Greece: Back To A Fiscal Disaster Zone

In my book Industrial Poverty: Yesterday Sweden, Today Europe, Tomorrow America, I analyzed the causes and consequences of what was then an ongoing fiscal crisis in the European Union. I pointed to how several countries – far more than what the public narrative in America would suggest – were subject to harsh austerity measures in the wake of the Great Recession. These measures were suggested by the EU in line with the Union’s constitution, which prescribes fiscal measures to avoid excessive budget deficits and government debt.

In some countries, the EU joined forces with the European Central Bank and the International Monetary Fund to enforce harsh fiscal policies, with sharp tax hikes and crippling cuts in government spending. Greece was not the only country subjected to such measures, but it was by far the worst example. The fiscal iron fist has been holding the Greek economy in a chokehold since the first austerity measures went into effect in 2010; today, when America finds herself on the brink of a major fiscal crisis, it is time to take a look back at what happened to Greece, where the country is today – and what we can learn from their experience.

Austerity: The Theory

To begin with, it is essential to establish what we actually mean by “austerity”. The term is revered among many libertarians who think that austerity means that you liberate the economy from the burden of big government. This is a mistake, and it is based in large part on the inability among libertarian pundits to distinguish between government spending and taxes. Austerity means, simply, that government tries to close a budget deficit by cutting spending, or raising taxes, or both. Unfortunately for my libertarian friends, all three versions have the same effect:

  • Spending cuts at constant taxes means government gives back less to the economy of every dollar it takes;
  • Tax hikes at given spending means government raises the price – charges more – for every dollar it gives back to the economy;
  • A combination of the two means you absolutely raise the cost of government while giving less back.

One way to understand these effects of austerity is to think of a Ford dealer that wants to sell you a new 2017 Explorer but wants you to pay the same price as for a new 2022 example.

In other words, austerity does not shrink government. It makes government more expensive. Economic doctrinaires from the Austrian background will protest and say that when government cuts spending, it leaves more resources out there in the economy for the private sector to use. They point, e.g., to laid-off government workers who are now free to be scooped up by private employers who can then expand their businesses and help grow the economy.

The only problem is that those private businesses still pay the same high taxes. Even if the austerity measures consist exclusively of spending cuts, the private sector is not better off as a result. Consumers do not have more money; businesses do not have less of a government burden to carry. On the contrary, given the structure of the government spending cuts, the private sector can actually see its costs of operation and of living go up. If government runs the health care system and reduces the number of doctors, nurses and other employees, then health care quality declines, waiting lists grow longer and households lose income when they have to stay away from work longer while waiting for medical treatment. Employers find themselves crippled when employees cannot return to work as quickly as they could before.

To deal with a situation like this, the private sector now has to take money out of its other spending commitments and divert it to alternative paths to medical care. This reduces spending elsewhere, contributing to economic stagnation rather than economic growth.

The more areas of the economy that government spends money on, and therefore the more areas government pulls back from without cutting taxes, the more of this re-allocation of scarce private money we will see. Just imagine the effects on the economy if spending cuts on public schools force families to reduce workforce participation to homeschool their kids. Or cuts in Social Security force consumers to considerably increase their retirement savings.

None of this is an argument against reductions in the size of government. It is, however, an argument against doing it by means of austerity; the correct way to reduce the size of government is to do it structurally, through reforms that permanently reduce both spending and taxes. I am not going to discuss such reforms today; for those who are interested, I published a collection of papers back in 2012 about structural spending reform.

In addition to understanding the fiscal and macroeconomic mechanics of austerity, it is important to see what those mechanics tell us about the policy purpose behind austerity. When the size of government does not shrink – when the only result is an increase in its price to the private sector – it is because the purpose is not to shrink government but to preserve it. Governments implement fiscal austerity because they want to save as much as they can of government programs in an economy with a weaker tax base.

In short: austerity is the fiscal equivalent of what Cinderella’s stepsisters did to be able to wear the famous glass slipper.

Greece Today: A Macroeconomic Overview

The bulk of the Greek austerity experience took place in 2009-2014. It did not end there, but that was when the harshest budget cuts and most crippling tax hikes went into effect. I account for them in detail in my 2018 two-part series for Prosperitas on the Greek lessons for America; see Part 1 and Part 2.

Figures 1a and 1b report government spending, tax revenue and budget deficits as share of current-price GDP. Starting with the deficit, prior to the austerity campaign it was as chronic as the U.S. budget deficit:

Figure 1a

Source of raw data: Eurostat

The elimination of the budget deficit came at a heavy price:

  • Taxes rose as share of GDP from 38.9 percent in 2009 to 49.5 percent in 2013, a combination of massive tax hikes and an imploding GDP;
  • Spending increased at first, 47.1 percent of GDP in 2007 to 62.9 percent in 2013, due to the entitlement structure of the welfare state which obligates government to spend more the worse the economy is doing;
  • When austerity finally caught up with the welfare state, the Greek parliament cut spending from the extreme 2013 level down to 48.5 percent in 2017.

Figure 1b

Source of raw data: Eurostat

Since 2016 the Greek government has been able to balance its budget (the 2020 artificial economic shutdown being an expectable exception), but this has come at an enormous cost for the economy. The tax hikes and spending cuts have taken such a big toll on the Greek economy that adjusted for inflation, in 2019 it was just one percent bigger than it was in 2000 and three percent smaller than in 2001:

Figure 2

Source of raw data: Eurostat

The big decline happened in 2009-2014, a period during which Greece lost 26 percent of its GDP, as much of its private consumption – and 63 percent of its business investments (all figures adjusted for inflation).

