Tim Taylor: The Evolution of Exchange Rate Markets [feedly]

fascinating and accessible discussion of exchange rates by Tim Taylor, refuting an early assertion by John Stuart Mill of "money's insignificance". Keynes, and Lenin, said: "the easiest way to undermine capitalism is to debauch its currency."

The Evolution of Exchange Rate Markets
http://conversableeconomist.blogspot.com/2020/01/the-evolution-of-exchange-rate-markets.html

Back in 1848, John Stuart Mill made a classic argument that money was insignificant to the essential nature of an economy, because it was only a facilitator for what really matters--the actual transactions. Mill wrote (Principles of Political Economy, Book III, Ch. VII):

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.

In a globalized economy, one might similarly argue that the exchange rate market is an insignificant thing. What really matters, one might claim, is the real flows of imports and exports, or the patterns of international financial investments. However, the exchange rate market involves trades totaling  $6.6 trillion per day. This is vastly more than needed to finance exports and imports, or to finance foreign direct investment and portfolio investment. Instead, the foreign exchange market is clearly being driven by financial transactions: specifically, those who are hedging against shifts in exchange rates, those who are trying to make a profit by trading in exchange rate markets, or both. It cannot be viewed as, in Mill's language, an intrinsically insignificant thing.

The go-to source for information about exchange rate markets is the Triennial Survey conducted by the Bank for International Settlements (an international organization run by the central banks and monetary authorities of 60 different countries).  The BIS Quarterly Review for December 2019 offers a five-paper symposium with details on the size and operation of exchange rate markets. Here, I'll mention some of the highlights from the overview paper by  Philip Wooldridge, "FX and OTC derivatives markets through the lens of the Triennial Survey."  The five papers that follow in the issue are:

• "Sizing up global foreign exchange markets," by Andreas Schrimpf and Vladyslav Sushko
• FX trade execution: complex and highly fragmented, by Andreas Schrimpf and Vladyslav Sushko
• "Offshore markets drive trading of emerging market currencies," by Nikhil Patel and Dora Xia
• "The evolution of OTC interest rate derivatives markets," by Torsten Ehlers and Bryan Hardy
• "OTC derivatives: euro exposures rise and central clearing advances," by Sirio Aramonte and Wenqian Huang

A basic question in the issue is how to account for the fact that the size of exchange rate markets expanded by roughly 30% from $5.1 trillion per day in the April 2016 survey to $6.6 trillion per day in the April 2019 survey. Again, this rise cannot be explained by a rise in exports and imports, or by a rise in international foreign direct investment and portfolio investment, which aren't nearly large enough to be explain a foreign exchange market of this size.

One shift is that exchange rate trading is happening with shorter-term financial instruments. As a result, they need to be traded more often during a calendar year. Wooldridge writes:

The trading of short-term instruments grew faster than that of long-term instruments. This mechanically increased reported turnover because such contracts need to be replaced more often. Schrimpf and Sushko (2019a) emphasise that the trading of FX swaps, which is concentrated in maturities of less than a week, rose from $2.4 trillion in April 2016 to $3.2 trillion in April 2019 and accounted for most of the overall increase in FX trading.

Another shift is that exchange market trades involving currencies of emerging market countries is on the rise:

While globally trading continued to be dominated by the major currencies, in particular the US dollar and the euro, in FX markets the trading of emerging market currencies grew faster than that of major currencies. As discussed by Patel and Xia (2019), the share of emerging market currencies in global FX turnover rose to 23% in April 2019 from 19% in 2016 and 15% in 2013.

In my reading, the biggest underlying changes relate to what Wooldridge calls "electronification," which is the pattern that more exchange rate transactions are happening through electronic or automated trading. The cost of exchange rate transactions has fallen, but the cost of the information technology infrastructure for carrying out those transactions has risen. 

This shift helps to explain the pattern just mentioned, that exchange rates markets have become more likely to operate through a series of short-term transactions. In addition, more of the exchange rate market is happening in a few major financial centers. Wooldridge writes: 

"In FX markets, London, New York, Singapore and Hong Kong SAR increased their collective share of global trading to 75% in April 2019, up from 71% in 2016 and 65% in 2010. Trading in OTC interest rate derivatives markets was also increasingly concentrated in a few financial centres, especially London. Schrimpf and Sushko (2019a) attribute this geographical concentration to network externalities. For example, it is more cost-effective to centralise counterparty and credit relationships, or technical and legal infrastructures, in a handful of hubs than to spread them across many countries. The faster pace of trading also increased the advantages of locating traders' IT systems physically close to those of the platforms on which they trade."

