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In my new The Week column, I argue against the idea that the GOP 2016 presidential contenders should offer big tax-cut plans that sharply lower top personal tax rates. Here is a taste:
First, there’s little evidence they will supercharge the economy. Modeling of a recent plan put forward by Rep. Dave Camp (R-Mich.), the outgoing Ways and Means chairman, suggests it would increase the economy’s size by less than 1 percent over a decade.
Second, the income gains from modestly faster growth might not reach the middle class, where after-tax income has been stagnant for nearly a decade. The Congressional Budget Office recently found that top income growth has been five times faster than middle-income growth over the past 30 years.
Finally, sharply cutting top rates will lose the government trillions in revenue at a time the national debt is at historically high levels — unless, that is, lots of tax breaks are also eliminated. But many of those — such as the Earned Income Tax Credit — benefit middle- and working-class Americans, which is why more than 40 percent pay no federal income taxes, according to the Tax Policy Center.
So, please, no fantasy tax plans that only balance if (a) you use implausible GDP growth forecasts, (b) spending is reduced to where it was during the Truman administration or (c) taxes are raised on folks not currently paying them. I would prefer any tax relief focus on families and promoting new business investment and startups. And even that should be part of a broader economic agenda focusing on anti-cronyism deregulation, lowering middle-class living costs (healthcare, education), and creating a more pro-work safety net.
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Covered is unemployment insurance, disability payments, old-age assistance, government-provided health care, family allowances and the like. By this measure [of government social spending] alone, the United States is hardly a leader. It ranks 23rd in the world with social spending of roughly 19 percent of gross domestic product (GDP). This is slightly below the OECD average of 22 percent. France is the champ at nearly 32 percent. (The data are generally the latest available, including some estimates for 2014.)
But wait. Direct government spending isn’t the only way that societies provide social services. They also channel payments through private companies, encouraged, regulated and subsidized by government. This is what the United States does, notably with employer-provided health insurance (which is subsidized by government by not counting employer contributions as taxable income) and tax-favored retirement savings accounts. When these are added to government’s direct payments, rankings shift. France remains at the top, but the United States vaults into second position with roughly 30 percent of its GDP spent on social services, including health care. We have a hybrid welfare state, partly run by the government and partly outsourced to private markets.
And this chart illustrates the comparison:
As I have written before, one big difference between the US and other social democracies is America’s more vibrant entrepreneurial culture. But sticking to the safety net issue, another OECD chart illustrates just where all those welfare dollars are going. As far as direct social spending goes, the US spends a greater share on the upper-middle class than countries such as Australia, Canada, Sweden, and Norway:
And that chart reminds me of this one from CBO which shows where flow the top ten US tax expenditures, including the employer-sponsored health insurance exclusion, mortgage interest deduction, and preferential rates on capital gains and dividends:
So the US runs a good chunk of its “hybrid welfare state” through the tax code and the private sector, mostly to the benefit of the non-poor. And why is that? An observation by Monica Prasad:
Why do European countries have lower levels of poverty and inequality than the United States? We used to think this was a result of American anti-government sentiment, which produced a government too small to redistribute income or to attend to the needs of the poor. But over the past three decades scholars have discovered that our government wasn’t as small as we thought. Historians, sociologists and political scientists have all uncovered evidence that points to a surprisingly large governmental presence in the United States throughout the 20th century and even earlier, in some cases surpassing what we find in Western Europe. …
Beginning after World War II, Germany, France and several other countries aimed to restrain private consumption and channel profits toward export industries, in a bid to reconstruct their war-devastated economies. … The United States, on the other hand, developed a consumer economy based on government-subsidized mortgage credit, a kind of “mortgage Keynesianism.” Increasing consumption was a Depression-era response to a problem that puzzled observers at the time.
