The Long Run and the Short Run

Posted on March 23, 2014 by jackheidel

“I agree with you that something must be done now. The trick is what will work the best in the short term to trigger the agreement between the fiscal conservatives and the modern liberals to cut costs and balance the budget that we both agree on. We can agree to disagree on the solution details but I hope you are successful in achieving the short term goals you are working tirelessly on.
Just as big a question is what will work the best in the long run to prevent it from happening again. I will continue to work on changing the intellectual environment that I see as a precondition to solidifying your short-term gains and preventing a re-occurrence.”
These are the words of my Omaha libertarian friend, David Demarest, with whom I have an ongoing dialogue. He wants to cut back and limit the scope of government. I’m willing to have a more expansive government as long as we’re willing to pay for it.
The secret to solving many of our current problems (stagnant economy, high unemployment, massive debt, increasing inequality) is to grow our economy faster. The best way to accomplish this is by boosting investment and entrepreneurship with broad-based tax reform, by lowering tax rates for both individuals and corporations, paid for by eliminating deductions and closing loopholes.
But some people think that lowering tax rates means lower taxes on the rich. To counteract this perception, and at the same time to raise additional tax revenue to lower the deficit, I propose to levy a new wealth tax of 1% of assets with an exemption of $10 million per person to make sure that the tax only applies to the “truly wealthy.”
I believe that a program along these lines is the best way to get our economy back on track. But, at the same time we need to figure out how to avoid falling back into another slow growth, high debt trap anytime soon.
A good way to achieve long run protection is with a balanced budget amendment. It would need to be flexible, allowing for emergencies, and also phased in over several years to allow citizens and legislators time to make the necessary adjustments to spending and taxes.

Should We Be Optimistic or Pessimistic about Our Country’s Future?

Posted on March 2, 2014 by jackheidel

Last month the Congressional Budget Office issued the report “The Budget and Economic Outlook: 2014 to 2024”, giving an updated prediction on economic performance. It predicts continued slow growth of GDP leveling off in the next few years at a rate of about 2.2% per year. The public debt (on which we pay interest) will be 74% of GDP this year and increase to 79% of GDP by 2024. Federal revenues will grow this year to 17.5% of GDP while federal spending will be 20.5% of GDP. The problem is that the gap between revenue and spending will get worse as indicated by the chart below.
CBO estimates that interest rates on three month Treasury bills will rise from 0.1% today to 3.7% in 2018, and higher in subsequent years, which means that interest payments on our public debt will increase dramatically as shown in the chart below. Inflation is predicted to average about 2% over this time period. Unemployment will slowly drop to 5.8% in 2017 and not reach 5.5% until 2024.
In an article two days ago, an economics reporter for the New York Times, Floyd Norris, writes that this is “A Dire Economic Forecast Based on New Assumptions”. Mr. Floyd argues that it is unlikely that we will continue to have both anemic growth and high interest rates at the same time. Of course, if the economy does grow more quickly, then government revenues will also grow faster which will slow down the growth of the debt. But CBO predicts that our recovery from the Great Recession will continue to be tortuously slow.
The problem is that when interest rates do go up, as they will sooner or later, interest payment on the national debt will rise quickly, as shown in the CBO chart. This is going to happen and will be unpleasant to deal with. Are we going to have slow growth in the meantime, with high unemployment along with it, and then also have expensive debt payment later? This is indeed a pessimistic prospect!
We have a continuum of choices:

Do nothing until the big crunch hits in a few years (like Greece)
Cut spending dramatically, including for entitlements (politically infeasible)
Raise taxes dramatically (also politically infeasible)
Both cut spending and raise taxes (perhaps doable as we get closer to the big crunch)
Grow the economy faster which would both lower unemployment and raise revenue

I know what my choice is, how about you?

