Choosing DOGE Over a Prodigal State Apparatus

03 Thursday Apr 2025

Posted by Nuetzel in Big Government, DOGE

Tags

Al Gore, Barack Obama, Bernie Sanders, Bill Clinton, Border Security, Chuck Schumer, DEI, Department of Education, Department of Government Efficiency, Department of Interior, Discretionary Budget, DOGE, Donald Trump, Elon Musk, entitlements, FDA, Force Reductions, Fourth Branch, Fraud, Graft, HHS, Indirect Costs, Jimmy Carter, Joe Biden, Mandatory Budget, Medicaid, Medicare, Nancy Pelosi, NIH Grants, Obamacare, Provisional Employees, Public debt, Severance Packages, Social Security, U.S. Digital Service, U.S. Postal Service, USAID, Voluntary Separations, Waste

I prefer a government that is limited in size and scope, sticking closely to the provision of public goods without interfering in private markets. Therefore, I’m delighted with the mission of the Department of Government Efficiency (DOGE), a rebranded version of the U.S. Digital Service created by Barack Obama in 2014 to clean up technical issues then plaguing the Obamacare web site. The “new” DOGE is fanning out across federal agencies to upgrade systems and eliminate waste and fraud.

A Strawman

For years, democrats such as Barack Obama and Joe Biden have advocated for eliminating waste in government. So did Bill Clinton, Al Gore, Bernie Sanders, Chuck Schumer, and Nancy Pelosi. Here’s Mark Cuban on the same point. Were these exhortations made in earnest? Or were they just lip service? Now that a real effort is underway to get it done, we’re told that only fascists would do such a thing.

I’m seeing scary posts about DOGE even on LinkedIn, such as the plight of Americans unable to get federal public health communications due to layoffs at HHS, while failing to mention the thousands of new HHS employees hired by Biden in recent years. As if HHS was particularly effective in dispensing good public health advice during the pandemic!

Those kinds of assertions are hard to take seriously. For reasons like these and still others, I tend to dismiss nearly all of the horror stories I hear about DOGE’s activities as nitwitted virtue signals or propaganda.

Many on the left claim that DOGE’s work is careless, and especially the force reductions they’ve spearheaded. For example, they claim that DOGE has failed to identify key employees critical to the functioning of the bureaucracy. The tone of this argument is that “this would not pass muster at a well-managed business”. A “sober” effort to achieve efficiencies within the federal bureaucracy, the argument goes, would involve much more consideration. In other words, given political realities, it would not get done, and they really don’t want it to get done.

The best rationale for the ostensible position of these critics might be situations like the dismissal of several thousand provisional employees at the FDA, a few of whom were later rehired to help manage the work load of reviewing and approving drugs. However, thus far, only a tiny percentage of the federal force reductions under consideration have involved immediate layoffs.

Of course, DOGE is not being tasked to review the practices of a well-managed business or a well-managed governmental organization. What we have here is a dysfunctional government. It is a bloated, low productivity Leviathan run by management and staff who, all too frequently, seem oblivious to the predicament. Large force reductions at all levels are probably necessary to make headway against entrenched interests that have operated as a fourth branch of government.

Thus, I see the leftist critique of Trump’s force reductions as something of a strawman, and it falls flat for several other reasons. First, the vast bulk of the prospective reduction in headcount will be voluntary, as the separating employees have been offered attractive severance packages. Second, force reductions in the private sector always feel chaotic, and they often are. And they are sometimes executed without regard to the qualifications of specific employees. Tough luck!

Duplicative functions, poor data systems, and a lack of control have led to massive misappropriations of funds. The dysfunction has been enabled by a metastasization of nests of administrative authority inside agencies with “incomprehensible” org charts, often having multiple departments with identical functions that do not communicate. These departments frequently use redundant but unconnected systems. A related problem is the inadequacy of documentation for outgoing payments. Needless to say, this is a hostile environment for effective spending controls.

It’s worth emphasizing, by the way, DOGE’s “open book” transparency. It’s not as if Elon Musk and DOGE are attempting to sabotage the deep state in the dark of night. Indeed, they are shouting from the rooftops!

Doing It Fast

Every day we have a new revelation from DOGE of incredible waste in the federal bureaucracy. Check out this story about a VA contact for web site maintenance. All too ironically, what we call government waste tends to have powerful, self-interested, and deeply corrupt constituencies. This makes speed an imperative for DOGE. In a highly politicized and litigious environment, the extent to which the Leviathan can be brought to heel is partly a function of how quickly the deconstruction takes place. One must pardon a few temporary dislocations that otherwise might be avoided in a world free of rent seeking behavior. Otherwise, the graft (no, NOT “grift”) will continue unabated.

The foregoing offers sufficient rationale not only for speedy force reductions, but also for system upgrades, dissolution of certain offices, and consolidation of core functions under single-agency umbrellas.

The Bloody Budget

It’s difficult to know when budget legislation will begin to reflect DOGE’s successes. The actual budget deficit might be affected in fiscal year 2025, but so far the savings touted by DOGE are chump change compared to the expected $2 trillion deficit, and only a fraction of those savings contribute to ongoing deficit reduction.

Uncontrolled spending is the root cause of the deficit, as opposed to insufficient tax revenue, as evidenced by a relatively stable ratio of taxes to GDP. The spending problem was exacerbated by the pandemic, but Congress and the Biden Administration never managed to scale outlays back to their previous trend once the economy recovered. Balancing the budget is made impossible when the prevailing psychology among legislators and the media is that reductions in the growth of spending represent spending cuts.

Federal spending is excessive on both the discretionary and mandatory sides of the budget. Ultimately, eliminating the budget deficit without allowing the 2017 Trump tax cuts to expire will require reform to mandatory entitlements like Social Security, Medicare, and Medicaid, as well as reductions across an array of discretionary programs.

DOGE’s focus on fraud and waste extends to entitlements. At a minimum, the data and tracking systems in place at HHS and SSA are antiquated, sometimes inaccurate, and are highly susceptible to manipulation and fraud. Systems upgrades are likely to pay for themselves many times over.

But all indications are that it’s much worse than that. Social security numbers were issued to millions of illegal immigrants during the Biden Administration, and those enrollees were cleared for maximum benefits. There were a significant number of illegals enrolled in Medicaid and registered to vote. While some of these immigrants might be employed and contributing to the entitlement system, they should not be employed without legal status. Of course, one can defend these entitlement benefits on purely compassionate grounds, but the availability of benefits has served to attract a massive flow of illegal border crossings. This illustrates both the extent to which the entitlement system has been compromised as well as the breakdown of border security.

On the discretionary side of the budget, DOGE has identified an impressive array programs that were not just wasteful, but by turns ridiculous or politically motivated (for example, the bulk of USAID’s budget). Many of these funding initiatives belong on the chopping block, and components that might be worthwhile have been moved to agencies with related missions. In addition, authorized but unspent allocations have been identified that seem to have been held in reserve, and which now can be used to reduce the public debt.

Research Grants?

Of course, like the initial scale of the FDA layoffs, a few mistakes have and will be made by DOGE and agencies under DOGE’s guidance. Many believe another powerful argument against DOGE is the Trump Administration’s 15% limit on indirect costs as an add-on to NIH grants. Critics assert that this limit will hamstring U.S. scientific advancement. However, it won’t “kill” publicly funded research. As this article in Reason points out, historically public funding has not been critical to scientific advancement in the U.S. In fact, private funding accounts for the vast bulk of U.S. R&D, according to the Congressional Research Service. Moreover, it’s broadly acknowledged that indirect costs are subject to distortion, and that generous funding of those costs creates bad incentives and raises thorny questions about cross-subsidies across funders (15% is the rate at which charities typically fund indirect costs).

No doubt some elite research universities will suffer declines in grants, but their case is weakened politically by a combination of lax control over anti-Semitic protests on campus, the growing unpopularity of DEI initiatives in education, and public awareness of the huge endowments over which these universities preside. Nevertheless, I won’t be surprised to see the 15% limit on indirect research costs revised upward somewhat.

More DOGE Please

I’ve criticized the numbers posted on DOGE’s website elsewhere. They could do a much better job of categorizing and reporting the savings they’ve achieved, and they have far to go before meeting the goals stated by Elon Musk. Be that as it may, DOGE is making progress. Here is a report on a few of the latest cuts.

As I’ve emphasized on numerous occasions, the federal government is a strangling mass of tentacles, squeezing excessive resources out of the private sector and suffocating producers with an endless catalogue of burdensome rules. There are many examples of systemic waste taking place within the federal bureaucracy. For example, since its creation by Jimmy Carter, the Department of Education has managed to piss away trillions of dollars while student performance has declined. The Small Business Administration has doled out millions of dollars in subsidized loans to super-centenarians as well as children. The U.S. Postal Service keeps losing money and mail while deliveries slow to a crawl. Big projects become mired in endless iterations of reviews and revisions, such as Obama’s infrastructure plan and Joe Biden’s infrastructure and rural broadband initiative.

And again, regulatory agencies are often our worst enemies, imposing burdensome requirements with which only the largest industry players can afford to comply. Indeed, the savings achieved through the DOGE process might pale in comparison to the resources that could be liberated by rationalizing the tangle of regulations now choking private business.

A significant narrowing of the budget deficit would be a major accomplishment for DOGE. Even one-time savings to help pay down the public debt are worthwhile. In this latter regard, I hope DOGE’s work with the Department of Interior helps facilitate the sale of dormant federal assets. This includes land (not parks) and buildings worth literally trillions of dollars, and sometimes costing billions annually to maintain.

Medicaid Funding Scam Tolerated For Years

18 Tuesday Mar 2025

Posted by Nuetzel in Medicaid, rent seeking

≈ 1 Comment

Tags

Affordable Care Act, Block Grants, DOGE, Federal Matching Funds, Federal Medical Assistance Percentages, FMAP, Government Accountability Office, Issues & Insights, Joe Biden, Medicaid, National Library of Medicine, Obamacare, Provider Reimbursements, Provider Taxes, Supplemental Reimbursements

It’s been underway in various forms for a long time, at least since the early 1980s. It’s a basic variant of what the National Library of Medicine once called “creative financing” by some states “to get more federal dollars than they otherwise would qualify for” under Medicaid. It was even recognized as a scam by Joe Biden during Barack Obama’s presidency, and more recently by a number of legislators. Perhaps DOGE can do something to bring it under scrutiny, but ending it would probably take legislation.

Here’s the gist of it: increases in state Medicaid reimbursements qualify for a federal match at a rate known as the Federal Medical Assistance Percentage (FMAPs). First, increases in Medicaid reimbursements must be funded at the state level. To do this, states tax Medicaid providers, but then the revenue is kicked back to providers in higher reimbursements. The deluge of matching federal dollars follows, and states are free to use those dollars in their general budgets.

FMAPs vary based on state income level, so states with poorer residents have higher matching rates. The minimum FMAP is 50%, and it ranges up to 90% for marginal reimbursements falling under expanded Medicaid under Obamacare. The dollar value of the federal match is not capped.

