Champagne diet on a beer budget

I’ve been exchanging facebook comments with my friend Dave Snellen, who is a good, smart guy, a former Commodore of a sailing club I belong to, and at least as far over on the conservative side of the political spectrum as I am on the progressive side.  We were discussing whether the federal budget is like a family budget, and whether the current budget is has veered disastrously off-course due to Obama spending projects over the last four years.  He argued this way:

“Like a family, it is fine for the government to borrow money IF it leads to an increase in GDP/income. Otherwise the interest on the debt just leads to increase outflow without a corresponding inflow…

Over the past four years, we've had an increase in debt of about $6B without a corresponding increase in GDP. Not good. No increase in income to pay off the new debt. So we have just added to our burden and need to borrow more. This trend cannot be sustained.”

He recognized that

“We are 'borrowing’ it from ourselves. The major purchaser of government bonds is the government.”

And concluded with

“The point being you cannot continue on a champagne diet with a beer budget.”

I thought his arguments were well stated, and they are widely shared over on his side of the political world---as a progressive, of course I have different views.  In fact, I seem to reach different conclusions even when I nod in agreement to many of his phrases, such as the last one about beer and budgets, and many of his facts.  I’ll use this blog post to try to state why.

First, I’ll at least brush the question of whether we can treat federal budgets as analogous to family budgets.  It would take its own long blog post to set out all the implications of this, and to show in any detail what mischief can be done by this analogy, so here I’ll just say that nations live much longer than families do, that they are organized completely differently, have different goals and purposes, that unlike families the money that national governments pay for goods and services is largely internal to the nation they govern, meaning that the money largely ends up in the hands of the nation’s own citizens and benefits them (which is part of the nation’s purpose), and finally that nations that control their own currency can’t go broke in terms of that currency. They, unlike families, can simply create money if they have to.  They might cause themselves a lot of economic misery by using that power too liberally at the wrong times, but they can do it, and families can’t. States can’t. Counties can’t. Cities can’t.  Businesses can’t. In our system, only the Federal Reserve has that power, delegated to it by Congress, and delegated to Congress by the Constitution.

But all of that doesn’t mean that I’m indifferent to national debt.  Contrary to Abba Lerner’s view on this, I think excessive debt does create possibly harsh limits for national governments, even for governments that control their own currencies and could, in theory, simply print money to pay their bills. If I thought that we were really on a champagne diet with a beer budget, I would agree with Dave completely on this---but I don't think either of those descriptions is right. 

Our revenue is low right now for two reasons: one, because while we emerged from the recession some time ago by the official definition, we are still in its dismal grip out here in the real world, and two, because we have been on a tax cutting binge for the last 30 years. 

The tax cutting was intentional.  As a nation we voted for it, or at least for the representation in Congress that enacted it, and the general opinion of a large segment of the voting population is still that we haven’t cut taxes far enough.  But whether you agree or disagree with that, the impact of those tax cuts is pretty clear.  Here’s a graph from the Federal Reserve Economic Data (FRED) web site, showing federal receipts from 1970 to July of 2012:

 

The blue line is total federal receipts presented as a natural log because changes in growth rates are easier to see that way.  The red dotted lines are mine.  They show the slopes of the lines from 1970 to 1980, then from 1980 through 2000, and from 2000 through the present.  The changing slopes are in part due to changes in tax policy.  It could, and should, be argued that they are also in part due to decreased overall economic growth rates---but I don’t think those who argue for low marginal tax rates want to depend on that argument.  It doesn’t lend a lot of support to the general philosophy that drove our move to lower tax rates and looser regulations, does it?  Those policies were supposed to increase economic growth.  There may be other, more basic reasons that growth has declined, and it may be sheer coincidence that the decline seems to coincide with the emergence of a new governing philosophy.  But at the very least, we can say that this data doesn’t add credibility to the new vision.

But the real force behind the current large deficits is, without question, the huge recession we are still slogging our way through.  Here’s a second graph from FRED, showing federal receipts and federal expenditures as a share of GDP from 1970 through July of 2012:

I know it looks like static, but slog through it with me for a minute.

The blue line shows federal government receipts as a percent of GDP, and the red line shows expenditures.  The gray vertical bars are the narrow official dates of recessions---and look what happens whenever there is a recession, no matter who is president or which party controls Congress: in or near every gray bar receipts decline and expenses rise.  In the mid-1970s we had a recession under Gerald Ford; look at the gap between expenses and receipts that quickly develops.  The gap gradually improves until the big recessions in the early 1980s under Ronald Reagan, which caused expenses to take off yet again, and revenues to collapse.  And look at this century: that big collapse of revenues from well above 20% of GDP in 2000 down to about 16% in 2004 resulted from both a recession early in Bush’s first term and from the impact of the Bush tax cuts.  The blue-line bulge after that was the housing boom, and the collapse in 2009 to less than 15% of GDP, from which we have not yet fully recovered, was the massive recession that began at the end of Bush’s second term. 

So it makes no sense to blame Obama, or any president, for the widening deficit that this massive recession, this Great Recession, caused.  In fact that collapse happened during 2008, before Obama took office.  In January of 2007 revenues were 19.2% of GDP; by January of 2008 they had dropped to 18.4%, and by January of 2009 they had dropped to 15.9% and were still on their way down.  Obama was inaugurated on January 20^th of  2009.  By 2010 revenues were once again rising as a share of GDP, and by the middle of 2011 expenditures as a share of GDP were falling.

 So, with respect to the title of this post, even though federal receipts have declined as a share of GDP in this recession that doesn’t mean that we are necessarily on a long run beer budget.  The recession, eventually, will pass, and the budget constraints we are left with after that are those we choose to impose on ourselves.  We are the largest, wealthiest economy in the history of the planet, and since that’s true it’s more than passing strange to claim that we are forced to remain on a beer budget---if the United States budget is a beer budget, whose budget anywhere is not?  We can choose to spend less or more through our government; conservatives would prefer to spend less, and there’s nothing wrong with that as a choice.  But low taxes and low revenues are a choice, not a requirement for us.  We’re not constrained by national poverty to a small federal budget. 

