Tag: debt

The National Debt Is Huge, but Unfunded Liabilities Are America’s Real Red-Ink Challenge

I frequently argue that government spending is the problem, not budget deficits. Regardless of whether it is financed by taxing or borrowing, every penny of spending diverts resources from the productive sector of the economy. I narrated a video explaining why excessive spending is bad from a theoretical perspective. I did another looking at the empirical evidence for smaller government. And I had another video discussing why deficits are a symptom and the real problem is bloated budgets.

Nonetheless, some people seem convinced that deficits and debt are the real problem. While I think that focus is a bit misguided, I certainly agree that there is something utterly immoral about spending today and imposing a fiscal burden on future taxpayers (especially since so much government spending is for current consumption and transfers).

But here’s some really depressing news for the anti-debt crowd. Today’s deficits and debt actually are just the tip of the iceberg. Here’s a new video exposing the enormous unfunded liabilities resulting from entitlement programs. As the video explains, unfunded liabilities are promises by politicians that impose enormous long-term obligations for more spending and debt.

The narrator of the video is Kelly McDonough, a student at American University and a former Cato Institute intern. If this video is anywhere near as successful as the other video narrated by a former Cato intern, perhaps this will become a new tradition. That won’t be good for my video career, but it shows that the Cato Institute is doing a good job cultivating a new generation of freedom fighters.

What’s the Future for Supply-Side Economics?

Kevin Williamson has a long-overdue piece in National Review making two essential points about supply-side economics and the Laffer Curve. First, he explains that tax cuts are not the fiscal equivalent of a perpetual motion machine. Simply stated, too many Republicans have fallen into very sloppy habits. They oftentimes fail to understand the difference between “supply-side” tax rate reductions that actually improve incentives to engage in productive behavior and social-engineering tax cuts that simply allow people to keep more money, regardless of whether they create more wealth. This does not necessarily mean the latter form of tax cuts are bad, but they definitely do not boost economic performance and generate revenue feedback. Moreover, even when GOPers are talking about supply-side tax cuts, they frequently exaggerate the positive effects by claiming that lower tax rates “pay for themselves.” I certainly think that can happen, and I give real-world examples in this video on the Laffer Curve (including Reagan’s lower tax rates on those evil rich people), but self-financing tax cuts are not common.

Williamson’s second point is that the true fiscal burden is best measured by looking at how much government is spending. I might quibble with his description of deficits as a form of deferred taxation since technically debt can be rolled over in perpetuity, but his main point is right on the mark. There is no doubt that most forms of government spending – regardless of the means of financing – harm growth by diverting money from the productive sector of the economy (technically, the economic damage occurs because capital and labor are misallocated and incentives are diminished, but let’s not get too wonky). Here are some excerpts from Williamson’s article:

Properly understood, there were no Reagan tax cuts. In 1980 federal spending was $590 billion and in 1989 it was $1.14 trillion; you don’t get Reagan tax cuts without Tip O’Neill spending cuts. Looked at from the proper perspective, we haven’t really had any tax cuts to speak of — we’ve had tax deferrals. …even during periods of strong economic growth, there has been nothing to indicate that our economy is going to grow so fast that it will surmount our deficits and debt without serious spending restraint. This should be a shrieking klaxon of alarm for conservatives still falling for happy talk about pro-growth tax cuts and strategic Laffer Curve optimizing. …The exaggeration of supply-side effects — the belief that tax-rate cuts pay for themselves or more than pay for themselves over some measurable period — is more an article of faith than an economic fact. But it’s a widespread faith: George W. Bush argued that tax cuts would serve to increase tax revenues. So did John McCain. …It is true that tax cuts can promote growth, and that the growth they promote can help generate tax revenue that offsets some of the losses from the cuts. …The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending — just keep cutting taxes, the argument goes, and somebody else will eventually have to cut spending. The results speak for themselves: Tom DeLay and Dennis Hastert and Trent Lott and Bill Frist all know how to count, but, under their leadership, Republicans spent all the money the country had and then some.

