Asymmetrical Information

taxing the future. now there is taxation without representation!

We have Netflix and the Internet. They had PBS and folk dancing.

This totally cracked me up. I love being educated and entertained at the same time.

While I think that Jane makes a very cogent case for not making the tax-cuts permanent, my experience says that Bush's tax cuts have helped the economy. A friend of mine (and former boss) who owns his own business was able to hire two employees for his small business in 2003 (including me) because of Bush's tax cut (as in, he was able to invest more of his own capital back into his business). And, he falls in the upper echelons of the tax bracket. One thing that people don't really think about is that lower- and mid-tax bracket people tend not to hire employees, whereas high-tax bracket people (even if they don't own their own businesses) do. I'm not saying that we should all go out and sacrifice a goat at the altar of Arthur Laffer. But, even small reductions in the marginal rates can be a good thing.

We're always doing stuff for posterity. It's only right that posterity do something for us.

There's no way to make any tax cuts permanent. That became obvious to me after the "permanent" Reagan tax cuts in the 1980's ... they were all gone by 1995 if not sooner. Inflation took care of some of the rest, even with indexing.

As for posterity, Alan Greenspan himself has pledged that payments can be guaranteed, although the value of those payments cannot...which ought to be a big clue, on the order of a billboard on top of the nearest skyscraper with letters in neon reading "C.L.U.E.".

Or, to leap upon my favorite hobby horse: why is the Federal Reserve Bank dropping M3 next month?

Very true, ellipsis... i would add also, "why is the Treasury bringing back the long bond?" Increase the duration of the national debt and the required increase in the inflation rate to reduce its real value by a given percentage becomes lower.

Riddle me this, how is borrowing money, thus creating a future interest expense different than economically inefficient taxes (like capital gains, or business income taxes) that reduce growth (thus lowering future GDP? Both reduce the amount of wealth available to be enjoyed by future generations? Why is *borrowing* so much more onerous than growth destroying *taxing*?

When is it right to run deficits:

When the reduction in available future consumption from borrowing money exceeds the cost in future consumption of levying the tax that would allow you to fund government spending without borrowing.

For example, one can make a pretty good case that capital gains taxes, and corporate incomes taxes do a lot to reduce GDP growth. If given the choice between raising those taxes and borrowing, it's probably better to borrow.

When is it bad to run a deficit:

When the reduction in future available consumption is greater from borrowing than it is from increasing taxes to avoid borrowing.

Please note, both of these presume that government spending is completely independent of available revenue sources. If borrowing reduces the percentage of GDP spent by the federal government, then it's probably much better to borrow (I see little to no evidence that this is true though).

“Also, once spending money is in place it never goes away, so the Keynsian model (deficits in recessions, surpluses in expansions) never happens -- you get deficits all the time.”

Amen. Keynsian economics is premised upon an optimistic view of human nature. In the real world, democratically elected politicians will always find a way to continue spending more money. Hypocritical voters demand no less. The at least metaphorical reality of Original Sin is alive and well on planet earth. It is foolish to pretend otherwise.

An economist of the Keynesian variety once opined to me that deficits, good or bad, are sometimes obligatory.

No, he didn't have "stimulating the economy" in mind. Apparently he'd been beaten up on that score too many times. His argument was --

Wait. Are you sitting down? Comfortably? No liquids within arm-waving range?

Okay. His argument was that a lot of people want to lend to the government -- it's widely regarded as a safe and virtuous "investment" -- and that the government has an obligation to facilitate such lending.

Yeah, it took a toll of my self-control, too.

"Why is *borrowing* so much more onerous than growth destroying *taxing*?" Government borrowing can also destroy growth. Capital invested in government bonds is capital that is not invested in businesses. I doubt that this is inhibiting growth right now, but it could be a major factor in an economic crunch, when there isn't that much capital out there and the government needs to borrow more to cover increases in unemployment and welfare payments.

Worse, at least since the early 1960's, the government has covered it's interest payments by borrowing more money, and usually borrowed more on top of that. With all that accumulated debt, a balanced budget was only conceivable a few years ago because of the coincidence of three favorable conditions: the reduction in military spending following the Soviet collapse, the lowest interest rates in 30 years, and the strongest economy I can recall ever.

It's quite possible for a government to borrow until a crunch comes, and then discover that it's interest payments exceed the maximum possible tax revenues. Businesses that put themselves into this situation file bankruptcy. The US government cannot - but it can in effect default on the debt by inflating the currency. For all you youngsters out there that haven't lived through double-digit inflation, you don't want to experience it. And historically, 10 or 12% inflation like we had in the 70's doesn't do it - in the 1920's, the French had to handle excess debt by devaluing the Franc 10 to 1, that is a one-time 1,000% inflation.