As for the champagne diet, that has to refer to the size of the federal budget deficit as a share of GDP.  And it’s true that in January of 2007 the deficit was about 1.15% of GDP, and in January of 2011 it was over 8.6% of GDP.  From the FRED graphs above it’s clear that a large chunk of that deficit growth was a collapse of revenues that resulted from the recession.  Most of the rest of it, the increase in spending, is also a result of recession, rather than a result of Obama initiatives.  How do we know that?  Because in January of 2009, before Obama took office, the deficit as a percent of GDP was even higher: it was 10.1% of GDP.  That percent actually declined over Obama’s first term, and continues to fall.   There was a big jump in FY2009, which was the last Bush budget (ie, it was passed in 2008), and it included the bank bailout (Bush) and some fiscal stimulus (Obama).  But the trend since then has was pretty flat for a bit over a year, and then started to fall. There’s a belief on the right that Obama has been on a spending spree, but that simply isn’t true*.  We, as a nation, have had much smaller revenues and higher expenses because of the recession.  But there haven’t really been any great increases in federal profligacy in other areas.

As a last point, I do agree with Dave’s support of government investment in things that will increase economic growth.  That’s why, along with many others, I’ve been hoping that we could get support from both progressives and conservatives for providing stimulus by investing in infrastructure, particularly now when interest rates are close to zero, and real interest rates are actually negative. 

__________________

* For a Factcheck.org discussion of this, go here. 

Oh, and...

Did I mention that  dockworkers are set to close down American ports along the east coast and on the gulf by going on strike this Sunday? No?  That's because I didn't know about that until I read this morning's Washington Post. 

So let's see---dockworkers strike on Sunday December 30, and we squash our heads on the debt ceiling on the 31st, and we fall off a fiscal cliff the following day. 

The first days of 2013 are going to be a real kick in the pants, aren't they?

A toast to debt ceiling eve.

It turns out that the debt ceiling debacle will coincide with the fiscal cliff debacle, to create a perfect fiscal storm to start the new year.  We will reach the debt ceiling on New Year’s Eve.  

For those new to this topic, here's the short version: Congress has enacted a ceiling on our national debt, and Congress has also passed budgets and tax laws that imply that the Treasury must violate that ceiling to pay for all the things that Congress has required the government to do.  That debt ceiling will be reached on New Year's Eve, and if Congress does not raise the debt ceiling by that date the federal government will not be allowed, under the law, to pay any more of its bills than current revenues will support: it will have to simply default on some of the financial obligations that Congress has enacted.   At least that's been the interpretation for a long time now.

Note to the Republican Party: come back to Earth.  I say this as a concerned American.  I’m not always with you on issues---ok, to be honest I’m very rarely with you on issues.  But I’m very much in favor of continuing to have at least two sensible, viable parties in this country, and you, the Republican Party, are in real jeopardy right now; you are about to do something very, very foolish. Seriously.  If your plan is to try to use the debt ceiling as a bargaining tool, find a different plan. You can’t really expect to gain friends and influence people by holding our national honor hostage to your whims. Yes, the debt ceiling drama will be carried out over a couple of months as the Treasury twists itself silly around “extraordinary measures” to avoid complete financial collapse, so even thought the ceiling itself is reached in a few days the drama can be teased out for some time to come.  But I mean, what is the negotiating theory here?  That this gives Republicans some kind of leverage because Republicans don’t really care whether the United States defaults on its debts but Democrats do?  It comes very close to treason, frankly, which is not the kind of image that is likely to make a national party grow. 

And of course, as I’ve said here before, the whole concept of a debt ceiling makes no sense.  Congress passes all the bills that create national deficits; it creates the tax laws that provide revenue, and it passes every single line of every single budget---in fact, it hast to pass those lines twice, in a sense, once to authorize an expenditure, and a second time to appropriate funds to expend.  Let me repeat that last phrase: Congress has already voted to expend these funds.  The debt ceiling vote is to determine whether Congress intends to pay the bills for the budget expenditures it has already agreed to make, and which it has already legally appropriated the funds to make.

The Fourteenth Amendment, section 4, says that “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”  I don’t want to get into the issue of whether the existence of a debt ceiling is itself unconstitutional once the budgets that require the Treasury to violate that ceiling have passed through Congress, although I thought that Lawrence Tribe’s arguments against that interpretation were intellectually vacuous.   Still, I’ll leave that issue to lawyers, I have no expertise there.  But whether or not a debt ceiling vote violates the Fourteenth Amendment in a technical legal sense, it certainly violates its spirit.  Congress enacts an obligation for the federal government to pay for every line item in the budgets it passes.  If Congress, and particularly the Republicans in Congress (because no one else is suggesting that there will be a contest over passage of the debt ceiling bill), refuse to allow the Treasury to borrow money to meet that obligation, then Congress must either find an alternative way to make those payments, or it is very explicitly stating that the public obligations of the United States are not valid, and that Congress has no intention to pay them.   

Now, there are only three methods that I know about to raise money to pay our national bills.  We can borrow it, we can raise it through increased taxes, or we can print it.  If the Republicans in Congress do not intend to invalidate the nation’s public obligations, and if they refuse to allow the Treasury to take the first option, then they must pick from the other two.

Which will it be?

Back on the air slowly…and a call for Lori Montgomery and Paul Kane to please, please get a grip.

In my last post on October 29^th , I told you that my father was experiencing “sudden, surprising weakness”.  The weakness continued and deepened over the next days.  He died on November 1^st.  Blogging took a back seat for a while. 

It's been a month.  It’s time to try to get back on the air again.  Blogging will be a little slow for a few weeks as I get back into the routine, but a few weeks is actually pretty good timing.  The economic news right now seems slow, at least to me, and the op-eds in the Post have been mild.  But in a few weeks the fiscal cliff frenzy will probably be well underway, and there will be a lot to respond to.

