Tag: fiscal policy

I Hope I’m Wrong, But Here’s Why Republicans Will Lose the Debt-Limit Fight

There are three reasons why I’m not very hopeful about the outcome of the debt-limit battle.

1. There is no unity in the GOP camp.

Republicans have been all over the map during this fight. Some of them want a balanced budget amendment. Some want a one-for-one deal of $2 trillion of spending cuts in exchange for a $2 trillion increase in the debt limit. Others want some sort of spending cap, akin to Senator Corker’s CAP Act. Some want to mix all these ideas together in a cut-cap-balance package. Others want Obamacare repeal.  And the latest proposal is Sen. McConnell’s proposal to let Obama unilaterally raise the debt limit.

These are mostly good ideas, but the failure to coalesce around one proposal – preferably one that is easy to understand – has made the Republican position difficult to define, defend, or advance.

2. The fear of demagoguery is high.

As I explained months ago, Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner are trying to spook financial markets with hyperbolic warnings about a risk of default. This is blatant dishonesty and demagoguery, but Republicans are nervous that this tactic might be successful if there is a high-stakes showdown as the government’s borrowing authority runs out.

For those with short memories, this is what happened with TARP back in 2008. The initial bailout proposal was rejected, leading to short-run market gyrations, and many Republicans panicked and switched their votes to yes.

3. Republicans don’t control the Senate or the White House.

I’m stating the obvious, of course, but people seem to forget that any debt limit increase will need to get through the Senate and get signed by Obama.

Imagine you are Harry Reid or Barack Obama. Is there any reason why you would acquiesce to Republican demands? Yes, you need to at least pretend to care about big government, wasteful spending, and red ink, but why not hold firm and then strike a deal based on make-believe spending cuts? That’s exactly what happened during the “government-shutdown” debate earlier this year.

This post, incidentally, is not an attack on Republicans. I’m very willing to attack GOPers when they do the wrong thing, but I’m not sure they deserve to get hammered in this case.

Simply stated, I don’t think there’s a winning strategy, so I don’t see any point in going nuclear.

If nothing else, at least Republicans resisted the siren song of tax increases, which is not a trivial achievement since Democrats clearly were hoping to trick GOPers into giving up one of their strongest political positions.

I’m Willing to Go Along with President Obama’s ‘Balanced Approach’ to Deficit Reduction, but Only if We Use Honest Math

The President has issued an ultimatum that more tax revenue must be part of budget negotiations. Indeed, he endlessly repeats his desire for a “balanced approach,” implying that as much as 50 percent of the deficit reduction in any agreement should come from higher revenues.

Because I am a thoughtful, middle-of-the-road, pragmatic guy, I’m willing to accept the President’s ultimatum. I do have one tiny request, however, and that is for any such deal to be based on honest math.

What I mean by this is that I don’t want politicians to approve a budget that results in more spending, but then claim that they “cut spending” because the budget didn’t grow even faster. I want a spending cut to mean less spending (gee, what a novel idea).

And when they talk about new revenue, I want to see how much revenue the IRS is collecting this year, and measure revenue increases against that number. After all, the crowd in Washington should be happy to get more money, even if it is the result of benign factors such as more jobs being created, companies earning higher profits, and people getting more pay.

I assume these are reasonable requests. After all, this is how businesses and households operate their budgets, and I’m sure the political insiders wouldn’t want to use dishonest numbers to mislead voters (perish the thought!).

So what would a balanced approach look like, assuming we want to use honest math? The answer isn’t that complicated. I started with the latest estimates from the Congressional Budget Office for spending and revenues for this fiscal year (FY2011). I then assume, in the interest of a “balanced approach,” that spending should be cut by 5 percent each year and that revenues should climb by 5 percent each year.

The results, as illustrated by the graph, are remarkable. If we use a 50-50 deal of higher revenue and lower spending, we balance the budget in just five years. The President is right!

Taxpayers will be happy to know the “balanced approach” gets rid of red ink and also leaves enough room to make the 2001 and 2003 tax cuts permanent. Heck, there would be enough left-over revenue to enact additional tax cuts. After all, since we’re looking for balance, there’s no need to let revenues grow by 7 percent or 8 percent each year.