Now that we’ve chastised Republicans, it’s time to turn our attention to the Democrats. We know they are bad on spending (I often joke that Republicans expand government out of stupidity, while Democrats do it for reasons of malice), so let’s focus on their approach to Laffer Curve issues. If the GOP is guilty of being too exuberant, the Democrats and their allies at the Joint Committee on Taxation (the bureaucracy on Capitol Hill that estimates the revenue impact of tax policy changes) are guilty of deliberate blindness. The current methodology used by the JCT (with the full support of the Democrats) is to assume that changes in tax policy – regardless of magnitude – have zero impact on economic performance. If you double tax rates, the JCT assumes the economy is unaffected and people earn just as much taxable income. If you replace the IRS with a flat tax, the JCT assumes there is no effect on macroeconomic performance. Sounds unbelievable, but this video has the gory details, including when my former boss, Senator Bob Packwood was told by JCT that revenues would rise year after year even if the government imposed a 100 percent tax rate.

Interestingly, the European Central Bank just released a new study showing that there are substantial Laffer Curve affects and that lower tax rates generate large amounts of revenue feedback. In a few cases (Sweden and Denmark), the researchers even conclude that some lower tax rates would be in that rare category of self-financing tax cuts. But the key point from this ultra-establishment institution is that changes in tax rates do lead to changes in taxable income. This means it is an empirical question to determine the revenue impact. Here’s a key excerpt from the study’s conclusion:

We show that there exist robust steady state Laffer curves for labor taxes as well as capital taxes. …EU-14 countries are much closer to the slippery slopes than the US. More precisely, we find that the US can increase tax revenues by 30% by raising labor taxes but only 6% by raising capital income taxes, while the same numbers for EU-14 are 8% and 1% respectively. …We find that for the US model 32% of a labor tax cut and 51% of a capital tax cut are self-financing in the steady state. In the EU-14 economy 54% of a labor tax cut and 79% of a capital tax cut are self-financing. We therefore conclude that there rarely is a free lunch due to tax cuts. However, a substantial fraction of the lunch will be paid for by the efficiency gains in the economy due to tax cuts.

Contrary to over-enthusiastic Republicans and deliberately-dour Democrats, the Laffer Curve/supply-side economics debate is not a binary choice between self-financing tax cuts and zero-impact tax cuts. Yes, there are examples of each, but the real debate should focus on which types of tax reforms generate the most bang for the buck. In the 1980s, the GOP seems to have the right grasp of this issue, focusing on lowering tax rates and reducing the discriminatory tax bias against saving and investment. This approach generated meaningful results. As Nobel laureate Robert Lucas wrote, “The supply side economists, if that is the right term for those whose research we have been discussing, have delivered the largest genuinely free lunch that I have seen in 25 years of this business, and I believe we would be a better society if we followed their advice.”

But identifying and advocating pro-growth tax reforms, as Williamson notes, is just part of the battle. The real test of fiscal responsibility if controlling the size of government. Republicans miserably failed at this essential task during the Bush year. If they want to do the right thing for the nation, and if they want to avert a Greek-style fiscal collapse, they should devote most of their energies to reducing the burden of government spending.

Greece’s Problem Is High Tax Rates, Not Tax Evasion

The New York Times has an article describing widespread tax evasion in Greece, along with an implication that the country’s fiscal crisis is largely the result of unpaid taxes and could be mostly solved if taxpayers were more obedient to the state. This is grossly inaccurate. A quick look at the budget numbers reveals that tax revenues have remained relatively constant in recent years, consuming nearly 40 percent of GDP. The burden of government spending, by contrast, has jumped significantly and now exceeds 50 percent of Greek economic output.

The article also is flawed in assuming that harsher enforcement is the key to compliance. As this video shows, even the economists at the Paris-based Organization for Economic Cooperation and Development admit that tax evasion is driven by high tax rates (which is remarkable since the OECD is the international bureaucracy pushing for global tax rules to undermine tax competition and reduce fiscal sovereignty).

Ironically, the New York Times article quotes Friedrich Schneider of Johannes Kepler University in Austria, but only to provide an estimate of Greece’s shadow economy. The reporter should have looked at an article that Schneider wrote for the International Monetary Fund, which found that:

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy. …In Austria, the burden of direct taxes (including social security payments) has been the biggest influence on the growth of the shadow economy… Other studies show similar results for the Scandinavian countries, Germany, and the United States. In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points. …A study of Quebec City in Canada shows that people are highly mobile between the official and the shadow economy, and that as net wages in the official economy go up, they work less in the shadow economy. This study also emphasizes that where people perceive the tax rate as too high, an increase in the (marginal) tax rate will lead to a decrease in tax revenue.

