Book Forum: The Ukraine Crisis and U.S.-Russian Relations

Nearly three years ago, Ukraine’s Kremlin-backed president fled the country’s capital amidst massive anti-government protests. The series of events to follow would alter the geopolitical landscape of post-Soviet Eurasia, destabilize security within the wider region and pose a major challenge for U.S.-Russia relations.

Following an unrecognized referendum in eastern Ukraine, Russia proceeded in its annexation of the Crimean peninsula in a brazen act transgressing the notion of Westphalian sovereignty. The United States and the European Union responded by imposing sanctions on Russia, with debatable efficacy, while two ceasefire agreements have failed to end a protracted and bloody conflict on the ground.

Against this backdrop, the Trump administration has indicated a willingness to lift Russian sanctions in order to improve bilateral relations—a move which would be unpopular in Congress. Simultaneously, there is continued insistence from the United States and Europe that Russia must return control of the Crimea to Ukraine—a stipulation which Russia refuses to consider. Where do U.S.-Russia relations go from here?

Prior to looking into the policy options, an upcoming Book Forum presenting the recently released book Everyone Loses: The Ukraine Crisis and the Ruinous Contest for Post-Soviet Eurasia (Routledge, January 2017) will first examine how U.S.-Russian relations arrived at such a precarious point in the first place.  

The book’s authors, Timothy J. Colton (Morris and Anna Feldberg Professor of Government and Russian Studies, Harvard University) and Samuel Charap (Senior Fellow for Russia and Eurasia, International Institute for Strategic Studies; Former Senior Advisor, U.S. Under Secretary of State for Arms Control and International Security), argue that a series of grave strategic miscalculations, resulting from years of zero-sum behavior on the parts of both Russia and the United States, have destabilized the post-Soviet Eurasian sphere to the detriment of the West, Russia and the countries caught in the midst. With regional and international security now deteriorated and all parties worse off, Colton and Charap conclude that all governments must commit to patient negotiation aimed at finding mutually acceptable alternatives, rather than policies aimed at securing one-sided advantages.

Please join us for what is sure to be an insightful and comprehensive foray into the roots of the Ukraine crisis during Cato’s Book Forum on March 10th, featuring co-author Samuel Charap with comments provided by Emma Ashford, Cato Institute Research Fellow. You are invited to register for the event here.

WSJ: How ObamaCare Punishes the Sick

In today’s Wall Street Journal, I discuss new economic research showing ObamaCare is making health insurance worse for patients with high-cost medical conditions.

Republicans are nervous about repealing ObamaCare’s supposed ban on discrimination against patients with pre-existing conditions. But a new study by Harvard and the University of Texas-Austin finds those rules penalize high-quality coverage for the sick, reward insurers who slash coverage for the sick, and leave patients unable to obtain adequate insurance…

If anything, Republicans should fear not repealing ObamaCare’s pre-existing-conditions rules. The Congressional Budget Office predicts a partial repeal would wipe out the individual market and cause nine million to lose coverage unnecessarily. And contrary to conventional wisdom, the consequences of those rules are wildly unpopular. In a new Cato Institute/YouGov poll, 63% of respondents initially supported ObamaCare’s pre-existing-condition rules. That dropped to 31%—with 60% opposition—when they were told of the impact on quality.

Republicans can’t keep their promise to repeal ObamaCare and improve access for the sick without repealing the ACA’s penalties on high-quality coverage.

The lesson is clear. To repeal ObamaCare, opponents need to talk to voters about how the law is reducing the quality of health insurance and medical care for the sick.

Read the whole thing.

Trump’s Budget Situation

President Donald Trump will lay out some of his budget priorities in an address to Congress tonight. He wants to increase spending on defense, a border wall, and perhaps infrastructure. He also wants to cut taxes and balance the budget, yet does not favor reductions to Medicare or Social Security. His budget chief, Mick Mulvaney, faces a challenge in meshing all those priorities.

The chart shows federal spending in four categories as a percent of gross domestic product (GDP). No doubt, Mulvaney is pondering the CBO baseline projections to the right of the vertical line for 2018-2027. As a share of GDP, entitlement and interest spending are expected to soar, while defense and nondefense discretionary spending are expected to fall. Below the chart, I discuss the ups and downs of the four categories since 1970.

Here are some of the causes of the fluctuations seen in the chart:

1970s: Defense spending plunges as the Vietnam War subsides in the early 1970s. But the cost of new Lyndon Johnson/Richard Nixon entitlement and discretionary programs skyrockets.

