James Pethokoukis

Politics and policy from inside Washington

Illinois, a kleptocracy in action

Jan 14, 2011 18:58 UTC

What should America do about its troubled economy? Sometimes the real world provides the best laboratory for political and economic experiments. Democratic capitalism vs. totalitarian communism? One quick look at East Germany and West Germany in the 1980s or North Korea and South Korea today provides easy analysis of which is the preferable way to create and organize a peaceful and prosperous society.

Now we have Illinois vs. Indiana. The Prairie State has the worst debt rating of any state in the union and heading into 2011 faced a funding shortfall equal to 40 percent of its total budget. Only Nevada, hit particularly hard by the housing depression, is as nearly bad off, according to the Center on Budget and Policy Priorities

Yet directly east of Illinois is the Hoosier State with a AAA credit rating. Indiana faces a 2011 shortfall of just 9 percent and expects to balance its budget even though the economic downturn has struck just as hard as in Illinois. Under Governor Mitch Daniels, a noted budget hawk who may run for the Republican 2012 presidential nomination, Indiana has continually pared back spending. It now has the fewest public employees per capita of any state. And it spends half as much per citizen as Illinois.

But faced with a fiscal crisis, Illinois decided this week to raise taxes by $7 billion a year, jacking up the individual rate to 5 percent from 3 percent and the corporate rate to 7 percent from 4.8 percent. That the state didn’t instead cut spending dramatically is not really surprising. One-party kleptocracies — and that pretty much is what Illinois is — always want more taxpayer money, not less.

Yet it is unlikely the state will raise anywhere near that $7 billion now that it chose to undermine its competitiveness. This, from the nonpartisan Tax Foundation:

Our 2011 State Business Tax Climate Index ranked Illinois 23rd in the country, middle-of-the-pack compared with its immediate neighbors. Illinois’s low, one-rate individual income tax offers the advantages of simplicity, stability, and a competitive rate relative to other states, outweighing more negative elements of the state’s tax system.

If this legislation enacted on January 12, 2011 had been in place on July 1, 2010 (the snapshot date for the 2011 State Business Tax Climate Index), Illinois would have ranked 36th instead of 23rd. This is a fall of thirteen places, past South Carolina, Georgia, Pennsylvania, Tennessee, Alabama, Nebraska, Oklahoma, Maine, Massachusetts, New Mexico, Arizona, and Kansas.

On the individual income tax sub-index, Illinois would have ranked 14th instead of 9th, a drop of five places. On the corporate income tax sub-index, Illinois would have ranked 45th instead of 27th, a drop of 18 places.

Three  lessons here:

1. Neither states nor countries exist in isolation. Just as it’s foolish for Illinois to act as if what Indiana and Wisconsin are doing fiscally is irrelevant, so to must the U.S. take into account that is has, for instance,  a marginal and effective corporate tax rate far above that of the average advanced economy. The Obama White House may call for a cut. If he doesn’t, the congressional GOP should.

2. As the Indiana experience shows, the earlier you get started on budget cutting the better. Even though Uncle Sam has been running trillion-dollar deficits in recent years, the bond market hasn’t seemed too worried about the accumulation of all that debt. This has given President Barack Obama and Congress a window to make fiscal fixes that are reasonable rather than radical.

But the window could easily, and even quickly, close someday. If it does, the Federal Reserve chairman and the Treasury Secretary may be forced to trudge up to Capitol Hill and beg for action to reassure markets, such as a big tax hike (like a VAT). This is exactly the scenario some GOP spending hawks fear.

3. States should realize that Washington is not coming to their rescue, unless making it possible for them to declare bankruptcy counts as a “rescue.”

COMMENT

We hear so much about the evil corporations. Who has caused the financial crises in these states: Corporations?
Unions?
Union-Politician collaboration?

Posted by Leon1 | Report as abusive

U.S. growth agenda must broaden beyond tax cuts

Jan 14, 2011 18:55 UTC

U.S. Treasury Secretary Timothy Geithner’s meeting with chief financial officers further suggests the White House may push for corporate tax reform. But with unemployment high, President Barack Obama’s efforts to boost growth shouldn’t stop there. More government investment in research and infrastructure is also warranted.