The graphic at the top of this post highlights the circularity of this funding scheme. The graphic is taken from the Government Accountability Office’s “Medicaid Managed Care: Rapid Spending Growth In State Directed Payments Needs Enhanced Oversight and Transparency”. Here’s how Issues & Insights puts it:

“Let’s say, for example, a state imposes a provider tax on hospitals that raises $100 million. And then it returns that $100 million to the hospitals in the form of higher Medicaid reimbursement rates. There’s been no increase in benefits. Providers aren’t better off. But the state gets an extra $50 million from the federal government’s matching fund, money that it can use for anything it wants.“

However, whatever the increment to state coffers, and no matter what state programs are funded as a result, the increment is always expressed as a federal contribution to state Medicaid spending. That bit of shading helps cover for the convoluted and pernicious nature of the scheme. The lack of transparency is obvious, cloaking the circular nature of the flow of funds from providers to states and then back to providers. It’s possible that the arrangement inflates total annual Medicaid costs by as $50 – $65 billion a year, or by 6% – 8%.

Of course, this is also a blatant example of bureaucratic waste, and the allocation of “supplemental reimbursements” are a potential seedbed for cronyism and graft.

It would be better for the federal government to simply give states the money under block grants without the rigmarole. But of course that would change the character of the rent seeking already taking place, and the political daylight might not serve beneficiary states and providers well.

Putting aside the deception inherent in the funding mechanism, states vary tremendously in their reliance on federal matching revenue. States with large populations and high average incomes rely more heavily on the circular inflating of Medicaid reimbursements. California and New York lead the way in both Medicaid provider taxes and federal matching funds. Alaska, however, imposes no Medicaid provider taxes, and smaller states like Wyoming collect little in provider taxes.

High income states receive lower FMAPs, which seemingly encourages both higher Medicaid provider taxes and more “generous” provider reimbursements in order to harvest more federal matching funds. In addition, states have an incentive to participate in expanded Medicaid under the Affordable Care Act in order to receive higher matching rates.

The reciprocal nature of state-level Medicaid provider taxes and provider reimbursements implies a substantial but fictitious component of state Medicaid costs. The purpose is to qualify for federal matching dollars under Medicaid. The governments of 49 states have carried on with this escapade for years. Their misguided defenders insist that the federal contribution is necessary to protect benefits that states might otherwise have to cut. But even that stipulation would not justify the pairing of taxes on and reimbursements to Medicaid providers, which inflates the spending base upon which federal reimbursements are calculated. You have to wonder whether federal taxpayers should forgive the overstatement of costs and misallocation of funds.

Only a Statist Could Love a Sovereign Wealth Fund

12 Wednesday Feb 2025

Posted by Nuetzel in Central Planning, Public debt

≈ 7 Comments

Tags

Bitcoin, Blockchain, Capital Reserve, Carnegie Endowment for International Peace, Crypto Reserve, Donald Trump, Federal Asset Sales, Fiscal Sustainability, Government Corruption, Interest Expense, Joe Biden, Knowledge Problem, Pension Reserves, Peter Earle, Public debt, Sovereign Wealth Fund, Strategic Petroleum Reserve, Tariffs, Taxes, TikTok

I want a federal government with a less pervasive presence in the private sphere. That’s why I oppose a U.S. sovereign wealth fund (SWF), but President Trump issued an executive order (EO) on February 3 setting in motion the creation of an SWF. It would hold various assets with the ostensible intent to earn a return benefiting American taxpayers.

Here are a few comments on the form an SWF might take:

1) How would the SWF be funded?

—Sales of federal assets like federal land, buildings, and the sale of extraction rights? These are probably the least offensive possibilities for funding an SWF, but the proceeds, if and when they materialize, should be used to pay off our massive federal debt, not to fund a governmental piggy bank.

—Taxes/Tariffs? Funding an SWF via taxes or tariffs would be contrary to the EO’s stated objective to “lessen the burden of taxes on American families and small businesses”. Moreover, it would be contrary to a pro-growth agenda, undermining any gains an SWF might produce.

—Borrowing? Another contradiction of a basic rationale for the SWF, which is “to promote fiscal sustainability”. It would mean more debt on top of a mountain of debt that is already growing at an unsustainable rate.

—“Deals” that might place assets under government ownership? Already, potential buyers of TikTok are singing the praises of a partnership with the SWF. Trump seems to think the government can acquire interests in certain enterprises in exchange for allowing them to operate in the U.S. He also believes that federal dollars can be used for development in order to acquire ownership capital. The federal government should not engage in the development of private resources. Business enterprises should remain private or be privatized, to the extent that their ownership has nothing to do with the provision of public goods.

2) What kinds of investments would be held in the SWF? Stocks and bonds? TikTok shares? Private equity? Crypto? The Gaza Riviera REIT?

These are all terrible ideas. Government ownership of the means of production, or socialism, virtually guarantees underperformance and subservience to political objectives. Federal acquisition of private businesses is not a legitimate function of the state.

There is no point in having the government hold a Bitcoin or crypto reserve. First, giving the U.S. government an interest in the private blockchain undermines the very purpose that most users feel gives the blockchain value. Second, the return on crypto depends only on price changes, and most forms of crypto are volatile. It is a stretch to believe that crypto assets have value in promoting “fiscal sustainability” or national security.

3) How would the SWF’s assets and earnings ultimately be used?

The EO plainly states that earnings in the SWF are to be used to promote fiscal sustainability and benefit taxpayers. In the presence of a large and growing national debt, the best path toward those objectives would be to use any and all spare funds to pay off debt and limit the explosive interest burden it imposes. This puts the funds back into hands of private investors, who will respond to market incentives by deploying the capital as they see fit. Does anyone truly think government planners know better how to put those funds to use?

SWF and Future Debt Service

Just to clarify matters, let’s quantify two alternatives: 1) pay off debt immediately; 2) create an SWF to invest funds and pay off debt later. Suppose the government stumbles upon a spare $100. It can immediately pay off $100 of debt and avoid a certain $3.50 in interest expense in year one. If instead an SWF invests the funds at an expected (but uncertain) return of 7%, then perhaps a greater reduction in the debt can be made a year later. How much? Not $107, but only $103.50 (assuming the 7% return is realized) because the $3.50 interest expense on the debt was not avoided in year one. The SWF must earn twice the interest cost on debt to break even on the proposition. That might be possible for an average return over many years, but the returns will vary and the government is likely to botch the job in any case.

An Itch For Intervention

The SWF is subject to dangers inherent in many government activities. One is that the funds held in reserve might be used as a tool of market intervention and/or political mischief, much as Joe Biden attempted to tamp down oil prices by releasing millions of barrels from the Strategic Petroleum Reserve. An administration having available a large pool of financial assets might be tempted to use it to intervene in various markets to manipulate asset prices. And even if you happen to like the interventions of one administration, you might hate the interventions of another.

The Scratch That Corrupts

In testament to the inefficacy and corruption inherent in government intervention in private markets, Peter Earle offers a number of examples of government planning gone awry. It’s not difficult to understand the dysfunction:

“A sovereign wealth fund would not, whatever the intentions of its government administrators, be guided purely by market signals but rather by political interests. That virtually ensures poor investment choices, investments in politically favored industries, and/or wasteful subsidies tending to yield subpar returns.

“Government officials will not have the same rigorous concern for opportunity costs that drives private investors and for-profit managers, as bureaucratic decision-making is often guided by political priorities and budget cycles rather than the disciplined allocation of capital to its most productive use. The Knowledge Problem is real — and ignoring it is expensive.“

Big money in government is an invitation to corruption, and an SWF is no exception. According to the Carnegie Endowment for International Peace:

“…there are systemic governance issues and regulatory gaps that can enable SWFs to act as conduits of corruption, money laundering, and other illicit activities.“

Therefore, the management and operations of an SWF require great transparency as well as strong governance and oversight. This obviously adds a layer of cost as well.

Sound Planning

There is an economic rationale for holding funds in reserve for certain, earmarked purposes. For example, private businesses usually maintain reserves for the upkeep or replacement of physical capital. Shouldn’t the government do the same for public infrastructure such as highways or harbors? Public investments in physical capital should be planned such that the flow of tax revenue is adequate to replenish infrastructure from wear and tear. To the extent that the necessary expenditures are “lumpy”, however, a maintenance reserve fund is sound practice, as long as its management is transparent and accountable, and its holdings represent prudent risks.

Another example is the maintenance of a reserve fund for pension payments. This is a reasonable and even necessary practice under traditional defined benefit plans, but those plans have often fallen short of their obligations in practice. The private sector stayed ahead of this risk by shifting overwhelmingly to defined contribution plans. As part of this shift, the existing pension obligations of many private entities were converted to vested “cash value” balances. The public sector should do the same, putting employees in charge of their own retirement savings.

Countries with SWFs tend to be small and also tend to run budget surpluses. Very often, they are funded with revenue earned from abundant natural resources. But even those governments short-change their citizens by failing to reduce tax rates, which would promote growth.

Nonsensical Appeal to Nationalism

Why does the creation of an SWF sound so good to people who should know better? I think it has something to do with the nationalist urge to embrace symbols of patriotic strength. An SWF might evoke the emotive impact of phrases like “sound money” or “a strong dollar”. But in the presence of a large public debt and large, continuing budget deficits, the kind of SWF envisioned by Trump would be counterproductive. Future obligations to pay down the public debt are better addressed in the present, to the extent possible. The government has no business hoarding private financial assets as a means of outrunning debt. Sure, the return on equity usually exceeds the interest rate on public debt, but private investors are better at allocating capital than government, so government should not attempt to take on that role.

Promises and Policies: Grading the Candidates

29 Tuesday Oct 2024

Posted by Nuetzel in Election

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Tags

2024 Election, Abortion, Abraham Accords, Barack Obama, Capitalism, Climate Change, Corporatism, DEI, Dobbs, Donald Trump, Elon Musk, fascism, Federal Reserve, First Amendment, Fossil fuels, Housing, Hysteria, Immigration, Inflation, Israel, Joe Biden, Kamala Harris, Medicaid, Medicare, Obamacare, Renewable energy, Second Amendment, Social Security, Supreme Court, Tariffs, Tax Policy, Ukraine, Vladimir Putin

Wow! We’re less than a week from Election Day! I’d hoped to write a few more detailed posts about the platforms and policies of Kamala Harris and Donald Trump, but I was waylaid by Hurricane Milton. It sent us scrambling into prep mode, then we evacuated to the Florida Panhandle. The drive there and back took much longer than expected due to the mass exodus. On our return we found the house was fine, but there was significant damage to an exterior structure and a mess in the yard. We also had to “de-prep” the house, and we’ve been dealing with contractors ever since. It was an exhausting episode, but we feel like we were very lucky.

Now, with less than a week left till the election, I’ll limit myself to a summary of the positions of the candidates in a number of areas, mostly but not all directly related to policy. I assign “grades” in each area and calculate an equally-weighted “GPA” for each candidate. My summaries (and “grades”) are pretty off-the-cuff and not adequate treatments on their own. Some of these areas are more general than others, and I readily admit that a GPA taken from my grade assignments is subject to a bit of double counting. Oh well!

