What's an easy way to get going on progressive income taxes? Simply remove all limits on contributions to and withdrawals from IRAs. (I thank my Hoover colleague Michael Bernstam for this clever idea, and the Hoover coffee room for bumping us into each other.)
Background: Once people see that a consumption tax, in place of income tax, corporate tax, estate tax, etc. is much simpler and more economically efficient, the natural question is "what about progressivity?" The answer is that there are lots of ways to make a consumption tax progressive.
My favorite (today) is a flat consumption tax, with the same rate on everything, collected as a VAT.
Then, realize that progressive taxation is the same thing as flat taxation plus redistribution. If I pay 40% tax and you pay 20% tax, that's the same thing as both of us paying 40% tax and you receiving a check from the government. So, I think, separate taxation (raising revenue for the government at minimum cost), subsidy, and redistribution. Make redistribution coherent, integrate it with other programs, and implement it by sending people checks, on budget.
Most countries try to make it progressive by charging different rates for things that rich people buy vs. poor people. But that is a mistake as it distorts the economy. Even rich people can buy more tacos and less yachts, and maybe a poor person wanted to buy a yacht and start a rental business.
An alternative implementation is to turn the current income tax system into a progressive consumption tax. If you can fully deduct savings from income, the "income" tax becomes a consumption tax. Alternatively, pay taxes on all "earned" income, but no tax on dividends, interest, or capital gains. That works out to the same thing -- no tax distortion on whether you consume the day you get the income, or later after returns compound.
That approach leads to all sorts of definitional problems, which is why I haven't been a huge fan. (Though I'm not strongly opinionated, recognizing that people who advocate it know a lot more about the tax code than I do.)
So, along comes Michael. Why not just remove all limits on IRAs? Contribute as many pre-tax dollars as you want. Interest, dividends, and capital gains accumulate tax free. No minimum distributions, estate taxes, etc. But when you take money out of the IRA, to consume it (otherwise you'd leave it in!) you pay income tax.
Yes, it's imperfect. It doesn't solve the Trump issue that what is "income" is an elastic concept in the hands of lawyers and lobbyists. But it's a quick and easy step that gets us a long way there.
Our tax code sort of recognizes that taxing rates of return is a bad idea. We tax "unearned" income -- but then there is a huge list of complex exemptions. 401(k), 526(b), IRA, Roth IRA, health savings accounts, college savings accounts, step up of capital gains at death, like-kind exchanges, and on and on, each with complex rules to follow. Just removing all limits on IRAs would be a big step towards a consumption tax, and then we wouldn't need all these other ones either.
Objections? I'm not great on tax law, so it will be fun to hear comments.
Tampilkan postingan dengan label Taxes. Tampilkan semua postingan
Tampilkan postingan dengan label Taxes. Tampilkan semua postingan
Rabu, 05 Oktober 2016
Senin, 03 Oktober 2016
Trump Taxes
As I see it, important points about the Trump tax affair are not yet reflected in media coverage. 1) This affair reflects the intrinsic difficulties of an income tax. A consumption tax can be more progressive -- Mr. Trump would have likely have paid a lot more. 2) Raising personal income tax rates and especially capital gains and estate tax rates will do little to raise tax payments from the likes of Mr. Trump. No taxable income = no tax at any rate. It will likely have the opposite effect, making more lawyer, accountant, and lobbyist time worthwhile.
The main issue, really, is not what taxes Mr. Trump did or did not pay after the big loss. The big issue is what taxes he did or did not pay beforehand.
If we're going to tax income, the principle of net operating loss carry-forward (this sort of taxese by itself tells you a lot about what's wrong with the system) makes a lot of sense. Suppose you run a business that makes $1,000,000 in even years, and loses $900,000 in odd years. On average, you make $50,000 per year. But if you pay a 40% Federal income tax rate (plus state, local, etc.) in the good years, then you pay $200,000 per year on average in taxes, a 400% tax rate.
So, if Mr. Trump really had earned $1,000,000,000 of income, paid taxes on that income, then lost $900,000,000 as reported, allowing him to deduct future income against that $900,000,000 until he pays taxes only on the net $100,000,000 makes abundant sense. (I'm struggling to keep track of the zeros here.)
Now you see the big issue. The real question is, did Mr. Trump actually make income, pay taxes, and then suffer that $900,000,000 loss? Or, did other people suffer the loss, and Mr. Trump got to use the losses to protect his future income? Or, are the losses basically fictitious? The reporting (New York Times ) suggests the latter
Now, for lessons.
Income and corporate taxes. Compare this outcome to a consumption tax. Suppose that no matter what his income, Mr. Trump had to pay, say, 25% VAT on
It's not just Trump. The great news of this story is that it shines a light on the affairs of America's "dynastic families" (aristocracy), and the puzzle of why they all seem to be so heavily invested in real estate. From the Times again,
What fixes it? Neither candidate's tax plan does anything that I see to eliminate these shenanigans among the super-rich who can afford to hire armies of lawyers. (Correct me if I am wrong, please. I have not read them in great detail as I know they will be shredded on Nov. 7). Mrs. Clinton's plans to raise personal income tax rates doesn't raise more taxes from people who have sheltered all their income. Raising capital gains and estate tax rates just raises the incentive to pursue shelters. (See for example Zuckerberg's GRAT)
The right response to this affair is outrage at the astonishing crony complexity of the tax code, not really Mr. Trump's apparently perfectly legal behavior. I can't see a way to get around this than to abandon the attempt to tax income, and just tax consumption instead.
As for Mr. Trump, I actually have a kind thing to say: This affair makes it clear that politics is indeed a recent avocation. You can tell which economists want government jobs and which don't by how they pay their nannies. Nobody planning to run for office would have done this!
Update: Debt Parking by John Hempton (HT Marginal Revolution). Short version: Borrow lots of money. Lose it, take tax loss. Sell worthless debt to offshore entity. Get creditors to forgive debt. Normally, debt forgiveness counts as income and eats back your tax losses. But since that "income" is not cash, it's easy to hide it. The big question will be whether Mr. Trump did this, or whether he later paid taxes on the forgiven debt or not.
Hampton speculates he did not pay that tax:
I stick to my interpretation that the episode reveals more about insane complexity of the tax code, a necessary result of trying to tax income, than much of anything else.
The main issue, really, is not what taxes Mr. Trump did or did not pay after the big loss. The big issue is what taxes he did or did not pay beforehand.
If we're going to tax income, the principle of net operating loss carry-forward (this sort of taxese by itself tells you a lot about what's wrong with the system) makes a lot of sense. Suppose you run a business that makes $1,000,000 in even years, and loses $900,000 in odd years. On average, you make $50,000 per year. But if you pay a 40% Federal income tax rate (plus state, local, etc.) in the good years, then you pay $200,000 per year on average in taxes, a 400% tax rate.
So, if Mr. Trump really had earned $1,000,000,000 of income, paid taxes on that income, then lost $900,000,000 as reported, allowing him to deduct future income against that $900,000,000 until he pays taxes only on the net $100,000,000 makes abundant sense. (I'm struggling to keep track of the zeros here.)
Now you see the big issue. The real question is, did Mr. Trump actually make income, pay taxes, and then suffer that $900,000,000 loss? Or, did other people suffer the loss, and Mr. Trump got to use the losses to protect his future income? Or, are the losses basically fictitious? The reporting (New York Times ) suggests the latter
...net operating loss, or N.O.L., allows a dizzying array of deductions, business expenses, real estate depreciation, losses from the sale of business assets and even operating losses to flow from the balance sheets of those partnerships, limited liability companies and S corporations onto the personal tax returns of men like Mr. Trump.The follow up offered more detail on where fictitious or other people's losses come from:
... he might have been able to record write-downs of assets under a doctrine known as “abandonment,” an aggressive accounting tactic used when an investor walks away from a worthless or nearly worthless asset and writes off the entire capital investment in the property. ["The" does not mean "his?"]
... Mr. Trump personally guaranteed $832 million of debt related to his casinos and other assets. Under tax code provisions available to real estate developers, he could take the full amount as a deduction even if he didn’t invest a dime of his own money. [my emphasis]
Ordinarily, that deduction would be recaptured when the debt was forgiven or the underlying assets sold. If the debt were forgiven, Mr. Trump would have to report that as income. But there are various exceptions. If Mr. Trump was insolvent at the time — if his debts exceeded his assets — he might have avoided having to report the forgiveness of debt as income...
There are other provisions, too, that might have allowed Mr. Trump to deduct the loans but never have to report them as income.
Real estate developers are also uniquely able to realize losses as soon as they occur, but defer gains, often indefinitely, through such tactics as like-kind exchanges. “It’s heads Trump wins, and tails the government loses,” Mr. Knoll said.As a simple version, lunch conversation had the following anecdote: If you rent out property here, you can depreciate the cost of the house. But the cost of the house in the bay area is 99% value of land which doesn't depreciate. So you can cut your taxable income by this fictitious depreciation. I don't know if it's true, but it is a similar story.
Now, for lessons.
Income and corporate taxes. Compare this outcome to a consumption tax. Suppose that no matter what his income, Mr. Trump had to pay, say, 25% VAT on
...Mr. Trump’s opulent lifestyle over the years. At the nadir of his personal financial crisis in the early 1990s, his lenders put him on an annual “budget” of $450,000 in personal expenses — more than enough to sustain his lifestyle of lavish homes, private jets, country clubs and golf coursesAssuming that he did not, in fact, pay 40% taxes on the $900,000,000 before he "lost" it, he would have ended up paying a lot more in consumption taxes. A consumption tax can be more progressive than an income tax. The attempt to tax income is at the root of all this mess.
It's not just Trump. The great news of this story is that it shines a light on the affairs of America's "dynastic families" (aristocracy), and the puzzle of why they all seem to be so heavily invested in real estate. From the Times again,
...America’s dynastic families, which, like the Trumps, hold their wealth inside byzantine networks of partnerships, limited liability companies and S corporations.
...According to Mr. Mitnick, Mr. Trump’s use of net operating losses was no different from that of his other wealthy clients.
“If it wasn’t clear before, it is now: The tax code is tilted toward the rich in its statutory framework, its exceptions, and in how it is enforced and administered,” said Steven M. Rosenthal, a real estate tax specialist and senior fellow at the Urban-Brookings Tax Policy Center.It goes on. A real estate lawyer once explained to me how she set up trusts for one of these "dynastic families." On Junior's first birthday he gets complex shares in a limited partnership worth just under the gift tax limit. 50 years later, what do you know by capital gains it's worth $50 million, so the property passes outside of estate taxes.
What fixes it? Neither candidate's tax plan does anything that I see to eliminate these shenanigans among the super-rich who can afford to hire armies of lawyers. (Correct me if I am wrong, please. I have not read them in great detail as I know they will be shredded on Nov. 7). Mrs. Clinton's plans to raise personal income tax rates doesn't raise more taxes from people who have sheltered all their income. Raising capital gains and estate tax rates just raises the incentive to pursue shelters. (See for example Zuckerberg's GRAT)
The right response to this affair is outrage at the astonishing crony complexity of the tax code, not really Mr. Trump's apparently perfectly legal behavior. I can't see a way to get around this than to abandon the attempt to tax income, and just tax consumption instead.
As for Mr. Trump, I actually have a kind thing to say: This affair makes it clear that politics is indeed a recent avocation. You can tell which economists want government jobs and which don't by how they pay their nannies. Nobody planning to run for office would have done this!
Update: Debt Parking by John Hempton (HT Marginal Revolution). Short version: Borrow lots of money. Lose it, take tax loss. Sell worthless debt to offshore entity. Get creditors to forgive debt. Normally, debt forgiveness counts as income and eats back your tax losses. But since that "income" is not cash, it's easy to hide it. The big question will be whether Mr. Trump did this, or whether he later paid taxes on the forgiven debt or not.
Hampton speculates he did not pay that tax:
There is a vehicle out there (say an offshore trust or other undisclosed related party effectively controlled by Donald Trump) - which owns over $900 million in debt and is not bothering to collect it.
I do not have the time or energy to find that vehicle. But it is there. Now that this blog has gone public journalists are going to look for it.
There is a Pulitzer prize for whoever finds it. Just give me a nod at the acceptance ceremonyUpdate 2: Josh Barro writes about a more plausible explanation from Lee Sheppard -- the "Gitlitz loophole." Until 2002, someone in Mr. Trump's position could, in fact, set up a company, borrow a ton of money, lose it, have the debt forgiven in the company's bankruptcy, but use the lost borrowed money against future personal taxes. Apparently, it was an error in writing the tax code, which Congress fixed when it came to light.
I stick to my interpretation that the episode reveals more about insane complexity of the tax code, a necessary result of trying to tax income, than much of anything else.
Selasa, 27 September 2016
EconTalk
As in other recent projects (growth essay, testimony) I'm trying to synthesize, and also to find policies and ways to talk about them that avoid the stale left-right debate, where people just shout base-pleasing spin ever louder. "You're a tax and spend socialist" "You just want tax cuts for your rich buddies" is getting about as far as "You always leave your socks on the floor" "Well, you spend the whole day on the phone to your mother."
We did this as an interview before a live audience, at a Chicago Booth alumni event held at Hoover, so it's a bit lighter than the usual EconTalk. This kind of thought helps the synthesis process a lot for me. Russ' pointed questions make me think, as did the audience in follow up Q&A (not recorded). Plus, it was fun.
I always leave any interview full of regrets about things I could have said better or differently. The top of the regret pile here was leaving a short joke in response to Russ' question about what the government should spend more on. Russ was kindly teeing up the section of the growth essay "there is good spending" and perhaps "spend more to spend less" ideas in several other recent writings. It would have been a good idea to go there and spend a lot more time on the question.
From the growth essay, I think the government could profitably spend a lot more money on the justice system. That so many of our fellow citizens rot in jail awaiting trials, that the vast majority never receive a trial anyway but a hasty plea-bargain, that their legal representation is so thin, is a disgrace -- and causing huge problems. If a wrongly accused young man spends two years in jail before charges are dropped, the consequences for him and his family are awful. Business relies on a speedy and efficient justice system to adjudicate commercial disputes, and that seems to be falling apart too, partly for lack of resources. The cost here is peanuts compared to, say, peanut subsidies.
Our public infrastructure doesn't just consist of steel and asphalt. The public software needs investment as well, or more.
Public health is one of the most essential public goods. Of all the civilization-ending scenarios you can think of, nuclear war and a pandemics top my list. Many past pandemics followed a surge in globalization -- the plague of the 1350s, that wiped out half or more of the population; the smallpox that wiped out native America in the 1500s, the 1918 flu. (Larry Summers has a good article on this point.) We are ripe for antibiotics to stop working and new diseases to spread catastrophically, if not among humans among the plants and animals on which we depend. Don't count on the UN and the WHO.
The government can profitably fund basic research. "Yes, 95% of funded research is silly. Yes, the government allocates money inefficiently. Yes, research should also attract private donations. But the 5% that is not silly is often vital, and can produce big breakthroughs." (Basic research is not the same thing as subsidies for commercializing research.)
Yes, Martha, I should have said, there are public goods here and there.
Of course, more spending on things like these does not imply more spending overall. They're all remarkably cheap, and could easily be funded by spending a little less on some of the colossal waste. (Example: We spend $6 billion on the FBI and $13 billion on border control.) Of course, one must also spend wisely and use the results wisely. And one could add a lot to the list. But repeating a fun joke about spending is not the right answer.
Kamis, 15 September 2016
Testimony 2
On the way back from Washington, I passed the time reformatting my little essay for the Budget committee to html for blog readers. See below. (Short oral remarks here in the last blog post, and pdf version of this post here.)
I learned a few things while in DC.
