Fiscal Cliff Talks Underway; Both Sides Upbeat

Negotiations on the Fiscal Cliff have started, and both sides are sounding positive. According to the Washington Post:

The four Republican and Democratic leaders of the House and Senate were unanimous after the initial round of talks in saying they were confident that they and the White House could agree on measures to raise federal revenue and cut spending before a Jan. 1 deadline, when draconian provisions originally designed to force a compromise are scheduled to take effect.

The stock market was cheered by the positive tone of the news, with the S&P 500 index closing up by half a percentage point today, after having trended downward since the election on November 6.

Fiscal Cliffnotes: The Crisis in a Nutshell

With the election over, politicians in Washington are scrambling to avoid the “fiscal cliff”.

So what is this ominous-sounding escarpment?

Because the Republicans and Democrats were unable to agree on reducing the deficit, they passed the Budget Control Act in August 2011. This provided for automatic spending cuts if budget negotiations by a “super-committee”  failed. The negotiations did fail, so now Congress and the President have to find a new solution or else those increases and decreases will kick in beginning in January.

At the same time, “temporary” tax cuts passed by earlier Congresses are due to expire at the end of 2012 as well.

The fiscal cliff will effectively cut federal government spending by about $70 billion in 2013 and by $150 billion in 2014, increasing to nearly $500 billion in 2022. At the same time, taxes will increase by more than $300 billion in 2013 and by more than $380 in 2014, increasing to nearly $700 billion more in 2022. Together, these will decrease the deficit by more than $1 trillion in 2022.

So why is decreasing the deficit such a bad thing?

It’s not a matter of just decreasing the deficit. It’s how the fiscal cliff would do it: suddenly and indiscriminately.

According to the nonpartisan Congressional Budget Office, the fiscal cliff will drive the U.S. economy into another recession next year, and increase the unemployment rate from its current 7.9 percent to 9.1 percent by the end of 2013. Also, GDP will drop by 0.5 percent in 2013.

As Forbes points out,

The cuts hit all areas of the federal budget, including a $55 billion reduction to the Pentagon’s budget in 2013, a reduction of payments to physicians participating in Medicare, substantial cuts to FEMA and the Dept. of Education budget along with a host of serious reductions across the wide ranging operations of the federal government.

And let’s not even talk about the horror of those huge tax increases hitting in the midst of this fragile recovery.

Congress passed this plan never intending it to actually go into effect. It was supposed to be so horrible that both Democrats and Republicans would do anything in order to avoid it, forcing everyone to compromise. As of yet, that hasn’t worked, and time’s running out.

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The bets are that the fiscal cliff still will be avoided one way or another. The most likely outcome is a cop-out compromise that kicks the problem further down the road. Perhaps some spending cuts and a few revenue increases that make no one happy but attempt to show goodwill on each side’s part.

Both Democrats and Republicans are posturing heavily, putting on their game faces in hopes of cowing the other side into compromise. President Obama has announced that he won’t accept any agreement that doesn’t include tax increases on the wealthiest Americans. Meanwhile, as of late 2011, 238 of the 242 Republicans in the House of Representatives and 41 out of the 47 Republicans in the Senate had signed agreements to “oppose any and all efforts to increase the marginal income tax rate for individuals and business”.

Some see President Obama as having an upper hand, given his recent election victory and the pickup of 2 seats in the Senate. However, this is hardly a solid mandate by any historical standards. Yet Republicans have a lot to lose if defense and other funding is cut dramatically. It’s also been suggested that President Obama has little choice but to play hardball in negotiations, or else he’ll be paying for any signs of weakness through the next four years.

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A big part of the equation, as with all budget impasses, is which side would be able to paint the other as the real obstructionists. The bottom line is that no one really wants this impending fiscal cliff, and everyone has an incentive to want to avert it. But depending on the political and interpersonal dynamics, it’s still possible.

No one’s questioning the need to reduce the deficit eventually. No government can continue to borrow an increasing amount at an increasing rate indefinitely. The real issue is how best to do it. As with everything in economics, there are trade-offs, and people with different values have different view about which trade-offs are worth it.

At the end of the day, all we can do is hope that our politicians can rise above politics to find a solution – and contact them regularly to tell them we want them to do so.

Good News – The Unemployment Rate Increased

The Bureau of Labor Statistics (BLS) had some good news for us yesterday. The unemployment rate increased from 7.8 percent to 7.9 percent.

You read that right: it’s good news that the unemployment rate increased. In fact, economists have been waiting for it to increase, and have been a little disappointed that it didn’t increase sooner.

