…because I’m an economist and a mom–that’s why!

“LivingSocial”: The NEW “Entertainment Book”

May 31st, 2010 . by economistmom


In today’s Washington Post “Washington Business” section, there’s the story behind “LivingSocial,” an online source of half-off, 2-for-1 (or even better)-type deals toward fun activities (e.g., dance lessons, museum tours), personal grooming/pampering, and restaurant meals and other “libations.”  As the Post’s Thomas Heath explains:

It looks as if one Washington enterprise might have cracked the code.

LivingSocial is a start-up run by some online entrepreneurs, led by Georgetown University graduate Tim O’Shaughnessy, 28. [That's a Washington Post photo of O'Shaughnessy, above.]

The company has a simple online model: It has a deal of the day, in which participants use a credit card to buy, for instance, $50 of goods or services from a local company for $25. LivingSocial customers punch in their credit-card information and receive a code (or coupon) redeemable at the restaurant, spa or retailer participating in the offer. LivingSocial keeps 30 to 50 percent of each transaction and passes the rest to the deal-of-the-day business.

I’ve known about and taken advantage of LivingSocial for awhile now (I think I first found out about it via something that showed up on the sidebar of my Facebook page or maybe a WashingtonPost email?), and I love it.  It’s really the new, hip “Entertainment Book,” except so much easier to use and much more enticing, with its single “deal of the day,” which I always look forward to opening each morning.  How many Entertainment Books have you bought for fundraisers or otherwise that sat idle on your kitchen counter because you couldn’t be bothered to page through its hundreds of pages of coupons to see if what you already wanted to do was in there?  The beauty of LivingSocial is that it suggests in a very direct, “in your face” (morning in box) way that ____ (the deal of the day) is what you want to do!  And the limited time offer (one only has a day to take the deal or leave it) encourages one to contemplate and “go for it” right away–sort of the way the “Cash for Clunkers” limited time (and it turned out, limited pot of money) rebate had the effect of spurring into action anyone who might have otherwise not thought about whether they wanted to buy a new car at that moment.

If you are a DC-area resident, I highly recommend it.  It’s super easy to use, involves no commitment (no membership fees), and will get you to broaden your horizons about all the wonderful variety of things the DC-area has to offer.  So go have some fun:)

What If We Could Eliminate All Our Debt Today?

May 30th, 2010 . by economistmom


OK.  In my last post I did not mean to suggest that the US doesn’t have a problem with our federal debt–in fact, just the opposite.  I was trying to say that the reason we do indeed have a big and very serious and very real problem has little to do with the particular level of debt to GDP (whether gross or net) that we are at today.  And while having a goal of staying under a particular level of debt to GDP at a certain date in the future would serve as a useful “checkpoint” or “weigh station” (as I have suggested the 3 percent of GDP deficit by 2015, which happens to be the fiscal commission’s short-term goal, would be), it would certainly not be sufficient to say “phew!  well, I guess we dodged that bullet.”  It might not even be necessary, actually, but without those shorter-term “checkpoints,” the rest of the necessary fiscal path to sustainability would be much tougher.

The day before my last post, I had been interviewed by NPR’s David Kestenbaum, who asked me to comment on the phenomenon of the few thousand private citizens who voluntarily make donations to the federal government to reduce the national debt.  My first reaction was “who are these very generous people who are doing something so contrary to their own self interest?”  The problem of fiscal irresponsibility has a lot to do with the “free rider” problem when it comes to the actual or perceived disconnect between any one individual’s government services received and the taxes they pay, after all.  My second reaction was that the few million dollars collected through such donations is such a small drop in the bucket when the debt is trillions of dollars, and if these people really wanted to make a donation that would effectively be “mega matched” and thus make more of a difference, they should give to organizations that promote fiscal responsibility as a “movement” from the grassroots up–organizations like, well, the Concord Coalition, for example.  (The one person who donated $1.5 million could have sustained the entirety of the Concord Coalition’s payroll for a year, by the way.)  But I digress into my own self-serving thoughts…

