Economics, Public Policy, and Whatever Else Interests Me
Commentary based on this recent post aired this evening on NPR's marketplace. The teaser:
The proposal for the $150 billion stimulus package has Washington basking in bipartisanship. But commentator Andrew Samwick says the pricetag for all that collegiality might be too high.
Enjoy!
Tom Toles "says" it very well.
I enjoyed Len Burman's op-ed in today's New York Times for reaching this conclusion, in "Make the Tax Cuts Work:"
There’s bipartisan agreement that something along these lines should be done, but the president has also argued for an extension of his tax cuts, now scheduled to expire at the end of 2010. This idea has met with less support. It would accomplish nothing in the short run, and most of the benefits would go to the very rich — the group least likely to spend a tax windfall.
But if they were repealed in a year, the Bush tax cuts could spur a burst of economic activity in 2008. If people knew that their tax rates were going up next year, they’d work to make sure that more of their income is taxed at this year’s lower rates. Investors would likewise have a giant incentive to cash out their capital gains now to avoid paying higher taxes later. In 1986, stock sales doubled as taxpayers rushed to avoid the capital gains tax rate increase scheduled for 1987. If people pour their stock gains into yachts and fast cars, that’s pure fiscal stimulus.
The money involved could be considerable. Capital gains in 2007 were something like $700 billion, representing well over $1 trillion in asset sales. It looks as if gains will be much lower in 2008, but a looming tax increase could easily spur an additional $500 billion in sales. If only 20 percent of that translated into extra spending, we’d have as much or more short-term stimulus as we could get from the package Congress and the president are considering.
Best of all, this is one stimulus proposal that would reduce the deficit — the single largest threat to the economy’s long-term health. And that long-term benefit wouldn’t depend on our getting the timing and amount of stimulus right, something policymakers are notoriously inept at.
UPDATE: Len responds to some of his fan mail at the TaxVox blog.
All of the recent discussion of fiscal stimulus is very disappointing to an economist and deficit hawk like me. I'll ask two questions in this post and highlight them in bold.
Over the past few years, cheap credit and imprudent lending policies by some bad actors generated excessive consumption and investment in the real estate sector. This boosted economic activity beyond the level that would have prevailed with policies that we now wish, with hindsight, had been in place. That level of economic activity is the starting point for discussion of a recession, defined as two consecutive quarters of negative growth in real GDP. If we acknowledge that bad loans fueled the activity, why is it now a widely shared policy objective to maintain that level of activity?
The buzzwords for the stimulus discussion are that whatever the government does, it should be "timely, targeted, and temporary." Much of the discussion centers on a tax rebate, which would primarily boost consumption. Treasury Secretary Paulson is quoted as follows:
Asked if tax rebates to individuals - reportedly one of the cornerstones to the stimulus plan - is an effective course, Paulson said, “the evidence from [the] 2001 [rebate] was that people spent between a third and two-thirds of the money and spent it quickly, so the lesson here is we need to move quickly and do something in enough size.”
Forget the "stimulus" label, this is merely additional deficit spending. There is no discussion of repaying the money through higher taxes in the near term. Based on the President's remarks this morning, the deficit bill will be for about $150 billion. So this proposal is just another $150 billion of some future generations' resources that we will be using for our own consumption today. Why are we entitled to pass them this additional debt?
My views of how the government should conduct fiscal policy are presented here. We should expect some cyclical widening of the deficit with no change in policy. But if we have no intention of balancing the budget over the business cycle (i.e., of running an additional $150 billion surplus when the economy turns around), then we have no business pushing this deficit bill forward now.
UPDATE: Bruce Bartlett provides some background on tax rebates at the WSJ online and concludes:
A new rebate probably won't do much harm. But anyone who thinks it will prevent a recession -- if one is actually in the pipeline, which is not at all certain -- is dreaming. It's an insult to Keynes even to call a tax rebate Keynesian economics. It should be called "feel good economics" because its only real effect is to make politicians feel good about themselves and buy re-election with the public purse.
PGL at Angry Bear, reacting to the previous post, asks why stop with criticizing Governor Romney for his pandering? It's a reasonable question, but it has the standard economic answer--diminishing marginal returns to blogging about other people's mistakes.
Thinking a bit more about it, candidates deserve less slack when they make statements that are at odds with the personas they project in the campaign. Governor Romney campaigns specifically on his experience in the private sector and its contribution to economic growth. When he panders based on moving government resources to the aid of one particular constituency, that should be identified for what it is.
PGL then takes Governor Huckabee to task for, in the context of a question about lagging economic growth, advocating energy independence without acknowledging that any path to energy independence (e.g., a carbon tax) will reduce economic well-being in the near term. PGL is absolutely right. It's another answer that doesn't add up. But lots of people say silly things about energy independence, and this one didn't grab my attention.
