Why Do We Need Private Investors

Felix Salmon asks why we need to cut private managers in on the deal when all of the risk is systemic. What good does it do to have the best bond pickers out there when all the bonds will rise and fall together.

My Answer: Political Cover.

Most of the public is under the notion that the government is incompetent. Even when the government is staffed with former CEOs of major financial firms there is a sense that once they become employed by the government they loose all of their former skills and knowledge.

So, how to get around people saying "See, I knew the government would screw this up?" Pull Bill Gross and Warren Buffet into the deal. If it goes bad, Obama just stands back and points at Buffet and says "how could we have done any better, even the master was fooled"

Bailouts and the Marginal Tax Payer

So here is meme that I want to question: "Our biggest concern about the bailouts is that taxpayers will wind up giving money to Wall Street firms or other big corporations."

This meme exists on both the left and the right though the lens each side see it through is a bit different.

However, who is actually paying for the bailout. Is it "The Taxpayer?"

Well, not exactly. Its not the tax payer in general, its what economists would call the "marginal" tax payer.

What does that mean?

Well no matter what most of us are going to pay some taxes. The bailout doesn't change that. The questions is whether or not we will have to pay more taxes. But when taxes go up, not everyone's taxes go up.

So the real question is - If taxes go up, who will wind up paying more taxes?

The last attempt to pay down the government debt was the Deficit Reduction Act of 1993. It was incidentally very successful. It worked in large part by raising taxes. But raising taxes on whom?

The act had a number of provisions but almost all the revenue increases were driven by two of them

1) The creation of a new 36% tax bracket for those making more than 140K (205K in 2009 dollars)

2) The creation of a new 39.6% tax bracket for those making more than 250K (367K in 2009 dollars)


So the last attempt to pay down the debt was paid for almost entirely by tax increases on those making more than 200K in 2009 dollars.

Then who payed down the debt built up in the 1970s and 1980s? Americans making more than 200K did. For everyone else taxes pretty much stayed the same and so it didn't really matter that all of that debt had be built up over the years.


Fast forward to today when we are worried about giving too much taxpayer money to big corporations. This implicitly represents transferring money from taxpayers to the owners, the shareholders, of those companies.

So one question is, who are those shareholders? Well according to the census bureau 91% of all households making more 150K owned stock. The last year of data is 1998 which was more than 10 years ago. Its probably a safe bet that the percentage is even higher today, perhaps approaching 100%.

The conclusion then is taking money from "taxpayers" to give to "big corporations" in large part is taking money from Americans who make more than 200K to give to Americans making more than 200K.

Of course because young people with much lower incomes also tend to own stock this could be seen as taking money from older Americans making more than 200K and giving to younger Americans of all income levels.

However, I suspect that the big tax increases to pay down the debt will only come after some number of years. At that time those lower income young people will have become the higher income older Americans. In a real sense the government will have given to them as young investors and turned around and taken from them as older investors.

This may make it seem like all the government is doing is an exercise in futility, but not quite. If the government can use money today to repair shareholder's investments today and then turn around and tax those same shareholders tomorrow, it may leave the whole nation better off.

Thats because the current corporate collapse is a self-feeding phenomenon that leaves idle resources and unemployed workers. If it continues there will be less total profit over this entire period because a big chunk of that period will have been spent with factories that are not running and workers that are not working.


Now, I don't want to overstate the case. There are still serious distributional issues associated with what the government is doing. However, it may not be as cut and dry as the basic analysis would make it seem. The population of taxpayers and owners of corporations is not as disparate as it may seem.