One of the first questions David asked me was (something like):  well, couldn’t we just pay off all of the national debt today, by (somehow) collecting an average of about $40,000 per person?  (David’s $40,000 figure signaled what he was proposing to do was to pay off the $13 trillion in gross debt, not just the net–in other words, repaying the trust funds and not just our creditors.)  To which I responded that it might be theoretically possible to do that, but economically it would be stupid; unless it were done very progressively such that only old and idle wealth were confiscated (rather than income), it would cripple the economy.  (Note that the $13 trillion in gross debt is about 90 percent of GDP.)  And not only would it be economically unwise, it would be grossly unfair to current taxpayers, because the debt is something we’ve been accumulating since the start of our nation, so why should it all be paid back by only those currently alive–no matter how rich some of them may be?

But let’s assume we could do it without destroying our nation; let’s assume we could go “poof” and wipe the debt slate clean.  What would paying off the debt entirely today accomplish in terms of fiscal sustainability?  Not nearly as much as it would seem.  Unfortunately, reaching even zero debt does not eliminate what’s “unsustainable” about our fiscal outlook.  We would start with a clean slate, but right away our debt would start accumulating again–because the dynamics of the fiscal outlook would still be all wrong:  promised entitlement benefits would still be growing too fast for the economy and revenues to keep up.  While without any debt we’d eliminate about $200 billion in net interest this year, the rest of mandatory spending alone–without counting any discretionary spending–would still use up nearly all of our revenue.  So even having “zeroed out the debt clock” we would still have a large deficit right away this year, immediately starting the debt clock back up again, and that new debt would be immediately projected to keep growing faster than GDP–the definition of an “unsustainable” fiscal outlook.

So even a magical zero debt to GDP situation is not “sustainable” if the unsustainable paths in the fiscal outlook are not changed.

Conversely, a high debt to GDP situation, while not ideal (because of the interest burden), might still be “sustainable” if the economy is on a growth path that manages to keep pace with the gap between spending (including interest) and revenues.  That’s a big “if” though.  Which is why when I said that there’s no such thing as an unsustainable level of debt to GDP (at any one particular point in time) I didn’t mean to imply that a high level of debt to GDP couldn’t be consistent with a completely unsustainable path of debt to GDP over time.  What I’m trying to say is what defines that unsustainability isn’t where we are right now but what we’re doing (or not) to change where we’re headed.

So, yes, we should talk about checkpoint/weigh station goals like getting net debt to GDP stabilized at some level not too far from where we are now–which is 60 percent of GDP–but not because that level of debt is anything that special or significant or sufficient for fiscal sustainability, but because to stabilize at the level of debt where we’re at now, we’ll have to start changing policy paths now–emphasis on policy and paths and now.  And the sooner we start the better, or else we’ll be perpetually counting on the economically foolish and grossly unfair idea that future generations will have to eliminate all our debt “tomorrow.”

Is There Such a Thing As an Unsustainable Level of Debt?

May 28th, 2010 . by economistmom

My short answer is: “no.”  Debt is a stock concept, not a flow one.  To determine whether something is “sustainable” or not (whether it be the government’s fiscal condition, a family’s personal finances, environmental quality, one’s physical health, or even personal relationships) requires a look at the dynamics of the situation, not just a snapshot.

I mention this because there’s been a lot of buzz among fiscal policy economists over the past couple days, ever since the President’s fiscal commission discussed the idea of setting a specific level of gross federal debt to GDP as a policy goal.  Experts from all sides attacked this notion immediately, focusing on the “gross” part.  They emphasize that economically, it’s really net debt, or debt held by the public (investors whether American or foreign), that matters.  Jim Horney of the (left-leaning) Center on Budget and Policy Priorities explains this very well, and Andrew Biggs of the (right-leaning) American Enterprise Institute agrees.