In addition, electronification of exchange rate markets has made it possible for investors who want to do high-frequency automated trading to participate, including hedge funds and what are called "platform-traded funds" (which operate in a way similar to exchange-traded funds). Of course, this change fits with the other patterns in exchange rate markets, like more short-term trades and a greater concentration of this trading in big financial centers. 

For those of us who will always bear the emotional scars from the meltdowns of financial markets during the Great Recession, the rapid growth of exchange rate market raises natural concerns over whether this rapid rise in exchange rate markets should raise concerns about financial risks that could in theory spill over into the rest of the global economy. At least so far, these concerns seem fairly muted. 

Behind the financial scenes, exchange rate transactions are ultimately handled by "dealers," of whom there are about 75 in the world at present. What if some of the major dealers become involved in a pattern of trading where they are exposed to risk, and end up going broke? However, a large share of exchange rate transactions are now carried out through central "clearinghouse" financial institutions.  The clearinghouse helps to match up buyers and sellers for transactions in exchange rate markets. The result is that while the number of exchange market transactions has risen, the amount of money truly at risk (once offsetting transactions are taken into account, has actually declined. Wooldridge writes: 

The marked pickup in the trading of FX and OTC derivatives between the 2016 and 2019 surveys did not lead to an increase in outstanding exposures. To be sure, since 2015 the notional principal of outstanding OTC derivatives has trended upwards, and at end-June 2019 it reached its highest level since 2014. However, their gross market value - a more meaningful measure of amounts at risk than notional principal - has trended downward since 2012. 

Just to be clear, I'm not saying that trying to trying to make money in foreign exchange markets or trying to hedge against movements in foreign exchange markets is low-risk. Foreign exchange markets are well-known for making sharp and unexpected movements in the short-term and medium-term, and for sticking at levels that seem "too low" or "too high" for unexpectedly long periods of time. Indeed, these features explain why the size of exchange rate markets is so large, as investors are trying either to hedge against these movements or to make a profit by anticipating them. But the rise of central clearninghouses for these markets seems to have reduced the risk that a meltdown originating in failures of the main global exchange rate dealiers will bleed into the rest of the global economy.

 -- via my feedly newsfeed

Dean Baker: The Economic Impact of War [feedly]

The Economic Impact of War
http://cepr.net/publications/op-eds-columns/the-economic-impact-of-war

Dean Baker
Truthout, January 13, 2020

See article on original site

With the surprise assassination of Qassim Suleimani, it's hard not to wonder if Trump was trying to start a full-fledged war for an election year economic boost. To be clear, economics is not ever a justification for war, but it is important to understand the impact war can have on the economy.

The basic story with spending on a war, or any other military spending, is that it provides a boost to demand in the economy. In this sense, it is like anything else that would provide a boost in demand, such as increased spending on health care, child care or housing.

If we think about spending another 1 percent of GDP on a war (roughly $220 billion this year), in addition to current spending, it would have approximately the same impact on the economy as spending another $220 billion in any other area of the economy. There will always be some differences, because some spending will lead to more employment per dollar than others, and there will be differences in the composition of employment. However, the immediate effect on output will be similar.

Whether this or any war means a net boost to demand and growth depends on the amount of slack in the economy. In an economy with lots of slack, as was the case with the U.S. economy immediately following the Great Recession, a boost of spending due to a war or anything else would have undoubtedly led to an increase in demand and employment.

We saw this in a really big way with World War II, where we were spending more than 40 percent of GDP (over $8 trillion in today's economy) at the peak. This led to huge increases in output and employment, as the unemployment rate fell to less than 2 percent.

This sort of massive increase in military spending was possible because of the enormous amount of unemployment resulting from the Great Depression. Of course, even as we put to work unemployed workers and unused productive capacity, the increase in spending was so large that we still needed rationing and wage and price controls to prevent runaway inflation.

