Wednesday, May 19, 2010

The Spending Seesaw

by VINCENT FULMER

In tough economic times it is all the more important for consumers to distinguish between items they “must have and those they “would like to have.” One cannot be postponed: The other most certainly can wait.


The problem is that all too many consumers do not take the time or trouble to ask themselves “Do I really need this? Can I just as well postpone it or do without?” The choice is often difficult because the options are not always clear. The problem is muddied and magnified when all of the economic experts and most government entities urge consumers to spend themselves silly to help the economy recover. The problem is deepened by desperate merchants who engage in complex price discounting, noisy up-grades, confusing introductory offers and exaggerated advertising claims—the dark side of merchandising.

Thorstein Veblin, the economist, wrote extensively about the phenomenon of “conspicuous consumption” as to pervasive practice by consumers. Will Rogers complained that “Too many people spend money they haven’t earned, to buy things they don’t’ want, to impress people they don’t like.” Where is Andy Rooney of 60 Minutes when we need him?

What inescapably dooms the rational decision to purchase an item is the universal consumer memory lapse about income taxation. Almost everyone assumes that the price tag shown on an item is the actual cost to the purchaser. Nothing could be further from the truth. What the purchaser sees is not what he or she gets! When income is taxed before the consumer makes a purchase, the consumer has already paid a price for the dollars he or she is about to spend.

The actual cost, then, is not 100% of the price tag but more like 120% of the price tag shown for anything, for everybody. Add two extra cost items that add to the bad news:
1. Sales taxes might apply, depending upon local or state laws or the item purchased. These generally range from 5% to 8% of the price tag.
2. Finance charges if the consumer buys on credit or otherwise borrows to get the money to make the purchase.

How does it look for consumers to pay 130% or 140% of the price shown? It ought to feel good because most consumers are doing it. Isn’t it high time for consumers to do a better job of distinguishing between must have and would like? Isn’t it time for consumers to spend less and save more if they can? Alas, consumers are an irrational, disorganized lot to begin with, and an unpredictable prop for the economy.

Now, businesses face a similar challenge and a responsibility to distinguish between things they must have to conduct their operations and the things they would like to have—in order to remain competitive. But businesses have three powerful advantages consumers almost never have.

1. Businesses typically have a basic choice between incurring a current operating expense or investing in assets like equipment and inventory to save on current and future operating expense, or to grow the business. Consumers rarely have such options. The tax laws allow businesses to spread their investment cost over a number of years, but not consumers.

2. Businesses are allowed to deduct the current year cost of an expense from their revenue before arriving at their profit—which is then taxed at lower rates than consumer income. Generally speaking, businesses spend on their needs with less costly before tax dollars; and unlike consumers, businesses are not noted for irresponsible, carefree or casual spending, or impose buying—despite all of the current concern about executive compensation.

3. Unlike consumers, businesses can also pass along some or all of their expense increase to customers, in the form of price increases. When times are tough, it is more difficult or impossible to do so. But well-managed businesses are able to use highly skilled professional resources to help them contain and control expenses.
In addition, for a variety of justifiable reasons, the interest charged on consumer borrowing is roughly double the interest charged on business loans. Time payment, or consumer credit card purchases on consumer durables—kitchen appliances, TV’s, home furnishings and the like cost the equivalent of 20% per year. Business loans are typically in the range of 10%.

Home buying interest rates might seem like a glaring expectation. But they are not. Because of the traditionally long periods used in mortgage financing, the published rate of 5% on a 30-year mortgage seems low enough. But the 5% translates into three to four times itself when the period of the loan is normalized to a ten-year payoff.

Businesses account for roughly 25% of the nation’s spending, consumers roughly 50% and government roughly 25%. The fiscal sedative/stimulus spending debate in the government sector is a subject of hourly public debate and needs no further elaboration here. At its core government spending is a must have versus would like seesaw, no less than the challenge in the private sector.

One does not have to be an economic genius or policy maker to know that business investment spending is the most direct and effective way to stimulate the economy and create jobs. That is where the jobs are. That is where employment opportunities are created, now and for the future. What can all of us in America do to encourage business to invest?


The author is an economist and consultant to early stage companies in New England.

Wednesday, May 5, 2010

BHI offers testimony on debt restructuring bill before Senate committee

At the request of Chairman Mark Montigny, the Beacon Hill Institute at Suffolk University offered testimony on "An act relative to debt restructuring," this morning at 11:30 a.m. in Room A-1 of the State House in Boston.

Good afternoon, I am Paul Bachman and I am the Director of Research at the Beacon Hill Institute at Suffolk University. I would like to thank the members of the Senate Committee on Bonding, Capital Expenditure and State Assets for opportunity to testify today and, in particular, Sen. Mark Montigny, chairman.

House Bill No. 4617 would authorize the state treasurer to restructure some $573.7 million dollars in state bonds. Given the current budget problems facing the legislature, restructuring is an attractive option. While the restructuring may serve the best interest of the Commonwealth in the current fiscal year, the state's outstanding debt obligations could become problematic in the medium and long term, particularly in light of the state's current high debt burden relative to other states.

Massachusetts Current Debt Burden

Massachusetts carries one of the highest government debt burdens of all 50 states. The Patrick administration's "FY 2010 Capital Budget & Investment Plan" includes a debt affordability analysis. The report section titled "Existing Debt Burden" cites a 2007 U.S. Census Bureau study that ranked Massachusetts third in the nation in outstanding debt and first in the nation in debt per capita. The report also cites numerous debt measurements by Moody's Investor Services and Standards & Poor's that ranks Massachusetts first in tax-supported debt per capita; second in net tax-supported debt as a percentage of personal income; fourth in total net tax-supported debt and fifth in total gross tax-supported debt.

The A&F report attempts to mitigate these sobering statistics by noting that these figures include certain debt issued by entities other than the Commonwealth for which the Commonwealth is not liable such as the Massachusetts School Building Authority (MSBA). The report also notes that the numbers exclude local debt, which can be substantial in other states that have "stronger county governments and other political subdivisions that issue debt to finance capital improvements." The report observes that "it is safe to assume that Massachusetts would likely rank lower when measuring debt as a percentage of personal income or per capita if both state and local debt were taken into account."

Unfortunately, the numbers do not support this safe assumption. The Beacon Hill Institute used U.S. Census Bureau data for FY 2007 to compare the debt burden of Massachusetts to other states using data for both state and local government. At $89.6 billion in FY 2007, Massachusetts state and local debt represented 28% of state personal income compared to an average of 20% for all states. Massachusetts ranked third, behind Alaska at 35.6% and New York at 28.4%. This outstanding debt represents $13,792 per capita, nearly double the $7,990 average for all states, putting us in second place, again behind Alaska.

The A & F report is technically correct that the Commonwealth is not liable for a portion of the debt, which is issued by entities, such as the $4.6 billion in MSBA debt. In fact, the newly created Massachusetts Department of Transportation holds a large portion of this debt, including debt from the MBTA and Massachusetts Transportation Authority. Moreover, the MBTA debt of $6.2 billion for FY 2009 is no longer subject to the statutory bond cap.

However, it is naive to suggest that the state would not ultimately bear at least partial responsibility for the debts of the MSBA or other agencies in the event of a change in status. I am reminded of the Special Investment Vehicles, or SIVs used by banks to remove risky assets from their balance sheets, which eventually wound up back on the balance sheets of many banks. More recently, European Union member states joined the International Monetary Fund to bailout Greece in spite of the fact that Germany and other European states were not liable for this debt.

Thus, I do not think we can rest comfortably with the notion that the Commonwealth is "not liable" for the debts of these entities. Moreover, I think the debt of these agencies should be included in any future debt affordability analysis.

