Tag Archives: incomes

Is the mortgage crisis to blame for San Bernardino’s bankruptcy?

The LA Times contains a new kind of argument on why cities like Stockton and San Bernardino are in bankruptcy. To date, politicians, analysts and journalists have drawn a direct line from rising employee costs and declining revenues to municipal fiscal stress. Harold Meyerson takes another path to reach his own destination – to burnish the image of unions and  politicians. His bankruptcy diagnosis gets lost along the way.

He blames the banks. These cities went bankrupt because, “banks were peddling subprime mortgages to poorly-paid workers.” While the banks are certainly involved in the economic and fiscal train wreck he is upfront that the goal is to weave a counter-narrative, challenging the “right and center right” story of fiscal irresponsibility and overpaid public employees.

The problem with narratives (on either the right or the left) is when they cobble together related events and actors without a theoretical framework and empirical evidence. Mr. Meyerson is holding several of the puzzle pieces but then forces them together without regard to how they fit.

Some puzzle pieces he correctly identifies: a housing bubble, the role of banks, the economic fortunes of the Inland Empire, and the fiscal effects of California’s Proposition 13. What he airbrushes or ignores are the roles of Fed Policy, government lending, regulatory and land-use interventions, the short-term incentives of politicians, the hand of special interests, unions, and erroneous accounting assumptions that generated the perfect storm for a fiscal fallout in 2008.

Stockton’s troubles are plain for all to see. Steven Malanga discusses them here. The municipality’s spending spree can be traced to an overheated housing market which drove Bay Area homebuyers into Stockton in search of cheaper properties. That lead to a 20 percent population growth and a surge in property tax revenues fueling Stockton’s appetite for redevelopment. In 2003 the city borrowed for a waterfront revitalization and a 5000-seat sports arena. They bonded for pension enhancements. In total the city issued $700 million in debt.

Part of the pension deal allowed workers to retire at 50 with 90 percent of their final pay plus COLAs. To pay for this, Stockton invested some bond proceeds into CALpers on the bet it would earn more than the interest payments on that debt. They lost that bet. The housing boom – itself the creation of decades of government interventions – created the mirage of ever-increasing revenues that encouraged politicians to play fast and loose with bonds and future promises to workers.

The next claim is that defined benefit plans have been “demonized” also misses the mark. Defined benefit plans – or annuities – have been destroyed by those who champion them most loudly. Faulty government actuarial assumptions made them appear cheap to operate. That encourage politicians to offer workers (in union negotiations) increasingly generous retirement terms all while underfunding those benefits and taking risks with plan assets. This is accounting chicanery, and sadly, it was not (and still isn’t fully) recognized as such. The blame there can be pinned on the esoteric but well-documented trouble with defined benefit pension accounting. This case has been made in great technical detail by economists and practitioners.

The right salary for a public worker can really only be determined with reference to a private sector counterpart. It isn’t backed into based on area housing prices. Biggs and Richwine find public teacher salaries are on par with a private sector counterpart (in terms of SAT scores and skills). But, salary is only one component of total compensation for public sector workers. Compensation also includes (undervalued and underfunded) pension benefits and (largely unfunded) health benefits. Public sector compensation is a big and growing part of many municipal budgets. What can be said is that the cost of San Bernardino’s police and firefighters represent three-quarters of the city’s expenditures and revenues are flat.

Again, Meyerson is holding one of the right puzzle pieces: the revenue bust that followed the housing bubble. But he fails to note that it was the government-induced housing bubble and subsequent revenue boom that tempted public officials to overextend themselves. This house of cards was supported by flawed accounting and incentivized by short-term gains. This is why to make those pieces fit one needs a theory and empirics otherwise the diagnosis of San Bernardino’s and Stockton’s bankruptcy is cast aside in service of the meme. It is “politics with romance.”

What caused these two cities to tank? A host of economic and fiscal factors and scores of regulatory interventions over many decades. Some of that can be found in the accounts and CAFRs. They are no fun to comb over but they reveal choices, bargains, and tradeoffs under constraints and contain the record of the evasions and faulty assumptions of “public choosers.”

Maryland realtors fight to protect their subsidy

Image via Flickr user Images_of_Money

We’ve already explored Governor O’Malley’s proposal for the Maryland budget here and here, but recently, a perhaps unintended consequence of the budget came to light. By limiting the deduction that residents earning over $100,000 can make on their state income taxes, the proposed budget would limit the size of the mortgage interest tax deduction for many taxpayers.

