The Congressional Budget Office has a sterling reputation for collecting accurate data and making credible predictions about basic economic and fiscal trends. CBO analyses, which are based on current law, are generally accepted as valid by both liberals and conservatives. Considering the degree of hyper-partisanship in most discussions of fundamental policy, it is reassuring to at least have an unimpeachable source of basic information. CBO has just released its regular annual report, ”The Budget and Economic Outlook: 2015-2025.” There is good news for the near term. As shown above, GDP is projected to grow by 2.9% in the (budget) years 2015 and 2016, and dropping to 2.5% growth in 2017, which is still better than 2014. This means that our national debt will not grow from its current level of 74% of GDP for the next few years and might even decrease slightly. Growth will then hover around 2.2% for the remainder of the 2015 – 2025 decade, which is the average GDP since the end of the Great Recession in June 2009. Likewise, unemployment will likely not fall much below its current value of 5.6% for the next ten years. In short, under current policy, except for the next couple of years, we are stuck in the same slow-growth rut where we have been for the past five and one-half years.
It should be obvious that we need new policies to speed up growth, put more people back to work, and raise the stagnant wages endured by many middle- and lower-income workers. How can this be accomplished?
Tax reform, both individual and corporate, is the primary route to faster growth. Lower tax rates across the board, paid for by closing loopholes and shrinking deductions. This will put extra income in the pockets of the 64% of taxpayers who do not itemize deductions, which they will likely spend. It will also make it easier for potential entrepreneurs to successfully launch a new business.
Immigration reform, expanded foreign trade and deregulation will also create more business opportunities which will in turn grow the economy and create more jobs.
Hopefully the new Congress will be able to move forward in this direction. A better future depends on it!
The New York Times has two recent articles about health care spending, “Good News inside the Health Spending Numbers” and “The Battle over Douglas Elmendorf – and the Inability to See Good News.” These two articles focus on the fact, clearly evident in the chart just below, that the rate of increase in overall health care spending has slowed down since 2009. In fact health care spending has been a constant 17.4% of GDP for the past four years, while it increased by 1.9% of GDP in the four years before that. More precisely, health care spending rose by 3.6% in 2013, down from 4.1% in 2012. It is, of course, very good news that increases in health care spending have dropped dramatically since the recession in 2007-2009, but is it really surprising that this has happened in the midst of so much economic pain, with a very high rate of unemployment as well as stagnant incomes for most Americans? In fact, even in these circumstances, health care spending is still growing at twice the rate of inflation, which has been under 2% during this same time period.
A more realistic view of health care spending has just been presented to the Health Subcommittee of the House Committee on Energy and Commerce by Marc Goldwein, from the non-partisan Committee for a Responsible Federal Budget, a Washington D.C. think tank focused on fiscal responsibility. Mr. Goldwein makes the following points:
Despite the recent slowdown in health care spending, it remains incredibly important that policymakers pursue reforms to reduce future projected health care costs.
Policymakers should focus first and foremost on health care “benders” that would improve incentives in order to slow the overall growth of health care spending.
Policymakers should next look to health cost “savers” which reduce federal costs by better allocating resources within the federal health programs.
Given the aging of the population, health reforms will be necessary but not sufficient to put the debt on a sustainable long-term track.
Slowing down the rate of growth of health care is going to be a huge challenge for our national leaders. I will elaborate on how to do this in forthcoming blog posts.
“I could end the deficit in 5 minutes. You just pass a law that says anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.” Warren Buffett, 1930 –
Mr. Buffett made this quip in a recent interview with CNBC. Since the economy has historically grown at a rate of about 3%, Mr. Buffett is saying that we’ll be alright as long as economic growth exceeds deficit spending. This is generally correct but, as Mr. Buffett well knows, the situation is more complicated than this. A very good, and nontechnical, discussion of this whole subject can be found in the newly published book, “The Death of Money: the coming collapse of the international monetary system” by the financier James Rickards. Look at Chapter 7, “Debt, Deficits and the Dollar.”
