Wal-Mart's Efficiency -- In Avoiding Taxes!

This Wall Street Journal article describes how Wal-Mart is able to pay about half as much state tax as a typical corporation.

Drucker, Jesse. 2007. "Inside Wal-Mart's Bid To Slash State Taxes." Wall Street Journal (23 October): p. A 1.

"In May 2001, Wal-Mart Stores Inc. issued an appeal to big accounting firms: Find us creative new ways to cut our state tax bills. Ernst & Young LLP swung into action. Senior tax experts at the big accounting firm swapped ideas via email and in a series of meetings. At least one gathering, according to an internal Ernst & Young calendar, took place in Wal-Mart's headquarters in the "Tax Shelter Room"."



"Big companies hardly ever discuss how outside accountants, lawyers and investment bankers help them cut their tax bills. But Ernst & Young's contributions to Wal-Mart's state-tax minimization project are outlined in a raft of documents filed in recent months in North Carolina state court, where the state's attorney general is challenging a Wal-Mart tax-cutting structure involving real-estate investment trusts. The material, which includes company emails and memos, provides a rare window into accountants' role in generating tax-reduction ideas at one major company."

"Companies often assert that tax savings are simply happy byproducts of transactions pursued for other business reasons. But documents from the North Carolina case indicate that Wal-Mart, from the outset, had one primary purpose: cutting its state income taxes. Ernst & Young worked to fulfill that goal. In 2002, for example, the accounting firm delivered a 37-page proposal laying out a smorgasbord of 27 potential tax strategies, most tailored to a particular state's tax code. It described one of them as "a very aggressive strategy with considerable risk."

"Publicly traded companies reduced their federal income taxes by about $12 billion in 2004 through potentially abusive tax transactions, according to Internal Revenue Service data. Some experts say companies save far more than that each year through elaborate tax-cutting maneuvers."

"Wal-Mart's 2001 letter to accounting firms got right to the point. It began: "Wal-Mart is requesting your proposal(s) for professional tax advice and related implementation services in connection with minimization of state income taxes in the following states: Arizona, California, Florida, Illinois, Indiana, Michigan, Minnesota, and Pennsylvania"."

"State income-tax rates for corporations average about 6.9%, and come on top of a federal statutory rate of 35%. Tax rates vary from state to state, and some states have no corporate tax at all on certain income. That provides ample opportunity for so-called tax arbitrage, in which companies allocate expenses and revenues between states in order to minimize taxes owed."

"On average, Wal-Mart has paid taxes at a rate equal to about half of the average statutory state rate over the past decade, according to an analysis of the company's regulatory filings by Standard & Poor's Compustat."

"In the early 1990s, it employed an "intangibles holding company," a unit operating in tax-friendly Delaware into which it transferred ownership of its brand names such as Sam's Club. It then made payments to that unit for use of those brands, deducting them as expenses from its taxable income in other states, according to court records. That strategy fell out of favor after several states successfully challenged Wal-Mart and other companies in court over the maneuver."

"Wal-Mart set aside about $526 million for state and local income taxes last year, not including its substantial property-tax bills, according to the company's financial reports. But its various state tax-cutting strategies seem to have had an impact. On average, Wal-Mart has paid taxes at a rate equal to about half of the average statutory state rate over the past decade, according to an analysis of the company's regulatory filings by Standard & Poor's Compustat."

"After Wal-Mart hired the firm in 1996 ..., an Ernst & Young tax executive urged his team to be discreet, according to a staff memo included in North Carolina court records. "We don't think there is much the state taxing authorities can do to mitigate these savings to Wal-Mart, however some states might attempt something if they had advance notification," he wrote. "We think the best course of action is to keep the project relatively quiet .... there just seems to be too many opportunities for it to get out to the press or financial community and we all know they are difficult to control, particularly when we are dealing with a client as well-known as Wal-Mart"."

"David Bullington, Wal-Mart's vice president for tax policy, said in a deposition that he began feeling pressure to lower the company's effective tax rate after the current chief financial officer, Thomas Schoewe, was hired in 2000. Mr. Schoewe was familiar with "some very sophisticated and aggressive tax planning," Mr. Bullington said, according to a transcript of the deposition, taken by the North Carolina attorney general's office in July. "And he ride herds [sic] on us all the time that we have the world's highest tax rate of any major company"."

"As Ernst & Young worked on its proposals, one high-ranking tax partner sent an email to a colleague addressing a concern often faced by companies: how to describe a tax-driven transaction in a way that won't create problems later on with tax authorities. "You asked if we have a document that details how the tax savings will work, how much they will save .... We really don't have anything like that except for the sales document, partly because we have avoided calling this a 'tax' project, to show that we did not have a tax savings motivation, rather it is a 'domestic restructuring' project," he wrote."

"As for Wal-Mart's "Tax Shelter Room," North Carolina officials asked Mr. Bullington about the odd name. In his deposition, the Wal-Mart vice president said the moniker was "a bit of a pun," stemming from the conference room's use by tax-department employees to conduct safety drills for natural disasters such as tornadoes."

Fred Thompson Takes Credit for Clinton’s Fiscal Record

This CNN Video is entitled Thompson Talks Immigration but the real whoppers come when Fred talks fiscal policy. Take a listen and then let’s talk.



Fred Thompson mentions cutting taxes and balancing the budget almost in the same sentence. He fails to mention the 1993 tax increase – opposed by all Republicans in the Senate – even though this was one of the two major moves that did lead to fiscal responsibility. The other major move has often been called the “Peace Dividend” where we felt able to sharply reduce defense spending. There is only one candidate running for the GOP Presidential nomination that would once again reduce defense spending. His name is Ron Paul and he tends to be mocked by his colleagues when they are not promising more tax cuts. So it goes in the Spend & Borrow wing that dominates the Republican Party.

CHINA: EMERGENCE OF THE NEW CLASS

The 17th National Congress of the Chinese Communist Party has just ended, with a roll-out of the new members of the Standing Committee of the Poltiburo of the Central Committee of the party. Identified among those as the current leading candidate to succeed newly reentrenched leader, Hu Jintao, is Xi Jinping, identified by news reports (WaPo) as one of many "princelings" in newly powerful positions, in his case, son of Xi Zhongxun, a former Politburo member and Vice Premier. Just as in North Korea, with Kim Il Jong succeeding his father, and the children of the ruling Nomenklatura coming to power in the later stages of the former Soviet Union, we see The New Class reproducing itself in the PRC. (Of course in the US we cannot complain to much with our succession of Bushes.)

PER CAPITA CARBON EMISSIONS AND PER CAPITA INCOME

Here is ranking of top 25 or so countries in real per capita income with their ranks in per capita carbon emissions, with Singapore and Taiwan missing data. Oil producers mostly do badly, but users of nuclear for electricity tend to do well. Real GDP is for 2006, IMF data, per capita carbon emissions from Wikipedia for 2004.

Real per cap GDP in order Per cap carbon emissions rank

Luxembourg 4 (burns lots of coal for electricity)
Ireland 32
Norway 12
USA 10 (third worst on list, big surprise)
Iceland 53 (lots of geothermal)
Hong Kong 72 (don't know why so good, best on list)
Switzerland 69 (don't know its breakdown for electricity production)
Netherlands 43
Denmark 36 (tops in use of wind power)
Qatar 1 (small OPEC oil producer)
Austria 46
Finland 21
Canada 11 (fourth worst on list, oil)
UK 37
Belgium 40
Sweden 66 (lots of nuclear and hydro)
UAE 3 (small OPEC oil producer)
Australia 13
Greece 44
Japan 34
France 63 (lots of nuclear)
Israel 29
Germany 38
Italy 52

Book Announcement

MORE UNEQUAL: ASPECTS OF CLASS IN THE UNITED STATES

Monthly Review Press Edited by Michael D. Yates

With contributions by John Bellamy Foster, Vincent Navarro, William K. Tabb, Michael Perelman, Richard D. Vogel, David Roediger, Kristen Lavelle and Joe Feagin, Sabiyha Prince, Martha Gimenez, Stephanie Luce and Mark Brenner, Peter McLaren and Ramin Farahmandpur, Michael D. Yates, Angela Jancius, and Michael Zweig.

"Workers in the United States are systematically being allocated a shrinking share of the prodigious wealth we produce, and that's old news. This widening exploitation of workers and communities further exposes the myth of a 'just' capitalist economy. Despite the radical increase in economic and social inequality, we still lack a cohesive popular understanding and consciousness of why and how our market-based economic system facilitates this 'one-sided class war' against us.