My objection is on the emphasis of a particular level of debt–whether gross or net, actually–as some sort of magical number that would trigger a particular set of bad economic outcomes if we were to reach it.  Here, I think I agree with Paul Krugman’s sentiment when he wraps up his complaint with (my emphasis added):

So what’s happening is that the idea that Really Bad Things happen when [gross] debt crosses 90 percent of GDP is being treated as a solid fact, when it’s nothing of the sort. And if the Obama commission feeds that false perception, right there it’s doing a lot of harm.

But… I agree with Paul’s sentiment not because I think the debt (whether gross or net) is nothing to worry about, but because we should worry about it–not for the particular level it’s at right now and not even for any particular level it may reach by some date in the future, but for the whole dynamic path we see it taking from here forward.  In other words, roll the video; don’t just study the photo.

What makes the fiscal outlook unsustainable is not that there exists a debt (which is good thing to be able to carry by the way) and not even that the debt will be larger in the future (which also can be a good thing if it allows us to grow our income by even more in the future).  What makes it unsustainable is that the moving picture of the debt shows it growing faster than our economy (our capacity to pay the costs of carrying that debt).  And if you look around at the scenery in this video, you realize that there’s nothing yet visible on the stage or in the scene that will do anything to change that scary course we’re on.

I think it’s impossible to label any particular level of gross OR net debt to GDP as the “breaking point” for our economy.  It’s easier to point to a particularly high particular level by a particular time–such as net debt reaching 100% of GDP within the next ten years–as “well, yes, that’s certainly sufficiently unsustainable.”  I have said something like that often, but even then, not because debt (a stock) equaling 100% of GDP (a flow) means anything.  Such a level of debt would be unsustainable for a number of factors, all of which are “moving” pieces that aren’t moving in the right directions.  Our federal spending commitments via the entitlement programs are only increasing.  Our investments in things that would grow the economy over the long term and preserve our resources for the long term seem to be shrinking.  Our revenue base is at best stagnating–certainly not keeping up with our needs.  And our indebtedness is increasingly to foreign investors rather than to other fellow Americans.

These are all the moving pieces that make our fiscal situation unsustainable, and to point to a particular measure of debt as telling the story sells the story short and perpetuates the propaganda that fiscal hawks are just a bunch of “fearmongerers” full of Chicken Little stories that are just a bunch of bull.  The story of fiscal unsustainability is not a bunch of bull.  You just need to watch the video to understand it.

The “Mother of All Tax Extenders” Is a “Sprouting Leaf of Spinach”

May 27th, 2010 . by economistmom


The Tax Policy Center’s Howard Gleckman astutely observes that the “jobs-creating, loophole-closing tax [extenders] bill does little of either.”   He notes the irony in claims that these temporary-but-perennial tax cuts (more formally referred to as the extension of “expiring tax provisions”) are fiscally responsible and good (even “essential”) for the economy:

The Joint Committee on Taxation estimates that extending the expiring provisions would reduce federal revenues by $32.5 billion over 10 years. But keep in mind these tax subsidies would all expire—on paper at least—over just a year or two. A more accurate 10-year estimate of the revenue loss (assuming the tax breaks eventually are continued throughout the decade) would likely approach $200 billion…

[W]hile nearly all of the cost of extending the 70 expiring provisions occurs in 2010 and 2011, 90 percent of the revenue to pay for these goodies would not be collected until 2012 and beyond. It isn’t hard to imagine that much of this money will never materialize, either because the law will be changed or because very smart lawyers will figure ways around it. The overall bill, including the new spending, would add about $140 billion to the deficit. It is hard to be too cynical about tax extenders that have reached a state of near-immortality. But the least Congress could do is to call this annual rite what it is: Continuing tax loopholes, not closing them.

And speaking of the deficit-financed extension of expiring tax cuts being twisted around and artistically re-characterized as “fiscally responsible,” let’s bring up my favorite issue–or more accurately, “peeve.”  I consider the “mother of all tax extenders” the proposed extension of most of the Bush (2001 and 2003) tax cuts, which is the single most costly deficit-financed policy proposed in President Obama’s budget.  This week the Pew Charitable Trusts issued a report (”Decision Time: The Fiscal Effects of Extending the 2001 and 2003 Tax Cuts”) that puts the cost of extending the Bush tax cuts in better perspective.  The report notes how the deficit-financed permanent extension of these tax cuts (even “just” most of them as proposed by President Obama) would add significantly to the federal debt, bringing it to more clearly “unsustainable” levels of around 80 percent of GDP in just ten years–and highlights the fact that allowing (just) the top-end rate brackets to expire (continuing tax cuts in full for those with incomes under $250,000) barely saves money relative to the cost of extending the entirety of the Bush tax cuts.  Another way the Pew report highlights how costly the Bush tax cuts are is to point out how hard it would be to pay for the extension of the tax cuts by reducing government spending; for example, one way to pay for extending “only” the Bush tax cuts that President Obama proposes to extend would be to cut all mandatory and discretionary federal spending by 5 percent.  (If you want to extend all the Bush tax cuts, you’d have to cut all federal spending by 7 percent.)

The Pew report also suggests that you could make the extension of the Bush tax cuts not so much a “mother of a” tax extender by extending them for only two years, rather than permanently.  But then of course you get back to Howard’s fundamental question: is there really such a thing as a fiscally-responsible (inexpensive and truly “expiring”) tax extender?

The Pew report doesn’t really provide any estimates that the CBO budget outlook hadn’t already provided; it just more clearly highlights the significance of the policy choice the Obama Administration will make about the Bush tax cuts.  Concord’s “plausible baseline” uses the CBO numbers on expiring tax provisions another way, to show that under a fiscally “worst-case” scenario where all expiring tax provisions currently on the books (including stimulus tax cuts) are permanently extended and entirely deficit financed, these tax cuts would add $6.3 trillion to the ten-year (2010-20) budget deficit, which under current law (assuming all expiring tax provisions actually expire as scheduled) is “just” $6.0 trillion.

So this is a huge deal–this proposed permanent extension of most of the Bush tax cuts.  As this hilarious Onion story suggests, it is like a “sprouting leaf of spinach.” How so?

After nervously clearing his throat, Motley was heard to ask, “Wherefore is the National Debt like a sprouting leaf of spinach?” When a glowering Obama demanded the answer, Motley stated, “For it shall rapidly grow into something our children cannot bear.”

We’re Not Greece, But That’s No Consolation

May 24th, 2010 . by economistmom


Both Bruce Bartlett and the Brookings Institution (Economic Studies directors Karen Dynan and Ted Gayer) warn this week that although the U.S. is no “Greece,” we still should be worried about our fiscal situation.

From Bruce’s Forbes column:

Many doomsayers believe that our fiscal profligacy will end in a bang, as happened recently to Greece and previously to many other countries. However, it’s very unlikely that the U.S. would ever suffer the sort of abrupt inability to sell its bonds that triggered a fiscal crisis in other countries.

Historically, the principal cause of debt crises is that countries have borrowed in currencies other than their own. Their problems had less to do with debt per se than a decline in their currency, which made it difficult or even impossible for them to obtain the foreign exchange necessary to service their debt. This cannot be the trigger for a debt crisis here because all of our debt, including that owned by foreigners, is denominated in dollars, of which we have an unlimited supply…

[W]hat would trigger a fiscal crisis? I believe it will come from the credit rating agencies, such as Moody’s and Standard and Poor’s, which rate sovereign debt as well as that of private businesses and subnational governments.

For at least five years these agencies have been warning that America’s AAA bond rating isn’t guaranteed. Any downgrade would send shock waves throughout the entire financial system because so many bonds are priced off of equivalent Treasuries, which are assumed to have zero risk of default. Thus a rise in Treasury rates, which would necessarily follow from a credit rating downgrade, would automatically raise other interest rates…

What might trigger such a downgrade? The rating agencies have already told us what it will be: a rise in the federal government’s interest payments to 20% of revenue, not spending. That is the limit of what the agencies view as acceptable…

I think it is very likely that the 20% threshold will be reached well in advance of the year 2020. And once the Fed begins tightening, forecasts of higher interest rates will also rise and become incorporated into projections of interest on the debt and the impact on federal finances. This will force the credit agencies to start making forceful warnings about downgrading Treasury debt that will begin impacting on markets long before the day of reckoning occurs.

