Month: May 2011

The Day the United States Defaulted on Treasury Bills

In October 2013, a slightly updated version of this post appeared here.

Since the day of Alexander Hamilton, the United States has never defaulted on the federal debt.

That’s what we budget-watchers always say. It’s a great talking point. One that helps bolster the argument that default should not be an option in Washington’s ongoing debt limit slowdown.

There’s just one teensy problem: it isn’t true. As Jason Zweig of the Wall Street Journal recently noted, the United States defaulted on some Treasury bills in 1979. And it paid a steep price for stiffing bondholders.

Terry Zivney and Richard Marcus describe the default in The Financial Review (sorry, I can’t find an ungated version):

Investors in T-bills maturing April 26, 1979 were told that the U.S. Treasury could not make its payments on maturing securities to individual investors. The Treasury was also late in redeeming T-bills which become due on May 3 and May 10, 1979. The Treasury blamed this delay on an unprecedented volume of participation by small investors, on failure of Congress to act in a timely fashion on the debt ceiling legislation in April, and on an unanticipated failure of word processing equipment used to prepare check schedules.

The United States thus defaulted because Treasury’s back office was on the fritz.

This default was, of course, temporary. Treasury did pay these T-bills after a short delay. But it balked at paying additional interest to cover the period of delay. According to Zivney and Marcus, it required both legal arm twisting and new legislation before Treasury made all investors whole for that additional interest.

Some may quibble about whether this constitutes default. After all, the United States did eventually make its payments. And the disruption applied to only a sliver of its debt – certain T-bills owned by individual investors.

But I think it’s unambiguous. A debt default occurs anytime a creditor fails to make a timely interest or principal payment. By that standard, the United States did default. It was small. It was unintentional. But it was indeed a default.

And the nation still stands. But that hardly means we should run the experiment again and at larger scale. Zivney and Marcus examined what happened to T-bill interest rates as a result of this small, temporary default. They find a surprisingly large effect. As best they can tell, T-bill interest rates increased about 60 basis points after the first default and remained elevated for at least several months thereafter. A simple way to see that is to look at daily changes in T-bill yields:

T-bill rates spiked upwards four times in the months around the default. In November 1978, Henry “Dr. Doom” Kaufman predicted that interest rates would rise. They did. Turn-of-the-year cash management caused rates to fall and then rise as 1978 became 1979. And rates spiked and fell in October 1979 when Paul Volcker announced that the Fed would target monetary aggregates rather than interest rates (the “Saturday night special”).

The fourth big move was the day of the first default, when T-bill rates rose almost 0.6 percentage points (i.e., 60 basis points).There’s no indication this increase reversed in the days that followed (the vertical line on the chart is just a marker for the day of default). Indeed, using more sophisticated means, including comparing T-bill rates to interest on commercial paper, the authors conclude that default led to a persistent increase in T-bill rates and, therefore, higher borrowing costs for the federal government.

The financial world has changed dramatically in the intervening decades. T-bill rates hover near zero compared to the 9-10 percent range of the late 1970s; that means a temporary delay in payments would be less costly for creditors. Treasury’s IT systems are, one hopes, more reliable that 1970s vintage word processors. And one should take care not to make too much of a single data point.

But it’s the only data point we have on a U.S. default. Not surprisingly it shows that even temporary default is a bad idea.

P.S. Some observers believe the United States also defaulted in 1933 when it abrogated the gold clause. The United States made its payments on time in dollars, but eliminated the option to take payment in gold. For a quick overview of this and related issues, see this blog post by Catherine Rampell at the New York Times and the associated comments.

Cut Spending by Raising Taxes

My latest column at the Christian Science Monitor argues that we can cut spending by raising taxes:

Here’s a shocker: America can cut government spending by eliminating tax breaks.

I know that sounds crazy. Everyone usually talks as if spending and tax breaks are distinct. Spending is what the government gives out or uses for purchases; tax breaks reduce how much revenue it collects.

Reality, however, is a lot blurrier. Hundreds of billions of dollars of spending are disguised as tax cuts.

It’s not hard to see why. Voters like tax cuts more than spending increases. Politicians understand that, so they convert spending into tax breaks.

The ethanol tax credit is a perfect example. Fuel producers qualify for a 45-cent tax credit for each gallon of ethanol they blend into gasoline. Blenders calculate their income taxes like other businesses, then deduct the value of the credit before they send their check to the Internal Revenue Service (IRS).

