Calling The Bailouts Profitable Is Dishonest

Politico published a piece this week by ex-Geithner ghostwriter Michael Grunwald extolling the virtues of large banks and dismissing legislation that seeks to end “Too Big To Fail” (TBTF) as crackpot hysterics. If you’re going to argue in favor of TBTF, then you have come up with reasons why we should be grateful for JPMorgan and Bank of America. To that end, kudos to Grunwald for not backing down. We have mega-banks to thank for swallowing the Bear Stearns and Washington Mutual’s of the world, for financing global mega-projects and mega-mergers (yay!), and for giving reckless traders the opportunity to lose $6 billion in a day. The problem, Grunwald says, is not size, but leverage, and on that end Dodd-Frank and Basell III’s more stringent capital requirements are working. Interestingly, Grunwald’s proof is a link to another article he authored. It summarizes a Government Accountability Office (GAO) study that shows waning expectations of government support, though it has nothing to say about capital requirements. Perhaps I wasn’t supposed to click on it.

At a later date I might offer an exhaustive critique of Grunwald’s TBTF defense. For now, I’d like to address a oft-mentioned claim that sneaks into the middle of the piece, namely that the financial bailouts turned a profit for taxpayers. Here, like before, Grunwald links to a self-authored piece from 2010 that doesn’t really defend the profitability point he’s trying to make. At the time of his 2010 writing, it was being widely reported that the federal government had returned $25 billion in profit on the first $300 billion that banks had paid back. That made for a great talking point for bailout apologists. However, as some commentators made note of, the biggest loans hadn’t yet been repaid, and it was possible that when all was said and done the federal government would lose money. It just so happens that all is now said and done, and while the bailed out banks have returned more nominal dollars then were lent to them, the supposed bailout profit dwindled to $15 billion.

Despite his shady use of hyperlinks, Grunwald is likely aware of the $15 billion figure. That sounds like a lot of money until you compare it to the $426 billion the federal government injected into bailed out companies. Compared to the size of the bailout, the federal government over six years received about a 3.5% cumulative return. That means their investment yielded a 0.57% return every year. Moreover, those figures are nominal, so the real return is even smaller. I suppose you could still stick to the $15 billion figure because $441 billion is indeed more money than $426 billion, but calling it profitable is a stretch. Would anyone consider it profitable to lend someone $10 today, only to be paid back $10.35 in 2021? Of course not. The bailouts can still be defended if it runs at a loss to the federal government – after all the government’s responsibilities extend well beyond making money – but it’s lazy and irresponsible to pad those arguments with eye-grabbing claims about how it turned a profit for “taxpayers”.

Taking Supply Chains Seriously

Now that I have gainful employment I’ve transitioned from renting books at the library to purchasing used ones online. Internet retailers are cool for nerds because they allow you to track in real-time the geographic movement of your package. The last book I bought, for example, started somewhere in the Northwest, was shipped to a DHL eCommerce facility in Auburn, WA, was then loaded onto a plane to be flown across the country to another DHL facility in Franklin, MA, after which DHL tendered it to the local post office in Franklin, who then drove it about 40 miles northeast to a post office in Brookline, MA where it was finally sorted and delivered to my doorstep. The whole process took about six days. Judging by the intricate journey traveled it probably involved the coordination of hundreds of workers. Did I mention that I paid $3 for the book with free shipping?

There’s nothing unique about the delivery route described above. Millions of packages make similar trips everyday. Many of the most profitable businesses in the world rely on complicated logistical networks to produce and deliver goods that workers produce. In industry parlance the combination of production centers, shipping routes, insurance contracts and finance capital necessary to sustain the system is called a supply chain. Supply chains are the pulse of the global economy. As such, they occupy a strategic battlefield for organizers intent on wrestling power away from capitalists and into the hands of workers.

A sophisticated global supply chain’s impact is greater than the convenience it offers wealthy consumers or the profits it yields business; it also introduces several degrees of separation between the purchasers of consumer goods and the workers who produce them. In a wonderful feature – the sort of stuff viewers can reliably expect from him – John Oliver explores the many ridiculous ways this separation manifests itself in the clothing industry:

TL;DR – The cheap clothes Americans love to buy and discard frequently are the product of especially exploitative labor conditions in countries like Bangladesh. Every once in a while, something so ghastly happens that it captures the attention of Western buyers. This leads to pressures on corporations selling these clothes (GAP, H&M, Zara, etc.) to introduce less inhumane standards in the factories they source from. To that end, they have failed utterly and completely.

