Where’s Warren?

by Kevin D. Williamson

 

Where is Senator Elizabeth Warren when we need her? Senator Warren — whose main mode of political operation is grandstanding during financial-oversight hearings — recently browbeat some feckless Treasury officials over the HSBC money-laundering case. HSBC was fined just under $2 billion in the settlement, but that was not enough for the crusading Senator Warren: She wanted to see bankers led off in leg irons. “Your company pays a fine,” she said, “and you go home and sleep in your own bed at night — every single individual associated with this — and I just think that’s fundamentally wrong.”

I am inclined to agree with Senator Warren in the case of HSBC. Somebody over there belongs in a prison cell, and possibly in stocks. When Larry Kudlow put the question to his bipartisan panel a while back, nobody, left or right, seemed to think that Senator Warren was being unfair to the bank. It was a rare moment of bipartisan agreement.

So I am hoping that Senator Warren will join me in asking: Why haven’t the powers that be in the ailing state of Illinois been dragged off to the hoosegow? Or at least given a $2 billion fine, as HSBC was?

The state of Illinois is a criminal enterprise engaged in securities fraud. Illinois this week became only the second state in history to be charged with fraud by the Securities and Exchange Commission. As I reported back in 2010, the state of Illinois is habitually underfunding its public-employee pensions, placing the state government’s finances in an ever more precarious state. And the Illinois government systematically misled the public about the state of its finances in order to allow it to keep selling bonds to witless investors. As the SEC puts it: “Time after time, Illinois failed to inform its bond investors about the risk to its financial condition posed by the structural underfunding of its pension system.”

Illinois is hardly alone in this. New Jersey was charged with fraud on precisely the same grounds — lying to investors about its pensions. Former prosecutor Kevin James, in the course of his campaign for mayor of Los Angeles, went so far as to compile a dossier on the city’s finances and file a complaint with the SEC. Shortly after the municipal bankruptcy of our friends in San Bernardino, America’s worst-governed city, the SEC came calling, asking the city authorities to be sure to hang onto bond documents and communications with underwriters, and by all means to forgo putting them in the shredder.

As Senator Warren put it in a different context: “They did it over and over and over again, across a period of years. And they were caught doing it, warned not to do it, and kept right on doing it.”

It is time to put some lying, defrauding bureaucrats in prison.

The U.S. municipal-bond market is enormous: between $3.5 trillion and $4 trillion, or about a quarter of GDP. It is a sensitive market: Most municipal debt is held by individuals, including a great many easily spooked older investors, but a great deal is held by banks and other financial institutions. A meltdown in that market — one possible result of widespread fraud — could bring down banks and investment companies along with cities and states, and decimate retirement savings across the fruited plain.

It is, in other words, a situation that cries out for an example to be made of wrongdoers.

But Illinois did not even get a fine — just a settlement in which it agrees to mend the error of its ways. Why is that? A cynic might be tempted to think that, because all this governmental book-cooking helps the authorities in Springfield and elsewhere keep their public-sector unions fat and happy — which in turn helps keep Democratic campaign coffers full — the Obama administration may be taking it a little easy on the president’s friends and colleagues back home in Illinois. Maybe it’s political self-interest. Maybe it’s laziness. I would not rule out haplessness or stupidity, either. But I cannot help noticing: Illinois, New Jersey, California — they have something in common politically, no?

It is a very bad thing when private-sector bankers commit crimes. It is a much more serious thing when government commits crimes, because criminal governments undermine the entire enterprise of law enforcement, weakening our institutions and thereby interfering with the operation of markets. If you are a victim of fraud in Illinois, to whom do you take your complaint? To a state that is itself guilty of fraud? That is a serious problem in a free society.

Senator Warren has been working hard to build credibility on these issues, and her baby was the new federal Consumer Financial Protection Bureau. Perhaps she could reach into that organization for some advice on how to proceed with the case of the state-organized fraud in Illinois. But if she does, she should probably forgo the counsel of Anthony Gibbs. Who is he? He is the former executive vice president of legal compliance . . . at HSBC. Of course he now works at the Consumer Financial Protection Bureau. Where else would he work?

