Tag: debt

My Testimony on the Illegal IRS Rule Increasing Taxes & Spending under ObamaCare

Here is the video of my recent opening statement before a House Oversight Committee hearing on the IRS rule that Jonathan Adler and I write about in our forthcoming Health Matrix article, “Taxation without Representation: the Illegal IRS Rule to Expand Tax Credits under the PPACA.”

Please forgive the audio.

In addition, Pete Suderman writes that Adler and I “have jointly authored a long and quite convincing rebuttal to defenders of the IRS rule over at the journal Health Affairs. If they are right, it could be a fatal blow to the law.”

How to Increase the Money Supply, Without Increasing the Government’s Debt

In my August 2012 Globe Asia column, “Money, Where’s the Money?”, I explained why the global economy is still sputtering, and proposed a partial solution. In short, I called for governments (not central banks) to engage in debt market operations – a way to increase the money supply directly, without increasing the overall level of government debt. A number of readers have since contacted me with questions about the specific example I discussed in my column. The most frequent question was:

“Isn’t your proposal just the same as the Fed’s Operation Twist, where the Fed purchases long-term government securities from the public and increases high-powered money?”

The answer is, in short, no – and here’s why:

The first thing that should be noted is that both a central bank and a government can conduct debt market operations. Debt market operations constitute either central bank, or government, transactions with non-banks, which change the bank deposits held by those non-banks. There are many combinations of such operations that can be employed, but with all debt market operations of the type I am envisioning, long-dated debt is replaced with short-dated debt (and so, in one sense, there would be some similarity with Operation Twist).

In my Globe Asia example, however, the government would conduct the debt market operations with no involvement by the central bank. The government would borrow from private banks and purchase outstanding long-dated government debt from the public, and then cancel the debt that had been purchased. The result would be an increase in the money supply, with no change in the monetary base. If the government were instead to borrow from the central bank, both base money and broad money would increase – a fundamental difference.

The central bank could engage directly in debt market operations (and several have done so in recent QE operations). But, in this case, the long-dated bonds purchased by the central bank would end up on the central bank’s balance sheet. The debt would not be canceled out, as it would be if the government was to conduct debt market operations. It is this fact that defines one of the fundamental differences between debt market operations conducted by a central bank and those conducted by a government. A central bank engaged in debt market operations would be left with holdings of long-dated government debt and be exposed to interest rate risk on those securities. It could incur large accounting losses if interest rates were to rise. This would not be the case if the government conducted debt market operations.

Europe’s Crisis Is Because of Too Much Government, Not the Euro Currency

The mess in Europe has been rather frustrating, largely because almost everybody is on the wrong side.

Some folks say they want “austerity,” but that’s largely a code word for higher taxes. They’re fighting against the people who say they want “growth,” but that’s generally a code word for more Keynesian spending.

So you can understand how this debate between higher taxes and higher spending is like nails on a chalkboard for someone who wants smaller government.

And then, to get me even more irritated, lots of people support bailouts because they supposedly are needed to save the euro currency.

When I ask these people why a default in, say, Greece threatens the euro, they look at me as if it’s the year 1491 and I’ve declared the earth isn’t flat.

So I’m delighted that the Wall Street Journal has published some wise observations by a leading French economist (an intellectual heir to Bastiat!), who shares my disdain for the current discussion. Here are some excerpts from Prof. Salin’s column, starting with his common-sense hypothesis.

…there is no “euro crisis.” The single currency doesn’t have to be “saved” or else explode. The present crisis is not a European monetary problem at all, but rather a debt problem in some countries—Greece, Spain and some others—that happen to be members of the euro zone. Specifically, these are public-debt problems, stemming from bad budget management by their governments. But there is no logical link between these countries’ fiscal situations and the functioning of the euro system.

Salin then looks at how the artificial link was created between the euro currency and the fiscal crisis, and he makes a very good analogy (and I think it’s good because I’ve made the same point) to a potential state-level bankruptcy in America.

The public-debt problem becomes a euro problem only insofar as governments arbitrarily decide that there must be some “European solidarity” inside the euro zone. But how does mutual participation in the same currency logically imply that spendthrift governments should get help from the others? When a state in the U.S. has a debt problem, one never hears that there is a “dollar crisis.” There is simply a problem of budget management in that state.

