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Iowa Impact of Fiscal Cliff Deal

posted on January 4, 2013

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Compromise plateau.  Midwest economists assessing the effects of moving away from the fiscal cliff.  Perspective from Creighton University's Ernie Goss and Iowa State's David Swenson on this edition of Iowa Press.

Borg: By now, most Americans know the term fiscal cliff very well and most are sick of it, sick of it because the congressional impasse was colliding with holiday festivities and causing most taxpayers fiscal heartburn.  Economists such as Creighton University's Ernie Goss and Iowa State University's David Swenson are factoring that congressional action now into their ongoing assessments of Iowa and Midwest businesses and consumers and forecasts for what might be ahead.  And we've asked them to share their insights today.  Gentlemen, welcome back to Iowa Press.

Thanks, good to be here.

Borg: And Mr. Swenson, you brought along a lot of notes.  I don't know whether we're going to have time for all of those notes.  We want to get in some questions too.  Across the table, Des Moines Register Political Columnist Kathie Obradovich and Radio Iowa's News Director Kay Henderson.

Henderson: Gentlemen, on Friday morning the government announced that the unemployment rate for December was 7.8%.  The economy created something like 155,000 jobs.  Mr. Goss, as a snapshot, what does that tell us about the U.S. economy?

Goss: It tells us that things haven't changed much.  We're still growing but growing very slowly and not enough to really bring down the unemployment rate.  Five years ago we would never have accepted 7.8% unemployment and now that's okay, we're going in the right direction.  We are but, boy, we may not be there where we want to be in my lifetime.  Maybe in my daughter's lifetime perhaps.

Borg: Where is that?  Where do you want to be?

Goss: Between 4% and 5% on the unemployment rate.  I'd like to see -- right now we should be seeing, in my judgment, 200,000 to 300,000 jobs a month.  We're seeing 155,000.  That's what we saw this month.  We have averaged about 140,000 jobs a month.  And all of a sudden we're being told we have to accept this, this is the new normal.  I don't think -- I think we're all of a sudden accepting it.  I don't think we should accept it.  We're told, well, we're going to be like Japan, the lost decade.  Well, we may in fact be that way but we don't have to be that way.  We could take some policy steps that I think would move us in the opposite or at least give us more positive growth in my judgment.

Henderson: We'll ask for some of those policy prescriptions later.  Mr. Swenson, if you could weigh in on this.  Iowa's unemployment rate of course is far below the national rate of 7.8%.  How does Iowa stack up in your view when it comes to the employment situation and the workforce?

Swenson: Sure. Early in this recession -- early in this recession we looked a lot better than the nation.  We went into recession a little bit later.  We seemed to not lose as many workers as rapidly as the nation.  But once we went in we dropped and we started to emulate and behave like the nation.  We look better but we had less slack in our workforce.  We have historically had a lower unemployment rate because we have historically had out migration of our skilled workers.  So our skilled workers have done us the favor of being unemployed elsewhere.  And so Iowa can only hold so many workers and it typically has a lower unemployment rate. 

Swenson: Back to something though that Ernie was talking about.  We have some demographic changes that we have to factor in when we think about unemployment rates and the workforce and what is acceptable and what is not.  Right now we have people exiting the workforce at an accelerated pace, baby boomers like me, like Ernie are accelerating our departures and the replacement coming in isn't as great as the number going out.  So the definition --

Borg: Are you speaking the nation as a whole or can you say that is accelerated or exacerbated in Iowa because of our demographics?

Swenson: Right, nationwide it is that way and it is worse in Iowa because we have a more difficult time holding onto our young adults.  And we have a disproportionate relative to the nation component of our population, that is elderly or going to be elderly.  So those factors do influence what becomes the new normal for the unemployment rate or the ratio of workers to the population over the next ten years.  It's going to be different than what it was in the last ten years irrespective of the recovery.

Goss: But 7.8% is still unacceptable.

Swenson: I don't disagree with that but I don't know that we can get down to maybe 4% and maybe 5% is something we're going to have to live with and limp along with for quite a while.

Obradovich: What do you think the new normal is going to be?  What does the new normal look like?  And are there things that have to happen before we get there?

