Lobbyists Present Wish Lists For Stimulus Bill Tax Breaks:
With hundreds of billions in stimulus spending up for grabs shortly after the holidays, Congress is being deluged with wish lists for tax breaks for specific industries.
Business lobbying groups ranging from carpet and rug dealers to hotels to biotech companies all want to make sure they do not get left out of the bounty. They are making their voices heard with lawmakers and members of the incoming administration of President-elect Barack Obama.
Biden, joined by Summers, pledged not to back earmarks in the stimulus. (Associated Press)
The size of the package, which could reach as high as $1 trillion, and the lack of details on its contents have led to an unusual profusion of lobbying activity.
“The most staggering thing to us about this stimulus is that it’s a big number without any definition,” said Steve Ellis, vice president of the spending watchdog group Taxpayers for Common Sense. “When you have that lack of definition, it brings a large number of lobbyists to the table to try to fill in the blanks.”
Vice President-elect Joe Biden told reporters Tuesday that the Obama administration will not support “earmarks” in the package. While an earmark is usually considered to be a lawmaker’s pet project, Biden didn’t define what he meant.
“There will be strict accountability here. And there also will be no Christmas tree, notwithstanding the season,” Biden said, before a meeting with Obama economic advisers.
Furniture dealers and rug and carpet retailers want Congress to provide consumers with a $500 to $1,000 refundable tax credit they can use to buy home furnishings. The credit would be available only to those with incomes of $50,000 or less, but higher-income families would be able to deduct 10% of home furnishing costs, according to a one-page industry proposal.
Such a tax credit “fits conceptually within the Obama economic stimulus plan and the Obama economic philosophy of strengthening the economy from the bottom up,” the industry paper says.
Biotech firms, which typically face losses in their early years because of the intense research needed to bring a product to market, are looking for additional research subsidies through the tax code.
Biotech groups have proposed a refund for net operating losses, essentially giving them cash upfront if the firms agree to forgo the larger tax benefit to which they would eventually be entitled. That benefit could be limited to smaller firms and come with a dollar cap, according to an industry white paper.
Meanwhile, hoteliers want an enhanced tax credit for hiring individuals that have been receiving unemployment benefits.
The Work Opportunity Tax Credit, now used widely by hotels and restaurants
…
Easy come, easy go — shocking.
…Most of the loss of value occurred because the bankruptcy filing caused the bank to default on trading contracts with counterparties, immediately cancelling 900,000 separate derivatives contracts. These cancellations included contracts in which Lehman was owed money. If there had been on orderly unwinding of the contracts over several weeks, at least $US50 billion could have been saved, the liquidators found.
Further value was destroyed when the unplanned bankruptcy forced down prices for Lehman’s assets in a market that had already been artificially depressed by the shock collapse of the bank. This meant that the bank’s trading and investment banking businesses were sold for less than $US500 million although they had made about $US4 billion in annual profits before the bankruptcy.
We’re in a race to see whether politics will become the dominant means of allocating financial wealth in this country. That could be the single biggest domestic issue today, but too few economists are speaking up about it.
writes Tyler Cowen. Do read the whole thing.
I’m not sure who Tyler thinks is “in a race” with politics. But I’m confident that politics will dominate — that is why it is so important to minimize the amount of funds that the politicians get to control.
Again, I recommend Lindsey: Not All Stimuli Are Created Equal.
An excellent essay by Charles Krauthammer explaining the virtues of a “net-zero gasoline tax”. A politically superior term for what we usually call a “revenue-neutral” carbon tax.
Greg Mankiw linked to
Larry Lindsey’s plan to stimulute the economy, including his membership application to the Pigou Club.
…Sounds good to me.
Update: More Pigou Club endorsements here and here.
Former Fed governor Lindsey’s proposal is so perfectly on-target that I’m going to just quote the whole piece. There is unfortunately a very stark contrast between the Lindsey plan and the Summers plan.