The ethanol subsidy thus looks like a tax cut, but it’s really government spending in disguise. The Department of Energy could accomplish the same thing by sending out subsidy checks. The same is true for dozens of other tax provisions, such as the business credit for research and development and personal tax breaks for mortgage interest, health insurance, and charitable giving.

Politicians act as if those provisions are tax cuts. That seems plausible. Businesses and families send less money to the IRS because of them.

But think about it. These tax breaks don’t let you keep your money. They pay you for doing what government wants, whether that’s taking out a mortgage, giving to charity, or investing in R&D. What you pay the IRS equals the taxes you owe minus the payments for which you’ve qualified. Those payments are no different from spending; they just happen to be netted against your tax bill.

That doesn’t mean all tax preferences are bad policy. Some support important goals, and the tax system is sometimes the best way to administer a program. The income tax, for example, provides a natural structure for benefits like the earned income tax credit that should vary with income.

It does mean, however, that these provisions should get the same scrutiny as traditional spending programs. Social Security, health care, defense, and domestic spending must all go under the budget knife if we want to avoid unsustainable debts. The middle-class entitlements, business incentives, and social programs embedded in the tax code shouldn’t escape that surgery just because they’re designed as tax breaks.

That’s why many budget hawks believe that cutting these preferences is essential to deficit reduction. The president’s fiscal commission, for example, proposed dramatic cuts to “spending-like” tax preferences as a way to reduce future deficits while lowering – not raising – income tax rates.

That approach has great merit, but has not yet been universally embraced. When Sen. Tom Coburn, a conservative Republican and budget hawk from Oklahoma, recently introduced legislation to eliminate the ethanol tax credit, he drew fierce opposition from some advocacy groups that favor lower taxes. Both Senator Coburn and the advocates favor smaller government. Where they differ is that Coburn recognizes that spending can hide in the tax code.

Trimming tax preferences won’t be painless – many businesses and families would send more to the IRS. But the result would be a fairer, more honest tax code and a broader, more solid base of revenue to pay for government services.

Preparedness 101: Zombie Apocalypse

The Centers for Disease Control offers emergency preparedness tips with a sense of humor:

So what do you need to do before zombies…or hurricanes or pandemics for example, actually happen? First of all, you should have an emergency kit in your house. This includes things like water, food, and other supplies to get you through the first couple of days before you can locate a zombie-free refugee camp (or in the event of a natural disaster, it will buy you some time until you are able to make your way to an evacuation shelter or utility lines are restored). Below are a few items you should include in your kit, for a full list visit the CDC Emergency page.

     

  • Water (1 gallon per person per day)
  • Food (stock up on non-perishable items that you eat regularly)
  • Medications (this includes prescription and non-prescription meds)
  • Tools and Supplies (utility knife, duct tape, battery powered radio, etc.)
  • Sanitation and Hygiene (household bleach, soap, towels, etc.)
  • Clothing and Bedding (a change of clothes for each family member and blankets)
  • Important documents (copies of your driver’s license, passport, and birth certificate to name a few)
  • First Aid supplies (although you’re a goner if a zombie bites you, you can use these supplies to treat basic cuts and lacerations that you might get during a tornado or hurricane)

Once you’ve made your emergency kit, you should sit down with your family and come up with an emergency plan. This includes where you would go and who you would call if zombies started appearing outside your door step. You can also implement this plan if there is a flood, earthquake, or other emergency.

ht: Alex Tabarrok

Congestion Pricing Saves Time and Money

The Highway Trust Fund will soon be broke. Gasoline tax revenues haven’t kept up with spending, and it’s likely that demands for new highway infrastructure will grow in the future.

Joseph Kile, head of the microeconomics studies division at the Congressional Budget Office, discussed various policy options to deal with this funding gap in his testimony to the Senate Finance Committee on Tuesday. Most news coverage of Joe’s testimony emphasized his suggestion that taxes based on miles traveled, rather than gasoline consumption, might be a better way to finance America’s highways. After all, miles traveled is, along with weight, the primary driver of wear and tear on the roads. And it’s a decent proxy for the benefit that drivers get from having functioning roads.

That’s an interesting idea, but I’d like to highlight another important point that Joe made: the amount of infrastructure America should build depends very much on how we price it.

If a six-lane highway gets congested, that doesn’t necessarily mean that we need to build new lanes or lay out parallel roads.

