On the Economy
The editorial page of the WSJ is at it again, torturing numbers until they confess to crimes they did not commit. In this case, they’re claiming that Mitt Romney’s tax rate is a lot higher than the 15% he himself has acknowledged, and that his tax records confirm. It’s a claim that requires considerable sleight of hand, as I’ll show. But more importantly, when you actually start to look at the tax code that applies to rich folks like Gov Romney, with all their income from investments as opposed to earnings, you get a sense of just how tilted tax policy is in their favor.
The Journal’s main point is this:
One reason investment income is taxed at a lower rate than wage and salary income is because it is a double tax—profits are taxed once under the statutory 35% corporate tax rate and then again when they are paid out to individuals as dividends.
But this is almost certainly not the case with income from private equity firms like Bain Capital, because they are invariably set up as “pass throughs,” meaning that profits face only the individual rates of the owners, not the corporate rate.
What about the corporations in which the PE funds invest? Don’t they pay the corporate rate and wouldn’t that be capitalized into their profits (which would be lower due to the corp tax)? But that’s not how the PE guys roll. They profit from buying and selling undervalued stock in the company, or for that matter, selling the undervalued company itself. The corp rate doesn’t come into play in either scenario (Dan Shaviro makes these points here).
And to the extent that these companies are themselves pass-throughs, the corporate rate again doesn’t apply. Based on Romney’s tax returns, it’s impossible to tell whether the capital gains he realized through these companies reflect corporate taxes at all (interestingly, Romney’s trustee actually made this point to the WSJ, which chose to ignore it).
Finally, remember this: PEs are masters of debt financing, and debt financing carries an effective tax rate of -6% because business interest can be deducted from your tax bill. For the highly leveraged PE crowd, debt financing is a tax shelter for other liabilities they face, including any corporate income that might slip through the cracks…if I were the WSJ here, I’d crow that Romney’s tax rate is actually 9% (15-6)!
Let me be clear: I’m not saying Gov Romney did anything wrong here—though I am saying that without dealing with all of the issues above, the WSJ’s claims are clearly unfounded. What’s wrong is the tax system itself—by favoring investment income, the excessive use of pass-throughs, and subsidizing debt financing, it’s even more distortionary and unfair than the WSJ editorial page.
The President gave a strong speech tonight, laying out what he called “a blueprint for an economy that’s built to last.”
The overall message of the economics in the speech—and it was largely an economics speech—was that there’s a lot we need to get done if we’re going to get this economy working for working people. More so than in any of his past SOTUs, he laid out a large number of quite specific policy initiatives. This wasn’t “win the future” with a long-term investment agenda. It was “build on the momentum we’ve got right now“ by creating incentives for manufacturers, skills for workers, jobs in fossil fuel extraction and clean energy innovation, all financed by a fairer tax code.
A few specifics that caught my ear:
Manufacturing: Mostly favorable tax treatment for domestic production and visa versa. There’s already a good bit of this in the tax code—about $40 billion this year alone in accelerated depreciation for equipment purchases and the production tax credit. But what the President laid out tonight was targeted at discouraging outsourcing and encouraging insourcing. He also introduced a minimum tax on overseas profits and jobs. We’ll have to see the details, but for years the President has tried to close overseas tax loopholes and hasn’t gotten very far. Perhaps this is a milder alternative—a minimum tax designed to prevent firms from just going to the lowest tax havens—that Congress could get behind. Not likely, in this Congress, but stay tuned.
His trade enforcement ideas are clearly targeted at China for their currency management, but there are lots of other non-tariff barriers that such a unit could usefully go after.
Use War Savings for Infrastructure: Some will call this a budget gimmick, and they’ll have a point in that this is money we’ve plugged into future budgets that we now know we’re not going to use for the wars (about $440 billion in savings over ten, half of which the President claimed for “rebuilding America”). But these bucks do count as “scorable savings” and especially given the current cost of borrowing and our infrastructure and job needs, I’m all for it.
Note that the President also announced here that he would sign an Executive Order “clearing the red tape that can slow down new infrastructure projects.” That could refer to environmental studies, but it could also refer to Davis-Bacon prevailing wage rules—that would be a big setback for construction workers.
Sectoral Job Training: I’m a big advocate of this—it may be the only kind of job training that reliably works right now. It’s basically partnerships between businesses and educators—usually community colleges—designed to identify specific pockets of future labor demand and train accordingly, as opposed to blanket training that’s not connected to actual job creation.
