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V A
Economic
I
Review
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ï
FEDERAL RESERVE BANK OF
j' FUTURES
tBANKS
I
TAXES
JOBS
N Y L m r A ^ ^ ^
SEPTEMBER 1982
Rising Popularity with S&Ls
Preparing for Interstate Competition
Can a Flat-Rate Tax Work?
Unemployment Benefits and Temporary Layoffs
SUPPLY-SIDE
INFORMATION
w,
I
Tracing its American History
Problem-Solving for Small Business
Economic
Review
FEDERAL
RESERVE
BANK
O F ATLANTA
President:
William F. Ford
Sr. Vice President and
Director of Research:
Donald L. Koch
Vice President and
Associate Director of Research:
William N. Cox
Financial Stucture:
B. Frank King, Research Officer
David D. Whitehead
National Economics:
Robert E. Keleher, Research Officer
Stephen O. Morrell
Regional Economics:
Gene D. Sullivan, Research Officer
Charlie Carter
William J. Kahley
Database Management:
Delores W. Steinhauser
Payments Research:
Veronica M. Bennett
Paul F. Metzker
Visiting Scholars:
James R. Barth
George Washington University
James T. Bennett
George Mason University
George J. Benston
University of Rochester
Gerald P. Dwyer Jr.
Emory University
Robert A. Eisenbeis
University of North Carolina
John Hekman
University of North Carolina
Paul M. Horvitz
University of Houston
Peter Merrill
Peter Merrill Associates
Communications Officer:
Donald E. Bedwell
Public Information Representative:
Duane Kline
Editing:
Gary W. Tapp
Graphics:
Susan F. Taylor
Eddie W. Lee, Jr.
The purpose ot the E c o n o m i c Review is to inform the
public about Federal Reserve policies and the economic environment and, in particular, to narrow the gap
between specialists and concerned laymen.
Views expressed in the Economic Review aren't necessarily those of this Bank or the
Federal Reserve System. Material herein may be reprinted or abstracted if the Review
and author are credited. Please provide the Bank's Research Department with a copy of
any publication containing reprinted material. Free subscriptions and additional copies
are available from the Information Center, Federal Reserve Bank of Atlanta, P.O. Box
1731, Atlanta, Ga. 30301 (404/586-8788). Also contact the Information Center to
receive Southeastern Economic Insight, a free newsletter on economic trends
published by the Atlanta Fed twice a month and mailed first class to subscribers. Insight
is designed to give readers fresh and timely data, analyses and forecasts on the
Southeast's economy.
^
lililí
Financial Futures as a
Risk Management Tool for
Banks and S&Ls
IK
«i*
4
Positioning for
Interstate Banking
15
Financial futures are one of the newest and least
understood tools used by financial managers to
cope with high and volatile interest rates. How
popular is this new tool with southeastern banks
and S&Ls, and what strategies are they using?
What are bank holding companies doing to prepare for the possible legalization of interstate
banking? One indication is the degree to which
they are establishing nonbank subsidiaries across
state lines.
The Flat-Rate Income Tax:
Boon or Boondoggle?
24
Does Unemployment Insurance Affect
the Composition of Joblessness?
31
What are the advantages of a flat-rate income tax?
Would it necessarily mean that lower income
taxpayers would pay more tax? What obstacles
stand in the way of the proposal's passage?
Do higher unemployment benefits make firms
more willing to lay off workers temporarily? If so,
how do socio-demographic factors such as age
and sex affect the probability of temporary layoff?
Supply-Side Economics:
Guiding Principles for the
Founding Fathers
Asking the Right Question:
Small Business and
the Information Future
42
Supply-side views were the essence of the economic principles behind the American Revolution
and the U.S. Constitution. The Revolution can be
seen, in part, as a reaction against government
intervention and high tax rates.
Statistical Summary
V O L U M E LXVII, N O . 9
55
How can small businesses cope with today's
exploding information needs? Even without massive computer resources, a systematic approach
to information-gathering can be crucial to a small
business' survival.
60
Financial Futures as a
Risk Management Tool
for Banks and S&Ls
Southeastern S&Ls in
increasing numbers are
turning to the financial futures
market as a shield against
unexpected interest rate
changes. Banks in the region,
which generally managed to
align their asset and liability
maturities better than S&Ls,
have shown less enthusiasm.
Financial managers have learned the dangers
of interest rate risk in recent years as rates
reached new heights and increased in volatility.
W i d e swings in financial markets underscored
the sensitivity of banks' and S&Ls' portfolios to
interest rate changes. W h e n assets have a longer
maturity structure than liabilities, liability costs ',
respond more quickly to interest rate fluctuations
than do returns on assets. As a result, rising rates
squeeze earnings.
One of the newest and least understood tools
employed by asset/liability managers to cope
with high and volatile interest rates is hedging in
the financial futures market. Financial futures
represent an obligation to buy or sell a particular
financial instrument at a specified future delivery
date, at a price established on an organized
exchange (see "Mechanics of
Hedging,"
pp. 6 & 7).
Drawing from 230 replies to a mail survey of
370 banks and savings and loan associations, we
recently explored southeastern institutions' use
of financial futures as a risk management tool.1
W e found that 22 responding financial institutions — 15 S&Ls and seven banks — are now
using financial futures. Our findings indicate that
more of the responding institutions entered the
futures markets over the past year than in any
year since trading began in financial futures in
1975.
'Our sampling procedure for the survey of 370 financial instiutions was
random and stratified. Sixth District banks and savings and loan associations
were stratified by state and by size of institutions, with both divided into two
size classes. W e counted the large institutions as those with assets of more
than $150 million and the small as those with assets less than that amount.
The large bank category also includes multi-bank holding companies. W e
sampled more heavily in the large category in the belief that the larger
institutions would more likely be knowledgeable about and involved in
futures trading. Questionnaires were mailed on May 27,1982. Our analysis
is based only on those responding to the survey. For both banks and S&Ls,
our response rate was slightly over 60 percent.
4
,
1
I
*
f
)
The response suggests that an increasing number of southeastern S&Ls are turning to the
financial futures market as a shield against unexpected interest rate changes, while banks in the
region show less enthusiasm. Since a higher
percentage of the responding S&Ls indicate they
also plan to use the market more in the future,
this pattern should continue.
The S&Ls' enthusiasm may seem surprising in
light of the depressed state of the thrift industry
and the way hedging with interest rate futures
"locks in" current earnings. But most S&L managers
indicate they are limiting their involvement until
earnings improve. Once earnings increase, they
plan to expand their futures activity, drawing on
the experience they are gaining now.
Most of the survey respondents who are not
using financial futures attributed their decision
to a lack of trained personnel, the risks of futures
trading, and their own ability to hedge risks
without relying on futures.
Hedging with financial futures (taking offsetting
positions in the futures market) is a management
technique for limiting the interest rate exposure
in balance sheets. Hedging replaces the risk of
interest rate fluctuations with the risk of changes
in the difference between cash yield and yield
on a particular futures contract.
Chart 1 illustrates yield patterns for certificates
of deposit and Treasury bill futures contractscontracts often used for hedging borrowing costs.
The difference between the two yields is less
volatile than either individual yield. Financial
managers hedging with futures instruments are
protecting their earnings from volatile interest
rates by subjecting earnings instead to a smaller,
more manageable risk.
In investigating the futures market participation
of banks and thrifts, we examined reasons for
and against hedging interest rate risk, methods
and strategies of those currently trading in the
futures market, and the effects of regulatory and
accounting guidelines on hedging strategies.
Who is Using Financial Futures in the
Southeast?
Our survey suggested that S&Ls rely on the
futures market far more than do banks. A larger
proportion of S&Ls are currently hedging their
interest rate exposure or planning to do so later.
Chart 1.
Three-month Domestic Certificates of Deposit
and Three-month Treasury Bill Futures*
20 •— Yields
(percent)
15
3-month
CDs
¡
10
J^M
\ f
5
I
1979
3-month
T-Bill Futures
1
1980
I
1981
'Treasury bill futures yields correspond to the close-in contract
Traditional differences between S&Ls and banks
help explain their different levels of activity.
Through the years, S&Ls have dealt in long-term,
fixed-rate residential mortgages. Associations with
many fixed-rate loans on their books face a
greater threat that interest rate increases which
raise the costs of deposits will reduce their
earnings.
A Georgia S&L commented, "although our
experience is short, we see hedging as an essential tool to reduce the rate risk associated with
long term assets supported by short term liabilities."
Banks and S&Ls increasingly rely on variable
rate loans to help restructure their balance sheets
and pass along interest rate exposure to customers.
Banks have been more successful in this effort,
largely because of the generally shorter maturities
of their outstanding loans, and, as a result, they
have managed to align their asset and liability
maturities betterthan S&Ls. Their success encourages banks to favor hedging in the cash market
instead of the futures market. For this reason,
many banks are staying out of the futures market
altogether. Several banks currently hedging say
they are using futures positions only to cover
temporary mismatches.
continued
FEDERAL RESERVE B A N K O F A T L A N T A
•
1982
on p. 8
5
The general goal of hedging is to protect against
possible unexpected price changes. Keeping this in
mind, several important points should be noted.
First, hedging with financial futures gives protection
only from unanticipated interest rate moves. Hedging
does not provide protection from future interest rate
changes which are generally held and embedded in
futures prices. For example, if the overall market
expects a rise in interest rates, and, reflecting this,
futures prices for distant delivery dates are lower in
correspondence to higher interest rates, the seller
of futures contracts cannot gain protection from the
anticipated rise.
Second, when a financial institution is hedging in
the true sense of the word, its goal is not to gain from
futures positions, but instead to smooth out income
over time. A hedge is placed to "lock in" today's
return. The user of financial futures is foregoing
possible gains from a favorable interest rate change
to prevent the losses from unfavorable rate moves.
The third important point is that hedges are rarely
perfect in the sense that any gain or loss in the
futures position will completely offset any loss or
gain in the cash position.
The futures industry uses the term "basis" to refer
to the arithmetic difference between the cash price
(or yield) of a financial instrument and the price (or
yield) of a particular futures contract. The outcome of
a hedge depends directly on the difference in the
basis at the time the hedge is placed and lifted. With
no change in basis, the hedge will be "perfect" in the
sense that any gain (or loss) in the futures market
will exactly offset any loss (or gain) in the cash
market. If the basis changes, there will be a net gain
or a net loss in the futures and cash positions
combined.
A short hedge is the sale of futures contracts, and
a long hedge is the purchase of futures contracts.
Short hedges are appropriate when the objective is
to guard against rising interest rates. Financial
institutions that hedge are, in the majority of cases,
short hedgers. Since today's balance sheets are
sensitive to rising rates, the applications of long
hedges are more limited.
The hedging of six-month money market certificates
with 90-day Treasury bill futures was by far the most
common hedge among our sample. Since the objective of such a hedge is to lock in current borrowing
costs, short positions are taken. The following example illustrates the mechanics of this common liability
hedge.
Suppose a bank issues $10 million of six-month
money market certificates (MMCs) at 13.4 percent
in November. To protect borrowing costs from any
increases in interest rates between November and
May, they short 90-day T-bill futures.
The Mechaitt
with Finah
At the same time, it sells 20 J u n e 90-day T-bi{7**
contracts. Each T-bill contract has a face value of $1
million. The T-bill position is double that for MMCs*- 4
because the maturity of the T-bill contract is half that;
for M M C s For example, consider the effect of hedging \
a $1,000,000, pool of six-month M M C s with a single i *
($1,000,000) T-bill contract. A one basis point chana? £
in the yields of both cash and futures instrument
would bring about a change in the market value c "
M M C s equal to twice that of the futures contract.
In May, when the M M C pool is refunded, the ban¡c
goes back into the futures market and buys 20 June
90-day T-bill contracts. Suppose that interest rates
have risen to 15.35 percent so that the cost of the]
pool of M M C s increases by $97,500. Since future^«
yields tend to move with cash yields, the yield of the
J u n e futures contract is also higher in May (14.7^'
percent). There is then a gain in the futures marked
to offset the loss in the cash market. Following is a"1
summary of the hedge:
Nov. 5
May 6
Cash
Market
Futures
Market
Issues $10
million of
M M C s at
13.4 percent. Sixmonth
interest
cost =
$670,000
Renew $10
million of
M M C s at
15.35 percent. New
six-month
interest
cost =
$767,500
Sells 20
J u n e T-Bill
contracts at
87.23 (12.77
percent)
Value:
$19,361,500
Loss (equal
to increase
in six-month
interest cost)
$97,500
Gain $97,500
Buys 20
J u n e T-Bill
contracts at
85.28 (14.72
percent)
Value:
$19,264,000
Basis
.63
.63
Increased interest cost
Futures gain
Net increased cost
$97,500
$97,500
- 0 -
In November, the bank's cash market transaction
is the issue of $10 million of M M C s at 13.4 percent.
6 SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
tes of Hedging
¡liai Futures
r ^ J o In this example, borrowing costs increased $97,500
1j
because of the increase in interest rates from 13.40
percent to 15.35 percent. This represents the feared
t/
loss in the cash market. To offset this there is a gain
in the futures market of $97,500. This particular
^
hedge was "perfect," since the futures gain is iden• 1 ,tical to the cash market loss. The offset is exact only
tj
when the basis does not change. Note that when the
jiedge was placed the basis expressed in yields was
.63 (13.40-12.77). W h e n the hedge was lifted the
basis was also .63 (15.35-14.72).
A A
The perfect hedge is the exception rather than the
rule. Normally the basis does fluctuate somewhat.
Consider the results of the above hedge if the yield
«on the J u n e T-bill contract increased to 14.00 percent
rather than 14.72 percent. In this case the basis
,would differ at the time the hedge was placed and
lifted, resulting in a less than perfect offset. The
following transactions summarize the results of
such a hedge.
Nov. 5
-?May 6
Cash
Market
Futures
Market
Issues $10
million of
M M C s at
13.4 percent. Sixmonth
interest
cost =
$670,000
Sells 20
J u n e T-Bill
contracts
at 87.23
(12.77 percent)
Value:
$19,361,500
Renew $10
million of
M M C s at
15.35 percent. New
six-month
interest
cost =
$767,500.
Buys 20
J u n e T-Bill
contracts
at 86.00
(14.00 percent)
Value:
$19,300,000
Loss (equal
to increase
in six-month
interest cost)
$97,500
Gain $61,500
Increased interest cost
Futures gain
Net increased cost
FEDERAL RESERVE B A N K O F A T L A N T A
Basis
.63
1.35
$97,500
$61,500
$36,000
Note that the gain of $61,500 in the futures
market partially offsets the $97,500 cash market
loss. Even though the gain in the futures position did
not completely offset the loss in the cash position,
the hedge successfully reduced interest rate exposure by reducing the impact of rising rates on
borrowing costs.
The prices of futures contracts fluctuate with
interest rate changes and in response to supply and
demand, but the coupon rate, maturity, quantity and
issuer remain standard.
A futures transaction is rarely taken with the
objective of taking or making delivery. The holder of
a futures position can at any time cancel his position
by reentering the market and placing an offsetting
position. The liquidity of the market which allows
such offsets is a product of both the standardization
of the futures contracts and the large volume traded
on the markets. For example, an individual who
bought a J u n e T-bill futures contract in January can
clear his position by selling a J u n e T-bill contract
any time between January and the J u n e delivery
date. If the price he paid for it in January exceeded
the selling price, the futures position would result in
a loss. If the selling price was higher than the buying
price, a gain would result.
A futures position such as in this example is not
inherently either speculative (risk-increasing) or
hedging (risk-reducing). Whether such a futures
position is used as a hedge or for speculation
depends on the underlying cash position of the
holder of the futures position. Banks and S & L s are
restricted by their respective regulations to entering
the futures market only for hedging (not speculative)
purposes.
Since the introduction of the G N M A contracts in
1975, new futures contracts have become available
on a number of exchanges.
The Chicago
Board of Trade (CBT) and the International Monetary
Market (IMM) are the most active exchanges for
financial futures. The C B T has the successful (high
volume) G N M A and Treasury bond futures contracts.
In May 1982 it offered a new ten year Treasury note
contract which has high early volume figures.
The highly successful Treasury Bill contract is
traded on the IMM. The new CD future offered by the
IMM has been the most successful of the new CD
futures contracts.
Credit risk is eliminated in futures transactions,
since the exchanges in their role as a clearing
corporation act as a buyer to every seller and a seller
to every buyer. The futures markets are cleared
daily. Trading cannot begin on any day until all
transactions from the prior day are resolved. Margin
accounts are important in this process. Each individual with a futures position must maintain a margin
account with his broker. W h e n the markets are
cleared each day, the margin accounts of all the
winners are credited and the margin accounts of all
the losers are debited. When a margin account falls
below a certain specified minimum, it must be replenished. If the account is not brought up to the required
minimum, it will be closed out. This process limits
losses and insures market integrity.
A Tennessee banker explained how he expects
financial futures to cover temporary imbalances:
" W e view the futures markets as something like
an insurance policy. While we may not feel the
need to use them, the capacity to do so could be
important Under certain market conditions, futures
market activities could provide a temporary
solution to unwanted balance sheet exposure,
allowing us time to develop more nearly permanent
solutions through cash market strategy."
Another banker noted: "The experience of our
bank is that financial futures provide an invaluable
tool for managing the swings in interest rates
when the exact asset or corresponding liability
cannot be obtained immediately. Futures have
helped immensely over the last several years in
many areas of spread management."
Larger institutions, whether banks or S&Ls, are
definitely more active participants in financial
futures markets. All the banks using futures came
from the ranks of the largest institutions. Among
the S&Ls, the largest are most active, but some
small-sized institutions with $50 million to $150
million in total assets are also hedging with
futures.
Among holding companies and independent
banks with assets greater than $150 million, 13
percent of those who responded are now using
financial futures, 24 percent are planning to use
futures and 63 percent are not using futures. The
large S&Ls with assets exceeding $150 million
show higher participation and planned participation rates. Of the large responding S&Ls in our
sample, 18 percent are now using futures, 55
percent are planning to, and 27 percent are not
using futures.
No responding small banks are currently using
financial futures, and only 3 percent are drawing
plans to participate. Small S&Ls generally were
knowledgeable and more heavily involved in
planning than their bank counterparts, with 6
percent now participating and another 18 percent
planning to begin in the near future.
"Larger institutions . . . are
definitely more active
participants in financial
futures markets."
8
Varieties of Futures Positions
Of 15 S&Ls involved in financial futures, most
y
place Treasury bill futures positions to hedge
v
the cost of their money market certificates or
other CDs. A few have short Government
National Mortgage Association (GNMA) futures
positions on loans or other existing investments.
Among the S&Ls planning to hedge, the majority
t
will start with a short hedge on six-month money
market certificates using three-month Treasury
r
bill futures.
The strategies of the seven banks using futures
were varied. Three of the five large multi-bank
holding companies reported limited activity, with
two hedging in the trading account only and one •»
hedging only mortgage commitments in a mortgage subsidiary. The other four banks use a
variety of strategies. Financial futures are most
^
commonly used to hedge borrowing rates and
returns in the investment portfolio. The average
W
size of the hedge position expressed as a percentage of total assets was 2 percent for banks. The
reported plans of banks that will begin hedging
l
later reflect the same varied patterns.
S&Ls are hedging a larger proportion of their
portfolios than banks, which is not surprising in
light of their larger interest rate exposure. The
average total hedged position as a percentage of
ft
total assets for S&Ls is 8 percent. Several S&Ls
have futures positions in excess of 1 5 percent,
while the banks' positions were 5 percent or less.
The majority of these institutions plan to increase
their degree of involvement; none expects a
»
decrease. Nineteen of the 22 participating banks
and S&Ls expect to increase their use of futures, *
while the remaining three anticipate that their f \
use will remain the same.
f
The limited current activity in some cases
reflects necessary caution while institutions gain
the expertise to hedge effectively. I n other cases,
depressed earnings restrict institutions from full- *
scale futures activity. Many S&Ls burdened with
j
large quantities of below market fixed rate mort- <
gages are in such a situation. Hedging today will
not help them recover losses on the devalued
assets. Recognizing this, many of these S&Ls are
currently following a strategy of remaining exposed
and hoping to gain from falling rates.
*
Some institutions plan to hedge liability costs if
„
the anticipated decline in rates widens interest *
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
spreads. A large Mississippi S&L reported limited
involvement now but plans to "hedge liability
cost as the level of interest rates appears more
favorable." A Florida S&L said, "our hedging
program is expected to expand in size as cost of
borrowings reaches (falls to) attractive levels for
'lock-in'."
Because banks have been much more successful in aligning asset and liability maturities, they
have narrower, more volatile maturity gaps. To
be certain that hedging does not increase interest
rate risk, banks with small gaps must monitor
hedges more closely. Hedging strategies for these
banks are therefore more complicated than
appropriate strategies for the typical S&L and
normally require detailed information on maturities
of portfolio items.
Planning and Managing
the Hedging Program
The majority of institutions studied the markets
and mechanics of hedging for less than a year
before launching their programs. Executives
demonstrated a strong reluctance to delegate
hedging responsibility far from the top of the
chain of command or to turn the program over to
outsiders. Top managers in both banks and S&Ls
bear the largest responsibility for administering
hedging programs and are actively involved in
determining when hedges are placed and lifted.
In small S&Ls, the president is commonly an
active participant. In large S&Ls and banks, various
combinations of senior vice presidents, financial
officers, treasurers, and portfolio managers were
most often cited as key players.
Outside consultants and brokers are working
quite closely with internal management in determining futures positions in 60 percent of the
active institutions. S&Ls are relying more heavily
on outside input, and are consulting with brokers
to a much greater degree than with financial
consultants.
Several institutions indicated a reluctance to
rely on any form of outside assistance. One large
S&L just entering the futures market said its
major concern "involves advice from brokers
who try to churn the accounts for their own
benefit." A non-participating S&L explained that
the "primary reason for not using financial futures
AA FEDERAL RESERVE B A N K O F A T L A N T A
"The majority of institutions
studied the markets and
mechanics of hedging for
less than a year before
launching their programs."
is having to deal with brokers who may or may
not act in the association's best interest."
None of the S&Ls and only one of the banks
hired additional personnel for their futures hedging
programs. However, two other banks and one
S&L had people on their staff with prior trading
experience in futures. W e found the institutions'
failure to hire many new people somewhat
surprising, particularly since the mechanics of
hedging are rather complex for the inexperienced
and since several respondents said they lacked
trained personnel. There appears to be a shortage
of skilled individuals, and there may be a reluctance to bring in new people to manage a
program which directly affects profits.
Rather than hiring new people, the majority of
institutions gave employees additional training
in futures. Professional seminars were the most
commonly cited source of training and information,
and all futures markets participants in our survey
had attended at least one. Besides seminars, the
most frequently cited source of training was self
study, using information from a variety of sources
such as journals, publications, and commodity
exchanges. Others said they benefited from
discussions with brokers, financial consultants,
and peer institutions already involved with financial futures.
Why Some Institutions have
Decided Against Financial Futures
Some financial institutions say they are staying
out of the futures market largely because they
lack the skilled analysts and knowledge to assess
the risks and rewards of hedging interest rate
exposure.
Among those not trading in futures, we found
different levels of expertise. At one end of the
spectrum were institutions that had seriously
r
compared financial futures with alternative risk
management strategies and concluded that futures
were not the tool for them. At the other end were
those that knew little or even nothing about
financial futures.
Amongthe banks neither using nor planningto
use financial futures, 90 percent said their ability
to match assets and liabilities in the cash market
influenced their decision not to hedge with
futures.
Given banks' success in the cash markets,
many bankers limit futures hedging to situations
of temporary imbalances. At the same time, the
costs of starting and administering a futures
program are significant in terms of management's
time. Finally, the performance of the futures
hedge is likely not to be perfect.
A Tennessee banker who reported coping
successfully with interest rate volatility through
increasing the sensitivity of assets decided against
financial futures after extensive study. He expressed
the sentiments of many peers when he noted as
factors in his decision, "the commitment of
resources for a successful use of the program in
terms of time and expertise, the accounting
treatments, the imperfect nature of the hedge
through futures and the necessity to educate
state supervisory authorities." These comments
reflect the concerns of many large banks in our
sample that have seriously investigated and rejected
futures hedging.
For the total sample, a shortage of trained
personnel was most often cited as the greatest
obstacle to using financial futures. Two-thirds of
the non-participating S&Ls reported that a conservative board of directors was a major influence
in their decision not to hedge. For some institutions
that decided to use futures, educating the board
was an important step in starting their programs.
Several banks and S&Ls mentioned that they
lack knowledge about futures markets, the
mechanics of hedging, and the risks involved.
Another, " W e have no working knowledge of
financial futures; not even enough to answer the
above questions intelligently."
Regulatory Guidelines for Futures
Regulators, charged with ensuringthat financial
institutions avoid excessive risk, allow financial
The Risks:
with Finar
Hedging with financial futures does not eliminate risk, *
but rather exchanges one type of risk for more manageable
risks. Any financial institution involved in hedging should
be aware of the risks associated with financial futures.
The hedging process exchanges the risk of price fluctua- '
tions for the lesser risk of fluctuations between the cash
price and the price of a particular futures contract. As long
as the cash and futures prices move together, hedging
reduces interest rate risk. While it is not common, cash4
and futures prices occasionally move in opposite directions.
When this happens, the hedge could result in losses in
both the cash and futures markets.
Another potential pitfall of playing the financial future? •
game is that margin calls (see "Mechanics..." pp. 6 & 7)
create cash flow problems. When the institution experi- a
ences losses in the futures position, meeting margin calls
can create serious cash flow problems for under-capitalized»
institutions.
Institutions should be aware of potential risk when they *
take a futures position to lock into a given interest rate on
an anticipated future transaction. If the expected cash ' )
position fails to materialize, there will be no cash gain to
offset any loss in the futures market. As a general rule,
»1
institutions to use financial futures for hedging
purposes only. Financial futures can be used to
either increase or decrease interest rate exposure.
"Speculators" enter the futures market to increase
their interest rate exposure and profit by outguessing the market in predicting interest rate
fluctuations. " Hedgers" enter the futures market
to decrease interest rate exposure by taking a
futures position to offset a cash position that
fluctuates with interest rates. Therefore, regulators
are challenged to design guidelines allowing
financial institutions the flexibility to decrease
interest rate risk while preventing speculative
abuses.