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A helpful explanation on video by JPMorgan European economist David Mackie:
Secular stagnation is about understanding low growth … There’s a demand-side, secular-stagnation story about forces weighing on demand. Then there’s a supply-side, secular-stagnation story about forces weighing on the potential growth of the economy. Both of those things are important in terms of understanding lackluster growth. … In some places, particularly the US and UK, the demand-side secular stagnation story is kind of faded quite a bit, and we are now more preoccupied with the supply-side, secular-stagnation story, whereas in the euro area it is still very much both. … The immediate problem of the euro area is the demand problem, I think you need to deal with that first. The secular stagnation on the supply side can itself have two aspects to it: One is just the low growth in population and productivity. But there’s also a sort of hysteresis problem where if you allow the weak demand to persist for too long that further erodes your supply side.
It was economist Larry Summers who reintroduced “secular stagnation” into the modern economics debate, with much of the focus on persistently weak demand — too much income inequality means too little consumption, for instance. In short, the economy needs more redistribution. But now with the US economy continuing to grow closer to 2% than 3% — we’ll see if the recent couple of strong quarters can be expanded upon — even Summers seems to be shifting his focus to the supply side and boosting potential GDP:
Why has the economy’s supply potential declined so much relative to the pre-2007 trend? This will be debated in the years to come. Part of the answer lies in the damaging effect of past economic weakness on future potential. Part is the brutal demographics of an ageing population, the end of the trend towards increased women’s labour force participation, and the exhaustion of the gains from an increasingly educated workforce. And part is the apparent slowing of at least measured productivity. … To achieve growth of even 2 per cent over the next decade, active support for demand will be necessary but not sufficient. Structural reform is essential to increase the productivity of both workers and capital, and to increase growth in the number of people able and willing to work productively. Infrastructure investment, immigration reform, policies to promote family-friendly work, support for exploitation of energy resources, and business tax reform become ever more important policy imperatives.
Hey, Washington, there is your economic agenda right there.
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Until recently, the strong consensus was energy prices must inexorably rise through time. Fossil fuels are finite, the easy fields have been developed and the next generation of production must come from more remote and, therefore, more costly operations. The seductive argument pushed companies into ever-deeper water and difficult terrain. Strange then that prices of all the major sources of energy (except nuclear power) are falling. The oil price has fallen by 30 per cent since June and shows no sign of rebounding. In real terms, oil prices are now back to the level of November 1979, the height of the Islamic revolution in Iran, as the [above chart} from Centre for Economic and Business Research has shown.
The question I seem to be asked every day is whether the present fall is temporary or permanent. Of course, no one knows. Given that energy is a very political market, prices can be volatile. But there is a strong case for arguing that prices are more like to fall than rise over time and that the inevitable volatility will be around a downward trend line due to the underlying structural forces within the industry. … The reason for taking this view is simple. Technology in many different ways is adding to supply and reducing demand. In the past decade, technology has opened up the potential of shale gas in the US, the international ripples of which are still being felt. Coal has been pushed out of the US power sector, with the result that world prices are falling. Gas to gas competition will soon be the norm. Technology has also raised recovery rates and cut costs, taking the industry into deeper water and opened up new provinces. Technology is reducing costs in some parts of the renewables business – especially solar. Cars use less fuel per mile and through meters and smart grid technology we can fine tune the amounts of energy we consume
Let me add that (a) transportation expert, and blogger David Levinson argues car traffic is declining and will continue to decline dramatically in the coming decades, (b) solar prices also continue to drop, (c) it isn’t unreasonable to consider a stunning energy breakthrough. So maybe Butler is right, and so too this Russian central banker: “It appears increasingly likely that there will be a long-term decline in oil prices.” Barring geopolitical tensions and war, of course.
