Category: The Economy

GOVERNMENT AUSTERITY DEBUNKED

ABSTRACT: The argument for government austerity was largely built on two economic theories, both of which have been debunked recently by academia and reality. First was the theory that if government debt exceeded 90% of economic activity, then economic growth would be sharply lower. The second was that cutting spending in a depressed economy would create jobs.

 

The study the first was based on was dramatically discredited when an error was discovered in the Excel spreadsheet used to calculate its findings. Furthermore, the link highlighted between government debt and slow economic growth does not indicate that government debt causes slow growth; it could just as likely be the reverse.

The second theory was based on another academic study that was refuted by a 2010 study by the International Monetary Fund, which used better data. And finally, real life experiences in the US and Europe have not borne out what the austerity advocates predicted or promised.

Despite this debunking of the rationales for austerity, there hasn’t been any change in policies or political rhetoric in the US. The US austerity movement appears to be driven by small government ideologues who are using the economic crisis as an opportunity to push for cuts in social programs they’ve always opposed. There also appears to be an issue of class hiding behind austerity advocacy. While the years since the Great Depression and of austerity policies in Washington have been hard on the middle and lower classes, for the well off they’ve been pretty good. So, perhaps it shouldn’t be a surprise that the wealthy and political elites keep pushing austerity policies despite the lack of support from theory or reality.

FULL POST: The argument for government austerity – reducing the deficit by cutting spending and perhaps raising taxes – was largely built on two economic theories, both of which have been debunked recently by academia and reality. First was the theory that if government debt exceeded 90% of economic activity (measured by gross domestic product [GDP]), then economic growth would be sharply lower. The second was that cutting spending in a depressed economy would create jobs.

The first, on the danger of government debt, was based on a 2010 study by two Harvard economists, Reinhart and Rogoff, “Growth in a Time of Debt.” Despite significant controversy about it, its finding of a tipping point for reduced economic growth when government debt hit 90% of GDP was presented as fact by politicians and media arguing for the need for austerity. [1]

This study was dramatically discredited when an error was discovered by Thomas Herndon, a Ph.D. student at the University of Massachusetts, Amherst, in the Excel spreadsheet Reinhart and Rogoff used to calculate their findings. An error in one of their formulas had excluded data from Canada, New Zealand, and Australia, all of which had experienced strong economic growth in periods of high government debt. [2] (Reinhart and Rogoff have acknowledged the error.) This explained why other researchers, using similar data, hadn’t been able to replicate their findings. As Reinhart and Rogoff’s work was scrutinized, it was also criticized for omitting data and using questionable statistical procedures.

Furthermore, the link they highlighted between government debt and slow economic growth does not indicate that government debt causes slow growth; it could just as likely be the reverse, that slow growth leads to higher government debt. Indeed, the latter is clearly what happened in Japan in the early 1990s when government debt grew after the economy collapsed. [3]

The second theory, that cutting spending in a depressed economy would create jobs, was based on another academic study. It was refuted by a 2010 study by the International Monetary Fund (IMF), which used better data. The IMF study found that austerity reduced job growth instead of accelerating it as the original study and austerity promoters claimed. [4]

Finally, real life experiences in the US and Europe have not borne out what the austerity advocates predicted or promised. In the US, government debt and a bit of stimulus did not produce high interest rates and a shrinking economy. Most recently, the austerity measures adopted in March – namely the sequester’s budget cuts – are clearly causing jobs to be cut, with no signs of resultant job creation. Meanwhile, most of Europe is in recession despite consistent application of the austerity medicine for the last four years.

Despite this debunking of the rationales for austerity, there hasn’t been any change in policies or political rhetoric in the US, and little in Europe. This suggests that the austerity movement is not based on research and reality, but on ideology.

The US austerity movement appears to be driven by small government ideologues, given that the push for budget cuts continues unabated. These ideologues are using the economic crisis as an opportunity to push for cuts in social programs they’ve always opposed. They’ve seized on the austerity theories from academia as justification for their actions, and aren’t letting go of them even when they have been soundly discredited. [5]

There also appears to be an issue of class hiding behind austerity advocacy. The wealthy in the US regard the deficit as the most important problem we face and favor solving it by cutting spending on health care and Social Security. The middle and lower classes, although they see the deficit as a problem, view unemployment as a more important problem and want to see spending on health care and Social Security increase. [6] Given the political power of the wealthy elites, it’s not surprising to see policy bending to their preferences. While the years since the Great Depression and of austerity policies in Washington have been hard on the middle and lower classes (high unemployment, incomes that aren’t keeping up with inflation, home values that haven’t recovered to 2008 levels), for the well off they’ve been pretty good (incomes growing faster than inflation, corporate profits and stock prices surging). So, perhaps it shouldn’t be a surprise that the wealthy and political elites keep pushing austerity policies despite the lack of support from theory or reality.

 

[1]       Krugman, P., 4/18/13, “The Excel depression,” The New York Times

[2]       Roose, K., 4/18/13, “Meet the 28-year-old grad student who just shook the global austerity movement,” Daily Intelligencer

[3]       Krugman, P., 4/18/12, see above

[4]       Krugman, P., 5/3/13, “Playing whack-a-mole with expansionary austerity,” The New York Times

[5]       Editorial, 5/5/13, “Blame ideologues, not economists for failed ‘austerity’ policies,” The Boston Globe

[6]       Krugman, P., 4/15/13, “The 1 percent’s solution,” The New York Times

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THE SHRINKING DEFICIT

ABSTRACT: The federal government’s annual budget deficit is falling, and falling faster than at any time since WWII. Overall government spending has been falling since 2007. Roughly 750,000 government jobs have been cut since the recovery began in 2009, cancelling out much of the benefit of increased private sector employment, and leaving unemployment higher than it would be otherwise.

Many economists believe that an austerity strategy of a rapidly declining deficit and spending cuts such as the “sequester” could hurt the economy and its recovery. Europe is experiencing a second recession and very high unemployment (12%) due to its austerity strategy. The current, irrational obsession with the deficit is precluding investments that have a high return and would improve the fiscal picture over the long-term.

Ultimately, jobs and a strong economy are the answer to taming the deficit, which is already shrinking rapidly.

FULL POST: The federal government’s annual budget deficit is falling. And it’s falling faster than at any time since the end of World War II. And that’s even before the March 1 spending cuts (the “sequester”) are factored in. [1] The deficit for this year is projected by the Congressional Budget Office to be $845 billion, down from $1,100 billion last year and $1,413 billion in 2009. It grew in 2008 and 2009 because the Great Recession led to 1) a dramatic loss of tax revenue due to decreased economic activity and jobs; [2] 2) increased expenditures for unemployment, food assistance, and other government benefits that softened the impact of the recession on families; and 3) tax cuts that were used to stimulate the economy, reducing the depth of the recession. [3]

Overall government spending, including the federal, state, and local levels, has been falling since 2007. Although the decline in federal spending in the fourth quarter of 2012 is seen as the culprit in causing the economy to shrink (i.e., negative growth) in that quarter, spending reductions and job losses have been most pronounced at the state and local levels. Federal spending has declined from 25.2% of our total economy or Gross Domestic Product (GDP) in 2009 to 22.8% in 2012, and is projected to fall to 21.5% by 2017 without any dramatic changes in budget policy. (The 40 year average has been 21.0%.)

Roughly 750,000 government jobs have been cut since the recovery began in 2009. This has been a “massive drag on the economy,” cancelling out much of the benefit of increased private sector employment. [4] Although the US unemployment rate has fallen to 7.7%, it would have fallen significantly further if these government jobs, including those of many teachers, had not been lost.

Many economists believe that an austerity strategy of a rapidly declining deficit and spending cuts such as the “sequester” could hurt the economy and its recovery. Historically, rapidly falling government deficits and spending have tended to lead to recessions. [5] If you want evidence of this, you need look no further than Europe at this moment. Europe is experiencing a second recession and very high unemployment (12%) due to its austerity strategy. Mark Cliffe, chief economist at IMG, describes its austerity strategy as “a bit of a vicious circle. Europe is pursuing a policy that is self-evidently failing.” [6]

The current, irrational obsession with the deficit (rather than a focus on creating jobs and strengthening the economy), is precluding investments in infrastructure and other activities that have a high return on investment and would improve the fiscal picture over the long-term. Especially given the federal government’s ability to borrow money at near zero interest rates, now is an ideal time to make investments in the future strength and growth of our economy, which is the best long-term strategy for reducing the deficit. [7]

There isn’t a good answer to the question of why the deficit – which is already rapidly falling – is more important now than creating jobs and strengthening the economy. [8] And if we look at Europe, we can see clear evidence that an austerity strategy does not lead to a falling deficit or a stronger economy with more jobs. The only answer is ideology – a belief that a smaller public sector is more important than putting struggling Americans back to work and back on their feet.

Ultimately, jobs and a strong economy are the answer to taming the deficit and the overall accumulated debt. Furthermore, a focus on creating jobs would resonate with the American public, many of whom are still struggling with the impacts of the Great Recession. It’s a matter of delivering a clear message about the need to create jobs and stimulate the economy, and that this will solve the issue of the deficit, which is already shrinking rapidly.

 

[1]       Klein, E., 2/12/13, “The deficit chart that should embarrass deficit hawks,” The Washington Post

[2]       Raum, T., 2/22/13, see above

[3]       Konczal, M., 1/22/13, “The most important graph on the deficit, “ The Roosevelt Institute

[4]       Raum, T., 2/22/13, “Government downsizes amid GOP demands for more cuts,” Associated Press (in the Reading Daily Times Chronicle)

[5]       Klein, E., 2/12/13, see above

[6]       The Balance Sheet, 4/3/13, “Europe’s austerity addiction,” The American Prospect

[7]       Summers, L., 1/21/13, “America’s deficits: The problem is more than fiscal,” The Washington Post

[8]       Wolf, M., 1/22/13, “America’s fiscal policy is not in crisis,” Financial Times

CUTTING SPENDING TO REDUCE THE DEFICIT

ABSTRACT: A deal was reached to address the year-end “fiscal cliff” or austerity crisis. Spending cuts were postponed for two months and most of the tax increases were eliminated, while some tax and revenue increases were enacted. The deficit reduction focus will now largely shift to spending cuts. We should be focusing on job creation and strengthening the economy, but somehow the deficit is the hot topic.