Of course, the key words there are “job creation.” We can’t fix what ails us on the supply side alone.
In this regard, and as expected, the President said:
Right now, our most immediate priority is stopping a tax hike on 160 million working Americans while the recovery is still fragile. People cannot afford losing $40 out of each paycheck this year. There are plenty of ways to get this done. So let’s agree right here, right now: No side issues. No drama. Pass the payroll tax cut without delay.
Energy: As noted above, a lot in the speech on both fossil fuel extraction and clean energy. On the latter, Congressional opposition to positioning America as a clean energy producing is terribly shortsighted but given that reality, the President announced “the largest renewable energy purchase in history”—one gigawatt to be purchased by the Dept of Defense, which is, in fact, a huge energy consumer. This is clever, but it’s not transformative. For that, we need new legislators.
Taxes: Nothing new here, though I think this is the first time the White House has attached a number—30%–to the Buffet rule (this would be the minimum effective rate for millionaires—from what I saw earlier today, Newt would be in compliance; Mitt, however, would be way out of line).
Re the predictable class warfare retort to this part, I thought this was a well-framed point about the tradeoffs in play here:
We don’t begrudge financial success in this country. We admire it. When Americans talk about folks like me paying my fair share of taxes, it’s not because they envy the rich. It’s because they understand that when I get tax breaks I don’t need and the country can’t afford, it either adds to the deficit, or somebody else has to make up the difference – like a senior on a fixed income; or a student trying to get through school; or a family trying to make ends meet. That’s not right. Americans know it’s not right. They know that this generation’s success is only possible because past generations felt a responsibility to each other, and to their country’s future, and they know our way of life will only endure if we feel that same sense of shared responsibility.
So what does it all mean? Many pundits stress, correctly, I think, that big speeches like this don’t usually amount to much. What does anyone have to show from last year’s SOTU?
But if you’re playing the long game here, and given partisan dysfunction, that’s the only game in town, the speech was another brick in the foundation the President began to build in Osawatomie, one I’ve followed up on in numerous places on this site.
We can and should argue about the details—your blueprint might be very different than the President’s (mine is outlined in the previous link and parts 1 and 2 in that series). But you’re either on the bus or you’re off the bus on this stuff. That is, you either recognize the need for such an economic blueprint or you don’t. The President does; his opponents do not. That, in a nutshell, was the contrast in tonight’s speech, and it’s what the campaign will ultimately come down to as well.
My CBPP colleagues have crunched some important numbers documenting the impact of Gov Romney’s fiscal plans. To me, their piece is the latest example of a truism in this biz: it’s easy to brag about how deeply you’re going cut if you stay up in the clouds; when you get down to earth…not so much.
The Gov’s problem starts with his proposal to cap federal spending at 20% of GDP (i.e., he could go lower, but he won’t go higher) and at the same time, increase defense spending to no less than 4% of the economy.
That leaves…um…let me see…carry the naughts…ahh—I’ve got it!: 16% of GDP for everything else!
As Jon Cohn pointed out last week, this implies massive spending cuts. From our report:
–If policymakers spread these cuts proportionately across all nondefense programs — including Social Security and Medicare — they would have to cut every program by 17 percent in 2016 and 24 percent in 2021.
–If policymakers protected both Social Security and Medicare, they would have to cut other programs 34 percent in 2016 and 50 percent in 2021.
What do such cuts mean to actual people? Well, cutting Social Security benefits by 17% by 2016 would reduce the average monthly benefit from $1,230 to $1,020 and push more than 2.6 million additional people into poverty. But Gov Romney has said he wants to protect current retirees and those 55 and up (like me!) from such cuts. Doing so would push that 17% to 24%, and put Medicaid and Medicare right in the crosshairs:
–Medicare would be cut by $153 billion in 2016 and $1.4 trillion through 2021. Achieving cuts of this size solely through reducing payments to hospitals, physicians, and other health care providers would threaten beneficiaries’ access to care. Thus, beneficiaries would almost certainly face large increases in premiums and cost-sharing charges.
–Medicaid and the Children’s Health Insurance Program (CHIP) would face cumulative cuts of $946 billion through 2021. Repealing the coverage expansions of the 2010 health reform legislation, as Governor Romney has proposed, would achieve more than the necessary savings. But it would leave 34 million people uninsured who would have gained coverage under health reform.
