I Have Been Outflanked

By A Red Mind in a Blue State:

As I posted before, if we are going to insist on burdening our children and grandchildren with more debt, the least we could do is build or repair some roads, or bridges, or help end our dependency on foreign oil by building more refineries or by slapping solar panels on every flat roof in America-- something that will help the next generation.

Anyone receiving this check should know what it is-- a welfare check drawn on our children's checking account.

Read the whole thing.

A Capital Idea

Thinking more about how to use fiscal policy as economic stimulus, I hold forth in the current issue of the Ripon Forum. Here's a teaser:

The agreement reached by the House and White House in January addressed two problems that the United States does not have.

First, the nation does not have an underconsumption problem. The personal saving rate hovers around zero. The government’s budget has been in surplus in only four of the last 35 years. The nation has run current account deficits with the rest of the world for the last 15 years. If we are looking for additional economic activity, consumption is a poor choice.

Second, we do not have an underinvestment problem in the private sector. Interest rates have been very low by historical standards, and the Federal Reserve intervened immediately to lower them even further. With or without additional tax-based incentives, corporations have plenty of access to cheap credit to expand their capital stocks.

Where our country does have an underinvestment problem is in our public infrastructure. The failed levees of New Orleans. The collapsed bridge in Minneapolis. Those are but two recent examples of an area where the federal government is falling down on the job. Regrettably, they are not the only examples. In 2005, the American Society of Civil Engineers released a report card in which it estimated that $1.6 trillion would be required over a five-year period to restore the nation’s physical infrastructure to good condition.

Because infrastructure projects are in many cases public goods or natural monopolies that can be provided more efficiently with government regulation or implementation, the government should bear responsibility for them. Looking ahead, the country faces potential bottlenecks in network infrastructures in broadband and alternative energy that could be added to the ASCE report’s recommendations.

Read the whole thing.

In Praise of Senator Bob Corker (R-TN)

It's nice to have some company in my anti-stimulus writings. Here is the Senator's op-ed:

The Political Stimulus Package
Op-ed by U.S. Sen. Bob Corker
February 6, 2008

Today, in classrooms and homes across our state, Tennessee children are looking to the adults in their lives — their parents, teachers, coaches and Sunday school teachers — to teach them life principles and help prepare them for the future.

I hope, at times, the adults these children look up to are their elected officials in Washington, but I hope they aren't looking this week.

Because instead of dealing with the fundamental issues that have led to our country's current economic ills, the U.S. Congress is on a fast track to pass a so-called economic stimulus package to be paid for — entirely — by those same schoolchildren, and their children.

Don't get me wrong, I'm happy for Tennesseans who will receive checks if the stimulus package becomes law, but our citizens should know that this is not an economic stimulus package — it's a political stimulus package designed to generate election-year public favor. I think our citizens are more intelligent than that. I will not support it.

My heart goes out to people who find themselves in financial situations that in many cases are beyond their control.

And I'm always happy when I see Americans receive refunds from the federal government, but I find something extremely inappropriate about a deficit-ridden federal government borrowing money from our grandchildren and sprinkling it across the country for a short-term fix that will do little, if anything, to jump-start our troubled economy.

I think all of us know our country has been fiscally reckless over the past several years and that generations after us will be dealing with the brunt of our actions.

I'm a strong believer in low taxes and creating a structure that people can count on to move ahead and to make investments, but in support of these policies we must get spending under control. My generation will never pay the $150 billion cost of this package. Our children and grandchildren will.

Our country would be better served if we took the time to discuss and debate solutions that positively impact and help grow our economy over the long haul — creating more and better-paying jobs here in the United States. Unfortunately, folks may take their refunds and buy products that are in large part made overseas, and the money borrowed to finance this political stimulus package in many cases will be loaned to us by foreign countries. It just doesn't add up.

In Washington, we always seem to find an excuse to spend money we don't have. Correcting this means being honest about our future obligations and having the courage to make difficult decisions that may not be politically convenient.

Our country has been built on sacrifice. It's been built on generations before us making tough decisions and sacrifices to benefit future generations. I hope in the very near future Congress will have the courage to do the same and act in the best long-term interest of our country.

