The Government We Deserve II. How Do We Make It Better?

 

“When the Athenians finally wanted not to give to society but for society to give to them, when the freedom they wished for most was freedom from responsibility, then Athens ceased to be free.”
Edward Gibbon, 1737 – 1794, The Decline and Fall of the Roman Empire

In my last blog, “The Government We Deserve,” I reported on a new book “Dead Men Ruling” by Eugene Steuerle, which shows how “Dead and retired policymakers have put America on a budget path in which spending will grow faster than any conceivable growth in revenues.”
CaptureOur country is clearly in a huge predicament.  We can get out of this jam by:

  • Restoring Balance: our legislators should only appropriate spending for one year at a time.
  • Investing in our future: i) opportunity is a more optimistic goal than adequacy ii) policies to assure adequacy often reduce opportunity by creating negative incentives    (e.g. food stamps, disability programs, housing vouchers) iii) means-tested programs are often anti-family (i.e. discourage marriage)
  • Building a Better Government: our main goal today should be to restore fiscal freedom by allowing future generations to create the government they need and want. i)   constrain the automatic growth in big federal tax subsidy, health and retirement      programs ii) reorient government towards investment, children, opportunity and leanness

“Both parties talk the talk about deficit reduction but fail to see that the deficit is but a symptom of a much broader disease – the extent to which both have tried to legislate far too much of what future government should look like.”
Here are the kinds of fixes which are needed:

  • Eschew Constitutional Fixes (i.e. a balanced budget amendment, term limits).
  • Require Presidents to propose budgets which balance over a business cycle.
  • A True Grand Compromise (end automatic growth of entitlements, generate revenues needed to pay current bills).

As Mr. Steuerle says, “If the obstacles to progress are considerable, the payoffs are enormous.”

The Government We Deserve

 

“As for the future, your task is not to foresee it, but to enable it.”
Antoine de Saint-Exupery, 1900 – 1944

An important new book, “Dead Men Ruling,” by the Urban Institute’s C. Eugene Steuerle, has just been published.  Here is the flavor of its message:
Capture“Dead and retired policymakers have put America on a budget path in which spending will grow faster than any conceivable growth in revenues. … The same policy makers also cut taxes so much below spending that they created huge deficits, which have now compounded the problem with additional debt.”
“Both sides have largely achieved their central policy goals – liberals have expanded social welfare programs, conservatives have delivered lower taxes.  Both now cling tenaciously to their victories.”
In short, “our central problem is the loss of fiscal freedom.” There are “four deadly economic consequences of this disease:

  • rising and unsustainable levels of debt,
  • shrinking ability of policymakers to fight recession or address other emergencies,
  • a budget that invests ever less in our future and is now a blueprint for a declining nation, and
  • a broken government, as reflected in antiquated tax and social welfare systems.”

In addition there are “three deadly political consequences:

  • a decline of ‘fiscal democracy’ depriving current and future voters of the right to control their own budget,
  • a classic ‘prisoner’s dilemma’ where both left and right leaning elected officials conclude that they will suffer politically if they lead efforts to impose either spending cuts or tax hikes, and
  • rising hurdles to changing our fiscal course because, to do anything new, requires reneging on past promises of rising benefits and low taxes, that voters have come to expect.”

In other words the U.S. is in a very difficult predicament.  Mr. Steuerle thinks it will take a major “fiscal turning point” to escape from the present danger.  Both sides will have to make big concessions in order for us to get out of this jam.  But how is this possibly ever going to happen?  More next time!

Saving the System

 

I seldom use the New York Times sociological columnist, David Brooks, as a source for my blog posts because I am focused primarily on economic and fiscal issues.  But his column today, “Saving The System,” is highly pertinent to my message.
Capture1“All around, the fabric of peace and order is fraying.  The leaders of Russia and Ukraine escalate their apocalyptic rhetoric.  The Sunni-Shiite split worsens as Syria and Iraq slide into chaos.  China pushes its weight around in the Pacific. … The U.S. faces a death by a thousand cuts dilemma.  No individual problem is worth devoting giant resources to.  But, collectively, all the little problems can undermine the modern system.”
In addition to all of these pesky worldwide problems, our free enterprise economic system is under siege.  Wages have been largely stagnant since the early 1970s and income inequality is growing as the top 1%, and perhaps the top 10 or 15% as well, do much better than everyone else.  And just lately we have also learned from the French economist, Thomas Piketty, that wealth inequality has been growing steadily ever since about 1950 and is likely to get substantially worse in the future.
In other words, western civilization is under threat in more ways than one.  What are we going to do about it?  At the risk of oversimplifying, I believe that the single best thing we can do is to undertake fundamental tax reform to make our economy stronger.  Cut everyone’s tax rates and pay for it by closing loopholes and deductions which primarily benefit the wealthy.

