What Should the Federal Government Do about Infrastructure?

 

President Trump has proposed spending $1 trillion over the next decade on public and private investment in infrastructure. The CATO Institute’s Ryan Bourne has just published an excellent analysis of the whole issue.  Here are the highlights:

  • Any new federal spending must take into account that federal public debt now stands at 77% of GDP and is likely to keep rising given the demographic pressures on entitlement spending. This means that the long-term outlook for public finances is dire.
  • With a current low unemployment rate of 4.4% and a high of 6 million job openings, the economy does not need more government stimulus at the present time.

  • Bridge quality has improved substantially since 1990 (see chart) although roadway congestion has become more acute (second chart). Rail and transit systems appear to be the main areas with observable deterioration.

  • The difference between state highways (which are in good condition), local roads (which are in fair condition) and transit systems (which are in poor condition) is simple: state road maintenance is paid almost entirely out of user fees (gasoline taxes), local road maintenance is paid for by a combination of taxes and user fees (motor vehicle registrations and parking meters) while transit maintenance is paid for almost entirely out of taxes.

The above indicates that the following policy framework should be followed:

  • Privatize areas where government is not needed such as airports, air traffic control systems and railways (Amtrak).
  • Localize decision making as far as possible such as decentralizing responsibility for transportation infrastructure back to the states.
  • Remove payment barriers for charging users. This could reduce the cost of capital investment required for highway systems by 30%.
  • Level the playing field for private sector funding. Currently interest income received for investing in municipal bonds is tax free which is not the case for private debt.

Conclusion. “Rather than imposing further costs on taxpayers, the Trump Administration should prioritize localizing decision making, removing regulatory barriers to private investment, encouraging use of user fees and removing tax exemptions for public investment.”

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How to Achieve a Balanced U.S. Budget

 

President Trump’s proposed 2018 Budget lays out a plan to achieve a balanced budget over a ten year period. I strongly endorse this goal whether or not the Trump budget is a realistic way to get this done.
The virtue of the Trump budget is to tackle waste and inefficiency across many different domestic programs (see chart below).


Its main defect is that neither healthcare reform nor tax reform has yet been implemented and the cost and/or savings of these two major initiatives are not yet known.
In the meantime the only way to think about balancing the budget is conceptually in terms of how it might be done.  Barron’s economic analyst Gene Epstein has done this recently.


Mr. Epstein proposes:

  • $8.6 trillion worth of spending cuts over ten years, of which 40% would come from programs other than Social Security and healthcare. By achieving a balanced budget in ten years it would lower our public debt (on which we pay interest) from 77% today to 58% in 2027.
  • By raising the age limit for full SS benefits to 67 (already enacted) at a faster pace, and indexing initial benefits to price inflation rather than wage inflation, $200 billion can be saved over ten years. Another $300 billion can be saved by phasing in a 25% reduction in SSDI benefits.
  • Cutting the estimated improper payment rate for Medicare of 12.1% in half would save $400 billion over ten years. Raising the premiums for Medicare Part B and Part D to 35% of costs from the current 25% of costs would save $400 billion.
  • Another $600 billion would be saved by turning Medicaid into a block grant program to the states and giving the states much more flexibility in how it is spent.
  • $950 billion could be cut from the military budget by cutting back on overly expensive new weapon systems as well as closing unnecessary military bases, both foreign and domestic.
  • Many cuts in government subsidies to individuals and businesses would save $1 trillion. Grants in aid to sates could be cut by $500 billion.

Conclusion. There are many different ways to curtail federal spending. It has to be done and the sooner we get started the less painful it will be for all concerned.

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Objections to the Trump Budget

 

President Trump’s budget for 2018 presents a plan to achieve a balanced federal budget in ten years, by 2027.  This is a highly desirable goal but there is much skepticism about whether or not his budget is realistic, see here and here.


