Reid Reminder: Electoral Paradox

Last week, Senator Harry Reid (D-Nevada) reminded us why we need to "throw the bums out." During a debate over the teacher/first responder bill (S. 1723), Reid observed:

It's very clear that private-sector jobs have been doing just fine; it's the public-sector jobs where we've lost huge numbers, and that's what this legislation is all about.

Yes, he really said that. Reid went on the record and stated that the pace of job creation in the private sector is "just fine."

The last time I checked, we had a 9% headline unemployment rate, and a 16-20% effective unemployment rate. The 16-20% effective unemployment rate is an unofficial number which includes people who are too discouraged to continue seeking work. For Harry Reid, 9% headline unemployment and 16-20% effective unemployment is "just fine."

Reid's comments aren't particularly shocking. He makes airhead comments all the time. But that's no excuse. Why do we have such diminished expectations for our political leaders? We should not have to tolerate a Senate majority leader who projects such an air of incompetence. His own party should have demonstrated some common sense years ago and delegated Reid to the back benches. Let's prioritize leadership over seniority until we emerge from this period of economic malaise.

Reid apologists will argue that I'm taking his comments out of context. He was contrasting recent employment data in the private sector against similar data regarding state and local government employees. He was tilting at "obstructionist" Republicans who oppose more federal spending on state and local services. Blah blah blah. It was an airhead comment, and it projects an air of incompetence, regardless of political motivation.

I'm not just picking on the invertebrate* Harry Reid. Harry Reid is symbolic of a problem that has been festering on Capitol Hill for decades. It's not a problem with the Republican party or Democrat party; both parties share the blame for bad policies and incompetent leadership over the years. It's a structural problem baked into the U.S. electoral system itself. (*Credit to tax fashionista Lee Sheppard)

The problem is that our members of Congress are, for the most part, unaccountable for their actions as legislators. I won't digress far into PolySci 101. Suffice it to say that the deck is stacked in favor of incumbent legislators. Critically, incumbents can control or influence federal spending in their districts. Federal spending sometimes translates into permanent jobs (think military bases). Local constituents can sense where their bread is buttered, even if a given legislator is failing the country as a whole. Special interests trade campaign donations and elector muscle for direct or indirect legislative perks. Legislative districts are gerrymandered to maximize political support for one party or the other. The list goes on.

Because the deck is stacked in favor of incumbents, we get an Electoral Paradox. Depending on the poll, roughly 80 to 90 percent of Americans disapprove of Congress. Nearly 80 percent of the country believes that we're on the "wrong track." But paradoxically, local constituents continue to re-elect their incumbent members of Congress, cycle after cycle after cycle. Even in 2010, when the Tea Party energized a backlash against political incumbents from both parties, incumbents prevailed in an large majority of electoral contests. The American public is enormously disgruntled on a macro level, but doesn't hold incumbent legislators responsible on a micro level.

As a result of the Electoral Paradox, our nominal democracy has become a political oligarchy. We have a cadre of career politicians; men and women who are focused primarily on their individual re-election campaigns. Their secondary focus involves jockeying to create internal and external alliances and other legislative accoutrements (committee appointments, etc.) that support their primary focus on re-election. They are effectively neglecting the long-term interests of the country to pursue short-term agendas that "refresh" every two to six years.

We're emerging from a financial crisis that prompted the worst economic downturn since the Great Depression. The political class has attempted to pin the sole responsibility for the financial crisis on Wall Street. (To be fair, politicians on the left are more vocal advocates of this view. They also blame "de-regulation," despite the fact that the banking industry was highly regulated. But sheer volume of regulation is not the same as prudent and effective regulation.)

In reality, the financial crisis originated when the U.S. real estate bubble popped. The real estate bubble was fueled by government policies that distorted traditional lending practices. That problem was compounded by lax regulation of mortgage origination practices and feeble regulation of banks and other financial institutions. On both counts, legislators share culpability with Wall Street financial engineers. Politicians took the credit for a bubbly economy driven by the housing bubble. They scattered like cockroaches when the bubble popped and a vicious de-leveraging cycle ensued.