Simplifying Mr. Rickards’ approach a little bit, and keeping it in Mr. Buffett’s framework, for a stable economy we need to have
G > D
where the nominal growth G = real GDP + I (I is the rate of inflation) and the deficit D = S – T (S is spending and T is tax revenue). I have included interest paid on the debt as part of total spending. As long as the left hand side is greater than the right hand side, the economy is growing faster than the deficit and the accumulated debt will shrink as a percentage of GDP. Notice that the rate of inflation affects the left hand side of the inequality while the interest rate is part of the right hand side.
Negative inflation is deflation which is clearly undesirable. The Federal Reserve’s current target for inflation is 2%. The challenge for the Fed is 1) to keep inflation high enough and interest rates low enough so that G > D, while at the same time, 2) to make sure that inflation does not grow so high as to destabilize the markets.
Given our underperforming economy with low real GDP growth, and huge deficits, Mr. Rickards is pessimistic that the Fed can continue successfully “in the position of a tightrope walker with no net … exuding confidence while having no idea whether its policies will work or when they might end.”
Thus the gloomy title for his book.
This morning’s Wall Street Journal has a book review by the New York fund manager, Daniel Shuchman, “Thomas Piketty Revives Karl Marx for the 21st Century” of Thomas Piketty’s new book “Capitalism in the Twenty-First Century.” As I recently discussed, Piketty makes the simple observation that income from wealth, i.e. investment income, grows faster than income from wages or GDP. He then provides a large quantity of data showing how this has played out since the end of WWII. He plausibly predicts that the value of private capital as a percentage of national income will continue to grow indefinitely into the future. This much is straightforward. The question is how we should react to a steadily increasing and very large concentration of wealth in the hands of a small percentage of people. Mr. Piketty’s own idea is, for example, to establish an 80% tax rate on incomes starting at “$500,000 or $1,000,000” in order “to put an end to such incomes.” Mr. Shuchman attempts to discredit Mr. Piketty by focusing in on such socialistic views for dealing with the problem rather than discussing the intrinsic merit of Piketty’s basic thesis about the buildup of great wealth in the first place.
My own view is that Mr. Piketty has clearly identified a weakness of capitalism and that it behooves supporters of free markets and private initiative to address this problem in a constructive way, for example, as follows.
We need fundamental broad-based tax reform, i.e. lower tax rates in exchange for closing loop-holes and lowering deductions, in order to boost the economy and create more jobs. As part of a major tax overhaul, we could also establish a relatively small wealth tax, of about 1% or 2%, on assets over $10,000,000, which would raise as much as $200 billion per year. This much money could be used to begin a large scale program of infrastructure renewal as well as leaving a lot left over to make significant payments on reducing our annual deficit.
Such an overall plan would address both income inequality and wealth inequality in a highly visible manner while simultaneously helping our economy.
Last week I summarized the latest economic report from the Congressional Budget Office which very clearly describes both the slow rate of growth of our economy since the end of the recession, the enormous buildup of our national debt in the past five years and also the likelihood that it will continue getting worse for the foreseeable future unless big changes are made. About a week ago the two economists Edward Prescott and Lee Ohanian had an Op Ed in the Wall Street Journal, “U.S. Productivity Growth Has Taken a Dive”, pointing out that the productivity of U.S. workers has grown at an average annual rate of only 1.1% since 2011, much lower than the average annual rate of about 2.5% since 1948 (see the above chart). They also point out that the rate of new business creation is 28% below where it was in the 1980s (see the chart just below). Growth of worker productivity and growth of new business formation are the two main forces which drive economic growth. “Why is the startup rate so low? The answer lies in Washington and the policies implemented in the wake of the 2008 financial crisis that were, ironically, intended to grow and stabilize the economy.” Mr. Prescott and Mr. Ohanian continue that it is the “explosion in federal regulation, intervention and subsidies (which) has retarded productivity growth by protecting incumbents at the expense of more efficient producers, including startups.”
It is easy to be pessimistic about the prospects for change in the government policies which are retarding economic growth. Unfortunately, many political and social leaders have the point of view that it is income inequality which is “the defining issue of our time.”
The best response to this pervasive attitude is to shift the conversation towards equality of opportunity rather than dwelling on income inequality. By far the best way to increase opportunity for those who desire it and are willing to work for it is to grow the economy faster in order to create more and better jobs. If we are able to do this, we’ll all be much better off.
