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Greenspan Breaks Free from an “Ideological Straitjacket”

July 19th, 2010 . by economistmom

In an op-ed by my boss, Bob Bixby, which ran in yesterday’s Boston Globe, Bob mentions how “ideological straitjackets” have been preventing us from effectively treating either of our two largest economic ailments:

We have two distinct problems. The economy remains shaky in the near-term, and fiscal policy remains unsustainable in the long-term. These problems can, and should, be treated with different remedies.

The good news is that we can treat both problems at once if we set aside rigid ideological straitjackets. Fiscal stimulus need not have an adverse impact on economic growth over the long term, and long-term discipline need not have an adverse impact on economic activity in the short term. We don’t need to sacrifice one to achieve the other, but we need to be clear about the trade-offs.

This suggests that deficit-financed initiatives may still be appropriate for policies with the highest propensity to support the near-term recovery. Items that fit into this category include extended unemployment benefits and further, but temporary, aid to state and local governments. These policies would directly address serious needs created by the severe recession without adding to the long-term structural deficit.

At the federal level, we can hold down the size of near-term deficits and help engender public trust that tax dollars are not being wasted, by making every effort to identify savings from unnecessary programs.

That includes cutting narrowly targeted tax breaks that add to the complexity of the tax code without producing meaningful economic benefits. Such provisions divert resources from more pressing national needs and increase public cynicism about the fairness of the federal budget.

Again, there is no inconsistency in cutting some under-performing programs while boosting spending (or cutting taxes) in areas where it will do more good.

Even with a robust recovery in the next few years, the pre-existing mismatch between future benefit promises and current levels of taxation would leave us on an unsustainable path. No amount of fiscal stimulus will solve that problem. This makes it all the more important to combine near-term deficit spending with a credible plan to bring our long-term structural deficit under control.

Balancing the risks, we should keep assistance flowing in those areas where it is most needed and can take effect most swiftly, and, as soon as possible, begin a planned phase-in of spending cuts and tax increases that will bring the structural deficit under control.

Of course, this will require some compromise.

Can we handle that?

Kevin Williamson of the National Review seems to be screaming over his frustration with the conservative straitjacketed position that deficit-financed tax cuts are somehow fiscally responsible:

You know what? Kyl is right: The money does belong to the taxpayer. You know what else? The money Jon Kyl and his colleagues are spending belongs to the taxpayer, too. Jon Kyl’s been known to pork up a highway bill in 2008 — even as he voted against one of the worst of them in 2005. (And Kyl’s one of the good ones.) If you spend the taxpayer’s money, you have to tax the taxpayer, at some point. You cannot magic that money into existence. As I’ve been arguing — ad nauseam, forgive me — taxes are a secondary issue. The primary issue is spending. As ye spend, so shall ye tax. The rate of spending is the rate of taxation; debt and deficits only push the date of tax collection into the future. You can collect the taxes today or you can collect the taxes tomorrow — but what you spend, you will have to collect.

Tax cuts without spending cuts, spending increases without tax increases: These are not merely irresponsible, they are impossible — unless you think that nobody is going to pay the debt. You might make a reasonable case that tax cuts without spending cuts are, in some cases, preferable to deficit stimulus spending, especially since the stimulus spending has been channeled to a lot of dumb and wasteful projects. But, broadly speaking, the two things are equivalent. The Democrats prefer unfunded spending, the Republicans unfunded tax cuts. And almost nobody is serious about reducing spending, because spending is where power dwells in Washington.

But on a very positive note, this weekend former Fed chairman Alan Greenspan seemed to be busting loose from his long-worn, but perhaps often misunderstood, ideological straitjacket of the Bush tax cuts, when, in an interview with Judy Woodruff (see a clip here), he said the best thing we could do with the expiring Bush tax cuts is to simply let them go (emphasis added):

WOODRUFF: You embraced the tax cuts of former President Bush, George W. Bush, in 2001, with the caveat that this hinged on keeping the deficit under control. In retrospect, do you wish that you would have spoken out any louder as it became clear that that deficit was growing?

GREENSPAN: Well, I thought I did. In fact, there are all sorts of hearings. I remember conversations between Barney Frank and myself, where he was saying, in a sense that, do I understand you essentially saying that effectively unless the second tranche of the tax cut — which was then occurring in the context of deficits — was adjusted by pay-go — meaning financed — that you would not support it. And the answer was I would not support it. And I did not support it.

The trouble is, there is a very selective reading of history out there. I mean, I find it unfortunate, but there are a lot of things that happened which I discussed in great detail and it sort of is — my main concern myself is the fact that we ought to go back and look at the records.