When it comes to fighting recessions, there’s a tendency to see “fiscal stimulus” packages as wasteful, as a form of “throwing money at the problem.” The critics have a point. But the conclusion that therefore we should do nothing is also wrong. Instead, careful attention should be paid to the details. Just as a family pinched for cash might find borrowing for the purchase of a new car or appliance prudent while taking a vacation in Las Vegas wouldn’t be, some government programs to combat recession make sense while others do not.
Three criteria are crucial for evaluating fiscal stimulus packages. First, does the program target the weakness in the economy that caused the recession, or is it largely peripheral? Second, are the funds going to be spent in a timely fashion? Third, does the program fundamentally strengthen the economy going forward into the expansion phase? A look at the economy’s current circumstances suggests that a large fiscal stimulus is needed, but a badly designed one will, in the words of an old song, merely leave America “another day older and deeper in debt.”
The cause of the current recession is buried in the balance sheet of the private economy, particularly the financial sector and the household sector. The government and the Federal Reserve have begun a number of programs to fix the balance sheet of the financial sector, some more effective than others.
The main challenge facing the new administration and Congress is how to handle the inevitable efforts of Americans to fight the effects of the financial crisis by saving. It would be foolish to stop this adjustment with government policy both because any efforts to do so would fail and because the restoration of a healthier household balance sheet is essential to the long-term recovery of the economy. Instead, the government must focus on how to ameliorate the effects that the resulting reduction in household spending will have on the economy.
The household saving rate is likely to rise by roughly 7 percentage points, from roughly one-half of one percent of disposable income to between 7 and 8 percent. The majority of this adjustment is likely to occur well before the end of 2009, with some further modest increase thereafter. Our estimate suggests a drop in consumer demand of roughly $500 billion in 2009 and a further drop of roughly half that figure in 2010. These frame the quantitative parameters for an appropriate fiscal stimulus.
The bulk of government spending programs that have been suggested involve transfers of federal resources to state and local governments. While any or all of these programs might qualify as meritorious in their own right, they collectively fail the tests of well targeted stimulus.
Note first that such spending programs do not directly address the household balance sheet problem. The history of such programs overwhelmingly suggests that states and localities will simply substitute federal funds for their own resources for the vast bulk of the money spent. As such, little net impact will be had on household balance sheets.
These programs also generally fail the test of timeliness. Consider the phrase “shovel ready” being used to describe many of these programs. By definition a shovel-ready project is one that state or local government has already spent a good deal of money developing and is likely to continue spending on. On the other hand, infrastructure projects that actually will produce net new spending are never shovel-ready. Most of the spending will end up occurring at the peak of the business cycle when it is not needed, not at the bottom.
By contrast, there are some ongoing federal spending programs that can be quickly ramped up during a recession. Most notable is defense procurement. There is wide agreement that we have run down our defense infrastructure substantially. Much of this can be remedied by simply increasing the pace of existing production programs. Think of it as “assembly line-ready” instead of shovel-ready. Defense spending also gets around the problem of federal dollars supplanting other spending, as only the federal government is involved.
The third test involves whether projects assist the economy in entering the expansion phase. In general, government spending programs divert resources from the private sector as it tries to expand. Some infrastructure projects genuinely assist the private sector by making it more efficient. One such project now being discussed is the creation of a national energy grid. This has been tried before, but failed to get through the legal roadblocks thrown in its path by environmental groups and private landowners. Thus, a project may be highly desirable, but not timely. It may be a good idea, but it is not stimulus.
The question to ask about any infrastructure project being sold as “stimulus” is why the project hasn’t been done already. The most common answer is that the state and local political process didn’t find that the benefits met the costs–a sure sign that the project is not likely to pay for itself during the expansion phase of the business cycle. Another test of the genuineness of the stimulus intent is whether the federal political process is willing to let go of its own political interests in an effort to maximize the stimulus effect. For example, will Congress waive the Davis-Bacon requirements that drive up costs and reduce the job creating benefits of infrastructure spending? Will they abandon earmarks?
The final argument made for federal funding of infrastructure spending by states is that it is needed to prevent or offset cuts that states will have to make in a weak economy. This argument essentially concedes the points made above, that such spending is really just a safety net for the public sector. It is at best job preserving, not job creating.