Role of Government: Kamala Harris is a statist through and through. No mystery there. Trump is more selective in his statist tendencies. He’ll often favor government action if it’s politically advantageous. However, in general I think he is amenable to a smaller role for the public than the private sector. Harris: F; Trump: C

Regulation: There is no question that Trump stands for badly needed federal regulatory reform. This spans a wide range of areas, and it extends to a light approach to crypto and AI regulation. Trump plans to appoint Elon Musk as his “Secretary of Cost Cutting”. Harris, on the other hand, seems to favor a continuation of the Biden Administration’s heavy regulatory oversight. This encourages a bloated federal bureaucracy, inflicts high compliance costs on the private sector, stifles innovation, and tends to concentrate industrial power. Harris: F; Trump: A

Border Policy: Trump wants to close the borders (complete the wall) and deport illegal immigrants. Both are easier said than done. Except for criminal elements, the latter will be especially controversial. I’d feel better about Trump’s position if it were accompanied by a commitment to expanded legal immigration. We need more legal immigrants, especially the highly skilled. For her part, Harris would offer mass amnesty to illegals. She’d continue an open border policy, though she claims to want certain limits on illegal border crossings going forward. She also claims to favor more funds for border control. However, it is not clear how well this would translate into thorough vetting of illegal entrants, drug interdiction at the border, or sex trafficking. Harris: D; Trump: B-

Antitrust: Accusations of price gouging by American businesses? Harris! Forty three corporations in the S&P 500 under investigation by the DOJ? The Biden-Harris Administration. This reflects an aggressively hostile and manipulative attitude toward the business community. Trump, meanwhile, might wheedle corporations to act on behalf of certain of his agendas, but he is unlikely to take such a broadly punitive approach. Harris: F; Trump: B-

Foreign Policy: Harris is likely to continue the Biden Administration’s conciliatory approach to dealing with America’s adversaries. The other side of that coin is an often tepid commitment to longtime allies like Israel. Trump believes that dealing from a position of strength is imperative, and he’s willing to challenge enemies with an array of economic and political sticks and carrots. He had success during his first term in office promoting peace in the Middle East. A renewed version of the Abraham Accords that strengthened economic ties across the region would do just that. Ideally, he would like to restore the strength of America’s military, about which Harris has less interest. Trump has also shown a willingness to challenge our NATO partners in order to get them to “pay their fair share” toward the alliance’s shared defense. My major qualification here has to do with the candidates’ positions with respect to supporting Ukraine in its war against Putin’s mad aggression. Harris seems more likely than Trump to continue America’s support for Ukraine. Harris: D+; Trump: B-

Trade: Nations who trade with one another tend to be more prosperous and at peace. Unfortunately, neither candidate has much recognition of these facts. Harris is willing to extend the tariffs enforced during the Biden Administration. Trump, however, is under the delusion that tariffs can solve almost anything that ails the country. Of course, tariffs are a destructive tax on American consumers and businesses. Part of this owes to the direct effects of the tax. Part owes to the pricing power tariffs grant to domestic producers. Tariffs harm incentives for efficiency and the competitiveness of American industry. Retaliatory action by foreign governments is a likely response, which magnifies the harm.

To be fair, Trump believes he can use tariffs as a negotiating tool in nearly all international matters, whether economic, political, or military. This might work to achieve some objectives, but at the cost of damaging relations more broadly and undermining the U.S. economy. Trump is an advocate for not just selective, punitive tariffs, but for broad application of tariffs. Someone needs to disabuse him of the notion that tariffs have great revenue-raising potential. They don’t. And Trump is seemingly unaware of another basic fact: the trade deficit is mirrored by foreign investment in the U.S. economy, which spurs domestic economic growth. Quashing imports via tariffs will also quash that source of growth. I’ll add one other qualification below in the section on taxes, but I’m not sure it has a meaningful chance.

Harris: C-; Trump: F

Inflation: This is a tough one to grade. The President has no direct control over inflation. Harris wants to challenge “price gougers”, which has little to do with actual inflation. I expect both candidates to tolerate large deficits in order to fulfill campaign promises and other objectives. That will put pressure on credit markets and is likely to be inflationary if bond investors are surprised by the higher trajectory of permanent government indebtedness, or if the Federal Reserve monetizes increasing amounts of federal debt. Deficits are likely to be larger under Trump than Harris due in large part to differences in their tax plans, but I’m skeptical that Harris will hold spending in check. Trump’s policies are more growth oriented, and these along with his energy policies and deregulatory actions could limit the inflationary consequences of his spending and tax policies. Higher tariffs will not be of much help in funding larger deficits, and in fact they will be inflationary. Harris: C; Trump: C

Federal Reserve Independence: Harris would undoubtedly like to have the Fed partner closely with the Treasury in funding federal spending. Her appointments to the Board would almost certainly lead to a more activist Fed with a willingness to tolerate rapid monetary expansion and inflation. Trump might be even worse. He has signaled disdain for the Fed’s independence, and he would be happy to lean on the Fed to ease his efforts to fulfill promises to special interests. Harris: D; Trump: F

Entitlement Reform: Social Security and Medicare are both insolvent and benefits will be cut in 2035 without reforms. Harris would certainly be willing to tax the benefits of higher-income retirees more heavily, and she would likely be willing to impose FICA and Medicare taxes on incomes above current earning limits. These are not my favorite reform proposals. Trump has been silent on the issue except to promise no cuts in benefits. Harris: C-; Trump: F

Health Care: Harris is an Obamacare supporter and an advocate of expanded Medicaid. She favors policies that would short-circuit consumer discipline for health care spending and hasten the depletion of the already insolvent Medicare and Medicaid trust funds. These include a $2,000 cap on health care spending for Americans on Medicare, having Medicare cover in-home care, and extending tax credits for health insurance premia. She supports funding to address presumed health care disparities faced by black men. She also promises efforts to discipline or supplant pharmacy benefit managers. Trump, for his part, has said little about his plans for health care policy. He is not a fan of Obamacare and he has promised to take on Big Pharma, whatever that might mean. I fear that both candidates would happily place additional controls of the pricing of pharmaceuticals, a sure prescription for curtailed research and development and higher mortality. Harris: F; Trump: D+

Abortion: The Supreme Court’s 2022 decision in Dobbs v. Jackson essentially relegated abortion law to individual states. That’s consistent with federalist principles, leaving the controversial balancing of abortion vs. the unborn child’s rights up to state voters. Geographic differences of opinion on this question are dramatic, and Dobbs respects those differences. Trump is content with it. Meanwhile, Harris advocates for the establishment of expanded abortion rights at the federal level, including authorization of third trimester abortions by “care providers”. And Harris does not believe there should be religious exemptions for providers who do not wish to offer abortion services. No doubt she also approves of federally funded abortions. Harris: F; Trump: A

Housing: The nation faces an acute housing shortage owing to excessive regulation that limits construction of new or revitalized housing. These excessive rules are primarily imposed at the state and local level. While the federal government has little direct control over many of these decisions, it has abetted this regulatory onslaught in a variety of ways, especially in the environmental arena. Harris is offering stimulus to the demand side through a $25,000 housing tax credit for first-time home buyers. This will succeed in raising the cost of housing. She has also called for heavier subsidies for developers of low-income housing. If past is prologue, this might do more to line the pockets of developers than add meaningfully to the stock of affordable housing. Harris also favors rent controls, a sure prescription for deterioration in the housing stock, and she would prohibit software allowing landlords to determine competitive neighborhood rents. Trump has called for deregulation generally and would not favor rent controls. Harris: F; Trump B

Taxes: Harris has broached several wildly destructive tax proposals. Perhaps the worst of these is to tax unrealized capital gains, and while she promises it would apply only to extremely wealthy taxpayers, it would constitute a wealth tax. Once that line is crossed, the threat of widening the base becomes a very slippery slope. It would also be a strong detriment to domestic capital investment and economic growth. Harris would increase the top marginal personal tax rate and the corporate tax rate, which would discourage investment and undermine real wage growth. She’d also increase estate tax rates. As discussed above, she unwisely calls for a $25,000 tax credit for first-time homebuyers. She also wants to expand the child care tax credit to $6,000 for families with newborns. A proposed $50,000 small business tax credit would allow the federal government to subsidize and encourage risky entrepreneurial activity at taxpayers’ expense. I’m all for small business, but this style of industrial planning is bonkers. She would sunset the Trump (TCJA) tax cuts in 2026.

Finally, Harris has mimicked Trump in calling for no taxes on tips. Treating certain forms of income more favorably than others is a recipe for distortions in economic activity. Employers of tip-earning workers will find ways to shift employees’ income to tips that are mandatory for patrons. It will also skew labor supply decisions toward occupations that would otherwise have less economic value. But Trump managed to find an idea so politically seductive that Harris couldn’t resist.

Trump’s tax plans are a mixed bag of good and bad ideas. They include extending his earlier tax cuts (TCJA) and restoring the SALT deduction. The latter is an alluring campaign tidbit for voters in high-tax states. He would reduce the corporate tax rate, which I strongly favor. Corporate income is double-taxed, which is a detriment to growth as well as a weight on real wages. He would eliminate taxes on overtime income, another example of favoring a particular form of income over others. Wage earners would gain at the expense of salaried employees, so one could expect a transition in the form employees are paid over time. Otherwise, the classification of hours as “overtime” would have to be standardized. One could expect existing employees to work longer hours, but at the expense of new jobs. Finally, Trump says Social Security benefits should not be taxed, another kind of special treatment by form of income. This might encourage early retirement and become an additional drain on the Social Security Trust Fund.

The higher tariffs promised by Trump would collect some revenue. I’d be more supportive of this plank if the tariffs were part of a larger transition from income taxes to consumption taxes. However, Trump would still like to see large differentials between tariffs and taxes imposed on the consumption of domestically-produced goods and services.

Harris: F; Trump C+

Climate Policy: This topic has undergone a steep decline in relative importance to voters. Harris favors more drastic climate interventions than Trump, including steep renewable subsidies, EV mandates, and a panoply of other initiatives, many of which would carry over from the Biden Administration. Harris: F; Trump: B

Energy: Low-cost energy encourages economic growth. Just ask the Germans! Consistent with the climate change narrative, Harris wishes to discourage the use of fossil fuels, their domestic production, and even their export. She has been very dodgy with respect to restrictions on fracking. Her apparent stance on energy policy would be an obvious detriment to growth and price stability (or I should say a continuing detriment). Trump wishes to encourage fossil fuel production. Harris: F; Trump: A

Constitutional Integrity: Harris has supported the idea of packing the Supreme Court, which would lead to an escalating competition to appoint more and more justices with every shift in political power. She’s also disparaged the Electoral College, without which many states would never have agreed to join the Union. Under the questionable pretense of “protecting voting rights”, she has opposed steps to improve election integrity, such voter ID laws. And operatives within her party have done everything possible to register non-citizens as voters. Harris: F; Trump: A

First Amendment Rights: Harris has called for regulation and oversight of social media content and moderation. A more descriptive word for this is censorship. Trump is generally a free speech advocate. Harris: F; Trump A-

Second Amendment Rights: Harris would like to ban so-called “assault weapons” and high-capacity magazines, and she backs universal background checks for gun purchases. Trump has not called for any new restrictions on gun rights. Harris: F; Trump: A

DEI: Harris is strongly supportive of diversity and equity initiatives, which have undermined social cohesion and the economy. That necessarily makes her an enemy of merit-based rewards. Trump has no such confusion. Harris: F; Trump: A

Hysteria: The Harris campaign has embraced a strategy of demonizing Donald Trump. Of course, that’s not a new approach among Democrats, who have fabricated bizarre stories about Trump escapades in Russia, Trump as a pawn of Vladimir Putin, and Russian manipulation of the 2016 Trump campaign. Congressional democrats spent nearly all of Trump’s first term in office trying to find grounds for impeachment. Concurrently, there were a number of other crazy and false stories about Trump. The current variation on “Orange Man Bad” is that Trump is a fascist and a Nazi, and that all of his supporters are Nazis. And that Trump will use the military against his domestic political opponents, the so-called “enemy within”. And that Trump will send half the country’s populace to labor camps. The nonsense never ends, but could anything more powerfully ignite the passions of violent extremists than this sort of hateful rhetoric? Would it not be surprising if at least a few leftists weren’t interested in assassinating “Hitler” himself. This is hysteria, and one has to wonder if that is not, in fact, the intent.

