The Pete Davis Archives

Financial Reform Is About To Be Gunned Down In The Senate

Pete Davis — Sun, 14 Mar 2010 02:47:30 +0000

Next Monday, Senate Banking Chair Chris Dodd (D-CT) will introduce his financial reform bill without Republican support, despite pledges of Senators Richard Shelby (R-AL) and Bob Corker (R-TN) to work with him. Our recent worst financial crisis since the Depression cries out for major changes, but our broken government may fail to enact them. Absent public outcry, heavily financed industry lobbying will gun down financial reform in the Senate this spring.

Why?

Consumer Financial Protection Agency -- Give it too much independence and authority, and it might stop financial predation of consumers, or it might stop financial innovation. Which is it? It all depends on where you sit. Obviously too many people of insufficient means became homeowners, at least seven million of whom have or will face foreclosure. Were they speculators who deserve what's coming, or were they taken advantage of by mortgage companies gobbling up quick profits by selling the American dream without asking too many questions? Housing a CFPA within the Fed or the FDIC or Treasury would be in direct conflict with their duties to regulate banks. It would be like putting the district attorney in charge of public defenders. An independent CFPA could damage the industry and probably would, until it was captured by the industry like most other Washington regulatory bodies. I would note that we demand lots of consumer protection for cars, drugs, food, and baby strollers, but comparatively little when it comes to new financial products.

Derivatives -- Exchange trading of standardized products and increased transparency sounds good until you start talking with end users of jet fuel, agricultural products, metals, etc., who had nothing to do with causing the financial crisis, but who will incur increased costs. Any exceptions you make for end users will eventually be broadened by Congress to gut these protections and would lead to the next financial crisis.

Too Big To Fail -- At least there's some bipartisan agreement here. Set up a council of regulators with clear authority to take apart large financial institutions of any kind. Increase capital requirements, and put limits on leverage. However, the Administration would go one step further and leave some Senate Democrats and most Senate Republicans behind by imposing a tax on institutions with assets over $50 billion of 0.15% of their liabilities. The idea is to tax risk and use the proceeds to repay the taxpayers for TARP. This populist appeal runs into problems when you start looking at who would pay and how responsible they were for this financial crisis or might for the next one. Most of the bad actors are gone already. If similar taxes aren't imposed on other world financial centers, our affected institutions would labor at a competitive disadvantage or shift operations and jobs overseas.

These issues are not easily resolved, but that doesn't mean we should stand by and watch financial reform get gunned down in the Senate. Our kids are going to have plenty of our debts to pay for without leaving them unprotected against the next financial crisis.

Thank You Marjorie Margolies-Mezvinsky

Pete Davis — Fri, 12 Mar 2010 23:13:33 +0000

I've always wanted to thank Marjorie Margolies-Mezvinsky (D-PA) for her courageous deciding vote for President Clinton's 1993 deficit reduction bill. Her Republican colleagues jeered her as she walked down the aisle to cast her vote with shouts of "Bye, Bye Marjorie!" Her crime -- voting for the Omnibus Budget Reconciliation Act of 1993 that reduced the FY94-FY98 deficits by an estimated $496 b., with $241 b. of tax increases and $255 b. of spending cuts. The bill capped a 12-year deficit reduction effort, leading to the budget surpluses of FY98-FY01. She paid the political price, losing her seat in suburban Philadelphia after her first term in office, but she set the U.S. economy on course for its strongest decade since the 1960s.

Now that we face the hard choices on reining in 10% of GDP deficits and runaway health care costs, who in today's House of Representatives will provide the deciding vote in favor of the Senate health reform bill, H.R.3590? Whoever it is may lose their seat. Charlie Cook recently said, "If current trends continue, the Republicans could take the House." That's what happened in 1994. As then, there is no easy bipartisan solution to our health care and deficit problems. The Senate version of H.R.3590 is flawed to say the least, but, in my opinion, it's a lot better than doing nothing. We have to attack inefficient and ineffective health care and unsustainable deficits. If we shy away, we will suffer prolonged low growth and high unemployment. Sometime before the start of the Easter recess on March 26, 2010, we'll find out whether another Marjorie Margolies-Mezvinsky can be found.

Antiquated Air Traffic Control and Fedex v. UPS

Pete Davis — Thu, 11 Mar 2010 01:26:31 +0000

Today, the Senate turned to the Federal Aviation Administration authorization, H.R.1586. The last four-year authorization expired September 30, 2007. What caused this 2½ year delay? Congress couldn't agree on how to apportion the excise and ticket taxes to pay for a desperately needed modernization of the air traffic control system. Your car has GPS. Your phone has GPS. Commercial airliners have GPS, but the air traffic control system still relies on radar and radio position reports. That costs billions of dollars in extra miles traveled every year. The airlines correctly believe they pay more than their fair share of the costs, but private pilots (I used to be one.) have more political clout and refuse to share more costs. Then there's the problem of Memphis, TN-based Fedex's avoidance of a union for its workers, which puts it at an advantage over its main competitor, unionized United Parcel Service. The House version of H.R.1586 would apply existing labor laws equally to both companies, but that prompted Tennessee Senators Lamar Alexander (R-TN) and Bob Corker (R-TN) to hold up the bill. They relented when they concluded they have the votes to kill the bill before it goes to President Obama if it includes the Fedex provision. Airline objections to increased inspections of foreign repair shops are another hangup, as is a provision to publicize pilot performance information, and the killer -- your yet to be enacted right to food, water, and a bathroom after getting stuck on the tarmac for 3 hours. As always, the traveler in me must trade off with the economist in me weighing the additional costs. I haven't done the analysis, but the fuel and time savings from improved air traffic control would sure seem to outweigh the costs.

