Category: Politics

Let’s Eliminate the Debt Limit

My latest column at the Christian Science Monitor:

America’s leaders need to get to yes on a budget deal – one that marries substantial deficit cuts with a much-needed increase in the debt limit.

But that’s not enough. Rather than merely increasing the debt limit, we should eliminate it.

I realize that sounds strange. With all the Sturm und Drang in the budget talks, you might think that the debt limit is essential to controlling Washington’s profligate ways. It’s not.

Washington has other tools for managing its finances. The annual budget process includes a series of steps by which Congress decides how much to spend and to collect in taxes. Those decisions determine the size of America’s deficits and debt.

That simple fact often gets lost in the debate, so let me say it again: When Congress decides how much to spend and how much to tax, it is also deciding how much to borrow.

Unfortunately, the debt limit allows lawmakers to pretend that they can separate the two. Members routinely try to wrap themselves in the flag of fiscal responsibility by voting against debt limit increases. In most cases, though, those members have also voted for spending and tax policies that make those debt increases necessary.

Votes on the debt limit thus usually reflect raw politics, not substantive policy differences. Everyone knows that the debt limit has to rise. But they also know that voters hate debt. So law-makers jockey to see who can win the right to vote no and who must bear the burden of voting yes.

Democrats opposed debt limit increases when President George W. Bush was in office and Republicans controlled Congress. Republicans returned the favor under President Obama and the Democratic Congress. The only times we’ve seen hints of bipartisanship are when, as now, divided government has placed some responsibility on both parties.

A larger problem is that the debt limit institutionalizes risky brinkmanship. In divided government, both parties must agree to raise the debt limit. If they don’t, the United States can’t pay all its bills. We might even default on our debt. That’s the economic equivalent of driving over a cliff.

Both sides would regret that outcome. But they face very different incentives. The party that holds the White House has to make sure that the government functions. That’s why Treasury Secretary Timothy Geithner has repeatedly warned Congress about the damage that would result if the debt limit isn’t raised in time.

But the opposing party wants to extract the highest possible price for agreeing to more debt. So they have to act as though hitting the limit is no big deal. That’s why many Republicans have been discussing the potential to prioritize payments (putting interest first), and some have flirted with endorsing temporary default.

The problem with that strategy is that negotiations can fail, prioritization might not work, or we might be surprised with a sudden need for funds. In short, we might accidentally go over the brink.

Even if we don’t, dancing on the edge is costly. Alone among major nations, the US talks openly about the possibility of default. Financial markets usually discount that rhetoric as mere politics. As the deadline nears, however, that rhetoric will sow doubt in financial markets, inspire warning shots from credit-rating agencies, and potentially increase our borrowing costs.

There’s no reason to subject ourselves to those needless costs. The debt limit is an anachronism. Congress should eliminate it.

P.S. In conjunction with the eliminating the debt limit, I would strengthen the existing budget process along the line the Bipartisan Policy Center’s SAVEGO proposal. We do need budget procedures to force action, just not the brinkmanship of the debt limit.

P.P.S. Reuters reports that Moody’s is also recommending the elimination of the debt limit.

A Big Error in the Senate Republicans’ Balanced Budget Amendment

Senate Republicans made a striking error in the balanced budget amendment they introduced last week. As written, the amendment would limit federal spending far more than those senators realize or, I suspect, desire.

The Republicans want the budget to be balanced by keeping spending down rather than by raising tax revenues. They thus propose limiting spending to no more than 18% of gross domestic product (GDP). That’s in line with average tax revenues over the past four decades, but well below average spending, which has been just short of 21% of GDP.

So what’s the problem? The way the amendment would implement the spending limit:

Total outlays for any fiscal year shall not exceed 18 percent of the gross domestic product of the United States for the calendar year ending before the beginning of such fiscal year, unless two-thirds of the duly chosen and sworn Members of each House of Congress shall provide by law for a specific amount in excess of such 18 percent by a roll call vote.

The amendment compares spending in one period (the upcoming fiscal year) to the size of the economy in an earlier period (the last complete calendar year). If the amendment were in force today, for example, spending in fiscal 2012, which starts in October, would be limited to 18 percent of GDP in calendar 2010. That’s a gap of 21 months.

As Bruce Bartlett pointed out in analyzing an earlier version of this amendment, that time lag can add up to big money. Why? Because both real economic growth and inflation will expand the economy during those 21 months.

The Congressional Budget Office projects, for example, that nominal GDP will grow about 4.5% annually in the latter part of this decade (the earliest the amendment could go into effect). Over 21 months, that works out to roughly 8% growth. The amendment would thus limit federal spending in those years to about 16.7% of each year’s GDP (16.7% = 18% / 1.08) not the advertised 18%. In 2020 alone that amounts to a difference of more than $300 billion in spending.

