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Debt – Part One: Personal and Business

Saturday, January 5th, 2013

People like to argue about the national debt as if it were the same thing as private or business debt. That does compare apples with oranges and bananas. But let’s assume for a moment that all these fruits can be rationally compared.

Personal debt typically consists of three things: a home mortgage, a car loan and credit card debt. But let’s start with a home mortgage. Suppose a family with an income of $50,000; that is slightly below the U.S. median income. Suppose that they somehow have been able to accumulate $36,000 for the down payment on a $180,000 house – again slightly less than the median. They will have a $144,000 debt. That is 288% of their income. Typically such a family will also have other debts – a car loan and some credit card debt. Now we don’t really regard such a situation as “unsustainable.” And, in any event, the “issue” is whether or not they can “service” the debt – i.e., make timely payment over the life of the mortgage, loans and other credit. The real “risk” involved is if they should experience either loss of income – through loss of job – or catastrophic loss – such as a major illness or accident.

Businesses also typically carry some debt. They may borrow money for capital equipment, inventory and even some operating costs such as payroll. They may even carry debt incurred when private equity capitalists bought them with money borrowed against business’ assets. A business may borrow for inventory, the ability to repay depending on the eventual sale of that inventory. A manufacturer may borrow to make payroll because the revenue to pay the workers will not be realized until the goods produced by the workers are sold. The revenue produced by capital equipment also will not be realized until after the equipment has been bought and put into operation. Again, the issue is whether or not the business will be able to service the debt from revenues. It will, of course, happen from time to time that revenues do not meet expectations. When that happens over a long period of time the consequence is bankruptcy.

Debt isn’t a problem for either individuals or businesses as long as they can service that debt. That is the real issue – not whether debt, as such, is a bad thing. Yes, if a business or person runs up such a level of debt that they cannot service that debt there is a problem. If a person or business is spending more than they take in, there is a problem. In either case, the solution is twofold – increase revenue and decrease spending. Cutting expenses may or may not be a good idea. For the person, foregoing certain kinds of expenses is actually a bad idea – for example, foregoing medications, dropping health or disability insurance, even cutting food expense. Such measures may actually reduce revenue – you may not be able to work if you are sick and your expenses would go up more than the savings. The person might also increase income by taking a second job, turning a hobby into revenue, holding a garage sale, or even finding a better paying job.

There are similar examples for business. A retail store might cut expenses by laying off sales people or reducing inventory. But that could actually reduce revenue as customers find service affected or a poor selection of goods.  Or the business might actually go further in debt to open another store in another town. In other words in business, going into debt can actually increase revenue and sometimes reduce expense (e.g., a new machine might be less expensive to operate and maintain and increase output).

Generally speaking a growing economy helps both individuals and businesses deal with their debt. As the economy grows, individuals find it is an “employees’ market” – it is easier to get better paying jobs when the economy is enjoying full employment. When workers are fully employed and earning good wages, consumer demand for goods and services translates into more sales and revenue. All this good economic news can trigger inflation – which is actually good news for debtors, if not creditors. A shrinking economy (i.e., an economy in recession) has the opposite effect. It adversely affects individual income and business revenue. And, if it results in deflation, that is bad news for debtors – and good news for creditors (at least up to the point where defaults occur).

So many of the assumptions made about personal and business debt actually turn out to be misleading if not simply false. People are quite able under normal economic conditions to have debt that is two or three times their income. Businesses use debt to operate and to grow their businesses. But what about government? One major difference between individuals and businesses is that a government’s central bank can increase the money supply to pay debt. (Incidentally, that is a major difference between the U.S. and Greece, which has no central bank and whose debt is held by German and French banks so it cannot increase its supply of euros.) Yes, increasing money supply can trigger major inflation – which actually helps pay the debt! Central banks can deal with runaway inflation by shrinking the money supply; that was how the Federal Reserve under Volker stopped the runaway inflation that occurred in the U.S. in the mid-1970s.

Coming soon: Part II: U.S. Public Debt

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On “Fixing” Social Security and Medicare

Friday, December 28th, 2012

We keep hearing about the urgency of “reforming” Social Security and Medicare. But that is a red herring. If we are to reduce deficits in the next ten years, we must address revenue and discretionary funding.