For the moment, let me just say that the fiscal cliff itself offers little terror: it can come and go, and the economy will survive.  If nothing is done over the next six months it could hurt, but is that really likely?  Once we pass the fiscal cliff moment the Defense department will be facing enormous sequesters, and the Bush tax cuts will all be gone.  All of them, not just for the top 2% but for the top 100%.  There will be a sudden increase in payroll tax deductions as the payroll tax holiday (an Obama economic stimulus policy) expires.  And a few other spending cuts and tax increases will happen automatically, all of which will cause anger, disgust, wailing and rending of garments among the populace---which means among the voters in every Congressional district. Is it really likely that Congress will offer no better alternative in the face of all of that constituent anguish?  My guess is that we will go over the fiscal cliff first, and then Congress will act.  But provisions of the cliff will not last as they are.

Obama’s first proposal is interesting, and contrary to the huge outcry from the Republican side, it is useful.  It presents a Democratic first offer perfectly.  The Republican reject it on the grounds that it doesn’t offer a proposal on Medicare reform---but, of course, it does: by default it’s a proposal to leave Medicare as it is.  That may be a proposal the Republicans don’t like, but it is a proposal.  It is one of the many options available to us.  If the Republican side has a better option, they should offer it, rather than demand that the Democrats create their counter-offer for them.

One line from the Washington Post’s front page article on this needs a response---in fact, it’s the first line, the topic line.  Here it is, complete, from the piece by Lori Montgomery and Paul Kane:

“President Obama offered Republicans a detailed plan Thursday for averting the year-end ‘fiscal cliff’ that calls for $1.6 trillion in new taxes, $50 billion in fresh spending on the economy and an effective end to congressional control over the size of the national debt.”  (emphasis is mine)

Ms. Montgomery, Mr. Kane, please get a grip.  The Constitution is pretty clear on this: Congress exercises absolute and complete control over the size of the national debt, every penny of it, every time. Every single deficit is enacted through Congress.  Congress passes the budgets---all of them, every line.  The President can (and of course does) propose budgets, but it’s reasonably clear that Congress does not feel any binding obligation to pass the President’s proposals.  Congress passes tax policy.  Every single tax policy, every time.  Yes, there is wiggle room both on spending and taxing sides, and the Executive branch does use it.  But every bit of wiggle room is provided in legislation passed by Congress.  Every time.

I have to guess here, since I haven’t actually seen the Obama proposal to the Republican leadership.  But my guess is that Obama has asked Congress to stop the regular habit of threatening to default on the national debts that Congress has created.  He has, probably, asked them to abandon the truly odd process of having to pass a debt ceiling increase in addition to their votes on taxes and budgets.  He has probably asked them instead to treat their votes on budgets as granting the right to finance any deficit they just voted to create: in other words, to vote, every time, as part of the budget process, to raise the debt ceiling if necessary to cover the deficit the new budget implies. 

This shouldn’t be controversial, frankly.  Congress has the right, and the power, to default on our national financial obligations if it really wants to. But the rule should be that if it really feels that is the best course of action it should have to propose that, and vote on it specifically.  Right now, under the current process, default on our national debt is the default position: under current law the nation will default automatically unless Congress votes to prevent it by raising the debt ceiling over and over and over.  

And we’re about to go through that painful, shameful, process again. That absurdity is approaching too, right on the heels of the fiscal cliff.

Sorry about the silence…

 

We’re bumbling toward the core of FrankenStorm Sandy.  That will reach us in about two hours or so, and is expected to last late into the night, with gusts well up above 60 to 70 MPH, and perhaps even higher.  But there are serious winds already puffing and shoving up under the eaves, and bending whole trees sideways.  So of course I thought I’d sit at my computer as long as the power is on, and offer an excuse for the long silence in this blog.  I have several to choose from. 

The first, and biggest, is that I have had some family responsibilities. Nothing really unexpected.  My father is 97 years old.  But he is suddenly surprisingly weak, and has lost a lot of weight in a short time.  The responsibilities that implies have kept me from this space for a while.

And I was tired, because I am also not 20 anymore.  It was great to be out on the Chesapeake last weekend, but it took a few days to recover. The trip included as much motoring as sailing, but there were a few of hours of good wind both days.  On Saturday we had our sails up coming out of the West River and pretty far down the bay toward our destination for the day, which was Hudson Creek in the Little Choptank.   We had to motor for an hour or two at the end of the day to get there in daylight.  But in the evening the wind came back, and we had a cold, very clear night at anchor with winds, judging from the volume of their drone through the rigging, somewhere up near twenty knots.   I slept like a baby, which means, of course, that I woke up every two hours, and since I was awake I went topside to check the anchor.  The cold felt very good.  I probably spent too much time up there, looking at stars I never see in the city, and the trees along the skyline, and the anchor light about 200 yard away of the only other boat out there in the night.  We had a rocking rolling ride all morning out of the Little Choptank on Sunday.  We were well into the Bay before the wind died, and we finally had to take our sails down and motor south to Solomons.  My thanks to Jeff and Monica for the opportunity to spend two days on a sailboat, which is something I haven’t done nearly enough in the last year or two, and probably won’t again for a while. 

There was a bit of discussion in the columns of government job creation, the topic of my last post.   The New York Times agreed with me, and Robert Samuelson exhibited an awe inspiring failure to grasp the implications of his own words in a column responding to the Times editorial.  If you read his column carefully, his argument is simply that government jobs don’t count because the private market will always achieve full employment without them.  If people aren’t required to fund government jobs by paying taxes they will buy something else, and that will create private sector jobs, so the government is just displacing jobs in the private sector.  In other words, he is relying on Say’s law.  Private markets will, in his mind, always achieve full employment of resources.  Of course the same argument can apply to jobs at General Electric or Apple, or any charity or church.  If Apple goes out of business and people can’t buy iPhones they will still have the money they would have spent on them, and they will presumably buy something else instead.  So by Samuelson's logic the jobs at Apple don’t count either.  If full employment is always guaranteed, then Apple didn’t really create those jobs building iPhones, it just displaced them from some other purpose. 

