Here’s how high levels of household debt affect economic growth

Posted on by Bridget Ansel

The Great Recession and its aftermath sparked a lot of rethinking about economics and economic policy. One recurring theme in this rethinking is the danger of debt.

In “This Time Is Different,” a recent book that explores financial crises throughout history, Harvard University economists Carmen Reinhart and Ken Rogoff show how run-ups in debt are key to setting up crises. But what kind of debt should set off alarms for economists and policymakers? A new working paper by economists Atif Mian and Emil Verner of Princeton University and Amir Sufi of the University of Chicago points to household debt as a source of instability and lower economic growth.

The working paper looks at the relationship between household debt and economic growth in 30 countries from 1960 to 2012. Earlier research found that recessions driven by household debt—particularly mortgage debt—are particularly nasty. But Mian, Sufi, and Verner push this research a bit further to find that high levels of household debt, measured as the ratio of household debt to gross domestic product, predict lower economic growth.

The three economists can’t say exactly why household debt has a negative effect on growth and stability. Instead they point out that their results are consistent with models of the economy where the supply of credit expands, lenders are more likely to lend, or a decline in risk allows households to take out more loans to finance consumption.

The dynamics of how household debt affects economic growth are quite interesting. Higher debt results in more consumption by households and a larger share of economic output coming from consumption. At the same time, this results in the country running a larger current account deficit with the rest of the world as imports increase, with consumption goods making up a larger share of those imports. Once the economy enters a recession, however, imports fall dramatically and the country starts to export more than it imports. This mechanism allows the country that ran up debt to bounce back by selling goods to the global economy.

But that mechanism only works if the rest of the global economy is doing well and other countries didn’t also see an increase in the household debt. If the entire global economy has more household debt, then individual countries will have nowhere to export their goods when growth stalls. Mian, Sufi, and Verner find that an increase in global household debt is also predictive of lower economic growth for individual countries, and that countries particularly dependent on trade are affected even more by this global buildup.

A lot of these dynamics sound a lot like what happened during the 2000s in the run up to the Great Recession of 2007-2009, so it’s plausible that the general results are artifacts of what happened over the past 15 years and are not symptomatic of a more systemic issue. But when Mian, Sufi, and Verner look at the data before 2000, they find very similar results. And using those results, they can show that the run-up in household debt during the 2000s indicated a recession of the size and severity of the Great Recession.

These results seem almost obvious given what’s happened over the past decade, but the idea that household debt is bad for economic growth runs counter to quite a few economic models. Mian, Sufi, and Verner show that both the International Monetary Fund and the Organisation for Economic Co-Operation and Development have consistently been overly optimistic about economic growth because they have seen increasing household debt as a positive for economic growth. The evidence now points to just the opposite.

These results are important not for shaming certain institutions, but rather to show how important it is to consider the role of household debt in economic stability and growth.

Noted for the Evening of September 28, 2015

Posted on by Brad DeLong

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Must-Read: Marshall Steinbaum: Why Is so Much Wealth hidden? Failed Democracy

Posted on by Brad DeLong

Must-Read: Marshall Steinbaum: Why Is so Much Wealth hidden? Failed Democracy: “It’s worth noting that few economists would support the existence or proliferation of tax havens…

… [which] impair both efficiency and equity. Zucman proposes… first and foremost, to create a public database of the ownership of registered securities… straightforward, but… still radical: the nationalization of quasi-administrative data for the public benefit. We already do that for the property and housing market in the United States…. Doing the same for financial wealth is straightforward, but it would challenge the interests of an even wealthier demographic…. Zucman further proposes to move to a global apportionment system for corporate taxation…. If the economics is so clearly against tax havens and the policy solutions are straightforward, then how did we get to where we are? The answer is not that a few villainous, self-serving countries act as parasites…. U.S. policymakers tacitly encourage the proliferation of tax havens…. Even now, Congress is debating a ‘Repatriation Holiday’….

Moving beyond tax havens in particular, the ideological justification for low and falling rates of taxation on capital is the Chamley-Judd Theorem, which ‘proves’ that the optimal tax rate on capital is zero in the long run…. The intellectual influence of the theorem has been strong…. Policymakers [tend] to be too credulous about formal ‘optimal policy’ results in theoretical economics. But the worse tendency is to enshrine those theoretical results in the policymaking apparatus at the expense of democratic control…. Subverting democratic control of economic policy is a big reason why inequality has gotten so high across the developed world…

Must-Read: Mark Kleiman: The Moral Universe of the Corporate Killers

Posted on by Brad DeLong

Must-Read: I have long thought that both Forbes and the Wall Street Journal have in mind as their target audiences that small segment of the human race that actually enjoys being free-riders, rather than that much larger segment of the human race that wants to engage in win-win reciprocal gift-exchange as a mode of social interaction…

Mark Kleiman: The Moral Universe of the Corporate Killers: “Daniel Fisher… writes for Forbes… hates plaintiffs’ lawyers…

…his first reaction to the VW emissions-cheating scandal was to criticize–not VW–but a class-action law firm threatening to sue VW on behalf of consumers. His point is that the buyers… weren’t in any direct sense harmed by VW’s fraud…. Therefore, the plaintiffs’ lawyers are being silly again. Tort reform, tort reform, sis, boom, bah!… Of course an individual car buyer isn’t directly harmed by driving a car that pollutes a lot, unless that buyer is burdened with a conscience ….