The Congressional Budget Office has just issued the report ”The Budget and Economic Outlook: 2014 to 2024”, giving its usual objective and nonpartisan look at our prospects for the next ten years. My purpose today is to give a simple interpretation of its basic data. In my next post I will address the implications of this interpretation. The first chart above shows a forty year history of government deficit spending. The average deficit for this time period is 3% of GDP. From 1982 – 1987 the deficits were worse than this and from 2009 – 2013 they were much worse. The real problem is the accumulated deficits, i.e. the debt. The second chart above shows the public debt (what we pay interest on) all the way back to 1940 as a percent of GDP. As recently as 2008, the public debt was below 40% of GDP. Now it is 73% and climbing. This is very serious for two reasons. Right now our public debt is almost free money because interest rates are so low. But when interest rates return to their normal level of about 5%, interest payments will explode and be a huge drain on the economy. In addition, these CBO predictions assume continued steady growth of the economy. If and when we have a new recession or some other financial crisis, there will be much less flexibility available for dealing with it. Now look at the last two charts. The first one shows the rate of GDP growth since 2000 which has averaged about 2% since the end of the recession in June 2009 and is projected by the CBO to level off at this same rate over the next 10 years. This is an historically low rate of growth for our economy. The final chart shows the gradual decrease of the labor force participation rate over this same time period. These two graphs are related! When fewer people are working, the economy simply will not grow as fast.
High debt and slow growth are big problems for an economy. We’re falling more deeply into this perilous state of affairs all the time. We need to take strong measures to break out of this dangerous trap!
Restore Fiscal Stability: constrain federal spending in a manner that reduces long-term spending growth, making both Medicare and Social Security more progressive and less expensive.
Enact Comprehensive Tax Reform: adopt a competitive, pro-growth tax framework that levels the playing field for U.S. companies competing in global markets. Several studies estimate that cutting the U.S. corporate tax rate by 10 % (e.g. from 35% to 25%) would boost GDP by 1% or more.
Expand U.S. Trade and Investment Opportunities: pass updated Trade Promotion Authority legislation and use TPA to complete many new trade agreements which are already pending.
Repair America’s Broken Immigration System: increase the number of visas for higher skilled workers and provide legal status for the millions of undocumented immigrants currently living in the U.S.
These are the same “big four” policy changes which many progressive business leaders as well as evenhanded think tank experts often recommend. They are really just common sense ideas which reasonable people should be able to come together on.
Isn’t it obvious that we’ll soon be in big trouble if we don’t get our enormous budget deficits under control? And that controlling entitlement spending is key to getting this done?
Isn’t it just as obviously commonsensical that even U.S. based multinational corporations will try to avoid locating business operations in countries like the United States with very high corporate tax rates?
Isn’t it likewise obvious that foreign trade is just an extension of domestic trade and that the world is better off with as much trade as possible?
Finally, the secret of a vibrant, growing economy is to encourage as much initiative and innovation as possible. Who take more initiative than the immigrants who figure out how to get here in the first place?
We don’t have to accept a sluggish economy, high unemployment and massive debt! But we do need to take intelligent action to extricate ourselves from the predicament we are in!
On the eve of the President’s State of the Union address, the New York Times gives an answer to this question in today’s paper, “Obama’s Puzzle: Economy Rarely Better, Approval Rarely Worse”. The charts below do show the basic trends all moving in the right direction. But is this good enough? The unemployment rate is moving steadily downward but it is still a high 6.7% almost five years after the recession ended in June 2009. And this is with a labor participation rate of only 58.6%, which is historically very low.
The budget deficit is dropping but is still unsustainably high. In the five years, 2009 – 2013, deficits have totaled $6 trillion dollars. As soon as interest rates return to their historical average of 5%, interest on this $6 trillion in new debt alone will total $300 billion per year, forever! Furthermore, the Congressional Budget Office, the most credible source of budget information, predicts that the deficit is likely to resume an inexorable climb within a few years as baby boomers retire in ever greater numbers, rapidly driving up entitlement costs.