Even if we put aside redistribution from the richer future to the poorer present, it should be justified to tax the future for the expenditures of the present. A huge slice of our current government expenditures are future oriented (education, for instance).

markm

You are mistaken. Government borrowing doesn't crowd out investment, government *spending* crowds out investment. Reduce government spending as a percentage of GDP while holding the deficit constant and you will see more money available for investment. Increase government spending as a percentage of GDP while reducing the deficit and you will see less money available for investment. It really is all on the spending side.

The question is what is the manor in which we can allocate the cost of government spending in a manor which least reduces future avaliable future consumption (aka usable GDP).

Isn't it obvious that running moderate deficits is a better default position than running moderate surpluses? (Balancing the budget is only a theorectical possibility.) Leaving aside the macroeconomic effects, which seem to be effectively zero for both moderate deficits and surpluses, a surplus is a moral hazard, as we've seen recently. Further, taxing money in order to, in effect, have the government receive a government bond return is almost sure to be a deadweight loss. I have also seen the argument to which Mr. Parretto refers and, while I agree that it's not emotionally satisfying, it is useful to have a near zero risk security in the marketplace.

More to the point, the US national debt is older than the nation (although it got so small in the 1830s that this is mostly a technical point). So we are, technically, still paying interest on the Revolution and, less technically, on the Civil War, WWII, the Apollo project, etc. Anyone feel oppressed by our predecessors' irresponsiblity? Anyone able to show any long term structual economic weakness caused by our national debt?

For me, the real question is whether the current deficit is moderate. This year's deficit is probably going to come in at something like $300 billion. (Although it hasn't been widely reported, tax receipts so far in fiscal 2006 have been very strong and January's surplus was the largest January surplus on record.) That will turn out to be something like 2.5% of GDP. That seems pretty moderate. Moreover, if we ignore intra-governmental debt (i.e., social security), national debt is less than 40% of GDP, which is also pretty moderate.

Now, I've included off-budget receipts in looking at the deficit as a percentage of GDP and excluded the "trust funds" when looking at national debt as a percentage of GDP. If we exclude off-budget receipts, then the deficit becomes more like 4.0% of GDP, which strikes me as immoderate. But I think the way I've done this is the proper way because it treats the trust funds as fictional -- which they are.

David Cohen--the numbers I'm hearing for 2006 are well over the $400 billion mark, thanks to Iraq & Katrina. Where are you getting that?

Jane: It's basically my guess. I'm looking at CBO's January prediction ($339 before Katrina and the war), tax receipts, unemployment, the lack of economic effect from Katrina (which is odd and may not play out) and the Administration's announced funding for the war, which is surprisingly small. Any of these are subject to change and $400 million isn't by any means out of the question, although I'd be surprised.

The cumulative deficit through January (one/third of the fiscal year) is $98 billion. Just multiplying by three is unbelievable naive, but that's about where I think it's going to come out. Also coincidentally, that would be a CBO overshoot in January 2006 about equal to their overshoot in January 2005, which makes some sense given the constraints they have to work with.

Even if the deficit is in the $400 million neighborhood, it still seems pretty moderate as a percentage of GDP.

The question is what is the manor in which we can allocate the cost of government spending in a manor which least reduces future avaliable future consumption (aka usable GDP).

A "manor" is a landed estate and the lord's mansion thereon. Oddly, in a way your sentence still works out with that substitution, but the next question is: Where IS this large house in which we can lock up all the politicians in order to reduce government spending?

"When is it right to run them?" may be answered by the simple answer, "When there is war". There are times when questions of economy must yield to other spheres.

Small Pink Mouse: I sort of agree with you. Unfortunately, the corollary would be that it's wrong to run them when there isn't war (or some similar national emergency). Right now, with really low interest rates, a war and a natural disaster to deal with, seems like the perfect time to run a deficit; I'd be much more enthusiastic if we hadn't also been running a deficit for the past half-century.

"His argument was that a lot of people want to lend to the government -- it's widely regarded as a safe and virtuous "investment" -- and that the government has an obligation to facilitate such lending."

I was in Hong Kong in the 1990s when the HK government began issuing government debt even though it was running surpluses and had a huge exchange fund (to back the currency peg). Many Asian countries were trying to develop their corporate debt markets at the time, so Thailand started a bond ratings agency and HK began borrowing money it didn't need, simply to provide a benchmark 'risk-free' interest rate. Governments can issue debt without running deficits.

Our financial markets would have to do a lot of adjusting if we didn't have Treasury securities. And many, including many foreigners, do indeed like to lend money to the US government. But 1) we have so much debt that we could safely run surpluses for many years without running out of government bonds; 2) we could do what they did in HK and issue government bonds whether we needed to or not, if it meant that much to investors; and 3) the markets could adjust, if they had to, and it might spur some other innovations.

What a bizarre argument for deficit spending!

Tyler and Jane have a very sophisticated point about this ("...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) which I do not understand.

