Why Is U.S. Productivity Growth Declining?

Posted on May 17, 2015 by jackheidel

The economist Alan Blinder has just reported, “The Mystery of Declining Productivity Growth” that U.S. productivity growth has fallen dramatically in the last few years. “The healthy 2.6% a year from 1995-2010 has since been an anemic 0.4%. What’s scary is that we don’t know why.”
The economists Edward Prescott and Lee Ohanian believe the productivity slowdown is caused by a corresponding slowdown in new startups (as illustrated by the above chart). They point out, for example, that:

The creation rate of new businesses in 2011 was 30% lower than the average rate of the 1980s.
New startups are critical for growth since many of today’s heavyweights will decline as new businesses take their place. For example, only half of the Fortune 500 firms in 1995 remained on that list in 2010.
Startups in high technology have also declined since 2000 even though there is no slowdown in the development of new technology.

Consistent with the recommendations of James Bessen in a recent post of mine, “Learning by Doing,” Messrs. Prescott and Ohanian recommend policy changes such as:

Better training, plus immigration reform, to produce more skilled workers.
Streamlining regulations that raise cost, especially for small businesses.
Tax reform to reduce marginal tax rates.
Reforming Dodd-Frank to make it easier for small businesses to obtain loans from main street banks.

In today’s New York Times, the economist Tyler Cowen wonders whether our economy is in the midst of a “Great Reset.” “Perhaps the most crucial issue is whether economies will return to normal conditions of steady growth, or whether we are witnessing a fundamental transformation” to a less productive economy.
Here’s another way to put it: shall we attempt to adopt better pro-growth policies or shall we just give in to the status quo and accept that we can’t do any better? Are we optimists or are we pessimists?

Will Wage Stagnation Continue Indefinitely?

Posted on May 3, 2015 by jackheidel

It is widely deplored that wages for both middle- and lower-income workers are stagnant and have not even recovered from where they were before the beginning of the Great Recession. The latest issue of The Economist explores this problem, “When what comes down doesn’t go up.”
The Economist sees several factors at work:

As the unemployment rate continues to drop, many new jobs are paying less than the old jobs that were lost.
In Germany “mini jobs,” paying under $440 per month, are skyrocketing. In Britain “zero hours” contracts, with no commitment to a fixed number of hours, are becoming more common.
In 2013 Kelly Services, which provides temporary workers, was the second largest employer in the U.S. with a staff of 750,000. 2.9 million temps account for 2% of all jobs in the U.S.

As The Economist points out, if low pay does in fact lock in, inflation will stay low even as the unemployment rate continues to fall. The Federal Reserve will then be likely to keep interest rates low indefinitely as well. But this means there will be far less incentive for Congress and the President to cut back on huge deficit spending because debt is almost “free money” when interest rates are low. Long term, massive debt, is a huge threat to our security and prosperity.
Breaking out of this pernicious low wage trap will require a bold effort by Congress and the President to boost economic growth. By far the best way to do this is with broad-based tax reform at both the individual and corporate levels. As I have discussed in previous posts, what is needed is lower tax rates paid for by closing loopholes and deductions. Hopefully, the new Congress is headed in this direction!

“We’ve Got to Do Something about Income Inequality”

Posted on April 12, 2015 by jackheidel

This is what I hear over and over again from my liberal-minded friends. Their solution is to raise taxes on the rich and give to the poor. This might help a little but not nearly enough.
The best way to help middle- and lower-income people is to give them more opportunities for self-advancement by providing more upward mobility in society. Right now the middle class is being “hollowed out” as shown in the chart just below.
There are three major reasons for this:

Economic Globalization which provides low cost goods from around the world and thus puts pressure on low- and semi-skilled workers in the U.S.
Rapid technological advancement which puts a higher premium on educational attainment and advanced skill acquisition.
Slow economic growth averaging only 2.3% since the end of the Great Recession in June 2009.

Globalization and technological advancement are strong worldwide forces likely to continue indefinitely. We will simply have to adapt to them with long term strategies such as improved educational outcomes at all levels (early childhood, K-12 and post-secondary). But speeding up economic growth is under our direct control with tried and true methods which are not being fully utilized at the present time. Such as:

Tax Reform. We should lower tax rates for individuals across the board, paid for by shrinking deductions for the wealthy. This will give middle- and lower-income workers, as well as new entrepreneurs, more money to spend, thereby boosting both supply and demand in the economy.
Increasing the Earned Income Tax Credit paid for by using some of the increased revenues from shrinking deductions for the wealthy. This would encourage more people to take and hold onto entry level jobs, thus boosting the economy by increasing the size of the workforce.