Trend GDP growth of 3 percent will little improve the nation’s dire jobs situation. The broadest measure of unemployment — which includes part-timers who would prefer full-time work — is double pre-recession levels, as is the percentage of the unemployed jobless for 27 weeks or longer. Clearly government must do more to foster long-term growth and job creation while also keeping an eye on the public purse.

Cutting the top corporate tax rate to a level more competitive with other advanced economies could boost investment, hiring and worker wages. Congressional Republicans like the idea so much they will push it even if Obama doesn’t. And as long as the rate reduction is paid for by reducing market-distorting corporate tax breaks and subsidies, Democrats may play ball, too.

The GOP, which opposed Obama’s 2009 stimulus plan, has been cool to any notion of using spending to juice growth. That may be short-sighted. For instance, government funding of basic research can have a significant economic payoff. But a plan by House Republicans to roll back non-defense discretionary spending to 2008 levels could result in an 11 percent cut to the National Science Foundation’s already skimpy budget. Republicans should instead listen to Newt Gingrich — a possible 2012 GOP presidential candidate — and triple NSF funding.

Republicans, as General Electric Chief Executive Jeffrey Immelt noted this week, have also shown little enthusiasm for Obama’s idea of creating a national infrastructure bank to prioritize and financially seed projects around the country. But there’s no ideological reason that a Republican shouldn’t support such a plan. Even Tea Partiers mostly want to shrink government rather than abolish it.

And it’s really not that much money. Dramatically boosting research and infrastructure spending would cost roughly $75 billion a year, or 0.5 percent of GDP. Anyway, the major cutting needs to come in entitlements and defense, which combined account for 70 percent of the budget. All spending isn’t alike when it comes to boosting the economy and putting people back to work — a lesson Obama has a chance to teach.

The U.S. jobs problem in chart

Jan 13, 2011 16:40 UTC

Until this  lump moves through the python (full of workers growing less employable by the day), unemployment may stay unusually high for years. From the Economic Policy Institute:

epichart

More questions on U.S. credit rating from Moody’s, S&P

Jan 13, 2011 16:30 UTC

Once again, S&P and Moody’s are raising question about America’s creditworthiness (via the WSJ):

Moody’s Investors Service said in a report Thursday that the U.S. will need to reverse an upward trajectory in the debt ratios to support its triple-A rating. ”We have become increasingly clear about the fact that if there are not offsetting measures to reverse the deterioration in negative fundamentals in the U.S., the likelihood of a negative outlook over the next two years will increase,” said Sarah Carlson, senior analyst at Moody’s.

Standard & Poor’s Corp. on Thursday also didn’t rule out changing the outlook for its U.S. sovereign-debt rating because of the recent deterioration of the country’s fiscal situation. …  ”The view of markets is that the U.S. will continue to benefit from the exorbitant privilege linked to the U.S. dollar” to fund its deficits, Carol Sirou, head of S&P France, said at a Paris conference Thursday. “But that may change. We can’t rule out changing the outlook” on the U.S. sovereign debt rating in the future, she warned. She added the jobless nature of the U.S. recovery was one of the biggest threats to the U.S. economy. “No triple-A rating is forever,” she said.

I am pretty sure these folks will lower the U.S. debt rating the day after bond and currency markets go nuts in, as the econ guys say, “a non-linear event.”  That’s right, a Black Swan, baby. Instead of a gradual repricing of U.S. debt, there’s a sudden and seemingly unpredictable break. Of course,  a lack of action by Washington makes such a happening completely predictable.  One interesting bit is the remark by Sirou on the jobless nature of the recovery. Not only is high unemployment costly, but it is a sign of a lack of vigor in the economy. Slow growth will only make it that much harder to escape the debt trap.

Does Bill Daley appointment further enshrine Too Big To Fail?

Jan 11, 2011 18:27 UTC

Cato’s Mark Calabria thinks the problem is not people but policy:

MIT Professor Simon Johnson recently argued that Bill Daley’s appointment as Obama’s Chief of Staff signals that “too big to fail”, as it relates to our largest financial institutions, is here to stay. Personally I never thought it was in doubt. With Geithner at Treasury and Dodd-Frank further codifiying “too big to fail”, its been clear for sometime that the bailout net is larger than its ever been, and is not being pulled back.

