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Bernanke on Going Big in Both Ways

October 5th, 2011 . by economistmom


(Video from the Wall Street Journal’s website.)

It would seem we have heard this so many times before that we shouldn’t need to hear it again. The U.S. faces two major economic challenges at the same time: (1) an economy still desperately struggling to get out of (or avoid falling back into) recession; and (2) a fiscal outlook on such an unsustainable longer-term path that it threatens our near-term, and not just longer-term, economic health. The first is mostly a “lack of demand” problem, and the second is more about failing to keep up the supply of productive resources in our economy. The two challenges are very different and might suggest very different policy strategies, but we really can and should address both. We’ve heard this (”we can do both”) principle many times before, but it always helps when someone as prominent as the Chair of the Federal Reserve Board makes it crystal clear in his written and oral (and official) remarks. From Bernanke’s testimony before the Joint Economic Committee (on Tuesday), emphasis added:

To be sure, fiscal policymakers face a complex situation. I would submit that, in setting tax and spending policies for now and the future, policymakers should consider at least four key objectives. One crucial objective is to achieve long-run fiscal sustainability. The federal budget is clearly not on a sustainable path at present. The Joint Select Committee on Deficit Reduction, formed as part of the Budget Control Act, is charged with achieving $1.5 trillion in additional deficit reduction over the next 10 years on top of the spending caps enacted this summer. Accomplishing that goal would be a substantial step; however, more will be needed to achieve fiscal sustainability.

A second important objective is to avoid fiscal actions that could impede the ongoing economic recovery. These first two objectives are certainly not incompatible, as putting in place a credible plan for reducing future deficits over the longer term does not preclude attending to the implications of fiscal choices for the recovery in the near term. Third, fiscal policy should aim to promote long-term growth and economic opportunity. As a nation, we need to think carefully about how federal spending priorities and the design of the tax code affect the productivity and vitality of our economy in the longer term. Fourth, there is evident need to improve the process for making long-term budget decisions, to create greater predictability and clarity, while avoiding disruptions to the financial markets and the economy. In sum, the nation faces difficult and fundamental fiscal choices, which cannot be safely or responsibly postponed.

And don’t just take our monetary policy leader’s word for it.  How about listening to Doug Elmendorf, the director of the Congressional Budget Office, which obviously makes him one of our top fiscal policy advisers.  From Doug’s testimony before the Joint Select Committee on Deficit Reduction (a.k.a. the “super committee”) on September 13th–again, emphasis added:

There is no inherent contradiction between using fiscal policy to support the economy today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential. If policymakers wanted to achieve both a short-term economic boost and medium-term and long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade. Such an approach would work best if the future policy changes were sufficiently specific and widely supported so that households, businesses, state and local governments, and participants in the financial markets believed that the future fiscal restraint would truly take effect.

And don’t just take the CBO director’s word for it.  How about listening to a mom–i.e., me?!  ;)  Here’s what I wrote in the Christian Science Monitor last week.  I kind of go a little further than either Bernanke or Elmendorf in the argument that you can “do both,” in that I actually believe we could do both at the same time–if only we were willing to make the tougher and better policy choices (i.e., better optimize) in pursuing both our short-term stimulus and longer-term growth goals:

Many policymakers and experts characterize this as long-term versus short-term policy and argue that the short-term spending rise needs to take priority right now.

Actually, both can be pursued at the same time, if Washington is willing to put in place policies that have been proven to work and cut those programs that are less effective.

For the short term, stimulus policies should adhere to the three T’s that President Obama’s former economic adviser Larry Summers first espoused: timely, well-targeted, and temporary. That means policies that as quickly as possible put more money in the hands of the households most likely to immediately spend the money on goods and services, and the businesses most likely to hire more workers…

Over the longer term, deficit reduction can encourage economic growth via higher national saving, while freeing up resources to go to the most productive areas of our economy. Then, instead of having a rising share of resources going toward interest on the national debt or other forms of government spending that provide no public benefits, more funds will get steered toward areas of government spending that our society values highly.

So, you hear a lot of “Go Big” advice to the super committee these days–and even the corollaries to “go long” and “go smart.” But to that we should add to do all those wise things in “both ways,” to address both of the major challenges facing the economy at the same time:  we need more jobs, and we need lower deficits.

8 Responses to “Bernanke on Going Big in Both Ways”

  1. comment number 1 by: AMTbuff

    I wish the committee would agree to means-testing of all benefits based on lifetime earnings, phasing in from 2013 to 2017. Enactment of stringent means testing would lift the long-term fiscal cloud and probably avert a bond market crash. Avoiding a catastrophe is a huge win, even if it does not seem to be.

    Yes, means testing is similar to a big tax increase on the affluent. But that’s where the money is, and those people are going to be hit the hardest by any resolution of the fiscal gap.