For those of you who are wondering, this is what a fiscal conservative sounds like in elected office. He should have more company on Capitol Hill. The Senate passed the political stimulus bill by a vote of 81 - 16.

Public Infrastructure and Fiscal Stimulus

It doesn't happen very often, but I agree with much of what Paul Krugman writes in his column today, "A Long Story." Here's the key part:

Meanwhile, Congress and the Bush administration have reached agreement on a much-hyped stimulus package. But the package, while probably better than nothing, is unlikely to make a noticeable dent in the problem — in part because the insistence of the administration and Senate Republicans on blocking precisely the measures, such as expanded unemployment insurance and food stamps, that are most likely to be effective.

Still, by January the White House will have a new occupant. If the slump is still going on, which is likely, this will offer a chance to consider other, more effective measures.

In particular, now would be a good time to think about the possibility of going beyond tax cuts and rebate checks, and stimulating the economy with some much-needed public investment — say, in repairing the country’s crumbling infrastructure.

The usual rap against public spending as a form of economic stimulus is that it takes too long to get going — that by the time the money starts flowing, the recession is already over. But if this turns out to be a prolonged slump, which seems likely, that won’t be a problem.

On the radio show yesterday, I argued that one month of job loss and an unemployment rate of 5 percent was a little early for extended unemployment insurance benefits. Initial UI claims have jumped in the past few weeks--we've got several months before that wave of entrants will exhaust their benefits. And these benefits can be made available as needed.

Krugman's last paragraph is a good counterpoint to those who argue that public infrastructure projects are not feasible for stimulus, if his thesis about the length of the downturn is correct. But as I argued in The Washington Post last month, the reason to do the infrastructure projects is that they are needed. The reason to accelerate their timing is that in an economic downturn, we can do them more cheaply. Quoting from that op-ed:

The federal government has a critical role in maintaining and developing public infrastructure, whether in transportation, telecommunications or energy transmission projects. A sensible capital budget would include a prioritized list of projects that need attention. Some would be slated for this year, some for 2009 and so on, over the useful lives of the projects. When economic growth falters, the government would be in a position to move some of the projects from later years into the present year.

This approach to counter-cyclical fiscal policy has several advantages. Perhaps most obvious is that it forces the government to establish priorities for capital projects. It reduces overall expenditures by doing more of the work in times of economic slack, when costs are lower. It also abides by pay-go rules, since projects moved up to 2008 need not be done in 2009.

I've got another column in the works that maps this out in more detail. See Mark Thoma for additional commentary.

Debt in the White House

Greg Mankiw posts an e-mail from a colleague in the White House regarding "Debt and the Real Threat." Some elements are correct (like the need to scale debt or deficit figures by GDP and the challenges presented by future entitlement programs). One element is not correct, and it is reflected in a couple of instances regarding whether it is appropriate to include the Treasury bonds in the Social Security trust fund in the measure of total indebtedness or whether the right deficit measure is the unified deficit (which includes the Social Security surplus) or the on-budget deficit (which excludes it). Here's the key excerpt:

2. gross debt vs. debt held by the public - (this is the hard part) What we care about is how much the US Government owes to the American public and the rest of the world (meaning to those who buy Treasury bonds). This is commonly known as "debt held by the public". To this amount, the Chairman adds debt that one part
of the government owes to another part of the government, to get what budgeters call "gross federal debt". If you use funds from your savings account to pay down a credit card, you have decreased your "debt held by the public". For comparison, if you borrow from your savings account and put it into your checking account, and leave in your savings account an IOU from you to you, Chairman Conrad's metric would say that you have "increased your gross debt." This is economically meaningless.

Not so fast. The difference between Total Debt and Debt held by the Public is the bonds held in the Social Security trust fund. Those bonds represent a claim on future tax revenues just like bonds held directly by the public. The taxpayers in 2025 will not care whether the additional income taxes they are paying are to pay off an American citizen who holds a Treasury bond or the Social Security beneficiaries who have presented a bond from the trust fund to the Treasury for redemption so that they can collect benefits. It's the same to them--it should be the same to us.