"More Unequal: Aspects of Class in the United States is a strategically assembled collection which binds diverse, informed, often compellingly personal explorations of social and economic inequity together into a revealing journey through the scarred terrain of today's working-class reality. This book should be off the shelf and in the hands, and backpacks, of a new generation of working-class activists who can lead the struggle to collectively claim a new direction." -Jerry Tucker, former UAW International Executive Board Member & co-founder of the Center for Labor Renewal

"The shocking data about wealth, income, home ownership, access to health care, education, and political influence cry out for analysis which is driven by the desire not only to understand but also to transform. Fortunately, the scholars and activists who have contributed to More Unequal offer such analysis, and they do so clearly and succinctly. This book will prove useful to teachers, students, researchers, and activists as we struggle to understand how class is working in the twenty-first century United States." -Peter Rachleff, professor of history, Macalester College, and President, Working Class Studies Association

"This excellent collection helps us to further rehabilitate the discussion of class both in the United States and globally." -Bill Fletcher, Jr., writer and activist

"Extraordinarily comprehensive.focuses on the effects of class oppression and exploitation" -Roxanne Dunbar-Ortiz, writer

Table of Contents

Introduction & Acknowledgements - Mike Yates

1. Aspects of Class in the United States: A Prologue - John Bellamy Foster

2. The Worldwide Class Struggle - Vincent Navarro

3. The Power of the Rich - William K. Tabb

4. Some Economics of Class - Michael Perelman

5. Harder Times: Undocumented Workers and the U.S. Informal Economy - Richard D. Vogel

6. The Retreat from Race and Class - David Roediger

7. Hard Truth in the Big Easy: Race and Class in New Orleans, Pre- and Post-Katrina - Kristen Lavelle and Joe Feagin

8. Will the Real Black Middle Class Please Stand Up? - Sabiyha Prince

9. Back to Class: Reflections on the Dialectics of Class and Identity - Martha Gimenez

10. Women and Class: What Has Happened in Forty Years? - Stephanie Luce and Mark Brenner

11. The Pedagogy of Oppression - Peter McLaren and Ramin Farahmandpur

12. Class: A Personal Story - Michael D. Yates

13. Class for a Downwardly Mobile Generation - Angela Jancius

14. Six Points on Class - Michael Zweig

Contributors Notes Index

Michael D. Yates is associate editor of Monthly Review. For many years he taught economics at the University of Pittsburgh at Johnstown. He is the author of Cheap Motels and a Hotplate: An Economist's Travelogue (2006), Naming the System: Inequality and Work in the Global System (2004), and Why Unions Matter (1998), all published by Monthly Review Press.

Rich and Poor Multipliers Again

Earlier I asked about the multipliers for the consumption of rich and poor people. Let me be a little bit and more explicit. I would assume that rich people spend a lot more on personal services and expensive goods.

Expensive goods tend to have much higher markups. Remember Henry Ford II responding to the influx of Volkswagens observing that mini cars mean mini profits. Expensive branded goods have very high markups, meaning relatively few jobs per dollar of expenditure compared to the spending of the less affluent. Personal services are probably bimodal. Some professional work would probably mean relatively few jobs per dollar of expenditure; some less prestigious work might mean quite a few jobs per dollar of expenditure; for example, underpaid immigrant nannies. Any thoughts?

Would Redistributing Income to the Poor Increase National Savings and Long-term Growth?

It would seem that Scott Patterson has turned the usual tinkle down argument on its head.



As Michael notes, this WSJ piece is arguing:

The Wall Street Journal suggests that the economy might not be affected by the credit crunch because it will mostly hit the poor. Since the poor don't spend that much, the economy can happily sail along. I was wondering how multipliers might differ by income class.

Exactly the right question. The usual rightwing argument for NIBOR DOOH economics (take from the poor and give to the rich) is that the poor have a high marginal propensity to consume, while the rich have a high marginal propensity to save. My own (maybe too much Ando-Modigliani lifecycle dominated) is that the marginal propensities to consume v. save don’t differ by income class. But if the WSJ wants to tell us that the poor save more – great. I’m all in favor of things that would increase long-term growth such as movements that would reduce income inequality!

Economic Benefits of the Trickle-up?

The Wall Street Journal suggests that the economy might not be affected by the credit crunch because it will mostly hit the poor. Since the poor don't spend that much, the economy can happily sail along. I was wondering how multipliers might differ by income class.


Patterson, Scott. 2007. "Has the Crunch Filtered Down to Consumers?" Wall Street Journal (18 October): p. C 1.
"Dean Maki, an economist at Barclays Capital, expects households to muddle through even as lenders get more strict. He says many of these credit problems have hit lower-income consumers, while wealthier spenders remain largely unscathed. Roughly half of consumer spending comes from the top 20% of the income bracket, Mr. Maki says."

Lieberman-Warner: The Fall Lineup

I haven’t had time to study the new edition of Lieberman-Warner, which bills itself as this fall’s comprehensive political consensus on national climate change policy. The broad outlines provided here make two things clear however:



1. The bill falls far short of what is needed. It covers only a portion of the economy, sets targets that are too low and auctions too few of the permits. It allows too many loopholes, such as offsets and provisions to raise the caps against promises of future tightening. It rebates exactly none of the (insufficient) auction revenues. This last point is important for both political and economic (demand-sustaining) reasons. It micromanages funding for energy alternatives, with several earmarks that are dubious at best. It would take a much longer post to spell out all of the particulars, but I hope we will soon have a thorough analysis. (If you are producing one, or if one crosses your screen, please give us a link.)

2. The bill represents a compromise based on today’s political alignment. If it were to be passed, and if someone could get Bush to sign it as he lay in a hospital post-surgical room fogged out on painkillers, it would be a terrible mistake, locking us into a bad framework for years to come. 2008 should be the year of climate debate, not climate decision. Progressives should put forward a simple, comprehensive, forward-looking bill to focus the discussion, even though it would have no chance in the current congress. After November 2008 we should be in a position to get something on climate that goes far beyond what is possible today.

The U.S. Tax Bite: 1975 v. 2006

Via Greg Mankiw comes a chart provided by David Cay Johnston entitled Increasing Cost of Government. A couple of things strike me about this graph. The first is that the U.S. “tax share” as Greg calls it is #17 out of the 20 nations listed. The second is the statement that the share of GDP has increased in most nations, which includes the U.S. according to this 1975 v. 2006 comparison.

Point in time comparisons can be misleading especially when the measurement of taxes does not included deferred tax liabilities, which is why I have graphed both spending and taxes as a share of GDP for the period from 1967 to 2006 using information provided by table 3.1 from this source. The year 1975 was an odd one to pick for the comparison point. Taxes as a share of GDP may have been less than 27% as compared to 29.8% in 2006, but government spending as a share of GDP was 31% in 1975 as compared to 31.3% in 2006. You see, we had a recession back then followed by Ford’s tax cut designed to offset this recession.

To be fair, government spending as a share of GDP had spiked and then retreated for the next four years. Who knew Jimmy Carter was a small government Republican? President Carter’s term of office was followed by 12 years of Republican leadership where Ronald Reagan and George H. W. Bush promised to keep our taxes low. But it seems government spending as a share of GDP grew over this period. They were followed by big spending Bill Clinton – or so some would have you believe. But our graph shows spending as a share of GDP fell to 29.4% by 2000. Since then – spending as a share of GDP has increased. While George W. Bush would tell you that he cut our taxes, Milton Friedman might rebut with simply “to spend is to tax”.

Raiding Your Social Security Benefits

Mark Thoma demolishes some nonsense from Amity Shlaes so we don’t have to. First the nonsense:

The wage increases mean that newer beneficiaries get a bigger pension than their predecessors, even after adjusting for inflation. Thompson was suggesting that we base the formula upon inflation alone. Then every pensioner gets what his big brother or sister did, adjusted for inflation. But not more.

Mark notes:

Now, as to indexing, here's what happens if you don't adjust for rising living standards. Nominal wage indexing (as is done now) accounts for both changes in inflation and changes productivity over time (see the %Δ equation above), whereas price indexing only adjusts for price changes, it makes no allowance at all for changes in living standards (i.e. for changes in productivity).

True but we need to add one bit to this. Ms. Shlaes is not comparing what my son will receive when he retires some 45 years from now to what my daughter will get when she retires. Fred Thompson’s proposal will make sure that my kids get no more than I get even though they are likely to earn more over their lifetime than I did. Which means they will pay more into the Trust Fund than I did. Yet, they are supposed to get no more than their dad got? Is Amity Shlaes too stupid to understand this? If so, why is Bloomberg giving her a column?

Schumpeter, War, and the Woeful Deficiency of Economic Theory

Was Schumpeter correct when he wrote: "Economics is a very unsatisfactory science. But it would have to be much more unsatisfactory than it is if such an event as a war, however extensive and destructive, sufficed to upset its teaching."



Was Schumpeter correct when he wrote: "Economics is a very unsatisfactory science. But it would have to be much more unsatisfactory than it is if such an event as a war, however extensive and destructive, sufficed to upset its teaching."

Schumpeter, Joseph A. 1954. History of Economic Analysis (NY: Oxford University Press): p. 1146

During all-out wars when a country's very existence is at stake, only the most foolish leader would rely on markets to run the economy. Also, during wartime, many people (excluding corporate executives?) respond to nonmarket incentives, allowing the economy to produce much more than conventional economic theory would predict.

Here is a short section from my book, Transcending the Economy:

Earlier, we discussed how economies cast aside the market when society mobilizes for war. People too behave differently during wars. Rather than performing work in a perfunctory manner, many people redouble their efforts on the job in order to contribute to the mobilization.

I do not deny that many people are unmoved by patriotic fervor. Nor would I suggest that wartime profiteering is unknown. The point is that such individualistic motives recede during times of war, while more socially-oriented behavior becomes more common.

People even leave traces of this changed motivation in the statistical residue of the times. For example, Robert Lucas, a conservative economist who won the Nobel Prize in Economics for his work in developing techniques that cast doubt on the effectiveness of government policy, estimated the average level of economic efficiency for the United States economy by calculating the trend of the ratio of output per unit of capital between 1890 and 1954. He found that, at times, for instance during depressions, the actual output per unit of capital fell below his trend line. At other times, the actual output per unit of capital exceeded the trend line.

