Daily Archives: December 28, 2010 @ 9:44 am (Tuesday)

State Revenues Rising

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Yes, revenues are going up, but my guess is actual state spending is not.

In other words, the rate of state ‘borrowing to spend’ including capital budgets has likely slowed?

That’s a net drop in aggregate demand- higher taxes without that much higher spending.

Also, spending federal funds is already figured in aggregate demand calculations as part of federal deficit spending.

And states are still struggling with the likes of pension contributions which decrease aggregate demand as well.

So looks to me states remain a net negative for growth next year, though as credits things are probably a lot less bleak than recent headlines have suggested.

As previously discussed, federal deficit spending floats all boats, etc.

THE ECONOMY
States Begin Slow Recovery as Revenues Increase
 

STATE BUDGETS IMPROVE
State and local budgets are in far better shape than a year ago as receipts from sales tax and corporate taxes pick up, but pressures remain from pension costs and Medicaid commitments.
By JAMES C. COOPER, The Fiscal Times
 

• Total state and local receipts, excluding federal grants, are up $120 billion..
• 42 states show increased tax revenues compared to a year ago.
• There were 72 municipal bond defaults in 2010, down 65 percent from 2009.
 

The poor condition of state and local budgets is on everyone’s radar, but just how much should we worry? Wall Street analyst Meredith Whitney recently declared on CBS’s 60 Minutes that, next to housing, the situation was the single biggest threat to the U.S. economy. That may have been true a year ago, when the recession had ravaged tax receipts and a lasting economic recovery was still in doubt. However, recent trends in both revenues and the economy look much more encouraging, and the risk of major short-term economic damage appears to be waning, not waxing.
 
Budget problems are not going to disappear anytime soon as states face the burden of huge unfunded pension obligations and rising Medicaid costs, among other expenses. California, for one, has a $28 billion deficit this year. The state received $630 million of stimulus funds for job creation, but according to the L.A. Times, only 25% of those funds have been spent due to bureaucratic red tape.
But governments are making significant progress, as many start to feel the updraft from the economic recovery. Tax receipts of state and local governments rose 5.1 percent in the third quarter from the same quarter a year ago, based on the latest accounting from the Bureau of Economic Analysis. Personal income taxes have yet to show much progress amid slow job growth, but sales tax receipts picked up notably last quarter, reflecting improving retail sales. The lion’s share of the growth in revenues has come from corporate taxes, which have surged 87 percent over the past year, as a result of this year’s surprisingly strong gain in corporate profits.
 
One often-cited problem for many states in the coming year is the expected loss of some $40 billion in federal money provided by the 2009 Recovery Act. However, many governments stand ready to make up the difference. State and local revenues from individual and corporate income taxes and sales taxes in the third quarter were up by $54 billion from a year ago, a growth rate that is likely to pick up in 2011, as economic growth and labor markets strengthen. In fact, since hitting bottom in the second quarter of 2009, total receipts from all sources, excluding federal grants-in-aid, have increased by $120 billion and have recovered all of their recession losses.
 

Analysts at the Rockefeller Institute noted a “significant improvement” in the state revenue picture and that the trend in tax collections for 2011 is “positive.” Based on their preliminary tracking for the third quarter, 42 states show an increase in revenues compared to a year earlier. However, individual stress levels vary greatly. Overall, the Rockefeller analysts say budget pressures remain, and additional revenue growth will be needed at a time when spending commitments continue to grow.
 
More revenue may well be the key surprise in the coming year. Revenue projections for the 2011 fiscal year, which began for most states on July 1, were based partly on economic forecasts at that time. Six months ago, the economy was slowing down as the European debt crisis sparked fears of a double-dip recession, and economists widely projected growth only in the 2-2.5 percent range for 2011. Now, given the rebound in consumer spending in the second half of 2010 and significant new stimulus in the recent tax deal, which offers a big boost to household incomes, a broad brush of economists have raised their 2011 growth projections into the 3.5-4 percent range. If realized, that pace and its implied boost to payrolls would greatly lift receipts from income, profits, and sales taxes, which make up 46 percent of state revenues, compared to 34 percent from federal grants.
 