"The Great Prostate Mistake"

Pete Davis — Thu, 11 Mar 2010 00:40:00 +0000

Richard J. Ablin is the University of Arizona research professor who discovered the prostate-specific antigen (PSA) test in 1970. Today, in a New York Times op-ed, he decried the misuse of that test by health care monopolies to drive up profits with promises of catching prostate cancer early. First of all, the test can't detect cancer. Screening most men over age 50 costs over $3 billion a year, but has been proven in two recent studies to have little or no effect on life expectancy. Only 16% of men will ever be diagnosed with prostate cancer and only 3% will ever die of it. A European study concluded 47 men suffer grievous treatments that result in loss of sexual activity and incontinence for each life saved. Professional associations are beginning to recommend against PSA tests, but not those captive of the drug companies. Ablin concluded, "I never dreamed that my discovery four decades ago would lead to such a profit-driven public health disaster. The medical community must confront reality and stop the inappropriate use of P.S.A. screening. Doing so would save billions of dollars and rescue millions of men from unnecessary, debilitating treatments." The profit motive in competitive markets has proven benefits, but, in monopolistic markets, it leads to uncontrolled costs and, in this case, to human suffering.

Reconciliation

Pete Davis — Sun, 28 Feb 2010 00:44:06 +0000

"Reconciliation" is getting a lot of attention in Washington lately. Most understand a reconciliation bill can pass the Senate by majority vote after 20 hours of debate, but that's often where the understanding stops. Reconciliation originated in the Congressional Budget and Impoundment Control Act of 1974 as an optional means of changing (mostly) entitlement spending, but not Social Security, and taxes to achieve the deficit target set forth in the budget resolution. Because a reconciliation bill has a high likelihood of becoming law, it quickly became a magnet for extraneous amendments, which Senator Robert C. Byrd (D-WV) deterred in 1985 with the Byrd Rule, now Section 313 of the Budget Act, which lays out six criteria for determining what is extraneous. Implementing these rules in the Senate has become so complicated that no one can be entirely sure of what will emerge until the Senate Parliamentarian has ruled.

So how would this affect health reform? Any section of the bill that doesn't change budget authority, outlays, or revenues would be knocked out. Out would go definitions, administrative provisions, abortion spending prohibitions, insurance reforms that lack direct budgetary effects, and etc. Out would go any provisions that boost the deficit in the five years after FY14, unless their overall effect from FY09 through FY19 was to reduce the deficit. Out would go any provisions outside of the jurisdictions of the Senate Finance and HELP Committees. To me, that would leave remnants of health reform that couldn't be properly implemented or interpreted the way Congress intended. However, my friends on the Senate Finance Majority staff, who are far more knowledgeable than I, tell me that they have found ways to draft around these impediments to produce a health reform bill that can be implemented. House Democratic leaders have drafted a reconciliation bill as well. All that remains is to pass them, work out a compromise, pass the conference report in both houses, and send it off to the president.

Reconciliation may not be that easy because enough Democrats in both houses of Congress may oppose ramming a bill through which contains provisions they oppose and lacks a public insurance option. Republicans have long threatened to shut down the Senate if the Democrats "go nuclear" with reconciliation to pass health reform. Like most intense conflicts, there will be no clean victories, only bloody confrontation with mixed results.

CBO Director Doug Elmendorf Offered A Sobering Jobs And Budget Outlook Today

Pete Davis — Thu, 25 Feb 2010 22:58:33 +0000

Congressional Budget Office Director Doug Elmendorf addressed the National Economists Club luncheon today in D.C. He started with the good news: "In the near term (FY10-FY12), we expect the economy to recover." However, his job outlook was grim: "More pain of unemployment lies ahead of us than behind us." That's because this recession has had much more permanent job loss than past recessions and because our recovery is likely to be weak, with subpar job growth. We've lost 8.5 million jobs so far, and it would take 11 million new jobs to reach the level we would have had if the recession hadn't occurred. He expects the unemployment rate to drop to 5% by FY13, but, "That's a long ways away."