Of course, reductions in projected deficits would change the calculation. But deficits aren’t going to fall by much as long as Republicans are insistent that taxes must not be increased for any reason and they have the votes to block any budget deal containing higher taxes, as they have done repeatedly in California.

But if interest payments as a share of revenues is the key measure of debt sustainability, then waiting until the last minute to act absolutely guarantees that only tax increases will calm financial markets. It will be too late at that point to cut spending quickly enough to reduce interest on the debt. Indeed, it would require a very large surplus to accomplish that in the absence of any rise in revenues…This means that those favoring spending cuts must act now while that is still an option.

And Karen and Ted (of Brookings) express a similar mix of reassurance and warning:

The good news is that Greece’s fiscal situation differs importantly from that of the United States. Greece has higher debt and a larger deficit relative to its GDP and a lack of competitiveness stemming in part from high labor costs. Greece cannot compensate for its competitiveness problem by adjusting its exchange rate because it uses the euro. Its government has embarked on a difficult fiscal austerity program, but results — aided by foreign support on realistic terms and, ideally, a stronger world economy — will take a while.

In contrast, U.S. competitiveness remains relatively high. Although the U.S. debt-to-GDP ratio is increasing, it remains well below that of Greece (86 percent as of last year). The U.S. dollar is in high demand, and if anything, concerns about sovereign debt elsewhere have increased demand for U.S. Treasury securities, thereby holding our borrowing costs down.

Even if the massive policy response to Greece succeeds in stabilizing world financial markets, there are longer-term implications of rising U.S. public indebtedness. The textbook concern is that it eventually leads to higher interest rates, which will lower capital formation and productivity, ultimately reducing economic wealth. But the financial crisis of the past two years provides further lessons. First, the government must be prepared to step in when private demand for goods and services deteriorates, but significant long-term debt will constrain the U.S. government’s ability to respond to an economic crisis if required. Second, in the highly interconnected global economy, markets can respond suddenly and punitively to highly leveraged institutions. Financial markets in 2008 witnessed an abrupt loss in investor confidence, triggering runs on such financial institutions (remember Lehman Brothers?).

The U.S. government provided — and should continue to provide — critical short-term support for the still-recovering domestic economy. But to reduce the chances of future economic crises, we urgently need to show a convincing commitment to longer-term fiscal strength.

So no, we’re not that much like Greece, but at the same time we’re a lot more like the Greece now than the U.S. we used to be.

Learning at the Naval War College This Week

May 20th, 2010 . by economistmom


I’ve been in Newport, RI for the past couple days learning a lot about national security and defense spending–and talking about my perspective on the federal budget outlook–at a workshop at the Naval War College on “Economics and Security: Resourcing National Priorities.”  I’ve been hanging around a small group of very senior military officers, ambassadors, and national security experts, and I’ve been learning a lot.  The around 4000-word paper I wrote for the conference is called “The Way Out of the Fiscal Hole: An Economist Mom’s Perspective.”  It is sort of a “best of” paper which I will share here once it’s published–or perhaps even post excerpts from beforehand.  But mostly what’s been great about this experience is learning that just because someone is a high-up person in the military doesn’t mean he or she doesn’t question the wisdom of the way the U.S. spends money on defense and national security or the federal budget as a whole.  There’s a lot going on within the defense and national security budget that is really just a smaller version of the dysfunction within the federal budget and the U.S. economy as a whole.  I hope to share some of what I learn here with my readers when I get back.  (I’m here for one more day.)

