Higher Taxes Better than Forced Charity

January 11, 2010 — Jon

Kevin Drum points to a report in the New York Times that Goldman Sachs is weighing an increase in charitable giving requirements for its senior staff. Kevin poo-poos it:

I think it’s great if corporations support charities or set up charitable foundations of their own. It’s also great if corporations urge their employees to give to charity. But that’s as far as it goes. Charitable giving isn’t a smokescreen for indefensible behavior, and in any case it’s not charity if you’re forced to do it at the point of a gun. Bankers who make millions ought to feel obligated to give some back to the community, but if they don’t, that’s their business, not Goldman’s.

While I think Kevin is definitely right about the limited PR upside here, I think he’s wrong that “it’s not charity if you’re forced to do it at the point of a gun.” That is, I don’t think anyone in need really cares whether or not the food, shelter, or research money or whatever it is that benefits them comes from the end of a gun or not.

Anyway, anyone who hasn’t been lobotomized knows that’s not really Goldman’s objective here, so the debate as to whether Goldman’s charity is valuable irrespective of it’s intent is sort of moot. Rather, Goldman’s play here is much more of an attempt to “self-regulate” before the government, bowing to common sense and popular outrage, does something about an unsustainable situation. To wit, the issue isn’t just that bankers pay themselves obscene amounts of money, it’s that the pay and incentive structure of the banking industry encourages recklessness behavior that endangers the wider economy while providing dubious societal good.

While greater charitable giving requirements would provide some marginal good on the charitable perspective,  they wouldn’t do anything to address the incentive problem. Luckily for us — but not as much for banking executive –  we already have in a place a system called the “tax code” that can helps push income distribution in a socially beneficial way while also shaping incentive structures.

The situation that Goldman fears are regulations on payment structures that reduce incentives for reckless investment and changes to the tax code that significantly increase the marginal tax rates on the upper extremes of the income spectrum to something closer to our historical norm.

Taken together, these would policies would both limit behavior that endangers the economy and help ensure that at least some of banking profits are funneled into a socially beneficial direction.

(By the way, the most likely outcome of this policy is that Goldman just pays  even more to account for the difference of the charity requirement. After all, the banking industry has notoriously argued it must maintain absurd bonuses to preserve its talent. If Goldman starts lowering its real compensation levels, how can it retain talent?)

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When Genius Fails, Keep Trying

October 23, 2009 — Jon

There’s been some surprise among a number of bloggers that John Merriweather, of ignominious Long-Term Capital Management fame, is starting his third hedge fund using the same strategy that failed so spectacularly in the late 90s it almost brought down the entire banking system. It’s also the same strategy that failed last year in a less grandiose fashion — simply losing 44 percent. Felix Salmon remarks:

You’ve got to give this to Meriwether, though: the guy’s clearly a spectacularly good salesman. That’s a key attribute of hedge fund managers which they tend not to talk about: after all, they love to give the impression that people are giving them billions of dollars just because of their unsurpassed investment prowess. The truth is clearly very different.

This is pretty clearly true, but I’d also add that Merriweather’s salesmanship is at least equaled by much of the elite investor class’ steadfast faith in the power of humans to decode the machinations of complex markets. Obviously, we’ve shown a fair bit of acumen in doing this, but really the only predictable constant is that from time to time, markets behave irrationally. It’s one thing to say it, but it’s another to really understand what this should mean for highly leveraged investing, and frankly, if you really do understand it, I don’t think you’d do it. Participation in these sorts of funds almost necessarily requires you already believe in the soundness of the pursuit. In this case, being a good salesman is really a lot like preaching to the choir. As Matt Yglesias quips, “If [Merriweather] finds investors for a third spin around the wheel I’m going to propose confiscating all the rich peoples’ money and giving it to capuchin monkeys.”

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Robotic Dystopia and Economic Growth

August 10, 2009 — Jon
Youre fired!

This robot has an impressive resume.

Gregory Clark painted a dismal picture of the future in the Washington Post this weekend. In Clark’s future, the growth and spread of technological developments will push more and more unskilled laborers out of the workforce, necessitating higher taxes on those with marketable skills to pay for the basic living expenses of the unemployable masses.

