Trickle Down Tax Policy

Last week I wrote about the Tower of Babel we call tax reform. The main point was the incredible lack of clarity when it comes to changing or reforming taxes. Given all the deductions and other special preferences and the many conflicting goals of tax change, it is very easy to never meet a tax change you ever liked. It is hard to see how legislative progress can be made and even with it, how it might have a discernible positive impact on the country.

But there is even more to the story that I came across in some remarks I read by critics under the rubric of “trickle down”. As an elderly gentleman, I try not to be offended by terms like trickle down, but as an economist I get annoyed when I hear people throwing those terms around. These words are the heart of an argument made by those who are primarily motivated by issues of distribution of income. Trickle down is vivid. A lovely flow of benefits come to the rich folks and by the time they are finished gorging themselves, a couple of drops trickle down to the poor. We could switch the analogy to a lovely and delicious cake consumed by royalty with nothing left but a few crumbs for everyone else. But whether it is a trickle of water or a few nasty crumbs, the point is the same. It is all about how any policy tilts the flow of income or benefits towards the rich. No matter what the intended impacts of the policy might be, all we hear about is trickle trickle trickle.

Common sense allows for the possibility that the true or full impact of a policy could differ from its initial incidence. Let’s suppose a professional team has always done poorly. Its players are paid commensurately. Then the owner decides to bid for a new quarterback. The immediate impact is the apparent unfairness as the new player makes much more money than the others. If the new QB is as good as heralded, the team will win the championship and all the players get bonuses and a big raise. The ultimate impact is what counts despite the apparent unfairness of the initial one. While it is true that these other players still earn considerably less than the handsome, young, sensation with TV contracts and important friends, they are making more than they did before and most would not vote to fire the new player.

Think about one of the many elements of tax reform – significantly reducing the rate of taxation on corporate profits. The immediate impact is easy to envision – a bunch of very rich company owners or stockholders in their condominiums in Vail smoking fine cigars and drinking Spanish brandy. While I cannot deny that owners of corporations will get richer, there is obviously more to the story. Think accounting. I was not a stellar accounting student in Professor Gamoneda’s class at Georgia Tech in 1966, but I do know that if you apply a smaller tax rate to a company’s profits, the company has some additional money to play with. What can that company do with that extra money afforded by the lower tax rate? Here are some examples in no particular order:

            Bribe a government official

            Give it to the owners

            Give it to the employees

            Give a new or improved benefit to employees 

            Add a new wing to the factory

            Buy new production equipment

            Buy new software

            Lower price to get a competitive advantage

            Give more to the local Boys and Girls Club

            Pay off debt faster

            Save it

            Give it to Larry

I am sure I missed something in that list but you get the point. It is tempting, and there might be times when giving most of the extra proceeds to the owners might make sense. But most companies have to compete, and it is pretty clear that they will spend a lot of money to gain an advantage over their adversaries. 

Though this list is long, keep in mind that if your concern is employees, many of those items in the list contain indirect impacts on the incomes of those employees. Any expense – whether it is to better train the employee or it gives that person better equipment to work with – should result in higher productivity. Higher productivity makes it easier for firms to pay them more.

The above can be extrapolated to any element of tax change. There is an immediate and obvious impact followed by less certain and/or less obvious ones. If a tax cut for a higher income person leads to more saving and lower interest rates, that might reduce what a middle income person pays to borrow for a house or a car. Maybe you want to call that trickle down. I just call it economics. To ignore these subsequent but undeniable impacts is folly. 

It is very bad economics to pretend that the only impacts of a tax change make rich people richer and poor people poorer. My advice for those of us who care about the income distribution and poverty is to quit harping on tax reform and spend a few minutes focusing on the real problems that prevent people from leaving poverty status. Or maybe that is too hard to do. If Lyndon Johnson were around and saw the results of his War on Poverty, he might wonder who won the war. 

Lesson 20 Taxes (Tower of Babel)

I am sitting at my desk reading all the articles about the latest proposal for tax change in the US. What a mess. Despite it being morning, it makes me want to reach for the extra-large bottle of JD. Have you ever tried JD on Honey Monster Puffs? Wow.

So I scratched my head hoping for some sort of stimulation in brain activity and decided it was time to start at ground zero with a lesson on taxes. Imagine us regular folks trying to decide the best route to Mars. I could begin by wondering about rocket fuel, sun spots, and billboards. And that might lead to discussions with neighbors and perhaps heated arguments, but the truth is that we amateurs might never converge on a realistic answer about the best way to get to Mars. There are so many issues! Better to argue about landscape issues.

So how does any of the above relate to taxes and recent tax proposals? The answer is that while the main idea of a tax is pretty simple, it is the use of taxes that makes the topic so complex. What is a tax? A tax is a way for the government to raise money so it can buy its citizens things. We take for granted that cities, states, and the nation should provide things to their citizens. 

Our Bloomington mayor wanted some shiny, new trash collection trucks so he added a new tax for that purpose. He already gets lots of our money for silly things like fire and police protection but he needed a wee bit more for these pretty new trucks. Each house got equally attractive new garbage cans that come in three sizes so it all made sense and none of us complained.

I think I already got off track. The main idea so far is that governments provide for their citizens, and they need money to do so. So they tax us. Taxes come in all shapes and sizes. In the USA, the main taxes the federal government collects are based on our incomes. State and local governments tend to tax incomes as well as goods we buy. Regardless of the source, these governments use the proceeds to take care of their citizens. That seems pretty simple. If the government wants to spend more, it has to tax more. So why are our friends in Washington, DC, so wild and crazy about the recent tax proposals? Have they been watching too many Steve Martin reruns? 

I can see at least three reasons beyond Steve Martin why the tax proposal generates so much commotion. First, the Federal government is allowed to go in debt. So we have a choice when we want to spend more. We can raise taxes or we can incur more debt or we can have a little more of both. Second, we not only raise most tax revenues based on income but we have a progressive tax system that charges higher rates on higher incomes. Third, the tax system is “holier” than Swiss cheese. No offense to Roger Federer implied. These holes are there for a purpose. Most of us are the recipients of at least one tiny little hole. For example, realtors love it when people can write-off the interest they pay when they borrow to buy their new tiny house. It makes it a lot easier to sell a house when the buyer is being subsidized. The same goes for electric cars and pain pills. Geez, how many of these so-called loopholes or deductions are there? Please don’t count them all up – you have better things to do today.