The deficit outlook is grim also. We closed FY09 last September 30 with a 9.9% of GDP deficit, and CBO estimates this year, FY10, will end at about 9%. FY12 drops to 4% under present law, but that assumes the Bush Tax cuts, equal to 2% of GDP, will expire -- a very unlikely event, so FY12 has a 6% of GDP deficit under current policy. The 3% of GDP deficit decline over the next two years breaks down into 2% from the expiration of the American Recovery and Reinvestment Act stimulus bill and 1% from automatic stabilizers. Federal debt held by the public was 40% of GDP at the end of FY08, and it will end FY10 just over 60%. Assuming the extension of the Bush tax cuts and no other changes in policy, it would reach 87% of GDP by FY20.

CBO expects subpar economic growth averaging 2.4% of GDP in the medium term, CY13-CY20, because of this large amount of debt and rising interest rates. He expects the 10-year Treasury bond to reach 5.5% by CY16. Another factor weighing on economic growth is continued decline in labor force participation by men.

In the Q&A, Doug said deficit reduction wouldn't necessarily reduce growth if it was done gradually and with credibility. He added that our low savings rate and high current account deficits put us as "higher risk" of weak growth. He cited the work of Ken Rogoff and Carmen Reinhart to that effect.

Some of Doug's charts are on the CBO web site, and those used today may be posted on his blog.

Wyden-Gregg Tax Reform Proposal Would Lower The Top Corporate Rate To 24% And Keep The Top Individual Rate At 35%.

Pete Davis — Tue, 23 Feb 2010 20:48:33 +0000

I applaud the tax reform proposal just put forth by Senators Ron Wyden (D-OR) and Judd Gregg (R-NH). Lowering the top corporate tax rate is very important for improving the competitiveness of our exports, and keeping the top individual rate at 35% while repealing the dysfunctional Alternative Minimum Tax is an achievement in itself.

Tax reform is all about efficiency gains. They're not easy to measure. They don't lend themselves to politically charged sound bites, but they do improve long-run productivity. They level the playing field among businesses and individuals with similar incomes. Special tax breaks grow on the Tax Code like barnacles on the bottom of a boat, with similar effects. The more barnacles, the slower you go; the more tax breaks, the weaker the economy. However, barnacles on a boat are a lot easier to see.

I would hope for hearings at the Senate Finance and Senate Budget Committees this year, but I'd be surprised if Congress got serious about tax reform until at least a year from now. If the Tax Reform Act of 1986 is any example, it will take a strong push from the president to get this going. That effort started with the Bradley-Gephardt proposal of 1978, which I estimated when I was at the Joint Committee on Taxation. It took eight years of debate and political jostling to enact tax reform then. Hopefully, we can proceed more rapidly this time.

This 20th anniversary retrospective of the '86 Act is instructive.

See this 2005 CBO study of corporate tax rates around the world.

Here are corporate tax rates by state and by country from a 2008 Tax Foundation study.

One concern: The Wyden-Gregg proposal would encourage high income individuals to become Sub S and Limited Liability Corporations to enjoy the 24% top corporate rate, 11% points lower than the top individual income tax rate. That's too big a difference. Ideally, we should have identical top rates for corporations and individuals.

Health Reform, Or Is It?

Pete Davis — Tue, 23 Feb 2010 01:41:58 +0000

Today, as promised, President Obama released his new health reform proposal three days in advance of Thursday's Blair House summit. Senate Minority Leader Mitch McConnell (R-KY) said he will attend, so at least some Republicans will be there. It's anybody's guess whether we get health reform this year. To me, it looks like we'll either get a watered down bill or nothing but more political posturing. I'll bet every Congress for the next 10 years passes another health reform bill too. I just hope we don't end up with the aimless policymaking like we've had with energy legislation since the 1973 energy crisis.

A quick look at President Obama's plan certainly raises concerns about busting the budget more than it already is. He would:

Increase tax credit subsidies for low-income Americans to buy health insurance
Close the Medicare prescription drug "donut hole"
Lower the penalties on individuals who don't buy health insurance
Provide $40 billion to help small businesses afford health insurance
Delay the excise tax on "Cadillac" insurance plans from 2013 to 2018 and raise the thresholds
Delays the excise taxes on medical device manufacturers to 2013 and health insurers to 2014

Mr. Obama estimates his plan would save $100 billion over FY11-FY20 and $1 trillion over FY21-FY30, however those estimates depend upon a lot of changes in health decisionmaking by patients and by providers that may or may not occur. Health insurers are already jacking up rates to beat the gun. Health monopolies are buying up competitors as fast as they can to beat the gun. If we can have "too big to fail" financial institutions, why not "too big to fail" health providers? Doctors need to provide more cost effective diagnoses and treatments, but too many are quitting the professional in disgust at the way they have to practice medicine. We're not training enough nurses, so we're importing them from overseas. There's a jobs program in reverse. Meanwhile, the average American is overweight, doesn't exercise, and eats a lot of low nutrition fast food at the urging of a lot of slick advertising.

Let's wake up people: It's going to take a lot more than a weak health reform bill this year to fix our health system. If we do nothing, we can just wait for higher health insurance rates to drive the next march on Washington.