So, Mr. President, do we have a deal? Should we use your “balanced approach” and eliminate today’s big deficit by cutting spending and raising revenue by equal amounts? You were serious about your request, right? Hello, is anybody there?

As you already realize, I don’t think the President actually means what he says about a “balanced approach.” Or, to be more specific, I think he’s happy to do a 50-50 deal, but only if “spending cuts” and “revenue increases” are defined in ways that enable the growth of government.

Inside the beltway, this is known as “baseline budgeting” or “current services budgeting.” But whatever it’s called, it is a dishonest way of presenting information to the American people, as explained in this video.

European Political Elite React to Deteriorating Fiscal Outlook with Decisive Moves to…Kill the Messenger

I’m not a big fan of the rating agencies. I’ve warned in TV interviews that they generally wait too long before downgrading profligate governments.

So when the rating agencies finally catch up to everyone else and lower their outlook for failing welfare states such as Greece and Portugal, one would think that this would be seen as a useful – albeit late – warning sign. But European politicians are not very happy about this development. At the risk of mixing metaphors, they want everyone to keep their heads buried in the sand and to continue complimenting the emperor on his new clothes.

Here are some excerpts from a BBC report.

The European Commission has strongly criticised international credit ratings agencies following the downgrade of Portugal by Moody’s. The Commission said the timing of the downgrade was “questionable” and raised the issue of the “appropriateness of behaviour” of the agencies in general. Earlier, Greek Foreign Minister Stavros Lambridinis said the agencies’ actions in the debt crisis had been “madness”. Ratings agencies have downgraded Greece and Portugal many times recently. …German Finance Minister Wolfgang Schaeuble told a news conference that he wanted to “break the oligopoly of the ratings agencies” and limit their influence. …”The timing of Moody’s decision is not only questionable, but also based on absolutely hypothetical scenarios which are not in line at all with implementation,” said Commission spokesman Amadeu Altafaj. “This is an unfortunate episode and it raises once more the issue of the appropriateness of behaviour of credit rating agencies.” Commission President Manuel Barroso added that the move by Moody’s “added another speculative element to the situation”.

This is not the first time this has happened, by the way. Back in January, I mocked the President of the European Council for whining that “bond vigilantes” had the nerve and gall to demand higher interest rates to compensate for the risk of lending money to incontinent governments.

The “Tax Expenditure” Con Job

For both political and policy reasons, the left is desperately trying to maneuver Republicans into going along with a tax increase. And they are smart to make this their top goal. After all, it will be very difficult – if not impossible – to increase the burden of government spending without more revenue coming to Washington.

But how to make this happen? President Obama is mostly arguing in favor of class-warfare tax increases, but that’s a non-serious gambit driven by 2012 political considerations. Moreover, there’s presumably zero chance that Republicans would surrender to higher tax rates on work, saving, and investment.

The real threat is back-door hikes resulting from the elimination and/or reduction of so-called tax breaks. The big spenders on the left are being very clever about this effort, appealing to anti-spending and pro-tax reform sentiments by arguing that it is important to get rid of “tax expenditures” and “spending in the tax code.”

recently warned, however, that GOPers shouldn’t fall for this sophistry, noting that “If legislation is enacted that results in more money coming into Washington, that is a tax increase.” I also explained that tax breaks are not spending, stating that “When politicians tax (or borrow) money from one person and give it to another, that’s government spending. But if politicians allow a person keep more of their own money, that’s a tax cut.”

To be sure, the tax code is riddled with inefficient and corrupt loopholes. But those provisions should be eliminated as part of fundamental tax reform, such as a flat tax. More specifically, every penny of revenue generated by shutting down tax preferences should be used to lower tax rates. This is a win-win situation that would make America more prosperous and competitive.

It’s also important to understand what’s a loophole and what isn’t. Ideally, you determine special tax breaks by first deciding on the right benchmark and then measuring how the current tax system deviates from that ideal. That presumably means all income should be taxed, but only one time.

