2009 Carbon Tax Up, Payroll Tax Down Act

I want to get behind a cause that is so plainly reasonable that only Congress could figure out a way to kill it. The name of my cause is: Carbon Tax Up, Payroll Tax Down. Catchier names are welcome.

About a year ago, my old microeconomics professor at Berkeley, Severin Bornstein, came to NY to give a speech to alumni about energy policy. It was timely for me, because just that week, The New Yorker had published an article attempting to explain the difference in energy consumption (including everything: heating oil, electricity, gasoline, etc.) among European households and American households. The numbers are astonishing: European per capita energy consumption in 2006 was 146M BTUs/year. The major Western European nations are the UK (162M), France (181M), Spain (161M), Italy (139M) and Germany (178M). What is the US number? 335M. Roughly double the Western European average. The reason the Western European numbers are so compelling is because the standard of living is so similar. How is it possible that people in Europe are able to live lives full of the same conveniences (nice houses, cars, lots of household electronics, etc.) that we enjoy with half the energy consumption?

The answer can be explained partly by urbanization. There just aren't as many dense areas in the US per capita as there are in Europe. Indeed, if you break down the US numbers, by far the most energy-efficient city in the country is New York, followed by San Francisco and Chicago. Those are the three of the most urbanized cities in America (note that two of the three are not in warm weather climates, either, although climate is obviously a factor). Population density primarily reduces energy consumption in two ways: less driving reduces gas consumption and smaller dwellings reduce heating and cooling usage.

But aside from quality of life, climate and population density, there is a fourth factor that goes largely unnoticed. I asked Prof. Bornstein how energy consumption can be so dramatically lower in Western Europe vs. the US, even after controlling for factors like climate and urbanization. He answered without hesitation: by and large, European countries tax energy more and payrolls less. He exasperatedly lamented, "For some reason, in this country, we tax the things we want people to do (like work) and don't tax things we don't want people to do (like consume fossil fuels)."

It has been over a year, and that sentence has stuck with me ever since. Why do we have such a perverted set of incentives in place? Conversely, what could be simpler to fix? The Obama administration should propose a revenue-neutral reduction in the payroll tax and creation of a national carbon tax. Aside from the usual special interests, like oil and coal companies, and ultra-commuters driving 50+ miles to work each day, who would oppose this? Think of the economic, environmental, strategic and political benefits:

• Lower payroll taxes help businesses, both large and small, and incent companies to hire, thereby reducing unemployment. Unemployment (along with government debt) is probably the single biggest threat to our country's economic health. It would be hard for Republicans to oppose such a plainly pro-business bill such as this one.
• The entire package would be revenue-neutral, satisfying the deficit hawks (of course, a change in consumer behavior that reduces fossil fuel consumption as a result of a carbon tax may lead to larger deficits in the long-run; this would have to be accounted for in the calculation of the effective tax rates in the bill).
• A carbon tax would incent lower fossil fuel consumption and provide a subsidy to renewable energy. A cleaner environment would certainly be popular with the Democrats and would put the country in good stead with the international climate control community, which can't hurt. And fostering the growth of a national renewable energy industry (not to mention the production of more energy-efficient cars, homes and electronics) is the icing on the cake. Again, who would be opposed, outside of a narrow set of special interests?
• It just so happens that most of the major oil exporters in the world are not friendly to the notions of democracy and freedom in general, and the US in particular. Why not reduce our reliance on these countries' petroleum reserves and increase our national security at the same time? The Congressional hawks would be happy to see that happen.
• Even the protectionists have something to cheer here: we would effectively be subsidizing a domestically-produced commodity (American labor) and taxing a foreign-produced commodity (oil).
• Politically, the timing could not be better for President Obama: after so much hand-wringing about the stimulus plan and health care that has cut into his popular support and made him an easy target for conservatives, he needs a "triangulation" strategy. What could be better than a pro-business bill that would provide an immediate boost to job creation with no increase in the national deficit? Aside from the oil- and coal-producing states, this bill would garner some Republican votes, further isolate the right-wingers, appeal to independent voters, and give Obama some air cover to push for his more liberal initiatives.
  