State budgets may actually fair better than local finances next year. That reflects the different sources of revenues between states and cities. Property taxes account for 35 percent of local government receipts, while grants-in-aid from their respective state governments make up another 40 percent. The problem: Property taxes fluctuate with assessments, which are bound to go nowhere in the coming year, and many states under continued stress will find it difficult to funnel money to municipalities. Clearly, the better state coffers do in 2011, the better the condition of local budgets.
 
All this raises fears of a rash of defaults in the $2.8-trillion municipal bond market, as the 60-minutes report suggested. States and cities under the heaviest fiscal stress are already paying a significant premium on new borrowing, and the loss of Build America Bonds at the end of 2010, part of the 2009 Recovery Act, could lift borrowing costs further.
 
However, muni-bond defaults have actually fallen in 2010, to 72 totaling $2.5 billion, down from 204 in 2009, according to data reported by Bloomberg. Chris Hoene, director of research and innovation at the National League of Cities, notes that interest expense is only about 5 percent of state and local expenditures, and nearly all debt is long-term with predictable payments. Plus, almost all states and cities have balanced-budget requirements with provisions to address debt issues before default can occur.
 
Unfortunately, the draconian cuts already seen in state and local services and jobs have been the chief reason defaults have been held in check. For 2011, however, fewer cutbacks and a smaller hit to the overall economy seem likely. Economists at Barclays Capital project further declines in state and local payrolls of about 150,000 by the end of 2011. Every job is important, but in the big picture, that’s a drop in the bucket. Moody’s Analytics estimates that, if the economy grows nearly 4 percent next year, it will create about 2.6 million jobs, each one adding new revenues to state and local coffers. The same Barclays analysis projects that state and local governments will subtract only about 0.1 percentage point from growth in GDP in 2011.
 
State and local budgets are by no means out of the woods. Pressure will most likely continue into 2012, and longer-term problems loom with rising pension costs and Medicaid commitments. For now, at least, governments are making progress, and a stronger economy will add to the positive trend.

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Comments on Robert J. Shiller Article

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Glenn wrote:
Warren – would you care to comment on the ny times article by Robert Shiller?
http://www.nytimes.com/2010/12/26/business/26view.html?_r=1

He’s correct on all counts, including the point that the multiplier might not be 1.

In fact, a 1 multiplier requires all of our demand leakages (pension/ira type contributions, insurance reserves, other corporate reserves, demand for actual cash in circulation, net foreign demand to accumulate $ financial assets, etc. etc. etc.) to be offset by enough non govt sector debt expansion to make up for those ‘savings’ desires.

Sometimes that happens. In the late 90’s the domestic sector was increasing it’s ‘borrowing to spend’ by maybe 7% of gdp per year, more than offsetting the 2% or so govt surplus as well as the foreign sector savings desires. But that was unsustainable as domestic debt is ultimately limited by income, and it all came apart not long after y2k. And a few years ago we had an ok expansion going also driven by private sector debt expansion which also proved unsustainable and came to an abrupt end when the debt turned out to be largely fraudulent mtg lending, etc.

So today, with a highly subdued lending infrastructure, including regulatory over reach by bank regulators, seems to me a balanced budget expansion approach is high risk at best. The outcome could easily be a public sector expansion more than matched by a private sector setback.

However, the larger point is why not just do the spending without a tax increase? That’s sure to increase aggregate demand, and if demand pull inflation does ensue, and unemployment gets ‘too low’ (whatever that means), etc. taxes can always then be raised to cool demand.

The answer can only be that the author either doesn’t understand actual monetary operations and the monetary system fundamentally, or is afraid to say so?

Unfortunately, the ‘headline progressives’ continue to be
THE problem, imho.

A quick read of ‘The 7 Deadly Innocent Frauds’ might help:

https://moslereconomics.com/?p=8662/

I tried to connect with him when I was running for the US Senate in CT with no response.