That’s a big error.

I doubt that Senate Republicans really want to limit spending to only 18% of GDP. Even the House Republican budget calls for spending of more than 20% of GDP for at least two decades. But if the Senate Republicans are serious, their first step should be to fix the drafting error in their amendment.

The Cost of Sunshine: Hugo Chavez Edition

Campaign systems often rely on disclosure (e.g., of campaign contributions and petition signing) to limit corruption and inform the voting public. Such sunshine provides important benefits, but, as I’ve noted before (here and here), it can also have costs. For example, disclosure makes it easier for politicians to identify their supporters and opponents and, if they are so inclined, to mete out rewards and punishments accordingly.

A recent paper in the American Economic Journal: Applied Economics reports a striking example of this in Venezuela. Chang-Tai Hsieh, Edward Miguel, Daniel Ortega, and Francisco Rodriguez document (here; ungated version here) what happened to Venezuelans who signed at least one of three petitions in 2002-03 calling for a recall vote against President Hugo Chavez. The third petition was successful, but Chavez survived the vote.

He then got his hands on the list of Venezuelans who signed the third petition. Using household survey data, the authors were able to track what happened to those signers, Here’s their abstract:

In 2004, the Hugo Chávez regime in Venezuela distributed the list of several million voters who had attempted to remove him from office throughout the government bureaucracy, allegedly to identify and punish these voters. We match the list of petition signers distributed by the government to household survey respondents to measure the economic effects of being identified as a Chávez political opponent. We find that voters who were identified as Chávez opponents experienced a 5 percent drop in earnings and a 1.3 percentage point drop in employment rates after the voter list was released.

In short, a notable fraction of the opponents lost their jobs, were unable to get new jobs, or had their pay cut.

Individuals who signed the first or second petition, but not the third, did not experience any decline in earnings or employment.

Why the difference? Because only information about the third petition appeared in the computerized data sets that Chavez distributed.

So it wasn’t disclosure alone that allowed the punishment, but disclosure coupled with easy-to-access dissemination.

Spending in Disguise

Republicans are demanding a deficit-reduction package that’s entirely spending cuts. Democrats insist that revenues must also be included.

Are these positions completely irreconcilable? Not if both sides are willing to attack the spending hidden in our tax code.

I explore this idea for finding common ground in a new essay in National Affairs, “Spending in Disguise”:

A great deal of government spending is hidden in the federal tax code in the form of deductions, credits, and other preferences that seem like they let taxpayers keep their own money but are actually spending in disguise. Those preferences complicate the code and often needlessly distort family and business decisions. Their magnitude raises the possibility of a dramatic reform of the tax code—making it simpler, fairer, and more pro-growth—that would amount to both cutting spending and increasing government revenue at once, and without raising tax rates. 

Such a reform would not eliminate the need for serious spending cuts, of course, nor would it take tax increases off the table. But it could dramatically improve the government’s fiscal outlook and make the task of budget negotiators far easier. It will only be possible, however, if we clearly understand how spending is hidden in the tax code and what reformers might do about it—if we see that tax policy and spending policy are not always as distinct as we might think.

In short, there is a deal to be done in which revenues go up solely because spending in the tax code goes down.

The trillion-dollar question is whether President Obama, Speaker Boehner, and Leader Reid can cut that deal by August 2nd. If not, one side will have to cave on a core principle (no prize for guessing which party that’s likely to be), or we will find out just how painful it really is to run out of fresh borrowing room.

Don’t Fall for a Repatriation Holiday

Recent weeks has brought much chatter — from both Republicans and Democrats — about offering companies a temporary tax holiday for repatriating foreign earnings. A typical proposal would effectively tax any repatriated earnings at 5.25% this year, rather than the usual rates which can be as a high as 35%.

Proponents tout this as a form of economic stimulus. But, as my Tax Policy Center colleagues Bill Gale and Ben Harris point out, that’s doubtful. In “Don’t Fall for Repatriation” at Politico, they say:

In addition, firms are unlikely to invest the repatriated funds. Congress passed a similar repatriation tax holiday in 2004 and required firms to create domestic jobs or make new domestic investments to get the tax break. Nonetheless, the firms, on average, used the tax break to repurchase shares or pay dividends — not to increase investment.

The holiday, instead, turned into a massive tax break for shareholders — resulting in little or no economic gain or job market expansion. Why? Because money is fungible, to satisfy the requirements of the law, corporations reported repatriated funds as the source of money for investments or jobs they would have created anyway — and used other funds to increase shareholder wealth.

