February 9, 2006
From the desk of Jane Galt:Deficit Dogma
I confess to being shocked at the level of rancor and partisan sloganeering that the subject of budget deficits continue to attract. I'm reminded of this famous1 post by Sgt. Stryker on the subject of steel tariffs:
Dude, let me clue you into something:NOBODY GIVES A [Expletive Deleted] ABOUT STEEL TARIFFS
I can see it now: "Honey, how about we go out to the porch, sit on the swing and watch the grass grow as we discuss the finer points of trade law and it's effects on the economy?"
"Oh, Robert..."
Or how about, "Timmy, I think it's time we've had a talk. You're going to be growing up fast soon and going through changes at a rapid pace. You'll be confused, you'll experience new sensations, and you'll be looking at Steel Tariffs in a whole new way."
I mean, hey, guys, we're talking about the drier points of fiscal policy here. No one's going to die from them--at least not until my generation of senior citizens is handed the bill for our medical care. And the mass heart attack that ensues may well take care of any budget issues, so what's the fuss?
"But Aunty Jane!" I hear you cry, "'twas but a few days ago when you told us we should care about the budget deficit!"
. . . erm . . . yes, well, a foolish consistency is a hobgoblin of little minds, my little chickadees. Besides, what I meant when I said that you should care about the budget deficit is that you should educate yourself on the subject, and worry about our seeming inability to match revenues to spending, even when our economy is in relatively fine fettle. What I did not mean is that you should care about this so much that you are tempted to engage in nasty interpersonal exchanges. This is not a Detroit Pistons game.
Let me clear up some of the questions, anguish, and misinformation currently flying through my comment section.
Question Number One: You want us to raise taxes to close the budget deficit? How can you stand there and call yourself a libertarian with a straight face?
Well, really, should anyone call themselves a libertarian with a straight face? Or want to, given that the Libertarian Party apparently thinks that tax-dodging, driver's-license-refusing, barking moonbat Michael Badnarik is the finest that we have to offer the country? But I digresss . . .
I agree with Tyler Cowen: once the government raised spending, we got the tax increase, whether we want it or not. The question is only whether we pay for it now or later. To my commenters moaning that they shouldn't have to pay the taxes because they don't want the spending, I ask: what's fairer? That you pay taxes for spending you didn't want--or that an as-yet-unborn child who doesn't want the spending, gets not even the most trivial benefit from it, and doesn't even get to vote against the spending, pays the taxes for it? I mean, welcome to representative democracy. The fact that you don't agree with all the decisions made by your representatives doesn't mean that you get to selectively opt out, else very soon we'd be living in anarchy (and I'm not the sort of libertarian who thinks that that would be a good thing).
As Tyler says:
We could raise (nominal) tax rates sooner rather than later, and hope that the subsequent "financial calming" effect will improve the chances for better policy in the future. Alternatively, we could play "chicken" with the marginal tax rates, and hope that holding them lower, for longer, will increase the chance of the appropriate entitlement reforms. I don't have any strong views as to which is the best way to proceed, at least assuming we cannot raise the gas tax instead.
I, like Tyler, favour a carbon/oil tax above either of the other strategies; I, like Tyler, recognize that politically, this is no more likely than a special law naming me "Queen for a Day" . . . a little less, maybe. And while I used to be hopeful, it seems to me that the "playing chicken" strategy has failed pretty miserably. Hence, I'm in favour of raising taxes. We're already passing off an enormous entitlement mess to our grandchildren; I don't see why we should add more debt on top of that. Plus, it seems to me that there's a chance that politicians forced to pay for any new spending with higher taxes might blanche; we know that higher deficits don't bother 'em.
But tax revenues grew after Reagan cut taxes!
Hold on there, partner. Reagan's early years included the worst recession since The Big One. Give me a monster recession to start with, and I can make tax revenues grow astonishingly rapidly in the following years just by performing my secret Tax Revenue Enhancing Dance (TRED for short). Besides, the Reagan rate cuts are heavily oversold by supply-siders. Along with cutting rates, Reagan got rid of a whole slew of deductions, which meant that effective tax rates dropped by much less than the marginal cuts would imply.
But tax revenue exceeded the Congressional Budget Office's expectations after Bush cut taxes! Doesn't that prove that tax cuts work?
Define "work". Do tax cuts reduce deadweight loss, spurring economic growth? Yes. Does that bring in more revenue than you would otherwise anticipate, if you merely multiplied the new, lower rate by the current amount of income? Absolutely. Does that mean that tax cuts pay for themselves, as supply-siders aver? No, no, a thousand times no! Thanks to the Bush tax cuts, revenue is lower now than it would have been if he hadn't cut taxes.
In some cases, I think the gains to economic efficiency outweigh the losses of revenue, particularly in the case of the much-reviled capital gains and dividends cuts, which have increased the returns to investment and lowered the incentive for companies to hoard big piles of cash for their executives to play with. In other cases, I don't think that there's much evidence that taxes make a huge difference: raising the top marginal rate from 35% to 39.5% will not, in my humble opinion, make all that much difference to the economy one way or another--though it undoubtedly will to the upper-middle-class professionals upon whom such tax burdens fall hardest.
Yeah, you know, I bet you wouldn't be so sanguine if you were going to pay more taxes!
Check your premises, chum--I live in the highest-taxed city in America, and pay almost 40% of my income to the taxman every year (more if you count sales tax, and the property tax buried in my rent), despite the fact that I make, oh, about one-fifth what those in the top tax brackets do2. And to be honest, it's hard to work up all that much sympathy for the poor overtaxed upper-middle-class, when I'm in the supermarket trying to decide whether I can afford the brand name Ho-ho's.
Well, what about entitlement spending? Isn't that a bigger problem than the budget deficit?
Indeed, it is--and any of my liberal interlocutors who profess to care deeply about the budget deficit, while resisting entitlement reform By Any Means Necessary, have thereby forfeited any shred of credibility they have on the issue. The annual growth in the unfunded liabilities we're leaving our grandchildren of just the prescription drug benefit dwarfs the impact of the Bush tax cuts.
But . . . but . . . I thought this meant you were coming over to our side, Jane!
