James Pethokoukis

Politics and policy from inside Washington

Walking on the supply-side

Mar 23, 2011 20:09 UTC

One of my favorite blogs, The Supply Side, has a great round-up of an NY conference supply-side economics:

Regarding substance, here are a few notes:

Lindsey predicted the end of fiat money by the end of the decade. He also observed that congressional Democrats lost the House because they lost seniors. He believes Nancy Pelosi plans to win them back in 2012 by aggressively attacking GOP proposals to cut entitlement costs.

Kudlow disputed that the budget deficit represents a “red menace” (Indiana Gov. Mitch Daniels’ description), arguing slow growth was the bigger threat. He noted that one can almost plot the rise of American power in recent decades with gold coming down, and its decline with gold’s rise.

Lehrman explained that the U.S. will never get fiscal deficits under control without monetary reform through a convertible dollar, because the world sells us its goods, then uses the dollars buy up our debt.

Laffer was typically optimistic, saying supply-siders are still winning the tax cut argument and that the rate of growth over the next three decades will exceed the 1980s and ‘90s.

Prof. Mundell argued the route to stronger U.S. growth is making the Bush tax cuts permanent and cutting the corporate tax rate to 15 percent. Explaining his view that exchange rates – set by the U.S. Treasury not the Federal Reserve – transmit inflation and deflation to the domestic economy, he suggested the biggest threat to recovery isn’t inflation but a significant rise in the dollar against the euro later this year. Such a rise would cut off the already-weak expansion and magnify America’s debt crisis.

White House confusion on corporate tax holiday

Mar 23, 2011 19:18 UTC

The White House perhaps rightly worries, via a Treasury blog posting, that a tax amnesty for U.S. companies repatriating profit might distract from broader reform. (House GOP Majority Leader Eric Cantor recently came out for the idea.)  But its economic objection to the idea is confused.

As things stand, there’s an incentive for companies to stash cash overseas, because bringing it back triggers a U.S. tax rate of up to 35 percent, depending on the level of local taxes already paid. A big but temporary reduction could see a lot of cash returning to the domestic economy — especially in the technology and drugs sectors.

Treasury notes, though, that this might result in very little direct new investment or job creation. When such a holiday was last tried in 2004, tax data show that 843 companies brought back nearly $400 billion. But for every dollar returned, about 91 cents went toward share buybacks with another eight cents toward boosting dividends, according to research from economists at the University of Connecticut and the National Bureau of Economic Research.

Meanwhile, President Barack Obama and others want to reform corporate taxes more broadly. A reduction in America’s fairly high headline tax rate would most likely come with the elimination of some tax breaks beloved of companies. With limited political capital available — his own congressional Democrats don’t want to cut rates or provide a tax holiday — Obama may need to focus on this more lasting change. Moreover, if company bosses are given reason to believe they’ll get an amnesty every few years, they might lobby harder to keep their favorite tax breaks, thereby derailing reform.

If the political calculation is slightly negative, though, the economic one tips the other way. Treasury is stretching a point in assuming the government would somehow lose revenue by taxing repatriated income at a sharply lower rate. In reality, without the reduction most of the money will remain offshore.

And even if all the cash returning to the United States went to companies’ shareholders, that could still generate more consumption, growth and jobs, a knock-on effect Treasury ignores. Yet this so-called wealth effect is explicitly part of the rationale behind the Fed’s second round of quantitative easing. Some economists dispute the linkages, but not the ones that work for Obama. So despite some political risks, it might be time go on holiday — as long Washington also continues the work of reform.

COMMENT

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Obama’s wildly dangerous budget

Mar 22, 2011 15:20 UTC

President Barack Obama’s 2012 budget plan is dead on arrival — and rightfully so, it turns out. U.S. fiscal scorekeepers calculate it taking federal debt levels into dangerous territory. Meanwhile, both parties in Congress are showing tentative new signs of embracing fiscal responsibility. But without some leadership from the White House, nothing will get done.

