I hate to sound like a deficit hawk, but…

I’d like to elaborate on this post more soon with more detail (and fun graphs), but the topic of fiscal policy and continuing federal budget deficits has been on my mind lately. My thoughts are:

  1. The economy is operating close enough to full potential that any Keynesian deficit-financed stimulus would potentially be counterproductive at this point. Similarly, continued annual deficits increasingly run the risk of crowding out private sector spending as resources are used to fuller capacity. If crowding out were to occur, interest rates would almost certainly rise, hurting growth. Though economic slack does remain, we should be increasingly cautious about running large-ish deficits in the coming years.
  2. Our long-term debt sustainability issues (which are our actual problems) certainly are not helped by short-term debt accumulation. Though acceptable in times of economic downturn and during recovery, short-term debt accumulation is less acceptable when an economy is both growing and has almost returned to near full operating capacity. If we continue to run structural (e.g. cyclical = 0) deficits, as we have for the past four decades, even in good times, our capacity to deal with the coming surge of entitlement spending will be greatly diminished. In many ways, though, we’re already too late on this regard.
  3. It might even be optimal to try to run a balanced or even more than balanced (e.g. surplus) budget for a few years. Normally, the rule-of-thumb is that, in the long run, annual debt growth (which roughly equal annual deficits) must be equal to or less than annual economic growth in the long-run (indicating that even balanced budgets are technically required for sustainability). Though this is now the case at the moment, our current deficit of around 3% of GDP is only small enough to about stabilize our debt/GDP ratio of around 75%, not reduce it. And arguably, reductions in debt/GDP would be preferable soon to give us more room for the coming entitlement spending and any future recessions we might encounter (and also to reduce the risk of a debt crisis).
  4. At the very least, we should continue to try to reduce our structural budget deficits while promoting long-term government investments (for example, in infrastructure, R&D, etc.). At the present time, further fiscal stimulus would seem inappropriate; the window for action has passed.
  5. Reduction of budget deficits is not only about timing, but rates of change (which is where the calculus comes in). Any plan must not just offer targets and amounts, but how quickly those targets and amounts are to be achieved and any feedback loops that might ensue
  6. None of the presidential candidates offers a viable long-term deficit reduction/debt stabilization plan, which is appalling. Indeed, many (especially Trump and Sanders) would dramatically increase our rate of debt accumulation in a very unsustainable way. Though many candidates offer proposals for productive spending, both that spending and, more crucially, the coming increase in mandatory program spending should be at least partially paid for, via tax increases or spending cuts. None elaborate on such a plan.

In my world, the government would:

  1. Enact reforms to mandatory programs (e.g. Social Security, Medicare, Medicaid) that progressively reduced benefit growth and raised more dedicated revenue (for example, by increasing the payroll taxes’ income cap)
  2. Reduce wasteful spending in the form of corporate subsidies (e.g. agricultural, fossil fuel), DOD procurement waste, redundant programs (for example, many overlapping government assistance programs)
  3. Raise general revenue (via reductions in excludability of health insurance from taxation, gradual phase-out of mortgage interest deduction, caps on deductions/deductability of some items, etc.)
  4. Modestly raise spending on direct R&D and R&D tax credit, transportation (highway) funding, job training programs

A more detailed discussion of the fiscal situation and solutions I would endorse will follow soon. But I thought it would be good to write down my general thoughts on the matter.

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Achieving a “2020” Vision

I wouldn’t be surprised if people on the internet have already used this play on words, but seriously – why isn’t this a major campaign slogan yet? Even if the vision is inarticulate and 2020 has nothing to do with the objectives, it’s still a catchy phrase.

But I take it one step further by integrating it into a neat little tax plan. Specifically: 20% flat rate. $20,000 standard deduction. By 2020.  It’s that easy.

Here’s how my dream plan would work:

  • Repeal the current income tax code.  Replace with a 20% flat rate applied to all taxable income (including capital income).  This provision contains a lot of benefits, with some amendable drawbacks.  A flat 20% rate would be fair and efficient.  Everyone could calculate it (exactly 1/5 of their taxable income), and its simplicity would destroy the artificial need for tax-preparation services.  This saves the economy billions in both dollars & hours.  It is reasonably fair – proportionally, everyone pays the same, but the rich still pay more in absolute amounts.  It would not change the tax owed by those with capital income too much (already, the top rate on capital gains is around 20%).  Additionally, its simplicity is pro-poor, who often lack the resources for tax consultation services.  Granted, it would represent, in some ways, a “tax hike” for many lower and middle-income people (who previously had lower rates applied to their incomes).  But this can be at least partially (if not fully) offset by a much higher personal exemption and preservation/improvement of a few antipoverty tax-credits (see below).
  • Introduce a $20,000 personal exemption for all households, indexed to inflation.  Starting in 2020, this generous exemption amount would be fully phased in.  It essentially means that not a penny of every dollar up to $20,000 per year will have the income tax applied to it.  In this way, people at or near poverty would not see their tax burdens increased (for many, potentially decreased compared to the current system).  Indeed, it’s at least five times larger than the current personal exemption ($4,000) and provides complete relief to people whose income is nearly twice the poverty line ($11,770/year in 2015).  The exemption amount would be adjusted for non-real increases in income (e.g. inflation) on an annual basis, chained to the index of the candidate’s choice.  Such a high exemption amount should help pave the way for elimination (or near-elimination) of any deductions (especially itemized deductions, such as the mortgage interest deduction, which primarily benefits wealthy taxpayers).  Among the biggest benefits in the vision’s exemption provision is that it allows for some continued progressivity in the tax code.  For example, a person with $20,000 in annual income would pay 0% in income taxes ($20,000 total income – $20,000 exemption = $0 in taxable income * 20% = $0 in taxes = 0% of total income); in contrast, someone with an income of $100,000 would pay about 16% in income taxes ($100,000 total income – $20,000 exemption = $80,000 in taxable income * 20% = $16,000 in taxes = 16% of total income).  So, the effective tax rate is progressive (increases by income), but it is proportionally the same for everyone above $20,000.

And there you have it.  Those two elements – the 20% rate with the $20,000 personal exemption – form the 2020 in the plan.  Benefits, already described somewhat above, include:

  • Simple calculation
  • Elements of fairness (combo of progressivity and equal proportionality)
  • Would likely boost growth & efficiency of tax collections
  • Could very well boost economic growth
    • simple calculation = less time & resources devoted to calculation = higher productivity, savings
    • lower rates boost economic demand and/or supply

Drawbacks include an uncertain impact on the federal budget and the tax burden of the poor/middle class.  For the former, there is reason to think that this plan could well boost tax revenues (thereby helping to close the annual deficit).  The simple calculation of the tax could boost compliance, and the higher growth it could produce would mean higher incomes = more revenues.  Additionally, the elimination of many deductions and credits would save a ton of money; currently, federal tax expenditures total around $1 trillion per year.  As for the burden on the poor/middle class, this plan could entail the loss of several tax credits or deductions that currently benefit them.  To mitigate the impact, some of these credits/deductions could be maintained, but at the threat of making the plan less fiscally sustainable.  Additionally, the impact on those whose incomes are not high but fairly above the poverty line (e.g. those above $20,000, but not too far above) is concerning; it’s unclear whether the proposed tax plan would represent a sizable increase in their tax burden relative to the current system (despite the $20,000 exemption).  People will also scream that this is a tax cut for the rich (who face marginal tax rates of up to almost 40% in the highest income quintiles).  However, it’s important to remember that even the effective income tax rate of the richest in America usually comes in around 20%.  With the 20% rate applied to all of the income of the super-rich (except the first $20,000), their effective rate will basically be 20%.  And with the elimination of some of their favorite deductions and loopholes, it could even represent a tax hike for them.

