Asymmetrical Information

The original outcry over the creation of structural as opposed to cyclical deficit under Reagan was called crowding out. That idea said that govt borrowing would force up rates and damage the interest sensitive sectors of the economy. But because this was based on a closed economy model it ignored the inflow of foreign capital that could keep rates low. So the crowding out thesis was discreditied. But the inflow of foreign capital had to be offset by a similiar sized current account deficit. consequently the trade, current account deficit soared. So the only difference is that the crowing out damage is just showing up in the tradable goods sector rather then the interest sensitive sector.

A significant part of the reason GM and other traditional manufacturing sectors are suffering such severe international competition is the impact of the structural federal deficit on the structural trade, current account deficit.

PS Y is generally used to denote income but I guess since you are using it to denote govt income it is ok this time.

Jane,

Re; "I should clarify that I am in favour of raising taxes if and only if it occurs in the context of balancing the budget..."

Okay, I can live with that. But, once bitten, twice shy. Why should I trust them? How do we enforce it?

We would kill the whole Medicare/Medicaid debacle, along with the tax deduction for corporate-provided health care benefits, replacing it all with catastrophic federal insurance for those whose medical bills exceed 15-20% of gross income (phasing out for those whose incomes put them in, say, the top .1% of earners) and another means-tested benefit for those who genuinely cannot afford to spend 15% of gross income on health care benefits.

Because the last group amounts to "sick people," this amounts to national health insurance (with a couple de minimis takebacks against the rich that might cost more to administer than they are worth).

It is a historical fact that Japanese investors will accept negative nominal interest rates. Google negative interest rates Japan if you're interested.

Raising taxes won't close the deficit, it will just shift the source of the tax receipts. Receipts as a % of GNP has been virtually flat for years. The problem is spending.

My brother recently remarked that budget deficit can actually be viewed as a sort of (possibly deferred) tax with a weird collection mechanism. From this point of view, only the deferred payment of the "deficit tax" differentiates it from other taxes and if one discounts the deficit to the present, there is no difference to regular taxes, except for who pays what part of them. He even suggested that a government might dispense with regular taxes altogether, just printing enough money to cover spending. I feel that there is something wrong with this idea, but not being an economist cannot pin it down. I would appreciate a few stabs at this idea.

"I don't think that deficits are particularly worrying; but I also don't see why we should be running them. We're a wealthy nation, and our economy is in pretty good shape."

Bingo, Jane. But of course, we can, and furthermore, we can blame the party we like less for the resulting discomfort we have over them. Now that's a win-win.

BTW Jane, what's with the footnotes lately. Have you been reading David Foster Wallace? The result of some indoctrination at Not-to-be-Named Foreign "Newspaper"?

The basic formula is Y = C + I + G + NX (gdp = consumption + investment + government spending + net exports).

Japanese investors accept negative nominal interest rates because those are real interest rates in a deflationary environment. Jane was referencing negative _real_ interest rates -- something else entirely.

How does you tax plan apply to non-incorporated businesses? Right now, all revenue (gross revenue, not net revenue) received from such a business is considered income for the owner, but this is offset by deductions for payroll, capital purchases, etc.

In your plan as described, the combination of eliminating corporate taxes plus the elimination of business deductions (unless the definition of income also changes to only include the net revenue from the business), you're pretty much going to eliminate all non-incorporated businesses in the country.

i agree entirely with your "when i'm in charge of the budget plan," and also with your assessment of why the problems are insoluble (politically). so that leaves the question of what to do when you know the right thing can't be done. your proposal of what you believe to be less than perfect makes sense, but so does letting things break, so that people cannot debate what we have to fix or how drastic the measures will have to be to do so. as silly as it sounds, i honestly believe that half-measures will hurt us by propping up a broken system (we would have endless incremental tax increases, likely not offset in whole or in part by decreased spending, that would slowly strangle us). by contrast, letting things continue until the day of reckoning means that there will be no discussion of whether we can tax our way out of it, we will simply have to repudiate unsustainable past promises. and we have the obvious example of how this likely will and perhaps must play out -- what's happening to big companies with union obligations -- there's no fixing it, there's no way delphi ever pays the silly amounts it promised, you just ultimately go into bankruptcy and force the necessary changes down whoevers' throats. (all this talk about the deficit is just fiddling around the edges, and see cafe hayek today for why the trade deficit doesn't matter.)

