Archive for the ‘Taxes’ Category

Big Employers Extorting States, Pocketing Employee Income Tax Withholding

Wonder why states are broke? It isn’t just the global financial crisis induced knock-on effects of a plunge in tax receipts and a rise in social safety net payments. Nor is it just pension fund time bombs (note that despite the press hysteria, the problem is unmanageable only in a comparatively small number of states, with New Jersey way out in front, thanks to 15 years of the state stealing from the workers’ kitty, plus a decision to take big risk at exactly the wrong moment, in 2007, which resulted in large losses). A significant unrecognized culprit is companies managing to divert tax revenue from stressed states to their coffers. The device, in this case, is demanding the right to keep state income taxes withheld from employee paychecks.

David Cay Johnston detailed this stunning development in an April 12 column and a related interview late last week (hat tip p78). He suggests that this movement is driven by banks, since financial players and private equity fund owned firms are heavily represented among these corporate welfare queens. His discovery seems to have gone largely unnoticed and I hope readers circulate this clip widely.

Will the Fiscal Cliff Eat the Recovery, Such as It Is?

Lately, the US has been winning the investment beauty contest among Cinderella’s ugly sisters. Europe’s addiction to austerity, rolling rescues, and inability to address internal imbalances means at best a wild ride and at worst a crisis resurgence. China still has its perennial fans, but long-standing bears like Jim Chanos have been joined more recently by Marc Faber, who foresees 3% growth, which is tantamount to a recession. Japan is struggling with a mile high currency. The US, by comparison, does not look too bad.

Or does it? One of the lurking worries in the background is the so-called fiscal cliff. At the end of 2012, a whole passel of tax breaks and special programs expire, from lower payroll tax rates to extended unemployment benefits. This has been lurking in the background for a while (indeed, the US would have faced a contraction in fiscal spending at the end of 2012 had various breaks not been extended).

Ben Bernanke brought the issue to the fore in Congressional testimony today, stating that consumer spending would suffer if Washington continues on an inertial course. Estimates of impact vary considerably. Normura puts the effect at nearly 5% of GDP in the first half of fiscal 2013, which starts October 2012. Deutsche Bank estimates the drag at only 1% of GDP, but the consensus seems to be 3% to 5%.

Needless to say, Wall Street does not want its punchbowl taken away (they really don’t care about the impact on ordinary people) and Uncle Ben also said clearly that he can’t compensate for the contractionary impact, so we have a flurry of alarmed reports tonight. (Mind you, I’m not saying this isn’t a big deal, but what it takes to precipitate coverage is amusing).

Some recent commentators are worried that it isn’t possible to get a deal done post election (the trigger date for most of the changes is calendar year end). For instance, FT Alphaville pointed to this column by Stan Collander a few days ago:

Even if there were an agreement on what that should include — and there absolutely isn’t ­— it would take longer than four to seven weeks just to draft the basic legislation, let alone debate and pass it in committee, debate and pass it in the full House and Senate, come up with a compromise agreement between the two chambers, redraft the compromise and pass the conference report. Add in the need for transition rules, which took a year to draft when the 1986 tax act was adopted, and it’s ludicrous to think that tax reform has any chance of going anywhere during the lame duck.

Keep in mind this is the wrong frame. The issue is whether Congress will decide to renew EXISTING initiatives, not fundamental tax overhaul (in fairness, Collander predicts that stopgap measures are all that will result). Tax maven Lee Shepperd points out that a surprisingly large portion of the tax code is renewed every year, and she is sanguine about the fiscal cliff turning out to be a non-issue.

But as we so far away from business in usual in DC that all bets are off? The Republicans are keen to cut the deficit, or at least like to pretend to be, and if the economy is more or less where it is now or a smidge better, they’ll certainly be champing at the bit to drop the extended unemployment benefits. The Dems would posture that they’d want different breaks eliminated, such as ones like the Bush tax cuts that would hit the well off more. Normally, the expected resolution would be simply to extend the whole shebang, since neither side would give up its half a loaf. But this is a Congress already beset by intransigence, and lame-duck sessions aren’t great for rallying the troops. And on top of that, the budget ceiling will come into play, which will further complicate agreeing on stopgaps.

The lack of focus on the issue in Congress is not a good sign. As Sebastian Mallaby writes in the Financial Times:

….the omens are bleak. Rather than seek a mandate to eliminate tax loopholes and discipline health spending, which are the two central components of any intelligent budget fix, candidates on both sides resort to sound bites

The better way to frame this might be: will all the talk of grand bargains get in the way of some fixes to keep the US from unwittingly going the austerian route? I’d hazard it is too early to tell. While Congress can often squeak legislation through just before deadlines, the ascendancy of the deficit hawks may mean the non-fix is in.

.

Philip Pilkington: Econ for Pirates – Rescuing Art from the Clutches of the Megacorporations

By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

I seen a lot of rappers turn soft, I turn my TV off (uh)
And thugs got commercials (yea) thugs in commercials (uh)
And everybody’s chick turned gladiator and shit
No pimps, no hustlers, yo where’s your whips
No Maybachs, no Lambos on the field
Towncar, ridin Music Express
You the best example, yo the industry is whack yo
Now you can bet your label and your Phantom on that
– Kool Keith ‘Bamboozled’

Daily, megacorporations shovel crap into our eyes and ears. There is no worse indictment for the so-called ‘free market’ – which is really just a few giant bureaucratic institutions – than the suppression of creativity in favour of the commoditised effluent of the corporate culture industry.

In truth the commoditised crap churned out by the great corporate machine is wholly reliant on creativity that emerges from the ground up. Today’s mainstream music scene relies on the hip hop and rap movements that emerged between the 1970s and the early 1990s in black communities in California and New York – needless to say that it is completely out of date but such is the stale nature of these institutions. Contemporary ‘alternative’ music feeds on the punk and post-punk scenes that emerged in Britain and the US in the late-70s and 80s – again, hopelessly out of date.

The great corporate machine simply sanitises and repackages culture in order to feed the masses through their tele-visual tubing. Fine. But it cannot truly create new flavours to inject into the tubes – and anyone who has an instinct to chase the new and the interesting will be quickly turned off. Put simply: corporate capitalism produces many things well – from clothing to furniture (although the question of style once again arises when we examine these in any serious way) – but it cannot produce true art. An alternative mechanism is needed.

Many have come to see this. People have discovered that the internet can provide them far more effectively with their cultural sustenance, so they take out the corporate tubing and logon. But this creates problems.

Stirrings of an Alternative

The economist Dean Baker outlined an alternative some time ago. He calls it the ‘artistic freedom voucher’. An excellent and detailed primer can be found here. Basically, taxpayers fork over money to their favourite artists and in return get tax credits. So, they pay their favourite artists some of the money that should have gone to the government in tax payments. The music would then be published under a ‘creative commons license’ that would allow everyone to access it for free.

Okay great. But this means that the government receives less money because the tax credits are ‘cashed in’ by people donating to the arts. This means that the government receives less revenue. Some have suggested that we offset this with taxes levied on digital audio equipment, blank CDs and internet connections. I have absolutely no problem with this. However, there is, once again, an alternative: we could run the system as a stimulus program and supplement it with an ambitious attempt to publicly subsidise institutions that artists could work in free from corporate influence at little personal cost.

Stimulating Creativity

Across the world today governments have been forced to run massive deficits in order to keep economies ticking over as private sector spending falls. Many of us would prefer that governments increase this spending in order to counter the unemployment that currently plagues most advanced capitalist countries.

Modern Monetary Theorists (MMTers) point out that governments that issue their own currencies can run such stimulus indefinitely until inflationary pressures build which will only happen after recovery takes place. They cite Japan as an example who, having stimulated their economy for over 20 years after the bursting of a private sector debt bubble in 1991, still have not encountered any problems with amassing government debts to the tune of 220% of GDP.

Countries that do not issue their own currencies have problems with large debt burdens – as is shown in certain Eurozone countries at the moment. However, either some formal mechanism is going to have to be put in place to allow these countries to run deficits or the Eurozone itself will collapse in the next few years.

(It is not difficult to fix the Eurozone problem. Although this is not the place to discuss such solutions – of which there are many – suffice it to say that the Eurocrats are well aware of what they can do but are being blocked by political pressures, mainly coming from the current German and French governments and their allies).

What we should do is build the ‘artistic freedom voucher’ into the deficits as a stimulus program. This has been done before in a slightly cruder way. During the Great Depression the Roosevelt administration used the works program they had put in place (the WPA) to channel money to artists. Many artists took part and it was a great success. (For music buffs it should be noted that Woody Guthrie received funding, who would later go on to exert a huge influence over Bob Dylan).

The ‘artistic freedom voucher’ is more consumer friendly, however, in that people are allowed to choose which artists they give their tax credits to. In this it allows greater consumer choice. However, it could be supplemented by a WPA-style compensation fund for new and emerging artists. After all, many a would-be artist might be intimidated by the prospect of having to attract funding to set themselves up, so perhaps we could have a pool out of which to subsidise them for the first, say, 12 months of their career until they can build a fan base for their material.

Through such a stimulus program we could also open public recording studios, public art studios, public filmmaking studios and other facilities that anyone could use for a very small fee. We could do all this in a highly decentralised manner, allowing artists, engineers, directors and producers full control of setting these facilities up while government representatives merely keep an eye on their funding to ensure they’re spending reasonable amounts.

The Politics

This piece was originally written, of course, for the pirates. For those unfamiliar, the pirates are a successful and promising political party that have taken root in Germany and other countries. They have a membership of 24,000 and are growing. They are particularly concerned with many of the issues outlined above.

The pirate political model is perfect for instituting the above reforms. It is through political piracy that the above reforms can be implemented. By supporting these reforms the pirates will no longer be subject to criticism that they are hurting artists and producers. Instead they will be supporting a system where artists can throw off the corporate shackles and embrace their inner potential.

Starting with the arts we can then move on to other areas such as drug patents. Why not have governments subsidise drug research? Rather than having corporations prey on their customers in search of profits – while in the process producing sometimes dangerous drugs with dubious medical value – we can leave it up to the scientists and keep the patents under creative commons, to be used by humanity when needed.

The piracy movement has already taken shape in places like Germany and Sweden, but this should be pushed further. By adopting a real platform based on MMT principles they can start to expand to other countries by encouraging disillusioned young people who support the public good over corporate greed to form pirate parties of their own.

Corporate Shills in Libertarian Clothing

There are, of course, arguments against such proposals. Corporate shills like J. Mark Stanley say that it restricts freedom of choice which, according to him, only the Great God of The Market can provide. Most people with any sense aren’t fooled by Stanley’s theological rhetoric. They know that The Market doesn’t exist in the way Stanley imagines that it should – that is, as a great equaliser that guarantees freedom of choice.