The Paul Ryan "A better way" plan is serious, detailed, and you will be hearing a lot about it. I read most of it in preparation for my trip, and it's impressive. Expect reviews here soon. I learned that Republicans seem to be uniting behind it and ready to make a major push to publicize it. It is, by design, a document that Senatorial and Congressional candidates will use to define a positive agenda for their campaigns, as well as describing a comprehensive legislative and policy agenda.
"Infrastructure" is bigger in the conversation than I thought. But since there is no case that potholes caused the halving of America's trend growth rate, do not be surprised if infrastructure fails to double the trend growth rate. It's also a bit sad that the most common growth idea in Washington is, acording to my commenters, about 2,500 years old -- employment on public works.
Washington conversation remains in thrall to the latest numbers. There was lots of buzz at my hearing about a recent census report that median family income was up 5%. Chicagoans used to get excited about the 40 degree February thaw.
The quality can be very very good. Congressman Price, the chair of my session, covered just about every topic in my testimony, and possibly better. Congressional staff are really good, and they are paying attention to the latest. If you write policy-related economics, take heart, they really are listening.
The questions at my hearing pushed me to clarify just how will debt problems affect the average American. What I had not said in the prepared remarks needs to be said. If we don't get an explosion of growth, the US will not be able to make good on its promises to social security, health care, government pensions, credit guarantees, taxpayers, and bondholders. Something's got to give. And the growing size of entitlements means they must give. Even a default on the debt, raising taxes to the long-run Laffer limit, will not pay for current pension and health promises. Those will be cut. The question is how. If we wait to a fiscal crisis, they will be cut unexpectedly and by large amounts, leaving people who counted on them in dire straits. Greece is a good example. If we make sensible sustainable promises now, they will be cut less, and people will have decades to adjust.
Ok, on to html testimony:
Chairman Price, Ranking Member Van Hollen, and members of the committee: It is an honor to speak to you today.
I am John H. Cochrane. I am a Senior Fellow of the Hoover Institution at Stanford University1. I speak to you today on my own behalf on not that of any institution with which I am affiliated.
Sclerotic growth is our country's most fundamental economic problem.2 From 1950 to 2000, our economy grew at 3.6% per year.3 Since 2000, it has grown at barely half that rate, 1.8% per year. Even starting at the bottom of the recession in 2009, usually a period of super-fast catch-up growth, it has grown at just over 2% per year. Growth per person fell from 2.3% to 0.9%, and since the recession has been 1.3%.
The CBO long-term budget analysis4 looks out 30 years, and forecasts roughly 2% growth. On current trends that is likely an over-estimate, as it presumes we will have no recessions, or that future recessions will have not have the permanent effects we have seen of the last several recessions. If we grow at 2%, the economy will expand by 82% in 30 years, almost doubling.5 But if we can just get back to the 3.6% postwar normal growth rate, the economy will expand by 194%, almost tripling instead. We will add the entire current US economic output to the total. In per-person terms, a 1.3% trend gives the average American 48% more income in 30 years. Reverting to the postwar 2.3% average means 99% more income, twice as much. And economic policy was not perfect in the last half of the 20th century. We should be able to do even better.
Restoring sustained, long-term economic growth is the key to just about every economic and budgetary problem we face.
Nowhere else are we talking about doubling or not the average American's income.6
Nowhere else are we talking about doubling or not Federal revenues. Long-term Federal revenues depend almost entirely on economic growth. In 1990, the Federal Government raised $1.6 trillion inflation-adjusted dollars. In 2016, this has doubled to $3.1 trillion. Wow! Did the government double tax rates? No. The overall federal tax rate stayed almost the same -- 18.0% of GDP in 1990, 18.8% of GDP today. Income doubled.
Whether deficits and debt balloon, whether we our government can pay for Social Security and health care, defend the country, and fund other goals such as protecting the environment, depend most crucially on economic growth.
Why has growth halved? Some will tell you that the economy is working as well as it can, but we've just run out of new ideas.7 A quick tour of the Silicon Valley makes one suspicious of that claim.
Others will bring you novel and untested economic theories: we suffer an ill-defined "secular stagnation" that requires massive borrowing and spending, even wasted spending. The "multiplier" translating government spending to output is not one and a half, and a temporary expedient which can briefly raise the level of income in a depression, but six or more, enough to finance itself by the larger tax revenues which larger output induces --a proposition long derided of the "supply side" --and it can now kick off long-term growth.8 Like 18th century doctors to whom disease was an imbalance of humors, modern macroeconomic doctors have one diagnosis and remedy for all the complex ills that can befall a modern economy: "demand!"
I'm here to tell you the most plausible answer is simple, clear, sensible, and much more difficult. Our legal and regulatory system is slowly strangling the golden goose of growth. There is no single Big Fix. Each market, industry, law, and agency is screwed up in its own particular way, and needs patient reform.
America is middle aged, out of shape and overweight. One voice says: well, get used to it, buy bigger pants. Another voice says: 10 day miracle detox cleanse! I'm here to tell you that the only reliable answer is good old-fashioned diet and exercise.
Or, a better metaphor perhaps: our economy, legal and regulatory system has become like a hoarder's house. No, there isn't a miracle organizer system. We have to patiently clean out every room.
Economic regulation, law and policy all slow growth by their nature. Growth comes from new ideas, new products, new processes, new ways of doing things, and most of these embodied in new companies. And these upend old companies, and displace their workers, both of whom come to Washington pleading that you save them and their jobs. It is a painful process. It is natural that the administration, regulatory agencies, and you, listen and try to protect them. But every time we protect an old company, an old industry, or an old job, from innovation and competition, we slow down growth.
How do we solve this problem and get back to growth? Our national political and economic debate has gotten stale, each side repeating the same base-pleasing talking points, but making no progress persuading the other. Making one or the other points again, or louder, will get us nowhere. I will try, instead, to find policies that think outside of these tired boxes, and that can appeal to all sides of the political spectrum.
Rather than "more government" or "less government," let's focus on fixing government. We need above all a grand simplification of our economic, legal, and political life, so that government does what it does competently and efficiently.
Regulation: fix the process.
"There's too much regulation, we're stifling business. No, there's too little regulation, businesses are hurting people." Or so goes the tired argument. Regulation is strangling business investment, and especially the formation of new businesses. But the main problem with regulation is how it's done, not how much. If we fix regulation, the quantity will take care of itself. We can agree on smarter regulation, better regulation, not just "more" or "less" regulation.9
Regulation is too discretionary --you can't read the rules and know what to do, you have to ask for permission granted on regulators' whim. No wonder that the revolving door revolves faster and faster, oiled by more and more money.
Regulatory decisions take forever. Just deciding on the Keystone Pipeline or California's high speed train --I pick examples from left and right on purpose --takes longer than it did to build the transcontinental railroad in the 1860s. By hand.
Regulation has lost rule-of-law protections. You often can't see the evidence, challenge witnesses, or appeal. The agency is cop, prosecutor, judge, jury and executioner all rolled in to one. [And, a Congressman pointed out during the discussion, recipient of collected fines.]
Most dangerous of all, regulation and associated legal action are becoming more politicized. Each week brings a new scandal. Last week10, we learned how the Government shut down ITT tech, but not the well-connected Laureate International. The IRS still targets conservative groups11. The week before, we learned how the company that makes Epi-pens, headed by the daughter of a Senator, got the FDA to block its competitors, Congress to mandate its products, and jacked up the price of an item that costs a few bucks to $600. This is a bi-partisan danger. For example, presidential candidate Donald Trump has already threatened to use the power of the government against people who donate to opponents' campaigns.12
America works because you can lose an election, support an unpopular cause, speak out against a policy you disagree with, and this will not bring down the attentions of the IRS, the EPA, the NLRB, the SEC, the CFPB, the DOJ, the FDA, the FTC, the Department of Education, and so forth, who can swiftly put you out of business even if eventually you are proven innocent, or just slow-roll your requests for permissions until you run out of money.
This freedom does not exist in much of the world. The Administrative state is an excellent tool for cementing power. But when people can't afford to lose an election, countries come unglued. Do not let this happen in the US.
Congress can take back its control of the regulatory process. Write no more thousand-page bills with vague authorizations. Fight back hard when agencies exceed their authorization. Insist on objective and retrospective cost benefit analysis. Put in rule-of law protections, including discovery of how agencies make decisions. Insist on strict timelines --if an agency takes more than a year to rule on a request, it's granted. [I later learned this is called a "shot clock" in Washington, a nice metaphor.]
Health care and finance are the two biggest new regulatory headaches. The ACA and Dodd-Frank aren't working, and are important drags on employment and economic growth. Simple workable alternatives exist. Implement them.
The real health care problem is not how we pay for health care, but the many restrictions on its supply and competition.13 If hospitals were as competitive as airlines, they would work darn hard to heal us at much lower --and disclosed! --prices. If the FDA did not strangle new medicines and devices, even generics, prices would fall.
Competition is always the best disinfectant, guarantor of good service and low prices. Yet almost all uncompetitive markets in the US are uncompetitive because some law or regulation keeps competitors out.
Rather than guarantee bank debts, and unleash an army of regulators to make sure banks don't risk too much, we should instead insist that banks get their money in ways that do not risk crises, primarily issuing equity and long-term debt. Then banks can fail just like other companies, and begin to compete just like other companies.14
"The planet is dying, control carbon!" "Your crony energy boondoggles and regulations are killing the economy!" Well, that argument is not getting us anywhere, is it? The answer is straightforward: A simple carbon tax in exchange for elimination of all the growth-killing, intrusive, cronyist, and ineffective micromanagement. We can continue to argue about the rate of that tax, but it will both reduce more carbon, and increase more growth, than the current ineffective policies --and stagnant debate.
None of these recommendations are ideological or partisan. These are just simple, clean-out-the-junk, workable ways to get our regulatory system to actually work, for its goal of protecting consumers and the environment, at minimal economic and political damage.
Social programs: Fix the incentives.
"Cut spending, or the debt will balloon!" "Raise spending or people will die in the streets!" That's getting nowhere too. And it ignores central problems.
In many social programs, if you earn an extra dollar, you lose a dollar or more of benefits. Many programs have cliffs, especially in health care and disability, where earning one extra dollar triggers an enormous loss. Even when one program cuts benefits modestly with income, the interaction of many programs makes work impossible.15 No wonder that people become trapped. We need to fix these disincentives. Doing so will help people better. If we fix the incentives, though it may look like we spend more, in the end we will spend less --and encourage economic growth as well as opportunity.
Spend more to spend less. "Spending is out of control! We need to spend less or there will be a debt crisis!" "Oh there you go being heartless again. We need to invest more in programs that help Americans in need." I feel like I'm at a dinner party hosted by a couple in a bad marriage. This isn't getting us anywhere.
It is important to limit Federal spending. However, we tend to just limit the appearance of spending by moving the same activities off the books. Off-the-books spending does the same economic damage. Or more.
For example, we allow an income tax deduction for mortgage interest, in order to subsidize homeownership. From an economic point of view, this is exactly the same thing as collecting higher taxes, and then sending checks to homeowners. It looks like we're taxing and spending less than we really are. But from an economic growth point of view, it's the same thing.
Actually, it's worse, because it adds unfairness and inefficiency. Suppose a colleague proposes a bill to you: The U.S. Treasury will send checks to homeowners, but high income people get much bigger checks, as will people who borrow a lot, and people who refinance often and take cash out. People with low incomes, who save up to buy houses, or don't refinance, get a lot less. You would say, "You're out of your mind!" But that's exactly what the mortgage interest deduction achieves!
If we were to eliminate the mortgage deduction, and put housing subsidies on budget, where taxpayers can see where their money is going, the resulting homeowner subsidy would surely be a lot smaller, much more progressive, helping lower income people, better targeted at getting people in houses, and less damaging of savings and economic growth. Both Republicans and Democrats should rejoice. Except the headline amount of taxing and spending will increase. Well, spend more to spend less.
We allow a tax deduction for charitable deductions. This is exactly the same thing as taxing more, but then sending checks to non-profits as matching contributions --but much larger checks for contributions from rich people than from poorer people. Then, many "non-profits" spend a lot of money on private jet travel, executive salaries, and political activities. Actual on-budget federal spending, convoluted and inefficient as it is, at least has a modicum of oversight and transparency. If we removed the deduction, but subsidized worthy charities, with transparency and oversight, we'd do a lot more good, and probably overall tax less and spend less. Except the headline amount of taxing and spending might increase. Well, spend more to spend less.
Mandates are the same thing as taxing and spending. Many European countries tax a lot, and then provide services, like health insurance. We mandate that employers provide health insurance. It looks like we're taxing and spending less, but we're not. A health insurance mandate has exactly the same economic effects as a $15,000 head tax on each employee, financing a $15,000 health insurance voucher.
Economics pays no heed to budget tricks. Spending too much rhetorical effort on lowering taxes and spending induces our government to such tricks, with the same growth-destroying effects. If you want economic growth, treat every mandate as taxing and spending.
Taxes: break up the argument.
The outlines of tax reform have been plain for a long time: lower marginal rates, broaden the base by getting rid of the massive welter of special deals. But it can't get done. Why not?
When we try to fix taxes,16 we argue about four things at once: 1) What is the right structure for a tax code? 2) What is the right level of taxes, and therefore, of spending? 3) What activities should the government subsidize -- home mortgages, charitable contributions, electric cars, and so on? 4) How much should the government redistribute income?
Tax reforms fail because we argue about all these together. For example, the Bowles-Simpson commission got to an improvement on the structure of taxes, but then the reform effort fell apart when the Administration wanted more revenue and congressional Republicans less.
I am back at my dysfunctional dinner party. Sometimes, in politics as in marriage, it is wise to bundle issues together, each side accepting a minor loss to ensure what they see as a major gain. You clean up your socks, I'll clean up my makeup. Sometimes, however, we bundle too many issues together, and the result is paralysis, as each side vetoes a package of improvements over a small issue. Then, it's better to work on the issues separately.
So, let's fix taxes by separating these four issues, in four commissions possibly, or better in four completely separate sections of law.
1) Structure. Agree on the right structure of the tax code, with its only goal to raise revenue at minimal economic distortion, but leave the rates blank.
2) Rates. Determine the rates, without touching the structure of the tax code. A good tax code should last decades. Rates may change every year, and likely will be renegotiated every four. But those who want higher or lower rates know they can agree on the structure of the tax code.
3) Separate the subsidy code from the tax code. Mortgage interest subsidies? Electric car subsidies? Sure, we'll talk about them, but separately. Then, we don't have to muck up raising revenue for the government with subsidies, and the budgetary and economic impact of subsidies can be evaluated on their own merits
4) Separate the redistribution code from the tax code. Then we don't muck up raising revenue for the government with income transfers.
The main point is that by separating these four elements of law, each with fundamentally different purposes, we are much more likely to make coherent progress on each. You need not oppose beneficial aspects of an economically efficient tax simplification, say, if you wish to have a greater level of redistribution --well, at least any more than you might oppose any random bill in order to force your way on that issue.
Some thoughts on how each of these might work:
Structure. The economic damage of taxation is entirely about "marginal'' rates --if you earn an extra dollar, how much do you get to enjoy it, after all taxes, federal, state, local, sales, estate, and so forth. Economics has really little to say about how much taxes people pay. The economists' ideal is a tax system in which people pay as much as the Government needs --but each extra dollar earned is tax-free. Politics, of course, focuses pretty much on the opposite, how much people pay and ignoring the economically-distorting margins.