It is worth noting the Schneider’s research also shows why Obama’s tax policy is very misguided. The President wants to boost the top tax rate by nearly five percentage points, and that’s on top of the big increase in the tax rate on saving and investment included in Obamacare. Based on Schneider’s research, we can expect America’s underground economy to expand.

Shifting back to Greece, Schneider does not claim that tax rates are the only factor determining compliance. But his research indicates that more onerous enforcement regimes are unlikely to put much of a dent in tax evasion unless accompanied by better tax policy (i.e., lower tax rates). Moreover, compliance also is undermined by the rampant corruption and incompetence of the Greek government, but that problem won’t be solved unless politicians reduce the size and scope of the public sector. Needless to say, that’s not very likely. So when I read some of the details in this excerpt from the New York Times, much of my sympathy is for taxpayers rather than the greedy politicians that turned Greece into a fiscal mess:

In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools. So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools. That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here. …Such evasion has played a significant role in Greece’s debt crisis, and as the country struggles to get its financial house in order, it is going after tax cheats as never before. …To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker. …Various studies have concluded that Greece’s shadow economy represented 20 to 30 percent of its gross domestic product. Friedrich Schneider, the chairman of the economics department at Johannes Kepler University of Linz, studies Europe’s shadow economies; he said that Greece’s was at 25 percent last year and estimated that it would rise to 25.2 percent in 2010.

Bernanke’s Hollow Deficit Warning

Even though I’ve been in Washington almost 25 years, I am endlessly amazed at the chutzpah of people who support higher spending and bigger government while piously lecturing the rest of us about the need to control deficits. Fed Chairman Ben Bernanke is a good (though “bad” might be a better term) example of this hypocrisy. He was an avid supporter of bailouts and so-called stimulus, yet the Washington Post reports that he is now hectoring us to be fiscally responsible:

Federal Reserve Chairman Ben S. Bernanke warned Wednesday that Americans may have to accept higher taxes or changes in cherished entitlements such as Medicare and Social Security if the nation is to avoid staggering budget deficits that threaten to choke off economic growth. “These choices are difficult, and it always seems easier to put them off – until the day they cannot be put off anymore,” Bernanke said in a speech. “But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.”

ObamaCare’s New Entitlement Spending “Sows the Seeds” of a Budget Crisis

From Robert J. Samuelson’s column in today’s Washington Post:

When historians recount the momentous events of recent weeks, they will note a curious coincidence. On March 15, Moody’s Investors Service – the bond rating agency – published a paper warning that the exploding U.S. government debt could cause a downgrade of Treasury bonds. Just six days later, the House of Representatives passed President Obama’s health-care legislation costing $900 billion or so over a decade and worsening an already-bleak budget outlook.

Should the United States someday suffer a budget crisis, it will be hard not to conclude that Obama and his allies sowed the seeds, because they ignored conspicuous warnings. A further irony will not escape historians. For two years, Obama and members of Congress have angrily blamed the shortsightedness and selfishness of bankers and rating agencies for causing the recent financial crisis. The president and his supporters, historians will note, were equally shortsighted and self-centered – though their quest was for political glory, not financial gain.

I hope Samuelson is wrong, but it’s probably a good idea to behave as if he’s right, and repeal ObamaCare’s new entitlement spending.

Senator Bunning Exposes Washington’s Fiscal Frauds

President Obama and many other politicians in Washington are big fans of pay-as-you-go budgeting, which means they want any new spending or tax relief offset (or “paid for”) with tax increases or spending cuts from other parts of the budget. Or at least that’s what they claim. But when Senator Bunning took them at their word and blocked a $10 billion spending bill because his colleagues were unwilling to make some tiny changes elsewhere, he was treated like a leper. Even his Republicans colleagues largely disapproved of his actions (so much for having learned any lessons from the drubbings they took at the polls in 2006 and 2008). Attacked from all sides, Bunning eventually relented in exchange for an offset vote (which was defeated, of course). What makes this episode interesting is not the specific policies that were being considered. As I posted earlier this week, Bunning was not even trying to shrink the size of government. Indeed, his “offset” was actually a tax increase (getting rid of a special tax break for paper manufacturing).

But this incident does expose the gross hypocrisy of the supposed deficit hawks in Washington. President Obama and the Democrats (and many Republicans) pretend they care about deficits, but their concerns magically disappear whenever there is a chance to buy votes by spending other people’s money. When tax cuts or tax increases are being debated, however, many of these same politicians piously declare their unwavering opposition to red ink (unless, of course, it’s a special tax break for a contributor). But perhaps it’s no surprise to discover that politicians think higher taxes are the solution to the over-spending problem in Washington.

What about the organizations that supposedly exist to fight deficits, such as the Concord Coalition and the Committee for a Responsible Federal Budget (they should be fighting spending instead, but let’s set that issue aside). Folks from these groups often ask politicians to be courageous and make “tough choices.” So I went to the Concord Coalition’s homepage and was shocked, shocked to find nothing about Bunning’s effort. I checked the blog and the press releases and found lots of tough rhetoric, but not one word of praise (or one word of any sort) for a Senator who tried to put the Concord Coalition’s words into action. And what about the Committee for a Responsible Federal Budget? Same song, second verse. Not a mention of Bunning on the homepage, blog, or in the press releases. (See update below)

Anybody care to make any predictions whether these groups will be similarly silent when President Obama’s “Fiscal Responsibility Commission” unveils a big tax hike?

Mea Culpa: On another matter, I have to confess an error. I did an interview for NBC affiliate stations on the financial mess at the Postal Service. I haven’t spent any time on that issue, so I quickly scanned some material from my Cato colleagues Chris Edwards and Tad DeHaven and saw that Congress had given an indirect bailout to the Postal Service by suspending $4 billion of required pre-funding for retiree health benefits. I then went on the air and said that this was a taxpayer subsidy for the Postal Service’s lavish pay and benefits. The Postal Service does have lavish pay and benefits, and the indirect bailout may lead to a direct infusion of taxpayer money at some point in the near future, but what I said I was wrong because no taxpayer money is currently being allocated (and I would have avoided the mistake if I paid closer attention to what Chris and Tad wrote). So, please, postal workers, don’t go…um…postal on me.

Mea Culpa, Part II: I am getting sloppy in my old age. Maya MacGuineas of the Committee for a Responsible Federal Budget nailed me fair and square. CFRB did say something nice about Bunning on its blog back on February 26. I should have scrolled down farther. I did just check the Concord Coalition blog, all the way back to the beginning of the year, and was relieved (from a personal perspective, not on policy grounds) to find no mention of Bunning’s effort.

A Value-Added Tax Is Not the Answer…Unless the Question Is How to Finance Bigger Government

While admitting that spending restraint is the ideal approach, Tyler Cowen of Marginal Revolution asks whether a value-added tax (VAT) might be the most desirable of all realistic options for dealing with an unsustainable budget situation.

Read his post for yourself, but I think a fair summary is that he is basically saying that a) there will be a crisis if we don’t do something about future deficits, b) a crisis will result in very bad policy, and c) if we support a VAT now, we will at least be able to extract concessions from the other side.

I have no idea whether there will be a future crisis, but I think the rest of Tyler’s argument is wrong.

But before explaining my position, let’s start by stating what I assume to be our mutual objective, which is to control the size of government. We all agree that there is a problem because government is too big now, and it is projected to get even bigger because of the built-in growth of entitlement programs. One symptom of growing government is deficits, which are very large today and will be even bigger in the near future as more and more baby boomers retire and push up costs for Social Security, Medicare, and Medicaid.

Our side (broadly speaking) wants to solve the budgetary situation by restraining the growth of government. One proposed solution is Congressman Paul Ryan’s Roadmap Plan, which would reform entitlements and curtail other programs so that the long-term burden of federal spending is reduced to less than 20 percent of GDP. Since long-term federal tax revenues under current law - even if the 2001 and 2003 tax cuts are made permanent - are expected to be about 19 percent of GDP, this solves the budet problem  (the tax reform component of the Roadmap includes a VAT, which is a poison pill in an otherwise excellent plan, but let’s set that aside for another day).

The left, by contrast, generally wants to let federal spending consume ever-larger shares of economic output, and they believe that increasing the tax burden is the right way of keeping the deficit from getting too large. No statist has put forth a detailed plan to match Rep. Ryan, but several high-ranking Democrats have made no secret about their desire for a VAT (see here, here, and here). And everyone agrees that a VAT is capable of extracting a lot of money from the productive sector of the economy.

