The Neverending Quest for a More Redistributionist Tax System

I just listened to President Obama's latest remarks on fiscal policy.  This passage caught my attention:

I want to make clear that any agreement we have to deal with these automatic spending cuts that are being threatened for next month, those also have to be balanced, because, remember, my principle always has been let’s do things in a balanced, responsible way. And that means the revenues have to be part of the equation in turning off the sequester and eliminating these automatic spending cuts, as well as spending cuts.

Now, the same is true for any future deficit agreement. Obviously we’re going to have to do more to reduce our debt and our deficit. I’m willing to do more, but it’s going to have to be balanced. We’re going to have do it in a balanced responsible way.

For example, I’m willing to reduce our government’s Medicare bills by finding new ways to reduce the cost of health care in this country. That’s something that we all should agree on. We want to make sure that Medicare is there for future generations. But the current trajectory of health care costs has gone up so high, we’ve got to find ways to make sure that it’s sustainable.

But that kind of reform has to go hand and hand with doing some more work to reform our tax code, so that wealthy individuals, the biggest corporations, can’t take advantage of loopholes and deductions that aren’t available to most of the folks standing up here; aren’t available to most Americans.

So there is still more work to be done in the tax code to make it fair, even as we’re also looking at how we can strengthen something like Medicare.

Translation: The deal we are about to strike will raise taxes on the rich. But the fiscal imbalances we face will remain unsustainably large.  So I will ask for more tax increases on the rich later.

Maybe the Rs and Ds are both wrong

Click here to read my column in Sunday's NY Times.

Fiscal Cliff Rock

Theater Recommendation

For those in the Boston area: Yesterday, my family and I enjoyed one of our Christmas presents from Santa and went to the new production of the musical Pippin at the American Repertory Theater in Cambridge. I recall seeing the original Broadway production in the 1970s when I was in high school and liking the play then. I went to see it yesterday with a bit of trepidation, wondering whether my sensibilities had changed too much over the past four decades for me to still enjoy it. But the play did not disappoint, not even one bit. This new production is absolutely terrific: great acting, music, dancing, and even acrobatics. Everyone had a blast, from my teenage sons to my 85-year-old mother.

The play's run lasts until January 20. Go see it if you can.

Glaeser on Disability

Ed considers what might be behind this fact:

Thirty years ago, there was a 40-to-1 ratio between the total labor force and those workers receiving Social Security disability payments. Today that ratio is less than 18-to-1.

A Reading for Christmas

My favorite Christmas-themed economics article is this one by Steve Landsburg. From 2004, but truly timeless.

A Krugman Puzzler

I often disagree with Paul Krugman, but I usually understand him.  Lately, however, I have been puzzled about his view of the bond market.  In a recent post, he takes President Obama to task for believing that the failure to deal with our long-term fiscal imbalance might cause a spike in interest rates:

America can’t run out of cash (except politically, if Congress refuses to raise the debt ceiling); it basically can’t experience an interest rate spike unless people see an increased chance of economic recovery and hence a rise in short-term rates. And the people who have been predicting an interest rate spike any day now for four years shouldn’t have any credibility at this point.

But back in 2003, when the fiscal imbalance was much smaller, he wrote:

With war looming, it's time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.... 

How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. 

And as that temptation becomes obvious, interest rates will soar. It won't happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future. 

I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared -- the ultra-establishment Committee for Economic Development now warns that ''a fiscal crisis threatens our future standard of living'' -- investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions -- and I've locked in my rate.

I am having trouble reconciling these points of views.  Has Paul changed his mind since 2003 about how the bond market works?  Or are circumstances different now?  If anything, I would have thought that the fiscal situation is more dire now and so the logic from 2003 would apply with more force.  I am puzzled.

Update: Several people have emailed me possible resolutions of the puzzle, but none is really satisfying.

