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Thursday, October 1, 2015

Can tax cuts pay for themselves?

The assorted Republican hopefuls are now trotting out pieces of policy platforms. Most of them aren't very good working with media. Then there's Trump. If you have to watch a would-be politician speaking nonsense, then he's the clear winner, so untroubled by consistency and logic as to be fun. So while Jim Bresnahan, the host of my radio show on WREL Lexington VA (at 1450 AM), asked me to comment on Trump. Well, I'm not willing to read much into any of the Republican policy pronouncements at this point. Those will flip: we know that what appeals to Republican primary voters does not work with the general electorate. Trump will do well if he reaches that point, as no one expects him to be consistent.

...the mantra that tax cuts ... pay for themselves.

That said, the biggest dollar component of Trump's proposals – as with those of Jeb Bush – consists of tax cuts for the rich. Yes, there's Trump's headline proposal of zero taxes below a certain income level, but those people already pay little or no income tax. Yes, certain deductions for the wealthy will be removed. At the same time, he's put forward a lot of arcane-sounding items that in fact represent very large tax cuts for the wealthy. That shouldn't be a surprise: he makes no bones about being a billionaire, and when it comes to taxes he knows how to butter his own bread. In any case, he's not shy about chanting the one mantra all Republicans share: cut taxes. Remember: presidential candidates can propose, but it's the actual elected Congress that legislates.

So let me turn to the other mantra our candidates are chanting: tax cuts are not only good for growth, there's so good for growth they'll pay for themselves. (There's jargon for that: dynamic scoring.)

First, there's basic arithmetic of what it takes for a tax cut to be revenue neutral: if you cut taxes by 10%, then the economy has to grow by more than 10%, because you've shrunk the tax base. Furthermore, it has to do that immediately, because you lose revenues up front. That a decade from now the economy is larger does not do the trick

Second, there's diminishing returns. If tax cuts work, then most of the bang comes from the initial round of cuts. The second time around they won't work as well. By the third round they lose virtually all of their power. So if there is a big effect, that would have been with those of Reagan's first-term in the early 1980s. Now many listeners won't remember that era, after all the youngest of those who voted for him are now 53 years old. But while growth wasn't bad, most of that can be attributed to recovery from the Volcker recession and the second oil crisis, which included a drop in interest rates by over 10 percentage points from peak. (Three-year bond rates fell from a peak of over 16.5% to a bit under 6.5%.) Our second big round of cuts was under Bush Jr, with little visible impact. The third round under Obama had even less impact. (While that fact has disappeared from political rhetoric, Obama sided with Republicans, with half of the ARRA "stimulus" package in the form of tax cuts.) A fourth round will get us nothing.

Furthermore, the empirical evidence is that the biggest part of tax cuts in fact take the form of losses in revenue. The Federal deficit ballooned from 1.5% of GDP during the Reagan's first election campaign to 4.9% in 1986, well into his second term. Whatever gains those cuts brought through growth were far short of what was needed to offset them. A quick example: tax cuts for regular workers were up to 25%. So you'd need 25% more labor income to offset them. But while they were sold as "supply side" cuts, we didn't see the average work week go from 40 hours to 50 hours, or a huge jump in wages. But we did see consumption boom: these tax cuts did have a clear demand-side effect.

So neither logic nor empirical evidence provides a direct case that cuts pay for themselves.

Let's examine this from another angle: labor and capital. If the economy is to grow, then inputs have to grow. Is there evidence that employers can't find enough workers, and that is what is holding back growth? Likewise, do businesses find it hard to come up with the cash for investment?

On the first point, it's very clear that the problem is that workers lack of jobs, not that jobs lack workers. The number of long-term unemployed remains high by the standards of the past 70 years. Ditto the number of workers on involuntary short hours, the number of discouraged workers, and the number of workers with jobs that pay low wages.

On the second, firms are sitting on record amounts of cash, and they earn very little on it. Similarly, if a modest cut in tax rates would boost investment, then a modest cut in interest rates should likewise boost investment. Well, we've tried the latter to little effect: investment isn't low, but it's not enough to drive growth higher. The bottom line is that when it comes to investment businesses see a lack of opportunity, not a lack of ability.