These two visions are fundamentally incompatible, which helps to explain why there is a standoff. The bad guys do not want to control the size of government and the good guys do not want to raise taxes. But now we have to add one more piece to the puzzle. While gridlock normally is a good result, inaction to some degree favors the other side because entitlement programs automatically expand. The helps to explain why Tyler (with reluctance) thinks that it may be best to acquiesce to a VAT now rather than to wait for a fiscal crisis.

Now, let’s explain why Tyler is wrong. First, it is far from clear that surrendering to a VAT now will result in better (less worse) policy than what will happen during a crisis. It certainly is true that some past crises have led to terrible policy, such as the failed policies of Hoover and Roosevelt in the 1930s or the more recent Bush-Paulson-Obama-Geithner TARP debacle. But at other points in time, a crisis atmosphere has paved the way for better policy, with Reagan’s presidency being the most obvious example.

The wait-for-a-crisis strategy clearly is a bit of a gamble, but even if we lose, we get a VAT in the future rather than a VAT today. So what’s the downside? Tyler and others might say that the future legislation in the midst of a crisis could be a vehicle for other bad provisions, but he offers no evidence for this proposition. And it may be the case that the other side would be forced to add good provisions instead. Moreover, the lack of a VAT in the period between today and the future crisis might help lead to some much-needed spending restraint.

What about Tyler’s argument that the good guys could extract some concessions from the other side by putting a VAT on the table. This is horribly naive. Even though George Mason University is less than 20 miles from Washington, and even though Tyler is a renassaince man with many talents, he does not understand how Washington really works.

Imagine there is a budget summit where politicians from both sides get together to work on this supposed deal. Here are the inevitable ground rules - and the consequences they will produce:

1. The deal will be 50 percent spending cuts and 50 percent tax increases, but the supposed spending “cuts” will be nothing more than reductions in already-legislated increases. The tax increases, by contrast, will be on top of all the additional revenue that is already exepected under current law (not a trivial matter since receipts will be $1.5 trillion higher in 2015 than they are today according to OMB). For proponents of limited government, using the “current services baseline” as a benchmark in budget negotiations is like playing a five-minute basketball game after spotting the other team a 20-point lead.

2. All spending and revenue decisions will be examined through the prism of CBO income distribution tables, and the left will successfully insist that nothing is done to make the tax code less progressive. But since a VAT is a proportional tax, the only way of preserving overall progressivity is to raise tax rates on those wicked and evil rich people and/or to massively increase “refundable” tax credits (what normal people call income redistribution). Any proposal to lower income tax rates or eliminate the corporate income tax, as Tyler envisions, would be laughed out of the room (though Democrats will offer a fig leaf or two in order to seduce a sufficient number of gullible Republicans into supporting a terrible agreement, and that might include a cosmetic change to the corporate tax regime).

3. Many of the supposed spending cuts, for all intents and purposes, will be back-door tax increases on saving and investment. More specifically, a big chunk of the supposed spending cut portion of a budget deal will be from means-testing entitlement programs. This sounds good. After all, who wants to send a Social Security check to Bill Gates when he retires? But consider how such a system actually will work. The government will say that people with income (and/or assets) above a certain level are ineligible for some or all of the benefits available to less-fortunate retirees. From an economic persepective, this is very much akin to a higher tax rate on people who save and invest during their working years. And since means testing would only generate substantial budgetary savings if it applied to millions of regular people in addition to Bill Gates, we would wind up with a system that created big penalties on middle-class families who were dumb enough to save and invest.

I’ve already pontificated enough for one blog post, so let me summarize by stating that Tyler’s approach, while not unreasonable, is about how to lose gracefully. Even if his strategy works perfectly, the result is bigger government. I’d much rather fight. If you want some inspiration for the battle, watch this video. If you haven’t had enough of me already, here’s my video explaining why the VAT is a horrible idea.

Update: Tyler has emailed to object to how his position is being characterized. He writes, “I am asking anti-VAT forces to strengthen their argument and am very clearly agnostic and certainly not calling for a VAT today.” Everyone I’ve spoken with has interpreted his post as pro-VAT, and that’s certainly how I read it, but I want to add this addendum to my post so people can see Tyler’s response in case I’m not being fair.