, the US government is very preoccupied with reducing this fiscal gap. Both parties want to see this gap managed better. The fiscal cliff is just one aspect of this gap. A year ago policymakers said the fiscal gap was so worrisome that they agreed to enact a poison pill of sorts to put pressure on themselves to enact legislation to reduce the gap. This poison pill was an agreement to put in a very tough short-run solution to the gap – one that raised taxes and lowered both military and non-military spending. Most of us thought – wow – these legislators are really serious. Of course they won’t want to take such an awful pill. Of course, they will legislate something before the end of 2012. They had a whole year to get the job done. But alas, they didn’t. They talked and they accused and they argued and they spat and they even had an election. Yet still no agreement.

So as I write it is November 20 – two days before we Americans gorge ourselves with turkey and JD to celebrate Thanksgiving. We read and hear the news that Senator Reid will not even think about some solutions. Boehner has drawn the line or at least obfuscated the line with respect to other solutions. But one thing remains clear – to solve the problem of the fiscal gap means that two lines have to meet somewhere down the road. The gap will close only when the spending line meets the tax revenue line. This means that spending must grow more slowly in the future and it means that tax revenues must grow faster.

At least for the purpose of this blog – as the title indicates – I want to focus on tax revenues. So I am not going to get into spending this time. As I see it the problem with tax revenues has many dimensions but one really important one is definitional. Many people do not know what the term means.  It is a little like sport fans who want to talk about football. If it is a talk between two Hoosiers we probably are referring to American football and probably a game between lackluster teams like Indiana University and Purdue. Two Europeans would instead be talking about a game we Americans refer to as soccer. If an Aussie and a Kiwi are involved in a football discussion it would be a totally different game. So if we are sitting in the 3 Alley Pub in Itaewon – a place where a lot of foreigners congregate in Seoul – and someone says football – it could take a long time before the group can figure out what they are really going to talk about.

The same thing goes with taxes. In the same discussion you might hear all these terms bandied about – taxes, revenues, average tax rates, marginal tax rates, tax base, percent of income, value added, and more. If people are not familiar with the differences and distinctions of these terms, then it is hard to have a good conversation. So perhaps it is worthwhile to work on this language issue.

My above discussion of the gap concluded that tax revenues will have to not only grow but probably grow more quickly. Much of the tax discussion focuses on income tax. Income tax revenue equals the tax rate a person pays times the income they earn. So if Charles makes $100,000 this year and finds himself in the 28% tax bracket, he then pays $28,000 in income taxes, right? WRONG. Wrong for several reasons.

First, Charles may receive $100,000 this year from his wages, interest, and so on – but Charles has deductions. Whether or not he files a Schedule A, Charles will have some deductions so the income that is actually taxed will be lower than $100,000. Charles gave a lot of money last year to the Georgia Tech Foundation for the Advancement of Beer. Some might call this a tax loophole but Charles loves beer and the foundation appreciates the gift. Anyway, let’s say that his deductions come to $30,000. This means that Charles pays tax only on $70,000. A taxable income of $70,000 puts Charles in the 25% bracket so he will pay $17,500 in taxes. Right?  WRONG.

Charles might be in the 25%  bracket – or what we call the marginal tax rate – but the total amount of income taxes he pays depends on all the other marginal tax rates for incomes below $70,000. To break it down he pays:

  $870 = 10% on income up to $8700
            Plus

  $3,390 = 15% on the income above $8700 up to $35,300

Plus

  $8,675 = 25% on the income above $35,300 up to the $70,000

           

= $12,935

If Charles pays $12,935 on a taxable income of $70,000 then his AVERAGE TAX RATE is 18.5%. Charles has a marginal tax rate of 25% and an average tax rate of 18.5%

Arrgghhh. Don’t you just love math! But without knowing the difference between income, taxable income, marginal tax rates, and average tax rates – you do not really understand the current debates.

