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Fiscal policy delusions

My hat tip to Diane at Economistmom and her essay on the scrambling in Congress around the Bush tax cuts:

… In other words, let’s try to avoid doing something with the Bush tax cuts that seems totally crazy given what we say our fiscal policy goals are for both adequately supporting the (still fragile) short-term economy and better encouraging economic growth by reducing the deficit over the longer term.

The fiscal policymaking in this town seems totally schizophrenic right now. What a juxtaposition to have President Obama’s deficit-reduction commission release its final report while the Administration “negotiates” with Congress on whether all of the Bush tax cuts, or just most of them, should be permanently extended (and deficit financed). The media has been reporting that whether the bulk of the Bush tax cuts will be extended or not is not the issue–it is whether the upper-bracket ones benefitting only the rich will be included as well, and what constitutes “rich.”

I think most Americans who are paying attention to today’s fiscal policy news are probably shaking their heads and/or cussing and/or laughing in a dark-humor sort of way. It seems both ridiculous and tragic that our leaders can proclaim their intent to get our fiscal house in order out of one side of their mouths, while arguing to keep (forever) their favorite piece of the fiscally-reckless and economically-ineffective Bush tax cuts out the other. They are so busy screaming at each other from their (sticky, embedded) corners that they can’t see the common ground between them.

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Conclusion to my Kauffman Institute Presentation

Note: This is “what I believe I said,” not“what I would have said” and is presented here solely to document the confluences that were, perhaps, clearer in my head than they were in the presentation itself.  As such, several references here are echoes of earlier pieces of the presentation. (Links to same will be updated as soon as possible.)

To review, there are three standard methods of reducing a fiscal debt: default, inflate, and taxation and/or budget cutting.  I believe it is clear that default is not desirable; the historic examples of 1917 Russia and the State of Louisiana are clear indicators that issues persist long after the act itself, and the recent suffering of the Argentineans in 2002 and 2003 clearly shows that, even at the time, default is at best a problematic solution, more an amputation than a lancing.

The second, moderate inflation, has the collateral issue that some of the assumed benefits of an inflationary policy—especially an inflationary policy in an environment with a relatively low savings rate—do not accrue to the country whose currency is the dominant one in the world.  As I noted earlier, David Beckworth is doing some research in this area, and I look forward to seeing the results.It seems safe to assume that the benefits of inflation will not accrue in the way a model might predict, and therefore “solving” the problem with inflation will require a suboptimal level to achieve optimal policy.  The chance of having to repeat “the Volcker experiment” would not be small, while the likelihood of success would not be so large.

Budget cutting is an abiding idea. While I’m perfectly willing to stipulate that one might be able to cut around 1% of GDP from the US defense budget, and that some direct consumption—though much of this is a State and Local issue more than a Federal one—might be reducible, this appears unlikely to have more than a marginal effect. While we like—indeed, make a living from identifying—marginal effects, the magnitude of the issue at hand requires more.  Since we generally can stipulate that transfer payments are at worst neutral (or, by Jim Baker’s “supply-side/conspicuous consumption” theory presented earlier, likely beneficial to both the velocity of money and overall tax revenues), gains from there will, at best, not help the team.



This leaves taxation, and it is perfectly reasonable to assume that taxation can be increased. Except that, as you can see from the graphic I have left on the screen, we have a large deadweight loss in health care spending. We spend approximately 6% more, on a percent-of-GDP basis, than the next country, with no noticeable economic value-added.  Having that deadweight loss hanging over the economy limits options—possibly as much or more than being the dominant currency.  And since the basic premise of this panel appears to be that we would prefer that the US Dollar remain the dominant world currency—that is, becoming the 21st century equivalent of 20th century Britain not being a desired outcome—we are left to the reality that we cannot solve the budget crisis without reducing or eliminating much of the deadweight loss in the health-care system.

