Highlights of the NABE and AUBER 2004 Washington Economic Policy Conference

For those AUBER members who were unable to attend the 2004 NABE and AUBER Economic Policy Conference held in Washington, DC, at the end of March, the following paragraphs briefly summarize selected sessions.

Fiscal Stress on State Governments
Marshall J. Vest, AUBER president and director of Economic and Business Research at the University of Arizona, presided over the session, which was organized by AUBER and the Regional Utility Roundtable.

Roger E. Brinner, partner and chief economist, The Parthenon Group, presented work he has conducted over the past few years, initially for the National Association of State Budget Officers (NASBO), that examines the current state budget crises. In recent months, he has applied his forecasting methodology to several states, including Massachusetts, Texas, Pennsylvania, and California.

As background, Brinner has concluded that the creation of expensive new programs financed by a temporary surge in revenues during the high-tech boom left states vulnerable to huge deficits. Fortunately, rainy day funds established during the 1990s have allowed most states to avoid huge tax increases like those enacted during the early 1990s.

He also noted that most state tax models tend to underestimate economic sensitivity of taxes, and most fail to exclude pro-cyclical legislated spending increases. Using NASBO data, he found that a 1% rise in the unemployment rate cuts 4.5% from state tax revenues. This varies, of course, from state to state.

One of Brinner's more controversial findings is that state tax systems are biased toward structural surpluses. He argues that spending (sans new programs) grows with population and inflation. Revenues grow by that amount, plus productivity gains, plus progressivity of the tax system. Revenue growth is therefore greater than spending.

States that have adopted a spending limitation based on the sum of overall population growth and inflation are suffering extreme stress. Colorado, for example, where any excess dollars collected above the limit are sent back to taxpayers, is one of the hardest hit states in this recession and is still losing jobs on a year-over-year basis.

Brinner concluded by recommending an optimal state tax strategy. He proposed that out of four main tax categories-personal income, general sales, business profit, and specific excise-the best option for state legislators is to raise personal income taxes for taxpayers in higher income brackets. That is because state personal income taxes are deductible on a taxpayer's federal return. In essence, the federal government finances roughly one-third of any new taxes raised. Sales taxes and excise taxes are highly regressive and are not deductible so they cannot be exported.

Brinner's model is an "easy to explain" and reasonably accurate approach to forecasting revenues that promises to generate wide interest among policymakers and practitioners who are charged with the task of forecasting state revenues.

Understanding Social Security Reform Options
Douglas Holtz-Eakin, director of the Congressional Budget Office, moderated the session.

Eric M. Engen, resident scholar at the American Enterprise Institute, pointed out that over the next 75 years and beyond, tax payments to Social Security will remain relatively constant (compared to GDP), while spending for the program will increase markedly. In addition, Social Security benefit payments will increase (relative to GDP) because of an aging U.S. population. Engen also indicated that longer life expectancy poses challenges for Social Security, Medicare, Medicaid, and the economy.

Engen's proposed reforms include changing the way initial benefits are calculated so that they increase with price inflation instead of wage growth. This assures that future retirees would have the same purchasing power from their Social Security benefits as current retirees. Also, the proposal would accelerate the increase in the full-benefit retirement age to 67 and thereafter raise the age to keep pace with projected increases in life expectancy in order to more fully account for increased life expectancy. Engen also pointed out that currently, a low-wage earner is scheduled to receive an annual benefit of about $8,800, while a maximum wage earner will receive almost $22,000. To improve the social safety net, he proposed an increase in benefits by a proportionally larger amount to below-average earners and decreased by a proportionally larger amount to above-average earners. This adjustment would be made to keep aggregate Social Security benefits the same. Engen also suggests diverting two percentage points of the current 12.4% payroll tax into personal accounts, which would leave the payroll system with small deficits until around 2035. These could be approximately covered by the revenue claims in the Social Security trust fund. These changes would make the Social Security system financially sustainable and would generate increasingly large surpluses after about 2035.

Peter R. Orszag, senior fellow at the Brookings Institution, focused his presentation on Social Security reforms. Orszag, along with coauthor Peter A. Diamond, has devised a plan to restore long-term balance and sustainable solvency to an ailing Social Security program. To achieve these goals, the plan combines benefit reductions and revenue increases. Average earners would be asked to accept small reductions in benefits, while higher earners would be asked to accept more substantial cutbacks. Concurrently, increases in payroll taxes would be used to generate higher revenues, thus helping to restore long-term solvency to the program.

