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What the President’s Economic Report Leaves Out

February 28th, 2011 . by economistmom

Today I got a note from Bruce Bartlett pointing out that in the new Economic Report of the President there is no mention of the terms “tax reform” or “entitlements.” (Bruce did a search of the entire pdf document.) But that doesn’t surprise me because even if the report had actually discussed better ways to raise revenue or to trim the costs of the Social Security and Medicare programs, it would have judiciously avoided using the dirty words “taxes” or “entitlements.”

More disappointing is the fact that it wasn’t just semantics.  The President’s Council of Economic Advisers really did avoid the substance of the “tough choices” on tax and spending policy–you know, all that “fiscal responsibility” and “living within our means” that the President loves to mention only as an abstract virtue and never as a specific proposal.

And the CEA even went beyond not emphasizing the need for tax and entitlement reform. With their main theme for this year’s report being “The Foundations of Growth” (the title of their Chapter 3), they had the nerve to completely leave out an explanation of how deficits very directly harm economic growth by reducing public and national (public plus private) saving.  The omission is obvious from the first sentence of the second paragraph in Chapter 3, which says:

At the core of the Nation’s economic growth is our capacity to innovate, educate, and build.

…but then goes on to devote the rest of the chapter to the innovating, educating, and building (the “investing”), just assuming we already have the capacity (the “saving”) to do all that innovating, educating, and building.  But we don’t have either the private saving or public saving to fund those investments, so we have to be talking about borrowing to finance those investments.  And the problem with borrowing to finance even the kind of spending that may encourage economic activity is that there’s no guarantee that we will come out ahead on net, after we have to repay the debt (with interest).

During the Clinton Administration we learned that reducing the federal budget deficit contributed positively to the economy’s productive capacity by boosting national saving.  In President Clinton’s final economic report, we explained that the direct, positive boost to public saving was barely offset by any decline in private (household and business) saving.

Now take it in reverse, because in this economic report the Obama Administration is trying to make the case for deficit-financed ‘investments”–all those things that fall under the “innovating, educating, and building’ umbrella–as investments that are good for economic activity.  I don’t dispute that those types of spending and tax cuts will generate specific types of economic activity that otherwise would not have happened.  But it is another matter entirely whether those investments will pay off so well that they will grow the economy even net of the negative effect of higher budget deficits on national saving.  When you borrow to finance an investment, you start off in a hole.  To end up better than before you have much further to climb.

Many of these ideas the Obama Administration has for new spending and tax cuts to encourage certain investments in our economy are good ones.  But whether they are good enough to overcome the handicap of deficit financing, I’m not so sure.  (Some of you might recognize that these deficit-financed investments are destined to generate the Democrats’ version of the Republican push for “dynamic scoring” of deficit-financed tax cuts.)  A far surer payoff could be had if instead of deficit financing these investments we paid for them by reducing the types of federal spending and tax cuts that are much less productive uses of our precious resources.

For the President’s economists to not explain that deficit financing tends to reduce, not increase, national saving and economic growth–in a report which purports to address the central question “how can we best grow the economy?” no less–is extremely disappointing and even, I think, dishonest.

What happened to the Austan Goolsbee (now President Obama’s chair of the CEA) who wrote this just 4 years ago?

Commission-Eyed Optimists

February 20th, 2011 . by economistmom

In Sunday’s Washington Post, the “Topic A” question (at the back of the A section) asked about the (my italics) “prospects that the president and congressional Republicans would reach a serious budget deal this year.”  My answer was “basically nil” because politicians still view putting things on the table as admitting fault.  Bill Gale’s answer was “small” because the Republicans are still too entrenched in their “no new taxes” fantasy world.  Maya MacGuineas sounded a bit more optimistic that policymakers might actually try doing the right thing but only after they try all the wrong things first!  But Alice Rivlin, the only person who was on both President Obama’s fiscal commission as well as (co-chair of) the Bipartisan Policy Center’s version, was clearly the most optimistic of us all, saying (emphasis added):

Here is an optimistic scenario that could result in a serious long-run budget agreement this year: First, a bipartisan group of senators crafts a long-run budget plan that slows the future growth of Medicare and Medicaid, puts Social Security on sound fiscal basis, simplifies the tax code to raise more revenue from broader base with lower rates, and caps discretionary spending (defense and domestic). This step doesn’t take long, because the bipartisan group is already working and has the Simpson-Bowles and Domenici-Rivlin plans to build on. Next, the president and the House leadership join the negotiations. Political perceptions begin to shift. After the sharp world-market reaction to the brief battle over the debt-ceiling increase, all participants are scared of not acting. Fear of taking the first step to slow entitlement growth or raise additional revenue is replaced by fear of being blamed for blowing up the deal and throwing the economy into a new tailspin. The deal no one thought possible is signed in the Rose Garden in the October sunshine, markets react positively, business steps up hiring and economic growth accelerates.

I think Alice was thinking like Mitzi Gaynor’s “Cockeyed Optimist” (in South Pacific, above)–right down to the bright canary yellow skies!  Then when the Post came out with an op-ed by Alan Simpson and Erskine Bowles, the co-chairs of the president’s commission, also displaying an unusual helping of optimism (right above our Topic A responses), I realized that for one to want to chair a fiscal commission for a task as impossible (given the politics) as deficit reduction, one must be an inherently optimistic person.  So they’re just “commission-eyed optimists.”  ;)

Which, by the way, is the way you can tell a true devotee to fiscal discipline apart from a wannabe who plays a fiscal hawk for purely political gain.  As my boss (the Concord Coalition’s executive director) Bob Bixby likes to say, if it were all “doom and gloom” we wouldn’t keep doing what we do to try to encourage fiscal responsibility.

A Budget Fitting for Valentine’s Day

February 14th, 2011 . by economistmom

Here’s OMB director Jack Lew explaining how the Obama Administration’s proposed budget (released this morning) will reduce the budget deficit over the next ten years–cutting it in half by 2013 and by two-thirds by 2020.  Problem is that that’s only relative to a “baseline” that builds in a lot of tax cuts that go beyond current law (extended beyond their expiration), and the President’s budget stays away from the major pressures on the federal budget–the growth of Medicare and Social Security spending and the lack of a solid enough revenue base to keep up with that spending.

I think it’s a fitting “Valentine’s Day” budget because it only pays “lip service” to the work of the President’s fiscal commission, writes a lot of “love notes” to those enduring Bush/Obama tax cuts, and still contains an awful lot of red ink.

More details later…

***UPDATE (1:30 pm):  A few quick observations from my (admitted) Bush/Obama-tax-cuts-obsessed perspective:

  • The “lip service” the Administration pays to the fiscal commission comes from very skinny, non-luscious lips (see Ezra Klein on this point!); absolutely nothing in the President’s message and only a mention about “reset[ting] the debate” in the chapter on the “sustainable fiscal path”
  • Budget does not achieve sustainability (below 3% of GDP deficits) by the end of the budget window; it is slightly above by 2020-21 (see Table S-1).  Problem with “almost sustainable” is that that’s still unsustainable.
  • Same table (S-1) shows as memo that IF we could pay for extended AMT relief we would get to sustainability by the second half of the budget window.  Just like IF we could pay for any other ongoing tax cuts or spending that we haven’t been in the practice of paying for.
  • Table S-2 makes it look like there is $2.2 trillion (over 10 years) in deficit reduction proposed in the President’s budget, including $665 billion in revenue raisers.  But that’s relative to their “adjusted baseline” which already assumes nearly $3.1 trillion in extended tax cuts that are not in current law (the “middle-class” cuts and 2009 estate tax law and AMT relief; see Table S-7).  In other words, their proposed spending cuts or revenue raisers fall short of even paying for the assumed tax cut extensions they are implicitly proposing (tucked away into their “adjusted baseline”), by nearly $1 trillion.
  • And although they want to be seen as more honest in not adding in all of the Bush/Obama tax cuts into their “adjusted baseline,” in the memo to Table S-2 they still try to characterize letting the high-end Bush tax cuts expire (after the current two-year extension) as deficit reduction (”costs avoided”).
  • Table S-8 lays out their tax proposals as containing just around $392 billion (over 10 years) in tax cuts, while tax increases (”revenue changes and loophole closers”) total $356 billion.  On net this looks as if they come close to revenue-neutral tax policy, but of course that doesn’t count the over $3 trillion in extended tax cuts already built into their baseline.
  • Note we are back to the same old story:  if Congress went home and didn’t pass any extensions of tax cuts, and the President didn’t sign any extended tax cuts into law (i.e., if they stopped doing the kind of “bipartisan compromise” they did in the lame duck session), we’d do way better at reducing the deficit than if we adopted the policies the President’s budget proposes.