The regulators have all been very clear on one
point: financial institutions should use interest
rate futures only to reduce their interest rate
exposure. The regulatory agencies have adopted
different approaches to ensure that depository
institutions maintain this objective. The guidelines
»,
M
10
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
t
¡ ¿f Hedging
-çial Futures
bank regulators do not consider such anticipatory hedges
to be valid.
There is some concern, particularly among regulators,
that the financial futures markets could be "cornered" by
speculators as was the silver market. The exchanges
themselves argue that, while theoretically possible, the
risk of cornering is miniscule because of the size and
diversity of financial futures markets.
There are a few other potential drawbacks of hedging
with financial futures, discussed more fully later in this
article. First, those "hedges" that do not reduce the net
interest rate exposure in the balance sheet actually
increase interest rate risk. A mismanaged program thus
can increase an institution's risk position. Secondly, the
accounting treatment of futures positions for banks, by
increasing the volatility of reported income, may make
the banks' positions appear riskier to stockholders when,
in fact, the futures hedge has decreased risk. Third, the
optimal time to place a hedge is when earnings are at an
acceptable level. If a full-scale hedging program is put in
place when spreads are at a low point in the cycle, the
institution will be "locking in" a relatively low earnings
spread.
r
for insured commercial banks are very similar
even though they come from three regulatory
bodies — The Federal Reserve Board, the FDIC,
and the Comptroller of the Currency. S&Ls are
covered by a different set of guidelines issued by
the FHLBB.
Since many banks have been much more
successful than S&Ls at matching maturities of
assets and liabilities (i.e. hedging in the cash
markets), their interest rate gaps are in general
lower and more variable than S&Ls' gaps. Therefore,
the banks' guidelines must be flexible to permit
banks with a variety of balance sheet configurations to utilize futures to reduce interest rate
exposure. Toward that objective, bank regulators
have been reluctant to dictate specific position
guidelines and banks are permitted to take both
long and short hedge positions.
The accounting profession has yet to agree on
generally accepted standards for financial futures,
AA FEDERAL RESERVE B A N K O F A T L A N T A
but public accounting guidelines are currently
being developed by the Financial Accounting
Standards Board. It is not yet clear what effect
the guidelines still to be issued by the FASB
ultimately will have on regulatory guidelines.
Their influence will likely depend on the degree
to which they include safeguards deemed necessary by regulators.
As a deterrent to speculation, bank regulators
require that banks recognize futures losses in
current income. Under mark-to-market accounting for futures positions, any gains on futures
positions are recognized as current income and
any losses as current expenses.2 By reflecting the
changes in an open futures position, this accounting treatment prevents speculative positions
from being hidden for long periods, a situation
which could allow large losses to accumulate.
While it successfully deters banks from speculative abuses, mark-to-market accounting also may
discourage legitimate uses of financial futures.
Most banks have no objections to marking
futures positions to market when the item being
hedged is also marked-to-market. Since items in
the trading account are currently marked-tomarket, the accounting treatment of a futures
position and any hedged trading account item is
symmetrical. Objections are normally raised to
mark-to-market accounting treatment when hedging the investment portfolio, since gains and
losses on these assets are normally reported only
after they are sold.
If a bank hedges an investment portfolio
item with a futures contract,3 normally the portfolio item would be carried on the books at
' B a n k s may opt to use a "lower of cost or market" accounting treatment
which requires current recognition of futures losses, but defers gains until a
futures position is offset
3 A specific hedge sample is used to illustrate the accounting issue. S e e
'Futures Hedging Strategy 1 for a discussion of specific versus net balance
sheet hedges
"Regulators are challenged
to design guidelines allowing
financial institutions the
flexibility to decrease interest
rate risk while preventing
speculative abuses."
<\
cost while the futures position would be markedto-market. Thus, any loss on the futures side
would be reflected in the bank's income statement, but any offsetting gain in the value of the
investment portfolio item would be recognized
not in the current period but when the item is
sold. For this reason the mark-to-market accounting treatment would result in greater volatility
in bank income when banks have outstanding
futures positions. The asymmetrical accounting
treatment makes a bank's position appear risky
when actually the outstanding futures position
has decreased the risk of income fluctuations
resulting from interest rate changes. For this
reason, the current accounting treatment is a
disincentive for banks to hedge in futures
markets.
The guidelines for S&Ls differ from those for
banks and in large measure reflect the differing
balance sheet construction. Since almost all S&Ls
possess large negative gaps because of their
long-term mortgage lending, there is less variation
in appropriate risk-reducing hedging strategies.
The FHLBB was able to issue more specific
regulatory guidelines which restrict most S&Ls to
short positions in futures. This requirement ensures
that S&Ls are closing their negative gaps, provided
they do not "over hedge" the gap.
Since it can control potential speculative abuses
through specific guidelines, the FHLBB has given
S&Ls guidelines more favorable than those covering
banks. New regulations adopted by the FHLBB in
July 1981 relaxed some earlier restrictions on
S&Ls' futures trading. The new guidelines emphasize that net interest rate exposure is the appropriate basis for hedges. They authorize a wider
range of futures contracts and permit S& Ls to use
a type of deferral accounting for futures. Under
deferral accounting, futures positions are accounted
for in the same manner as the item hedged,
thereby better reflecting the true effects of
hedge positions.
W e asked the financial futures users how the
accounting guidelines affect their involvement.
As we expected, S&Ls and banks differed in their
responses to this question. Fourteen of 1 5 active
S&Ls said the accounting guidelines either encouraged or had no effect, while six of the seven
banks said the current guidelines discouraged
their involvement. Several commented that the
guidelines were currently dampening their involve-
12
ment. For the banks not using financial futures,
the influence of the accounting guidelines on
their decisions was in most cases marginal. Somewhat surprisingly, very few said this was a major
factor in their decision against hedging.
W e asked S&Ls whether the recent changes in
accounting guidelines affected their involvement
in futures. A few indicated that the changes
made it possible for them to hedge with futures.
The majority, however, commented that while
the new guidelines encouraged their involvement,
they would have begun a futures program without
the changes. Those that began hedging before
the accounting changes took effect commented
that the changes encouraged them to become
more involved than they might have been in the
past. So, for the majority, the changes likely
affected the degree but not the fact of their
participation.
W e also asked how regulatory guidelines other
than accounting regulations and examination
practices affected involvement in futures. The
responses suggested that the overall regulatory
environment is at present neutral for S&Ls and
slightly discouraging for banks.
The regulators all emphasize through their
guidelines that placing a financial futures position
Hedging in Isolation
To demonstrate how a specific hedge seen in isolation
can increase the interest rate exposure, consider the case
of an institution that is perfectly matched in the cash
market. That is, its asset and liability maturity structures
are such that both sides of the balance sheet are equally
sensitive to interest rate fluctuations.
Suppose this institution fears that future interest rate
fluctuations could adversely affect its costs of liabilities
(deposits). To lock in current rates paid on six-month
Money Market Certificates, it shorts Treasury bill futures.
But if the institution is perfectly matched in the cash
market, then the six-month M M C s have a "match" on
the asset side, such as variable rate loans which reset
interest rates every six months. If interest rates rise, the
return on the variable rate loan increases to offset the
higher interest paid on MMCs. The short T-bill position
generates a gain not offset by a cash position. If rates
fall, the futures position results in a loss with no offset.
Thus, a futures position in this case would increase
interest rate exposure and make earnings more sensitive
to rate fluctuations.
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
ft
^
\
"Since it can control potential
speculative abuses through
specific guidelines, the
FHLBB has given S&Ls
guidelines more favorable
than those covering banks."
is appropriate only when it reduces net interest
rate exposure. They stress that for this reason
hedges on specific assets or liabilities cannot be
considered in isolation, but must be examined in
light of the effect on net interest rate exposure in
the balance sheet.
Futures Hedging Strategy
1
Bank regulators insist that banks hedge net
interest rate exposure in the balance sheet, a
practice often called "macro" hedging. Taken to
the extreme, this strategy has been interpreted
as placing futures positions to hedge their entire
gap without regard for the underlying assets or
liabilities comprising the maturity mismatch or
"gap." This type of hedging strategy may be
referred to as "blind macro" hedging.
Hedging specific assets and liabilities instead
of hedging a measure of net interest rate exposure
is often called "micro" hedging. The extreme,
where specific hedges are placed with no regard
for the overall net interest rate exposure in the
balance sheet, may be called "blind micro"
hedging.
In practice, probably the most common strategy
is placing micro hedges to reduce overall gaps.
Bank regulators have indicated that placing micro
hedges with proof of reducing net interest rate
exposure complies with their regulations. Many
financial institutions use sophisticated information
systems which allow them to hedge gap or net
interest rate exposure while at the same time
hedging specific items in the portfolio. Others
lack such complex information systems but
determine the offset in some gap measure
brought about by any hedge.
AA FEDERAL RESERVE B A N K O F A T L A N T A
All the participating banks said they measure
gap regularly. Two said that when the particular
gap they monitor reaches a threshold level, they
hedge all or part of the gap with futures. Only two
of the seven active banks indicated that their
futures positions do not correspond to specific
assets or liabilities.
S&Ls are not measuring gap to the degree that
banks are, with slightly over half the active S&Ls
regularly constructing a measure. Among the
S&Ls planning to enter the futures market, less
than half currently measure gap, but most of
these plan to start before beginning a futures
program.
Ten of the S&Ls classified themselves as blind
micro hedgers and only one a macro hedger. The
other four S&Ls place micro hedges to reduce
a measure of gap. The micro hedging of such
S&Ls is likely no cause for concern, because the
combination of large negative gaps and the
regulation-guaranteed short hedges should ensure
a reduction of interest rate risk. Also, many of the
micro hedgers are among those hedging on a
limited basis while awaiting the hoped-for fall in
interest rates.
I n short, it appears that institutions generally are
employing futures for their intended purpose-to
reduce interest rate exposure.
Another controversial issue is whether or not
institutions should base their futures positions
on the expected direction of interest rates.
"Core" hedges are placed in order to avoid
predicting interest rates. The intent of core hedging
is merely to smooth income fluctuations and
break even in the futures market "Timed" hedges
are placed and lifted only when a futures gain is
expected. Thus, timed hedgers attempt to gain in
the futures market with every hedge. Succeeding
at timed hedging requires interest rate projections
consistently better than the market's.
One view holds that the purpose of hedging by
financial institutions is to avoid the necessity of
predicting interest rates; in other words, only
core hedges are appropriate. Proponents of this
view usually cite the poor forecasting records of
financial experts and econometric models. Further,
they argue that placing hedges only when a profit
is expected from the hedge is in a sense speculation.
W e asked the institutions in our sample if their
hedging programs depend on interest rate pre-
"Two-thirds of the active
banks and one-fourth of the
active S&Ls indicated that
their hedges do not depend
on interest rate predictions."
dictions. Two-thirds of the active banks and onefourth of the active S&Ls indicated that their
hedges do not depend on interest rate predictions.
Some institutions using interest rate forecasts
qualified their responses to this question, often
noting that their hedging is part of a larger spread
management program. Since for many aspects of
spread management an interest rate forecast is
needed, the hedge positions in this sense rely at
least indirectly on an interest rate forecast.
The S&Ls' greater reliance on interest rate
forecasts reflects several different uses of interest
rate predictions in a futures program. Some
institutions forecast rates to help in pinpointing
an optimal time for a full-scale hedging program.
Other S&Ls with more active futures programs
use their rate projections for timed hedges. Since
many S&Ls currently need tactics that can increase
expected profits, most tend to be more enthusiastic about timed hedges. The drawback with the
timed program is that if they consistently fail to
predict interest rates better than the market,
hedging will worsen their situation.
Summary
While a few of the southeastern respondents
were among the early users of financial futures,
most began in the last 18 months. Our results
suggest that more southeastern institutions began
hedging in the past year than ever before. On
average, S&Ls had 8 percent of their total assets
in futures positions—compared to 2 percent for
banks. Since in general S&Ls tend to have large
negative interest rate gaps, it was not surprising
that they have both larger participation rates and
larger positions in the financial futures markets.
Oursample included institutions with a variety
of hedge positions. By far the largest number of
hedges are placed to lock in borrowing costs. The
most commonly reported hedge was the shorting
of T-bill futuresto hedge money market certificates
and other certificates of deposit.
Almost all of the participating S&Ls and twothirds of the participating banks plan to increase
their futures activity. Many are proceeding cautiously until they gain more experience and
knowledge in the mechanics of hedging. Others,
particularly S&Ls, are choosing not to hedge all
their interest rate exposure, hoping that falling
interest rates will improve their earnings spreads.
Among those involved in hedging activity, the
banks reported that overall regulations, especially
the accounting guidelines, have discouraged
their use of futures. The accounting guidelines
seem to have the most significant impact on the
degree of involvement rather than on the decision
to hedge with futures. Somewhat surprisingly,
only a small percentage of the non-participating
banks cited the accounting guidelines as the
reason they are not hedging. S&Ls reported that
the recent changes in their accounting guidelines
have encouraged their participation in futures.
Our results suggest that the major reason that
banks are not using futures as much as S&Ls is
that banks have been more successful at reducing
their gaps in the cash market. Many, particularly
large banks, have examined futures carefully and
decided that, in light of the risks involved with
using futures, their interest rate risk is insufficient
to justify adopting this complex new tool.
Financial institutions can benefit from the use
of the financial futures market as a tool to
stabilize income during periods of highly volatile
interest rates. In the Southeast, banks and S&Ls
are cautiously beginning to explore financial
futures hedges. Financial managers will be seeking
greater understandingof the mechanics of hedging
and possible problem areas as they decide
whether to adopt financial futures as one of their
risk management tools.
—Donald L. Koch
Delores W. Steinhauser
and Pamela Whigham
14
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
Positioning for
Interstate Banking
Although interstate banking is prohibited by the
McFadden Act and bank holding companies are
prohibited from interstate expansion by the
Douglas Amendment to the Bank Holding Company Act, the fact is banking organizations are
providing financial services across states lines
and have been for some time. Nothing prevents
a commercial bank in one state from accepting
demand deposits or saving deposits from consumers in another state. In fact many large
commercial banks aggressively sell large certificates of deposits on an interstate basis, they
have calling offices which seek out major ac^
counts nationwide, and they actively
market their credit cards nationwide.
In addition, commercial banks are
offering such financial services
as cash management electronic
funds transfer accounts, loan
production offices, loan participations and a variety of correspondent banking services which
know no state boundary.
The laws prohibiting interstate
banking effectively eliminate
the ability of a formal banking
organization to offer both de-
mand deposits and commercial loans at a single
brick and mortar location in more than one state.
Any organization which offers both demand
deposits and commercial loans may be defined
as a commercial bank and, hence, would fall
under the interstate banking restrictions. By
separating the lending and deposit functions it is
possible for banking organizations to circumvent
the interstate restrictions and provide financial
services on an interstate basis.
One way to accomplish this is through the
creation or acquisition of nonbank subsidiaries
by bank holding companies. Nonbank subsidiaries offer a more limited array of
financial services than commercial
banks and do not offer both demand deposits and commercial
loans. The nonbank subsidiary
would not, therefore, constitute a commercial bank and,
hence, would be free to open
offices on an interstate basis.
Through the use of nonbank
subsidiaries the bank holding
companies are capable of providing various types of financial
services on an interstate basis.
Few bank holding companies in the Southeast are offering
interstate financial sen/ices. Florida holding companies, which
have not shown much interest in entering other states, should
expect an influx of out-of-state competitors if interstate
banking is permitted.
FEDERAL RESERVE B A N K O F A T L A N T A
i*
15
This in turn allows the bank holding company to
establish its name, its expertise and contacts in
geographic areas prohibited to its banking subsidiaries. Besides the profit and/or risk diversification motives, the establishment of nonbank
subsidiaries across state lines may be a good
indication that a given holding company may be
more likely to move to interstate banking if or
when the law permits. (This is not to say that
some bank holding companies that have not
"By separating the lending
and deposit functions it is
possible for banking
organizations to circumvent
the interstate restrictions and
provide financial services on
an interstate basis."
diversified in this manner might also be interested
in expansion if it were permitted.) This article
analyzes the degree and geographic extent to
which bank holding companies in the Southeast
are engaged in nonbank activities in states other
than their headquarters state.*
Allowable Nonbank Activities
The Bank Holding Company Act of 1956 as
amended in 1970 defines a bank holding company
as " — a n y company which has control over any
bank or over any company that is or becomes a
bank holding company by virtue of this Act." The
Board of Governors of the Federal Reserve System
has wide latitude in determining what constitutes
control and, hence, what is or is not a holding
company.1
Section 4(c)8 of the Bank Holding Company
Act states the criteria the Board must apply in its
determination to allow bank holding companies
to engage in certain nonbank activities some of
•The Southeast in this article will be defined as those states all or partly within
the Sixth Federal Reserve District—Alabama, Florida, Georgia, Louisiana,
Mississippi, and Tennessee.
' S e e statutory appendix to Regulation Y.
which are prohibited to individual banks. The
majority of the nonbank activities approved by
the Board, however, are activities in which nationally chartered banks may engage.2 Researchers
have observed that the Board has approved
activities in which banks have historically engaged,
or activities complementing services normally
provided by banks or activities in which banks
clearly possess technical skills.3
To date, the Board has approved and added to
the "laundry list" 16 activities which bank holding
companies may engage in by either establishing
de novo nonbank subsidiaries or acquiring nonbank subsidiaries (Table 1).
Through an application process, one bank and
multibank holding companies may gain approval
to establish a nonbank subsidiary to engage in
any or a combination of the approved activities.
By definition, a nonbank subsidiary is not a bank
and, hence, does not fall under regulation or laws
which apply only to banks. The nonbank entities
are, therefore, capable of unrestricted geographic
expansion both intra and interstate. Since the
vast majority of the approved nonbank activities
are activities in which banks may engage, i.e.
"activities which are closely related to banking or
managing or controlling banks...," the 4(c)8 provisions effectively allow bank holding companies
to provide financial services similar to those
provided by banks but on an interstate basis. The
extent that bank holding companies have actively
proceeded to offer financial services on an interstate basis through the 4(c)8 vehicle should give
us some indication of what we can expect if and
when interstate banking is permitted. It should
also tell us something about the characteristics of
holding companies that provide interstate financial services.
2See
Dale S. Drum, "Nonbanking Activities of Bank Holding Companies,"
E c o n o m i c Perspective—Federal Reserve Bank of Chicago, March/April
1977, page 13.Under 4(c)8 a banking holding company may be exempted
from the general prohibition against acquiring or establishing nonbank
activities and allowed to acquire "shares of any company the activity of
which the Board after due notice and opportunity for hearing has determined
(by order or regulation) to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. In determining whether
a particular activity is a proper incident to banking or managing or controlling
banks the Board shall consider whether its performance by an affiliate of a
holding company can reasonably be expected to produce benefits to the
public, such as greater convenience, increased competition or gains in
efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or
unsound banking practices."
3See
for example, Harvey Rosenblum "Bank Holding Companies: An Overview" Business Conditions, Federal Reserve Bank of Chicago, August
1973, or Samuel H. Talley, "Developments in the Bank Holding Company
Movement" Proceedings of a C o n f e r e n c e o n Bank Structure a n d
C o m p e t i t i o n 1972, Federal Reserve Bank of Chicago.
16
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
T a b l e 1 - Permissible Nonbank Activities for Bank Holding Companies
Under Section 4(c)8 of Regulation Y, May 1, 1982
Activities permitted by regulation
Activities permitted by order
Activities denied by the Board
1. Extensions of credit2
Mortgage banking
Finance companies:
consumer, sales, and
commercial
Credit Cards
Factoring
2. Industrial bank, Morris Plan bank
industrial loan company
3. Servicing loans and other extensions of credit2
4. Trust company2
5. Investment or financial advising2
6. Full-payout leasing of personal or
real property2
7. Investments in community welfare
projects2
8. Providing bookkeeping ordata processing services2
9. Acting as insurance agent or broker
primarily in connection with credit
extensions2
10. Underwriting credit life, accident,
and health insurance
11. Providing courier services2
12. Management consulting for unaffiliated banks1'2
13. Sale at retail of money orders with
a face value of not more than $1000,
travelers checks and savings bonds1'2
14. Performing appraisals of real estate1
15. Audit services for unaffiliated banks
16. Issuance and sale of travelers
checks
17. Management consulting to nonbank depository institutions
1. Issuance and sale of travelers
checks2-6
2. Buying and selling gold and silver
bullion and silver coin2-4
3. Issuing money orders and generalpurpose variable denominated payment instruments1'2-4
4. Futures commission merchant to
cover gold and silver bullion and
coins1-2
5. Underwriting certain federal, state,
and municipal securities1-2
6. Check verification1'2'4
7. Financial advice to consumers1'2
8. Issuance of small denomination debt
instruments1
1. Insurance premium funding (combined sales of mutual funds and
insurance)
2. Underwriting life insurance not
related to credit extension
3. Real estate brokerage2
4. Land development
5. Real estate syndication
6. General management consulting
7. Property management
8. Computer output microfilm services
9. Underwriting mortgage guaranty
insurance3
10. Operating a savings and loan
association1'5
11. Operating a travel agency1-2
12. Underwriting property and casualty
insurance1
13. Underwriting home loan life mortgage insurance1
14. Orbanco: Investment note issue
with transactional characteristics
FOOTNOTES:
'Added to list since January 1, 1975.
Activities permissible to national banks.
3 Board orders found these activities closely related to banking but denied proposed acquisitions as part ot its "go slow" policy.
"To be decided on a case-by-case basis.
Operating a thrift institution has been permitted by order in Rhode Island and New Hampshire only.
6 Subsequently permitted by regulation.
Nonbank Subsidiaries in the Southeast
The Southeast contained 257 bank holding
companies in June of 1981 which controlled
$72.3 billion in deposits representing 57 percent of the region's total. These 257 holding
companies controlled 637 banks or 30 percent
of the region's total bank charters.
: FEDERAL RESERVE B A N K O F ATLANTA
Four of the states in the Southeast (Alabama,
Florida, Georgia and Tennessee) allow multibank holding company formation, while banks
in Louisiana and Mississippi are restricted to
one bank holding companies. (See the Box on
southeastern banking laws regarding holding
companies and branching.) Table 2 shows the
number, size and type of bank holding companies by state. Of the 257 holding companies
17
T a b l e 2 . Number, Deposit S i z e arid Type of Multibank Holding Companies
Located in the Sixth District by State a s of J u n e 30, 1981
(Deposits in Millions)
Multibank
Holding Companies
Number
Deposits
All Bank
Holding Companies
Number
Deposits
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
TOTAL
One Bank
Holding Companies
Number
Deposits
23
78
66
36
15
39
8,873.8
33,420.8
12,459.7
7,943.4
2,959.9
6,654.9
9
26
16
1
0
5
8,519.0
27,035.7
6,423.7
94.6
0.0
5,317.9
14
52
50
35
15
34
257
72,312.5
57
47,390.9
200
354.8
6,385.1
6,036.1
7,848.8
2,959.9
1,337.0
24,921.6
Source: Federal Reserve Bank of Atlanta
T a b l e 3 . Geographic Distribution of Holding Companies
Performing 4(c)8 Activities on an Inter or Intrastate Basis
Total Number of
Holding Companies
in the State
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
TOTAL
Number with only
Intrastate Subs
23
78
66
36
15
39
7
18
6
3
3
6
3
16
2
3
2
2
4
2
4
0
1
4
257
43
28
15
in the region, 200 are one bank and 57 are
multibank. In terms of relative size the multibank holding companies dominate controlling
437 or 69 percent of all holding company
banking subsidiaries and 66 percent of all
deposits held by bank holding company subsidiaries in the Southeast.
The geographic distribution of holding companies in the Southeast is heavily skewed
toward Florida and Georgia. Florida houses
better than 30 percent of the region's holding
companies, 46 percent of the multibank and
26 percent of the one bank holding companies.
Georgia, a relatively recent entry into the ranks
of states which allow multibank holding companies, houses 26 percent of the region's total
holding companies and 28 percent and 25
percent respectively of the multibank and one
bank holding companies. Alabama, Tennessee,
and Louisiana are in the mid-range, even though
Louisiana does not allow the multibank form of
holding companies. The one multibank holding
18
Number with
Interstate Subs
Number with
4(c)8 Subs
company in Louisiana is a "grandfather situation.
Mississippi is on the low end of the scale,
allowing no multibank holding company formations and housing only 15 of the region's
200 one bank holding companies. Therefore,
each state in the Southeast houses bank holding
companies of one form or another, but the
majority of both the one bank and multibank
holding companies in the region are concentrated in Florida and Georgia.
Deposit holdings of the organizations show a
somewhat similar pattern, with Florida leading
the way with $33.4 billion which represents
81.5 percent of the state's total.
Of the 257 bank holding companies in the
Southeast, only 43 control nonbank subsidiaries engaged in one of the 4(c)8 activities.
Table 3 shows the geographic distribution of
bank holding companies performing one or
more of the 4(c)8 activities. Table 3 also shows
the extent to which these organizations are
engaged in interstate 4(c)8 activities.
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
T a b l e 4 . Asset Distribution of Nonbank Subsidiaries by Geographic Coverage
of the Nonbank Subsidiary, Intra or Interstate
(Assets in Millions)
Total Nonbank
Assets
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
District
Intrastate
Subsidiaries
% of State
Assets
Total
$153.5
167.7
384.8
21.3
17.4
114.6
74.0
159.6
133.4
21.3
4.7
13.1
48
95
34
100
27
12
79.5
8.1
251.4
127.5
101.4
73.3
88.5
859.5
406.2
47
453.2
53
Only 8.3 percent of the bank holding companies in Louisiana engage in 4(c)8 activities
through nonbank subsidiaries, and none of
these subsidiaries is engaged in these activities
on an interstate basis. This is in marked contrast
to Alabama in which 33 percent of the bank
holding companies have 4(c)8 subsidiaries and
four have subsidiaries which engage in at least
one 4(c)8 activity on an interstate basis. In total
only 15 bank holding companies in the region
control at least one subsidiary which performs
4(c) 8 activities on an interstate basis. Interestingly, Florida, which has the largest number
of bank holding companies and the largest
number of holding companies with nonbank
subsidiaries, houses only two bank holding
companies which have subsidiaries offering at
least one 4(c)8 activity on an interstate basis.