Today, domestic firms are sitting on near-record levels of liquid assets. The reason they’re not investing or creating more jobs is not a cash shortage. 

 Bill and Ben also note the costs of a repatriation holiday:

First, allowing repatriation today means less taxable corporate profits in the future — which would translate into less government revenue.

Second, and perhaps even more costly than the lost revenue, would be the dangerous precedent that firms would expect regular repatriation holidays. This expectation may persuade firms to hoard profits overseas and perhaps even move production abroad, betting that Congress will eventually grant another “one-time” tax break.

Indeed, the prior tax holiday was supposed to discourage firms from holding profits overseas. But instead, firms stockpiled new reserves, presumably in anticipation of another holiday. The Joint Committee on Taxation estimates that these two factors would contribute to the $79 billion 10-year price tag on a second repatriation.

Playing with Fire with the Debt Limit

My latest column in the Christian Science Monitor:

America sometimes takes its exceptionalism too far.

Case in point: We are the only major economy that talks openly of default.

Government debt has ballooned throughout the developed world in the aftermath of the Great Recession. France and Britain are as deep in debt as the United States, for example, and Japan is much further in the hole.

But their leaders never mention the possibility of default. Why would they? If you have the ability to pay your bills, there’s no reason to scare your creditors.

But that’s exactly what we do in America. Treasury Secretary Timothy Geithner has been warning about the risks of default since January.

If we don’t increase the debt limit by early August, he tells us, default becomes a real possibility. And that could pose grievous risks to our already weak economy.

Many Republicans play down that risk. Echoing famed investor Stanley Druckenmiller, some argue that a temporary default would be acceptable if it’s part of a larger political strategy that brings future deficits under control.

But that is a dangerous game.

Large swaths of America’s financial infrastructure have been built on the assumption that US Treasuries pay on time. And financial markets would likely punish the US with higher interest rates if we defaulted. That’s what happened in 1979, for example, when back office snafus caused Treasury to unintentionally miss payments to some investors.

This time, Fitch, Moody’s, and Standard & Poors are threatening to cut the US credit rating if we choose to default. Given the risks, most observers recognize that default is not, and should not be, an option. The US is not a deadbeat nation.

But does that mean the debt limit has to go up in early August? Some Republicans say no because of a simple fact: Every month, the federal government collects more in taxes than it pays in interest. With careful cash management (which would likely have to start before the August deadline), Mr. Geithner should be able to prioritize debt payments and thus avoid debt default.

As best as I can tell, that argument is correct, but it’s hardly a reason for complacency. America is currently spending about $100 billion more each month than it collects in revenues. If we hit the debt limit, we won’t be able to pay everyone who is rightly expecting to be paid.

Geithner can and should ensure that our debtholders get paid.

But someone – perhaps millions of someones – won’t be paid on time. Contractors, federal workers, program beneficiaries, or state and local governments will suddenly find themselves short on their cash flow.

That won’t be good for the economy. Even though it’s not as bad as debt default, it still would paint the US as a deadbeat.

The US faces severe fiscal challenges in the years ahead. It’s perfectly reasonable that lawmakers want to combine an increase in the debt limit with efforts to rein in future deficits.

But that worthy goal should not weaken our commitment to paying – on time and in full – the obligations that we have already incurred.

As the debt limit draws near, our leaders should stop playing with fire and craft instead a plan to rein in future deficits without threatening our struggling recovery.

That’s a difficult balancing act, requiring tough compromises across the political spectrum. But as everybody knows on Capitol Hill and beyond, it would be the best step for the nation and our fragile economy.

It would also be exceptional.

What Would We Need for Persistent 5% Growth?

Last week, I argued that Governor Tim Pawlenty’s aspiration for 5% economic growth over a full decade is implausible since the United States has achieved such steady growth only once since World War II.

Over at Economics One, Stanford economics professor John Taylor offers a more positive take, defending the goal and offering a recipe for achieving it: 1% from population growth, 1% from employment growing faster than the population, and 2.7% from productivity growth.

Add it all up and you get 4.7% growth, a bit short of Pawlenty’s target but close enough for government work.

That sounds great, and I hope it happens, regardless of who is president. But let’s take a moment to kick the tires on Taylor’s assumptions.

Two seem fine:

  • His population growth assumption is perfectly reasonable. Indeed, it matches the estimate used by the President’s Council of Economic Advisers in its most recent Economic Report of the President (Table 2-2).
  • His productivity growth assumption is optimistic, but realistically so. Nonfarm productivity has grown at a 2.7% pace, on average, since 1996. Few analysts see that persisting. CEA forecasts assume 2.3%, for example. But the U.S. economy has demonstrated that 2.7% productivity growth is possible for a decade or more.