For too long, our political system has been paralyzed by short-term thinking and an unhealthy attachment to everyday opinion polls.  Now more than ever is the time for policymakers to start projecting clear, attainable visions for the future, with workable frameworks.  When it comes to the tax code, this plan isn’t anywhere near perfect; not by a long shot.  But it’s a place for them to start.

 

 

 

American Freedom: it’s time to put a ring on it

Well, this is it. Any day now (possibly within just hours of this posting), the Supreme Court will finally determine the constitutional status of gay marriage nationwide; and in the process, will likely end up overturning the few remaining barriers to a new era of positive freedom for the United States. Though being deliberated on by just nine elderly justices, I’m confident their determination will reflect both the overwhelming tide of public opinion and the true meaning of liberty as intended by the Constitution. It is something that is inevitable; it is something that is unprecedented; and simultaneously, at the same time, it is something that is long, long overdue.

To many, this will be a bitter pill to swallow (surprise!) . I know, because at one point, that would’ve been my situation. Social conservatism is a very powerful force in this country. That’s not at all inherently a bad thing (I’d argue much of that sentiment is actually a force for much good), and many well-meaning, good people, people whom I love very much, hold very traditional, socially conservative values.  And they have a right to do so.  But the ideology and core beliefs that they espouse has a tendency (sometimes, but not always) to overrule independent thinking, or the ability to think of different possibilities and to adapt accordingly (although to be fair, that’s generally true for all ideologies).  The value system that structures “traditionalists'” world, in reaction to a non-traditional concept, tells them no, or that it’s wrong, and that no other reality can or ever should exist.  Whether it be for moral or religious or status quo reasons, preservation of “tradition” (as constructed) is key.  Anything else is a threat, and is labeled as wrong and undesirable accordingly.

I deeply understand all of this; again, like I said, I was at that point once.  But I strongly challenge all those who still hold “traditional” views to seriously rethink their positions; if not on every social issue (which is understandable), then at the very least on this issue of gay marriage.  Because the arguments for gay marriage are simply overwhelming on all angles – from a societal, economic, and moral standpoint.  Now, it should go without saying I won’t be able to address anywhere near the full amount of arguments both sides pose (nor do I really want to), and I’m certainly not an expert on anything.  But here are a few brief things that I think people who oppose gay marriage should consider (and yes, full disclosure, my opinion is injected into many of these arguments):

1)  First and foremost, having “unconventional” attractions is simply NOT a choice.  Too many people, too many studies, too many instances in the animal kingdom confirm this.  And I have no idea why someone would EVER choose (given rampant societal discrimination) to have “unconventional” attractions.  It’s a perfectly natural thing that just is.  If this cannot be swallowed, spend some time on it (especially if you want to even begin considering gay marriage pros/cons).  If second-hand sources don’t suit you, then please, go out and meet people who have these “unconventional” attractions (there are many such people – more than you’d think – and whether they identify as LGBTQ or not).  Your perspective will be transformed; perhaps not instantly, but inevitably, it will be.

2) America is (quite simply) built for freedom (including religious) and the pursuit of happiness.  If you object to gay marriage, you can freely say so, refuse to endorse it, say you think it is wrong, etc.  Those are all legitimate beliefs you are entitled to personally have.  But America’s promise is to allow all people to live their lives as they see fit to pursue happiness (as long as they are not harming anyone else).  If you object on religious grounds, that’s fine; but America is not about forcing people (via the government, of all institutions) to be confined to your beliefs, or for you to be forced to follow theirs.  Let’s not deny any group of people their right to pursue happiness; especially those who are not harming others or infringing upon anyone else’s rights.

3) Gay marriage does NOT harm anything, including the institution of marriage.  Quite the contrary; it bestows countless benefits from almost every angle imaginable.  To put it in a rambling, incoherent sort of way: economically, expanded marriage rights increases people’s financial security, decreasing expenditures on social assistance programs. This reduces the budget deficit, resulting in lower-than-status-quo-trajectory debt levels.  Psychologically/economically, expanded marriage rights boosts happiness/self esteem, leading to higher productivity and more economic growth. This allows for more tax revenues/less social expenditures, again resulting in a lower budget deficit and lower-than-status-quo-trajectory debt levels.  Socially, expanded marriage rights helps to save (not destroy) the institution of marriage, which is already crumbling due to 50% + divorce rates among “traditional” marriages.  Socially again, expanded marriage rights helps to reinvigorate the nuclear family (again, crumbling largely due to high divorce rates).  Again from a social standpoint, marriage is not an unchanging institution (it has changed countless times over centuries and millenia).  Thus, the expansion of marriage rights does not constitute an attack on marriage.   Socially/morally, expanded marriage rights allows for continued/easier discussion on the inherent humanity and entitlement to equality of LGBTQ people, providing progress towards further acceptance and integration (among other economic, psychological, social benefits, etc.).  Morally, it also represents a basic expansion of positive freedoms (freedoms to do something, not from something), which, especially in this case , is a very good thing.    And the list can go on and on and on.

Nothing I’m writing here is in any way revolutionary, or is something that hasn’t been said before. Really, all I’m doing is simply adding my voice to the voices of millions of my (far more courageous) fellow millennials in calling for full marriage equality within the United States, and providing a short list of supporting rationales. But I felt like I should at least go on record expressing said support, mere hours/days before a ruling, even if it ultimately does nothing to change the minds of naysayers.  Because right now, fifteen years into the 21st century, it is time for American freedom to start reaching its fullest extent possible – and for us to finally do the right thing, and put a ring on it. Those who have been denied the right to marry whom they love, simply because of who they are, surely deserve nothing less than that.

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Not yet, Janet: America’s still not ready for a higher target rate

A common observation of my blog by readers is the fact that I don’t oftentimes take strong positions on the issues I discuss.  At first,  I took these comments with great pride, because being impartial and presenting multiple possibilities to a question is the defining hallmark of the economics profession.  President Harry Truman once remarked: “Give me a one-handed economist! All my economics say, ”On the one hand, on the other…”.  But, as the Truman quote suggests, this is not always a splendid thing.  People want precise answers and opinions; and although I do oftentimes think in ways that incorporates both sides of an argument, I am not without biases of my own.  So to mix it up a bit, I’m going to prominently infuse those biases into the posts I make.

And what a perfect time to do so, because policymakers (particularly of the monetary kind) have some big decisions to make soon.  The context can be painted as the following: the American economy is finally operating close to (or much closer to) its productive capacity.  Official employment is almost “full” (with U3 at 5.5% in May), and wages are finally beginning to rise at a faster clip (nominal wages are up 2.3% year-over-year in May, the fastest since 09′).  But inflation remains very subdued, with year-over-year core PCE and CPI inflation rates still hovering between 1 and 2% (below the Fed’s 2% target).  The Fed, under the direction of chair Janet Yellen, has indicated (currently and historically) that it’s target for the Federal Funds rate (the key rate on overnight bank loans) will be raised once these thresholds are approached.  But there’s a few reasons why I think it needs to wait longer:

1) Historically, inflation hasn’t spiked when unemployment fell below its estimated “NAIRU” rate.  As noted elsewhere on this blog, as the U.S. economy reaches it’s productive capacity (equilibrium), this is likely to push up wages as employers compete more for a scarcer supply of workers. This helps to produce “wage-push” inflation; businesses hike prices to pay for higher wages (at least partially), and workers use their higher wages to push up aggregate demand in an economy already producing at capacity.  These capacity constraints also help to produce the “too much money chasing too few goods” explanation of inflation.  This means that, theoretically, we should see a rise in inflation very soon.