Permanent tax cuts offer a much better option. The incoming chairman of the Council of Economic Advisers, Christina Romer, has estimated that the macroeconomic benefits of tax cuts can be two to three times larger than common estimates of the benefits related to spending increases. The relative advantage of tax cuts over spending is even clearer when the recession is centered on the household balance sheet. Some relatively minor changes, like making the current 15 percent tax rate on dividends and capital gains permanent, would not only help household cash flow, but also put a floor under equity prices much as their introduction did in 2003. This would help protect against further wealth destruction and balance sheet deterioration.
But the centerpiece of any tax cut should be employment taxes: in particular, a permanent halving of the current 12.4 percent Social Security payroll tax on the first $106,800 of wages, split evenly between workers and employers. The direct revenue effect of that would be a bit under $400 billion per year, roughly in line with the present quantitative needs of the economy. It also meets our three tests of effective stimulus.
First, the funds would flow directly to households through higher take-home pay and indirectly through a reduction in the cost of employment. Economic studies conclude that the benefits of a reduction in the employer portion of the payroll tax are ultimately received by employees. But the immediate effect would be an improvement in the cash flow of credit-starved businesses (as well as being a marginal incentive to keep employment up).
Second, the funds would be extremely timely, with the benefits hitting the economy with the first paycheck after the plan was implemented.
Third, by lowering the taxation of labor, the plan would help produce a higher-employment recovery than would otherwise be the case.
Since the tax cut should be permanent to have maximum effect, the biggest challenge would be how to make up for the lost revenue once the macroeconomic need for fiscal stimulus had passed. In the short run, effective fiscal stimulus requires that government revenue drop, thereby enriching the private sector, and with the Treasury making the Social Security trust fund whole by way of intergovernmental bookkeeping. Longer term, however, spending cuts or a new source of revenue would be needed.
Given the agenda of the incoming administration, the best source of such funds would be a greenhouse emissions tax. It would be a much more efficient way of achieving the desired environmental objectives of the administration than any of the regulatory or “cap and trade” ideas now being considered. Such programs have failed in Europe since they are so easily gamed. Unlike regulations or cap and trade, moreover, an emissions tax can be phased in and calibrated as macroeconomic conditions permitted, specifically as the unemployment rate declined.
The country would be getting the stimulus it needed in the short run. In the long run it would enjoy a permanent improvement in its tax system, with higher taxes on things it wants to discourage (pollution and oil imports) and lower taxes on things it wants to encourage, specifically employment. A greener America with higher employment is a lot better than simply being another day older and deeper in debt.
Lawrence B. Lindsey is a former governor of the Federal Reserve. His most recent book is What a President Should Know . . . but Most Learn Too Late.
Larry Summers wrote a very short op-ed for the WaPo that offer some principles. It sounds good, but it sure doesn’t sound like the real world political sausage familiar to observers of Washington. It sounds like the New Deal rhetoric, promising optimal policies crafted by self-interested politicians. I hope I am wrong…
When President-elect Barack Obama takes office, he will face what may well be the bleakest economic outlook since World War II. Economic forecasts have been revised significantly downward over the past several months; today, many experts believe that unemployment could reach 10 percent by the end of next year and our economy could fall $1 trillion short of its full capacity — which translates into more than $12,000 in lost income for a family of four.
As difficult as these conditions are, however, the Obama administration also inherits an economy with great potential for the medium and long terms. Investments in an array of areas — including energy, education, infrastructure and health care — offer the potential of extraordinarily high social returns while allowing our country to address some long-standing national challenges and put our economy on a solid footing for years to come.
In this crisis, doing too little poses a greater threat than doing too much. Any sound economic strategy in the current context must be directed at both creating the jobs that Americans need and doing the work that our economy requires. Any plan geared toward only one of these objectives would be dangerously deficient. Failure to create enough jobs in the short term would put the prospect of recovery at risk. Failure to start undertaking necessary long-term investments would endanger the foundation of our recovery and, ultimately, our children’s prosperity.
Our president-elect understands both the peril and the promise of the situation and the importance of responding to changing conditions. That is why his economic team is crafting a broad proposal, the American Recovery and Reinvestment Plan, to support the jobs and incomes essential for recovery while also making a down payment on our nation’s long-term financial health.
…The president-elect has insisted that investments proposed in the recovery plan meet standards much higher than has been traditional. There will be no earmarks. Investments will be chosen strategically based on what yields the highest rate of return for the economy and monitored closely not just by officials but also by the public as government becomes more transparent. We expect to evaluate and to be evaluated rigorously to ensure that Washington is held accountable for how tax dollars are spent.
Read on…
…than they have been getting:
Noah Millman has a fascinating post about his initial belief in the promise of synthetic CDOs and his eventual disillusionment. Ultimately, it all comes down to what the ratings agencies were willing to let people get away with:
How did a market that, I thought, had really helped capitalism work in 2002 become the great destroyer of capitalism of the last two years? There were a lot of contributors to the catastrophe, but one indispensable one is that the ratings agencies monetized their sterling reputations in an extraordinary fashion, and nobody in regulatory apparatus of government saw that this was happening, and what it might portend. The success of 2002 depended on market confidence in the ratings agency process: that’s what made investors willing to buy the notes issued by structured finance vehicles that issued the credit protection that made it possible for banks to hedge. Without that confidence, the market would never have developed. And by 2006, the agencies understood just how much that confidence was worth. […]
Now, of course, the agencies have radically reversed course. They have completely changed their models, of course. But they’ve also begun to “follow the market”, incorporating credit derivatives swap and equity market pricing into their ratings for companies. If in 2006 the market had, to an alarming degree, delegated its risk-management to the ratings agencies, now the ratings agencies have delegated a great deal of their ratings process to the market. And so the market has lost any reason for confidence in the agencies in both directions: they cannot be trusted when the market is strong to assess the downside risks the market is ignoring, and they cannot be trusted when the market is weak to assess a company’s financial condition independently of the market panic.
I’m not really sure what we’re supposed to do about this. I’m inclined to say that if ratings agencies are going to have such an important public function we ought to have that function performed by a public agency. In practice, as soon as people went back to not wanting to pay attention to financial services regulations, I think you’d have a big regulatory capture problem. But beyond the fact that the private ratings agencies performed poorly, the fact of their poor performance doesn’t seem to opened the market to competition or new entrants or whatever it is that leaving this kind of thing in private hands is supposed to accomplish.
Economist James Kwak offers some excellent holiday suggestions:
On one level, recessions are about numbers, like the post I just wrote about the November statistics. On another level, recessions cause enormous hardship and misery to real families. I know most of us have less wealth than we did a year ago, since two major sources of household wealth - stocks and housing - have fallen steeply in value this year. But even if you don’t feel like you can afford to donate as much as usual to charities, there is still something you can do.
Most middle- and upper-income American households have lots of stuff. Many of us, particularly adults, have lots of clothes and other things we rarely or no longer use. You can think of this either as a behavioral phenomenon (people don’t like to get rid of things, even if they cause more disutility by taking up closet space than any utility they will ever provide) or as a market failure (it’s too much of a hassle to get rid of things, so we keep them). But if you just take a day, identify the things you will never use again, put them in bags, and drive them to a local shelter, you can help allocate those goods to the people who value them most. Or, as non-economists put it, you can help people. And, of course, you can get a tax deduction (the shelter in my town recommends using the Salvation Army valuation guidelines), which is itself probably worth more to you than those clothes you will never wear again.
Nobel laureate Robert Lucas clarifies the logic of the Fed’s quantitative easing. Lucas really understands growth, his views are worth a careful study.
I highly recommend the Russ Roberts Econtalk interview with Bob Lucas.
Tom at Cash and Burn summarizes the path to ruin:
The article – in the New York Times – makes a stab of explaining the near impossible, giving a background to one of the most complex financial products around, as well as a human face or two. However, it falls a little short of providing a fuller explanation of the details. (For more on investment banks failing, here’s the FT giving a good insight into the PwC team restructuring Lehman.)