Jobs Bill Just Got Bipartisan Senate Support

Pete Davis — Tue, 23 Feb 2010 00:58:01 +0000

It's too early to get our hopes up for sustained Senate bipartisanship, but just before 6 p.m. tonight, five Republicans joined 57 Democrats to invoke cloture on Senator Harry Reid's (D-NV) amendment to the House jobs bill, H.R.2847. Newly elected Scott Brown (R-MA), Kit Bond (R-MO), Sue Collins (R-ME), Olympia Snow (R-ME), and George Voinovitch (R-OH) voted with the Democrats. Ben Nelson (D-NE) was the only Democrat to vote with the Republicans. Not voting were Frank Lautenberg (D-NJ), who is hospitalized for stomach cancer, and eight Republicans, who ducked the vote. So far, Reid's amendment would be limited to $12 b. FY10-FY12, and it's "paid for" over 10 years, but amendments could add to that, and it will grow larger in any compromise with the House's $65 b. FY10-FY19 bill.

Reid's amendment is outlined here, and its CBO cost estimate is here.

The House bill is described here, and its cost estimate is here.

I'm not a big fan of throwing money at job creation because too much is spent ineffectively or too late, but I am concerned enough about declining economic growth in the second half of this year to believe that additional stimulus is warranted. The Fed is going to stop buying mortgage backed securities at the end of next month, several million mortgage foreclosures will be finalized during the second half, commercial real estate will continue its decline, and banks remain reluctant to lend,

I am hopeful that the Senate can continue to find ways to hammer out bipartisan compromises on these issues which cry out for legislation:

Jobs bill
Deficit reduction for FY12 and beyond
Already expired:
1. Estate Tax, currently repealed, but jumping to 2001 law in 2011
2. 71 other expired tax provisions, including the R&D tax credit.
About to expire:
1. Highway authorization
2. flood insurance
3. postponement of the 21% cut in Medicare physician reimbursement rates
Defense supplemental to fund the Iraq and Afghanistan wars
budget resolution
Confirm non-controversial judges and other presidential appointees on "hold" for reasons having nothing to do with their qualifications.
Financial reforms

Simulated Q&A With Ben Bernanke and Barney Frank

Pete Davis — Sat, 20 Feb 2010 15:13:07 +0000

Before every major Hill hearing, staff prepare a briefing book for the Chair with simulated Q&A and background information. I imagine the following for next Wednesday morning's Humphrey-Hawkins hearing with Fed Chair Ben Bernanke.

Q. from Chair Barney Frank: "Mr. Bernanke, where are the jobs?"

Expected A: "We create the best possible monetary conditions for job growth. Under the law, that's all we can do."

What Bernanke would like to answer, but won't: "Zero interest rates aren't easy enough money for you! If Congress wasn't always pushing for easy money, we might not be in this mess."

Followup Q.: "Mr. Bernanke, isn't it true that on the night of September 16, 2008, you bailed out AIG with $85 billion of taxpayer money that could have been used instead to create jobs?"

Expected A: "When your neighbor's house is on fire, you don't hire more household help, you fight the fire."

What Bernanke would like to answer, but won't: "Let's trade places here and see how well you do!"

Q. from Chair Ben Bernanke: "Mr. Frank, where are the jobs?"

Expected A: "We threw $787 billion at job creation last February, and we're getting ready to throw some more."

What Frank would like to answer, but won't: "You control the FOMC. You can do anything you please! I've got to scrape up the votes and keep the people back home happy. How many tea parties have been held on Constitution Avenue? Ted Kennedy was my friend. Now I've got to work with Scott Brown!"

Followup Q.: "Mr. Frank, isn't it true that on the afternoon of July 23, 2008, you voted for a plan you created to bail out Fannie Mae and Freddie Mac to the tune of $200 billion each?"

Expected A: "When your neighbor's mortgage is underwater, you send in Fannie Mae and Freddie Mac to buy it. We can't kick voters out of their homes."

What Frank would like to answer, but won't: "Give Fannie Mae and Freddie Mac back to me. These government conservatorships are bad for getting reelected."

Final Q: "Mr. Frank, who is going to pay for all of this? The Fed isn't a piggybank."

Expected A: "It isn't?"

Watch what actually transpires on the House Financial Services Committee web site.

The Deficit Threatens Fed Independence

Pete Davis — Thu, 18 Feb 2010 04:19:43 +0000

I too attended yesterday's Peterson-Pew Commission on Budget Reform Policy Forum, and I highly recommend that you watch it for several reasons:

1) Kansas City Fed President Thomas Hoenig offered a blunt and chilling statement:

"It is a fact that the current outlook for fiscal policy poses a threat to the Federal Reserve’s ability to achieve its dual objectives of price stability and maximum sustainable long-term growth, and therefore is a threat to its independence as well." In other words, future deficits are so large that the Fed may lose the political support it needs to stop inflation.

2) Peterson Foundation President and Former Comptroller General of the United States David Walker gave a succinct and compelling critique of federal budgeting. This is the famous speech he has given in just about every state in the country over the past several years. It's short in riveting.

