“Gross” Exaggeration in a Letter to “President Obama”
July 4th, 2008 . by economistmomI was asked for my reactions to the “Dear President Obama” open letter written by Bill Gross of PIMCO, an bond-fund investment company.
I enjoyed reading the letter and found it quite intriguing in its tone and its numbers.
First, it’s intriguing (and pleasantly surprising) that a Republican investment manager could be this critical of the Bush Administration:
You have inherited a mess. Your predecessor, fixated on emulating a former Republican icon from a far different economic era, chose to emphasize tax cuts for the rich and excessive consumption for all Americans. He promoted deregulation and free markets when, in fact, the markets and their institutions needed tough love. Over eight years, he failed to put forth a coherent energy policy. He needlessly invaded Iraq and lowered worldwide esteem for this nation as a symbol of freedom and benevolence.
…and so down on extreme supply-side/Laffer Curve economics:
I myself won’t enjoy paying that near 50 percent marginal tax rate after you remove the current cap on the payroll tax, but my wealthy neighbors and I in Newport Beach should just look at it this way: we’ve had an eight-year lease extension on the “high life.” Now it’s time to give something back and I suspect we won’t be working any less hard. That ol’ Laffer Curve has a certain logic to it, but it only makes sense at the upper margin. People did work less at confiscatory tax rates imposed pre-Thatcher/Reagan but once they got down to 50 percent or lower, it was all gravy – promoting conspicuous consumption as opposed to higher productivity and overtime at the office.
I don’t find those passages above to be “gross” exaggerations at all. But then Gross gets to the intriguing (really, shocking) numbers regarding deficits under an Obama Administration:
…let’s start out by dropping all of that “budget neutral” rhetoric and admit where we’re headed. Your administration will produce this nation’s first trillion dollar deficit!
…this economy will need an additional jolt of $500 billion or so of government spending real quick. It must replace both reduced residential investment and consumption whose decline has placed the U.S. economy near, if not in a recession. Some quick math for you Sir: gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006. Due to higher unemployment and energy costs, domestic consumption will soon be $300 billion less than it should be if we are to return to historical economic growth rates. According to that old C + I + G formula (scratch the trade deficit for now) when C + I is reduced by $500 billion, then G should increase by that amount in order to fill the gap. The G, Sir, is you– the government deficit, the fiscal stabilizer popularized by Keynes following the Depression. And since the fiscal deficit for 2008 is likely to press $500 billion even before you take the oath of office, well there you have it: $500 billion + $500 billion = $1 trillion big ones, probably by sometime in 2011 or so. It takes time to spend those types of bucks.
…and that’s where he lost me. The $500 billion in extra fiscal stimulus, which he seems to suggest is justifiable, not just likely, under an Obama Administration, seems way too big. First, the $500 billion deficit Gross starts with as the likely fiscal year 2008 deficit already includes the cost of the fiscal stimulus already enacted, as well as a lot of built-in ”automatic stabilizers.” Second, Gross’ calculation of a “hole” of another $500 billion that needs to be filled is too big, both because he doesn’t count the effects of already enacted and built-in stimulus in filling that hole (he only counts the cost of the stimulus in that first $500 billion), and because the lopping off of net exports from the calculation is indeed a big deal if economists are right that export growth from a weakening dollar will help offset other declines in the national income equation (the “hole” he calculates is thus too big). Finally, it’s not clear that Gross is really talking about achieving an annual deficit of a trillion dollars, when he talks of spending the extra $500 billion “by 2011 or so” and mentions how such spending “takes time.”
In fact, the nature and magnitude of fiscal spending Gross describes as filling in that $500 billion hole doesn’t sound that much like short-term stimulus of the “timely, targeted, and temporary” variety at all (see this CBO analysis), but maybe more like government spending designed to encourage longer-term economic growth–e.g., spending on infrastructure (the next version of the Hoover Dam?). Now, it may very well be that there’s a good case to be made for the next Administration to do a lot more of that kind of pro-growth government spending, and I know plenty of policymakers have ideas on how best to do that, but I doubt we can justify $500 billion extra in Keynesian-style countercyclical stimulus as a response to the current (cyclical) downturn–a downturn which could very well be over by the time “President Obama” takes office.
