Entries for October 2007

It's news that'll surely get overshadowed by the Federal Reserve rate cut, but the 3.9 percent third-quarter report on gross domestic product that came out a few hours earlier could have huge political ramifications. The report shows the economy is continuing to shake off the housing slump with amazing resilience. Back out the terribly weak housing numbers, and the rest of the economy grew at around a 5 percent clip.

Yes, the economy may slow further but perhaps not enough to substantially boost the unemployment rate. Indeed, the new ADP private-sector job report hints at total net new job growth of around 125,000 for October. And don't forget that incomes continue to grow. Disposable personal income grew at a 4.4 percent clip last quarter and has averaged more than 6 percent a year since 2004.

Instead of recession, we may be closer to an economic reacceleration that could allow the GOP presidential candidate in 2008 to better argue that the Republicans and not Democrats are really the "party of prosperity," the party that kept the economy humming despite the housing slump with two rounds of tax cuts in 2001 and 2003. The GOP nominee would then surely argue that not only do we need to extend the Bush tax cuts but we must cut some more taxes as well to better compete with rising Asia.

Helping this argument is House Ways and Means Committee Chairman Charles Rangel's package to reform the alternative minimum tax, which gives the impression that repealing the Bush tax cuts would be only the beginning for Democrats, who need revenue to pay for new healthcare and education spending. What's more, Republicans could argue that higher capital-gains taxes—which Rangel proposes—would hurt the stock market, the very thing that is offsetting the decline in people's net worth caused by the housing slump.

Again, as top political analyst Greg Valliere noted earlier this week, the AMT bill by Rangel "was a chilling reminder of the Democrats' fervor to raise taxes—and despite polls showing the public favors higher taxes on 'the wealthy,' this issue could become an albatross for [Hillary] Clinton."

A few things struck me as I watched the MSNBC Democratic presidential debate in Philadelphia, other than I was glad it didn't take place Monday night or else it would have conflicted with Heroes:

1) When Social Security's impending solvency crisis came up, Hillary Clinton said "we have to change the Bush tax cuts" and create "a more fair and progressive tax system" as part of a broad solution. In short, wealthier Americans can kiss their 2001 and 2003 tax cuts goodbye. But here is the real issue: As I have mentioned many times in this blog, restoring the old Bill Clinton-era tax rates on those making over $250,000 brings in only an additional $50 billion a year at most, assuming no ill economic effects from the rate rise. That is the same $50 billion that is supposed to go to funding Hillarycare 2.0. Plus, Clinton wants to reform the alternative minimum tax, though she would not sign on to Charley Rangel's recent AMT elimination plan and its surtax on families making as little as $200,000 a year. Does she plan on using that magic $50 billion for AMT reform as well? She also said America "should be investing in college affordability, universal pre-K..." Are there other possible tax increases that she is considering if elected and not mentioning? Right now, the math does not add up.

2) Clinton and Barack Obama both recommended a "bipartisan commission" to come up with some options for fixing Social Security. (As if there are not dozens and dozens of plans already floating around D.C.) First of all, many Americans may be operating under the assumption that they've already installed a pretty big bipartisan commission to deal with Social Security and other major problems. It's called Congress. Second, any truly bipartisan panel will almost assuredly come up with some mix of tax hikes, spending cuts, and extending the retirement age. So why not skip the blue-ribbon panel and get right to a discussion of which solutions are best? Isn't that what these debates are for?

3) Bill Richardson spoke about an economic "competitiveness gap" between the United States and other nations. Interestingly, a report on this very issue came out today. From the Associated Press: "The United States has regained its status as the world's most competitive economy thanks to strong innovation and excellent universities, according to...the World Economic Forum."

4) Despite Clinton's past experience with commodity futures, it was Obama and Joe Biden who accurately explained that a big chunk of the recent price rise in oil prices is due to geopolitical tension with Iran.

5) Tim Russert related this quote from Bill Clinton: "Charley Rangel wants me to pay more taxes so you can pay less, and I think that's a good idea." And billionaire investor Warren Buffett just came out and said pretty much the same thing, adding, "I just follow what the U.S. Congress tells me to do." Hey, nothing is preventing these gentlemen from voluntarily adding a zero to their IRS checks come April 15.

6) Chris Dodd came out for a carbon tax, even referring to former Bush economic adviser Greg Mankiw's advocacy in the process. But Mankiw also thinks that a $100 billion-a-year carbon tax should be offset by a cut in income taxes. So it would be revenue neutral and not create a new pot of money to fund higher government spending.

Greg Valliere, politics guru at Stanford Research here in Washington, D.C., tries hard to come up with a scenario where Hillary Clinton does not end up as our 44th president. Here is one of his scenarios:

We have written extensively this fall about the Great Tax Hike of 2009. Even a Republican president is going to be forced into tax hikes because Democrats in Congress will threaten to let all the Bush tax cuts expire in 2010. But Sen. Clinton would move immediately to raise a wide range of taxes—the top rate, capital gains, dividends, etc. A preview from House Ways and Means Committee Chairman Charles Rangel (D-N.Y.) was a chilling reminder of the Democrats' fervor to raise taxes—and despite polls showing the public favors higher taxes on "the wealthy," this issue could become an albatross for Clinton.

Forget the credit crunch and mortgage crisis for a moment. What about rising oil prices? So far, the economy has shaken off high prices at the pump, no problemo. But what if oil his $100 or more? Don't fret, says Jim Glassman of JPMorgan:

1) The sticker shock related to $90-$100 oil won't spark new alarms. That's because, for all intents and purposes, consumers already saw $100 per barrel oil this spring, when large numbers of refineries shut down for a long-needed maintenance, gasoline prices spiked above $3.00 per gallon, and retail margins temporarily widened to unprecedented levels.

2) Today's economy is better able to absorb the rise in the relative price of energy, because it is more flexible, it is still relatively strong, and we use energy far more efficiently than we once did so that oil is not as important as it once was. In addition, contrary to popular opinion, oil may be a "tax" initially, for consumers and net oil consuming countries, but eventually oil revenues get spent—recycled—if not in the spending stream, into financial markets.

3) $100 oil implies that [3 trillion] of petroleum dollars are cycling into financial markets annually today, compared with an annual flow of only $600 billion back in 2003 when oil prices were close to $20 per barrel.

4) OPEC shocks get a bad rap for the stagflation and recessions of the 1970s. In fact, oil may be guilty only by association.

5) High oil prices, as unhappy as they make us, are doing God's work, by curbing our appetite for carbon fuel, pointing us to greater energy security and limiting the impact of human activity on the environment. The decline in gasoline demand in response to rising energy costs is proof that markets work and that market mechanisms are our best energy policy.

"We would actually have for more people higher tax rates than what we had under Jimmy Carter" is the way Lawrence Lindsey, former director of President Bush's National Economic Council, described to me what might happen if the tax reform bill from House Ways and Means Committee Chairman Charlie Rangel ever became law. Here is a bit more of our possible financial future as sketched to me by Lindsey, who now runs his own consulting firm and is also an economic adviser to GOP presidential candidate Fred Thompson—though Lindsey was speaking for himself and not any campaign:

Until very recently, there had been a growing bipartisan consensus, acknowledged at least implicitly, that you cannot run a high-tax [economic] regime and be competitive. The great unspoken fact is that [Rangel's 4.6 percentage-point surtax on high incomes] only looks like a restoration of [Clinton's tax rates]. But if the Bush tax cuts expire, the four-and-a-half points stays on top of the 39.6 [top Clinton tax rate]. So they are taking the rate to 44 percent. Then you add on 1.3 points [for the return of certain limits on tax exemptions], and if you are an entrepreneur another 2.9 points on top of that for the Medicare tax. So we are back to the 50 percent marginal rate under that plan.

What's more, if you eliminate the income cap on Social Security taxes—as some Democrats have proposed—Lindsey explains that "then we're 60 percent." The top tax bracket when Ronald Reagan took office in 1981 was 70 percent. Reagan then cut it down to 50 percent with the 1981 tax cuts and then to 28 percent with the 1986 tax reform package. "And remember," Lindsey continued, "$200,000 was the cutoff for the 70 percent bracket back then, which would be like $400,000 today. And they would be taking the 60 percent bracket to income levels well under half that number." Lindsey, who once wrote a fascinating book while at Harvard University about the Reagan tax cuts called The Growth Experiment, went on to joke that Dems were planning to run the "Shrinkage Experiment."

It's unclear, though, whether the Democratic presidential candidates want to run Rangel's economic science project. The Clinton campaign, for instance, has said only that it's "studying the proposal closely." Then again, some left-of-center groups have already called for a rollback of the Bush and Reagan tax cuts if the Democrats take the White House and keep Congress in 2009. As the liberal advocacy group Common Dreams said last August in a report, "When Reagan dropped the top income tax rate from over 70 percent down to under 30 percent, all hell broke loose. With the legal and social restraint to unlimited selfishness removed, 'the good of the nation' was replaced by 'greed is good' as the primary paradigm."

But how might higher taxes affect U.S. competitiveness in the global economy? Two interesting global comparisons via the Tax Foundation:

For the first time since the Tax Reform Act of 1986, the top combined (federal and state) marginal tax rate on individual income would climb above 50 percent under the Rangel plan. When the rate reaches that peak in 2011 with the expiration of the 2001 tax cuts, the U.S. will have the 7th highest individual income tax rate in the developed world. The U.S. currently ranks 21st in that comparison.... Chairman Rangel's proposal to cut the U.S. federal corporate tax rate from 35% to 30.5% would make the U.S. combined federal-state rate fourth-highest internationally, instead of second-highest, where it stands right now. The average OECD corporate tax rate, U.S. excluded, is 28.1%. In the OECD, only Japan's 39.5% rate is higher than the U.S. rate right now. The U.S. would leapfrog only Italy and Canada under Rangel's proposal.

You've got to give House Ways and Means Chairman Charley Rangel some credit. He promised the "mother of all tax reforms" and that seems to be what he delivered. Now his proposal, ostensibly to eliminate the alternative minimum tax, has almost zero chance of passing. But it does set the stage for a huge tax fight in 2009. As investment firm Goldman Sachs put it in a note to clients today: "This bill is very unlikely to become law before the 2008 election, but is important because it signals the possible direction of tax reform efforts in 2009 if Democrats control both the White House and Congress." And the crux of that fight is going to be this: Should we radically change the economic direction of this country by reversing the low-tax bias of national economic policy?

In short, should America reverse Reaganomics?

Consider this: President Reagan's tax cuts in the 1980s lowered the top marginal income tax rate from 70 percent down, eventually, to 28 percent. By itself, Rangel's plan would more or less reverse the Bush tax cuts of 2001 and 2003 by tacking on a 4.6 percent surtax on higher incomes as well as phasing out the number of itemized deductions taxpayers can take. (Capital gains taxes go up, too.) What's more, the bill does nothing to keep the Bush tax cuts themselves, which are due to expire at the end of 2010. Finally, you have Democratic proposals to deal with Social Security solvency by eliminating the income cap on payroll taxes. Add that all together and what you get, as economist Kevin Hassett of the American Enterprise Institute told me today, is an effective top marginal rate of right around 70 percent. That's right where it was during the Jimmy Carter years. "I think the Democratic war on the rich is such an emotional thing for them that they are willing to take the rates back to where they were before Reagan took office." Now keep in mind that Hassett leans to the right, but it seems hard to dispute that the Rangel bill could mark a critical inflection point in the direction of the American economy. But maybe that is what America wants. As a new Bloomberg-L.A. Times poll found, 60 percent of respondents said they would repeal the Bush tax cuts to pay for universal healthcare. But would they go all the way and repeal the Reagan tax cuts, too?

So Charlie Rangel, chair of the House Ways and Means Committee, has finally gotten around to unveiling his plan to repeal the alternative minimum tax. To pay for an $800 billion (over 10 years) repeal of the AMT, Rangel would slap a 4 percent tax-rate surcharge on adjusted gross incomes over $200,000 for married couples. That surcharge would climb to 4.6 percent for those with income of more than $500,000. And on top of that, households with income of more than $200,000 would have to pay rates as high as 19.6 percent on capital gains and dividends, instead of the current rate of 15 percent. Plus, Rangel would cut corporate income taxes but eliminate certain tax breaks.

My quick take is as follows: As I have been saying, Democrats have been strangely double-counting the supposed revenue gains they assume they will be getting by raising taxes on wealthier Americans. The Rangel bill would effectively roll back a big part of the 2001 and 2003 Bush tax cuts for people with higher incomes—though the bill is silent on the cuts themselves. But that "new" revenue would be the same dough that is also supposed to be used to pay for HillaryCare 2.0 (or other healthcare reform), as well as additional education spending. Does this mean Democrats plan on raising additional taxes? Good question, since the Rangel bill will almost assuredly go nowhere but may shape the battlefield for a big tax fight in 2009. It sure seems possible that if Democrats control the White House and Congress, we might see a rollback of the Bush tax cuts, plus a surtax, plus higher Social Security taxes.

My guy Dan Clifton over at Strategas Research tells me that new pension regulations issued yesterday by the Department of Labor will significantly alter the way Americans save for retirement by providing new incentives for workers to participate in a 401(k). The regulations will also increase the amount of equity and bond exposure and gradually reduce the use of traditional defined benefit plans. Clifton sums it up:

Yesterday's regulations ended that uncertainty. Employers can now automatically enroll their employees in a 401(k) plan which will boost participation. To qualify for a legal safe harbor, employers must provide a 3 percent match to workers. Therefore not only will more people hold a 401(k), more money will be flowing into equity and bond markets. Additionally, higher returning Lifecycle funds were determined tobe the appropriate default fund away from the lower returning money market and stable valuefunds. The net result of these rules are more people saving, more pre-tax income being saved, higher returns, and increased equity and bond demand. Provisions take effect 1/1/08.

My take: All this stems from passage last year of the Pension Protection Act. I can tell you that more than one Republican activist has told me that he hopes more Americans with more dough in the stock market will help create more support for investor-friendly policies like capital-gains tax cuts and personal savings accounts. At least that's the theory.

Yuck! The National Association of Realtors reported today that existing-homes sales plunged 8 percent last month, far worse than the 4.5 percent analysts had been expecting. Cleary, the numbers reflect the bite of the credit crunch in August. But here are the numbers you should really focus on, courtesy of Action Economics:

The supply of single family homes rose to 10.2 months in September from 9.3. This marks the highest inventory level since 1986 and highlights the continued difficulties in the residential housing market. The months supply for total existing homes (single family plus condo/co-op sales) surged to 10.5 months from 9.6 months, the strongest on record going back to January of 1999. Meanwhile, the condo/co-op supply surged to 12.6 months from 11.4, the highest level on record going back to 1999.

Let me know when those numbers start shrinking.

A few quick thoughts from last night's Republican presidential debate in Orlando:

1) Once again, the GOP debate seemed to take place in a sealed vacuum, isolated from the news of the day. No comments from the major candidates about the credit crunch, housing market, falling dollar, or plunging stock market. (The anniversary of Black Monday was just two days earlier.) All of these current events provide golden opportunities to tie in the candidates' economic policies and views to people's real lives and experiences. And once again, Romney seemed to be the only guy to recognize that we're engaged in a rising global economic competition with Asia. Still, yet another debate with zero references to "productivity" or "innovation"—you know, the things that will determine our future standard of living.

2) McCain won the "Strange Quote of the Evening" award with this one-liner: "I didn't manage for profit; I led for patriotism." I can only assume that was a jab at Romney's private-sector career, a weird populist comment for a guy who declared "wealth creates wealth" at the previous GOP debate in Dearborn, Mich.

3) Romney offered up a nice wonky reference—though one that completely lost about 99 percent of the audience—to the "Pozen plan" for Social Security. (It was like he was giving a PowerPoint presentation without a laptop.) Romney was referring to a proposal advanced by Robert Pozen, a former executive at Fidelity Investments. Pozen advocates a plan in which low earners would continue to receive Social Security benefits based on wage growth while middle-class and wealthier workers would have their benefits determined by a combination of wage indexing and inflation indexing. Pozen also recommends that half of any new Social Security taxes be diverted into private retirement accounts. Again, this makes me believe that the "Grand Compromise" on Social Security will involve projected benefit cuts, higher taxes, and retirement accounts funded by new taxes. Anyway, all this stuff needs to be carefully explained, or it will be totally lost on voters.

