Why It Is Such a Bad Idea to Increase the Debt

 

As the readers of this blog know very well, I am so upset about our rapidly increasing national debt that I am preparing (in just a few days) to enter the 2018 Nebraska Republican Primary for U.S. Senate against the incumbent Deb Fischer because she just voted (with the new tax law) to increase our debt by $1 trillion over the next decade.  Of course, so did all of the other 52 Republican Senators as well but she is up for reelection this year and I live in her state.
The analyst Desmond Lachman from the American Enterprise Institute has a cogent summary of why increasing our debt at this time is such a bad idea:

  • With the public debt (on which we pay interest) at 77% the highest it has been since WWII, the U.S. already has a compromised debt position.
  • Basic principles of public finance suggest that when the economy is humming along (like now at 3% annual growth) and when unemployment is low (like now at 4.1%), one should try to reduce the public debt.
  • By having used up our fiscal space in good times, we run the risk of not having room to increase budget deficits in bad times.
  • The very low interest rates today (an artificial product of the Federal Reserve’s extraordinarily easy monetary policy over the past 8 years) are unlikely to last much longer and, in fact, the Fed has already started the process of raising interest rates, as inflation begins to heat up (see chart below).

  • Increased budget deficits make us increasingly reliant on foreign financing.
  • By our own sowing in joy with unfunded tax cuts, our children are likely to reap in sorrow the fruits of lower long-run economic growth.

Conclusion. By raising our debt by $1 trillion, the new Republican tax law is appallingly short-sited policy. I hope to make Senator Fischer pay a political price by her bad judgment in voting for it.

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The GOP Tax Plan: Bad Economic Policy and Bad Fiscal Policy

 

It is a very good idea to cut the top corporate tax rate to 20% or so from its current 35% level. This will make the U.S. competitive with other developed countries and encourage our multinational companies to bring their foreign profits back home for reinvestment in the U.S.  It will also encourage other foreign companies to set up shop in the U.S.
My last post, however, strongly criticizes the current GOP tax plan, now in Conference Committee, because it will add $1 trillion to our already huge debt:

  • Current national debt, at 77% of GDP (for the public part on which we pay interest) is the highest it has been since right after WWII, and is already predicted by CBO to keep getting worse, without major changes in current policy. When interest rates eventually return to more normal and higher levels, interest payments on the debt will skyrocket. And this will continue indefinitely, eventually leading to a new fiscal crisis, much worse than the Financial Crisis of 2008.

This means that the GOP tax plan, by adding an additional $1 trillion to our debt, is terrible fiscal policy. But the situation is even worse than this.  It is also bad economic policy:

  • Economic growth is finally becoming robust.  We now have had two quarters in a row of 3% growth. In 2015 median household income grew by 5.2% with another 3.2% added in 2016. Blue collar wages are beginning to take off (see chart).  The overall unemployment rate has dropped to 4.1%. Even the unemployment rate for Americans age 25 and older, without a high school diploma, has dropped to 5.2% (see second chart).

Conclusion. The last thing our economy needs right now is the artificial stimulus caused by a deficit-financed tax cut. It is likely to overheat an already hot economy and thereby ignite inflation which will force the Federal Reserve to raise interest rates much faster than would otherwise be necessary.

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Democrats Need to Get More Serious about Economics

 

My last post makes the case that the “American Idea” is thriving, contrary to a sense of gloom from many quarters. For example, the Democratic Party is so tied up with complaining about Donald Trump, that it is failing to address the fundamental reason why Mr. Trump was elected President last fall: the plight of blue-collar workers.
For well-known reasons (globalization and the growth of technology), blue-collar workers are not yet enjoying the full benefits of rising prosperity as much as the college educated managerial and professional classes. The basic reason for this is:

  • Slow economic growth, averaging just 2% of GDP per year since the end of the Great Recession in June 2009. Our currently low unemployment rate of 4.2% and the prospects for regulatory reform and tax reform suggest that growth might start picking up soon.

Faster growth is already occurring in the area of ecommerce, see here and here.


Consider:

  • Fulfillment center weekly wages are 31% higher on average than for brick-and-mortar retail in the same area.
  • Ecommerce workers are not likely to be college graduates but need a mixture of physical and cognitive skills.
  • In the past two years the ecommerce industry has added 178,000 jobs in electronic shopping firms and another 58,000 jobs for express delivery companies. At the same time brick-and-mortar retail full time equivalent jobs have dropped by 123,000.
  • Americans spend 1.2 billion hours per week shopping in brick-and-mortar stores. Since 2007, roughly 64 million hours per week of these “unpaid hours” have shifted to fulfillment center workers and truck drivers. In this way unpaid household shopping hours are turning into paid market work.
  • The economics of manufacturing will likely soon be changed in a similar manner from producing and distributing goods in bulk to small-batch manufacturing closer to the customer.

Conclusion. “The internet of goods,” spearheaded by Amazon, has already increased the productivity and wages of many retail (fulfillment center) workers and will soon do the same thing in manufacturing. This is private enterprise at its finest.

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Another Reason for Tax Reform to Be Revenue Neutral

 

My last post noted that with our unemployment rate down to 4.2% and with median household income having increased by 3.2% in 2016, the emphasis now should be totally directed to addressing our number one long term problem:

  • Massive national debt. With a deficit of $668 billion for Fiscal Year 2017, our debt now stands at 77% of GDP (for the public part on which we pay interest), the highest it has been since the end of WWII. It is predicted by the Congressional Budget Office to go much higher without significant changes in current policy.

