James Pethokoukis

Politics and policy from inside Washington

Ezra Klein accidentally argues against GOP accepting tax hikes

Jul 7, 2011 19:39 UTC

The WaPo’s Ezra Klein has cooked up a chart attempting to show previous debt deals had plenty of tax increases in them, even more than what Obama is demanding:


As you can see on the graph, in each case, taxes were at least a third of the total, and in Reagan’s case, his massive tax cuts were followed by deficit-reduction deals that actually relied on tax increases. Today, tea party conservatives would be begging Sen. Jim DeMint to primary the Gipper. … The one-third rule doesn’t break down until you get to the deal Obama reportedly offered Republicans in the first round of debt-ceiling talks: $2 trillion in spending cuts for $400 billion in taxes, or an 83:17 split. And that, if anything, understates how good of a deal Republicans are getting.

This isn’t going to persuade conservatives of anything, the bit about Reagan in particular. The Gipper was promised big spending cuts in 1982 that never materialized. And the Bush deal has gone down in infamy among those on the right. Here is Grover Norquist:

The spending interests in Washington, D.C., convinced President Ronald Reagan in 1982 that they would cut $3 of spending for every $1 of tax increase that Reagan would permit. The tax hikes were real, painful and permanent; the spending restraint never materialized. Then only eight years later, the same spending interests concocted the infamous Andrews Air Force Base budget summit that negotiated a supposed deficit reduction deal with President George H.W. Bush. It was to cut spending by $2 for every dollar of tax increase. Again, the tax hikes were real and spending increased more rapidly after the deal than before.

As for the Obama offer, I have no idea what that red line is supposed to represent. How much, for instance,  is baseline tinkering due to the wind down of the wars in Iraq and Afghanistan? That could account for as much as $1.4 trillion of the $2.0 trillion in cuts Obama is offering. Permanent tax increases in exchange for accounting chicanery?


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U.S. debt crisis might be on fast track

Jul 7, 2011 15:59 UTC

One of the outside economic-analysis firms that the White House likes to quote is Macroeconomic Advisers. Here’s what the firm said yesterday about where the U.S. economy is heading (bold is mine):

Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021.

– Private interest rates will rise as federal borrowing competes for saving that might otherwise finance private investment.

– In addition, yields could rise if there is growing risk associated with current fiscal policy.  If such risk is systemic, it raises yields generally.  If it reflects a growing probability of sovereign default, it raises Treasury yields relative to private yields.

Rising rates would be a precursor to something worse: a full-fledged fiscal crisis with further sharp increases in yields, declines in stock prices, and a plummeting dollar.

This is bad. Really bad. The official budget forecasts ones typically hears about in the media are from the Congressional Budget Office. And those forecasts assume Uncle Same can borrow at low interest rates, like, forever. The super-cautious CBO baseline predicts the U.S. government will add an additional $6.8 trillion in debt over the next decade, bringing cumulative debt held by the public to $18.2 trillion. Debt as a share of the economy would be 76.7 percent. The forecast also assumes short-term interest rates average 3.3 percent, long-term 4.8 percent.

But MA thinks long rates will hit 9 percent. This would cause U.S. indebtedness to explode. The CBO, at the request of Rep. Paul Ryan, recently looked at how various interest rate scenarios would affect U.S. debt (chart and graph via the Committee for a Responsible Federal Budget):

Note the scenarios that has interest rates at close to 9 percent. It would add an additional $5 trillion to the national debt by 2021. That would push the U.S. debt-to-GDP ratio to an alarming 98 percent of GDP.

But those calculations tend to understate the problem because they are based on the CBO’s baseline forecast. Its “alternative fiscal scenario” – which many budgeteers think is a more accurate – assumes debt-to-GDP will already be 101 percent in 2021.

But again, this is assuming low interest rates. The MA scenario could push that level even higher. And again, this also assumes all that debt would not effect economic growth. Here is how the CBO says various economic variables affects its forecasts

CBO estimated that 1 percent higher interest rates each year could increase deficits by $1.3 trillion over ten years. CBO also estimated a few other “rules of thumb” to show how changes in inflation and economic growth have significant impacts on budget forecasts. The projections show that lower economic growth of just 0.1 percentage point each year could increase deficits by $310 billion over ten years, while 1 percentage point higher inflation each year could add almost $900 billion to deficits.