SOCIAL SECURITY

Social Security had a trust fund of $2.7 trillion dollars at the end of 2011. Generally, Social Security revenues have exceeded expenses, although in the six quarter from July 2010 through December 2011 there were three quarters in which expenses exceeded revenues. But the historic trend of a growing Social Security trust fund continues. If we do absolutely nothing, Social Security is solvent until 2035, although it will have to rely on the trust fund to meet obligations. It does not need to be “fixed” before January 2013 or even before 2014.

The proposal to end the current cost of living adjustment with a chained cost of living adjustment will extend the actuarial life of Social Security. But it will have absolutely no effect on federal deficits in 2013 – the old COLA is already in place for 2013. It most likely will have no impact on federal deficits until sometime after 2023. That impact would be that possibly Social Security would have to draw less on the trust fund to meet obligations. Since the trust fund is U.S. Treasury notes, Congress would have to repay the debt or else face default on the national debt. On the other hand the chained COLA would effectively reduce the income of those on Social Security, especially the older they become, penalizing them for living too long.

One could significantly increase the actuarial life of the Social Security program simply by lifting or eliminating the cap on income subject to the Social Security tax. (2012 income above $110,100 is not taxed for Social Security; that amount is adjusted annually for inflation.) But that doesn’t have to be done today.

MEDICARE

Medicare is a bit different. It does, however, have a $324.9 billion trust fund. It is true that Medicare expenses are exceeding revenues and are likely to continue to do so for some time. That requires the Medicare program to draw upon the trust fund to pay out their expenses. Even so, the Medicare program is actuarially solvent until 2024.

The usual proposal is to gradually raise the eligibility age (currently 65) for those under 55. Note that this will not have any effect until after 2023. Even then it will only have an small impact on the Medicare program. But it also would have the effect of increasing costs for Medicaid and Obamacare, as it would increase the numbers of people eligible for those programs. It probably would also increase the cost of medical insurance as those people who have insurance would keep it longer, even as they experience more health problems due to age.

MEDICAID

Medicaid poses other problems in that that program has no dedicated revenue source and no trust fund, so increases in Medicaid costs have a direct impact on the federal (and state) budgets. However, cutting Medicaid doesn’t really solve anything. Similarly cutting Obamacare solves nothing. As those who are outside the system of health insurance and Medicare experience illnesses and accidents requiring medical attention, they will use costly emergency rooms which drive up the cost of health care for everyone else as those costs are passed off to those paying out of pocket, through insurance and tax supported hospitals and doctors. It should also be noted that sick people are not as productive as workers and thus depress national economic growth.

AN ALTERNATIVE ‘FIX’ TO HEALTH CARE ISSUES

One solution to health care costs in the U.S. would be to do away with Medicare, Medicaid, Obamacare and health insurance programs and to adopt a modern universal, single payer health care system. Such systems provide health care for less of the GDP with generally better outcomes. It would also be a boon to employers who would be relieved of the need to provide health insurance to employees. The reason we do not have such a system is the millions of dollars that the health insurance and pharmaceutical special interests pour into lobbying and congressional campaigns.

NOTES

On the Social Security trust fund: http://www.ssa.gov/oact/progdata/assets.html. On the actuarial projections for Social Security: http://www.ssa.gov/oact/trsum/index.html.

On Medicare: http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/ReportsTrustFunds/downloads/tr2012.pdf.

 

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On Debt and the Scope of Government

Tuesday, September 11th, 2012

A Response to William McKenzie of the Dallas Morning Nees

McKenzie wants us to focus on the $16 trillion federal debt ( “Let’s make right-sizing government the goal”). First, remember that the United States has never been out of debt. We came close in 1835. The historical trend from the beginning of the Revolutionary War to the present has been a growing debt. The size of the national government has been growing since the adoption of the Articles of Confederation. In fact, the adoption of the Constitution was a significant growth in federal government.[1]

So, let’s talk about debt in terms of presidential periods, remembering that fiscal policy involves Congress as well as presidents. I will also begin with Wilson because that era first saw a billion dollar debt. The Wilson era saw a 722% increase in the national debt, largely attributable to WWI. The last two years, as we demobilized the debt was actually reduced. That reduction continued under Coolidge (-14%) and Harding (-17%) and into the first two years of Hoover. Those debt reductions ended with the beginning of the Great Depression; the Hoover years saw the national debt increase 33%, accumulated after the 1929 crash.

Roosevelt (whom McKenzie mentions) saw the biggest debt run up – a whopping 1,048%. Some of that was the New Deal attempt to end the Great Depression; most of it was the cost of WWII – which big, deficit spending most economists agree ended the Great Depression. Yes, you can spend your way out of a depression.

