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.”


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

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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.


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.

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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.


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”.

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GOP to spendthrift states: The check will never be in the mail

Jan 7, 2011 20:33 UTC

Exactly a month ago, I wrote a piece on a  “secret GOP plan” to nudge fiscally troubled states in bankruptcy, giving their governors a chance to rewrite existing public employee union contracts and take other drastic measure to restore solvency. Step 1: Eliminate the Build American Bond subsidy to make it hard for states to borrow.  [DONE] Step 2: Force states to reveal the true extent of their pension liabilities. [COMING SOON] Step 3. Rewrite the federal bankruptcy code [COMING SOON]. Two recent events give me further confidence in my call:

1) Note that Rep. Paul Ryan yesterday reiterated that the GOP had no interest in a state bailout. Here his exact words:

We can’t do a bailout. If we bailed out one state, then all of the debt of all of the states is not just implied,  but almost explicitly put on the books of the federal government. Then the federal debt will go from here to here by the amount of state debt. There seems to be some kind of implicit belief that [state bonds] are federally backed — they’re not.  … I am a supporter of Devin Nunes’ bill which is asking just for a clearer accounting. If you want to enjoy the tax expenditure of tax-free bonds as a state or a municipality, give us a clear accounting of your liabilities. They use discounts rates of something like eight percent in many states to measure their pension liabilities, which is just not reality. We’re going to have lots of hearing on this. … We need to learn more about what states are in what situations, what are the timing of these things, and what’s the proper response. And I’ve been working on something myself on what I think would be the proper federal response … but we are not interested in a bailout. …   [Some states] are already telling us [about their dire circumstace]. But should taxpayers in frugal states be bailing out taxpayers in profligate states? …  Should taxpayers in Indiana, who have paid their bills on time, who have done their job fiscally, be bailing out Californians, who haven’t? No, that’s a moral hazard we are not interested in creating.

2) Also note today’s posting by Joe Weisenthal at Business Insider:

Ben Bernanke is speaking in front of the Senate today, and one of the big topics during the Q&A session is the state of muni finances. The Fed Chairman doesn’t expect any state to default, but he also says he doesn’t believe it’s within his mandate to bail out the states (e.g. by buying muni debate) should it come to that. The Senators keep hammering on this point, and there’s a reason for it. The GOP is hoping for states to collapse, and they want to be absolutely sure nothing gets in the way of that. … They’re also pushing for changes to accounting rules that would force states to present their finances in a manner that would look uglier. Also, part of it is endless talking about the issues, which has the effect of unnerving investors. There are various reasons the GOP wants this. One is that it would be disruptive to the economy ahead of the 2012 election. The medium term goal is to crush public sector unions. A longer term goal is to fundamentally alter the pension system.


A good pie chart would be tax revenue by state before we hit the bog.

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The tax deal and Obama’s reelection chances

Jan 5, 2011 15:42 UTC

It looks like Robert Gibbs will be leaving the White House to run his own consultancy and work on Obama’s 2012 campaign. Ruy Teixeira, a politics guys not an econ guy, thinks the Obama-Republican tax deal makes it far more likely that campaign will be a successful one:

A significantly better economy is certainly the key to reaching voters in the white working class, which supported House Republicans by an unprecedented 30 points in 2010. To be reelected, Obama needs to bring that gap down to around its size in 2008 (18 points), and he simply won’t get there if these voters, unsympathetic to Obama to begin with, continue to see a lack of economic progress.

That much may seem obvious. But, in addition, it’s also true that Obama’s performance among sympathetic constituencies will depend to a very great degree on the economy. … The fact is that tens of millions of ordinary rank-and-file Obama supporters will end up basing their decisions on the state of their pocketbooks and the job market: Want 18-to-29-year-olds to turn out as 18 percent of the electorate and support Obama by anything like the 66-32 margin of 2008? Want minorities to turn out as 28 percent of the electorate and vote for Obama by a margin of 80-18? Want moderates to turn out as 44 percent of the electorate and support Obama by a margin of 60-39? Numbers near these will be impossible to achieve if the economy continues to stumble. Conversely, if a recovery seems to be kicking in, confidence will rise in Obama and his agenda, making it more likely that these voters will turn out and back the president.

It’s as simple as that. And Obama’s $858 billion package of tax cuts, tax credits, and unemployment benefits will in effect deliver a second economic stimulus, albeit not one any progressive—or sane—economist would have dreamed up on their own. In a world where unemployment barely budged and GDP growth couldn’t get above 3 percent, Obama’s re-election would be in considerable doubt. But with the tax-cut deal, there should be a significant decline in unemployment (though the absolute level will remain high) and a more robust growth rate, including during quarters two and three of election year, which political scientists tell us is particularly important to electoral outcomes.