Swenson: Well, I'll tell you one of the new normals is an incredibly slow recovery.  We used to bounce back more rapidly.  It might have been eighteen months.  It might have been thirty months.  The last recession, not this one we're getting out of, took almost five years here in Iowa.  This one we're still limping along and we don't look at recovering for maybe two years more until we had our pre-recession employment levels.  So one new normal is relatively sluggish growth and I don't know anything out there right now that suggests that that is going to accelerate, neither a policy nor a technology nor any set of business behaviors don't seem to suggest that we're going to accelerate.

Obradovich: Mr. Goss, do you agree with that?  And add into that how does that affect the overall picture for 2013?  Are we talking about another year of just incremental change?  Or are there things that could accelerate recovery?

Goss: Well, maybe I'm living in fantasy and Dave is the realist here.  I'm sure we could take some steps and Dave understands, perhaps I think would agree with the steps and maybe he's just saying those steps won't be taken.  Fundamental tax reform.  You will not find an economist, I don't think you will, that wouldn't say we need fundamental tax reform.  That would be something like Simpson-Bowles.  That is already out there.  It's on the table.  It has been discarded by almost everyone which means it might be good for us.  Let's do fundamental tax reform.  On the issue of age, that is also in Europe, that's also in Japan.  You've got areas that are undergoing significant deceleration because of a lack of young people coming into the labor market.  26% of us are baby boomers.   We need some new ones coming in behind and also change the immigration policy.  Let's have an immigration policy that makes more sense for economic development.  We're now -- we have men and women that are here when they graduate from Iowa State or Creighton they are being sent home.  That doesn't make sense.

Borg: Let's go back to that statement, fundamental tax reform is what the nation needs.  Did we get any of that fundamental tax reform in the most recent compromise by the Congress?

Goss: I would say we got the opposite.  We have -- Dave and I were talking about this earlier -- that we got little bits of give Hollywood this amount of money, let's give alternative energy this, let's give educators that.  No.  We're getting into everybody is an interest group now.  We're out there lobbying instead of mining for natural gas and mining for oil and so on we're mining for tax credits, mining for tax benefits and this and that.  It's not healthy economics in my view.

Borg: Do you agree, Mr. Swenson?

Swenson: Oh, I agree that fundamental tax reform is important.  It's distorting and --

Borg: But what about the effects of what was just passed?

Swenson: Oh, with regard to the effects of what were just passed, first of all the only thing that changed was on the top 1.5%.  They are paying -- let's get real -- just a little bit more, just a little bit more relative to what they were going to pay last year.  So the impacts on the economy aren't that big.  Most of the rest of us aren't going to see much of a difference.  We are going to see of course a reduction in consumption because of the payroll tax increase.  We are subject to the payroll tax, that 2% tax holiday has been taken away.  That's going to have an impact.

Borg: And that was the amount that was suspended for a while that would be going into Social Security.

Swenson: Right.  And we have to repay that one way or the other.  It was a tax holiday and now we're going back to the existing law to pay what we should be paying.  Overall, most of us aren't going to see a tax increase besides the payroll tax increase.  But with the payroll tax increase we are going to consume less.

Borg: So that says there will be an effect then on consumer spending.  This is what you're saying?

Swenson: Yes, oh of course and it is going to be literally 2% of taxable payroll and that is going to contract the economy some.

Henderson: Another part of that deal was a temporary extension of the current farm bill.  Mr. Goss, does that provide enough certainty to bankers who are working with farmers who are paying tens of thousands of dollars to buy seed and fertilizer for the growing season?  Or is there too much uncertainty for the banking community in farming right now?

Goss: I think the tone of your question, Kay, tells me you know the answer which is no, there's not enough certainty.  We keep pushing -- we don't have five year plans and one year plans, we have monthly plans that have to change because we don't know what is going on.  The farm bill now has been pushed out until September.  We'll have to have some answers and some reconciliation between what is in the House bill and the Senate bill.  And how can one take action?  Again, there are some changes that we can make that would grow this economy, that would take that uncertainty out, that Monsanto, for example, if you're talking on the company side what their sales might or might not be.  But the farmer, the banker about lending, we're talking about uncertainty rising significantly and that's not good.

