Power To The People

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A moment to acknowledge the personal caring and effort of ordinary people, the courage and doggedness of first responders during the superstorm “Sandy” and a heartfelt sympathy for those who lost loved ones during the storm.  Mile long lines of cars waiting for gas brought back vivid and unpleasant memories of the 1970s when many of us who lived in NYC would get up at 4 AM just to wait in line for a few hours to buy gas so we could get to work.  Resilience and persistence are bred into many New Yawkers (that includes you guys and gals in Jersey, too).  The clean up and repair will test every ounce of both during the next year.  Some losses, of course, are not the kind that can be repaired, only endured with the support of family and friends.

                                                                  _________________

The October employment figures released two days ago showed an increase of 171,000 jobs this past month, about 50,000 more than expected and a welcome relief to the Obama campaign.  Retail and restaurant jobs posted strong gains and health care jobs continued their strong growth. 

More people started looking for jobs, bringing the unemployment rate up a smidge to 7.9%. The year over year percent change in unemployment is relatively healthy, as shown on the 60 year chart below.

This past week came a series of positive reports.  Consumer spending rose .8% in September and home prices continue to improve, showing a .5% monthly gain in the Case Shiller index of 20 leading cities.  Both of these indicators have shown recent strength but the year-over-year gains for both consumer spending and home prices is a plodding 2%.

Consumer confidence has shown strong improvement the past four months and is expected to have about the same positive sentiment level as last month’s survey. As I noted last week, the consumer has lately shown more confidence than the business community.  The Chicago manufacturing index dropped last month and is now at a stall speed.  Tomorrow the national manufacturing report will be released.  The manufacturing sector is certainly responding to the weakness in Europe and slowing growth in China and southeast Asia.

While the employment gains were welcome, there are too many negatives that continue to show.  We are barely keeping ahead of population growth.  Below is a chart showing an index of employment and population growth.  We are still down about 7% from the peak in late 2007, which was more of a bubble level of employment.  We could reasonably target mid-2004 levels.

The core work force of those aged 25 – 54 is showing a little upward movement over the past two years but is still anemic.

Most of the job gains are going to older workers above 55. “Get out of the way, pops!” may become the mantra of younger generations. 

The loss in production jobs leads to a continual increase in the proportion of management and professional jobs.

Hourly Earnings gains are flat out terrible, hitting an all time low.

There are still too many people working part time because they can’t find a full time job.

The number of discouraged workers is declining but is not healthy.

Retail sales, particularly auto sales, are an indication of rising consumer demand.

But after adjusting for population growth in the past decade, we have finally climbed back up to where we were 8 years ago.

To show the correlation between retail spending and employment, I’ve overlaid an index of one over the other.

As you can see, retail sales lead employment gains and losses.  I sincerely hope that retail sales will continue to improve and turn around the recent business pessimism.  My chief concern is the lack of competence and character in Congress on both sides of the aisle.  This coming election will do little to alleviate those concerns.

Capital and Consumer Spending

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If I hit my thumb with a hammer, maybe it won’t hurt this time.  Not likely.  Last week I noted a warning sign in non-defense new orders for capital goods, excluding aircraft.  As I noted previously, aircraft orders are volatile; they may be up 30% one month and down 30% a few months later because orders for planes are placed in rather large blocks with the actual delivery of the aircraft occurring over many months.

A few days ago the most recent durable goods report came out for September, showing a continued decline in the year-over-year gains for new orders.  Declines like this have preceded the past two recessions.

We like to think that this time may be different. Our imagination is capable of soaring the heights of creativity in art and science.  In the economics of our personal lives, it can lead to fanciful thinking.  Fanciful notions led many to buy houses with little money down at the height of the housing boom, thinking that somehow they would refinance when mortgage payments escalated after a certain period.  Magical thinking induced many to increase their credit balances far beyond their means to pay, thinking that they could pay down their credit balances by refinancing their homes.  No matter how much homes went up in value, housing prices would continue to rise.  Then they didn’t.

The chart below shows the housing inflation.  Recessions in the latter part of the past century had caused housing starts to decline to 400,000 before recovering.  In the 2001 recession, easy money and loose standards for mortgage securitization curbed the natural decline.  The bill eventually came due in 2008.

Single family homes create jobs; the market has shown life recently but is still very weak.

The Conference Board’s Consumer Confidence index rose 9 points to 70 in September and is about the same level as this past February, when confidence started sliding to a summer low point of 60.   The new consumer survey is due to be released next week and analysts are predicting another increase of 3 to 4 points. Consumers are feeling upbeat but the decline in new orders shows that businesses continue to be cautious as the prospect of rising taxes and budget cuts next year dampens any optimistic planning.  The slowdown in Europe and Asia contributes to the gloomy reading of Moody’s Business Confidence survey.  Rising consumer confidence before the critical Christmas shopping season may alleviate the pessimism of businesses if consumers actually open up their wallets and spend but retailers have not been building inventory ahead of the shopping season.

