This past Memorial Day weekend, I spent some time thinking about the roots of the peace and prosperity we enjoy in this country. I live on a farm in Western Iowa, where green rolling hills planted in corn, soybeans, and alfalfa stretch for miles and miles, dotted intermittently with farmsteads, barns, and silos. When reading Tolkein, I always imagined that the Shire looked much like our community. We have friendly neighbors who are there to help in times of need, and we all work hard trying to make a living. We can live in peace because of what others have done before us. Let me mention a few of those people.
Within a mile of my home, two young men left home in the fall of 1941. My dad was one of them, and our neighbor, Lester Wells, was the other. I never knew Lester, as he did not return. But I knew his father, Earl, who is now deceased, was a fine man. His sister, Rosemary, is still my neighbor. I imagine Lester was a fine man, too. My father tried to look him up when he was overseas, as both of them served in the European theater. Seeing someone from home would be a welcome sight, but he learned that his neighbor and friend did not make it. So many did not make it. We must not forget them.
My father served in the Third Armored Division, which landed on Omaha beach and made their way through France, Belgium, and Germany during the war. They were in the Battle of the Bulge, and they witnessed the horrors of the internment camp at Nordhausen. They came face to face with the brutality of evil (yes, it does exist) and the hardships that must be endured to oppose it. To borrow the term from Stephen Ambrose, they were citizen soldiers, and they did their duty. And then they went home.
Before my dad left for the Service on December 6, 1941, he put the finishing touches on a barn that is found behind my home. Four years later, he returned and milked cows and stored hay in that barn. He then went on to work hard to make it possible for us kids to have a better life. He succeeded.
We also worked in that barn when I was growing up, and my children now have their horses and chickens in that barn. During cold spring days, our cows have their calves in that barn. It is a warm, sheltering place. It must have seemed so to him during cold nights in the Ardennes forest, when that barn seemed but a distant memory.
My father in law served in Korea, which was also no picnic. These fellows get less recognition for what they accomplished, as the fate of the free world did not seem to hang in the balance in that war. But if you asked the people in Seoul how they have fared in a democratic, thriving economy, as compared with their relatives in the North, we all know how they should answer. The folks who served there did not get paid much at the time, but in retrospect there are many who could now not pay them enough to thank them for what they did.
So, as you enjoy a good meal with family around you, and you look out on your equivalent of the Shire, please take a moment to think kindly of those who served, and who are serving now. These people have undoubtedly made the world a better place because they have been in it. From the past, it was men like Lester, who paid the ultimate price, and others like my dad and father-in-law, who gave us a magnificent legacy. As the future unfolds, it will be the young people who are serving in places in Iraq, Afghanistan, and in other far-flung regions, whom I hope that future generations will come to appreciate in the same way I appreciate the generations of the past.
I hope your Memorial Day was also meaningful.
EAM
Tuesday, May 31, 2005
Thursday, May 26, 2005
More on the Social Security Tax Base: S Corp Problems
George Yin, Chief of Staff on the Joint Committee on Taxation, testified before the Senate Finance Committee yesterday. A story in today’s BNA Daily Tax Report reports his discussion of the problem of S Corporations potentially eroding the social security tax base. Yin is a bright fellow, and his idea is worth mentioning.
S Corporations are often owned by the same people who work for them. As a result, the S corporation owner potentially receives income generated by the business in the form of a salary as well as in the form of investment returns. Unlike the C corporation, where there is an incentive to extract money from the corporate solution in a deductible form, such as a salary payment, to avoid two levels of taxation, the S corporation has only one level of tax on income imposed at the shareholder level. Thus, the S corporation shareholder has a reverse incentive: pay a low salary that will require the payment of little employment taxes, and pay the rest of the returns in the form of distributions. Both face the same income tax rates, but the distributions avoid employment taxes. Yin suggests that taxing all such income would result in net revenues of over $60 billion during the next ten years.
There probably is a need to fix this with some form of rulemaking, as gamesmanship on salaries to S corporation shareholders appears to pay off for their owners, who get to shirk a responsibility. Although heavy audit attention could uncover unreasonably low salary payments, this would be a costly effort. Moreover, since we are talking about reasonable compensation, there is some wiggle room involved. The rule may end up overtaxing them, however, to the extent that the business is capital intensive. I guess in that case you always have the option of moving to C corporation, though that has other detriments.
Yin is on the right track, as partners in partnerships don’t get this kind of opportunity. Neither do sole proprietors. Though I support the interests of small business owners, this is one area that needs reforming.
You can access Yin’s testimony here, http://finance.senate.gov/sitepages/hearing052505.htm.
EAM
S Corporations are often owned by the same people who work for them. As a result, the S corporation owner potentially receives income generated by the business in the form of a salary as well as in the form of investment returns. Unlike the C corporation, where there is an incentive to extract money from the corporate solution in a deductible form, such as a salary payment, to avoid two levels of taxation, the S corporation has only one level of tax on income imposed at the shareholder level. Thus, the S corporation shareholder has a reverse incentive: pay a low salary that will require the payment of little employment taxes, and pay the rest of the returns in the form of distributions. Both face the same income tax rates, but the distributions avoid employment taxes. Yin suggests that taxing all such income would result in net revenues of over $60 billion during the next ten years.
There probably is a need to fix this with some form of rulemaking, as gamesmanship on salaries to S corporation shareholders appears to pay off for their owners, who get to shirk a responsibility. Although heavy audit attention could uncover unreasonably low salary payments, this would be a costly effort. Moreover, since we are talking about reasonable compensation, there is some wiggle room involved. The rule may end up overtaxing them, however, to the extent that the business is capital intensive. I guess in that case you always have the option of moving to C corporation, though that has other detriments.
Yin is on the right track, as partners in partnerships don’t get this kind of opportunity. Neither do sole proprietors. Though I support the interests of small business owners, this is one area that needs reforming.
You can access Yin’s testimony here, http://finance.senate.gov/sitepages/hearing052505.htm.
EAM
Wednesday, May 25, 2005
Fed May Generate Inverted Yield
Over the past 25 years, the difference between long term rates, such as the 10-year U.S. Treasury, and short term rates, such as the 6 month U.S. Treasury, has dipped below zero (termed an inverted yield) very few times. However, each time that it has, the U.S. economy entered a recession.
Since 1959 the 10-year U.S. Treasury has exceeded the 6 month U.S. Treasury by an average of 1.46 percent. However from November 1980 to August 1981, the yield was inverted or negative. According to the National Bureau of Economic Analysis, the official recession dating organization, the U.S. entered a recession in July 1981. NBER determined that the next recession began in July 1990. While the yield did not decease below zero, it did plummet to an average of 0.37 percent between June 1989 and March 1990. According to the NBER, the next recession began in March 2001. In advance of this recession, the yield once again was negative or inverted. The difference between long rates and short rates was negative between August 2000 and December of 2000. At no other time between 1981 and 2005 did the yield drop below zero.
Why does a negative or very low yield signal a recession or slowdown? The Federal Reserve (Fed) determines short term rates, while the market determines long term rates. Thus when the Fed judges that inflation is excessive, they raise short term rates to cool inflation and slow the economy. If the market, made up of individuals across the globe, estimate that inflation is low and growth moderate, long term interest rates will remain low. In this case, short term rates rise while long-term rates decline or remain low and the yield becomes inverted. Thus inverted yields result essentially from Fed mistakes.
