Category: Equitablog

What kind of fiscal policy works best at the zero lower bound?

Posted on by Emilie Openchowski
A screen on the floor of the New York Stock Exchange shows the closing number for the Dow Jones industrial average.

When central banks can no longer push down short-term interest rates, what are macroeconomic policymakers to do? Policymakers and researchers had a wide-ranging debate about the kinds of unconventional monetary policy that could have been tried to boost growth in the years after U.S. interest rates hit zero back in December 2008. At the same time, fiscal policy—once regarded as unnecessary in an era of omnipotent central banks—made a comeback as the federal government passed a roughly $800 billion stimulus package.

The U.S. economy today is in its seventh year of recovery, and interest rates are on the rise. Yet another recession is inevitable, perhaps another powerful one. Among policymakers and researchers who favor fiscal stimulus, the relative merits of different kinds of stimulus when monetary policy hits the zero lower bound is still up for debate. Should a stimulus program focus more on direct government purchases, or should it favor transfers to households?

New research tries to unpack what kind of fiscal policy is most effective at the zero lower bound. In a recently released Equitable Growth working paper, Neil Mehrotra of Brown University and the Federal Reserve Bank of Minneapolis looks at the relative effectiveness of government transfers—say, a tax rebate—versus government purchases such as the construction of a new road. Mehrotra doesn’t directly answer the question at hand, but he does build a model of the economy and then figure out the conditions under which fiscal policy featuring these two kinds of stimulus are most effective.

What he finds (akin to what other models show) is that fiscal policy in general is most powerful when prices are “sticky,” meaning they don’t change quickly and conventional monetary policy is constrained. Mehrotra’s model shows that the effectiveness of transfer-stimulus programs—think tax breaks—depends on the relationship between household debt and access to credit. The more a decrease in household debt decreases the difference between the rates at which banks borrow and lend to households, the more effective transfer programs are at boosting growth. In other words, if allowing households to pay down debt by giving them government transfers ends up reducing the cost of borrowing, then the result is a bigger boost to economic growth.

This strong relationship between household debt and access to credit means that government transfers boost growth in two ways. The first is that households will spend a larger share of temporary income, which increases the boost in demand in the economy from transfers. The second is that a decline in borrowing costs increases household incomes since households will be spending less to get credit.

While both kinds of fiscal stimulus are effective when monetary policy is at the zero lower bound in Mehrotra’s model, the feedback between household debt and the cost of borrowing is key to understanding the choice between transfers and purchases. Mehrotra points to some research finding a weak relationship, but fully understanding this relationship is an important research question for the future.

We don’t know when the next recession will hit or if it’ll be anywhere near as debilitating as the last one. But we should try to better understand the most effective tools policymakers possess for the next time. Just in case.

Must-Read: Ezra Klein: Trump’s weak closing argument on health care — and why it matters

Posted on by Brad DeLong

Must-Read: Ezra Klein: Trump’s weak closing argument on health care — and why it matters: “President Trump’s closing argument was weak…

…“doesn’t include anything even remotely resembling an affirmative case for the actual bill House Republicans have to vote on.” This may be because Trump doesn’t actually understand the bill they’re voting on…. Lacking a persuasive case to make on the merits, Trump has defaulted to an unpersuasive case on the politics… telling Republicans that they’ll have “a political problem” if they don’t pass the AHCA…. At times, he’s resorted to explicit threats — “I’m gonna come after you”….

The American Health Care Act isn’t Obamacare…. The particular ways in which it is not Obamacare look worse, not better, for Republicans…. Trump, at 40 percent in the latest Gallup poll, is significantly less popular than Obama was when the Affordable Care Act passed. So his protective effect looks weaker…. The American Health Care Act, however, starts up in 2018… 14 million people will become uninsured that year…. You don’t need to be a political genius to intuit the chaos that will create….

By the time Obamacare passed, it was clearly unpopular, and it was clearly going to endanger vulnerable Democrats who voted for it. But it was also a bill Democrats believed in substantively, and many voted for it because they thought its passage would be worth the sacrifice of their seats. But GOP leadership is rushing legislation that has little enthusiastic support from stakeholders, policy experts, key Republican voices, or really anyone outside of Paul Ryan and Donald Trump…. When Trump instead appears before them and tells them that cynical political calculations are why they should pass an unpopular bill backed by an unpopular president that will cause a nightmarish amount of upheaval in an election year, it’s not the world’s most convincing case. Which isn’t to say the AHCA won’t pass tomorrow. Stranger things have happened…

Should-Read: Timothy Burke: Fighting for the Ancien Regime

Posted on by Brad DeLong

Should-Read: Timothy Burke: Fighting for the Ancien Regime: “We were… part of the system…