While these two forces tug at each other, a prudent investor might exercise some caution.

New Orders

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No, this is not about the New Order, the conspiracist’s nemesis.  This is about New Orders of Capital Goods.  When companies forecast sales growth ahead, they place orders for capital equipment to meet the projected increase in demand.  One version of the monthly report on new orders excludes aircraft orders which are volatile; fulfilling the order – the delivery of the new aircraft – are structured over time.

Below is a chart of the year-over-year percentage in new orders excluding both aircraft and defense spending.  I have used quarterly averages to smooth and show the trend. (Click to enlarge in separate tab)

As you can see, there are warning signs of recession or very low economic activity as the quarterly change is close to zero. The most recent monthly change has, in fact, dropped below zero.

The value of new orders has a fairly strong correlation with the S&P500 stock index, adjusted to scale.

Some have suggested that business plans are on hold till after the election and the coming negotiations over budget sequestration, or the “fiscal cliff.”  If so, this may be a temporary drop. The stock index usually either anticipates or is concurrent with the drop in the dollar amount of new orders.  Further gains in the index may be minimal unless this new order indicator of business sentiment turns upward.

Obligations and Entitlements

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“Social Security and Medicare are the two largest federal programs, accounting for 36 percent of federal expenditures in fiscal year 2011.”  (Trustee’s annual report)

So how did we get here?

When Social Security was enacted in 1935, President Roosevelt promoted it as an insurance program for the old, widowed and orphaned. The language of the law called the employee portion of the tax an “income tax”, and the employer portion an “excise tax,” not an insurance program. Regardless of the language, Social Security has acted both as an annuity for retired workers and an insurance program for disabled workers and survivors of workers.

Several challenges to the law were brought before the Supreme Court, which issued several decisions in 1937 that confirmed that various components of the Social Security tax were valid. By law, the Social Security reserve fund could invest only in the debt of the U.S., either through marketable Treasury bonds or through special bonds which could not be sold. (A history of the financing of Social Security)  Since 1960, the Social Security funds are “invested” in these special bonds, which are little more than promises that the federal government will pay Social Security benefits. 1960 is also the last year that the federal government ran a budget surplus except for the years 1999 and 2000; in two years out of 52, the federal government has been able to balance its books. In overwhelming numbers, voters send lawyers to Washington; most of them have little if any business experience or education.  We reap what we sow.

The Bureau of Labor Statistics (BLS) estimates the total number of workers at 135 million.  More than 55 million people are currently receiving some form of benefit under the Social Security program, a ratio of about 2.5 workers per beneficiary.  In 2011, 2.6 million applied for retirement benefits while one million applied for disability benefits.  In the past 40 years, the number of retirees receiving benefits has doubled, the number of disabled has more than doubled.  Both disabled and retiree claims have declined since 2010.  (Fast Facts) 

There is a demonstrated increase in disability applications when the unemployment rate rises.  As one guy with a bad back explained to me, “I’d rather be working scheduling service calls.  I worked in the heating and cooling business for almost 30 years.  After looking for a year, I gave up.  Who’s gonna hire a 60 year old guy with a bad back in this economy?”

(SSA Source)

The number of retirees has doubled but the population has grown only 50%.  The growth of women in the workforce has contributed to the growth in retirees and in disability claims.

Most people receiving Social Security benefits of one type or another feel as though they entered a contract with the federal government.  In return for their Social Security taxes, retirees and the disabled are owed promised benefits from the federal government, just as one would expect from an insurance company. Likewise, veterans also feel that they entered a contract with the federal government when they risked their lives in defense of the country. In exchange for their service, the federal government made promises of benefits to veterans.  Too many Republican politicians are fond of lumping Social Security beneficiaries and veterans under the umbrella term of “entitlement” programs when the more proper term is one of obligation.  When someone buys a Treasury bond, they expect to be paid the value of the bond when it matures.  Is that person part of an “entitlement” program?  No.  The bond is a contractual obligation between the bondholder and the federal government.  Why should a bondholder be treated with any more or less respect than a person who has “lent” the government money throughout their working years through their Social Security taxes?  Neither Paul Ryan or Mitt Romney understand that, to many of us, an obligation is an obligation.  Period.

So I want to distinguish between obligation programs like Social Security, and entitlement programs.

