economic stimulus (2): focus on income and equity

November 1, 2008 | Vetting explained

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Last updated: November 2, 2008

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In order to have the consumer return to spending, the income/cost gap has to be addressed swiftly. I have established in my previous article that falling incomes and rising home values and other cost have led to consumers being DISABLED from spending. This phenomenon is fundamentally different from any recession or downturn that we have seen in the last decades, where consumers kept on spending through bad times. Banks have shifted how credit and assets are valued to a healthier, more prudent way, from an irrational "free credit for all" attitude. The "free-ride" economy won't return for a generation to come. The disaster has to be wiped from memory until our children walk obliviously into the same trap again. Four income/cost factors of the consumers are pretty much under government influence, if not control: * taxes * interest rates on credit * health care cost * minimum wage * energy would be a fifth element for countries that raise energy taxes The basic proposal is to maximize the consumers' disposable income while taxing the actual consumption and providing incentives to build equity similar to subsidized home equity plans throughout Europe. Why can't we let the markets sort it out? Markets work well as long as everything is within "normal" ranges. If things heat up, people get greedy and create bubbles. If that is not addressed by governments early on (we all enjoyed the party), the bubble pops. This time around, a domino of bubbles pops and leads us into a situation where the self-interest is destructive for the economy as a hole. The market fails (never mind, I am a Capitalist). The risk of letting the markets sorting it out is widespread social unrest and poverty. The risk of governments addressing the downfall is that measures that are not clearly targeted might aggravate the situation or, even if they are targeted, they might not work and the society might end up in the same disaster. In this case, however, the cause can be identified and can thus be repaired. In order to get consumers back to spending, they have to be relieved from their credit deadlocks and, at the same time, their disposable incomes have to be adjusted to compensate for equity building. Just how big is the problem (note: I play with rough numbers for the big picture not to get entangled in complex numbers)? * the average American's income/spending gap is about 14% in order to get spending and saving in balance * its overspending gap is about 13% * the total spending gap is about $1000/month for average Americans or a whopping 27%, and that's without a rise in unemployment factored in. 1) income tax In other words, cutting all income taxes and replacing them with a 20% sales tax is not enough. That takes about $300 a month of the burden. However, it puts the consumer into a position to start thinking about how to balance spending and saving. Thus, number one measure is to replace the individual income tax altogether with a 20% sales tax, including services, excluding food. A universal sales tax, split between state and Federal Government is easy to implement through states. Most of them have those processes already in place and the Federal Government can receive a monthly check of its 12 point share minus half of the states' administrative cost. The other states can copy proven systems from other states and most of the federal infrastructure can be either transferred to states or shut down. The biggest effect however, would be coming from wealthier people that would have to stop worrying about evading their income from the state. It would probably lead to a massive (re)influx of hidden investments into America. I am going to address corporate income taxes in my article "be globally the most competitive". Much more is needed. 2) Interest rates on credit It seems that JPMorgan, after being forced through a settlement, is leading the way and uses the financial tools to contain the losses with mortgages. They can simply adjust interest rates for their customers, where it makes sense, and they can refinance cheaply. I understand that they don't do it in grasp of a trillion dollar bounty. Government guarantees are more gifts for banks, and they will do nothing to change the banks' merciless and irresponsible attitude. Banks will let homeowners default in order to collect the guarantees. The Fed has done its part and cut the interest rate. Apparently, the banks need to be mandated to do their part to make sure that the adjustable rate mortgage (ARM) interest rates come down in a hurry and that they sweep up the mess with the roughly $1 trillion mortgages that are delinquent or in foreclosure. Some losses are to be expected and are part of business as usual, in particular where high risk mortgages were provided in the first place. As a regulator, I would step up and say: "I give the financial system ONE week to come up with a refinancing plan and commit to it. If not, the government will mandate interest spread caps* and mortgage rules quickly." The banks understand that language very well (check * below if you don't). 3 million mortgages are estimated to be subprime. Around $500 billion mortgages per year are switching from fixed rates to the more expensive floating rates. This contributed gravely to the income/spending gap and caused houses to be less affordable and homeowners to default. Now, with proper government direction, ARM rates have to be down and there is time to switch homeowners to affordable fixed rate mortgages. The same scenario accounts for all other consumer credit: Fix it fast or it will be mandated. This won't cost the government much over and above the irrational bailout money that is already spent. The banks can choose between having $2 trillion mortgages in foreclosures and lose a lot of it or change the practice of kicking people out of their homes to adjusting. Maybe that does cost the banks $50 billion a year, maybe less. The impact for the average consumer would be about $300 per month. We are still short $400. 