The Federal Balance Sheet

Matthew Klein at The Economist‘s Free Exchange blog has some interesting ideas on how to view the financial position of the government.

My modest suggestion is that we start calculating the public sector’s “book value” by taking the difference between its actual assets and liabilities. (Since governments have the power to tax their productive citizens, the asset side of the public sector’s balance sheet should be thought of as a share of the country’s total asset holdings.) This approach would probably be more useful than the simple public debt to national income ratio, even if it comes with its own (significant) complications.

He goes on to note:

Under this framework, all government spending could be divided into three basic categories: investment to increase the future standard of living, hedging that reduces the nation’s risk exposure, and resource redistribution.

The post is fairly long and definitely worth reading.

A quick note on spending and growth

The graph below has been making its rounds (see this post by Tyler Cowen for several links).  Upon first glance it appears to refute any sort of fiscal approach to restoring GDP.  The red (GDP) line is table although the blue (government spending) line decreases.  However the key here is noting that this graph actually shows continued growth in GDP once government spending has hit a relatively stable level.  It becomes much more clear in the graph below that I put together (note red now represents government spending and blue represent GDP).

Obviously this leaves out many other factors that I would consider relevant to the NGDP recovery (tax stimulus, low interest rates, right-sized asset prices, low steady inflation, etc.), but it at least gives an accurate depiction of the spending-growth pattern that emerged after the recession.

Krugman on Medicare costs

I think he oversimplifies a little when he says:

And the truth is that we know a lot about how to do that — after all, every other advanced country has much lower health costs than we do, and even within the US, the VHA and even Medicaid are much better at controlling costs than Medicare, and even more so relative to private insurance.

The key is having a health insurance system that can say no — no, we won’t pay premium prices for drugs that are little if any better, we won’t pay for medical procedures that yield little or no benefit.

Though the truth is most policy questions have elegantly simple solutions that no one likes.

The Economist on tax proposals

The Economist this week includes a summary (above) of some of the major tax policy proposals being tossed around.  It also includes this blurb about some GOP ideas:

One way this could be done is to target deductions that primarily benefit the rich. During the election campaign, Mitt Romney proposed paying for big marginal rate cuts by setting a cap on total deductions. The Tax Policy Centre, a think-tank, reckons a cap of $50,000 would raise $749 billion over ten years, comparable to the $800 billion that Mr Boehner entertained during failed negotiations with Mr Obama in 2011. Importantly, this fix would make the tax system much more progressive: 80% of the additional money would come from the top 1% of earners. This has helped draw interest from some Democrats.

A slightly different proposal by Martin Feldstein, a prominent Republican economist, and Maya MacGuineas of the Committee for a Responsible Federal Budget, a think-tank, would cap the tax benefit of itemised deductions at 2% of income for all households. Mr Feldstein reckons that would raise more than $2 trillion over ten years, although almost all families would pay more tax, not just the rich.

 

 

The Marginal Impact of Tax Credits (plus some thoughts on progressive consumption taxes)

Timothy Taylor reviews some of the CBO’s findings in its Effective Marginal Tax Rates for Low- and Moderate-Income Workers report.  He concludes (referencing the graph below in part):

These high marginal tax rates on those with low and moderate levels of income raise some questions for those on all sides of the tax debates. For those who don’t believe that high marginal tax rates have much affect on incentives to work at higher income levels, like households earning $250,000 or more per year, consistency would seem to suggest that they shouldn’t worry too much about incentives to work at lower income levels, either. For those who express a lot of concern about how high marginal tax rates would injure incentives to work for those at the top income levels, consistency would seem to suggest that they express similar concern over lower marginal tax rates for those at the lower and moderate income levels, too–which means making programs like the Earned Income Tax Credit, food stamps, welfare, and others more generous, so that they can be phased down more slowly as people earn income.

From the report itself, I particularly enjoyed this section on marginal tax rates and the decision to enter the workforce.