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Some two-thirds of Americans think the US is on the wrong track. Stagnant living standards are at the heart of those concerns. Will our children have more opportunity than we’ve had? Upward mobility hasn’t gotten worse over the past four decades, nor has it improved. In a spot-on Financial Times comment, Ed Luce wonder what Democrats and their potential 2016 presidential nominee are offering worried voters beyond social issues:
Come the glamour of 2016, Hispanic, millennial, single female and African American voters will be back in force. All that Hillary Clinton need do – or whoever takes the Democratic nomination – is tick the right boxes and let demography fix the rest. Such is the US left’s world view. It is also a measure of its intellectual poverty. Whatever liberals are smoking, it is no stimulant to new ideas. The left’s sense of destiny is based on America’s shift to a minority-majority nation within the next 30 years. As the white vote shrinks, each presidential race will be harder for Republicans to win. What is missing is a compelling reason for people to embrace Democrats, as opposed to rejecting Republicans. For the time being, the latter can be relied upon to offend minorities – notably Hispanics. But Democrats have remarkably little new to say about the future of America’s middle classes, regardless of ethnicity. Without a credible economic plan, the US left risks being little more than a rainbow coalition.
What is the next-stage Democratic economic agenda to boost growth and opportunity? A higher minimum wage for the 3% of workers who currently earn it (more than half being part-timers)? Universal preschool? Beyond the cost, “analysts have yet to prove that expanding middle-class access to preschool has as much impact as it does for low-income children,” according to a recent piece in The Atlantic magazine. (And as a Slate piece on pre-kindergarten put it, “If you are reading this article, your kid probably doesn’t need preschool.”) More infrastructure spending? Larry Summers has been pushing this idea hard as a macro way boost to potential growth and current demand, but micro details of how much spending and on what are hard to come by.
Do those ideas meet the Schumer Standard? As New York’s senior US senator said last week, “Democrats must embrace government, not run away from it. … Together, Democrats must embrace government. It’s what we believe in; it’s what unites our party; and, most importantly, it’s the only thing that’s going to get the middle class going again.”
And how would that translate into policy? Perhaps a spate of Scandinavian-like social programs to relieve middle-class anxiety such as wage insurance, one-year parental leave, and a universal basic income among others — all financed with a value-added tax? Or maybe the pay-for would be dramatically higher taxes on the 1% ( or 2% or 3% or 4% …) given that many left-center economists have embraced the idea of sharply higher marginal tax rates without economic damage. Fingers crossed, I guess. Anyway, much of the emphasis here is on improving economic security through redistribution rather than economic dynamism. And without the latter, the former is far less affordable. What is the Democratic plan for growth and creating a more innovative American economy?
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What about the losers from creative destruction? I got that question yesterday on Twitter, in the context of how the rise of Uber and other ride-sharing services affects the existing owners of taxicab medallions. As is seen in the above chart, these supply-limited medallions have been an excellent investment. Over the past 80 years, Stewart Dompe and Adam Smith note in a must-read new Mercatus report, “taxi medallions have generated annualized 15.5 percent rate of return. Put another way, the value of a medallion doubled, on average, every four and a half years.”
And now this rent-seeking racket of artificial scarcity is under threat. Sure, all pretty good news for low-paid drivers and service-starved consumers, but what about the medallion owners who paid such big bucks? Don’t they have a valid property right that is being made worthless by government regulators? Not long ago on the EconTalk podcast, host Russ Roberts and Duke University economist Mike Munger explored this very issue:
Munger: … But I think the cost advantage is really a problem, because it actually raises a lot of questions about the nature of due process. Suppose that we don’t take any action and the value of these medallions falls to zero. Are we obliged to offer compensation, because we in effect made a regulatory decision that is a taking? This property right, this medallion, had significant value. We made a choice, without due process, that said we are going to reduce the value of this medallion to zero. Are we obliged to compensate?
Roberts: Who is ‘we’?
Munger: The state. Just like we would if we were taking your land under eminent domain to build a road.
Roberts: Yeah, I’m just giving you a heard time. Um, I don’t think that would win. But I’ll be interested.
Munger: It would not. And one of the reasons I wanted to bring it up was my good friend Peter Van Doren had an article at Cato this past week that’s a really terrific discussion of that, and in fact gives good reasons why “we”–in quotes–would not be obliged. Because it’s something different.
This is a sort of political property right that we all recognize is contingent on policy. It changes all the time. And it’s a restriction on competition. Now, the thing that kind of bothers me is you could say all property is. So I have 35 acres of pine forest south of Pittsboro, North Carolina. And suppose I were down there one day, and I heard some chain saws, and I walked back 300 or 400 yards into the woods, and I saw some guys with chain saws cutting down my trees? I’d say, What are you guys doing? They said, We’ve had a tremendous cost to manage; because we can just take these trees and sell them, we can really undercut you! And I’d say, It’s my land! He said: ‘You need to read Rousseau: The fruits of the earth belong to all and the earth to no one. So, we can just take this. And that piece of paper that you say has property–well, the state’s going to change that. As soon as they realize that you took this land from the Indians; it’s unjust. It’s not a real property right.’ This is the same argument that people make about taxing medallions: It was unjust, it was a restriction on competition; it’s not a real property right. Once we start saying property rights aren’t real, I’m not sure I have my pine forest any more, either.
Roberts: Well, it is certainly true that if you paid a million dollars six months ago and now you find that asset isn’t paying out–first of all you can’t resell it for a million, and secondly, it’s not the cash flow that you anticipated from it. Using the medallion isn’t coming through. That’s a real unpleasant surprise. You definitely lost money.
Mumger: Isn’t it a violation of due process? Because did we make a promise? The reason that you need this medallion is we are going to force anyone who provides transportation services to have a medallion. No one else can provide this. And so when you pay for it, you can in good faith think we’re going to protect your property right. And that’s why you pay for it.
Roberts: Yeah, it’s an interesting question. It’s a dangerous slope. Because what it does, of course, is set in stone all rent-seeking victories. It’s very depressing.
Munger: I think the answer is [that] there is a difference between private property and kind of reifying rent-seeking victories. … But if it’s clearly just a restriction on competition and entry into an industry where there would be big benefits, then we shouldn’t compensate. … But in the pine forest it makes sense. We don’t want it to be a commons. We don’t want everyone coming in and overfishing, overharvesting; and so it’s a solution to an externalities problem. Whereas the medallion–maybe it’s a solution to an externalities problem. That’s the argument we make–is we don’t want too much congestion. But if you look, there probably are not enough taxis in New York, particularly at peak times. And so I think the congestion story doesn’t hold up as well.
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A great summary from Scott Winship on how tough or easy it is these days to climb the opportunity ladder:
A just-released paper examined, better than any previous study, mobility across multiple countries using administrative data for each and the same methods and income concepts. That paper reported — for the U.S., Sweden, and Canada — the probability that a man raised by a father in the bottom fifth of earnings has earnings that exceed the bottom fifth of grown sons. The figures were 68 percent in the U.S. and Sweden and 69 percent in Canada. The essentially identical rates of upward mobility — also reflected in other measures in the paper — contradict the prior consensus that the U.S. features lower upward mobility than other nations, a conclusion that now appears compromised by data inconsistencies or driven by family structure differences that affect household income.
Upward mobility rates in the U.S. differ notably by race. Among whites, 74 percent of sons raised in the bottom make it out, compared with just 49 percent of African American sons. Even among whites, however, upward mobility is arguably insufficient. Just 37 percent of sons raised in the bottom fifth end up in the top three fifths, while equality of outcomes would put that figure at 60 percent. Among black sons, the figure is just 29 percent.
And while upward mobility probably has not declined in recent decades, neither has it increased. My own estimates, for example, indicate that 63 percent of sons born in the late 1940s and raised in the bottom quarter of family income made it out of the bottom quarter of earnings in early adulthood. For sons born in the early 1980s, the figure was 60 percent.