Truman saw the deficits fall dramatically and even surpluses that reduced the national debt in 1947, 1948 and 1951. This era saw an increase in the national debt by 3%.

Eisenhower was the last president who saw a reduction in the national debt in 1956 and 1957, but in the entire period the debt rose 9%.

Kennedy/Johnson saw the debt rise by 22% — partly due to Great Society programs and the Vietnam War.

Nixon/Ford saw the debt rise by 98% — partly due to the Vietnam War and sharply rising inflation in Nixon’s second term.

Carter saw the debt rise 43% as inflation continued.

Reagan saw the debt rise by 186%; G.H.W. Bush by 54%.

Clinton saw the debt rise by 32%. In 2000 it rose less than 1%.

G.W. Bush saw the debt rise 105%, attributed to the tax cuts of 2001 and 2003, the prescription drug program and the Iraq and Afghanistan wars. The sharpest rises occurred in the last two fiscal years – 11% and 18%.

The first full full year of Obama’s presidency saw the increase fall to 14%.

I can only conclude that since the days of Truman, Democratic presidents have seen more fiscal restraint than Republicans. Truman 3%, Kennedy/Johnson 9%, Carter 98% and Clinton 32% compared to Eisenhower 9%, Nixon/Ford 22%, Reagan 186%, G.H.W. Bush 54% and G.W. Bush 105%.

But absolute debt isn’t a particularly useful number. If you are considering taking out a mortgage (i.e. increasing debt) to by a $500,000 house, there is a difference if your income is $50,000 or $500,000. All else being equal, the debt load for the higher income is less than for the lower. The closest comparison is national debt as a percentage of Gross Domestic Product, which serves and an indicator of the ability of the nation to service the debt.[2]

At the end of Fiscal Year 1946 the national debt stood at 121% of the GDP. That is the highest I have found going back to 1900. That debt represents the debt accumulated by the U.S. government during the Great Depression and WWII. In 1981 it had fallen to 32% of GDP. Remember this is not a reduction in the dollar amount of the national debt — that had risen by $79 billion.

Beginning with FY 1982 we see the debt as a percentage of GDP rising every year except for FYs 1996 through 2001. Thus from Truman through Carter, the trend was for the debt to GDP ratio to fall; and from Reagan through Obama, except during the Clinton years, for the debt to GDP ratio to rise.

It is generally said that the fiscal policies of the federal government during WWII created the modern middle class. That may be an exaggeration, but it is certainly true that the size of the middle class grew in those years. The debates in the early postwar period were whether or not that middle class could be sustained in a postwar economy. The remarkable thing is that it was, and it grew. Certainly things like the G.I. Bill contributed to that. Returning veterans were often the first in their families to get a college education and become “white collar professionals” instead of “blue collar laborers.” Veterans could obtain ownership of homes, cars, refrigerators, TVs, etc.

We also see in that postwar period an increase in median income and, in fact proportional increases for low, middle and high income groups. Virtually all Americans were enjoying increased prosperity. That phenomenon does seem to have slowed some in the 1970s. But beginning in the 1980s we saw something new (or rather more like what we had seen in the 1920s and even the 1890s. High income groups saw their income soar, middle income workers saw their incomes stagnate, and low income workers saw their incomes fall. The result was a radically changed income disparity and wealth disparity. Many economists do not believe this bodes well for the future. The economic precedents (e.g., 1920s and 1890s) suggest grave dangers.

Finally, I would close with an observation. I suspect that the management of the Dallas Morning News, when considering going into debt to obtain a new press will weigh both its ability to service the resulting debt and the potential increase in profit resulting from the more efficient press. It would seem to me sensible that such factors enter into the discussion when discussing federal fiscal policy. As mentioned earlier, federal investment in education (via the G.I. Bill) resulted in increased productivity and prosperity for the American people. And, although it increased debt, it more than increased the capacity of the government to service that debt and also increased government revenues. Many, many other examples of this could be cited such as the government guarantee of home loans to returning veterans in the G.I. Bill, the construction of the interstate highway system begun by Eisenhower, rural electrification and so forth. It can similarly be argued that government investment in the health of the American people is such an activity, since there can be no doubt that healthy workers are more productive than unhealthy workers.

 

[1] “Historical Debt Outsanding” In the discussion that follows I have begun the “Presidential Eras” with the first full fiscal year of their term – typically beginning in September – through the fiscal year that ends in the first year of the next president. While that may bias somewhat, I would argue that the roughly u.5 months that overlaps is more a consequence of the predecessor than the incumbent.

