Blog postings by CEPR staff and updates on the latest briefings and activities at the Center for Economic and Policy Research.

Trump and CEPR

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Dean, Mark, and CEPR Staff

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Rigged, by Dean Baker

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The Federal Reserve announced after their December meeting that “in view of realized and expected labor market conditions and inflation” it will raise interest rates to ¾ of a percentage point, anticipating further hikes throughout 2017.

The statement released by the Fed cited solid job gains and the decline in unemployment amongst their reasoning behind the interest hike. However, as this analysis of the last employment report from CEPR points out, the decline in unemployment was partly due to people leaving the labor force, rather than finding jobs. Furthermore, the employment-to-population ratio for prime-age workers is 2 percentage points lower than before the recession, and 4 percentage points lower than its peak in 2000.

The current labor market, while substantially recovered from the Great Recession, is still significantly weaker than in 2000 and even 2007. We can recall the pressure on the Fed to raise interest rates in 1996, based on fears of inflation. However, Alan Greenspan, then chair of the Fed, did not succumb to that pressure and held rates steady. The result was that between 1996 and 2000, over 11.6 million jobs were added without causing inflation to shoot up.

There is little evidence of any acceleration in the inflation rate regardless of which index is used.

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Since there are many more wage earners than people with substantial stock holdings in the division of corporate income between wages and profits, most people stand directly to gain from a smaller profit share. Nonetheless, there is an argument for a higher profit share (and a lower wage share) if companies will invest more when their profits rise. In that case, higher investment would lead to more growth, which would benefit workers as well, even if their share of income might be somewhat lower. However, as this post shows, the data do not backup up this argument.

Corporate profits before-tax are currently only one percentage point higher as a share of GDP than in 1970. However, after-tax profits are now about 2 percentage points higher compared to their 1970 levels.

merling investment figure1 2016 12
The figure above illustrates before- and after-tax corporate profits as a share of GDP since 1970.[1] Until the 1980s, the spread between before- and  after-tax profits was significantly larger, with a difference of about 3 percent of GDP. This difference has since decreased to about 2 percent of GDP, as corporate taxes have fallen sharply relative to GDP. After tax profits comprised 5 percent of GDP in 1970, and peaked at over 8 percent between 2012 and 2014 before declining in the past two years.

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The following reports on labor market policy were recently released:


The Center for Law and Social Policy

Juggling Time: Young Workers and Scheduling Practices in the Los Angeles County Service Sector
CLASP, UCLA Labor Center


Demos

The Parent Trap: The Economic Insecurity of Families with Young Children
Amy Traub, Robert Hiltonsmith, Tamara Draut

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A common story is that rapid automation is taking away jobs. If humans were being replaced by robots and machines, we would be seeing rapid productivity growth. Since automation generally replaces low-skill jobs, the impact on productivity growth would be significant.

However, if we look the average productivity growth in the past 10 years, the data show we are actually in a period of slow growth.
merling productivity growth 1 2016 12The figure above shows the average yearly productivity growth for 4 periods in the post Word War II era. Between 1948 and 1973, productivity growth averaged 3.3 percent a year. This was followed by a period of slow growth between 1974 and 1995, when growth averaged only 1.5 percent per year. Productivity increased at a rapid pace again from 1996 until 2005, when it picked up at an average rate of 3.1 percent per year. The current period, starting in 2006, records the lowest productivity growth since 1948, at an average rate of only 1.3 percent per year.

Given that productivity growth is at its lowest post-war level, the story that automation is a large threat looming over the job market is not supported by the data.

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As we do every December, we here at CEPR are reaching out to ask that you consider making an end of the year donation to support our work. Usually this entails regaling you with a list of all our accomplishments over the past year.

But this year we decided to do something different (which, given the extraordinary events of this past year, we felt was fitting). We want to talk candidly and honestly about the challenges we progressives face, and discuss where we need to go from here. 

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Federal Reserve interest rate policy is aimed at targeting inflation and unemployment. The impact of interest rates on consumer borrowing and spending is an important channel for this policy since the rates financial institutions charge consumers for loans depend on the Federal Reserve’s interest policy. If the Fed decides to raise interest rates, the cost of borrowing by households would also increase. This post shows trends in consumer debt from 1990 until now.

Over the past 25 years the dollar value of outstanding consumer credit increased dramatically, but the overall share of income consumer credit  has decreased. The current interest rate climate allows for a low debt service level.