  • Lower tax rates will put more money in the hands of the two thirds of Americans who don’t itemize their tax deductions. These are largely the same people with stagnant wages and so they will spend this extra income they receive.
  • The resulting increase in demand will put millions of people back to work and thereby increase tax revenues which will help balance the budget. This shift of income from the wealthy to the less wealthy will reduce income inequality.
  • Although harder to implement politically, a low (between 1% and 2%) wealth tax on financial assets above a threshold of $10 million per individual, would be a highly visible way to address wealth inequality. The substantial sum of revenue raised by this method could be used to fund national priorities as well as paying down the deficit.

I don’t want to leave the impression that I consider this program to be a panacea for strengthening our country.  But it would help and we need to make some big changes to maintain our status as world leader.

Why Debt Matters

 

The House Committee on Financial Services recently held a hearing on the topic “Why Debt Matters.” One of the speakers was David Cote, CEO of Honeywell International. He pointed out that the percentage of world GDP generated by the developed countries (the U.S., Western Europe, Canada and Japan) is predicted to decline from 41% in 2010 to 29% by 2030. High growth developing economies are expected to grow in GDP from 33% in 2010 to 47% in 2030. In order to compete in this new world we need an “American Competitiveness Agenda.”
Mr.Cote suggests eight components: debt reduction, infrastructure development, better math and science education, immigration reform, tort reform, stronger patent support, more energy generation and efficiency, and trade expansion. “To compete effectively on the increasingly competitive world stage, we have to have a strong balance sheet. We don’t have a strong balance sheet today and it will worsen over time with our current plan. … In 2025, just 11 years from now, we will be spending a trillion dollars a year just in interest.” And this is assuming no more recessions in the meantime!
CaptureOur public debt level today, at 72% of GDP, is higher than at any time in our nation’s past, except for during World War II when the survival of the free world was at stake. And while public debt will be 78% of GDP in 2023, which might not sound much worse than today, it is also projected to be much higher, 99% of GDP, by 2033. Is this really the legacy that we want to leave for our children and grandchildren?
Capture1Some people say that we should run even bigger deficits right now until we are fully recovered from the Great Recession. But this is what we’ve been doing for the past five years and it’s not working. How much longer do we wait until we change course?
It’s possible to shrink our deficits and speed up the growth of our economy both at the same time. This is what Mr. Cote is saying and what I am constantly talking about on this website!

Do We Need a New School of Economics?

 

“Consider the following scenario. You are an airline pilot charged with flying a planeload of passengers across the Atlantic. You are offered the choice of two different aircraft. The first aircraft has been prepared by chief engineer Keynes and the second by chief engineer Hayek.
You have to choose which plane to use, so naturally you ask the advice of the two engineers. Keynes urges you to use his aircraft, offering a convincing explanation of why Hayek’s plane will crash on take-off. Hayek urges you to use his aircraft, offering an equally convincing explanation of why Keynes’s plane will crash on landing.

At loss as to which plane to choose, you seek the advice of two leading independent experts – Karl Marx and Adam Smith. Marx assures you that it does not matter which aircraft you choose as both will inevitably suffer catastrophic failure. Similarly, Smith also reassures you that it does not matter which aircraft you choose, as long as you allow your chosen craft to fly itself.”
Thus begins a fascinating new book, “Money, Blood and Revolution: How Darwin and the doctor of King Charles I could turn economics into a true science,” by the fund manager and economist, George Cooper.
CaptureMr. Cooper sets up a circulatory model of democratic capitalism whereby rent, interest payments and profits flow from low income people at the bottom of the pyramid to the wealthy at the top. And then tax revenue (collected mostly from the wealthy) is redistributed downward in the form of government programs.
According to Mr. Cooper, the financial crisis was caused by a combination of lax regulation and excessive credit and monetary stimulus. The question is what to do about it. Mr. Cooper says:

  • Stop adding to the problem. High student debt and high mortgage debt are still being supported by government programs.
  • Change the course of the monetary river. Quantitative easing does not work because it just puts money into the hands of the wealthy and they have no incentive to spend it.
  • Change the course of the fiscal river. Instead put money into the hands of the people at the bottom of the pyramid with expanded government spending on infrastructure (paid for by taxing the wealthy).

Without endorsing all of Mr. Cooper’s suggestions, he nevertheless has many good ones and expresses them in a highly entertaining style!

Truth and Myth about Inequality

 

Two of my favorite columnists are the Brooking Institution’s William Galston, a social economist who has a weekly column in the Wall Street Journal and the economics journalist Robert Samuelson who writes for the Washington Post.  
Most people agree that income inequality in the U.S. is steadily getting worse.  Mr. Galston make a good case (see my last post) that it is primarily caused by the large gap between the rising productivity of American workers and the stagnant level of their pay which has developed since 1973.  He thinks that we need a fundamentally new social contract which links worker compensation to productivity.  This, of course, is a tall order and it is not at all clear how such a new order would be achieved.
CaptureMr. Samuelson has a different perspective: “Myth-making about Economic Inequality”.  For example:

  • The poor are not poor because the rich are rich
  • Most of the poor will not benefit from an increase in the minimum wage because only 6% of the 46 million poor people have full time jobs
  • All income groups have gained in the past three decades, even though the top 1% has gained the most (see the above chart from the CBO, December 2013)
  • Widening economic inequality did not cause the Great Recession

These two perspectives on inequality are quite different but not contradictory.  Basically what Mr. Samuelson is saying is that we have to be careful in how we address this problem or we’ll just make it worse.  Raising taxes on the rich is unlikely to help and might hurt if it slows down the economy.  Raising the minimum wage will only raise a fairly small number of people out of poverty and may cause a lot of unemployment along the way.
My solution: focus on boosting the economy to create more jobs in the short run (tax reform, immigration reform, trade expansion) and improved educational outcomes for the long run (early childhood education, increasing high school graduation rates, better career education).
But I agree with Mr. Galston that it is imperative to lessen income inequality, one way or another.  Otherwise as a society we’ll have big trouble on our hands.

Inequality, Productivity and Compensation

The Brookings Institution social economist, William Galston, has an interesting column in yesterday’s Wall Street Journal, “The U.S. Needs a New Social Contract”, deploring the fact that worker compensation (i.e. wages + benefits) has not kept up with gains in worker productivity since the 1970s.  Here is a chart published by the Economic Policy Institute showing the divergence between productivity and compensation for a “typical” ( i.e. in the middle) worker beginning in the 1970s:
CaptureThe Heritage Foundation’s James Sherk has addressed this same question in a recent report “Productivity and Compensation: Growing Together” and shows that the “average” compensation of an American worker does track productivity very closely as shown in the chart below:
Capture1What is the explanation for this apparent discrepancy?  In fact, it is the difference between the average earnings of U.S. workers and the earnings of the median or middle worker.  The very high earnings of the top 10% and the even higher earnings of the top 1% raise average worker compensation way above the income level of the median worker.  In other words it is the result of the skewed and unequal distribution of incomes which is heavily weighted toward those at the top of the scale.  The typical or median worker is falling behind and is not benefitting from the steady rise in the overall productivity of the American economy.  This is what income inequality is all about.
The question is what to do about it.  Faster economic growth will create more opportunity by creating more jobs and better paying jobs.  Raising high school graduation rates as well as creating high quality technical training programs will also help.
Mr. Galston insists that this is not enough.  Too many workers will continue to lag farther and farther behind.  We could raise the Earned Income Tax Credit for low income workers but this would be very expensive in our currently tight fiscal situation which is likely to continue indefinitely.
Do we need a new social contract?  If so, what form will it take?  How will we pay for it?  These are indeed very difficult questions to answer!