US GDP grew at an estimated 1.8% annual rate in Q1 2011, according to the latest data from the Bureau of Economic Analysis. The January-March 2011 quarter was the 7th consecutive quarter of growth since the end of the recession that lasted from Dec 2007 to Jun 2009. The growth rate of 1.8 percent disappointed many observers. Growth is expected to recover somewhat later in the year, but the recovery remains weak.
Consumption was the fastest growing GDP component, but slower than in Q4 2010. Investment grew at 1.45%, with strong business equipment purchases offsetting weak residential investment. Federal, state, and local government spending all declined, led by a drop in defense spending. Net exports were almost unchanged, as strong export growth was slightly more than offset by rising imports.
Follow this link to view or download a classroom-ready slideshow presenting highlights of the Q1 2011 GDP data.
Jumat, 27 Mei 2011
Kamis, 26 Mei 2011
Failure of Austerity in Europe? What Does the Latvian Exception Prove?
Writing in The New York Times this week, Paul Krugman argues that austerity has failed in Europe. Budget cuts and tax increases were supposed to provide the confidence needed to get troubled EU economies back on track, but the "confidence fairy" hasn't shown up. Austerity has not just failed to work, says Krugman—it has made matters worse. He shares the view, held almost universally outside official circles, that doubling down on austerity will not save Greece, Ireland and Portugal from eventual default in one form or another.
Meanwhile, there is the case of Latvia, where a stringent austerity program, supported by the EU and the IMF, predates those of Greece, Ireland, and Portugal. Austerity brought on a stunning 18 percent drop in Latvian GDP in 2009, but now the country is returning to growth. Unemployment and the budget deficit are still high, but falling. Is Latvia the exception that proves that austerity is a good idea after all?
→Read the full post on Ed Dolan's Econ Blog at Economonitor.com
Meanwhile, there is the case of Latvia, where a stringent austerity program, supported by the EU and the IMF, predates those of Greece, Ireland, and Portugal. Austerity brought on a stunning 18 percent drop in Latvian GDP in 2009, but now the country is returning to growth. Unemployment and the budget deficit are still high, but falling. Is Latvia the exception that proves that austerity is a good idea after all?
→Read the full post on Ed Dolan's Econ Blog at Economonitor.com
Rabu, 18 Mei 2011
Will Shifting Political Winds Finally Kill Ethanol Subsidies?
As recently as last December, the coalition backing U.S. ethanol subsidies appeared to be alive and well, despite the fact that everyone knew they were bad for the environment, bad for energy efficiency, and bad for the budget. The largest subsidy, a tax credit for blending ethanol into gasoline, was set to expire at the end of 2010. At the last minute, though, ethanol's friends rallied to slip a little-noticed one-year renewal of the subsidy into a bill extending the Bush tax cuts and benefits for the long-term unemployed. As I blogged at the time, it looked like ethanol subsidies were a classic case of a bad policy that refused to die.
Now ethanol subsidies are back in the news, and this time they may be on the way out. One piece of legislation, introduced by Senators Tom Coburn (R-OK) and Dianne Feinstein (D-CA), would not only end the 45-cent per gallon tax credit, but also eliminate the 54-cent per gallon tariff on imported ethanol. To understand what has changed, we need to look at the economics behind the shifting pro- and anti-ethanol coalitions.
One shift is that environmentalist support for ethanol has pretty much evaporated. Environmentalists originally joined the ethanol coalition in the belief that using more ethanol, a renewable biofuel, would reduce greenhouse gas emissions. Years of study, however, have shown that corn-based ethanol, over its full life cycle, does little to reduce carbon emissions and may actually increase them. Late last year even Al Gore, long an ethanol booster, reversed his position. While serving as vice-president, Gore had cast a critical tie-breaking Senate vote to secure support for corn-based fuel. Now he admits that there are no environmental benefits, and that his original support was motivated, in part, by the hope of getting Iowa caucus votes in a later run for president.
Environmentalists are not the only ones to fall away from ethanol. As time has gone by, it has proved easier than once thought to find fault lines in the seemingly solid ethanol coalition. At first glance, it might appear that subsidies would find strong support all along the supply chain, from landowners to corn growers to ethanol distillers to fuel suppliers who blend ethanol with gasoline. However, closer economic analysis has shown that benefits are not distributed equally among the parties.
An interesting paper by Farzad Taheripour and Wallace Tyner of the Purdue University Department of Agricultural Economics analyzes the way subsidies are distributed by looking at elasticity of substitution between ethanol and gasoline as a motor fuel, and at the elasticity of supply at various points along the supply chain. (Elasticity means the percentage by which one variable, like quantity supplied, changes in response to a one percent change in another variable, like price.) The authors reach two conclusions that are relevant to the politics of ethanol.
One is that ethanol distillers and corn growers are engaged in a tug-of-war over the benefits of the subsidies. Who wins the biggest share depends partly on government policies that encourage blending of ethanol with gasoline and partly on the supply elasticity of corn. The authors find that over time, as the share of total corn production that goes to ethanol increases, corn farmers can be expected to capture more of the subsidy, leaving less for blenders and distillers. According to USDA data, the percentage of the U.S. corn crop going to ethanol increased from about 7 percent in 2001 to almost 40 percent by 2010. The predictable result would be for ethanol producers to become less attached to the subsidy, and farmers to become more attached.