The Beacon Hill Institute's Competitive Index includes a subindex that measures the state's bond rating against other states. The index has shown that Massachusetts consistently ranks between 22nd and 28th over the past five years. The Commonwealth's middle- of-the-pack bond rating doesn't impinge on the state's ability to remain competitive, that is to say to put in place policies that promote economic growth and sustain high levels of income for its citizens. Massachusetts, thanks to the strength of its high tech, finance and human resources sectors, tops our latest ranking. Nonetheless, our index does show that Massachusetts has room to improve (or stay near the top) and our bond rating is one thing we can control to some extent.

The Economic Impact

In isolation, House No. 4617 would have very little, if any impact on the state's ability to issue bonds or to the state economy. However, the bill would allow the legislature and put off unpleasant budgetary decisions in hopes that the extra time will allow the state budget deficit to shrink with a growing economy. A persistent and large budget deficit may tempt the Legislature to use debt restructuring again and again.

Bear in mind that outside factors come into play: 1) federal fiscal policy and 2) a demographic shift. FY 2012 may prove just as challenging as FY 2011 as federal stimulus money dries up and the 2001 and 2003 federal tax cuts expire. Tighter monetary policy, almost a sure thing given the very loose current policy, could also restrain economic growth.

In the longer term, the state cannot push into the future the payment of its relatively high debts indefinitely. Repeated debt restructuring could risk future downgrades to its bond rating and take place in an environment of higher interest rates in the bond market. Also, debt servicing costs would rise and begin to consume an increasing portion of state resources, inhibiting the state's ability to deliver services in the future.

Notes:

Governor Deval Patrick's Five Year Capital Investment Plan FY2010 - FY2014 "Existing Debt Burden" Administration and Finance (2009) http://www.mass.gov/bb/cap/fy2009/exec/hdebtafford_5.htm (accessed May 3, 2010).

2 Massachusetts School Building Authority Annual Report 2008 – 2009 http://www.massschoolbuildings.org/uploadedFiles/Pressroom/Newsletters/2208.2009_Annual_Report.pdf (accessed May 3, 2010).

3 Massachusetts Department of Transportation, "Stakeholder Briefing," (October 2009) http://www.eot.state.ma.us/downloads/90_DayReport/briefing100609.pdf (accessed May 3, 2010).

Is it something we said?

Massachusetts ranks 47th according to Chief Executive magazine.

Details here.

Tuesday, May 4, 2010

Government failure: Too many vaccines on the shelf

SWINE FLU FOLLIES:
WASHINGTON, May 3 (Reuters) - The United States still has 71 million doses of H1N1 swine flu vaccine that have not been used, but it is not yet time to throw them out, the federal government said on Monday.

States and other providers should hang on to the vaccine and continue to offer them to people until drug companies can start distributing seasonal vaccine for the coming influenza season in the autumn, said Health and Human Services Department spokesman Bill Hall.

Senator Chuck Grassley, the ranking Republican on the Senate Finance committee, released a letter on Monday that he sent to HHS secretary Kathleen Sebelius asking her how much vaccine was left over and when it would expire...

Sebelius said last month that 162 million doses were produced and distributed, but only 90 million actually got into people's arms or noses.


Full article here.

Amazing

How else could we say it?
MANDEL: "We all know that state and local government finances are a mess. This chart helps explain why."

Chart is here.
Key paragraph:
Now, I’m not anti-government, by any means. But this trend is disturbing. In times of crisis and economic struggle, government workers should not be getting bigger pay increases than the private sector. The domestic private sector has really been struggling for a decade, both in terms of job and pay. But the public sector kept paying higher compensation.

The arithmetic is very clear. State and local governments can’t keep funding higher wages and better benefits for their workers, while the private sector struggles. As a wise man once said, you can’t wring blood from a stone. And you can’t ask troubled taxpayers to pony up bigger pay gains for government workers than they are getting themselves.
Hat tip to Marginal Revolution.

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