It is absolutely exceptional for a developed country to lose one quarter of its economy, especially in peace time. What is even more disturbing is the the Greeks have not been able to recover, having lost two decades’ worth of standard of living.

Imagine earning the same money you did 20 years ago while paying today’s cost of living.

The Greek economy has undergone another remarkable, and equally troubling transformation. Its youth has left the country in droves: in 2019 the total workforce aged 15-24 amounted to 234,000 individuals; in 1999, that same demographic equaled 583,000. In other words, over the past two decades Greece has lost 60 percent of its youth workforce.

This has happened in two phases, the first taking place during the time period (1) in Figure 3 below. Already in the late ’90s Greek youth began looking for work in other EU member states. This trend continued into the 2000s: from 1999 to 2009 the Greek youth workforce fell by 36.4 percent. The decline continued during the tougher austerity episode, (2) in Figure 3, with a 17.5-percent drop from 2009 to 2014.

As yet more evidence of how the Greek youth have lost hope for a future in their own country, from 2014 to 2019 the youth workforce fell by 72,000 individuals. By 2019, again, the number of young workers in the Greek economy was 60 percent lower than it was two decades earlier:

Figure 3

Source of raw data: Eurostat

This almost unprecedented loss of hope among an entire generation is backdropped by exceptional unemployment rates. Among the 15-24-year-olds in Greece,

  • 55.3 percent were unemployed in 2013;
  • 58.4 percent were unemployed in 2014; and
  • 52.3 percent were unemployed in 2015.

It was not until 2018 that youth unemployment fell below 40 percent, but that did not happen because of a strong recovery on the labor market. In ’18 there were 42,000 fewer unemployed, only 6,000 of whom had found a job. The rest left the workforce, ostensibly for emigration.

Another piece of evidence proving the loss of hope in the Greek economy: adjusted for inflation, business investments in 2019 were half of what they were in 1999.

These numbers only give a partial view of the Greek economy and its journey through a decade of austerity. However, they do tell a story of what can only be characterized as the macroeconomic destruction of a country. This destruction, in turn, is exclusively and entirely the result of unforgiving austerity measures, taken by a Greek government that lost its ability to finance its deficits, ran into a fiscal dead end and fell at the mercy of its creditors.

Can the same happen in America? Of course it can. If we continue to deficit-spend like there is no tomorrow, it will happen soon.

Money, Inflation and Deficits, Part 1

Monetary policy is often surrounded by a lot of mysticism and superstition:

  • On the one hand, we have the Mad Monetary Theorists whose doctrine says that you can print an unending amount of money to fund government spending, and when inflation starts rising you simply raise taxes and bring that money back into government coffers;
  • On the other hand, gold-standard purists claim that if we just tied the U.S. dollar back to gold in a fixed $/ounce ratio, we would never have inflation or budget deficits again.

Both these positions are fancifully detached from reality. To start with the gold-standard advocates, they forget the slight problem that money today is a lot more than just cash; a return to the gold standard would wipe out practically all modern forms of liquidity used as payments for all sorts of transactions throughout the economy. They also ignore the minor problem that the amount of gold in the world does not grow with the growth of our economy.

To show the problem in this, let us go back to 1990 and tie our money supply to the supply of gold. Just as a strictly hypothetical example, suppose the world’s total known reserves of gold that year had been 244,000 metric tons (which happens to be the known reserves of gold around the world today). With the M2 money supply standing at $3,222.6 billion that year, this translates into a money-supply-per-ounce ratio of $374.42.*

In 1990 our current-price GDP stood at $5,963.1 billion, giving us a GDP-to-M2 ratio of 1.85: over the course of one year, we use 85 percent of the M2 money supply twice, in order to pay for all economic transactions in the economy.

Suppose, again for the sake of our experiment, that all the world’s gold reserves are under U.S. control. Suppose also that we do not discover any new reserves of gold anywhere.

In 1991 our actual GDP was $6,158.1 billion. This is an increase of 3.27 percent in current prices, but since inflation was 4.37 percent (measured by the GDP deflator) we had a real contraction of 1.1 percent. If we assume – as is often claimed under the gold-standard proposition – that inflation is a purely monetary phenomenon, the tie of money supply to gold means that the real contraction would also be the nominal change in GDP.

So far so good. But what happens in 1992, when real economic growth amounted to 3.5 percent, the situation is quite different. In other words, if there is no inflation, this is the actual percentage by which the economy would expand. Now we have an economy of $6,374.9 billion. We now need to use almost the entire M2 money supply twice in order to clear all transactions throughout the economy.

Here is where the problems begin. When the economy does not have enough cash (and other means of payments) circulating, people start withdrawing money from their savings accounts. They sell off Treasury securities and liquidate other near-cash assets in order to have the means of payments to clear their transactions. In doing so, they force up interest rates: banks raise interest rates to encourage people to keep their money in savings accounts; any increase the supply of Treasury securities at given demand automatically results in higher interest rates.

To give an idea of what this means, in 1990 the federal funds rate exceeded eight percent. In real life, where the supply of money outpaced GDP, by the end of 1992 the federal funds rate had fallen below three percent. Under the gold-standard scenario, the exact opposite would happen; when interest rates go up, businesses are more reluctant to invest. Households are more reluctant to buy a new home, finance a new car, etc. Both businesses and households postpone spending to an unspecified future date when they believe they might have more of a down payment to make, and since this future date is unspecified, this means a net loss of economic activity that could last for years.