Simply put, I cannot think of another national policy that offers so many immediate and long-term benefits, for so little cost and effort, and with such a bipartisan base of support as the 2009 Carbon Tax Up, Payroll Tax Down Act. How can we make this happen?

Two Political Observations

1. The phony "balloon boy" story is getting far more play on the news networks than the Taliban/Al Qaeda advance on Pakistan's police and military facilities. Is anyone besides me concerned about the fact that end-of-days religious fanatics and terrorists now have a fighting chance of getting their hands on an arsenal of nuclear weapons? And how exactly is there a debate about whether or not we need to allocate more resources to this part of the world? There should be a thorough debate about how and where to deploy our country's blood and treasure, but it seems fairly clear that this region is an extremely high priority for national security.
2. Bill Thompson has climbed within eight points of Mike Bloomberg in the New York mayoral race despite being outspent 16-1 and now the Daily News is predicting one of the nation's biggest political upsets ever. When asked in a debate this week whether or not he would replace the incredibly effective and popular Police Commissioner Ray Kelly (annual murders will fall below 400 this year...they were at 1,800 when Giuliani took office), Thompson replied without hesitation, "Yes." When asked why, Thompson said, “I believe in bringing my own team to the table." Ah, yes...NY party hack machine politics. How I long for a return to those halcyon days!

Treasury's 2009 Real Estate Forecast: Look Out Below!

In their evaluation of the financial health of US banks, Treasury is making certain assumptions about the future of the economy, including real estate values.  They are applying two scenarios.  The baseline "consensus" scenario envisions real estate values will fall 14% this year.  Considering values fell 18% YoY in January, that assumption says that the rate of decline will flatten out and decrease before the end of the year.  The more pessimistic scenario assumes a 22% drop, which means the rate of decline would actually accelerate downward from the January numbers (yikes!).  Deceleration would probably not happen until late 2009 or early 2010.  Who knows when we would reach the point of flat or increasing values? (mid- to late-2010, is my guess)

Think about that: if we are going to average a 22% drop in real estate values for the year and we are currently at 18%, then there will have to be some months this year when real estate falls more than 22% YoY.  To put that number in perspective, the highest monthly increase that Shiller has recorded since 1987 was just over 20% (late 2004).  The biggest decrease was a little over 6%, recorded in 1991.  We are in an era of unprecedented volatility.  To put it another way, the expected annual decrease in real estate values in this scenario is more than the average down payment on a home, which means that Treasury is predicting in this scenario that most people who bought a home in 2008 will be underwater in 2009.  Hello, foreclosure spike!

I guess the good news is that if Treasury is right, we will reach bottom a lot faster than we reached the peak.  Gotta find a silver lining somewhere.

Stimulated to Death

I watched Obama's press conference on Monday about the new stimulus package and noted how everything was about jobs, jobs, jobs.  This is a reassuring message to all those millions that have lost work over the course of the past year.  But it rings false to me.

The most interesting moment in the press conference was when NBC's Chuck Todd asked the president if deeply indebted households should use their stimulus money to save or spend.  That is a difficult question for a politician to answer and it forms the crux of the issue. (Obama acknowledged that saving was a good idea now, but then gave all the reasons we should spend.)  The correct answer is indeed "save" and the data shows that that is exactly what Americans are doing now.  This is a good thing.  For years now, we have seen Americans binge on unnecessary luxuries by taking out home equity loans and maxing out credit cards.  This led in 2005 to the first negative annual savings rates since 1933.  We were living beyond our means and now is the time to pay the piper.  That means, save.  But saving doesn't "stimulate" the economy.  It just pays off the sins of the old one.

