What the Federal Reserve Can and Can’t Do

Posted on October 6, 2015 by jackheidel

I have a good impression of Ben Bernanke, chair of the Federal Reserve from 2006-2014. Partly because he comes across as being both competent and honest and partly because Sheila Bair, chair of the Federal Deposit Insurance Corporation from 2006-2011, and whom I greatly admire, gives him high marks in her book, “Bull by the Horns,” about the financial crisis.
Mr. Bernanke has an excellent Op Ed in yesterday’s Wall Street Journal, “How the Fed Saved the Economy,” clearly describing what the Federal Reserve both can and can’t do. What it can do is:

Make recessions less severe. The unemployment rate has been steadily dropping and now is apparently almost back to normal at 5.1% even though the relatively low labor-force participation rate and lack of wage pressure indicate remaining weakness.
Keep inflation low and stable. The Fed’s expansionary monetary policy has helped bring down unemployment without igniting inflation whose underlying rate is currently only 1.5%.

Mr. Bernanke states that “the Fed has little or no control over long-term economic fundamentals – the skills of the workforce, the energy and vision of entrepreneurs, and the pace at which new technologies are developed and adapted for commercial use.” He goes on to say that “further economic growth will have to come from the supply-side, primarily from increases in productivity. … Fiscal-policy makers in Congress need to step up” by adopting policies to:

Improve worker skills. (how about immigration reform, better vocational education, reforming SSDI and expanding the EITC to boost incentives to work)
Foster capital investment. (how about both individual and corporate tax reform and relaxing Dodd-Frank regulations on main street banks)
Support research and development. (how about making life easier for entrepreneurs with fewer regulations)

Mr. Bernanke has a very good handle on our current financial situation. The Federal Reserve has done and is doing its job. It’s time (long past time!) for fiscal policy makers (i.e. Congress and the President) to adopt policies, such as above, to speed up economic growth.

Why the Federal Government Fails So Often

Posted on October 4, 2015 by jackheidel

This blog is about the major fiscal and economic problems of our country and specifically our stagnant economy (2% real growth for the past six years) and massive federal debt (the public debt, on which we pay interest, is 74% of GDP, the highest since WWII). My major sources of information are the New York Times and Wall Street Journal but I also make use of reports from various think tanks. Today’s source is the recent report, “Why the Federal Government Fails,” by the Cato Institute’s Chris Edwards.
According to Mr. Edwards, there are five main reasons for this:

Top-Down Coercion. Federal agencies impose more than 3,000 regulations each year. Total regulations now span 168,000 pages. Benefits are distributed through more than 2,300 programs. Federal policies are often based on guesswork. Failed policies are seldom weeded out because they are funded by taxes and are not contingent on performance.
Lack of Knowledge. Private markets operate efficiently on the basis of price information. Government subsidies and regulations throw a monkey wrench into the price mechanism.
Political Incentives. Congress focuses on the benefits of programs but does not consider the full costs because benefits are delivered to narrow groups while the costs are spread widely. There are too many fiscal illusions to hide costs such as: paying with debt rather than higher taxes, taxing businesses which then just raise prices, conferring benefits by regulation (e.g. requiring employers to provide healthcare) rather than direct subsidy.
Bureaucratic Incentives. There are too many rewards for inertia and not enough for the creation of value such as the absence of profits and losses, rigid compensation, lack of firing, red tape, agency capture, etc.
Hugh Size and Scope. The $4 trillion annual budget is 100 times the average state budget of $40 billion. It is simply too vast for members of Congress, and other top officials, to understand what is going on. The more programs the government has, the more likely they will work at cross-purposes.

Mr. Edwards concludes that “the most important way to improve federal performance would be to greatly cut the government’s size” and to do this by shifting federal activities back to the states. With this recommendation I heartily agree!

Social Inequality vs Income Inequality

Posted on October 1, 2015 by jackheidel

There is today in the U.S. much concern about income inequality and I have devoted many posts to this topic recently such as “Are economics and Social Progress Related to Each Other?”, “How to Expand Economic Mobility”, and “Richer and Poorer.”
The above CBO chart shows that income inequality has not changed much in the last 30 years once government transfers and federal taxes are taken into account. Along the same line, the Manhattan Institute’s Oren Cass makes a strong case in, “The Inequality Cycle,” that Americans should be paying at least as much attention to the social aspects of inequality as to the economic aspects.
For example:

As Charles Murray shows in “Coming Apart,” (http://www.amazon.com/Coming-Apart-State-America-1960-2010/dp/030745343X) the upper class has remained stable with respect to marriage rates (94% in 1960, 84% in 2010), civic involvement, and trust in society while for the lower class marriage rates (84% in 1960, 48% in 2010 and dropping), civic involvement and public trust have all declined significantly.
Children in the lower classes are five times more likely to face abuse, violence, addiction and the death or imprisonment of a parent.
By the time they reach kindergarten, 72% of middle class children know the alphabet compared with only 19% of poor children.
The fraction of children with a single parent is the best predictor of upward economic mobility in a particular region, whereas the level of income inequality is not a significant predictor.

