Saturday, August 14, 2004

Do the rich save more?

From Buffett: Bush Tax Cuts Favor Corporations, Wealthy:

..."If class warfare is being waged in America, my class is clearly winning," Buffett said in Berkshire Hathaway Inc.'s annual report.

Except for 1983, the percentage of federal tax receipts from corporate income taxes last year was the lowest since data was first published in 1934, Buffett said.

"Tax breaks for corporations (and their investors, particularly large ones) were a major part of the administration's 2002 and 2003 initiatives," Buffett said....

to Report Finds Tax Cuts Heavily Favor the Wealthy:

...The report calculated that households with incomes in that top 1 percent were receiving an average tax cut of $78,460 this year, while households in the middle 20 percent of earnings - averaging about $57,000 a year - were getting an average cut of only $1,090.

...Mr. Kerry has argued that the cuts were tilted so much in favor of the wealthy that they provided relatively little stimulus to the economy and set the stage for record budget deficits. Since 2001, the federal budget has deteriorated from a surplus of more than $100 billion to a deficit expected to exceed $400 billion in 2004.
Mr. Bush's top economic priority has been to make his tax cuts permanent, rather than letting them expire at the end of this decade as they would under current law. Mr. Kerry would seek to roll back the tax cuts for households with incomes above $200,000 a year, a move his campaign estimates would save $860 billion over 10 years, and use that money in large part to pay for a vast new national health care plan...
...According to the new report from the Congressional Budget Office, about two-thirds of the benefits from the tax cuts, enacted in 2001 and 2003, went to households in the top fifth of earnings, with an average income of $203,740....

All this begs the larger question: Do the rich mostly spend or save?

If they save more, as a policy criteria, should the rich get the bulk of the tax cuts - especially in an anemic economy that presently requires direct stimulation of domestic demand (vs. a now oversupply of investment) to produce concommittant growth?

A detailed technical paper with extensive economic analysis and discussion on the topic by economists at the Federal Reserve, Dartmouth, and Columbia provides some answers on how much the rich save. As it turns out, a whole lot.

"Do the Rich Save More" provides a stylized analysis of data from the University of Michigan's Panel Study of Income Dynamics (PSID), the Federal Reserve's Survey of Consumer Finances (SCF), and the Bureau of Labor Statistics' Consumer Expenditure Survey (CEX).

A salient set of results are diagrammed on pp 34-35 showing a clear trend slope measuring the much greater degree (2-3 times or more) by which the rich save over those of lower- and middle-income.

Their conclusion, in part, states:
...For households aged 30-59, we consistently find that higher lifetime income households save a larger fraction of their income than lower income households. Also, there is no evidence that high lifetime income households dissave more at post-retirement ages...
Whereas for the middle-class, the savings (including retirement) picture is the reverse and bleak - a University College of London and University of Chicago professor state in "Do IRAs Increase National Saving?":

...households financed their IRA contributions not from a reduction in consumption, but rather from existing saving or from planned saving. Their findings indicate that only a small fraction of IRA contributions actually represented net additions to national saving. These results should lead policymakers and researchers to reexamine tax-favored saving accounts and to determine whether the additions to household saving that are induced by tax incentives are substantial enough to justify the loss in tax revenue from the program.

...While participation in the IRA program may have increased household saving (through reduced tax liabilities), results indicate that there was little or no increase in national saving between 1982-1986. Attanasio and DeLeire also examine changes in the non-IRA financial assets of IRA contributors. They find that on average, new contributors reduced their non-IRA assets by over $1,400 compared with old contributors.

...Researchers estimate that at most 9% to 20% of the IRA contributions of new contributors represent new national saving. These figures are lower than the results found by studies that compared IRA contributors with non-IRA contributors, only using data on assets. The key policy question remaining is whether a 9% or 20% increase is a large enough percentage to justify the IRA program....

Living beyond means

Numbers speak for themselves, over & over again...

U.S. Trade Deficit Increased 19% in June: Analysts Worry That Burgeoning Gap Will Lead to Higher Interest Rates, Lower Dollar

...By the end of June, imports exceeded exports by $55.8 billion, another record U.S. trade deficit, the Commerce Department reported yesterday. The size of the gap forced many economists to trash their forecasts and pencil in lower estimates of the economy's strength in coming months.

..."The U.S. as a nation is just living way beyond its means," said Nigel Gault, U.S. economist for Global Insight, an conomic research firm, noting that household debt has soared in recent years and that the federal budget deficit is ballooning to a record size. "There is a worry that at some point, U.S. spending growth will have to slow sharply to get this under control."The size of the trade gap surprised many analysts because it showed the U.S. economy had slowed more significantly than thought in the spring.

...Several analysts said they also expect weaker U.S. economic growth in coming months as trade provides an additional drag on a recovery that may be faltering under the weight of high energy prices, stalling job creation and tepid consumer spending. "Unless there is significant improvement in coming months, the deficit's trajectory poses serious questions about the growth outlook in the second half," Joseph Abate, of Lehman Brothers Global Economics, wrote in a note to clients, calling the trade figures "shockingly dismal."...