Closing the Productivity and Pay Gap

Posted on February 23, 2014 by jackheidel

The social economist William Galston has a column, in last week’s Wall Street Journal, “Closing the Productivity and Pay Gap”, discussing the large gap between the rising productivity of American workers and the stagnant pay level which has developed since 1973 (see below). He points out that “the erosion of the compensation/productivity link has made it harder to sustain robust domestic demand for goods and services, which constitutes more than two-thirds of our entire economy. As the gap widened, U.S. households responded by sending more women into the workforce, expanding the numbers of hours worked, and taking on a greater burden of debt. These strategies have hit a wall. Unless compensation rises more rapidly, stagnant domestic demand will depress economic growth as far as the eye can see.” In other words, workers are no longer receiving their fair share of the productivity gains. And this retards the increased economic growth which we all desire. Without detracting from the seriousness of Mr. Galston’s argument, I would like to make several observations which are pertinent to the discussion.
First of all, as pointed out by the Heritage Foundation (in the second chart), wage stagnation since 1973 does not take into account the growth of total compensation including healthcare and other benefits. And since healthcare costs are twice what they are in any other country, this is a huge drag on the growth of worker’s pay. In other words, if the U.S. were able to cut healthcare costs nearly in half, as should be possible with a more efficient system, then the hundreds of billions of dollars saved would give a huge boost to paychecks.
Secondly (as shown in the last chart), there is a direct correlation between wages and education level for U.S. workers. Of course, boosting educational outcomes is much easier said than done and, in any event, is a long term process. Nevertheless, any highly motivated and ambitious person can increase their earnings prospects by succeeding in school.
Finally, a combination of minimum wage increases and perhaps an expansion of the Earned Income Tax Credit can help those people at the lowest levels of the income scale earn a living wage as long as they are willing to work.
As Mr. Galston said in an earlier piece, “We need nothing less than a new norm – a revised social contract – that links compensation to productivity. And because we cannot return to the conditions that once sustained that link, we need new policies to bring it about.”

The Economic Outlook: 2014 – 2024 II. How Can We Grow Faster?

Posted on February 11, 2014 by jackheidel

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 Economic Effect of ObamaCare

Posted on February 9, 2014 by jackheidel

Last week’s report from the Congressional Budget Office “The Economic Outlook: 2014 – 2024” (which I discussed in my last post) caused a big stir with its prediction that ObamaCare will cause a loss of 2,000,000 mostly low wage jobs by 2017 and 2,500,000 such jobs by 2024. The lost jobs aren’t necessarily from workers being fired or fewer workers being hired but rather the overall decreased incentive for individuals to find work. The CBO analysis is based on the research of the economist Casey Mulligan featured in yesterday’s Wall Street Journal as “The Economist Who Exposed ObamaCare”.
The above chart of Mr. Mulligan interprets several recent government subsidy programs as a new marginal tax rate, i.e. the “extra taxes paid and government benefits foregone as a result of earning an extra dollar of income.” The 2009 stimulus, the Recovery and Reinvestment Act, had an effect like this but it was temporary. The marginal tax increase of the Affordable Care Act will last as long as it remains in effect.
The above chart from the same CBO report, showing the steady decline in the Labor Force Participation Rate from the year 2000 onward, demonstrates the critical nature of this problem. Lower labor force participation means lower growth in overall labor productivity which in turn means slower economic growth. Since the Great Recession ended in June 2009, GDP growth has averaged only about 2% annually.
Slow GDP growth means, in addition to a higher unemployment rate, that America’s standard of living will not increase very rapidly if at all. But the problem is really much worse than this. We have an enormous debt problem which is only getting worse every year that we continue to have large deficits. The CBO report predicts increasing growth in the size of our national debt. By far the least painful way of shrinking our debt (relative to the size of the economy) is to grow the economy as fast as we reasonably can. But our economy is actually slowing down, not speeding up!
This is a very serious problem which many of our national leaders are much too complacent about!

Fundamental Tax Reform Is the Key to Solving Our Economic and Fiscal Problems I. Why Change Is Needed

Posted on January 5, 2014 by jackheidel

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!

What is the Biggest Drag on the Economy?

Posted on March 21, 2013 by jackheidel

In today’s Wall Street Journal columnist David Wessel has an article entitled “Biggest Drag on Economy? Washington”. He quotes Senator Dick Durbin (Democrat, Illinois) as saying “We have the Fed hitting the accelerator as hard as it can, and we have Congress doing the opposite.” He is referring to across the board spending cuts (the Sequester) and raising of the top tax rates.

What we should be doing, according to Senator Durbin, Mr. Wessel and the experts he cites, is reforming entitlements, especially for health care, rather than trimming core functions of government across the board. Likewise we should be implementing pro-growth tax reform , by lowering tax rates and shrinking deductions, rather than raising tax rates.