So what have we learned?  Taxes are pretty simple in principle but in practice they are more complicated than a mission to Mars. It is not simply a matter of government raising taxes so it can buy us shiny new garbage trucks. It becomes a series of questions about how every single person – dare I saw every voter – will react to any given specific way to raise those taxes.

            Tax increase or debt increase?

            Tax high-income people or low-income people?

            Tax young people or old people?

            Tax workers or retired people?

            Tax savers or spenders?

            Tax students or professors?

            Impact housing industry or stockbrokers?

            Tax heirs or new children?

            Tax sexy persons or economists?

            Should I go on?

If you answered yes to the last question, then you need help. If you thought the above stuff was fun, keep reading. It gets even more complicated. We blandly assumed that the tax increase is about raising the resources to spend more. But that is never the whole truth. We use the tax system to cure everything from male impotency to invasive Asian carp.

Think of all the hidden tunnels in our discussions today. Some of us want to use the tax change legislation to reform the tax code so it will create more growth. Others want to use it to address the distribution of income. Still others want to use it for short run stabilization of national spending. While all these goals are laudable, a tax change that improves growth might not immediately improve the distribution of income. A tax program that favors more short-term spending might damage sustainable economic growth. And of course, many of us worry about how these tax changes will affect the price of JD.

I am getting close to my word limit so I better sum up. I can do that with two words – Tower of Babel. Okay, that’s three words. That’s not many words compared to the number you will see and hear in the next days about tax reform. And I bet you this: Few if any of the authors of those words will explain what taxes are and what they should be used to accomplish. Each of these selfish people will take the easy road and will loudly point out how one group is to be favored over another. Having a realistic and thoughtful approach to taxes is beyond them. They would rather achieve star status by fussing about the low hanging fruit. Inasmuch, it is difficult to see any proposal that would have any beneficial impacts passed by the mental institution we call Congress. No one wants to be a loser, and no one will admit what goals they hope to accomplish. 

Even if a proposal is passed into law, we will accomplish no national goals, and we will end up pointing more fingers at each other after the tax change than we did before it. 

Post Wedding Blues

My daughter got married last weekend and I was sworn, along with other family members, to not discuss politics at wedding events. I managed to honor my promise Thursday through Saturday but then at the Sunday brunch, a wonderful relative found me and egged me on.

I am not writing about the specifics of that interchange. But our back-and-forth did make me think. It made me think about the impossible situation we find ourselves in today. This rock and hard place defines us. The rock is the fact that we have threatening problems in this country. We have a highly tilted distribution of income. We have a very expensive and failing health system. We have a drug epidemic. We have too many people making insufficient incomes. We have lackluster economic growth. That’s the rock. The hard place is that government spending is rising faster than tax revenue, creating larger yearly deficits and a bigger national debt. 

“Caught between a rock and a hard place” is a way to say that there are no easy choices left. Solving the problems I listed above will take a lot more money. But there is no money. And like anyone with a tendency to have larger and larger debts, the USA can and most likely will reach a point when people will stop lending to us. They will also stop investing in us. So on the one hand (do I sound like an economist now?), it is going to be very hard to spend more on these critical problems. On the other hand, if we try to reduce our debts, we will need to reduce the growth of spending relative to tax revenues. How can we reduce the growth of spending when we have so many needs?

If there is a robust (better than saying hateful) debate among the citizens, it is for a good reason. No matter which side of the rock and hard place you begin with, there is going to have to be a very negative impact. At Georgia Tech, I had the honor of taking a course from a professor named Phil Adler who introduced us pimply-faced Industrial Management majors to a concept called bubble management. If a well-inflated balloon has a bubble on one surface, any attempt to push it in will lead to a bubble on the opposing surface of the balloon. That is, if a management problem surfaces and you attack it, you should know you will ALWAYS create another problem. The trick to good management is having solutions that reduce the size of the problems (bubbles).

Unfortunately, most of today’s politicians did not have the opportunity to learn from Professor Adler. Unfortunately, what works in business management does not work in the political arena. So here we are with a really big and ugly bubble today, and no one has the guts to push it in. Why? Because we are afraid of the bubbles that will be created. Any politician who creates a bubble by trying to escape today’s problems fears he or she will be punished by the voters.

Is this problem new? No, but our current dilemma is really severe. Seems to me we had a similar situation in the late 1970s, and it required a Fed that raised the interest rate to 22%. That took guts. It smacked us into a recession. But someone knew that the only way forward was to take a step backward. And they had the guts to take on the wrath of a whole country. These extreme rock-and-hard-place situations are rare but they always require the same solution – wherein policymakers understand they must do something very unpopular to exit a very bad situation and make things eventually better.

That’s where we stand today. The public watches politicians on all sides abdicate their sworn duties as they lead cheers and rile up their constituents into thinking that rants against their opponents will somehow help us. They appear caring and intelligent as they enumerate all the bad things that will happen if their adversaries get their way. But as Professor Adler would say, there is always going to be another bubble. Let’s accept that and try to make the next bubble smaller than the current one.

The short-run impacts of any new policy cannot be absorbed by one group. And the impacts should be of manageable size and limited duration. This will take a bipartisan effort. There’s no other way. Otherwise, we are stuck between a very hard rock and a very hard hard place. 

What do we need to do? Generally, we need to reduce the budgetary risks that haunt us today. Specifically we can begin by controlling government spending. This won't be easy because we will have to prioritize. We will have to determine which programs will be slowed the most. Second, we have to permanently raise government revenues. The surest way to do this is to raise the long-term growth rate of the economy. Third, long-term growth can be raised by attending to factors that inhibit growth. We need to aim policy at increasing labor force participation and productivity. 

If we do all this, we will probably take a step backward. Some will be temporarily injured more than others. Howls will be heard from many sources. But this situation is no different than that facing a drug addict. Without a time of withdrawal from the drug, there is no miracle cure to end an addiction. Withdrawal hurts. But it is the only way to find a permanent cure. Putting it off just makes the eventual pain even worse. 

As far as the wedding goes -- it was an incredible weekend filled with happiness and love at the joining of two wonderful ladies. 

Impossible Mission -- Finding a New Fed Chair

I just wrote a piece about monetary policy and choosing the next Fed Chair. It was kinda cute and like all my posts, it was pretty brilliant in my own opinion. But alas, I ditched it. I deep-sixed it. I trashed it. I crumpled it up and threw it in the hopper. Actually, I just hit the delete button.

