Ask the Economist: Should we bail out Detroit?
November 20, 2008 by Michael DonnellyPosted in: Ask the Economist, Economy, Government, In this week's e-newsletter, Latest news & views
The financial and airline sectors got a bailout. Defaulting homeowners and other companies are in line. How about GM, Ford and Chrysler?
I say no. But like any good economist, I see two sides to every story.
On one hand, why not? We’re already giving billions to banks who don’t need the money. (They’re still paying dividends and handing out bonus checks.) And we’re giving it to companies who aren’t banks but who’ve decided to become banks just to get in on the fun. (American Express was first.) Next in line are some really smart companies who want some federal money and are now buying distressed banks to become eligible! You can never underestimate American ingenuity.
There’s also the argument that now isn’t the time to get tough. “Lord grant me chastity but not quite yet,” as St. Augustine famously said back in 400 A.D. Throwing another few million out of work may be the right long-term medicine, but it’s ill-advised when a record number of unemployed are already collecting weekly benefits.
Some of the lure to save GM is symbolic — based partly on what GM used to be. No longer is it a $60 stock paying a 50-cent dividend, as it was from 1982 to 2002. Nor does it produce a sizable percentage of total national retail sales, as it did for decades. GM is now a shadow of its former shelf, the title of largest American private employer having long ago been passed.
Others rightly point out that saving GM is in our self-interest. GM has pension obligations to 800,000 retirees. True, but giving GM $25 billion now (and probably more over the next two years) isn’t likely to reduce the impact of the pension liability. Realistically, we’d likely end up giving them $25 billion and take the pensions on anyway.
And there are other arguments for letting Detroit fall victim to its own failures? David Yermack, from the excellent NYU Stern School of Business (1), has a long essay that appeared in the Wall Street Journal over the weekend.
His point:
GM and Ford already burned through $110 billion from 1980-1990. They’ve torn through another $400 billion in the last 10 years. Meanwhile, Chrysler has turned Daimler’s $30 billion infusion into smoke over the last 10 years. In other words, these guys are really, really good at taking billions and blowing them. So why would you give them any more? And the requested $25 billion is a trivial amount to these guys. Experts on Bloomberg news say GM alone was burning $3 billion a month over the summer. They’ll be back for more in mere months.
I’ve got some points of my own.
The current management teams are the same ones that wrecked these companies. Why would you rehire them? Plus, they want to keep making the same product that got them into trouble in the first place.
They continue to fight innovation and progress at every step. In their most recent demand, they said (via the White House) the requirement that the money be spent on converting to fuel-efficient vehicles must be dropped. Why would we entrust billions to them and hope for innovation now? If anything, shouldn’t we give $25 billion to American-made Tesla Motors?
More reasons not to bail out Detroit: It’s a moral hazard and it goes against free market principles. Doesn’t bankruptcy still work in this country? Let them go Chapter 11 and continue to operate. Worried sales might drop? They’re already at 60-year lows anyway.
The New York Times has a must-read article on GM and Chapter 11: “A Bridge Loan? U.S. Should Guide G.M. in a Chapter 11”
Of course, if we do let GM head into bankruptcy, we should be very generous with its employees. Putting an additional million out of work during a recession is dangerous, so you have a choice: Extend unemployment duration, or let them work for it.
Create a public works program. It’s no secret our infrastructure is falling apart. We need to build bridges and roads and hospitals for returning vets. Build mass transit systems, water treatment plants and fix our water systems. Many are 100 years old and rusting away. We also need to install solar panels on every new roof in America to kick our oil and coal habit — plus build more nuclear reactors, and transport the radioactive material we have to Nevada’s Yucca Mountain storage site. Also, human waste is creating massive dead zones in the oceans, destroying the worlds’ supply of fish stock. That issue needs to be dealt with.
Those projects would safely employ all those workers and more, deepen our investment (increase the capital base), add to productivity and improve our lives — certainly a better investment than spending $1-2 trillion in Iraq, or the $1 trillion we’ve spent to date bailing out Wall Street. At least we’d have something to show for our money at the end of the day.
The Daily Beast has a nice summary of both sides of the story as well.
In our weekly “Ask the Economist” feature, our resident Economist, Mike Donnelly, tackles your questions about the economy. If you’ve got a question — and no topic is too big or small — you’d like him to field, e-mail us at economist@pbp.com or leave your queries in the comments section.
Tags: Chrysler, Detroit, Ford, GM, Government bailout, Homeowners
November 24th, 2008 at 1:56 pm
Michael, I agreed with you right up until you got the the massive public works programs, ala FDR. I agree with infrastructure improvements, but I’d shy clear of a public works program. The problem is that Government is notoriously poor at evaluation public worth projects on the basis of ROI. More often they use the greasy-palm method, and we’ve had enough wasteful spending, thank you.
Yes, we need to build bridges and roads and perhaps hospitals for returning vets. Yes, we should water treatment plants and fix our water systems, especially those that are 100 years old and rusting away. (We should have been doing this all along.)
But mass transit systems should be built only where they will be profitable, and I’m not convinced that solar panels on every new roof in America is the most cost-effective way to kick our oil and coal habit — building more nuclear reactors, and spent fuel retreatment centers is already competitive with Coal. Meanwhile drilling for domestic oil will have am immediate impact on jobs and economy, and will also help is become a bit less dependent on foreigh oil.
As for bailouts, there was—and still is—another, far less costly way to correct the credit and mortgage problem, one that will not require any government borrowing whatsoever, and one that fulfills President-elect Obama’s tax promise without any harm to small businesses or employment. The bill is already in Congress.