We could charge congestion fees instead. That would discourage driving at peak times and thus speed traffic without new construction. That’s what London and Singapore famously do to limit traffic in their downtowns. And it’s something we should more here in the United States.

Joe reports estimates from the Federal Highway Administration (FHWA) that congestion pricing could decrease highway spending needs by 25 to 33 percent:

The federal government spent about $43 billion on highway investment in 2010. To maintain the same quality of highway performance would require an average of $57 billion in annual federal spending in coming years, according to the FHWA. That price tag drops to only $38 billion, however, if we make good use of congestion pricing. Congestion pricing would thus save federal taxpayers almost $20 billion per year; state and local governments would save even more, since they pay for more than half the costs of these projects.

Congestion pricing can make our roadways work better, save Americans precious time, and reduce federal, state, and local budget pressures. That a great combination in this time of growing infrastructure needs and tightening budgets.

Moral Hazard, Pakistan Edition

The United States can’t pursue al Qaeda alone. We need help from other nations. To encourage nations to provide that help, the U.S. created the Coalition Support Fund to reimburse coalition partners for the costs they incur fighting terrorism.

As Adam Entous reports in the WSJ, the prospect for such “reimbursement” creates an obvious incentive: our partners may exaggerate how much they are really spending:

The U.S. and Pakistan are engaged in a billing dispute of sizable proportions, sparring behind closed doors over billions of dollars Washington pays Islamabad to fight al Qaeda and other militants along the Afghanistan border.

Washington, increasingly dubious of what it sees as Islamabad’s mixed record against militants, has been quietly rejecting more than 40% of the claims submitted by Pakistan as compensation for military gear, food, water, troop housing and other expenses, according to internal Pentagon documents. Those records, reviewed by The Wall Street Journal, detail $3.2 billion in expense claims submitted to the U.S. for operations from January 2009 through June 2010.

According to the documents and interviews with officials, Pakistan has routinely submitted requests that were unsubstantiated, or were deemed by the U.S. to be exaggerated or of little or no use in the war on terror—underscoring what officials and experts see as a deep undercurrent of mistrust between the supposed allies.

Zanran: Google for Data?

Zanran is a new search engine, now in beta testing, that focuses on charts and tables. As its website says:

Zanran helps you to find ‘semi-structured’ data on the web. This is the numerical data that people have presented as graphs and tables and charts. For example, the data could be a graph in a PDF report, or a table in an Excel spreadsheet, or a barchart shown as an image in an HTML page. This huge amount of information can be difficult to find using conventional search engines, which are focused primarily on finding text rather than graphs, tables and bar charts.

Put more simply: Zanran is Google for data.

This is a stellar idea. The web holds phenomenal amounts of data that are hard to find buried inside documents. And Zanran offers a fast way to find and scan through documents that may have relevant material. Particularly helpful is the ability to hover your cursor over each document to see the chart Zanran’s thinks you are interested in before you click through to the document.

Zanran is clearly in beta, however, and has some major challenges ahead. Perhaps most important are determining which results should rank high and identifying recent data. If you type “united states GDP” into Zanran, for example, the top results are rather idiosyncratic and there’s nothing on the first few pages that directs you to the latest data from the Bureau of Economic Analysis. Google, in contrast, has the BEA as its third result. And its first result is a graphical display of GDP data via Google’s Public Data project. Too bad, though, it goes up only to 2009. For some reason, both Google and Zanran think the CIA is the best place to get U.S. GDP data. It is a good source for international comparisons, but it falls out of date.

Here’s wishing Zanran good luck in strengthening its search results as its competes with Google, Wolfram Alpha, and others in the data search.

Chain, Chain, Chain, Chain CPI

Over at the Moment of Truth project (a continuation of the president’s fiscal commission), Adam Rosenberg and Marc Goldwein make a compelling case that the government should use a different inflation measure when calculating cost of living increases and indexing the tax code:

Maintaining purchasing power in spending programs and indexing various parts of the tax code is an important policy goal. However, policymakers should ensure that the most accurate measure of inflation is being used.

To correct the problem of over-indexation, many have proposed switching to the chained CPI [consumer price index] to provide a more accurate measure of inflation for indexed provisions in the federal budget. This switch was recommended by the National Commission on Fiscal Responsibility and Reform (“Fiscal Commission”) and the Bipartisan Policy Center ‘s Debt Reduction Task Force (“Domenici-Rivlin”). It has been incorporated into a large number of other plans, including from the Heritage Foundation on the right and the Center for American Progress on the left. An overwhelming majority of economists from both parties agree that the chained CPI is far more accurate measure of inflation than the CPI measurements currently in use.