[2] “Revenue as Percent of GDP” I’m using the GDP figures here and the previously cited debt figures.

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Equity Capital Is Not Venture Capital

Thursday, August 16th, 2012

There is a difference between venture capital and private equity. If John Doe comes up with an idea to manufacture and market widgets, but needs $50 million startup capital for plant and labor, he goes for venture capitalists. If he is successful they will put up the capital and perhaps provide some management advice. This is very risky because probably most startups fail, but the rewards can be substantial if the startup succeeds.

Let us suppose that American Widget, LLP, (hereafter AW) is modestly successful. The private equity outfit — Watkins, Tolbert and Farmer (hereafter WTF) see AW as a good target for a leveraged takeover. So they put up $10.5 million of their capital. They then seek out partners who put up another $9.5 million. With this $20 million they go to an investment bank for a $40 million loan backed by AW’s assets and future profits. The bank takes $800,000 closing and WTF takes $800,000 “finder’s fee” for the loan and another $800,000 as a management fee. The bank has already recovered 2% of the loan, and WTF has recovered $1.6 million of its $10.5 million. With the remaining $57.6 they buy AW. Notice that AW now owes the bank $40 million plus interest. While that nets them $17.6 million new capital, it isn’t going to be used to create jobs.

It immediate goal of WTF managers is to increase the profit of AW as quickly as possible. There are a number of ways they can (and will) do this. Employee pensions and insurance programs can be eliminated. Workers can be laid off. The whole plant operation can be moved to a low wage, “right-to-work” state, thus ending any union or other labor contracts and lowering pay. Some jobs can be shipped overseas. Some operations can be shut down – typically Research and Development and Quality Assurance. Less expensive materials can be used in manufacturing.

One interesting variation is that some of that $17.6 new capital can be used for a leveraged buyout of yet some other victim. Such a merger can provide other opportunities for employee reduction, especially some of the better paid management type roles. For example, one clothing chain taken over proceeded to take over some other chains and eliminated buyer positions.

These kinds of moves will reduce costs and increase profit in the short term. AW’s “good name” will carry it forward for a while in spite of lack of innovation and declining quality – or, in the case of the clothing chain declining selections. But it is that initial increase in profit that the managers are after, not long term “good will” or success.

With the increased profit the management will contract for an analysis. Say in the first year profits increased 10%. The analysis will project profits next year of 20%, then 30%, 44%, 50% and 60% in the next five years. (Remember WTF management is paying for the analysis.) They will then go to the bank and take out yet another loan based on these projected profits. The bank will take out its fee, WTF will take out its finder’s fee, WTF will increase management fees and pay itself bonuses, and also pay dividends to itself (remember that original $10.5 million) and its friends (remember that $9.5 million).

Eventually, though, the cost cutting will affect income as quality declines and competitors come up with new and improved widgets. AW is also vulnerable to other events. For example, a recession can significantly reduce demand for widgets. More of its cash flow is absorbed by debt service. WTF may take the AW back to the bank to borrow more money (taking their finder’s fee and paying itself dividends with part of the proceeds) to service AW’s debt.

At this point WTF may actually manage to sell the company to recoup some of its investment and that of WFT’s friends. Probably that will, along with the healthy dividends paid over the few years, recoup the investment plus some profit. But for the private equity firm, the real profits were in those finder’s and management fees taken as the took AW to the cleaners. Eventually, AW will simply go bankrupt and cease operation. So much for jobs and boosting the economy.

And, of course, those profits are capital gains and dividends – taxed at 15%.

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Book Review: Corporate Takeover of America

Thursday, May 10th, 2012

Winner-Take-All Politics: How Washington Made the Rich Richer — And Turned Its Back on the Middle Class by Jacob S. Hacker & Paul Pierson

As Will Rogers famously said, “I am not a member of any organized party — I am a Democrat.”

Jacob Hacker and Paul Pierson detail how the U.S. Chamber of Commerce and the National Association of Manufacturers organized business interests to block progressive legislation in the 70s. This involved both the long affinity between corporate America and the Republican Party and intensive lobbying efforts to dissuade moderate Democrats from voting for progressive legislation in the Senate during the Carter administration.