 The discussion of spending cuts will probably focus on the military and on entitlement programs, specifically Social Security and the health care programs, Medicare and Medicaid. Much of the discussion of cutting military spending will be on avoiding cuts. However, military spending can be reduced up to $200 billion per year – without jeopardizing national security.

 Turning to calls for cuts in Social Security and our public sector health programs, keep in mind that every other advanced economy has health care for all and a retirement support system. Social Security has its own funding stream and does not contribute to the deficit, so rationally it shouldn’t be part of this discussion. Ideologues are using the deficit issue to target Social Security because of their doctrinaire opposition to it. Minor changes to its funding would cover benefits for the next 75 years.

 My next post will review proposed cuts to Medicare and Medicaid.

 FULL POST: As you probably know, a deal was reached to address the year-end “fiscal cliff” or austerity crisis. Spending cuts were postponed for two months and most of the tax increases were eliminated, while some tax and revenue increases were enacted. The cap on the US government’s debt was not addressed and will be hit in about two months. Here’s a quick summary of what was enacted: [1]

  • Income tax rates on incomes over $400,000 will increase from 35% to 39.6% and some reductions in deductions will start at $250,000 in income, but there is no “Buffett Rule” requiring 30% be paid on incomes over $1 million. The net result is that new revenue from income taxes will be only about $60 billion per year as opposed to up to $450 billion with the rates increased on incomes over $250,000 and the “Buffet Rule”.
  • The Social Security payroll tax reduction was NOT extended, so all workers will have an additional 2% taken out of their paychecks on earnings up to $110,000.
  • Tax benefits for low income households were extended: a child credit and the Earned Income Tax Credit, which supplements income from low paying jobs. The tuition credit was extended as was the corporate research and development credit. The Alternative Minimum Tax, which originally was to function like the “Buffett Rule”, was adjusted so it won’t affect middle income taxpayers.
  • Unemployment benefits for the long-term unemployed were extended for a year.
  • The estate tax was increased slightly but not nearly as much as some had proposed and only on individual estates of over $5 million or joint estates of over $10 million.

The deficit reduction focus will now largely shift to spending cuts. We should be focusing on job creation and strengthening the economy, given high unemployment and slow economic growth, but somehow the deficit is the hot topic. As the current experience in Europe is clearly showing, cutting government spending weakens the economy and job growth and can put countries back into a recession.

Having said that, the discussion of spending cuts will probably focus on the military and on entitlement programs, specifically Social Security and the health care programs, Medicare (for seniors) and Medicaid (for low income people including low income seniors).

Unfortunately, much of the discussion of cutting military spending will be on avoiding cuts, including the $50 billion per year cut that is now scheduled for March 1. Military spending can be reduced this much and more – up to $200 billion per year – without jeopardizing national security. (See blog posts of 9/29/12 and 11/17/11 for more information.) For example, Lawrence Korb, an assistant defense secretary under President Reagan, has itemized $150 billion in annual cuts to the military budget. [2]

In the recently enacted $633 billion Defense Department spending bill, there was widespread criticism of inclusion of unnecessary spending. The dollar amount was more than the Department or President requested.  The Pentagon complained that it is required to keep weapons, as well as bases and units, that are not needed or efficient. Defense Secretary Panetta decried meddling by Congress that required “excess force structure and infrastructure.” [3][4]

Turning to calls for cuts in Social Security and our public sector health programs, keep in mind that every other advanced economy has health care for all and a retirement support system. So the issue is not whether it is possible to have these programs, it is are we willing to pay for them and are we willing to control health care costs.

Social Security has its own funding stream and does not contribute to the deficit, so rationally it shouldn’t be part of this discussion. Ideologues are using the deficit issue to target Social Security because of their doctrinaire opposition to it. Furthermore, its current funding will cover its benefits for roughly the next 20 years and after that minor changes to its funding would cover benefits for the next 75 years without any cuts in benefits. (See post of 12/4/11 for more details.)

The most prominent proposal for cutting Social Security spending is to reduce the annual increase in benefits that adjusts for inflation. This would save less than $20 billion per year over 10 years. [5] Ask any senior you know if the inflation adjustment is sufficient to keep up with their cost of living and I bet they’ll say, “No.” So cutting this will only hurt our seniors and reduce Social Security’s ability to keep seniors out of poverty. Furthermore, Social Security has become an increasingly important part of retirement income as private sector pensions have largely disappeared; cutting its rather modest benefits seems inappropriate in this environment.

My next post will review proposed cuts to Medicare and Medicaid.

[1]       New York Times, 1/1/13, “Highlights of the agreement,” The Boston Globe

[2]       Dubose, L., 11/15/12, Book review of Ralph Nader’s “The seventeen solutions: Bold ideas for our American future,” The Washington Spectator

[3]       Bender, B., 1/5/13, “A reprieve for local military bases: New Congressional funding flouts Pentagon’s plan for cutbacks,” The Boston Globe

[4]       Boston Globe Political Notebook, 12/21/12, “House approves defense bill despite Pentagon objections,” The Boston Globe

[5]       Krugman, P., 12/3/12, “The GOP’s big budget mumble,” The New York Times

INCREASING REVENUE TO CUT THE DEFICIT

ABSTRACT: Increased revenue needs to be part of the effort to reduce the federal government’s budget deficit. Two revenue sources that are not included in the austerity package are closing corporate tax loopholes and enacting a financial transactions tax. They could eliminate over half the deficit with little negative impact on the economy.

 The highest profile revenue issue in the austerity package is the personal income tax. Given that the 2001 – 2003 tax cuts on earned and unearned income were significant contributors to creating the deficit, reversing them for high income individuals would seem appropriate. Maintaining the Bush tax cuts on high incomes would cost up to $160 billion per year in lost revenue. Alternatively, using these funds on high impact spending will reduce the deficit over the long-term while strengthening the economy and creating jobs in the short-term.

FULL POST: Increased revenue needs to be part of the effort to reduce the federal government’s budget deficit. However, the increased or new taxes that produce the revenue should not be so large or so quickly implemented that they put the economy back into recession. Here’s a look at the revenue increases that are part of the current austerity package (aka the “fiscal cliff”), some of the negotiations that have occurred on them, and some alternatives that are not included in the package.

First, two revenue sources that are not included in the austerity package are closing corporate tax loopholes and enacting a financial transactions tax (as 10 European countries are doing). These could provide $250 billion and $350 – $500 billion annually, respectively, in new revenue, and eliminate over half the deficit with little negative impact on the economy. (See my post of 9/29/12 for more detail.) An alternative minimum tax for highly profitable corporations that would ensure that they pay a minimum tax rate – similar to the Buffet Tax proposal for high income individuals – would seem quite reasonable. Roughly a quarter of our large and profitable corporations pay NO federal income tax despite multi-billion dollar annual profits. (See my post of 11/5/11 for more detail.) Google, for example, avoided paying $2 billion in taxes in 2011 by funneling profits to overseas shell companies. [1]

The highest profile revenue issue in the austerity package is the personal income tax. The tax cuts enacted by President Bush in 2001 and 2003 are scheduled to expire. President Obama originally proposed letting the cuts expire on income over $250,000 per year, but keeping the cuts on income under that amount. The Republicans proposed a $1 million cut off and Obama has countered with a $400,000 cut off. As the cut off gets higher, the amount of revenue (and deficit reduction) is reduced. The difference between a $250,000 and a $400,000 cut off is estimated to be $40 billion per year in revenue (i.e., $160 billion versus $120 billion in increased revenue).

Expiration means the tax rate on upper incomes would increase from the current 35% to 39.6%, the rate that was in place in the late 1990s. (Note that for an individual with $20 million in taxable income, the Bush tax cuts of 2001 – 2003 have put roughly $1 million in their pockets each year for the last 10 years.) In addition, increasing the tax rate on unearned income – capital gains, dividends, and interest – back to 1990s rates is another hot topic. Given that the 2001 – 2003 tax cuts on earned and unearned income were significant contributors to creating the deficit, reversing them for high income individuals would seem appropriate.

The bottom line is that maintaining the Bush tax cuts on high incomes would cost up to $160 billion per year in lost revenue. Alternatively, using these funds on high impact spending, such as infrastructure investments or unemployment benefits, would generate an estimated net gain of 1.2 million to 1.5 million jobs and add 1.0% to 1.5% to economic growth. The growth in jobs and the economy will, in and of itself, reduce the deficit because taxes and revenue grow when the economy grows. Therefore, this approach will reduce the deficit over the long-term while strengthening the economy and creating jobs in the short-term. The only revenue increase in the austerity package that has a greater positive effect on jobs and the economy than letting the tax cuts on high incomes expire is terminating the cuts in the estate and gift taxes. [2]

In my next post, I’ll review the arguments against raising tax rates on high income individuals. In subsequent posts, I’ll take a look at cutting the deficit through spending cuts, the spending cuts in the austerity package, and alternatives to them.

[1]       Brown, C., 12/13/12, “Google on ‘immoral’ tax evasion: ‘It’s capitalism’,” Common Dreams

[2]       Bivens, J., & Fieldhouse, A., 9/18/12, “A fiscal obstacle course, not a cliff,” Economic Policy Institute

A MANUFACTURED AUSTERITY CRISIS, NOT A FISCAL CLIFF

ABSTRACT: The so-called fiscal cliff you’ve been hearing so much about is actually a manufactured austerity crisis. There is widespread agreement that if nothing is changed by or relatively soon after December 31 that our economy is extremely likely to fall into a recession and unemployment is likely to increase to over 9%, an increase of between 1% and 1.5%.