A second conclusion is that farmers, in turn, are driven by market forces to pass much of the benefit of the subsidy along to landowners. That happens because land suited to growing corn is in less elastic supply than farm inputs of labor and capital. The pass-through to landowners, too, tends to splinter the ethanol coalition. Farmers who own their own land and landowners who lease to corn farmers remain solidly in favor of ethanol subsidies, but farmers who grow corn on leased land gain little or nothing.
Still another factor behind shifting pro- and anti-ethanol coalitions is the effect of corn ethanol subsidies on food prices. A paper by economist Bruce Gardner of the University of Maryland explains how the effect on food prices helps farmers capture a larger share of ethanol subsidies. The gain comes because demand for corn as food is less elastic than the demand for corn as an ethanol feedstock. If corn were used only for ethanol, distillers and blenders would capture a large part of the subsidy. Instead, though, farmers lose part of the benefits of the subsidy to ethanol producers but they more than gain it back when diversion of corn to ethanol drives up the price of corn as food.
When it comes to coalition building, the effect on food prices cuts both ways. Although higher corn prices increase the tenacity with which landowners cling to subsidies, they generate opposition from corn consumers. Those include both domestic consumers of everything from cornflakes to corn-fed beef, and people who are concerned about the effects of high corn prices on consumers in poorer countries.
All of the above suggests a paradox: Subsidies have succeeded in increasing the percentage of the corn crop that goes to ethanol, but that very success has narrowed the originally broad pro-ethanol coalition. Too much of the benefit goes to too small a group, landowners, and others in the supply chain have too small a stake. The Coburn-Feinstein proposal further splits ethanol producers from downstream users by removing the tariff on imports. Fuel suppliers would be quite happy to blend in tariff-free imported ethanol in place of subsidized domestic ethanol.
The final blow is likely to come less in the form of defections from the pro-ethanol camp than from a powerful addition to the anti-ethanol forces, namely, Congressional deficit hawks. True, ethanol subsidies, estimated to cost the budget about $6 billion a year, are chump change beside the trillions needed to close the federal budget gap. Still, everything helps. Many fiscal conservatives—at least those who do not plan to participate in next year's Iowa caucuses—know that farm subsidies must be cut back across the board, ethanol included.
The present relationship of the deficit to ethanol subsidies is a little like that of inflation to transportation regulation during the Carter administration. At that time, captive regulatory agencies had long propped up cartels in trucking, airlines, and railroads, and the cartels, in turn, were keeping prices high. Realistically, inflation was mostly a macroeconomic problem. The effect of the cartels on inflation was small. Still, the effect was there, and it was enough to allow free-marketeers, who favored deregulation as a matter of principle, to bring inflation hawks into their coalition. The outcome: the transportation cartels were busted once and for all. (Disclosure: I myself played a bit part in the deregulation drive as a transportation analyst for the Department of Justice and later the Interstate Commerce Commission.)
The bottom line: Ethanol subsidies may not be dead yet, but they are breathing their last. A symptom of their weakened position is that pro-ethanol forces are no longer trying to maintain the status quo. Instead, the counterproposal to Coburn and Feinstein's ethanol legislation is a bill being pushed by Sen. Chuck Grassley (R-IA) that would phase the subsidies out gradually rather than ending them cold turkey. The only remaining element of suspense is whether ethanol subsidies will go before the firing squad as part of current negotiations over the debt ceiling, or will instead be left to expire peacefully at midnight on December 31.
Now ethanol subsidies are back in the news, and this time they may be on the way out. One piece of legislation, introduced by Senators Tom Coburn (R-OK) and Dianne Feinstein (D-CA), would not only end the 45-cent per gallon tax credit, but also eliminate the 54-cent per gallon tariff on imported ethanol. To understand what has changed, we need to look at the economics behind the shifting pro- and anti-ethanol coalitions.
One shift is that environmentalist support for ethanol has pretty much evaporated. Environmentalists originally joined the ethanol coalition in the belief that using more ethanol, a renewable biofuel, would reduce greenhouse gas emissions. Years of study, however, have shown that corn-based ethanol, over its full life cycle, does little to reduce carbon emissions and may actually increase them. Late last year even Al Gore, long an ethanol booster, reversed his position. While serving as vice-president, Gore had cast a critical tie-breaking Senate vote to secure support for corn-based fuel. Now he admits that there are no environmental benefits, and that his original support was motivated, in part, by the hope of getting Iowa caucus votes in a later run for president.
Environmentalists are not the only ones to fall away from ethanol. As time has gone by, it has proved easier than once thought to find fault lines in the seemingly solid ethanol coalition. At first glance, it might appear that subsidies would find strong support all along the supply chain, from landowners to corn growers to ethanol distillers to fuel suppliers who blend ethanol with gasoline. However, closer economic analysis has shown that benefits are not distributed equally among the parties.
An interesting paper by Farzad Taheripour and Wallace Tyner of the Purdue University Department of Agricultural Economics analyzes the way subsidies are distributed by looking at elasticity of substitution between ethanol and gasoline as a motor fuel, and at the elasticity of supply at various points along the supply chain. (Elasticity means the percentage by which one variable, like quantity supplied, changes in response to a one percent change in another variable, like price.) The authors reach two conclusions that are relevant to the politics of ethanol.
