And Speaking of Honesty…
November 7th, 2009 . by economistmomIn his Forbes column this week, Bruce Bartlett explains how to set up a deficit-reduction commission who can speak the real truth and thus come up with real solutions. Bruce’s key recommendations (emphasis added):
In my opinion, the commission should have no members of Congress at all among its members. Former politicians with no further political ambitions would be far better suited to the task. They can speak the truth in a way no sitting member can about things like putting higher taxes on the table as part of a deficit reduction package…
I believe that a deficit reduction target should be specified–$X trillion over 10 years with, say, a third coming from higher revenues, a third from entitlements and a third from discretionary spending. In particular, unless Congress commits itself in advance to raising taxes then I think the whole exercise will be for naught because that will be the toughest nut to crack.
It’s unrealistic to think that a budget commission is going to find some painless way of reducing benefits and raising taxes–taking real dollars out of people’s pockets. If Congress acknowledges this fact up front then I think there is a much better chance that the commission will be able to come up with the best ways of doing so.
And in the cover story of this week’s National Journal magazine (“The Debt Problem Is Worse Than You Think” by John Maggs), Bill Gale doesn’t seem to have much faith in President Obama’s willingness to level with the American public either. The story’s closing paragraph (emphasis added):
Not coincidentally, 1990 to ‘92 was a time when difficult decisions on fiscal and monetary policy converged. While Congress and President George H.W. Bush were reaching a budget deal in 1990, Fed Chairman Greenspan was resisting pressure from the White House to lower interest rates. Greenspan sensed inflationary pressure in the pipeline, and he held off. The result was a recession that surely cost Bush a second term. Likewise, tougher stances on fiscal policy can have electoral consequences. Voters then were also angry that in reaching a budget deal in 1990, Bush broke his vow of no tax hikes. Gale says that Obama will similarly have to go back on his promise to protect the middle class from tax increases, if he is to have any chance of getting a handle on the deficit. “Do I expect that [soon]? No.”
*SIGH* Here’s why this commission idea will never work. Look what Bruce does with his 1/3, 1/3, 1/3 commentary. Why should it be that ratio as opposed to some other? This is exactly the nature of the problem with a commission. What’s the mandate for it? Who decides? The biggest decision such a group would have to make is the balance of spending cuts and tax increases. If you make that part of the charter, you’ve made the major decision before they’ve even met.
Not to mention the fact that entitlement spending is much larger than discretionary spending to begin with and a much greater source of future budget problems. So I ask you, why that particular set of metrics? I suspect it reflects Bruce’s point of view on the optimal solution but, with due respect, it’s just his point of view.
Let me propose an alternative approach.
1. Step 1 — Each government agency must propose cuts representing 20% of its existing budget (we’ll exclude interest). Those cuts can be of any type as long as they total 20%. You can argue this 20% is arbitrary and I agree it is. It’s high enough to make people turn over rocks and that’s why it’s there. Make it 25 or 30 and you will get the same result in step 2.
2. Step 2 — Congress makes an up or down vote on each and every cut individually. No bundling, no horse trading. No amendments. Up or down on each item with normal veto procedures in place.
3. Step 3 — Once that’s done, we hold a national referendum (non binding) on the size of government as a percentage of the national rvonomy.
4. Step 4 — Congress acts accordingly — notionally moving the government in the direction suggested by the nonbinding referrendum. If this means more taxes, so be it. If it means more cuts, back to step 1.
This approach has only 1 presumption in it — much of the money we spend today is wasted or low value added (that’s the point of steps 1 and 2). Beyond that it is selfpolicing and doesn’t require someone to resolve the debate before turning it over to a commission.
All evidence point to the fact that leftist in Congress — i.e. most of the Democrats in Congress — are perfectly happy with bankrupting the county and destoying the market economy, as long as they are re-elected in the short term and they can fulfill their personal ambitions and make themselves feel good about their leftist good intentions.