Turns out, the CBO looked at how at the deluge of debt from its “alternative fiscal scenario” would impact the economy (and, in turn, total indebtedness). The results are absolutely frightening:

Of course, the U.S. would have a debt crisis long before we hit that 250 percent of GDP level. And if MA is right,  the crisis might come sooner rather than later.


Credit Writedowns responded with an article entitled Scared To Death.
http://www.creditwritedowns.com/2011/07/ scared-to-death.html

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Obama’s $4 trillion Grand Bargain

Jul 7, 2011 13:44 UTC

The president says it’s time to go big (via Reuters):

After weeks of impasse, President Barack Obama and top congressional leaders are aiming for “something big” as they resume budget talks on Thursday to avert an imminent default. With Republicans showing new flexibility on taxes, Democrats say Obama will push negotiators to double their target to $4 trillion in budget savings over 10 years. That would be an ambitious goal, but there have been a few hints of progress since talks hit a brick wall two weeks ago.

1) If Obama wants a $4 trillion debt reduction package, how about the one his own debt commission produced last December:


2) But I don’t think Obama will agree to  or propose anything as sweeping as that. Instead, I would expect more than $1 trillion in savings from defense cuts, most of which will be tweaking the baseline of projected spending, which assumed perpetual war in Iraq and Afghanistan. Along with interest savings, that would be put you right around $2 trillion. Republicans may be offering $200 billion in new revenue from user fees and asset sales.

3) So how to close the remaining gap of roughly $2 trillion? Maybe another $400 billion in Medicare and Medicare savings.  And tweaks in how you measure inflation for Social Security benefits and tax brackets gets you another $150 billion, assuming Rs don’t view that as a tax hike.  And in his April speech, Obama called for $770 billion in non-security discretionary spending cuts over 12 years. To me, it still looks close to $1 trillion gap.

4) And recall that Obama’s debt speech which called for $4 trillion in debt cuts over 12 years would actually cut debt by just $2.5 trillion over ten years.

Does Obama want to cut the deficit?

Jul 7, 2011 00:54 UTC

Let’s keep in mind that if President Obama had his druthers, the debt ceiling would’ve already been raised some $2 trillion via a “clean vote” in Congress. No spending cuts. Yes, I know  Obama said the following this earlier this week:

I believe that right now we’ve got a unique opportunity to do something big — to tackle our deficit in a way that forces our government to live within its means, that puts our economy on a stronger footing for the future, and still allows us to invest in that future.

But that’s Obama trying to make it sound like it was his goal all along to link a debt-limit bill with deficit reduction. Of course, it was Republicans who forced him to accept such a linkage. This was Team Obama in April (via The Hill):

White House press secretary Jay Carney said it is “imperative” that a debt-limit vote not be “held hostage to any other action, because of the consequences of not raising the debt ceiling.” Jack Lew, the director of the Office of Management and Budget, struck a similar tone in an interview airing this weekend. “Our very strong view is that the debt limit should be passed as a clean, standalone bill,” he said in an interview with Bloomberg TV’s “Political Capital With Al Hunt.”

Also keep in mind that since the November elections, Obama has a) blown off his own debt reduction commission, b) offered an official budget that added $10 trillion in new debt over 10 years, c) had to be nudged, according to reports, by Treasury Secretary Geithner into giving a debt speech, which turned out to be smoke and mirrors and can’t even be scored by the Congressional Budget Office.