(I’m not going to link to Stanley’s article due to its horrific, robot-prose and juvenile argument. Interested readers can find it for themselves.)

In reality we live in a world where corporations control much of the decisions of production. These corporations operate in oligopolistic or monopolistic fashion. Personally, I don’t think it can be otherwise. Mass production on the scale that modern societies require necessitates huge manufacturing plants and institutions to assist in distribution. It’s really a simple issue of economies of scale – the more of a product is produced, the bigger need be the producing institutions.

Now, that’s fine for producing cell phones and sunglasses, but we simply cannot trust these institutions with other public goods – especially art. Anyone that is not content with the current output of MTV must see the point being made here clearly and shun utopia and childish libertarian rhetoric.

Personally, I know an awful lot of professional artists (I’m an amateur musician myself) and I know well how difficult they find it to survive. Many musicians I know are pressed into destroying their own output and creativity so as to play crappy popularised songs in bars just to make ends meet. Together with the corporate audio-visual tube-feeding system that many of us have in our homes, this is the reality of the ‘market’ insofar as it functions at all. The winner is the participant with the most advertising, PR and corporate monopoly-backing. Like it or lump it, that’s reality. Anyone who believes otherwise is merely a fantasist who has an emotional need for a quasi-religious doctrine – these people generally have no political influence because practical people laugh at them and shun them.

Let’s get to work on eking out a free space for our artists to operate in – a creative space, that is at the same time a commons.

The political forces are aligning, now all we need is the correct approach toward policy. The first thing we must do is to remove the fiscal shackles that bind the minds of most politicians and recognise that, in today’s world, government deficits are a good thing – and it is only a case of channelling funding in the right direction.

Philip Pilkington: MMT to the Rescue in the the Eurozone?

By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

We’ve already seen how, paraphrasing Archimedes, that financial instruments can move the world in a bad way. We have an opportunity to reverse that. Warren Mosler and I have just published a policy note at the Levy Institute that would, if implemented, bring an end to the Eurozone sovereign debt crisis.

The ‘tax-backed bond’ or ‘Mosler bond’ is based on the MMT idea that fiat money gets its value because the government accepts it in the payment of taxes. As the MMTers have been saying since the Eurozone crisis began the reason that the European periphery nations are having such a hard time with their sovereign debt burdens is because they do not issue their own currencies. The policy note we have just published outlines a new approach to the problem. The country will issue new tax-backed bonds that in the event a sovereign proves unable to meet its financial obligation to its creditors can be used to repay taxes in the country in question.

The policy note itself is short and readable enough (I hope), so for further information I’d ask the reader consult the document in the original. Here I would prefer to deal with the politics of the tax-backed bond approach and the chances we have of getting it accepted.

Pilkington-Mosler Tax-Backed Bonds

First of all, the reason Warren and I published this paper is because I have been able to drum up some interest from one of the main opposition parties in Ireland. In the coming weeks our hope is to present the idea to them and then, if all goes well, to the government themselves. I cannot promise this however and much will rest on my own lobbying abilities. I can, however, speculate as to how the plan might be perceived by those involved.

The Irish government should love the idea — and so should any other peripheral country considering it. If successful it will mean that they will be able to return to the international credit markets straight away. Given that this is what the Irish government currently aspires to above almost all else they should have few objections to immediate implementation of the plan.

If the plan works the government that adopts it will also see their austerity burden instantly relaxed. While it will be up to them what type of fiscal policy they run after the adoption of the scheme with interest rates held steady they will have a lot more policy space than they currently have.

We all know the lobbying power of the banks, of course — both national and international — so what about them? Well, they should adore the idea too. After all, many of them hold large amounts of government debt from Ireland and the periphery that is currently at risk of default. Many have also taken rather large losses on the recent Greek PSI deal (the haircut, in finance-speak). If the tax-backed bonds were deployed and yields fell the banks would see their balance sheets improve overnight as previously toxic assets became liquid once more.

But what about the rest of Europe? What about those that are currently pushing austerity? My thinking is that they will like the plan too. Ask yourself this: why is it that other European countries are so mad at the periphery right now? Well, its because they’re seen as leaching off the rest of the European system. The core countries today feel like they’re bailing out the periphery. They feel like they are racking up government debt and shouldering risk because the periphery countries cannot keep their own fiscal houses in order.

But if the tax-backed bonds work there won’t be any more bailouts! The periphery would become solvent on their own. They would no longer be seen as a burden on the rest of Europe. This would mean that Ms. Merkel and others could go back to their populations and honestly tell them that the periphery countries are no longer relying on them for support. Instead they would have have shouldered their own debt burdens and taken responsibility for their own balance sheets.

Furthermore, if the tax-backed bonds work we will see an easing of tensions within Europe. While the economic crisis will not come to an end without further policy actions the political crises will slowly but surely dissolve. The air of panic that is currently stifling Europe will be removed and everyone will be able to breath easy. With the crisis gone leaders will be able to sit down and have an adult conversation about the future of Europe; about trade imbalances and budget deficits; and about democratic accountability and capital flows. Only then can we put all the childishness of the past few years behind us and focus on the real issues.

One final note — for posterity. If this plan gets implemented and it works MMT will have won a major victory. How many economists and commentators have poo-pooed the ideas of MMT as being fanciful and needlessly contrarian? Well, if these ideas can be used to solve what has become a major financial, economic and even geopolitical problem MMT will have more than proved its worth as an area of serious study. If this plan were to work and the economics departments continue to shun the MMT approach we will then all know for sure that those working within them are not merely incompetent but criminally ignorant.

Yes, Virginia, Heads of Nonprofits Get Egregious Salaries Too

One of the side effects of increased income disparity is the assumption in some circles that anyone who has a “big” job deserves a lot of money, whether or not the circumstances or their performance warrants it. It wasn’t all that long ago that the prevailing assumptions were radically different: CEOs (except maybe in the auto industry) did not see themselves as near royalty, and most well run businesses recognized that firing staff in downturns and rehiring was costly (search time and training are bigger costs than most top brass admit to themselves).

A great piece at the Village Voice, “The Nonprofit 1 Percent” describes how this logic plays out in the not-for-profit sector. The centerpiece of the story is the Jewish Guild for the Blind. The opening anecdote describes how a meagerly-paid music therapist who worked there 20 years was fired, and she is in despair of the impact on her charges, who are elderly, poor,and have little else in the way of enrichment. The ostensible reason for the cut was that the Guild had a bad year in 2009. But its CEO, Alan Morse, saw his pay increase 82%, from $844,000 to over $1.5 million.

And it’s not as there is a ready justification for either the pay level or the increase. The Guild’s main source of revenue is Medicare. It was closing an operation in Yonkers because it was “unprofitable” at a time when employees were raising questions about the use of funds:

In a September 2011 article, the New York Daily News reported that “Michael Henderson, who once oversaw the guild’s procurement, claimed he was fired in 2009 after complaining about irregularities. Henderson said the guild spent $100,000 on imported furniture for Morse’s part-time White Plains office and he claimed another officer pocketed $100,000 from the sale of guild property.”

Management told staffers that the Daily News misrepresented Morse’s pay, and the increase was due largely to an increase in his retirement pay. Funny, that, since employee pension funds were frozen before that grant was made. And this little sweetener can’t be justified by Morse’s fundraising, since it lost money after expenses in the preceding period.

Morse isn’t alone. Huffington Post points out that there are other not-for-profits that are hardly deserving of the name, for instance, lobbying groups. The head of the Chamber of Commerce earned $4.7 million in 2010, and the head of the American Petroleum Institute made $6.4 million. that year. The Village Voice story lists other examples: the pastor of the Riverside Church in Manhattan, who made $600,000 in 2009; the head of Homes for the Homeless, whose funding comes almost entirely from government grants, earned over $460,000. (The article usefully debunks the rationalizations for lofty pay in the not-for-profit sector).

Reader bob supplied yet another egregious example: the “not for profit” Excellus BlueCross BlueShield, which reported $223 million of profit for 2011 and tripled the pay of its departing CEO to $5.2 million.

There’s a simple way to stop this feather-bedding. Implement Doug Smith’s maximum wage. Limit the pay of senior executives at nonprofits to no more than 25 times that of their lowest paid worker. Contractors that work on a full time or consistent part-time basis are to have their pay normalized to full time equivalents and be included in determining who the lowest paid workers are. It’s also time that people who donate to various causes look at the pay of the top executives to make sure their contributions really are going to the highest and best use.

Taxing the Rich Does Not Hurt Jobs

This Real News Network interview with professor of economics Jeffrey Thompson debunks the notion that increasing taxes on the well off is a negative for employment.


More at The Real News

Will Expiration of Tax Break Render Much of Mortgage Settlement Moot?

Even though the mortgage settlement deal was without a doubt massively lawyered from the bank end, and should have received similar levels of scrutiny from the Federal and state officials, a major fly in the ointment may have been overlooked. The tax rule allowing a reduction in mortgage debt not to be counted as income expires at the end of this year. As the Seattle Times explains (hat tip Lisa Epstein):

Before 2007, all cancellations of debt by creditors — whether on auto loans, personal loans or mortgages — were treated as taxable events under the federal tax code. If you owed $200,000, but paid off only $150,000 through an agreement with the lender, the $50,000 difference would be ordinary income, taxable at regular rates.

Under the debt-relief law for qualified homeowners, you can avoid taxation on forgiven mortgage amounts up to $2 million if married filing jointly, or $1 million for single filers. To be eligible, the debt must be canceled by a lender in connection with a mortgage restructuring, short sale, deed-in-lieu of foreclosure or foreclosure. The transaction must be completed no later than Dec. 31…

Picture this scenario: You negotiate for months with your lender, realty agents and potential buyers. Finally you pull together a short-sale package calling for the bank to forgive $100,000. But the deal runs into hitches and doesn’t go to closing until after the Dec. 31 expiration date. Now your house is gone, your credit is shot, you’re looking for a place to rent, and the IRS demands taxes on your phantom “gain” of $100,000 on the sale.

The Seattle Times article estimates the odds of renewal of this program at less than 50%, since Republicans claim a two-year extension would cost $2.7 billion and would help deadbeats.

Consider how this interacts with the mortgage settlement deal. $10 billion of the total headline amount of $25 billion is to come from mortgage mods, which the Administration expects to come to a much bigger number in actual value, since banks are expected to get a credit of only 50% for mods of securitized mortgages. Since the Administration estimates that 85% of the mods would be on mortgages not on bank balance sheets, that would give a total value of $18-$19 billion. Another “up to $7 billion” is for “forbearance of principal for unemployed borrowers, anti-blight measures, short sales, and transition assistance.”

