Author: James Kwak

Once More, With Feeling*

By James Kwak

Peter Orszag wrote an article for the latest Democracy** about political dysfunction and the “looming fiscal showdown” at the end of this year. A lot of it is a warmed-over description of political polarization, although Orszag ignores one of its most important causes: the growing influence of money in politics and the resulting need for politicians to go chasing after contributions from extremist billionaires. (Orszag instead subscribes to the theory that political polarization results from public polarization, which has been pretty well debunked by Fiorina and Abrams.)

Orszag’s recommendation, however, is spot-on: First let the Bush tax cuts expire; then, assuming that economic stimulus is necessary, push for a big, across-the-board, temporary tax cut. (Orszag proposes a payroll tax cut and an increase in the standard deduction; I’ve previously proposed a payroll tax cut.)

Continue reading “Once More, With Feeling*” →

Why Raise Taxes on Poor People?

By James Kwak

My Atlantic column today is on the bizarre fixation that some conservatives have with taxing poor people, pointed out by Bruce Bartlett in his latest column. Here’s one explanation:

The other, even-more-disturbing explanation, is that Republicans see the rich as worthy members of society (the “producers”) and the poor as a drain on society (the “takers”). In this warped moral universe, it isn’t enough that someone with a gross income of $10 million takes home $8.1 million while someone with a gross income of $20,000 takes home $19,000. That’s called “punishing success,” so we should really increase taxes on the poor person so we can “reward success” by letting the rich person take home even more. This is why today’s conservatives have gone beyond the typical libertarian and supply-side arguments for lower taxes on the rich, and the campaign to transfer wealth from the poor to the rich has taken on such self-righteous tones.

Also, in some housekeeping news, I’ve switched to a personal Twitter account, @JamesYKwak. My blog posts should generate tweets in that account; Simon’s should generate tweets in the old account, @baselinescene. I’ll try to aggregate all the stuff I write in various places in my new Twitter stream.

The Baseline Scenario Facebook page should be aggregating both of our Twitter streams, but I had a little difficulty with it on Monday, so who knows. It seems like Facebook changes the way everything works every other Tuesday, so you never know when something will break.

Does Lindsey Graham Think Before He Opens His Mouth?

By James Kwak

“The debate on the debt is an opportunity to send the world a signal that we are going to remain the strongest military force in the world. We’re saying, ‘We’re going to keep it, and we’re going to make it the No. 1 priority of a broke nation.’  ”

That’s Lindsey Graham, as reported in the Times today (emphasis added).

Graham is trying to make the case that we should undo the automatic reductions in defense spending mandated by the Budget Control Act of 2011 (last summer’s the debt ceiling compromise). But as a conservative Republican, he is also wedded to the notion that the United States is “broke.” (Which, of course, is nonsense. If you’re not sure why, see chapter 5 of White House Burning.) Graham has also signed the Taxpayer Protection Pledge, meaning that the federal government can only solve its fiscal problems by cutting spending, not increasing tax revenues.

To make this balancing act work, Graham makes the claim that a country that is “broke” (again, his word) should continue to make military spending its top priority—including military intervention in both Syria and Iran. Does he really think that, under that assumption, we should continue slashing domestic spending so we can continue paying for expensive overseas adventures? Yet this is the unavoidable, nonsensical conclusion of today’s Republican orthodoxy.

Facebook’s Long-Term Problem

By James Kwak

Facebook went public a week ago, to great embarrassment. NASDAQ creaked under the strain and, more important, the price dropped from an offer price of $38 to as low as $27 over the next week as investors decided that Facebook wasn’t so exciting now that anyone off the street could buy it.

In the long run, this could become a footnote. (Remember all the criticism of Google’s IPO?) With over $200 million in profits per quarter, Facebook’s P/E ratio is still less than 100, which isn’t bad for an Internet company that dominates its market and hasn’t fully opened the advertising spigot yet.

In the long term, Facebook’s ambition is to succeed Google (or Apple, depending on how you see it) as the dominant company on the Internet. And that’s where its real problems lie.