No Wonder We’re Confused About Tax Cuts and the Deficit

February 7th, 2011 . by economistmom

reagan-july-1981-on-tax-cut-bills1

I think I may have found the seeds of the “largest tax increase in American history” rhetoric–the start of Americans’ confusion about tax cuts vs. tax increases, whether tax cuts add or subtract from the deficit, and whether tax cuts shrink or grow the size and reach of government.

One of my kids first shared the photo above, from a July 1981 address of President Reagan to the nation on competing tax proposals being considered in Congress at that time.  Only when I first saw the photo I didn’t know what “our bill” vs. “their bill” referred to and the first thing to come to me (perhaps because the photo came from my daughter) was that “our bill” meant “our generation’s bill” (what we would pay for) and “their bill” meant “our kids’ bill” (what they would end up paying for).

I had to hunt down and watch the video of the address (on YouTube, here) to figure out that Reagan was referring to his Administration’s favored tax cut proposal (which he labels a “bipartisan” bill) versus a competing Democratic proposal (which also was for a tax cut but a smaller tax cut that ends up being labeled a tax increase).

In any case, how is this address supposed to have helped Americans understand what was at stake regarding tax proposals, the deficit, and the role of government?  Note the highly informative (not) labeling of the Y axis scale in the chart Reagan features, and the general obfuscation of the choice between the competing tax (cut) proposals.

If you read Chapter 5 on “The Early Reagan Era: 1981″ in Gene Steuerle’s excellent book “Contemporary U.S. Tax Policy”, you’ll see this assessment of Gene’s in the section titled “It Didn’t Add Up” (pages 96-97):

The 1981 tax reductions were in many ways an extremest parody of previous tax reform efforts, especially the Kennedy round of tax reduction.  Investment incentives proliferated and drove many tax rates to zero or below…Base broadeniing to remove special preferences that reduced that tax base was abandoned–not just early on, as in the Kennedy round–but completely.

Most of all, the change in underlying budget conditions was set in the law, and Congress in 1981 effectively removed the fiscal slack that the next congresses would need to enact their own laws and set their own priorities.  This was the biggest mistake of all…The 1981 cut…was enacted in an era when it would be vastly harder to harvest future revenues that hadn’t yet been committed.

I know there’s a lot of nostalgia right now about President Reagan given his 100th birthday, but it’s clear our politicians didn’t need that as an excuse to renew the early-Reagan-era rhetoric.  But they should read ahead to the next chapter in Gene’s book that talks about the tax increases that began the very next year (1982).  Tax policy tends to be cyclical like fashion; what goes around comes around.

It’s That Damned “Holey” Tax System

February 3rd, 2011 . by economistmom

mouse-in-swiss-cheese

Fed Chairman Ben Bernanke gave a very good speech today at the National Press Club.  In it he emphasized why having a plan to get back to economically sustainable deficits is not only important for longer-term economic growth, but to our near-term economic health as well.  He also suggested that “acting now to develop a credible program to reduce future deficits” is not so daunting a task now that the President’s fiscal commission and related groups have put forward proposals that “provide useful starting points.”

Chairman Bernanke then hints about what he likes about the commission proposals, in his concluding paragraph (emphasis added):

Of course, economic growth is affected not only by the levels of taxes and spending, but also by their composition and structure. I hope that, in addressing our long-term fiscal challenges, the Congress and the Administration will seek reforms to the government’s tax policies and spending priorities that serve not only to reduce the deficit, but also to enhance the long-term growth potential of our economy–for example, by reducing disincentives to work and to save, by encouraging investment in the skills of our workforce as well as in new machinery and equipment, by promoting research and development, and by providing necessary public infrastructure. Our nation cannot reasonably expect to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face.