I was disappointed.  I had hoped that the argument for Romney’s (and apparently Samuelson’s) view that “the government does not create jobs” was more sophisticated than that.  I had hoped, and thought, that it was some misunderstanding of the Solow growth model, for example, which uses variables like population growth, savings rate, depreciation and capital investment to show how economies grow.  The misunderstanding would be that “capital investment” only means lathes and backhoes, but does not include roads, bridges, dams, and so on; in other words, that growth only occurs when private industry invests, not when government invests.  Of course that’s absurd. But it would at least show some background in the topic, and some knowledge of the theories of economic growth.

I have to wrap this up.  The storm is getting insistent.  But I’ll try to get back to this topic soon with more details. 

Another Mystery of Romneynomics

I want to get this out today because I won’t have time to post anything over the weekend.  I’ll be out sailing on the Cheasapeake Bay, helping to deliver a friend’s boat from Galesville just south of Annapolis to Solomons in the Patuxent River.   Hey, it’s a burden, but someone has to do it.

But I’ve been puzzling about one comment from the second Presidential debate, a comment that Romney made as Obama was ending his response about Candy Crowley’s question about jobs lost to China, toward the end of the debate.  I’ll quote the whole relevant section, so we have the context:

“MS. CROWLEY: Let me go to the president here, because we really are running out of time. And the question is can we ever get — we can’t get wages like that. It can’t be sustained here.

PRESIDENT OBAMA: Candy, there are some jobs that are not going to come back, because they’re low-wage, low-skill jobs. I want high- wage, high-skill jobs. That’s why we have to emphasize manufacturing. That’s why we have to invest in advanced manufacturing. That’s why we’ve got to make sure that we’ve got the best science and research in the world.

And when we talk about deficits, if we’re adding to our deficit for tax cuts for folks who don’t need them and we’re cutting investments in research and science that will create the next Apple, create the next new innovation that will sell products around the world, we will lose that race. If we’re not training engineers to make sure that they are equipped here in this country, then companies won’t come here. Those investments are what’s going to help to make sure that we continue to lead this world economy not just next year, but 10 years from now, 50 years from now, a hundred years from now.

MS. CROWLEY: Thanks, Mr. President.

Governor Romney —

MR. ROMNEY: Government does not create jobs. Government does not create jobs. (Chuckles.)

MS. CROWLEY: — but Governor Romney, I want to introduce you to Barry Green, because he’s going to have the last question to you first. ”

The italics are mine, but he said these words with great emphasis, as though this were a point he needed to make that the world was not quite getting, as though he were talking to people who were hard of hearing, or who were too ideologically stubborn to get this basic fact.  This appears to be a fundamental element in his economic philosophy: “government does not create jobs”.  It seems to be a fundamental element in the economic philosophy of the right, so I understand that he was calling out to his base when he said that.  But it’s an odd thing to say, in my opinion, and an odd thing to think.

The curious thing is that this is clearly false on the face of it, at least at the visible, factual level.  At that level this isn’t a matter of philosophy, it’s a matter of plain numbers: governments at various levels directly employ more than 22 million people.  (To be clear, only about 3 million of those jobs are federal, the rest are state and local government jobs.  I’ll throw in a graph from FRED below to illustrate.)   And these are only the jobs that are direct government employment; in addition to these jobs, the government hires contractors to do immense amounts of public work---to help build roads and dams and airports, to build ships and aircraft and tanks and all-terrain trucks for defense, and to help with all of that science research Obama mentioned in the quote above.   Governor Romney certainly knows that these jobs exist, and that the government creates them.  Why don’t all of these jobs count in Romney’s philosophy? 

But I think Romney’s idea is that aside from these jobs that government creates directly or by contract to accomplish public work---many of which he might think are unnecessary, even wasteful---the government’s role is negligible, that government efforts don’t have a big role in creating private sector jobs, which in his inner heart are the only real jobs.  His idea might be that the work of government simply gets in the way of private industry.  If that’s what he means, he might want to consider this letter to the editor of the Las Vegas Sun.  The writer, Mark Bird, points out that in Las Vegas government has done a few things that matter:

“Government created Hoover Dam, Interstate 15 and McCarran International Airport. Does any rational person really believe the MGM, Mirage or Venetian hotels are responsible for more jobs than these three government projects? Lake Mead supplies 90 percent of the water used in Las Vegas. Would these hotels have been built without the water source?”

Mr. Bird might have also mentioned the existence of police, EMT, firefighters, national defense, and numerous other public services that allow business people to go about their work in safety.  But this has all been said before, and I think that Governor Romney knows that these government efforts are vital to a healthy private sector. 

Or he might mean that in spite of all of the jobs the government creates directly or by contract as the nation’s largest customer, and the indirect jobs that are enabled by the existence of government’s products and services, the government also does harm by, for example, regulating industries that, if they could only work unfettered, might create many new jobs.  In that case he might want to consider his own words from the first Presidential debate:

“MR. LEHRER: All right. So, to finish quickly, briefly, on the economy, what is your view about the level of federal regulation of the economy right now? Is there too much, and in your case, Mr. President, is there -- should there be more? Beginning with you -- this is not a new two-minute segment -- to start, and we’ll go for a few minutes and then we’re going to go to health care. OK?

MR. ROMNEY: Regulation is essential. You can’t have a free market work if you don’t have regulation. As a business person, I had to have -- I needed to know the regulations. I needed them there. You couldn’t have people opening up banks in their -- in their garage and making loans. I mean, you have to have regulations so that you can have an economy work. Every free economy has good regulation.”