Lucas discovered that during the war years, 1944 through 1946, the output per unit of capital surpassed the trend line by more than 20 percent. At no time, before or after, did the United States economy match this remarkable performance (Lucas 1970, p. 154).

This achievement is extraordinary because during this period, many of the most qualified workers were in the military rather than on the shop floor. The workers who replaced them had considerably less work experience. Because of decades of discrimination, the black workers who came from the South to work in Northern factories had far less education than the workers that they replaced. Similarly, many women without much experience in working for wages effectively "manned" the assembly lines.

Conventional economic theory suggests that industrial efficiency should have suffered dire consequences from this reliance on a supposedly less qualified labor force, yet Lucas shows that nothing of the sort happened. Instead, productivity soared.

Of course, we are accustomed to expecting productivity to increase during war time. War stimulates demand, which makes the economy work more efficiently. In addition, Lucas himself attributes some of the marvelous performance of the wartime economy to the use of overtime in industry.

While increased demand and overtime may have been a factor in stimulating the economy, emotional forces were also at work. War can make people pull together. War can create a sense of urgency. At times, powerful ideals can motivate working during times of war.

In the United States, World War II called forth just such a sense of idealism. People who labored in the factories in the United States during the war often did their best in order to contribute to the struggle against fascism. Such ideals were more compelling than greed for most workers.

Casey B. Mulligan, a colleague of Lucas's at the University of Chicago, found further statistical evidence suggesting the influence of ideals (Mulligan 1998). According to economic theory, only changes in monetary incentives can change behavior. When wages fall, work effort should shrink accordingly.

He found that roughly ten million more civilians were employed during the war than if employment had followed its prewar trend (Mulligan 1998, p. 1040), even though "after-tax real wages of manufacturing production workers were lower in absolute terms (and even lower relative to trend) during the war years 1942-1945 than in the few years immediately preceding and following the war" (p. 1044). Mulligan reported on his efforts to attempt to develop alternative explanations within the confines of standard economic theory to interpret this bulge in employment even though real after-tax wages were falling. In every case he failed, suggesting that patriotic idealism lay behind the rise in labor force participation. In other words, more people were working than would be expected based merely on the desire to earn more wages. Instead, people were coming into the labor force to contribute to the war effort.

Eventually, the patriotic consensus frayed around the edges. Workers became frustrated seeing their sacrifices unmatched by their employers who were enjoying unparalleled profits. As a result, toward the end of the war, strike activity began to pick up. Still, the spirit of community was sufficiently strong to produce the high levels of productivity that caught the attention of Robert Lucas.

Similarly, Israel mobilized 15 percent of its labor force for the Yom Kippur War, but the Gross National Product declined only 5 percent (Maital 1982, p. 114). The decline in production might not seem to be as impressive as the experience of the United States, but remember the United States had time to adjust to the wartime demands, while the Yom Kippur War was a brief affair.

The wartime experiences of Japan and Germany offer even more powerful illustrations of the ability of people to overcome adversity. Jack Hirshleifer, an economist from the University of California at Los Angeles, reported that ten days of bombing raids during July and August 1943 destroyed half the buildings in Hamburg. Yet, within five months the city had regained up to 80 percent of its productive capacity (Hirshleifer 1987, pp. 32-33). The United States government was interested to find out what determined the effectiveness of the Allied bombing attacks. John Kenneth Galbraith, the famous Harvard University economist, assembled a team that included some of the most prominent economists in the world. These researchers found that bombing only made the Germans more resolute. According to the findings of the survey, "the air raids of 1943-4 ... may have kept up the tension of national danger, and created the requisite atmosphere for sacrifice" (cited in Galbraith 1994, p. 131; see also Galbraith 1981, p. 205; and Scitovsky 1991, p. 258).

On August 6, 1945, the United States Air Force dropped an atomic bomb on Hiroshima. The next day, electric power service was restored to surviving areas. One week later, telephone service restarted (Hirshleifer 1987, p. 34).

No doubt the Germans and the Japanese, like their counterparts in the United States, worked overtime to rebuild their economic capacity, but even trebling the average work day would not have sufficed to accomplish what they did. Their success in reconstructing their economy required enormous creativity and ingenuity.

We also see a more intensive development of new technologies during periods of crisis. Ordinarily, the typical large corporation is timid about exploring new ideas, yet the same people, who typically display little creativity within the confines of the large corporations, are more inclined to promote great scientific breakthroughs under the urgency of war.

Based on his reading of Japanese history, Shigeto Tsuru, an important Japanese economist, proposed the concept of creative defeat, meaning that a horrendous defeat can unleash a torrent of energy and ingenuity. The end result can be an even greater level of economic development than would have occurred in the absence of the setback. In his words: "Japan is an example of a fantastically creative response to defeat. One recalls that Schumpeter used to puzzle the students of his 'Business Cycle' course ascribing the Japanese boom of 1924-1925 to the Great Kanto Earthquake of 1923. The defeat in the last war brought about, of course, a far greater scale of devastation in the economy of Japan, necessitating a fresh renovating start in almost every aspect" (Tsuru 1993, p. 67).

Sustainability Is Us

Dani Rodrik wonders whether econ blogging is sustainable. We have the answer.

Rodrik cites Mankiw, who thinks his blog is eating up too much of his time and concludes:

So if economists with high opportunity costs of time start to get out, shall we have a lemons problem on our hands? Will eventually the only prolific bloggers remain the ones that are not worth reading?

Now there is the obvious point that some of the big names in economics (not Dani thankfully) are a bit lemonish themselves, but we won’t go there. No, we will just point out that a shared blog like this one is the sustainable solution. I can’t speak for my co-conspirators, but I can barely find the time to write even short, minimal content posts like this one. If I had to do this every day I wouldn’t. But we have a team to pick up the slack.

The McGovern-Clinton Demogrant

John Hinderaker thought this idea was awful:

McGovern ran on a far-left platform that included a proposal that at the time was deemed risible - the "demogrant." The demogrant program was simple: the federal government would write a check for $1,000 to every American … But the demogrant has returned! Today, Hillary Clinton unveiled her own demogrant proposal: every newborn American baby will get a birthday present from the federal government in the form of a $5,000 check … It occurred to Scott that Hillary's proposal is basically a demogrant, adjusted for inflation. Out of curiosity, he went here and did the math. The result was striking. McGovern's $1,000 in 1972 was worth, in 2006 dollars, $4808.90. Add a few bucks for 2007, and Hillary's baby present is a dead ringer for the demogrant proposal that was laughed off the stage in 1972!

Guess which conservative economist gave this idea some support?



Greg Mankiw directs us to a paper by Jon Gruber and Emmanuel Saez entitled The Elasticity Of Taxable Income: Evidence And Implications. Greg emphasized this portion of their paper:

the optimal system for most redistributional preferences consists of a large demogrant that is rapidly taxed away for low income taxpayers, with lower marginal rates at higher income levels.

He adds:

If I were a redistributionist, here is what I might propose: A large fixed payment to every citizen, paid at the beginning of every month, financed by a proportional tax on consumption, such as a value-added tax.

When Senator Clinton floated her demogrant, Greg wrote:

The big problem with U.S. fiscal policy is that, over the years, politicians of both parties have voted for unfunded entitlements for the elderly, which will (unless scaled back) result in substantially higher taxes on future generations … How might this be funded? There are only three groups that could be asked to pay for the new entitlement with higher taxes (or lower benefits): the current elderly, those currently of working age, or the same future generations who are getting the new benefit and are slated to pay for existing unfunded entitlements. Which group do you think Senator Clinton has in mind?

It’s a fair question – but it does seem, the demogrant is not such a crazy idea if it is done in a fiscally neutral way. Of course, fiscal neutrality never stopped the GOP candidates for President from advocating tax cuts.

Social Security: U.S. Treasury Declares Trust Fund Reserves Not To Exist

Mark Thoma reads the latest from the Treasury Department so we don’t have to:

To the extent, however, that Social Security surpluses result in higher deficits in the non-Social Security portion of the budget, then government saving is not increased by higher Social Security surpluses. In that case, future Social Security benefits that would have been financed with higher issuance of publicly held debt will instead have to be financed with reductions in non-Social Security spending or increases in non-Social Security taxes.

Is it that easy for the Republican thieves in the White House? This line was put in context by Kent Smetters as I discussed here.



Check this out:

Today's deficit estimate release by the Congressional Budget Office is good news for American taxpayers. Like the estimates put forward by the Office of Management and Budget, it shows that our government is on a path to meeting the goal I set forth of putting the budget into surplus by 2012.

James Hamilton (exuse me: Jim's capable sidekick - Menzie Chinn) challenges this happy talk and Mark Thoma has more. Both note that the surge in tax revenues may be over so the deficit might not continue to fall. But notice that President Bush is talking about the unified deficit. As noted here, the general fund deficit remains quite large.

Yet George W. Bush and those in the GOP who wish to replace him as President have no intention to either scale down our defense spending (after all, our stupid invasion of Iraq is their priority) or reverse that tax “cuts”. Translation –they wish to squander those Trust Fund surpluses on the Iraq War and income tax cuts for the rich. And now his Treasury Department admits he has looted the Lock Box. Besides ending our stupid invasion of Iraq, the issue during the 2008 campaign should be whether the Lock Box will be honored.