So what can we say about the internal revenue code using this neutral benchmark? Well, there are lots of genuine loopholes. The government completely exempts compensation in the form of employer-provided health insurance, for instance, and everyone agrees that’s a special tax break. There’s also the standard deduction and personal exemptions, but most people think it’s appropriate to protect poor people from the income tax (though perhaps we’ve gone too far in that direction since only 49 percent of households now pay income tax).

Sometimes the tax code goes overboard in the other direction, however, subjecting some income to double taxation. Indeed, because of the capital gains tax, corporate income tax, personal income tax, and death tax, it’s possible for some types of income to be taxed as many of three or four times.

Double taxation is a special tax penalty, which is the opposite of a special tax break. The good news is that there are some provisions in the tax code, such as IRAs and 401(k)s, that reduce these tax penalties.

The bad news is that these provisions get added to “tax expenditure” lists, and therefore get mixed up with the provisions that provide special tax breaks. This may sound too strange to be true, but here’s a list of the biggest so-called tax expenditures from the Tax Policy Center (which is a left-leaning organization, but their numbers are basically the same as the ones found at the Joint Committee on Taxation).

Since this post already is too long, I’ll close by simply noting that items 2, 4, 7, 8, 11, and 12 are not loopholes. They are not “tax expenditures.” And they are not “spending in the tax code.” Every one of those provisions is designed to mitigate a penalty in the tax code.

So even if lawmakers have good motives (i.e., pursuing real tax reform such as the flat tax) when looking to get rid of special tax breaks, they need to understand what’s actually a loophole.

But since politicians rarely have good motives, there’s a real threat that they will take existing tax penalties and make them even worse. That’s another reason why tax increases should be a non-starter.

Block-Granting Medicaid Is a Long-Overdue Way of Restoring Federalism and Promoting Good Fiscal Policy

This new video, based in large part on the good work of Michael Cannon, explains why Medicaid should be shifted to the states. As I note in the title of this post, it’s good federalism policy and good fiscal policy. But the video also explains that Medicaid reform is good health policy since it creates an opportunity to deal with the third-party payer problem.

One of the key observations of the video is that Medicaid block grants would replicate the success of welfare reform. Getting rid of the federal welfare entitlement in the 1990s and shifting the program to the states was a very successful policy, saving billions of dollars for taxpayers and significantly reducing poverty. There is every reason to think ending the Medicaid entitlement will have similar positive results.

Medicaid block grants were included in Congressman Ryan’s budget, so this reform is definitely part of the current fiscal debate. Unfortunately, the Senate apparently is not going to produce any budget, and the White House also has expressed opposition. On the left, reducing dependency is sometimes seen as a bad thing, even though poor people are the biggest victims of big government.

It’s wroth noting that Medicaid reform and Medicare reform often are lumped together, but they are separate policies. Instead of block grants, Medicare reform is based on something akin to vouchers, sort of like the health system available for Members of Congress. This video from last month explains the details.

In closing, I suppose it would be worth mentioning that there are two alternatives to Medicaid and Medicare reform. The first alternative is to do nothing and allow America to become another Greece. The second alternative is to impose bureaucratic restrictions on access to health care—what is colloquially known as the death panel approach. Neither option seems terribly attractive compared to the pro-market reforms discussed above.

Andrew Sullivan Has No Idea What He’s Talking about, but I Agree with His Conclusion

Even though he’s become more partisan in recent years, I still enjoy an occasional visit to Andrew Sullivan’s blog. But I was disappointed last night when I read one of his posts, in which he discussed whether government spending helps or hurts economic performance. He took the view that a bigger public sector stimulates growth, and criticized those who want to reduce the burden of government spending, snarkily observing that, “The notion that Herbert Hoover was right has become quite a dogged meme on the reality-challenged right.”

Since I’m one of those “reality-challenged” people who prefer smaller government, I obviously disagree with his analysis. But his reference to Hoover set off alarm bells. As I have noted before, Hoover increased the burden of government during his time in office.

But maybe my memory was wrong. So I went to the Historical Tables of the Budget and looked up the annual spending data. As you can see from the chart (click for larger image), it turns out that Hoover increased government spending by 47 percent in just four years. (If you adjust for falling prices, as Russ Roberts did at Cafe Hayek, it turns out that Hoover increased real government spending by more than 50 percent.)

