James Pethokoukis

Politics and policy from inside Washington

Pay attention: How New Zealand cut spending and taxes

Oct 19, 2010 16:03 UTC

A fantastic Reason article looks at how Canada and New Zealand cut government spending.  Since GOPers often cite NZ’s experience, I found that portion of the piece particularly interesting. Over the span of a decade from the mid 1980s on,  the government’s share of GDP  fell to 27 percent from 45 percent. Here is a bit on how they did it, according to former government official Maurice McTigue (but please read the whole thing):

Privatization: From 1986 through the mid-1990s, New Zealand sold off airlines, airports, maritime ports, shipping lines, irrigation projects, radio spectrum, printing offices, insurance companies, banks, securities, mortgages, railways, bus services, hotels, farms, forests, and more.

Rightsizing government agencies: After we eliminated those government functions, the bureaucracies that used to perform them were too large to perform their remaining tasks. So the civil service was reduced by 66 percent. Some agencies remained almost the same size, while others were reduced by 90 percent to 100 percent.

Cutting taxes: At the same time, we reformed the revenue system by eliminating capital gains taxes, inheritance taxes, luxury taxes, and excise duties and by allowing income to be taxed only once. We halved tax rates, eliminated all deductions that were not a cost of earning income, and created a system where one-third of revenue came from consumption taxes and two-thirds came from income taxes. Under the simplified system, about 65 percent of the population no longer had to file tax returns—a major selling point for reform.

Reforming the appropriations process: With the State Sector Act of 1987 and subsequent laws, funding was linked directly to results. Agency heads were now CEOs, chosen for capability. They received fixed-term contracts: five years with a possible three-year extension.

A decade-long dollar disaster

Oct 19, 2010 15:46 UTC

They’re calling The Oughts a Lost Decade. Yet how could that possibly be? The experts keep telling me a weak dollar brings prosperity. But look at this chart from Carpe Diem:


A bank tax? Really?

Oct 18, 2010 16:36 UTC

I just did a CNBC  spot debating whether robust banks profits should spur new efforts to tax them. Here were my talking points:

1. My Hill sources tell me the bank tax is not going to happen, at least not the Geithner version.

2. That being said, Dems will surely raise it again both as a way of paying for high-end tax cuts and a way of making banks less reliant on short-term funding. The whole idea might also be coupled with a transaction tax.

3. The TARP rationale for the bank tax has collapsed with banks paying back their bailout funds.

4.  What banks do need to worry about is a future bank tax that would pay for Fannie and Freddie losses. There are Republicans who would vote for that.

5.  Is is a good idea? Given all the uncertainty raised by Dodd-Frank, do we really want to add a punitive bank tax? To begin with, this idea came from David Axelrod, not Tim  Geithner or the Obama econ team. And how would it add one decimal point to GDP or create one job?

How a VAT would affect growth

Oct 14, 2010 19:00 UTC

Just how would tacking a 10 percent value-added tax onto the current tax system affect the economy? Well, an Ernst & Young study commissioned by the National Retail Federation came up with this result:

1. An add-on VAT would reduce retail spending by $2.5 trillion over the next decade. Retail spending would decline by almost $260 billion or 5.0 percent in the first year after enactment of the VAT.

2. An add-on VAT would cause GDP to fall for several years. The economy would lose 850,000 jobs in the first year, and there would be 700,000 fewer jobs ten years later. By comparison, a comparable reduction in the deficit through reduced government spending would have less adverse effects on the economy, and could have positive effects for economic growth.

3. Although lower deficits and debt would have positive long-run effects for the economy, most Americans over 21 years of age when the VAT is enacted would be worse off due to enactment of an add-on VAT. A VAT would have significant redistributional effects across generations, reducing real incomes and employment for current workers.