Swenson: In the short run, in the short run it is a modicum of certainty for farmers because we're going out into September, it's going to be current law, they already know what that's like and it's not going to affect. But farther down the road what does it mean?  What does it mean for the farm economy?  What does it mean for those industries that either feed into or feed off of the farm economy?  Those types of things will be determined by the next farm bill and there's a huge gap between the Senate and the House right now in terms of what that is going to be.

Henderson: So sort of what I hear you saying is that it's going to help farmers get a crop in the ground but it's not going to help them make investments or buy additional land or things like that?

Swenson: Or guide strategic decisions one way or the other as to what they produce, how they produce, when they produce.

Henderson: Because, Mr. Goss, farm equipment sales have been through the roof.  

Goss: Absolutely.

Henderson: Is that going to grind to a halt?

Goss: They haven't thus far.  Surveys, we do a monthly survey of bank CEOs and Iowa is in that survey.  They're still running strong.  But we're now looking into some issues, the drought even though we have snow out there all of us who live in this part of the country understand the drought continues.  Then you've got the Mississippi that is down to record low levels in terms of barge traffic down there.  And we've got the impending long shoreman strike which stretches from Boston all the way around to Galveston and Houston which will affect the exports of farm products and manufacturing of course.  All of these are real unknowns out there.  And in Washington everybody is seeing farm as well, the farm sector, they're okay.  In fact, we want to see how we can tap into some of the wealth that is in Iowa, that is in Nebraska and somehow get it to another place where it is more needed perhaps.  And of course there is some need in terms of Hurricane Sandy.  But we were talking also about what is going on in California of overspending.  They continue to overspend.  Illinois, the Iowa neighbor, overspending as well.

Obradovich: Mr. Swenson, we've been talking about uncertainty and in fact during the debate in Congress about this latest fiscal cliff deal on the tax code, republicans often mentioned that they felt that now we have certainty about where the taxes are going to be, that the revenue question is settled.  President Obama came back and said, by no means is this revenue question settled.  He has definitely reserved the right to seek more revenue and probably through some sort of tax reforms.  We've basically got another three months at the very minimum of uncertainty.  So how does that factor in to what you see employers doing as they are making decisions about whether to hire, whether to invest?

Swenson: Okay, any kind of uncertainty as to how you're going to perform next year, how fast you might be able to grow, what your tax rates might be or what might be an allowable, let's say, depreciable item, any of those types of things are going to affect business decisions.  What's going on right now is it is still status quo with the fiscal cliff, the fiscal side of the fiscal cliff, the spending side yet to be debated.  The President has said and others have offered up base-broadening, removal of deductions, eliminating some of the dodges that are available to people.  That truly -- now, economists are going to argue we need to get rid of all of those.  Ernie is talking about fundamental tax reform.  Everything, we need a new base line, we need to get rid of all manner of elusive deductions that create distortions.  We're going to have to wait and see piece by piece.  Ernie has also said, though, that what we can't do is grand schemes, grand plans, long-term planning.  It's incremental changes.  So what remains to be seen is what are they able to do on the incremental -- I believe we're stuck in incrementalism for the next five, ten years.  We can't think in terms of a great big fundamental reform --

Obradovich: And by that you mean short-term decisions?

Swenson: Short-term, small changes so that they're not too disruptive to a staggering economy, that they don’t' alienate interest groups too severely and voters.  And so small changes.

Obradovich: That's how our political system is set up.

Goss: The big interest group baby boomers, everybody wants somebody else's taxes, taxes to go up for someone else, spending cuts in someone else's program.  But we have to face the fact that baby boomers are 26% of the population and people say we're not like Greece.  Well, we are like Greece in that population issue and the debt situation but we've got Social Security, Medicare and the proposal to limit the growth, for example, limit the yearly growth and the cost of living adjustment for Social Security, off the table.  It should be on the table.

Borg: I want to take the statement of fundamental tax reform that you promoted and espoused here a moment ago on the federal level, back to Iowa.  Governor Branstad is proposing widespread property tax reform, comprehensive is a better word, property tax reform and maybe also supporting, maybe won't propose it himself, but a gas tax increase.  How will that, Mr. Swenson, affect the Iowa economy?