Matt Miller: The Primaries Prove the Voters Like Enablers

May 19th, 2010 . by economistmom

In the Washington Post, Matt Miller asks “What do the primaries mean?”…and then he responds “Beats me.” But Matt reveals a lot more than he takes credit for, when he leads off with the following (emphasis added):

I know I could lose my pundit’s license for saying this, but I have no idea what Tuesday’s elections mean. Yes, of course, they mean “incumbents beware” — unless you’re an incumbent like Ron Wyden of Oregon, who skated easily to victory. Or maybe they mean voters want Washington to get serious about our out-of-control deficits — except that Tea Party poster boy Rand Paul opposes cuts in Medicare, the biggest source of our spending woes, and Pennsylvania victor Joe Sestak says we can fix the budget without raising taxes on anyone but the rich, which isn’t true. Which also cuts against the theory that voters want “answers” from Washington.

What these candidates seem to have in common is their talent in perpetuating the delusion of many Americans that the budget deficit is the fault of “the establishment” in Washington–and has nothing to do with what they themselves have demanded from that “establishment” in terms of tax cuts or government programs, or their unwillingness to pay for those desires.

Matt concludes that whatever is going on right now, it’s a familiar pattern that we tend to see every two years or so, as voters repeat the familiar, “not my fault” script:

What these trends portend is lasting voter frustration as it dawns on a widening swath of Americans that the perquisites of middle-class life, and the prospects of upward mobility for their children, may elude them. These strains won’t change in the two years before the next election, or in the two years after that, or the in two after that, unless policies are introduced that go radically beyond the boundaries of current debate. Instead we’ll see a cycle in which voters take stock every two years and say: “My insurance premiums are still going up — we still can’t save enough for college, let alone for retirement — and you people in charge haven’t fixed any of this!”

Yep.  Americans sure love those politicians that enable them to shun personal responsibility and remain in that state of dysfunctional denial where nothing is their fault and everyone else is to blame.  I think that’s a big part of what these primaries tell us.  That doesn’t bode well for getting a new crop of politicians who will actually improve the very situation the voters claim to be complaining about.

A Statistic in Need of a Baseline: A Trillion-Calorie Reduction?

May 19th, 2010 . by economistmom


I have complained before of the Obama Administration’s use of a “policy extended” rather than current-law budget baseline against which to evaluate the costs of their budgetary proposals.  Measured against the CBO-official, current-law baseline, the President’s proposals add nearly $4 trillion to the ten-year deficit–increasing the deficit from $6.0 trillion to $9.8 trillion, or more than 60 percent.  Measured against the Obama Administration’s “policy extended” baseline where all the Bush tax cuts are extended permanently (and entirely deficit financed, of course), the Administration shows they reduce the ten-year deficit by over $2 trillion–decreasing the deficit from $10.6 trillion to $8.5 trillion, or nearly 20 percent.

Baselines matter.  And not just to budget geeks or other people who care about budget rules and the pay-as-you-go (PAYGO) standard (with many exemptions, of course).  But they matter to ordinary people, too, to provide perspective on what exactly is being changed and how large or small the change is (and how good or bad).

That’s why when I read this story in the Washington Post on Tuesday about the First Lady’s fight against childhood obesity and getting food manufacturers to commit to reducing the calorie content of their foods, I heard myself screaming:  “but what is the baseline?!… and is this big or small, and good or bad?!”  I mean, what the heck does a trillion or a trillion and a half calories mean?… Key points from the article, that yet do not help me understand how significant this is (emphasis added):

In a direct response to Michelle Obama’s declared war on childhood obesity, an alliance of major food manufacturers on Monday pledged to introduce new, more healthful options, cut portion sizes and trim calories in existing products.