That said, Professor Johnson’s focus on Daley distracts from the real issue, which is changing our bank regulatory structure to end bailouts. The focus on Daley has the potential to lead us down that path of “if we just had the right people in government.” We shouldn’t be designing our regulatory structures with the “right” people in mind, but rather with the rule of law in mind. In fact one of the benefits of the Obama Administration is that it serves as a great test of the “right people” hypothesis of government. One is unlikely to see a more left-leaning White House than this one, so if this one gets captured by special interests, including Wall Street, than its a safe bet that any future Administration will as well.

Since I believe most of us actually want to end “too big to fail”, the real question is over how. It strikes me that we have three options: regulate the largest institutions to death (or competitive disadvantage), break them up, or credibly impose losses on their creditors. Ultimately I think the regulation approach is bound to fail, if for no other reason than regulatory capture. (Even Elizabeth Warren seems to get this: “Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”) The breaking them up might sound attractive in theory, but I have a hard time seeing how it truly works in practice. After all few in Washington viewed Bear Stearns as “too big to fail”. Accordingly I believe the best approach would be to force creditors to take losses, or be converted into equity. To make this credible, we must bind the hands of the regulators. As long as the Fed. Treasury or the FDIC can inject money, then bailouts are always on the table.

Sadly what the Daley appointment reminds us is that any attempt to end “too big to fail” will likely have to wait until the next Administration. Not only is this one wed to bailouts, the President would likely veto any bill that really tied the hands of the Fed.

COMMENT

Thanks for the information. As almost any financial advisor can attest, there is nothing too big to fail. From the sinking of the Titanic to the myriad of economic fluctuations that have plagued society throughout history, it seems like any endeavor is subject to potential failure no matter how much people want it to succeed.

Posted by GramJ | Report as abusive

What is tax-crazy Illinois thinking?

Jan 11, 2011 17:58 UTC

The news just gets worse and worse from my home state (via The Tax Foundation):

llinois’ legislature is currently considering an alternative to the initial tax increase proposed last week. Instead of pushing for a 75% increase in the personal income tax and a 49% increase corporate income tax, this proposal would raise the individual income tax rate to 5% and the corporate rate 9.5%. While this proposal is more modest than the first, but it still hurts the competitiveness of Illinois when it comes to maintaining and attracting new business.

If this passes, Illinois will have the third highest corporate income tax in the country behind only Minnesota and Pennsylvania. The corporate income tax has been shown to be among most damaging tax in terms of economic growth.

The individual income tax is often times ignored as a factor in business decisions. This is unfortunate because a large amount of business income is actually filed through the individual income tax. In raising the rate to 5%, Illinois would have the one of the highest flat individual income tax in the country.

In solving their budget problems, Illinois needs to do something that it has not done in a long time and that is look to the future. The governor and the legislature need to look past the next day, week and month and consider the long term effect of their policy decisions.

COMMENT

‘Friday, December 31, 2010
New pension law could force municipalities to raise property taxes 60% While most emphasis has been on Speaker Madigan’s pension reform law setting up for later retirements and less cushy pensions for new firemen and law enforcement hires, little attention has been focused on the shift in pension fund pay=in burden that local city councils argue will now suddenly fall on their already cash-strapped budgets. Chicago’s Mayor Daley blasted the reform bill Quinn signed on Thursday, predicting it will cause Chicago to hike its property taxes up to 60%.

ABC Chicago News covered the topic’

http://illinoisreview.typepad.com/illino isreview/2010/12/new-pension-law-could-f orce-municipalities-to-raise-property-ta xes-60-mayor-says.html

Posted by kostalbk | Report as abusive

Will the Fed need (gasp!) a government bailout?

