Isabel Sawhill, frequently offers commentary on the economic situation in the U.S. in both
The National Journal and
POLITICO's "
The Arena" online debate.
National Journal commentary |
POLITICO commentary National Journal commentary
How Would You Steer Fed On Quantitative Easing?
Quantitative Easing Is Only Tool Left
October 4, 2010
I am very much in agreement with Jeffrey Frankel. The risks of a double-dip or a prolonged period of stagnation are uncomfortably high since there is no sector that is adding much to demand and one sector – federal and state government – that is subtracting from that demand.
Ideally, we should have some additional fiscal stimulus combined with steps to restrain the longer term accumulation of debt, but our politics doesn’t seem to make that feasible.
Under these circumstances, the Fed has no choice but to try some additional quantitative easing. Whether it will be sufficient or not is another matter. I do worry that they will be pushing on a string because the system is already awash with reserves, businesses are sitting on a lot of cash, and consumer demand is weak, but the equivalent of a negative interest rate may help to keep the economy growing, albeit at a modest pace, and then we can only hope that consumers and businesses begin to spend enough to reduce unemployment below currently high levels. It will be a long slog and we could get stuck in the mud but it’s the only weapon left in the economic tool box.
Fed Option: Buying More Debt
Don't Leave it to the Fed
August 30, 2010
I think too great a burden is being put on monetary policy to get us out of the woods. The options discussed by Bernanke at Jackson Hole all sound reasonable to me but are weak reeds on which to prevent a long period of slow growth or a double dip. I don’t think anyone should be worrying about inflation right now; and whatever risks are built into the need to eventually unload these assets on the Fed’s balance sheet, they are small compared to the risks of allowing the economy to stagnate or worse.
I hope that Bernanke can find a way to quietly – and behind the scenes – put some pressure on Congress to stop the ridiculous political posturing over deficit reduction vs. stimulus. We need both and there is no reason we can’t have both – just not at the same time. If the President’s fiscal commission can come up with a good package of spending cuts and revenue increases and Congress enacts them but phases them in after the economy recovers, then this might counter worries that we “can’t afford” any more stimulus. My favorite option would involve a VAT that is phased in slowly – thereby encouraging consumption now and savings later -- combined with an effort to enact some reforms in Social Security and some limits on tax expenditures, especially for those with higher incomes. But state governments and the unemployed need more help now to prevent some of the fiscal drag associated with the premature withdrawal of stimulus funds.
The economy is in deep trouble. Our elected representatives need to step up to the plate and not leave all of the problem on the Fed’s doorstep.
VAT Or Not?
Use VAT for Tax Cuts Now
April 26, 2010
A VAT has a lot to recommend it. It is a relatively efficient way of raising revenue, producing far fewer distortions than the current income tax. Moreover, by encouraging saving and productivity, it is exactly what the nation needs to raise future standards of living. A 10 percent broad-based VAT could produce in the neighborhood of $500 billion a year by 2012 according to the Brookings-Urban Tax Policy Center.
In my view, the way to make this politically palatable while advancing other policy goals is to use some of the revenues to provide a refundable credit to lower-income households, thereby offsetting the regressive features of the tax, some to lowering the corporate tax rate to make the U.S. more competitive with other countries, and some to eliminating income taxes for many in the middle class, thereby greatly simplifying their lives and making April 15 just another day on the calendar. More affluent Americans would continue to pay income taxes.
Most importantly, the rate of the tax should be linked as closely as possible to the growth of health expenditures over time. Even if the new tax did not reduce the deficit very much or at all in the short-run – something that would be desirable as long as the economy is depressed – it would begin to bite over time, and provide financial markets with a reason to have some confidence that we have gotten our fiscal house in order. The key here would be to make the linkage as automatic as possible so that any further increases in health care spending (as a proportion of the economy) would be fully paid for. To be sure, Congress could delink the two at any time if it so chose, but if the VAT rate was triggered, with some lag, by recent increases in health care spending, as determined by an independent body such as the new Medicare commission, this just might work. If the public rebelled against the higher rates, this would create pressures to rein in health care costs which in the absence of such constraints are likely to rise very rapidly over the next few decades. Coupled with continued innovations in the delivery and financing of health care this could help to bring the rate of growth of health spending within more reasonable bounds. If it didn’t, then at least we’d be paying for the health care we’re collectively consuming.