The Healthy Weight Commitment Foundation, a coalition including Campbell Soup, Coca-Cola, General Mills, Kellogg, Kraft Foods and PepsiCo, will slash 1 trillion calories by the end of 2012 and 1.5 trillion calories by the end of 2015. The 16 members make 20-25 percent of food consumed in the United States…

Missing from the announcement were any specifics on the new products or cuts that will be made to existing items. But White House officials stressed that the companies will be held accountable. Each year, their progress will be assessed by the Partnership for a Healthier America, a nonpartisan organization for which the first lady serves as honorary chair. If any one of the companies doesn’t meet its target, all of the companies will be held responsible, White House sources said. The Robert Wood Johnson Foundation, a nonprofit dedicated to improve Americans’ health, also will track the effort’s impact on childhood obesity. A first report is tentatively slated for 2013.

“What the White House is doing is consistent and relentless,” said Marion Nestle, a professor of nutrition at New York University and a frequent critic of the food industry. “The food companies are having their feet held to the fire for making kids fat. That’s awkward. And it is not good for business.”

Eliminating 1.5 trillion calories sounds like a lot. But can it help turn the tide on obesity?

A spokesman for the Healthy Weight Commitment Foundation was unable to put the number in context. Instead, he said the number is designed to eliminate the “energy gap” — the number of calories consumed that are not expended through physical activity. Recent research estimates that gap is approximately 100 calories per day per person, and less for teenagers and children.

Hmmm…. sounds like the First Lady is trying to eliminate the “unsustainable” part of calories (the “energy gap”) just like her husband’s trying to eliminate–with the help of his fiscal commission, that is–the “unsustainable” part of the budget deficit (the part that exceeds growth in the economy).  ;)

But I still find myself asking (like any well-conditioned budget policy analyst would) “a trillion-calorie reduction relative to what?–and spread over how many foods or people?–and over what kinds of people?”…  How do we evaluate the success of this calorie-reduction portion of the overall campaign to reduce childhood obesity?

Should It All Be Greek to Us?

May 17th, 2010 . by economistmom

The IMF’s Fiscal Monitor released on Friday should be troubling to us Americans for what it says about the required adjustments we’ll have to make to get to sustainable levels of public debt–because it puts us in the same category as Greece.  From page 32 in the report:

26. The extent of fiscal adjustment required to achieve certain debt targets varies significantly across advanced economies.

The adjustment is highest—close to or above 10 percent of GDP in the baseline scenario described above—in countries with high initial CA primary deficit and debt levels (Greece, Ireland, Japan, Spain, the United Kingdom, and the United States) (Figure 13 and Appendix 2).

…and yet the report also explains why the U.S. will find such a large adjustment especially difficult to achieve given our projected age-related spending needs.  From page 36, where Figure 14 shows the U.S. as the top-rightmost data point in a graph that plots the required fiscal adjustment against projected age-related spending increases:

29. The fiscal adjustment described above will be made more challenging by the spending pressures that will arise in the decades ahead, particularly in advanced economies.

The adjustments discussed above do not take into account those needed to offset the spending pressures already in train due to population aging and other spending trend increases. In particular, for several countries, total adjustment required goes well beyond the net improvement needed in the primary balance, as measures will also be required to offset higher health and pension spending (let alone pressures arising from global warming). On average, spending increases in health and pensions are projected at 4 to 5 percentage points of GDP in advanced economies over the next 20 years (see IMF 2010c). The relative position across countries along these two dimensions—the needed change in the primary balance to lower public debt below 60 percent of GDP for advanced economies, and the increase in spending pressures for pensions and health—is illustrated in Figure 14. Countries with adjustment requirements clearly above the (simple) averages in both dimensions—those located far in the upper right quadrant—include the United States, Spain, the United Kingdom, France, and the Netherlands.

That’s why the IMF report also explains that although the challenges are created by pressures on the spending side of the federal budget, “achieving large fiscal adjustments will require a variety of measures”–and they examine a variety of specific revenue measures (VAT, excise tax increases, and carbon fees/taxes–as shown in Table 11 on page 47) that for the U.S. could contribute a total of over 6 percent of GDP, or just about half the 12 percent of GDP adjustment needed over the next couple decades to stabilize debt/GDP to around 60 percent.  That doesn’t even include any possible base broadening of the current federal income tax.