    I doubt progressives will agree to this, because it destroys the fantasy that the middle class can enjoy benefits that they don’t pay (and overpay) for.

  2. comment number 2 by: Vivian Darkbloom

    AMTBuff,

    Two major “entitlement” programs already have limited means testing on benefits (contributions are already progressive).

    First, the method in which (some) social security benefits are taxed is a sort of means testing, albeit a limited one and the amount of revenues to be returned to the government via this mechanism is almost already “maxed out”.

    Second, Medicare B and D benefits are subject to higher premiums according to income (income based on one’s prior-year tax return). This is a sort of means testing and I understand higher premiums are part of the administration’s proposal. Higher premiums also presumably would not violate the “Tax Pledge”. The biggest immediate problem for the budget is Medicaid, not Medicare, because the former is not supported by any dedicated payroll levies or premiums paid by beneficiaries. Medicaid is, by definition, “means tested”. The Medicare situation is, however, unsustainable and obviously supports persons who are financially able to self-insure.

    It’s likely that if there is any compromise on Medicare it would be to increase the premiums to be paid by higher income enrollees and to lower the income levels used to determine premiums. This presumably would be the goal of “progressives” rather than taking these persons out of the program completely.

    It’s not clear to me how your idea of means testing would differ from, say, a policy under which high earners effectively pay the full cost of Medicare through greater means tested premium scales (and perhaps extending this concept to Medicare A). If the scale is steep enough, most of the “affluent” would simply drop out voluntarily.

    It’s also not clear to me how (or why) means testing should be based on lifetime earnings rather than one’s “means” at the time the benefits are to be doled out. Isn’t that the proper time to test one”s means for benefits?

  3. comment number 3 by: Vivian Darkbloom

    As an afterthought to the above post, if the premium scale were ratcheted up radically in combination with lowering the income levels at which higher premiums are charged, one could argue that this is in effect scrapping Medicare in favor of a somewhat expanded Medicaid. There is already significant overlap.

    Or, we could just give the poor vouchers…..

  4. comment number 4 by: AMTbuff

    I was thinking of Australia’s SS-style program, where benefits are completely cut off above about $60k income, including imputed income from assets. Current means testing in the US is very mild by comparison.

    Using lifetime income reduces the obvious incentive to squander assets and the disincentive to save. Australia uses current income despite this defect.

    Lifetime income is harder to fudge, and it’s more equitable to savers vs. those who spend every dime they get. Also, people are unlikely to decide to reduce their income for a period of decades when government policy could change at any time, wiping out the benefit of this strategy.

  5. comment number 5 by: Jim Glass

    Chuck Schumer is in the NY papers today saying “no” to raising taxes on mere $250kers.
    ~~~

    “Drawing the line at a million dollars is the right thing to do …”

    But the president also wanted to raise taxes on families making more than $250,000 a year by limiting income-tax deductions they can take.

    That didn’t sit well with rank-and-file Democrats.

    Schumer said families that earn $250,000 or $300,000 a year aren’t rich enough to deserve extra taxes. He described them as “firmly in the middle class. They are not rich”.
    – Today’s NY Post
    ~~~~

    When the top Democratic senators are going on like this in public, it shows what the chances are of any real revenue-raising. Fuhgetabout it.

    The “millionaires tax” is pure political posing. Even if enacted the revenue would be negligible relative to the deficit, it’s not serious.

    It serves the purpose of letting Obama say “tax the rich” without actually making any voters worry that he might tax them. We’re already in next year’s election season, we’re going to get nothing from either side except posing like this until 2013.

  6. comment number 6 by: Jim Glass

    The “income tax” on Social Security, which functionally is a disguised means test as its creators well knew (the tax goes back to SSA, reducing the net benefit in an amount determined by income level) has turned out to be the biggest part of the ‘83 SS bailout, er, reform.

    The tax was originally set to apply only at a fairly high income level, but as it has never been inflation-indexed it applies to more income every year (like the AMT) and is set to continue doing so forever.

    It’s funny how people who scream murder at the thought of any cut to SS ever accept this every year without a word. It shows how politics works.

    Maybe we should do the same thing with Medicare -make the value of Medicare benefits received taxable income. After all, they are income.

    There are enough tax deductions for medical costs so that anybody with modest income would still get them tax free, while those who can afford to pay for them will at least pay the tax on them, cents on the dollar, progressively. After all, even Buffett says the rich should be means-tested out of entitlements.

    It already works for Social Security — so what objection could anyone raise? ;-)

  7. comment number 7 by: Vivian Darkbloom

    “It already works for Social Security — so what objection could anyone raise?”

