James Pethokoukis

Politics and policy from inside Washington

The coming assault on the Fed

Dec 11, 2009 15:09 UTC

This piece by Paul Krugman reinforces my feeling that the Federal Reserve is going to be hit hard for not doing even more to boost the economy. He wants the Fed balance sheet expanded even more to promote faster growth.

The most specific, persuasive case I’ve seen for more Fed action comes from Joseph Gagnon, a former Fed staffer now at the Peterson Institute for International Economics. Basing his analysis on the prior work of none other than Mr. Bernanke himself, in his previous incarnation as an economic researcher, Mr. Gagnon urges the Fed to expand credit by buying a further $2 trillion in assets. Such a program could do a lot to promote faster growth, while having hardly any downside.

So why isn’t the Fed doing it? Part of the answer may be political: Ideological opponents of government activism tend to be as critical of the Fed’s credit expansion as they are of the Obama administration’s fiscal stimulus. And this has probably made the Fed reluctant to use its powers to their fullest extent. Meanwhile, a significant number of Fed officials, especially at the regional banks, are obsessed with the fear of 1970s-style inflation, which they see lurking just around the bend even though there’s not a hint of it in the actual data.

Me: The Fed is going to get hammered if it starts clearing the balance sheet and raising rates while unemployment is still elevated. Expect more attacks by Congress like Barney Frank’s wish to depower the regional Fed presidents, kicking them off the FOMC. Yes, the Fed is getting his in Congress by this audit bill. But the worst is yet to come.

COMMENT

More reason to be short the dollar!

Posted by Johnba | Report as abusive

VAT Attack! Will deficit commission lead to a VAT?

Dec 11, 2009 15:02 UTC

That is one theory offered up as the eventual outcome of the C0nrad-Gregg deficit commission. And today in the NYT, there is a story extolling the virtues of a VAT.  Indeed, it is a great revenue raiser, and liberals love it because they think Americans are undertaxed and don’t want to cut spending to reduce the long-term structural budget deficit.

Now given that it will take 60 votes by Congress to approve the commission’s reforms, I am not so worried about a huge tax increase passing with phony spending cuts.  A currency or bond market crisis, though, could lead to calls for a VAT to show markets the US is serious about the deficit. And the WH would love to slap one on the US economy,  A better solution is actual cuts in the rise in entitlement spending accompanies by a more growthy, efficient tax system. I like the Hall-Rabushka flat consumption tax, as long as it replaced the existing taxes on labor and capital and corporate income.  It has VAT-like features, but is not hidden the way a VAT is. Here is Greg Mankiw:

If you look at the economic effects, a VAT is similar to the Hall-Rabushka Flat Tax, which many economists love. Essentially, the main difference between a VAT and the flat tax as developed by Hall and Rabushka is that firms get to deduct wages as a cost under a flat tax, but then those wages are taxed at the household level. Other than this minor change of shifting the responsibility for the tax on wage income from the firm to the household, the Hall-Rabushka flat tax and VAT have identical economic effects. (There is also an exclusion for the first X thousands of dollars of wage income under Hall-Rabushka, making it progressive in average tax rates, but the same result can be accomplished with a VAT as well by rebating some of the revenue via a demogrant.)

My bottom line: If I could replace our current tax system (including the personal income tax, corporate income tax, payroll tax, and estate tax) with a VAT, I would gladly do it.

COMMENT

I do not believe that the Hall-Rabushka flat tax is border-adjustable, which is a prime competitive advantage to the VAT, which is accepted as border-adjustable by OECD under GATT rules.

Posted by SteveA | Report as abusive

The risk of a supertax on banker bonuses

Dec 11, 2009 14:31 UTC

U.S.-based bankers shouldn’t worry too much about their bonuses. Even though Wall Street remains wildly unpopular and Washington needs more revenue, it’s unlikely U.S. authorities will follow their UK counterparts with a giant windfall tax on banker payouts.

That upcoming election cycle will certainly give American politicians all the impetus they need. A combination of fat payouts of 2009 bonuses in the first quarter and high unemployment will tempt incumbent lawmakers to play the populist card ahead of the 2010 vote.

But past efforts at such radical moves have failed. Congress is again struggling to raise taxes on carried interest, the profit generated by private equity firms and hedge funds. Some Democrats want such performance-based compensation to be considered regular income taxed at a 35 percent rate rather than the current capital-gains treatment it gets with the accompanying 15 percent rate.

The policy logic is plausible. Plus, as Warren Buffett has famously argued, fund managers shouldn’t pay lower tax rates than their office assistants.

But legislation to change carried interest taxation probably isn’t going anywhere. Sure, the House just voted in favor of it. But the bill is DOA in the Senate, which has shown scant interest in direct higher taxes on the wealthy or on capital. For example, it declined to copy one of the House’s preferred methods of paying for healthcare reform — a surtax on the wages and capital gains of top earners.

Moreover, New York Democrat Charles Schumer, a key player on the Senate Finance Committee, is an avowed opponent of higher taxes on alternative asset managers.

What’s more, the United States has already trod this path unsuccessfully. The House voted overwhelmingly to tax 90 percent of AIG bonuses, but the effort went nowhere in the Senate. The Obama administration didn’t push the issue, and polls showed only a bare majority in favor once the issue was fully explained. There were also substantial questions about the constitutionality of a tax targeting a specific group.

U.S. bankers have another six weeks or so to stew before seeing an actual bonus check. But in reality, they should be able to enjoy the holidays.

  •