The Government Spending Scam

Last week I wrote about the fiscal gap and implications for tax revenues and income tax rates. This week I focus on federal government spending and the fiscal gap. I call the spending discussion a scam because much of the wording describing the course of future spending is all about cuts. And while there are some cuts and the overall message suggests smaller deficits in the future, the truth is that spending will increase at very strong rates and it does not appear that much is being accomplished with respect to the fiscal gap on the spending side. Thus either debt or tax revenues will have to cover the spending.  The data show also that by taking some of the bigger spending programs out of the discussion we purposely and unnecessarily jeopardize the great majority of government services and therefore put even more stress on taxes and debt.

This is not an easy project to do right now. I get my data for federal government spending from the White House web site. It comes from what the President calls the 2013 budget. Fiscal year 2013 started about two months ago on October 1, 2012. The problem is that the budget projection numbers for 2013 and beyond are being estimated based on so-called spending caps legislated in something called the Budget Control Act. I could have used another version of spending produced with a different set of assumptions published by the Congressional Budget Office but that just adds more speculation about what budget changes will be made in the next month or two or longer.

So I am sticking with what is published on the White House site because it is the only official budget right now.  (http://www.whitehouse.gov/omb/budget ) This budget version exaggerates how much spending restraint there will be – assuming that some of the caps will be removed in new legislation. So if spending looks like it is growing in the White House budget – then it will probably grow even more under a new compromise bill. So let’s at least see what is in store for us at the moment.

To create some basis of comparison let’s start by identifying what might be normal changes in federal government spending. From 1992 to 1997 spending increased by $220 billion. In five years the level of spending increased from $1.38 trillion in 1992 to a level of $1.6 trillion in 1997. In the next five years, 1997 to 2002, the level of spending rose by $400 billion. The increase in five years was about double the five years before. From 2002 to 2007 spending increased by $720 billion. So let’s stop there. You can see a progression of government spending increases over five years periods – expanding by $220 billion, then $400 billion, then $720 billion. I am not sure what you would call normal. Focusing on increases you can see a rapidly rising curve of federal spending.

One would expect a significant yet temporary increase in government spending during the recession and slow economic recovery that followed. And we got it. From 2007 to 2012 federal government spending increased by a little more than $1 trillion. Federal spending went from $2.73 trillion in 2007 to $3.8 trillion in 2012. So the change curve was  not dented and simply continued. The President’s budget –- with spending caps in place – has government spending rising from $3.8 trillion in 2012 to $4.53 billion in 2017. That amounts to another five year increase of $730 billion. How do we interpret that increase?

First, does it look like gut crunching austerity? I don’t think so. The government will be spending more and more and more – as we approach 2017.

Second, how do we evaluate the size of the projected future $736 billion increase? Well it is really big. It is bigger than the increase in the 10 years from 1992 to 2002. It is also bigger than the very rapid period from 2002 to 2007 when spending rose by $720 billion.

Point taken – the government is spending at about as high a rate as it ever has – and by "ever has" we mean more and more and more. I could present all this spending information in real terms or as a percent of GDP and it would show slightly different relative outcomes – but the general point would be the same. There is no austerity. Government spending is not decreasing. Government spending did not take a breather after the recession. What was supposed to be temporary government spending to stimulate a recessionary economy is now permanent.

But the issue is more interesting because we haven’t talked about specific components of spending. Luckily the White House website provides lots of details of spending by year and by program. What we see is very interesting especially in light of Harry Reid’s threat that he will never touch one cent of Social Security, Medicare, and Medicaid.

Recall that total federal spending is projected to increase by $730 trillion between 2012 and 2017. Here are the main* spending categories that account for the increases:

Interest on the debt                                        $340 billion

Social Security                                                 254

Healthcare Services                                          251

Medicare                                                         157

Income Security for Veterans                             29

Federal Employment Retirement/Security            24

Other Income Security                                        24

Higher Education                                                19

Ground Transportation                                       16

     Non-Interest Sub-Total                          $774 billion

Total                                                      $1,114 billion

If we count interest on the national debt the government is planning to spend $1.1 trillion over the next five years on these nine categories. That is, in 2017 we will be spending on an annual basis more than $1 trillion than we did in 2012 in these areas.