But it is wrong to say that World War II was necessary to get the United States out of the Great Depression. We could have had a massive increase in spending on infrastructure, health care or any number of other areas that would have provided a comparable boost. There just was not the political support needed to undertake big spending increases outside of a war.

In the current political situation, that is also true. There is no way that the Republican-controlled Senate would support a substantial increase in spending on social programs, even if the House approved it. And, there is no way that even House approval could be taken for granted. This could change after the 2020 election, but there is no doubt that if we are to see any large-scale increase in spending in 2020, it will be because of war or the fear of war.

Whether this provides a boost to the economy is difficult to determine, since the 3.5 percent rate is quite low compared to rates we have seen over the last 50 years. Can we push down the unemployment rate another 0.5 percentage points to 3 percent, or perhaps even lower, without triggering a serious problem with inflation?

Anyone who claims to know the answer to that one has not been following the data closely. A few years ago, most economists argued that inflation would start to become a problem if the unemployment rate fell below 5 percent. That was obviously wrong. We still don't see evidence of inflationary pressures, but that doesn't mean the unemployment rate can go still lower without any problems.

This brings up the other part of the story. If we do start to see inflationary pressures, the Federal Reserve will move to slow the economy by raising interest rates. This will slow home building, reduce consumption fueled by mortgage refinancing, and also, to a lesser extent, reduce public and private investment. In that story, the increase in spending associated with a war doesn't lead to a gain in employment and growth, it just pulls away resources from productive areas of the economy.

Insofar as we have less public and private investment, that will mean the economy will be less productive in the future. That's a story where a war will slow growth, at least over the longer term.

This is a major difference between spending on a war and spending in areas like education, health care and clean energy. These forms of spending will have positive long-term effects on the economy, so they can be net long-term gainers even if the economy is near its capacity.

So the final answer on Trump using a war as a way to boost the economy: It is not clear that it will offer even a short-term benefit. What is clear is that war will carry a long-term cost, even before we start to consider all the deaths and ruined lives among the victims.

 -- via my feedly newsfeed

Calculated Risk: Paul Volcker on the "Existential test" facing America [feedly]

Bill McBride is a longtime expert on the housing  market, especially, being a voice warning of what became the mortgage bubble leading to the 2008 crash.
He took his warnings from Paul Volcker, an architect of the post war financial system, who, in his last testaments, clearly saw that that model is badly failing, and huge risks are piling up.

Paul Volcker on the "Existential test" facing America
http://www.calculatedriskblog.com/2020/01/paul-volcker-on-existential-test-facing.html

Fifteen years ago, in February 2005, I excerpted from a speech by former Fed Chair Paul Volcker at Stanford. That prescient speech about housing and excessive borrowing is available on YouTube. Some of Volcker's comments were: "Altogether, the circumstances seem as dangerous and intractable as I can remember. … Homeownership has become a vehicle for borrowing and leveraging as much as a source of financial security."

I shared Volcker's concerns back then.

Sadly Paul Volcker passed away in December.   Just a few months before his death, he wrote an "afterword to the forthcoming paperback edition of his autobiography". Here are a few excerpts (via the Financial Times):

By the late summer of 2018, it was already clear that the US and the world order it had helped establish during my lifetime were facing deep-seated political, economic, and cultural challenges.

Nonetheless, I drew reassurance from my mother's reminder that the US had endured a brutal civil war, two world wars, a great depression, and still emerged as the leader of the "free world", a model for democracy, open markets, free trade, and economic growth. That was, for me, a source of both pride and hope. Today, threats facing that model have grown more ominous, and our ability to withstand them feels less certain. …

Today … Nihilistic forces ... seek to discredit the pillars of our democracy: voting rights and fair elections, the rule of law, the free press, the separation of powers, the belief in science, and the concept of truth itself.

Without them, the American example that my mother so cherished will revert to the kind of tyranny that once seemed to be on its way to extinction — though, sadly, it remains ensconced in some less fortunate parts of the world.
...
Seventy-five years ago, Americans rose to the challenge of vanquishing tyranny overseas. We joined with our allies, keenly recognising the need to defend and sustain our hard-won democratic freedoms. Today's generation faces a different, but equally existential, test. How we respond will determine the future of our own democracy and, ultimately, of the planet itself.
emphasis added

Once again I share Volcker's concerns. Although most of my writing this year will be on the economy, I will be writing about U.S. politics this year.