4) The advantage of having executive experience could really be seen when comparing Fred Thompson's answer about education with that of Rudy Giuliani. Both were for expanded school choice, but Giuliani was able to embellish his answer with anecdotes and numbers from his time as mayor of New York City.

Anyone who watched U.S. Treasury Secretary Hank Paulson's caffeinated—if not somewhat manic—press-conference performance last Friday evening at the end of the G-7 meetings might be forgiven for thinking that the former Goldman Sachs CEO needed a long, restful weekend. It had been a busy week, after all. In addition to hobnobbing with financial ministers from the major economies—and keeping an eye on the plunging Dow—Paulson announced an $80 billion rescue fund for big banks stuck with illiquid asset-backed debt securities. He also gave a gloomy speech on the housing market. That being said, might it be time for him to devote some precious energy and attention to the falling dollar? As CNBC's Lawrence Kudlow put it in his latest syndicated column:

Wouldn't this be a good time for Mr. Paulson to signal that enough is enough, and call a halt to the dollar's decline? Oil prices are rising. Gold prices are rising. And currency traders around the world have set up huge short-selling positions in the greenback. But a few strong words from Mr. Paulson, coupled with a few well-timed rounds of dollar-buying, could turn the U.S. currency story around.

Indeed, the Bush administration hasn't intervened to boost the dollar a single time since taking office, only offering the usual rhetorical boilerplate about the value of a "strong dollar." And that policy seems unlikely to change, barring a catastrophic plunge. The dollar was not even mentioned in the post-meeting communiqué from the United States. As economist Robert Brusca notes in a letter to clients:

But the U.S. Secretary when asked about the dollar and language about cooperation did not say anything about the dollar's recent weakness at all (he did NOT call it undesirable or term it something to be reversed). Sometimes it is what they don't say that is as important, or more important, than what they do say. And the attention paid to the language of "cooperation" did not result in any favorable comments made by Paulson about the potential for FX intervention.

As one Wall Street economist told me over the weekend:

It's a hard-core position of the U.S. side that, barring outright turmoil, there is little purpose in [foreign exchange] intervention. This certainly seems to be the position of this administration. Of course, this is not the attitude of the Japanese. Without an agreement from the U.S. side to conduct coordinated intervention, intervention by the Europeans would be futile.

Would a currency intervention work? You could argue that with so many traders betting one way on the greenback, just the right amount of financial pressure at the right moment and right place would be tantamount to a sort of financial jujitsu move that would reverse the dollar's downward momentum. Then again, today's huge, high-velocity currency markets might shake off a currency intervention like a burly fullback shedding a lightweight tackler. Paulson might face a currency version of Alan Greenspan's interest-rate "conundrum" when global credit markets seemed to ignore his moves to raise interest rates.

Look, over the long run, a country's currency reflects a country's economic strength. So anyone worried about the dollar should be advocating policies that strengthen the American economy. Perhaps traders were looking forward to the unveiling this week of House Ways and Means Chairman Charles Rangel's huge tax overhaul plan and finding it antigrowth. Indeed, a 2001 study from the Federal Reserve Bank of New York found that "an analysis of the link between the dollar's movements and productivity developments in the United States, Japan, and the euro area suggests that productivity can account for much of the change in the external value of the dollar over the past three decades." Want to boost the dollar? Implement pro-growth, pro-innovation, and pro-productivity policies.

Next week, House Ways and Means Committee Chairman Charles Rangel, a New York Democrat, will unveil his plan to overhaul the U.S. tax code, with likely measures including repealing the alternative minimum tax, cutting corporate taxes (though also eliminating some tax breaks), and raising taxes on wealthier Americans and, specifically, hedge fund managers. He will also introduce a bill to temporarily patch the AMT so it doesn't snag millions of new middle-class taxpayers next year. A longtime Capitol Hill observer tells me that finding the $65 billion to pay for the one-year fix will probably mean that Dems will abandon their pay-as-you-go rule, which requires tax cuts to be paid for through spending cuts or higher taxes elsewhere. Another Congress watcher puts it this way in E-mail to me:

This Rangel situation is a mess. He needs to find $65 billion for this year's patch which is no small task—a major tax increase on some group/industry is needed. On the larger bill, he was creative to include the corporate tax reduction with the idea of "closing loopholes." But he is not doing this for efficiency or simplicity purposes—he is doing it to raise revenue. So you may have a 1 percent drop in the rate, $4 billion per year, but have $20 billion per year in corporate tax increases. (These are random numbers for illustrative purposes.) In my view he is pushing hard to do this so the Dems don't need to raise taxes upon entering office with full control in '09.

Policy analyst Ann Mathias of the Stanford Group, an institutional research firm, sees things this way: "[Rangel] undoubtedly knows such a measure would be vetoed this fall by President Bush; by year-end a clean bill will pass, waiving the pay-as-you-go provisions [for a temporary AMT fix]. ... [But the bigger bill] is a preview of what will come as Congress considers the Great Tax Hike of 2009."

Two European Central Bank economists, in a paper presented at a conference run by the St. Louis Federal Reserve Bank, say the housing boom—and slightly higher inflation—were caused by the Alan Greenspan-led Fed's holding interest rates too low for too long earlier this decade. "Easy monetary policy designed to stave off perceived risks of deflation in 2002 to 2004 has contributed to the boom in the housing market in 2004 and 2005,'' economists Marek Jarocinski and Frank Smets said in the academic paper.

Ultimately, I don't think this is much of an indictment. Their calculations show inflation was only one quarter of a percentage point higher than it would have been without the Fed rate cuts. That seems like a small price to pay for avoiding a deflationary spiral and gaining a housing boom that dramatically increased the net worth of many Americans, who are still sitting on huge gains even with the bubble now deflating. And even after all the subprime defaults and foreclosures, homeownership is still likely to be higher than it otherwise would have been.

Indeed, Greenspan might want to fully embrace and tout his role in all this. Just as the Internet bubble left behind Google, eBay, and 90 million miles of fiber-optic cable, the credit bubble upgraded America's aging housing infrastructure and created a host of online services—Realtor.com, Zillow—that have permanently shifted the balance of power from real-estate agents to consumers. (This whole argument is wonderfully argued in the book Pop! by Daniel Gross.) And as Australian economist and bubble-ologist Jason Potts puts it, "A bubble is good for growth because it creates a low-cost environment for experimentation." Even if it eventually pops.

The International Monetary Fund just cut its estimate for U.S. growth this year and next to 1.9 percent. Now plenty of economists think that's too low. (Then again, a new poll shows that nearly half of Americans—46 percent to be exact—think we're already in a recession even though the economy grew briskly last quarter.) But if the IMF is right, it will be one more factor helping Democrats next year. I can already hear Democratic presidential nominee Hillary Clinton (or one of her rivals) echoing the rhetoric of the first Clinton-Gore campaign next year: "Are you ready for change, America? Gas prices are up; home prices are down. The trade deficit is up; the dollar is down. Health costs are up; jobs and wages are down. Insecurity is up; hope is down. Everything that should be down is up, and everything that should be up is down. America is ready for change, and change is on the way!"

(Another in an occasional series looking at how the 2008 election seems to be paralleling the 1992 election.)

It's some measure of the scope and depth of Treasury Secretary Hank Paulson's portfolio that instigating and arranging an $80 billion bank bailout fund isn't the biggest item on his packed agenda. Yes, dealing with the fallout from the subprime implosion and ensuing credit market fallout is important stuff, but it pales with successfully tackling the two major long-term issues that Paulson is actively confronting: creating a policy framework for keeping Social Security solvent and, most important, managing trade relations with China.

At least the former Goldman Sachs honcho is having some success with the credit crisis. Social Security and China will probably go down in history as nice efforts but ultimately failing ones. The Treasury Department has been releasing research reports on Social Security's fiscal situation and what measures—higher taxes and spending cuts—would need to be taken to make the system self-sustaining.