Must-Read: Jason Furman and Greg Leiserson: The real cost of the Republican tax cuts: “The House Republican plan will itself be incomplete…
…Sending cuts or tax increases will almost certainly still be required to pay for it. Analyses that do not account for those spending cuts or tax increases, whether they occur in the near term or in the longer term, obscure…
Should-Read: Wladimir Woytinsky (1952): Lerner’s Economics of Employment: A Review: “The first and most obvious objection-conforming with the idea of Functional Finance as a supplement to the ordinary budget-is…
…that, as long as inflationary and deflationary forces are in balance with each other, the government’s revenues must be likewise in balance with outlays. The balanced budget is the simplest way for ensuring the desired equilibrium. It implies that each dollar the government spends for its operation must be extracted from national income by means of taxation.
Lerner ridicules this procedure, but its only alternative is a financial system in which the government prints all the money it needs and-as a completely separate operation-destroys an equal amount of the purchasing power of individuals. The latter purpose could be achieved, theoretically, by confiscation, or demolition of houses, or setting fire to selected properties. Few people will agree that such measures make more sense than the orthodox procedure.
Lerner is right when he objects to worshipping a balanced budget and “sound” currency, but his arguments are very thin when-by means of repetition-he tries to persuade his readers that the best way to run public finance is to print notes-or occasionally borrow-when money is needed for public establishments, and destroy the purchasing power of individuals when his model indicates that there is too much fat in the community.
Lerner’s argument would win if it were free from such iconoclastic outbursts as the assertion that “taxes should never (Lerner’s italics) be imposed for the sake of the tax revenues,” that money “could be provided by an appropriate printing job”, etc….
When explaining the need for central bank independence, economists and central bankers often turn to the metaphor of Odysseus and the Sirens. In order to hear the song of the Sirens without being drawn toward certain doom, the legendary Greek hero had his crew tie him to the ship’s mast, plug their ears with wax, and sail past the Sirens. Just as Odysseus saved himself and his crew from shipwreck by creating a binding commitment, so too can governments, according to this metaphor, protect themselves from the temptation of goosing inflation to boost economic growth by giving central banks independence.
As President Donald Trump seems ready to announce his nominee for chair of the Federal Reserve System this week, it may be time to revisit this metaphor. It was crafted at a time and place when the fear around inflation was that it would get too high, a fear confirmed by the high inflation of the late 1970s. Being concerned that elected officials would overheat the economy to win reelection and accidentally smash the U.S. economy against the rocks made more sense when the Sirens’ song seemed to have worked in the recent past. More recently, however, some members of Congress have raised concerns that monetary policy has been too loose despite inflation running consistently below the Federal Reserve’s inflation target of 2 percent. Today, the bias of elected officials isn’t always toward running the economy too hot.
The Federal Reserve has to balance a number of concerns as it navigates changes in the U.S. economy. A more apt metaphor today could be Odysseus’s attempt to sail between the riptide monsters Scylla and Charybdis—forces in the economy that would require tighter policy and those that necessitate looser policy. The issue is that sometimes the central bank might have to veer further toward one creature in order to get away from the other and safely continue on. This ability to steer the ship is the very independence of the Federal Reserve to use the federal funds rate and other policy tools to hit congressional mandates.
The Fed, in theory, is allowed to use the federal funds rate however it likes to fulfill its mandate. But some recent legislation—most recently the Financial CHOICE Act—would try to reduce the amount of leeway the Federal Reserve has when it comes to setting interest rates. The bill would require the central bank to compare its policy rate—the federal funds rate—to the proscribed rate arrived at according to the so-called Taylor rule. That rule, or more accurately a version of that rule, calculates an interest-rate level based on how far inflation is from the central bank’s target, how far current Gross Domestic Product is from its potential, and the equilibrium interest rate. While not explicitly ordering the Fed to follow a Taylor rule, the constant justification of why current policy is deviating from the rule is likely to have a similar effect.
