Saturday, March 31, 2018

Why “Entitlement” Cuts and Not Tax Increases Again?

John Cochrane has to remind us that he co-authored a really bizarre oped:
Unless Congress acts to reduce federal budget deficits, the outstanding public debt will reach $20 trillion a scant five years from now, up from its current level of $15 trillion. That amounts to almost a quarter of million dollars for a family of four, more than twice the median household wealth. This string of perpetually rising trillion-dollar-plus deficits is unprecedented in U.S. history.
Oh good grief! Can one say relative to GDP? We are also about to see a $20 trillion per year level of national income – “unprecedented in U.S. history”. But yea – they did begin with mocking this Trump nonsense:
President Trump's recently released budget is a wake-up call. It projects that this year, a year of relatively strong economic growth, low unemployment and continued historically low interest rates, the deficit will reach $870 billion, 30 percent greater than last year.
Relatively strong economic growth is not exactly the same as Kudlow’s forecast of 5% growth is it? Oh wait – Cochrane and company have been touting strong growth effects from the Trump tax cuts. Never mind. Back to Cochrane the new found deficit alarmist:
In recent months, we have seen an inevitable rise in interest rates from their low levels of recent years. Rising interest rates and increasing deficits threaten to build upon each other to send public debt spiraling upward even faster. When treasury debt holders start to doubt our government's ability to repay, or to attract future lenders, they will demand higher interest rates to compensate for the risk. If current spending and tax policy continue unaltered, higher interest costs will have to be financed by even more debt. More borrowing puts more upward pressure on interest rates, and the spiral continues. If, for example, interest rates were to rise to 5 percent, instead of the Trump administration's prediction of just under 3.5 percent, the interest cost alone on the projected $20 trillion of public debt would total $1 trillion per year. More than half of all personal income taxes would be needed to pay bondholders. Such high interest payments would crowd out financing of needed expenditures to restore our depleted national defense budget, our domestic infrastructure and other critical government activities. Unchecked, such a debt spiral raises the specter of a crisis. Some may think that such concerns are overblown, as there is no current evidence in financial futures markets that a crisis is on the horizon.
Let’s stop right there and note that the interest rate on 30-year government bonds is only 3% not 5%. But of course Cochrane knows so much more than the market knows – I guess. But yea there is a long-run government budget constraint so let’s get to the policy prescription:
To address the debt problem, Congress must reform and restrain the growth of entitlement programs and adopt further pro-growth tax and regulatory policies. The recently enacted corporate-tax-reform plan is a good first step, as it sharply increases the incentive to invest and grow businesses, which will increase incomes. The revenue loss, which amounts to about 0.4 percent of gross-domestic product in 2025, is not by itself a budget buster, considering both the offsetting revenue reflow from higher incomes and the far larger long-run entitlement explosion.
Yea – that Laffer curve! Kudlow is a genius! PLEASE! Their message is that tax cuts for the rich as fine and dandy but we cannot afford to honor your Social Security benefits. Didn’t we cover this already? AddendumOf course I should turn the microphone over to the two Justins! Justin Fox is right: Beware of Economists Crying 'Entitlement Explosion'- Our inability to speak frankly about the nation's fiscal situation has real consequences. He is criticizing the same oped as he provides a much more detailed and honest discussion of the issues. Meanwhile Justin Wolfers does a nice job of debunking the supply-side silliness:
Corporate tax cuts will put billions of dollars back in the hands of businesses this year. Naturally, people want to know how those businesses will spend it. But the answer doesn’t really matter, at least not for understanding whether the tax cuts were a good idea. That’s because the economic case for corporate tax cuts has almost nothing to do with what corporations do with the extra cash. Economists generally recognize that corporate tax cuts have two quite distinct effects. First, a tax cut increases the incentive to invest... This incentive effect drives most economic models of investment, and few economists debate its underlying logic, although there’s considerable debate as to whether it will yield a large or small increase. Second, a tax cut showers extra cash on companies. That cash largely comes from companies that are suddenly paying a lower tax rate on profits earned from past investments. This windfall has a big effect on the distribution of income, with billions of dollars going to owners of capital at the expense of taxpayers. But few economists believe that this cash transfusion will do much to bolster future investment, because the profitability of a new capital project depends on future revenues and expenses, not on how much cash a company has lying around.
Most models of investment also note that a higher cost of capital discourages investment. Cochrane et al. are worried about higher interest rates but then they ignore this effect on investment as they hype the incentive effects. It is entirely plausible that the extra consumption from rich people getting showered with the Trump tax cuts will actually crowd out investment and reduce long-term growth. So what we will get is mainly a higher deficit. When Cochrane calls this a good first step – one has to wonder what the real agenda is.

5 comments:

rosserjb@jmu.edu said...

Because they also want more tax cuts, and again, focused on upper income folks.

ProGrowthLiberal said...

Jonathan Chait says it very well:

http://nymag.com/daily/intelligencer/2018/03/conservative-economists-turning-back-to-debt-hysteria.html

Hat tip to EMichael over at Angrybear's comment section!

media said...

I looked at gdp/national debt ratio---seems to go up (actually down--flip the curve over--from a potential surfvace to a fitness landscaep) in 1940's (ww2_ and then down and then back up around iraq war or 2008. herstory repeates itself.

one could also look at gdp/national debt/per capita. probably give similar picture or selfie. one could look at personal debt (fake PhF student debt/condo/drug/meds/ mi rehab ) compared to GDP , debt, etc.

Steven Pinker (famous linguist, ethical altruist, who has proven everything is getting better--using the cambridge metric (gauge theory--if my life is getting better over here, its getting better everywhere --u can use QALY's or utilitarianism. one more war is 1 more NSF grant).

Anonymous said...

Re: "It is entirely plausible that the extra consumption from rich people getting showered with the Trump tax cuts will actually crowd out investment and reduce long-term growth. " ---> Not to mention impose unaffordable 'adaptation' costs from resulting climate change on the poor.

The consumption of the rich is responsible for most greenhouse gases. And the big discovery is that planet Earth does not generally engage in gradual change. The current methane burp in the Arctic being but one expression of this. "Since the area of geological disjunctives (fault zones, tectonically and seismically active areas) within the Siberian Arctic shelf composes not less than 1-2% of the total area and area of open taliks (area of melt through permafrost), acting as a pathway for methane escape within the Siberian Arctic shelf reaches up to 5-10% of the total area, we consider release of up to 50 Gt of predicted amount of hydrate storage as highly possible for abrupt release at any time. That may cause ∼12-times increase of modern atmospheric methane burden with consequent catastrophic greenhouse warming." [Anomalies of methane in the atmosphere over the East Siberian shelf: Is there any sign of methane leakage from shallow shelf hydrates?
N. Shakhova , I. Semiletov A. Salyuk , D. Kosmach]
Brenda Rosser

ProGrowthLiberal said...

"The consumption of the rich is responsible for most greenhouse gases."

So rather than Mankiw's regressive carbon tax, this would suggest we adopt a progressive version of cap and trade!