Can any of these people actually define the term fascist? Most fundamentally, a fascist desires the use of government coercion for private gain (of wealth or power) for oneself and/or one’s circle of allies. By that definition, we could probably categorize a great many American politicians as fascists, including Barack Obama, Joe Biden, Donald Trump, and a majority of both houses of Congress. That only demonstrates that corporatism is fundamental to fascist politics. Less-informed definitions of fascism conflate it with everything from racism (certainly can play a part) and homophobia (certainly can play a part) to mere capitalism. But take a look at the demographics of Trump’s supporters and you can see that most of these definitions are inapt.

Is the Trump campaign suffering from any form of hysteria? It’s shown great talent at poking fun at the left. Of course, Trump’s reactions to illegal immigration, crime, and third-trimester abortions are construed by leftists to be hysterical. I mean, why would anyone get upset about those kinds of things?

Harris: F; Trump: A

“Grade Point Average”

I’m sure I forgot an area or two I should have covered. Anyway, the following are four-point “GPAs” calculated over 20 categories. I’m deducting a quarter point for a “minus” grade and adding a quarter point for a “plus” grade. Here’s what I get:

Harris: 0.44; Trump: 2.68

Hmmm

Joy-Politik: Taxing Unrealized Capital Gains

25 Wednesday Sep 2024

Posted by Nuetzel in Wealth Taxes

≈ 1 Comment

Tags

Alex Tabarrok, Billionaire Tax, Capital Flight, Jason Furman, Joe Biden, Kamala Harris, Michael Munger, Moore v. United States, Notional Equity Interest, Sam Altman, Tyler Cowen, ULTRA, Unrealized Capital Gains, Wealth Tax

Kamala Harris’ campaign platform lifts several tax provisions from Joe Biden’s ill-fated campaign. The most pernicious of these are lauded by observers on the Left for their “fairness”, but they dismiss some rather obvious economic damage these provisions would inflict. Here, I’ll cover Harris’ proposal to tax unrealized capital gains of the rich in two different ways:

A minimum 25% “billionaire tax” on the “incomes” of taxpayers with net worth exceeding $100 million. This definition of income would include unrealized capital gains.
A tax of 28% at the time of death on unrealized capital gains in excess of $5 million ($10 million for joint returns).

Why Bother?

To get a whiff of the complexity involved, take a look at the description on pp. 79 – 85 of this document, to which the Harris proposal seems to correspond. It’s not fully fleshed out, but it’s easy to imagine the lucrative opportunities this would create for tax attorneys and accountants, to say nothing of job openings at the IRS!

On the other hand, there’s little chance these proposals would be approved by Congress, no matter which party holds a majority. Harris knows that, or at least her advisors do. That taxation of unrealized gains is even part of the conversation in a presidential election year tells us how normalized the idea has become within the Democrat Party, which seems to have lost all regard for private property rights. These are classist proposals designed to garner the votes of the “tax-the-rich” crowd, who either aren’t aware or haven’t come to grips with the fact that the U.S. already has a very progressive income tax system. “The rich” already pay a disproportionately high share of taxes.

Taxable Income

These provisions would complicate and corrupt the income tax code by distorting the definition of income for tax purposes. The Internal Revenue Code has always been consistent in defining taxable income as realized income. One might use the expression “mark-to-market taxation” to characterize a tax on unrealized gains from tradable assets. It’s much more difficult to estimate unrealized gains on non-tradable or infrequently traded investments, for which there is no ready market value.

There is one type of income that some believe to be taxed as unrealized. A few weeks ago, in a post about Sam Altman’s infatuation with a wealth tax, I cited a recent Supreme Court decision that has been mistakenly interpreted as favoring income taxation of unrealized gains or a wealth tax. In fact, Moore v. United States involved the undistributed profits of a foreign pass-through entity (i.e., not a C corporation) for purposes of the mandatory repatriation tax. The foreign firm’s profits were realized, and its pass-through status meant that the U.S. owners had also, by definition, realized the profits. So this case did not set a precedent or create an exception to the rule that income taxation applies only to realized income.

Forced Sales

Tradable assets with easily recorded market values will often have unrealized gains in a given year. While tax payments might be spread over the current and future tax years, these taxes could necessitate asset sales to pay the taxes owed. If unrealized losses are treated symmetrically, they would require either future deductions or possibly credits for prior tax payments.

Estimates of unrealized gains on illiquid or private investments like closely-held business interests, artwork, or real estate are highly uncertain and subject to dispute. A large tax liability on such an asset could be especially burdensome. Cash must be raised, which might require a forced sale of other assets. And again, these valuations often come with great complexity and exorbitant administrative costs, not just for the IRS, but especially for taxpayers.

Economic Downsides

As I noted above, additional taxes on unrealized gains would create an obvious need for liquidity, if not immediately then at death. With or without careful planning, sales of assets by wealthy investors to pay the tax would undermine market values of equity (and other assets), producing a broader loss of wealth economy-wide.

Avoidance schemes would be heavily utilized. For example, a wealthy investor could borrow heavily against assets so as to offset unrealized gains with deductible debt-service costs.

Capital flight is likely to be intense if a Harris tax regime began to take shape in Congress. This might be the best avoidance scheme of all. The U.S. is likely to experience massive capital outflows. Furthermore, investment in new physical capital will decline, ultimately leading to lower productivity and real wages.

Entrepreneurial activity would also take a hit. In a critique of Jason Furman’s effort to justify Harris’ proposal, Tyler Cowen asks why we should be so eager to “whack” venture capital. He also quotes an email from Alex Tabarrok on the detrimental policy effects on rapidly growing start-ups:

“What’s really going on is that you are divorcing the entrepreneur from their capital at precisely the moment that the team is likely most productive. Separation of capital from entrepreneur could negatively impact the company’s growth or the entrepreneur’s ability to manage effectively. The entrepreneur could lose control, for example. If you wait until the entrepreneur realizes the gain that’s the time that the entrepreneur wants out and is ready to consume so it’s closer to taxing consumption and better timed in the entrepreneurial growth process.“

Or the entrepreneur might just decide that a startup would be more rewarding in a tax-friendly environment, perhaps somewhere overseas.

Interest Rates and Tax Receipts

Tabarrok notes in a separate post that much of the variation in stock prices is caused by changes in interest rates. Investors use market rates to determine discount rates at which a firm’s future cash flows can be valued. Thus, changes in rates engender changes in stock prices, capital gains, and capital losses.

A decline in interest rates can raise market valuations without any change in dividends. However, a long-term investor would see no change in pre-tax income or consumption, so the tax could force a series of premature sales. A change in a firm’s expected growth rate would also create an unrealized gain (or loss), but the tax would undermine U.S. equity values. Taxing an actual increase in the dividend is one thing, but taxing a change in expectations of future dividends is another. As Tabarrok puts it, “It’s taxing the chickens before the eggs have hatched.“

Dangerous Narrative, Dangerous Policy

A final objection to taxing unrealized capital gains is that it would cross the line into a form of wealth taxation. Assets come in many forms, but the only time realized values can be discerned are when they are traded. That goes for collectibles, homes, boats, and the full array of financial assets. A corollary is that a very large percentage of wealth is unrealized.

A tax on unrealized gains would be the proverbial camel’s nose under the tent and another incursion into the private realm. So often in the history of taxation we’ve seen narrow taxes expand into broad taxes. This is one more opportunity for the state to extend its dominance and control.

I’ve written in the past about the economic dangers of a wealth tax. First, every dollar of income used to purchase capital is already taxed once. In that sense, the cost basis of wealth would be double taxed under a wealth tax. Second, the supply of capital is highly elastic. This implies a high propensity for capital flight, shallowing of productive physical capital, and reduced productivity and real wages. Avoidance schemes would rapidly be put into play. Given these limitations, the revenue raising potential of a wealth tax is unlikely to live up to expectations. Finally, a wealth tax is unconstitutional, but that won’t stop the Left from pushing for one, especially if they first get a tax on unrealized gains. Even if they are unsuccessful now, the conversation tends to normalize the idea of a wealth tax among low-information voters, and that is a shame.

Big Spending, Explosive Debt, and the Inflation Tax

07 Tuesday May 2024

Posted by Nuetzel in Deficits, Fiscal policy, Inflation

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Tags

American Rescue Plan, CBO, Child Tax Credit, CHIPS Act, Debt to GDP, Discretionary Spending, Donald Trump, Emergency Spending, entitlements, Eric Boehm, Inflation Premium, Inflation tax, Infrastructure Investment and Jobs Act, Joe Biden, John Cochrane, Medicare, OMB, Promise to Address Comprehensive Toxics Act, Social Security, Soft Default, Student Loan Forgiveness, Supreme Court, Treasury Debt

The chart above makes a convincing case that we have a spending problem at the federal level. Really, we’ve had a spending problem for a long time. But at least tax revenue today remains reasonably well-aligned with its 50-year historical average as a share of GDP. Not spending. Even larger deficits opened up during the pandemic and they haven’t returned to pre-pandemic levels.

We’ve seen Joe Biden break spending records. His initiatives, often with questionable merit, have included the $1.8 trillion American Rescue Plan and the nearly $0.8 trillion Infrastructure Investment and Jobs Act, along with several other significant spending initiatives such as the Promise to Address Comprehensive Toxics Act and the subsidy-laden CHIPS Act. Meanwhile, emergency spending has become a regular occurrence on Biden’s watch. More recently, he’s made repeated efforts to forgive massive amounts of student loans despite the Supreme Court’s clear ruling that such gifts are unconstitutional.

Indeed, while Biden keeps pretty busy spinning tales of his days driving an 18-wheeler, cannibals devouring his Uncle Bosie Finnegan, his upbringing in black churches, synagogues, or in the Puerto Rican community, he still finds time to dream up ways for the government to spend money it doesn’t have. Or his kindly puppeteers do.

Biden’s New Budget

Eric Boehm expressed wonderment at Biden’s fiscal 2025 budget not long after its release in March. He was also mystified by the gall it took to produce a “fact sheet” in which the White House congratulated itself on fiscal responsibility. That’s how this Administration characterizes deficits projected at $16 trillion over the next ten years. No joke!

Furthermore, the Administration says the record spending will be “paid for”. Well, yes, with tax increases and lots of borrowing! There are a great many fabulist claims made by the White House about the budget. This link from the Office of Management and Budget includes a handy list of propaganda sheets they’ve managed to produce on the virtues of their proposal.

