• Political agency risk  
• Profiteering and rent seeking
• Enron as the poster child of "regulatory business"

Lomborg also cites research that questions the all to frequent "green collar jobs" mantra. As we've pointed out, the important question is what the net effect on employment is (green collar jobs created less other collar jobs lost). He concludes, "[T]he partnership among self-interested businesses, grandstanding politicians and alarmist campaigners is an unholy alliance." 

Of course, Lomborg is probably well aware that his arguments will do little to sway true believers on either side of the issue. In fact, it's likely to have the opposite effect, as research into political beliefs demonstrates:

...when partisans face threatening information, not only are they likely to “reason” to emotionally biased conclusions, but we can trace their neural footprints as they do it.

When confronted with potentially troubling political information, a network of neurons becomes active that produces distress...

The brain registers the conflict between data and desire and begins to search for ways to turn off the spigot of unpleasant emotion...

Not only did the brain manage to shut down distress through faulty reasoning, but it did so quickly... The neural circuits charged with regulation of emotional states seemed to recruit beliefs that eliminated the distress and conflict partisans had experienced when they confronted unpleasant realities. And this all seemed to happen with little involvement of the neural circuits normally involved in reasoning.

...Once partisans had found a way to reason to false conclusions, not only did neural circuits involved in negative emotions turn off, but circuits involved in positive emotions turned on. The partisan brain didn’t seem satisfied in just feeling better. It worked overtime to feel good, activating reward circuits that give partisans a jolt of positive reinforcement for their biased reasoning.

Here's a challenge to climate skeptics reading (and writing!) this post - try to avoid the partisan rationalization trap! Is climate change worth worrying about? You bet. In fact, what we like about Lomborg is his centrism and sobriety. Yes, he's a reviled scourge of climate change proponents, and a comforting presence to skeptics and deniers. But if the latter read him more carefully, he would probably be loved by no one - which makes him all the more compelling, in our view.

URLs:

http://online.wsj.com/article/SB124286145192740987.html

http://www.bbc.co.uk/blogs/newsnight/2007/08/the_political_brain_by_drew_westen.html

http://www.youtube.com/watch?v=8y06NSBBRtY

To be fair, the survey responses almost surely were inspired by institutional and economy level malfeasance and errors of judgement, as AIG was the lowest ranked financial services firm in the survey.

Whatever the perceptions behind the survey responses, it should be a wake up call to the industry.

URLs:

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090429/REG/904299977/1094/INDaily03&ht=

Tax evasion does occur, occasionally on a massive scale. But it's impportant to distinguish between evasion and avoidance. A profit oriented enterprise essentially has to avoid taxes, whenever it can do so legally, and our federal tax code clearly embodies this idea. The problems that Obama is focusing on relate to the inescapable reality that other countries also have tax policies, and that those policies can attract otherwise taxable business income away from the United States. The resulting phenomenon is known as "tax competition". In general, businesses love it, and bureaucrats hate it.

To the extent that businesses take advantage of international tax competition in ways that lack substance (i.e., evasion), stepped up enforcement makes sense, as long as there's a reasonable expected return on the resources invested. But what constitutes evasion? And who should the benefits of stepped up enforcement accrue to? Therein lie the risks, in our view.

First, the AP reports that Obama will seek to change at least one underlying legal principle:

Obama also planned to ask Congress to...implement a major shift in the way courts view guilt...Americans would have to prove they were not breaking U.S. tax laws by sending money to banks that don't cooperate with tax officials. It essentially would reverse the long-held assumption of innocence in U.S. courts.

Perhaps there's a valid debate here, given the extra-legal nature of some tax havens to U.S. law. We'll leave that to the legal philosophers. More important to us is the philosophy (philosophies, really) that will drive the eventual outcomes, and how they will impact long term U.S. competitiveness.

For example, based on the plan as telegraphed by the administration, there's little attention paid to the fact that a successful crackdown on tax evasion and avoidance should help lower the burden on those businesses not engaged in such activities. In technical jargon, a broader tax base should mean a lower tax rate. This mimics the philosophy embodied by Rep. Rangel's Ways and Means Committee since 2006, where the ultimate objective is increased public revenues, with scant lip service paid to increased U.S. competitiveness. It also echoes the plans to impose a cap and trade system without any announced intention to ease taxes or other regulations in order to offset the additional burden on the private sector (as we've pointed out before, taxing businesses for legitimate externalities - like CO2 if it is indeed the bugaboo it is reported to be - makes sense, and should precede any other kind of tax).

The worst case outcome here is that the overall tax burden on profit seeking business activity in the U.S. will become even less competitive than it currently is. If such a situation persists, it will mean lower domestic investment at the margin, with less employment, lower incomes than would otherwise exist (including to the U.S. Treasury!), and a significantly lower ability to meet looming demographic and other public sector challenges.

Secretary Geithner has just started his remarks...let's hope for the best, or at least something better than worst...

POST PRESS CONFERENCE: The President said some of the "right things" that were not in the AP article, including an emphasis on making tax burdens fairer, and making the business tax system more efficient. These principles leave the door open for reforms that would not be a worst case outcome. The competitive position of the U.S. in attracting private capital will almost certainly continue to erode, as the rest of the world closes the various competitive gaps. Tax reform and other public policies can either accelerate or dampen this process. Like so many other policy measures now underway, we'll have to wait and see what the sausage factory produces.