Check your premises, chum. I'm in favour of actual fiscal responsibility . . . not "fiscal responsibility as long as it doesn't interfere with my pet political projects". I mean, it's fine if you care more about spending huge gobs of money on senior citizens than you do about the budget deficit. There are things that I care about more than the budget deficit . . . like . . . well, I think World War II was a fine idea, despite the enormous debt it entailed. But to say you care about the deficit, and then fight anything that might conceivably reduce the terrible, horrible, no good very bad choice we are leaving to our children--i.e. to pay for the seniors who didn't save enough because the government implied they'd be taken care of, or put them on ice floes--well, a person could get seriously hurt laughing that hard. It's all fun and games until someone loses a hernia.
But the Democrats are the party of fiscal responsibility!
Doubtful. Clinton's deficit-reduction package did something to reduce the deficit; I give him due credit for that3. But only something. Clintonistas give him credit for most of the deficit reduction, which is a rather charitable interpretation; they get to that figure by assuming rather less deadweight loss to the tax hikes than neutral estimates, and by giving Clinton credit for some rather fortuitous events that kept spending down:
1. The end of the Cold War, which allowed him to slash military spending and reallocate it to other domestic programs at almost no political loss to himself or his friends in Congress2. The election of a firebreathing Republican congress, who held domestic discretionary spending down after 1994
3. The untimely demise of his health care plan, which would have put enormous pressure on the budget. As you'll know if you spend any time observing non-US politics (strangely, most of the single-payer advocates I know don't), other Western parliaments seem to spend most of their time arguing about what to do with the health care budget.
In my book, Clinton gets credit for not, say, spending all the dough we saved on missiles on the William Jefferson Clinton Memorial Trenchmouth Research Center at the University of Arkansas . . . but only middling credit, since he was largely restrained from doing so by political exigency. The fetishisation of budget deficit closure by Clinton afficionadoes is mostly retrospective; it is just about the only substantive policy achievement they can point to after NAFTA, and they get mighty angry when you suggest that the surpluses were mostly caused by things he had nothing to do with: a booming stock market that caused capital gains income to balloon, a bubble economy, and a combination of tax cuts and spending increases implemented under Bush I.
But the budget deficit closure caused the economic boom!
Unlikely. For one thing, as Glen Hubbard has repeatedly pointed out, it is very, very hard to build a credible model in which budget deficits matter to investors, but taxes do not. The basic idea behind the "Deficit reduction causes growth thesis", known to journalists as "Rubinomics", is that by reducing the government's demand for capital, you lower interest rates. Ceteris paribus, I agree with that.
However, the Clinton deficit reduction was not ceteris paribus; he got as far as he got mostly by raising taxes. If you lower interest rates, but increase taxes, you increase the demand for investment capital, but you decrease the supply of it, because savers now make less of a return on each dollar they invest. Higher demand for capital, combined with a lower supply of it, raises interest rates right back up again. How far is a matter for debate, but I see no reason to believe that the positive effect of deficit reduction could be anything close to what the Clinton team claims.
Indeed, Robert Rubin's claims in his memoir border on the ludicrous. (Border? Hell, the hedges are growing well over the property line, and the neighbours are threatening to sue.) At one point, he asserts4 that the swing from deficit to surplus knocked 2.8% off the real interest rate. Since interest rates dropped by 1.3% between the day when Clinton took office and the day he left it, while inflation actually dropped by 20 basis points, that would imply that the underlying real interest rate actually climbed by 1.7% under Clinton.
When one listens to the Clinton team talk about the effects of the budget deficit, one hears them say things like "we were surprised by how large the effect was . . . ", which to a social scienctist should imply that there might be something else at work there. Bob Rubin's book contains passages like this:
In February 1993 there were already indications that the plan was having an effect, even before it had passed. In one of our morning briefings, I told the President that the bond market was reacting more quickly and strongly than I had anticipated.So strongly that, two years later, the bond market was right back where it had been when Clinton took office . . . a situation that was reversed only when Uncle Newt and his Merry Band of Marauders took over. Not that I give Uncle Newt all that much credit either. Both he and Clinton benefitted from a long, slow, secular decline in interest rates that IMHO has much more to do with freer flow of capital across borders, more efficient financial markets, and the growing credibility of the Federal Reserve, which battered back entrenched inflationary expectations. You can see for yourself here.
No to repeat myself, but when you find yourself saying the phrases "the effect is much stronger than we anticipated" and "the bond market reacted to the act before it was passed5", that's a sign that you might want to look for some other cause of the remarkable effects you're experiencing.
But still, it did something!
Indeed. But even if Mr Rubin's lavish estimates were correct, there's not much chance we could pull the same stunt again. The current rate on a 30-year bond is about 4.7%. The inflation rate is around 3.3%. That means, my little chickadees, that real interest rates are very low . . . meaning that even if Rubinomics had worked before, it couldn't possibly this time, unless foriegners start paying us to take their money.
But the economy grew very rapidly when Clinton took office, and terribly before and after!
Correlation is not causation, my little chickadees. Clinton had the really astonishing good fortune to take office just as a recession was ending; Bushes I and II had the pretty astonishing good fortune to take office just as recessions were starting. Recessions tend to screw up your economic track record for years and years.
But still, Kerry was better than Bush on the deficit!
Oh, really? So how come his policy plans spent every single dollar he promised to collect by raising taxes? And that's if you accept his laughably lowball estimates of the cost of his health care plan, which using a very conservative guess, understated the ten-year cost of his plan by at least $500 million through the magic of "administrative savings", the last refuge of a lying politician.
But he said he'd adjust his spending plans if he needed to to close the deficit!
But he did need to. The defict was, IIRC, roughly $400 billion a year back then. The total cash value of his tax-cut repeal was about $700 billion over ten years. He could have poured every cent of that tax money into deficit reduction, and still had a very sizeable hole left. Or as one of my commenters put it:
Candidate A: I will raise taxes. Here is a proposed spending program but I am willing to cut it if I need to..Candidate A's critics: You do need to. Why aren't those cuts already in your spending program?
Candidate A: (crickets.wav)
[Expletive deleted]. I hate you.
You do remember that we're talking about the budget, right?
1 Or at least, it should be
2 So move! you say. Sigh. Why don't you move to the Caymans? You mean, you have a job, a family, and a social life in the United States that you don't want to leave? Do you think maybe that I might have the same problem? In my career, there are two cities I can live in: New York, and Washington D.C., neither of which is a bargain, tax-wise.