One is that ethanol distillers and corn growers are engaged in a tug-of-war over the benefits of the subsidies. Who wins the biggest share depends partly on government policies that encourage blending of ethanol with gasoline and partly on the supply elasticity of corn. The authors find that over time, as the share of total corn production that goes to ethanol increases, corn farmers can be expected to capture more of the subsidy, leaving less for blenders and distillers. According to USDA data, the percentage of the U.S. corn crop going to ethanol increased from about 7 percent in 2001 to almost 40 percent by 2010. The predictable result would be for ethanol producers to become less attached to the subsidy, and farmers to become more attached.
A second conclusion is that farmers, in turn, are driven by market forces to pass much of the benefit of the subsidy along to landowners. That happens because land suited to growing corn is in less elastic supply than farm inputs of labor and capital. The pass-through to landowners, too, tends to splinter the ethanol coalition. Farmers who own their own land and landowners who lease to corn farmers remain solidly in favor of ethanol subsidies, but farmers who grow corn on leased land gain little or nothing.
Still another factor behind shifting pro- and anti-ethanol coalitions is the effect of corn ethanol subsidies on food prices. A paper by economist Bruce Gardner of the University of Maryland explains how the effect on food prices helps farmers capture a larger share of ethanol subsidies. The gain comes because demand for corn as food is less elastic than the demand for corn as an ethanol feedstock. If corn were used only for ethanol, distillers and blenders would capture a large part of the subsidy. Instead, though, farmers lose part of the benefits of the subsidy to ethanol producers but they more than gain it back when diversion of corn to ethanol drives up the price of corn as food.
When it comes to coalition building, the effect on food prices cuts both ways. Although higher corn prices increase the tenacity with which landowners cling to subsidies, they generate opposition from corn consumers. Those include both domestic consumers of everything from cornflakes to corn-fed beef, and people who are concerned about the effects of high corn prices on consumers in poorer countries.
All of the above suggests a paradox: Subsidies have succeeded in increasing the percentage of the corn crop that goes to ethanol, but that very success has narrowed the originally broad pro-ethanol coalition. Too much of the benefit goes to too small a group, landowners, and others in the supply chain have too small a stake. The Coburn-Feinstein proposal further splits ethanol producers from downstream users by removing the tariff on imports. Fuel suppliers would be quite happy to blend in tariff-free imported ethanol in place of subsidized domestic ethanol.
The final blow is likely to come less in the form of defections from the pro-ethanol camp than from a powerful addition to the anti-ethanol forces, namely, Congressional deficit hawks. True, ethanol subsidies, estimated to cost the budget about $6 billion a year, are chump change beside the trillions needed to close the federal budget gap. Still, everything helps. Many fiscal conservatives—at least those who do not plan to participate in next year's Iowa caucuses—know that farm subsidies must be cut back across the board, ethanol included.
The present relationship of the deficit to ethanol subsidies is a little like that of inflation to transportation regulation during the Carter administration. At that time, captive regulatory agencies had long propped up cartels in trucking, airlines, and railroads, and the cartels, in turn, were keeping prices high. Realistically, inflation was mostly a macroeconomic problem. The effect of the cartels on inflation was small. Still, the effect was there, and it was enough to allow free-marketeers, who favored deregulation as a matter of principle, to bring inflation hawks into their coalition. The outcome: the transportation cartels were busted once and for all. (Disclosure: I myself played a bit part in the deregulation drive as a transportation analyst for the Department of Justice and later the Interstate Commerce Commission.)
The bottom line: Ethanol subsidies may not be dead yet, but they are breathing their last. A symptom of their weakened position is that pro-ethanol forces are no longer trying to maintain the status quo. Instead, the counterproposal to Coburn and Feinstein's ethanol legislation is a bill being pushed by Sen. Chuck Grassley (R-IA) that would phase the subsidies out gradually rather than ending them cold turkey. The only remaining element of suspense is whether ethanol subsidies will go before the firing squad as part of current negotiations over the debt ceiling, or will instead be left to expire peacefully at midnight on December 31.
Selasa, 10 Mei 2011
Are Financial Regulators Flying Blind? Could Better Risk Topography Help?
Data on the capital and liquidity of banks are the navigation aids that regulators depend on to avoid another financial crash. Improvements to these indicators, adopted last year by the Basel Committee on Bank Supervision, are among the most heralded regulatory reforms since the 2008 crisis. But what if the instruments are faulty, even in their upgraded form? If so, regulators are flying blind, and our chances of avoiding another crash are slim. What can be done?
A recent paper by three prominent financial economists suggests one possible answer: a sort of Manhattan project that would map out a "risk topography" of the financial system. The authors are Markus K. Brunnermeier of Princeton, Gary Gorton of Yale, and Arvind Krishnamurthy of Northwestern. All three are also affiliated with the National Bureau of Economics Research. ( I will refer to the team in what follows as BG&K.)
Their work on risk topography is part of a growing literature on macroprudential regulation of the financial system. Traditional microprudential regulation focused on the safety and soundness of individual institutions. It operated on the implicit premise that if each institution was sound, then the system as a whole would be sound, too. Macroprudential regulation, in contrast, recognizes that interactions among disparate institutions—commercial banks, investment banks, hedge funds, derivatives markets, and all the rest—may pose threats to the system as a whole even when each firm taken separately appears sound. The need for better macroprudential regulation was recognized in last year's Dodd-Frank Act, which created an interagency Financial Stability Oversight Council (FSOC) to deal with systemic risks. It was the subject of an important speech that Fed Chairman Ben Bernanke gave in Chicago last week.
