Guest Post: Heather Boushey on Inequality and Growth

Nov 6, 2012Mike Konczal

Mike here: Special guest post by Heather Boushey of the Center for American Progress, responding to a recent citation of her work with Adam Hersh on inequality and growth (work we discussed here). The launch of this post was delayed on my end as a result of Sandy-induced work/email chaos.

Mike here: Special guest post by Heather Boushey of the Center for American Progress, responding to a recent citation of her work with Adam Hersh on inequality and growth (work we discussed here). The launch of this post was delayed on my end as a result of Sandy-induced work/email chaos. Hope you check it out, as well as their excellent report that is discussed within.

Inequality does appear to affect economic growth

by Heather Boushey

It is now a well-known fact that the United States has the highest levels of inequality among developed countries. Increasingly, the economics profession is questioning how this affects our economy, not only in terms of what it means for those at the bottom of the income distribution, but in terms of how high inequality affects economic growth and stability.

The New York Times recently published a thoughtful piece on the relationship of rising U.S. inequality to long-term economic growth. In the wake of that article, they published a Room for Debate online forum on this topic and Scott Winship, a scholar a the Brooking’s Institution was among those participating. Mr. Winship cites our report on the topic to discuss what he argues is inadequate evidence linking inequality and growth.

We are grateful that Mr. Winship acknowledges CAP's central role in this debate, but grossly mischaracterizes our conclusions. The quote he pulled from our report gives the false impression that our research supports the conclusionthat inequality is not a problem for economic growth.

Our argument is that we need to look specifically at the channels through which inequality affects economic growth, specifically in the U.S. context. For example, there is evidence that documents how the rich don’t spend as much of their income as the non-rich. If inequality keeps rising and the rich pull in a larger and larger share of national income, this stunts demand, the lifeblood of the economy.

Another mechanism is through entrepreneurship, which is often portrayed as the dynamic force in a capitalist economy. Yet, most entrepreneurs come from the middle class. The middle class provides both the economic security and access to education and credit that entrepreneursneed.

If inequality is due to the top pulling far away from the rest of the economy,which creates a very wealthy elite, this is often associated with a well-known economic phenomenon of “rent-seeking.” The wealthy will tend to use their outsized resources to garner a bigger piece of the pie, rather than on investments that will increase productivity and make the whole pie bigger. And, there is growing evidence that this is exactly what is happening to our economy, threatening long-term growth. For example, economists have been finding that as money has flowed into the financial sector, that industry has increasingly used its resources to promote policies that benefit itself only.

In opposition to Mr. Winship’s claim, the preponderance of evidence does supports the conclusion that inequality can hamper economic growth. We conducted a thorough review of the literature and in the quote he took, we were highlighting methodological limitations in a specific class of empirical studies. We also pointed out that cross-country panel data studies look at reduced form equations for growth and we argue that we should be thinking instead about a structural model.

Others have found our report to be data-driven. Jim Tankersley, journalist with the National Journal encouraged his readers to consume the report “in its entirety,” describing is as a “The bulk of Boushey and Hersh's sources aren't partisan in any way - just detailed, data-driven analysis from top economists.” This blog called it “the best up-to-date arguments that progressives discussing inequality should understand inside out.” And in a lengthy discussion on the subject last month by Jared Bernstein, former chief economist to the vice president, our work was used to frame a summary of the latest research on this topic. 

We are typically pleased to have our research cited in the paper of record, the New York Times. However, it is no fun to have our work grossly misrepresented.

 

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What Explains Wall Street's Shift Away From Obama: Fat Cat Comments or Dodd-Frank?

Nov 1, 2012Mike Konczal

In an interesting column on President Obama as the last of the "New Democrats" presidents, Michael Lind brings up the idea that the financial sector has permanently moved away from Democrats. "In 2012, most Wall Street donors, offended by Obama’s mild criticism and alarmed by the support shown by many Democrats for Occupy Wall Street, have swung their support away from the Democrats to the Republicans. It is unlikely that most of them will ever come back.

In an interesting column on President Obama as the last of the "New Democrats" presidents, Michael Lind brings up the idea that the financial sector has permanently moved away from Democrats. "In 2012, most Wall Street donors, offended by Obama’s mild criticism and alarmed by the support shown by many Democrats for Occupy Wall Street, have swung their support away from the Democrats to the Republicans. It is unlikely that most of them will ever come back. In the aftermath of the Great Recession, moderate as well as progressive Democrats are going to emphasize deficit reduction through tax increases far more than even moderate Republicans...Any such reform will cut deeply into the incomes of many Wall Street rentiers whose 'progressivism' extends only to cost-free support for gay rights and abortion rights."

It'll be interesting to see if the political coalitions permanently shift in this manner. One reason for a shift is if Wall Street is leaving President Obama less for rhetorical reasons and more for economic and regulatory ones, especially when it comes to Dodd-Frank, which Democrats will continue to defend and Republicans will look to overturn.

When people discuss why Wall Street has turned against President Obama, it is usually a story about personalities and ego. Obama once said, “I did not run for office to be helping out a bunch of fat cat bankers on Wall Street,” and that particularly stung them. Or maybe Obama is terrible with fundraising and managing the egos of rich donors. Or maybe it runs deeper psychologically. As an investor who voted for Obama in 2008 told Gayle Tzemach Lemmon, "There is just this feeling across the financial services community, across the business community, that this guy hates us."