The evidence strongly points to Obama not really caring much about debt reduction right now. It also points to him believing – as do many left-of-center economists – that the debt issue is a long-term problem and that any near-term austerity is big risk with such a weak economy. Macroeconomic Advisers, a economic consulting firm respected by the White House, just put out this analysis of the the debt reduction plan put forward by Obama’s commission (bold is mine):

Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021. We estimated the effects of a fiscal contraction that is patterned after the so-called Bowles-Simpson plan and that averts this dire scenario. The plan would pare more than $4 trillion from the federal debt by 2021 relative to current policy. Roughly two thirds of this contraction is from spending cuts, the rest from tax increases. For a given path of long-dated yields, the macroeconomic effects of the fiscal contraction are sizable. “Fiscal drag” would reduce real GDP growth by 0.4 to 0.5 percentage point per year through 2015, leaving the unemployment rate a percentage point higher by then.

This is key: Keynesian models like this assume all spending cuts and taxes increases slow growth by reducing overall demand. (Former Obama economist Christina Romer, however, thinks tax increases are less harmful.) The White House has the same kind of models. Slower growth hurts incomes and jobs, which, in turn, hurts the standing of the guy in the Oval Office.

There is a high likelihood that Obama believes spending cuts and tax increases in 2011 and 2012 would hurt his re-election.  This is why he would prefer a clean debt ceiling bill – or, since that is not possible, a debt reduction bill that’s as small as possible. (Or, even better, one with a bit more stimulus in it, like a payroll tax cut extension.) Every dollar in spending cuts or tax hikes makes him just a bit more likely to lose in 2012. From his perspective, better to push off austerity to 2013 — 0r beyond.




ahtohg2: Why not write a better comment by providing sufficient context? 90% of economists generally agree with each other? Where did you pull that number from? Trickle down economics failed? How? Context, sir.

James: excellent op/ed. Cynicism of this administration (and, unfortunately, most politicians) is in order. You offer a reasonable explanation for what I thought was just inexplicable stupidity: it’s all political posturing.

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Obama really might have made it worse

Jul 6, 2011 04:34 UTC

The Republican charge is a body shot aimed right at the belly of President Barack Obama’s re-election effort: He made it worse.

No, not that White House efforts at boosting the American economy and creating jobs and “winning the future” were merely inefficient or wasteful, which they certainly were. Even Obama finally seems to understand that. “Shovel-ready was not as shovel-ready as we expected,” he joked lamely at a meeting of his jobs council.

Rather, that the product of all the administration’s stimulating and regulating is an economy that’s in significantly worse competitive and productive shape than when Obama took the oath in January 2009. He was dealt a bad hand, to be sure – and then proceeded to play it badly. At least, that is what Republicans have been saying. “He didn’t cause the recession as we know,” presidential candidate Mitt Romney said in New Hampshire yesterday. “He didn’t make it better, he made things worse.”

Team Obama offers a different narrative, of course. As the president said in his State of the Union address earlier this year, “Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again. … These steps we’ve taken over the last two years may have broken the back of this recession.” He somehow failed to insert his usual boilerplate about the economy losing 700,000 jobs a month when he took office.

But Obama is correct, to a degree. The economy is growing (slowly) now and adding jobs (modestly) whereas neither was happening back in early 2009. Of course, economies in recession will eventually recover even without government action. So the question is whether Obamanomics helped, hurt or was inconsequential.

The centerpiece of Obama’s plan to “push the car out of the ditch” was the trillion-dollar (including interest expense on the borrowed money) American Recovery and Reinvestment Act. A recent article in The Weekly Standard determined that it may have cost as much as $278,000 for each job created. But that’s generous. Respected Stanford economist John Taylor, perhaps the next chairman of the Federal Reserve, has analyzed the actual results of the ARRA. Not what the White House’s garbage-in, garbage-out models say happened, but what actually happened as gleaned from government statistics. Taylor, simply put, looked at whether consumers actually consumed and whether government actually spent in a way that produced real growth and jobs. His devastating conclusion:

Individuals and families largely saved the transfers and tax rebates. The federal government increased purchases, but by only an immaterial amount. State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures, and they shifted expenditures away from purchases toward transfers. Some argue that the economy would have been worse off without these stimulus packages, but the results do not support that view.