For example, the goal is to raise tax revenue. Tax revenue is defined as taxable income times the average tax rate. This definition is not debatable. A bourbon whiskey has a definition. It is not debatable. What you do to increase your intake of bourbon is an interesting question. What we do to raise tax revenues is also an interesting question.

So the formula says you can raise tax revenue in only two ways – raise the average tax rate or raise the taxable income. That’s it. Those are the only two ways to increase income tax revenues. But here is where the fun begins.

How can you raise the average tax rate? How can you raise taxable income?

The government can increase the national average tax rate by legislating an increase in the marginal tax rate of any or all of the income tax brackets. Presently in the USA the marginal rates for individuals or couples are 10%, 15%, 25%, 28%, 33%, and 35%. By increasing the marginal rate for any of the income categories the average rate paid by the country will increase. Of course if you only raise the rate for the richest people paying 35% -- only the richest will pay a higher marginal and average tax rate. Everyone below will pay the same marginal and average rates as before. So you can see the political issue. You want to increase the nation’s average tax rate. But the question is whose ox gets gored? You can gore everyone or you can gore those only with higher incomes. Either way you can raise the average national tax rate.

You can raise taxable income in several ways. One way is through policies that increase economic growth that raises earned incomes. A second way is by what some people call widening the tax base. Widening the tax base means either having more people pay tax or by having fewer loopholes or deductions from earned income. We know many very poor people in US do not pay income taxes. Some of them could be added by reducing the earned income tax credit. A more popular remedy is to reduce deductions of people with higher incomes. We have more deductions in the US tax code than Apple has i-phones. Popular deductions are for mortgage interest paid on a primary residence. Charitable giving is another one. 

EVERY TAX LOOP-HOLE is in place for what someone at some time thought was a really good reason. I got a tax break one year because I bought a new furnace. This benefit was given to me because it was more fuel efficient that the old one, I was helping the country’s battle against air pollution. One year I got a tax deduction because I drank more than 100 bottles of JD. I forget why I got that deduction and I am sure that is not why the IRS has been calling me repeatedly lately.

So here is the political issue. Whether it is the average tax rate or the taxable income, there is much to debate with respect to who bears the burden of the new policy to remove the fiscal gap and how the new policy affects the country at large. Any policy that raises marginal tax rates often hits the wealthier people the most, but has ramifications for US economic growth. Any increase in marginal and average tax rates will impact consumer spending, national saving, business profitability, investment, innovation, stock market, and exchange rate. Any policy that increases the tax base will have impacts on charitable organizations, housing construction, and so on.

The fiscal gap has got to go. Tax revenue has to increase. Average tax rates, some marginal tax rates and/or loopholes have to be changed. Some groups will pay more than others. The nation’s economic growth and ability to increase income will be impacted negatively for a time. Democrats were born on Venus. Republicans came from Mars. We need a solution. Hopefully this little primer on tax revenues helps you to better understand the difficulties. 

Self-Evident Truths

1. When politicians say they are ready to compromise they probably are not
2. Economic growth in the US remains stubbornly mediocre and employment is a major problem
3. World economic growth is slowing and could easily weigh negatively on US economic growth in coming months
4. Accommodative monetary policy has been controversial but most of us understand that too low interest rates for too long is a major risk for economic growth
5. Dealing with defaulted housing and other financial contracts must be accelerated yet if such policies result in a return to dangerous attitudes and practices in household and business debt, then we will have accomplished very little
6. The fiscal cliff is deep but is only one of many. Once that one is skirted we remain at 3,000 meters
7. The real fiscal challenge involves a more permanent fix to overcoming the economic risks associated with unsustainable national government deficits and debts
8. Without pointing fingers it is clear than once a country reaches a point wherein a minority of citizens pays benefits to a majority of citizens, a democratic political system will be challenged to find ways to balance its budgets and accomplish its goals
9. Pre-university education continues to fail to adequately prepare enough students for life’s challenges
10. There is a very large group of friends and relatives who are not heterosexual and who very much want the same kinds of rights as other Americans.
11. Too many school districts do not graduate even 50% of their students
12. University education is becoming unaffordable
13. We have more hope than reality when it comes to controlling costs of healthcare and pensions
14. Notwithstanding women’s rights to choose no one wants risky surgery to become a form of birth control
15. Immigration has always been a source of strength for the US but unfettered and illegal immigration will threaten security and social cohesion
16. Mandate has more than one meaning. A look at Wikipedia says that a legitimate mandate occurs when a government wins election because of its promise to put in new specific policies. A second definition points out that a large margin of victory supports the notion of new specific policies that were part of the campaign.