This might sound a little balmy, but there’s method to this madness. It’s all in the reason the unemployment rate increased.

The unemployment rate is the number of unemployed people divided by the total number of unemployed plus employed. The BLS collects these numbers by contacting 60,000 households every month.

To be “unemployed”, you have to be actively looking for work. People who are aren’t actively looking aren’t included, even if they’d like to be working.

During a severe recession like we just had, lots of people get so discouraged about finding work that they give up and stop looking – or, as economists say, they exit the workforce. They’re no longer considered either employed or unemployed if they’re not actively looking.

When job markets improve after the downturn, many of these discouraged workers again start to look for work. This is a good sign for the economy, and typically indicates that things will continue to improve.

In October, the number of unemployed in the U.S. increased by 170,000, to 12.3 million. At the same time, the number of employed increased by 410,000, to 143.4 million. As a result, the unemployment rate increased from 7.8 to 7.9 percent.

I’ll be anxious to see the JOLT (Job Openings, Layoffs, and Turnover) data that will be coming out on Tuesday, November 6. It will provide more details about exactly what is going on in the job market, and what is (likely) causing it.

Voting with Your Wallet II: Education, Liberalism, and Unemployment

Last time I talked about an apparent positive relationship between state unemployment rates and state support for President Obama in political polls. This despite the conventional wisdom that Americans vote with their wallets. That would suggest that states with higher unemployment rates should be less likely to support an incumbent President.

I have to be honest. I started this thinking that the positive relationship was just a fluke. That it was really just a sort of anomaly that would go away if I included the right other variables. So I did what any good data analyst would do in the situation. I played with my data. That is to say, I added other variables, tried this and that, checked correlations here, ran regressions there.

And it didn’t turn out the way I expected.

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Again, my Economical Oath requires me to point out in advance that there are assorted technical issues with approaching this problem this way. But that doesn’t mean we can’t learn some interesting things from it. Virtually every economic analysis has technical problems with it; it’s mostly a matter of degree.

“Regression” is an intimidating term to many people. It sounds all complicated and statistical. All it really means is trying to find out how a some numbers affect other numbers. Practically speaking, it’s just using a computer to do calculations – you can even do it in Excel.

In addition to correlations, I used simple regression analysis to look at the relationships here. In the end, you come out with an equation that represents the relationships, along with numbers that tell you how good the relationships are, statistically-speaking.

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Bbefore I tell you about the relationships that I found, let me first tell you about the variables that didn’t work.

First, the percentage of the states’ populations that are black. Virtually no relationship to speak of – a correlation of -0.002. Likewise percentage Latino had a correlation of 0.18, but this went away after taking account of other factors.

Percentage urban versus rural, percentage with a Bachelor’s degree, population, population density, even acres of farmland – all of these have some correlation with support for Obama, but all of these apparent relationships proved small or insignificant when other variables were included.

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Including the state median family income looked really good at first. And in fact it made the state unemployment rate look even more important, statistically. A $1000 increase in a state’s median family income  was associated with a 0.5 percent increase in support for Obama.

But it turns out that family income was just capturing something else: the effects of advanced college degrees. States with a larger percentage of people with masters and doctor’s degrees have higher family incomes. And it’s those advanced degrees that really are associated with more support for Obama.

Education really does make you liberal. Or, properly speaking, appears to make you more likely to support the more liberal candidate. In this case, anyhow.

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So shut up and cut to the chase. What’s the bottom line?

After looking at more than a dozen different variables, here’s the equation that turned out to explain the most differences in state support for Obama in the best statistical way:

By “religiosity”, I mean the percentage of the state population who say that religion is very important in their lives. I used state data from 2007 Pew Research survey for this. My thinking was that many people base their political views on their religious faith, and that this might explain some of the differences in support for Obama.

And it does. For every 5 percent increase in state religiosity, support for Obama decreases by 1 percent, and that relationship is statistically significant. In other words it isn’t just be caused by random factors.

For the curious, the R-squared for this equation was 0.54, meaning these variables explain 54 percent of the differences in state support for Obama — not too shabby for a back-of-the-cocktail-napkin analysis. All three variables were significant at the 0.05 level.

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In the end, including percentage with advanced degrees and religiosity in the equation made the relationship between state unemployment rate and support for Obama look even better than it did without them. In fact, no matter what variables I included, there still was a positive relationship between unemployment and Obama support.

So the relationship that I didn’t think existed, the one that I thought would go away if I included the right variables, turns out to be pretty solid. Higher unemployment rates do seem to be associated with more support for President Obama.

Maybe Americans do vote with the wallets, only not the way you might think.