 

The federal government’s deficit does need to be addressed, but doing so precipitously and in the wrong ways will hurt the economic recovery. The immediate problems are not the government deficit, but the lack of jobs, particularly middle class jobs, and the lack of consumer spending, which represents two-thirds of our economic activity. We should use strategies for addressing the deficit that minimize negative effects on jobs and the economy, and phase them in over time to reduce their impact on our weak economy.

 The austerity package bundles together a variety of measures that are largely unrelated. Addressing these complex issues individually and with time for thoughtful consideration would make more sense than doing so in a bundle under severe time constraints. The austerity package’s cuts to social programs would be 8.4% across the board, with a few programs exempted. These cuts would have very significant negative effects on low income families and on education.

FULL POST: The so-called fiscal cliff you’ve been hearing so much about is actually a manufactured austerity crisis. [1] Congress and the President agreed on this package of spending cuts and tax increases (which take effect on December 31) because the Republicans demanded it in exchange for their votes to increase the federal government’s debt cap back in August 2011. As you may remember, they pushed the government to the brink of default – which hurt its credit rating and the economy – in order to extract these austerity measures. (By the way, I believe this brinksmanship and the harm it caused is incredibly UNpatriotic; but that’s a separate discussion.) A Congressional “Super-committee” was created to find alternative ways to reduce the deficit but was unable to come to a consensus recommendation, so we are left with this “fiscal cliff.” However, the effects of the austerity package would occur over time, so it is actually more of a “slope” than a “cliff.” [2]

There is widespread agreement that if nothing is changed by or relatively soon after December 31 that our economy is extremely likely to fall into a recession and unemployment is likely to increase to over 9%, an increase of between 1% and 1.5%. The roughly $100 billion per year in spending cuts and $350 billion in annual tax increases would reduce the deficit from about $1 trillion per year to about $600 billion. But taking this $400 billion out of the country’s economic activity would almost certainly turn slow economic growth into a recession. (See my post, The “Fiscal Cliff” and the Economy of 9/19/12 for more details.) As we’ve seen in Europe, austerity measures have pushed Greece, Spain, and Britain into a recession and the whole Eurozone is teetering on the edge of recession.

The federal government’s deficit does need to be addressed, but doing so precipitously and in the wrong ways will hurt the economic recovery. The immediate problems are not the government deficit, but the lack of jobs, particularly middle class jobs, and the lack of consumer spending, which represents two-thirds of our economic activity. [3] In addressing the deficit, we should use strategies that minimize negative effects on jobs and the economy. (See my post, Addressing the Deficit on 9/29/12 for four specific policy changes that would eliminate the roughly $1 trillion per year deficit with minimal impact on jobs and the economy.) Furthermore, spending cuts and increased tax revenue should be phased in over time to reduce their impact on our weak economy. [4]

The austerity package bundles together a variety of measures that are largely unrelated other than they have some impact on the federal government’s revenue or spending; although some actually have no impact on the deficit. Therefore, some view this “fiscal cliff’ as more of a “fiscal obstacle course.” [5] Major changes to both the personal and corporate tax codes are included, as well as significant changes to spending on a wide range of government programs from defense to social programs. Addressing these complex issues individually and with time for thoughtful consideration would make more sense than doing so in a bundle under severe time constraints.

In addition to the expiration of the Bush tax cuts, which expire for all income levels in the austerity package, other benefits for middle and low income households are scheduled to expire as well. These include:

  • Unemployment benefit extensions beyond the traditional 26 weeks (2 million individuals would lose benefits in December and another 1 million in April)
  • The reduction in the Social Security and Medicare payroll tax (by 2% of pay, which puts about $1,000 a year in the average worker’s pocket)
  • An enhancement to the Child Care Tax Credit
  • The expansion of the Earned Income Tax Credit, which augments incomes of low income workers
  • An exemption from income tax on mortgage debt that is forgiven

The austerity package’s spending cuts come 50% from the military and 50% from social programs. Many members of Congress oppose the cuts to the military. However, there are strong arguments for cutting military spending: 1) it has more than doubled (to $733 billion per year) since 2001, 2) we are winding down the wars in Iraq and Afghanistan, 3) we have far and away the largest military budget in the world, and 4) it’s widely acknowledged that there is significant waste in the military budget. Furthermore, military spending is not an efficient way to create jobs and at 58% of the federal government’s discretionary spending, it would be difficult and unfair to significantly reduce spending without cutting the military budget. (See posts of 9/29/12 and 11/17/11 for more details.)

The austerity package’s cuts to social programs would be 8.4% across the board, with a few programs exempted, such as Medicaid and the Children’s Health Insurance Program. These cuts would have very significant negative effects on low income families and on education. It is estimated that: [6]

  • 75,000 3 and 4 year old, disadvantaged children would lose the enriched preschool services of Head Start;
  • 25,000 young children would lose subsidies for early care and education (aka child care);
  • 16,000 teachers and other school staff would lose their jobs;
  • 460,000 students would lose special education services and 12,500 special education staff would lose their jobs;
  • 20,000 youth would lose job training;
  • 734,000 households would lose heating (or cooling) assistance;
  • Community health centers would lose $55 million; and
  • 1.3 million college students would lose tuition support.

If cuts to military spending are reduced, but overall spending reductions are maintained, cuts to social programs would be even more severe.

In my next two posts, I’ll discuss reducing the deficit through alternatives to the current austerity package, including reviewing various alternative proposals that have been put forth. I’ll focus first on options for increasing revenue and second on options for cutting spending.

[1]       Klein, E., 11/28/12, “It’s not a fiscal cliff, it’s an austerity crisis,” Bloomberg

[2]       Stone, C., 9/24/12, “Misguided ‘fiscal cliff’ fears pose challenges to productive budget negotiations. Failure to extend tax cuts before January will not plunge economy into immediate recession,” Center on Budget and Policy Priorities

[3]       Krugman, P., 11/12/12, “On deficit hawks and hypocrites,” The New York Times

[4]       Woolhouse, M., 11/19/12, “Phase in deficit cuts, economists say,” The Boston Globe

[5]       Bivens, J., & Fieldhouse, A., 9/18/12, “A fiscal obstacle course, not a cliff,” Economic Policy Institute

[6]       Every Child Matters Education Fund, 11/16/12, “The pending threat of Congressional actions to children’s safety net programs,” Every Child Matters, http://everychildmatters.org

THE DEBT, THE ECONOMY, AND THE POLITICAL PARTIES

ABSTRACT: Since 1945, Democratic presidents have on average reduced the federal government’s debt as a percentage of GDP by about 3% while Republican presidents have on average increased it by about 3%. PresidentObama has increased the debt percentage more than any president in this period. However, this is largely due to his inheriting a large deficit and the worst recession since the Great Depression. Other than this, the six largest increases in the debt percentage have occurred in recent Republican presidents’ terms.

Multiple measures of economic performance are better under Democratic presidents than Republican ones. Since 1949, overall economic growth measured by median annual increase in GDP has been 4.2% under Democratic presidents and 2.6% under Republican presidents. Stock market performance since 1913 as measured by the median increase in Standard and Poor’s index of 500 stocks has increased 12.1% under Democratic presidents and 5.1% under Republican presidents. The annual increase in corporate earnings since 1936 has been 10.5% under Democrats and 8.9% under Republicans.

This data certainly shows that Republicans aren’t more fiscally responsible than Democrats; if anything it strongly suggests the opposite. The data also show that Republicans aren’t the party of economic prosperity more so than Democrats.

FULL POST: The historical record of the federal debt and the performance of the economy under Republican and Democratic presidents is interesting to examine.

First, the federal government’s total debt (the total of all the previous annual deficits and surpluses) as a percentage of the overall economy (i.e., the Gross Domestic Product or GDP) is probably the most meaningful statistic about the debt. Since 1945, Democratic presidents have on average reduced the debt’s percentage of GDP by about 3% while Republican presidents have on average increased it by about 3%.

President Obama has increased the debt percentage more than any president in this period. However, this is largely, if not totally, due to his inheriting a large deficit and the worst recession since the Great Depression. Other than this, the six largest increases in the debt percentage have occurred in recent Republican presidents’ terms: George W. Bush’s two terms (with 2005 – 2009 being the worst other than Obama), George H.W. Bush’s term, Ronald Reagan’s two terms, and Gerald Ford’s partial term. The only two terms under Democratic presidents where the debt percentage increased were Harry Truman’s and Bill Clinton’s first terms. Both of them reduced the debt percentage in their second terms significantly more than the increase in their first terms, so overall they both reduced the debt percentage. [1]

Multiple measures of economic performance are better under Democratic presidents than Republican ones. Since 1949, overall economic growth measured by median annual increase in GDP has been 4.2% under Democratic presidents and 2.6% under Republican presidents.

Stock market performance since 1913 as measured by the median increase in Standard and Poor’s index of 500 stocks has increased 12.1% under Democratic presidents and 5.1% under Republican presidents. The annual increase in corporate earnings since 1936 has been 10.5% under Democrats and 8.9% under Republicans. [2]

While a president’s actions have only indirect influences on these measures and a president inherits policies and the state of the economy from his predecessors, this data certainly shows that Republicans aren’t more fiscally responsible than Democrats; if anything it strongly suggests the opposite. The data also show that Republicans aren’t the party of economic prosperity more so than Democrats.

[1]       The Economist, 11/1/12, “The change in America’s debt by presidential term,” www.economist.com/blogs/graphicdetail/2012/11/daily-chart

[2]      Healy, B., 11/2/12, “Taking stock of past races,” The Boston Globe

CANDIDATES’ BUDGET PROPOSALS AND THE DEFICIT

ABSTRACT: Both Presidential candidates, Obama and Romney, have put forward tax and budget proposals that they say will reduce the deficit. Obama’s tax and spending proposals would reduce the deficit by about one quarter. Romney’s proposals cannot be reasonably expected to reduce the deficit. Furthermore, they are likely to increase the deficit and the already high levels of inequality in income and wealth.