To sum up, there's no evidence that yet one more round of tax cuts will be effective, much less serve as a panacea to America's slow recovery from the Great Recession. The evidence is however clear that cuts would boost our deficit.

[Aside: As an economist analyzing the impact of tax cuts provides empirical challenges. The underlying dynamics of population growth and ongoing investment and new technologies mean that there's a strong base of growth. This is the "cake," the substance of the economy. If tax cuts matter, then it's because they add icing to the cake. Since many other factors add icing, the bottom line is inevitably that tax cuts are at best a part. However, there is one major offsetting effect that does allow us to "bracket" the empirical impact: unfortunately the US cake isn't top-heavy with icing, the share of growth that can't be tied to extraneous factors such as taxes has shrunk over the past 25 years. So if taxes matter, they don't matter much.]


A quick news item was the failure of the latest effort to legislate by temper tantrum. Funding for the government isn't guaranteed, the bill that passed merely kicks the can down the road to December. Now those who voted for a shutdown surely could count votes, and knew it wouldn't go through, so it's hard to know whether they were serious. In any case, I personally dislike grandstanding of this sort.

United Way of Rockbridge:

We've now launched our 2015-16 fundraising campaign, with a goal of $250,000. It's too early to have any results. In any case, we've always had far more demand than resources: whatever we succeed in raising, we realistically have non-profits who could do much more for our community if we could help them with additional funding. So what I want to focus on during the next three months are these community-oriented non-profits.

One is the Rockbridge Area Occupation Center (RAOC), headquartered on Sycamore Street in Buena Vista. Their mission is to employ disabled members of our community. That helps these individuals to maintain a measure of independence, it improves their lives by giving them purpose, it lets them contribute directly to their community, and it provides for regular interaction with others. Towards this end RAOC defines its mission as to "Create a safe workplace where people with disabilities can provide high quality products & services in a timely manner." (http://raoc.org) They are very good at their mission: about 10% of their workers are ultimately able to find private-sector jobs.

To turn mission into practice requires three components. First, they need to locate work that aligns with the capabilities of their workforce of about 30-35 individuals. Second, they need to provide training and supervision. Third, they need to provide transportation, as most of their workers are unable to drive.

The Great Recession has made their operation more challenging, as numbers of businesses that employed their workers went out of business or cut back. So they are now undertaking jobs as far away as Lynchburg, with the attendant costs in transportation.

Keep them in mind this fall: they can assist with yardwork, some of their workers can use a chainsaw and help clear out woods, and of course there are other tasks that they can undertake. If you run a small business, consider using them to clean your workplace once a month. Willy Funkhouser, the Executive Director, can help you sort out what their workers can realistically do. Contact him through their website, or call 261-6159. Of course they welcome cash contributions, too, and have a click-to-donate function on their website.

Contributing to the United Way of Rockbridge is a way to help an array of such non-profits that serve our community. We currently fund 22 organizations and projects; for each, we review their funding proposal, check their financial statements, and have reviewers from our community meet with their leadership to gather information first-hand. We do say "no" when groups cannot make a compelling case that they will use our – your! – money well. And unfortunately we also turn down projects – and fund them at levels below what they request – because we don't have enough money to fund them all.

You can go to our website to contribute via a secure click-to-donate button at uwrockbridge.org, or contact us at our offices at 218 South Main Street (P. O. Box 1094) in Lexington, VA 24450. We do answer our phone, too, at 463-4414.