3 Yes, Republicans, he did reduce the deficit somewhat, no matter what Uncle Laffer may have told you.
4 Strenuously implies, anyway. He kinda tries to weasel, while still leaving the impression in the minds of his more impressionable readers.
5 Indeed, if you look at the chart, you'll see that the 30-year treasury experienced nearly all of the putative benefit from the deficit reduction before it had even been proposed to Congress, an effect that would be . . . well . . . let's just say rather unusual if true.
Posted by Jane Galt at February 9, 2006 4:19 PM | TrackBack | Technorati inbound links"); ?>truly stunning that you actually can assert with a straight face that a difference of 4 points in the marginal rate doesn't make much of a difference in incentives. if you believe in markets and incentives, the law of large numbers, whatever, if it's true that taxing at 80% on the margin would decrease work, and taxing at 60% on the margin would decrease work, etc., then those margins matter. i promise i'm not trying to be catty, but i suspect if you had a larger income you might realize how true this is (and how that affects one's spending, and how that affects the contractor's income, and how that affects boat sales at etc.). i'm not wading into the rest, but part of your argument is like asserting that evolution only works when it's really extreme. no, it works on the margin too, as the beak of the finch changes in size, etc. finally, why can't one argue that keeping the economy booming now through low taxes and spending makes the future rosier for the as yet unborn? again, if individuals routinely borrow on the expectation that they will be able to make better use of money now, debt ain't bad, etc., why can't government? leaving aside the train wreck presented by entitlements, which cannot be solved even though everyone knows a reckoning must come (and thus must simply be left to break).
anyways, love your blog, sorry to vent, nothing personal.
Posted by: dj superflat on February 9, 2006 8:07 PM...performing my secret Tax Revenue Enhancing Dance (TRED for short).
If it involves diaphanous chiffon, I'd pay serious money to see that.
That aside, though, I assert that no change in the tax rates is necessary so long as the rate of growth in government expenditures can be constrained to be less than the rate of growth in taxable national product; but that no increase in tax rates can balance the budget if the rate of increase in spending exceeds the rate at which actual revenues increase.
Counterintuitive as it may seem, it follows that tax rates are not the issue.
Posted by: Charlie (Colorado) on February 9, 2006 8:26 PMdj,
Where do you come up with comparisons mentioning 80% and 60%? We don't have income tax rates at that level for anyone. We haven't for decades. Hate to tell you this but cuts in marginal rates when you're at the taxation levels we're at don't have the large effects you'd like to believe. Large cuts if we were at the kind of numbers you apparently think we are at would make a difference. But your basic assumption is all wrong.
Jane,
Just saying let's cut programs isn't reform. Most of what I hear from the political right comes down to that. Cut it and damn the consequences. Like the Bush budget proposals on Medicare. They claim that it won't make any difference to the availability of health care when they cut the funds to providers when the example of how many doctors don't take Medicaid has already proven them wrong is an example. If conservatives really want to reform the programs they should admit that there will be problems if they are just cut and try to ameliorate the problems. But that's not what they really want or care about. It's all about ideology and a belief that all poor people are that way because of character flaws and those flaws should be punished. And if I'm wrong about it then maybe instead of condemning me as some liberal goofball they should ask why they come across that way.
Posted by: Jim S on February 9, 2006 8:56 PMIt wasn't just the end of a recession by which Clinton benefited, Jane. There was a confluence of events in his second term: the Internet boom, Y2K (which resulted in an enormous amount of IT spending which might otherwise have been deferred i.e. it moved IT spending from the years 2000-2003 into 1997-1999), and decades of investment in computer technology finally paid off.
IMO a critical mistake that the Bush Administration is making is that they still believe that the economy “will get back to normal”. It is back to normal; the 90's were the exception. We'll grow but it's unlikely that we'll grow fast enough to compensate for their profligacy.
Posted by: Dave Schuler on February 9, 2006 9:00 PMJim S,
It's not about punishment, but rather that the safety net is too generous. This applies at both the federal and state level. One of the problems at the federal level is the "national" poverty rate, which is set too low for the big cities but too big for the rural areas. And New York State has a cadillac of Medicaid plans. Why should someone on Medicaid be entitled to better health care than the best health plans of workers (usually teachers)?
Posted by: Rex on February 9, 2006 9:15 PMI like your analysis, but be careful in asserting that future generations bear the burden of deficits. They pay the taxes but they also inherit the bonds. Often the relevant transfers are within generations. Much depends on timing. This question is very tricky. I may blog it soon, unless of course I am too busy reading GWTW.
Posted by: Tyler Cowen on February 9, 2006 9:22 PMHAHAHAHAHAHAHAHAHAHAHA!
HAHAHAHAHAHAHAHAHAHAHA!HAHAHAHAHAHAHAHAHAHAHA!
The saliva that that will be sputtered in response to this post will be measured in 100s of gallons.
This quote from Rubin isn't as crazy as it sounds and given his background, I am sure he believes it.
"In February 1993 there were already indications that the plan was having an effect, even before it had passed. In one of our morning briefings, I told the President that the bond market was reacting more quickly and strongly than I had anticipated."
He is assuming, correctly, that a proposal has some % chance of passing, and that the bond market would price that in. Also, that even if the proposal didn't pass as originally designed, they would try to work in a portion of it. This is not really all that controversial of a claim by RR.
Posted by: mickslam on February 9, 2006 9:25 PMGood article Jane. I think we need to raise taxes also. But the income tax is not what I would raise. first $2.50/gal gas tax -- if we are at all serious about cureing that addiction. Second, VAT. Not having one has gutted the corporate tax and prevented us from taxing imports.
Posted by: Robert Schwartz on February 9, 2006 9:28 PMNice post Jane. I know I like to rile up you and crowd over here.
Really nice post.
Posted by: mickslam on February 9, 2006 9:28 PMLike the post, but one quibble. You missed one huge pillar of the Clinton-era deficit reduction -- the end of the S&L bailout. The resolution of the banking crisis exerted a pretty significant fiscal drag. Later on, Clinton benefitted from a reversal of some of those costs, as RTC was able to dispose of assets at better than expected prices. In 1991, RTC outlays added something like $90bio to the budget deficit. By 1994, RTC was generating a hefty profit from disposals ($20bio or so, if i recall), which was accounted for as "negative spending" (government accounting is a marvel, ain't it?).