…The Establishment… not… a bad or shameful thing, but instead a very good thing that is now threatened…. Career diplomats at the State Department, lawyers working for large urban firms, surgeons working in major hospitals, financial executives working for banks, understood it. Many professors, non-profit community organization managers, actors, and others understood it poorly…. The manager of a local dance company in a Midwestern city who only makes $40,000 a year and is an African-American vegan lesbian with a BA from Reed is still linked to the Establishment. That dance company doesn’t exist without the infrastructure where small trickles of revenue flow from cities, states, and nations into such organizations, without the educated professionals who donate because they believe in the arts, without the dancers themselves who chase a life of meaning through art but who also want to get paid….

We… should have known we were defending institutions that we believed in against those who for some reason or another are dead set on destroying those institutions. That speaking from the center was not a sin or a crime…. Because we didn’t see our ties to the establishment as virtue and we didn’t understand that our forms of power were important for defending what we had already achieved… we were unready to wake up in the year 2016…. It will help even now if we recognize that this is part of what we’re doing: defending a structure of manners, of virtues, of practices, of expectations, of constraints and outcomes, against people who… don’t recognize that this structure is important for them….

We are the center, we are the norm, we are the majority…. Even people mistreated or excluded in relative terms by the systems which are now under attack have a better chance to make those systems function more inclusively and with greater justice than they would under the new order that is seeking to seize the high ground of the government, economy and civil society…

Will Somebody Please Tell Me Again Why the Federal Reserve Has Embarked on a Tightening Cycle?

Posted on by Brad DeLong
Real Gross Domestic Product Growth Personal Consumption Expenditures Excluding Food and Energy Chain Type Price Index FRED St Louis Fed

With 2017Q1 real GDP growth currently forecast at a 1.2% annual rate—down from 2.7% expected last December—it is worth pausing to remember that if that number comes true:

  • 4Q real GDP growth is: 2.0%/year
  • 8Q real GDP growth is: 1.9%/year

Maybe this is an economy in which slow productivity growth is constraining expansion. But if that is the case, where is the inflation? More likely this is the case in which overly-tight fiscal and monetary policy are constraining an economy that still has some significant amount of macroeconomic slack in it…

Plus: this is what you would expect from a central bank that regards 2.0%/year core PCE inflation as a ceiling not to be crossed, rather than as a central-tendency target…

Is an even larger pass-through business tax loophole destined to become part of the U.S. tax code?

Posted on by Emilie Openchowski
Federal tax forms on display at a U.S. Post Office.

Current conversations among academics and policymakers about corporate tax reform in the United States largely focus on the controversial border adjustment tax, projected revenue losses, and the distributional impacts of proposed federal tax reforms now under discussion in Washington, D.C. While it is critical to unpack these tax reform ideas, there’s another important ingredient to consider: pass-through businesses.

Pass-through businesses—such as S Corporations, Limited Liability Companies, Sole Proprietorships, and Partnerships—are firms whose income is not subject to the typical corporate income tax. Instead, their profits are “passed-through” to the owners of businesses and taxed on their individual income tax returns. Currently, this means that pass-through business income can be taxed up to the top individual marginal tax rate of 39.6 percent.

By organizing as a pass-through business as opposed to a traditional C Corporation, owners can gain a tax advantage, which can happen in two ways. First, they will face a lower rate if their personal income tax rate is lower than the corporate rate. But even if the personal rate isn’t lower, their ownership stake won’t face the capital gains tax in addition to corporate tax, which again gives them an advantage.

These advantages are important given that the number of pass-through firms has grown tremendously since the 1980s. (See Figure 1.) Over this same period, according to research that uses tax data from the U.S. Treasury Department, the business income accruing to pass-through businesses has also grown. In 1980, 21 percent of business income went to pass-through businesses, but by 2011, pass-throughs earned 54 percent of business income.

Figure 1

Pass-through firms clearly play a central role in the U.S. business milieu. But even still, there is significant ambiguity and disagreement about how Congress and the new Trump administration will handle any reforms to this part of the U.S. tax code. On one hand, Speaker of the House Paul Ryan (R-WI) has unveiled a plan that would cap the pass-through tax rate at 25 percent—though the top tax rate for individuals would be reduced to 30 percent. On the other hand, President Donald Trump’s tax agenda reduces the individual income tax rate to 33 percent and sets the corporate tax rate and the pass-through business tax rate at 15 percent.

As the Center on Budget and Policy Priorities and the Tax Policy Center both note, the gap between the top pass-through business rate and the top individual tax rate would, in all likelihood, encourage tax avoidance. In an example, Chuck Marr, Chye-Ching Huang, Brandon Debot, and Guillermo Herrera of the CBPP explain that business executives—a law firm partner for instance—could recategorize their high salaries as business income to exploit the lower pass-through tax rate, resulting in a large tax cut. To make matters worse, these changes to pass-through taxation would ultimately benefit only people at the very top of the U.S. income ladder. In the same study that used data from the Treasury Department, the researchers found that 69 percent of pass-through business income goes to the top 1 percent, dispelling the idea that middle-class small-business owners are the target population.

While there is still uncertainty about the fate of pass-through business taxation—and even corporate tax reform writ large in Congress this year—the growing concerns about both the Ryan and Trump plans’ inequitable effects can’t be ignored. To begin to address these issues, economist Kim Clausing of Reed College instead suggests harmonizing the taxation of different types of businesses. Specifically, she argues that the size of a business could be another requirement for garnering pass-through status. The Center for American Progress also put forward the idea of implementing mechanisms such as an entity-level tax for large pass-through businesses. Regardless of what the solution to the pass-through loophole may look like, it must help assure the economic health of the U.S. economy and Americans up and down the income ladder.

Must- and Should-Reads: March 21, 2017

Posted on by Brad DeLong

Interesting Reads:

How life experiences affect the views of U.S. monetary policymakers

Posted on by Emilie Openchowski
Federal Reserve Chair Janet Yellen answers a question during a news conference after the 2016 Federal Open Market Committee meeting in Washington in June 2016.

The minutes of meetings of the Federal Open Market Committee are full of considerations of the latest economic data and deliberations about economic models. Data are parsed and the stability of current trends is considered, but something very important that informs the decisions of committee members is never explicitly discussed: their life experiences. Monetary policymakers are often thought to be purely meritocratic, making decisions that conform with an objective model of the U.S. economy. But the world and times in which they grew up shape these people—ignoring that reality is harmful to good economic policymaking.

Consider inflation. A new research paper by Ulrike Malmendier of the University of California, Berkeley, and Stefan Nagel and Zhen Yan of the University of Michigan looks at how a member of the Fed is influenced by rates of inflation over his or her lifetime. The hypothesis of the paper—that policymakers are influenced by the times they live in—makes intuitive sense and has been offered by others. If a policymaker’s career started in an era of high inflation, then he or she might be more concerned about the inflation rate than a younger policymaker. Differences in concern about inflation could result in differences in monetary policy views.

Malmendier, Nagel, and Yan look at the voting record of Federal Open Market Committee members, as well as the transcripts of meetings available after 1993. In short, they find evidence that life experience matters. Inflation over a policymaker’s life affects not only his or her voting behavior in committee meetings, but also the tone of his or her speeches. Most importantly, past inflation seems to influence a policymaker’s view of future inflation. People who experience higher inflation tend to project higher inflation than Federal Reserve staff projections, and those who experience less inflation have lower projections.

It stands to reason that the life experiences of policymakers also influence their views of other future developments in the economy. Views on the other half of the Federal Reserve’s dual mandate—ensuring full employment in the economy—are probably influenced by policymakers’ experiences as well. But not only does the unemployment rate vary over time, it also varies by race and ethnicity. The unemployment rate for black Americans is consistently around two times the unemployment rate for white Americans. If experiences of inflation can have a lifelong impact, then being part of a group that has structurally higher unemployment rates seems very likely to have an influence on a policymaker’s view of unemployment.

In the past, the Federal Open Market Committee hasn’t paid much attention to the racial and ethnic differences in unemployment. Former Minneapolis Federal Reserve President Naryana Kocherlakota notes that throughout 2010, the inequality in unemployment wasn’t noted once during the committee’s meetings that year. Perhaps that lack of attention shouldn’t be surprising given the composition of the committee.

Running an analysis for racial differences on unemployment for Fed voters would be interesting, but we lack enough data. In the more than 100-year history of the Federal Reserve system, there have only been three African American members of the committee. Raphael Bostic will soon be the fourth member—and the first black Federal Reserve Bank president—when he becomes the president of the Federal Reserve Bank of Atlanta in June. The appointment came after the lack of diversity of the Federal Reserve was highlighted by members of Congress and the Fed Up coalition.

Life experience isn’t the sole determinant of policy decisions, but it’s an important component of the process. For an organization that has significant power over the U.S. economy, a lack of diversity at the Federal Reserve results in policy that can alter the lives of millions of Americans.

Does Supplemental Security Income inhibit success?