If enacted, this bill (HR25 & S1025), called the “FairTax Bill”, will immediately solve the current liquidity crisis in the credit markets. Many economists estimate that there are between $10 and $15 TRILLION dollars being held offshore in safe haven countries to avoid United States income tax laws. Enacting the FairTax will bring these moneys flowing back into this country, eliminating the credit crunch immediately.
More information may be found at http://www.fairtax.org, but, in a nutshell, the FairTax bill proposes the following changes to our Federal Tax code:
1. No Personal Income Tax.
2. No Social Security Tax (This program will continue to exist but will be funded from general tax revenues.)
3. No Medicare Tax (This program will also continue to exist and will be funded from general tax revenues.)
4. No self-employment tax.
5. No Corporate Income Tax.
6. No Capital Gains Tax.
7. No “Death” or inheritance tax.
8. No Gift Tax. (In other words, NO INCOME TAXES of any sort whatsoever.)
9. All these taxes will be replaced by a National Retail Sales Tax on new goods & services of 23% – i.e. of a $100.00 purchase, $23.00 will be tax, and $77.00 will be product/service cost. (Tuition is exempted, as it is considered an investment, not a service.) Studies have shown that the 23% tax rate will be revenue neutral and raise the same amount of money as the current tax code.
10. Furthermore, to defray costs to the poor & keep this tax progressive, each household will receive a monthly refund, in advance, of the taxes they would pay for their spending up to the Federally-defined poverty level, (adjusted to eliminate a marriage penalty). For example, a household of four will receive a prebate of $537.00, which is the monthly tax they would pay on $28,000 in annual purchases.
The FairTax proposal represents a paradigm shift in tax policy and has numerous benefits to American society, including:
• The FairTax is the only taxation plan that COMPLETELY UNTAXES the poor. Even a person with a zero percent Federal income tax rate today must pay payroll taxes on the first dollar they earn. They also pay the federal taxes and compliance costs now hidden in the prices of everything they buy. Under the FairTax, however, no American family pays ANY TAX on the basic necessities of life (as defined by the Federal poverty level).
• The FairTax is far more progressive than the current income tax system. With a GINI score of 0.62, it is even more progressive than your own tax proposal. This is because the FairTax eliminates single most regressive element (the FICA payroll tax) for the poor and middle class wage earners, while improving funding for these important programs by basing them on general tax revenues. Under the FairTax, low-income households will experience five times the benefit increase as high-income households. Indeed, with the prebate, no-one spends so much as a penny in taxes for spending up to the poverty level, and people below the poverty level even receive extra money.
• The FairTax is Simple – It removes the IRS and the 67,500 pages of tax code, as well as the estimated $265 billion spent yearly in tax code filing and compliance. No more complex tax code, no compliance costs for individuals. Every American keeps their entire paycheck (there is no Federal withholding whatsoever), and nobody has the hassle of filing taxes every April 15th. The FairTax removes not only the income tax, but also the regressive FICA, Medicare, capital gains, death taxes and payroll taxes. (Note again, these programs are NOT ELIMINATED; only their funding method is changed.)
• The FairTax is Fair – Under the FairTax, there are no more special interest exemptions, no more tax loopholes. Every American is treated the same.
• The FairTax is Transparent – Under the FairTax, there are no more taxes or compliance costs hidden in the purchase price of goods & services. Citizens will see exactly what their government is costing them. The FairTax will thus create transparency in government and achieve lobbying reform by removing the tax code as a means for Congress to punish enemies and help friends.
• The FairTax stops the export of jobs overseas and puts American businesses back on a level playing field with their foreign competition. Our current income tax structure actually favors imports over U.S. production. Most foreign products reach our shores free of the country of origin’s tax to compete with domestic products that retain the US embedded tax. Conversely, the embedded tax on domestic products are NOT rebated when they leave our docks. Since the FairTax has NO corporate component, our companies will once again be on a level playing field.
• The FairTax completely untaxes education. The FairTax rewards education and upward mobility in the simplest and most powerful way: It eliminates tuition from all federal taxation.
• The FairTax provides a huge boost to the American economy and key sectors such as manufacturing.
• The FairTax shores up Social Security, Medicare and Military funding by creating a larger base of payers including tourists and travelers, not just current tax payers. It will also tax illegal immigrants and much of the underground economy for the first time ever.
• The FairTax will bring jobs back home by making the US the worldwide magnet for capital and investment. As I mentioned before, there are literally trillions of dollars that will flood into this country to create the largest economic boom you could ever imagine. With this money, we can completely retool the American economy to compete in a 21st-century economy.
• The FairTax gives individual control back to the American citizen. People will be taxed only when they spend, not when they work or invest.
• The FairTax promotes the American Dream. The FairTax will make home ownership more affordable because used homes will be totally untaxed, and three out of four homebuyers buy used homes.
• The FairTax is revenue neutral. The FairTax, at a 23 percent tax rate, raises the same amount of money for the federal government as today’s complicated income tax system. This means that steep budget cuts are not required to pass meaningful tax reform.
• The FairTax is the only plan that does not target the fruits of labor or encourage debt, but rather taxes every dollar of accumulated wealth in the most efficient way possible - when it is spent. With no Corporate tax component embedded in the cost of purchases and with the prebate, the FairTax is truly a tax that only affects the rich.
• The FairTax sales tax rate isn’t graduated, which means everyone is treated the same. Everyone’s resources get taxed at the same 23 percent effective rate. What makes the FairTax progressive is its rebate. The rebate is a trivial share of the resources of the rich, but 23 percent of the resources of the poor—a massive benefit. Since our current payroll tax system is regressive, adopting the FairTax will achieve progressivity.
November 24th, 2008 at 3:47 pm
Under your plan would medical expenses like health insurance premiums, perscription drug co-pays, doctor visit co-pays, medicare B premiums, medicare D premiums and suplemental insurance premiums be taxes?