The Congressional Budget Office (CBO) projects ten-year deficits under current law that are $3 trillion higher than Biden’s proposed budget. That’s the basis of the White House’s boast of fiscal restraint. But the difference is basically paid for with a couple of accounting tricks (see below). More charitably, one could say it’s paid for with higher taxes, aided by the assumption of slightly faster economic growth. The latter will be a good trick while undercutting incentives and wages with a big boost to the corporate tax rate.

The revenue projected by the While House from those taxes does not come anywhere close to eliminating the gap shown in the CBO’s chart above. Federal spending under Biden’s budget grows at about 4% annually, just a bit slower than nominal GDP. Thus, the federal share of GDP remains roughly constant and only slightly higher than the CBO’s current projection for 2034. Nevertheless, spending relative to GDP would continue at an historically high rate. Over the next decade, it would average more than 3% higher than its 50-year average. That would be about $1.3 trillion in 2034!

Meanwhile, the ratio of tax revenue to GDP under Biden’s proposal, as they project it, would average slightly higher than its 50-year average, reaching a full percentage point above by 2034 (and higher than the CBO baseline). That’s probably optimistic.

There is little real effort in this budget to reduce federal deficits, with Treasury borrowing rates now near 15-year highs. Interest expense has grown to an alarming share of spending. In fact, it’s expected to exceed spending on defense in 2024! Perhaps not coincidentally, the White House assumes a greater decline in interest rates than CBO over the next 10 years.

Treats or Tricks?

The situation is likely worse than the White House depicts, given that its budget incorporates assumptions that look generous to their claim of fiscal restraint. First, they frontload nondefense discretionary spending, allowing Biden to make extravagant promises for the near-term while pushing off steep declines in budget commitments to the out-years. The sharp reductions in this category of spending pares more than $2 trillion from the 10-year deficit. From the link above:

Biden also proposes to restore the expanded the child tax credit — for one year! How handy from a budget perspective: heroically call for an expanded credit (for a year) while avoiding, for the time being, the addition of a couple of trillion to the 10-year deficit.

Code Red

So where does this end? The ratio of federal debt to GDP will resume its ascent after a slight decline from the pandemic high. Here is the CBO’s projection:

The Biden budget shows a relatively stable debt to GDP ratio through 2034 due to the assumptions of slightly faster GDP growth, lower Treasury borrowing rates, and the aforementioned “fiscal restraint”. But don’t count on it!

The government’s growing dominance over real resources will have negative consequences for growth in the long-term. Purely as a fiscal matter, however, it must be paid for in one of three ways: revenue from explicit taxes, federal borrowing, or an implicit tax on the public more commonly known as the inflation tax. The last two are intimately related.

Bond investors always face at least a small measure of default risk even when lending to the U.S. Treasury. There is almost no chance the government would ever default outright by failing to pay interest or principal when due. However, investors hold an expectation that the value of their bonds will erode in real terms due to inflation. To compensate, they demand an “inflation premium” in the interest rate they earn on Treasury bonds. But an upside surprise to inflation would constitute a “soft default” on the real value of their bonds. This occurred during and after the pandemic, and it was triggered by a burgeoning federal deficit.

Brief Mechanics

John Cochrane has explained the mechanism by which acts of fiscal profligacy can be transmitted to the price of goods. The real value of outstanding federal debt cannot exceed the expected real value of future surpluses (a present value summed across positive and negative surpluses). If expected surpluses are reduced via some emergency or shock such that repayment in real terms is less likely, then the real value of government debt must fall. That means either interest rates or the price level must rise, or some combination of the two.

The Federal Reserve can prevent interest rates from rising (by purchasing bonds and increasing the money supply), but that leaves a higher price level as the only way the real value of debt can come into line. In other words, an unexpected increase in the path of federal deficits would be financed by money printing and an inflation tax. The incidence of this unexpected “implicit” tax falls not only to bondholders, but also on the public at large, who suffer an unexpected decline in the purchasing power of their nominal assets and incomes. This in turn tends to free-up real resources for government absorption.

Government Debt Is Risky

It appears that investors expect the future deficits now projected by the CBO (and the White House) to be paid down someday, to some extent, by future surpluses. That might seem preposterous, but markets apparently aren’t surprised by the projected deficits. After all, fiscal policy decisions can change tremendously over the course of a few years. But it still feels like excessive optimism. Whatever the case, Cochrane cautions that the next fiscal emergency, be it a new pandemic, a war, a recession, or some other crisis, is likely to create another huge expansion in debt and a substantial increase price level. Joe Biden doesn’t seem inclined to put us in a position to deal with that risk very effectively. Unfortunately, it’s not clear that Donald Trump will either. And neither seems inclined to seriously address the insolvencies of Social Security and Medicare. If unaddressed, those mandatory obligations will become real crises over the next decade.

They Pave Paradise Because Users Pay No Price

24 Wednesday Jan 2024

Posted by Nuetzel in Price Mechanism, Scarcity

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Tags

Car Dependence, Cloverleaf Interchanges, Congestion pricing, Diamond Interchange, Diverging Diamond, Dynamic Pricing, Failure of the Commons, Flyover Ramps, Gas Taxes, Infrastructure Investment and Jobs Act, Interstate Highways, Jessica Trounstine, Joe Biden, Joel Kotkin, Lyft, New York City, Paved Paradise, Private Roads, Reddit, Robert P. Murphy, Sarasota, Socialized Roads, SunPass, Tolls, Uber, Urban planning, Urban Sprawl, Willian Frey

The interchange above is just a few miles from my new home. It’s the world’s largest “diverging diamond” design and it usually works quite well, so I was interested to see this video discussing both its benefits and the conditions under which it hasn’t performed well.

Unfortunately, the video maintains a dubious focus on car dependence in most urban areas. The tale it tells is daunting… and if the reaction on Reddit is any indication, it seems to excite the populist mind. The narrator blames car dependence and sprawl on poor urban planning. I agree in a sense, and I’ll even stipulate that our car dependence is often excessive, but not because anyone could have “planned” better. Top-down planning is notoriously failure-prone. Rather, the corrective is something the creators of the video never contemplate: effective pricing for the use of roads.

There is deserved emphasis near the end of the video on the cost of building and maintaining roads and interchanges. For example, the cost of the interchange above was $74.5 million when it was built about 15 years ago. That sounds exorbitant, and it’s natural for people (and especially urban planners) to question the necessity of building an interchange of that magnitude in what many feel “should be” an outlying district. Did sprawl make it necessary? Can that be avoided in a growing region? What can or should be done?

Good Interchange Design

The interchange in question is at I-75 and University Parkway in Sarasota, FL. It’s used by many drivers to access a large shopping mall, other commercial centers, and nearby residential areas. The video stresses the diverging diamond’s effectiveness and safety in handling high flows of traffic. The design reduces the number of conflict points relative to conventional diamond interchanges, especially for crossing traffic.

Both diverging diamonds and conventional diamond interchanges have advantages over cloverleaf designs. While the latter have no crossover conflict points, they require more land use. They also create additional complexities for grading and drainage, and they are often constrained in the length of space available for left-turn merges. Furthermore, a cloverleaf places more severe limits on traffic flow. Flyover ramps are another alternative that can save space but entail greater expense.

The interchange in question serves an area of rapid growth. Residents increasingly complain about traffic, especially when “snow birds” are in town during the winter months. The video shows that even the diverging diamond has problems once traffic reaches a certain volume. But new residential communities and commercial areas continue to come on-line, adding to traffic flows and requiring additional roads and infrastructure. Again, the narrator believes the resulting traffic and sprawl could have been avoided, and he’s partly correct as far as that goes.

Sprawl Reflects Preferences

The video fails to consider important qualifications to the “car dependence” critique of suburban sprawl. For example, many people like to use their cars and enjoy the freedom of mobility their cars confer. More importantly, most people prefer to live in low-density residential environments rather than dense urban neighborhoods, or even the kinds of communities depicted as ideal in the video. I’m one of those people. More space, more privacy, and more greenery (though I grant that sprawling mall parking lots are not my favorite aesthetic).

Joel Kotkin presents data along those lines, quoting research by Jessica Trounstine, who says, “preferences for single-family development are ubiquitous.” And low-density communities have broad appeal across demographics, as noted by Kotkin:

“Even in blue states, the majority of ethnic minorities live in suburbs, who have accounted for virtually all the suburban growth over the past decade. William Frey of the Brookings Institution notes that in 1990 roughly 20 percent of suburbanites were non-white. That rose to 30 percent in 2000 and 45 percent in 2020.”

Urban Planning Myopia

As to the video’s emphasis on car dependence, its most serious omission is a failure to recognize the economics of pricing. Road use comes with various costs, but the key here is the zero price at the margin for using specific routes, interchanges, bridges, and suburban parking lots. There are many exceptions to be sure, but the video makes no mention of road pricing as a development tool. Nor does it consider “socialized roads” as the chief cause of ever-expanding demands for roads, parking, and the all-too-typical failure of these ersatz “commons”.

The federal government is complicit in this. After all, the interstate highway system was a federal initiative, and interchanges (along with concomitant commercial development) are integral to its success. Interstate highways often supplemented regional efforts to facilitate commuting to cities from distant suburbs. More recently, Joe Biden’s Infrastructure Investment and Jobs Act of 2021 added $110 billion a year from the government’s general fund to subsidize highways and bridges. It should be no surprise that federal gas taxes don’t fund these subsidies. (Gas taxes are user fees only in a vague sense, as they don’t price specific routes at the margin).

More Roads, Trains, Buses?

There are two knee-jerk reactions to congested roads. The first is a tendency to double-down on invested plant, building more, bigger, and wider roads in the hope that they can handle the growing traffic load. Presumably this must be funded by taxpayers, as in the past, and seldom if ever by charging per marginal use of these facilities. This “solution” basically calls for more socialized roads.

The second knee-jerk reaction to congestion, and it is also a reaction to the real or presumed shortcomings of a “paved paradise”, is to call for more buses, streetcars, or light rail. But mass transit systems seldom pay for their operating costs let alone their capital costs. One of the reasons, of course, is that they must compete with free roads!

What else might the urban planners have us do? We can’t just tear down the sprawling developments and road infrastructure and start over. However, we can accomplish a few other things like: 1) raise revenue from users to make the upkeep of road infrastructure self-funding; 2) minimize congestion, emissions, and time-use while improving safety; and 3) stem growth in demand that eventually would require more lanes, more parking, and other measures to maximize traffic flow. Pricing the actual use of roads would do all these things in greater or lesser degree, and it would more effectively balance development preferences with costs. In turn, positive road-use prices would incentivize other development models such as the “human-centric” communities the video’s narrator finds so attractive.

Those Who Benefit Shall Pay

Tolls for the use of roads and bridges (and paid parking) are hardly new ideas. Tolls on bridges were a natural continuation of fees charged by operators of ferry boats. Tolling was instituted by large landholders to extract rents from anyone wishing to traverse their property, and only later was used as a mechanism for funding road construction and maintenance. But like any price, tolls serve to ration the availability of a resource.