–Cuts in the Supplemental Nutrition Assistance Program (SNAP, formerly known as the Food Stamp Program) would throw 10 million low-income people off the benefit rolls, cut benefits by thousands of dollars a year, or some combination of the two. These cuts would primarily affect very-low-income families with children, seniors, and people with disabilities.
–Compensation payments for disabled veterans (which average less than $13,000 a year) would be cut by one-fourth, as would pensions for low-income veterans (which average about $11,000 a year) and Supplemental Security Income (SSI) benefits for poor aged and disabled individuals (which average about $6,000 a year and leave poor elderly and disabled people far below the poverty line).
As you see, such proposals may look pretty from the clouds, but on the ground, they provide a stark reminder of just what’s at stake in the forthcoming election.
I try to be careful not to get into the horse race aspects of things around here, but I thought Gov Perry’s rise and fall was notable in the following sense.
It takes a lot to run an effective primary campaign these days, with money and organization and name recognition often at the top of the list. But you also need to be a good debater. Gov Perry wasn’t, and his high scores on those other assets failed to offset that by a Texas mile.
Newt, on the other hand, is a sharp debater. And his lack of those other attributes, e.g., organization, has, at least for now, been largely offset by his debating prowess.
But here’s the thing: does being a good debater make you a good president? I can’t see that it does.
Republican candidate Mitt Romney believes his effective tax rate—the share of his income he pays in federal taxes is around 15%, or, as he put it, “probably closer to the 15 percent rate than anything.”
15% is the current rate on capital gains and dividends, which presumably comprise most of his income. The figure below, using data recently released by the Tax Policy Center, shows who mostly gets this type of income. To be clear, this is not yet the “bitter politics of envy”…so far, it’s just numbers.
Ordinary income, like paychecks, is taxed at a top rate of 35%, going to about 40% if the sun should ever set on the highend Bush cuts. The average effective rate for federal taxes these days is around 20%, about five points higher than Mitt’s. Basically, he’s paying what a middle class family—average income, around $65K, pays in federal taxes.
Is this a problem? Well, the fact that our tax code favors assets over wages is one factor behind the rise in income inequality. It’s also one reason we’re starved for revenues—this new report from the Joint Committee on Taxation shows that the favorable treatment of cap gains and dividends will cost the Treasury about $450 billion between 2011 and 2015 (that’s the whole American Jobs Act, right there!). Then there’s basic fairness…(whoops, straying from the numbers!)
And for what? The evidence doesn’t support the view that favoring asset-based income raises investment, productivity, or job growth.
Frankly, I doubt many people are envious about the above. I suspect few begrudge the wealth. What I think bothers people is the tax breaks on the wealth. And that’s more anger and disgust than envy. Just to be clear.
I’m pretty old school in that I believe elected officials are always worthy of respect, so I tried to be respectful in this dust up with Senator Pat Toomey on CNBC this AM. The thing is, it’s important not to let anyone—elected official or otherwise—mislead like this, especially when their version is just so contradictory to the truth.
Sen Toomey, who was a member of the failed supercommittee, argued that the President simply wouldn’t offer any help to the committee, nor would he countenance any cuts to entitlements.
Except for this:
In September, the President proposed a budget to the supercommittee. There’s a chapter in that budget document called “Health Savings” which proposes about $250 billion in Medicare savings and about $70 billion in Medicaid savings (both over 10 years).
When I pointed this out to the Senator, he complained about the lack of bipartisanship, reaching across the aisle, etc. But again, as I pointed out, the President’s proposals were exactly that—a reach across the aisle to an issue—entitlement cuts—about which R’s have been clamoring and frankly, as I noted in the clip, go well beyond many D’s comfort zone.
I’m sorry, but with respect, it is impossible to take such politicians’ calls for bipartisan compromise seriously when, on national TV, they refuse to acknowledge such efforts. The President is, at this point, well within his rights to say, “I tried.”
One question I was left with after reading this was why does the President score so low on that ratio? Why hasn’t he gotten more credit for what I believe history will ultimately judge as a record of remarkable accomplishments?
A few thoughts:
–The main reason is that people don’t do “counterfactuals”—things are getting better but still pretty bad for a lot of folks and pointing out that “it coulda been worse,” while true, is not…um…good politics. It didn’t help that the admin—and I played a role in this one—underestimated how high unemployment would go.
–On the other hand, where we were and where we are is (good politics, that is)…and good economics too (if we don’t accurately evaluate the impact of policies like the Recovery Act, we won’t be guided by lessons learned next time).