Interesting. The thing I’d add though is that implied in the process of technology outmoding human labor is the assumption that technology performs the job more efficiently, which is to say, more cost-effectively. This means those who control the technology (or are under the illusion of controlling them — don’t rule out the AI uprising and subsequent enslavement of humanity) will be the recipients of larger and larger shares of profits, so the need for them to pay higher taxes wouldn’t exactly be some sort of gross imposition. Clark doesn’t seem to suggest that it is, mind you, but I’m just saying this vision doesn’t have to be quite as foreboding as it seems.

Also, I guess from the perspective of someone who is for the most part a committed utilitarian (and also at the risk of appearing a Luddite), it would be worth having a discussion about whether or not it’s really in society’s best interest to replace humans with machines that work more efficiently. It’s pretty clear that technological innovation starting in the industrial revolution has proven to be good for mankind, but if the goal is to produce a better society we really need to be weighing the tradeoffs to ensure magical innovations don’t just engender some sort of neo-feudalism. Or rather, at least ensure that any neo-feudalism therein engendered is Pareto improving.

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Amity Shlaes Is Arguing With Herself

August 9, 2009 — Jon

Amity Shlaes and Spock would not be good friends.

Amity Shlaes and Spock would not be good friends.

Amity Shlaes, best known for attempting to exculpate Herbert Hoover from any role in stewarding the Great Depression and instead blaming the whole mess on the New Deal, has written one of the stupidest columns I’ve ever read. I mean, at this point it’s hardly surprising, but here you have a Senior Fellow at the CFR making the argument that because professional baseball players get lucrative contracts despite uneven performance, we shouldn’t pass legislation allowing shareholders to make a non-binding vote on executive compensation or the SEC to ensure compensation schemes of executives are aligned appropriately with sound risk management. This is the crux of her argument:

The first assumption is that a snapshot of a highly paid executive at a failing company is proof that the executive is overpaid and that something in the company structure is broken. Rep. Barney Frank (D-Mass.), the legislation’s chief proponent, has noted that there are moments when it looks as though “the company loses money and the economy may suffer, but the decision-makers do not.”

But as baseball fans know, such snapshots get taken all the time. Buehrle got a four-year, $56 million contract in 2007. Yet this spring his company — the Chicago White Sox — was doing so poorly that Chicagoans weren’t showing up for games. “The White Sox stink,” wrote one columnist. At that point, Buehrle’s pay looked awfully high relative to what the owners and the fans were getting for their investment in the team. Yet no one said that this required a bailout for the Sox, or a hearing and a government-set pay cut for Buehrle.

And now, after that storied game against the Tampa Bay Rays, just about everyone feels like lining up behind the House members to congratulate the White Sox for their prophetic hire. No one thinks about Buehrle’s pay, even though we know it is sure to go up. That ugly snapshot no longer matters. Overall, we see, Buerhle was a good investment, for himself, for his team, for his fans and for baseball.

Shlaes conclusion is that a company’s failure doesn’t suggest an executive is overpaid, which she bases on the observation that Mark Buerhle at one point seemed overpaid but then later pitched a no-hitter. Apparently, this is also prima facie evidence that Buerhle’s compensation is not only correct, but also good for baseball (which I think we can take to mean “the economy.”) I could go on for hours on the number of ways in which the analogy makes absolutely no sense, but let’s try to stay on point. Shlaes argues that an executive’s worth shouldn’t be judged on a short-term time horizon, and therefore …we should oppose regulations that aim to align executive compensation with long-term considerations. That sort of illogic, even from someone at CFR, is pretty impressive.

Now in all seriousness, Shlaes eventually makes a decent point (albeit accidentally).

After all, people hire for the long term, not just for one recession or recovery. And talent is rarer than we tend to think. “In a world where skill is in great demand and markets are large — when a lot of money is at stake, whether it’s baseball or finance — market forces insure that those skilled people get paid a lot,” says Kaplan. Pay caps, or even too much harassment from regulators, will drive the talent to jobs where there aren’t such obstacles. The result will be fewer perfect games in the corporate world: “You pay peanuts, you get monkeys,” says Kaplan.