US-INDIA NUKE DEAL REPORTEDLY GOING DOWN

By Barkley Rosser

A front page story in WaPo today reports that the proposed agreement between the US and India for the US to assist in providing fuel for civilian nuclear power plants in India may be going down due to opposition from leftist parties in India to India becoming "too close" to the US, although the right-wing BJP has also joined in opposing this agreement (the leftists are in the coalition government, the BJP is not). This is true on the surface, but the report leaves out important details. One is that the US has been pressing India not to build a natural gas pipeline to Iran, long an ally (neither is too fond of Pakistan), which feeds the complaints of the opposition. Also, there has been opposition in the US over India violating the Non-Proliferation Treaty by actually building nuclear weapons, with vague US pressure on that issue also raising hackles in India.

The further wiggle on this not covered in the story is that many nuclear scientists in India also oppose the plan because they see it bringing to an end India's efforts to develop an alternative, independent, cheaper, and safer nuclear technology, thorium reactors, while putting India into a dependent position on the US for nuclear fuel. Beyond this, failure of this agreement may well make far more difficult any meaningful effort to restrain global carbon emissions over the next few decades. The thorium tech is not really ready to go. India will be massively increasing its electricity production potential over the next couple of decades, no matter what anybody says. Given its poverty, they are only going to go for the cheapest available "off the shelf techs." The hard bottom line is that those alternatives for India in a serious way are coal or nukes (although natural gas from Iran might help a bit). Failure of this agreement may mean that they will go with coal, and that will be that, too bad for the world with respect to global warming.

Conduitry: A Blast from the Past?

It appears that the conduit consortium is simply an extra layer of securitization. It reminds me of the way the lender of last resort function was implemented, sort of, with several noticeable failures, in the era preceding the creation of the Fed. It has the potential to further concentrate risk, like an Army Corps flood control project that can withstand a category 3 but not 4 storm—if there are any buyers.

From an equity standpoint, I think James Hamilton has it right:

In my opinion, part of what created the current problem was the perception that participants were too big and too many to fail. If the government won't let Citigroup fail, could it allow a superconduit to go down?

I am skeptical of any claims for a feel-good, this-will-solve-all-the-problems fix. The reality is that someone must absorb a huge capital loss. The question we should be asking from the point of view of public policy is, Who should that someone be?

My answer is: the shareholders of Citigroup.

PREDICTION MARKETS AND THE ECONOMICS NOBEL: OOOOPS!

One of the more innovative of the George Masonites is Robin Hanson, who runs the philosophy of science-oriented blog, overcoming bias. He is a big fan of the accuracy of prediction markets. But the various betting markets on the Sveriges Riksbank Prize for Economics in Memory of Alfred Nobel, such as intrade.com, were just way off. The top bets as of yesterday were in order, Fama, Barro, Tullokck, Helpmann, Grossman, Dixit, and Tirole. None of the actual winners: Hurwicz, Maskin, or Myerson, was even in the betting pool. Oooops!

I think what we see here is the hand of the Committee Chair, Juergen Weibull, a game theorist. I had heard scuttlebutt that Myerson and Maskin would be the winners of "the next Nobel in game theory," but figured that was a ways off because of that being it two years ago. So, Weibull figured out to give it to game theory for an application, in this case, mechanism design. A question arises if this is his last gasp before stepping off the committee, or if he is a new Assar Lindbeck, a dominating figure who will be around for years. In any case, for those who are not aware of it, Hurwicz's approach to mechanism design looks an awful lot like a an effort to figure out how to do central planning right.

stock options

Krugman has beat me to the punch on this, but Floyd Norris' article in the Friday Times is interesting. He summarizes a paper looking at the effect of stock options on CEO risk-taking. The paper finds that there is a tendency to take inefficient levels of risk associated with being paid with options. This is what would be predicted by simple theory, but I haven't seen it tested before. Here is an example I use with my classes:

Suppose a CEO has option with exercise prices equal to the current market price of the stock, $20. She has two directions she might take the company in. In one, earnings and therefore the stock price, will more or less certainly increase by 20% over the next year (the "therefore" depending on the heroic assumption that the stock market is efficient). With the other direction, earnings have equal chances of doubling or being cut in half. Unless the owners are insanely risk-loving, the second direction is one they would never take; it has both higher variance and lower (actually zero) expected return. The CEO, on the other hand, makes an expected return of $4 per share taking the first direction, compared to 1/2($20) = $10 taking the second. The point is that, for the CEO, the 2nd direction constitutes a one-sided gamble. If the price doubles he exrecises the option and makes $20 per share. If the pice tanks, the option is worthless - the CEO neither gains not loses: heads, she wins; tails, the stockholders lose. Norris notes that in-the-money options would take away these perverse incentives - then the CEO would lose something if the stock price fell. (Hmm: is this last point destined to emerge as part of an apologia for back-dating options!)

Savings: The Consequence, not the Cause, of Current Account Imbalances

You write stuff and hope people read it. Clearly the recent discussion on this blog and elsewhere of whether there is a savings glut over there or a savings shortage over here ignores completely the argument I made this year in Challenge. Was my case really that weak?

If Manufacturing Creates a Middle Class, What Does a Service Economy Create?

Dani Rodrik thinks about the Chinese billionaires and has this insight:

I think because incomes from real estate are based on scarcity rents: you buy the right property at the right time, and you get rich very quick. No-one can dissipate your rents. But if you are in manufacturing, you have to compete not only with your international competitors, but also with copycats and imitators at home. So the rents from successful ideas get dissipated quickly. It's not that the overall gains are not large, and even larger than in successful property investments. It's that the innovators can hold on just to a small share. So real estate creates billionaires; manufacturing creates a middle class.

The U.S. is seeing its manufacturing sector decline as job creation seems to be in the service-producing sector rather than the goods producing-sector. This source notes the total nonfarm employment rose from 121.232 million in January 1997 to 138.265 million last month. But the goods-producing sector fell from 23.619 million in January 1997 to 22.324 million last month, while the service-producing sector saw employment rise from 97.613 million in January 1997 to 115.914 million last month. Over this period, we have also seen an increase in income inequality. When I think of the service economy, I think in terms of bimodal distributions:

Bimodality of the distribution in a sample is often a strong indication that the distribution of the variable in population is not normal. Bimodality of the distribution may provide important information about the nature of the investigated variable (i.e., the measured quality). For example, if the variable represents a reported preference or attitude, then bimodality may indicate a polarization of opinions. Often however, the bimodality may indicate that the sample is not homogenous and the observations come in fact from two or more "overlapping" distributions.

Some service sector jobs require few skills and have intense competition. Think of burger flippers and those who clean hotel rooms. Some service sector jobs require an advanced degree and have all sorts of barriers to entry. Think of doctors and lawyers. So how much of the increase in income inequality comes for the U.S. moving from a manufacturing economy to a service economy?

Government, Corporations, Corruption, Money, Power, and Skirting the Law

I was stuck by three stories today in which the Government, Politicians, and Business used their influence for nefarious purposes.

The Washington Post reports that court documents unsealed in Denver this week suggest that the indictment of former Qwest chief executive Joseph P. Nacchio, who was convicted in April of 19 counts of insider trading, may have not have been guilty. The documents suggest that because Qwest refused to go along with illegal wiretapping, the government retaliated by yanking a lucrative contract that threw the company into turmoil. He is using the allegation to try to show why his stock sale should not have been considered improper.

http://www.washingtonpost.com/wp-dyn/content/article/2007/10/12/AR2007101202485.html?hpid=topnews

At the same time, Congressman Jefferson argues that his case should be dismissed because such an act is technically closer to influence-peddling than bribery.
http://www.washingtonpost.com/wp-dyn/content/article/2007/10/12/AR2007101202217.html?hpid=sec-politics

Finally, Kathleen Brown of Goldman Sachs, who is also a miserably failed Democratic for Governor of California and who is also the sister and daughter of other governors of the state, was the person who first broached the idea that Governor Arny lease the state lottery to a private company. Arny is proposing that the proceeds from the lease will help to finance his health care proposal.

The New York Times also estimates if "privatization plans now being considered in four large states -- California, Illinois, Texas and Florida -- were to go through, Wall Street could conservatively reap a minimum of $250 million in fees alone.
http://www.nytimes.com/2007/10/14/business/14private.html?pagewanted=1&hp

Sucking Up the World Savings Glut

If the world has been through a savings glut, Michael raises a very good question as to why wages are not being bid up. Some of us, however, have wondered whether we have gone through a global investment deficiency. To some Americans, the notion of a savings glut sounds foreign as our graphs show that the nation’s “gross savings” as a share of GDP fell from around 14 percent to just over 10 percent – in part because of the Bush spend but do not tax policies. Net national savings, which is gross savings minus depreciation, has barely been above zero. We are thus running a repeat of what happened in the 1980’s when Ronald Reagan’s “save and invest” translated into less of each.

But notice something - the fall in U.S. savings did not translate into a one-for-one decline in investment. At first, U.S. exports declined but have recently returned to the same level of GDP as we saw in 2000. Also, imports as a share of GDP have increased so our current account deficit is doing as much as one nation seems to be able to suck up whatever world savings glut it can. But maybe this is the whole idea behind GOP fiscal policy – less saving means capital-shallowing rather than capital-deepening. Which of course as Michael notes – translates into less long-term wage growth.