Continue reading “Facebook’s Long-Term Problem” →

Why Markets Won’t Fix JPMorgan

By James Kwak

Jonathan Macey, a former professor of mine at Yale Law School,* recently wrote an op-ed for the Wall Street Journal (paywall; excerpts here) arguing that we shouldn’t worry about JPMorgan’s recent trading loss because market forces will ensure that the bank does a better job next time. Here’s a key paragraph:

“Thus, far from serving as a pretext to justify still more regulation of providers of capital, J.P. Morgan’s losses should be treated as further proof that markets work. J.P. Morgan and its competitors will learn from this experience and do a better job of hedging the next time. They will learn because they have to: In the long run their survival depends on it. And in the short run their jobs and bonuses depend on it.”

Macey’s central point is that companies don’t like losing money, so losing $2 billion means that they will do a better job of figuring out how not to lose money in the future. That’s obvious. But it’s also beside the point.

Continue reading “Why Markets Won’t Fix JPMorgan” →

Because They Can

By James Kwak

It seems as if the Republicans, meaning both John Boehner and Mitt Romney, are trying to turn the national debt back into a major political issue. Now, a visitor from Mars might wonder how this is possible. How could a party that (a) passed the massive tax cuts that were the single largest legislative contributor to today’s record deficits, (b) increased spending rapidly the last time it controlled the federal government, and (c) cannot talk in detail about anything except deficit-increasing tax cuts possibly think that calling attention to deficits could be a political winner?

Well, despite the Republican Party’s abysmal record when it comes to fiscal responsibility, it could still turn out to be smart politics, for a few reasons. One is that many Americans reflexively associate large deficits with excessive spending, even though reductions in tax revenues have played just as big a role since George W. Bush became president. (Compare, for example, receipts and outlays in 2000 and 2011 as a percentage of GDP.) Then they associate excessive spending with Democrats, although the only president to reduce spending significantly in the past forty years was Bill Clinton. It turns out that if you repeat the same tired attack lines year after year—Democrats are all tax and spend liberals, for example—people believe them.

The other, more important reason why Republicans like talking about the national debt is that Democrats don’t have a good response. Sure, Democrats have lots of policy proposals, and theirs make a good deal more sense than the Republicans’; it was President Obama who proposed trillions of dollars in spending cuts and tax increases, which is what people supposedly want (according to opinion surveys, at least).

But most Democrats just don’t like talking about deficits and the national debt. They think it’s a distraction from talking about jobs and unemployment, or they think simply broaching the subject is succumbing to a vast right-wing conspiracy to slash entitlements, or both. The result is that there is no liberal progressive position on the national debt. There’s the Republican one (Romney, Boehner, Ryan), which is to cut taxes (boggle); and there’s the Obama one, which is basically the Republican-Lite position of George H. W. Bush, and which many liberal Democrats run away from. On the left, all there is is a vague belief that you can balance the budget by increasing taxes on the rich, but no one really wants to come out and say it. (Also, the numbers don’t add up unless you’re willing to boost the tax rates on millionaires to very high levels; just, say, repealing the Bush tax cuts for the rich won’t cut it.) Instead, the strategy is to demonize RyanCare, which is effective as a short-term tactic, but doesn’t really amount to a coherent message on the national debt.

This is one reason why I wrote White House Burning. I say “I” because Simon probably wouldn’t call himself a liberal, but I do call myself a liberal, and I think liberals need to have a coherent message on the national debt. I think the message should be something like this: the national debt is a real problem that needs to be addressed; we need to address it in the way that’s best for the American people as a whole; that means preserving the social insurance programs that almost everyone depends on; and we can preserve those programs, while bringing the debt under control, through a set of policy changes that make sense on their own grounds (eliminating distorting subsidies, eliminating tax expenditures, introducing Pigovian  taxes like a carbon tax and a financial activities tax).