Indeed, the results are horrifying. The two-year-old recovery’s terrible tale of the tape: A 9.1 percent unemployment rate that’s probably closer to 16 percent counting the discouraged and underemployed, the worst income growth and weakest GDP growth of any upturn since World War II, a still-weakening housing market. Oh, and a trillion bucks down the tube. Oh, and two-and-a-half years … and counting … wasted during which time the skills of unemployed workers continue to erode and the careers of younger Americans suffer long-term income damage. Losing the future.

Next, add in healthcare reform that Medicare’s chief actuary says will not slow the overall growth of healthcare spending. (Even its Obama administration godfather, Peter Orszag, warns that “more drastic measures may ultimately be needed.”) And toss in a financial reform plan that the outspoken and independent president of the Kansas City Fed says he “can’t imagine” working. “I don’t have faith in it all.” Indeed, markets continue to treat the biggest banks as if they are still too big to fail.

But wait there’s more. Obama created a debt commission that produced a reasonable though imperfect plan to deal with America’s long-term fiscal woes. But he stiffed it and then failed to supply a plan of his own, sowing the seeds for an impending debt ceiling crisis and making an eventual fiscal fix that much harder. One more step along the path not taken, along with pro-growth tax and regulatory policies that would have reduced policy and economic uncertainty and unleashed the private sector to invest, expand and create.

Elections have results. So do bad policies. Obama’s choices on taxing and spending and regulating, sorry to say, seem to have made things worse.




Edited by the media again.

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China’s black box economy

Jul 5, 2011 21:03 UTC

The more you know about Rising China, the more you want to know. Minxin Pei gives some valuable perspective on the nation’s suddenly emerging debt problem:

Based on the figure released by the National Audit Office (NAO) at the end of June, local governments have accumulated debts totalling 10.7 trillion renminbi (RMB) or $1.65 trillion – about 27 percent of China’s GDP in 2010. Because the NAO’s figure was based on a sampling of 6,500 local government-backed financial vehicles (out of more than 10,000 such vehicles nationwide), the actual magnitude of local government indebtedness is much greater. The People’s Bank of China, the central bank, recently estimated that local government debt totalled 14 trillion RMB (most of which was owed to banks), almost 30 percent higher than the NAO figure.

… On paper, China’s debt to GDP ratio is under 20 percent, making Beijing a paragon of fiscal virtue compared with profligate Western governments. However, if we factor in various government obligations that are typically counted as public debt, the picture doesn’t look pretty for China. Once local government debts, costs of re-capitalizing state-owned banks, bonds issued by state-owned banks, and railway bonds are included, China’s total debt amounts to 70 to 80 percent of GDP, roughly the level of public debt in the United States and the United Kingdom. Since most of China’s debt has been borrowed in the last decade, China is on an unsustainable trajectory at the current rate of debt accumulation, particularly when economic growth slows down, as it’s expected to do in the coming decade.

The longer term effects of massive non-performing loans owed to state banks by local governments are likely to manifest not in the form of a banking crisis, but in other more insidious – yet equally – harmful ways. Because the Chinese state owns trillions of RMB in assets (land, natural resources, state-owned monopolies, and $3 trillion in foreign exchange), Beijing should have enough resources to bail out local governments when these loans have to be repaid. But there’s no free lunch. Bailing out local governments with valuable financial resources in the coming decade – a decade in which China will experience the end of the demographic dividend, rising costs of healthcare and pensions, and slower economic growth – will mean China will have less capital to invest. For an investment-led economy, this implies even more sluggish growth.

I dunno.  Covering local debt, dealing with an aging population — is there really enough dough left over for a military that can project power globally?


“Once local government debts, costs of re-capitalizing state-owned banks, bonds issued by state-owned banks, and railway bonds are included, China’s total debt amounts to 70 to 80 percent of GDP, roughly the level of public debt in the United States and the United Kingdom.”

It is clearly misguide and wrong statement. 80% of GDP is counting only US federal debt. If all local and state government added together using same measurement, it is way more than 80%.

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The U.S. jobs gap

Jul 5, 2011 16:18 UTC

This chart from the Heritage Foundation kind of says it all:


That chart is missing three lines:
1: Date Obama was elected President
2: Date President Obama was inaugurated
3: Date the “stimulus” passed

My eyeball line says the line started misbehaving sometime between 1 and 2, but I’d love to see reality.