–A useful concept in this regard is what economists call the “swing”—(see table; and you thought we economists weren’t swingers!). It’s the difference between changes in a variable over two different periods. So if GDP was falling 9% last year and growing 4% this year, the swing—the change from how you were falling to how fast you’re now growing is 4%-(-9%), or 13%. The swings in GDP and jobs over the President’s first year in office are historically large.
–People don’t like bailouts. Saving the banks and autos was necessary but unpopular. I get why helping the banks was unpopular; I don’t really get why the autos weren’t. People particularly dislike bailouts when too little is asked of the recipients (again, this should have favored the autos, where creditors took haircuts, unions made concessions, execs were replaced…I think that story was just not well explained).
–Housing: missing from Sullivan’s review, these programs underperformed, and millions were hit by the bursting of the bubble.
–Stuff Kicks in Later : Health care reform, financial regulation, consumer protection—most people haven’t yet benefitted from these changes.
–A level of opposition heretofore unseen: when a national leader (senate minority leader Mitch McConnell) says out loud that his party’s #1 goal is not jobs, deficit reduction, improving education, the business climate, etc…but is instead defeating the President, you’re into some unchartered territory. These are the same folks that flirted with default on US debt. When one side is willing to self-inflict wounds of that magnitude on the body politic, it’s awfully hard for anyone to look good.
–Budget deficits: Polls show most people actually hold a reasonable view of federal budget deficits in that they don’t see them as our biggest problem right now (that would be “jobs”). But the echo chamber resounds with noise about all of our borrowing–Europe’s debt problems amplify the noise–and the admin has had trouble talking about the short-term imperative of more stimulus to attack unemployment at the same time as persuing the longer term imperative of getting on a sustainable budget path.
I’m sure there’s more, but those are some of the big ticket entries. Still, I could be wrong, but unless the economy heads south again, the truth of Sullivan’s survey will dominate in coming months. I may be way too optimistic about this, but you can’t fool all the people all the time.
This whole dust up over candidate Mitt Romney’s tenure at the private equity firm Bain Capital has been surreal. Obviously—I think it’s obvious—his R competitors who are attacking him, like Perry and Gingrich, are faux OWS’ers—it’s awfully hard to imagine they really have a problem with Bain and others like them.
But other than the fact that politicians can be hypocrites, is there anything voters can learn from this episode (and I suspect most of us already knew about the hypocrite thing)?
I think there is, and it has to do with how Gov. Romney thinks about economics. He keeps stressing how he understands the economy, while President Obama does not. But I submit to you that few people know what a person means when they claim to “understand the economy.” I know I don’t. Do you understand the economy like Arthur Laffer understands it or like Paul Krugman understands it?
For example, here’s an interchange that conveys a certain understanding—a not uncommon one, but a profoundly incomplete one.
A woman at a campaign stop complained that because her company moved out of state, she now faces a five-hour commute to work. What, she asked, would Gov Romney do to keep good jobs in Iowa?
According to this account: “Sometimes it’s counterintuitive,” replied Romney, a former businessman, explaining that businesses often invent new, more efficient ways to compete.
“The term is called productivity. Output per person,” he said. “Our productivity equals our income.”
I’m not playing “gottcha” here—his response wasn’t a gaffe. There are many in business, and many in economics, who believe this or something close to it—productivity is really output (or aggregated national income) divided by hours worked. And more output per hour provide the potential for higher living standards.
But here’s the rub: for decades, for most American workers, that potential has not been realized. Our productivity has anything but “equaled our income.”
In the decade of the 2000s, productivity grew 28% while real median household income fell 7%. Since 1979, productivity is up 84% and real median compensation, including fringe benefits,* rose 12%.
To me, and not just based on this snippet, of course, it sounds like Romney probably really does understand the part of the economy he’s come to know in his business career. It’s an economy whose metrics are return on investment, rates of profit, and particularly in the PE world, leverage, or debt financing, since a) profit margins for the PE guys are significantly amplified if they can borrow their investment capital, and b) there’s a huge tax advantage since they can deduct interest payments as a business expense.
You will note that the word “jobs” isn’t on that list. And the reason for that is very simple: the metric of job creation is not how PE firms measure their success. Grading PE firms on job creation is like grading chess masters on their ability to dunk the basketball. It’s a non-sequitur. Here’s one of Mitt’s former colleagues, quoted recently in the LA Times:
Bain managers said their mission was clear. “I never thought of what I do for a living as job creation,” said Marc B. Walpow, a former managing partner at Bain who worked closely with Romney for nine years before forming his own firm. “The primary goal of private equity is to create wealth for your investors.”