FULL POST: Both Presidential candidates, Obama and Romney, have put forward tax and budget proposals that they say will reduce the deficit. Obama has specified tax increases and a cut to military spending that would begin to reduce the deficit. Romney says his tax proposals would be revenue neutral, although he fails to specify how he would offset his tax cuts, and he promises to increase military spending. He asserts that his proposals would produce economic growth that would increase tax revenue and reduce the deficit; however, there is no credible evidence for that assertion. (Note: President G. W. Bush’s tax cuts, increases in military spending, and promises of economic growth that would pay for them are what began the process of turning a federal government surplus into deficits.)

Obama would let the Bush tax cuts on income over $250,000 expire and would also restore or increase taxes on unearned income (i.e., capital gains, dividends, and interest). He has also proposed limiting deductions and exclusions from income, as well as implementing the “Buffett Rule,” so that households with incomes over $1 million would at least pay taxes at the rate that middle class families do. These measures would generate roughly $200 billion per year in additional revenue, reducing the deficit by one-fifth. [1]

Obama has also proposed reducing the $700 billion military budget by about $50 billion per year as the wars in Afghanistan and Iraq wind down. Together, these tax and spending proposals would reduce the deficit by about one quarter.

Romney proposes keeping the Bush tax cuts and further reducing tax rates on earned income by one-fifth. He would maintain even lower tax rates on unearned income than earned income. Overall, these proposals would reduce income tax revenue by about $400 billion per year. Romney says he will make up for the lost revenue by reducing tax deductions and credits, and that the well-off will continue to pay at least the same amount in taxes. He says would do this by limiting total deductions and credits on a tax return to a fixed dollar amount and has mentioned amounts ranging from $17,000 to $50,000. [2]

While it is theoretically possible to achieve the same amount of revenue (i.e., revenue neutrality) under Romney’s proposals, it would be challenging and would require significantly cutting very popular deductions. [3] Four deductions account for 80% of all deductions and credits; in order of size they are the deductions for 1) home mortgage interest, 2) state and local taxes paid, 3) real estate taxes paid, and 4) charitable contributions. If an across the board cut to deductions were used to offset the loss in revenue, Romney would have to cut all these deductions by about one-third. Clearly, this would be unpopular and would also hit the middle class as well as high income families.

Romney has also proposed eliminating the estate tax, while Obama proposes maintaining an estate tax on estates over $3.5 million. Romney has also stated that he will increase the military budget. Here again, Obama’s proposal clearly reduces the deficit and these Romney proposals would clearly increase the deficit. The benefits of eliminating the estate tax, of course, go to wealthy families.

With a backdrop of 30 years of decreasing income tax rates that have seen dramatic increases in income and wealth in our best-off households and middle class families struggling to keep their heads above water, further cuts in tax rates do not seem at all likely to reverse this trend or benefit the middle class. Further, to provide some perspective on Romney’s proposal, looking at the cuts in tax rates alone, a family with taxable income of $100,000 or less, whose tax rate is cut from 25% to 20%, would see a benefit of $5,000 or less. A family with taxable income of $1 million, whose rate is cut from 35% to 28%, would see a benefit of $70,000; and if income is $10 million, a benefit of $700,000. This just doesn’t seem fair, especially on top of the huge tax cuts these high income households have seen over the last 30 years.

In addition, Romney’s proposal maintains lower rates on all unearned income (i.e., capital gains, dividends, and interest), while Obama’s has lower rates only on long-term capital gains (i.e., investments held for over one year). Having lower rates on all unearned income also doesn’t seem fair, especially given that the great bulk of unearned income goes to high income, high wealth households. Moreover, one of Romney’s arguments for lower tax rates is that by letting taxpayers keep more of what they earn, they will be rewarded for working. If we want to reward work, then income tax rates on work, namely earned income, should be lower (not higher) than the rates on non-work (unearned) income.

Finally, Romney’s assertion that cuts in tax rates will spur economic growth does not have any credible evidence. [4] This rationale has been used for the tax rate cuts that have occurred over the last 30 years. The strongest economic growth of the past 30 years (and the only elimination of the federal government’s deficit) occurred under President Clinton when he increased tax rates on high incomes. Furthermore, the rationale for tax cuts spurring growth has been that they put more money in consumers’ pockets and, with consumer spending being two-thirds of our economy, their spending will grow the economy. However, Romney has said his tax cuts will be offset by reducing deductions so that there will be no loss in government revenue or increase in the deficit. Therefore, there is no increase in the money in consumers’ pockets and no increased spending to spur economic growth.

If Romney’s tax cuts are indeed offset by reducing deductions so the result is revenue neutral, and if he lives up to his commitment to cap federal government spending at 20% of the overall economy (i.e., of gross domestic product), which would require significant spending cuts, Romney’s plans are likely to lead to job losses and a recession, not economic growth. Overall, Obama’s budget and tax proposals are highly likely to do more to spur near-term growth in jobs and the economy than Romney’s. [5]

In conclusion, Obama’s tax and budget proposals do take steps that can be reasonably expected to reduce the deficit by about one-quarter. Romney’s proposals cannot be reasonably expected to reduce the deficit. Furthermore, they are likely to increase the deficit and the already high levels of inequality in income and wealth.

[1]       Tax Policy Center, Oct. 2012, “Major tax proposals by President Obama and Governor Romney”

[2]       Wirzbicki, A., & Borchers, C., 10/5/12, “Questions on challenger’s idea to cap tax deductions,” The Boston Globe

[3]       Kranish, M., 9/21/12, “Candidates leave much unsaid on tax plans,” The Boston Globe

[4]       Rowland, C., 10/15/12, “GOP faith unshaken in supply-side tax policies,” The Boston Globe

[5]      Bivens, J., & Fieldhouse, A., 9/26/12, “Who would promote job growth most in the near term?” The Century Foundation

ADDRESSING THE DEFICIT

ABSTRACT: The federal government’s deficit does need to be addressed, but doing so precipitously and in the wrong ways will hurt the economic recovery. Spending cuts and tax increases that have the least negative impact on jobs and the economy should be used. Given these criteria, four items come to the top of the list: 1) A financial transaction tax, 2) Cuts in military spending, 3) Reversing tax cuts and loopholes for high income individuals, and 4) Closing tax loopholes for profitable corporations. These four policy changes would eliminate the roughly $1 trillion per year deficit.

 I urge you to determine where candidates for election stand on these measures as alternatives to the “fiscal cliff”. After the election, I urge you to contact your elected representatives to let them know where you stand and to ask them their position on these issues.

FULL POST: The federal government’s deficit does need to be addressed, but doing so precipitously and in the wrong ways will hurt the economic recovery. Specifically, the austerity approach of across the board budget cuts and tax increases, as in the 12/31/12 US deficit reduction “fiscal cliff” (see 9/19/12 blog post) and as currently being implemented in Europe, would hurt job creation and likely push our economy back into a recession, as is happening in Europe.

Selected spending cuts and tax increases that have the least negative impact on jobs and the economy should be used, as opposed to the broad ones of the “fiscal cliff.” Spending cuts in areas that have seen significant recent increases and the reversing of recent tax cuts should be prioritized. Fairness should also be considered.

Given these criteria, four items come to the top of the list:

  • A financial transaction tax
  • Cuts in military spending
  • Reversing tax cuts and loopholes for high income individuals
  • Closing tax loopholes for profitable corporations

These four policy changes would eliminate the roughly $1 trillion per year deficit. Here’s some detail on each of them.

A financial transaction tax (FTT) could generate $500 billion of revenue per year with a very low tax rate of between 0.1% and 0.5% on financial transactions (i.e., between $1.00 and $5.00 on the purchase or sale of each $1,000 worth of stocks, bonds, currency, commodities, or other financial instruments, including “derivatives”). If such a tax were applied very broadly to all financial transactions (there are over $1 quadrillion of financial transactions each year in the US), a 0.1% tax would actually generate over $1 trillion and eliminate the full deficit by itself. [1] A bill to create a FTT tax has been introduced in Congress. It would generate an estimated $350 billion per year. Most of us pay a sales tax on many of our purchases, so why shouldn’t there be a sales tax on Wall St. transactions? (More on the FTT in my next post.)

Military spending could be reduced without jeopardizing national security because:

  • We are winding down the wars in Iraq and Afghanistan ($170 billion in 2011),
  • Military spending has more than doubled since 2001 (increasing almost $400 billion per year and more in percentage terms than any other component of the federal budget),
  • There is significant waste (easily tens of billions each year) in the military budget (some of it pork barrel spending to favor specific Congressional districts), and
  • The US alone spends over 40% of all global military expenditures and three times what our European allies spend relative to the size of their economies. (See blog post of 11/17/11.)

 Furthermore, military spending produces fewer jobs than just about any other kind of public spending. Overall, phasing in cuts to military spending of $100 – $200 billion per year would be quite reasonable.

Personal income tax rates have been reduced significantly over the last 30 years and most recently in 2001 and 2003. Since 1981, tax rates on high incomes (the cut off has varied between incomes over $200,000 and over $400,000) have been cut in half (from 70% to 35% on regular income). The lowest rate has been cut from 14% or 15% to 10%. Note that if you have taxable income of $1 million, the reduction from 70% to 35% puts $350,000 in your pocket every year. (See blog post of 11/27/11 for more detail.)

Reversing the tax cuts of 2001 – 2003 for those with incomes over $250,000 would generate $200 billion per year. If The Buffet Rule were implemented, eliminating loopholes and special tax benefits so that those with the top 10% of incomes actually paid at least 30% in income tax, revenue of $450 billion would be generated.