The only way the trust fund is equivalent to "using funds from your savings account to pay down a credit card" is if the Social Security surplus is used to repurchase Debt from the Public as an equivalent amount of special issue debt is placed in the trust fund. Debt held by the Public should go down, but Total Debt should stay constant if we are operating the trust fund as it was intended.

In 2025, we get the reverse. As beneficiaries make their claims, bonds come out of the trust fund. Either taxes go up, or new debt must be issued to the public to generate funds to pay off those bonds. Debt held by the Public goes up, but Total Debt stays the same. In both cases, it is Total Debt that is telling you accurately about the size of the liabilities being passed on to future generations. Debt not currently held by the public will eventually be held by the public.

The honest budget policy is to target the on-budget deficit or Total Debt/GDP. Anything else leaves you open to the charge that you are spending the Social Security surplus, raiding the Social Security trust fund, etc. You can ignore the debt held in the trust fund only if you don't intend to honor its redemption. Let's not go there.

For more on these issues, see these earlier posts: "Chairman Ben and the Long-Term Budget" and "Which Budget Deficit to Target?"

Samwick Media Watch

I've been invited to be a guest on Warren Olney's "To the Point" show today on Public Radio International. Here's the teaser:

The Public, the Economy and the Federal 'Fiscal Stimulus'

With the stock market falling as they went to the polls, Super Tuesday voters were thinking about the economy. But those rebates many Americans may be counting on are now tied up in Congress. Thursday, on To the Point, will the rebates be fair? Will the "fiscal stimulus" come in time to help avoid a recession?

You can listen online or on one of these fine stations.

UPDATE: A fun show, until I stumbled my way through this line of reasoning. Jason Furman was also on the segment, and he made his points very well.

Your Essential Budget Reading

If you read only one thing about President Bush's FY 2009 budget, read this post by Brad DeLong and heed its conclusion:

We want to run a budget that is in surplus during boom, in deficit during recession, that borrows in order to fund investments that benefit the future, and that runs surpluses and pays down debt in order to fund future expenditures that benefit today's taxpayers. The Bushies have not done that.

Some day, there will be enough of a critical mass of people both inside and outside Washington to make sure that elected officials adhere to this. But that day is sadly not close, even with a change in the Administration next year.

But don't read just one post. Bookmark Stan Collender's blog for a free education on the way the government spends its money. This post points out a number of "off-the-wall" assumptions that were made in order to get the talking point, "surplus by 2012."

Your next stop is the Committee for a Responsible Federal Budget. They've released a first look on the budget and some projections based on a more realistic alternative baseline for the budget.

I posted about most of these issues last week based on the State of the Union Address.

The Whiner of First Resort

Via Mark Thoma, this piece in the Financial Times by Ricardo Hausmann is quite good. Here's the big finish:

The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth. Faster bank recapitalisation, fiscal investment stimulus and international co-ordination should be first on the ­policy agenda.

Read the whole thing.

Budget Policy in the SOTU

Let's continue with the budget policy theme, but let's also move on from the discussion of the $150 billion of new deficit spending that the House leaders and the President proposed last week. In the text of the State of the Union address, the word "budget" appears only in the following paragraph:

Just as we trust Americans with their own money, we need to earn their trust by spending their tax dollars wisely. Next week, I'll send you a budget that terminates or substantially reduces 151 wasteful or bloated programs, totaling more than $18 billion. The budget that I will submit will keep America on track for a surplus in 2012. American families have to balance their budgets; so should their government.

I had three reactions, none of them particularly favorable.

1) While I'm likely to be pleased at the details of the $18 billion in expenditure reductions, let's not confuse that with significant spending reduction. Total (defense and nondefense) discretionary outlays in 2008 are $1,089 billion. [See Table 3-7 here and keep the file open.] So even if Social Security, Medicare, and Medicaid (the bulk of the mandatory outlays, see Table 3-3 above) are held harmless, this is a reduction of 18/1089 = 1.7%.