Friday, August 13, 2004

Why Bush's top-heavy tax cuts don't work

This entry is in response to a blog posting, where a comment was made a while back objecting to my assertion stating that the rich save more than the poor, and as a result the Bush tax cuts is not an effective stimulus for a slow-growing economy.

The Economic Irrationality of Supply Side-driven Tax Cuts
Setting aside the fact that jobs growth has been slowing down tremendously (as evidenced by the latest monthly jobs report of an anemic 32,000 new jobs) despite *record* monies spent on tax cuts, I think tax cuts are perceived in fundamentally different ways, one of which does not jive well with the economic data. I believe too many go through a certain thought process or experiment where one analyzes things at the margin and make assumptions leading to the belief that the rich are actually more likely to spend than the poor, thereby justifying the top-heavy tax cut approach.

Here is an alternative view. For a point of reference most of us can agree to, here is a set of time-series data from the Bureau of Labor Statistic's Consumer Expenditure Survey:

[Column #'s]
[1] Income quintiles (fifth)
[2] Share of total income
[3] Fraction of income saved
[4] Contributions to overall savings rate

1981 TO 1983 AVERAGE
lowest 3.9% -108.2% -4.2%
second 10.1% -15.4% -1.6%
third 16.7% 6.3% 1.1%
fourth 24.8% 18.4% 4.6%
highest 44.4% 31.3% 13.9%
Overall savings rate (1981-83) 13.7%

1987 TO 1991 AVERAGE
lowest 3.8% -122.6% -4.7%
second 9.3% -28.1% -2.6%
third 15.8% -0.9% -0.1%
fourth 24.3% 12.2% 3.0%
highest 46.9% 30.6% 14.4%
Overall savings rate (1987-91) 9.9%

Source. Consumer Expenditure Surveys, Bureau of Labor Statistics,U.S. Department of Labor.

Besides the obvious fact that the rich do save significantly more then the poor, here's some context behind this trend that should leave little room for doubt.

A Little Economic History
Beginning in the mid-1970s the share of their incomes which U.S. households save steadily declined, and this drop accelerated in the 1980s. According to household surveys, the savings rate averaged 13.8% of income during 1981 to 1983, but fell sharply to 10% during 1987 to 1991.

Most economists, and many policymakers, believe this decline is a critical economic problem. Why? First, since they view saving as the source of capital for business investment, lower savings will mean higher interest rates, resulting in less investment and slower economic growth. Second, higher interest rates will harm consumers by making it more difficult to finance home mortgages, car loans and other purchases. Third, the current generation, by not saving enough, will face greater hardships in retirement.

While economists and policymakers of many political stripes agree that we should be deeply troubled about this situation, they don't agree on why the rate fell, or what to do about it. One political viewpoint, that of "supply side" economics, became prominent in part due to concerns during the 1980s about the falling savings rate. Among other things, supply-siders argue for redistributing income toward corporations and the wealthy, on the theory that these sectors save at higher rates. But while such a redistribution has taken place during the past 15 years, overall savings have continued to fall.

Evidence from recent decades shows that while the rich are saving more, this increase has been outweighed by dramatically lower savings from all other income groups. And the reason is that widening inequality has so harmed the incomes of moderate- and low-income households that they are unable to save, and in fact are living on borrowed money (dissaving).

Flaws in Standard Economic Assumptions
One problem with standard models (and every day folks as matter of fact) is that they assume all households, regardless of their income or wealth, make consumption decisions in similar ways. All families, the models assume, balance their current consumption needs versus the need to save for retirement, and all have reliable estimates of their future income.

These assumptions are suspect for several reasons. First, only households that have relatively stable sources of income can make long-term decisions concerning future consumption in retirement. But a large and growing number of households face great uncertainty concerning their jobs and income. Second, many households, even if they would like to save for retirement, cannot do so, because they don't have enough income to cover their current consumption needs.

Standard models also fail by assuming that households adjust their behavior similarly whether incomes rise or fall - when they rise, households consume more, and when they fall, households consume proportionally less. But the "Relative Income Hypothesis" (RIH), suggested in 1949 by economist James Duesenberry - reminiscent of eclectic economist Thorstein Veblen's earlier work dissecting the [ir]rationalities of the leisurely class (in his best known book, the Theory of the Leisurely Class, chapter 4 is on Conspicuous Consumption - a term he originated) - argues that when incomes decline (such as in a recession) households resist giving up the consumption patterns they have become accustomed to.

To maintain their previous living standards, households will either reduce their savings rates, consume out of previous savings, increase their use of debt, or raise household income by having another household member enter the labor market. This all can be summed up by what someone said to me recently: "It's amazing to see how customer care representatives at my company are driving BMWs and Lexus on a 30K a year salary." I make a bit more yet I bought a Nissan Altima in 2002, albeit souped up a bit with a V6 and spoiler but at least 10K cheaper than the former two.

In other words, the more wealthy you are on the economic continuum, the more likely you are in making more rational economic decisions that involve heightened consideration of future and present values of costs and returns of goods and assets (many with help of fine accountants everywhere), which lead in the end to a much higher rate of savings to play a large part. This trend persists through times of growth and recession over the long-run (note how static the results held over the decade-long time series). If one had time to dig the more recent '01, '02, and '03 survey data, it would show the same trend.