— Kevin D. Williamson is National Review’s roving correspondent. His newest book, The End Is Near and It’s Going to Be Awesome, will be published in May. 

Children of the Corn

by Kevin D. Williamson

Everybody loves the idea of the self-sufficient farmer — hardy, independent, working his own land to produce what he needs on his own terms. It is a romantic vision, unless you have the experience of having lived that way: In the modern parlance, we call that economic model “subsistence agriculture,” and it is associated with places like Afghanistan and Uganda, a neolithic standard of living, and intervals of famine.

But the nice thing about having a primitive economy is that the economics gets real simple real quick. Let’s say you live in Grainville, population 100, a village of self-sufficient corn farmers who among them produce 1,000 bushels of corn every year. Corn farming is their only form of organized economic activity — otherwise, they are reduced to foraging in the countryside in old-fashioned hunter-gatherer style. If they lack trade or economic diversification, we know precisely how much the people of Cornville can consume in any given year: exactly what they produce, i.e., 1,000 bushels of corn. In order to make the math easy, let’s say that Grainville’s corn consumption follows the same pattern every year: 800 bushels eaten, 200 bushels used as seed for the next year’s crop, producing the same 1,000 bushels for the next season. Over and over.

The same pattern holds true at Corntown, the nearly identical village down the road. They put 800 bushels in the granary and 200 bushels in the seed silo. On and on it goes, for generations, until one year somebody in Corntown gets a big idea: 1,000 bushels of corn minus the 200 needed for seed leaves eight bushels per person per year, which is by no means a lavish standard of living, but they know from bad crop years that they can, if absolutely necessary, live on a little less — 7.5 bushels per person per year is enough to get by, if only barely. So why not put 750 bushels in the granary and 250 in the seed silo? It would be a very lean year, but with a little luck, and perhaps a milder winter, they would have an extra 50 bushels of seed corn the next planting season.

People grumble when stomachs rumble. But when the next harvest comes around, Corntown is, if not exactly fat and happy, better off: Instead of 1,000 bushels of corn, they have 1,250—a better harvest than anybody can remember having seen. But this bumper crop brings with it a heated debate among the yeomen of the Corntown Growers’ Cooperative. Yeoman Smith says that they should declare a festival year, set aside the usual 200 bushels for seed, and distribute the remaining 1,050, giving everybody 10.5 bushels instead of the usual eight. Yeoman Jones says that they should return to their usual practice of putting 800 bushels in the granary and set aside the remaining 450 for seed, producing an even bigger crop next time around. And Yeoman Flint proposes an even more radical idea: Tough out one more year of putting only 750 bushels in the granary and set aside 500 bushels for seed. Nobody much likes Yeoman Flint’s proposal: The past year was pretty tough, and another year like it might lead to serious discontent in Corntown. But Yeoman Flint has a compelling argument: If the winter is especially tough or there is another unforeseen need, that corn sitting in the seed silo is still there for them — they could always eat some of the extra seed if things proved tough, dipping into their corn savings.

There are three possible scenarios for the next harvest:

1.     Under the Smith model, the harvest is 1,000 bushels, back to square one, with the one fat year a fading memory.

2.     Under the Jones model, the next harvest is an astounding 2,250 bushels — more than twice what the people of Corntown are used to having.

3.     Under the Flint model, the next harvest is 2,500 bushels, a truly mind-boggling harvest for Corntown.

The people of Corntown are mostly moderates. They know a good thing when they see it, but they do not want to go overboard, so the Jones model is the most popular — after all, when you are used to having only 1,000 bushels a year, the difference between 2,250 and 2,500 does not seem that vast. But the Flintists turn out to be hardcore, uncompromising ideologues, and they are not prepared to give way, so 20 of them decide to take their share of the year’s crop — 250 bushels — and go their own way, forming their own cooperative down the road a bit.