Economic growth was stronger than expected in the last quarter of 2013 and this is a good sign. But it has averaged only about 2% since the recession ended which is very low by historical standards, in a post recessionary period.
The point is, do we really need to settle for such mediocre performance: a stagnant economy, high unemployment and massively accumulating debt? Should we just declare that in a highly competitive global economy with an ever higher premium on information and technology, that we just can’t do any better than we already are? Isn’t there some way to make our economy grow faster in order to provide more and higher paying jobs?
I think that the answer to this last question is an emphatic yes! In fact, this is what my blog is all about. Just read some of the other recent posts and let me know if you disagree with what I am saying!
The Yale Tax Law Professor, Michael Graetz, has proposed a new tax system “100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States” which would do wonders towards straightening out the huge fiscal and economic problems now facing our country. How do we rev up the national economy in order to put more people back to work and, at the same time, raise the revenue needed to operate the government in the 21st century without mountains of debt? Mr. Graetz’s basic idea is to tax consumption rather than relying totally on an income tax. Under his plan both savings and investments will be taxed at a lower rate which will encourage more of both. The Plan has these features:
A broad based Value Added Tax of about 14% is enacted on goods and services. The U.S. is the only advanced economy without a VAT.
Families earning less than $100,000 are exempted from the income tax. For incomes between $100,000 and $250,000, the tax rate would be 15%. For income over $250,000, the rate would be 25%.
The corporate income tax rate is lowered to 15%.
The Earned Income Tax Credit (EITC) is used to provide relief from the VAT burden to low-income families by using payroll tax offsets.
The plan is designed to be revenue neutral as verified by the Tax Policy Center.
This plan has many advantages including:
Taxing consumption and lowering the corporate tax rate to 15% from its current level of 35% would dramatically encourage investment in the U.S. thereby stimulating the economy and creating both new jobs and higher wages for American workers.
It would eliminate more than 100 million of the 140 million U.S. tax returns.
With many fewer Americans paying income taxes there would be far less temptation for Congress to use income tax exclusions, deductions and credits to try to address social and economic problems.
The plan retains all of the progressive features of our current tax system whereby higher income earners pay higher tax rates.
The point of describing the Graetz Plan in some detail is not to suggest that it is the best way to implement tax reform but rather that here, at least, is one attractive way to do it. The purpose is to move the discussion forward. We badly need to make changes along these lines!
I have been writing this blog for just over a year. It addresses what I consider to be the two biggest problems faced by our country at the present time. First is our enormous national debt, now over $17 trillion, and the huge annual budget deficits which are continuing to make it worse. The second problem, of equal magnitude, is our slow rate of economic growth, about 2% of GDP annually, ever since the Great Recession ended in June 2009. These two problems are closely related. If the economy grew faster, federal tax revenue would grow faster and the annual deficit would shrink faster. Not to mention that a faster growing economy would create more jobs and lower the unemployment rate, which is still a high 7%.
The impediments to solving these problems are huge. Our public debt, on which we pay interest, is now over $12 trillion or 73% of GDP. Although it may stabilize at this level for a few years, it will soon begin climbing much higher, without major changes in current policy. This is primarily because of exploding entitlement spending for retirees (Social Security and Medicare) who will increase in number from about 50 million today to over 70 million in just 20 years. As interest rates return to normal higher levels, just paying interest on the national debt will become, all by itself, a larger and larger drain on the economy.
The impediments to faster economic growth are increasing global competition, such as inexpensive foreign labor, as well as rapid advances in technology, such as electronics and robotics. Both of these trends reduce the need for unskilled workers in America which in turn holds down wages and slows down economic growth.
At the same time we have an antiquated tax code to raise the huge sums of money necessary to pay for a large and complex national government. It worked fine through the post-World War II period, as long as the U.S. had the dominant world economy with little significant competition from others. But this situation no longer exists. We now have a tax system which doesn’t raise enough money to pay our bills and at the same time is so progressive that the highest rates (39.6% on individuals and 35% for corporations) are not sufficiently competitive with other countries. This discourages the entrepreneurship and business investment we need to grow the economy faster and create more jobs.
We have an enormous problem on our hands! Is it possible to fundamentally change our tax system to turn things around? My next post will answer this question in the affirmative!