Category: Income Inequality

When House Speaker Nancy Pelosi told Charlie Rose last October that a value-added tax was “on the table” as a possible way to solve the nation’s fiscal woes, the remark didn’t generate much interest. But as recent budget figures have put the depth of America’s problem into black and white, and with former Federal Reserve Chairman and White House adviser Paul Volcker nearly seconding Pelosi’s view recently, the idea of a VAT — already in use in nearly 160 countries — is gaining traction.

Trillions were spent bailout bankers, and every dollar spent fixing the mess since then is also effectively caused by the failure’s of the rich.

A VAT isn’t necessarily evil, but until progressive taxation is restored, capital gains are taxed at the same level as ordinary income, corporations are forced to pay taxes on their actual profits (rather than making billions and paying no taxes) and a financial transactions tax is implemented, why is another regressive tax (one that hits the poor instead of the rich) even being considered?

Oh, yeah, because this government exists to do unpopular things Republicans want to do while allowing Republicans to vote against them, as with HCR, essentially a 1994 Republican plan.

With Democrats like these, who needs Republicans?

Knowing your interests

By Ian Welsh

On December 15, 2009

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Are the rich just like us? In one sense they are – they eat, sleep and defecate just like everyone else. They love, cry and die – just like everyone else. But when you’re dealing with policy – no, they aren’t just like everyone else. It’s fashionable (one of those evergreen fashions) to argue that the policies that benefit the rich, benefit everyone. There are certainly policies that benefit everyone, but there are few policies which primarily benefit the rich which are to everyone’s interest. Let’s run through this in a bit more detail.

Rich
Most rich people get most of their money from investments – also know as unearned income. So when investment income is taxed at a lower rate than earned income (what you get on your paycheck), which it is – then those who rely primarily on earned income are being taxed at a higher effective rate. This is a deliberate policy choice.

When jobs are outsourced, the profits still flow back into the hands of US investors. While many people own stock and bonds (especially through pension funds) this disproportionately benefits the rich because the rich (as noted above) disproportionately receive their money from unearned income.

When the domestic economy does badly, but corporate and general investment profits are up – the rich do fine because the cost of things they want (like servants) goes down as supply goes up. Those few people they do deign to employ cost less.

When tax changes are made that are less progressive (moving to fees or flat taxes, for example, and away from income tax) it benefits the rich – because they earn more money and regressive taxes benefit those with more.

When estate taxes are gotten rid of – it benefits the rich (or rather their children).

When public schools are defunded it benefits the rich. Their kids aren’t going to them anyway, and now they don’t have to pay for your kids to go there.

When capital flow laws are relaxed it benfits the rich. Do you need to move a million dollars out of China in a few minutes to get an extra .1% overnight return? No?

When the spread between inflation rates and the interest rate is high it benefits the rich, because most of them are creditors. It hurts the middle class and the poor – because they are debtors.

When bankruptcy laws are tightened it hurts the poor and the middle class and helps the rich.

The Middle Class

When jobs are plentiful, it benefits the middle class. But if you’re already middle class and you keep your job, but others are losing theirs, you can win relatively – especially if prices are dropping relative to your salary.

When jobs pay well and are keeping up with inflation, it benefits the middle class.

When house prices go up it benefits the middle class – because they have the majority of their money in their houses – that’s their savings account. It hurts the poor, because they can’t get housing and it hurts the subset of the middle class that doesn’t yet have a house, because they can’t get one.

When medical care prices increase it hurts the middle classes because their employers stop paying for it, pay for less or leave the country to a domicile where either the government provides it (Canada) or they don’t have to provide it.

The Poor

When rent, food or fuel costs go up it hurts the poor because they spend most of their income on those three things. It hurts them disporoptionately compared to the pain to the rich.

When the economy doesn’t produce new jobs it hurts the poor because they then can’t get jobs, especially the long term poor who are only hired when those with more recent experience are used up.

When medical care becomes more expensive it hurts the poor, because they can’t afford it. So they live in pain, or with chronic diseases and get treated only when it’s close to mortal and they can’t be turned away.