As I write this we are one week beyond a major presidential election. We all know that the Democratic Party won the presidency by a large number of electoral votes but by a slim popular margin. The House and Senate remain respectively Republican and Democrat. Many Democrats are decrying a mandate – often expressed as a mandate to tax rich people at higher rates. Many Republicans have noted that a conglomeration of minority interests resulted in the Democratic victory and they worry about the loss of voice of the once-majority parts of America in the democratic process. Of course those brief sentences do not fully represent the feelings of most Democrats and Republicans.

These self-evident truths above imply that our nation has a lot of things to accomplish in the coming years. These truths also emphasize just how much we stand to lose if we fail to act. But failing to act is where we seem to excel. Hey mom we had a swim meet at school today and I decided to debate stroke mechanics with my coach and I missed my event. Sorry I didn’t compete.  That sounds pretty stupid. But that is exactly what we have been doing – and we pay those guys and gals in government handsomely to debate mechanics.

The above list was written in such a way that I at least tried to be objective. I know it is impossible to be totally objective as one who has since the age of 18 had a secret love thing for Ayn Rand. But I tried to lay things out in way that focuses on real challenges. I doubt, however, that the challenge statement is the problem. When we take off our Obama blinders and our Romney goggles we all know that this country needs a lot of work. So if that is true, then what is the problem? Why do we have such a dysfunctional government? 

The problem is that we have different approaches to solving these problems. These different ways are sometimes supported by very different assumptions about human instincts and behaviors. They are buttressed often by different religious beliefs. But those differences have always existed. Somehow Reagan worked with Democrats and Clinton worked with Republics. The history of legislation in the US is full if not dominated by parties working together to solve national problems and challenges.

I hear some of my Republican friends saying that we simply cannot compromise our basic beliefs. Some of them worry that the country is becoming too socialistic – too much run by government. Some of my Democrat friends point at the plight of the middle class and think that it is impossible to allow rich people to keep low tax rates. These are, I think, entrenched positions. Right now I am hearing and reading about too many people already drawing lines in the sand. A line in the sand means to me that the self-evident truths will take a back-seat to basic beliefs.

Both sides say the same thing – if we compromise then we will be kicking the can down the road and we will be worsening the country. So like good Tarheels from North Carolina, they dig in their heels for the good of the country.  These are not bad people. They care. 

But coming up with a solution is not necessarily a compromise. For example, aside from raising the tax rate on households and small businesses earning $250,000 per year, there might be other less disruptive ways to increase tax revenue from wealthy people. If we would earnestly work on this we might find ways to do this without causing unnecessary impacts of higher rates on the economy. Furthermore, some Democrats draw a line at Medicare and Social Security. But surely there are changes to recipients of these programs that would be less objectionable than others.  Finding a way to generate more tax revenue and finding other ways to slow the growth of government spending is a no-brainer. Finding these ways does not mean giving up on one’s core principles. It leads to advancing those principles because it means finding solutions to real problems.

But if people gain power in today’s society not by finding solutions but by being passionate and stubborn orators, then I suppose we will have lots of lines drawn in sand in a sandbox that will get smaller and smaller. I am not for compromise. I am not for kicking cans. I am not for giving up on principles. I think we can have all that and a solution. We just need to get away from the microphones and work hard at solutions.