Do Americans Vote With Their Wallets? State Unemployment Rates and Support for the Incumbent

Americans vote with their wallets, or at least that’s the conventional wisdom. Economic issues are supposed to be of primary concern to American voters. Or, as Bill Clinton’s presidential campaign famously put it in 1992, “It’s the Economy, Stupid.”

I avoid politics here – it’s not that kind of blog – but sometimes it’s impossible to separate economy from political economy, particularly in an election year. So I decided to take a look at this piece of conventional wisdom. In a non-partisan sort of way.

If the economy really is key to American voters, then one might expect that – all else being equal – states with high unemployment rates should be less likely to support the incumbent (Obama), and states with low unemployment rates should be more like to support him.

Put another way, there should be a negative correlation between support for the incumbent and state unemployment rate. A graph of states with support for Obama on one axis and state unemployment rate on the other should tend to slope downward.

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The economists’ union requires that I preface this with caveats: There are various technical issues with analyzing aggregate data this way, and this is not intended to be a scientific study. That said, back-of-the-cocktail-napkin analyses can still be interesting and enlightening.

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Correlations are measures of how much two sets of numbers tend to move in the same or opposite directions. A correlation of 0 means there’s no relationship, close to -1 means the two move in opposite directions, and close to 1 means there’s a strong positive relationship. In this case, we’re expecting a negative number.

The correlation between state support for Obama and state unemployment rate actually turns out to be positive 0.27. This means that – all else being equal – the higher the unemployment rate in a given state, the higher the support for President Obama. The opposite of what we’d expect, if economic issues are driving voter preferences.

(Note: I used FiveThirtyEight’s unadjusted average poll numbers by state, simply because they were available in an easy-to-use format. The numbers were as of 3:00 pm on 28 October. The unemployment rates are those for September 2012, from the Bureau of Labor Statistics, bls.gov.)

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Correlations are rather unexciting to many people. After all, they’re just numbers. A mentor of mine used to recommend an alternative technique that he called, “Look at your data”. So here’s a – yes, I am an economist – graph of state preference for Obama versus state unemployment rate.

As suggested by the positive correlation, the data points do tend to slope upward. The best fitting line is shown, and it has a positive slope too.

States such as Rhode Island, California, New Jersey, and Nevada have relatively high unemployment rates and yet have relatively large percentages supporting Obama. States such as North Dakota, Nebraska, and Oklahoma have low unemployment rate yet have smaller percentages supporting Obama.

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What gives? Is the conventional wisdom about Americans voting with their wallets wrong? Is it not the economy, stupid? Does high unemployment actually cause people to prefer the incumbent?

That’s hard to say. Political preferences are complex, and many factors combine and interact to determine an individual’s political views. It gets even more complicated when you consider things at the state level.

It’s possible that higher unemployment rates really do cause people to support this incumbant. Perhaps people who are unemployed are more likely to prefer Obama because they believe, for whatever reason, that they personally will be better off if he is re-elected. On the other hand, it’s also possible that other factors are affecting both unemployment rates and political preferences, making it appear that higher unemployment rates are causing people to support Obama.

Whatever the details, it’s clear that saying money is all that matters to American voters vote is too simplistic. Maybe Americans do vote with their wallets, but that could mean voting for the candidate they believe is most likely to fill them.

More on this Topic: Voting With Your Wallet II: Education, Liberalism, and Unemployment

Little-Known Fact: Corporate Tax Rates Have Been Decreasing for Decades

How much tax should corporations pay?

That’s a more complicated question than it sounds. To a large degree, how a government how one raises the raises revenue is a matter of values and priorities.

And practicality. Willie Sutton is said to have robbed banks because that’s where the money is. Jean Baptiste Colbert, finance minister to King Louis XIV in the 1600s, said “The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing.”

Like it or not, there’s truth to that. Governments get the money where they can. Corporations spend heavily on public relations and campaign contributions. Corporate feather-plucking tends to be accompanied by considerable hissing.

There also are economic arguments to be made against corporate taxation. Corporate profits are taxed twice – once when the corporation earns them, and again when shareholders receive the profits as dividends or as capital gains. This double taxation is economically inefficient and distorts capital markets, at least to some degree.

In addition, corporations that feel over-burdened by taxes have the option of taking their ball and playing in a different field, i.e. moving to a country with lower taxes. According to the Wall Street Journal, “10 companies in the last three years” have moved from the U.S. to other countries such as Ireland, Switzerland, the U.K., and the Netherlands. The Journal repeats the mantra that U.S. corporate tax rates are the “highest in the developed world”.

