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House Budget Committee Ranking Member, Paul Ryan, made an interesting request for CBO analysis, which they responded to today.  From the CBO Director’s Blog (i.e., Peter Orszag), the explanation of what Congressman Ryan requested:

Macroeconomic effects of future fiscal policies

Under current law, rising costs for health care and the aging of the population will cause federal spending on Medicare, Medicaid, and Social Security to rise substantially as a share of the economy. At the request of the Ranking Member of the House Budget Committee, CBO released a letter examining the potential economic effects of (1) allowing federal debt to climb as projected under the alternative fiscal scenario presented in CBO’s December 2007 Long-Term Budget Outlook; (2) slowing the growth of deficits and then eliminating them over the next several decades; and (3) using higher income tax rates alone to finance the increases in spending projected under that scenario.

And what I find most interesting, their answer to part (1), which explains why deficits matter, and why the policy path we’re on is not sustainable:

How Would Rising Budget Deficits Affect the Economy? Sustained and rising budget deficits would affect the economy by absorbing funds from the nation’s pool of savings and reducing investment in the domestic capital stock and in foreign assets. As capital investment dwindled, the growth of workers’ productivity and of real (inflation-adjusted) wages would gradually slow and begin to stagnate. As capital became scarce relative to labor, real interest rates would rise. In the near term, foreign investors would probably increase their financing of investment in the United States, but such borrowing would involve costs over time, as foreign investors would claim larger and larger shares of the nation’s output and fewer resources would be available for domestic consumption.

How much would the deficits projected under the alternative fiscal scenario presented in the December 2007 Long Term Budget Outlook affect the economy? For its analysis, CBO used a textbook growth model that can assess how persistent deficits might affect the economy over the long term. According to CBO’s simulations using that model, the rising federal budget deficits under this scenario would cause real gross national product (GNP) per person to stop growing and then to begin to contract in the late 2040s. By 2060, real GNP per person would be about 17 percent below its peak in the late 2040s and would be declining at a rapid pace. Beyond 2060, projected deficits would become so large and unsustainable that the model cannot calculate their effects. Despite the substantial economic costs generated by deficits under this model, such estimates greatly understate the potential loss to economic growth because the effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario.

Less interesting to me are their findings for parts (2) and (3) of Congressman Ryan’s request.  CBO’s response to (2) is not very interesting, because it just reverses all the bad economics of part (1) by reducing the deficit in an unspecified way (without modeling specific spending cuts or tax increases), which leaves the hard part out.  CBO’s response to (3) is not very interesting, because of course we can’t do it all on the tax side (by letting spending rise completely unchecked and raising marginal tax rates to close the deficit–and wouldn’t want to do it that way, anyway), just like we can’t do it all on the spending side.  Congressman Ryan didn’t ask CBO to show what cuts to the entitlement programs and other government spending would have to be done in order to keep taxes as a share of the economy at its 40-year historical average, now did he?

My boss, Concord Coalition Executive Director, Bob Bixby (on the left in this photo), is in Jacksonville, Florida today, along with former Comptroller General David Walker (on the right in this photo), Paul Cullinan of Brookings, and Andrew Biggs of the American Enterprise Institute, for another stop on the “Fiscal Wake-Up Tour”.  Click here to see the details of the event and bios of each of today’s tour members. 

Besides the usual Tour town-hall meeting, this trip included a special showing of the movie I.O.U.S.A. at the Jacksonville Film Festival (last night…sorry I didn’t think to announce here earlier).  (The photo is from a scene in the movie.)  If you would like to learn more about I.O.U.S.A., which stars Bob Bixby and David Walker and has the Fiscal Wake-Up Tour as its centerpiece, please visit the movie’s website here.  The documentary movie is expected to start showing in “selected theatres” by late summer.

Here’s a good press report on the Jacksonville stop of the Tour:  PR Newswire story on Jacksonville trip.