What are more properly called entitlement programs are those programs for the unfortunate and the vulnerable, whose financial circumstances qualify them for some kind of income assistance program.  Many have paid little in income taxes over the years for any number of reasons.  Some are children, some don’t or can’t work, some work but make so little that they owe no taxes.  Some may have paid a good share of income taxes in the past but found themselves in a bad way in recent times.  There are a lot of programs: SNAP(food stamps), SSI (Supplementary Security Income), and TANF (traditionally called welfare), to name but a few.

Let’s look at one program: SSI, an income assistance program for the blind, disabled and aged, whose beneficiaries comprise a mere 2.5% of the population.  The SSI program is paid out of general revenues, not Social Security taxes. In 2011, blind and disabled recipients made up 86% of the total of about 8 million. (Source)  The average monthly benefit is about $500. The cost of the program is about $50 billion, or 1.4% of total Federal expenditures. 2% of the cost of the SSI program includes vocational training and other back to work programs. When some politicians talk about reforms to “entitlement” programs, they know that some of these programs are small but they cite examples of abuse, of someone gaming the system, because they hope that you don’t know that the programs are small.  Vote them into office and what they really want to chop are the big obligation programs, Social Security and Medicare.

However, there are some legitimate concerns in these small programs; the number of SSI recipients has grown 33% in the past 17 years.

The number of disabled, aged 18 – 64, receiving income assistance under the SSI program has tripled in the past forty years, a growth rate six times that of the overall population. 

The SSI program also helps low income retirees, who have declined in real numbers by 15% in the past 16 years.

The percentage decline is explained partially by the explosive growth of the disabled who are younger than 65.  The number of women receiving SSI payments has also increased dramatically. 

Let’s look at another entitlement program that Mitt Romney and Paul Ryan have targeted in their stump speeches: SNAP or Food Stamps.  “45 million people on food stamps!” is the cry of either of these candidates to illustrate the runaway spending in entitlements and the poor economy.  What neither will tell you is that the program cost $78 billion in 2011 (CBO source).  That is 2.2% of Federal spending.  Whatever reforms these guys propose to this program will save a very small percentage of the budget.  In that same report, the CBO summarized the characteristics of those on the program: “three out of four SNAP households included a child, a person age 60 or older, or a disabled person. Most people who received SNAP benefits lived in households with very low income, about $8,800 per year on average in [2010].”  I can excuse Mitt Romney because he may not be aware of the numbers.  There is no excuse for Paul Ryan, who is the “budget-meister” and certainly knows that any savings to a program this small is chump change in a budget of $3600 billion. 

What both of them are counting on it that you don’t know that.  Their ultimate goal is to reform the big guy, Social Security, so that they can short change one type of federal obligation, Social Security recipients, to pay another obligation, the buyers of Treasury bonds.  Many of the large institutions that buy Treasury bonds are not suckers so Mr. Romney and Mr. Ryan turn to those with the least information – suckers who will vote for them.

Labor Report and Debate

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A less than forceful President Obama appeared in Denver this past Wednesday at the first of three debates in the closing weeks before the November elections. (The Secret Service was rather more forceful, mandating a shut down of the main north-south highway through town during the debate.)  Republican contender Mitt Romney showed more preparation and assertiveness but unfortunately left some of the facts behind in his hotel room.  Neither candidate can look the truth in the face.  Mr. Obama’s repeated claim that his economic plan saves $4 trillion uses many discredited (even by his sympathizers) gimmicks to arrive at that figure and yet he continues to trot out the assertion.  Mr. Romney really wants us to believe that Congress is going to jeopardize their jobs by taking away popular tax deductions in order to pass his 20% rate cuts.  Congress will pass the rate cuts, which are good for re-election.  Take away the mortgage interest deduction?  We’re not betting on it, Mr. Romney.  The end result of his tax plan and his pledge to increase military spending would be a $2 trillion deficit, double the annual deficit we are currently running.

Mr. Obama continues to pledge his support for the middle class, many of whom continue to slide down from the middle middle class to the lower middle class on their way to upper lower class and downright poverty.  Mr. Obama spent much of the debate consulting his notes on supporting the middle class as though he were teaching a class on the subject.  Note to Mr. Obama: you are no longer in the classroom.  This is the real world.

There are any number of fact checks on claims by both Mr. Romney and Mr. Obama during the debate.  Here is a fairly short summary from several Associated Press writers.

Then Friday morning, the heavens parted and the voice of – no, not God – the Bureau of Labor Statistics issued forth in their monthly pronouncement on the state of the job market: “The unemployment rate decreased to 7.8 percent in September”.

Throughout the country millions of pundits, economists and average Joes and Bettys stopped in disbelief and reached for their ear trumpets.  Had they heard right, they wondered?  Tweet, tweet, tweet went the twittersphere.  Blah, blah, blah went the blogosphere.  Lies, lies, lies went the right wing cons over at Fox and dance, dance, dance went the lefties at MSNBC.  For the first time in his presidency, Mr. Obama has seen the unemployment rate drop below 8%.