The Election: Did It and Does It Matter?

This is a guest blogger -- Buck Klemkosky

As election day 2012 approaches, an interesting question is: Did it matter for the economy who won the 2008 presidential election, Obama or McCain? And a more relevant question today is: Does it matter in 2012 in terms of the economy whether Obama gets reelected or Mitt Romney? A case could be made that it didn’t matter in 2008 and may not matter in 2012 for the economy anyway.

While Obama and Romney differ on many major issues, the compelling fact is that the Great Recession of 2008-2009 was caused by a financial crisis. Empirical evidence shows that recovery from a financial crisis takes not only good economic policy decisions but more importantly, time – time for the economic excesses that caused the financial crisis and recession to adjust back to some level of normalcy.

The root causes of a financial crisis don’t materialize overnight or even over a few years. It may take a decade or longer; in the case of the U.S. financial crisis, the excesses started several decades earlier. Some of you are old enough to remember the 1970s slow-growth economy and high inflation, referred to as stagflation. Treasury long-term interest rates approached 15 percent, and short-term rates 20 percent – some of the highest interest rates in U.S. history.

Paul Volcker was selected as head of the Fed in 1979 and immediately decided to wring inflation and inflationary expectations out of the U.S. economic system. In what became known as “Volcker’s Massacre,” in October 1979 he decided to tightly control the money supply and let interest rates go where they may. And they did go up further. It took a while, but by August 1982, inflationary expectations started to cool and interest rates started their secular downtrend to today’s historically low interest rates.

One consequence of lower interest rates and inflation was massive amounts of wealth created from 1982 to 2007. As interest rates came down, bond prices went up dramatically and trillions of dollars of wealth were created in the bond markets. Likewise, lower interest rates were reflected in lower mortgage rates, and home prices began to rise again – although not out of line with historical trends until 1996 when the housing bubble started. Stocks also don’t do well in high inflation environments, so stock prices were depressed in 1982. The total valuation of publicly traded U.S. stocks was only $2 trillion in mid-1982. By March 2000, they were worth $16 trillion.

The trillions of dollars of wealth created from 1982-2007 and an economy that grew and only experienced two short recessions in 1991 and 2001, resulted in a consumption bubble in the U.S. Consumption increased from 66 percent of GDP to more than 70 percent over this time period. Much of the increased consumption was funded by the increased financial wealth as well as by credit. Increasing home equity also fueled consumption as consumers used home equity like an ATM machine. The end result was a credit bubble of massive proportions. Consumer debt relative to GDP reached an all-time high in 2007.

Another consequence of the wealth creation and associated credit bubble was a financial system bubble.  The repeal of the Glass-Steagall Act by the Clinton administration in 1999 allowed commercial banks to move into investment banking. There was also dramatic growth in the “shadow banking” system, which included non-commercial bank institutions such as hedge funds, private equity funds, mutual funds, money market funds and a multitude of others.

In addition to the financial system bubble, the long period of moderation in terms of steady economic growth, declining interest rates and inflation, and increasing wealth from 1982-2007 created other problems, such as aggressive risk taking by consumers, corporations (remember Enron, WorldCom and others), and financial institutions. Credit standards became lax, the complexity of the system increased – especially as the derivatives market grew from nothing in 1982 to $600 trillion in 2007 – and transparency declined as overconfidence increased.

All of this credit expansion and wealth creation began to impact home prices in 1996 when they began to increase above historical trend lines; from 1996 to 2006 median home prices more than doubled. Both the Clinton and George W. Bush administrations promoted the home ownership society. They and Congress pressured the government-sponsored agencies, Fannie Mae and Freddie Mac, to not only provide mortgage financing but also to provide financing to lower-income individuals and families. Thus the advent of the sub-prime mortgages, which grew from nothing in 1996 to more than $1 trillion by 2006.