McCain's answer to the question was better (some reasonably straight talk about the jobs not coming back and the need for retraining opportunities). Giuliani's was awful. Thompson's answer defended Giuliani's awful answer. Ron Paul's was probably the best. Read the whole transcript here--this is the first question to each candidate. What I liked about Paul's answer was that, in the course of his rambling answer, he said:
The recession has been predictable. We just don't know exactly when it will come.
If you do the wrong thing, it's going to last for a long time. The boom period comes when they just pour out easy credit and it teaches people to do the wrong things. There's a lot of malinvestment, debt that goes in the wrong direction, consumers who do the wrong things, and businessmen who do the wrong thing.
So we have to attack this and understand the importance of Austrian theory of the business cycle. If you don't, we're going to continue to do this and the longer you delay the recession, the worse the recession is, and we've delayed a serious recession for a long time.
The housing market's already in depression and a lot of people are hurt and the standing of living in this country is going down. Look at what's happening to the dollar.
And what is being offered by the Federal Reserve and Treasury and everybody in Washington? Lower interest rates. Well, lower interest rates is the problem. Artificially low interest rates is the artificial stimulus which causes the bubble, which allows the inevitable recession to come.
So what we need to do is deal with monetary policy and not pretend that artificial stimulus by more spending is going to help. That won't do you one bit of good.
It isn't perfect, but it's pretty good. To be clear, more government spending will mechanically prop up the rate of GDP growth. As PGL notes, given the way we do budgeting in this country, that means our kids will be paying (through a higher government debt burden) for our desire to avoid a slowdown in GDP growth. Why are we entitled to their money to clean up our housing mess?
As if being a CBO Director weren't time consuming enough, Peter Orszag has joined the blogosphere:
What are you likely to read on this blog? First, you will learn more about CBO — the types of work we do, how we do it, and more about the outstanding analysts we have. For example, when we come out with a new report or important cost estimate, I may write a bit about the analytical substance and also introduce you to the key staff who took the lead in the analysis. Second, CBO’s research and cost estimates are often discussed extensively in the media and elsewhere — and not surprisingly, from time to time misunderstandings or misinterpretations arise about some analysis we have done. In those kinds of situations, I will use the blog to further explain our work and address possible or potential misunderstanding. Finally, when it seems appropriate, I will use the blog to link our work to relevant outside research from academic or other institutions that may shed additional light on the challenging issues the Congress is working to address.
CBO's website was already very helpful. This makes it even better. Bookmark it today.
I've got the DVR all set for today's Republican candidates debate. John Harwood of CNBC and the Wall Street Journal has his preview here. As this debate is about the economy, he is looking for three big issues: taxes, spending, and trade.
I don't blog much about trade. I'm a free trader. Economic exchange by mutual consent is one of the things that ties the world together in a positive way. In the absence of some identifiable non-pecuniary externality, Republicans have no business restricting free trade.
I've gone off on the Republicans for their budget policy a number of times. (Here's a good one.) If any of these candidates are going to sway me on budget policy, they are going to have to do two things. First, do not say that tax cuts pay for themselves. Second, say that you are going to balance the budget without reference to a Constitutional amendment. And I'll have to believe them. That's a tall order, given what we've seen so far.
But the most important issues of budget policy are going to come in the form of budget priorities. I hope they all get asked the question of SCHIP funding vs. war funding. That will tell us something about their leadership potential. For very good commentary, see this post at SnowDahlia.
There was a portion of the debate on Wednesday night focused on Social Security, and, in particular, raising the maximum taxable earnings as a way to collect more revenue and improve projected solvency. You can watch the segment here. The issue at hand is whether solvency can be restored by removing the cap on taxable earnings, so that all earnings are subject to the 12.4% combined (employer plus employee) tax for Social Security. This is currently the case for the 2.9% combined payroll tax for Medicare Part A.
There are two ways in which this might be done. In the first, workers who pay this additional tax would have the earnings on which they were taxed included in the calculation of their subsequent benefits. In the second, workers who pay this additional tax would not have these incremental earnings included in the calculation of their benefits. The Office of the Chief Actuary at the Social Security Administration has made it very easy to assess the effect of changes of this sort on projected solvency. The first case is shown here, and the second case is shown here.
In the first case, the system can pay full benefits for almost all of the 75-year projection period. You can see this in two ways. First, the second to last column is -0.10, meaning that over the 75-year period, full benefits could be paid entirely if this provision were enacted and the combined payroll tax rate were increased (on the old base) from 12.4 to 12.5 percent. Second, you can see that the new path of the trust fund crosses zero just at the end of the projection period.