Swenson: Well, first of all, we're paying the cost of not adequately underwriting and maintaining our infrastructure right now.  The roads need repair, there's a big backlog of projects that need to be done.  The bill is coming due, it has been due for a while, we need to start dealing with that. So we can't ride on these roads without correcting them.  It's going to affect our ability to grow and maintain business activity.

Borg: But the gas tax increase may create some jobs then.

Swenson: Well of course it's going to create jobs, it's going to show up on the construction side and you can argue that this is construction and/or maintenance activity that we have deferred and we just haven't been maintaining.  Lowering the business tax -- we've got this imbalance between householder's tax and the taxes that are due on commercial, different treatments of different properties and that includes agricultural property has an incredibly favorable treatment in the current tax code.  Houses have an incredibly favorable treatment in the tax code.  But those benefits don't accumulate to commercial property basically because commercial property is different than those other two types of properties.  So what we end up with is a very apparent difference in what constitutes taxable property and the fraction that is taxed.  That is what they are trying to reconcile, bringing it down for the commercial side but not bringing the others who are benefited heavily, the householders and ag to back up, to off set the difference.  They just really want to bring this down.

Borg: You look at it as being positive then?

Swenson: I look at it as we have to be careful with it because governments depend on those taxes and we worry about our local government's ability to provide services if we do this incorrectly.

Borg: Quickly, agree?

Goss: To somewhat but I think in terms of what Iowa needs to look at in my judgment, giving what is going on in Kansas, what is about to go on in Nebraska, Iowa's neighbors, you need to look at income taxes in terms of being more competitive.  I would argue that Iowa is not income tax competitive.  Property taxes are sort of what people complain about but it's not as fundamental, in my judgment, to economic growth as the income tax.  So I think I would argue for fixing some of your income tax issues in terms of lowering those rates and, again, cutting out some of the deductions.  Again, we are arguing for lowering rates and cutting some deductions.

Henderson: As you know, the most major deduction here is called federal deductibility whereby Iowans can deduct the amount of federal taxes they pay, which is not the case in most other states.  I think Louisiana still does it.  Should Iowa get rid of that deduction?

Goss: I think they should, not simply -- but primarily because you can't gauge what your actual tax rate is.  How do you compare Iowa to Nebraska where you don't have that same deduction?  And it makes you somewhat subject to the whims, goodness knows the whims of Washington.  Think about that.  I mean, what goes on when you raise taxes there of course that reduces, that raises your deduction here in Iowa and cuts your tax collections.

Henderson: So, should income taxes go up?  Or what sort of adjustment do you think would put Iowa in line with what is happening in Nebraska and Kansas?

Goss: Overall I think the revenues should go down by reducing the rate but also getting rid of some of those deductions.  And I think I would argue to certainly getting rid of the deductibility of the national, U.S., the federal tax deduction.

Obradovich: We talked a little bit about the fact that one fiscal cliff was sort of dealt with but we have three more to come.  The next one will be the debt ceiling which, of course, the U.S. has already reached the debt ceiling, it's just a question of how long before we actually go into default.  We've been on this ride before.  In July of 2011 we reached the debt ceiling and saw a downgrade in the credit rating.  Mr. Swenson, are we looking at a similar scenario for 2013?

Swenson: Well, I'm hoping that folks were wounded so badly in the last fight over the debt ceiling that they don't want to go there.  The President has already announced he doesn't even want to negotiate this.

Obradovich: Do you think the effects would be as bad though?  Are we talking about similar sorts of consequences?

Swenson: Yeah, I think so.  I don’t know about a continued downgrading of the American bond rating, their credit ratings but what I do worry about is that we start to impinge our ability to govern period by focusing on this debt ceiling issue as an artificial obstacle to good governance.  Remember, the debt ceiling is just authorizing the United States to pay for what is has already legislated into law.  And so there's a certain amount of strange hypocrisy associated with having a debt ceiling battle.

Borg: I'm going to bring back to Iowa here, Kathie, if I may and that is change the subject to gambling.  I know you've done quite a lot of comment on the effect of gambling.  A lot of Iowa communities want casinos in their hometown, Cedar Rapids being one that is gearing up to try to get one there.  Is that an economic development boom?