Notice that if we focus on the Big Three programs – Social Security, Healthcare Services, and Medicare this accounts for $662 of the planned spending increases. When Harry Reid says he is not going to touch these categories of spending he is basically saying there is no way to control federal government spending. Since he can’t eliminate interest on the debt without a national default, any politician who says he can control government spending and not include all spending categories is involved in a scam. What he really means when he says this is that he either wants higher taxes or higher debt.

One final point. The government does plan to cut quite a few programs. The largest cuts will go to Defense ($126 billion), Commerce and Housing Credit ($114 billion), ), Unemployment Compensation ($56 billion), and Elementary, Secondary and Vocational Education ($46 billion). Quite a few others will be cut by smaller amounts.  Some of those cuts are not real policy changes but are the automatic result of an improving economy.  Others are debatable. A lot of programs will see true cuts so that the Big Three programs can enjoy large increases.

I am not advocating that we cut any particular program but I do see a real scam in operation here. By purposely letting the Big Three programs grow we take a blunt ax to the rest of government AND we raise taxes and probably the debt. It seems to me that putting everything on the table is the only way to make progress on our fiscal gap. We can control government spending but we cannot do it by playing politics as usual. 

*There were other categories that had increased spending but I did not include in this table any increases that were less than $10 billion. 

Taxes 2013

Our government is debating what to do about future tax revenues. This is a big issue because there is a gaping hole or gap between what the government plans to spend and the money it will have to make those expenditures. When I was a teenager is was pretty cool to have a small hole in my Levis. But when the hole got big enough I had to buy a new pair of jeans. As you probably know if you live on the planet Earth the US government is spending more than a trillion dollars each year MORE than what they bring in. When governments have such gaps they have to go into debt. This means that each year they have to sell government bonds to the public of a trillion dollars or more. Selling bonds is usually pretty easy but at some point the public begins to wonder if the government will have the resources to pay the interest each year and then the principal balance when the bonds mature. We see this playing our daily with respect to the bonds of Greece, Ireland, Italy and several other places. The result is not pretty. Bloody street demonstrations are just one visible sign of how painful it becomes when people begin to worry that governments are in financial trouble.

In short, the US government is very preoccupied with reducing this fiscal gap. Both parties want to see this gap managed better. The fiscal cliff is just one aspect of this gap. A year ago policymakers said the fiscal gap was so worrisome that they agreed to enact a poison pill of sorts to put pressure on themselves to enact legislation to reduce the gap. This poison pill was an agreement to put in a very tough short-run solution to the gap – one that raised taxes and lowered both military and non-military spending. Most of us thought – wow – these legislators are really serious. Of course they won’t want to take such an awful pill. Of course, they will legislate something before the end of 2012. They had a whole year to get the job done. But alas, they didn’t. They talked and they accused and they argued and they spat and they even had an election. Yet still no agreement.

So as I write it is November 20 – two days before we Americans gorge ourselves with turkey and JD to celebrate Thanksgiving. We read and hear the news that Senator Reid will not even think about some solutions. Boehner has drawn the line or at least obfuscated the line with respect to other solutions. But one thing remains clear – to solve the problem of the fiscal gap means that two lines have to meet somewhere down the road. The gap will close only when the spending line meets the tax revenue line. This means that spending must grow more slowly in the future and it means that tax revenues must grow faster.

At least for the purpose of this blog – as the title indicates – I want to focus on tax revenues. So I am not going to get into spending this time. As I see it the problem with tax revenues has many dimensions but one really important one is definitional. Many people do not know what the term means.  It is a little like sport fans who want to talk about football. If it is a talk between two Hoosiers we probably are referring to American football and probably a game between lackluster teams like Indiana University and Purdue. Two Europeans would instead be talking about a game we Americans refer to as soccer. If an Aussie and a Kiwi are involved in a football discussion it would be a totally different game. So if we are sitting in the 3 Alley Pub in Itaewon – a place where a lot of foreigners congregate in Seoul – and someone says football – it could take a long time before the group can figure out what they are really going to talk about.

The same thing goes with taxes. In the same discussion you might hear all these terms bandied about – taxes, revenues, average tax rates, marginal tax rates, tax base, percent of income, value added, and more. If people are not familiar with the differences and distinctions of these terms, then it is hard to have a good conversation. So perhaps it is worthwhile to work on this language issue.

My above discussion of the gap concluded that tax revenues will have to not only grow but probably grow more quickly. Much of the tax discussion focuses on income tax. Income tax revenue equals the tax rate a person pays times the income they earn. So if Charles makes $100,000 this year and finds himself in the 28% tax bracket, he then pays $28,000 in income taxes, right? WRONG. Wrong for several reasons.

First, Charles may receive $100,000 this year from his wages, interest, and so on – but Charles has deductions. Whether or not he files a Schedule A, Charles will have some deductions so the income that is actually taxed will be lower than $100,000. Charles gave a lot of money last year to the Georgia Tech Foundation for the Advancement of Beer. Some might call this a tax loophole but Charles loves beer and the foundation appreciates the gift. Anyway, let’s say that his deductions come to $30,000. This means that Charles pays tax only on $70,000. A taxable income of $70,000 puts Charles in the 25% bracket so he will pay $17,500 in taxes. Right?  WRONG.

Charles might be in the 25%  bracket – or what we call the marginal tax rate – but the total amount of income taxes he pays depends on all the other marginal tax rates for incomes below $70,000. To break it down he pays:

  $870 = 10% on income up to $8700
            Plus

  $3,390 = 15% on the income above $8700 up to $35,300

Plus

  $8,675 = 25% on the income above $35,300 up to the $70,000

           

= $12,935

If Charles pays $12,935 on a taxable income of $70,000 then his AVERAGE TAX RATE is 18.5%. Charles has a marginal tax rate of 25% and an average tax rate of 18.5%

Arrgghhh. Don’t you just love math! But without knowing the difference between income, taxable income, marginal tax rates, and average tax rates – you do not really understand the current debates.

For example, the goal is to raise tax revenue. Tax revenue is defined as taxable income times the average tax rate. This definition is not debatable. A bourbon whiskey has a definition. It is not debatable. What you do to increase your intake of bourbon is an interesting question. What we do to raise tax revenues is also an interesting question.

So the formula says you can raise tax revenue in only two ways – raise the average tax rate or raise the taxable income. That’s it. Those are the only two ways to increase income tax revenues. But here is where the fun begins.

How can you raise the average tax rate? How can you raise taxable income?

The government can increase the national average tax rate by legislating an increase in the marginal tax rate of any or all of the income tax brackets. Presently in the USA the marginal rates for individuals or couples are 10%, 15%, 25%, 28%, 33%, and 35%. By increasing the marginal rate for any of the income categories the average rate paid by the country will increase. Of course if you only raise the rate for the richest people paying 35% -- only the richest will pay a higher marginal and average tax rate. Everyone below will pay the same marginal and average rates as before. So you can see the political issue. You want to increase the nation’s average tax rate. But the question is whose ox gets gored? You can gore everyone or you can gore those only with higher incomes. Either way you can raise the average national tax rate.

You can raise taxable income in several ways. One way is through policies that increase economic growth that raises earned incomes. A second way is by what some people call widening the tax base. Widening the tax base means either having more people pay tax or by having fewer loopholes or deductions from earned income. We know many very poor people in US do not pay income taxes. Some of them could be added by reducing the earned income tax credit. A more popular remedy is to reduce deductions of people with higher incomes. We have more deductions in the US tax code than Apple has i-phones. Popular deductions are for mortgage interest paid on a primary residence. Charitable giving is another one. 

EVERY TAX LOOP-HOLE is in place for what someone at some time thought was a really good reason. I got a tax break one year because I bought a new furnace. This benefit was given to me because it was more fuel efficient that the old one, I was helping the country’s battle against air pollution. One year I got a tax deduction because I drank more than 100 bottles of JD. I forget why I got that deduction and I am sure that is not why the IRS has been calling me repeatedly lately.