Also, the economy did pretty well after World War II largely helped by the Marshall plan which was, functionally, a form of govt. deficit spending. We loaned Europe about $15 billion (back when that was a lot of money) to buy stuff from us, if I recall correctly. And enough of the war time deficit spending was held by soldiers coming home and others who spent from their savings for a while.

ECONOMIC VIEW
Stimulus, Without More Debt
 

THE $858 billion tax package signed into law this month provides some stimulus for our ailing economy. With the unemployment rate at 9.8 percent, more will certainly be needed, yet further deficit spending may not be a politically viable option.
 

Instead, we are likely to see a big fight over raising the national debt ceiling, and a push to reverse the stimulus we already have.
 

In that context, here’s some good news extracted from economic theory: We don’t need to go deeper into debt to stimulate the economy more.
 

For economists, of course, this isn’t really news. It has long been known that Keynesian economic stimulus does not require deficit spending. Under certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase.
 

The reasoning is very simple: On average, people’s pretax incomes rise because of the business directly generated by the new government expenditures. If the income increase is equal to the tax increase, people have the same disposable income before and after. So there is no reason for people, taken as a group, to change their economic behavior. But the national income has increased by the amount of government expenditure, and job opportunities have increased in proportion.
 

During the Great Depression, there was a debate about “pump priming” — about whether the government had to go into debt to stimulate the economy. John Maynard Keynes, who originated the Keynesian theory in 1936, liked to emphasize that the deficit-spending multiplier was greater than 1, because the income generated by deficit spending also induces second and third rounds of expenditure. If the government buys more goods and services and there is no tax increase, people will spend much of the income that they earned from these sales, which in turn will generate more income for others, who will spend much of it too, and so on.
 

In contrast, the balanced-budget multiplier theory says that there are no extra rounds of expenditure. You get just one round of spending — meaning that the multiplier is 1.0 — but sometimes that is enough.
 

Paul Samuelson, an economist at M.I.T., first drew national attention to the balanced-budget multiplier in 1943 , seven years after Keynes introduced his theory. The multiplier was an immediate consequence of the Keynes theory, but Keynes didn’t articulate it himself.
 

Economists embraced this multiplier because it seemed to offer a solution to a looming problem: a possible repeat of the Great Depression after wartime stimulus was withdrawn, and when new rounds of deficit spending might be impossible because of the federal government’s huge, war-induced debt.
 

It turns out that this worry was unfounded. The Depression did not return after the war. But in the early 1940s, economists justifiably saw the possibility as their biggest concern. Their discussions have been mostly forgotten because they didn’t have much relevance for public policy — until now, that is, when we again have a huge federal debt and a vulnerable economy.
 

Of course, the balanced-budget theorem is only as good as its assumptions. Other possible repercussions could make its multiplier something other than 1.0. The number could be less, for example, if people cut consumption because of psychological reactions to higher taxes. Alternatively, it could be greater if income-earning people who are taxed more cut their consumption less than newly employed people increase their spending. We can’t be sure what will happen.
 

Researchers haven’t pinned down the deficit-spending multiplier either, even though that has been the focus of their efforts. In fact, a recent survey article on the effects of government stimulus by Alan Auerbach at the University of California, Berkeley, and two of his colleagues has found that “the range of mainstream estimates for multiplier effects is almost embarrassingly large.” Last month, a Congressional Budget Office study revealed similar uncertainty. The trouble comes in estimating how people will react in generating those subsequent rounds of spending.
 

But the balanced-budget multiplier is simpler to judge: If the government spends the money directly on goods and services, that activity goes directly into national income. And with a balanced budget, there is no clear reason to expect further repercussions. People have jobs again: end of story.
 

What kind of jobs? Building highways and improving our schools are just two examples — as cited in 1944 by Henry Wallich, an enthusiast of balanced-budget stimulus who would later become a Yale economist and a Federal Reserve Board governor.
 