In June 2004 when the yield was 3.46 percent, the Federal Reserve began the first of eight interest rates hikes. By May 2005 as a result of the Fed action, the yield declined to 1.25 percent or slightly below the historical average. Moreover, the Fed has indicated that they will raise rates again at their next meetings June 29/30. In my estimation, further rate hikes will slow the U.S. economy below Fed intentions and market expectations.
Ernie Goss
Since 1959 the 10-year U.S. Treasury has exceeded the 6 month U.S. Treasury by an average of 1.46 percent. However from November 1980 to August 1981, the yield was inverted or negative. According to the National Bureau of Economic Analysis, the official recession dating organization, the U.S. entered a recession in July 1981. NBER determined that the next recession began in July 1990. While the yield did not decease below zero, it did plummet to an average of 0.37 percent between June 1989 and March 1990. According to the NBER, the next recession began in March 2001. In advance of this recession, the yield once again was negative or inverted. The difference between long rates and short rates was negative between August 2000 and December of 2000. At no other time between 1981 and 2005 did the yield drop below zero.
Why does a negative or very low yield signal a recession or slowdown? The Federal Reserve (Fed) determines short term rates, while the market determines long term rates. Thus when the Fed judges that inflation is excessive, they raise short term rates to cool inflation and slow the economy. If the market, made up of individuals across the globe, estimate that inflation is low and growth moderate, long term interest rates will remain low. In this case, short term rates rise while long-term rates decline or remain low and the yield becomes inverted. Thus inverted yields result essentially from Fed mistakes.
In June 2004 when the yield was 3.46 percent, the Federal Reserve began the first of eight interest rates hikes. By May 2005 as a result of the Fed action, the yield declined to 1.25 percent or slightly below the historical average. Moreover, the Fed has indicated that they will raise rates again at their next meetings June 29/30. In my estimation, further rate hikes will slow the U.S. economy below Fed intentions and market expectations.
Ernie Goss
Tuesday, May 24, 2005
Reputation and Trust: A Recent Survey
A recent press release from the American Institute of Certified Public Accountants (AICPA) touted recent research that showed positive perceptions of CPAs. (Their press release is available at http://www.aicpa.org/download/news/2005_0522a.pdf.)
CPAs have traditionally enjoyed solid reputations of trust among the public and in the business community. (I maintain my ACIPA membership to cheer me up when my brothers and sisters in the legal profession let me down.) However, after the Enron and Worldcom debacles, CPAs took a hit along with other professions. Although only a few actors were really responsible, an entire firm with very solid and talented professionals (some of whom I know personally) was professionally ruined. Unfortunately, professions can be tainted by a few bad experiences, and these got a lot of press.
Among those who know the profession best – business decisionmakers and executives – the accounting profession got favorable ratings of 97% and 95% respectively. These numbers are stunningly good. (With numbers that good, one wonders whether they polled only mothers of CPAs!) Investors were slightly lower at 89% -- as some were probably still smarting from losses. But it is remarkable how favorable these views are, given what has happened in recent memory.
One might wonder whether Sarbanes-Oxley has anything to do with an improved professional reputation. Through this legislation, Congress stepped in to fix what the profession’s own standards were apparently unable to accomplish. Interestingly, 80% of business decisionmakers thought that the accounting profession had taken steps to fix problems leading to past accounting scandals, while 70% of executives agreed. I would guess that a good number of these folks are familiar with the legislation, as they are probably impacted by it.
When it comes to investors, however, only 52% felt that the profession had taken steps to fix these problems. However, 71% of those investors admitted not being familiar with Sarbanes-Oxley. Thus, the investing public seems to have some lingering doubt about how much trust they are willing to commit. Some skepticism here is definitely healthy.
EAM
CPAs have traditionally enjoyed solid reputations of trust among the public and in the business community. (I maintain my ACIPA membership to cheer me up when my brothers and sisters in the legal profession let me down.) However, after the Enron and Worldcom debacles, CPAs took a hit along with other professions. Although only a few actors were really responsible, an entire firm with very solid and talented professionals (some of whom I know personally) was professionally ruined. Unfortunately, professions can be tainted by a few bad experiences, and these got a lot of press.
Among those who know the profession best – business decisionmakers and executives – the accounting profession got favorable ratings of 97% and 95% respectively. These numbers are stunningly good. (With numbers that good, one wonders whether they polled only mothers of CPAs!) Investors were slightly lower at 89% -- as some were probably still smarting from losses. But it is remarkable how favorable these views are, given what has happened in recent memory.
One might wonder whether Sarbanes-Oxley has anything to do with an improved professional reputation. Through this legislation, Congress stepped in to fix what the profession’s own standards were apparently unable to accomplish. Interestingly, 80% of business decisionmakers thought that the accounting profession had taken steps to fix problems leading to past accounting scandals, while 70% of executives agreed. I would guess that a good number of these folks are familiar with the legislation, as they are probably impacted by it.
When it comes to investors, however, only 52% felt that the profession had taken steps to fix these problems. However, 71% of those investors admitted not being familiar with Sarbanes-Oxley. Thus, the investing public seems to have some lingering doubt about how much trust they are willing to commit. Some skepticism here is definitely healthy.
EAM
Sunday, May 22, 2005
Snow on Chinese Trade
Sadly, but perhaps predictably, Secretary of Treasury John Snow recently declared, “Addressing imbalance in the global economy is a shared responsibility among the major economic regions of the world.” This, along with other less oblique statements, is intended to force, or at least encourage, the Chinese to de-link their currency to the U.S. dollar.
Be careful Mr. Snow. The outcomes from a sudden or quick decoupling could produce some very unexpected and potentially harsh outcomes for the U.S. economy. While the de-linking would almost certainly push the dollar lower against the Chinese Yuan increasing the price of Chinese goods in the U.S. and lowering the price of U.S. goods in China, it would have several deleterious impacts on the U.S economy.
First, by increasing the price of Chinese goods in the U.S., the move would contribute to higher U.S. inflation. This would, of course, force the Federal Reserve to more aggressively raise short-term interest rates. The current funds rate of 3.0 percent is the highest since the summer of 2001 and is still accommodative by historical standards. This simply means that the Fed, even without Chinese action, would be raising short term rates. Allowing the Chinese currency to float would mean even higher rates in the months ahead. Cheap Chinese goods have been an important factor restraining U.S. inflation.
Second, the trade deficit with China has meant that the Chinese central bank has accumulated a mountain of U.S. dollars over the past decade. They have used these dollars to buy U.S. Treasurys, particularly long term instruments. This action raises the price of U.S. Treasurys and lowers the yield (or effective interest rate) on them. This is an important factor that has produced what Alan Greenspan terms a “conundrum.” (Why are long term interest rates so low?) They are so low because our Asian neighbors, including China, have sent their accumulated dollars to the U.S. Treasury. They have been especially generous lenders to a gluttonous U.S. government and big-spending U.S. consumer.
While it is certainly correct that allowing the Chinese Yuan to float would lower the U.S. trade deficit with this very large trading partner, the Bush Administration must be prepared to deal with some of the negative consequences. Don’t let CNN’s Lou Dobbs bully you into unwise policy. I do support a market determined Chinese currency. However, the movement must be at a measured pace free from the demagogic blather of protectionists such as Senator Charles Schumer of New York.
Ernie Goss
Be careful Mr. Snow. The outcomes from a sudden or quick decoupling could produce some very unexpected and potentially harsh outcomes for the U.S. economy. While the de-linking would almost certainly push the dollar lower against the Chinese Yuan increasing the price of Chinese goods in the U.S. and lowering the price of U.S. goods in China, it would have several deleterious impacts on the U.S economy.
First, by increasing the price of Chinese goods in the U.S., the move would contribute to higher U.S. inflation. This would, of course, force the Federal Reserve to more aggressively raise short-term interest rates. The current funds rate of 3.0 percent is the highest since the summer of 2001 and is still accommodative by historical standards. This simply means that the Fed, even without Chinese action, would be raising short term rates. Allowing the Chinese currency to float would mean even higher rates in the months ahead. Cheap Chinese goods have been an important factor restraining U.S. inflation.
Second, the trade deficit with China has meant that the Chinese central bank has accumulated a mountain of U.S. dollars over the past decade. They have used these dollars to buy U.S. Treasurys, particularly long term instruments. This action raises the price of U.S. Treasurys and lowers the yield (or effective interest rate) on them. This is an important factor that has produced what Alan Greenspan terms a “conundrum.” (Why are long term interest rates so low?) They are so low because our Asian neighbors, including China, have sent their accumulated dollars to the U.S. Treasury. They have been especially generous lenders to a gluttonous U.S. government and big-spending U.S. consumer.
While it is certainly correct that allowing the Chinese Yuan to float would lower the U.S. trade deficit with this very large trading partner, the Bush Administration must be prepared to deal with some of the negative consequences. Don’t let CNN’s Lou Dobbs bully you into unwise policy. I do support a market determined Chinese currency. However, the movement must be at a measured pace free from the demagogic blather of protectionists such as Senator Charles Schumer of New York.
Ernie Goss
Thursday, May 19, 2005
Tax Reform: State Tax Deductions?
Taxes are always the product of a rate times a base. Our federal income tax is especially complicated because the rates vary, and the base is particularly complex due to varying deductions that can be taken by taxpayers.
One idea on the table for federal income tax reform involves broadening the base by eliminating the deduction for state and local taxes. This is a very controversial idea, since lots of folks pay these taxes and wish to reduce their federal taxable income by the amount they pay to the states. If there was no deduction, you would have a tax on a tax. That sounds bad, unless you consider the state and local tax burden as a form of consumption expenditure. Thus, you are paying for roads, schools, parks, and things like this that may benefit you. Of course, there are also expenditures for lots of things that don’t benefit you at all, and you may well be paying more than what seems to be your fair share. The federal government does not have a monopoly on wasteful practices.
The state and local tax deduction is an itemized deduction that is worth a lot to taxpayers. According to IRS statistics of income figures for 2002 (preliminary), taxpayers deducted a total of $289 billion in state and local taxes on their returns. This is second only to mortgage interest ($343 billion), and it is higher than the amount of charitable contributions deducted (136 billion). Some 44.7 million returns are affected, so this means a lot of voters are potentially impacted by this deduction.
Not all states are alike in their tax burdens, and citizens of high-tax states (and local jurisdictions) are especially concerned about the continuation of this deduction. I recently ran across a letter to members of the President’s Advisory Panel on Federal Tax Reform by a Congressman Charles Rangel (D, NY) on this topic, which I found interesting.
Congressman Rangel states that we should not change this deduction “so that we do not hinder the ability of State and local governments to finance their operations.” He notes that the Reagan administration had previously proposed to repeal this deduction, but “[t]hat argument was not very effective because most individuals want good roads, good schools and law enforcement, and they do not want the Federal government to take actions to increase the burden of the taxes necessary to fund those items.”
Whoa, there, Congressman. First, any Federal change here would have no impact on the authority of the states to finance their operations through taxation. They can go on taxing as they wish, subject only to the will of the people to stop them. Of course, you are on to something: taking away a federal deduction would mean that people would really have to pay the full burden of those state taxes, without getting a federal reduction that acts much like a subsidy. For example, assume a taxpayer in a 25% federal tax bracket incurs $10,000 of state and local taxes, which may otherwise be deductible. Since the $10,000 deduction reduces federal taxes by $2500, this taxpayer can effectively agree to have his legislature vote for spending, knowing that his real after-tax cost will be only 75 cents on the dollar. Some might call this a federal subsidy for the states.
Making citizens aware of the real cost of their taxes paid to whatever jurisdiction is a helpful precursor to encouraging accountability and responsibilty. It may also engender competition among states, leading to lower government costs for those who are willing to vote with their feet if they can't change the results at the ballot box. This kind of freedom is vigorous and affirming, though it vexes those who know how to spend other people's money and feel they have a right to do so.
Better accountability also addresses the second point of the good Congressman: those people who want good roads, schools and law enforcement – will have to pay the real tax burden for those improvements. And this is as it should be. We all want things, but we have to pay for them. Keeping those decisions at the level closest to the citizen is ideal.
Though broadening the tax base may seem troubling, it is an idea worth considering. Once again, it seems that the Reagan administration was on the right track.
EAM
One idea on the table for federal income tax reform involves broadening the base by eliminating the deduction for state and local taxes. This is a very controversial idea, since lots of folks pay these taxes and wish to reduce their federal taxable income by the amount they pay to the states. If there was no deduction, you would have a tax on a tax. That sounds bad, unless you consider the state and local tax burden as a form of consumption expenditure. Thus, you are paying for roads, schools, parks, and things like this that may benefit you. Of course, there are also expenditures for lots of things that don’t benefit you at all, and you may well be paying more than what seems to be your fair share. The federal government does not have a monopoly on wasteful practices.
The state and local tax deduction is an itemized deduction that is worth a lot to taxpayers. According to IRS statistics of income figures for 2002 (preliminary), taxpayers deducted a total of $289 billion in state and local taxes on their returns. This is second only to mortgage interest ($343 billion), and it is higher than the amount of charitable contributions deducted (136 billion). Some 44.7 million returns are affected, so this means a lot of voters are potentially impacted by this deduction.
Not all states are alike in their tax burdens, and citizens of high-tax states (and local jurisdictions) are especially concerned about the continuation of this deduction. I recently ran across a letter to members of the President’s Advisory Panel on Federal Tax Reform by a Congressman Charles Rangel (D, NY) on this topic, which I found interesting.
Congressman Rangel states that we should not change this deduction “so that we do not hinder the ability of State and local governments to finance their operations.” He notes that the Reagan administration had previously proposed to repeal this deduction, but “[t]hat argument was not very effective because most individuals want good roads, good schools and law enforcement, and they do not want the Federal government to take actions to increase the burden of the taxes necessary to fund those items.”
Whoa, there, Congressman. First, any Federal change here would have no impact on the authority of the states to finance their operations through taxation. They can go on taxing as they wish, subject only to the will of the people to stop them. Of course, you are on to something: taking away a federal deduction would mean that people would really have to pay the full burden of those state taxes, without getting a federal reduction that acts much like a subsidy. For example, assume a taxpayer in a 25% federal tax bracket incurs $10,000 of state and local taxes, which may otherwise be deductible. Since the $10,000 deduction reduces federal taxes by $2500, this taxpayer can effectively agree to have his legislature vote for spending, knowing that his real after-tax cost will be only 75 cents on the dollar. Some might call this a federal subsidy for the states.