ON LABOR INCOME vs CORPORATE PROFITS: An important debate often left out of tax reform sound bites relates to who bears the burden of business taxation (see this Glen Hubbard op-ed, for example). There's still plenty of debate over whether corporate taxes impact labor income and wages significantly (our two cents is that in a world of multiple open economies, the impact on labor would be pronounced, moreso than for private, non-fixed capital). But whatever one's view, it does not appear that the current direction of the President's tax reform is going to provide much help for some important Democrat constituencies - namely, the working poor and certain unions. For example, the administration plans to make R&D business tax credits permanent, financing them with "crackdown" revenues. And while one of this country's biggest competitive advantages is the capacity of its labor force to provide high value added production - President Obama has observed this in prior speeches, and frequently makes the case for increasing that advantage through education and other policy reforms - R&D credits will have minimal impact, if any, on the availability of opportunities for unskilled and low skilled workers (one could even make a case that they are marginally negative). In one recent paper on who bears the incidence of corporate taxes, it was estimated that workers bore between 45 and 75 percent. Thus, if the pending reforms are not well designed, the majority of any crackdown effects are likely to fall on wage earners -- the very people that the majority party claim to represent -- rather than on business owners (of course, the labor-capital dichotomy is not quite what it used to be, as many workers are also owners of business capital, eg, when one owns shares in one's employer - but clearly, unless their labor income is less than the income from their shares of stock, the corporate tax hits them hardest in their paycheck - and it hits non-capital owning workers most).

URLs:

http://news.yahoo.com/s/ap/20090504/ap_on_bi_ge/us_obama_taxes

http://online.wsj.com/article/SB118541232986178417.html?mod=opinion_main_commentaries

www.people.hbs.edu/mdesai/PDFs/Labor%20and%20Capital.pdf

Several GOP senators did win approval of their amendments, including freshman Mike Johanns (R-NE), who secured adoption of language prohibiting climate legislation involving a cap-and-trade system from being considered under the fast-track and filibuster-proof procedure called "reconciliation." 

"[N]ow it will be possible to have the full and open debate this issue deserves," Johanns said after yesterday's 67 to 31 vote in favor of his amendment.

This measure appears to slow the push towards an emissions management system that in our view would lower the aggregate value of existing equity, at least in the short to intermediate term. It might also have a net negative impact on economic production (though some forecast that the long term cost of doing nothing would be higher), and it will certainly lower household incomes, although no one can say with certainty what the cost to households would be. There's a GOP talking point that puts it at $3,100 annually per family, while other studies put it below $500 on average. In any case, we suspect that some of the ~7% rise in equity values from Monday's lows, most of which occurred yesterday, could have been driven by this development.

However, there are at least two reasons for caution following this move up. First, as the Capitol Hill Reports story points out in a sidebar:

...There is no guarantee that [Sen. Johanns'] amendment -- or any other amendment adopted during Senate floor debate -- will find its way into the final version of the FY 2010 budget resolution. House and Senate Democratic leaders will have the final say on which provisions to keep, modify, and/or strike during the conference negotiations, which are expected to begin over the two-week Easter recess. It is also important to note that the annual budget resolution does not have the force of law, and therefore neither do the amendments adopted during committee and floor consideration that end up being preserved in the conference report. The final FY 2010 budget measure will provide only a broad framework for legislation drafted later this year, with the committees of jurisdiction deciding specific spending, tax, and authorizing provisions.

A second reason for caution is that this impressive equity rally (20%+ over four weeks) is getting a little long in the tooth by traditional measures. If cap and trade and/or other potentially costly measures work their way back into legislation in April, we could see a similar downside reaction. There's also a risk that a legislative down draft could be timed coincidentally with the old (though not foolproof) stock market adage to "sell in May and go away".

Our current view of things hasn't changed much, although as we'll outline in a future Idle Speculator piece,  our worst cases for the economy and equity markets are off the table barring any new developments. Our general outlook:

1. The U.S. economy should bottom in late 2009 or early 2010, the global economy in 2010.
   
2. Output and profits could rebound more sharply than expected, given the deep and sudden contraction they've been through.
   
3. U.S. employment should begin to rise some time in 2010, although it looks very unlikely that it will return to a 4-5% level any time soon. At the margin, this will intensify longer term demographic and fiscal challenges, and contribute to social unrest in the short to intermediate term.
   
4. Mister Market, going through one of his periodic bouts of depression, is still offering to sell attractive assets at steep discounts to their actual value. It's a wonderful time to be a stock picker, though that's an anachronistic misnomer, given how much more there is for sale in markets these days.
   
5. Our calculation of expected U.S. stock market returns is now only slightly below historic average returns. But demographics and the risk of additional shareholder dilution will be a drag on long and short term performance, respectively. Less developed markets and economies continue to offer the most attractive long term opportunities, with far more attractive demographics overall, plus rising productivity and low valuations. Policy making in mature economies (the U.S., Europe, and Japan) will continue to pose significant risks to developing regions, but from a long term perspective, the periodic crises they cause (including the present one) should be viewed as compelling investment opportunities. 
   

*** Our back of the envelope event analysis indicates that the legislative events around cap and trade are a plausible factor in yesterday's returns. That doesn't prove anything, of course, it just allows us to say that the evidence doesn't appear to disprove it.

Post script 4/6/2009: An interesting letter to the editor in the WSJ today regarding cap and trade from Greg Ebel, CEO of Spectra Energy Corporation, who argues that a revenue-neutral carbon tax is preferable to a cap and trade system:

Murphy's Law says that any system that can be gamed, will be gamed, and at the worst possible time. A cap-and-trade system is inherently and entirely gameable. The financial derivatives associated with emissions credits would be traded in a new hugely complex, multitrillion-dollar carbon market. So if you liked what traders did to our financial system with mortgage-backed securities and credit-default swaps, then you'll love what these traders will do to our environment.