In terms of asset size, nonbank subsidiaries
of bank holding companies in the Southeast
control total assets of $859.5 million. Table 4
shows the distribution of these assets both by
state and by interstate status of the nonbank
subsidiary. An interstate subsidiary is one that
has established offices external to the state
where the home office of its parent holding
company is located.
Within the region, asset sizes of interstate
and intrastate nonbanking subsidiaries are approximately equal ($453 million as compared
to $406 million), just slightly favoring interstate
subsidiaries. In Alabama, Georgia, Mississippi
and Tennessee, nonbank subsidiaries with interstate locations account for the majority of the
assets. Louisiana has four holding companies
which hold eight nonbank subsidiaries, no one
: FEDERAL RESERVE B A N K O F A T L A N T A
Interstate
Subsidiaries
% of State
Assets
Total
—
51.8
4.8
65.3
—
of which is larger than five million dollars in
assets. Consequently, it is not surprising that
each of these nonbank subsidiaries has only
intrastate offices. This contrasts to Mississippi,
which has three holding companies with nonbank subsidiaries, but one of these subsidiaries
controls 73 percent of all nonbank subsidiary
assets in the state. Consequently it is not
surprising that this organization has interstate
offices of 4(c)8 subsidiaries.
"Florida houses only two
bank holding companies
which have subsidiaries
offering at least one 4(c)8
activity on an interstate basis."
The only state which has a sizable number of
relatively large nonbank subsidiaries which
limit themselves to intrastate locations is Florida
While Florida houses the largest number of
bank holding companies in the Southeast, the
largest number of bank holding companies
controlling 4(c)8 subsidiaries, and ranks second
in terms of asset size of nonbank subsidiaries, it
has only two bank holding companies which
control 4(c)8 subsidiaries with interstate locations. Perhaps the reason for this is that given
19
T a b l e 5 . Number of Bank Holding Companies with Nonbank Subsidiaries
Engaged in 4(c)8 Activity by State and Type of Activity, August 1, 1980
4(c)8 Activity
a(1)
Mortgage Company
Finance Company
Factor
a(2)
industrial loan company
a(3)
Servicing loans
a(4)
Trust company
a(5)
investment or financial
advisor
a(6)
Leasing
a(8)
Data Processing
a(9)
Insurance extension of
credit related to insurance
a(10) Underwriting credit life
insurance
a(11 ) Providing Courier Services
a(12) Providing management
consulting advice
Alabama
Florida
1
2
8
3
.
1
2
1
9
3
2
3
2
4
2
Louisiana
Mississippi
Tennessee
Total
-
1
2
1
1
16
10
2
3
18
5
1
-
-
-
1
-
-
-
•
3
4
8
3
1
3
1
1
1
2
•
•
6
16
12
12
6
2
1
4
29
„
2
1
-
5
-
-
9
1
1
-
-
Interstate Positioning
Turning to the question of interstate positioning, we find that only 15 bank holding companies
in the Southeast operated nonbank subsidiaries
4
3
1
1
3
1
1
the rapid population and economic growth in
Florida, the Florida bank holding companies
have had their hands full simply providing
financial services in Florida.
In total, 43 of the region's bank holding
companies perform some type of 4(c)8 activity
through at least one nonbank subsidiary. Table
5 shows the number of bank holding companies
engaging in a given 4(c)8 activity by state.
The most popular type of 4 (c) 8 activity appears
to be insurance related to the extension of
credit; 29 holding companies in the Southeast
perform this activity at more than 482 locations.
In large part these locations are the banking
subsidiaries of the holding company. The second
most popular activity was the servicing of
loans, an activity closely related to a number of
the other 4(c)8 activities. Next in order of
popularity comes mortgage companies, leasing
companies, data processing, finance companies
and underwriting credit life insurance. Interestingly, bank holding companies" in Florida are
more active in providing 4(c)8 services and
over a broader range than are holding companies
in other states in the region.
20
Georgia
.
-
-
-
3
-
1
which perform 4(c)8 activities on an interstate
basis as of November 1981 (Table 6).
All of the holding companies with interstate
4(c)8 subsidiaries are multibank holding companies except Deposit Guaranty Corporation
which is a one bank holding company. Each of
these organizations is relatively large in terms
of its deposit size within its state; each ranks
6th or higher in its respective state. And except
for two cases all of these bank holding companies
have home offices in the same city in their
respective states; Birmingham, Alabama; Jacksonville, Florida; Jackson, Mississippi; Atlanta,
Georgia (except for one located in Augusta);
and Nashville, Tennessee (except for one located
in Chattanooga). These characteristics are consistent with the view that relatively large multibank holding companies are more probable
interstate competitors (Table 7).
The most popular 4(c)8 activity is acting as
an insurance agent in connection with credit
extensions. This activity, however, is not highly
visible and is normally provided as a complementary service to some other 4(c)8 activity on
an interstate basis, such as mortgage banking
and/or finance company subsidiaries. These
latter two activities account for the vast majority
of highly visible activities which may be used to
establish a presence in an interstate environment. Only two industrial loan banks and
leasing companies with interstate offices are
controlled by southeastern holding companies
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
Alabama
Am South
Alabama Finance Corporation
X
Management Consulting Nonaffiliate
Check Verification
Travelers Checks
Real Estate Appraisal
Audit Services
Money Order $1000, Travelers Checks
Management Consulting
Underwriting Credit Life
S T A T E S IN W H I C H P E R F O R M E
GA(1),SC(1)
X
X
Central Bancshares of the South, Inc.
Trust Company of California
Courier Sen/ice
¡5
CO
CD
_J
Insurance Agent
u>
C
Data Processing
Investment in Community Welfare
Financial Advisor
Trust Company
Ö
Industrial Bank
o
w
•o
CO
O
g
Servicing Loans
c
ta
m
a>
ca
Factoring
?
Financial Company
Table 6 .
Financial services offered
on an interstate basis by
nonbank subsidiaries of
bank holding companies in
the Southeast
(as of November 1981)
CA(1)
X
First Alabama Bancshares, inc.
First Alabama Life
AR(1)
X
Southtrust Corporation
Southern State Life
AR(1)
X
Florida
Barnett Banks of Florida, Inc.
Verification, Inc.
X
Florida National Banks of Florida, Inc.
Florida National Credit
X
GA(1),AL(1),NC(1)
GA(9),NC<12),SC<7)
X
Georgia
Citizens and Southern Georgia Corporation
Citizens and Southern Finance
Citizens and Southern Mortgage Co.
AL(8),FL(4),LA(1 ),NC(2),SC(1 )
X
X
First Atlanta Corporation
Gulf Finance
X
TN(1),NC(1)
—
AL(19),FL(14),LA(18),MS(37),TN(i
SqiO),NC<1),IN(4)
X
X
FL(1), Hold Title to Real Estate
Amelia Properties
X
First Grand Junction Industrial Bank
First Railroad and Banking Company of Georgia
CMC Group
X
Capital Credit
Trust Company of Georgia
Trust Mortgage
Fickling & Walker
Mississippi
Deposit Guaranty
Deposit Guaranty Mortgage Corp.
X
NCO6),SC(7),TN(5),MD(1 >,DQ1
X
TN(5)
AL<1)
X
First Financial
FLO)
X
X
SC.FL
X
X
X
LA(3),FL(2)
X
ARO)
X
FL(28),GA(4)
X
ARO)
X
ARO)
Tennessee
Ancorp Bancshares, Inc.
Ancorp Insurance
First American Corporation
Atlantic Discount
X
First American Tennessee Insurance
Commerce Union Corporation
Tennessee Valley Life Insurance
Third National Corporation
Third Financial
Tennessee Life Insurance
X
Sqi),KY(6)
X
X
_
—
X
—
—
ARO)
Note: The above analysis is based on records of 4(c)8 activities filed by individual holding companies with the Federal Reserve System.
It does not include Southeast Banking Corporation of Florida's acquisition in December 1981 of Churchill Mortgage Corporation of Atlanta, which has two
offices in Texas.
T a b l e 7 . Rank Within State of Holding Companies
With Interstate 4(c)8 Subsidiaries
by Deposit S i z e
1
2
3
4
Alabama
AmSouth Bancorporation (MB)
Central Bancshares of the South, Inc. (MB)
First Alabama Bancshares, Inc. (MB)
SouthTrust Corporation (MB)
Florida
1 Barnett Banks of Florida, Ine (MB)
4 Florida National Banks of Florida, Inc. (MB)
1
2
3
6
Georgia
Citizens and Southern Georgia Corporation (MB)
First Atlanta Corporation (MB)
Trust Company of Georgia (MB)
First Railroad and Banking Company of Georgia (MB)
Mississippi
1 Deposit Guaranty Corporation (One-Bank)
1
2
3
4
Tennessee
First American Corporation (MB)
Commerce Union Corporation (MB)
Third National Corporation (MB)
Ancorp Bancshares, Inc. (MB)
and only one interstate trust subsidiary. Therefore, to the extent that southeastern holding
companies are attempting to establish an interstate presence, they are doing so through two
vehicles, mortgage banking subsidiaries and
finance company subsidiaries.
In total, only eight of the fifteen holding
companies in the region control either or both
a mortgage banking and finance company subsidiary. All four Georgia holding companies
with interstate 4(c)8 subsidiaries have a mortgage or finance company subsidiary, three
have finance company subsidiaries and two
have mortgage company subsidiaries. Two holding companies in Tennessee, oné in Mississippi
and one in Alabama also control these types of
subsidiaries, three finance companies and two
mortgage subsidiaries.
In contrast, not a single Florida holding company controls either a finance company or a
mortgage company with interstate offices. Again
22
this indicates that Florida holding companies
have very little need or propensity to look
outside their home state for profitable financial
activities. Looking at the other side of this coin,
of the eight holding companies with interstate
mortgage or finance company subsidiaries, five
have Florida subsidiaries. While Florida holding
companies have little propensity to provide
these interstate services to the other states in
our region, holding companies in other states
evidently view Florida as an attractive opportunity. From an overall perspective, southeastern
holding companies with interstate finance and
mortgage company subsidiaries have, with only
one exception, limited their geographic scope
to the states of Alabama, Georgia, South Carolina,
North Carolina, Florida, Louisiana, Mississippi,
Tennessee and Kentucky.
Conclusion
Three interesting conclusions arise from this
analysis. First, few bank holding companies in
the Southeast show a propensity to offer high
profile 4(c)8 financial services on an interstate
basis. If these holding companies are the most
likely interstate competitors if or when full
interstate banking is permitted, then the region
will have few organizations likely to be competitive at the district or national level.
Second, quite obviously, the most attractive
target for interstate expansion in the region is
Florida Competition from southeastern holding
companies through 4(c)8 subsidiaries in Florida
is markedly greater than Florida holding company
presence in the other states in our region.
Given the 4(c)8 activity, Florida banks and
bank holding companies should expect a tremendous influx of financial competitors from
both within the region and from the nation.
And third, again if the interstate 4(c)8 activities
may be used as a gauge, Florida holding companies are not likely entrants into other states if
interstate banking is permitted. It appears Florida
will be a financial battleground.
—David D. Whitehead
and Pamela Frisbee
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
GEOGRAPHIC LIMITATIONS ON INTRASTATE BANK EXPANSION IN THE SOUTHEAST
As the probability increases that the nation will adopt
some form of interstate banking and as banks find
ways to cross state lines without branches, the issue
of expansion within a state is becoming more intense.
A frequently-heard, though empirically unsupported
argument from advocates of intrastate banking is that
restricting geographic expansion within a state may
severely handicap banking organizations if the nation
adopts interstate banking. In other words, unless
geographic expansion by banks is allowed, no banking
organization within the state may be capable of
growing large enough to compete with a large interstate organization. Geographic limitations on banking
expansion vary widely among the southeastern states.
Geographic expansion by a banking organization
through a deposit taking facility may take either of two
formalized procedures; branching through merger or
de novo (new charter), or multibank holding company
by acquisition orde novo entry. Branching restrictions
within the region vary from state to state. I n most of the
southeastern states these restrictions have eased
somewhat during the past ten years. States which
allowed some type of branching and holding company
formations have in most cases relaxed their limitations
to encourage greater geographic expansion within
the state.
Each of the region's states now allows branching of
one form or another (generally limited to the county of
the home office of the parent bank) and four of the six
states now allow expansion by multi-bank holding
companies. Georgia which prior to 1970 limited branching to the municipality of the parent bank now allows
branching countywide by independent banks and
statewide banking by holding company subsidiaries.
Florida which allowed statewide acquisition by holding
companies but did not allow branching prior to 1975,
now allows branching statewide by merger and multibank holding companies. Alabama also allows branching
statewide by merger and holding company acquisition.
Rules applying to branching by de novo entry are in
most cases more limiting geographically than those
concerning branching by merger.
Regulations concerning holding company acquisitions of banks also vary from state to state. Unless a
state explicitly prohibits or restricts holding company
expansion, multibank holding companies are permitted
by federal laws. Alabama, Florida, and Tennessee
were the first states in the region with multibank
holding companies—their laws were silent on bank
holding companies, and bank holding companies took
advantage to expand statewide. Georgia followed
several years later with a similar ruling. Louisiana and
Mississippi still prohibit the formation of multibank
holding companies, although attempts are being made
to change the Louisiana law.
Branching of one form or another is allowed in each
of the states in the Southeast, though the degree to
which it is permitted varies from state to state. Banks
in Alabama and Florida have more geographic freedom
: FEDERAL RESERVE BANK O F A T L A N T A
than banks in other states; they are allowed to branch
statewide by merger with few restrictions. Certain
counties in Alabama do not permit branching within
the county, while banks in Mississippi may branch
within a one hundred mile radius. Except for "grandfathered" cases and those banks established to protect
the depositors of a closed state bank branching of
any form in Tennessee is limited to the county of the
parent bank
Regulations applying to bank holding companies
are basically the same in each of the states, except
Louisiana and Mississippi. Holding companies are
authorized by the federal government, but each state
can impose its own restrictions. In each of the region's
states except Louisiana and Mississippi holding companies may own banks statewide. Multibank holding
companies in a state tend to bring changes in that
state's geographic restrictions. Georgia changed its
laws in 1976 to permit multibank holding companies
to bank statewide, while holding companies in Alabama,
Florida, and Tennessee took advantage of the silence
of the law and expanded statewide before the law
could prevent it
Southeastern states in which multibank holding
companies are allowed have eased their geographic
limitations on branching somewhat Florida, for example,
was a unit banking state prior to holding company
activity. Branching restrictions gradually eased as
holding companies began expansion. Florida moved
through the following phases: unit banks, unit banks
with limited facilities, banks with limited branching,
and now to statewide branching through merger.
Statewide branching by merger is also allowed in
Alabama through both independent banks and holding
company subsidiaries. Georgia and Tennessee also
allow holding company expansion statewide, but
branching is limited to the county of the parent bank.
States which do not allow multibank holding companies have seen very few changes in their branching
and geographic restrictions. Louisiana and Mississippi
have kept out multibanks and have virtually the same
geographic limitations on branching as they did ten
years ago. Louisiana and Mississippi limit the ownership of holding companies to one bank. One bank
holding companies do not enjoy the same ability to
acquire banks as multibank holding companies, they
are prohibited from acquiring a second bank and
hence do not enjoy the ability to expand across the
state. These restrictions have tended to concentrate
holding companies in areas of high economic growth.
Southeastern states have moved progressively toward easing the geographic restrictions applied to
banks as they prepare themselves gradually for the
advent of statewide and interstate banking. Holding
companies are eyeing the possibilities of acquisitions
of holding companies in otherstates. The probabilities
are increasing that geographic restrictions on expansion
by banking organizations will continue to loosen in the
future.
23
The Flat-Rate Income Tax:
Boon or Boondoggle?
I n spite of the income tax cuts recently enacted
by Congress, discussions of alternative tax plans
continue. Because cuts in marginal tax rates are
largely offset by bracket creep, boosts in Social
Security taxes and increases in state and local
taxation, many middle-income taxpayers remain
in tax brackets originally intended for the rich.1
Thus, the tax rate structure continues to erode
economic incentives. Moreover, the numerous
exemptions, deductions, and loopholes remain
imbedded in a complicated tax structure. (See
page 27 for a discussion of the evolution of the
U.S. income tax structure.) The tax program, then,
provided some relief from tax rate increases but
not genuine tax reform. Not only is the current
tax system both inefficient and costly to maintain,
but tax evasion isgrowingand horizontal inequities
(that is, individuals with similar incomes paying
widely different amounts of taxes) persist Marginal
tax rates remain high and, because of the various
exemptions, deductions, and loopholes, we have
a narrow tax base. As a consequence, more and
more policymakers have turned their attention
to more comprehensive tax reform. This article
will examine one widely-discussed reform—the
flat-rate income tax.
Proponents of the flat-rate tax say it could
eliminate"bracket creep" (where higher salaries,
pushed up by inflation, propel taxpayers into
higher tax brackets). The plan's simplicity would
reduce the huge amounts of time and money
currently spent on calculating taxes. Advocates
also argue that a flat rate tax would reduce the
incentives to shelter or otherwise avoid taxes.
Finally, replying to critics who fear the plan
' S e e , for example, Richard B. McKenzie, "Supply-Side Economics and the
Vanishing Tax Cut," this Review, May 1982, pp. 20-24; J a m e s R. Barth and
J o s e p h J. Cordes, "Industrial Impacts of the 1981 Business Tax Cuts,"
this Review, May 1982, pp. 42-49; and Stephen A. Meyer and Robert J.
R o s s a n a "Did the Tax Cut Really Cut Taxes?" Business Review, Federal
Reserve Bank of Phiadelphia, Novermber/December 1981.
24
would hurt lower bracket taxpayers, advocates
say the plan can be modified to prevent that
from happening.
Advantages of the Flat-Rate Income Tax
A flat-rate income tax promises many substantial
advantages. One obvious major advantage is
simplicity. A flat-rate tax would be easy for
taxpayers to comply with and easy for tax collectors to administer. This simplicity would save
resources for both taxpayer and tax collector. It
has been estimated, for example, that 40 percent
of all taxpayers currently pay for professional
help with their tax returns. And $60 billion a year
is spent by people complying with or taking
advantage of IRS regulations.2 Thus, a great deal
of human ingenuity and entrepreneurial talent is
devoted to legal tax avoidance. A flat-rate income
tax would end this distortion and misdirection of
entrepreneurial talent and direct these resources
back toward making economically productive
investments.
Second, a flat-rate tax is more fair. It would
provide similar treatment to taxpayers with the
same incomes (horizontal equity) rather than
imposing different tax rates on individuals who
happen to spend their incomes differently. Accordingly, this system would ensure that all
wealthy taxpayers would pay some taxes and, in
addition, it would eliminate the marriage penalty
(the higher taxes paid when couples combine
their income and enter a higher bracket).
Moreover, all flat-rate tax proposals have provisions to protect the poor, and some (notably
the proposal by Senator Bill Bradley and
2 See,
for example, Peter Brimelow, " O n e Tax Bracket?" Barrens, August 3,
1981, p. 22; and William Safire, "The Flat Tax," N e w York Times, April 30,
1982, p. 29.
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
A flat-rate income tax would broaden the tax base and thus
lower marginal tax rates. Its simplicity and fairness are
appealing, but the proposal faces serious economic and
political obstacles.
Representative Richard Gephardt) even maintain
a degree of progressivity in effective rates (the
percentage of income paid in taxes). Specifically,
the impact of a flat-rate system on lower income
groups could be lessened by raising the individual
exemption or by changing the zero bracket. The
system could even incorporate a negative income
tax (payments to people with low incomes).
A third major advantage is that the elimination
of most (or all) exemptions, deductions, and
loopholes would substantially broaden the tax
base. This would reduce the incentive to cheat
through fraudulent deductions and consequently
would bring about greater voluntary compliance
with the tax laws. It might even enhance citizens'
respect and compliance for other laws and government regulations. Moreover, eliminating
exemptions would remove many of the distortions
that cause savings and investment to flow into
below-market-rate investments and inefficient
projects. As a result, economic efficiency would
improve.
But most important of all, a broadening of the
tax base would enable marginal tax rates to be
lowered significantly from the current aggregate
marginal rate of about 32 percent. As supply-side
economists have continually insisted, a lowering
of marginal tax rates would improve significantly
the economy's incentive-reward system. As a
result, the supply of labor, capital, innovation,
entrepreneurial skill and market activity would
be increased.3 People would again be able to
concern themselves with earning additional income
without worrying that their rewards would be
confiscated by ever higher marginal tax rates.
3 Jerry
Hausman, for example, has indicated that aflat-rate tax would increase
the supply of labor. S e e Jerry Hausman, "Labor Supply," H o w Taxes Affect
E c o n o m i c Behavior, edited by Henry J . Aaron and Joseph A Pechman,
Brookings Instituiton, Washington, D.C., 1981.
: FEDERAL RESERVE B A N K O F A T L A N T A
THE FLAT-RATE INCOME TAX:
SOME HISTORICAL PERSPECTIVES
Although a flat-rate system s e e m s novel, history
reveals that it had several early proponents Perhaps
the earliest mention of such a system can be traced
to an eminent advisor to Louis XIV, Sebastian de
Vauban. During his era, the tax system of the French
economy w a s both prohibitive and complex. Tax
rates for example, were in some instances as high
as 82 percent of the net produce of small proprietors 1
Indeed, it w a s cheaper in some cases, to ship wine
from China to Paris than to transport it to Paris from
other French provinces 2 A prestigious occupation
of the day was an appointment to one of the various
bureaus that dealt with the accounting and legal
aspects of taxation. B y then, the tax c o d e w a s open
to so many interpretations that tax computation
often depended on the whimsical judgement of the
court's appointees.
In reaction to this state of affairs Vauban proposed
his well-known version of the flat-rate income tax,
the Dixme Royale (10 percent income tax). H e
suggested that the entire tax system with all its
complexities be scrapped in favor of a simple 10
percent tax on a strictly defined base of income.
Vauban is recognized a s one of the first to view fiscal
policy a s an important determinant of economic
prosperity. For all of his efforts, however, Vauban
w a s banished from the court of Louis XIV. His
banishment illustrates the political risks associated
with comprehensive tax reform. Unfortunately for
France, politics did not permit comprehensive reform
until after the French Revolution. Curiously, Napoleon
is often credited with being a fiscal "genius," since
he was able to reform the French tax system and, in
the process, to cut the tax rate by over 70 percent. 3
Theoretical arguments for a tax system like the
flat-rate scheme were spelled out clearly by classical
economists of the 19th Century such a s J a m e s Mill,
J . R. McCulloch, and J o h n Stuart Mill. They were
guided by the fiscal insights of Adam Smith, who
posited four maxims of taxation—equality, certainty,
convenience of payment and economy in collection.
These maxims were considered indispensable standards for the development of tax policy.4 The flatrate scheme is fully consistent
with all of these
classical
principles.
continued
25
THE FLAT-RATE INCOME TAX:
SOME HISTORICAL PERSPECTIVES
continued
The pro-growth perspective of these classical
economists led them to maintain that tax rates must
remain light or moderate. They specified, for example,
that if tax rates exceeded even 10 percent of the
national income, such rates would eventually result
in a "slowdown of public wealth." 5 They repeatedly
stressed that high tax rates would encourage tax
evasion, cheating, smuggling, and the development
of an underground economy. In fact, some of these
economists argued that an increase in these activities
was one sure w a y to recognize that tax rates were
too high.6
To keep tax rates moderate, they realized the tax
base must remain as broad as possible. Consequently,
they gave close attention to certain administrative
aspects of taxation. Specifically, they maintained
that the tax system must remain free of special
exclusions and arbitrary interpretations; they abhorred
the tendency of policymakers to create tax loopholes
For these classical writers, the complexity of the
18th Century French tax system with its special
favors and mammoth bureaucracy served a s a model
to avoid. They noted the physiocrats' discussion of
the "tax farmers" who engaged in tax manipulation,
interpretation, and lobbying.7 As a consequence,
they stressed the taxation maxims of certainty,
convenience of payment and economy in collection.
Thus, these economists were among the first to
identify the problems of a tax code characterized by
high rates and many loopholes.
In addition, they noted that such a complex system
can produce inequities. A system with many exceptions and seemingly arbitrary interpretations leads
to unequal taxation of people with the same income.
Finally, these writers recognized that a complex tax
code distorts the allocation of resources. Many of
the exceptions and deductions associated with a
complex c o d e stimulate certain sectors of the economy by drawing resources from other, higher valued
activities.
In short, the low-rate, broad-based tax system
finds its theoretical roots in the doctrines of 19th
Century classical writers. These economists emphasized all of the desirable features claimed for a flatrate scheme—equity, simplicity, and incentive.
'Henry Higgs, T h e Physiocrats, Langlarid Press, New York, 1952, p. 10.
'David Ames Wells, T h e o r y a n d Practice of Taxation, D. Appleton and Sons,
New York, 1900, p. 76.
3 J u d e Wanniski, T h e W a y t h e World Works, Simon & Schuster, New York,
1978, p.36.
"Robert E. Keleher and William Orzechowski, "Supply-Side Effects of Fiscal
Policy: S o m e Historical Perspectives," Working paper, Federal Reserve
Bank of Atlanta August 1980, p.44.
5 Keleher and Orzechowski, ibid., p. 50.
6 Keleher and Orzechowski, p. 37.
' S e e Ronald Meek, T h e E c o n o m i c s of Physiocracy, Harvard University
Press, Cambridge, 1963.
26
The flat-rate system would also eliminate bracket
creep. And a substantial lowering of marginal tax
rates could be accompanied without lowering
tax revenues. Indeed, it is possible that a lowering
of marginal tax rates could actually increase tax
revenues. A flat-rate income tax system, then, is
in full accord with the basic premises of supplyside economics and, indeed, has been endorsed
by several well known supply-side economists.
Finally, the flat-rate system is fully consistent
with the four maxims of taxation originally set out
by Adam Smith in the Wealth of Nations: equality,
certainty, convenience of payment, and economy
in collection. (See box on "The Flat-Rate Income
Tax: Some Historical Perspectives.")