I suppose I could make my own snarky comment about being “reality-challenged,” but Sullivan’s mistake is understandable. The historical analysis and understanding of the Great Depression is woefully inadequate, and millions of people genuinely believe that Hoover was an early version of Ronald Reagan.

I will say, however, that I agree with Sullivan’s conclusion. He closed by saying it would be “bonkers” to replicate Hoover’s policies today. I might have picked a different word, but I fully subscribe to the notion that making government bigger was a mistake then, and it’s a mistake now.

Tax Cuts, Loopholes, and Government Size

President Obama wants to raise revenues by reducing tax deductions and other tax breaks, which the administration calls “spending in the tax code.” Donald Marron of the Tax Policy Center argues that “hundreds of billions of dollars of spending are disguised as tax cuts.”

Don is a very good economist, and he is concerned that special interest tax breaks can misallocate resources the same way that spending subsidies do. I agree. But I’m also concerned that tax breaks and spending subsidies have different implications for the size of government, which is where I part ways with Don and the president.

The following Tax Policy Matrix helps sort out which sorts of tax cuts make economic sense when government size is also a consideration.

The government distorts the economy and reduces GDP through both its taxing and spending actions. One reason is that both taxes and spending cause individuals and businesses to change their behaviors and reallocate resources in suboptimal ways. The table has columns for tax and spending distortions. It also has a column for government debt because running deficits today may translate into higher levels of distortionary taxes tomorrow.

The table includes two Starve-the-Beast scenarios. “With Starve-the-Beast” means that tax cuts will reduce government spending to some extent over time. A narrow tax base shot full of loopholes creates allocation distortions, but if starve-the-beast works that sort of tax base also limits the government’s size creating a counterbalancing benefit to GDP.

In the short run, starve-the-beast may or may not work. Bill Niskanen says that it does not, but I think the effectiveness of it changes over time as political culture changes. In the 1980s and 1990s, policymakers took corrective actions when deficits rose, but the revival of Keynesianism in recent years changed the political culture and, for a while, nullified the fear of deficits for many politicians.

In the long run, it seems obvious that the inflow of tax revenues to the government is a hard check on spending because there are financial market limits to government borrowing.

Let’s go through the rows in the table:

Row 1. The government starts off with a balanced budget and with tax and spending systems that cause medium damage.

Row 2. The government cuts taxes $100 by way of a loophole. Tax distortions rise because marginal tax rates are unchanged and we’ve added a new distortion. Higher debt likely pushes up future tax distortions. This appears to be a poor policy choice.

Row 3. The government cuts taxes $100 by way of marginal rate cut. Tax distortions are reduced, which increases economic growth. The downside is higher debt. This may or may be a good policy depending on the quality of the tax cut. If the cut is to a very distortionary part of the tax code—such as the corporate income tax rate—this policy could make sense. One reason is that the deficit increase might end up being quite small because of the positive economic response to the pro-efficiency tax cut.

Row 4. With starve-the-beast operational, a special interest tax cut becomes a bit of a closer call. Tax distortions and debt rise, but government spending falls somewhat, so the net effect on the economy is unclear. However, I think there are considerations here aside from economics. Special interest tax breaks—such as the ethanol tax break—are troubling because they represent a corruption of the law, an affront to the American ideal of “equal justice under law.” So just on that basis, I’m against special interest breaks, and indeed am in favor replacing the current code with a flat tax.

Row 5. A pro-efficiency tax cut is very likely a winner if you assume that starve-the-beast is operational. Tax and spending distortions both fall, although there is a modest increase in debt.

So far we’ve left out the most important fiscal tool available to policymakers—spending cuts to unneeded and damaging programs to reduce government harm to the economy. The best policy choice would be to combine pro-growth tax cuts with spending cuts to harmful programs. That would reduce government distortions on both sides of the budget, and thus unambiguously increase GDP.

In sum, without matching spending cuts, tax cuts may or may not make sense depending on the type of cut and whether reducing Uncle Sam’s diet will force him to slim down in subsequent years. But it is a fiscal policy win-win to match spending cuts with cuts to the most damaging parts of the tax code.