Savings Glut Conundrum

If there is a global savings glut, why does capital get such a big share of the pie? If finance is so abundant, why is there not great competition for labor, bidding up wages?

Does Greg Mankiw Think the Long-run Budget Constraint is “Cute”?

In the comment box of this post, Greg Mankiw may have been the first to call this Angrybear cute. Why thank you! The point of Greg’s post is that the Federal income tax is quite progressive. My point is that talking about a subset of taxes is a bit disingenuous. Kevin Drum and the conservative Tax Foundation prefer to look at total taxes. My only complaint with their analyzes is that they did not factor in those deferred tax liability from George W. Bush’s fiscal irresponsibility. But then how could? This Administration is not telling us who will pay these deferred taxes. In their view, no one will.

Update: Greg took his graph from Chris Edwards who claimed:

The Bush tax cuts substantially reduced tax rates for people in every income group. Indeed, those at the bottom had the largest relative reductions in their tax rates … I’m for lower taxes for everyone, but I wish people would look at the actual data first before carping about the rich supposedly being specially favored by recent tax cuts.

So much malarkey, so little time. Chris and Greg know the following two things are true: (1) the long-run government budget constraint holds; and (2) Federal spending rose even as a share of GDP since George W. Bush took office. The implications are clear: George W. Bush has raised – not lowered – the tax bite. But Greg pretended he did not get my “cute” point at first. I find this truly amazing. After all – economists have been talking about deferred taxation ever since the 2001 tax deferral was signed into law.

Irony Alert: Stock Market Punishes American Airline for NOT Going Bankrupt

"During the industry downturn after the September 11, 2001, terrorist attacks, American was one of the most frugal spenders and, in some areas, aggressive cost-cutters as Mr. Arpey avoided the easier path taken by rivals in bankruptcy-court proceedings. Now, investments to improve operations for the long haul, including better customer service and new aircraft interiors, are adding to the carrier's high costs. "They have a lot more work ahead of them than other names because of the fact that they haven't been through bankruptcy," said Standard & Poor's airline equity analyst Jim Corridore, who has a "hold" recommendation on the stock."

Whatever Happened to the Efficient Market Hypothesis?

The Wall Street Journal has a front page story today about the lack of transparency in securities. Remember, one of the great accomplishments of the market is to provide accurate information to allow for something akin to perfect efficiency. Milton Friedman would tell us that there will be inefficient speculators, but the market will ruthlessly purged them, leaving only the great ones who can guide the economy efficiently.

Financialization and securitization was supposed to distribute risk even more efficiently. Unlike most fairytales, I suspect this one will not have a happy ending. Well, here is the article:


Pulliam, Susan, Randall Smith and Michael Siconolfi. 2007. "U.S. Investors Face An Age of Murky Pricing: Values of Securities Tougher to Pin Down." Wall Street Journal (12 October): p. A 1.

"Since the invention of the ticker tape 140 years ago, America has been able to boast of having the world's most transparent financial markets. The tape and its electronic descendants ensured that crystal-clear prices for stocks and many other securities were readily available to everyone, encouraging millions to entrust their money to the markets. These days, after a decade of frantic growth in mortgage-backed securities and other complex investments traded off exchanges, that clarity is gone. Large parts of American financial markets have become a hall of mirrors."

"The hazards of this new age of uncertainty became clear at Dillon Read in March, when rising defaults by homeowners were hammering the value of mortgage securities. John Niblo, a hedge-fund manager at the firm, acted fast. He twice slashed his fund's valuation of securities tied to "subprime" mortgages, knocking them down by about 20%, or nearly $100 million, say traders familiar with the matter. But managers at UBS AG, Dillon Read's parent company, were irate. The Swiss banking giant was carrying similar securities on its books at a far higher price, the traders say. In conference calls, the UBS managers grilled Mr. Niblo on his move. "I'm marking to where I could reasonably sell them," Mr. Niblo responded during one call, according to the traders familiar with the conversations."

"Today, "way less than half" of all securities trade on exchanges with readily available price information, according to Goldman Sachs Group Inc. analyst Daniel Harris. More and more securities are priced by dealers who don't publish quotes. As a result, money managers can no longer gauge with certainty the value of some assets in mutual funds, hedge funds and other investment vehicles -- a process known as marking to market. An official at the Securities and Exchange Commission said recently that some bond mutual funds might be using outdated or unrealistic prices to value their portfolios."

"Billionaire investor Warren Buffett advocates more transparency in pricing. "Some marks can be pretty imaginative," he says. "They call it 'marking to market,' but it's really marking to myth." He says that before funds publish financial statements, they should sell 5% of hard-to-value positions to gauge values."

"Some Wall Streeters have a motive to inflate marks: Their bonuses often are tied to the value of their holdings. A Lipper & Co. hedge-fund manager, Edward Strafaci, earned bonuses of $3.9 million between 1998 and 2001 based on improperly marked convertible bonds, according to the SEC. Mr. Strafaci overstated the value of the bonds he managed, despite warnings from his traders, according to a civil complaint charging securities fraud. The value of a $722 million Lipper hedge fund later was cut in half, and Mr. Strafaci pleaded guilty to criminal securities fraud."

TURKEY-ARMENIA-KURDISTAN: THE GREAT UNRAVELING

If I were in Congress, I would have voted for the resolution to identify the Ottoman genocide of Armenians a genocide as a matter of principle. However, I share with Juan Cole (http://www.juancole.com/) the sense that out of the 92 years since that horrific event, this is probably the most inappropriate year to have passed such a resolution, even though it is totally bizarre that the Republic of Turkey does not simply agree that its corrupt predecessor did indeed engage in such a genocide and then move on. Cole points out that while Turkey has been a super good ally of the US in NATO, ranging from providing troops in the Korean War to its continuing provision of the crucial Incirclik Air base, the US has: a) promised a billion in aid after the 91 Gulf war, only to renege, b) invaded and overthrown Saddam against specific desires of Turkey, thereby increasing the threat of Salafist Sunnis and fundamentalist Shi'is (including in neighboring Iran) and also leading to c) the newly empowered Kurdish Regional Government (KRG) allowing bases for PKK guerrillas who have killed 28 Turkish soldiers in the last few weeks, leading to Turkey threatening to invade Kurdistan, and d) allowing the KRG to control the police in oil-rich Kirkuk and also Turkmen-inhabited Tal Afar, with possible full control passing to the KRG, including of the massive future oil revenues to come out of that area.

Speaking of the KRG, Ben Lando at http://www.iraqoilreport.com/ reports that the KRG has signed two more oil exploration agreements, with two more pending. The new deals are with Heritage Energy of Canada and Perenco S.A. of France. While the KRG has declared that this is "come and get it now or miss out" time, the big oil majors continue to hold back due to the continuing opposition of the central Iraqi government in Baghdad to all these deals. Oh, and btw, Lando also reports that contrary to previous public statements, apparently a rep of Hunt Oil did discuss their impending oil deal with the KRG with State Dept. reps (AID to be precise) in Irbil on Sept. 5.

General Fund Deficit Tops $550 Billion for Fourth Year in a Row

My Angrybear post graphs and discusses the fact that total Federal debt has increased by more than $550 billion over the fiscal year – again! The White House will tout how the unified deficit has declined but since they will not tell you that this is because those Trust Fund surpluses are rising, I will. Please excuse my testiness in this AB post. It seems my old cave has been invaded by some of Karl Rove’s trolls.

Very Nice Interview about The Confiscation of American Prosperity

I just uploaded a copy of the first interview about my new book on our local NPR station.

http://www.archive.org/details/michael.perelman.KCHO_820

Free Trade: Bhagwati Takes on the Critics with Harsh Rhetoric

Dani Rodrik makes the following observation about a recent op-ed from Jadesh Bhagwati:

Jagdish Bhagwati is a sweet and courteous man in private, but his writing often makes me cringe. That is not because I frequently disagree with him, but because of the rhetoric he uses to attack his intellectual opponents. It's as if he has an evil twin that sometimes takes control of his writing hand.

The passage that made Dani cringe seems to have been:

But Mr Blinder seemed unaware of the fact that outsourcing via the internet was the mode of service transactions that the US lobbies were keenest about in the Uruguay round of trade negotiations: they saw that they would be the big winners, as no doubt they are. They hugely dominate transactions in high-skill and high-value services in architecture, law, medicine, accounting and other professions. Mr Blinder, when challenged, shifted ground to arguing that, as services became tradeable online, the number of jobs that would become “vulnerable” would rise pari passu, requiring adjustment assistance. However, there is hardly any serious trade economist who has objected to providing adjustment assistance. The first adjustment assistance programme in the US goes back to 1962. Virtually all trade legislation since has tried to improve on it. Many trade economists have written extensively on the subject. Mr Blinder, who started talking poetry, has therefore wound up talking prose. We free traders have no problem with him as he backs into our corner. But if he is to remain the new icon for those who oppose free trade, they have to be pretty desperate.