In other words, much can be done to reduce income inequality. Redistribution of tax revenue is fine as long as it is done in a way which increases economic growth, rather than just punishing the rich.

How Do We Boost Middle Class Jobs?

Posted on April 7, 2015 by jackheidel

Income inequality is a serious political issue these days as it should be. America’s future well-being depends on widely shared prosperity. One of the very best ways to lessen inequality is to increase mobility into the middle class.
The political and economic analysis group, FiveThirtyEight, has just reported new data (see above) that “Mid-tier Jobs Are Seeing Less Growth.” The middle class has already been hollowed out by the gale-wind forces of globalization and technological advancement. Now the Great Recession, and the slow recovery from it, has made things that much worse. It’s long past time to focus on middle class recovery.
The best way to do this is to make the economy grow faster as follows:

Tax Reform. Lowering individual rates should be the first priority, paid for by closing loopholes and shrinking deductions for the wealthy. This will give middle- and lower-income workers more money to spend and encourage startup small businesses. Lowering corporate tax rates, again offset by shrinking deductions, will incentivize multi-national corporations to bring their profits back home for distribution or reinvestment.

Increase the Earned Income Tax Credit, paid for with some of the increased revenues from shrinking deductions for the well-to-do. This will encourage more people to take and hold onto entry level low-wage jobs, thus increasing the size of the workforce.

Putting More Emphasis on Career Education in High School. Not everyone wants to or needs to go to college. There are lots of well-paying middle class jobs for high skilled workers and a shortage of workers for these jobs in many labor markets.

Miscellaneous. Immigration reform, trade expansion, and easing regulations on small business would also help grow the economy.

Economic growth since the end of the Great Recession in June 2009 has averaged a meager 2.3%. Speeding up growth is the best way to raise wages and lower unemployment at a much faster rate. This is the best way to boost middle class jobs!

Can We Solve All Our Fiscal and Economic Problems at the Same Time?

Posted on April 2, 2015 by jackheidel

This website, It Does Not Add Up, is devoted to discussing our country’s most serious economic and fiscal problems. They are:

Stagnant Economy. Since the end of the Great Recession in June 2009, the economy has been growing on average at the historically slow rate of about 2.3%. Slow growth means higher unemployment, stagnant wages and less tax revenue.

Massive Debt. U.S. public (on which we pay interest) debt is now 74% of GDP (highest since WW II) and projected by CBO to grow rapidly unless strong measures are taken to reduce it. This puts our country’s future wellbeing and prosperity at great risk.

Increasing Income Inequality. Incomes for the high-skilled and well-educated are increasing much faster than for the low-skilled and less-educated workers.

The new Republican majorities in Congress are stirring the waters by proposing a ten year plan to shrink the deficit down to zero, i.e. to balance the budget by 2025. The opposition claims that this would “sharply cut the scale of domestic spending, which would mostly fall on the poor.”
But the American Enterprise Institute’s James Pethokoukis points out that social spending in the U.S., both public and private, is very generous and second only to France in the entire OECD. So here is how we could proceed to address our basic problems in a unified manner:

Balance the Budget by a combination of Republican spending cuts and cutting back on two major tax deductions: Employer-sponsored Health Insurance (cost: $250 billion per year) and Mortgage Interest (cost: $70 billion per year).
Boost Economic Growth by expanding the Earned Income Tax Credit to encourage more people to accept low paying, entry level jobs. Increase the Social Security eligibility age from 67 to 70, thereby keeping near retirees in the workforce for three additional years (this will also extend the solvency of the Social Security Trust Fund).
Decrease Income Inequality. Cutting back on tax deductions, in part to pay for expansion of the EITC, lessens income inequality as well as shrinking the deficit. A faster growing economy also lessens inequality by providing more opportunities for upward mobility.

In other words, addressing each of these fundamental problems in an intelligent manner contributes to solving the remaining problems as well. This creates a virtuous circle for economic progress!

How the Obama and Republican Budgets Compare

Posted on March 22, 2015 by jackheidel

The Budget Committees for both the House of Representatives and the Senate have now passed plans to achieve balanced budgets within a ten year period. My last two posts have discussed the compelling need to get deficit spending under control and an overall rationale for how to approach this difficult task. Today I will take a look at the major differences between the Obama budget and the House and Senate budgets. The two congressional budgets are quite similar and will surely be reconciled into a single budget.
Here are the major differences:

Revenue. The President wants to raise taxes by $3 trillion over 10 years to pay for more spending while the Republicans wants revenue-neutral tax reform in order to increase economic growth.