Orszag's plan also addresses what he has defined as the three causes of the Social Security deficit: life expectancy, income inequality, and legacy debt. Higher life expectancies raise the cost of Social Security as beneficiaries collect benefits over longer periods of time. To deal with this issue, Orszag suggests offsetting the rising costs by both gradually decreasing benefits and gradually increasing payroll taxes. Unlike some other proposals for Social Security reform, Orszag's plan recommends against increasing the minimum retirement or full benefit age. On the issue of income inequality, Orszag stated that the percentage of workers earning more than the maximum taxable earnings base ($87,900 in 2004) has increased significantly, from 10% in 1983, to 15% in 2002. To mitigate this so-called inequality, his plan proposes raising the maximum taxable earnings base and reducing benefits to the top tier of Social Security beneficiaries (top 15%). Orszag's plan also addresses the concern with legacy debt-the idea that past beneficiaries received benefits greater than contributions plus market interest rate. To pay off this debt, he suggests mandatory Social Security coverage for all newly hired state and local government workers as well as a 3% legacy tax charged to workers earning more than the maximum taxable earnings base, and slight benefit reductions and payroll tax increases.

Orszag believes his plan achieves a good balance of benefit and revenue adjustments, while preserving the role Social Security plays as a social insurance mechanism. He stressed the fact that the plan assures strong protection for the neediest Social Security beneficiaries, such as widows, low earners, young survivors, and individuals with disabilities.

Although the debate on Social Security will likely continue for some time, many comprehensive plans like this are beginning to take form and offer good insight into some of the problems and solutions surrounding the issue.

Views from the Treasury and CEA
Treasury Secretary John Snow and Council of Economic Advisers Chairman Gregory Mankiw described President Bush's economic policy initiatives and how the state of the economy has figured into their formulation.

The Honorable N. Gregory Mankiw, chair of the Council of Economic Advisers, presented his views on the state of the national economy. Mankiw began by listing "powerful contractionary forces" that have weighed on the economy over the past several years. These include the end of the high-tech bubble, the revelation of corporate governance problems, and geopolitical uncertainty stemming from terrorist attacks and the war in Iraq. Mankiw emphasized that policymakers took prompt and decisive actions to counteract the effects of these adverse shocks to the economy. The administration and Congress passed substantial tax relief to provide a much-needed economic stimulus. He mentioned that the real GDP expanded at an annual rate exceeding 6% in the second half of 2003, which was the best half-year performance in nearly 20 years and the best among the major developed economies.

Payroll employment gains have lagged the rest of the economy because of high productivity growth over the past three years. The output of goods and services hasexpanded without typical increases in employment. Nonetheless, Mankiw pointed out that these gains have boosted national income, and they have reduced inflationary pressures by holding down growth in unit labor costs. In the short run, productivity bursts add to business profits, but in the longer term, they benefit workers as well. Economic theory and history both point to productivity growth as the primary determinant of rising real wages.

Mankiw stated that most signs suggest that the economy will expand vigorously in 2004. The index of leading economic indicators has risen impressively over the past 12 months. The Blue Chip consensus of private forecasters predicts that real GDP will expand by 4.2% over the four quarters of 2004. He also said that even though the budget deficit could impede growth, the deficit as a share of GDP is projected to diminish by more than half over the next five years.

Mankiw warned that the greatest fiscal challenge ahead is the growth in entitlement spending from the aging population and the retirement of the baby-boom generation. Unless the entitlement programs are modernized for future generations, truly worrisome budgetary pressures will arise over the next few decades. This is one reason that a prescription drug benefit was added to Medicare and the president moved to include greater choice for seniors and competition among private providers. It is also why the president has stressed the need for fundamental reform of Social Security, including a role for personal accounts.

Mankiw also pointed out that as technology expands, the range of commercial activities that can be traded internationally increases and the number of American workers who are exposed to global competition grows. However, he stressed that free markets remain the best way to promote growth, create good jobs, and ensure rising living standards.

Mankiw emphasized that as trade expands and the world economy evolves, it is natural to ask what new jobs will be created in the future. This question is best answered by market forces. Policymakers should foster an environment in which businesses will expand and jobs will be created. However, we must appreciate that any economic change, whether arising from trade or technology, can cause painful dislocations for some workers and their families. Public policy should ease the transition and help workers prepare for the global economy and the jobs of the future.

As the economy grows and changes, the choices facing the nation are clear. Raising taxes and turning inward, as some have proposed, would depress economic growth. The better choice is to continue the president's policies to fuel growth and capitalize on the strength and creativity of the American people.

Economic Impact of Offshore Outsourcing
Chris Swann, senior consultant with Global Insight, presided over the outsourcing session.

Lael Brainard, senior fellow at the Brookings Institution, pondered the issue of job outsourcing and why it has become so politicized. She recognized that there is a lot of anxiety regarding the jobless recovery and that outsourcing is impacting a set of workers previously unaffected.