Had a large number of people simply given up and left the work force, causing them not to be counted as unemployed?  This has been a characteristic of the decline in the unemployment rate earlier in the year.  But not this month. 

Was the number of jobs created particularly strong?  Not this month.  At 114,000, job growth was not strong or weak and probably not enough to keep up with population growth.  A third of that job growth was in the health care sector.  A nation that continues to show its greatest growth in taking care of an aging and poorer population is not building a foundation for sound long term economic growth.

Many of the unemployed simply did the best they could do – get a part time job.  The number of involuntary part timers increased by more than a half million this past month. From the BLS Employment Release:

“The number of persons employed part time for economic reasons (sometimes
referred to as involuntary part-time workers) rose from 8.0 million in August
to 8.6 million in September. These individuals were working part time because
their hours had been cut back or because they were unable to find a full-time
job.”

There are good and bad trends that cause the unemployment rate to fall.  The two most problematic of the bad trends are 1) unemployed people simply giving up, and 2) involuntary part timers.  We have now seen both of these trends this year.

The steep drop in discouraged workers contributed to the decline in the unemployment rate.

“Among the marginally attached, there were 802,000 discouraged workers in
September, a decline of 235,000 from a year earlier. (These data are not
seasonally adjusted.) Discouraged workers are persons not currently looking
for work because they believe no jobs are available for them.”

Below is a 10 year graph showing the level of discouraged workers. (Click to enlarge in separate tab)

Another contributing factor was the revision in the number of net jobs gained in the two previous months.

“The change in total nonfarm payroll employment for July was revised from
+141,000 to +181,000, and the change for August was revised from +96,000 to
+142,000.”  Last month, many were scratching their heads when the BLS released their August report showing a dramatically lower number of jobs gained than reported by the payroll processing company ADP. It seems that some companies may have been too busy hiring to fill out and turn in their August BLS survey form.

Discouraged workers comprise part of a larger total of 6.4 million people who want a job but have not actively looked for one in the past 4 weeks.  A year ago, in Sept. 2011, the figure was 5.9 million.

Homebuilder stocks have been on a tear this year but construction employment, at 5.5 million, has barely budged in the past 3 years.

The core work force, those aged 25 – 54, continue to show some improvement but still have not reached the post-recession level of late 2009.

In the larger work force, aged 25 and up, the number of employed has risen almost to pre-recession levels, indicating that there are more older people continuing to work when they can – at full or part time jobs. 

As the population ages, so too does the work force – a natural demographic change.  But older workers are not stepping aside for young workers just entering the work force.  Those who can work do so to compensate for the lackluster growth or decline of retirement funds and declining property values, the two chief sources of wealth that a person builds over a lifetime of work. Below is a graph of workers aged 55 and older.

The number of hours worked per week edged up slightly – a good sign.  But – “over the past 12 months, average hourly earnings have risen by 1.8 percent, ” the BLS report notes, indicating that family earnings are just not keeping up with inflation.

On the bright side, we are doing better than much of Europe which is probably already in recession.  Returning to the topic of debates, did we hear either candidate offer a recovery plan for … not this past recession but the one that will probably occur during the next Presidential term.  “What!!!???” you say, “we haven’t even gotten out of this past recession!”  The law of averages, like the law of gravity, is a pesky, problematic force of nature.  The 1960s and the 1990s are the only two decades in the past century where we did not witness a recession within an eight year period (Source), yet few Presidential candidates dare to discuss the eventuality of such a thing.  Even the Congressional Budget Office does not factor in recessions to their ten year budget projections unless the recession is ongoing.  As the Presidential contender, Mr. Romney must play the part of the man with a plan.  After four years, Mr. Obama probably understands that “hope and change” is little more than rousing rhetoric; that the President must steer the raft through dangerous currents without capsizing or losing any passengers, while the other political party rocks the raft enough to make his task even more difficult.  Should Mr. Romney win the Presidency, he will discover the same sobering truth.

We Are Young

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There are many conflicting opinions and studies regarding the effect that the minimum wage (MW) has on employment, particularly the employment of teens who often work at jobs that pay MW.  Some studies show an increase in employment of teenage workers after the MW is increased.  Some show a decrease, some show no change.  A 2006 paper by two economists at the University of California reviewed early studies of MW prior to 1982 and those after 1990.  Methodologies, correlations and conclusions in one study are criticized in another study.  Reading just the first six pages of the 150 page paper will give you a sense of the arguments.

