Governor Corzine Finds It’s Not Easy Being Fiscally Responsible
July 1st, 2008 . by economistmom
AP photo
I have a friend who works on fiscal policy for the New Jersey state government and has been working like crazy lately, because Governor Corzine’s been on a mission to get NJ out of the red.
I greatly admire the Governor for his efforts to reduce the shortfall through both the spending and the revenue sides of the budget–for recognizing the “basic budget math” that leadership at the federal level has failed to do. (I’ve admired Jon Corzine and his economic wisdom since he served on the Joint Economic Committee, where I was often the committee staffer who sat behind him at hearings, helping him with his questions on fiscal policy and budget deficits.)
But as Stan pointed out on Capital Gains and Games, such honesty (or “testicular fortitude” as Stan puts it) comes at a political price: Governor Corzine’s approval rating has been falling. Here’s the AP story that Stan links to, and from which the photo above comes. He looks weary more than “testicularly fit”, doesn’t he? I know from my NJ fiscal policy friend that it’s been a very exhausting budget process this year.
The Governor’s experience is a microcosm of the general, huge challenge of achieving meaningful deficit reduction. If your constituents don’t understand why deficits should matter to them, then promises to raise taxes or cut spending aren’t going to win you votes, even if they win you the admiration of economists like me.
So how do you make the economic consequences of deficits feel real? It seems like most people treat deficits like a free lunch. How do you convince people that a deficit of 3% of GDP isn’t a free lunch?
Michael: It’s hard, yet I’ll be trying my darndest here…
The economist in me is trying to use basic math and to explain that yes, we really do have to pay it back even if it’s “government debt”–the government can’t just write it off or print (money) our way out of it (unless we want to turn our money into worthless paper). The mom in me is trying to appeal to the common sense and common good (and a good dose of parental guilt) in all of us.
I think we deficit hawks really have a job to do in explaining to real people why all our individual efforts in working so hard to make ends meet for our families, and trying to do the best things we can to secure our kids’ financial futures–all our trying to do the right thing for our own families–would all be for naught if at the same time we’re demanding fiscally IRresponsible behavior from our policymakers, clamoring for tax cuts and increased government spending.
I think people wear blinders (suffer from that “cognitive dissonance”) when it comes to the budget deficit. Tax cuts are just giving back the people’s money, entitlement spending is just giving people their entitled, deserved benefits, but the deficits and debt that come from the mismatch of spending and revenues are somehow just “the government’s problem.” (I think Brooks is with me on this phenomenon from a recent comment of his.) There’s a NIMBY attitude when it comes to deficit reduction, where everyone thinks their favorite part of the deficit problem, if not the main source of the mismatch, deserves to be left alone, and any attempts to suggest compromises where ALL parts of the budget are called up to sacrifice are attacked as evidence of extremist positions. This is what I’ve encountered so far at least, but I am not giving up!
So how do you make the economic consequences of deficits feel real? It seems like most people treat deficits like a free lunch. How do you convince people that a deficit of 3% of GDP isn’t a free lunch?
I agree with economistmom that this can be very difficult. Concerning your question about a deficit of 3% of GDP, I assume that this is related to the fact that the 2008 unified deficit was projected to be 2.9% of GDP in the most recent budget. To determine what level of deficit might be acceptable, I first assume that the real concern is the federal debt. Afterall, it is the debt, not the deficit, that we will have to pay interest on forever (unless we pay it back). Secondly, I assume that the most critical debt is the “gross federal debt” which is currently about $9.5 trillion. This debt includes the debt owed to Social Security and other trust funds which will have to be serviced and/or paid back just like the “debt held by the public”. Given this, following is point 5 from this link:
The gross debt was at 65.5 percent of GDP at the end of 2007. In order to stabilize at that level, the gross deficit would need to stabilize at about 65.5 percent of the projected GDP growth rate. As GDP is projected to grow at about 5 percent per year for the next six years, this would be a level of about 3.3 percent of GDP. Because the gross deficit is projected to be above this level for the next 3 years, the gross debt is projected to rise modestly, peaking at 69.4 percent of GDP in 2010.