Mr. Cass suggests that public policy should focus on these social problems at least as much as on income inequality. For example:

Education reform should be focused on both ends of the K-12 spectrum: early childhood education to ensure that all children are ready to learn when they get to school and better vocational education in high school so that graduates can find a good job if they’re not going to college.
Remove onerous regulations on the workplace so that employers are not pushed unnecessarily into independent contractor arrangements.
The federal government should be more supportive of marriage (e.g. with tax policy), and the participation of religious organizations in the delivery of public social services (to improve their quality).

Conclusion: Being poorly raised does more to cut off opportunity than being raised poor.

Donald Trump’s Tax Plan: More Bad than Good

Posted on September 29, 2015 by jackheidel

Republican presidential candidate Donald Trump has just released his tax plan. Some of its basic features are:

Lowering and consolidating seven current tax brackets into three: 10%, 20% and 25%.
The corporate tax rate would be cut from the current level of 35% to just 15%.
The income tax on all businesses would be cut to 15% as well.
Taxing carried interest at ordinary income tax rates instead of at the lower capital gains rate.
Eliminating the Alternative Minimum Tax as well as the Estate Tax.

The nonpartisan Tax Foundation has analyzed the Trump plan and predicts the following positive long term effects:

11.5% higher GDP,
29% increase in capital investment,
6.5% higher wages and
5.3 million more full-time equivalent jobs.

The tax Foundation also performed an analysis of Jeb Bush’s tax plan and found roughly similar economic benefits except for a lesser number, 2.7 million, of new jobs created. But the Tax Foundation also predicts that the Trump plan would cut tax revenue by $11.98 trillion over ten years on a static basis or $10.14 trillion on a dynamic basis (accounting for economic growth effects of the plan). This compares with a loss of revenue of $3.6 trillion over ten years (static) or $1.6 trillion over ten years (dynamic) for the Bush plan.
In other words, for a substantially larger growth in new jobs under the Trump plan, there is an enormous cost in additional deficit spending.
Conclusion: I have previously criticized the Bush plan for increasing deficit spending and therefore adding to the debt when we should be shrinking it. The Trump plan is much, much worse in this respect, running annual deficits of over $1 trillion per year, moving in exactly the wrong direction.
The Bush tax plan, while needing changes to make it revenue neutral, is far superior to the Trump plan, which simply blows off any concern for deficits and debt.

Cutting the Federal Budget, an Example: The Highway Trust Fund

Posted on September 27, 2015 by jackheidel

As an advocate of cutting federal spending, people sometimes ask me exactly what I would cut to save money and lower the deficit. I have two standard answers to this question:

Often I will respond, it is up to Congress to figure this out. The important thing is to shrink the deficit one way or another. It doesn’t matter from a fiscal point of view exactly what is cut.
Another answer I like to give is that with the sequester already slowing down discretionary spending, we should concentrate on finding savings in entitlement programs like Social Security, Medicare and Medicaid.

While both of these answers have validity in a general sense, nevertheless I do look for ways to cut back on discretionary spending as well. Here is a good idea from Reason magazine’s Veronique de Rugy, “Let States Build Their Own Highways.” The rationale is very simple. The federal gasoline tax of 18.4 cents/gallon brings in about $40 billion per year which goes into the Highway Trust Fund. But the HTF is spending $53 billion per year, meaning that federal gas tax revenue is being supplemented by $13 billion from general revenues. This additional $13 billion per year can be viewed as an unjustified federal expense merely adding to the deficit.
The way to address this issue is to:

Abolish the federal gasoline tax of 18.4 cents/gallon as of some specific date in the future, say in a year from the time such a law is enacted.
Turn over all responsibility for highway construction to the states.
States can then decide individually how much of the federal gasoline tax they wish to continue as a state gasoline tax in order to finance their own highway funding.
Minimal federal guidelines could be maintained if desired to insure uniform quality control by the states.

Of course, a $13 billion annual budget savings could be looked at as a drop in the bucket, not nearly large enough to make a sizable dent in the federal deficit (latest projection for fiscal year 2015: $426 billion). That would be too cynical. There are undoubtedly many other smart ways to cut back federal spending. I am constantly looking for them!