When mandatory sentencing for blue collar crime goes in it hurts the poor because more of them commit crime and it takes away their husbands and their sons.

When some drugs are made illegal while others with psychoactive effects are legal but prescribed only to those who can afford both price controlled drugs and doctors scripts it hurts the poor.

Yes Virginia, the rich are different…

not because they are better or worse than us, not because they are bad people, but because they have different interests and different incentives and they live in a world that is different from the one the middle class or the poor live in. Policies that enrich them could enrich everyone. There are policies and economies that help everyone. From 1945 to around 1970 the rising economy made everyone better off equally – the rich, the middle class, the poor. Everyone prospered together.

It can be that way, but it doesn’t have to be. You can make the pie bigger – or you can make your slice larger. Over the last thirty years Americans have fought over the pie. Warren Buffett once noted that if there was a class war then his class was winning. There is a class war and the rich are indeed winning – and it is one of the things that is slowly destroying the United States.

As Stirling has said in the past – everyone can be prosperous. But everyone can’t be rich. Choose what sort of society you want – or have others choose for you.

(Another repost from BOP. 2004. This is basic class and policy analysis stuff. I would make some changes to the definition of rich these days, to make sure the the managerial capture class was unambiguously included.)

The Fed and the Pay Czar’s Executive Compensation Restriction Plans

By Ian Welsh

On October 23, 2009

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So, the Fed has unveiled its plan. Details are somewhat sparse, but as best I can tell:

It won’t significantly reduce pay
It will concentrate on risk management, which is to say trying to tie pay to longer term measures rather than shorter term measures
The big banks will have to give their compensation packages to the Fed upfront, but the review will be confidential. Only the bank and the Fed will know the contents of the review.
Small banks will have their pay reviewed when they are examined.

Meanwhile, Feinberg, the pay czar, has restricted compensation at bailout recipients. Cash compensation is restricted to 500K a year until they pay back the bailouts, but once they do they can receive more, and they do have bonuses tied to various goals given by the treasury till then.

I am skeptical. The end result of Feinberg’s plan will simply be that the companies will pay off the bailouts as fast as they can, even if that means borrowing the money at higher rates than the feds have loaned it to them.

As for the Fed’s plan, it requires us to trust the Federal Reserve to really restrict pay and to really understand what type of compensation creates long and short term risks. Given the Federal Reserve’s track record in understanding systemic risk, which indicates they have no understanding of systemic risk worth speaking of, I’m skeptical that they can do this. And that assumes one trusts the Fed to tell its friends in the banks they can’t have what they want, which, again, given their track record, is questionable. Especially when the Federal Reserve itself seems to essentially be run by Goldman Sachs.

Furthermore, the Federal Reserve is confused. When they say it’s not about “social equity” it’s about risk, what they mean is “we don’t mind them getting paid a lot of money if it doesn’t lead to risky behavior”. But receiving enough money in a year or 3 years to retire inevitably means that people will engage in risky behavior because they don’t need the job. They may want to keep it, they may like it, but if their company goes under, at the end of the day, they’re still going to be rich, rich, rich—and never have to work another day of their lives. And, after all, even if they do blow it, this crisis shows that the government will probably bail them out so they probably will keep their jobs.

Paul Volcker, the last good central banker the US had, is right. This finicky micromanaging won’t work. He’s right to want to break the banks back up, dividing retail banking from investment banking. And while as far as I’m aware he hasn’t suggested high marginal taxation as a solution to the perverse wage incentive issue, that’s my suggestion. Just tax every dollar after 1 million, on all income equally and with no deductions, at 90%. Tax every dollar after 5 million at 95%.

The objection to this sort of taxation, or any other severe restrictions on excessive pay is:

But, bowing to concerns that too heavy a hand could lead to a mass exodus of executives, both the Treasury and Fed policies will permit top earners to reap millions of dollars.

This is insane. These executives are the folks who lead the world to the greatest financial crisis since the great depression. The goal shouldn’t be to keep them working, the goal should be to convince them to quit. Let some middle managers take over, it is beyond comprehension that they could cause a greater disaster, and if they are only earning a few hundred K a year, they’ll have every incentive to turn their banks around so they can keep their jobs, which they’ll actually need to keep unlike the current generation of overpaid, incompetent, executives.