Not even the bursting of the dot.com stock bubble and subsequent bear market from March 2000 to October 2002, when U.S. stocks lost approximately half their value ($8 trillion), could dampen the real estate enthusiasm, speculation and the increase in home prices. Home ownership increased from 64 percent to 68 percent of those eligible during this period, something most thought was stabilizing for the economy. The basis assumption was that home prices would not decline, which they had not since 1930s.

So 2007 found home prices inflated, consumers with too much debt, financial institutions that were too complex and too big to fail, and a financial system that had become not only innovative, but also complex and interrelated. Nobody knew where the risks were in the financial system. The long period of credit expansion, excess leverage, and aggressive risk taking was about to end in dramatic fashion.

The first cracks in the system came from the sub-prime mortgage market in 2007 as default rates increased and mortgage prices decreased. Most thought the problem was controllable, as the sub-prime mortgage market was less than 10 percent of the total mortgage market. But home prices in general began to decline, and problems spread to other markets and to most financial institutions – especially the large investment and commercial banks. What started out as a small credit crisis became a liquidity crisis, then a financial crisis and then the Great Recession.

Who is to blame for the financial crisis? There is plenty of blame to go around and plenty to blame. You could start with the borrower who took on too much debt, real estate speculators, mortgage lenders with lax or no credit standards, bankers who lent and then securitized mortgages, ratings agencies that gave a AAA rating to low-quality mortgages, investors in mortgage-backed securities who relied on the ratings agencies and didn’t perform due diligence, bank regulators who were clueless, the Federal Reserve for keeping interest rates too low in the latter part of the housing bubble, and two U.S. presidents and the U.S. Congress for promoting home ownership to those that couldn’t afford it. But certainly the leverage in the system exacerbated the problem once housing prices started to fall and collateral prices declined. Calls for more collateral forced margin selling, and the downward spiral began.

If the sub-prime mortgage market was the trigger that started the financial crisis, then financial innovation and derivatives also can be blamed. Sub-prime mortgages were pooled into mortgage-backed securities, which were then pooled into collateralized debt obligations (CDOs), each of which was subdivided into tranches – with the highest tranche rated AAA by the ratings agencies.  In hindsight, we now know that you can’t create quality from junk. If the CDO had not existed and credit default swaps (CDSs) not available to insure CDOs, the sub-prime mortgage market would not have developed. Would this have prevented a financial crisis? Probably not, as the housing bubble was pervasive and leverage as well.

The peak of the financial crisis was probably the collapse of Lehman Brothers in September 2008. This prompted Congress to pass TARP, which bailed out the financial system as well as GM and Chrysler. In addition, Congress and the Fed threw many things against the wall. Some stuck, some didn’t.

Back to the basic question: Did it matter for the economy who was elected president in 2008? Probably not. The Fed still would have pumped massive amounts of liquidity into the system and lowered interest rates to historical lows. The U.S. Congress would have still approved of a stimulus package, and the U.S. government would still have had deficits of $5 trillion for the last four fiscal years. As Reinhart and Rogoff point out in their book, “This Time Is Different: Eight Centuries of Financial Folly,” it usually takes an economy seven to eight years to recover from a financial crisis. Consumers have to reduce debt, which they have done to the tune of $1.3 trillion since 2008. The financial system, especially the banks, has to be stabilized and recapitalized. And confidence has to be restored so consumers can spend and corporations can invest and hire. Lately U.S. consumers are spending more than U.S. corporations are investing, even though median family income in the U.S. has fallen five consecutive years.

If the U.S. economy follows the norm, it may take another three to four years to get out of the slow-growth environment and back to normal growth of 3.5 percent annually. The next president, the Fed and Congress have little ammunition left, given the magnitude of our debt and deficits. Given that world GDP growth has fallen, the problems in Europe, and the slowdown in the emerging economies (especially China), the next U.S. president faces challenging economic problems with few options. But good luck to him, whoever it may be.