Spending. Under current policy the government will spend $48.6 trillion over the next ten years which represents a 5.1% annual rate of spending increase over the present. The President wants to spend an additional $1 trillion over this time period on new initiatives. The Republicans propose spending about $5.4 trillion less, or $43.2 trillion, which still works out to a 3.3% annual rate of increase over the present.

Deficits. Under current policy the deficit would start to increase, as a percentage of GDP, in 2018. The President proposes to stabilize the deficit at 2.5% of GDP. The Republicans would balance the budget within ten years by shrinking the deficit down to zero.

Public Debt. Under current policy the public debt (on which interest is paid) will increase to 79% of GDP by 2025. The President’s budget would stabilize the debt at the current level of 73% of GDP. The Republican’s balanced budget would shrink the debt to 57% of GDP by 2025.

There are stark differences between the President’s proposed budget and the Republican alternative. Which is the better route to progress and prosperity? Is it to raise taxes, increase government spending and only stabilize the debt or is it to streamline taxes, slow down the growth of spending and shrink the debt? This is a fundamental question of government policy which will not be quickly resolved. But at least the question is being raised in a dramatic way!

We Need Fundamental Tax Reform!

Posted on March 5, 2015 by jackheidel

Most Americans would agree that our tax code is a mess and needs major reform. The last reform was in 1986 when the top rate was reduced from 50% to 28% and many deductions were eliminated. However this reform effort turned out to be short lived in the sense that many of these deductions have now been added back in. The Romney plan of 2012, cutting all tax rates by 20% in a revenue neutral way, would have been an improvement over our current system. But, it’s gains would likely also have been only short-lived.
Consumption taxes are now being used in many parts of the world and, in recent years, the idea of a national sales tax has gained popularity in the U.S. The so-called Fair Tax would impose a single 30% tax on all sales at the retail level. The proponents claim that this would raise enough income to replace all federal taxes: the individual income tax, the corporate income tax, the payroll tax and the estate tax.
The tax attorney, Michael Graetz, has evidence that a 34% tax rate would be necessary to replace just the individual and corporate income taxes alone. This is a large discrepancy. Regardless, a major argument against the Fair Tax is that such a high single tax of 30% or higher would create a compliance problem because of the incentive for people to try to avoid paying it.
Mr. Graetz has proposed a hybrid consumption and income tax, which he calls the Competitive Tax Plan, as a more reasonable but still fundamental change to our current tax system. Although I have discussed this proposal previously, I will summarize it again here:

A broad-based Value Added Tax of about 14% is enacted on goods and services.
Families earning less than $100,000 per year are exempted from the income tax. The tax rate would be 15% for incomes between $100,000 and $250,000, and 25% above this level.
The corporate income tax rate is lowered to 15%.
The Earned Income Tax Credit is retained and used to provide relief from the Payroll Tax for low-income families.
The plan is designed to be revenue neutral as verified by the Tax Policy Center.

There are many advantages of the Graetz Plan over our current system. 100 million returns, for all those with incomes under $100,000, would be eliminated. This would, in turn, make it less politically expedient for Congress to constantly add new exemptions and preferences into the code. Lower income tax rates for both individuals and corporations would give the economy a big boost.
The Competitive Tax Plan is an example of the type of bold, fundamental reform that we need to make to our federal tax system.

Is the Democratic Party Giving Up On Growth?

Posted on February 12, 2015 by jackheidel

Prospects for future economic growth are decidedly grim. The Congressional Budget Office has just reported that after a brief improvement for a couple of years, annual GDP growth will likely hover around 2.2% for the remainder of the ten year window 2015 – 2025. This means, in turn, that the unemployment rate will also not likely fall much below its current level of 5.7% for the same ten year period.
A new report from the McKinsey Global Institute makes the even gloomier prediction that average U.S. GDP growth rate for the next 50 years will be only 1.9% per year, given current trends and policies. A summary of this report is provided by the Brookings Institution social economist, William Galston.
On the other hand, according to New York Times columnist, Nate Cohn, the Democratic Party may be adopting a new policy direction, “The Parent Agenda, The Democrats’ New Focus.” By this new focus he means:

Paid family leave
Universal preschool
An expanded earned-income tax credit and child tax credit
Free community college
Free four year college in time

Mr. Cohn points out that both President Obama as well as Hillary Clinton have endorsed such ideas. Initiatives such as these are unlikely to go far in the current Republican Congress but they may still sound very attractive to the many hard-pressed middle class families with stagnant incomes.
The problem is that to emphasize a “family” political agenda like this is in effect to accept the conventional wisdom that faster economic growth is unattainable. This is a defeatist attitude which is very harmful to the 20 million Americans who are either unemployed or under-employed. Here, briefly, is what could be done to boost economic growth in the short term:

Implement broad-based tax reform with lower tax rates for all, paid for by closing loopholes and limiting deductions.
Reduce regulatory burdens on business by, for example, streamlining (not repealing!) the Affordable Care Act and the Dodd-Frank Financial Reform Act.
Expand legal immigration with additional high-skill visas as well as an adequate guest worker program.
Expand international trade with new trade agreements.