Posted on by Emilie Openchowski
Terry Work stands outside a store that accepts food stamps in Tennessee. Work’s 27-year-old deaf son recently was denied disability payments.

It’s been nearly 21 years since the federal Personal Responsibility and Work Opportunity Reconciliation Act—commonly known as welfare reform—was passed. Most of the debate about the legacy of the bill centers on the elimination of the Aid to Families with Dependent Children program and its replacement with Temporary Assistance to Needy Families. But the legislation also created new reforms to another cash assistance program, the Supplemental Security Income program. The reforms to SSI made it less likely that disabled children would continue to receive cash assistance in adulthood. One might think that reducing cash payments would help spur some workers into fully engaging with the labor market and replace lost SSI income with labor earnings. But new research casts doubt on this line of thinking.

Among the cash welfare assistance programs in place after the enactment of the 1996 welfare reform law, Supplemental Security Income is the largest, with expenditures more than double the level of the Temporary Assistance to Needy Families program as of 2013, according to the Congressional Budget Office. About $50 billion through SSI is allocated to 8 million recipients annually, including 1.3 million children.

In her paper, “Does Welfare Inhibit Success? The Long-Term Effects of Removing Low-Income Youth from the Disability Rolls,” University of Chicago economist Manasi Deshpande evaluates the effects of removing low-income youth with disabilities from Supplemental Security Income on their earnings and income earned in adulthood. Many children receiving this stipend through the Social Security Administration are diagnosed with such conditions as Attention Deficit Hyperactivity Disorder, speech delay, and autism spectrum disorder—any one of which can greatly affect their integration into the labor market later in life.

Yet for young adults to continue receiving these SSI benefits, they must requalify for the program when they reach the age of 18 by undergoing a medical examination to determine their ability to participate in the workforce. While almost no young adults nearing the age of 18 immediately before the cut off received a medical review, nearly 90 percent of them did receive one after their 18th birthday. Because people who turned 18 right before the deadline and those who did right after are very similar, this sudden change can tell us about the causal impact of the policy change.

Deshpande’s results show that previously eligible SSI recipients do increase their earnings after their 18th birthdays, yet their earnings do not make up for the loss of stable SSI income. Removing youth from this income-assistance program reduces their observed lifetime income and results in an increase in income volatility. Over the span of 16 years after their 18th birthdays, individuals removed from SSI lose $21,000 in “present discounted total observed” income—or a $21,000 decline in the value today of all future income. This represents a 20 percent decrease relative to those who are not removed from the program at age 18. Deshpande also finds that individuals move from a stable income to a much more volatile income stream.

Policymakers should take two key points away from this paper. First, the fact that increased labor-market earnings didn’t nearly make up for the loss of SSI cash support means that these workers face significant labor-market challenges. It seems very unlikely that the cash payments from SSI are a compelling reason these young adults lack significant labor earnings. Second, the increased volatility in overall income for young adults who lose SSI support means that the program was effectively providing economic security to disabled young adults.

Reducing young adults’ access to Supplemental Security Income might have succeeded in pushing some workers into the labor force and increasing their labor earnings. Yet Deshpande’s findings show that the tradeoff maybe be a reduction in lifetime overall income and more volatile income. Whether that tradeoff is worth it is something policymakers and the general public should decide.

Must-Read: Bob Christie: 380,000 Arizonans May Lose Medicaid

Posted on by Brad DeLong

Must-Read: Bob Christie: 380,000 Arizonans May Lose Medicaid: “The report looks at the patients who gained coverage under a Medicaid expansion pushed through in 2013 by former Gov. Jan Brewer…

…Brewer said in an interview earlier this week that “it weighs heavy on my heart” when she thinks of the current Republican plan to repeal and replace Obama’s law. “It just really affects our most vulnerable, our elderly, our disabled, our childless adults, our chronically mentally ill, our drug addicted,” she said of the potential elimination of coverage for the expansion population. “It will simply devastate their lives and the lives that surround them. Because they’re dealing with an issue which is very expensive to take care of as a family with no money.”…

Gov. Doug Ducey said earlier this week that he isn’t pleased with the current proposal. “I’ve said that I don’t want to see anybody have the rug pulled out from underneath them, and that’s what I’m going to be advocating,” he told reporters Tuesday. “I have concerns with the bill as its written today.” Ducey said he has the ear of the state’s congressional delegation and the new Secretary of Health and Human Services, Tom Price, and expects to see changes. He was on a call with White House officials talking about the health law on Tuesday. “I think you’re going to see a different bill if it does get out of the House, if it does get out of the Senate, than the bill you see today,” he said….

“I just want to let the world know I am 100 percent in favor” of the measure, Trump said at the White House…