Thus, if you ask 100 economists, "now, forget politics for a moment --that's our job --and tell me what the right tax code is, with the only objective being to raise revenue without distorting the economy,'' the pretty universal answer will be a consumption tax --with no corporate tax, income tax, tax on savings or rates of return, estates, or anything else, and essentially no deductions. (They will then say "but..." and go on to demand subsidies and income redistribution, at which time you have to assure them too that we'll discuss these separately.)
A massive simplification of the tax code is, in my opinion, as or more important than the rates --and it's something we're more likely to agree on. America's tax code is an obscenely complex cronyist nightmare.
For example, that's why I favor, and you should seriously consider, eliminating the corporate tax. Corporations never pay any taxes. All money they send to the government comes from higher prices, lower wages, or lower returns to shareholders --and mostly the former two. If you tax people who receive corporate profits, rather than collecting taxes from higher prices and lower wages, you will have a more progressive tax system.
But more importantly, if you eliminate the corporate tax, you will eliminate the constant stream of lobbyists in your offices each day asking for special favors.
Far too many businesses are structured around taxes, and far too many smart minds are spending their time devising corporate tax avoidance schemes and lobbying strategies. A much simpler tax code even with sharply higher rates --but very clear rates, that we all know about and can plan on --may well have less economic distortion than a massively complex code, with high statutory rates, but a welter of complex schemes and deductions that result in lower taxes.
Subsidy code. Tax expenditures --things like deductions for mortgage interest, employer provided health care, charitable contributions, and the $10,000 credit my wealthy Palo Alto neighbor got from the taxpayers for buying a Tesla -- are estimated at $1.4 trillion,17 compare with $3.5 trillion Federal Receipts and $4 trillion Federal Expenditures.18 Our Federal Government is really a third larger than it looks.
While the subsidy code could consist of a separate discussion of tax expenditures, it would be far better for the rules of the subsidy code to be: all subsidies must be on budget, where we can all see what's going on.
Redistribution. Even a consumption tax can be as progressive as one wants. One can use the regular income tax code with full deduction of savings and omitting capital income, thus taxing high consumption at higher rates and low consumption at lower rates.
Again, however, it might well be more efficient to integrate income redistribution with social programs. Put it on budget, and send checks to people. Yes, that makes spending look larger, but sending a check is the same thing as giving a tax break. And spending can be more carefully monitored.
Infrastructure
Infrastructure is all the rage19. America needs infrastructure. Good infrastructure, purchased at minimum cost, that passes objective cost-benefit criteria, built promptly, can help the economy in the long run. Soft infrastructure --a better justice system, for example --matters as much as hard infrastructure --more asphalt.
However, there is no case that the halving of America's growth rate in the last 20 years is centrally due to potholes and rusting bridges. Poor infrastructure is not the cause of sclerosis, so already one should be wary of infrastructure investment as the central plan to cure that sclerosis.
The claim that infrastructure spending will lift the economy out of its doldrums lies on the "multiplier" effect, that any spending, even wasted, is good for the economy. That is a dubious proposition, especially when the task is to raise the economy by tens of trillions, over decades.
Modern infrastructure is built by machines, and not many people; even less people who do not have the specialized skills. A Freeway in California will do little to help employment of a high school dropout in New York, or a middle-aged mortgage broker in New Jersey. Neither knows how to operate a grader.
The problem with infrastructure is not lack of money. President Obama inaugurated a nearly trillion dollar stimulus plan 8 years ago. His Administration found out there are few shovel-ready projects in America today. They're all tied up waiting for historic review, environmental review, and legal challenges.
The problem with infrastructure is a broken process. Put a time limit on historic, environmental, and other reviews. Require serious, objective, and retrospective cost-benefit analysis. Repeal Davis-Bacon and other contracting requirements that send costs soaring. If the point is infrastructure it should be infrastructure, not passing money around. You ought to be able to agree on more money in return for assurance that the money is wisely spent.
Debt and deficits
This hearing is also about budgets and debts, which I have left to the end. Yes, our deficits are increasing. Yes, every year the Congressional Budget Office declares our long-term promises unsustainable.
I have not emphasized this problem, though in my opinion it is centrally important, and I think I was invited here to say so.
Recognize that computer simulations with hockey-stick debt, designed to frighten into submission a supporter of what he or she feels is necessary government spending, are as ineffective as computer simulations with hockey-stick temperatures, designed to frighten into submission a supporter of current economic growth and skeptic of draconian energy regulation. Yelling about each, louder, is not going to be productive.
And there are many voices who tell you debt is not a problem. Interest rates are at record lows. Why not borrow more, and worry about paying it back later? So, let me offer a few out of the box observations, and suggestions that you might agree on.
It is useful to clarify why debt is a problem. The case that large debts will slowly and inexorably push up interest rates, and crowd out investment, is hard to make in this era of ultra-low rates. Debt does place a burden of repayment on our children and grandchildren, but if we have reasonable economic growth they will be wealthier than we are.
The biggest danger that debt poses is a crisis.
Debt crises, like all crises that really threaten an economy and society, do not come with decades of warning. Do not expect slowly rising interest rates to canary the coalmine. Even Greece could borrow at remarkably low rates. Until, one day, it couldn't, with catastrophic results.
The fear for the US is similar. We will have long years of low rates. Until, someday, it is discovered that some books are cooked, and somebody owes a lot of money that they can't pay back, and people start to question debts everywhere.
For example, suppose Chinese debts blow up, and southern Europe as well. Both Europe and China will start selling Treasury debt quickly. Suppose at the same time that student loans, state and local pensions, and state governments are blowing up, along with some large U.S. companies, and banks under deposit insurance. A recession looms, which the US will want to fight with fiscal stimulus. The last crisis occasioned about $5 trillion of extra borrowing. The next one could double that.
So, the U.S. needs to quickly borrow additional trillions of dollars, while its major customers --foreign central banks --are selling. In addition, the U.S. borrows relatively short term. Each year, the U.S. borrows about $7 trillion to pay off $7 trillion of maturing debt, and then more to cover the deficit.
Imagine all this happens 10 years from now, with social security and medicare unresolved and increasing deficits. The CBO is still issuing its annual warnings that our debt is unsustainable. Now, bond investors are willing to lend to the US government so long as they think someone else will lend tomorrow to pay off their loans today. When they suspect that isn't true, they pull back and interest rates spike.
But our large debts leave our fiscal position sensitive to interest rate rises. At 100% debt to GDP ratio, if interest rates rise to just 5%, that means the deficit rises by 5 percentage points of GDP, or approximately $1 Trillion extra dollars per year. If bond investors were worried about sustainability already, an extra trillion a year of deficits makes it worse. So they demand even higher interest rates. Debt that is easily financed at 1% rates is not sustainable at 5% rates and a catastrophe at 10% rates --if you have a large debt outstanding.
This is a big part of what happened to Greece and nearly happened to Italy. At low interest rates, they are solvent. At high interest rates, they are not.
Debt crises are like an earthquakes. It's always quiet. People laugh at you for worrying. Buying insurance seems like a waste of money. Until it isn't.
So, the way to think about the dangers of debt is not like a predictable problem that comes to us slowly. View the issue as managing a small risk of a catastrophic problem, like a war or pandemic.
The easy answers are straightforward. Sensible reforms to Social Security and Medicare are on the table. Fix the indexing, improve the incentives for older people to keep working. Convert medicare to a premium support policy.
The harder problems are those less recognized. Underfunded pensions, widespread credit guarantees, and explicit or implicit too big to fail guarantees add tinder to the fire. Dry powder and good credit are invaluable.
Above all, undertake a pro-growth economic policy. We grew out of larger debts after World War II; we can do that again.
You can also buy some insurance. Every American household that takes out a mortgage faces the choice: fixed rate, or variable rate? The fixed rate is a little higher. But it can't go up, no matter what happens. The variable rate starts out lower. But if interest rates rise, you might not be able to make the payments, and you might lose the house. That is what happens to countries in a debt crisis.
For the US, this decision is made by the Treasury Department and the Federal Reserve. The Treasury has been gently lengthening the maturity of its borrowings. The Federal Reserve has been neatly undoing that effort.
Both Treasury and Fed need direction from Congress. The Treasury does not regard managing risks to the budget posed by interest rate rises as a central part of its job, and the Fed does not even consider this fact. Congress needs to decide who is in charge of the maturity structure of US debt, and guide the Treasury. I hope that guidance leans towards the fixed rate plan. By issuing long-term debt --I argue in fact for perpetuities, that simply pay a $1 coupon forever with no fixed roll over date -- and engaging in simple swap transactions that every bank uses to manage interest rate risk, the U.S. can isolate itself from a debt crisis very effectively.20 But at least ask that fixed or floating interest rate question and make a decision.
As I have warned against focusing too much attention on on-budget spending, so let me warn against too much attention on deficits rather than spending. If you focus on debt and deficits, the natural inclination is to raise tax rates. Europe's experience in the last few years argues against "austerity" in the form of sharply higher tax rates, as always adding to the disincentive to hire, invest, or start innovative businesses.
Concluding comments
I have sketched some novel and radical-sounding approaches to restoring robust economic growth. Economic growth, together with commonsense fiscal discipline are keys to solving our budget problems.
This is not pie in the sky. These are simple straightforward steps, none controversial as a matter of economics. And there really is no alternative. Ask of other approaches: Does this at all plausibly diagnose why America's growth rate has fallen in half? Does the cure at all plausibly address the diagnosis? Is the cure based on a reasonable causal channel that you can actually explain to a constituent? Does the cure have a ghost of a chance of having a large enough effect to really make a difference?
You may object that fundamental reform is not "politically feasible." Well, what's "politically feasible" can change fast in this country. This is an exciting time politically. The people are mad as hell, and they're not taking it any more. They are ready for fundamental changes.
Furthermore, it is time for Congress to take the lead. These are properly Congressional matters, and no matter who wins the Presidential election you are unlikely to see leadership in this direction.
Winston Churchill once said that Americans can be trusted to do the right thing after we've tried everything else. [NB: apparently this is an urban legend. Oh well, it's a good quip if not a quote] Well, we've tried everything else. It's time to prove him right.
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1. You can find a full CV, a list of all affiliations, and a catalog of written work at http://faculty.chicagobooth.edu/john.cochrane/index.htm. ↩
2.This testimony summarizes several recent essays. On growth and for an overview, see "Economic Growth." 2016. In John Norton Moore, ed., The Presidential Debates Carolina Academic Press p. 65-90. http://faculty.chicagobooth.edu/john.cochrane/research/papers/cochrane_growth.pdf; "Ending America's Slow-Growth Tailspin." Wall Street Journal, May 3 2016. http://www.wsj.com/articles/ending-americas-slow-growth-tailspin-1462230818, and "Ideas for Renewing American Prosperity" Wall Street Journal July 4 2014. http://online.wsj.com/articles/ideas-for-renewing-american-prosperity-1404777194. ↩
3. https://fred.stlouisfed.org/series/GDPCA, Continuously compounded annual rates of growth. Per capita https://fred.stlouisfed.org/series/A939RX0Q048SBEA ↩
4. https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51580-LTBO-2.pdf ↩
5. 100*exp(30 x 0.02) = 182. 100*exp(30*0.035) = 286. ↩
6. As an example of agreement on the fundamental importance of growth among economists of all political leanings, see Larry Summers, "The Progressive Case for Championing Pro-Growth Policies," 2016. http://larrysummers.com/2016/08/08/the-progressive-case-for-championing-pro-growth-policies/ ↩
7. For an excellent recent exposition of this view, see Robert J. Gordon, The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. Princeton University Press 2016. http://press.princeton.edu/titles/10544.html ↩
8. An influential example of these views, including self-financing stimulus: J. Bradford DeLong and Lawrence H. Summers, "Fiscal Policy in a Depressed Economy" Brookings Papers on Economic Activity. Spring 2012. https://www.brookings.edu/bpea-articles/fiscal-policy-in-a-depressed-economy/. Interestingly, DeLong and Summers condition their view on interest rates stuck at zero, a cautionary limitation that current stimulus advocates seem to have forgotten. ↩
9. See "Rule of Law in the Regulatory State." 2015. http://faculty.chicagobooth.edu/john.cochrane/research/papers/ rule_of_law_and_regulation essay.pdf ↩
10. http://www.wsj.com/articles/the-clinton-for-profit-college-standard-1473204250 ↩
11. http://www.washingtontimes.com/news/2016/sep/7/irs-refuses-to-abandon-targeting-criteria-used-aga/ ↩
12. http://www.usatoday.com/story/news/politics/onpolitics/2016/02/22/trump-ricketts-family-better-careful/80761060/ ↩
13. See "After the ACA: Freeing the market for health care." 2015. In Anup Malani and Michael H. Schill, Eds. The Future of Healthcare Reform in the United States, p. 161-201, Chicago: University of Chicago Press. http://faculty.chicagobooth.edu/john.cochrane/research/papers/after_aca_published.pdf ↩
14. See "Toward a run-free financial system." 2014. In Across the Great Divide: New Perspectives on the Financial Crisis, Martin Neil Baily and John B. Taylor, Editors, Stanford: Hoover Institution Press, p. 197-249. http://faculty.chicagobooth.edu/john.cochrane/research/papers/across-the-great-divide-ch10.pdf, and "A Blueprint for Effective Financial Reform." 2016. In George P. Shultz, ed, Blueprint for America Hoover Institution Press, p. 71 - 84. http://faculty.chicagobooth.edu/john.cochrane/research/papers/george_shultz_blueprint_for_america_ch7.pdf ↩
15. See Casey Mulligan The Redistributon Recession, Oxford University Press 2012. ↩
16. See "Here's what genuine tax reform looks like." Wall Street Journal, December 23 2015. http://www.wsj.com/articles/heres-what-genuine-tax-reform-looks-like-1450828827 ↩
17. https://www.whitehouse.gov/omb/budget/Analytical_Perspectives Table 14; http://www.taxpolicycenter.org/briefing-book/what-tax-expenditure-budget ↩
18. https://fred.stlouisfed.org/series/W019RCQ027SBEA ↩
19. See "The Clinton Plan's Growth Deficit." Wall Street Journal, August 12 2016. http://www.wsj.com/articles/the-clinton-plans-growth-deficit-1470957720. Also, for an excellent and well documented review of these issues, see Edward L. Glaeser, 2016, "If you Build it..." City Journal, Summer 2016, http://www.city-journal.org/html/if-you-build-it-14606.html ↩
20. For more details see: A New Structure For U. S. Federal Debt." 2015. In David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt, pp. 91-146. Washington DC: Brookings Institution Press. https://www.brookings.edu/book/the-13-trillion-question/ and http://faculty.chicagobooth.edu/john.cochrane/research/papers/Cochrane_US_Federal_Debt.pdf. For a clear analysis of the problem, that recommends the opposite action --shortening the maturity structure to take advantage of low rates --see Robin Greenwood, Samuel G. Hanson, Joshua S. Rudolph, and Lawrence H. Summers, "The Optimal Maturity of Government Debt" and "Debt Management Conflicts between the U.S. Treasury and the Federal Reserve," also in David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt.↩
I learned a few things while in DC.
The Paul Ryan "A better way" plan is serious, detailed, and you will be hearing a lot about it. I read most of it in preparation for my trip, and it's impressive. Expect reviews here soon. I learned that Republicans seem to be uniting behind it and ready to make a major push to publicize it. It is, by design, a document that Senatorial and Congressional candidates will use to define a positive agenda for their campaigns, as well as describing a comprehensive legislative and policy agenda.
"Infrastructure" is bigger in the conversation than I thought. But since there is no case that potholes caused the halving of America's trend growth rate, do not be surprised if infrastructure fails to double the trend growth rate. It's also a bit sad that the most common growth idea in Washington is, acording to my commenters, about 2,500 years old -- employment on public works.
