Once Again, the Deregulation Myth Taken Down

I have asserted numerous times, often out of frustration, that there has not been any meaningful financial sector deregulation over the past 8 years, and therefore it is competely disingenuous and nonsensical for Barack Obama to blame deregulation for the financial crisis. Here the Wall Street Journal delves more in-depth into the US' regulatory changes under Bush. It is a good read.

A Little Obama Preview

This from the Cleveland Plain Dealer:

"Obama's answers...made it crystal-clear that he sees taxation as a tool not only to pay for government, but as a tool to reassign the wealth of individual Americans directly to other individual Americans as government sees fit. If he doesn't believe in trickle-down economics, fine. But having government decide precisely how full each American's glass should be -- and them making the necessary adjustments -- would be a whole new ballgame."

And this, from the Denver Post:

"You know, once upon a time, the stated purpose of taxation was to fund public needs -- such as schools and roads -- assist those who could not help themselves, defend our security and freedom, and yes, occasionally offer bailouts to sleazy fat cats.

Obama is the first major presidential candidate in memory to assert that taxation's principal purpose should be redistribution.

The proposition that government should take one group's lawfully earned profits and hand them to another group -- not a collection of destitute or impaired Americans, mind you, but a still-vibrant middle class -- is the foundational premise of Obama's fiscal policy.

It was Joe Biden who said (not long ago, when he still was permitted to speak in public), "We want to take money and put it back in the pocket of middle-class people." The only entity that "takes" money from the middle class -- or any class for that matter -- is the Internal Revenue Service. Other than that, there is nothing to give back."

The Stagnating Middle Class?

It has become accepted wisdom among the pundit class that outside of the wealthiest few, the majority of Americans have seen their economic well-being decline over the past decade, and in fact, over the past few decades. They routinely point to data which indicates that the average income of households in the US has not changed much since 1973. See the image below.



However, in this article, Steve Chapman points out some of the flaws in this prognosis. To me, the most important point that many seem to miss is that compensation includes much more than wages, so measuring wages alone gives skewed results about compensation changes.

McCain's Health Insurance Tax Credit

Obama likes to scare people by saying that McCain will replace their $12,000 family insurance plan with a $5,000 tax credit, leaving them $7,000 in the hole. The problem with that argument is that the government does not provide $12,000 worth of subsidies for the $12,000 plan. In fact, since the government grants tax deductions for employer-provided health insurance, the most that you would possibly be saving in taxes would be 35% of $12,000, if you were in the highest tax bracket. In case you are wondering if that means that wealthier people get a bigger tax break than less wealthy people under the current setup, you are right. McCain, on the other hand, proposes giving everybody $5,000 to put towards purchasing health insurance, which is more assistance than they get now, and is not skewed towards the wealthy.

A Look into the Crystal Ball

Budget Realities

We seem to be on the cusp of electing Barack Obama as the next President of the United States, but the sad reality is that neither he nor John McCain has shown any creativity or will to address the long-term budget deficits that we are likely to incur. McCain may rail against earmarks, and Obama may wax poetic about unspecific efficiencies that we can bring about, but at the end of the day, the bulk of federal government spending is on three things: defense, Medicare, and Social Security. Two out of those three-- Medicare and Social Security-- are poised to grow unboundedly and eat up even larger portions of the budget, and are likely to go bankrupt unless fundamentally reformed. Time will tell how Obama proposes that we deal with this huge shortfall, and "redistributive change" from the top 5% will not even come close to solving the problem.

Obama In His Own Words

"But the Supreme Court never ventured into the issues of redistribution of wealth... And sort of more basic issues of political and economic justice in this society. And to that extent, I think, as radical as people try to characterize the Warren Court, it wasn't that radical. It didn't break free from the essential constraints that were placed by the Founding Fathers in the Constitution, at least as it's been interpreted, and the Warren Court interpreted it in the same way, that generally the Constitution is a charter of negative liberties, says what the states can't do to you, says what the federal government can't do to you, but it doesn't say what the federal government or the state government must do on your behalf, and that hasn't shifted, and one of the, I think, the tragedies of the Civil Rights movement was, because the Civil Rights movement became so court focused, I think there was a tendency to lose track of the political and community organizing activities on the ground that are able to put together the actual coalitions of power through which you bring about redistributive change. And, ah, in some ways we still suffer from that."