2) While I would be happier in 2012 with a surplus than without one, this is another one of those incredibly weak budget targets. (The earlier one was to "cut the deficit in half in 5 years.") First, it includes the Social Security surplus in 2012, projected by CBO to be about $45 billion in that year. (See Tables 4-5 and 3-3 above.) An honest budget--one that would not be "raiding" the Social Security Trust Fund--would exclude the off-budget surplus and have the entitlement programs in long-term balance. Second, the economic forecast on which this projection is based assumes positive annual growth in real GDP between now and then. [See Table 2-4 above.] So if we are experiencing positive economic growth over this period, why is it that only in 2012 do we reach the number zero? Should we not be running surpluses in every year in which growth is above its long-term average? See this earlier post for further discussion of these points.

3) I can't be 100% sure on this one, but it appears from Slide 11 in these slides accompanying CBO Director Peter Orszag's testimony on the budget outlook from January 23 that if modifications to the baseline are made which are consistent with other things the President has said, we don't come anywhere close to budget balance in 2012. The modifications made are: to exented all expiring tax provisions, make reforms to the alternative minimum tax, to assume that the number of military personnel in the war on terrorism falls to 75,000 by 2013, and to assume regular appropriations grow at the rate of nominal GDP. The first one is critical, since the President also insisted that "Unless Congress acts, most of the tax relief we've delivered over the past seven years will be taken away." So the projections for surplus in 2012 are inconsistent with other policy statements the President would has made.

This Is Rich

From the Real Time Economics Blog:

Huckabee and Paulson Spar over Stimulus Plan
Republican presidential hopeful Mike Huckabee accused President Bush and the House of Representatives of missing the point with their new emergency anti-recession plan, including $100 billion in payments to individuals and $50 billion in tax breaks to get businesses to invest.

“The problem I have is that what we are really doing is borrowing about $150 billion from the Chinese, which is where this money has got to end up coming from,” Huckabee said on CNN’s “Late Edition” Sunday.

“Then we’re going to give rebates to taxpayers, and that’s great. - I’m glad,” Huckabee continued. “But what will most of them do with it? They’re going to buy things that were imported from China.”

“So I have to ask,” he added, “whose economy is being stimulated the most?”

The former Arkansas governor said a better plan would be to provide an infusion of federal dollars to repair and replace crumbling bridges, airports and other infrastructure.

Huckabee has a reasonable argument, to a point. If the purpose of the stimulus package is to prevent GDP growth from turning negative by boosting consumption, then the import share of the incremental consumption (relative to total consumption) has to be considered. And as I've argued before, he is right in noting that this deficit spending on simple consumption when public infrastructure might be a more sensible addition to the budget.

A Better Way to Deal With Downturns

A wise man in Washington once told me that in politics, you can't beat something with nothing. In that spirit, I continue the anti-fiscal-stimulus rant with a Sunday op-ed in The Washington Post, available a day early online. Welcome to Washington Post readers. For those new to the blog, please take a look at some of the other posts categorized in the sidebar on the right side of the page when you are done with this post.

The constructive idea in the op-ed is to consider the backlog of public infrastructure projects needing attention, prioritize them, schedule them in over a multiyear horizon, include their costs in budget projections, and then move them forward in time if the economy weakens and prices go down to make them cheaper to do sooner rather than later. Note well the parts I put in bold.

The imperative to enact a fiscal stimulus bill (the motives for which I discuss in the op-ed) kicked up such an election year hurricane that even the usual watchdogs seemed to get swept up in it. Consider:

1) Fed Chairman Ben Bernanke's testimony to the House Budget Committee on January 17. The last two paragraphs address the topic of fiscal stimulus. He provides the right context and the usual warnings, but the Representatives could have interpreted all of this as a yellow light. The red light would have been if he said, "It would be unwise and imprudent to enact a fiscal stimulus bill until we get some data on whether the large monetary stimulus has had the intended effect." On Capitol Hill, yellow lights mean speed up, not slow down.

2) The Blue Dog Democrats. Here's how it looked on January 15, and then hardly a whimper out of them in the following week.

