Deficit compromise

The Washington Post reported last week on a discouraging poll. Americans supposedly want to reduce the deficit, but not if it means changing Medicare, cutting programs like defense or Medicaid, or raising taxes on anybody but the very richest Americans. Democrats and Republicans seem farther than ever from finding agreement. It’s times like this that I’m glad there are some optimists around who still see some basis for making progress with America’s daunting fiscal challenge.

Diane Lim Rogers sees the issue this way:

Stories about [the Washington Post-ABC] poll have tended to emphasize the majority who are opposed to each item in a “pick one” menu of tough choices: 78 percent opposed to cutting Medicare, 69 percent opposed to cutting Medicaid, 56 percent opposed to cutting defense spending. The only “pick one” option that a majority (72 percent) supported: “raising taxes on incomes over $250,000.” And even that is not as agreeable as it sounds, considering that households with incomes over $250,000 make up only about 2 percent of the population– i.e., you’d think we could get a little closer to 98 percent support on that one.

But that majority opposition to each of the “tough choices” is because respondents were asked to take or leave each of those tough choices as the single strategy for deficit reduction. No one wants to agree to give up something if they think others in society aren’t going to give up something, too. None of those “pick one” choices conveyed a notion of shared sacrifice or a “balanced” approach.

Diane notes that only a slight majority opposed a

more balanced approach which combines (“small”) cuts in the major entitlement programs with “raising taxes on all Americans.” This is a glass that is (almost) half full. We haven’t even begun to make the full sales pitch on this “shared sacrifice” plan with more specifics about how Medicare and Social Security can be trimmed while actually strengthening the safety-net parts of those programs (reassuring the liberals), or how revenues can be raised in a progressive manner by reducing “tax entitlements” rather than merely jacking up tax rates (reassuring the conservatives).

This gives me hope.


The same poll shows that a majority of Americans (59 percent) already agree that the best way to reduce the deficit is through the only-generally-described “combination” of tax increases and spending cuts– not just one or the other.

David Paul Kuhn quotes a related analysis of the Washington Post-ABC poll by political psychologist Steven Kull, director of the Program for Public Consultation at the University of Maryland:

It’s like you are saying, would you like to have some cake? Yes. Would you like to eat your cake? Yes. Ah, they want to have their cake and eat it too!

The public is capable of dealing with the budget in a rational fashion. When you ask one-off questions they can only react in a visceral way. No, it’s not attractive to cut spending. No, it’s not attractive to raise taxes. Yes, you want to balance the budget. You haven’t asked them to make tradeoffs.

Kuhn reports an approach by Kull that tried to get at this more constructively:

Kull’s study asked a random sample of Americans to do precisely that. They presented adults with the discretionary budget shortfall of $625 billion by 2015, as well as shortfalls in Social Security and Medicare. Participants chose from a range of realistic options using a computer application.


The majority made Social Security solvent. They accomplished that by raising the income limit subject to the payroll tax and increasing the retirement age to at least age 68; majorities agreed to similar tweaks of Medicare eligibility and benefits.


The average respondent reduced the discretionary budget deficit by 70 percent. One third of deficit reductions came from cuts to government programs. Two-thirds came from increased taxes and adjustments to the tax code.

A budget proposal from Representative Paul Ryan (R-WI) relies on sharp cuts in future Medicare benefits, but the accompanying reductions in tax rates make both the claimed effects on the deficit implausible and the proposal a political nonstarter when Democrats control the Senate and White House. Paul Krugman endorses an alternative calling itself the People’s Budget, though Tyler Cowen thinks it implies 70% marginal state plus federal tax rates, 50% tax on capital gains, and yet the plan’s calculations assume that this is going to raise the real GDP growth rate by 0.3% per year. Ditto what I said about the Ryan plan.

It is abundantly clear to me that the only plan that is going to work must be based on Diane’s principle of shared sacrifice– taxes need to be raised and entitlements need to be cut.

Now just give us some leaders with the courage to state the obvious.

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56 thoughts on “Deficit compromise

  1. Qc

    The so-called “America’s daunting fiscal challenge” is totally a figment of your imagination. But don’t give up, economists have been predicting Japan’s imminent fiscal crisis for the last 15 years.
    Folks, beware, all the hysteria you are reading today about America’s imminent fiscal crisis is just the start of a long serie of groundless warnings from people that do not understand anything about monetary and banking operations of a country with its own floating non convertible currency.
    You have been warned.

  2. Steven Kopits

    Jim -
    What do you believe the appropriate share of government spending (all in) in GDP is?
    Since the 1970s, it’s been around 32% or less. Government spending is now 42% of GDP, if I recall correctly. Do you see going to European levels of taxation? Did that solve the UK’s problems?
    And how do they do it in Singapore? The top marginal rate, I seem to have read, is 15%. But there’s no apparent poverty over there. (There are performanced-based bonuses to bureaucrats though.)
    And, then, surely we’re looking down the throat of another oil shock, no? Or do you anticipate some sort of soft landing? How do we include that in the calculus? How does that affect the prospective composition of the 113th (2012) Congress and resulting budget considerations?