My thoughts on this important matter are:

  • Fiscal restraint is a common sense necessity, and is not austerity. Our public debt (on which we pay interest) now stands at 77% of GDP, the highest since WWII, and will continue to increase without major changes in public policy. Right now the debt is almost “free” money because interest rates are so low. As interest rates inevitably go up in the near future, interest payments on the debt will skyrocket and become a huge drain on our federal budget and make annual deficits even worse than they already are.
  • 3% annual GDP growth, as assumed in the Trump budget, is almost certainly too optimistic. However the Trump Administration is on track to achieve significant deregulation  and averaging 2.5% growth over the next ten years is doable.
  • Insufficient entitlement reform is a big drawback for the budget. It will be very difficult, essentially impossible, to achieve and sustain a balanced budget without modifying Social Security and Medicare to make them self-financing. Turning Medicaid into a block grant program to the states would finally put Medicaid on a sensible budget.
  • Requiring able-bodied welfare recipients to work is a good idea and is the basis for cutbacks in social welfare programs.
  • The Departments of State, Interior, Education and Justice should be able to absorb cutbacks and operate more efficiently.

Conclusion. There are many good initiatives built into the Trump budget. Unfortunately there are also some invalid assumptions and glaring omissions.  It does not represent a bona fide plan to balance the budget in ten years but at least it recognizes the importance of doing so.

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Is Trump Serious about Shrinking the Debt?

The newly released Trump budget for Fiscal Year 2018 claims that it will lead to a balanced budget in ten years.  This is a highly desirable goal.  However the projected $4.5 trillion in spending cutbacks for many popular programs, as well as the projected 3% GDP growth for the next ten years, are both unrealistically optimistic.  Nevertheless, at least the Trump Administration is moving in the right direction.


Here is a good summary by Donald Marron in National Affairs of why it is so important to keep deficits and debt under control:

  • Prolonged deficits and mounting debt will undermine economic growth by interfering with investment in the private sector.
  • Prolonged deficits risk fueling inflation as the government lowers the value of the dollar by printing more of them.
  • High levels of debt held by foreign lenders put us at the mercy of foreign countries.
  • The growing debt exposes America to greater “rollover” risk with the increasing reliance on short term debt which frequently has to be rolled over.
  • Rising debt limits flexibility for increased spending in times of recession or other emergency. For example, when the Financial Crisis occurred in 2008, the debt level was just half of its current level. This meant the government could risk higher deficit spending in order to stimulate the economy.
  • Deficits have an unfortunate tendency to feed on themselves. Our current deficit level of approximately $500 billion per year is so large that it can only be significantly reduced with great pain. The only possible way to make deficit reduction politically feasible is to spread this pain widely amongst the public as shared sacrifice. This will be very hard to do.
  • Deficits and debt are grossly unfair to future generations who are stuck with servicing the debt and/or struggling to pay it down.

Conclusion. The Trump Administration recognizes the strong need to get deficits and debt under control. Unfortunately its current budget just submitted is not a realistic plan to get this done.

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How Donald Trump Could Redeem Himself

 

From a reader of my blog:
I think he is too flawed, self-centered and sociopathic to accomplish much. I believe that tax reform will become tax cuts for the wealthy (no inheritance tax, etc.) and dealing with budget deficits will not happen. I know you think Trump will be contained by the conservative members of Congress. The Republicans seem unwilling to confront him or speak out as long as his base continues to be very loyal. I think he is so wounded now that it will be hard to accomplish much.


Granted that Donald Trump is hopelessly ensnared in controversy and incapable of changing his ways, he still has many opportunities to do something positive. For example regarding our extremely serious debt problem, he could focus on:

  • Coming up with a budget that reduces the debt path. No one expects the budget to be balanced in one year. Last year’s Republican plan would have taken ten years to get the job done. The important thing is to clearly move in this direction.
  • Focusing healthcare reform on cost control. Give the Democrats credit for expanding healthcare access with the Affordable Care Act. But now focus on reining in the cost of healthcare in America.

