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November 28, 2011

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Paul Krugman: Things to Tax

Posted: 28 Nov 2011 12:33 AM PST

Increased in revenue from taxes on very high incomes and taxes on financial transactions should be part of the long-term deficit reduction plan:

Things to Tax, by Paul Krugman, Commentary, NY Times: The supercommittee was a superdud — and we should be glad. Nonetheless, at some point we'll have to rein in budget deficits. And when we do, here's a thought: How about making increased revenue an important part of the deal?
And I don't just mean a return to Clinton-era tax rates. ... The long-run budget outlook has darkened, which means that some hard choices must be made. Why should those choices only involve spending cuts? Why not also push some taxes above their levels in the 1990s?
Let me suggest two areas in which it would make a lot of sense to raise taxes in earnest...: taxes on very high incomes and taxes on financial transactions.
About those high incomes: In my last column I suggested that the very rich ... should pay more in taxes. I got many responses from readers ... that even confiscatory taxes on the wealthy couldn't possibly raise enough money to matter.
Folks, you're living in the past. ... The IRS reports that in 2007 ... the top 0.1 percent of taxpayers — roughly speaking, people with annual incomes over $2 million — had a combined income of more than a trillion dollars. That's a lot of money, and ... taxes ... would raise a significant amount of revenue...
For example,... before 1980 very-high-income individuals fell into tax brackets well above the 35 percent top rate that applies today. ... I've extrapolated ... using Congressional Budget Office projections, and what I get for the next decade is that high-income taxation could shave more than $1 trillion off the deficit. ...
So raising taxes on the very rich could make a serious contribution to deficit reduction. Don't believe anyone who claims otherwise.
And then there's the idea of taxing financial transactions... Because there are so many transactions, such a fee could yield several hundred billion dollars in revenue over the next decade. Again, this compares favorably with the savings from many of the harsh spending cuts being proposed in the name of fiscal responsibility.
But wouldn't such a tax hurt economic growth? As I said, the evidence suggests not — if anything,... to the extent that taxing financial transactions reduces the volume of wheeling and dealing, that would be a good thing. ...
Now, the tax ideas I've just mentioned wouldn't be enough, by themselves, to fix our deficit. But the same is true of proposals for spending cuts. The point I'm making here isn't that taxes are all we need; it is that they could and should be a significant part of the solution.

Links for 2011-11-28

Posted: 28 Nov 2011 12:06 AM PST

Social Insurance and Unemployment: Do People Deserve Poverty?

Posted: 27 Nov 2011 01:17 PM PST

Casey Mulligan claims that social insurance is a big reason that unemployment is so high:

Were it not for government assistance,... the recession would have pushed 4.2 percent of the population into poverty, rather than 0.6 percent.

One interpretation of these results is that the safety net did a great job... Perhaps if the 2009 stimulus law had been a little bigger or a little more oriented to safety-net programs, all seven would have been caught.
Another interpretation is that the safety net has taken away incentives... Of course, most people work hard despite a generous safety net, and 140 million people are still working today. But in a labor force as big as ours, it takes only a small fraction of people who react to a generous safety net by working less to create millions of unemployed. I suspect that employment cannot return to pre-recession levels until safety-net generosity does, too.

A comment from this post responding to Casey Mulligan takes on this claim:

I'm sure my daughter connived to get herself laid off at Peet's Coffee just as her health insurance would have kicked in and live on $98 a week, far less than she would have brought in in wages, and not even enough to pay her $500 a month rent. And she was so thrilled with this condition that she kept it up for a full two months, and then found herself another job, this one with no health benefits.

The idea that the unemployment problem is due to lack of effort on behalf of the unemployed rather than a lack of demand is convenient for the moralists, but inconsistent with the facts. The problem is lack of demand, not the means through which we smooth the negative consequences of recessions.

But what really irks me is the implicit moralizing, the idea that people deserve to be thrown into poverty. Someone who gets up every day and goes to a job day after day, often a job they don't like very much, to support their families can suddenly become unemployed in a recession through no fault of their own. They did nothing wrong -- it's not their fault the economy went into a recession and they certainly couldn't be expected to foresee a recession that experts such as Casey Mulligan missed entirely. They had no reason to believe they had chosen the wrong place to go to work, but unemployment hit them anyway. And since one of the biggest causes of foreclosure is an event like unemployment, it's entirely possible that this household would lose its home, be forced to declare bankruptcy, etc., and end up in severe poverty if there were no social services to rely upon.

What moral lesson is being taught here? Why does this household deserve to be punished for their bad decisions? It did nothing wrong. I understand that people should suffer the consequences of their own bad choices, but that's not what happens in recessions. People who have done nothing to deserve it are nevertheless hit by severe negative shocks. That's what social insurance is for, to smooth the path for such unfortunate households, to avoid sending people into poverty who have done nothing to deserve it (see "The Need for Social Insurance"). It is not an attempt to reward bad behavior and most programs do their best to avoid giving benefits to people who have made bad choices (for example, the system is far from perfect but in most states unemployment insurance can only be obtained if you lose your job through no fault of your, e.g. if you quit or get yourself fired it is not available). The extent to which we should distinguish between deserving and undeserving households for social insurance programs is debatable and depends upon the type of program, but the idea that all households are undeserving is, in my view, simply wrong. I would apply the social safety net widely myself -- I think the benefit of the doubt should go to compassion, not harshness and moralizing -- but in any case I'd dispute the idea that "safety-net generosity" is too high. If anything, we are not generous enough.

Update: Karl Smith comments on this topic.