So, now we have three corn-farming villages: Grainville follows the Smith plan, planting 200, harvesting 1,000, eating 800 (or eight per person per year), planting 200, etc. Corntown now follows the Jones plan, modified for their new, smaller population: They set aside 640 bushels to eat (eight bushels for each of their 80 remaining residents) and plant the balance, which comes to 360 bushels. And the tiny new village of Flintstown, population 20, sets aside 150 bushels to eat (7.5 bushels per person) and plants its remaining 100.

The next year, then, the harvest looks like this:

1.     Grainville: 10 bushels/person

2.     Corntown: 22.5 bushels/person

3.     Flintstown: 25 bushels/person

People start to think of Grainville as kind of déclassé: With a per capita GVP (Gross Village Product) of only ten bushels, it is by far the poorest of the three villages. But almost nobody from Corntown is looking to move to Flintstown, either: Even though its GVP is slightly higher, life is kind of hard there, and its current standard of living — as measured by how much corn you get to eat — is slightly lower. The people of Corntown congratulate themselves on their moderation. The people of Flintstown come to think of the people of Corntown as high-living libertines. Which brings us to:

Year Two Per Capita GVP

Grainville: 10B (0.00 growth rate)

Corntown: 72.5B (322 percent growth rate)

Flintstown: 87.5B (350 percent growth rate)

Discovering the power of investment — forgoing a little consumption now in order to produce more in the future — was a powerful thing, indeed. Both corn-investing villages now are producing far more seed corn than corn to eat. But of course that kind of spectacular growth cannot last forever. There’s only so much land and water, only so many laborers — and only so much corn, cornmeal mush, hoecakes, and unsalted popcorn you can stomach. (Neither village has made contact with the far-flung communities of Pigtown, Cowtown, Avocadoville, or Tomatoburg yet.) And even with its higher level of investment, Flintstown’s growth rate is not going to be 8 percent higher than Corntown’s forever. But it will be higher.

After the initial boom, Corntown levels out at 6 percent growth, and thrifty Flintstown at 7.5 percent in Year Three and going forward. In the coming years, that does not make an earth-shattering difference in their per capita GVPs. In Year Eight, Corntown’s per capita GVP is 97B, while Flintstown’s is 126B. And Flintstown gets a little less flinty: Corn consumption goes up a little bit, meaning that the amount of corn replanted goes down proportionally, and so the difference in their growth rates is diminished, too: Corntown continues growing at 6 percent, and Flintstown, still relatively tight with a bushel, grows at 6.5 percent. That half of a percentage point does not seem like much to brag about — until you check in with the great-grandkids. In Year 100, Corntown’s per capita GVP is 19,481B — but Flintstown’s is a whopping 38,832B, meaning that Yeoman Flint’s great-grandkids are on average twice as wealthy as Yeoman Jones’s. (Grainville, of course, disappeared after the first serious drought. And since Flintstown hasn’t developed a market for domestic laborers, Grainvillians perish from the earth, and nothing is left of them but sad stories.)

And when the corn-investing villages finally get around to establishing trade ties with Pigtown and inventing the tamale, the merchants prefer trading with Flintstown — sure, Corntown is a bigger market, but Flintstown is twice as wealthy, and they can afford to pay more for pork, avocados, beef, cotton — and for farming tools that make their corn operations more efficient, helping them to sustain their growth edge. In Year 200, Flintstown still has only a quarter the population of Corntown, but its economy is equal to 80 percent of that of its neighbor, and its citizens are on average three times wealthier. In another 50 years, Flintstown’s total GVP will be greater than Corntown’s, and its per capita GVP will be four times as much — which is to say, the difference between Flintstown and Cornville will be more than the difference was between either of them and long-forgotten Grainville back in the early days of the corn-investing boom. And Flintstown will have so much capital accumulated that its citizens will have long been able to consume at higher levels than the once-proud residents of Corntown, even while their economy continues to grow at a faster pace.

You can imagine what happens from there. All the trade roads lead to Flintstown, which is home to the best markets. If you want to be an artist or a poet instead of a corn-trader, Flintstown is where you go — it is wealthy enough to support art and high culture. All the most enterprising and energetic residents of other villages dream of a better life in Flintstown. If invaders come from foreign shores, Flintstown has the resources to protect itself. And it has so much corn that it can experiment with new corn-growing techniques; if it loses a little in a bad experiment, nobody is going to starve. Corntown does okay, too, but it will never catch up with Flintstown — not unless it gets more serious about investing or Flintstown lets up.

And all that is possible because the Flintstowners decided, a long time ago, that they could make do with a half-bushel less of corn every year.

There are other ways to get your hands on that seed corn, of course. Perhaps some enterprising investors from another rich village saw an opportunity in Flintstown, admiring the thrifty ways of its residents, and lent them the extra seed corn in exchange for a cut of future harvests. That would work, too, but there is no way of getting around the fact that you can’t plant corn you eat, and you can’t eat corn you plant. Somebody, somewhere, had to consume less corn than they produced to make that growth possible.

And the worst-case scenario is borrowing corn to eat today to be paid back out of future harvests.

Wait . . . You Have Kids?

The Facts about Gas Prices and Oil Profits

by Kevin D. Williamson

Please spare a moment for this hilariously illiterate piece of “analysis” from the Union of Concerned Scientists, which apparently gets its best material from the Union of Half-Educated Sophomores.

The subject is gasoline retailing and the villain is Big Oil. And the shocking headline repeated by Doug Newcomb of Wired (whose editors really should know better) is this: Two-thirds of the cost of a gallon of gas is . . . oil. Gasp, shock, awe, etc. Newcomb quotes Joshua Goldman, the author of the UCS study: “I was actually surprised to learn how little gas stations make from selling gas.” You know who is not surprised to learn that gas stations earn only a few pennies on the gallon? People who work at gas stations. I myself uncovered that particular nugget way back in the summer of 1991, when I was enrolled in a fascinating econ seminar called “Working at 7-Eleven.” Goldman may not have my special academic insights as a former member of the smock-wearing elite — he probably doesn’t even know how to clean a Slurpee machine — but the fact that gas stations make very little money from selling gas is common knowledge. (How common? Even Matt Yglesias knows!)

UCS writes:

Your gas money doesn’t support your local gas station, nor does it benefit you financially, even if you own oil company stock. Most of the money you spend at the pump goes directly to one place: oil companies.

You have a choice when it comes to your oil use: Continue pumping your money into oil company profits or invest in fuel efficiency and keep the profits in your pocket instead.

This will take some unpacking. It is true that about 68 cents on the dollar of gas sales goes toward oil costs, but that is not the same thing as “pumping your money into oil company profits.” That 68 cents on the dollar is revenue, not profit. Oil companies could be posting profits of $0.00 and the cost of oil would still account for the majority of the cost of a gallon of gas. As it turns out, gasoline is made out of oil. Oil and gasoline are pretty much the definition of undifferentiated commodities, so it is no surprise that in a very competitive market the profit margin for selling them is low. If you do not know the difference between revenue and profit, you should not be writing in public.

The question of how much profit an Exxon or a Chevron actually makes off a gallon of gas is a complicated one; the short answer is: nobody knows. Exxon’s “downstream” earnings — the money it makes selling gasoline and other refined petroleum products — run about 7 or 8 cents a gallon. Critics point out that this figure does not include the money that Exxon makes from crude-production operations, and that is fair enough. In total, Exxon makes about 8 cents on the dollar for everything it does, soup to nuts: Its profit margin for the past 20 quarters averages 8.26 percent. That is, it is worth noting, a good deal lower profit margin than Wired parent company Conde Nast generally achieves, according to the company’s CEO, Charles Townsend. Apple’s profit margin runs about three times Exxon’s. Chip-maker Linear Technology’s profit margins routinely run four times those of Exxon. Energy is a high-volume business, not a high-profit-margin business. But regardless of the size of the margin, how much revenue goes where tells you nothing about profit.