  • Enacting fiscally responsible tax reform. Most people agree that the tax code is a complicated mess and, especially, that the corporate tax rate is too high. There are many ways to achieve lower tax rates and simplification in a revenue neutral way.
  • Stop digging the debt hole deeper by just adding new initiatives. There will always be attractive new programs which are worth pursuing. But in adding them to the federal budget, other programs which are no longer effective need to be phased out.
  • Reforming entitlements such as Social Security, Medicare and Medicaid. These are the big drivers of national debt. Without entitlement reform, all other efforts to restrain federal spending will be insufficient.

Conclusion. There is nothing easy about pursuing the above agenda. Implementing it will be highly controversial with lots of vociferous opposition.  It will take strong leadership to push it through.  But it represents a huge opportunity for a controversial president to do something worthwhile.

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What Will Happen if We Have a New Fiscal Crisis?

 

As I often remind the readers of this blog, the two main topics are what I consider to be America’s two biggest economic and fiscal problems:

  • Slow economic growth, averaging just 2% since the end of the Great Recession in June 2009. This means fewer new jobs and smaller raises.
  • Massive debt, now 77% of GDP for the public part on which we pay interest, the largest since the end of WWII and predicted by the CBO to keep getting worse. As interest rates rise from their currently unusually low levels, interest payments on the debt will skyrocket.

 

The first problem, slow growth, is being addressed by the Trump Administration with various deregulatory actions as well as likely tax reform action by Congress.  Furthermore, the current low 4.4% unemployment rate means that the labor market is tightening on its own.


The second problem, massive debt, is much more worrisome for the future.  Right now interest rates are so low that our entire debt is essentially “free” money.  But every 1% increase will add nearly $150 billion per year in interest payments.  And this continues indefinitely (and keeps getting worse with more debt) because debt is rarely if ever paid back, it is only rolled over!  What are the likely outcomes of such an upward spiral in interest payments?  There are two possibilities:

  • First, the unthinkable. We default on our debt. This would immediately end the role of the U.S. dollar as the international currency and end our superpower status. The fallout would be disastrous for world peace and stability.
  • Second, a huge tax increase. The only alternative to default will be a large tax increase just to keep afloat on interest payments. A likely new tax for this purpose is a consumption tax in the form of a value added tax.

Conclusion. It is extremely shortsighted to keep on delaying a necessary solution to our rapidly worsening debt problem. It’s going to be unpleasant to either cut back on spending or to raise taxes but the longer we delay action the more painful it will become in the end.  Isn’t it obvious that we should get started immediately?

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Quo Vadis America?

 

In many respects things are going quite well in the U.S. at the present time:

  • The economy is chugging along at 2% annual growth, not spectacular but better than in most other developed countries. In fact a rather severe labor shortage is developing in some industries such as construction and agriculture.   More specialized guest worker visas would help relieve these shortages. Better career and vocational education in high school as well as targeted job retraining programs for the underemployed would help prepare workers for the millions of high-skill manufacturing jobs going unfilled.
  • Pesky foreign policy problems are under control. ISIS is being squeezed in the Middle East. China appears willing to help contain the North Korean nuclear threat. Iran is mostly abiding by the 2015 nuclear agreement.
  • Congress is inching its way towards resolution of the healthcare stalemate, by repairing Obamacare rather than repealing it. It’s not clear how much tax reform will be implemented this session but there is at least a consensus on lowering the corporate tax rate to encourage multinational companies to bring their profits back home.
  • Deregulation efforts by the Trump Administration will give the economy at least a small beneficial boost.

    But there is one huge problem which is constantly being swept under the rug or being kicked down the road by both parties in Congress and by Democratic as well as Republican presidential administrations alike. I am referring, of course, to our massive national debt, now sitting at 77% of GDP (and growing) for the public part on which we pay interest.  Right now this debt is essentially “free” money because interest rates are so low.  But it’s really a ticking time bomb because sooner or later interest rates will return to more normal levels and then interest payments will skyrocket causing a huge fiscal crisis.

Conclusion. It is imperative for Congress to reform entitlement programs to make them less costly to the federal budget and to otherwise restrain discretionary federal spending across the board. The future of our country depends on our national leaders exercising much greater fiscal restraint.  They need to get much better at doing this!

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