The question that needs to be addressed is not nit-picking Gross’s analysis, but highlighting the fact that $1 trillion deficits (plural) are inevitable, very likely in the next 4-8 years.
More importantly the first trillion dollar deficit will be followed by $1.2, $1.4, $1.6,…. deficits.
The favorite code word for the problem is “unsustainable.” What needs to be addressed honestly is the economic impact that attempting to finance such deficits will be.
But I believe such $1+ trillion deficits are NOT inevitable, because the natural mechanics of the economy (e.g., rising interest rates) will ultimately discourage running deficits that high. The economy always has a way of getting us back to a more stable, sustainable “equilibrium,” but the path to that new equilibrium (how smooth or jarring it is) and where exactly we find ourselves in that new equilibrium (how well off we are in aggregate and individually), is affected by our policy choices. As a fiscal hawk, I think it would be wise to start adjusting before the market shocks us or forces us into more drastic, sudden changes in our budget policy. (I think fiscal policy can do a lot to “control our economic destiny.”) Doing something before we’re backed into a corner is what requires strong leadership and bipartisan cooperation to carry out the tough (political) choices that make sense for the health of our economy.
Thanks for addresssing this issue. I’m not sure I share your faith that our elected representatives will act in time to avert a fiscal/financial emergency. I am curious as to what form that emergency might take? You mentioned higher interest rates? But suuppose the Fed buys the debt, then what? Higher inflation? Bond market collapse?
Well it is nice that bond trader Gross is willing to share the pain of a cap increase, and moreover volunteer his Newport neighbors to join in. But absent some information from the Obama side as to where the incidence of tax will land (wage/non wage) and from Gross and his neighbors as to where the balance of their income comes from, this shared ‘pain’ may be more like a tingle.
Would anyone at the current 35% marginal rate really see their federal burden go to 50%? Apart from entertainers and sports figures I would think that few people actually earn much of their income above $357,000 from straight wages, of those that do have relatively simple ways of changing their compensation packages to shelter them from a wage based FICA tax.
But without details from the Obama camp we can only fruitlessly speculate about the ‘where’ and ‘how much’ of these fairly vague cap increase proposals.
mentioning the cap increase
this is a stupid idea, proving that even Democrats have them.
Social Security does not need the money. All a cap increase would do is increase the size of the Slush Fund that Congress uses to fool itself about how much it is borrowing.
Meanwhile it would turn Social Security in welfare by taxing people who have no expectation of getting an equitable benefit.
Social Security is a savings-insurance program for workers, paid for by workers. Turn it into welfare and you destroy it.
It’s bad enough now that ignorant people say that “it all comes out of the same pie.”
Actually it doesn’t. Social Security is an entirely separate pie from the Federal Budget, and it’s time some economics writers understood that.
The real surprise would be if there was a public letter at this stage of the election cycle that DIDN’T exaggerate, don’t you think?
coberly,
To the extent that projected medicare and medicare spending increases are reasonably accurate by virtue of anticipated health care cost inflation and an aging population, you honestly believe that congress won’t need to reassess tax rates and structure and the entire federal budget from a spending priorities perspective to pay for it all?
If it isn’t one pie (our economy, the tax revenue it produces, and the foreign borrowing it afford us) then what pie is social security coming from?
Looking forward, is there generational equality where younger generations are looking at substantially higher tax rates to pay for all promised / expected federal spending (defense, education, transportation, entitlements, interest payments, etc.) when older generations enjoyed relatively lower tax rates?
I get the fact that life longevity wasn’t fully anticipated but the demographics of the baby boomers is a fact and the flawed structure (in my opinion) of Social Security has been a well known issue since the early 1980’s.
I think it is reasonable and moral that younger generations should pay somewhat higher tax rates in the not to distant future given the aging population but there needs to be a limit such that younger generations have a reasonable opportunity to pursue their own happiness by having the economic resources to address unanticipated problems and invest for future generations.