I suspect that this sounds far too wonkish! The point is that there is a relationship between the deficit, the debt, and GDP growth. Another thing to note is that at an interest rate of 5 percent, the annual interest costs on a debt of 65.5 percent of GDP will be about 3.3% of GDP. Hence, we may be close to the point where our deficit does little more than pay the interest on our past debt. This is the annual cost of our “free lunch”.
A clearer picture of the cost of our deficits may be Table 13-2 in the Analytical Perspectives of the most recent budget. This table has been in the budget for years and it’s long been the most disturbing table in the budget that I’m aware of. The graphs and numbers at http://home.att.net/~rdavis2/pro2009.html are based on that table. As can be seen, it projects that the debt help by the public will reach 154% of GDP, higher than the level at the end of World War II. And that’s assuming that certain proposed entitlement savings are enacted. Without those savings, it is projected to reach 283% of GDP. Hence, our current near stability in the federal debt is likely to be very short-lived.
So how do you make the economic consequences of deficits feel real?
One simple way is to translate deficits into the tax increases that people will have to pay in the future.
CBO recently did the best example of this type of “plain English” explanation that I’ve ever seen come from the government at http://www.cbo.gov/doc.cfm?index=9216
They say, 50% across the board income tax rate increase by 2030, 91% by 2050, *or* deficits so big GDP strarts falling in the 2040s and “the end” is in the 2060s. (So much for 75-year projections!).
I took those CBO numbers for 2030 and put them in context of the size of past tax increases, comparing them to those of Greenspan Commision, the Clinton increase, and to fight WWII, at
http://www.scrivener.net/2008/05/how-much-will-income-taxes-have-to-go.html
S&P also projects that on current law the credit rating of the US will fall from from AAA to “junk” during 2017 to 2027. (link through my link above) You know, 2027 and 2030 are not so far away, only about two-thirds of a home-mortgage term. These things are simple enough for most persons to understand, in realistic practice.
Analytically, in principle, I like to use Milton Friedman’s explanation that spending = taxes, so that it is impossible to cut taxes without cutting spending.
That is, if the govt wants to spend $1,000 it can…
* Collect $1,000 of taxes to pay for it.
* Issue $1,000 of debt and then, with say an interest rate of 5% on federal bonds, collect $50 of taxes per year forever to pay the interest on it, which = $1,000 of taxes at present value.
Either way, $1,000 of spending results in $1,000 of taxes. It is just that the second way much of the tax collection is deferred.
But saying that deferring taxes via deficit spending is “cutting taxes” is exactly the same as saying deferring your personal spending by charging up your credit card instead of paying cash is “cutting spending”. Well, it’s not.
So if you believe tax cuts are good to spur the economy — and I do! — you must compliment a current tax cut with a comparable spending cut to get that benefit, or you will hurt the economy in the long run with higher taxes!
A simple numeric example: The govt budget is balanced at $200x of spending and tax collections each year. You want a tax cut of $100x in year 1. That’s good. But if spending isn’t cut, with a 5% interest rate, tax collections in all future years must rise to $205x. You’ve imposed a tax increase forever on the future. If you multiple the years of up-front years of cuts, you multiply the size of future tax increases. And if you think taxes hurt the economy, that’s bad!
At this point some ideological tax cutters will say, “but the tax cut up front grows the economy so much as to cover the cost of the later tax increases for free!”
I let Bush’s own tax-cutters answer this one, (via Greg Mankiw). http://gregmankiw.blogspot.com/2006/07/growth-effects-of-tax-policy.html
~~~
Lesson No 3: How tax relief is financed is crucial for its economic impact.
…
Like all of us, the government eventually has to pay its bills…. This means that when taxes are cut, other offsetting adjustments are required to make the numbers add up.
The Treasury’s main analysis assumes that lower tax revenue will over time be accompanied by reduced spending on government consumption.