If 3 percent growth and 9.5 percent unemployment is inadequate, will 4 percent growth with 8.5 percent unemployment be good enough? That, along with a lousy housing market and high national debt which makes the future especially worrisome? I have written repeatedly that there is a lag between when an economy improves on paper and when voters recognize improvements in their own standards of living. Just as the Bush (I) campaign team in 1992.

Bill Daley to the White House? Business would love it

Jan 5, 2011 14:10 UTC

If President Barack Obama chooses JPMorgan executive William Daley as his next chief of staff he could at last build bridges with the disgruntled U.S. business community, both on Main Street and Wall Street. Daley’s pro-trade views are a big reason the buzz around his potential nomination is so loud. The pick would also bode well for reaching deals with Republicans on taxes and spending. A few observations (via my column for Reuters Breakingviews):

1. It might be a stretch to call Daley a potential “dream pick” for Corporate America — but not by much. He was President Bill Clinton’s point man on trade in 1993 and deserves much of the credit for steering the North American Free Trade Agreement through a hostile Congress. As president of SBC Communications from 2001 through 2004, his job was to schmooze top regulators and the Republican Congress. More recently, Daley said Obama — a fellow Chicagoan whom he knows well — made a mistake by focusing on healthcare reform rather than job creation. That’s a view shared by many pragmatic members of the president’s own party.

2. The Daley Scenario is more than just a bout of wishful thinking from CEOs still cranky about Obama’s accusatory tone and pro-regulatory policies during the past two years. And it’s more than just a White House trial balloon to gauge the intensity of liberal outrage over hiring a Wall Street banker for a key administration position. (The early result on that are already in: Liberals are most unhappy at the prospect.)  My sources confirm that Team Obama and Daley are having a serious conversation about the gig, though it’s hardly fait accompli. There’s even a chance Daley might instead replace Larry Summers as National Economic Council.

3. But Daley as chief of staff seems the more plausible outcome. It is certainly the more important job. When Rahm Emanuel held the position before leaving to run for Chicago mayor (replacing Daley’s brother), he was both White House gatekeeper and de facto chief economic policy adviser. Obama adviser Valerie Jarrett is the administration’s current liaison to business. But if Daley is the pick, it’s his phone number corporate bosses will dial if they need something from 1600 Pennsylvania Avenue.

4. The same would go for Republicans. Daley is a fixer, not a general for waging ideological war against the Republicans in the next two years of Obama’s term. If party leaders want to cut a sweeping budget deal with Obama, Daley’s probably the right guy to grease the skids and make it happen. Come to think of it, it’s hard to see why the White House hadn’t thought of bringing Daley in before now.


The Obama administration will continue its headlong dash to the right. What they don’t understand is that no matter how far to the right they run, the political right and the media will continue their shrieking about what a communist, socialist, marxist, business-hating, economy-destroying monster he is.

Obama would’ve been far better served simply pursuing his own agenda – even with healthcare “reform,” despite essentially passing the version Republicans promoted originally, he was still accused of “cramming it down the throat” of America.

Instead, Obama’s cowardice has him abandoning and alienating his base in a fruitless quest to garner the support of people who are totally committed to his destruction. It’s foolish.

I say this all from the perspective of a libertarian who didn’t even vote for the guy.

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‘Cut and grow’ is really the only way forward

Jan 4, 2011 20:39 UTC

In theory, at least, the House GOP is exactly right:

The new House Republican majority will use the three weeks before President Obama’s State of the Union address to repeal the healthcare law, cut spending and scrap federal regulations, incoming Majority Leader Eric Cantor  (R-Va.) said Tuesday.

Cantor said Republicans would be “a cut and grow majority,” deploying a new label to define the GOP’s twin goals of reducing government spending while expanding the economy.

The incoming majority leader said that once House Republicans vote next week to repeal the healthcare overhaul, they will move quickly to fulfill their stated commitment to cutting spending to 2008 levels. In the third part of the majority’s opening act, he said, the GOP will target “job-killing” regulations across the federal government. The goal is to lay down a clear marker before Obama addresses the new Congress in his annual State of the Union speech, which is expected to take place the final week of January.

And I hope a big cut in corporate taxes is also on the table.


The TeaOP is exactly wrong, and showing a a stunning amount of hypocrisy, to boot. Throughout the 15-month health reform debate, the TeaOP repeatedly accused Democrats of ramming through the health care bill without going through a bipartisan process, despite the fact that House Democrats held 79 bipartisan hearings and markups since 2008, incorporated Republican amendments, and posted the original House bill online for 30 days.