The headline number from the Congressional Budget Office finds the White House budget adding $9.5 trillion to the U.S. national debt over the next decade against the administration’s estimate of $7.2 trillion. The two rarely agree, but the gap this time is particularly large. And both sets of predictions remain uncomfortably dependent on low and stable interest rates.

That’s a questionable assumption:

1) The CBO’s take suggests bond markets have reason to grow queasy about rising U.S. borrowing. Public debt as a share of the economy would hit 87 percent by 2021 — uncomfortably close to the 90 percent level economists Carmen Reinhart and Kenneth Rogoff have found crimps economic growth. And slower growth makes it harder to pay down debt. Recall that Obama had been promoting his budget as stabilizing the debt-GDP ratio at around 77 percent.

2) The CBO also determined interest payments would absorb 18 percent of federal revenue in 2018. Moody’s Investors Service has previously identified such a threshold as triggering downward pressure on Uncle Sam’s credit rating. U.S. debt service hasn’t been so high since 1980. Then, though, interest rates were high, and when they declined servicing the debt became more affordable. This time, rates are already low and it’s the sheer quantity of debt that’s the problem.

3) Even a slight rise in rates above White House forecasts — say, a single percentage point — would add $1.3 trillion to the 10-year debt number. And as the great folks at e21 point out

In the Administration’s baseline estimate, the public debt will rise from 62.2% of GDP in 2010 ($9 trillion) to 77% of GDP in 2021 ($18.9 trillion). … Over this period, the effective interest rate implied by the ratio of net interest expense to public debt is 3.5%. (This happens to be the average for the 5-year constant maturity Treasury rate over the past 10 years.)

However, the average 5-year borrowing cost for the 10 years ending in January 2000 was 6.3%, while the average 5-year borrowing cost for the 10 years ending in 1990 was 10.4%. If the average effective interest rate on the debt were to climb to the 10.4% average of the 10 years ending in January 1990, the public debt would explode to nearly 150% of GDP by 2021. Under the more modest 6.3% assumption of the 1990s, the debt ratio would exceed 100% of GDP by the end of the decade. Rather than doubling, as assumed by OMB, the public debt would quadruple over ten years to more than $36 trillion.

Obama’s budget anyway didn’t begin to address long-term healthcare and Social Security spending commitments. The word is that his political advisers think he should stall. A bit better news from Capitol Hill, though. Bipartisan support seems to be growing for the deficit reduction measures proposed late last year by Obama’s debt commission. And more Republicans, including the ranking member of the Senate Budget Committee, are sounding willing to consider higher taxes in exchange for deep spending cuts.

But history suggests no major fiscal fixes will become law without presidential involvement. The White House was a full partner in restoring Social Security’s solvency in the 1980s and balancing the budget in the 1990s. No wonder 64 senators, 32 from each party, just sent Obama a letter urging he “engage” on the budget.

Obama should learn from his recent involvement with the U.N. Security Council and Libya. Nothing gets done there or in Congress without presidential leadership.  Of course, maybe  the U.S. can wait until after the next election before taking action on its debt woes. Bu that, like Obama’s budget, is a terribly risky proposition.

COMMENT

What is most interesting in Mr. Pethokoukis’ analysis & are his omissions of fact & CBO assumptions!

1. Compare – Obama Budget Expense Levels: 2010/$4.2 trillion, 2011/$3.69 trillion, 2012/$3.73 trillion with
Bush Budget Expense Levels: 2007/$3.25 trillion, 2008/$3.89 trillion, 2009/$3.74 trillion.

The big difference? 2007 & 2008 Federal Tax Revenues were $2.6 trillion, plunging to $2.1 trillion+ in 2009 & 2010 – - an almost $500 billion drop in Fed Tax Revenues, adding $1 trillion to Deficit

2. Obama’s “Wildly Dangerous 2011/2012 $3.69T/$3.73T Budgets” are slightly lower than Bush 2008/2009 $3.89T/$3.74T & he had estimated higher fed revenues for both, now diminshed by extending Bush Tax Cuts

3. Mr. P omitted CBO stated: “CBO’s baseline projections largely reflect the assumption that current tax and spending laws will remain unchanged” – hopefully not since Bush Tax Cuts added $2.7T to US Debt, plus heaps of interest/debt service cost.

Bush Tax Cuts:
2011 & 2012 Deficits will include $80 billion tax cuts for Top 2% Richest. Americans earning $200,000+ increased under Bush, and so those who pay ZERO tax…from 2,959 in 2002 to 22,256 in 2008! Top 0.01%, who earn between $3 million & $37 million annually got big tax breaks -How can anyone take Republican deficit-cutting seriously, especially when all $61 billion cuts punish the middle-class, poor, children, unemployed, public education, women & children’s health, national security, PBS, etc….whereas ending Bush Tax Cuts & tax avoidance loopholes for CEO’s, Hedge Fund, Richest Americans & Big Biz would save 10x as many billions & not hurt anyone or deprive poor children of food stamps?

Corporate Tax Gap:
Republicans whine about 35% US corp. tax rate – in 2010 despite record pre-tax profits of $1.67T US corps paid a total $1.7B tax! In 2009/2010 US Corp.Tax Gap totalled $700B (Bush gave Wall St xtra $140B tax break in Oct 2008). Bush expanded tax breaks also allowed 1/3rd of Top 275 US corps. to pay ZERO tax between 2001-2003. GOP/Bush tax gifts to corp. buddies reduced Fed Revenues by $2T.

Role of Estate Tax:
CBO claimed “President proposes, beg in January 2013, that estate and gift taxes return permanently to the rates and exemption levels that were in effect in CY09″ which “would reduce tax revenues and boost outlays for refundable tax credits more than $3.0 trillion over the next decade” – GOP are defenders of Estate Taxes, not Dems…is Obama pandering to Republicans? If so, Obama must not.

If Obama is allowed to implement individ/corp tax reforms/increases he campaigned on, Fed Revenues will increase from 2013 on – best deficit reduction strategy.

3.GOP Blockage of Revenue-boosting Obama Policy:
CBO has shown Obama Health Care Reform will reduce Deficit by $143 billion over first decade – GOP want to repeal! CBO claims repealing the SuperFund Energy Tax Rebate would save $200 billion – GOP refuses are blocking repeal. GOP have blocked 2 of Obama bills to close offshore tax haven loopholes & tax incentives for offshoring US jobs & close some Big Oil tax subsidies. These would increase federal revenue by over $160B a year or $1T over next decade.

Only a few examples above of GOP obstruction, adding to the Deficit & Debt every year & keeping federal tax revenues at lowest level in 60 years plus killing US economy & America’s middle-class!

Posted by Truthfairy | Report as abusive

Japan shows why U.S. must slash debt

Mar 15, 2011 20:33 UTC

You never know when a black swan will float your way. And when your credit card is nearly maxed out, dealing with emergencies can be tricky. A massive rebuilding effort may stretch Japan to its financial limits. Politicians in Washington should take note of the warning for several reasons:

1) Trying to calculate a country’s available “fiscal space” — the additional amount they can borrow before markets demand a sharply higher premium — is guesswork. The global financial crisis took the public debt of advanced economies to 75 percent of GDP in 2009 from 60 percent in late 2007. And by 2015, the International Monetary Fund reckons, the average ratio may hit 85 percent. That’s perilously close to the 90 percent level where debt seems to really hamper growth, according to economists Carmen Reinhart and Kenneth Rogoff. (The White House is somewhat skeptical of this research, by the way.)

2) But all nations are not alike in their profligacy. They have different debt levels and different track records in dealing with debt. Based on those variables, new IMF research suggests that some nations — including Japan with its 200 percent debt-to-GDP ratio — have very little room to add new debt before markets balk. (CDS prices for Japanese debt, are closer to that of Mexico’s than America’s or Germany’s.)

The United States and the UK, by contrast, probably have a bit more capacity, the IMF says. But that extra space could easily be gobbled up by unforeseen events, such as the earthquake-triggered disasters that may cost Japan 3 percent to 5 percent of its GDP to address.

3) One unforeseen event that Team Obama might want to consider is a rise in interest rates. If  long-rates are just a single percentage point higher over the next decade than White House forecasts, it will add $1.3 trillion to the national debt.  Or consider these calculations from the e21 think tank:

In the Administration’s baseline estimate, the public debt will rise from 62.2% of GDP in 2010 ($9 trillion) to 77% of GDP in 2021 ($18.9 trillion). … Over this period, the effective interest rate implied by the ratio of net interest expense to public debt is 3.5%. (This happens to be the average for the 5-year constant maturity Treasury rate over the past 10 years.)

However, the average 5-year borrowing cost for the 10 years ending in January 2000 was 6.3%, while the average 5-year borrowing cost for the 10 years ending in 1990 was 10.4%.  If the average effective interest rate on the debt were to climb to the 10.4% average of the 10 years ending in January 1990, the public debt would explode to nearly 150% of GDP by 2021. Under the more modest 6.3% assumption of the 1990s, the debt ratio would exceed 100% of GDP by the end of the decade. Rather than doubling, as assumed by OMB, the public debt would quadruple over ten years to more than $36 trillion.

e21

4) And the unexpected natural disaster isn’t so unusual. Reconstruction after America’s Hurricane Katrina in 2005 cost something of the order of 1 percent of U.S. GDP, while New Zealand’s recent earthquake could cost it more in relation to the country’s output than the current estimates for Japan. Then there’s the question of necessary-seeming activity abroad. President Barack Obama may be pondering the potential $300 million a week tab for enforcing a no-fly zone over Libya; if so, he won’t be alone among NATO members in wondering how to pay for it.

The United States and quite a few other developed nations would appear to have little headroom to deal with the costs of another bank crisis — much less, say, a new war. It’s something for those running cash-strapped governments to remember. If they don’t create breathing room, they not only have to make hard budget choices but also pray that Mother Nature will be kind.

Impact of earthquakes, natural disasters on economic growth in Japan

Mar 11, 2011 19:56 UTC

How will today’s terrible earthquake and tsunami affect Japan’s economy, not to mention those of other global economies? After spending all day reviewing a bunch of academic research, the verdict remains unclear. For instance,  simulations run by the Inter-American Development Bank find only the biggest disasters have an  impact. Take disasters in the 99th percentile:

The 99th percentile cutoff is equivalent to a natural disaster that kills more than 233 people per million inhabitants. Although the number is large, many recent large events have exceeded this rate. For example, the 2004 Indian Ocean Tsunami killed 772 people per million inhabitants in Indonesia, and almost 2,000 per million inhabitants in Sri Lanka. Moreover, by the latest accounts, the 2010 earthquake in Haiti killed over 20,000 people per million inhabitants (see Cavallo, Powell and Becerra (2010))

For these types of disaster, the economic drag is persistent:

quake

But smaller, though still devastating disaster show little economic impact:

quake2

The study’s conclusion:

Contrary to previous work, we find that natural disasters, even when we
focus only on the effects of the largest events, do not have any significant effect on subsequent
economic growth. Indeed, the only two cases where we found that truly large natural disasters
were followed by an important decline in GDP per capita were cases where the natural disaster
was followed, though in one case not immediately, by radical political revolution, which severely
affected the institutional organization of society.

Contrary to previous work, we find that natural disasters, even when we focus only on the effects of the largest events, do not have any significant effect on subsequent economic growth. Indeed, the only two cases where we found that truly large natural disasters were followed by an important decline in GDP per capita were cases where the natural disaster was followed, though in one case not immediately, by radical political revolution, which severely affected the institutional organization of society.

But a highly regarded 2002 study that tracked disasters in 89 countries for 30 years came to a different conclusion, as summarized by the IADB:

Skidmore and Toya (2002) explain their somewhat counterintuitive finding by suggesting that disasters may be speeding up the Schumpeterian “creative destruction” process that is at the heart of the development of market economies. Cuaresma et al. (2008) attempt to investigate this creative destruction hypothesis empirically by closely examining the evolution of R&D from foreign origin and how it is affected by catastrophic risk. They conclude that the creative destruction dynamic most likely only occurs in countries with high per capita income.

