The New Tax Bill Is Likely to Take Us over a Fiscal Cliff


The Republican tax bill has now come out of conference and will soon be voted on by both the House and the Senate. It is expected to easily pass both chambers and be signed by the President. As I have discussed extensively on this blog, I have no argument with the individual features of this bill.  They will definitely increase economic growth which is highly desirable.
The problem is that the tax bill will also add $1 trillion to the debt over ten years (as scored by the JCT).  It is simply outrageous for the GOP to consciously add $1 trillion to our already $15 trillion debt (the public part on which we pay interest), which at 77% and climbing, is the highest it has been since right after WWII.

But the damage will be even worse than this.  The trillion dollar artificial stimulus is likely to overheat an already briskly growing economy.  As the Economist reports in its latest issue:

  • Second quarter growth of 3.1% and third quarter growth of 3.3% are very strong.
  • Median household income grew 5.2% in 2015 and 3.2% in 2016.
  • The average net worth of households in the middle income quintile grew by 34% between 2013 and 2015.
  • The wages and salaries of production workers grew at a 3.8% pace in the third quarter of 2017.
  • The unemployment rate at the end of 2018 is likely to be between 3.4% and 3.8%.

Economic growth is good because it raises living standards across the board. But faster growth also means higher inflation which means higher interest rates as the Federal Reserve responds.  Higher interest rates mean higher interest payments on our massive debt. Every time the Federal Reserve raises interest rates by ¼ %, the interest payments on our debt will increase by about $38 billion per year.  A 2% increase in interest rates, likely within two years, means a $300 billion increase in annual interest (on top of the $266 billion paid in FY 2017).  Our massive debt will soon become a huge burden for the federal budget.

Conclusion. Adding $1 trillion to the debt on top of the existing debt is a terrible idea. Such artificial stimulus at a time when GDP growth is already picking up will drive up interest rates all the faster and greatly speed up the day of reckoning for extreme fiscal irresponsibility.

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Keeping Global Warming in Perspective


The evidence for man-made global warming is now overwhelming. For example:

  • The extent of artic summer sea ice is steadily shrinking.
  • The world’s oceans are getting warmer.
  • Spring in the U.S. is coming sooner each year on average.

The three biggest carbon emitters in the world are China, the U.S. and India in that order. But what is also true, and not sufficiently well appreciated, is that carbon emissions in the U.S. are dropping while they are still increasing in China and India:

  • In the 2015 Paris climate agreement, China pledged that it would start reducing carbon emissions by 2030 but, in the meantime, is still continuing to open coal burning power plants.
  • In the U.S. carbon emissions have been steadily decreasing since 2000 (see chart).
  • In India the economy is growing at 7% per year and 240 million people still lack electric power. This means that carbon emissions from coal burning are likely to double in the years ahead.

Coal use in the U.S. will continue to drop with or without enforcement of the Obama era Clean Power Plan because natural gas is now so plentiful and so much less expensive than coal. The best way for the U.S. to continue showing leadership in combatting global warming is for it to adopt a revenue-neutral carbon tax.  This would let the market sort out which type of energy is the cleanest and most efficient in meeting our country’s growing energy needs.  In fact a carbon tax might even be beneficial for the coal industry by creating a strong incentive to develop carbon capture and storage technology.
Conclusion. Most Americans now agree that global warming is real and that this presents a huge threat to human civilization.  It is likely that a revenue-neutral carbon tax will be adopted by our country in the near future.

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Can She Fix It?


As I have recently pointed out, Hillary Clinton is now likely to be our next president.  In my last post I provided vivid evidence that middle class income grew dramatically between 1971 and 2001 and has been either stagnant or declining since then.  The fact is that the years from 1971 – 2001 were a time of rapid economic growth, about 3.5% per year.
Capture2So it is obvious what needs to be done to fix America’s economic woes: grow the economy faster!  In its latest issue, the Economist asks, “Can she fix it?” The tentative answer suggested by the Economist is no, based on Mrs. Clinton’s tepid policy proposals to date:

  • She wants to make college more affordable, grant paid leave to parents, raise the national minimum wage to $12 per hour, and increase infrastructure spending. These are nice sounding proposals but will have only minor effects on growth or add greatly to the national debt (infrastructure spending).
  • She proposes a tax-credit for companies to encourage profit-sharing schemes. This would just make the tax code more complicated.
  • She wants an extra tax on the debt of big banks but simply increasing capital requirements on big banks would be more effective.
  • She wants to raise the top tax individual tax rate to 45% but shrinking deductions and closing loopholes would be a more efficient way to make the tax code more progressive.
  • She wants to abandon the Trans Pacific Trade Partnership rather than figuring out how to help those workers who lose from expanded trade with such measures as wage insurance or better job retraining.

As the Economist concludes, “A bigger plan to help American workers would start by boosting competition, both by slashing unnecessary regulations for small businesses, and by ensuring that big firms no longer operate in protected markets.”
If we are going to end up with another Clinton presidency, we certainly don’t want four more years of Obama-type economic stagnation!

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The Best Way to Stop Donald Trump


The main sources of background information for my posts are The New York Times and the Wall Street Journal. I read the Economist but most of the time it is either too esoteric or else too far  removed from the specifics of U.S. fiscal and economic policy which I am interested in.  But this week they have hit the nail on the head regarding Donald Trump and his fellow right-wing populists around the world.
Says the Economist:

  • Populists differ but the bedrock for them all is economic and cultural insecurity. Stagnant wages hurt a cohort of older working-class white men whose jobs are threatened by globalization and technology. Jihadist terrorism pours petrol on this resentment and extends populism’s appeal.
  • Nobody should underestimate how hard it is to take the populists on. It is a huge mistake to dismiss their arguments by calling them fascist or extremist. Such disdain risks suggesting that political leaders are uninterested in the real grievances the populists play on.
  • The best way to overcome resentment is economic growth – not putting up walls. The best way to defeat Islamist terrorism is to enlist the help of Muslims – not to treat them as hostile.
  • Voters are often more reasonable than the populist leaders who are trying to appeal to them. Most of them would sooner hear something more optimistic than rage against a dangerous world.
  • Politicians also need to deal with the populists’ complaint that government often fails them. Reluctance to deploy more troops against the ISIS caliphate in Syria and Iraq does not appear to be a serious strategy to defeat it.

Conclusion: There is a clear path forward for candidates with a positive message of openness and tolerance and realistic plans to make the economy grow faster. Who is best situated to deliver such a message?  Stay tuned!

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Why Inequality Is Harmful and What to Do About It


I describe this blog as addressing our fiscal and economic problems, meaning deficits and debt on the one hand and slow economic growth on the other.  But these topics, while being of critical importance to our national welfare, are also somewhat on the dry side.  The subject of economic inequality stirs up lots more interest and response. In the Fall of 2012 The Economist declared that “a new form of radical centrist politics is needed to tackle inequality without hurting economic growth.”
CaptureSays The Economist:

  • There’s too much cronyism in the rich world. Banks which are “too big to fail” have an implicit subsidy. From doctors to lawyers, many high paying professions are full of unnecessarily restrictive practices. Social spending often helps the rich more than the poor. For example housing subsidies for the top 20% (mortgage-interest deductions) are four times the amount spent on public housing for the poorest 20%.
  • If income gaps become too wide, they can lead to less equality of opportunity, especially in education. The gap in test scores between rich and poor American children is 30 – 40% wider than it was 25 years ago.
  • If those on the top of the heap resist equalizing changes, it could lead to political pressure which serves nobody’s best interests.

Here are The Economist’s proposals for a True Progressive Agenda to attack inequality:

  • Compete.   A Rooseveltian attack on monopolies and vested interests is needed. School reform is crucial: no Wall Street financier has done as much damage to social mobility as the teacher’s unions have.
  • Target. Government spending need to be focused on the poor and the young. Governments can’t hope to spend less on the elderly but they can reduce the pace of increase.
  • Reform. Eliminate tax deductions which primarily benefit the wealthy such as for mortgage-interest; narrow the gap between tax rates on wages and capital income.

“The right is still not convinced that inequality matters.  The left’s default position is to raise income tax rates for the wealthy and to increase spending still further – unwise when sluggish economies need to attract entrepreneurs and when governments are overburdened with promises of future spending.”
Surely there is a better way!

Will Wage Stagnation Continue Indefinitely?


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.”
CaptureThe 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!

Redistribution, Inequality and Growth


Most people agree that income inequality and wealth inequality are increasing in the U.S. Likewise anyone who’s paying attention is aware of our slow rate of GDP growth, averaging 2.2% per year, since the end of the recession five years ago.  Is there a connection between inequality and slow growth?  Maybe!
CaptureFirst of all, it is important to note that income inequality in the past 30 years has been greatly offset by federal taxes and transfer programs as shown in the October 2011 chart (above) from the Congressional Budget Office.
Capture1Secondly, the Economist discusses this situation in the article “Inequality v growth”.  The economists Jonathan Ostry, Andrew Berg and Charalambos Tasangarides have shown (see above chart) that a large amount of redistribution affects growth more negatively than a smaller amount of redistribution.
Economists generally agree that the recovery has been slowed down by a lack of demand by consumers for more goods.  So the recovery should speed up as less affluent consumers feel secure enough to spend more money.  Two things, to start with, can make this happen.  One is a restoration of the housing market so that homeowners have more equity (which can be borrowed and spent).  Another way to accomplish this is with government redistribution programs, such as food stamps and Medicaid, for low income people.
But there is an even better way to put money in the hands of people who will spend it, and at no cost to the government.  I am talking about broad based tax reform, whereby tax rates are lowered for everyone, offset by closing tax loopholes and shrinking deductions, which primarily benefit the wealthy.  For the two-thirds of taxpayers who do not itemize deductions, and who tend to be the less affluent, such a tax rate cut will put money in their pockets, most of which they will spend.
Such a tax program as this would be a direct shift of resources from the wealthy to everyone else, thereby lessening inequality.  It would stimulate the economy, creating millions of new and higher paying jobs, and thereby increasing tax revenue and lowering the deficit.  Win, win, win, win!

Is Voucher Really a Dirty Word?


The current issue (May 25, 2013) of the Economist has an excellent article “Entitlements in America”, which tackles the broad issues of entitlement spending and health care inflation in America.  There are many aspects of this whole problem but let’s focus here on “Medicare, the hardest part of the budget”, as the Economist says and with which I totally agree.  We cannot get government spending under control, i.e. deficits on a steep downward path, until we figure out how to control the cost of Medicare.
The Economist makes some standard recommendations, such as increasing the eligibility age from 65 to 67 (as for Social Security) and raising premiums on the well-to-do (means testing).  These are good ideas but not large enough in scope to make a significant dent on the problem.  Somehow or other we need to convert Medicare from a defined benefit program (with no cap on expenses) to the same kind of limited defined contribution program which everyone else has through private insurance.  But how can we accomplish this within our political process?  Republican House Budget Chair Paul Ryan has taken an enormous amount of heat for proposing to make this switch with a premium support or “voucher” plan.  It is much too easy for Democrats to accuse him of trying to destroy Medicare when he’s really just trying to save it by making it financially sound.
The Economist proposes converting the Federal Employee Health Benefits program into a voucher system as an experiment to see if it saves money.  Right now FEHB offers unlimited benefits with federal employees paying 35% of the cost.  This makes FEHB open ended with no constraint on overall spending, which is exactly the problem with Medicare.  Each federal employee would have an annual health benefit amount and would have to decide on what kind of health insurance benefit to purchase with the fixed amount, supplementing with personal funds if desired.  If a voucher program for federal employees saves money for the federal government, as it undoubtedly would, then we could confidently convert Medicare to a similarly system.
We have to make big changes in our current Medicare program and here is an excellent suggestion for one possible way to do it!