There's some hyperbole at work in Ebel's letter, and some of it could be motivated by competitive concerns. We also believe that investment bankers, rating agencies, insurers, and policymakers are more culpable than traders for the mortgage mess, though this could be a semantic argument. But Ebel's point about gaming is absolutely valid, and there are plenty of real life examples, including energy markets and Enron. A true externality - like carbon emissions, if curbing them is as critical to human well being as proponents say - is the ideal target for taxation. And as we've argued previously, the optimal tax rate is most likely to be found via referendum. But the revenues from such a tax should accrue to citizens as broadly as possible. With cap-and-trade, there's a significant risk that privileged firms will be able to enrich themselves without making the revenue capture any more efficient.

URLs:

http://www.capitolhillreports.com/040209.htm

http://www.lasvegassun.com/news/2009/apr/03/climate-change-law-will-cost-how-much/

http://www.wealthmanagermag.com/Issues/2008/7/Pages/Sell-in-May-and-Go-Away--Not-so-fast--according-to-the-numbers-.aspx

http://www.sscommonsense.org/page04.html

http://online.wsj.com/article/SB123897674519391303.html

http://en.wikipedia.org/wiki/California_electricity_crisis

First is a letter to the WSJ editorial page by our friend Ray Galkowski at Par Capital, LLC, in response to an op-ed by Berkeley economist and Clinton Labor Department chief Robert Reich:

Mr. Reich argues that the primary philosophical difference between Messrs. Reagan and Obama is that Reagan tried to advance economic growth with "top-down" policies, while Mr. Obama is working through the more egalitarian "bottom-up" approach...

In fact, it is Messrs. Obama and Reich who are attempting to manipulate from the top down by taking resources from every American and allocating it as they, the central planners, see fit. It is Messrs. Obama and Reich who are disregarding what we the people want. What could be more conceited than that?

In his letter, Ray captures the traditional American sentiment towards taxation rather well. But are his letter and the similar ones accompanying it a harbinger of a national tax revolt? We think it depends on how heavy the overall tax burden gets in coming years. Because tax revolts unfold at the margin, each increase is a potential catalyst. And on that count, there has been evidence of increasingly heavy handedness by government treasuries. In the U.S., Congress is pushing tighter loopholes for expatriates, and the President's budget allegedly imposes a less generous tax schedule on estates in 2010 (that's according to the WSJ editorial page - we haven't read the legislation yet). By themselves, these aren't likely to catalyze much. However, as the proverb notes, every straw in the camel's hay bale counts.***

It's also worrisome that expatriate initiatives appear to be spreading, which could put globalization at further. In Bahrain for example, a new labor tax was enough to spur protests, while India has been pursuing a parallel tack on citizens employed abroad by multi-nationals.

If there's any upside, it's that some countries, such as Canada and Brazil, continue to lead in positive directions on taxes. Who would have thought fifteen or twenty years ago that those two countries would become the western hemisphere's leading lights on economic policy? It boggles the mind.

***Tobacco excise taxes could be a stronger catalyst, given the larger number of people impacted, and the intensely contradictory thinking behind them, ie: the tax will produce revenue for desired programs like health insurance for children, AND it will also deter the undesirable behavior from which those revenues are derived. If the deterrence aspect proves effective, where's the slack going to be made up? By cutting other programs? Not without a tax revolt. Higher tobacco taxes should also provide a small windfall for Indian reservations and nicotine smugglers, in addition to tobacco companies, who have reportedly already raised their prices, although this could be due to tax induced demand spikes (an ironic side note in that last linked article - a grandson of tobacco giant RJR's founder heads a foundation called Smokefree America - we're speculating, but would assume that he's able to do so at least in part because of the wealth amassed from dear old grand dad's cancer sticks!).

URLs:

http://en.wikipedia.org/wiki/Tax_revolt 

http://ballotpedia.org/wiki/index.php/Tax_revolt 

http://online.wsj.com/article/SB123846479778072325.html 

http://online.wsj.com/article/SB123819895769662043.html 

http://online.wsj.com/article/SB123431935722571333.html 

http://in.reuters.com/article/indiaDeals/idINIndia-38724720090326 

http://in.reuters.com/article/governmentFilingsNews/idINSPG00024520090330 

http://www.kpmg.ca/en/services/tax/documents/20082009General_English_Jan312009_WEB.pdf 

http://news.google.com/news?um=1&ned=us&hl=en&q=tobacco+taxes 

http://www.wowt.com/news/headlines/42125942.html 

http://www.timesdaily.com/article/20090331/ARTICLES/903315024/1011/NEWS?Title=Tobacco-sales-soar-pending-tax-increase 

The Black Swan theory (in Nassim Nicholas Taleb's version) refers to a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations. Unlike the philosophical "black swan problem", the "Black Swan" theory (capitalized) refers only to events of large consequence and their dominant role in history...

The term black swan comes from the assumption that 'All swans are white'. In that context, a black swan was a metaphor for something that could not exist. The 17th Century discovery of black swans in Australia metamorphosed the term to connote that the perceived impossibility actually came to pass. Taleb notes that John Stuart Mill first used the black swan narrative to discuss falsification.

Well, way back in May 2008, a clever chartist with a sense of humor found the dreaded black swan lurking in a chart of the S&P 500. We're coming across it a bit late, but it's definitely worth a look: http://img208.imageshack.us/img208/8818/blackswanchartael4.png.

A detailed and nuanced analysis is available here.

No surprises among the sponsoring organizations, which include American Spectator, Heartland Institute, Americans for Tax Reform, and National Taxpayers Union, so we aren't making too much of it yet. But if their membership ranks were to swell and diversify, either directly or in sympathy, then we would infer that TR2 is gaining significant traction.  We think that could begin to happen in 2011-2014.