Today, tolling in the U.S. is an increasingly important source of funding for highways and bridges. This importance is growing due to a less sanguine outlook for gas tax collections. In any case, tolls are often more advantageous politically than taxes. Technological advance has allowed tolling to become more cost effective as well. In Florida, for example, the SunPass system allows drivers to cruise through toll collection points at moderate speeds. It’s also used for parking at certain facilities like airports. SunPass holders are required to set up automatic “recharge” of their available balance for toll payments. Similar systems are in place in other states.

Technology has enabled dynamic congestion pricing to be implemented by commercial interests like Uber and Lyft. This means that price responds to demand and supply conditions in real time. In coming years, congestion pricing is likely to be instituted by jurisdictions experiencing heavy traffic volumes. New York City’s congestion pricing plan has stalled, but it would charge a toll on vehicles using Manhattan streets below Central Park.

Law of Demand

Tolls at interchanges like the one at I-75 and University Parkway would help to allocate resources more efficiently. First, the mechanics could be simple enough in concept, but toll booths are probably out of the question, and toll authorities would have to sort through various administrative issues.

Let’s suppose SunPass was put to use here, with the revenue distributed to several jurisdictions or agencies responsible for maintaining the interchange and a defined set of connecting streets. When a driver exits I-75 to University, enters I-75 from University, or uses the through lanes on University, the SunPass transponder in their vehicle would communicate with the toll system to record their passage, and their account would be charged the appropriate toll. The charge might differ for through lanes versus I-75 entry or exit. Over the course of a month, tolls on various roads and interchanges would accumulate and be summarized by road or interchange on a statement for the driver.

Vehicles without SunPass (or another toll system partnering with SunPass) would have to be charged via photo identification of tags with billing by mail once a month. This is already a feature of toll roads in Florida (and other states) when vehicles without a SunPass use the SunPass lanes. The volume of mail billing would increase substantially, but that is not an obstacle in principle.

One other wrinkle would allow existing residents of neighborhoods with street entrances within one or two miles of the interchange to receive discounted tolls. That seems fair, but the danger is that discounts of this kind, if extended too far, would blunt incentives that otherwise discourage overuse and underpriced road sprawl. It would also add another layer of complexity to the tolling system.

The behavior of drivers will change in response to tolls. They derive benefits from using particular interchanges which depend upon the importance of errands or appointments in each vicinity, the distance and convenience of other shopping areas, the time of day, and the time saved by using any one route instead of alternates. The toll paid for using an interchange might depend on the size of vehicle, the time of day, or some measure of average congestion at that time of day. A higher toll prompts drivers to consider other routes, other shopping areas (including on-line shopping), or different times of day for those errands. Thus, tolls will redistribute traffic across space and time and are likely to reduce overall traffic at the most congested interchanges, at least at peak hours when tolls are highest.

Smart Pricing

The advent and installation of more sophisticated tolling infrastructure will enable “smart roads”, time-of-day pricing, or even dynamic congestion pricing on some routes. Integrating dynamic pricing with information systems guiding driver decisions about route choice and timing would be another major step. Implementing sophisticated route pricing systems like this will take time, but ultimately the technology will allow tolls to be applied broadly and efficiently… if we allow it to happen.

Private Vs. Public

The private sector is likely to play a greater role in a world of more widespread tolling. To some extent this will take the form of more privately-owned roads. Short of that, many toll roads and smart roads will be privately administered and operated. Private concerns will also play a major role in provisioning infrastructure and systems for more widespread and sophisticated toll roads.

There is a long history of private roads in the U.S. Robert P. Murphy offers a brief summary:

“… many analysts simply assume, because currently the government virtually monopolizes the production and administration of roads, that it must always have done so. And yet, from the 1790s through the 1830s, the private sector was responsible for the creation and operation of many turnpikes. According to economist Daniel Klein, ‘The turnpike companies were legally organized like corporate businesses of the day. The first, connecting Philadelphia and Lancaster, was chartered in 1792, opened in 1794, and proved significant in the competition for trade.’3 ‘By 1800,’ Klein reports, ‘sixty-nine companies had been chartered’ in New England and the Middle Atlantic states. Merchants would often underwrite the expense of building a turnpike, knowing that it would bring in extra traffic to their businesses.”

In Norway and Sweden, most roads are owned and operated privately, though most of the private roads are local. The funding is generally provided by property owners along those routes. Private roads are increasingly common in the U.S., but they are mostly confined to private communities funded by residents. Broader private ownership of roads, and tolling, is likely to occur in the U.S. as governments at all levels struggle with issues of funding, maintenance, traffic control, and growth.

Pricing For Scarcity

There will be political obstacles to widespread tolling and road congestion pricing. Questions of equity and privacy will be raised, but pricing may hold the key to achieving more equitable outcomes. Greater reliance on tolls would avoid regressive tax increases, and selective tolls themselves might well have a progressive incidence, to the extent that congestion tends to be high in prosperous commercial districts. It would make alternatives like mass transit more competitive and viable as well. Furthermore, price signals will cause geographic patterns of commerce and development to shift, potentially encouraging the kinds of high-density, pedestrian communities long-favored by urban planners.

Urban sprawl and auto dependence are old targets of the urban planning community, not to mention the populist left. But those critics rely on a stylized characterization of geographic and social arrangements that happen to be preferred by masses of individuals. As an economist, I sympathize with the critics because those preferences are revealed under incentives that do not reflect the scarcity and real costs of roads and driving. However, in the absence of adequate price incentives, solutions offered by critics of sprawl and autos are at worst brutally intrusive and at best ineffectual. More efficient pricing of roads can be achieved with the installation of tolling solutions that are now technologically feasible. Optimizing tolls over specific roads, bridges, blocks, intersections, and interchanges will require more sophisticated systems, but for now, let’s at least get road-use prices going in the right direction!

Real Short-Term Rates Have Been Positive For Months

21 Friday Jul 2023

Posted by Nuetzel in Inflation, Monetary Policy

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Bidenomics, Cleveland Fed, Inflation Expectations, Joe Biden, Kevin Erdman, Monetary Aggregates, Neutral Fed Funds Rate, Real Interest Rates, Restrictive Policy, TIPS

Note: I’m moving for the first time in many years. We have a lot to do quickly because we’ll close on our new home in early September. It’s in a place with palm trees, but no basements! The clean-up and winnowing of our accumulated papers, possessions, and … junk — not to mention attending to all the details of the move — is taking up all of my time. Anyway, I started the post below a week ago and had to put it aside. Not sure how frequently I’ll be posting till we’re fully settled in the fall, but we’ll see how it goes.

____________________________________________

The inflation news was great last week, with both the Consumer Price Index (CPI) and the Producer Price Index (PPI) reported below expectations. Month-over-month, the increase in the overall CPI was just 0.2%. Year-over-year, CPI inflation was 3%, down from 9% a year ago. Of course, contrary to Joe Biden’s ridiculous claims, this inflation news came despite, and not because of, the pernicious effects of “Bidenomics”. But that aside, just like that, we heard proclamations that the Federal Reserve had finally succeeded in bringing real short-term interest rates into positive territory. Finally, some said, Fed policy had moved into more restrictive territory. But in fact, real rates moved above zero months ago.

The popular rate narrative is based on the fact that the effective Fed Funds rate is now 5.08% while “headline” CPI inflation fell to 2.97%. That would give us a real Fed Funds rate of 3.11%… if that sort of calculation made sense. Here’s an appropriate reaction from Kevin Erdman:

“The short term rate minus trailing 12 month inflation is not a thing. It’s an irrelevant number. Nothing about June 2022 inflation has anything to do with the real fed funds rate in July 2023.”

His statement generalizes to interest rates at any maturity less a corresponding measure of trailing inflation. They are all irrelevant. A proper real rate of interest must incorporate a measure of inflation expectations. Survey data is often used for this purpose, but a better measure can be taken from market expectations by comparing a nominal Treasury rate with a rate on an inflation-indexed Treasury (TIPS) of the same maturity. This is a fairly convenient approach.

Below, we can see that the real one-year Treasury rate has been positive since last November.

And here is the real one-month Treasury rate:

Again, these charts suggest that real short-term rates have been positive much longer than some believe. Whether that represents a “restrictive policy stance” by the Federal Reserve is another matter. We know the Fed has tightened policy, but that began after the notably loose policy conducted throughout the pandemic. Have we truly crossed the threshold into “tightness”?

Here’s the effective (nominal) federal funds rate over the past year.

This rate is under fairly direct control by the Fed, and it is the primary focus of most Fed watchers. It’s an overnight lending rate on loans of reserves between banks, so to adjust it precisely for expected inflation requires an annualized, overnight inflation rate. That’s pretty tricky!

Finding a published measure of expected inflation over durations of less than a year forward is difficult. One can derive one or use a longer-term rate of expected inflation as a proxy, with the proviso that near-term expectations might be more extreme than the proxy, especially if inflation is expected to change from its current pace. Here are one-year inflation expectations over the past year from a Cleveland Fed model that utilizes TIPS returns and other data.

So inflation expectations have declined substantially. If we compare them with short-term interest rates or the effective fed funds rate over the past year, it’s likely the real fed funds rate climbed above zero before the end of the first quarter of 2023. It might even have exceeded the so called “neutral” real Fed funds rate (R*), which was estimated by the Fed to be 1.14% in the first quarter of 2023. A real Fed funds rate above that level would have been deemed restrictive in the first quarter.

My own view is that changes in the Fed funds rate are not at the heart of the transmission mechanism from monetary policy to the real economy. The monetary aggregates are more reliable guides. The broad money stock M2 has been edging lower for well over a year now. That certainly qualifies as a restrictive move, but there is still a lot of excess liquidity out there, left over from the pandemic deluge engineered by the Fed.

The good reports last week might not mark the end of the inflation problem. There are still price pressures from both the demand and supply-sides. Furthermore, to put things in context, the month-to-month increases in May and June of last year were large, which helped to hold down the 12-month increases this May and June. But the CPI was flat during the second half of last year. That means month-to-month inflation over the next six months may well translate into an escalation of year-over-year inflation. That might or might not be turn out to be meaningful, but it would provide a pretext for additional Fed tightening.

The main point of this post is that real interest rates cannot be calculated on the basis of reported inflation over prior months. Doing so at this juncture understates the degree of monetary tightening in terms of short-term rates. Real interest rates can only be determined by nominal rates relative to expectations of future inflation. This gives a more accurate picture of actual credit market conditions and the Fed’s rate policy stance.

Tariffs, Content Quotas, and What Passes for Patriotism

10 Friday Mar 2023

Posted by Nuetzel in Free Trade, Protectionism

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budget deficits, Buy American, CCP, CHIPS Act, Comparative advantage, Consumer Sovereignty, Content Restrictions, Critical Supply Chains, Domestic Content, Donald Trump, Dumping, Export Markets, Federal Procurement, Foreign Trade, Free trade, George Will, Import Waivers, Joe Biden, Made-In-America Laws, Mercantilism, National Security, Nationalism, Patriotism, Price Competition, Price Preference, Protectionism, Tariffs, Trade Retaliation, Universal Baseline Tariffs, Uyghur Muslims

If there’s one simple lesson in economics that’s hard to get across it’s the destructive nature of protectionism. The economics aren’t hard to explain, but for many, the lessons of protectionist failure just don’t want to sink in. Putting aside matters of national security, the harms of protectionism to the domestic economy are greater than any gains that might inure to protected firms and workers. Shielding home industries and workers from foreign competition is generally not smart nor an act of patriotism, but that sentiment seems fairly common nonetheless.