Alan Blinder gets an F in Macro 101

Alan Blinder is a very competent economist with lots of publications, textbooks, and real-world policy experience. He is a chaired Professor at Princeton and is a former vice chairman of the Federal Reserve. The Wall Street Journal  published an article by him yesterday November 1, 2012, page A17.

Alan Blinder joins with Larry Summer, Paul Krugman, Martin Wolf and other liberal economists who think that we don’t have enough stimulus in the US economy. He can have his opinion and he certainly influences a lot of important people – but when he is wrong on something he is wrong and there is no way else to call it. These guys have enough publications to sink a Japanese freighter on its way to Dokdo Island and about as much joint common sense as Sheldon (the Big Bang Theory TV Show).

In his article Blinder says, “…fiscal policy should be giving us a combination of sizeable stimulus right now and thorough going deficit reduction starting in a year or two….Instead it is doing neither…”

Translation: Alan Blinder said that fiscal policy is not now giving us a sizeable stimulus. Say that again – Alan Blinder says that fiscal policy is not now giving us a sizeable stimulus. Say it again….

Okay Professor Blinder – take out any textbook written for any level and you will find the following:

·         Government budget balance – neutral impact of fiscal policy

·         Government budget surplus – contractionary impact of fiscal policy

·         Government budget deficit – expansionary impact of fiscal policy

·         The average government deficit – through thick and thin – for the USA has been about 3%

·         Let’s call a budget deficit of 3% of GDP normal

For the USA the budget deficit in 2012 (Fiscal year 2012 ended on September 30, 2012) was 8.5% of GDP. That is almost three times its normal impact on the economy. Professor Blinder – that is a ton of stimulus. To say it is not a huge stimulus is to turn macroeconomics on its head and then twirl it around 10 times.  Would four times be better? Five times?

You might retort that the deficit was over 10% of GDP in 2009 and taking it from 10% to 8.5% in three years is contractionary. But please do not retort that. First, any size deficit is a stimulus. Second, at 3 times normal it is a huge stimulus. Third, recall that the economy has now been recovering from a recession that ended three years ago. When a country recovers its deficit ALWAYS improves. That is not because of a lack of stimulus -- it is a simple fact that when the economy recovers it generates more tax revenue and less spending automatically. If the deficit was declining because of legislated tax increases or spending cuts between 2011 and 2012 please show me the legislation. As far as I know Congress has not passed anything but continuing resolutions.

Professor Blinder can want more stimulus but he cannot say that we don’t have a huge stimulus now. It is beyond belief that given his second goal to reduce deficits in the future he can say with a straight face that he will actively promote smaller future deficits? When will the US economy be strong enough in Blinder’s mind to start working on smaller future deficits?  A year or two? Really? When hell freezes over?

Sorry to say this Professor Blinder but you get an F in Macro 101.  

The Middle Class, Macro, and TinkerBell

The middle class has become one if not the major concept for the coming US election. Both parties attempt to capture it. VP Biden almost cried as he described in his debate his oneness with the middle class. His opponent Ryan was cooler as he claimed his party knows the right ways to help the middle class. It is clear that both sides need more middle class voters to win the coming election.

While middle class comes up in many different campaign and policy issues it most often comes up in the context of the budget – whether controlling entitlement spending or extending the Bush tax cuts – the focus always comes back to the impacts on the middle class. The Democrats want to continue these entitlements and possibly expand them while mostly paying for it with higher taxes on the rich. Let’s call this the direct approach to helping middle class at the expense of the rich.  The Republicans think the middle class is better served in a low tax rate environment, with stronger control over debt, and resulting higher economic growth. Let’s call that the indirect effect because it believes that hurting the rich eventually ends up hurting the middle class.

While the above position descriptions are brief I hope they reasonably and fairly connect the topic of middle class with typical macro policies. If the above already inflames you then I am in big trouble.