Washington conversation remains in thrall to the latest numbers. There was lots of buzz at my hearing about a recent census report that median family income was up 5%. Chicagoans used to get excited about the 40 degree February thaw.
The quality can be very very good. Congressman Price, the chair of my session, covered just about every topic in my testimony, and possibly better. Congressional staff are really good, and they are paying attention to the latest. If you write policy-related economics, take heart, they really are listening.
The questions at my hearing pushed me to clarify just how will debt problems affect the average American. What I had not said in the prepared remarks needs to be said. If we don't get an explosion of growth, the US will not be able to make good on its promises to social security, health care, government pensions, credit guarantees, taxpayers, and bondholders. Something's got to give. And the growing size of entitlements means they must give. Even a default on the debt, raising taxes to the long-run Laffer limit, will not pay for current pension and health promises. Those will be cut. The question is how. If we wait to a fiscal crisis, they will be cut unexpectedly and by large amounts, leaving people who counted on them in dire straits. Greece is a good example. If we make sensible sustainable promises now, they will be cut less, and people will have decades to adjust.
Ok, on to html testimony:
Growing Risks to the Budget and the Economy.
Testimony of John H. Cochrane before the House Committee on Budget.
September 14 2016
Chairman Price, Ranking Member Van Hollen, and members of the committee: It is an honor to speak to you today.
I am John H. Cochrane. I am a Senior Fellow of the Hoover Institution at Stanford University1. I speak to you today on my own behalf on not that of any institution with which I am affiliated.
Sclerotic growth is our country's most fundamental economic problem.2 From 1950 to 2000, our economy grew at 3.6% per year.3 Since 2000, it has grown at barely half that rate, 1.8% per year. Even starting at the bottom of the recession in 2009, usually a period of super-fast catch-up growth, it has grown at just over 2% per year. Growth per person fell from 2.3% to 0.9%, and since the recession has been 1.3%.
The CBO long-term budget analysis4 looks out 30 years, and forecasts roughly 2% growth. On current trends that is likely an over-estimate, as it presumes we will have no recessions, or that future recessions will have not have the permanent effects we have seen of the last several recessions. If we grow at 2%, the economy will expand by 82% in 30 years, almost doubling.5 But if we can just get back to the 3.6% postwar normal growth rate, the economy will expand by 194%, almost tripling instead. We will add the entire current US economic output to the total. In per-person terms, a 1.3% trend gives the average American 48% more income in 30 years. Reverting to the postwar 2.3% average means 99% more income, twice as much. And economic policy was not perfect in the last half of the 20th century. We should be able to do even better.
Restoring sustained, long-term economic growth is the key to just about every economic and budgetary problem we face.
Nowhere else are we talking about doubling or not the average American's income.6
Nowhere else are we talking about doubling or not Federal revenues. Long-term Federal revenues depend almost entirely on economic growth. In 1990, the Federal Government raised $1.6 trillion inflation-adjusted dollars. In 2016, this has doubled to $3.1 trillion. Wow! Did the government double tax rates? No. The overall federal tax rate stayed almost the same -- 18.0% of GDP in 1990, 18.8% of GDP today. Income doubled.
Whether deficits and debt balloon, whether we our government can pay for Social Security and health care, defend the country, and fund other goals such as protecting the environment, depend most crucially on economic growth.
Why has growth halved? Some will tell you that the economy is working as well as it can, but we've just run out of new ideas.7 A quick tour of the Silicon Valley makes one suspicious of that claim.
Others will bring you novel and untested economic theories: we suffer an ill-defined "secular stagnation" that requires massive borrowing and spending, even wasted spending. The "multiplier" translating government spending to output is not one and a half, and a temporary expedient which can briefly raise the level of income in a depression, but six or more, enough to finance itself by the larger tax revenues which larger output induces --a proposition long derided of the "supply side" --and it can now kick off long-term growth.8 Like 18th century doctors to whom disease was an imbalance of humors, modern macroeconomic doctors have one diagnosis and remedy for all the complex ills that can befall a modern economy: "demand!"
I'm here to tell you the most plausible answer is simple, clear, sensible, and much more difficult. Our legal and regulatory system is slowly strangling the golden goose of growth. There is no single Big Fix. Each market, industry, law, and agency is screwed up in its own particular way, and needs patient reform.
America is middle aged, out of shape and overweight. One voice says: well, get used to it, buy bigger pants. Another voice says: 10 day miracle detox cleanse! I'm here to tell you that the only reliable answer is good old-fashioned diet and exercise.
Or, a better metaphor perhaps: our economy, legal and regulatory system has become like a hoarder's house. No, there isn't a miracle organizer system. We have to patiently clean out every room.
Economic regulation, law and policy all slow growth by their nature. Growth comes from new ideas, new products, new processes, new ways of doing things, and most of these embodied in new companies. And these upend old companies, and displace their workers, both of whom come to Washington pleading that you save them and their jobs. It is a painful process. It is natural that the administration, regulatory agencies, and you, listen and try to protect them. But every time we protect an old company, an old industry, or an old job, from innovation and competition, we slow down growth.
How do we solve this problem and get back to growth? Our national political and economic debate has gotten stale, each side repeating the same base-pleasing talking points, but making no progress persuading the other. Making one or the other points again, or louder, will get us nowhere. I will try, instead, to find policies that think outside of these tired boxes, and that can appeal to all sides of the political spectrum.
Rather than "more government" or "less government," let's focus on fixing government. We need above all a grand simplification of our economic, legal, and political life, so that government does what it does competently and efficiently.
Regulation: fix the process.
"There's too much regulation, we're stifling business. No, there's too little regulation, businesses are hurting people." Or so goes the tired argument. Regulation is strangling business investment, and especially the formation of new businesses. But the main problem with regulation is how it's done, not how much. If we fix regulation, the quantity will take care of itself. We can agree on smarter regulation, better regulation, not just "more" or "less" regulation.9
Regulation is too discretionary --you can't read the rules and know what to do, you have to ask for permission granted on regulators' whim. No wonder that the revolving door revolves faster and faster, oiled by more and more money.
Regulatory decisions take forever. Just deciding on the Keystone Pipeline or California's high speed train --I pick examples from left and right on purpose --takes longer than it did to build the transcontinental railroad in the 1860s. By hand.
Regulation has lost rule-of-law protections. You often can't see the evidence, challenge witnesses, or appeal. The agency is cop, prosecutor, judge, jury and executioner all rolled in to one. [And, a Congressman pointed out during the discussion, recipient of collected fines.]
Most dangerous of all, regulation and associated legal action are becoming more politicized. Each week brings a new scandal. Last week10, we learned how the Government shut down ITT tech, but not the well-connected Laureate International. The IRS still targets conservative groups11. The week before, we learned how the company that makes Epi-pens, headed by the daughter of a Senator, got the FDA to block its competitors, Congress to mandate its products, and jacked up the price of an item that costs a few bucks to $600. This is a bi-partisan danger. For example, presidential candidate Donald Trump has already threatened to use the power of the government against people who donate to opponents' campaigns.12
America works because you can lose an election, support an unpopular cause, speak out against a policy you disagree with, and this will not bring down the attentions of the IRS, the EPA, the NLRB, the SEC, the CFPB, the DOJ, the FDA, the FTC, the Department of Education, and so forth, who can swiftly put you out of business even if eventually you are proven innocent, or just slow-roll your requests for permissions until you run out of money.
This freedom does not exist in much of the world. The Administrative state is an excellent tool for cementing power. But when people can't afford to lose an election, countries come unglued. Do not let this happen in the US.
Congress can take back its control of the regulatory process. Write no more thousand-page bills with vague authorizations. Fight back hard when agencies exceed their authorization. Insist on objective and retrospective cost benefit analysis. Put in rule-of law protections, including discovery of how agencies make decisions. Insist on strict timelines --if an agency takes more than a year to rule on a request, it's granted. [I later learned this is called a "shot clock" in Washington, a nice metaphor.]
Health care and finance are the two biggest new regulatory headaches. The ACA and Dodd-Frank aren't working, and are important drags on employment and economic growth. Simple workable alternatives exist. Implement them.
The real health care problem is not how we pay for health care, but the many restrictions on its supply and competition.13 If hospitals were as competitive as airlines, they would work darn hard to heal us at much lower --and disclosed! --prices. If the FDA did not strangle new medicines and devices, even generics, prices would fall.
Competition is always the best disinfectant, guarantor of good service and low prices. Yet almost all uncompetitive markets in the US are uncompetitive because some law or regulation keeps competitors out.
Rather than guarantee bank debts, and unleash an army of regulators to make sure banks don't risk too much, we should instead insist that banks get their money in ways that do not risk crises, primarily issuing equity and long-term debt. Then banks can fail just like other companies, and begin to compete just like other companies.14
"The planet is dying, control carbon!" "Your crony energy boondoggles and regulations are killing the economy!" Well, that argument is not getting us anywhere, is it? The answer is straightforward: A simple carbon tax in exchange for elimination of all the growth-killing, intrusive, cronyist, and ineffective micromanagement. We can continue to argue about the rate of that tax, but it will both reduce more carbon, and increase more growth, than the current ineffective policies --and stagnant debate.
None of these recommendations are ideological or partisan. These are just simple, clean-out-the-junk, workable ways to get our regulatory system to actually work, for its goal of protecting consumers and the environment, at minimal economic and political damage.
Social programs: Fix the incentives.
"Cut spending, or the debt will balloon!" "Raise spending or people will die in the streets!" That's getting nowhere too. And it ignores central problems.
In many social programs, if you earn an extra dollar, you lose a dollar or more of benefits. Many programs have cliffs, especially in health care and disability, where earning one extra dollar triggers an enormous loss. Even when one program cuts benefits modestly with income, the interaction of many programs makes work impossible.15 No wonder that people become trapped. We need to fix these disincentives. Doing so will help people better. If we fix the incentives, though it may look like we spend more, in the end we will spend less --and encourage economic growth as well as opportunity.
Spend more to spend less. "Spending is out of control! We need to spend less or there will be a debt crisis!" "Oh there you go being heartless again. We need to invest more in programs that help Americans in need." I feel like I'm at a dinner party hosted by a couple in a bad marriage. This isn't getting us anywhere.
It is important to limit Federal spending. However, we tend to just limit the appearance of spending by moving the same activities off the books. Off-the-books spending does the same economic damage. Or more.
For example, we allow an income tax deduction for mortgage interest, in order to subsidize homeownership. From an economic point of view, this is exactly the same thing as collecting higher taxes, and then sending checks to homeowners. It looks like we're taxing and spending less than we really are. But from an economic growth point of view, it's the same thing.
Actually, it's worse, because it adds unfairness and inefficiency. Suppose a colleague proposes a bill to you: The U.S. Treasury will send checks to homeowners, but high income people get much bigger checks, as will people who borrow a lot, and people who refinance often and take cash out. People with low incomes, who save up to buy houses, or don't refinance, get a lot less. You would say, "You're out of your mind!" But that's exactly what the mortgage interest deduction achieves!
If we were to eliminate the mortgage deduction, and put housing subsidies on budget, where taxpayers can see where their money is going, the resulting homeowner subsidy would surely be a lot smaller, much more progressive, helping lower income people, better targeted at getting people in houses, and less damaging of savings and economic growth. Both Republicans and Democrats should rejoice. Except the headline amount of taxing and spending will increase. Well, spend more to spend less.
We allow a tax deduction for charitable deductions. This is exactly the same thing as taxing more, but then sending checks to non-profits as matching contributions --but much larger checks for contributions from rich people than from poorer people. Then, many "non-profits" spend a lot of money on private jet travel, executive salaries, and political activities. Actual on-budget federal spending, convoluted and inefficient as it is, at least has a modicum of oversight and transparency. If we removed the deduction, but subsidized worthy charities, with transparency and oversight, we'd do a lot more good, and probably overall tax less and spend less. Except the headline amount of taxing and spending might increase. Well, spend more to spend less.
Mandates are the same thing as taxing and spending. Many European countries tax a lot, and then provide services, like health insurance. We mandate that employers provide health insurance. It looks like we're taxing and spending less, but we're not. A health insurance mandate has exactly the same economic effects as a $15,000 head tax on each employee, financing a $15,000 health insurance voucher.
Economics pays no heed to budget tricks. Spending too much rhetorical effort on lowering taxes and spending induces our government to such tricks, with the same growth-destroying effects. If you want economic growth, treat every mandate as taxing and spending.
Taxes: break up the argument.
The outlines of tax reform have been plain for a long time: lower marginal rates, broaden the base by getting rid of the massive welter of special deals. But it can't get done. Why not?
When we try to fix taxes,16 we argue about four things at once: 1) What is the right structure for a tax code? 2) What is the right level of taxes, and therefore, of spending? 3) What activities should the government subsidize -- home mortgages, charitable contributions, electric cars, and so on? 4) How much should the government redistribute income?
Tax reforms fail because we argue about all these together. For example, the Bowles-Simpson commission got to an improvement on the structure of taxes, but then the reform effort fell apart when the Administration wanted more revenue and congressional Republicans less.
I am back at my dysfunctional dinner party. Sometimes, in politics as in marriage, it is wise to bundle issues together, each side accepting a minor loss to ensure what they see as a major gain. You clean up your socks, I'll clean up my makeup. Sometimes, however, we bundle too many issues together, and the result is paralysis, as each side vetoes a package of improvements over a small issue. Then, it's better to work on the issues separately.
So, let's fix taxes by separating these four issues, in four commissions possibly, or better in four completely separate sections of law.
1) Structure. Agree on the right structure of the tax code, with its only goal to raise revenue at minimal economic distortion, but leave the rates blank.
2) Rates. Determine the rates, without touching the structure of the tax code. A good tax code should last decades. Rates may change every year, and likely will be renegotiated every four. But those who want higher or lower rates know they can agree on the structure of the tax code.
3) Separate the subsidy code from the tax code. Mortgage interest subsidies? Electric car subsidies? Sure, we'll talk about them, but separately. Then, we don't have to muck up raising revenue for the government with subsidies, and the budgetary and economic impact of subsidies can be evaluated on their own merits
4) Separate the redistribution code from the tax code. Then we don't muck up raising revenue for the government with income transfers.
The main point is that by separating these four elements of law, each with fundamentally different purposes, we are much more likely to make coherent progress on each. You need not oppose beneficial aspects of an economically efficient tax simplification, say, if you wish to have a greater level of redistribution --well, at least any more than you might oppose any random bill in order to force your way on that issue.
Some thoughts on how each of these might work:
Structure. The economic damage of taxation is entirely about "marginal'' rates --if you earn an extra dollar, how much do you get to enjoy it, after all taxes, federal, state, local, sales, estate, and so forth. Economics has really little to say about how much taxes people pay. The economists' ideal is a tax system in which people pay as much as the Government needs --but each extra dollar earned is tax-free. Politics, of course, focuses pretty much on the opposite, how much people pay and ignoring the economically-distorting margins.
Thus, if you ask 100 economists, "now, forget politics for a moment --that's our job --and tell me what the right tax code is, with the only objective being to raise revenue without distorting the economy,'' the pretty universal answer will be a consumption tax --with no corporate tax, income tax, tax on savings or rates of return, estates, or anything else, and essentially no deductions. (They will then say "but..." and go on to demand subsidies and income redistribution, at which time you have to assure them too that we'll discuss these separately.)
A massive simplification of the tax code is, in my opinion, as or more important than the rates --and it's something we're more likely to agree on. America's tax code is an obscenely complex cronyist nightmare.
For example, that's why I favor, and you should seriously consider, eliminating the corporate tax. Corporations never pay any taxes. All money they send to the government comes from higher prices, lower wages, or lower returns to shareholders --and mostly the former two. If you tax people who receive corporate profits, rather than collecting taxes from higher prices and lower wages, you will have a more progressive tax system.