Posted by: Ben H on February 9, 2006 9:34 PMVery nice post. One quibble:
I ask: what's fairer? That you pay taxes for spending you didn't want--or that an as-yet-unborn child who doesn't want the spending, gets not even the most trivial benefit from it, and doesn't even get to vote against the spending, pays the taxes for it?
I don't think it is a given that those unborn children receive less of a benefit than I do from the programs I don't want; after all, they'll be inheriting the money their parents saved by having the government pay their bills. In any event, I certainly don't see myself as having any moral obligation to take the debt off one group of people who shouldn't be getting stuck with it and place it on myself, just because my fellow Americans can't balance a budget.
Posted by: Dan on February 9, 2006 10:32 PM"Along with cutting rates, Reagan got rid of a whole slew of deductions, which meant that effective tax rates dropped by much less than the marginal cuts would imply." How v sensible: to get us wage slaves to try harder, cut marginal tax rates. To fill the government's maw, increase average tax rates. No fool, the Blessed Ronnie.
"If conservatives really want to reform the programs they should admit that there will be problems if they are just cut and try to ameliorate the problems."
Right, because then the liberal goofballs such as yourself would say, "Oh, well, it's great that you admitted there will be problems! Now that we're all in agreement on that, we'll all stop questioning the motives of those who disagree about what programs to cut, engaging in cheap class warfare and political point-scoring, and posting lame and dogmatic comments to blog posts about the deficit! We can get to work and deal with the fact that government is trying to do too much and it's going to put future generations in the poorhouse!"
Right? That's what you and those who share your views would say, right? They wouldn't use any concessions about problems with spending cuts as an excuse to keep their heads in the sand, mercilessly demagogue anyone who points out problems with the present level of government spending, and keep spending money like there's no tomorrow because they'll be dead before the bill comes due? Right?
Boy I wish I lived in that alternate universe.
Posted by: asg on February 9, 2006 11:13 PMIt also seems worth noting that Reagan followed up the massive tax cuts of 1981 with the largest tax hikes of the last 40 years in 1982.
Source: Office of Tax Analysis Working Paper 81, July 2003
Posted by: Brendan on February 9, 2006 11:15 PM"NOBODY GIVES A [Expletive Deleted] ABOUT STEEL TARIFFS"
Well, outgoing Congressional Budget Office head Douglas Holtz-Eakin says he doesn't care about all the current budget brouhaha, and says others shouldn't either.
"I think this is self-evident," says Mr. Holtz-Eakin, chuckling. "... I wake up every morning saying it doesn't matter what happens in the next five years, and people say I am really weird."
And he has good reason.
be careful in asserting that future generations bear the burden of deficits. They pay the taxes but they also inherit the bonds.Yes but the debt owed to the public via bonds is in no way this nation's real fiscal problem. The $300 billion deficit on $11 trillion GDP actually reduced the total debt as a % of GDP, since the latter grew by more than 3%. If that deficit goes to $400+ billion ... the economy can run deficits of 3% to 4% of GDP happily forever.
As Holtz-Eakin says in so many words, taking the public debt represented by T-bonds as the main fiscal issue overlooks the woolly mammoth at the Medicare office.
Posted by: Jim Glass on February 9, 2006 11:17 PMJane -
You've got a factual error in your post. There was no recession anywhere around the time Bush I took office.
Source: NBER Business Cycle Dates
http://www.nber.org/cycles.html/
Also, I think you're overstating the case by describing the late 90s economy as a bubble and describing the 2001 recession as the kind of event that would screw up your economic track record for years.
Posted by: Brendan on February 9, 2006 11:31 PMJim S --
I think there's a problem with your math on the deficit as a percentage of GDP, but I can't put my finger on it yet. Still, try plugging in the real numbers, and you'll see:
Year 0:
Debt: $5 Trillion
GDP: $11 Trillion
Debt as % of GDP: 45.5%
Year 1:
Debt: $5.33 Trillion (deficit was 3% of GDP)
GDP: $11.44 Trillion (growth of 4%)
Debt as % of GDP: 46.6%
Posted by: Brendan on February 9, 2006 11:31 PMAny idea how to write a balanced-budget Constitutional amendment with some real teeth in it? I've thought for some time that that may be a necessity to save the damn Republic at this point. Otherwise we are, from now on, going to go through bulimic fiscal binge-and-purge cycles -- with the party that does the ginging always getting the praise from the public, and the party that does the purging always getting the blame.
There is, of course, nothing automatically conservative OR liberal about backing such an amendment, which is why Sen. Paul Simon and Michal Kinsley backed it when Clinton zapped the last one. All it does is try to eliminate that pernicious fake Third Ideology which David Frum calls "fake conservatism" but which could just as easily be called "fake liberalism", in which legislators (and Presidents) pump up their personal popularity by letting the deficit grow to the size of the Crab Nebula in the (frequently fulfilled) hope that they'll be safely out of office by the time the roof falls in on their successors. (As George Will said, Reagan's brand of "conservatism" was popular precisely because it gave the voters "a dollar's worth of government for 80 cents worth of taxes, with the rest being borrowed.")
It's now clear that Keynes unintentionally opened the gates of Hell -- by pointing out, entirely correctly, that there are SOME times when we should run a deficit, he gave politicians the excuse they had always dreamed of to say that we should ALWAYS do so. The gates need to be closed again, but how should we do it?
Posted by: Bruce Moomaw on February 9, 2006 11:34 PMNo to repeat myself, but when you find yourself saying the phrases "the effect is much stronger than we anticipated" and "the bond market reacted to the act before it was passed5", that's a sign that you might want to look for some other cause of the remarkable effects you're experiencing.
So, I assume you also don't believe that governmentthe boutique shops providing intelligence services on D.C. provide the value that those foolish traders who consume their services seem to?
Markets move on information (asymmetrical information, in fact), so one would expect forward movement in such a situation, no?
when I'm in the supermarket trying to decide whether I can afford the brand name Ho-ho's.
Side note: Little Debbie Swiss Cake Rolls are much cheaper than Ho-Hos, and taste better. But maybe that's just me.
