James Pethokoukis

Politics and policy from inside Washington

The Looting Scenario for America

Apr 13, 2010 17:25 UTC

The Great Arnold Kling thinks there is a high probability of a two-decade economic fiasco, outlined below.

In the Looting Scenario, what is going to be rewarded is what we call rent-seeking. Basically, over the next twenty years, wealth transfer by government will be much more important than wealth creation–and the amount available for transfer could actually decline. For example, I expect that benefits for the elderly will become increasingly means-tested and savings will be increasingly taxed, to the point where the marginal return to saving will approach zero. If the marginal return to saving is low, and government deficits are high, then capital formation is going to be low. It’s hard to see how you get rapid innovation in that kind of world.

The Looting Scenario is one in which public employees and pensioners have the incentive to just take as much as they can while they can get it. It is a scenario in which people talk about the deficit, and wise heads say we must do something about it, but the only politically feasible approach is to raise taxes. Even so, it turns out that higher tax rates bring in less revenue than projected, because of the incentives to consume leisure and engage in black-market activity.

Seven years ago, it would not have occurred to me that our ruling class would be so bad that the Looting Scenario would be likely. My guess is that, even among libertarians, just about everyone else still has faith that our ruling class will not let the Looting Scenario take place. However, I think it is one of the higher-probability scenarios out there.

COMMENT

Current trends in US ethnic demographics will continue to reduce the amount of wealth available for transfer.

When people say that betting against the US has always been a losing wager, they forget — or don’t want to acknowledge — that they’re not talking about the same country.

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Imagining a V-shaped recovery and the 2010 midterms

Apr 12, 2010 17:39 UTC

Those who argue that Democrats might lose one or both houses of Congress are making an economic argument. Slow growth/high unemployment = angry, anti-incumbent voters. But what if the economy really perks up? First some analysis by Larry Kudlow:

Sometimes you have to take your political lenses out and look at the actual economic statistics in order to gauge whether we’re on the road to recovery or not. … No one has written more about the future tax-and-regulatory threats from the big-government assault of Obamanomics. But most of that is in the future. The current reality is that a strong rebound in corporate profits (the greatest and truest stimulus of all), ultra-easy money from the Fed, and some very small stimuli from government spending are all working to generate a cyclical recovery in a basically free-market economy that is a lot more resilient than capitalist critics would have us believe. So conservatives should not lose their cool and blow their credibility over a cyclical rebound that is backed by the statistics.

And now the econ team of Wesbury and Stein at First Trust Advisors:

Unfortunately, there is a group of people who still haven’t arrived at the station – mostly because they confuse politics with economic forecasting. Many Republicans and quite a few conservative television commentators are still trying to use the Clinton/Carville method of winning elections – “It’s the Economy, Stupid.” As a result, they keep telling anyone who will listen that the Obama agenda is going to kill the economy – RIGHT NOW.

But they will be wrong. It is true that more government spending and regulation, higher taxes, and government mandates will erode growth in the future. And it is true that recent growth in government will make it less likely the US will be the home of the next Apple iPad-type device. The fact of the matter is that big government and high tax rates hurt the entrepreneurial spirit and slow economic activity (see growth in Europe versus the U.S.).

But arguing that this recovery is not happening is a losing proposition. It is happening; And it’s V-shaped. We expected a V-shaped recovery as the panic ended, as monetary velocity returned and because Fed policy was easy.

Me: I think the key here is to see what happens with unemployment, incomes, housing and gas prices.  Certainly the economic consensus is for unemployment to stay above 9 percent. And my own analysis shows a big lag between an economic turn around and public perception. Perhaps the jobless rate will outperform on the upside as it has underperformed on the downside. One thing to keep an eye on is Obama’s approval rating which is now 45-48, according to Gallup.

COMMENT

zzzzzzz…bed time

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Why Henry Blodget is wrong about taxes

Apr 6, 2010 16:06 UTC

Henry Blodget says he’s pretty confident taxes are headed higher to deal with the historic rise in federal spending  and agrees with Northern Trust’s Paul Kasriel that higher rates won’t be an economy killer. Blodget quotes Kasriel:

The economy performed pretty well in the eight years ended 2000 even though the top marginal tax rate was higher in these eight years than it was in the prior eight years. The economy did not perform better because of the increase in the top marginal tax rate. Nevertheless, this increase was not sufficient to derail economic progress. In the eight years ended 2008, the economy performed relatively poorly despite the lower top marginal tax rate.  The economy did not under-perform because of the marginal tax rate cut. Nevertheless, the cut in the tax rate was not sufficient to enhance economic performance. The point of all this is that although tax rates matter, they are not all that matters.