“The synthetic CDO grew out of a structure that an elite team of JP Morgan bankers invented in 1997. Their goal was to reduce the risk that Morgan would lose money when it made loans to top-tier corporate borrowers like IBM, General Electric and Procter & Gamble.”
Normal (or cash) CDOs (collateralised debt obligations) are funds that invest in bonds and loans, and then are themselves parcelled and then sliced up and sold onto bond investors. A kind of bond squared, with a dose of leverage (borrowing) at each turn. Meanwhile synthetic CDOs are like normal CDOs but instead of being made up of lots of bonds and loans, they are packed with credit-default swaps, a form of derivative. (For more detail, here’s one prescient essay on the subject, and here’s another from 2004, but with the usual industry defence of the product.)
According to the NYT’s jaundiced post-credit-crunch eye: “Synthetics could be slapped together faster, and they generated fatter fees than regular CDOs, making them especially attractive to Wall Street.”
The originator of the synthetic CDO would usually retain a stake in the product but sell on much of it to other investors, and it was originally used as a mechanism to offsetting the risk of high-grade corporate lending. But from around 2002 there was shift away from insurance (aka ‘balance sheet’) to speculation (aka ‘arbitrage’) CDOs, writes the NYT, when investors were looking for yields after they had sold out of equities but could expect little return from bonds. This led to more borrowing (much of which went into the property market) and more appetite for risky investments with ever-increasing complexity.
These developments were supported by the belief that by spreading risks throughout the system, and cutting these risky investments up into small pieces, would mean that a few bad apples would not, and could not, spoil the whole barrel. The above-linked article from Credit magazine notes the following:
“it is broadly accepted that the risk embedded in the super-senior tranche of a synthetic CLO referencing a pool of investment-grade assets is remote in the extreme. This is because even if a super-senior swap accounts for as much as 90% of a CDO’s capital structure (which is not uncommon), more than 10% of the assets within the reference pool would have to default for losses to be sustained by the most senior tranche – an improbably high default rate for investment-grade bonds when the historical norm has been for a default rate of about 0.3%.”
The NYT focuses on Merrill Lynch’s land-grab for mortgage lending, explaining that the bank sought to emulate the profits made by Lehman Brothers. “The firm’s goal, according to people who met with Merrill executives about possible deals, was to generate in-house mortgages that it could package into CDOs. This allowed Merrill to avoid relying entirely on other companies for mortgages.” According to executives interviewed by the NYT, Merrill Lynch focused more on profits than evaluating risk.
And unlike the pioneers of synthetic CDOs, Merrill Lynch “seemed unafraid to stockpile CDOs to reap more fees”. By 2006 it was the world’s biggest underwriter of the products. But the risks began to spread after AIG suddenly stopped insuring the highest-quality portion of the company’s CDOs against default. Merrill Lynch couldn’t find a replacement but continued to create new CDOs, and the company’s unhedged exposure to mortgages continued to grow.
“In 2005, firms issued $178 billion in mortgage and other asset-backed CDOs, compared with just $4 billion worth of C.D.O.’s that used safer, high-grade corporate bonds as collateral. In 2006, issuance of mortgage and asset-backed CDOs totaled $316 billion, versus $40 billion backed by corporate bonds.
Firms underwriting the CDOs generated fees of 0.4 percent to 2.5 percent of the amount sold. So the fees generated on the $316 billion worth of mortgage- and asset-backed CDOs issued in 2006 alone, for example, would have been about $1.3 billion to $8 billion.”
But when the market turned, in 2007, “the impact was brutal”. The market collapsed, and Merrill Lynch was forced to take a USD 7.9bn write-down related to its exposure to mortgage CDOs. Chief Executive Stan O’Neal was also forced out, replaced with John Thain.
“None of the trading businesses should be taking risks, either single positions or single trades, that wipe out the entire year’s earnings of their own business,” Mr. Thain said in January. “And they certainly shouldn’t take a risk to wipe out the earnings of the entire firm.”
In August, Thain arranged the sale of the CDO assets for 22 cents on the dollar. For the first nine months of 2008, Merrill recorded a net loss of USD 14.7bn on its CDOs. Shortly afterwards, Merrill was taken over by Bank of America.
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