Making citizens aware of the real cost of their taxes paid to whatever jurisdiction is a helpful precursor to encouraging accountability and responsibilty. It may also engender competition among states, leading to lower government costs for those who are willing to vote with their feet if they can't change the results at the ballot box. This kind of freedom is vigorous and affirming, though it vexes those who know how to spend other people's money and feel they have a right to do so.
Better accountability also addresses the second point of the good Congressman: those people who want good roads, schools and law enforcement – will have to pay the real tax burden for those improvements. And this is as it should be. We all want things, but we have to pay for them. Keeping those decisions at the level closest to the citizen is ideal.
Though broadening the tax base may seem troubling, it is an idea worth considering. Once again, it seems that the Reagan administration was on the right track.
EAM
Wednesday, May 18, 2005
Good Economics vs. Originalism (The Wine Dilemma)
On Monday, May 16, the United States Supreme Court issued its opinion in a matter of some interest to wine-lovers everywhere. This case, Granholm v. Heald, addressed a tension in Constitutional law between the 21st Amendment, which repealed prohibition and granted extensive rights to the states to regulate the sale of alcohol, and the Commerce Clause, which constrains the states from discriminatory treatment of in-state and out-of-state actors with regard to commercial sales.
The laws of Michigan and New York were both challenged in this case. Though both differed in details, they essentially either prohibited or set up a barrier that made it more difficult for out-of-state wineries to ship their products to customers in their states, while allowing in-state wineries to make such shipments. On one hand, this seems to be facial discrimination against out-of-state wineries, which is problematic under the Commerce Clause. On the other hand, clause 2 of the 21st Amendment provides:
"The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited."
Who is harmed but such laws? Well, for one thing, Michigan citizens are harmed. They can receive direct shipments of Michigan wineries, or they can buy from the retail establishments though in-person purchases. This means they are deprived of access to great products. Though I have had some Michigan wines that were very good (we have vacationed there often), I would not want to deprive myself of the products of small wineries elsewhere. Thus, if I were a Michigan resident, I would be hammering my local representatives to change this law.
However, some Michigan wineries might well think otherwise, as this law kept them from having to compete with some of the smaller wineries, which could not convince retailers to give them shelf space to market their products, and given their small output, may not even be able to do so. Their scarce output could be rationed efficiently, however, if they could ship to their customers directly. Thus, the smaller wineries were harmed, and they would not be protected by the political process in Michigan. They could not conceivably induce their customers to seek political change for them, so they chose the judicial route.
There is much that could be said about this opinion, but one point that really interests me is the tension between good economics and originalism. In this case, the barriers to trade erected by the states are inefficient and bad for consumers and business alike. They are protectionist measures, which may have some redeeming qualities (such as ensuring tax collections for the state), but on balance mean people are less well served in their quests for a product that they want. Such laws are prime targets for judicial action under the Commerce Clause, as Congress may always intervene and allow the states to do crazy things like this if they really want to do so. It keeps the states from competing unfairly, and benefits business and consumers alike. Five judges came down on this side of the decision, and majority rules.
On the other hand, originalism serves a valuable function, particularly if you are of a conservative persuasion, in providing a constraint on judicial power. Here, four judges on the court focused on the language of the 21st Amendment, which includes “in violation of the laws thereof”, as giving significant power to the states to structure laws governing liquor transportation. Though we moderns may look at a bottle of wine as just another product and no big deal, it was certainly a big deal to lots of people when the 21st Amendment was enacted. After all, only a few years before a majority voted to ban alcohol! This issue is raised in the dissent, and it presents a real dilemma for conservatives. Most of us want economic matters to be free from silly government constraints. But we also want to stick to the rules as they were written. Some more puzzling needs to be done here.
EAM
The laws of Michigan and New York were both challenged in this case. Though both differed in details, they essentially either prohibited or set up a barrier that made it more difficult for out-of-state wineries to ship their products to customers in their states, while allowing in-state wineries to make such shipments. On one hand, this seems to be facial discrimination against out-of-state wineries, which is problematic under the Commerce Clause. On the other hand, clause 2 of the 21st Amendment provides:
"The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited."
Who is harmed but such laws? Well, for one thing, Michigan citizens are harmed. They can receive direct shipments of Michigan wineries, or they can buy from the retail establishments though in-person purchases. This means they are deprived of access to great products. Though I have had some Michigan wines that were very good (we have vacationed there often), I would not want to deprive myself of the products of small wineries elsewhere. Thus, if I were a Michigan resident, I would be hammering my local representatives to change this law.
However, some Michigan wineries might well think otherwise, as this law kept them from having to compete with some of the smaller wineries, which could not convince retailers to give them shelf space to market their products, and given their small output, may not even be able to do so. Their scarce output could be rationed efficiently, however, if they could ship to their customers directly. Thus, the smaller wineries were harmed, and they would not be protected by the political process in Michigan. They could not conceivably induce their customers to seek political change for them, so they chose the judicial route.
There is much that could be said about this opinion, but one point that really interests me is the tension between good economics and originalism. In this case, the barriers to trade erected by the states are inefficient and bad for consumers and business alike. They are protectionist measures, which may have some redeeming qualities (such as ensuring tax collections for the state), but on balance mean people are less well served in their quests for a product that they want. Such laws are prime targets for judicial action under the Commerce Clause, as Congress may always intervene and allow the states to do crazy things like this if they really want to do so. It keeps the states from competing unfairly, and benefits business and consumers alike. Five judges came down on this side of the decision, and majority rules.
On the other hand, originalism serves a valuable function, particularly if you are of a conservative persuasion, in providing a constraint on judicial power. Here, four judges on the court focused on the language of the 21st Amendment, which includes “in violation of the laws thereof”, as giving significant power to the states to structure laws governing liquor transportation. Though we moderns may look at a bottle of wine as just another product and no big deal, it was certainly a big deal to lots of people when the 21st Amendment was enacted. After all, only a few years before a majority voted to ban alcohol! This issue is raised in the dissent, and it presents a real dilemma for conservatives. Most of us want economic matters to be free from silly government constraints. But we also want to stick to the rules as they were written. Some more puzzling needs to be done here.
EAM
Tuesday, May 17, 2005
Saving Social Security with Added Taxes
We are beginning to see more and more U.S. Senators and Congressional Representatitves state that they agree with all of President Bush's social security proposals except private accounts. In other words, "we all can agree that social security is in trouble and needs to be saved with addional revenue enhancements but we cannot accept private accounts.'
All this means is that the American working stiff will pay higher social security taxes without the opportunity to establish his/her own retirement nest egg. In addition to burdening the U.S. worker and employer, it does not save the social security system. The only thing that can save the system is for the federal government to cease overspending. A social security tax increase, likely termed a "bailout" will simply reduce the pressure on the Congress and the President to "live within their means."
Without private accounts, this is not reform.
Ernie Goss
All this means is that the American working stiff will pay higher social security taxes without the opportunity to establish his/her own retirement nest egg. In addition to burdening the U.S. worker and employer, it does not save the social security system. The only thing that can save the system is for the federal government to cease overspending. A social security tax increase, likely termed a "bailout" will simply reduce the pressure on the Congress and the President to "live within their means."
Without private accounts, this is not reform.
Ernie Goss
Saturday, May 14, 2005
Social Security Saga - part IV
In addition to reducing future benefits by cutting benefit formulas, there is another alternative to address benefits that is less direct: Tax them. This, of course, already happens, but it could get worse. Section 86 of the Code includes up to 85 percent of social security benefits in taxable income. Thus, assuming a taxpayer gets $100 in social security benefits, $85 could be included in taxable income. Assuming a marginal federal tax rate of 35%, that means you don’t get to keep $100 in benefits: you get to keep only $70.25 after paying $29.75 in federal income taxes. Of course, this amount could be even less if your state taxes such benefits. That, my friends, is a benefit cut of approximately 30% (oops, I’m using that “C” word, even though I’m not part of one of those groups who like to use it the most. Note, however, that I’m not going apoplectic when I use it.)
So, where does that leave us? Taxpayers earning wages are already paying more taxes and will continue to do so, regardless of whether Congress ultimately increases the cap on wages from the current rate of $90,000. That cap will raise automatically by wage indexing, and this means it will reach six figures shortly.
One solution for changing social security could involve raising taxes on all wage earners, but this will probably not be palatable to most politicians. It hits everyone, and the voting public might not like it if you raise their taxes.
A second solution, raising the earnings cap, will be politically easier for the politicians to swallow. It will only hit persons earning more than the current cap, though it will hit them (and their employers) hard. There are not many voters in this group, however, and that makes this group vulnerable to the class-warfare mentality. Make the rich guys pay, they say, even though this means a hit on a particular group that could potentially offset any tax savings from the rate cuts enacted under the Bush Administration.
A third solution, cutting benefit growth (and limiting the reduction to middle and upper income taxpayers) may be more politically palatable, as the hurt comes in the future. Voters would feel the pain of the loss of the income cap in the current year, but they would not feel this pain for some years to come due to the phase-in effects. However, they should make a current-year adjustment in personal retirement saving that could significantly affect current-year consumption, assuming they are really rational planners. (But there probably aren’t near enough of those.)
Both the second and third solutions outlined above, however, have a significant political cost to them: they force us to recognize that what we may like to view as a retirement savings program is really a form of intergenerational wealth redistribution that will look more and more like a welfare program. Blowing the cap (or raising it) will enhance the disparities between contributions and benefits. Ratcheting down benefit growth will add fuel to that fire. As noted in a previous post, the ultimate effect of reduced benefit growth on middle and upper income folk will someday (maybe in 100 years) mean that everyone gets the same benefit. That may suit you, comrade, but I’m not so comfortable with such a system.
Of course, other solutions could also be discussed, and these might include using general tax revenues to support the program. Some of the proponents of national sales or consumption taxes support this, though it, too, smacks of a general welfare program. If we recognize the significant redistributive element, and choose to enhance it, then it seems to me that there is no reason to limit the pain to wage earners – other forms of income could also be included so that those with investment income could share the burden.
Have a good weekend.
EAM
So, where does that leave us? Taxpayers earning wages are already paying more taxes and will continue to do so, regardless of whether Congress ultimately increases the cap on wages from the current rate of $90,000. That cap will raise automatically by wage indexing, and this means it will reach six figures shortly.
One solution for changing social security could involve raising taxes on all wage earners, but this will probably not be palatable to most politicians. It hits everyone, and the voting public might not like it if you raise their taxes.
A second solution, raising the earnings cap, will be politically easier for the politicians to swallow. It will only hit persons earning more than the current cap, though it will hit them (and their employers) hard. There are not many voters in this group, however, and that makes this group vulnerable to the class-warfare mentality. Make the rich guys pay, they say, even though this means a hit on a particular group that could potentially offset any tax savings from the rate cuts enacted under the Bush Administration.
A third solution, cutting benefit growth (and limiting the reduction to middle and upper income taxpayers) may be more politically palatable, as the hurt comes in the future. Voters would feel the pain of the loss of the income cap in the current year, but they would not feel this pain for some years to come due to the phase-in effects. However, they should make a current-year adjustment in personal retirement saving that could significantly affect current-year consumption, assuming they are really rational planners. (But there probably aren’t near enough of those.)
Both the second and third solutions outlined above, however, have a significant political cost to them: they force us to recognize that what we may like to view as a retirement savings program is really a form of intergenerational wealth redistribution that will look more and more like a welfare program. Blowing the cap (or raising it) will enhance the disparities between contributions and benefits. Ratcheting down benefit growth will add fuel to that fire. As noted in a previous post, the ultimate effect of reduced benefit growth on middle and upper income folk will someday (maybe in 100 years) mean that everyone gets the same benefit. That may suit you, comrade, but I’m not so comfortable with such a system.
Of course, other solutions could also be discussed, and these might include using general tax revenues to support the program. Some of the proponents of national sales or consumption taxes support this, though it, too, smacks of a general welfare program. If we recognize the significant redistributive element, and choose to enhance it, then it seems to me that there is no reason to limit the pain to wage earners – other forms of income could also be included so that those with investment income could share the burden.
Have a good weekend.
EAM
Thursday, May 12, 2005
The Contribution of Foreign Capital to U.S. Productivity Growth
Economic alarmists, such as Lou Dobbs of CNN fame, continue to argue for sealing the U.S. borders to economic forces from abroad. However, Tourau and I recently completed a study that shows the folly of such actions. U.S. Bureau of Labor Statistics data show productivity growth since 1995 roughly doubling the rate achieved over the preceding two decades. A rapid inflow of foreign investment paralleled the surge in productivity growth, suggesting a positive link between the growth of productivity and foreign capital. The goal of our study was to investigative this relationship and determine the extent to which foreign capital contributed to nation’s rapid productivity growth during this period. Using industry panel data, we found that foreign capital accounted for none of the nation’s productivity growth between 1988 and 1994, but twenty-six percent of U.S. productivity gain from 1995 to 1999.
To see the full paper go to:
http://www.outlook-economic.com/ResearchAndNews/Research/fdiprod5.pdf
To see the full paper go to:
http://www.outlook-economic.com/ResearchAndNews/Research/fdiprod5.pdf
Tuesday, May 10, 2005
Social Security Reform Saga - Part III (Benefits)
Following up on previous posts, today’s topic is benefit changes as a means to address Social Security reform. As an alternative to raising taxes, benefits can be reduced. There are many ways to accomplish this, and some are more devious than others.
Whenever we have a change in government benefits, there is first of all a terminology problem. Some groups (you can figure out who) want to call nearly every change a cut. So, for example, if we had previously grown spending on a particular issue by 5 percent, and we instead grow it by 3 percent, this is a “cut”. For those groups that believe in spending more and more, this applies to virtually every change in government funding, despite the fact that we are spending more than we spent last year.
One option being discussed today involves the manner of indexing benefit growth. A recent memo by the Congressional Research Service (April 22, 2005) helps to explain what is meant by “progressive indexing” of benefits. Basically, it works like this. Our current benefit structure is based on wage indexing. In other words, we increase the amount of future benefit levels based on the growth in wages that we measure over time. Due to such factors as greater worker productivity, wage growth generally exceeds inflation. (This is good, as it means we have more purchasing power and we can buy more stuff, assuming increasing tax rates don’t offset this growth. It also means that retirement benefit will tend to reflect the growth in the standard of living you have come to expect over your working career.)