You don’t have to agree with our recommendations. But as long as the liberal wing of the Democratic Party has nothing to say about the national debt, conservatives will be free to lead the debate, and the most likely outcome will be some sort of compromise between the moderate Republican Barack Obama an the now-“severe” conservative Mitt Romney. And you can expect the Republicans to bang on this drum from now until November.

Regression to the Mean, JPMorgan Edition

By James Kwak

I haven’t been writing about the JPMorgan debacle because, well, everyone else is writing about it. One theme that has stuck out for me, however, has been everyone’s reflexive surprise that this could happen at JPMorgan, supposedly the best and most competent of the big banks. For example, Lisa Pollock of Alphaville, who has provided some of the most detailed analyses of what happened, asked, “could this really happen under CEO Jamie Dimon’s watch?” Dawn Kopecki and Max Adelson at Bloomberg referred to “JPMorgan’s cultivated reputation for policing risk.” Articles about Ina Drew’s resignation are sure to point out her relative success at dealing with the financial crisis of 2007–2009.

“Highly intelligent women tend to marry men who are less intelligent than they are.” Why? Is it that intelligent men don’t want to compete with intelligent women?

Continue reading “Regression to the Mean, JPMorgan Edition” →

Bad Dividend Math

By James Kwak

While working on a new Atlantic column, I came across this article by Donald Luskin (hat tip Felix Salmon/Ben Walsh) arguing that “Taxmageddon” (the expiration of the Bush tax cuts at the end of the year) will cause the stock market to fall by 30 percent.* His argument is basically this: if the marginal tax rate on dividends increases from 15 percent to 43.4 percent, the after-tax yield falls by 33.4 percent, so stock prices should fall by about the same amount.

Ordinarily I don’t bother with faulty claims like this—there are only so many hours in the day—but it bothered me so much it cost me some sleep last night.

The first problem is the only one that Luskin acknowledges: lots of investors don’t pay taxes on dividends. He mentions pension funds; there are also non-profits and anyone with a 401(k) or IRA. According to Luskin, only about one-quarter of dividends are received by people who will pay the top rate. Maybe they are the marginal investors who set prices, he speculates. Well, maybe. But an increase in the tax rate will make dividend-paying stocks more expensive for them but the same price as before for non-taxpaying investors—so as long as we’re going to stick to theory, the former should sell their stocks to the latter for some price between the two.

More important, the price of a stock (in theory, again) is the discounted present value of its future dividend stream aggregated over an infinite horizon. So we need to know what the tax rates will be in all future years. That’s clearly unknowable. If the tax rate goes up on January 1, 2013, that will give us no information about the tax rate in 2113. On the other hand, it will give us very good information about the tax rate in 2013. And it will give us a little bit of information about the tax rate in 2023. In other words, the informational value of a change in tax rates only affects a small part of the summation you have to do if you want to value a stock by its dividend stream. If a company is going to shut down in 2013, liquidate its assets, and return one massive dividend to shareholders, it affects most of the value. If a company is Facebook and is unlikely to pay dividends for a long time, it affects very little of the value. So the impact of such a change on stock prices will be a lot less than the theoretical 33.4 percent that Luskin calculates.

Then there’s the little matter of markets. Luskin’s article chides the “stock market” for ignoring the upcoming change in tax rates on dividends. How does he know? Did he ask the market? More likely, the market is pricing in the possibility of a change in tax policy. In theory, market prices today should reflect the expected future tax level, which is somewhere between 15 percent and 43.4 percent—closer to which one, we don’t know. This is another reason why the actual impact of a tax increase will be smaller than 33.4 percent; the latter assumes that every single investor today is blindly assuming that the tax rate will remain at 15 percent.  (Actually, since the Medicare surtax is already law, every single investor knows that the tax rate will be at least 18.8 percent, not 15 percent.)

