Saturday, October 11, 2008

Ignorance keeps up from saving ourselves

The article below explains why we are powerless to save ourselves. My comments are in italics.

U.S.News & World Report
As the Economy Sinks, So Do Odds of a Tax Cut
Thursday October 9, 6:15 pm ET

By Rick Newman

One of the riskiest financial moves you make this year could be listening to the presidential candidates--and banking on a tax cut after the November elections.
John McCain and Barack Obama both promise that widespread tax cuts will be one major way they'll revive the economy and help lift consumers' sagging spirits. They differ, of course, on who should enjoy the largesse. McCain wants to cut estate and corporate income taxes, and extend broad-based tax cuts that were enacted earlier this decade. Obama agrees about extending some of those Bush era tax cuts, while offering lots of other relief to people earning less than $250,000 and raising taxes on the wealthy.

But here's what you're not likely to hear either candidate say before Election Day on November 4: There's no money left for tax cuts. And a slumping economy--now almost certainly in recession--will make it hard to pass tax cuts for the next couple of years, and maybe longer.

"There's no money left for tax cuts." That is an absolutely absurd statement. Where did the $700 billion suddenly come from for the bailout plan? Where did the money to fight WWII come from? Did we save up after WWI thinking that we'd better sock away some money for another World War??? This is gold standard thinking--the idea that the government is somehow constrained. Thinking like this, in all its forms, about debt, deficits, debt limits, etc widespread and the reason why we can't save ourselves.

One obvious reason is the huge, unexpected bill for bailing out banks and other firms saddled with bad debts. All told, the government has committed more than $1 trillion in public funds to help the financial sector get back on its feet. That's more than one third of the government's entire budget in a given year. The feds (and the taxpayers) might get some of the money back--but nobody will know for years.

The Fed has alread lent out more than $2 trillion. Where did that money come from?? It's just credits to the banking system. Accounting entries. That's all.

Meanwhile, the Congressional Budget Office recently took a much gloomier view of the future, casting a cloud over both candidates' tax-cut plans. For most of the year, CBO had been projecting that government revenues would be more or less in line with spending over the next 10 years. But with the economy spiraling into recession, CBO now projects that the government will spend $2.3 trillion more than it brings in over the next decade. And that's before accounting for any bailout costs.

Yes and that deficit will be the "shock absorber" that, hopefully, sustains some level of demand and keeps us out of depression.

Such huge deficits will make it hard for Congress to justify any additional funding for tax cuts. "The next president is going to be strongly tied by what's happened over the last year," says Tom Cooley, dean of New York University's Stern School of Business. "It's dubious that any of these tax-cut plans will get through."

It's a political constraint, not an operational constraint. We impose these silly limits on ourselves.

Here are the prospects for a variety of scenarios:

If McCain gets elected. The estimated cost of McCain's tax cuts over five years is $1.48 trillion, according to the nonpartisan Tax Policy Center. The most costly part of McCain's plan would be the permanent extension of the Bush tax cuts from 2001 and 2003, which lowered taxes for most Americans. Those extensions would amount to $585 billion of lost government revenue, compared to letting tax rates go back to their earlier levels. And if there's any good news for taxpayers, it's that most of the Bush tax cuts are likely to stay in place, regardless of who wins in November. "Resetting them would amount to raising taxes when the economy is not doing so well," says Roberton Williams of the Tax Policy Center. "That harkens back to Herbert Hoover and the Great Depression." If the Bush cuts do become permanent, most workers won't notice--their paychecks will stay the same.

The phrase, "lost government revenue" is ridiculous. The government spends in its own money. The money to pay taxes and purchase securities comes from government spending, not the other way around. Think of "lost government revenue" as revenue retained or gained by the non-governmental sector, which means, us!!

McCain's other ideas--like lowering the estate tax and making other changes in the tax code that would favor higher earners--would probably meet a tough audience in Congress. By most projections, both houses of Congress will remain in Democratic hands, and there won't be much of a welcome mat for a Republican president hoping to lower taxes on the wealthy.

If Obama gets elected. The estimated cost of Obama's tax cuts over five years is $967 billion, according to the Tax Policy Center. Obama also favors the extension of many of the Bush tax cuts, though he'd repeal some that benefit higher earners. In addition, Obama frequently says that under his plan, many people who earn less than $250,000 will pay lower taxes through a variety of credits that target groups like working parents with kids and seniors who make less than $50,000.

The problem with Obama's plan is that once it gets to Congress, choosing from a long list of targeted tax credits would fuel bitter fights over who deserves help and who doesn't. Even with Democrats in charge on Capitol Hill, there are fiscal conservatives in both parties sure to oppose the passage of Obama's expensive tax cuts in full. And some of his ideas--like rebates for people who don't even earn enough to pay taxes--are controversial even among Democrats.