Steel tariffs? Heck, it's incredibly hard to get people to give a damn about the sugar supports. Some people do prick up their ears about the idea of getting Coke with real sugar.
Posted by: John Thacker on February 9, 2006 11:48 PMIt's all about ideology and a belief that all poor people are that way because of character flaws and those flaws should be punished. And if I'm wrong about it then maybe instead of condemning me as some liberal goofball they should ask why they come across that way.
The first half of that is known as "projection", the second half is something I admit to having nearly said more than once. Mostly because of the first.
Simply stated, as a point of fact, people respond to incentives. Once you begin handing out free money, the number of people willing to qualify for handouts will rise in strong correlation to (1) how much you are handing out and (2) how carefully you screen the applicants to determine who actually needs the handout, as compared to those who are merely willing to take it (exploiters).
And yes, whether they fit conveniently into your worldview or not, the exploiters do include people who are definably poor, but are only there because they are unwilling to work at the level of their own consumption. Would that everyone had a high-paying job in a field they enjoy, especially since that would benefit ME right now, but this is the real world: you work, or you starve. That is man's lot in life. (Man's desire, of course, is to both work less and starve less, but that is no right even though some obtain it by cunning or by birth.)
Government programs designed to help the unfortunate must either pay respect to this philosophy in their design, or be destroyed by exploitation, because good intentions alone do not a financially-sound vehicle make. And that is primarily where I part ways with many liberal thinkers, a large portion seem to have generous intentions well beyond fiduciary sanity.
I am not opposed to aiding the poor on principle, quite the opposite in fact -- although I do think that it works best when it begins at the individual charitable level.
Posted by: anony-mouse on February 10, 2006 12:19 AMI also liked to post. However, I am much less certain than you seem to be that significant entitlement cuts are not only possible, but likely. I accept that the evidence so far is scant, but I can refer you to a discussion over at TAPPED about changes or possible changes in Hillary Clinton's health care proposals from 94 to the present. That kind of political event (massive entitlement reform), if it occurs, will be catastrophic, not implying bad which is not an argument I would make here, but sudden and unexpected.
Now even massive entitlement reform would only transfer the costs of care, not eliminate them, and might affect consumer spending and saving in to the extent there would be no net benefit to the economy. Way over my head.
Posted by: bob mcmanus on February 10, 2006 2:08 AMJane:
How do we know that the deficit hasn't restrained spending? Government spending as a percentage of GDP hit 18.4%--its lowest level since the '60s--in FY2000. But that was at the height of the boom, so it's reasonable to suppose that it was artificially depressed a bit. Let's say 19% would have been a reasonable number to hope for over the next few years.
We haven't gotten that. In FY2005, outlays were 20.1% of GDP, and the projection for FY2006 is 20.8%. That's bad, but outlays exceeding 21% (all the way up to 23.5% in FY1983) were par for the course from the mid '70s through the mid '90s.
So it could be worse. And who's to say that it wouldn't have been worse, if not for the taxes? What I fear, if we raise taxes to close the deficit, is that Congress will just spend all we give them and another 2-3% on top of that, and then we'll end up with the Feds spending 23% of the GDP again.
It's not that I don't agree that the deficit is a problem--it's that I think that deficits exert enough of a restraining effect on Congress to justify their drawbacks.
Regarding Reagan, the easiest way to illustrate the problems with the supply-side story is to look at tax receipts as a percentage of GDP. Following the fabled tax cuts, they were at about the same level as they were in the seventies. If the supply-side explanation were correct, this figure would have been significantly lower (as it was after the Bush tax cuts).
Finally, the libertarian argument for the fiscal superiority of Kerry isn't that his plans were good--it's just that a Republican Congress wouldn't have let a Democrat implement them. A Kerry administration would have been fiscally responsible for the same reason the Clinton administration was--fierce Republican opposition.
Posted by: Brandon Berg on February 10, 2006 2:47 AMBrendan --
YOu are confusing real and nominal variables. The growth rate Jim S. quotes is real, not nominal. You need to account for the effect of inflation on nominal GDP (your denominator). The debt (the numerator) is not indexed to inflation.
More generally, the "rule-of-thumb" condition for non-explosive debt dynamics is:
(t - g)
where
t is ratio of government revenue to GDP
g is ratio government primary (that is, non-interest) expenditure to GDP
r is the *real* interest rate
dy is rate of growth of real GDP
B is starting government debt to GDP ratio
And "debt sustainability" means stationarity of the debt-to-GDP ratio.
The basic idea: the primary surplus needs to be greater than or equal to debt times the excess of the real interest rate over GDP growth rate.
Given how low real interest rates are in the U.S. right now (TIPS yield is around 2%) and how robust growth is, this is not a very challenging condition.
The problem is that the massive upcoming growth in entitlement spending will, if not dealt with, push the federal budget balance into a massive deficit.
Posted by: Ben H on February 10, 2006 6:33 AMYou're still young Jane. Those of us who have seen this all before know that raising taxes will not balance the budget or even reduce the deficit. It will simply be yet another victory for those who favor higher taxes to reduced spending. They have forced the issue yet again and you are going to let them off the hook - again.
Raising taxes is not the responsible thing to do. It is simply passing the problem on to yet another generation. Your mistake is in thinking that the problem is the budget deficit. But the problem is a dysfunctional government. The responsible thing to do is an intervention.
Posted by: Randy on February 10, 2006 7:10 AMYou said:
"I don't think that there's much evidence that taxes make a huge difference:..."
That's why you have to be a lesser princess instead of supreme princess. My decision is as arbitrary and final as yours.
Very good article.
I suggest you look at the change in the composition of capital spending before you go to far on the impact of taxs changes on incentives.
If you look at nonresidential fixed investment as a percent of gdp there has been a secular rise in that measure. but if you break that down into information technology (IT) and softwear vs all other you find that all of the increase in fixed investment stems from IT & softwear. The all other has stayed at roughly the same share of gdp it was in 1980.
One conclusion to draw from this is the the reason that such investment grew is that the technological break throughs made such investment very profitable and this is what drove the increase in capital spending. Tax policy played little or no role in this change in the economy. If a significant part of the reason for expanded capital spending stemmed from tax cuts we should have seen an increase in other types of spending as well.