3) Policy Experts. The buzzwords of "timely, targeted, and temporary" were spoon fed to the policy makers by Doug Elmendorf and Jason Furman earlier this month with this primer from the Hamilton Project. I don't fault them for doing it, either. Once the battle over whether we should "do something" was lost, it was very reassuring to have focused the debate around these three principles. I just hope that policy makers work as hard on the conclusion of that report --Building a Better Long-run Policy--as they did on the short-term recommendations.

4) Think Tanks. Consider this statement from the Committee for a Responsible Federal Budget, released January 22 as the stimulus package was about to be announced. It says:

If a stimulus package were paid for in the out-years, we would certainly be pleased. However, we believe that such a requirement is likely to derail the process of trying to assemble an effective stimulus package.

That's a flashing yellow light. And, unfortunately, this part of the next paragraph is likely to be ignored:

Although the Committee would accept using increased deficits as a tool to spur the economy in the short-run, we urge the President and the Congress to take the next important step: A long-term budget plan that addresses entitlements, tax reform, and spending restraint.

We would all like to see that. We could get it, too, if we made a commitment to hold our elected officials accountable for it.

It's Not a Stimulus, It's Deficit Spending

Commentary based on this recent post aired this evening on NPR's marketplace. The teaser:

The proposal for the $150 billion stimulus package has Washington basking in bipartisanship. But commentator Andrew Samwick says the pricetag for all that collegiality might be too high.

Enjoy!

The Splurge

Tom Toles "says" it very well.

Len Burman Pokes a Finger in the Eye of the Stimulus

I enjoyed Len Burman's op-ed in today's New York Times for reaching this conclusion, in "Make the Tax Cuts Work:"

There’s bipartisan agreement that something along these lines should be done, but the president has also argued for an extension of his tax cuts, now scheduled to expire at the end of 2010. This idea has met with less support. It would accomplish nothing in the short run, and most of the benefits would go to the very rich — the group least likely to spend a tax windfall.

But if they were repealed in a year, the Bush tax cuts could spur a burst of economic activity in 2008. If people knew that their tax rates were going up next year, they’d work to make sure that more of their income is taxed at this year’s lower rates. Investors would likewise have a giant incentive to cash out their capital gains now to avoid paying higher taxes later. In 1986, stock sales doubled as taxpayers rushed to avoid the capital gains tax rate increase scheduled for 1987. If people pour their stock gains into yachts and fast cars, that’s pure fiscal stimulus.

The money involved could be considerable. Capital gains in 2007 were something like $700 billion, representing well over $1 trillion in asset sales. It looks as if gains will be much lower in 2008, but a looming tax increase could easily spur an additional $500 billion in sales. If only 20 percent of that translated into extra spending, we’d have as much or more short-term stimulus as we could get from the package Congress and the president are considering.

Best of all, this is one stimulus proposal that would reduce the deficit — the single largest threat to the economy’s long-term health. And that long-term benefit wouldn’t depend on our getting the timing and amount of stimulus right, something policymakers are notoriously inept at.

UPDATE: Len responds to some of his fan mail at the TaxVox blog.

Fiscal Stimulus? We Don't Need No ...

All of the recent discussion of fiscal stimulus is very disappointing to an economist and deficit hawk like me. I'll ask two questions in this post and highlight them in bold.

Over the past few years, cheap credit and imprudent lending policies by some bad actors generated excessive consumption and investment in the real estate sector. This boosted economic activity beyond the level that would have prevailed with policies that we now wish, with hindsight, had been in place. That level of economic activity is the starting point for discussion of a recession, defined as two consecutive quarters of negative growth in real GDP. If we acknowledge that bad loans fueled the activity, why is it now a widely shared policy objective to maintain that level of activity?

The buzzwords for the stimulus discussion are that whatever the government does, it should be "timely, targeted, and temporary." Much of the discussion centers on a tax rebate, which would primarily boost consumption. Treasury Secretary Paulson is quoted as follows:

Asked if tax rebates to individuals - reportedly one of the cornerstones to the stimulus plan - is an effective course, Paulson said, “the evidence from [the] 2001 [rebate] was that people spent between a third and two-thirds of the money and spent it quickly, so the lesson here is we need to move quickly and do something in enough size.”