But this is all theory. There is actually a way to test these things. To the extent that a change in the dividend tax rate affects stock prices, it should affect high-dividend stocks more than low-dividend stocks. Even on the theory that the value of a stock is the discounted value of its future dividend stream, for a high-dividend stock, much of that value comes from dividends in the next decade, which are likely to be affected by a change in the tax rate. By contrast, for a company that doesn’t pay dividends, the value of its dividend stream is located far out in the future, where a change in today’s tax rate has little expected impact. So if Luskin is right, the 2003 tax cut (which established the 15 percent rate for dividends) should have caused not only a sharp increase in stock prices but also a sharp increase in the price of value stocks relative to growth stocks.

So, courtesy of Yahoo! Finance, here are the closing prices of the Vanguard Value Index (red), which includes high-dividend stocks, and the Vanguard Growth Index (blue), which includes low-dividend stocks, for November 2002 through May 23 2003, the day the final bill was passed by both houses. The question, though, is when the 2003 tax cut would have affected stock prices. There’s no separation between value and growth stocks around November 5, the day the Republicans won the midterm elections.  (Remember, the Democrats had a Senate majority in 2002.) There’s none around January 28, when President Bush called for tax preferences for dividends in his State of the Union address. There’s no reaction around February 27, when the bill that would cut taxes on dividends was introduced.

Now, there is a separation around May 15, when the Senate version initially  passed. (Passage in the House was assured because of the Republican majority there.) This implies that there was significant uncertainty about whether the bill would pass; when the uncertainty cleared, high-dividend stocks gained relative to low-dividend stocks. Score one for Luskin!

But if there was uncertainty that cleared on May 15, and Luskin is right, then two things should have happened: high-dividend stocks should have gained relative to low-dividend stocks, and all stock prices should have shot up. But that’s not what happened. High-dividend stocks went up; low-dividend stocks went down. Investors’ overall appetite for U.S. stocks didn’t change; at the margin, some realized that after-tax dividend yields had just gone up, so they switched from low-dividend to high-dividend stocks.

By May 23, the last date on that chart, passage was a certainty, so the impact of the tax change should have been 100 percent priced in. Do you see a 30 percent increase? I don’t.

Want more evidence? Here are the same two index funds for December 1 through December 17, 2010, when the dividend tax cut was extended for two years. The extension was in serious doubt until December 6, when Democrats and Republicans reached a compromise agreement. Again, you can see an increase in the price of high-dividend stocks relative to the price of low-dividend stocks, starting around December 6. This indicates that the market was reacting to a significant change in the probability of an extension. But there’s no sharp, 30 percent increase in the overall level of stock prices.

So the tax rate on dividends does seem to have a small but visible impact on the relative price of high- and low-dividend stocks. And it may have a small impact on the overall price level, which would make sense. But 30 percent, or anything close to it, is pure fantasy.

So why all this hysteria about a collapse in the stock market on January 1? Well, here’s one hint, from Luskin’s article:

“If there’s a bargaining failure and the scheduled tax hikes on dividends aren’t stopped, we’ll be sorry we’re spending so much political energy now debating about the ‘1%’ and their supposed privileges. It’s the 30% down in the stock market we ought be worrying about.”

This is just another attempt to mask the blatant unfairness of the Bush tax cuts by arguing by arguing that that they are good for all of us (well, at least all of us who own stocks, but that’s a matter for another post). They’re not.

* Luskin also talks about “trillions more in new tax hikes under ObamaCare.” Huh? The revenue provisions of the Affordable Care Act are projected to bring in $520 billion over the next decade; even if you include the revenue-increasing coverage provisions (like the excise tax on high-cost health plans), you only get up to $813 billion. That’s not “trillions,” unless you’re talking about an undiscounted infinite horizon.

Who Pays for Facts?

By James Kwak

The Internet has made possible a golden age of commentary. Anyone with a computer and an Internet connection can create a blog and comment to her heart’s content.

Yet as one of those commenters with a free blog, I am painfully aware that this hypertrophy of analysis has not been matched by corresponding growth in the stuff that we analyze: facts. There is no way we could have written White House Burning, with its one hundred pages of endnotes, without someone else to do the primary research: either the journalistic kind, calling around to sources in Washington to figure out what’s going on, or the data-gathering kind, visiting grocery stores in Brooklyn to track prices and calculate the inflation rate.

