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Economist Mom

Former U.S. Senator Alan Simpson (R-WY) participates in a panel discussion during the Peterson Foundation 2012 Fiscal Summit in Washington, in this May 2012 file photo. The former statesman has urged young people to stand up for themselves on economic policy issues. (Jonathan Ernst/Reuters)

Youth of America, wake up! Your elders are using you.

By Guest blogger / 06.18.12

I found this very nice video of Simon Johnson explaining to CNN-Money’s Lex Harris why taxes will have to come up for everyone–not just the rich. (Simon’s video was embedded in an also-nice CNN-Money column by Joe Thorndike on the topic of “fairness” and taxing the rich.) Simon explains the basic math that I have emphasized over and over again here: (i) the fiscal gap is just too large to put just on the backs of (even) the rich; and (ii) yes, taxes will have to be part of the solution (no matter what you think about their role in creating the “problem”), because the spending paths are not something we could or would choose to flat-line, even as we try our best to damp them down. (BTW, I’m now reading Simon’s new book on the national debt, White House Burning (with James Kwak), which is excellent–particularly in putting the current problem in historical context and making common-sense recommendations that emphasize that “fiscal sustainability” depends on the paths of both the numerator of the debt and the denominator of the size of the economy.)

And what of the fact that the “Just Raise Taxes” solution is not yet gaining enough traction? Matt Miller explains the consequences in his Washington Post column:

Hear me, Americans under 35!

There’s plenty that divides the parties in this pivotal election — from taxes to drones, from public workers to private equity. But there’s one uber-policy that brings Democrats and Republicans together that doesn’t get the attention it deserves.

That policy involves you, younger Americans. You’re in big trouble. You don’t even know it. You’re busy trying to get a degree, land a job, start a family, save for a home. You don’t follow the news. But trust me — you’ve been taken for a ride by your elders.

The question isn’t whether such talk will stir up generational war. That’s already being waged — and you’re losing. The question is whether you’ll wake up and engage in a little generational self-defense. Let me see if I can motivate you.

How are you being swindled today? Let me count just some of the ways…

There’s no cash for such investments in the future because pension and health-care programs for seniors (plus a bloated Pentagon) take up so much of the budget. At the federal level, seven dollars go to programs supporting elderly consumption for every dollar invested in people under 18. Nationally (after taking account of the fact that most education is paid for at the state and local level), the ratio is still 2 1 / 2 to one.

And that’s just today’s elderly tilt. We have trillions in unfunded liabilities in these programs coming due as more and more boomers retire.

Yet amazingly, both parties would exempt every current senior from participating in the inevitable adjustments in these programs. Paul Ryan and Barack Obama lock arms in agreeing that everyone over 55 must be spared such changes, even though most of these Americans are getting back far more than they paid into the system. And millions are well-off…

The solution for the young people?  Matt (with the help of Alan Simpson) explains you gotta fight fire with fire (emphasis added):

There are answers to these challenges that are fair to young and old alike. But we won’t hear them until younger people wake up to what’s happening.

In 1995, when I was a (younger) generational equity worrywart, I asked then-Sen. Alan Simpson how to fix what was clearly coming. Simpson told me nothing would change until someone like me could walk into his office and say, “I’m from the American Association of Young People. We have 30 million members, and we’re watching you, Simpson. You [mess with] us and we’ll take you out.”

Simpson was right then. He’s still right now.

All this talk about what’s “fair” to burden the rich with, and so little mention of our kids.  That’s what’s really outrageous about the partisan bickering about deficit reduction, spending cuts, and tax increases:  the politicians like to claim they are all about doing what’s right for our kids and grandkids–but when you pay close attention, you see their specific actions don’t match up with their vague words.  I think the kids have to get more involved.  The so-called “grownups” aren’t getting it done.

Clarise McCants of Philadelphia, a Howard University political science major, speaks during a news conference on Capitol Hill in Washington,in this May 2012 file photo, in the run-up to a showdown on a failed Democratic proposal that would have kept federally subsidized loan interest rates from doubling. (J. Scott Applewhite/AP)

Q: How is college like owner-occupied housing?

By Guest blogger / 06.13.12

…A:  When loans to purchase it are subsidized, the price of it goes up!

I’m fascinated by this story that appeared in the Wall Street Journal this week (by Josh Mitchell), with the subtitle “As Student Debt Grows, Possible Link Seen Between Federal Aid and Rising Tuition.”  The article explains the link this way:

Rising student debt levels and fresh academic research have brought greater scrutiny to the question of whether the federal government’s expanding student-aid programs are driving up college tuition.

Studies of the relationship between increasing aid and climbing prices at nonprofit four-year colleges found mixed results, ranging from no link to a strong causal connection. But fresh academic research supports the idea that student aid in the form of grants leads to higher prices at for-profit schools, a small segment of postsecondary education.

The new evidence?  Continuing into the WSJ story, my emphasis added:

The new study found that tuition at for-profit schools where students receive federal aid was 75% higher than at comparable for-profit schools whose students don’t receive any aid. Aid-eligible institutions need to be accredited by the Education Department, licensed by the state and meet other standards such as a maximum rate of default by students on federal loans.

The tuition difference was roughly equal to the average $3,390 a year in federal grants that students in the first group received, according to the National Bureau of Economic Research working paper by Claudia Goldin of Harvard University and Stephanie Riegg Cellini of George Washington University

The authors said their findings lent “credence to the…hypothesis that aid-eligible institutions raise tuition to maximize aid.

I see two main problems with that bottom-line conclusion/suggestion–with the strong caveat that I have not read the actual NBER working paper but only this WSJ story on it (and would love to hear your comments, especially if any of you have read the academic paper).

First, it’s tough to do the “all else constant” experiment here, given that “aid-eligible institutions need to be accredited.” That means being aid-eligible is strongly correlated with whatever qualities make the schools qualify for accreditation.  The Education Department’s website explains how accreditation is done:

The goal of accreditation is to ensure that education provided by institutions of higher education meets acceptable levels of quality. Accrediting agencies, which are private educational associations of regional or national scope, develop evaluation criteria and conduct peer evaluations to assess whether or not those criteria are met. Institutions and/or programs that request an agency’s evaluation and that meet an agency’s criteria are then “accredited” by that agency.

In other words, how “comparable” can two for-profit schools really be with each other, if one (the one providing aid) qualifies as accredited and the other (the one without aid) not?  The way prices work in most markets (for all kinds of goods and services), is that higher quality goods and services command higher demand and hence higher prices.  Take houses, for example.  You could compare two houses that are alike in many measurable attributes–square footage, lot size, school district, age, number of bedrooms and bathrooms, etc–and yet there would be many unmeasured attributes (and some unmeasurable qualities) that might explain why one house sells for a much higher price than the other.  In the case of college tuition, whatever variables the researchers controlled for in terms of “comparability,” we know they couldn’t control for the underlying factors that determined accreditation of the schools–because any of those factors were indistinguishable (inseparable) from the characteristic of whether the school was aid-eligible or not.  I suspect that if we were shown any pair of “comparable” schools in this experiment, we would conclude the aid-eligible school was of obviously higher quality than the aid-ineligible school (it was obvious to the accrediting agency, after all), and that that difference in quality was a reasonable enough reason why the higher quality school charged higher tuition.  So theoretically, the aid doesn’t have to have anything to do with what causes the higher price, and it might be that the only reason why higher prices seem correlated with greater aid is because higher quality is correlated with higher prices.

Second, even if the subsidized loans do have at least something to do with higher tuition and fees, this is just due to the forces of supply and demand–not the ulterior motives of rent-seeking colleges. The WSJ article about the NBER paper suggests that the empirical research provides evidence that colleges take advantage of their aid eligibility to set higher tuition prices, and/or manipulate their tuition charges to increase their aid eligibility.  But I suspect the hard-to-measure true story doesn’t contain quite so much willful drama on the part of the actor playing the college.  Instead, the causation probably runs this way:  subsidized loans lower the out-of-pocket costs of college to students, the lower price increases demand (shifts out the demand curve), and higher demand means a higher market price.  (Microeconomics students learn that the government subsidy acts like a “wedge” between the price received by the seller (the college)–now higher–and the price paid by the consumer (the student)–now lower.)  The higher price received by colleges after the subsidized aid is  not because the suppliers just on their own decide to claim most or all of the benefits of the subsidy by simply setting the price of tuition to reflect a full (or otherwise whimsically-decided) mark-up.

So more subsidized loans means greater demand for the college educations those loans buy, and along with all the other reasons why demand for college is increasing (like, no one can get a job now anyway, but especially not those without college degrees), this raises the market price of college, and, yes, the profits of those for-profit institutions of higher education fortunate enough to be deemed good enough for (simultaneously) accreditation and government-subsidized aid.

So this reminds me of how the government subsidizes home mortgages, via the mortgage interest deduction.  (Actually, technically, it’s from the combination of the non-taxation of the imputed rental services from owner-occupied housing and the mortgage interest deduction.)  Economists universally understand that the mortgage interest deduction raises the price of owner-occupied housing, because the value of the mortgage interest subsidy gets capitalized into the price of houses everywhere–even the prices of houses that are not literally purchased by people who take out mortgages and live in them as owner occupiers.  The point is that many players in the market for housing will qualify for the subsidy, and market prices will reflect how much of the market is made up of those people.  On the issue of the mortgage interest deduction, economists often worry about what the economic effects of that subsidy are, and whether policymakers really intended for those effects.  We can say that homeownership is a good thing, and we can hope that this subsidy to homeownership actually increases homeownership.  But it is a subsidy not to homeownership per se, but to the costs of borrowing to purchase a home–and the larger and/or more expensive the house (and the bigger the loan), the bigger the value of the subsidy.  (And on top of that, the higher ones income, the bigger the subsidy–because the subsidy is run through a tax deduction that makes the subsidy an “upside down” one, with larger percentage subsidies given to people in higher income tax brackets.)  Economists have found evidence that the mortgage interest deduction definitely raises housing prices, but not as much evidence that the subsidy increases homeownership as much as encourages people to buy more expensive houses with larger mortgages.  (For microeconomics students out there, both the income and the substitution effects work in those directions.)  And then we get to the public policy concern:  is that government subsidy worth its cost?  What is the goal of the policy?  If there are social benefits to homeownership, are there even bigger social benefits when people buy bigger houses (even if by going into bigger personal debt)?

Now come back to the student loan story.  College is like owner-occupied housing in that if you subsidize the costs of borrowing for college, you will raise the market price of a college education–just like the mortgage interest deduction raises the market price of a house.  Further, you might hope that what you’re doing with the subsidy is making it possible for kids to go to college who otherwise wouldn’t be able to afford it.  That might be partly the case, just like there are surely some households at the cusp of the owning-vs-renting decision for which the mortgage interest deduction is the marginal factor that makes owning the winner.  But just like the mortgage interest deduction goes to a lot of people who would own homes anyway and might just opt for the more expensive home made possible by a bigger mortgage, subsidized student loans go to a lot of students who would have gone to college anyway but may now opt to go to more expensive colleges made possible by larger (but subsidized) student loans.  And some of us might wonder if that policy effect is worth the cost, because government-subsidized educational aid costs real money (it increases government spending and increases our public debt), just like government-subsidized mortgages do.  Do all of us really want to be partially paying for kids (not even our own) to go to expensive colleges?

By the way, I speak about this effect of subsidized aid on the demand for expensive colleges, not just conceptually, but from personal experience.  I have two daughters in college, one at Princeton and the other at Sarah Lawrence.  If you google their costs, you will see they certainly both qualify as “expensive.”  But a combination of need-based grant aid and subsidized loans have way narrowed the difference between the net cost to send my daughters to those schools and what the costs of sending them to the in-state (Virginia) public universities would be.  They would not be attending those schools were it not for the availability of such aid, but without that aid, they would have still gone to college–just to a cheaper (in-state) one.