V
A F L A T - R A T E TAX C A N B E P R O G R E S S I V E
The simplicity and the economic incentives of a flatrate tax system are widely acknowledged. But in the
popular discussion, many observers claim that gaining
these advantages would cost us the basic "progressivity*
of the U.S. income tax. That claim is incorrect. With
appropriate use of income exemptions, a flat-rate tax'
can be made quite progressive. 4
To illustrate the design of a progressive flat-rate tax'
let us begin with the median taxpayer in 1983. That
taxpayer will report an adjusted gross income of
approximately $25,000 and, under current income tax
laws, will pay about $2500, or 10 percent of that
income, in federal income tax 5 The median tax-payer's
marginal "tax bracket" will be much higher than 1C
percent, of course, but his average tax rate will be
reduced to about 10 percent by deductions and
exemptions of the current system, and by the increase
in tax brackets with higher incomes
If w e wanted to apply a flat-rate tax which would
leave that median taxpayer unaffected, the simplest
way would be to impose a flat-rate tax of 10 percent
( s e e p a g e 29). R e g a r d l e s s of income level, e a c h tax /
payer would pay 10 percent of income A taxpayer with
a $ 1 0 , 0 0 0 income would pay$1,000, a taxpayer with a
$1 million income would pay $100,000, and so forth.
This is apparently the kind of flat-rate tax that critics
have in mind when they claim a flat-rate tax cannot be "
progressive.
But it can be, a s w e c a n s e e by looking at the right- i
hand column of the table. This alternative provides to
a flat-rate tax of 20 percent on all income in excess of'
$12,500. Our median taxpayer still pays 10 percent in*
federal income taxes. But a s the table clearly shows, a
taxpayer with a $15,000 income only pays about 31/s , *
percent of his income in taxes, whereas the taxpayer
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
I
Problems with the Flat-Rate Income Tax
In spite of the many important advantages of
the flat-rate income tax, several problems remain.
These relate to both economics and politics.
One problem is the costly transition it would
involve. Individuals, corporations, and nonprofit
organizations have made major decisions and
investments designed to maximize returns based
on the current tax structure. They have made
these decisions on the premise that certain
deductions and tax rules would continue. Thus,
the introduction of a flat-rate scheme and elimination of all deductions, exemptions, and loopholes would alter longstanding tax rules sharply.
with a $1 million in income would pay 1 9 % percent in
federal income taxes. The resulting pattern is obviously
progressive, and in fact the higher-income taxpayers
wind up paying about 20 percent of their income in
taxes, twice the proportion of the median taxpayer.
Obviously, the exemption level introduces progressivity to the flat tax rate. As the exemption level is
increased from $5,000 to $10,000 to $12,500, the tax
schedule becomes more and more progressive. In
each case, the median taxpayer winds up paying 10
percent of his income in federal income taxes, because
the flat rate itself is increased from 10 percent, to 12V.2
percent, to 16% percent, to 20 percent so a s to
capture the same revenue from the median taxpayer.
t
a*»
For the exemption level to introduce progressivity to
the flat-rate tax, the level needs to be stipulated in
dollars rather than as a percent of income. Saying "the
first 20 percent of income is exempt from tax" is
equivalent to cutting the flat rate and does not introduce
progressivity. The exemption level could be tied to a
price index however. It could also be specified according
to the number of persons in a household without
losing the progressivity feature.
ì
{
-
I9
1
:
„
The accompanying tables are not meant to be
concrete proposals for tax schedules. W h a t they do
illustrate clearly is that, with appropriate use of a
simple dollar income exemption, the progressivity of
the existing tax system can be combined with the
appealing simplicity of the flat-rate proposal for tax
reform.
'"Progressive" means that taxpayers with higher incomes pay a higher
proportion of those incomes in taxes.
s
Monthly Tax Features, June-July 1982, Tax Foundation, Incorporated.
EVOLUTION OF THE U. S.
INCOME TAX SYSTEM
The evolution of the U. S. tax system exemplifies
how a well-designed tax system developed by wellintentioned policymakers c a n grow into a form drastically different from the intentions of its original
architects. The federal income tax started out well,
almost a s if it were designed to be consistent with
the maxims of Adam Smith (see Box on page 25 for a
description of these maxims). W h e n Congress passed
the first income tax law in 1913, it provided for a 1
percent tax on income over $3,000—a level exceeded
by only 3 percent of American w a g e earners. A tax of
up to 7 percent w a s levied on high incomes—from
$20,000 to over $500,000. 1 F e w expected these
rates ever to go much higher.
Rates did rise during World W a r I but were reduced
soon after the war. They were reduced mainly at the
insistence of (Secretary of the Treasury) Andrew
Mellon, who understood quite well the connection
between taxation, incentive, and economic growth. 2
Marginal tax rates increased during the 1930s and
soared as high as 94 percent during World W a r II.
However, few taxpayers actually paid these confiscatory rates. As late a s 1947, fully 80 percent of all
American families had annual incomes of less than
$5,000. Consequently, the effective tax rate w a s
about 8 1/2 percent. 3 Thus, after two world wars, few
people w e r e in high marginal tax brackets.
Today, the situation has changed dramatically.
Over 80 percent of all families in the U. S. report
incomes over $11,000 and 50 percent have incomes
over $23,000. Consequently, the median income
earner faces marginal rates of over 25 percent and
those with double the median income confront
marginal rates in excess of 40 percent. Moreover,
maximum Social Security taxes have risen from $30
annually in 1947 to $2,179 in 1982, an increase of
7,233 percent! 4 It is noteworthy that most of these
developments were not planned or consciously
designed. Rather, they are the consequence of
decades of inflation in conjunction with a progressive
income tax. Bracket creep has pushed average
taxpayers into tax brackets originally designed only
for the rich.
The increase in marginal tax rates over recent
years has induced legislators to find various new
w a y s to lighten their constituents' tax burden. Under
the pressure of special interest groups, their desire
to lessen the tax burden resulted in a proliferation of
special exemptions. Legislators used tax shelters,
tax credits, deductions, and exemptions to reward
special interests. The important point is that because
of these various exemptions, tax shelters and deductions, the tax base has narrowed steadily. In one
widely cited study, for example, P e c h m a n and Okner
estimated that elimination of selected tax exemptions
continued
27
FEDERAL RESERVE B A N K O F A T L A N T A
EVOLUTION OF THE
U.S. INCOME TAX SYSTEM
continued
would increase the tax revenues by 7 5 percent. 5
This continually narrowing tax base has prompted
legislators to rely on bracket creep to raise tax
revenues—something for which they cannot be held
personally responsible. Consequently, the tax system
has been trapped in a "vicious circle" of rising tax
rates and proliferating loopholes that has created
an incredibly complex tax structure. The result is a
set of tax provisions so complicated "that no mortal
can comprehend and that no national tax legislature
starting from scratch could or would devise." 6
The wastes and inefficiencies of the present tax
system are reflected in a number of ways. For
example, tax laws and interpretations have doubled
in the past 15 years, to about 40,000 pages. As a
consequence, nearly 50 percent of all taxpayers
need some kind of professional help. Virtually all
large business firms maintain full-time legal and
accounting staffs. However, not only do individuals
need help, but so do the professionals A few years
ago, when the I R S tested its agents on their knowledge of the tax laws, 80 percent failed. Indeed, the
costs of administering the tax code are quite formidable, some estimate it to be as much a s $60
billion annually. 7
In sum, a s the tax system has evolved, marginal
tax rates have increased dramatically, the tax base
has narrowed, and the tax structure has become
incredibly complex. Supply-side economists emphasize that high tax rates are adversely affecting
incentives. The empirical evidence and many economists now largely support their contentions. The
distorting effects of various costly tax loopholes
now are receiving emphasis If these many loopholes,
deductions, and exemptions could be eliminated,
tax rates could be reduced through the widening of
the tax base. This is the major advantage of all flat
rate income tax proposals.
' S e e David Boaz, "A History of the Income Tax: It J e s ' Grew," W a l l Street
Journal, May 14, 1982. This section draws from this article.
for example, the discussion of Andrew Mellon in Robert E. Keleher and
William P. Orzechowski, "Supply-Side Effects of Fiscal Policy: Some Historical
Perspectives," Working paper Series, Federal Reserve Bank of Atlanta,
August 1980, pp. 52-56.
3 S e e Boaz, op. cit.
"Boaz, op. cit.
s J o s e p h A Pechman and Benjamin A. Okner, "Individual Income Tax Erosion
by Income Tax Classes," Brookings Institution, Reprint No. 230, Washington,
D.C., 1972.
6 Milton Friedman, "Tax Follies of 1970," An E c o n o m i s t ' s Protest Thomas
Horton & Co., Glen Ridge, New Jersey, 1972, p. 83.
'Edgar K. Browning and Jacquelene M. Browning, Public F i n a n c e a n d t h e
Price System, MacMillan, New York, 1979, pp. 345-47; and Peter Brimelow,
" O n e Tax Bracket?" Barrons, August 3, 1981, pp. 11, 21-23.
2 See,
Because of the disruptions that such an implementation would involve, any change would
probably have to be gradual and/or include
various "grandfather" clauses.
A second important problem is that the implementation of such a system would have definite
effects on the distribution of income and wealth.
That is, it would increase taxes on some income
groups and lessen taxes on others. The critical
question is who gains and who loses. The answer
depends, of course, on various considerations
such as personal exemption levels, the zero
bracket level, the actual tax rate chosen, and
various other factors. The answer to this question
would determine the political feasibility of the
system. That is why the notion that progressivity
can be incorporated with the use of personal
exemptions is so important.
Political realities, of course, pose other important barriers to implementating a flat-rate tax
allowing for only personal deductions. After all,
behind every existing deduction stands a powerful
constituency. The elimination of all deductions,
for example, probably would encounter heated
resistance from special interest groups and lobbies
representing churches, schools, state and local
governments, the real estate and housing industries,
oil and gas properties, veterans, the elderly,
women's groups, Wall Street interests, and many
others. And, if a single exception (such as mortgage
interest deductions) were allowed, there would
be a "stampede" of other special interest groups
to get their exemptions.
For the legislator, then, broadening the tax
base implies taking away tax favors rather than
giving them out. Consequently, Congress can be
expected to resist giving up some of its discretionary powers. Thus resistance to a flat-rate tax
scheme can be expected from both the suppliers
and demanders of special tax breaks.
Welfare Reform Through
a Negative Income Tax
The introduction of a simple income exemption
also opens up the opportunity to combine welfare
reform with tax reform. This can be done by
substituting the negative income tax for current
welfare programs. Under a negative income tax,
"taxpayers" with lower incomes would receive
negative tax payments directly from the Treasury.
Their taxes would be negative, rather than zero.
The shaded portion of the accompanying table,
illustrates that applying the same arithmetic of
28
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
T a b l e - A Progressive F l a t - R a t e Tax
Income Level
Flat-Rate Tax
on Total
Income
Flat-Tax rate to
equalize taxes paid on
median income of $25,000
10%
Flat-Rate Tax
on all but
the first $ 5 0 0 0
of Income
1 2%%
Flat-rtate Tax
on all but
the first $10,000
of Income
16%%
Flat-Rate Tax
on all but
the first $12,500
of Income
20%
15,000
10% on $15,000
= $ 1 5 0 0 or 1 0 %
of income
121/2% on $10,000
= $ 1 2 5 0 or 8Vs%
of income
16%% on $ 5 0 0 0
= $ 8 3 3 or 5Va%
of income
20% on $ 2 5 0 0
= $ 5 0 0 or 3%%
of income
20,000
10% on $20,000
= $ 2 0 0 0 or 1 0 %
of income
12%% on $15,000
= $ 1 8 7 5 or 9 % %
of income
16%% of $10,000
= $ 1 6 6 6 or8Va%
of income
20% on $7,500
= $ 1 5 0 0 or 7Va%
of income
25,000
10% on $25,000
= $ 2 5 0 0 or 1 0 %
of income
12%% on $20,000
= $ 2 5 0 0 or 1 0 %
of income
16%% on $15,000
= $ 2 5 0 0 or 1 0 %
of income
20% on $12,500
= $ 2 5 0 0 or 1 0 %
of income
37,500
10% on $37,500
= $ 3 7 5 0 or 1 0 %
of income
12%% on $32,500
= $ 4 0 6 3 or 1 0 . 8 %
of income
16%% on $27,500
= $ 4 5 8 3 or 1 2 . 2 %
of income
20% on $25,000
= $ 5 0 0 0 or 1 3 . 3 %
of income
50,000
10% on $50,000
= $ 5 0 0 0 or 1 0 %
of income
12%% on $45,000
= $ 5 6 2 5 or 11V«%
of income
16%% on $40,000
= $ 6 6 6 7 or 13Va%
of income
20% on $37,500
= $ 7 5 0 0 or 1 5 %
of income
100,000
10% on $100,000
= $10,000 or 1 0 %
of income
12%% on $95,000
= $11,875 or 1 1 % %
of income
16%% on $90,000
= $15,000 or 1 5 %
of income
20% on $87,500
= $17,500 or 1 7 % %
of income
500,000
10% on $500,000
= $50,000 or 1 0 %
of income
12%% on $495,000
= $61,875 or 1 2 % %
of income
16%% on $490,000
= $81,666 or 16%%
of income
20% on $487,500
= $97,500 or 19Va%
of income
10% on $1,000,000
= $100,000 or 1 0 %
of income
12%% on $995,000
= $124,375 or 1 2 % %
of income
16%% on $990,000
= $165,000 or 16Va%
of income
20% on $987,500
= $ 1 9 7 , 0 0 0 or 1 9 % %
of income
10% on $10,000
= $ 1 0 0 0 or 1 0 %
of income
12%% on $5,000
= $ 6 2 5 or eV4%
of income
16%% on zero
= zero or 0 %
of income
20% on - $ 2 5 0 0
= - $ 5 0 0 or - 5 %
of income
7,500
10% on $ 7 5 0 0
= $ 7 5 0 or 1 0 %
of income
12%% on $ 2 5 0 0
= $313or4Ve
of income
16%% on $ 2 5 0 0
= —$417 or —51/a%
of income
20% on - $ 5 0 0 0
= - $ 1 0 0 0 or - 1 3 % %
of income
5,000
10% on $ 5 0 0 0
= $ 5 0 0 or 1 0 %
of income
12%% on zero
= zero or 0 %
of income
16%% on - $ 5 0 0 0
= - $ 8 3 3 or - 1 6 % %
of income
10% on - $ 7 5 0 0
= - $ 1 5 0 0 or - 3 0 %
of income
2,500
10% on $ 2 5 0 0
= $ 2 5 0 or 1 0 %
of income
12% on - $ 2 5 0 0
= - $ 3 1 3 or - 4 '/«
of income
16%% on - $ 7 5 0 0
= -$1250 or-50%
of income
20% on - $ 1 0 , 0 0 0
= - $ 2 0 0 0 or - 8 0 %
of income
1,000,000
10,000
: FEDERAL RESERVE BANK OF ATLANTA
29
the flat-rate tax with exemption produces a
negative income tax at incomes below the
exemption level.
Milton Friedman summarized the advantages
of such a negative income tax system 20 years
ago.
"The advantages of this arrangement are
clear. It is directed specifically at the problem
of poverty. It gives help in the form most
useful to the individual, namely, cash. It is
general and could be substituted for the
host of special measures now in effect. It
makes explicit the cost borne by society. It
operates outside the market. Like any other
measures to alleviate poverty, it reduces
the incentives of those helped to help
themselves, but it does not eliminate that
incentive entirely, as a system of supplementing incomes up to some fixed minimum
would. An extra dollar earned always means
more money available for expenditure."6
Under a 16 2/3 percent flat-rate tax with a
$10,000 exemption, for example, a $2,500 income
would "pay" a minus $1,250 in taxes, implying a
negative tax rate of minus 50 percent. That
would carry the progressivity of the flat-rate tax
down through the exemption level, offering the
much-discussed advantages of simplicity, direct
delivery and elimination of the disincentive effects
of current welfare programs.
Conclusion
In theory, a flat-rate income tax would save
taxpayers and the government considerable time
and money by simplifying the tax laws. It would
also make the tax system fairer and more equitable by reducing deductions, exemptions and
loopholes. By including some degree of progressivity, and/or a negative income tax scheme, it
also could protect the poor. Finally, it would
broaden the tax base, thus reducing people's
incentive to avoid the tax laws, and would allow
for a significant lowering of marginal tax rates.
Despite these advantages, the flat-rate proposal
faces serious economic and political obstacles.
The shift to a flat-rate tax would disrupt investments and other business plans based on the
present system. Depending on exactly what
version of the flat-rate tax was adopted, the tax
also could be vulnerable to charges of inequitieshelping the wealthy more than middle-income
taxpayers. Finally and perhaps most damaging to
the proposal's chances, eliminating all deductions,
exemptions and loopholes would meet resistance
from a broad range of special interest groups.
Much of the flat-rate tax's appeal rests on its
dramatic simplicity. Paradoxically, however, its
chances for enactment will depend on the delicate
balancing of economic and political complexities.
—Robert E. Keleher
William N. Cox
and William P. Orzechowski
Orzechowski
is assistant professor ot
at George Mason
economics
University.
6 Milton
Friedman, Capitalism a n d Freedom, Chicago: University of Chicago
Press, 1962, p. 192.
30
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
Does
Unemployment
Insurance
Affect the
Composition of
Joblessness?
When Georgia unemployment
insurance benefits went up . . .
— employers were more likely
to resort to temporary layoffs...
— the share of men and older
workers on temporary layoff
tended to increase...
— as temporary layoffs increased,
the average duration of unemployment declined.
U.S. unemployment insurance programs are
designed to provide temporary maintenance
for unemployed workers and to allow them to
refuse jobs substantially below their skill levels.
In the current debate over how to reduce the
nation's chronically high unemployment rate,
many argue that liberal benefits tend to increase
the unemployment level by lengthening the job
search.1 Studies suggest, in fact, that increased
unemployment insurance (Ul) benefit levels will
increase unemployment by increasing its mean
duration.2
As Martin Feldstein has noted, the concentration of previous research on Ul's effects on the
duration of unemployment is both unfortunate
and surprising, since Ul can actually increase the
volume of unemployment while simultaneously
reducing its mean duration.3 By providing benefits that offset a high proportion of lost after-tax
wages, the system of unemployment insurance
could increase the frequency of very short spells
of unemployment. The average duration of
unemployment might then fall while the percent
of the labor force unemployed increased.
In this article, we review the rationale for this
effect and then examine another, widely ignored,
effect of unemployment benefits. W e find that
the unemployment insurance system is changing
the composition of unemployment from indefinite
unemployment to temporary. Our study of Georgia,
for example, showed that the 1981 increase in
maximum benefits from $95 to $115 resulted in
a 2 percent increase in the share of unemployed
on temporary layoff.
Examining Ul's Effects on Frequency of
Unemployment
In the absence of Ul, firms would be more
reluctant to lay off workers for short spells in
response to an unexpected reduction in demand.
The perceived risk of losing trained workers to
other firms would serve as a restraint The existence
of Ul lessens this risk by significantly reducing
workers' economic incentive to seek jobs while
on temporary layoff. This tendency is likely to be
greater for those on temporary layoff versus
'Kathleen Classen, "The Effects of Unemployment Insurance on the
Duration of Unemployment and Subsequent Earnings," Industrial a n d
Labor Relations Review ( J u n e 1977), pp. 438-444.
*Dale T. Mortensen, " J o b Search, The Duration of Unemployment and the
Phillips Curve," A m e r i c a n E c o n o m i c Review (April 1977), pp. 847-862.
3 Martin
Feldstein, "Unemployment Compensation: Adverse Incentives
and Distributional Anomalies," National Tax Journal 27 ( J u n e 1974), pp.
231-234.
31
those on indefinite layoff. It is important to note
that our focus is not on whether UI increases the
overall length of unemployment Instead, this
analysis deals exclusively with whether Ul shifts
the composition of the unemployed toward
temporary as opposed to indefinite unemployment
Our primary objective was to determine the
degree to which unemployment compensation
increases the probability that a worker will be
laid off on a temporary basis rather than indefinitely. For our purposes, an unemployed person
is considered to be on temporary layoff if he
expects to be recalled by his previous employer.4
To measure the consequence of unemployment
insurance on temporary layoffs, we used two
variables designed to represent the extent to
which unemployment compensation replaces
net-of-tax foregone wages. First we used marginal
benefit replacement rates (MBRR), which represent the extent to which unemployment compensation replaces foregone wages at the margin.
Next, we replaced this measure with a weighted
average replacement rate with weights reflecting
the share of income represented by different
marginal net replacement rates. Our hypothesis
would be supported, for instance, if people with
higher replacement rates have a greater likelihood of being on temporary layoff than those
with lower replacement rates.
Our second objective was to examine whether
socio-demographic factors such as age, race, sex,
marital status and education affect the probability
of a worker's being laid off temporarily rather
than indefinitely. Is an older worker, for example,
less likely to be laid off indefinitely because firms
fear losing experienced workers to other companies?5
Replacement Rates
Slightly over three-fifths of the 223 unemployed
individuals we studied in Georgia were on temporary layoff (that is, they expected to be recalled
4So
measured, it is a binary dependent variable which assumes a value of
one if he is on temporary layoff and zero otherwise.
statistical examination was conducted using the linear probability
model. However, problems usually associated with this model were not
a particular handicap to our study. The primary difficulty with the model is
with the unconstrained predicted values falling outside of the 0-1 probability range of the binary dependent variable. To determine the
importance of this problem with our study, we reported the predicted
values of the ordinary least squares equations In only 4.5 percent of the
223 observations in our sample did predicted values lie outside the 0-1
range. Performing the tests without these values did not significantly alter
the results. Therefore, the linear probability model provided reliable
estimates of the importance of unemployment compensation and other
socio-demographic variables on temporary layoff probability.
5 The
32
by their previous employer). Unemployment
compensation replaced an average of 67 percent
of prior net wages. Married men, however, could
replace only 61.5 percent of net-of-tax prior
earnings, while married women were able to
offset nearly 71 percent of their prior after-tax
wages. Slightly over half (53 percent) of the
sample was male and roughly the same proportion
was married. The typical unemployed Ul claimant
was 34 years old and had completed 11 years of
schooling. Finally, 58 percent of the claimants
were white and 17 percent had completed some
type of vocational training.
"The 1981 increase in
Georgia maximum benefits
from $95 to $ 1 1 5 resulted in
a 2 percent increase in the
share of unemployed on
temporary layoff."
The average family income of female applicants
was $18,930 per year in 1981 (Table 1). Married
women's income was responsible for as much as
45.4 percent of the typical husband-wife annual
employment income. Taking federal, state, and
Social Security taxes as well as personal exemptions into consideration, and assuming the standard
deduction, the marginal tax rate on the last dollar
of the wife's wages was 33.8 percent Finally,
taking into account that Georgia's Ul pays 50
percent of the average weekly wages during the
high-quarter, married women were able to replace
as much as 70.7 percent of the after-tax wages
they could have earned by returning to work at
the prior wage (Chart 1). However, forty percent
of the married women could replace from 72 to
84 percent of what they would earn in disposable
income by returning to work.
W h e n a claimant is deciding whether to work
or not work, perhaps the average tax rate is as
important as the marginal tax rate. For example,
the first dollar of employment income is taxed at
a rate lower than the last dollar. Thus we calculated
a weighted benefit replacement rate with weights
assigned to benefit replacement rates according
to their respective share of the wife's annual
earnings (Table 2).
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
T a b l e 1 . Distribution of Married Females by Family Income, Benefit Replacement Rate, and Age
(percent)
Sample Proportions, Means and Medians
Category
Benefit Replacement Rate (percent)
54.2-60.2
60.3 - 66.3
66.4 - 72.4
72.5 - 78.5
78.6 - 84.7
Mean Ratio
Median Ratio
Family Income (dollars)
Under 10,000
10,000 - 20,000
20,000 - 30,000
30,000 and over
Mean Income
Median Income
Age
25-34
35-44
45-54
55 and over
Mean Age
Median Age
Minimum
Maximum
Mean
100.0
100.0
100.0
4.7
34.4
23.4
20.3
17.2
70.4
70.2
4.7
28.1
25.0
26.6
15.6
4.7
31.3
24.2
23.5
16.4
71.0
70.2
70.7
100.0
100.0
100.0
34.4
29.7
23.4
12.5
$17,703
$16,320
29.7
21.9
26.6
21.9
$20,157
$18,319
32.1
25.8
25.0
17.2
$18,930
—
—
100.0
15.6
35.9
14.1
10.9
—
_
—
—
—
—
—
—
—
—
—
37.0
33.0
~—
Source: Federal Reserve Bank of Atlanta
Although this weighted benefit replacement
rate for married women is lower than the marginal
benefit replacement rate, it is still surprisingly
high. The mean was 66.2 percent compared to
70.7 percent for the marginal benefit replacement
rate.
Married men in the sample lived in families
with lower combined incomes than married
women, but had higher annual employment
incomes than women—$12,925 vs. $8,602.
Married men were also older than married
women, having a median age of 36 compared
with 33, which partly explains their higher
income. However, higher employment income
for married men also reduces the share of their
net-of-tax wages that potentially can be replaced
by unemployment compensation (Tables 3
and 4).
: FEDERAL RESERVE B A N K O F A T L A N T A
Chart 1. Marginal Tax Rate
and Benefit Replacement Rate
by Income for Married Female*
%
I
I Tax Rate
Replacement Rate
60
40
20
n
$400
$4,600
$8,900
$13,000
$13,520
•Combined family income totaled $19,520 in this case. Of this amount
$6,000 was earned by the female's spouse. Figures based on household of
four.