So I would just like to second what Menzie Chinn said about the importance of government statistical organizations, which are (along with most of the rest of the government) under attack from Paul Ryan and his troops. Even if you don’t agree with what I say, if you like reading economics blogs, you should realize that they couldn’t really exist without the BEA, BLS, Census Bureau, etc.

Of course, if your economic policy prescriptions are based entirely on pure theory, then I guess you can do without data.

Stephen King Weighs In

Great article by Stephen King (hat tip Felix Salmon/Ben Walsh). Excerpt:

“The Mitch McConnells and John Boehners and Eric Cantors just can’t seem to help themselves. These guys and their right-wing supporters regard deep pockets like Christy Walton and Sheldon Adelson the way little girls regard Justin Bieber … which is to say, with wide eyes, slack jaws, and the drool of adoration dripping from their chins.”

Like me, King wants his tax bill to go up.

My Daughter Will Be CEO of the World’s Most Valuable Company Someday

By James Kwak

At least, that’s the impression I get from reading Walter Isaacson’s biography of Steve Jobs, which I finally finished this weekend. It’s not a particularly compelling read; it basically marches through the stages of his professional life, which is already the subject of legend, so there isn’t much suspense. I fear that it will inspire a new generation of corporate executives to imitate all of Jobs’s personal shortcomings—but without his genius.

The picture you get from the book is basically that Steve Jobs acted like a five-year-old for his whole life. He could be wrong about some basic, uncontroversial fact yet insist stubbornly that he was right. He divided the world into things that were great and things that were terrible, and his classifications could be arbitrary. He was an obnoxiously picky eater, constantly complaining about his food and sending it back. He threw epic tantrums that only a CEO (or a five-year-old) could get away with.

Continue reading “My Daughter Will Be CEO of the World’s Most Valuable Company Someday” →

About That State and Local Tax Deduction

By James Kwak

A couple of days ago I criticized Mitt Romney for thinking that eliminating the deductions for mortgages on second homes and for state and local taxes would pay for his 20 percent rate cuts. But there’s a more important general point to be made.

The deduction for state and local taxes is a subsidy from the federal government to state and local governments. This is how it works: If you’re in the 35 percent tax bracket, for every $100 of taxes you pay to state and local governments, the federal government gives you $35. In other words, for every $100 of taxes levied, you pay $65 and Barack Obama pays $35. That’s called a subsidy. Without it, the state and local governments would only get $65—or they would have to raise taxes by over 50 percent, which would make you mad.

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Mitt Romney Still Can’t Do Arithmetic

By James Kwak

From his closed-door fundraiser yesterday, courtesy of NBC:

“I’m going to probably eliminate for high income people the second home mortgage deduction,” Romney said, adding that he would also likely eliminate deductions for state income and property taxes as well.

“By virtue of doing that, we’ll get the same tax revenue, but we’ll have lower rates,” Romney explained.

Let’s check Romney’s arithmetic.

Continue reading “Mitt Romney Still Can’t Do Arithmetic” →

The Conventional Wisdom of Tax Reform

By James Kwak

In the Times this weekend, David Leonhardt has a generally good overview of the tax policy showdown that is scheduled for later this year, as the Bush tax cuts approach expiration on January 1. He outlines several of the central issues we face: “hypothetical solutions are a lot more popular than actual ones”; everyone says she wants tax reform, but the tax expenditures that would have to be eliminated are very popular; and any significant deficit solution will directly affect vast numbers of Americans.

I have a few differences with Leonhardt, however. First, after his colleagues David Brooks and James Stewart, he seems to have fallen briefly under the spell of Paul Ryan: “Mr. Ryan’s plan would cut the top rate to 25 percent, from 35 percent, and still leave overall tax collection roughly where it has been, by eliminating tax breaks.”

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