Tax Policy, Metaphysics, Extremeties and Moderation in One Post

Recently I linked a Wolfers-Stevenson tax commentary about behavioral biases and tax expenditures as well as some follow-up by Will Wilkinson (from before and from this morning). The post that I linked this morning had an especially inspiring paragraph:

Now, we’re still stuck with crazy endogeneity problems. Whether public spending or private investment will do better in a particular case may be a function of shared beliefs, trust, public-spiritedness, etc. If we treat mental models, belief systems, cultural values, ideologies, etc. as fixed points, we may be able to determine whether public or private investment is more “expensive.” But if we don’t, and acknowledge that belief systems and policy systems are reciprocally influencing, it may be impossible to identify in any clear way the ideal baseline, in which case there may be no identifiable fact of the matter about whether public spending on this or that costs money or makes money. We’re going to have to guess a lot of the time, and hope.

This quote, to me, really highlights the symphonic messiness of republics; the democratic underpinnings typically pull the society to a libertarian stance, while conversely the social contractarian trajectory (regarding equality, justice, etc.) tend to push things away from a libertarian culture position. This push and pull somehow works out into a hindsight appearance of a moderate/cooperative society. Simply put, a messy process creates masterful results.

So in a system that fosters libertarians that see property as unilaterally defined by possession on one extreme, social contractarians that would prefer to pool resources and reallocate them in a neo-Marxist process based on optimized utility, and literally everything between the two (in fact most of society is concentrated in this latter amalgamation of groups).

As an adendum to Will Wilkinson’s above commentary on the challenge of endogeneity within this question, I would add a consideration for a posivite observer effect whereby acknowledge and further relating the fact of moderation within a republic could lead to a moderation of principles rather than a retreat to extremes. In tax policy this could manifest itself as a move towards the gray area between all taxation as stolen property and all tax expenditures and subsidies as unfair payments. This is not a move solely towards the utility maximizing level of the social contractarians, but it is a move away from a possession only approach to property. Reality in a republic seems to dictate this cooperation.

A new way of thinking about the big vs. small government debate

$40 million… That is .0031% of the budget deficit in 2010. It is also the amount of money allocated to funding 28,000 $1,500 scholarships based on academic and extracurricular achievement in the Robert C. Byrd Honors Scholarship Program.

$161.3 million… That was the 2010 budget for the National Endowment for the Arts. The Commission on Fine Arts spent about $12 million that year and the National Endowment for the Humanities had a budget of about $170 million.

Out of a $1.3 trillion deficit these are some of the specific line items that have been recommended to be cut by various pieces of spending reduction legislation. These combined would save around $400 million, or $0.0004 trillion.

Do not misunderstand that I am against cutting programs or the budgets of programs in an effort to balance the budget. But is this budget balancing or program slashing? How is it that Section 23 of Rand Paul’s proposal to cut $500 billion from the budget states, “The Social Security Administration shall not be subject to funding cuts in fiscal year 2011,” and is still considered a serious deficit proposal.

As I am writing this, I just read three great things on the Washington Post that help me make my point. The first is Robert Samuelson’s quite balanced critique of our budgetary conundrum. The second and third are the first two parts of the Post’s. Part one explains how we eroded the surplus the country had after the Clinton Administration (although to be fair I think it downplays the effect of the 2001 recession); and part two, which I find more interesting, deals, very honestly I might add, with the Republican Party’s obsession with lowering taxes.

The two most frustrating things about the deficit talks, in my opinion, are (1) the refusal by Democrats to honestly deal with elephant, no pun intended, in the room – that being Social Security and the aging population – and (2) the Republicans strange ideological mission to only have revenue neutral (i.e. essentially useless) changes to taxes. This would be like Peyton Manning having the chance to throw a game winning 20-yard touchdown on the last play to a wide-open receiver but being convinced he can run the ball in himself and the fact that Patrick Willis is staring him down will actually make him run faster than he would otherwise be able to run. Everyone knows that he should just throw the touchdown and be honest that he’s slow.