Receipts as a % of GNP has been virtually flat for years.

Not hardly. Govt receipts as a share of GDP are just now beginning to recover from their lowest levels since at least 1960 (my CBO table of historical budget data only goes to 1960)

Tax Receipts as a % of GDP:
2005: 17.5%
2004: 16.3%
2003: 16.5%
2002: 17.9%
2001: 19.8%
2000: 20.9%
===========
1990s 18.6%
1980s 18.3%

Keep in mind that each percentage point represents $125 Billion today.

DJ Superflat -

The international banking system is based upon the U.S. Treasury market. And the world economy is based upon the international banking system. The U.S. declaring bankruptcy would be an inconceivably awful event. I can't believe that you're suggesting it as a positive alternative.

We should be running deficits because they are a "perfectly progressive" tax. Selling bonds takes money voluntarily from those who need the money the least. Since deficits have little effect on spending, tax cuts transfer money from people who choose the treasury interest rate over the return they think they would get themselves to investors who think they will get a better return than bonds. At current financial conditions this is a good investment considering the persistent "dark matter" differences in investment returns. Deficits transfer "oil curse" money to competent investors. Bonds also save human capital because it only requires a few computers to run an exchange and calculate interest. We need to compare the benefits of voluntary bond sales against the cost of interest to determine the the optimal size of our budget deficit.

The whole "unborn children" thing is bogus. If you borrow money then the bond-buyer's children won't have the money unless they sell the bonds to someone else who won't have the money. If you tax then the taxpayer's children won't have the money no matter how much they might need it. Spending matters. The rich will always get richer and demand for treasuries will always increase. We will never need to transfer the debt from rich bond-holders to poor taxpayers in the future.

if the budget deficit were in surplus,

Talk about newspeak! No wonder no one understands economists.

I love Big Brother!

Rubin's error in linking deficit reduction to lower real interest rates is really an error of application. In countries with a poor borrowing record or a non-independent monetary authority, "fiscal dominance" can arise. That is, large fiscal deficits raise the probability of default or inflationary finance. In response, investors demand a higher risk premium to hold the government's liabilities (bonds or cash issued by that non-independent monetary authority).

The US dollar and US Treasuries are considered by most of the world to be risk-free assets. Therefore, the US finds itself very far from suffering "fiscal dominance." Budget deficits have very little effect on US rates. Granted, the privileged status of the US dollar and US Treasuries may not last forever, but if you compare the debt dynamics and politics of other countries with those of the US, it is hard to see where their replacements will come from

A/
would imply that the real interest rate would drop to . . . 0%. That's right, savers would be in the business of handing out money for free.

B/
An increase in the national debt of 3% of GDP will probably be mostly taken care of by inflation and economic growth.

You contradict yourself. Either nobody will lend at a REAL zero rate or the debt will be eaten by inflation.

What when growth is ca. 0%, like it often is in Germany?

Japanese investors accept negative nominal interest rates because those are real interest rates in a deflationary environment.

That explanation doesn't work, because cash, which, for all its shortcomings, gives a non-negative nominal return (specifically, zero). I read some articles I found via Google, and I still don't get it. Is it a security thing? Were banks afraid to hold on to physical cash because they were afraid of losing it due to fire or theft?

Clinton's Legacy - He had another legacy - welfare reform. It did a lot of good and was a political risk for Clinton. Mickey Kaus has written quite a bit about it in his blog and elsewhere.

Oskar:

The deficit gets eaten by inflation if the deficit as a percentage of the total national debt is less than or equal to the inflation rate. Depending on the size of the deficit and the size of the debt, this can happen at any positive inflation rate. I think you're assuming the deficit is equal to the interest on the debt.

Currenty the national debt is $8.2 trillion (sort of; this includes the social security trust fund, but excludes the present value of the long-term social security shortfall). The inflation rate is 3.4%. 3.4% of $8.2 trillion is $280 billion, or about 88% of last year's deficit of $317 billion.