Obama certainly wants change, but do we really want to abandon the vision of the Founding Fathers and move to one where the government has a more active role in "redistributive change"? I know I don't.

A Comprehensive Policy Review of the Bailout

Ricardo Caballero, an economics professor at MIT who specializes in macroeconomic and financial issues, has written a long and detailed policy review of bailouts and flight-to-quality episodes, which is what the US is currently experiencing with the credit crisis. If you have time, you should read as much of it as you can. I will try to summarize some key points in the near future (at least I plan to do that). Read his paper here.

Get Ready '08

Wondering what Congress' reaction will be if the Democrats sweep into power and Obama wins the Presidency? Look no further than Barney Frank:

"I think at this point there needs to be a focus on an immediate increase in spending and I think this is a time when deficit fear has to take a second seat . . . I believe later on there should be tax increases. Speaking personally, I think there are a lot of very rich people out there whom we can tax at a point down the road and recover some of the money." -- Barney Frank, October 20, 2008

Apparently Barney Frank believes that he is a joint owner on all the bank accounts owned by these "rich people," and he can just withdraw however much money he wants to fund his new government projects.

Even beyond this objection, Barney Frank appears to be stuck in the mindset of 1960's economic policy-- in a recession? Give more money to the government to spend! Sure, we have been accumulating huge deficits over the past few years with no apparent surge in economic growth, but why let failure stop you from continuing the course?

A Crisis of Distorted Markets

The Washington Post has a fantastic article here about the dangerous effects of the government distorting markets, and how this helped create the crisis that we are in. If a President Obama, Nancy Pelosi, and Harry Reid learn the wrong lesson of this crisis-- that more government manipulation and control of markets is needed-- then we are in for even more trouble, either in the form of diminished prosperity or another crisis, down the road.

Financial Times: McCain is no salesman on tax proposals

No, he is most definitely not. The Financial Times article is here, and I will paste the article in its entirety below.

So much has gone wrong for John McCain that it is surprising he is not further behind in the polls. He has been a victim of circumstances and his own bad judgment. Some of his errors, however, are more perplexing than others. How is it, for example, that Mr McCain has been so thoroughly outmanoeuvred on tax policy?

Both candidates have offered complex tax proposals. Proliferating alternative baselines (with or without the extension of the Bush tax cuts, with or without a “patch” for the alternative minimum tax, and so forth) deepen the confusion. Unable to fathom the details, voters are left to weigh the competing slogans. Mr Obama promises to cut taxes for 95 per cent of working families. Mr McCain says the rich need a tax cut, too. Guess who wins that argument.

Here is a fact you might not have noticed. It certainly seems to have slipped by most Americans. The typical US household would get a bigger tax cut under Mr McCain’s proposals than under Mr Obama’s. I know a few politicians who could do something with that.

Broadly speaking, Mr McCain proposes to leave the Bush tax cuts in place. Mr Obama proposes a big increase in taxes on people earning more than $250,000 (€187,000, £145,000) a year, in order to cut taxes and increase subsidies at the bottom; for the middle, he too would mostly keep the Bush tax code. Middle-income households do come out slightly ahead under the Obama plan – but only if you leave out the effect of Mr McCain’s healthcare proposal. The question is, why would you do that?

Mr McCain wants to abolish the tax-break for employer-provided healthcare and replace it with a refundable $5,000 credit. Mr Obama says that a family health plan might cost $12,000 a year – leaving families who buy their own policy $7,000 worse off. This is incorrect. So far as I know, Mr McCain has never taken the trouble to explain why.

Suppose a family currently has a $12,000 policy provided by an employer. Under the McCain proposal, instead of attracting relief as at present, this benefit would be taxed as ordinary employment income – but the extra tax paid would be more than offset by the new $5,000 credit. In the first analysis, nothing changes so far as employers are concerned: all the action is on the employee’s pay cheque. The policy delivers a net tax cut to middle-income households and is enough to make the McCain tax plan on average a better overall deal for them than the Obama plan.