Goss: I don't think it is.  I think if you treat it as amusement, you treat it as entertainment but a high tax entertainment, a high tax amusement then it's fine.  But what you're encouraging is the dependency of the state with these up and down movements in tax collections.  It's a very risky bet in my judgment to depend on gambling revenues and whether you have smoking is allowed or not allowed and these issues all of a sudden your tax collections are subject to a lot more volatility.

Henderson: What about Internet gambling?

Goss: There you go, right there.  That is a real threat to what you could collect and these cities, these communities that depend heavily after they got the revenues, the local option sales tax for example, you could jeopardize that with Internet gambling.  And they say, well we can work that out.  That's going to be a toughie.

Henderson: Mr. Swenson, we began by talking about the federal unemployment rate.  Another federal agency, the Federal Reserve, has decided that interest rates are going to be low for the foreseeable future.  What impact does that have on the economy?

Swenson: Well, first it has added certainty in terms of the cost of borrowing money.  Second, we're going to argue that is has increased liquidity and the ability of businesses to borrow to the extent that businesses need to borrow and are not hoarding cash. And so to a certain degree it has freed up the credit markets and tried to help the economy continue to recover.  It hasn't done enough, many people will argue, but they have shot all the arrows in their quiver I think.  I don't know that they can do much more.

Henderson: How low can they go?

Goss: Well, right now the Federal Reserve has purchased about $3 to $4 trillion in debt, U.S. debt.  Our overall debt is about $16.4 trillion.  So you see how much we have depended, how much the federal government has depended on the Federal Reserve.  Now, the Federal Reserve is going to move out of that market meaning they're going to sell the bonds which means yields are going to go up.  So what I need, I think we need to stand by for, and particularly the farm sector, what happens when interest rates begin to really rise?  It's gone up by about a third of a percent the last couple of weeks alone.

Obradovich: One of the other fiscal cliffs that we haven't talked about yet is the spending cuts that are coming from the federal government and, in fact, it could have an effect on Iowa's economy as well.  Up until now the most recent, the biggest impact in the jobless rate has really been government employees.  It has had a big effect on government employees.  Obviously cutting federal programs will probably make that worse.  Is that -- which is worse for the economy really, if you see a continued strain of unemployment for government employees or the fact that we're not dealing with our debt crisis?

Swenson: Right.  Well first of all too many government employees isn't good for the economy and too few government employees isn't good for the economy either.  The gap between our revenue flow and our spending has to be closed, everybody agrees with that.  We know that gap has been made worse by the recession, it is slowly closing.  The better the economy does the narrower that gap.  So reducing debt, reducing spending in targeted, strategic areas is probably going to be an important component of long-term sustainability and an important component of our underlying economic growth.

Obradovich: And we're going to see this play out at the statehouse as well with the conflict between the Governor and state employee unions.  Are we still trying to achieve a balance here in Iowa as far as government employment is concerned?

Goss: I think so.  If you look nationally, if you look for good government across the U.S. a lot of it is right here in this part of the country.  And I'm a research faculty member at Cal State Fresno so I know a little bit about the opposite, what is going on or not going on in the state of California.  They have bailed them out by raising taxes this year.  But to your point also in terms, it's not just -- you've got the sequestration as it is called, the s word and the f word, that would be the fiscal cliff. 

Borg: Sequestration is a cut in government spending.

Goss: But it is also, it's going to be a cut to, it could potentially be a cut to contractors, defense contractors.  Of course, that is not as big an issue in Iowa as it is in California or it is in Virginia but it's still an issue.

Henderson: We have about fifteen seconds.  Explain succinctly in one sentence, what is fundamental tax reform.  You have mentioned it several times.  In one sentence, what is it?

Goss: Cut the rates, reduce the deductions.

Borg: Well, with that we have to close.  I know that many of our viewers are saying, let them go on because always we get lots of good comments when you are on and we appreciate your comments today.  Thank you very much.

Thanks for having us on.

Borg: And we'll be back with another edition of Iowa Press next weekend, usual times, 7:30 Friday night and a second chance to see the show at noon on Sunday.  I'm Dean Borg.  Thank you for joining us today.

Tags: David Swenson economy Ernie Goss fiscal cliff Iowa