Monetary policy is the most misunderstood topic I ever write about. It’s not even that 

hard. The main confusion is that monetary policy is about every-day things that we think we know something about. So people blab on and on about it. But the truth is that most of us know almost nothing about it. It’s like climate change. I love climate change. Or is that season change? Anyway, I love it when the leaves turn color and fall off the trees and scream at me to rake them into piles.  I have a lot of opinions about climate change (and seasonal change which happens to be late this year) but I don’t know squat about molecules, CO2, H20 or the FBI.

So I can be very dangerous talking about climate change among real scientists since I don’t know a thing about chemistry or physics. But it is truly amazing how many people like me have very strong opinions. I know that because I see the veins on their neck pop out when they drink JD and talk about climate change. Why? Because they trust the scientists. Scientists are great.  My physicist friends – yes I have physics friends and an odd chemist or two – really understand what is going on with respect to weather, and climate, and how many angels can dance on the tip of a pin.

Scientists don’t have opinions. Okay maybe they have opinions about the things like the World Series and what color to paint the hall bathroom. But unlike most of us scientists have theory-based predictions. Scientists are famous for saying things like – based on my assumptions and my model (if you don’t like the word model replace it with theory) I predict that a chain reaction that started a jillion years ago in outer space will cause a blue light in a telescope in 2017. Now that is cool.

Scientists give us driverless cars, a nice lady named Alexa, and JD. But here is the thing about science. Science is not just about the past. It is about the future. And there is where the party and the gumbayas end. When we are dealing with new insights and the future we can use our models all day and all night – but not all models and not all approaches will be the same. Are all developmental driverless cars the same? As scientists develop batteries that will store solar energy, are they using the exact same technologies? Are all biologists and chemists using the exact same approaches to curing cancer and athlete’s foot?

When it comes to new things and to the future, we realize that scientists will use different approaches. We usually like that. This competition of ideas routinely produces better results than if Lee Corso was orchestrating research along one theory.

And thus we get to monetary theory. Money is simple. It’s stuff we use to make final payment. If you have a fist-full of money your bookie has to accept it. But that is where the simple part ends. How much money does the US economy need on October 24, 2017? Or more pertinent, how much money will the economy need between October 24 and December 31, 2017? The answer to that question depends on many things – things which will unfold between now and the end of the year.

Will the economy explode in a fit of growth or will it suddenly slow? Will events abroad cause a flood of foreign investment into New York and Seattle causing US interest rates to decline? Will productivity decline causing lower wages and inflation? How much money we need in the future depends on all those things and more.

Monetary scientists – people who have spent their lives memorizing monetary theories and egg foo young recipes – had similar training and know all the models. But because they could have different visions about the future, they might come away with very different prescriptions for monetary policy. Of course, much also depends on what I call their basic potty training. Some monetary scientists are perennial optimists who believe in Adam Smith’s invisible hand and conclude that we hardly ever predict the future accurately. They are conservative about monetary policy because they worry that they’d have to change it every two weeks as their view of the future changes. All that change causes uncertainty for buyers and sellers.

For every one of these conservative monetary scientists there is one of the opposite potty training. They do not have faith in the resiliency of the economy. They believe it takes an active hand of government to keep us from horrible consequences. They stand ready to alter monetary policy every time the economy twists or turns. They are like helicopter parents who believe they should room with their child in college or else they turn into monsters or professors.   

This has gone on long enough. I like this one better than the last one I wrote and deleted. I am truly a genius (in my own humble opinion). But what have I concluded? Basically nothing. Or maybe I made a prediction that despite the millions of words that will be said about this or that candidate to run the FED – all of it will sound very understandable but essentially will be a gobbly gook of opinions about which candidate has the proper potty training and which one can predict the future course of the economy better. Good luck with all that. Let's just pick one with some common sense and perhaps some real experience with money and financial markets.

IMF says Global Economic Upswing Creates a Window of Opportunity

The International Monetary Fund publishes a world economic outlook every six months. The latest one was just published this month (https://blogs.imf.org/2017/10/10/global-economic-upswing-creates-a-window-of-opportunity/ ) and is entitled "Global Economic Upswing Creates a Window of Opportunity".

This report is not for the faint-of-heart as it is long and treacherous and filled with words and phrases like "raising potential output" and "strengthening international cooperation". Far be it for me to summarize the most current document but I thought I would copy a key table (see the bottom of this post) and then go on and on a bit about some of that.

First, notice that the title of the table says the global recovery is continuing at a faster pace. Yet, the top of the table says that after growing at 3.6% in 2017 (technically this is a forecast since we have not yet shopped for Halloween much less Thanksgiving or Christmas in 2017) we will grow at 3.7% in 2018. For those of you who know a little about statistics, I doubt that 3.7 is statistically different from 3.6.  For those of you who were never punished by a Stats class and don't know a standard deviation from your local neighborhood deviant, this means that the entire publication is suspect. While the thousands of words in the report support this view of faster growth, we all know that the main table of the report says the world will not grow faster next year. It might grow faster. It might grow slower. And Humpty Dumpty had a great fall.

Read down farther and you will learn the following world areas/countries will grow slower in 2018 than in 2017:

Advanced Nations
Euro Area         
Germany               
Italy                       
Spain                     
Japan                     
UK                       
Canada                 
Russia                   
China                   
Emerging Europe 
Mexico 

Given the title of the report and table say that world  growth will be faster, there must be some places that will grow faster in 2018.   The table says these places will grow faster -- the US by a smidge, France, CIS less Russia, India, Brazil, Saudi Arabia, Nigeria, South Africa, and Low Income Developing Countries.

How you can average the growth rates of the slower list with the faster list and come up with faster world growth is a mystery to me. If I was writing this report based on this table I would say that the world seems to be on its last JD of the night. Or maybe -- "While growth in our bigger world markets is stuck in first gear, we see some hopeful spots for growth in some developing countries."
         
Second is the part of the title that claims that 2018 is a window of opportunity. I recall being in high school and thinking that my bedroom window provided a great opportunity to escape in the wee hours of Sunday morning. But when was my bedroom window not a window of opportunity? And so it goes for the IMF -- why is 2018 going to be a window of opportunity that wasn't there in 2017? And the answer is that  the IMF thinks we have kicked the policy can down the road long enough because growth was too weak in too many countries. But now that so many countries are doing so much better, they will button down, quit kicking cans, and attend to important things like economic growth.