Source: Federal Reserve Bank of Atlanta
33
T a b l e 2 . Distribution of Married Females by Wife's Earnings,
Benefit Replacement Rate, and Marginal Tax Rate
(percent)
Category
Benefit Replacement Rate Weighted Average (percent)
53.4-59.4
59.5 - 65.5
65.6-71.6
71.7-77.7
77.8 and over
Mean Ratio
Median Ratio
Marginal Tax Rates (percent)
Under 24
24 - 30
31 - 4 0
Over 40
Mean Rate
Median Rate
Sample Proportions, Means and Medians
Minimum
Maximum
Mean
100.0
100.0
100.0
23.4
26.6
29.7
17.2
ai
20.3
20.3
28.1
25.0
6.3
21.9
23.5
28.9
21.1
4.7
65.7
65.1
66.6
66.6
66.2
—
100.0
100.0
100.0
25.0
20.3
26.6
28.1
32.8
33.3
21.9
20.3
18.8
39.1
34.8
33.3
23.5
20.3
22.7
33.6
33.8
—
—
—
—
—
—
—
—
—
—
—
—
—
100.0
96.9
73.4
34.4
15.6
6.3
8,602
8,320
Wife's Earnings (dollars)
Over 3,000
Over 5,000
Over 7,000
Over 9,000
Over 11,000
Over 13,000
Mean Earnings
Median Earnings
Source: Federal Reserve Bank of Atlanta
Averages often mask important variations
within a sample. For instance, 16.4 percent of
the married women but only 7.4 percent of the
married men were able to replace between
78.4 and 84.7 percent of prior net earnings by
drawing unemployment benefits. The higher
benefit replacement rates for married women
stem from the high initial marginal tax rates
caused by higher employment income of husbands. Since most husband-wife families combine their incomes for tax purposes, the wife's
income is taxed at rates determined by the
higher earnings of her spouse. Furthermore,
since women generally earn less than men, the
first dollar of a wife's earnings is subject to
higher marginal tax rates than the first dollar of
a husband's wage income. These higher tax
rates tend to make nontaxable income and
benefits more valuable to married women than
to married men. Other things being equal,
lower employment income and higher marginal
tax rates produce higher benefit replacement
rates for women. Theoretically, married females'
labor force participation rates would tend to be
more sensitive to reduction in marginal tax
rates.
Our final sub-group consisted of 113 single
individuals about evenly divided between men
and women. As was true of married males and
married females, single men earned more than
34
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
T a b l e 3 . Distribution of Married Males by Family Income, Benefit Replacement Rate, and Age
(percent)
Category
Benefit Replacement Rate (percent)
Under 54.2
54.2 - 60.2
60.3 - 66.3
66.4 - 72.4
72.5 - 78.5
78.6 - 84.7
Mean Ratio
Median Ratio
Family Income (dollars)
Under 10,000
10,000-15,000
15,000 - 20,000
20,000 - 25,000
25,000 and over
Mean Income
Median Income
Age (years)
Under 25
25-34
35-44
45-54
55 and over
Mean Age
Median Age
Sample Pro portions, Means and Medians
Mean
Maximum
Minimum
100.0
100.0
100.0
26.1
9.1
26.1
25.0
9.1
4.6
25.0
9.0
20.5
23.9
11.4
10.2
25.6
9.1
23.3
24.5
10.3
7.4
61.1
64.9
61.9
65.2
61.5
100.0
17.1
34.1
25.0
13.6
10.2
100.0
17.1
26.1
27.3
18.2
11.4
$16,618
$15,600
100.0
$15,840
$14,840
—
17.1
30.1
26.2
15.9
10.8
$16,229
—
—
—
100.0
_
—
—
—
8.0
37.5
28.4
15.9
10.2
—
—
—
—
—
—
—
—
38.0
36.0
Source: Federal Reserve Bank of Atlanta
single women—$11,424 compared to $8,222.
Lower wages for single women are also consistent with our findings that single women were
an average 3.6 years younger than single men.
Employment income enabled single women to
replace 67.1 percent of potential wages compared to 64.6 percent for single men, despite
higher marginal tax rate for men.
These results are not substantially different
from those found by others. Feldstein noted
that for families in which the husband earned
the median male earnings and the wife is
unemployed but earned 70 percent of the
median of females, the mean benefit replacement rate was 77 percent. The slight difference
in results suggests that Georgia's Ul law is less
liberal than those of other states, especially for
those states which offer dependency benefits.
However, Georgia's slightly lower benefit replacement rate offers little cause for rejoicing. High
mean replacement rates, even for those with
low wages, suggest that the disincentive effect
of Ul in Georgia should not be ignored.
Factors Influencing Temporary Layoff
Our tests showed that the marginal benefit
replacement rate had a statistically significant
effect on the probability of being temporarily
laid off. The age and sex of the individual were
35
: FEDERAL RESERVE B A N K O F A T L A N T A
T a b l e 4 . Distribution of Married Males by Husband's Earnings,
Benefit Replacement Rate, and Marginal Tax Rate
(percent)
Category
Benefit Replacement Rate Weighted Average (percent)
Under 53.4
53.4 - 59.4
59.5 - 65.5
65.6-71.6
71.7-76.9
Mean Ratio
Median Ratio
Marginal Tax Rates (percent)
Under 24
24-30
31 - 4 0
Over 40
Mean Rate
Median Rate
Husband's Earnings (dollars)
Over 3,000
Over 7,000
Over 11,000
Over 15,000
Over 19,000
Over 23,000
Mean Earnings
Median Earnings
Sample Proportions, Means, and Medians
Minimum
Maximum
Mean
100.0
25.0
28.4
25.0
14.8
6.8
56.5
sag
100.0
23.9
26.1
23.9
13.6
12.5
57.3
59.4
100.0
24.5
27.3
24.5
14.2
9.7
100.0
14.8
39.8
36.4
9.1
100.0
14.8
35.2
34.1
14.8
30.4
29.6
100.0
14.8
37.5
35.3
12.0
30.0
29.5
29.1 .
—
_
_
—
—
—
_
—
—
_
—
—
56.9
—
—
100.0
88.6
59.1
27.3
14.8
6.8
12,925
11,752
Source: Federal Reserve Bank of Atlanta
"The higher benefit
replacement rates for married
women stem from the high
initial marginal tax rates
caused by higher employment
income of husbands."
36
also important determinants of temporary layoff.
Education, marital status, vocational training,
and ethnic group, however, seemed insignificant
When we used the weighted average replacement rate, the results were similar but not as
significant as the marginal replacement rate.
These results imply, for example, that a one
percentage point increase in the percentage of
previous wage income replaced by Ul raises
the fraction of the unemployed on temporary
layoff by a half percentage point W e also
found that each year of age adds fully one
percentage point to this fraction and that men
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
Table 5. Factors Influencing Temporary Layoff Unemployment For Single Women and Men
Single Women
Variable
Mean
Marginal Benefit Replacement Rate
.67
Average Benefit Replacement Rate
.62
Ethnic Group (White=1)
.38
Age
31.92
Education
11.12
Vocational Training (Yes=1)
R2
F-statistic
Mean of Dependent
Variable
Sample Size
.16
Single Men
Régression Coefficients
(1)
(2)
(3)
.317
(.772)
.008
(.036)
-.153
(.203)
.136
1.778
.085
(.818)
.290"
(-157)
.006
(.007)
.018
(.035)
-.171
(.203)
.133
1.732
.520
.520
-302 b
(-157)
.004
(.007)
50
50
(4)
.467k
(-294)
328a
(-148)
.003
(.006)
Mean
.65
.463 b
(.319)
,328 a
(-148)
.003
(.006)
.60
.52
27.70
11.26
.18
.126
3.374
.118
3.151
.520
.520
50
50
Régression Coefficients
(1)
(2)
(3)
.507
(.644)
-.213
(-143)
.010 a
(.006)
.006
(.033)
.206
(.190)
.072
.872
.600
50
.581
(.653)
-.215
(.142)
.010 a
(.006)
.005
(.032)
.210
(.189)
.075
.917
.600
50
699a
(.306)
-.187
(.140)
.009 b
(.006)
.044
(4)
.753 a
(.325)
-.188
(.140)
.009 b
(.006)
.047
1.089
1.160
.600
50
.600
50
Note: Numbers in parentheses are standard errors of regression coefficients,
a - significant at 5 percent level
b - significant at 10 percent level
are 10 percent more likely to be on temporary
as opposed to indefinite layoff than women.
For single women, a one point increase in
their replacement rate will result in a 0.47 point
increase in the percent of unemployed women
on temporary layoff. For single men, on the
other hand, a one point increase in their replacement rate will result in a 0.70 point rise in this
percentage. Unemployed nonwhite single men
have a greater likelihood of being on temporarily
layoff than whites.
Age, a proxy for seniority, is the most significant
factor among married females (Table 5). Each
additional year adds two percentage points to
their likelihood of temporary layoff compared
to the indefinite alternative. For married males,
the level of benefits was the most significant
factor. A one point increase in the replacement
rate increase? the likelihood of temporary layoff
by 0.47 percentage points. Unemployed whites
are 18 percent more likely to be on temporary
layoff than nonwhites.
In summary, the regression results imply a
significant relationship between demographic
characteristics and temporary layoff probability.
Age is positively related to this probability in all
cases, implying an additional year of experience
Chart 2. Percent of Unemployed Who Expect
to be Recalled
Married W o m e n
Married M e n
Single W o m e n
Single M e n
Source: Continued W a g e and Benefit History ( C W B H ) project (Georgia
State Department of Labor).
37
: FEDERAL RESERVE B A N K O F A T L A N T A
Table 6 . Factors Influencing Temporary Layoff Unemployment For Married Women and Men
Married W o m e n
Variable
Marginal Benefit Replacement Rate
Average Benefit Replacement Rate
Ethnic Group (White=1)
Age
Education
Vocational Training (Yes=1)
R2
F-statistic
M e a n of Dependent
N
Variable
Mean
.70
.65
.78
37.13
10.52
.11
Married M e n
Regression Coefficients
(1)
(2)
(3)
.833 b
(.562)
-.198
(-144)
.018 a
(.004)
-.042b
(.028)
.040
(.182)
.320
5.754
.648
54
.071
(.249)
-.162
(.143)
.020 a
(.004)
.288
10.304
.648
54
(4)
Mean
.60
.438
(.558)
-.163
(-146)
.020 a
(.004)
-.023
(.026)
.030
(.185)
.300
5.198
.648
54
.005
(.263)
-.145
(-143)
.020 a
(.004)
.55
.61
37.62
10.42
.22
Regression Coefficients
(1)
(2)
(3)
.502 b
(.336)
.179
(.124)
.007 b
(.005)
-.001
(.019)
-.039
(-142)
.067
(4)
.474 a
(271)
.178
(-122)
.007 b
(.005)
.287
10.248
1.156
.066
2.334
.648
54
.652
69
.652
69
519b
(3.59)
.186
(.124)
.007 b
(.005)
.000
(.018)
-.040
(-142)
.065
1.119
.652
69
-503 a
(294)
.185
(-122)
.007 b
(.005)
.064
2.262
.652
69
Note: Numbers in parentheses are standard errors of regression coefficients,
a - significant at 5 percent level
b - significant at 10 percent level
will increase the likelihood of temporary versus
indefinite layoff. Unemployed men have a
greater likelihood of assignment to temporary
layoff than women (Chart 2). Single white
women and married white men have a greater
likelihood of temporary layoff than nonwhites.
However, single nonwhite men and married
nonwhite women have a greater probability of
temporary layoff than do whites. Higher educational levels reduce the probability of temporary
layoff for married women but are not significant
for other groups.
But more importantly, the likelihood of temporary layoff is directly related to the individual's
marginal replacement rate. Specifically, we
found that an increase of one percentage point
in replacement rate will increase the percentage
of the unemployed on temporary layoff approximately one-half percentage point. The 1981
increase in Georgia's maximum benefit allotment from $95 to $115, for example resulted in
a two percent increase in the share of unemployed on temporary layoff.6 Thus, we conclude
6 The
maximum benefit allotment change resulted in an increase from 67.09
to 71.33 in the mean marginal replacement rate. Since a one point increase
in the replacement rate raises temporary layoff incidence .5 percent, a 4.24
point increase results in a two percent increase in temporary layoffs.
"The likelihood of temporary
layoff is directly related to the
individual's marginal
replacement rate."
that the Ul system is changing the structure of
unemployment toward more temporary layoffs.
In particular, those people with more seniority
and those whose Ul benefits replace a large
portion of previous net income are more likely
to be on temporary than indefinite layoff.
Although the empirical results are only moderately significant, the effects are sufficiently
important to warrant further research in this
area.
38
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
DATA S O U R C E A N D SYSTEM PARAMETERS
The data used in performing the empirical tests come
from the Georgia Department of Labor's surveys of new
applicants for unemployment insurance under the
Continuous W a g e and Benefit History ( C W B H ) project.
Response to the questionnaire is completely voluntary,
yet the response rate is high because many participants
believe that failure to complete the questionnaire will
delay processing of their claim. Ten percent of all
claimants are selected at random based upon the last
four digits of their social security number. Since the
sample is drawn from the population of all new Ul
claims applicants, many responses are from individuals
whose claims are not valid. The sample size is determined
by the number of people who file applications. For
example, there were approximately 46,000 unemployment insurance applications filed in the state during
December 1981. So the 10 percent sample comprised
4,600 questionnaires being mailed in the month of
December.
The purpose of the C W B H is to obtain economic and
demographic characteristics of the applicants. Thus,
such information regarding the applicant's age, sex,
race, and marital status provides the basic demographic
characteristics necessary for our study. Number of
dependents, the worker's previous wages, his reason
for being unemployed, whether or not he expects to be
recalled, and income of other members of the household
provide the basic economic information. Combining
the economic and demographic data from C W B H with
some basic parameters of the unemployment insurance
system enabled us to compute benefit replacement
rates for 265 individuals in Georgia who were presumably unemployed.
To be eligible for unemployment compensation in
Georgia, the applicant must have earned a minimum
amount and those earnings must have been earned in
more than one calendar quarter during the baseperiod. The purpose of these requirements is to limit
eligibility only to those who have been genuinely
attached to the labor force of covered workers.
To be sure, the Georgia Ul system has no explicit
minimum period of work or eligibility. However, the
stipulation that base-period wages are more multiple in
excess of unity of high-quarter wages indirectly requires
more than one quarter of employment. To be eligible
for minimum benefits in Georgia, the applicant must
have earned a minimum of $413 during the baseperiod defined as the first four of the last five completed
calendar quarters preceding the date the claim is filed.
Moreover, at least $275 of the base-period wages must
have been earned in one of the four calendar quarters
that constitute the base period.
To be eligible for the maximum benefit under the
current Georgia system, the claimant must have had
wages of at least $2,225 in one quarter of the baseperiod and aggregate base-period wages must have
been at least $3,338 during this period. There is a oneweek waiting period before the benefit year begins.1
The actual weekly benefit amount is computed as 4
percent of the applicant's high-quarter wages plus one
dollar. Unlike 13 other states, Georgia's Ul system
offers no allowance for dependents of the claimant.
Since there are 13 weeks in the statistical quarter, a
weekly benefit amount of 4 percent of high-quarter
wages is slightly more than half (52 percent) of the
average weekly wages earned during the high-quarter.
The applicant who qualifies for Georgia's unemployment insurance is eligible to receive those benefits up
1. Under Georgia law, the one-week waiting requirement does not apply
to those who have lost their job due to reasons other than refusal to
work
39
: FEDERAL RESERVE B A N K O F A T L A N T A
to a maximum of 26 weeks. With a minimum weekly
benefit of $115, the maximum amount of benefit
comes to $2,990. In April 1981, 56 percent of those
who receive Ul in Georgia received between $88 and
$96 per week. Recipients are also allowed to earn up to
$8 per week, which does not affect benefits.
Figuring the Cost of Remaining Unemployed
In evaluating the cost of remaining unemployed, the
rational job seeker should compare Ul benefit levels
with net-of-tax potential wages from accepting a specific
job offer. The potential disincentive effect of unemployment compensation can perhaps be understood better
by thinking of unemployment benefits as imposing a
high tax on employment income if the individual
returned to work. This "net tax rate" is the Ul benefits
that the individual foregoes relative to net after-tax
wage income gained from returning to work. So defined,
such a tax rate measures the extent to which unemployment compensation replaces prospective after-tax
employment income. In cases in which the insured
unemployed lives in a family where other employment
income exists, the marginal tax rate is determined by
the combined family income.
After-tax wages are more relevant for those whose
unemployment insurance benefits are not taxable.
However, when wages exceed $25,000 per year for
joint filers and $20,000 per year for individuals, onehalf of Ul benefits is subject to federal income taxes at
ordinary rates. This widely overlooked observation in
existing Ul research tends to understate the net cost of
remaining unemployed to higher income families and
individuals making for measurement errors in those
studies. After-tax Ul benefits should, therefore, be
compared with after-tax wages to more accurately
capture the net cost of remaining unemployed. Therefore, the relative cost to a member of a two-income
family of remaining unemployed, C, may be stated
conditionally as:
(1) C =
?
,
Wp(l-t)
for W D + B < 25,000
6 ( 1 ~'/2t> ,
Wp(l-t)
for W D + B > 25,000
P
P
H
where W p is the individual's potential weekly wage, t is
the marginal tax rate applied to those wages, and B is
the weekly benefit allowance from unemployment
insurance.
Ideally, W p would be the individual's post-unemployment wage. However, post-unemployment wages are
unobservable from our data source. Some authors have
used alternative data sources where pre-unemployment
and post-unemployment wages are directly observable.
Others have used a measure of the discounted present
value of wages from expected future job offers. Given
data limitations and time constraints, w e assumed that
the individual's pre-unemployment and post-unemployment wages were equal.
In summary, we computed marginal tax and benefit
replacement rates for levels of earnings consistent with
applicable ranges in computing federal income taxes.
Since Georgia's taxable income brackets were not
compatible with those of the federal income tax, the
applicable marginal state tax rate is a weighted average
of that portion of income that lies in the federal income
tax range. Finally, weighted overall marginal tax and
benefit replacement rates were computed on the total
annual earnings.
—Charlie Carter
and Edward Waller
40
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
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41
Supply-Side Economics:
Guiding Principles for
the Founding Fathers
Not only did leading American statesmen identify
with the supply-side views of Locke, Montesquieu, and the
Physiocrats in the 18th century, but those supply-side views
were popularized in America through the pamphlets of
Trenchard and Gordon.
Supply-side views were the very essence of the
economic principles servingto inspire the American Revolution and to guide the architects of the
U.S. Constitution. Supply-side economic principles, then, constitute a re-emergence of the
economic principles governing the founders of
the American experience—in a sense, an American Renaissance.
A reaction to mercantilist economic policies of
government intervention and planning as well as
high tax rates served to unite the American
colonies into revolt and to inspire the Founding
Fathers. And it was the English Whig-Libertarian
heritage that served as the philosophical base
upon which these principles developed.
It is ironic that so much opposition to supplyside economic policies has arisen in a country
where these principles were part of its conception,
a country that has prospered and developed
largely as a result of its supply-side foundations.
Essential Features of
Supply-Side Economics
Supply-side economics recognizes that human
behavior responds to changes in economic incentives. In other words, the quantity supplied and
demanded responds to price. Since taxes always
affect the prices paid and received for goods and
services, poor economic performance is related
42
to the existence of high tax rates and regulatory
burdens on work, saving, and output. Supplysiders contend that if you want more of something,
tax it less. Consequently, to get more work,
saving, and output, these economists recommend
lowering tax rates on these activities. Thus, supplyside economics has to do with the use of fiscal
and regulatory policy to increase production and
aggregate supply by making work more attractive
than nonwork and saving more attractive than
nonsaving. In short, supply-side economics focuses on the effects that tax rates have on
relative prices, aggregate supply, and, hence,
economic growth.
There are three basic elements of this view.
First, and probably most fundamental, is the idea
that changes in (marginal) tax rates are changes
in relative prices and, consequently, will always
affect choice, the allocation of resources, and
real economic activity. Accordingly, changes in
tax rates will have important repercussions on
individuals' incentives to supply labor and capital
to the market Tax-induced relative price changes
affect choices between (1) work and leisure, (2)
consumption and saving, and (3) market activity
and nonmarket activity. Consequently, reductions in tax rates—by inducing shifts from leisure
to work, from consumption to saving, and from
nonmarket activity to market activity—have
important implications for changes in aggregate
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
supply and economic growth. In sum, supplyside economists view changes in tax rates as
incentive changes rather than income changes.
A second fundamental element of supply-side
economics is the relationship between tax rates
and output. Specifically, when tax rates are near
zero, output is low because certain essential
public goods are not being provided. Examples
of such goods might include justice (a conducive
legal framework), defense, law and order, the
maintenance of roads, and primary education. As
tax rates rise, these essential public goods and
services are provided and economic activity
expands. That is, the provision of these public
goods contributes to rapid increases in the productive efficiency of capital and labor and, consequently, output. At this initial stage, the effects of
these increases in productive efficiency outweigh
(or increase faster than) any disincentive effects
of higher tax rates (i.e., efficiency gains due to
government expenditures are greater at initial
stages than efficiency losses due to increased tax
rates).
"Supply-siders contend that if
you want more of something,
tax it less."
AA FEDERAL RESERVE BANK O F A T L A N T A
However, as tax rates are increased further,
disincentives and inefficiencies due to these
higher tax rates begin to emerge. Increased tax
rates alter relative prices and cause the after-tax
rewards to saving, investing, and working for
taxable income to decline. Individuals, then,
have less incentive to save, invest, and work for
taxable income. Consequently, people shift out
of these activities into leisure, consumption, tax
shelters, and working for nontaxable income. As
a result, the market supply of goods and services—
that is, aggregate supply and, hence, economic
growth—is less than would otherwise be the
case. At the same time, public good-induced
improvements in the productive efficiency of
factors increase at a slower rate (because fewer
essential public goods are provided). Consequently, output gains become smaller and smaller.
Eventually, total output peaks and begins to
decline as the efficiency gains due to government
expenditures are more than offset by efficiency
losses and disincentives due to high tax rates.
Additional tax rate increases lead to even further
declines as factor supplies continue to be withdrawn from production.
This relationship between aggregate market
output and tax rates represents the basic concern
of the supply-side view, which is to support those
public policies under which economic growth is
maximized. The fact that tax rate changes affect
the supply of factors of production and, in turn,
aggregate supply implies that tax rate changes
also have implications related to tax revenues. In
particular, tax revenue is equal to the product of
the tax rate times the tax base. Since tax rate
changes affect aggregate supply, these rate changes
also affect the tax base—sometimes in the opposite direction. This recognition has led to the
explicit depiction of the relationship between
tax rates and tax revenues or the Laffer curve.
The Laffer curve is essentially a by-product of the
above relationship between tax rates and output
A third basic element of supply-side economics
is the recognition that the various relationships of
changes in tax rates to incentives, factor supplies,
output, and tax revenues are long-run relationships.
All economists recognize that elasticities become
larger the longer the time frame under consideration. Hence, the longer the time frame, the
more potent will supply-side tax cuts become.
Supply-side economics, then, relates to policies
for long-run economic growth and not to policies
for smoothing the business cycle—it pertains to
growth, not stabilization.
The Mercantilist Era
To understand both the reasons for the
American Revolution and the philosophical
underpinnings and economic principles guiding
the Founding Fathers, we need to appreciate
the economic circumstances and environment
of the mid-18th Century. This period was dominated by mercantilist thought and mercantilist
economic policies, consisting of various forms
of governmental intervention and control of
both the domestic and colonial economies.
Mercantilists "considered it one of the functions of government to guide, encourage, and
direct economic activity,"1 i.e., "to promote
the national interest through economic controls."2
Governmental intervention took the form of
strict regulation of markets and guilds, the
fixing of prices, wages and interest rates,3
quotas, licensing for export and import trade,
royal or state enterprise, public works, paternalism, the subsidization of certain industries,
grants of monopoly charters and patents, and
all sorts of special restrictions on economic
activity in the colonies. Special interest groups
were able to obtain governmental favors ranging
from price-fixing to the exclusion of competitors.
High tariffs and other taxes (such as transportation tolls, church taxes, and excise taxes)
were commonplace. Mercantilists, then, were
not at all adverse to high tax rates.
Like the tax and regulatory policies of the
mercantilists, the wage policies they endorsed
were intended to bring about a balance of
trade surplus. Since mercantilists viewed lower
production costs as being beneficial to exports
and, hence, the balance of trade, they prescribed
policies which promoted and maintained low
costs of production, including wages, the largest
component of these costs. Low wages, according
to mercantilist writers, would not only contribute
to low (export) production costs and, hence, to
a favorable balance of trade but were also
viewed as a stimulus to productive work effort.
According to this "low wage doctrine," workers
would increase their effort only out of necessity;
if the existing structure of low wages fell,
workers would increase their efforts, whereas
high wages led to idleness. Necessity, then,
was the mother of industry and invention,
according to the mercantilists. Consequently,
these writers supported policies which promoted
low wages. Accordingly, mercantilists endorsed
schemes to increase population growth and
44
were not adverse to taxation on work effort,
believing that if such taxes lowered (after-tax)
wages, work effort, productivity, and innovative
activity would increase. These writers, then,
did not recognize the efficacy of positive incentives to work effort. And high rates of taxation
on work effort were not at all in conflict with
the mercantilist scheme.
Moreover, mercantilists viewed wealth creation as a zero-sum game, something gained at
the expense of someone else. So mercantilists
were more concerned with the transfer than
the creation of wealth. In short, mercantilist
policies were characterized by both high tax
rates and a high degree of government regulation
of the economy; a conspicuous feature of
mercantilist policies was the royal (governmental) control of the national and colonial
economy.