I didn’t post yesterday because I was distracted.  I locked my keys in my minivan in what turned out to be a failed attempt to do too many things at once.  With a great plan for how I could: (1) teach one yoga class in the morning, (2) quickly change clothes, (3) drive straight to daughter #3’s ballet venue while eating “breakfast”, and then (4) leave her performance a little early to get to the second yoga class of the day, I celebrated the success of the plan prematurely–at step #3–and got so unfocused that I managed to lock my keys in the car–and not notice until I was to implement step #4 (instead of hours earlier at step #3 when I could have had time to remedy it).

See, my tragic downfall was that I picked up the banana peel.

Arriving at the ballet theatre, I was rushing out, opened the door, hooked my purse over my arm, then realized I needed to grab my cell phone.  So I grabbed the cell phone in one hand, keys in another, and then locked the car door from the door lock.

Then I noticed the banana peel I had left on the floor.  Oh, better pick that up, or the car will reek of banana by the time I get back here, hours later…

So I picked up the banana peel in one hand, cell phone still in the other, purse still hooked over one arm, and then closed the car door, running toward the theatre focused on finding a trash can along the way for my banana peel.

Somehow with two hands full (cell phone in one, banana peel in the other), I didn’t notice I didn’t have my keys… not until I had to implement step #4, hours later.  Step #4 failed.   

Of course, this was just another of the regularly-occuring signals to me that I try to do too much.  It also served as a lesson:  “don’t pick up the banana peel”–meaning, don’t let minor distractions and trivial things get in the way of accomplishing one’s major tasks “at hand.”   (ha ha)

I suppose a lot of you people out there (but especially parents) have your own picking-up-the-banana-peel moments, and I know that this applies big time to the way the government conducts business.  Why, government has tons of banana peels lying around them!  I suppose next week I will find a way to talk about the “banana peels” in the congressional budget resolution.

What do you think are good examples of ”picking up the banana peel” and “locking the keys in the car” that you see in the public policy arena?  Or in your own daily lives? 

I’m inspired by Drew’s last comment to “Mommy, Why Do Revenues Grow?”…

Tax cut proponents love to argue that the longer-term fiscal challenge is a spending problem–due to the aging population and the associated projected rise in entitlement spending (Social Security, Medicare, and Medicaid).  And if it’s a spending problem, why should taxes have to be raised?  After all, taxes as a share of the economy exceed that magic 40-year historical average and are projected to rise even if the Bush tax cuts were to be permanently extended.  (You can refer back to the basic budget math on this.)

But this is a very backward way of budgeting, and a family would never do it that way.   Families face new “spending pressures” all the time.  As a family faces new priorities and the associated new expenses, they figure out how they’re going to make it work–how to line up those necessary or desired expenses with their income.  With every new expense, does the family say “gee, up to now our income has been just fine at covering our ongoing expenses, so why should we have to change anything?…we’ll just have to do whatever we can to avoid those new expenses.”  Do families tell their college-bound kids:  “Hey, this is a college expense problem, not a problem with anything else in our family budget …If you don’t get into college for free, you’re not going to college”?  I don’t think so.  Even with a very rational weighing of costs versus benefits (which I will argue later is hard for parents to do), families who recognize the benefits of a college education are willing to do whatever is necessary to make it something they can and will afford. 

Budgeting responsibly means first, considering the relative value the family or society places on certain types of spending, and second, figuring out how much of that spending is worth doing, given how easy or hard it is to pay for it.   There’s a logical sequencial order:  (i) what do you want to do/accomplish, and (ii) how are you going to pay for it?   As Drew commented, there’s not a problem if you decide you want to do more, and you’re willing to pay for it.  And there’s not a problem if you decide to do less and hence pay less.  The problem is doing more (or at least spending more), without paying for it.  That’s not responsible budgeting.  That’s not even budgeting, period.  That’s acting as if there are no constraints and immorally passing the burden–and even tighter constraints–onto our children and grandchildren.

So that’s why we have to pick on taxes, too.