In the second case, the system can pay full benefits for the full 75-year projection period. The second to last column is now +0.28, and the trust fund has a balance of about 3.5 years worth of benefits at the end of the period. Is this enough to say that the system is solvent? I don't think so. Even in this case, the balance in the trust fund is declining and will cross zero at some point after the 75-year projection period ends. The last column of numbers shows that annual deficits are equal to almost 3 percent of (the old base) taxable payroll. More would need to be done here to ensure that the trust fund is never projected to cross zero.
It is not clear which provision the candidates meant, but I am going to assert that it was the second one. If the problem is that there is not enough money to pay currently projected benefits, then it seems odd to now increase the claims that will be made on the system by the very wealthiest recipients. (Very roughly, if I pay these taxes on another million dollars of earnings each year over the course of a career, my benefits will go up by $150,000 per year during retirement.)
This is a large increase in top marginal tax rates on incomes where the supply-side response could be relevant. When Jeff, Maya, and I were developing the LMS plan, we decided that we didn't want to do this all on the revenue side and didn't want to get all of our revenue via increases in the cap. Instead, we borrowed the idea from the Diamond-Orszag plan to lift the cap to a point where 90% of all earnings were taxed (with no incremental benefits for the additional earnings subject to taxation). This was roughly the amount subject to the tax at the time of the last big reform in 1983. (Since a lot of the increase in average earnings has been at the high end, over time, a lower share of total earnings have been below the cap.) We also added an increase in the payroll tax rate for 1.5 percent of (the old base) taxable payroll, and made up the rest of the financial shortfall with changes on the benefit side.
More importantly, we required that all new revenues go into a system of personal accounts. This was my deal-breaker. If we were to raise this much additional revenue, without channeling it to personal accounts, we would simply be compounding a budget problem that is already severe. When the government runs a Social Security surplus, it treats those monies as available to spend on things other than Social Security. We know this because it targets the unified budget deficit, and has done so pretty routinely over the last several decades. (See here and here.) If these government inflows are matched by offsetting outflows (into the personal accounts), then there is no danger that they will be used to finance current expenditures, and the additional revenues will actually raise saving rates to help prefund future obligations.
From the WSJ editorial with Paul Gigot, in which Karl Rove announced his departure from his current position as Deputy Chief of Staff at the White House:
"I'm a myth. There's the Mark of Rove," he says, with a bemused air. "I read about some of the things I'm supposed to have done, and I have to try not to laugh." He says the real target is Mr. Bush, whom many Democrats have never accepted as a legitimate president and "never will."
When I was at CEA, I was in perhaps a dozen meetings where Karl Rove was also present. I never spoke to him personally--I was more in the role of observer at those meetings. I took two things away from those meetings. First, when Rove was in the room, you had better be on mission. He would have no hesitancy at all in asking anyone the direct question, "What have you done to advance the President's agenda today?" He'd be expecting a lengthy and comprehensive reply, and you'd feel like a moron if you didn't have one for him. Second, and it's worth keeping in mind that I would only be at such a meeting if much of the content were economics (as opposed to national security or some other policy), I never heard him take the wrong side of an argument based on the economics.
That said, there is quite a bit of myth in Rove's interview. Gigot's editorial comments around the quotes from Rove are right on the money:
Mr. Rove also makes a spirited defense of this president's policy legacy, sometimes more convincingly than others. On foreign affairs, he predicts that at least two parts of the Bush Doctrine will live on: The policy that if you harbor a terrorist, you are as culpable as the terrorist; and pre-emption. "There may be a debate about degree," he says, "but it's going to be hard for any president to reverse that."
He's less persuasive on Medicare, where he insists that market reforms and health savings accounts are building a "critical mass" of popular support that will make them unrepealable. Yet Democrats are even now trying to kill Medicare Advantage, blocked only by the promise of a veto. If Mrs. Clinton wins in 2008, the Medicare drug expansion may prove to have been all spending and no reform.
He also insists that Social Security reform was worth the failed effort, and that Mr. Bush's ideas will be adopted inevitably by some future president. I ask if, given Mr. Bush's falling approval ratings in 2005 due to Iraq, he shouldn't have pushed for something less ambitious. Not a chance. "You cannot advance on the fronts you want to advance if you're playing mini-ball," he says, once again sounding like Mr. Bush.
Medicare Part D was a betrayal of conservatism. Conservatives are supposed to see fiscal responsibility as their friend, precisely because the need to pay for what the government does should constrain the overall size of that government. This Administration let go of fiscal responsibility early in its first term and has been undermined by its absence ever since. (With the current budget target, weak as it is, we are essentially in a pay-as-you-go situation, so it's not quite so bad.)