When the loss of activity today is not followed by any reasons to expect a near-future return to higher levels, a loss of jobs begins that by multiplier effects proliferates throughout the economy. In other words, the gold standard traps us in a perennial recession.

By contrast, MMT, Mad Monetary Theory, suggests that monetary expansion has no limit, even as they recognize that inflation is a monetary phenomenon. In reality, inflation originates in the real sector of the economy; money printing fuels inflation if it is channeled through certain transmission mechanisms into a sustained, artificial rise in spending in the economy. However, even if MMT proponents would recognize these transmission mechanisms, they would still claim that inflation cannot become a hyper phenomenon as it has in Venezuela. The reason, they say, is that they will simply raise taxes and thereby pull the extra cash out of the economy again.

Any MMT proponent who cannot explain better than that the distance between Venezuela and his vision of an MMT-ridden America, should by logical necessity be disqualified from influencing any kind of economic policy, anywhere. The Venezuelan experience with 300,000 percent inflation – per month – is directly caused by the nation’s unending monetary expansion. I will explain this in more detail in a later article, though I do discuss Venezuela in my book Democracy or Socialism. For now, though, let us look at where monetary policy stands in the United States and what the risks are that we end up in hyperinflation.

In the following I take a brief look at recent American monetary-policy history. In just the past 40 years we have shifted from having a central bank that operated independently of the federal government to one that is highly accommodating. This transition is the main reason why we have reasons to believe that our country is not entirely safe from hyperinflation. Figure 1 and the following text outline the story:

Figure 1

Source of raw data: Federal Reserve

The seven episodes are as follows:

  1. This is the Volcker-Greenspan purge of inflation from the U.S. economy. It was a successful endeavor, with inflation staying low for 40 years.
  2. This is an interesting period, albeit a short one. With the exception of the second quarter in 1981, the period Q3 1989 – Q2 1990 was unique in the sense that the Federal Reserve reduced its holdings of Treasury securities. Their portfolio was not cut by much, only approximately $14 billion or less than six percent, but the reduction was accompanied by an unusually tight monetary policy where M2 money supply increased by less than two percent on an annual basis.
  3. Greenspan kept monetary expansion in a tight leash all the way up to 1995, when the U.S. economy was reaching, even exceeding four percent growth per year. The monetary expansion came in response to rising interest rates. By increasing the supply of liquidity in the economy, the Federal Reserve reversed the trend: as just one example among many, the ten-year Treasury note fell from 7.96 percent in November 1994 to 6.2 percent two years later.
  4. In the midst of the brief, shallow Millennium recession, the 9/11 terror attacks brought about a disruptive change in U.S. monetary policy. Immediately after the attacks, in the fourth quarter of 2001, the federal funds rate, a key monetary-policy indicator, fell from 3+ percent in the two preceding quarters to 1.82 percent. It continued downward, dipping below one percent in Q4 of 2003. That was the first time it had been at sub-one percent since 1958.
  5. When the 9/11 driven monetary expansion began, the general belief among economists and other policy analysts was that it would be a temporary exception to the norms of the otherwise monetarily conservative Federal Reserve. That turned out not to be the case. While Greenspan led an unwinding of the monetary excesses post 2001, he was only able to bring the monetary expansion back to where it had been in the mid-’90s. When Bernanke takes over, the Federal Reserve sets its crosshairs on monetary expansion. The federal funds rate is again pushed downward, in a year and a half plunging from 5+ percent to less than 0.25 percent.
  6. It is interesting to note that while Bernanke champions a return to high monetary expansion rates, his Federal Reserve reduces its holdings of Treasury securities. Over the next year from Q4 2007, the Fed cuts its $790.5 billion portfolio of U.S. government debt by almost 40 percent. However, this divestment episode comes to an abrupt end in 2009 it re-enters the sovereign-debt market and buys almost as much Treasurys as it got rid of. Under his Quantitative Easing regime, Bernanke goes on a Treasury buying spree that more than quadruples the value of Treasury securities on the Federal Reserve’s balance sheets. When he hands over the helm of the central bank to Janet Yellen in 2014, he has more than quadrupled the U.S. debt to its portfolio: from $475 billion to almost $2.5 trillion.
  7. Yellen, a central banker in the tradition of Paul Volcker and Alan Greenspan, reverses Bernanke’s expansionism. However, due to the unending deficits in the federal budget she is only able to reduce the U.S. debt stock owned by the Fed by roughly $100 billion. Nevertheless, she does change course compared to Bernanke.

Then Jerome Powell takes over, the 2020 artificial economic shutdown happens and all Hell breaks loose…

In other words, the accommodating monetary policy that popped up as a temporary phenomenon under Greenspan was turned into the default setting for the Federal Reserve under Bernanke. Yellen and her relatively moderate policy actually stands out as the exception to the expansionary rule…

Figure 2 takes a different look at the same phenomenon. Measuring GDP per dollar of M2 money supply, we now get a money-velocity style view of how money supply has expanded over the past two decades. The seven episodes are the same as in Figure 1:

Figure 2

Sources of raw data: Bureau of Economic Analysis (GDP); Federal Reserve (M2)

We currently have the largest money supply relative demand (i.e., current-price GDP) that we have had since the 1950s. Up until this year, it has not created any significant inflation pressure. That, however, has now happened, and the reason is excessive monetization of deficits; the Federal Reserve has entered a Faustian Pact with Congress.