American Enterprise Institute’s (and McCain economic advisor) Kevin Hassett likes polar bears.  He likes them so much that he brought them up yesterday at a tax conference, during his panel on advising the presidential candidates.  (This morning we’ll hear from an entire panel discussing “can tax policy save the penguins.” I think they should have said “polar bears,” which are cuter….  )  You see, Kevin, a low-tax kind of guy, favors the idea of a carbon tax.

And by the way, so does Greg Mankiw, a former Chairman of the Council of Economic Advisers under this Bush Administration.  And so does Glenn Hubbard, another former CEA Chairman under this Bush Administration, known as the “architect” of the Bush tax cuts.

And I have proposed this idea as well, but that’s not a shocker–I’m a tax-loving Democrat, after all.

The point is, like the fact that economists univerally (across the political and ideological spectra) seem to hate the idea of a gas tax holiday, we universally seem to love the idea of environmentally-motivated taxes.  Yes, a tax increase that even tax-cutting economists support.

Why?  Sustainability.  Some economists support the carbon tax purely on the grounds that it would help combat global warming and promote environmental sustainability.  As a mom and an economist, I love the carbon tax idea because it promotes fiscal as well as environmental sustainability.  It’s a revenue increase–yes, a tax increase!–but an efficient one, with the potential for at least some of that revenue to go toward deficit reduction. 

I’d like to think we parents can do better in terms of leaving behind a sound economy and a decent environment for our kids.

Well, they grow for lots of reasons, but mostly they grow because the economy grows…

I said I was going to post on this subject, and I thought I’d have to tell a long story, but lo and behold, I discovered CBO has already told this story very recently, in this report that I only noticed when going to their site to look up the historical data.

If you look at the historical data on revenues, you’ll notice that revenues almost always grow, in current dollar terms, because the economy almost always grows in current dollar terms.  In the 40 years that CBO’s historical data spans (1968-2007), total federal revenues, and individual tax revenues, only decreased two times, prior to the Bush Administration tax cuts:  in 1971 and in 1983.  Revenues decreased continuously in current dollar terms in 2001, 2002, and 2003.  Some folks point to the subsequent nominal revenue rise in 2004 on, as proof that tax cuts pay for themselves:  they say capital gains and dividend tax rates were cut, and revenues rose.  Well, no, revenues grew in 2004-07 because the economy grew–as is most of the explanation throughout history.  (This is a correlation without causation; perhaps I could say that my growing older caused revenues to rise, too.) 

And CBO’s report shows that the fact that the economy grew (at least a little) had little to do with the tax cuts.  It’s easy for the economy to grow in nominal terms, and in fact, economists view nominal growth as pretty meaningless.  What really matters is real growth in the economy, and when the economy is growing strongly enough to keep ahead of inflation, well, now you’re really talking helpful in terms of revenue growth–because then revenues even relative to the size of the economy (revenues/GDP) grow.  Revenues grow especially fast if taxable personal incomes keep ahead of growth in the overall economy.  Revenues also grow more strongly when the distribution of income becomes more skewed, and yes, revenue levels can increase and decrease with tax legislation (changes in tax bases and rates), although not in the directions often claimed. 

So on this more meaningful, “why do revenues as a share of GDP grow?” question, it turns out that the Bush tax cuts didn’t grow revenue at all, because the economy and taxable incomes haven’t been growing that strongly in real terms.  The whole premise of the CBO study was to focus on the 1994-2004 period and determine why individual tax revenues as a share of GDP rose so dramatically in the 1994-2000 period, then fell so sharply in the 2000-2004 period.  (See the cover of the CBO report for the picture.)  To quote from their summary:

Those changes in individual income tax revenues relative to the economy present a complicated story. The key factors include:

• A rising and falling income tax base, resulting from growth in wages and capital gains realizations that first exceeded and then lagged behind overall economic growth;
• A rising and falling effective tax rate on adjusted gross income, caused by changes in real (inflation-adjusted) bracket creep and a concentration of income in higher tax brackets; and
• Tax legislation, which was a major factor in the decline in income taxes relative to GDP from 2000 to 2004 but had little to do with the increase from 1994 to 2000.