Once again, the italics are mine, but the emphasis is clear in his voice in his response.
  

So Governor Romney seems to understand that government, through regulations, creates the framework in which private business is conducted, and that having a framework like that (like having rules in a football game) can make the difference between a productive private sector and a brutal free-for-all in which no one wins.   And he clearly also knows about the people who work directly for government at various levels, and those whose businesses depend on the government as their customer.   He surely understands that even if those jobs don’t seem real to him they are very real to the people who do them.  And he knows as well that businesses do depend on the availability of clean water, power, roads and airports, and so on.  He’s sometimes complained while campaigning about the fact that the U.S. infrastructure is “crumbling”.  

Government is central to all of this, and in playing its role it provides jobs.  Romney knows this.  The right side of the political spectrum has to know all of this.  

So why is there such urgency and emphasis in Governor Romney’s denial of government’s role in the economy?  Why is this so important to the right?    

It’s a mystery.

____________________________________

Here’s the FRED graph.  The big blue line at the top is total government employment, at all levels; the red line at the bottom is federal government employment---notice that it’s been pretty level since the fifties, in spite of all the population growth since then.  The green is state government employment, and the orange is local government employment.

Nick Rowe Agonistes

I’m astonished, once again, that a topic as fundamental and important as the impact of national deficits on future “generations” (quotes explained below) is still a debated issue in economics.  But apparently it is.  And once again it has created a flurry of blog posts, from Dean Baker, a frustrated response from Nick Rowe who wonders why his overlapping generations model has not settled this issue, and responses to Rowe from Brad DeLong, Dean Baker, Mark Thoma, and Paul Krugman.  I’ll also point to Robert Murphy here (worth reading for the comedy value alone, although I think he may have been too hard on David Brooks, who seems like a perfectly nice gentleman) and here, and Robert Waldman at Angry Bear here,   And of course as long as you’re in the neighborhood you can look at my own posts on phantoms in the dark, starting here…but if you’re in a link-following mood, start with Baker and Rowe.  They are where the latest flurry started.

Wow.

I’m not sure that my additions to this will help resolve anything if the sheer mass of intellect represented at the end of those links has not.  But heck---it can’t hurt to make my comments, can it?  Particularly when the issue is this important.  It relates to many of the topics that are prominent in politics right now, and probably will be for the next decade or two at least.  National debt, the aging population, income distribution and redistribution, are all part of this discussion.  Professor Rowe’s overlapping generation model in particular is almost a direct picture of the impact of the creation of social security, and of the loss of social security if that should ever happen. 

The reason for the quotes around the word “generations” above is that this word has caused some confusion in the conversation.  Most of the papers and blog posts that discuss this topic have not actually been concerned with generations, with groups of people born at roughly the same time who travel through the same bit of history together: they use that word only to indicate that they are considering accounting periods---years, generally, or decades---that are far apart from each other in time.  They are asking whether debts incurred in one year will have a negative economic impact in some other year far in the future, a year populated by members of future generations, perhaps, but considering each period on its own merits without trying to separate the multiple cohorts that share earth at any time or follow each cohort through its time here.  But others do really mean cohorts; and sometimes, particularly when politicians are using it, the meaning intended by using that word slips from one interpretation to the other within the same argument, or even within the same sentence.

In the list of links above Krugman, Baker, Thoma and DeLong seem to me to intend the first meaning; they seem to be talking about the economic potential available to people alive at a particular future period.  But Nick Rowe and Robert Murphy, in particular, are looking instead at the second meaning.  They specifically write about, and give examples of, overlapping cohort-type generations, looking at the total consumption available to each generation through their lives, the total that they have consumed after passing through all the individual time periods in their bit of history.  I want to comment primarily on the examples discussed by Rowe and Murphy, but I’ll introduce that by saying that I don’t think the other writers actually respond to Rowe’s model.  Krugman recognizes the terminology issue but talks right past it when he says:

“First, however, let me suggest that the phrasing in terms of “future generations” can easily become a trap. It’s quite possible that debt can raise the consumption of one generation and reduce the consumption of the next generation during the period when members of both generations are still alive.”   

The emphasis is his, and that matters---because Rowe’s overlapping generations model, in his own example of it, and mine that I presented here and reproduce below, and very explicitly in Murphy, shows that consumption can be raised for the lifetime of the present generation and reduced for the lifetime of one or more generations in the far future, long after the present generation has left the field.  In other words, this model is explicitly not talking about “the period when members of both generations are still alive.”

Here’s the example I used in this post to explain it:

Each of the diagonal arrows represents a single generation, with consumption represented by apples available during two separate periods of their lives.  The first diagonal-line generation gets what Murphy at one point calls the “free market” allocation, which is a large number of apples when they are young, and then a small number when they are old, with a total of 4 apples over their lifetime.  Generation 2, counting from the left, has the good fortune to spend its young years under a free-market allocation, but then benefits from a redistribution---Social Security, perhaps---during its old years, with the result that as a generation they get to consume 5 apples over their lifetime.  Then they die, and new generations take their place.  The next generation spends both young and old periods under the redistribution scheme that helps the elderly, and they get 4 apples over their lifetime, and they die.  But then the redistribution scheme is repealed, and the fourth generation from the left has to accept redistribution away from itself during its young period, but does not benefit from redistribution toward itself during its old period.  Over their lives they only get to consume 3 apples.   The generation that benefited from all of this was absolutely not alive in the same time period as the generation that lost out.  And there’s nothing that requires the redistribution scheme to last only two generations; it could last fifty generations, and when it is removed the final generation that pays in when it is young and receives no benefit when it is older will pay the cost, perhaps hundreds of years later. 

I’m grateful to Professor Rowe for explaining this model to me in a comment after I first mentioned that I was puzzled about it.  I think the insight in this model is important.  We instituted Social Security in 1935, and generations have benefited from it ever since.  Now there is talk about changing it, and there are many who would like to end it or expect it to end on its own by going broke.  We can see that if it does end the last generation under SS runs some risk of having its lifetime consumption reduced.