When the House Republican plan to repeal the entirety of the Affordable Care Act comes to the floor next week, Democrats plan to introduce amendments forcing Republicans to vote to scrap specific provisions in the law, all of which happen to be quite popular.

Republicans, not surprisingly, will block efforts to have any amendments.

Remember when Republicans demanded again and again that they be allowed to introduce amendments and generally enjoy an open process while health reform was being debated? For two years, Republicans said it was imperative for the minority to be allowed to offer amendments to legislation … but when it comes time to repeal health care reform, Republicans no longer care about their alleged principles.

But that’s not even the half of it.

For two years, Republicans said all legislation had to be paid for … but when it comes time to repeal health care reform, Republicans no longer care about their alleged principles.

For two years, Republicans said all legislation needed scores from the Congressional Budget Office … but when it comes time to repeal health care reform, Republicans no longer care about their alleged principles.

For two years, Republicans said self-executing rules and bypassing committees were outrageous abuses … but when it comes time to repeal health care reform, Republicans no longer care about their alleged principles.

As if they ever cared.

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Of debt ceilings and budget deals

Jan 4, 2011 17:42 UTC

There’s a big budget deal coming, says NRO’s Daniel Foster:

My argument is dead simple.

P1) The debt ceiling won’t be raised without a ‘yea’ vote from Sen. Lindsey Graham (R., S.C.)

P2) Senator Graham said on Meet the Press that

“I will not vote for the debt ceiling increase until I see a plan in place that will deal with our long-term debt obligations, starting with Social Security, a real bipartisan effort to make sure that Social Security stays solvent, adjusting the age, looking at means tests for benefits. On the spending side, I’m not going to vote for debt ceiling increase unless we go back to 2008 spending levels, cutting discretionary spending.”

P3) The debt ceiling must be raised.

C: Graham will get what he wants, or something approximating it. That is, there will be significant revenue-side concessions from Democrats in exchange for support from the likes of Graham and Senate Republicans in his ideological neighborhood.

Don’t buy it? Okay, so which premise is false? P1? Does anyone think 53 Democrats can overcome a filibuster, in a tea-infused Senate, on anything significant, without Lindsey Graham? P3? Does anyone think either party’s leadership will allow a federal debt default?

That leaves P2, which, admittedly, is the shakiest. It rests on us taking a politician at his word. But Graham has been — for good and ill — remarkably transparent about his strategic calculus when it comes to votes. Remember when he publicly, and baldly, abandoned the energy bill he helped write because Harry Reid was going to make his life in South Carolina exceedingly difficult by doing immigration reform first? Graham is a known bipartisan deal-maker, and one of the few Senate Republicans with an open line to the White House. So not only does Graham almost certainly want to make a deal, but he is in a better position than most to know what kind of deal is possible. Indeed, knowing Graham’s style, the hidden premise in his Meet the Press comments is that he has reason to believe Democrats in the White House and in the Senate are willing to negotiate.

Bill Daley as Obama’s new chief of staff?

Jan 4, 2011 15:08 UTC

That is the buzz. But it is more than just buzz. My sources tell me that serious conversations are being had, though it is not a done deal. Certainly the business folks I have chatted with would be delighted. Forget about Valerie Jarret. When a top CEO had an issue, he or she would be calling Bill Daley from now on, not Jarrett. Daley would be “their guy.” (And I would also call Gene Sperling the frontrunner to replace Larry Summers.)  Here is the Reuters take:

Longtime Obama aide Pete Rouse is currently serving as interim chief of staff. He replaced Rahm Emanuel, who left the administration in October to enter the race for mayor of Chicago.

Many businesspeople had hoped Obama would fill Summers’ job as director of the National Economic Council with a chief executive. While Sperling has done consulting work for Goldman Sachs, his career has been heavily focused on public policy.

Daley served at Commerce during former President Bill Clinton’s administration.

Daley would bring a breadth of experience in business, not just in the financial sector. He serves on the board of Boeing Co. and has served in the past as director at Merck and Co. He is also a past president of SBC Communications.

J.P. Morgan spokesman Joe Evangelisti declined to comment.


Bill Daley? Never heard of him, but the fact that he has considerable private sector experience and also served in Bill Clinton’s cabinet is a) a good thing and b) yet more evidence that Mr. Clinton is gently pushing Mr. Obama to the centre.

The GOP had best be careful. They’ve been outwitted by Mr. Clinton before.

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