Let’s leave aside for the moment the fact that the financial industry collapsed while paying itself lavishly, Shlaes is right that we shouldn’t be trying to target small-bore regulations at large scale problems. After all, financial executives can always take high paying jobs as Major League baseball players. No but seriously, this is why instead of trying to regulate the pay of Wall Street executives, we should simply tax ludicrous high incomes at commensurately high rates.

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Health Care Should Reform Health Care

July 17, 2009 — Jon

So, the big news in health care is the CBO’s assessment that the bills under consideration (sans, of course, the Wyden-Bennet bill) won’t do anything to curb spending — or in wonk speak, “bend the curve.” This is partially a reflection of the difficulty of scoring expected, but essentially uncharted savings in things like health IT and comparative effectiveness. However, the bigger problem is that it’s right.

Asked what provisions should be added, Elmendorf suggested changing the way Medicare reimburses providers to create incentives for reducing costs. He also suggested ending or limiting the tax-free treatment of employer-provided health benefits, calling it a federal “subsidy” that encourages spending on ever-more-expensive health packages.

It seems the Administration is responding to this charge, most notably through this proposal to give teeth to proposed Medicare adjustments.

The proposed five-member Independent Medicare Advisory Council would be charged with making two annual reports dictating updated rates for Medicare providers including physicians, hospitals, skilled nursing facilities, home health and durable medical equipment. Congress could block the recommendations only if lawmakers agreed within 30 days on a resolution, and the greater veto power would lie with the White House itself.

To be sure, this is a demand trimming measure. Basically, the IMAC would set reimbursement rates (limit demand) and those who take Medicare would be forced to accept them. The problem is that while this might be great for reducing federal expenditures on health care, it’s a bit more difficult to see how savings would spread widely to the rest of the system. That is, the mechanism for lowering Medicare and Medicaid payments is simple: contain costs by fiat (subject to Congressional review). However, there’s really no reason this would prevent providers from simply making up the difference — or a large chunk thereof — elsewhere. It’s worth noting the same thing applies to ending the employer tax exclusion. Obviously, this would do a great deal to reducing federal spending on health care, but it’s not clear why it would reduce total health spending on its own.

In order to contain health spending across the entire economy, both of these measures need to be paired with broader reforms that will have more systematic reach. A strong public option to which anyone had access — like the one included in the House Tri-Committee Bill with a greater emphasis on access — would accomplish this, but it looks like that proposal faces significant hurdles in the House, not to mention the Senate.

I guess what I’m trying to say is that it’s useful to differentiate between what’s the right thing to do, what’s good for the federal treasury, what’s good for the economy and what’s good for all of the above. The House bill, which sadly is the best option being seriously debated (unless the Wyden-Bennett bill picks up steam), performs best on the “right thing to do” metric. The HELP bill is similar, but will be worse for the treasury and economy, and the Finance bill will be best for the treasury and worse on the other two metrics.

I guess I’ve talked myself into being a bit pessimestic, but it seems the real danger to health reform is forgetting that we’re trying to reform the health system. The legislative process is just that — the process.

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Health Care Reform In Graphs, By Me!

July 16, 2009 — Jon

Well I wish I hadn’t hastily put up the last post and ended with a stupid comment like “And of course, none of this even deals with demand,” because investment in medical innovation is in fact a function of demand for medical services. So let’s take a look at the bigger picture! Here’s roughly what the health care market in the US looks like.

healthcarebaseDemand for medical services is basically inelastic. That is, when we are sick, we will continue to consume health care services until we die, run out of treatments, or run out of money (there are exceptions, but generally, our desire for self-preservation is fairly limitless). This is true for all health systems: France, UK, Canada, you name it. The difference is that in the United States, we allow the free market to determine price, and since the United States is incredibly wealthy, this pushes demand to the limit of supply, driving the price of medical care with it. Of course, bargaining through large insurance pools — as happens in the employer and public markets — helps contain growth, but the trend still remains.

This unrestrained demand produces two bad outcomes. First, it creates a de facto system of health rationing by price. Because we consume medical services at the upward limit of supply, only those with enough money can afford it. The second problem is that because supply is finite, value generated by marginal demand approaches zero (again, consider that 10 to 30 percent of medical expenses are waste). This inflates prices, thus forcing even more people off the rolls (we’re now at 2.3 million per year).

