Topic: Tax and Budget Policy

There Krugman Goes Again

In his Monday columnNew York Times writer Paul Krugman claims to (borrowing the headline) “Debunk… the Reagan Myth,” arguing that Ronald Reagan’s economic policies “did fail.” (The column does not mention that Krugman worked for Reagan’s Council of Economic Advisers in 1982–1983.)

In fact, Krugman devotes precious little space to examining (or debunking) Reagan’s economic policies or their performance. The column is mostly a lament that Americans view Reagan positively and that Democrats have not challenged (and may even share) that opinion.

Krugman’s criticisms comprise just seven of the column’s 37 sentences (and three of the seven are throwaway lines). Here they are verbatim:

For it did fail. The Reagan economy was a one-hit wonder. Yes, there was a boom in the mid-1980s, as the economy recovered from a severe recession. But while the rich got much richer, there was little sustained economic improvement for most Americans. By the late 1980s, middle-class incomes were barely higher than they had been a decade before — and the poverty rate had actually risen.

[T]here wasn’t any resurgence [in productivity growth] in the Reagan years.

Like productivity, American business prestige didn’t stage a comeback until the mid-1990s….

In short, Krugman makes four criticisms: Reagan’s policies resulted in (1) stagnant middle-class incomes, (2) an increase in the poverty rate, (3) stagnancy in productivity growth, and (4) stagnancy in “American business prestige.”

Are those claims true and do they show that Reagan’s economic policies “did fail”? Let’s look at the data. (Hyperlinks connect to the relevant federal data sets.)

MIDDLE-CLASS INCOME   To determine the course of middle-class income over Reagan’s presidency, let’s examine the U.S Census Bureau’s Current Population Reports on median real income over time. That is, let’s look at inflation-adjusted family income and household income for families/households that are in the exact middle of all U.S. families/households.

From 1981 to 1988 (which roughly corresponds with Reagan’s tenure), median real family income grew 11.1 percent while real household income grew 10.3 percent. Those growth rates are in the top third of the 30 eight-year periods from 1968–1975 to 1998–2005.

To be fair, Krugman did not speak of middle-class income over Reagan’s tenure, but instead compared middle-class incomes of “the late 1980s” with the decade before. So we look at the data again and find that, in 1986, despite two recessions (1980, 1982) in the intervening years, median family income was 10.7 percent higher than a decade ago and median household income was 10.3 percent higher. The following year, median family income was 11.8 and 11.0 percent higher than a decade before. (The gains were smaller in 1988.)

In contrast, income growth during Bill Clinton’s administration only eclipsed Reagan’s 1986 and 1987 numbers once: at the height of the tech bubble in 2000, family income was 12.3 percent higher than a decade previous (however, household income was lower than Reagan’s 11.0 percent). Further, the George W. Bush administration eclipsed those numbers in three straight years — in 2001, 2002 and 2003, both family and median income gains over the preceding decade were higher than the best Reagan or Clinton numbers. Curiously, Krugman does not credit G.W. Bush with being more successful, economically, than either Reagan or Clinton.

POVERTY   Krugman is correct that the poverty rate was higher at the end of Reagan’s term than it was “a decade before” in 1978. However, the poverty data show much more that Krugman doesn’t discuss.

In 1978, 9.1 percent of families and 11.4 percent of individuals in the United States were living below the poverty line. The year marked the penultimate in a previously unprecedented span of years (beginning in 1972) where the poverty rate for families fell below 10 percent. However, both rates began climbing in 1979, preceding the onset of the twin recessions of 1980 and 1982. Poverty topped out at 12.3 percent for families and 15.2 percent for individuals in 1983.

From there, though, poverty under Reagan moved downward steadily, reaching 10.4 percent for families and 13.0 percent for individuals in 1988. Both rates fell further in the first year of the George H.W. Bush administration. However, neither rate would be that low again until 1997, the year after welfare reform passed Congress. The poverty rate for families would not duck below 10 percent again until the last two years of the Clinton administration and the first three years of the George W. Bush administration.

PRESTIGE   On this point, I cannot challenge Krugman. He gives no evidence to support this claim, and I know of no data sets that measure “prestige.”