But the report also shows what happens if spending cuts are not forthcoming. In this alternative scenario, a permanent extension of recent tax relief is assumed to lead to an eventual increase in income taxes.
The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%.
Tax relief is good for growth, but only if the tax reductions are financed by spending restraint….
~~~
I mean, if Bush’s own tax cutters say it’s not true….
I first assume that the real concern is the federal debt. Afterall, it is the debt, not the deficit, that we will have to pay interest on forever (unless we pay it back).
Secondly, I assume that the most critical debt is the “gross federal debt” which is currently about $9.5 trillion. This debt includes the debt owed to Social Security and other trust funds which will have to be serviced and/or paid back just like the “debt held by the public”.
I believe there are two national debt numbers that make analytical sense.
1) The debt owed to the public, payment on which is guaranteed by the Constitution. That’s $5.3 trillion. The gov’t legally must pay every penny of that.
2) Total net accrued liabilities the govt has promised to pay (over future revenue) at present value. I.e. debt computed using accrual financial accounting like the private sector uses. Total debt about, what, $54 trillion, more?
This isn’t included in the “official” debt numbers because the govt doens’t have to pay it. It can change programs to get out of the debt. But it is what is going to be driving massive tax increases (or benefit cuts, or debt) post 2017.
But #3) the $9.4 trillion of the official total public debt, including the $4 trillion of intra-government debt, seems neither fish nor fowl to me.
On the one hand the govt legally can get out of paying the $4T exactly the same way as it can get out of the $50T, by changing the programs. On the other hand, if you think the govt is on the hook for these program promises, $4T doesn’t come anywhere near to representing their full cost. So the number seems illogical and useless to me, I take it as an historical anachronism.
The “tax increases you wil pay” as per above, show the future effects of today’s deficits.
At the risk of running on and getting banned from this site, I’ll add that analytically, to explain how “tax cut” driven deficits increase future taxes, I like to use Milton Friedman’s explanation that spending equals and determines taxes, so it is impossible to cut taxes without cutting spending.
I think a state-level politician can invoke this — one doesn’t need massive, federal-scale entitlement deficits to understand the logic.
That is, if the govt wants to spend $1,000 it can: (1) Collect $1,000 of taxes, or (2) Issue $1,000 of debt and then, at an interest rate of say 5%, collect $50 of taxes per year forever to pay the interest on it, which equals $1,000 of taxes at present value.
Either way, $1,000 of spending results in $1,000 of taxes. It’s just that the second way much of the tax collection is deferred. But saying that deferring taxes via deficit spending is “cutting taxes” is just like saying deferring your personal spending by charging up your credit card instead of paying cash is “cutting spending”.
This only hurts the economy of the future via higher taxes (!) because you will have to collect enough future taxes to cover then-unreduced spending *plus* the deferred taxes.
At this point some ideological tax cutters will say, “but the tax cut up front grows the economy so much as to cover the cost of the later tax increases for free!” I let Bush’s own tax-cutters answer this one, (via Greg Mankiw)…
“Lesson No 3: How tax relief is financed is crucial for its economic impact….
“Tax relief is good for growth, but only if the tax reductions are financed by spending restraint….”
I mean, if Bush’s own tax cutters say it’s not true….
Jim Glass wrote:
But #3) the $9.4 trillion of the official total public debt, including the $4 trillion of intra-government debt, seems neither fish nor fowl to me.
On the one hand the govt legally can get out of paying the $4T exactly the same way as it can get out of the $50T, by changing the programs. On the other hand, if you think the govt is on the hook for these program promises, $4T doesn’t come anywhere near to representing their full cost. So the number seems illogical and useless to me, I take it as an historical anachronism.