Such a rule is trying to create consistence in the Fed’s “reaction function” based on past reactions to changes in GDP and inflation. The problem is that a Taylor rule assumes that unobservable variables such as potential GDP or the natural rate of interest can be readily determined and agreed upon by all the members of the Federal Open Markets Committee, who set the federal funds rate—a presumption that may not occur in reality.
Furthermore, these unobservable variables might change over time. Think, for example, of all the research on the decline in the equilibrium interest rate. If the Taylor rule had been in place for quite some time, it’s not certain the underlying variables to determine the natural rate of interest would have stayed put. A “reaction-function rule” is akin to the passengers on Odysseus’s ship specifying exactly when and how hard the captain and crew should row based on previous trips between Scylla and Charybdis, without considering whether the currents have changed over the years.
The general public and their elected officials are not simply passengers on a ship. They have a right and an obligation to set the role of the Federal Reserve because the central bank has tremendous influence over the health of the U.S. economy, and it should be bound to hit targets and goals that are set in a democratic manner. But there is room for sensible delegation—not fixing the navigational points regardless of economic conditions. Making sure the delegated powers and goals are well-defined and that the central bank uses its powers to actually meet those goals seems the proper role for elected policymakers.
Should-Read: Steven Rosenthal: Foreigners Would Win Big from A Corporate Tax Cut: “The Trump Administration and congressional Republican leaders (the Big Six) have proposed a $70 billion-a-year tax cut for foreign investors…
…[Of] outstanding U.S. corporate stock… foreigners now own about 35 percent… would reap about 35 percent of the benefits of the cut in corporate taxes, which translates to around $70 billion a year.
[In] the long run… four conditions that must be met for the corporate tax cut to increase wages: U.S. corporate tax rates must attract lots of new investment capital. Corporations must use the money to purchase a lot of new equipment for their U.S. businesses. All that new investment must make U.S. workers much more productive. And, finally, that productivity growth must translate into far higher wages…. The length of the short run may be stretched… [as] a stronger dollar… discourage[s the] capital inflows from abroad that would finance new investments….
In the short run the Big Six is proposing to cut taxes for investments that have already been made, providing a windfall to existing investors, including foreign shareholders…. The recently passed Senate Budget Resolution would allow Congress to borrow $1.5 trillion to pay for coming tax cuts. Future generations of U.S. taxpayers will bear the burden of that shortfall, which could prove especially onerous on top of the $10 trillion of deficits CBO projects under current law….
Promising big corporate tax cuts, with large windfalls for foreigners, is a lot easier than enacting real tax reform. But unless Congress changes the Big Six plan, Americans will pay a big price for a corporate tax cut—much of which would be a windfall for foreign investors…
Should-Read: Heather Boushey: Equitable Growth in Conversation: Kimberly A. Clausing: “Boushey: One of the arguments that you hear time and time again for why Congress needs to reduce the corporate tax rate is that doing so will boost investment in overall economic growth…
…Tell us a little bit about how strongly investment would react to a reduction in the tax rate at the corporate side?
Clausing: On the corporate side, there are a couple of considerations to keep in mind. One is that the distribution of corporate income within the tax base is highly skewed, with about three-quarters of it due to excess profits or rents. What are excess profits or rents? Well, there’s a normal return of capital, which enables a company to pay the interest costs or the equity costs of raising capital, but any income earned above that normal return is an excess profit.
For those firms that have a lot of excess profits—the Googles and Apples and General Electrics of the world—they are earning more than we normally expect for business activity. It’s not clear that giving them a windfall is going to lead to new investments. They already have more than enough after-tax profits from which to make investments.
If policymakers believe more after-tax profits are the way to suddenly spur investment, we might ask why it hasn’t already happened, since these kinds of firms are sitting on piles of cash. It’s unclear that giving them a bigger pile of cash is going to spur investment. We need companies to have desirable investments. And often what’s stopping them is not the absence of funds, but the absence of viable investments they want to make. If policymakers really think after-tax profits are what’s needed to drive investment, then we should already be in an investment nirvana, since lately we’ve had much higher profits than we’ve ever had in the past 50 years of our history.