One group of emailers says that things are different now because we are in a liquidity trap.  But back in 2003 the federal funds rate was at about 1 percent, so we were very close to the zero lower bound.

Another group of emailers says that Paul has admitted that his 2003 forecast was mistaken.  But that is not the issue.  Of course, we can look back and say it was mistaken.  No big deal.  Any economist who has ever made a forecast has made some mistaken forecasts.  The puzzle to me is how Paul can act so certain that the outcome he viewed as likely in 2003 is now beyond the realm of the plausible, even though the fiscal imbalances are much larger.

By the way, my column coming out in Sunday's NY Times touches on these issues, which is why the puzzle came to mind.

Russ Roberts talks with John Taylor

Previous installments are here.

A Cartoon for the Pigou Club

Asness on Buffett

Warren may be a great investor, but he really doesn't cut it as a policy wonk.

A New Way to Reduce Our National Debt

Sell Alaska.

Feldstein on the Fiscal Cliff

Marty offers his recommendation.

Interpreting the Fed

My friend and sometime coauthor Larry Ball sends me his quick analysis of the Federal Reserve's recent announcement:

I think the FOMC announcement is big news: for the first time, the Fed clearly says it will be more dovish in the future than the pre-crisis Taylor Rule (TR) dicates.

In my estimation, the pre-crisis TR is something like the following for the real interest rate r:

r = 2.0 - (1.5)(u-u*) + (0.5)(pi-2.0).

Let’s say u* is still 5.0. Then if u=6.5 and pi=2.5, the TR says r = 0, which implies the nominal interest rate is i = 2.5. Yet the Fed says that i will still be zero!

Some argue that u* has risen above 5.0. That would raise the i implied by the TR, strengthening the conclusion that the Fed’s new rule is more dovish than the TR.

Some argue that r* [the constant term in the TR] has fallen from 2.0 to 1.0. I doubt it, but even with that change, the TR still implies i = 1.5. My conclusion about dovishness is robust.

This deviation from the TR has not happened since the TR was discovered. In particular, the Fed was NOT more dovish than the TR in 2003. I believe the numbers for 2003 are roughly u=6.0, u*=5.0, and pi=1.0. For the TR shown above, the 2003 numbers imply r =0 and i=1.0, which is about the same as the actual i.

It is not clear whether the Fed’s announcement of future dovishness will have significant effects today. The efficacy of announcements about future monetary policy is unproven.

Option C

In the negotiations over the fiscal cliff, many people think the House Republicans are in a tough spot.  The logic is that they have little leverage, because they face only two choices:

A. Concede to most of the president's demands.
B. Take the economy over the cliff, and get blamed for it.

As a result, the logic goes, they will end up doing A, because B is so much worse.

Keith Hennessey points out that there is also option C: Extend the tax cuts, except at the top, for one year. Apparently (and I was not aware of this), Senate Democrats passed a bill doing exactly this back in July.  If the House passes it now, it goes to the President's desk, and he would have a hard time vetoing it.

This is not great policy, as it sets up another fiscal cliff one year from now, and it does not address all the spending cuts that are part of the fiscal cliff.  But from the Republicans' point of view, it may be better than either A or B.  Keith argues that the ability of Speaker Boehner to fall back on this option should give him more bargaining power as he negotiates with the president.  That is, because the president won't like option C either, the possibility that it could occur may make him more willing to compromise.  From the president's perspective, it is better to make concessions today than having to do this whole fiscal-cliff thing again a year from now.

The Poverty Trap in France

From Forbes:

Let’s take an unemployed mother living alone with two children between six and 10 years old. In 2010, there were 284,445 French families in this situation that were on welfare.

This mother will be given the “Active Solidarity Income.” Since she has two children, the amount will be $1,100. If she is renting an apartment with a $650 rent, she will be given the “Housing Customized Aid,” amounting to $620. Then she will receive “Family Allowances,” which amounts to another $160. Finally, let’s add the payment known as “Allowance for the start of the school year,” which is $750 once a year, or $62.50 per month. (She might even benefit from other aids, but these are the most common.) She will be given a total of $1,942.50 per month.