However, if the opposition party remains relatively impotent (insert Bob Dole/Viagra pun here), as it did in the late 1930s, then the revolt probably won't get very far. Instead, the best hope for sensible tax reform might be a realization among some key Democrat constituencies that our corporate code is becoming an increasingly severe competitive disadvantage, and also hampers the government's ability to fulfill on long term social promises. If that conversation were to unfold, it might be possible to extend it to personal and payroll taxes as well. We have no idea what the probability of that is - we suspect it's not very high - but if it occurred, it would be a very bullish development. 

...a wave of energy companies has in the last few months announced plans to move to Switzerland -- mainly for its appeal as a low-tax corporate domicile that looks relatively likely to stay out of reach of Barack Obama's tax-seeking administration. 

This is interesting to us, because we recently had to vote a Swiss "redomestication" proxy for an energy stock that was recently transferred into one of our clients' accounts. What caught our attention was that the move was not from a U.S. location, but from a traditional Caribbean tax haven! We've noted elsewhere that the IRS has been diligently working at cracking offshore tax havens, using both carrot and stick approaches. Interestingly, these energy companies are moving to the one country that has received the 'stick' most publicly in recent months.

URLs:

http://www.reuters.com/article/rbssEnergyNews/idUSL312427120090312?feedType=RSS&feedName=rbssEnergyNews&rpc=22 

"Advisers are agitated by the SEC’s decision to expand its examinations of advisory firms to include contact with clients...

The agency’s decision to go directly to clients is a legitimate way to track their account positions and balances against what advisers are showing on their books, said Gene Gohlke, associate director of the SEC’s Office of Compliance, Inspections and Examinations...

[According to] William Stockwell, branch manager at Stockwell Wealth Management of Boston, an affiliate of LPL Financial of Boston...[if] this policy was instituted five years ago, it would it have uncovered the Madoff scheme...

There was some vigorous push back from the advisers interviewed for the article. In our opinion, only two of them gave the right answer: 

Tim Kochis, founder of Aspiriant LLC, a San Francisco-based RIA...has no problem with the adjusted exam procedures, or its focus on custody.

“The SEC and other regulators are doing well to look at issues like this, rather than on the fill-in-the-blank, check-the box inspection regime,” he said. “If this changes to more in-depth exams, I think that would be great."

Mr. Kochis said he would not be concerned if an examiner calls a client, noting that accounting firms that audit his company check at times with clients selected at random to verify certain records.

And

“I think it’s great,” said William Stockwell... “Absolutely anything that can be done to verify and reassure clients is a good thing...”

Let's be clear: if you're running your practice the right way, you will have nothing to hide. Not only that, but you will also be adept at winning and keeping your clients' trust, whoever they may talk to, and a big part of that is (obviously) open and effective communication. Let your clients know that the SEC is instituting this tactic into its auditing practices - it's really not a big deal. And as Kochis and Stockwell both note, more effective regulation and consumer protection can only strengthen the industry. If an individual practice would be weakened by regulators speaking with clients, well...that raises some red flags, in our view.

URLs:

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090312/REG/903129989/1094/INDaily01&template=printart 

Interesting online debate being hosted by The Economist, on Brad DeLong's proposition, paraphrasing Milton Friedman circa 1965, that we are all Keynesians now, or more precisely, that we all should be.

A word to the wise - policy disagreements among economists tend to be veiled disputes over social values. What you'll read is a debate between representatives of 'liberal' Berkeley and 'conservative' (U. of) Chicago economics, where there are many points of theoretical and empirical agreement, but nearly intractable differences between what kinds of policies each side finds attractive. For example, DeLong admits the possibility of a primary objection to 'Keynesian stimulus':

Could it happen that as the government starts its spending that the spending is, in Fama's words, "funded by issuing more government debt ... The added debt absorbs savings that would otherwise go to private investment ... and just moves resources from one use [private investment] to another [government purchases]"? Yes, it can happen. When government deficit spending triggers a sharp rise in interest rates, that rise in interest rates will discourage and crowd out private investment spending.

He then points out - correctly, we think - that interest rates are not currently behaving in a way that indicates that the federal government is 'crowding out' private investment to any degree. In other words, there is a lot of 'slack' in the economy (meaning underutilized resources), and government can be the risk taker of last resort that steps into the breech in that situation, directing or incentivizing investment (for example, as in the Obama stimulus and budget, in health care technology, infrastructure, and 'green' energy technologies), distributing more claims on goods and services (monetary and/or vouchers, such as payroll tax holidays, unemployment insurance, and food stamps), and making direct demands for goods and services, including the hiring of unemployed labor.

Opponent Luigi Zingales also admits to a general point of agreement between schools of thought: "I am not disputing the idea that some government intervention can alleviate the current economic conditions, I am disputing that a Keynesian economic policy can do it." He supports the latter assertion by first pointing out that the meaning of 'Keynesian' is somewhat nebulous, and then arguing that all but one of the four possibilities he sets up are false:

1. Professional research does not indicate widespread support for the effectiveness of fiscal expansion as a counter recessionary measure.
2. Few economists "would dare to say that the current US economic crisis has been caused by underconsumption." He also argues that 'Keynesian' thinking contributed to the crisis in large part by ignoring the effect of incentives on behavior.
   
3. Based on his second argument, he claims that the solution is unlikely to be found in the same kind of thinking that caused the problem.
   
4. The respect in which DeLong's proposition is true is in the widespread belief in and practice of Keynesian economic principles: "Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription. Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good."

In my experience, heavy reliance on analogy, as exhibited in argument four, is usually a good sign that a disagreement is based upon competing social and political values, and not a purely empirical, weight-of-the-evidence approach.