Look at the timetable. The mortgage deal is supposed to be finalized by the end of the month and submitted to court for approval by a Federal judge. We have been told the great unwashed public won’t see the actual terms prior to its submission. Given that various press leaks have indicated that some items are less nailed down than the officialdom would have your believe, there is good reason to think the court filing will come after the planned date of the end of this month.

Let’s assume the filing is made by the Ides of March. Since there is not a precedent for this sort of deal, I would hope the judge would allow for an adequate amount of time for interested parties to submit amicus briefs on the filing. The Administration, of course, will press for fast track approval. Let’s assume 60 days from a mid March filing, so mid May approval. The banks are given three years to accomplish the required principal mods, with 75% to take place in the first two years. Let’s assume the other $7 billion is on the same timetable.

If the banks are to be on track for their 75% in two years, you could expect them to do 37.5% in the first year. That’s actually likely to be generous, since they’d be ramping up in the first year, plus it will take time to get any mod or short sale done (the article said that short sales take four to twelve months).

Take (7.5 months/12 months)N x 37.5% and you get less than 25%. So the bank are likely to be at the very best a bit over 20% of the way though their required mods and other forms of relief, and given start-up and lead time factors, may be well below even that level.

What happens as of December 31? What borrowers will remain interested in short sales and principal mods if they will be hit with large tax bills? The benefit of the mod will take place over time, but the adverse tax consequences will be immediate.

With the old tax rules in place, foreclosure is likely to wind up being the least bad of poor choices for most underwater borrowers who are under financial stress. Even if they would like to reduce the damage to their credit record via a short sale, the tax consequences may make that unaffordable.

And what does this mean for the banks? A substantial portion of the value of the settlement was to come in the form of mortgage mods and short sales. Even though the banks are supposed to be liable for the dollar amount in the settlement, what happens if they can legitimately argue that demand for principal mods and short sales has evaporated thanks to the expiration of tax relief? Is there any penalty or Plan B in the deal if the banks fail to produce the required level of mortgage modifications? I have a sneaking suspicion that this scenario is not reflected in the pact, and it gives the banks a perfect excuse for underperforming on an agreement that was already badly skewed in their favor.

Romney’s Wife Had $3 Million in Secret Swiss Bank Account Through 2010; Not Reported in Federal Disclosure Forms

Remember how peculiar it was that presidential candidate Mitt Romney refused to release his tax returns? That was predictably a non-starter. Most voters probably assume the reason he resisted was to avoid the controversy over his strikingly low tax rate.

Another factor appears to have played into this decision. The release of the tax returns shows Romney neglected to disclose some required financial information in his personal disclosure form filed with the Office of Government Ethics last year. His team apparently timed the release of his tax records with the hope that State of the Union hooplah would dominate news coverage and result in his finances getting less attention than they might otherwise. And that appears to been correct. His failure to divulge information about 23 investments, and more important his use of secret Swiss bank accounts, has been given a free pass. As Citizens for Responsibility and Ethics in Washington director Melanie Sloan observed, “Mr. Romney says the errors are minor, but then again he also claims earning $374,000 in speaking fees isn’t much money.”

This anodyne coverage in a Los Angeles Times article from last week is typical:

Some investments listed in Mitt and Ann Romney’s 2010 tax returns — including a now-closed Swiss bank account and other funds located overseas — were not explicitly disclosed in the personal financial statement the Republican presidential hopeful filed in August as part of his White House bid.

The Romney campaign described the discrepancies as “trivial” but acknowledged Thursday that it was reviewing how the investments were reported and would make “some minor technical amendments” to Romney’s financial disclosure that would not alter the overall picture….

The campaign has emphasized that Romney has paid all required U.S. taxes on his foreign funds….

Among the assets omitted is a Swiss bank account in Ann Romney’s blind trust that held $3 million until it closed in 2010. The account was listed on a financial disclosure Romney filed in 2007, but it was mistakenly named as an asset held by the couple, not as part of Ann Romney’s trust. A campaign spokeswoman said Thursday that Romney will file amendments to both his 2007 and 2011 financial disclosures to correctly identify the bank account.

That account was at UBS. Pretty much anyone who follows the financial press known of the pitched battle between the US government and first UBS, then Swiss banking regulators, over Swiss bank secrecy. The US engaged in a series of prosecutions that led one UBS unit that catered to wealthy individuals to be shuttered as part of a deal in which UBS also turned over the names of several thousand US customers that the US suspected of engaging in tax evasion. This case effectively ended Swiss bank secrecy; the efforts of the Swiss to avoid divulging the names of its customers was front page news in the Financial Times for the better part of two years. This is the summary in Wikipedia:

UBS agreed on February 18, 2009 to pay a fine of $780 million to the U.S. government and entered into a deferred prosecution agreement on charges of conspiring to defraud the United States by impeding the Internal Revenue Service. Of the $780 million that UBS will pay, $380 million represents disgorgement of profits from its cross-border business; the balance represents United States taxes that UBS failed to withhold on the accounts. As part of the deal, UBS also settled Securities and Exchange Commission charges of having acted as an unregistered broker-dealer and investment adviser for Americans.

The day after settling its criminal case on February 19, 2009, the U.S. government filed a civil suit against UBS to reveal the names of all 52,000 American customers, alleging that the bank and these customers conspired to defraud the IRS and federal government of legitimately owed tax revenue. The Swiss Financial Market Supervisory Authority (FINMA) had given the United States government the identities of, and account information for, certain United States customers of UBS’s cross-border business as part of its criminal investigation in 2009. On August 12, 2009, UBS announced a settlement deal that ended its litigation with the IRS. However, this settlement set up a showdown between the U.S. and Swiss governments over the secrecy of Swiss bank accounts. It was not until June 2010 that Swiss lawmakers approved a deal to reveal client data and account details of U.S. clients who were suspected of tax evasion.

Let us stress: the US prosecutors were firmly of the view that the main purpose of these accounts was tax evasion. As the Financial Times noted:

Bradley Birkenfeld, Mario Staggl and “others known and unknown” were accused in the indictment, unsealed yesterday, of conspiring to defraud the US from at least 2001 by engaging in a scheme that included falsifying documents, helping to set up shell companies and destroying banking records…

The indictment said while marketing their services to wealthy US clients, Mr Birkenfeld and Mr Staggl claimed that “Swiss and Liechtenstein bank secrecy was impenetrable”.

That indictment was followed by the indictment of the head of the UBS’s global wealth management business.

The Financial Times provided some details on how customers who had accounts with that unit fared:

The criminal case alleged UBS had failed to prevent a handful of private bankers from helping US clients to evade tax. The evidence showed UBS had 20,000 offshore US clients holding $20bn in assets in an operation that generated revenues of $200m a year.

The disclosures included tantalising details about specially encrypted computers and training in counter-surveillance techniques for bankers before they travelled to the US. Bradley Birkenfeld, a former UBS private banker turned whistleblower, even admitted to having squeezed diamonds into a tube of toothpaste for a billionaire client determined to export assets without detection.

The UBS unit concerned, which employed 60-70 bankers, has been wound down. Clients are receiving letters informing them their accounts are being closed. While those whose holdings were declared to the IRS have nothing to fear, the rest face a bleak choice. Clients who transfer their money risk leaving a paper trail that could lead to scrutiny. Even those who sit on their funds may fear questioning. The letters advise clients to seek professional advice and consider coming forward voluntarily.

The unit was shut down in early 2009, but UBS did not settle the tax-related charges until later in the year, which then set off a battle royale between the Swiss banking regulator and the US over the secrecy of customer identities. The US sought the release of 52,000 names but settled for several thousand. An adverse court ruling in Switzerland led to further machinations, and the deal was effective in July 2010.

It appears that the Romneys kept this $3 million offshore until it was clear the secrecy gig was up (note it is not clear that their account was with the unit that was targeted in the probe). Even though it is pretty unlikely that they were among the customers whose names were turned over to the US ($3 million is chump change in private banking), Swiss accounts were no longer assured of safety.

The answers given by the Romney’s financial advisor about this account aren’t entirely satisfactory. From Reuters:

Brad Malt, who oversees the Romney blind trusts, said on the conference call that Romney’s wife’s trust had a $3 million bank account at UBS AG, the Swiss banking giant. Malt told Reuters he closed the UBS account in late 2010.

“I am aware that there have been some allegations recently that some Swiss bank accounts have been used to evade taxes – I would like to emphasize that this account is not … one of those,” Malt said.

“I decided to remove any possible source of embarrassment,” he said, adding that “taxes were all fully paid” on the UBS account and that he closed it because “it just wasn’t worth it.”

The closing of the account came amid a crackdown by the U.S. Justice Department and the U.S. Internal Revenue Service on Swiss and Swiss-style banks suspected of selling offshore tax evasion services to wealthy Americans.

The Romney campaign said on Tuesday in an emailed response to a reporter’s queries that the UBS account held by Ann Romney’s blind trust “was set up for diversification.”

The email described the account as “a passive bank account that simply earned interest. It did not make any other investments. It did not pay any bills.” The email went on to say that the account was “fully compliant with all tax laws.”

The problem is that the story does not add up. Diversification? Huh? You don’t diversify by putting money in a no-yielding cash account in Switzerland; you can hold cash as an asset class far more simply and at better returns pretty much any other way. The account earned a grand total $1.718, or .06%, in 2010; low returns were the usual tradeoff for vaunted Swiss secrecy. It might be that this $3 million was excess cash targeted for opportunistic investments and was never deployed.

So you have to assume that the Romneys did want the secrecy. After all, they were paying for it with terrible returns on their money. And if not for tax reasons, then why?

Moreover, one has to wonder whether the income from this account was reported on a current basis. The Romneys no doubt NOW paid the taxes due, query whether they paid them prior to the loss of certainty of account secrecy. The IRS launched a voluntary disclosure program in the wake of the UBS settlement, so it is possible that the relevant taxes were paid as part of that initiative, rather than on a current basis. Notice also that Romney delayed the release of his tax returns till January, and got his filings done early so he could report tax years 2011 and 2010 (I’m really impressed that someone with a tax situation as complex as his can file so early). What would his 2009 tax returns have shown? Was the Swiss account on them? (He could have amended them if they had been “missed”, but returns are seldom amended for small amounts).

Whether or not Romney has something to hide, the failure to include the Swiss account in his Federal ethics filing has him acting as if he has something to hide. Even if there was nothing technically amiss with what Romney did, having a large stash in a secrecy jurisdiction does not pass the smell test. It speaks of an intent to skirt the law even if that never actually took place.