The problem, say BG&K, is that as things now stand, macroprudential regulation cannot be effectively implemented because the FSOC lacks the data needed to measure systemic risk. BG&K compare the situation to that faced by Presidents Hoover and Roosevelt in the early years of the Great Depression. Because national income accounts did not then exist, those presidents and their advisors struggled to develop stabilization policy using fragmentary data like factory output and boxcar loadings.
Some people have reacted to the data deficit by throwing up their hands in surrender. For example, in a recent Financial Times op ed, Former Fed Chairman Alan Greenspan argued that modern financial markets are "unredeemably opaque," and that neither regulators nor anyone else can ever "get more than a glimpse" of their internal workings. If so, attempts at macroprudential regulation would not just be doomed to failure, but would have harmful unintended consequences.
BG&K are not willing to accept the opacity of financial markets as irremediable. Instead, they propose developing a whole new system of reporting and measurement, no less ambitious in its scope than the national income accounts. It is hard to summarize the breadth of their proposal in a few words, but some key ideas will give an idea of their general approach.
First, BG&K point out that in assessing systemic risk, it is not enough simply to look at balance sheet measures during periods of calm. Instead, regulators need to know where pockets of risks are building up within the system in ways that are not revealed by existing balance-sheet based measurements of liquidity and capital adequacy. Instead, they propose requiring financial firms to report, on a regular basis, their sensitivity to a list of specified scenarios. For example, firms might be asked to estimate their dollar gain or loss if house prices rise or fall by 5, 10, or 15 percent, and also how such events would affect their liquidity position. Sensitivity estimates like these are already required as part of stress tests that regulators conduct from time to time, but BG&K propose gathering the data more frequently and from more institutions.
The BG&K approach also focuses on feedback mechanisms between problems of capital adequacy and problems of liquidity. They are particularly concerned with "liquidity spirals" that begin when firms that use short-term funding to finance longer-term investments experience runs or have trouble rolling over short-term borrowing. They are then forced into sales of illiquid assets at fire-sale prices. Those sales, in turn reduce capital and lead to further funding problems. When liquidity spirals, off-balance sheet positions, derivatives, and collateral requirements are taken into account, concepts like leverage and liquidity, which are well-defined in simple, stylized models, become fuzzy and hard to measure on the basis of data derived solely from balance sheets.
Cross scenarios that involve interactive exposure to two or more different risks are the third problem addressed by the BG&K proposal. Their paper uses the example of a U.S. bank that buys Spanish mortgage backed securities, denominated in euros, leaving it exposed both to the risk of falling Spanish housing prices and that of euro depreciation. If both risks materialize simultaneously, the impact on the bank may be greater than the sum of the events taken individually, and may not be adequately revealed by anything the bank would be required to report under the current system.
The end product of the required reporting would be a multidimensionl "risk map" of the financial system that would make visible all manner of risk pockets, sinkholes, pitfalls, soft spots, and other hazards, not only as they exist at the moment, but as they would shift and grow with changes in interest rates, exchange rates, asset prices, and so on.
A final key feature of the BG&K proposal is to make the resulting risk map of the financial system publicly available, just like the national income accounts and the Fed's flow of funds accounts. Public availability of the data would do more than just increase transparency. More importantly, availability of the new data would stimulate the development of macroeconomic models that better incorporate the financial sector than today's models do. The authors point out that when national income accounts and flow of funds accounts were first introduced, no one really knew how to use them. Their full value became apparent only over time as models based on them were developed.
Is this ambitious risk topography project feasible? I can see two kinds of barriers to its effective implementation.
First, the very complexity and novelty of the project would make it expensive and time-consuming to implement. True, as BG&K point out, many building blocks of a risk mapping system already exist. Past experience with stress testing of financial institutions provides one building block. Another is provided by the internal risk models already in use by the financial firms for their own purposes. Presumably, well-run firms are already equipped, at the click of a mouse, to answer questions about the impact on their operations of changes in asset prices and exchange rates. Even so, figuring out just what scenarios should be explored, how to assemble the resulting data, and how to ensure its integrity would be enormous tasks. One imagines a long process of sampling, beta-testing, and revision before the system would be up and running. Even then, by its very nature, we would not know whether the whole exercise was worthwhile until it was tested in a real-world crisis.
Second, we can be pretty certain that a large-scale risk mapping project would run into political resistance. BG&K rightly point out that the Dodd-Frank Act already provides the needed legal framework. The Act calls for establishment of an Office of Financial Research (OFR) within the Treasury Department, which, in turn, is tasked with providing research and information to the Financial Stability Oversight Council. The OFR even has subpoena power to require financial institutions to produce the data that it requests.
Legal authority or no, there would be resistance to the idea of using the OFR to undertake the vast task that BG&K propose. Given the tight-fistedness of the current Congress, just coming up with the money needed to staff and operate the exercise would be hard enough. Furthermore, not all of the component institutions of our financial system are as deeply in love with transparency as are critics in academia. One can easily imagine that every appointment and authorization would give rise to the same kind of trench warfare currently being waged over the Bureau of Consumer Financial Protection. That agency, also authorized by the Dodd-Frank Act, may very well end up stillborn, or if not, extensively re-engineered before it sees the light of day. The same thing could happen to the OFR if it were given too large an assignment.