Thursday, September 24, 2015

Econ Update: WREL Lexington VA

by Mike Smitka, Economics Dept, Washington and Lee University

Sept 17 (here) and Sept 24 (below)

The Fed – specifically the Federal Open Market Committee, comprised of the 12 presidents of the regional Federal Reserve banks and the five members of the Board of Governors – meet today, and will issue their press release at 2 pm. Even if they bump rates [they did not], "bump" is the operative term as any increase would be from 0% to 0.25% or 25 bp (basis points). Now 6 month rates have built into them a bump up to 0.5% by March 2016. In the past 12 months two year rates have really climbed – to 0.75%. [Laugh: sarcasm.] Keep going: 5 year rates, car loan territory, are at 1.5%. You have to get to 30 yrs (mortgage rate territory) to be above 3.0%. But those looking at long-term bonds don't have much to gain (or lose) by what the Fed announces tomorrow – they anticipate rates gradually rising, but over 30 years it matters little whether it occurs today or early next year. So don't expect those to move much, whichever way the FOMC votes. Remember, too, that rates jump around every day for a wide variety of reasons – so far this year 10 year and 30 year rates have averaged a bump up or down of 5 bp (.05 percentage points) each business day.

Monday, September 21, 2015

Electric Cars: Renault's the Leader, not Tesla!

by Mike Smitka
During the GERPISA auto conference in Paris in June I stayed in a hotel with a row of electric vehicles parked out front. The "Bluecar" wasn't fancy, but they were used: at times all slots were full, at others none were parked there. I don't know whether the company involved, Autolib', is doing well. But the point is that in parts of Europe a sizable part of the population sees electric cars, day-in and day-out. In Norway, they're 17% of the cars on the road, despite the challenge that batteries face in a low ambient temperature environment.
Within the electric car market the clear leader is the Renault-Nissan alliance, not Tesla. On a worldwide basis they now have over 250,000 vehicles on the road. What is most interesting are the components of Renault's business model.
First, Renault is launching multiple vehicles. Their best seller is the ZOE, made on the same assembly line as the Clio. In other words, they are not needing to design a whole new vehicle, and are gradually leveraging their multiple platforms. (They also have the Kangoo light commercial van.) With this experience in hand they are now ready to launch additional electric vehicles in short order, of course subject to demand.

Thursday, September 10, 2015

Reconsidering China: An Essay

by James Vena | Jun 3, 2014 | Essays |

posted by David Ruggles

Co-blogger Mike Smitka (住老师 in his China class) comments at the end.
He's also edited out typos, filled in dates and so on using [italics].

In light of recent events some might be interested in what this China expert had to say over a year ago. He speaks as someone who has done business there for decades. Ruggles

Have China’s “growing pains” manifested into something a bit more troubling relative to its growth, internally and externally?

My first visits to Asia & China (on business) were in the early-mid 1980’s and things were obviously much different back then. Aside from being much more socially oppressed and isolated, the most glaring difference was in its local economy, as all business was nationalized.

Tuesday, September 8, 2015

Generational War: Do Older Worker Squeeze Today's Young Out of Jobs? Weekly WREL Radio Show

Click on Figures to enlarge!
Figure 1

Mike Smitka

I generally focus on the medium-run picture of the US labor market, the recovery process from the Great Recession. (Here is an example from this blog, replete with graphs.) As noted last week, my analysis shows we're on track to reach "normalcy" in 2018, assuming various headwinds don't slow us down. That's also the bottom line of the latest July 2015 IMF Article IV review of the US economy: we still have lots of excess capacity, in this case people who would like a full-time job but either have stopped looking on a regular basis (and hence are not counted as "unemployed") or are on involuntary short hours.

Thursday, August 27, 2015

Thursday morning radio: the economy on WREL

Mike Smitka

Well, I've gone through another week without a post on the auto industry, but Thursday has come and my WREL Lexington (VA) radio segment with it. Here's my latest.

First, our host Jim Bresnahan asks about the gyrations of global stock markets. China? – attributing a reason to what happens in the stock market is hard. As an economist I don't pay attention to the stock market, because how it does has no link to the economy in the short run, and little or no impact on the economy. Most trading now is computer to computer, operating faster than the blink of an eye, and opaque in details. So why things move in a particular direction, and how much, no one can explain. Now the reporter on CNN has to give a report every hour, and we as humans like things to have causes, and they'll attribute the up or down to something. So in the short run the market is random, and betting on it is a crap shoot, one where the house – Wall Street – wins. You have to pay a fee, and the computers can see your trade before it gets executed and (legally – there's no regulation) bet against you. As to the US, we're seen a strong rise in the market the past few years have seen; the US economy has after all been growing, and corporate profits are up. Stock prices ought to reflect that, but the link is loose so things will go up and down. Don't panic, invest for that long-run link and don't let yourself try to beat the house in the short run.