1980s: Ronald Reagan boosts defense spending, and interest costs soar due to the rising debt. But Reagan cuts numerous discretionary and entitlement programs. For example, “income security” programs fall from 1.6 percent of GDP in 1981 to 1.1 percent by 1989.

1990s: The end of the Cold War prompts large defense cuts. But the recession and spendthrift approach of George H.W. Bush causes other spending to rise early in the decade. Bill Clinton lucks out as Social Security spending falls from 4.4 percent in 1992 to 4.0 percent by the end of the decade, while spending on Medicare and Medicaid remains fairly flat.

2000s: Medicare spending soars under George W. Bush, partly due to his Part D drug plan. Bush also pushes up spending on defense, homeland security, food stamps, education subsidies, and other programs. However, Bush benefits from the Fed’s policy of low interest rates, which moderates federal interest costs.

2010s: The recession of 2007 to 2009 causes spending on entitlements—such as unemployment insurance and food stamps—to soar. The Obama stimulus package includes big increases for many discretionary and entitlement programs in 2009 and subsequent years. The early Obama years also include high levels of Iraq and Afghanistan war spending. However, Obama also benefits from the Fed’s interest rate policies.

2018-2027: CBO projections show entitlement and interest costs rising rapidly, and deficits topping $1 trillion by 2023. To sustain economic growth and avert a fiscal disaster, Trump should push to terminate and privatize programs in every federal department. He talks a good game, but we will see whether he is interested in actual budget reforms in coming weeks as he rolls out specific proposals.

Notes: CBO data is here. I adjusted the entitlement line to take out TARP from 2009-2011 because it ended up costing taxpayers little or nothing.

For ways to cut federal spending, see this essay at

The End of Self Government?

In Federalist 39, James Madison asks whether the 1787 Constitution

be strictly republican. It is evident that no other form would be reconcilable with the genius of the people of America; with the fundamental principles of the Revolution; or with that honorable determination which animates every votary of freedom, to rest all our political experiments on the capacity of mankind for self-government.

The political scientist John DiIulio, Jr. answers ten questions about big government. He shows that regulations and spending by the federal government have risen a lot over the past half century. At the same time, representatives of the people have less control over the people who implement big government. The feds delegate implementation to state and local governments and contractors. These “agents of the people” by and large, he argues, do a poor job.

DiIulio concludes that Americans “want big government benefits and programs, but they do not want to pay big government taxes and they prefer not to receive their goods and services directly from the hand of big government bureaucracies.” Add some lobbying by contractors and state and local officials, and you have big, incompetent government.

DiIulio recalls Alexander Hamilton’s claim that “the true test of good government is its aptitude and tendency to produce a good administration.” That’s a Hamiltonian thing to say!

Madisonian things ought also be said. The U.S. Constitution promised republican self-government, not efficient tax collection and a skilled civil service. The government DiIulio outlines involves so many people doing so much that elected representatives can hardly be expected to control this vast administrative state. The old hope for republican liberty too has been diminished by the rise of big government.

Deductions Could Spell WTO Trouble for the GOP “Border Adjustable Tax” Plan

In a previous Cato blog post, I explained how the House Republican “Better Way” corporate tax plan, which replaces our current 35% corporate income tax with a 20% “destination-based cash flow tax” (DBCFT), could theoretically avoid litigation at the World Trade Organization (WTO) and member countries’ eventual, WTO-approved retaliation against billions of dollars worth of US exports. I concluded therein that, while there wasn’t yet enough concrete information about the DBCFT’s final form to determine its WTO-consistency, the conventional wisdom was wrong to assume that any US corporate tax plan would violate the United States’ international trade obligations. Today, on the other hand, I’ll explain the quickest way that the DBCFT could get into trouble at the WTO. 

Spoiler: it’s all about the deductions.

I won’t reiterate here how the DBCFT is intended to operate and again will acknowledge that we haven’t actually seen any legislative text yet. That said, there is a pretty clear consensus view among economists that the DBCFT would essentially operate as a modified “subtraction-method” value-added tax (VAT) on US corporations’ domestic sales revenue, minus taxable input purchases. This was helpfully summarized in a recent Paul Krugman blog post (emphasis mine):

[A] VAT is just a sales tax, with no competitive impact. But a DBCFT isn’t quite the same as a VAT. With a VAT, a firm pays tax on the value of its sales, minus the cost of intermediate inputs—the goods it buys from other companies. With a DBCFT, firms similarly get to deduct the cost of intermediate inputs. But they also get to deduct the cost of factors of production, mostly labor but also land. So one way to think of a DBCFT is as a VAT combined with a subsidy for employment of domestic factors of production. The VAT part has no competitive effect, but the subsidy part would lead to expanded domestic production if wages and exchange rates didn’t change.

Just so we’re clear that I’m not playing partisan favorites here, Krugman’s view was essentially echoed by Republican/conservative economist Greg Mankiw, who called the DBCFT “like a value-added tax” on corporations’ US sales with “a deduction for labor payments.”

While economists disagree about the economic and trade effects of the DBCFT, the aforementioned descriptions have generated significant (though certainly not consensus) concerns with respect the whether the new tax would be consistent with WTO rules—concerns that don’t arise with a VAT. As I discussed last time, the DBCFT would have to clear at least three hurdles at the WTO—two on the export subsidy side and one on the import side:

  • Export subsidy: The DBCFT would be found to confer prohibited export subsidies under the Article 3 of the WTO Subsidies Agreement where (1) the tax is found to be a “direct tax,” which the Agreement defines as “taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of real property” (VATs are a type of “indirect tax”); and (2) the “border adjustment” (i.e., tax exemption or rebate) for a company’s export sales is greater than the actual amount of tax due or collected.
  • Import discrimination: The DBCFT would violate the “national treatment” principle of GATT Articles II and III (on internal taxes) where it imposes a higher tax burden on an imported good than that imposed on an identical domestically produced product.

The concern among us trade lawyers rests in the deductions for labor and (maybe) land that a VAT doesn’t have but the DBCFT does—deductions that could generate violations of one or more of the aforementioned disciplines. This can be pretty difficult to see in the abstract, but the problems—as well as their absence for a normal VAT—become clearer through a simple hypothetical assessment of the tax’s effect on two identical US companies selling and exporting the same product, with one company selling only imported final goods and the other selling identical products with 100% US content. So let’s do that now, starting with a classic example used by the US Government Accounting Office to show how a standard subtraction-method VAT, which taxes corporations’ domestic (not export) sales revenue and permits one deduction for domestic (and thus taxable) input purchases, works in practice.


Why There Is No Fiscal Case for the Fed’s Large Balance Sheet

It is well known that the Federal Reserve System expanded its assets more than four-fold during and after the 2007-09 financial crisis by making massive purchases of mortgage-backed securities and Treasuries. The balance sheet has not returned to normal since. Total Fed assets stand today at $4.45 trillion, up from less than $1 trillion before the crisis. Whether, when, and how to normalize the size of the Fed’s balance sheet have been under discussion for years.

Economist-blogger David Andolfatto — not speaking for his employer the Federal Reserve Bank of St. Louis — now offers “a public finance argument” for “keeping the Fed’s balance sheet large.” Viewing the Fed as a financial intermediary, he observes that “The Fed transforms high-interest government debt into low-interest Fed liabilities (money),” and that this is a profitable business.

Curiously, Andolfatto omits to mention two important details: the Fed enjoys such a spread only because it is — for the first times in its history — (a) borrowing short and lending very long, also known as practicing “duration transformation” or “playing the yield curve,” and (b) heavily invested in mortgage-backed securities. The Fed is borrowing short by currently paying 0.75% (not 0.50% as Andolfatto reports) on zero-maturity bank reserves. It lends long by holding 10-year and longer Treasuries (paying 2.42% and up as of 17 Feb. 2017) and long-term mortgage-backed securities.

Not Just the Press

How can unelected judges limit the power of an elected official like the president? Two political scientists offer some answers in The Washington Post.

First, the public should broadly agree “about the basic legitimacy of the procedures used to review the powerful.” Second, the public needs “accurate information about the behavior of public officials.”

The authors say a free press should and does provide that information in various ways. That’s a good answer as far as it goes, but it does not go nearly far enough. Many other parts of our polity have the power and responsibility to provide information about government. To name a few: interest groups, bloggers, think tanks, professors, leakers, labor unions, trade associations, grassroots groups, and many others who might spring to mind with more reflection.

The media does not have a monopoly on informing the public. “The freedom of speech and of the press” belongs to all Americans. This diffusion of power seems especially valuable at a moment when the media lack credibility for so many Americans.