WOODRUFF: On those tax cuts, they are due to expire at the end of this year. Should they be extended? What should Congress do?

GREENSPAN: I should say they should follow the law and let them lapse.

WOODRUFF: Meaning what happens?

GREENSPAN: Taxes go up. The problem is, unless we start to come to grips with this long-term outlook, we are going to have major problems. I think we misunderstand the momentum of this deficit going forward.

This argument of stimulus versus non-stimulus, in my judgment, is not a critical issue, in one sense. We are going to be doing very well if we can keep the deficit to where we are now projecting it. The notion that we are somehow going to bring it in far more sharply is just utterly, politically unrealistic.

So it is not a question, do you have more stimulus now or do you have basically a significant contraction in the deficit? We are going to have continued expansion in government spending and increasing debt, because there is no evidence that we are closing the debt — the gap between receipts and expenditures yet. And it is going to be very tough to go up against the momentum that is currently going on.

WOODRUFF: So to those interests who say but wait a minute, if you let these taxes go my taxes go up, it is going to depress growth?

GREENSPAN: Yes, it probably will, but I think we have no choice in doing that, because we have to recognize there are no solutions which are optimum. These are choices between bad and worse.

Greenspan suggests at the end that raising taxes will (unfortunately) mean economic growth will be harmed–just by not as much as if we let the deficit swell by the cost of extending the Bush tax cuts.  But I’d remind readers that raising revenue to keep taxes at current-law levels does not necessarily mean sticking to current tax law and allowing marginal tax rates to come back up.  What Greenspan is saying is that we need more revenue (and in particular, the level dictated by the current-law baseline looks pretty appropriate), and that however we come up with it looks good relative to not coming up with it.  But some ways of coming up with the extra revenue are still going to be better than others.  That’s why tax reform has to be part of our overall strategy to get back to fiscal sustainability, along with reform of the entitlement programs and greater discipline in our discretionary spending.

8 Responses to “Greenspan Breaks Free from an “Ideological Straitjacket””

  1. comment number 1 by: AMTbuff

    Fiscal stimulus need not have an adverse impact on economic growth over the long term, and long-term discipline need not have an adverse impact on economic activity in the short term.

    Correct. The obvious win-win course is to FIRST break enough promises to irreversibly bring the big 3 (now big 4) entitlements down to sustainable levels of spending in the long run. Then and only then, long-run tax increases can be enacted.

    Moving rapidly to put the long-term budget in balance will do more to build confidence and stimulate the economy than any amount of borrowed money that everyone expects to be followed by high inflation or default. The latter policy has already proven to be ineffective, so more of the same is not warranted.

  2. comment number 2 by: VAT Brat

    Let me get this straight. Letting the Bush tax cuts expire won’t adversely affect the stimulus to short-term growth? But cutting $38 billion from existing programs to pay for unemployment benefit extensions is going to choke the recovery? Am I missing something?

  3. comment number 3 by: economistmom

    VAT Brat: it’s all about: (i) timing, and (ii) distribution. Considering both, I think we can address both the short-term and long-term economic concerns by extending only the middle-class portions of the Bush tax cuts only temporarily. And yes, unemployment benefits still have more stimulative bang per buck than even “middle class” tax cuts in terms of immediately boosting demand for goods and services, because unemployed people have even less income (are more cash-constrained and hence will immediately spend all that you give them) than “middle class” working people. As for any offsets one might use to “pay” for stimulus (vs. deficit finance it), the distribution of the burden of those offsets affects how detrimental to the stimulus effort the added costs to households or businesses would be. For the purely short-term goal of immediately boosting aggregate demand, if I pay for extended unemployment benefits by immediately raising taxes on the rich, or cutting government spending that is purely wasteful (as if it is thrown away and benefits no one), such offsets would not “harm” the stimulative effect as much as if I pay for those benefits by cutting some other spending that truly benefits/assists low-income households (and hence would undo the helpful effect of additional unemployment benefits). Most economists assume an effective stimulus requires that on net the spending be deficit financed, because we presume that a “Robin Hood” deficit-neutral policy (where we would take from the rich to give to the poor) would not be politically viable. Still, that is an example of a deficit-neutral policy that would effectively boost aggregate demand. If it continued too long, however, that effective stimulus would turn into a policy very harmful to longer-term economic growth via the effects on the aggregate supply (labor supply, saving–the inputs that add to our economy’s productive capacity) of a full-employment economy.

  4. comment number 4 by: AMTbuff

    Diane, your arguments about aggregate demand are all correct according to conventional wisdom. The difference today is that everyone is afraid of when and how the other shoe is going to drop. Nobody knows how the unsustainable promises will be reconciled to reality. Everyone is afraid, and therefore they are saving as much as they can to prepare. You can’t force people to spend when fear of future calamity makes them want to save. They might respond to more stimulus by spending even less!

    One stimulus that could free some money would be to announce a 10% target for inflation. But the better stimulus would get to the root cause by eliminating the fear. Break all those long-term promises and bring the books back into balance in the out years.

    The public is way ahead of pundits and politicians on this issue. Politicians have no idea how aware the public is of the long-term imbalance, and they have no idea how much the public distrusts anything they say. The inchoate tea party movement should have been a wake-up call to start breaking impossible promises, but it was not sufficient.

    On the other hand, the agenda of major media is beginning to prepare the public for promise breaking. Social Security cuts are no longer merely whispered, and now the media have conducted a poll to prove what anyone outside the beltway knows: the public doesn’t believe long-term promises from the government: http://www.usatoday.com/news/washington/2010-07-20-1Asocialsecurity20_ST_N.htm

  5. comment number 5 by: VAT Brat

    Economistmom,

    Regarding offsets, you mentioned the possible existence of government spending programs that are “purely wasteful” Can you name a few examples? Is there $38 billion of that lurking in the federal budget?

    Based on consumption multiplier reasoning, would you would agree that it would be more stimulative to the economy if state governments forced all government employees to take pay cuts proportional to the reduction in revenues rather than do layoffs or raise taxes?

    For example, better to have 100 employees earning $40,000/yr. than 80 employees earning $50,000/yr. and 20 unemployed. The multiplier is higher for those with lower incomes.

  6. comment number 6 by: Jason Seligman

    Bixby and Greenspan both have it right.

    And I’ll offer a thought on the Geniis of Genus for Greenspan here:

    Greenspan, like other hugely popular and talented stars of merit (think: Lance Armstrong and John Lennon, for example) is having to find balance with his audience — having once been given to much credit for good things, and subsequently too much blame for bad, he is now well aware of the merits of being human.

    Speaking of being human - some (some I say) of the other comments here strike me as being a bit tied up in the “Ideologically Straitjacket” our host Diane was rallying against.

    We must keep an open mind to the very many ways in which a society can grow and enrich its self over time if we are to prosper. The fact is the public sector offers many goods. Let’s focus on four basic types:

    -1- Cheap and Good
    -2- Expensive and Good
    -3- Cheap and Bad
    -4- Expensive and Bad

    Some “policy advice:”

    A(1): Buy the cheap and good,
    A(2): Comparison shop on the expensive but good, and buy just what you need.
    A(3): Stop using cheap as an excuse to buy bad (death by a thousand cuts is… death.)
    A(4): And thank your forefathers that you live in a land that has done a pretty good job of avoiding the expensive and bad for most of its history.

    How has that occurred? Well, we have nice institutions, plenty of resources, but really it has occurred because by and large we as a public have avoided Ideological Straitjackets, voters and analysts rejoice.

  7. comment number 7 by: VAT Brat

    Jason,

    If commentary from our host and others were free of ideological straightjackets, then we’d be hearing about proposals to maintain constant employment levels by state governments by cutting salaries of government employees. That avoids layoffs and increases the consumption multiplier effect. Not to mention that the level of goverment services would be held constant and class room sizes wouldn’t have to increase. I mean, it’s not as if government workers getting pay cuts are just going to leave their jobs for better paying jobs in a recession, correct?

    Also, we’d be hearing recommendations to “temporarily” lower the minimum wage to encourage job formation and alleviate the staggering unemployment rates among those under 25. Why haven’t Obama’s CEA or the Economistmom weighed in on these policy options? Hmmm.

    Instead we hear recommendations to redistribute the wealth through taxation.

    Also, think about this for ideological bias of scientific research: Have you ever heard a Keynesian ever admit that any expenditure by the government could ever harm economic growth?

    The Keynesian models have their ideological bias baked into the equations. That’s the only way we could have heard the claim last week by Romer that the stimulus has actually saved over 2 million jobs. There is no way those models could have yielded a result that government spending could have cost jobs. Is that ideologically-content free science?

  8. comment number 8 by: Matt Franko

    VAT,
    Govt expenditures of any type add Net Financial Assets to the non-govt sector, taxes take them away. You can argue that the transfer of NFAs that the stimulus caused may have been better/more fairly applied, but the fact is that the stimulus increased the NFA of the non-govt sector and helped employment and output of the economy.

    I would have prefered the 700B+ of deficits would have been applied to a FICA tax holiday for the ‘workin’ man’, but we have to take what we can get.

    Matt Franko
    http://www.moslereconomics.com
    Counter Insurgency, Deficit Errorist Unit