Bartlett is livin in a fantasy land of the past where people actually cared about what they did to the country.
I don’t think Congress is yet to the point where it is ready to grapple seriously with it.
That will only happen when the American people are suffering from problems that can plausibly be traced directly to the deficit. At that point, deficit reduction will have mass support because whatever pain it involves will be seen as less than that caused by [the deficit]
IOW, until it is too late. Yes, that is how the incentives work out.
One “optimistic” consideration: As shown in the S&P chart I’ve linked to several times of projected future credit ratings of various nations, several other developed economies are in even worse fiscal shape than we are, with bigger national debts today, bigger unfunded retiree liabilities, faster aging populations, etc. And they don’t have the advantage of having the world’s reserve currency.
It’s entirely possible that one of them — Britain, France, Japan — will go “off the cliff” first, and the visible consequences for it will be an object lesson for us that sobers up our politicians into taking some remedial action before it really becomes too late for us.
I hate to think of that as an “optimistic” scenario, but…
All you have to do is look at California. That’s where we’re headed.
The 1/3 for “discretionary spending” should be coming from the Department of Defense. The actual amount of “discretionary spending” that is “pork” is pretty minor at this point. Would you include NOAA? The Coast Guard? National Parks and Forests? The BLM? How about the Centers for Disease Control?
We tried letting the public services provided by the Federal government go to shit during the Bush Dynasty Restoration. That didn’t work out so well, did it?
And someone should define “entitlement spending” before we go driving off a cliff by accept that 1/3 should come from that. Does it include the disability and survivors’ portions of OASDI? Does it include Medicare? Medicaid?
Do cuts to Medicaid mean that hospitals will be relieved of the mandate to care if they cannot be sure of reimbursement from Medicaid?
Do cuts to Medicare mean that as people age beyond 65 that fewer and fewer services will be provided to them?
In other words, does “1/3 from entitlement spending” mean Death Panels?
Anandakos makes a good point (#5).
The comment by murf (#4) demonstrates the giant misunderstanding regarding federal debt. He (she?) says, “All you have to do is look at California. That’s where we’re headed.”
Wrong. The federal government cannot go bankrupt. Unlike California or any other state, county, city, company or person, the government has the unlimited power to create money.
It does so by creating T-securities, which it can do in unlimited amounts, and selling them. It also can create money directly, also in unlimited amounts.
That is why no federal check ever has bounced, or ever will.
Through a related process, the government also has complete control over inflation. Despite massive deficits, the government currently is fighting deflation, which it also has the power to do.
So, before we destroy America with needless budget cuts, perhaps we should provide proof that budget cuts are necessary.
Anandakos,
So, I am to infer that you propose cutting defense spending by roughly 70%. The proposed 2010 budget for the DoD is $664 billion, including $130 billion for operations in Iraq and Afghanistan. The budget deficit is roughly $1.4 trillion. One third of that is $466 billion give or take or a little more than two-thirds of the total. Other than the $130 billion, where are you planning to cut just out of curiosity?
As to your question on entitlements, I would define an entitlement as any payment to a citizen of the United States by the government of the United States in exchange for them being solely in a class of citizens and where that payment is not the subject of an annual budget review process. So yes, it would include Medicaid but I rather imagine you’d get less out of that and more out of SS and Medicare.
It’s quite easy to manage down entitlement spending if you are willing to redefine the class of people “entitled” to the spending. As everyone here knows, I favor means testing entitlements because I think it is wrong as a matter or principle to take money from the less wealthy to give it to the more wealthy, which is exactly what SS and Medicare do in part. Parenthetically, there are a lot of other programs in discretionary spending (e.g., farm price supports) that do this as well.
And in answer to PG’s common refrain, it may well be the case that no Federal check has ever bounced or ever will because the government can always inflate the currency to solve the problem. As someone who is trying to save for the future, I find that problem quite concerning and would rather the government live within its means than take that risk. PG feels differently and that is his right but it is not cost free to have the government run large deficits forever.