I stand by my earlier argument that reducing deductions for only one group of people is not a step in the direction of fairness, but a reduction in the mortgage interest tax deduction may be a positive side effect of an otherwise bad policy. From a limited-government perspective, the obvious downside of a reduction in the mortgage-interest tax deduction is that this represents a revenue-positive change in Maryland’s tax code in a state that already has one of the highest tax burdens in the country. Overall though, I think reducing this tax expenditure is a positive change because the policy has many negative consequences.

While the causes of the financial crisis were many, by subsidizing investment in homes, the mortgage interest tax deduction played some part in the overvaluation of housing stock. Aside from the poor incentives that this tax expenditure creates in financial markets, it amounts to favoritism of suburbs over cities. In Triumph of the City, Ed Glaeser argues that the deduction leads many people to abandon renting in a city center for homeownership in the suburbs. However the Federal Reserve Bank of Boston provides evidence that the policy is more likely to lead people to buy larger homes than they otherwise would rather than trading renting for buying a home. Richard K. Green and Andrew Reschovsky write:

If one set out to design a policy to encourage homeownership, it would make sense to target the
largest subsidies to the households least likely to be homeowners, while providing little or no subsidy to
households likely to become homeowners even without a subsidy. Data from countries that do not
subsidize homeownership (such as Canada, Australia, and Japan) indicate, not surprisingly, that
homeownership rates rise with household income. This suggests that a policy to encourage
homeownership should give the largest incentives to households with modest incomes and no subsidies
to high-income households.

The MID, however, does exactly the opposite. For low- to middle-income taxpayers, the mortgage
deduction provides little financial incentive to abandon renting for homeownership. For those
purchasing modestly priced houses and facing the lowest marginal tax rate (currently 10 percent) the
benefits of the mortgage deduction are small. In fact, for households with low state income taxes, the
mortgage deduction may be of no value at all, because the mortgage deduction, even when combined
with other itemized deductions, may be smaller than the standard deduction.

For most high-income taxpayers, the tax savings resulting from the MID are a minor influence on
their decision to become homeowners; these households are likely to own a home regardless of the tax
treatment of housing. Rather than encouraging homeownership among high-income households, the
MID provides an incentive to buy a larger house and to take out a bigger mortgage. Economists have
long argued that the result is an inefficient pattern of investment, with too many resources invested in
housing and too few resources placed in more productive investments in factories and machinery (Mills,
1989; Poterba, 1992).

This analysis ignores that those at the margin of being least likely to be homeowners are likely the riskiest loan candidates and those most likely to foreclose, but they do make a strong case for why the MID leads to larger homes. Regardless of whether the deduction primarily increases homeownership or leads to larger houses, it results in a subsidy for suburban sprawl and its negative side effects of traffic congestion and demand for public services across a wider geographic area.

Unsurprisingly, the Maryland Association of Realtors is strongly opposed to a budget that would lead to lower tax expenditures on housing. The current policy directly subsidizes their industry. The Washington Post reports:

The Greater Capital Area Association of Realtors says that mortgage interest and property taxes account for almost 70 percent of total itemized deductions in Maryland, and they argue that the proposal, if passed, would further harm the area’s housing market, which has struggled to recover.

WAMU interviewed a leader among MD realtors on the issue:

Jim Scurvin, past president of the Howard County Realtors Association says it’s just wrong to jeopardize an industry responsible for 49 percent of revenue that goes to state and local government

“When someone buys a house, on the average you employ two people, and you put $60,000 into the economy right then and there,” he says. “Real estate is the lead when it comes to getting the economy moving again. We have the wind in our sails, the last thing we need is someone to knock the wind out.”

Scurvin, however, is acknowledging only the visible impact of the tax expenditure. As Frederic Bastiat artfully explained, all policies have unseen consequences. In this case, the unseen impact is that the mortgage interest tax deduction fuels malinvestment in housing at the expense of other, more productive sectors of the economy. While Governor O’Malley’s budget proposal has many negative features, the potential for reducing the state subsidy to housing could be its silver lining. Unfortunately as Maryland realtors demonstrate, eliminating tax expenditures is a painful and politically difficult process.

Genuine Economic Progress is about Higher Incomes AND Lower Prices

A few months back I wrote:

From the perspective of a worker, the point of a job is not simply to have a paycheck; it is to have a paycheck that permits one to buy useful goods and services.