The corporate income tax rate today is 35%, down from 46% in the late 1980s. The effective tax rate (what is actually paid) was 18.5% in a recent study of 280 large, profitable corporations; down from 26.5% in the late 1980s. (See blog post of 11/5/11 for more detail.) If corporations actually paid the 35% rate an additional $500 billion in revenue would be generated. If they paid an effective rate of 22.5%, which was the average between 1987 and 2008, revenue would increase by $250 billion.

In summary, four manageable steps that would return us to the status quo of the 1990s and add a financial transactions tax from the 1960s, both periods when the economy was doing very well, would eliminate the $1 trillion deficit:

  • A financial transaction tax: $350 – $500 billion
  • Cuts in military spending: $100 – $200 billion
  • Reversing tax cuts and loopholes for high income individuals: $200 – $450 billion
  • Closing tax loopholes for profitable corporations: $250 billion
  • TOTAL: $900 billion – $1.4 trillion

These steps, some phased in over time, would result in federal budget surpluses (as occurred in the 1990s). They would strengthen our economy and reduce inequality. None of them are radical; they simply reinstitute previous policies.

I urge you to determine where candidates for election stand on these measures as alternatives to the “fiscal cliff” that is in place for December 31, 2012. (See 9/19/12 blog post.) And after the election, I urge you to contact your elected representatives to let them know where you stand and to ask them their position on these issues.

[1]       Buchheit, P., 8/27/12, “Add it up: Taxes avoided by the rich could pay off the deficit,” http://www.CommonDreams.org/view/2012/08/27

THE “FISCAL CLIFF” AND THE ECONOMY

ABSTRACT: The federal budget’s “fiscal cliff” is looming on December 31, 2012. If Congress and the President let us fall over its edge, it will significantly harm our fragile economy. It cuts annual spending by about $100 billion per year and increases taxes by about $350 billion per year. The result would be a significant reduction in the annual deficit, from about $1 trillion to about $600 billion. However it would also negatively affect the economy: a recession or projected growth of only 0.5% versus growth of between 1.7% and 4.4% if the fiscal cliff were completely eliminated. The negative impact on the economy would make it harder, over the longer-term, to reduce the deficit.

There are many ways to soften the cliff’s impact. One would be to eliminate the tax increase on income under $250,000. Another would be reducing the spending cuts. It’s clear that the US government’s stimulus package helped soften the US recession; it’s equally clear that austerity is not a route to economic recovery. Austerity in Europe has turned a slow recovery into a stalled economy with recession in some countries. We need to call on Congress and the President to soften the fiscal cliff. Right now, the primary focus needs to be on strengthening the economy and creating jobs, which, over the longer-term, will help reduce the deficit.

FULL POST: The federal budget’s “fiscal cliff” is looming on December 31, 2012. If Congress and the President let us fall over its edge, it will significantly harm our fragile economy. Under current law, annual spending cuts of about $100 billion per year would occur and the Bush tax cuts of 2001 through 2003 would expire, which would result in an annual tax increase of about $350 billion.

The result would be a significant reduction in the annual deficit, from about $1 trillion to about $600 billion. However, it would also negatively affect the economy; projections range from a recession (i.e., negative economic growth as economic output shrinks) to growth of only 0.5%. If the fiscal cliff is completely eliminated, in other words if all the tax cuts are extended and the spending cuts are eliminated, projected economic growth would be between 1.7% and 4.4%. [1][2] The negative impact on the economy would make it harder, over the longer-term, to reduce the deficit.

There are, of course, many ways to soften the impact on the economy and on specific groups or agencies. The fiscal cliff’s increased taxes would affect almost everyone and, therefore, hurt consumer spending. Some people are proposing eliminating the tax increase on income under $250,000. This would reduce the tax increase to about $200 billion per year (instead of $350 billion). In addition, it would significantly reduce the impact on our economy (which is 70% consumer spending) because those with incomes over $250,000, who would see their taxes increase, spend only a fraction of their income on goods and services in the local economy. The real job creators in our economy are the vast middle class; their consumer spending is businesses’ revenue and increased business revenue is what leads to job creation. [3]

Reducing the spending cuts would soften their impact. The fiscal cliff’s spending cuts would be split roughly evenly between the military and social programs. Some of the loudest voices arguing for reducing the spending cuts are opposing the $50 billion cut to military spending despite the facts that:

  • Military spending has more than doubled since 2001,
  • We’re winding down two wars, and
  • This represents less than 7% of the over $700 billion per year military budget, which is roughly half of discretionary spending.

One argument that is being put forth is that a cut to military spending would cost jobs. Ironically, this argument is being put forward by many of the same people who have said that government spending doesn’t create jobs and that the way to improve the economy and create jobs is to cut government spending. Yes, cutting military spending will cost jobs in the military-industrial complex. But because military spending creates fewer jobs per dollar than other types of spending, cutting it will cost fewer jobs than cuts in other areas, or, if these cuts will allow spending elsewhere, more jobs will be created than those lost, resulting in a net gain in jobs. [4] (See 11/17/11 post: Defense spending: Can we afford to cut it?)

It’s clear that the US government’s stimulus package helped soften the US recession; it’s equally clear that austerity – cutting government spending and benefits often while raising taxes in an effort to reduce government deficits – is not a route to economic recovery. [5] While deficits do need to be addressed over the longer term, doing so while our economy is weak will only exacerbate the problem. Austerity in Europe has turned the slow recovery of 2009 into, at best, a stalled economy and recession or even depression in some countries. Demands for austerity in exchange for financial aid have occurred five times in Europe, with Greece, Portugal, Ireland, Spain, and Italy. Each time the austerity measures have deepened the economic crisis and weakened the country’s economy. Cutting public spending and benefits, while increasing taxes, decreases employment and incomes. This reduces consumer spending which hurts businesses and kills jobs. As a result, tax revenue falls, increasing (not reducing) government deficits. [6]

We need to call on Congress and the President to soften the fiscal cliff. Right now, the primary focus needs to be on strengthening the economy and creating jobs, which, over the longer-term, will help reduce the deficit. There is ample evidence that austerity will only make the economy and the deficit problem worse.

My next post will examine strategies for reducing the deficit in both the short and the long-term that would be less damaging to the economy than the fiscal cliff.

[1]       Businessweek, 8/2/12, “A decade of tax cuts and deficits,” Bloomberg Businessweek

[2]       Lipschutz, N., 8/22/12, “Even if ‘fiscal cliff’ gets resolved, outlook is anemic,” The Wall Street Journal

[3]       Reich, R., 8/30/12, “Labor Day 2012 and the election of 2012: It’s inequality, stupid,” http://www.RobertReich.org

[4]       Pemberton, M., 8/16/12, “Top 10 myths of the jobs argument against military cuts,” Institute for Policy Studies

[5]       Loth, R., 9/1/12, “The value of public-sector jobs,” The Boston Globe

[6]       Kuttner, R., 9/10/12, “Angela Merkel’s bad medicine,” The American Prospect

OUR SLOW ECONOMIC RECOVERY

ABSTRACT: Our economy is recovering slowly, as would be expected after such a deep recession and the near collapse of the financial system. Most economists agree that the federal government’s stimulus package aided the recovery by increasing employment by about 3 million jobs. Since the recovery began in 2009, the private sector has added 4.5 million jobs. The loss of public sector jobs, however, has been a drag on the recovery; over 600,000 jobs have been lost since 2009, including over 200,000 teachers. Without these job losses, the unemployment rate would be about 0.5% lower, or roughly 7.6%. Regardless of some people’s rhetoric, a public sector job puts money into a family and the economy the same way a private sector job does.

The current rate of economic growth is too slow to generate enough jobs to quickly and significantly reduce the unemployment rate. Federal Reserve Chairman Ben Bernanke recently made a forceful argument that additional steps are needed to stimulate the economy and attack high unemployment. The implied message is that stimulus through spending by the federal government would make sense and that cuts in government spending would not help economic growth or unemployment reduction.

FULL POST: Our economy was the subject of much rhetoric at the recent Republican and Democratic conventions. The reality is that the economy is recovering slowly, as would be expected after such a deep recession and the near collapse of the financial system. Most economists agree that the federal government’s stimulus package aided the recovery by increasing employment by about 3 million jobs and keeping the unemployment rate lower than it would have been (by about 2%).

The recovery began in mid-2009. The private sector has added 4.5 million jobs with net increases in each of the last 29 months. However, this is only half of the 9 million jobs lost in the recession and unemployment is still high at 8.1%. The worst month for job losses was January 2009 when over 800,000 jobs were lost just as President Obama was taking office.

The loss of public sector jobs has been a drag on the recovery; over 600,000 jobs have been lost since 2009, including over 200,000 teachers. The public sector continues to lose roughly 10,000 jobs per month, including teachers, firefighters, police, and other local, state, and federal government workers. Without these job losses, the unemployment rate would be about 0.5% lower, or roughly 7.6%. [1][2] Regardless of some people’s rhetoric, a public sector job is a job and puts money into a family and the economy the same way a private sector job does.

Harvard economist Kenneth Rogoff, who has studied recessions historically and globally, says the pace of the current recovery is consistent with what would be expected after this recession, which continues to reverberate around the globe. Economies damaged by financial crises recover more slowly and the brinkmanship in Congress over increasing the debt ceiling in the summer of 2011 created an additional drag on the recovery. The recovery after the 2001 recession (one of four in the last 30 years) actually experienced even slower job growth than the current recession.

Mark Zandi, chief economist at Moody’s Analytics and advisor to Republican Presidential nominee John McCain, notes that the economy’s problems were brought on by Wall Street’s recklessness and that “government saved our bacon. … the cost [to the economy] would have been measurably … greater had the government not interceded.” [3]

Nonetheless, the rate of economic growth has been too slow to generate enough jobs to quickly and significantly reduce the unemployment rate, let alone the numbers of underemployed workers and those who have given up looking for a job and therefore are not counted in the unemployment figures. Federal Reserve Chairman Ben Bernanke recently made a forceful argument that additional steps are needed to stimulate the economy and attack high unemployment. He noted that the likely benefits outweigh the potential costs. However, monetary policy from the Federal Reserve has limited ability to stimulate the economy at this point because interest rates, the main tool at its disposal, are already extremely low. Therefore, the Federal Reserve may take other, nontraditional steps. [4] The implied message is that stimulus through spending by the federal government would also make sense and that cuts in government spending would not help economic growth or unemployment reduction.