AT present, however, political problems could make it hard to use the balanced-budget multiplier to reduce unemployment. People are bound to notice that the benefits of the plan go disproportionately to the minority who are unemployed, while most of the costs are borne by the majority who are working. There is also exaggerated sensitivity to “earmarks,” government expenditures that benefit one group more than another.
 

Another problem is that pursuing balanced-budget stimulus requires raising taxes. And, as we all know, today’s voters are extremely sensitive to the very words “tax increase.”
 

But voters are likely to accept higher taxes eventually, as they have done repeatedly in the past. It would be a mistake to consider the present atmosphere as unchangeable. It’s conceivable that an effective case will be made in the future for a new stimulus package, if more people come to understand that a few years of higher taxes and government expenditures could fix our weak economy and provide benefits like better highways and schools — without increasing the national debt.

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ECB’s Stark: Helping Governments Cannot and Should Not be a Goal of These Operations

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The Fed is conducting it’s QE to lower the risk free term structure of rates for the further purpose of supporting lending in the economy in general.

The ECB is buying member nation debt in the marketplace specifically to help member nations fund the deficits and avoid default.

What the ECB is doing for Greece, Portugal, and Ireland is more analogous to what the Fed did a couple of years ago when it bought corporate debt (commercial paper) from the likes of GE and GM to keep them afloat.

In fact, the ECB can’t ‘expand into US Federal Reserve-style“quantitative easing” ‘ even if it wanted to, because there are no euro equivalents of US Treasury securities. (Not that the Fed’s QE does anything of substance for the US economy, inflation, or the dollar.) About the closest the ECB could come to a ‘Fed style QE’ would be to receive fixed in euribor swap market, which is not even a consideration, as their issue is the solvency of their member nations and not the risk free term structure of rates in general.

Meanwhile, as previously discussed, as long as the ECB keeps buying, it all muddles through.

ECB Increases Intervention in Bond Markets
 

The European Central Bank increased its intervention in government bond markets last week, indicating that the euro’s monetary guardian remained wary of an escalation of the eurozone debt crisis.
 

Purchases under the ECB’s securities market programme rose to €1.1 billion ($1.4 billion) from €603 million in the previous week, according to figures released on Monday.
 

The acceleration highlights how the ECB has been forced into action to prevent governments’ borrowing costs spinning out of control, even though it sees the main responsibility for restoring investor confidence in Europe’s 12-year-old monetary union as lying with political leaders.
 

The previous week’s figures had pointed to a lull in the ECB’s intervention. The rise came in spite of thin trading before the Christmas and new year holidays.
 

The ECB argues its action is aimed simply at correcting malfunctioning markets – and will not be allowed to expand into US Federal Reserve-style“quantitative easing” to support the economy.
 

“Helping governments cannot and should not be a goal of these operations,” Jürgen Stark, an ECB executive and one of its governing council’s more hawkish members, told the German newspaper Stuttgarter Zeitung at the weekend.
 

The latest increase could add to the discomfort of ECB policymakers, however, if it encourages expectations that the ECB will become more aggressive.
 

Because of the increased risks it is bearing, the ECB said this month it would double to €10.76 billion its subscribed capital, which would allow it to increase provisions against losses.
 

The announcement triggered speculation that the ECB was preparing to accelerate its bond purchases. However, Mr Stark said the increase had “nothing to do with the current situation but dates from analysis that we started in 2009”.
 

The ECB began buying bonds in May, at the height of this year’s eurozone crisis. After weekly purchases of €10 bilion or more, the programme was scaled down, with the weekly figures sometimes falling to zero.
 

But in early December the programme was reactivated – although still not up to its initial scale.
 

The ECB does not give precise details but recent purchases are thought to have been concentrated on Portuguese and Irish bonds, where financial market tensions have been focused.
 

Total purchases since the programme started in May have reached €73.5 billion – an amount the ECB will on Tuesday seek to reabsorb from the eurozone financial system to offset the inflationary impact of its action.

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