So currently, the deficit is not quite being eaten by inflation. It is, however, being eaten inflation plus real GDP growth (6.9% total, which would eat a deficit of up to $565 billion). So at current deficit levels, the national debt as a percentage of GDP is declining, but the inflation adjusted size of the debt is increasing to the tune of $40 billion a year.

NAFTA indeed, but don't forget Clinton's other major accomplishment, equally pushed on him by those pesky Republicans: welfare reform.

Maniakes -

I think that for consistency sake (you use it in your nominal GDP calculation) and because it is a better measure of broad inflation, you should be using the GDP deflator instead of your 3.4% inflation rate. (I'm guessing this is the CPI). The GDP deflator for 2005 was 2.76% which means that the inflation-adjusted debt grew by about $90 billion -- a little more than twice what you stated. It also means that, at this rate, this year's projected deficit would cause a $200 billion increase in the debt in inflation-adjusted terms.

Other than that, I agreed with your post.

Brendan--the reason I use the higher number is that inflation right now is much higher than las year because of higher oil prices, a condition that is expected to continue for quite some time.

Debts are always paid, sometimes by the borrower, sometimes by the lender. Since 95% of the population is going to be getting more money from social security and medicare than from treasury bonds and stock dividends, we know which way they are going to vote.
We are setting ourselves up for an interesting showdown between the loanholders and the landholders when we stop being able to borrow. The last time that happened to the world's greatest power was in 1789 when Louis the sixteenth had to call the Estates General to straighten things out by raising taxes on land to pay interest on loans. We all know how that turned out...

Thanks for the correction Brendan. The 3.4% was CPI, which was the first thing to come up when I googled for "inflation rate". The inflation-plus-growth number also needs to come down, as I added the CPI to the real GDP growth, which I now realize is just plain wrong.

The basic reason why we would start paying down the federal debt now, while it's still 'easy', if we collectively had any guts or sense:

"This is a good plan for life in general. If you have two choices, choose the harder. If you're trying to decide whether to go out running or sit home and watch TV, go running. Probably the reason this trick works so well is that when you have two choices and one is harder, the only reason you're even considering the other is laziness. You know in the back of your mind what's the right thing to do, and this trick merely forces you to acknowledge it."

--Paul Graham, "How to Make Wealth"

I suspect that most of the people making silly-clever arguments why a $7T federal debt is somehow actually good for the U.S. are intelligent enough to know better -- way in the dark, unexamined backs of their heads -- but simply are too afraid to face the hard reality: paying down the debt now will already be difficult, and will only get harder with time. The advantage of pretending not to notice these things yet is that one can be comfortably and fashionably lazy for about one decade longer.

Before things go completely insane in the 2010s, of course. But, by then, revisionist memory will have set in and folks like "Winterspeak" will all be pretending that they never did favor letting the debt go unpaid, oh, no sir!

The good news about the universe is that folly is always punished. The bad news about the universe is that essentially all of us humans are mortal fools about something or another. Born so, no doubt.

Exaggerator! Hyperboler!

If you can show me a 30-year noncallable piece of treasury paper with even a 15% coupon, I'll eat my hat.

Jane -

I had been assuming that you were just picking a close-at-hand number. Frankly, I think that you should stick with that explanation because your timeliness argument is flim-flam.

I gave 2.76%, the GDP deflator for all of 2005. You used 3.4%, the CPI for all of 2005. Somehow you claim that your CPI number is a better reflection of recent oil prices. Not sure how that could be. Inflation actually peaked in the third quarter, and the CPI change over Q4 is negative (1.6% annualized rate). Run your calculation with those numbers and Bob Rubin looks like a genius. However, I'd stick with the GDP deflator (3% in Q4).

You've made no secret that you're trying to balance the criticisms of Bush's policies with shots at the Democrats, and I have no problem with that. Using a higher inflation number makes the anti-Rubin case stronger. So does using a 10-year yield kept artificially low by capping issuance of long-dated debt. That's fine. I wasn't going to comment on your calculation because I understood the larger point you were trying to make. But I don't understand your post in the comments since it's not just misleading but totally factually inaccurate. I gotta call bullshit here.

I enjoy your work, and I hope you keep it up. Please don't take this as a personal attack. It's certainly not intended as one.

