Tag Archives: TARP

With Government Shekels Come Government Shackles

Though privileged firms may not focus on it when they obtain their favors, privilege almost always come with strings attached. And these strings can sometimes be quite debilitating. Call it one of the pathologies of government-granted privilege.

Perhaps the best statement of this comes from the man whose job it was to pull the strings on TARP recipients. In 2009, Kai Ryssdal of Marketplace interviewed Kenneth Feinberg. The Washington compensation guru had just been appointed to oversee compensation practices among the biggest TARP recipients. Here is how he described his powers:

Ryssdal: How much power do you have in your new job?

FEINBERG: Well, the law grants to the secretary who delegates to me the authority to determine compensation packages for 175 senior executives of the seven largest corporate top recipients. The law also permits me, or requires me, to design compensation programs for these recipients, governing overall compensation of every senior official. And finally, the law gives me great discretion in deciding whether I should seek to recoup funds that have already been distributed to executives by top recipients. So it’s a substantial delegation of power to one person.

Another example of shackles following shekels comes from Maryland. That state has doled out over $20 million in tax privileges to a film production company called MRC. MRC films House of Cards, a show about a remarkably corrupt politician named Frank Underwood. The goal of these privileges was to “induce” (others might call it bribe) MRC to film House of Cards in Maryland. One problem (among many) with targeted privileges like this is that there is no guarantee that the induced firm will stay induced; there’s nothing to keep it from coming back for more.

In this case, MRC executives recently sent a letter to Governor Martin O’Malley threatening to “break down our stage, sets and offices and set up in another state” if “sufficient incentives do not become available.” Chagrined, state Delegate William Frick came up with a plan to seize the company’s assets through eminent domain. It is clear that Delegate Frick’s intention was to shackle the company. He told the Washington Post:

I literally thought: What is an appropriate Frank Underwood response to a threat like this?…Eminent domain really struck me as the most dramatic response.

As George Mason University’s Ilya Somin aptly puts it:

But even if the courts would uphold this taking, it is extremely foolish policy. State governments rarely condemn mobile property, for the very good reason that if they try to do so, the owners can simply take it out of the jurisdiction – a lesson Maryland should have learned when it tried to condemn the Baltimore Colts to keep them from leaving back in 1984. Moreover, other businesses are likely to avoid bringing similar property into the state in the first place.

My colleague Chris Koopman notes that there are also a number of practical problems with this proposal. The only real property the state could seize from MRC would be its filming equipment: its cameras, its lights, maybe a set piece or two. And by the U.S. Constitution, it would have to offer MRC “just compensation” for these takings. The company’s real assets—the minds of its writers and the talents of its actors—would, of course, remain intact and free to move elsewhere. So essentially Mr. Frick is offering to buy MRC a bunch of new cameras, leaving the state with a bunch of old cameras which it will use for…well that hasn’t been determined yet.

In this case, it would seem that the shackles are more like bangles.

The Maryland State House adopted Frick’s measure without debate. It now goes to the Senate.

Trickle-Down Economics: Does Anyone Actually Believe In It?

I have heard a lot about “trickle-down economics” lately. The President has taken to using it in speeches. And pundits have increasingly invoked the idea. Back in February, I was asked about the term when I testified before a House committee and had to confess that I have never met an economist who has advocated anything close to “trickle down” economics.

The words “trickle down” imply that if you redistribute money to the wealthy, they will spend it (say, by hiring workers or by buying products) and it will somehow find its way into the hands of the poor. To the extent that any economists endorse such a notion, they are emphatically not free market economists.

This is not to say that there is no case for low taxation. There is a strong theoretical case for low taxation (so long as it is accompanied by low spending!). And it is backed by good empirical evidence.

But the case for low taxation is not—as the phrase “trickle down” implies—based on the idea that we should give money to a wealthy person so she can spend it. Instead, it is based on the idea that if we take money away from either a rich or a poor person when they engage in some activity, they will tend to engage in less of that activity.

If we tax work, people will tend to work less. If we tax consumption, people will tend to consume less. If we tax saving, people will tend to save less. The idea is rooted in basic microeconomics. Taxing labor, for example, makes leisure less expensive. So people choose more leisure. This is called the substitution effect.*

All this theory is well and good, but is there any evidence to back it up? Yes. Michael Keane offers a nice survey of labor supply and taxation studies in the December issue of the Journal of Economic Literature. He identifies at least two major patterns in the evidence:

  1. Women are more responsive to taxes than men (most economists think men are relatively unresponsive to labor taxes, especially in the short run).
  2. People—particularly women—are more responsive to taxes when they consider whether to work than they are when they consider how much to work. In the average study, the long-run elasticity for female labor is 3.6. This means that if a tax hike reduces after tax wages by 10 percent, female labor force participation tends to fall by about 36 percent. As Keane puts it, this is a “very large” effect.

