Special Tax Breaks for Big Oil?

The Senate recently concluded a debate on ending Section 199 deductions of the American Job Creations Act of 2004 for the five largest American oil companies.  With a few exceptions, the debate was framed by language that I believe was designed to elicit an emotional rather than an informed response from voters.  After reading or listening to news accounts of the debate, I was unable to express an informed decision.  I went back to the original legislation and read it.  Because it uses both arcane accounting and legal language, I searched the Internet for short descriptions of the legislation.

William Perez does a nice job of summarizing Section 199 (“Domestic Production Activities Deduction: Section 199 Deduction”).  The entire article is well written and worth the time spent in reading it.  In part, he writes

Here's the basics:

Businesses with "qualified production activities" can take a tax deduction of 3% from net income. This is a tax break pure and simple. The more complicated the business, the more complicated the math for calculating the Domestic Production Activities Deduction. In a nutshell, businesses engaged in manufacturing and other qualified production activities will need to implement cost accounting mechanisms to make sure their tax deduction is accurately calculated.

Domestic Production Activities Deduction

A business engaged in a qualfying production activity is eligible to take a tax deduction of 3% in tax years 2005 and 2006. The deduction increases to 6% in year 2007, and 9% in year 2010.

Qualified Production Activities

A business engaged in the following lines of business may qualify for the Domestic Production Activities Deduction. These are the "qualified production activities" eligible for claiming the deduction under Internal Revenue Code Section 199:

• Manufacturing based in the United States,
• Selling, leasing, or licensing items that have been manufactured in the United States,
• Selling, leasing, or licensing motion pictures that have been produced in the United States,
• Construction services in the United States, including building and renovation of residential and commercial properties,
• Engineering and architectural services relating to a US-based construction project,
• Software development in the United States, including the development of video games.

I hope that this information helps readers obtain an informed opinion.Replace this text with...
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Cut the First Lady’s Staff

I know a good place to cut the budget.  It is with the first lady’s staff.  Please don’t interpret my opinion on a particular dislike of Michelle Obama or any other first lady.  As an aside, I do not like the title of First Lady of the United States.  Because they are not elected, I prefer Mrs. Obama, Mrs. Bush, etc.  According to Snopes.com (“Mixture of True and False Information”), Mrs. Obama has 23 or 24 staffers assisting her, approximately the same number as Laura Bush and significantly less than Betty Ford, Lady Bird Johnson or Jacqueline Kennedy.  Four should be more than enough.  The Congress should also cut all funds to support pet projects of the presidents’ wives.  

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Yertle on Circumcision

When I write against an opinion presented in a blog or news article I try to sick to the issue and avoid name calling.  I do make an exception for those who would make their private opinions law without a compelling cause.  They are a pack of Yertles who, unsatisfied with being king of the pond, force their opinions on others through law.

MGM Bill (Male Genital Mutilation Bill) is currently stacking turtles to expand their importance.  They recently made the news by introducing a ballot initiative in Santa Monica that would outlaw circumcision but that is not their only effort.  They have introduced similar initiatives in other cities and are attempting to introduce legislation that would outlaw circumcision at the state and national level as well (“Ban on Circumcision Could Become Law in Santa Monica,” “Male circumcision opponents propose ballot measure in Santa Monica”).  If their arguments are good, let them persuade others to not to circumcise their male children.  If they are not good enough to persuade they should accept that others should be free to make decisions that they believe are in the best interest of their male children.

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Your Report Card for President Obama

Voters on the left claim that President Obama is extraordinary, restoring employment while transforming the economy to meet the challenges of the 21st century.  Voters on the left claim that he is among the worst presidents, a reincarnation of President Carter who has ineffectively dealt with the Great Recession and through health care and regulatory reform has placed the dynamic American economy into a comatose state.