But more importantly, if you eliminate the corporate tax, you will eliminate the constant stream of lobbyists in your offices each day asking for special favors.
Far too many businesses are structured around taxes, and far too many smart minds are spending their time devising corporate tax avoidance schemes and lobbying strategies. A much simpler tax code even with sharply higher rates --but very clear rates, that we all know about and can plan on --may well have less economic distortion than a massively complex code, with high statutory rates, but a welter of complex schemes and deductions that result in lower taxes.
Subsidy code. Tax expenditures --things like deductions for mortgage interest, employer provided health care, charitable contributions, and the $10,000 credit my wealthy Palo Alto neighbor got from the taxpayers for buying a Tesla -- are estimated at $1.4 trillion,17 compare with $3.5 trillion Federal Receipts and $4 trillion Federal Expenditures.18 Our Federal Government is really a third larger than it looks.
While the subsidy code could consist of a separate discussion of tax expenditures, it would be far better for the rules of the subsidy code to be: all subsidies must be on budget, where we can all see what's going on.
Redistribution. Even a consumption tax can be as progressive as one wants. One can use the regular income tax code with full deduction of savings and omitting capital income, thus taxing high consumption at higher rates and low consumption at lower rates.
Again, however, it might well be more efficient to integrate income redistribution with social programs. Put it on budget, and send checks to people. Yes, that makes spending look larger, but sending a check is the same thing as giving a tax break. And spending can be more carefully monitored.
Infrastructure
Infrastructure is all the rage19. America needs infrastructure. Good infrastructure, purchased at minimum cost, that passes objective cost-benefit criteria, built promptly, can help the economy in the long run. Soft infrastructure --a better justice system, for example --matters as much as hard infrastructure --more asphalt.
However, there is no case that the halving of America's growth rate in the last 20 years is centrally due to potholes and rusting bridges. Poor infrastructure is not the cause of sclerosis, so already one should be wary of infrastructure investment as the central plan to cure that sclerosis.
The claim that infrastructure spending will lift the economy out of its doldrums lies on the "multiplier" effect, that any spending, even wasted, is good for the economy. That is a dubious proposition, especially when the task is to raise the economy by tens of trillions, over decades.
Modern infrastructure is built by machines, and not many people; even less people who do not have the specialized skills. A Freeway in California will do little to help employment of a high school dropout in New York, or a middle-aged mortgage broker in New Jersey. Neither knows how to operate a grader.
The problem with infrastructure is not lack of money. President Obama inaugurated a nearly trillion dollar stimulus plan 8 years ago. His Administration found out there are few shovel-ready projects in America today. They're all tied up waiting for historic review, environmental review, and legal challenges.
The problem with infrastructure is a broken process. Put a time limit on historic, environmental, and other reviews. Require serious, objective, and retrospective cost-benefit analysis. Repeal Davis-Bacon and other contracting requirements that send costs soaring. If the point is infrastructure it should be infrastructure, not passing money around. You ought to be able to agree on more money in return for assurance that the money is wisely spent.
Debt and deficits
This hearing is also about budgets and debts, which I have left to the end. Yes, our deficits are increasing. Yes, every year the Congressional Budget Office declares our long-term promises unsustainable.
I have not emphasized this problem, though in my opinion it is centrally important, and I think I was invited here to say so.
Recognize that computer simulations with hockey-stick debt, designed to frighten into submission a supporter of what he or she feels is necessary government spending, are as ineffective as computer simulations with hockey-stick temperatures, designed to frighten into submission a supporter of current economic growth and skeptic of draconian energy regulation. Yelling about each, louder, is not going to be productive.
And there are many voices who tell you debt is not a problem. Interest rates are at record lows. Why not borrow more, and worry about paying it back later? So, let me offer a few out of the box observations, and suggestions that you might agree on.
It is useful to clarify why debt is a problem. The case that large debts will slowly and inexorably push up interest rates, and crowd out investment, is hard to make in this era of ultra-low rates. Debt does place a burden of repayment on our children and grandchildren, but if we have reasonable economic growth they will be wealthier than we are.
The biggest danger that debt poses is a crisis.
Debt crises, like all crises that really threaten an economy and society, do not come with decades of warning. Do not expect slowly rising interest rates to canary the coalmine. Even Greece could borrow at remarkably low rates. Until, one day, it couldn't, with catastrophic results.
The fear for the US is similar. We will have long years of low rates. Until, someday, it is discovered that some books are cooked, and somebody owes a lot of money that they can't pay back, and people start to question debts everywhere.
For example, suppose Chinese debts blow up, and southern Europe as well. Both Europe and China will start selling Treasury debt quickly. Suppose at the same time that student loans, state and local pensions, and state governments are blowing up, along with some large U.S. companies, and banks under deposit insurance. A recession looms, which the US will want to fight with fiscal stimulus. The last crisis occasioned about $5 trillion of extra borrowing. The next one could double that.
So, the U.S. needs to quickly borrow additional trillions of dollars, while its major customers --foreign central banks --are selling. In addition, the U.S. borrows relatively short term. Each year, the U.S. borrows about $7 trillion to pay off $7 trillion of maturing debt, and then more to cover the deficit.
Imagine all this happens 10 years from now, with social security and medicare unresolved and increasing deficits. The CBO is still issuing its annual warnings that our debt is unsustainable. Now, bond investors are willing to lend to the US government so long as they think someone else will lend tomorrow to pay off their loans today. When they suspect that isn't true, they pull back and interest rates spike.
But our large debts leave our fiscal position sensitive to interest rate rises. At 100% debt to GDP ratio, if interest rates rise to just 5%, that means the deficit rises by 5 percentage points of GDP, or approximately $1 Trillion extra dollars per year. If bond investors were worried about sustainability already, an extra trillion a year of deficits makes it worse. So they demand even higher interest rates. Debt that is easily financed at 1% rates is not sustainable at 5% rates and a catastrophe at 10% rates --if you have a large debt outstanding.
This is a big part of what happened to Greece and nearly happened to Italy. At low interest rates, they are solvent. At high interest rates, they are not.
Debt crises are like an earthquakes. It's always quiet. People laugh at you for worrying. Buying insurance seems like a waste of money. Until it isn't.
So, the way to think about the dangers of debt is not like a predictable problem that comes to us slowly. View the issue as managing a small risk of a catastrophic problem, like a war or pandemic.
The easy answers are straightforward. Sensible reforms to Social Security and Medicare are on the table. Fix the indexing, improve the incentives for older people to keep working. Convert medicare to a premium support policy.
The harder problems are those less recognized. Underfunded pensions, widespread credit guarantees, and explicit or implicit too big to fail guarantees add tinder to the fire. Dry powder and good credit are invaluable.
Above all, undertake a pro-growth economic policy. We grew out of larger debts after World War II; we can do that again.
You can also buy some insurance. Every American household that takes out a mortgage faces the choice: fixed rate, or variable rate? The fixed rate is a little higher. But it can't go up, no matter what happens. The variable rate starts out lower. But if interest rates rise, you might not be able to make the payments, and you might lose the house. That is what happens to countries in a debt crisis.
For the US, this decision is made by the Treasury Department and the Federal Reserve. The Treasury has been gently lengthening the maturity of its borrowings. The Federal Reserve has been neatly undoing that effort.
Both Treasury and Fed need direction from Congress. The Treasury does not regard managing risks to the budget posed by interest rate rises as a central part of its job, and the Fed does not even consider this fact. Congress needs to decide who is in charge of the maturity structure of US debt, and guide the Treasury. I hope that guidance leans towards the fixed rate plan. By issuing long-term debt --I argue in fact for perpetuities, that simply pay a $1 coupon forever with no fixed roll over date -- and engaging in simple swap transactions that every bank uses to manage interest rate risk, the U.S. can isolate itself from a debt crisis very effectively.20 But at least ask that fixed or floating interest rate question and make a decision.
As I have warned against focusing too much attention on on-budget spending, so let me warn against too much attention on deficits rather than spending. If you focus on debt and deficits, the natural inclination is to raise tax rates. Europe's experience in the last few years argues against "austerity" in the form of sharply higher tax rates, as always adding to the disincentive to hire, invest, or start innovative businesses.
Concluding comments
I have sketched some novel and radical-sounding approaches to restoring robust economic growth. Economic growth, together with commonsense fiscal discipline are keys to solving our budget problems.
This is not pie in the sky. These are simple straightforward steps, none controversial as a matter of economics. And there really is no alternative. Ask of other approaches: Does this at all plausibly diagnose why America's growth rate has fallen in half? Does the cure at all plausibly address the diagnosis? Is the cure based on a reasonable causal channel that you can actually explain to a constituent? Does the cure have a ghost of a chance of having a large enough effect to really make a difference?
You may object that fundamental reform is not "politically feasible." Well, what's "politically feasible" can change fast in this country. This is an exciting time politically. The people are mad as hell, and they're not taking it any more. They are ready for fundamental changes.
Furthermore, it is time for Congress to take the lead. These are properly Congressional matters, and no matter who wins the Presidential election you are unlikely to see leadership in this direction.
Winston Churchill once said that Americans can be trusted to do the right thing after we've tried everything else. [NB: apparently this is an urban legend. Oh well, it's a good quip if not a quote] Well, we've tried everything else. It's time to prove him right.
------
1. You can find a full CV, a list of all affiliations, and a catalog of written work at http://faculty.chicagobooth.edu/john.cochrane/index.htm. ↩
2.This testimony summarizes several recent essays. On growth and for an overview, see "Economic Growth." 2016. In John Norton Moore, ed., The Presidential Debates Carolina Academic Press p. 65-90. http://faculty.chicagobooth.edu/john.cochrane/research/papers/cochrane_growth.pdf; "Ending America's Slow-Growth Tailspin." Wall Street Journal, May 3 2016. http://www.wsj.com/articles/ending-americas-slow-growth-tailspin-1462230818, and "Ideas for Renewing American Prosperity" Wall Street Journal July 4 2014. http://online.wsj.com/articles/ideas-for-renewing-american-prosperity-1404777194. ↩
3. https://fred.stlouisfed.org/series/GDPCA, Continuously compounded annual rates of growth. Per capita https://fred.stlouisfed.org/series/A939RX0Q048SBEA ↩
4. https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51580-LTBO-2.pdf ↩
5. 100*exp(30 x 0.02) = 182. 100*exp(30*0.035) = 286. ↩
6. As an example of agreement on the fundamental importance of growth among economists of all political leanings, see Larry Summers, "The Progressive Case for Championing Pro-Growth Policies," 2016. http://larrysummers.com/2016/08/08/the-progressive-case-for-championing-pro-growth-policies/ ↩
7. For an excellent recent exposition of this view, see Robert J. Gordon, The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. Princeton University Press 2016. http://press.princeton.edu/titles/10544.html ↩
8. An influential example of these views, including self-financing stimulus: J. Bradford DeLong and Lawrence H. Summers, "Fiscal Policy in a Depressed Economy" Brookings Papers on Economic Activity. Spring 2012. https://www.brookings.edu/bpea-articles/fiscal-policy-in-a-depressed-economy/. Interestingly, DeLong and Summers condition their view on interest rates stuck at zero, a cautionary limitation that current stimulus advocates seem to have forgotten. ↩
9. See "Rule of Law in the Regulatory State." 2015. http://faculty.chicagobooth.edu/john.cochrane/research/papers/ rule_of_law_and_regulation essay.pdf ↩
10. http://www.wsj.com/articles/the-clinton-for-profit-college-standard-1473204250 ↩
11. http://www.washingtontimes.com/news/2016/sep/7/irs-refuses-to-abandon-targeting-criteria-used-aga/ ↩
12. http://www.usatoday.com/story/news/politics/onpolitics/2016/02/22/trump-ricketts-family-better-careful/80761060/ ↩
13. See "After the ACA: Freeing the market for health care." 2015. In Anup Malani and Michael H. Schill, Eds. The Future of Healthcare Reform in the United States, p. 161-201, Chicago: University of Chicago Press. http://faculty.chicagobooth.edu/john.cochrane/research/papers/after_aca_published.pdf ↩
14. See "Toward a run-free financial system." 2014. In Across the Great Divide: New Perspectives on the Financial Crisis, Martin Neil Baily and John B. Taylor, Editors, Stanford: Hoover Institution Press, p. 197-249. http://faculty.chicagobooth.edu/john.cochrane/research/papers/across-the-great-divide-ch10.pdf, and "A Blueprint for Effective Financial Reform." 2016. In George P. Shultz, ed, Blueprint for America Hoover Institution Press, p. 71 - 84. http://faculty.chicagobooth.edu/john.cochrane/research/papers/george_shultz_blueprint_for_america_ch7.pdf ↩
15. See Casey Mulligan The Redistributon Recession, Oxford University Press 2012. ↩
16. See "Here's what genuine tax reform looks like." Wall Street Journal, December 23 2015. http://www.wsj.com/articles/heres-what-genuine-tax-reform-looks-like-1450828827 ↩
17. https://www.whitehouse.gov/omb/budget/Analytical_Perspectives Table 14; http://www.taxpolicycenter.org/briefing-book/what-tax-expenditure-budget ↩
18. https://fred.stlouisfed.org/series/W019RCQ027SBEA ↩
19. See "The Clinton Plan's Growth Deficit." Wall Street Journal, August 12 2016. http://www.wsj.com/articles/the-clinton-plans-growth-deficit-1470957720. Also, for an excellent and well documented review of these issues, see Edward L. Glaeser, 2016, "If you Build it..." City Journal, Summer 2016, http://www.city-journal.org/html/if-you-build-it-14606.html ↩
20. For more details see: A New Structure For U. S. Federal Debt." 2015. In David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt, pp. 91-146. Washington DC: Brookings Institution Press. https://www.brookings.edu/book/the-13-trillion-question/ and http://faculty.chicagobooth.edu/john.cochrane/research/papers/Cochrane_US_Federal_Debt.pdf. For a clear analysis of the problem, that recommends the opposite action --shortening the maturity structure to take advantage of low rates --see Robin Greenwood, Samuel G. Hanson, Joshua S. Rudolph, and Lawrence H. Summers, "The Optimal Maturity of Government Debt" and "Debt Management Conflicts between the U.S. Treasury and the Federal Reserve," also in David Wessel, Ed., The $13 Trillion Question: Managing the U.S. Government's Debt.↩
Rabu, 14 September 2016
Testimony
I was invited to testify at a hearing of the House budget committee on Sept 14. It's nothing novel or revolutionary, but a chance to put my thoughts together on how to get growth going again, and policy approaches that get past the usual partisan squabbling. Here are my oral remarks. (pdf version here.) The written testimony, with lots of explanation and footnotes, is here. (pdf) (Getting footnotes in html is a pain.)
Chairman Price, Ranking Member Van Hollen, and members of the committee: It is an honor to speak to you today.
Sclerotic growth is our country’s most fundamental economic problem. If we could get back to the three and half percent postwar average, we would, in the next 30 years, triple rather than double the size of the economy—and tax revenues, which would do wonders for our debt problem.
Why has growth halved? The most plausible answer is simple and sensible: Our legal and regulatory system is slowly strangling the golden goose of growth.
How do we fix it? Our national political and economic debate just makes the same points again, louder, and going nowhere. Instead, let us look together for novel and effective policies that can appeal to all sides.
Regulation:
Let’s get past “too much” or “too little” regulation, and fix regulation instead.
Regulation is too discretionary – people can’t read the rules and know what to do. Regulatory decisions take forever. Regulation has lost rule-of-law protections. Agencies are cop, prosecutor, judge, jury and executioner all rolled in to one. Most dangerous of all, regulation is becoming more politicized.