Marketplace from American Public Media put out a very interesting game/app called Budget Hero that further confirms my suspicion. We can have small government without having no government. If we simply get better at doing the big things that government does, we can keep the government from getting too big. Does cutting a program that costs $40 million dollars make the government smaller? No. Does it make it serve the population better? No. It only cuts out something that it appears is being done fairly efficiently.

Government plays a very important role in providing a safety net for the elderly, disabled, unemployed, impoverished, and children and we need to make sure that the programs aimed at these societal challenges are sustainable. If that means coming to the table over higher retirement age, reducing some big ticket spending inefficiencies, getting more revenue, or any combination of the three, then we should be willing to do that. However, getting rid of the small government programs that work, really does nothing to solve the problem.

Is Grover Norquist the worst thing that has happened to the modern GOP?

In Politico’s The Arena section today, David Brooks’ column chastising the bulk of GOP Congressman for their unwillingness to accept reasonable proposals was the topic of discussion. Grover Norquist, the discussion’s first respondent, declares that David Brooks is mistaken and claims that policies like those endorsed by Brooks, Richard Darman, and George H.W. Bush (i.e. willingness to raise taxes with the idea that they will actually raise revenue and reduce deficits) are necessarily anti-growth.

Norquist states, “The tax hikes were real and painful. A recession followed. And government spending went up faster than it was projected to increase before the ‘deal.’ Spending got worse, not marginally better. And the deficit got worse.” Interestingly enough, however, Grover Norquist is not really telling the truth.

George H.W. Bush’s famous (or infamous, depending on one’s point of view) increase to taxes (and reversal in his, in my opinion, foolish “no new taxes” pledge) came out of the Omnibus Budget Reconciliation Act (OBRA) of 1990, which took affect on January 1, 1991. So what actually happened? Technically yes (see graph below), the United States went into a recession following the OBRA of 1990 going into effect. Per the official definition of a recession, that a recession is two consecutive quarters of negative GDP growth (I’m using real GDP figures), the United States experienced negative growth in the fourth quarter of 1990 and the first quarter of 1991. HOWEVER, the largest period of economic contraction actually occurred in 1990 NOT 1991. The first quarter of 1991 showed a trend of growth beginning that would continue throughout the rest of the 1990s. So using Grover Norquist’s post hoc ergo propter hoc view of the world, The OBRA of 1990 actually brought the country OUT of a recession rather than INTO a recession – of course this would be equally (well maybe not quite equally) fallacious.

Data from Bureau of Economic Analysis

Of course, while GDP contraction may create a technical recession, it is really unemployment that creates the recession mindset in a population. Again, upon first look, the data seems to say the OBRA of 1990 created higher unemployment. Average unemployment for 1990, 1991, and 1992 was 5.6%, 6.9%, and 7.5% respectively. In fact, average unemployment for the five-year period prior to the OBRA of 1990 was 5.9% versus 6.6% after its enactment; although, when this period is expanded to the decade before and after the data shows an average of 7.1% from 1981-1990 and 5.6% from 1991 through 2000. Still, both the five and ten year periods are subject to many factors and could be misleading. The more important issue in addressing the concerns of Mr. Norquist is the trend of unemployment immediately around January 1, 1991. The graph below shows that in the latter half of 1990, the unemployment rate was experiencing its most rapid growth in this period. Early-1991 still saw growth in unemployment, although this would begin to moderate through (with the exception of Dec. 1991) mid- to late-1992 when the unemployment rate began to drop. This is, of course, consistent with the expectation of a lag between economic growth recovery, which in this case began occurring in the second quarter of 1991, and improvement in the unemployment rate.

Data from Bureau of Labor Statistics

One of Norquist’s economic statements was correct; spending did grow following the OBRA of 1990 and along with it the deficit. In fact, public debt as a percent of GDP in the mid-1990s is very similar to its levels in the mid-2000s (around 67% of GDP in each case) – of course we all know that the late-1990s and late-2000s saw deficit and debt figures move in opposite directions (surpluses in the ‘90s reduced debt while growing deficits in the 2000s caused even higher debt). There is, again, more to this story however. The next graph illustrates how total spending and non-defense spending evolved for the last few decades compared to GDP. It shows relative rises with respect to GDP around the time of various recessions and also shows the spike Norquist alluded to in 1991. This is where the data does not tell the whole story and the historical narrative provides some important information. The OBRA of 1990 was not the first budget proposal by President Bush that year, it was actually the third. The first included spending cuts with no tax increases and was rejected by Democrats, the second included spending cuts with tax increases and was rejected by Republicans, and the third was accepted. Interestingly enough, the third proposal increased spending more than the second proposal, but came in the face of government shutdown, which forced enough support to get higher taxes through. The third option also shifted much of the tax increases from excise increases to income tax increases, which is also less conservative – although preferable from a growth and equity perspective.

Data from Office of Management and Budget

Politically it is obvious what raising taxes did to President Bush, but it may not be as much of “the economy stupid,” as then future President Clinton suggested in his 1992 campaign, as it was “the lie stupid.” Interestingly enough, it was Richard Darman who first expressed fear that making the pledge might mean better politics and worse governance; Darman appears to have been correct. The economics suggests that the OBRA of 1990 was smart policy given the economic environment and did not have a direct negative effect on the economy as Grover Norquist suggests.

The politics of the pledge created an unnecessary dilemma between good policy and political survival. President Bush made a noble sacrifice. It is unfortunate that Grover Norquist continues to recreate this dilemma even today. The fact that one of the biggest questions surrounding the debt ceiling compromise proposals being put forth is, “does this method of raising revenue violate the pledge?” and not, “does this method of raising revenue provide the most good and least harm for our country’s economy?” is not a good sign. This leaves Republicans looking unable to govern, irresponsible, and selfish.

How Obama Learned to Stop Worrying and Love the Bush Tax Cuts

The Senate is set to pass President Obama’s tax cut legislation today with broad bipartisan support. Later this week it will move to the House, where, despite threats of a Democratic backbench revolt, passage seems increasingly secure. The reason is clear enough. Since no deal would mean that tax rates would increase across income spectrum, Democrats who don’t like the estate tax provisions or marginal tax rate extensions for the top 2 percent of earners don’t have the leverage to make a populist appeal. The most they can do is bitch and moan behind closed doors, then vote for an eminently reasonable piece of legislation.

The Republicans, on the other hand, made it abundantly clear that the only constituency they hold dear are the rich. As the below graph illustrates, the GOP conceded on a 13-month extension of unemployment insurance, a payroll tax moratorium, and extensions of the Recovery Act’s low- and-middle-income tax credits. All are major policy goals of the Obama administration that would have been unachievable under standard Republican obstruction. (For perspective, here‘s the GOP filibustering a 2-month unemployment extension in July.) In return, the Republicans demanded $91 billion in tax breaks for households earning over $250,000/year and an increase in the estate tax floor to $5 million. So adamant was their desire to protect the wealthiest that they gave up more than twice as much as they got in return. To top it off, for all the Tea Party fervor about the deficit, the GOP did not make any effort to pay for the $900 billion price tag of the total tax cut package.

Source: Ezra Klein

 

Meanwhile, President Obama is enjoying the most clear-cut triumph of his presidency. Rarely does good politics line up with good policy, but on this occasion, Obama saw it long before anyone else and seized it with both hands. This deal will provide a much-needed fiscal boost to the economy and an extension of the safety net for the unemployed. Both make for sound economic policy, and — as Obama’s political capital is inversely tied to the unemployment rate — good politics. In the meantime, he separates himself from the pettiness of both parties and preserves a winning populist issue, the expiration of the tax cuts for the wealthy, for his reelection campaign in two years.

So how did he do it? It started with Harry Reid’s failure to pass two bills extending all but the upper-income tax cuts through the Senate. What appeared as a defeat actually accomplished two things. First, the GOP tipped their hand that they were so committed to extending the tax cuts for the wealthy that they would play chicken with a massive tax hike for all households come January 1st. Second, every GOP senator was put on record opposing the tax cuts for the bottom 98 percent of earners. Republican leadership was forced to the negotiating table in a severely weakened position.

President Obama identified the GOP’s leverage point, the top tax cuts, and exploited it shrewdly. His dual objectives were to a) provide relief for the unemployed and b) inject fiscal stimulus into the economic recovery. Of course, he had to be willing to give in on the tax cuts for the wealthy, but Obama was never as dogmatic about eliminating the tax cuts as the GOP was about extending them. Publicly, he dug in his heels to oppose them, if only to make the compromise seem more equitable to the Republicans. After all, extending the top tax cuts would provide some economic boost (though not very efficiently.)

So he put the tax cuts on the table and named his price. All the GOP cared about was extending the top rates, so they quickly acceded to the President’s demands. After announcing the deal publicly, he took it to the Democratic Congressional caucuses. In essence, Obama was forcing them into a shotgun marriage with the threat of being blamed for across-the-board tax hikes if they backed out. This teed up the Left’s bitterness, which Obama took a swing at in his post-deal press conference. Exit, Barack Obama, liberal ideologue. Re-enter Barack Obama, post-partisan voice of reason.

 

Obama asked, and the GOP got told

Our collective stance toward gays in the military has been treated — at least for the last few decades — as a bellwether for how gays are treated in the rest of society. I’m not quite sure why that is. Perhaps it bears symbolic value because the military is where Truman chose to launch his assault on racial segregation in 1948. Whatever the reason, there’s no denying that gay men and women will be able to serve openly in the military before they will be able to marry whom they choose. For social conservatives, gays in the military is the first line of defense against widespread acceptance of homosexuality as a legitimate lifestyle.

That’s why today’s news that the long-anticipated Pentagon report about the effects of the repeal of Don’t Ask, Don’t Tell is so important. The key finding from the report is that an overwhelming majority of service members have no problem serving with their LGBT brothers and sisters. While that in itself deserves recognition, for purposes of this post I’d instead like to praise the process by which the Obama administration approached the DADT debate.

President Obama argued during the campaign that DADT amounted to state-sponsored discrimination that was both immoral and had adverse effects on the performance of our military. The counter-argument, made by conservatives such as Sen. John McCain, was that DADT was not inherently discriminatory (gays could serve, after all, by hiding their sexual orientation) and that such a policy shift would damage troop morale and unit preparedness. When Obama was elected, many in his party wanted him to denounce DADT supporters as bigots and end the policy through executive decree. Instead of fighting on moral grounds, though, he chose to engage the GOP on the argument that could be empirically tested: the effect on current service members.

Obama infuriated many of his base supporters by postponing action until an exhaustive, nine-month survey of military personnel could be completed. The man chosen to head the study, Defense Sec. Bob Gates, had been smoothly confirmed by the Senate twice — once under Bush, once under Obama — and enjoyed bipartisan credibility. Now that the study is complete, the GOP’s argument has been largely discredited. The Obama administration has empirical evidence that troop morale and unit cohesion will not be harmed, and that any small disruptions can be mitigated through effective leadership.

The debate will now move to the Senate floor, where several high-profile social conservatives are lining up behind the repeal. Had Obama indiscriminately accused his opponents of outright bigotry, Republicans likely would have closed ranks. The Pentagon report not only provides a political trump card for Obama, but it also gives Republicans cover to vote for the repeal. Instead of capitulating to Obama’s liberal worldview, GOP senators can justify their votes for repeal as respect for the wishes of the military service members.

Of course, that’s how the debate should proceed from here. Because we’re talking about the U.S. Senate, though, things will probably be a good bit messier. Nevertheless, Obama has maximized his chances of achieving the policy goal that he sought while minimizing the pain inflicted on his political opponents by supporting it. That, my friends, is an effective model for getting things done.

Fixing the Deficit: Even “Rivals” Can Agree on Some Things

Yesterday’s Budget Puzzle on the NY Times website inspired Jake and me to play a little game to see how we would fix the budget. Below are charts showing our results.

Over the next couple of days we will provide commentary on our on choices and each other’s choices.

All picks were made independently. The first chart shows those picks we both agreed on, the second shows Jake’s unique picks, and the third shows my unique picks.

Interestingly 48% of Jake’s total savings came from tax revenue with 52% coming from spending cuts; 34% of my total savings came from tax revenue, while 66% came from spending cuts; and our mutual picks fell right in the middle with 42% of savings coming from tax revenue and 58% from spending cuts.

What the Fiscal Commission Seems to Understand: My Reaction to “The Debt Commission’s Policy Deficit”

I am going to save my full reaction to the Fiscal Commission‘s proposals until the Fiscal Commission actually makes its proposals (on or around December 2); I do, however, want to respond to Jake’s frustration with what the Commission’s co-chairs outlined last week.

Here is what at least the Fiscal Commission’s co-chairs seem to realize, America is a center-right country. The graphic below is comes from a Gallup Poll just before the recent midterm election and includes historical data from previous elections.

Particularly interesting is the last segment of the table, which shows the ideological leanings of the American electorate. As of October 2010, about 80% of the country is not liberal and a plurality self-identifies as conservative. This, however, is not a recent phenomenon, as is blatantly obvious from this data.

This is the political reality of which the co-chairs of the Fiscal Commission are all too aware (after all, one was a President’s Chief of Staff and the other a Senator).

A right-leaning country is not going to embrace a tax increase based proposal, even if it is necessary (there Jake, I endorsed some tax increases to cut the deficit). However, just to be clear, there is a difference between lowering the effective tax rate and lowering the tax rate. One of the likely proposals the Fiscal Commission will present is to cut tax loopholes while lowering tax rates. This will result in higher government revenue by increasing the effective tax rate.

Other items in the co-chair’s presentation like, the 21% of GDP spending cap, which was not arbitrary – it is the average annual government spending as a percent of GDP since 1980 – were aimed at making sure the center-right nature of the country is represented in any proposal that the Commission offers.

A center-right country will not accept a liberal deficit reduction proposal. Does that mean tax increases are out the door? No. What it does mean is that tax increases will not be the centerpiece of the proposal.

One Bill, Two Lessons in Policy-Making

The Rural Energy Savings Program Act probably does not ring a bell even to some of the most wonkish individual; however, it offers two interesting lessons in policy-making. Both lessons work to explain why this Bill has been sponsored by a bipartisan group of legislators in both houses.

Incremental Policies versus Sweeping Policies

Healthcare legislation, climate change legislation, and comprehensive stimulus packages have become the legislative norm of accomplishing lasting goals. Many people (my blogging “rival” included) see these large, policy-shifting pieces of legislation as a model for success in the style of the New Deal and the Great Society. However, this Great Man Theory of history seems to suggest that things were otherwise stagnant outside of the actions of these three administrations.

Cooperative Compromise versus Combative Policies

The second lesson of the Rural Energy Savings Program Act goes to the nature of the policy. Rather completely restructuring the country’s energy policy, the bill finds common ground on the front end of the bills development. The bill was authored in a cooperative manner that results in a less antagonist approval process. By doing this, the bill gained bipartisan sponsorship.

A combative approach would have been to develop a more partisan bill only to see “compromise” reached through deal-making and the amendment process as the bill went through Congress.

This second lesson in policy-making closely relates to the first. By setting smaller, achievable goals, all policy-actors were able to find common ground and develop good policy.

This bill is not through Congress yet but it at least offers an illustration of good policy formulation. Although, when it passed the House, votes were generally partisan (only six Republicans voted in favor of the bill), it was not a major point of contention either; additionally in the senate it has received sponsorship from two Republican senators.

As an aside to give credit where it is due, the idea for the Rural Energy Savings Program Act actually originated in a policy memo written at the moderate-progressive think tank Third Way.