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This is the last blog post in a three-part series on the Affordable Care Act’s potential effects on part-time employment. The first and second posts can be read here and here

The first blog post in this series looked at Obamacare’s effect on voluntary part-time employment, arguing that the law may have given workers the freedom to shift from full-time to part-time schedules. The second post said that when some workers cut back on their hours, it likely freed up opportunities for other workers. According to the post, this allowed part-time workers seeking full-time jobs to increase their hours. It may also have given unemployed workers seeking part-time jobs a better shot at being hired.

Instead of advancing a new argument about Obamacare’s effect on part-time work, this post simply examines the changes in different types of part-time employment over the past couple of years. Regardless of whether we believe that Obamacare is behind these positive changes, it’s clear that the forecasts made by the law’s critics simply haven’t come true.

It is worth noting that part-time employment is actually down slightly since before Obamacare went into effect. But more importantly, the experience of working part-time has itself improved dramatically. For instance, the share of part-time workers with health insurance increased nearly 6 percentage-points between 2013 and 2014. And after three years of completely stagnant wages, part-time workers saw significant wage growth beginning in 2014. If Obamacare is supposed to immiserate part-time workers, this misery isn’t showing up in the data; if anything, part-time workers’ wages and benefits both began rising right when the Affordable Care Act (ACA) went into effect.

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This is the second blog post in a three-part series on the Affordable Care Act’s potential effects on part-time employment. The first and third posts can be read here and here.

In 2013, critics of the Affordable Care Act (ACA) rolled out a new complaint about the law: it would lead to a dramatic increase in involuntary part-time employment. Maria BartiromoRobert Samuelson, and Fox News all argued that firms would move workers from full-time to part-time status due to the law’s “employer mandate”. And while most critics have since shifted to other arguments against the ACA, Fox News has continued pushing this particular line.

To be clear, there is anecdotal evidence that at least some firms really are cutting back on their workers’ hours. So there has undoubtedly been at least some increase in involuntary part-time employment as a result of the mandate.

However, the discussion surrounding the employer mandate paints a rather incomplete picture of the ACA’s effect on involuntary part-time work, for two reasons. First, the discussion often lacks empirical evidence about the potential size of the mandate’s impact. To the extent that economic analysts have looked into this particular issue, they have generally found that the mandate caused little to no increase in involuntary part-time work, with even the largest purported increases being completely invisible in the aggregate national data.[1]

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Jeff Hauser runs the Revolving Door Project, an effort to increase scrutiny on executive branch appointments and ensure that political appointees are focused on serving the public interest, rather than personal professional advancement.

As I’ve noted previously, Donald Trump’s relationship with billionaire hedge funder John Paulson seems likely to be very, very good for Paulson.  

Paulson, who came to fame making $4  billion personally by betting against the housing bubble, also seems about to win big on having bet against pre-election favorite Hillary Clinton.

Interestingly, it now seems clear that the relationship between Paulson and Trump is mutually profitable.

First, per the Wall Street Journal, “Hours after being announced as President-elect Donald Trump’s nominee for Treasury secretary on Wednesday, Steven Mnuchin sent shares of Fannie Mae and Freddie Mac way up after he said government control of the companies should end.”

Second, “One beneficiary of the rally: John Paulson, who has been a Trump donor and adviser, as well as a business partner of Mr. Mnuchin. His hedge-fund firm, Paulson & Co., is invested in the two mortgage firms’ [“Fannie” and “Freddie,” aka government-sponsored enterprises, “the GSEs”] preferred shares, according to a person familiar with Mr. Paulson’s firm.”

Third, “The president-elect himself may benefit if the firms’ stocks move. According to a financial disclosure form filed in May, Mr. Trump has invested between $3 million and $15 million in three funds run by Mr. Paulson."

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This is the first blog post in a three-part series on the Affordable Care Act’s potential effects on part-time employment. The second and third posts can be found here and here.

In 2013, shortly before the main provisions of the Affordable Care Act (ACA) went into effect, critics warned that the law might have dire effects on working hours. They said that the ACA would lead employers to shift workers from full-time to part-time positions, prompting a dramatic increase in involuntary part-time employment. CNBC host Maria Bartiromo argued that the law would make the U.S. “a part-time employment country”; Washington Post columnist Robert Samuelson and others stated that the U.S. would become “a nation of part-timers.” In contrast, there is an extensive literature on health insurance related “job lock.” (Gruber and Madrian review this literature.) According to this literature, there is reason to believe that many workers are employed full-time only because they need health care insurance. If they have the option to get insurance outside of employment, they may decide to take time off from a job to care for children or other family members, they may start their own business, or they may decide to work part-time. There is considerable evidence that many workers have chosen the option of voluntary part-time employment since the exchanges were put in place at the start of 2014.