Now imagine that this mother has found work and will be paid the “legal minimum wage,” which amounts to $1,820 gross—or $1,430 after taxes. Since she would be earning $1,430, she will no longer receive the “Active Solidarity income.” Her “Housing Customized Aid” will be lowered to $460, but she will still be given “Family Allowances” and the “Allowance for the start of the school year.” Therefore, her total income will amount to $2,112.50....

For this mother of two, working again will bring her family an additional income of only $170. Moreover, this $170 is likely to be lost in the cost of transportation to work, since the cost of gas in France is $7 per gallon. In any case, such a small amount of money is not an incentive to go back to work. Between staying home and working, the choice is simple: welfare is a better deal.

Make Your Own Deficit-Reduction Plan

The Wall Street Journal's interactive graphic lets you choose from a menu of options.

She's German. He's Greek. It's Christmas.

Click here for the previous installment.

Fiscal Cliff Fact of the Day

As reported in the NY Times:

Even if Republicans were to agree to Mr. Obama’s core demand — that the top marginal income rates return to the Clinton-era levels of 36 percent and 39.6 percent after Dec. 31, rather than stay at the Bush-era rates of 33 percent and 35 percent — the additional revenue would be only about a quarter of the $1.6 trillion that Mr. Obama wants to collect over 10 years.

This Debuted at the Harvard Holiday Party

Deck the Halls

Not quite fair to Keynesianism, but fun nonetheless:

An Unfortunate Broken Promise

Back in 2008, when President Obama was running for his first term, he promised to be a post-partisan leader.  While a Democrat, he said he would accept good ideas when they came from Republicans.  At the time, I believed him, at least to some degree.  And I wrote about it in this NY Times column.

Sadly, I was wrong.  The short version of the story is this: As a candidate, President Obama campaigned on a platform of raising taxes on the rich.  Yet he and his economic advisers also said they wanted to raise dividend taxes only slightly, from 15 to 20 percent.  For reasons I explained in the Times article, keeping dividend taxes low was a position bolstered by good economics. Now, however, the president wants to raise dividend taxes to ordinary income tax rates (plus, for high-income taxpayers, the new tax of 3.8 percent that is part of the Obamacare legislation).

To put it another way, he campaigned as a moderate, willing to concede that the other party had some good ideas on tax policy.  Once in office, he gave up on those ideas.

A similar thing happened with Bowles-Simpson.  During his first term, he appointed a bipartisan panel, which concluded we could address our long-term fiscal problem with lower tax rates and a broader tax base.  Now, the President goes around the country lambasting that approach.

Reasonable people can disagree about whether President Obama is a good or bad president.  But the claim that he has tried to transcend partisanship and find a middle ground is just impossible to square with the facts.

A Reading for the Pigou Club

From The New Yorker.  One disappointing quotation:

"We would never propose a carbon tax, and have no intention of proposing one," [White House spokesman Jay] Carney told reporters.

Some Advice on Tax Planning

I don't normally give advice on personal finances, but in light of the fiscal situation we are facing, I will pass along one tidbit.  Consider converting some of your retirement savings into a Roth IRA. Over the past few years, I have converted all that I can, which is about half of my retirement savings. 

To make the best of a Roth conversion, you need liquid assets outside of retirement accounts to pay the resulting tax liability.  But if you can do this, you will shelter more of your savings from capital taxation, and you will avoid required minimum distributions when you turn 70 1/2, which means tax-free accumulation for a longer period of time.

To read more about this option, click here.

Why the President is Not So Keen on Just Limiting Deductions

From the White House blog.  Bottom line: If you apply a $25,000 deduction cap only to households with income above $250K, phase in the cap gradually as income rises above $250K, and exclude charitible giving from the cap, you increase revenue by only $450 billion over ten years.