Something tells me that Alan Blinder can rise above this rough rhetoric. The specific passage that surprised me was the notion that the possibility that compensation might theoretically be possible cures all ills. Professor Bhagwati earlier had noted the 2004 paper by Paul Samuelson:

Autarky real per capita well being, does not deny that new technical Chinese progress in goods that America previously had competitive advantage in can, ceteris paribus, lower permanently measurable per capita U.S. real income. Nor does it deny that technical progress in China's export goods can, ceteris paribus, hurt permanently her own net measurable per capita real income itself when demand inelasticity prevails. Ergo, the winds of dynamic comparative advantage cannot be counted on to create in each region new net gains of the gainers assuredly greater than the new net losses of the losers. However, correct Ricardian theory does imply that worldwide real income per capita does gain net, so that winners' winnings will suffice worldwide to more than compensate losers' losings--some cold comfort in a scenario of many semi-autonomous nations.

Bhagwati would correctly note that the Chinese likely gain more than the losers lose –so in theory – the Chinese winners could compensate the American losers. But seriously – when do we ever see such compensation taking place?

The Obama Carbon Plan

2008 will be the year America debates climate change policy, hopefully without descending completely into election-year inanity. 2009 will be the year we get a policy. For an issue of this magnitude, that’s a fairly short time frame, so every turn of events counts.

Today Barack Obama has gone on record with his own approach. By my reckoning he got almost everything right, but there’s one huge missing piece. He is right on:

• setting a serious target: an 80% reduction in emissions by 2050 is the minimum we should aim for, if we take the scientific evidence seriously. We can get there only by starting soon and staying on course.

• capping carbon emissions: a cap is necessary if we are going to try to live within ecological limits, and it is far preferable to a carbon tax, as I’ve argued earlier on this august site.

• auctioning the permits: as Obama said, letting the cows out of the Barnes, “Businesses don’t own the sky, the public does...”

• rejecting offsets: he doesn’t even mention them.

• investing in a non-carbon future: we need basic R&D, infrastructure and other initiatives to turn our economy around.

The only element that’s lacking is a commitment to rebating most of the auction revenues back to the people on a per capita basis. Economically, this is necessary to protect real incomes and avoid a dangerous contraction of consumer demand. (The higher energy prices we will be paying under any reasonable cap will be in the hundreds of billions of dollars.) Politically, it is necessary to win support for tough limits on carbon emissions. After all, if it is true that we own the sky, we should share in the income it generates. Finally, a per capita rebate would constitute the most progressive income redistribution program since the New Deal, a big consideration at a time of spiraling inequality.

So how do you finance those green investments if you give the money back? Answer: by ending pork barrel subsidies to the nuclear and fossil fuel mafias ($24B give or take a few) and rethinking national security, for starters. NB: if rebating the auction proceeds on an equal share basis is highly progressive, withholding a big chunk of it for other uses is highly regressive. Finance public investment out of taxes.

Find me a lyrical economist

From a review in today's Times of a concert devoted to the work of Esa-Pekka Salonen:

(Salonen's music contains) "a recurring impulse to battle its own tendency towards lyricism, quashing a melodic passage in "Prologue," for instance, with a flatulent blat from the oboe."

I suppose "flatulent blat" is otiose - can there be a non-flatulent blat?- which just goes to show that non-otiosity (which may spell-checker says isn't a word) in writing isn't everything.

Would that we had economists with a tendency towards lyricism, to battle or not. Maybe some of Samuelson's history of thought papers would qualify, with elegant derivations undercut here and there with sly wit. Any other candidates?

A Tangled Web of the Old and the New Economy

Franklin, H. Bruce. 2007. The Most Important Fish in the Sea (Washington, DC: Island Press) tells the gruesome tale of the depredation of world's supply of menhaden, a fish that represents the basic feedstock for the carnivorous fish and which keep the overgrowth of algae in check. A single corporation, Omega, owned by Malcolm Glazer is the chief destroyer. Omega got the business from Zapata Oil, a company founded by Bush the First back in 1953. By 1961, Bush sold his stake in the company. By 1998, Zapata became one of the most ridiculous examples of the excess of the dot.com world.

Ofek, Eli and Matthew Richardson. 2002. "The Valuation and Market Rationality of Internet Stock Prices." Oxford Review of Economic Policy, 18: 3 (Autumn): pp. 265-87.

275: "As an example, consider our favourite illustration of Zapata corporation. Zapala was founded in 1953 by former US President George Bush as an oil and gas company. However, by early 1998, Zapata had transformed itself into a company, albeit still 'old economy', specializing in meat-casings and fish oil. On 27 April 1998, Zapata's management announced that it was going to form a new company to acquire and consolidate Internet and e-commerce businesses. Its first foray into this sector occurred in May when it bid for Excite, which was the second largest Internet search directory at the time. Zapata's bid was rejected by Excite's management for its 'complete lack of synergy', as quoted in Bloomberg at the time, covering Excite's press release. In July, Zapata made further announcements that it was purchasing about 30 Internet websites. As the market for Internet stocks deteriorated through summer and autumn of 1998, Zapata announced that it was re-evaluating its Internet business strategy and no longer purchasing the websites. On 23 December 1998 the company reversed course again. And stated that it was getting back into the internet business and would be forming the subsidiary, Zap.com. On this news, shares rose 98 per cent in New York stock-exchange composite trading. This type of example is not atypical and is representative of the Cooper et al. (2001) study." Cooper, Michael, Orlin Dimitrov, and P. Raghavendra Rau. 2001. "A Rose.com by Any Other Name." Journal of Finance, Journal of Finance, 56: 6 (June): pp. 2371-88.

[On 8 October 2007, Reuters reported, "Zap.Com is a public shell company that does not have any existing business operations. From time to time, Zap.Com considers acquisitions that would result in it becoming an operating company. Zap.Com may also consider developing a new business suitable for its situation.

http://stocks.us.reuters.com/stocks/fullDescription.asp?rpc=66&symbol=ZAP

More on Martin Feldstein

ProGrowth Liberal just posted interesting information about Martin Feldstein on Social Security. Here is an extract from my new book, The Confiscation of American Prosperity, regarding Feldstein's obsession with the subject.

Feldstein first came to national attention in 1974, the same year that Arthur Laffer produced his famous napkin. Feldstein published a model that "proved" that Social Security caused enormous losses for the US economy. According to Feldstein, Social Security was reducing personal savings by 30 to 50 percent. He estimated that if Social Security had not existed, the stock of plant and equipment in the United States would have been as much as 50 percent larger and total personal income 20 percent greater than the level in 1971 (Feldstein 1974). Since Social Security had only been functioning 24 years at the end of the time period that his data covered, Feldstein's article implies that the present effect of Social Security on total personal income today would be far higher ‑‑ perhaps almost 50 percent since the program has had another 35 years at the time of this writing.

The same Jude Wanniski, who popularized supply side economics, later recalled, "I came across a paper that a fellow at Harvard had written on Social Security, saying it was causing the national saving rate to decrease. And I thought, 'Great .... I've got to publish it'" (Bernasek 2004). In other words, because Feldstein's results were welcome, people of influence rushed to embrace him.

The only problem was that Feldstein's work was seriously flawed. A few weeks before the election of Ronald Reagan at the 1980 annual meeting of the American Economic Association in Denver and after Feldstein had already ascended to the head of the National Bureau of Economic Research, two less famous economists, Selig D. Lesnoy and Dean R. Leimer, reported that they were unable to replicate Feldstein's results (later published as Leimer and Lesnoy 1982). Upon analyzing Feldstein's work, they discovered that his results critically depended upon an elementary programming error. With that error corrected, Feldstein's data no longer had the disastrous effects Feldstein claimed. Instead, his model showed that Social Security could have actually had a positive impact on savings.

In all fairness, errors in economic model building are extremely common. In 1982, the Journal of Money, Credit, and Banking began a project to replicate previously published articles. The results were unsettling to say the least. Sixty‑six percent of the authors were unable or unwilling to supply the materials necessary to rerun the model. The authors who responded did so after an average delay of 217 days. All but one of these articles had problems, including programming errors, such as Feldstein committed (Dewald, Thursby and Anderson 1986). This project was hardly likely to inspire confidence in the scientific rigor of economics.

Feldstein admitted his programming error. Undeterred, he soon rejiggled his model. By adding a few new assumptions, he was able to "prove" once again that Social Security was still destructive. Some years later, in 1996, Feldstein gave his own Richard T. Ely lecture. There, Feldstein regaled his audience with new data demonstrating one more time the harmful effects of Social Security. According to Feldstein, the present value of privatizing Social Security would be an astounding $20 trillion dollars ‑‑ about twice the GDP of the United States (Feldstein 1996, p. 12).

In a 2005 Wall Street Journal opinion piece, disingenuously entitled, "Saving Social Security," Feldstein returned once more to his bête noire. This time he was arguing in support of an unpopular piece of Republican legislation to mix Security and private accounts. Feldstein promised great benefits from this "reform": "A higher national saving rate would finance investment in plant and equipment that raises productivity and produces the extra national income to finance future retiree benefits" (Feldstein 2005b). So, Feldstein would rescue Social Security by gutting it.

Earlier in the year, the American Economic Association had given Feldstein a platform to renew his attack on Social Security in his presidential address. Here Feldstein adopted a new pitch. He protested that the program did too little to redistribute income from the rich to the poor. His argument was that because the rich live longer than the poor, they will have more opportunity to benefit from Social Security (Feldstein 2005a).