Zingales' second argument is also worth a closer look, specifically his claim that "Keynes studied the relation between macroeconomic aggregates, without any consideration for the underlying incentives that lead to the formation of these aggregates." That statement is too strong. While well developed theories of incentives and behavior were not available in Keynes' time, they were most certainly at work in the background of his General Theory and some earlier writings (in GT, he typically referred to them as psychology). Tempering Zingales' assertion, it wouldn't be unreasonable to argue that neo-Keynesians and other liberal economists (and Keynes himself in the GT) tend to subsume a focus on incentives to interventions aimed at directly manipulating some outcome(s) of interest, while neo-classicals and other conservative economists tend to make incentives primary, and then either accept the aggregate 'wisdom' embedded in market and economic outcomes, or less commonly, motivate economic agents to pursue some desired outcome.

In both of those approaches, moral principles are clearly at work. On the liberal side, it's "sharing the wealth" in good times, and limiting the damage in bad times. On the conservative side, it's a desire to maximize voluntarism over compulsion, and minimize the involvement of political authorities in economic decisions and activity. Said another way, the former makes equitable distribution of the economic pie the primary policy objective, while the latter makes the long term size of the pie the primary objective. These competing objectives are as old as human beings, and perhaps even older, judging by some primate research.***  One of the primary functions of political processes is to strike a balance between the two, and it should be obvious that, despite the fact that economists too often shroud the debate in models, numbers, and forecasts, it's important to the health of our political economy and society that these debates occur. Kudos to The Economist for providing a public setting for one of them.

Our take? Both schools have a lot to offer (and sycophants of both tend to waste far too much time and effort disparaging the idols and ideas of the other). Two people that we'd introduce to the debate are Bruce Bartlett and Robert Mundell.

Bartlett has penned two good syntheses for Forbes this year, one of which illuminates more productive and important questions for debate, such as the uncertainty governments often create when altering "rules of the game", which can amplify business cycles and cause downturns to persist longer than they might otherwise, and the other on whether government spending was too high or too low during the 1930s. Bartlett also provided a sober assessment of conservative mythology around taxes and growth recently; despite losing many friends on the right, beginning with his public criticisms of G.W. Bush policies. He remains, in our view, one of the most critically honest - and thus insightful - conservative analysts, and his work reminds us that in the political domain, we all need to become more comfortable hearing and thinking through ideas and evidence that we reflexively don't like.

Stepping off of our soap box, we'd also point once again to Chicago School icon Robert Mundell's characterization of Keynesian economics in 1971 as being borne out of a world of closed economies with pessimistic expectations, and not widely applicable to an integrated and growing global economy. To us, that leaves room for both 'liberal' and 'conservative' economic policies, depending upon where we are in cyclical and secular business cycles, and what the current "rules of the game" happen to be. Today, dampening the downside of a historically rare global recession or contraction, and financing it from future tax revenues, might be the preferable alternative. And as we opined recently, while the Obama stimulus and budget plans might not be as powerful as their architects and proponents believe - and while they might put the cart alongside if not in front of the horse in some important respects - they are also unlikely to be as disastrous as many opposing pundits and policymakers have claimed. We still believe that tax reform is one of our most pressing policy challenges, and that it's still being pushed to the back burner, if not off the stove entirely. But we don't think that Obamanomics will turn out to be the destructive gale force that some fear.

***Consider, for example, the archetypical case of a successful hunter returning to their band, while some members are facing the prospect of going hungry. How much should be shared with whom? What individual(s) has authority to make the decision? How should the hunter be compensated for his efforts and/or sacrifice, if at all? It's hypothesized by some observers that chimpanzees in the wild wrestle with similar challenges, to such an extent that ritualized behaviors have evolved around the sharing of meat. These examples illuminate the importance of Zingales' point about incentives - how do you best incentivize the successful hunter to continue producing and to willingly share a reasonable proportion of their catch? How deeply is "respect" for the productive member of a society embedded in us? The contrasts between human and chimp societies raise some important questions as well, eg, in a political system as large as our national one, how do you incentivize productive "donors" to willingly provide a portion of the fruits of their labor to bureaucrats to be distributed to anonymous "nonkin" recipients? And just how severe is the agency risk at work in the redistribution of resouces, in light of evidence that resource sharing among chimps appears to be primarily motivated by the desire to build and strengthen social networks? In other words, if we bump government into the role of the successful hunter, government beneficiaries into the role of the successful hunter's network, and the taxpayer into the role of the dead juvenile baboon or other prey, the situation starts to look far less equitable for whoever's footing the government's bill! Our system, as imperfect as it is, was thankfully designed with these risks in mind.

URLs:

http://www.economist.com/debate/days/view/276#pro_statement_anchor 

http://www.forbes.com/2009/01/22/stimulus-keynes-taxes-oped-cx_bb_0123bartlett.html 

http://www.forbes.com/2009/02/12/stimulus-depression-deficits-opinions-columnists_0213_bruce_bartlett.html 

http://www.forbes.com/2009/02/26/obama-budget-reagan-clinton-bush-opinions-columnists_higher_taxes.html?feed=rss_mostemailed 

http://www.symmetrycapital.net/newsandviews/newsandviews/2009030904.html 

http://savannachimp.blogspot.com/2008/01/january-16-2008-siberuts-monkey-hunt.html 

http://sitemaker.umich.edu/mitani/files/mitani_and_watts_2001.pdf 

http://www.people.fas.harvard.edu/~gilby/gilby_2006.pdf 

This much is certain: when we finally enter into the post-crisis period, the business and economic context will not have returned to its pre-crisis state. Executives preparing their organizations to succeed in the new normal must focus on what has changed and what remains basically the same for their customers, companies, and industries. The result will be an environment that, while different from the past, is no less rich in possibilities for those who are prepared.