Based on just my personal experience (thus far), I think that more expensive colleges tend to be worth their higher costs.  Certainly they must be worth their higher costs if they continue to attract students, and I know many students go to these expensive colleges without any subsidized aid–because they can afford it and decide it is worth spending their own money that way over other ways.  More expensive homes are worth their prices, too, given that (or to the extent that) there are people who demand such expensive homes.  The public policy question about whether we want to be subsidizing expensive homes, however, seems a more damning criticism than asking the same question about subsidized college aid, because there’s probably more value added–to society, broadly–in encouraging higher-quality educations that happen to come with higher prices, than in encouraging higher-priced homes that are made possible with larger mortgages.  If the bigger, more important, public policy goal regarding higher education is to make it possible for more students to attend any college, however, then the government’s subsidized student loan policy might score poorly compared with an alternative policy of increasing need-based grants–in the same way that the mortgage interest deduction scores poorly compared with alternative policies that subsidize affordable housing if the goal is to increase homeownership.

Senate Budget Committee Chairman Kent Conrad, D-N.D., speaks on Capitol Hill in Washington before hearing testimony from Congressional Budget Office (CBO) Director Douglas Elmendorf in this January 2011 file photo. The CBO released its latest estimates of the long-term budget outlook Tuesday. (Charles Dharapak/AP/File)

CBO budget outlook: a long-term view of the 'fiscal cliff'

By Guest blogger / 06.06.12

The Congressional Budget Office released its latest estimates of the long-term federal budget outlook yesterday. If you are familiar with the report, this year’s offers nothing that new, but it’s a good way to take a step back from current policy debates (dominated by the politics) and put impending decisions in the context of the bigger picture (important for the economics).  The biggest difference between the unsustainable deficits resulting from the business-as-usual “extended alternative fiscal scenario,” and the sustainable deficits that would occur under the “extended baseline scenario” (current law), continues to be–as it has ever since 2001 when the Bush tax cuts were first passed–what we do about expiring tax cuts.  From Table 1-2 in the report (page 12), under the “baseline”/current-law scenario where expiring tax cuts either actually expire or are extended but paid for with offsetting revenue increases, revenues grow from 15.8 percent of GDP in 2012 to 23.7 percent of GDP in 2037.  If instead the expiring tax cuts are extended and deficit financed (as has been standard practice since 2001), revenues only reach 18.5 percent of GDP in 2037–which happens to be right around the 40-year historical average policymakers who don’t want to raise taxes like to label the “right” level of revenues for the future. 

Comparing primary deficits (the difference between revenues and non-interest spending), the CBO table and graphic show that the 2037 deficit is 7.7 percent of GDP under business as usual, but is a primary surplus of 1.1 percent of GDP under current law.  This implies that nearly 60 percent of the difference between the unsustainable deficits under business as usual and the sustainable ones under current law (or paygo-compliant extended policies) is explained by the financing of expiring tax cuts.  Only about 40 percent of the difference is explained by the difference in spending paths under the CBO’s two scenarios.  And if you look in further detail at the spending breakdown, you might notice that despite the major contribution of Medicare, Medicaid, and Social Security spending to  federal spending growth over the next several decades, the difference between the CBO’s two scenarios on these spending levels in 2037 is just 0.8 percent of GDP–in contrast to the 5.2 percent of GDP difference in revenue levels.

This just reminds me that the current debate over what to do about the “fiscal cliff” is not irrelevant, even if somewhat misguided.  The “fiscal cliff” is also largely about the expiring tax cuts, representing one possible way of making them comply with current law: let current law play out, literally, and let all the tax cuts expire at the end of this year–the Bush tax cuts, the payroll tax cut, AMT relief, everything!–along with letting the spending cuts of the “sequester,” and other cuts like those to Medicare physician payments, kick in as well.  The emphasis on this particular version of sticking to the current-law baseline is misguided because it makes it seem as if the choice is between the “cliff” in full form (which seems dangerous and not very smart given the state of the economy) and no cliff or fiscal restraint at all.  If that is the debate, it is easy to predict that “not at all” will win in the end (at the end of the year).  The CBO report in the context of the fiscal cliff debate is very relevant, however, in reminding us that current law offers us a path to longer-term fiscal sustainability–at least over the next couple decades–which we ought to be considering more seriously beyond the “take the cliff now–or not” question.  I’ve repeatedly harped on the point that sticking to the current-law baseline levels of revenues and spending (and even keeping the two sides of the ledger separate) doesn’t have to mean literally sticking to current law and that very particular composition and timing of the expiring tax cuts.  We could achieve sustainable deficits by sticking to strict pay-as-you-go rules on expiring tax cuts.  We do not have to let all the expiring tax cuts actually expire; we just have to be willing to pay for them over the next ten years.  Spreading out the timing of the revenue increase (and the spending cuts) could turn the fiscal “cliff” in current law into that more manageable “climb” towards fiscal sustainability I’ve talked about before–an admittedly tough climb, but one we cannot keep avoiding forever.

***UPDATE, 3:15 pm:  Here’s a link to the Concord Coalition’s press release on the CBO report.

In this April 2011 file photo Americans for Tax Reform President Grover Norquist speaks on Capitol Hill in Washington. Some newly elected Republicans are refusing to sign Norquist's tax pledge, formerly a rite of passage for the GOP. (Lauren Victoria Burke/AP/File)

A rift over the GOP's tax pledge?

By Guest blogger / 05.29.12

Rosalind Helderman of the Washington Post reports in Saturday’s paper that a “Faint rift opens in GOP over tax pledge”–referring to the pledge that Americans for Tax Reform’s Grover Norquist has compelled virtually all Republican policymakers to sign.  Helderman explains how the ground seems to be shifting:

In GOP activist circles it is known simply as “the pledge,” and over the past generation it has become the essential conservative credential for Republicans seeking elective office. Of the 242 Republicans in the House today, all but six have signed the pledge.

But now, an increasing number of GOP candidates for Congress are declining to sign the promise to oppose any tax increase, a small sign that could signal a big shift in Republican politics on taxes.

Of the 25 candidates this year promoted by the National Republican Congressional Committee as “Young Guns” and “Contenders” — the top rungs of a program that highlights promising candidates who are challenging Democrats or running in open seats — at least a third have indicated they do not plan to sign the pledge authored by anti-tax crusader Grover Norquist.

