Macroeconomic Controversies

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Transcript Macroeconomic Controversies

Finance 30220: Macroeconomic
Analysis
Recent Macroeconomic Controversies
Distribution of Household Income: 2004
Median Household Income = $45,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Under $2,500
$12,500 to
$14,999
$25,000 to
$27,499
$37,500 to
$39,999
Source: US Census Bureau (www.census.gov)
$50,000 to
$52,499
$62,500 to
$64,999
$75,000 to
$77,499
$87,500 to
$89,999
Total Households = 112M
Average vs. Median Income (1979 = 100)
115
110
105
100
Mean
Median
95
90
85
80
1979
1981
1983
Source: US Census Bureau (www.census.gov)
1985
1987
1989
US Income Quintiles
Highest 5th
$147,078
Fourth 5th
3rd Fifth
2nd Fifth
Lowest 5th
$68,994
$43,588
$25,678
23.1%
14.6%
8.7%
$9,996 (3.5% )
Source: US Census Bureau (www.census.gov)
50.1%
% Income
The Lorenz Curve
100
90
80
70
60
50
40
30
20
10
0
100
80
60
49.9
40
26.8
20
12.2
3.5
0
10
20
30
40
50
60
70
80
90
100
% of Households
US
Perfect Equality
The Lorenz curve plots the cumulative distribution of US income
The Gini Coefficient
A
Gini 
A B
The US currently has a Gini
coefficient of .45
0 = Perfect
Equality
1 = Perfect
inequality
Rising Inequality in the US?


The Gini Coefficient
has been steadily rising
in the US from a low of
.35 to a current level of
.44
The increase in the Gini
coefficient has
accelerated in recent
years.
The Good Old Days: Economic Growth
from 1947-1973
5
4.5
4
Annual Growth
3.5
3
2.5
2
1.5
1
0.5
0
Bottom Fifth
2nd Fifth
3rd Fifth
4th Fifth
Top Fifth
The Times, They are a Changin’: Economic
growth from 1977-1989
3
2.5
2
1.5
1
0.5
0
-0.5
-1
Bottom
Fifth
2nd Fifth 3rd Fifth 4th Fifth Top Fifth Top 5%
Why is income inequality rising?
 New technologies favor skilled labor (an increase in
the “skill premium”)
 Increasing importance of international trade
 Decline of labor unions
Should we be doing something about this?
And if so, what?
The Bush Tax Cuts of 2001 & 2003 Had four main components:
Across the board reductions in marginal tax rates
Increase in the child tax credit, and a reduction in the “marriage
penalty”
A repeal of the estate tax
A reduction in the tax rate on dividend payments
Bracket
Old Rate
New Rate
$0 - $6,000
15%
10%
$6,000 - $27,250
15%
15%
$27,251 - $67,550
28%
25%
$67,551 - $141,600
31%
28%
$141,601 - $307,300
36%
33%
$307,301 +
39.6%
35%
The bush tax cut was advertised as “the largest tax cut in history”.
However, when put in equal units, the Bush tax cut was actually
relatively modest compared to earlier policies.
Tax Bill
Cost in Current
Dollars
(Billions)
Cost in
2003
Dollars
(Billions)
Cost as a %
of GDP
Kennedy Tax Cut (1964) $11.5
$54.9
1.9%
Reagan Tax Cut (1981)
$38.3
$68.7
1.4%
Bush Tax Cut (2001)
$73.8
$75.8
.8%
Bush Tax Cut (2003)
$60.8
$60.8
.6%
What do we mean by the “cost” of a tax cut,
anyways?
Suppose that the Johnson family has a household
income of $50,000. Currently, the income tax rate is
20%.
Under the current tax code, the Johnsons
pay $10,000 per year in Taxes.
If the government cuts the tax rate to 10%,
then the Johnson’s tax bill falls to $5,000
The cost of the tax cut
is the $5,000 in lost
revenues
Suppose that a drop in the marginal rate encourages Mrs. Jones
to go back to work. With the two income earners, the Jones
family income rises to $120,000. At the 10% rate, their tax rises
to $12,000
Could this happen?
Tax Revenues = (Tax Rate) (Tax Base)
The basic logic behind the
Laffer Curve is that the tax base
should be negatively related to
the tax rate.
Tax
Revenues
Are taxes too high or too
low?