Once you become eligible for Social Security benefits, your benefits then grow by an inflation-adjusted rate. This ensures that you have basic purchasing power parity over the term of your retirement.
The “progressive indexing” proposal wants to change the way that the preretirement benefits are calculated by moving away from wage indexing and toward price indexing, but only for upper income workers. Though the differences are small, over the long term it reduces the size of the benefit for average and upper-income workers, while leaving lower-income workers the same.
This can be understood by looking at the concept of replacement rates. These rates measure the percentage of the income history of the Social Security recipient that will be replaced by the benefit to be received. For so-called low-wage workers, social security replaces about 55 percent of career average earnings. Those with average wages get 41 percent, and those with the maximum get 27 percent. Given that tax rates are proportional for the first $90,000 of income (in 2005), that means the low-wage worker is getting a better deal than the upper-wage workers. Some of the upper-wage worker’s taxes are being redistributed to help out those with lower earnings.
If the benefits growth for average and upper income workers are changed, this disparity will grow. The CRS estimates that by 2080 (which will be long past the time I have reached room temperature) the replacement rate for the average wage worker will fall from 39 percent (as projected under current rules) to only 16 percent. Eventually (after say 100 years or so), they also note that the effect of changing indexing combined with wage growth rates could eventually mean all citizens get the same social security benefit, regardless of income.
It is hard to predict stable operations of a system for 75 or 100 years. We all know that no one has a crystal ball that clear. But changes in benefit structures need to be considered carefully for their political effects. The Social Security system has long been viewed as an entitlement that was bought and paid for over time by everyone’s payroll tax contributions. It has never been viewed as a welfare program. Even those who favor government growth, including Congressman Charles Rangel (D NY), don’t want to turn Social Security into welfare. Yet these same folks object strenuously to any proposal that turns retirees into owners of even a portion of the retirement funds. They instead want to keep them in a dependent status – getting whatever the government tells you that you can receive. You can’t have it both ways, though. Reducing the growth of future benefits selectively can, over time, turn Social Security into something quite different than it is now.
EAM
Whenever we have a change in government benefits, there is first of all a terminology problem. Some groups (you can figure out who) want to call nearly every change a cut. So, for example, if we had previously grown spending on a particular issue by 5 percent, and we instead grow it by 3 percent, this is a “cut”. For those groups that believe in spending more and more, this applies to virtually every change in government funding, despite the fact that we are spending more than we spent last year.
One option being discussed today involves the manner of indexing benefit growth. A recent memo by the Congressional Research Service (April 22, 2005) helps to explain what is meant by “progressive indexing” of benefits. Basically, it works like this. Our current benefit structure is based on wage indexing. In other words, we increase the amount of future benefit levels based on the growth in wages that we measure over time. Due to such factors as greater worker productivity, wage growth generally exceeds inflation. (This is good, as it means we have more purchasing power and we can buy more stuff, assuming increasing tax rates don’t offset this growth. It also means that retirement benefit will tend to reflect the growth in the standard of living you have come to expect over your working career.)
Once you become eligible for Social Security benefits, your benefits then grow by an inflation-adjusted rate. This ensures that you have basic purchasing power parity over the term of your retirement.
The “progressive indexing” proposal wants to change the way that the preretirement benefits are calculated by moving away from wage indexing and toward price indexing, but only for upper income workers. Though the differences are small, over the long term it reduces the size of the benefit for average and upper-income workers, while leaving lower-income workers the same.
This can be understood by looking at the concept of replacement rates. These rates measure the percentage of the income history of the Social Security recipient that will be replaced by the benefit to be received. For so-called low-wage workers, social security replaces about 55 percent of career average earnings. Those with average wages get 41 percent, and those with the maximum get 27 percent. Given that tax rates are proportional for the first $90,000 of income (in 2005), that means the low-wage worker is getting a better deal than the upper-wage workers. Some of the upper-wage worker’s taxes are being redistributed to help out those with lower earnings.
If the benefits growth for average and upper income workers are changed, this disparity will grow. The CRS estimates that by 2080 (which will be long past the time I have reached room temperature) the replacement rate for the average wage worker will fall from 39 percent (as projected under current rules) to only 16 percent. Eventually (after say 100 years or so), they also note that the effect of changing indexing combined with wage growth rates could eventually mean all citizens get the same social security benefit, regardless of income.
It is hard to predict stable operations of a system for 75 or 100 years. We all know that no one has a crystal ball that clear. But changes in benefit structures need to be considered carefully for their political effects. The Social Security system has long been viewed as an entitlement that was bought and paid for over time by everyone’s payroll tax contributions. It has never been viewed as a welfare program. Even those who favor government growth, including Congressman Charles Rangel (D NY), don’t want to turn Social Security into welfare. Yet these same folks object strenuously to any proposal that turns retirees into owners of even a portion of the retirement funds. They instead want to keep them in a dependent status – getting whatever the government tells you that you can receive. You can’t have it both ways, though. Reducing the growth of future benefits selectively can, over time, turn Social Security into something quite different than it is now.
EAM
Monday, May 09, 2005
Mother's Day & Music
I am going to vary off the usual topics today for the purpose of making some comments on events that took place this past weekend.
First, I want to mention Mother's Day. If you have a mother, I hope you recognized her contribution to your life. My mom has had so many positive influences in forming who I am today. Though my mom is now 81 and I am comfortably in middle age, I am still buoyed by her smile, her cheerful voice, and her enthusiasm that greets me every time we meet or we talk on the phone. I know that no matter how others may feel about me at the time, I can count on my mom to be in my corner. That is immensely comforting.
At our church, we did the traditional thing of honoring mothers on Mother's Day. Included in this ceremony was a tea bag with a quote from Eleanor Roosevelt: Women are like tea. You don't know how strong they are until they get in hot water. There is a lot of truth in that, I must say. So, hats off to mothers everywhere. You really have more influence in the world that many of us believe -- until we stop and think about all you have done for us.
Second, on a related topic, I also had some experiences with my kids this past weekend that are worth sharing. On Friday evening, my wife and I went to beautiful Atlantic, Iowa, for the southwest Iowa large group music festival. The folks in Atlantic have a wonderful, pristine town with nice people. It is worth the stop off of Interstate 80 just to drive through their community. You can sense a lot of commitment and community involvement there.
We witnessed several groups performing, including our daughter's group from St. Albert and our son's group from Treynor. All of these kids were immensely focused and enthusiastic about their music. They all put in long hours, and their directors (Mr. Spann and Mr. Jensen, respectively) and their accompanists (the lovely and capable Mrs. Schmitt and Mrs. Stephany) have such immense talent that they dedicate so thoughtfully and thoroughly to these kids. If you have a moment when you think the next generation is going the wrong direction, go attend a music concert at your local high school. You may be right about some kids, but these kids involved in music are making steps in the right direction.