The economy that Gov Romney understands is the economy of Wall St., not Main St., and it’s by no means the only economy you want your president to understand. In today’s America, the president needs to understand the economy measured by middle-class incomes, paychecks, the quantity and quality of jobs, rates of poverty, income gaps.
And sure, the president must also understand that part of the economy measured by productivity and profits. But if he thinks understanding the latter is “understanding the economy,” he is dangerously wrong.
*It’s important to add benefits to this type of calculation so you’re not leaving off an important and growing part of the wage bill. To construct median compensation for this calculation, I multiplied the median wage by the ratio of aggregate compensation to aggregate wages. This essentially assigns the average benefit package to the median worker, which is too generous. And you still get the large gap stressed in the text.
The Chairman of the White House Council of Economic Advisers, Alan Krueger, gave a great talk on inequality the other day, definitely worth a read (slides here, though why they’re not in the same doc as the talk is beyond me).
What’s particularly notable about Alan’s approach to the issue is his emphasis on the consequences of such high levels of income inequality as have developed here in the US. Too often, analysts just cite the problem without explaining why it’s a problem.
Alan focuses on inequality’s negative impact on macroeconomic growth, and thus job growth. That’s obviously extremely important, given our recent history (predating the Great Recession) as shown here.
But the consequence I wanted to amplify was one I’ve discussed frequently: the link between higher inequality and diminished mobility. Check out this slide from Alan’s talk (above).
This scatter diagram compares something called the “intergenerational earnings elasticity” (y-axis) with a measure of income inequality on the x-axis. The former measure links kids’ earnings when they’re adults to that of their parents. It’s one of those “how-far-does-the-apple-fall-from-the-tree” metrics, wherein higher numbers represent less mobility. So, basically, this figure is asking whether countries with higher inequality are countries with less mobility. Clearly, the correlation is strong.
The points cluster around an upward sloping line, indicating that countries that had more inequality across households also had more persistence in income from one generation to the next…Countries that have a high degree of inequality also tend to have less economic mobility across generations.
This is extremely important in the political debate. We often hear politicians claim that we shouldn’t worry about growing inequality—Romney’s taken to calling such concerns “the bitter politics of envy”—because we’ve got the mobility to offset it. Not only is that wrong on the facts—you actually need more mobility to offset more inequality, and mobility has certainly not been increasing. But it also appears to be the case that higher inequality is itself associated with less mobility.
The transmission mechanisms for this are not well known, but surely have to do with educational access, employment networks, and so many other mobility enhancers that grow further from the reach of the have-nots in a highly unequal society…things like quality pre-school, good libraries, safe neighborhoods, environmental benefits, stimulating vacations and summer camps, and so on.
One of the saddest things is life—and one of the most wasteful, from the economy’s perspective—is a child blocked from realizing his or her potential. That’s what’s embedded in the slope of that graph and it’s something this nation needs to elevate to its top problem.
Here’s a thought: instead of all these budget deficit commissions that never amount to anything anyway, how about we get serious about tackling income mobility?
…but not to their own facts.
When Republican presidential candidate Mitt Romney asserted that federal low-income programs are administered so inefficiently that “very little of the money that’s actually needed by those that really need help, those that can’t care for themselves, actually reaches them,” my colleagues at the CBPP got to work on this graph.
It shows that “federal administrative costs range from less than 1 percent to 8 percent of total federal program spending. Combined federal and state administrative costs range from 1 percent to 10 percent of total federal- and state-funded program spending.”
Gov Romney is singing from the same playbook as Rep Paul Ryan along with a litany of conservatives whose goal for years has been for the Federal gov’t to shed the responsibility for Medicaid, food stamps (SNAP), low-income housing, and so on. Once you “block grant” these functions to the states, it’s easier to cut them. And remember, this is from a candidate (and the same is true for the House R’s budget) that wants to cut taxes deeply for the richest households.
So he’s launching his attack based on inefficient administration—the claim that most of the dollars don’t reach the clients. Trouble is, the facts got in the way.
Many people argue that Gov Romney is the reasonable R candidate…you might not love his policies, they tell me, but he’s not known for making stuff up, for repeating outrageous statements with no basis in fact.
OK, let’s see—if he keeps repeating this falsehood, then they’re wrong.
I know these are dark times for substantive debate, but there are people out there to whom facts still matter and they need to know when someone asking for their vote is trying to mislead them.