Obama has already termed his plan, "a net spending cut." That equates to a reduction in aggregate demand for the economy at a time when we are facing an economic depression!

With the economy rapidly deteriorating in the last months of the campaign, some analysts foresee the next president holding a 21st century fireside chat to explain the dire reality to his fellow Americans. "He could say, 'The economic situation is a lot worse than I expected, and we're going to have to put this off,' " predicts Williams of the Tax Policy Center. "Nobody's going to say that in the campaign, but I think that will be the first speech either one of them gives in office." That would still leave time for the next president to cut taxes later in his first term--allowing him to save face and still say he fulfilled his tax-cut promises.

"Putting things off" is not what President Roosevelt said in his fireside chats. He ramped up government spending and that got us out of the Depression.

No matter who gets elected, a second stimulus plan is starting to look more plausible than a quick round of permanent tax cuts. Democratic House Speaker Nancy Pelosi has already called for a second set of rebate checks to be sent to consumers, matching the $150 billion worth of checks sent out earlier this year. That won't happen before the election, because Congress isn't in session, but it could happen right afterward, even before the next president takes the oath in January. Pelosi's plan coincides with a smaller stimulus plan that Obama is calling for, and McCain, like Obama, favored the first stimulus plan. So, it's plausible that instead of tax cuts, many Americans could find another $600 or $1,200 check in their mailboxes sometime next spring.

Oh great, more I-Phone sales with rebate checks! When will we learn? We need investment in the wealth producing capital stock of this nation. An infrastructure program, investment in alternative energy. Health care investment. Much higher levels of education investment. These are what's needed now.

If there are no meaningful tax cuts, then the wealthy could be the unintended beneficiaries of Washington's red ink, at least for a while. If there are no middle-class tax cuts, then there's no need to raise taxes on the wealthy in order to pay for them, as Obama's plan calls for. Obama, if elected, could still burnish his populist credentials by calling for some sort of tax hike on corporations or the top 1 percent of earners. But odds are he'd get shouted down. In the midst of a scary recession, many economists have already been pointing out the devastating effects of Herbert Hoover's 1932 tax increases, widely blamed for deepening the Depression. By next January, the economy will be scary enough. No president will want to risk making it worse.

Bottom line: we can fix all of this, but stupid thinking will keep us from doing so.

2 comments:

Paul said...

After last weeks performance I will be starting to selectively put some money to work in the equities markets. On the grounds that emotion and capitulation are running the market without any reference to fundamentals.

However, at a time when I and my countrymen are looking to the US to guide us through this period, I keep reading comments like this:
"Fri Oct 3, 9:07 PM ET
(AP) -- California should not get an emergency loan from the U.S. government because the move may lead to more states asking for federal money, House Financial Services Committee Chairman Barney Frank said.

Frank said passage of a $700 billion financial-rescue package being considered today in Congress may mean the loan "might not be necessary." "

To be fair my own countries politicians are saying simarlaly stupid things. However, these comments leave me with an uneasy feeling that things could get worse before they get better. On the flip side the previous post on "Freddie and Fannie" are signs that maybe someone has figured out that they will need to circumvent the political process. Mr Paulsen?. Good News.

Another commentator has given a good appraisal of the current process that we are in worlwide. I copy it here as a matter of interest. There are a couple of points I had not considered before:

"Here is our analysis.

1. Our system has created a climate where banks will not lend with each other. Why not? After Lehman was allowed to fail, no one knows which financial institutions will get government support. Why lend to an institution that might not deliver?
2. We are de-leveraging at Warp speed, since any write down at one institution ripples through the entire system as required by FAS 157 mark-to-market rules.
3. The lenders to hedge funds, all becoming regular banks, now have more conservative business models. Leading fund manager Ken Heebner made this point tonight on Kudlow. See the video here and here. The hedge funds can no longer take a strategy that makes 5 or 6 percent a year and leverage it five times. This means that hedge funds are selling -- forced selling -- the good with the bad.
4. Individual investors are dumping their mutual funds, as they always do in times of stress. "

Full text at:
http://oldprof.typepad.com/a_dash_of_insight/
(I have no affiliation).

Great interview with Bob Mcteer! Keep up the good fight!

Regards
Paul

Mike Norman said...

These politicians should keep a wary eye on Europe now. The countries within the eurozone are like states within the U.S. and they have no "Federal Authority" to come up with loans for them. As banks continue to fail their depositors will be wiped out and it will lead to social chaos. Let California and other states go, and you have the same thing here. The Federal Gov't should be prepared to be the lender of last resort, especially to a state that represents a huge chunk of GDP. To even consider anything else is being foolish.