These executives’ management lead to the greatest destruction of wealth and the largest job downturn in post-war history. They did so by pushing products and practices which were frankly fraudulent. In a sane world, huge criminal investigations would be ongoing and most of them would be spending all of their time huddled with their lawyers, rather than sending out millions of dollars worth of lobbyists.

However, as a second best scenario, their pay should be restricted, and if that makes them leave, well, that’s a bonus. Let them go work for companies in any country stupid enough to want them. Hopefully if not operating from the US anymore they’ll only be able to trash their new host economy, and not the entire world economy. These men and (a few) women, are parasites who feed off and damage their hosts. They are not a benefit to the country or company they work for, but an active hazard.

I’m glad to see the Fed and Feinberg doing something. But it’s not nearly enough, and it won’t be sufficient to stop the same suspects from causing yet another financial crisis.

The Next Bailout: Guaranteeing Municipal Bonds

By Ian Welsh

On May 29, 2009

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Barney Frank, chairman of the House Financial Services Committee is apparently putting together a bill to guarantee municipal bonds. In particular, variable rate demand obligations (VRDOs), which make up a little under one-seventh of the muni-bond market, have been imploding, with their interest rates jumping to higher rates, costing municipalities a great deal of money when they can least afford it.

Debt guarantees are one of the main ways the Feds have dealt with the crisis. The Feds have promised that if a raft of banks default on their loans, the Feds will make it up. With such promises, the banks (among others) have been able to borrow money at lower rates than they otherwise could have, and in some cases borrow money when they normally couldn’t have at all.

The problem with debt guarantees is that the Fed is on the hook. That is to say, you, the taxpayer, is on the hook for what are essentially no different than credit default swaps (CDS), in which a private entity promises to pay up if a loan or bond defaults. CDSs are the business which destroyed AIG.

Moreover, as with CDSs, rather than decreasing risk, debt guarantees increase them. If you know that you’re going to get paid whether the borrower defaults or not, you’ll be willing to lend money even to folks who probably will default. Heads you get the money, tails the taxpayer will give you the money. This sort of systemic risk transfer is one of the major causes of the current financial crisis.

So if the government goes ahead and guarantees muni-bonds, expect defaults to increase, not decrease, as municipalities borrow even more money they can’t afford to pay back and investors lend it to them knowing they’re covered no matter what. Then you, personally, as a taxpayer, will eventually pay for it.

Now that’s not to say that guarantees are necessarily always a bad idea. The advantages of not having municipalities go bankrupt right now may outweigh the disadvantages. But at the least some protections need to be added in.

First: New issues of VRDOs need to not be guaranteed. Perhaps guarantee the old ones, on the condition that once guaranteed interest rates drop, since default chances have dropped, but not new ones. Such bonds are inherently risky, and municipalities shouldn’t be playing in that market.

Second: new bonds guaranteed must be vanilla bonds. Fixed rate, fixed curation, no fancy features.

Third: the municipality must have a reasonable shot at repaying its debt load. The worst of the housing crash is not over, there is a wave of defaults yet to move through the system. Housing prices, and thus housing taxes, will not recover to pre-crash levels for many years, probably not for over a decade, at best. Municipal revenue projections and budgets which assume otherwise are unrealistic, and guarantees made to such municipalities will default. That’s not insurance, that’s giving municipalities money. So just give them the money if you want to, instead of making guarantees you know will fail.

In general, just giving municipalities the money they need is the smarter way to go. There is going to have to be a new round of stimulus, since the last one wasn’t large enough. One of the focuses will have to be local government. Debt guarantees are much more problematic, due to the way they actually increase systematic risk, because of how they encourage municipalites to borrow money they may not have the capacity to pay back, and because they increase rather than decrease certainty about the final cost of the intervention.

The horizon is not so far as we can see, but as far as we can imagine

Category: Income Inequality

Taxing the Poor to Bail out the Rich

Knowing your interests

The Fed and the Pay Czar’s Executive Compensation Restriction Plans

The Next Bailout: Guaranteeing Municipal Bonds