Subscribe to Dollars & Sense magazine. Recent articles related to the financial crisis. Kwak on Mankiw on the DeficitFrom Baseline Scenario; hat-tip to LF. James Kwak and Simon Johnson have a new book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, which will be available on March 30th.Greg Mankiw on the Deficit By James Kwak Broken record alert: Another post on the deficit ahead. Wouldn't you rather look at funny pictures of cats? Why do I keep writing these? (Hint: The other side keeps writing them.) You have been warned. Greg Mankiw, noted economics textbook author and former chair of Bush 43's Council of Economic Advisers, has an op-ed on the deficit that is relatively sensible by the standards of recent debate. He points out that modest deficits can be sustainable, that taxes will probably need to go up, and that a value-added tax is a plausible option. He also points out that Obama's projections are based on optimistic economic forecasts that very plausibly may not pan out, and that Obama's main deficit-reduction strategy is to kick the problem over to a deficit-reduction commission, which are valid criticisms. Unfortunately, his bottom line seems to be throwing more rocks at President Obama, under the general Republican principle that since he's the president, everything is his fault: "But unless the president revises his spending plans substantially, he will have no choice but to find some major source of government revenue. Ms. Pelosi's suggestion of a VAT may be the best of a bunch of bad alternatives. Unfortunately, in this new era of responsibility, the president is not ready to face up to the long-term fiscal challenge." Mankiw, not I, brings up the comparison between Bush 43 and Obama: "From 2005 to 2007, before the recession and financial crisis, the federal government ran budget deficits, but they averaged less than 2 percent of gross domestic product. Because this borrowing was moderate in magnitude and the economy was growing at about its normal rate, the federal debt held by the public fell from 36.8 percent of gross domestic product at the end of the 2004 fiscal year to 36.2 percent three years later. . . . What's missing from this comparison? First, the economic growth of 2005-2007 was at best a mixed blessing, as we now know, driven by an unsustainable and ultimately catastrophic credit bubble. Second, and more importantly, the comparison leaves out the long-term trend . . . wait for it . . . Medicare. Here's my favorite chart again, from the 2008 CBO Budget and Economic Outlook. In 2007, Medicare, Social Security, and Medicaid cost 8.9 percent of GDP (see Table 3-1). By 2018, they were already projected to grow to 10.8 percent of GDP; extrapolating forward at constant growth rates, by 2020 they would grow to about 11.3 percent—an increase of 2.4 percentage points over 2007. That, in one number, is the difference between Bush 43 and Obama. (Ongoing patches to the AMT—something that Obama includes in his projections that Bush did not—also grow to $150 billion by 2018, or another 0.7 percent of GDP.) Did Bush 43 do anything about this looming problem? No, because one conservative aspiration since Ronald Reagan has been to crimp government by crippling its finances ("starving the beast"). If Bush had actually reduced the size of government to match his tax cuts, in true conservative fashion, we would face less of a long-term deficit problem now.* But whether by accident or design, it turned out to be politically advantageous to kick the problem down the road and therefore make it harder for his successor to govern. Now, this doesn't change the fact that it's Obama's problem now, and it's his responsibility to do something about it. But Obama realized that the long-term deficit is a health care problem, while Mankiw doesn't even use the word "health" in his op-ed on the deficit. If we don't slow the growth of health care costs, there is no real solution to the deficit problem; the only way out from the budget perspective will be slashing Medicare, but that doesn't solve the problem—it just shifts it onto individuals. And Obama spent much of the last year pushing for health care reform with major cost-cutting components,** attracting support from some Republican health experts (though not from any Republican Congressmen). Now, it would be meaningful to criticize Obama for having the wrong ideas about how to control health care spending, as a few Republicans have done. But to say he's not up to the challenge without mentioning health care misses the real point. Still, it's true that Obama could put forward a more aggressive deficit reduction plan. If I were king, my plan would include modest increases in the Medicare eligibility age, a whole bevy of health care cost reduction initiatives, modest tax increases (pushed out into the future and made contingent on economic recovery) such as eliminating the cap on the Social Security tax and reinstating the estate tax, and bigger tax increases that would kick in if health care cost savings failed to materialize. But in our current political climate, that would be political suicide for any president and would have zero chance of passage. I'm skeptical about the deficit commission, too, but we have collectively backed ourselves into a position where neither party can afford to even propose the necessary steps on its own. The political problem is that there's no politically palatable way to solve the long-term deficit problem. The Republican strategy, after (almost) killing health care reform, is to attack Obama for not having a long-term solution, daring him to propose one so they can then attack him for raising taxes. Yes, that's the way the game is played. That doesn't change the fact that it's a game. * Bush did make an attempt to reform Social Security. But even if we assume he had managed to stop the growth of Social Security completely, the growth in Medicare, Medicaid, and the AMT fix would by themselves account for the difference between the 2005-2007 deficits and the projected 2020 deficit. ** The Senate health care bill only reduces the deficit by a little by year ten, because the CBO gives it very little credit for its cost-cutting measures, particularly the delivery system reforms. It is fair for the CBO to give those reforms little credit, since they are unproven. But it is also important to remember that there is no proven way to reduce health care costs (Paul Ryan's plan reduces government expenditures reliably, but it is no more proven to reduce actual health care costs), so the only way to have any chance to reduce health care costs is to undertake the kind of experimentation proposed by the Senate bill. Read the original post. Labels: deficit, deficit hawks, Greg Mankiw, James Kwak, recession, Simon Johnson, value added tax Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Deficit Hawk, Progressive Style, Part IIAs I wrote in Part I (Feb 3), the deficit hawks legitimately claim that huge deficits will hinder investment and kill jobs. But their solutions would make matters worse. What are those solutions? What are alternatives? A leading hawk, C. Fred Bergsten of the Peterson Institute for International Economics, proposes three control measures: containing Medicare and Medicaid costs, "comprehensive Social Security reform, including gradual increases in the retirement age and an alteration of the benefits formula" and a national consumption tax.The hawks are right that we need to control all--not just public--health care spending, but only as part of national health reform. They are wrong about Social Security, which does just fine under any reasonable projections. They're especially wrong about a consumption tax. A consumption tax is essentially a national sales tax. Why a consumption tax? Because, the argument goes, it will encourage more saving. More saving will engender more investment. Of course, as even proponents recognize, a consumption tax hits poorer people harder, because they consume proportionately more of their income. There's little evidence a consumption tax will encourage saving and investment, let alone productive investment. To see why, consider the main reason that U.S. saving and investment fell so low in recent years: the real estate bubble. Middle class homeowners thought they were saving through the appreciation of the land under their houses. So why put aside a portion of their wages? Banks and other investors thought they were investing by buying up high-yield mortgage-based securities. So why lend at lower returns to productive businesses? In fact, real estate bubble investments closely resemble investment in government debt: both are passive investments, parasites on the real economy. Here are three alternatives to the conservative hawks' program of entitlement-cutting and consumption taxes: 1. Cut military spending. 2. Restore progressivity of federal taxes and raise rates, and 3. At state and local levels, rediscover the original wealth tax--the property tax.  1. Cut military spending. Dollar for dollar, military spending generates the fewest jobs and creates the most waste. Even strong advocates of a second "stimulus" wouldn’t demand more military pork. Chart III (click to enlarge) shows military spending from 1940 to 2013, in 2005 dollars and as a percentage of GDP. Cutting military spending both absolutely and relative to GDP helped Clinton lower debt and stimulate the economy. Obama seems headed the other way. 2. Restore the progressive income tax system. Since World War II, the federal income tax system has both declined as a proportion of GDP, and grown steadily less progressive. Top rates of the official income tax have fallen from over 90% to 35%, and unearned income like capital gains gets special low rates or disappears into loopholes. Meanwhile the other income tax--the payroll tax supporting Social Security and Medicare--has grown larger than the official income tax itself! The payroll tax hits all earned income up to a cap, now $106,800. The payroll tax rate, 2% in 1937 at the start of Social Security, has risen to 15.3%. Some two thirds of American families pay more payroll tax than income tax. Chart IV (click to enlarge) shows how the payroll tax has overtaken the official income tax as a source of federal revenue.  Conservative economist Greg Mankiw wrote in a recent New York Times op-ed that "Higher tax rates mean reduced work incentives and lower potential output." That's true, but only at the lower end of the income scale, not the upper. (Can you imagine a CEO saying, "If you cut my pay by $1 million, I'll go home early on Friday"?) The payroll tax has become the ultimate killer of small business and low-wage jobs. Federal taxes as a percentage of GDP have hit a historic low, well under 20%. There's plenty of room to raise taxes and make the system much more progressive. To do so, we should: a. Reinstate high progressive rates for the regular income tax. b. Cut or eliminate payroll taxes at the lower end, and remove the cap.  3. At state and local levels, rediscover the property tax. The property tax? Despite much rhetoric to the contrary, the property tax really is a tax on property--including corporate property (about 50% of the base). It's a wealth tax, intrinsically the most progressive tax we have. Until World War II, it was the most important tax in the US. Since then, as Chart V (click to enlarge) shows, sales and income taxes have substantially displaced the property tax. But as also evident in Chart V, the property tax doesn't fall off in recessions as do income and sales taxes--if states had stuck with the property tax, as has New Hampshire, they wouldn't be in their present fiscal jam. As an added bonus, because the property tax hits land values, it checks the false savings of real estate bubbles--encouraging real saving!Conclusion: If we want to reduce debt, lessen inequality, stimulate small business investment and create jobs, here's how to do it: cut military spending; restore progressivity and raise rates in the income tax system; and resurrect the property tax. Politically impossible? Only if it's unthinkable! Labels: deficit, deficit hawks, Fred Bergsten, Greg Mankiw, income tax, military spending, payroll taxes Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). |