There is a lot to the lost feeling of proper stewardship over the economy, but as Matt Yglesias points out, it likely goes beyond the fat cats line. These conversations almost always put Dodd-Frank in the far background, even though it is a major reform of the financial sector that will reduce Wall Street's power and profits. Let's look at a few reforms.

Derivatives. One of the goals of Dodd-Frank is to bring transparency and standardization to the derivatives markets by requiring derivatives to go through a clearinghouse with pricing transparency. According to the FT's Michael Mackenzie and Tracy Alloway in "Swaps profits threatened by Dodd-Frank," "Analysts at Standard & Poor’s expect an annual drop in revenues for large dealers of between $4bn and $4.5bn once rules that include...mandatory central clearing of OTC swaps are fully implemented... But for smaller broker dealers and others, the future looks brighter as competition potentially opens across the OTC arena."

In the article, CFTC chairman Gensler recognizes "all [the] benefit[s] from the lower costs and greater pricing information of a more transparent, accessible and competitive swaps market.” But not everybody actually does. Those who cornered the market pre-reform lose out on rents they were collecting from dominating the information in the market. Dodd-Frank is tackling the market in a way that expands access and transparency and reduces the pricing power of powerful incumbents. That's fantastic, unless you are one of those incumbents who will lose billions of dollars.

Interchange. Even the little things challenge the power of the financial sector over the real economy. Take interchange, the fees the financial sector charges to the real economy for using debit and credit cards. That now resembles a public utility after Dodd-Frank, which rationalizes the system in much the same way that personal checks were rationalized by the Federal Reserve in the early 20th century. S&P estimates that "the Durbin Amendment's immediate financial impact for the banking industry is a $6.5 billion to $7 billion annual reduction in debit card-related revenue... Bank of America, JPMorgan Chase, and Wells Fargo have absorbed the majority of these losses, considering the size of their debit card businesses relative to peers." This balances the playing field between the real economy and the financial sector while taking away a powerful set of contracts the banks were using to squeeze merchants.

CFPB. Meanwhile, consumer financial protection used to be the orphan mission of 10 different agencies, a number that encourages race-to-the-bottom regulatory arbitrage, none of which had the incentives to build expertise in this area or directly fight for consumers over other mission priorities. Now that mission is squarely placed in the CFPB, an agency whose funding and organizational structure is designed to prevent capture. The CFPB is already successfully going after illegal and deceptive practices at places like American Express, Discover, and Capital One, winning damages in the hundreds of millions of dollars. The financial sector is noticing that there is now an agency designed to enforce accountability.

(One might note that hedge funds don't fall under these requirements, yet they are very mad. Some of that is the result of the push to remove special tax breaks, which is a direct economic issue. Some might be the result of other financial regulations.)

These are just items with visible price tags, so it doesn't include things like the Volcker Rule, extra-prudential regulations of larger and riskier firms, trying to tackle the ratings agencies, the presumption that the FDIC will need to resolve and liquidate large firms and will require those firms to prepare for that event, and the other new regulations of the financial sector. With billions of dollars a year in profits on the line in repealing Dodd-Frank (and with those who benefit from regulation dispersed across the entire economy), it isn't surprising that we are seeing a lot of donations go to those saying they will substantially weaken reform. And the GOP is specifically targeting these kinds of reforms.

Notice that though these regulations have a large price tag, they aren't "soak the rich" or "let's get the fat cats" regulations. They are all designed to make the financial markets run better by bringing transparency, a level playing field, and accountability to the system. We haven't seen how they'll be fully implemented, and a lot is still at risk even without a Republican victory in the presidental election. But right now there are billions of reasons Wall Street should want to stop the Democratic Party and Dodd-Frank beyond hurt feelings.

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Angry cat image via Shutterstock.com.

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Live at Dissent Magazine with "From Master Plan To No Plan"

Oct 24, 2012Mike Konczal

I have an article in the latest Dissent Magazine, co-written with Aaron Bady, titled "From Master Plan to No Plan: The Slow Death of Public Higher Education." It's now live and kicking off their newly redesigned webpage. It starts with Ronald Reagan in California in the 1960s, does a history of the creation and strengths of the University of California's Master Plan system and its dissembly, and ends with what John Aubrey Douglass calls the the Brazilian Effect. It's full of riot cops, occupations, moderate Republicans, thoughts on elasticities of supply, for-profit schools and more.

I have an article in the latest Dissent Magazine, co-written with Aaron Bady, titled "From Master Plan to No Plan: The Slow Death of Public Higher Education." It's now live and kicking off their newly redesigned webpage. It starts with Ronald Reagan in California in the 1960s, does a history of the creation and strengths of the University of California's Master Plan system and its dissembly, and ends with what John Aubrey Douglass calls the the Brazilian Effect. It's full of riot cops, occupations, moderate Republicans, thoughts on elasticities of supply, for-profit schools and more.

I hope this starts to move the conversation forward on higher education outside a specific focus on student debt, because that is likely to reach its limits outside a broader vision of what needs to be accomplished. Andy Kroll wrote a similar piece that went live earlier this month, so I think there's a lot of interest in this topic. In March, Catherine Rampell wrote about the Brazilian Effect in economix. Andrew Ross wrote a fantastic piece for Dissent's series on education on the aggressive expansion of NYU and other universities as part of a conscious urban planning framework, combining growth models based on the FIRE industires with those in the ICE (intellectual, cultural and educational) industries, which is an important part of the puzzle.