Tax Rate
0%
Revenue
Maximizing Rate
100%
Tax
Revenues
History suggests that taxes are two
high, but be careful…
Tax Rate
0%
Revenue
Maximizing Rate
100%
Annual Federal
Year 0
Receipts (Billions)
Year 1
Year 2
Year 3
Year 4
Kennedy (1964)
$116.8
$130.8
$148.8
$153.0
$186.9
Reagan (1981)
$617.7
$600.5
$666.5
$734.0
$769.2
Bush (2001)
$1,853.4 $1,782.5
$1,880.2
$2,153.8 $2,402.7
Source: Congressional Budget Office
The Social Security Act was signed into law by
President Roosevelt on August 14, 1935. In
addition to several provisions for general welfare,
the new Act created a social insurance program
designed to pay retired workers age 65 or older a
continuing income after retirement.
By late 1937, every American
had a social security number
The first benefits were
paid in 1940
John David Sweeney of
New Rochelle, NY had
the first official Social
Security account – his
number was 055-09-0001
The lowest number belonged to
Grace Owen of Concord, NH – her
number was 001-01-0001
Social Security numbers are assigned NOT in
numerical order, but based on area – each state is
assigned a set of area numbers.
Group numbers are done
using an “odd – even”
system
First Groups
For example, Indiana uses area
numbers 303 - 317
Some Possible Sequences
01 03 05 07 09
305 – 52 - 5555
305 – 52 - 5556
Second Groups
10 12 14 … 98
305 – 52 - 9999
306 – 52 - 0001
NOT 305 - 54 - 0001
Third Groups
02 04 06 08 10
Fourth Groups
11 13 15 … 99
317 – 52 - 9999
303 – 54 - 0001
Old Age, Survivors, and Disabilities Insurance (OASDI) is the official name
for social security (also called the “Payroll Tax”). Social Security is paid
out of gross income – your contributions are matched by your employer
Medicare: 1.45%
Social Security: 6.2%
Maximum Taxable Income: $94,200 (Maximum Annual Tax = (.062)($94,200) = $5,840.40
(Roughly $1,800/wk)
The first step to calculating your
benefits is to calculate your
average indexed monthly
earnings (AIME)
For every year in which you
had earnings, multiply that
number (or the yearly maximum
– whichever is bigger) by the
index factor for that year – this
converts your earnings to
current dollars
Add up the 35 highest years and
then divide by 420 (the number of
months in 35 years) – this is your
AIME
AIME
Benefit Rate
$0 - $656
90%
$657 - $3,955
32%
$3,955 +
15%
You get full benefits if you retire at age 66.
Your benefits are reduced by 25% if you
retire at 62.
Benefits are capped at $2,053/mo.
Example #1: Mr. Jones has an AIME of $750 (Roughly $9,000 per year)
AIME
Benefit Rate
$0 - $656
90%
(.90)($656) = $590.40
$657 - $750
32%
(.32)($ 93) = $ 29.76
$620.16 (Retire at 66)
Example #2: Mr. Smith has an AIME of $5,000 (Roughly $60,000 per year)
AIME
Benefit Rate
$0 - $656
90%
(.90)($656)
$657 - $3,955
32%
(.32)($3,298) = $1,055.36
$3,955 - $5,000
15%
(.15)($1,045) = $156.75
= $590.40
$1,802.51 (Retire at 66)
The Federal Budget (Fiscal Year 2005)
Individual Income Taxes: $1,082B
Other Mandatory Spending:
$985B
Corporate Income Taxes: $278B
Discretionary Spending:
$968B
+ Social Security Tax:
$794B + Social Security Payments:
Total: $2.154T
$519B
Total: $2.472T
Social Security Surplus = $794B - $519B
= $275B
Non-Social Security Deficit = $1,360B - $1953B = - $593B
Net Deficit = $318B
Since its creation, the social security system has run a surplus (social
security payments are less than social security taxes). The government
has used this surplus to fund other programs. This is done by selling
Treasuries to the social security administration. The social security trust
fund currently holds around $2T worth of US treasuries!
The social security system has relied on the fact that there are a lot more
people currently working than currently collecting benefits. This won’t
always be the case
1935: 9 workers for every 1 retiree
2005: 3.5 workers for every 1 retiree
2010: 1.5 workers for every 1 retiree
Trust fund
exhausted –
revenues
sufficient to cover
70% of benefits
Social security
payments exceed
social security
taxes
2022
2014
2034
Social security
payments exceed
social security
taxes plus interest
on trust fund
The payroll tax (social security tax) is a highly regressive
tax.
Annual Income: $20,000
Annual Income: $100,000
Annual Income: $500,000
Payroll Tax Paid: $1240
Payroll Tax Paid: $5840
Payroll Tax Paid: $5840
Effective Rate: 6.2%
Effective Rate: 5.8%
Effective Rate: 1.1%
Effective Rate
6.2%
3.8%
1.1%
Income
$20,000
$150,00
$500,000
Consider Homer Simpson, safety inspector at the local
nuclear power plant. Homer earns $7,000 per year (poor
sap!). Lets assume that he starts working at 21 and
retires at 66.