Still, despite the technical and political hazards of a large scale risk mapping project, to give up on the idea in advance would be to admit that the financial system is in fact "unredeemably opaque." If so, the alternatives are bleak. Regulators would then either have to abandon the concept of macroprudential regulation altogether and passively await the next crisis, or they would run a severely heightened risk that their regulatory initiatives would have harmful unintended consequences.
A recent paper by three prominent financial economists suggests one possible answer: a sort of Manhattan project that would map out a "risk topography" of the financial system. The authors are Markus K. Brunnermeier of Princeton, Gary Gorton of Yale, and Arvind Krishnamurthy of Northwestern. All three are also affiliated with the National Bureau of Economics Research. ( I will refer to the team in what follows as BG&K.)
Their work on risk topography is part of a growing literature on macroprudential regulation of the financial system. Traditional microprudential regulation focused on the safety and soundness of individual institutions. It operated on the implicit premise that if each institution was sound, then the system as a whole would be sound, too. Macroprudential regulation, in contrast, recognizes that interactions among disparate institutions—commercial banks, investment banks, hedge funds, derivatives markets, and all the rest—may pose threats to the system as a whole even when each firm taken separately appears sound. The need for better macroprudential regulation was recognized in last year's Dodd-Frank Act, which created an interagency Financial Stability Oversight Council (FSOC) to deal with systemic risks. It was the subject of an important speech that Fed Chairman Ben Bernanke gave in Chicago last week.
The problem, say BG&K, is that as things now stand, macroprudential regulation cannot be effectively implemented because the FSOC lacks the data needed to measure systemic risk. BG&K compare the situation to that faced by Presidents Hoover and Roosevelt in the early years of the Great Depression. Because national income accounts did not then exist, those presidents and their advisors struggled to develop stabilization policy using fragmentary data like factory output and boxcar loadings.
Some people have reacted to the data deficit by throwing up their hands in surrender. For example, in a recent Financial Times op ed, Former Fed Chairman Alan Greenspan argued that modern financial markets are "unredeemably opaque," and that neither regulators nor anyone else can ever "get more than a glimpse" of their internal workings. If so, attempts at macroprudential regulation would not just be doomed to failure, but would have harmful unintended consequences.
BG&K are not willing to accept the opacity of financial markets as irremediable. Instead, they propose developing a whole new system of reporting and measurement, no less ambitious in its scope than the national income accounts. It is hard to summarize the breadth of their proposal in a few words, but some key ideas will give an idea of their general approach.
First, BG&K point out that in assessing systemic risk, it is not enough simply to look at balance sheet measures during periods of calm. Instead, regulators need to know where pockets of risks are building up within the system in ways that are not revealed by existing balance-sheet based measurements of liquidity and capital adequacy. Instead, they propose requiring financial firms to report, on a regular basis, their sensitivity to a list of specified scenarios. For example, firms might be asked to estimate their dollar gain or loss if house prices rise or fall by 5, 10, or 15 percent, and also how such events would affect their liquidity position. Sensitivity estimates like these are already required as part of stress tests that regulators conduct from time to time, but BG&K propose gathering the data more frequently and from more institutions.
The BG&K approach also focuses on feedback mechanisms between problems of capital adequacy and problems of liquidity. They are particularly concerned with "liquidity spirals" that begin when firms that use short-term funding to finance longer-term investments experience runs or have trouble rolling over short-term borrowing. They are then forced into sales of illiquid assets at fire-sale prices. Those sales, in turn reduce capital and lead to further funding problems. When liquidity spirals, off-balance sheet positions, derivatives, and collateral requirements are taken into account, concepts like leverage and liquidity, which are well-defined in simple, stylized models, become fuzzy and hard to measure on the basis of data derived solely from balance sheets.
Cross scenarios that involve interactive exposure to two or more different risks are the third problem addressed by the BG&K proposal. Their paper uses the example of a U.S. bank that buys Spanish mortgage backed securities, denominated in euros, leaving it exposed both to the risk of falling Spanish housing prices and that of euro depreciation. If both risks materialize simultaneously, the impact on the bank may be greater than the sum of the events taken individually, and may not be adequately revealed by anything the bank would be required to report under the current system.
The end product of the required reporting would be a multidimensionl "risk map" of the financial system that would make visible all manner of risk pockets, sinkholes, pitfalls, soft spots, and other hazards, not only as they exist at the moment, but as they would shift and grow with changes in interest rates, exchange rates, asset prices, and so on.
A final key feature of the BG&K proposal is to make the resulting risk map of the financial system publicly available, just like the national income accounts and the Fed's flow of funds accounts. Public availability of the data would do more than just increase transparency. More importantly, availability of the new data would stimulate the development of macroeconomic models that better incorporate the financial sector than today's models do. The authors point out that when national income accounts and flow of funds accounts were first introduced, no one really knew how to use them. Their full value became apparent only over time as models based on them were developed.
Is this ambitious risk topography project feasible? I can see two kinds of barriers to its effective implementation.
First, the very complexity and novelty of the project would make it expensive and time-consuming to implement. True, as BG&K point out, many building blocks of a risk mapping system already exist. Past experience with stress testing of financial institutions provides one building block. Another is provided by the internal risk models already in use by the financial firms for their own purposes. Presumably, well-run firms are already equipped, at the click of a mouse, to answer questions about the impact on their operations of changes in asset prices and exchange rates. Even so, figuring out just what scenarios should be explored, how to assemble the resulting data, and how to ensure its integrity would be enormous tasks. One imagines a long process of sampling, beta-testing, and revision before the system would be up and running. Even then, by its very nature, we would not know whether the whole exercise was worthwhile until it was tested in a real-world crisis.