A person’s marginal tax rate influences many different decisions about working: whether to increase or decrease the number of hours worked, bargain for wages or nontaxable fringe benefits, get or quit a second job, or enter or leave the labor force. For people who are already working, an increase in marginal tax rates on additional earnings lowers the financial gain from working additional hours, which in turn has two effects:

• Hours worked tend to fall from their initial level because other uses of time become relatively more attractive; and
• Hours worked tend to increase from their initial level because the amount of additional disposable income (income after accounting for taxes and transfers) available to reach consumption and saving goals is lower.

Because those two effects work in opposite directions, the net effect depends on which one dominates.On balance, in CBO’s judgment, increases in marginal tax rates on earnings tend to decrease the supply of labor by inducing people already in the workforce to put in fewer hours or to be less productive. The responsiveness of labor supply to tax changes varies across groups. On average, working-age men are not very responsive to changes in marginal tax rates. Married women, who tended in the past to be the lower earner in the household, typically decreased their hours of work—on average—when marginal tax rates rose. In recent decades, their decisions about decreasing or increasing the number of hours worked have become more similar to those made by men.

Marginal tax rates that result from a relatively large increase in income are relevant to the decision to enter the workforce. For instance, because the earned income tax credit increases disposable income for all eligible workers, the ability to qualify for the credit makes work more appealing. Studies have found that expansions of the EITC between 1986 and 1996 significantly increased the movement of single mothers into the workforce but had little effect on the number of hours they worked.

This, I think, adds some granularity to the debate of the disincentives of things like the EITC; though I would add one very important caveat.  The work incentive is only a component of the overall picture related to tax policy benefits for the unemployed and working poor.  As the fiscal debate continues in Washington, I suspect the quantification of specific tax and spending policies will become very popular (rightfully so).  What I will be interested in seeing is if there is any quantification of secondary and tertiary effects of policy changes.  For instance, I have been reading quite a bit lately about the idea of progressive consumption taxes (something I’ve written about in the past) as an alternative to income taxes.  Beyond the practical and political challenges of implementation; there are two problems I see with such a system (not to imply that these issues are without remedy).

1. A PCT does not easily allow for fiscal policy shocks through the tax code.  While tax preferences for certain behavior are generally distortionary and not beneficial, things like education and HSAs ought to be encouraged.  Obviously tax relief for such spending could be implemented, but I think it amplifies some of the practicality concerns.
2. I have seen no writing as of yet on the transition costs of such a system.  Businesses, individuals, investors, savers, spenders, charities, etc. have all developed systems based on an income tax structure.  Not to say the status quo is best by virtue of being the status quo, but there are certainly costs for any change that must be analyzed.

Point 2 above really goes to my concern in the current and upcoming debate over taxes and spending.  Will we properly access the impacts of our various tax and spending proposals?  Will we consider the fact that by incentivizing increased transitions from the unemployed poor to the working poor without increasing HHS benefits, we are potentially disincentivizing focusing on children’s behavior.

The numbers mandate action on the fiscal front and I am very much in favor of creating work incentives, but that probably also means maintaining strong familiar support for certain segments of society.

Good Observations on Fiscal Policy

Karl Smith writes (sorry for quoting half the post):

Sometimes the net return-to-action is positive over the entire relevant range. In those cases smart finely tuned action is worthless and getting the most bang for your buck is actively harmful.

You always maximize simply by going full throttle regardless of the cost. This is because marginal benefit always exceeds marginal cost over your range. Note that this will generally not be the point that maximizes the rate-of-return or “bang for the buck.”

Thus, getting the most bang-for-your-buck is the wrong answer.

This is the perfect realm for something like fiscal policy. Efficiency is not something that central governments are good at. On the other hand, really-freaking-huge, is something that central governments are good at it.

A depression, where idle resources are plentiful and real borrowing costs are zero or negative is exactly where you find almost no return to precision.

Indeed, Austrians might find comfort in my suggestion that a general crisis is almost by definition a time when “knowledge of the particular circumstances of time and place” has low value. This is both why strong governments can do a lot of good in crisis and why people are wrong to assert that “if government is so good at mobilizing for war, then surely it can manage making shoes during a time of peace.”

That gets things exactly backwards.

To boil down his premise as I see it, efficiency matters increasingly less the farther the economy gets from potential, as there are few, if any, individual actions that will return the economy to potential.  I think this is a good simplification, but has some hints at oversimplification.  If one thinks of recoveries as a chain of related or semi-related events and believes that there are many chains that can be used to achieve recovery, then targeting the shortest chain should be the goal.  That may mean grasping at the first link in several chains to account for uncertainty (the public sector is not limited to one policy approach after all), but a slightly more targeted approach might be beneficial in selecting the proper chain of events.  Of course I am oversimplifying the process of determining the shortest course of action to a recovery, but this is a blog.

Amtrak: In it for the Long Haul

From The Economist‘s Gulliver blog:

Amtrak loses a lot of money providing food service on its long-haul routes because it loses a lot of money on almost everything related to those routes. Long-haul passenger train trips, especially at Amtrak speeds, are for hobbyists, people with lots of time and very restricted budgets, and people who are afraid of flying. No private-sector company without Amtrak’s political and legal obligations would continue to operate its long-haul routes without substantial changes. In a world where members of Congress actually cared about making Amtrak more viable, they would be focusing on pushing the company to scrap or drastically alter its long-haul services, and not suggesting that serving food to people is the heart of the problem.

Why do characters like Parks and Rec.’s Chris Traeger and Ben Wyatt exist?

Matt Mitchell at the Mercatus Center points out that, “after 60 years, the private economy is 5 times its 1950 size. But state and local governments are spending almost 13 times as much as they did in 1950,” in the graph below.

Josh Barro also looks into this issue; focusing on San Jose he says, “In other words, the city made a lot of promises that it could barely afford when times were good, and now that times are bad, it really can’t afford them.”  And uses the graph below to point out the recessions impact on local public sector jobs in San Jose.

Ezra Klein sees the same data in an entirely different way.  He notes:

That said, the place where you can most fairly blame the government for the shape of the labor market is in public-sector jobs. The federal government can choose to hire, fire or hold employment steady. It can give states money to keep emmployees on the job, or it can withhold that money. So the fact that the public sector is losing jobs isn’t just a problem, but a problem that the federal government could, with 100 percent certainty, fix. Today’s press conference wasn’t about whether the private sector is fine. It was about whether Congress could do more for both the private and public sectors. And that’s what we should be talking about.

Thanks to Tyler Cowen for the pointer on much of this.

Taxes and Cheap Public Borrowing

Matt Yglesias writes in defense of a suggestion to temporarily end income taxation:

Normally you face a tradeoff. Taxes impose costs on the present-day population that might impair wealth creation over the long-term, but to avoid taxes by borrowing you need to pay interest to creditors. But the real interest rate we’re being asked for is low. Less than zero. So what’s the tradeoff? Why not sell as many negative-yield ten-year bonds as the market will buy (sell enough bonds and presumably interest rates will rise) and let that auction revenue “crowd out” taxes as a way of financing government activities? Now in an ideal world we’d use that money to finance valuable public sector investments, but that all gets very politically controversial and you can see why it’s impossible to agree on this given our dysfunctional politics. But what’s the constituency for taxes in a negative interest rate environment?

Tyler Cowen unintentionally responded to this Matt, saying, “Maybe, but keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up.”

I tend to fall with Cowen on this.  Because something is a relatively unrisky asset, it is not necessarily an unrisky asset.  It might be advisable on some level to take advantage of cheap public funds right now to stimulate growth, which presumably would grow the economy and reduce the risk premium by improving the state of the private sector.  This is all assuming that public issues are inversely correlated to the private economies performance in some way (increasing public debt will not impact private sector confidence), but the chart below from yesterday’s Stevenson-Wolfers article that I linked seems to suggest otherwise.

Visualization of Campaign Policy Alternatives

From The Economist: