A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, July 13, 2010

Transcript: 394 Forecast, Social Security, Inequality and the Multiplier

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While we were away there was a dramatic drop in the stock market. We've called for the end of the bear market rally, and predict a long term decline of stock values. But it surely woke up the Street. That and the continuing sick numbers. Demand Side has never called a recovery and predicted twelve percent headline unemployment and 20 percent U-6 before its over. To others it is a surprise. In the following clip, the surprise is evidenced by Bloomberg's Tom Keene, the reality reflected by long-time bear David Rosenberg.


Recently the Social Security and Medicare Boards of Trustees released their 2009 annual reports. The summary of them attracted the gamut of response, from it is time to privatize to "save" them, to "all this stuff is scare tactics."

Reviewing the release, Demand Side falls not in the middle, but outside this range.

The trustees message, in brief:

The financial condition of the Social Security and Medicare programs remains challenging. Projected long run program costs are not sustainable under current program parameters. Social Security's annual surpluses of tax income over expenditures are expected to fall sharply this year and to ... to rise only briefly before declining and turning to cash flow deficits beginning in 2016 ... The deficits will be made up by redeeming trust fund assets until reserves are exhausted in 2037, at which point tax income would be sufficient to pay about three fourths of scheduled benefits through 2083.

The message that social security is completely solvent until 2037, and that it will continue to run a surplus until 2016, reveals the finances of the social insurance programs are far better than those of the general fund. The operating budget has paid out more than its revenues for decades, is projected to be in the red for the foreseeable future, and has no trust fund at all. For the operating budget, 2016 and even 2037 has come and gone and is now a distant memory.

The Trustees correctly define Medicare's financial status as much worse, saying:

As was true in 2008, Medicare's Hospital Insurance (HI) Trust Fund is expected to pay out more in hospital benefits and other expenditures this year than it receives in taxes and other dedicated revenues. The difference will be made up by redeeming trust fund assets. ...

For the third consecutive year, a "Medicare funding warning" is being triggered, signaling that non-dedicated sources of revenues—primarily general revenues—will soon account for more than 45 percent of Medicare's outlays. A Presidential proposal will be needed in response to the latest warning.

The Trustee's warning means that the Treasury will have to make good on its bonds in substantial form. Indeed, it is our understanding that the net outflow is now negative. That is, while Social Security is still running a surplus, it is more than matched by the Medicare deficit. In fact, it is the pathetic operating budget that is under stress. With a revenue source based on the shoddy and corrupted personal income tax, the operating budget has been borrowing trust fund surpluses for decades to maintain its facade of substance.

Meanwhile both liberals and conservatives trumpet the new subsidies they provide by way of tax breaks. There is an argument that, if you want to subsidize something, do it through the front door, with a check made out to the appropriate party. It's easier for everybody. And it is transparent. The tax code is so muddy now it supports a $300 billion plus industry in compliance, avoidance and evasion specialists.

Be that as it may, it is time to blow up the hypocrisy and end the cap on payroll taxes by which tax cuts for the rich are finance by regressive taxes on the middle class.

Galbraith on Inequality

James K. Galbraith, one of the most progressive economists with a wide audience, is also one of the world's foremost experts on inequality. As director of the University of Texas Inequality Project, he has led efforts to devise metrics and to communicate the issue to broad audiences.

Here are some comments made to an OECD media arm recently.


Charts expressing Galbraith's description of changes in inequality over time are provided in the transcript of today's podcast. Perhaps most striking is the turn at the year 1980. The slope in the growth of inequality is steep and continuous for twenty years, until, as Galbraith says, the low interest rates sponsored by Alan Greenspan promoted the housing boom and the demand for commodities produced by the developing world.


Domestically, the trajectory is broadly similar.

At Demand Side, we are exponents of the income multiplier. We take additional lessons. 1980 also marks a bend in the slope of real GDP growth. To us, the increase in inequality and the decline in economic growth are connected. The middle and lower classes exchange goods and services far more fluidly than the upper classes. As income becomes concentrated at the top, the internal vitality of the economy wanes. Similarly, the attempt by the middle class to maintain its standard of living by borrowing affected the multiplier by draining it to make debt service payments.

To be clear, as we've discussed before, the multiplier in a perfectly homogeneous economy without debt would be the inverse of the savings rate. That is, as butcher and baker and farmer and teacher and so on pay each other, each retains some for savings, which is the only portion not passed on for the next good or service. This savings, if even ten percent of income, would restrict the multiplier to only a factor of ten. If savings were five percent, the multiplier would be twenty.

But we know from the many attempts to determine the multiplier empirically, that it is only around two.

It is odd that more interest has not been expressed for the reason for this discrepancy. After all, the ten and twenty are algebraically mandated. The only possible reductions are for people saving more than the norm. Well, not so. Debt, of course, is a payment for a good already received. In this way it counts as savings, income minus spending. As Michael Hudson pointed out on a relay not too long ago, most of the real saving is done by the top ten percent. The savings in the lower nine deciles is the paying back of debt, the negation of a negative, hardly a cause for celebration.

The multiplier in principle applies only to exogenously introduced stimulus or spending, that is, to investment or government spending. In practice, there are no exogenous sources. But the practice of the multiplier reveals the effects not only of debt and savings rates, but of consumer confidence, different types of spending and investment, and as today, the dynamics of inequality.

A really bad idea was floated by David Rosenberg in a part of the interview with Keen we did not reproduce. That was extending the Bush tax cuts. Not only do tax cuts in general in depression have a very low multiplier, since the marginal income will be saved or used to pay down debt, but the Bush version was canted to the upper quintile, which as we've seen is a sump for economic activity. Better to hire people.

Jobs distribute spending not only to the hired, but to the 95 percent of the activity they engage in which is not saving. Tax cuts, again, will be devoted inordinately to saving.

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