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The following reports on labor market policy were recently released:

 

Center for American Progress

Making Paid Leave Work for Every Family
Moira Bowman, Laura E. Durso, Sharita Gruberg, Marcella Kocolatos, Kalpana Krishnamurthy, Jared Make, Ashe McGovern, and Katherine Gallagher Robbins


Institute for Women’s Policy Research


Undervalued and Underpaid in America: Women in Low-Wage, Female-Dominated Jobs
Ariane Hegewisch, Emma Williams-Baron, Barbara Gault


Urban Institute


Practical Considerations for Pay for Success Evaluations
Sarah Gillespie, Akiva Liberman, Janine M. Zweig, Devlin Hanson, Mary K. Cunningham, Mike Pergamit

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The unemployment rate fell to 4.6 percent in November, almost equal to the pre-recession lows in 2007. However the sharp decline was partly due to people leaving the labor force, the employment-to-population ratio was unchanged at 59.7 percent. It actually fell slightly for prime-age (ages 25-54) workers, from 78.2 percent to 78.1 percent, although it is still 0.7 percentage points above its year ago level.

Most other data in the household survey was positive, most notably a drop of 220,000 in the number of people involuntarily working part-time to a new post-recession low. At the same time, those choosing to work part-time jumped by 327,000. This is likely a dividend of the Affordable Care Act with workers now having the option to get insurance through the exchanges so that they don't need full-time jobs to get insurance through an employer. This number is now up by almost 2.2 million from December 2013, the month before the exchanges came into existence.

Job growth for the month was 178,000, roughly in line with expectations. The average hourly wage reportedly fell 3 cents in November after a sharp jump reported for October. This is likely due to measurement error, but it does undermine the case for accelerating wage growth. Wages have risen by 2.5 percent over the last year. When we factor in the shift from non-wage to wage compensation (mostly a reduction in health care benefits), this means there is essentially no evidence of wage acceleration whatsoever.

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As a prelude to CEPR’s upcoming Blue-Collar Jobs Tracker, this post provides an overview of manufacturing jobs in Illinois, Indiana, Michigan, Minnesota, Ohio, and Pennsylvania from 1990 until the present. In all these states the amount of manufacturing jobs has declined since 1990.

However, losses were more severe in some states than in others. Over a third of manufacturing jobs were lost in Pennsylvania, Michigan and Ohio. In Minnesota and Indiana the losses were somewhat lower, with a 7 percent and 14 percent decline, respectively.

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The following reports on labor market policy were recently released:

Center for Law and Social Policy

Improving Connections to Student Aid
Lauren Walizer

Urban Institute

Improving the Efficiency of Benefit Delivery
Julia B. Isaacs, Michael Katz, Ria Amin

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Jeff Hauser runs the Revolving Door Project, an effort to increase scrutiny on executive branch appointments and ensure that political appointees are focused on serving the public interest, rather than personal professional advancement.

There is belated but considerable press attention to Donald Trump’s nearly inextricable conflicts of interest: He and his family run a complex, far-flung, non-public company that largely relies on his name as a branding asset.

Entities without America’s public interest in mind, be they foreign or domestic companies, are already beginning to cultivate the Trump family. Ivanka Trump, groomed to run the family business in something that will be a blind trust only in the most Orwellian sense imaginable, is being included in meetings with international leaders potentially useful to “The Trump Organization.”

And Trump has encouraged them, telling the New York Times, "The law's totally on my side, the president can't have a conflict of interest."

It’s…not good.

But lest one be wholly distracted by familial self-dealing and assessing the various problems posed by the role of son-in-law Jared Kushner

Or wound up about former Speaker of the House Newt Gingrich planning to be a “sort of be a senior planner” in the Trump administration while serving as “a senior adviser at Dentons, the law and lobbying giant.”

There’s more. Two giants of the shadow banking field are exerting enormous influence and potentially making billions by virtue of their close ties to Electoral College winner Donald Trump. Trump appears poised to make Crony Capitalism Great (in scale) Again.