The UCS argument that the structure of the gasoline industry ensures that fuel purchases do not “benefit you financially, even if you own oil company stock,” is also ground-poundingly absurd. UCS elaborates: “Say you have $20,000 invested in ExxonMobil, the largest publicly traded oil company in the world. If you spent $1,700 on gas from ExxonMobil over the course of a year, your fuel purchase would yield far less than a penny in stock earnings. Even if you had $1 million invested, you would still get less than one cent in return after spending almost $2,000 on gasoline.” Or, as Newcomb puts it: “The UCS says that even drivers who own shares in an oil company and buy that brand of gas won’t see a bump in their stock portfolio because of their loyalty.”

I myself do not own a car and rarely buy a tank of gas, but I do invest in oil companies on the theory that — pay attention, here, Goldman and Newcomb — lots of other people buy gasoline, billions of them, in fact. That my gasoline-buying habits have a very small impact on the performance of my oil stocks is the very definition of the fact that is trivially true. As for brand loyalty, somebody ought to let Newcomb in on the fact that Exxon-branded gas stations do not really have anything to do with ExxonMobil, which began selling off its U.S. gas stations back in 2008 and at the moment does not own a single gas station in the United States. They kept the Exxon name, but Exxon sold them to distributors and local oil companies, and is doing so in Europe as well. Why? Because — this is news to the people at UCS and Wired — it’s hard to make much money retailing gas. “[The] fuels marketing sector continues to be challenging, with reduced margins and significant competitive growth,” Exxon’s Premlata Nair told the Washington Post, five years ago. Five years is like 60 in Wired years, right?

Did UCS even consider the math behind its own argument? Did Wired? If $1,700 in gasoline purchases generates $1,156 in revenue for an oil company but far less than a penny in revenue for somebody who owns $20,000 worth of stock (or 225 shares in Exxon), what could that possibly mean? That revenue elves are running off with the money? That Exxon shareholders are suckers? What it mainly means, of course, is that there are lots of shares of Exxon stock on the market: 4.5 billion shares outstanding and a market capitalization of nearly $400 billion. So, yeah, your piece of the action on $1,700 worth of sales when you own 0.000005 percent (five millionths of 1 percent) of the company is apt to be quite small. Ingenious observation, guys! It also means that (cf. those profit margins cited above) getting oil out of the ground and into the high-test pump is not cheap. Your conclusion might be that you should buy less gasoline. Or your conclusion might be that you should buy more Exxon shares. It depends on what your goals are.

Also: If you ordered a hamburger and learned that 68 percent of the revenue went to a beef rancher, would that make you feel better or worse about your hamburger? Isn’t the point of things like local farm coops to send more revenue to the producers?

The economic illiteracy continues, both at UCS and at Wired. “Fuel efficiency is really what’s going to put more money back in your pocket and put more money back in our communities,” Goldman tells Wired, and Newcomb worries that “very little of the remaining cash goes into the local economy.” Can we please lay aside the primitive superstition that in the developed world in the 21st century there is such a thing as the “local economy”? Let’s say we took the Brooklyn farm coop approach to gas, and a quaint little store on my corner had a oil well in the back, a DIY-refinery in the garage, and a hand-lettered chalkboard outside advertising its artisanal gas. The bearded hipster inside runs the whole thing. Local economy, right? But I assume he lives in a house or an apartment, which is bound to be made of concrete and steel not locally sourced. He probably has a cell phone and a computer and may even shop at Trader Joe’s or Whole Food or — angels and ministers of grace defend us! — Walmart, thus sending the money I spend at his shop far and wide. You know who has a “local economy”? North Koreans and hunter-gatherers. Autarky is no way to live. Somebody should explain comparative advantage and gains from trade to these gentlemen.

And how exactly is fuel efficiency going to “put more money back into our communities”? I took a little walk around my neighborhood this morning, and I did not see a single Prius factory.

Finally, neither party seems to appreciate the importance of UCS’s “finding” that, after oil, the No. 2 contributor to the cost of a gallon of gasoline is taxes. UCS writes: “Of the remainder, 14 percent of the money spent on gasoline goes to taxes that help pay for roads and transportation services, 10 percent to refining costs, and 8 percent to distribution and marketing.” Think on that: For refined petroleum products, taxes cost more than refining, but less than petroleum. Which one of those seems out of whack?