Their point being that age-related spending may be driving most of the longer-term problem but it can’t be all of the solution, because it’s doubtful we could damp down such spending enough, and even if we theoretically could, would we really want to (as a compassionate society)?  On the other hand, there are a lot of ways to raise revenue in a socially-optimal, economically-efficient way–by as they put it “strengthening broad-based taxes on relatively immobile bases and increasing externality-reducing taxes” (pg. 45).

And if we don’t take advantage of the luxury of having adjustments like these available for us to make gradually over the next couple decades, we may be forced instead to make that huge adjustment suddenly.  And then suddenly we may look a lot more like Greece.

Using Sticker Shock to Clarify the Costs of Deficit Spending

May 13th, 2010 . by economistmom

I attended the National Tax Association’s spring symposium today, and heard a fascinating presentation by Raj Chetty, a “wunderkind” economics professor from Harvard, on using “behavioral economics” (sometimes now referred to as “cognitive economics”) to better understand the effects of tax policy.  Among the many interesting behavioral studies of his that Raj summarized today, one focused on how the “salience” of taxes (how obvious taxes are) matters in terms of how those taxes affect economic behavior.  The hypothesis was that the more visible or obvious taxes are, the bigger the behavioral responses would be.  Raj described how he conducted an experiment involving price tags in a drug store, where for a period of time the price tags on a certain subset of items (hair accessories, actually) in one particular store were elaborated upon, such that the (usual) price before taxes and the gross-of-sales-tax price (referred to as the “total price”) were displayed.  (You can find a photo of these price tags in this slide presentation.) Comparing with the appropriate “controls” (demand for other goods in the same store with ordinary price tags, demand for the same type of (hair accessory) products with ordinary price tags in other stores), Raj and his coauthors found that when the sales taxes and gross prices were spelled out on the price tags (note: taxes were not raised, just clarified), sales of those goods (quantity demanded) fell.  Raj had a funny story about how the store manager did not let him use the special price tags on a larger class of goods, because he had a hunch Raj’s hypothesis would prove right!

It got me thinking on the spot about how this bit of behavioral economics applies to deficit spending.  The reason why deficit financing of government spending and tax cuts proliferates is because it’s (falsely) perceived as “free”–or at least as less painful (less costly) than having to come up with offsetting tax increases or spending cuts.  When in fact, economically at least, exactly the opposite is true.  Even leaving aside the riskiness of high deficits and debt to the stability of our entire economy, there’s at least the objective and easy-to-quantify cost of the compounding interest on the added debt.

So what if every time a deficit-financed spending program or tax cut is proposed, the CBO puts a “price tag” on it that is not just the standard legislative cost of the spending or tax cut, but the gross-of-interest amount, maybe under various assumptions about how long paying down that debt will be put off?  Just for example, if the Bush tax cuts that President Obama wants to extend (all but the top two brackets) are extended and deficit financed (as the President proposes, and remember, these Bush tax cuts are exempt from Obama PAYGO rules), the gross-of-interest “price” would not be “just” $2 trillion over ten years, but maybe over $5 trillion over ten years if you count the compounded daily interest and assume the paying down of principal doesn’t begin for 20 years.  (I got that by assuming a 5 percent annual interest rate, but you can play around with different rates and terms using this handy dandy compound interest calculator here.)

In other words, this would spell out for people–the politicians and ordinary citizens alike–that a deficit-financed tax cut today just means a several-fold tax increase (on our kids) later.  And the later “later” is, the larger the “multiplier” on that future tax increase (or spending cut).

I guess this seems the opposite of the “dynamic scoring” of tax cuts that some conservatives who embrace supply-side economics advocate as a way of reducing the officially-scored costs of tax cuts.  But if deficit-financed tax cuts were to be truly “dynamically scored,” not only would the direct costs of compound interest count against it (which is all I’m here suggesting be added to the “price tag”), but the adverse effects of reduced public and national saving on economic growth would raise, not lower, the costs.

« Previous Entries