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In 2007, before the Great Recession, the unemployment rate was 4.6 percent. The employment rate ― the percentage of all Americans age 16 and older who had a job ― was 63.0 percent. By 2010, the unemployment rate had risen to 9.6 percent, and the employment rate had dropped to 58.5 percent. Since then, a weird thing has happened. Although unemployment has fallen back to 4.9 percent ― just 0.3 percentage points above the 2007 average ― the employment rate has remained stubbornly low.

Looking at the data more closely, it is clear what is driving these seemingly incompatible trends: people are dropping out of the labor force. In order to be counted as unemployed, a prospective worker must have “actively looked for work in the prior 4 weeks.” This means that if someone has been searching for work for a long period of time, but has become dissatisfied with their job prospects and hasn’t applied for any jobs over the past month, he or she is no longer counted as “unemployed.” Instead, that person will be counted as “not in the labor force,” a classification that covers people who are neither employed nor unemployed. The share of the population not in the labor force has risen from about 34 percent in 2007 to over 37 percent today.

If the long-term unemployed drop out of the labor force due to discouragement over their job prospects, employment is a more useful measure than unemployment. However, the overall employment rate doesn’t adjust for the changing age distribution of the population; with more Americans hitting retirement age, we expect employment to fall not because workers have relatively few job opportunities, but simply because people in their sixties, seventies, and eighties prefer retirement to work.

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In the summer of 1996, the Los Angeles Times was warning its readers about “the shadow of rising inflation” [1] looming over U.S. financial markets “like the mammoth alien spacecrafts of Independence Day,” the blockbuster movie of the time. The article suggested the danger of inflation was imminent and concluded that “for the shell-shocked bond market, there will be an assumption that either the Fed is going to tighten credit, or inflation is going to continue to rise, or both.”

The general consensus in 1996 was that the economy was at, or very close to full employment. Unemployment was at its lowest level in years, which was about 5.4 percent. In their outlook for 1996–2000, the Congressional Budget Office (CBO) estimated the non-accelerating inflation rate of unemployment (NAIRU) was 6 percent. The CBO also warned that “if rapid growth continues, inflationary pressures will mount.”

Martin Feldstein, then President of the National Bureau of Economic Research, expressed his concern with unemployment being too low as early as March 1995. Feldstein stated that while “people have argued that we can tolerate much lower interest rates than in past U.S. historical experience,” he did not “think that’s true.” Feldstein declared the unemployment rate of 5.4 percent as being “well below the unemployment rate that even the Congressional Budget Office (CBO) would call full employment” and urged the Fed to severely tighten monetary policy. Feldstein estimated NAIRU at 6.23 percent and concluded that the possibility of being wrong was “quite low.”

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Jeff Hauser runs the Revolving Door Project, an effort to increase scrutiny on executive branch appointments and ensure that political appointees are focused on serving the public interest, rather than personal professional advancement.

As we hear of a settlement in the “Trump University” civil fraud case brought in part by New York State Attorney General and learn more and more about potential Treasury Secretary Steven Mnuchin, the phrase “personnel is policy” takes on an unfortunate new meaning.

Will Trump’s appointees to high government office ensure Donald Trump does not use control of the executive branch to enrich himself and his family?

Trump enriching himself as president is not an idle or libelous question. Trump himself raised the prospect in 2000 to Fortune Magazine, telling them that “[i]t’s very possible that I could be the first presidential candidate to run and make money on it.”

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A common argument for the decline in employment in recent years is that more workers are dropping out of the labor force to live off public benefits, particularly Social Security Disability Insurance (SSDI). SSDI is a program that provides cash benefits and healthcare to former workers who become too disabled to continue at their jobs. The average benefit payment is about $15,000 per year, and workers must have an extensive work history in order to qualify.

While the percentage of the workforce receiving disability benefits has increased since 2000, much of this rise is simply due to demographics, most importantly the aging of the population.[1] Figure 1 shows the unadjusted SSDI beneficiary rate and a second rate that has been adjusted for the age and gender composition of the labor force. [2,3]

Figure 1

buffie 2016 11 16 1

SSDI is actually one of two major programs benefiting disabled workers. The other is Workers’ Compensation (WC), a privately-run insurance system for workers who get injured at their jobs and are unable to continue working. While there are some differences between WC and SSDI, the two programs are broadly similar. Moreover, previous CEPR research indicates that they function as substitutes: when enrollment goes up for WC, it goes down for SSDI, and vice versa.