The Pathology of Protectionism

Jingoistic slogans like “Buy American” are a pitch for voluntary loyalty to American brands. I’m all for voluntary action. Still, that propaganda relies on shaming those who find certain foreign products to have superior attributes or to be more economical. This feeds a psychology of economic insularity and encourages those who favors trade barriers, which is one of the earliest species of failed central planning.

The cognitive resistance to a liberal trade regime might have to do with the concentrated benefits of protectionist measures relative to the more diffuse (but high) costs it imposes on society. Some of the costs of protectionism manifest only with time, which makes the connection to policy less obvious to observers. Or again, obstructing trade and taxing “others” in the hope of helping ourselves may simply inflame nationalist passions.

Both Democrats and Republicans rally around policy measures that tilt the playing field in favor of domestic producers, often severely. And again, this near unanimity exists despite innumerable bouts with the laws of economics. I mean, how many times do you have to be beaten over the head to realize that this is a mistake? Unfortunately, politicians just don’t live in the long-term, they leap to defend powerful interests, and they seldom pay the long-term consequences of their mistakes.

Joe Biden’s “Buy American”

The Biden Administration has pushed a “Made In America” agenda since the President took office, It’s partly a sop to unions for their election support. Much of it had to do with tightening waivers granted under made-in-America laws (dating back to 1933) governing foreign content in goods procured by the federal government. The most recent change by Biden is an increase in the requirement for domestic content to 60% immediately and gradually to 75% from there. Also, “price preferences” will be granted to domestic producers of goods to strengthen supply chains identified as “critical”, including active pharmaceutical ingredients, certain minerals including rare earths and carbon fibers, semiconductors and their advanced packaging, and large capacity batteries such as those used in EVs.

There’s a strong case to be made for developing domestic supplies of certain goods based on national security considerations. That can play a legitimate role where defense goods or even some kinds of civilian infrastructure are involved, but Biden’s order applies much more broadly, including protections for industries that are already heavily subsidized by taxpayers. For example, the CHIPS Act of 2022 included $76 billion of subsidies and tax credits to the semiconductor industry.

George Will describes the cost of protectionism and Biden’s “Buy American”:

“‘Buy American,’ like protectionism generally, can protect some blue-collar jobs — but at a steep price: A Peterson Institute for International Economics study concludes that it costs taxpayers $250,000 annually for each job saved in a protected industry. And lots of white-collar jobs are created for lawyers seeking waivers from the rules. And for accountants tabulating U.S. content in this and that, when, say, an auto component might cross international borders (U.S., Canadian, Mexican) five times before it is ready for installation in a vehicle.”

Biden’s new rules will increase the cost of federal procurement. They will squeeze out contracts with foreign suppliers whose wares are sometimes the most price-competitive or best-suited to a project. This is not a prescription for spending restraint, and it comes at a time when the federal budget is under severe strain. Here’s George Will again:

“This will mean more borrowing, not fewer projects. Federal spending is not constrained by a mere shortage of revenue. So, Biden was promising to increase the deficit. And this policy, which elicited red-and-blue bonhomie in the State of the Union audience, also will give other nations an excuse to retaliate (often doing what they want to do anyway) by penalizing U.S. exporters of manufactured goods. ….. Washington lobbyists for both will prosper.”

Domestic manufacturers who find their contracting status “protected” from foreign competition will face less incentive to perform efficiently. They can relax, rather than improve or even maintain productivity levels, and they’ll feel less pressure to price competitively. Those domestic firms providing goods designated by the government as “critical” will be advantaged by the “price preferences” granted in the rules, leading to a less competitive landscape and higher prices. Thus, Biden’s “Buy American” order is likely to mean higher prices and more federal spending. This is destructive and counter to our national interests.

Donald Trump’s Tariffs

In a recent set of proposals trialed for his presidential election campaign, Donald Trump called for “Universal Baseline Tariffs” on imported goods. In a testament to how far Trump has stumbled down the path of economic ignorance, his campaign mentions “patriotic protectionism” and “mercantilism for the 21st century”. Good God! Trump might be worse than Biden!

This isn’t just about China, though there are some specific sanctions against China in the proposal. After all, these new tariffs would be “universal”. Nevertheless, the Trump campaign took great pains to cloak the tariffs in anti-China rhetoric. Now, I’m very unfavorably disposed to the CCP and to businesses who serve or rely on China and (by implication) the CCP. Certainly, in the case of China, national security may dictate the imposition of certain forms of protectionism, slippery slope though it might be. Nevertheless, that is not what universal tariffs are about.

One destructive consequence of imposing tariffs or import quotas is that foreign governments are usually quick to retaliate with tariffs and quotas of their own. Thus, export markets are shut off to American producers in an escalating trade conflict. That creates serious recession risks or might reinforce other recessionary forces. Lost production for foreign markets and job losses in the affected export industries are the most obvious examples of protectionist harm.

Then consider what happens in protected industries in the U.S. and the negative repercussions in other sectors. The prices charged for protected goods by domestic producers rise for two reasons: more output is demanded of them, and protected firms have less incentive to restrain pricing. Just what the protectionists wanted! In turn, with their new-found, government-granted market power, protected firms will compete more aggressively for workers and other inputs. That puts non-protected firms in a bind, as they’ll be forced to pay higher wages to compete with protected firms for labor. Other inputs may be more costly as well, particularly if they are imported. These distortions lead to reduced output and jobs in non-protected industries. It also means American consumers pay higher prices for both protected and unprotected goods.

Consumers not only lose on price. They also suffer a loss of consumer sovereignty to a government wishing to manipulate their choices. When choices are curtailed, consumers typically lose on other product attributes they value. It also curtails capital inflows to the U.S. from abroad, which can have further negative repercussions for U.S. productivity growth.

When imports constitute a large share of a particular market, it implies that foreign nations have a comparative advantage in producing the good in question. In other words, they sacrifice less to produce the good than we would sacrifice to produce it in the U.S. But if country X has a comparative advantage in producing good X, it means it must have a comparative disadvantage in producing certain other goods, let’s say good Y. (That is, positive tradeoffs in one direction necessarily imply negative tradeoffs in the other.) It makes more economic sense for other countries (country Y, or perhaps the U.S.) to produce good Y, rather than country X, since country Y sacrifices less to do so. And that is why countries engage in trade with each other, or allow their free citizens to do so. It is mutually beneficial. It makes economic sense!

To outlaw or penalize opportunities for mutually beneficial trade will only bring harm to both erstwhile trading partners, though it might well benefit specific interests, including some third parties. Those third parties include opportunistic politicians wishing to leverage nationalist sentiments, their cronies in protected industries, and the bureaucrats, attorneys, and bean counters who manage compliance.

When Is Trade Problematic?

Protectionists often accuse other nations of subsidizing their export industries, giving them unfair advantages or dumping their exports below cost on the U.S. market. There are cases in which this happens, but all such self-interested claims should be approached with a degree of skepticism. There are established channels for filing complaints (and see here) with government agencies and trade organizations, and specific instances often prompt penalties or formal retaliatory actions.

There are frequently claims that foreign producers and even prominent American businesses are beneficiaries of foreign slave labor. A prominent example is the enslavement of Uyghur Muslims in China, who reportedly have been used in the manufacture of goods sold by a number of big-name American companies. This should not be tolerated by these American firms, their customers, or by the U.S. government. Unfortunately, there is a notable lack of responsiveness among many of these parties.

Much less compelling are assertions of slave labor based on low foreign wage rates without actual evidence of compulsion. This is a case of severely misplaced righteousness. Foreign wage rates may be very low by American standards, but they typically provide for a standard of living in the workers’ home country that is better than average. There is no sin in providing jobs to foreign workers at a local wage premium or even a discount, depending on the job. In fact, a foreign wage that is low relative to American wages is often the basis for their comparative advantage in producing certain goods. Under these innocent circumstances, there is no rational argument for producing those goods at much higher cost in the U.S.

Very troublesome are the national security risks that are sometimes attendant to foreign trade. When dealing with a clear adversary nation, there is no easy “free trade” answer. It is not always clear or agreed, however, when international relations have become truly adversarial, and whether trade can be usefully leveraged in diplomacy.

Conclusion

As I noted earlier, protectionism has appeal from a nationalist perspective, but it is seldom a legitimate form of patriotism. It’s not patriotic to limit the choices and sovereignty of the individual, nor to favor certain firms or workers by shielding them from competition while penalizing firms requiring inputs from abroad. We want our domestic industries to be healthy and competitive. Shielding them from competition is the wrong approach.

So much of the “problem” we have with trade is the infatuation with goals tied to jobs and production. Those things are good, but protectionists focus primarily on first-order effects without considering the damaging second-order consequences. And of course, jobs and production are not the ultimate goals of economic activity. In the end, we engage in economic activity in order to consume. We are a rich nation, and we can afford to consume what we like from abroad. It satisfies wants, it brings market discipline, and it leads to foreign investment in the American economy.

Biden and Trump share the misplaced objectives of mercantilism. They are both salesmen in the end, though with strikingly different personas. Salesmen want to sell, and I’m almost tempted to say that their compulsion causes them see trade as a one-way street. Biden is selling his newest “Buy American” rules not only as patriotic, but as a national security imperative. The former is false and the latter is largely false. In fact, obstructions to trade make us weaker. They will also contribute to our fiscal imbalances, and that contributes to monetary and price instability.

Like “Buy American”, Trump’s tariffs are misguided. Apparently, Trump and other protectionists wish to tax the purchases of foreign goods by American consumers and businesses. In fact, they fail to recognize tariffs as the taxes on Americans that they are! And tariffs represent a pointed invitation to foreign trading partners to impose tariffs of their own on American goods. You really can’t maximize anything by foreclosing opportunities for gain, but that’s what protectionism does. It’s astonishing that such a distorted perspective sells so well.

Oh To Squeeze Fiscal Discipline From a Debt Limit Turnip

01 Wednesday Feb 2023

Posted by Nuetzel in Fiscal policy, Monetary Policy

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Brinksmanship, British Consols, Congressional Budget Office, consumption tax, David Andolfatto, Debt Limit, Debt to GDP, Entitlement Trust Funds, Extraordinary Measures, Fed Independence, Federal Debt, Federal Default, Federal Reserve, Fiscal Restraint, Income Tax, Inflation tax, IRS, Janet Yellen, Joe Biden, John Cochrane, Josh Barro, Kevin McCarthy, Matt Levine, Modern Monetary Theory, Monetarist Arithmetic, Neil Wallace, Pandemic Benefits, Payment Prioritization, Perpetuities, Platinum Coin, Premium Bonds, Privatization, Rashida Tlaib, Rohan Grey, Saving Incentives, Thomas Sargent, Treasury Debt, Trillion Dollar Coin, Value Added Tax

It’s as if people view the debt limit controversy as a political nuisance rather than the stopgap enforcement mechanism for fiscal sanity that it’s intended to be. That’s a lesson in how far we’ve gone toward an unhealthy acceptance of permanent federal deficits. Oh, most people seem to realize the the government’s spending is prodigious and beyond our capacity to collect taxes, but many don’t grasp the recklessness of the ongoing blowout. Federal deficits are expected to average $1.6 trillion per year over the next decade, versus less than $0.9 trillion and $1.25 trillion over the two previous decades, respectively. That $1.25 trillion includes the massive (and excessive) transfers that took place during the pandemic, which is why we’ve bumped up against the debt limit earlier than had been expected. The trend isn’t abating, despite the fact that the pandemic is behind us. And keep in mind that the Congressional Budget Office has been too optimistic for the past 20 years or so. Take a look at federal debt relative to GDP:

Unpleasant Arithmetic

With federal debt growing faster than GDP, the burden of servicing the debt mounts. This creates a strain in the coordination of fiscal and monetary policy, as described by David Andolfatto, who last year reviewed the implications of “Some Unpleasant Monetarist Arithmetic” for current policy. His title was taken from a seminal paper written by Thomas Sargent and Neil Wallace in 1981. Andolfatto says that:

“… attempting to monetize a smaller fraction of outstanding Treasury securities has the effect of increasing the rate of inflation. A tighter monetary policy ends up increasing the interest expense of debt issuance. And if the fiscal authority is unwilling to curtail the rate of debt issuance, the added interest expense must be monetized—at least if outright default is to be avoided.