Second, we can be pretty certain that a large-scale risk mapping project would run into political resistance. BG&K rightly point out that the Dodd-Frank Act already provides the needed legal framework. The Act calls for establishment of an Office of Financial Research (OFR) within the Treasury Department, which, in turn, is tasked with providing research and information to the Financial Stability Oversight Council. The OFR even has subpoena power to require financial institutions to produce the data that it requests.
Legal authority or no, there would be resistance to the idea of using the OFR to undertake the vast task that BG&K propose. Given the tight-fistedness of the current Congress, just coming up with the money needed to staff and operate the exercise would be hard enough. Furthermore, not all of the component institutions of our financial system are as deeply in love with transparency as are critics in academia. One can easily imagine that every appointment and authorization would give rise to the same kind of trench warfare currently being waged over the Bureau of Consumer Financial Protection. That agency, also authorized by the Dodd-Frank Act, may very well end up stillborn, or if not, extensively re-engineered before it sees the light of day. The same thing could happen to the OFR if it were given too large an assignment.
Still, despite the technical and political hazards of a large scale risk mapping project, to give up on the idea in advance would be to admit that the financial system is in fact "unredeemably opaque." If so, the alternatives are bleak. Regulators would then either have to abandon the concept of macroprudential regulation altogether and passively await the next crisis, or they would run a severely heightened risk that their regulatory initiatives would have harmful unintended consequences.
Selasa, 03 Mei 2011
The People's Budget: Cutting the Deficit the Progressive Way
In previous posts, I have discussed bipartisan attempts to find a fiscal policy compromise (here and here), and also Republican plans for closing the budget gap through spending cuts alone (here and here). Today's post turns to the less widely publicized People's Budget from the Congressional Progressive Caucus. What is there to like about the progressive fiscal plan, and what not to like?
First what I like. On the spending side, the People's Budget does not limit itself to swinging a meat-ax at tiny targets like NPR and AmeriCorps within the 12 percent of the budget that is made up of discretionary nondefense spending. Instead, it goes after some really juicy chunks, including defense. Not just at waste, fraud, and abuse in the military budget, either. It comes right out and proposes an orderly but swift end to the military adventure in Afghanistan, thereby saving something between $400 billion and $1.6 trillion, depending on what baseline you compare it to. But the progressives do not really have a monopoly here. Concerns that the United States has not gotten its money's worth from wars in Iraq and Afghanistan are increasingly voiced on the Republican side of the aisle, including like Ron and Rand Paul, Jason Chafitz, and Walter Jones.
Next, the People's Budget takes aim at the nation's infrastructure deficit. As I argued in an earlier post, cutting infrastructure investment below what is needed to cover depreciation, as has been done in many areas, is an illusory way of improving the national balance sheet. What is saved in terms of reduced financial liabilities is offset by more rapid depreciation of real assets like bridges, dams, and power lines. In fact, since deferral of needed maintenance almost always means greater spending later when something breaks, cuts to infrastructure spending often end up making the nation's consolidated balance sheet weaker, not stronger. On the whole, without endorsing every line item, I would count the $1.7 trillion added to infrastructure investment over ten years as a plus for the People's Budget.
On entitlements, the People's Budget recognizes, as every observer must, that any realistic plan for fiscal consolidation must do something about the projected growth of government health care outlays. The Republican budget plan deals with this problem largely by shifting the cost of Medicare from the federal government to senior citizens themselves. There are relatively few cost-saving measures in the Republican plan except for malpractice reform and a vague hope that competition will force costs down in the future, even though it has not done so in the past.
The People's Budget takes cost saving in health care more seriously. Its initiatives include adding a public option to the array of private plans to be offered on health insurance exchanges and allowing the government to bargain with pharmaceutical companies over drug prices. Big insurance companies and big pharmas are terrified of these ideas: They might work!
The experience of countries like France and Germany shows that when a full array of cost-saving strategies are used, it is possible to provide better quality health care at lower cost, and to do so without moving to British-style, single-payer, "socialized medicine." The People's budget picks up some good ideas that have been shown to work elsewhere, although more could be added.
Let's turn now to the revenue side of the People's Budget. Out of $5.6 trillion in projected deficit reduction in the progressive plan, $3.9 billion, or nearly 70 percent, comes from revenue increases. That contrasts with the one-third revenue, two-thirds spending-cut formula of the bipartisan Simpson-Bowles plan, and even more with Republican plans to balance the budget with spending cuts alone.
What disappoints me about the revenue side of the People's Budget is the degree to which it depends on higher marginal tax rates rather than on tax reform. The biggest piece of revenue, an estimated $873 billion, is to come from enacting Representative Jan Schakowsky's Fairness in Taxation Act (HR 1124), which would create several new income tax brackets, ranging from 45 percent on incomes over $1 million to 49 percent for incomes over $1 billion. The second biggest piece, $330 billion, is to come from Senator Bernie Sanders' Responsible Estate Tax Act (S 3533), which introduces estate tax rates up to 65 percent. Some smaller new taxes for the financial sector are added, as well.
The revenue estimates for the tax increases are set out in a technical analysis of the People's Budget prepared by the Economic Policy Institute. Those, in turn, rely on analysis by the Joint Committee on Taxation that has not been released to the public. From context, it would appear that we are looking at static estimates, which do not take into account behavioral responses to tax rate changes, in contrast to dynamic estimates, which do. Static scoring tends to overestimate the revenue from tax rate increases, although it is often hard to know by how much.
