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Peter Orszag, President Obama’s budget director, gave a “farewell speech” of sorts yesterday at the Brookings Institution (his former professional “home”). Although an incident with a protester stole most of the media attention, Peter’s point about the “false debate” between those concerned about the deficit and those concerned about jobs–shown in the video clip above–was probably the most significant message to take away from the event. If only someone could write an opera song to go along with it.

In the Q and A that followed, the Washington Post’s Lori Montgomery and Ruth Marcus made for a dynamic duo–trying valiantly yet playfully to get Peter to answer questions about another great Obama Administration debate: what to do about the expiring Bush tax cuts. Ruth had just published this column with her opinion on the issue, which I agree wholeheartedly with.

Nice issue brief just released by the Congressional Budget Office.  It explains that besides the “gradual consequences” of the gradual worsening of the fiscal outlook, there are these shorter-term risks to the economy:

Beyond those gradual consequences, a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors’ confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis. But as other countries’ experiences show, it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply. The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the government’s long-term budget outlook, its near-term borrowing needs, and the health of the economy. When fiscal crises do occur, they often happen during an economic downturn, which amplifies the difficulties of adjusting fiscal policy in response.

If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. To restore investors’ confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.

In other words (or in “EconomistMom words”), the more we put off coming up with a sensible weight-loss program which combines a reasonable diet (spending restraint) with a decent amount of exercise (revenue increases), the more likely we’ll end up binging and purging–which is never a sustainable strategy.

And speaking of that optimal weight-loss program, the Center on Budget and Policy Priorities makes a recommendation for letting the upper-income Bush tax cuts immediately expire as scheduled, but permanently extending the “middle-class” portions proposed by President Obama.  My reaction is that’s still not enough exercise as well as not the most effective exercise.  More on what I mean by that later this week.

Here’s an excellent interview of Bruce Bartlett on The Economist.  Like the point I tried to make at the Paul Ryan event, Bruce says it’s ridiculous–or even worse–to claim the deficit must be reduced entirely on the spending side of the budget (you know, all diet and no exercise):

Republicans have a completely indefensible position on taxes. In their view, deficits cannot arise from tax cuts. No matter how much taxes are cut, no matter how low revenues go as a share of GDP, tax cuts are never a cause of deficits; they result ONLY AND EXCLUSIVELY from spending—and never from spending put in place by Republicans, such as Medicare Part D, TARP, two unfunded wars, bridges to nowhere, etc—but ONLY from Democratic efforts to stimulate growth, help the unemployed, provide health insurance for those without it, etc…

Unfortunately, I don’t think Democrats have the guts or the stamina to put forward a meaningful deficit-reduction programme because they know—as I do—that it will require higher revenues. But facing big losses in the elections this fall I can’t blame them. That leaves us facing political gridlock between the sensible but cowardly party and the greedy, sociopathic party. Not a pleasant choice for those of us in the sensible, lets-do-what-we-have-to-do-for-the-good-of-the-country independent centre…

The key area where Republicans and conservatives continue to live in a fantasy world relates to the inevitability of higher taxes to the long-run solution to our fiscal problem. At present, they all live in a dream world in which massive spending cuts that don’t hurt average Americans are the only solution to the deficit that they will entertain. But sooner or later, they will realise that this is simply not possible and that tax increases are not the worst thing in the world—Ronald Reagan raised taxes 11 times, including in 1982 when the economy was still in recession, and contrary to right-wing predictions Bill Clinton’s 1993 tax increase did not send the economy into a tailspin…

Eventually, we will have to enact measures to reduce the deficit. These measures will necessarily have to include higher revenues. Initially, they may be called user fees, offsetting receipts or other euphemisms, but they will raise revenues…

Read the whole interview for many more quotable Bruce-isms.  He’s a little heavy on the Republican bashing than I would be (his line above about the “cowardly” Democrats is really his only critique of them here), but I pretty much agree with all his substance on tax and budget policy.

Ezra Klein says “yes.” How so?

[A]t this point, [deficit-neutral emergency spending is] worth trying. It’s best to do jobs legislation using deficit dollars. That way you’re not taking money out of one part of the economy to put it into another. But as Dylan Matthews wrote yesterday, money spent in different places does provide different levels of stimulus. It’s plausible that you could move cash from, say, tax cuts for the wealthy, which tend to get saved, and use it instead for a payroll tax holiday, or infrastructure projects, or a tier of unemployment benefits for people in states with unemployment rates above 9 percent and who’ve been out of a job for more than 99 weeks.

This is pretty close to what I wrote in a comment to my own post on Greenspan’s apparent reversal on the Bush tax cuts (emphasis added):

[I]t’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.