Except we probably won’t.  Why?  Due to historical experience and the readings of several other economic indicators, I don’t think the economy is actually near full capacity yet.  In other words, our estimates of the non-accelerating inflation rate of unemployment (NAIRU) are too high.  The experience of the 1990’s (as elaborated on by Jared Bernstein and Dean Baker) provides support for this view.  Near the end of the decade, unemployment plummeted – from 5.6% in 1995 all the way down to 4% by year 2000.  NAIRU estimates for the year 2000 were consistently higher than the actual unemployment rates achieved; starting at 5.4% in 1994, those estimates actually increased to 5.8% in 1996 before dropping back down to 5.2% by year 2000.  In other words, economists expected inflation to start accelerating once U3 unemployment reached and fell below these rates.  Yet, as the charts below demonstrate, inflation (especially PCE less food & energy) barely budged during the 1990s – and actual unemployment rates were far below NAIRU estimates!  Part of that was no doubt due to the late 90’s productivity spurt, but productivity is still growing at a decent (if not stellar) clip right now, meaning more output can be produced with a given (or less) amount of input.  As more output can be squeezed out of given inputs, there is less of a need to raise prices to maintain profitability.  If now is anything like the late 90’s, productivity growth can absorb wage growth/cost pressures for a while before businesses will have to raise prices to maintain profits.  In other words, unemployment could fall a ways further from its current 5.5% rate before we start to see inflationary pressures, which means that our current NAIRU estimates (around 5-5.5%) are too high.  This would make sense; I feel like, ever since the 1970s hyperinflation episode, policymakers have been overly cautious in making sure that policy tightening begins before inflation gets too high.  Thus the artificially high NAIRU estimates.

Source:

Source: “The Unemployment Rate at Full Employment: How Low Can You Go?” by Jared Bernstein and Dean Baker. http://economix.blogs.nytimes.com/2013/11/20/the-unemployment-rate-at-full-employment-how-low-can-you-go/?_r=1

Source:

Source: “The Unemployment Rate at Full Employment: How Low Can You Go?” by Jared Bernstein and Dean Baker. http://economix.blogs.nytimes.com/2013/11/20/the-unemployment-rate-at-full-employment-how-low-can-you-go/?_r=1

Additionally, there are the countless other indicators that suggest the economy is still being underutilized.  The more comprehensive U6 unemployment rate, which, as the BLS describes, measures “…total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force”, still stands at 10.8% in May 2015 (seasonally adjusted).  The employment-to-population ratio has also yet to recover from the recession, standing at 59.4% in May 2015 (down from a cyclical high of 63.4% back in December 2006).

2) It’d be good to have a long period of low unemployment after the disastrous labor market of the past few years.  As everyone (especially recent college graduates) knows, the job market hasn’t been stellar for a while; it’s only just getting back to “normal”.  U3 hit a 3-decade high of 10.0% as recently as late 2009, the U-6 measures were even higher, and worst of all, long-term unemployment as a share of the unemployed hit both a record high and stayed high for a record amount of time (see chart below).  Such high rates of unemployment for such long periods of time undoubtedly have helped destroy millions of household finances over the years while also threatening to create structural unemployment (as skills atrophy and people become less “employable”).  I think, like a yo-yo, such high and extended periods of unemployment should swing the opposite way: exceptionally low unemployment for an exceptionally long period of time.  This will aid households in naturally repairing their finances (which did appear to actually “improve” over the years, but it seems personal bankruptcy and/or exceptionally painful (destructive?) saving were the main reasons).  It will allow workers to practice their skills and boost their self-esteem (which can create a virtuous cycle of higher productivity).  Additionally, it can also help to generate wage pressures so wages can “catch up” the ground they lost (as in, the growth that would have occurred had the economy been operating at full capacity since 2007).  Some might argue that this could threaten profits too much; however, coming at the heels of several years of record profits and high volumes of cash reserves, I think employers would be able to healthy absorb wage hikes for a fairly long period of time before this became an issue.

3) Continued loose policy would help counteract an over-appreciation of the dollar.  The U.S. dollar has gained rapidly against a basket of currencies since last fall (up by a full 21% against the Euro since this time last year).  There are many reasons for its rapid rise – a collapse in oil prices, investor confidence in the strength of the U.S. economy, and – ironically enough – investor expectations of a target rate hike.  The concern is that either this appreciation continues or that its rapid rise has already done too much damage.  Stronger currencies make exports more expensive (by boosting the relative prices of exporters and decreasing their competitiveness) while simultaneously making it relatively cheaper to import.  Though the latter is good for consumers, the combination of lower exports and higher imports wreaks havoc on the trade balance (which, for America, is almost always in deficit), thereby lowering GDP growth.  Arguably one of the biggest forces restraining the dollar from rising much further is a continuation of loose monetary policy.  End it, and the dollar rise alone could stall a still rather mediocre recovery (by historical standards).  Along with the other reasons above, it’d be preferable to continue a low target rate at least until some of the other pressures are alleviated.

4) Even if it did threaten to raise inflation a bit above current targets, this wouldn’t necessarily be a bad thing.  Look, too much inflation is bad.  Everyone knows that rising prices squeeze family budgets and distorts economic decision making (shifting future demand into the present to avoid higher future prices, leading to a negative feedback loop of higher inflation).  It’s literally a hidden (or not-so-hidden) tax that eats up the purchasing power of savings and investments.  But a little bit of inflation is not a bad thing.  Stable, fairly low inflation can actually benefit an economy.  It makes wages less sticky by placing pressure on employers to raise them (so employees can maintain cost-of-living).  By lowering the purchasing power of dollars spent on repaying fixed-amount burdens, it also reduces the real debt of indebted consumers who, after becoming extremely over-leveraged during the 2000s, could still use some relief so they can resume healthy (but moderate) spending.  This reduction in real debt burdens also goes for the federal government (whose $18 trillion tab, while manageable in a $17 trillion economy, could still use some relief).  Inflation a bit above the current target of 2% (say, 3 or 4%) would still be manageable; and in my opinion, is absolutely worth it if low unemployment can be attained.  Now, this does present a credibility problem for the Fed; it’s consistently stated that 2% target figure, and if inflation were to rise higher than that, then it could spook investors and lead to concerns that the Fed will not contain it (and that another Weimar Republic-style meltdown is on its way).  So perhaps the Fed should inform investors of a new, slightly higher target rate, while making it clear that absolutely no higher rates will ever be tolerated.  It might help to remind economic agents that these targets didn’t even exist as recently as 40 years ago, so it’s hardly like they’ve remained consistent.

5) A recession can still be handled by both fiscal and monetary policy, even if rates start out at zero.  So what if the Fed can’t lower nominal rates any further?  They have Q.E. and a general unlimited capacity to purchase securities, emergency lending capabilities, operation twist, forward guidance, etc., etc.  And there are tens of thousands of governments in the United States that theoretically have the capability to engage in expansionary fiscal policy (though the Federal government, with its unique status of having no balanced operating budget requirement, will probably remain the most potent public sector actor).  If you raised rates now and caused a recession, you probably still wouldn’t be able to cut them that far anyway (since they probably won’t reach that high before equilibrium is breached).

6) Savings rates were plummeting anyway…and the boost to equities is (arguably) still good.  Due to a myriad of factors (wage stagnation, cultural shifts, a global savings glut, etc.), Americans no longer save the way they used to.  Indeed, in 2005, the savings rate went negative for the first time since the Great Depression, and in recent years has only climbed back up to around 5%.  Too many trends outside of the Fed’s control will continue to keep downward pressure on savings rates.  And there’s no guarantee that a rise in the effective Fed Funds rate would necessarily translate into higher interest rates for savers (in savings accounts, C.D.’s, etc.)  Additionally, the effect of the Fed continue to purchase securities to maintain a low effective Fed Funds rate is to lower the yield (and boost the price) of bonds/securities, making equities relatively more attractive (for their higher returns).  This has allowed the stock market to soar, bolstering the “wealth effect” for households (prompting them to spend more) and increasing the returns to retirement accounts tied to the equity markets.  And we can’t forget the impact of low rates making long-term borrowing (e.g. for mortgages) easier, translating into higher house prices (and thus greatly boosting the wealth-effect for the middle class).