It would be instructive to understand given the shift in income toward the wealthy during the 1980s, what caused the decline in savings rates from 1981-83 to 1987-91? It was not a lack of savings by the richest Americans, but rather by everyone else.

The dissavings rates of the lowest two fifths rose, while the savings rates for the third and fourth fifths (perhaps approximating the middle class) fell greatly. In 1981-83 the lowest two fifths dissaved at rates of-108% and - 15% respectively, while in 1987-91 their negative saving rates grew to -122% and -28%. In addition, the third fifth went from net savers to dissavers, while the savings of the fourth fifth fell from 18% to 12% of their incomes. The savings rate of the wealthiest fifth of households also worsened slightly. But this was more than offset by their increased share of national income. As a result, this was the only income group that increased its total savings (from a 13.9 to a 14.4 percentage point contribution toward the overall savings rate, as shown in column three of the table).

...And Why Bush's Tax Cuts Don't Add Up
As such, the Bush tax cuts are not very effective given such economic realities. The problem is only worsened considering that the tax cuts are funded on borrowed money that is costly, debt-financed by our very willing co-optitors of the Far East and Europe.

Many analysts expected the overall U.S. savings rate to rise as wealthier households, with higher savings propensities, gained a greater share of the total income. And supply-side theorists continue to recommend shifting income toward the wealthy as a means of raising total savings in the United States. But the evidence demonstrates the opposite - higher savings by the rich did not make up for the severely reduced savings of the remaining 80% of households.

As some economists have argued, the bottom three fifths found it necessary to increase their dissaving in order to maintain living standards in the face of stagnating real incomes and rising costs of living, especially for housing, since the early 1970s, and now rising commodities, oil, and food prices.

In the end, the tax cuts are needed much more by the middle- and lower-income class (by middle, I mean most of you and I making less than $200,000 a year), more to buttress up the savings rate *and* to increase the consumption rate since the rich (BillG and his closest 1,000 friends) are not consuming but investing for the rest of us to consume thus completing, ideally speaking, a virtuous cycle of economic growth.

However, Bush's belief in discredited "trickle-down" supply-side economics of the 80's (whereby people making >$200K a year receive bulk of the billions in aggregate benefits of the tax cuts and save much of it, vs. just marginally speaking viewed by impact as % of their income, which fails to provide a weighted measure of the economic impact of tax cut dollars spent that stimulate aggregate demand) is a disaster for this day and age of free capital flows, debt-driven foreign-funded demand, coupled with oil and basic materials volality and price increases, political instability, and a wholesale lack of investment in education, technology and research vis-a-vis the G-8 and *China*.

The real behind-the-scenes Mideast story

An impressive piece of journalism that I read a few weeks back. A gripping blow-by-blow of the Iraqi situation, how Iran poses the real threat in the region capitalizing on the current tie-down and distraction of the US, and how the Israeli’s are doing all they can to stop them a la real politick.

Sunday, August 08, 2004

Kumar and Harold go to Whitecastle

Chani and I went to see the flick last night - what a hilarious blast! It's the funniest movie I've seen this year. A tinge of Better Luck Tomorrow. It's doubled up with an Asian and Indian mixed together who play off each other really well. Great writing and acting; it exceeded my expectations by far.

The political economist

BillMon dispels the myths and confusion behind the employment rate and the influence of the household v. payroll surveys. It is very disappointing to see someone of Mankiw’s qualifications turn into a political hack. He is one of the nation’s leading macroeconomists, and like Larry Summers (treasury secretary under Rubin/Clinton), both are bright stars and were one of the youngest tenured professors at Harvard.

Brad DeLong is also a noted economic historian at UC Berkeley who specializes in macroeconomic growth, also a leader in the field. And since we’re on topic, Paul Krugman, before he became a vocal NY Times columnist, was a professor of international trade at Stanford, then MIT, now Princeton, and won the Bates medal, an honor bestowed to the best economist under 40.

Note that while Bush has a legion of supply-side think tanks full of mediocre economists backing him, you have over 50 Nobel prize scientists and economists (not counting the 4 exceptional ones above), a dozen 3- and 4-star generals and admirals (including the 2 most recent retired chiefs of the Joint Chiefs of Staff), as well as over 200 business leaders of the Fortune 1000 that have signed on to the Kerry bandwagon.

The reasons behind this support is not ideology - it simply lies in the fact that the numbers just haven’t added up using Bush’s arithmetic – whether one is speaking about the president’s war or peace policies. And when numbers don’t add up, it doesn’t matter what you say as president or if people think he’s a great, straight-shooter from Texas. However, it does matter whether a president deliver on what he says most (or for 3rd rate presidents, half?) of the time.

If you do the political math yourself, you’ll see that Bush has a big deficit in this area – big on rhetoric, small on tangible, measurable results. So it’s no surprise that he has an increasing credibility gap with the American people, which I doubt will change regardless of how Bush spins, smears, and pontificates in November….