This is an important point to keep in mind because so many policies—from subsidies and regulations to occupational licenses—simultaneously increase the prices paid by consumers and the incomes received by (some) producers. In fact, I’d go so far as to speculate that a majority of policies have this effect. (There are, of course, exceptions; taxes push consumer prices up and producer net-of-tax revenues down). From a public choice perspective, this makes sense: any one of these policies is likely to raise the incomes of a few well-connected producers by quite a bit while it is likely to raise the prices paid by a vast multitude by only a little. Even if, in aggregate, the price increases outweigh the income increases, it makes political if not economic sense for a politician to favor such a policy.

This is tragic because genuine economic progress is about both rising real incomes and falling real prices.

The indispensable Mark Perry makes this point beautifully in a classic and brief post from 2010 (I’m sorry, Mark, to quote the entire thing. But I can’t find anything worth leaving out):

In 1964, here’s what the average American consumer could afford after working 152 hours (almost a full month) at the average hourly wage then of $2.50: a “moderately priced, excellent stereo system” from Radio Shack on sale for $379.95.

In contrast, the typical consumer today working 152 hours at the current average hourly wage of $19 could afford this “cornucopia” of electronic goods:

Keep this in mind the next time you hear a politician plugging some new policy that promises to raise incomes. Will it also raise prices above what they would otherwise be? Is it worth it, on net?

Brookings Study on HCV Demographics; Results to be Expected

A new Brookings study by Kenya Covington, Lance Freeman, and Michael Stoll finds that increasingly, recipients of housing vouchers are using these subsidies to move from inner cities to suburbs. The authors support low-income people moving to high-income suburbs because they suggest that this is where they would have the best job prospects.

However the study authors find that about half of all HCV recipients moved to low-income suburbs rather than high-income suburbs, and they assert that this is a problem because low-income suburbs do not have as many job opportunities as their high-income counterparts. This result is unsurprising, though, since vouchers go further in areas with lower housing costs. The study does not take into account the individualized process of housing decisions because it relies on aggregate statistics and looks only at the ratio of people to jobs, ignoring other variables such as availability of housing and transit.

In the executive summary, Covington, Freeman, and Stoll suggest that “policies that … reevaluate existing zoning laws and development impact fees … could give HCV recipients access to a broader range of high-quality residential environments,” but they do not pick up on these themes in their policy recommendations. Instead they focus on shaping the way that individuals choose to use their housing subsidies. By relaxing density restrictions both in urban cores and in suburbs, policymakers would allow landlords to build housing that is accessible to a wider range of incomes with and without housing vouchers.

HCVs offer a major improvement over publicly provided housing specifically because they allow individuals to choose the best place to live for themselves, using local knowledge rather than top-down planning. The Brookings authors discount this important asset of vouchers, suggesting that voucher recipients need help in determining where to live:

There is some evidence to suggest that mobility counseling, whereby HCV recipients are made aware of housing opportunities in low-poverty neighborhoods and local housing authorities recruit landlords in low-poverty neighborhoods to participate in the HCV program can have an impact [in encouraging program participants to use their vouchers in neighborhoods that have low poverty rates].

This policy prescription takes a step backward, dampening the market incentives that allow voucher recipients to select where they live for themselves. If policy makers relaxed density restrictions to allow construction of affordable housing in a wider range of neighborhoods, HCV recipients would have increased housing options without needing counseling to choose the best neighborhood to live in.

California’s shrinking property tax revenues

Proposition 13, the 1978 law that caps property taxes in California at 1 percent of a home’s value and, “forbids major tax increases unless a home is sold or rebuilt,” has left counties with a revenue problem. While falling home values usually lead local governments in other states to increase property tax rates, California counties can only watch as property tax revenues fall with the housing market.

According to the Wall Street Journal, Stanislaus County’s assessed property tax values fell 21 percent over the past four years and 4.7 percent this year. This year’s property tax collection of $447 million is 11.6 percent lower than two years ago. The debate over whether Proposition 13 has worked as intended – protecting the elderly and those on fixed incomes from rapidly rising property tax increases or whether it has led to fiscal distortion and centralization continues.

Does Progressive Taxation Make State Budgeting More Difficult?

Virtually every state reported growth in overall tax collections as well as in tax collections from two major sources: personal income tax and sales tax.

That is according to the Nelson A. Rockefeller Institute of Government. Their new report examines preliminary tax data for the January-March quarter of 2011. In the median state, total tax revenue is up nearly 11 percent, with the two fastest-growing components being corporate income tax revenue (up 10 percent) and personal income tax revenue (up 14 percent).

It should not surprise that states reported the most growth in these two taxes: These are the most-progressive forms of taxation at the state level, so it stands to reason that these would be the most-responsive to changes in economic conditions. When the economy is growing, individuals and corporations make more money, are pushed into higher tax brackets, and fork over larger percentages of their higher incomes to the state. (Since many states fail to index their tax brackets for inflation, “bracket creep” forces many into higher brackets even though their real incomes–as measured by their purchasing power–are unchanged.)  

One might conclude from this data that progressive taxes like these are the panacea for state budget woes. They are not. Just as these types of taxes generate a revenue boom during good years, they also tend to lead to a bust during bad years. In fact, I’d argue that the states’ gradual shift away from flat sales taxes toward progressive income taxes helps explain why states seem to have gotten worse at revenue forecasting in recent years. The Wall Street Journal had an informative piece on this phenomenon a few weeks back. There is also a nice paper by Alison Felix of the Kansas City Fed examining the most-volatile sources of state tax revenue.  

To see if progressive taxation has anything to do with states’ current budget woes, I gathered data on 2010 state budget gaps from the Center on Budget and Policy Priorities. I used their figure “Total gap as a percent of FY2010 general fund” and then ran a simple regression, controlling for regional effects, to see whether reliance on different tax instruments might impact the size of a state’s budget gap. Using pre-recession (2007) data from the Census, I calculated the percentage of tax revenue each state typically obtains from each of six sources: personal income taxes, corporate income taxes, general sales taxes, selective sales taxes, licenses, and other taxes (using pre-recession data diminishes the chance of an “endogeneity” problem whereby the regression picks up the recession’s impact on both revenue shares and budget gaps).[1]

Among the six varieties of taxes, the share of revenue coming from two of them was statistically significantly related to the size of states’ 2010 budget gaps: the personal income tax share (significant at the 1 percent level) and the corporate income tax share (significant at the 10 percent level). Other factors being equal, a ten percentage point increase in a state’s reliance on personal income taxation increased the state’s budget gap by 3.7 percentage points (or 2.85 standard deviations). The partial regression plot shows the estimated effect. The horizontal axis depicts states’ share of taxes collected through the personal income tax, while the vertical axis shows states’ budget gaps as a share of general fund spending. The upward-sloping line indicates the positive relationship between reliance on personal income taxation and budget gap size:

Reliance on the corporate income tax seemed to have an even greater impact on the size of a state’s budget gap. Other factors being equal, a 10 percentage point increase in a state’s reliance on the corporate income tax tended to lead to an 8.7 percentage point increase in the size of a state’s budget gap (6.78 standard deviations). Here, the horizontal axis shows the share of tax revenue derived from the corporate income tax while the vertical axis again shows the budget gap. Notice the wider-dispersion of data points (lower level of statistical significance) and the steeper line, indicating a more-powerful effect:

These are relatively simple regressions. It’d be interesting to see if the same results hold with more-sophisticated anlyses. In sum: it appears that progressive taxation seems to be a recipe for rapid revenue growth when the economy is expanding (even tepidly). But it also seems to lead to larger budget gaps during recessions.


[1] Each of the tax shares sum to 100 percent. So if I included all six in the regression, it would be perfectly co-linear; I therefore dropped the “license share” from the regression.

Medicaid Rules are Weird

In case yesterday’s post on economic freedom was a bit long for your taste, I was on the Fox Business Channel yesterday talking about, among other things, economic freedom.

At the end, I discuss Arizona and their Medicaid program. In my view, a reasonable cost-containment approach to Medicaid would put benefits on a sliding scale: the most-needy would be eligible for larger benefits, while those with higher incomes and/or greater wealth would be eligible for fewer benefits.

Unfortunately, the federal government won’t let states do that. Another thing they won’t let states do? Scale back non-emergency taxi service to Medicaid recipients. After an 8 month review, the Feds recently denied Arizona’s petition to eliminate this service. They will, apparently, permit the state to no longer finance certain transplant procedures. Does this strike anyone else as bizarre?