Congress has a responsibility to pilot the U.S. economy around financial crises. Individually and collectively, members of Congress failed to live up to that obligation. Political incumbents should acknowledge that they contributed to the financial crisis, accept responsibility, and pass the political reins to a new class of legislators. Instead, a majority of the political oligarchs have clung to power. Chuck Rangel, Henry Waxman, Barney Frank, and their senior colleagues on the political right, should not be able to look themselves in the mirror. The fact that they continue to influence legislation -- despite their abject failure as trustees of the American economy -- should make us all shudder. With some exceptions (e.g., Chris Dodd), these men and women have chosen to ride out their political careers in disgrace.

One Job Saved?

Obama's much-hyped speech outlining the "American Jobs Act" did not seem to resonate with anyone except this guy and this guy on YouTube. His cheerleaders on the political left questioned why Obama would rely so heavily on tax cuts, given the "obstructionist" bent of Congressional Republicans. His critics on the political right questioned why another round of temporary stimulus proposals would translate into net, long-term employment gains.

Various observers suggested that Obama's speech was primarily intended to launch his 2012 election campaign. He framed the stimulus proposal as a "silver bullet" that would create millions of jobs and reduce unemployment. A cynic would argue that he is mainly trying to save one job: his own.

The total cost of the new stimulus proposals is estimated to be $447 billion. How would that get "spread around"?

[1] The proposal would pump $175 billion into the private economy by cutting employee payroll taxes in half in 2012. This measure should be politically popular, because most working Americans will benefit, temporarily, from the payroll tax holiday. But we've been down this path before. Like a night of hard drinking, a temporary stimulus might be fun while it lasts. But the next day, or the next year, we'll wake up with a hangover. One "temporary" stimulus leads to the next (the "hair of the dog") and the next, and the next. President Obama (the politician) is perfectly happy to kick the can down the road. The rest of us see a looming budget crisis and desire a permanent improvement in the conditions to economic growth.

[2] The proposal has $62 billion in targeted spending intended to help the long-term unemployed. Most of that ($54 billion) involves a series of fuzzy changes to the unemployment insurance system, including a $5 billion "pathways back to work fund." Although not broken out, I'm guessing that a big chunk of the other $49 billion simply represents an extension of unemployment assistance.

The $62 billion also includes a tax credit of up to $4,000 for hiring workers who have been looking for a job over six months (projected cost of $8 billion). Although the price tag is low, this type of credit is frustrating tax policy at its worst. Very few (if any) managers or business owners would hire new employees for a $4,000 (or smaller) credit. The credit would primarily be a windfall to businesses that were otherwise intending to hire employees (so no stimulative impact). It would create an additional audit burden for the IRS, which is already overwhelmed by new responsibilities enforcing social programs. As such, it virtually invites fraud and abuse (which plagues all these ill-conceived stimulus efforts). Perversely, it does not reward employers that have struggled to retain employees during the Great Recession.

[3] The proposal includes $140 billion in "stimulus" measures, including $35 billion for "teacher rehiring" ($30 billion) and "first responders" ($5 billion), $30 billion for "modernizing schools," $50 billion for "immediate surface transportation," a $10 billion "national infrastructure bank" and $15 billion for "neighborhood stabilization."

The $50 billion in transportation spending is infrastructure spending that should be part of the regular Congressional budgeting process. We need first-class infrastructure if we are to remain a first-class global economic competitor. The funding mechanism should be part of the regular Congressional budgeting process.

The state grants for "rehiring" and "modernizing schools" represents a bail out for undisciplined state governments. State governments do not need federal funding to address local education and security objectives. They need to prioritize state and local spending on education and security over other spending measures. For example, if a state legislature cannot adequately fund teaching salaries, the state could impose cuts on other state employees (or other spending programs) and allocate the "savings" to the teachers.