So here is the political issue. Whether it is the average tax rate or the taxable income, there is much to debate with respect to who bears the burden of the new policy to remove the fiscal gap and how the new policy affects the country at large. Any policy that raises marginal tax rates often hits the wealthier people the most, but has ramifications for US economic growth. Any increase in marginal and average tax rates will impact consumer spending, national saving, business profitability, investment, innovation, stock market, and exchange rate. Any policy that increases the tax base will have impacts on charitable organizations, housing construction, and so on.

The fiscal gap has got to go. Tax revenue has to increase. Average tax rates, some marginal tax rates and/or loopholes have to be changed. Some groups will pay more than others. The nation’s economic growth and ability to increase income will be impacted negatively for a time. Democrats were born on Venus. Republicans came from Mars. We need a solution. Hopefully this little primer on tax revenues helps you to better understand the difficulties. 

Self-Evident Truths

1. When politicians say they are ready to compromise they probably are not
2. Economic growth in the US remains stubbornly mediocre and employment is a major problem
3. World economic growth is slowing and could easily weigh negatively on US economic growth in coming months
4. Accommodative monetary policy has been controversial but most of us understand that too low interest rates for too long is a major risk for economic growth
5. Dealing with defaulted housing and other financial contracts must be accelerated yet if such policies result in a return to dangerous attitudes and practices in household and business debt, then we will have accomplished very little
6. The fiscal cliff is deep but is only one of many. Once that one is skirted we remain at 3,000 meters
7. The real fiscal challenge involves a more permanent fix to overcoming the economic risks associated with unsustainable national government deficits and debts
8. Without pointing fingers it is clear than once a country reaches a point wherein a minority of citizens pays benefits to a majority of citizens, a democratic political system will be challenged to find ways to balance its budgets and accomplish its goals
9. Pre-university education continues to fail to adequately prepare enough students for life’s challenges
10. There is a very large group of friends and relatives who are not heterosexual and who very much want the same kinds of rights as other Americans.
11. Too many school districts do not graduate even 50% of their students
12. University education is becoming unaffordable
13. We have more hope than reality when it comes to controlling costs of healthcare and pensions
14. Notwithstanding women’s rights to choose no one wants risky surgery to become a form of birth control
15. Immigration has always been a source of strength for the US but unfettered and illegal immigration will threaten security and social cohesion
16. Mandate has more than one meaning. A look at Wikipedia says that a legitimate mandate occurs when a government wins election because of its promise to put in new specific policies. A second definition points out that a large margin of victory supports the notion of new specific policies that were part of the campaign.

As I write this we are one week beyond a major presidential election. We all know that the Democratic Party won the presidency by a large number of electoral votes but by a slim popular margin. The House and Senate remain respectively Republican and Democrat. Many Democrats are decrying a mandate – often expressed as a mandate to tax rich people at higher rates. Many Republicans have noted that a conglomeration of minority interests resulted in the Democratic victory and they worry about the loss of voice of the once-majority parts of America in the democratic process. Of course those brief sentences do not fully represent the feelings of most Democrats and Republicans.

These self-evident truths above imply that our nation has a lot of things to accomplish in the coming years. These truths also emphasize just how much we stand to lose if we fail to act. But failing to act is where we seem to excel. Hey mom we had a swim meet at school today and I decided to debate stroke mechanics with my coach and I missed my event. Sorry I didn’t compete.  That sounds pretty stupid. But that is exactly what we have been doing – and we pay those guys and gals in government handsomely to debate mechanics.

The above list was written in such a way that I at least tried to be objective. I know it is impossible to be totally objective as one who has since the age of 18 had a secret love thing for Ayn Rand. But I tried to lay things out in way that focuses on real challenges. I doubt, however, that the challenge statement is the problem. When we take off our Obama blinders and our Romney goggles we all know that this country needs a lot of work. So if that is true, then what is the problem? Why do we have such a dysfunctional government? 

The problem is that we have different approaches to solving these problems. These different ways are sometimes supported by very different assumptions about human instincts and behaviors. They are buttressed often by different religious beliefs. But those differences have always existed. Somehow Reagan worked with Democrats and Clinton worked with Republics. The history of legislation in the US is full if not dominated by parties working together to solve national problems and challenges.

I hear some of my Republican friends saying that we simply cannot compromise our basic beliefs. Some of them worry that the country is becoming too socialistic – too much run by government. Some of my Democrat friends point at the plight of the middle class and think that it is impossible to allow rich people to keep low tax rates. These are, I think, entrenched positions. Right now I am hearing and reading about too many people already drawing lines in the sand. A line in the sand means to me that the self-evident truths will take a back-seat to basic beliefs.

Both sides say the same thing – if we compromise then we will be kicking the can down the road and we will be worsening the country. So like good Tarheels from North Carolina, they dig in their heels for the good of the country.  These are not bad people. They care. 

But coming up with a solution is not necessarily a compromise. For example, aside from raising the tax rate on households and small businesses earning $250,000 per year, there might be other less disruptive ways to increase tax revenue from wealthy people. If we would earnestly work on this we might find ways to do this without causing unnecessary impacts of higher rates on the economy. Furthermore, some Democrats draw a line at Medicare and Social Security. But surely there are changes to recipients of these programs that would be less objectionable than others.  Finding a way to generate more tax revenue and finding other ways to slow the growth of government spending is a no-brainer. Finding these ways does not mean giving up on one’s core principles. It leads to advancing those principles because it means finding solutions to real problems.

But if people gain power in today’s society not by finding solutions but by being passionate and stubborn orators, then I suppose we will have lots of lines drawn in sand in a sandbox that will get smaller and smaller. I am not for compromise. I am not for kicking cans. I am not for giving up on principles. I think we can have all that and a solution. We just need to get away from the microphones and work hard at solutions.

The Election: Did It and Does It Matter?

This is a guest blogger -- Buck Klemkosky

As election day 2012 approaches, an interesting question is: Did it matter for the economy who won the 2008 presidential election, Obama or McCain? And a more relevant question today is: Does it matter in 2012 in terms of the economy whether Obama gets reelected or Mitt Romney? A case could be made that it didn’t matter in 2008 and may not matter in 2012 for the economy anyway.

While Obama and Romney differ on many major issues, the compelling fact is that the Great Recession of 2008-2009 was caused by a financial crisis. Empirical evidence shows that recovery from a financial crisis takes not only good economic policy decisions but more importantly, time – time for the economic excesses that caused the financial crisis and recession to adjust back to some level of normalcy.

The root causes of a financial crisis don’t materialize overnight or even over a few years. It may take a decade or longer; in the case of the U.S. financial crisis, the excesses started several decades earlier. Some of you are old enough to remember the 1970s slow-growth economy and high inflation, referred to as stagflation. Treasury long-term interest rates approached 15 percent, and short-term rates 20 percent – some of the highest interest rates in U.S. history.

Paul Volcker was selected as head of the Fed in 1979 and immediately decided to wring inflation and inflationary expectations out of the U.S. economic system. In what became known as “Volcker’s Massacre,” in October 1979 he decided to tightly control the money supply and let interest rates go where they may. And they did go up further. It took a while, but by August 1982, inflationary expectations started to cool and interest rates started their secular downtrend to today’s historically low interest rates.

One consequence of lower interest rates and inflation was massive amounts of wealth created from 1982 to 2007. As interest rates came down, bond prices went up dramatically and trillions of dollars of wealth were created in the bond markets. Likewise, lower interest rates were reflected in lower mortgage rates, and home prices began to rise again – although not out of line with historical trends until 1996 when the housing bubble started. Stocks also don’t do well in high inflation environments, so stock prices were depressed in 1982. The total valuation of publicly traded U.S. stocks was only $2 trillion in mid-1982. By March 2000, they were worth $16 trillion.

The trillions of dollars of wealth created from 1982-2007 and an economy that grew and only experienced two short recessions in 1991 and 2001, resulted in a consumption bubble in the U.S. Consumption increased from 66 percent of GDP to more than 70 percent over this time period. Much of the increased consumption was funded by the increased financial wealth as well as by credit. Increasing home equity also fueled consumption as consumers used home equity like an ATM machine. The end result was a credit bubble of massive proportions. Consumer debt relative to GDP reached an all-time high in 2007.