3) Morgan Stanley Chief U.S. Economist Dick Berner predicted that interest rates could rise sharply to 5½% on the 10 year Treasury from 3¾% currently in a year or two if we do nothing about our deficits as foreign investors just slow down their purchases of Treasury debt. Sharply rising interest rates will make it difficult to restore a strong economy.

4) Former Congressmen Charlie Stenholm (D-TX) and Jim Kolbe (R-AZ) offered their views after fighting in the deficit reduction trenches during their long careers. Of particular interest to me was their assessment that the American people need to be told the truth -- what a concept -- but no one is doing that yet.

5) Former Congressional Budget Office Directors Rudy Penner, Bob Reischauer, and Doug Holtz-Eakin explained more detailed economic and political dynamics of deficit fighting. Doug proposed one metric for measuring progress, or the lack of it, in reestablishing responsible budgeting, the public debt as a percentage of GDP. It was 36.2% at the end of FY07, 40.2% in FY08, 53.0% in FY09, and it's headed to 60% in FY11. That burgeoning debt is unsustainable.

6) Former Clinton White House Chief of Staff John Podesta brought the view from a Democratic White House. As you might expect, he laid the blame squarely on President George W. Bush for large tax cuts, two wars, and Medicare Part D, none of which were paid for. Now that we're in this mess, he doesn't see any way out without higher taxes on the rich.

7) Top economists Martin Bailey of Brookings and the Peterson Institute and IMF economist Carlo Cottarelli ably presented the latest research on the economic crisis and what needs to happen for the U.S. to return to a reasonable economic growth path.

8) Political Scientist Norm Ornstein, Atlantic Monthly Senior Editor Clive Crook, and Clinton/Gore campaign spokesman Jamal Simmons gave their observations on the breakdown of governance in Washington and back home. Ornstein recommended mandatory voting to restore the middle in U.S. politics. Crook concluded that the public is not scared enough of deficits yet to force their leaders to make tough decisions.

I saw a lot of good friends in the room, so I came away with some hope that we might restore some fiscal responsibility over the next few years, but I admit, it's going to take a lot more than one good conference to make that happen.

I commend Committee for a Responsible Federal Budget President Maya MacGuineas for putting such a fine program together and for an excellent job moderating it.

Here's the event summary.

Are We Governable?

Pete Davis — Tue, 16 Feb 2010 03:26:49 +0000

We certainly aren't acting like it. It's time to reflect when good people -- well liked on both sides of the aisle and certain to be reelected -- bow out. Senator Evan Bayh's (D-IN) retirement announcement today was a shocker. Read his statement. I would lift up:

"After all these years, my passion for service to my fellow citizens is undiminished, but my desire to do so by serving in Congress has waned. For some time, I have had a growing conviction that Congress is not operating as it should. There is too much partisanship and not enough progress -- too much narrow ideology and not enough practical problem-solving. Even at a time of enormous challenge, the peoples’ business is not being done."

He cited the failure to pass the bipartisan deficit reduction commission and the failure to pass the jobs bill as evidence. He's fed up and has decided he can be more effective elsewhere.

Senate Majority Leader Harry Reid (D-NV) was understandably livid to be informed of Bayh's decision at 11:30 a.m., just after it leaked to the press. This put him and Senate Democrats at a huge disadvantage, both in terms of immediate public relations and in terms of the appearance that the Democrats are on the run going into November's election. Former Senator Dan Coats (R-IN) has a good chance to wrest the seat from the Democrats. Delaware and North Dakota will almost certainly flip to the Republicans, Charlie Cook lists five other Democrats in tight races: Lincoln (AR); Bennet (CO); (IL) Burris retiring; Reid (NV); and Specter (PA). He also lists four currently Republican seats that are tossups because of the retirements of Bond (MO); Bunning (KY); Gregg (NH); and Voinovitch (OH). Right now it doesn't look like the Republicans will pick up more than five or so, but that could change. The Senate is currently 59D-41R, so it would take a 10 seat pickup to flip it.

No matter what happens in November, the Senate is likely to fail to do the people's business. Action is desperately needed on a wide range of issues. Here's my short list of Senate actions required by the end of April:

Jobs bill
Deficit Reduction Commission
Already expired:
1. Estate Tax, currently repealed, but jumping to 2001 law in 2011
2. 71 other expired tax provisions, including the R&D tax credit.
About to expire:
1. Highway authorization
2. flood insurance
3. postponement of the 21% cut in Medicare physician reimbursement rates
Defense supplemental to fund the Iraq and Afghanistan wars
budget resolution
Confirm non-controversial judges and other presidential appointees on "hold" for reasons having nothing to do with their qualifications.

We also desperately need financial reform and health reform this year, or else we risk another AIG and skyrocketing health insurance premiums.

Unfortunately, we're going to test the theory that no action is better than action that confers partisan advantage.