With tax policy, the only way to raise revenue (and reduce the deficit) while reducing disincentives to work and to save is to broaden the tax base rather than raising marginal tax rates.  Luckily we have tremendous room to broaden the tax base, because the existing federal income tax base is really “holey”–as in chock full of holes.

Such tax base “holes”–as in special exemptions, deductions, and credits that narrow the definition of taxable income–comprise the bulk of what are labeled “tax expenditures.”  In total, federal tax expenditures add up to around $1 trillion per year, or about as much as all of discretionary spending (both defense and nondefense) combined.

It so happens that the Tax Policy Center’s Donald Marron testified before the Senate Budget Committee yesterday and very clearly presented the case for getting rid of some of these tax expenditures, in the title of his testimony calling “cutting tax preferences” the “key to tax reform and deficit reduction.”  His main points:

My message is simple: the income tax is riddled with tax preferences. These preferences narrow the tax base, reduce revenues, distort economic activity, complicate the tax system, force tax rates higher than they would otherwise be, and are often unfair. By reducing, eliminating, or redesigning many of these preferences, policymakers can

  • Make the tax system simpler, fairer, and more conducive to America’s future prosperity;
  • Raise revenues to finance both across-the-board tax rate cuts and deficit reduction; and
  • Improve the efficiency and fairness of any remaining preferences.

Donald later explains some analysis with Eric Toder that I have previously mentioned here, stressing the point that when tax preferences take the form of reducing the definition of taxable income (what I think of as “poking holes” in the tax base), then they both reduce revenues and expand (not reduce) the size of government.  Donald’s bad news for tea partiers is that to be truly committed to smaller government may require a willingness to give up one’s (very own) tax preferences and end up paying more, not less, in taxes (my emphasis added):

In some preliminary research, my Tax Policy Center colleague Eric Toder and I (2011) have tried to estimate how large the government is when we recognize that many (but not all) tax preferences are effectively spending programs. For fiscal 2007, we estimate that spending-like tax preferences amounted to 4.1 percent of GDP. Adding that to official outlays yields a broader definition of spending, 23.7 percent of GDP in 2007, about a fifth larger than the official 19.6 percent. Similarly, our broader definition of revenues—official revenues plus revenues foregone through spending-like tax preferences—is 22.6 percent of GDP rather than the official 18.5 percent.

These figures illustrate that conventional budget measures understate the extent to which federal fiscal policy affects economic activity. They also suggest that some policy proposals that increase revenues, as conventionally measured, may nonetheless reduce the size of government. If policymakers reduce the tax preference for employer-provided health insurance, for example, that would increase federal revenue but reduce the government’s role in private insurance markets.

Advocates of smaller government are often skeptical of proposals that would increase federal revenues. When it comes to paring back spending-like tax preferences, however, an increase in revenues may actually mean that government’s role is narrowing.

The trouble is that once people start realizing that reducing govenment “spending” may include things like reducing the subsidy to employer-provided health insurance received via their (very own) tax exclusion, instead of clamoring for government to get smaller they might start screaming that “the government needs to get its hands off of”…”my tax preferences.”

The “holey” tax system enlarges the deficit and enlarges the government, but most of us don’t want to give up our (very own) precious holes.  See, tax cuts can be just like spending dressed up in a different costume.

(**NOTE: here’s the link to Donald’s own blog post on his testimony, and here’s a link to the Senate Budget Committee page where you can read/watch testimony by the other witnesses, Gene Steuerle, Rosanne Altshuler, and Larry Lindsey.)

Economics in Plainer English

February 1st, 2011 . by economistmom

On Tuesday I am part of panel for the Urban Institute’s “First Tuesdays” event, “What Policymakers, The Public, The Press, and Parents Need to Know About Economics…In 90 Minutes or Less.” I’m pretty sure I’m unofficially responsible for the “Parents” part of the billing.  My official assignment is the part about “the bottom line on how government uses your dollars.”  I’m planning on bringing out my usual EconomistMom analogies between the federal budget and a family budget.  Hope you’ll “tune in” for the live webcast, accessible via the link on the event page.

I’m happy I’ll be speaking alongside my friends Donald Marron and Gene Steuerle as Bob Reischauer plays “Oprah,” and I’m also looking forward to meeting the Economist magazine’s Greg Ip.