Unit 4 - Special Topics in Economics

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United Nations' 2002 World Summit in Johannesburg (World Summit on Sustainable Development)

History

The first UN summit that was organized to deal with environmental matters took place in 1972 in Stockholm, Sweden. As the delegates and world leaders met in 1972, little attention was given to environmental matters. In the United States, rivers that flowed through urban areas were often severely polluted, often to the extent that swimming or eating fish from the river represented a significant health hazard to humans. A few Midwestern rivers had so much toxic and combustible pollutants in them that they caught on fire.

Air quality was not given any attention. Leaded gasoline was the norm causing health and developmental problems for children exposed to high levels. There were no emissions controls on automobiles or factories. Overall, laws that protected the environment were almost non-existent. Fortunately, the 1972 summit inspired industrial nations to start cleaning up the air and water. In the United States, the Clean Air Act and Clean Water Act were passed and the Environmental Protection Agency (EPA) was created. For the first time, US policy makers were trying to help the environment with laws and regulations aimed at consumers and industry.

Twenty years later in 1992, the United Nations held the second environmental summit in Rio de Janeiro, Brazil. Two of the major topics of discussion were global warming and biodiversity. As a result the summit produced treaties that committed the developed counties to address the environmental threat of global warming (Kyoto accord) and the promotion of biodiversity. In the United States, the U.S. Senate voted 100 to zero to support the agreements made in Rio and make progress towards what would become the Kyoto accord to limit greenhouse gasses such as carbon dioxide that the majority of experts agree is a major contributor to global warming. Supported by the Clinton administration and other developed countries, if ratified, the Kyoto accords would place a limit on total carbon dioxide emissions within the next decade. After taking office in 2001, one of the first actions by President Bush was to declare that his administration would not support the goals of Kyoto stating that his administration "has our sovereign choice to pursue another path."

The third UN summit that emphasized environmental issues took place in Johannesburg, South Africa, in August 2002.  The major focus of the Johannesburg summit is to promote improved economic and environmental conditions in developing countries without destroying or degrading the ecosystem. The summit was attended by almost all of the world's leaders - over 100 presidents and prime ministers from around the world attended. Notably absent was President Bush who instead continued his typical August vacation.

Important issues covered at the summit

Water and Sanitation

For developing countries, critical environmental issues often focus on items that citizens of developed countries often take for granted - clean water and sanitation for example. For this reason reducing global poverty and at the same time ensuring the survival of the world's natural resources and environment intact is a central element on the agenda. It is estimated that in 25 years, two-thirds of the world may suffer from chronic shortages of fresh water. Presently, 1of the approximately 8.5 billion people on the earth today, 1.1 billion people lack access to safe water and over 2 billion have no sanitation. The conference has set a goal to reduce by 50% the proportion of people who lacks access to safe water by the year 2015. To achieve this goal, current spending of $16 billion per year in water-related infrastructure (building and maintaining) will need to be increased to $23 billion per year.

This objective is supported by the Bush administration.

Agricultural Subsidies

An area where there is a large difference between many of the wealthy developed countries and the developing countries is in the area of farms subsidies in wealthy countries. The governments of the United States, Japan and in many European countries give large subsidies to domestic farmers. For example, President Bush who added an additional $180 billion over the next 10 years doubled the already generous farm subsidies present in the United States in 2001. For the most part, these subsidies hand out huge amounts of money to the wealthiest farmers in America.

For many poor countries, the best way to generate income is through agricultural exports, but due to farm subsidies, poor farmers cannot compete with the subsidized prices on wealthy country farmers who in addition, are exporting to poor countries. For example, markets in sugar, coffee, cotton and other commodities that farmers in developing countries can grow cheaply are distorted by over $300 billion in annual subsidies given to rich-world growers, an amount greater than the entire GDP of sub-Saharan Africa. In addition, wealthy countries put tariffs on imports from developing countries. European countries place 140% tariffs on sugar imports from Africa, subsidizes domestic sugar beet growers and dumps the surpluses on world markets.

For example, American farmers can produce cotton for 73 cents per pound and lower-cost African farmers can produce cotton for 50 cents a pound. Add in the significant subsidies received by American farmers and the world price falls to 35 cents per pound. Without the subsidies, African farmers would be able to sell in local and world markets. With the subsidies, the increased output and lower price allows less efficient American cotton growers to sell their cotton at a below-cost price throughout the world, crowding out local farmers.

As African farmers and economies are hurt by the unfair trade advantage that producers in developed countries receive, the need for foreign aid to African countries increases. The irony is that the U.S. government gives foreign aid to African countries and at the same time contributes to many of the problems with domestic subsidies.

The Bush administration and some of the other countries that offer heavy subsidies to domestic farmers (e.g. France) oppose measures that would curtail distorting trade policies. The Bush administration claims that these requested commitments are unnecessary.