Congress can fix this.
Social programs
Let’s get past spending “more” or “less” on social programs, and fix them instead.
Often, if you earn an extra dollar, you lose more than a dollar of benefits. No wonder people get stuck. If we fix these disincentives, we will help people better, encourage growth and opportunity--and in the end we will spend less.
Spend more to spend less.
Spending is a serious problem. But moving spending off the books does not help.
For example, we allow a mortgage interest tax deduction. This is exactly the same as collecting taxes, and sending checks to homeowners – but larger checks for high income people, people who borrow a lot, and people who refinance often.
Suppose we eliminate the mortgage deduction, and put housing subsidies on budget. The resulting homeowner subsidy would surely be a lot smaller, help lower-income people a lot more, and be better targeted at getting people in houses.
The budget would look bigger. But we would really spend less -- and grow more.
Taxes
Tax reform fails because arguments over the level of taxes, subsidies, or redistribution torpedo sensible simplifications. We could achieve tax reform by separating its four confounding issues.
First, determine the structure of taxes, to raise revenue with minimal economic damages, but leave the rates blank. Separately negotiate the rates. Put all tax incentives in a separate subsidy code, preferably as visible on-budget expenditures. Add a separate income-redistribution code. Then necessary big fights over each element need not derail the others.
A massive simplification of the tax code is, I think, more important than the rates – and easier for us to agree on.
Debt and deficits
Each year the CBO correctly declares our long-term debt unsustainable. Yelling louder won’t work.
First, let’s face the big problem: a debt crisis, when the U.S. suddenly needs to borrow a lot and roll over debts, and markets refuse. This, not a slow predictable rise in interest rates and crowding out, strikes me as the biggest problem. Crises are always sudden and unexpected, like earthquakes and wars. Even Greece could borrow at remarkably low rates. Until, one day, it couldn’t.
The answers are straightforward. Sensible reforms to Social Security and Medicare are on the table. Address underfunded pensions, widespread credit and bailout guarantees.
Buy some insurance. Like every homeowner shopping for a mortgage, the US chooses between a floating rate, lower initially, and a fixed rate, higher initially, but forever insulating the budget from interest rate risks, which are the essential ingredient of a debt crisis. Direct the Treasury and Fed to buy the fixed rate.
Above all, undertake this simple, pro-growth economic policy, and grow out of debt.
Concluding comments
You may object that fundamental reform is not “politically feasible.” Well, what’s “politically feasible” changes fast these days.
Winston Churchill once said that Americans can be trusted to do the right thing, after we’ve tried everything else. Well, we’ve tried everything else. It’s time to do the right thing.
Chairman Price, Ranking Member Van Hollen, and members of the committee: It is an honor to speak to you today.
Sclerotic growth is our country’s most fundamental economic problem. If we could get back to the three and half percent postwar average, we would, in the next 30 years, triple rather than double the size of the economy—and tax revenues, which would do wonders for our debt problem.
Why has growth halved? The most plausible answer is simple and sensible: Our legal and regulatory system is slowly strangling the golden goose of growth.
How do we fix it? Our national political and economic debate just makes the same points again, louder, and going nowhere. Instead, let us look together for novel and effective policies that can appeal to all sides.
Regulation:
Let’s get past “too much” or “too little” regulation, and fix regulation instead.
Regulation is too discretionary – people can’t read the rules and know what to do. Regulatory decisions take forever. Regulation has lost rule-of-law protections. Agencies are cop, prosecutor, judge, jury and executioner all rolled in to one. Most dangerous of all, regulation is becoming more politicized.
Congress can fix this.
Social programs
Let’s get past spending “more” or “less” on social programs, and fix them instead.
Often, if you earn an extra dollar, you lose more than a dollar of benefits. No wonder people get stuck. If we fix these disincentives, we will help people better, encourage growth and opportunity--and in the end we will spend less.
Spend more to spend less.
Spending is a serious problem. But moving spending off the books does not help.
For example, we allow a mortgage interest tax deduction. This is exactly the same as collecting taxes, and sending checks to homeowners – but larger checks for high income people, people who borrow a lot, and people who refinance often.
Suppose we eliminate the mortgage deduction, and put housing subsidies on budget. The resulting homeowner subsidy would surely be a lot smaller, help lower-income people a lot more, and be better targeted at getting people in houses.
The budget would look bigger. But we would really spend less -- and grow more.
Taxes
Tax reform fails because arguments over the level of taxes, subsidies, or redistribution torpedo sensible simplifications. We could achieve tax reform by separating its four confounding issues.
First, determine the structure of taxes, to raise revenue with minimal economic damages, but leave the rates blank. Separately negotiate the rates. Put all tax incentives in a separate subsidy code, preferably as visible on-budget expenditures. Add a separate income-redistribution code. Then necessary big fights over each element need not derail the others.
A massive simplification of the tax code is, I think, more important than the rates – and easier for us to agree on.
Debt and deficits
Each year the CBO correctly declares our long-term debt unsustainable. Yelling louder won’t work.
First, let’s face the big problem: a debt crisis, when the U.S. suddenly needs to borrow a lot and roll over debts, and markets refuse. This, not a slow predictable rise in interest rates and crowding out, strikes me as the biggest problem. Crises are always sudden and unexpected, like earthquakes and wars. Even Greece could borrow at remarkably low rates. Until, one day, it couldn’t.
The answers are straightforward. Sensible reforms to Social Security and Medicare are on the table. Address underfunded pensions, widespread credit and bailout guarantees.
Buy some insurance. Like every homeowner shopping for a mortgage, the US chooses between a floating rate, lower initially, and a fixed rate, higher initially, but forever insulating the budget from interest rate risks, which are the essential ingredient of a debt crisis. Direct the Treasury and Fed to buy the fixed rate.
Above all, undertake this simple, pro-growth economic policy, and grow out of debt.
Concluding comments
You may object that fundamental reform is not “politically feasible.” Well, what’s “politically feasible” changes fast these days.
Winston Churchill once said that Americans can be trusted to do the right thing, after we’ve tried everything else. Well, we’ve tried everything else. It’s time to do the right thing.
Selasa, 09 Agustus 2016
Summers on growth and stimulus
Larry Summers has an important, and 95% excellent, Financial Times column. Larry is especially worth listening to. I can't imagine that if not a main Hilary Clinton adviser he will surely be an eminence grise on its economic policies. He's saying loud and clear what they are, so far, not: Focus on growth.
The title "the progressive case" for growth, is interesting enough. Perhaps Larry now uses the word "progressive" to describe himself. More importantly, Larry's audience here is the Clinton campaign and the Democratic party. He's saying loud and clear: you're not paying enough attention to growth, and growth ought to be at the center of the party, and the new Administration's, economic plans.
Alas, Larry blows that spirit right off the bat with a sentence that take a gold medal for convoluted calumny and bombastic bulverism:
This is below Larry -- in person I have always known him to recognize that conservatives and free-marketers have exactly the same dispassionate goal, advocate growth primarily to help the less well off, and tax-cutting and deregulation as time-proven policies that improve growth. But, again, his audience is to the left, so perhaps one can excuse some I-hear-you agreeing with common demonizations.
But then he gets to well written and praiseworthy work, so good I must quote it in entirety:
And now to the remaining 5%:
Leave aside the last 30 years of growth theory, which is silent on "demand," we can do nothing better than move around 1970s era IS and LM curves, and revive ideas from the 1930s?
Read the second paragraph carefully. "More demand" is the ""core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness."
That "more demand" is the "core of the case" for (The Federal Government to borrow a lot of money and spend it on things labeled as) "public investment" admits up front that the actual value of such investment is at best secondary. Public investment in a great Ice Wall of Westeros on the southern border, or for high-speed trains from Tonopah to Winemucca, do just as well in boosting "demand."
What is needed is a serious negotiation: Fund needed infrastructure investment, but put in serious cost-benefit analysis, buy it at reasonable prices, and so forth. That negotiation should start by abandoning the whole idea that we're doing it to provide "jobs" and "demand." If you're not wiling to do that, at least be honest and state that Mr. Trump's wall provides the same "demand."
Then explain to us how Japan has been at this for 20 years, producing no great shakes of growth.
"policy-approaches to... increasing worker's purchasing power" is another classic hidden-subject clause. I presume it means [The Federal Government, by legislation, regulation, or threat, will force companies to pay workers more, and then control employment to make sure those companies don't just fire workers or select better ones in order to ] increase [some] worker's purchasing power." Gary Johson's program also increases worker's purchasing power, and I don't think that's what Larry has in mind. I'm also curious where in modern economics forced transfers increase employment and long-run growth.
But in context, this is a small complaint. If Larry can persuade Mrs. Clinton and the "progressives" in the Democratic Party to focus on growth, to state goals for growth, and to hold themselves accountable for growth, then we can have an honest and very productive conversation about what's stopping growth and what steps can further it.
The title "the progressive case" for growth, is interesting enough. Perhaps Larry now uses the word "progressive" to describe himself. More importantly, Larry's audience here is the Clinton campaign and the Democratic party. He's saying loud and clear: you're not paying enough attention to growth, and growth ought to be at the center of the party, and the new Administration's, economic plans.
...many people, in their eagerness to focus on fairness, neglect the single most important determinant of almost every aspect of economic performance: the rate of growth of total income,Hooray. Not only is this vitally important and factually correct, a growth oriented policy, if sold without the usual demonization, could well attract bipartisan support. That sentence could come from Paul Ryan's a better way
Alas, Larry blows that spirit right off the bat with a sentence that take a gold medal for convoluted calumny and bombastic bulverism:
Because those who champion strategies that centre on business tax-cutting and deregulation and favour the wealthy have placed the most emphasis on growth over the past 35 years, the objective of increasing growth has been discredited in the minds of too many progressives.Translated into something approximating English: because people whose only and base motive was "favoring the wealthy" happened to advocate growth to sell their (as later described) useless tax-cutting and deregulation strategies, the goal of growth has become tarnished in the minds of good progressives.
This is below Larry -- in person I have always known him to recognize that conservatives and free-marketers have exactly the same dispassionate goal, advocate growth primarily to help the less well off, and tax-cutting and deregulation as time-proven policies that improve growth. But, again, his audience is to the left, so perhaps one can excuse some I-hear-you agreeing with common demonizations.
But then he gets to well written and praiseworthy work, so good I must quote it in entirety:
It can hardly be an accident that the decades of maximum growth, the 1960s and 1990s, also saw the most rapid job growth and most rapid increase in middle-class living standards.
Growth provides the wherewithal for increased federal revenue and so encourages the protection of vital social insurance programmes such as Social Security and Medicare....
Tight labour markets are the best social programme, as they force employers to hire and mentor inexperienced people in order to be adequately staffed. Some years ago, I estimated that for each 1 per cent point increase in adult male employment, the employment of young black men rose 7 per cent. More recent research confirms economic growth has an outsized benefit for younger people and minorities.
Rising growth has other benefits, as well. It strengthens the power of the American example in the world. It obviates the need for desperation monetary policies that risk future financial stability. Greater growth also has historically operated to reduce crime, encourage environmental protection and contributes to public optimism about the country that our children will inherit.
The reality is that if American growth continues to have a 2 per cent ceiling, it is doubtful that we will achieve any of our major national objectives.
If, on the other hand, we can boost growth to 3 per cent, interest rates will normalise, middle-class wages will rise faster than inflation, debt burdens will tend to melt away and the power of the American example will be greatly enhanced.
...the vast majority of job creation and income growth comes from the private sector. If the next president is lucky enough to oversee the creation of 10m jobs from 2017-20, more than 8m of them will surely come from businesses hiring in response to profit opportunities.All true, excellent, well-stated, and bipartisan (at least for the pre-Trump era). Jeb Bush's 4%, Paul Ryan's opportunity society agree totally. Heck, even Gary Johnson might find little to quibble with here. If growth could be the mantra for the Hilary Clinton administration, and if Larry can persuade his fellow "progressives," great things could follow.
And now to the remaining 5%:
There is no case for reducing already low corporate taxes or removing regulations unless it can be shown that these have costs in excess of benefits.No case? Really? The higher taxes, steadily more convoluted tax code, vast expansion of regulation (Dodd-Frank, Obamacare are just the start) that coincided with our epic slow growth, have nothing at all to do with that sorry experience? There is absolutely nothing wrong with the microeconomics of the American economy and its vast administrative, judicial and regulatory state, we just need a bit more "demand?"
What is needed is more demand for the product of business. This is the core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness.
Leave aside the last 30 years of growth theory, which is silent on "demand," we can do nothing better than move around 1970s era IS and LM curves, and revive ideas from the 1930s?
Read the second paragraph carefully. "More demand" is the ""core of the case for policy approaches to raising public investment, increasing workers’ purchasing power and promoting competitiveness."
That "more demand" is the "core of the case" for (The Federal Government to borrow a lot of money and spend it on things labeled as) "public investment" admits up front that the actual value of such investment is at best secondary. Public investment in a great Ice Wall of Westeros on the southern border, or for high-speed trains from Tonopah to Winemucca, do just as well in boosting "demand."
What is needed is a serious negotiation: Fund needed infrastructure investment, but put in serious cost-benefit analysis, buy it at reasonable prices, and so forth. That negotiation should start by abandoning the whole idea that we're doing it to provide "jobs" and "demand." If you're not wiling to do that, at least be honest and state that Mr. Trump's wall provides the same "demand."
Then explain to us how Japan has been at this for 20 years, producing no great shakes of growth.
"policy-approaches to... increasing worker's purchasing power" is another classic hidden-subject clause. I presume it means [The Federal Government, by legislation, regulation, or threat, will force companies to pay workers more, and then control employment to make sure those companies don't just fire workers or select better ones in order to ] increase [some] worker's purchasing power." Gary Johson's program also increases worker's purchasing power, and I don't think that's what Larry has in mind. I'm also curious where in modern economics forced transfers increase employment and long-run growth.
But in context, this is a small complaint. If Larry can persuade Mrs. Clinton and the "progressives" in the Democratic Party to focus on growth, to state goals for growth, and to hold themselves accountable for growth, then we can have an honest and very productive conversation about what's stopping growth and what steps can further it.
Selasa, 12 Juli 2016
Blueprint for America
Some of the inspiration for this project came from the remarkable 1980 memo (here) to President-elect Ronald Reagan from his Coordinating Committee on Economic Policy.
Like that memo, this is a book about governance, not politics. It's not partisan -- copies are being sent to both campaigns. It's not about choosing or spinning policies to attract voters or win elections.
The book is about long-term policies and policy frameworks -- how policy is made, return to rule of law, is as important as what the policy is -- that can fix America's problems. It focuses on what we think are the important issues as well as policies to address those issues -- it does not address every passion of the latest two-week news cycle.
The book comprises the answers we would give to an incoming Administration of any party, or incoming Congress, if they asked us for a policy package that is best for the long-term welfare of the country.
The chapters, to whet your appetite:
INTRODUCTION
CHAPTER 1: The Domestic Landscape by Michael J. Boskin
IN BRIEF: Spending by George P. Shultz
CHAPTER 2: Entitlements and the Budget by John F. Cogan
CHAPTER 3: A Blueprint for Tax Reform by Michael J. Boskin
CHAPTER 4: Transformational Health Care Reform by Scott W. Atlas
CHAPTER 5: Reforming Regulation by Michael J. Boskin
CHAPTER 6: National and International Monetary Reform by John B. Taylor
CHAPTER 7: A Blueprint for Effective Financial Reform by John H. Cochrane
IN BRIEF: National Human Resources by George P. Shultz
CHAPTER 8: Education and the Nation’s Future by Eric A. Hanushek
CHAPTER 9: Trade and Immigration by John H. Cochrane
IN BRIEF: A World Awash in Change
CHAPTER 10: Restoring Our National Security by James O. Ellis Jr., James N. Mattis, and Kori Schake
CHAPTER 11: Redefining Energy Security by James O. Ellis Jr.