In accordance with their interventionist policies, mercantilists advocated the strict regulation
of colonial commerce and industry because
"the purpose of the colonies was to increase
the wealth of the mother country by providing
a market for the products of the homeland and
a source of essential raw materials.... The rules
and regulations imposed upon the colonies
were designed to promote (the interests of the
mother country)."4 The colonies, then, existed
for the mother country and—as with other
mercantilist policies—were regulated with the
objective of attracting and retaining gold for
the mother country.5
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British Colonial Policy
and the American Colonies
British colonial economic policy was generally
consistent with these mercantilist policies. The
Navigation Acts of 1651 and 1660 as well as the
Staple Act of 1663, for example, provide ample
support for this contention. These acts provided
that all colonial exports of certain goods first
had to be shipped directly to England, that all
exports and imports of both England and her
colonies had to be carried in either English or
colonial ships, and that the master and threefourths of the crew had to be Englishmen.6 As a
further illustration, a 1699 law banned the
export of colonial wool products to any foreign
country or even to other colonies.7 Moreover,
the Molasses Act of 1733 forced the colonies
to buy from the British West Indies when
cheaper alternatives were available. Colonial
merchants, then, had to ship their products
first to England, pay a tax, and then reship them
to the ultimate consumer. It was illegal for the
colonists to buy certain products from foreign
producers. They had to be sent to England for
the payment of English customs duties before
reshipment to the colonies.8 These laws forced
the colonies to buy directly from England, to
pay English customs duties, and generally to
limit the scope of colonial trading activities.9
Before 1763, the British government had
made little effort to enforce strictly such mercantilist laws in the American colonies. "During
the long series of wars with France and other
nations prior to 1763, the British government
had been too busy with troubles in Europe,
Asia, and Africa to devote much time, attention,
or effort to the American colonies."10 With the
British victory over the French in 1763 and the
heavy burden that the war had placed on the
treasury, however, the British decided to enforce
tightly their mercantilist policies over the colonies. The national debt in Britain had, after all,
nearly doubled during the Seven Years War
and the debt as a percentage of national wealth
was at its highest level of the 18th Century.11
This decision to regulate more rigorously the
economic life of the colonies and to increase
various colonial taxes and tariffs was therefore
intended (in part) to raise revenue, and thus to
relieve heavy burdens on the British Treasury.
There are many examples of increased taxes
and other restrictive-interventionist measures
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imposed by the British on the American colonies
after 1763.12
The American Reaction
Some Background:
The Evolving Influence of
Liberal Economic Writings
in America
John Locke
To understand the colonial reaction to these
mercantilist policies, an appreciation of evolving
intellectual influences on American writers
and statesmen during the mid-18th Century is
important. Many scholars have demonstrated
the strong influence of John Locke on American
writers and the influence of Lockean ideas on
the American Revolution.13
One of Locke's most important ideas was
that, as part of the "social contract" in the
formation of government, men surrendered
some of their freedom so that the state could
protect each citizen in enjoying the fruit of his
labors. Property rights guaranteed by government were a form of protection for incentives
to produce. If a man's property could be stolen
or expropriated at any moment, for example,
what incentive would he have to produce and
accumulate wealth? According to Locke, then,
the consent of the governed was necessary
before government could demand a portion of
a person's property through taxes.14 And if
government infringed too much on its citizens' enjoyment of the fruits of their labor,
these citizens had a right to dispose of their
government. In this regard, Locke believed the
role of government in the management of the
economy to be a limited one. As Vaughn has
indicated:
Locke believed civil government to be naturally
subordinate to the economy in its function in social
life, and that the ability of the government to play an
active role in the economy was therefore limited." 15
Thus, Locke believed that in organizing economic activity, the market was superior to the
"bungling of men" and consequently government should have a limited role in economic
affairs.16 All of this related to Locke's concern
with economic growth. He showed that the
right to own property—and hence the incentive
to produce and accumulate such propertywas necessary for economic well being. Locke
V
tried to show how a wisely administered country
could be industrious and thereby grow to
become wealthy.17 Locke, then, presented some
early essentials of the relationships between
governmental policy, incentives to produce
and accumulate, and economic growth; that is,
he offered some early rudiments of supplyside economics.
The Whigs—Trenchard and Gordon
Lockean views influenced American thinkers
and laymen not only directly but through the
writings of other Whigs. In particular, the popular
writings and pamphlets of such Whigs as John
Trenchard and Thomas Gordon—whose writings
were largely based on Locke—were especially
influential, particularly in the American colonies.18
Since the lay public did not read formal political
theory and hence were not familiar with Locke,
Trenchard and Gordon were able to spell out
these views in an easily understandable form.
These popular writings made possible the rapid
spread of Lockean thought among the masses.
One of the elemental promises of the Whig
argument presented by Trenchard and Gordon
was that liberty was more important than all
other concerns. To Gordon, liberty meant the
right of producers and workers to reap the
rewards of their labors.
In addition, Trenchard and Gordon indicated
that incentives to work and produce were very
much dependent on such just rewards:
M e n will not spontaneously toil and labour but for
their own advantage, for their pleasure or their
Profit, and to obtain something which they want or
desire, and which, for the most part, is not to be
obtained but by Force or Consent." 19
Moreover, they contended any state that promotes such incentives by taxing less and rewarding
more will produce more aggregate supply and
wealth. According to Trenchard and Gordon,
only under conditions of liberty—where men
were rewarded for their efforts—would commerce flourish.20
If governments confiscate rewards to labor
and production and act in an arbitrary manner
without regard to incentives, then production,
growth, and the economy will languish. Under
such circumstances, they argued:
"Great M e n will rather throw their Estates into
Forests and^Chaces, for the Support of wild Beasts,
and for their own Pleasure in hunting them, than into
Farms, Gardens, and fruitful Fields, if they can get
nothing from the Productions of them." 21
essence of the supply-side position. They recognized the importance of rewards and incentives to produce and accumulate and recognized
the importance of incentives in fostering economic growth. They spelled out the forms of
government interference such as taxation and
arbitrary behavior which would destroy these
incentives and hence cause economic growth
to languish.
Although their work passed into obscurity by
the mid-18th century and remained there for
much of the 20th, their significant influence in
the American colonies has recently been reestablished by various scholars. Jacobson demonstrates, for example, that Trenchard and
Gordon had a much more profound and significant affect on American colonial thinking
than they had in Great Britain.22
"Trenchard and Gordon,
writing in the early
18th century, summarized
much of the essence of the
supply-side position."
Trenchard and Gordon, then, writing in the
early 18th century, summarized much of the
46
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W I
There is little doubt, then, that the Whig
principles presented by writers such as Locke
and Trenchard and Gordon had a profound
influence on the American colonies. Even English
spokesmen of the day acknowledged that "the
American cause....was the cause of Whiggism."23
Montesquieu
Another influential work of the mid-18th
century was Baron De Montesquieu's The Spirit
of Laws (1748, first published in English in
1750). Montesquieu reaffirmed much of the
essence of the supply-side position.24 For
example, Montesquieu attacked the prevalent
mercantilist "low wage doctrine." He noted
that:
"...some have concluded from the poverty of
(certain) states that in order to render the people
industrious they should be loaded with taxes. But it
would be a juster inference, that they ought to pay
no taxes at all.... The effect of wealth in a country is to
inspire every heart with ambition: that of poverty is
to give birth to despair. The former is excited by
labor. The latter is soothed by indolence." 25
Montesquieu, then, contended that workers
respond to positive incentives,—that the supply
of labor will increase with increases in rewards
and tax burdens will serve to discourage work
effort. In addition to recognizing the effect of
taxes on incentives to work, he realized that the
economy had to be healthy for tax revenues to
be substantial; he sensed the difference between
tax rates and tax revenues. He contended that
excessive taxation fails to inspire industry and
weakens the tax base by depressing the fortunes
of the individuals capable of supporting the
government 26 Montesquieu, then, certainly
recognized and endorsed several of the key
features of the supply-side position.27
His influence on the American colonies was
substantial. Many scholars have documented
the fact that the "colonials were surprisingly
well acquainted with Montesquieu." 28 Several
of these scholars contend that Montesquieu
had more influence on eighteenth century
American political thought than any other writer.29
David Hume
Montesquieu's views reached the American
colonies not only directly but indirectly through
the influential writings of David Hume. Hume
had carefully read The Spirit of Laws by at least
1749 as indicated in his correspondence with
Montesquieu.
Hume challenged several tax-related views
held by mercantilist writers. He challenged the
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mercantilist view that tax rate increases stimulate work effort and create a new ability to
bear the tax burden, for example. He stated
clearly that under general circumstances, tax
rate increases could destroy work effort and
cause output and aggregate supply to diminish.
Specifically, he believed that exorbitant tax
rates (and sharp increases in tax rates) would
destroy industry and productive work effort.
Indeed, he believed that this was occurring in
Europe at the time he wrote:
"Exorbitant taxes, like extreme necessity, destroy industry,
by producing despair; and even before they reach this
pitch, they raise the wages of the laborer and manufacturer, and heighten the price of all commodities." 30
Thus, Hume recognized that taxation had
profound effects on production, output, and
growth.31 Consequently, his work suggested
that government should support those tax
policies tending to enhance and encourage
productive effort, aggregate supply, and economic growth.
Also contrary to mercantilist notions, Hume
recognized the importance and significance of
positive work incentives—which he believed
"[Hume] believed that
exorbitant tax rates (and sharp
increases in tax rates) would
destroy industry and
productive work effort."
would stimulate rather than discourage work
effort. According to Hume, then, cultivating
incentives in a positive direction could enhance
output and growth.
Hume also recognized the relationship
between tax rates and tax revenues. He indicated
that, in certain circumstances, tax rate increases
may lead to tax revenue decreases.
Because he recognized the counterproductive
effect of high tax rates, Hume argued that
governments should pursue those tax strategies
which provide for numerous sources of revenue
and maintain a wide tax base.32
In sum, Hume endorsed many essentials of
the supply-side view. Hume recognized the
adverse effects of high taxation on aggregate
supply and growth, the importance of positive
incentives to productive work effort, and the
essence of the tax rate/tax revenue relationship
(or the Laffer curve).
The Physiocrats
Other economists who influenced economic
thought in the colonies were writing in France
during the mid-18th century, attacking mercantilist policies and prescribing alternatives
consistent with supply-side views. They were
known as the physiocrats and included Gournay,
Cantillon, Quesnay, the elder Mirabeau, Turgot,
Dupont de Nemours, and Mercier de la Riviere.
The physiocrats rejected the mercantilist preoccupation with accumulating precious metals
and instead emphasized the level of economic
activity or the annual flow of goods and services
(i.e., net product). They maintained that the
king "should be concerned to achieve the
largest possible product net for the entire
country (and hence the highest revenue from
taxes)."33 In so doing, their analysis stressed
the circular nature of commodity and money
flows in the exchange process and, hence, the
general equilibrium nature of economic activity
at the macroeconomic level. Given no obstructions to this circular flow, increases in output
would always lead to increases in income and
spending. That is, demand would keep pace
with an expansion of output:
The central lesson of (Quesnay's) Tableau is...that
the creation of output automatically generates the
income whose disbursement makes impossible to
enter upon another cycle of production." 34
Thus, the primacy that the physiocrats placed
on aggregate supply led them to anticipate
Say's inference that an increase in output
always generates an increase in demand; i.e.,
the origins of Say's Law are found in the writings
Qf the physiocrats.
Physiocrats also stressed the importance of
positive incentives in fostering the supply of
labor. They saw high wages as enhancing rather
than inhibiting innovative activity and productive
work effort.
According to the physiocrats, exorbitant taxation adversely affected the circular flow of
spending and, hence, the level of economic
activity. High rates of taxation reduced the
rewards to produce and, hence, adversely
48
affected aggregate supply which, in turn, brought
about a reduction in aggregate demand and in
the circular flow of spending.35 French tax rates
during this period were exorbitant. In some
sectors, for example, the tax rate was estimated
to be as high as 80 percent. As a result, the
French economy was stagnant, with output
and production well below capacity.36
Since the physiocrats were aware of the
adverse effects these tax rates were having on
the French economy, they insisted that tax
rates be lowered. Such a reduction, they contended, would increase importantly the economy's output and production. They maintained
that exorbitant tax rates would reduce the
income of the people and the revenue of the
sovereign.37 Moreover, the physiocrats indicated
that the increasingly higher tax rates which the
government had imposed to reduce the public
deficit more likely had the effect of increasing
it.38 On the other hand, the physiocrats contended that lower tax rates would increase tax
revenue.
The physiocrats, then, supported several elements of the supply-side view, recognizing the
importance of positive incentives to encourage
work effort and acknowledging the relationship
between tax rates and output as well as the
relationship between tax rates and tax revenues.
Benjamin Franklin, Thomas Jefferson, and
many later-day followers of Jefferson were
influenced importantly by these French writers.
Some scholars even contend that Franklin was
a "disciple" of the physiocrats. Jefferson often
mentioned the physiocrats in his letters. One
author contends that "if we would define
briefly Jefferson's role in the history of economic
thought in the U. S., we should say: Franklin
introduced physiocracy to this country, Jefferson
spread it...."39
Benjamin Franklin
By far the most important figure in the colonial
history of American economic thought was
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
Benjamin Franklin, frequently called "the first
American economist/'^Franklin was a friend of
many of the leading economists of his age.
During his sojourn to Europe, he met David
Hume and many of the French physiocrats.
Moreover, Franklin had met Adam Smith in 1759
and probably saw him later in London.41
Much of Franklin's economic thinking was
formulated well before his sojourn in Europe
and, consequently, before he met these influential economists. Nevertheless, his economic
thought is consistent with both that of these
economists and the supply-side views outlined
above.
Franklin's economic beliefs were based on
his opposition to mercantilist policies, especially
British mercantilist policies which he recognized
as adversely affecting the American colonies.
Long before he met the French physiocrats,
Franklin believed strongly in free trade and
opposed British government regulation of economic activity and interference with free trade
in the American colonies.42 This regulation and
interference, he believed, was adversely affecting
colonial economic growth.
Franklin attacked the prevalent mercantilist
low wage doctrine as "both cruel and ill-founded"
in that it hindered rather than aided industry.43
In his Reflections on the Augmentation
of
Wages, Franklin argued that high wages stimulated the incentives and motivation of workers
and hence served to increase the supply of
labor and thereby of output.44 He recognized
clearly the importance of positive incentives to
work effort:
"High wages attract the most skillful and industrious
workmen. Thus the article is better made, it sells
better, and in this way the employer makes a greater
profit then he would do by diminishing the pay of
the workmen. A good workman spoils fewer tools,
wastes less material, and works faster than one of
inferior skill; and thus the profits of the manufacturer
are increased still more." 45
In addition to recognizing how positive
incentives affect the supply of labor, Franklin
saw the incentive-stifling effects of taxes. He
indicated, for example, how tariffs and duties
prevent the wholesale exchange of products
between two countries and destroy honest
trade; he believed that tariffs work to lessen
commerce and industry in general.46 In short,
Franklin acknowledged a relationship between
tax rates and output. He argued that if taxes,
tariffs, and restrictions were removed, economic activity and industry would flourish. On
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the other hand, when government imposed
high taxes and various restrictions, economic
activity would languish.
In fact, Franklin presented the essentials of
an early version of the Laffer Curve. He stated,
for example, that although the intention of an
increase in the tariff imposed by Connecticut
was to increase the revenue of its treasury, the
result may have been to lessen its revenues as
trade decreased.47 Moreover, he indicated that
high taxes lead to tax avoidance activity, spelling
out how tariffs (which at that time constituted
the main source of revenues) lead to evasion
and smuggling.48
Franklin also opposed mercantilism because
of its stifling effects on economic growth. His
concern for growth is manifest in the title of his
influential pamphlet, The Way to Wealth. In
this pamphlet, Franklin espoused individual
industry, frugality, and enterprise, all vital ingredients for economic growth from a supply-side
perspective.
Franklin's work was quite influential. The
Way to Wealth was "printed and translated
oftener than anything else ever penned by an
American (during this period). It appeared in
more than 150 editions and was translated into
every European language."49
"In fact, [Benjamin] Franklin
presented the essentials of
an early version of the Laffer
Curve."
The American Revolution
With the British victory over the French in
1763 and the heavy burden that the war had
placed on the Treasury, the British decided to
raise taxes and enforce stringently their mercantilist policies after 1763. From 1763 to
1775, the British continuously attempted to
impose more taxes and enforce additional
restrictions and controls on the American
colonies.50
That certain of these taxes were excessive is
evidenced by the adverse revenue response to
the Stamp Act Initially expected to yield between
60,000 and 100,000 pounds, "the actual yield
for the six months the tax was in force was
4,000 pounds, which...proved insufficient to
pay the expenses attending the execution of
the Act." 51
Given the influence of the writers reviewed
above and the firmly established supply-side
beliefs existing by this time in the colonies, it is
no wonder that these increased tax and regulatory burdens induced a sharp American reaction.
Most authorities concur that the American
Revolution had economic origins.52 But it was
in terms of the above-cited pattern of ideas and
attitudes that the colonists responded to the
new British regulations and taxes.53 In brief, the
"Americans concluded that the English mercantilist policies... were detrimental to their economic welfare and growth.... British restrictions
and regulations came to be viewed as a threat
to future economic expansion and prosperity."54
Thus, the American Revolution was a revolt
against the British mercantilist polices of governmental regulation and high taxes—taxes imposed
in order to relieve heavy burdens on the British
Treasury but that stifled the colonies'
economic
growth.
That a revolution was the predictable outcome of excessive government intervention,
high taxes, and regulations is evidenced in the
prophetic statements made as early as 1 722 by
the English Whigs Trenchard and Gordon:
"The proper method of keeping the loyalty of the
colonists would be to encourage their growth and
prosperity through wise trade regulations designed
to increase their production.... Restraints or restrictions-would finally lead to the 'Independency" of
the Americas." 55
The Period 1781-1789
The Continued Endorsement of
Supply-Side Principles:
Adam Smith and
the Wealth of Nations
Supply-side principles continued to be endorsed during and after the American Revolution.
In this regard, American writers such as Pelatiah
Webster, Tench Coxe, and Albert Gallatin merit
mention. The year 1776, however, was notable
not only because of the Declaration of Independence but also because it marked the
publication of Adam Smith's Wealth of Nations,
perhaps one of the most important supply-side
50
in general after 1776.
In presenting his arguments, Adam Smith—
who was a Whig—restated and refined many of
the positions consistent with the supply-side
view, especially as presented by the physiocrats
and Hume. There is no doubt that these latter
writers influenced Smith's thinking.56 Smith's
view was fully supportive of the supply-side
position.
Thus, the intellectual linkage between the
American Revolution and the Wealth of Nations
is fairly simple—both were products of the
same intellectual origins and influences. Both
emerged in opposition to mercantilist policies
of high taxes and government intervention and
both had the objectives of promoting economic
growth and development and thereby making
a country's independence secure.
The Supply-Side Content of the Wealth of Nations
Part of the reason Smith was able to construct
such a supply-side view relates to his idea
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
i
regarding the nature of wealth. As suggested
above, mercantilist views were premised on
some misconceptions of wealth.57 Mercantilist^
concepts of the wealth of a nation, for example,
"tended to amount to the power of the national
government in general"58 as well as to its stock
of precious metals. According to Smith, though,
wealth was neither state power nor precious
metals but rather the supply of useful goods
and services being produced and made available
to the people in the marketplace.59
This concept of wealth is basic to the supplyside view and formed the basis of his primary
theme, namely, the nature and causes of wealth,
aggregate supply, and growth.
Since their concepts as to the nature of wealth
differed, it is not surprising that the prescriptions
offered by Smith and the mercantilists differed
as well. Unlike the mercantilists, Smith indicated
that increases in the quantity of money tended
to be neutral or to have no predictable long-run
effect on aggregate supply, output, or growth.
Hence, increases in the supply of money could
not produce wealth. To increase wealth, Smith
indicated that emphasis must be placed on facilitating production, aggregate supply, and growth
but not necessarily on the money supply of
aggregate demand.60
Smith's emphasis on aggregate supply rather
than demand was based on his belief that the
demand for most products was "indefinitely
extensible."61 Smith, for example, found no
limits to the expansion of consumption "in
civilized commercial societies.... Societal pressures made for the expansion and multiplication
of wants and self-interest prompted receivers
of money income to spend or invest it promptly."62
Smith, therefore, endorsed views which, although rudimentary at the time, later became
known as Say's Law when further developed by
J. B. Say and James Mill.
Smith always emphasized the importance of
positive incentives for both labor and capital.
Unlike the mercantilists, Smith indicated that
high wages would not reduce the incentive to
work. He contended that an increase in wages
would always induce an increase in the supply of
labor services.63 In addition to the supply of
labor, capital accumulation also played a major
role in the growth process envisioned by Smith.
In short, Smith emphasized aggregate supply
and growth and advocated the use of positive
incentives to stimulate the supply of factor
inputs such as capital and labor into the pro: FEDERAL RESERVE BANK O F A T L A N T A
duction process. In accordance with these
objectives, Smith supported various fiscal taxrelated policies or principles by which to enhance
the supply of both factor inputs and aggregate
output. In this regard, Smith made some important contributions to the principles of public
finance. In particular, Smith posited four maxims
of taxation, namely, equality, certainty, convenience of payment, and economy in collection.64 It should be noted that of the various
concerns of taxation emphasized by Smith,
little was said about distribution in the Wealth
of Nations.65 Distribution, then, was not nearly
as important a tax concern to Smith as was
economic growth.
Direct taxes on the wages of labor were
"absurd and destructive," according to Smith,
since they led to decreased employment as
well as to a "diminution of the annual produce
of the land and labour of the country."66 Moreover, taxes on capital and profits would have
disincentive effects on saving and investment,
might induce an out-migration of capital, and,
hence, would adversely affect growth.67
While emphasizing the disincentive effects
of taxation, Smith recognized the importance
of the provision of a limited set of essential
governmental services such as justice, defense,
police and fire protection. Smith always emphasized, however, that public expenditures should
be held to a necessary minimum.68
In addition to recognizing the relationship
between tax rates and output described above,
Smith also recognized clearly the relationship
between tax rates and tax revenues. In several
passages, for example, Smith indicated clearly
that tax rates and tax revenues were often
negatively rather than positively related. One
such statement could hardly have been more
explicit:
"High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes
by encouraging smuggling, frequently afford a smaller
revenue to government than what might be drawn
from more moderate taxes."69
Smith recognized the primacy of aggregate
supply for economic growth and always emphasized the importance of positive incentives to
enhance the supply of factors of production
and to promote economic growth. Indeed, the
growth process was the central policy concern
for Smith; his Wealth of Nations contained a
remarkably advanced theory of economic
development. 70 In addition, Smith recognized
the relationships between tax rates and output
51
as well as between tax rates and tax revenues.
Smith's supply-side view was important not
only in and of itself but because he was so
influential in America during the constitutional
era.
The Influence of Smith's
Wealth of Nations
in America
Adam Smith's Wealth of Nations had a powerful influence on those statesmen who mapped
out the structure of American government.
Grampp indicates that Smith's influence during
the constitutional period exceeded that of
Locke, Hume, the physiocrats and others.71
Grampp contends that Smith "was the most
important single influence on the men who wrote
and debated the Constitution and first put it into
practice."72
It is well known that a number of American
statesmen and leaders had a direct knowledge
of the Wealth of Nations. There can be no
doubt, for example, as to Benjamin Franklin's
knowledge of the Wealth of Nations; he once
was believed to have contributed to it73 Thomas
Jefferson, John Adams, James Monroe, and
James Wilson also were all familiar with the
Wealth of Nations.74
The influence of Smith on Alexander Hamilton
is especially apparent. Hamilton apparently
changed his views regarding economic policy
after reading Smith. Of course, he may have
changed his mind for other reasons, but his
policy prescriptions after becoming familiar
with the Wealth of Nations changed and became
quite similar to those of Smith. In his later and
more persuasive writings, for example, "Hamilton
disclaimed any wish to impose direct and
detailed controls over the economy;'' i.e., he
rejected mercantilist policies.75
Madison—"probably the most influential of
all the men who made the Constitution"—was
familiar with the Wealth of Nations at least as
early as 1785.76 He was essentially a free trader
and often explicitly supported "the theory of
'let us alone'."77 One of Madison's first speeches
in the House of Representatives related to
protecting commerce "was taken out of Smith's
Wealth of Nations."78
The available evidence, then, clearly indicates
that many of the principal statesmen who
designed the structure of American government
were familiar with and importantly influenced
by Adam Smith.
52
The Federalist Papers
and the Constitution
The influence of Locke, Montesquieu, the
English Whigs, Hume and especially Smith on
American thought is unmistakable in the major
post-Revolutionary written products of the
founding fathers—namely The Federalist Papers
and the Constitution. The Federalist has been
called the most important work in political
economy ever written in the U. S. It has always
commanded widespread respect as the first
and still most authoritative commentary on the
Constitution and is rightly counted among the
classics of political theory. The U.S. Constitution,
of course, is "one of the most important presentations of American economic thought."79
The authors of these documents clearly were
importantly influenced by the supply-side principles outlined by the various economists cited
above. The essential ideas set out in the Federalist Papers, for example, were close enough
to those supply-side views in the Wealth of
Nations" to make one think Hamilton and
Madison had Adam Smith in mind when they
wrote." 80
The influence of supply-side principles on
the Founding Fathers is particularly evident in
the realm of economic policy. Both the Federalists
and the architects of the Constitution were
above all concerned with economic
growth.
The primary objectives of the Federalists, for
example, were "to promote the economic development of the country, particularly to increase
the amount of industrial capital ....(and) to
make the country's independence secure."81
Similarly, a principle issue before the delegates
to the Constitutional Convention when they
met in Philadelphia was to maximize economic
growth while preserving individual liberty. They
believed that governmental control and regulation should be minimized since such interference would affect adversely the incentives
of suppliers of labor and capital and hence
constrain economic growth. Significantly, many
such common governmental powers of the day
as the power "to control prices, wages, interest
rates, the quality of goods, the conditions of
their sale, and the allocation of labor" were not
even considered by the Founding Fathers.82
That is, mercantilist policies of the day were
clearly rejected. The resulting Constitution was
a pro-growth, anti-government intervention
document, fully consistent with the essentials
of supply-side economics.
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
In addition to their predilection for economic
growth, the Founding Fathers understood the
essence of the relationship between tax rates
and output After the Revolution, these American
statesmen became familiar with the economic
problems of the existing confederation. Various
taxes between states taught them that such
taxes were destructive to commerce and should
be prohibited. They recognized that high taxes
were associated with a languishing economy
and low output
These American statesmen supported the
provision of a limited set of government services
viewed as consistent with a policy of laissezfaire and as essential for markets to properly
function. The limited powers recommended
by the Founding Fathers included the power to
tax, borrow, regulate commerce, pass uniform
bankruptcy laws, coin money, establish post
offices and post roads, and grant patents.83
Thus, the role of government they advocated
was almost identical to that endorsed by Adam
Smith in the Wealth of Nations.