Another interesting data point came from the Department of Labor on February 5th when it was revealed that labor productivity shot up in the fourth quarter of 2008 by 3.2%.  This was primarily due to layoffs, but nonetheless, the fact remains that American workers were able to produce more valuable output per person/hour than the year prior.  Again, that is a good thing.  But it doesn't produce jobs, it reduces them.  In the long run, productivity generates higher wages, although most likely for fewer people.

So Americans are producing more and saving the rewards of that production.  This is incredibly heartening for the future of our country (I have long advocated for a progressive consumption tax to replace the income tax precisely to incent even more savings).  But it is also the exact opposite of what the stimulus plan seeks to achieve.  The stimulus plan would throw millions of people back to work, and sad to say, most likely produce less per worker/hour.  It would also seek to get Americans spending again by "increasing consumer confidence."  Today's bank bailout plan will "get credit flowing again" so that Americans can spend even more.  All of this can feel good in the short term, but does not dig us out of our long-term hole.

I remember reading about an episode from the campaign trail in 2000 when Al Gore was speaking to a group of factory managers at a plant in Ohio, I believe.  He started talking about how plants like this one can produce good jobs for Americans.  A reporter standing in the back of the room overheard one of the managers say to the other, "He just doesn't get it, does he?  Our goal is not to increase jobs, it is to reduce them."

Harsh, true.  But this is capitalism.  Producers seek to maximize output from the minimum number of inputs, including labor.  No IT or plant manager ever installed a computer or robot in order to increase the number of workers he or she had to hire.  The idea is to do more with less, and the result is "jobless growth."  In this scenario, there are two winners: the equityholders who receive the economic rents from the produced goods and services, and the shrinking working population, who enjoy higher wages.  The losers: everyone else.

But what if we could make all workers more productive, you ask?  What if we can squeeze out high productivity from more workers?  A nice thought, but it runs smack into one difficult economic reality: there actually is a limit to how much stuff we need.  To be sure, there are great swaths of this country and this planet that do not have enough of what they need.  Standards of living can always be raised.  (This, in fact is a good argument for opening up trade; of course, the stimulus bill may end up doing the opposite by imposing "buy American" clauses).  But still, there is a limit.  If everyone in the world loved bananas and would ideally like to eat one each day, then the maximum demand for bananas would be six million bananas per day.  Producing 10 million bananas would do nobody any good.  Likewise, does the world need infinitely more HDTVs and SUVs?  No.  Does producing more of them "stimulate" the economy?  In the short term, yes, because induced demand ends up putting more money in the pockets of the owners of those companies and the people who produced the products.  In the long term, no, because Americans would simply be borrowing even more money (mostly from China, who inexplicably keep buying our debt) and going deeper into debt to purchase more.  At some point, the piper must be paid.

America has been drunk on debt for the better part of a decade and President Bush, the ex-Andover cheerleader, sat next to us at the bar, chanting, "Drink, drink, drink!"  Lower interest rates!  Loosen credit!  Buy more houses!  Buy more cars!  Spend more, save less!  This is all we heard for years.  Even today, there is talk about "housing stimulus"...both Democrats and Republicans, along with the president, want to reduce mortgage interest rates further, free up credit for borrowers, offer incentives for first-time buyers, and most perniciously, "keep people in their homes."  I have news for you: a massive chunk of these people, including the ones that are most in trouble, don't own these homes, by any reasonable definition of the word.  The banks do, and they overpaid for them.  An interest-only loan with no money down means the resident is a renter, not an owner.  There are millions of these out there.  And many families can't afford the rent.  Well, in most parts of the world, when you can't afford the rent, you move to a cheaper place.  But not here.  Our housing stimulus is meant to simply reduce the "rent" across the board, by reducing the interest payments.  Problem solved!  Everyone can live large again!  Any chance Congress can reduce the price of TVs?  How about cars?  I have my eye on a sweet Lexus. (a hybrid...I'm saving the environment...everybody wins!)