More on that pact in Part 2.

*) I should note that under a gold standard, the M2 money supply might not even be possible. We could all be restricted to M1, or even cash. I will return to the intricacies of that issue in a later article.

Taxing the Rich: A Fair Share Value Test

As I explained in a recent article, there are a lot of myths floating around out there about the results of the Trump tax reform. The common nonsense about corporate taxes is that corporations don’t pay them; anyone suggesting as much is blissfully ignoring the $95.7 billion that corporations paid to the federal and state governments just in the second quarter of this year.

Another pervasive myth is that the rich don’t pay “their fair share”. Those who suggest as much never present any evidence, and certainly do not offer any metrics of “fair share”. To fill that void, I am hereby introducing the Fair Share Value, a way to measure whether or not people of a certain income pay their “fair share” in taxes.

The Fair Share Value is very simple:

If F=1 it means the taxpayer contributes the same share of taxes as his share of taxable income. That makes his tax burden fair. If F>1, it means the taxpayer contributes a larger share of taxes than what is fair; if F<1 his tax burden is less than what is fair.

The following three figures report the Fair Share Value for IRS tax-return data from 2001 through 2018. First out is one that covers the top-one percent income earners. The solid red line represents the share of total personal federal income taxes paid by this group, while the dashed red line represents their share of total taxable income. The former is consistently higher than the latter, resulting in Fair Share Values reported by the grey columns (and their attached values) for each year. For example, in 2007 the top-one percent income earners paid 39.4 percent of all personal federal income taxes but earned only 22.7 percent of the taxable income. This resulted in a Fair Share Value of 1.741, telling us that this group was unfairly over-taxed; similar calculations for every other year gives us the same result:

Figure 1

Source of raw data: Internal Revenue Service

Next up is the Fair Share Value calculated for the top-20 percent income earners. As the solid red line in Figure 2 indicates, this group has been paying more than two thirds of all personal federal income taxes since the Bush tax reform went into effect. Since their income share has varied but never exceeded 50 percent of total taxable income, the Fair Share Value for this income group has consistently hovered around 1.5:

Figure 2

Source of raw data: Internal Revenue Service

In other words, the taxpayers in the top-20 percent income group carry a heavy load in funding the federal government, while also being heavily, and unfairly over-taxed.

By contrast, the Fair Share Value for the 50 percent who make the lowest incomes is far below unity. In fact, as Figure 3 reports, they are as unfairly under-taxed as the top-20 percent are unfairly over-taxed:

Figure 3

Source of raw data: Internal Revenue Service

In addition to the Fair Share Values, Figures 1-3 report some interesting changes in the tax burden as a result of the Bush and Trump tax reforms. After the first step of the 2001 and 2003 Bush tax reform, the Fair Share Value for the lowest-50 percent income earners fell from 0.34 to just over 0.29. In other words, their tax burden was shifted away from this lower-income group to the higher income layers.

The same thing happened after the Trump tax reform: in 2017 the Fair Share Value for the bottom-50 percent was 0.276; in 2018, the first year with the Trump tax reform in place, that value fell to 0.253.

As visible in Figure 1, the top-one percent income earners – often criticized for not paying their “fair share” – saw their tax burden increase relative their taxable income. Their Fair Share Value increased in both 2002 and 2018.

The same happened to the top-20 percent, of course. In fact, in 2018 they paid 71.4 percent of all personal federal income taxes, yet they only made 47.7 percent of the taxable income.

In short, the last two tax reforms have sharpened the ideological profile of our income-tax system. More and more of the tax burden is placed on the higher incomes, relatively speaking relieving those with lower incomes. This design of our tax system is deliberate and serves the purpose of economic redistribution. As I explained in my book Democracy or Socialism: The Fateful Question for America in 2024, economic redistribution is the ideological purpose behind socialism.

Ironically, the last two tax reforms, championed by conservatives in Congress and signed by right-leaning presidents, have functionally reinforced the socialist profile of our income-tax system. As a result, this system is now heavily unfair, with everyone making $200,000 or more being over-taxed and everyone making less than that being under-taxed:

Figure 4

Source of raw data: Internal Revenue Service

The stark differences in Fair Share Values are reflected in the actual tax rates for each group, i.e., the taxes they pay out of their taxable income:

Figure 5

Source of raw data: Internal Revenue Service

The fact that the actual tax rate drops when incomes exceed $10 million is easily explained by the lower tax rate on equity-based income relative work-based income.

The federal income-tax system is heavily redistributive in nature, in other words it is a socialist tax system. It makes one fifth of the taxpayers contribute $70 of every $100 in income taxes and puts a relatively lenient tax burden on those making less than $100,000.

In short: anyone claiming that the “rich” don’t pay their “fair share” is dispensing nonsense.

Economic Newsletter 39 2021

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Treasury Yield Update

Last week we reported on the yield rumble going on at the short end of the U.S. Treasury maturity spectrum. We explained that the yields are currently not structured as they would be if the market had a free rein, suggesting that the Federal Reserve’s June increase in its rate on reversed repos from zero to 0.05 percent went against market preferences. Judging from the ongoing yield mess, the central bank and the market are still not in agreement. The yield on 1-6 month Treasury securities have been bouncing around the 0.05-percent mark like high-school guys fighting over a date with the prom queen.

In other words, demand for Treasurys with 1-6 month maturity is higher than what is consistent with a 0.05-yield level. Yet, the Fed insists on going against the mainstream, and the only rational explanation is that the Fed is trying to return the sovereign-debt market to higher interest rates.

For a number of reasons, it is easier for the central bank to push interest rates upward by hiking yields on short-term securities, than trying to pull rates upward from the longer end of the maturity spectrum. A major reason is that higher interest rates are political dynamite. A rise in longer-maturity yield inevitably includes the ten-year Treasury, which is considered a benchmark and therefore has high media visibility. In a political climate where higher interest rates are controversial, a push upward from the bottom attracts less attention and therefore comes with a lower risk for political backlash against Fed chairman Powell.

Unfortunately, the politics of Powell’s reappointment refuses to die down. On Tuesday, Senator Elizabeth Warren explained that she opposes his helmsmanship at the central bank. She even went so far as to call him

a “dangerous man” because of the financial regulations that have been loosened during his tenure. “Your record gives me grave concern,” the Massachusetts Democrat told Powell while he was testifying before the Senate Banking Committee. “Over and over, you have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed. And it’s why I will oppose your renomination.”

On September 22, the Wall Street Journal aimed to defend Chairman Powell, though the Journal also suggested that under his chairmanship the central bank’s “biggest … mistake by far has been underestimating how much its policies would lead to inflation”. This argument misses the point that the Federal Reserve really had no choice but to monetize the enormous deficits of 2020 and – so far – 2021. There is little doubt that leading policy makers at the Fed understand the inflation threat; their problem is how to walk back its harmfully expansionary monetary policy.

Plainly, the central bank is caught between the fiscal-policy devil’s unending appetite for more spending and the deep blue sea of growing sovereign-debt market mistrust in long-term U.S. debt. When the Fed pushed up short-term yields back in June, the hope was apparently to move investors into longer-term Treasurys. Higher demand for those would have pushed down their yield rates, but after falling initially after the June rate hike, the average yield on the 10-30 year Treasurys has stabilized just above 1.6 percent.

This tells us that investors aren’t as eager as the Fed might need them to be, to buy longer-term U.S. debt. More than three months after the June increase, the Fed is still battling it out with the market over the short-term structure. Behold the absurdities on September 29, 29 and 30:

  • The one-month security paid 0.07, 0.05 and 0.07 percent, respectively;
  • The two-month security paid 0.04, 0.04 and 0.05 percent;
  • The three-month security paid 0.04 percent all three days; and
  • The six-month security paid 0.06, 0.05 and 0.05 percent.

In other words, two of these three days buyers of the one-month bill got more than buyers of the six-month bill. On average, over the past seven trading days the one-month bill has paid more than the two, three and six month bills, with the biggest margin being over the three-month bill: 0.057 vs. 0.036 percent.

Markets do not allow such arbitrage-like opportunities to exist more than momentarily, but since June this absurd yield pattern has been the norm rather than the exception. As Figure 1 reports, the average yield for 1-3 month Treasurys has actually become more volatile recently than it was earlier in the summer.

Figure 1

Source of raw data: U.S. Treasury

Figure 1 also illustrates a spike in the long-term maturity average. In two weeks, from Sept. 16 to Sept. 30,

  • The 10-year security has risen from 1.34 percent to 1.52;
  • The 20-year has increased from 1.83 percent to 2.02; and
  • The 30-year is up from 1.88 percent to 2.08.

Most of these increases have taken place in the past week.

These are not unprecedented increases per se, and would be logical if the Treasury market finally had come to a point where it learned to love longer U.S. debt. However, the sharpness of the rise suggest a different explanation, as does the fact that it coincides with prevailing, possibly even rising, uneasiness about the yields on the shortest Treasury bills. Therefore, a more likely explanation is that the rise in long-term yields is driven by politics. It cannot be ruled out that this increase in yield is the result of a deliberate attempt to create highly visible interest-rate turmoil around the debt-ceiling debate.

On Sept. 28 Jamie Dimon, CEO of JP Morgan Chase, made a highly publicized comment where he called a ceiling-driven default on U.S. debt “catastrophic”. This is unusual for the U.S. public debate, though not unheard of from earlier debt-ceiling battles. If there is a political intent behind Dimon’s comment, it will likely be followed by similar statements from others with comparable positions, whereupon interest rates will rise further and – as the ultimate goal – this be used as pressure on Republicans in Congress to vote in favor of raising the debt ceiling.

America’s Entitlement Dependency

There are three major sources of personal income: workforce participation, investments or equity, and entitlements. The composition of income from these sources is essential to the long-term resiliency of an economy: the more of the income that comes from, primarily, workforce participation and, secondarily, equity, the more resilient the economy will be through any phase of the business cycle.

By contrast, rising dependency on entitlements makes an economy increasingly vulnerable to adverse macroeconomic episodes. It is also a recipe for increasingly violent fiscal episodes, eventually resulting in a full-scale meltdown of the Greek kind. Therefore, it is troubling to see that entitlements have grown their presence in personal income in all 50 states. Using data from the second quarter of 2021 we can get an idea of where the economy is – and where the states are – in the recovery from last year’s artificial economic shutdown; unlike the first quarter, the second quarter is largely free of discretionary stimulus checks affecting personal income.