[4] Finally, the proposal involves $65 billion in payroll tax cuts for employers (and $5 billion to extend 100% bonus depreciation into 2012). The main thrust of the proposal involves: a cut in the "employer portion" of the payroll tax from 6.2% to 3.1% in 2012; and a full payroll tax holiday for any expansion of payroll up to $50 million above the prior year. These proposals suffer from the same defects as the employee payroll tax cut and the $4,000 hiring tax credit. They are short-term in nature, are unlikely to "stimulate" hiring, and would primarily result in windfalls for businesses in growth mode.

President Obama's stimulus plan (ahem, "jobs bill") may save one job and get him re-elected. But its mix of short-term incentives and bad tax policy measures has failed before. Our political leaders should be focused on regulatory and tax reforms that will encourage private business investment and result in long-term employment opportunities. Short-term stimuli may appeal to a sitting President, but the rest of us will have to live with the hangover.

Repatriation Holiday Part II: The Horror Continues

As the U.S. economy recovers from the Great Recession, U.S.-based multinationals continue to build large cash balances offshore. Some U.S. pundits and politicians view the offshore cash as a "holy grail" of economic stimulus. They propose a sequel to the "repatriation holiday" that Congress enacted in 2004. From a policy perspective, the original act was a bust. Let's hope that reason prevails, and Congress doesn't release the sequel.

(This will be a relatively short blog on a complicated topic that requires further elaboration.)

Tonight on CNBC, Larry Kudlow discussed a proposed repatriation holiday with Andy Stern, Former SEIU President, and Bob Lutz, Former Vice Chairman of General Motors. Interestingly, Stern -- a national Democratic figure -- argued in favor of a repatriation holiday, while Lutz -- a career industrialist -- argued against a repatriation holiday.

Stern's basic argument for a repatriation tax holiday is that 'it can't hurt to flow a trillion dollars back into the United States from offshore balance sheets.' He favors a holiday now because (i) it will probably create some U.S. jobs directly, (ii) it will help some multinationals shore up underfunded U.S. pension plans, and (iii) although much of the cash may be used for dividends and share buybacks, some of the dividends/buybacks will be taxable, increasing tax revenue to desperate federal, state and local governments.

Lutz argued that the 2004 holiday failed to stimulate the economy or create jobs. Moreover, Lutz noted that the 'trillion dollar' figure is an exaggeration. On that point, Lutz emphasized that the "strings attached" to a tax holiday would deter many corporate executives from repatriating cash. (A current proposal, H.R. 1834, would effectively penalize corporations that repatriate cash without maintaining existing U.S. employee headcounts.)

I'm on Lutz's side of this policy debate. The 2004 holiday was a total bust. Two points escaped policymakers in 2004:

First, cash is fungible. Although multinationals repatriated cash to the United States, they did not use the "offshore cash" to expand their U.S. business activities. They shored up pensions, and they increased dividends/buybacks, but those uses of cash did not have a stimulative impact on the overall economy. (Technically, a multinational that repatriated cash was required to implement a "domestic reinvestment plan" or "DRIP" to document use of the cash within the United States. Economic analysis suggests that the DRIPs were droops.)

Second, a huge amount of offshore cash was (and is) controlled by multinational tech and pharma companies (think Cisco, Microsoft, Pfizer). Although the tech and pharma industries are robust engines of growth, they have low external leverage ratios and are not cash constrained in the United States. If they want to build factories or hire employees, they have existing sources of financing to achieve those objectives.

Unlike the tech and pharma industries, America's small- and mid-size business managers are not sitting on buckets of offshore cash. Another repatriation holiday may have some indirect benefits for these businesses, but no direct benefits. It's simply not the "holy grail" that its advocates would suggest.

We need fundamental corporate income tax reform, including lower tax rates on all business income. A tax holiday would make reform more difficult, because repatriation is a significant lever in the overall policy debate. Let's hope Congress leaves the sequel to 2004 on the cutting room floor.