Odd, don’t you think, that the McCain campaign should think this unworthy of emphasis?

It is true that the healthcare credit would have additional longer-term consequences – some desirable, some not. Since the credit is fixed in value, taxpayers would have an incentive to choose cheaper plans (with bigger deductibles and co-payments). That is a good consequence: it would exert some downward pressure on healthcare inflation. Less desirable is that healthy young workers might prefer to opt out of employer-provided plans in return for more pay, because they could find cheaper cover for themselves elsewhere. This would make the employer’s pool of employees riskier, and drive up premiums. It might encourage some employers to stop providing cover altogether and that would leave riskier workers at a disadvantage.

A defect of the McCain plan is that it fails to combine the tax incentive to economise with adequate measures to assure coverage. Its direct effect on middle-income households, though, is still to cut taxes by more than Mr Obama’s plan.

As well as failing to drive this home, Mr McCain has only weakly resisted his opponent’s notion that “wealthy companies” can afford to pay more. Business taxes, in the end, are paid by people – in lower wages, higher prices and lower dividends in their 401k plans. The point is not just that US corporate taxes are high by international standards and that this discourages investment and employment but that the burden eventually falls on ordinary Americans. Perhaps Mr McCain’s recent emphasis on corporate greed makes it difficult for him to point this out.

When Mr McCain misrepresents Mr Obama, he cannot even do it plausibly. Mr Obama is indeed planning to cut taxes for 95 per cent of working families. Rather than saying, “No he isn’t”, Mr McCain could have said: “Look at what his changes do to marginal tax rates, at the bottom of the income scale (as benefits are phased out), as well as at the top.” Rather than saying, “He wants to raise your taxes,” he could have said, “His spending plans will force him to raise your taxes.”

Joe the Plumber featured prominently in last week’s presidential debate. Mr McCain said that Joe wanted to set up in business but was worried about the taxes on his income of more than $250,000 a year. Mr Obama was effective: he dismissed Joe as a rare case. Not many plumbers make that much; 98 per cent of small businesses make less. (Never mind that the 2 per cent account for a disproportionate share of new jobs.) It makes sense, Mr Obama said, to “spread the wealth around”.

Even in 2008 that is an un-American idea, as Mr McCain did point out. But the degree to which he has yielded on taxes is nonetheless surprising. Given the cost of the financial rescue, this whole debate may be moot. The fact remains, he is offering middle-income families – not just the rich – a bigger tax cut than Mr Obama, and they don’t appear to know it.

Some Quick Links

• Is Obama's tax plan socialistic? McCain says so here. Charges of socialism may be hyperbole, but consider this: I define a tax cut as meaning that you get to keep more of your own money. Obama, on the other hand, sends everybody (except those making over $200,000) a check, including those who do not pay any income taxes.
• The Wall Street Journal, in another piece here, explores the folly of blaming the financial crisis on deregulation.
• McCain wants to end employment-based health insurance? I certainly hope so. In this article Jeff Jacoby explains here some of the faults of the current system. I hope at some point soon to discuss health policy in more depth.

The Folly of Setting Pay Limits

In an ideal world, I would like to think that every aspect of the labor market is efficient and competitive, and that people get paid according to the value that they provide to the firm for which they are employed. In most cases, I believe this is a good approximation to the truth. However, when it comes to the instance of CEO pay for very large firms, I find this hypothesis to require a stretch of the imagination.

In an ideal world, CEOs would be looking out for the long-term interests of the shareholders. This means maximizing long-run profits. However, what CEOs are actually interested in is how well they personally do. The job of boardrooms is to design incentive schemes that align the personal interests of the CEO with the interests of the stock holders. I would say that in many well-publicized instances, they have failed. This is an example of a problem in economics called the principal-agent problem.

There may indeed be effective policy reforms which could mitigate the principal-agent problem in the market for CEOs. Setting arbitrary pay limits, however, is no solution. This very clear and intelligent article in the Financial Times explains why.