If you aren't sure what is coming, see this post concerning the mid-term election.  

 -- via my feedly newsfeed

Robert Scott: China trade deal will not restore 3.7 million U.S. jobs lost since China entered the WTO in 2001 [feedly]

For many years, Robert Scott's trade writing at the EPI has been a foundation of the AFL-CIO's criticism of trade deals. The job losses documented, however, omit mention of the jobs created, mostly in services, and non union of course, but there WERE, and ARE offsetting jobs created. Scott loses credibility in the econ profession by such omissions. Likewise on NAFTA, the job losses were accelerating for years BEFORE NAFTA. I can testify to the fate of machine tools and textiles New England. Further, ANY trade agreement is going to partially realign work and investment in the trading partners. The important question is: is there a net gain in income and growth for all partners. Also important are any losers in the change compensated and/or retrained for the modified division of labor?Lastly -- nationalism on trade can be sucker bait for fascists like Trump. Does Scott's remedies address this? I do not think so.

Interested in other comments on this.

China trade deal will not restore 3.7 million U.S. jobs lost since China entered the WTO in 2001
https://www.epi.org/blog/china-trade-deal-will-not-restore-3-7-million-u-s-jobs-lost-since-china-entered-the-wto-in-2001/

he White House has announced plans for a ceremony to sign a "phase one" trade deal with China on Wednesday, although details of the agreement have yet to be announced. As one analyst noted, this deal may not amount to more than a hill of soybeans. It is unlikely to significantly reduce massive U.S. job losses due to growing U.S. trade deficits—the difference between imports and exports—which are dominated by trade deficits in manufactured goods. As shown in a forthcoming EPI report to be released later this month, growing U.S. trade deficits with China eliminated 3.7 million U.S. jobs between 2001 and 2018 alone (see Figure A), including 2.8 million jobs in manufacturing (details will be provided in the forthcoming report).

Figure A

Trade deficits and jobs losses with China continued to grow during the first two years of the Trump administration—despite the administration's heated rhetoric and imposition of tariffs. The U.S. trade deficit with China rose from $347 billion in 2016 to $420 billion in 2018, an increase of 21.0%. U.S. jobs displaced by those China trade deficits increased from nearly 3.0 million jobs lost in 2016 to 3.7 million jobs lost in 2018, an increase of more than 700,000 jobs lost or displaced in the first two years of the Trump administration.

Although the bilateral trade deficit with China has declined in 2019 (through November), the overall U.S. trade deficit in non-oil goods, which is dominated by trade in manufactured and farm products, has continued to increase, suggesting that trade diversion has grown in importance. These are important topics for future research.

While growing exports support some American jobs, growing imports eliminate existing jobs and prevent new job creation—as imports displace goods that otherwise would have been made in the United States by domestic workers. As a result, growing trade deficits result in increasing U.S. job losses. The top half of Table 1 shows just how much the trade deficit has grown: The U.S. trade deficit with China increased from $83.0 billion in 2001 to $420 billion in 2018. While U.S. exports to China increased in this period, growing exports were overwhelmed by the massive growth of imports from China, which increased by $437 billion in this period. 

U.S. trade deficits with China displaced 956,700 jobs in 2001 when China entered the World Trade Organization (WTO) and the number of jobs lost due to the trade deficit increased to 4,661,400 in 2018, leading to a net 3.7 million jobs lost, as shown in the bottom half of Table 1.

Table 1

The single most important ca

use of growing trade deficits with China is its history of currency manipulation and dollar misalignment that has persisted for more than two decades. And yet, the reported deal will provide extremely unfavorable terms for the United States on exchange rates, essentially locking in the current exchange rate. This deal is a step backwards on currency manipulation and misalignment.

Despite all of the tariffs and other restrictions imposed on China trade by the Trump administration, the bilateral trade deficit continued to grow between 2016 and 2018, resulting in the loss of more than 700,000 U.S. job opportunities. It remains to be seen whether bilateral and global trade balances improve in the wake of the phase one trade agreement with China, and future trade deals to come. But the phase one trade deal does not appear to address the key structural concerns with the long-term imbalance in trade between the United States and China.