URL:

http://www.mckinseyquarterly.com/Strategy/Strategic_Thinking/The_new_normal_2326 

PROVIDENCE, R.I. (AP) -- An advisory panel soon issues its final recommendations for changing Rhode Island's tax code in ways that are supposed to attract businesses and retain jobs. Governor Carcieri created the group in May. The panel is expected to release its ideas during a meeting Wednesday morning at the State House. Carcieri has pledged that he will not raise personal income, corporate or sales taxes as the state faces a tanking economy and massive budget deficits. Carcieri has said he would support lowering Rhode Island's corporate tax to make the state more competitive with neighboring Massachusetts and Connecticut.

A recent Providence Journal column offered some additional detail and background:

The proposals also include a drop in the state’s corporate income tax rate to 8 percent from the current 9 percent, a clear signal to businesses that state leaders have heard their complaint that Rhode Island’s rate is too high and among the highest in New England... A new tax code that is fair, transparent and competitive is a key to making Rhode Island a leader, not a laggard.

URLs:

http://news.yahoo.com/s/ap/20090311/ap_on_bi_go_ec_fi/state_unemployment

http://www.gtowntimes.com/story/editorial-dec--29- 

http://newsblog.projo.com/2009/02/panel-to-recomm.html

http://www.projo.com/business/johnkostrzewa/BZ_JK0201_02-01-09_A5D4A1I_v19.3f43181.html  

Economist James Galbraith, who has been critical of the administration's rescue effort as insufficient, said in an e-mail that "the recognition that the fundamental decline (collapse) in asset prices is the problem firmly contradicts the administration's line that credit is 'blocked' and can be made to 'flow.' The asset price (read: housing price) problem undercuts that completely, not so much by establishing insolvency of the banks, but by establishing the lack of credit-worthiness of the borrowers. Whether Christina Romer recognizes this is an interesting question."

Consider that many of those troubled financial assets were created in an environment of 30-50x leverage (or more) in important parts of the system, historically low domestic savings, and 'twin deficits' that may finally have reached a tipping point. In an environment of massive deleveraging, increasing saving, and collapsing global trade, the average credit worthiness of existing borrowers is surely not likely to rise in the short run - thus the huge run up in the number of banks tightening lending standards. Against that back drop, an 'economically hawkish' Congress was seated in 2007, and an even more 'hawkish' federal government in 2009, which may well have made the solvency issue worse at the margin.

As we pointed out in 2008, there's only one way for strapped debtors to improve their long term solvency - as opposed to covering short term pressures via asset sales - and that's via rising incomes. Expenses can be cut to a point, an approach that the relative performance of discount to high end retailers indicates is well underway. But incomes will tend to rise only in response to incentives. Beyond providing short term life support to the financial system, a policy mix aimed at expanding real incomes broadly would be the best choice for getting us through this crisis. That's something that Japanese policy makers never got right, and their economy continues to struggle as a result; and at the moment, our policy makers appear to be making similar mistakes.

URLs:

http://www.huffingtonpost.com/2009/03/10/howd-we-get-here-romer-di_n_173426.html 

Tyson: "The president's budget is progressive and ambitious. It will not, however, explode the size of government as some critics warn. If the economy recovers as projected, over the next decade taxes as a share of GDP at around 19% will be lower than they were during the second half of the 1990s, government spending as a share of GDP at around 22.5% will be about where it was under Reagan, and nondefense discretionary spending at around 3.6% of GDP will fall to its lowest level since that data was first collected in 1962."

Our take: This is Tyson's essential argument, and it's important to read/hear. She notes that the projections are subject to some uncertainty: "The real risk lies in the possibility that the economy's recovery starts later and is much weaker than the economic assumptions in the budget." However, we think the underlying objectives are the ones to pay attention to. In our view, people on the political left and right tend to expect far too much good from their own policy preferences than warranted, and far too much harm from their opponents'. And right now, too many folks on the right are gnashing teeth, rending garments, and calling for the end of the world as we know it. We've been saying for some time that investors should brace themselves for public policy shifts that will lower most financial asset values at the margin, perhaps substantially. But it's also important to keep in mind that (1) there's nothing in Obama's plans that spells doom or outright collapse (in fact they contain some worthy economic objectives) and (2) our political system tends to be very responsive to costly policy errors, at least compared to most current and historical alternatives.

Tyson: "President Obama's budget will restore the top two marginal tax rates to their 1990s levels of 36% and 39.6% for individuals earning more than $200,000 and couples earning more than $250,000. These changes will affect only the top 3% of taxpayers, the group that has enjoyed the largest gains in income and wealth over the last decade. In addition, for these taxpayers the tax rate on capital gains will increase to 20%, the lowest rate in the 1990s and the rate President Bush proposed in 2001, and the tax rate on dividends will increase to 20%, a rate lower than the rate of the 1990s and nearly 40% lower than that proposed by President Bush in 2001."

Our take: Good policy context, and there have been some stubborn problems with the U.S. income distribution over the last few decades, which we believe is an important factor in the Democratic party's return to power. In another passage, she also clarified the change in treatment of charitable deductions, which will be deducted at a maximum rate of 28%; that's not as dire as some commentators have described However, we have to keep a few counter points in mind. First, in the U.S., there is a relatively high rate of movement between tax brackets; the people being taxed more heavily in coming years may not be the people who benefited from rising incomes at the top over recent decades. Second, taxing the beneficiaries more heavily is not the only solution to improving the income distribution; for example, the inflation tax on savings, and most importantly, our relatively high marginal tax rates on corporate income (as demonstrated by David and Christina Romer, colleagues of Tyson's at Berkeley) are compelling alternatives that might confer greater long term benefits to society as a whole. In fact, there was some thin but tantalizing data following the 2003 tax cuts that indicated income improvements among lower wage earners; unfortunately, the relevant measures expired before any firm conclusions could be drawn, but the 2003-2006 period might prove to be a fruitful area for research into taxes and income distribution. Tyson also waves away the impact on small businesses, arguing that only 3% of them would be subject to a higher rate; perhaps, but it still imposes a marginal cost during a time of deep economic recession and uncertainty, and it also worsens the relative distortions between personal and corporate income taxes. Third, the federal government must be very careful not to cross that unknown threshold where human capital begins to emigrate from the U.S., something that has happened in states like California and Illinois in recent years. As a country, we may be nowhere near that point yet, but we are closer than we were in 2008. And if we are reckless enough to cross it, the long term consequences would be depressing.