Jan 11, 2011 16:06 UTC

Interesting piece from Team Reuters that examines that possibility (and what it really means) as a result of all the central bank’s asset buys (bold is mine):

But the Fed’s newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to “recapitalize” the Fed — economist-speak for what others might call a bail-out. That would be a strange role reversal given the Fed’s efforts to ease monetary policy by buying the Treasury’s debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk. … Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke — at least on paper. ”The most obvious exit strategy is, when inflation starts to pick up, to stop and reverse asset purchases,” he said. “That’s likely to include requiring the Fed in an accounting sense to see a significant accounting loss.”

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss. “I’m sure it will have some negative political fallout,” Chari said. “But not economic consequences. Their ability to print money means it (insolvency) doesn’t mean anything.”

The problem lies in the basic workings of fixed income. By definition, bond prices decline when their yields or interest rates go up. That means that as the economy recovers and pushes inflation higher, the Fed will move to increase interest rates, pushing down the value of its giant bond portfolio. “What would the international reaction be if the Fed suddenly had to go and be recapitalized?” said Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former head of research at the Atlanta Fed. “I don’t think that would bode well for Treasuries, or for the dollar, or anything else. It would be embarrassing.”

Eisenbeis is right. If and when this happens, the financial nuances will certainly get lost and give plenty of additional ammo (not that they need it) to the anti-Fed movement.


COMMENT

Maybe the IRS could use a bail-in in the form of a voluntary tax that repays if the economy improved to a level that protects national security – ability to transfer debts to a guarantee note to share risk and reward specific shared goals if attained where downside simply confirms a more aggressive natural devaluation.

Posted by phyvyn | Report as abusive

The Great Wage Drop and wage insurance

Jan 11, 2011 15:58 UTC

Big WSJ story on how the Great Recession has reduced wage growth. When the unemployed do return to work, it is often with markedly lower salaries. Here is the money graf:

Between 2007 and 2009, more than half the full-time workers who lost jobs that they had held for at least three years and then found new full-time work by early last year reported wage declines, according to the Labor Department. Thirty-six percent reported the new job paid at least 20% less than the one they lost The severity of the latest downturn makes it likely that many of the unemployed who get rehired will take wage cuts, and that it will be years, if ever, before many of their wages return to pre-recession levels, says Columbia University labor economist Till von Wachter. “The deeper the recession, the lower the wage you’re going to get in the next job and the lower the quality of your next job,” he said.

And here is the money chart:

wsj2

I am always a bit dubious of these sorts of charts since they depend on accurately measuring inflation.  Some liberal economists, for instance, claim wages have been falling since the Golden Era of the 1970s. More likely that they actually went up by at leasts 20 percent in real terms, according to researchers at the Fed.  But I have no doubt that wage growth slowed during the downturn and many folks have suffered a real and permanent loss of income. I think you will hear Democrats talk more and more about wage insurance — having government temporarily make up the shortfall between old and new jobs — especially with Gene Sperling back in the White House. He is a big proponent of the policy.  And we shouldn’t forget that John McCain proposed something like this back in 2008 during the campaign. Here is what I said back then:

This is an idea that Democrats have been inching toward: a move to a Danish-style “flexicurity” system. In that country, workers who lose their jobs have almost their entire salary replaced by the government but are also required by the government to aggressively look for new employment or accept retraining in a new field.

It’s very expensive. For the United States, completely copying the Danish model—lauded by many as a response to globalization-inspired worker angst—could cost some $400 billion to $500 billion a year if it is as expensive for us as it is for the Danes.

Now what McCain seems to be proposing is a more modest “wage insurance” idea. Under a plan originally put forward by Brookings Institution economist Robert Litan and University of California-Santa Cruz economics Prof. Lori Kletzer, a laid-off worker who once earned $40,000 and found a new job paying just $30,000 would receive $5,000 a year–broken down into quarterly payments–for two years after the initial layoff. Such a plan might cost $4 billion a year.

Yale political scientist Jacob Hacker would up the ante considerably with a $34 billion-a-year “universal insurance” program. If a family experienced catastrophic medical costs or a large drop in income—say, more than 20 percent—owing to a variety of common risks (unemployment, loss of wages because of sickness or childbirth, temporary disability, or the death of a spouse), Hacker’s universal insurance plan would make up a portion of the loss ranging from 20 percent to 50 percent of all losses or costs in excess of a fifth of that family’s income. And House Ways and Means Chairman Charles Rangel has a $1 billion-a-year plan to expand Trade Adjustment Assistance, a benefit and training program for manufacturing workers who lose jobs to trade, to include service workers.