Brainard explained that, in the past, outsourcing was caused by technological changes, but now, increased bandwidth and policy revisions made abroad are triggering these changes. Combined, these forces are putting jobs at risk that were once considered nontradable.

Brainard expressed a need for a long-term agenda to assist displaced workers with skill acquisition and retraining that would help make America an attractive place to conduct business. A long-term agenda would also assist in collecting better data to determine the extent of jobs being lost. Brainard also recommended more comprehensive social safety nets (health care and insurance) to help workers whose jobs are lost due to increased trade.

Obie Whichard, chief of the International Investment Division of the Bureau of Economic Analysis (BEA), U.S. Department of Commerce, has been involved for many years in the BEA's program to improve and expand its data collection and analytical capacities in the areas of foreign direct investment and international trade in services. His presentation examined the economic impact of offshore outsourcing in terms of U.S. multinational companies (MNC) and their patterns of production and employment. He pointed out a few patterns in U.S.-MNC operations:

• Worldwide operations of U.S. MNCs are concentrated in the United States.
• The foreign operations of U.S. MNCs are centered in high-wage countries, suggesting that access to markets has been a key consideration in their decisions to locate operations abroad.
• Not surprisingly, in 2001, 65% of sales by foreign affiliates were to local customers-that is, customers who resided in the same country as the foreign affiliate.
• Employment by foreign affiliates remains concentrated in high-wage countries, but recently it has grown faster in lower-wage countries.

He further suggests that the trends and patterns of U.S. MNCs have been relatively stable over the years, but the effects of these operations and the inferences that can be drawn are limited, due to the fact that data are only available up to year 2001. The BEA does not collect data on the types of jobs held by employees of either U.S. parents or foreign affiliates. Hence, it is not possible to fully determine the changes in the types of jobs offered by parents and affiliates in terms of occupation or the skills required for the job.

Thomas F. Siems, senior economist and policy advisor at the Federal Reserve Bank of Dallas, explained the benefits of outsourcing as they apply to consumers, companies, and investors involved in the outsourcing process. Siems gave several reasons to support his claims, including creating value for U.S companies and freeing up U.S. resources for activities with more added value. He sees the creation of value occurring in four ways:

• Cost savings: $1 outsourced saves $0.58 (mostly wages)
• New revenues: $1 outsourced buys $0.05 goods/services in the United States
• Repatriated earnings: $1 outsourced generates $0.04 profits in the United States
• Redeployed labor: $1 outsourced creates $0.46 from U.S. labor reemployment

The benefactors of this process include consumers (by receiving lower prices and better products), companies (by becoming more competitive in the global market), investors (by realizing potentially higher returns), and the general world population (by obtaining higher standards of living). In order to repair any damages outsourcing may cause to U.S. employment, Siems suggests that training programs; generous severance/retraining packages; and incentives for R&D, risk-taking, and entrepreneurship be enacted. By accepting the inevitability of outsourcing and adapting to it, U.S. companies can ensure that they remain at the top of the industrial ladder.

The Uses of Federal and State Statistics
J. Bruce Kellison, associate director of the Bureau of Business Research at University of Texas at Austin, presided over the panel.

Rick Clayton, chief of the Division of Administrative Statistics and Labor Turnover at the Bureau of Labor Statistics, presented the "Quarterly Census of Employment and Wages (QCEW)." He began the panel by summarizing the QCEW/ES-202 data collected by BLS and its many uses. The only quarterly "universe count" in the federal statistical system, the ES-202 has a variety of uses, from shift-share projects and cluster analysis in local development research, to job creation/destruction and minimum wage analyses. One of the more innovative recent trends in ES-202 data usage appears in geocoding, where an analyst can use BLS QCEW data to look at spatial geographies of development in specific regions or neighborhoods.

Tom Nardone, chief of the Division of Labor Force Statistics at the Bureau of Labor Statistics, presented "Reconciling Payroll and Household Employment Statistics." He addressed the growing discrepancies that exist between household and payroll employment surveys. Nardone emphasized that the differences in the household (CES) and payroll (CPS) surveys stem from their different methodologies, but evidence from the two actually shows the same overall employment trends over many decades. The spread of the two surveys narrowed after the 2000 Census, however, it has widened more recently. The current spread in the two survey results is 2.1 million persons (with CES being the higher total). Analysts are generally at a loss to explain why. Most possible explanations, like workers holding two jobs or people moving between jobs frequently, would account for only a small number of additional jobs in the CES. Nardone believes that small changes in population estimates, which have been successful at closing the CES-CPS gap in the past, will once again help to achieve reconciliation between the two.

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