Bastiat’s Bastions

…Then, the finances.

When I tell someone that I fear the U.S. is going to be completely transformed into a socialist economy, two of the most common responses I get are: (1) No way; and (2) There’s nothing wrong with that. Notwithstanding the validity of the second response, there is mounting evidence that “no way” is completely wrong.

To begin, there is the potential Obama/Bush Treasury/Federal Reserve set of issues. Then, there’s this lovely story (via Best of the Web Today), where we learn of “A plan by Teresa Ghilarducci, professor of economic-policy analysis at the New School for Social Research in New York.”

Ghilarducci actually testified about her plan last week, on Capitol Hill, though I don’t recall her (apparently well-received) testimony making the evening news.

What is the crux of her plan?

…all workers would receive a $600 annual inflation-adjusted subsidy from the U.S. government but would be required to invest 5 percent of their pay into a guaranteed retirement account administered by the Social Security Administration. The money in turn would be invested in special government bonds that would pay 3 percent a year, adjusted for inflation. The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated.

We can call this by any name that we like, but it does not change the end result of the plan: the government will take over private retirement accounts. But why only 3 percent? With the rates the Feds are charging AIG, surely they can do better than 3 percent. I almost wish I didn’t believe this was happening.

NM

Anyone who knows me very well (and now, anyone reading this post) knows that I really struggle coming up with article titles. But, I think I could have come up with this subtitle (in the Wall Street Journal): The federal bailout needs a private rescue.

This paragraph summarizes the point of the article:

The Feds are charging AIG more than 10% interest on the entire $85 billion, even if the company doesn’t borrow that much. The interest rate on money actually borrowed is more than 14%. One AIG shareholder likens it to a financial counselor advising someone struggling to pay the 6% interest on his mortgage to solve the problem by running up debt on his credit card. That’s why the New York Federal Reserve recently had to bail out the bailout, lending another $37.8 billion at more attractive terms.

Maybe the Wikipedia entry for predatory lending should be updated?

NM

My recent post noted that many low-income workers do not need additional tax credits to offset Social Security taxes because of the Earned Income Tax Credit. This afternoon, I was reminded of a related conversation I had with a former president of the National Tax Association (NTA).

The NTA person (I don’t want to name names) let me know that he was tired of “conservatives” saying that low-income people don’t pay taxes. In fact, he let me know, poor people pay social security taxes and sales taxes, both of which are highly regressive. Well, I’ve already posted on one problem with this logic (the EITC). Still there are others.

For one, it turns out that many people do not pay state and/or local sales taxes on food and “necessities,” the definition of which depends on where one lives. These data are very difficult to pin down because so many municipalities have so many different rules. However, there are several papers at the Tax Foundation that provide a good summary.

Beyond that, the claim that Social Security taxes are regressive is simply a farce. The goal of the Social Security program is to provide a safety net for retirement (call it a pension, if you must). More importantly, the system works by providing retirees with benefits based on what they put in.
In other words, if you work more, you pay more in, but you’re eligible for more when you retire.

On the flip side, if you work less, you pay less in, and end up with lower benefits at retirement…precisely because you didn’t work as much. The only way this can be considered a regressive tax is if you believe (a) Social Security is not a retirement program at all; and, (b) people who work more (and thus pay higher payroll taxes) should have their benefits reduced. I can think of a few words for part b.

NM

In today’s Wall Street Journal, William McGurn does an excellent job describing why it is impossible for Obama (or anyone else) to give an income tax cut to 95 percent of Americans. Why? Because approximately 40 percent of Americans don’t pay income taxes.

McGurn writes:

In most parts of America, getting money back on taxes you haven’t paid sounds a lot like welfare. Ah, say the Obama people, you forget: Even those who pay no income taxes pay payroll taxes for Social Security. Under the Obama plan, they say, these Americans would get an income tax credit up to $500 based on what they are paying into Social Security.

McGurn does a very nice job of debunking the notion that, as Obama’s camp suggests, the tax credit won’t really be a payroll tax cut. Still, McGurn misses a larger point called the Earned Income Tax Credit (EITC).

Many low income families qualify for the EITC, which was originally designed to offset some of their payroll taxes. Naturally, the EITC has been expanded through the years. For at least the last seven years, EITC payments more than offset low-income workers’ payroll taxes.
The exact amount of the credit depends on martial status, the amount of income earned, and the number of children in the family.