Public Money for Public Purpose: Toward the End of Plutocracy and the Triumph of Democracy – Part IV

By Dan Kervick, a PhD in Philosophy and an active independent scholar specializing in the philosophy of David Hume who also does research in decision theory and analytic metaphysics. Cross posted from New Economics Perspectives

I have set out a simplified model of a monetarily sovereign government. But near the end of the previous section, I began to suggest that the United States government is indeed a monetary sovereign by this kind. The reader might now suspect that I have yielded my rational mind over to a simplistic fiction of my own creation. And by this point, the reader is probably thinking that however interesting it might be to imagine this fictional entity, the so-called monetary sovereign, such fictions have nothing to do with the complexities of the real world, because actual governments maintain accounts that are indeed constrained by the amount of money in those accounts and by the external sources of funding to which they have access. After all, can’t a government default on its debt? What about the recent debt ceiling debate in the US? What about what is happening in Europe with the sovereign debt crisis? Also, if a government like the United States government was a monetary sovereign of the kind I have described, the consequences would seem to be enormous. Surely if a democratic government possessed this kind of power, we would make much more use of it than we do. In short, monetary sovereignty as described seems both too simple to be real and too good to be true.

These skeptical intuitions are reasonable, so they need to be addressed. First, let’s consider the question of whether monetary sovereignty is too simple to be real.

I will argue that the government of a country like the United States is much closer to the ideal of monetary sovereignty than the typical citizen recognizes. To theextent the model is overly simplified, that is due entirely to choices we have made about how our government should be organized internally. The financial and monetary operations that occur in our actual government are not carried out by a single operational center, but rather involve several parts of the executive branch, most prominently the Treasury department. Congress is involved as well, as is the Federal Reserve System. These branches of the government are subject to various legal restrictions and constraints. But these are all constraints that the country’s legislators have chosen to impose on the government’s financial operations. They are to that extent voluntary and could thereforebe altered.

Congress has chosen, for example, to make the US Treasury,and even Congress itself to some extent, function as a currency user rather than a currency issuer, and has attempted to assign to the Fed all primary responsibility for direct decisions over the increase and decrease of the money supply. Ultimate monetary authority obviously resides in Congress, but Congress has delegated much of that authority to the Fed, and has been reluctant to exercise the authority directly by engaging in direct monetary operations on behalf of the public it represents.

These restrictions have been implemented in several ways: The Treasury Department can only spend if there are sufficient points on its monetary scorecard – that is, if sufficient dollars are credited to its bank accounts. Its accounts are held at the Fed and administered by the Fed. It is forbidden from overdrawing its accounts at the Federal Reserve, and the Fed has no authorization to credit those accounts directly and unilaterally. So the Treasury can’t create money itself by a direct act, in the course of its ordinary operations, nor can the Fed create it directly for the Treasury. If Congress has authorized some spending by the Treasury Department, the Treasury can only carry out that spending if the combination of tax revenues and borrowed funds currently supplying Treasury accounts constitute sufficient funds for the spending. If tax revenues are insufficient, then in most cases the Treasury Department will sell bonds to theprivate sector, and raise funds in that way. However, Congress has also imposed a debt ceiling on Treasury borrowing, so the Treasury’s prerogative in issuing bonds is capped.

The Treasury Department does possess, through its operation of the US Mint and as a result of certain loopholes in existing authorizationsto mint coins, a potential source of direct control over monetary operations. But taking advantage of these loopholes would be highly unusual and politically controversial. And if Congress remained determined to keep delegated monetary authority with the Fed, then the loopholes would probably be closed quickly by legislation.

Also, the Treasury Department is forbidden from selling bonds directly to the Fed. So while the Fed is permitted to create money and use it for making loans to banks in the Federal Reserve System, or for the purchase of financial assets from private sector owners of those assets, it cannot purchase bonds directly from Treasury. And thus the Treasury cannot borrow directly from the Fed. The two departments must instead follow a more roundabout method. The Treasury can sell bonds to private sector dealers in an auction, as it ordinarily does. The Fed can then, at its discretion, purchase those bonds from the private dealers in separate auctions. Treasury ends up with some amount of borrowed funds, but also with a liability to pay the Fed the principle on the loan. Any interest payments on the bonds will be returned to the Treasury, since the Fed is not permitted to collect interest from the sale of Treasury bonds. So the Treasury ends up in a better position than if the bonds were still owned by the private sector dealer. But the Treasury still owes the Fed the principle. How these loan payments are funded is then ultimately up to Congress to decide.

Let’s conduct a thought experiment, and imagine how things might work if the Treasury could sell bonds directly to the Fed, and if Congress exercised more direct supervision over the Fed’s purchases of Treasury dept.

Suppose the Treasury Department were permitted to issue a special class of bonds – call them “M-bonds”. These bonds could not be sold to private sector purchasers on the open market, but could only be sold to the Fed directly. Suppose that the bonds carried no coupon payments and 0% interest, and matured in a year. In other words, if the Treasury sells a $1 billion M-bond to the Fed today, then the Treasury receives $1 billion from the Fed today, and next year they pay the Fed exactly $1 billion, with no interest payments in between.

Suppose also that the Fed were not permitted to refuse to buy M-bonds. Let’s imagine that Congress has passed a law mandating that, if Treasury issues an M-bond and offers it for sale to the Fed, the Fed has to buy it. But let’s also assume that Treasury is still not permitted any overdrafts on its account at the Fed. Congress continues to mandate that any Treasury spending must be cleared through its Fed account, and that the only ways of funding that account are though tax revenues, sales of ordinary Treasury bonds to the private sector and sales of M-bonds to the Fed.

Now, finally, let’s suppose that the Treasury Department has a standing policy of funding $100 billion of public sector spending each year through the sale of M-bonds. It also hasa policy of issuing new M-bonds each year to meet the full costs of servicing its outstanding M-bond debt. In other words, it always pays the debt it owes on its M-bonds just by selling more M-bonds. So, in Year One it sells the Fed $100 billion of M-bonds, and spends the proceeds. In Year Two, it sells $200 billion of M-bonds, spending $100 billion of the proceeds and using the other $100 billion to pay off the Year One debt. In Year Three, it borrows $300 billion, spends $100 billion and uses the remaining $200 billion to pay off the Year Two debt. Etc.

We can see that the portion of Federal debt attributable to M-bond issuance grows arithmetically by $100 billion each year. So the national debt continues to rise. But we can also see that that portion of the debt is relatively meaningless. And it wouldn’t matter if M-bonds were not sold at 0% interest, but carried some positive interest rate – say 10% or more. In the latter case, the debt due to M-bonds would not rise only arithmetically, but would rapidly compound. But it would be just as meaningless, since the whole quantity of the previous year’s M-bond debt would be borrowed from the Fed each year, and then paid back the next year with additional borrowings from the Fed. The Fed would be required to purchase this additional M-bond debt each year, so the rising debt places no rising burden on the US Treasury or the American taxpayer.

It should be clear at this point that the entire functional effect of all that borrowing and repayment with M-bonds could be accomplished by the following simpler alternative operation: Congress simply mandates that each year that the Fed must directly credit $100 billion to Treasury Department accounts at the Fed. No bonds. No borrowing. End of story. While this might appear to be an entirely different kind of operation, ultimately they are just too different mechanisms for accomplishing exactly the same effect. Thus, the rapid arithmetical rise in M-bond debt in our thought experiment is not functionally equivalent to a cycle of hyperinflationary runaway money printing. There is instead a fixed, modest annual amount of net money creation – $100 billion, which is just a fraction of annual US GDP – and the ballooning debt payments are just an artifact of the convoluted M-bond method Congress has hypothetically prescribed in our thought experiment to accomplish this money creation. The M-Bond debt owed by the government to the Fed – which is itself part of the government – has a fictional quality.

It is vital to recognize, then, that the third party private sector involvement in the current borrowing relationship between the Fed andthe Treasury is entirely voluntary on the part of the US government. Congress could remove it at any time, simply bypassing the appropriate legislation.

Congress could also, at any time, direct the Fed to credit Treasury Department’s accounts – their monetary scorecards – by any amount Congress seesfit. The recent debt ceiling crisis,therefore, is entirely the result of self-imposed, voluntary government constraints. The government can never runout of money unless it chooses to subject itself to various self-imposed constraints.

Congress has not provided itself with any institutionalized means for conducting monetary operations directly, and has imposed on both itself and the Executive Branch – the two political, elected branches of the government – a system that requires both branches to act as though they are the mere users of a currency that is controlled by the Fed. Congress has thus imposed a quotidian accounting constraint – to use a term introduced earlier – on the political branches of government. The Fed, on the other hand, is effectively permittedto spend without a scorecard. But its spending options are limited by law: It can buy government bonds and other bonds on the open market. It can also lend funds to banks at a rate ofits own choosing. But it can’t buy a battleship, or hire 100,000 people to spruce up the national parks or build ahighway or rail line, or simply send checks to selected American citizens. Or at least if it tried to do these things it would likely be challenged legally for conducting operations that appear to exceed its intended legal powers. Just what theactual limits of those powers are, and how much Congressional spending power has been delegated to the Fed, seems to be a matter of some controversy. But it is clear that the Constitutional intention is that the “power of the purse” is supposed to reside with Congress. And thus any move by the Fed to begin conducting fiscal policy byspending money on all matter of goods and services would be extremely controversial to say the least.

It sounds a little bit strange, of course, to say that Congress has imposed operational constraints or restrictions on itself in the area of monetarypolicy. After all, apart from thosesupreme laws that are embedded in the US Constitution, Congress makes the laws. So in what sense can Congress beconstrained by laws of which Congress itself is the author and master? We might think here of the ancient Greek hero Odysseus, who had himself bound to the mast of his own ship to prevent his ship’s ruin on the rocky island of the Sirens. But the important thing to remember in this area is that while the US Congress might be bound by laws that Congress itself has created, these laws can be changed at any time by the same Congress that enacted them. Congress can intervene in US monetary operations at any time, since US monetary power is constitutionally vested in Congress.

So the parts of the government that can actually accomplish a lot with their spending – Congress and the Executive Branch – are presently required by law to act as mere currency users that must draw on private sector funding sources to carry out that spending, while the part of the government that is permitted to act as a currency creator – the Fed – is subject to fairly strict limits on what it can accomplish and whom it can affect with that spending.