Tyson: "Reducing the nation's dependence on foreign oil and cutting carbon emissions are also priorities, supported by overwhelming scientific evidence on the risks and costs of climate change."

Our take: This is the point we would take vigorous exception to; in fact, it's almost reflexive any time we hear the phrase "overwhelming scientific evidence." If we had a dollar for every time that phrase has been misapplied in the history of humankind, we could retire and write these missives for our own amusement. Good science acknowledges that uncertainty looms large in any model, however the evidence may look at any point in time. Human beings have been diligently modeling climate change and anthropogenic warming - an exceedingly complex and chaotic system of interactions - for less than thirty years. Our knowledge of many important contributing factors is just as young or younger, and for yet to be discovered factors, it's nonexistent. As Benoit Mandelbrot wrote in Fractals and Scaling in Finance, "it is prudent to fear that 'what we know' is not necessarily the last word."

But the climate change movement reminds us very much of other movements once based on “overwhelming scientific evidence”. For example, it was believed for a time, by some otherwise intelligent people, that autism was primarily caused by cold and emotionally distant mothering! A more credible and persistent one is the connection between diet (saturated fat and/or cholesterol) and Coronary Heart Disease (CHD). The consensus built upon "overwhelming scientific evidence" has been subjected to an increasing number of attacks in recent decades, as evidence accumulates that limiting the ingestion of cholesterol and/or saturated fat to lower the risk of CHD in populations is highly questionable. To wit:

"[In the Framingham Massachusetts study,] the more saturated fat one ate, the more cholesterol one ate, the more calories one ate, the lower people's serum cholesterol...we found that the people who ate the most cholesterol, ate the most saturated fat, ate the most calories weighed the least and were the most physically active." Dr William Castelli 1992 (source link).

Dr. Clare Hasler noted in a 2000 Journal of the American College of Nutrition article, "it is now known that there is little if any connection between dietary cholesterol and blood cholesterol levels."

According to Dr. Uffe Ravnskov, "observations strongly suggest that high cholesterol is only a risk marker, a factor that is secondary to the real cause of coronary heart disease. It is just as logical to lower cholesterol to prevent a heart attack, as to lower an elevated body temperature to combat an underlying infection or cancer." He has also aggregated substantial evidence that calls the association of saturated fat intake and CHD into question.

There are countless other examples, from many fields of life, that "overwhelming scientific evidence" is often extremely plastic, and that "consensus" is often oversold. And our sense is that the anthropogenic global warming movement has many of the features of such movements. If true, the costs of pursuing this particular piece of change could far, far outweigh the realized benefits. And as long as we profess to care about future generations of citizens and taxpayers, we should be explicitly mindful of this risk.

Another important concern relates to cap and trade as a means of limiting carbon emissions - the so-called "market based" approach. This sets up a public-private system that allows privileged entities to extract significant economic rents. According to Tyson, the Obama Administration claims that 80% of the initial auction revenues from a cap and trade system "will be used to finance a refundable tax credit of up to $400 for individuals and up to $800 for families." There are severe agency risks in a cap and trade system, far more than a straight carbon tax, and its planned implementation strikingly contradicts, for example, the decision made by Treasury and Congress to end the use of private debt collectors by the IRS.

----------------------------------- 

Epilogue: We have a serious beef with some of the global warming related thinking and marketing being peddled these days. One of the most irritating examples comes from our local cable company - it's an ad with children ranging from perhaps three to twelve years old, warning their parents about impending ecological collapse - as if the planet itself needs us to save it! This idea is so inane that it borders on insane. The planet will be absolutely fine, with or without us, presumably until our solar system collapses. As Professor Valerius Geist noted in the book Whitetail Tracks:

The type of landscapes we take for granted as "natural" are actually an article of human intervention caused by human elimination of megaherbivores...

The huge, tree-crunching giants [are] gone, a profound departure from normal landscape ecology...Kill the big plant-eaters and continents sprout forests...That was the new setting, the new ecological stage, for a new beginning for life on Earth...Fires replaced giant herbivores as devourers of trees...Life adores opportunity. It simply will not rest!

In other words, life on planet earth is capable of adapting to many different climates. Thus, the whole global warming movement, for the most part, is not about the planet, but about us! It is propelled by our evolved capacity to think about the future, to worry about our place in it, and perhaps by cultural and institutional backgrounds that encourage us to embrace personal guilt and responsibility. This should not lessen the material concerns raised by the global warming hypothesis, of course. But it should at least start to demolish the old "Mother Earth needs our help" myth as the  mindless bunch of nonsense that it is.

Geist's observations also tie back into anthropogenic global warming, as the past existence of megafauna would argue that the earth's climate has been much warmer in past epochs, perhaps warmer than the worst climate models currently predict. Imagine a world of giant herbivores toppling flora of any size, crunching, munching, and ingesting massive amounts of plant material, fermenting them in specialized digestive systems with multi chambered stomachs, and acting as giant fertilizing machines spreading seed-laden dung far and wide. The "greenhouse gas" emissions of such processes would have been massive, and a hot, tropical planet would have been the norm. Looked at in that light, it's unreasonable to argue, for example, that large, stable polar ice caps represent some normal state of affairs in the natural history of the planet's climate. Rather, their contraction represents a threat to our species' and some other species' status quos. But the planet will get along swimmingly with or without humans, polar bears, arctic seals, or the many other species at risk from a significantly warmer climate, many of whom exploited niches created by past shifts in climate. As Geist observes, life adores opportunity and will not rest - no new niche will go unfilled.