Wow --- what is the IMF smoking because I would like some of it. No, the world is not growing any faster according to their own numbers and mostly is growing faster in places like Kokomo (fictional one of the song and not the one in Indiana), Gotham, and Atlantis. And in what places will politicians in 2018 resoundingly decide that long-term economic growth is their number one priority? Watch France. Their child Prime Minister is trying such things and every union in France is suggesting that statues of Emmanuel Macron be broken into tiny little pieces.

If that isn't enough, the IMF has the audacity to imagine that this is a great opportunity for countries to get together in a pro-growth fit and further reduce trade barriers and expand international economic cooperation. Really? Have they looked around? What part of the world is not cracking up? Have they read about Spain or Brexit?  What free trade agreement is universally loved?

From the above you would think that I am either into my third JD of the morning or that I am pessimistic about 2018. I won't comment on the former since children might be reading this but I am not pessimistic. My reading of the world economy is that modest growth is good since it doesn't create huge imbalances and threaten high inflation. Momentum is our friend as more and more countries attach to a slightly stronger world economy. The biggest risks arise from the absence of what the IMF predicts -- that we will continue to kick the growth policy can down the road and countries will outdo themselves with counterproductive protectionist policies. That is -- the economy is fine -- it is the politicians that we have to worry about. Let's hope they take an extended vacation.

Economic Growth Anemia

Many of my friends cannot remember which one was Laurel and which one was Hardy. I do remember which one was Sonny and which one was Cher. And so it goes with economic growth and business cycles. In truth, growth and cycles are as different as Simon and Garfunkel but you would never know it.

Economic growth has become the Cinderella of macro. Pushed into the back room and assigned to the lowliest cleaning duties, economic growth is hardly heard of in favor of business cycles. The Fed has never been more neurotic. Are we at full employment today? Are we too strong? Is inflation too low? Should I drink JD or Scotch?

Whew. I feel a lot better now. Let’s start at the beginning. Macro has two main areas – growth and cycles. Growth is a long-run concept. It is all about how the capacity to produce changes over time. Imagine the economy as one big factory. What makes the factory able to produce more (or less) as a long-term or permanent outcome? You can imagine the kinds of things that affect the capacity to produce – better equipment, new structures, a more efficient layout, better training of the workforce, are just some of them.

The second part of macro – cycle theory – is very short-run-oriented and poses questions about why the nation’s output deviates from the capacity to produce. That is where things like recessions come into play. Most recessions are over in a matter of months. Their impacts can go on for a while, but the large and sometimes sharp turns in output are usually limited to half a year, plus or minus. Policies designed to reduce these cyclical changes are very different from those that augment long-run capacity changes. Typically the causes of such short-term cyclical events have something to do with the ever-fickle desire to buy – or what we refer to as demand changes. Suffice it to say, the things that cause short-term changes in demand are very different from the things that impact long-run capacity – and so too are the policies different.

With all that behind us, let’s think more about Cinderella -- i.e., long-term or capacity growth. While capacity growth sounds like engineering, the reason we emphasize it is that capacity growth is the key to improving both the standard and the cost of living. The evidence is around us. Whether it is a rich country like the USA or a dramatically growing country like China or Vietnam, the evidence is that producing a larger pile of goods brings permanently higher incomes and lower poverty incidence to the citizens of those countries. With those higher incomes come safer and more environmentally friendly production. While there are some who would argue against growth, most of those people are on the fringe.

We usually use sustained real GDP growth to measure capacity changes. Not focusing on short-term changes, I present some figures for the time period from 1955 to 2016 – 61 years.

Average Annual Growth in U.S. Real GDP

1955 to 1970           4.8%

1970 to 1985           4.1%

1985 to 2000           4.4%

2000 to 2016           2.0%

The US economy expanded at an annual rate of over 4% for about 45 years from 1955 to 2000. After that we saw a pronounced slowing to 2% per year. It is true that we had a major recession in 2008 and part of 2009, but it is also true there were many recessions between 1955 and 2000. If we look at shorter time periods after 2000, we see 2.7% annual growth from 2000 to 2005, slower growth of 0.7% per year in 2005 to 2010, and then 1.9% per year in the six expansion years from 2010 to 2016.

While anything is arguable, the data seem clear that something changed to permanently alter the growth rate of the US economy after the turn of the century. Left to its own course, this slowdown threatens our ability to increase our standard of living and reduce poverty.

What causes economic growth to slow? To answer that question, economists use growth models. These models ignore many things that cause short-term deviations in demand and output to instead focus on capacity-altering events. Growth models boil down to two sets of factors – those that impact the supply of labor and those that impact the productivity of labor. A retiring baby boom, global competition, government regulation, tax rates and other policies towards business are often discussed in the context of waning capacity.

The surprising thing is that most legislators ignore the bull in the china shop. Maybe it is too complicated for them. Instead they would rather spend their precious few working hours heatedly debating social policy. Policies relating to regulation and tax reform are a case in point. Such policies have the potential to raise the growth of output yet few of the public discussions focus on output, instead pointing fingers about how they might harm social goals and income distribution.

Social goals are critical to a nation. But so is growth. If we continue to relegate serious growth discussion to the background, we will suffer the consequences as we become a stagnant economy with few resources for much of anything including solving difficult social problems.

The National Football League

I had to do it. I had to get sucked into this mess. I am a card-carrying global macroeconomist and here I am writing about the NFL. Does the NFL cause inflation or recessions? No, I think not. Does the NFL cause productivity or wages to rise? I doubt it. But here I am writing about it.

As one of my friends wrote me recently, why would anyone be interested in macro when there is all this other stuff to talk about? He told me that only the elites care about the usual macro policy issues. So, on to the NFL.

So what do I say? I thought long and hard and here is what I could come up with: The NFL is the canary in the mine shaft. The NFL is the beginning of a road that leads directly to chaos and eventually bloody revolution.

That’s a big statement, right? I just watched part of the Vietnam film on PBS, and it reminded me that we are not immune to violence and revolution in the USA. People my age participated in mistakes in Vietnam and were glad when the Cold War seemed to end. We also experienced the Civil Rights protests and were glad to see that situation improved. But it has been a while since all that transpired and it is not unbelievable that we have come full circle. It is quite possible that what we are seeing in the NFL is just the beginning of some very tough times ahead.