To get an idea of how our economy has changed we compare the Q2 2021 numbers to the same numbers from Q2 2019. That year was, of course, the peak year of the Trump economy. Nationally, in the second quarter of 2019 entitlements paid for on average 18.4 percent of personal income. In Q2 2021 that share had risen to 22.3 percent.

Put differently,

  • In Q2 2019 entitlements accounted for more than 20 percent of personal income in 13 states;
  • In Q2 2021 another 20 states had been added to that list.

Figure 1 illustrates the rise in dependency on entitlements:

Figure 1

Source of raw data: Bureau of Economic Analysis

It is worth repeating that Q2 in 2021 was not a “stimulus check” quarter. Except for minor spillover, those funds went out in Q1; to illustrate the effects of those checks on the personal-income data for that quarter, entitlements accounted for more than 20 percent of personal income in all the 50 states, exceeded 25 percent in 39 states, passed 30 percent in 23 states and topped 40 percent in West Virginia.

Again, by Q2 the extreme entitlement dependency had returned to what can be considered a “normal” level. In other words, Q2 data are more representative than Q1 data of how the economy is structured post-2020. For this reason, it is troubling to see that the increase in entitlement dependency from 2019 to 2021 is mirrored by a reduction in the role of workforce participation and equity as sources of personal income.* The equity-based share of personal income has fallen, with the national average declining from 20.1 percent to 18 percent. As for the states:

  • In Q2 2019, equity provided more than 20 percent of personal income in 19 states, with Florida topping the list at 28.7 percent and Wyoming coming in a hair behind at 28.6 percent;
  • In Q2 2021 only seven states edged above the 20-percent threshold, with Wyoming at 26.6 percent and Florida at 25.7 percent.

The relative decline in equity as a source of personal income is reflected in a small decline in actual equity-based income, from $914.2 billion in Q2 2019 to $912 billion in Q2 2021. By contrast, entitlements went from $782.4 billion to almost $1.1 trillion. This is driven in part by higher unemployment numbers and the unemployment-bonus program; states began phasing out the bonus program in Q2, but as we have reported in previous issues of this Newsletter, the main effect of the phase-out was not visible until July, i.e., the first month of Q3.

Figure 2 reports the share of unemployment benefits in personal income as a comparison between 2019 and 2021:

Figure 2

Source of raw data: Bureau of Economic Analysis

The rise in unemployment benefits as a contributor to personal income is reflected in the amount paid out per unemployed person. As shown in Table 1, this amount varies significantly across the country; states marked in green are opt-out states, though it deserves to be pointed out again that the unemployment bonus opt-out did not take full effect until Q3.

The numbers reported in Figure 1 are not actual payout amounts; they are, instead, an illustration of state spending on benefits if divided up as weekly benefits, among the individuals reported as unemployed. A very high number, as in Massachusetts or New York, is likely to some degree reflective of fraudulent unemployment-benefits filings (a point we made in our first report on the effect of state opt-outs) more than exorbitant per-unemployed benefits. That said, fraud does not account for anywhere near the bulk of state-to-state differences:

Table 1

Sources of raw data: Bureau of Labor Statistics (unemployed); Bureau of Economic Analysis (benefits)

In addition to unemployment benefits, the “other” category of entitlements accounts for a larger share of personal income now than it did in 2019. As mentioned, the stimulus checks were part of the “other” category, pushing first-quarter “other” entitlement payouts nationally to $2,586 billion. However, they do not have more than a marginal (lingering) role to play in the $960.4 billion paid out under this category in the second quarter. This number is to be compared to $495.4 billion in Q2 2019.

In total, the “other” entitlement category and unemployment benefits account for a significant share of personal income. Figure 3 illustrates a disturbing rise in dependency on entitlements:

Figure 3

Source of raw data: Bureau of Economic Analysis

Let us keep in mind that these dependency rates do not include Social Security, Medicare or Medicaid. In other words, America’s households are at a historic high in terms of government dependency. More than ever, the American family needs government handouts to make ends meet.

This does not bode well for a future fiscal crisis.

*) The definition of “equity income” is limited to dividends, interest and rent. It could be construed to include proprietors’ income, but this category is less obviously a distinction between workforce-based and investment-based income. Furthermore, the narrower definition of equity applied here is more easily tied to macroeconomic fluctuations than one which included proprietors’ income. However, for a more comprehensive analysis of the long-term effects of economic policy – especially fiscal policy – it is advisable to also include proprietors’ income under equity.

The Truth about Trump’s Business Tax Cut

The Democrats have proposed an increase in the federal corporate income tax. It is so big that the Americans for Tax Reform refers to it as the “largest tax increase since 1968”.

There is no shortage of research to show the harmful effects of raising the corporate income tax and the benefits of cutting it. See, e.g., contributions from the Fraser Institute in 2015, the Tax Foundation in 2016, American Action Forum in 2017, and with specific reference to the Democrat proposal, by Parker Sheppard with the Heritage Foundation from April this year. In other words, I am not going to argue the case against tax hikes per se.

Instead, I want to point to a void in the debate that has not been filled on the conservative side. There is very little effort in comprehensively responding to the allegations by proponents of higher taxes that corporations don’t pay taxes, and if they do, certainly not their “fair share”. The former, of course, refers to the actual amount of taxes paid, while the latter is a loosely defined attack on the actual tax rate that the corporate income tax inflicts on businesses.

Neither allegation stands up to scrutiny, but before we get to the very interesting case against the “fair share” argument, let us make a couple of observations regarding the actual amount of corporate income taxes paid in the United States in the last few years.