 -- via my feedly newsfeed

Calculated Risk: Comments on December Employment Report [feedly]

CR's first release of annual econ graphs on important trends is beautiful

Comments on December Employment Report
http://www.calculatedriskblog.com/2020/01/comments-on-december-employment-report.html

he headline jobs number at 145 thousand for December was below consensus expectations of 160 thousand, and the previous two months were revised down 14 thousand, combined. The unemployment rate was unchanged at 3.5%.

Earlier: December Employment Report: 145,000 Jobs Added, 3.5% Unemployment Rate

In December, the year-over-year employment change was 2.108 million jobs including Census hires.

Seasonal Retail Hiring

Typically retail companies start hiring for the holiday season in October, and really increase hiring in November. Here is a graph that shows the historical net retail jobs added for October, November and December by year.

Click on graph for larger image.

This graph really shows the collapse in retail hiring in 2008. Since then seasonal hiring has increased back close to more normal levels. Note: I expect the long term trend will be down with more and more internet holiday shopping.

Retailers hired 76 thousand workers (NSA) net in December.   Note: this is NSA (Not Seasonally Adjusted).

In October, November and December combined, retailers hired more seasonal workers than in the previous two years.

Average Hourly Earnings

Wage growth was below expectations. From the BLS: 

"In December, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $28.32. Over the last 12 months, average hourly earnings have increased by 2.9 percent."

This graph is based on "Average Hourly Earnings" from the Current Employment Statistics (CES) (aka "Establishment") monthly employment report. Note: There are also two quarterly sources for earnings data: 1) "Hourly Compensation," from the BLS's Productivity and Costs; and 2) the Employment Cost Index which includes wage/salary and benefit compensation.

The graph shows the nominal year-over-year change in "Average Hourly Earnings" for all private employees.  Nominal wage growth was at 2.9% YoY in December. 

Wage growth had been generally trending up, but weakened in 2019.

Prime (25 to 54 Years Old) Participation

Since the overall participation rate has declined due to cyclical (recession) and demographic (aging population, younger people staying in school) reasons, here is the employment-population ratio for the key working age group: 25 to 54 years old.

In the earlier period the participation rate for this group was trending up as women joined the labor force. Since the early '90s, the participation rate moved more sideways, with a downward drift starting around '00 - and with ups and downs related to the business cycle.

The 25 to 54 participation rate was increased in December to 82.9%, and the 25 to 54 employment population ratio increased to 80.4%.

Part Time for Economic Reasons 

From the BLS report:

"The number of persons employed part time for economic reasons, at 4.1 million, changed little in December but was down by 507,000 over the year. These individuals, who would have preferred full-time employment, were working part time because their hours had been reduced or they were unable to find full-time jobs."

The number of persons working part time for economic reasons decreased in December to 4.148 million from 4.288 million in November.   The number of persons working part time for economic reason has been generally trending down. 

These workers are included in the alternate measure of labor underutilization (U-6) that decreased to 6.7% in December.

Unemployed over 26 Weeks

This graph shows the number of workers unemployed for 27 weeks or more. 

According to the BLS, there are 1.186 million workers who have been unemployed for more than 26 weeks and still want a job. This was down from 1.219 million in November.

Summary:

The headline jobs number was below expectations, and the previous two months were revised down.  The headline unemployment rate was unchanged at 3.5%; wage growth was well below expectations.  Overall this was a disappointing report.

In 2019, the economy added 2.108 million jobs, down from 2.679 million jobs during 2018 (although 2018 will be revised down with benchmark revision to be released in February 2020).   So job growth has slowed.  

 -- via my feedly newsfeed

The labor market continues to improve in 2019 as women surpass men in payroll employment, but wage growth slows [feedly]

The labor market continues to improve in 2019 as women surpass men in payroll employment, but wage growth slows
https://www.epi.org/blog/the-labor-market-continues-to-improve-in-2019-as-women-surpass-men-in-payroll-employment-but-wage-growth-slows/

Today's Bureau of Labor Statistics (BLS) jobs report provides the opportunity to look at 2019 as a whole and in comparison with previous years. As the recovery has strengthened over the last several years, we've generally seen improvements in most measures of the labor market: employment, unemployment, and wage growth. These measures tell a consistent story—an economy on its way to full employment, but not there yet. Wage growth continues to be the lagging indicator, which is not as strong as would be expected given the health of the labor market and actually slowed through much of 2019.