The big advantage of this plan is that it devotes virtually all of the new revenue initially to lowering other taxes, not to increased spending. But at the same time, it deals with unsustainable budgets by linking the rate of the tax to health care spending, the major driver of unsustainable deficits. The law could even specify that none of the revenues from the VAT could be used to fund new spending programs and that all of the initial revenues would have be used to reduce existing taxes, especially if this is what it would take to get bipartisan agreement on such a plan.
If we could substantially broaden the base of the current income tax, I’d be all in favor of doing so. But the political challenges of doing so should not be underestimated. With this in mind, a clean start with a broad-based consumption tax linked to health care spending, and partially offsetting existing corporate and personal income taxes with some relief for lower-income families, makes a lot of sense.
Do Bankers Pay the Rent?
March 22, 2010
Greenspan argues that monetary policy didn’t contribute significantly to the housing bubble; he lays most of the blame on a glut of global saving that lowered interest rates worldwide. He also argues that if the Fed had tightened more in response to “irrational exuberance” it would have damaged the real economy at a time when overall inflation was under control. He provides some empirical evidence to support these arguments but I still find it hard to believe that the fed funds rate didn’t affect longer-term rates, including ARMs, and thus the housing market. But he makes a good point when he argues that it’s hard for central bankers to deliberately burst a bubble when the real economy seems to be doing well – even though in retrospect it might have been less harmful if we had had a moderate recession earlier in this process, thereby potentially forcing some much earlier deleveraging without the disastrous effects we later experienced. His argument that higher capital requirements and contingent debt along with “living wills” spelling out how a firm will unwind if disaster strikes all seem like good ideas. He is opposed to the idea of a systemic regulator on the grounds that it’s impossible to foresee when a “black swan” is going to appear.
One of the most interesting portions of the paper is called “the purpose of finance.” Here, he argues that the sector is vital to efficiently funneling saving into productive investments. He notes that the sector has grown as a share of GDP over recent decades but not because more assets are under management. The question that intrigues me is whether the productivity gains in the real economy are linked in any way to the growth of this sector – perhaps because of greater complexity and the need for greater skill in managing the process – or whether the sector has reaped big rents because of the scarcity of what I would call “reputational capital” and the inelasticity of the demand for its services. It may be some of both but rents are, in my view, a big part of the picture. Investment bankers earn rents for the same reason that real estate brokers earn rents: their fees are a small portion of the total cost of the deal and no buyer wants to risk engaging a new or unknown entrant into the field with a big and important transaction.
A Few Questions On Freezing Tax Expenditures
Target the Health Exclusion
February 8, 2010
I think the spirit of Len Burman’s argument in his Washington Post oped on tax expenditures is exactly right. Tax expenditures are just a form of back door spending. Although they may be used to favor certain types of spending, they also distort decision-making and lose a ton of revenue – over $1 trillion a year. They also tend to provide the biggest benefits to those in the highest brackets, tilting the tax structure in favor of the most affluent. Yet the public is only dimly aware of these key facts. Given the current political impasse caused by the fact that many Republicans refuse to put taxes on the table, a recognition that some tax provisions are spending programs by a different name could change the debate. In addition to the argument that tax expenditures are just another form of spending, most economists believe that tax expenditures are bad for efficiency and growth. Take the mortgage interest deduction; it encourages allocating savings to housing instead of to growth-enhancing innovative investments. Or take the exclusion of health insurance benefits from taxable income; this leads to overconsumption of health care and the growth of health care spending, now at 17 percent of GDP and growing rapidly with adverse effects on our competitiveness. So the old supply side argument that reducing taxes leads to greater efficiency or growth is simply wrong in these cases.
