This I hate to hear.

Joseph E. Stiglitz, professor of economics at Columbia, awarded the Nobel prize in economics in 2001, writes in the NYT about the Obama administration’s $500 billion or more proposal to deal with America’s ailing banks, “The Geithner plan works only if and when the taxpayer loses big time.”

Stiglitz says, “What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a ‘partnership’ in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.”

He says, “We are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.”

Excerpts from the article:

• Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency.
• In theory, the administration’s plan is based on letting the market determine the prices of the banks’ “toxic assets” — including outstanding house loans and securities based on those loans. The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets. The two have little to do with each other. The government plan in effect involves insuring almost all losses.
• Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!
• Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That’s 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest — $12 in “equity” plus $126 in the form of a guaranteed loan.
• If, in a year’s time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.
• With the government absorbing the losses, the market doesn’t care if the banks are “cheating” them by selling their lousiest assets, because the government bears the cost.

Amy Forsthoefel sent me this e-mail message:

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I received a prompt reply from Zach Schiller to the e-mail I sent to him yesterday as reported — Question For Policy Matters Ohio, Zach Schiller: Was Tax Data Used In Your DDN Article Incorrect?

Schiller had written in a DDN article that if Ohio’s 2005 Tax Reduction Law was modified, to reinstate the top income tax rate of 7.5% on incomes over $200,000, that Ohio would gain $375 million each year in additional revenue. I objected to this statement because I’ve been posting that that correct amount of additional revenue would much more than $375 million. I estimated the amount of reduction to be $572 million — if the top rate was applied to incomes over $340,000

I’ve written a number of posts that used the Ohio Policy statistic that incomes in excess of $340,000 received 26% of the total of tax reductions of $2.2 billion ($572 million).

Schiller pointed out my mistake. When the top rate of 7.5% is reinstated on incomes over $200,000, the Tax Reduction Act still applies to incomes less than $200,000 and these incomes will still get a 21% decrease in tax. Someone earning $250,000, for example, would pay additional tax only on the $50,000. Reinstating the top 7.5% rate would mean that for every $10,000 of income over $200,000 an additional tax of $157.50 would be required. If the 7.5% tax was reinstated, a taxable income of $250,000 would need to pay $788 in additional Ohio taxes.

In my new e-mail to Schiller, I ask for an explanation for how the $375 million was calculated. My estimate was much too large, but, it seems to me Schiller’s number is too small.  Based on an earlier Policy Matters article (p. 6 chart), it still seems to me that the accurate amount should be much greater than $375 million. I’m wondering if I’m making some other dumb mistake.  Here is the e-mail that explains my reasoning:

Zach, thanks for the reply.  You point out that in my thinking I made a fundamental error. According to Honeck’s chart, the top 1% of incomes received 26% of  the total tax reduction of $2.2 billion or $572 million.   My error was that I didn’t account for the fact that if the top rate of 7.5% for incomes in excess of $200,000 would be reinstated, then, of course this top 1% of incomes — incomes in excess of $339,000 — according to the 2005 Tax Reduction Act, would still have taxes on the first $200,000 reduced by 21%.

But, it seems to me that Honeck’s chart indicates that if the 7.5% top rate would be reinstated on incomes in excess of $200,000, then a lot more than $375 million would be recouped.

Look at only that top 1% of incomes.  According to Honeck, this group starts at incomes of $339,000 and the average income for this group is $890,000.  If the top rate of 7.5% were reinstated only for this group, then, on average, the new tax would be .075 x (890,000 – 339,000) = $41,325.  The 2005 Tax Reduction Act reduced this by 21% or $8678.   So reinstating the 7.5% top rate would mean that, on average, $8678 of the  $10,273 current average tax savings for these top incomes (Honeck’s chart) — 84.5% —  would be recouped.

If 84.5% of the tax reduction for incomes in excess of $339,000 is recouped, then, according to the above, this would amount to 84.5% of $572 million or $483 million.

I think a good recommendation to the State Assembly would be that a new tax bracket be made that would reinstate the 7.5% tax rate for only this top 1% group.  The public would be much more willing to reinstate the 7.5% top rate on incomes in excess of $340,000, rather than reinstating it on all incomes in excess of $200,000.

If the 7.5% top rate would be reinstated on taxable incomes in excess of $200,000, rather than $339,000, according to Honeck’s chart, according to the reasoning above, the amount recouped would be much more than the $375 million that you cite.    (I don’t have the data to calculate how much would be recouped on incomes from $200,000 to $339,000.)

Any enlightenment you can give to all of this will be appreciated.  Thanks.