This make some sense to me.  This is not the Broken Windows Fallacy where the repair of damage is thought to boost growth. That sort of thing is just redistributing economic activity and is at best is a wash. But if a disaster is a catalyst for better infrastructure or less regulation to promote rebuilding, S&T could be correct.  (Of course, it is worth noting that Japan already has great infrastructure after spending like crazy to boost economic output the past two decades. Plus there is the issue of taking on more debt by a highly indebted country.)

COMMENT

The hit Japan’s economy has surely taken will definitely affect the world. In the month’s ahead, we’ll have to watch and see what happens. I wonder how their insurance industry will pull through?

Posted by Elloise | Report as abusive

Americans growing more worried about debt

Mar 10, 2011 20:51 UTC

They are still more concerned about jobs —  but debt fears are growing, Gallup says:

gallup

Yes, discretionary spending is a big problem

Mar 10, 2011 20:30 UTC

Congress should be looking hard at dramatic discretionary spending cuts.  It’s really gotten out of control (via the Congressional Budget Office):

Such outlays equaled about 10 percent of gross domestic product (GDP) during much of the 1970s and 1980s, then gradually fell to 6.2 percent of GDP in 1999 . Thereafter, discretionary outlays began increasing relative to GDP— reaching 7.0 percent in 2002 and 7.9 percent by 2008— partly because of actions taken in response to the terrorist attacks of September 11, 2011, and subsequent military operations in Afghanistan and Iraq. In the past few years, discretionary spending has been boosted by funding provided in the American Recovery and Reinvestment Act of 2009 and by policy responses to the recent turmoil in financial markets. Discretionary outlays rose to 8.8 percent of GDP in 2009 and to 9.3 percent last year—the highest share of GDP since 1988.

And here is what is in discretionary spending:

dspend

Have Republicans forgotten Reagan?

Mar 10, 2011 15:38 UTC

My pal Charlie Gasparino questions whether the GOP is making a huge mistake by focusing so intently on cutting deficits and spending:

The GOP — where Jack Kemp and Ronald Reagan once saw a limitless future based on a free-market plan for growth — has become the party of green eyeshades, government shutdowns and dour predictions about our future, while the American people continue to suffer. …  In recent weeks, the left-leaning and bailed-out Wall Street firm Goldman Sachs offered what the mainstream media considered a credible take on how GOP efforts to block the president’s spending initiatives will slow our feeble economic recovery and modest reductions in unemployment. … Wisconsin Gov. Scott Walker and New Jersey Gov. Chris Christie have become GOP icons for their courage in taking on public-sector unions — but the broader appeal of their message of cutting budgets before cutting taxes is still questionable.

On the face of it, at least, Charlie may have the politics right. Here are two recent polls (via PollingReport.com) that look at national priorities. Both put jobs ahead of deficits.

polls1

Of course, what Republicans are trying to do is make the case that cutting spending is good for growth because a) it will prevent a debt crisis like Ireland and Greece have experienced, and b) it will shift resources from  low-productivity government to the higher-productivity private sector. And I think there is some evidence that the argument is starting to take hold, such as this recent Bloomberg poll:

bloompoll

That being said, I would like to see a clear and comprehensive plan to reform taxes and reduce regulation. Still waiting, though.

COMMENT

I hope so. Didn’t Ronald Reagan Jr recently confide that his father was suffering from Alzheimer’s during his second term as President. Which would still make him more forward-thinking than the tea-partiers.

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Who’s up, down for White House 2012

Mar 10, 2011 15:34 UTC

National Journal’s Hotline is out with its insiders’ take on the state of the Republican race for the White House:

nj

Obama’s nightmare jobs chart

Mar 10, 2011 14:07 UTC

The infamous Bernstein-Romer chart, now updated for political freshness:

hellchart

COMMENT

A real nightmare chart would include unemployment under the proposed GOP plan. It’s even higher than the ‘without recovery plan’ pattern.

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