Could we simply freeze tax expenditures along with discretionary spending as Burman suggests? There are a whole host of practical problems attached to this proposal. It would be better, I think, to limit deductions and exemptions as the Administration proposed in both last year’s and this year’s budget – although I would limit them to 15% and not 28% both to raise additional revenue and make them even more targeted on the middle class. Unfortunately, even the Administration’s proposal was shunned by members of both parties on the Hill. There is no political courage anywhere these days.
Another idea that needs to be revived is eliminating the health exclusion – gradually perhaps but not in the wimpy way that it survived as part of health care reform. Perhaps it is time to start over so that we can get more cost control and more fundamental reform into the health care system. As many have argued, getting our deficits under control requires getting health care spending under control and the bills that emerged from Congress last year did far too little on this front. Yes, it is politically difficult but no more difficult than freezing tax expenditures. The elements of a more sensible approach exist: phase out the health exclusion, mandate coverage, reform insurance markets, and use the funds to partially subsidize that coverage. I envision McCain and Obama having a beer together and agreeing to these elements. And one thing they should agree to is that a tax credit and a subsidy are one and the same animal.
Obama and the Deficit
December 1, 2009
The Administration will likely propose to reduce the deficit to 3% of GDP by 2016 in its next budget. This goal is a far cry from the older norm of trying to balance the budget and shows how seriously out of balance the budget is and how much we have had to compromise our fiscal goals as a result. Can the Administration achieve even this limited goal? I think not. They may find a way to achieve it on paper but if the economy remains as depressed as most economists believe it will over the next 5 years, the big changes in spending or revenues that would be required would not only be politically infeasible but probably economically undesirable as well. It would be better to focus on the longer term (the years after 2016) and on health care spending, Social Security, and taxes in particular. The current health care bill does not do enough to constrain costs, and could be strengthened by, for example, not indexing the thresholds for the excise tax on high end plans and by providing more flexibility and authority to the independent Medicare commission in the Senate bill. Social Security should be reformed by constraining the growth of benefits for the more affluent and by increasing the normal retirement age. Although allowing the Bush tax cuts to expire at the end of 2010 as they are scheduled to do under current law is one way to get more revenue, the entire tax code needs to be simplified and the myriad deductions and preferences (totalling close to $1 trillion a year) need to be pared back. The Administration's proposal to limit such deductions for the top brackets makes enormous sense and should be reconsidered by the Congress. Alternatively, we may need a new value added tax that would partially replace the income tax (on individuals and corporations) and could be earmarked for health care. If it were enacted soon but phased in only after the economy recovered as proposed by Len Burman and by myself and Henry Aaron here, it would reassure financial markets, encourage households to consume now before the tax took effect -- thus helping the recovery along -- and promote more saving over the longer run. We will probably need a bipartisan commission to jump start the process since our political system seems paralyzed by partisanship, but our ability to regain some measure of economic stability may well depend on whether our elected officials can find a way to place the public interest above their own more narrow interests.
Bipartisan Budget Solution
November 3, 2009
I applaud the 10 Senators who are calling for a bipartisan commission on the budget. Too bad there are no Republicans in the group so far but perhaps that will change. And too bad some other Democrats, such as Pelosi, are also opposed. In both cases, they are ducking their responsibilities unless they come up with specific proposals to reduce long-term projected deficits - which is not happening and is not likely to happen any time soon. In the meantime, we are courting all kinds of trouble from slower growth, to an economic crisis, along with reduced flexibility to get the economy moving again or handle a new international threat. But perhaps even more important than the effects on the economy is the effects on confidence in government. A group of us has been going around the country talking about these issues as part of the Fiscal Wake Up Tour. We find that citizens are much more upset about the failure of their elected leaders to act than they are about accepting the specific sacrifices that deficit reduction implies. If the two parties could join hands and take joint responsibility for proposing some tough actions the public would go along. It has happened before: in 1983 on Social Security reform, in 1986 on tax reform, in 1990 and again in 1997 on the budget. Presidential leadership is needed as well. Too many people on the left think that we can solve the problem by controlling health care costs but it is now apparent that we'll be lucky if health care reform doesn't dig the hole any deeper. The bills currently under consideration contain very little that will "bend the long-term cost curve." And too many people on the right believe that higher revenues lead to an intrusive and inefficient public sector despite the fact that we are now spending about $1 trillion a year on tax preferences for all kinds of activities, most of which would be better left to the market.