The end of the Cold War and the Civil Rights Revolution brought positive change. In the 1970s, one would have expected a great period of healing to follow – and maybe it did. It is one thing for whites and blacks and capitalists and communists to be ignorant of each other. It might follow that as we joined closer together, as in any marriage, many problems would be solved. But what we did not expect is that when we got to know each other a little better we would sometimes get on each other’s nerves. As we all became more equal, some got equal faster than others and some got less equal.

A half a century later we find that the world might be fairer than it was in 1960. But we also find as we become more familiar and equal, we have new and larger problems between capitalists and communists, blacks and whites, gays and heteros, JD and Scotch drinkers. (I had to get JD in somewhere!)

Conservatives can defend their records and describe how much minorities have gained in the last half-century. Liberals can point out the vast inequalities that remain. This is not an argument that can be resolved easily. Major progress on income distribution, job discrimination, crime, policing, immigration, national security and defense will not come easily. These are tough nuts to crack. Solutions won't reduce to ”my way or the highway.”

Reasoned approaches to our most difficult challenges are not to be had. And the NFL is the beautiful example of why. Our President said horrible things about our players and our players responded in kind. Is this stupid or what? We have proper forums to work through sensitive national issues. Why are those fleet of feet and marbled by muscle feeling the need to make their political desires known at NFL games? Why do actors do the same at award ceremonies? Why do college students wear masks and beat each other with sticks on campus?

I think this is because the answers to the questions are tougher than we are. We either want or don't want dramatic change. We want to be on the right side. We want to curse at those who disagree with us. But the truth is that the more we act in these ways, the less headway we make and the more entrenched our adversaries become.

That all this has come to the NFL shows how far we have come down a very bad road. Does it seem far-fetched that these behaviors will come to baseball? To college athletics? To Macy’s holiday parade? To a local music concert? To your next family gathering? It does not seem impossible that, in light of the lack of any real leadership in this country, we will keep playing out our demand for a better world outside of regular political/government frameworks. It also does not seem impossible that those who are the most frustrated will bring their impatience and hatred to situations that will give them notoriety. With all the sides hardening, it is not difficult to imagine even more violence in even more places.

Where is the national leader who will tell us that these behaviors are counter-productive and convince us of the following: First, our situation today in the USA is enviable compared to most places around the world. Second, we made a start to become the shining light on the hill. Third, some of the hardest challenges are ahead of us. And finally, we are good enough to meet those challenges.  Can you think of one politician today who could pass this muster?

Happy Birthday to the National Debt

Let’s call her Natty. Natty just reached 20 -- $20 trillion that is. Okay, it’s not a birthday but it is a milestone and one that bears a little time and attention.

There are so many things to say that I don’t know where to begin.

Let’s think first about the words “national debt.” Natty is most definitely not a measure of all the debt of the nation. Households have many kinds of debt and none of them are included in the $20 trillion national debt. Borrowing money for houses, cars, JD, and college are not part of Natty. All that credit created by slipping your credit card into a little machine is not included in Natty. That loan to Uncle Chuck isn’t part of it either. And when companies large and small borrow from banks or sell bonds or find other means to finance their acquisitions of plant, equipment, and software – none of that is included either.

So what is included in Natty? Natty is simply the debt owed by the federal government. Notice that Natty does not include any borrowings of your state and local governments. Natty’s $20 trillion pile of debt includes only that which the US federal government borrowed.

Why does the government owe any money? Doesn’t the government have the power to tax us? Surely there are plenty of federal taxes. The truth is that the government owes money because, like the Tuna, it loves to spend money and hates to ask us taxpayers to pay the whole deal. Take 2016 for example. The government collected $3.3 trillion in tax revenue. On Social Security, Medicare, defense, and many other programs, it spent approximately $3.9 trillion. Thus the government had to borrow $585 billion to meet the difference.

Why did the government have to borrow that money? Doesn’t the government have the power to print money without limit? In most countries, including the USA, a central bank exists and it is allowed to print money. But budget deficits must be funded by government borrowing through bonds. Clever governments ask central banks to buy their debt and that eases the process. But as we will see below, most of the debt is held by private investors.

In 2016 the government borrowed $585 billion. That’s a long way from $20 trillion. How did the debt get so large? The answer is that the US government is addicted to debt. In the 49 years between 1967 and 2016, the US had a surplus only five times. Thus we had deficits and we added to the debt in 44 of those 49 years. That’s how the debt got so large. We piled up almost $8 trillion of the $20 trillion in the nine years since the great recession started in 2008. While the additions to the debt have been somewhat less lately, we had at least three years in which the annual deficits were well over $1 trillion per year.

Who holds the national debt? I heard China has a lot of it. Let’s start with the 2016 national debt of $19.6 trillion. Of that amount, $5.4 trillion was money that some parts of government owed to other parts of government. So we call the public debt the remaining $14.2 trillion. Of that amount, the Federal Reserve owned $2.8 trillion. That left $11.7 trillion for private investors. Of that amount, Chinese and other foreigners owned $6.2 trillion. 

Is that $6.2 trillion enough for foreigners to push the US around? I doubt it. But in the event that foreigners decided to quickly sell all their US bonds, that could throw us for a loop. But keep this in mind, if any investors in US bonds decided they are a risky bet – it doesn’t matter whether the sales come from foreigners or US citizens – the results could be terrible.

This leads us to the big question: Does the $20 trillion debt put the US in a risky position? The government is a pretty big cat; is $20 trillion a lot of money? Here is where an example might be helpful. Suppose you have debt of $100,000. Is that risky? It depends on your ability to pay it off. Maybe you have a savings account of $3 million. Not so bad. Maybe you have an annual income of $300,000. Not so bad. But if instead you have no money in the bank and you have a very low income, then your bank is going to worry about your ability to repay the $100,000.

Similar ideas apply to countries. How do you measure the ability of a country to repay its debt? We might look at foreign reserves they accumulated to pay foreigners. We might also look at tax revenues. Those tax revenues are driven by the strength of the economy and the soundness of the financial system. If a country is about to implode, it worries a lot of people – including people who hold that government’s bonds.

Is $20 trillion too much debt for the USA? Probably not at the moment. But psychology moves quickly. If we seem unable to restrain our future debts because we spend too much and tax too little that will not make bondholders happy. If our economy grows too slowly or if a recession threatens even worse economic outcomes, that realization will make things scarey. At that point the $20 trillion will seem like a very risky burden.