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What Reaganomics meant to accomplish

Jul 5, 2011 15:43 UTC

Excellent piece by Brian Domitrovic of Forbes:

What was the point of Reaganomics? Starving the beast? None of the above. The point was to get the private sector booming. And could we ever use this as an objective today.

The prophet of the renaissance of the 1980s was the Reagan budget team’s economic forecaster, John Rutledge. Rutledge noticed that in the dozen years prior to 1981, money had been fleeing from the real economy, what with its taxes, regulations, and currency devaluations, and into tangible safe havens – especially commodities: oil, gold, and land.

Rutledge calculated that over the 1970s, some $11 trillion had migrated out of real economic enterprises into these hedges – a whopping number. And yet if the burdens on the economy were to lessen, a prodigious amount of money stood to flow back into the real sector, with epic growth, employment, and profits in tow.

This is of course what happened in the 1980s, as taxes got cut, regulation stymied, and money stabilized. GDP growth was north of 4% per year for a seven-year run, job creation was measured in the eight digits, and the stock market was off on a 15-fold advance. All because huge money had been parked elsewhere waiting for the real sector to become attractive again.

Sound familiar? Today, we see gold at $1500 an ounce, oil crossing $100, massive retained profits at corporations, and excess reserves at banks. And we’ve just endured a real estate bubble. If economically inert investments – vehicles that are not themselves businesses or their financing instruments – are capturing an extra-large portion of our financial capital, our economy is underperforming.

America’s missing trillions

Jul 5, 2011 15:18 UTC

In the WSJ, David Malpass and  Steve Moore note a disturbing trend in foreign investment in the U.S.:

It is true that foreign direct investment rose to $236 billion in 2010 from $159 billion in 2009. But that was still well below the $310 billion invested in 2008. The White House also neglected to disclose that in the first quarter of 2011 foreign investment fell by 51% from the first quarter of last year, according to data released last month from the federal Bureau of Economic Analysis. Foreigners of late have not found the U.S. to be a receptive, high-return home for investment.

… To be sure, foreigners still park a huge amount of money in this country, but in the last several years they’ve shifted their investment toward U.S. Treasury securities and government-guaranteed bonds, and away from the private-sector staples—corporate bonds, intellectual property, ownership of businesses—that create sustainable jobs. Since 2009, foreigners have invested just over $1 trillion in U.S. Treasury bonds, according to the Bureau of Economic Analysis.

Some economists argue that investing in low-interest-rate government bonds works fine for America because it allows the government to boost spending on programs—the latest doozies are windmills, high-speed rail and 99 weeks of unemployment benefits. The low interest rates, this argument goes, prove there is no negative “crowding out” from America’s near $1.5 trillion deficit.

That misses the point. To produce rapid growth, most capital must be allocated by markets. The effect of $4.5 trillion of borrowing since 2009 is that foreigners and Americans are buying Treasury bills instead of investing in the next Google, Oracle, Wal-Mart or biomedical company. Today, foreigners are financing food stamps and the next bridge to nowhere while Americans are building state-of-the-art production systems abroad. This is the real pernicious “crowding out effect” of the federal government’s borrowing.

But wait, there’s more. Don’t forget about the more than $1 trillion in U.S. corporate earnings parked offshore, just waiting to be repatriated if U.S. corporate tax rates were lowered.

Why Christina Romer is wrong on taxes

Jul 5, 2011 14:41 UTC

President Obama’s economic all-star team from 2009 is all but gone. But it’s the gift that keeps on giving. In yesterday’s NY Times, former White House economist Christina Romer offered a rather strange op-ed in favor of tax increases. The crux of her argument is this:

The economic evidence doesn’t support the anti-tax view. Both tax increases and spending cuts will tend to slow the recovery in the near term, but spending cuts will likely slow it more. Over the longer term, sensible tax increases will probably do less damage to economic growth and productivity than cuts in government investment.

And her evidence?

