Market Update – October 1, 2012
Today, I want to share three ideas that I read that I found interesting.
How Martin Feldstein Thinks We’ll Solve Our Problems
Martin Feldstein (Chair of President Reagan’s Council of Economic Advisers, currently a member of President Obama’s Council on Jobs and Competitiveness and also a Harvard professor) discusses how we’re going to fix our ongoing budget deficit. He says that we’re going to have to slow the growth in entitlement spending and also increase our revenue. “The task is made more complex by the large number of legislators who insist that the deficit should be reduced by spending cuts alone.”
Here’s how he thinks it will be resolved:
1. Shortly after the election, Congress will vote to postpone the fiscal cliff for six months.
2. Next, they’ll agree to slow the growth of the Social Security benefits for future middle – and upper-income retirees.
3. Raise revenue by cutting tax expenditures (deductions, credits, exclusions).
In order for this to happen, he says that those legislators who are against raising taxes must view “cutting tax expenditures” as “cutting government spending.” (Good luck in convincing them.) At the same time, he recognizes that every large tax expenditure has fervent defenders.
As a result, he thinks that the most practical approach is to simply cap the amount by which we are allowed to lower our tax bill. As an example, he thinks that the actual tax benefit (the amount that our tax bill is lowered by tax expenditures) should be capped at 2% of AGI. In other words, if your tax bill amounts to 16% of AGI (16% is not the marginal rate, but the average tax rate), this means that you could lower your tax bill by 1/8, but no more.
I agree with Professor Feldstein. Our problems are not going to be solved by one side getting everything they want. There are going to be cuts in spending and there will be higher taxes. I find it unbelievable to think that we’re going to eliminate tax expenditures such as the mortgage interest deduction or the exclusion (from income) of employer sponsored health insurance. The only way that any of this could happen is by limiting the exclusions indirectly (by capping their use). Of course, this fails to simplify the tax code. (My gut feeling is that Congress will cap these expenditures and also lower the tax rates.)
He Said / She Said
Many in Congress don’t like the Fed or Fed policy. But, members of the Fed are arguing that the Fed is engaging in their policy because of fiscal policy. We’ve often heard Fed presidents (such as President Fisher) argue that the Fed couldn’t be buying debt if Congress wasn’t overspending (and issuing this debt).
Now, Chicago Fed President (Charles) Evans has added to this argument through his explanation of the most recent Fed actions. “In part, last week’s additional monetary policy actions were a response to the disappointing pace of the recovery. However, they were also intended to increase the resiliency of the economy in the face of the increasing headwinds and greater downside risks posed by the slowdown in global economic growth, the economic turmoil in Europe and the fast-approaching U.S. fiscal cliff.”
In other words, President Evans is arguing that part of the reason that we need this Fed policy is because of the uncertainty that is being caused by the fiscal cliff.
Stat of the Day
The Education Department said that of the students whose loans came due after October 2009, 9.1% had defaulted within two years. This is almost double the rate from five years ago. (The Wall Street Journal had a chart that showed the rate going back to the late 1980s. As grave as this statistic sounds, it looks like the two year default rate was above 20% during the recession in the early 1990s.)
The government projects that roughly one in five borrowers who took out federal loans for undergraduate study will default at some point in their lifetime.
A study by the Pew Research Center showed that 40% of households headed by someone younger than 35 years old have student debt.
Have a great week.
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