In addition to improving technical accuracy, switching to chained CPI would have the secondary benefit of reducing the deficit – by about $300 billion over the next decade alone.

For the reasons they mention, I endorse this change and predict it will be part of any “grand bargain” on America’s budget.

With apologies to Aretha Franklin (and any of you with sensitive music sensibiities), let me suggest a theme song for the effort:

Chain, Chain, Chain, Chain CPI

Chain, chain, chain, chain, chain, chain

Chain, chain, chain, chain CPI

For these long years, we have indexed all wrong

We pay too much, that leads to fiscal pain

And now money’s getting tight

But we have no need to cry

We know what to do, oh a better measure we can try

Chain, chain, chain, chain CPI

P.S. To my readers who believe that the regular CPI understates inflation, rather than overstating it: Yes, Aretha’s song is “Chain of Fools”. And yes, that makes it easy for you to make up lyrics that mock the chain CPI rather than endorse it. Have fun.

Incentives and Property Rights, Dead Raccoon Edition

It seems like only yesterday that I met Rocky. Probably because it was yesterday.

Our smallest cat Caramel was staring intently upward. Following his gaze, I spied Rocky tucked between two branches high in the silver maple near our deck.

Rocky didn’t look well. Raccoons aren’t usually out and about at 3:00 on a sunny afternoon. Lounging in the sun isn’t their thing.

Esther and I thought about calling the animal control authorities–rabies is not unheard of around here–but decided to wait until morning to see if Rocky looked better. No point harassing (or worse) the poor guy if he’s just an eccentric raccoon who wanted some sun.

A higher authority came calling overnight, though, and Esther found Rocky motionless under our deck.

Wild animals are one of my domestic responsibilities, so it fell to me to go poke Rocky with a stick to check his status. Result: deceased.

So what do you do with a dead raccoon?

This is precisely the sort of question at which the web excels. Sure enough, “dead raccoon” generates more than 30,000 hits on Google. But they boil down to only three flavors of advice: (1) Do it yourself, (2) Make it someone else’s problem, or (3) Turn it into a media sensation by claiming you’ve discovered a monster.

#3 wasn’t really an option – Rocky was clearly a raccoon — so I tried the nice version of #2, calling Montgomery County Animal Control to see if they handle deceased raccoons. No dice. If the deceased is on your property, it’s your responsibility – bag him and put in the trash was the advice. If he were on a county road, however, that would be a different matter. Then the county would pick him up.

Fair enough. Property rights ought to convey responsibilities as well as ownership. I’m good with that. But I couldn’t miss the implied incentive. If I were so inclined, I could simply pick Rocky up, suitably attired in latex gloves etc. (me, not him), and deposit him by the curb. I suspect such littering is a popular strategy. People do respond to incentives after all. See, e.g., Stacey Robinsmith’s dead raccoon trilogy.

Being a respecter of property rights and embracer of responsibility, however, I went with option #1. Here are some tips if you ever find yourself in a similar circumstance:

  • Fortune favors the swift. Rigor mortis is your friend. Just trust me on this.
  • Raccoons have claws; use extra bags. Several cheery folks recommended putting Rocky in a trash bag. Well, his claws sliced right through that when I placed him inside. I ended up going with a full-on Babushka doll solution – five nested bags. That might have been a teensy bit excessive. But I suspect the garbage collectors will appreciate it.
  • Burial would, of course, be a more natural solution. But given the number of dogs, cats, and other critters that roam the neighborhood and dig better than I do, that seemed like a bad idea with Rocky’s suspicious cause of death.
RIP Rocky.

Uncertainty Still Reigns in the Latest Blogger Word Cloud

Tim Kane at the Kauffman Foundation is out with his latest survey of economics bloggers (full disclosure: I am both an adviser to the survey and a participant in it).

My favorite feature is a word cloud of adjective that respondents offered to an open-ended question about the U.S. economy:

Uncertainty still reigns (as it should), but ”recovering”, “improving”, and “growing” hold some prime real estate. As do “weak”, fragile”, and “sluggish.”

For comparison, here’s last quarter’s word cloud: