A Few Thoughts on the Debt Ceiling Deal

By James Kwak

1. Obama still has his hostage—if he wants it. As far as I can tell, the Bush tax cuts are nowhere in the debt ceiling agreement, which means that at current course and speed they expire at the end of 2012. Extending the tax cuts would reduce revenue by about $3.5 trillion over the next decade. According to news reports, Obama was willing to extend the Bush tax cuts in exchange for $800-1,200 billion of additional tax revenue—in other words, he was willing to cut taxes by about $2.5 trillion relative to current law. Boehner and Cantor walked out because of some combination of (a) they couldn’t get their members to vote for that tax “increase” or (b) they think they will be able to extend all the tax cuts if they negotiate that deal separately. I wouldn’t be so sure about (b). Remember, gridlock means the tax cuts expire.

2. The next step of the deal is that a joint Congressional committee is supposed to come up with a plan to reduce deficits by $1.2-1.5 trillion over ten years. If they fail to come up with a plan, or their plan is rejected by Congress, then there will be major automatic cuts in discretionary spending, including defense. (There will also be cuts in Medicare reimbursement rates, but not in Social Security or Medicaid.) The idea on Obama’s side is that the prospect of major defense cuts will force Republicans to negotiate. But if they were willing to let the government default rather than increase taxes—even by closing tax loopholes—why do we think they will be afraid of some defense budget cuts? Traditional Republicans may have liked high defense spending, but not the new breed. Ron Paul is basically an isolationist; Grover Norquist thinks the defense budget should be reduced.

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Who Is In Worse Shape – the United States or Europe?

By Simon Johnson

If economic performance is in part a beauty pageant, as John Maynard Keynes suggested, both the U.S. and Europe seem to be competing hard this summer for last place. If anything, based on the latest flow of news coverage, Europe might seem to be experiencing something of a resurgence – last week the eurozone agreed on a big deal involving mutual support and limiting the fallout from Greece’s debt problems. In contrast, the U.S. this week seems to be completely mired in a political stalemate that becomes more complex and confused at every turn.

But rhetoric masks the reality on both sides of the Atlantic. The eurozone still faces an immediate crisis – the can was kicked down the road last week, but not far. The United States, on the other hand, is in much better shape over the next decade than you might think listening to politicians of any stripe. The American problems loom in the decades that follow 2021 – the good news is that there is still plenty of time to sort these out; the bad news is that almost no one is currently talking about the real issues.

In a policy paper released by the Peterson Institute for International Economics last Thursday, Peter Boone and I went through the details on the eurozone crisis, including how this common currency area got itself into such deep trouble – and what exactly are the likely scenarios now (you can also see the discussion and contrasting views at the launch here). Continue reading “Who Is In Worse Shape – the United States or Europe?” →

Two Can Play

By James Kwak

Quick, what was the greatest conservative accomplishment of the George W. Bush presidency? It wasn’t Medicare Part D: that was a clever way to steal a Democratic issue and pass it in a form that was friendly to the pharmaceutical industry. It wasn’t Roberts and Alito: yes, they are young and conservative, but the majority is still only 5-4. It wasn’t Social Security privatization: that didn’t happen. Iraq? Getting political support to invade Iraq was a major coup, but everything went downhill from there.

The answer is obvious: the tax cuts of 2001 and 2003. Together, they were a wish list of conservative tax policy: a reduction in the top marginal income tax rate from 39.1 percent to 35 percent; a reduction in the top rates for capital gains and dividends to 15 percent; much higher contribution limits for tax-preferred retirement accounts (meaning that if you have enough money to save, you can shield more of it from taxes); and eventual elimination of the estate tax. In total, when fully phased in, the Bush-era tax cuts sliced almost 3 percent of GDP out of federal government revenues.*

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Could Tax Reform Help Make the Financial System Safer?

By Simon Johnson. My written testimony to the joint hearing of the House Ways and Means Committee with the Senate Finance Committee is here.

In the deafening cacophony of Washington-based voices on the debt ceiling, it is easy to miss a potentially more significant development. There is growing bipartisan interest in tax reform, including changing the corporate tax system to make it more sensible – and a bulwark against financial sector instability.

The House Ways and Means Committee and Senate Finance Committee held a joint hearing last week – apparently the first time these two committees have met in this fashion to discuss tax in over 70 years. The theme of the hearing might sound a little dry, “Tax Reform and the Tax Treatment of Debt and Equity,” but in fact it was well-designed to carve out some space for future agreement across the political spectrum.

The basic premise of the hearing was the question: Did the tax code contribute to the severity of the financial crisis in 2008-09? At one level the answer is simple: Yes, because the tax deductibility of interest payments encourages families to take out bigger mortgages and companies to borrow more relative to their equity capital (as dividend payments to stock owners are not tax deductible). But where within the tax code should we focus attention, if the goal is preventing similar crises in the future? Continue reading “Could Tax Reform Help Make the Financial System Safer?” →

What Is Obama Getting?

By James Kwak

Nothing, as far as I can tell.

The media are reporting the potential Obama-Boehner deal as $3 trillion in spending cuts and $1 trillion in unspecified future revenue increases. But as far as I can tell (details are vague), the baseline for that $1 trillion tax increase is a world in which all of the Bush/Obama tax cuts are extended.*

President Obama can personally guarantee that none of those tax cuts will be extended, simply by promising to veto any bill that extends them. That would increase tax revenues by $3-4 trillion over ten years, not $1 trillion. That is enormous bargaining leverage against a Republican Party that only cares about one thing: tax cuts.

So as far as I can tell, Obama is handing the Republicans $3 trillion in spending cuts, and also handing them $3 trillion in tax cuts. There are only two possible interpretations that I can think of. One: Obama thinks this is the best deal he can get — but if that’s the case, then you have to ask why his starting point wasn’t letting all of the tax cuts expire. Two: Obama thinks this is a good outcome.

But this certainly isn’t a progressive outcome. And giving up $3 trillion in revenues isn’t a fiscally responsible outcome, either. So what does that say?

* That’s how Ezra Klein reads it.

The Weirdness of 10-Year Deficit Reduction

By James Kwak

The Gang of Six plan proposes to reduce the cumulative deficit by $3.6-3.7 trillion over ten years relative to the CBO’s March 2011 baseline. Everyone’s excited about it. Four trillion dollars! Hooray!

The weird thing is that if you are claiming deficit reductions against the CBO’s baseline, I think intellectual honesty requires you to point out that, according to the CBO’s baseline, there is no deficit problem. The projected 2021 deficit is $729 billion, but net interest spending is $807 billion (Table 1-5). That means that the primary budget is running a surplus of $78 billion, the entire deficit is due to interest payments on the debt, and the debt has stabilized around 75 percent of GDP. This is not a great situation, but it’s no emergency, either.

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Then Why Are Treasuries Up?

By James Kwak

The Times:

Markets Stumble on Deficit and Debt Worries

Stocks in the United States and Europe fell more than 1 percent on Monday in the wake of the publication late Friday of the results of stress tests on European banks, and as investors remained wary about the debt-ceiling talks in Washington.

The Journal:

Stocks Slump on Debt Fears

Stocks fell as the combination of anxieties about debt in the block of euro-using nations and a lack of progress in U.S. debt-ceiling negotiations sparked a selloff.

If people are worried about the debt ceiling, then why are short-term and intermediate-term Treasuries flat or slightly up? Presumably the mechanism by which a debt ceiling breakdown would affect stocks would have to go through Treasuries somehow.

The Size-of-Government Fallacy

By James Kwak

You hear all the time that the government must get smaller. John Boehner said it the day after the elections: “We’re going to continue and renew our efforts for a smaller, less costly and more accountable government.” Barack Obama agreed in part earlier this week: “We have agreed to a series of spending cuts that will make the government leaner, meaner, more effective, more efficient, and give taxpayers a greater bang for their buck.” And a large majority of Americans agree in the abstract (while simultaneously opposing any significant spending cuts).

Conservatives like to point to high levels of federal spending—23.8 percent of GDP last year—as evidence that government is too big. But the idea that there is one thing called “government”—and that you can measure it by looking at total spending—makes no sense. Worse yet, it can lead to fundamentally misguided policy decisions.

That’s the opening of a column I wrote for The Atlantic’s online business section. I’m trying out writing an occasional column for them. Today’s is about the idea that the total volume of government outlays or receipts can tell you anything worth knowing about the size of government — and the damage that is being done by people who fetishize the total spending number.

So What?

By James Kwak

Everyone (well, the media at least) seems to be acting as if Moody’s downgrading the United States would be a bad thing. I feel like I must be missing something.

First of all, we know what bond ratings are worth. See, oh, the entire past decade for evidence. (It wasn’t just mortgage-backed securities; they didn’t downgrade Enron until after the SEC announced an inquiry and CFO Andrew Fastow was forced out, and less than five weeks before the company declared bankruptcy.)

Still, the point of bond rating agencies is to do research on securities that other investors may not know well. If I’m a buy-side investor, I don’t have the time to review tens of thousands of different debt securities I could buy. It makes sense for me to turn to someone like Moody’s or S&P, because I can count on them to do at least some level of research and analysis on them. In other words, the ratings may not be great, but they still carry information.

But this is emphatically not true when it comes to U.S. government debt. Enormous amounts of information about the government’s finances are open to the public and are pored over by thousands of analysts from all around the world. Moody’s is no better at estimating future tax revenues and spending commitments than anyone else.

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Should We Blame Bank Examiners For Slow Job Growth?

By Simon Johnson. My written testimony to House Financial Services, Subcommittee on Financial Institutions and Consumer Credit is here.

With unemployment back up to 9.2 percent, in the numbers that came out last week, the hunt is on for an explanation of why job creation has been so slow since the financial crisis of 2008. Some House Republicans think they have found a specific culprit: bank examiners.

In the view of Representative Bill Posey (R.) and a number of his colleagues on the House Financial Services Committee, bank examiners are clamping down on otherwise perfectly healthy banks – and forcing them to inappropriately classify some loans as “nonaccrual” (meaning less likely to be paid back). Mr. Posey has therefore introduced a bill that would direct examiners to regard all loans as accrual, as long as payments are still being made – and a hearing was held last Friday to discuss the merits of the matter.

I testified at the hearing and was not supportive of Mr. Posey’s legislation. On the subsequent panel of witnesses, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) testified – as the relevant regulators – and they were even more forcefully against the proposal. Continue reading “Should We Blame Bank Examiners For Slow Job Growth?” →

My Christmas Present

By James Kwak

For Christmas, Simon gave me a copy of Why the West Rules — For Now, by Ian Morris. I thought it was an amusing but flawed book and put it back on my shelf, but yesterday a friend told me that everyone was talking about the book and I should say what I thought about it. So here goes. (And bear in mind that I do have a Ph.D. in history — though no one has a Ph.D. in all of the history that Morris covers.)

First of all, it’s a fun read. It isn’t particularly engaging, and the narrative is pretty weak (not the author’s fault — it’s just that the history of all of human civilization just doesn’t make for a great story), but it’s filled with interesting historical facts and fills in all those gaps in your knowledge of ancient history. My knowledge of ancient history was mainly gaps, so it was news to me that Western civilization began not in Mesopotamia, as I was taught thirty years ago, but in the “Hilly Flanks” — an arc that runs mainly through Western Syria, Southeastern Turkey, and the Iraq-Iran border.

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Not Worth Mentioning Department

By James Kwak

I was trying to read “Path to Prosperity,” the House Budget Committee’s glossy version of its budget resolution, also known as the Ryan Plan. (Don’t ask.) On page 13, I found this:

“An inevitable consequence of the last Congress’s decision to ramp up spending so quickly was that billions of Americans’ hard-earned tax dollars were squandered.The Government Accountability Office (GAO) – the non- partisan agency that audits the government’s books – recently found between $100 billion to $200 billion in duplication, overlap, and waste in federal spending.”

I thought, “There probably was some waste, I wonder what the GAO found.” So I looked at the source cited in a footnote: a March 2011 GAO report entitled Opportunities to Reduce Potential Duplication in Government Programs, Save Tax Dollars, and Enhance Revenue. You can see where this is heading from the title of that report. It is specifically intended to “identify federal programs, agencies, offices, and initiatives, either within departments or governmentwide, which have duplicative goals or activities” (p. 1). The report was required by a statute passed in 2010. The first targeted area, for example, is this: “Fragmented food safety system has caused inconsistent oversight, ineffective coordination, and inefficient use of resources.”

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Gene Sperling, Then and Now

By James Kwak

Mike Konczal points out Gene Sperling’s recent performance on MSNBC, arguing that uncertainty about long-term deficits is weighing on the economy.

What surprised me is that I was just (re-)reading about the early days of the Clinton economic team, and back then Sperling was on the other side of the debate. In Robert Rubin’s account of the famous January 7, 1993 meeting (well, famous if you’re into economic policy debates from two decades ago), the deficit hawks were Al Gore, Lloyd Bentsen, Leon Panetta, and Rubin. The people who wanted more stimulus and less deficit reduction were Robert Reich, Laura Tyson, George Stephanopoulos, and Sperling. (See In an Uncertain World, pp. 123-24.) In Clinton’s memoir, Sperling was also on the side of stimulus and investment: “Gene Sperling made a presentation of options for new investments, arguing for the most expensive one, about $90 billion, which would meet all my campaign commitments immediately.” (My Life, p. 461.)

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