The whole system seems cumbersome and byzantine when viewed in this light. But perhaps the seself-imposed constraints have important policy justifications? Perhaps Congress in its wisdom has seen that monetary power is simply too dangerous for direct democratic governance, and that even Congress itself cannot be trusted to carry out monetary operations inconjunction with spending and taxing operations, in a democratically influencedfashion? We will return to this question later. But for now, let’s turn to the other instinctive reaction to the model we have developed of a monetarily sovereign government: that it is too good to be true.

If the monetary sovereign is not subject to any operational requirement either to tax or to borrow in order to spend, and if the monetary sovereign has the power to create money at will, then isn’t that the ultimate free lunch? Doesn’t that mean that a government of this kind can spend without limit either to purchase goods or services for the public sector or to effect direct transfers of monetary bonanzas to private sector accounts?

We all know something is wrong with this suggestion, if we interpret it in its most obvious sense. And where it goes wrong is in its loose use of the word “can”. Of course, in one sense the monetarilysovereign government can spend without limit. There is no operational constraint on this spending. The US Congress can authorize as much spending as it desires, and of almost any kind. It can, if it chooses, permit that expanded spending to go forward in the absence of any additional taxrevenues. It could remove the debt ceiling and authorize, or even direct, unlimited borrowing by the Treasury. Or it could direct the Fed to credit the Treasury Department account directly with some large amount of money. It could even eliminate the Treasury Department’s Fed account entirely, and simply direct the Fed to clear any check issued by the Treasury Department, and always make a payment directly to the account of whatever bank presents that Treasury check to the Fed.

In the purely operational sense of “can”, our government can do all of these things. But we all know that under many circumstances, such actions could have very bad effects. In addition to whatever operational constraints do or do not bind government actions, there are also what we have called policy constraints. A policy constraint on government actions is simply a policy choice the government has made that cannot be effectively carried out if the government does not act within that constraint. And if the policies are sensible ones, thepolicy constraints are sensible as well.

One such policy which most governments seek to implement isa price stability policy. For good reasons, governments seek to prevent prices on goods and services from rising or falling too much in a short period of time; or from rising or falling sharply and suddenly, or in an accelerating fashion; or from behaving in an erratic and unpredictable manner. Price instability of these kinds can have an inhibiting, recessionary effect on economic activity, as the participants in the economy struggle to predict the outcomes of their medium-term and long-term contracts and transactions. If a monetarily sovereign government suddenly authorizes the creation of excessively massive amounts of new money, and simply spends that money into the private sector directly to make public sector purchases, or transfers it to individuals who in turn spend it, the effect could be a sharp and sudden surge in the level of prices. High inflation and shortages of goods are the likely result.

And yet the risk of runaway inflation as a result of government money creation is frequently exaggerated. Some commentators seem to assume that the merecreation of new money will always have a corresponding inflationary effect, no matter how the new money is spent. Theyare constantly warning is that “hyperinflation” is just around the corner as aresult of government money creation. But this inference does not meet the test of either common sense or considered examination. Adding money to the economy only exerts pressure on prices if that money is in the marketplace, in the hands of customers, competing with other potential customers for goods and services to bid up the prices of those goods and services. If the money is inserted into the economy insuch a way that it mostly goes into savings or bank reserve buffers, it will not contribute to price pressure. Such appears to be the case with recent “quantitative easing” policies pursued bythe Fed.

But even if the money does accompany hungry customers straight into the marketplace in pursuit of goods and services, it still might not exert much pressure on prices. It really depends on how and where the money is inserted. Consider an economy like the one we are enduring currently, with double-digit real unemployment and substantial underutilized human and material resources. Many businesses are experiencing empty shelves, unused warehouse space, vacant office space, idle productive machinery and internal systems operating well short of their capacity. In response to a surge in demand from new customers with money to spend, such businesses can ramp up production rather quickly. They can hire workers from among the huge army of unemployed people hungry for jobs, put productive capacity back online, and fill up existing shelves or distribution facilities with very little additional cost per unit of output. In fact, with so much underutilized capacity, the cost per unit of output sometimes even falls with additional production, as current capacity is used more efficiently. So businesses would have little reason in these circumstances to raise prices on the basis of cost pressures alone. At the same time, any business that is even tempted to raise prices in response to the new demand would face intense pressure from their competitors, who have been starved for customers throughout the recession, and who will be only too happy to keep prices low and reap increased revenues from boosted sales alone, with the same unit production costs, and without attempting to frost the tasty new cake with an uncompetitive price increase.

So, inflation fears vented over proposals for more government deficit spending assisted by sovereign monetary power are often overblown. An economy in a deep recession like ours would likely benefit greatly from such a direct expansion of government spending.

In fact, not only is government spending in a recession likely to be beneficial, but the decision to throttle down government spending and reduce deficits – that is, the decision to practice austerity – is positively harmful in the same circumstances. That is because, in the absence of any change in a country’s current account status with respect to its trade abroad, any decrease in the government deficit corresponds to an aggregate worsening of private sector balance sheet positions. If the government insists on pushing its own balance sheet into a position of surplus, it will likely push the private sector into a deeper deficit, which is precisely the wrong thing todo as the private sector struggles to deleverage, and as household and business incomes fall. And in the context of a global recession, where virtually every country would like to increase exports significantly but few countries can do so because there are not enough foreign buyers for their goods, the clear present need is for expanded public sector spending.

But suppose our government chose to expand spending by making use of additional borrowing from the private sector? In that case, the additional deficit spending would drive up the national debt. Isn’t there great risk in these high debt levels? If the government’s debt goes to 100% ormore of our entire annual national product, isn’t that dangerous? Many pundits are warning these days about the allegedly calamitous level of debt and the threat of ruin or bankruptcy governments face as a result.

And private sector debtis certainly a big problem. As we have discussed, individuals, households and firms – unlike monetarily sovereign governments – are mere users of debt instruments and monetary instruments they don’t control, and operate under real and inviolable budget constraints. They can face insolvency if their debts gettoo large. And even if they are not in immediate danger of insolvency, high debt burdens place serious limits on the ability of private sector borrowers to spend their income on satisfying other wants and needs.

Politicians have recently drawn on these fears of private sector debt in the United States to elevate similar fears about the debts of the US government. We hear politicians and other national opinion leaders warn that the government faces “bankruptcy”. They say that it is “broke” or “out of money”. And they are exploiting these fears to pressure Americans to reduce the size of their public sector spending,and grant even more power to the private sector firms that helped steer us intoour current crisis. But the claims behind these warnings about government debt are often downright false. At best they are often wildly overblown, and based on significant misunderstandings about how our government’s monetary system operates, and how any monetarily sovereign government relates to the world ofprivate sector finance with which it interacts. Here are several facts to bear in my about federal government debt in the United States:

First, the US government, as a monetarily sovereign nationthat is the monopoly producer of the US dollar, can face no solvency risk otherthan a voluntary, self-imposed solvency risk. The US borrows in dollars, a currency that the US government itself controls and produces. The US government therefore simply cannot go bankrupt and fail to pay its debts unless the US Congress chooses to prohibit the Treasury Department from paying those debts, by choosing to prohibit the Treasury from making use of the inherent monetary power of the United States. Now this is in fact what the US Congress threatened to do in the summer of 2011. That is not because the government faced an externally imposed solvency crisis. It is because some members of Congress chose to manufacture a crisis by threatening a voluntary default, in order to blackmail American citizens and other members of Congress into reducing the size of public sector spending.

It is true that the Treasury Department is currently constrained by Congress to sell its bonds to private sector lenders. But that is again an arrangement that Congress has chosen. At any time Congress could enact legislation permitting direct borrowing from the Fed –effectively creating what I called “M-bonds” – or direct the Fed to credit the Treasury Department’s account by any amount Congress desires, including whatever amount might be necessary to pay any existing debt liabilities. So there is simply no risk of US government bankruptcy other than the risk that the US Congress might, somewhat recklessly and fanatically, choose to default on US government debt.

The only real constraint that needs to be born in mind in the area of government borrowing is the policy constraint of price stability. Once economic activity returns to full capacity, the need to preserve price stability will require that government debt liabilities to the private are met through processes that begin to remove compensating monetary assets from the non-governmental sector through taxation rather than processes that continually expand those monetary assets through more central bank purchases of debt. Most of that transition will occur automatically. As economic growth returns and incomes rise, tax revenues will automatically rise along with the incomes.

Some worry about the size of the debt we owe to foreign lenders, including foreign governments. The Chinese government, for example, currently possesses over 9% of US treasury debt. Politicians use this fact to portray the Chinese as a potentially oppressive creditor that could choose to “call in our loan” and drive us into insolvency or crisis. These fears are also overblown. When the Chinese or others purchase US treasury debt, they purchase it with dollars – dollars they already possess. There are only so money things you can do with a foreign government’s currency you possess. One of those things is to buy bonds from that foreign government (or save it with a financial institution that is itself buying government bonds). A bond issued by the Treasury Department functions as the equivalent of an interest bearing savings account for people with dollars to save. If the dollar holding foreign nation chooses not to put their dollars in “savings” by purchasingbonds either directly or indirectly, they will have to keep their dollars in “checking” by leaving them in bank accounts earning lower interest. Why would they do that?

Suppose the Chinese decided they no longer wanted to purchase US government debt. What would they do with their dollars? Their only real alternative would be to exchange those dollars for something else. That is, they could buy something with the dollars in markets where the dollar is accepted – primarily America. At that point, it is hard to imagine the media screaming, “Crisis! Chinese seeking to buy massive amounts of American goods!”

Under current arrangements, as we have seen, the Treasury Department is constrained to sell bonds on the private market. So the fear might be that even if the Fed is prepared to buy up as much Treasury debt as is needed in order to support Treasury spending operations, the Fed might not get that option if skittish private sector borrowers refuse to buy government debt at high prices. Again, the problem with this line of thinking is that the entire world that does business in dollars has no otheroptions but to save its dollars in savings vehicles that are in one way or another founded on government debt liabilities. The Fed exercises tremendous control overinterest rates through its open market operations. So realistically, there will always belenders ready to purchase bonds that the government issues, at the interest rates we desire, so long as the Fed stands ready to purchase as much government debt as needed to set the interest rates its desires to set. Borrowing costs for the US government remain extremely low, despite the warnings of those who fear federal government debt is too high. Nor do people in other countries seem any lessinclined to save and do business in dollars. The dollar is currently very strong on world currency markets, despite persistent warnings by the fear mongers that government money creation will lead to a hyperinflationary loss of value in the dollar.

