Here is an excerpt from the most important article you will read this year, by George Lakoff:

Here’s how public intimidation by framing works.

The mechanism of intimidation is framing, not just the use of words or slogans, but rather the changing of what voters take as right as a matter of principle. Framing is much more than mere language or messaging. A frame is a conceptual structure used to think with. Frames come in hierarchies. At the top of the hierarchies are moral frames. All politics is moral. Politicians support policies because they are right, not wrong. The problem is that there is more than one conception of what is moral. Moreover, voters tend to vote their morality, since it is what defines their identity. Poor conservatives vote against their material interests, but for their moral identity.

All language activates frames in the brain. Conservative language activates conservative frames, which activate conservative moral worldviews in the brains of those who hear the language. The more those frames are activated, the stronger the conservative moral views get in people’s brains.

Please go to this link, read the article, and then we will discuss it.  (Continued at EconoMonitor…)

The Congressional deficit reduction committee has numerous government programs on the chopping block, and we may soon see some very severe spending reductions. The committee must agree upon, and Congress must pass, $1.2 trillion in spending cuts and/or tax increases by November 23, or automatic, across-the-board spending cuts will go into effect in 2013. I hope that cuts to Social Security are not among the committee’s recommendations, but fiscal hawks are beating the drum harder than ever with their insistence that spending on the program must be reduced soon.

The Social Security issue came to mind a week or two ago, when I read James B. Stewart’s article in the New York Times on possible changes in the way the federal government taxes certain kinds of investment income.  Stewart’s article makes the point that some of the wealthiest taxpayers benefit greatly from the special tax rate of 15 percent that currently applies to capital gains* and dividends:

“The IRS reports that for taxpayers with the top 400 adjusted gross incomes, capital gains in 2008 amounted to an eye-popping average of $154 million for each of these taxpayers…and this in a year when the stock market plunged.”

Suppose the government taxed capital gains at the same rate as “ordinary income” (wages, salaries, most interest payments, etc.). For the 400 ultra-wealthy taxpayers mentioned in the quote above, a marginal tax rate of 35 percent would have applied to this income, instead of the special rate of 15 percent. Hence, if all 400 had been required to count their capital gains as ordinary income for tax purposes, their tax bills would presumably have been about $31 million higher on average than they actually were. It seems that the special, reduced rate for capital gains yields a large amount of tax savings for these 400 income tax filers, along with others who report capital gains on their income tax forms—who make up a fairly wealthy group themselves.

This brings us back to Social Security and to the relatively modest benefits that it offers. Social Security literature available on the web  lists the 2009 primary insurance amounts (PIAs) for covered workers with various income levels. (By the way, 2010 numbers can be found at this link.) This is the monthly payment to which a worker is currently entitled if he or she retires at the current full retirement age of 65 years old (not including Medicare, any applicable spousal benefits, etc.). Here are three examples: continue reading…

Throughout the weekend, television news coverage dwelled on Friday’s downgrade of U.S. debt securities by Standard and Poor’s, one of the three main ratings agencies that assess the creditworthiness of the federal government. The meaning of S & P’s action remains somewhat uncertain, and we doubt that, as important as the story was, the downgrade will have strong economic repercussions, provided that it is well understood.

In Sunday’s early print edition of the New York Times, Nelson Schwartz and Eric Dash reported that “…many analysts say the impact [on interest rates] could be modest, in part because the other ratings agencies, Moody’s and Fitch, have not downgraded the government at this time.”

Indeed, yields on U.S. government debt instruments remained very low following the downgrade, after decreasing over the past few months. Investors seem unconvinced that the government could somehow fail to come up with the dollars it needed to meet its repayment and interest-payment commitments. Nonetheless, financial markets were jittery, if only because of the downgrade announcement itself.

Also, we remain convinced that there is no basis for a belief that the federal government will ever have to default on its debt. This statement applies to the United States or any other country with a sovereign currency and a floating exchange rate.

The real problem was probably a fear on the part of S & P that the government might not repay its debt, not that it could not. The debt level has been very high for a long time, but the S & P move did not occur before the near-stalemate over the debt limit. This was a real crisis. A failure to raise the ceiling might conceivably have led to a default. However, a U.S. government failure to pay interest or repay principal cannot occur, as long as national political leaders make it clear that they will permit routine debt issuance and money creation to continue.

What’s more, taxpayer advocates should be aware, as Ronald Reagan was, that the ability to run deficits conferred by a sovereign currency enhances the government’s powers to lower taxes as Congress and the President see fit. (As an aside, it follows that if all of the national governments in Europe had independent, unbacked currencies like the U.S. greenback, they could avoid the ineluctable defaults and ensuing austerity measures that come with a currency union, gold standard, or similar international system, though they would sacrifice the many advantages of a shared currency.)

It goes without saying that in any country, balance is required in decision-making about taxes and spending, bond issuance and money creation, and workers and corporations to go along with competing policy goals, such as low inflation, low unemployment, economic growth, income security, stability of the exchange rate, equity and the like. The U.S. government lost the mostly symbolic weight of its top S & P bond rating mostly because brinksmanship over the debt limit jeopardized its power to weigh these objectives and act upon them.

A deal was reached over the weekend by congressional leaders and the President to resolve the debt-ceiling impasse. By that point, it was clear that the possible way out described by John Carney in a blog post to which we linked on Thursday would not be feasible. Nonetheless, the Fed’s ability to supply cash as needed if the deadline were missed had been made clear in official statements reported by the New York Times in Sunday’s early print edition. To wit, in response to concerns expressed by top banking executives,

“Mr. Geithner made it clear that the Treasury and the Federal Reserve had taken precautions so that payments for food stamps, military wages, and other federal obligations would not bounce, according to people involved in the call.”