This may be my favorite written thing with my name on it and, as I've been given opportunities I wouldn't have had without public higher education, this political and economic battle means a lot to me. Hope you check it out.

 

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A Post-Debate Interview with Glenn Hubbard on Housing Policy

Oct 22, 2012Mike Konczal

There were no serious housing questions at any of the presidental debates. Given how important the housing market is for both voters and the economy, this is surprising and disappointing. As Zachary Goldfarb noted, "here are a few words that surprisingly have not shown up through much of this debate: housing, mortgage, refinance, underwater." 

There were no serious housing questions at any of the presidental debates. Given how important the housing market is for both voters and the economy, this is surprising and disappointing. As Zachary Goldfarb noted, "here are a few words that surprisingly have not shown up through much of this debate: housing, mortgage, refinance, underwater." 

I attended last Tuesday's presidential debate at Hofstra University as press for Al-Jazeera English, providing TV commentary on economic issues. It was my first debate, so I took some time to wander around. While exploring after the debate was over, I found the Spin Alley area, which is the area where politicians and campaign people stand by to give quick media responses. Handlers held large signs advertising the people in question. I saw a "Hubbard, Glenn" sign in the air, and the Columbia economist and Romney economic advisor standing by to give spin on the debate.

I decided to get some housing questions on the table. When some people, notably Josh Barro, argue Romney has a secret economic plan, and in particular a secret housing plan, they cite Hubbard, who has been very vocal on boosting demand through interventions in the housing market. I've noted that his plans might not be that different from what Obama is currently doing.

Below is a transcript of what I got a chance to ask him:

Mike Konczal: In 2008 you co-wrote a plan with Chris Mayer on the housing market that called for mass refinancing and principal reduction through the GSE. In 2011 you released another plan with Mayer that just featured the mass refinancing. Why was there the change?

Glenn Hubbard: It wasn't principal reduction; it was setting up a Home Owners' Loan Corporation model.

There was a debt-to-equity swap in your proposal.

Right. What we focused on in 2011 was trying to give direction to the Obama administration, which was bungling the mass refinancing so badly. That's why we focused on that. I still think it would be a good idea to have a Home Owners' Loan Corporation. But the point of that piece was that the Obama administration had bungled every housing plan, so we were trying to provide some guidance.

Earlier this year, HARP, the Home Affordable Refinancing Program, was relaunched as HARP 2.0.

It's still a failure.

After the relaunch, we are seeing a large increase in refinancing on very underwater homes, particularly those with loan-to-value over 125 percent.

It's still a failure. If you compare it to the number that Chris Mayer and I had argued, it's trivial.

Compared to the number of possible refinancing?

Yes. The reason is the GSEs have stood in the way, and the Obama Treasury has not managed the GSEs in such a way as to facilitate its own policies. It's really quite sad.

But that's an FHFA problem, is it not?

I'm sorry, but you can't duck the FHFA.

So you think President Obama should have done a recess appointment [to replace Ed DeMarco] at the FHFA?

I don't manage the Obama appointments, but I do know that the FHFA has mismanaged the president's own plan.

What would a President Romney put forward in the housing market?

What Governor Romney wisely is focused on is the long term in housing. We need to wind down the portfolios of the GSEs and reassess the government's role in such a way to get more private capital back into housing.

In 2008 you argued that cramdown, or some sort of bankruptcy reform, was a bad idea because it could impact long-term growth. In retrospect, do you still think that?

Yes. I still believe that. I absolutely think that was the correct call.

Thank you for your time.

==========

Mike here, with a few notes. According to the latest data from FHFA, there have been 118,470 refinances of mortgages with an LTV over 125 percent between February, when HARP 2.0 allows for these seriously underwater refinancings, and now. Here's a graph from Dan Green's Mortgage report:

Matt Zeitlin has more on the initial successes of HARP 2.0 at the Daily Beast. Rather than the legal issues at FHFA, it seems that the next big blockages in turning record low mortgage rates into increased consumer demand through refinancing are applications overwhelming banks, the financial sector collecting oligopolistic rents from not passing along low rates to consumers via their pricing power, and lack of competition on HARP refinances.

Hubbard is correct that Ed DeMarco is blocking principal reduction at FHFA, preventing the adminstration from pursuing their own plans. I was surprised to see Hubbard pushing for a a Home Owners' Loan Corporation (HOLC) structure now, and I wonder if he'd fight for what Senator Merkley is currently proposing. An HOLC model could bypass some of these new blockage problems we are seeing on record low interest rates, benefiting homeowners.

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New Article at The American Prospect on Full Employment

Oct 10, 2012Mike Konczal

I have a new article at The American Prospect - Full Employment Is the Best Social Program - about the potential future battle among liberal economists over NAIRU, full employment and when to st

I have a new article at The American Prospect - Full Employment Is the Best Social Program - about the potential future battle among liberal economists over NAIRU, full employment and when to start to back off efforts to boost the economy as unemployment falls. There's also a discussion about policy in the 1990s, using this Stephanie Kelton paper and this Dean Baker paper for reference. I hope you check it out.

 
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Worried About TBTF Banks? Ignore Romney's Attacks in the Debate.