Ask other countries about how quickly a difficult situation can turn into a crisis. One day you are the darling of the world. The next day people are selling your assets and your currency and you are the basket-case of the world.

We manage debt to be prudent. A modest debt load is normal. A larger amount of debt won’t necessarily undo you but it does raise the risk of some very bad things happening. It is time our US government acted as if they knew this valuable truth.

Lesson 19 Tax Reform and Simultaneous Organization

Who is up next? I am. My name is Tax Reform. My friend healthcare already struck out. Budget, debt limit, and immigration will be up in future innings or maybe in future games. I don’t know.

No, government policy is not a baseball game. But it sure seems like one as policy deliberations and decisions flow sequentially from one month (inning) to the next. 

What other choice is there? While it seems almost crazy to mention, a better choice is to do it all at once – simultaneous instead of sequential.

We seem to be focused now on tax reform. But we are already hearing that you can’t do tax reform until you settle healthcare. Or you can’t get much accomplished with tax reform until you settle the budget or change the debt ceiling. It’s all related. Who came first, the chicken or the egg?

There must be a prize in government that is awarded to the people who make simple things impossible. People make budgets all the time. So do companies and churches and drug dealers. We plan and make budgets because this activity produces better results. Instead we could wake each morning and make a new decision. It’s Tuesday so maybe I will buy a TV. It is Wednesday so I might sell some shares of stock. It is Thursday, and I will get a job and earn some money.

Sound stupid? It should. But this is the way government works each year. The main reason that sequential budgeting does not work in government is that each policy affects many aspects of our lives. A given policy helps Nolan while is hurts Jenny. Of course, Jenny and her friends scream bloody murder. The next policy helps Jenny but not Nolan. Nolan organizes his kindergarten buddies, and they throw rotten eggs at guilty politicians. The upshot is that sequential decision making gets nowhere because EACH decision has a natural resistance.

Better would be a more simultaneous approach. Let’s take five different areas of policy and find the best solutions. Policy 1 helps one group. Policy 2 helps another group. Policy 3 might help both groups. If you decide and then announce all five policies at once, it is harder for resistance to form. For one thing, figuring out the net effects on people might not be easy when summing up all the pluses and minuses of all the policies. For another, it might be the truth that most of us benefit from the whole package, warts and all.

The above is too abstract. Think next how this might play out in the real world. Good planners begin with a statement of problems. Once the problems are known they can then think about the remedies. What are our national problems?

Low labor participation
Low capital spending 
Slow economic growth
Unequal distribution of income
High government debt
Inefficient tax system
Too little/too much government spending
Too much/too little government regulation of business
Healthcare
Pimples, JD, and other

We can argue about these problems and their order of importance but it seems possible that a fruitful beginning step by national policymakers would be to list these problems according to some definition of priority or importance. Ties are permissible. Just rank them, damn it.

Then they would produce a list of policies that might address one or more of those problems. Such policies would include tax reform, tax cuts, government spending changes, reforms to healthcare, immigration policies, and so on.

Assign every policy a positive or negative number as to how that policy might impact each and every problem listed. Note that a tax reform policy might help the rich more than the poor in dollar terms. A government spending policy might do the opposite. Do not try to make every policy help every problem and every person. Each policy should have an intended benefit though with side effects.

Summarize the positive and negative impacts of each policy on each problem area. The first round of this simultaneous approach will find some policymakers do not approve of the results. Go back at it and adjust each policy so that the net result of all the policies is acceptable. No set of policies will make everyone happy. This approach has a chance of finding a solution that recognizes that not every policy will make everyone happy but that the sum of all the policies generally improves things.

Every major organization works this way. The board approves a comprehensive plan whose purpose is to best meet the goals of the organization – be they marketing, finance, or human resources. They do not go from day-to-day making decisions willy-nilly. Call me a dreamer for believing that government can be thoughtful and goal focused. But that just shows how we have come to accept idiotic and failed approaches to our very important problems and goals. Or maybe, like watching a good fist fight, we revel in the blood and guts. Government policy is pure entertainment. In that case, we deserve what we get. 

Happiness in 2017

It is nearly impossible to be among people and JD (or other forms of alcohol) and not get into a fierce debate about politics. People are energized by the current political scene in ways I have not seen since I first went to Disney World and Lego Land. Otherwise gentle and thoughtful folks look as if their heads are going to blow off standing next to the appetizer table. Red-faced and sweating, they speak in loud voices and won’t put up with hearing things that defy their own opinions. We don’t mind telling our dear friends that if they hold a particular view, they are lower than the slime on the belly of reptile.

So in the spirit of making things horribly worse, I decided to do a little research. If this is the way people want to spend their evenings, I wanted to try to understand how this behavior fits into well-recognized theories about happiness. Let’s be clear: I am not trying to change you, and I am not taking sides. But I do wonder why we want to spend our precious time on this planet screaming and yelling at our friends, relatives, and pets.

What’s important? What makes us happy? I admit that the quotes and summaries I display below leave out some critical aspects of happiness. But this topic ain’t macro and it ain’t football -- in other words, I did the best I could. Maybe you can see in the philosophies below why so many of us seem to be happy being ugly. Or not.  

Abraham Maslow, in his 1943 paper “A Theory of Human Motivation”, set out what people now call Maslow’s hierarchy. The hierarchy of wants is often shown as a triangle in which the base represents the most basic human needs to stay alive. Once one level of the triangle is satisfied, the human moves upward to satisfy higher needs with the highest level called self-actualization. My interpretation of this is that things like eating, breathing, feeling safe, having loving family and friends, are among the key things that make us happy each day.

Confucius (according to a blog I found (https://www.linkedin.com/pulse/confucius-happiness-suzana-aleksic )

Confucius believed that anyone could change themselves regardless of social status and financial situation. In other words, happiness was not reserved for aristocrats. For Confucius, happiness had nothing to do with financial situation of a person; it depended on a person's level of self-development and virtue attainment. In addition to this, Confucius emphasized action over thoughts. He stated that to reach happiness, it was not enough to think well; one had to act on these thoughts. Similarly, doing good deeds without good intentions did not count for Confucius. To advance on the "happiness path", one had to think good and then act on those thoughts. This great philosopher stated that the "reciprocity" is what should lead people through their lives, as "what you do not want done to yourself, do not do to others."