Me: Even though this is sponsored by a retailing trade group, the results are hardly shocking since an add-on VAT is a massive tax increase.  Replacing the current tax system with a consumption tax is one thing, but this would  take the US tax burden to record levels. And those levels would likely rise with time given the international experience with the VAT:



I don’t think the combined HST rates in Canada run as high as 20%, even in the “hold-out” provinces, there is no provincial retail sales tax rates higher than 10.5%. The highest combined rate is actually in two harmonized provinces of Nova Scotia + P.E.I where the rate is 15 + 15.5% respectively. Compared to other GST / VAT countries this seems on the low side (NZ – 15%, Ireland 21(+1+1), UK 20…And don’t forget Canada will soon have a corporate tax rate of 15%, one of the lowest in the OECD.

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The Obama recovery vs. the Reagan recovery

Oct 13, 2010 19:52 UTC

Expect to see this chart from the Heritage Foundation all around the blogosphere. I don’ t think it is completely fair given the different flavors of the two recessions. But I certainly don’t think the current recovery is a robust as could possibly be expected. I think even the POTUS would concede that.



I agree with James Pethokoukis and CND I guess it’s too naive to judge two completely different recessions with a simple graph line without undertanding the context.

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A chat with economist Glenn Hubbard

Oct 13, 2010 15:26 UTC

In their must-read policy manifesto, “Seeds of Destruction,” Glenn Hubbard and Peter Navarro outline the biggest economic problems facing America and what can be done about them. Hubbard is the former head of the Council of Economic Advisers under George W. Bush and is now dean of Columbia Business School. Navarro, a Democrat, is a business professor at the University of California, Irvine and author of  ”The Coming China Wars.” Here are some excerpt from a chat I had with Hubbard:

What could we have done back in 2009 to put the U.S. economy on a better growth trajectory today?

One, not introduce a lot of policy uncertainty — not have healthcare mandates that raise the cost of hiring, threaten tax increases on small  business — but more positively, if one wanted to do stimulus, things you could have done included a payroll tax cut, investment incentives and perhaps even a corporate tax cut.

In the book, you mention trade reform to deal with China’s weak currency and protectionist limits on market access. But what should be done beyond more talks with Beijing?

We have to remind the Chinese leadership that it is in their self-interest to increase domestic consumption. Our self-interest is just the opposite, we need to be saving more. For that environment to be successful, we still need to open markets between the two countries. And where we do see unfair practices, we continue to call attention to them. The currency is not the top thing I am worried about.

You have an idea for a flexible carbon tax. Why would Republicans go for that?

I am not a politician, but I think a couple of things might attract Republican interest. We’re not trying to raise revenue with this. The revenue should be recycled through tax cuts. The point here would be to solve the uncertainty problem in the private sector. You want to promote innovation, but you don’t want something like cap and trade.  But [with really low oil prices], you won’t have the innovation. But if you can go to businesspeople and say I guarantee you [big price swings] won’t happen, then you will get the innovation.

Did we really need to put taxpayer money into the bank back in 2008?

I do think we needed to recapitalize some of the banks. TARP got off to a rocky start because that is not where the Bush administration started. They sort of wound up in a good place but it was a rocky road. The other issue at the time that made is hard was the seeming capriciousness of how each bank failure was handled. That kind of policy uncertainty was chilling.

What would be the best way to deal with the housing market?

I would try to do what we can promote overall economic growth and do what we can to aid consumers in the housing market without subsidizing housing, the plan that Chris Mayer and I put out.  It’s actually a pretty simple solution. Normally a recovery would be helped by a lot of refinancings given the very low mortgage interest rates. But that isn’t happening. And I think if we took away some of the structural impediments and allowed more refinancings, more people could stay in their homes. It would be like a long-term tax cut, and it wouldn’t cost the treasury a dime.

What are the political and economic risk to more quantitative easing by the Federal Reserve?

Quantitative easing still probably has the capacity to lower long-term rates a bit, but it’s only a bit. If the Fed did another trillion dollars of quantitative easing, maybe 20 or 30 basis points in the ten-year rate — but is that what’s really holding back investment? I don’t  think so, and it raises the risk of a very large balance sheet being hard to pull back, politically. So personally I wouldn’t do it. And it also complicates the recapitalization of the banks because currently banks are recapitalizing themselves by borrowing money from the Fed at zero and buying government bonds. The flatter the slope of the yield curve, the lower the profitability. I am just mystified why people think this is a silver bullet.

How long before the U.S. debt burden begins to cause an adverse market reaction?

I think as soon as a real recovery takes hold, we are going to see some real uncertainty being created in the bond market. The U.S. fiscal situation is really perilous. It’s not a new story, but the political unwillingness to deal with it will finally start to really trouble people. In order to head that off, we need to do something. Personally, I would start with Social Security since it something we know how to do and shouldn’t be that controversial.

Does America need to pay more in taxes?

I think it’s a question for the American people about what they want government to do. If we want a government [where spending as a percentage of GDP] is rising into the mid [20 percent range], then the easy answer to your question is “yes.”  But if we want a government that is more along traditional lines, then we don’t need to do that. That is really the first order question, and once we decide the answer to the that question, we need to pick a tax system that raises revenue at the lowest cost. But the big thing is “What government do you want?” and this is what voters will have to decide.


I don’t even know how I ended up here, but I thought this post was good. I do not know who you are but certainly you are going to a famous blogger if you aren’t already Cheers!

Why we don’t need a currency war, more Fed easing or additional stimulus

Oct 13, 2010 13:54 UTC

Great, great stuff from economic analyst Ed Yardeni, busting some myths and taking names:

1. The U.S. will prosper if the yuan appreciates. The number one urban legend today, in my opinion, is that if the Chinese stopped manipulating their currency and let it appreciate by say 20%, then the U.S. trade deficit would shrink and employment would rebound at a faster pace in the U.S. Didn’t the Chinese do that recently without the expected positive impact on the U.S.? Yes indeed. From mid-2005 through mid-2008, they let the yuan appreciate by 20%. It was then pegged again until it was allowed to move a bit higher in recent days. (See Fig. 26 in our China briefing book linked below.) America’s trade deficit with China was $248.8bn during the 12 months through July of this year. The Chinese simply manufacture lots of merchandise that the U.S. no longer produces because labor costs are too high in the U.S. The standard of living of U.S. consumers has improved as a consequence of cheaper imports. If the ones from China were made more expensive through currency appreciation or tariffs, the goods would be made in and imported from other low wage countries rather than made in the USA again. Besides, among the weakest sectors in the U.S. labor markets are construction and local governments. They have home-grown problems that have nothing to do with China. Productivity gains in sectors with high labor costs have cost some Americans their jobs, while they have boosted the real pay of those who remain employed.

Me:  Indeed, a new study out indicates that offshoring (and immigration) has not cost America jobs.

2. The Fed must continue to ease. Another Fed-inspired legend is that since the federal funds rate is down to zero, it means the Fed can’t do anything more to stimulate the economy. There is some bizarre chatter among Fed officials that based on the Taylor Rule, the federal funds rate should be negative! Indeed, FRBNY President William Dudley recently touted the idea that another $500bn in quantitative easing would be equivalent to lowering the federal funds rate by 50-75bps. The problem is that near-zero interest rates are depressing the interest income of many Americans. Americans may also understand that the only real beneficiary of such low interest rates is the U.S. federal government. So, the Fed is enabling the fiscal excesses of Congress. Eventually, such excesses must lead to higher taxes and higher inflation. In other words, Washington’s irrationally stimulative monetary and fiscal policies are getting offset by depressed rational expectations.

Me:  Low rates create more bubbles as investors search for high yields. The stage is not being set for strong, sustainable economic growth. But the lack of sound fiscal policy is pushing the Fed to act.

3. More fiscal stimulus is necessary. Keynesians continue to promote the fiction that government spending can create jobs through the fiscal multiplier effect. A significant portion of the 2009 fiscal stimulus program was directed at protecting the jobs of state and local public employees. Now that the stimulus is wearing off, they are losing their jobs anyway. The problem is that many of them are retiring early with huge pension benefits, making it impossible for state and local governments to hire more workers. The notion that the stimulus program wasn’t enough and that more deficit-financed government spending is required is nutty. What about more government spending on infrastructure? Congress regularly passes bills that purport to do that, yet the money never seems to show up as new roads, bridges, tunnels, and train tracks.

Me:  States need to restructure, and the their fiscal woes are forcing them to take action. Washington should focus on tax and budget reform ASAP.


Everything you state will prove to be true but the following idea is allowing China to laugh all the way to the bank and is killing any hopes of returning jobs back to the United States because it is simply not true. Their quality is awful but we will never have the opportunity to compete and demonstrate this until we find a way of throttling down their imports:

“The Chinese simply manufacture lots of merchandise that the U.S. no longer produces because labor costs are too high in the U.S. The standard of living of U.S. consumers has improved as a consequence of cheaper imports. If the ones from China were made more expensive through currency appreciation or tariffs, the goods would be made in and imported from other low wage countries rather than made in the USA again.”

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Obama and the Investor Class

Oct 12, 2010 21:19 UTC

Larry Kudlow lays out a compelling case here:

A series of investor-related polls shows how totally detached the president is from the nearly 100 million folks who directly or indirectly own stocks.

A survey conducted by Citigroup Global Markets of 100 mutual-fund, hedge-fund, and pension-fund managers finds that institutional investors fear a government policy mistake far more than inflation, terrorism, a housing double-dip, poor earnings, or any other potential risk to the economy. (Hat tip to CNBC producer John Melloy.) One-third of the survey’s participants list government policy missteps as their biggest worry, ahead of the more than 15 percent who cite protectionism.

But these investors believe the chances of a big policy error will decrease if Republicans take back the House of Representatives in November.

In another poll conducted by Reuters, 75 percent of respondents believe the employment situation is the most important issue for Wall Street, followed by 41 percent who point to consumer confidence. Fleshing out the survey, nearly two-thirds of respondents say extending the Bush era tax cuts should be a high priority; just over a third say the budget deficit is the main concern; more than two-fifths say interest rates will start to rise and the dollar will weaken more if the deficit is not addressed; more than a quarter want Obamacare repealed; and only one-fifth say additional action by the Fed is crucial.

Then there’s a new poll from Investor’s Business Daily. It shows 56 percent of respondents saying they want tax cuts extended even for households with more than $250,000 in income. Only 39 percent in the poll want the rich to pay more, while support for making tax cuts for the rich permanent hit 63 percent for both Republicans and independents. By solid majorities, that includes taxes on capital gains, dividends, and estates, all to be frozen at current rates.

These polls reveal how utterly alien Obama is to the investor class. And it’s worth noting that investors are among the most likely voters to turn out for elections.


Of course Mr. Obama is alien to the investor class, always has been. The question is whether he and his advisors care in the slightest. Given his shameless sucking up to unions along with China-, bank-, big oil- and Wall Steet-bashing, the answer should be clear.

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U.S. states in a $3.2 trillion pension hole

Oct 12, 2010 20:06 UTC

Some scary numbers from new research by finance professors Robert Novy-Marx of the University of Chicago and Joshua Rauh, Associate Professor of Northwestern University in Evanston, Illinois.

We begin this article by discussing the true economic funding of state public pension plans. Using market-based discount rates that reflect the risk profile of the pension liabilities, we calculate that the present value of the already-promised pension liabilities of the 50 U.S. states amount to $5.17 trillion, assuming that states cannot default on pension benefits that workers have already earned. Net of the $1.94 trillion in assets, these pensions are underfunded by $3.23 trillion. This “pension debt” dwarfs the states’ publicly traded debt of $0.94 trillion. We show that even before the market collapse of 2008, the system was economically severely underfunded, even though public actuarial reports presented the plans’ funding status in a more favorable light. While we take no stand regarding the optimal amount of state government debt, we do believe it is important to point out that total state debt with pension liabilities included is actually almost 4.5 times the value of outstanding state bonds.

The recovering financial system

Oct 12, 2010 16:43 UTC

The St. Louis Fed had put together a “financial stress index.” It incorporates a number of financial variables.  And it looks a whole lot better than it did two years ago.