The Demand for Jobs

Posted: 27 Nov 2011 09:45 AM PST

Businesses won't hire workers because there is not enough demand to support them, and the public can't supply the needed demand because too many people don't have jobs.

That's what's so frustrating. If the unemployed had jobs, the demand would be there to support them. But the demand has to come first, and workers won't be hired until the demand is there.

I wonder who could provide the missing demand needed to overcome this problem?

Fed Watch: Europe Scrambles for Solutions

Posted: 27 Nov 2011 09:36 AM PST

Tim Duy:

Europe Scrambles for Solutions, by Tim Duy: Monday morning is fast approaching, and European leaders are scrambling to come up with something credible to float ahead of the market opening. Recall that we ended last week with the S&P downgrade of Belgium, and policymakers would like to have something on the table in response. Most significant is that policymakers now realize that changing the Lisbon Treaty to enshrine fiscal discipline is a far too lengthy process to serve as an effective counterweight to emerging the soveriegn debt crisis. From Reuters:

Germany's original plan was to try to secure agreement among all 27 EU countries for a limited change to the Lisbon Treaty by the end of 2012, making it possible to impose much tighter budget controls over the 17 euro zone countries -- a way of shoring up the region's defenses against the debt crisis.

But in meetings with EU leaders in recent weeks, it has become clear to both German Chancellor Angela Merkel and French President Nicolas Sarkozy that it may not be possible to get all 27 countries on board, EU sources say.

Even if that were possible, it could take a year or more to finally secure the changes while market attacks on Italy, Spain and now France suggest bold measures are needed within weeks.

As a result, senior French and German civil servants have been exploring other ways of achieving the goal, either via an agreement among just the euro zone countries, or a separate agreement outside the EU treaty that could involve a core of around 8-10 euro zone countries, officials say.

The goal is to provide enough of a framework to allow the ECB to step in and shore up debt markets more decisively:

Germany's Welt am Sonntag newspaper reported on Sunday that Merkel and Sarkozy were working on a new Stability Pact, setting out national debt limits, that could be signed up to by a number of euro zone countries and which would allow the ECB to act more decisively in the crisis.

"If the politicians can agree to a comprehensive step, the ECB will jump in and help," the paper quoted a central banker as saying.

Is the plan for real or just a bargaining ploy?

While EU officials are clear about the determination of France and Germany to push for more rapid euro zone integration, some caution that the idea of doing so with fewer than 17 countries via a sideline agreement may be more about applying pressure on the remainder to act.

By threatening that some countries could be left behind if they don't sign up to deeper integration, it may be impossible for a country to say no, fearing that doing so could leave it even more exposed to market pressures.

The risk here is that market paricipants read the bilateral agreements as they emerge as an invitation to attack those nations not yet signed up to the plan. Those nations would be even more vulnerable as they would explicitly lose any ECB backstop. The other choice for some nations would to be to go down the road of Greece and accept crushing austerity in order to stay in the Eurozone. Damned if you do, damned if you don't.

Note also that although these ideas are bandied about in terms of "greater fiscal integration," I don't think we are seeing much mention of fiscal transfers, just mechanisms to enforce budget discipline. This is certainly a framework for a two-speed Europe.

In other news, someone is floating rumors that the IMF is preparing a massive lending program for Italy. From Bloomberg:

The International Monetary Fund is preparing a 600-billion euro ($794 billion) loan for Italy in case the country's debt crisis worsens, La Stampa said.

The money would give Italy's Prime Minister Mario Monti 12 to 18 months to implement his reforms without having to refinance the country's existing debt, the Italian daily reported, without saying where it got the information. Monti could draw on the money if his planned austerity measures fail to stop speculation on Italian debt, La Stampa said.

Details are unclear. Ed Harrison at Credit Writedowns has a translation of a German version of the story that mentions the possibility of ECB funding of the bailout, with an IMF gaurantee.

Speaking of Italy, the austerity parade marches forward, via Bloomberg:

The Italian government, led by Prime Minister Mario Monti, may introduce additional austerity measures totaling as much as 15 billion euros ($20 billion) on Dec. 5, Il Sole 24 Ore reported.

Monti may levy a tax on first homes, increase value-added tax, and introduce anti-evasion measures on transactions of more than 300 euros to 500 euros, the Italian daily reported, without saying where it got the information. The introduction of a wealth tax is still uncertain, Il Sole said.

Italy needs reform, to be sure. But in the near term, austerity only worsens the European crisis. Troubled European nations need compasionate austerity that rewards progress toward long-term goals with near-term stimulus. But without a fiscal transfer mechanism, their is no way to offer such stimulus.

Finally, I emphasize that austerity and ECB intervention may bring short-term relief to financial markets, and at least one element of the crisis under control, but these efforts do not address the banking crisis that is settling over the Continent. Felix Salmon points us to a must-read IFR report:

European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.

Lenders have instead turned their attention to reducing the burden of carrying such assets over months and years, with many looking at popular pre-crisis "capital alchemy" arrangements to minimise capital requirements and boost their ability to use the assets to tap central banks for cash.

Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry's ability to save itself from collapse through a mass deleveraging.

The article concludes with a key insight:

"Natural deleveraging through not renewing loans is one of the few options remaining to banks to shrink their balance sheets, but the timetable for implementing this kind of strategy can be very protracted," said Ryan O'Grady, head of fixed income syndicate for EMEA at JP Morgan.

One way or another, Europe will experience a massive credit shock. Presumable, the ECB could help offset this by allowing governments to loosen spending to support demand and fund bank recapitalization. But the path we are on appears to provide ECB help only in return for more austerity. And it is that never-ending pursuit of austerity that leaves me bearish on Europe, regardless of the political news of the day.

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