CHAPTER 12: Diplomacy in a Time of Transition by James E. Goodby
CLOSING NOTE: The Art and Practice of Governance by George P. Shultz
My chapter on a Blueprint for Effective Financial Reform is a better version of the talk on Equity Financed banking which I posted here. (The talk was based on the paper. Now you have the paper.)
My chapter on Trade and Immigration is new, and an uncompromising red-meat free-market view. I don't think one should compromise centuries old economic understanding just because it's not politically popular at the moment.
If you got this far, you might also be interested in my Economic Growth essay written for a parallel but similar project.
Kamis, 02 Juni 2016
WSJ growth oped -- full version
WSJ Oped. Now that 30 days have passed, I can post the whole thing. Previous post.
Ending America’s Slow-Growth Tailspin
Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes.
The differences in these small percentages might seem minor, but over time they have big consequences. By 2008, the average American was more than three times better off than in 1952. Real GDP per person rose from $16,000 to $49,000. And those numbers understate the advances in the quality of goods, health and environment that came with growth. But if U.S. growth between 1950 and 2000 had been the 2% of recent years, instead of 3.5%, income per person in 2000 would have risen to just $23,000, not $50,000. That’s a huge difference.
Looking ahead, solving almost all of America’s problems hinges on re-establishing robust economic growth. Over the next 50 years, if income could be doubled relative to 2% growth, the U.S. would be able to pay for Social Security, Medicare, defense, environmental concerns and the debt. Halve that income gain, and none of those spending challenges can be addressed. Doubling income per capita would help the less well off far more than any imaginable transfer scheme.
Why is growth slowing down? One camp says that we’ve run out of ideas. We were supposed to have flying cars and all we got was Twitter. Get used to it, the thinking goes, and start fighting over the shrinking pie.
Another camp holds that the culprit is “secular stagnation,” a “savings glut” demanding sharply negative interest rates that the Federal Reserve cannot deliver. That outlook attracts clever new economic theories and promotes vast new stimulus spending of the sort that Japan has fruitlessly followed.
The third camp (mine) holds that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate. The U.S. needs simple, common-sense, Adam Smith policies.
America is middle-aged and overweight. The first camp says, well, that’s nature, stop complaining. The second camp looks for the latest miracle diet—try the 10-day detox cleanse! The third camp says get back to the tried, true and sometimes painful: eat right and exercise.
The first two camps are doubtful. How much more growth is really possible from better policies? To get an idea, see the nearby chart plotting 2014 income per capita for 189 countries against the World Bank’s “Distance to Frontier” ease-of-doing-business measure for the same year. The measure combines individual indicators, including starting a business, dealing with construction permits, protecting minority investors, paying taxes and trading across borders. Unlike the more popular ease-of-doing business rankings, this is a measure of how good or bad things are with 100 being the best observed so far, or “Frontier,” score.
In general, the higher a country’s score, the higher its per capita income. The Central African Republic scores a dismal 33, and has an annual per capita income of just $328. Compare that to India (50.3, $1,455), China (61, $7,000) and the U.S. (82, $53,000).
The U.S. scores well, but there is plenty of room for improvement. A score of 100 unites the best already-observed performance in each category. So a score of 100—labeled Frontier—is certainly possible. And, following the fitted line in the chart, Frontier generates $163,000 of income per capita, 209% better than the U.S., or 6% additional annual growth for 20 years. If America could improve on the best seen in other countries by 10%, a 110 score would generate $400,000 income per capita, a 650% improvement, or 15% additional growth for 20 years.
If you think these numbers are absurd, consider China. Between 2000 and 2014, China averaged 15% growth and a 700% improvement in income per capita. This growth did not follow from some grand stimulus or central plan; Mao tried that in the 1960s, producing famine, not steel. China just turned an awful business climate into a moderately bad one.
It is amazing that governments can do so much damage. Yet the evidence of the graph is strong. The nearly controlled experimental comparison of North Korea versus South Korea, or East Germany versus West Germany, is stronger. But if bad institutions can do such enormous harm, it follows inescapably that better institutions can do enormous good.
A growth agenda doesn’t fit neatly into current policy debates. This is fortunate, as new ideas are easier to swallow than defeats.
Parties argue over tax rates, but what’s really needed is deep tax reform, cleaning out the insane complexity and cronyism.
Parties argue over how much to raise or cut spending for social programs, but what’s needed is a thorough overhaul of the programs’ pernicious incentives. For example, Social Security disability needs to remove its disincentives to work, move or change careers.
Parties argue about education spending, but America needs the better schools that come from increased choice and competition.
Most of all, the country needs a dramatic legal and regulatory simplification, restoring the rule of law. Middle-aged America is living in a hoarder’s house of a legal system. State and local impediments such as occupational licensing and zoning are also part of the problem.
Growth-oriented policies will be resisted. Growth comes from productivity, which comes from new technologies and new companies. These displace the profits of old companies, and the healthy pay and settled lives of their managers and workers. Economic regulation is largely designed to protect profits, jobs and wages tied to old ways of doing things. Everyone likes growth, but only in someone else’s backyard.
There is hope. Washington lawmakers need to bring about a grand bargain, moving the debate from “they’re getting their special deal, I want mine,” to “I’m losing my special deal, so they’d better lose theirs too.” While the current presidential front-runners are not championing economic growth, House Speaker Paul Ryan (R., Wis.) and other House members are. And if economic-policy leadership moves from a chaotic presidency to a well-run Congress, that may be healthy for America’s political system as well as for the economy.
Update: response to some criticis
Ending America’s Slow-Growth Tailspin
Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes.
The differences in these small percentages might seem minor, but over time they have big consequences. By 2008, the average American was more than three times better off than in 1952. Real GDP per person rose from $16,000 to $49,000. And those numbers understate the advances in the quality of goods, health and environment that came with growth. But if U.S. growth between 1950 and 2000 had been the 2% of recent years, instead of 3.5%, income per person in 2000 would have risen to just $23,000, not $50,000. That’s a huge difference.
Looking ahead, solving almost all of America’s problems hinges on re-establishing robust economic growth. Over the next 50 years, if income could be doubled relative to 2% growth, the U.S. would be able to pay for Social Security, Medicare, defense, environmental concerns and the debt. Halve that income gain, and none of those spending challenges can be addressed. Doubling income per capita would help the less well off far more than any imaginable transfer scheme.
Why is growth slowing down? One camp says that we’ve run out of ideas. We were supposed to have flying cars and all we got was Twitter. Get used to it, the thinking goes, and start fighting over the shrinking pie.
Another camp holds that the culprit is “secular stagnation,” a “savings glut” demanding sharply negative interest rates that the Federal Reserve cannot deliver. That outlook attracts clever new economic theories and promotes vast new stimulus spending of the sort that Japan has fruitlessly followed.
The third camp (mine) holds that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate. The U.S. needs simple, common-sense, Adam Smith policies.
America is middle-aged and overweight. The first camp says, well, that’s nature, stop complaining. The second camp looks for the latest miracle diet—try the 10-day detox cleanse! The third camp says get back to the tried, true and sometimes painful: eat right and exercise.
The first two camps are doubtful. How much more growth is really possible from better policies? To get an idea, see the nearby chart plotting 2014 income per capita for 189 countries against the World Bank’s “Distance to Frontier” ease-of-doing-business measure for the same year. The measure combines individual indicators, including starting a business, dealing with construction permits, protecting minority investors, paying taxes and trading across borders. Unlike the more popular ease-of-doing business rankings, this is a measure of how good or bad things are with 100 being the best observed so far, or “Frontier,” score.
In general, the higher a country’s score, the higher its per capita income. The Central African Republic scores a dismal 33, and has an annual per capita income of just $328. Compare that to India (50.3, $1,455), China (61, $7,000) and the U.S. (82, $53,000).
The U.S. scores well, but there is plenty of room for improvement. A score of 100 unites the best already-observed performance in each category. So a score of 100—labeled Frontier—is certainly possible. And, following the fitted line in the chart, Frontier generates $163,000 of income per capita, 209% better than the U.S., or 6% additional annual growth for 20 years. If America could improve on the best seen in other countries by 10%, a 110 score would generate $400,000 income per capita, a 650% improvement, or 15% additional growth for 20 years.
If you think these numbers are absurd, consider China. Between 2000 and 2014, China averaged 15% growth and a 700% improvement in income per capita. This growth did not follow from some grand stimulus or central plan; Mao tried that in the 1960s, producing famine, not steel. China just turned an awful business climate into a moderately bad one.
It is amazing that governments can do so much damage. Yet the evidence of the graph is strong. The nearly controlled experimental comparison of North Korea versus South Korea, or East Germany versus West Germany, is stronger. But if bad institutions can do such enormous harm, it follows inescapably that better institutions can do enormous good.
A growth agenda doesn’t fit neatly into current policy debates. This is fortunate, as new ideas are easier to swallow than defeats.
Parties argue over tax rates, but what’s really needed is deep tax reform, cleaning out the insane complexity and cronyism.
Parties argue over how much to raise or cut spending for social programs, but what’s needed is a thorough overhaul of the programs’ pernicious incentives. For example, Social Security disability needs to remove its disincentives to work, move or change careers.
Parties argue about education spending, but America needs the better schools that come from increased choice and competition.
Most of all, the country needs a dramatic legal and regulatory simplification, restoring the rule of law. Middle-aged America is living in a hoarder’s house of a legal system. State and local impediments such as occupational licensing and zoning are also part of the problem.
Growth-oriented policies will be resisted. Growth comes from productivity, which comes from new technologies and new companies. These displace the profits of old companies, and the healthy pay and settled lives of their managers and workers. Economic regulation is largely designed to protect profits, jobs and wages tied to old ways of doing things. Everyone likes growth, but only in someone else’s backyard.
There is hope. Washington lawmakers need to bring about a grand bargain, moving the debate from “they’re getting their special deal, I want mine,” to “I’m losing my special deal, so they’d better lose theirs too.” While the current presidential front-runners are not championing economic growth, House Speaker Paul Ryan (R., Wis.) and other House members are. And if economic-policy leadership moves from a chaotic presidency to a well-run Congress, that may be healthy for America’s political system as well as for the economy.
Update: response to some criticis
Selasa, 03 Mei 2016
Growth Interview
I did a short interview with the WSJ's Mary Kissel about my growth oped. If you can't see the embed above, try this direct link or this one.
WSJ Growth Oped
I did an oped on growth in the Wall Street Journal, titled "Ending America’s Slow-Growth Tailspin." I'll post the full thing here in 30 days.
Blog readers will recognize a distilled version of my longer essay on growth (blog post here, html here, pdf here), and the graph from Smith v. Jones blog post. I think out loud. The growth essay is much more detailed on diagnosis and especially on policy.
There are three basic ideas (two too many for a good oped).
1) Growth is everything. Increasing growth will do way more for every problem you can name than anything else on the economic agenda. Even if workers in 1910 could have taken all of Rockefeller's wealth, they would have been disastrously poor compared to today.
2) Can policies actually improve growth? The tut-tutters mocked Jeb Bush's 4% aspiration. I outline the "we've run out of ideas" school of thought, most recently in Bob Gordon's thoughtful book; the "everything is right but the zero bound" secular-staglation school, and the view that the growth giant is being held back by a liliputian army of politicized regulators.
As evidence, I improved on the graph from an earlier post of the World Bank's ease of doing business score vs. GDP per capita,
(if you can't see the graph, click here)
This graph adds a few things relative to the one in WSJ. I added some outliers. Libya and Venzuela seem like countries with good reasons to have temporarily more GDP than their institutions can long support, Rwanda and Georgia the opposite. So the correlation is even better than it looks. Given how crude the world bank measure is, it's surprising it works so well. It's mostly about the difficulties of starting small businesses. I added Greece too to gives some sense of variation within the Euro-US world.
The point: Bad policies can do dramatic harm. Ipso facto, good policies must be able to do a lot of good. The US is not perfect!
A famous economist challenged my view that regulation is causing a lot of problems, noting that all of the big business types he talks to don't complain that much. But I think that's a horrendous selection bias. If you talk to the people still in business, you are talking to the ones that have figured out the political and regulatory game. Go talk to the ones whose businesses are closed, or not even started.
Another point, regulation has been getting worse for decades. Why the slump now? I think that a lot of the government onslaught's effect has been to make the economy less resilient. For example, social security disability is not a problem as long as you have a job. When you lose a job, and go on disability, now the huge disincentive to work, study, move, kicks in. Recovering from a recession needs new jobs, new businesses, new innovations.
3) A very brief outline of policies to get growth going again. I think the key is to move past the standard rhetoric that defines our current partisan bickering. It's not how much we spend, really, it's how we spend it. Free market economics is not "trickle-down" economics, it's about incentives, simplicity, rule of law, and so forth.
Blog readers will recognize a distilled version of my longer essay on growth (blog post here, html here, pdf here), and the graph from Smith v. Jones blog post. I think out loud. The growth essay is much more detailed on diagnosis and especially on policy.
There are three basic ideas (two too many for a good oped).
1) Growth is everything. Increasing growth will do way more for every problem you can name than anything else on the economic agenda. Even if workers in 1910 could have taken all of Rockefeller's wealth, they would have been disastrously poor compared to today.
2) Can policies actually improve growth? The tut-tutters mocked Jeb Bush's 4% aspiration. I outline the "we've run out of ideas" school of thought, most recently in Bob Gordon's thoughtful book; the "everything is right but the zero bound" secular-staglation school, and the view that the growth giant is being held back by a liliputian army of politicized regulators.
As evidence, I improved on the graph from an earlier post of the World Bank's ease of doing business score vs. GDP per capita,
(if you can't see the graph, click here)
This graph adds a few things relative to the one in WSJ. I added some outliers. Libya and Venzuela seem like countries with good reasons to have temporarily more GDP than their institutions can long support, Rwanda and Georgia the opposite. So the correlation is even better than it looks. Given how crude the world bank measure is, it's surprising it works so well. It's mostly about the difficulties of starting small businesses. I added Greece too to gives some sense of variation within the Euro-US world.
The point: Bad policies can do dramatic harm. Ipso facto, good policies must be able to do a lot of good. The US is not perfect!
A famous economist challenged my view that regulation is causing a lot of problems, noting that all of the big business types he talks to don't complain that much. But I think that's a horrendous selection bias. If you talk to the people still in business, you are talking to the ones that have figured out the political and regulatory game. Go talk to the ones whose businesses are closed, or not even started.
Another point, regulation has been getting worse for decades. Why the slump now? I think that a lot of the government onslaught's effect has been to make the economy less resilient. For example, social security disability is not a problem as long as you have a job. When you lose a job, and go on disability, now the huge disincentive to work, study, move, kicks in. Recovering from a recession needs new jobs, new businesses, new innovations.
3) A very brief outline of policies to get growth going again. I think the key is to move past the standard rhetoric that defines our current partisan bickering. It's not how much we spend, really, it's how we spend it. Free market economics is not "trickle-down" economics, it's about incentives, simplicity, rule of law, and so forth.
Selasa, 05 April 2016
Next Steps for FTPL
Last Friday April 1, Eric Leeper Tom Coleman and I organized a conference at the Becker-Friedman Institute, "Next Steps for the Fiscal Theory of the Price Level." Follow the link for the whole agenda, slides, and papers.
The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.
A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.
(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)
That idea surfaced in many of the papers.