Of course, the provision of these limited but
essential services implied that some taxes were
necessary in order to finance them. They realized
that when tax rates increase from low levels,
output initially increases because the efficiency
gains from these public goods outweigh the
disincentive effects of higher tax rates. Expanded
governmental services and further tax increases,
however, decrease output as the disincentive
effects of taxes outweigh any efficiency gains
from additional public goods.
The Founding Fathers' recognition of the
relationship between tax rates and tax revenues
is even more apparent Hamilton's contributions
to the Federalist Papers underscore this contention. Experience has shown, Hamilton notes,
that moderate taxes yield more aggregate revenue than high taxes.84 Hamilton notes that
high tax rates also induce tax avoidance activity
which also works to reduce tax revenues.
According to Hamilton, this was especially
relevant to the various states where, because
of the geographic proximity and social likeness,
taxes of one state on the commerce of another
would be evaded easily. Consequently, if such
This article is excerpted from a longer working paper,
"Supply-Side Economics and the Founding Fathers: The
Linkage," Working Paper Series, Federal Reserve Bank
of Atlanta, July 1982.
AA FEDERAL RESERVE B A N K O F A T L A N T A
taxes existed at all, they would have to be very
low in order to produce any revenue.85
Summary and Conclusions
American statesmen and the American public
were influenced importantly (either directly or
indirectly) by such writers as Locke, the English
Whigs, Montesquieu, Hume, and the Physiocrats.
These writers' views were fully consistent with
and indeed synonymous with supply-side
principles. Benjamin Franklin supported many
of these supply-side views. As a result of these
firmly held views in the American colonies and
the sudden imposition of additional British
taxes and regulations after 1763, the American
Revolution occurred.
In the post-Revolutionary period, American
thinking was further influenced by Adam Smith's
Wealth of Nations. Smith and the leaders of the
American Revolution had been influenced by
the same supply-side-oriented writers; they
had a common intellectual heritage that helps
to explain the immediate American acceptance
and endorsement of Smith's views. Nevertheless,
Smith's lucid articulation of these supply-side
principles had a powerful influence on American
statesmen who mapped out the structure of a
new government This influence is unmistakable
in the economic policy realm of the Federalist
Papers and the U.S. Constitution.
Supply-side economics, then, was the very
essence of the economic principles serving to
inspire the American Revolution and to guide
the architects of the U. S. Constitution. Supplyside economics represents a re-emergence of
the economic principles governing the founders
of the American experience.
It is, consequently, astonishing to observe
the opposition to and skepticism of supplyside economics not only by the American
leaders and statesmen but especially by economists in the U. S. This is particularly surprising in
view of the increases in both marginal tax rates
and government regulation in recent years.
These additional burdens are in many ways
identical to the government intervention imposed
by mercantilists that was resisted by our
American forefathers centuries earlier.86
—Robert E. Keleher
NOTES
'Gilbert Fite and J i m Reese, An E c o n o m i c History of t h e U.S., p. 98.
Sowell, "Adam Smith in Theory and Practice," A d a m S m i t h a n d
M o d e m Political E c o n o m y , p. 4.
3 W a g e s , for example, "were kept low through maximum wage laws, in order
to lower production costs and help domestic producers to undersell foreign
competitors in the world market. Prices were controlled to create a
consumption pattern suited to government's desires and beliefs." (Thomas
Sowell, ibid, p. 4.)
"Fite and Reese, op. cit., p. 72. ( S e e also p. 98.)
s Virgle Glenn Wilhite, Founders of A m e r i c a n E c o n o m i c T h o u g h t a n d
Policy, p. 66.
6 Fite and Reese, op. cit, p. 73.
'Robertson, op. cit, p. 85.
"Fite and Reese, ibid., p. 73. S e e also Ross Robertson, History of t h e
A m e r i c a n E c o n o m y (second edition) p. 84.
9 Fite and Reese, ibid, p. 73.
'"Wilhite, op. cit, p. 113.
" H a r v e y E Fisk, English Public F i n a n c e , 1920, p. 93. S e e also J u d e
Wanniski, H o w t h e World Works, pp. 181-182.
12 ln addition to new and higher taxes and increased regulation of commerce
and industry, these laws pertained to restrictive land policies as well as to
restrictions on the fur trade.
' 3 See, for example, William Grampp, E c o n o m i c Liberalism Volume 1, p. 130,
and Gerald P. O'Driscoll, Jr., A d a m Smith a n d M o d e r n Political Economy,
pp. X, XV, footnote. Grampp indicates that "Jefferson inserted in the
Declaration of Independence a paragraph very similar to one in Locke's
S e c o n d Treatise o n Civil G o v e r n m e n t " p. 130, and R. R. Palmer and J o e l
Colton, A History of t h e M o d e r n World (third edition), pp. 285-287.
(O'Driscoll, o p . cit, p. XV.)
" S e e , for example, J a m e s Ring Adams, "Supply-Side Roots of the Founding
Fathers," W a l l Street Journal, November 17,1981, and Karen I. Vaughn,
J o h n Locke, pp. 78-79, 121.
,5 Vaughn, ibid, p. 111.
'"Vaughn, ibid, p. 123.
"Vaughn, ibid, p. 134.
'""Many of the revolutionary leaders knew the work of Trenchard and Gordon
directly; others, like Thomas Paine, knew of it indirectly." (O'Driscoll, op- cit,
pp. XV, XI, and David L. Jacobson, T h e English Libertarian H e r i t a g e p. VII.)
' " J o h n Trenchard, "Arts and Sciences the Effects of Civil Liberty only, and
ever destroyed or oppressed by Tyranny," February 24, 1721, Cato's
Letters, Jacobson, op. cit, p. 172.
2 0 Jacobson, op. cit., p. XXXVI.
''Trenchard and Gordon, Cato's Letters, Jacobson, op. cit, pp. 173,181-2.
" J a c o b s o n , op. cit, p. XLVIII.
" G . H. Guttridge, English W h i g g i s m a n d t h e A m e r i c a n Revolution, p.142.
" M a n y of the important insights made byMontesquieu were "derived from
his study of the English constitution and English political system." (Paul M.
Spurlin, M o n t e s q u i e u in A m e r i c a 1760-1801, p. 23.)
" B a r o n De Montesquieu, T h e Spirit of Laws (translated by Nugent) p. 208.
26 Baron De Montesquieu, T h e Spirit of Laws (edited by D. W. Carrithers), p.
229.
"Montesquieu also perceived some elements of the relationship between
output and tax rates described above. H e noted that people often do not
object to initial increases in tax rates (in republics, for example) because the
citizens believes he is paying himself for the few public goods he receives in
return. That is the citizen sees a connection between the cost (taxes) and
benefits of government But as taxes increase, the citizens recognizes less
and less of such a connection. H e sees little, if any, connection between the
tax dollar and the benefits of government spending.
2 "Spurlin, op. cit, p. 258.
2 9 lbid, pp. 9-10, 23, 258-259.
«•David Hume, Writings o n E c o n o m i c s (edited by Eugene Rotwein), p. 85.
footnote (emphasis added).
3 ' S e e , for example, E A J . Johnson, Predecessors of A d a m S m i t h , pp. 175177.
" S e e Johnson op. cit, p. 175.
" L o u i s Gottschalk, Loren MacKinney, and Earl H. Pritchurd, History of
M a n k i n d Volume IV, p. 529.
34 Mark Blaug, E c o n o m i c Theory in Retrospect, p. 30 (parenthesis added).
3 S J . J . Spengler, "The Physiocrats and Say's Law of Markets," Essays in
E c o n o m i c Theory, edited by Spengler and W. R. Allen, p. 177-178.
36 Henry Higgs, T h e Physiocrats, p. 10. Higgs indicates that some estimates
of the tax rate on small proprietors were as high as 82 percent of net
produce. Moreover, E. J . West indicated that when Adam Smith was in
France in 1766, "his friend Turgot-.found that in his district the proportion of
net income of the peasant proprietors taken by the government was about
80 percent." (E.J. West "Adam Smith's Economics of Politics," A d a m S m i t h
a n d M o d e r n Political Economy, O'Driscoll, editor, p. 149.) Indirect tax
rates were so high, according to David Wells, that it was "not an infrequent
occurrence that prior to the Revolution of 1789, a duty was levied 27 times
on a barrel of wine in the course of its transportation from the place it was
grown to that where it is sold; so that it was said to be cheaper to send wine
from China to France than from one of the departments of France to Paris,"
David Ames Wells, Theory a n d Practice of Taxation, p. 76.
3 'Spengler, op. cit, p. 173.
" R o n a l d Meek, T h e E c o n o m i c s of Physiocracy, p. 25.
"Normano, op. cit, p. 50.
" F r a n k A Fetter, "The Early History of Political Economy in th e U.S.,"
E c o n o m i c T h o u g h t edited b y J a m e s Gherity, p. 475.
"Eliot, ibid, p. 70, 86. S e e also Nutter op. cit, p. 2.
42 Wilhite op. cit, p. 307. S e e also Lewis J. Carey, Franklin's E c o n o m i c
Views p. 162.
2 Thomas
43 W.
A Wetzel, "Benjamin Franklin as an Economist" J o h n s H o p k i n s
University Studies in Historical a n d Political Science, Thirteenth Series,
IX September 1895, pp. 23-24.
" W e t z e l , op. cit, p. 24.
"Franklin, quoted in Wetzel, op. cit, p. 24.
46 Benjamin Franklin, Essays on G e n e r a l Politics, C o m m e r c e a n d Political
E c o n o m y , p. 386. S e e also Carey, op. cit, p. 160.
"'Carey , op. cit, p. 200.
4 "Wetzel, op. cit, p. 41. S e e also Carey, op. cit, pp. 158, 199-200.
"Fetter, op. cit, p. 475.
" G e r a l d Gunderson, A N e w E c o n o m i c History of America, p. 87.
s ' S t e p h e n Dowell, History of Taxation a n d T a x e s in England, 4 volumes, p.
3:149, as quoted in J u d e Wanniski, T h e Way t h e World Works, p. 182.
" S e e , for example, Fite and Reese, op. cit, pp. 104,114; Robertson, op. cit,
pp. 87, 90, Wilhite, op. cit, pp. 3,114; and Fetter, op, cit, p. 475.
5 3 See Bernard Bailyn, T h e Ideological Origins of t h e A m e r i c a n Revolution,
p. 54.
64 Fite and Reese, op, cit, pp. 104,114 (parenthesis added). S e e also Fetter,
op, cit, p. 475.
5 5 Jacobson, op, cit, p. XLIX.
" I t is well documented that Smith was a close friend of Hume's and that he
thought well of the Physiocratic writings. It is known, for example, that
"Smith was intimately acquainted with Hume and his works," W. L Taylor,
Francis H u t c h e s o n a n d David H u m e As Predecessors of A d a m S m i t h ,
p. 131. Hume and Smith, it will be recalled, were often in correspondence
with one another, and, as indicated by Taylor, "mutually influenced each
other's thinking." (Taylor, op, cit, p. 35.) Indeed, Taylor contends that:
"There can be little doubt that Smith's close intimacy with
Hume...exercised a powerful influence on his economic philosophy.... Hume w a s both the perceptiveanticipatorof Adam Smith
and his acute critic, and Smith benefited greatly from almost
thirty years of close relationship with him." (Taylor, Ibid, p. 51.)
In addition, as indicated by Spengler, "Adam Smith thought well of the
physiocratic system.... Of this we have evidence n his characterizing it as 'the
nearest approximation to the truth...yet...published...upon political economy.'"
(J.J. Spengler, "The Physiocrats and Says's Law of Markets," op. cit, pp. 182183.)
" S e e , for example, Sowell, op cit, p. 5.
58 Sowell, ibid, p. 5.
59 Overton H. Taylor, A History of E c o n o m i c T h o u g h t pp. 91-92.
"Thus, "whereas mercantilism concentrated on the transfer of wealth...Smith
and classical economies in general concentrated on the production of
wealth." (Sowell, op, cit, p. 6.)
6 ' J . J . Spengler, "Adam Smith's Theory of Economic Growth - Part I,"
S o u t h e r n E c o n o m i c Journal, Volume XXV, No. 4, April 1959, p. 403.
6 2 J. J. Spengler, "Adam Smith's Theory of Economic Growth - Part II,"
S o u t h e r n E c o n o m i c Journal, Volume XXVI, No. 1, J u l y 1959, p. 10.
" B l a u g , op, cit, p. 48. S e e Adam Smith, A n Inquiry into t h e Nature a n d
C a u s e s of t h e W e a l t h of Nations, edited by Edwin Cannan, p. 92, for his
rejection of the notion that low wages stimulate work effort
" T h e Maxims set out by Smith were derived in part from earlier writings of the
physiocrats. See, for example, Higgs, op. cit, p. 41, and Meek, op, cit., p.
231.
" R i c h a r d Musgrave, for example, indicates that "on (the distribution-function
of the fiscal system) very little is to be found in the W e a l t h of Nations. .. The
distribution issue was-.largely omitted from Book V." (Musgrave, "Adam
Smith on Public Finance and Distribution," T h e Market a n d t h e State:
Essays in H o n o u r of A d a m S m i t h , edited by Thomas Wilson and Andrew
S. Skinner, p. 296.)
66 Smith, op, cit, ii, p. 394. S e e also Musgrave, op, cit, p. 307, and E Rotwein,
"Introduction," Hume op, cit, p. LXXXIII.
6? Smith, op, cit, ii, p. 376, and Musgrave, op. cit., p. 308.
" S m i t h , op. cit,Book V. S e e also Musgrave, op. cit, p. 296, and J . J . Spengler,
"Adam Smith's Theory of Economic Growth - Part I," op. cit, pp. 412,4I4415.
69 Smith, op. cit, ii, p. 414.
' ° L a w r e n c e J . Moss, "Power and Value Relationships in the W e a l t h of
Nations," A d a m S m i t h a n d M o d e r n Political E c o n o m y , p. 86.
' ' S e e , for example, Grampp, "Adam Smith and the American Revolutionists,"
History of Political Economy, 11:2,1979, p. 180; and Grampp, E c o n o m i c
Liberalism: Volume 1, p. 129.
' 2 Grampp, Liberalism, p. XII (emphasis added).
' 3 S e e , for example, Grampp, "Adam Smith and the American Revolutionists,"
p. 180. S e e also Wetzel, op. cit., and Carey, op. cit.
'"Spengler, "The Political Economy," p. 9.
"Grampp, Liberalism, pp. 135,145. Grampp emphasizes (p. 145) that taxrelated proposals—and the reasoning underlying them—were quite similar
to those endorsed by Smith.
" T h i s is indicated in a letter from Madison to Jefferson in April 1785. Nutter,
o p . cit., pp. 6,10. S e e also Spengler, "The Political Economy of Jefferson,
Madison, and Adams," p. 9.
"Grampp, Liberalism, p. 129.
'"Nutter, op. cit, p. 11 (quoted from Fisher Ames).
' 9 Normano, op, cit, p. 39.
""Grampp, Liberalism, p. 121.
" ' I b i d , p. 127. S e e also Nutter, op. cit., p. 6, (emDhasis added).
"Grampp, Liberalism, p. 109.
"Grampp, Liberalism, p. 108.
"Wilhite, op. cit, p. 253.
"Hamilton, "No. 12: Hamilton, " T h e Federalist Papers, p. 94.
" S e e , for example, O'Driscoll, op. cit, p. XIV.
C o m p l e t e b i b l i o g r a p h y available from I n f o r m a t i o n C e n t e r , F e d e r a l R e s e r v e B a n k of Atlanta, P.O. Box 1 7 3 1 , Atlanta, G a . 3 0 3 0 1 .
Asking the Right Question
»
)
>
Small Business and
the Information Future
Information
makes the difference
between
success and failure,
Knowledge
between a decision
and a guess,
between
wealth and
poverty.
is power.
Andrew Garvin
How to Win with Information or Lose without It
*
i
I
I
3
Information—the only inexhaustible resource—
has become as important to the entrepreneur as capital, labor and natural
resources, the
triumvirate historically viewed
as the chief ingredients of our economy. Just as a scarcity of any of those
three can sidetrack a
small business, an information deficit can
prove fatal to the businesses, which suffer an
awesome mortality rate within their first five
years. This article examines some of the
information-gathering problems facing small
businesses and suggests that a systematic
approach to information-gathering will be
increasingly vital to these businesses' survival.
Today's small business failure rates are
running close to the records set in the 1930s.1
Just how many of these failures are attributable to misinformation can only be surmised,
but observers are repeatedly pointing a finger
in that direction. Joe Lommer, who directs
Atlanta's Service Corps of Retired Executives,
flatly states: "A high percentage of new
businesses go out of business and the No. 1
reason, and it's a harsh word, is incompetence."2
He equates this incompetence with inadequate
knowledge about running a business. The case
also is stated emphatically by Gumpert and
Timmons, authors of The Insider's Guide to
Small Business Resources, when they claim
that, "an entrepreneur who doesn't know what
his or her options are is operating at a serious
competitive disadvantage."3 And a Small Business Administration (SBA) source agrees that,
" O n e of the greatest needs of managers of
small business is to have adequate, accurate,
and current information on which to base their
decisions."4
Despite the good sense of these warnings,
small business owners might still be inclined
to shrug off information as something of a
long-term luxury. For after all, doesn't their
2 Quoted
in Secrest, op. c i t p. 1.
D. Gumpert and Jeffrey A. Timmons, T h e Insider's G u i d e to S m a l l
Business Resources (Garden City, N.Y., 1982), p. viii.
"Small Business Administration, "Marketing Research Procedures," S B A
Bibliography No. 9 (April 1979), p. 2.
3 David
'Dun and Bradstreet data, cited in David K. Secrest, "Small Business No
Small Feat" Atlanta Journal, February 21, 1982, sect. D, p. 1.
Acquiring information quickly and accurately is essential for
small businesses, but the small business owner is generally
not an information specialist. Asking the right question is the
first step in an information-oriented approach to business
problems.
AA FEDERAL RESERVE BANK O F A T L A N T A
survival follow Mr. Micawber's law? "Annual
income twenty pounds, annual expenditure
nineteen nineteen six, result happiness. Annual
income twenty pounds, annual expenditure
twenty pounds ought and six, result misery." It
is in controlling income and expenditures that
leeway for decision-making is minimal, and
where information can make the largest contribution. As Gumpert and Timmons point out,
"It's one thing to make an incorrect decision,
but quite another to make an uninformed
decision. . . . Decisions made out of ignorance
can be disastrous, and are avoidable." 5
For a simple example, let's talk apples and
oranges. Imagine the restaurateur who budgets
for these at a price only slightly above what he
paid in September 1981. Depending on the
volumes of fruit his business requires, he may
have made a serious error. The informationconscious entrepreneur, rather than relying on
routine, might have consulted one of the
many fruit-price forecasts published since last
spring's untimely freeze. Armed with these
facts he can fend off unpleasant surprises on
the expenditure side, adjusting either his
budget or his menu to absorb the shock of
price changes.
Payroll is another inevitable expenditure that
bears heavily on small business survival, and
which further illustrates the advantages of
good information. Anyone who follows current
events can vaguely anticipate the general
course of wage trends. But the business
person who actively ferrets out information
on such wage-related topics as the health
insurance industry and Social Security legislation can zero in on those specific areas where
his business might need help.
Beyond planning a profitable response to
economic events, the informed entrepreneur
can have a hand in actually shaping them.
Over 85 percent of the members of Congress
who responded to a recent survey by Nation's
Business affirmed that small business had a
strong involvement in their campaigns and
that its voice was increasingly heard. They
offered this advice for using their clout to the
best advantage: "Small business can also be
more effective in seeking to influence congressional policy decisions, senators and representatives say, if their communications give
5 lbid
56
concrete information on how they are directly
affected by an issue."6 To do this, entrepreneurs
must monitor closely issues that may have an
impact on small business, and close monitoring
involves gaining access to information.
The Information Future
If acquiring good information gives the competitive edge to a small business today, it will
be essential for success in the near future. In
the last half of the 1970s alone the number of
components that can be fit on a silicon chip
increased by a factor of 100. More than likely,
this rate of progress will persist through the
1980s, "resulting in a 10,000-fold increase in
performance for the same cost."7 This unprecedented growth in information processing
and control is already ushering in what Alvin
Toffler has dubbed the "Third Wave" civilization,
one that engages predominantly in informationrelated activities, as opposed to the agricultural
and industrial activities of the first two waves.
Information access will be democratized—
not monopolized by Big Brother—in the envisioned Third W a v e civilization. Sociologist
Marie Haug shares this view of the information
future. As early as 1975 she wrote, " N o longer
need knowledge be packed only in the professional's head
It can be available not just
to those who know, but also to those who
know how to get it."8 Additionally, Toffler and
fellow futurists perceive distinct socio-economic
trends towards the customization of products
and services, the ascendance of regional
economies, and a scaling-down in the size of
businesses. Together, these trends point to a
uniquely productive and profitable future for
the information-conscious small businessperson.
What is it that transforms information from a
paralyzing burden to a vital business bonus?
Above all, it is the attitude of the information's
recipient. For example, the entrepreneur can
submit to being bombarded by indiscriminate
volleys of information in each day's mail, or he
can develop a system for rapidly scanning and
6 Michael
Thoryn, "Small Business Speaks, Government Listens," Nation's
Business, May 1982, pp. 38-42.
'Robert D. Hamrin, "The Information Economy: Exploiting an Infinite Resource"
T h e Futurist (Aug. 1981), p. 25.
"Marie R. Haug, "The Deprofessionalization of Everyone?" quoted in William
F. Birdsoil, "Librarianship, Professionalism, and Social Change," Library
Journal, Feb. 1, 1982, p. 225.
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
seizing on whatever information has productive
value for him. Similarly, he or she can passively
worry about his business "problems" or can
actively consider them to be "information
needs." To state a problem as a need for
information implies some confidence that the
need can be met and incites the business
owner to act. Just as a business problem can
ultimately detract from the entire enterprise, a
specific information need derives from the
larger context. To meet that need well is to
improve the business overall.
What is Your Real Question?
In How To Win with Information or Lose
without It, Andrew Garvin emphasizes that
you, the small business owner, should begin to
think of an information need as a whole series
of questions requiring answers.9 Garvin says the
importance of articulating these questions in a
painstaking, thoughtful manner cannot
be stressed enough.
Without the guidance of clear and
accurate questions, he says it
is unlikely that
you can recognize
the answers. To spend
time and money on
the crucial step of problem statement and question formation is to
save time and money on the entire project and
to ensure success. As an anonymous sage once
wrote, "A problem without a solution is usually
a problem which is put the wrong way."
Garvin outlines a preliminary question process
which begins by asking why you need the
information. You might, for instance, require
voluminous data on trends in magazine publishing to bolster a loan application, or you
might need a trade anecdote for a speech to
your local chamber of commerce. To incorporate
a statement of end use into your question
directly points the way towards an appropriate
array of sources and thus increases accuracy.
You eliminate such futile steps as seeking
•Andrew Garvin, H o w T o W i n with Information or Lose without It
(Washington, 1980).
AA FEDERAL RESERVE BANK O F A T L A N T A
current data in an encyclopedia or an anecdote
in an industry handbook.
For greater precision you next attempt to
narrow down your question. Do you, for
instance, really "want to know all about the
wide-screen television," or do you specifically
wish to know the state-of-the-art for color
tube development? To ask the more general
question will certainly muddy the waters,
possibly turning up sociological studies on
the importance of wide-screen television at
the corner tavern!
Having specified the overall question, you
might next break it down into component
parts that will direct your research into
discrete areas. Perhaps Atlanta's tavern market
for wide-screen television is indeed your
chief interest. In that case the sociological
study may be a welcome find, but you will
probably wish to venture into demographic,
market, and industry studies as well. What
are the characteristics of Atlanta's population?
W h o are your competitors in the field? What
are the cutting-edge developments in widescreen television technology? Taken together,
the answers to clusters of questions such as
these enable informed decision-making about
your market as opposed to costly assumption.
Additional preliminary questions arise when
you are relying on a librarian or other information
broker for professional research. For example,
at the start you should ask yourself the priority
value of your information need. To return to
our publishing example, hiring a researcher to
find a particular Life magazine anecdote which
you only dimly recall can mean a hefty expenditure of time and money. But if you clarify at
the outset that nearly any publishingrelated anecdote will suffice and that you are
not delivering the speech for another three
weeks, this can make a vast difference in the
way the professional carries out the search,
and hence in its cost. Likewise, to inform a
researcher that you already have consulted
several industry trade associations for data
on growth rates for magazine subscriptions,
and that you have found a per-capita expenditure figure for the Southeast eliminates
wasteful duplication of this portion of the
search. Furthermore, expressing what you
have already found helps you to define what
you really want to find (for example, per-capita
expenditure on sports magazine subscriptions
by state), which makes the search even more
direct and economical.
There is one more important factor in question formation. Regardless of whether you are
carrying out the research yourself, or hiring a
professional researcher, make sure you are
personally involved. Failing to participate personally in negotiation of the question risks
short-circuiting the entire problem-solving
process. An unsatisfactory answer is nearly
always guaranteed.
Finding the Source
And so, having framed preliminary questions
to approach your particular need, what next?
You can begin your information-gathering process
by identifying where among the major business categories your question falls: the
political, economic, social, and regulatory environment for doing business; the structure of your
own industry, as well as that of your supplier
and consumer networks; your competition; or
management issues. While each of these
categories may possess unique information
sources, abundant general sources exist that
can enable you to find answers to questions in
any of the categories.
By keeping handy a few essential resources,
like The Wall Street Journal, a good dictionary,
an atlas, and an almanac, you can easily
dispatch many of the quick factual questions
that threaten to interrupt your daily business.10
For more detailed research, a wealth of
resources abound and, with some sleuthing,
can be readily obtained from the major
information gathering and disseminating organizations: libraries and information centers;
federal, state, and local government agencies;
and trade and professional associations. Even if
you have access to an in-house reference
library or you plan to contract out your
research to an information broker, an understanding of what resources are available and
how to find them will assist you in planning
any research project.
As Andrew Garvin reminds us, "rather than
making any assumptions that might lead to
failure, make the assumption that the information needed for success is out there
somewhere and available at a reasonable
price. Then go look for it."11 The best place to
begin looking is the business section of the
local public library. You can discusss your
series of questions with the library's information
professionals to determine whether what you
need is already available in published form. In
addition to its catalog, indexes, and bibliographies, your library may have access to
computerized databases, which can yield literally millions of current references to publications
on every imaginable topic from sweep accounts
to shrimp farming. Even if your library does
not own a specific publication that you
need, a vast inter-library loan network can
deliver the information to you within days.
