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Economix Blog: How the Revival of Postwar Germany Began

June 18, 2013 by NewsMaker Leave a Comment

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Sixty-five years ago this week, in June 1948, a remarkable economic transformation took place in Germany. Almost overnight, the economy went from stagnation to revival. Most of the credit goes to the German economist Ludwig Erhard.

Reuters Ludwig Erhard in 1963.

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In 1948, the German economy was a basket case, not merely because of the damage from war but because economic policy was thoroughly confused. Some in the West, including the United States Treasury secretary, Henry Morgenthau, thought Germany’s industrial capacity should be completely dismantled to prevent it from ever again becoming a military threat.

This was a minority point of view, however. The rising Soviet threat overwhelmed any desire for vengeance against Germany and required that it be built up as quickly as possible. The big problem was that Germany was divided into four occupation zones after the war, one each controlled by Britain, France, the Soviet Union and the United States.

Action required agreement among the four powers, which was difficult not only because of Soviet intransigence. In 1945, Prime Minister Winston Churchill of Britain’s Conservative Party had lost his position to Clement Attlee of the Labor Party, who quickly moved to nationalize industry in Britain and adopt other socialist policies. Some new British leaders wanted their socialist ideas implemented in Germany as well.

Thus there were political, ideological and diplomatic divisions among the allies that prevented action in Germany, with economic policy remaining on automatic pilot. Ironically, this led to the continuation of Nazi economic controls, because there was no agreement on what should replace them.

In 1947, the United States and Britain decided to unify the administration of their occupation zones into an area called Bizonia. Mr. Erhard, a respected German business economist from Bavaria, was named economic minister.

In 1948, Britain, France and the United States agreed to end their occupation and establish an independent German state with or without inclusion of the Soviet zone. The handover of power was set to begin on June 15, thus setting up a confrontation with the Soviets.

As soon as German economic autonomy was restored, Mr. Erhard wanted to institute sweeping economic reforms, especially currency reform. Because of inflation, the Germany currency was virtually worthless and the economy largely functioned on barter, which was extremely inefficient and severely hindered the growth of industry.

Introduction of a new German mark was set for June 20, 1948. As word of the currency reform leaked out, stores closed until the effects of the new currency could be determined. Simultaneously, the Soviets cut off supplies for Berlin, which was deep in their zone of occupation but administered jointly by the four powers. The Western powers responded by airlifting supplies to the city, the beginning of the famous Berlin Airlift, one of the most dramatic events in postwar history.

A key part of Mr. Erhard’s plan was the elimination of price controls, which was essential for the currency reform to be effective. He needed permission from the allies to change any of the price controls, but Mr. Erhard concluded that he did not need their consent to simply abolish them. As he wrote in his 1958 book “Prosperity Through Competition”:

It was strictly laid down by the British and American control authorities that permission had to be obtained before any definite price changes could be made. The Allies never seemed to have thought it possible that someone could have the idea, not to alter price controls, but simply to remove them.

Gen. Lucius D. Clay, the United States commander in Germany, was well aware of what Mr. Erhard was up to and could have stopped him. But General Clay’s personal economic adviser, the American businessman Joseph Dodge, urged him not to and the general wisely followed his advice, turning a blind eye to Mr. Erhard’s actions. (Mr. Dodge, an extraordinarily important but virtually unknown figure in postwar economic policy, also played a key role in advising Gen. Douglas MacArthur, the United States commander in Japan, on reforming its economy as well.)

Mr. Erhard instituted many other reforms as well, including a 33 percent cut in income taxes. On June 26, the French, British and American authorities ratified Mr. Erhard’s actions. This led the Soviets to tighten the isolation of Berlin, creating a severe political and economic crisis. The allied airlift quickly ratcheted up. By July 4, 362 American and British planes brought 3,000 tons of food into the city in a single day, an amazing accomplishment given the limited landing and takeoff facilities in Berlin.

By August, the Communists were organizing demonstrations against Mr. Erhard and his reforms, but General Clay stood behind him. Fortunately, tangible signs of economic recovery were becoming evident. Rationing was ended completely in September. In October, a bumper crop of potatoes was cheered, with production up 60 percent over 1947.

By November, it was clearly apparent that the western zone of Germany was taking off, economically, leaving the eastern zone, still under Soviet control, behind. According to an article in The New York Times, industrial production was “far better than even the most optimistic economic planners envisaged when currency reform went into effect.”

The strong economic growth in the west was a major factor leading the Soviet Union to call off its blockade of Berlin on May 12, 1949, and the airlift ended.

A year after the Erhard reforms, they were generally viewed as an unqualified success. C.L. Sulzberger of The New York Times interviewed Mr. Erhard in July 1949 and he pointed with pride to the fact that the quality of German goods was rising, prices were falling and the standard of living was improving. On July 20, Mr. Sulzberger wrote, “Germany is coming back.”

The West German economy continued to expand, aided by the Marshall Plan, and Mr. Erhard remained as the nation’s economics minister until 1963, when he became West Germany’s second chancellor. He died in 1977.

Article source: http://economix.blogs.nytimes.com/2013/06/18/the-revival-of-postwar-germany-began-65-years-ago/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: german economist, jack kemp, united states treasury

Today’s Economist: Bruce Bartlett: America’s Most Profitable Export Is Cash

April 9, 2013 by NewsMaker Leave a Comment

Two things I’ve heard my whole life that always seem within reach but have never occurred are that we will move to paperless offices and a cashless society. In theory, it seems simple enough; computers and the Internet should obviate the need for paper, and credit and debit cards and electronic bill pay should make cash superfluous.

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However, as we all know, we are no closer to a paperless office than we were at the dawn of the computer era. Same goes for the cashless society. As a new report from the Federal Reserve Bank of San Francisco explains, cash has not only held its own against competitors but continues to grow in popularity. Measured in dollar terms, there is 42 percent more cash in circulation today than five years ago.

Among the reasons for the rise in cash holdings are convenience, dependability and anonymity. Another key factor is the decline in interest rates, which has reduced the opportunity cost of holding cash relative to such interest-earning assets as bank deposits, money market funds and Treasury bills.

Many economists believe that the rise in cash is strongly related to growth in the so-called underground economy – criminal activity such as drug dealing, as well as tax evasion by people working off the books for cash. Strong evidence for this proposition comes from examining the distribution of cash holdings by denomination.

Federal Reserve Board

As one can see, 84 percent of the increase in cash since 1990 has been in the form of $100 bills, which have risen to 77 percent of the value of cash outstanding in 2012 from 52 percent in 1990.

I seldom use $100 bills for anything except Christmas gifts to nieces and nephews, nor do I ever see people use them in stores. I suspect that most people have the same experience. For large purchases, most law-abiding people use checks or credit cards.

Studies and common sense suggest that those people most likely to use large bills are doing so for nefarious purposes, especially drug dealing. One can easily fit $1 million in $100 bills into a briefcase.

Another key factor has been the rising amount of United States currency being exported. The Federal Reserve estimates the annual flow of United States currency abroad as well as the total level of such currency, which is counted in the aggregate currency figures in the table above. (These data appear on Line 25 in Tables F.204 and L.204 in the Fed’s Z.1 flow of funds release.)

Federal Reserve

One consequence of the rising share of United States currency held abroad is that it may distort analyses of the relationship between the money supply and economic activity. Many economists believe that inflation results largely, if not exclusively, from an increase in the money supply, much of which consists of currency, the rest being bank deposits, travelers checks and other forms of money.

But if much of the money supply circulates abroad, then any analysis correlating the money supply to domestic economic activity may be distorted and provide false conclusions.

Incidentally, exports of cash appear in the Commerce Department’s data on international transactions (Line 67). It is recorded as an increase in foreign-owned assets in the United States, but is better thought of as an almost costless way of financing a good chunk of our current account deficit. It’s like borrowing money from foreigners that most likely will never have to be paid back, at zero interest.

Foreigners hold United States currency for the same reasons Americans do and may have better motives for doing so, especially in countries suffering severe financial problems such as Cyprus and Greece. Moreover, the continuing economic crisis in Europe has diminished the popularity of the euro even though it has the advantage of coming in 500-euro denominations, about $645 at current exchange rates, making it more compact and convenient for large cash transactions.

However, some countries have withdrawn those notes as a crime-fighting measure, which has probably raised the popularity of the good old $100 bill. (United States $500 and larger bills are no longer produced and are withdrawn when found.)

According to a Federal Reserve study, the vast bulk of United States currency held abroad is $100 bills. Indeed, 65 percent of all $100 bills in existence circulate outside the United States.

Article source: http://economix.blogs.nytimes.com/2013/04/09/americas-most-profitable-export-is-cash/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: jack kemp, paperless office, tax evasion

Economix Blog: The Legend of Margaret Thatcher

April 8, 2013 by NewsMaker Leave a Comment

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

Former Prime Minister Margaret Thatcher of Britain, here in 2008, is venerated by many conservative Republicans in the United States.

Republicans have always admired former Prime Minister Margaret Thatcher of Britain. Her 1979 election excited them enormously; Republicans viewed it as proof that their views were on the upswing and greatly increased their confidence that Ronald Reagan would be elected president in 1980 as part of a worldwide conservative trend.

Mrs. Thatcher’s stature among the American right has only increased since she was ousted by her own party in 1990. This is especially true now. Benjy Sarlin of Talking Points Memo says Mrs. Thatcher “has always been a popular figure in Republican circles across the pond, but she seems to have taken on a new relevance in recent years for the party’s leading lights.”

Mr. Sarlin cites a blog post on Mitt Romney’s Web site that draws a parallel between economic conditions in Britain in the late 1970s and those in America today. He reports that Newt Gingrich and Rick Santorum also invoke Thatcher’s name frequently in their quest for the Republican presidential nomination. And last month, Sarah Palin publicly requested a meeting with Thatcher that fell through because of Mrs. Thatcher’s physical condition.

While Mrs. Thatcher is a towering figure in British political history, well deserving of admiration, the conservative legend about her time in power is at odds with the facts. In this legend, she was even more aggressive than Reagan in cutting taxes and the welfare state. But that is not true.

As this table shows, taxes as a share of the gross domestic product in Britain actually increased sharply during Mrs. Thatcher’s first seven years in office before falling in the later years. Even at the end, they were significantly higher than they were when she took office. Spending also rose during her first seven years before falling in Mrs. Thatcher’s later years.