According to Aristotle, happiness consists in achieving, through the course of a whole lifetime, all the goods — health, wealth, knowledge, friends, etc. — that lead to the perfection of human nature and to the enrichment of human life. This requires us to make choices, some of which may be very difficult. Often the lesser good promises immediate pleasure and is more tempting, while the greater good is painful and requires some sort of sacrifice. For example, it may be easier and more enjoyable to spend the night watching television, but you know that you will be better off if you spend it researching for your term paper. Developing a good character requires a strong effort of will to do the right thing, even in difficult situations.

A quote from Ayn Rand (from For the New Intellectual): Happiness is not to be achieved at the command of emotional whims. Happiness is not the satisfaction of whatever irrational wishes you might blindly attempt to indulge. Happiness is a state of non-contradictory joy—a joy without penalty or guilt, a joy that does not clash with any of your values and does not work for your own destruction, not the joy of escaping from your mind, but of using your mind’s fullest power, not the joy of faking reality, but of achieving values that are real, not the joy of a drunkard, but of a producer. Happiness is possible only to a rational man, the man who desires nothing but rational goals, seeks nothing but rational values and finds his joy in nothing but rational actions.

10 Commandments (It is debatable among Christians if following all the commandments is the key to happiness and salvation but they do express a view of what the Bible says God wants from his followers.

1.  You shall have no other gods before Me.

2.  You shall not make idols.

3.  You shall not take the name of the LORD your God in vain.

4.  Remember the Sabbath day, to keep it holy.

5.  Honor your father and your mother.

6.  You shall not murder.

7.  You shall not commit adultery.

8.  You shall not steal.

9.  You shall not bear false witness against your neighbor.
10.You shall not covet.

And then there is Buddha ( http://www.lucidcafe.com/library/96jun/buddha2.html )

The Four Noble Truths:
1.  All things and experiences are marked by suffering/ disharmony/ frustration (dukkha).
2.  The arising of suffering/ disharmony/ frustration comes from desire/ craving/ clinging.
3.  To achieve the cessation or end of suffering/ disharmony/ frustration, let go of desire/ craving/ clinging.
4.  The way to achieve that cessation of suffering/ disharmony/ frustration is walking the Eightfold Path.

The eightfold path to the cessation of suffering:
1.  Right Understanding of truth suffering impermanence and separate self as an illusion.
2.  Right Determination to give up what is wrong and evil;
3.  Right Speech: Abstain from telling lies and harsh speech or language
4.  Right Action: Moral, peaceful, honorable conduct
5.  Right Livelihood: Abstain from making your living from an occupation that brings harm and suffering to humans or animals, or diminish their well being.
6.  Right Effort: Foster good and prevent evil; work on yourself—be engaged in appropriate self-improvement.
7.  Right Mindfulness or wakefulness: Foster right attention.
8.  Right Concentration: Developed by practicing meditation and/or mental focusing.

Here are some interesting quotes from Martin Luther King:

• Darkness cannot drive out darkness; only light can do that. Hate cannot drive out hate; only love can do that. 
• The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy. 
• In the End, we will remember not the words of our enemies but the silence of our friends. 

It is tempting to summarize at this point but infinitely more enjoyable to have you tell me if and how any of this makes heated argument a good thing! 😊

Lesson 18 Inflation

The posts in my blog space named “lessons” are meant to provide some background on concepts I throw around like fish at a Seattle fish market. Some of my readers are not economists, and they often send me emails requesting that I try to better explain macro concepts. I sometimes direct them to my online resource called MacroNotes (http://macronotesmba.com/ ) but that’s a little like sending someone who wants to taste a little pho to Hanoi when our local Vietnamese restaurant, Rush Hour Station, has perfectly good pho. So instead of going to MacroNotes for more information about inflation ( http://macronotesmba.com/lessons/inflation-and-unemployment/ ), I will post today on that topic.

Inflation isn’t an easy topic and therefore deserves some attention. And inflation is a very important topic these days for several reasons. First, it is growing slower in the USA and that makes us wonder about it. Second, it seems to be associated with economic growth forecasts that are less than rosy. Something is going on out there that makes lower inflation a sign and maybe even a cause of slower economic growth. And third, our policymakers see the lower inflation rates as a reason to keep pouring fuel on the economy.

Inflation will never be as exciting as a Confederate War Memorial or an Indiana University football game, but inflation is pretty interesting these days. So what is inflation?

Let’s begin with this definition: inflation is the rate of change of prices. For you math buffs, this definition is basically an equation. I can talk about the inflation rate of weed prices in Colorado. Suppose a sack of weed went from $2.00 to $2.20 in the last month. Applying the formula, we can say that the inflation rate of weed during that time period was 10%. Anything that has a price has an inflation rate associated with it.

Applying this concept of a rate of change means that inflation of something could be positive, negative, or zero. If it is negative then we call that deflation as it means prices are falling. If the calculation is positive then we simply call that inflation. If the calculation is zero we have no name for that. We would say inflation is zero. Once a teacher called me "zero" but that had nothing to do with inflation. 

We also have terms to describe how the inflation rate is changing over time. If the inflation rate goes from 2% to 1% we say inflation in decreasing or we say we call this disinflation. A rising inflation rate is called reflation.

The inflation rate we are discussing today is the inflation rate of a nation. In the USA each day, we not only buy weed but we buy silly things like cars and doctor visits and Uber rides. Our Labor Department defines someone called the typical Urban Consumer. Let’s call her Jaden. Jaden buys stuff each month at Target, Kroger, and of course Amazon. Since she is the typical Urban Consumer, the Labor Department tracks what she pays for all the goods and services she buys. She hides this information from Chuck but that is another story. 

The idea is that the Labor Department can get a number that represents what she paid for all the stuff she bought in any month, say for example, December of 2016. We would call that number the CPI for December 2016 for the USA. Let’s say that number is 200. We collect that same price information in January of 2017. Suppose the number for January turns out to be 210. We would use our formula and conclude that the inflation rate in January was 5%. If that rate kept up for every month in 2017, then we would say the annualized rate of inflation in January was 60%. But the inflation probably won’t keep up at that rate and the 60% is just a way to express what happened in one month.