But I may need another comment from Professor Rowe to clarify the model’s conclusions.  I don’t see this model as having anything directly to do with debt or deficits.  Nothing in the picture above mentioned how the redistribution was financed.  If the redistribution during the middle two periods is financed entirely through taxes, the same benefit is experienced by generation 2, and the same loss by generation 4.  And, of course, it’s possible to create debt for other reasons than redistribution of incomes: if a debt leaves everyone’s incomes the same through time, how does the overlapping generations model indict it?  If the redistribution it creates is random with respect to age in its impact, so that the while income may be redistributed between people, the result does not imply a redistribution between cohorts, how does an overlapping generations model indict it?  This model seems to be directed very narrowly on debt created to finance redistribution between generations.   And finally, the cost to a future generation only occurs when the redistribution is reversed.  If it is maintained forever, through taxes or through new debt, or even through the creation of new money, there is no future generation that endures a cost. 

Nick Rowe responses to this last criticism this way:

“Some people might argue that the interest rate is below the growth rate, and will stay that way, which means the economy is dynamically inefficient, ponzi schemes are sustainable, and what the economy really needs is a government-run ponzi scheme which really would not be a burden on future generations, because the debt plus interest would be rolled over forever, with no tax increase on any future generation. That's OK too, if you can convince us your assumption is correct.”

But that’s the way it has worked for a very long time.  National debt is rarely really paid off completely with budget surpluses, but it is often reduces as a share of GDP through GDP growth, which will happen only if growth is greater than whatever new deficits must be financed, including interest.  It is possible that the economy is dynamically inefficient with regard to federal debt due to a general political disapproval of debt in the public sector.  It seems arguable, at least, that it is the assertion that the future will be different from the past, the assertion that the debt will harm us more in the future than it does right now, that requires evidence.  (I don’t think that models and evidence to show that are impossible: total federal debt in the United States is now more than 100% of GDP, and there are big expenses looming in the middle distance.  There is a wide discussion right now, as there should be, about the impact and limits of debt overhang, with some people arguing that a national debt that is too large actually reduces growth.  But that’s a completely different argument than the overlapping generations model, and it’s an argument that’s still just beginning.)

And finally, even if we convince ourselves that this overlapping generations model directly addresses debt, rather than redistribution however financed, or otherwise convince ourselves that debt not only can but must impose a burden on some future cohort through their lifetime, that doesn’t really impact the argument that is being made by Krugman and the others.  They are time-slicers, arguing that debt may redistribute income within a future year but that it doesn’t burden the national population as a whole, young and old together, during that year; they aren’t really looking at cohorts, so their “zombie idea” can’t be killed by a model that may illuminate the redistributional impact of debt on cohorts.  They can agree with the overlapping generations model, and still maintain that current debt doesn’t impose a burden on future time slices or accounting periods. 

The overlapping generations model does not deny that, in fact.  During each vertical time slice in the picture above the economy creates 4 apples altogether, time period after time period.  I think that part of the point of the model is that some cohorts may be burdened over their lifetimes even if no time period suffers any economic damage from debt-financed redistribution schemes.

Romney's Base-Broadening Curiosity

There have been plenty of responses to the first Presidential debate.  Here is a play-by-play, in a sense, from Ezra Klein and his colleagues at the Wonkblog that goes through the basic assertions that were made, and gives background for each. 

But there is an economics-related curiosity about one of Governor Romney’s assertions---or rather, about a sequence of claims that he has made in the past and seemed to amend during the debate.  They lead to a theoretical peculiarity related to his purpose in lowering tax rates and “broadening the base”. 

During the debate Romney denied that he intends to implement a tax cut that could result in a $5 trillion loss of revenue over a decade.  But he has called for a 20% tax rate cut for every income level.  He has also called for eliminating the alternative minimum tax, cutting the corporate tax rate to 25%, and maintaining all preferential tax treatment of capital gains and dividends.  If you do the math, this does amount to about $5 trillion of tax cuts over the next 10 years relative to the current policy baseline, and even more compared to current law (which would allow the Bush tax cuts to expire at the end of this year).   Still, Romney claims that other changes he intends to make, changes to “broaden the base”, will offset his tax rate changes to make the whole package revenue neutral---meaning that it will neither raise nor lose revenue for the government.  

When he says he wants to broaden the base, I think he may be trying to give the impression that he wants to get the 47% of the population who he claims pay no federal income taxes toss some money into the pot so that he can reduce taxes for the other 53% of the population.  That’s been the long-held vision on the right: everyone should have “skin in the game”, they say, ignoring the fact that almost everyone already does have skin in the tax game.  Nearly all adult American pay taxes of some kind.   But in general, broadening the base doesn’t need to mean including people in the tax system that are not now included: it means including income that is not now included.  That income may be earned by the same people who are now paying taxes, but it is income that is now sheltered from taxes by some special tax code provision.  And that’s why Romney has been talking about eliminating deductions and exemptions and other tax breaks to make up the revenue lost by his tax rate change.  Most studies have concluded that there is no set of tax break changes that could make the whole package revenue neutral without raising taxes on the middle class, and reducing taxes on the wealthy, and there was a strong suspicion on the left that a tax reduction for the wealthy was Romney’s real purpose.

But during the debate, Romney claimed that he had no intention reducing taxes for the wealthy, and he denied absolutely that he ever intended to raise taxes on the middle class.  He gave the strong impression that when he said the plan would be revenue neutral, he meant neutral at every income level: that no income level would pay any more or less taxes than they do now.  So the question is: what is the point, then?  If everyone pays the same taxes after the long exhausting ordeal of changing the tax code, why are we doing it?  And the answer seems, from other comments Romney has made, and comments from others on the right, that the purpose is not to change total taxes paid, but to lower the marginal tax rates.  The idea is that people respond to lower tax rates by working harder or working more. 