Some in Washington and in the news media have seized on a study I conducted with David Romer, my husband and colleague, that they say shows tax increases having a bigger short-term effect on the economy than spending cuts. Our study, which examined only federal tax policy, found that conventional analysis underestimates the effect of tax changes on the economy substantially. The key problem we address is that changes in taxes are often linked to what is happening in the economy.

That Romer-Romer study offered this conclusion:

Our results indicate that tax changes have very large effects on output. Our baseline specification implies that an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent. Our many robustness checks for the most part point to a slightly smaller decline, but one that is still typically over 2.5 percent

Right, tax increases hurt economic growth. Agreed. And they may only raise half of the revenue predicted by static analysis that does not take into account behavioral effects. But then Romer makes this claim:

If there were a similar study on government spending, it would likely show that spending cuts also have larger effects than conventionally believed. Like tax actions, spending changes are often correlated with other factors affecting economic activity. For example, large cuts in military spending, like those after World War II and the Korean War, were typically accompanied by the end of wartime taxes and production controls. Those probably lessened the economic impact of the spending cuts, leading many researchers to underestimate the reductions’ effects.

It is hard to argue against a hypothetical study. But Romer’s reasoning, though flawed, is hardly novel:

1) She states that, at least over the short-term, $100 less in government spending reduces aggregate demand by $100. On the other hand, a $100 tax increase on “wealthier households” does not reduce demand by $100 since at least part of that tax increase would be paid from savings rather than consumption.

Me: Been there, done that. This is sort of the flipside of the Keynesian argument in favor of the $800 billion Obama-Romer-Bernstein stimulus plan.  Except she uses a smaller fiscal multiplier here , 1.0, than she used in analyzing potential impact of the stimulus plan, 1.6. But even that may be too high. Economist John Taylor thinks the multiplier is about 0.5. In fact, there are several models that find such a low multiplier.

Unfortunately, we find substantially smaller government spending multipliers than those used by Romer and Bernstein. For example, the multiplier associated with a permanent increase in government spending by the end of 2010 lies between 0.5 and 0.6. In other words, government spending does not induce additional private spending but instead quickly crowds out private consumption and investment.

We also provide an assessment of the impact of the American Recovery and Re-investment Act. This legislation implies measures amounting to $787 billion and spread over 2009 to 2013 but peaking in 2010. Our estimate of the total impact is closer to 1/6 of the effect estimated by Romer and Bernstein. By 2010 we project output to be about 0.65% higher. Using the same rule-of-thumb as Romer and Bernstein, this increase in GDP would translate to about 600,000 additional jobs rather than three to four million.

2)  Next, Romer says that while “higher tax rates reduce the rewards of work and investing,” raising current tax rates by 10 percent would only reduce reported income by 2 percent.

Me: Again, I am not sure whose taxes she is talking about, but research by Martin Feldstein on the 1993 Clinton tax increase found that a) high-income taxpayers reported 8.5 percent less  taxable income than if their taxes had not been raised, which resulted in b) the tax increase only raising about one-third as much dough as Team Clinton has predicted.

3)  Romer also worries that “certain spending cuts may also have small effects on long-run growth.” She’s talking about stuff like basic scientific research, education and infrastructure.

Me: Ah yes, the “good” sort of spending. But as I have noted before, McKinsey consultants have found that if the U.S. public sector could just halve the productivity gap with the private sector, its productivity would be as much as 15 percent higher and would generate annual savings of up to $300 billion a year. We’re far from cutting into the muscle and bone. And there’s no reason not to take a look at basic research, infrastructure and other investment spending to see if they could be done  more productively.

Bottom line: But the basic problem here is that Romer, like the rest of Obama’s all-star team, is worried about stimulating consumer demand rather than encouraging — by the removal of tax and regulatory barriers – established businesses and new entrepreneurs to invest, expand, hire and create. And talk of raising taxes distracts from the real work that needs to be done to reduce spending. Whenever economists talk about the need to raises taxes, they are actually making a political argument rather than an economic one.  Either they are ideologically opposed to smaller government or they don’t believe Washington will ever cut spending. But that isn’t surprising since there really isn’t a valid economic argument to support the long-term Obama spending binge.