PAYGO Statute Reveals 2011 Top Rate Of 20% On Capital Gains and 39.6% On Dividends

Pete Davis — Wed, 10 Feb 2010 17:28:42 +0000

Soon, President Obama will sign H.J.Res.45 to increase the debt limit by $1.9 trillion and to restore statutory PAYGO. The exceptions to PAYGO totaling $3.157 tr. (using estimates from the President's FY11 budget) reveal what Congress expects to pass later this year:

extending the Bush tax cuts ($1.865 tr. FY11-FY20) , except for those over $250,000 ($969 b.)
extending the estate and gift tax as in 2009 ($262 b.)
indexing the Alternative Minimum Tax ($659 b.) See the tables on pages 152-3.
lifting the 21% Medicare physician pay cut ($371 b. See Table S-7 on page158)

The 15% top rate on capital gains and dividends for those under $250,000 would be exempt too, but not for those over $250,000. That means the top rate for those over $250,000 would revert to the 2001 20% for capital gains and 39.6% for dividends. OMB estimated keeping the 15% top rate on capital gains would cost $111 b. FY11-FY20, and keeping the $15% top rate on dividends would cost $233 b. Paying for either one seems prohibitively large to me, so, after this year, I'd expect a 20% top rate on capital gains and a 39.6% top rate on dividends.

Financial Crisis Was Rooted In The Corporate Income Tax Interest Deduction

Pete Davis — Mon, 08 Feb 2010 16:25:51 +0000

Washington invariably prefers the quick fix and ignores the underlying causes of whatever problem it faces. What better example than the financial crisis? At its most fundamental level, we underpriced the risk of mortgages and other financial assets. Why? President Obama and Congress have focused on the moral hazard of "too big to fail" financial institutions driven by bonus crazy CEOs making bets backed by government insurance. There's plenty of truth in that, but the deeper cause was easy money. A month ago, I defended Ben Bernanke's refutation of charges that the Fed's 2004 to 2006 easy money policy was to blame. So if, Fed monetary policy wasn't too easy, what was wrong? The corporate income tax deduction for interest produced a -6.4% tax rate on debt financed investments, while the double taxation of equity income (dividends and capital gains) produced a 36.1% tax on equity financed investments according to this 2005 Congressional Budget Office study. See Table 1. That negative tax rate is the root of the fiscal crisis. Taxpayers paid a large subsidy for Wall Street investors to take those risks.

Marty Sullivan of Tax Notes (a former Joint Committee on Taxation economist) laid out the evidence very well on September 28, 2008. He showed how huge tax subsidies for mortgage interest and corporate interest expense fueled the Wall Street conflagration of 2007 and since. He also cites the warnings of the Joint Committee and Treasury of twenty years earlier. What politician is going to raise taxes on homeowners and on big financial institutions when times were good to avoid a financial crisis two decades later? No way! President Bush's 2005 Advisory Panel on Federal Tax Reform made the same point, but it's recommendations were ignored too.

On April 15, 2008, Brookings scholar Jason Furman (now Deputy Director of President Obama's National Economic Council) made the same point before the Senate Finance Committee at the bottom of page 8 of his testimony. This New Yorker piece presents a well-written summary. Former Congressional Budget Office Director and McCain economic adviser Doug Holtz-Eakin made the same point on p.375 of this Tax Notes volume on October 23, 2006.

Yesterday, on NBC/s Meet the Press, former Treasury Secretary Hank Paulson called for tax reform to address "borrow[ing] too much" along with "too big to fail" regulatory reform, another recognition that our Tax Code is at the root of the financial crisis.

The hard part of tax reform is that you have to raise taxes on those getting the subsidies. There are far fewer of them than the many taxpayers who stand to get slightly lower tax rates, so Wall Street corporations will finance the lobbying to kill tax reform before it has to chance to prevent the next financial crisis. We'll end up with watered down quick fixes at best, and the roots of the next financial crisis will remain in the Tax Code.

Tax Cut Era Is Over Dave Stockman Just Said

Pete Davis — Sat, 06 Feb 2010 00:00:37 +0000

I could hardly believe my ears just now, watching former Reagan OMB Director Dave Stockman pronounce the end of the tax cut era on the PBS Newshour.

Stockman started by lambasting Wall Street gunslingers, of which he was one, for wrecking the financial system. Then he cited the AIG bailout as the worst policy mistake of our era. Then he said the deficits will have to be addressed, that the Reagan tax cuts failed to restrain government spending, and that we'll be forced to raise taxes from now on. That's an amazing turnaround from one of the original supply side torch bearers.

I formulated the Roth-Kemp tax cuts in early 1977 and couldn't conceive of their enactment. Four years later, I stood on the Senate floor in disbelief as they passed, wondering how long the red ink would last. The answer was 17 years. I saw plenty of wasteful spending along the way too. My Senate Budget Committee experience taught me that genuine deficit reduction is slow, tough work, which only succeeds when every tax loophole and wasteful spending project is attacked relentlessly, year in and year out, for decades.

I'm very concerned about the weakness of our recovery this year when the stimulus bill wears off in the second half of the year and when the Fed starts shrinking its balance sheet, so I would favor additional stimulus right now, particularly to avoid state government layoffs, but starting in 2011, we're going to have to get serious about spending cuts and tax increases -- just like Dave Stockman just said. Watch the video here.