The more I look at the facts behind the issues I keep being drawn to the conclusions that the changes in tax policy on investment incentives for individuals are so small that they do not really matter one way or another.
Posted by: spencer on February 10, 2006 9:06 AMI agree with Bruce Moomaw and Randy that raising taxes is unlikely to reduce deficits, because spending simply increases.
My criticism of your earlier post and Economist article was that you made the very, very strong yet unstated assumption that both economic growth AND government spending were independent of tax rates.
On evidence of where we are on the Laffer curve: I don't think it's possible to prove either way, using past numbers, whether cutting the tax rates has increased or decreased revenues. Of the two effects - the direct effect of lower rates and the stimulatory effect on output and growth - we don't have enough data to be sure which was stronger.
But the deficit depends on the gap between spending and tax revenues, and you've also been assuming that spending is somehow independent of tax rates and expected revenues.
Raising taxes will do one of two things: either 1) reduce economic growth so much that revenues falls; or 2) raise expected revenues, which will lead to increased spending. Or we might even get the worst of both worlds - a tax increase might actually reduce revenues, but politicians may expect it to increase revenues and thus spend more anyway.
You were inaccurate in your post when you implied that Clinton only spent the "peace dividend" once - he and other politicians spent it many times over. They all used decreased defense spending at the end of the Cold War as an excuse to increase spending by many times the expected savings, and they would do the same with a tax increase.
Clinton only signed the balanced budget amendment because he had already vetoed it twice, and his advisors said that it would look bad to veto it a third time. And the 'balanced' (not counting social security) budgets were used as an excuse for politicians to spend like drunken sailors in the last Clinton budget.
Do you have any evidence whatsoever that politicans won't spend any expected 'bonus' from a tax increase many times over, thus increasing the deficit even more? Does such an outcome sound logical or likely to you, based on the past behavior of politicians? What basis do you have for your incredibly strong assumption that spending is independent of expected tax revenues?
Posted by: Ann on February 10, 2006 9:27 AMonce the government raised spending, we got the tax increase, whether we want it or not. The question is only whether we pay for it now or later.
Sad, even libertarians can no longer conceive of lowering the deficit through spending cuts (whether we get them now, or later).
Incidentally, I live in Indiana and was glad that our governor, Mitch Daniels, proposed raising my taxes. But he didn't raise taxes so that politicians could throw more away - he had clear proposals to streamline government and get rid of waste.
If I thought that we could truly balance the budget, cut back on waste and deal with the many problems we have with our entitlement programs, I'd be happy to pay more in taxes. I wish Bush were more like Mitch Daniels in his handling of the budget. But, to be fair, Bush also has to worry about national defense, etc., and the Democrats have done everything they could to stop him from fixing social security and other problems.
But, Jane, before you can say that it's 'responsible' to raise taxes under the current system, you need to specify your assumptions - what do you think will happen to spending?
Posted by: Ann on February 10, 2006 9:44 AMOUTSTANDING RANT & WELL DESERVED. I love THIS POST. THANKS, & thx to Marc K for the link.
Posted by: bailey on February 10, 2006 10:44 AMI think that many of us self-proclaimed liberals would like to end some (if not many) entitlements (like the medicare drug plan) but we don't feel like to can make promises to a whole generation of people and then, when they have relied on the promise, call "take-backs" and leave them high and dry. Therefore, I am completely for REFORM.
In addition, I don't really care which party has someone as president. I just want the house and senate to be controlled by someone who is in the opposing party. It worked very well with Clinton and I suspect the tremendous corruption issues we have now would be less prevalent (in every sense of the word) if we had a split between the legislative and executive branches. I suspect if this was the case Bush would not be sending budgets like this to congress, he would have no choice but to be at least a bit more fiscally responsible. I'd really like that.
Posted by: Kate on February 10, 2006 11:31 AMKate is probably correct. A friend, staffer to a Republican congressman, asserts that spending would be much lower if the GOP did not control the White House too. It is far easier to say no to a president who is not of your party.
Posted by: Creech on February 10, 2006 11:53 AMJane,
THANK YOU for bringing us back to the fact that the Laffer Curve is, well, a curve. The supply-side crowd seems to have moved from economics to some Kool Aid Kult where it is actually just an upward sloping line. Last week someone actually told me that, given a 1% flat tax rate, government revenues would increase if reduced to 0%.
What the Clinton tax hikes showed is that we're short of the maximum on the Laffer Curve and that, at this point, slightly higher marginal tax rates probably will result in higher revenue. Remember, we're talking about the difference between 33 percent and 35 percent. This is not the 1940s, when the highest marginal rates were over 90 percent.
Posted by: Dan II on February 10, 2006 12:00 PMjim s --
ummmmmmmmmmm, those numbers were quite obviously examples. that is, you wouldn't debate that a 60% or 80% rate affects incentives, growth, etc. so you can't really debate whether 4% does the same. you either in or out. and i agree with whoever commented on jane's age, because you have to be pretty young or naive not to realize that, if the government has more money, it will spend more. but much of the commentary seems to miss the point -- the deficits are irrelevant, the entitlements are everything. and taxes cannot fix the latter.
Posted by: dj superflat on February 10, 2006 12:05 PMyou could live in the Virginia suburbs, which are a tax bargain. DC - yes, it's high taxes, and not very good services. But there is no point in DC which is more than eight miles from Virginia, the downtown is more like two. And there is a convenient subway, which even smells good.
Posted by: dave s on February 10, 2006 12:38 PM"Jim -- I think there's a problem with your math on the deficit as a percentage of GDP..."
Right you are, I shouldn't try to think numbers after my bedtime.
But here's the point more accurately:
A 3.2% of GDP deficit is entirely moderate and reasonable by historical standards -- in fact it would be the median, 13th largest of the last 25 years.
Moreover, deficits equal to a percentage of GDP smaller than the GDP growth rate can be readily sustained forever.
So what's to be so upset about all the things that go into a 3.2% of GDP deficit?
As Holtz-Eakin points out, there are fiscal dangers to be worried about, really big ones -- but a 3.2% of GDP deficit just isn't among them. The priority of worries among the budget worriers is confusing.
Perspective: The accruing liability for the Bush Medicare drug benefit is over $560 billion a year -- more than twice the cost of his tax cuts, yet the fiscal worriers damn the tax cuts and mostly ignore the drug benefit.