The good news is that the solution is relatively simple. Pull back demand from the margin, and savings are large:

healthcarereformHealth care reform, if it’s expected to be sustainable, rests on reducing demand for health care services. In the UK or Canada, this is accomplished through strict government rationing. In other places, it’s accomplished through risk pooling and bargaining (I’ll add this and hard-cap rationing aren’t mutually exclusive). The problem isn’t in the theory, it’s in the politics. In the United States, reducing demand for health care services will hurt the bottom lines of pharmaceutical companies, private insurance companies, and of course, doctors, nurses, and hospitals. And these are powerful people.

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About That Deficit

June 10, 2009 — Jon

While I previously stated a desire to avoid cherry picking Henry’s posts, I really couldn’t disagree more with this in Henry’s post on the budget deficit:

I am highly skeptical of the Obama team’s insistence that financing health care reform first is the best way forward. While lowering health costs in America—an enormous issue best left to its own post—is critical for our long term economic strength, I think making drastic eliminations to our government entitlements ought to be the immediate priority.

As commenter jackofspades83 says, millions of Americans rely on so-called entitlement programs, and cutting them in the midst of a recession would have dire consequences. Further reduction in the spending gap would result in an even worse economic outlook as those who already spend a high share of their income would be forced to spend even less. Of course, this doesn’t even address the cruelty of imposing drastic cuts to social security benefits, from which a full two-thirds of elderly households (65 and up) receive more than half of their income and a full third of elderly households receive over 90 percent of their income.

As for health care, let’s just look at this graph that was put together by the Center for Economic Policy and Research. It plots out how various levels of health care spending in other countries would look if applied to the United States. The skyrocketing blue line is a world where we fail to enact any health care reform at all.

As you can plainly see, the easiest way to lower the deficit would be to lower health care expenditures so they matched per capita spending in other countries. As you can also plainly see, failing to do so will exponentially increase the share of health care spending as part of GDP. Now, it’s quite possible health care legislation currently being considered won’t have that sort of impact, but to illustrate what even modest savings do to spending, the Council of Economic Advisers put together this report.

Even if we assume only .5 percent cost containment, the results are pretty sizable as we move forward. If we select the very realistic 1.5 percent, we begin to see enormous savings as we extrapolate outwards. From the report’s executive summary:

[P]roperly measured GDP could be more than 2 percent higher in 2020 than it would have been without reform and almost 8 percent higher in 2030. The real income of the typical family of four could be $2,600 higher in 2020 than it otherwise would have been and $10,000 higher in 2030. And, the government budget deficit could be reduced by 3 percent of GDP relative to the no-reform baseline in 2030.

Those are serious numbers. Given that the article Henry himself cites reports that only 3 percent of the deficit would come from Obama’s agenda on health care, it’s really difficult to see how now is not the time to reform the health care system. It would be like refusing to use a credit card to have a plumber fix a pipe that’s threatening to flood your entire basement.

Now, as for concern over Treasury yields, let’s look at another graph, this time of the historical rates of 30 Year Treasury bonds.

You’ll note that the interest rates on Treasury bonds are still very low by a historical average, but more to the point, as Martin Fox argues here, this is a healthy balancing of priorities as investors decide there are more worthwhile investments than the least risky proposition around. Consider as evidence the ability of many banks to repay TARP funds with capital they have raised privately. And with respect to China — whatever their misgivings — there’s simply no avoiding the fact that as owners of such large quantities of US debt, it’s in China’s best interest for the US economy to prosper. As Gao Xiqing, president of the China Investment Corporation argued about the bailout in December:

With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?

Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. So we’re trying to help, at least by not aggravating the problem.

Finally, I’m not sure why Henry elided the possibility of raising taxes. The fact is, after 30 years of Republican electoral domination, taxes have been reduced to an unsustainably low level, and they’re going to have to come up.

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Economic Pain Abroad

May 21, 2009 — Jon

The Wall Street Journal reports that as bad as the economy has been in the U.S., it’s been truly calamitous elsewhere.