We are a country that has maxed out its credit card at Bloomingdales and is now being offered, courtesy of Congress and the president, 75%-off sales on everything in the store.  We'd be losing money by not buying!

Back to my original metaphor: alcoholic America, it is time to sober up.  Hair of the Dog is more fun, but not a long-term plan for success.  Yes, there will be a hangover (fewer jobs, more productivity, higher savings, negative economic growth).  This hangover could last years (just looking at mortgage debt levels, one could argue the bender started way back in 1998, so 2-3 years of penance is not a relatively high price to pay), but we will feel a heck of lot better when it is over, and more capable of being productive.  Giving an alcoholic another drink so he or she doesn't feel so miserable does not nurse the drunk to health; it just prolongs and worsens the inevitable hangover and prevents the person from doing anything useful.  Similarly, fiscal stimulus for the sake of short-term job growth and increased consumer spending doesn't fix anything long-term either.

In the meantime, while we nurse our hangover, we need to focus instead on three crucial areas, so that we can prosper as a nation once we're back on our feet:

1. Investment in New Forms of Energy, Science, Technology, Education and Infrastructure: This is the only part of the stimulus package that I support.  It is being sold as a way to put Americans back to work, but the resultant jobs are really a byproduct of something much more important.  Simply put, these initiatives can increase US productivity, increase energy security, and protect the global environment.  Unlike in my banana example, the world is severely undernourished in these areas...there is excess demand, so let's figure out a way to produce more supply.
   
2. Entitlement Reform: You've heard it a million times: Social Security and Medicare are going broke.  Again, we are accruing massive debts to the poor, elderly and ill that we will never be able to pay off if current trends continue.  Particularly in health care, we spend more each year, outpacing inflation by 4.9%/year since 1965, and our health standards are declining.  This is unacceptable and a massive looming crisis.
3. Wealth Redistribution: There, I said it.  As I noted above, increased technology leads to increased productivity that ultimately reduces the number of jobs required to adequately serve global demand.  I acknowledge, again, that there are massively poor parts of the world (and here at home) that could use more goods and services, and that is an excellent argument for lower trade barriers and improvements in global distribution and logistics.  But there is no avoiding the fact that as Americans become more productive, the economic rents will accrue disproportionately to equityholders and the remaining workforce.  A larger number of people will be left out each passing year.  We need to think long and hard about how to take care of these people, while also providing incentives for them to become productive members of society.  Back in the 1950s, people dreamed of a world where robots would do all the work and humans would live a life of leisure.  Well, it may not feel like it (especially today), but that era has already dawned.  I don't stuff memos into interoffice envelopes for a messenger to pick up anymore; I send an email.  That messenger job has been eliminated.  I don't hand a five-dollar bill to a toll collector at the Midtown Tunnel; those jobs have been reduced by EZ-Pass.  A switchboard operator doesn't connect my phone calls.  And so on.  There are countless other examples and there undoubtedly will be countless more as technology develops.  So, what, as a society, would we have the ex-messengers, ex-toll collectors, and ex-switchboard operators do?  Certainly, education and job training are part of the answer, but will that cover everyone?  We will need to answer this question sooner rather than later; my suspicion is that more wealth redistribution, in the form of higher taxes on the wealthy, will end up being the unavoidable answer.  Hey, it beats wealth restribution in the other direction (see "Tax Policy, George W. Bush" and "Bank Bailout, 2008").

So, there you have it.  Years of high savings and productivity, but low or negative economic growth.  Followed by a structurally sound economy that produces more with less.  The equityholders and workers earn more thanks to government investment in education, infrastructure, energy, science and technology.  At the same time, a higher percentage of their wealth is shared with the elderly, sick and unemployed.  Nevertheless, the owners and workers still net out ahead and live better than ever.  Those that aren't working live modestly, but enjoy a safety net, and are incented to join the ranks of the working.  Energy security is enhanced, people live longer and healthier lives, and the planet doesn't suffocate on burning fuels.  I don't know if this is a socialist or capitalist utopia, but it sure sounds better than what we've got.