Why the change in heart?  For one reason, because the lopsided, no new revenues (not just no new higher tax rates) stance just doesn’t make policy sense to many of these Republicans, who can’t see how spending-side-only approaches are easier than approaches involving a mix of spending cuts and revenue increases:

Republican candidates declining to sign generally indicate that they nevertheless oppose tax hikes. But some chafe against the constraint on eliminating tax loopholes, believing those restrictions limit Republicans’ ability to negotiate seriously with Democrats on a deal to tackle the nation’s mounting debt.

In Pennsylvania, Republican state Rep. Scott Perry said he was disappointed to see his party’s presidential candidates — all but one of whom signed the pledge — uniformly indicate in a debate last year that they would reject a deficit reduction deal that paired $1 in revenue increases for every $10 in spending cuts.

“I just think it’s imprudent to hem yourself in where you can’t make a good agreement that overall supports the things you want to do,” said Perry, who said he generally opposes tax increases but recently won a Republican primary in a conservative district over candidates who had signed the pledge. “I just don’t see what the point of signing would be for me. .?.?. I’ve got a record, and everyone who wants to know where I’ve been and where I’m at can look to that.”…

“I don’t want to get tied up in knots,” said Richard Tisei, an NRCC Young Gun and former Republican state senator in Massachusetts who is running against Democratic Rep. John F. Tierney. “If there’s a loophole that can be closed that ends up generating additional revenue that can be used specifically to pay down the national debt, I’m not going to lose sleep. And I don’t want to be bound by the pledge not to close it.”

The refusals among some new candidates come as a handful of incumbent Republicans who signed the pledge when they first ran for office also are publicly rejecting it.

Freshman Rep. Scott Rigell (R-Va.), who signed the pledge in 2010, recently posted an open letter to constituents indicating that he would not renew the promise as he runs for reelection. He said he fears it could stand in the way of an everything-on-the-table approach to tackling the mounting debt.

“Averting bankruptcy requires us to grasp the severity of our fiscal condition and summon the courage to speak boldly about the difficult steps needed to increase revenues and sharply decrease spending,” he wrote.

For another reason, it seems that voters don’t find a candidate’s blind allegiance to one man’s idea of the best fiscal policy very attractive:

[A]fter months of Democratic attacks on ATR and Norquist as obstacles to a debt deal, some Republican candidates report that they are hearing from more voters who want them to reject the pledge than the opposite.

Gary DeLong, a member of the Long Beach City Council who is labeled a “contender” for a House seat by the NRCC, said he is routinely encouraged on doorsteps and at town halls and candidate coffees to avoid the pledge.

Voters “ want me to represent them and not special interests,” said DeLong, who will compete next month in California’s unusual mixed-party primary for one of two spots on the November ballot in a newly drawn district.

What is it that has kept so many Republican policymakers so enthralled with Norquist, despite all the evidence to the contrary that “no new taxes” just makes no sense–and (perhaps the most puzzling part) despite Norquist’s lack of charisma?  Senator Coburn has certainly been working to get his colleagues to snap out of the Norquist trance; the Post article concludes with this:

Sen. Tom Coburn (R-Okla.), a fiscal conservative who has tangled with Norquist, said he believes candidates are starting to understand that the ATR pledge’s power has been exaggerated by Norquist and the media and that Norquist is wrong when he asserts that it is nearly impossible to win a Republican primary without signing the pledge.

“That’s him patting himself on the back,” Coburn said. “And I think it’s bull crap.”

[UPDATE 3 pm Sunday:] And this just out from another Republican who’s even more fed up than Coburn about Norquist… Former Senator and co-chair of President Obama’s fiscal commission, Alan Simpson, had this to say today on CNN’s Fareed Zakaria GPS (as reported on Talking Points Memo):

“For heaven’s sake, you have Grover Norquist wandering the earth in his white robes saying that if you raise taxes one penny, he’ll defeat you,” [Simpson] added. “He can’t murder you. He can’t burn your house. The only thing he can do to you, as an elected official, is defeat you for reelection. And if that means more to you than your country when we need patriots to come out in a situation when we’re in extremity, you shouldn’t even be in Congress.”

This November 2011 file photo shows the U.S. Capitol building in Washington. Rogers argues that steep budget cuts to reduce the deficit are unavoidable, but steps can be taken to make the cuts gentler on a recovering economy. (Pablo Martinez Monsivais/AP/File)

Turning the 'fiscal cliff' into a gentle slope

By Guest blogger / 05.24.12

The Congressional Budget Office has just released an excellent analysis prepared by CBO economist Ben Page on the “Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013″ (in typically dry CBO-speak).  I prefer to think of it as an economics version of the story “The Little Engine That Could.”  You see, the “engine” is the U.S. economy, and this so-called “fiscal cliff” is, rather than something we are in danger of falling off of, something we are about to ram straight into–like a huge wall just ahead on the tracks, at January 2013.  When economists and policymakers fret about this fiscal cliff, it’s not the usual worrying about the unsustainable deficits we are projected to run over the next several decades; it’s concern that our economy, still in “recovery,” can’t handle the amount of deficit reduction that is scheduled to be forced upon us in just a matter of months.

The CBO analysis validates this worry, first defining the scale of the cliff as $607 billion worth of deficit reduction in one year (or $560 billion net of economic feedback, cutting the deficit nearly in half between fiscal years 2012 and 2013), then explaining that letting our economy run head onto this cliff will in fact, slow it down and perhaps even cause the “double-dip recession” economists have been fearing.  From the summary (emphasis added):

Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects—with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.

So CBO then looks at the question: what if we could avoid the cliff entirely–by sort of going around it?  Well, going around it would indeed keep us going in 2013:

CBO analyzed what would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013. In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law.

So that sounds, good: if we can’t go through the fiscal cliff, just go around it (or just say “poof” and imagine it away).  OK, I’ll take that ticket… Except, as CBO next explains, then the inevitable (real) “cliffs” ahead just get taller and steeper:

However, eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years would reduce output and income in the longer run relative to what would occur if the scheduled fiscal restraint remained in place. If all current policies were extended for a prolonged period, federal debt held by the public—currently about 70 percent of GDP, its highest mark since 1950—would continue to rise much faster than GDP.