Payroll employment growth in December was 145,000, bringing average job growth in 2019 to 176,000. This is a bit softer than the 223,000 average for 2018, but still more than enough to keep up with growth in the working-age population and pull in thousands of workers off the sidelines every month.

Figure A

For the first time in nearly 10 years, women's share of payroll employment has just surpassed that of men's. The figure below shows payroll employment for both men and women since 2000. From 2000 to 2007, men's share of total employment was about 1–2% higher than women's. In the recession, employment fell markedly in male-dominated professions—notably manufacturing and construction—and women's share of employment rose in kind. Since 2010, women's and men's employment have both increased, with men's growing faster than women's initially. In the last couple of years, women's payroll employment has grown just a bit faster than men's.

We can turn again to a sector approach as one explanation for why women's employment has now just surpassed men's in December. Men make up 77% of employment in construction and manufacturing combined. Coincidentally, women make up 77% of employment in education and health services. Between 2018 and 2019, construction and manufacturing together increased by 356,000, but education and health services employment increased much more—by 603,000. Furthermore, manufacturing employment has faltered late in the year, helping women's employment eke ahead of men's in December.

It is important to note that in absolute terms the shares of men's and women's employment haven't changed that dramatically. But, it holds true that women's payroll employment is now 50.04% of the total, the first time it has been a majority since the depths of the (construction and manufacturing-led) Great Recession.

Figure B

Turning to the household survey, the labor market continues to not only absorb population growth, but also chip away at the slack remaining in the labor market—namely workers who continue to be sidelined and who I expect will enter or re-enter the labor market as opportunities for jobs and better pay expand. As the unemployment rate has continued to fall between 2018 and 2019, labor force participation has increased as people re-enter the labor market and find jobs. Since December 2018, the unemployment rate dropped 0.4 percentage points (3.9% to 3.5%) while the employment-to-population ratio, or the share of the population with a job, rose 0.4 percentage points (60.6% to 61.0%). This means the unemployment rate over the last year fell for the right reasons—not because workers gave up looking, but because more would-be workers actually found jobs.

The share of 25–54 year olds with a job, otherwise known as the prime-age employment-to-population ratio (EPOP), has now exceeded its immediate pre-Great Recession high point, hitting 80.4% in December. This is decidedly good news, but there's still room for improvement. As the figure below shows, the prime-age EPOP remains 1.5 percentage points below the high point it reached in the spring of 2000. And, other news from the household survey reminds us that different groups face a decidedly different labor markets than others. For instance, while the economy continued to chug along, we still see higher unemployment for black workers than white. In December, black unemployment rose to 5.9% while white unemployment held at 3.2%.

Figure C

After some improvement in 2018, slowing nominal wage growth in 2019, as shown in the figure below, is one of the key sticking points in the labor market today. After hitting a high point of 3.4% year-over-year wage growth in February, the growth rate has measurably decelerated and wage growth closed out the year at only 2.9% in December, its lowest point in 18 months. While wage growth was faster among production/nonsupervisory workers over the prior several months, this growth slowed markedly in today's data. These workers—roughly 82% of the private-sector workforce—saw wage growth of just 3.0% year-over-year in December, the slowest growth in over a year. As would-be workers become scarcer, we would expect employers to have to work harder to attract and retain the workers they want. Unfortunately, in lieu of stronger labor standards and worker bargaining power, it takes tighter and tighter labor markets for most workers to reap the rewards of a strong and growing economy. It remains to be seen whether the recent trends will continue or if the tighter economy will provide workers with the necessary leverage to bid up their wages.

On the whole, as we look to 2020, the labor market should continue on its path to full employment as long as nothing throws it off the tracks.

Figure D

 -- via my feedly newsfeed

Dan Shaviro (NYU) and Tim Smeeding (WISC) on NPR's Detroit Today Show [feedly]

Linda Beale is a Prof at Wayne State, and a knowledgeable blogger on tax law and tax bills.