    First, regarding the taxation of social security benefits: The threshold set for the taxation of 50 percent of benefits was $25,000 in the 1983 Act (married couples). You are right that Congress very intentionally did not index this for inflation. A second threshold ($44,000) was introduced in 1993 to tax up to 85 percent of social security benefits (this bill needed Al Gore’s tie-breaker to pass the Senate). This second threshold was also, quite intentionally, not indexed for inflation.

    From the beginning, Congress had a hard time trying to determine if social security should be treated like any other individual retirement plan or another welfare plan. In the end, primarily over constitutional concerns and the resulting need to fit the program under the “taxing power” (sound familiar?) it chose the latter.

    Whether benefits from social security (more on Medicare later) constitute “income” depends on whether you are using the Tax Code concept or some other. If the analogy is to a private pension or annuity plan, the “income” would be limited to the amounts exceeding one’s after-tax contributions (i.e. one’s “basis”). This was also wrestled with in the debate over the 1983 “reform”. In the end, it was reasoned that taxing 50 percent of the benefits would be (roughly) analogous to private plans because only 50 percent of the contributions (the employees’) came from after-tax income (employer contributions). The 1993 amendment was rationalized more on the desire to make the distribution more equitable (and of course the need to raise revenue).

    Per the 1983 Act, revenues from the tax go to the fund from which the benefits arose (primarily the OASI Fund). Per the 1993 Act, the tax raised goes to the HI Fund (Medicare). Per the most recent Trustee’s Report, the revenues raised and allocated in 2010 were (billions) :

    OASI $22.1
    DI 1.9
    HI 13.8

    Failure to index the thresholds will result in additional (real) revenues over time; however, my sense is (I’m not aware of any study) that due to the indexing of the brackets themselves and the relatively “paltry” sums raised thus far, this cannot constitute the major source of revenue to save Social Security or Medicare. The low hanging fruit seems to have already been picked. It does, however, confirm the fact that Congressmen and women are cowards when it comes to raising taxes on the middle class—to do so, it must be done by stealth. Witness the recent failure to index the threshold for the “Cadillac tax”. I fully expect the Buffett rule will be proposed, if not implemented, in the same fashion.

    As for Medicare, I can think of a quite valid objection. Unless I’m misunderstanding the proposal, it is to tax the benefits of Medicare; i.e., the “insurance proceeds”. If the analogy is to “income” as defined in the current Tax Code, private health insurance proceeds are not taxed (nor are most other types of insurance proceeds). That’s not to say that we need to stick to the current Tax Code definitions, but the Tax Code is an amalgam of both theoretical and practical concerns. Here, the objection is based on the latter. The practical concern is that, unlike social security, the amount that might be subject to income tax (and the ability to pay that tax) is not predictable. Someone with a very serious illness can easily have “income” far exceeding his or her ability to pay the tax on that “income”. This applies even to moderately “affluent” taxpayers. Of course, the answer to this, as suggested by Jim Glass, is that we maintain (or modify) the existing rules that allow deduction of medical expenses above a certain percentage of annual income. It strikes me that one would need to revise the existing concept of “income” for private insurance to provide consistency. And, there is the issue of income and expense “averaging”, etc. While this might work, it strikes me as altogether too messy and complicated, and unnecessarily so.

    Again, I think the more likely and feasible approach would be to raise the level of premiums to be paid by more affluent Medicare beneficiaries. Indeed, this seems to be part of the administration’s revenue raising plans. And, it is probably something that politicians on both sides of the aisle could and probably should embrace (The Ryan Plan essentially does so in a somewhat different fashion by pegging the amount of premium support to income). Initially, I think, the purpose of the ACA was to try to slowly kill the private health insurance market and replace it with “single payer”. But, unless participation in Medicare is made mandatory, increasing premiums in that program would likely have the effect of moving more affluent people out of that program when they realize that due to the higher premium costs of Medicare they are better off (financially and otherwise) opting out completely for private plans. At the end of the day, one would basically be left with Medicaid and private plans.

  8. comment number 8 by: AMTbuff

    >Initially, I think, the purpose of the ACA was to try to slowly kill the private health insurance market and replace it with “single payer”. But, unless participation in Medicare is made mandatory, increasing premiums in that program would likely have the effect of moving more affluent people out of that program when they realize that due to the higher premium costs of Medicare they are better off (financially and otherwise) opting out completely for private plans. At the end of the day, one would basically be left with Medicaid and private plans.

    Yes, that’s how I see it. As to taxing benefits, it’s more likely that the premium subsidy would be taxed, not the actual expense payout. The premium subsidy is simpler to compute and known at the beginning of the year. It would be published in a table like the actuarial values the IRS uses. As the affluent are taxed more and more on this subsidy, they will have an incentive to drop Medicare, as you said.

    The eventual result of inferior government-paid care and expensive private care is regrettable, but it appears to be the only affordable option. Britain is almost there now, and if there is a better way out they will find it for us.