Three other assumptions are problematic.

  • Taylor uses a very optimistic assumption about how much employment growth can exceed population growth. Today, about 58% of the working age population has a job. That woefully low level ought to rise as the Great Recession recedes. Taylor assumes that we can boost that ratio back to its 2000 level of almost 65%. But 2000 was the tail end of a technology boom that lifted America’s employment-to-population ratio to record heights. Since then, the working population has aged, so the employment-to-population ratio will be persistently lower even in good times. CEA thus forecasts that labor force changes will trim about 0.3% annually from potential growth in coming years. Getting the employment-to-population ratio back up to 65% thus won’t happen unless we have an even bigger boom than the late 1990s delivered.
  • Taylor assumes that workers will keep working the same number of hours that they do today. That sounds innocuous except for one thing: average hours have been declining. CEA estimates that trimmed 0.3% per year from potential economic growth from 1958 to 2007 and will trim another 0.1% per year from 2010 through 2021.
  • Taylor assumes that the rest of the economy will enjoy the same productivity growth as the nonfarm business sector. In reality, the other parts of the economy – most notably government – are lagging behind. CEA estimates that slower productivity growth outside the nonfarm business sector trimmed 0.2% from potential economic growth from 1958 to 2007 and sees an even bigger bite, 0.4% annually, in the coming decade.

Taylor’s scenario thus assumes that everything breaks right for the U.S. economy for a full decade, with remarkable job growth and remarkable productivity growth in the economy as a whole. Not impossible but, unfortunately, not likely either.

How Ambitious is Pawlenty’s Growth Goal?

Plenty.

In his economic speech on Tuesday, presidential candidate Tim Pawlenty set out an ambitious goal for economic growth:

Let’s grow the economy by 5%, instead of the anemic 2% currently envisioned.  Such a national economic growth target will set our sights on a positive future.  And inspire the actions needed to reach it. By the way, 5% growth is not some pie-in-the-sky number. We’ve done it before. And with the right policies, we can do it again.

Between 1983 and 1987, the Reagan recovery grew at 4.9%.  Between 1996 and 1999, under President Bill Clinton and a Republican Congress the economy grew at more than 4.7%. In each case millions of new jobs were created, incomes rose and unemployment fell to historic lows. The same can happen again.

In the aftermath of the Great Recession, it wouldn’t be surprising to see a couple years of strong growth at some point. Let’s hope it’s soon.

But could we have remarkably strong growth for a full decade, as Pawlenty hopes? His two examples don’t inspire confidence. In each case, strong growth ended in four years or less.

So when was the last time the United States grew at 5% for a full decade?

Mid-1958 through Mid-1968. Over that span, U.S. growth averaged exactly 5.0% per year.

But that’s the only instance since World War II. Economic growth was lower than 5%, usually much lower, in every other decade since 1947:

Growth hasn’t reached even 4% over any decade since the late 60s and early 70s.

Getting up to 5% over the next decade thus seems not merely ambitious, but almost unthinkable.

Of course, a few years back many would have said the same thing about getting the U.S. growth rate down to 2%. Until the Great Recession, there was only one ten-year stretch in the post-war period, ending in early 1983, in which growth averaged as low as 2%.

Sadly, we’ve broken that record handily. Over the past ten years, growth has averaged a meager 1.8%.

So maybe T-Paw’s right, and the economy can break out to the upside just as we’ve done to the down.

But I wouldn’t bet on it, regardless of who is president.

P.S. The quarterly data I use here are available since 1947. Annual data go back to 1929. Perhaps not surprisingly, every ten-year period ending in 1941 through 1951 had an average growth rate of 5% or more, thanks to World War II and the rebound from the Great Depression.   

A $5,000 Bill on the Sidewalk

Someone is offering a free $5,000 bill tonight over at Intrade.com:

That’s right. You can sell 9,999 shares of The Donald (not me, the other one) at $0.52 a piece. In just that one trade, you can pocket almost $5,200 of free money. Unless, of course, you believe that Donald Trump could actually be elected president.

So why haven’t I picked up this $5,000+ bill? Because I haven’t seen an unambiguous  statement that buying and selling on Intrade is completely legit for U.S. citizens. Not worth the risk.

If Gary Gensler (Chairman of the Commodities Futures Trading Commission) or other relevant regulator would issue a ruling clarifying that Intrade trading is copacetic, that would be much appreciated.

For the latest Trump action, click here.

P.S. For sticklers: yes, the margin requirements on this trade could be rather a nuisance.

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