On Wednesday, Mexico became the latest country to report a plunge in output. The country’s gross domestic product fell at an annualized rate of 21.5% in the first quarter, the worst performance since the 1995 peso crisis led to an International Monetary Fund and U.S. Treasury financial rescue. This time, Mexico has insulated itself somewhat by arranging a $47 billion IMF credit line in advance.

Mexico’s decline followed by a day Japan’s report that its economy contracted in the first quarter at a 15.2% clip, its worst performance since 1955. Last week, Germany said its first quarter decline in GDP, an annualized 14.4%, was the worst since 1970.

The article notes these countries rely on U.S. exports, I wonder if part of the disparity between the U.S. and others results from weak to piddling efforts to shore up spending gaps with fiscal stimulus. The Germans haven’t done much, the Mexicans have done very little, and though Japan recently pledged more, it’s still fairly small in terms of  what we’ve done in the U.S. Meanwhile fiscal stimulus heavy China saw growth of 6.1 percent in the first quarter (though this is sluggish by Chinese standards).

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Hilarious/Depressing But Mostly Just Depressing Graph of the Day

May 11, 2009 — Jon

Via Ezra Klein, we see this graph, from Adam S. Posen and Mark Hinterschweiger at the Peterson Institute for International Economics, which shows the growth of fake money in relation to the growth of real money.

Posen and Hinterschweiger’s dry, academic take:

Between 2003 and 2008, US gross fixed capital increased by about 25 percent, a reasonable number during an economic expansion, but hardly a boom. During the same five-year period, the global amount of over-the-counter (OTC) derivatives increased by 300 percent, while derivatives held by the 25 largest US commercial banks rose by 170 percent. Clearly, growth in new financial products has outpaced fixed capital formation both globally and in the United States by a large margin. This has been especially true since 2006, when investment stagnated, but derivatives continued to grow at a rapid rate. There only seems to be a weak link, if any, between the growth of the newest complex—and now proven dangerous if not toxic—financial products and real corporate investment.

Meanwhile, note that 89 percent of these derivatives were held by the financial services industry, which should further demolish the notion that the much vaunted “financial innovation” really did anything to streamline capital — as you might expect innovation to do — but did help inflate the size of the financial sector.

As a side note, I’ll add that when this lost “wealth” is put in context correctly (that is, it wasn’t “lost” nor “wealth” per se), it illustrates just how ethereal the whole machine was. You should think about this when you hear Tim Geithner or Barack Obama say they want to return the banking industry to its precrash position.

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Jedi Mind Tricks: Finance Edition

May 6, 2009 — Jon

It makes me feel better about myself that Felix Salmon is similarly perplexed about this:

The government has told Bank of America it needs $33.9 billion in capital to withstand any worsening of the economic downturn, according to an executive at the bank.[...]

[...]But J. Steele Alphin, the bank’s chief administrative officer, said Bank of America would have plenty of options to raise the capital on its own before it would have to convert any of the taxpayer money into common stock.

“We’re not happy about it because it’s still a big number,” Mr. Alphin said. “We think it should be a bit less at the end of the day.”[...]

[...]Mr. Alphin said since the government figure is less than the $45 billion provided to Bank of America, the bank will now start looking at ways of repaying the $11 billion difference over time to the government.

In addition to the obvious that TARP repayment will be contingent on a bank’s ability to survive without assistance from other government programs (like loan guarantees), the notion that a difference between the amount of TARP money already provided and the amount of additional capital the government thinks BoA needs somehow demonstrates a clean bill of health is flatly insane. I’ll be the first to admit that the techno-jargon bandied about in banking can be confusing, but even I have no problem understanding that the government is trying to tell BoA that it needs $35 billion more than it already has on reserve. As Felix Salmon notes:

It seems to me that BofA is in some weird state of denial here, where a $35 billion capital shortfall can be considered evidence that it actually has more regulatory capital than it really needs. What’s more, the bank now seems to be happy going on the record with this kind of analysis. Which doesn’t instill in me a great deal of confidence in its management.

More frightening, the spin seems to be working.

Posted in Policy, Politics. Tags: , . 1 Comment »
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