Global supply chains give business a veil to hide behind. Wal-Mart, for example, doesn’t own or even manage the factories in poor countries that manufacture Wal-Mart products. Instead, their warehousing and production needs are contracted out to companies who often subcontract work to other companies, and so on and so forth. What Wal-Mart does do is use their market power to squeeze subcontractor’s margins, and in so doing encourages lower wages and more dangerous workplaces. Consumers get cheap goods, laborers in poor countries get long hours in factories without fire extinguishers, quid pro quo.

What can people not complacent with sweatshop labor subsidizing their well-being do to alter this balance? What might a strategy that makes corporate behemoths more vulnerable look like? Research suggests that power resides in the subcontracting relationship. In her 2010 book Labor Rights and Multinational Production, political scientist Layna Mosely argues that “the ‘mode of entry’ employed by multinational corporations (MNCs) has important – and under-theorized – consequences for workers’ rights and working conditions”. Her argument extends the distinction between “climbs to the top” – where foreign direct investment (FDI) raises productivity and wages – and “races to the bottom” – where trade competition puts downward pressure on labor rights – by suggesting that how MNCs structure their production networks in poor countries impacts how laborers collective rights. Her empirical work shows how countries that receive production from MNCs that is offshored (via FDI, owned by MNC) have higher labor standards than countries integrated in the global economy through outsourcing (subcontracted facilities, not owned by MNC).

The intuitive explanation for Mosely’s findings is that MNCs are more accountable for working conditions when they own the facilities manufacturing their products. Subcontracting, on the other hand, allows MNCs to pass the buck to small factory owners in other countries. Even if GAP tries their hardest to clamp down on abuse in Bengali factories producing GAP jeans, they can only do so much. Or so they say.

The offshoring/outsourcing division has become extremely relevant for labor advocates in this advanced stage of global capitalism. Fast food workers in the United States are facing an analogous situation in the form of franchising. Battles over ownership structure determine the field labor struggles are fought on. It’s high time for the Left to take that battle seriously.

What Does It Mean To Be A Welfare Queen?

Ask my father’s generation what it means to be a ‘welfare queen’, and perhaps they will reference the infamous Linda Taylor, who reportedly “used 80 names, 30 addresses, [and] 15 telephone numbers to collect food stamps, Social Security, veterans’ benefits for four nonexistent deceased veteran husbands, as well as welfare.” The subset of America being referred to is clear. Welfare queens are poor, black women with a heightened proclivity to trade pregnancy for welfare benefits. They are parasitical, producing nothing of value while taking gratuitously from the public coffer that the hardworking fill. Irrespective of job market participation and by the virtue of occupying a particular space in the distribution of ownership and goods, they are lavished with material things. The welfare queen is a textbook rent-seeker.

The conservative strategy of invoking variants of the welfare queen to drum up political support among whites is well-documented. Perhaps hopeful that white support rested more on tax fairness than on racial animosity, the left has appropriated ‘welfare queen’ for its own purposes. Instead of targeting poor, black women, the left increasingly uses ‘welfare queen’ to indict very large businesses that pay very low wages. Because welfare programs are designed to ensure some basic level of welfare, government covers the difference between wages and that basic level. Wal-Mart employees, for example, rely on $2.66 billion in government assistance every year. Absent these programs, the Walton family would have to pay laborers a wage sufficient for reproducing their labor. Thus in effect, welfare programs allow business to lower their labor costs without any corresponding fall in labor supply. Just like the (imagined) welfare queens of yesteryear, Wal-Mart captures an effective rent.

It may seem counterintuitive that subsidies granted to workers can be captured by non-workers, but ‘tax incidence’ (as the phenomenon is referred to in the academy) is an established economic reality. Underlying the theory is that more important than who a tax or subsidy is levied on is how sensitive quantities supplied and quantities demanded are to price changes. If you absolutely need to eat exactly one apple per day to continue living, then the quantity of apples you consume will not change when the price of apples increases tenfold. Similarly, if government levies a tax on apple producers to the effect of $1 per apple, apple producers will raise their price by $1 and consumers will shoulder the entire tax burden. This is true whether the tax is on producers or consumers. It’s a hyperbolic example, and it doesn’t consider income, but you get the picture.

We can understand the ‘welfare queen’ argument by applying tax incidence to the labor market. Below is a generalized graph of the labor market and how it responds to the Earned Income Tax Credit* (EITC), where S(w) shows labor supply pre-EITC and S'(w(1+e)) shows labor supply with EITC accounted for (EITC benefit = e = (w + e) – (w’)).