And later in his same blog post, Ezra mentions “stimulus” as another “bad word.” I agree, not just for the knee-jerk, visceral reactions it might incite from people who don’t like typical “stimulus” policies, but because it’s somewhat inaccurate and pretty insufficient in describing short-term countercyclical fiscal policy even among economists who support such policies.  Way back when the American Recovery and Reinvestment Act was first passed in February of last year, I explained that what the recovery act sought to accomplish seemed to me to be a variety of very different (and very ambitious) economic goals.  “Stimulus”–what I interpret as policies designed to provide an immediate boost to (aggregate) GDP–was just one of the goals.  “Assistance”–providing help to households suffering from severe drops in their economic well-being–was another, and that was regardless of whether such assistance at the household level boosted (aggregate) GDP effectively or not.  Fortunately, with spending on extended unemployment benefits, it does both, so the fact that we are deficit financing perhaps the final bit of this recession’s deficit-financed “stimulus” spending, seems a reasonable–and decent–thing to do.  (I tried to suggest so in my short live radio interview with Marketplace Morning Report’s Steve Chiotakis yesterday morning.)

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.

…I’ve been inundated with spam comments!  Most have been captured by my spam blocker, but some have not.  Just wanted to warn readers that if the normal defensive mechanisms break down (and they have big time a couple times in the past two years), I’ll have to put up thicker “screens.”

I guess with the good publicity (and THANKS very much, Ezra!) comes some undesirable (if only “automated”) attention!  Not that I’m complaining.  I’m just sayin’… 

Over the past week I’ve been home full time with my kids, which is why I haven’t been posting much.  I have an overdue list of matters of fiscal-policy substance I’ve been wanting to write about, which I hope to get to next week when things are quiet for me on the home front.

I’ve also got a couple things coming up next week that some of you might be able to follow/listen to/attend:

• On Monday I do a live radio show (”Your Call”) with KALW public radio in San Francisco (91.7 on the dial) at 11 am PST (2 pm EST).  I will be on with Mike Konczal from the (liberal/progressive) Roosevelt Institute who according to the radio producer will argue that we need more deficit spending, so the producer presumes it will be a “debate.”  (Me thinks they are not aware of what got Ezra to quote me–and those many automatons to spam me.)  You can listen live over the internet here.  (Coincidentally, my daughter Emily is there in SF right now and will be there to tune into the show–if she cares to, I mean.)
• On Thursday I am on a panel at this Brookings Institution event where Congressman Paul Ryan (R-WI) will discuss his “Roadmap” plan and where I will be one of the commentators to follow, where I am no doubt expected to take a very different, perhaps opposite, position from the Wall Street Journal’s Stephen Moore–or from Heritage’s Stuart Butler, but Stuart and I have spoken on panels often in the past and really do not disagree much at all.

Hope you all have a good weekend in the meantime!  And thanks for sticking with me even when I occasionally go quiet, busy with the other things in my life.

The first problem with the distinction Republicans are making between the need to offset the cost of extended unemployment benefits (they say “yes”) versus the need to offset the cost of tax cuts for the rich (they say “no”) is that they are mixing up the short-term fiscal policy goal of stimulating aggregate demand with the longer-term fiscal policy goal of encouraging aggregate supply.

But then there’s the issue of how great these tax cuts for the rich actually are (I mean, besides for the rich), even for encouraging aggregate supply over the longer run.  Today Bruce Bartlett reminds us that there’s a wealth of evidence that tax cuts don’t work well as a “diet” to “starve the beast” of government spending.  And the literature also shows that they don’t work that well as an “exercise” program to build up those major “supply-side” muscles in our economy:  labor supply and saving– especially not when deficit financing acts as the public sector’s counter-drag on national saving.  (One example of that latter literature, which I’m sure Bruce has gathered in many other places at other times (including in his latest book), is this 2004 piece by Bill Gale and departing OMB director Peter Orszag.)

And to be fair, when the economy comes out of its current slump and is back to “full employment,” I’m sure Democrats will be saying things that suggest that their favored deficit-financed stimulus policies (which are indeed very effective at stimulating aggregate demand immediately) are also the best things for the longer term, doing their own flip-side version of mixing up the short-term economic goals with the longer-term ones.

If only it took just this to get us back to fiscal sustainability: put back in place the budget director who last saw the federal government running budget surpluses–Jack Lew, President Clinton’s last OMB director.  Well, it can’t work as magically as that, unfortunately, despite the President’s whimsical remarks that may suggest so. But Jack Lew does know more than the mere experience of budget surpluses; he understands the policies that produced those surpluses.  And I presume he remembers that although there was certainly a little bit of luck involved in the “irrational exuberance” of the stock market in the late 1990s which provided such convenient, repeated “revenue surprises” (via capital gains and dividend tax revenues), there was a bit of hard and good policy work in the Clinton mix, too, with effective budget rules that controlled spending (statutory PAYGO without costly exemptions, caps on discretionary spending), and even tax increases that raised revenue (yes, raised revenue!) and national saving and, hence, economic growth.

So now Jack Lew will get a chance to advise President Obama on what he should do about the Bush tax cuts which he presumably did not approve of at the end of the Clinton Administration, at a time when we were projected to run $5.6 trillion in surpluses over the next ten years (FY2002-11).  If those tax cuts were considered fiscally irresponsible back then, how will they be seen in this new context of $6 trillion to $10 trillion in projected deficits over the now next ten years (FY2011-20)?  Will turning them into the Obama tax cuts under the direction of a Clinton-surpluses budget director somehow make them better?  The coming debate over what to do with these tax cuts is sure to be very interesting–but also quite agonizing for anyone with Jack Lew’s combination of historical budget experience and current budget role.

In case you missed it, on the 4th of July CNN’s Fareed Zakaria (on his “GPS” show) hosted a debate between Paul Krugman and Niall Ferguson (video embedded above; link to video on CNN site is here).

But as I’ve mentioned before, I don’t think it has to be a “versus” situation.  We can do both, and in fact, that would be the ideal combination of strategies to promote both a better outlook for the federal budget as well as a stronger longer-term economy.  Last week I did a radio show on Minnesota Public Radio with UC Berkeley’s Alan Auerbach (you can listen here –the first few minutes are the most relevant), and both of us were singing that tune. And if you keep watching the CNN video until you get to Fareed’s own conclusion–following his careful consideration of Krugman’s and Ferguson’s different sides of the issue–you’ll notice he seems to feel the same way.

(Chart taken from TaxVox blog (post by D. Marron), 7/7/10.)

Today’s blog post by Donald Marron and column by the Washington Post’s Ruth Marcus give me occasion to say “here, here” as well as an excuse to trot out yet again a really old point (or maybe three points) I’ve made over and over again on this blog (but which I personally never tire of as long as it’s clear most Americans and our policymakers still don’t get it):

1. We need more tax revenue;
2. the current-law baseline is a good “role model” for the right level of revenue; but…
3. sticking to current-law baseline revenue levels doesn’t require sticking to current tax law, and doesn’t even require seeing marginal tax rates go up.

Donald explains “why taxes are [inevitably] going up” (it’s going to be impossible to flat-line health spending or otherwise reform entitlements fast enough), and he points out that the CBO baseline shows us that taxes are already scheduled to go up according to what’s already in current tax law:

Revenues are already on track to rise substantially in coming years. And not just because of an economic rebound and expiring tax cuts. There are structural reasons why tax revenues will grow faster than the economy. The Congressional Budget Office estimates that tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 if current law remains in place…

That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.

So one way to achieve a more sustainable outlook as far as the revenue side of the budget goes is to just let current tax law happen–and avoid passing any new tax legislation, including any extension of any of the Bush tax cuts.  But that’s not the only way…

Ruth discusses an alternative tax policy strategy made popular by President Obama:  raise taxes only on the rich.  (You see, the trouble with currently scheduled revenue increases is that much of that revenue would come from the middle class.)  It sounds like a great idea, until you realize that relying on such a small fraction of the population for most of the needed tax revenue sets up a really tiny tax base that requires really high marginal tax rates in order to raise the required level of revenue–precisely the economist’s definition of a highly inefficient tax system.  It gets all economists, even those not considered “supply-side” economists, nervous.  And it sets up a bad political dynamic where people will be encouraged to clamor for more government spending without regard for its cost, when they think that it’ll always be someone else (those ultra-rich people and those evil corporations) who will pay for it.

But we also probably don’t want to let current tax law totally play out because some of those tax increases Donald lists we really don’t want to see–such as an alternative minimum tax that would extend its reach down to those considered truly “middle class.”  And even those tax increases that don’t seem quite so objectionable–such as letting the entirety of the Bush tax cuts expire (at least eventually) and going back to Clinton-era income tax rates across the board–still raise marginal tax rates in ways that would increase the inefficiency of the federal tax system and could at least partially offset the positive economic effects of deficit reduction.

The CBO long-term budget outlook shows us that sticking to current-law baseline revenue levels is a good and fairly immediate strategy for fiscal sustainability (where debt/GDP is relatively stable, staying below 80 percent over the next 25 years).  In contrast, CBO’s “alternative fiscal scenario” assumes the bulk of the Bush tax cuts, the ones President Obama wants to keep, are extended, which leads to debt reaching 185 percent of GDP in 25 years (and continuing to grow exponentially thereafter). Donald Marron labels this scenario as “Temptation” in his graph above but I think it should be more accurately labeled “Done Deed”, those being the tax cuts exempted from the statutory pay-as-you-go rule.

But the funny thing is that current tax law is probably not the best way to raise the current-law level of revenues.  Put this challenge to any tax economist:  how can we raise that given level of revenue most efficiently? –and you will get the answer that we need to find the marginal (new) sources of revenue from the broadest, most neutral/efficient tax bases available to us.  There are two main possibilities here, and I think we ought to seize both possibilities:

1. reform the existing federal income tax system to clean up and broaden the income tax base–e.g., close up inefficient tax expenditures that “poke holes” in the income tax base (the many exclusions/exemptions, deductions, and credits); or
2. add on “cleaner” (broader, purer, or externality-correcting) new tax bases–e.g., an add-on value-added tax (VAT) or environmentally-motivated taxes such as a carbon tax.

With these sorts of base-broadening strategies to achieve current-law revenue levels, marginal tax rates on productive economic activities don’t have to come up.  Thus there doesn’t have to be a tradeoff between the positive economic growth effects of deficit reduction and the negative economic growth effects of higher marginal tax rates on income.  There doesn’t have to be a tradeoff at all.