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Economic Reporting Review

June 19, 2000:

Estate Tax Repeal; Growing Trade Deficit; Rising Housing Prices

By Dean Baker

Budget and Taxes | Trade | Housing | India | Japan | Argentina | Outstanding Stories


"House Approves a Bill to Repeal the Estate Tax"
Richard L. Stevenson
New York Times, June 10, 2000, page A1

This article reports on a vote in the House of Representatives to repeal the estate tax. At one point the article presents arguments both for and against the repeal. One of the arguments attributed to critics of the tax is that "it allows the government to tax money that has already been taxed at least once, as personal or business income."

In fact, many of the largest inheritances have never been subject to personal income tax, since individuals only pay tax on capital gains when they are realized. If Bill Gates were to pass on his estate tomorrow, and the estate tax did not exist, the vast majority of his income would have never been taxed, since it results from capital gains on his holdings of Microsoft stock.

The article then presents an account of a "37-year old entrepreneur," who claims to be paying $35,000 a year in life insurance premiums, so that if he dies, his children will have the cash to pay his estate taxes without having to sell off part of his business of eight supermarkets in inner-city neighborhoods. The entrepreneur goes on to claim that this is not an issue just about the rich, because if it were, it would not apply to him.

The estate tax exempts small businesses worth up to $1.3 million. If this entrepreneur's business is valuable enough that it warrants paying a $35,000 annual insurance premium, than it must be worth well in excess of $1.3 million. (The tax rate is 35 percent on the portion of the estate that exceeds the exemption.) If his business is worth $2 million, then the total tax would equal just seven years of insurance payments. A worth of $2 million would place this person among the richest 1 percent of the population, with more than 30 times the wealth of a typical family. By most definitions, this would be considered rich.

The article also refers to President Clinton's opposition to the repeal of the tax. He apparently claimed that the repeal was too expensive at a time when the nation faced pressing needs such as "ensuring the solvency of Social Security and Medicare." The Social Security system is projected to be fully solvent for the next 37 years with no changes whatsoever, while Medicare is projected to be solvent for the next 22 years. Dealing with the distant and possibly non-existent shortfalls in the funding for these programs can hardly be termed a "pressing need."

"Bush and Gore Revise Plans to Match a Growing Surplus
Richard L. Stevenson
New York Times, June 13, 2000, page A1

This article discusses the latest plans for spending and tax cuts by the presidential candidates, now that it appears the size of the projected surplus will be larger in the next report from the Congressional Budget Office. At one point the article presents the assertion from economists at Credit Suisse First Boston that "massive surpluses and retirement of Treasury debt are 'baked in the cake' almost no matter what the economy does over the next 10 years."

The most recent budget projections assume that the government will collect nearly $1 trillion in capital gains taxes over the next 10 years. If the ratio of stock prices to corporate earnings returns to its historic level, then stock prices will fall by close to 50 percent. Under these circumstances, capital gains tax revenue would be reduced to almost nothing. This would significantly reduce the size of projected surpluses. A stock market crash is also likely to lead to a severe recession. This would substantially reduce the size of future surpluses as well.



"Economy May Have a Soft Spot: Swelling Trade Gap Worries Some Experts and Policy Makers"
Richard W. Stevenson
New York Times, June 10, 2000, page B1

This article discusses the growth of the United States trade deficit, which was running at an annual rate of more than $330 billion in the first quarter of 2000. While the article presents a useful examination of a largely neglected problem, it is inaccurate on several points.

The most important inaccuracy is that it misrepresents cause and effect in discussing the trade deficit. It states that the primary cause of the growth in the deficit has been rapid economic growth in the United States. It then comments that "foreign companies and investors have been happy so far to finance the deficit by recycling the dollars they earn through trade back into the United States."

Since 1997, foreign investors have placed hundreds of billions of dollars into the United States, raising the value of the dollar by close to 20 percent against foreign currencies. The rise in the value of the dollar has made imports much cheaper for people in the United States, and made U.S. exports far more expensive for people living in other nations. A trade deficit in the United States cannot be the cause of foreign money entering the country. The causation goes from the inflow of money to the trade deficit.

When it discusses the sustainability of the trade deficit, the article implies that if the rest of the world starts to grow more rapidly, then the deficit can come down to manageable levels. At present, the United States is borrowing close to 4.5 percent of its GDP from abroad, or $450 billion a year. This level of borrowing cannot be sustained for long, just as a federal budget deficit of this magnitude could not be sustained for long. It is difficult to describe a plausible scenario where the deficit will be reduced to manageable levels simply through more rapid foreign growth. (See "Double Bubble: The Implication of the Over-Valuation of the Stock Market and the Dollar," by Dean Baker, To bring the trade deficit down to manageable levels, either the United States economy will have to sink into a recession or there will have to be a decline of 20-30 percent in the value of the dollar.

At one point the article comments that the U.S. budget surplus is "providing a substantial cushion for the economy" against the effects of the trade deficit, as compared to the '80s when the government was running a large deficit. It is not clear what is meant by this statement, since there is no obvious way in which the budget surplus provides any cushion at all against the effects of the trade deficit. If the nation had a very high savings rate, then it could provide a cushion to cover foreign borrowing, but the shift from a government deficit in the '80s to a surplus at present has been completely offset by a decline in private savings. National savings, measured as a share of GDP, is slightly lower at present than it was at the peak of the business cycle in the '80s.