Here’s an example (using numbers from a couple of years ago):

Single with no children, earning $15,400
- .0765 payroll tax = 1,178; EITC = $2,747
- Federal income tax = $613
- Net Credit: $956

Married with one child, earning $16,849 in wages
- .0765 payroll tax = 1,289; EITC = $2,747
- Federal income tax = $0 (may even get an additional “refund”)
- Net Credit: $2,747 (at least)

Granted, someone in either of these two situations probably is not having an easy time of things, but that is not the point. The point is simply that our tax system already has the type of credits Obama’s plan is calling for and then some. All the more frightening that Obama is quoted as saying: “We’re not going to solve Social Security and Medicare unless we understand the rest of our tax policies.”

NM

Here’s a revealing video clip of Barney Frank, chairman of the House Financial Services Committee, on CNBC’s Closing Bell. I found it pretty hard to decipher, but he does say something along the lines of “there are some very rich people we can tax.” I find this revealing for several reasons.

First, it seems to be yet another example of losing all pretense that we’re in a capitalist economy – we’re just going right after the “rich” people’s money. Second, the typical member of Congress (i.e., those not in leadership positions) earns just shy of $170,000 per year. It’s very lucky, I suppose, that this annual salary is just south of Obama’s $250,000 cutoff (no tax increase for Barney?).

Frank’s statements are also revealing for their lack of economic logic. He calls for a “dose of Keynesianism,” but Keynes is unlikely to have advocated tax increases in the middle of an economic downturn precisely because they tend to slow down the economy. Aside from whether his policies are good or bad Keynesian policies, they certainly are poor economics.

Frank is advocating the following:
(1) “Spend” more tax dollars than we currently collect to boost the economy.
(2) Cut taxes to boost the economy.
(3) Wait a little while.
(4) Raise taxes to get those tax dollars back.
(5) Ignore the fact that tax cuts and tax increases provide opposing incentives.

I guess it is possible that Frank is nothing more than a politician playing to his base. But, if not, at least he is making his agenda clear – he wants to take money away from rich people. I guess the little people should just hope that those making more than $250,000 don’t run out of money too soon.

NM

Testifying before Congress today, Fed Chairman Ben Bernanke urged lawmakers to pass a new “stimulus” package, one that would help “…limit the risk of a ‘protracted’ slowdown in the economy.” This provides perfect cover to those lawmakers who have been trying to pass a stimulus package of $150 billion since January.

What, exactly, is a stimulus package? It’s when the government tries to grow the economy by “spending” on things like road construction, jobless benefits, and grants to states. You may be tempted to ask: Where does the money come from? The answer: those are your tax dollars. Most recently, the stimulus packages have been centered around tax rebates. With tax rebates, the thinking goes, we let citizens spend the money as they see fit.

Does it make sense to take money away from someone just to give it to someone else in the hope they will spend it? Yes, but only if you live in Washington D.C.

My (somewhat informed) opinion on this subject is that the bulk of the research shows these tax rebate plans do not “stimulate” the economy (even though they do seem to stimulate votes). (the link should work now.) In fact, starting in 2001, we’ve been given an unprecedented amount of stimulus. Here’s the rundown:

– The Economic Growth and Tax Relief Reconciliation Act of 2001 provided us with about $38 billion in tax “rebates.”

– The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) gave families with children an additional $15 billion in stimulus checks (in aggregate, of course).

– The Economic Stimulus Act of 2008 sent out an additional $100 billion in tax rebates.

With the last round of rebates, the White House proudly proclaimed that the bill was “large enough to have an impact,” as if the first two rounds were a waste because they were too small. It couldn’t possibly be that these things don’t work, it’s just that we didn’t take enough money away from people.

So, if we take more money away from people (who could have spent it in the first place), the economy will grow even faster. Makes sense, right?

NM

This past weekend I attended a conference in Tucson and, while there, was able to get together with a former Nicholls professor, current co-author, Tom Dalton, who is now teaching at the University of Arizona.  In talking about the current crisis, he mentioned that one of his colleagues, Price Fishback, just wrote a blog post for Steven Levitt, at Freakonomics.com.  I will get straight to the point.  Take a look at Fishback’s article here.

-MC

In one of my favorite books, A.J. Jacobs discusses something (I would imagine) all parents have experienced: looking at their child and thinking that they cannot let anything bad happen to them. When Jacobs goes too far protecting his child, drifting into the overprotective realm, his wife stops him with a code word: helmet. (As in, take the bike helmet off the baby, he’s just walking around.) Excesses aside, I suspect that this feeling is one of the up-sides of human nature, and it probably helps to explain how we end up with politicians that can’t stop “protecting” us.