Popular discussions of dynamic scoring often focus on the idea that corporations and small businesses won't try as hard to innovate and create jobs if their tax rates go up. However, the real damage of higher marginal tax rates comes not from decreased work effort, but from increased efforts to avoid taxes. Given the complexity of the federal tax code, the possibilities for legal tax avoidance are almost limitless. Everyone has heard the horror stories: Warren Buffet pays a lower tax rate than his secretary; the corporate giant General Electric no tax at all.
Tax avoidance does not just reduce revenues; it leads to efficiency-killing distortions when investment decisions or operational strategies are modified to make income from one source look like something else from somewhere else. Raising marginal tax rates only makes the problem worse. Tax reform that keeps marginal tax rates low while closing loopholes is a much better strategy. Reform could raise as much, or more, revenue than boosting rates, while reducing opportunities for tax avoidance rather than increasing them.
To its credit, the People's Budget does close a few loopholes. For example, it equalizes the tax treatment of capital gains and ordinary income, although it sacrifices potential efficiency gains by raising the marginal rates on both. It leaves most itemized deductions in place, but does take the modest step of capping the degree to which top earners' taxes can be reduced. It eliminates the deductibility of municipal bond interest, although the deduction is replaced with a subsidy to municipal bond issuers that not everyone will like. It broadens the corporate tax base by eliminating oil and gas preferences and taxing foreign corporate income as it is earned, although it leaves the marginal corporate tax rate unchanged at what is already one of the highest in the world.
But these tax reform proposals are half-steps compared with what could have been done, in complete consistency with the progressive agenda. For example, why not repeal the mortgage interest deduction? As I noted in an earlier post, the Urban Institute-Brookings Tax Policy Center estimates the mortgage interest deduction to be worth $5,393 a year for tax units in the top 1 percent of the income distribution (average income $1,302,188) but only $215 per year to those in the middle 20 percent (average income $43,678). For households in the bottom 20 percent of the income distribution, the deduction has almost no value. Getting rid of the deduction would raise $108 billion in 2012, rising to $162 billion a year by 2019. What keeps the mortgage interest deduction off the progressive hit list? Who knows. Maybe campaign contributions from the United Brotherhood of Carpenters.
In all, the People's Budget leaves untouched the entire top half of the dirty-dozen list of tax loopholes. All of those loopholes—from employer-paid health care to mortgage interest to charitable deductions—are regressive in their impact. All of them encourage efficiency-sapping tax avoidance strategies, the effects of which would be even worse if the higher marginal rates of the People's Budget were to be enacted. Collectively, eliminating the top six loopholes could raise close to $500 billion a year in added revenue, enough to pay for a cornucopia of progressive delights.
The bottom line: The People's budget does represent a real alternative to Republican budget plans. It takes on some sacred cows that the Republicans fear to touch, most notably defense spending. It correctly recognizes that cuts to infrastructure investment are false economies that reduce the headline deficit number without really improving the national balance sheet. It also deserves credit for seeing that real cost savings, not just cost shifting, will be needed to make health care affordable.
Finally, the People's Budget is more realistic than Republican plans in recognizing that both spending cuts and revenue increases will be needed to close the budget gap. Sadly, though, the way it seeks added revenue is just plain bad. Its "millionaire's tax" plays to the class warfare instincts of the progressive base, but its efforts fall flat when it comes to tax reform. The People's Budget could have been very much better, and without giving an inch on its progressive principles.
Follow this link to view or download a short slideshow with graphs, data, and other highlights from the People's Budget.
First what I like. On the spending side, the People's Budget does not limit itself to swinging a meat-ax at tiny targets like NPR and AmeriCorps within the 12 percent of the budget that is made up of discretionary nondefense spending. Instead, it goes after some really juicy chunks, including defense. Not just at waste, fraud, and abuse in the military budget, either. It comes right out and proposes an orderly but swift end to the military adventure in Afghanistan, thereby saving something between $400 billion and $1.6 trillion, depending on what baseline you compare it to. But the progressives do not really have a monopoly here. Concerns that the United States has not gotten its money's worth from wars in Iraq and Afghanistan are increasingly voiced on the Republican side of the aisle, including like Ron and Rand Paul, Jason Chafitz, and Walter Jones.
Next, the People's Budget takes aim at the nation's infrastructure deficit. As I argued in an earlier post, cutting infrastructure investment below what is needed to cover depreciation, as has been done in many areas, is an illusory way of improving the national balance sheet. What is saved in terms of reduced financial liabilities is offset by more rapid depreciation of real assets like bridges, dams, and power lines. In fact, since deferral of needed maintenance almost always means greater spending later when something breaks, cuts to infrastructure spending often end up making the nation's consolidated balance sheet weaker, not stronger. On the whole, without endorsing every line item, I would count the $1.7 trillion added to infrastructure investment over ten years as a plus for the People's Budget.
On entitlements, the People's Budget recognizes, as every observer must, that any realistic plan for fiscal consolidation must do something about the projected growth of government health care outlays. The Republican budget plan deals with this problem largely by shifting the cost of Medicare from the federal government to senior citizens themselves. There are relatively few cost-saving measures in the Republican plan except for malpractice reform and a vague hope that competition will force costs down in the future, even though it has not done so in the past.