Such a path for federal debt could not be sustained indefinitely, and policy changes would be required at some point. The more that debt increased before policies were changed, the greater would be the negative consequences—for the nation’s future output and income, for the burden imposed by interest payments on the federal debt, for policymakers’ ability to use tax and spending policies to respond to unexpected challenges, and for the likelihood of a sudden fiscal crisis. And the longer the necessary adjustments in policies were delayed, the more uncertain individuals and businesses would be about future government policies, and the more drastic the ultimate changes in policy would need to be.

You see, even over the longer term, the “fiscal cliff” is more like one we will have to climb rather than one we’re in danger of falling off of.  And the higher the cliff gets, the harder it will be in the future to ignore it or continue to go around it, or actually get up it.  So going around and avoiding the cliff entirely isn’t a long-term option, nor necessarily the best option even now.  CBO explains the policy options, which I’m labeling as different strategies for driving the train called the U.S. economy toward the 2013 fiscal train stop.  The CBO concludes that there are three basic options (my labels and emphasis added):

What Might Policymakers Do Under These Circumstances?

[1: "Going Around the Cliff, For Now"]  They could address the short-term economic challenge by eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years—but that would have substantial economic costs over the longer run.

[2: "Running Head-On Into the Cliff"]  Alternatively, they could move rapidly to address the longer-run budgetary problem by allowing the full measure of fiscal restraint now embodied in current law to take effect next year—but that would have substantial economic costs in the short run. Or,

[3: "Grading the Cliff Into a Climbable Hill"]  if policymakers wanted to minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist, they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.

In other words, the U.S. economy does face an “uphill battle” in terms of the fiscal outlook; heading to higher ground (meaning lower deficits), eventually, is unavoidable.  But to quote from a particularly wise engine, “I think [we] can” do it.  The 2013 fiscal cliff is at least an opportunity to take a constructive attitude toward climbing that hill, and hopefully our policymakers, after the election, might have the wisdom and courage and work ethic needed to start turning that fiscal cliff into something our economy can more easily and successfully climb.

Barack Obama is greeted by well-wishers Monday evening, May 21, 2012 at the airport in Joplin, Mo. According to a recent poll, the President inspires more than Mitt Romney, but respondents are so sure about his ability to get things done when it comes to the economy. (Rich Sugg/The Kansas City Star/AP/File)

Obama vs. Romney: spirit vs. substance

By Guest blogger / 05.23.12

Very interesting poll results reported in the Washington Post. Note that President Obama continues to reign in the overall inspirational category:  if the question is how excited one gets about supporting the candidate and knowing that the candidate will support and understand you (and your economic problems and concerns), Obama wins hands down.  But if the question is how well the candidate has actually done or is expected to do on objective, measurable economic goals, Obama and Romney look virtually the same.  If the President actually wins reelection, this suggests that he could and probably should go bolder in his second term to put the money where the confidence in him is–to come up with and follow through on the policies that are consistent with all of his inspirational talk.  If Romney wins, or maybe rather, in order for him to win, the poll suggests he has a lot of PR and perhaps substantive policy work to do to convince Americans that his economic policies will be good not just for this abstract concept of “the economy” or other people’s “jobs,” but good for Americans very broadly as well.

House Speaker John Boehner of Ohio speaks at the Peter G. Peterson Foundation's 2012 Fiscal Summit, Tuesday, May 15, 2012 in Washington. Rogers attended the summit and senses lingering confusion over the bodgetary goals of our recovering economy. She argues that creating jobs and reducing the deficit need not be mutually exclusive. (Manuel Balce Ceneta/AP)

Creating jobs while reducing the deficit: hard but possible

By Guest blogger / 05.16.12

This is an old theme  here, but the issue and the confusion persists, as I have just come from attending the Peter G. Peterson Foundation’s fiscal summit today, complete with a protest/press conference  on the front steps of the summit venue, with the protesters arguing against the “austerity” measures they think the summit participants and attendees advocate.

Just coincidentally, here is a blog post I wrote on Concord’s blog today.  In it, I say deficits can sometimes be good, and deficits can sometimes be bad, depending on the condition of the economy (emphasis added):

In a recovering economy still below “full employment” level, the binding constraint is lack of demand for goods and services. Increasing the supply of productive resources won’t increase GDP if there is already excess supply, or idle capacity, in the economy. It will only increase unemployment. In such an economy, fiscal policy can increase GDP by stimulating consumption — either through the government’s direct purchases of goods and services, or through tax cuts or transfer payments that indirectly increase private spending. Deficit spending can be effective at increasing demand and GDP immediately; how effective it is depends on how well targeted the policies are toward households and businesses most likely to spend additional funds on goods and services, and on how much the industries that produce those goods and services respond by hiring additional workers.

Sudden fiscal consolidation or deficit reduction, on the other hand, can jeopardize an economic recovery if it substantially reduces the net incomes of households that spend most of their income. (Such “austerity” measures can also spur a political backlash, as we are seeing now in Greece and France.)

In contrast, in a fully-recovered, full-employment economy, the size of the economy is limited by the level of productive capacity, or the aggregate “supply side” of the economy. Increasing demand without increasing supply only creates inflationary pressures. Under these conditions, higher private and/or public saving will most effectively expand the economy.

Deficits harm economic growth by reducing national saving (public plus private saving), which reduces the capital stock, labor productivity and household incomes. So deficit financing of tax cuts or spending designed to encourage the supply of productive resources handicaps the likely payoff. If policies can be structured to preserve the positive incentive effects on the supply of labor and capital while avoiding deficit financing, then those policies are much more likely to increase GDP.

As the economy gets closer to full employment and there is less need to stimulate demand, fiscal policy should transition from deficit-financed policies that encourage consumption, to paid-for policies that increase national saving.

And just because deficit spending in general can be helpful in a recession and recovery and harmful in general in a recovered economy, doesn’t mean all deficit spending is equally good in a recession and recovery, or all deficit spending is equally bad in a full-employment economy.  There are benefits and costs in either situation that should be evaluated as thoughtfully as possible in order to maximize the net benefits of the policy.

So I don’t support “austere” fiscal policy, but I do keep hoping for “smarter” and (net) beneficial fiscal policy.  It is not at all hard to do in economic theory.  The difficulty lies mostly in political practice.  I’ll explain more on that soon when I write more about what happened at today’s fiscal summit.