Without bothering to contest Feldstein's questionable calculations about the redistributional impact of Social Security, this last attack is especially notable for its unusual rhetorical turn. Not too long ago, the same Professor Feldstein discussed the question of inequality with the New York Times. Feldstein began as if he took the subject seriously, observing, "Why there has been increasing inequality in this country has been one of the big puzzles in our field and has absorbed a lot of intellectual effort." Feldstein's own intellectual effort in this debate left something to be desired. Rather than address the question of inequality seriously, he merely trivialized the question, responding to the reporter: "But if you ask me whether we should worry about the fact that some people on Wall Street and basketball players are making a lot of money, I say no" (Stille 2001).

This dismissal of the question of inequality was not some uncharacteristic, off‑hand remark. In an earlier article, entitled, "Reducing Poverty Not Inequality," Feldstein described the proper approach to an imagined increase in inequality occurring because a small number of affluent people received $1000 each at no cost to the rest of society. For Feldstein, only a "spiteful egalitarian" would not welcome such an improvement in society (Feldstein 1999, p. 34).

Of course, Feldstein and his fellow 'spiteful inegalitarians' have been adamant in their hostility to any redistribution of income toward the less fortunate. Such policies threaten to hinder the magical trickle down upon which all progress supposedly defends. Suddenly, however, when it gave credence to his attack on Social Security, Professor Feldstein refurbished himself as a populist advocate of redistribution of income from the rich to the poor by arguing that Social Security benefited the rich. Professor Feldstein never bothered to explain why the rich are so hostile to this program that benefits them so lavishly.

One might expect such a flurry of conflicting arguments from an unscrupulous salesman who wants to earn his commission from a confused customer, but not from one of the most prominent academic economists in the country. One might suspect that ideology rather than an objective search for the truth is at work.

Feldstein did not limit his political activism to Social Security. For example, he used the Wall Street Journal to publicize his work predicting that Clinton's economic taxes would harm the economy while raising little revenue (Feldstein 1993). Unlike his Social Security work, this article made a specific prediction. Unfortunately for Feldstein, his estimates turned out to be demonstrably false. The economy experienced a sudden burst of prosperity during the rest of the Clinton administration.

Alicia H. Munnell, a former student of Feldstein whom he thanked in the acknowledgements to his original Social Security paper and who later rose to become a member of the President's Council of Economic Advisers and Assistant Secretary of the Treasury for Economic Policy, offered this damning verdict in a Business Week article following the Denver meeting: "I get the feeling that the NBER does adopt a position on an issue ‑‑ explicit or implicit ‑‑ and then they go about generating research to support the position" (Anon. 1980). In light of Feldstein's later work, I see no reason to revise her evaluation.

Even if an economist avoids rudimentary programming errors and questionable procedures in handling the data, problems with economic models still remain. The economy is far too complex to reduce it to a mathematical equation or a computer model, even a very large and sophisticated one. As a result, such models necessarily rely on simplifying assumptions.

Although Feldstein proved nothing with his unrelenting attacks on government programs, he demonstrated how clever economists, armed with sophisticated mathematical and statistical techniques, along with the help of well‑trained graduate assistants, are capable of manipulating models to get whatever results they desire. As economists like to joke, that if you torture the data long enough they will confess. So, although economists such as Feldstein can give their work the appearance of scientific precision, their work must necessarily remain suspect.

For example, Social Security's presumably negative effect on saving was at the core of Feldstein's model, but saving has a contradictory effect on the economy. Some models assume that saving encourages investment, while others assume that saving depresses demand, which, in turn, holds back investment. No matter which assumption about the effect of saving economists choose, they can point to reputable theories and models that support them. Admittedly, as economists marginalized Keynesian theory, the models that show the positive influence of saving have become more common. That shift does not reflect an advance in knowledge, but rather a consequence of the right‑wing offensive.

Also, economists can pick and choose among various time periods and data sets, avoiding combinations that do not confirm what they want to find. While such models ‑‑ including many of the models to which I have referred in this book ‑‑ might suggest new lines of research or raise questions about previously accepted truths, they cannot constitute proof by any means.

So, economists may build their models and pundits or politicians can foist the results of these models on the unsuspecting public as if they were scientific evidence, but they are not grounded in science. For example, almost two decades after the errors in Feldstein's original model had been revealed, conservative ideologists, such as those at the Heritage Foundation, still continue to trumpet his long‑discredited calculation as serious evidence of the damage done by Social Security (see, for example, Mitchell 1998).

I believe that Social Security is one of the most effective government programs ever devised in the United States, but I can neither prove nor disprove that assertion with a computer model. In fact, Feldstein's results might possibly turn out to be correct after all, but nobody can know for certain. Different economists have come up with a wide range of estimates (see Lesnoy and Leimer 1985).

Unfortunately, the public rarely has the opportunity to hear about the full range of economic information. Ideological filters determine who gets hired or tenured in economics departments. Those economists who manage to defy the conventional wisdom face the added barrier of getting their work published in "reputable" journals. Even if such papers manage to find their way into journals, they lack the "megaphone" of powerful agencies, such as the Heritage Foundation, which give wide distribution to long‑discredited material without much fear of being exposed. So, ultimately what the public learns about how the economy works are those results that conform to the desires of the rich and powerful.

Martin Feldstein on Social Security

Via Mark Thoma comes an op-ed by Martin Feldstein. Mark focuses on this:

As everyone now recognizes, the current 12.4% Social Security employer-employee payroll tax will not be enough to finance the benefits specified in current law as the population ages. Continuing to finance those benefits with a pure tax-financed system would require raising the payroll tax rate to more than 18%, or finding other ways to raise tax revenue.

Mark rebuts by turning the microphone over to Dean Baker:

The Congressional Budget Office's projections show that the program can pay all benefits, with no changes whatsoever, through the year 2046... The projected shortfall over the whole 75-year planning period is 0.4 percent of GDP, approximately 30 percent of the current cost of the war in Iraq

Besides playing the shock figure nonsense, Martin Feldstein peddles the free lunch fallacy of privatization so let me focus on this:

Unfortunately, Democratic critics argued that individual accounts would be "gambling" with the retirement savings of working men and women.

I never bought into this increased risk argument, but the flip side of the same coin is that we should not false claim there is some overall increase in expected returns as I tried to explain here by quoting Andrew Abel:

Some economists have argued that investing part of the Social Security Trust Fund in equity is simply a rearrangement of paper assets without any real allocational effects, and they have described such a policy as a “shell game.” The shell game argument is similar to the Ricardian equivalence proposition in public finance and macroeconomics and the Modigliani-Miller theorem in corporate finance. The argumentis that private investors will react to any rearrangement of the social security system’s portfolio in a way that completely neutralizes the effect of the portfolio change. For example, if the social security system sells a dollar of bonds and purchases a dollar of equity, private investors would buy a dollar of bonds and sell a dollar of equity.

Robert Barro and Gary Becker have made similar arguments. So why does Martin Feldstein think that this argument is incorrect?

A Different Cost of Securitization

This article shows how securitization has enriched middlemen, while impoverishing lenders. The difference between mortgage rates and Treasury rates is now more than a half percentage point higher than in 1972-8.

Silva, Lauren and Martin Hutchinson. 2007. "The Cost of Complexity." Wall Street Journal (6 September): p. C 14.

"Well, one defense of all the complexity would be that it saved home buyers money -- but that doesn't seem to be the case. It looks like borrowers now pay more for this financial technology. Between 1972 and 1978, in the days when banks offered mortgages to their customers and held the loans, the average mortgage interest rate was 1.07 percentage points higher than Treasury bonds, according to Fed figures. Between 2000 and 2006, when most mortgages were securitized, the spread was 1.59. The figures don't include more expensive subprime loans. One-half percentage point is a big number in debt markets."

"While home buyers may wonder if they are getting their money's worth, financial institutions probably have no so such qualms about the change in the home-lending business over the past 30 years. Mortgage securitization, despite the slide in the subprime sector, has made Wall Street a lot of money."

Taxes and Employment Growth: How Stupid is Rudy Giuliani?

James Pethokoukis interviewed Rudy right after the “tax summit” in Manchester, N.H.

The Democrats are going to say, "We raised taxes in the '90s, cut the deficit, and the economy boomed." Why not try and rerun the '90s instead of cutting taxes? Because we have actually done more job creation by lowering taxes than by raising taxes.

Really? See this post including the second update with Paul Krugman’s comments. Rudy continues:

The federal government is collecting 21 percent more revenues from the lower taxes than the higher taxes. And when they argue with me about this, most of them are arguing about theory - meaning the Democrats. They've never done it. They've sat in a legislature somewhere and debated. I actually did it. I actually did what I'm talking about. I'm not talking about this from the point of view of theory. I actually did it. I lowered taxes at a time in which we were in economic distress … The Kennedy tax cuts led to the same results of the Reagan tax cuts and the Bush tax cuts. One of the worse tax increases in the history of this country was by Herbert Hoover. They all got frightened with the stock market crash. Taxes got raised, tariffs got raised, and they took what could have been a cyclical problem and turned it into a long, 10-, 12-year problem.

I see Rudy is taking credit for the Clinton boom again. Tax rate cuts leading to more tax revenues - what a complete and utter idiot. Of course, Pethokoukis never challenged this complete and utter horseshit as he rather let Rudy babble some meaningless spin about cutting spending. Rudy notes some government employees will retire, which will likely mean their jobs will have to be filled with someone else. There was not a single serious discussion of what programs would be cut. And not a real follow-up question from Pethokoukis.