"Tepid" economic recovery seen by Fannie Mae's Chief Economist.

Pete Davis — Thu, 04 Feb 2010 23:28:27 +0000

Doug Duncan told the National Economists Club at lunch today in D.C. that "We're not there yet [on stabilizing the housing market]." "So many things are going on that it's hard to sort out the effects." The most important driver of the housing market is private sector payroll. With the unemployment rate stuck above 10% for most of the rest of this year, the housing market turnaround will await stronger jobs growth.

Regional differences are quite large. Speculative activity was concentrated in California, Nevada, Arizona, and Florida. The upper Midwest has suffered tremendous job losses, hurting home prices there too. Elsewhere, once recovery takes hold, housing will return to normal, but, in those areas, it will take longer.

Duncan estimated excess housing supply at 7 million units : 780,000 excess homes based upon a 1.7% historical vacancy rate; 1.2 million rental units based upon a 7.7% vacancy rate; 500,000 vacant units currently held off the market; and 4.6 milion homes which are now seriously delinquent. If historical demographic demand holds constant, it will take until early 2013 to work off those excess 7 million units.

Distressed sales are currently running 30% to 40% of total sales. One in four homes in America today is worth less than it's mortgage. There's little research so far on how low home values have to go before homeowners walk away, but we're learning right now.

We'll have to find a sustainable homeownership rate. It peaked in June 2004 at 69.2%, and it appears it could stabilize around the current level of 66%.

"The central issue [for a housing recovery] is policy." Fifty percent of homes purchases today are FHA insured, up from 2.6% in 2005. The home purchase tax credit is behind many sales. The Fed has bought $1.25 trillion of mortgage backed securities, but it will stop at the end of March. Duncan estimated this would raise mortgage rates 25 basis points, but other estimates range from 0 to 75 basis points. Policy stimulus will drive the housing market until employment recovers.

Does The Economy Need -- And Can We Afford -- Another Jolt of Stimulus?

Pete Davis — Sat, 30 Jan 2010 00:28:04 +0000

This morning's Urban Institute discussion with Moody's Analytics Mark Zandi and Urban Institute Fellow Rudy Penner is well worth watching. Zandi recommended another stimulus bill of at least $200 billion, as Congress and President Obama have already embarked upon, and Penner questioned the "bang for the buck" of last year's stimulus and this year's additional stimulus. "The risk is that the politicians will put off the day of reckoning, but the world won't let us...There may be an Ireland in our future," Penner said.

Zandi sees between a 25% chance and a 33% chance that the recovery will stall late this year because of rising home foreclosures, commercial real estate failures, state and local government layoffs, and frozen bank lending. He noted that for the first time in history, in the third quarter of 2009, net credit in the United States declined. In other words, massive government borrowing was overtaken by private debt reduction. He warned, if housing prices resume their slide this year, "It's going to be a mess."

Penner said, "You can't ignore the pain out there." He recommended focussing on assistance for the poor and the unemployed and generalized aid to the states. In particular, he questioned the value of most energy and infrastructure spending because it takes so long to get spent. He would claw back such infrastructure funds which haven't been obligated yet. He admitted highway money has been spent faster than he expected.

Bottom Line: Zandi believes we can't take a chance that the recovery stalls, and Penner believes we need to spend less and to spend it more wisely.

Also check out Zandi's paper, "What Is Wrong With The Job market And How To Fix It."

Here are their bios.

President Obama made a number of market moving statements tonight.

Pete Davis — Thu, 28 Jan 2010 05:03:22 +0000

Bush tax cuts for the wealthy and on dividends and capital gains won't be extended. That means 2010 is the last year for the 35% top rate for individuals and for the 15% top rate on dividends and on capital gains. Those rates will go up to at least 39.6% and 20% respectively.

A jobs bill of roughly $150 b. will be on his desk in the next month or so. It will include a new tax credit for jobs created by small businesses and for increased wages to existing workers. It will extend unemployment benefits, COBRA health benefits, and provide more money to state and local governments to avoid laying off police, fire, first responders, and teachers. Neither House nor Senate bill includes bonus depreciation yet, but he called for it for all businesses, large and small. The House bill would be partially paid for with $75 b. of TARP.

Community banks would get $30 b. of TARP to lend to small businesses.

Tax increases for multinationals that export U.S. jobs. He reiterated last years proposal to limit deferral of offshore income, which went nowhere in Congress last year and will probably go nowhere this year.

Banks: A tax on liabilities to repay taxpayers and to limit risk. No more detail, just reiteration. One of the loudest applause lines of the night was "...we all hated the bank bailout. I hated it. I hated it. I hated it. You hated it. It was about as popular as a root canal."

Financial regulatory reform must have teeth, or he'll veto it: "Now, the House has already passed financial reform with many of these changes. And -- and the lobbyists are trying to kill it. Well, we cannot let them win this fight. And if the bill that ends up on my desk does not meet the test of real reform, I will send it back until we get it right. We've got to get it right."