Again, to be clear, global warming is a possibility that could severe ecological consequences for human beings and other species. But it's important to contemplate it in the broadest context possible, and with a clear understanding of our motivations for doing so. We will also point out that given the complexity and significance of the subject, the highest probability of optimal policy outcomes is likely to be conferred by referenda. However, there are few causes whose champions and true believers would agree to subject them to such a process, much less abide by an "undesirable" outcome. Hence the rush to implement programs - based, of course, on "overwhelming scientific evidence".

URLs:

http://online.wsj.com/article/SB123655553728965955.html 

http://homodiet.netfirms.com/otherssay/chd/heart_disease1.htm 

http://www.jacn.org/cgi/reprint/19/suppl_5/499S 

http://www.ravnskov.nu/cholesterol.htm 

http://www.webcpa.com/article.cfm?ARTICLEID=30927 

http://www.palaeos.com/Mesozoic/Mesozoic.htm

Still, as we noted recently, Frank's statesmanship seems to have taken a notable leap forward since the start of this session, and he seems to have some good insights into the financial crisis (CRA and GSE's excluded), and a very good grasp of where the regulatory gaps exist and how they ought to be filled. If he's listening, we would simply point to some credible research by CEA chairwoman Romer that the burden of corporate taxes seems to fall disproportionately on the incomes of workers. We believe that that factor is the most compelling explanation for some Americans falling behind as global trade has expanded. If rising employment and incomes are the political objective, then the state of the corporate tax code - indeed, the entire U.S. tax code - should be the focus.

There are some aspects of our argument that I want to emphasize, lest we be called 'Economic Flat Earthers'. First, the U.S. corporate tax burden means little in isolation - it is the relative burden that determines the marginal impact on capital flows, investment, and ultimately, production and employment. Outside of 2003 and 2004, the trend has been disturbing:

In 2006, in the wake of the temporarily lower 2003-2004 corporate tax burden, the New York Times reported a fact that would undoubtedly surprise the hurlers of 'flat earth' and 'wing nut' aspersions: "Tax revenues are climbing twice as fast as the administration predicted in February, so fast that the budget deficit could actually decline this year. The main reason is a big spike in corporate tax receipts, which have nearly tripled since 2003..." That outcome certainly upended the pessimistic forecasts of the CBPP in 2003. Granted, that increase was accelerated by the low but temporary rate on repatriated profits. However, we predict that a more competitive corporate tax code would have a very favorable effect on the overall production of public revenues, especially when this country's other advantages are taken into account. We have a lot to trade on. We shouldn't allow our tax code to prevent us from capitalizing on them.

A common rebuttal to this argument is that the effective tax rate is the one that matters, and that on that metric, the U.S. is one of the least burdensome tax authorities. Yes, effective and marginal tax rates are very different, and are both important, but let's think this through. First, there is far less disagreement over microeconomic theory than there is over macroeconomics, meaning that marginalism is alive and well in most economic schools of thought, and that precious few economists would argue against the idea that when it comes to decision making, everything happens at the margin. Second, tax rules vary widely between countries, and the U.S. has some of the most complex ones, as well as a fairly bizarre bracket structure. This only worsens the confusion and uncertainty associated with predicting the tax effects of any business decision, whether marginal or effective, and it does nothing positive for the overall level of investment. Third, the effective tax rate argument ignores the opportunity costs imposed on a country by its corporate tax code. For example, many ventures, especially those that hire less skilled employees, do not begin until certain tax credits, subsidies, and/or other guarantees have been successfully negotiated. One way to look at this is that if all business investment were domestic and proceeded without consideration of the tax code, the effective rate would begin to converge to the marginal rate(s). Another perspective is that if the marginal statutory rate were more competitive, more domestic investment would occur; indeed, one could even hypothesize that the gap between the marginal and effective corporate tax rates is itself an indication of the opportunity costs imposed. Lastly, opponents often overlook entirely the aggregate costs imposed by all business related taxes (e.g., payroll and a variety of state and local taxes) and regulations that dictate the allocation of a significant share of resources. Left leaning critics should be mindful of the risk that these kinds of barriers are more beneficial than harmful to 'big business', as they tend to limit competition.

This stuff isn't rocket science, folks, and it's far too important to be subjected to either the airy claims of cheerleaders or the caustic jeers of opposing sycophants. We're fiercely independent, and not trying to pick a political fight with anyone. In fact, one of the most important things we've learned, via 'wing nut' extraordinaire Jude Wanniski, is that our political system is designed to produce optimal outcomes. Thus, the way we see it, Democrats control the Executive and Legislative branches precisely because that was the best of all possible outcomes as of November 2008. We're just throwing in our citizen's two cents on an issue that we think is extremely pressing, widely overlooked, and poorly framed by most of its advocates, because we think it would have a broad, positive, and significant impact on our current economic malaise.

URLs:

http://rickwrites.blogspot.com/2009/02/flat-earth-economics-corporate-income.html 

http://www.nytimes.com/2006/07/09/washington/09econ.html 

http://www.symmetrycapital.net/idlespeculation/2007110701.pdf 

http://www.cbpp.org/10-16-03tax.htm 

http://mediamatters.org/items/200902030003 

http://www.polyconomics.com/jw-bio.htm