Obviously our annual deficits are way too large and we need to shrink them dramatically. One way to start doing this is to speed up economic growth which will increase tax revenue especially by creating more jobs and better paying jobs.  Faster economic growth is quite feasible and this is one of the main goals of tax reform, now being considered by Congress.  But it needs to increase growth without increasing the deficit which is entirely doable.

But there is another big reason for revenue neutral tax reform as well. The dollar has depreciated by 10% in 2017 while the stock market has increased by 13%.  The S&P price-earnings ratio has risen to 30 at present which is way above average.  All of this means that we are in a loose money financial bubble.  For Congress to make our annual deficits worse than they already are, with deficit increasing tax reform, would make this bubble even bigger and therefore be highly irresponsible.

Conclusion. When interest rates return to much higher normal levels, as they inevitably will, interest payments on our debt will grow dramatically and cause a huge budget crunch. If ignored, this situation will eventually lead to a new fiscal crisis, much worse than the Financial Crisis of 2008.

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The Republicans Need to Adopt a Responsible Budget Plan for 2018

 

With the unemployment rate now down to 4.2% and household incomes having recently reached an all-time high, the first order of government business should be:

  • Fiscal responsibility which means to start reducing the size of the national debt, which is now 77% of GDP (for the public part on which we pay interest), the highest since the end of WWII. The only practical way to do this is to begin to shrink the size of our annual deficits from the very high level of almost $700 billion for the 2017 Fiscal Year which just ended on September 30.
  • A responsible budget for the 2018 Fiscal Year can have a deficit of at most $500 billion which amounts to 2.5% of our total GDP of $20 trillion. A realistic forecast for economic growth in the coming year is 2.5% of GDP which means that a deficit for the 2018 FY of $500 billion would at least not increase our debt as a percentage of GDP.

  • Budgets for later years need to actually shrink (not just hold steady) the debt. The goal should be to decrease annual deficits down close to zero which would mean achieving a balanced budget. The Congressional Budget Office projects that the cumulative deficits will climb by $10 trillion over the next ten years under current policy, pushing the debt up to 91% of GDP in 2027.
  • Tax reform, to be considered next by Congress, is likely to stall if it is not pursued within a sensible fiscal policy just as healthcare reform stalled last summer. Sensible tax reform, both growth enhancing and revenue neutral, is quite doable  and will make the debt problem that much easier to solve.

Conclusion. It cannot be emphasized too strongly that our rapidly growing debt puts us in a dire fiscal bind. We must change policy significantly and soon or else we will put our prized liberty and prosperity in grave danger.

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Fundamental Principle for Tax Reform II. What to Avoid

 

In my last post I made the case that the two fundamental principles for effective tax reform are:

  • Faster economic growth, to create more jobs and bigger pay raises.
  • Revenue neutrality, since more debt at this time is just too risky.

And then I went on to suggest the specific changes in the tax code which would achieve these goals:

  • Reducing the corporate tax rate to approximately 20%.
  • Full expensing for business investment replacing depreciation spread out over many years.
  • Simplification of rules for individuals such as fewer tax rates and fewer credits.
  • Achieving revenue neutrality by eliminating as many deductions as necessary to pay for the above tax rate cuts.

There are different ways to accomplish all this and I recently described one attractive plan put together by the Tax Foundation. The Republican Congressional Leadership (Big Six) has proposed a different plan which has been analyzed by the nonpartisan Committee for a Responsible Federal Budget.  Unfortunately CRFB concludes that this plan will cost $2.2 trillion over ten years in lost revenue.  But it could be modified in the following ways to become revenue neutral:

  • The mortgage interest deduction is maintained but limited to one dwelling and $500,000, down from the current limit of two homes and $1 million.
  • The tax exemption for employer provided health insurance is limited. This not only increases tax revenue but also forces the 150 million Americans who receive health insurance from their employer to take an active role in holding down the cost of healthcare.
  • Drop the proposal of establishing a maximum “pass through” rate of 25% for business owners. Any such proposal would be subject to wide spread abuse. Businesses would be benefitting from the full expensing provision above and their owners should pay taxes at the same rates as everyone else.
  • Keep the estate tax until annual deficits are greatly reduced. It only brings in $20 billion per year but every little bit helps.

Conclusion. These common sense changes in the Big Six plan would make it revenue neutral and still capable of achieving a significant boost to the economy.

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Why Entitlement Spending Is So Difficult to Control

 

The readers of this blog know that my favorite topic is our very large national debt, now 77% of GDP (for the public part on which we pay interest) and predicted by the Congressional Budget Office to keep steadily getting worse, without major changes in current policy.


It is also well documented (see chart)  that our entitlement programs of Social Security, Medicare and Medicaid are the drivers of the huge annual budget deficits which make the accumulated debt so much worse and worse.
The economist John Cogan has an informative interview in yesterday’s Wall Street Journal explaining why entitlement spending is so difficult to control. First of all, according to Mr. Cogan, only three modern presidents have made any effort to control entitlement spending:

  • FDR who persuaded Congress to repeal unjustified disability entitlements to 400,000 WWI, Philippine War and Boxer Rebellion veterans.
  • Ronald Reagan “slowed the growth of entitlements like no other president ever had.”
  • Bill Clinton’s welfare-reform plan not only reduced welfare’s burden on taxpayers but also benefitted the recipients, whom the old program had been harming.

 

Mr. Cogan identified three necessary political conditions for any entitlement reform. They are:

  • Presidential leadership “without which there has never been a significant reduction in an entitlement.”
  • Significant agreement among the general public and the elected representatives that there’s a problem.
  • Bipartisan consensus on the solution for correcting the problem.

Conclusion.  Think about it.  This is a quite a gloomy assessment.  Nothing will get done on the primary reason for our huge debt problem without both presidential leadership and bipartisan political support. When is this going to happen?

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