my doxy

Orthodoxy is my doxy; heterodoxy is your doxy.
--William Warburton

Commentary on politics, finance, and sometimes other tidbits when I can't restrain myself.

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Saturday, January 11, 2003

Milton Friedman's dividend tax alternative

I don't generally expect to agree with Milton Friedman on policy issues, as our philosophies differ quite a bit, but if this description of his views in Gene Epstein's column on the Bush tax proposal in the January 13 Barron's is correct, I completely agree with him on the following:

"Milton Friedman describes a much fairer approach: Abolish the corporate income tax, whicle taxing interest income to bondholders at ordinary rates. And require stockholders to pay a personal income tax on their pro rata share of the company's earnings, regardless of how much is paid as dividends and how much retained."

This is essentially the same way that S corporations are currently taxed. The main argument against this was that accounting for the phantom (reported but necessarily received) income seemed like a pain, but compared to the problems in accounting for how much US corporate tax was paid on the earnings being paid as a dividend or, worse, embedded in a capital gain over an arbitrary number of years, as the Bush proposal would require, it seems like a walk in the park, and has the advantage, as one would expect of a proposal by Prof. Friedman, of being economically defensible.

It would also make shareholders less willing to let corporations reinvest earnings, which based upon historical observation is probably all to the good. Under the Bush plan and the current system, shareholders have an incentive to prefer corporations keep their excess cash, which they hope will morph into lightly-taxed capital gains. Unfortunately, cash hoards tend to be converted into unsuccessful expansions or dumb acquisitions--what Peter Lynch calls di-worse-ification--as corporate managers tend to prefer increasing the size of their domains to maximizing shareholder returns.

Sunday, January 05, 2003

Why oil prices aren't so interesting

As promised in the previous post, a short discussion of why oil prices are less important to the US economy than some people seem to think they are. (I may be referring to people who seem to think that taking over Iraqi oil fields would be an economic boon to the US.).

The US uses about 20M barrels of oil/day, or about 7300M barrels/yr. This means that a $10 increase in crude price increases the price of crude by $73B. That sounds like a lot of money, and it is. But remember a few things:

1) About half of that is a transfer inside the US--primarily from the Northeast and drivers to oil companies. It shouldn't be expected to have a major impact on overall economic activity.

2) High crude prices tend to depress refining margins, so the oil companies tend to give some of it back to consumers.

3) The US economy is really big. GDP is more than $10000B/yr. The US merchandise trade deficit in 2002 hasn't been released yet, but it was certainly over $400B. The deficit for fuels (mostly oil) was probably about $100B. It isn't plausible that the $10/barrel change of $35B-$40B would make much difference to the US economy.

4) People may be confused because it used to be more important. In 1978, (not chosen at random) US oil use was almost as high as it is today--about 18.5M barrels/day, but the GDP was only about $2300B. Oil was around $14/bbl, soon to double. That amounted to a $94B hit, or almost 4% of GDP (actually it was a bit less, as consumption declined, but close enough). To get a 4% hit today, you would need more than a $50 change in the price of oil.

So while lower oil prices would be a net positive for the US (and would deprive certain odious regimes of income, which wouldn't be a bad thing either) it probably wouldn't have an very noticible effect on the US economy, and hence shouldn't be expected to be a major stimulating factor in 2003.

My New Year's blog resolution is to get one article posted each week. That may not happen, but here's one for this week.

US unemployment will almost certainly rise in 2003.

I don't have any very profound reason for believing this--it is pretty obvious. However, if it isn't yet obvious to you, you might want to read this.

  • The world economy stinks.

    On the same day that the ISM report was released, a truly awful report was released from Germany, and the rest of Europe doesn't look all that much better. Japan isn't recovering, and although it may start to clean up its sick banks, that isn't going to be over with soon enough to help much with this year. With slack throughout the world, any increased demand in the US will be diffused throughout the world economy, reducing its effect in the US.

  • US data doesn't currently support the idea of a strong recovery this year.

    The best indicators I am aware of for this are published by the Economic Cycles Research Institute. Their leading indicators show us skirting a second recession, but there is nothing there to indicate that we will be doing any kind of rapid growing either.

  • State governments are really hurting.

    Because almost all states have some kind of balanced-budget requirement, it is certain that there will be both net losses of jobs in state employment and reductions in state purchases.

  • Monetary policy is probably pretty much played out.

    Short-term interest rates are already very low, and further cuts could increase the risk of a dollar crash, so further Fed cuts are not to be expected at this time. There are other means, such as buying assets other than the Treasury securities they usually buy to pump money into the system, that the Federal Reserve could resort to, but these are untried and unless there is an actual second recession, I doubt they will be tried this year. If they are tried, it will mean the economy is doing even worse than I am predicting.

  • The Administration stimulus package probably won't be very stimulative.

    The Administration has even decided not to call it a stimulus package--the official term is now a "growth" package, and although it isn't clear exactly what its provisions will be, it looks like a big chunk of it will be spent on dividend tax relief which we can expect to provide essentially no stimulus. There some talk of providing new support to the states, which would help, but it appears to be spread over 10 years, which should pretty much render it meaningless this year. Policies which would be immediately helpful such as a payroll tax reduction seem to have been ruled out.

  • Technology spending doesn't appear ready to pick up

    The Goldman Sachs survey, which has been pretty accurate, showed that corporate executives expect a sharp downturn in technology spending in 2003, presumably because corporate budgetting has been done and they didn't end up with as much money for such purchases as they had expected earlier. It should be noted that this survey correctly picked up the increase in such spending in the 4th quarter.

  • Strong productivity growth isn't helping employment.

    US productivity is growing rapidly, and although that should be good news in the long run, in the short run, it means that a given amount of economic growth produces fewer new jobs than it would otherwise. In the 60's, Okun's Law said that 3% growth was the dividing line between unemployment rising and falling. In 2002, growth appears to have been 3% or more, yet unemployment rose. I expect that it would probably take at least 4% growth in 2003 to stabilize unemployment, and I think we will get less than that.

  • Exogenous shocks are unlikely to be helpful.

    The weather, Korea, Iraq, Venezuela, and al-Qaeda are all more likely to be negative rather than positive factors during 2003, if only because uncertainty tends to restrain spending and investment. The only good thing that is likely to happen is that oil prices may drop somewhat. Despite frequently heard blather to the contrary, oil price fluctuations within their range of the past decade or two (as opposed to oil supply disruptions) are just not that important to most of the US economy anymore. I will try to find the time to do some rough calculations on the impact of oil price reductions in a separate post, but I don't expect even a rapid and successful war in Iraq to make a big difference in the US economy this year.

  • Conclusion: Unemployment is headed up.

    Between the overall economic weakness and the severe state budget problems, I am confident that unemployment will continue to rise for much if not all of 2003, and I'm guessing it will reach 7% by the end of the year.