An article posted to the Times website Saturday had phrased this point somewhat differently:

“Mr. Geithner assured [JPMorgan Chase CEO Jamie Dimon] that the Treasury and Federal Reserve had taken steps to keep the payment system functioning smoothly, according to individuals briefed on the call.”

The phrase “keep the payment system functioning smoothly” is a euphemism known by Fed observers to entail in practice the types of functions described  in the above quote of the print edition.

Obviously however, this use of overdrafts could not be continued very long, owing to the will of the negotiators and probably the relevant laws. These laws are intended to keep the Federal Reserve largely independent from the federal government.   Hence, while the Fed honors checks written by the Treasury Department and presented to it by banks, the use of this privilege is extremely limited in the U.S. system, compared to “overdraft systems” of the type I described in this earlier post.

On the other hand, if the somewhat artificial distinction between the central bank and the central government were to be eliminated in the United States, the federal government would gain access to the printing press, enabling it hypothetically to back a virtually unlimited amount of outlays. Of course, this process would not create new “debt,” but rather new currency and bank reserves. Of course, the Fed itself can currently use its “printing press,” mostly to stabilize the banking system, a role that led to a massive expansion of bank reserves during the financial crisis of 2007–08.

In current mainstream macroeconomic thought, which is carrying the day in most of the developed world now, a system in which the government has control of the printing press is thought to court intolerable levels of inflation. However, in an economy growing as slowly as this one, it is extremely doubtful that excessive inflation would necessarily follow if the impasse were to be resolved by creating new currency and bank reserves, rather than by selling bonds, increasing taxes, or cutting spending. Yet given the legal independence of the Fed, the latter two options were the only ones open to the negotiators last weekend. Moreover, new taxes were unacceptable to many, if not most, in Congress.  Hence, it now appears that the government may be about to make potentially devastating new cuts to key federal programs.

In Paul Krugman’s blog, a bit of good news from the August 2010 Social Security Trustees’ Report on the finances of the Social Security entitlement programs (retirement, survivors, and disability):

Given the apocalyptic rhetoric we’re hearing, once again, about Social Security finances, it comes as something of a shock—even to me—to look at the actual projections in the latest Trustees’ Report. OASDI [ed.: in plain English, Social Security spending] is projected to rise from 4.8 percent of GDP now to about 6 percent of GDP in 2030, and level off. That’s not trivial—but it’s not huge either.

Hence, the intermediate forecast reported by Krugman seems to indicate that we can maintain current benefit levels, retirement ages, and other rules for the foreseeable future using existing payroll and benefit taxes plus only a modest increase in federal revenues dedicated to Social Security programs. Perhaps more Americans will be able to retire fairly comfortably and at a reasonable age than some have predicted.

Coincidentally, not long after the report was released, a new exhibit marking the 75th anniversary of the signing of the Social Security Act opened here in the Hudson Valley, not far from the Levy Institute, at the Franklin D. Roosevelt Presidential Library and Museum. (The famous Roosevelt home is on the same site.) I hope to see the Social Security exhibit soon and may report back to you on what I find there.

In the Wall Street Journal, Stanford’s Robert Hall tells Jon Hilsenrath that last year’s stimulus just about made up for the cuts in state and local government spending forced by the recession (most states have balanced budget requirements, so when tax revenues dip, as they do in a recession, spending must follow).

So, there was no net stimulus from government spending last year! Still, it could have been worse. What David Leonhardt doesn’t say (in his take on the subject for the New York Times) is that the initial stimulus was too small. Certainly state fiscal support was too small. States have still had to cut their budgets, laying off teachers and police officers. These layoffs have not been helpful to recovery, to say the least.

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I’m Italian, and I’m an economist, so as European leaders work feverishly to save the Euro, I’ve been wondering: what would happen if the feared contagion occured and my own country saw its finances melt down just as Greece’s have? The short answer is that this would generate a fatal shock to the Euro, given the size of Italian public debt and the fact that a large share is owned by other Euro countries.

Of course, such an event is by no means a foregone conclusion. But I can’t help noticing an ominous correlation. The country in Europe with the biggest untaxed, or “shadow,” economy as a proportion of GDP is Greece. Next is (gulp) Italy. Then Portugal and Spain. On the chart below, in fact, the bars look unsettlingly like dominoes.

Much of the problem in these countries in Europe, in other words, is tax evasion. As the chart shows, the size of the shadow economy in Italy and Greece is much larger than in other developed countries, inside and outside the Euro area.

Massive tax evasion helps produce large public-sector deficits. Let’s make some simple back-of-the-envelope calculations: if the shadow economy is adding 25 percent to GDP, with income going untaxed, and if the average tax rate on such income is a conservative 20 percent, recovering such tax revenues would imply an additional 5 percent of GDP in tax revenues, which would bring down the Italian 2009 deficit to zero. As deficits cumulate into debt, prolonged tax evasion could explain – by itself – the whole of the Italian public debt, now projected at 118.4 percent of GDP.

Attacking these deficits by raising taxes or freezing wages in countries where the shadow economy is so large could encourage further tax evasion, placing an ever-greater burden on an ever-shrinking proportion of law-abiding citizens who pay what they are asked. If Europe’s troubled public finances are ever to be set right, Greece, Italy and other nations with large underground economies must find a way to collect the taxes that now go unpaid.

(Figures in the chart are from F. Schneider, Shadow Economies and Corruption all over the World: New Estimates for 145 Countries)