Institute for Fiscal Studies

To those familiar with Mrs. Thatcher’s tax policies, these data are not surprising. Although she cut the top personal income tax rate to 60 percent from 83 percent immediately upon taking office, the basic tax rate was only reduced to 30 percent from 33 percent. And in 1980, the 25 percent lower rate of taxation was eliminated so that 30 percent became the lowest tax rate.

More importantly, Mrs. Thatcher paid for her 1979 tax cut by nearly doubling the value-added tax to 15 percent, from 8 percent. Among those who thought Mrs. Thatcher was making a dreadful mistake was the American economist Arthur Laffer. Writing in The Wall Street Journal on Aug. 20, 1979, he excoriated her for taking with the one hand while giving with the other.

“The Thatcher budget lowers tax rates where they have little economic consequence and raises tax rates where they affect economic activity directly,” he complained.

In the 1982 forward to the British edition of his American best-seller, “Wealth and Poverty,” George Gilder was also highly critical of Mrs. Thatcher for failing to cut either taxes or spending: “The net effect of the Thatcher program has been a substantial increase in taxation on virtually all taxpayers.”

Although Mrs. Thatcher privatized many British industries and businesses that had been nationalized after World War II and sold off much of Britain’s public housing, in which the bulk of the working class lived, she did little to reduce the size of the nation’s welfare state.

In particular, Mrs. Thatcher, like all the members of her party, strongly supported the National Health Service, which provides national health insurance for every Briton.

A review of long-term spending trends in Britain by the Institute for Fiscal Studies shows that Mrs. Thatcher basically flattened a trajectory that had been rising since the war. That took a lot of political effort even though her party controlled Parliament and the prime minister of Britain has far fewer constitutional constraints than an American president. But at the end of the Thatcher era, the welfare state was still intact.

As Martin Wolf, a columnist for The Financial Times, told me, “Like all great politicians, Thatcher was a pragmatist, not an ideologue, who picked her fights carefully. She recognized that any head-on attack on the welfare state would have destroyed the party’s electability.”

Mr. Wolf said Mrs. Thatcher was far more concerned about fiscal stability and deficit reduction than lower taxes, and the idea that a debt default “would have been sensible would, to her, have been insane.”

Mrs. Thatcher, like Reagan, moved her country in a conservative direction. But Mrs. Thatcher’s fiscal accomplishments were much more modest than many of today’s Republicans think.

The lesson they should learn from her is that it is very hard to shrink the size of government even when a strong leader has complete control of the legislature, that it takes many years of arduous work to do so and that at the end of the day it won’t shrink very much.

Article source: http://economix.blogs.nytimes.com/2013/04/08/the-legend-of-margaret-thatcher-2/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: jack kemp, towering figure, welfare state

Today’s Economist: Bruce Bartlett: The Worst Possible Way to Cut Spending

March 5, 2013 by NewsMaker Leave a Comment

One big problem in the sequestration debate is that both sides have been talking past each other, with unstated assumptions underlying their statements and positions. There is also a great deal of posturing going on that disguises more agreement than the public knows.

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The guiding Republican premise is that there is a vast amount of fat and waste in the federal government. Just as when individuals are overweight, a diet will improve their health.

Contrary to popular belief, Democrats don’t disagree that many programs could be cut substantially without harming government’s core mission. The problem is twofold. First, they disagree with Republicans on which programs are wasteful. Second, Republicans tend to believe that any program they disagree with, philosophically, is, per se, money wasted.

Democrats, I think, are more inclined to think that money spent inefficiently, that doesn’t advance a program’s basic purpose, is the primary source of wasteful spending.

In general, Republicans think of national security as the federal government’s primary function and just about everything else as optional. Democrats don’t disagree that national security is a core function of government but also believe that it has a responsibility to help those who can’t help themselves and to improve the quality of life of all Americans.

Thus in broad terms, Republicans seek to protect national security spending while Democrats are more concerned about domestic spending. From this dichotomy was born the idea of the sequester, which both Republicans and Democrats agreed to in 2011 in the deal that increased the federal debt limit.

The assumption was that both sides would fight equally to protect their sides of the budget and from this struggle something better would emerge than a sequester, which everyone viewed as a meat-ax approach. It tends to be forgotten now, but simultaneous with the budget deal Congress established a Joint Select Committee on Deficit Reduction that was expected to propose a better mix of spending cuts and revenue increases to achieve the bipartisan deficit target.

In the end, the so-called super committee failed. Republicans simply refused to consider any revenue increases, and Democrats opposed a deficit package consisting entirely of spending cuts.

I’m not sure what everyone thought would happen if the super committee failed, but my impression is that everyone supporting the initial budget deal just assumed that sequestration would never actually occur. No Plan B was put in place.

So people looked to the presidential election to somehow clarify the situation. Although Republicans were initially chastened by their failure to win back the White House, they quickly convinced themselves that because they remained in control of the House of Representatives, this meant there was broad public support for their approach to the deficit of spending cuts only and no tax increases whatsoever.

Republicans reluctantly accepted tax increases in the fiscal cliff deal on Jan. 1, feeling they had no choice, because failure to act would have involved a very large automatic tax increase, as all the tax cuts enacted over the previous decade expired under existing law.

They treated this retreat as giving in to extortion and resolved to double down on their insistence that there would not be one penny of tax increase in any new budget deal to replace the sequestration. For his part, President Obama has repeatedly said that eliminating tax loopholes must be part of any new deal.

Economists generally agree that “tax expenditures” such as loopholes and subsidies are the same thing as direct spending. But Republicans insist there is a fundamental philosophical difference between keeping your own money, even through an unjustified and egregious tax loophole, and receiving a check from the government.

The stalemate has been something akin to the situation leading up to the First World War: all parties knew a disaster loomed but were unable to find a way to stop it.

Conservatives appear to believe that the sequester is a big nothing, that cutting 9 percent out of nonmilitary spending and 13 percent from military spending can be borne easily. There is more than enough fat and waste in the budget to permit such cuts, they believe, without jeopardizing anything vital.

The problem, as Democrats say, is that many of the cuts are to muscle and bone, not fat. The sequester mechanism requires that cuts come equally from every line item in the budget except for a few areas, such as veterans’ programs, that were exempted in the original legislation.

It’s as if an overweight person adopted a diet that cut the same percentage from fat, liver, kidneys and other vital organs equally. That’s obviously nuts, but essentially what the sequester does to the budget. The cuts are indiscriminate, leaving bloated programs still bloated, while those that were underfinanced to begin with may lose their ability to function at all.

One thing that has surprised everyone in the sequestration debate has been how blasé Republicans have been about cutting military spending. The House minority leader, Steny Hoyer of Maryland, has said that Democrats miscalculated, thinking Republicans would fight hard to protect the military and thus be forced to negotiate.

My theory is that Republicans have concluded that the military would suffer worse under any budget deal that replaces the sequester. They may also believe they can replace military cuts resulting from sequestration in future appropriations bills.

It’s too soon to say whether the pain of the sequester will be enough to force Congress to end it or replace it with something more rational. According to the Bipartisan Policy Center, a Washington think tank, past sequesters have seldom been allowed to run their course.

Insiders generally believe that the impending expiration of government funding for fiscal year 2013, on March 27, will provide the vehicle for compromise. But as yet, the outlines of such a compromise are opaque.

Article source: http://economix.blogs.nytimes.com/2013/03/05/the-worst-possible-way-to-cut-spending/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: core mission, george h w bush, jack kemp

Today’s Economist: Bruce Bartlett: Tax Increases and Bull Markets

January 8, 2013 by NewsMaker Leave a Comment

Many years ago, I was talking to Jack Kemp, for whom I worked in the 1970s. He told me that just before George H.W. Bush signed into law the 1990 tax increase, which Kemp strenuously opposed, he made an appointment to see Bush and made a last-ditch effort to get him to reject the legislation. Kemp was then serving as secretary of housing and urban development.

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Kemp told me that Bush told him the legislation would stimulate the economy, which was then suffering from a recession that began in July 1990. The expansion of the 1980s, Bush said, didn’t begin until Ronald Reagan signed the Tax Equity and Fiscal Responsibility Act of 1982. Kemp was incredulous.

Tefra, as the Reagan tax increase was called, remains the largest peacetime tax increase in American history. Kemp, despite his love for Reagan, opposed it in Congress, asserting that it would tank the economy, which was still in recession.

I laughed when Kemp told me his Bush story, because that was what he expected me to do. But in the back of my mind, I thought Bush was right.
The economic recovery did begin almost exactly when Tefra took effect.

I recalled this incident last week when the stock market rose sharply after the passage of the tax deal, which raised the top income tax rate and the rate on capital gains and dividends. This is the opposite of what should have happened according to Republican doctrine, which holds that the tiniest increase in tax rates, especially on the rich, is economically devastating.

That got me thinking about the impact of other tax increases in history. A little research showed that sharp increases in the stock market have often followed big tax increases.

For example, in 1932 Herbert Hoover enacted a large tax increase to stabilize federal finances devastated by the Great Depression, which began in 1929. Among other things, the 1932 tax increase raised the top federal income tax rate to 63 percent from 25 percent. But the Dow Jones industrial average increased sharply in 1933, rising 69 percent.

The Dow remained flat for the next several years and then took a sharp jump beginning in 1935. Intriguingly, 1935 just happens to be the year Franklin D. Roosevelt rammed a big tax increase on the rich through Congress. In his message to Congress on June 19, 1935, he emphasized that no wealthy person became wealthy alone, but only in cooperation with many others:

Wealth in the modern world does not come merely from individual effort; it results from a combination of individual effort and of the manifold uses to which the community puts that effort.

The top federal income tax rate rose to 79 percent beginning in 1936, from 63 percent. Yet the Dow was up 48 percent in 1935 and another 25 percent in 1936.

Anyone following standard supply-side advice would have sold everything the day Roosevelt sent his message to Congress. But anyone buying that day would have made 50 percent on their money by the end of 1936 if they did as well as the Dow.

Federal Reserve Bank of St. Louis, 2013 Shaded area indicates a recession in the United States.

World War II led to further tax increases. The really big one came in 1942 and raised revenues by 70 percent, 5 percent of the gross domestic product. The Revenue Act of 1942 was the largest tax increase in American history.

Someone following supply-side theory would undoubtedly have anticipated a stock market crash from such a large tax increase. In fact, an enormous boom followed, despite further large tax increases in 1943, including the institution of tax withholding. From early 1942 through the end of 1945, the Dow doubled, and a supply-sider would have lost out on one of the great bull markets in history.

Fast forward to 1982. Tefra passed the House and Senate on Aug. 19; the Dow closed at 838.57. By the end of the year, it was up to 1,075.70, an increase of 28 percent. The market continued to rise through 1983, closing at 1,258.64.

Bush signed the 1990 budget deal on Nov. 5 of that year, and the Dow closed at 2,502.23. By the end of 1992, the Dow was up 32 percent. Anyone following supply-side theory would have missed yet another bull market.

As most adults are old enough to remember, the 1993 tax increase, which was opposed by every Republican in Congress on the grounds that it would devastate the economy, initiated one of the greatest bull markets in history.

The 1993 legislation raised the top federal income tax rate to 39.6 percent from 31 percent – a huge destruction of incentives for the wealthy,
according to Republican doctrine. It was signed into law on Aug. 10 of that year and the Dow closed at 3,572.73. But by the end of 1993, it was up to 3,754.09, and by the end of 1996 had risen to 6,448.26, a three-year increase of 72 percent.

According to Republican legend, the market didn’t take off until Republicans in Congress cut the capital gains tax in 1997. While much of the bull market did come after 1997, there is no denying that Republican predictions about the effect of the 1993 tax increase were dead wrong.

I’m not going to pretend that tax increases always lead to bull markets or that tax cuts have no effect. I’m saying only that the relationship between taxes, on the one hand, and the economy and the stock market, on the other, is vastly more complex than simplistic Republican dogma would have us believe.

Clearly, there are times when a tax increase sets in motion positive economic forces, like deficit reduction or a more expansionary monetary policy by the Federal Reserve, that overwhelm whatever negative effects may result from higher taxes. The precise impact can only be determined by careful analysis unencumbered by dogmatic beliefs not anchored in empirical results.

Insofar as taxes affect the market, I have long suspected that when tax rates are low they make it too easy for investors to get an adequate after-tax return. When rates rise, they must work harder for a higher before-tax return to compensate for the higher taxes. This pushes money into growth sectors.

I’m not prepared to predict that the great bull market of the 2010s began on Jan. 2. But I do know that anyone who thinks tax increases never precede a bull market is wrong. History proves that.

Article source: http://economix.blogs.nytimes.com/2013/01/08/tax-increases-and-bull-markets/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: jack kemp, reagan tax, secretary of housing and urban development

Today’s Economist: Bruce Bartlett: The Real Long-Term Budget Challenge

December 11, 2012 by NewsMaker Leave a Comment

On Dec. 3, the Government Accountability Office released new estimates of the federal government’s long-term budget outlook. They show that our real long-term problem is quite different from the one constantly portrayed by congressional Republicans.

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As the table shows, spending is not out of control. Entitlement programs like Social Security and Medicare are rising gently as the baby-boom generation retires. All other spending, including that for the military and domestic discretionary programs, falls – with the notable exception of interest on the debt. Interest rises sharply as the deficit rises, principally because the G.A.O. assumes that revenue will not be permitted to rise above its historical average – as Republicans continually insist.

Government Accountability Office
Government Accountability Office analysis of Census Bureau data

Republicans demand that Social Security and Medicare be cut immediately to deal with the so-called fiscal cliff. Popular suggestions for doing so include raising the age of eligibility for Medicare and changing the indexing formula that adjusts Social Security benefits for inflation.

To be sure, some restraint is needed in federal entitlement programs. But the idea that we are facing a crisis is complete nonsense. Spending for Social Security, in particular, is very stable. Relatively modest changes, such as raising the taxable earnings base slightly, would be sufficient to put the program on a sound footing virtually forever.

As a Nov. 28 Congressional Research Service report explains, historically 90 percent of covered earnings was subject to the Social Security tax. In recent years, this percentage has fallen to 84 percent, as the bulk of wage gains has gone to those making more than the maximum taxable income, currently $110,100. Raising the share of covered earnings back to 90 percent would be sufficient to eliminate almost half of Social Security’s long-run actuarial deficit, according to the Social Security actuaries.

Frequently, Republicans assert that domestic discretionary spending is the major source of bloated government. These are basically all programs other than entitlements and interest on the debt outside the Department of Defense, which always needs more money in the Republican world view. These include agriculture, education, energy, science, law enforcement and many other programs that people take for granted and oppose reducing. Moreover, such programs have already been cut sharply by the Budget Control Act of 2011.

That leaves interest on the debt as the principal driver of long-term spending and deficits. As the G.A.O. projections show, net interest rises from 1.4 percent of gross domestic product this year to 3 percent in 2020, 4.9 percent in 2030 and continues rising astronomically thereafter as interest accrues on the bonds previously sold to pay interest on the debt.

Interest rises from 6.1 percent of the federal budget in 2012 to 12.9 percent in 2020, 21 percent in 2030 and eventually reaches 59 percent if current projections are maintained through 2082, the last year in the G.A.O. analysis. As a share of the deficit, interest would rise from 19.2 percent this year to 62 percent in 2020. In the long run, virtually all of the deficit is accounted for by interest on the debt.