Forget the "stimulus" label, this is merely additional deficit spending. There is no discussion of repaying the money through higher taxes in the near term. Based on the President's remarks this morning, the deficit bill will be for about $150 billion. So this proposal is just another $150 billion of some future generations' resources that we will be using for our own consumption today. Why are we entitled to pass them this additional debt?

My views of how the government should conduct fiscal policy are presented here. We should expect some cyclical widening of the deficit with no change in policy. But if we have no intention of balancing the budget over the business cycle (i.e., of running an additional $150 billion surplus when the economy turns around), then we have no business pushing this deficit bill forward now.

UPDATE: Bruce Bartlett provides some background on tax rebates at the WSJ online and concludes:

A new rebate probably won't do much harm. But anyone who thinks it will prevent a recession -- if one is actually in the pipeline, which is not at all certain -- is dreaming. It's an insult to Keynes even to call a tax rebate Keynesian economics. It should be called "feel good economics" because its only real effect is to make politicians feel good about themselves and buy re-election with the public purse.

Why Stop There?

PGL at Angry Bear, reacting to the previous post, asks why stop with criticizing Governor Romney for his pandering? It's a reasonable question, but it has the standard economic answer--diminishing marginal returns to blogging about other people's mistakes.

Thinking a bit more about it, candidates deserve less slack when they make statements that are at odds with the personas they project in the campaign. Governor Romney campaigns specifically on his experience in the private sector and its contribution to economic growth. When he panders based on moving government resources to the aid of one particular constituency, that should be identified for what it is.

PGL then takes Governor Huckabee to task for, in the context of a question about lagging economic growth, advocating energy independence without acknowledging that any path to energy independence (e.g., a carbon tax) will reduce economic well-being in the near term. PGL is absolutely right. It's another answer that doesn't add up. But lots of people say silly things about energy independence, and this one didn't grab my attention.

McCain's answer to the question was better (some reasonably straight talk about the jobs not coming back and the need for retraining opportunities). Giuliani's was awful. Thompson's answer defended Giuliani's awful answer. Ron Paul's was probably the best. Read the whole transcript here--this is the first question to each candidate. What I liked about Paul's answer was that, in the course of his rambling answer, he said:

The recession has been predictable. We just don't know exactly when it will come.

If you do the wrong thing, it's going to last for a long time. The boom period comes when they just pour out easy credit and it teaches people to do the wrong things. There's a lot of malinvestment, debt that goes in the wrong direction, consumers who do the wrong things, and businessmen who do the wrong thing.

So we have to attack this and understand the importance of Austrian theory of the business cycle. If you don't, we're going to continue to do this and the longer you delay the recession, the worse the recession is, and we've delayed a serious recession for a long time.

The housing market's already in depression and a lot of people are hurt and the standing of living in this country is going down. Look at what's happening to the dollar.

And what is being offered by the Federal Reserve and Treasury and everybody in Washington? Lower interest rates. Well, lower interest rates is the problem. Artificially low interest rates is the artificial stimulus which causes the bubble, which allows the inevitable recession to come.

So what we need to do is deal with monetary policy and not pretend that artificial stimulus by more spending is going to help. That won't do you one bit of good.

It isn't perfect, but it's pretty good. To be clear, more government spending will mechanically prop up the rate of GDP growth. As PGL notes, given the way we do budgeting in this country, that means our kids will be paying (through a higher government debt burden) for our desire to avoid a slowdown in GDP growth. Why are we entitled to their money to clean up our housing mess?

CBO Joins the Blogosphere

As if being a CBO Director weren't time consuming enough, Peter Orszag has joined the blogosphere:

What are you likely to read on this blog? First, you will learn more about CBO — the types of work we do, how we do it, and more about the outstanding analysts we have. For example, when we come out with a new report or important cost estimate, I may write a bit about the analytical substance and also introduce you to the key staff who took the lead in the analysis. Second, CBO’s research and cost estimates are often discussed extensively in the media and elsewhere — and not surprisingly, from time to time misunderstandings or misinterpretations arise about some analysis we have done. In those kinds of situations, I will use the blog to further explain our work and address possible or potential misunderstanding. Finally, when it seems appropriate, I will use the blog to link our work to relevant outside research from academic or other institutions that may shed additional light on the challenging issues the Congress is working to address.