On the contrary, I believe that there are more than two measures of the debt, generally on a continuum from “harder measures” to “softer measures”. At this link, I’ve listed several of them including the debt held by the public, the gross federal debt, and the projected debt held by the public. I’ve also listed the “Net Position” and “Social Insurance Exposures” in the June 16th and June 23rd posts on my blog (click on my name B Davis above). Both come from the Financial Report of the United States Government. The Net Position is an accrual-based measure of our debt and at $9.2 trillion is very close in size to the gross federal debt. The Social Insurance Exposures are the present value of the liability for social insurance programs (chiefly Social Security and Medicare) over the next 75 years and is about $41 trillion. Together, the Net Position and Social Insurance Exposures add up to the $50 trillion that you mentioned.
As you stated, payment on the debt owed to the public is guaranteed by the Constitution. However, the Trust Fund FAQ page on the official Social Security site states the following:
Far from being “worthless IOUs,” the investments held by the trust funds are backed by the full faith and credit of the U. S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government.
There are some who may contest the precise legalities of this claim. Still, it seems extremely far-fetched to believe that the government will renege on this debt as it would likely make holders of publicly-held debt very nervous. In addition, it’s hard to believe that politicians will vote to renege on a debt to what is likely to be the most powerful voting block in American history. At most, they will likely just modify the formulas so that the bonds are cashed in more slowly. However, interest will continue to be paid on the trust fund debt so this slowing down of repayment will not lessen the total impact of the debt.
The Social Insurance Exposures, on the other hand, will be cut by future changes to the Social Security and Medicare programs. In fact, it seems extremely unlikely that these programs will not have to change, at least if current projections turn out to be accurate. In that sense, these numbers underline the importance of preparing for those modifications now. But they are a “softer measure” of debt than any of the debt held by the public, the gross federal debt, or Net Position. In any case, I don’t think it’s proper to simply limit our discussion to the two extreme measures of debt. The gross federal debt and Net Position are relatively hard measures of debt which deserve to be a part of the discussion.
The SS trust fund and its bonds, in the big picture of gov’t entitlement financing, are rather small things that generate far more heat and rhetoric than they are worth. But I can be as bad an offender as anybody, and since the subject has come up…
“Far from being “worthless IOUs,” the investments held by the trust funds are backed by the full faith and credit of the U. S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government”.
There are some who may contest the precise legalities of this claim.
Yes, indeed, as a lawyer who works in the areas of tax and finance, I can report that “precise legalities” can make big differences.
Still, it seems extremely far-fetched to believe that the government will renege on this debt.
For instance, it is legally impossible for the govt to “renege” or default on the trust fund bonds. To default on a bond it must have a maturity date upon which payment is due, with failure to make payment constituting default. But these bonds have no maturity date.
Among the unique traits of these bonds is that they are demand bonds, which roll over automatically even when the Treasury is not issuing bonds (as during the surplus years) and which also can be “cashed in” even before their maturity date. (Let’s see you or the Chinese try to buy T-bonds like that.)
If Congress in the future adjusts SS benefit levels to a point where the trust fund bonds are never needed — which Congress has an absolute right to do — the bonds can sit in the trust fund forever and no default or “reneging” will ever occur. (E.g. nominally the bonds are 15-year bonds, they’ve been in the trust fund for 35 years so far, not one of them has ever been paid off, and no default or reneging has occurred yet.)
Now let’s look for a moment at the claim that the trust fund bonds are…
“just as safe as U.S. Savings Bonds”
The relevant issue (precise legality) is safe for whom. Savings bonds, if you buy them, are safe for you, their owner. Payment on them to you is guaranteed by the Constitution.
But the trust fund bonds are owned by the government. So they are safe for the government. You and all other citizens as participants have zero, zip, nada, no legal right to or interest in them. There’s no “safe” right of legal payment to you represented in those bonds at all.
(And as far as the bonds being “safe” for the government goes, being that payment on them goes both from and to the government, as an offsetting asset and liability of exactly equal amount, they are reported on the Balance Sheet of the US Govt, at a value of $0 — so the government hasn’t assumed a whole lot of risk in them!)
Thus, the claim that the trust fund bonds are “just as safe as savings bonds” is at best meaningless for SS participants, since they have no legal interest in the bonds as they would savings bonds they owned, and at worst grossly misleading, since it could lead them to believe they do have such an interest.