Another Look at Income Mobility

Back in December I did a post on income mobility. I used data from a 2007 Treasury Department study that followed actual individuals over time (most press treatments of the subject fail to do that). At the time, I could not find the link. My colleague, Seth Goldin, however, recently dug it up. So I’m reposting the entire post below, now with a working link.

Before I get to that, though, here is an illuminating video by Professor Steven Horwitz of St. Lawrence University. He addresses the same subject with a different dataset. Yet he arrives at the same conclusion:

Here is my updated December post:

Every so often, the Census releases new data on income inequality. Typically, the numbers look something like this:

Pretty bad, huh? The chart, derived from data in a Census report, seems to show that the rich are getting richer while the poor are basically stagnating. 

Unfortunately, these numbers are not particularly helpful in describing what is actually happening. The problem is that they show a snapshot of groups over time. They do not, however, tell us how individuals’ incomes have changed over time. Maybe people who were in the bottom 20% in 1996 were no longer in the bottom 20% by 2005?

To see the problem, imagine the story were not about income inequality but about mathematical proficiency. Imagine that you saw the following data (which I completely made up).

 

Here we see that 12th graders grew more proficient in trigonometry over time. But, sadly, 6th graders seem to have been left behind. Few of them knew trig in 1996 and only a slightly larger percentage knew it 9 years later. But wait. Those people who were in 6th grade in 1996 grew up. By 2005, they were out of high school. Wouldn’t it make sense to follow individuals and see whether they knew more trig 9 years later?

We can apply this same line of thinking to the often-cited numbers on income inequality. And when we do, we see that the first chart above really isn’t helpful at all. 

Is there a better way? Yes. Consider a Treasury study from a few years ago. It is called “Income Mobility in the U.S. from 1996 to 2005.” Instead of checking in with groups over time, it used IRS data to follow the same people over the course of nine years. The results were quite different than those presented by the first chart.  

 

Among those who were in the bottom 20 percent of earners in 1996, their average incomes had increased by 233 percent just nine years later. Using the IRS data, it appears that low-income people experienced pretty significant income growth from 1996-2005. A totally different picture, huh?

As far as I am concerned, the important thing is to have a dynamic and growing economy with plenty of opportunities for those who are the least well-off among us. We can debate about whether or not ours is that sort of economy—especially given the current economic climate—but a simplistic analysis of income groups gives us very little information on this score.

What is Happening with Income Mobility?

Every so often, the Census releases new data on income inequality. Typically, the numbers look something like this:

Pretty bad, huh? The chart, derived from data in a Census report, seems to show that the rich are getting richer while the poor are basically stagnating. 

Unfortunately, these numbers are not particularly helpful in describing what is actually happening. The problem is that they show a snapshot of groups over time. They do not, however, tell us how individuals’ incomes have changed over time. Maybe people who were in the bottom 20% in 1996 were no longer in the bottom 20% by 2005?

To see the problem, imagine the story were not about income inequality but about mathematical proficiency. Imagine that you saw the following data (which I completely made up).

 

Here we see that 12th graders grew more proficient in trigonometry over time. But, sadly, 6th graders seem to have been left behind. Few of them knew trig in 1996 and only a slightly larger percentage knew it 9 years later. But wait. Those people who were in 6th grade in 1996 grew up. By 2005, they were out of high school. Wouldn’t it make sense to follow individuals and see whether they knew more trig 9 years later?

We can apply this same line of thinking to the often-cited numbers on income inequality. And when we do, we see that the first chart above really isn’t helpful at all. 

Is there a better way? Yes. Consider a Treasury study from a few years ago. It is called “Income Mobility in the U.S. from 1996 to 2005.” I downloaded a copy a few months ago. Strangely enough, it seems not be available at the Treasury site anymore (please email if you have a working link or know the story behind this). In any case, instead of checking in with groups over time, it used IRS data to follow the same people over the course of nine years. The results were quite different than those presented by the first chart.  

 

Among those who were in the bottom 20 percent of earners in 1996, their average incomes had increased by 233 percent just nine years later. Using the IRS data, it appears that low-income people experienced pretty significant income growth from 1996-2005. A totally different picture, huh?

As far as I am concerned, the important thing is to have a dynamic and growing economy with plenty of opportunities for those who are the least well-off among us. We can debate about whether or not ours is that sort of economy—especially given the current economic climate—but a simplistic analysis of income groups gives us very little information on this score.