Overall, then, the argument against raising rates now is clear.  Now granted, the target rate will have to be raised eventually (probably within the next year or so) – these positive effects will not last forever, and there is a risk of overshooting targets and objectives if rates stay low too long.  But it’s time to break from the past policy hyper-conservatism and boldly declare a new approach; today’s challenging economic environment requires nothing less.

Building a New Era of Governance – Part 1

*Note: the views expressed in this posting are my own, and do not in any way represent the views of any other group or institution, public or private


Last Tuesday, November 4th, it is fair to say that the second Republican “wave” since 2010 swamped Congress and state governments across the nation. In Congress, the GOP managed to pick up at least 7 seats in the Senate (giving them a majority of 52, over the key threshold of 51), as well as at least 12 seats in the House (increasing their majority to at least 244). Gubernatorial elections also proved to be a route for the Democrats, as the Republicans snatched up another 3 governor-ships from the Democrats.

Despite these impressive gains, however, they will prove to be utterly meaningless unless Republicans in Congress can seize this opportunity to act in a bold, pragmatic, and bipartisan manner to go about conducting the nation’s business. More than anything, people are simply disgusted and fed up with what is shaping up to be (by many measures) one of the least productive governmental terms in American history (see chart).  While some may view inaction as a good thing (less activity means a smaller government = good, right?) I do not see this stagnation as benefiting anyone.  Even if few bills are passed, old ones already enacted are left to atrophy and will not be updated regularly to adapt to changing circumstances, creating new problems.  Additionally, it takes legislation to repeal legislation; inaction does not mean the government is in fact getting any smaller (and assuming a smaller government is even desirable in the first place).

Overall, as many pundits have noted, it is best to view the results of this election as an expression of disillusionment with a lack of leadership on either side of the aisle and a desperate plea for governance, as opposed to an endorsement of some ideological mandate. Especially when it comes to Congress, people are incredibly irritated that its members are well-paid, work part time (with much of their time spent campaigning), and yet very little of the country’s increasingly urgent problems are attended to. It is true, what many business-minded people would say: if the government were a private entity, they would’ve pushed out of the market a long, long time ago.

4.10.14.2

In terms of bills passed per legislative session, the 113th Congress is shaping up to be among the least productive in recent history

It is true that the outlook for an increase in Congressional productivity remains bleak, at least for the next two years. It’s a well-established pattern by now that American government doesn’t do too much unless a single political parties occupies both the Whitehouse and controls both chambers of Congress. However, this need not be an excuse for inaction; in fact, it cannot. The following is an agenda that I think Republicans can pursue that will not only help to solve the problems the public wants solved (and in a way that is congruent with the wishes of the electorate), but to help to build a new era of lasting American governance.

1) Lengthen the terms of the President, House, and Senate.  Of the many issues facing the country, this one (along with the next two agenda items) may seem like one of the least deserving of our attention.  However, relatively short Senate, Presidential, and (especially) House terms I believe has had a dramatic impact on the productivity of individual members.  Since elections come so frequently, many in the federal government must be in a near constant campaign mode that not only distracts them from legislative work but serves to polarize their “views”, making bipartisan consensus much more difficult.  At least attempting a Constitutional amendment, though quite unlikely to pass, could get the ball rolling on a future reform down the road.  Enactment of this reform, along with the following agenda item, could help to address the entrenched legislative paralysis.

2) Find a way to tie Congressional & Presidential pay to performance.  This one would be tough to implement (requiring another Constitutional amendment) and to find sufficient political support for, but I think it is an absolute must if we are to make meaningful legislative activity a core incentive for our politicians.  In my view, an independent committee (much like a state-level Civil Service Commission) would simply be given power to set Congressional & Presidential salaries and benefits upon a non-biased, impartial “performance review”.  This commission would be made up of individuals equally divided between the main political parties and would themselves be subject to background checks to ensure institutional independence

Many other potential reforms, such as a partial or complete scrapping of First-Past-The-Post (FPTP) representation in favor of more proportional representation and the outsourcing of congressional redistricting to independent commissions could help to both decrease the partisanship of the federal legislature and increase the “representative-ness” of individual members of Congress.  Ironically, the prospects of these reforms passing is weak at best; nonetheless, they would be crucial for the government to enact productive agendas in the future, and thus should be given priority in the agenda of the 114th Congress, even if chances of passage are slim.

As for other politically-feasible policy objectives that should be on the Congressional calendar:

3) Immigration reform.  No, seriously.  As discussed in more detail in my post “Why Republicans Should Embrace Comprehensive Immigration Reform”, the United States is in desperate need of both low and high-skilled labor, especially as the population ages in the coming decades.  Allowing in more immigrants (especially high-skilled) is not only politically reachable but is in line with a Republican emphasis on supply-side economic reforms.  Emphasis on increased border security (which is a prerequisite for any action for the party base, even if redundant and impractical) could be combined with reforms and/or increased funding to streamline the legal naturalization process.  At the very least, both Democrats and Republicans agree on the need for more high-skilled immigrants and an increase on the cap for H-1B work visas.  Increasing visa caps could help stem the tide of illegal immigrants (which Republicans are more concerned about anyway) via the substitution effect.  For best chances of passage, I would leave out measures that deal with illegal immigrants currently residing in the U.S. – a piecemeal, incremental approach would work best here.  Overall, immigration reform is an almost cost-free method to spur the economy in both the short and long-term, and considering how long it has been on the national agenda, it is incomprehensible that some sort of agreement cannot occur.

Due in part to an aging population, the U.S. Labor Force Participation Rate has reached levels not seen since 1978, increasing the need for new sources of labor

4) Corporate tax reform 

Again, opportunities for bipartisan agreement are rife here.  Everyone knows the corporate tax code is an unmitigated disaster, with high rates, too many loopholes, lost revenue, and distorted economic activity.  Make the system more territorial, modify depreciation schedules, scale down MNC deferral opportunities, eliminate tax expenditures, and reduce marginal rates.  Specific expenditures that are especially worthy of the chopping block are special preferences for oil & gas operations, insurance companies, corporate jets.  This operation need not be revenue-neutral, either; although this would technically constitute a tax “increase”, the removal of distortions and tax compliance hurdles will act as a counter-acting tax cut.  The government can gain revenue by increasing effective rates while simultaneously increasing growth and leaving businesses feeling better off than they do under the current tax regime.

5) Replace the sequester with targeted cuts & incremental, implement long-term reforms

The era of yawning short-term fiscal deficits is over – temporarily, at least.  Indeed, America has witnessed its fastest pace of fiscal consolidation since World War 2, with deficits as a percentage of GDP falling from 9.8% of GDP in FY 2009 to 2.8% of GDP in FY 2014 – a swing of 7% in just 6 fiscal years.  This has come about due to a variety of factors, including economic growth, slightly higher taxes and broad-based cuts to discretionary outlays.  It is this last option that is cause for concern, however, as the cuts initially enacted in the Budget Control Act of 2011 (the founding legislation of the so-called “sequester”) are quite blunt.  They also come at a time when discretionary spending is approaching record lows as a percentage of GDP, and arguably when increased federal spending on items such as infrastructure are desperately needed and interest rates remain at historic lows.  Additionally, they have subtracted from economic growth in the short-term, lengthening the time needed to close the output gap between real and potential GDP.  As has been projected for decades now, the biggest threat to American fiscal sustainability is the coming explosion in mandatory spending.  Therefore, the new GOP-led Congress must enact gradual but effective entitlement reform now – the longer it waits (as past Congresses have), the more abrupt the future adjustment.

Fiscal policy has not been this contractionary since the end of World War 2

Fiscal policy has not been this contractionary since the end of World War 2

Economic growth since 2009 has increased revenues and decreased "automatic stabilization" spending.  Meanwhile, higher taxes have also increased revenues, and new spending cuts have been enacted.

Economic growth since 2009 has increased revenues and decreased “automatic stabilization” spending. Meanwhile, higher taxes have also increased revenues, and new spending cuts have been enacted.

Non-defense discretionary spending has fallen to record lows as a percentage of the American economy

Non-defense discretionary spending has fallen to record lows as a percentage of the American economy…

...even as interest rates remain at record lows

…even as interest rates remain at record lows

Debt Held

The true threat to America’s finances comes from the coming explosion in mandatory “entitlement” spending. Congress much enact tough reforms now to stem this tide of red ink.

 

To be continued…

The Imperative of Tax Reform in a Distracted World

Taxes. Nobody likes them, nobody wants them, and they’re only considered good when they’re going one direction: down. But they are fundamentally necessary for any society to function. In fact, if levied at moderate rates and the revenues they generate are properly spent, taxes are key for societal prosperity.

In America’s case, taxes are generally somewhat lower, especially at the federal level, compared to other developed countries . This is not to say that Americans don’t pay a significant amount of tax. Being a country with a sizeable tax burden and one that is relatively low tax are not mutually exclusive concepts. Still, at the federal level, marginal income tax rates and top rates are generally lower than those prevailing in Europe, and a Federal sales tax simply does not exist (also unlike Europe). When factoring in state and local taxes, levels are equalized a bit more, but burdens still are generally lower in America.

Figure-2

Americans’ average tax burdens generally lower than peer countries

However, looking at rates and the revenue bite is only a part of the burden story. As is often said, America’s federal tax code is, quite simply, horrendous. In addition to the normal complexities of a progressive system (e.g. different rates for different brackets at various stages of income generation), the tax code is stuffed with various deductions, exemptions, credits, and loopholes that impose a not-so-insignificant burden on all Americans.  In the aggregate, this complexity is in itself a massive tax (or set of taxes). Precious time and real dollars must be spent to navigate and understand the code, resources that could be used for far more productive uses. The real tragedy of all this complexity is that it ultimately benefits no one in the end. The government does not generate revenue from complexity (indeed, it loses revenue from the loopholes and from reduced economic activity). Society as a whole wastes resources that could otherwise generate positive returns to try and minimize their burdens. The result is the potential for slower growth and lower living standards than would have been the case.

In this way, the net economic burden of America’s federal tax code could actually be on par with (or even exceed) the burden experienced in European countries (especially when including state and local codes). It is naturally rather difficult to put a value on this non-revenue burden, though most estimates place it at at least a few hundred billion dollars annually for the country as a whole.

Since personal income taxes represent a sizeable portion of the federal tax code (and its various complexities), many proposed “solutions” to the federal tax code burden (assuming it is labeled as a problem) focus on restructuring the federal income tax. One of the most popular proposals is replacing the current structure with a flat personal income tax.

policybasics-taxrevenues-f1

The Income Tax is the single largest source of Federal Tax Revenue

There are many laudable benefits to a flat tax. For one, it would be much easier for each taxpayer to calculate his or her “effective tax rate”. With a progressive income tax, rates change as income progresses. For (hypothetical) example, each dollar of taxable income within the $1 to $9,999 range would have a rate applied to each dollar, say, 10%. However, dollars within the $10, 000 through $19,999 bracket would have a different rate, say 15%, applied to each dollar. Naturally then, this makes calculating the effective tax rate (the total amount of tax as a percentage of total income) rather difficult. With a flat tax, however, there are no brackets – for all taxable income, the same rate is applied to each dollar. This makes the flat tax rate and effective tax rate essentially equal (assuming no credits, deductions, exemptions, or loopholes). In this way, unlike the current income tax structure, an individual can know with much greater certainty how much of their income will be withheld.  The need to outsource tax liability calculations to a firm is reduced, if not eliminated, freeing up resources and largely destroying a major source of federal lobbying efforts.

Second, in my view, a flat tax conceivably has something for everyone to like. It is simple, transparent, and does not penalize people who generate more income, which is especially important to conservatives . They see it as being neutral and as a means to boost individual productivity, efficiency, savings, and investment. However, a flat tax still makes people with higher income pay more in absolute amounts. The difference is that the proportion of income that goes to taxes is the same for everyone. For a simplistic example, let’s say there are two individuals A and B. Say A has a taxable income of $100 and B has a taxable income of $1000. If a flat rate of 10% is applied, A will pay $10 in tax while B will pay $100. B, being higher income, still pays more than A in taxes. But the proportion payed is the same for both A and B. This seems fair and attractive to both ends of the American political spectrum.

Third, the elimination of brackets and all of the other complexities riddling the current code would likely boost public confidence in the government and would reduce the feeling that a person is being unfairly taxed at arbitrary rates within arbitrary brackets.  This increased confidence might boost tax collection and faith in political institutions, which has been severely lacking in recent years.

Of course, the flat tax has many drawbacks. One of the most important concerns raised by critics of the flat tax is that it lacks the counter-cyclical elements of progressive income taxes.  For example: during a recession, incomes generally fall.  Falling incomes will place individuals in lower top tax brackets (meaning they have to “progress” through less brackets).  This means a lower effective tax rate – in essence, the structure of a progressive tax code means that it provides an effective tax cut during recessions or periods of slow economic activity.  In other words, it acts as an automatic stabilizer.  This is not so for flat taxes – the rate is always the same, regardless of changes in income.  The only route for effective tax cuts in a flat-tax world is via discretionary fiscal policy – actual legislative action – to reduce the applied rate.  This runs into the problems of policy lags – recognition lags, implementation lags, and impact lags.  It takes time for policymakers to identify economic conditions and the need for change, more time to actually make and implement a policy change, and even more time for an implemented change to have an affect – by which point, the policy change may be inappropriate for the macroeconomic environment.  If policymakers ever move towards a flat tax one day, they may have to consider a revamp of federal automatic stabilization systems for smoothing out the business cycle – and if not, the onus of economic stabilization will continue shifting towards monetary policy.

A second and virtually identical concern is the lack of progressiveness of flat taxes.  The US income tax code is currently considered among the most progressive in the developed world.  However, overall progressiveness in America’s redistribution systems is rather low, as many other federal, state, and local taxes are regressive, and “social assistance” programs, regardless of their impact of work incentives, are fairly skimpy by rich country standards.  Make the income tax code flat, and you remove a major source of progressiveness in America’s redistribution systems and would almost certainly increase after-tax income inequality.  Depending on your views regarding redistribution and income inequality, this could be either a good thing or a bad thing.

Regardless of whether a flat tax is pursued or not, it is (quietly) agreed by both the American Left and the American Right that the tax code needs radical simplification.  Right now, though, the imperative of tax reform has been pushed to the side to make way for a focus on ISIS, poverty reduction, immigration, and healthcare issues (to name a few), and ironically, the complexities that tax reform would attempt to solve helps to further ensure that such reform never takes place.  It is overcoming this entrenched policy stagnation that is the great task of our times.