Understanding those forces is critical to projecting the future path of federal revenues.

Note that CBO says that tax legislation “…was a major factor in the decline in income taxes relative to GDP from 2000 to 2004″.  This is consistent with the way in which the Bush Administration has habitually bragged about the merits of their tax cuts in their Economic Reports of the President –based on how much revenue they have lost (or rather, “given back to the people”) and not on how much economic growth they’ve produced.

So for readers interested in the tax cuts and economic growth issue, please read this CBO report (”Sources of the Growth and Decline in Individual Income Tax Revenues Since 1994″), check out the historical data on revenues, and let us know what you think.

The fiscally-disciplined Blue Dogs appear to have gotten their way in insisting that the veterans benefits portion of the war funding bill be paid for…  Well, at least in the House, and at least for now…

From an AP story by Andrew Taylor, posted last night:

Conservative “Blue Dog” Democrats blocked a vote last week over Democratic leaders’ attempts to add an additional $51.8 billion over the next decade for veterans education to the $183.8 billion war funding tab. They insisted on finding a way to pay for the new benefit without simply adding to the deficit.

“What we’re talking about is a one-half percent income tax surcharge on incomes above $1 million,” said Rep. Mike Ross, D-Ark., a leader of the Blue Dog group. “So someone who earns $2 million a year would pay $5,000. … They’re not going to miss it.”

The $1 million adjusted gross income level would apply to couples. Individuals would pay the surcharge on adjusted income exceeding $500,000.

The idea earned support from House leaders at a late afternoon meeting of top Democrats, including Speaker Nancy Pelosi of California.

The new GI Bill would essentially guarantee a full-ride scholarship to any in-state public university, along with a monthly housing stipend, for individuals who serve the military for at least three years.

It’s not at all clear that the tax surcharge could survive the Senate and it would likely prompt a veto from President Bush if it were to be presented to him. Still, the development allows House Democrats to keep promises to adhere to pay-as-you-go budget rules that were a top campaign plank in 2006.

The war funding bill still faces a troubled path to enactment and Democrats appear likely to miss their goal of passing the bill by Memorial Day.

I actually like the idea of the millionaire surtax in terms of the “shared sacrifice” it conveys, as well as the relative simplicity and efficiency of it.  (I know it does raise the marginal tax rate on those millionaires, but as Mike Ross says, not by enough for them to notice it or react to it much.)  And on principle, because these new vets benefits are new, permanent, entitlement spending, the Blue Dogs felt that at least that part of the costs of war should be paid for rather than deficit-financed.

But this is rather like picking up the “tip” at the restaurant while avoiding paying the actual tab.  The much larger issue is the fact that we current taxpayers have not paid for the “temporary” costs of the war but instead will run up a least a trillion more dollars in debt.  Now, I know a lot of us think the war should have never happened, and so the last thing we might want to do is to pay for it with higher taxes.  But the deficit-finance route doesn’t rip up the tab–it only passes it along to our kids and grandkids as it swells along through time, growing with compounding interest.  For those of us who are horrified by the talk of the war or at least the war’s “legacy” lasting decades and perhaps 100 years, unfortunately the fiscal legacy of the war is likely to go on much longer. 

So we at the Concord Coalition say hooray for the Blue Dogs for keeping up the fight for our kids’ economic future.  

Having just read the string of comments left on the Seattle P-I website in response to my Mother’s Day column, I noticed many readers were more fascinated by what happened in my household than interested in how I was trying to relate family budgeting to the federal budget.  So I feel compelled to explain that:

• No, my four kids did not drive my au pair (literally) crazy.  It turned out she was schizophrenic.  What I had interpreted from the first day as her just being an unusually uptight person (a “worrier”), turned out to be symptoms of a person hovering precariously over a schizophrenic cliff.  Apparently if one is predisposed to schizophrenia, one of the surest ways to trigger its onset is to put that person in a foreign country where their native language (in her case, German) is not spoken.
• We decided not to replace her with another au pair, because we could not find a “part time” au pair (there are such au pairs these days, called “EduCare au pairs”), and we had managed with so little help since she had arrived that we realized it would not make economic sense to pay for a full-time caregiver… especially given that our oldest was just a couple months away from getting her full drivers license and just two years from going to college, plus teenaged daughter #2 is very capable on the home front and also conveniently doesn’t have a lot of extracurricular activities.   (We realized the money we would have spent on child care would be really nice to have to save for college.)
• I decided to leave my Hill job not because the hours were bad in terms of average hours per week (they were not), but because the hours were not very flexible or predictable.  I needed to find a job where I could spend a lot of time working at home in the after-school hours, where I could be around my kids and not worry about them, and hence actually be more productive at my work, not less, than if I were stuck in my office.  And as I’d look around the Hill at the typical staffer, I realized that I didn’t really know anyone else with as many responsibilities back home as I had.  Plus most are a lot younger than I and have some ambition to move up to more powerful and prominent government positions–or to a lucrative lobbying job on K Street–and I wanted neither at this stage in my career and family life. 
• When my kids were younger, I never felt like they missed me or needed me that much during the workday.  The au pairs we’ve had over the years were wonderful with them, and you know how little kids like anyone with a bright, smiling face who will feed them and play with them.  But as my kids got older, I realized that the au pair wasn’t as great of a substitute for mom or dad during that after-school time.  The kids got busier with their own activities, which I wanted to be a part of, and had more going on in their own lives, which I wanted to be around more to hear about and help them through.

So we are now a household completely without hired household help, with one teenager who serves as our ”driver” when she’s not working at her Baskin-Robbins job, with a house that’s a mess from months of housekeeping neglect (there’s a clear downside to having had 14 years worth of au pairs who picked up after the kids), and lots of evenings of carryout or frozen meals.  We’re still transitioning and figuring out what we’re willing to do without to save money, versus what we need to replace in terms of all the tasks around home that aren’t now getting done–to either newly do it ourselves, or to hire help.  Two things that have helped me already that I’ll plug here:  Let’s Dish (seems a little better than microwave and carryout meals) and Google calendar (a life saver for coordinating 6 people’s schedules from different locations).  (No, they’re not paying me for advertising…)   So stay tuned if you’re interested in the “home economics” of the EconomistMom household.  In the future you may hear about 1-800-GOTJUNK, new vacuum cleaners, and who knows what else.

This is the “chaos I call home.”

To elaborate a bit on the points in that “Mastercard commercial” I posted yesterday…

Some policymakers who oppose using revenue increases to address our short- and long-term deficit problems argue that taxes are already high enough, or even too high.  They argue that tax cuts can’t be responsible for our deficit situation because the current level of federal revenues as a share of the economy (at 18.8%) is higher than the 40-year (1968-2007) average (of 18.3%).  In fact, even if the Bush tax cuts were permanently extended, and even if relief from the Alternative Minimum Tax (AMT) was permanently extended, revenues as a share of GDP would rise to the 19-20% range over the next few decades.  (Yes, that fact is a fact; see CBO’s Analysis of the President’s Budget or their Long-Term Budget Outlook… I will have to do a post soon called something like ”Why Revenues Rise”…) 

I have several problems with this argument that a historical perspective proves our current revenue levels (and path of revenues under extension of current tax policy) are adequate.  It goes back to that basic math in the “commercial”… 

There is nothing significant about the historical average of revenues/GDP as a guide for whether revenue levels are adequate today or in the future.  In fact, there’s nothing significant about it as a guide for whether revenue levels were adequate in the past.  The 40-year historical average of federal government spending/GDP is 20.6% (below where it is currently, at 20.0%).  If we were to hold to those historical norms, that would imply a goal of achieving permanent budget deficits of 3.1% of GDP, year after year.  That’s not sustainable, but we should be so lucky if that’s all we were facing…

Fiscal responsibility means the ”right” level of revenues is that which is sufficient to pay for the government programs we desire–not that which we’ve averaged over the past 40 years.  We decide what are our priorities as a society, and then we figure out how much of those priorities we can afford.  Ideally this decision process is not a “first come, first served” one, but is based on some sort of cost-benefit analysis that accounts for both how much benefit our society gets from the spending, as well as how large are the costs associated with the taxes that pay for that spending.