Me: I agree that taxes matter but they are not the only thing that matters. But they do matter a lot.  Back when tax rates rose in the 1990′s, the economy was starting from a position of strength, not weakness. There was already  a powerful, self-sustaining recovery in place. Let me point out this 2009 study that examined the affect of higher marginal tax rates on the rich:

Taxes trigger a host of behavioral responses designed to minimize the burden on the individual. … all such responses are sources of inefficiency, whether they take the form of reduced labor supply, increased charitable contributions, increased expenditures for tax professionals, or a different form of business organization, and thus they add to the burden of taxes from society’s perspective.

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above X is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above X and increase government revenue, which can in principle be used to benefit other taxpayers. … Using our previous … the revenue-maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

And this is before the 2011 tax increases and the increase in taxes related to healthcare reform. We are probably now on the wrong side of the Laffer Curve.  Greg Mankiw also makes the case that Americans are not undertaxed compared with the rest of the planet’s advanced economies.

COMMENT

I would also add there were 3 growth drivers during the 1990’s. 1) The initial build-out of the Internet when firms spent billions on fiber, chips, software, webhosting, etc. 2) The Y2K computer conversion increased demand for some of the same equipment plus lots of high-paying software programmers. 3) Now we also found out the Clinton HUD lowered the lending standards for home ownership and set off a housing boom to boot.

The first two aren’t coming back, and who knows about the third.

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How America might get a VAT of its own

Apr 6, 2010 00:14 UTC

When will the other chaussure drop? Now that America has gone French (and German and British) with universal healthcare, expect Washington to eventually propose a European-style, value-added consumption tax to pay for it — as well as the rest of the historic rise in federal spending. But U.S. voters are in a severe anti-tax mood. It might take another financial crisis to give politicians the will and hubris to ignore them.

Here’s how it might all play out:

1) For Washington insiders, it’s a matter of “when” not “if.” Politicians and economists I chat with from the White House to Capitol Hill to the Federal Reserve think a VAT inevitable. Healthcare reform has only hardened that consensus. Spending cuts to pay for expanded coverage may not happen. Either way, the budget numbers scream for action. Annual federal spending as a share of GDP will likely outpace revenue by at least six percentage points for years to come. Trillion-dollar deficits the norm.

2) Just slashing spending is one option. But that would require a radical reshaping of social-insurance schemes as outlined by Rep. Paul Ryan in his recent white paper, “A Roadmap for America’s Future.” The war over healthcare would seem a minor skirmish by comparison.  A battle worth fighting, but a coalition of the willing might be small.

3) Maybe a broad income tax increase? So far Washington has shown an appetite for nicking only the rich. And one study suggests the tax burden on wealthy households is approaching — or has perhaps even exceeded — the revenue-maximizing level. That’s right, America is on the wrong side of the Laffer Curve again. Even assuming the rich wouldn’t flee to tax shelters, top income tax rates would need rise to economy-crushing levels to balance the budget.

4) Anyway, it’s smarter to tax consumption broadly rather than work and investment narrowly. Especially in an economy that needs less of the former and more of the latter. And that is what a VAT does. Few doubt its ability to raise massive amount of revenue with fewer disincentives than the current system. But if the economics are clear, the politics are a puzzle in Tea Party America. VAT proponents assume political intransigence without a financial crisis to spur action, just as market chaos helped get the $700 billion bank rescue passed in 2008.

5) Yet there is a reasonable scenario where America would accept a VAT. In fact, it is the only scenario under which we should accept a VAT.

First, Washington would have to demonstrate it could manage the public purse by reforming entitlements in a Ryan-esque manner. A tall order, but a necessary prerequisite or else voters would fear that entire six-point budget gap would be closed by tax hikes via a VAT. So, in the end, government spending needs to be dramatically cut. (Preferably, we would never need to get past this step.;)

Second, a VAT would have to completely overwrite the current complex and inefficient tax code. If not, voters would fear getting hit by both VAT and income tax hikes. A VAT can’t be an add on.

Third, every sales receipt in America would have to indicate the VAT penalty. But politicians love the hidden aspect of a VAT as way of duping voters. To them opaqueness is a feature, not a bug.

Fourth, the intended tax burden should be kept level at first. A pro-growth VAT — one that does away with corporate and investment taxes — might produce more revenue merely by expanding the economic pie.

Still a tough sell. Better skip the part about the French.

COMMENT

Democrats: taxing and spending us into bankruptcy.

$14 trillion debt. $2 trillion deficits. High unemployment. A president living like Louis XVI.

Of course, it’s all George Bush’s fault!

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Preventing the Great Stagnation

Mar 31, 2010 19:14 UTC

David Gitlitz, chief economist at High View Economics, has a thought or two about my “20-year bust” post:

Gordon is very good in his areas of expertise, but you’re right to point out that there’s nothing predetermined about this. Enacting full bore Obanomics would make even Gordon’s outlook look like a day at the beach. On the other hand, adopting a supply-side, free-market growth strategy would put in place the incentives to reinvigorate entrepreneurship and innovation and put us on track to restore at least the historical trend rate of productivity growth.

Me: Markets have a funny way of driving policy. A high-debt, high-tax, high-regulation economy would not be good for the dollar, bonds or stocks. And while we are on the topic, an interesting post from the great Larry Kudlow on where taxes are heading.

Obama and America’s 20-year bust

Mar 31, 2010 11:51 UTC

It is an alarming, jaw-dropping conclusion. The U.S. standard of living, says superstar Northwestern University economist Robert Gordon in a new paper, is about to experience its slowest growth “over any two-decade interval recorded since the inauguration of George Washington.” That’s right, get ready for twenty years of major-league economic suckage. It is an event that would change America’s material expectations, self-identity and political landscape.  Change in the worst way.

Now it’s not so much that the Great Recession will morph into the Long Recession. More like ease into the Great Stagnation. As Gordon calculates it, the economy will average only 2.4 percent annual real GDP growth over that span vs. 3 percent or so during the previous 20 years. On a per capita basis, the economy will grow at just a 1.5 percent average annual rate vs. 2.17 percent between 1929 and 2007.

That might not seem like much of a difference, but it really is. Over time, the power of compounding would create a huge growth gap measured in the trillions of dollars. To look at it another way, assume you had an annual salary of $100,000. If you received a 1.5 percent raise each year, you would be making $134,000 after 20 years, $153,000 after 40 years. But a 2.17 annual raise would boost your income to $153,000 after 20 years and $236,000 after 40 years.

For Gordon, the culprit is weaker productivity. Productivity, economists like to say, isn’t everything — but in the long run it is almost everything. A nation’s GDP growth is little more than a derivative of how many workers the nation has and how much they produce. And if Gordon  is correct, U.S. productivity is about to weaken. He forecasts that over the next two decades, the metric will grow at just a 1.7 percent annual rate. From 1996-2007, economy-wide productivity averaged just over 2 percent with GDP growing at 3.1 percent.

Gordon’s argument is simple: The productivity surge starting in the 1990s was driven primarily by the Internet, though drastic corporate cost-cutting in the early 2000s helped, too. Going forward, though, Gordon thinks the IT revolution will be marked by diminishing returns. He concludes, for instance, that most of the product innovations since 2000, like flat screen TVs and iPods, have been directed at consumer enjoyment rather than business productivity. (Also not helping are a more protectionist trade policy and a tax code where the penalties on savings and investment are about to skyrocket with rates soaring 60 percent on capital gains and 200 percent on dividends.)

All this dovetails nicely with research showing financial crises are followed by negative, long-term side-effects such as slow economic growth and higher interest rates. Lots of debt, too. Indeed, researchers Carmen Reinhart and Kenneth Rogoff find advanced economies with debt-to-GDP ratios above 90 percent grow more slowly than less-indebted ones. (Japan is the classic example.) America is on track to hit that level in 2020, according to the Congressional Budget Office.

But maybe Gordon is wrong. Productivity has been surprisingly robust during the downturn, helping the overall economy (though not the labor market) weather the storm better than most expected. Maybe nanotechnology or genetic engineering will be the next Internet and ignite further creative destruction. Yet even if Gordon is correct, Americans still control their own economic destiny.

Since the 2008 election, American economic policy has been about wealth preservation (keeping the economy from sliding into a depression) and wealth redistribution (healthcare reform.) Wealth creation? Not so much.  That needs to change. Washington needs to focus on growing the economy and competing with the rest of the G20 nations, including the other member of the G2, China. Every policy — from education to trade to the tax code — needs to be seen through that lens.

America faced a similar turning point a generation ago. During the Jimmy Carter years, the Malthusian, Limits to Growth crowd argued that natural-resource constraints meant Americans would have to lower their economic expectations and accept economic stagnation — or worse. Carter more or less accepted an end to American Exceptionalism, but the 1980 presidential election showed few of his countrymen did. They chose growth economics and the economy grew.

Now they face another choice. Preserve wealth, redistribute wealth or create wealth.  Hopefully, President Barack Obama will choose door #3. Investing more in basic research (not just healthcare) would be a start, as would slashing the corporate tax rate. A new consumption tax would be better for growth, but only if it replaced the current wage and investment income taxes. Real entitlement reform would help avoid the Reinhart-Rogoff scenario. The choices made during the next few years could the difference between America in Decline or the American (21st) Century.

COMMENT

This state of affairs are known to many Americans and in general public.
Because of economic slow down, no clear cut policy on major issues,last two years banks financial crisis, not much appreciated exports from America, more expenditure on Iraq/Afghans areas, some misconception on Mr.Obama!s new health care proposals made his downward rating on his policies,actions etc.,from Americans.
Mr.Obama wants to do more welfare measures to native Americans and to others as early as possible.
Those who attracts by his or speeches may be short lived.
America was in very pretty positions and enjoying their wealth for many centuries.
Now, other nations had started moving towards forward journey and getting favorable results from now and then.
If government wants to build more cash reserve, more expenditure on running and sustaining economic and social growth, creating more infrastructure, then, our college economics speaks in real terms.
There is no other ways, only to get more revenue by regulations, more and more exported industries formation,more productive work, increase their standard of income,then, some taxes to be levied and can be collected from many high,upper classes.
Still,some years to go and to find what happens on American soil by Mr.Obama and his team.
These findings may be a search type for any corrections and bring his ratings to upwards.,

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7 reasons a VAT is a dicey proposition

Mar 29, 2010 15:38 UTC

My guy Pete Davis over at Capital Gains and Games unsheathes the katana and slices up the VAT. Not so easy to implement he says. A brief summary of his reasons (though read the whole thing, of course):

1. Like the U.K. when it adopted its VAT in 1973, the U.S. will struggle for at least two years and probably longer to implement a VAT.

2. Compared to our income tax, the VAT is regressive.

3. Tax reformers lambast the complexity of our income tax with good reason, but somehow assume that the same people who legislated that complexity will legislate a clean VAT.

4. I can’t think of a faster way to kill Rust Belt jobs than to impose a VAT.

5. Housing would be hurt by a VAT even if it is zero rated.

6. Exporters would benefit from a VAT, but that benefit would be partially offset to the extent that the dollar appreciated against the currencies of our trading partners.

7. State government sales tax revenues would be directly impacted by a federal VAT.

Economic guru: US faces its worst two decades in history

Mar 29, 2010 14:04 UTC

Get ready for the Long Recession.

Well, at least a long period of time where it is going to seem like the US economy is kind of sickly. That is the conclusion of productivity guru Robert Gordon in a new paper. He says US living standards now face their slowest two-decade growth rate “since the inauguration of George Washington.” More:

The statistical trend for growth in total economy [labor productivity] ranged from 2.75 percent in early 1962 down to 1.25 percent in late 1979 and recovered to 2.45 percent in 2002. Our results on productivity trends identify a problem in the interpretation of the 2008-09 recession and conclude that at present statistical trends cannot be extended past 2007.

For the longer stretch of history back to 1891, the paper provides numerous corrections to the growth of labor quality and to capital quantity and quality, leading to significant rearrangements of the growth pattern of MFP, generally lowering the unadjusted MFP growth rates during 1928-50 and raising them after 1950. Nevertheless, by far the most rapid MFP growth in U. S. history occurred in 1928-50, a phenomenon that I have previously dubbed the “one big wave.”

The paper approaches the task of forecasting 20 years into the future by extracting relevant precedents from the growth in labor productivity and in MFP over the last seven years, the last 20 years, and the last 116 years. Its conclusion is that over the next 20 years (2007-2027) growth in real potential GDP will be 2.4 percent (the same as in 2000-07), growth in total economy labor productivity will be 1.7 percent, and growth in the more familiar concept of NFPB sector labor productivity will be 2.05 percent. The implied forecast 1.50 percent growth rate of per-capita real GDP falls far short of the historical achievement of 2.17 percent between 1929 and 2007 and represents the slowest growth of the measured American standard of living over any two-decade interval recorded since the inauguration of George Washington.

Me: There is no more basic political and economic issue than a nation’s standard of living. If  Gordon is right, this will dominate US politics as another sign of American decline.

COMMENT

Or Plan B we could just throw the Democrats out of office (which even the “Greatest Generation” wouldn’t do), rip Obama’s poisoned laws out of the ground, and get our economy back to a nice happy 4.5% unemployment rate.

Posted by Joshua A. Schaeffer | Report as abusive

Yup, America hates Big Anything

Mar 25, 2010 12:27 UTC

A new poll shows Americans hate Wall Street. Of course, bankers are never popular. But maybe never less so than right now. Yet polls also show Americans cynical about Big Anything — Big Money, Big Business, Big Government. As Sen. John McCain likes to say, the approval ratings of Congress are so low, its only supporters must be paid staffers and blood relatives.

That helps explains why the nation has not been flocking to government-created solutions such as the stimulus plan and healthcare reform. This isn’t a time when Americans are shifting from believing in markets to believing in government. It’s a time when the last remaining shred of faith in the country’s elite is quickly eroding.

COMMENT

I beg to differ, the US loves huge arsenals of weapons, nukes, oil, junk food, health care, extravaganza’s and last, but not least, its massive stock of flags.

Posted by Gandhiolfini | Report as abusive

The crushing cost of the public sector

Mar 24, 2010 16:38 UTC

Great post with oodles of charts from Mike Mandel. I did want to highlight one chart, though:

benefit chart

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