Over the past twenty years, many states have made significant cuts to their WC programs. Benefits have declined, as have the number of injuries covered by WC. Not surprisingly, these cuts have coincided with a decline in the number of WC beneficiaries and a proportionate increase in the number of SSDI beneficiaries.[4]

If the number of beneficiaries in these two programs is combined, there is almost no change from 2000 to 2011 in the percentage of the workforce getting benefits. (Our data on WC recipients only go through 2011.) Furthermore, if we include the impact of changing demographics on the number of SSDI beneficiaries, the share of the workforce receiving benefits has actually declined, as shown in Figure 2.[5,6] (Note that the age- and sex-adjustment only applies to the number of workers receiving SSDI, as the data on WC beneficiaries do not include demographic breakdowns.)

Figure 2

buffie 2016 11 16 2

In short, there has been no increase in the share of the SSDI-eligible population living off some form of disability benefits over this period. Moreover, there has actually been a drop if we take into account the impact of changing demographics.

Finally, it is worth mapping the trend depicted in Figure 2 onto more recent years. Unfortunately, as stated earlier, our data on the number of WC recipients only go through 2011. Figure 3-1 shows the number of WC and SSDI beneficiaries as a share of the SSDI-eligible population from 2000 to 2015; for the years 2012 through 2015, it is assumed that either the number of workers receiving WC benefits (the dashed line) or the percentage of workers receiving WC benefits (the dotted line) hasn’t changed since 2011. If one of these assumptions is true, then the share of the workforce receiving some form of disability benefits would’ve fallen between 0.14 and 0.31 percentage-points between 2000 and 2015.[7]

Figure 3-1

buffie 2016 11 16 3

But the assumption made in Figure 3-1 is likely too generous; after all, the number of WC beneficiaries fell every single year between 2000 and 2011. Figure 3-2 shows the number of WC and SSDI beneficiaries as a percentage of the SSDI-eligible population under the assumption that the number (the dashed line) or share (the dotted line) of WC recipients continued falling at the same rate from 2011-2015 as during the previous 11 years. Using this set of assumptions, the share of the workforce receiving either WC or SSDI would’ve fallen 0.93 to 1.01 percentage-points.

Figure 3-2

buffie 2016 11 16 4

The number of workers receiving disability benefits has fallen over the past 15 years, though we can’t say by how much. The decrease may be comparable to a rounding error (0.14 percentage-points), or it may be rather large (1.01 percentage-points). But even if we don’t know the size of the decrease, we can be certain that at least some decrease has occurred – and this should put a real dent in the “SSDI recipients as takers” argument. Prominent conservative pundits have argued that the drop in employment since 2000 is driven in large part by the fact that more Americans are choosing to take disability benefits rather than work. Those who use this argument are engaging in serious cherry-picking: they are highlighting the program with rising enrollment (SSDI) while ignoring the program with declining enrollment (WC). When both programs are examined together, there is no apparent increase in the number of Americans receiving benefits.


[1] Another source of rising SSDI enrollment is the increase in Social Security’s “full retirement age”. When SSDI beneficiaries hit full retirement age, they stop receiving SSDI benefits and start receiving normal Social Security retirement benefits. This means that the one-year increase (from 65 to 66) in Social Security’s full retirement age has kept many disabled workers on SSDI for an extra year. Between 2000 and 2014, the number of 65-year-old SSDI beneficiaries went from zero to 467,000; this accounts for 11.9 percent of the increase in SSDI beneficiaries during this time.

[2] An extensive work history is required in order to become eligible for SSDI benefits. For a full description, see pg. 20-21 of this CEPR report, “Benefits Planner: Social Security Credits” at the Social Security Administration (SSA) website, and this SSA pamphlet. The SSDI beneficiary rate is calculated by dividing the number of SSDI recipients by the number of people eligible for benefits.

[3] The demographic adjustment is based on data presented in Table V.C5 on page 141 of the 2016 Social Security Trustees’ Report.

[4] To determine the number of WC beneficiaries, data are drawn from two sources: the Annual Statistical Bulletin published by the National Council on Compensation Insurance (NCCI), and various annual reports on WC published by the National Academy of Social Insurance (NASI). NCCI’s Annual Statistical Bulletin provides data, by state, on the number of WC beneficiaries per 100,000 covered workers. By combining NCCI’s data with NASI’s data on the number of covered workers, we are able to determine the number of WC beneficiaries in each state in any given year. However, because NCCI’s data do not cover North Dakota, Ohio, Washington (state), West Virginia, and Wyoming, it is assumed that the take-up rate among covered workers in those states is the same as the average take-up rate for workers in the other 45 states and DC.