Of course, it is impossible to directly observe barriers to opportunity since we can neither observe the potential outcomes of children under different circumstances nor identify how their preferences form and evolve. Relative mobility rates cannot even be taken as prima facie evidence of unequal opportunity. However, we do know that there are large test score gaps when children enter school, which do not diminish much, if at all, over the course of primary and secondary schooling. We also know that college graduation rates are six times higher for children born in upper-income families than for those in lower-income families. Even children with test scores in the top quartile in eighth grade have dramatically different probabilities of getting a bachelor’s degree depending on whether they come from advantaged or disadvantaged families.
And let me add that even if mobility is stable — to me, another discouraging sign of American economic stasis — higher inequality increases the economic penalty for an inability to move up the ladder. Anyway, rather than a neat 10-point agenda for increasing mobility, Winship recommends lots of policy experiments in key areas such as education, marriage, and safety-net programs. Terribly reasonable stuff. But my key takeaway is that faster GDP growth is necessary but not sufficient in helping enhance opportunity to create the meaningful lives we wish to live.
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Here is a needed addendum to my post earlier on how policymakers must focus on key middle-class, cost-of-living issues such as healthcare and higher education. I should have also mentioned housing, however. And has it happens, my pal Ryan Avent has an essay on this topic over at Cato Institute’s new online forum on economic growth.
It’s pretty logical: People should go where the jobs are if they are living where the jobs are not. In particular, they should move to places where high levels of productivity and innovation result in strong wage growth. But that is not happening. A lot more Americans are moving to lower-productivity Dallas or Houston than higher-productivity San Francisco. Of course, housing is five times more expensive in the Bay Area as Houston has built five times as much housing since 2000.
Here is Avent:
If one had a magic wand to wave and wanted to boost growth, magically neutralizing opposition to new development in the most productive cities would be one’s best bet. In the absence of a magic wand, solving the problem probably requires a two-pronged approach. On the one hand, it must be made easier for big cities to invest in big infrastructure projects, like the ones that allowed them to get so large in the first place. That means simplifying the regulations that constrain such investments and raise their costs. It means designing project bidding in ways that encourage competition and create the incentives for efficient, on-time construction. It means reforming the federal government rules that channel infrastructure money toward places that don’t need it, and, yes, it means using the federal government’s ability to borrow at remarkably low interest rates to make an economically justified investment in America’s future.
But infrastructure alone will not solve the problem. Instead, metropolitan areas may need institutional reforms that better balance the economic interests of the metropolitan area (and the country as a whole) with the interests and preferences of those living in neighborhoods that are likely to be affected by new development. When land-use decisions are made at a hyper-local level — giving local councilmembers or commissions extensive influence over which projects are approved, or focusing negotiation between residents and developers at the street level rather than the metropolitan level — the result will typically be far too little development. Those living immediately around a project enjoy some of its benefits but bear nearly all of its costs, in terms of disruption and congestion; they are therefore highly motivated to block projects and can succeed when local institutions enable them.
At a macro level, the payoff could be pretty big. Housing mismatch may be costing Americans a trillion dollars a year. It also makes sense to make it easier for the jobless to move to economically stronger cities through relocation vouchers, not mention better public transit — whether buses or congestion-priced highways — to connect workers to jobs within urban areas.
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The more I review various immigration reform plans, the more I think this rather libertarian one by the late Gary Becker makes more sense. From Guy Sorman in City Journal:
Immigrants know that they will find a better life in the United States. Most will work hard at achieving that better life, Becker believed, because the American welfare state today doesn’t provide all that much support for those unwilling to work (unlike in Western Europe, where many immigrants live permanently on welfare). A Mexican or Chinese immigrant working in America will usually multiply his income by five or even ten times over what it would be in his country of origin. Given that reality, Becker thought, such immigrants, legal or illegal, would be willing to pay for such an opportunity—just as students and their families pay for college, perceiving it, rightly, as an investment that will bring greater earning power. “Visa seekers,” he wrote, “are comparable to college degree seekers”: they’re entrepreneurs, investing in human capital. Thus, Becker proposed, all visas should come with a price tag attached, set by the market. For American taxpayers, Becker claimed, the benefits of such a visa-for-money system would be substantial. Border control would cost less, for starters, since some immigrants who are tempted to sneak into America illegally (which costs them time and money) could now buy their way in legally. And immigrants ready to pay for visas would have an even stronger incentive to work to recoup their investment.
In a Beckerian system, wouldn’t wealthy immigrants be favored over the deserving poor? This is already the case, he replied: the rich can often obtain U.S. residency permits if they invest in the country. Becker wanted to extend the market for visas, now enjoyed by the wealthy, to the hardworking poor. If they didn’t have the money up front, aspirational immigrants should be able to borrow it, just as American students and their families do. In Becker’s view, the only losers in an open market for visas would be the often unsavory “coyotes” paid to transport Latin American migrants across the Texas border.
A visa market would remain imperfect, Becker admitted; he wasn’t a free-market fundamentalist (a breed that exists more in the liberal imagination than on the University of Chicago campus). Not all foreign workers purchasing a visa would earn back their investments. Some might fail completely, costing American society more than what they generate. Such realities illustrate the limitations of economics as a discipline: the individual’s personal fate is hidden in the data and models that the economist proposes. On average, though, Becker predicted, his visa plan would work far better than the dysfunctional current immigration system.
Of course, politics would still have a role, most obviously in setting the price. And I am sure that before long politicians would attempt to carve out exceptions or create multi-level pricing schemes. What’s more, the immigration reform mostly likely to happen is the one that most resembles the existing system, not something totally different. But at least the Becker plan is an attempt to look and economic costs and benefits and inject some economic rationality into our immigration system. A 2010 piece from The Economist offers a few downsides to the idea versus a “points” system like the one used in Canada.
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We should want the US economy to be as innovative as possible. For instance: Innovative new companies provide new goods, services, and high-paying jobs. Innovation also helps raise living standards by making good and services more affordable. As Scott Andes of Brookings notes in a blog post:
Computers, information technology services, and appliances are all cheaper today than 25 years ago, while the price of automobiles has grown by less than a percentage point annually. Today it takes fewer hours of work for a middle income wage earner to afford a car than at any time in history. These price declines constitute unequivocal wins for the American middle and working classes.
But as the above chart from Andes shows, the cost of some key services — including health and education — have outpaced incomes. And this reflects a lack of innovation and productivity and competition. Many Republicans fret about inflation. But it’s the wrong kind of inflation that they are worrying about. The problem isn’t the government central bank’s “money printing,” but the government’s distortion and inefficient provision of important services. And it is addressing these cost-of-living issues that is at the core of the conservative reform movement. As Ramesh Ponnuru wrote just after the 2012 election:
The Republican story about how societies prosper — not just the Romney story — dwelt on the heroic entrepreneur stifled by taxes and regulations: an important story with which most people do not identify. The ordinary person does not see himself as a great innovator. He, or she, is trying to make a living and support or maybe start a family. A conservative reform of our health-care system and tax code, among other institutions, might help with these goals. About this person, however, Republicans have had little to say. ..
The perception that the Republican party serves the interests only of the rich underlies all the demographic weaknesses that get discussed in narrower terms. Hispanics do not vote for the Democrats solely because of immigration. Many of them are poor and lack health insurance, and they hear nothing from the Republicans but a lot from the Democrats about bettering their situation. Young people, too, are economically insecure, especially these days. If Republicans found a way to apply conservative principles in ways that offered tangible benefits to most voters and then talked about this agenda in those terms, they would improve their standing among all of these groups while also increasing their appeal to white working-class voters.
I guess I view it this way: A smart, center-right policy agenda would include a focus on a) revitalizing US entrepreneurship, b) modernizing the safety net to make it more affordable long-term and more pro-work, and c) dealing with the cost, availability, and quality of education (K-12 and college) and healthcare. What am I missing here?