Who is holding up the big budget deal which Senator Durbin says he wants? He needs to look in the mirror! It is the Democrats who are dragging their feet on entitlement reform as well as replacing tax deductions with lower tax rates. The Democrats control two thirds of the executive and legislative branches of government. If they continue to stall on implementing the economic and fiscal policies which we so badly need to get our country moving again, they will eventually pay a severe price at the polls.

Why $16 Trillion Only Hints at the True U.S. Debt

Posted on February 4, 2013 by jackheidel

In an Op Ed article last fall in the Wall Street Journal two former Congressmen, Chris Cox and Bill Archer, point out that the total US government debt, now over $16 trillion, is only a fraction of the total unfunded liabilities of the government, which now exceed $87 trillion. The unfunded liabilities represent future expected payments for Social Security, Medicare benefits for currently employed workers as well as current retirees and also the future retirement benefits of current federal employees and retirees.

If this enormous sum of already obligated future payouts is not bad enough, even scarier is the rate of growth of these unfunded liabilities. In calendar year 2011, the accrued expense was $7 trillion, double the entire current revenue of the federal government of about $3.5 trillion. In other words this awful problem is getting much worse every year.

The House Republican majority is trying to address our almost incomprehensibly bad debt problem. Will they be able to generate enough public support to force the Senate and the President to take the problem seriously? Right now the odds do not look very good for effective action to be taken. An enormous crisis is almost on our doorsteps. How bad will it have to get before public opinion demands action? It is very hard to remain optimistic about the future of our country when we appear to lack the collective will to take the action which is so obviously needed

Is inequality Holding Back the Recovery?

Posted on January 21, 2013 by jackheidel

The Nobel prize-winning Keynesian economist, Joseph Stiglitz, claims in the January 20, 2013 New York Times, that “Inequality is holding back the recovery”. He says that the most important reason is because the middle class is too weak to support the consumer spending we need. And that the weakness of the middle class is holding back tax receipts. And that we are squandering our young who are increasingly unable to get an education without borrowing huge sums of money.

Many liberals deplore the slow rate of economic growth since the recession ended in June 2009 and all of the problems it creates and exacerbates such as high unemployment and lower tax revenue to support public services. What these liberals amazingly fail to understand is that there are tried and true methods to promote economic growth. What we need to do is to lower tax rates (offset by eliminating tax deductions and loopholes), remove or diminish the enormous new regulatory burdens which have recently been placed on the economy, boost domestic energy production and aggressively, rather than halfheartedly, pursue new trade agreements to lower the barriers to free trade.

Powerful trends such as globalization and computer technology are driving economic progress and causing the inequality which Stiglitz and many others deplore. We need to embrace these trends and use them to our advantage. The way to boost the middle class is to boost our stagnant economy in the tried and true ways which have worked in the past. The way to boost postsecondary education is to recognize that there are many high quality and low cost schools all over the country. And that it is not necessary to borrow lots of money to get a good education.

In short, the solution to the urgent and critical economic and fiscal problems we are now facing lies entirely under our control. All we need are national leaders who have the vision, capability and fortitude to lead the way.

No Deal is better than a Bad Deal

Posted on December 22, 2012 by jackheidel

It is beginning to look like President Obama and House Speaker Boehner may not be able to negotiate an acceptable deal by December 31^st to avoid going over the Fiscal Cliff. The President wants tax rates to rise for incomes above $400,000. The Speaker has offered to raise tax rates for incomes over $1,000,000 but it is not clear if House Republicans will go along with this, even if accepted by the President.

What is the effect of such increases in tax rates? According to the Wall Street Journal, raising taxes for incomes over $500,000 would affect 750,000 small business owners, while an income cutoff of $1,000,000 would affect 311,000 small business owners.

What will be the economic impact of restoring Clinton era tax rates on small business owners? A recent study by Ernst & Young predicts that employment would fall by 710,000 jobs and that economic output (GDP) would decrease by 1.3% on an annual basis.

Conclusion: although more tax revenue is needed, as well as significant spending cuts, to get our fiscal house in order, it matters where this new revenue comes from. What we really need is pro-growth tax reform. This means lowering marginal tax rates and curtailing deductions and loopholes.

Yes, it is preferable to avoid going over the fiscal cliff. But a deal needs to be structured which puts us on a sound fiscal and economic track for the long term. Principle matters. No deal is better than a bad deal.

It Does Not Add Up

Jack Heidel's blog on fiscal responsibility

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