Caught Between Iraq and a Hard Place

Just a few years ago, things were looking up for the Middle East.  The Arab Spring , in which peoples across the region rose up to overturn oppressive and authoritarian governments (many of them dictatorships), spread like wildfires in 2011 and 2012 across the region, raising the prospects of the establishment of liberal democratic institutions.  World oil prices, having plunged during the Great Recession (with some indices reaching a low of approximately $30/barrel in late 2008 and early 2009), rebounded sharply as the aughts came to a close, propping up the region’s oil-dependent economy.  After a brief conflict with Gaza, the Israeli-Palestinian conflict grew quieter, and there existed emerging optimism that American-led interventions would finally be drawing to a close.

What a difference a few years can make.  The Arab Spring has collapsed, having produced only one quasi-legitimate democracy (Tunisia).  Many authoritarian governments remain intact, and even the ones that were overthrown (such as the regime of Egyptian President Hosni Mubarak) were replaced by illiberal “democracies” that have since slid back towards authoritarian tendencies (or outright coup d’états).  Oil prices gains have stalled, having yet to reach their mid-2008 peak, and the Israeli-Palestinian conflict has yet again reared its ugly head.

Of the many fires now consuming the region, however, none are quite as disheartening as the disintegration of Iraq.  The steady march of the so-called “Islamic State” (IS) across much of northern and central Iraq has caused horrific casualties and undermined the already struggling legitimacy of the regime in Baghdad (which has pretty much collapsed with Nouri al-Maliki’s resignation on August 14th, 2014) .  That this follows a multi-trillion dollar 9-year American-led war there, whose purported objectives was to establish a peaceful, legitimate Iraqi liberal democracy, makes this disintegration especially galling.

Barely two and a half years after pulling out the last American troops there, the US is (according to Vox.com) yet again contemplating sending in troops of some form or another, mainly to help save the minority Yazidi population currently trapped by the IS.  The decision as to whether to pursue further intervention into the broader conflict, however, is muddied by a few complicated factors:

  • Who exactly are the “good guys” and “bad guys” here?  This seems like a ridiculous question, especially considering the horrific brutality of IS tactics and the fanatical ideology they espouse.  However, just as in the Syrian Civil War, the existing alternatives to IS rule (including the pre-IS status quo) aren’t exactly ideal either.  Indeed, the (now nonexistent) Shia-dominated government of Nouri al-Maliki has reportedly continued to persecute Iraq’s Sunni minority, and has not formed a government representative or inclusive of Sunnis.  While most Sunnis do not appear to favor IS either, many are frustrated with the regime in Baghdad.  If the US intervenes in support of the Iraqi government, it would be doing this with full knowledge that it, like the IS, has also committed many abuses.  A choice has to be made between the lesser of two evils – you really can’t win here.
  • The IS is providing needed social services to many Iraqis.  According to PBS, the IS has established and funded a variety of social services to much of the population in its territorial control.  While this is obviously a tactic to buy-off the population and garner support, it does provide a modicum of short-term human security (and thus, potentially, stability).  Also, some services, such as healthcare, education, power, and water, etc.  have the potential to promote economic development and diversification (and thus long-run stability), although whether growth & development or quality services come first is admittedly a longstanding chicken-and-egg controversy in the economics profession.  Diversification, especially, is key to long-term economic prosperity in Iraq, which still disproportionately relies on oil production to generate wealth and to provide fiscal resources.  Such dependency reflects a classic case of the resource curse, whereby the resource at hand (in this case, oil) stunts development in the long run by appreciating the currency and making industrial exports uncompetitive.  Thus, ironically, the IS could be indirectly (and inadvertently) promoting the long-run social and economic well-being of the country via its provision of these services, and efforts to stop it could do the opposite.  Of course, this ignores the profound violence and economic disruption caused by the IS, not to mention the groups’ many other non-negligible negative qualities.  But it is something to consider by the Americans and the Iraqi state (and other involved actors) as they consider how to move forward.  Perhaps a reshuffling of Iraqi budgetary priorities is in order?
  • Substantial American opposition to US military intervention.  Simply put, Americans are really, really war-weary.  They are tired of the very real human and financial costs of war, and feel like Iraq (among other interventions) is a hopeless basket case that should just solve its own problems.  The difficulty that Barack Obama and the American government faces is the conflict between pragmatic action (which, given the uncertainty and number of variables involved, has yet to be defined) and appeasing the electorate (mostly for the sake of his party, as he is no longer eligible for reelection, although presidential legacy is always an influencing factor as well).
  • Would US intervention help or hurt Iraqi, American, and global interests?   What exactly are those interests in the first place?  These questions are very, very broad.  First, it must be asked which Iraqi domestic scenario is in the interests of the Iraqi people.  A Shia-dominated government?  A Sunni government?  A mixed government?  State partition?  Some have even questioned, especially since the Iraq war, whether democracy is even in Iraq’s best interest at this time, considering cultural factors and lack of established democratic precedent in the country.  This relates to the debate as to whether growth and form of government are best compatible, and which should be emphasized first.  For America and the globe, there are questions as to whether a certain Iraqi domestic situation is best for regional stability, especially when it comes to providing a counterbalance to the hostile Shia-dominated government of Iran.  How about oil price stability?  Since the commodity price surge of the 2000s, the global economy has certainly adjusted to higher prices and more prepared for price shocks via structural efficiency gains (note that the Great Recession was preceded by an oil price shock in which prices exceeded $100/barrel; prices have since consistently been around $100/barrel, and yet global growth has long since resumed).  Thus, conflict in Iraq might not be as much of an economic red flag as it once was.  But it still is important.  Considering all of these different questions (a non-exhaustive list which has been provided here),  it then has to be determined whether American military intervention of any form would help or hurt all of those interests.

Personally, I have no concrete opinion as to what course of action I think should be pursued.  Like so many subjects in the realm of public policy, each action has its costs and benefits, the net effect of which is extremely difficult to ascertain.  Literally millions, if not billions, of variables are at play here.  Yet in the end, a choice must be made by America’s leaders, even if that choice is ultimately to do nothing.  Regardless of what they choose, they can be assured to face unflinching judgement by millions of people with an understandable yet fatally simplistic view of the world who, like the rest of humanity, are limited in the amount and scope of information available to them.  That is the unfortunate reality of politics – a reality that, in this case, is further exacerbated by the life-and-death nature of the situation. It is an unenviable position for any policymaker to be in.  Invoking the old phrase, they are truly caught – caught between a rock and a hard place.

Why Republicans Should Embrace Comprehensive Immigration Reform

The escalating child migrant crisis has once again brought our ailing immigration system back into the mainstream spotlight.  As usual, both sides revert back to their usual arguments.  Republicans take the migrant crisis as being a result of loose borders and lax executive enforcement, and many call for more deportation of both the child migrants and all illegal aliens within the United States.  In contrast, Democrats generally argue for making it easier and faster to become a citizen and to implement gradual amnesty. Though both sides have legitimate concerns and arguments, I (surprisingly) mostly side with Democrats on this issue, and I strongly believe that Republicans should reconsider their stance on immigration reform.  Here’s why:

  1. We need more immigrants, legal or illegal, and badly.  Contrary to the beliefs of many, virtually all types of immigrants – legal or illegal, skilled or unskilled, etc. – benefit the country economically (though legal immigrants are, of course, preferable to illegal immigrants).  Skilled immigrants make up a large proportion of  innovative business start-ups, while low-skilled immigrants lower prices for consumers & employers and take jobs that natives are less inclined to perform.  All groups add to national GDP, and (unlike in many European countries), they usually contribute more to overall tax revenues than they consume via social programs, helping to balance budgets at the federal, state, and local levels.  As such, there is a strong economic argument to expanding legal immigration and making legal naturalization avenues more efficient.  Macro-economically, more legal immigrants could serve as both a short and long-term economic stimulant to the moribound US economy, adding to short and long-term supply and demand.  Due to the retirement of the baby boomers, the US labor force will continue to contract in the coming decades, producing labor shortages that an influx of immigrants could help fill (and freeing up natives to perform other jobs, thus boosting job creation).  Additionally (and largely due to the aforementioned retirement of the baby boomers), America faces long-run fiscal challenges that more legal immigrants (with their contribution to higher GDP and higher tax revenues) could help to alleviate.  Considering that Republicans are broadly regarded as the “party of business” and of fiscal conservatism, Republicans should thus be embracing legal immigration.  Instead, though they pay lip service to legal immigration, their laser-like focus on illegal immigration and accelerating enforcement measures overshadows their support for legal immigration.  Ironically, an increasing of legal immigration via immigration reform would help to solve illegal immigration and the presence of large numbers of undocumented workers.
  2. Continued deportation of unauthorized immigrants is impractical and costly.  Currently, there are over 11 million unauthorized immigrants residing within the United States.  Many Republicans argue that deportation should be ramped up to deal with them.  I disagree.  First of all, despite the perception among many, deportation rates have stabilized at relatively high levels in recent years – rates have not fallen off a cliff, so it’s not like this strategy isn’t being actively pursued.  Second, can you imagine trying to deport all 11 million + immigrants from the US?  Deportation already costs the government quite a bit, with the Department of Homeland Security reportedly requesting approximately $230 million in budgetary authority for the deportation of undocumented immigrants just in fiscal year 2015.  That is for the current rate of about 400,000 people a year, which is, of course, partially offset by continued inflows of unauthorized immigrants.  Logistically, deportations of a larger scale would undoubtedly create massive strains on the system.  Additionally, the removal of 11 million people would be hugely destructive economically – lowering productivity, raising prices, and disrupting both the creation and operation of businesses, at a time when the US has yet to fully recover from the 2007-2009 recession.  Of course, we also cannot forget the costs of splitting up families, which imposes deep scars the social fabric of the nation.  If anything, deportation should be scaled down.
  3. Resources devoted to immigration enforcement are at historical highs – and further enforcement measures, like building a wall, will not stop illegal immigration.  As partially mentioned above, immigration enforcement (such as deportations) is hardly on decline.  Indeed, according to The Economist, border enforcement costs about $20 billion a year, which is more than all other federal law enforcement agencies combined.  Yet, despite all these costs, we clearly still have enforcement problems, and until we reform the immigration system, we always will.  Why?  The reason is simple: the economic incentives for people to immigrate to the United States are overwhelming.  Even for low-skilled immigrants, pay is usually several times greater in the United States than it is in their country of origin.  No matter how much the federal government devotes to border enforcement and trying to prevent people from immigrating (legally or not), people will keep trying to come here – and many will find ways to succeed.  Since these forces will not be disappearing anytime soon, it would be better to work with the force, not against.
  4. Current immigration policy is tantamount to anti-trade protectionism – the antithesis of Republican ideology.  Republicans, in accordance with their belief in free markets, tend to be much more supportive of free trade than liberal Democrats.  However, the current legal immigration system is based largely on a series of quotas.  According to Vox.com, on the employment side a maximum of 65,000 H1B visas (for high-skilled workers) and 66,000 H2B visas (for low-skilled workers) are issued by the federal government annually.  Both of these quotas are usually hit pretty quickly, indicating that employer demand in the US is far outstripping supply.  These quotas are artificially restricting the supply of workers, raising employment costs and decreasing growth prospects.  Additionally, the number of “green cards” supplied tends to be less than demanded, especially for people without US-based relatives or prospective employers.  These restrictions do not let the market to operate efficiently, which goes against Republican notions of free market capitalism.  Not to mention, these quotas help to drive the illegal immigration that everybody is so furious about.
  5. Current immigration proposals do not grant unconditional amnesty – nor should they.  Last time I checked, the current mainstream immigration reform bills passed by House committees in the summer of 2013 allowed unauthorized residents to gain citizenship only after meeting several conditions, including paying several fines and going through vigorous checks.  Republicans are right to be weary of the granting of unconditional amnesty – unauthorized immigrants did, after all, technically break the law, and the rule of law must be upheld for the republic to function properly.  However, the current bills (and any bill that is likely to be passed) will not let unauthorized immigrants  off the hook.  Now, many Republicans say that any form of amnesty, conditional or not, is both unfair (as others still had to wait to become naturalized) and undermines the rule of law.  I think the fines help to partially offset this, punishing those who broke the law.  Though it (understandably) seems unfair that immigrants would be able to gain a “special” route to citizenship this way, such a route is, on net, still much more practical than sending those residing here illegally “to the back of the immigration line”.  Doing so would be too costly economically, difficult logistically, and would overwhelm the already strained legal immigration system.
  6. Republicans could use immigration reform to their political advantage.  Everyone knows that Hispanic voters tend to lean Democratic, and that this persuasion is becoming increasingly costly for Republicans electorally.  As the Hispanic population continues to grow in influence, the political parties increasingly need their support in order to win elections.  Right now, Republican opposition to immigration reform and a perceived anti-immigrant ideology is hurting the party.  Embrace immigration reform, and the Republicans could vastly improve their political fortunes.

Considering all of the outstanding issues on the federal policy radar, it is understandable that immigration reform might not top the policy agenda at the moment.  But until Washington is ready to devote its full attention to the issue, Republicans should seriously consider revising their views on the subject.  Too much is at stake for them not to do so.

Our 5-Year-Old Recovery: A Belated Birthday Wish

So much has been happening lately that it’s hard to know what is most deserving to talk about. Outside the US, the biggest news is that the middle east is further accelerating its long post-Arab Spring slide, with Iraq plunging back into civil war and tensions between Israel and Palestine yet again escalating.  Here at home, meanwhile, the Supreme Court has ruled against the Obama Administration on issues ranging from mandated contraception vs. religious freedom to “recess” presidential appointments.

Perhaps the strangest news, however, is that the current business cycle expansion (the economic recovery” turned 5 years old in June.  This comes at the heels of revelations that just a month prior, we finally reached pre-recession levels of total employment (really no achievement at all, since growth in the potential labor force thoughout all this time still leaves a massive jobs gap.  Not only is it unprecedented that the 5th birthday of the recovery comes only one month after a return to pre-recession employment levels, but it’s also unprecedented that such a large output gap remains at a point where we’re likely closer to the next recession than the end of the last one.   At 61 months, it is now past the average of 58 months for all post-war recoveries.

Now that the party has died down, its time to face some ugly truths.  First of all, longevity does not imply good health.  Despite repeated predictions, this recovery has proven to be neither broad-based nor robust, and unfortunately, its running out of time to ever show sustained periods of health.  From indicators ranging from GDP growth to income growth to productivity growth (etc, etc), there has been sub-par performance.  There are many plausible reasons why (both supply and demand-side explanations), which have been discussed to the point of exhaustion.  I’ll re-list the main ones anyway:

  • contractionary fiscal policy
  • inadvertently contractionary monetary policy? (see Vox.com explanation)
  • lingering effects of private debt deleveraging on consumer spending
  • lack of public investment in physical & nonphysical capital
  • High energy costs
  • Business uncertainty (due to regulations, policy ambiguity, shaky macroeconomic environment, etc.)
  • High or complex taxes, especially corporate taxes

Considering that this year is shaping up to be another economic disappointment recovery-wise, and the recovery’s rapid aging, we now face the troubling prospect of entering the next recession far from having truly recovered from the last one.  By recovered, I mean not just a complete closing of the output gap.  My definition also includes labor market healing, such as a reversal of skills erosion and a return to full employment, as well as meaningful gains in median income and wealth.  Since it is increasingly likely that none of this will happen, would a small recession now be far more painful than usual?  And what will we do policy-wise?  Monetary policy is, at least in terms of fed funds targeting, is as loose as it can get, and its doubtful the federal government will be willing to pursue aggressive fiscal stimulus like they did in 2008 and 2009.