The first part of the book outlines the contrast between the American economic and political scene after World War II and the 70s with the scene in the past 30 years. Most of this material repeats what has been shown in study after study. The authors counter the usual explanations of the change in a CSI detective style, showing that such things as education and technology do not explain the concentration of power and wealth that has occurred.

What has happened, according to Hacker and Paul Pierson  is the strengthen organization of corporate America led by the U.S. Chamber of Commerce and the National Association of Manufacturers and the weakening of organizations which represented a broad spectrum of middle America. The authors describe how the Chamber of Commerce and National Association of Manufacturers successfully lobbied to block labor laws and business regulations during the Carter administration when progressives thought that a Democratic President, Senate and House would enhance regulation of environment and work and product safety as well as eliminate impediments to labor organizations. They also describe how corporate America has transformed the Democratic Party from a pro-working class party to a pro-business party, albeit perhaps not quite as pro-business as the Republicans.

Part of the reason for corporate success in Washington is attributed to the decline in participation in labor unions and a variety of middle American organizations including the Veterans of Foreign Wars and service clubs such as Lions, Shriners and Rotary clubs all of which did provide middle America with a more unified voice in the 1940-60s.

The authors also detail the fact that, at least in the late 1970s it wasn’t necessary for the corporate interests to enact new “business-friendly” legislation or to repeal older legislation; all that was necessary was to block passage of progressive legislation. We have seen this strategy repeated both during the Clinton administration which was unable to get health care reform passed. Doing nothing was all that the health care segments required. We have also seen it in 2009 — the Republicans do not need to pass anything for corporate America. All they have to do — and they have been very successful in this — is to block progressive legislation either by threat of filibuster in the Senate, or in committee, or in the 112th Congress the House. And, in either case, we have minority rule.

Hacker and Pierson do not go into great detail about the role of corporate America money in political campaigns. For that side of the story you should read Republic, Lost: How Money Corrupts Congress — and a Plan to Stop It by Lawrence Lessig.

The authors conclude the book with a conclusion “Beating Winner-Take-All” which I must confess is rather disappointing. Having identified the problem as being the effective political organization of corporate America to oppose progressive legislation and even to roll back progressive laws, Hacker and Pierson focus more on the difficulties of getting the tens of millions of middle Americans organized to oppose the corporate takeover of the political system of America. The opposition will require that middle Americans once again organize themselves to speak in Washington — and I might add in their state capitals.

I recommend this book for those who want to have a better understanding of the American political scene today.

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Four Books to Read before November

Friday, May 4th, 2012

Forty-forty: Eras of American Political and Economic History.

Recent American political and economic history can be conveniently divided into two forty year periods: 1933-1972 (from FDR’s first term through Nixon’s first term) and 1973-2012 (Nixon’s second term through Obama’s first). The first period covers a spectacular recovery from the Great Depression dominated progressives of the Democratic Party. It was an era of an improving standard of living for all Americans and of an unprecedented absence of economic crisis. The second period is an era of economic stagnation, wildly widening income discrepancy and repeated booms and ever worsening busts, the latest of which still depresses the American economy, especially for low and middle income workers. What happened?

Winner-Take-All Politics: How Washington Made the Rich Richer — And Turned Its Back on the Middle Class by Jacob S. Hacker & Paul Pierson

This book briefly describes the economic contrast between Richistan and Broadland, two mythical countries, one of which sees the concentration of wealth in the hands of a few and the other in which economic growth is shared by all. Our second era is represented by Richistan, while Broadland is more like our first era. How did this happen? The authors use a CSI analogy to ferret out the causes, dealing effectively with the arguments for rapidly growing income and wealth disparity. They conclude that the “criminal” is government.

But how was the government transformed from a moderately progressive democratic institution to a regressive institution representing wealth? The authors provide a good historical analysis of how, at the end of our first era and beginning of the second, the American political parties came to be owned by corporate America rather than the people. This section of the book is worth the price of the book. We see the huge increase in lobbying, campaign contributions, political action committees and propaganda mills posing as think tanks in the 1970s and 1980s.

Republic, Lost: How Money Corrupts Congress — and a Plan to Stop It by Lawrence Lessig 

Lessig explains in depressing detail how money corrupts our Congress. Although dealing specifically with congressional campaign finance, it is applicable to state politics and presidential campaigns. He argues that quid quo pro bribery is actually very rare, but the need for congressmen to raise large sums of money to pay for campaigns makes them dependent on their contributors rather than on the people alone. He also details the problem created by the “revolving door” by which government officials move from the private sector and back — often to very substantial incomes — is part of the problem. Less helpful are his suggestion on how to fight this corruption, although some of his arguments have merit. The main problem is getting reform through Congress (and legislatures) dependent on corporate campaign cash.