Solving the Student Debt Problem

Posted on September 24, 2015 by jackheidel

I have devoted several posts recently, here, here, and here, to discussing the rapidly increasing costs of higher education (see chart below) and the corresponding rapid rise of student debt.
Here are the basic facts:

There are too few college graduates in the U.S. At least ten OECD countries have a higher percentage of college graduates than we do.
America is graduating inequality. College degree attainment has increased between 1970 and 2011 for all income groups; however this is happening much more quickly for higher income groups.
Not all college degrees are created equal. Students at private, nonprofit institutions graduate at higher rates, and with lower debt, than students from public institutions who, in turn, graduate at higher rates and with lower debt, than students from for-profit institutions.
The Federal Reserve Bank of New York has found a close connection between subsidized loan and Pell Grant limits and the increase in college tuition costs.
The Federal Reserve Bank of St. Louis has found that “white and Asian college grads do much better than their counterparts without degrees, while college-grad Hispanics and blacks do much worse proportionately.”
The percentage of student borrowers at for-profit as well as community colleges who default on their loans has greatly increased since the year 2000 (see below)
In other words, our current federal student loan program is not only driving up college costs for everyone but is also creating a huge financial burden for the very low-income students who are most in need of financial aid to succeed in college.
The way to respond to this is to put strict lids on the amount of subsidized loans available to both undergraduate and graduate students ($30,000 and $60,000 respectively) and, at the same time, use the savings achieved in doing this to increase the size of Pell Grants available for the lowest income students who need the most help.
Conclusion: our high-tech society needs more college trained workers and we should especially encourage capable low-income young people to go to college. We could also do a much better job of targeting Pell grants instead of loans to this group of students.

The Pope, the United Nations and Global Poverty

Posted on September 22, 2015 by jackheidel

This is a big week in the U.S. Pope Francis is coming here and the UN will convene a conference in NYC to endorse international development goals for the next 15 years. As I explained in a recent post, “The Dung of the Devil,” the Pope should pay more attention to the recent accomplishments of free enterprise in decreasing the amount of poverty and economic inequality around the world.
In an article just a few days ago in the Wall Street Journal, Bjorn Lomborg, the Director of the Copenhagen Consensus Center, explains that the U.N. is likely to endorse 169 targets for global investment for the next 15 years. Mr. Lomborg demonstrates with cost-benefit analysis that focusing on just 19 of these goals would accomplish far more than adopting everything on the U.N.’s much longer list.
Here are a few of Mr. Lomborg’s items:

Completing the World Trade Organization’s Doha agreement would return $2000 for every dollar spent to retrain and compensate displaced workers.
The elimination of fossil fuel subsidies would be worth $15 for every dollar spent in direct support of the very poor who are unable to afford higher fuel prices. By contrast, trying to drastically increase the production of renewable energy would return less than a dollar for every dollar spent because renewable forms of energy remain so expensive.
Tripling access to preschool in sub-Saharan Africa would have benefits worth more than $30 for every dollar spent because of improved future earnings. On the other hand, efforts to improve exams and teacher accountability are much harder to achieve and the benefits would only amount to $5 for every dollar spent.
Other actions: boosting agricultural yields, cutting indoor air pollution with clean cook stoves, increasing access to family planning, fighting malaria and combatting malnutrition are other examples where investment would lead to big dollar returns.

Conclusion: Free enterprise economics has done much in recent years to eliminate poverty and inequality around the world. Additional public and private investment, focusing on just a relatively few major goals, can accomplish even more.

The Six Issues That Could Cause a Government Shutdown

Posted on September 20, 2015 by jackheidel

It is now just ten days until the new government fiscal year begins on October 1 and Congress has not yet passed a budget for the new fiscal year. Although a temporary funding bill could be brought up and passed at any time, the Washington Post thinks that there are six big impediments to adopting a new budget.
They are:

Planned Parenthood. 31 House Republicans insist that they will support no spending bill which has funding for Planned Parenthood. Short term funding should not be in danger because the Democrats will step in if necessary to keep the government open.

The Sequester. This is a much tougher issue because the Democrats want to break the 10 year Sequester spending limits. It’s the Republicans strongest leverage and they should insist on dollar for dollar spending cuts elsewhere in order to relax the Sequester cuts.

A Challenge to Boehner. The anti-Planned Parenthood caucus is threatening to try to oust John Boehner as Speaker if they don’t get their way. Hopefully the Democrats would help to keep Boehner because any replacement would be more conservative and less accommodating to them. I personally think that John Boehner is a miracle worker given the hyper-partisanship in Washington at the present time.

The Iran Nuclear Deal. Republican desire to express opposition to the Nuclear Deal could surface as a bargaining chip in budget negotiations. As bad as the Nuclear Deal is, this is a bad budget strategy.