Anandakos,
One other thing…
“We tried letting the public services provided by the Federal government go to shit during the Bush Dynasty Restoration. That didn’t work out so well, did it?”
Actually, we didn’t. One of the things that Bush did very wrong is that he ran up spending on just about everything. If services are an issue, the reason isn’t that we didn’t spend enough. It’s like education in Chicago. We spend roughly $13k per year for primary and secondary education. There are many issues in the system but it’s hard to believe that lack of funding is high up the list.
SteveinCH says, “. . .it is not cost free to have the government run large deficits forever,” but as always is the case, provides no proof.
Proof? Who needs proof?
Everyone knows the federal deficit and debt are too large. Everyone knows large deficits cause inflation, recession and depression. Everyone knows our children and grandchildren will have to pay for the debt. Everyone knows taxes are more prudent than deficits. Since everyone knows, why should I look for proof?
Maybe if I just list a bunch of countries that have experienced inflation, like Brazil, Zimbabwe, Mexico, Iceland, Italy and Germany, no one will realize I have no idea what happened in those countries and what caused their problems. Why should I go through the agony of actually searching for facts and finding proof for what I already know?
And what if I were to find facts that disagree with Mom, like for instance, the fact that large deficits actually have not caused inflation? Everyone would blast me. It’s easier and much more pleasant agreeing with her and repeating, “The debt and deficit are too large; the debt and deficit are too large.” Proof? Who needs proof when everyone knows?
I’m just so sure.
P.G.,
I’m sorry that I didn’t offer proof. Let’s try basic math. The government currently estimates that interest on the debt will hit nearly $800 billion by 2019. Your argument, which also is bedeviled by a lack of proof is that we can borrow as much as we want for as long as we want and nothing will happen.
The reason nobody can offer proof here is that we are debating a future scenario that has never been seen. Yes there are nations with higher debt to GDP ratios than the US which suggests that we can run debt higher than we have so far (maybe). Remember that none of those currencies serve as the World’s reserve currency. Might that have an effect? I don’t know and neither does anyone else.
I guess my question to you is: do you believe there is any level of debt that would cause a catastrophic problem? If not, the logical implication is for the US to abolish all taxes. If there is some level that could provoke a crisis, what is it?
My point on this is simple. You’ll note I simply argued above that if the government inflates its way out of the problem, it would hurt me and I would be opposed. I believe the risk of the government doing this increases as the debt to GDP ratio increases. Therefore I am opposed to increasing the ratio through cycle as the current administration (and the last one) is choosing to do.
Wrong. The federal government cannot go bankrupt. Unlike California or any other state, county, city, company or person, the government has the unlimited power to create money.
It does so by creating T-securities, which it can do in unlimited amounts, and selling them. It also can create money directly, also in unlimited amounts.
That is why no federal check ever has bounced, or ever will.
This myth that a government that owes debt in its own currency can never default, because it can instead inflate its currency, print however much money it takes to pay its own bills, has somehow become an Internet urban legend — even though it is totally bogus.
Let’s put aside the fact that default is paying less than one promised to pay — and that inflating a currency to escape the real cost of paying debt IS default, by all but the most technical legal definition.
(Say that to avoid technical default due to the cost of entitlements the govt pulls a Weimar and reduces the value of the dollar so that Grandma’s monthly Social Security check buys her half a can of cat food. Default avoided! Are you happy, Grandma? Are you receiving all that was promised to you?)
Let’s also put aside the fact that in practice it is totally impossible to use inflation to print money and inflate to cover the cost of otherwise default-causing entitlements — because Social Security and federal pensions are inflation-indexed while Medicare and Medicaid are payable in real terms, making them all “inflation proof”.
The plain and simple fact is that nations that owe debt denominated in their own currency do default — don’t pay — repeatedly.
Russia did it in 1997. For a nice long list of other nations that have too, go to your local bookstore and take a look at “This Time is Different”, a history of financial and fiscal crises by Rogoff and Reinhart, former top economists at the IMF. They specifically debunk this myth.
What the myth-believers forget is that when a govt that owes debt in its own money but can’t afford to pay what it owes, there is nothing at all automatic about inflation resulting — the ruling politicians make a calculated choice of whether to inflate or not, according to what is least bad for them. Who do they want to get more angry at them, the people who hold their debt or the people who hold their currency?
In 1997 the Russian politicians decided that they would rather have their creditors holding their ruble-denominated debt mad at them, rather than the currency-holding mob in the street with the pitchforks. So they defaulted.
In real history, this has happened time and time again.
The remedy for this naive thinking “we can always print enough money to pay our debt” is to think of the debt NOT in terms of “money” but in terms of “percentage of GDP”.
If you’ve promised to pay a percentage of GDP, you have to collect that percentage of GDP in taxes to pay it. If you pay less than that percentage you renege on your debt (though you can tell Grandma with her half a can of cat food “It’s not really default, you know!”)
You can’t collect an increased percentage of GDP in taxes by printing money — that only reduces the value of the money. You have to raise real taxes.
History has shown time and again that nations can collect only a finite, limited, maximum percentage of GDP in taxes — as evidenced by how governments have defaulted on their own domestic debt, denominated in their own currency, time and again.
We see the US’s promised future spending as a percentatge of GDP in Hennessey’s last chart here.
SteveinCH and Jim Glass.
Thank you for your thoughtful answers and for not calling me names (It’s happened).
Your arguments have to do with two main issues: paying debt and inflation.
PAYING DEBT: What if there were no debt to pay? Federal borrowing, a relic of the gold-standard days, no longer is necessary. The government borrows by creating unlimited amounts of T-bills (and bonds and notes) out of thin air, then sells these securities. They are collateralized solely by full faith and credit.
Rather than creating T-bills from thin air and selling them, the government directly could create money from thin air, similarly collateralized by full faith and credit. This would be equally prudent, but it would eliminate borrowing and federal debt.
INFLATION: Money is a commodity. Like all commodities, it’s value is determined by supply and demand. If the supply goes up, and the demand does not go up proportionately, the value will go down. In the case of money, we call this “inflation.”
So to prevent inflation, when printing more money, the government needs to increase the demand, which is determined by risk and reward. In the case of money, the risk of owning money is default or inflation. The reward for owning money is interest.
Therefore, to prevent or cure inflation, the government must increase the reward for owning money, i.e. increase interest rates.
In summary, the government controls both the supply and the demand for money, thereby controlling the value of money.
I cannot tell you why another nation might prefer to default on its debt. I can’t even explain our own government’s foolish actions. But the fact remains, the U.S. government could stop borrowing tomorrow, end federal debt and control inflation.
Lest you believe I am alone in this, please go to: http://www.moslereconomics.com/ and click “The 7 Deadly Innocent Frauds.
Also go to: http://csis.org/multimedia/audio-great-recessions-lessons-learned-japan for Richard Koo’s analysis. Finally, try http://rodgermmitchell.wordpress.com
Thank you again for your thoughts.
Steve,
I’m cool with a 70% reduction in “defense” spending. Unlike most progressives I don’t have a problem with threatening to incinerate any country that directly harms America seriously. And doing it if they dare.
(By the way, I would not consider a psychologically powerful but actual flea bite like 9/11 to meet the definition of “seriously”). It would take some sort of WMD attack.
So let’s keep our “deterrent” right up to date and let the hotheads around the world go at each other hammer and tong. Eventually they’ll get tired of it like the Europeans did.
As long as we’re the big daddies of the world with our boots on the hotheads’ necks we’ll postpone that ugly but necessary day.
Farm price supports are not entitlements. Farm aid, transit and highway improvements and the like must be renewed every five years. Now grant they’ve certainly gained the expectation that they’re entitlements, but they’re not permanent statutory commitments.