End This Depression Now! by Paul Krugman

We know how to end this depression but our political leaders lack the will to do so. Lessons learned from the Great Depression, the New Deal, World War II, and the postwar economy in America show the way. Paul Krugman traces the causes of the current financial crises, not as an attempt to fix blame (there is plenty to go around), but so we can understand why it happened and what can be done about it. These lessons are also learned from other nations that have experienced similar conditions in the late 20th century. The reasons recovery has been so slow is that the stimulus was too little, too brief and in some cases misdirected.

The shift of focus on the deficits and debt misdirects our attention from what must be done. At the end of World War II, the national debt was 120% of Gross Domestic Product. It “fell” to about 60% by 1964, not because we had budget surpluses and paid down the debt, but because the economy grew significantly. The dollar amount of the debt had actually increased. The debt as a percentage of GDP did begin to grow in the 1970s, but did not really take off until the 1980s and following.

The slow recovery does aggravate the debt because revenues are suppressed and expenses increased. Government spending increases aggregate demand which creates jobs — which increases the GDP and revenues and reduces expenditures for unemployment compensation, nutrition programs, medicaid, housing assistance, etc. That in turn reduces both the deficits and the debt as a percentage of GDP. Prolonging the recession will have costly long term effects. Long term unemployment makes it more difficult for older workers to reenter the labor market at previous levels, much less at levels they would have achieved if employment had been continuous. Even more dire is the fact that the recession is retarding young workers entering the labor market which will have a negative effect throughout their lifetimes.

Krugman offers a way to bring the current economy up to speed and refutes the arguments of the naysayers.

The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too by James K. Galbraith

Galbraith provides economic data on income and wealth disparity in a readable manner. The major problem with “free trade” is that business really does not want it. What the corporate lobby has done in the past 40 years is to “unlevel” the playing board to benefit large corporate profit.

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Eliminate the Income Tax?

Sunday, March 18th, 2012

In the course of a discussion with a supporter of Ron Paul, it was stated that we should eliminate the federal income tax. I pointed out that this was a campaign to destroy the United States of America because there is no way for the national government to pay its bills without the income tax. To this I received the response that would be a good thing because then the national government would be constrained to the powers enumerated in the Constitution. That is not a reasonable response. Here is why.

In 2010 the total revenues of the United States Treasury were $2.2 trillion dollars. Of that 42% or $924 billion was from individual income taxes, 40% or $880 billion was from payroll taxes, $198 billion was from corporate income taxes, 3% or $66 billion was from excises and  6% or $132 billion was from other sources. If you eliminate individual and corporate income taxes and payroll taxes, which are a dedicated tax on income, the government revenues fall to $198 billion.

If you take the very narrow definition of constitutional enumerated powers to exclude the general welfare and a restrictive interpretation of the commerce clause advocated by many on the right, you have some government expenses remaining, specifically:

  • Defense at $847.2 billion,
  • Interest at $196.2 billion,
  • Protection at $54.4 billion, and
  • General government at $24.7 billion

Or a constitutional expense of $1,122.5 billion – and a deficit of -$1,077.5 billion. That is almost the kind of deficits we are currently running. If we require a balanced budget, as do many on the right, we would have enough to pay the interest on the national debt with $1.8 billion left over for defense, protection (e.g., Homeland Security and border control), and general government (i.e., the executive, legislative and judicial branches of government).

Notice that this involves a default on the national debt in the form the termination of all current and future Social Security and Medicare benefits. That’s even without the balanced budget amendment!

It also would result in the termination of all federal grants to state and local governments for a wide range of things including health and human services, education, and transportation.

It would also eliminate all federal disaster relief for hurricanes, tornados, floods, fires, drought, and earthquakes.

Eliminated would be any subsidy to farmers and businesses. Cuts in subsidies to oil companies would drive up the cost of gasoline.

Maintenance of national parks would end. The Constitution says nothing about national parks. It would end payments in lieu of taxes on federal properties to states and local communities. For that matter, it makes no mention of the purchase of land from foreign nations. Were the Louisiana, Gadsden and Alaska purchases constitutional?