Dan Shaviro (NYU) and Tim Smeeding (WISC) on NPR's Detroit Today Show
https://ataxingmatter.blogs.com/tax/2020/01/dan-shaviro-nyu-and-tim-speeding-wisc-on-nprs-detroit-today-show.html

For those of you who may not have the opportunity to tune into Stephen Henderson's radio program Detroit Today on NPR, it might be useful to have a short summary of the January 9 discussion of the "wealth gap" from that program.

Background 

Tax lawyers have traditionally talked of the "tax gap"¹  and frequently mentioned the growing "income gap" between the top 1% of the income distribution and the remaining 99%, but the "wealth gap"²discussion among tax lawyers, tax policy thinkers, economic analysts and indeed progressive legislators about the relative net assets of different segments of the population has become increasingly important as people have recognized the trend of increasing wealth for the top 0.1% in the US and stagnating wealth for most of the US population.  The wealth gap is even more significant when race/ethnicity is taken into account: the 400 wealthiest families in 2015 owned as much as the country's entire African-American population plus 1/3 of the Latino population.⁴  The median white household in 2011 had about $111 thousand in wealth, while the median black household had $7 thousand and the median Latino household had $8 thousand, with the impact of slavery and post-WWII homeownership policies being the underlying source of most of the disparities.³ See also How Ameria's Vast Racial Wealth Gap Grew: By Plunder, New York Times, Aug. 14, 2019.  The generational wealth gap is also worrisome: older Americans' wealth grew between 1989 and 2013 but all other age groups had their wealth decline.³  The gender wealth gap underlies the power distinction that lies at the bottom of the MeToo movement: women earn less than men for the same work at the same level, and they save less and are more likely to live in poverty in old age.

That means that children in this country born to families in the top 10% of the wealth distribution have enormous advantages from birth:  they are essentially guaranteed the best medical, educational, and institutional support imaginable, with every opportunity for learning and advancement laid before them.  Their parents can afford to ensure they are able to get into top colleges (e.g., Harvard alumni preferences for their children), meet the "right" people for success in their preferred field (the "connections" that wealthy families build), take a preferred non-paying internship in another city with family funds supporting living expenses and more, all the way up the ladders of success.  Children born into families in the bottom half of the wealth distribution face a struggle at every point along that ladder:  schools that are inadequately funded after decades of Republican concentration on assessment and hurdles rather than support and educational opportunities; lack of exposure to different possibilities and the people who can open doors into those possibilities; lack of funding to make it possible to accept an opportunity when it presents itself.

These wealth disparities don't just impact these choices--they also affect aging parents who have inadequate retirement savings, young adults who have inadequate resources to deal with sudden medical emergencies, or aspiring students who get tangled in the payday loan vicious cycle of ever-escalating interest payments. And the wealth gap is compounded by at least three key components of the US federal tax system: 

1. the income tax system that claims to be progressive yet has income tiers that ignore the escalating heights of the highest paid corporate managers, university presidents, and other high-income labor and a capital gains preference that privileges ownership over labor;
2. the estate tax system that has been a GOP target for decades that has too low a rate on too little income of the dynastic estates that the run up in wealth over the last four decades has created while passing the estate along to heirs without taking any tax bite because of the absurd step-up in basis rule;
3. the cap on the social security tax that requires even the poorest laborer to pay in while letting the CEO earning a $10 million annual salary pay on only a pittance of the total compensation.

The wealth gap has in some sense always existed, but it is increasing⁵and today begins to look like the Gilded Age before the Great Depression.  While the tax system isn't solely responsible for the increasing wealth gap in this country, it has played a significant role in aggravating the problem and thus deserves focussed attention as a matter of tax policy.

Key Points from Dan Shaviro's Interview

Dan noted that the wealth gap had its beginning in the 19th century when the government didn't respond to increasing disparities.  The progressive era under Roosevelt and Wilson, then the New Deal era under FDR did see some reduction in the wealth gap, much of which could be attributed to the reduction in wealth because of the stock market crash and the Great Depression.

As wealth increases, power increases.  Even proposals that have huge public support are rejected by Congress--including the idea that corporations and the wealthy should be taxed more.