Means testing looks nice but its not just unless you make the retirement programs voluntary. If everyone pays in everyone should get at least a minimal return. Remember that if one’s total AGI exceeds some amount ($42,000 for a couple????) 85% of Social Security is taxable. So for even not terribly wealthy people the government is getting back up to a third of the payments.
So Jim,
Where do us useless oldsters line up to become Soylent in order that your rich buddies will be spared the hideous rising white line?
“we useless oldsters”. Tacky; disculpe me.
Anandakos,
SS is not a pension program. It never has been. It’s a direct transfer. You don’t earn any return on “your” money. Sure the SS administration presents it that way to make you feel better about it but that’s not how it works.
As for the taxation of SS income, help me understand why it should be different than any other form of income. Income is either taxable or it’s not. No reason SS income should be different except that we don’t want seniors to get mad at politicians.
It really doesn’t matter anyway since people with 40K of income pretty much don’t pay Federal income taxes anyway.
As for farm aid, I agree it’s a quasi-entitlement program. I think I called it out as such above. My point was that it too should be means tested even though it is not strictly speaking an entitltement.
As for cutting military spending 70 percent, I haven’t done an in-depth look but my suspicion is that a change of that magnitude would do away, at least in large part, with a standing volunteer armed forces. I’m not sure that would be a good thing for the country in the medium/long term but it’s certainly an option.
SteveinCH said, “I guess my question to you is: do you believe there is any level of debt that would cause a catastrophic problem? If not, the logical implication is for the US to abolish all taxes. If there is some level that could provoke a crisis, what is it?”
Excellent comment. Regarding “any level of debt,” I have explained how debt is unnecessary. So instead, I’ll change “any level of debt” to “any level of money creation.” Agreed?
I believe infinite money creation would cause problems. I also believe eliminating certain taxes would help the economy, greatly.
I’d start by eliminating FICA. This would help working people and business far more than any stimulus spending, so far. The government would pay for Social Security and Medicare.
The limit to money creation is this: Stop creating net money when we reach an unacceptable level of inflation that is not cured with the highest acceptable level of interest rates.
What is an “acceptable” level of inflation? What is the highest acceptable level of interest rates? We can argue that endlessly, but here’s some history.
Inflation reached double digits in the early 80’s, , then fell dramatically coincident with the massive Reagan deficits. Since then, the debt has grown more than 1000%, inflation has averaged somewhat below 3%, and the Fed Funds rate has fallen from near 20% to near 0% today.
Seemingly, a 1000% debt growth in 25 years doesn’t cause “unacceptable” inflation. A continuation of that debt growth would put the gross debt at $132 trillion by 2034, an average deficit of nearly than $5 trillion.
That is just a bit of historical evidence, abbreviated for this blog. But it’s a starting point for discussion. What is your suggested limit to debt growth and what is your evidence?
No, actually it fell coincident with the massive “Reagan recession”* in which unemployment reached 10.8% — a worse recession than today’s, to date.
(*Not that the recession was Reagan’s fault, the Fed engineered it to break the inflation left from the Carter years.)
No, again. After the Reagan/Bush I years the national debt held by the public declined from 49% of GDP to 38% of GDP in 2007 (then rose in 2008 as the recession hit to 44% — still less than the debt of Dubya’s daddy’s time).
When making factual arguments, it is important to get the facts somewhere close to right.
Find some nations that have had 1,000% debt growth relative to GDP, then repeat that claim.
For instance… For the U.S. that would have meant debt held by the public increasing from 49% of GDP to 490% of GDP, instead of falling to 38%.
With the debt at 38% of GDP the Treasury was paying 5% interest on it.
Assuming that when owing debt at 490% of GDP it would still be paying the same 5% (a brave assumption!), then to pay the interest it owed on that debt the Treasury would have had to collect an additional 22.6% of GDP in taxes to pay the interest (490 - 38 = 452 x 5%). Debt ain’t free!