To help readers grade President Obama’s performance and the economy’s performance since the beginning of recession, I have included three characteristics that Reinhart and Rogoff (“This Time is Different”) believe that financial crisis share juxtaposed with corresponding U.S. statistics which are bolded.

Asset Markets

First, Asset market collapses are deep and prolonged.  Declines in real housing prices average 35 percent stretched out over six years, whereas equity price collapses average 56 percent over a downturn of about three and a half years. 

Housing prices fell 24.7 percent from the their peak in the third quarter of 2007 and are forecast to fall another 5.5 percent in total (“Fiserv Case-Shiller Home Price Insights: After Five Years of Record Declines, U.S. Home Prices Begin To Stabilize”). The DJIA fell 43% from a high of 14,164.53 on October 9, 2007 to a low of 8,046.42 on November 21, 2008.  The index has recovered to 88 percent of its high value and now stands at 12,468.19 at the opening of trading on May 27, 2011. 

Output and Employment

Second, the aftermath of a banking crisis is associated with profound declines in output and employment.  The unemployment rate rise an average of 7 percentage points during the down phase of the cycle, which lasts on average more than four years.  Output falls (from peak to trough) more than 9 percent on average, although the duration of the downturn, averaging roughly two years, is considerably shorter than that of unemployment. 

The U.S. unemployment rate rose 5.4 percentage points from 4.7 percent in September 2007 to 10.1 percent in October 2009.  Nearly four years later, unemployment stands at 8.8 percent.  Real GDP (2005 dollars) fell 4.1 percent from $13.363 trillion in December 2007 to $12,810 trillion in June 2009.  By first quarter 2011, real GDP had fully recovered to $14,438 trillion. 

Government Debt

Third, as noted earlier, the value of government debt tends to explode; it rose an average 86 percent (in real terms, relative to precrisis debt) in the major post-World War II episodes. 

Nominal debt held by the public has increased from $5,055 trillion on August 29, 2007 and rose 90 percent as of April 2011.  

A few other facts may be useful in grading the president’s success in managing the economy.  The Troubled Asset Relief Program was signed on October 3, 2008 during the Bush administration.  Funds were immediately released.  Senator Obama voted in favor of the bill and retained the services of Tim Geithner and Ben Bernanke both have played significant roles during the Bush and Obama administrations.  These facts will make it difficult to separate the performance of the two presidents.

The American Recovery and Reinvestment Act was signed on February 17, 2009.  Very few funds were released prior to the ending of the recession in June 2009.

Rising oil prices may be harming the recovery.  There is little a president can do in the short-run to lower energy prices.
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Light Bulbs

Governments face daunting yet ignored difficulties imposing efficiency standards on markets.  They presume to have the knowledge and foresight that producers and consumers acting in markets lack.  Hayek called this presumption the fatal conceit and famously wrote, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The government’s imposition of energy standards for light bulbs illustrates the fatal conceit.  I believe that their thinking went something like this.

Edison’s incandescent light bulb is more than 100 years old.  When lighting the bulb, more energy is lost to heat than used in light.  Certainly, it would be easy to make lighting more energy efficient.  We will require bulbs to be 30 percent more efficient by 2014 and 70 percent more efficient by 2020.

In 2007, the Congress passed and President Bush signed legislation with this energy requirement and since that time manufacturers have had problems meeting new standards.  Compact Fluorescent Lights (CFL’s) cost more, don’t last as long as promised, and pose a small environmental hazard.  Light emitting diode bulbs (LED’s) are very expensive and will remain expensive even after production costs fall and competition increases.

Elected officials do not seem to realize that consumers pay attention to cost, both the purchase price and operating cost.  I own a minivan rather than an SUV because it gets better gas mileage.  My wife and I recently considered buying a bigger home.  We considered the extra energy and water cost of maintaining the home.  Manufactures have a profit incentive to provide products with characteristics that consumers desire and if consumers want energy efficient products, they will get them.

If our elected officials believe that energy consumption results in a negative externality, they should tax it and not establish “command and control” regulations like those imposed on light bulbs that are fraught with inefficiencies.  Faced with higher costs for electricity, the interaction between buyers and sellers will efficiently determine the lowest cost method to consumers for lowering the consumption of electricity. 

 
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Boehner at the Catholic University of America

President Obama is not the only politician to land in an awkward political position (See “Obama on Government Jobs”). As House Speaker John Boehner prepared to deliver a commencement speech at the Catholic University of America he was greeted with a letter signed by 70 signatories including faculty, priests and nuns that chided him for cuts in the social safety net contained in the budget that he guided through the House.  In part, the letter read (transcript),

Mr. Speaker, your voting record is at variance from one of the Church’s most ancient moral teachings. From the apostles to the present, the Magisterium of the Church has insisted that those in power are morally obliged to preference the needs of the poor. Your record in support of legislation to address the desperate needs of the poor is among the worst in Congress. This fundamental concern should have great urgency for Catholic policy makers. Yet, even now, you work in opposition to it.

The 2012 budget you shepherded to passage in the House of Representatives guts long-established protections for the most vulnerable members of society. It is particularly cruel to pregnant women and children, gutting Maternal and Child Health grants and slashing $500 million from the highly successful Women Infants and Children nutrition program. When they graduate from WIC at age 5, these children will face a 20% cut in food stamps. The House budget radically cuts Medicaid and effectively ends Medicare. It invokes the deficit to justify visiting such hardship upon the vulnerable, while it carves out $3 trillion in new tax cuts for corporations and the wealthy.

I once read the majority of a book used in a Catholic high school that suggested social policies that Catholics in a market oriented society should support.  That ideas the book were consistent with the values expressed in the letter.  Both suggest that Catholics should support a government that actively helps the poor.  Normative values are visions of what ought to be and as such are close to impossible to argue against and a vision of government rendering assistance to the poor is probably held by most Americans.  I hold similar normative beliefs but different positive interpretation about how markets work and the impact of many social policies on the poor and the economy as a whole.  I would not use the same policies the signatories to achieve their objectives.  More often than not, policies that support competitive markets are best at aiding the poor.

In a similar vain, Speaker Boehner’s budget is defendable as aiding the poor.  The budget cuts he supported are significant but less significant than the cuts that will be forced on the government should the national debt continue to grow unabated.  A sovereign crisis could be more severe than the market crash of 2008.  
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Obama on Government Jobs

Last week, President Obama was the guest at a Town Hall meeting hosted by CBS News.  As I watched the interchange between Karin Gallo and President Obama I shook my head and wondered why any president would expose them self to this sort of event (transcript)(video).

KARIN GALLO: About three years ago, just under three years ago, I took a job with the federal government, thinking it was a secure job. Recently I've been told I'm being laid off as of June 4th. And it is not an opportune time for me, I am seven months pregnant in a high-risk pregnancy, my first pregnancy. My husband and I are in the middle of building a house. We're not sure if we're gonna be completely approved. I'm not exactly in a position to waltz right in and -- and do great on interviews, based on my timing with the birth. And -- so, I'm stressed, I'm worried. I'm scared about what I -- what my future holds. I definitely need a job. And -- I just wonder what would you do, if you were me? (LAUGH)

Where did CBS News find this woman?  She is at the end of a high risk pregnancy, and was fired from a job after her husband and she began to build a new home.  She is articulate and has a good sense of humor with a great sense of comedic timing.  What are the odds that another person would have her skill set and experience this series of unfortunate events?  She is certainly not a representative American.  President Obama starts well suggesting that she should get a job but then gives a normative opinion that does not have positive support.

…let me just first of all say that -- workers like you for the federal, state, and local governments are so important for our vital services. And in -- and it frustrates me sometimes when people talk about "government jobs" as if somehow those are worth less than private sector jobs. I -- I think there's nothin' more important than -- workin' on behalf of the American people.

