Wednesday, November 01, 2017

Taking a (more) charitable ad hominem view of CEA wage claims about corporate tax reform

Kevin Hassett, in his new perch at CEA, has dismayed me by claiming - I would say (and I'm not alone in this) absurdly - that cutting the corporate rate from 35% to 20% would in short order raise wages by at least $4,000 per household. Indeed, I have considered this claim dubious enough to cause me to speculate that he has consciously decided that academic and think tank economists, among whom he has certainly hurt his credibility by making this claim, are not the audience that he believes will matter to him personally or professionally when his CEA stint is done.

But to put it more charitably, perhaps he is subject to sincere (if ill-founded) over-exuberance - akin to Dr. Malcolm's "deplorable excess of personality" in the Jurassic Park I movie - that can lead him astray without evidencing bad faith. As evidence for continued sincerity and good faith, he  today reiterated, in a Politico interview, a previously expressed view that is anathema to right-wing Trumpite opinion leaders, and hence that presumably reflects sincere conviction while not otherwise serving his or the Administration's interests.

He says, in particular: "We've not done a good job as a society at thinking about how do we take people who have become discouraged [from participating in the workforce] and reconnect them. And it's such an urgent problem that government programs that directly hire people might be part of the solution."

As the Politico column describing the interview notes, "[t]hat's a New Deal-style idea more closely associated with highly progressive Democrats." It has already begun to attract the inevitable brickbats, and I see no reason to think that there's anything more behind it than his believing that it's actually true. It doesn't look, from here at least, like a  deliberate sop or pitch to the Bannon wing.

The interview does, however, rewrite history a bit concerning a prior instance of ill-founded over-exuberance:

"Hassett, an affable economist with friends on both sides of the partisan aisle, also spoke about his often-lampooned 1999 book with James Glassman, Dow 36,000, that predicted stocks would hit that mark by 2004. Instead, the dot-com bubble burst and stocks tanked.

"Hassett described the title of the book as a bit of a 'youthful indiscretion' that was also somewhat unfairly maligned. 'The point was that people who buy and hold stocks tend to do well, but that stocks go up and down a lot and it's scary.'"

With all due respect, while that may reflect how he thinks about the stock market now, it's not quite the same as what the book said. Again, Dow 36,000 offered a specific prediction with an equally specific analysis behind it. This framework went well beyond "buy and hold," to assert that historical evidence supported viewing stocks as grossly undervalued based on their expected future payouts, even allowing for a reasonable degree of risk aversion.

I actually recall speaking to Kevin, at an AEI event, before Dow 36,000 came out or had been widely publicized. He explained the book's basic undervaluation claim to me, and added that, because he was so convinced it was true, he had placed all his savings in the stock market, none in bonds.

I asked him (obviously paraphrasing here): "If you're so bullish about stocks, why stop at 100% of your net equity, instead of also borrowing a lot of money and putting that in the stock market, too?"  But someone else came up to chat just then, so I never got an answer to this question.  From today's perspective, I'd note that even going 100% of net equity, without also borrowing so that one can push past that line, seems a bit aggressive (even allowing for the fact that Kevin, like me, was younger at the time) if "stocks go up and down a lot and it's scary."

In fairness, he was not alone in 1999 in thinking that the stock market was undervalued, even duly adjusting for risk (e.g., based on evidence of comparative asset riskiness and how people adjusted for it elsewhere). Finance folk were writing a lot more in those days than they seem to be doing today about the "equity premium puzzle," i.e., the view that, all things considered, stock prices seemed to be over-discounting for risk.

At a general conceptual level, the main things that Dow 36,000 added to merely relying on the equity premium puzzle were (1) a particular set of claims about what stock values "should" be if the premium, assumed to be mysterious and irrational, were to disappear, and (2) as assertion of confidence that it would indeed disappear in fairly short order.  (This too I recall, perhaps from the same conversation, as resting on the idea, not exactly uncommon among economists, that surely rationality will soon prevail.)

Even back then, however, a mutual friend with unimpeachable academic credentials, who was highly skeptical of the book's thesis even at the time, told me that he had advised Kevin to have stickers ready for all the book's copies to cover the last zero if necessary. This would have allowed rapidly changing the title to Dow 3600.

In sum, one could think of Dow 36,000 as supporting a relatively charitable explanation for what we are hearing from Kevin these days about how a corporate rate cut would rapidly boost wages. Both in a personal sense and given his possible influence while at CEA, that's good to know. But I believe that at least the general basics of his Dow 36,000 claim were closer to the mainstream, and to apparent contemporary plausibility, than what he is saying about corporate tax rates and wages now.

3 comments:

blissex said...

«I asked him (obviously paraphrasing here): "If you're so bullish about stocks, why stop at 100% of your net equity, instead of also borrowing a lot of money and putting that in the stock market, too?" But someone else came up to chat just then, so I never got an answer to this question.»

B DeLong, a mostly-good and interesting author who however is a committed neoliberal in the "Rubin wing of the Democratic party" (I rather think viceversa...) and often seems to me to act as a Wall Street promoter, has answered that question with math, and the answer is that so far a 2.28 leverage has been risk -free:

http://www.bradford-delong.com/2017/07/here-we-have-robert-shillers-stock-market-index-data-since-1871-the-cumulative-real-return-from-investing-in-the-sp-compos.html

http://www.bradford-delong.com/2017/07/comment-of-the-day-investingidiocy-how-leveraged-should-your-stock-market-investments-have-been-so-optimal-kelly.html

From these I concluded that B DeLong had "jumped the shark". If his argument (which I think is based on ridiculous data and a ridiculous interpretation) were true, it would be insane for any american to invest a cent in risky, low return activities like factories, shops, professional careers, agriculture, mining etc; all americans should become leveraged passive investors in the S&P and GDI would grow much faster; and it would be utterly wasteful for the government to waste a cent in low productivity silly things like roads, dams, hospitals, research, instead of putting every dollar of its budget into S&P leveraged passive investing.

«From today's perspective, I'd note that even going 100% of net equity, without also borrowing so that one can push past that line, seems a bit aggressive (even allowing for the fact that Kevin, like me, was younger at the time) if "stocks go up and down a lot and it's scary."»

But Hasset's argument is that in the long run the S&P is 100% risk free even if if it fluctuates, in essence because the S&P has never fallen to zero and it has always recovered to beat its previous high. DeLong exposes this argument unwittingly when writing:

if we limit ourselves to portfolios with constant leverage and thus a constant β, the portfolio that does the best since 1871 has β = 2.28. That portfolio escapes bankruptcy in 1932 by 1 percent of its peak-1929 value

That's how laughable that argument is.

blissex said...

One of the ironies of Hasset's "DOW 36000" arguments, apart from the obvious absurdity related to the construction of the index, is that in some indirect but very relevant way it is based on the idea that investing in a wide spread of american businesses is 100% risk free because they will never go bankrupt all at the same time, and that is because the USA government backstops their sales and profits in the aggregate thanks to counter-cyclical keynesian demand management.

That is true, but there is a "truer" point: that so far no devastating war has reduced to rubble most of the Union and its businesses and assets. Because in other countries, as Piketty reminds us, it is lost wars that cause national physical bankruptcies. That's admittedly a giant advantage that the USA (and to a much smaller extent the UK) stockmarket has had over the french, german, spanish, italian, chinese, japanese, korean, ... ones.

blissex said...

As to Hasset's optimism about corporate tax cuts resulting in huge wage gains, I think this strip is apposite:
http://dilbert.com/strip/2001-11-19

Note also that usually such claims are carefully worded: these three claims are very different:

#1 A big corporate tax cut will demonstrably cause within a medium term time frame wages to grow by $4,000 more than the would otherwise have move.
#2 A big corporate tax cut today may cause a large wage increase, possibly of as much as $4,000 over the next several thousand years.
#3 There is no proof that a corporate tax cut today will prevent wages from increasing by a total $4,000 at some point in the future because of any other reasons.

My understanding is that Hasset is actually arguing #3, which in effect the "Laffer curve" point rewritten for a different case.