[1]       Loth, R., 9/1/12, “The value of public-sector jobs,” The Boston Globe

[2]       Woolhouse, M., 9/9/12, “Recovery slow, fits post-crisis pattern,” The Boston Globe

[3]       Quoted in Woolhouse, 9/9/12, see above

[4]       Appelbaum, B., 9/1/12, “Fed chief makes a detailed case for a stimulus,” The New York Times

CORPORATE RIGHTS IN TRADE TREATIES

ABSTRACT: The “Investor State Dispute Settlement” provisions in the draft of the Trans-Pacific Partnership trade treaty (TPP) give an investor (generally a multi-national corporation) the right to sue a government directly for compensation for any negative effect on its profits of any law or regulation. These suits are decided by international tribunals and raise significant concern that they can undermine public health, environmental protection, human rights, and management of economic activity. Under the North American Free Trade Agreement (NAFTA), these tribunals have required governments to pay more than $350 million to corporations and there are more than $12 billion in pending cases. Cases involve food and cigarette labeling; pesticides, drugs, and health care; and pollution and toxic waste. Australia has announced it will stop supporting the inclusion of investor state dispute settlement provisions in trade treaties.

We need openness and debate during the development of the Trans-Pacific Partnership trade treaty to ensure that protections for workers and the middle class are at least as strong as they are for corporations and the investor class. “At stake is nothing less than a democratic society’s ability to regulate a market economy in the broad public interest.” [1]

FULL POST: The “Investor State Dispute Settlement” provisions in the draft of the Trans-Pacific Partnership trade treaty (TPP), as well as in North American Free Trade Agreement (NAFTA) and numerous other treaties, give an investor (generally a multi-national corporation) the right to sue a government directly for compensation for any negative effect on its profits of any law or regulation. These suits are decided by international tribunals made up of three trade lawyers from the private sector who hear the cases and have the power to order trade sanctions or unlimited amounts in fines payable by governments to corporations. The lawyers rotate between serving as the tribunals’ judges and representing the corporations bringing the suits, thereby earning income from the corporations bringing the suits. The tribunals are conducted in secret with no accountability to the public and taking into account only the claim to profits, not health, environmental, or other concerns. [2][3]

Traditionally, international law has been used to settle disputes between countries, while a corporation was required to pursue a dispute in the courts of the country concerned. However, trade and investment treaties, of which there are now over 2,000 worldwide, typically give foreign investors (generally corporations) the right to bypass local court systems and directly sue governments. NAFTA expanded these rights and the TPP draft expands them further. (Note that these treaties allow companies to sue governments but not the reverse.) [4]

The investor state dispute settlement provisions in these treaties raise significant concern that they can undermine the ability of democratically elected governments to implement policies on public health, environmental protection, human rights, and management of economic activity. [5] Laws and regulations that could be attacked include Buy American provisions in government contracting, requirements that energy come from renewable sources, regulation of financial products and companies, and anti-sweat shops rules.

Based on suits under NAFTA, international tribunals have required governments to pay more than $350 million to corporations based on issues such as bans on toxic substances and land-use policies. There are more than $12 billion in pending cases under US trade treaties. [6] Through 2011, the United Nations Conference on Trade and Development had identified 450 lawsuits brought by companies against governments under trade and investment treaties. These are the known cases (see some examples below); most are kept secret. Argentina had the most cases (51), many related to its financial crisis and the privatization of water. It has been required to pay over $1 billion to multi-national corporations. [7]

Based on its experiences, Australia announced in 2011 it would stop supporting the inclusion of investor state dispute settlement provisions in trade treaties. It stated that it supported equal treatment of domestic and foreign business, but felt that these provisions provided greater legal rights to foreign businesses. Furthermore, it stated that it would not support these provisions because they constrained its ability to make laws on social, environmental, and economic matters. Finally, it noted that these provisions had been included at the behest of Australian businesses seeking protections when they entered foreign markets. It stated that if Australian businesses had concerns about investing in foreign countries, they should make there own assessments and decisions and not look to trade treaties for protection. [8]

In the US, concerns about previous trade and investment treaties led to press coverage, debate, and stopping them: the 1998 Multilateral Agreement on Investment, the 2005 Free Trade Area of the Americas, and the original efforts at an Asian-Pacific free trade area. We need openness and debate during the development of the Trans-Pacific Partnership trade treaty. We need to ensure that protections for workers and the middle class are at least as strong as they are for corporations and the investor class. [9] “At stake is nothing less than a democratic society’s ability to regulate a market economy in the broad public interest.” [10]

Examples of investor state dispute settlements include:

  •  The World Trade Organization (WTO) recently ruled that the US cannot require country of origin labeling on meat. Canada and Mexico brought suit against the policy and now will be able to impose trade sanctions on the US if it does not comply with the ruling. Not only will consumers not know where their meat is coming from but public health personnel will have a harder time tracking down the source if health problems occur. [11]
  • In 2012, the WTO ruled against US dolphin-safe tuna labeling and against a US ban on clove, candy, and cola flavored cigarettes.
  • Foreign manufacturers of generic drugs have sued the US government claiming US patent laws and court decisions have prevented them from marketing their generic versions of drugs.
  • A US health care provider has sued Canada, challenging its Canada Health Act, as interfering with its ability to provide services and make profits in Canada.
  • Two US manufacturers of pesticides have sued Canada based on its ban of certain pesticides.
  • Philip Morris, the multi-national tobacco company, has sued Australia and Uruguay over health warnings and advertizing on cigarette packages, even though their regulations are in compliance with and encouraged by the World Health Organization’s convention on tobacco control.
  • Ecuador was required to pay Chevron $78 million because its efforts to protect the Amazon from pollution were found to have negatively affected Chevron’s profits.
  • A Swedish energy company is threatening to sue Germany for its decision to phase out nuclear energy. It previously challenged a German standard on the increase in river water temperatures at its coal-fired power plant and got Germany to relax the standard.
  • Mexico was required to pay $17 million to US-based Metalclad because a local government refused to give it a permit to build a toxic waste dump.

[1]       Wallach, L., 3/13/12, “A stealth attack on democratic governance,” The American Prospect

[2]       Wikipedia, retrieved 7/18/12, “Investor state dispute settlement,” http://en.wikipedia.org/wiki/Investor_state_dispute_settlement

[3]       Wallach, L., 3/13/12, “A stealth attack on democratic governance,” The American Prospect

[4]       Wikipedia, retrieved 7/18/12, see above

[5]       Wallach, L., 3/13/12, see above

[6]       Wallach, L., 3/13/12, see above

[7]       Agazzi, I., 5/7/12, “Global corporations undermining democracy worldwide,” Inter Press Service

[8]       Wikipedia, retrieved 7/18/12, see above

[9]       Faux, J., 3/13/12, “The myth of the level playing field,” The American Prospect

[10]     Wallach, L., 3/13/12, see above

[11]     Public Citizen, 6/29/12, “WTO rules against yet another US consumer protection policy,” Public Citizen

TRADE AGREEMENTS PAST AND PRESENT

ABSTRACT: Past trade agreements have not lived up to their promises of new, good jobs for Americans and increased exports. While they have provided cheaper goods for us to buy, they have reduced jobs and put downward pressure on wages in the U.S., while increasing our trade deficit. [1] They have undermined U.S. laws protecting workers, the environment, and public health.

The currently under-negotiation Trans-Pacific Partnership (TPP) appears to be taking all of this a step further. TPP negotiations are being kept secret, although corporate representatives are fully involved. The big winners under past trade agreements and the TPP (as drafted) are multi-national corporations. The TPP negotiations and draft documents must be open to the public and Congress. This will ensure that various interests are appropriately balanced and that corporate interests don’t dominate.

FULL POST: First, a little history. NAFTA, the North American Free Trade Agreement, was signed in 1993. The best estimates are that NAFTA has resulted in the loss of almost 700,000 jobs in the US. Our trade deficit with the other participants, Canada and Mexico, has increased from $9 billion to $101 billion. [2][3] In the 20 years since China joined the World Trade Organization, 2.9 million jobs have been offshored to China, many of them well-paying manufacturing jobs. “[S]tate-subsidized Chinese production [has] decimated American industry and reduced the incomes of American workers.” [4] Our trade deficit with China has grown from $13 billion in 1991 to $295 billion in 2011. [5] “[I]n the past, the U.S. trade imbalance has widened after each new agreement. … U.S. businesses … profit immensely from outsourcing and offshoring … Nor is there any apparent economic benefit to the United States.” [6] “Historically, trade deals like NAFTA … are associated with economic displacement and instability, the erosion of labor and human rights standards, and the subordination of national sovereignty to foreign investors.” [7]

The current Trans-Pacific Partnership negotiations (13 negotiating meetings over two years) involve Australia, Canada, Chile, Malaysia, Mexico, Peru, Singapore, Vietnam, and other countries. TPP is actually much more than a traditional trade agreement and the negotiations have been conducted in secret because US Trade Representative Ron Kirk has indicated that he believes the only way to complete the deal is to keep it secret. (Negotiators have agreed not to release negotiating documents until four years after the deal is completed or abandoned.) Although 600 corporate representatives serve as official US trade advisors and have full access to the negotiations, the US Senate committee with jurisdiction over TPP has been denied access to the negotiations. [8][9]

Recently, two of the 26 chapters of the draft agreement were leaked. The TPP draft text includes:

  • International rights for pharmaceutical corporations that would prohibit generic versions of drugs in developing countries, dramatically increasing drug prices and reducing access [10]
  • Further financial industry deregulation
  • Prohibition on controlling the flow of money among countries and other measures designed to limit negative effects of financial speculation
  • Increased protection for foreign investors
  • Incentives for US firms to offshore jobs and investment
  • Provisions that favor foreign corporations (including government subsidized ones) over domestic ones
  • Provisions allowing corporations, including foreign corporations, to assert control over natural resources
  • Expansion of NAFTA’s international tribunals where corporations can sue governments if laws or regulations that protect the public interest (e.g., health, safety, and the environment) might have a negative affect on profits (More on this in my next post.)