Student loans: He called once again for the removal of subsidies for private lenders to make student loans and for a $10,000 higher education tax credit. Repayments would be limited to 10% of income, and the loan would be forgiven after 20 years, or, in the case of public service, after 10 years.

Energy: Nuclear and offshore drilling backed. Mr. Obama backed the green energy initiatives he's always back, without mentioning ethanol this time. He called for "building a new generation of safe, clean nuclear power plants in this country" and for "making tough decisions about opening new off-shore areas for oil and gas development."

Climate Change: Mr. Obama called for a "comprehensive energy and climate bill." He acknowledged those who question whether a weak economy can weather a climate change bill and those who question the scientific evidence of climate change, and he called for passing climate change because it's "the right thing to do for our future, [and] because the nation that leads the clean-energy economy will be the nation that leads the global economy, and America must be that nation."

Health reform: President Obama vowed to fight for health insurance reform in a lengthy and impassioned part of his speech. He concluded by offering to consider proposals from either party as long as they lowered premiums, lowered the deficit, covered the uninsured, strengthened Medicare, and stopped insurance company abuses.

Deficit reduction commission will be created by executive order. Despite his promise that this will be no ordinary commission, it will have a tough job getting the Senate to take up its recommendations without having any authority under law.

Statutory PAYGO: He called upon the Senate to pass this amendment tomorrow on the debt limit bill, H.J.Res.45. It will probably pass and become law along with a $1.9 tr. debt limit increase to $14.294 tr. That should be enough to last until a year from now.

Discretionary spending freeze to save $250 b. over the next 10 years. That's just over 4% of the underlying $6 tr. baseline. There are plenty of exceptions, defense, homeland security, veterans benefits, education, and probably some more we haven't seen yet.

Trade: Mr. Obama called for a doubling of U.S. exports over the next five years through a new initiative and for enforcing trade rules and for "shape[ing] a Doha agreement." No details here.

War: Iraq combat troops to come home by August.

New bioterror and infectious disease initiative. No details. Washington was stung by a Washington Post article by a respected former CIA official claiming we still have hardly any capability to deal with a bioterror attack.

Broken government: Mr. Obama offered a surprisingly frank discussion of how Americans have lost faith in their government in Washington. He challenged Congress to take responsibility, to lead on the tough issues, and to make the hard decisions. It sounded good, but it will take a lot more than eloquence to restore faith in Washington.

Obama's Spending Freeze Is A Budgetary Fig Leaf.

Pete Davis — Tue, 26 Jan 2010 02:55:43 +0000

This evening, the White House leaked President Obama's proposed three year freeze on non-defense discretionary spending not including certain Homeland Security, Veterans' Affairs, and International Affairs programs. That spending would be capped for the next three years at its current level of $447 billion, saving $250 billion over the next 10 years. That sounds like at lot of money, but it's not much when compared to the roughly $6 trillion of non-defense discretionary spending in the current services baseline budget. Most of that $250 billion will occur in the last five years of the next decade. With the decline of American Recovery and Reconstruction Act stimulus spending over the next few years, both OMB (Table S-3 on p.28) and CBO (Table 1-5 on p.20) show declining non-defense discretionary outlays from FY11 through FY13 already. Every little bit helps, but this is barely a budgetary fig leaf.

Middle Class Benefits Proposed by President Obama

Pete Davis — Tue, 26 Jan 2010 01:06:38 +0000

Just before noon today, President Barack Obama proposed five new middle class benefits that will be detailed in his budget next Monday:

Doubling the child care credit
Funding child care for 235,000 additional children
Supporting elder caregivers with counseling, training, transportation, and temporary respite care
Ensuring Federal Student Loan payments won't exceed 10% of income
Establishing automatic IRA's and expanding the saver's credit for working families

I am very concerned about the strength of our economic recovery during the second half of this year, but these tax cut won't have much impact on the recovery until at least a year from now if Congress passed them this spring.

We won't see official cost estimates until Monday morning, but these will undoubtedly add significantly to the deficit.

Targeting children and students through established programs makes sense to the extent that these children grow up to be more productive taxpayers. Too many elderly worked for employers without retirement plans or earned too little to set aside much for retirement, so I wouldn't object to a well designed program there either.

However, you have to ask yourself, when do the tax cuts stop? What about the Bush tax cuts? Last May, President Obama proposed extending most of them, except for those with incomes over $250,000, and recently his White House leaked the possibility that he might propose extending all of them. That would cost approximately $3 trillion over the next 10 years according to Treasury's Green Book. See Appendix Table B at the very back. The previous table shows that removing the Bush tax cuts for those over $250,000 would only save about 20% of that. Somebody is going to have to pay the taxes to restore fiscal balance in the face of the first ever trillion dollar deficits. Scott Hodge of the Tax Foundation shows that about one-third of individual income tax filers report zero or negative liability. Ten years ago it was only one-quarter and forty years ago it was one-fifth.

It will be interesting to see how much deficit reduction President Obama proposes.