Sunday, August 23, 2015

Low oil prices: not a Saudi conspiracy

Mike Smitka

Saudi Arabia is not what it used to be. Their petroleum and other liquids production in 2014, at 11.6 million barrels per day [mbd], is only about 1 mbd above what it was in 1981 (and is just shy of the peak over the period 1980-2013). But their market share is distinctly lower, falling from 17% (of global output of 60.6 mbd) to under 13% (of 93.0 mbd). That limits their pricing power.


Elasticities tell the story. The short-term price elasticity of demand is about -0.2, the medium-term one of course is more elastic at -0.5 or greater. [In most energy markets the income elasticity of demand is roughly 1, though recent work finds it is less in the OECD.] So if the Saudis cut output by 10%, global output falls about 1%. That means prices rise 5%. But with the quantity they sell down 10% and prices up only 5%, that means their income falls by 5%. With a population burgeoning in numbers and expectations, and as the ideological seat of the Wahhabi sect that fuels radical Islam – but so far has not seen cause to bite the Saudi hand that feeds them – well, the kingdom can't afford a large income hit. Oh, and they're consuming what to me is a surprising amount of oil.

One other bit of economic logic reinforces this argument: when interest rates are low and prices are low, it makes sense to leave oil in the ground rather than to pump and sell it. Selling turns oil into bank deposits, and those earn nothing. Leaving oil in the ground also provides the option to benefit from future price rises [though the option loses its value if prices fall further]. So do you want to store your oil in the ground, or store your oil in the bank? (Those with finance acumen can do the corresponding net present value calculation, and maybe even put a valuation on the option.) For the Saudis, pumping oil makes sense only if their focus is cash flow rather than maximizing national income.

Saturday, August 22, 2015

Thursday Update (albeit posting late)

Mike Smitka

I do a weekly radio segment on the economy on WREL, the local Lexington Virgina AM radio station. Here are my notes from the Aug 20th show. These are not necessarily the order in which I presented them, and I avoid numbers when I can - radio is not the medium for conveying data – but I like to have them in front of me.

Employment: I won't talk details, but job growth continued to trend somewhat above population growth, with no sign of acceleration. Projecting out, as I've mentioned periodically for the past two years, we won't return to normal levels of employment until 2017 and more likely 2018. I'll return to that topic later in the fall.
New Residential Construction: The latest data were out Tuesday [Aug 18]. The showed slow improvement, especially for multifamily units, the latter something we've seen all this year. For all the feel-good headlines, residential construction is still only level of January 1992 when the population was 20% smaller [321 mil today vs 255 mil then]. Corrected for population growth, the adjusted rate is still below any point of the last 60 years – we're at about the 1990 trough, but still below the level of the early 1980s housing bust. [If numbers are bad on radio, graphs are worse, but I can include here!] The recent peak was in January 2006. Today we're at half that level [49%] in per capita terms. Times are good only if you don't remember what things were like a decade ago, before the Greenspan-Bush bubble burst: relative to April 2009, well, housing starts are 2.4x that level! The bottom line is that housing continues to be a big drag on the economy.

Tuesday, August 18, 2015

China: yuan depreciation or dollar appreciation?

by Mike Smitka, Economics, Washington and Lee University

forex BIS

The coverage I've read focuses, implicitly or explicitly, on the RMB [yuan 元] / US$ rate, that is, the bilateral context. (An exception is the graph in the latest Economist article, The Devaluation of the Yuan: The Battle of Midpoint, 15 Aug 2015, 63). Their focus is however capital flows, which as I've blogged about before in "China's Pending Depreciation" [on this blog] and "Foreign Exchange Controls" [on my Econ 274 "China's Economy" class blog] will lead to a fall in the value of the yuan – exactly what's happened.