Wallach sums up TPP with these words: “Countries would be obliged to conform all their domestic laws and regulations to TPP’s rules – in effect a corporate coup d’état.” [11]

We need to know more about the TPP draft. And we need to apply what we’ve learned from past experience with trade agreements so intended results are achieved and various interests are more appropriately balanced. The US is a democracy; therefore the TPP negotiations and draft documents must be open to the public and to Congress. Then, there can be open discussion and debate about its provisions and its balancing of various interests – those of the public, workers, corporations, investors, local communities, and countries. We need to ensure that corporate power doesn’t run roughshod over other interests.

[1]       Faux, J., 3/13/12, “The myth of the level playing field,” The American Prospect

[2]       Hindery, L., 5/1/12, “Free trade run amok: the TPP,” The Huffington Post

[3]       D’Amico, S.J., 7/10/11, “Trade deals are no deals for the US,” The Boston Globe

[4]       Lind, M., Dec. 2011, “The cost of free trade,” The American Prospect

[5]       U.S. Census Bureau, retrieved 7/16/12, “Trade in goods with China,” http://www.census.gov/foreign-trade/balance/c5700.html

[6]       Prestowitz, C., 3/13/12, “The pacific pivot,” The American Prospect

[7]       Chen, M., 6/21/12, “Backdoor talks on trans-Pacific trade deal aim to globalize corporatocracy,” In These Times

[8]       Wallach, L., 7/3/12, “NAFTA on steroids: The Trans-Pacific Partnership is a global coup d’état,” The Nation

[9]       Chen, M., 6/21/12, see above

[10]     Common Dreams, 7/10/12, “Obama’s trade policy ensures big pharma profit at expense of world’s poor,” http://www.commondreams.org/headline/2012/07/10-2

[11]     Wallach, L., 7/3/12, see above

THE ROLE OF LABOR UNIONS

Here’s issue #37 of my Policy and Politics Newsletter, written 6/28/12. Labor unions have been in the news quite a bit lately. This issue focuses on the role of unions in our society and economy.

Labor unions allow workers to approach employers as a group to discuss working conditions, pay, benefits, and other workplace issues. This affects the balance of power between workers and employers.

If you as an individual employee approach your employer about any of these issues, for example, receiving paid sick days if you currently had none, where does the balance of power lie? With the employer, of course. But if workers as a group approach the employer about such issues the balance of power is quite different.

Pay is probably the first item that comes to mind when thinking about employer – employee issues. There is lots of evidence that when employees are members of unions and bargain collectively on pay, they average 10 – 30% higher pay after controlling for other important variables. [1]

Employee pay is ultimately about how the profits of a business are divvied up among front-line or on-the-floor workers, senior executives and managers, and owners (which may be senior executives or stockholders). The balance of power among these groups affects how the rewards of the business are split. If workers participate in the discussion as a group, i.e., as members of a union, the result will be different, as indicated by hard evidence, common sense, and economic theory. Highly visible examples of this have been the negotiations between professional athletes and team owners in basketball most recently, but also in football, baseball, and hockey.

Therefore, it’s not surprising that as union membership in the private sector has dropped dramatically (from 34%in 1954 to 7% today [2]), income inequality has widened. Senior executives and stockholders have gotten much richer, while the rest of us have barely maintained our standard of living. The share of profits going to workers’ pay is the smallest it’s been since tracking began in 1947. [3]

This has not just increased in income inequality, but has undermined the middle class broadly. Union members’ pay and benefits used to set a standard in many sectors of the economy and to some extent for the economy as a whole. Non-union workers would receive similar compensation because there was competition in the job market, so companies with non-union workforces had to pay competitively to attract good workers. As union membership has declined, this is less of a factor in the job market and therefore there is downward pressure on wages and benefits.

The erosion in benefits has been very visible. Fewer and fewer workers have company managed pension plans, which were standard for union workers. And workers are paying more and more for their health care. Reductions in job security and increasing use of part-time workers are also partially the result of decreased union membership. Other issues that unions over the years have had an impact on are the length of the work week, overtime rules, availability of paid vacation and sick time, safety in the workplace (there are an estimated 58,000 workplace related deaths each year [4]), the minimum wage, unemployment and workplace injury compensation, how layoffs are handled, unfair or arbitrary actions by supervisors, and discrimination in hiring, pay, and promotions in the workplace.

Without or with weakened unions, union and non-union employees have less power and employers have more power. As a result, workers are likely to receive less pay, fewer benefits, and experience less desirable working conditions.

The next issue of the newsletter will address the reasons for the decline in private sector union membership.

[1]       Wikipedia, retrieved 4/23/12, “Labor unions in theUS,” en.wikipedia.org/wiki/Labor_unions_in_the_Unitede_States

[2]       Bureau of LaborStatistics,US Dept. of Labor, 1/27/12, “Union members – 2011”

[3]       Reich, R., 3/2/12, “Bye bye American pie: The challenge of the productivity revolution,” retrieved on 3/3/12 from www.commondreams.org/view/2012/03/02-6

[4]       Nader, R., 3/30/12, “If big labor would fight millions would join them on the ramparts,” retrieved at http://www.commondreams.org/view/2012/03/30-5

STUDENT DEBT: THE NEXT MIDDLE CLASS CRISIS?

Here’s issue #34 of my Policy and Politics Newsletter, written 6/6/12. It examines the rising levels of student debt.

Total student debt topped $1 trillion dollars recently (surpassing credit card debt) with borrowing exceeding $100 billion for the first time in 2010. The average 2010 graduating senior who had a student loan owed a little over $25,000 and 17% of graduating seniors’ parents had loans, and they averaged $34,000. Family incomes, grants, and public investments in higher education have not kept up with rising higher education costs, and therefore the use of loans has increased. Use by older students has grown as they pursue re-training and further education in an effort to increase their chances of landing a good job. Parents are taking on increasing debt to support their children’s education (roughly 10% of the total or $100 billion) and increasing numbers of seniors who are receiving Social Security owe money on student loans.

There is growing concern that student loan defaults could become a problem for lenders. Among members of the Class of 2005 who had begun repaying loans, an estimated 25% have missed at least one payment, making them delinquent, and 15-20% have defaulted, having been delinquent for nine months or more. Once default has occurred, the full amount of the loan is due immediately and interest, penalties, and fees can accumulate. Also, for federal government loans, the borrower loses eligibility for loan forgiveness and future aid, and can also have wages, tax refunds, and federal benefits (including Social Security) garnished. There is no statute of limitations (as there is for most crimes except murder and treason), so borrowers are responsible for the loan literally forever.

There is no relief from student loans under bankruptcy except under very rare and difficult to assert hardship situations. Prior to 1976, student loans were forgiven in bankruptcy, but since then bankruptcy laws have been tightened and in 2005, in a major rewriting of the bankruptcy laws (with a big push by financial institutions wanting to make it harder for consumers to escape credit card debt), student loans were made “non-dischargeable” except for “undue hardship.” This provision was slipped into the 2005 law by an unidentified lawmaker with no hearings or public discussion. After the law was passed but before it went into effect, the House Judiciary Committee recommended that this student loan provision be repealed because less than 1% of student loans were being discharged in bankruptcy. However, repeal never happened. [1]

The student loan debt burden is hampering the economic recovery; it dampens consumer spending, which is what drives our economy. The middle class is getting squeezed again. It is struggling to maintain its standard of living through higher education but can only afford it with increased debt. With high unemployment, jobs that reward education and allow students to pay off their debt are hard to get. The middle class has no economic margin. If they have jobs, wages and benefits are stagnant at best, and families have increased work hours as much as possible. Home prices are depressed with no equity to tap and credit card debt is high. Defaulting on student debt could be the next crisis for middle class families – and for lenders. Long-term delinquency rates on student loans (around 9%) are already higher than they are for mortgages, auto loans, and home equity lines of credit. [2]

In the midst of this, the interest rate on federal student loans will double, from 3.4% to 6.8%, on July 1 unless Congress acts. This will affect 7.4 million students. The cost for keeping the rate at 3.4% is about $6 billion in lost revenue. (This is less than 0.2% of the federal budget of $3.8 trillion including Social Security and Medicare.) Despite the fact that the federal government can currently borrow money at rates well below 3%, in the current political and fiscal environment every reduction in projected revenue must be offset. The fight in Congress is, ostensibly, over how to pay for the cost. The Republicans have proposed cutting preventive health care programs in the new health care law. This was defeated. The Democrats’ version had 51 votes but was filibustered by the Republicans. [3]

In addition, to keeping the interest rate low, advocates are calling for reinstating bankruptcy relief, a reasonable statute of limitations on loan collection, and controls on private interest rates and collection practices. [4] [5]

[1]       National Association of Consumer Bankruptcy Attorneys, 2/7/12, “The student loan ‘debt bomb’:America’s next mortgage-style economic crisis?”

[2]       Common Dreams, 5/31/12, “Student debt explodes, climbing 275% since 2003,” www.commondreams.org/headline/2012/05/31-8

[3]       Associated Press, 5/26/12, “Senate rejects two plans on student loan rates,” The Boston Globe

[4]       Brown, E., 5/11/12, “Indentured servitude for seniors: Social Security garnished for student debts,” Common Dreams, www.commondreams.org/view/2012/01/11-8

[5]       National Association of Consumer Bankruptcy Attorneys, 2/7/12, see above

SPURRING ECONOMIC RECOVERY

Here’s issue #30 of my Policy and Politics Newsletter, written 5/15/12. The US government budget process and the elections in Europe have focused attention on how government can best spur economic recovery.