The best place to find information on actual tax revenue is, of course, the Bureau of Economic Analysis. In their National Income and Product Account tables 8.3 and 8.4 they report – among so much more – raw numbers on federal, state and local government revenue from corporate taxes. Using these numbers, we find that corporations paid, in income taxes,

  • $300 billion in 2017;
  • $269.4 billion in 2018;
  • $289.9 billion in 2019; and
  • $263.7 billion in 2020.

A friend of higher taxes will immediately point out that the total revenue from the corporate income tax declined after 2017. This is due entirely to the “Milton Friedman” effect of the tax cut: Friedman is known to have criticized tax cuts for supply-side purposes by stating that if the tax cut resulted in more revenue after the cut than before, the tax cut was not big enough.

A more comprehensive explanation is that the tax cut was not aimed at increasing revenue. It was not the kind of tax cut that the left portrays it to be: the purpose behind Trump’s Tax Cuts and Jobs Act was to stimulate economic growth, not to close the budget gap. In fact, Trump’s attitude to the budget deficit was essentially the same as Reagan’s, namely that the budget deficit is big enough to take care of itself.

In other words, the lesser revenue in 2019 – the top year of the Trump economy – is not a symptom of failure of the tax reform. To judge its success we should instead look to the one variable that can evaluate it based on its purpose: state and local government tax revenue. All other things equal, a surge in corporate tax revenue in state coffers is a sign that the economic base for the tax expanded as a result of the tax cut.


  • In 2017 states and local governments received $54.6 billion in corporate income taxes;
  • In 2019 that number had grown to $72.9 billion.

This is a rise by 33.5 percent; assuming that state tax rates were unchanged from ’17 to ’19, this tells us that the base for the corporate income tax expanded by one third directly after the Tax Cuts and Jobs Act had gone into effect.

In reality, according to the Tax Foundation, several states reduced their corporate income tax during this period. Connecticut cut its rate from 9 to 7.5 percent, Indiana cut their from 6.5 to 5.75 percent. Corporations in Kentucky paid a whole percentage point less in 2019 (five percent) than they did in 2017. New Mexico went from 6.2 to 5.9 percent, Georgia cut one quarter of a percent off its six-percent rate, while North Carolina dropped their rate from three to 2.5 percent.

It is perfectly reasonable to suggest that none of these tax cuts were big enough to have a Friedman effect on corporate tax revenue in their respective states. It takes a lot more for that to happen. It is also worth noting that New Jersey went against the majority by raising the top bracket in their corporate income tax from nine to 11.5 percent.

In short, we can safely conclude that the rise in state revenue from the corporate income tax is due entirely to the positive growth effects of the cut in the federal corporate income tax. Therefore, the tax did what it was designed to do. But if we need more evidence, the Bureau of Labor Statistics reports that there were four million more people working in the private sector in 2019 than in 2017. That is four million more income-tax payers that both the federal government and states and local governments benefited from.

But what about individual corporations? On April 2 this year the Institute on Taxation and Economic Policy claimed:

At least 55 of the largest corporations in America paid no federal corporate income taxes in their most recent fiscal year despite enjoying substantial pretax profits in the United States. This continues a decades-long trend of corporate tax avoidance by the biggest U.S. corporations, and it appears to be the product of long-standing tax breaks preserved or expanded by the 2017 Tax Cuts and Jobs Act (TCJA) as well as the CARES Act tax breaks enacted in the spring of 2020.

Attached to their article is a list of corporations and their tax payments as per Securities and Exchange Commission filings. However, ITEP does not specify how they calculate the tax base, only referring vaguely to “profits”. This is not a stringent analysis, but their lack of stringency is not unique to this paper. It is also reflected in their 2017 study claiming to show that under the 35-percent corporate tax rate, the effective rate paid was just above 21 percent.

There are a number of problems with the ITEP studies, one being that the more recent one is based on numbers from 2020. That was a year when extraordinary circumstances – including an emergency provision to give businesses tax relief – went into effect (passed, we might point out, by the Democrat-led House of Representatives). However, the deeper problem is that ITEP does not tell us how they arrive at their numbers, even though they claim to use the Securities and Exchange Commission as their source. Therefore, I made my own little survey of corporate income-tax payments.

Based on corporate finance reports from NASDAQ, I pieced together data from ten corporations on their total revenue, gross profit, earnings before taxes, and corporate income-tax payments. The corporations are: Amazon, Apple, Citigroup, Coca Cola, Exxon, Ford, Microsoft, Tesla, Uber and Walmart. These are significant corporations: in 2017 they paid one quarter of all the corporate income taxes received by the federal, state and local governments.