How many people does the MW affect?  Is it only those making the MW or does it also include those making just above MW?  What is the effect on the local economy as well as local employment?  Whatever you want to claim about MW, you can probably find a study in this area that will backup your claim.  What we can know for certain is that the MW has declined in real dollars over the past 50 years.  Using MW data  from the Dept of Labor and a CPI calculator from the Bureau of Labor Statistics, I have graphed the minimum wage in both current dollars and real inflation-adjusted dollars.

From 1963 to 2012, the MW has fallen 17%.  The unemployment rate for teens aged 16 – 19 stays stubbornly near 25%.

The unemployment rate for those aged 20 – 24 years has been steadily declining since late 2010 but has ticked up in the past few months.

Low wages and high unemployment breed a sense of futility in young people entering the work force.  During the late sixties and early seventies, the prospect of being drafted into the Vietnam War prompted many high school male graduates to go to college to gain a student deferment from the war.  Almost fifty years later, this generation of high school graduates – both men and women – feel the pressure of having to go to college to escape the bleak job prospects of this labor market.  As I wrote last week, older people are continuing to hold onto jobs, making it doubly difficult for young people entering the labor market supply chain.  Few young people can comprehend the multi-decade generational employment mechanism.  In our late teens and early twenties, we first step on the slow moving employment escalator, gaining experience, knowledge and judgment as we work for relatively low wages.  During our working years we build our skills and the amount of money our labor can command.  For too many young people waiting to step on this job escalator, the escalator is broken.  Each year more young people gather at the base of the escalator and wait. 

Labor Report – August Doldrums

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This past Friday, the Bureau of Labor Statistics (BLS) released their monthly report for August and the employment gains of 96,000 were below the already muted expectations of 120,000 jobs gained.  Many economists estimate that it takes 150,000 jobs per month just to keep up with population growth.  On the day before the BLS report, the large payroll processing company, ADP, released their estimate of 201,000 private job gains in August, leading some to speculate that total job gains for the month would be above 150,000.  As you can see below, the BLS and ADP counts of private employment closely track each other. (Click to enlarge charts in a separate tab)

On Thursday afternoon before the Friday morning release of the BLS report, the White House is notified of the numbers.  The disappointing numbers may have led President Obama to tone down the rhetoric of his speech that evening at the Democratic National Convention.  He did not seem to have the “fire in the belly” when he delivered his acceptance speech.  The unemployment rate ticked down from 8.3% to 8.1% because 368,000 dropped out of the work force and are no longer counted as unemployed.  Some of this number retired, either voluntarily or involuntarily.  Some have simply become discouraged.  Some have gone back to school.  The average number of weeks of unemployment is still at high levels. 

Some of this is due to changes in BLS reporting since Obama took office.  Before January 2011, the BLS allowed a maxiumum of 2 years, or 104 weeks in their survey.  Starting in 2011, the BLS allows a maximum of five years, or 260 weeks.  Since a small number of unemployed forces the average number higher, the BLS recommends using the mean for comparison. (BLS Source) 

Most of Europe is in recession; growth in South America, China and India have slowed.  Several strong economic reports in the winter and spring of this year led many to think that the U.S. economy might be less tethered to this global malaise.  The stock market rose over 10% in the first few months of 2012; then China reported contracting manufacturing and real estate sectors, and European leaders showed their continued inability to resolve the fiscal and monetary policy challenges that threaten to crack the European Union.  We realized that we were not immune to the global financial flu and the stock market fell 10% in May, wiping out the gains of the winter and spring. The monthly employment gains dropped during the summer.

Recent employment and industrial reports have showed that our growth, while still positive, is struggling.  Private job growth has been hampered by the layoffs of government workers, as the chart below shows.

The shedding of government jobs halted this past month as Federal employees actually gained about 3,000.  Those on the left have criticized the Republican House for aggravating job losses in state and local governments by blocking any further federal aid to the states.  A comparison with the first term of the Reagan administration shows a similar decline in government employment during the 1981 – 1982 recession.  However, following the end of the recession, government employment increased in the last two years of his first term and helped Reagan get elected to a second term.  The Democratic House was kinder to Reagan than the current Republican House is to Obama.

The slow growth of the past several months has fueled speculation that the Federal Reserve will once again come to the rescue with a bond buying program.  Since the beginning of June, the stock market has “melted up” on very low volume.  Once again, it is at the peak reached earlier this year and in 2007 before the recession began.

The uninspiring lack of job growth among what I call the core labor force, those aged 25 – 54, is a predictor of a sluggish economy in the near future.  These workers buy a lot of stuff. No jobs, no stuff.

The larger group of adult workers, those aged 25 plus, continues to show gains, indicating that older workers are continuing to keep and get jobs.  The old are simply not making way for the young.  Severe declines in house values and the loss of value in their retirement funds has forced many older workers to continue working longer than they may have planned.  Older workers do no buy a lot of stuff.