Were we to solve only half of the difference and transfer that amount to tax revenues, we would solve the budget deficit without adding any drag to the economy, effectively substituting tax revenues for cost overruns. We would, in short, have produced a better team: a better engine for growth and a greater potential for entrepreneurial opportunity, even if a groundskeeper becomes underutilized in the process.

The most viable alternative to addressing the deficit by addressing the deadweight loss in the health-care system appears to be to yield our place as the world’s Reserve currency of choice. There does not appear to be much of an appetite for that, even if there were a clear mechanism to do so.

As economists we look for the suboptimal.  In this case, we can identify the areas where the returns are low—defense spending—the areas where spending growth might be moderated—Government Direct Consumption, although that is a very nominal portion of the Federal budget—and areas where there are clear deadweight losses—health care spending.  Only the latter shows much promise as a direct, not just a marginal, way to address the problem.

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War taxes?

by Linda Beale
(cross posted at ataxingmatter)

One can question the timing of implementation, but can one argue against the financing? …Rdan

War taxes?

Since Bush invaded Afghanistan in 2001 (and then, Iraq), we have been paying for war as an afterthought. In the Bush era attempt to treat war as something that happened “over there” and didn’t disrupt the credit-fed consumer binging happening “over here,” there were no pics, no war bonds, and certainly no war taxes to pay for it. Instead, we actually cut taxes year after year after year, reducing government revenues at a time when we were passing supplemental appropriations year after year after year to pay for the war. With reduced taxes and increased military spending, that meant we borrowed to pay for the war of choice that Bush led us into.

In most wars, this country’s citizens and leaders have been somewhat wiser on the fiscal score. In the past, we generally raised taxes to pay for the huge expenditures that war necessitates–for caring for soldiers overseas and after they come home, for tanks and trucks and planes and drones and all the guns and missiles, not to mention warships and fuel, the construction of bases and building of roads and provision of power and all the other expenses of going to war (including, increasingly under Bush, the privatization of the military and the much higher costs of contracted mercenaries compared to Army soldiers and of Halliburton cafeterias that, in quite a few cases, didn’t serve the food they charged the US for).

Now that Bush and much of the Bush Congress are gone from office, it’s time to look at the costs of war when we think about what our tax burden should be. As one writer notes:

[O]ne thing literally everyone agrees Vietnam showed, from flaiming liberals to fire-breathing neocons, is that it’s a very bad idea to get involved in a long, grueling, expensive war without explaining to the American people how much they will have to sacrifice, and securing their support.” The Economist, David Obey’s war tax (Nov. 27, 2009).

David Obey, chair of the House Appropriations Committee, introduced on Nov. 19–with 10 Dems as co-sponsors–the “Share the Sacrifice Act of 2010” to do just. See Pincus, If It is to be fought, it ought to be paid for, Wash. Post, Dec. 1, 2009. How? by adding a graduated surtax, in 2011, to the income tax for those earning more than $30,000 a year. The rate would be 1% on incomes up to $150,000 and more above that–generally, a few hundred dollars, with the rate on higher incomes set to generate enough revenues to pay for the prior year’s cost of being at war, with returning GIs and families of those killed in combat exempt. And the surtax could be delayed (from 2011 to 2012) if the economy is weak.

The article notes an irony that has been mentioned also in the context of the health care reform debate about paying for government action. IN health care, many of those (especially republicans) who argue that “oh no, we can’t do this to fix the health care system, it costs too much and will create deficits” are the same ones who supported the series of Bush tax cuts that led to huge deficits, and their argument was “deficits don’t matter.” In the war tax debate, many of those most eager for further commitment to Afghanistan are unwilling to support taxes to pay for the conflict rather than living on borrowed money. (Or, they’d probably be willing to cut various “entitlements” for the vulnerable amongst us, even while extending even more “entitlements” to corporate taxpayers those who own significant financial assets in the way of further tax cuts.) Note the article quotes Lindsey Graham as saying spending has been out of control “since the administration came into power.” Funny–the spending that has happened was necessitated by the economic mess left by the Bush Administration, that fought wars and INCREASED SPENDING while cutting taxes. Was it spending out of control? or was it spending while going on a multi-year tax cut binge that was out of control? I’d say the latter.