Fish

One area where everyone agreed is to take measures to restore the world’s depleted fisheries by the year 2015.

Electricity

Currently, 1.6 billion people in the world have no access to electricity. To provide fuel for heat and cooking, these people often have to cut down the local forests or use coal that is burned in a poorly ventilated stove. As a result of poor local air quality acute respiratory infections kill or disable about 30% of sub-Saharan Africa's children each year and the problem is spread throughout the globe. A solution to this major environmental and health concern is to provide access to electricity to those people who do not have it. With a focus on sustainability, global warming and practicality, the quickest and most cost-effective way to increase access to electricity is to build off-grid micropower plants that use solar or wind technologies. The UN summit desired to increase funding for the development of solar and wind power in areas that lacked access to the existing electrical grid.

The Bush administration and several Middle Eastern oil exporting nations opposed committing to a time frame for this program.

Renewable Energy

In an attempt to promote renewable energy sources to deal with global warming and depletion of existing limited resources, the UN conference emphasized the conversion world energy production from fossil fuels to solar, wind power and other renewable energy sources. The goal was to make a commitment that renewable sources account for 15% of the world energy output by 2010.

The Bush administration was against setting a deadline to reduce greenhouse gas emission or for conversion to renewable energy sources from hydrocarbon-based electrical sources. Due to opposition from the Bush administration, Japan, Australia and several Middle Eastern oil exporting nations the goal of 15% by 2010 has been dropped. The Bush administration says that it prefers concrete action to target dates.

Foreign Aid

Developing countries want wealthy countries to commit 0.7% of their GDP to aid developing countries (for the US this would amount to over $70 billion each year). In response, European Union countries have agreed to commit 0.39% of their GDP to foreign aid by 2006

The US and some other developed countries argue that developing countries need to eliminate corruption and strengthen democratic institutions before additional aid is committed.

At the conference, Prime Minister Blair of Great Britain states that "the consequence of inaction on these issues is not unknown. They are calculable. Poverty and environmental degradation, if unchecked, spell catastrophe for our world."

Biodiversity

All participants agreed to continue a commitment made in the 1992 Rio summit to reduce the loss of endangered plants and animals by 2010.

What is the Economic Impact of Globalization?

Globalization refers to the increase in trade and foreign investment throughout the world.

We begin our discussion with a look at the Mexican economy and the consequences for the middle and working classes. Incubated in a closed economy that was driven by state-owned monopolies, the middle class grew steadily from the 1920's to the 1970's. Faced with declining economic efficiency and a mounting public debt, successive presidents opened Mexico's protected economy, igniting an industrial revolution that turned the country into one of the world's leading exporters.

It has been two decades since Mexico committed itself to free-market reforms aimed at propelling this country into the developed world. The North American Free Trade Agreement, considered the centerpiece of the new Mexican philosophy, has generated a quarter trillion dollars in cross-border trade with the United States. The treaty helped turn a closed, inefficient economy dominated by state-owned companies into one that was flooded by foreign investment and driven by foreign competition. But government statistics show that economic liberalization has done little to close the huge divide between the privileged few and the poor, and left the middle class worse off than before. Battered by a series of severe recessions, the 35 percent of Mexico's population that lives in the middle with average earnings of about $1,000 a month have seen their outlook and finances diminish in the last decade. On the plus side, the Mexican peso is strong, inflation is projected to decline to 4 percent annually and levels of foreign investment have remained stable.

An economist, Rogelio Ramírez de la O, argues that in the 1970's, when Mexico's population was 50 million people and the country had begun to enjoy the benefits of an oil boom, some 60 percent of Mexicans were middle and working class. Their numbers and buying power have declined "dramatically" since then, Mr. Ramírez said. In an effort to reduce its external debt, the government simultaneously slashed spending for higher education, transportation and health care - all traditional pillars of middle-class life.

Taking a broader look, a 1999 United Nations' Human Development Report argued that the global income gap has increased steadily. According to the report, in 1960, the 20% of the world's people in the richest countries had 30 times the income of the poorest 20%. In 1997, 74 times as much. This continues the trend of nearly two centuries. Some have predicted convergence, but the past decade has shown increasing concentration of income among people, corporations and countries.

UN economists make two points. First, inequality has worsened within countries. Second, inequality has worsened across countries. From these two things, the UN reckons, it follows, third, that inequality among the people of the world is rising as well.

However, an Economist at Columbia University, Xavier Sala-i-Martin agrees that while inequality has probably increased, on average, within countries. But the distribution is not uniform, inequality has gone up in some countries and down in others. Rapid globalization does not push all one-way: emerging-market countries such as South Korea and Indonesia have seen within-country income inequality fall. On the whole, though, Martin reckons that within-country inequality has most likely gone up during recent decades.

When looking at inequality across countries, the UN neglects an important point. If you measure incomes in terms of purchasing power (the local cost of living) rather than at market exchange rates, incomes are a lot more equal. The reason is that the cost of living is lower in poor countries - a loaf of bread costs more in Denver than in many developing countries. When the UN says that the incomes of the richest 20% were 30 times bigger than the incomes of the poorest 20% in 1960, and 74 times bigger in 1997, it is using market exchange rates that assume uniform prices across countries. In purchasing-power terms, the corresponding ratios were 11 and 15. While the trend for the period as a whole increases, the increase in significantly smaller when measured in purchasing-power.

To examine global income inequality, imagine that five-sixths of the world's population lives in poor and stagnant economies, and one-sixth in rich fast-growing ones. In across-country terms, this gives you divergence in incomes. Now imagine that one poor but very populous economy starts to grow very quickly. At the same time, inequality within this country worsens somewhat. Despite its size, this country is only one data-point in the across-country comparisons: its rapid growth is not enough to make any difference to divergence. So you have rising within-country inequality and rising across-country inequality.

Yet one-sixth of the world's population, by assumption, is seeing its incomes rise rapidly towards those of the rich. Inequality measured across all the people of the world, therefore, may very well be falling. The big poor country growing very fast is China. (India has also been doing pretty well.) If you simply weight the across-country measures of divergence by population, you see not a rising trend of inequality, but the opposite - convergence. Mr. Martin finds that rising global inequality is “nowhere to be seen”.

In summary, if we measure income inequality with each of the world's countries weighted equally, there is increasing divergence. Many poor countries are falling further behind the faster growing wealthy countries. However, if we measure income inequality on an individual basis, there is convergence due to the fact the China is both growing very rapidly and has a large number of people in proportion to the total world population. Incomes are rising faster in China than in the wealthy countries.

When considering the number of people living in poverty, the proportion of people living on less than a dollar a day fell from 20% in 1970 to 5% in 1998; the proportion living on less than two dollars a day fell from 44% to 8%. The total headcount of poverty worldwide has fallen by some 400m. Overall, globalization has helped to reduce poverty and is leading to increasing income convergence for many of the world's population. The only bad news is that, after the respite provided recently by surging globalization, inequality may well resume its long-term historical trend and start rising again in due course. The reason is that China and India will no longer be poor—and if the world's poorest countries, mainly in Africa, continue to stagnate, the global dispersion of incomes will widen.

The American Tax System

Reading or discussing taxes is seldom an interesting topic. In general, people prefer lower taxes but also want a functional government that is supported by sufficient tax revenues. In this section we take a look about the facts regarding the U.S. tax system and recent tax policy. The topic is worthwhile covering in some detail as the reality is often very different than the political myths that surround it.

The Federal Income Tax – as the following table shows, income taxes represent a progressive tax structure. As income increases into higher tax brackets, the additional dollars are taxed at a higher marginal rate. For example, someone who earns $20,000 in taxable income per year will be subject to two tax brackets. The first $7,000 of income is taxed at a 10% rate, the remaining $13,000 is taxed at a 15% rate.

An individual with $100,000 per year in taxable income will pay a 10% rate on the first $7,000 in earnings, a 15% rate on the money earned between $7,000 to $28,000, capping at a 28% rate for income earned over $68,000.

For working Americans, tax payments to the federal government do not end with the income tax. In fact, for the majority of employees, the biggest tax bill comes in the form of payroll taxes. Payroll taxes are comprised of Social Security and Medicare components. The Social Security tax rate is 12.4% - one-half (6.2%) paid by the employee as a deduction from gross income and another 6.2% paid as an employer match. The Medicare tax rate is 2.90% - applied the same way as a 1.45% deduction from gross pay and 1.45% as an employer match. For both Social Security and Medicare, taxable income in 2004 was capped at $87,900.

Several key points should be made about payroll taxes:

·          Since the income that is subject to payroll taxes is limited to $87,900, for the country as a whole, the payroll tax is a regressive tax. The tax is a flat tax for taxpayers with total income below $87,900, but becomes regressive for taxpayers earning above the limit. For example, someone earning $200,000 per year will pay the same amount of payroll taxes as a person earning $88,000. However, as a percentage of income, the payroll tax decreases as income rises above the $87,900 limit.

·          At the present time, the government collects about $200 billion more in Social Security tax revenues that it pays out to current beneficiaries.

·          When the federal government runs a deficit, the annual surplus of Social Security tax revenues is spent by the government the year that is collected.

·          The majority of American workers pay more in payroll taxes than they do in income taxes to the federal government.

The critical myth about the Social Security system is that current workers save for their eventual retirement – the money saved during the working years will fund retirement. The Supreme Court ruled that workers have no legal right to the money they pay to the government in payroll taxes. The money that the government collects in payroll taxes is used to fund current Social Security and Medicare payments by the government and the extra is used other current government spending.