Some of those who spread fear about dramatic inflation or hyperinflation resulting from government money creation point to the recent rounds of “quantitative easing”, in which the Fed purchased large quantities of financial assets on the private market. Since the Fed effectively creates the money on the spot that it needs topurchase those assets, some fear that this massive program of purchases has flooded the economic system with money, and the pressures from this deluge will eventually lead to a runaway rise in prices. But it is important to recognize that when the Fed buys financial assets, that purchase amounts to a removal of money from the economy over time as well as an insertion of money in the present.

Suppose that some private sector entity A possesses a bond issued by some other entity B, where B can be either the Treasury Department orsome private sector lender. Suppose that the bond commits B to the payment of $10,000 to A over the next five years, on some pre-determined schedule. Now suppose that the Fed offers to purchase this bond from A for $9000, and that A decides to sell the bond because A prefers the $9000 now to the delayed receipt of $10,000 over five years. It is true that when the Fed makes the purchase it inserts an additional $9000 into the economy. But remember that $10,000 was originally supposed to move from B to A over five years. Now the $10,000 will flow from B to the Fed rather than to A. In other words, the Fed has poured $9000 out of its infinite money well into the private sector today, but over the next five years B will pour $10,000 back down into that infinite money well. That amounts to a net removal of $1000 from the private sector. All the Fed has done with its bond purchase is swap out one financial asset- a bond – for a different asset – some money. It has adjusted the schedule of insertions and removals of money from the private sector without effecting a net increase in the amount of money inserted.

Finally, before moving on to a discussion of making the US monetary system more democratic, it will be worthwhile saying a few words about how the current European monetary system falls short of the kind of monetary sovereignty – or near monetary sovereignty – I have attributed to the system in the United States.

European governments are all part of a currency union – the Eurosystem. Each government issues its own bonds and each operates its own central bank. All of these transactions occur in Euros,the common currency of the Eurosystem. But those national central banks are subject to rigorous policy constraints set by the European Central Bank. The individual countries themselves do not set their own monetary policies, and they borrow in a currency they do not themselves control. In effect this makes each government acurrency user rather than a monetary sovereign. If we think of government bonds as the equivalent of bank savings accounts, then each of the governments is in effect the equivalent of a savings bank that competes with the other governments in the Eurosystem to offer attractive interest rates to savers. This gives holders of Euros tremendous bargaining power to drive up bond yields and interest on government debt, because they can always take their money elsewhere to other governments if they don’t get the yields they want. And since the individual governments do not control their own monetary policies, they cannot maintain spending during periods of low revenues by selling debt directly to their national central bank and drawing on the money-creating power of that national central bank. Only the European Central Bank can alter those monetary policies, but the ECB is prohibited by treatyfrom buying government debt directly. The ECB also lacks the capacity to carry out a fiscal policy of central bank financed spending operations in Europe.

In effect, then, the technocratically-managed ECB runs Europe’s private banking system and the private banking system runs Europe’s governments. The citizens of Europe have turned their capacity for economic self-determination over to an undemocratic, continent-wide banking conglomerate. This is the worst kind of nightmare in the long struggle between democracy and private wealth. It’s not as though the Europeans have surrendered their sovereignty to be part of a larger sovereign democratic government encompassing all of Europe. Rather, sovereign democratic governments have been transformed in this instance into something like mere business enterprises that are dependent on private wealth and financing for their operations. These governments now govern only at the pleasure of bankers.

This is Part Three of a six-part series. Part One is here Part Two is here and Part Three is here.

Piketty, Saez and Stantcheva: Taxing the 1% – Why the Top Tax Rate Could be Over 80%

Yves here. By happy coincidence, a mere day after Jamie Dimon offered yet another misleading defense of the 1% (among other howlers, claiming that their marginal tax rates were their effective tax rates), the gurus of income inequality, Thomas Piketty and Emmanuel Saez, say there is no good case for coddling the rich. Their analysis shows that top marginal tax rates could rise to near Eisenhower administration levels (the top tax rate then was 91%) and not hurt growth.

By Thomas Piketty, Professor, Paris School of Economic, Emmanuel Saez Professor of Economics, University of California, Berkeley and Stefanie Stantcheva, PhD candidate in Economics, MIT. Cross posted from VoxEU

The top 1% of US earners now command a far higher share of the country’s income than they did 40 years ago. This column looks at 18 OECD countries and disputes the claim that low taxes on the rich raise productivity and economic growth. It says the optimal top tax rate could be over 80% and no one but the mega rich would lose out.

In the United States, the share of total pre-tax income accruing to the top 1% has more than doubled from less than 10% in the 1970s to over 20% today (CBO 2011 and Piketty and Saez 2003). A similar pattern is true of other English-speaking countries. Contrary to the widely held view, however, globalisation and new technologies are not to blame. Other OECD countries such as those in continental Europe or Japan have seen far less concentration of income among the mega rich (World Top Incomes Database 2011).

At the same time, top income tax rates on upper income earners have declined significantly since the 1970s in many OECD countries, again particularly in English-speaking ones. For example, top marginal income tax rates in the United States or the United Kingdom were above 70% in the 1970s before the Reagan and Thatcher revolutions drastically cut them by 40 percentage points within a decade.

At a time when most OECD countries face large deficits and debt burdens, a crucial public policy question is whether governments should tax high earners more. The potential tax revenue at stake is now very large. For example, doubling the average US individual income tax rate on the top 1% income earners from the current 22.5% level to 45% would increase tax revenue by 2.7% of GDP per year,1 as much as letting all of the Bush tax cuts expire. But, of course, this simple calculation is static and such a large increase in taxes may well affect the economic behaviour of the rich and the income they report pre-tax, the broader economy, and ultimately the tax revenue generated. In recent research (Piketty et al 2011), we analyse this issue both conceptually and empirically using international evidence on top incomes and top tax rates since the 1970s.

Figure 1 shows that there is indeed a strong correlation between the reductions in top tax rates and the increases in top 1% pre-tax income shares from 1975–79 to 2004–08 across 18 OECD countries for which top income share information is available. For example, the United States experienced a 35 percentage point reduction in its top income tax rate and a very large ten percentage point increase in its top 1% pre-tax income share. By contrast, France or Germany saw very little change in their top tax rates and their top 1% income shares during the same period. Hence, the evolution of top tax rates is a good predictor of changes in pre-tax income concentration. There are three scenarios to explain the strong response of top pre-tax incomes to top tax rates. They have very different policy implications and can be tested in the data.

First, higher top tax rates may discourage work effort and business creation among the most talented – the so-called supply-side effect. In this scenario, lower top tax rates would lead to more economic activity by the rich and hence more economic growth. If all the correlation of top income shares and top tax rates documented on Figure 1 were due to such supply-side effects, the revenue-maximising top tax rate would be 57%. This would still imply that the United States still has some leeway to increase taxes on the rich, but that the upper limit has already been reached in many European countries.

Second, higher top tax rates can increase tax avoidance. In that scenario, increasing top rates in a tax system riddled with loopholes and tax avoidance opportunities is not productive either. However, a better policy would be to first close loopholes so as to eliminate most tax avoidance opportunities and only then increase top tax rates. With sufficient political will and international cooperation to enforce taxes, it is possible to eliminate most tax avoidance opportunities, which are well known and documented. With a broad tax base offering no significant avoidance opportunities, only real supply-side responses would limit how high top tax rate can be set before becoming counter-productive.

Third, while standard economic models assume that pay reflects productivity, there are strong reasons to be sceptical, especially at the top of the income distribution where the actual economic contribution of managers working in complex organisations is particularly difficult to measure. In this scenario, top earners might be able to partly set their own pay by bargaining harder or influencing compensation committees. Naturally, the incentives for such ‘rent-seeking’ are much stronger when top tax rates are low. In this scenario, cuts in top tax rates can still increase top income shares – consistent with the observed trend in Figure 1 – but the increases in top 1% incomes now come at the expense of the remaining 99%. In other words, top rate cuts stimulate rent-seeking at the top but not overall economic growth – the key difference with the first, supply-side, scenario.

To tell these various scenarios apart, we need to analyse to what extent top tax rate cuts lead to higher economic growth. Figure 2 shows that there is no correlation between cuts in top tax rates and average annual real GDP-per-capita growth since the 1970s. For example, countries that made large cuts in top tax rates such as the United Kingdom or the United States have not grown significantly faster than countries that did not, such as Germany or Denmark. Hence, a substantial fraction of the response of pre-tax top incomes to top tax rates documented in Figure 1 may be due to increased rent-seeking at the top rather than increased productive effort.

Naturally, cross-country comparisons are bound to be fragile, and the exact results vary with the specification, years, and countries. But by and large, the bottom line is that rich countries have all grown at roughly the same rate over the past 30 years – in spite of huge variations in tax policies. Using our model and mid-range parameter values where the response of top earners to top tax rate cuts is due in part to increased rent-seeking behaviour and in part to increased productive work, we find that the top tax rate could potentially be set as high as 83% – as opposed to 57% in the pure supply-side model.

Up until the 1970s, policymakers and public opinion probably considered – rightly or wrongly – that at the very top of the income ladder, pay increases reflected mostly greed or other socially wasteful activities rather than productive work effort. This is why they were able to set marginal tax rates as high as 80% in the US and the UK. The Reagan/Thatcher revolution has succeeded in making such top tax rate levels unthinkable since then. But after decades of increasing income concentration that has brought about mediocre growth since the 1970s and a Great Recession triggered by financial sector excesses, a rethinking of the Reagan and Thatcher revolutions is perhaps underway. The United Kingdom has increased its top income tax rate from 40% to 50% in 2010 in part to curb top pay excesses. In the United States, the Occupy Wall Street movement and its famous “We are the 99%” slogan also reflects the view that the top 1% may have gained at the expense of the 99%.

In the end, the future of top tax rates depends on the public’s beliefs of whether top pay fairly reflects productivity or whether top pay, rather unfairly, arises from rent-seeking. With higher income concentration, top earners have more economic resources to influence social beliefs (through think tanks and media) and policies (through lobbying), thereby creating some reverse causality between income inequality, perceptions, and policies. We hope economists can shed light on these beliefs with compelling theoretical and empirical analysis.

Figure 1. Changes in top 1% pre-tax income shares and top marginal tax rates since the 1970s

Note: The Figure depicts the change in top 1% pre-tax income shares against the change in top marginal income tax rates from 1975-9 to 2004-8 for 18 OECD countries (top tax rates include both central and local individual income tax rates, exact years vary slightly by countries depending on data availability in the World Top Income Database). Source: Piketty et al (2011), Figure 4A.

Figure 2. GDP-per-capita growth rates and top marginal tax rates since the 1970s

Note: The Figure depicts the average real GDP-per-capita annual growth rate from 1975-9 to 2004-8 against the change in top marginal tax rates from 1975-9 to 2004-(exact years are the same as Figure 1 and vary slightly by countries). The correlation is virtually zero and insignificant suggesting that cuts in top tax rates do not lead to higher economic growth. Source: Piketty et al (2011), Figure 4B.