That additional tax, 22.6% of GDP, would have been larger than the entire amount of all federal government exenditures in our real-life world, 20.0% of GDP.
Interest on the debt is financed with income taxes. In our world, at the end of Bush II income taxes were 11.2% of GDP. To add another 22.6% of GDP to them would take them up to to 33.8% — a tripling.
If done with an across-the-board rate increase, the top income tax bracket would become 105%.
So with the national debt increasing from 49% to 490% of GDP, circa 2008 we are left with two options to finance it:
#1) Triple all income tax revenue with a tax increase dwarfing that used to pay for World War II (or enact some other equally huge tax increase), or
#2) Use inflation to reduce the real value of the dollars used to pay the debt, to pay less than 33.8% of GDP — 300% inflation would keep taxes at the level of our time. Drop the value of the dollar by two-thirds. Is 300% inflation “acceptable”?
There is no other option. The interest on the debt has to be paid. Lenders don’t lend for nothing. And default is not permitted.
Which do you think would’ve been most likely?
(PS: Inflation actually couldn’t possibly work in this case, but that’s another story.)
Talking about “gross debt” is silly — it’s like saying Bill Gates carries a hell of a lot more debt on his credit card today than he did during his years as a college student, and it hasn’t hurt his credit rating, so you can run up as much debt as you want on your credit card and it won’t hurt your credit rating.
What matters, obviously — to me, you & Bill, and to businesses, nations, and govenments — is debt relative to income.
So run your numbers and examples again using that: debt relative to income — remembering the interest cost that borrowers have to pay in cash every year all along the way.
You know, 5% interest on $132 trillion will be more than 100% of total US GDP in 2034, if inflation doesn’t top 3%.
So you might want to propose a more plausible starting point for your discussion than that.
Commenter #2 (Greg Ransom) threw out classic Republican lines, all of which deserve refuting.
First, Bartlett CREATED your precious Republican economic history. Go look up his CV.
Second: Your precious Republican market economy CREATED the current economic crisis. Non-bank lending (read: a creation of the market) was over 80% of the home lending from 02-07, because FNM and FRE were under conservatorship at the time.
The free market does NOT police itself, despite Greenspan’s bloviating. Glass-Steagall was a GOOD bill, despite what Phil Gramm and his wife (she was on the board of Enron) had to say.
The free market is NOT a panacea of all that is good. If you’d bother to actually read Adam Smith, you’d see that he warned about this very type of deflationary bust based upon an asset bubble back in the 1700’s.
But hey, who cares about those pesky things called facts - Republicans, be proud of your ignorance!
Steve,
No, you don’t have a separate investment account. But most people who live more than about five years beyond full retirement age get back all the money they contributed, ignoring inflation of course.
Now sure, if one were an ideal investor at 18 when work begins and invested 7.5% of one’s earnings in the stock market, one would have a much larger earnings stream from the resulting nest egg.
But most people aren’t the “ideal investor” and Social Security provides a guarantee of at least some income in old age, regardless of one’s investment acumen.
People who read this blog are probably all sophisticated investors, now at least. I know for sure that I wasn’t thinking about retirement when I was 18 or 25 or even 30. It started about that time.
So I’m very happy that I have “grossed up” wages for those first twelve years of work — much of it intermittent because of school.
Human beings are not “ideal economic actors”. We all need a social backstop in our modern, non-agrarian world. We really cannot feed, clothe, and house ourselves by our sweat. We have to trade money for those things. Families are spread across the land and around the world. We cannot rely on our children to take care of us.
Now I wish that beginning long ago a portion of the SS trust fund had been passively invested in equities around the world. The only active management would be adjusting the percentage invested at any time based on risk/return analysis.
We wouldn’t be having this discussion about the coming involvency of Social Security, but the Republicans screamed like a stuck pig when investment of the trust fund in the market was suggested by the Roosevelt administration. That would be “Socialism”, and I guess it would if the investments weren’t passively managed.