Oct 5, 2012Mike Konczal

The big question is not whether to dismantle Dodd-Frank, but whether it gets implemented correctly.

Wednesday's presidential debate had a relatively detailed discussion of the Dodd-Frank financial reform bill. From a transcript, this is how President Obama described what the bill does:

The big question is not whether to dismantle Dodd-Frank, but whether it gets implemented correctly.

Wednesday's presidential debate had a relatively detailed discussion of the Dodd-Frank financial reform bill. From a transcript, this is how President Obama described what the bill does:

We said you've got -- banks, you've got to raise your capital requirements. You can't engage in some of this risky behavior that is putting Main Street at risk. We've going to make sure that you've got to have a living will so -- so we can know how you're going to wind things down if you make a bad bet so we don't have other taxpayer bailouts. [...] And, you know, I appreciate and it appears we've got some agreement that a marketplace to work has to have some regulation. But in the past, Governor Romney has said he just want to repeal Dodd- Frank, roll it back.
 
And so the question is: Does anybody out there think that the big problem we had is that there was too much oversight and regulation of Wall Street? Because if you do, then Governor Romney is your candidate. But that's not what I believe.
The sleepy delivery aside, this is a good description. I would have liked to seen a reference to the CFPB ("cops on the beat protecting consumers") and derivatives reform ("making sure our financial markets are transparent"), since they are both under serious attack from conservatives. But it's not bad for a high-level overview.
 
What was Mitt Romney's critique of Dodd-Frank?
One is it designates a number of banks as too big to fail, and they're effectively guaranteed by the federal government. This is the biggest kiss that's been given to -- to New York banks I've ever seen. This is an enormous boon for them....We need to get rid of that provision because it's killing regional and small banks. They're getting hurt.
 
Let me mention another regulation in Dodd-Frank. You say we were giving mortgages to people who weren't qualified. That's exactly right. It's one of the reasons for the great financial calamity we had. And so Dodd-Frank correctly says we need to have qualified mortgages, and if you give a mortgage that's not qualified, there are big penalties, except they didn't ever go on and define what a qualified mortgage was.
 
It's been two years. We don't know what a qualified mortgage is yet. So banks are reluctant to make loans, mortgages. Try and get a mortgage these days. It's hurt the housing market because Dodd-Frank didn't anticipate putting in place the kinds of regulations you have to have. It's not that Dodd-Frank always was wrong with too much regulation. Sometimes they didn't come out with a clear regulation.

First off, as Adam Levitin notes, the reason that we don't have a QM definition is because that requires having a CFPB director. And who has been blocking a CFPB director consistently from the beginning? Senate Republicans. President Obama had to recess appoint a director in order to get this rule started, much to the chagrin of Republicans. So it is a bit much to block the nominee necessary to start the agency and then complain the agency isn't getting things done.

That said, there are two major complaints here. The first is that Dodd-Frank's "resolution authority" and regulations for systemically important financial institutions (SIFI) are a "wet kiss" to the banks, and the second is that qualified mortgages are holding up the financial market. Let's take them in turn.

SIFI and Too Big To Fail

Part of Dodd-Frank's approach involves creating a graduated system of regulatory burdens for risky financial firms, combined with special resolution authority powers housed at the FDIC to resolve these firms when they fail. This gets attacked by conservatives, an attack Mitt Romney reiterated, because, they believe, it has three problems: (1) it picks a handful of winners, (2) protects those winners from competition through regulations that have no teeth, and (3) gives a signal to the market that these firms will be bailed out again in the future.

To address complaint (1), all bank holding companies with $50 billion or more in consolidated assets are included without a necessary designation, and systemically important financial institutions (SIFI) are included as well after a determination process. So it isn't just the top five firms, but instead the 35 plus that are all larger in size. If it were an advantage to be declared systemically important, SIFI financial firms would be fighting to get the designation. By all accounts they are not, and indeed they are fighting against this status.

For (2), it makes sense that they are fighting the designation because Dodd-Frank requires more capital and includes more requirements for riskier firms. Take Sec. 165, which requires "large, interconnected financial institutions" to be subject to "prudential standards...more stringent than the standards and requirements applicable to nonbank financial companies and bank holding companies that do not present similar risks to the financial stability of the United States."

Or Sec. 171, which requires that capital requirements scale with "concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity." The idea is that if a firm wants to get bigger or engage in riskier activity, the normal prudential requirements to hold more capital and plan for a failure should scale as well.

For (3), the question is whether it will work or whether the market will think there will be endless bailouts. As I've described at length elsewhere, the resolution authority in Dodd-Frank is designed to precommit against bailouts. You need three institutions to approve resolution, who must consider the decision with a bias toward the market and the bankruptcy code. If there's a liquidation, the FDIC has to wipe out shareholders, hit creditors, fire management and board members, and can't buy equity in the firm to keep it alive. The problem we face isn't Dodd-Frank, but Congress and the executive branch passing "TARP: Part Two."

So how is the market reacting? Jennie Bai, Christian Cabanilla, and Menno Middeldorp of the Federal Reserve Bank of New York wrote a great paper recently that used "Moody’s KMV credit default swap (CDS) implied probability of default to gauge changes in the market perception of the risk that senior bondholders will not be completely repaid." (Disclosure: In the past, I worked at Moody’s KMV, a well regarded credit risk firm founded as KMV by three old-school quants, as a financial engineer. As a result, I'm biased towards their probability of default methodologies as a metric.)