3) health care cost As Americans, we think that we are a FREE people, but we forget that freedom does not come free. A sick person is not free. Individual liberty requires individual responsibility for yourself and for safeguarding the common liberties. The fundament to individual liberty is clean water, basic health, basic old age protection, basic education, the right to associate, the right to think and speak out WHATEVER it may be (including religious believes) as long as it is responsible, and the freedom of the media to express their views in a "balanced" way. If health care hits home at $800 for a family per month, we have a problem, and we also have an opportunity. BASIC (I say "basic") health care should be no more than $100 per month for a family. However, in return there should be substantial deductibles for using the health care system (with life-threatening chronic illnesses excluded). Thus, basic health care should be public, not socialized. For example, America's neighbour Canada spends just under 11% of GDP for health care, while the U.S. spends 15% or an incredible $7439 per person and year. In other words, there might be something to learn from a system that is providing BASIC public health care at $100/month for a family and that relies on private businesses and employers for extended health care. Quite frankly, Americans going bankrupt because they're sick is a disgrace. If we factor in extended health care for the average American, the monthly cost would probably be close to $500 instead of $800. We are still $100 short. 4) minimum wage If you are amongst those millions of Americans that are working 3 jobs and still don't manage, you probably see yourself in a state of Slavery, which we were supposed to have abolished after the Civil War. Somehow, we have managed to "trickle down" slavery right back into American's daily lives. The minimum wage needs to be raised such that a hard working person does not remain poor and can somehow make a decent living. Raising the minimum wage from an average 8$ an hour to 10$ hour would boost the salaries of over 2 million workers by 25% and probably 5 million workers by around 10 %. Just what does a $10 job mean? It translates to under $1800 a month. There is no way that somebody can even exist comfortably in the United States where one single day in legal fees is double that. I think that the minimum wage should, in a second step a year later, increased to $13 an hour. I expect some fallout in unemployment from that step. Those people will need to be swooped up, and I will address that problem in one of my next articles. That should do the trick to close the income/cost gap relatively quickly. If you are amongst those that think that these combined approaches are a little to bold, let me scare you a little bit and remind you that rising unemployment is not even a factor in the above line of thought. The situation is getting worse by the day and companies will stay in line to announce more layoffs of hard working Americans. CEOs have the perfect excuse to cut their work force fast, a Recession turning Depression. There will be no shame involved. Home equity building However, we want to make sure that the $500/month that are meant to go into equity, have enough incentives to be placed there and are not spent on a spree. Many European countries have home equity building plans. Such plans are very popular and the government can provide incentives for accelerated saving. For example, it can provide a home equity subsidy for long term equity plans. The banks that accept home equity building plans would need to pay the same amount in interest that they would have to pay for financing through bonds and the government could add an extra 25% or so. There are a couple of conditions to this. Firstly, this plan would be limited in time until the problems have sorted out themselves. Secondly, the money can be pulled for homes, education, or for health cost only. Before looking into how to sweep up the unemployed, I am going to talk about risks that are looming uncontained in the financial system. This article is part of a series of articles focussing on what local, state and federal governments need to do now in order to address the upcoming economic Depression. economic stimulus (1): the disabled consumer at http://www.ireport.com/docs/DOC-132064 economic stimulus (2): focus on income and equity at http://www.ireport.com/docs/DOC-132067 economic stimulus (3): quarantine risk at http://www.ireport.com/docs/DOC-132200 economic stimulus (4): sweep up the unemployed at http://www.ireport.com/docs/DOC-132202 economic stimulus (5): bailout state governments at http://www.ireport.com/docs/DOC-132205 economic stimulus (6): protect food and energy supply at http://www.ireport.com/docs/DOC-132795 economic stimulus (7): invest into the future at http://www.ireport.com/docs/DOC-132856 economic stimulus (8): be globally the most competitive at http://www.ireport.com/docs/DOC-133022 economic stimulus (9): change politics at http://www.ireport.com/docs/DOC-133026 economic stimulus (10): prepare for budget cuts at http://www.ireport.com/docs/DOC-133113 Please comment. I will try to address questions, if I can. H.R. Tschudi, economist and entrepreneur, Vancouver *an interest spread cap is a limit on how many points in interest a bank is allowed to charge over and above the Fed's financing rate, depending on the type of risk

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