Andolfatto wrote that last spring, before the Federal Reserve began its ongoing campaign to tighten monetary policy by raising short-term interest rates. But he went on to say:

“Deficit and debt levels are elevated relative to their historical norms, and the current administration seems poised to embark on an ambitious public spending program. … In the event that inflation rises and then remains intolerably above target, the Federal Reserve is expected to raise its policy rate. … if the fiscal authority is determined to pursue its deficit policy into the indefinite future, raising the policy rate may only keep a lid on inflation temporarily and possibly only at the expense of a recession. In the longer run, an aggressive interest rate policy may contribute to inflationary pressure—at least until the fiscal regime changes.”

So it is with a spendthrift government: escalating debt and interest expense must ultimately be dealt with via higher taxes or inflation, despite the best intentions of a monetary authority.

Fiscal Wrasslin’

Some people think the debt limit debate is all a big fake. Maybe … there are spendthrifts on both sides of the aisle. Still, the current debt limit impasse could serve a useful purpose if fiscal conservatives succeed in efforts to restrain spending. There is, however, an exaggerated uproar over the possibility of default, meaning a failure to make scheduled payments on Treasury securities. The capital markets aren’t especially worried because an outright default is very unlikely. Establishment Republicans may well resort to their usual cowardice and accept compromise without holding out for better controls on spending. Already, in a politically defensive gesture, House Speaker Kevin McCarthy has said the GOP wishes to strengthen certain entitlement programs. Let’s hope he really means restoring solvency to the Social Security and Medicare Trust Funds via fundamental reforms. And if the GOP rules out cuts to any program, let’s hope they don’t rule out cuts in the growth of these programs, or privatization. For their part, of course, Democrats would like to eliminate the debt ceiling entirely.

One of the demands made by Republicans is a transformation of the federal tax system. They would like to eliminate the income tax and substitute a tax on consumption. Economists have long favored the latter because it would eliminate incentives that penalize saving, which undermine economic growth. Unfortunately, this is almost dead in the water as a political matter, but the GOP further sabotaged their own proposal in their zeal to abolish the IRS. Their consumption tax would be implemented as a national sales tax applied at the point of sale, complete with a new Treasury agency to administer the tax. They’d have done better to propose a value added tax (VAT) or a tax on a simple base of income less saving (and other allowances).

Gimmicks and Measures

We’ve seen proposals for various accounting tricks to allow the government to avoid a technical default and buy time for an agreement to be reached on the debt limit. Treasury Secretary Janet Yellen already has implemented “extraordinary measures” to stay under the debt limit until June, she estimates. The Treasury is drawing down cash, skipping additional investments in government retirement accounts (which can be made up later without any postponement of benefits), plus a few other creative accounting maneuvers.

Payment prioritization, whereby the Treasury makes payments on debt and critical programs such as Social Security and Medicare, but defers a variety of other payments, has also been considered. Those deferrals could include amounts owed to contractors or even government salaries. However, a deferral of payments owed to anyone represents a de facto default. Thus, payment prioritization is not a popular idea, but if push comes to shove, it might be viewed as the lesser of two evils. Missing payments on government bonds could precipitate a financial crisis, but no one believes it will come to that.

Two other ideas for avoiding a breach of the debt ceiling are rather audacious. One involves raising new cash via the sale of premium bonds by the Treasury, as described here by Josh Barro (and here by Matt Levine). The other idea is to mint a large denomination ($1 trillion) platinum, “commemorative” coin, which the Treasury would deposit at the Federal Reserve, enabling it to conduct business as usual until the debt limit impasse is resolved. I’ll briefly describe each of these ideas in more detail below.

Premium Bonds

Premium bonds would offer a solution to the debt limit controversy because the debt ceiling is defined in terms of the par value of Treasury debt outstanding, as opposed to the amount actually raised from selling bonds at auction. For example, a note that promises to pay $100 in one year has a par value of $100. If it also promises to pay $100 in interest, it will sell at a steep premium. Thus, the Treasury collects, say, $185 at auction, and it could use the proceeds to pay off $100 of maturing debt and fund $85 of federal spending. That would almost certainly require a “market test” by the Treasury on a limited scale, and the very idea might reveal any distaste the market might have for obviating the debt limit in this fashion. But distaste is probably too mild a word.

An extreme example of this idea is for the Treasury to sell perpetuities, which have a zero par value but pay interest forever, or at least until redeemed beyond some minimum (but lengthy) term. John Cochrane has made this suggestion, though mainly just “for fun”. The British government sold perpetuities called consols for many years. Such bonds would completely circumvent the debt limit, at least without legislation to redefine the limit, which really is long overdue.

The $1 Trillion Coin

Minting a trillion dollar coin is another thing entirely. Barro has a separate discussion of this option, as does Cochrane. The idea was originally proposed and rejected during an earlier debt-limit controversy in 2011. Keep in mind, in what follows, that the Fed does not follow Generally Accepted Accounting Principles (GAAP).

Skeptics might be tempted to conclude that the “coin trick” is a ploy to engineer a huge increase the money supply to fund government expansion, but that’s not really the gist of this proposal. Instead, the Treasury would deposit the coin in its account at the Fed. The Fed would hold the coin and give the Treasury access to a like amount of cash. To raise that cash, the Fed would sell to the public $1 trillion out of its massive holdings of government securities. The Treasury would use that cash to meet its obligations without exceeding the debt ceiling. As Barro says, the Fed would essentially substitute sales of government bonds from its portfolio for bonds the Treasury is prohibited from selling under the debt limit. The effect on the supply of money is basically zero, and it is non-inflationary unless the approach has an unsettling impact on markets and inflation expectations (which of course is a distinct possibility).

When the debt ceiling is finally increased by Congress, the process is reversed. The Treasury can borrow again and redeem its coin from the Fed for $1 trillion, then “melt it down”, as Barro says. The Fed would repurchase from the public the government securities it had sold, adding them back to its portfolio (if that is consistent with its objectives at that time). Everything is a wash with respect to the “coin trick”, as long as the Treasury ultimately gets a higher debt limit.

Lust For the Coin

In fairness to skeptics, it’s easy to understand why the “coin trick” described above might be confused with another coin minting idea that arose from the collectivist vanguard during the pandemic. Representative Rashida Tlaib (D-MI) proposed minting coins to fund monthly relief payments of $1,000 – $2,000 for every American via electronic benefit cards. She was assisted in crafting this proposal by Rohan Grey, a prominent advocate of Modern Monetary Theory (MMT), the misguided idea that government can simply print money to pay for the resources it demands without inflationary consequences.

Tlaib’s plan would have required the Federal Reserve to accept the minted coins as deposits into the Treasury’s checking account. But then, rather than neutralizing the impact on the money supply by selling government bonds, the coin itself would be treated as base money. Cash balances would simply be made available in the Treasury’s checking account with the Fed. That’s money printing, pure and simple, but it’s not at all the mechanism under discussion with respect to short-term circumvention of the debt limit.

Fed Independence

The “coin trick” as a debt limit work-around is probably an impossibility, as Barro and others point out. First, the Fed would have to accept the coin as a deposit, and it is under no legal obligation to do so. Second, it obligates the Fed to closely coordinate monetary policy with the Treasury, effectively undermining its independence and its ability to pursue its legal mandates of high employment and low inflation. Depending on how badly markets react, it might even present the Fed with conflicting objectives.

Believe me, you might not like the Fed, but we certainly don’t want a Fed that is subservient to the Treasury… maintaining financial and economic stability in the presence of an irresponsible fiscal authority is bad enough without seating that authority at the table. As Barro says of the “coin trick”:

“These actions would politicize the Fed and undermine its independence. In order to stabilize expectations about inflation, the Fed would have to communicate very clearly about its intentions to coordinate its fiscal actions with Treasury — that is, it would have to tell the world that it’s going to act as Treasury’s surrogate in selling bonds when Treasury can’t. …

These actions would interfere with the Fed’s normal monetary operations. … the Fed is currently already reducing its holdings of bonds as part of its strategy to fight inflation. If economic conditions change (fairly likely, in the event of a near-default situation) that might change the Fed’s desired balance sheet strategy.”

On With The Show

Discussions about the debt limit continue between the White House and both parties in Congress. Kevin McCarthy met with President Biden today (2/1), but apparently nothing significant came it. Fiscal conservatives wonder whether McCarthy and other members of the GOP lack seriousness when it comes to fiscal restraint. But spending growth must slow to achieve deficit reduction, non-inflationary growth, and financial stability.

Meanwhile, even conservative media pundits seem to focus only on the negative politics of deficit reduction, ceding the advantage to Democrats and other fiscal expansionists. For those pundits, the economic reality pales in significance. That is a mistake. Market participants are increasingly skeptical that the federal government will ever pay down its debts out of future surpluses. This will undermine the real value of government debt, other nominal assets, incomes and buying power. That’s the inflation tax in action.

Unbridled growth of the government’s claims on resources at the expense of the private sector destroys the economy’s productive potential, to say nothing of growth. The same goes for government’s insatiable urge to regulate private activities and to direct patterns of private resource use. Unfortunately, so many policy areas are in need of reform that imposition of top-down controls on spending seems attractive as a stopgap. Concessions on the debt limit should only be granted in exchange for meaningful change: limits on spending growth, regulatory reforms, and tax simplification (perhaps replacing the income tax with a consumption tax) should all be priorities.

In the meantime, let’s avoid trillion dollar coins. As a debt limit work-around, premium bonds are more practical without requiring any compromise to the Fed’s independence. Other accounting gimmicks will be used to avoid missing payments, of course, but the fact that premium bonds and platinum coins are under discussion highlights the need to redefine the debt limit. When the eventual time of default draws near, fiscal conservatives must be prepared to stand up to their opponents’ convenient accusations of “brinksmanship”. The allegation is insincere and merely a cover for government expansionism.

Sacred Cow Chips

Tag Archives: Joe Biden

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Real Short-Term Rates Have Been Positive For Months

Tariffs, Content Quotas, and What Passes for Patriotism

Oh To Squeeze Fiscal Discipline From a Debt Limit Turnip