These facts explain why the tax pledge that virtually all Republicans blindly support is ultimately self-defeating. Refusing to raise revenue automatically leads to higher spending for interest on the debt. However, Republicans routinely deny this, asserting that capping revenue at some arbitrary percentage of G.D.P. will somehow or other force huge cuts in spending that will prevent deficits from rising to inconceivable levels. Implicitly, they believe in a nonsensical theory called starve-the-beast that is totally refuted by the budgetary experience of the last 20 years.

The frightening thing is that the projections for interest on the debt assume that interest rates don’t rise in the near term and don’t rise at all even as the federal debt rises to 200 percent of G.D.P. in 2037 and to 885 percent of G.D.P. in 2082. The G.A.O. assumes that short-term rates on Treasury securities average 1.3 percent through 2017 and 3.7 percent in the long run, and rates on 10-year Treasuries will average 3.4 percent in the short-run and 5 percent in the long run.

These assumptions cannot be taken at face value. Federal borrowing of the magnitude projected would undoubtedly raise inflation and real interest rates, both of which would raise market interest rates far above those projected, sharply raising federal spending for interest. Rising inflation would also force the Federal Reserve to tighten monetary policy, which would also raise real rates.

In short, the G.A.O. projections are a best-case situation insofar as interest on the debt is concerned. It could get a lot worse very quickly, and at that point it is almost a certainty that taxes will rise far more than would be necessary to stabilize the debt-to-G.D.P. ratio and hence interest on the debt. Therefore, the absolutist position against raising revenue is essentially penny-wise and pound-foolish.

It’s too bad that misplaced fears about the fiscal cliff have taken off the table the option of simply letting all the automatic tax increases and spending cuts go into effect. While this would indeed reduce short-run growth, the Congressional Budget Office says the reduction in projected deficits would actually raise growth in the medium- and long-term (see pages 24-25 of the report).

Article source: http://economix.blogs.nytimes.com/2012/12/11/the-real-long-term-budget-challenge/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: budget outlook, jack kemp, social security and medicare

Economix Blog: Bruce Bartlett: The Real Long-Term Budget Challenge

December 11, 2012 by NewsMaker Leave a Comment

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Government Accountability Office
Government Accountability Office analysis of Census Bureau data

Article source: http://economix.blogs.nytimes.com/2012/12/11/the-real-long-term-budget-challenge/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: bruce bartlett, congressional republicans, jack kemp

Today’s Economist: Bruce Bartlett: Tax Cuts, Tax Rates and Tax Shares

November 27, 2012 by NewsMaker Leave a Comment

Last week, the Internal Revenue Service posted the latest individual income tax data for tax year 2010. Supporting the Republican worldview, the data show that the share of total income taxes paid by the rich increased; supporting the Democratic worldview, they show that the wealthy’s share of total income increased more, leading to a decline in their average tax rate. Sorting through these competing facts is a bit like determining whether the glass is half-empty or half-full, but I’m going to try.

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I will start with the top 1 percent of income taxpayers, who are unambiguously rich by any definition of the term. In 2010, this group included all tax filers with adjusted gross incomes above $369,691. Remember that A.G.I. excludes many forms of income, including benefits such as employer-provided health insurance, unrealized capital gains and interest on tax-exempt municipal bonds.

Internal Revenue Service

Conservatives like to contend that the increasing share of federal income taxes borne by the wealthy shows that they are carrying the rest of us on their backs, so to speak. Indeed, the percentage of all income taxes paid by the top 1 percent has risen to 37.4 percent from 33.2 percent in 2001. This necessarily means that the share of the bottom 99 percent has fallen.

The following table shows that in fact the share of total income taxes borne by those with lower incomes has indeed fallen. For example, the bottom 90 percent of tax filers now pay 29.4 percent of all income taxes, compared with 36.3 percent in 2001.

Internal Revenue Service

Liberals note that a key reason for this is that the incomes of most people outside the rich have stagnated or fallen. In 2001, it required an income of $23,187 in 1990 dollars to be in the top 50 percent of tax filers; in 2010, that income figure had fallen to $20,586. Concomitantly, the share of total income accruing to the bottom 50 percent fell to 11.7 percent in 2010 from 14.4 percent in 2001.

Another key reason for the declining share of income taxes paid by the nonwealthy is that Republican tax policy since the 1970s has consciously aimed at reducing their tax burden.

The following chart from the conservative Tax Foundation illustrates how Republican-sponsored increases in the personal exemption and creation of the earned-income tax credit and child credit completely eliminates the income tax liability for a family of four with $45,000 of income.

Tax Foundation

The declining share of income taxes paid by the nonwealthy was at the root of Mitt Romney’s charge that 47 percent of Americans are dependent on government. After the election, he attributed his loss to “gifts” that certain constituencies, “especially the African-American community, the Hispanic community and young people,” receive courtesy of taxpayers.

Needless to say, there are many problems with this grossly simplistic view of who gets government benefits and who pays for them.

It’s undoubtedly the case that a great many of the elderly still think of themselves as taxpayers even though they may not have actually paid any income taxes in years. Nor do they view themselves as receiving gifts in the form of Social Security and Medicare benefits. They believe they paid for these benefits from taxes during their working lives and would resent being characterized as moochers.