If Congress decides to use the SS bonds for some non-SS purpose (such as funding Medicare or whatever) or to just let them sit, it can, that’s that. Because Congress owns the bonds. SS participants have no recourse. This has been explained by the govt in the Analytical Perspectives, among other places.
as it would likely make holders of publicly-held debt very nervous.
Since default/”reneging” on the trust fund bonds is impossible, it unlikely to ever make anyone nervous.
To the contrary, it is not adjusting the current tax-spend formulas for social spending programs that is projected to reduce the credit rating of US bonds starting in 2017 (only nine years away!) down all the way to “junk” by 2027, according to S&P.
“Credit rating” is based on ability to pay creditors. The creditors of the US are the owners of the debt issued to the public - that $5 trillion.
Participants in social spending programs such as Social Security are *not* creditors of the US.
Any claim that reducing SS benefits would harm the credit rating of the US is patent nonsense — exactly the reverse is true.
“In addition, it’s hard to believe that politicians will vote to renege on a debt to what is likely to be the most powerful voting block in American history…”
This is a very common comment, but people who say it almost always are thinking of the interests of this voting block in the past, as opposed to their voting interests in the future, when they may be very different indeed.
I think this is a very significant point when considering the likely future of SS — but as it is very far from the original “Corzine” topic, and I’ve run on in this thread as it is, I’ve posted thoughts on it elsewhere.
Back “on topic” re govt accounting…
“But #3) the $9.4 trillion of the official total public debt, including the $4 trillion of intra-government debt, seems neither fish nor fowl to me.”
The Net Position is an accrual-based measure of our debt and at $9.2 trillion is very close in size to the gross federal debt…
I mentioned and am discussing here only the three specific most common measures of the federal debt, that (1) owed to the public, $5.3 T, (2) the gross public debt, $9.4 T , which is the $5.3 $4.1T of intra-governmental debt, and (3) the $50 T including accrued liabilities for the promises made for social spending programs, as per the US financials available through here.
(Discussion of other accounting tallies could be limitless.)
The (1) debt owed to the public is critical because the government’s continued ability to service it is what determines the credit rating of the US government — which is of some importance!
The (3) total accrued promises figure is critical because it quantifies the full long-term fiscal challenges that must be met through politics to keep to the (1) figure producing a satisfactory credit rating for the US govt.
The (2) gross debt figure I find of little use and uninteresting at best, highly misleading at worst. It grossly overstates (1) and really grossly understates (3), and has little analytical value to me on its own. For my purposes. That’s just me. Your mileage may vary.
In any case, I don’t think it’s proper to simply limit our discussion to the two extreme measures of debt.
Of course, you’re right, there are all kinds of financial measures to use for different purposes. But I’m wasting enough of our host’s bandwidth as it is.
At most, they will likely just modify the formulas so that the [SS] bonds are cashed in more slowly. However, interest will continue to be paid on the trust fund debt so this slowing down of repayment will not lessen the total impact of the debt….
But it will. You’ve put your finger on one of the problems with (2). Say when you have $3 trillion of SS bonds issued you reduce SS benefits and so reduce the present value of the obligation for SS to the govt, and so stretch out the period over which the $3 trillion of intra-governmental liability will be paid from 30 years to 50 or 80, whatever. You’ve reduced the real SS liability to the govt at present value. But it is still carried in (2) at a full $3 trillion unchanged because all those bonds are still there. The real debt reduction isn’t reflected in the debt accounting.
In the extreme — but entirely plausible (if you follow the link in my prior comment) — case where Congress decides to defer payment on the SS bonds indefinitely, never pay them, their real present value liability to the govt drops to $0. But they retain a liability as counted in (2) as an unchanged $3 trillion. Then because of the nominal but not cash liability for interest accruing on them, they effectively become a huge zero-coupon bond with no maturity date. Present value liability to the govt $0, but over time their nominal value liability compounds to infinity. This is accounting? Or say Congress instead decides to cut SS benefits by $3 trillion present value and transfer that many SS bonds to cover a previously promised but “unsecured” Medicare benefit. (Making that benefit as safe as US Savings Bonds!) The liability of the US drops $3 trillion, but its liability in (2) is unchanged. Is there an accounting benefit in that?
