The Budget Process–What Went Wrong?

October 3, 2013

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To understand the breakdown in budget negotiations and the resulting government shutdown, start with the basics of the budget process. The Senate passed a budget. The House of Representatives passed a somewhat different budget. What is supposed to happen is that a conference committee with members from both houses reconciles the two budgets and sends the compromise to both houses to be passed. That didn’t happen this year because the Republican-led House refused to appoint members to a conference committee, holding out instead for the Senate to adopt their budget.

When the two houses are unable to agree on a budget by the beginning of the new fiscal year, what they usually do is pass a continuing resolution to keep the government operating at the current budget level. Democrats are willing to do that, although it means continuing the austerity budget known as the “sequester,” which they feel underfunds many of the programs they support. Without a continuing resolution, all discretionary government spending is cut off, resulting in a partial government shutdown. Spending that is mandated by existing law, such as Social Security payments, is not affected.

At the insistence of the “Tea Party” wing of their party, House Republicans support a continuing resolution to keep the government functioning only if it includes a provision to defund or delay the Affordable Care Act. The audacity of this demand is breathtaking. The Affordable Care Act isn’t even part of the discretionary budget that is under consideration. Its funding is already mandated by the law passed three years ago, which is exactly why the Republicans need new legislation to defund it. Having failed to stop it through the normal legislative process, and having run against it and lost in the 2012 election, Republicans want to use the threat of a government shutdown to accomplish what they couldn’t accomplish through normal democratic means. Having refused to negotiate over the budget for months, they now propose to renegotiate the Affordable Care Act–which isn’t even a part of the budget at issue–as a condition for passing any budget at all. If President Obama doesn’t agree, then he’s “refusing to negotiate”! And if the Senate won’t pass the House’s resolution with its poison pill attached, then it’s the Senate that’s shutting down the government.

What can one call this except a perversion of the democratic process? The Senate has passed a continuing resolution to fund the government unconditionally. A majority of the House would almost certainly pass it too, if the Republican leadership would let them vote on it! But so far Speaker Boehner hasn’t allowed that because it would anger the right wing of his party and perhaps cost him his job. Keeping ultraconservatives happy and John Boehner in his job is apparently a higher priority than honoring the will of the majority and keeping the government functioning.

President Obama is by nature a pretty flexible, conciliatory fellow. He first came to national attention with his speech to the Democratic convention about working together to overcome the division of Americans into “red states” and “blue states.” During his first term he seriously underestimated how little flexibility or cooperation he would get from the other party on anything. Now he is faced with a choice between making concessions that would reward undemocratic behavior or sharing the blame for the breakdown of the budget process. What he needs to convey to the American people is that extortion is not a good-faith negotiation. You don’t earn extra points or special concessions just by offering to do what you’re supposed to be doing anyway, in this case keeping the government functioning. First pass a budget resolution, and then pursue other legislative aims through the normal democratic process. No responsible president can ask for less.

Stimulus, R.I.P.

February 27, 2013

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Most criticism of the impending federal budget cuts–the “sequester”–focus on their clumsiness. They hit a wide range of defense and domestic programs, with no rational prioritization except for what particular agencies can come up with on short notice. Opinions differ on the larger question of whether cuts of this magnitude are wise at this time. Supporters say that the cuts only amount to about 2% of the federal budget, and it’s high time we tackled the federal deficit. Critics point out that the exemption of certain areas of the budget requires larger cuts elsewhere: about 8% for defense and 5% for non-defense discretionary programs. The timing of the cuts, coming with the economy still sluggish and other stimulus measures expiring, is also a concern.