  3. 2slugbaits

    Not sure how “fixing” Social Security adds or subtracts from the long run deficit problem. Social Security may very well need some kind of adjustment in order to ensure its long term viability, so it might be a good idea in its own right; but fixing Social Security has no effect on the larger deficit problem. Even the deficit commission admitted in a little noticed footnote that their recommendation to increase the age for full SS benefits didn’t have anything to do with the deficit, but they just thought it was a good idea although outside their portfolio.
    Just cutting Medicare & Medicaid no doubt fixes the government’s deficit problem (and may help Social Security if people die earlier as a result), but unless healthcare costs in general come down I don’t see how saving the govt the expense accomplishes very much. We need to slow the growth of healthcare costs as a percent of GDP. So where to start? My understanding is that a person typically consumes the lion’s share of their lifetime healthcare expenditures in the last two months of life. If people want to reduce consumption during their younger years in order to accumulate personal savings to pay for extreme care during the last few months of life, then that’s their business; but I don’t think the taxpayers should be asked to pay for heroic efforts to squeeze out a few extra days of life in a coma. And almost every economist that I’m aware of says we should tax so called “Cadillac” insurance plans because they drive up costs for everyone.
    But it’s all pretty discouraging. Just look at all of the whacko teabaggers that think it might be a fun idea to see the govt default on its debt by not increasing the debt limit. With knuckledraggers like that in Congress it’s hard to avoid the conclusion that we’re headed for banana republic status.

  4. JW Mason

    Sorry, what’s that fiscal challenge again?
    The physiocrats back in the day thought there was a limit to how high the proportion of “unproductive” (i.e. Non-agricultural) labor could go. If the ratio of non-agricultural to agricultural labor was approaching 1:1, the economy was certainly heading for crisis.
    Turns out, that wasn’t true. The ratio of non-agricultural to qgiciltural labor rises secularly with economic development, at least so far. No crisis.
    In general, we can calculate lots of ratios between economic quantities. Some are stationary, some aren’t. That a particular ratio (debt/GDP, let’s say) is expected to be higher in the future than in the past is not in any way evidence of a crisis, or a problem that needs to be solve, unless you can provide concrete evidence that the new ratio involves an unfavorable mix of costs and benefits relative to the old one.
    If inflation and interest rates on public debt are historically low, why isn’t that evidence that the optimal level of fiscal deficits has gotten higher? We have an unemployment crisis, definitely, but where is the evidence that we have a fiscal crisis, or even a fiscal problem?

  5. Randall Parker

    Since I expect the economy to contract in the next 10+ years due to Peak Oil the People’s Budget seems especially impractical. With declining living standards are people going to accept tax increases on top of less income? So big cuts in the US federal government’s spending (along with that of most governments around the world) seem unavoidable.
    But the Ryan Plan is not severe enough in its budget cuts because, again, the economy won’t perform well enough to generate enough tax revenue.
    To put it another way: The Ray Plan and People’s Budget both assume something assuming Business As Usual for economic growth. But what if that does not happen?
    Another point: if US marginal tax rates go thru the roof I predict lots of the most talented Americans will become expats with their own corps in foreign lands thru which they sell their services and collect their income without generating income taxes for themselves. Basically, the most talented will flee to tax shelters.

  6. JDH

    Steven Kopits: I’m not advocated significant spending cuts or tax increases for 2012. But I am interested in making commitments now for a sustainable fiscal path beginning, say, in 2015.

  7. Charles

    As much as I respect your work, Jim (if I may), you’re missing some points that are fairly obvious.
    “Cutting” Medicare and Social Security is really cost shifting. It’s harder and harder for people in their 50s, much less their 60s to get work; among blue collar workers, people are often physically not up to the work. You can raise the retirement age, but what does it mean if people are unable to work? It means the living costs of the elderly are shifted in one of four ways: (a) these individuals reduce non-essential consumption, (b) children of these individuals pick up the costs, cutting into their consumption and saving, (c) the state/locality/charities pick up the costs, or (d) the individual suffers diminished health and premature death.
    Elites are convinced that the adjustment will be accomplished benignly by forcing individuals to cut non-essential consumption. Less booze, cigarettes, gambling, and floozies– it’ll be good for them! Or, if it’s really essential healthcare or whatever, the soup kitchens and volunteers will pick it up. The evidence is that this is not what is happening. Instead, people are doing without essential services and/or their children are sacrificing their own retirement savings to take care of their parents. Cutting “entitlements”–a term that embraces everything from veteran’s benefits to agribusiness subsidies is very likely to backfire if it’s done haphazardly.
    Similarly, it’s nice to talk about how rich and poor alike should share in any tax rises, but the fact is that the progressive federal tax system has been replaced with regressive state and local taxes, shifting the tax burden onto the poor and middle class. To further burden them is not fairness. Like cutting Medicare and Social Security, it is likely to have perverse effects.
    Another point is that the real problem with Medicare has nothing to do with Medicare per se. Medical costs as a whole are rising much too fast, and this is because of: (a) insurance profits, (b) waste, especially in ineffective treatments in the last months of life (basically, corrupt doctors and hospitals), (c) the inefficiencies created by cost-shifting, and so on. Clean up the medical insurance system, and the medical care system will be cheaper and better.
    Another point: people don’t want to cut “defense”… but they do want to cut money spent on wars. The public correctly perceives that our Department of “Defense” is actually doing quite a lot of expensive non-defensive meddling. Ask the poll question appropriately, and you will get a different answer.
    I could go on, but my point should be obvious: the answer you offer (“taxes need to be raised and entitlements need to be cut”) is facile, and not as thoughtful as we have grown to expect from you. Agribusiness subsidies need to be cut. Taxes on very wealthy people need to be raised. Veteran’s benefits, especially at the low end, probably need to be raised. The medical insurance system needs to be reformed (which will produce positive changes to Medicare). Social Security benefits, which increasingly are the only pension people have, probably need to be raised.
    America is showing signs of extreme strain. Whatever the economic statistics, the US increasingly looks like an impoverished country. This is expressed in decaying higher education and research, rotting infrastructure, declining manufacturing strength and so on. These will be made worse if the middle class and poor are further burdened.

  8. Joseph

    It’s hard to believe that just 10 years ago we had a budget surplus. Back then the Republicans actually said that the surplus was a threat to the economy which required tax cuts. Now the same people say that deficits are the new crisis and the cure is again tax cuts. Republicans have no credibility in the debate and should be ignored.
    All we need to do is go back to the Clinton era tax rates and stop the endless wars and we have pretty well fixed the deficit in the medium term.
    For the long term we just need to handle health care like the rest of the developed world which provides universal, high quality care for half the cost.

  9. Lord

    Since so much of this is driven by healthcare and aging, would we even know we had a solution if we had one? We can make agreements for cuts and taxes, yet people will deny the cuts will be made and taxes will be cut whenever at any sign of weakness. Whatever responsibility is demonstrated can be as quickly abandoned. Money problems are easy to solve, problems of will never are.

  10. colonelmoore

    I think that Ryan knows that there will be tax increases. But this is a negotiating position. I cannot say what the Democrats’ negotiating position will be until the Senate develops its budget.
    The amount of cuts versus the amount of taxes will in the end be determined by election results. This is the actual game. It seems hard to believe that, with the lessons of Europe behind us, the voters will choose to ignore the problem.

  11. ivars

    “I’m not advocated significant spending cuts or tax increases for 2012. But I am interested in making commitments now for a sustainable fiscal path beginning, say, in 2015.”
    The revenues will fall short already in 2012, so debt will have to be increased rapidly. Debt growth is already showing precrash superexponential dynamics, and will continue to accelerate, so, the usual outcome would be the USA default on its obligations either by devaluation or restructuring.
    Crash correction to USA debt is imminent, however, austerity if implemented already from 2012 can shorten the period of pain to some 5 years. In 2015 if things continue as they are, with reduced growth ( where does everyone get this nice growth in future with oil and Chinese import prices going up and up while salaries staying low), USA will already have defaulted.
    That is also a viable cost cutting plan, of course. Delay the pain as long as possible and then put everyone under the bus.
    But I doubt people who will run the country from 2012 will accept it. They will not also be running the policy according to polls, but according to what has to be done to stave of or rather minimize bankruptcy effects.
    USA is just Greece 2. No big difference anymore. No lenders of last resort anymore. Only printing press( Greece used hidden deficits and ECB printing press) . I think the USA will not be able to make hidden stimulus for much longer as creditors are getting aware of coming haircuts.

  12. 2slugbaits

    JDH I’m not advocated significant spending cuts or tax increases for 2012. I am interested in making commitments now for a sustainable fiscal path beginning, say, in 2015.
    Exactly. We really can’t move towards contractionary fiscal policies until the economy is strong enough that we’re safely above the ZIRP so that the Fed is once again able to do the heavy lifting…as it should be in normal times.
    On the revenue side we need to let the Bush tax cuts expire, look to a small national VAT, and probably phase-in a slightly higher Medicare contribution from payroll taxes. On the spending side cut ag subsidies, cut DoD, and establish govt bureaucrat “death panels” to decide which medical procedures Medicare should be willing to pay for and which ones Medicare won’t pay for.
    Investment in energy polcies should be paid for via a carbon tax.
    Steve Kopits You really can’t look at govt spending as a percent of GDP without asking yourself how much of it is due to cyclical effects. And right now a LOT of it is due to cyclcial effects in both directions…higher govt spending to support safety nets (increases in the numerator) and lower GDP (decreases in the denominator).

  13. tj

    What am I missing in this hypothetical that shows we need a national tax rate of 50% to fund total government (local, state, federal) spending at a level of 33% of GDP.
    To simplify assume exports = imports, so GDP = C+I+G.
    If nominal GDP = 15 trillion (T) then total government spending, G = 5T.
    That means total houshold and business income = GDP – G = C+I = 10T.
    Thus, if we want a government that makes up 1/3 of our economy then we need to tax household and business income at 50%, on average.
    I claim this is not a politically vialbe alternative given the number of loopholes in our current tax collection system. Simply layering more taxes, like a VAT, on top of what we already have is also dumb idea. It’s like putting a band-aid on the Titanic.
    We need a new and more simple tax collection system that replaces all current individual and business taxes.
    Note that if total government spending were ~26.5% of GDP, G would be 4T and an average tax rate of ~ 37% would cover all of government spending.

  14. Anonymous

    “A budget proposal from Representative Paul Ryan (R-WI) relies on sharp cuts in future Medicare benefits, but the accompanying reductions in tax rates make both the claimed effects on the deficit implausible..”
    So Jim, the fact that the top marginal rate was 70% in 1980 and was cut to 28% in 1986, yet total government receipts were 21% higher in real terms means that we cannot cut rates and get higher revenues, eh?

  15. JDH

    tj: You’re missing that output = income. The spending on G generates income and that income is taxed along with the income from sales of goods to households and businesses.

  16. ppcm

    Difficult to see, what is structural from cyclical,when comparing real gross private domestic investment 200 billion usd in the 50s, culminating at 2.3 trillion usd 2009.Whilst the government expenditures have jumped from zero in 1950 to 3.8 trillion usd.More use of capital and less use of labour and a decreasing marginal efficiency of the capital employed as Thomas Philippon paper may outline (The evolution of the financial industry from 1860 to 2007:Theory and evidence) in (page 33 ) The same paper suggests to postpone to further studies the efficiency of the distribution of capital financial versus non financial sectors,whilst evidencing the decreasing marginal efficiency of the capital employed (table P35)
    In conclusion thoughts should be given on disturbing trends and moral hazard occurence between knowledge,expertise and capital.
    Real Gross Private Domestic Investment, 3 Decimal
    http://research.stlouisfed.org/fred2/series/GPDIC96
    Whilst the governement expenditures have jumped from nul 1950 to 3.8 trillion usd now
    Federal Government: Current Expenditures (FGEXPND)
    http://research.stlouisfed.org/fred2/series/FGEXPND
    Same pattern in Europe (ECB data warehouse)

  17. markg

    I too would like a definition of “sustainable”. Is it a debt/gdp ratio? What is the result when we exceed “sustainable”? Is it inflation, bankruptcy, etc.? I am sure an economics professor must know the answer. Please enlighten me.

  18. Anonymous

    From Wikipedia-
    “The Grace Commission Report was presented to Congress in January 1984. The report claimed that if its recommendations were followed, $424 billion could be saved in three years, rising to $1.9 trillion per year by the year 2000. It estimated that the national debt, without these reforms, would rise to $13 trillion by the year 2000, while with the reforms they projected it would rise to only $2.5 trillion.[3] Congress ignored the commission’s report. The debt reached $5.8 trillion in the year 2000.[4][5] The national debt reached 13 trillion after the subprime mortgage-collateralized debt obligation crisis in 2008.
    The report said that one-third of all income taxes is consumed by waste and inefficiency in the federal government, and another one-third escapes collection owing to the underground economy. “With two thirds of everyone’s personal income taxes wasted or not collected, 100 percent of what is collected is absorbed solely by interest on the federal debt and by federal government contributions to transfer payments. In other words, all individual income tax revenues are gone before one nickel is spent on the services [that] taxpayers expect from their government.”[3]
    I was just reminded of this while reading the “Age of Reagan”. I don’t imagine that the government has gotten any more efficient as it has gotten much bigger. Before any tax hikes first eliminate wasteful programs.
    Incidentally, as I read about Reagan I realize that even when things look bad, one man can help turn them around. The nation was quite gloomy before he came on the scene.

  19. Ricardo

    The Mellon tax cuts brought us out of the 1920-21 recession.
    The Kennedy (Johnson) tax cuts brought us prosperity in the 1960s.
    The Reagan tax cuts brought us recovery in the 1980s.
    Even the anemic Bush tax cuts in 2003 brought increasing revenue in 2005-6.
    Now please don’t rehash all the old canards about tax cuts not paying for themselves. Instead give me one instance when there was economic recovery from spending increases and tax increases. Then an example of the Rogers/Hamilton formula of spending cuts and tax increases bringing recovery.
    As Steve Kopits points out the UK is trying this and it is failing, yet Singapore is humming right along.

  20. The Rage

    tj has the “rentier” mindset. When that happens, economies fail as the productive parts of the economy are stripped of resources to produce.
    Capital and Labor war over the crumbs. Governments must tax(granted, the arguements over this have divided people for 100 years, but some good policy references are there to use) the rentier to squash speculation and asset inflation while internally subsidizing production through trade. America has long been absent in this policy and instead been bullied by rent seeking leaches of the world. It must stop or the end result will be far worse.

  21. JDH

    JW Mason and markg: By “sustainable fiscal path” I refer to a deficit-to-gdp ratio that is maintained below 3%.

  22. dave

    Don’t you think “combination” really means combination where most of it is other people giving up stuff and me giving up a little.

  23. 2slugbaits

    tj The government sector adds value, so its contribution is included in GDP. And as JDH notes, part of that added value is itself taxed. This is why Ricardo’s (the poster, not the economist David Ricardo) view that government is entirely parasitic is both intellectually confused and bad economics. Although he isn’t aware of it, Ricardo’s economics are fundamentally Marxist with a little bit of crypto-Austrian libertarianism sprinkled on top. But basically he’s a Marxist in his economic thinking. In his heart-of-hearts he believes in something like the labor theory of value, with a little smattering of Austrian “roundabout” to replace class struggle as the economic dynamo. From time-to-time I’ve noticed that you will occassionally fall into the same trap. Good to see that you took note of JDH’s correction.

  24. Steven Kopits

    Jim -
    You wrote: “It is abundantly clear to me that the only plan that is going to work must be based on Diane’s principle of shared sacrifice– taxes need to be raised and entitlements need to be cut.”
    Thus, you are indeed advocating tax increases.
    This is not necessarily a bad thing, I just wanted to bring to your attention the risk that being reasonable may lead to a quite different conception of role of government in society.
    Best I can tell, govt spending in GDP is in the 40% range for the next several years. If we split the difference from historical levels, then government revenues as a share of GDP would rise to 36%. This is a material departure from the past, and it is not even remotely a neutral statement–it involves increasingly average tax rates by 12%.
    And let’s suppose we do this. What’s the guarantee that the budget balances there? Absolutely nothing. We all know that, because we can see that high tax countries are not more likely to balance their budgets than low tax countries. Democracies have a deficit bias, because we haven’t aligned incentives (and we’re not even allowed to discuss it!). All that we gain from a tax hike is the ability to have this same discussion a decade from now at even higher tax rates.
    So I disagree. If you are advocating Diane’s principle at projected government spending levels, as a practical matter, you are advocating for an expanded role for government.

  25. Frank in midtown

    Oh, Ricardo, yet another “little” analysis of tired tropes. It couldn’t be that government deficits cause increases in tax revenues, only tax cuts (feel free to ignore the deficits caused by those revenue increase tax cuts.)

  26. 2slugbaits

    JDH a deficit-to-gdp ratio that is maintained below 3%.
    Shouldn’t that be primary deficit-to-gdp ratio?

  27. westslope

    I’m impressed with how President Obama steered the USA into playing the pivotal role in NATO’s campaign of violent regime change in Libya. Early in the process, he stood with leaders of the non-aligned movement. Then he waited for a bullet-proof multi-lateral endorsement of a no-fly zone.

    Impressive because this noble exercise guarantees that the USA will face punishing high oil prices for the foreseeable future. If the economy does not retract, it will stagnate with relatively high rates of unemployment. President Obama slashed his chances of re-election by agreeing to attack Libyan state targets.

    An outside observer might wonder if the American elite was attempting to replicate many of the economic and strategic conditions present in the mid-1970s.

  28. benamery21

    JDH: With all due respect, the bottom 90% have already made our contribution to the needed shared sacrifice. The top 2% need to do their part to make up for the free ride they’ve taken over the past 30 years.
    2slugbaits: Thank you for addressing Kopits percent GDP comment. I have to take issue with you on another point, however. A VAT?? You really think what we need is more REGRESSIVE taxation??

  29. benamery21

    2slugbaits: You’ve made the ‘last 2 months’ comments several times in various places. Do you have a source? I have a hard time believing that inappropriate heroic treatment of the near-dead is the major cause of our healthcare cost growth. I’m a lot more inclined to believe in Paul O’Neill’s thoughts on the gross inefficiencies of American healthcare. Not exactly a liberal, but he has stated many times that we should be able to acheive better outcomes at half the cost.

  30. ivars

    After FOMC decision yesterday and Bernankes comments I finally understood ( since I am not American) that the USA is just another Greece, but heavily armed.
    I am sure retaliation against ongoing USD debasement will come from foreign holders of USA debt and money. Either by increasing prices to USA imports to hedge against further devaluation, or by reducing oil supply to send the message.
    Which will lead to accelerating “transitionary” inflation in the USA, drag on growth,less revenue, and need for more debt.
    So who will bail out the USA as it defaults in few years? War?
    Why can not the USA just live within its means, adjusting after financial crisis as many countries have successfully though painfully done in past years ( e.g. Sweden, Finland)?
    I am totally puzzled as to what is the fiscal thinking of the USA government?

  31. bill j

    Its pretty obvious how to correct the deficit, if indeed the deficit needs correcting. The proportion of national income accruing to wages has fallen consistently since the early 1980s, while conversely the proportion of national income accruing to corporate profits, executive pay and rents has soared.
    Tax the rich to pay off your debts. Simple.

  32. Ricardo

    JDH wrote:
    tj: You’re missing that output = income. The spending on G generates income and that income is taxed along with the income from sales of goods to households and businesses.”
    While this is true G does not produce. So G is actually tax taken from C then given back to C in exchange for goods and then C is required to pay tax on this previously paid tax.

  33. JW Mason

    By “sustainable fiscal path” I refer to a deficit-to-gdp ratio that is maintained below 3%.
    Right, and again, the physiocrats thought a sustainable ratio of non-agricultural to agricultural labor was one that stayed below 1:1. In both cases, you have to ask what will happen if the ratio is exceeded.
    Wouldn’t it be better to set economic policy based on weighing costs and benefits, and not just picking arbitrary numbers?

  34. JDH

    benamery21 at April 27, 2011 09:50 PM: My plan is to discuss the current oil shock implications in a post next week.

    JW Mason at April 28, 2011 08:56 AM: A deficit-to-GDP ratio that continues to grow over time is not sustainable– check the math yourself. As for setting a number such as 3% above which we don’t want to see it grow, people asked me to be very specific as to what I meant by “sustainable”, so I graciously obliged.

  35. anti.twitter

    I generally like your analyses, JDH, but I disagree with your thrust here. First of all, you should give minimal attention to polls. The real function of polls and ballot initiatives today is to let off steam, not to aid decision-making.
    If I announce a big purchase, my family ask where the money will come from. Most Americans today are convinced that they are victims- even many of the richest think this – our culture makes a sow’s ear out of a silk purse. So we let off steam when asked for a political opinion, we send a message. Those opinions are indicators of momentary emotion. Pity that our politicians and newspapers put so much stock in them. Now consider ballot initiatives- maybe in 1920 when there was much less advertising, they had some value. Today, they are vehicles to manipulate the electorate for corporate good. Are you going to fight back against all those illegal aliens (read MEXICANS) who flood our hospitals, get all the special government deals, etc? The only valid poll would be one that came back with tough questions- you want to cut taxes even further, what do you think will happen to public education? You want to raise taxes, well how would you sell this idea? Polls encourage the childish attitude of I want it, but don’t ask how I’ll pay for it.
    Consider the difference between sending a message (how I feel) and executive function. We often sleep on an executive decision; we can’t wait to send a message or denunciation.
    I agree with Charles from April 26th. The US has become a banana republic. We don’t maintain bridges or roads, we provide lousy mental healthcare, look at the PBS autism series and how we leave most autistic adults high and dry. We ensure that our schools rarely help the children of the poor, then we wonder why our prisons are so full… Don’t be a technocrat who functions as a short-term crisis manager. Debt is important, but it must be put in context. Compare the US & Japan, two countries whose borrowing has been criticized by Standard & Poor (I respect S & P and Donald Trump equally, e.g. zero).
    Japan’s debt to GDP ratio is significantly higher than that of the US. In fact, I attended several financial seminars early this year, before the triple disaster, in which libertarian gurus confidently predicted that Japan would default before the end of 2012. I’m no expert on Japan, but I believe that there is a fundamental difference between majority attitudes in Japan and the USA. Most Japanese (I have relatives living there) seem to accept the idea that they personally must sacrifice and do something extra to pull the country out of its crisis. They don’t have our American I’ve been victimized attitude. I can’t see Americans accepting extra sacrifice for the good of the country (while much of this would be taxes, people in the lower income levels could be given an option of 2 hours a month doing a public service under supervision, even street sweeping in their neighborhood instead of paying money. Those of normal mind who can’t walk could do indoor tasks. Only those who can’t walk and are mentally impaired would be excused.) I think that it was somewhat this way in the Massachusetts Bay Colony. There was also less civil liberty- you had to go to church and people were not permitted to live alone.
    Average Americans, the lower 85% have taken a beating in the last 40 years. I remember the 50s with high taxes and high benefits (for whites). Tax policy and Federal Reserve policy has been transferring wealth up to the top since the early 1970s. The balance must be redressed or the dam will break at some future date, with violence and destruction. Policies such as those of the Simpson-Bowles commission only hasten that terrible day. I’m a lucky and wealthy man, I don’t want my grandchildren to face that cataclysm.
    Austerity programs are decimating the UK and Ireland. Please think long term.

  36. CoRev

    Ricardo said: “”tj: You’re missing that output = income. The spending on G generates income and that income is taxed along with the income from sales of goods to households and businesses.”
    While this is true G does not produce. So G is actually tax taken from C then given back to C in exchange for goods and then C is required to pay tax on this previously paid tax.”
    This has bothered me, since it appears we are trying to measure a perpetual motion/taxing machine. At what point does that $1 stop in the circle of gearing in the perpetual taxation machine?

  37. Anonymous

    I guess I am missing a lot. I do not see how federal Government spending, when it is two blocked with debt, is a net positive on the economy. I understand the concept of using government spending in a counter cyclical plan to dampen recessions and lead to growth. But, that model assumes that the government will develop surplus in the good times to spend in the bad. If the G spends more than its revenue in times of growth and even more in times of contraction, there must be dimishing returns. At some point the returns must approach zero. At that point more government spending is just more government spending without real benefit and possibly the basis for the crowding out arguments. At the UW I was force fed Keynes and Samuelson. Neither dealt with the issue of governments which continuously (over protratced periods)spend beyond their revenues.
    I also find Ricardo’s observation compelling. G spends money on workers. The taxes paid by government workers are really only a discount on their wages. They are net tax receivers–not a true source of revenue.
    From my own observation over many years Government’s purchase of goods and services is never efficient. The Federal Acquisition Rules place amazing costs upon those who contract with the Government. Obviously, the contractors recoup their costs through higher prices on government contracts. When the regulators balk, then the contractors raise their prices across the board, but provide discounts to their favored customers. Many businesses simply refuse to bid on government contracts due to the long term continuing costs (six years after contract performance) of accepting the King’s sovereign once. Therefore, even in its best open market pricing (simplified contracting) the government does not obtain truly competitive prices.
    Perhaps this ‘waste’ inures to the benefit of the economy as whole, but I suspect that it materially skews the statistics which support an indicia of GDP growth from government spending.
    Since my observations seem to be at odds with economic study, are there good resources for me to read to help cure my confusion?

  38. 2slugbaits

    benamery21 2slugbaits: You’ve made the ‘last 2 months’ comments several times in various places. Do you have a source?
    Try this. It’s from 60 Minutes:
    http://www.cbsnews.com/stories/2009/11/19/60minutes/main5711689.shtml
    I agree that there’s plenty of waste in healthcare, but I think you have to distinguish between cutting waste and bending the cost curve. Cutting waste is like shifting the intercept. What we need is to actually change the slope of the cost curve and over the long run you don’t do that by cutting waste. You actually have to confront hard choices as to what will and will not be covered.
    There’s a new NBER paper that breaks medical technology down into three categories. One of the categories is very expensive and shows little evidence of making any significant difference in outcomes. Those are the kinds of technology that are driving healthcare costs. People want Medicare to pay for very expensive procedures that have marginal benefit (if any) all in the desperate hope of extending life. We can’t afford that. Here’s the NBER paper:
    http://www.nber.org/papers/w16953

  39. 2slugbaits

    CoRev This has bothered me, since it appears we are trying to measure a perpetual motion/taxing machine. At what point does that $1 stop in the circle of gearing in the perpetual taxation machine?
    This is because you and Ricardo, like a lot of conservatives, ultimately have a deep belief in the Labor Theory of Value. See, deep down you’re really a closet Marxist. I once had an econ prof who used to make the same point about Reagan because Reagan could never understand that government adds value and is not parasitic. Austrians fall into the same fallacy.

  40. 2slugbaits

    benamery21 A VAT?? You really think what we need is more REGRESSIVE taxation??
    The regressive nature of a VAT could be mitigated with some kind of rebate for low incomes, that way most of the burden would fall on middle and upper incomes. I’m not crazy about taxing the lowest quintile anymore than they are already taxed, but there are plenty of people deep into 6 figures that still fall under the $250K threshold. Basically folks like me. Middle and upper middle class folks should be paying more taxes. I think that a VAT is a better way of capturing tax income from middle, upper middle and very high income groups than raising the income tax rate. I just think it would be more efficient and there’d be less distortion. I’m not a fan of replacing the income tax with a VAT, but I do think that a small VAT (say 2%) would be a good way to supplement income tax revenues.

  41. Anon

    I say listen to the Keynesians on this board and everything will be ok. After all they are the ones who (snicker, snicker) told us the Obama stimulus would solve everything…..
    What a hoot! What hacks…..
    And where is ole Menzie pushing his class warfare drivel masked as (failed) Keynesian economics….. all backed by the IS-LM model? Could he be hiding behind the laughable posts of 2slugbaits(n switch)?
    Hope and change….

  42. 2slugbaits

    Anonymous But, that model assumes that the government will develop surplus in the good times to spend in the bad. If the G spends more than its revenue in times of growth and even more in times of contraction, there must be dimishing returns.
    It would be nice if govts did run surpluses during the good times, but there is nothing in the model that says they must in order for deficit spending to work. Deficit spending works when there is slack in aggregate demand. If the economy is operating at full employment and the govt still runs large deficits, and if the Fed does not sterilize things with higher interest rates, then you’ll end up with the 1970s.
    I also find Ricardo’s observation compelling. G spends money on workers. The taxes paid by government workers are really only a discount on their wages. They are net tax receivers–not a true source of revenue.
    Ricardo’s observation is nonsense. Government adds value to the economy. We build GDP by summing up the value added pieces of everything in the larger economic flow. When police provide protection, that adds value. When the courts provide justice, that adds value. When Social Security provides an affordable income insurance plan, that adds value. When the Navy protects the fleet, that adds value. When immigration patrols the border, that adds value. When the FAA lands planes, that adds value, just as falling asleep in the tower subtracts from value. There are millions of things that govt does that add value to the economy.
    From my own observation over many years Government’s purchase of goods and services is never efficient.
    True. And one reason is that taxpayers value accountability more than efficiency. So what the taxpayers are buying isn’t just a good or service, it’s also another good called “accountability.”
    Therefore, even in its best open market pricing (simplified contracting) the government does not obtain truly competitive prices.
    Sometimes the govt can do better than competitive market prices. For example, last Monday I had to explain to the Army’s deputy chief of staff (in 7 Powerpoint slides!!!) the concept of monopsony pricing power in the defense sector and why it was not socially efficient for the govt to exercise that monopsony power even though it resulted in a lower price.

  43. CoRev

    2slugs, and the and the Deputy CoS bought it for a non-COTS or otherwise specialty product? Some how I think the discussion was hypothetical and not reality based.

  44. benamery21

    I tend to think that most of the waste is dynamic, that the healthcare system creates much of it’s own demand. In other words, there isn’t a static demand plus some waste, where the cost curve intercept is shifted by eliminating waste. Instead, I think demand actually goes away due to improved care management, shifting the cost curve.
    A couple examples:
    A buddy of mine developed and sells a recovery kit for vitrectomy to help patients maintain the necessary face-down posture for recovery. Very cheap (package delivery almost anywhere in the world for a few hundred bucks). Repeat surgery rates due to procedure failure due to poor post-op development is very high for this procedure. Medical studies show dramatically reduced recovery time and reduced repeat surgery rates with use of his product. However, because of fee-for-service care and lack of reimbursement for his product by Medicare, Medicare continues to pay for many repeat procedures at far higher cost than his product.
    Another case: My brother-in-law had a brain tumor in college and has had 3 brain surgeries. He has a shunt in his head. Surgery 2 was to remove sponge left behind in Surgery 1. Surgery 3 was to replace shunt due to clogging due to complications from surgery 2. He recently began therapy for neurological deterioration from the surgeries and shunt. The neurologist insists that many of his current physical problems relate to not having had proper post-op therapy.
    My otherwise healthy 35 y.o. cousin died of complications from the flu earlier this year. He developed pneumonia, collapsed, was hospitalized, and suffered kidney failure after being sent home from urgent care after the first time he collapsed. Almost all the medical costs in his life occurred in the last week of his life.

  45. benamery21

    Medical ‘care’ continued.
    About 10 years ago my uncle died of cancer. He was under 50.
    By the time they diagnosed cancer it was basically untreatable. He, despite a medical history best described as not going to the doctor, had made repeated trips to his HMO’s GP over the previous several years. All of the visits related to throat problems. All of the visits resulted in a lack of diagnosis of serious problems and repeated denials of a referral to an ENT. My uncle eventually paid to see an ENT out of pocket. He was diagnosed with throat cancer, it had already metastasized thruout his body. He died a few months later. Almost all his lifetime medical expenses were in the last few months of his life.
    I think these few personal anecdotes are adequate to point up the fact that earlier and better care prevents later expense and that not all end-of-life expense is the GOMER care described long ago in “House of God” despite the validity of that problem.

  46. Ricardo

    Slug wrote:
    This is because you and Ricardo, like a lot of conservatives, ultimately have a deep belief in the Labor Theory of Value. See, deep down you’re really a closet Marxist.
    Slug,
    I actually am probably more Marxist than Keynesian, but the Marxist Labor Theory of Value is more closely related to Keynes. I actually agree with Menger’s subjective theory of value.
    Where I am Marxist is that that he was correct about gold. He was correct about capitalisms ability to produce more than any other system(though he saw it as over-production I see it as supplying wants and needs). He was also correct in the analysis of the unholy alliance between business and government in exploiting the worker.
    Marx missed the mark in not seeing that there can be no calculation in socialism. He also missed the mark in understanding that in his utopia the only way goods could be distributed equitably without government is under capitalism where proper value is represented by money and the optimal distribution of goods for production and consumption is determined by the price structure of capitalism.
    Now that leads us to the fact that Keynes explicitly embraced Fascism in the introduction to his German translation of his General Theory and in this case he was spot on.

  47. 2slugbaits

    CoRev Yes, we’re talking non-COTS. Obviously there wouldn’t be any opportunity for monopsony leveraging if it were COTS. It was not a hypothetical exercise. It was about a real weapon system and the appropriate life cycle strategy. The issue had to do with finding the optimal number of suppliers. One’s first instinct based on high school economics and GOP ideology is to think that increasing the number of suppliers and bidders will always guarantee the socially optimal price and output. A little math can show that this isn’t always true in the defense sector because of the potential for monopsony pricing. On the surface it looks good because prices are lower, but it can create a deadweight loss of producer surplus. You have to pay attention to what you’re doing.

  48. 2slugbaits

    Ricardo I haven’t read the German translation of The General Theory…and somehow I don’t think Keynes did either. So there’s no telling what it says. But I have read the English version written in Keynes’ own tongue and it does not endorse fascism. Keynes was hardly a Marxist either. He only agreed with Marx and a few others that it was possible to have a deficiency to aggregate demand; i.e., he believed Says’ Law did not always hold. Marx believed that as well, although for entirely different reasons. Keynes was a student of Alfred Marshall and was brought up on the marginal theory of value, not the labor theory of value.
    A lot of today’s political conservatives have a deep down aversion to anything that smacks of relativism. They can’t stand situational ethics. They crave some kind of true, unchanging standard. Might be why they also tend to be religious. It’s this longing for an unchanging standard that, I believe, stands behind this otherwise inexplicable belief in a gold standard. Or constant and unchanging fiscal & monetary policies. And a fondness for the labor theory of value rather than the marginalist view, which conservatives see as another form of moral relativism. Except of course that conservatives can’t stand being associated with Marx, so they align themselves with the political leanings of many Austrians, such as Hayek and von Mises. But if you strip away the political stuff and look at what makes their economics tick, I think you’ll see that the Austrians and the Marxists have a lot in common. They both believe in some fundamental unit of value. And they both need some kind of dynamo to drive economic change. In the case of Marxists it’s class warfare, while Austrians look to out-of-sync long and short production times (“roundabouts”), or in the case of Hayek “concertina” effects. Marginalists like Keynes will have none of it.

  49. acerimusdux

    To say that government adds no value is not an expression of economic theory, it’s a statement of a personal utility function. You may certainly hold that opinion of government spending, but clearly the “marketplace” of voters has decided otherwise. And as the polls cited above show, large majorities seem to think there is value in current levels of spending on health care, national defense, etc.

    Of course this marketplace could be wrong; but wouldn’t they just as likely be wrong about their choices with regard to C as to G? There doesn’t seem to be any reason to think that people make any less efficient decisions in choosing their politicians, than they do in choosing their breakfast cereals.

    So for purposes of measurement, clearly both C & G are counted as contributing to GDP. One can as easily ask “what does C produce?” as “what does G produce?” Buying and consuming things doesn’t produce them.

    But as JDH pointed out, income=output. When people choose to spend on G, that must be because they put some value on what it produces, whether that is health care, security, roads, etc. And that spending in turn becomes income for someone else, the same as if they had spent on shoes, haircuts, or ipods.

  50. endorendil

    Ricardo said: “”tj: You’re missing that output = income. The spending on G generates income and that income is taxed along with the income from sales of goods to households and businesses.”
    While this is true G does not produce. So G is actually tax taken from C then given back to C in exchange for goods and then C is required to pay tax on this previously paid tax”
    Actually, this doesn’t change JDH’s point – your calculations of the needed tax rate are wrong.
    But it’s also untrue that G does not produce. Aside from all the obvious ways in which government creates things that otherwise either wouldn’t be created or not created efficiently (such as security, a legal framework, etc), government also creates trust.
    When you’re done laughing, remember that trust is what allows the government (and many private institutions, and even individuals) to borrow money. To the extent that this borrowed money was created out of thin air (like when the Fed buys Treasuries) or borrowed from non-US actors, this is money that can be spent in the US economy that did not come from taxes.
    We have to remember that GDP is therefor artificially inflated when financing for government (and corporations, and households) comes from outside the US. Without this influx of money, GDP would drop significantly.

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