If you want the right’s take on this, read Amy Ridenour–a self-admitted Rush Limbaugh enthusiast. She thinks Rush’s “logic” is fine. By the way, his argument translates to: we’re in debt [implying it’s all Obama’s fault and not because of the Bush screwups of the economy and the huge amount of borrowing already committed under Bush] so this argument about paying for the war is silly when we already have so much debt; and/or yeah, well, just cut the spending on all those silly programs that progressives have put in place since Roosevelt (Rush calls it the “Fair Deal, New Deal, Rotten Deal, Raw Deal and Great Society”)–ie, the programs (subtracting out Rush’s trash talk) that we as a people have decided over many decades to use to support the vulnerable and improve opportunities for decent living standards for all. And like many right-wingers, Ms. Ridenour claims that her goal is supporting “principles of a free market, individual liberty and personal responsibility, combined with a commitment to a strong national defense.” Amy, how do not paying for the wars we CHOOSE to wage add up to either “personal responsibility” or “commitment to a strong national defense” or even “free market”–since there is no such thing as a “free” market without the stability, institutional structure, and legal forms provided by a stable and functioning government?

At any rate, mainstream commentators seem to think the bill wouldn’t pass, which means that they seem to think that it won’t get substantial Republican support, which the Rush-Ridenour excerpt surely suggests is correct. See David Obey’s war tax, Economist (Nov. 27, 2009). Those very people who are gung ho for war (“commitment to strong national defense”) and gung ho for not having deficits aren’t likely, that is, to vote to pay for the war in which they are so gung ho for others to fight. As the Economist article hints, how better to support the troops than paying for their fight?

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A Year and Counting: re-regulation of Wall Street

by Linda Beale

A Year and Counting: re-regulation of Wall Street

On Monday night, I participated in a symposium on the Financial Crisis: One Year Later, sponsored by the Center for the Study of Citizenship and others. With me were Larry Ingrassia, Business Editor of the New York Times, and Chip Dickson, CFO of W2Freedom, a private equity fund that purchases community banks. We talked about the causes and potential solutions to the financial crisis and the Great Recession that it had spawned. Much of our focus was on the way financial institutions had grown “too big to fail”, creating a “casino mentality” that assumed that the government would come to the rescue if needed, thus socializing losses while privatizing gains.

As Amity, a commenter on Salon’s post by Andrew Leonard on Wall Street’s risk-taking, noted:

The whole point of society is to moderate and channel wild animal impulses into productive forms. In keeping with that purpose, we as a civilization once saw fit to impose on high finance a series of regulatory restrictions and frameworks for oversight so as to moderate and channel the risk-taking behaviors of financiers.

Then we as a civilization saw fit to remove those restrictions and oversight. The result was as foregone, and as predictable, as if we were stalling an aircraft and letting gravity take over.

I kicked off the discussion session of the symposium with the following question:

It’s been a year now since we were hit with a financial system tsunami, and recognized that we had let banks get “too big to fail” and speculation in derivatives explode. Yet here we are, one year later—we’ve actually encouraged banks to grow larger; we have not yet enacted any regulation of derivatives; we have not yet enacted any tighter regulation of hedge funds and private equity funds or the “shadow banking” system generally, we have not yet formed a consumer financial protection agency—in fact, we’ve done essentially nothing to change the conditions that apply. What does this mean, in terms of the stability of the financial system?

I’m not sure that there is a satisfactory answer to that question. Because it suggests that our political processes are now so beholden to the corrupting influence of the financial behemoths that we will not be able to find the will to rein them in. See, e.g., Robert Reich, so much happening in D.C., so little to show for it, (Oct. 9, 2009) (lamenting the fact that “Congress is overwhelmed with corporate and Wall Street lobbyists”).
(cross posted from ataxingmatter 10/09/2009)

Update: Barney Frank and the SEC on derivatives, Naked Capitalism

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