During the financial crisis, one common refrain of the Democrats is that Republicans/George W. Bush deregulated at an alarming rate during his tenure. It’s interesting, though, that very few critics can point to specific examples of these deregulatory actions. Not to mention that these critics seem to have forgotten Sarbanes Oxley, a law passed in 2002, during the last “worst crisis since the great depression.” The truth of the matter is that there is an enormous amount of regulation throughout most major industries in the U.S.

This weekend, the Wall Street Journal ran a piece that points out some specific flaws with the “deregulation” hypothesis, some which I had not yet seen in print. For instance, the article takes aim at the Basel II regulations. Even though these capital regulations were designed for commercial banks, the Securities and Exchange Commission (SEC) tried to apply these to other financial companies during 2004.

The article points out: “One fair question is how such regulation could have allowed Wall Street to employ so much more debt than the commercial banks. Part of the answer is that, instead of a fixed capital ratio standard, Basel II uses mathematical models crunching historical data to determine how risky an institution’s assets are and therefore how much capital it needs. For this reason, when the investment banks switched to Basel II in the middle of a housing boom, AAA-rated mortgage-backed securities appeared almost as safe as cash. Oops.”

Were the Basel II standards the result of good intentions? Perhaps. Regardless, the implementation of Basel II was just another example of government trying to regulate a dynamic market by trying to prevent failure. As painful as it may be, markets work better when participants are allowed to experience both success and failure. Learning what to do is just as important as learning what not to do.

NM

Anna Schwartz, famous for collaborating with Milton Friedman, discusses the financial crisis in The Wall Street Journal’s Weekend Interview (by Brian Carney).

She doesn’t exactly hide how she feels about the Fed’s response to the current mess:

“In general, it’s easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well.” Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman’s 90th birthday, “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

“This was [his] claim to be worthy of running the Fed,” she says. He was “familiar with history. He knew what had been done.” But perhaps this is actually Mr. Bernanke’s biggest problem. Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. “I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.”

Earlier in the interview, she makes several points that I’ve made on our blog during the last week. For example:

“The Fed,” she argues, “has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible.”

And, my favorite:

“…firms that made wrong decisions should fail,” she says bluntly. “You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.” The trouble is, “that’s not the way the world has been going in recent years.”

It’s nice to see that someone with Anna’s stature makes the same economic argument I’ve been making. I won’t feel slighted if someone (maybe someone important?) starts listening to her.

NM

My last post discussed what was happening to small banks in the midst of the “bailout”; this post provides a similarly scary account of the meeting that U.S. banking officials had with the CEOs of the nations largest banks. The full account is here in the Wall Street Journal (you may need a subscription).

Among the highlights:

- As the meeting neared a close, each banker was handed a term sheet detailing how the government would take stakes valued at a combined $125
billion in their banks, and impose new restrictions on executive pay and dividend policies.

-Mr. Geithner, whose job as New York Fed chief makes him the central bank’s main man on Wall Street, delivered the most sobering news. He described
how much preferred stock the government was going to buy from each firm. The government would take $25 billion in Citigroup, $10 billion in Goldman
Sachs Group Inc., and so on.

-The CEOs shot off questions, peppering officials for details about how the share purchases would be structured and how it might constrain them. At
one tense moment, Mr. Bernanke jumped in to calm nerves. The meeting didn’t need to be confrontational, he said, describing paralysis in the market
and the threat that posed to everyone in the room.

-”The system needs more money, and all of you will be better off if there’s more capital in the system,” Mr. Paulson told the bankers.

- During the discussion, the most animated response came from Wells Fargo Chairman Richard Kovacevich, say people present. Why was this
necessary? he asked. Why did the government need to buy stakes in these banks?

Let us assume that, in fact, too much credit has caused this awful crisis. Apparently, when too much bad credit causes a financial meltdown, the way to solve the problem is by providing more credit AND using taxpayer funds to literally take stakes in the private financial companies with the bad debts on their books. Taxpayers should relax, though, because now these banks have to pay dividends to the government, so the taxpayers don’t really have that much risk.

I must have missed this lecture in my monetary theory classes.

As for Mr. Paulson’s assertion that the system needs more money, I realize there are many different measures of credit, but I’ve checked available data and several measures indicate the same upward trend. For example, according to the Fed, the broadest measure of outstanding debt, in billions, went from 31,829 in 2002 to 51,019 in the second quarter of 2008. Net lending has dropped this year, back to early 2002/2003 levels, but at this point we are probably looking at the paralysis that, in my view, the government has contributed to.

I don’t know what is worse here, the fact that the government is hell-bent on taking ownership stakes, or the fact that they are insistent on using even more credit to solve a credit crisis. If this really is the worst crisis since the great depression, no amount of additional credit will solve the problem.

NM