Is someone collecting trash for the government really “working more on the behalf of the American people” than someone who collects trash for a private firm?  Is a government doctor or professor really more valuable to society than a private doctor or professor?  Taking his statement to its logical conclusion, should we all work for the government to maximize our benefit to the American people?

Economists agree that government can provide valuable jobs within an economy.  Milton Friedman, an economist famed for supporting a minimalist government, wrote in “Capitalism and Freedom”

A government which maintained law and order, defined property rights, served as a means whereby we could modify property rights and other rules of the economic game, adjudicated disputes about the interpretation of the rules, enforced contracts, promoted competition, provided a monetary framework, engaged in activities to counter technical monopolies and to overcome neighborhood effects widely regarded as sufficiently important to justify government intervention, and which supplemented private charity and the private family in protecting the irresponsible, whether madman or child—such a government would clearly have important functions to perform.

The correct question to ask is, given the current allocation of private and government jobs, should the next job added be private or government.
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Speculators

Every time oil prices rise rapidly, politicians seeking to curry support from beleaguered consumers blame speculators, a nebulous gang of ne’er-do-wells.  If speculators have the power to drive up oil prices, why would Brent crfe prices fall by 13.3% and U.S. crude fall 14.7% for the week (“Oil falls again, gutted in record weekly drop”)?

The price of oil is determined by the interaction of supply and demand.  The demand for oil has been growing because consumers in developing countries like China, India and Brazil have more income.  Supply of oil has largely stagnated.  It is not just that the supply of oil beneath the earth’s surface is finite, in many countries governments restrain exploration and production.  Policies that limit production when demand is growing cause to higher prices.

The expectation of future price affects both the demand and supply for oil.  If buyers expect prices to increase in the future, they buy now.  If sellers expect prices to increase in the future, they sell later.  Profit motivates speculators.  If they guess the direction of prices correctly they can make hefty profits.  If wrong, they will face similar losses.  On the whole, speculators act in future markets to adjust and smooth prices over time, providing an important service to producers and consumers.

Oil prices will remain volatile because both supply and demand are not particularly responsive to price and much of the production for export markets is in politically unstable countries (For more information on the function of speculators see “Oil Speculators: Bad or Good”).Replace this text with...
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An Observation on Chairman Bernanke’s Press Conference

On April 27, 2011 held his first press conference as Fed Chairman Bernanke, such press conferences will now be held quarterly.  Beginning at 53 minutes and 40 seconds, Chairman Bernanke was asked by a reporter who prefaced his question by quoting Reinhart and Rogoff’s book, “This Time is Different,” in which they found that recoveries following financial crisis tended to be slow if he thought that Americans expected too much from monetary policy. 

Bernanke praised Reinhart and Rogoff’s now classic work but correctly explained that the book did not provide a full explanation of why these recoveries were slower and offered some possibilities from his research.  These included problems in credit markets and housing sector, and inadequate fiscal and monetary response.

What constitutes and adequate or appropriate response is controversial and inspires an interesting and heated debate.  I will focus on fiscal policy and debt accumulation.  Reinhart and Rogoff write that “Arguably, the true legacy of banking cries is greater pubic indebtedness—far over and beyond the direct headline costs of big bailout packages.”  The Bush and Obama administrations have followed a traditional path of bailing out financial institutions (TARP authorized spending of $700 billion) and offering fiscal stimulus through deficit spending (ARRA authorized expenditures of $787 billion).  The recession has also reduced tax receipts.

The graph shows an index of the national debt held by the public.  The index begins at 100 at the end of August 2007 as the housing bubble bursts.  The gray area is represents the eighteen month recession that began in December 2007.  The index has increase to 190.7, meaning that debt held by the public has increased 90.7 percent.  This is an unfortunate sequence of events given the anticipated explosion of debt due to unfunded entitlements.Replace this text with...
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