During the 2010 elections, Republican candidates for the House promised that job programs would be first priority.  We have been waiting two years.  Both houses of Congress have historically low voter approval ratings yet the burden of the sluggish job growth continues to fall on the President’s shoulders.  Politicians on the Republican side of this dysfunctional Congress point to the President as the cause of the muddle through labor market; they know most voters can’t remember what they learned in civics class in grade school and don’t understand that it is Congress, not the President, that initiates legislation.  It is Congress, both Democrats and Republicans in the House and Senate, that is responsible for the lack of job growth.  Who elected these men and women to the Congress?  Look in the mirror.  That’s who’s responsible for the slow job growth. 

Tax Cuts and Us

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Until the end of the year, we will hear and read a lot about the expiration of the Bush tax cuts.  For those who want to extend all the Bush tax cuts, you will hear stuff like this: “The non-partisan Congressional Budget Office (CBO) has predicted a recession in 2013 if the Bush tax cuts are allowed to expire.”  As with most political claims, this is slightly true.  Remember that politicians are little more than magicians practicing a logical sleight of hand in order to convince you of some claim.  What the CBO actually said in a May 2012 report was “if the fiscal policies currently in place are continued in coming years, the revenues collected by the federal government will fall far short of federal spending, putting the budget on an unsustainable path.” (Source)  In the next sentence, the CBO cautions “On the other hand, immediate spending cuts or tax increases would represent an added drag on the weak economic expansion.”  Is there room for compromise in this dysfunctional Congress?

While many politicians are aware of the difficult trade-offs, they dare not mention that to voters, who, they presume, are stupid.  On Fox News, MSNBC and other media, we will continue to hear simplified versions of a complex debate because – well, we’re just too dumb to pay attention to complex arguments that involve math.  If you are like most voters, many politicians reason, you have already stopped reading this because it has too many adjectives, verbs and commas.

The CBO does its best to estimate the long term impact on the federal budget and economic activity as a result of a paticular policy. To illustrate just how difficult this task is, let’s look at a July 2007 letter from the CBO to the Congressional Budget Committee projecting “For 2008 through 2011, CBO’s baseline budget projections show deficits of $113 billion, $134 billion, $157 billion, and $35 billion, respectively.”  Deficits were actually $458 billion, $1,413 billion, $1,293 billion and $1,300 billion.  Actual deficits were almost ten times what the CBO projected!  Knowing that ten year projections are almost pure fantasy, Congress continues this practice.  Each party uses the CBO estimates to support or attack a particular policy. 

The CBO projects a recession in 2013 if ALL tax policies were allowed to expire, including the Bush tax cuts.  “These include the Bush tax cuts, the alternative minimum tax (AMT) patch, the temporary payroll tax cut, and other temporary expiring provisions, many of which are commonly referred to as “tax extenders.” (Source)   The Congressional Joint Committee On Taxation (JCT) has a complete seven page (!!!) list of “temporary” tax cuts that are due to expire at the end of this year. 

What is the bottom line for the individual taxpayer if ALL the fiscal policies, including the Bush tax cuts, were allowed to expire?  In a 2012 report by the Congressional Research Service, they cite estimates by the Tax Policy Center that, in 2010, “the Bush tax cuts resulted in the lowest 20% of taxpayers seeing their income rise by 0.5%, while the top 20% saw their after-tax incomes rise by 4.9% and the top 1% saw their income rise by 6.6%”. (Source).  What will be the impact on most taxpayers if the Bush tax cuts expire?  Some but certainly not as dire as some politicans predict.  But that is not how politicians get votes.  To get us to the polls, politicians and their pundit lackeys who appear on TV and radio talk shows try to breed fear in voters.  The media is happy to oblige; fear makes for better ratings.

Based on estimates from the Tax Policy Center and the IRS, below is a comparison of what 2012 tax rates would be with and without the effect of what are commonly called the Bush tax cuts. (Source) This is just a “what if” scenario since the Bush tax cuts are still in effect for the 2012 tax year, but it does give us a good guesstimate of the effect of letting the tax cuts expire.

Using that data, I have projected what the effective tax rate on adjusted gross income would be for 2013 if the tax cuts are allowed to lapse.  It includes the tax brackets that includes the majority of tax payers.

The couple making $40K in adjusted gross income would pay $645 more in Federal income taxes.  The couple making $80K would pay $2225 more; the couple making $120K would pay $6669 more.  Those in the top 20% would see tax increases of $16K and more.  It is understandable that taxpayers with income in the millions would want to keep their gravy train going.  They need government mostly to protect their property rights; everything else, all the regulations and social support programs, is just wasted tax money.  Most of the rest of us don’t like paying taxes either.  We could step up to the plate and pay down some of the debt that we have run up; or maybe we should just let our kids figure it out.

Spending and Revenue

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This Labor Day weekend is the eye in the storm of the Republican and Democratic conventions.  As we listen to all the rhetoric and half-truths (at best) coming out of both conventions, it might be best to take a long term view of government spending.  The two biggest components of federal spending are defense and what is called human resource spending, which includes federal Education and Training Programs, Medicare, Medicaid, Social Security, various social safety net programs and veterans’s benefits (functions 500 – 700 described here ).  Data is from the Office of Management and Budget (Source), Table 3.1, Outlays by Function and Super-function.

The 70 year average (1940 – 2011) of total government spending is 20.6% of GDP.  The 30 year average from 1981 to 2011 is 21.2%.  During the Obama administration, spending has increased to 24.1% of GDP.  Each 1% of GDP is about $150 billion at current levels of GDP. (Click to enlarge in separate tab)

Defense spending has doubled in the past decade.

This spending figure includes only active defense spending.  Outlays for Veterans benefits, education and job training for vets are included under the Human Resources superfunction.  Housing benefits for veterans are included under another superfunction, Physical Resources.  The total outlay is estimated at over a trillion dollars and that figure has been acknowledged by Senator John McCain, a long time supporter of strong defense spending.

As a percent of GDP, however, active defense spending has remained below 5%. Putting this increase in spending in historical perspective puts the lie to the contention by some liberals that our budget problems are mostly due to defense spending.

Human Resource spending includes Social Security payments, which comes out of current taxes and a trust fund surplus of $2.7 trillion (Source).  Since most Social Security payments come out of a tax that has been dedicated to those payments, I have deducted them from total Human Resource spending to get a more accurate picture of the trend in spending on the social safety net. 

When financial conservatives on both sides of the aisle warn of this upward trend, this is what they are talking about.

What too many Republicans won’t acknowledge is that we have had and continue to have a severe revenue problem.

Since I listen to and read a lot of “conservative” media each day, I repeatedly hear the mantra that Reagan lowered tax rates and revenues increased.  This is the justification for pushing for continued tax cuts. Reagan and a Democratic Congress lowered tax rates.  The president signs bills that are passed by the Congress.  This is not a one man show.  Total revenues, including Social Security and Medicare taxes, did increase because Social Security taxes were increased 12% during the Reagan years (Source).  When we look at tax revenues without Social Security taxes, revenues as a percent of GDP fell, just as anyone would expect when tax rates are reduced.  Since WW2, tax rates have been gradually reduced, and, as expected, tax revenues as a percentage of the economy have fallen.  There is no magic formula here.  Lower tax rates = lower revenue.

In this ongoing battle of ideologies, there are three real issues.  Should we spend more than 5% of GDP on active defense spending?  Should we spend more than 10% of GDP on social safety programs (excluding Social Security)?  Can we expect to ever live within our means if we collect only 10% of GDP in income and excise taxes?  We can not do all three.

The Job Growth President

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Both incumbent President Barack Obama and Republican challenger Mitt Romney are making the case to American voters that each has better policy answers for future job growth.   Obama touts total job gains of 4+ million jobs since the recession ended.  Romney points out that this is less than half of the 9 million jobs lost since the end of 2007.

An economy is a dynamic resolution of the tension between supply and demand among all the people, companies and governments that participate in that marketplace.  Obama’s approach focuses on the demand side of the economy and believes in government borrowing and spending to temporarily take up the slack in private sector demand. The stimulus of government spending is supposed to both support and kickstart demand in the private sector, particularly consumer demand.  The fault of focusing on the demand side of an economy is that “demand-siders” presume that the supply side of the economy will naturally increase production to meet the sustained or increased demand.  In 2009, the Obama administration, together with a Democratic House and Senate passed a stimulus bill that included a lot of money for sorely needed infrastructure projects.  Democrats, most of them demand-siders, simply assumed that there would be a number of “shovel-ready” projects on the drawing board, projects that would employ construction workers laid off during the severe housing decline.  Since demand-siders do not pay as much attention to the process of producing or constructing something, they were dismayed that there were so few such projects ready to go.  Decades of labor, environmental impact and traffic impact regulations had dramatically increased the planning time required for many highway improvement projects.  At a meeting with his council on stimulus planning, Obama commented wryly, “Shovel-ready was not as shovel-ready as we expected.”

Romney’s approach focuses on the supply side of the economic dynamic.  “Supply-siders” believe that the government’s role in the economy should be limited; that government should remove many regulatory barriers and hinderances to the producers of economic goods and services.  The fault of this approach is that it presumes that consumer and inter-business demand will naturally increase as producers are able to make more goods and products available at a cost that has been lowered by the removal of hurdles to production.  The producers will hire more workers, will buy goods and services from other businesses who will hire more workers;  demand will inevitably increase which will support and stimulate more production.  Many adherents of the supply-sider hypothesis believe that defense of the country is a government’s primary proper role.  They advocate a large amount of military spending but regard taxation as a barrier to production.  These two competing and antagonistic ideas – more military spending, less tax revenue per dollar of economic activity – has resulted in large budget deficits which contradict the professed fiscal frugalness of many in this ideological camp.  Libertarians advocate a more consistent supply-side philosophy, arguing for lower military spending in addition to reduced government spending on social programs. 

Demand-siders argue that workers are both producers and consumers.  Supply siders contend that workers are consumers but not producers; workers are a cost of production.  Demand-siders focus on domestic civilian consumption.  Although supply-siders do not focus on consumption, they do emphasize military consumption.

Who is right?  Both of them and neither of them.  The political discourse and election structure aims to separate people into ideological and emotional teams; over the past decade many politicians who were less polarized in this debate have lost their seats.  A hundred years ago, this country began a transition away from party leaders picking candidates for national office to a primary system whereby voters would choose candidates.  In the two decades after World War 2, our political system made a complete transformation to a primary system, which has produced two increasingly polarized political teams.  A small group of voters in each political camp now elects the candidates for national office; in the last presidential election, less than a 1/4 of registered voters voted in the primaries.  We have traded a system where party bosses in a backroom picked candidates to one in which a small contingent of passionate people pick candidates.  We need a new system.

In his “Believe in America” plan Romney asserts that his policies will foster stronger job growth. (Long version and Short version).  They include reducing the corporate income tax rate, more free trade agreements, more oil and gas leases, reducing federal retraining programs and a 5 percent reduction in non-defense discretionary spending, a relatively small reduction in federal spending of $20 billion, or 1/2 of 1% of total federal spending. (Discretionary spending is government spending which excludes those social programs like Social Security and Medicare and Medicaid whose spending is on “auto pilot”).  Romney’s proposals are consistent with a supply-sider philosophy.

Beginning with the conventions in these next few weeks, both political campaigns are about to go into full court press during the remaining days before the election in November.  Each candidate will argue that their approach will foster job growth.  What neither candidate will tell us are some of the complexities that continue to trouble economists who study the labor market.  Why has job growth been rather anemic during the recoveries of the past thirty years?  Below is a chart of the year-over-year (yoy) percent gain in employment.

Notice two changes in the pattern:  the frequency of job losses has decreased but so have the employment gains during recoveries.  Economists at the Federal Reserve have analyzed the factors for this long term trend and concluded: “The analyses discussed here suggest that weak labor demand is the primary explanation for prolonged unemployment duration observed in the recent recession and recovery. The weak recovery of employment is similar to the jobless recoveries that followed the 1990–91 and 2001 recessions. This suggests that the labor market has changed in ways that prevent the cyclical bounceback in the labor market that followed past recessions. ” (Source)  The authors of the study analyze and isolate several factors to account for the change, including changes in how the numbers are reported, the longer duration of unemployment benefits, and the reduced manufacturing production in this country which would respond quickly during recoveries and recall laid off workers.  Weak labor demand is the chief culprit of anemic job growth and the lengthening duration of unemployment.  Why?  In the past thirty years, underdeveloped countries in Asia, India and South America are now offering a ready supply of un-educated or moderately educated workers.

The increase in the global labor supply is a particularly challenging problem because it is accompanied by an increase in productivity; i.e. less workers are needed to produce a unit of something.  Obama’s answer to this problem is more government support for educating young people and retraining those in the workforce whose skills are not suited to the changing demands of producers.  Obama has essentially given up on jobs for low and moderately educated U.S. workers other than government spending on infrastructure projects.  He hopes that American workers can command more of the global market for highly skilled workers. 

Romney wants to reduce federal retraining programs for workers and turn that task over to states.  He hopes that, somehow, someway, businesses with lower production costs will hire more workers.  More oil and gas drilling will employ more moderately educated workers but even Romney knows that these job gains are modest relative to the entire labor market.  More defense spending will employ workers in defense industries but many of those jobs require higher skills; lower skilled workers will benefit as a consequence, as part of an economy that supports defense contractors and military bases.  Increasing the number of soldiers reduces the number of available workers and reduces unemployment.

Neither candidate proposes to address an intractable problem:  too many workers around the globe.  Below is a chart of the y-o-y change in the number of people employed.  Due to a glut of workers, the structure of the labor workforce in this country is inherently weak.  The chart below shows the drastic drop in employment.

A winning economy, like a top-rated tennis player, blends strategies.  Politicians and players that strictly adhere to a school of thought or a school of play lose out to those are able to see and employ the benefits of differing strategies.