I do have a thank you for James Pethokoukis. You had the decency to stop emailing me these utterly worthless pieces of yours. Now if you’d cease from submitting them to U.S. News – maybe they’d hire a real business reporter.

Watch This

The Saturday/Sunday Wall Street Journal for October 6-7 has a special 11 page advertising section for collecting and investing in luxury watches. According to

Frank, Robert. 2007. Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich (New York: Crown): p. 143: A top of the line Franck Muller watch costs $736,000.

It must be very difficult for somebody earning tens of millions of dollars to figure out what to do with it.

House Democrats on Carbon Controls: Hold the Applause

The House Energy and Commerce Committee just issued a White Paper on carbon controls. To its credit, the report makes a reasonable case for the advantage of using permits rather than taxes as the starting point, but everything else is up in the air. It talks about a target of either 60% or 80% reduction by 2050, when the steeper cut represents the minimum acceptable amount if we are serious about stabilizing at less than 550 ppm. It meanders a bit in its discussion over where the permits should be applied, when the only feasible approach is one that goes after carbon at its point of entry into the economy. And worst of all, it speaks vaguely of “distributing” permits without even raising the possibility that they should be auctioned. It would be interesting to know whether the Democratic policy staff is simply slow to pick up on the ideas the rest of the country is talking about, or whether they think the best chance of surviving an election year is to keep their climate change plans as fuzzy as possible.

The September Employment Report

When Kash was an Angrybear, he would update us as to the latest from the Bureau of Labor Statistics. I would often tag along with something on the household survey with a graph of the employment-population ratio to remind folks that the rightwing spin on the allegedly amazing growth of employment per the household survey had to be put in context of how that compared to the growth in population. I started also adding the labor force participation rate to remind these rightwing idiots that declines in the unemployment rate could comes from a decline in the labor force participation rate. This morning, the tradition continues over at Angrybear with news from September that was a bit better than the news from August. Note, however, an employment-population rate of 62.9 percent is still far below the employment-population rate that we observed in the late 1990’s.

HAPPY SPUTNIK DAY!

by the Sandwichman

Welcome to the future:

Hurtling unseen, hundreds of miles from the earth, a polished metal sphere the size of a beach ball passed over the world's continents and oceans one day last week. -- Time, October 14, 1957

The true picture of the past flits by. The past can be seized only as an image which flashes up at an instant when it can be recognized and is never seen again. -- Walter Benjamin

Meanwhile, technology is speeding up communication's stepchild, the mails. Guided missles loaded with letters instead of war heads are being planned for the distant future. After their successful launching and arrival, new sorting systems now in use will still be indispensible. -- Life, November 11, 1957

But as for rocket mail, remember what they said in London about the V-2: if you heard it coming, you were safe (because the rocket traveled faster than its propaganda). -- Brad McCormick, September 14, 1996

The word 'automation' so new to the English vocabulary that it can't be found in last year's dictionary, is causing a stir in the business world. A shorter workweek is union labor's answer to the new machines. The big trend to automation in factories has leaders talking in terms of 30 to 32 hours -- four days of work instead of five. US News and World Report, October 28, 1955

Do you really want a four-day week? The whole question may be decided not by workers but by their wives. "Do you think," one psychiatrist asked Parade, "that American women can stand to have their husbands underfoot three days in a row?" -- Parade, October 13, 1957

Has Mark Thoma Sipped from the Supply-side Kool Aid?

Mark Thoma features the Iraq War surtax proposal endorsed by James McGovern. As a member of the deficit hawk wing of the Democratic Party, I like this idea. Mark objects:

While it's certainly true that someone will have to pay for the war at some point - somebody, someday, somewhere will have to give up something to pay the bills - raising taxes right now is not good short-run economic policy given the current weakness in the economy. Driving the economy into a recession would show sacrifice, but that's not the best way to show our support.

If this had been written by someone in the White House, I’d expect Mark to actually mock this suggestion. But this is Mark making the statement and as much as I respect his insights on these matters, it’s my turn to do some mocking. Sure we have seen some recent weakness in aggregate demand growth. But is an increase in national savings necessarily recessionary? Has easy monetary policy lost all of its potency? After all, lower interest rates could encourage more investment as well as even more dollar devaluation with its encouragement of more net exports.

Absurd Interpretation of Fairness

This article condemns Radiohead for ripping off consumers by allowing them to pay what they think is appropriate to download the group's new album. Apparently, some consumer might pay Radiohead money that should rightfully go to the major labels. Read this and laugh.

"Will Radiohead leave fans high and dry? It may sound preposterous to accuse the British rockers of gouging their followers. The band is letting them decide how much to pay for a downloaded version of new album "In Rainbows." But early indications suggest that Radiohead's loyal followers are paying too much for the band's seventh disc."

"According to a poll conducted by United Kingdom music magazine NME, the average fan appears to be willing to pay $10 for a digital copy. Now, that may not sound like a blow out. It's the going price for most records on Apple's iTunes. And that price, in turn, looks to be about right for a digitally downloaded album."

"Consider the economics of the average CD. It retails for about $16 and costs about $6.40 to manufacture, distribute and sell in a store, research outfit Almighty Institute of Music Retail says. These costs are essentially zero when music is sold online. That's why iTunes can charge roughly $10 for a downloaded album."

"Radiohead's fitter, happier approach slices out even more cost. The band pulled the ripcord on EMI, so it doesn't have to share profits or help pay the label's overhead. As a well-known band it's also able to take the knives out on marketing and promotion costs, cutting these by as much as two-thirds. Subtract these expenses and Radiohead may be able to distribute an album for as little as $3.40 a copy."

"Now, fans may be delighted to pay $10 because they think the album is

so good and Radiohead deserves the extra cash. But Radiohead prides

itself on its anticorporate and anti-materialistic ethos. To avoid letting down fans, it might be more productive to adopt a no-surprises policy and fix a simple, fair charge for its record."

Cyran, Robert, Rob Cox and Mike Verdi. 2007. "What Price a Download? Given the Option to Name Their Own Price for Album, Radiohead Fans Overspend." (3 October): p. C 14.

http://online.wsj.com/article/SB119136863867147050.html?mod=googlenews_wsj

Heterodoc Speaks

from INSIDE HIGHER EDUCATION, 10/3/07, by Andy Guess:

>That label ["heterodox"] is sometimes reserved for a coterie of economists who go further, rejecting even some of the basic founding principles of economics. Sequestered in departments at the University of Notre Dame, the New School and others, the heterodox economists often complain that they aren’t respected in the field and are systematically kept out of mainstream debates. Most find it difficult to publish in mainstream journals or present at major conferences.

> “It’s kind of like the third parties in politics,” said James Devine, a professor at Loyola Marymount University who describes his approach as within the heterodox tradition.

>But, as with any vaguely defined term, “heterodox” can be used to mean anything. It’s “an ambiguous term,” Gordon said. “What’s heterodox changes over time,” said Avinash K. Dixit, at Princeton, who is the president-elect of the AEA. Sure enough, the Association for Heterodox Economics lists researchers who approach the discipline from an Austrian perspective — like some at George Mason.

>“Very conservative people can be heterodox,” added Devine, whose areas of interest include labor economics and Marxian political economy. “We’re basically seen as consumers. That’s the dominant [view] and I don’t think that’s going away in the near future, but there is some change, an opening, towards heterodox views, and that comes mostly from experimental economics and behavioral economics,” he said.

>As Devine sees it, the neoclassical model that dominates economics has a subset — laissez-faire market economics — that he calls “more of a political commitment” than a scholarly consensus. So within the field, he said, economists like Blinder and Card (who subscribe to most of the mainstream tenets) are rebelling against that political orthodoxy, while the “experimentalists” working in behavioral economics or more fringe heterodox circles are chipping away at the neoclassical foundations themselves.<

-- Jim

EADS Insider Trading and Rule 10b-5

I find this shocking:

Shareholders and executives at Airbus parent EADS engaged in "massive" insider trading, a press report said Wednesday, citing a document that also alleges the government had been aware of difficulties at EADS prior to the lucrative sale of shares … It cited the AMF as describing the selling, which took place between November 2005 and March 2006, as "simultaneous and massive" in scale. It said problems in the key Airbus A380 superjumbo programme that led to a June 2006 profit warning had been raised as early as June 2005 in an EADS board meeting.

I don’t know anything about security laws in France but I am aware of what the U.S. calls Rule 10b-5:

This provision defines when a purchase or sale constitutes trading "on the basis of" material nonpublic information in insider trading cases

Financial economists define an efficient market as a market in which security prices reflect all available information and adjust instantly to any new information. But what happens when the senior management of a company fails to disclose material information in a timely fashion? Fraud on the market can occur in a couple of ways. Perhaps the easiest to grasp is the case when an insider provides information that is false. For example, the CEO of a pharmaceutical company might try to claim their in-process R&D is about to garner regulatory approval for a hit new drug even though he knows the recent lab tests were discouraging. His fraudulent information sends the stock price soaring, which allows the CEO to cash in by selling his stock at a price above the true value of the firm based on full and correct information. This EADS situation is a good example where had negative information been provided in a timely way, the stock price would have declined as soon as the negative information was realized both by insiders and the public. However, the insiders here decided not to let this negative information become public, which means the stock price remained about what it would have been under full information.