The Paul Revere of the Fannie/Freddie Debacle

Former Louisiana Republican Richard Baker for years, dating back to 1996, had been predicting a major catastrophe in financial markets because of Fannie Mae and Freddie Mac and their politicized and imprudent lending. Nobody listened. Read what he has to say now.

Class Warfare

In the coming days I will post something more lengthy and discursive on class warfare, taxation, and redistribution, but until that time, this article provides a little background to my strong dislike of class warfare rhetoric.

Obama's "Tax Cuts"

Obama has been claiming for some time that he is proposing tax cuts for 95% of Americans. The problem with this is that one-third of Americans do not pay income taxes, thereby making it literally impossible to give 95% of the population a tax cut.

Does that mean that Obama is lying? No, but it means he is packaging something else with a false label. That something else is taking money from some taxpayers and giving it to everyone else. I'll leave it to The Economist, in this article, to clarify what I mean:

"Fact-checkers quibble that, according to his written plans, he really means 95% of families with children, not 95% of Americans. But his real sleight-of-hand is to count handouts administered through the tax code as “tax cuts”. You might think that a tax cut means keeping more of what you earn. The way Mr Obama uses the phrase, however, it can also mean being given a chunk of money that someone else has earned. That is how he is able to offer “tax cuts” to “95% of Americans” when about a third of American households already pay no federal income tax."

What Is The Purpose Of The Financial Rescue Bill?

According to Federal Reserve Chairman Bernanke,

"In this regard, the Federal Reserve supports the Treasury's proposal to buy illiquid assets from financial institutions. Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions."

One More Swing at the Piñata

I don't want to suggest without more thought and investigation that Fannie Mae and Freddie Mac are entirely responsible for the current financial crisis, but their role in this mess cannot be ignored. In this piece, the New York Times looks into how Fannie Mae was pushed to take more and more risks, with the results now well known.

Politics at its Worst

"Democrats say their candidates are benefiting from the wipeout on Wall Street with a single message in every region of the country: 'These are the Bush policies coming home to roost.'"

What a pile of crap and lies in place of a legitimate and intellectually honest argument...nothing else to say.

Note to Congress: You Were Wrong, Now Admit It

As Congress tries to blame this on Bush's deregulation philosophy, which never in any way during his tenure has been put to use in the financial sector, the Democrats in Congress should take a look at their own footprint in creating this problem.

The "Free Market" Isn't Dead

Critics of the "free market" have felt rather triumphant lately. They have been blaming the financial crisis on mythical deregulation (despite no major deregulation of the financial sector being passed during Bush's term) and are ready to usher us out of the era of the "free market" and into the era of major government regulation, oversight, and control.

The problem with this argument is that the completely untamed, unregulated, unwieldy "free market" hasn't been around in the financial sector for a long, long time. The government has for several decades played a major role in designing the rules, incentives, and institutions in financial markets, so it only makes sense that we look at the government's role in creating this mess, not just the supposedly new-found greed of Wall Street CEO's.

Robert Bruner, dean of UVA's business school, explains here.

Economists Debate How To Fix The Mess

Go here to see the transcript of a recent discussion between a few respectable economists on what is causing the current financial crisis, what the bill does and if it is likely to succeed, and if not, what should be done instead. I'll comment on what they had to say in the near future.

Also: Russell Roberts, in another article, discusses the government's very large role in causing and precipitating this crisis. A failure of the last 8 years of deregulation? That's a convenient story, except that there has been no major deregulation of financial markets during that time.

Wondering About The Financial Rescue Bill?

Notice that I do not use the word bail-out, which is a highly misleading and inflammatory description of the bill. In my opinion, it should pass. There are many flaws with the bill, ranging from irrelevant and unrelated elements inserted into the bill to the much larger issue of reform of the financial sector and of government regulations, which it puts off until later. That being said, I accept the word of Ben Bernanke and others "in the know" who believe that the credit markets in the country will dry-up without something to reassure them, to add confidence, and to establish a functioning market for these mortgage-backed securities. To read about what exactly the bill does, go to:

The Bailout: An Owner's Manual