The Treasury says the total budget deficit on a accrual basis, including the cost of accruing retiree benefits, is more than $3 trillion annually. The cost of the Bush tax cuts amount to no more than 8% of that -- yet everyone goes on about the cost of the tax cuts!
The most recent Analytical Perspectives on the Budget says the current value unfunded liability of Social Security and Medicare is now $80 trillion (and that doesn't include Medicaid, unfunded federal employee benefits, etc.) ... yet people moan about the cost of earmarks, and about discretionary expenditures that amount to 0% of that.
The priorities make no sense.
Posted by: Jim Glass on February 10, 2006 12:39 PMPerspective: The accruing liability for the Bush Medicare drug benefit is over $560 billion a year -- more than twice the cost of his tax cuts, yet the fiscal worriers damn the tax cuts and mostly ignore the drug benefit.
Sure -- because the stakes there are bipartisan (the Dems wanted an even bigger benefit than the one that passed). Once both pigs have their snout in the trough of a parictular issue, one cannot expect either party to complain about the quality of the slop.
Posted by: anony-mouse on February 10, 2006 1:07 PMBen H-
I don't think that your whole equation got posted -- you defined 5 variables and only used 2.
To your point though, I used nominal GDP because the debt is in nominal dollars, and because Jim didn't mention anything about real dollars or inflation in his post.
The real equation for figuring out whether debt as a % of GDP is easy, and there's no point in bringing real dollars into it.
Is the amount of debt you added in the year a bigger or smaller percentage of the GDP added in that year than the baseline?
Year 0:
Debt: $6 Trillion
GDP: $10 Trillion
Debt as % of GDP: 60%
Year 1:
GDP up 5% ($500 billion) to $10.5 Trillion
If:
- debt increases by 60% of the GDP growth ($300 billion), the debt to GDP ratio will stay at 60%
- debt increases by more than 60% of GDP growth (e.g. $400 billion), the debt to GDP ration will increase
- debt increases by less than 60% of GDP gorwth (e.g. $250 billion), the debt to GDP ratio will increase
P.S. greater than/less than signs apparently make the comment machine very very angry
Posted by: Brendan on February 10, 2006 1:21 PMJim Glass -
While deficits less than the rate of GDP growth can mathematically be sustained forever, it requires anti-Keynesian policies to maintain them -- because when GDP growth goes negative, you've got to run surpluses (negative deficits). I think that the generally accepted wisdom is to run the deficits during times of recession, and make it up with surpluses during the good times.
Running deficits of 3% of GDP during the peak period of economic growth (like, say, now) doesn't mean that we're on a sustainable course. It means that during the next recession, the deficit is going to be 6-8% of GDP and we're in big trouble.
Posted by: Brendan on February 10, 2006 1:34 PMObviously, medicare is the biggest baddest problem of all, and I don't think you'd find much argument from Democrats that in an administration filled with fiscal irresponsibility, proposing and passing a medicare drug benefit with no funding mechanism was the single craziest move.
Still, the tax cuts are a problem precisely because we've got so many problems to fix. Reagan showed that tax cuts can be the spoonful of sugar that helps the medicine go down -- he wanted to simplify the tax code, and he overcame opposition by sweetening the deal with tax cuts.
E.G.
If we were to start to try to deal with entitlements by, say, lifting the cap of wages subject to payroll taxes, it wouldn've been a lot more politically feasible to do that while coupling it with a cut in the top marginal rate from 39.6% to 38%.
-OR-
We still need to do a big tax cut by reforming the AMT, yet we have no surplus left to work with to do it in a fiscally responsible manner.
Also, I think people focus on the tax cuts because they don't understand the decisions. When we talk about fixing the funding for entitlements, we're talking about making changes to programs that were fully funded for the first several dcades that they were in effect. I think that the vast majority of people understand why social security and medicare were set up and that they were set up with funding mechanisms that work (or worked). In contrast, the tax cuts have come at a time when we're embarking on a Global War on Terror that is approaching $500 Billion in cost. The precedent had been to raise taxes in wartime (largest tax hike in history is the Revenue Act of 1942), not cut them. I think part of the focus on wartime tax cuts is because they're anomalous, not because they're necessarily the biggest problem.
Posted by: Brendan on February 10, 2006 1:52 PMBrendan, I think you miss my point.
Deficits that average 3% or 4% of GDP are sustainable pretty much forever. A 6% to 8% deficit in one or two years due to a recession is no serious problem.
But on current law we are heading to average deficits of 10% of GDP and rising well within the forseeable future, within the working years for most of us (not to mention our retirement years).
Then we will be in big trouble.
So why are so many people so worried about the sustainable 3% while ignoring the clamatous 10%?
Are deficit worriers so shortsighted?
Great post! It's not often that I see a libertarian who takes into account the realities of the situation instead of standing by dogma all day.
Posted by: KL on February 10, 2006 2:01 PM"I suspect the tremendous corruption issues we have now would be less prevalent (in every sense of the word) if we had a split between the legislative and executive branches."
But Clinton faced such a split for 6 of his 8 years in office, and we saw far more corruption (in the traditional sense of the word) then. Granted, Ron Brown got the first trade trip payoffs from, for example, Ken Lay of Enron and Bernard Schwartz of Loral in 1994, but the corruption continued. Enron's main bribes and payoffs (around Dabhol and other projects) came later, after the 1994 election. A split between the legislative and executive branches might help to reduce spending, but the Clinton administration is pretty strong evidence against the idea that it prevents corruption.
Posted by: Ann on February 10, 2006 2:09 PMNow, I generally like your recent display of a love of footnoting. And I hate to make more work for you. But if it's not too much trouble I think there're clever ways you can hyperlink the footnotes -- Slate does it all the time anyway -- so we can click on the surperscript, read the footnote, click on something else, and return to where we were. If it's not too much trouble, and if this trend continues, do please consider that.
Posted by: Sanjay Krishnaswamy on February 10, 2006 2:30 PMAlso, I think people focus on the tax cuts because they don't understand the decisions. When we talk about fixing the funding for entitlements, we're talking about making changes to programs that were fully funded for the first several dcades that they were in effect. I think that the vast majority of people understand why social security and medicare were set up and that they were set up with funding mechanisms that work (or worked).