There are basically two schools of thought on how governments can spur economic recovery:

  • Austerity: cut spending, raise taxes, and have tight monetary policy (i.e., high interest rates)
  • Stimulate: increase or maintain spending, cut taxes, and have loose monetary policy (i.e., low interest rates)

The theory behind the austerity approach is that it will spur consumer and business confidence so they will increase spending and grow the economy. In addition, government spending and borrowing (i.e., deficits) take money out of the private economy. The theory behind the stimulate approach is that when consumers and the private sector are not spending enough to grow the economy, the government should step in and spend, even if it creates deficits in the short run.

In the short run, cuts in government spending eliminate jobs, either those of public sector workers or those of the workers who provide the goods or services purchased. Those goods and services may be purchased directly by governments (e.g., military equipment or construction of highways) or by the beneficiaries of government benefits (e.g., purchases by those receiving unemployment benefits or food stamps). In the US, the public sector, primarily state and local governments, are laying off about 10,000 workers a month because of reduced spending. This hurts efforts to reduce unemployment and the economic recovery.

On the other hand, government spending does create jobs; the best estimates are that the 2009 federal stimulus package created roughly 3 million jobs and kept the unemployment rate 2% lower than it would have been otherwise. (See newsletter #26, Economic Recovery: How and for Whom.)

In the US, the federal government initially took the stimulate approach, increasing spending and cutting taxes while moving interest rates to near zero to stimulate business and consumer borrowing. Now, the approach is shifting toward austerity with calls for reducing the federal deficit by cutting spending as evidenced by the budget deal last August and the budget recently passed by the House.

In the Eurozone and Great Britain, the austerity approach was adopted. The 17 Eurozone countries have slipped back into recession and Britain is tottering on the edge of recession, while the US has seen slow growth for eleven consecutive quarters. As Paul Krugman puts it, “the confidence fairy doesn’t exist – … claims that slashing government spending would somehow encourage consumers and businesses to spend more have been overwhelmingly refuted by the experience of the last two years.” [1]

Although everyone agrees that the US government must address its deficit, the question is when. Many economists and Federal Reserve officials believe that austerity now would hurt the US economy and that we should stimulate the economy first and tackle deficits after the economy strengthens. [2] Keep in mind that when the economy strengthens, more jobs, more production, and more sales will increase tax revenues and automatically begin to reduce the deficit.

The evidence seems pretty clear, both from current experience and the Great Depression, that in the short run austerity doesn’t work and that government spending spurs job creation and economic recovery. However, it appears that ideology is overwhelming the facts in both the US and Europe.

[1]       Krugman, P., 5/7/12, “Those revolting Europeans: How dare the French and Greeks reject a failed strategy!” The New York Times

[2]       Fitzgerald, J., 5/13/12, “Austerity vs. stimulus debate revived by elections inEurope,” The Boston Globe

ECONOMIC RECOVERY: HOW AND FOR WHOM

Here’s issue #26 of my Policy and Politics Newsletter, written 3/31/12. The previous two issues examined the 2008 collapse of US financial firms that caused our current recession. This issue looks at the beginning of an economic recovery.

The US economy is beginning to recover from the Great Recession. It grew at an annual rate of 3% in the 4th quarter of 2011. That’s the good news. However, this growth is still too slow to generate the jobs needed to significantly reduce the high levels of unemployment any time soon.

The bad news is that the portion of household income growth going to workers is at a record low. Although the economy is producing more goods and services than before the recession began, it’s doing so with 6 million fewer workers. That reflects increased productivity, which could mean that everyone would be better off. However, due to public policies (including tax rates) and the weakening of unions, the bulk of the growth in incomes is going to managers and investors, and not to workers. [1]

In the current recovery (2009 – 2010), incomes have grown 2.3% (adjusted for inflation). However, the incomes of the top 1% have grown by 11.6% while the incomes of the bottom 99% have only grown 0.2%. In other words, 93% of the income growth of the current recovery has gone to the 1% with the highest incomes. [2]

The recovery has been slow because consumers don’t have the money to buy much. And consumer spending is 70% of our economy. [3] Our economy needs large numbers of middle and lower-income families with the purchasing power to buy more goods and services; the rich are too few in numbers and save more of their income than anyone else, so giving them more money and purchasing power is not nearly as effective a way to stimulate the economy.

Cuts in government spending are undermining the recovery. State and local governments are laying off about 10,000 workers a month because of reduced revenue and resultant deficits. Similarly, reducing the federal deficit at a time of high unemployment will not help the economy because budget cuts do not create jobs; rather they lead to public sector layoffs and reduced purchases of good and services by government. [4]

The federal government’s stimulus spending did create jobs and reduce the severity of the recession. 80% of economists believe the stimulus increased employment. [5] The best estimates are that it created roughly 3 million jobs and kept the unemployment rate 2% lower than it would have been otherwise. [6] [7] In particular, support for low income households appears to have been an extremely effective way to stimulate the economy and create jobs because these individuals are highly likely to spend their money in the short-term in the local economy. Infrastructure projects, such as highway construction projects, appear to have been nearly as effective. [8] The federal stimulus money that went to states helped them reduce their budget cutting and layoffs. However, the stimulus spending is over and additional government spending to stimulate the economy does not appear likely, to say the least, even though the lessons of the Great Depression would seem to strongly indicate that such spending would help the recovery.

[1]       Reich, R., 3/2/12, “Bye bye American pie: The challenge of the productivity revolution,” http://www.commondreams.org/view/2012/03/02-6

[2]       Saez, E., 3/2/12, “Striking it richer: The evolution of top incomes in theUS,”University ofCalifornia,Berkeley, Department of Economics, http://elsa.berkeley.edu/~saez/saez-UStopincomes-2010.pdf

[3]       Reich, R., 9/30/11, “America faces a jobs depression,” The Guardian, http://www.commondreams.org/view/2011/09/30-9

[4]       Krugman, P., 1/29/12, “The austerity debacle,” The New York Times

[5]       The American Prospect, 2/21/12, “The balance sheet”

[6]       Atcheson, J., 2/20/12, “US running on myths, lies, deceptions, and distractions,” http://www.commondreams.org/view/2012/02/20-0

[7]       Stiglitz, J., 9/8/11, “How to putAmerica back to work,” Politico.com

[8]       Feyrer, J., & Sacerdote, B., 1/25/10, “Did the stimulus stimulate? Real time estimates of the American Readjustment and Recovery Act,”DartmouthCollege and the National Bureau of Economic Research

GASOLINE PRICES: WHY SO HIGH?

Here’s issue #22 of my Policy and Politics Newsletter, written 3/5/12. This issue takes a look at gasoline prices and why they are so high.

Gasoline prices have been rising and have become an issue in the presidential campaign. So why are prices so high and is there anything that can be done about it?

Current gas prices are NOT driven by supply and demand. Supplies of oil and gas are up and demand in the US is down; so basic economics says that the price should be low. According to the Energy Information Administration, supply is higher than three years ago when gas prices fell (briefly) to around $2.00. And demand is at the lowest level since April 1997. [1] The US is actually producing more oil and gas than we can use, so we are exporting 3 million barrels of oil products per day. [2] All of this suggests that gas prices should be low.

Tension over Iran and concern about the oil it supplies to world markets is putting some upward pressure on oil prices. Financial speculators see this as an opportunity to make money and jump into the market heavily, which drives prices up much more. Wall Street firms and other financial players dominate the buying and selling of oil, even though they have no intention of ever taking possession of the oil they buy. Ten years ago, producers and end users (airlines, oil refiners and retailers, etc.) were responsible for 70% of the trading of oil; now the financial speculators make up 65% – 80% of the market. The only reason they are in the market is to make money and the money they make comes out of our pockets through higher prices. [3]

Estimating how much speculation increases the price of oil and gasoline is difficult; however, many experts, including ones from Exxon Mobil, Delta Airlines, and Goldman Sachs, believe that speculation drives up the price of oil by 40%. This is a “speculators’ tax” that we all pay. There is historical evidence to support this. For example, in the summer of 2008, when speculators were driving the oil market, gas prices spiked to over $4.00 a gallon before declining sharply to $2.00. [4]

Congress and the President tried to reduce the impact of this speculation as part of the Dodd-Frank financial reform legislation. The law directed the Commodity Futures Trading Commission, which regulates this market, to set a cap on how many contracts for oil any one trader or company could control, which would limit the level and impact of speculation. After significant delays, such a cap was proposed in October 2011. However, many supporters of the cap view the proposal as quite weak. Nonetheless, the speculators are suing to block the implementation of even this modest reform. [5]

Through speculation in the oil markets, the Wall Street-based financial industry is making substantial sums of money that are coming out of the pockets of average Americans. The motivation is to make money for the few; however, there’s no added value for society at large, only costs. This is a variation on the theme that also drove the subprime mortgage market – make money regardless of the consequences. Due to campaign contributions, lobbying, and the revolving door between Wall Street and the federal government – in other words, due to crony capitalism – it’s likely that nothing significant will be done and we will all continue to pay this “speculators’ tax.” As a result, the Wall Street speculators will get richer while we get poorer as we pay more for gas than we should.

[1]       Sanders, B., 2/28/12, “Wall street greed fueling higher gas prices,” CNN.com

[2]       McClatchy Newspapers, 2/21/12, “Once again, speculators behind sharply rising oil and gasoline prices,” The Sacramento Bee

[3]       McClatchy Newspapers, see above

[4]       Sanders, B., see above

[5]       Common Dreams staff, 3/2/12, “Obama’s oil speculation task force missing in action,” CommonDreams.org