VW managers [have] committed a rather horrible set of crimes…. Fisher offers an ignorant sneer about the health effects of what VW did: “The Volkswagen defeat software is hardly deadly, unless one thinks the marginal nitrogen oxide it allowed into the atmosphere was enough to kill innocent bystanders.” Well, actually, “deadly” is precisely the correct word. Increasing NOx increases particulate emissions, and particulates kill…. Somewhere between 50 and 150 deaths per year (times six years) seems like a good first approximation, well above any single mass-murder incident in the U.S. save 9/11…

Must-Read: Paul Krugman: Economics: What Went Right

Posted on by Brad DeLong

Must-Read: Let me underscore this: economists–especially economists who work for the Federal Reserve system–seem to strongly believe, unless they have themselves tried to estimate Phillips Curves, all three of:

  1. The slope of the Phillips Curve is a lot higher than actual statistical estimates suggest–unless you put your thumb on the scale and pick the single specification that generates the highest slope estimate.

  2. The gearing between recent past inflation and the expected-inflation measure that best forecasts is a lot higher than actual statistical estimates suggest–unless, once again, you put your thumb on the scale and pick the single specification that generates the highest slope estimate.

  3. The confidence intervals of parameters are a lot smaller than actual statistical estimates suggest.

Thus rising inflation in 2017 is a very real thing to the Federal Reserve system–but not to those outside the Federal Reserve who are working with the numbers without having as their goal finding a specification that generates such a forecast…

Paul Krugman: Economics: What Went Right: “One piece of the conventional story hasn’t worked that well…

…namely the Phillips curve, where the ‘clockwise spirals’ of previous protracted large output gaps haven’t materialized. Maybe it’s about what happens at very low inflation rates. What’s notable about the Fed’s urge to raise rates, however, is that Fed officials, including Janet Yellen, are acting as if they have high confidence in their models of inflation dynamics –which is the one thing we really haven’t done well at recently. I really fear that we’re looking at incestuous amplification here.

http://mobile.nytimes.com/blogs/krugman/2015/09/26/economics-what-went-right/?_r=0&referer=http://economistsview.typepad.com/economistsview/2015/09/economics-what-went-right.html

Must-Read: Matthew Yglesias: Thoughtful opponents of the welfare state have generally avoided…

Posted on by Brad DeLong

Must-Read: I sometimes wonder: would Matthew Yglesias be a better economist and moral philosopher now if he had been an Economics rather than a Philosophy major at Harvard College? If the answer is–as I think it is–“no”, then some people have a lot of ‘splainin to do…

Matthew Yglesias: Thoughtful opponents of the welfare state have generally avoided making the argument that capitalism is good because it promotes human well-being…

…Since capitalism does promote human well-being, ‘capitalism promotes human well-being’ sounds like a good argument in its favor. But it turns out that capitalism plus a large welfare state promotes human well-being even more. So you either need to embrace the welfare state (the correct answer) or come up with another justification of capitalism. One that frequently arises is what Greg Mankiw has referred to as the ‘just deserts’ perspective in which ‘people should receive compensation congruent with their contributions’ and we should aim for a society in which public policy ought to ensure that ‘every individual would earn the value of his or her own marginal product.’ So if… you are blind and… [thus find] hard for you to earn a living in an unregulated market that’s too bad for you… your ability to contribute… is limited… [so] it is morally appropriate that your living standards be limited as well…. If… genetics and childhood living conditions have left you with an IQ… 2 standard deviations below average… you deserve to have a much lower standard of living than [if] society… were willing to do… redistribution.

Mankiw’s moralized capitalism seems bone-chilling to me, but I don’t really think I can prove him wrong…. Mankiwism isn’t a Christian worldview. Jesus didn’t preach ‘blessed are those with high marginal products, for they shall inherit incomes proportionate to their contributions.’ The practical benefits of capitalism are something that maybe a Christian should care about, but the practical benefits of capitalism-plus-welfare-state are bigger. To justify the tax-cutter policy agenda, you need some thicker ethical theory, and it ends up being a distinctly non-Christian one.

Pay Attention to Gabriel Zucman on Tax Havens

Posted on by Brad DeLong

J. Bradford DeLong and Michael M. DeLong

Over at Project Syndicate: Pay attention to U.C. Berkeley’s newly-hired Gabriel Zucman, author of the just-released The Hidden Wealth of Nations: The Scourge of Tax Havens (Chicago: University of Chicago Press) http://amzn.to/1KziL29.

His figures are the hardest figures about tax havens–Switzerland, Bermuda, the Cayman Islands, Singapore, Luxembourg, and so forth–and about the quantity of money stored in them that we are likely to get. His estimate? 8% of the world’s financial wealth. $7.6 trillion. That is more wealth than is owned by the poorer half of the world. And this is money that is not in the tax base, but should be in the tax base–and would be if we had sufficient international tax harmonization to close off loopholes that allow for (legal) tax avoidance and sufficient cooperation and enforcement to make (illegal) tax evasion not worth the risk. READ MOAR

Zucman’s estimates are largely based on discrepancies in the international accounts we have. He is undertaking the hazardous leap of assuming that what are usually classified as “errors and omissions” have meaning. So how solid are his estimates? The Swiss Central Ban reports that $2.4 trillion in funds are held by foreigners in Swiss banks. Switzerland is the jurisdiction that has made living as a tax haven for the longest period of time, but it is not the most advantageous place for a plutocrat to park money. Thus we can be confident that $7.6 trillion is in the ballpark.

The North Atlantic has no chance of using national governments’ taxing powers to preserve social democracy and offset the great upward leaps in income and wealth inequality that have afflicted it over the past generation and continue to afflict it if its governments cannot tax. Emerging markets have no chance of instituting the progressive taxes needed to fund social democracy if they cannot find their plutocrats’ money. Tax havens are right now a small problem for a center or a left-of-center government in North America. They are a significant problem for Europe. But they are an enormous problem for the Middle East, for Russia, and for China. Or perhaps they are not a problem for these last three but an opportunity? To the extent that the executive of the modern state is little but a committee for managing the affairs of the ruling class, international tax havens are not a bug but a feature.

And even in the United States it is the case that too often in the past generation policy details have been deliberately constructed to enable rather than to discourage tax avoidance via tax havens. In the words of one former Bush 43 senior staffer: “it is, ultimately, about freedom”. This is a big chunk of the 1/3 fall in the effective reach of the U.S. corporate income tax since the late 1990s.

A century ago, when the First Gilded Age was at its height, noted American Progressive Louis Brandeis famously said that “sunlight is the best disinfectant”. Thus the creation of transparency is the first task–Zucman favors a single global registry, a publicly-accessible database of the ownership of financial instruments. If that is the first step, the shifting of the corporate tax base from profits reported to have been earned in a country to sales made in a country is the second. The point would still be to tax corporate profits–it does nobody any good to tax corporations that are truly losing money. But opportunities for tax havens would be greatly reduced if profits were apportioned among countries by the share of wages and of sales made in a country. As Zucman stresses, a corporation can move its legal headquarters and transfer-price its internal transactions, but it has a much much harder task in moving its employees across national borders, and it cannot move its customers.

It is fashionable to say that nothing can be done–that national sovereignty is too strong a meme, and that today’s plutocrats have too much political power both over elected politicians and even more so over appointed civil servants who expect someday not too far distant to go through the revolving door. It is fashionable to recall that, more than a century ago, then-Governor Woodrow Wilson of New Jersey convinced his legislature to get New Jersey out of the corporate-haven business. And America’s corporations picked up their legal headquarters and moved next door to Delaware.

Those who say that international policy coordination is impossible are always right–until, someday, things change and they are wrong. Why, right now it looks as though international policy coordination is very possible when it comes to ISDS: investor-state dispute settlement. But if we do not get the transparency and prepare the ground for formula apportionment now, someday the opportunities to make the taxation of our Second Gilded Age’s global plutocracy genuinely progressive when those opportunities will be at hand, yet we will fail to grasp them.

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Must-Read: Simon Wren-Lewis: The Path from Deficit Concern to Deficit Deceit

Posted on by Brad DeLong

Must-Read: I think that Simon Wren-Lewis is not nearly hard enough on Britain’s austerians here–if the Bank of England was indeed confident in the power of unconventional monetary policy, it was so without warrant. Elementary benefit-cost considerations strongly argued for waiting until a strong recovery was well-established before attempting to tackle not the desirable short-term deficit but the long-term funding challenges of the social insurance state:

Simon Wren-Lewis: The Path from Deficit Concern to Deficit Deceit: “I have always written that the arguments in 2010 for focusing fiscal policy on reducing debt were understandable…

…They were wrong, but you could understand why reasonable people might make those arguments…. The problem of the recession appeared to be over, recovery was under way, and the Bank of England seemed confident in the power of unconventional monetary policy. It seemed reasonable to move attention to the deficit. So when 20 economists and policy makers wrote in February 2010 apparently supporting George Osborne’s deficit reduction plans, I was not surprised. The majority… disagreed, and we were right, but I could understand…. One of those signing that letter was Lord Turnbull…. By August 2012 around half of those that signed the letter had the good sense and honesty to backtrack….

[When the] Chancellor… was re-elected in May, it was for a programme of renewed austerity…. Lord Turnbull had the opportunity to question the Chancellor….

I think what you are doing actually, is, the real argument is you want a smaller state and there are good arguments for that and some people don’t agree but you don’t tell people you are doing that. What you tell people is this story about the impoverishment of debt which is a smokescreen. The urgency of reducing debt, the extent, I just can’t see the justification for it.

A former head of the civil service, who had initially supported Osborne on the deficit, was now accusing him of deliberate deceit. Big news you might have thought. And quite a turnaround in just 5 years…. Either Osborne is just stupid and cannot take advice, or he has other motives. George Osborne is clearly not stupid, which leaves only the second possibility. It is therefore entirely logical that Lord Turnbull should come to agree with what some of us were saying some time ago. What a strange world we are now in. The government goes for rapid deficit reduction as a smokescreen for reducing the size of the state. No less than a former cabinet secretary accuses the Chancellor of this deceit. Yet when a Labour leadership contender adopts an anti-austerity policy he is told it is extreme and committing electoral suicide. Is it any wonder that a quarter of a million Labour party members voted for change?

The shifting sources of U.S. business income and its contribution to income inequality

Posted on by Nick Bunker

Conversations about business taxation in the United States usually center on the corporate income tax. For a long time, this intellectual shortcut made a good amount of sense, as traditional corporations that paid the corporate income tax earned the vast majority of business income. If you wanted to try to tax the capital flowing through businesses then you’d want to focus most of your attention on the corporate side.

But that doesn’t seem to be the case anymore. A new working paper by economists at the U.S. Treasury Department, the University of California-Berkeley, and the University of Chicago Booth School of Business uses administrative tax data to show that the majority of business income is now earned by companies set up as “pass-throughs,” such as partnerships. (With pass-through entities, income taxes aren’t paid at the business level—the income “passes through” the business to the owners’ individual tax returns.)

This new information on the rise of the pass-through sector should help shape our thinking about how business income contributes to income inequality in the United States, and how we tax businesses.

The paper’s authors have access to tax data at the Treasury Department for 2011 that lets them match pass-through entities with their respective owners. Again, this is important because pass-through entities themselves aren’t taxed; the income they earn is taxed as the income of the business owners. Take, for example, a law partnership. The profits from the partnership are dispersed to the different partners and the income is taxed once it shows up as income for the individual partner.

The new research reveals a number of new facts about business income in the United States. First, the share of business income going through pass-throughs has risen dramatically—from about 21 percent of business income in 1980 to 54 percent in 2011. Why is this shift significant? For starters, income earned in the pass-through sectors is much more unequally distributed than income in other business sectors. Sixty-nine percent of all income earned in pass-through companies goes to taxpayers in the top 1 percent, while only 45 percent of income from classic corporations goes to the top 1 percent. When it comes to partnerships, a sub-segment of pass-throughs, the majority of income earned by the top 1 percent is from partnerships in finance and professional services.

Not only are these incomes more unequal, they are also taxed less. According to the authors’ estimates, the average income tax rate for partnerships in 2011 was 15.9 percent. S corporations, another kind of pass-through business, have an average tax rate of 25 percent. That means the pass-through sectors have an average tax rate of 19.5 percent, compared to the average rate for traditional corporations of 31.6 percent. Combine all those estimates together and you get a total business tax rate of 24.3 percent. (All of these rates are from 2011.) The shift to pass-through entities has pushed this rate down—if the sources of business income were the same as they were in 1986, the overall business tax rate would be about 28 percent.

Partnership income is also quite opaque—the authors couldn’t confidently trace either the source or the ultimate destination of 30 percent of partnership income. The fact that almost a third of this income is hidden in one regard or another is, as the authors note, another sign that we should be concerned about businesses trying to hide business income in order to pay lower taxes.

This trend of more business income going to the pass-through sector should be seen in the light of other shifts among kinds of companies in the U.S. economy. The number of publicly traded companies in the United States peaked in 1998 and continues to decline. Firms are increasingly less likely to go public. Private companies are also opaque. And at the same time, start-up rates for businesses are declining, businesses are becoming larger, and workers increasingly work for those large companies.

These changes in the business sector shouldn’t be ignored when we’re talking about business taxation or a variety of other policy areas. The implications for the functioning of the U.S. economy, both for economic distribution and growth, look too important to ignore.

Noted for Blood Supermoon Time on September 27, 2015

Posted on by Brad DeLong

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