Huh? You are aware that "fully funded" doesn't mean "producing an operational surplus"?
Posted by: AT on February 10, 2006 3:02 PMJim Glass -
Doing some back of the envelope math (i.e. it might be wrong), 2 years of 8% deficits with 0% GDP growth would increase interest as a percentage of GDP by almost a full percentage point. That turns a 3-4% deficit into a 4-5% deficit.
What you're basically saying is that carrying debt equal to 100% of GDP (the product of deficits of 3-4% of GDP and growth of 3-4%) is sustainable. And it is. But by the time debt reaches 150% of GDP, you're in a debt spiral that's almost impossible to escape. And it only takes one bad recession with a couple years of highly stimulative policy to start closing in on that 150 mark pretty quickly.
Running constant large deficits eliminates the margin for error -- these things can snowball much more quickly than I think you're accounting for.
However, I know that all of this doesn't address your main point. The worst legacy of this administration is the unfunded drug bill. I don't know how it's going to be fixed (although if they keep screwing up implementation, maybe we can just get rid of it). However, in my second part of my post above, I laid out why I think people focus on the tax cuts. I'm not saying it makes sense, but we've got a lot of problems to solve, and I'd be happy to start anywhere.
Posted by: Brendan on February 10, 2006 3:13 PMAT -
Like it or not, the government doesn't use actuarial accounting. It has no mechanism by which to do so. Under the accounting rules it uses, social security and medicare were fully funded -- the payroll taxes devoted to them covered the outlays they required, and, most years, produced a small surplus.
The medicare drug benefit has no funding mechanism and is the fastest growing part of our outlays. It's hard to conceive of a more fiscally irresponsible program.
Posted by: Brendan on February 10, 2006 3:27 PM"2 years of 8% deficits with 0% GDP growth would increase interest as a percentage of GDP..."
Where do 8% deficits come from in this scenario?
I postulated long-term deficits like next year's projected, 3.2% of GDP, the median of the last 25 years, long-term average between 3% and 4%, no more than the growth rate of the economy. (Average means if a lot higher one year, then comparably lower in another.)
How does one produce two years of 8% deficits from that? Over those 25 years, during the worst recession since the Great Depression (and after a whole bunch of tax cuts) the deficit went up only to 5.6%, an increase of 3 points, for only one year.
"The worst legacy of this administration is the unfunded drug bill."
Very true. Though that's only 20% of the total unfunded cost of Medicare, the other 80% of which is the legacy of Democrats.
It's also true that deficits of 8% and rising are scheduled to arrive in the future, but not until the bill for entitlement spending arrives.
"Like it or not, the government doesn't use actuarial accounting. It has no mechanism by which to do so."
You'll have to explain how the government reports that Social Security is actuarially underfunded by $12.8 trillion, and Medicare by $68.4 trillion, if it has no mechanism by which it can do so.
"The medicare drug benefit has no funding mechanism and is the fastest growing part of our outlays."
Not true at all. Medicare part B's unfunded liabilities are running up almost twice as fast, $954 billion in 2005 alone, says the Treasury.
"It's hard to conceive of a more fiscally irresponsible program."
Medicare part B.
Jim Glass --
If we're running 3-4% deficits during our best periods of economic growth (like now), the budget's automatic economic stabilizers alone (e.g. unemployment insurance, higher welfare caseloads, etc) will push up the deficit during times of recession. Keynesian stimulus will push it up even further.
That is, if we're running 3-4% deficits now, it's highly unlikely that we'd average 3-4% for the cycle.
Posted by: Brendan on February 10, 2006 4:58 PMJim Glass -
When I said Medicare Part D was growing faster than anything else, I was speaking in terms of percentage increase in spending -- it's expected to grow by 400% over the next decade. I wasn't speaking to the growth in unfunded liabilities, although I'm surprised to see anything beat it. Would you be willing to post the link to that study again?
As for Medicare Part B, my memory is that it contains an automatic speed brake for cost increases called an SDR or something like that. Part D contains no such restraint. Thus, in my book, it (narrowly) wins the title of most fiscally irresponsible.
Posted by: Brendan on February 10, 2006 4:59 PMJim Glass --
As for actuarial accounting ... I wasn't precise enough in my language. Of course, the government can tally its obligations using actuarial tables and the accrual method, but it has no mechanism for setting aside the money to pay for them. There is no market in the world where it could park the hundreds of billions dollars a year it needs to meet its obligations.
It could pay down debt for a few years in order to create future capacity to borrow, but that only works until the debt is paid off. Any of the capital markets would be completely distorted by the presence of one buyer with so much money. As a result, the government has no choice but to use cash accounting for its operations.
Posted by: Brendan on February 10, 2006 5:04 PMdj,
No, it's not that you're either in or you're out. It just isn't that simple. What makes you think it is? Maybe some of the other readers can cite specifics but I'll swear I've read about studies that compared effects of different tax cuts and find that they do have vastly different effects depending on the initial tax levels and the amounts of the cuts. Thus the cuts Kennedy made are very different in their results than anything Bush could do because the rates aren't nearly as high as they were back then.
Posted by: Jim S on February 11, 2006 12:22 PMJim S -
It's the basic principle behind the Laffer Curve -- tax cuts at higher rates have greater stimulatory power than cuts at lower rates.
The most basic example is that the cut from 100% to 99% is more stimulative than the cut from say, 40% to 39%.
Posted by: Brendan on February 11, 2006 9:27 PM"Those of us who have seen this all before know that raising taxes will not balance the budget or even reduce the deficit."
My memory goes back to the Carter administration, so the wild spending of the Bush Administration is something new in my experience. But I can say that the experience of the past 30 years doesn't support your assertion.
Other than Bush, the biggest spending president I've observed is Reagan. I think that it is no coincidence that both Reagan and Bush passed tax cuts that contributed to the deficit. The common element in both cases was a willingness to run a deficit and let future presidents worry about the consequences. Of course, Reagan was a model of fiscal prudence compared to Bush.
Bush is so committed to his tax cuts that he threatened to veto spending on Iraq (including funding for body armor for our troops) if Congress paid for the speding by raising taxes. If Bush supporters weren't willing to tolerate deficit spending, the current size of government would be much more to the liking of libertarians.
Comments are Closed.