Suppose you don’t spend exactly like Jaden. Perhaps you really like Cuban black beans and you eat that with rice a disproportionate number of times per day. Aside from certain gastrointestinal issues that we won’t cover here, your own personal inflation rate might be different from the national rate. But us macro people do not care about you – we are more interested in how much the average of all of us is paying for goods and services. So when you read something about the CPI in the USA you need not feel concerned about your own cost of living, as it tells you only about the cost of living of the average person.

The CPI is not the only measure of prices in the USA. So sometimes you will hear about inflation as measured by the Personal Consumption Deflator or the GDP Deflator. Maybe you will read about Producer Prices. The truth is that there are many indicators of inflation but here is the main takeaway. For most of us, the CPI is just fine. And second, while the others are different in various ways they usually tell a similar story about inflation.

One more fun fact. Food and energy prices are notably erratic. They bounce around like a 4-year-old in a bounce house. To get a better reading of all prices, the Labor Department publishes the CPI without food and energy prices. If you are trying to understand the general trend of all prices over time, this CPI Less Food and Energy is your baby. Finally, stocks and bonds and other financial assets are not goods or services -- and therefore the prices of these assets are not included in the usual measures of inflation. 

So why is inflation of so much interest? For one thing it might have relevance to your own situation. For another it might tell you something about the national economy. It might influence your optimism or pessimism about future inflation, jobs, and income.

Here is where it gets a little complicated and even controversial. When inflation is high, the immediate message is that prices are rising at a faster pace. Most of us frown when that happens. But prices do not rise in isolation. Prices are part of a bigger macroeconomic scene. It depends very much on some of those other things as to how a rise in inflation impacts you and me and the nation.

Suppose we are living through a time of great optimism and growth. Jobs are plentiful and wages are rising. In that environment, a rise in the inflation rate doesn’t seem ominous. Okay the price of eggs went up, but I have a great job and my earnings are growing faster than prices. In that case, inflation is just part of a very positive economic situation.

Instead, suppose we are living through a time in which inflation is rising but people are losing jobs and/or wage growth is stagnant. That is the kind of time when inflation really hurts. Such times are not frequent but do happen and are usually the result of business productivity rising at a slower pace than business costs. Some of us geezers remember the 1970s when the price of energy was rising so fast that business costs were crippling many companies. Stagflation is a term coined to describe this kind of inflation.

Inflation can be part of a successful economy or the result of a very negative scenario. Since the national economy is not simple, different experts can look at the economy and come away with different opinions. Today the inflation rate is very low and some policymakers see this as a very negative sign. They want to use policy to bring the rate up. Others believe the macro economy is not so bad and attempts to engineer a higher inflation rate will come back to haunt us. So stay tuned.  

Tax Loopholes and Tax Reform

Not sure they will get around to tax reform this year, but I am told that tax reform is high on the legislative agenda. Tax reform usually involves significant changes in income and/or business tax rates. For example, we hear talk that US corporations pay tax rates that are very high. A tax reform might, therefore, reduce the rate to something lower. Tax reform might instead lower tax rates for the middle class or for rich people. There are many ways to do tax reform.

As a result of the lower tax rates of a tax reform, tax revenues would likely fall. So an important part of any tax reform that lowers tax rates but does not want to create larger government deficits is the accompanying ways to raise tax revenue. One approach would create a totally new tax. Some thought was given to the USA adopting a value added tax or perhaps an import tax. More likely, however, is the closing of existing tax loopholes. That approach sounds much better to most of us. But as I will show below, it is not so easy and the attempt to close loopholes may actually doom tax reform.

First, our friend Wikipedia says a loophole is an ambiguity or inadequacy of a system, such as a law or security, which can be used to circumvent or otherwise avoid the purpose, implied or explicitly stated, of the system. That makes a loophole sound pretty bad. It should be easy to eliminate tax avoidance. But a further look at tax loopholes suggests that many of the biggest ones are there for specific reasons.

We sometimes use the word tax expenditure for myriad reasons that allow people to avoid paying tax. Tax expenditures are defined as special provisions of the tax law such as exclusions, deductions, deferrals, credits, and tax rates that benefit specific activities or groups of taxpayers. Tax expenditure? Tax loophole? Pretty much the same thing. But the wording is kinder. Why? Because it implies that it isn’t an error or a deficiency in the system. Rather, it is an intent to promote an end. Getting rid of a loophole sounds easy. But a tax expenditure has a purpose. Do we really want to end it? If so, who gets hurt?

Below I list only some of the major tax expenditures and the amounts (in billions of dollars) estimated by the Tax Policy Center for 2018 (http://www.taxpolicycenter.org/briefing-book/what-are-largest-tax-expenditures)

Exclusion of employer contribution for medical care premiums

  and medical care $235.8

Exclusion of net imputed rental income $112.7

Deferral of income from controlled foreign corporations $112.6

Capital gains $108.6

Defined benefit and defined contribution employer health plans $140.4

Mortgage interest expense on owner-occupied homes $68.1

Earned income tax credit $63.6

Deductibility of state taxes $63.3

Child credit $54.3
Charitable giving $51.2

There are plenty more but this list adds up to just short of a trillion dollars. Thus we learn two points. First, that’s a healthy amount of money if we are looking for loopholes to close. Second, who is going to resist closing each one of these? People who want cheaper healthcare? People who receive rental income and capital gains? State and local governments? Poor people and those who represent poor people? Parents? Homeowners?

Other federal government tax loopholes?

            American Opportunity Tax Credit to reduce the cost of education

            Savers Tax Credit helps low income people save for retirement

            Lifetime Learning Credit to reduce cost of education

            Retirement Saving Accounts

            Carried Interest Loophole for mostly high income taxpayers

  529 College Saving Plan for parents saving for child’s education

                      

Finally comes the fun part. There are so many loopholes in our tax system that you would have difficulty listing them all. Investopedia (http://www.investopedia.com/financial-edge/0512/americas-most-outrageous-tax-loopholes.aspx) found some interesting ones that relate to state and local taxes:

            The Florida Rent-A-Cow Credit

            Washington DIY Cigarette Discount

            The Arkansas Credit for Naturally Destroyed Autos

            The Accelerated Depreciation of NASCAR Tracks

            Larry’s JD exemption (just kidding)

Even with these last few loopholes, there were reasons for instituting them. Closing tax loopholes is not a slam dunk. Tax reform and reducing our tax rates is valuable for many reasons. But if tax reform is not going to blow a hole in our national deficit and debt, then some of these tax loopholes have to go. Which ones will you vote for?