Nothing To Lose, A-Rod

Reading all the stories about A-Rod today, I feel like we have the perfect bookend to the steroid era in baseball. It all started just over a decade ago with the feel-good home run derby in 1998 between McGwire and Sosa, which later turned out to be a steroid-fueled fraud. The era then reached its apex with the revelations, subsequent angry denials, and finally trials, of Bonds and Clemens. And now it comes to an end with the greatest player of the modern era, who is clinically desperate to be liked and respected, and will now most certainly be neither.

The A-Rod story feels sadder than the others. Sure, he's a prick like the rest of them, but he's such a needy prick. I would guess that he'll react to his predicament differently than the others. His former manager/father figure just wrote a book that acknowledges his talents but also reveals that neither he nor his teammates like him very much. (This dude is having a seriously bad week.) This much bad karma might just be too much for him to maintain the charade. Instead of stubborn denials, we might see something resembling remorse.

But maybe that's his ticket out. Gone are the dreams that he would "cleanse" the home run record of the Bonds stain in a handsome pinstripe uni, trotting around the bases in a gold-plated new stadium.  As Dylan famously sang, "When you got nothing, you got nothing to lose."  Well, A-Rod certainly doesn't have "nothing," but he sure doesn't have the only things that seem to matter to him.  Maybe by telling the truth, he can finally get rid of the phony Roy Hobbs persona that he has been dragging around since he left Seattle for the big bucks and glory in Texas.  He can finally shed himself of all the emotional baggage and regain a shred of his honor. His legacy is tarnished forever, but maybe by telling the truth, he'll attain the one thing that's eluded him his entire career: maybe, for once, he'll come through in the clutch.

Hank Overpaid By 30%

The Congressional Oversight Panel reveals that Treasury overpaid the banks that received bailout funds by 30%, based on their then-current market values.  Oops.  I'm sure this was just an innocent mistake...a series of clerical errors, perhaps.  Considering that Pentagon procurement officials have been tried for overpaying for hammers, how long before someone suggests indicting Mr. Paulson, a once and potentially future investment bank chief, on corruption charges for overpaying banks to the tune of $80 billion?  I guess I just did.

More Bank Bailout Fury

Here's another article to make your blood boil, courtesy of Mike McIntire at NYT.  Some choice quotes:

A review of investor presentations and conference calls by executives of some two dozen banks around the country found that few cited lending as a priority. An overwhelming majority saw the bailout program as a no-strings-attached windfall that could be used to pay down debt, acquire other businesses or invest for the future.

The report concluded that the Treasury's top priority seemed to be to "stabilize financial markets" by simply giving healthy banks more money and letting them decide how best to use it.

During his presentation, John R. Buran, the chief executive of Flushing Financial in New York, said the government money was a way to up the "ante for acquisitions" of other companies.

It is increasingly clear that the sole purpose of TARP is to increase the stock price of financial firms and thereby shield management, partners, directors and equity holders from any further declines in the value of their holdings.  Case in point: the additional $20B that Hank Paulson just handed to Bank of America (on top of the $25B they were given already).  They claimed that they needed the money to help pay for unexpected losses at Merrill Lynch, which they acquired last September.  BofA paid $29/share for Merrill, which represented a 70% premium over the stock price at the time.  Recall that Merrill was on the brink of failure that weekend and the stock was plummeting.  Why would anyone pay a 70% premium when the acquisition target was begging for a lifeline from the Feds?  Instead of bailing out Merrill, Paulson asked a seemingly healthy bank, BofA, if they could buy them out, and they agreed.  Naturally, they agreed on a price only after confirming that Uncle Hank would fund $25B of the deal, no strings attached.  The net effect: Merrill shareholders, including their entire management, were given a 70% (or more) boost to their stock price and net wealth, courtesy of the American taxpayer.