See VoxEU for references.

Tom Ferguson: Democratic Governance Is Becoming Discredited

I suspect many Naked Capitalism readers would regard “democratic governance” as something of an oxymoron in the US. Our favorite curmudgeon, political scientist Tom Ferguson, discussed the failure of the supercommittee negotiations and what it means for politics and the economy. He sees the danger of government by technocrats, meaning experts who are really fronts for banking interests, as rising.


More at The Real News

Does Smaller Government Create More Jobs?

This Real News Network interview with economist Bob Pollin of the Political Economy Research Institute in Amherst, Massachusetts focuses on the deficit cutting impasse in Washington and what measures could create more jobs.


More at The Real News

Is JP Morgan Getting a Good Return on $4.6 Million “Gift” to NYC Police? (Like Special Protection from OccupyWallStreet?)

No matter how you look at this development, it does not smell right. From JP Morgan’s website, hat tip Lisa Epstein:

JPMorgan Chase recently donated an unprecedented $4.6 million to the New York City Police Foundation. The gift was the largest in the history of the foundation and will enable the New York City Police Department to strengthen security in the Big Apple. The money will pay for 1,000 new patrol car laptops, as well as security monitoring software in the NYPD’s main data center.

New York City Police Commissioner Raymond Kelly sent CEO and Chairman Jamie Dimon a note expressing “profound gratitude” for the company’s donation.

“These officers put their lives on the line every day to keep us safe,” Dimon said. “We’re incredibly proud to help them build this program and let them know how much we value their hard work.”

Perhaps I remember too much of the scruffy and not exactly safe New York City of the 1980s, where getting your wallet pinched was a pretty regular occurrence. My perception has been that police-related charities have relied overmuch on the never-stated notion that if you didn’t donate, you might not get the speediest response if you needed help. As a mere apartment-dweller, I can’t imagine that anyone could scan incoming 911 calls against a priority list. But the flip side is if I owned a retail store and thought the beat police would keep an extra eye on it if I gave to a police charity, it would seem like an awfully cheap form of insurance.

But what, pray tell, is this about? The JPM money is going directly from the foundation to the NYPD proper, not to, say, cops injured in the course of duty or police widows and orphans. But that is how the NYPD Police Foundation works. From its website:

The New York City Police Foundation, Inc. was established in 1971 by business and civic leaders as an independent, non-profit organization to promote excellence in the NYPD and improve public safety in New York City.

The Police Foundation supports programs designed to help the NYPD keep pace with rapidly evolving technology, strategies and training.

The New York City Police Foundation:

Provides resources that are not readily available through other means – to date over $100 million has been invested in 400+ innovative NYPD programs;

Serves as a vehicle for tax-exempt gifts and grants from individuals, businesses, and philanthropies;

Is the first municipal foundation of its kind in the country, and serves as a model for similar organizations in other cities;

Is the only organization authorized to raise funds on behalf of the NYPD and;

Does not solicit by telephone or use telemarketers.

The Police Foundation works closely with the Police Commissioner to develop a strategic program agenda. The Foundation encourages and supports NYPD programs in two main areas:

Projects, research studies, and equipment to improve the effectiveness of police activities; and

Education, training and skill development to strengthen the partnership between the police and the public.

Given when the NYC Police Foundation was formed, it looked to have been a desperate move during New York City’s fiscal crisis (remember the infamous headline: “Ford to City: Drop Dead”?) When I moved to the city in 1981, pretty much everyone I knew who lived in a non-doorman building had suffered a break-in. Guiliani’s reputation was built on cleaning up a perceived-to-be unsafe city (which he did by hiring William Bratton). Even in the later 1980s, when I lived in a townhouse on 69th between Park and Madison (translation: good neighborhood), I’d be the first out of the building in the AM. The inner door to the townhouse was locked, the outer one was closed but unlocked. I’d always have to navigate my way out carefully so as not to waken the homeless person sleeping in the vestibule.

So while this effort to supplement taxpayer funding has a certain logic, it raises the nasty specter of favoritism, that if private funding were to become a significant part of the Police Department’s total budget, it would understandably give priority to its patrons.

And look at the magnitude of the JP Morgan “gift”. The Foundation has been in existence for 40 years. If you assume that the $100 million it has received over that time is likely to mean “not much over $100 million” this contribution could easily be 3-4% of the total the Foundation have ever received.

Now readers can point out that this gift is bupkis relative to the budget of the police department, which is close to $4 billion. But looking at it on a mathematical basis likely misses the incentives at work. Dimon is one of the most powerful and connected corporate leaders in Gotham City. If he thinks the police donation was worthwhile, he might encourage other bank and big company CEOs to make large donations.

And what sort of benefits might JPM get? It is unlikely that there would be anything as crass as an explicit quid pro quo. But it certainly is useful to be confident that the police are on your side, say if an executive or worse an entire desk is caught in a sex or drugs scandal. Recall that Charles Ferguson in Inside Job alleged that the use of hookers is pervasive on Wall Street (duh) and is invoiced to the banks.

Or the police might be extra protective of your interests. Today, OccupyWallStreet decided to march across the Brooklyn Bridge (a proud New York tradition) to Chase Manhattan Plaza in Brooklyn. Reports in the media indicate that the police at first seemed to be encouraging the protestors not only to cross the bridge, but were walking in front of the crowd, seemingly escorting them across:

The wee problem is that the police are in the street, and part of the crowd is also on the street (others are on a pedestrian walkway that is above street level). That puts them in violation of NYC rules that against interfering with traffic. Note the protest were aware fo the rules; they were careful to stay on the sidewalk on the way to the bridge.

Over 700 of the marchers were arrested, and the media has a rather amusing “he said, she said” account, with OccupyWallStreet claiming entrapment and the cops batting their baby blues and trying to look innocent. From the New York Times:

But many protesters said they believed the police had tricked them…

“The cops watched and did nothing, indeed, seemed to guide us onto the roadway,” said Jesse A. Myerson, a media coordinator for Occupy Wall Street who marched but was not arrested…all insisted that the police had made no mention that the roadway was off limits. Ms.[Annie] Day and several others said that police officers had walked beside the crowd until the group reached about midway, then without warning began to corral the protesters behind orange nets…

Where the entrance to the bridge narrowed their path, some marchers, including organizers, stuck to the generally agreed-upon route and headed up onto the wooden walkway that runs between and about 15 feet above the bridge’s traffic lanes.

But about 20 others headed for the Brooklyn-bound roadway, said Christopher T. Dunn of the New York Civil Liberties Union, who accompanied the march…They were met by a handful of high-level police supervisors, who blocked the way and announced repeatedly through bullhorns that the marchers were blocking the roadway and that if they continued to do so, they would be subject to arrest.

There were no physical barriers, though, and at one point, the marchers began walking up the roadway with the police commanders in front of them – seeming, from a distance, as if they were leading the way. The Chief of Department Joseph J. Esposito, and a horde of other white-shirted commanders, were among them…

A freelance reporter for The New York Times, Natasha Lennard, was among those arrested….

Mr. Dunn said he was concerned that those in the back of the column who might not have heard the warnings “would have had no idea that it was not O.K. to walk on the roadway of the bridge.” Mr. Browne [of the NYPD] said that people who were in the rear of the crowd that may not have heard the warnings were not arrested and were free to leave.

Earlier in the afternoon, as many as 10 Department of Correction buses, big enough to hold 20 prisoners apiece, had been dispatched from Rikers Island in what one law enforcement official said was “a planned move on the protesters.”

Etan Ben-Ami, 56, a psychotherapist from Brooklyn who was up on the walkway, said that the police seemed to make a conscious decision to allow the protesters to claim the road. “They weren’t pushed back,” he said. “It seemed that they moved at the same time.”..

He added: “We thought they were escorting us because they wanted us to be safe.”

The part I find more interesting, which has not been as well reported, is that some (many?) the protestors who used the walkway and got across the bridge were also corralled and not permitted to proceed to the Chase plaza. Greg Basta, deputy director of the New York Communities for Change, told me by phone, based on multiple reports from people who participated in the march, that as soon as protestors got to the Brooklyn side of the bridge, they were kettled. Greg was under the impression that there were construction barricades at the foot of the bridge which made it impossible for the marchers not to walk on the street. Because the focus has been on the what happened on the bridge, the coverage of what happened to the rest of crowd is sparse.

Some confirmation in passing comes from MsExPat at Corrente (apparently some of the very first off the bridge were permitted to proceed):

My friends and I made it to the Brooklyn side okay–we ended up with about 350 other marchers in Cadman Plaza, a lovely 19th century park. What I didn’t find out until later is that several hundred people behind me also got kettled and barred from going all the way to Brooklyn. So I was among the lucky marchers in the middle.

But notice even then that the procession to Chase Manhattan Plaza [correction, Cadman Plaza} was effectively barred. [Note JPM may have operations nearby, Bear Stearns had much of its back office there, and if the leases were cheap, JPM may have kept the space].

We simply don’t know whether the police would have behaved one iota differently in the absence of the JP Morgan donation. But it raises the troubling perspective that they might have. Richard Kline pointed out that that local policing was important protection against control by the elites:

The oligarchy specifically and the Right in general are far less strong in American society apart from what their noise machines and bankroll flashing would make one think. The great bulk of the judiciary remains independent even if important higher appellate positions are tainted. Domestic policing is, by tradition and design, highly decentralized, with a good deal of local control, making overt police state actions difficult, visible, and highly unpopular (think TSA). While the military is a socially conservative society in itself, it is also an exceptionally depoliticized one, with civilian control an infrangible value. Popular voter commitment to the nominally more conservative political party has never been narrower or more fragile.

So far, the JP Morgan donation is an isolated example. But the high odds of continuing deep budget cuts at the state and local level open up the opportunity for corporate funding of preferred services, and with it, much greater private sector influence on the apparatus of government. This is a worrisome enough possibility to warrant a high degree of vigilance by all of us.

Update 5:00 AM: Debra C, via e-mail, points to FreakOut Nation, which has screen shots to show how the New York Times edited the OccupyWallStreet story after it went live to make it less protestor friendly:

Employers Diss Obama Job Plan

Wow, this is just embarrassing. A raspberry from businesses, the object of Obama’s tender ministrations. And the reason? Basically, too little demand, something that tax cuts won’t remedy.

From the New York Times:

The dismal state of the economy is the main reason many companies are reluctant to hire workers, and few executives are saying that President Obama’s jobs plan — while welcome — will change their minds any time soon.