The Export-Import Bank. The Ex-Im Bank expired in June. Its supporters might try to refund it as part of a budget deal for next year. It should be allowed to die unless it undergoes reform to remove subsidies for big businesses such as Boeing and GE.

The Highway Trust Fund. The problem is that the 18 cent/gallon federal gasoline tax is insufficient to fund our infrastructure needs. The most sensible approach is to raise the gas tax by a few cents per gallon. Attempts to provide funding from other sources should be resisted.

Bottom Line: Republicans should be flexible except on overall spending limits. It is absolutely essential to the future wellbeing of our country to strongly focus on eliminating budget deficits.

The Second Republican Presidential Debate

Posted on September 17, 2015 by jackheidel

Although I am a registered Independent, I lean strongly conservative on fiscal and economic issues. I hope the Republican Party ends up with a nominee who can make a compelling case for fundamental reform.
Here is my take on last night’s debate and the current state of the race.

Rand Paul. He stands up strongly for the Tenth Amendment (State’s Rights) but he is much too isolationist to take over after eight years of Obama.
Mike Huckabee. His social conservatism appeals to evangelicals but he has a weak grasp of economic and fiscal issues.
Marco Rubio. He is certainly a gifted political communicator. He is able to talk tough while also appearing moderate and reasonable at the same time. But some of his policy ideas are gimmicky.
Ted Cruz. He claims to be a true conservative because he won’t compromise on his basic principles, even if they lead to government shutdown. As such he is much too radical for my taste.
Ben Carson. I don’t see what his attraction is outside of a compelling personal story. His grasp of issues is quite weak.
Donald Trump. Leading in the polls, he is the wild card for the 2016 election cycle. As much as he disgusts me, his performance is improving. He has pledged to support the eventual party nominee, and not run as an independent. He also hurled fewer insults in the second debate than in the first.
Jeb Bush. Policy-wise, with his detailed tax plan and generally moderate views, he is outstanding. But it’s not clear that he can overcome the populist, anti-elite mood of the electorate.
Scott Walker. His outstanding record in Wisconsin gave him an early boost. But he hasn’t made the transition to national policy issues very well.
Carly Fiorina. She expresses herself in a crisp manner and has a good, general grasp of the issues. She’s rising in this campaign but still has a long way to go.
John Kasich. He has a superb background as a former Congressman and now as a very successful two term governor of Ohio. He expresses compassion for ordinary people. He deserves to climb in the polls but will he?
Chris Christie. He’s tough talking but his record in New Jersey isn’t that great. His obesity and reputation as a bully are turnoffs for me.

In short, I don’t want Trump to be the Republican nominee but who is going to emerge from the pack to defeat him? It isn’t clear if anyone will be able to do this.

Jeb Bush’s Tax Plan: Both Good and Bad

Posted on September 15, 2015 by jackheidel

Republican presidential candidate Jeb Bush has just released his tax reform proposal, “My Tax Overhaul to Unleash 4% Growth.” It has many good features such as:

Lowering and consolidating seven current tax brackets into three: 10%, 25% and 28%.
Essentially doubling the standard deduction for most filers, thereby achieving huge simplification for millions of average income filers.
Eliminating the state and local income tax deductions and capping all others, except for charitable deductions, at 2% of Adjusted Gross Income.
Doubling the Earned Income Tax Credit for childless filers, thus encouraging more low income people to work.
Exempting taxpayers over the age of 67 from the employee-side payroll tax, encouraging them to stay in the workforce longer.
Cutting the corporate tax rate from 35% to 20%.
Allowing 100% immediate expensing for all capital investments, including inventories.
Creating a territorial tax system so that multinationals are not taxed on foreign earnings, and therefore incentivized to bring their foreign profits home.
Eliminating the deductibility of interest expenses.

The lower individual and corporate tax rates, together with the separate investment and work incentives, will create a significant economic stimulus estimated to raise GDP by at least .5% per year or higher, depending you who ask.
According to the Tax Foundation, however, the plan would reduce federal revenue on a static basis by $3.66 trillion over ten years, and even by $1.6 trillion on a dynamic basis, taking into account the new tax revenue generated by the plan.
This is, of course, a huge problem. We badly need to speed up economic growth but we also need to lower, not increase, our annual deficit spending in order to put our debt on a downward path as a percentage of GDP.
The resolution of this quandary is to tighten up on those deductions, such as for mortgage interest, remaining in the code and also lessening the amount of the tax cuts if necessary in order to achieve overall revenue neutrality for the plan.

It Does Not Add Up

Jack Heidel's blog on fiscal responsibility

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