Maniakes -

Happy to help. As I said, I agreed with the rest of your post.

Brendan, 3-3.3% is the estimate of 2006 inflation that I've been hearing recently. I agree with you that 3.4%--which I didn't use--wouldn't be a very useful number, but neither is 2.76%, since that's the FY2005 budget. I'm taking a stab at estimating what the FY2006 GDP deflator will be, given that this is the relevant period for pricing our short term debt. Now, that number may be wrong; I haven't run the analyses myself. But it ain't bullshit.

Jane -

Why is it that when I assumed, I only made an ass out of me? My apologies.

brendan --

are you seriously claiming not to have understood that the reference to bankruptcy of businesses was an analogy? that i was not asserting the US should go bankrupt, but rather that, by putting this off, there will come a time when no one will pretend we can tax our way out of this (because it would require ridiculously high rates), and we will instead dial back the benefits? put another way, are you really that obtuse or just trying to score what you perceive to be easy points?

Brendan,

I think your "Gov't Receipts as a % of GDP" should be Federal Gov't....; my state taxes have almost doubled since the 1980s--they've increased 50% just in the last 5 years.

A Tykhyy, it might be possible for the government to fund itself entirely through inflation, which is what 7you (or your brother) proposes, but that would create all sorts of other distortions in the economy. If the Government's budget was 1% or 2% of GDP, it might work for a time, but with a budget around 19% of GDP, you're proposing 19% inflation every year.

Even with low real interest rates, and no accelerationary expectations, you're requiring every business to be able to produce a 25% nominal ROI on anything which requires financing. That's harder than producing a 6% ROI in a non-inflationary environment.

Sam Chevre -

Since this whole comment section and the entire discussion on this blog over the last week or so has been dealing with the finances of the federal government, I didn't note all of my "govt" figures as "federal govt." Of course, they are.

As for your state tax burden going up 100% in 15 years and 50% in 5 years, that places you way off the national average. I don't have distribution statistics, but I'd guess that's far from typical.

DJ Superflat --

It wasn't just your use of business bankruptcy as an analogy that led me to my apparently ridiculous conclusion. You said:

there will be no discussion of whether we can tax our way out of it, we will simply have to repudiate unsustainable past promises

All of our debt is, of course, a promise by the government to repay the bondholder at a later date. As a fine point of law, social security and medicare benefits are not promises, or, at least, not legally binding ones, but that's not really important.

What I'd hang my hat on is what will happen on that day of reckoning you're looking forward to. We owe more than we can pay, in benefits, interest, and bond redemptions. Our bonds are increasingly held overseas, but all of our entitlement program recipients are Americans. Who do you think is going to get the shaft? I doubt it's the folks with the right to vote.

I stand by my statement that your scenario would be disastrous to the world economy, although I'd be happy to amend it to include a possible alternate mechanism of widespread unrest in the world's biggest economy. If you think that statement scores points, that's great. If you think those points are cheap, I invite you to discuss why on an analytical level.

my mistake if i wasn't clear that i was refering to "entitlements" rather than actual debt, which, as you note, social security and medicare are not. put simply, i don't believe we will fix social security and medicare, i think we will just wait until it's apparent they're really broken, at which point the howling of the incredibly well off elderly will have to give way to fiscal reality (at that point, even the idiot young folk may realize how they're letting their elders screw them over (i say we inflate away their assets so i can buy a bigger house)). and i think there's a legitimate argument that propping up the system with half measures (or worse) over time in an ultimately doomed attempt to look like we're fixing the problem is counter-productive, worse than the day of reckoning, etc. you may not agree, but i don't think there's any basis to claim that it's ridiculous to think gov't/people won't get it together otherwise.

ps. as for the actual debt, i'm not worried. i believe in markets, people/banks/countries wouldn't buy US debt if they didn't think that its cost reflected its risk or the benefits (to the country of low value currency, etc.), i have no reason to think the cost does not reflect the risk. (yes, i recognize you might say i could have said the same about argentina, i have a response (US is sui generis), but it's not conclusive (you can claim sui generis comment cuts the other way, the US more like GM, which can get into really bad shape (because of importance, size, etc.) before anything's done), nor is anything conclusive when we're speculating.)

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