There is no Social Security Trust fund surplus – the government is spending all of the money for current government programs such as the transportation, farm subsidies and the military. Although paychecks show separate deductions for federal income taxes and payroll taxes, there is no difference between the two since the government can spend all of the money today. The taxes differ in name only, both are collected by the government for current expenditures.

In 2004, the reported federal government deficit is estimated to equal $422 billion. A deficit means that the government is spending more than it is collecting in tax revenues. The estimated deficit includes the $200 billion Social Security surplus for 2004. Without the surplus – which the government is spending in 2004 – the actual deficit would equal about $622 billion.

Since 1983, the total Social Security surplus (the difference between tax collections and payments to beneficiaries) is about $1.8 trillion, and every dime has already been spent. The surplus is a myth and has been used for past and current government spending. The money to finance future retirements will come from taxes collected on future workers.

The United States faces a problematic future for both retirees and workers. In 2004, about 12% of the population is 65 years of age or older. The percentage will double to about 24% of the population as the boomers age into their golden years by 2035. People over 55 years of age will make up 57% of the population by 2035. At the same time the worker-to-retiree ratio will fall from 5 workers paying into Social Security for each beneficiary to about three workers per beneficiary. Specifically, in 2000, there were five people aged 20 to 64 for each person 65 or older. By 2030, the ratio will be less than 3 to 1. As a result, the number of people drawing money from the system will soar at the same time that the proportion of workers contributing to the system will drop.

The Bush Tax Cuts of 2001-2003

After taking office in 2001, President Bush cut federal income tax rates as well as other taxes such as the tax rate on capital gains (profits made after an asset such as stocks are sold) and dividends (paid to stock shareholders). Additionally, the estate tax was eliminated. Before the Bush tax changes, a person could inherit $600,000 tax-free. Any amount above that limit would be taxed as normal income. For example, a person who inherits $1 million would pay taxes on $400,000. After the Bush tax plan, all inheritances are exempt from taxation – the son of Bill Gates can eventually inherit billions of dollars and pay no taxes on the money.

An August 2004 report issued by the non-partisan Congressional Budget Office (CBO) finds that due to the Bush tax cuts of 2001 and 2003, the effective tax rate for the top 1% of income earners with average annual incomes over $1 million, decreased by 6.8% in 2004. The average tax cut for the millionaires is over $78,000 per year. In contrast the report finds that for the bottom one-fifth of income earners with average annual incomes of $14,900, the tax rate fell, but only by 1.5% in 2004. The tax reduction added an average of $250 in disposable income for this group. For the middle 20% of taxpayers with average annual earnings of $57,000 (before taxes), the average tax cut was $1,090.

Overall, one-third of all the tax cut benefits in 2004 will go to the top 1% of income earners. At the same time, the top 10% of wage earners pay about 2/3 of all federal income taxes so it does make sense that a reduction in federal income taxes will favor the wealthy. However, while the wealthiest Americans do pay the greatest share of federal income taxes, their share of all federal taxes is much smaller. When the employer share is included, almost 80% of working Americans pay more in payroll taxes than in federal income taxes. About 20% of working Americans pay only the payroll tax since after deductions, their income does not qualify for the federal income tax.

Since at the present time the government spends all of the federal income and payroll tax revenues (and still runs a deficit), both the income and payroll tax are part of the current tax bill for working Americans. The bottom line is that by only cutting the federal income tax, President Bush gave the majority of the benefits to upper income Americans and by not reducing the payroll tax rate or increasing the cap, Bush provided little to no tax relief for most working Americans.

The economic impact of Bush’s tax policies is that they were designed to give the majority of benefits to wealthy Americans. As described here, a different combination of tax breaks would have helped the average worker to a much greater degree.

The Bush tax polices have done little to stimulate economic and job growth. The reason for this is what is known as the multiplier. When people spend money they help to create an income and livelihood for others. This in turn creates income that is spent and this creates more jobs. For the economy, the multiplier has a value that is close to 2. This indicates that for every dollar added to the economy through a tax cut or government spending, an additional $2 in economic activity is generated. In general, a tax cut that adds $1 in disposable income will have a multiplier effect of $2 in additional economic activity. The practical effect is to create jobs and increase incomes beyond the direct impact of the tax cut – the greater the multiplier, the greater the positive economic impact.

The advantage of giving a lower or middle class American a dollar in lower taxes is that these people spend most of that dollar and there is a full multiplier effect. Give the majority of the tax benefits to millionaires and the multiplier and economic effect is much lower. The typically wealthy American already spends as much of their income that they want to and saves the rest. It can be expected that only a small part of the tax savings was spent and most was saved.