He then says a euro crisis is being created, but only because the European Central Bank has surrendered its independence and is conducting backdoor bailouts.

Because European politicians have decided to create an artificial link between national budget problems and the functioning of the euro system, they have now effectively created a “euro crisis.” To help out badly managed governments, the European Central Bank is now buying public bonds issued by these governments or supplying liquidity to support their failing banks. In so doing, the ECB is violating its own principles and introducing harmful distortions.

Last but not least, Salin warns that politicians are using the crisis as an excuse for more bad policy - sort of the European version of Mitchell’s Law, with one bad policy (excessive spending) being the precursor of an additional bad policy (centralization).

Politicians now argue that “saving the euro” will require not only propping up Europe’s irresponsible governments, but also centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular. There are a few reasons why politicians in Paris might take that view. They might see themselves being in a similar situation as Greece in the near future, so all the schemes to “save the euro” could also be helpful to them shortly. They might also be looking to shift public attention away from France’s internal problems and toward the rest of Europe instead. It’s easier to complain about what one’s neighbors are doing than to tackle problems at home. France needs drastic tax cuts and far-reaching deregulation and labor-market liberalization. Much simpler to get the media worked up about the next “euro crisis” meeting with Angela Merkel.

This is a bit of a dry topic, but it has enormous implications since Europe already is a mess and the fiscal crisis sooner or later will spread to the supposedly prudent nations such as Germany and the Netherlands. And, thanks to entitlement programs, the United States isn’t that far behind.

So may as well enjoy some humor before the world falls apart, including this cartoon about bailouts to Europe from America, the parody video about Germany and downgrades, this cartoon about Greece deciding to stay in the euro, this “how the Greeks see Europe” map, and this cartoon about Obama’s approach to the European model.

P.S. Here’s a video narrated by a former Cato intern about the five lessons America should learn from the European fiscal crisis.

The Simple and Predictable Story of Fiscal Bankruptcy in Cyprus

With all the fiscal troubles in Greece, Spain, Ireland, Portugal, and Italy, there’s not much attention being paid to Cyprus.

But the Mediterranean island nation is a good case study illustrating the economic dangers of big government.

For all intents and purposes, Cyprus is now bankrupt, and the only question that remains to be answered is whether it will get handouts from the IMF-ECB-EC troika, handouts from Russia, or both. Here’s some of what has been reported by AP.

Cyprus’ president on Thursday defended his government’s decision to seek financial aid from the island nation’s eurozone partners while at the same time asking for a loan from Russia, insisting that the two are perfectly compatible. …Cyprus, with a population of 862,000 people, last week became the fifth country that uses the euro currency to seek a European bailout… The country is currently in talks with the so-called ‘troika’ — the body made up of officials from the European Commission, the European Central Bank and the International Monetary Fund — on how much bailout money it will need and the conditions that will come attached. Locked out of international markets because of its junk credit rating status, Cyprus is paying its bills thanks to a €2.5 billion ($3.14 billion) Russian loan that it clinched last year. But that money is expected to run out by the end of the year.

So what caused this mess? Is Cyprus merely the helpless and innocent victim of economic turmoil in nearby Greece?

That’s certainly the spin from Cypriot politicians, but the budget data shows that Cyprus is in trouble because of excessive spending. This chart, based on data from the International Monetary Fund, shows that the burden of government spending has jumped by an average of 8.3 percent annually since the mid-1990s.

My Golden Rule of fiscal policy is that government spending should grow slower than economic output. Nations that follow that rule generally enjoy good results, while nations that violate that rule inevitably get in trouble.

Interestingly, if Cypriot politicians had engaged in a very modest amount of spending restraint and limited annual budgetary increases to 3 percent, there would be a giant budget surplus today and the burden of government spending would be down to 21.4 percent of GDP, very close to the levels in the hyper-prosperous jurisdictions of Hong Kong and Singapore.

Actually, that’s not true. If the burden of government spending had grown as 3 percent instead of 8.3 percent, economic growth would have been much stronger, so GDP would have been much larger and the public sector would be an ever smaller share of economic output.

