Why Fiscal Responsibility at the Federal Level Is So Difficult

 

The United States faces many challenging problems but the biggest one of all is our national debt, right now 77% of GDP, the largest since right after WWII, and predicted by the Congressional Budget Office to keep getting steadily worse without major changes in current policy.
The only practical way to reduce the debt is to start shrinking our annual deficits, $680 billion for the current 2017, down to a much lower level, ideally close to zero, over a limited time period, perhaps ten years or so. This urgent need will, of course, be very difficult to accomplish.
For example:

  • Military spending. The military analyst, Mark Helprin, makes a cogent argument  that the most effective way to defuse the North Korean nuclear threat is for President Trump to ask Congress “for an emergency increase in funding to correct the longstanding degradation of American military power.” This would, among other things, provide for “a vigorous acceleration of every aspect of ballistic-missile defense.”

  • Omaha Rapid Bus Transit. Omaha NE (where I live) is spending $15 million in local funds for a $30 million bus system upgrade, subsidized by the Federal Transit Authority, which has an annual budget of $8.6 billion. The new ORBT will have sleek 60 foot-long buses as well as 27 individual modern bus stop shelters at a cost of $260,000 each. The system will be operational in 2018 and Mayor Jean Stothert says, “I’m looking forward to being one of the first riders.”

Conclusion. Who can argue with upgrading ballistic-missile defense at a time when we are threatened by a madman in North Korea?  And, it is nice for Omaha to have a sleek modern rapid  transit bus system on Dodge Street but should it be 50% subsidized by the federal government at a time when the U.S. is drowning in debt?  There will always be enormous pressure on Congress to increase funding for popular projects.
Who is going to stand up and say no?

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The Major Challenges Facing the U. S. II. National Debt

 

My last post, “The Major Challenges Facing the United States,” came to the conclusion that, while the U.S. has many big problems to address, our national debt is the biggest problem of all, because it will be so hard to deal with through the political process.
Our total national debt is now $19.9 trillion. The so-called public debt, on which we pay interest, is $15 trillion, or 77% of GDP, the highest it has been since right after WWII.  Furthermore it is predicted by the Congressional Budget Office to keep getting steadily worse, reaching 90% of GDP by 2025 and 150% of GDP by 2047 unless current policy is substantially changed.
Right now our debt is almost “free” money since interest rates are so low.  But when interest rates return to more normal levels, interest payments on the debt will skyrocket by hundreds of billions of dollars per year, likely leading to a new fiscal crisis, much worse than the Financial Crisis of 2008.
The only sane solution to this humongous problem is to start shrinking our annual deficits, this year at about $685 billion, down close to zero over a period of several years.  This will require a painful combination of spending curtailments and perhaps some tax increases as well.


One possible way to accomplish this herculean task has been laid out by Barron’s economic journalist Gene Epstein, see here and here.  Mr. Epstein’s plan would balance the budget in ten years by decreasing projected spending by $8.6 trillion, with 60% of spending curtailments coming from the entitlement programs of Social Security, Medicare and Medicaid and the rest from both military and domestic discretionary programs.
It needs to be strongly emphasized that under the Epstein plan spending would not actually decrease from one year to the next, but would rather grow at a slower rate, from $3.9 trillion in 2016 to $4.7 trillion in 2026.  His plan would decrease the public debt from 77% of GDP today to 58% in 2026.

Conclusion. The U.S. faces the very unpleasant problem of excessive debt which will just keep getting worse and worse without making some relatively unpleasant adjustments in the way that the federal government spends money. The sooner we get started in this process the better off we will be.

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The Major Challenges Facing the United States

 

As I frequently remind my readers I am a fiscal conservative and a social moderate. I usually write about particular economic and fiscal problems facing our country.  But every now and then I like to step back and view our overall situation at one time.  The last time I did this was here.
Let’s take another look:

  • The economy is puttering along at 2% annual growth with a relatively low unemployment rate of 4.3% and a good indication that faster growth, up to 2.5% annually, is right around the corner, see here and here.  The economy, at least, is headed in the right direction.
  • Foreign policy. Long term our biggest problem is China, which has four times as many people as we do and is growing economically three times as fast. China will soon surpass us in both economic and military strength. Our best insurance for this inevitable day is to have lots of democratic friends around the world.
  • Global warming is real and getting worse. Our best strategy for dealing with it is a revenue neutral carbon tax, rather than depending on ad hoc regulations like the Clean Power Plan and ever increasing auto emission standards. If the U.S. demonstrates its seriousness with a carbon tax, it is likely that the U.S. and China (which is highly polluted) could work together to establish world-wide carbon emission standards.
  • National debt, currently 77% of GDP (for the public debt on which we pay interest), is predicted by the CBO to keep getting steadily worse (see chart)  without major changes in current policy. Right now our approximately $14.3 trillion public debt is almost “free” money because interest rates are so low. But sooner or later interest rates will return to more normal levels and, when this happens, interest payments on the debt will rise by hundreds of billions of dollars per year. This will inevitably lead to a severe fiscal crisis, far worse than the Financial Crisis of 2008.

Conclusion. I am relatively optimistic that we can maintain good relations with China and will have the good sense to better control carbon emissions. But our debt problem is politically very difficult to address because it will require spending curtailments.  How do we successfully address such a huge problem?

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We Need More Low-Skilled Immigrant Labor, Not Less

 

Our economy is chugging along at 2% annual growth of GDP, not spectacular but not awful either. The unemployment rate has dropped to 4.3%, and low-wage earners are beginning to see decent pay raises. Furthermore there are good indications that GDP growth may rise in the near future to at least 2.5%, see here and here.
As growth increases, unemployment continues to drop, and wages increase more quickly, severe labor shortages in certain job categories are likely to develop.  As the New York Times economics reporter, Eduardo Porter, points out, “The Danger from Low-Skilled Immigrants: Not Having Them.”


Consider:

  • Eight of the fifteen occupations expected to experience the fastest growth – personal care and home health aides, food preparation workers, janitors and the like – require no schooling at all.
  • Low-skilled immigration does not just knock less-educated Americans out of their jobs, it often leads to the creation of new jobs – at better wages.
  • The strawberry crop in California owes its existence to cheap immigrant pickers. They are sustaining better paid American workers in the strawberry patch to market chain who would have to find other employment if the U.S. imported the strawberries directly from Mexico.

  • The benefits of immigration come from occupational specialization. Immigrants concentrated in more manual jobs free up natives to specialize in more communication-intensive (English speaking) jobs.
  • The average American worker is more likely to lose than to gain from immigration restrictions. Halting immigration completely would reduce annual economic growth by .3%.
  • The Pew Research Center estimates that about 30,000 unauthorized immigrants work in Nebraska, 3.2% of Nebraska’s total labor force. They are heavily represented in a handful of industries, making up 18% of Nebraska’s construction workers, 9% of production workers, and 5% of farm laborers.  With an unemployment rate hovering around 3%, the Nebraska economy would be severely stressed without these immigrant workers.

Conclusion. Both in Nebraska and nationwide, the U.S. economy has a strong need for immigrant workers. An adequate guest worker visa program is badly needed to provide legal status to these workers who are so critical to the success of the U.S. economy.

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An Optimistic View of the U.S. Economy

 

The current economic expansion, beginning in June 2009, is now one of the longest in recent years.  Furthermore, low-wage workers are beginning to see bigger gains in pay.  Since the rate of inflation is still remarkably low, under 2% annually, the expansion may well continue for some time.


The primary negative factor is the relatively slow rate of growth averaging just 2% since June 2009.  But two economists, Michael Mandel and Bret Swanson, have just issued a remarkable report, “The Coming Productivity Boom,” on behalf of the Technology CEO Council, predicting that the diffusion of information technology into physical industries is likely to boost economic growth to 2.7% over the coming 15 years.
Consider:

  • The next waves of the information revolution – interconnecting the physical world and infusing it with intelligence – are beginning to emerge. Increased use of mobile technologies, cloud services, artificial intelligence, big data, inexpensive and ubiquitous sensors, computer vision, virtual reality, robotics, 3D additive manufacturing and 5G wireless technology are on the verge of transforming the traditional physical industries – healthcare, transportation, energy, education, manufacturing, agriculture, retail and urban travel services.
  • At 2.7%, productivity growth in the digital industries over the past 15 years has been strong, compared with only an anemic .7% annual growth in productivity in the physical industries.

  • The digital industries, which account for 25% of U.S. private sector employment and 30% of private sector GDP, make 70% of all private sector investments in information technology.
  • This “information gap” means that the physical economy is operating well below its potential, dragging down growth and capping living standards.
  • The coming transformation could boost annual economic growth by .7% over the next 15 years. This would add $2.7 trillion to annual economic output by 2031.
  • Policy changes will be needed to achieve maximum growth. Better tax policy can encourage more domestic investment. Regulators will have to embrace innovation and technological change.

Conclusion. “The information age is not over. It has barely begun. … But launching this new productivity boom demands a new, pro-innovation focus of public policy.”  In turn it will lead to an increase of wages and salaries to workers of $8.6 trillion over the next 15 years.

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Making the World Safe for Democracy

 

One hundred years ago, in 1917, President Woodrow Wilson asked Congress to declare war on Germany “to make the world safe for democracy.”  Pax Americana, the relative peace and stability which has lasted since the end of WWII, is due to the overwhelming economic and military strength of the United States.
The Chinese population at 1.3 billion is four times as large as the U.S. population.  Its economy is growing much faster than ours and will surpass ours in 10 or 15 years.  There is little, if anything, the U.S. can do to prevent this from happening.


China is a non-free, non-democratic, totalitarian state.  We hope that it will remain peaceful towards the U.S. as its economic strength, and eventually also its military strength, surpasses our own, but it would be risky to assume this for sure.
What then should we do to prepare for the day when we are no longer the dominant power on earth?  In my opinion, our best preparation for this inevitable day is to make democracy as strong as possible around the world.


In this respect, look at the latest report from Freedom House which measures the state of freedom around the world on an annual basis.

  • In the past 30 years the percentage of free countries has increased from 34% to 45% and the percentage of non-free countries has declined from 32% to 25%.
  • In the past 10 years, the number of free countries has declined from 47% to 45% while the number of non-free countries has increased from 23% to 25%. In other words democratic progress has been stagnant for the past ten years.

Conclusion.  Democracies rarely go to war against one another.  Other democratic countries are our best friends and so we want more of them.  But there is nothing simple or obvious in figuring out how to accomplish this.

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How to Achieve Sensible Tax Reform

 

Experts across the political spectrum agree that the U.S. tax code is a huge mess and needs to be reformed as well as simplified.  It is also generally accepted that lower tax rates will lead to faster economic growth.
As Congress turns its attention to tax reform, Senate Democrats have stated the basic principles which they would like to see included in any changes which are made:

  • Increase the wages of working families. This could be accomplished by lowering tax rates for all individuals across the board, paid for by eliminating (or at least shrinking) many of the personal deductions in the tax code. The approximately two thirds of all taxpayers who do not itemize deductions would then receive a tax cut, equivalent to a wage increase.
  • Promote domestic investment and improve middle class job growth. Lower tax rates will give businesses and entrepreneurs a bigger incentive to invest in business expansion and therefore grow the economy faster and create more new jobs.

  • Modernize our outdated business and international tax system. Our corporate tax rate at 35% is the highest in the developed world and, at the same time, produces below average revenue (see chart). Another reform would be to adopt business expensing (immediate tax write-off for new investment). Again, all such changes should be paid for by eliminating loopholes and shrinking deductions.
  • Any rewrite of the tax code must be deficit neutral. As important and valuable as tax reform is, it has to take into account our country’s most fundamental problem: our huge and rapidly growing national debt and therefore end up being deficit neutral overall.

Conclusion. The above principles, stated by the Senate Democrats, represent a sound approach to reforming the U.S. tax system. I hope that the Republicans are willing to recognize the validity of these proposals and include the Democrats in developing a bipartisan tax reform plan.

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