The People's Budget takes cost saving in health care more seriously. Its initiatives include adding a public option to the array of private plans to be offered on health insurance exchanges and allowing the government to bargain with pharmaceutical companies over drug prices. Big insurance companies and big pharmas are terrified of these ideas: They might work!
The experience of countries like France and Germany shows that when a full array of cost-saving strategies are used, it is possible to provide better quality health care at lower cost, and to do so without moving to British-style, single-payer, "socialized medicine." The People's budget picks up some good ideas that have been shown to work elsewhere, although more could be added.
Let's turn now to the revenue side of the People's Budget. Out of $5.6 trillion in projected deficit reduction in the progressive plan, $3.9 billion, or nearly 70 percent, comes from revenue increases. That contrasts with the one-third revenue, two-thirds spending-cut formula of the bipartisan Simpson-Bowles plan, and even more with Republican plans to balance the budget with spending cuts alone.
What disappoints me about the revenue side of the People's Budget is the degree to which it depends on higher marginal tax rates rather than on tax reform. The biggest piece of revenue, an estimated $873 billion, is to come from enacting Representative Jan Schakowsky's Fairness in Taxation Act (HR 1124), which would create several new income tax brackets, ranging from 45 percent on incomes over $1 million to 49 percent for incomes over $1 billion. The second biggest piece, $330 billion, is to come from Senator Bernie Sanders' Responsible Estate Tax Act (S 3533), which introduces estate tax rates up to 65 percent. Some smaller new taxes for the financial sector are added, as well.
The revenue estimates for the tax increases are set out in a technical analysis of the People's Budget prepared by the Economic Policy Institute. Those, in turn, rely on analysis by the Joint Committee on Taxation that has not been released to the public. From context, it would appear that we are looking at static estimates, which do not take into account behavioral responses to tax rate changes, in contrast to dynamic estimates, which do. Static scoring tends to overestimate the revenue from tax rate increases, although it is often hard to know by how much.
Popular discussions of dynamic scoring often focus on the idea that corporations and small businesses won't try as hard to innovate and create jobs if their tax rates go up. However, the real damage of higher marginal tax rates comes not from decreased work effort, but from increased efforts to avoid taxes. Given the complexity of the federal tax code, the possibilities for legal tax avoidance are almost limitless. Everyone has heard the horror stories: Warren Buffet pays a lower tax rate than his secretary; the corporate giant General Electric no tax at all.
Tax avoidance does not just reduce revenues; it leads to efficiency-killing distortions when investment decisions or operational strategies are modified to make income from one source look like something else from somewhere else. Raising marginal tax rates only makes the problem worse. Tax reform that keeps marginal tax rates low while closing loopholes is a much better strategy. Reform could raise as much, or more, revenue than boosting rates, while reducing opportunities for tax avoidance rather than increasing them.
To its credit, the People's Budget does close a few loopholes. For example, it equalizes the tax treatment of capital gains and ordinary income, although it sacrifices potential efficiency gains by raising the marginal rates on both. It leaves most itemized deductions in place, but does take the modest step of capping the degree to which top earners' taxes can be reduced. It eliminates the deductibility of municipal bond interest, although the deduction is replaced with a subsidy to municipal bond issuers that not everyone will like. It broadens the corporate tax base by eliminating oil and gas preferences and taxing foreign corporate income as it is earned, although it leaves the marginal corporate tax rate unchanged at what is already one of the highest in the world.
But these tax reform proposals are half-steps compared with what could have been done, in complete consistency with the progressive agenda. For example, why not repeal the mortgage interest deduction? As I noted in an earlier post, the Urban Institute-Brookings Tax Policy Center estimates the mortgage interest deduction to be worth $5,393 a year for tax units in the top 1 percent of the income distribution (average income $1,302,188) but only $215 per year to those in the middle 20 percent (average income $43,678). For households in the bottom 20 percent of the income distribution, the deduction has almost no value. Getting rid of the deduction would raise $108 billion in 2012, rising to $162 billion a year by 2019. What keeps the mortgage interest deduction off the progressive hit list? Who knows. Maybe campaign contributions from the United Brotherhood of Carpenters.
In all, the People's Budget leaves untouched the entire top half of the dirty-dozen list of tax loopholes. All of those loopholes—from employer-paid health care to mortgage interest to charitable deductions—are regressive in their impact. All of them encourage efficiency-sapping tax avoidance strategies, the effects of which would be even worse if the higher marginal rates of the People's Budget were to be enacted. Collectively, eliminating the top six loopholes could raise close to $500 billion a year in added revenue, enough to pay for a cornucopia of progressive delights.
The bottom line: The People's budget does represent a real alternative to Republican budget plans. It takes on some sacred cows that the Republicans fear to touch, most notably defense spending. It correctly recognizes that cuts to infrastructure investment are false economies that reduce the headline deficit number without really improving the national balance sheet. It also deserves credit for seeing that real cost savings, not just cost shifting, will be needed to make health care affordable.
Finally, the People's Budget is more realistic than Republican plans in recognizing that both spending cuts and revenue increases will be needed to close the budget gap. Sadly, though, the way it seeks added revenue is just plain bad. Its "millionaire's tax" plays to the class warfare instincts of the progressive base, but its efforts fall flat when it comes to tax reform. The People's Budget could have been very much better, and without giving an inch on its progressive principles.
Follow this link to view or download a short slideshow with graphs, data, and other highlights from the People's Budget.
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