Under the social security
system, total contributions
for Homer would be 12.4%
of $7,000, or $868 per year.
During retirement, Homer’s
monthly social security
benefit would be $525.
Suppose, instead, that the
$868 in contributions were
put into a 401K earning 4%
per year.
At retirement, Homer’s
401K would have a
balance of $105,053. The
monthly interest earned
would be $350
Consider Apu Nahasapeemapetilon, owner of the local
Quickie Mart. Apu earns $15,000 per year. Lets assume
that he starts working at 21 and retires at 66.
Under the social security
system, total contributions
for Apu would be 12.4% of
$15,000, or $1860 per year.
Suppose, instead, that the
$1860 in contributions
were put into a 401K
earning 4% per year.
During retirement,
Homer’s monthly social
security benefit would be
$780.
At retirement, Homer’s
401K would have a
balance of $225,114. The
monthly interest earned
would be $750
Consider Montgomery Burns, owner of the local nuclear
power plant. Monty earns $150,000 per year. Lets assume
that he starts working at 21 and retires at 66.
Under the social security
system, total contributions
for Monty would be 12.4%
of $94,200, or $11,680 per
year. (the maximum)
During retirement,
Homer’s monthly social
security benefit would be
$2,053. (the maximum)
Suppose, instead, that the
$11,680 in contributions
were put into a 401K
earning 4% per year.
At retirement, Homer’s
401K would have a
balance of $1,413,613. The
monthly interest earned
would be $4,712
Over the years, social security tax rates have
increased, while benefits have decreased. This
has caused the implied rate of return in the
system to decline over the years.
Year of
Birth
Those that are just entering
the system have an implied
return of less than 1%!
10%
6%
2%
1905
1925
1960
Implied
Return
Recently, there have been discussions about “privatizing” the social
security system. Under a privatized system, individual payroll tax
contributions would be placed in individual accounts to be invested – very
much like a 401K plan.
Benefits
Costs
Higher return on investments
Financial risk passed on to
will generate more retirement
income
households
Increased saving should lower
interest rates and promote more
new capital formation
Individuals would be able to
pass social security account
balance to heirs
Social Security would be a self
sustaining system, independent of
population changes
What do we do with lower
income households?
Administrative costs would
increase dramatically
Do we want the government to
be a big player in financial
markets?
How do we transition to the new
system? (Current Social Security
liabilities are around $25T!!)
The Minimum wage was first
established in 1938 at $.25/hr
In 2002, 72 million US
workers were paid on an hourly
basis (60% of all workers)
2.2 Million reported hourly
wages at or below $5.15/hr (3%
of all workers). This number is
down from 13% in 1979.
States have the
option of choosing a
state/cities minimum
(San Francisco has a
minimum wage of
$8.50) – if Federal and
state wages differ, the
larger of the two is
applied
States with minimum wage rates
higher than the Federal wage
States with no minimum wage
law
States with minimum wage rates
the same as the Federal wage
States with minimum wage rates
lower than the Federal wage
What’s the profile of the average minimum wage worker?







Minimum wage earners tend to be young.
 50% are under 25
 25% are between 16 and 19
Women are more likely to be on minimum wage
 4% of women
 2% of men
Part time workers are 4 times more likely to be on minimum wage
(8% vs. 2%)
Most minimum wage workers have less than a high school diploma
 2% of high school graduates
 <1% of College Graduates
63% have never been married
By occupation, the largest proportion come from service industries
(roughly 2/3 of all minimum wage workers – mostly food service)
By geographic region, the South had the highest proportion (4%).
The West has the lowest (2%)
The important issue surrounding the minimum wage is:
“What is the purchasing power of minimum wage
workers?”
The minimum wage is set in
nominal terms. Therefore,
periods of high inflation will
erode the purchasing power of
the minimum wage.
The minimum wage tends to
average around 40% of the
average hourly wage.
Minimum wage workers tend to be at or below the poverty
threshold
Do we need a “living wage”? If so, what should it be?
The minimum wage is currently at $5.15 per hour. Assuming 40
hours per week and 50 weeks per year, this translates into an
annual salary of $10,300 – essentially equal to the poverty
threshold for a single person.
A living wage has often been defined as hourly wage that will
raise a family of four with one income earner to 125% of the
poverty threshold.
The poverty threshold
for a family of four is
currently $20,144.
This suggests a “living wage”
equal to $12.59 per hour (a
244% increase from its
current level.)
Does the Minimum Wage Cause Job Loss?