The above is meant to reveal or present a strong connection between what I would call the fiscal policy debate and the status of the middle class. Admittedly I am getting old and forgetful but my recollection of my economic education is that there is no strong and clear theory that relates macroeconomic policy and the middle class. In fact, take out any successful macro text book – freshman level or advanced graduate – and I doubt you will find a chapter or a section on macro policy and the middle class. In fact, you might not even be able to find a paragraph.

A little personal history may help put further light on this. I may have more credit hours in economics than any human being or reptile alive. I took a lot of econ as an undergrad at Georgia Tech. After Tech I was lucky enough to draw the short straw that sent me into the US Air Force for four years. While stationed in Arizona I took all the courses to receive an MA in Econ from the University of Arizona. Go Wildcats. Upon release from the USAF I went back to GA Tech and completed an MS program in Economics. Even more courses! Go Yellow Jackets. That’s when I decided to get a PhD at the University of North Carolina – and took courses for another three years. While at UNC I participated in a non-credit activity called the Macro Workshop. That workshop met once a week – even in the summers – for three years. Go Tarheels.

Your response might be – Larry – you are a very slow learner. And I would find it very hard to disagree with you and we can make that the topic of my next blog. But the point is in ALL THOSE COURSES I never ran into a course or a chapter or a topic called “Macro Policy and the Middle Class.”

This is important because it shows that all the so-called political and economic experts (you know who you are Paul Krugman) are just making this stuff up. Both sides of the aisle are making this stuff up as if it were a fairy tale. Take any macro model you want from any macro course you desire. It can be Keynesian, Monetarist or Gangnamian. Look at IS-LM curves, AD curves, AS curves or whatever – there is no middle class curve. Look at independent, dependent, or mutually dependent variables – there are no variables for middle class. There are equations for such things as output, employment, interest rates, consumer spending, business spending, etc – but there is NOTHING representing the middle class.

Larry you are screaming! Okay I took a big breath. That feels much better. Thanks. If I had taken Marxian Macro or if I perhaps had paid a little more attention to some specialized literatures in economics I might have found some theories and models about class and distribution of income. And you know what – I am not saying that distribution of income is not an important subject. It is important. It is very important.  And we should focus on it in a very direct and objective way.  But that is very different from two parties acting as if they had some great insights into how to improve the lot of the middle class via entitlement spending and tax rate changes. They know squat and they are using us in their frequent misleading and thoughtless conjectures about how their policies will impact the middle class.

This reminds us of what macro does. Most of what macro does is to help us better understand changes in key macro indicators like economic growth, inflation, interest rates and exchange rates. It does it in models that represent behaviors of consumers, workers, owners, foreigners, and the government. It mostly filters or tracks their behaviors by examining markets for consumer goods services, new housing, business structures and equipment, stocks, bonds, labor, and foreign exchange. That is macro and let’s admit – that’s a lot. 

Macro does not tell us about energy and food. It does not explain why companies move from north to the south. It does not tell us what causes poverty and why people give to charity. It does not discriminate the wages or the dividends or other sources of income for the middle class or the rich.

What politicians are doing is starting with bonafide macro and then adding fairy tales. Their passionate speeches make it sound like it all fits together and sound like a good story but they have nothing real to back it up. It is hot air. It is like when your doctor tells you how to improve your golf swing. He knows some anatomy but if he isn’t a golf coach I am not sure he has that much to offer.

The upshot about all this is that, again, these politicians create false debates to get us riled up and to distract us from their deficiencies. I wish we could get rid of the whole lot. We have real poverty issues in this country that need resolving. We need to improve education and job opportunities and economic growth.  We need stronger financial institutions. We need regulatory transparency. We need a smaller national debt. We need a lot. But instead of getting the tiniest amount of real analysis or policy we get Tinkerbell stories that have no basis in reality. Now where is that JD when I really need it?