That sentiment was echoed across numerous industries by executives in companies big and small on Friday….[M]any employers dismissed the notion that any particular tax break or incentive would be persuasive. Instead, they said they tended to hire more workers or expand when the economy improved.

Companies are focused on jittery consumer confidence, an unstable stock market, perceived obstacles to business expansion like government regulation and, above all, swings in demand for their products.

“You still need to have the business need to hire,” said Jeffery Braverman, owner of Nutsonline, an e-commerce company in Cranford, N.J., that sells nuts and dried fruit. While a $4,000 credit could offset the cost of the company’s lowest-cost health insurance plan, he said, it would not spur him to hire someone. “Business demand is what drives hiring,” he said.

This is why, as yours truly and others have said, we need more debt restructurings and writedowns to get the debt overhang resolved faster, and fiscal deficits to offset the deflationary effects. Monetary policy is not an adequate substitute, as we have seen, and barely stimulative stimulus programs, like inadequate doses of medicine, destroy faith in the remedy when the flaw is in how it is being administered.

Even if the Republicans do serve up one of their more extreme candidates as their presidential nominee, the economy’s certain-to-be-lousy-if-not-even-more-Godawful performance next may well seal his fate. It’s hard to get your base to turn out when you look so dedicated to doing the wrong thing.

Philip Pilkington: The Irish Establishment – Mad as Goats?

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

Learn to say the same thing
What defeats people is a double confession
One time they will confess one thing
And the next they will confess something else
Talk to them, they will say:
Learn to say the same thing
Let us hold fast to saying the same thing”
– Cat Power, ‘Say

In Ireland we used to measure our economic performance based on GDP (GNP actually, but we won’t go into that). Pretty standard fare for any advanced economy, really. Not so anymore. These days we measure our economic performance based on the government’s ability to extract tax revenue out of the general populace to pay for extortionate loans to our EU masters.

The Exchequer – that is, the Irish government body responsible for collecting taxes – released its monthly report today. Already there has been boasting in the media that we are ‘on target’ and this weekend I expect to be inundated with more self-deluded bragging from inept government officials and incompetent media commentators.

The truth – a scary word in modern-day Ireland – is that this latest news is less to be celebrated than to be feared. That the Exchequer met its targets is hazardous to the Irish economy and will prove self-defeating in the medium-to-long run.

Automatic Destabalisers

When the government extracts money out of the economy in the form of tax revenues this causes a contraction in economic activity by approximately the same amount – all else being equal. As the economy contracts and unemployment increases, tax revenues fall and transfer payments (social welfare etc.) increase. Hence, if the idea is to decrease the budget deficit (spending less tax revenues) in order to pay down usurperous debt, the process is clearly self-defeating as the deficit will probably increase in the medium-to-long term. These effects are known to economists as ‘automatic stabalisers’. In this case we might refer to them as ‘automatic destabailisers’ as even though transfer payments and decreased tax revenues will bolster GDP/GNP thus helping to maintain real living standards for Irish people, they will certainly destabalise insane government plans for deficit reduction.

Indeed, the Irish economy already seems to be headed in precisely the direction that the Irish government’s policy I geared toward. At the same time as we celebrate our extortion revenue collecting abilities, total manufacturing output slid for the third month in a row. This reflects significant weakness in domestic markets which, of course, will be further compounded by siphoning-off money in the form of taxation. And although export orders have risen, this is clearly against the general European trend and is likely to fall again in the coming months as the European markets weaken further.

Unsurprisingly, it was also recently reported that the unemployment rate had climbed from 14.3% to 14.4% month-on-month from July to August – a not insignificant increase. With less people spending their pay checks, the Irish economy is going to tip even further due to a lack of spending power. This lack of spending power will be again worsened by the announcement, made today by the Minister for Enterprise and Jobs [sic], that he will promote wage-undercutting by employers. Once again, at the risk of sounding like a broken record, all of this will be further exacerbated by collecting taxes.

We turn to the tax revenues themselves only to be further disturbed by their composition.

Vampire Squid in a Giant Novelty Leprechaun Hat

Yes, as officially announced today, the Irish government met their crazy revenue targets. And no, this is most certainly not a good thing. In fact, the figures lead one to believe that we are likely to see serious revenue shortfalls within a year or two due to these obscene government policies.

In order to understand why the taxation issue is an economic bomb waiting to go off we should look at revenue trends over the course of 2011 (if you don’t feel like wading through numbers and their implications, important as they are, I suggest skipping this section rather than clicking the ‘X’ tab on your browser – that way you can find out how Ireland can actually solve the bloody crisis).

The two most important components of Irish tax revenue are: (a) Income Taxes that take money out of working peoples’ pockets before they go and spend it and (b) VAT taxes that are taken out of consumers’ pockets when they try to spend it. What follows is a very rough and ready argument that contains some truth but more importantly allows the reader to clearly understand what is happening with Irish tax revenues – and what is likely going to happen in the coming years.

The following table – constructed by myself (hence the shoddy production values) – shows year-on-year monthly trends for both VAT and Income Tax receipts. If income taxes are a ‘+’ in January, for example, that much more have been collected in 2011 than were collected in 2010 and so on.

The trends are pretty clear. The government are raking in Income Tax but they’re falling short on VAT. It should also be noted that since last year they have raised their targets on both. So, for some reason they’re having an easy time pulling in more Income Tax and having a hard time pulling in more VAT.

The reason for this is that VAT taxes are dependent on consumer spending – and this is falling. Income Taxes on the other hand are largely dependent on, well, income. Now, here’s the kicker: when you increase Income Taxes, all else being equal, you should dampen consumer spending – because consumers spend out of income. Hence, if enough revenue is raised through Income Taxes this will negatively affect consumer spending and so will eat into VAT collection. This cannot be tracked directly in the data but it is the only logically consistent explanation – and we do, in fact, see this pattern broadly turning up in the data.

But wait, there’s more! When more taxes are sucked out of peoples’ income and they stop consuming as much, businesses don’t sell as much stuff; again, this will be reflected in the VAT receipts. And there’s something else to be brought into play here: if businesses don’t sell as much stuff the people working for those businesses will either be laid-off or they will have to take a pay-cut. If and when this occurs it will reduce consumer spending even more. Hence, less VAT – and so on and so on…

Do you see the dynamic taking shape here? When an economy is operating far below potential – as Ireland’s undoubtedly is – sucking out money by taxing people causes a negative spiral of ever-lower consumption and ever-increasing unemployment (or lower-wages).

Now, here’s where it gets really interesting. We have seen the two main taxes in Ireland come from – you got it – consumption and incomes. So, if consumption and incomes fall so will taxes.

And that is why we will probably see a decline in tax revenues in the near future. Whether this will be a year down the line or two is anyone’s guess. But while we’re waiting we can be sure that the Irish people will have plenty to think about as their economy gets ever more wretched. And if you’re Irish and you’re thinking about this wretchedness spare a thought for the idiotic Irish government. After all, it was them that sucked income out of the economy and then claimed that they’re ‘for jobs and growth’ or whatever disingenuous mush they’re trying to flog these days.

Solutions to the Crisis for the Deaf and Dumb

That this mess occurred is not so surprising, really. These pro-cyclical doomsday mechanisms were built into the Eurozone system from the outset. Eurozone nations foolishly reneged control over the right to issue their own currency and in doing so signed themselves over to a disorganised body of bureaucrats in Frankfurt.

Now there’s only two ways out of this mess for Ireland without ditching the Euro and defaulting its debt; both of which were first proposed by Warren Mosler.

The first requires that the European authorities and the ECB stop bickering like children, get their act together and make fiscal transfers to the distressed sovereigns – Ireland included. And not simply transfers that will allow for the alleviation of the current crushing debt burdens, but also transfers that will promote growth and expansion in these economies. Will this happen? Two words: ‘fat’ ‘chance’.

The other option is for the Irish government to issue ‘Mosler bonds’. This plan could easily be implemented by Ireland or any other Eurozone country and should also prove politically realistic within the current Eurozone structures.

Here’s how it works: the Irish government would issue new bonds to pay off the existing bonds as they mature. These new bonds would include a clause that states that, should the Irish sovereign default – and only in the case of said sovereign default – the bonds can be used to extinguish Irish tax liabilities. This would provide investors with an absolute guarantee as to the value of the bonds and this in turn will drive down interest rates significantly, making the Irish national debt affordable. It would also give the Irish government the breathing space necessary to stop extracting taxes from their beleaguered citizenry and start focusing on job creation through fiscal stimulus. (More detail here – the plan is laid out for Greece but would work identically for Ireland)

As stated a moment ago, this plan is perfectly viable. The Irish government can initiate it themselves without having to appeal to a foreign entity. But also, the European authorities would likely see it as an ideal solution as it would mean that the weight of the Irish debt problem was taken off their shoulders. Voters in the core countries would similarly approve as they would see it as Ireland ‘paying its own way’ rather than relying on them for backing.

Why won’t the Irish adopt such a sensible proposal? While anything to be said on this is indeed speculative, I think I am probably the most qualified person to do the speculating. I spent a number of weeks pitching the idea to various Irish media outlets and popular economic commentators. The response was tepid and confused. People either ignored me, didn’t understand the plan or pretended to understand the plan and then stopped corresponding with me so that I wouldn’t figure out that they didn’t understand the plan.

Moving on, I asked a friend of mine who is more ‘plugged into’ the politicos than I am to run it by them. The response was even worse. To say that they didn’t understand the proposal would be a vast understatement. They didn’t even listen. They just kept parroting what they’d read in the press about the need for deficit reduction. This wasn’t a case of talking to a brick wall; brick walls don’t parrot one-liners that they read in the newspaper. No, this was more like having an internet argument with a troll; they just repeated clichéd gobble-dee-gook ad nauseum until their unfortunate interlocutor had to surrender or risk suffering a hernia.

Ireland’s key problem is not so much its debt as the fact that its collective imagination has become stagnant and rotten. Mired in the depths of what may turn into a depression Irish politicians, together with their commentariat, have stopped thinking. They’ve come to believe their own soundbites: that raising tax revenue is progress and that deficit reduction is priority number one.

It’s not banks that will bring down the Irish economy. Nor is it the Europeans. It is the stale, crusty excuse for a ruling-class that inhabits the hallways of power. These creatures, upon entering into this brave new world post-2008, have shown that they passed their ‘sell-by date’ years ago. The Irish establishment now just rants and raves like a bunch of bipolar farm animals, shifting from elation to desperation every day or two as circumstances change and their internally contradictory strategies self-destruct. In their hopelessness they have gone mad… mad as goats.