These are all political footballs, of course, but also policies with much potential to speed up economic growth. Either we take initiatives such as these or we consign our country to a future of relative economic stagnation with slow wage growth, high unemployment and increasing income inequality.

The President’s Budget: Stabilization of the Debt Is Not Enough!

Posted on February 5, 2015 by jackheidel

President Obama has proposed a $3.99 trillion budget for next year, a $340 billion increase from the current 2015 budget year. As shown in the charts below, it projects deficits of about 2.6% over the next ten years equal to its (optimistic in comparison to the CBO) growth projections for GDP. This means that the debt would stabilize at about 73% of GDP. And, of course, achieving his predicted stabilization of debt will require big tax increases over this ten year period.
Here are the major weaknesses in the budget:

Sequestration. The President declares that “I’m not going to accept a budget that locks in sequestration going forward.” Everyone deplores the mindlessness of sequestration but the only responsible alternative is to make targeted cuts throughout the budget. The President makes no attempt to do this. And he wants to add spending for various new education and research initiatives, as well as an expanded Earned Income Tax Credit for low-income workers.

Infrastructure. Spending over the next six years would increase by $238 billion to be raised from a 14% repatriation tax on the $2 trillion in foreign earnings held overseas by American multinational corporations. The problem is that any repatriation tax should be tied in with overall corporate and business tax reform, exchanging lower tax rates in return for closing loopholes and deductions, in order to make U.S. business taxes competitive with those of other countries. Fundamental tax reform is the key to getting our economy growing faster.

Entitlements. The President’s budget does not even mention the biggest threat to long-term fiscal sustainability, namely the rapidly increasing spending for Social Security, Medicare and Medicaid. It will be very difficult to make progress on this critical issue without presidential leadership.

Stabilization of the Debt. The President’s budget, with quite optimistic revenue and growth projections, stabilizes the debt over ten years. But this is not nearly good enough. To be satisfied with a public debt of 73% of GDP indefinitely into the future is simply too risky. What’s going to happen when we have another financial crisis, as we surely will? How are we going to cope with our growing rivalry with China with very little budget flexibility? And one can imagine any number of other possible emergencies which might occur. Putting the debt on a clear downward trajectory is the only prudent thing to do!

It’s Paul Krugman Who Is Being Irresponsible!

Posted on February 3, 2015 by jackheidel

The New York Times columnist, Paul Krugman, writes provocatively on fiscal and economic issues and is well-known as a liberal icon. Usually I ignore his diatribes. But his column yesterday, “The Long-Run Cop-Out” goes way overboard.
I will refute several of the statements from this column.

“Think about it: Faced with mass unemployment and the enormous waste it entails, for years the beltway elite devoted all most all its energy not to promoting recovery, but to Bowles-Simpsonism – to devising “grand bargains” that would address the supposedly urgent problem of how we’ll pay for Social Security and Medicare a couple of decades from now.” Worrying about our enormous and rapidly increasing national debt, does not mean ignoring our sluggish economy and the high unemployment it causes. The way to increase economic growth is to enact broad based tax reform by lowering tax rates, offset by closing loopholes and limiting deductions. This will further boost the economy in the same way that lower gasoline prices is already doing.

“Many projections suggest that our major social insurance programs will face financial difficulties in the future (although the dramatic slowing of increases in health costs makes even that proposition uncertain).” Healthcare costs dropped to 4.1% in 2014 but this is still more than double the inflation rate of 1.7%. This isn’t nearly good enough.

“Why, exactly, is it crucial that we deal with the threat of future benefit cuts by locking in plans to cut future benefits?” The point is to protect benefits, not curtail them. If we act now, to increase revenue and/or slow down the growth of entitlement spending, then we won’t have to cut future benefits.

“So why the urge to change the subject (from austerity) to structural reform? The answer, I’d suggest, is intellectual laziness and lack of moral courage.” $6 trillion added to our debt in the last six years is profligacy, not austerity. It is immoral to burden future generations with such massive new debt.

“In today’s economic and political environment, long-termism is a cop-out.” Preparing for the future is just plain common sense. Should we ignore festering problems like global warming, illegal immigration and increasing poverty until they get much worse? Of course not. We should address these problems now and get our debt under control at the same time.

It Does Not Add Up

Jack Heidel's blog on fiscal responsibility

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