Probably the largest publisher of all kinds
of information is the U.S. government. Every
federal agency produces a vast array of
reports, studies, and
statistical publications; each agency
has its own cadre
of experts in almost all industries. Of particular interest to
the entrepreneur
should be the regularly publiched industry market studies and
reports available from the U.S. International
Trade Commission (USITC), the Department
of Commerce, and the Federal Trade Commission. The USITC's published report
contained statistcal data on production,
shipments, capacity, and imports which any
small businessperson in that industry would
value highly—free for the asking. Similar
market information can be obtained from
time to time from reports of the CIA, GAO,
Department of Justice, and from Senate and
House Committee hearings. The Securities
and Exchange Commission (SEC) maintains
files on all companies with publicly traded
stock; these filings are available to the public.
To help track down U. S. government
information, two sources in particular are
worth remembering: the American Statistics
Index helps you find government publications
on your subject; U. S. Federal Information
•°Lorna M. Daniells, of Harvard University's Baker Library, recommends "A
^ ï
n e s s p e 0 p l e
in B u s i n e s s
' " ' o r m a t i o n Sources
'Garvin, p. 21.
58
SEPTEMBER 1 9 8 2 , E C O N O M I C
REVIEW
"Knowledge of the general information resources available,
together with mastery of question formation, can take you a
long way towards solutions to present business
information problems."
Centers help find experts in a wide variety of
fields whom you can contact directly. Federal
Information Centers are scattered throughout
the U. S. in strategic cities, and so you can
most likely contact the center nearest you
with a local telephone call. And, of course,
the Small Business Administration is even
more accessible. It should always be considered as a principal resource, for the SBA's
job is to assist small firms in almost every way:
by providing counseling, educational publications, and seminars on small business management; by assisting with locating fair credit
terms; and by providing financial aid. Even
closer to home, state and local governments
furnish valuable information, particularly on
regional issues. Although the names vary, each
state has an agency for promoting commerce
and industry within the state. There are even
agencies devoted to one particular industry,
such as the Georgia Film Commission.
SEC reports and other common sources
abound for facts about publicly held
companies. The small business owner, however, is probably concerned with privately
held companies when tracking competitive
information. Each state's secretary of state's
office has annual reports, articles of incorporation, and other information on companies
incorporated there.
Industry, trade and professional associations
are excellent sources of information covering
every imaginable special interest group. Still
interested in publishing statistics? Try the
Magazine Publishers Association. Need information on the market for a new carbide
drill bit? Call the Cutting Tool Manufacturers
Association. Want some background on the
horseradish industry? The National Association
of Horseradish Packers should be able to
help. The Encyclopedia of Associations (Gale
Research) offers convenient access by key
word of the organization's name to over
AA FEDERAL RESERVE BANK O F
ATLANTA
1 5,000 groups, their membership, services,
and publications.
In addition to the association in your own
field, you may wish to investigate and join
one of the many associations dedicated to
small business concerns, such as the International Council for Small Business, the
American Federation of Small Business, or
the National Small Business Association.12
These groups can help you cope with small
business's special problems by offering lobbying assistance as well as information on
regulations, methods of handling operational
problems, and other issues. Of particular
importance, say Gumpert and Timmons, is
the fact that "small business organizations can
help relieve the sense of isolation many
entrepreneurs feel. Through their publications,
meetings, seminars, and other functions, they
bring small business owners into contact
with each other."13
Knowledge of the general information
resources available, together with mastery of
question formation, can take you a long way
towards solving present business information
problems. But the same process of controlled
questioning and answer-seeking—your information-gathering system—can have a significant
bearing on the future of a small business. The
skills it develops can strengthen planning and
budgeting skills as well. The challenge of the
information future is now upon us. Preparedness
for that future will position the small businessperson to seize its unique opportunities.
—Cynthia Walsh-Kloss
and Leigh Watson Healy
, 2 ln
addition to the associations listed in the Encyclopedia of Associations,
you may wish to contact some of the regional small business associations
listed in T h e Insider's G u i d e t o S m a l l Business Resources.
,3 Gumpert and Timmons, Insider's Guide, p. 344.
JUL
1982
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time
JUN
1982
JUL
1981
ANN.
%
CHG.
1,153,599 1,136,532 1,026,246
296,907
289,180
293,800
58,571
56,820
42,159
151,534
150,908 155,001
681,429 672,810 564,740
49,551
47,715
37,332
3,305
3,176
2,046
33,061
42,210
40,697
+
+
+
+
+
+
+
12
1
39
2
21
33
62
28
Savings & Loans
Total Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage Commitments
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savimrs <5t Time
124,578
34,789
7,614
14,881
71,134
4,633
329
3,874
123,302
34,138
7,376
14,848
70,329
4,502
321
3.804
109,687
33,449
5,330
15,151
58,531
3,442
230
2,974
+
+
+
+
+
+
+
14
4
43
2
22
35
43
30
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savines & Time
13,828
3,527
653
1,569
8,711
818
64
660
13,852
3,468
641
1,558
8,694
794
62
656
12,603
3,311
475
1,628
7,460
553
49
496
+
+
+
+
+
+
+
10
7
37
4
17
48
31
33
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savines & Time
40,816
12,318
3,332
6,276
20,036
2,133
186
1,654
40,388
12,070
3,219
6,282
19,791
2,061
177
1,617
36,308
12,227
2,331
6,435
16,073
1,588
129
1,231
+
+
+
+
+
+
+
12
1
43
2
25
34
44
34
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time
17,448
6,158
1,094
1,659
9,508
839
29
757
17,165
5,977
1,051
1,656
9,426
817
30
738
14,670
5,791
762
1,613
7,481
608
16
588
+
+
+
+
+
+
+
+
19
6
44
3
27
38
81
29
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savines & Time
22,597
6,102
1,041
2,473
13,595
124
10
115
22,301
6,073
1,015
2,466
13,313
122
13
114
19,705
5,804
722
2,478
11,120
83
5
77
+ 15
+ 5
+ 44
- 0
+ 22
+ 49
+100
+ 49
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time
10,324
2,354
563
747
6,899
N.A.
N.A.
N.A.
10,260
2,309
550
741
6,878
N.A.
N.A.
N.A.
9,148
2,257
395
767
5,919
N.A.
N.A.
N.A.
+ 13
+ 4
+ 43
- 3
+ 17
Savings & Loans
Total Deposits
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
Credit Union Deposits
Share D r a f t s
Savings & Time
19,564
4,331
932
2,157
12,385
719
40
688
19,336
4,242
899
2,145
12,227
708
39
679
17,253
4,059
645
2,230
10,478
610
31
582
Mortgages Outstanding
Mortgage Commitments
Mortgages Outstanding
Mortgage Commitments
Mortgages Outstanding
Mortgage Commitments
Mortgages Outstanding
Mortgage Commitments
Mortgages Outstanding
Mortgage Commitments
Mortgages Outstanding
Mortgage Commitments
+
+
+
+
+
+
+
13
7
44
3
18
18
29
18
Savings & Loans
Total Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage Commitments
ANN.
%
CHG.
JUL
1982
JUN
1982
JUL
1981
534,361
10,492
93,211
432,086
JUN
503,618
16,762
529,824
9,792
92,348
428,344
MAY
505,000
16,549
513,658
5,936
98,719
408,247
JUN
506,053
17,923
+ 4
+ 77
- 6
+ 6
78,686
1,700
11,666
65,539
JUN
69,933
3,142
78,295
1,582
11,639
65,099
MAY
74,256
3,242
75,039
912
12,304
61,062
JUN
73,831
3,753
+ 5
+ 86
- 5
+ 7
4,521
89
553
3,905
JUN
3,946
78
4,472
83
552
3,860
MAY
3,963
59
4,385
48
630
3,174
JUN
4,010
109
+ 3
+ 85
- 12
+ 23
47,524
1,171
7,768
38,660
JUN
41,364
2,519
47,551
1,087
7,773
38,598
MAY
45,525
2,650
45,533
645
8,165
36,479
JUN
44,924
3,133
+ 4
+ 82
- 5
+ 6
9,916
184
1,203
8,596
JUN
9,062
171
9,802
172
1,193
8,490
MAY
9,279
180
9,541
92
1,289
8,169
JUN
9,497
151
+ 4
+100
- 7
+ 5
7,858
109
1,236
6,535
JUN
7,293
242
7,733
105
1,221
6,420
MAY
7,260
267
7,121
53
1,240
5,840
JUN
7,001
238
+ 10
+106
- 0
+ 12
2,438
51
225
2,175
JUN
2,182
21
2,414
47
221
2,158
MAY
2,145
19
2,376
22
242
2,115
JUN
2,204
38
+ 3
+132
- 7
+ 3
6,428
95
681
5,667
JUN
6,086
111
6,323
89
679
5,572
MAY
6,084
67
6,083
52
738
5,285
JUN
6,195
84
+ 6
+ 83
- 8
+ 7
+
-
0
6
- 5
- 16
- 2
- 28
-
8
0
- 5
+ 13
+
+
4
2
- 1
- 45
- 2
+ 32
Notes:
All deposit data a r e e x t r a c t e d from the Federal Reserve Report of Transaction Accounts, other Deposits and Vault Cash (FR2900),
and are reported for the average of the week ending the 1st Wednesday of the month. This data, reported by institutions with
over $15 million in deposits as of December 31, 1979, represents 95% of deposits in the six s t a t e a r e a . The major d i f f e r e n c e s betw
this report and the "call report" a r e size, the t r e a t m e n t of interbank deposits, and the t r e a t m e n t of f l o a t . The data generated from
the Report of Transaction Accounts is for banks over $15 million in deposits as of December 31, 1979. The t o t a l deposit data genera
from the Report of Transaction Accounts eliminates interbank deposits by reporting the net of deposits "due to" and "due f r o m " other
depository institutions. The Report of Transaction Accounts s u b t r a c t s cash in process of collection f r o m demand deposits, while the
report does not. Savings and loan mortgage data a r e f r o m t h e F e d e r a l Home Loan Bank Board Selected Balance Sheet D a t a . The
Southeast data represent the t o t a l of the six s t a t e s . Subcategories were chosen on a selective basis and do not add t o t o t a l .
N.A. = fewer than four institutions reporting.
FRASER
Digitized for
http://fraser.stlouisfed.org/
60
Federal Reserve Bank of St. Louis
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
EMPLOYMENT
JUN
1982
MAY
1982
JUN
1981
ANN.
%
CHG.
JUN
1982
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
Civilian Labor Force - t l
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
Nonfarm E m ploym ent- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
2,663
2,467
196
7.6
N.A.
N.A.
39.2
263
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
1,804
1,647
157
7.8
N.A.
N.A.
41.4
351
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
1,894
1,676
218
10.6
N.A.
N.A.
40.4
379
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
1,059
1,076
968
107
10.6
N.A.
N.A.
38.8
248
1,066
civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. R a t e - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
2,101
1,866
2,085
1,864
2,067
1,888
Notes:
CHG.
92,056
20,445
4,350
20,671
16,168
18,711
5,353
5,199
3,726
466
284
972
Jonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
4,557
4,265
292
6.2
N.A.
N.A.
40.6
263
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. Avg. Wkly. Hours
Earn.
90,440
19,043
4,002
20,632
16,148
19,024
5,340
5,096
ANN.
%
JUN
1981
Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
1,714
1,485
229
13.9
N.A.
N.A.
39.3
284
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment R a t e - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. Avg. Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
90,741
19,074
4,102
20,721
16,055
19,124
5,402
5,112
MAY
1982
-
2
- 1
+ 2
- 1
+31
628
861
273
230
2,163
496
100
498
439
365
116
142
Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
Nonfarm Employment-Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. Util.
Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., Sc Real Est.
Trans. Com. & Pub. Util.
All labor f o r c e data a r e from Bureau of Labor S t a t i s t i c s reports supplied by s t a t e agencies.
Only the unemployment r a t e data a r e seasonally adjusted.
The Southeast data represent the t o t a l of the six s t a t e s .
The annual percent change calculation is based on the most recent data over prior year.
http://fraser.stlouisfed.org/
FEDERAL RESERVE BANK O F
Federal Reserve Bank of St. Louis
ATLANTA
61
CONSTRUCTION
JUN
1982
MAY
1982
JUN
1981
ANN
%
CHG
50,117
6,242
14,617
5,653
1,646
879
51,099
6,271
15,367
5,859
1,594
790
50,230
7,857
13,045
6,666
1,304
705
+
+
+
Nonresidential Building Permits Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
$ Mil.
6,605
817
1,420
1,059
293
92
6,683
810
1,447
1,089
286
90
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
$
401
82
41
70
32
8
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
ANN
JUN
1982
JUN
1981
MAY
1982
CHG
12-month Cumulative R a t e
0
21
12
15
26
25
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
7,069
859
1,333
1,007
169
96
- 7
- 5
+ 7
+ 5
+ 73
- 4
Residential Building P e r m i t s
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
400
79
41
68
32
7
432
50
65
72
16
13
- 7
+ 64
- 37
- 3
+100
- 38
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
! MU.
3,340
407
658
553
169
18
3,393
393
654
574
165
23
3,910
428
561
566
46
25
- 15
- 5
+ 17
- 2
+267
- 28
Residential Building P e r m i t s
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
! Mil.
1,056
177
256
119
27
35
1,054
177
260
122
24
32
1,142
197
330
104
20
30
-
8
10
- 22
+ 14
+ 35
+ 17
Nonresidential Building
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
Wil.
920
89
282
166
29
24
931
90
309
172
30
21
832
105
271
99
56
18
+ 11
ionresidential Building
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
189
23
44
40
6
1
180
22
43
38
6
1
179
13
35
49
5
1
+ 6
+ 77
+ 26
Ionresidential Building
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
699
39
139
111
30
6
725
49
140
115
29
6
574
66
71
117
26
9
+
+
+
-
Ionresidential Building
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
-
w
-
15
+ 4
+ 68
- 48
+ 33
-
Residential Building P e r m i t s
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
Residential Building P e r m i t s
Value - $ Mil.
Residential P e r m i t s - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
0
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
22
41
96
5
15
33
Residential Building P e r m i t s
Value - $ Mil.
Residential Permits - Thous.
Number single-family
Number multi-family
Total Building Permits
Value - $ Mil.
18
+ 15
34,819
35,175
49,790
- 30
466.8
381.1
473.1
380.9
733.8
498.9
- 36
- 24
84,936
86,275
100,020
- 15
6,648
6,770
10,270
- 35
94.9
85.7
96.9
85.6
159.7
128.7
- 41
- 33
13,257
13,451
17,348
- 24
241
241
415
- 42
4.1
5.1
4.1
5.0
8.6
7.3
- 52
- 30
642
641
847
- 24
4,272
4,445
6,969
- 39
51.7
55.3
54.4
56.5
94.7
90.4
- 45
- 39
7,613
7,838
10,878
- 30
1,055
1,016
1,303
- 19
20.7
9.9
20.0
9.2
27.5
10.8
- 25
- 8
2,112
2,070
2,444
- 14
555
553
719
- 23
9.2
7.6
9.1
7.6
12.2
9.3
- 25
- 18
1,476
1,483
1,551
144
141
254
- 43
2.9
1.9
2.9
1.8
4.9
4.0
- 41
- 53
334
320
433
- 23
381
374
610
- 38
6.3
5.9
6.4
5.5
11.8
6.9
- 47
- 14
1,080
1,099
1,195
- 10
-
5
NOTES:
Data supplied by the U. S. Bureau of the Census, Housing Units Authorized By Building Permits and Public Contracts, C-40.
Nonresidential data excludes the cost of construction for publicly owned buildings. The southeast data represent the total of
the six states. The annual percent change calculation is based on the most recent month over prior year. Publication of F. W.
Dodge construction c o n t r a c t s has been discontinued.
http://fraser.stlouisfed.org/
62 Bank of St. Louis
Federal Reserve
SEPTEMBER 1 9 8 2 , E C O N O M I C R E V I E W
GENERAL
JUL
1982
JUL
1981
2,493.1
87,887
N.A.
8,649.1
2,327.4
87,292
N.A.
8,626.7
+ 0
290.6
182.8
274.4
169.8
+ 6
+ 2
294.5
N.A.
4,463.9
1,387.0
271.3
N.A.
4,216.3
1,427.8
+ 9
+ 0
- 3
N.A.
27.8
N.A.
25.6
+ 1
33.0
N.A.
111.4
56.0
33.1
N.A.
106.2
55.0
31.2
N.A.
119.0
60.0
N.A.
3.5
N.A.
4.0
N.A.
3.7
107.3
67.2
2,251.3
77.0
MAY
96.9
63.9
1,826.2
101.0
JUL
51.7
N.A.
1,640.1
N.A.
APR
48.2
N.A.
1,784.6
N.A.
J UN
+ 7
42.5
N.A.
284.3
1,164.0
39.0
N.A.
293.5
1,171.5
+10
N.A.
4.2
N.A.
3.8
18.9
N.A.
32.7
93.0
18.9
N.A.
31.7
91.0
17.7
N.A.
35.8
95.3
N.A.
1.7
N.A.
1.8
N.A.
1.6
41.5
N.A.
163.3
N.A.
40.9
N.A.
150.3
N.A.
38.3
N.A.
157.2
N.A.
N.A.
5.5
N.A.
6.4
N.A.
5.9
Personal Income-» bu. SAAR
(Dates: 1Q, 4Q, 1Q)
2,518.6
R e t a i l Sales - $ mil.- SA
88,723
Plane Pass. Arrivals (thous.) MAY
N.A.
P e t r o l e u m P r o d , (thous. bis.)
8,701.0
Consumer P r i c e Index
1967=100
292.2
Kilowatt Hours - mils. (MAR)
173.9
Personal Income-$ b ü . SA/
(Dates: 1Q, 4Q, 1Q)
297.0
Taxable Sales - $ mil.
N.A.
Plane P a s s . Arrivals (thous.) MAY 4,240.8
P e t r o l e u m P r o d , (thous. bis.)
1,389.0
Consumer P r i c e Index
1967=100
N.A.
Kilowatt Hours - roils. (MAR)
25.9
Personal Income-$ bil. SAAI
(Dates: 1Q, 4Q, 1Q)
Taxable Sales - $ mil.
Plane Pass. Arrivals (thous.) MAY
P e t r o l e u m P r o d , (thous. bis.)
Consumer P r i c e Index
1967=100
Kilowatt Hours - mils. (MAR)
Personal Income-$ bil. SAAR
(Dates: 1Q, 4Q, 1Q)
108.7
Taxable Sales - $ mil.
66.8
Plane P a s s . Arrivals (thous.) MAY 2,114.9
P e t r o l e u m P r o d , (thous. bis.)
76.0
Consumer P r i c e Index - Miami
JUL
Nov. 1977 = 100
155.1
Kilowatt Hours - mils. (MAR)
6.7
Personal I n c o m e - ! bil. SAAR
(Dates: 1Q, 4Q, 1Q)
51.8
Taxable Sales - $ mil.
N.A.
Plane P a s s . Arrivals (thous.) MAY 1,548.8
P e t r o l e u m Prod, (thous. bis.)
N.A.
Consumer P r i c e Index - A t l a n t a
J UN
1967 = 100
291.1
Kilowatt Hours - mils. (MAR)
4.4
Persona
(Dates: 1Q, 4Q, 1Q)
43.0
Taxable Sales - $ mil.
N.A.
Plane Pass. Arrivals (thous.) MAY
269.7
P e t r o l e u m P r o d , (thous. bis.)
1,164.0
Consumer P r i c e Index
1967 = 100
N.A.
Kilowatt Hours - mils. (MAR)
4.1
Personal Income-$ bil. SAAR
(Dates: 1Q, 4Q, 1Q)
Taxable Sales - $ mil.
Plane P a s s . Arrivals (thous.) MAY
Petroleum P r o d , (thous. bis.)
Consumer P r i c e Index
1967 = 100
Kilowatt Hours - mils. (MAR)
Personal Income-$ bil. SAAR
(Dates: 1Q, 4Q, 1Q)
Taxable Sales - $ m ü .
Plane P a s s . Arrivals (thous.) MAY
P e t r o l e u m P r o d , (thous. bis.)
Consumer P r i c e Index
1967 = 100
Kilowatt Hours - mils. (MAR)
ANN.
%
CHG.
JUN
1982
+ 8
+ 2
+ 6
- 6
- 7
- 5
+12
+ 5
+16
-25
-14
- 8
- 1
+ 8
+ 7
- 9
- 3
+ 6
+ 4
- 7
JUL
1982
J U N (R)
1982
JUL
1981
ANN.
%
CHG.
Agriculture
P r i c e s R e c ' d by F a r m e r s
Index (1977=100)
137.0
Broiler P l a c e m e n t s (thous.)
82,704
Calf P r i c e s ($ per cwt.)
61.10
Broiler P r i c e s (* per lb.)
28.6
Soybean P r i c e s ($ per bu.)
6.05
Broiler F e e d C o s t ($ per ton)
217
137.0
84,455
61.90
28.6
6.12
215
142.0
81,103
62.00
30.1
7.13
233
- 4
+ 2
- 1
- 5
-15
- 7
Agriculture
P r i c e s R e c ' d by F a r m e r s
Index (1977=100)
128.0
Broiler P l a c e m e n t s (thous.)
32,847
Calf P r i c e s ($ per cwt.)
57.30
Broiler P r i c e s ( t per lb.)
27.7
Soybean P r i c e s ($ per bu.)
6.14
Broiler F e e d C o s t ($ p e r ton)
218
122.6
33,744
58.02
27.6
6.24
213
129.6
31,629
55.49
29.2
7.17
224
- 1
+ 4
+ 3
- 5
-14
- 3
Agriculture
Farm Cash R e c e i p t s - $ mil.
( D a t e s : A P R , APR)
572
Broiler P l a c e m e n t s (thous.)
10,368
Calf P r i c e s ($ per c w t . )
53.70
Broiler P r i c e s (<t per lb.)
26.5
6.14
Soybean P r i c e s ($ per bu.)
225
Broiler F e e d C o s t ($ p e r ton)
-
10,826
55.20
27.0
6.12
215
561
10,198
53.50
28.5
6.91
245
+ 2
+ 2
+ 0
- 7
-11
- 8
Agriculture
Farm Cash R e c e i p t s - $ mil.
1,907
(Dates: A P R , APR)
2,064
Broiler P l a c e m e n t s (thous.)
61.00
Calf P r i c e s ($ per c w t . )
27.0
Broiler P r i c e s (« p e r lb.)
Soybean P r i c e s ($ p e r bu.)
6.14
Broiler F e e d Cost ($ per ton)
225
1,887
62.50
28.0
6.12
225
1,839
1,771
59.70
29.0
6.91
240
+ 4
+17
+ 2
- 7
-11
- 6
Agriculture
Farm Cash R e c e i p t s - $ mil.
(Dates: A P R , APR)
801
Broiler P l a c e m e n t s (thous.)
12,863
Calf P r i c e s ($ per c w t . )
56.00
Broiler P r i c e s ($ per lb.)
27.0
Soybean P r i c e s ($ per bu.)
6.25
Broiler F e e d Cost ($ per ton)
215
13,065
56.50
27.0
6.12
205
803
12,365
52.20
29.0
7.03
210
- 0
+ 4
+ 7
- 7
-11
+ 2
Agriculture
Farm Cash R e c e i p t s - $ mil.
(Dates: A P R , APR)
420
Broiler P l a c e m e n t s (thous.)
N.A.
Calf P r i c e s ($ per cwt.)
59.50
Broiler P r i c e s (<t per lb.)
31.0
Soybean P r i c e s ($ per bu.)
6.22
Broiler F e e d C o s t ($ per ton)
250
N.A.
58.80
29.5
6.36
260
441
N.A.
57.90
31.0
7.44
250
+ 3
0
-16
0
Agriculture
Farm Cash R e c e i p t s - $ mil.
(Dates: A P R , APR)
605
Broiler P l a c e m e n t s (thous.)
6,247
Calf P r i c e s ($ per cwt.)
57.40
Broiler P r i c e s (<t per lb.)
30.5
Soybean P r i c e s ($ per bu.)
6.07
Broiler F e e d Cost ($ p e r ton)
205
6,566
59.60
29.0
6.29
210
559
6,031
56.30
30.5
7.13
210
+ 8
+ 4
+ 2
0
-15
-2
Agriculture
Farm Cash R e c e i p t s - $ mil.
(Dates: APR, APR)
486
Broiler P l a c e m e n t s (thous.)
1,305
Calf P r i c e s ($ per cwt.)
56.30
Broiler P r i c e s (4 per lb.)
28.0
Soybean P r i c e s ($ per bu.)
6.09
Broiler F e e d C o s t ($ per ton)
188
1,399
55.30
27.5
6.22
192
415
1,264
53.30
29.0
7.24
210
+17
+ 3
+ 6
- 3
-16
-10
-
-
-
-
-
- 5
Notes:
Personal I n c o m e d a t a supplied by U. S. D e p a r t m e n t of C o m m e r c e . T a x a b l e Sales a r e r e p o r t e d as a 12-month c u m u l a t i v e t o t a l . Plane
Passenger Arrivals are c o l l e c t e d f r o m 26 a i r p o r t s . P e t r o l e u m P r o d u c t i o n d a t a supplied by U. S. Bureau of Mines. C o n s u m e r P r i c e
Index d a t a supplied by_ Bureau of L a b o r S t a t i s t i c s . Agriculture d a t a supplied by U. S. D e p a r t m e n t of A g r i c u l t u r e . Farm Cash
R e c e i p t s d a t a a r e r e p o r t e d as c u m u l a t i v e f o r t h e c a l e n d a r year through t h e month shown. Broiler p l a c e m e n t s a r e an a v e r a g e weekly
r a t e . The S o u t h e a s t d a t a r e p r e s e n t t h e t o t a l of t h e six s t a t e s . N.A. = not available. The annual p e r c e n t change c a l c u l a t i o n is based
on most r e c e n t d a t a over prior y e a r .
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