Professor Krugman's Opus
September 8, 2009
Krugman is right that economics is now more about the elegance or beauty of ideas and their mathematical exposition than about shedding light on real world problems. As he notes, even the pragmatists among us ("the saltwater economists") have not found a way to reconcile Keynesian theories with our continuing belief in the ability of individual markets to equilibrate supply and demand. Behavioral economics has helped to wean a new generation of economists from the earlier fixation on perfect rationality along with full and unbiased information, equally available to both buyer and seller in a market, but the microeconomic foundations of macroeconomics still need shoring up. In the meantime, those of us who work in Washington in policy-advising or policy-making positions quickly learn that theoretical answers are nowhere near as useful as empirically-generated answers based on common sense conceptual frameworks. The sad thing, in my view, is the resources that are wasted teaching the best and the brightest in today's graduate schools that the ticket to success is a theoretically and mathematically derived answer to some trivial question. I agree that Krugman may have overstated or oversimplified his case in order to make it useful to the general reader but I very much welcome the debate I hope this will provoke.
The Recovery And The Deficit
August 17, 2009
I doubt that the deficit will be a serious drag on the recovery. The Treasury hasn't had much difficulty selling its debt so far and interest rates remain at reasonable levels. In addition, even if the economy starts moving in the right direction, it will likely remain depressed for several years, limiting the demand for credit from the private sector. And if the recovery is short-lived or falters, then another stimulus could be needed and should not be held hostage to concerns about short-term deficits. That said, it's important to get a handle on the long-term fiscal situation since it could at some point produce a serious problem in the form of higher interest rates, a plunging dollar, or a foreign policy complicated by the need to assuage the concerns of other countries about our massive borrowing. Right now, the prospects for dealing with the long-term problem look grim. All three of the likely solutions are stalled or off the table: Social Security reform, tax increases beyond those needed to pay for expanded health insurance coverage, and health care reforms that will seriously bend the longer-term health cost curve.
Savings, Stimulus And Recovery
August 3, 2009
Americans need to save more so that we can finance investments in the economy instead of borrowing the money from other countries (thereby necessitating that we earmark some of our incomes to pay them back with interest later). Granted this increase in saving will slow the recovery but it does not necessarily undermine the effectiveness of the stimulus bill. Without the stimulus bill things would simply be worse. It's true that there's a theory that says that consumers save more when the government stimulates the economy because they believe their taxes will go up as a result of the stimulus so they set money aside to pay the tax collector. If this theory were true, we would have to conclude that the stimulus caused the higher savings and thus has had little or no net effect. But ask your friends and relatives why they are saving more and very few will mention the stimulus bill and higher taxes as a prominent reason. They are saving more, in my view, because of uncertainty about job prospects, the stock market, and the value of their homes. I'm doubtful that the savings rate will go a lot higher or remain at elevated levels for very long because I think we have become a credit-based economy in which a culture of savings has lost its sway. If you look at each birth cohort's savings rate you can see a secular decline that to my way of thinking is more about culture than economics.
Soak The Rich
July 20, 2009
Given the growing inequality of incomes, especially at the very top of the distribution, asking this group to pay higher taxes seems like the right thing to do. And I have never been persuaded that people at the top of the distribution are going to work or save less just because their taxes have gone up from present levels. Back in the 1950s and 1960s, income tax rates were far higher and this doesn't seem to have adversely affected the rate of economic growth. Similarly, the increase in top tax rates during Clinton's first term was accompanied by vigorous economic growth during the remainder of the decade. Finally, income tax rates in the U.S. are far lower than in many other advanced countries which have experienced continued growth. That said, it would be a mistake to assume that we can pay for all of the Obama agenda and get our preexisting long-term deficits under control simply by taxing the rich. The middle class is going to need to contribute as well. And I would prefer to raise revenues by broadening the tax base rather than by raising rates. The proposal in the 2010 budget to limit deductions for high-income families would create more efficiency than an increase in rates. Moreover, unless health care reform is structured in a way that reduces cost growth over the longer term, this would just be the first of many tax increases that would be needed to pay for the rapidly growing expense of Medicare and other public health programs. It's absolutely essential to structure health care reform in a way that creates incentives for providers and patients to consume less.