The morning had several papers studying the gold standard and related historical arrangements. To a fiscal theorist the gold standard is really a fiscal commitment. No gold standard has ever backed its note issue 100%; and none has even dreamed of backing its nominal government debt 100%. If a government had that much gold, there would be no point to borrowing.
So a gold standard is a commitment to raise taxes, or to borrow against credible future taxes, to get enough gold should it ever be needed. The gold standard says, we commit to pay off this debt at one, and only one, price level. If inflation gets big, people will start to want to exchange money for gold, and we'll raise taxes. If inflation gets too low, people wills tart to exchange gold for money, and we'll print it up as needed. Usually, in the fiscal theory,
\[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \beta^j s_{t+j}\]
the expectation of future surpluses is a bit nebulous, so inflation might wander around a lot like stock prices. The gold standard is a way to commit to just the right path of surpluses that stabilize the price level.
A summary, with apologies in advance to authors whose points I missed or misunderstood:
Part I: History
George Hall presented his work with Tom Sargent on the history of US debt limits, together with a fantastic new data set on US debt that will be very useful going forward.
François Velde and Christophe Chalmley took us on a lighting tour of monetary arrangements across history, prompting a thoughtful discussion on just where Fiscal theory starts to matter and where it really is not relevant. (François easily gets the prize for the best set of slides. Picking just one was hard.)
Michael Bordo and Arunima Sinha presented an analysis of suspensions of convertibility: Governments temporarily abandon the gold standard during war, then go back at parity afterward. Maybe. By going back afterward, people are willing to hold a lot of unbacked debt and currency during the war. But sometimes the fiscal resources to go back afterward are tough to get, the benefits of establishing credibility so you can borrow in the next war seem further off. When people are unsure whether the country will go back, the wartime inflation is worse, and the cost of going back on parity are heavier. They analyze France vs. UK after WWI.
Martin Kleim took us on a tour of a big inflation in a previous European currency union, the Holy Roman Empire in the early 1600s. Europe has had currency union without fiscal union for a long time, under various metallic standards and coinages. In this case small states, under fiscal pressure from the 30 years' war, started to debase small coins, leading to a large inflation. It ended with an agreement to go back to parity, with the states absorbing the losses. (In my equation, they needed a lot of surpluses to match \(P\) with \(P^\ast\)). We had an interesting discussion on just where those funds came from. Disinflation is always and everywhere a fiscal reform.
Margaret Jacobson presented her work with Eric Leeper and Bruce Preston on the end of the gold standard in the US in the 1930s. (Eric modestly stated his contribution to the paper as finding the matlab color code for gold, as shown in the graph.) Margaret and Eric interpret the fiscal statements of the Roosevelt Administration to say that they would run unbacked deficits until the price level returned to its previous level, the \(P^\ast\) in my above equation. Much discussion followed on how governments today, if they really want inflation, could achieve something similar.
Part II Monetary Policy
Chris Sims took on that issue directly. If you want inflation, just running big deficits might not help. Hundreds of years in which governments built up hard-won reputations that when they borrow money, they pay it off, are hard to upend immediately. Even if you want to break that expectation -- all our governments have mixed promises of stimulus now with deficit reduction later. A devaluation would help, but we don't have a gold standard against which to devalue, and not everyone can devalue relative to each other's currency.
Chris' bottom line is a lot like Margaret and Eric's, and my fiscal Taylor rule,
Steve Williamson followed with a thoughtful model full of surprising results. The stock of money does not matter, but fed transfers to the treasury do. (I hope I got that right!)
My presentation (slides also here on my webpage) took on the "agenda" question. The basic fiscal equation is
\[\frac{B_{t-1}}{P_t} = E_t \sum M_{t,t+j} s_{t+j} \]
For the project of matching history, data, analyzing policy and finding better regimes, I opined we have spent too much time on the \(s\) fiscal part, and not nearly enough time on the \(M\) discount rate part, or the \(B\) part, which I map to monetary policy.
I argued that in order to understand the cyclical variation of inflation -- in recessions inflation declines while \(B\) is rising and \(s\) is declining -- we need to focus on discount rate variation. More generally, changes in the value of government debt due to interest rate variation are plausibly much bigger than changes in expected surpluses. As interest rates rise, government debt will be worth a lot less, an additionan inflationary pressure that is often overlooked.
Then I presented short versions of recent papers analyzing monetary policy in the fiscal theory of the price level. Interest rate targets with no change in surpluses can determine expected inflation, but the neo-Fisherian conundrum remains.
Harald Uhlig presented a skeptical view, provoking much discussion. Some main points: large debt and deficits are not associated with inflation, and M2 demand is stable.
I found Harald's critique quite useful. Even if you don't agree with something, knowing that this is how a really sharp and well informed macroeconomist perceives the issues is a vital lesson. I answered somewhat impertinently that we addressed these issues 15 years ago: High debt comes with large expected surpluses, just as in financing a war, because governments want to borrow without creating inflation. The stability of M2 velocity does not isolate cause and effect. The chocolate/GDP ratio is stable too, but eating more chocolate will not increase GDP.
But Harald knows this, and his overall point resonates: You guys need to find something like MV=PY that easily organizes historical events. The obvious graph doesn't work. Irving Fisher came up with MV=PY, but it took Friedman and Schwartz using it to make the idea come alive. That is the purpose of the whole conference.
Francesco Bianchi presented his work with Leonardo Melosi on the Great Recession. New Keynesian models typically predict huge deflation at the zero bound. Why didn't this happen? They specify a model with shifting fiscal vs money dominant regimes. The standard model specifies that once we leave the zero bound we go right back to a money-dominant, Taylor-rule regime with passive fiscal policy. However, if there is a chance of going back to a fiscal-dominant regime for a while, that changes expectations of inflation at the end of the zero bound. Even small changes in those expectations have big effects on inflation during the zero bound (Shameless plug for the New Keynesian Liquidity Trap which explains this point very simply.) So, as you see in the graph above, the "benchmark" model which includes a probability of reverting to a fiscal regime after the zero bound, produces the mild recession and disinflation we have seen, compared to the standard model prediction of a huge depression.
Fiscal policy is political of course. Campbell Leith presented, among other things, an intriguing tour of how political scientists think about political determinants of debt and deficits. My snarky quip, we learned with great precision that political scientists don't know a heck of a lot more than we do! But if so, that is also wisdom.
Part III International
Alexander Kriwoluzky presented thoughts on a fiscal theory of exchange rates, applying it to the US vs. Germany, the abandonment of the gold standard and switch to floating rates in the early 1970s. An exchange rate peg means that Germany must import US fiscal policy as well, importing the deficits that support more inflation. Germany didn't want to do that. People knew that, so a shift to floating rates was in the air. Expectations of that shift can explain the interest differential and apparent failure of uncovered interest parity.
Last but certainly not least, Bartosz Maćkowiak presented a thoughtful analysis of "Monetary-Fiscal Interactions and the Euro Area’s Malaise" joint work with Marek Jarosińsky.
Echoing the fiscal Taylor rule idea running through so many talks, they propose a fiscal rule
\[ S_{n,t} = \Psi_n + \Psi_B \left( B_{n,t-1} - \sum_n \theta_n B_{n,t-1} \right) + \psi_n (Y_{n,t}-Y_n) \]
In words, each country's surplus must react to that country's debt \(B_n\), but total EU surpluses do not react to total EU debt. In this way, the EU is "Ricardian" or "fiscal passive" for each country, but it is "non-Ricardian" or "fiscal active" for the EU as a whole. In their simulations, this fiscal commitment has the same beneficial effects running through Leeper and Jabcobson, Bianchi and Melosi, Sims, and others -- but maintaining the idea that individual countries pay their debts.
A big thanks to the Harris School and the Becker-Friedman Institute who sponsored the conference.
The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.
A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.
(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)
That idea surfaced in many of the papers.
The morning had several papers studying the gold standard and related historical arrangements. To a fiscal theorist the gold standard is really a fiscal commitment. No gold standard has ever backed its note issue 100%; and none has even dreamed of backing its nominal government debt 100%. If a government had that much gold, there would be no point to borrowing.
So a gold standard is a commitment to raise taxes, or to borrow against credible future taxes, to get enough gold should it ever be needed. The gold standard says, we commit to pay off this debt at one, and only one, price level. If inflation gets big, people will start to want to exchange money for gold, and we'll raise taxes. If inflation gets too low, people wills tart to exchange gold for money, and we'll print it up as needed. Usually, in the fiscal theory,
\[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \beta^j s_{t+j}\]
the expectation of future surpluses is a bit nebulous, so inflation might wander around a lot like stock prices. The gold standard is a way to commit to just the right path of surpluses that stabilize the price level.
A summary, with apologies in advance to authors whose points I missed or misunderstood:
Part I: History
George Hall presented his work with Tom Sargent on the history of US debt limits, together with a fantastic new data set on US debt that will be very useful going forward.
 |
| Price of a Chariot Horse: 100,000 Denarii |
Michael Bordo and Arunima Sinha presented an analysis of suspensions of convertibility: Governments temporarily abandon the gold standard during war, then go back at parity afterward. Maybe. By going back afterward, people are willing to hold a lot of unbacked debt and currency during the war. But sometimes the fiscal resources to go back afterward are tough to get, the benefits of establishing credibility so you can borrow in the next war seem further off. When people are unsure whether the country will go back, the wartime inflation is worse, and the cost of going back on parity are heavier. They analyze France vs. UK after WWI.
Martin Kleim took us on a tour of a big inflation in a previous European currency union, the Holy Roman Empire in the early 1600s. Europe has had currency union without fiscal union for a long time, under various metallic standards and coinages. In this case small states, under fiscal pressure from the 30 years' war, started to debase small coins, leading to a large inflation. It ended with an agreement to go back to parity, with the states absorbing the losses. (In my equation, they needed a lot of surpluses to match \(P\) with \(P^\ast\)). We had an interesting discussion on just where those funds came from. Disinflation is always and everywhere a fiscal reform.
Margaret Jacobson presented her work with Eric Leeper and Bruce Preston on the end of the gold standard in the US in the 1930s. (Eric modestly stated his contribution to the paper as finding the matlab color code for gold, as shown in the graph.) Margaret and Eric interpret the fiscal statements of the Roosevelt Administration to say that they would run unbacked deficits until the price level returned to its previous level, the \(P^\ast\) in my above equation. Much discussion followed on how governments today, if they really want inflation, could achieve something similar.
Part II Monetary Policy
Chris Sims took on that issue directly. If you want inflation, just running big deficits might not help. Hundreds of years in which governments built up hard-won reputations that when they borrow money, they pay it off, are hard to upend immediately. Even if you want to break that expectation -- all our governments have mixed promises of stimulus now with deficit reduction later. A devaluation would help, but we don't have a gold standard against which to devalue, and not everyone can devalue relative to each other's currency.
Chris' bottom line is a lot like Margaret and Eric's, and my fiscal Taylor rule,
Coordinating fiscal and monetary policy so that both are explicitly contingent on reaching an inflation target — not only interest rates low, but no tax increases or spending cuts until inflation rises.But,
• This might work because it would represent such a shift in political economy that people would rethink their inflation expectations.Chris led a long discussion including thoughts on rational expectations -- it's a stretch to impose rational expectations on policies that have never been tried before (though our history lesson reminded us just how few genuinely novel policies there are!)
Steve Williamson followed with a thoughtful model full of surprising results. The stock of money does not matter, but fed transfers to the treasury do. (I hope I got that right!)
My presentation (slides also here on my webpage) took on the "agenda" question. The basic fiscal equation is
\[\frac{B_{t-1}}{P_t} = E_t \sum M_{t,t+j} s_{t+j} \]
For the project of matching history, data, analyzing policy and finding better regimes, I opined we have spent too much time on the \(s\) fiscal part, and not nearly enough time on the \(M\) discount rate part, or the \(B\) part, which I map to monetary policy.
I argued that in order to understand the cyclical variation of inflation -- in recessions inflation declines while \(B\) is rising and \(s\) is declining -- we need to focus on discount rate variation. More generally, changes in the value of government debt due to interest rate variation are plausibly much bigger than changes in expected surpluses. As interest rates rise, government debt will be worth a lot less, an additionan inflationary pressure that is often overlooked.
Then I presented short versions of recent papers analyzing monetary policy in the fiscal theory of the price level. Interest rate targets with no change in surpluses can determine expected inflation, but the neo-Fisherian conundrum remains.
Harald Uhlig presented a skeptical view, provoking much discussion. Some main points: large debt and deficits are not associated with inflation, and M2 demand is stable.
I found Harald's critique quite useful. Even if you don't agree with something, knowing that this is how a really sharp and well informed macroeconomist perceives the issues is a vital lesson. I answered somewhat impertinently that we addressed these issues 15 years ago: High debt comes with large expected surpluses, just as in financing a war, because governments want to borrow without creating inflation. The stability of M2 velocity does not isolate cause and effect. The chocolate/GDP ratio is stable too, but eating more chocolate will not increase GDP.
But Harald knows this, and his overall point resonates: You guys need to find something like MV=PY that easily organizes historical events. The obvious graph doesn't work. Irving Fisher came up with MV=PY, but it took Friedman and Schwartz using it to make the idea come alive. That is the purpose of the whole conference.
Francesco Bianchi presented his work with Leonardo Melosi on the Great Recession. New Keynesian models typically predict huge deflation at the zero bound. Why didn't this happen? They specify a model with shifting fiscal vs money dominant regimes. The standard model specifies that once we leave the zero bound we go right back to a money-dominant, Taylor-rule regime with passive fiscal policy. However, if there is a chance of going back to a fiscal-dominant regime for a while, that changes expectations of inflation at the end of the zero bound. Even small changes in those expectations have big effects on inflation during the zero bound (Shameless plug for the New Keynesian Liquidity Trap which explains this point very simply.) So, as you see in the graph above, the "benchmark" model which includes a probability of reverting to a fiscal regime after the zero bound, produces the mild recession and disinflation we have seen, compared to the standard model prediction of a huge depression.
Fiscal policy is political of course. Campbell Leith presented, among other things, an intriguing tour of how political scientists think about political determinants of debt and deficits. My snarky quip, we learned with great precision that political scientists don't know a heck of a lot more than we do! But if so, that is also wisdom.
Part III International
 |
red line regime switching probability of 30%, blue line 0 % |
Alexander Kriwoluzky presented thoughts on a fiscal theory of exchange rates, applying it to the US vs. Germany, the abandonment of the gold standard and switch to floating rates in the early 1970s. An exchange rate peg means that Germany must import US fiscal policy as well, importing the deficits that support more inflation. Germany didn't want to do that. People knew that, so a shift to floating rates was in the air. Expectations of that shift can explain the interest differential and apparent failure of uncovered interest parity.
Last but certainly not least, Bartosz Maćkowiak presented a thoughtful analysis of "Monetary-Fiscal Interactions and the Euro Area’s Malaise" joint work with Marek Jarosińsky.
Echoing the fiscal Taylor rule idea running through so many talks, they propose a fiscal rule
\[ S_{n,t} = \Psi_n + \Psi_B \left( B_{n,t-1} - \sum_n \theta_n B_{n,t-1} \right) + \psi_n (Y_{n,t}-Y_n) \]
In words, each country's surplus must react to that country's debt \(B_n\), but total EU surpluses do not react to total EU debt. In this way, the EU is "Ricardian" or "fiscal passive" for each country, but it is "non-Ricardian" or "fiscal active" for the EU as a whole. In their simulations, this fiscal commitment has the same beneficial effects running through Leeper and Jabcobson, Bianchi and Melosi, Sims, and others -- but maintaining the idea that individual countries pay their debts.
A big thanks to the Harris School and the Becker-Friedman Institute who sponsored the conference.
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