Barack Obama smiles after signing into law a bill to extend the Bush-era tax cuts at the Eisenhower Executive Office Building in Washington in this 2010 file photo. Though they are set to expire, Rogers argues that the US should keep the Bush tax cuts but figure out a better way to pay for them. (Jim Young/Reuters/File)

How to make the Bush tax cuts work

By Guest blogger / 05.15.12

Here is the last of my “Taxes for a Civilized Society” columns, published in Tax Notes last Monday, reprinted in full with the permission of Tax Analysts:

This is my last column as a regular contributor to Tax Notes, so I thought I would close with a focus on my favorite tax topic, which somehow manages to stay evergreen because policymakers never quite settle the issue: the Bush tax cuts.

Policymakers are headed toward a big fiscal cliff after the election, with the expiration of the Bush tax cuts this time joined by automatic spending cuts known as the sequester. The looming sledgehammerlike spending cuts of about $1 trillion over 10 years have caused a panic. But the expiring tax cuts are worth several times that — more than $2.8 trillion over 10 years, or more than $4.5 trillion including alternative minimum tax relief, even without counting interest costs.1 It’s a good reminder that the most important aspect of the Bush tax cuts (leaving aside the politics) is their cost.

Instead of complaining about the size of the Bush tax cuts and not doing anything constructive about it, policymakers ought to commit to using that size in a positive way. The fact that we have a valuable policy lever available to us is fortunate.

Keep Them, but Pay for Them

Everyone loves the Bush tax cuts because they’re tax cuts. They increase after-tax incomes for most of us, so we personally benefit. The problem has been that financing them has kept the true cost out of the awareness of policymakers and the general public. The benefits of the tax cuts have been private goods, but the costs have been public bads.

Congressional Budget Office projections have shown repeatedly that achieving the current-law baseline level of revenues — the level consistent with letting all the expiring tax cuts actually expire — is one way to get us to an economically sustainable level of deficits over the next decade or two. (Beyond that we will need to cut net spending associated with the retirement programs.) But as I’ve emphasized many times, achieving current-law baseline levels doesn’t have to mean literally sticking to current law and letting the tax cuts expire as scheduled. It could instead mean paying for any of the tax cuts we choose to extend.

The question policymakers and the public must ask ourselves is not whether we like or have enjoyed having the Bush tax cuts, but which part of them we love the most, and whether we love them enough to be willing to pay for them. Do we prefer the Bush tax cuts (any part of them) to the other types of tax cuts (such as expensive tax expenditures) or areas of spending that would need to be given up to offset the cost of the Bush tax cuts?

If the answer is yes, then by all means we should extend those portions of the Bush tax cuts. Being forced to pay for something is a great way to figure out how valuable it really is. Having Bush tax cuts that are compliant with “pay as you go” rules also would preserve the private benefits of the tax cuts we choose to extend, while getting rid of the associated public cost of higher deficits.

Let Go of Them to Pay for Better Policies

If we decide not to extend the tax cuts, it’s probably because there is a more attractive policy alternative.

The several-trillion-dollars cost of the Bush tax cuts is huge, yet the evidence of their economic benefits has been limited. If you go back and read several past issues of the “Economic Report of the President” from the George W. Bush administration, you will notice that its praise of the Bush tax cuts mainly emphasizes how large they were (and still are). But that is an endorsement of the large income effects of the tax cuts — effects that would occur under any cost-equivalent tax cut or spending increase. Holding the cost of the tax cuts constant, we have to ask: Are there alternative tax cuts or spending that would achieve better economic effects in terms of microeconomic incentives, macroeconomic impacts, and the distribution of income?

For example, we may need the Bush tax cuts to continue because our economy can’t handle that large of a withdrawal of fiscal stimulus at once. But there might be alternatives that provide more bang for the buck. We may want to keep the lower marginal tax rates under the Bush tax cuts to encourage the longer-term, supply-side growth of the economy, but are there alternative tax cuts or spending increases that could do better at increasing human capital formation, labor supply, and investments in new and socially valuable technologies? And could even deficit reduction be a surer route to economic growth than the Bush tax cuts have been? The answer to both is yes — which means we should want those alternative policies and deficit reduction more.

Use Their Expiration for the ‘Buffett Rule’

One way in which the Bush tax cuts have clearly been viewed as not economically helpful has been regarding the distribution of income. President Obama has always complained about the unfairness of them — how they have given the lion’s share of their benefits to the rich. Obama repeatedly addresses his complaint by proposing to let expire only the top two brackets of the cuts — the brackets that affect only households with annual incomes exceeding $250,000. But that doesn’t mean the rest of the Bush tax cuts (still worth more than $2 trillion over 10 years) would not benefit households now in the top brackets.

In fact, even if the top two brackets (now at 33 and 35 percent) reverted to their pre-2001 law levels (of 36 and 39.6 percent), households in them would still benefit the most in dollar terms from the extended lower rates in the lower brackets. The rich would still be receiving a disproportionate share of the Bush tax cuts — no longer disproportionate relative to their shares of income, but still disproportionate relative to their shares of the population.

Because the $2.8 trillion in tax cuts disproportionately benefits the rich, letting them all expire would raise the tax burdens of the rich. In an earlier column, I pointed out that although the millionaires’ share of the tax burden of letting all the Bush tax cuts expire is much smaller than it would be if only the upper-bracket Bush tax cuts were allowed to expire, the additional tax revenue collected from millionaires would be higher under full expiration.2

Whether all of the Bush tax cuts or just the upper-bracket ones are allowed to expire, the result would be greater progressivity. Such a policy decision could be taken as a proactive component of any “Buffett rule.” Ideally, the expiration of some or all of the Bush tax rates, which on its own would generate reduced incentives to work and save, could be coupled with base-broadening reforms that would help promote the Buffett rule by reducing tax expenditures that solely or disproportionately benefit the rich but would also reduce rather than increase the distortions of the income tax system on economic decisions.

Let the Budgeteers Take Control

Given that the most valuable thing about the Bush tax cuts is their cost rather than the merits or flaws of the structure of the policy in terms of its base and rates, the budget committees and budget process will be a big deal in terms of what will happen to the tax cuts. The difference between “business as usual” deficit financing and the outcome if pay-go rules are applied without exception is more than $4.5 trillion over 10 years.

The budget committees should flex their policy muscles and do the heavy lifting regarding the impending expiration of the Bush tax cuts. They could propose legislation requiring strict pay-go rules on the tax cuts and setting revenue levels in the budget resolution consistent with letting the full complement expire. They could also explain and illustrate how complying with pay-go doesn’t have to mean increasing tax burdens at a time when our economy cannot handle it. Any part of the tax cuts that we want to extend immediately can be paid for with gradual revenue increases or spending cuts over the rest of the 10-year budget window. And while the budget committees cannot dictate the specifics of tax policy (that is left up to the House Ways and Means and Senate Finance committees), they are the ones that set the ground rules and boundaries that the taxwriting committees must work within.

The budget committees also have the option of at least stating their preferences about the specifics of tax policy (such as the mix of rate increases versus base broadeners in the revenue-raising strategy) in the policy sections of the budget resolution or in the committee reports accompanying the legislative text of the resolution.

Politically, the hardest part about making the best of the Bush tax cuts has always been paying for them. That is why the role of the budget committees and the budget process is unusually critical on this particular, and large, tax policy decision.

Deal With the Turkey in the Lame Duck

All these ways of making the best of the Bush tax cuts are not precluded by the fact that this is a presidential as well as congressional election year. If we consider the many ways in which policymakers have failed over the years regarding decisions about what to do about the Bush tax cuts, it’s clear we can’t blame just the budget committees for not putting their foot down about the current-law baseline and pay-go. When Obama and Republicans want to keep extending and deficit-financing them, we can understand why Congress on its own was unable to get its bipartisan act together and behave better. Doing the right thing by the Bush tax cuts requires strong leadership unencumbered by unrealistic campaign promises.

There are several reasons to be optimistic about doing better once we get past the next election. The near-term economy is not as fragile as it was two years ago, the last time the Bush tax cuts were about to expire, making the idea of letting go, even gradually, more palatable. At the same time, the various debt crises in Europe serve as a warning about the unsustainability of the U.S. fiscal outlook and its implications for the economy in terms of longer-term growth and shorter-term stability.

Finally, after this November’s election, no matter who is elected president, we are likely to have a president who is less tied to a campaign promise that commits him to keeping the Bush tax cuts and who was voted into office by a public that is now far less enamored of the Bush tax cuts than it has ever been.

The cliff on the Bush tax cuts comes less than two months after the election. Is that too little time to do better than business as usual? While it may not be possible to replace the Bush tax cuts and the rest of the federal income tax with a full-out version of base-broadening, rate-reducing, revenue-raising fundamental tax reform like the plans recommended by bipartisan groups, it is not hard to set a goal in the lame-duck session of making only positive, even if small, steps regarding the Bush tax cuts. In the lame-duck session, Congress and the administration can commit to either letting parts of the Bush tax cuts go or turning them into more fiscally responsible versions that achieve better economic results.

At a minimum, policymakers should not have to revert to full extension of the cuts as a form of compromise as they have done in the past. Deficit-financed extensions should be limited in scope and temporary in timing, and permanent extensions should comply with strict pay-go rules over the 10-year budget window. Policymakers will be able to do this with the help and leadership of the budget committees working with a president who is able to get off the campaign trail and back to work, all of them cheered on by an American public that well understands by now the inevitability and necessity of hard choices. They can turn this turkey of the Bush tax cuts into something much better.

FOOTNOTES

1 Congressional Budget Office, “The Budget and Economic Outlook, Fiscal Years 2012 to 2022,” Jan. 2012, Doc 2012-1855  2012 TNT 21-26 .

2 Diane Lim Rogers, “Who Wants to Tax a Millionaire?” Tax Notes, Feb. 6, 2012, p. 725, Doc 2012-1867 , 2012 TNT 24-16 .
 END OF FOOTNOTES

_______________________________________

Less time required for Tax Notes means maybe, finally, more time to get back to this blog!  And I have a new project developing that I hope to be able to tell readers about soon.  Thank you for sticking with me through thick and thin here!

In this file photo, a woman drops her federal tax return in the mail slot at a post office in Palo Alto, Calif. Rogers argues that ffor raising taxes on the rich to work, the definition of 'rich' has to be a lot broader than most people think. (Paul Sakuma/AP/File)

The rich should pay higher taxes. So who are the rich?

By Guest blogger / 04.17.12

As we arrive at the federal tax filing deadline (this year on Tuesday, 4/17), it just so happens that Congress and the Administration have been thinking of different ways to raise tax burdens on the rich.  Last week I participated in a “Tax Day” event at the Tax Policy Center called “Should the Rich Pay Higher Taxes?” as one of the “four Ds” panel which also included TPC’s director Donald Marron, former CBO director and former McCain adviser Doug Holtz-Eakin (now president of American Action Forum), and economist rich guy (and a member of the “Responsible Wealth” coalition) David Levine.  The TPC has our handouts and a video of the event posted here

TPC’s Howard Gleckman moderated the event (and blogged about it afterward, here) and at one point asked each of us “who is rich?”  I at first didn’t know how to answer that; “rich” is a relative concept that depends on one’s personal “baseline,” of course!  But then I circled back to the focus of the event–what the tax burdens of “the rich” should be–and I realized that in that context, all federal income taxpayers should be considered “rich,” in that we are all, all combined at least, paying too little in taxes.  Revenues as a share of GDP are far lower right now than the 18 percent historical average over the past several decades, which is too little anyway to produce economically sustainable budget deficits now and going forward (let alone enough to cover spending fully).  And although a lot of that currently-below-average level is because of the short-term but stubbornly persistent weakness in the economy (a cyclical phenomenon), projections show that even when the economy gets back to “full employment” and even when revenues/GDP recover back to and above the historical average (even under the policy-extended baseline, by the way), revenues are still not going to be enough to keep up with the growth in government spending–even if health reform (already in place and to come) successfully reduces the growth in Medicare spending.