Ho, hum: the 3% change still leaves the yuan stronger than in September 2008

Wednesday, June 3, 2015

How to Grow a Financial Business: Bubbles vs the Long Haul

I've been struck by the correlation between large shifts in the flow of funds and bubbles, but haven't found data other than for the US and Japan, and those metrics aren't directly comparable. So let me go from the macro(prodential) to the micro behavioral: how can you grow a financial business? There are three ways:

  1. provide better service
  2. price below competitors
  3. take on more risk than competitors

Monday, May 11, 2015

Employment: tortoise slow, tortoise steady?

Since Summer 2011 job growth has generally outpaced population growth, adjusting for the retirement of the baby boomers. However, it's a small mountain that we need to climb, given the severity of the Great Recession. As a result, the economy remains several years away from normal levels – an optimistic projection shows we might be back to normal as early as summer 2017. More realistically, we're looking at late 2018 or early 2019, given headwinds to the economy. These include slowing global growth and a strong dollar, and the end of the oil boom, which is hurting investment faster than lower gasoline prices are adding to consumption. In any case, the economy remains 6 million jobs shy of where we need to be. That's reflected in many things, large and small. To give one example, I sit on the board of the local United Way of Rockbridge. We hear that local non-profits that attempt to meet emergency needs for utilities, food and rent see more rather than less need, with more working poor showing up than two years ago: jobs are failing to provide income sufficient to keep up with long-run needs.

Friday, May 1, 2015

Lambo: A Rampage of Conspicuous Consumption

mike smitka

If vehicles were purely practical devices to get from point A to point B then car enthusiasts would not exist. Colors? – everything would be gray, easier than white but cooler and less prone to showing dirt than black. Acceleration? – why? Comfort, yes, critical for the commuter, and autonomous cruise control would be part of every vehicle, overriding any attempt at aggressive driving while eliminating rear-end collisions. Perhaps seats could be customized for those unusually tall or short, or for the minority with trim physiques. Sizes, well, there surely would need to be a range, from 2-seat commuters to soccer mom SUVs. And cost! – without superfluous variety, engineering and tooling would be spread across production runs of a few million, while advertising would be unnecessary. There'd be no need to maintain much inventory in the system, either -- in contrast to the 60+ days of inventory in the system today, and the megadealer with 300 vehicles on their and hundreds more off-site. Repairs would be cheaper, and so would insurance, so depreciation aside, the cost of ownership would be lower. Used cars would likewise be a commodity, carrying a minimal markup, and easy to sell.

Elephants in the Room! Startling New Studies Revealed!


Two important automotive conferences were held in New York City recently in conjunction with the New York International Auto Show. The first conference was the J. D. Power Automotive Forum, followed the next day by the Driving Sales President's Club Event. The conferences had at least one thing in common. They both were launching points for two new surveys regarding what consumers supposedly want in their retail shopping experience, based on consumers answering questions to survey questions. AutoTrader released its new survey at the Power conference while Driving Sales revealed its own survey the next day at their own conference. The presentations of these survey results were rife with anecdotes. Both "studies" "proved" what some people have been trying to prove for decades, that consumers prefer not to negotiate and don't like the sales process.

...the continuation of attempts to predict auto buying behavior by asking survey questions instead of observing actions...

Notes from the International Car Rental Show April 2015

Ruggles/Wards/Bobit Media

I was recently privileged to attend the International Car Rental Show, held at Bally’s Las Vegas. I have attended this show in previous years and always came away with something noteworthy. This year, for the first time, the show included a break out track for auto dealers. While my primary interest was keeping up with all things car rental as they impact residual values going forward, I felt compelled to attend the car dealer sessions. And was I in for a shock.

Pardon the Sarcasm


I am astonished that the new “hot trend” in auto retail is thinking that a car deal should be accomplished in an hour or so. Hell, it takes almost that long to explain how the infotainment system works, let alone the other gadgets in a new vehicle.

How long does it take to go over all of the forms demanded by government regulation, or do we just have the customer sign them without reading them? After all, we want our customers to be happy, right?