The graph shows us two things. First, (w+e) > (w), meaning the EITC increases the wages of workers it directly affects. Second, (w) > (w’), meaning the EITC lowers the wage businesses pay affected workers. Whereas previously business paid the ‘initial wage (w)‘, they now pay only the ‘market wage with employee subsidy (w’)‘. Workers received a subsidy, and so does business.

Thus, it appears there is some truth to the left’s appropriation of ‘welfare queen’. For equivalence, it should be noted that low-wage workers, to whom the EITC applies, also receive a benefit, lest we turn public opinion against programs that reduce poverty.

*I use the EITC because its a direct wage supplement. Programs like food stamps probably allow for big business to pay workers less, but those programs affect the shape of the labor supply curve (more elastic) rather than shifting the curve.                                                               **I should preface this entire post. Tax incidence assumes a baseline that doesn’t exist. Government doesn’t levy the EITC onto the labor market because the labor market doesn’t exist without government. The EITC is part of a larger set of institutions that establish what the distribution of resources is. Economic populism – to which ‘welfare queen’ belongs – is useful, but the arguments are hardly ever intellectually coherent.

The Imperial Presidency Examined

Texas Senator Ted Cruz, gentleman and scholar, penned a glorious op-ed in the WSJ following President Obama’s State of the Union address. As can be expected with Cruz, the piece was more timely hyperbole than reasoned critique. His thesis, that the Obama presidency’s most dangerous aspect is “his willingness to disregard the written law and instead enforce his own policies via executive fiat”, relies on a series of executive orders – hiking the minimum wage for federal contractors, deferred action, and choosing to not uphold the unconstitutional Defense of Marriage Act. Like any great conservative polemic, the argument is strong on procedural warnings of a despotic future and weak on historical accuracy.

Because I care for my weak readership, I put the 44th president beside his predecessors as it relates to their proclivity for executive action.

ImageThe graph depicts executive orders per year – a principal form of executive action – by presidential administrations since Grover Cleveland. Unilateral action peaked with Calvin Coolidge and FDR and since then, short of a brief surge by renowned anti-imperialist Ronald Reagan, has continuously decreased. If, as Cruz suggests, executive action is a measure of Constitutional adherence, President Obama holds up well comparatively.

For what it’s worth, I generally believe, as others have put forth, that procedural arguments surface only to mask substantive disagreements. Instead of a policy debate on whether federal contractors should be guaranteed $10.10/hour, we get handwaving over the President’s decision to avert further negotiations with history’s most unproductive Congress. Cruz speaks directly to this, admitting “Mr. Obama may be right that some of those laws should be changed”, but that “the typical way to voice that policy disagreement, for the preceding 43 presidents, has been to work with Congress to change the law.” The graph above shows that Obama works without Congress less than any other president of the 20th and 21st century, and we all know Cruz doesn’t believe Obama is right about laws being changed. But, of course, if Cruz had to engage the President on policy, then he would have to deal with the 71% of Americans that support raising the minimum wage. It’s quite obvious why we get procedural posturing instead.

The Poverty Rate is Nonexistent

In my last post, I made the argument that references to pre-tax income are incoherent because pre- and post-tax income are indivisible. Tax structures carry with them a long set of incentives that determine the pre-tax income the same tax structure is set upon. Making adjustments to the tax system thus changes both pre- and post-tax income. Government and taxes are equally indivisible, so short of a counterfactual with pre-government society compared against modern reality circumscribed analysis commits the era of fetishizing the current contrived distribution.

Shortly thereafter, it came to my attention via The Facebook that my philosophical musings were cute, yet irrelevant. Or, so the criticism went, which was hilariously followed by a textbook pre-income fetishization about the true purpose of taxes, namely to maximize economic output given pre-tax income. With my youthful arrogance restored, I thought I would take the time to provide a real life example of how we consistently misunderstand the nature of taxes and the distortions of public policy that ensue.

Enter the official poverty rate, courtesy of the Census Bureau. For the past 40 years, the US Government has calculated a poverty rate through a set of income thresholds varying by family size and composition. Income is constructed to include private earnings, transfers, and public cash transfers (Social Security, unemployment insurance, disability insurance etc.). Noticeably absent are noncash transfers like food stamps, Medicare/Medicaid, and housing subsidies that function as cash equivalents*. Further, the rate is calculated before taxation. Because so much distribution takes place through the tax code** in the form of tax credits, the official poverty measure – using the same income thresholds – overstates the ranks of the impoverished. Consider the following graph – taken from Wonkblog – which shows the official poverty rate and a newly minted alternative rate that includes the aforementioned in-kind transfers and post-tax incomes:

The graph shows a sizable disparity between pre- and post-tax/transfer poverty rates. Further, the disparity increases post-2007 recession, which I would hypothesize to be the effect of greater unemployment insurance expenditures. So, what are we to make of all this? The more conservatively-inclined observers might respond with accusations of liberal dishonesty, downplaying the severity of poverty in America. After all, even the poor have refrigerators. To those who are actually interested in eradicating poverty however, the graph confirms a fundamental belief: government transfers lift people out of poverty!