Predictions And Hard Numbers
May 18, 2009
There is no way to ever definitively establish how many jobs will be (or have been) created or saved by the stimulus plan. The reason is because we will never know what might have happened without the stimulus. As Greg Mankiw notes in his blog, recent unemployment rates have been more in line with what the Administration predicted in their baseline economic projection in January without the stimulus, leading to the impression that the stimulus has done virtually no good at all. But in my view, this would be the wrong conclusion. The Administration has correctly focused instead on the change rather than the level of employment likely to be associated with the stimulus package. It is almost certainly the case that the baseline forecast was too optimistic and that the picture would now look worse without the effects of the stimulus. It's also my impression that the spend-out rates have been slower than originally anticipated which is another potential explanation for the somewhat disappointing effects to date. My view is that the Administration had to make these kinds of estimates of jobs created or saved and that they have done so in a perfectly reasonable way.
POLITICO commentary
Obama's deficit plan: Did he make his case?
April 13, 2011
There is much to commend in the president's plan. He has put everything on the table and pointed out the deep flaws in a lopsided Republican plan. Moreover, I think he has figured out where the hearts and minds of the electorate lie. The independent voters who will be key to his reelection in 2012 are eager to see some serious downsizing of government and will likely welcome his emphasis on deep spending cuts combined with some modest tax increases for the wealthy. By contrast, his base in the Democratic Party is likely to be deeply disappointed. Achieving the deep spending cuts called for in this plan is not likely to be consistent with protecting investments in education, research and infrastructure or with enabling more Americans to climb the ladder of opportunity, despite rhetoric to the contrary. Two elements of his proposals especially caught my attention. One is the ratio of spending cuts to tax increases which is heavily tilted toward spending reductions. The second is the cuts to Medicare, which are based on some extremely optimistic assumptions about how much we can improve the efficiency of the system. In both cases his proposals are more conservative than Bowles-Simpson and seem to have been motivated by a desire to be responsive to Republican calls for a much smaller government while carrying out this agenda in a more reasonable way.
And are two-week budgets the new normal?
March 3, 2011
Sen. Durbin has it right. I’m horrified by the prospect of a series of short-run extensions. We have a solution in the form of the Bowles-Simpson Commission report. Why not put it into effect? After all, it got a majority of votes from this bipartisan group and was widely praised by most budget experts as a sensible compromise that put everything on the table. It should be the starting point for any discussion. The Commission argued, and most experts agree – including Fed Chairman Ben Bernanke – that cutting spending by $61 billion this year will slow the recovery. Instead, Congress needs to enact some confidence-building measures for the medium and longer-term. Instead, all of their energies are focused on a fiscal year that is almost half over. This is tantamount to fighting a tiger by pulling its tail, arguing about who pulled the hardest, and destroying jobs in the process.
Tax cut woulda, coulda, shoulda's
December 7, 2010
Deficit reduction is critical and I wish that the tax deal that was just announced had included at least a down payment on this urgent task. Republicans have been calling for spending cuts but have not been willing to put any specific cuts on the table. If the deal had included some spending reductions and a down payment on tax reform in the form of some limits on tax deductions – to be legislated now but phased in only after the economy has recovered - it would have done a lot to show that both parties are serious about addressing longer-term imbalances.
But what we got instead is all candy and no spinach. Granted the economy needs the extra boost that the package promises to deliver – especially the payroll tax cut and the incentive for businesses to invest the large sums of cash they have at their disposal. But everyone knows that the current path isn’t sustainable, creating a lot of uncertainty about the future and thus less willingness to grow the economy in ways that could benefit everyone.
In the meantime, voters should take note of the fact that Republicans talk about deficit-spending but when it was put to a vote in the Senate, they weren’t willing to deny even those making more than $1 million a year a tax cut costing many billions of dollars. Faced with their intransigence, the President had little choice but to extend tax cuts for the wealthy in order to get a package that at least helps the economy in the shorter run.
Open Mic
December 4, 2010
As congressional debate and negotiations on the Bush tax cuts heat up, I want to resurface an idea that might have some bipartisan support. Republicans want to preserve tax cuts for the wealthy on the grounds that this will help the recovery. Democrats note that the wealthy don’t spend much of their incomes and that few taxpayers in the upper brackets are genuine small businesses of the kind that put people back to work.
Possible compromise: don’t extend the tax cuts for the wealthy overall but create a carve out for small businesses and for wealthy individuals who give a big chunk of their money to charity. The former addresses the small business argument head-on (although definitions of what constitutes a small business would have to be negotiated). The latter would provide more help to those in need, including many community-based organizations that small-government fans love, while providing a big incentive (via an extra-big but temporary tax deduction) for the wealthy to spend rather than save their money, thereby accelerating the recovery.
Is an Obama-GOP compromise possible?
November 30, 2010
The president should hang tough. Not only should he not agree to an extension of the tax cuts for the wealthy, he should only extend the middle class tax cuts temporarily.
As I have argued in another POLITICO column, a permanent extension is not affordable. If the president wants to keep his pledge to make the middle class cuts permanent, then he should at least follow the lead of the co-chairs of his fiscal commission and limit tax expenditures by capping them in a way that pays for the tax cuts over time (as I have also argued before).
Will Republicans go along with any of this? No. But they have shown no willingness to compromise and the president should not negotiate with himself or give up on his earlier position unless he gets something important in return. Let the Republicans vote against a tax cut for the middle class or an extension of unemployment insurance. But put these proposals to a vote.
Is freezing federal workers' salaries a good idea?
November 29, 2010
I don’t think freezing federal workers’ pay for two years is good policy if done in isolation from other measures. Why should they be singled out? The simple answer is because it’s good politics even if it isn’t good policy. The problem with government salaries is not that they are too high; it’s that they are too uniform, too compressed, and not sufficiently performance-based.
This proposal also plays into the hands of conservatives over the longer run and could start a bidding war devoted to “get the bureaucrats." It’s a new version of “starve the beast.” The old version was that if you cut taxes, spending will have to be reduced. The new version is if you make government less effective by undermining its ability to attract and retain good people, the public will naturally demand less as services and decision-making deteriorate.
I’d feel differently if this proposal was being put forward in the context of a more comprehensive deficit reduction plan such as that offered by the co-chairs of the president’s fiscal commission or by the Bipartisan Task Force led by Alice Rivlin and Pete Domenici. Shared sacrifice is the right principle here. Are there individual government bureaucrats who are overpaid? Of course. Does it make sense to penalize all of them for the sins of the few? Absolutely not. As the National Commission for the Public Service said in its 2003 report, “far too many talented public servants are abandoning the middle levels of government, and too many of the best recruits are rethinking their commitment, either because they are fed up with the constraints of outmoded personnel systems and unmet expectations for advancement or simply lured away by the substantial difference between public and private sector salaries in many areas.”
Are cuts to Social Security and defense politically viable?
November 10, 2010
Pundits will pronounce the plan as totally unrealistic, but the public is really angry that members of Congress are unable to put the national interest above various special interests.
Who knows? Maybe spinach is coming into vogue. The key is to offer something that both parties can support. This plan promises to keep government spending under tight control but it does so in a way that is reasonably balanced and fair. It protects the least advantaged and it saves Social Security and Medicare by putting them on a more sustainable trajectory.
That said, the cuts are wide and deep. There will be blood all over the floor.