Although it is good news that the recovery is 5, and I wish it a belated happy birthday, its longevity should not make us complacent about past, present, or future performance.  Overall, past performance has been weak, present performance is weak, and it is likely that, in the near future, only more pain will appear.  It’s a rather sad, but realistic, outlook.

The clock is ticking…

On America’s “Great Stagnation”

This posting will briefly discuss the historically weak growth since the end of the 2007-2009 “Great Recession” (though a greater period of time, reaching into the 2000’s or “aughts” or even further back, can also be included in the definition).  It argues that, though we may have reason to be alarmed at slower long-run economic growth, by many measures living standards have improved at a rapid rate, and will continue to do so into the foreseeable future.


Since the end of the last business cycle trough in June 2009, countless observers have noted – and lamented – the historically anemic growth rate of America’s economy.  In the 19 quarters since the beginning of the recovery, GDP growth has averaged around 2% annually – well below the 4% average for recoveries after 1960, and barely enough to generate the jobs needed to absorb entries into the labor market.  Indeed, in the first quarter of 2014, the economy logged (at a seasonally adjusted annual rate) of  -1%; in other words, it registered an actual contraction, the first quarter since 2011 to do so.  Although the particular severity of Q1’s stagnation  is likely temporary, it nonetheless does well to highlight the unique sluggishness that has characterized this recovery since the beginning.  Also highlighting the recovery’s weakness is the economy’s failure to quickly return to potential output, reflected in the continued existence of a large output gap (see charts 1& 2).

Real vs. Potential

 

bivens-figure2

It is true that economic growth remains far from normal – especially considering the depth of the preceding recession, which usually are followed by sharp “bounceback” recoveries (as pent-up consumer & investor demand is unleashed).

However, there are a couple of things to keep in mind:

1) This was not a “normal” recession.  Normally, recessions are sparked by mild shocks in aggregate demand or aggregate supply, oftentimes instigated by a contractionary monetary policy.  This time, however, there was an extreme shock to aggregate demand as a plummet in housing prices pushed down household consumption (the “wealth” effect) and the deterioration in the balance sheets of financial institutions caused a freeze in credit markets.  “Balance-sheet” recessions like these are typically severe, and have long-lasting effects.  Growth tends to be much weaker in decade following financial crises than normal recessions as households and institutions “deleverage” their debts to repair their balance sheets.  Since the United States had not, until now, experienced a true financial crisis since the Great Depression, this sluggish recovery can be considered historically unique.

2) Growth and potential growth have been slowing for decades.  When one looks at real GDP and potential GDP over long periods of time (see chart), it becomes clear that long-term growth has been slowing for decades.  Especially recently, after each subsequent recession the recoveries have been weaker than the one preceding them.  Although it only shows data through 2011, the second chart below clearly demonstrates this pattern.

2.1.1-GDP-gap-OPT

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3) As the population continues to age and retire, sluggish growth is only to be expected – unless productivity growth accelerates.  An economy essentially grows for two reasons: the population/labor force is increasing and/or labor productivity (ouput/hour or, more generally, the amount of output with a set of given inputs) grows.  The latter is especially important in helping to boost living standards, as more efficient production allows for more income to be distributed and for goods and services to be produced at lower costs.  Historically, especially during the “golden age of capitalism” from the 1940s-1970s, the economy has benefited from both labor force growth and productivity growth.  Beginning in the 70s, however, the 2nd factor – productivity growth – began a to register a marked slowdown, even as the labor force continued to expand (especially with an increase in the participation of women).  The reasons for this slowdown are unclear.  Was US inflation distorting incentives and resource allocation?  Were technological waves delivering less of an impact as earlier technological waves?  And are these changes driven more by changes in the accumulation of capital stock or total factor productivity (TFP)?  Regardless, this slowdown in productivity has continued to the present day, interrupted only by a brief revival in the late 90s and early 2000s (see neat chart below that I made using data from the Bureau of Labor Statistics; as a note, the data represents quarterly % changes at annualized rates, and labor productivity is defined as output/hour).

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All of this points to a couple of things.  Comparing this recovery to past ones should be used with a grain of salt, because

a) it follows a historically unique financial crisis, unlike other recoveries, and thus can be expected to be slow in the short-term

b) the growth trajectory has long been slowing, making many recoveries naturally more sluggish than those that preceded them, suggesting that, even without the financial crisis, stagnation could have been expected anyway

While some parts of this decline in long-term growth appear natural (such as a decline in labor force participation due to ageing populations), other parts – such as the productivity element – may or may not be.  This is because productivity growth can arguably be more strongly influenced by deliberate policy/non-policy actions than labor force participation can (at least when considering that most older baby boomers will have to retire at some point soon). Should the public and/or private sectors, for instance, be investing more in public and private capital?  Maybe.  But the urgency of that question depends on how much that sluggishness is translating into a stagnation in actual living standards.

Certainly, there are good arguments that American living standards have shown signs of stagnation as of late (and not just following the 2007-2009 recession).  For instance, as the chart below demonstrates, median household income (the income level of the theoretical household in the exact center of a data set of all household incomes) has registered virtually no net growth since the late 1980s.

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Other trends are worrying as well.  Poverty rates as defined by the Census Bureau have made almost no net progress since the 1970s, and the prevalence of health insurance and retirement plans (think defined-benefit pensions) have evaporated (at least until recently).  Combined with a worrying increase in health care costs and tertiary education tuition, and the typical American household has indeed seemingly experienced a “stagnation” for a fairly long period of time.

However, despite all of this negative “evidence”, I personally would still contend that living standards have still registered marvelous improvements, and will continue to do so.  First of all, GDP & productivity growth figures do not account for a crucial aspect of capitalism that is often under-appreciated: a long-run rapid improvement in product quality and capability.  While such figures may capture value-added in the production process, they cannot completely account for improvements in product capability and the additional satisfaction these new capabilities give to consumers.  For example, think about cars.  Economic statistics may reflect the total output of cars, the efficiency of their production, etc, but they oftentimes may completely ignore how much the typical car has changed.  For example, many cars are now equipped with sensory technology that makes driving smoother and more comfortable.  Anti-lock brakes, air conditioning, and even GPS systems, all once reserved for those with the most cash, are now becoming increasingly widespread and standardized with the industry, improving the driving experience of millions of consumers.

Additionally, I think too much emphasis is placed on incomes when it is often ignored how dramatically consumer costs have actually fallen in many industries.  For example, according to statisticbrain.com, the average price/MB of RAM has decreased from approximately $411 million in 1957 to less than six-thousandths of a dollar in 2013.  This has greatly increased the purchasing power of the typical consumer, and has been replicated in many other sectors of the economy.

While it is true that some very important industries that impact the middle class – namely healthcare and education – have shown rising costs, which is a concern that should be addressed, even here this largely reflects increases in quality.  New (albeit costly) technology and healthcare procedures, for example, have given consumers innovative and state-of-the-art choices.  These technologies and procedures have greatly increased the quality of life of people, something the statistics cannot ever fully reflect.

Overall, while I do think America has entered a “Great Stagnation” (not just in the short-run but over the past couple of decades) in terms of economic growth, I do not think this fact should be assumed to be entirely a bad thing.  Indeed, I think it is somewhat misleading – despite slower growth, many elements of living standards (which I only briefly touched upon) continue to make rapid progress, even if many other components of such standards have stalled (e.g. household income, health insurance coverage, etc.)  While it is certainly no excuse for complacency – we would do well to figure out ways to sustainably boost long-run growth – it is reason to think twice about repeated observations of a supposed “decline” in American affluence and its middle class.  The trends are a bit more complex than that.