How rampant this trend is, whether it really is increasing, and how much of an impact this has had on the U.S. economy is unclear. Regardless, companies moving to other countries is hardly something that we’d want to encourage, particularly when the U.S. unemployment rate is at 7.8  percent.

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At the same time, there are reports of companies “re-shoring” jobs back to the U.S. after having previously off-shored jobs to other countries. The specific reasons vary, but companies have been finding that there are advantages to the U.S. and disadvantages to other countries that they hadn’t realized before.

But at the end of the day, of course corporations are going to say corporate taxes are too high. No company wants to pay more taxes, any more than individuals do. Everyone wants someone else to pay. But the implicit threat is always there: if corporate tax rates are too high, companies can and will move, as the Journal puts it, to “friendlier climes”.

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But individuals hear about corporations making billions of dollars in profits, and numbers like that tend to set off alarms. “They’re making that kind of money? They should be paying lots of taxes.” And who’s to say they’re wrong? The word is that corporations are “people”, and people pay taxes.

While the U.S. corporate tax rate is often listed as 35 percent, or even an “effective tax rate” of 39.2 percent, this is misleading at best and a lie at worst. The U.S. tax code is so riddled with exceptions and exemptions and loopholes that corporations usually don’t pay anything close to this.

The fact is that the federal tax rate the corporations actually pay has been decreasing for decades and is now close to 20 percent. This isn’t some biased analysis coming from a left-wing think-tank. This is coming straight from the Bureau of Economic Analysis’ data. A simple calculation – divide corporate federal income taxes paid by before-tax corporate profits. There’s not much room for biases to creep in there.

An ironic point that this graph shows is that the last big increase in corporate tax rates occurred in 1986, under President Reagan’s administration. People forget that Reagan had to raise corporate taxes in order to offset some of the deficit increases caused by cutting individual income taxes and increasing defense spending.

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What’s driving this decrease in effective corporate tax rates, at the same time corporate profits are increasing? That is much harder to determine. The byzantine complexity U.S. tax code is legendary, and Congress has a habit of tucking exemptions and credits into many bills. What’s clear, however, if that the rates that tax corporations are actually paying are decreasing substantially.

The question, however, is whether this decrease in corporate taxes is a good thing that we as a country want to embrace and encourage, or if this creeping de-taxation goes against our collective values and priorities.

With the U.S. public debt soaring to nearly unprecedented levels, we need to consider all revenue sources. Larger corporate profits mean there are lots feathers there, ripe for the plucking. Whether politicians be opt to avoid the hissing is yet to be seen.

Gross Domestic Product Grows at 2.0 Percent or 2.3 Percent

The Bureau of Economic Analysis (BEA) reported today that the U.S. real Gross Domestic Product (GDP) grew 2.0 percent last quarter over the previous quarter at an annual rate. But if you compare GDP in the most recent quarter with the same quarter in 2011, real GDP grew at a 2.3 percent annual rate.

Europe – indeed most other countries – report GDP growth on a percent-change-from-the-previous-year basis, comparing the most recent quarter with the same quarter last year. In other words, how big was the economy in July/August/September 2012 compared with July/August/September 2011, after adjusting for inflation?

But not here. In the U.S., the Bureau of Economic Analysis (BEA) reports real GDP growth on a percent-change-from-previous-quarter-at-an-annual-rate basis. In other words, how big was the economy in July/August/September 2012 compared with April/May/June 2012, adjusted to an annual growth rate instead of quarterly and adjusted for inflation?

Why the difference? Beats me. It could just be a case of, “We’ve always done it this way”, or even “We’re the U.S. and we’re different”. I know that the U.S. clung to Gross National Product (GNP) over Gross Domestic Product (GDP) for years even though the rest of the world was reporting GDP. So it’s possible that the BEA is just being conservative.

Regardless of the reason, I prefer the change from previous year to the change from previous quarter, and not just because it makes the U.S. number more comparable to the rest of the world.

First, looking at the annual changes gives a clearer picture of the longer term trends. It also is less susceptible to distortion due to one-time changes and thus doesn’t have as much random variation. That make it less noisy, as economic signals go.

Finally, the annual number eliminates the confusing “quarterly change at an annual rate” concept. Sure, I understand what that means, but do most people? Why make things so complicated and convoluted?

Of course, as is usually the case in economics, there’s a trade-off. While the change from previous year shows trends better, it doesn’t show immediate changes quite as clearly. Focusing on the annual change thus could make it hard to spot a turnaround right away.

On balance though, I prefer yearly to quarterly. When it comes to economic data, I’ll take smooth over noisy any day.