Another problem with (2) is it implies a debt will be satisfied when paid so payment will stop. As payments to a bondholder ends when his bonds are paid off.
But when the Medicare trust fund bonds are exhausted (long before the SS bonds are) will Congress cut the Medicare benefits they currently finance? Debt paid off? I don’t think so. But then the finite bond liability for Medicare bonds in (2) grossly understates the national liability for Medicare it represents. What’s the accounting benefit of that?
Similarly with SS, Congress may decide to pay all currently promised benefits by imposing higher income tax, creating a VAT, whatever, to provide general revenue to pay down the trust fund bonds — then keep paying the same benefits afterward with the same general revenue. Or it may cut benefits so it never uses general revenue and never pays the bonds. We don’t know what it will do.
But it seems very unlikely that Congress will secure general revenue to pay all promised SS benefits until the SS bonds are exhausted, then the next day slash benefits by 25%. Yet that is the only scenario in which debt measure (2) is preferable as a measure of the govt liability for SS.
IMHO. Debt figures (1) and (3) don’t have any of these problems. So I heed them and don’t give (2) much weight. Opinions may vary.
Jim Glass wrote:
The (1) debt owed to the public is critical because the government’s continued ability to service it is what determines the credit rating of the US government — which is of some importance!
The debt held by the public does represent debt that must be redeemed on a set date. However, many of the government’s liabilities have nearly as set redemption dates. For example, I believe that the liabilities for civilian and military pensions and health benefits are much less subject to change than Social Security or Medicare. That’s likely why they are included in the Net Position while Social Security and Medicare are not. In any event, all of these pending liabilities will have an effect on the government’s ability to service its public debt.
The (3) total accrued promises figure is critical because it quantifies the full long-term fiscal challenges that must be met through politics to keep to the (1) figure producing a satisfactory credit rating for the US govt.
The (2) gross debt figure I find of little use and uninteresting at best, highly misleading at worst. It grossly overstates (1) and really grossly understates (3), and has little analytical value to me on its own. For my purposes. That’s just me. Your mileage may vary.
I agree that this is largely a personal opinion and our mileage may vary. One problem that I have to limiting consideration to (1) and (3) is that, as you said, (1) gives no indication of future liabilities. If the Boomers were about to enter the workforce or if we had a steady worker-to-retiree ratio, I would have few concerns about our public debt. It’s the fact that the Boomers are entering retirement and we have a falling worker-to-retiree ratio that makes it a problem. However, (1) is blind to this fact. It’s only use, in my opinion, is possibly measuring the current effect of government borrowing on the economy. But it tells you almost nothing about the future.
(3), on the other hand, has the problem that it is not a widely reported or understood number. I only recall hearing it mentioned in one or more of Pete Peterson’s books, in the book “The Coming Generational Storm”, and in the Financial Report of the United States. I don’t recall hearing the media mention it except perhaps as a big, scary number be tossed around by “doomsayers”. If that is the only way in which future liabilities are discussed, then I fear that it will be largely ignored. While I think this number is very important, other measures have their advantage. For example, I think that the projected long-run debt mentioned in the U.S. Budget (see here) is likely easier for many people to understand that “present value”.
I agree that (2) is not a perfect measure but I believe that the following points given on the Concord Coalition website are correct:
While trust fund debt does not have the same economic and budgetary effects as publicly held debt, it is nevertheless a relevant, if incomplete, indicator of future burdens such as Social Security, Medicare and federal government pension payments.
As explained by the GAO: “Because debt held by the trust funds is neither equal to future benefit payments, nor a measure of the commitments of the current system, it cannot be seen as a measure of this future burden. Nevertheless, it provides an important signal of the existence of this burden.”