So here’s the problem going forward, and why the future budget calculus can’t be anything like the past.  We face two huge challenges in terms of federal government spending, given that our major entitlement programs provide income support and health care to older Americans:  (i) the changing demographics that will give us more older, retired people per younger, working person (that’s the going from 3.3 to 2.1 math where we lose more than one working person per retiree!), and (ii) the fact that for each of those older people, the costs of their health care will continue to rise faster than the economy grows (if historical trends continue, more than 2 percentage points faster), so that our economy cannot keep up.   It’s impossible for us to change (i), and at this point we don’t understand enough about how we can counter (ii).  With (i) and (ii) we face a distressingly-steep upward path of government spending as a share of our economy.  CBO’s long-term outlook shows that by 2050 under current policies, the federal government’s spending on Social Security, Medicare, and Medicaid alone will be 18.6% of GDP, and total federal spending will reach 41.8% of GDP. 

This distressing outlook for entitlement spending means that of course, entitlement reform is necessary, and that of course, policymakers will have to find ways to damp down health costs if the ”fiscal train wreck” is to be avoided.  But even under wildly optimistic assumptions of how successful we will be at containing health care spending, given the demographics, there is just no way we could possibly “flat line” government spending–that is, no way we could keep spending as a share of the economy anywhere close to the 20% it is now.  That spending path will continue to move upward, even if we are able to keep it from rising as steeply as under the current policy trajectory.  To assume anything other than a continued upward path means we are basically counting on implementing a policy which would “cut the old people off.”  Probability that would happen?  Zero.   (I’d hope.)

So that leads us back to that 40-year historical average of revenues as a share of GDP as looking pretty silly and meaningless.  CBO’s long-term outlook shows that under current tax policy extended (which is not the same as current tax law, some of which expires each year but a lot of which will expire at the end of 2010), revenues as a share of GDP will reach 19.4% in 2050.  To some that seems like “plenty,” and it’s more than a full percentage point above that 40-year average.  But given that spending in that year would reach 41.8% of GDP and that the possibility of cutting that by more than half is extremely bleak, 19.4% just aint gonna cut it.

And even worse news for our noble pay-go supporters in Congress (but please don’t let this dissuade you from your continued support):

Even if we were to stick to current-law revenue levels, either allowing the Bush tax cuts to expire, or paying for any extended tax cuts with offsetting revenue increases elsewhere, CBO shows that revenues as a share of GDP would be 23.5%.  That’s more than 4 percentage points higher than if tax cuts are permanently extended by increasing the deficit, but it still only covers about half of the projected spending costs.

So, what’s the lesson here?  In terms of the federal budget, history teaches us nothing about how to handle where we are going–because we have never started from here before.  

We’re not only going to have to work on entitlement reform, but we’re going to have to work on fundamental tax reform as well.  Because it’s just basic math to see we’re going to need to raise revenues as a share of the economy, and we’re going to want to do it in ways that minimize economic harm–or ideally in ways that might even encourage a more efficient economy.  I happen to believe that’s very possible.          

….Someone remind me to relate this “we haven’t started from here before” story to my family finances and how we’ll be facing college costs for the first time a couple years from now…  

One of the early comments I received here was asking what I thought of the idea of a gas tax holiday, which some of the presidential candidates have proposed.  Here is what I (and many other economists) think of it:

http://gastax08.blogspot.com/

A friend of mine (and tax policy expert extraordinaire), Len Burman, has in public labeled the idea “stupid.”  I want to be kinder and say it’s not stupid, when one considers the politics involved.  My first reaction was to call it “clever,” but then I realized it’s really better labeled “desperate.”  I guess that’s what the press means by the word “pandering”–it’s clever and desperate at the same time.