 Studies suggest that at the
w
ls
Minimum
Wage
$4
ld
l
*
Unemployment
l
aggregate level, any job
loss due to minimum wage
is negligible.
 One notable exception is
teenage employment. A
10% increase in the
wage rate lowers
employment by roughly
3%
 Employers have several
methods of absorbing
minimum wage costs
(lower benefits, higher
prices, etc)
Suppose that the current hourly wage is $4. At that wage, 100 hours are
being supplied. Now, suppose that the government imposes a $2 per
hour tax on labor – to be paid by employers.
w
As a result, hours drop to
90, wages (before tax) fall
to $3.
ls
Taxes Collected = ($2)(90) = $180
$5
$4
$3
ld
90
100
l
If those tax revenues
are redistributed back
to those still working,
the hourly “after tax”
wage rises to $5
How is this different from simply increasing the minimum wage to $5?
The minimum wage, if you think about it as a tax, is a very
strange tax.
The minimum wage taxes a
rather small subset of
employers in the US (those
employers that pay the
minimum wage)
Revenues “collected” by this
tax are distributed to
minimum wage workers
(most of which are
teenagers)
If our desire is to transfer income from one group to another,
why don’t we use the system already in place? (Earned
income tax credit, welfare, etc)
In 2005, the federal government spent $2.472T. IN the same year, the
government raised $2.154T in taxes. The difference ($318B) was
financed by issuing US Treasuries.
This represents about $1,000 per
person in the US.
This, however, is only new debt.
Total debt outstanding is a bit
larger….
Roughly $30,000 per person!!!!
In 1993, Harry Figgie wrote a book entitled
“Bankruptcy 1995”. In it, he argued that by
1995, interest payments on our debt would
surpass total taxes collected. At that point:
The government would be forced to
default on its obligations – this would
cause financial markets to crumble
The government would be forced to
raise taxes to stifling levels
The government would pay the debt
by printing money – this would cause a
hyperinflation ala Germany in the
1930s.
Could this actually happen?
Total Federal debt in the United States seems to be growing at
an alarming pace!!
7000
6000
5000
4000
3000
2000
1000
0
1946
1954
1962
1970
Total
1978
Public
1986
1994
2002
However, debt as a percentage of the overall economy
has been (until recent years) falling.
1.4
Debt Growth = 5.5%/yr
1.2
GDP Growth = 6.5%/yr
1
0.8
0.6
0.4
0.2
0
1946
1954
1962
1970
Total
1978
Public
1986
1994
2002
Alternatively, consider interest payments on the debt as a percentage
of the overall federal budget. As a benchmark, the defense budget is
currently around 18% of the total.
20%
Defense Budget
15%
10%
5%
0%
1946
1954
1962
1970
1978
1986
1994
2002
Can an excessive debt burden hamper our economy’s ability to grow
(and, hence affect our ability to repay it)?
i
Supply
i
Demand
The traditional argument
is that government raises
the demand for loans –
this increases the
interest rate and “crowds
out” private investment
Loans
However, as long as the supply of loans (aka savings) can keep
pace with the rising demand, interest rates don’t have to rise.
The Large Deficits of the mid-eighties were associated with falling
interest rates. In fact, the correlation between government borrowing
and interest rates is near zero
18.00
300
16.00
200
14.00
100
12.00
0
10.00
1 Year
-100
8.00
Deficit
-200
6.00
-300
4.00
2.00
-400
0.00
-500
4/1/53
5 Year
4/1/61
4/1/69
4/1/77
4/1/85
4/1/93
4/1/01
Further, there doesn’t appear to be any obvious relationship
between economic growth and the evolution of the government
debt relative to GDP
16
140%
14
120%
GDP Growth
100%
10
80%
8
60%
6
40%
4
2
20%
0
0%
1946
1956
1966
Debt/GDP
1976
GDP Growth
1986
1996
Debt (% of GDP)
12
It seems that savings is keeping pace with our borrowing….the real issue
is the source of that savings….
Ownership of US Net Debt (millions)
Investor
Total
Percentage of Debt Percent of GDP
International Entities
$1,225.5
35.5%
12.2%
Federal Reserve System
$511.4
14.8%
5.1%
Pension Funds
$390.9
11.4%
3.9%
Mutual Funds
$325.4
9.4%
3.2%
State/Local Governments $246.9
7.2%
2.5%
Domestic Investors
$224.4
6.5%
2.2%
US Savings Bonds
$184.3
5.3%
1.8%
Insurance Companies
$120.4
3.5%
1.2%
Total
$3,447.9
100%
34.3%
Currently, the US is borrowing $2B PER DAY from the rest of the world. In
fact, the US consumes 80% of total available funds worldwide!!