Like most athletes, many of the students involved in high school music programs are not bound for professional careers in music. A few stars like Mr. Spann (who incidentally taught my son's director, Mr. Jensen, when he was a cub) will go on to long careers in teaching, while still others may go on to be performers in other capacities. However, most will simply go on to study other things that will ultimately for the basis for their work. But they will do so with the richness of the soul that comes from learning something about music, and the commitment to excellence in small things that this study engenders. My hat is also off to people like Mr. Spann and Mr. Jensen, and those who help them kindle a flame for truth and beauty in young people. These people are doing phenomenal good and they deserve more recognition for it.
Thanks for bearing with me on this digression.
EAM
First, I want to mention Mother's Day. If you have a mother, I hope you recognized her contribution to your life. My mom has had so many positive influences in forming who I am today. Though my mom is now 81 and I am comfortably in middle age, I am still buoyed by her smile, her cheerful voice, and her enthusiasm that greets me every time we meet or we talk on the phone. I know that no matter how others may feel about me at the time, I can count on my mom to be in my corner. That is immensely comforting.
At our church, we did the traditional thing of honoring mothers on Mother's Day. Included in this ceremony was a tea bag with a quote from Eleanor Roosevelt: Women are like tea. You don't know how strong they are until they get in hot water. There is a lot of truth in that, I must say. So, hats off to mothers everywhere. You really have more influence in the world that many of us believe -- until we stop and think about all you have done for us.
Second, on a related topic, I also had some experiences with my kids this past weekend that are worth sharing. On Friday evening, my wife and I went to beautiful Atlantic, Iowa, for the southwest Iowa large group music festival. The folks in Atlantic have a wonderful, pristine town with nice people. It is worth the stop off of Interstate 80 just to drive through their community. You can sense a lot of commitment and community involvement there.
We witnessed several groups performing, including our daughter's group from St. Albert and our son's group from Treynor. All of these kids were immensely focused and enthusiastic about their music. They all put in long hours, and their directors (Mr. Spann and Mr. Jensen, respectively) and their accompanists (the lovely and capable Mrs. Schmitt and Mrs. Stephany) have such immense talent that they dedicate so thoughtfully and thoroughly to these kids. If you have a moment when you think the next generation is going the wrong direction, go attend a music concert at your local high school. You may be right about some kids, but these kids involved in music are making steps in the right direction.
Like most athletes, many of the students involved in high school music programs are not bound for professional careers in music. A few stars like Mr. Spann (who incidentally taught my son's director, Mr. Jensen, when he was a cub) will go on to long careers in teaching, while still others may go on to be performers in other capacities. However, most will simply go on to study other things that will ultimately for the basis for their work. But they will do so with the richness of the soul that comes from learning something about music, and the commitment to excellence in small things that this study engenders. My hat is also off to people like Mr. Spann and Mr. Jensen, and those who help them kindle a flame for truth and beauty in young people. These people are doing phenomenal good and they deserve more recognition for it.
Thanks for bearing with me on this digression.
EAM
Thursday, May 05, 2005
Turning Social Security to Welfare
President Bush has proposed reducing the growth in future social security benefits for all but the lowest income individuals. If enacted, this proposal, along with other measures designed to penalize high income workers, will push the social security system more to a welfare program. As it currently stands, high income workers pay 5.7 times the social security taxes as low income workers yet receive only 2.5 times the benefits. Thus even the current system is biased in favor of low income workers (source: http://www.outlook-economic.com/ResearchAndNews/Newsletters/spring2005d.pdf )
In addition to President Bush’s penalty for high income workers, many in Congress have proposed eliminating the income cap on social security wages. Currently, income above roughly $90,000 is not subject to the social security tax—both the individual & employer contributions. Thus the mood among lawmakers is to force workers making more than $90,000 to pay the brunt of their overspending mischief. Not only will this ravage the retirement characteristics of the current system, it will slow economic growth in the economy as workers and employers send a higher share of their paychecks and profits to Washington in the form of higher taxes disguised as a down payment on a revamped retirement program. The only thing these proposals revamp is federal spending at the expense of the most productive members of the work force.
Ernie Goss
In addition to President Bush’s penalty for high income workers, many in Congress have proposed eliminating the income cap on social security wages. Currently, income above roughly $90,000 is not subject to the social security tax—both the individual & employer contributions. Thus the mood among lawmakers is to force workers making more than $90,000 to pay the brunt of their overspending mischief. Not only will this ravage the retirement characteristics of the current system, it will slow economic growth in the economy as workers and employers send a higher share of their paychecks and profits to Washington in the form of higher taxes disguised as a down payment on a revamped retirement program. The only thing these proposals revamp is federal spending at the expense of the most productive members of the work force.
Ernie Goss
Wednesday, May 04, 2005
Social Security Reform Saga - Part II
My previous post provided some basic background on Social Security financing. Here are some updated statistics from the Trustees Report, which was issued in March.
“The annual cost of Social Security benefits represents 4.3 percent of Gross Domestic Product (GDP) today and is projected to rise to 6.4 percent of GDP in 2079. The projected 75-year actuarial deficit in the combined Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) Trust Funds is 1.92 percent of taxable payroll, up slightly from 1.89 percent in last year's report. The program continues to fail our long-range test of close actuarial balance by a wide margin. Projected OASDI tax income will begin to fall short of outlays in 2017 and will be sufficient to finance only 74 percent of scheduled annual benefits by 2041, when the combined OASDI trust fund is projected to be exhausted.”
The Trustees also state:
"Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase of 15 percent in the amount of payroll taxes or an immediate reduction in benefits of 13 percent (or some combination of the two). To the extent that changes are delayed or phased in gradually, greater adjustments in scheduled benefits and revenues would be required. Ensuring that the system is solvent on a sustainable basis over the next 75 years and beyond would also require larger changes."
Thus, in addition to expanding the labor base (an alternative discussed previously) increasing payroll taxes or reducing benefits are other alternatives. (Whether a change in benefit computations are “benefit cuts”, as those on the democratic side of the aisle want to call them, is another matter. More on this later.) A fifteen percent increase in the 12.4 percent in payroll taxes, if applied across the board to both employers and employees alike, would move that total tax rate up to 14.26 percent.
Such a tax increase would affect all workers earning at or below the base amount for social security income, which is currently at $90,000. Everyone with earned income would pay these higher rates, and if that option was chosen, everyone would have benefits as calculated in the system as currently structured. For someone earning $20,000, that would mean that the employee share (one half of the total) goes from 6.2 percent to 7.13 percent, or an additional $186. At $90,000, that is another $837. Of course, this also means similarly higher taxes on the employer side.
This method of increasing taxes has the appeal of taking something from everyone to support a common social program. Everyone covered by the system (with earned income) pays. We don’t single out particular groups and make them pay for all of it, as would be the case if we raised the wage base. Moreover, the effect of that change is modest, rather than an immediate change in marginal rates from zero to the applicable rate, as occurs as wage bases are expanded. (And you should note – the wage base expands through indexing each year – so the marginal taxes on those at the margins do indeed increase each year under the current system.)
However, some would say that this tax is regressive. If you earn $1 million, you are still paying $837 more with this tax increase, which is only .0837%, rather than .93% of your income. Keep in mind, however, that the tax is paying for benefits that are limited, rather than proportional to income. Those earning $1 million are not getting any more benefits than those that earn $90,000, and the benefits of those earning $90,000 are not three times the benefits of those earning $30,000. The system has a redistributional element to it, which makes it a better deal for the lower-earning folks than it is for the higher-earning folks.
More to come.
EAM
“The annual cost of Social Security benefits represents 4.3 percent of Gross Domestic Product (GDP) today and is projected to rise to 6.4 percent of GDP in 2079. The projected 75-year actuarial deficit in the combined Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) Trust Funds is 1.92 percent of taxable payroll, up slightly from 1.89 percent in last year's report. The program continues to fail our long-range test of close actuarial balance by a wide margin. Projected OASDI tax income will begin to fall short of outlays in 2017 and will be sufficient to finance only 74 percent of scheduled annual benefits by 2041, when the combined OASDI trust fund is projected to be exhausted.”
The Trustees also state:
"Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase of 15 percent in the amount of payroll taxes or an immediate reduction in benefits of 13 percent (or some combination of the two). To the extent that changes are delayed or phased in gradually, greater adjustments in scheduled benefits and revenues would be required. Ensuring that the system is solvent on a sustainable basis over the next 75 years and beyond would also require larger changes."
Thus, in addition to expanding the labor base (an alternative discussed previously) increasing payroll taxes or reducing benefits are other alternatives. (Whether a change in benefit computations are “benefit cuts”, as those on the democratic side of the aisle want to call them, is another matter. More on this later.) A fifteen percent increase in the 12.4 percent in payroll taxes, if applied across the board to both employers and employees alike, would move that total tax rate up to 14.26 percent.
Such a tax increase would affect all workers earning at or below the base amount for social security income, which is currently at $90,000. Everyone with earned income would pay these higher rates, and if that option was chosen, everyone would have benefits as calculated in the system as currently structured. For someone earning $20,000, that would mean that the employee share (one half of the total) goes from 6.2 percent to 7.13 percent, or an additional $186. At $90,000, that is another $837. Of course, this also means similarly higher taxes on the employer side.
This method of increasing taxes has the appeal of taking something from everyone to support a common social program. Everyone covered by the system (with earned income) pays. We don’t single out particular groups and make them pay for all of it, as would be the case if we raised the wage base. Moreover, the effect of that change is modest, rather than an immediate change in marginal rates from zero to the applicable rate, as occurs as wage bases are expanded. (And you should note – the wage base expands through indexing each year – so the marginal taxes on those at the margins do indeed increase each year under the current system.)
However, some would say that this tax is regressive. If you earn $1 million, you are still paying $837 more with this tax increase, which is only .0837%, rather than .93% of your income. Keep in mind, however, that the tax is paying for benefits that are limited, rather than proportional to income. Those earning $1 million are not getting any more benefits than those that earn $90,000, and the benefits of those earning $90,000 are not three times the benefits of those earning $30,000. The system has a redistributional element to it, which makes it a better deal for the lower-earning folks than it is for the higher-earning folks.
More to come.
EAM
Tuesday, May 03, 2005
More on Social Security Reform - The Continuing Saga
Social Security is a matter that has received frequent attention on these pages. (See the archives for earlier missives). The current system is a giant scheme that essentially works like this: (1) Current workers (and their employers) pay taxes on earned income into the federal government; (2) The Federal government pays out benefits to current retirees; (3) Currently, we have an excess of payroll taxes coming in over and above the outflow to the current retirees, and the Federal government spends that, too; (4) When the government spend those dollars, they replace them with promises to pay them back (with interest) in the future. Sometime in the near future, the demands of current retirees will outstrip the supply of current payroll tax collections. The government will have to pay back some of those IOUs, with no more easy sources for spending.
Under this system, the retirement security of future generations depends on the payments of younger workers. If population trends would continue to increase, then this would work just fine. There would always be more workers to pay for the retiring generation, and we would have nothing to worry about. (Though I would still contend that we should worry about how much the government is spending. It is very good at that. Ronald Reagan was right when he compared the government to a baby with a voracious appetite on one end and no responsibility on the other.)
However, in most developed countries, population growth is not occurring through births. But it may be occurring through migration. Thus, one solution to the social security funding is to allow more immigration by younger workers. This has been happening, though not legally in most cases. It would also not involve hard choices like cutting benefits or raising taxes. Query: will Social Security play any role in future debates about immigration policy?
More to come on this soon.
EAM
Under this system, the retirement security of future generations depends on the payments of younger workers. If population trends would continue to increase, then this would work just fine. There would always be more workers to pay for the retiring generation, and we would have nothing to worry about. (Though I would still contend that we should worry about how much the government is spending. It is very good at that. Ronald Reagan was right when he compared the government to a baby with a voracious appetite on one end and no responsibility on the other.)
However, in most developed countries, population growth is not occurring through births. But it may be occurring through migration. Thus, one solution to the social security funding is to allow more immigration by younger workers. This has been happening, though not legally in most cases. It would also not involve hard choices like cutting benefits or raising taxes. Query: will Social Security play any role in future debates about immigration policy?
More to come on this soon.
EAM
Sunday, May 01, 2005
April Trade Numbers Point to Rising Trade Deficits
Our latest survey of over 800 businesses in 12 states indicates that the nation’s trade deficit is likely to continue to grow at a record pace in the months ahead. Despite a cheap U.S. dollar making imported goods more expensive and exported goods less expensive, firms report increasing growth of imports with an April import index of 59.3, up from March’s 57.1 and little change in export orders with an April new export orders index of 53.6, up only slightly from March’s 53.0. An index of above 50.0 indicates expansion while an index below 50.0 points to contraction. With growth in imports exceeding exports, the nation’s trade deficit is likely to remain at record levels in the months ahead with the monthly deficit rising above $60 billion for the third consecutive month when the U.S. Bureau of Economic Analysis releases the March deficit on May 11 and the April number on June 3.
What accounts for the lack of self-correcting in the deficit? That is, a cheapening of the value of the dollar should encourage greater exports and declining imports. However, Americans continue to consume oil, a large share which is imported, despite rapidly rising prices for gasoline and other oil-related products. Furthermore, America’s trading partners, particularly Europe and Japan, are experiencing economic growth at approximately one-fourth that of the U.S. Lethargic economies don’t demand rising imports even with lower prices.
For those of you out there traveling to Europe this summer, you are going to be paying more for less. You could instead visit China where the government links their currency to the U.S. dollar. Thus, those large trade deficits with China won’t reduce the value of your tourist dollar in Beijing, or anywhere else in this vast nation. The question for policymakers is, when will China tire of investing their acquired U.S. dollars in the American Treasury? That time will come and usher in a period of rapidly rising long-term interest rates for the American consumer.
Ernie Goss
What accounts for the lack of self-correcting in the deficit? That is, a cheapening of the value of the dollar should encourage greater exports and declining imports. However, Americans continue to consume oil, a large share which is imported, despite rapidly rising prices for gasoline and other oil-related products. Furthermore, America’s trading partners, particularly Europe and Japan, are experiencing economic growth at approximately one-fourth that of the U.S. Lethargic economies don’t demand rising imports even with lower prices.
For those of you out there traveling to Europe this summer, you are going to be paying more for less. You could instead visit China where the government links their currency to the U.S. dollar. Thus, those large trade deficits with China won’t reduce the value of your tourist dollar in Beijing, or anywhere else in this vast nation. The question for policymakers is, when will China tire of investing their acquired U.S. dollars in the American Treasury? That time will come and usher in a period of rapidly rising long-term interest rates for the American consumer.
Ernie Goss
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