CBO's website was already very helpful. This makes it even better. Bookmark it today.

Looking Ahead to Today's GOP Debate

I've got the DVR all set for today's Republican candidates debate. John Harwood of CNBC and the Wall Street Journal has his preview here. As this debate is about the economy, he is looking for three big issues: taxes, spending, and trade.

I don't blog much about trade. I'm a free trader. Economic exchange by mutual consent is one of the things that ties the world together in a positive way. In the absence of some identifiable non-pecuniary externality, Republicans have no business restricting free trade.

I've gone off on the Republicans for their budget policy a number of times. (Here's a good one.) If any of these candidates are going to sway me on budget policy, they are going to have to do two things. First, do not say that tax cuts pay for themselves. Second, say that you are going to balance the budget without reference to a Constitutional amendment. And I'll have to believe them. That's a tall order, given what we've seen so far.

But the most important issues of budget policy are going to come in the form of budget priorities. I hope they all get asked the question of SCHIP funding vs. war funding. That will tell us something about their leadership potential. For very good commentary, see this post at SnowDahlia.

Social Security in the Democratic Candidates' Debate

There was a portion of the debate on Wednesday night focused on Social Security, and, in particular, raising the maximum taxable earnings as a way to collect more revenue and improve projected solvency. You can watch the segment here. The issue at hand is whether solvency can be restored by removing the cap on taxable earnings, so that all earnings are subject to the 12.4% combined (employer plus employee) tax for Social Security. This is currently the case for the 2.9% combined payroll tax for Medicare Part A.

There are two ways in which this might be done. In the first, workers who pay this additional tax would have the earnings on which they were taxed included in the calculation of their subsequent benefits. In the second, workers who pay this additional tax would not have these incremental earnings included in the calculation of their benefits. The Office of the Chief Actuary at the Social Security Administration has made it very easy to assess the effect of changes of this sort on projected solvency. The first case is shown here, and the second case is shown here.

In the first case, the system can pay full benefits for almost all of the 75-year projection period. You can see this in two ways. First, the second to last column is -0.10, meaning that over the 75-year period, full benefits could be paid entirely if this provision were enacted and the combined payroll tax rate were increased (on the old base) from 12.4 to 12.5 percent. Second, you can see that the new path of the trust fund crosses zero just at the end of the projection period.

In the second case, the system can pay full benefits for the full 75-year projection period. The second to last column is now +0.28, and the trust fund has a balance of about 3.5 years worth of benefits at the end of the period. Is this enough to say that the system is solvent? I don't think so. Even in this case, the balance in the trust fund is declining and will cross zero at some point after the 75-year projection period ends. The last column of numbers shows that annual deficits are equal to almost 3 percent of (the old base) taxable payroll. More would need to be done here to ensure that the trust fund is never projected to cross zero.

It is not clear which provision the candidates meant, but I am going to assert that it was the second one. If the problem is that there is not enough money to pay currently projected benefits, then it seems odd to now increase the claims that will be made on the system by the very wealthiest recipients. (Very roughly, if I pay these taxes on another million dollars of earnings each year over the course of a career, my benefits will go up by $150,000 per year during retirement.)

This is a large increase in top marginal tax rates on incomes where the supply-side response could be relevant. When Jeff, Maya, and I were developing the LMS plan, we decided that we didn't want to do this all on the revenue side and didn't want to get all of our revenue via increases in the cap. Instead, we borrowed the idea from the Diamond-Orszag plan to lift the cap to a point where 90% of all earnings were taxed (with no incremental benefits for the additional earnings subject to taxation). This was roughly the amount subject to the tax at the time of the last big reform in 1983. (Since a lot of the increase in average earnings has been at the high end, over time, a lower share of total earnings have been below the cap.) We also added an increase in the payroll tax rate for 1.5 percent of (the old base) taxable payroll, and made up the rest of the financial shortfall with changes on the benefit side.