Boushey: And yet our investment rate is quite low right now.
Clausing: Right. That’s why I don’t think after-tax profits are the answer…
At the Milken Review: When Globalization is Public Enemy Number One: The first 30 years after World War II saw the recovery and reintegration of the world economy (the “Thirty Glorious Years,” in the words of French economist Jean Fourastié). Yet after a troubled decade — one in which oil shocks, inflation, near-depression and asset bubbles temporarily left us demoralized — the subsequent 33 years (1984-2007) of perky growth and stable prices were even more impressive… Read MOAR at Milken Review
Should-Read: The extremely sharp David Glasner is very sick and tired of John Taylor’s incoherences and evasions. In my experience, Glasner’s net view of Taylor is about average of the private views of monetary economists worth respecting and listening to:
David Glasner: Larry Summers v. John Taylor: No Contest: “‘If a Fed Funds rate higher than the rate set for the past three years would have led, as the Taylor rule implies, to lower inflation…
…than we experienced, following the Taylor rule would have meant disregarding the Fed’s own inflation target. How is that consistent with a rules-based policy?
This is such an obvious point–and I am hardly the only one to have made it–that Taylor’s continuing failure to respond to it is simply inexcusable. In his apologetics for the Taylor rule and for legislation introduced (no doubt with his blessing and active assistance) by various Republican critics of Fed policy… Taylor repeatedly insists that the point… is just to require the Fed to state a rule… [and] when deviating from its own stated rule, to provide Congress with a rationale…. But if Taylor wants the Fed to be more candid and transparent in defending its own decisions about monetary policy, it would be only fitting and proper for Taylor, as an aspiring Fed Chairman, to be more forthcoming than he has yet been about the obvious, and rather scary, implications of following the Taylor Rule during the period since 2003…
Must-Read: Practically everything that the Democrats have been saying about the insanity of the Republicans (and that much of the media has been ignoring), said here by Republican ex-Speaker John Boehner:
Tim Alberta: John Boehner Unchained: “After railing against the defund strategy, however, Boehner surveyed his conference and realized…
…it was a fight many members wanted—and some needed. Yielding, he joined them in the trenches, abandoning his obligations of governance in hopes of strengthening his standing in the party. But the 17-day shutdown proved costly. Watching as Republicans got butchered in nationwide polling, the speaker finally called a meeting to inform members that they would vote to reopen the government and raise the debt ceiling. “I get a standing ovation,” Boehner says. “I’m thinking, ‘This place is irrational’”…
Must-Read: Jason Furman: @jasonfurman on Twitter: “THREAD. New results from Penn-Wharton Budget Model show wage effects of corporate tax changes…
…Under the default parameters cutting the corporate rate LOWERS wages. A well-designed plan a modest positive. You can try your own options….
I am looking at two plans. (1) Cut in the corporate rate to 20% without other changes, which is what CEA modeled. (2) Cut corp rate to 20%, has permanent expensing, disallows interest deductions, and broadens the base—House plan likely less pro-growth. For comparability to CEA’s “very conservative” $4,000 I am showing the %age change in labor income applied to 2016 household wages. I am showing all of the results for every combination of parameters in the PWBM—with a thicker line for their default assumptions.
Here is what it looks like for the 20% rate cut:
The default case is a wage decline but could be plus or minus ~$1,000. The +$1,000 case assumes the United States is a small open economy with complete capital mobility and no supernormal returns, FWIW….
With sensible/permanent design, modest wage increases in most scenarios. House plan likely much less well designed: maybe temporary/more limited expensing, maintain some interest deduction, & less base broadening….
Lazear, Kotlikoff, @MichaelRStrain, @aparnamath, @taxfoundation, Mankiw toy example all below CEA’s “very conservative” lower bound…. Debt weighs on the economy increasingly over time. Not sure what to make of jump in first yr, OLG models not designed to answer very SR Qs…. Medium/long results similar to past Treasury/JCT. These models capture complexity missing in simple finger exercises (eg, much I expensed already, EMTR up on those when statutory rate down)…
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