So if “the rich” are defined as those who can afford and ought to be expected to pay higher income taxes, then “the rich” really has to be much more broadly defined than “people like David Levine” (who are multi-millionaires).  And if you watch the video of the TPC event, we all pretty much agreed on the premises that: (i) we need more federal revenue; (ii) “the rich” can manage higher tax burdens the best (and should be asked first); and (iii) David definitely qualifies as “rich.”  We had more differences in opinion over: (i) how much more revenue we need (and implicitly, what the right size of government is); (ii) how that revenue should be raised in terms of base-broadening vs. rate-raising reforms; (iii) what the right basis of taxation is–income or consumption; (iv) if David’s wealth comes more from his high productivity and hard work, or more from good luck; and (v) if raising tax rates on people like David will cause them to not work so hard, or if it just means they will not be as “lucky” in terms of their tax burdens.

David is practically begging to make him, and other millionaires like him, pay higher taxes, and feels the best (maybe easiest) way to do so is in the latest legislative version of the “Buffett Rule”–which basically imposes another “alternative minimum tax” to brute-force effective tax rates on the incomes of the rich to be at least 30 percent, without changing (improving) the definition of taxable income.  I and Donald agreed that David can afford to face a much larger tax bill, but that it would be better (more economically efficient and better for supply-side incentives) if his burden were raised by paring back the tax subsidies David receives via, for example, itemized deductions and the preferential tax rates on capital gains and dividend income.  Doug also agreed that the best way to raise tax burdens on the rich is to reduce tax expenditures rather than raise marginal tax rates, but he did not count the preferential rates on capital income as a tax expenditure (because he advocates consumption as the right basis of taxation), and also probably would not agree with me and Donald on how much revenues/GDP need to rise.  And all of us, being economists, agree that in theory and all else constant, higher marginal tax rates can discourage the incentives to increase the supply of productive resources (via working and saving) to the economy. 

But if there’s one thing that economist and rich guy David made clear in telling of his own personal experience with wealth and taxes, it’s that even for really rich people, the economist-labeled “income effects” of taxes–the effects of having more or less after-tax income–are typically far bigger than the economist-labeled “substitution effects” of taxes–the effects of marginal tax rates on relative prices which cause people to substitute away from taxed or higher-taxed activities and into untaxed or lower-taxed ones.  I feel that conservatives (like Doug) who want lower marginal tax rates tend to over-sell the empirical significance of those substitution effects, yes, but liberals (even rich ones like David) tend to forget that as long as some substitution effects exist, it’s better to raise tax burdens by broadening the tax base (in a progressive manner) than by raising the top marginal tax rate.

So, the TPC event made clear that “yes, the rich should pay higher taxes.”  But it also highlighted where the challenges to achieving fundamental tax reform will be, in coming to agreement about who exactly is “rich,” and how exactly they will be made to pay more in taxes. We have far more work to do regarding federal tax policy than what is currently being debated–in a very narrow sense–about the “Buffett Rule.”

Examples of 'Understanding Taxes' graphic design posters hang in the halls of the US Internal Revenue Service building in Washington, DC. Rogers argues that effective tax reform is no picnic, but it isn't impossible, either. (Ann Hermes/The Christian Science Monitor)

Why broadening the tax base is so difficult

By Guest blogger / 03.26.12

The Congressional Research Service has released a new report by Jane Gravelle and Thomas Hungerford called “The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening.”  In a nutshell, the report could be called “Base Broadening Is Hard to Do.”  The Washington Post’s Lori Montgomery summarized it nicely on Friday, including getting this Republican staffer’s reaction to it:

Republican tax aides dismissed the report as unhelpful.

“Reports suggesting tax reform isn’t easy are greatly appreciated. We look forward to future reports on water being wet,” said Sage Eastman, a senior aide to House Ways and Means Committee Chairman Dave Camp (R-Mich.), whose panel drafted the principles for tax reform laid out in the Ryan budget.

The CRS report emphasizes that although the 200+ tax expenditures under the federal income tax (individual and corporate) are worth over $1 trillion per year, the largest 20 of them represent 90 percent of that revenue loss.  When you look closely at that “top 20″ list, copied here from the table in the CRS report, it is easy to get discouraged about the prospects for substantial tax base broadening.  As I explained last November in Tax Notes (subscription-only access here), the largest tax expenditures look a lot more like “entitlements” than “loopholes”:

Consider the biggest of the big tax expenditures: the exclusion for employer-provided healthcare and itemized deductions. Economically, there is little rationale for subsidizing those particular activities, especially for handing out the largest subsidies to people with the highest incomes. But politically they are untouchable. They clearly benefit real people, not just individuals or corporations of questionable reputation, and they are far from “loopholes” that are easy to cut.

Those individual income tax expenditures sound a lot like entitlement spending, defined by Merriam-Webster’s Dictionary of Law as “a government program that provides benefits to members of a group that has a statutory entitlement.” Those groups are employees with health insurance, households with mortgages, people who donate to charities, and so on.

And that’s why the CRS authors conclude that “It appears unlikely that a significant fraction of this potential revenue could be realized.” Instead of the more than $1 trillion that could be gained if all tax expenditures were eliminated–which would support substantial marginal tax rate reductions including getting the top rate down from 39.6% to 23%–they believe “it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues through base broadening.”

I think I’m slightly more optimistic than CRS, because their conclusion assumes we can’t touch (at all) those top 20 tax expenditures.  I think we could actually do better.  For example, in his latest budget the President himself has proposed to touch (or hammer?) a lot of these tax expenditures by limiting the benefit of those tax expenditures to the richest households to the levels of benefits that would be obtained at lower marginal tax rate brackets.  It’s an ambitious amount of base broadening, although only for a narrow group of taxpayers (the familiar households with incomes above $250,000).  (The limit of the broadening to that small group results in a revenue gain of $584 billion over ten years–which is like broadening the tax base by about 1/20th the total value of tax expenditures.)  But my point is there are ways to substantially reduce the cost of the most expensive tax expenditures to both make the proposals more palatable and to raise enough revenue to support a decent amount of rate reduction or at least “rate preservation.”  It still isn’t easy to do, but that’s still mostly a political obstacle rather than an economic or administrative one.

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