[5] The number of workers taking some form of disability benefits is less than the sum of “WC beneficiaries plus SSDI beneficiaries”. This is because a small number of people – between 361,000 and 401,000 per year between 2000 and 2011 – actually receive benefits from both programs. In order to not double-count people benefiting from both WC and SSDI, the number of people receiving some form of benefits is calculated as follows: (WC Beneficiaries) + (SSDI Beneficiaries) – (Dual Beneficiaries) = (Total Number of Beneficiaries).

[6] Data on the number of dual beneficiaries for the years 2000-2002 are drawn from the 2001, 2002, and 2003 NASI reports on WC coverage. Unfortunately, beginning with NASI’s 2004 paper, the reported number of dual beneficiaries includes people utilizing a third (relatively minor) disability program known as “public disability benefits”. Therefore, post-2002 data come from the Social Security Administration’s Annual Statistical Reports on the Social Security Disability Insurance Program. The number of dual beneficiaries is drawn from Table 31. Because Table 31 includes SSDI dual beneficiaries whose second disability program can be either WC or public disability benefits, the number of WC-SSDI dual beneficiaries is calculated as follows:

All workers receiving both WC and SSDI (lines 7-12) are included;

All workers receiving both SSDI and public disability benefits (lines 13-16) are excluded;

All workers receiving WC, SSDI, and public disability benefits (lines 17-20) are included;

For workers listed in lines 21-23, it is assumed that the same percentage of these workers receive both SSDI and WC as was divined from lines 7-20;

All workers with pending WC or public disability benefit applications (line 24) are excluded, since they are not receiving benefits at the time.

This formula gives us a close approximation for the number of WC-SSDI dual beneficiaries for each year from 2005 to 2011. However, because estimates are not available for 2003-2004, there is a gap in the data on dual beneficiaries for those two years. The number of dual beneficiaries for both 2003 and 2004 was determined by a process of linear interpolation linking the 2002 NASI data with the 2005 Social Security Administration data.

[7] For the year 2012, the number of dual beneficiaries is calculated according to the methodology outlined in footnote number six.  However, beginning in 2013, the Social Security Administration changed how it presents data on the number of dual beneficiaries. For the years 2013-2015, the number of dual beneficiaries (as determined from Table 31) has been calculated as follows:

All workers receiving both WC and SSDI (lines 9-12) are included;

All workers receiving both SSDI and public disability benefits (lines 14-16) are excluded;

All workers receiving WC, SSDI, and public disability benefits (lines 17) are included;

For workers listed in lines 18 and 20, it is assumed that the same percentage of these workers receive both SSDI and WC as was divined from lines 9-17;

All workers with pending WC or public disability benefit applications (line 21) are excluded, since they are not receiving benefits at the time.

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Private equity’s popularity among pension plans — still the largest source of investments in private equity funds — owes much to the fabled returns the industry earned in its glory days. Private equity (PE) firms claim that investing in their funds is the path to high returns and a secure retirement for pension plan beneficiaries. Returns over the last 10 years, however, have been disappointing. Research by leading finance economists demonstrates that the median private equity fund launched since 2006 has failed to beat the stock market. PE investors could have done as well investing in a stock market index fund without having to tie their money up for 10 years and without the lack of liquidity, lack of transparency and high fees of private equity.  

How does private equity manage to pull the wool over the eyes of supposedly sophisticated limited partner investors in PE funds — not just pension plans but insurance companies and university and foundation endowments? One part of the answer is that the private equity industry employs a flawed yardstick — the internal rate of return or IRR — to measure its performance. While this measure has been discredited by leading finance professors and discarded by them in favor of a truer measure of performance [1], the IRR has the virtue from the industry’s point of view that it exaggerates returns. This, however, is not its only virtue.

As PE firms have long known, the IRR is a mathematical algorithm that is easy to manipulate. For example, a PE fund that requires its highly indebted portfolio companies to sell junk bonds and take on even more debt in order to pay a dividend to investors in the fund in the first few years of the fund’s life will be rewarded with a boost to its IRR that bears little relation to what investors will ultimately receive. And that’s not the only trick PE firms use. Selling a profitable portfolio company early in the fund’s life will also goose returns as measured by the IRR even if holding onto the company and selling it later at a higher price would have increased the actual returns investors receive. But in the current low PE performance environment, these tricks may no longer raise the IRR sufficiently to make risky investments in PE look attractive.

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