What did they find?

Using the results from this regression and the shift in Bloomberg resolution news over our sample, we estimate that the anticipated and actual changes in resolution regime have increased the CDS market’s expectations of default by approximately 20 basis points, which is around a fifth of the average CDS-implied default probability for G-SIFIs in March 2012. While this doesn’t necessarily mean that markets are no longer pricing in any possibility of government support, it does suggest that the new laws have resulted in the CDS market taking into account the view that senior bondholders run a higher risk that they’ll need to share in the costs of bank resolution.

The market is starting to price in the risk that senior bondholders at risky, major financial firms will take hits, and those risks are priced in alongside movements in the resolution authority law. Given that the rules aren't completed yet and that there are additional ways to bolster them, this is a good sign. Mitt Romney's attack on the overall plan embodied in Dodd-Frank isn't the right approach for people serious about tackling Too Big To Fail. The problems we should be worried about are whether there is a good implementation of the law and if it is sufficient for taking down a major firm.

QM

In addition to Adam Levitin's piece, you should read John Griffith and Julia Gordon of Center for American Progress, writing over at Think Progress, who have a piece on the QM issue.

We’re thrilled to hear Romney give such a full-throated defense of the ability-to-repay rule. It’s a welcomed about-face from his recent calls to repeal Dodd-Frank and dismantle the Consumer Financial Protection Bureau, the federal agency that’s responsible for enforcing the rule. That said, Romney has a few key facts wrong.

As Romney points out, the ability-to-repay rule has not yet taken effect as regulators are still defining the “Qualified Mortgage” exemption. But the Republican candidate neglected to mention that the final rule isn’t due until January 2013 — a deadline regulators appear to be on pace to meet. The Consumer Financial Protection Bureau submitted its proposed rule back in April and is currently hashing through public comments.

Romney seems to imply some sort of negligence or malfeasance from the Obama administration that is preventing the rule from being completed. Alas, no scandal here. The Dodd-Frank law is actually quite clear about what type of loan should be considered a “Qualified Mortgage.” The loan must be well-underwritten with verified income, employment, and debt information. Loan payments can’t exceed a certain percentage of the borrower’s net monthly income. The loan can’t contain risky feature like negative amortization, interest-only payments, or balloon payments. The list goes on.

It's a shame the debates didn't include anything on foreclosures or the housing market more generally, but the Dodd-Frank discussion was a pleasant surprise.

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State and Local Education Funding Declined (Again) in 2011

Sep 28, 2012Mike Konczal

Here's something that might put larger trends into perspective. Earlier this month, the Bureau of Economic Analysis released data on state and local spending for the 2011 year. Here's how spending looks for state and local spending on elementary and secondary education:

Here's something that might put larger trends into perspective. Earlier this month, the Bureau of Economic Analysis released data on state and local spending for the 2011 year. Here's how spending looks for state and local spending on elementary and secondary education:

This isn't adjusted for inflation, so the decline is even worse. The dotted line is the seven-year pre-recession average projected forward. I'm pretty cynical about these things and knew that spending had declined in 2010, but I had expected it to even out or go up in 2011. Instead, it has declined further.

There's been yearly increases in spending on elementary and secondary education going back decades. We didn't develop some sort of technology that made educating young people cheaper in 2009 - instead, states were hit hard by a housing crash and liquidity issues that come with having to maintain a balanced budget in light of the worst downturn since the Great Depression. This also comes on top of the mass layoffs of teachers, some 200,000 during this recession. Rather than firing teachers while spending more elsewhere, we are just spending less educating our children, period. This is the worst kind of disinvestment, made at the worst possible time.

To bring in teachers' unions, the anti-teacher's union agitprop film "Won't Back Down" is getting negative reviews, including Liza Featherstone in Dissent and Dana Goldstein in The Nation. When you see examples of parents filling in for a failing school system, notice that this will increasingly be the case with declining funding for education. That gap in the graph above is being filled by parents and teachers for free or with children getting less education. Megan Erickson wrote about this trend in Jacobin, noting, "parents and kids are increasingly being asked to pitch in and paint the building or hawk candy bars to fill budget gaps. That’s because the values of freedom, autonomy, and choice are in perfect accordance with market-based 'reforms,' and with the neoliberal vision of society on which they’re based."

And this graph is why you need some organization at the front lines fighting for better spending on education, which is part of what teachers' unions do. There's been some great write-ups of the successes of the teachers' union strike in Chicago, including Richard D. Kahlenberg at The New Republic, Hamiltion Nolan at Gawker, and Josh Eidelson at Salon. A significant part of the strike was over broader and better educational outcome and more resources for schools. As this graph shows, it is a battle that will continue to be important.

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Is Taxing Capital Income Fair?

Sep 28, 2012Mike Konczal

In light of Mitt Romney's recent tax returns, the economic blogosphere has been kicking around the issue of capital taxation. Ryan Chittum at Columbia Journalism Review has an excellent overview of what people have been writing with "The capital gains preference." This is a response to Dylan Matthews and Matt Yglesias, who each present arguments from economists that capital gains taxes should be lower than other taxes, even potentially set at zero percent.

Many economic arguments are about tradeoffs, but the argument for the zero tax rate of savings, also similar to the arguments for a consumption tax, is usually phrased as an argument about fairness. In order to frame the fairness argument, economists bring up a story of two similar individuals with one as a saver and one as a spender. Yglesias has the framework in his post:

You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They're both pulling in incomes in the low six figures. One doctor chooses to spend basically 100 percent of his income on expensive non-durables. He goes on annual vacations to expensive cities and eats in a lot of fancy restaurants. The other doctor is much more frugal, not traveling much and eating modestly. Instead, he spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they're capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor. [...]

In the world where investment income is taxed like labor income, the first doctor says to the second "man you're a sucker—not only are you deferring enjoyment of the fruits of your labor (boring) but when the money you've saved comes back to you, it gets taxed all over again. Live in the now.  And the thinking is that world number one where people with valuable skills take a large share of their labor income and transform it into capital goods is ultimately a richer world...

Taxing savings by having an income tax punishes the Saver Doctor relative to the Spender Doctor. If you just taxed what they consumed, they would be treated equally.

Yglesias leans on the idea that we'll be a richer world without taxing savings, because people will respond to the incentives against savings here. I don't believe the research bears this out. I'm not an expert, but I believe the impact, if any, is small. In their excellent summary book on taxation, Taxing Ourselves (2004, 3rd edition), Joel Slemrod and Jon Bakija conclude that a "large number of studies have attempted to address these problems to some degree, and they generally come to the conclusion that saving is not very responsive to incentives."

But if the efficiency argument is weak evidence, the fairness argument is assumed to make the case, and make it for zero percent taxation. It is unfair to tax the Saver Doctor even a penny more than the Spender Doctor. Scott Sumner gives a similar example at The Economist: "The proper tax rate on capital income is zero [...] To see why this is so, consider twin brothers who each make $100,000 in wage income. Most people would regard these two people as equally well off, even if one freely chose to consume his income now, while the other chose to consume later. But not advocates of the income tax. They insist the more patient twin brother is 'richer' and deserves to be taxed at a higher income tax rate." Gilles Saint-Paul argues in the same forum that fairness requires that we shouldn't "penalise future consumption relative to current consumption."

In Joanathan Gruber's popular undergraduate textbook Public Finance and Public Policy, the two people are actually Homer Simpson and Ned Flanders!

Consider two individuals, Homer and Ned, who are identical except for their preferences for saving. Both live for two periods, earning $100 in the first period and nothing in the second period. Homer is impatient: he wants to consume his entire income in the first period and nothing in the second period. Ned is more patient; he wants to consume in both periods. Initially, they are both subject to an income tax, which taxes all labor earnings and interest income at 50%.The interest rate earned on savings is 10%. [...]  In present discounted value (PDV) terms, Homer pays only $50 in taxes across both periods, but Ned pays $51.11. Thus, savers such as Ned are penalized in an income tax regime.This tax treatment of savings is both horizontally inequitable (because Ned is taxed more simply for making a different choice) and inefficient because it may reduce the incentive to save (because savings leads to higher tax payments).

Let's stick with Homer and Ned. Is this fairness argument against the "inequitable" treatment of Ned either impressive or conclusive? I'd argue no. I'm going to rely on arguments from Barbara Fried's excellent "Fairness and the Consumption Tax" for the following to identify some problems, and I'd recommend her essay if you are interested in learning more.

The first issue is the assumption that Homer and Ned should pay in accordance with their consumption, or that equal spenders should have equal tax burdens, or, technically, that the present value of their tax burdens should be identical. This presupposes what is up for debate, which is what the appropriate tax base is. If the tax base is explicit wealth, then income from savings should also be taxed. There are significant advantages to owning wealth, including security, peace of mind, power, the ability to direct private investment, political control, and much more. It isn't clear why these shouldn't be part of the tax base.

A second issue is that it assumes that all income from savings is the result of delayed compensation, when much of it doesn't even come from the individuals themselves. We don't know how much of the United States' capital stock comes from the gifts, bequests, or inheritance that constitute intergenerational transfer, though averages of studies say about 50 percent. Fairness arguments become a lot more complicated here.
 
A third issue is the assumption that, since Homer and Ned are equally ranked in well-being in a no-tax world, they should be equally ranked after any tax comes into play. This equal ranking is the engine behind a lot of the fairness arguments -- as Gruber says, we don't want to penalize Ned for "making a different choice." Since a tax on savings would fall on Ned the Saver but not Homer the Spender, they would no longer be equally ranked, as Homer would end up better off than Ned with an income tax. It isn't clear how much savers would be disadvantaged relative to spenders, as some of that tax will fall to borrowers. But the general point remains.
 
But even granting this, a new question arises: why do we care about maintaining equal ranking from a "no-tax" world, and why would it be unfair to change it? This is only a claim to fairness if Homer and Ned, or savers and spenders more generally, have a claim to their relative ranking in a "no-tax" world. It's not clear that they do. They certainly don't under an entitlement theory, as the value the saver gets in this example is just the random quirk of his or her preference structure. It also presumes that the ranking in a "no-tax" world was just in-and-of-itself and thus worth preserving, which requires a lot of libertarian heavy lifting.
 
It also presumes a myth of ownership, or the idea that you can conceptualize the economy without the government or that tax policy isn't just one of many ways that the government affects interest rates. Sumner and Yglesias, for instance, believe the Federal Reserve should do some major things to raise nominal GDP, which would have a dramatic effect on the relative ranking of savers and spenders compared to a non-Federal Reserve world. How are they any different from this tax policy, other than the fact that they justify it within a larger set of social institutions, especially ones that produce the patterned world of full employment?
 
fourth thing to consider is the issue of generalizing this critique to other examples. Another way of reading the fairness issue in the example is that since both Homer and Ned start off equal, and had equal capability to generate wealth, they should have an equal tax burden, akin to an endowment or faculty tax.
 
If a tax on savings is removed, taxes on wages would have to go up. Now imagine that, in addition to Homer and Ned, there's Barney at time zero. Barney hates working but loves leisure, so he doesn't work at all but enjoys just as much utility as Homer and Ned when they consume their net present value of $100. Raising taxes on wages leaves Homer and Ned equally well off but punishes them both relative to Barney. Should taxes on wages therefore be set to maintain their ordering? Would we have to abolish taxes on consumption then? If so, then it isn't clear we can have a coherent tax policy period.
 
But we could have a coherent tax policy, especially if we focus on what kind of economy we want to build and use tax policy as one of many levers, working in concert with all the others, to create it.
 
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Simpsons images used without permission from 20th Century Fox.

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New Article on QE3, Plus the Kocherlakota Move

Sep 24, 2012Mike Konczal

I have a new article on understanding QE3 at The American Prospect which I hope you check out.

Several people have commented on it already, but I want to note that Narayana Kocherlakota is now in favor of more monetary action.

I have a new article on understanding QE3 at The American Prospect which I hope you check out.

Several people have commented on it already, but I want to note that Narayana Kocherlakota is now in favor of more monetary action.

To put this in perspective, here's the September 21st 2011 FOMC statement: "Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time." Kocherlakota also voted against this action in August.

At this time, he was making arguments that since "the U.S. economy has experienced large increases in the federal budget deficits, contributing substantially to the overall federal debt" and "In response to the recession, the federal government extended the duration of unemployment insurance benefits," this could have caused the natural rate of unemployment to shift so that "the implied u* is 8.7 percent." That the natural rate of unemployment was incredibly high was an argument Kocherlakota had been pushing for some time: here he is in August 2010 arguing mismatch had pushed the NAIRU up 3 percentage points in this recession.

A month later, in the November 2nd, 2011 FOMC statement, there was the first dissent on behalf of the unemployed and in favor of more easing during the entire Great Recession. "Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time."

Now, almost a year later, Kocherlakota is arguing a version of the Evans rule: "As long as the FOMC satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent." He explicitly credits Evans with this rule, noting "President Charles Evans of the Federal Reserve Bank of Chicago has also proposed what I’m calling a liftoff plan...Those familiar with his plan will see that my thinking has been greatly influenced by his. This is perhaps hardly surprising, since he sits next to me at every FOMC meeting!"

Even though this is a relatively conservative version of the Evans rule, there are two important consequences. The first is that dissent is now taking place on Evans' terms. During 2010-2011 the debate, especially on the hawks side, was about "structural unemployment" and whether or not the Federal Reserve should accept that unemployment should remain well above 8%. Now it is about what the Fed is willing to tolerate to get unemployment below 6%. This is a major sea change.

This also takes away the intellectual firepower of the monetary hawks. Kocherlakota is an academic's academic, and his arguments were always based in the dense mathematics of job search models and job-opening ratios. Now that he's moved over to Evans' framework on tradeoffs, it isn't clear that there will be anyone at the regional levels of the Federal Reserve producing numbers arguing that we should focus mainly on how to match workers to job openings. That's a major victory towards a more sensible monetary policy going forward.

 

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The War on Crime as a Conservative (and Progressive) Assault on Liberal Philosophy

Sep 21, 2012Mike Konczal

In case you didn't see, Aaron Schwartz just had an absurd level of felony charges brought against him for allegedly trying to mass download JSTOR by prosecutors. You can support him here. Meanwhile Twitter turned over the account records of Malcolm Harris to the New York criminal justice system.

In case you didn't see, Aaron Schwartz just had an absurd level of felony charges brought against him for allegedly trying to mass download JSTOR by prosecutors. You can support him here. Meanwhile Twitter turned over the account records of Malcolm Harris to the New York criminal justice system.

How can we theorize innovations in criminal justice policy over the past decades as a reaction to liberalism? Not liberalism like the New Deal or the Great Society, but liberalism as in the philosophical theory of the modern era. Let's start with the policy innovation driven by neoconservatives, and then examine how the progressive assault on classical liberalism also functions in the war on crime.

The Conservative Assault

One part of liberalism is about formal equality--liberty to participate as well as equal freedom from government interference. The War on Drugs and aggressive quality of life initiatives, beyond filling our jail cells, are about getting a lot of low-level charges and convictions on as many people as possible. From 1994-2000, arrests for smoking marijuana in public view (MPV) were up 2,670%. Why does this matter? They interact with three-strike laws to build to large sentences out of minor charges. This also allows for the creation of hierachy through a law ostensibly dedicated to equality and liberty. Once people have been prisoners, they face serious legal impediments, such as limits on access to voting, public housing, public employment, and public assistance. Tens of thousands of legal restrictions regulate the ability of ex-convicts to function and exist in society. There are also certain presumptions against individuals, especially felons, that deny any type of formal equality before the law. When Michelle Alexander talks about a New Jim Crow system of segregation through the legal code and policing, this is the dynamic she is discussing.