The income tax was agreed to by three quarters of the states in 1913 and by every state admitted to the Union since. It was agreed to because we, the people, recognized that duties, imposts and excises were insufficient to pay the costs of government a century ago. An income tax was first proposed in 1812 to pay for the costs of that war. The United States actually found the income tax necessary in 1861 to pay the expense of the national government. It was subsequently ruled by the Supreme Court to violate Article I, Section 9, which eventually lead to the 16th Amendment.

The United States has changed dramatically since the Constitution was first written in 1787. It has grown from a nation of around 3 million to nearly 400 million, from an area of less than 900 thousand square miles to over  3.5 million square miles. It has changed from a rural, agricultural society to an urban industrial and technological society. People are much more mobile now than then. The 50 states are far more interdependent and interrelated than the original 13, partly due to the success of the Constitution and national government promoting interstate commerce.

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Dollar Wise, Dollar Foolish

Monday, January 9th, 2012

The administration has decided to save $50 million a year by ending the production of dollar coins. The coins, it seems are not particularly popular and, as a result there is something like 1.4 billion of them in storage. It seems pointless to produce coins and then just storing them forever. There will be a small number of them produced each year because the presidential series has been mandated by Congress. These will go to collectors as premium prices so that the U.S. Mint will actually make money on them. And, of course, it will be the collectors that store them, not banks and the Federal Reserve.

But wait. In England there are no 1 pound notes, only 1 pound coins. In Europe there are no 1 euro notes, only 1 euro coins. While perhaps European and the British economies are not exactly booming at the moment, I’ve not heard it reported that their economic problems have anything to do with the absence of 1 pound or 1 euro notes and the reliance on 1 pound and 1 euro coins. In point of fact, the use of those coins helps reduce government costs.

It costs the Bureau of Printing and Engraving about 7¢ to produce a $1 bill. In 2010 it produced 1.9 billion $1 bills at a cost of around $133 million. Those bills will last about 42 months, after which they will be removed from circulation, cut up into confetti and burned — only to be replaced with new, crisp $1 bills.

The $1 coins are undoubtedly more expensive to produce; it costs the U.S. Mint about 15¢ to produce one. But that $1 coin will last 30  years (360 months). Over the life time of a $1 coin produced at a cost of 15¢, the Bureau of Printing and Engraving would have to produce 8.6 $1 bills at a cost of 60¢ — 4 times the cost of producing the coin. It is estimated that if we stopped producing $1 bills and relied entirely on $1 coins the government would save $184 million per year. The funding for the National Endowment for the Arts is $90 million.

What other countries learned was that as long as they kept producing 1 pound/euro bills the public would use them; but when production ceased, the public adapted to the coins.

If the U.S. stopped producing $1 bills today, the 1.9 billion notes pulled from circulation because they were worn out could almost entirely be replaced by the 1.4 billion coins currently stored. By simply not producing any more $1 bills, they would cease to circulate within 42 months. The only $1 bills anywhere would be in collectors’ storage. And we would reduce the federal deficit by around $184 billion a year.

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An Unintended Experiment in Education

Friday, December 9th, 2011

Southeast of Dallas there is the small town and school district of Forney. During the housing boom of the mid 00s, the town experienced phenomenal growth–something on the order of 25% to 35% annually.  The school population wasn’t growing quite as rapidly as the town because it includes a lot of rural area outside the city limits. But still it was growing at a double digit percentage every year. That meant that the school district was what Texas calls a “fast growth district.”

Texas accommodates fast growth districts by allowing them to estimate each year before the school year begins what their attendance will be. The state then funds that estimate, providing money for operations and building. If the district does not realize its forecast, then the state will call for a refund of the resulting surplus. The expectation is that the district will place the surplus in a reserve account, pending the state’s request for reimbursement.

For Forney ISD this was working exactly as intended by the state. But then came the recession and housing bust that began during the 2007-8 year. The town’s growth came to a screeching halt. When estimating growth for the 2008-9 school year and each year after, the school district made a serious mistake. It submitted its estimates based on the previous rapid growth which was no longer occurring. So they found themselves receiving millions of surplus state funding. Then they compounded that mistake with another–instead of putting the surplus in reserve accounts, they spent it.

They did not waste it on fluff. They used the building funds to build additional classrooms. They used the operational funds to hire additional teachers and to buy instructional equipment to be used by students to learn. In other words they spent educational money to educate children. True enough, they should not have done that. But they did it; hence the unintended experiment in education.

By hiring additional teachers, they reduced class sizes housed in the additional classrooms. With the reduced class sizes teachers could give more individual attention to students. It was also possible to introduce tutoring for those students experiencing difficulty. Equipment used by the students also promoted their learning.

The result? When the district was actually growing and there were no surplus funds, the district was rated “Accepted” by the state. That is essentially a grade of “C.” O.K., but not great. Passing, but you won’t get into Harvard, Yale, Texas University or Texas A&M with a grade of C. During the period of time when they were over funded and spent those surplus state dollars educating children the district rose in the state ratings–to “Recognized.” That’s a “B” instead of a “C.” But wait. Then they rose to a state rating of “Exemplary”–that is an “A.”

The argument that we should be “throwing money at schools” is nonsense. Yes, it is possible for schools to engage in wasteful spending on things that do not promote student learning. But when dollars are spent educating students, student outcomes do improve. Increasing those kinds of dollars increases student outcomes.

We’ve always known this. “Property rich districts”–that is those whose school property tax raises significant amounts of money per student–do tax and do spend more money educating students. The people in the district know it. Home values increase as real estate agents promote sales in a district with outstanding schools. People move into the district because schools are better, even though they may face a higher school tax bill.

Those parents who can afford to do so often pay big dollars to send their children to private schools. One of the reasons for this is that the classes are smaller and the students receive more individual attention. Private school advertise this fact.

The Forney experience, albeit unintended and now costly as they try to figure out how to return tens of millions of dollars to the state, does show that money is one factor that improves the quality of education. Withholding and reducing funding does not improve education. Yes, we must be sure that the funding is used to improve instruction and student outcomes. But that does not happen without an investment in our schools and future.

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Confession of a Capitalist

Thursday, December 8th, 2011

How I contribute to the economic problem.

I am a single guy. I have a retirement income of approximately the median income of a family of four. That means that I enjoy “surplus capital”–income I don’t need after I pay the rent, put food on the table, etc. Yes, I spend some of that “surplus capital” on non-essentials–computer, camera, music, stuff etc. That does create jobs. But I spend several hundred dollars each month on “investments”–several mutual index funds. That makes me a capitalist.

Now, you may think those “investments” create jobs. They don’t. When a business expands it issues stock in an Initial Public Offering (IPO) or auctions bonds. The sale of these equities yields capital that is used to expand–i.e., create jobs. Stock represents “ownership” of the company, bonds represent a debt obligation of the company. Most of us do not buy IPO stock or participate in bond auctions. Neither do most mutual funds.

Whether we buy individual stocks and bonds from a brokerage house or shares in a mutual fund we are buying securities from other owners of those securities. These exchanges do not result in new capital for the corporations, that occurred in the IPO or auction. All we are doing is moving ownership of existing plant and labor around; it does not yield new plant or new jobs. What results in real investment is consumer demand for goods and services, which cause businesses to seek new capital for new plant and labor through reinvested profits, IPO and bond auctions. If demand for goods and services is absent, profits become “retained earnings” which may be used to buy back stock, to accelerate pay down of debt or to buy existing stocks and bonds of other corporations. Again, this does not result in new capital for real investment in plant and labor–i.e., do not create jobs.

What we “capitalists” are doing is not investment. It is speculation. We hope to obtain dividends from the speculation. Note that in some cases, those dividends may be taxed at 15% regardless of income and in some cases at 0%. We also hope that the stocks and maybe the bonds appreciate in value over time, so that when we sell we will experience a capital gain (again, if held for a year or more, taxed at 15% regardless of income). Even if we sell at a loss, we experience a gain of sorts because the capital loss decreases our overall tax liability. Essentially what we are doing is gambling; generally speaking, the odds are better than the lottery, casino or slot machines. But we are gambling, not creating jobs.

My market speculation is an infinitesimal drop in the equity markets. It doesn’t create jobs. If I spent that money on useless widgets, I would be creating jobs. But if you are talking about the trillion or more dollars of corporate retained earnings, you are talking about a huge amount of “capital” which is expended in speculation in such things as Colateralized Debt Obligations, Credit Debt Swaps and equity purchases. This inevitably leads to economic “bubbles” as this activity drives up the cost of financial paper. Eventually, though the bubble bursts. It always does. It always will. It is a kind of grand, legal ponzi scheme. It is what was behind the recession and bust of 2007. It is what was behind the dot-com bust of 2001. It is what was behind the recessions of the early 90s and 80s. It is what was behind the Great Depression. It is what was behind the panic of the 1890s.

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