Of course, there are downsides here. First, it could make U.S. labor markets less mobile and dynamic as there would be less incentive for workers to get back into the workforce or start a new business because of Uncle Sam’s largess—especially if the carrot isn’t accompanied by a stick. Second, the program might grow ever bigger, becoming a massive new entitlement.

COMMENT

We’re in need of a “fairness” index in regards to public vs private sector wages-including legacy/pension costs! Also, why shouldn’t 20% of the FED & State jobs be PT and Temp like they are in the private sector? Ask what your country can do for you?

Posted by DrJJJJ | Report as abusive

Hawks and doves on the Fed

Jan 10, 2011 20:02 UTC

A handy chart from JPMorgan:

fed

Is America growing politically unstable?

Jan 10, 2011 17:27 UTC

Is America becoming less politically stable? A glance at some foreign newspapers would certainly give that impression. This is an important economic question. The global primacy of Treasury bonds and the dollar stems mostly from the nation’s massive economic might. But confidence in U.S. political stability also plays a role. The shooting of Arizona Congresswoman Gabrielle Giffords, though tragic, shouldn’t alter those perceptions — unless freedom of speech suffers.

Amateur criminal psychologists in the Democratic Party and liberal punditocracy have been quick to blame conservative political rhetoric for helping nudge an unbalanced 22-year-old into acting on his murderous impulses. Pointed charges have been flung at the Tea Party movement and at Sarah Palin. In 2008, her political team created an online map that featured 20 targeted Democratic congressional districts identified by crosshairs, including that of Giffords.

There’s no evidence at this stage that the shooter — whose bizarre anti-government rants centered on the use of grammar as mind control — ever saw the Palin map or even favored right-wing punditry. And Democratic operatives created similar midterm maps targeting Republicans. Within reason, though, even hard-hitting imagery is not necessarily sinister: political contests, like sports, are steeped in martial metaphors. Bids for election, for instance, are referred to as campaigns.

Yet political violence has been rare in the United States in recent years. That’s despite the disputed 2000 presidential election, the unpopular Iraq war and the election of the first black president.  Indeed, the World Bank ranks America above the UK when it comes to “political stability and absence of violence.” And the U.S. rank has actually been on the rise in recent years.

world bank

That ranking partly reflects the fact that even heated talk doesn’t cause instability. But if the freedom to indulge in such rhetoric and to protest is curtailed, it can be a different story — one reason, perhaps, why China receives low marks from the World Bank. So it’s disturbing that some in Congress are already working on new laws to limit political speech, in addition to ongoing attacks on talk radio. Those efforts, if they move toward limiting legitimate expression, should worry global investors far more than a one-off lunatic act, however shocking its results.

COMMENT

Enjoy your columns, James.

American political “instability” has taken the form of unprecedented (compared to most of the 20th century) turnover in political control of Congress (1994, 2006, 2010). I would argue the real instability is that, in all three cases, Congress changed control in response to failed national leadership (Clinton, Bush, Obama). High national campaign costs for the Presidency in the modern media era ensure that the office will be filled by the candidate who can represent the most monied special interests, as opposed to national interest. America’s presidents have been a series of bad jokes for the last 20+ years, so no surprise that America’s standing as the preferred destination/currency for capital has already started to erode. I think for many foreign investors perception of American political instability is only now catching-up with reality, post-Financial Crisis.

As for Tucson, I would say that if we are to remain a (relatively) free society then one deranged community college dropout with easy access to guns has to be treated as an outlier at this point (but what a horrible culmination of years of failed left-wing and right-wing social & economic policy embodied in one sick individual).

BTW somebody below said “you don’t hear radical members of the liberal left spouting gun metaphors”, which made me laugh considering the current occupant of the White House said, back in 2008, to the effect “I will bring a gun to a knife fight to defend the monied special interests who are working to get me elected”.

Posted by tmony30 | Report as abusive
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