Another part of liberal philosophy is that if the state wants to use its power to act against an individual, say for violating a crime, they need to make their case through an institution that is skeptical of that power. In the United States, that means trial by jury, under the supervision of a judge. The judge and a jury of one's peers are supposed to be the key agents in a court.

Another key policy innovation of neoconservatives is attacking the relative independence and power of judges. There have been a host of conservative policies designed to reduce the power of judges, of which mandatory minimums are one of the most important. As judges lose power, prosecutors gain it. Prosecutors are now the major presence in the courtroom, overseeing the overwhelming majority of cases that are run through plea-bargains.

When the evangelical Harvard law professor William J. Stuntz writes that the American criminal justice system has collapsed, this focus on the prosecutor as the arbiter of justice in the courtroom, rather than the judge and the jury, is what he means. Stuntz: "Prosecutors now decide whom to punish and how severely...To a degree that had not been true in America's past, official discretion rather than legal doctrine or juries' judgments came to define criminal justice outcomes....criminal law does not function as law. Rather, the law defines a menu of options for police officers and prosecutors to use as they see fit."

Notice how the prosecutor overseeing Aaron Schwartz's case just decided to charge him with 13 felonies, mostly for violating the Terms and Services "terms of service" of a website. At 13 charges, it looks like the prosecutor is trying to stack the deck on overreaching and arbitrary charges so they can have as much leverage as they can get when it comes time to go to court. That isn't a rule of law, it's a rule of prosecutorial discretion as justice. This is what a collapsed criminal justice system looks like.

The Progressive Assault

Part of the progressive assault on the laissez-faire of classical liberalism was creating the idea that there is no pre-political distribution in the economy. Property is a creation of government, and therefore the distribution of that property is also created by the government. Governments must balance conflicting boundaries of property, and must do so democratically, because appeals to "natural rights" or "economic liberty" will ultimately be empty. Matt Bruenig has several recent posts - one, two, three - spelling out this "myth of ownership" argument over distribution and property rights that are worth checking out.

This progressive approach to property and the state is absent in contemporary talk on economic policy, but it is being theorized and applied in the most avant-garde ways when it comes to criminal justice policy. Let's talk about dogs that do drug searches. If the police wanted to search your suitcase, or look through it with hypothetical x-ray goggles, they'd need a warrant. That would be an illegal search of your property, which is protected by the Constitution. However if a drug dog sniffs your suitcase and smells drugs, that doesn't count as a search.

Why? As Justice Stevens argued in United States v. Jacobsen (1984), "Congress has decided -- and there is no question about its power to do so -- to treat the interest in 'privately' possessing cocaine as illegitimate; thus governmental conduct that can reveal whether a substance is cocaine, and no other arguably 'private' fact, compromises no legitimate privacy interest." Since the dog can only "see" contraband such as cocaine when it sniffs, that sniff doesn't count as a search of your property, because you have no right to contraband.

You have a legitimate privacy interest in your property, except when you don't, because the government doesn't recognize your property as "property." Even though drugs are excludable, rivalrous, and have their price determined in large part by supply and demand, they aren't property the government recognizes, so the bundle of rights that go with property don't apply. The distribution of property outcomes is overwhelming determined by the government here.

People have talked about property this way in the past, but less so now. We talk about inheritance as almost a right now, but John Stuart Mill, for instance, argued in Principles of Political Economy that while "the right of bequest, or gift after death, forms part of the idea of private property, the right of inheritance, as distinguished from bequest, does not." Your right to receive inheritance doesn't exist outside of political framework, which can be held democratically accountable. (For those who think the war on drugs should be stopped and that you receiving an inheritance should be thought of as a type of quasi-contraband, the current policy framework is very backwards.)

There's not enough space here to really dive into it, but there's a mind-blowing legal realist seminar on the "Myth of Ownership" taking place in the realm of "asset forfeitures" criminal justice policy right now. The government sues property and money for being illegitimate under civil law; the government can seize the proceeds of the trade of contraband as well as property instrumental to that transaction. If you drive a car solely to sell contraband, and use the surplus of those sales to buy a home, what property claim can you have to own that car or that house? Here the government is actively creating and policing the boundaries and relationships of property through denying its existence as legitimate "property," all done under criminal law.

This brings us to Malcolm Harris' Twitter account. Who owns a tweet? Who has the ability to turn it over to a third party, and who has the ability to block it? The property claim of a tweet is now being determined through the ability of the government to take it for criminal justice purposes.

A New York criminal court had demanded Twitter hand over Malcolm Harris' tweets, and Twitter did so last week under extensive pressure. The court argued that "Here, the defendant [Malcolm Harris] has no proprietary interests in the @destructuremal account’s user information and Tweets between September 15, 2011 and December 31, 2011...While the Fourth Amendment provides protection for our physical homes, we do not have a physical 'home' on the Internet." They are determining that Harris has no legitmate property claim on the tweet and no right to prevent a search of his account on Twitter's mainframe.

It is fascinating, though problematic, to see the idea, boundaries and relationships of online "property" being determined through the criminal justice system. Here the "property" of online records are carved out and created based on where it will be easiest for cops and prosecutors to access them. Hence all the more reason to have Congress re-establish baselines on what our privacy expectations are online, in the opposite way it has been dissolving privacy and property claims under the banner of the War on Drugs.

 

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