Is this really a very sophisticated point? If so, maybe I don't understand it, either.

If we go on a spending spree and run up the national debt, our kids and grandkids are going to have to service that debt with their taxes. However, the interest payments made on t-bonds in say, 2080, are going to go to other living, breathing human beings in 2080, not the long-deceased folks who benefited from the profligate spending that ran up the debt in the first place. While the general transfer may be from young-ish taxpayers to old-ish bondholders, some of it goes to those who inherited bonds, and thus is intragenerational.

Anyway, that's how I read that sentence, but maybe it really is more subtle, and I missed the point.

You're also making an assumption that people will be better off in the future. That has been true before, but may not be going forward. Imagine a resurgent Democratic party that rolls back free trade, socialized medicine, supports unions, etc. It's not hard to imagine GDP running backwards in a scenario like that.

JoshK, please define "better off". People who do not own stocks or bonds might well be indifferent to macroeconomic indicators and prefer to purchase products made near where they live, government-funded health care and a decent wage.

I'm with Tyler Cowen and quadrupole in thinking that it is spending that matters, rather than deficits or taxing. Both to me are just funding methods. I'd be interested in knowing if the estimates of the 'crowding out' cost of goverment borrowing is much different from estimates of the 'deadweight cost' of taxation.

To me the main argument against deficits has always been that they allow the goverment to spend money without having to consider any tradeoffs. In effect a culture that demonises taxes while ignoring deficits does nothing restrain spending, thus allowing the government to soak up more and more of the economy. I'd like to see action on the deficit for the sole purpose of making politicians justify their spending in terms of the tradeoffs they would be required to make.

rcriii: The "crowding out" effects now might be the same, but deficits ensure that as interest compounds, each succeeding year the government will need to extract more money from the economy just to keep the same funding for programs. This effect has been masked in the past by continual increases in the population and even greater increases in the federal budget, but population growth has slowed and far, far too much of federal spending is wasted.

markm

The reduction in growth this year, echos forward as well. Think of it this way. If the GDP with tax policy A grows at a rate of 3% per year, and with policy B grows at 4% per year, and this years GDP is 1.0, then

Policy A:
Year 1: 1.03
Year 2: 1.069
Year 3: 1.092727
Year 4: 1.12550881
Year 5: 1.1592740743

Policy B:
Year 1: 1.04
Year 2: 1.0816
Year 3: 1.124864
Year 4: 1.16985856
Year 5: 1.2166529024

In other words, the growth reduction cost also compounds over time, just like the interest. If the taxes offset by your borrowing provide sufficient economic stimulus (like say, capital gains tax cuts) then you are better off with the compounded economic growth, rather than the lack of the compounded interest.

i'd like to second the point on the benefits of growth being compounded. the reason just about the only thing i care about is growth is that i read somewhere once -- i'm sure it's a myth, don't have time to google -- that the entire difference between the economies of the US and MX over the past century was, on average, 1% per annum. if true, growth is everything, and things that appear to have just a minimal impact on growth at present may be crippling over time.

as for the comment that we ignore deficits, you may think we don't pay them enough heed, but people have been using the deficit as an excuse to cut programs for a long time. maybe it's just a useful prop, but it seems like it does something to help keep spending from being whatever it might be if people truly did not care about deficits. easy example: you think our military would not be given twice as much money if no one cared about the bottom line at all?

djsuperflat

Just to point out the long term effects of 1% difference in growth over 100 years. If in year 0 you have 1.0 unit of wealth, what you have at year 100 is:

1% growth per year: 2.7
2% growth per year: 7.24
3% growth per year: 19.22
4% growth per year: 50.5
5% growth per year: 131.5

Or to put it differently, every time you gain a percentage point in growth long term growth, you can multiply your expected wealth in 100 years by about 2.6-2.7.

Wow! I didn't know we had that time travel thing worked out already.

Transfering wealth from the future to the present -- that is some cool technology.

And here I thought we were just rearranging the wealth that exists today (with promises to rearrange it again in the future).

Rob

djsuperflat: I'll concede that politicians at least pay lip service to the deficit (although I can think of one senior figure who thinks they don't matter). But I have a hard time thinking of an instance when anyone used the deficit as an excuse to make any meaningful spending cuts.

My point was more that I have not seen any evidence that high taxes are any worse than high deficits. It's the spending that matters. A government that trumpets large tax cuts while simultaneously increasing spending is functionally indistinguishable from one that just hands out pots of money to buy votes.

Also, once spending money is in place it never goes away...

Unless you create a deficit by holding spending and lowering taxes. New spending is not necessary to create deficit spending.

Peter,

You do realize that if we'd simply held spending increases to the rate of inflation since 2002 we would be in surplus right now? The deficit is entirely a spending side problem. Hold spending increase to inflation and you will generally find that deficits die within about 4 years.

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