Another problem is that when Republicans talk about the rising share of income taxes paid by the wealthy, I think they are implicitly assuming that the government is still paying for all its spending with taxes. But it’s not; the federal government has run deficits since fiscal year 2002, to a large extent because of tax cuts. According to the Congressional Budget Office, lower revenues have been responsible for about half the increase in the national debt since 2001, about half of which resulted from legislated tax cuts and half from slower-than-expected growth.

Congressional Budget Office

Across-the-board tax cuts financed with deficits will necessarily raise the share of taxes paid by those with upper incomes. Consider this example. The government raises $10 in taxes and it is divided among three taxpayers. Ms. Poor pays $1 (10 percent), Ms. Middle pays $3 (30 percent), and Ms. Rich pays $6 (60 percent). Now the government gives everyone a $1 tax cut and its revenues fall to $7. Ms. Poor now pays nothing, Ms. Middle pays about the same percentage (29 percent), but Ms. Rich now pays 71 percent. Everyone received a tax cut, but the tax shares are now skewed much more toward the wealthy.

In a general sense, this is what has happened to the income tax and illustrates why it is possible for effective tax rates on everyone to fall and at the same time raise the share of taxes paid by the wealthy.

Article source: http://economix.blogs.nytimes.com/2012/11/27/tax-cuts-tax-rates-and-tax-shares/?partner=rss&emc=rss

Filed Under: Economy News Tagged With: expert contributors, health insurance, jack kemp

Economix Blog: Bruce Bartlett: How to Avoid Reinventing the Wheel on Tax Reform

January 24, 2012 by NewsMaker Leave a Comment

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

An extensive discussion of tax reform is likely to take place over the next couple of years because it’s necessary and long overdue and because both political parties have things they hope to get out of it. Taken together, these suggest that something might actually happen.

That’s the premise of my new book, “The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take” (published today by Simon Schuster).

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Like many inside-Washington policy debates, much of that involving tax reform is unintelligible except to those who understand the jargon, players, history and unstated assumptions that underlie it. For those interested in following the discussion, which is likely to be protracted, my book is intended as a primer on some of the basic issues and concepts that will inevitably be part of the tax debate.

One of the main points I make is that tax reform is not a new subject, and many issues likely to be in the forefront of the debate have already been pretty thoroughly analyzed in ways that are still relevant.

Here’s one good example: “Blueprints for Basic Tax Reform” is perhaps the most important tax study of the postwar era. It was published 35 years ago this month – in the last weeks of the Ford administration. For many years, it was difficult to find and known only to hard-core tax experts; fortunately, the Treasury Department has made it available on its Web site.

The “Blueprints” study is important because the fundamental debate on tax policy is between two opposing ideas about the tax base – that is, what is taxed.

Historically, the “liberal” idea has been based on a definition of income devised by the economists Robert M. Haig and Henry Simons. It consists of all consumption during a calendar year plus the change in net worth. Thus, it consists of everything a taxpayer takes out of the economy plus the additional amount he or she could have taken out without diminishing her or his net worth.

Under a Haig-Simons definition of income, unrealized capital gains would be taxed as ordinary income, homeowners would be taxed on the imputed rent they pay to themselves by virtue of, in effect, being landlords who rent to themselves, and workers would pay taxes on health and other benefits they receive from their employers over and above their cash wages, among other things.

Almost all discussion of tax policy and tax reform from a liberal point of view assumes that the Haig-Simons definition of income is the correct one. Anything that deviates from it is an unjustified tax loophole, often called a “tax expenditure.”

The contrary “conservative” view is that only consumption should be taxed. This can be done directly, such as through a retail sales tax or value-added tax, or indirectly by exempting all saving from taxation.

Think of it this way. There are only two things one can do with income – save it or consume it. If saving is not taxed, all taxes must necessarily fall on consumption. The idea of taxing only consumption is most associated with the work of the economists John Stuart Mill and Irving Fisher.

During most of the postwar era, virtually all tax reform discussion was premised on the Haig-Simons view, and the Mill-Fisher view was largely forgotten. The tax reform acts of 1969 and 1976 represented efforts by liberals to make the tax code conform as much as possible to their vision. There was essentially no conservative alternative, and both bills were signed into law by Republican presidents.

Treasury Secretary William E. Simon, who served from 1974 to 1977, was disturbed by the lack of a conservative vision of what an ideal tax system should look like, and he recruited the Princeton economist David Bradford to come to Washington and devise one.

“Blueprints” was the result. It proposed two ideal tax systems: one based on a liberal Haig-Simons definition of income and another based on the conservative idea of taxing only consumption.

The liberal alternative in Professor Bradford’s study was largely ignored, because most tax theorists already understood and accepted it. But the conservative option was received as a revelation by conservatives, many of whom didn’t know there was a coherent conservative philosophy of taxation.

Subsequently, the “Blueprints” outline formed the foundation of the flat tax, Fair Tax and just about every other comprehensive conservative tax reform plan.

The reason why the “Blueprints” study remains relevant is that both liberals and conservatives have lost touch with the basics that underpin their respective philosophies of taxation. That is because since the Tax Reform Act of 1986 virtually all tax debate has either been about raising taxes to reduce the deficit or cutting taxes to stimulate growth.

First principles of taxation have been absent or implied rather than stated forthrightly. It would improve the debate on tax reform if each side understood the basics of its own philosophy.