Moreover, the noble lie that permeates the official poverty rate is that pre-tax income is something that can be isolated and measured. But, as we know, tax systems – particularly robust ones like the US’s – come with incentives and disincentives towards specific forms of accumulation. When ‘pre-tax incomes’ are realized, they are done so under the assumptions of the prevailing tax system. Trying to find a poverty rate that doesn’t include the full effect of government is searching for the nonexistent, it puts the cart before the horse. My friend was wrong when he wrote off the distinction as unimportant. The poverty rate is symptomatic of a view that disassociates the private from public so that the public intervenes to correct market failure. We need a more systemic approach that considers public and private as inseparable parts of a larger thing with you and I at the helm. Then, perhaps the folks who truly care about poverty will accept the most basic and unexciting solution of all.

*Noncash transfers are essentially cash such that if we distributed $200 in cash instead of $200 worth of food stamps, the recipient would spend that money on food. If you plan on spending $200 on food per month, it doesn’t matter whether you receive it as an in-kind transfer or as paper money. Of course, it is possible that the in-kind transfer exceeds the amount the recipient would spend on the good absent the in-kind transfer.
**Earned Income Tax Credit, Child Tax Credit, and Homeowners (extremely regressive) being the big ones. Check out The Submerged State for a more holistic picture.

How To Think About Taxes

Nothing in this world can be said to be certain, except death and taxes, so the adage goes. A quick observation of modern political debate brings forward a host of issues whose controversy can be reduced to differing tax philosophies. The conventional wisdom considers taxes to be the means through which government funds public programs. To this category goes national defense, welfare programs, and education, to name a few. Solidifying the conventional wisdom is the circus around the dreaded national debt, where one’s political disposition can be deduced from support of either reduced spending or increased taxes.

Believe it or not, while funding public programs is an important characteristic of taxes, it is hardly its sole feature. For instance, the taxing authority is also used to regulate economic growth. In times of excessive growth, governments issue new taxes to quell consumer demand and inflation. Conversely, during recessions, governments provide subsidies (negative taxation) to struggling economic actors in a bid to increase demand and national product. Alternatively, it has long been recognized that market equilibriums – prices and quantities absent government intrusion* – do not always reflect social goals, at times either producing too much or too little of some good. Private actors internalize private costs when making decisions and disregard the concurrent external cost their action imposes on society. For example, the amount of gasoline you consume is primarily a function of its market price, although the true price of gasoline consumption factors in pollution and accordingly is much higher. In light of market prices that do not reflect social prices, governments may issue taxes/subsidies to nudge consumer behavior towards the social optimum (i.e. carbon tax).

Lastly, and the feature all too often forgotten, is the function of taxes as a distributive tool. Truly understanding the enormity of taxes as a distributive tool requires a bit of abstraction. It directs us toward the grandest of counterfactuals, namely what would individual welfare (well-being) be in absence of government? The easiest – and in my opinion accurate – conception of society minus government refers to Hobbes “state of nature” as expressed in his seminal Leviathan. In the “state of nature”, humankind finds itself in constant war with each other, unable to agree upon issues of morality and justice. Welfare is low if at all existent, and even then solely a function of brute force. When establishing the distributive implications of taxes and government, we can use the distribution of resources in the “state of nature” as our baseline. Compared to our baseline, it so follows that barring enslavement the rise of government and taxes makes all persons better off.

For the counterfactual to be at all useful however requires us to explore what the “rise of government” implies. Perhaps the most integral feature of government through which it accrues power is its ‘monopolization of violence’. Through claiming violence, government affords itself the exclusive right to establish the rules and regulations of the society it presides over. For example, that which an individuals can claim dominion over – his/her property – becomes meaningful only to the extent that the sole disposer of violence will acknowledge and protect it. You may have the most intricate philosophical arguments for why the schools rightfully belong to students, but unless you can prove your case before a court of law, realizing your claim to ownership is a fantasy. If in the “state of nature”, students pool their capacities to lay forceful claim to the object of their desire, though their maintaining ownership would be highly tentative, then the “rise of government” distributes ownership of schools away from students and towards some other entity.