And now we get to the curious part. 

What is a tax rate?  Is it the additional taxes paid on each additional total dollar earned, or is it the nominal rate on each additional taxable dollar earned?  Here’s an example to show what this means.  Suppose you earn $100 million per year, you have $50 million in deductions---I know that this is a realistic example for all of you who read this---and your nominal tax rate on each additional taxable dollar is 20%.  Your taxable income is $100M total earned income-$50M deductions=$50M taxable income; 20% of that is $10 million, or 10% of the your total earned income.  Now suppose we eliminate all tax deductions and reduce the tax rate on taxable income to 10%.  Now you earn $100 million, have no deductions, and pay 10% of your total income, or $10 million, in taxes. Your nominal rate on taxable income has decreased, but your total tax bill hasn’t changed at all, just as Romney promised.

But Romney seemed to promise during the debate that the total tax payment rate will not change at any income level.  So as you rise to higher and higher income levels, you pay the same total amount in taxes at each new level that you would pay under current law.  The actual tax rate on each additional dollar earned has not changed, even though nominal tax rates on taxable income are reduced, because more of your income is now considered taxable.   

The curious thing is the apparent belief that people will respond to the nominal rate on taxable income, rather than the actual tax rate on total income. 

So what do you think?  Is that true?  And if so, why is it true?  Is this a kind of tax-rate blindness?  Is our logical incentive, the marginal tax on total income earned, hidden behind a taxable-income tax rate veil?

Curious.

Phantoms in the Dark Part 6: The Barro-Wight

 

I need to get to the crux of this, which is not really the issue of whether current deficits hurt or help growth, or whether the burden of current deficits are borne by the present population or by some distant future population.  No, the crux is really the question of how much total debt---not deficit---is too much, and whether there’s a point at which the total debt starts to slow growth down, or even reverse it, or otherwise cause damage to the economy.  That’s the real phantom here.  That’s the big one, the one that’s scaring everyone.  That’s the issue that makes people all over the political blogs claim that the country is, or will be, “bankrupt”, and that caused even Barack Obama to say at one point that we’ve run out of money.  So I need to discuss that, and I’ll do that soon.

But I’m aware, because I was reminded, that I never talked about the Barro/Ricardian equivalence idea about deficits, item number 3 in Nick Rowe’s list, which still talks only about deficits rather than total debt.  Barro’s idea is that whenever there is a federal budget deficit ordinary households will save more and spend less in order to prepare for what they think are the inevitable future taxes necessary to pay for the deficit.  As a result the total savings and total demand for goods and services is, according to this theory, the same if the government borrows to cover its costs as it would be if the government simply taxed the population and balanced the budget in the first place.  Deficits don’t burden future populations, this theory says, but only because the current populations rationally expect future taxation to pay for the deficits and all accumulated interest until the tax is applied.  Households rationally, and carefully, save just enough to pay the equivalent taxes, and pass their savings down the years until the taxes are imposed.

I am a little hesitant to approach this topic because it’s hard to know where to start: Robert Barro is a staggeringly smart economist, but I’m just puzzled by the whole set of assumptions that have to be made to make that concept work.  They seem to me to be the kind of assumptions you could make only if you have been absorbed in abstract mathematical models so deeply that you can no longer see the real world, absorbed so deeply that you think those models are the real world.  I can understand that.  I’ve been there, in my long-ago days in graduate school.  The mathematics were so beautiful that I wanted to live in the world they described instead of the world that exists.  But when we’re talking about actual policy prescriptions, we can’t pretend that the math is everything: we have to implement policy in the real world, and the results we get will be determined by how the real world works, not by how some seductive abstract model with perfect mathematical curves works.

But in any case, this post will be longer and wonkier than most of my posts, and longer and wonkier than I would like it to be.  I don’t know how else to express my problems with this item from the list. 

My examples will come from this version of Barro’s explanation of Ricardian equivalence.  To show what I mean about the assumptions that support the model, let’s start with this quote from that paper:

“I will sketch the standard model. The starting point is the assumption that the substitution of a budget deficit for current taxation leads to an expansion of aggregate consumer demand. In other words, desired private saving rises by less than the tax cut, so that desired national saving declines. It follows for a closed economy that the expected real interest rate would have to rise to restore equality between desired national saving and investment demand. The higher real interest rate crowds out investment, which shows up in the long run as a smaller stock of productive capital. Therefore…the public debt is an intergenerational burden in that it leads to a smaller stock of capital for future generations.”

It’s true that this model is fairly widely accepted in some parts of the economic world.  In fact, some parts of that world see this model, that government deficits reduce the total savings in the economy and that they therefore “crowd out” private investment, to be so self-evident that it requires no proof; there are those who are astonished and exasperated when anyone questions it. 

And I, on the other hand, am astonished and exasperated that anyone fails to question it, since to me it seems to be self evidently wrong. 

So let’s look at it.  Here are the assumptions I see in the quote above:

He assumes that deficit spending absorbs savings in the economy---that it competes with business for a limited supply of loanable funds.  It’s not a fixed supply, since he claims that a tax cut (or an increase in income caused by increased government spending) will increased desired savings, but, he asserts, not by as much as the deficit the government must cover. 

But as I pointed out a few posts ago, when the government spends, that act creates savings in the economy; it increases total savings by at least the amount of the government spending.  Someone in the economy, a business or a household, receives what the government spends.  I’m not proposing anything radical by saying this, these are just two sides of the same transaction.  Until that person or business spends the money, it is an increase in savings.  But what happens when a household does spend the money on consumption goods, for example?  Doesn’t that decrease savings?  No, it doesn’t.  The money is subtracted from the household’s bank account by the transaction---and is added to the bank account of the business that sold the consumption goods.  The savings is still there, but now it is corporate savings instead of household savings.  You can go through all the other possible kinds of transaction, such as investment or other spending by businesses, and you will find that because every transaction has two sides, one person buying and another selling, the money, the savings created by government spending, never leaves the system.  It always shows up as savings in someone’s account, unless the government taxes it away.   So when the government spends money, and then borrows to cover the cost, it is simply borrowing the savings that were created by its spending, not absorbing any share of a pool of savings that existed prior to those actions.  (That is not, of course, the end of the story: the actual savings that have shown up in people’s and business’s bank accounts may be more savings than they desire at their new level of income, and they will try to reduce it by spending or investing.  They will continue to do this until the total nominal national income rises enough to make the actual savings acceptable to the people and businesses who end up holding it---but that’s a much longer story than I can tell in this post.)