Speaking of GDP, the burden of government spending in Cyprus, measured as a share of GDP, has climbed dramatically since 1995.

A simple way to look at this data is that Cyprus used to have a Swiss-sized government and now it has a Greek-sized government. Government spending is just one of many policies that impact economic performance, but is anyone surprised that this huge increase in the size of the public sector has had a big negative impact on Cyprus?

Interestingly, if government spending had remained at 33.9 percent of GDP in Cyprus, the nation would have a big budget surplus today. Would that have required huge and savage budget cuts? Perhaps in the fantasy world of Paul Krugman, but politicians could have achieved that modest goal if they had simply limited annual spending increases to 6 percent.

But that was too “draconian” for Cypriot politicians, so they increased spending by an average of more than 8 percent each year.

What’s the moral of the story? Simply stated, the fiscal policy variable that matters most is the growth of government. Cyprus got in trouble because the burden of government grew faster than the productive sector of the economy.

That’s the disease, and deficits and debt are the symptoms of that underlying problem.

Europe’s political elite doubtlessly will push for higher taxes, but that approach - at best - simply masks the symptoms in the short run and usually exacerbates the disease in the long run.

Fidel Castro, Medicare Beneficiary?

There’s no proof yet, but it looks an awful lot like Medicare might be subsidizing the Castro brothers.

I, for one,  was not surprised to read that Medicare payments for non-existent medical services are ending up in Cuban (read: government-controlled) banks. Nor that “accused scammers are escaping in droves to Cuba and other Latin American countries to avoid prosecution — with more than 150 fugitives now wanted for stealing hundreds of millions of dollars from the U.S. healthcare program, according to the FBI and court records.”

In fact, I have been wondering for some time when we would see evidence that foreign governments have been stealing from Medicare. The official (read: conservative) estimates are that Medicare and Medicaid lose $70 billion each year to fraud and improper payments, a result of having almost zero meaningful controls in place. That’s practically an open invitation to steal from American taxpayers. Kleptocratic governments—and other organized-crime rings—would be insane not to wet their beaks.

In this National Review article, I explain how easily it could happen:

Last year, the feds indicted 44 members of an Armenian crime syndicate for operating a sprawling Medicare-fraud scheme. The syndicate had set up 118 phony clinics and billed Medicare for $35 million. They transferred at least some of their booty overseas. Who knows what LBJ’s Great Society is funding?

I also explain how these vast amounts of fraud aren’t going to stop without fundamental Medicare and Medicaid reform. Give the National Review article a read, and tell me if you share my suspicion that Medicare is bankrolling other governments.

Note to Larry Summers: The Government Borrows for Transfer Payments, Not Investment

“It is time for governments to borrow more money,” according to former treasury secretary Larry Summers.  He is not peddling this advice to Greece and Spain, but to countries like the United States and Japan that can still sell long-term bonds at very low interest rates. Summers urges the United States, in particular, to borrow more for “public investment projects” that are presumed to raise the economy’s future output. He offers the hypothetical example of “a $1 project that yielded even a permanent 4 cents a year in real terms increment to GDP by expanding the economy’s capacity or its ability to innovate.”

Even if such promising projects were easy to find, however, that is not the way the current government has been inclined to spend borrowed money. Despite all the rhetoric about “shovel-ready projects,” about 95 percent of the 2009 stimulus bill consisted of government consumption (salaries), refundable tax credits, and transfer payments which, as Robert Barro notes, “dilute incentives to work.”

Summers says, “Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates — the opposite of what central banks are doing.” Locking-in low borrowing costs would indeed make sense if the money from selling long bonds were used to retire short-term Treasury bills, but that would not involve borrowing more as Summers proposes.

For both government and households, it is certainly more prudent to use borrowed money to finance investments that will yield a stream of income in the future—either actual income (such as toll roads) or implicit income (the benefits from living in a mortgaged home).

Apostles of the Keynesian doctrine, such as Larry Summers, Paul Krugman, and Alan Blinder, invariably use hypothetical public works examples to make the case for more and more national (taxpayer) debt. Keynesian forecasting models, used by the Congressional Budget Office (CBO) to warn of the looming fiscal cliff and defend the fiscal stimulus of 2009, likewise assume the highest “multiplier” effect from tangible government investments.

In the real world of politics, however, Congress and the White House use borrowed money to placate constituencies with the most political clout. Federal spending on investment projects has essentially nothing to do with the huge 2009-2012 budget deficits (only 29 percent of which can be blamed on the legacy of recession, according to the CBO).

The Table shows that transfer payments and subsidies account for 63.8 percent of estimated spending in 2012, while federal purchases account for 28.4 percent. Also, most federal aid to states is for transfer payments like Medicaid.  Within federal purchases, only 7.6 percent of the spending ($152.5 billion) was counted as gross investment in the first quarter GDP report, and two thirds of that was military equipment and buildings. Net investment, minus depreciation, is smaller still.

If borrowing more for investment was a genuine political priority, rather than an academic conjecture, the government could do that by borrowing less for government payrolls, transfer payments, and subsidies.  At best, Larry Summers has made an argument for spending borrowed money much differently, not for borrowing more.

Will More Federal Debt Improve the U.S. Government’s Creditworthiness?

Writing in today’s Washington Post, former Obama economist Larry Summers put forth the strange hypothesis that more red ink would improve the federal government’s long-run fiscal position.

This sounds like an excuse for more Keynesian spending as part of another so-called stimulus plan, but Summers claims to have a much more modest goal of prudent financial management.

And if we assume there’s no hidden agenda, what he’s proposing isn’t unreasonable.

But before floating his idea, Summers starts with some skepticism about more easy-money policy from the Fed:

Many in the United States and Europe are arguing for further quantitative easing to bring down longer-term interest rates. …However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to undertake with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative rate. There is also the question of whether extremely low, safe, real interest rates promote bubbles of various kinds.

This is intuitively appealing. I try to stay away from monetary policy issues, but whenever I get sucked into a discussion with an advocate of easy money/quantitative easing, I always ask for a common-sense explanation of how dumping more liquidity into the economy is going to help.

Maybe it’s possible to push interest rates even lower, but it certainly doesn’t seem like there’s any evidence showing that the economy is being held back because today’s interest rates are too high.

Moreover, what’s the point of “pushing on a string” with easy money if it just means more reserves sitting at the Fed?

After suggesting that monetary policy isn’t the answer, Summers then proposes to utilize government borrowing. But he’s proposing more debt for management purposes, not Keynesian stimulus:

Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position, even assuming no positive demand stimulus effects of a kind likely to materialize with negative real rates. They should accelerate any necessary maintenance projects — issuing debt leaves the state richer not poorer, assuming that maintenance costs rise at or above the general inflation rate. …Similarly, government decisions to issue debt, and then buy space that is currently being leased, will improve the government’s financial position as long as the interest rate on debt is less than the ratio of rents to building values — a condition almost certain to be met in a world with government borrowing rates below 2 percent. These examples are the place to begin because they involve what is in effect an arbitrage, whereby the government uses its credit to deliver essentially the same bundle of services at a lower cost. …countries regarded as havens that can borrow long term at a very low cost should be rushing to take advantage of the opportunity.

Much of this seems reasonable, sort of like a homeowner taking advantage of low interest rates to refinance a mortgage.

But before embracing this idea, we have to move from the dream world of theory to the real world of politics. And to his credit, Summers offers the critical caveat that his idea only makes sense if politicians use their borrowing authority for the right reasons:

There is, of course, still the question of whether more borrowing will increase anxiety about a government’s creditworthiness. It should not, as long as the proceeds of borrowing are used either to reduce future spending or raise future incomes.

At the risk of being the wet-blanket curmudgeon who ruins the party by removing the punch bowl, I have zero faith that politicians would make sound decisions about financial management.

I wrote last month that eurobonds would be “the fiscal version of co-signing a loan for your unemployed alcoholic cousin who has a gambling addiction.”

Well, giving politicians more borrowing authority in hopes they’ll do a bit of prudent refinancing is akin to giving a bunch of money to your drug-addict brother-in-law in hopes that he’ll refinance his credit card debt rather than wind up in a crack house.

Considering that we just saw big bipartisan votes to expand the Export-Import Bank’s corporate welfare and we’re now witnessing both parties working on a bloated farm bill, good luck with that.