Taxes as a distributive tool are best understood under this rules and regulations framework. The market allocation of goods requires a functioning market, which in turn requires a strong property rights framework, the only source of which is government. Contrary to the romanticized story you received in your introductory microeconomics class, markets are fundamentally a creation of government. That said, we can only conceive of government in conjunction with taxes, for how else would it pay for protective services? The intuitive tendency to consider markets as neutral distributors and government/taxes as redistributors falls flat upon itself when we realize that markets are an effect of government. Therefore taxes, as an inseparable feature of government, serve coincidentally as a distributive tool of government.

Accepting taxes as a distributive tool has serious implications for the aforementioned political debates. Taxes are no longer reduced to “who can pay for this public program?” Instead, we adopt a systemic view whereby taxes help determine the resources individuals lay claim to. A tax rate on capital half that of labor may suffice to pay the bills, but it equally determines to whom national income is directed. For whatever distribution we desire we establish taxes that orient resources from some individuals and towards others. Taxes take on a justice component when it is recognized they determine who gets what.

Public Services Losing Money? Good.

In our modern, mixed-market economy, the goods and services we consume are largely provided by either private firms or government. Within the former, think of your last trip to the bookstore, and within the latter, if you are like me, the T you took to get there. A lot of pop commentary holds the two providers of goods and services to the same standard. Why should bureaucrats have the privilege of running an unprofitable business indefinitely, often with great barriers to competition?, you might ask.

Well, the answer is really quite straightforward. Public services exist to close some gap the private sector – left to its own accord – does not rectify even when fulfilling its highest potential. Private firms set a price to maximize their profits, but it makes no guarantee that price is within reach to all or even a majority of consumers. So it goes, we cannot all buy designer clothes. But, as is obvious, the private sector produces things much less conspicuous than leather jogging pants.

Take for example urban transportation. Left to itself – and for the time ignoring the logistical nightmare private subways would entail – private transportation firms will devise some system of buses/trains/etc. throughout a metro and set prices accordingly to maximize profit, given some demand for transportation. Suppose it is financially feasible for 70% of the city population without access to personal transportation to afford the market price for urban transportation. One, that would be really impressive. Two, 30% of the folks reliant upon transportation other than a personal automobile are left stranded on the East Side from job opportunities on the West Side.

Enter government. Given some mandate to make decisions (democratic, theocratic, autocratic), government recognizes the need for cost-accessible urban transportation, claims the exclusive right to operate an urban transportation system, and builds a series of bus and rail lines to best serve the needs of its clientele. Notice the intentions motivating government (need for cost-accessible service, and need to serve constituents) and notice what is not included (need to maximize profit).

After the infrastructure is built, government has to decide at what price – if any – to operate at, and how to plug the gap between revenues and expenses. For the case of public transportation, two issues are worthy of consideration. First, the public transportation system presumably complements other forms of private transportation, and they work together as the city’s circulatory system. You want people to get from A to B as quickly as possible for efficiency reasons. Game theory shows us more isn’t always better in this regard, so it is best to act wisely and strategically. Second, public transportation has to fulfill its primary goal of being affordable. If affordable transportation is indeed something the private sector cannot provide exhaustively, that price will be lower than what the private sector would charge and may be lower than what is necessary to break even.

STOP! yells the fiscally conservatives, socially liberal yuppie. How can a business be ran at a loss, short of robbing citizens of their hard-earned income? Well, we could issue municipal bonds, but the interest rate would surely be too high to be a solvent plan, so we’ll do just what Mr. Yuppie fears most: we will expropriate a portion of the product of Mr. Yuppie’s expropriation. Because we must appear reasonable, we will call said meta-expropriation taxes. Of course, because taxes come from the city residents and public transportation is open to the public it may be that the individual’s tax liability eradicates any surplus gain the lower ticket price affords. But, as we saw earlier, usage of public transportation disproportionately comes those without affordable access to cars. Those people tend to be poorer and because their use is disproportionate, they receive in value more than they pay in taxes. Conversely, wealthy folks who drive to work pay more into the pot than they withdraw, allowing the city to break even. Add in a progressive income tax and the effect is multiplied.

Voila, we have managed to provide affordable transportation to everyone in the city, run a business at a loss, and live to see another day. Next time someone dishes out the classic “What if business tried to operate like government?”, you can retort “They would fail, and people on the East Side still wouldn’t be able to commute to their jobs on the West side.” Public services are supposed to lose money, otherwise they wouldn’t be public. Government has at its disposal a very powerful distributive tool in the form of taxation, and its finest days are those when it uses it to help the people the market leaves behind.