In particular, both have forgotten the importance of defining the tax base properly, and both emphasize the rate schedule far too much. The truth is that statutory tax rates are far less important, either for the economy or fairness, than either side understands.

One goal of my book is to remind people that much of the heavy lifting on tax reform has already been done. The “Blueprints” study is just one example.

Both parties would benefit from better understanding the history and basics of their own tax philosophy. It would both save time and increase the chances that a new tax reform would improve the tax code if they get up to speed before tax reform becomes a partisan political football.

It is not necessary to reinvent the wheel. Policy makers can learn a lot about where we ought to be going from tax reform efforts in the past and the insights of experts whose work is still relevant. And thanks to the Internet, it is easily available.

Article source: http://feeds.nytimes.com/click.phdo?i=802bc399abbf8f822e5b4be1aea7738b

Filed Under: Economy News Tagged With: bush administrations, jack kemp, simon schuster

Economix Blog: Bruce Bartlett: The True Federal Debt

January 3, 2012 by NewsMaker Leave a Comment

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the coming book “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

In our personal lives, we all understand that debts may take different forms. They aren’t limited only to credit cards or loans taken out from banks; they consist of various promises and financial obligations as well.

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These might include commitments to pay for a daughter’s wedding or a child’s graduate school education, to provide the down payment on a sibling’s house or to care for aged parents. While these debts may not show up on anyone’s formal balance sheet, families are well aware of them, and failure to live up to them can be very costly indeed.

So, too, with the federal government. The national debt, which is the object of almost obsessive attention these days, is like a bank loan. It is an important part of national indebtedness, but only a small part. The vast bulk of the true debt is in the form of commitments to pay future benefits to retired federal employees, veterans, and Social Security and Medicare beneficiaries.

These commitments are generally invisible because the federal government operates on a cash basis. The federal budget is concerned only with income and outgo between two points in time — from Oct. 1 to Sept. 30, the fiscal year. Promises to pay benefits in the future generally show up in the budget only when those benefits are actually paid.

For many years, it was almost impossible even to find a list of the federal government’s financial commitments.

In 1949, the Hoover Commission recommended that the government move toward accrual accounting, which corporations are required to use, and book the full cost of programs on an annual basis. It wasn’t until 1966 that Congress required the Treasury Department to publish the data.

But it was available only as an obscure mimeographed document, difficult to obtain, called the Statement of Liabilities and Other Financial Commitments of the United States Government, known only to budget experts.

In 1977, the General Accounting Office and the Treasury published the first consolidated financial statement of the United States government. It was limited in scope, and insufficient data existed to calculate many of the government’s assets and liabilities, but it was an important start to providing a complete picture of federal indebtedness.

The successor to the consolidated financial statement is now called the Financial Report of the United States Government. The edition for the 2011 fiscal year was published on Dec. 23 by the Treasury’s Financial Management Service to no fanfare.

The Obama administration, like previous administrations, had little interest in telling the American people that their debt problem was vastly worse than they thought. It buried the report on a day when most reporters were preparing for the holidays and unlikely to pore through a 254-page document filled with long columns of numbers punctuated with footnotes and accounting jargon.

Predictably, the financial report was ignored. Even The New York Times took no notice of it.

According to the report, the federal debt — simply the cumulative value of all past budget deficits less surpluses — was $10.2 trillion on Sept. 30. But the government also owed $5.8 trillion to federal employees and veterans. Social Security’s unfunded liability — promised benefits over expected Social Security revenues — was $9.2 trillion over the next 75 years, or about 1 percent of the gross domestic product. Medicare’s unfunded liability was $24.6 trillion, or 3 percent of G.D.P.

Altogether, the Treasury reckons the government’s total indebtedness at $51.3 trillion – five times the size of the national debt. This would be an unbearable burden if it had to be paid by the current generation out of current resources, for it approximately equals the entire net worth of American households.

But national debts, of course, will also be paid by future generations out of future output. Those generations will also inherit most of the assets of the current generation, from which future commitments can be financed. For example, future generations will inherit the Treasury’s bonds as well as the responsibility for paying interest on them.

Even so, the Treasury projects that within a generation the federal debt will rise to 100 percent of G.D.P. as future commitments become part of annual spending over and above projected revenues.

Financial Report of the United States Government

Although it is commonly believed that our fiscal problem is purely one of spending, the financial report shows that this is not necessarily the case. The really rapid growth of future spending is not for programs but for interest on the debt.

In other words, it would not be nearly enough just to balance the budget. The federal government would have to begin running a surplus immediately and do so continuously for the next 75 years to prevent the debt/G.D.P. ratio from rising.

Financial Report of the United States Government

The critical point is that interest on the debt is not just another government program that can be cut. It can be reduced only by running a budget surplus, selling assets to reduce principal or reducing the interest paid on the debt.

With interest rates at historical lows and the vast bulk of the debt in the form of short-term securities that roll over rapidly, the figures in the chart above are probably conservative. It is not hard to envision a situation in which interest on the debt rises more quickly than spending can be cut — a problem many European nations are in today.

It’s essential that we strive to overcome budgetary myopia. Our debts are manageable, but only if we take a long-run perspective.

Article source: http://feeds.nytimes.com/click.phdo?i=6cab290c8ddf534aab537bacae62b751

Filed Under: Economy News Tagged With: bush administrations, jack kemp, retired federal employees

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