Now, after three months of looking at Merrill's books, BofA discovered last week that, lo and behold, Merrill was worth nowhere near $29/share.  Probably something closer to $17 or $18/share.  Hmm, $17 or $18/share...why does that number sound familiar?  Oh yeah, that's what ML was trading for when BofA dramatically overpaid for it (the actual closing price on the Friday before the weekend deal was $17.05).  That's called the "market price" in economics.  The difference from the market price and what BofA paid for it is worth roughly $20B in total market cap.  Since BofA "lost" $20B in market cap on the deal, Uncle Hank graciously offered BofA a "makegood" with another no-strings-attached $20B.  This time, the $20B goes toward supporting BofA stockholders. (many of whom are not even Americans, by the way.  In the case of the Citibank bailout, worth some $300B, the largest shareholder is Prince Al Waleed of Saudi Arabia.)  No capitalistic accountability for these boys, no way...that's just not their style.  If they make a killing on the market, the government has no right to tax them on their hard-earned money, they've claimed consistently, but if they make a bad deal, then the country must compensate them for it in order to "restore confidence in the American economy."  In fact, I suspect that the BofA boys knew the ML acquisition was a bad deal...after all, it was patently absurd to pay such a huge premium for a failing bank.  Any fool could have seen that (and did).  Is it not plausible that Uncle Hank promised them some taxpayer cash on the back end once the books were closed?  Seems at least suspicious, no?

So, you see, everybody wins: Merrill shareholders, BofA shareholders, "the economy"...oh wait, I forgot about you and me.  We lose...we lose big.  Each American household contributed about $400 to this fun little deal.  Think about that: there are janitors working in the Merrill and BofA buildings that will contribute a couple hundred bucks each to make sure that the megamillionaires, whose trash they are emptying, can remain acceptably rich.

I am still utterly perplexed at why our Congressional leaders felt that the bankruptcy courts were not an adequate tool to sort this mess out.  The Feds could have still pumped money in to support bad mortgages and the like.  The equity holders, quite rightly, are the ones that would have been left holding the bag, instead of you and me.  That's the way the system is supposed to work: those who take risks and stand to benefit hugely from them, also stand to lose as well.  Instead, taxpayers backstopped certain stockholder losses and there has been virtually no positive impact on lending or economic activity.

But taxpayers at least ended up with equity in the banks, you say.  If these banks survive, we'll get all of our money back when the government eventually sells the stock, right?  Um, no.  According to a fine article by Edmund Andrews at NYT, in an effort to lessen the appearance of nationalizing US banks, the Fed and Treasury have sought to minimize the amount of equity they received for the cash invested.  This kind of only-in-Washington, through-the-looking-glass logic has resulted in yet another screaming bargain for the officers and shareholders of America's banks.  Can you imagine the negotiations that took place between Mr. Paulson and these bank CEOs?

Paulson: "Now, I'm going to invest billions in your bank with few conditions and no disclosure of how you use the money in exchange for preferred shares, but there's a catch: I insist that you don't give me too many shares, or else people will start calling the US government socialistic.  As good-standing Republicans, we can't stand for that.  Do we have a deal?"

CEO: "Yes."

These negotiations must have lasted about 15 minutes.  No wonder over 200 banks took the deal in only a matter of weeks.  To give you an example of just how egregious these "investments" are, I cite the BofA deal again.  In exchange for investing $45B in capital, Mr. and Mrs. American Taxpayer now own roughly 6% of BofA.  That is an implied market cap for BofA of $750B.  And the latest market value of BofA shares? $36B, or roughly 1/21 of what we, the taxpayers, paid.  Boy, these bankers are going to be laughing their faces off telling these stories over martinis at the Maidstone Club in East Hampton this summer.  I wonder if they'll put the drinks on Hank's tab?

I've said it before and I'll say it again: this $700B TARP program is going to go down as the greatest financial rape of the US taxpayer in our nation's history.  It is absolutely infuriating, and the worst part is, unlike real rape, it is perfectly legal.