The President's attempt at Social Security reform was the first casualty. The reason to reform Social Security is its long-term fiscal imbalance. The President understood that, even if his rhetoric was at times hyperbolic or misleading. The President lost all credibility on using that as a motivation for reform when he decided that the short-term non-entitlement budget imbalances "don't matter" and when he passed a Medicare expansion whose unfunded obligations were larger than those in Social Security. That was contradiction number one. (Read more here.)
Contradiction number two came from the President's statements that he wanted to "strengthen" the system. It is reasonable to believe that strengthening an entitlement program means putting more resources into it. There was no plan put forward by the Administration, even in the form of a trial balloon, that tried to strengthen the system with new resources. That doesn't mean the proposals were bad ideas, but it does mean that the honest description of what his plans do is to pare back projected future spending so that it is balanced by projected future revenues. The President's intentions here were both conservative and (to use Rove's word) ambitious. They just weren't presented coherently, and so they got nowhere.
This notion that the President's legacy on matters of fiscal policy--which will be written by historians (and bloggers!) that Rove can't spin--will be anything but a severe and harsh critique is what I consider the Myth of Rove.
There has been some chatter among Jared Bernstein, Greg Mankiw, and Brad DeLong about whether it was appropriate for Greg to have advised President Bush in 2003 in support of the second round of major tax cuts. (See here, here, and here.) You can read everything I've blogged about budget policy, but here's a summary as it pertains to giving advice.
The overriding problem in conducting fiscal policy is that politicians, in both the executive and legislative branches, face electoral pressure to please their current constituencies. It is extremely tempting for them to boost spending or lower taxes today, handing out windfalls to today's voters and leaving an unrepresented constituency--future taxpayers--to foot the bill.
It takes an enormous amount of energy to resist that temptation. That energy has to come from the politician's advisers. In the White House, the most senior of them carry the titles Assistant to the President, in most cases preceded by the word "Deputy" or "Special" to connote their place in the hierarchy. During the year I spent at CEA, I worked with a number of them who were excellent. But if you ask them what their objectives are, or if you listen to their arguments during policy meetings, what you find is that they are working extremely hard to advance the President's policies (which they have often had a central role in shaping and hopefully improving). They may have very good intentions at heart, but in my experience they were not usually the ones looking at the larger picture who might help resist the temptation to act in a politically opportunistic manner. There were exceptions, and I'm not looking to impugn anyone here.
There are other advisers with a central role to play in fiscal policy, however, who are Presidential nominees who undergo Senate confirmation and who can be called to testify to Congress on the President's policies. We should expect them to be the ones who look at the larger picture, who take a longer horizon into their policy discussions, and who do the heavy lifting to help the politician resist the temptation to use future generations' resources to buy votes today. On fiscal policy, the three main advisers are the Secretary of the Treasury, the Director of the Office of Management and Budget, and the Chairman of the Council of Economic Advisers.
To address the overriding problem, these three advisers must insist on an explicit budget target. The weakest one that I would accept is that the debt-to-GDP ratio (including debt held by government trust funds) must show no upward trend. (A stronger one would be that the on-budget deficit should be in balance over a full business cycle.) Long-term entitlement programs should be in projected actuarial balance to the extent it is possible to make a projection. (You can see here what happened to one adviser who made reasonable arguments without first getting agreement on a standard.)
The standard can be that simple, and it isn't as austere as I'm trying to make it sound. It doesn't rule out cutting taxes during the weak part of a business cycle, for example, but it does rule out cutting taxes to run a deficit that the Administration has no intention of paying back during the strong part of a business cycle. As a corollary, it does rule out passing tax cuts with explicit sunset provisions and then arguing to extend them with the budget not in balance. There can be occasional exceptions, but their presumed infrequency should immediately cause them to be fully explained. (Think of the President addressing a joint session of Congress.)
Twice a year, the Administration makes an economic forecast to underlie the budget or its mid-session review. I'd be surprised if you ever see such a forecast that predicts an upcoming recession. That means that every budget or mid-session review should be projecting on-budget surpluses or their quick resumption if we are just coming out of a recession. As I've discussed elsewhere, the "cut the deficit in half in five years" policy was at variance with this standard.
I acknowledge that my views on this don't match the usual discussions of the impact of deficits. I think too much of those discussions are about their impact on interest rates and thus the incentive for private investment. This is where economists spend a lot of their time, but that doesn't make it the most relevant question. Suppose for the sake of argument that deficits don't put much upward pressure on interest rates. Even in that case, they still have to be financed at the existing interest rate, and the burden of financing them has to be borne by someone in the future. Taxing someone in 2020 to pay for our spending binge in 2003 violates my notions of fairness, and that is a substantially more salient issue here than any additional concerns about efficiency.