But even if it were not true as an accounting artifact that government spending creates new nominal savings, the quote from Barro above would be questionable, since it seems to assume that all savings that existed prior to the government action were already demanded by businesses or households for investment purposes. That is not necessarily true; in fact it is clearly not true right now.   There were $1.452 trillion dollars in excess reserves at the Federal Reserve bank as of September 19, 2012.

Now let’s get to the Ricardian model itself.  Barro says:

"The Ricardian modification to the standard analysis begins with the observation that, for a given path of government spending, a deficit-financed cut in current taxes leads to higher future taxes that have the same present value as the initial cut."

Alternatively, he would say that an increase in government spending without increasing taxes in the present must imply an increase in taxes in the future that has the same present value as the spending increase.  And he goes on to explicitly state:

"This result follows from the government's budget constraint, which equates the total expenditures for each period (including interest payments) to revenues from taxation or other sources and the net issue of interest-bearing public debt."

But if you have read the prior Phantom posts, you know that there are economists out there, from at least the time of Abba Lerner’s paper on Functional Finance, who do not accept the idea that the government even has a budget constraint.  Nor do I.   The usual expressions of an intertemporal government budget constraint that include only taxing, borrowing and spending as variables across time.  But if we include the government’s ability to create money into an expression of an intertemporal budget condition, or intertemporal budget equation, we see that it is no longer an intertemporal constraint: a  government that controls its own money supply can always purchase anything that is offered for sale in its own currency, either now or at any time in the future.  For other economic reasons, for example to avoid excessive demand that would drive inflation, the government may choose not to finance its spending by money creation, but its equally true that to stimulate demand and achieve full employment the government may prefer that means of finance in some periods in the future.  All of that simply means that the full intertemporal budget equation, including all methods of financing government activity, might be useful along with other equations in planning.  But it is not a constraint on government financing, and it can't be used in any simplistic way to forecast tax rates in the future.

So this whole Ricardian alternative depends on assumptions of eternal full employment of resources, eternal full employment of any existing savings, and the existence of an intertemporal government budget constraint, none of which are true in the real world.

But none of these is the biggest failing, in my view, of the Ricardian equivalence theory. The theory itself after all of this build up states that:

"household's demands for goods depend on the expected present value of taxes---that is, each household subtracts its share from the expected present value of income to determine a net wealth position."

This is the one that floors me, frankly.  I don't understand how anyone can suggest this with a straight face. 

Let me make this clear.  Future tax rates do not depend on current deficits even in theory, and if there is any such dependence as a practical matter it is a pretty feeble one.  As evidence, we could simply point to the post-WWII history of the United States, where deficits have been common but tax rates have consistently declined.  In fact when deficits exploded under Reagan/Bush in the eighties and under George W. Bush  in the oughts, tax rates declined a great deal in both decades.  The top tax rate at the end of WWII was above 90%.  In spite of all the decades of deficits since then the top tax rate is now 35%.

But ignoring all of that, ignoring all the questionable or simply false assumptions discussed above, and the feeble---in fact completely invisible---connection between observed tax rates and actual deficits, does anyone seriously believe that households---all of them, rich and poor, educated and not---take the time to calculate a discounted present value of all expected future taxes before they buy milk at Safeway?   People simply do not behave like this.  I don't mean that a few irresponsible people who fail to calculate their net wealth position including the discounted present value of all future taxes while they’re standing in the produce aisle weaken the theory.  I mean that because of this problem alone the theory is bunk because absolutely no one behaves like this.  If there are exceptions, I don’t know them.  I strongly doubt that Robert Barro behaves like this.  

Here's why I doubt it: the failure to do this calculation isn’t laziness.  And it isn't ignorance.  People do not try to make that calculation because neither an average person nor the world’s greatest economic expert can make it, so no rational person would try to make it as a basis for their daily decisions. While the CBO and other forecasters do try to peer into distant futures with huge macroeconomic models, they do so with a humility born of frequent error.  The CBO should not be blamed for these errors.  The distant future is impenetrable and unpredictable, even to the brightest and best-educated people on this planet.  As I pointed out in an earlier post, no one a quarter of a century ago could possibly have predicted the federal budget surpluses of the late nineties; they could not have predicted the dot-com boom or the subsequent dot-com collapse, because a quarter of a century ago even the concept of a dot-com was unknown and unimagined, except perhaps in the secret inner mind of Timothy Berners-Lee.  And if the best educated people on earth were trying to predict the stream of government revenue in the future they would include tax rates as only one of many variables: economic growth, population growth, income distribution, employment, the probability of new resources, new technologies, wars, booms, busts, and many other things would also enter their calculations.   And they still would not get it completely right.

So of the four items in Nick Rowe’s list on the burden of deficits, this is the one I find least plausible.  The real world is not nearly as perfect as the original “standard” model that Barro outlined in the quote at the top of this post.  The government does not actually face a budget constraint, so using one to predict tax rates in the future is misguided at best.  Unemployment does occur, not only of people, plant capacity, transportation capacity and other real things, but also of saved funds.  Future tax rates don’t really depend on current deficits, partly because future financing needs and strategies depend on many, many things, and accumulated debt is only one of them.  And finally, no one at all would ever, or could ever, make the calculations that Ricardian equivalence requires of them as they make their savings and consumption choices.