Finding policies to ameliorate this current situation is not easy.  There are a variety of ideas--Warren and Sanders have proposed wealth taxes, though there are  constitutionality concerns that might defeat such a tax given the current conservative Supreme Court.  And a wealth tax won't solve all the problems of inequality. Other ideas include more progressive income taxes or a mark-to-market system of taxing appreciation of capital assets.

The reasons for attempting to address the wealth gap are many, and include the need for better transportation, health care, education, end of life and geriatric care, etc. 

We live in a capitalist system, but markets don't work well for addressing all problems.  In particular, they don't work well for the kinds of things that are so important like health care and education. 

Any transition, of course, will be very difficult.  The top 10% own 77% of the wealth while the bottom 50% own less than 2%.  Those with financial wealth live very well indeed, since that wealth isn't taxed til it is used and may never be taxed.

 

Key Points from Timothy Smeeding's Interview

Understanding the wealth gap is critical, because wealth provides a "cushion for consequential life moments" such as when a parent covers a child's tuition or supports the child in their first apartment in a different city.

Deciding how to respond to the wealth gap is difficult, but various possibilities exist, including a wealth tax, a reinvigorated estate tax, elimination of the capital gains preferential rate compared to ordinary income, elimination of the carried interest provision that allows private equity managers to be compensated with capital gains at a 23.8% rate rather than a 38% plus 3.8% rate and avoid paying social security taxes, elimination of the one-time exclusion for capital gains on sales of residences, etc

There are many important institutional advantages that can better lives as well, especially providing access to health care and to university education.

Responding to a question about labor, Smeeding notes that unions will be important in areas such as the public sector, nursing, education.  But in the corporate context, an important change might be to consider bringing a labor voice to corporations' Boards of Directors.  Other possibilities are to reward corporations that reward their employees:  a tax break that goes only to corporations that raise their employees' wages, for example.

¹ Generally speaking, the tax gap is the difference between the tax burden owed and tax liabilities acknowledged and paid and thus provides some understandable standard for judging trends in compliance by taxpayers with their federal tax obligations. It is calculated periodically by the IRS and published on the website.  See The Tax Gap;  IR 2019-159 (Sept 26, 2019),  The 2019 document provides estimates for tax years 2011 through 2013 and shows an estimated average gross tax gap of $441 billion per year which, after enforcement efforts and late payments, yields a fibure of $381 billion a year.

² See, e.g.,  Lola Fadulu, Study Shows Income Gap between Rich and Poor Keeps Growing, With Deadly Effects, New York Times (Sept. 10, 2019) (summarizing research from the U.S. Government Accountability Office in August 2019 entitled Retirement Security: Income and Wealth Disparities Continue Through Old Age);  St. Louis Federal Reserve Bank Open Vault Blog, What Wealth Inequality in America Looks Like: Key Facts and Figures (Aug 14, 2019) (showing income distribution from 1989 to 2016 (before the impact of the highly distortive 2017 tax legislation) skewed to favor the top 10% of income earners at the expense of the bottom 90%).

³ See, e.g., Amelta Josephson, What is the Wealth Gap?SmartAsset.com (Jul 23, 2019) (noting that the CBO's 2013 wealth data showed a figure of $67 trillion for total family wealth, with the top 10% of families holding 76% of that total wealth (and having incomes of $942,000 a year or more).

⁴ See, e.g., Institute for Policy Studies, 2015.

⁵ See, e.g.,  Pedro Nicolaci da Costa, America's Humongous Wealth Gap is Widening Further, Forbes (May 29, 2019). Noting that "distribution is everything" in response to proclamations that the economy is healthy because of stock market trends or eomployment numbers, the article states that "a steady economic expansion and historically low jobless rate can mask deep inequalities in income and wealth that leave American families in vastly different financial situations."  It relies on a recent Federal Reserve Bank (Fed) report that shows that the poorest 50% are "getting crushed" by "rising inequalities."  The increase in net worth since 1989 (growing almost 4X the prior figure) has accrued mostly to the top of the distribution, with the bottom 50% seeing essentially zero net gains in wealth over 30 years.   Figure 2 from the article is duplicated below.

 -- via my feedly newsfeed