This UCS “study” is almost entirely empty of intellectual content, reducible to: If you spend less money on gas, you spend less money on gas. It is a juvenile example of dressing up baseless preferences as empirical observation. UCS describes itself thus: “The Union of Concerned Scientists puts rigorous, independent science to work to solve our planet’s most pressing problems.” Wired describes itself as a literate magazine. Neither organization’s reputation should escape this kind of sophomoric intellectual fraud undamaged. Both of them have made the world a little dumber today.

You Cannot Raise Taxes on the Rich

by Kevin D. Williamson

Thanks to the fiscal-cliff deal and the Obamacare tax, we now have a tax code that is more “progressive” than at any time since Jimmy Carter was president. It will be interesting to see what long-term effect that has on household-income trends. The results may prove counterintuitive.

Tax increases on high-income people may be redistributive, but not always in the way intended. That is because we pay taxes individually in the short term, but in the long term we pay taxes collectively: Individuals and firms pass on tax costs to employers and consumers to whatever extent they can, just like any other cost. But the same factors that make any given worker a high-income wage-earner in the first place are likely to make that worker one who can most effectively pass on tax expenses. Likewise, the most profitable firms in many cases will be the ones that have the most power to pass on tax expenses to consumers or suppliers.

A high-income worker is one who by definition is in high demand. The same factors that make him a high-income worker also enable him to demand higher wages in response to tax increases or other factors that diminish his real income. You see this all the time with financial and tech specialists who are recruited to positions in high-tax areas such as New York or California: Workers in that position, or headhunters recruiting them, simply add taxes and other cost-of-living factors into the starting point of income negotiations. A $100,000-a-year job in Manhattan is not the same as a $100,000-a-year job in Muleshoe.

Likewise, companies with very in-demand products (Apple, Mercedes-Benz) have the most ability to pass costs along to consumers, while equally powerful but price-constricted firms (Walmart) have the most power to pass expenses on to suppliers and other business partners. A tax hike on Walmart is not necessarily a tax hike on Walmart — it’s likely to be a tax hike on, for example, Cal Maine Foods, which relies on Walmart for a third of its business. In business as in love, the power in a relationship is always in the hands of the party with the least to lose by walking away from it.

Which is to say, it is not clear that you really can raise taxes on the rich, even if you try.

At the other end of the spectrum, low-wage workers are those who by definition are not in very much demand and therefore have the least ability to negotiate tax offsets. The same is true for less powerful firms.

So, let’s say you’re Walmart, and your top hundred inventory-management, systems, and finance guys all come to you looking for a 10 percent bump because of the fiscal-cliff tax hike and the Obamacare tax hike. Walmart does not live and die by greeters or Cal Maine eggs — it lives and dies by logistics and finance, and it really needs people who are good at that. It will work as hard to keep its top talent as Apple will to keep its top engineering and design talent. So where does Walmart go to get that money to keep its top talent? If you have 100 high-wage specialists you really need to keep happy and tens of thousands of low-skilled greeters, cashiers, warehousemen, etc., all of whom you are pretty confident you can easily replace, you are going to be tempted to shift some money from the big, low-skilled pot to the small, high-skilled pot. Likewise, if Walmart has a supplier that represents 0.01 percent of its sales but relies on Walmart for 33 percent of its own sales, who do you think is going to prevail if Walmart decides it needs to knock prices down by a nickel?

We may not consciously plan that kind of thing down to the dime, but people know that there is a difference between their pre-tax income and their real income, and people with the market power to maximize the former also have the power to maximize the latter. Put another way: Even a very progressive tax code “does very little to alter the market distribution of income.”

It is transfers, not taxes, that really generate such progressivity as we have in the United States. As Lane Kenworthy shows, the overall U.S. tax system — federal, state, and local — is not all that progressive in its effects, despite a very progressive graduated federal income tax. What low-income workers don’t pay in federal taxes, they make up for in state and local taxes, particularly sales taxes, which are basically a flat income tax for the poor. Kenworthy finds that each quintile pays about 30 percent of its income in taxes. But the system becomes much more progressive when transfers are accounted for.

Tax hikes on the so-called rich may decrease the private sector’s share of income, but they probably will not do much to decrease the real income of high-wage workers and may in reality increase government revenue at the expense of low-wage workers in the long term, though it is very difficult to disaggregate the complex relationships between taxes, wages, and prices. But those who say that they are most interested in economic inequality would do well to follow Kenworthy’s example and look at transfers rather than taxes. Means-testing Social Security and Medicare would do more to make the total package of taxes and transfers more progressive than any tax hike likely to pass Congress in the foreseeable future. It is also a reform that many conservatives and deficit hawks could support. This should be persuasive to those on the Left whose interest in tax hikes on the high-income is not strictly punitive, but I am afraid they are a very small minority.

– Kevin D. Williamson is National Review’s roving correspondent. His newest book, The End Is Near and It’s Going to Be Awesome, will be published in May. 

Democrats Raise Taxes on Poor to Subsidize Millionaires

by Kevin D. Williamson

There are basically two ways of looking at the fiscal-cliff deal. One possible headline reads:

“Congress does basically nothing.”

For all of the operatic angst and wailing surrounding the negotiations, what was produced was essentially a status quo, kick-the-can extension of most current policies, with a few minor changes that will have very little impact on the long-term fiscal health of the country.

But there is another possible headline:

Democrats insist on raising taxes on poor to protect millionaires and billionaires.”

That is not how the New York Times put it, but it is true.

Of all the tax cuts of the Bush-Obama era, the income-tax cuts for the so-called rich (households earning $250,000 or more) were the least expensive in terms of forgone revenue. The Bush tax cuts for $250,000-plus were estimated by the CBO to deprive the Treasury of about $80 billion a year; the income-tax cuts for the middle class were estimated to cost $220 billion a year; the payroll-tax holiday, which disproportionately benefits the poor and middle class, cost about $120 billion a year.

Extending the payroll-tax holiday was on almost nobody’s radar during the fiscal-cliff debate. Why? The cynical answer is that nobody really cares very much about the interests of poor people, and there is something to that. But I think the answer is a bit more complex: Republicans believe (correctly) that temporary tax holidays are bad economic policy, contributing very little in the way of stimulus or long-term growth prospects but increasing uncertainly about future tax conditions. Democrats dislike payroll-tax reductions because they undermine the myth that Social Security is a self-funding investment (payroll taxes allegedly fund Social Security) rather than what it is: a deficit-expanding welfare program for the middle class. And everybody had a good reason to knock that $120 billion a year off of their CBO scoring.

The expiration of the payroll-tax holiday will reduce the real income of middle-class and working-poor households by around 1.5 percent on average. So while the fiscal-cliff deal raises taxes on those making $400,000 and up, it also raises taxes on workers in the bottom (0.00 percent) income-tax bracket, who do pay payroll taxes. Republicans would have been happy to extend all of those tax cuts into the future, but President Obama and his Democratic allies insisted on tax increases — knowing full well that would mean tax increases on the poor as well as on the high-income.

But not all the rich folks got a tax hike. As usual, well-connected special interest groups — from Hollywood to the booze lobby — secured sweetheart deals for their own narrow interests. So the industry that employs Sean Penn and Ed Asner gets a nice fat tax break, and poor people with jobs get the shaft. The people who rail against “corporate welfare” and “crony capitalism” took the time to cut a nice side deal for the rum industry. You will notice that the Bacardi family is not poor. That’s Washington.

My own preference is to eliminate the payroll tax and with it the myth that Social Security and Medicare are self-funding insurance programs rather than old-fashioned welfare programs with a largely middle-class constituency. That would also help to end the game of playing the “discretionary” budget off the “mandatory” budget — all spending is discretionary, and when you’re running trillion-dollar deficits, some real discretion is called for.

Not that you will get it from the incompetents in Washington.

– Kevin D. Williamson is National Review’s roving correspondent. His newest book, The End Is Near And It’s Going To Be Awesome, will be published in May. 

CRA and Risky Lending

by Kevin D. Williamson

I had assumed that the effects of the Community Reinvestment Act were overstated by its critics. This is one of those times when I do not mind being wrong:

Did the Community Reinvestment Act (CRA) Lead to Risky Lending?

 

Yes, it did. We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract-month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.

 

There is a great deal of interesting information in the paper, which you can read here. (What, this isn’t what you do with your Christmas break?)

Teachers’ Pensions Are a Half-Trillion Short

by Kevin D. Williamson

The habitual overpromising and underfunding of government-employee pensions is a fiscal powder keg in an economy full of sparks — and a new report estimates that teachers’ pensions alone are underfunded by nearly a half-trillion dollars.

Strange, then, that the state of New York has decided to take about $1 billion out of its teachers’ pension system to “invest” in infrastructure projects related to recovery from Hurricane Sandy, an initiative announced by Bill Clinton. (Remember him?)

New York is one of the few states that can afford to roll the dice a little bit with its teachers’ pensions, because New York is one of the few states with pension systems that are not critically underfunded. (The few others include Idaho, Alaska, Wisconsin, South Dakota, North Carolina, Tennessee, and Washington.) City comptroller John Liu said yesterday: “This innovative plan could help us rebuild the city, create jobs, and yield solid returns on our pension funds,” but it is not yet entirely clear how that will happen, and the details of the particular investments remain murky. The pension fund may simply buy bonds related to infrastructure projects, or it may take a direct ownership interest in some of the projects.

I find this troubling inasmuch as mixing a pension manager’s fiduciary responsibility with political incentives invites conflicts. For example, the pension fund could face political pressure to make investments in the districts of influential elected officials, or to lend money on overly liberal terms. The public enterprises that perform well usually are those that do one thing and concentrate on doing it well, and it probably would be best for New York’s teachers if their pension manager focused exclusively on fiduciary concerns rather than try to act as a creator of jobs or an organizer of hurricane-recovery projects. It will be interesting to see what kind of returns these investments yield.

Beyond New York and the handful of funded-up states, the picture looks pretty grim. Key findings from “No One Benefits,” the report referenced above:

Pension systems are severely underfunded. According to the most recent data available, NCTQ estimates that teacher pension systems in the United States have almost $390 billion in unfunded liabilities. Funding shortfalls have grown in all  but 7 states between 2009 and 2012.

Pension underfunding is even worse than meets the eye due to unrealistic assumptions and projections about returns on investments. Even with states almost certainly overestimating how well funded their pension systems are, NCTQ finds that pension systems in just 10 states are, by industry standards, adequately funded.

Retirement eligibility rules add to costs. In 38 states, retirement eligibility is based on years of service, rather than age, which is costly to states and taxpayers as it allows teachers to retire relatively young with full lifetime benefits. In the just ten states—Alaska, California, Illinois, Kansas, Maine, Minnesota, New Hampshire, New Jersey, Rhode Island and Washington—that no longer allow teachers to begin collecting a defined benefit pension well before traditional retirement age, states save about $450,000 per teacher, on average.

Most pension systems are inflexible and unfair to teachers. Many assume that defined benefit pension plans are a clear win for teachers. But while most defenders of the status quo fight tooth and nail to preserve traditional pension plans, the reality is that these costly and inflexible models are out of sync with the realities of the modern workforce. Current National Council on Teacher Quality pension systems are built on a model that assumes low mobility and career stability and helps to put public education at a competitive disadvantage with other professions.

Note that the savings per teacher derived from the reform of eligibility rules runs $450,000, or more than two and a half times the average net worth of a retirement-age U.S. household. The real value of the average teacher’s retirement benefits in low-cost Wyoming is pushing the $1 million mark. The value of the average teacher’s retirement in Illinois is estimated at $2.4 million — and they were on strike over compensation not too long ago. Illinois has been issuing debt to meet its pension obligations, an unsustainable strategy.

The economics of the pension situation is of course worrisome (terrifying), but the political lesson is depressing, too: Government simply cannot be trusted to keep honest accounts.

NOTE: This has been corrected since first posting.