The article also wrongly implies that the Federal Reserve Board does not have discretion over its monetary policy, asserting that if the dollar begins to fall and this causes inflation to rise (because of a rise in the price of imports), "the Fed is forced to respond by driving interest rates sharply higher." If the Federal Reserve Board raises interest rates under the circumstances described in the article, it will be a policy decision. It will never be "forced" to raise interest rates because of a fall in the dollar.

More about Trade.



"Tech Boom Fuels Rising Home Costs
George Lardner Jr.
Washington Post, June 12, 2000, page A1

"Home Prices Are Out of Reach for Many
Michael Janofsky New York Times, June 12, 2000, page A20

These articles discuss a study released by the Department of Housing and Urban Development that found rapid increases in housing prices are making housing unaffordable for many of the nation's workers. Both articles attribute the run-up in housing prices to the boom in high-tech industries.

It is worth noting that the run-up in stock prices, apart from the actual growth in the high-tech industry, has been a major factor leading to the rise in housing prices. When people have large gains in the stock market, they are willing to pay more money to buy a house. In this sense, stock market gains for some people have come directly at the expense of others, making it more difficult for millions of workers to buy or rent homes. When the stock market rises for reasons not related to more rapid overall growth, it implies a redistribution of wealth, not a net gain to society.



"Market Economics: Chicken Shows the Difficulty of Exporting Food to India"
Celia W. Dugger
New York Times, June 14, 2000, page C1

This informative article reports on the efforts by U.S. poultry processors to have the tariffs on imported chicken in India lowered, and the opposition to tariff reduction within India. At one point the article notes that "many economists, including those at the World Bank, argue that India should quicken its integration with the global economy as the best path towards lower prices, economic growth and millions of new jobs. Countries in East and Southeast Asia that have moved quickly have had the greater success in reducing poverty, they say."

Actually, the countries in the region that have had the most success in improving the living standards of their population are ones that have maintained extensive government control over the economy such as Taiwan, South Korea, Thailand and China. These economies have routinely been denounced by economists (including some at the World Bank) for their "crony capitalism."

It is also worth noting that the chart accompanying this article is somewhat misleading. As a measure of a nation's openness the table presents the ratio of trade to GDP. This measure will to some extent reflect the size of trade barriers, but it also is affected by the size of the nation. By this measure a very large nation like India or China (or the United States), which has the capacity to be largely self-sufficient, will appear much more closed than nations like Thailand or South Korea, which must import many of the products they need for domestic uses.

More about Asia.



"Japanese Economy Rose 2.4 Percent in Quarter"
Stephanie Strom
New York Times, June 10, 2000, page B2

This article discusses the Japanese government's release of data for first quarter GDP growth. The article misrepresents Japan's actual growth rate in both the text and an accompanying table which shows quarterly growth since the beginning of 1996. The article reports that the economy grew by 2.4 percent in the first quarter of 2000. In fact, this is an annual rate of growth, as is the case of the other numbers for quarterly GDP growth shown in the chart. It would be extraordinary for a nation to have 2.4 percent GDP growth in a single quarter. This would imply an annual growth rate of 9.6 percent.

More about Asia.



"One-Day National Strike Freezes Much of Argentina"
Clifford Krauss
New York Times, June 10, 2000, page A3

This article reports on a strike staged by Argentina's labor unions to protest the austerity policies being imposed by its government at the insistence of the International Monetary Fund. The article notes that Argentina's economy is expected to show little growth this year, after shrinking last year. It comments that "with its currency tied to the strong dollar, Argentina lags behind its neighbors in exports."

It is important to recognize that this is a predictable result of Argentina's decision to tie its currency to the dollar. While there are beneficial effects of such a linkage, most importantly a stable inflation rate, this linkage prevents Argentina from matching de-valuations in the currencies of its major trading partners. It also means that Argentina will be subject to the contractionary effects of the Federal Reserve Board's high interest-rate policy, even as it tries to recover from a recession.

Past articles have written positively of Argentina's decision to link its currency to the dollar. The negative consequences Argentina is now experiencing is one of the reasons that other nations have not chosen to go this route.

More about Latin America.



"Small But Uncertain Indications That the Economy Is Slowing"
Louis Uchitelle
New York Times, June 14, 2000, page C1

This article examines evidence that the economy has been growing at a slower rate over the last two months.

"Hidden Costs of Stock Options May Soon Come Back to Haunt
Gretchen Morgenson
New York Times, June 13, 2000, page A1

This article examines some of the problems that will be facing corporations which have relied heavily on stock options as compensation for their employees. It notes that because of the favorable tax treatment of options, both Microsoft and Cisco Systems are likely to escape any tax liability this year. The reason for this is that companies are allowed to deduce the value of exercised options from their profits for tax purposes. By this method of calculating corporate profits, both companies are likely to report losses this year. As these corporations move away from stock options, or their options become less valuable, they will have to pay higher wages to their employees and will face large tax burdens in the future.


Dean Baker is an economist and the co-director of the Center for Economics and Policy Research (CEPR). His latest book (co-authored with Mark Weisbrot) is Social Security: The Phony Crisis (University of Chicago Press). ERR is a joint project of FAIR and CEPR.

ERR is edited by Jim Naureckas.

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