Another consequence of the wealth creation and associated credit bubble was a financial system bubble.  The repeal of the Glass-Steagall Act by the Clinton administration in 1999 allowed commercial banks to move into investment banking. There was also dramatic growth in the “shadow banking” system, which included non-commercial bank institutions such as hedge funds, private equity funds, mutual funds, money market funds and a multitude of others.

In addition to the financial system bubble, the long period of moderation in terms of steady economic growth, declining interest rates and inflation, and increasing wealth from 1982-2007 created other problems, such as aggressive risk taking by consumers, corporations (remember Enron, WorldCom and others), and financial institutions. Credit standards became lax, the complexity of the system increased – especially as the derivatives market grew from nothing in 1982 to $600 trillion in 2007 – and transparency declined as overconfidence increased.

All of this credit expansion and wealth creation began to impact home prices in 1996 when they began to increase above historical trend lines; from 1996 to 2006 median home prices more than doubled. Both the Clinton and George W. Bush administrations promoted the home ownership society. They and Congress pressured the government-sponsored agencies, Fannie Mae and Freddie Mac, to not only provide mortgage financing but also to provide financing to lower-income individuals and families. Thus the advent of the sub-prime mortgages, which grew from nothing in 1996 to more than $1 trillion by 2006.

Not even the bursting of the dot.com stock bubble and subsequent bear market from March 2000 to October 2002, when U.S. stocks lost approximately half their value ($8 trillion), could dampen the real estate enthusiasm, speculation and the increase in home prices. Home ownership increased from 64 percent to 68 percent of those eligible during this period, something most thought was stabilizing for the economy. The basis assumption was that home prices would not decline, which they had not since 1930s.

So 2007 found home prices inflated, consumers with too much debt, financial institutions that were too complex and too big to fail, and a financial system that had become not only innovative, but also complex and interrelated. Nobody knew where the risks were in the financial system. The long period of credit expansion, excess leverage, and aggressive risk taking was about to end in dramatic fashion.

The first cracks in the system came from the sub-prime mortgage market in 2007 as default rates increased and mortgage prices decreased. Most thought the problem was controllable, as the sub-prime mortgage market was less than 10 percent of the total mortgage market. But home prices in general began to decline, and problems spread to other markets and to most financial institutions – especially the large investment and commercial banks. What started out as a small credit crisis became a liquidity crisis, then a financial crisis and then the Great Recession.

Who is to blame for the financial crisis? There is plenty of blame to go around and plenty to blame. You could start with the borrower who took on too much debt, real estate speculators, mortgage lenders with lax or no credit standards, bankers who lent and then securitized mortgages, ratings agencies that gave a AAA rating to low-quality mortgages, investors in mortgage-backed securities who relied on the ratings agencies and didn’t perform due diligence, bank regulators who were clueless, the Federal Reserve for keeping interest rates too low in the latter part of the housing bubble, and two U.S. presidents and the U.S. Congress for promoting home ownership to those that couldn’t afford it. But certainly the leverage in the system exacerbated the problem once housing prices started to fall and collateral prices declined. Calls for more collateral forced margin selling, and the downward spiral began.

If the sub-prime mortgage market was the trigger that started the financial crisis, then financial innovation and derivatives also can be blamed. Sub-prime mortgages were pooled into mortgage-backed securities, which were then pooled into collateralized debt obligations (CDOs), each of which was subdivided into tranches – with the highest tranche rated AAA by the ratings agencies.  In hindsight, we now know that you can’t create quality from junk. If the CDO had not existed and credit default swaps (CDSs) not available to insure CDOs, the sub-prime mortgage market would not have developed. Would this have prevented a financial crisis? Probably not, as the housing bubble was pervasive and leverage as well.

The peak of the financial crisis was probably the collapse of Lehman Brothers in September 2008. This prompted Congress to pass TARP, which bailed out the financial system as well as GM and Chrysler. In addition, Congress and the Fed threw many things against the wall. Some stuck, some didn’t.

Back to the basic question: Did it matter for the economy who was elected president in 2008? Probably not. The Fed still would have pumped massive amounts of liquidity into the system and lowered interest rates to historical lows. The U.S. Congress would have still approved of a stimulus package, and the U.S. government would still have had deficits of $5 trillion for the last four fiscal years. As Reinhart and Rogoff point out in their book, “This Time Is Different: Eight Centuries of Financial Folly,” it usually takes an economy seven to eight years to recover from a financial crisis. Consumers have to reduce debt, which they have done to the tune of $1.3 trillion since 2008. The financial system, especially the banks, has to be stabilized and recapitalized. And confidence has to be restored so consumers can spend and corporations can invest and hire. Lately U.S. consumers are spending more than U.S. corporations are investing, even though median family income in the U.S. has fallen five consecutive years.

If the U.S. economy follows the norm, it may take another three to four years to get out of the slow-growth environment and back to normal growth of 3.5 percent annually. The next president, the Fed and Congress have little ammunition left, given the magnitude of our debt and deficits. Given that world GDP growth has fallen, the problems in Europe, and the slowdown in the emerging economies (especially China), the next U.S. president faces challenging economic problems with few options. But good luck to him, whoever it may be.

Alan Blinder gets an F in Macro 101

Alan Blinder is a very competent economist with lots of publications, textbooks, and real-world policy experience. He is a chaired Professor at Princeton and is a former vice chairman of the Federal Reserve. The Wall Street Journal  published an article by him yesterday November 1, 2012, page A17.

Alan Blinder joins with Larry Summer, Paul Krugman, Martin Wolf and other liberal economists who think that we don’t have enough stimulus in the US economy. He can have his opinion and he certainly influences a lot of important people – but when he is wrong on something he is wrong and there is no way else to call it. These guys have enough publications to sink a Japanese freighter on its way to Dokdo Island and about as much joint common sense as Sheldon (the Big Bang Theory TV Show).

In his article Blinder says, “…fiscal policy should be giving us a combination of sizeable stimulus right now and thorough going deficit reduction starting in a year or two….Instead it is doing neither…”

Translation: Alan Blinder said that fiscal policy is not now giving us a sizeable stimulus. Say that again – Alan Blinder says that fiscal policy is not now giving us a sizeable stimulus. Say it again….

Okay Professor Blinder – take out any textbook written for any level and you will find the following:

·         Government budget balance – neutral impact of fiscal policy

·         Government budget surplus – contractionary impact of fiscal policy

·         Government budget deficit – expansionary impact of fiscal policy

·         The average government deficit – through thick and thin – for the USA has been about 3%

·         Let’s call a budget deficit of 3% of GDP normal

For the USA the budget deficit in 2012 (Fiscal year 2012 ended on September 30, 2012) was 8.5% of GDP. That is almost three times its normal impact on the economy. Professor Blinder – that is a ton of stimulus. To say it is not a huge stimulus is to turn macroeconomics on its head and then twirl it around 10 times.  Would four times be better? Five times?

You might retort that the deficit was over 10% of GDP in 2009 and taking it from 10% to 8.5% in three years is contractionary. But please do not retort that. First, any size deficit is a stimulus. Second, at 3 times normal it is a huge stimulus. Third, recall that the economy has now been recovering from a recession that ended three years ago. When a country recovers its deficit ALWAYS improves. That is not because of a lack of stimulus -- it is a simple fact that when the economy recovers it generates more tax revenue and less spending automatically. If the deficit was declining because of legislated tax increases or spending cuts between 2011 and 2012 please show me the legislation. As far as I know Congress has not passed anything but continuing resolutions.

Professor Blinder can want more stimulus but he cannot say that we don’t have a huge stimulus now. It is beyond belief that given his second goal to reduce deficits in the future he can say with a straight face that he will actively promote smaller future deficits? When will the US economy be strong enough in Blinder’s mind to start working on smaller future deficits?  A year or two? Really? When hell freezes over?

Sorry to say this Professor Blinder but you get an F in Macro 101.