In my view, both of these patterns make sense. Historically, women have been more likely than men to work at home and so higher taxes seem more relevant for them than for men (as more women work outside the home and as more men stay home, I’d expect this gender difference to narrow). It also makes sense that taxes have a larger effect on the decision to work at all than on the decision to work a certain number of hours. Most of us can’t tell our employers that we want to work 30 hours a week rather than 40. But we can tell our employer that we don’t want to work at all. And evidently a lot of people—particularly women—do tell their employers this when taxes are high.

So far, I’ve only discussed how taxes affect labor supply. But they may also depress consumption and investment. What is the overall effect on the economy?

One of the best recent studies is that by President Obama’s former economic advisor, Christina Romer and her husband, macroeconomist David Romer. The Romers set out to understand the effect of taxation on an economy. But they knew that there was a major problem: taxes are not randomly increased or decreased. Instead, politicians tend to keep taxes low when the economy is in recession and raise them when the economy is booming. This makes it very difficult to disentangle cause and effect. So the Romers painstakingly analyzed decades of presidential speeches and government documents to identify exogenous tax changes (i.e., changes that were undertaken for reasons other than the condition of the economy). They then compared the performance of the economy following such exogenous changes. They concluded that exogenous tax increases are “highly contractionary.” As they put it in the conclusion:

Our results indicate that tax changes have very large effects on output. Our baseline specification implies that an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent.

Now here is the irony: As I note above, few if any economists advocate redistributing resources to the wealthy in the hopes that they will trickle down to the rest of us. But over the objection of economists—particularly free market economists—policy makers do this all the time. Think of President Bush’s TARP. Or President Obama’s decision to extend TARP to the auto companies. Or his excursions into venture capital. In each case, money was actually transferred from taxpayers to the (mostly) wealthy managers and shareholders of private firms.

If words mean anything, each of these policies—and not, say, an across the board reduction in marginal income tax rates—should be labeled “trickle-down economics.” But in politics, words often mean nothing.

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*  You might be thinking that the income effect offsets this: By taxing income, you not only make leisure less expensive, you also make people feel poorer. In response to feeling poorer, they may feel that they need to work harder to make up for the loss income. This works for an individual, but as economists James Gwartney and Richard Stroup long ago explained in the American Economic Review, it does not work for society as a whole. This is because governments do something with the money they collect in taxes. And the income effect of spending government revenue makes people work less. So at the economy-wide level, the income effect from spending offsets the income effect from taxing. All you have left is the substitution effect and that unambiguously reduces labor supply.

 

CAP Act: Baby Steps Towards Fiscal Responsibility – Tentative and Toothless

This afternoon Senators Bob Corker (R-Tenn.) and Claire McCaskill (D-Mo) will introduce legislation to “force Congress to dramatically cut spending over 10 years”. From the Senator’s website:

At a time when many families have been forced to tighten their pocketbooks, Congress must also learn to do the same. This bill isn’t just about cutting back this year or next year; it’s about instilling permanent discipline to keep spending at a responsible level,” McCaskill said.

The Commitment to American Prosperity Act, the “CAP Act,” would:

(1) Put in place a 10-year glide path to cap all spending – discretionary and mandatory – to a declining percentage of the country’s gross domestic product, eventually bringing spending down from the current level, 24.7 percent of GDP, to the 40-year historical level of 20.6 percent, and

(2) If Congress fails to meet the annual cap, authorize the Office of Management and Budget to make evenly distributed, simultaneous cuts throughout the federal budget to bring spending down to the pre-determined level. Only a two-thirds vote in both houses of Congress could override the binding cap …

I’m very pessimistic about this, for many reasons. Procedurally, the Act only institutes a new budgetary point of order, which can be overridden with super-majority votes in both houses. That is, the Act doesn’t compel anyone to act fiscally responsibly unless they’re inclined to do so. If we had such restrained legislators, a cap wouldn’t be necessary to begin with. Currently the House can override budgetary points of order with a simple majority vote, so this is an improvement, but not one I expect to have serious results.

The technical aspects of the Cap Act are similarly merit-less. First, the baselines are all skewed; why should we accept 20.6% of GDP spending as the new ‘normal’? Historically, Federal receipts average right around 18% of GDP, so locking in 20% would still put us on a trajectory towards systemic deficits. Given that we’re starting from a baseline where Federal debt rapidly approaches 100% of GDP, this isn’t a responsible plan to reign in spending. Similarly, the “lookback GDP” guidelines will count 2009, 2010, and 2011 spending, which has already exploded far beyond what is fiscally sustainable, or historically precedented. The “glide path” isn’t a serious measure of fiscal sustainability; it places us, in just five years, at the same debt-to-gdp ratio that trigged an economic meltdown in Greece last year. So the bill doesn’t set reasonable baselines, it doesn’t do anything to address the deficit, and if Matt’s work with similar TELs in the states holds, high-income economies like ours tend to use spending caps as excuses to grow spending beyond the levels they otherwise would.

There are some technical merits, but they’re merely cosmetic. Bringing Social Security back ‘on-budget’ is a good start, but this bill still leaves massive loopholes for ’emergency spending’, which the New York Times called a new way of political life six years ago. That trend hasn’t changed one iota since; if anything it’s gotten worse. A unified Democratic Congress couldn’t pass any budget last year. It’s one of the few constitutional powers actually entrusted to the Congress, and they failed. Which leads to my separation-of-powers concerns with this legislation. It’s unclear from a first reading, but where is the authority for Congress to entrust sequestration power with OMB, an executive branch agency?

Finally, there are massive political concerns with the legislation. It seems poised as a cover for fiscally irresponsible co-sponsors like McCaskill and John McCain (who both supported TARP and the GM Bailout; McCaskill also voted for Obamacare while McCain has his own big government medical plan to push) to claim the mantle of fiscal responsibility. We’ve already seen that movie, and it was terrible the first time.

In sum, I don’t see any reason the bill would restrain spending to a responsible or sustainable level. The bill has some good ideas, but they’re wandering in a wilderness of bad ones. The impulse is good, the execution is terrible.

Note: Sorry a rough draft went up on the RSS feed earlier, WordPress is a cruel mistress sometimes.

Why This Isn’t A Time to Worry that Government Is Spending Too Little

Last week, Ezra Klein wrote that state budget shortfalls constituted a massive “anti-stimulus” which might overwhelm the Federal Stimulus (implying the need for further federal spending). I responded with a post arguing that, while Klein’s story is plausible, the numbers just don’t add up. The massive increase in federal spending in the last few years has more-than made up for any decreases in state spending.

This, in turn, prompted an interesting response from Harry Moroz over at Huffington Post. Mr. Moroz writes:

Obama’s efforts to counteract the economic downturn…accounted for only 34 percent ($205 billion) of increased spending in 2009. The rest of the increases have little to do with stimulating the economy….A comparison of federal spending and aggregate state spending is irrelevant. Comparing federal stimulus spending and state spending cuts is only appropriate and useful because both are responses to the economic downturn.

In other words, Mr. Moroz would prefer that we not look at overall spending increases because most of these increases were not intended to be stimulative. (I trust that Mr. Moroz will correct me if I am mischaracterizing his assertion.)

I agree with Mr. Moroz’s point that most of the spending increases were not stimulative (that’s kinda the problem). But the much-ballyhooed Keynesian model—on which proponents of increased government spending hang their intellectual hats—makes no allowance for intentions. Instead, they assert that all government spending, no matter what it is spent on, is stimulative. Here is Lord Keynes on the subject:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again…there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

For his part, President Obama made a similar claim in February of 2009:

Then you get the argument ‘well, this is not a stimulus bill, this is a spending bill.’ What do you think a stimulus is? That’s the whole point. No, seriously. That’s the point.

And though Mr. Moroz would not like to count President Bush’s $700 billion TARP bill either, the fact remains that that president, too, thought he was stimulating the economy.

The real question is: Intentions aside, does government spending actually stimulate the economy? Over the long run (when Lord Keynes said we were all dead) the answer is almost certainly “no.”

Using international data, a number of peer-reviewed studies have examined the relationship between government size, somehow measured, and economic growth. Here is a sample: Barro (1991 and 1989); Folster and Henrekson (2001); Romero-Ávila and Strauch (2008); Afonso and Furceri (2008); Chobanov and Mladenova (2009); Roy (2009); and Bergh and Karlsson (2010). Each of these studies finds a strong, statistically significant, negative relationship between the size of government and economic growth.

What about the short run? Here again the evidence seems weak at best. Consider new research by Harvard’s Robert Barro and Charles Redlick. They find that for every dollar the government spends on the military (read: takes out of the private economy), the economy gains just 40 to 70 cents. Spending a dollar to obtain 40 to 70 cents does not a good deal make. Or consider another study by Harvard’s Laruen Cohen, Joshua Coval and Christopher Malloy. They rely on the fact that the federal government tends to spend more money in districts whose congressional members are chairs of powerful committees than in districts whose members are just rank-and-file. They find that firms actually cut capital expenditures by 15 percent following the ascendency of a congressman to the chairmanship. Moreover, firms seem to scale back employment and experience declines in sales.

It seems to me that by just about any measure, we are currently conducting a large-scale experiment in massive government spending. Moreover, I believe the results of previous experiments predict that this one will lead to slower growth and less economic opportunity. This is not the time to worry that perhaps we have spent too little.

I may be missing a nuance in Mr. Moroz’s argument. I hope he will disabuse me of my errors with a reply.