PRODUCTIVITY GROWTH   Krugman is correct that the data show productivity growth under Reagan was around 1.4 percent a year, not much higher than the previous period 1973–1979 (1.2 percent) and a little less than the subsequent period 1990–1995 (1.5 percent). Those numbers are all considerably lower than the 2.8 average annual increase for 1947–1973 and the 2.5 percent for 1996-2000.

Krugman does not mention the productivity rate for 2000–2006; at 2.7 percent, productivity growth is even higher under the George W. Bush administration than it was in the best of the Clinton years. Again, curiously, Krugman does not credit G.W. Bush with being even more successful economically than Reagan or Clinton.

This raises a question: If the average productivity growth rate increased over the last five years of the Clinton administration, and that growth continued (at a slightly higher rate) through the first five years of the G.W. Bush administration, then does policy (or politics) have much to do with productivity? The recent spurt in U.S. productivity seems the product of cheap computers and Americans’ special talent for using them, not the machinations of Washington, D.C. More broadly, significant increases in productivity growth have much more to do with stochastic innovation than White House actions (except, perhaps, Al Gore’s creating the Internet).

KRUGMAN CONSIDERED   This leads to a broader question: How much credit can any president take for economic growth that occurs during his presidency?

To be sure, Reagan deserves some credit for improving on the economic trends of the 1970s, but credit should also go to Gerry Ford and Jimmy Carter for taking the first steps toward deregulation, and to Paul Volcker and the Fed for tamping down inflation. Likewise, the economic success of Clinton and George W. Bush owe some debt to Reagan (and, in W’s case, to Clinton) and much to Alan Greenspan (not to mention Silicon Valley). If the United States successfully combats the current economic slowdown, the credit should go to Ben Bernanke and his Fed colleagues, not to any stimulus package cobbled together by the White House or Capitol Hill.

Economic policies are intended to have long-term effects (though those policies can have some immediate effects). But economic conditions are only partly the product of economic policies — they are products of many different decisions by many different economic actors, most of whom are not elected. Politicians receive far too much credit and blame for current economic conditions.

Krugman’s claims about the Reagan record are misleading and, in the case of middle-class income, outright false. But more significantly, the concept underlying Krugman’s column is facile.

Creating A National Mortgage Scandal

Details are murky, but Senator Dodd appears to want to spend many billions on a new federal agency to buy-up undefined “distressed” mortgages at less than their original value.

Suppose Mr. Jones has a $300,000 mortgage on a house now worth $250,000. The new agency would offer to pay off the loan for $250,000 and then let Jones stay in the house with a new $250,000 mortgage that would then be guaranteed by the Federal Housing Authority (which ultimately means the U.S. taxpayer). FHA would debase its customary lending standards.

If banks and mortgage service companies are willing to write-off a large part of the value of some mortgages, why would we need to put U.S. taxpayers at risk? Why couldn’t each borrower simply negotiate a new contract, as hundreds of thousands have already done (though usually for a lower interest rate rather than forgiveness of principal).

If a home owner or speculator like Mr. Jones could get a smaller mortgage through a government agency by not making payments and threatening to default, that would create a huge moral hazard. His neighbors would resent his special treatment, and threaten to default on their loans too.

Since everyone would rather have a smaller mortgage than a larger mortgage, there would be rationing problem of deciding who is or is not worthy for such special treatment. Such priorities are likely to be based on political considerations rather than sensible economics or risk management.

Since Mr. Jones is already seriously delinquent on the current mortgage, he may well have a history of not paying other bills and therefore a poor (subprime) credit rating. There is no good reason to expect that he will not also default on the new FHA mortgage. Risky loans still remain risky, but because of the FHA guarantee that risk would be shifted to taxpayers.

This scheme would convert a localized mortgage problem into a national mortgage scandal.

Real Growth or Fake Stimulus

Don Boudreaux’s column in the Christian Science Monitor is an excellent analysis of the stimulus debate in Washington. He starts by explaining why the bipartisan support for rebate checks is grossly misguided. And his point about consumer spending being a consequence of growth rather than a cause of growth is superb:

Government cannot create genuine spending power; the most it can do is to transfer it from Smith to Jones. If the Treasury sends a stimulus check to Jones, the money comes from taxes, from borrowing, or is newly created. If it comes from taxes, the value of Jones’s stimulus check is offset by the greater taxes paid by Smith, who will then have fewer dollars to spend or invest. If Uncle Sam borrows to pay for the stimulus checks, this borrowing takes money out of the private sector. Any dollars borrowed – whether from foreigners or fellow Americans – for purposes of stimulus would have been spent or invested in other ways were they not loaned to the government. The only other means of paying for such stimulus is for the Federal Reserve to create new money. Unfortunately, this option leads inevitably to inflation. …Spending power is not so much the fuel for economic growth as it is its reward. And the key to economic growth is investment that raises worker productivity.

Professor Boudreaux then explains the types of policies that will boost growth, both in the short run and long run. Smaller government on both the tax side and spending side of the fiscal equation would be very helpful, he explains, and he also makes the critically important point that an easy-money policy from the Fed is the wrong approach:

Mr. Bush should call for a substantial and permanent cut in both capital-gains and personal-income tax rates. …Cutting taxes is, of course, a good thing, but it’s important to know why. The goal would not be to increase consumer spending. Instead, it would be to raise the returns on investment and work. By letting investors and workers keep more of the fruits of their risk-taking, creativity, and efforts, the economy will enjoy more risk-taking, creativity, and effort. Businesses that would otherwise not be started would be created. …Cutting government spending would result in more of the economy’s resources being used by wealth-creating businesses rather than being siphoned away to special-interest groups and boondoggles such as bridges-to-nowhere and Woodstock museums. …Finally, Bush should assure the Board of Governors of the Federal Reserve that he neither expects nor wants them to use monetary policy politically. Reminding them of the wisdom of Milton Friedman, he should strongly urge them to keep a tight rein on the money supply.

Mon Dieu! Smaller Government in France

In a step that could have a damaging effect on the jokes I tell when giving speeches, the Prime Minster of France has announced a plan to freeze government spending for five years. Some of the details are a bit unclear. As the Financial Times notes, Minister Fillon did not state whether spending would be frozen at current levels, or frozen after adjusting for inflation. A hard freeze would be the best option, but either choice would shrink the aggregate burden of government in France. To their credit, policy makers in Paris seem to understand the problem:

France is planning to freeze public spending for five years under its biggest programme of social and economic reform since the late 1960s, according to François Fillon, the prime minister. …The government has said it wants to eliminate its deficit and reduce spending as a share of national output – the highest in the EU at 53.5 per cent – during Mr Sarkozy’s first five-year term… Mr Fillon did not say whether he was planning a real-terms or nominal freeze, nor whether it would encompass France’s indebted social insurance system. He admitted that France would only eliminate its deficit “if we do the underlying structural reforms, which would allow us to reduce in a much more significant way public-sector employment and public spending”. …Mr Fillon has been credited with keeping Mr Sarkozy’s government focused on repairing France’s precarious public finances and cutting welfare and pension costs.

Assuming Sarkozy’s government fulfills this pledge, France will take a big step in the right direction. With any luck, maybe American politicians then would do something similar. The same policy, if adopted in America, would reduce the burden of federal government spending from more than 20 percent of GDP today to 15.9 percent of GDP (with a hard freeze) or 17.8 percent of GDP (with an inflation-adjusted freeze) after five years.

Europeans Want Asian Financial Centers to Join Savings Tax Cartel

Politicians from Europe’s high-tax governments recognize that saving and investment are escaping to jurisdictions with less-punitive tax regimes. But rather than lower their oppressive tax rates, they are trying to gain the ability to track – and tax – flight capital.

A couple of years ago, they implemented the so-called savings tax directive, but this system is ineffective (from the perspective of politicians) since many financial centers are not part of the cartel and many types of investment vehicles are not covered. Not surprisingly, politicians from nations such as France and Germany want to expand the tax cartel to cover more nations and to capture more forms of saving and investment.

Fortunately, as reports, the Asian financial centers are not favorably disposed to serving as tax collectors for Europe’s inefficient welfare states. As such, high-tax nations may feel compelled to reduce tax rates to keep capital from fleeing:

Senior EU tax officials, including European Tax Commissioner Laszlo Kovacs, are preparing to make a fresh approach to Asian financial centres, in a bid to have them included within the ambit of the European Savings Tax Directive. According to a report from Reuters, Kovacs is scheduled to visit Hong Kong later this month, while other senior officials will launch a new charm offensive in the territory of Macau and the city-state of Singapore. The directive, which extends to a number of ‘third countries’ such as Switzerland, the Channel Islands and Caribbean offshore territories, facilitates the exchange of information between EU tax authorities on certain types of savings and investments held by EU residents in their territory, so that interest earned can be taxed in the resident investor’s home state. …

[W]hile the EU was effectively able to bully smaller territories such as those in the Caribbean with colonial links to member states like the UK and the Netherlands, the Asian territories have no such ties binding them to Europe. Unsurprisingly, EU officials have already received frosty responses from Hong Kong and Singapore regarding the issue, and little is expected to have changed. In the case of Hong Kong, signing up to the savings tax directive could mean altering the Basic Law which safeguards the future of its financial centre under Chinese rule.

Singapore on the other hand, is known to be staunchly opposed to the idea of sharing bank account information with the EU, and has rejected European overtures to include information exchange provisions within a broader economic agreement. The European Commission is currently reviewing the operation of the savings tax directive and is likely to make several recommendations for tightening up the legislation that would make it harder for EU-based investors to legitimately side-step the law - for example by moving assets from bank accounts to vehicles such as companies and trusts - which weren’t included in the legislation - or by shifting money to accounts based in territories out of the reach of the directive’s information sharing provisions.

It Hurts to Be Called Ugly by a Frog - Especially When the Frog is Right

European politicians are complaining that government spending in the United States is too high according to the EU Observer. Since government consumes a bigger share of economic output in almost every European nation than it does in America (see Table 25), they are throwing rocks in a glass house. But that doesn’t change the fact that they are right. Government is too big in the United States, and it wastes too much money. The EU’s Economy Commissioner, Joaquin Almunia, also is right to brag about the performance of the European Central Bank. Compared to the Fed’s easy-money policy, the ECB is Friedman-esque rock of price stability:

The European Commission has pointed to unhealthy public spending in the US as the main cause of the current global market turbulences and urged Washington to cut expenditure and boost savings, while praising Europe’s own “solid and sound” economy and the positive effect of the common currency. …Mr Almunia suggested that US policy-makers should tackle the current crisis with measures that would secure “reducing the external deficit and the fiscal deficit, and increasing domestic saving in the US both in the public and the private sectors.” He maintained that Europe’s own previous reforms and pressure for cuts in public finances have paid off, leaving the fundamentals of the bloc’s economy - in contrast to the situation across the Atlantic - as “solid and sound”.

Leave Them Teams Alone

Nick Gillespie and Matt Welch have a great article in Sunday’s Washington Post on the absurdity of Congress demanding that Major League Baseball do something about steroids right now, or else. They point out that, in the first place, “Major League Baseball, along with other sports leagues and private-sector ventures, simply should not be required to submit their business plans – much less blood and urine samples – to Congress or any other government body.” And in the second place, steroids just aren’t that big a deal, much as Congress wants them to be.

Alas, Reason’s editors do trip up on one point. They write that baseball’s exemption from federal antitrust legislation should be repealed. Why? Because it “has caused more harm than good by allowing owners to collude against players and prospective competitor leagues and by allowing cartel arrangements and restraints on trade unimaginable in other industries.”

Aside from the general problems with antitrust law, the notion that baseball owners “collude” in “cartel arrangements and restraints on trade” reflects a misunderstanding of the organization of a sports league. The different teams in Major League Baseball are not competitors like Coke and Pepsi. They’re not even quite like McDonald’s franchisees, who clearly don’t compete in the way different companies do. Rather, the economic unit is MLB, which is in the business of providing baseball games for entertainment. The competition on the field is real, but the teams are not actually economic competitors. As the Supreme Court ruled in a case involving the NFL:

The NFL owners are joint venturers who produce a product, professional football, which competes with other sports and other forms of entertainment in the entertainment marketplace. Although individual NFL teams compete on the playing field, they rarely compete in the marketplace… . The league competes as a unit against other forms of entertainment.

Gillespie and Welch are more right than they know. Congress should stay entirely out of baseball’s business, including by not siccing antitrust regulators on a single economic unit often misunderstood as 30 competing businesses.