I calculated tax payments as a share of total revenue, gross profit and earnings before taxes. Using the last one as the actual tax base, here is what I found:

  • Amazon paid $2.37 billion in income taxes in 2019, more than three times what it paid in 2017; as a share of earnings before taxes, these tax payments fell from 20 percent to 17 percent, a marginal reduction compared to the significant expansion in their tax payments;
  • Apple reduced its tax payments from $15.7 billion in 2017 to $10.5 billion in 2019, cutting its effective tax rate from 24.6 percent to 15.9 percent; at the same time, Apple repatriated well over $200 billion in foreign assets and made significant investments in several places around the country, including a $1 billion new campus outside Austin, Texas; these investments would not have happened without the Trump tax reform;
  • Citigroup paid a substantial amount of taxes in 2017, with its $29.4 billion check to the IRS amounting to a 129.1 percent effective tax rate (again over earnings before taxes); in 2019 they paid $4.4 billion, an effective tax rate of 18.5 percent;
  • Coca Cola also made an enormous tax payment in 2017, with its $5.6 billion equaling 81.4 percent of their earnings before taxes; by 2019 their tax payments had fallen to $1.8 billion but that still amounted to an effective tax rate of 16.7 percent;
  • Exxon went in the exact opposite direction, from a negative tax rate of 6.3 percent in 2017 (and tax deductions exceeding payments by almost $1.2 billion) to paying 26.3 percent of earnings before taxes – or $5.3 billion – in 2019;
  • Ford, a struggling car manufacturer, only paid $402 million in 2017 and ended up with a negative tax payment of $724 million two years later; by contrast, in 2018 they shipped $650 million into the federal, state and local government coffers, which amounted to 15 percent of their earnings before taxes;
  • Microsoft paid $19.9 billion in income taxes in 2017, equal to 54.6 percent of earnings before taxes; two years later they only paid 16.5 percent, but it still came out to almost $8.8 billion;
  • Tesla is a tax dwarf compared to the rest of this sample: in 2017 they paid $32 million, which is still impressive given that their earnings before taxes were negative at $2.2 billion; by 2019 their taxes had increased to $110 million, even though earnings before taxes were still in the red at -$665 million;
  • Walmart is the most consistent taxpayer in this sample: in 2017 they paid $4.6 billion; in 2018 $4.3 billion; in 2019 $4.9 billion; and in 2020 almost $6.9 billion; on average, they paid 31.4 percent of their earnings before taxes.

In total, these corporations paid $74.7 billion in income taxes in 2017. By 2019 that number had fallen to almost exactly half, just below $37.5 billion. During the same period of time, however, the federal government only lost 11.6 percent of its revenue from the corporate income tax. This indicates that other corporations delivered more tax revenue in ’19 than they did two years earlier. Or, put differently,

  • In 2017 the ten corporations in my sample paid 25 percent of all corporate-tax revenue, federal, state and local;
  • In 2019 they accounted for only 13 percent.

In other words, our governments got more tax payments from more corporations – the tax base was diversified. This is a forgotten benefit of the tax reform. Revenue from corporate taxes are highly volatile and among the first to plummet in a recession; a more diversified tax base makes government less vulnerable to industry-specific fluctuations in revenue. (The sample above has two large retail corporations, two computer technology corporations and two car manufacturers.) While the corporate income tax accounts for a lot less than ten percent of federal tax revenue, increased stability in revenue is always welcome.

And let us also not forget state revenue from the corporate tax: it increased by 33.5 percent from 2017 to 2019.

One last point: federal tax revenue indicate a Laffer effect from the Trump tax reform. In 2018, the first year the reform was in effect, total federal revenue from the corporate income tax amounted to $208.9 billion, down 15 percent from the $245.4 billion in 2017. However, in 2019 revenue was up by almost four percent over ’18, totaling $217 billion. If 2020 had been a normal economic year, it is likely that this would have formed a trend of growing revenue.

In other words, even if the tax reform followed the Friedman rule with prioritizing growth over increased revenue, the federal government was beginning to reap the benefits in the form of more revenue.

It is also worth mentioning that of the ten corporations in the aforementioned sample, seven paid a tax rate higher than 20 percent at least one year after 2017. This is significant, since corporations all over America began taking advantage of the entire tax reform, including changes to investment incentives.

The Trump tax reform worked. It stimulated economic growth as it was intended to do. The fact that it did not increase revenue from the corporate income tax is less important, and it is certainly not a reason to blast the reform for contributing to the budget deficit. After all, during the same period of time the U.S. Treasury increased its collections of personal income taxes from $1.6 trillion to $1.7 trillion. For every $100 that the corporate income tax revenue declined, revenue from personal income taxes increased $335.

In view of this, the fact that the budget deficit increased by $326.7 billion from ’17 to ’19 is entirely the fault of Congress for spending too much money.

So there you have it. The Tax Cuts and Jobs Act achieved its goal. Corporations are not tax absconders. To the extent that a corporation does not pay any taxes, it is because they are making investments or not making any money. Anyone who wants to deprive corporations of tax incentives to invest is welcome to explain what alternative he or she has to offer in terms of encouraging corporations to commit to the future of the American economy. To suggest “government” as the solution is not a valid option, for reasons I have explained in my latest book.

Economic Newsletter 38 2021

This week’s issue of The Liberty Bullhorn Economic Newsletter takes a closer look at some odd trends in Treasury yields. We also give an update on inflation and unemployment numbers.

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Larson’s Political Economy, Episode 7

What is the relationship between real wages, money wages and unemployment? An introduction to Keynes’s “General Theory of Employment, Interest and Money”.

But first, let’s make fun of economics:

Now for the serious stuff:

If you would like to listen to the entire series of Larson’s Political Economy podcasts, click here!

Larson’s Political Economy, Episode 6

Do sticky prices cause recessions? The answer is not what mainstream economics tries to tell you. But before we rip to pieces what Finn Kydland and Ed Prescott contributed to New Classical Macroeconomics, let’s enjoy some econ humor:

And now for this week’s episode of Larson’s Political Economy, where we discuss the relationship between sticky prices and recessions. Hold on to your conventional wisdom – or let it go: