I’d like my change back

Byline: | Category: Economy | Posted at: Friday, 27 February 2009

When President Reagan proposed the 1982 budget, economists scoffed that it was a “rosy scenario” based on unrealistic GDP and employment forecasts.  The economists were right. 

However, Reagan’s assumptions were based on the belief that the tax cuts would spur the economy.  They did.  It just took longer than he thought it would take for the effects to be felt.  President Obama’s rosy scenario is based on the apparent belief that the economy will be spurred by tax increases–an economic theory previously unknown.

Government receipts in his budget forecast are based on a decline in GDP of 1.2% in 2009 followed by an increase of 3.2% in 2010.  How realistic is that?

Last quarter (which, since the government’s fiscal year begins in October, was the first quarter of 2009) GDP fell by a whopping annualized rate of 6.2%.  This quarter doesn’t look any rosier:

Before Friday’s report was released, many economists were projecting an annualized drop of 5 percent in the current January-March quarter. However, given the fourth quarter’s showing and the dismal state of the jobs market, [president of ClearView Economics Ken] Mayland believes a decline of closer to 6 percent in the current quarter is possible.

Do the math.  If in the first two quarters of FY2009 the economy falls at annualized rates of 6.2% and 6.0% respectively, that means for the total yearly decline to be only 1.2%, the economy will have to expand 3.7% in the second half of the year.  That’s not even remotely feasible.  It is more likely that, best case, the economy in FY 2009 shrinks by 4%, and worst case, shrinks by 8%.  The current estimate of a $1.75 trillion deficit this year is, therefore, likely to balloon well past $2 trillion, since as the economy contracts, so too do tax receipts.

The Administration is not the only ones using unrealistic assumptions.  The FDIC in its “stress testing” of bank assets assumes a worst case output decline of only 3.2% when it calculates bank assets.  Equally as ludicrous is its assumption that the value of real estate will fall between 7 and 22 percent.  A 20 to 40 percent decline is more reasonable–particularly since California and Florida are already well into that range, and those two states account for a disproportionate amount of the value of total outstanding mortgages.  Many of the banks that “pass” the unrealistic stress test will really be insolvent.  The market will know that even as politicians pretend otherwise. 

The sad fact is that in many parts of the country the market price of a home is well below replacement cost, and there is little opportunity for the market price to rise significantly.  Here is why.  The rule of thumb is that a prudent home buyer can afford a mortgage about three times his household income.  Four times is pushing it.  In California at the peak of the boom, median house prices were eight or more times the median neighborhood household income.  People could “afford” it because the price of real estate always goes up and they were bolstering their income with returns from investments in the market.  Both of those are gone.  Gone also are jobs.   The unemployment rate in the Golden State is 2% higher than nationally.  [Just in:  the California jobless rate is now up to 10.1%]  And with the passage of a state budget adding another 14 billion dollars of tax burden to Californians, the exodus of California companies is likely to increase unemployment further still.  Housing prices must come down to a more reasonable three to four times earnings.  Eventually, against all government attempts to prevent it, they will. (Spend some time reading this site to learn how bad it really is in CA.)

Yes, that means that many mortgage notes in high growth markets are probably worth only half their face value.  Even worse, it means that new house construction in those places is at a dead stop until market values rise to where they exceed construction costs.  That will be years in some areas, perhaps a decade or more in the most overbuilt communities.  It will also mean that once construction does begin again, houses will be smaller and more in line with incomes.

Even if you don’t live in those areas, you are affected.  Take away the construction boom in those two states, plus Nevada and Arizona, and you’ve elminated millions of jobs, and billions of purchases.  Take away the leverage that those paper assets gave to both individuals and companies, and you’ve reduced overall consumption by a double-digit percentage.

How much leverage is that?  By one estimate the domestic portion of the US stock market was once $20 trillion.  Conservatively, that has fallen to $14 trillion.  The total value of outstanding mortgages was over $14 trillion.  The real value of those mortgages is now probably more like $10 trillion.  Between those two asset classes, Americans have lost at least ten trillion dollars of wealth in the last year–or about two-thirds of the country’s GDP.  That’s a lot of leveraged consumption that no longer exists.

Worse still–at least in the short term–is that, confronted with the economy, people and businesses are paying down loans and saving a greater portion of their incomes.  This puts further downward pressure on spending.  Although in the long term this is a good thing since individual savings is dreadfully low in this country.

But there is another reason individual savings has increased in recent months:  the people are smarter than their government.  Public pension funds are underfunded.  People are figuring out that no matter what the government promised them, they will have to provide for their own retirements.  Or at least, the smart people are figuring that out and are preparing for it.  The remainder will have nothing and will turn for help to a government that also has nothing.  California is already insolvent.  It will soon be bankrupt, if not de jure, at least de facto.  It’s not just California’s problem.  What will happen there in the next year or two is prelude to the nation’s social security and medicare insolvency.  You will not get what the government promised you; plan accordingly.

There are too many people at fault to even begin casting blame.  All of us, in some way, bear some responsibility.  But presidents, especially, own the nation’s problems.  There is no doubt that the last president gave the nation a recession.  But the new president gave us change.  His policy changes are the perfect recipe for a double dip recession, the second dip being a result of crippling taxes just as the economy begins to improve, combined with inflation as a consequence of astronomical increases in borrowing.  You can keep that change.


What I wrote is so obvious that today even the New York Times gently nudges the Obama Administration into realizing that there is a “sense of disconnect between the projections by the White House and the grim realities of everyday American life.”

If, as is widely anticipated, the economy grows more slowly than the White House assumes, revenue will be lower, forcing the government to cut spending, raise taxes or run larger deficits.

Economists also criticized as unrealistically hopeful the assumptions by the Federal Reserve as it began so-called stress tests to gauge the health of the nation’s largest banks.

The economy is already several decision cycles inside the President’s OODA loop, and that’s why he is floundering.

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6 Responses to “I’d like my change back”

  1. Donna Locke Says:

    You do a great job on this blog, Bob. I always learn something here.

  2. Dan Hughes Says:

    I’ve recently been wondering about something.

    What is going to happen to county-level tax income (property and school) when the next round of assessments are started? Very likely these are already underway somewhere.

    We are planning to contest ours if we don’t see a significant drop in assessed value.

    Thanks for any info.

  3. newscaper Says:

    I’m in Alabama, and what has always been baffling is the reflexive genuflection toward all things California (if not Europe) by all of the ‘enlightened’ here, when the failings of that most ‘progressive’ model are only becoming more and more readily apparent.

  4. Bruce Rockwell Says:

    Nice revisionist history, Mr. Krumm. This is a neocon mantra, but it’s the ultimate pig with lipstick.

    The actual history of the economy’s growth during the Reagan era was based not on the ability of tax cuts to “spur the economy,” but precisely the kind of Keynesian “big government” stimulus that the Obama administration is resorting to. It is always so nicely convenient for Mr. Krumm and other supply-side ostriches with their heads in the sand to ignore the TRILLIONS of dollars of borrowed money that funded those precious tax cuts, debt that will continue to be paid by future generations as far into the future as we might imagine.

    A historical chart of the U.S. debt as a percentage of the GDP shows just what kind of damage the borrow-and-spend fiscal malfeasance of this Reaganomic low tax orgy has had on the long term viability of our economy. Notice the trend lines precisely when Reagan cut the top tax rates, with a brief respite during the Clinton/Gingrich years when they were (partially) restored. And the continued trend when the Bush tax cuts were instated:


    If the supply side party line that cutting taxes produces economic growth which ultimately leads to more revenue were remotely true, why does the data reflect precisely the opposite reality?

    Ed: Generally I don’t bother responding to anonymous trolls–especially when they have amply demonstrated that their interests lie more in obfuscation than honest discussion. However, rather than try to enlighten your closed mind, I add this in the hopes that others who may have been persuaded by your false arguments will instead see the truth.

    You state:

    If the supply side party line that cutting taxes produces economic growth which ultimately leads to more revenue were remotely true, why does the data reflect precisely the opposite reality?

    Because that is not the supply side party line. The Laffer Curve (a great tutorial of what it is and what it is not can be found here), is an incontrovertible mathematical truism that there is a tax rate greater than zero, and less than 100% that yields maximum government receipts.

    That’s it. It does not state that a decrease in tax rates will, as you erroneously claim, lead to more “revenue.” (Point of fact: Government doesn’t have revenue. People and businesses have revenue. Government has tax receipts–a small, but incredibly vital, distinction.) However, a tax cut will, in almost all cases, result in increased economic growth, even while government, might receive less revenue.

    If you don’t believe me–and as indicated by your repeated recent (and futile) attempts to refute my logic, have demonstrated, you probably don’t–listen instead to no less an authority than former UC-Berkely Professor of Economic Christina Romer. She’s a “former” because she is now the Chairman of the Council of White House Economic Advisors:

    ” . . . tax increases appear to have a very large, sustained, and highly significant negative impact on output … [and] that tax cuts have very large and persistent positive output effects.”

    Bottom line:

    Tax cuts almost always spur the economy. Though as, Romer found, it usually takes four quarters for the positive effects to be felt. Tax cuts sometimes increase deficits, even as the economy improves. But tax increases are almost always bad for the economy–with or without “stimulus”.

  5. Bruce Rockwell Says:

    I don’t think any reasonable adult would confuse my substantial post as trolling (unless you define trolling as anybody who dares disagree with you). And as for anonymity, I find it odd that you would make that accusation when I alone left my true name on the post, among your many neocon know-nothing sycophants who actually do post anonymously (and for good reason, it would seem).

    Another point of confusion that you are laboring under: merely restating your conclusion in different words (or quoting a Berkeley economist who also merely restates the same dogma) is not, as you say, “logic.”

    Specifically, how does another, say, five thousand dollars in the hands of a wealthy taxpayer, who buys primarily imported goods and has little propensity to spend the extra income anyway, stimulate the economy more than putting that five thousand dollars to work by giving it to a middle class government employee or private contractor, who have a 100% propensity to spend it, and are more likely to spend it domestically?

    Yes you may accurately state that money remaining in the hands of taxpayers can stimulate economic growth, but the problem with supply side theory is there is no comparative discussion about what else might be done with that money. Yes, taxpayers retaining more of their income is *always* stimulative, but government spending is also *always* stimulative. And additionally, among supply-siders there seems to be no reality-based discussion about the spending side. There seems to be a naive assumption that starving the federal government of revenue (or, ahem, tax receipts) will shrink the federal government. And in our modern history has that ever proved remotely true?

    Mind you, I’m not an advocate for big government spending for big government’s sake. I am merely advocating for a more enlightened discussion about economics than you seem to be an advocate for, especially since you call me a troll merely for stating principled disagreement.

    Again I ask, if supply side theory is so great, why does history clearly show that it has blown a lunar crater in our debt picture? And as you tout its benefits why do you ignore that trillions of dollars of borrowing has been needed to shore up the budget in the wake of Reagan’s (and then Bush’s) tax cuts? And why do you consistently ignore a discussion about who’s going to be paying off Reaganomics’ debt as far as the eye can see?

    Again, the historical data does not lie, and doesn’t point such a rosy picture:


    Ed: You are right to decry deficits. You are wrong, however, to answer that to solve the ills created by them, the answer is to make them bigger. You can’t have it both ways: either deficits are bad and they must be ended now, or they aren’t, and the last quarter century of increased debt is a non-problem. I subscribe to the former view.

    You advocate that the government should stimulate the economy by what? Taking from the rich and the middle class and giving to the poor and the bureaucrats to spend? The history of the world is littered with the carcasses of economies based on such a model. Economic growth does not come from spending but from spending well. Increased productivity is how you grow an economy. Government intrusion into the marketplace only rarely increases the efficient allocation of resources, and more often than not props up the failed enterprises of those who could not otherwise compete. New Jerseyians pay more for their gasoline than their neighbors. Why? Because individuals are not allowed to pump their own gas. A gas station attendant must do it for them. Not only do they pay more, they wait in longer lines, not for an available pump, but an available attendant. This is an example of the government interfering in the marketplace in such a manner as to decrease productivity and efficiency in a way that has more negative consequences than the consumptive value of the attendants’s salaries.

    Government spending, not tax cuts, is the biggest source of the problem of the deficit. Take away No Child Left Behind, Medicare Part D, Homeland Security, and yes, the Iraq War, and the last President would have run surpluses just like his predecessor. The seven Bush budgets (2002 – 2008) added a total of $2.1 trillion to the deficit. Under unrealistically optimistic assumptions, President Obama’s first budget will add a minimum of $1.75 trillion of new debt in just one year. A more realistic projection of 2009 receipts will probably mean that the new president will do as much damage to the US treasury in one year as President Bush did in two terms. This is what you advocate as a solution? As one commenter crudely, but accurately pointed out, increasing the deficit because the national debt is too large is “like prescribing ex-lax to cure dysentery.”

    Finally, the Berkeley economist you so easily dismiss is not just some run of the mill academician. Or at least President Obama doesn’t seem to think so. Read the report. The post-war historical record is clear. Tax increases to increase government spending (as opposed to increases to pay down the debt) harm the economy by a factor of nearly three-to-one. That is, a tax increase designed to add one percent of new receipts to the government reduces GDP by an average of 3%. How could that be if when the government spends tax receipts it is always stimulative? For the very reason that you state is a problem with supply-side economics, but is in fact, the major fault of your flawed economic theories:

    “There is no comparative discussion about what else might be done with that money.” Demand-siders focus only on the money spent by the government or by its annointed recipients, not on what might have been done with the money by those who earned it.

  6. Orion Says:

    The economy contracted 1982-1984 not because of tax cuts or “Reaganomics” but quite simply because the Federal Reserve raised interest rates to wring inflation out of the economy.

    Conservatives call for tax cuts not because they dislike taxes per se; they call for tax cuts because taxes are too high for the economy to support. The “Laffer Curve” was studied by economists as far back as the 1920s and Laffer simply codified what had already been found: Above a certain point taxes harm the economy by creating disincentives to investment and encouraging capital either to leave the country or become hidden and unreported. Empirically that point has been found to be about 18.5% net taxation on income. Above this point taxes begin noticeably distorting the economy and reducing government revenues in the long term.