The Washington Post’s Wonkblog has an excellent factsheet on the sequester. The Budget Control Act of 2011 required these cuts to go into effect unless the Joint Select Committee on Deficit Reduction (the “supercommittee”) reached a bipartisan agreement on deficit reduction. The cuts were intended to be drastic enough to force a budget compromise. Compromise failed when the Republicans on the committee refused to consider any tax increases. The cuts fall equally on defense and non-defense spending. Most of the non-defense cuts come from discretionary programs, since “mandatory” programs like Social Security are protected. Other protected programs are Medicaid, SNAP (food stamps) and TANF (Temporary Assistance to Needy Families). Medicare gets only a 2% cut in payments to providers. Beyond that, the cuts don’t distinguish between more essential and less essential programs. They hit military operations, disease control, border and airport security, disaster relief, public housing, food and drug safety, federal prisons, and just about everything else. Two of the most inconvenient consequences at this time are reductions in unemployment compensation for the long-term unemployed and a smaller SEC budget at a time when Dodd-Frank has expanded the agency’s regulatory responsibilities.

Jared Bernstein has a good chart from Moody’s Analytics showing the estimated impact of changes in fiscal policy on GDP growth. The two biggest federal contributions to GDP growth were the American Recovery and Reinvestment Act of 2010–the “stimulus”–and the cut in payroll taxes begun in 2011. The phasing out of the first since 2011 and the termination of the second at the end of 2012 have already changed fiscal policy from a net stimulus to a net drag on growth. Higher taxes on incomes over $400,000 detract a little too, although not as much. In that context, the sequester should take another bite out of economic growth and cost many jobs. (Maryland, Virginia, California and Texas are expected to be the hardest hit states, with over 100,000 job losses each.) All told, Moody’s estimates that federal fiscal policy added over 2 points to GDP growth in 2009, but will deduct at least a point in 2013. Some of the money saved with the spending cuts will be offset by lower tax revenue when the economy doesn’t grow as it otherwise would have, so even the deficit reduction may be less than expected.

This situation dramatizes the dilemma a country faces when it lives too much on debt in good times. When bad times come, it then confronts the challenge of paying down debt and stimulating the economy at the same time. The fact that the government is turning from stimulus to austerity while unemployment remains so high doesn’t bode well for a vigorous recovery. Countries like Greece, Spain and Italy are in a similar situation, only worse.

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The Price of Inequality (part 2)

December 12, 2012

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The previous post summarized Joseph Stiglitz’s discussion of the market inefficiencies that allow more inequality than is necessary to reward productive activity. In any free market, some will be more successful than others; the problem is that the winners can win in ways that erect barriers to the success of others, or impose costs on the rest of society, or take advantage of privileged access to information. The excessive inequality that results then undermines social mobility, aggregate demand, investment in public goods, and economic growth in general. Contrary to the view that less government is always better economics, Stiglitz sees an essential role for government in keeping markets fair and efficient, countering tendencies toward excessive inequality, and encouraging economic growth for the benefit of all.

In general, the policies that Stiglitz recommends flow naturally from his understanding of market inefficiencies and limitations. Where markets allow companies to capture private benefits while evading responsibility for social costs (such as environmental damage), government can restore the balance with taxes and regulation, and make sure that producers pay a fair price for access to public resources (such as oil on federal lands). Where markets tend to give unearned benefits to those with inside information (such as bankers who know that some of the securities they market have been designed to fail), government can insist on regulated exchanges with greater transparency. Where markets underinvest in public goods, government can specialize in the creation of public goods. Where markets leave a large segment of society too poor to afford the products that they offer, government can use progressive taxation and spending to stimulate aggregate demand. Where markets erect barriers to upward mobility, government can provide better access to education and health care, as well as “active labor market policies” to help workers transition to occupations in which their labor is needed. It can also impose estate taxes to keep the children of the rich from enjoying large unearned advantages over other children.

All of these things are easier said than done, for the simple reason that the same inequalities that distort the economy also distort the political process, undermining government’s ability to address the inequalities. Stiglitz calls this an “adverse dynamic” or “vicious circle,” a self-amplifying feedback loop perpetuating and strengthening social inequality.

As the wealthy get wealthier, they have more to lose from attempts to restrict rent seeking and redistribute income in order to create a fairer economy, and they have more resources with which to resist such attempts. It might seem
strange that as inequality has increased we have been doing less to diminish its impact, but it’s what one might have expected. It’s certainly what one sees around the world: the more egalitarian societies work harder to preserve their social cohesion; in the more unequal societies, government policies and other institutions tend to foster the persistence of inequality. This pattern has been well documented.

Economic elites use a variety of tactics to tilt the political playing field in their favor. They employ lobbyists to make their case, and gain access to politicians with large campaign contributions (minimally regulated thanks to recent Supreme Court decisions). They “use their political influence to get people appointed to the regulatory agencies who are sympathetic to their perspectives,” so-called “regulatory capture.” In the global economy, capital can flow toward countries with the most permissive tax and regulatory policies, and international bankers have enormous power over countries that rely on foreign capital. “If the country doesn’t do what the financial markets like, they threaten to downgrade the ratings, to pull out their money, to raise interest rates; the threats are usually effective.”

In a nominally democratic country like the United States, ordinary people can theoretically outvote the wealthy. Much of Stiglitz’s political discussion concerns the question of why they don’t do so more often, that is, why people frequently vote against their own economic self-interest. Here he draws heavily on behavioral economics, which tries to understand “how people actually behave–rather than how they would behave if, for instance, they had access to perfect information and made efficient use of it in their attempts to reach their goals, which they themselves understood well.” Economic elites benefit from the fact that “many, if not most, Americans possess a limited understanding of the nature of the inequality in our society: They believe that there is less inequality than there is, they underestimate its adverse economic effects, they underestimate the ability of government to do anything about it, and they overestimate the costs of taking action.” In addition, the wealthy use their economic power to market their ideas, cleverly framing policies that benefit the few to make them appear beneficial to all. Weapons programs that profit defense contractors are always described as good for the economy, while the same amount to protect the environment is just “wasteful government spending.”

The media play a crucial role here, either performing a public mission of informing the citizenry, or just presenting whatever programing brings in the most advertising revenue, including political advertising revenue. In the US, not surprisingly, the media underperform their public mission, leaving citizens at the mercy of the advertisers with the deepest pockets. Stiglitz sees this as another example of rent-seeking: The media get an unearned private benefit from free access to a public resource, then use it in a way that produces private profit at the expense of democratic discourse. “The public owns the airwaves that the TV stations use. Rather than giving these away to the TV stations without restriction–a blatant form of corporate welfare–we should sell access to them; and we could sell it with the condition that a certain amount of airtime be made available for campaign advertising.” If the public is too often misinformed, manipulated, and alienated from a political process that doesn’t represent them very well, that works to the advantage of the economically powerful: “If voters have to be induced to vote because they are disillusioned, it becomes expensive to turn out the vote; the more disillusioned they are, the more it costs. But the more money that is required, the more power that the moneyed interests wield.”

The result of this distorted democracy is that legislation to serve the public interest is extremely difficult to pass. The government is prohibited from bargaining with pharmaceutical companies over the price of prescription drugs, costing the taxpayers an estimated $50 billion a year. Banks have succeeded in blocking most regulations intended to protect student borrowers from fraudulent educational programs, as well as most state laws intended to curb predatory lending. Patent law protects the interests of large corporations and their lawyers, but allows them to “trespass on the intellectual property rights of smaller ones almost with impunity.” Corporate executives who perpetrate fraud are rarely penalized personally for doing so. The recent housing crisis revealed that the foreclosure laws make it easy for banks to foreclose without actually proving that homeowners owe the amounts claimed. And on and on.

The biggest battle over public perceptions is fought over the role of government in the economy, over the Reagan question of whether government is the solution to economic difficulties or government is the problem. Since the Reagan years, conservatives have had great success convincing politicians, the media, and much of the general public that conservative fiscal and monetary policies are good for the economy, even if they favor the wealthy and aggravate inequality. In fiscal policy, the conservative approach is to tax and spend less; this is supposed to help the economy by freeing up capital for private investment. (Conservatives often support increases in military spending, however, which in combination with tax cuts produce large deficits.) Stiglitz acknowledges that constraints on taxes and spending might make sense under some conditions: “Of course, when the economy is at full employment, more government spending won’t increase GDP. It has to crowd out other spending….But these experiences are irrelevant…when unemployment is high (and it’s likely to be high for years to come) and when the Fed has committed itself to not increasing interest rates in response.” Under these conditions, government can borrow cheaply and spend with great economic effect, increasing the size of the pie for all.

The government could borrow today to invest in its future— for example, ensuring quality education for poor and middle-class Americans and developing technologies that increase the demand for America’s skilled labor force, and
simultaneously protect the environment. These high-return investments would improve the country’s balance sheet (which looks simultaneously at assets and liabilities) and yield a return more than adequate to repay the very low interest at which the country can borrow. All good businesses borrow to finance expansion. And if they have high-return investments, and face low costs of capital— as the United States does today— they borrow liberally.

Stiglitz maintains that government spending can help the economy even if it is balanced by higher taxes to avoid increasing the deficit:

There is another strategy that can stimulate the economy, even if there is an insistence that the deficit now not increase; it is based on a long-standing principle called the balanced-budget multiplier. If the government simultaneously increases taxes and increases expenditure— so that the current deficit remains unchanged— the economy is stimulated. Of course, the taxes by themselves dampen the economy, but the expenditures stimulate it. The analysis shows unambiguously that the stimulative effect is considerably greater than the contractionary effect. If the tax and expenditure increases are chosen carefully, the increase in GDP can be two to three times the increase in spending.

That means that by insisting on low taxes for the wealthy and low spending on public goods, the economically powerful and their political allies are putting private gain before the public good. They are not only promoting social inequality, but they are impeding rather than facilitating economic growth.

Stiglitz is also a long-time critic of conventional monetary policy, as practiced by the Federal Reserve, the European Central Bank and the International Monetary Fund. He believes that the so-called “independent” central banks have been captured by the financial sector, so that they serve private rather than public interests. Their main focus has been on fighting inflation, a policy that has the greatest benefit for wealthy lenders (since they have the most to lose if loans are repaid in devalued currency). Central banks tend to raise interest rates too quickly during an economic expansion, cooling the economy and maintaining unemployment at an unnecessarily high level. On the other hand, in the Great Recession governments have relied on expansionary monetary policy, pumping more capital into the system by lending banks money at near-zero rates. This is less effective than an expansionary fiscal policy, since the problem is not so much a lack of capital as a lack of spending. But it’s a sweet deal for banks, who get money so cheaply that they can make a good profit even from very low-risk investments like treasury bonds, and are not required to invest it in productive enterprises or housing loans. Cheap capital also encourages companies to finance labor-saving equipment instead of employing more workers, contributing to a jobless recovery.

Stiglitz describes a system so tilted in favor of the rich as to leave the reader pessimistic about finding any way out of the vicious circle of economic and political inequality. In the end, he suggests two general routes to reform. One is that “the 99 percent could come to realize that they have been duped by the 1 percent: that what is in the interest of the 1 percent is not in their interests.” The other is that the 1% themselves come to see beyond their own narrow and short-term self-interest. Although the wealthy have become more and more insulated from the problems experienced by ordinary people, that insulation is not absolute. If the United States were to become as unequal as a Latin American oligarchy, there would be plenty of costs to go around as a result of underutilized human talent and social unrest. Even Brazil, one of the world’s most unequal societies, has been taking steps to alleviate inequality recently. No doubt Stiglitz hopes that books like his can sound the alarm and help change opinions at all levels of American society.

Presidential Debate: Performance vs. Substance

October 5, 2012

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Reactions to Wednesday night’s first presidential debate seem to have reached a general consensus along these lines:

  • Governor Romney’s debate performance was stronger than President Obama’s
  • Many of Romney’s key statements were substantively inaccurate or misleading, but Obama didn’t respond very effectively
  • Performance matters more than substance, and so Romney won the debate

As Rachel Maddow pointed out last night, challengers have usually performed very well in their first debate against incumbent presidents, the most notable exception being Senator Bob Dole’s debate with President Clinton. A common strategy is to attack the president’s policies, which are clearly on the record, while remaining vague enough about one’s own plans to inspire hope–or should I say wishful thinking–among the voters. Mitt Romney has perfected this strategy, and it worked for him pretty well the other night. How much it contributes to useful policy debate is another question. In an earlier post, I quoted Ezra Klein’s remark, “Quite simply, the Romney campaign isn’t adhering to the minimum standards required for a real policy conversation.”

Steve Benen has been serving as a one-man truth squad, reporting on the remarkable number of discrepancies between Romney’s statements and reality as most of us know it. I can’t vouch for every single objection he raises, but he does document his points carefully. Benen’s take on Romney’s debate performance is here.

President Obama was particularly flummoxed by Romney’s denial that he was proposing a $5 trillion tax cut. That figure is based on the analysis of the governor’s proposal by the Tax Policy Center:

This plan would extend the 2001-03 tax cuts, reduce individual income tax rates by 20 percent, eliminate taxation of investment income of most taxpayers (including individuals earning less than $100,000, and married couples earning less than $200,000), eliminate the estate tax, reduce the corporate income tax rate, and repeal the alternative minimum tax (AMT) and the high-income taxes enacted in 2010’s health-reform legislation.

We estimate that these components would reduce revenues by $456 billion in 2015 relative to a current policy baseline. According to statements by Governor Romney and his advisors, the remainder of the plan will include policies to offset this revenue loss, although there are no details on how that would be achieved.

The $5 trillion figure comes from accumulating the annual revenue reductions over ten years (a common practice in fiscal projections) and rounding the result to the nearest trillion. When confronted with this figure, Romney doesn’t try to clarify it or revise it; he just denies it.

If we could agree on at least a ballpark figure for the magnitude of the Romney tax cuts, then we could have a substantive discussion of how to make up that revenue, since he insists that his tax cut will not increase the deficit. One way he can do it is by closing tax “loopholes,” but he refuses to say which deductions he would eliminate. He does claim that eliminating or capping deductions for wealthy taxpayers (incomes over $250,000) will make his proposal revenue neutral for that group. One problem with that is that it undercuts his own argument for cutting taxes in the first place, which is to give “job creators” more money to invest in new jobs. A second problem is that cutting deductions doesn’t make the numbers add up unless you hit very popular ones, such as the charitable deduction and home interest deduction, and also eliminate them for more taxpayers than just the very wealthy.

The other way to offset the big tax cut–and another matter for serious debate if Romney would engage in it–is to create a broader tax base by growing the economy. Romney claims that he will do that, but he provides no details. This is the familiar article of faith among “supply-siders” that tax cuts are always good for the economy, and so they can pay for themselves. The recent record on this is not encouraging, since Republican tax cuts from Ronald Reagan to George W. Bush have created large deficits. Faced with those deficits, Reagan was willing to put taxes back on the table, but recent Republicans have insisted that the budget axe fall entirely on domestic spending. Romney’s running mate, Paul Ryan, is famous for proposing unpopular budget cuts. But Romney avoids talking about such cuts, except for the vague promise to make people less dependent on government, as if throwing them off Medicaid were doing them a favor.

Romney’s wonderful “performance” is like a magic act–It’s mostly sleight-of-hand. He shows us a big tax cut, but if we question how he will pay for it, it suddenly disappears. He’s not really cutting taxes for the wealthy, you see, because he’s closing (unspecified) “loopholes,” and the rest is offset by “growing the economy.” He substitutes the dubious magic of supply-side economics for the inconvenient fact that he has a certain amount of revenue to find. (When Obama tried to bring that up, Romney hit him with the zinger that being President doesn’t give him the right to his own facts–point to Romney if you’re keeping score.) Paul Ryan worked the same magic with his budget plan; he instructed the Congressional Budget Office to assume that his tax cuts were revenue neutral without providing any supporting evidence. (And the CBO still couldn’t find too much deficit reduction in his plan because of his refusal to cut defense spending or allow the Bush tax cuts to expire. He achieved his reputation as a “deficit hawk” just by being tough on domestic spending.)

Whichever candidate won the debate, the American electorate lost. We deserve a serious policy debate; what we got was obfuscation and befuddlement.

Would Another Tax Cut Help?

October 1, 2012

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One of the biggest disagreements between the presidential candidates is over tax policy. It’s really another episode in the ongoing debate over how best to create jobs and maintain a strong economy. “Supply-siders” recommend low taxes to encourage savings and investment, while Keynesians recommend government spending to boost aggregate demand for goods and services. The government can’t do too much of both at once without running large deficits. Keynesians are explicitly willing to allow deficit spending when combating recessions. Supply-siders more often claim to be deficit “hawks,” but they often run up debt anyway because of their eagerness to cut taxes.

President Obama’s position on taxes is familiar by now. He would keep tax rates the same as they are now, except that he would allow the Bush tax cuts on incomes over $250,000 to expire. He would use part of the additional revenue to support spending intended to create jobs, and part to reduce the deficit. Republicans characterize Obama’s policy as a “job-killing” tax increase. Democrats defend it as just bringing tax rates on the wealthy back up to where they were in the Clinton years, when job growth was actually much stronger than it has been since then.

Governor Romney joins most Republicans in opposing any expiration of the Bush tax cuts. He would also preserve tax breaks that specifically encourage investment, such as low rates on capital gains and municipal bonds. In addition, he proposes another large cut in income tax rates, as well as the complete elimination of estate taxes. He maintains that he can cut taxes without increasing the deficit, for two reasons. First, for incomes over $250,000, the reductions in tax rates would be balanced by the elimination of “loopholes,” so the revenue collected from the wealthy would remain the same. Second, the rate reductions would encourage saving, investment and job-creation, and that would broaden the tax base and generate new revenue. So the idea is to help the economy without aggravating the deficit.

Critics of the Romney plan usually make one or more of these points:

  1. Offsetting rate cuts for the wealthy by closing loopholes is very difficult, perhaps mathematically impossible. Romney refuses to say what deductions he would eliminate, but the independent Tax Policy Center concluded that the eliminations would have to hit less wealthy taxpayers as well in order for the numbers to add up. Political resistance to some of the changes would be strong; for example, the deduction for mortgage interest is important to housing sales and the deduction for charitable contributions is vital to non-profits. This is one reason why the tax cuts are likely to increase the deficit, just as the Bush tax cuts did.
  2. Although the assumption that tax cuts generate economic growth is an article of faith for supply-siders, the evidence for it is weak. Testing it properly would require cutting taxes while holding other factors constant–especially spending–but that’s not what governments in recent memory have done. Ronald Reagan and George W. Bush both cut taxes, but they also increased military spending and ran big deficits; job growth was good for Reagan but poor for Bush. Job growth was even better during the 1950s and 60s when taxes were higher, as well as during the Clinton administration, as mentioned earlier. Overall, researchers have found little correlation between rates of taxation and rates of economic growth. If the Romney tax cuts turned out to be no more successful than the Bush tax cuts in expanding the economy, then that’s another reason why they might just aggravate the deficit.
  3. Even if we assume that another tax cut could pay for itself by creating jobs and broadening the tax base, the existing deficit would remain an issue. If the Romney tax cut turned out to be revenue neutral at best, and the Republicans continued their refusal to reduce military spending, then the entire burden of reducing the deficit would fall on domestic spending. That is essentially the Ryan budget plan. The trouble with that is that cuts in domestic spending destroy jobs, both the jobs of government employees and those of private workers whose work (such as road construction) doesn’t get funded. Economists such as Mark Zandi of Moody Analytics calculate that each dollar spent by the government has a larger multiplier effect on economic activity than each dollar reduction in taxes. For that reason, the Economic Policy Institute estimates that job creation would be much weaker under Romney’s plan than under President Obama’s plan (considering both his tax increase on the wealthy and his American Jobs Act).

A positive effect of another tax cut on the economy is not out of the question. But the benefits seem dubious, and the risks of higher deficits or more jobs destroyed seem very high.