More importantly, we required that all new revenues go into a system of personal accounts. This was my deal-breaker. If we were to raise this much additional revenue, without channeling it to personal accounts, we would simply be compounding a budget problem that is already severe. When the government runs a Social Security surplus, it treats those monies as available to spend on things other than Social Security. We know this because it targets the unified budget deficit, and has done so pretty routinely over the last several decades. (See here and here.) If these government inflows are matched by offsetting outflows (into the personal accounts), then there is no danger that they will be used to finance current expenditures, and the additional revenues will actually raise saving rates to help prefund future obligations.

Rove and Mythology

From the WSJ editorial with Paul Gigot, in which Karl Rove announced his departure from his current position as Deputy Chief of Staff at the White House:

"I'm a myth. There's the Mark of Rove," he says, with a bemused air. "I read about some of the things I'm supposed to have done, and I have to try not to laugh." He says the real target is Mr. Bush, whom many Democrats have never accepted as a legitimate president and "never will."

When I was at CEA, I was in perhaps a dozen meetings where Karl Rove was also present. I never spoke to him personally--I was more in the role of observer at those meetings. I took two things away from those meetings. First, when Rove was in the room, you had better be on mission. He would have no hesitancy at all in asking anyone the direct question, "What have you done to advance the President's agenda today?" He'd be expecting a lengthy and comprehensive reply, and you'd feel like a moron if you didn't have one for him. Second, and it's worth keeping in mind that I would only be at such a meeting if much of the content were economics (as opposed to national security or some other policy), I never heard him take the wrong side of an argument based on the economics.

That said, there is quite a bit of myth in Rove's interview. Gigot's editorial comments around the quotes from Rove are right on the money:

Mr. Rove also makes a spirited defense of this president's policy legacy, sometimes more convincingly than others. On foreign affairs, he predicts that at least two parts of the Bush Doctrine will live on: The policy that if you harbor a terrorist, you are as culpable as the terrorist; and pre-emption. "There may be a debate about degree," he says, "but it's going to be hard for any president to reverse that."

He's less persuasive on Medicare, where he insists that market reforms and health savings accounts are building a "critical mass" of popular support that will make them unrepealable. Yet Democrats are even now trying to kill Medicare Advantage, blocked only by the promise of a veto. If Mrs. Clinton wins in 2008, the Medicare drug expansion may prove to have been all spending and no reform.

He also insists that Social Security reform was worth the failed effort, and that Mr. Bush's ideas will be adopted inevitably by some future president. I ask if, given Mr. Bush's falling approval ratings in 2005 due to Iraq, he shouldn't have pushed for something less ambitious. Not a chance. "You cannot advance on the fronts you want to advance if you're playing mini-ball," he says, once again sounding like Mr. Bush.

Medicare Part D was a betrayal of conservatism. Conservatives are supposed to see fiscal responsibility as their friend, precisely because the need to pay for what the government does should constrain the overall size of that government. This Administration let go of fiscal responsibility early in its first term and has been undermined by its absence ever since. (With the current budget target, weak as it is, we are essentially in a pay-as-you-go situation, so it's not quite so bad.)

The President's attempt at Social Security reform was the first casualty. The reason to reform Social Security is its long-term fiscal imbalance. The President understood that, even if his rhetoric was at times hyperbolic or misleading. The President lost all credibility on using that as a motivation for reform when he decided that the short-term non-entitlement budget imbalances "don't matter" and when he passed a Medicare expansion whose unfunded obligations were larger than those in Social Security. That was contradiction number one. (Read more here.)

Contradiction number two came from the President's statements that he wanted to "strengthen" the system. It is reasonable to believe that strengthening an entitlement program means putting more resources into it. There was no plan put forward by the Administration, even in the form of a trial balloon, that tried to strengthen the system with new resources. That doesn't mean the proposals were bad ideas, but it does mean that the honest description of what his plans do is to pare back projected future spending so that it is balanced by projected future revenues. The President's intentions here were both conservative and (to use Rove's word) ambitious. They just weren't presented coherently, and so they got nowhere.

This notion that the President's legacy on matters of fiscal policy--which will be written by historians (and bloggers!) that Rove can't spin--will be anything but a severe and harsh critique is what I consider the Myth of Rove.