Sunday, November 23, 2014

America’s Exceptional Fiscal Conservatism

WASHINGTON, DC – In most countries, to be “fiscally conservative” means to worry a great deal about the budget deficit and debt levels – and to push these issues to the top of the policy agenda. In many eurozone countries today, “fiscal conservatives” are a powerful group, insisting on the need to boost government revenue while bringing spending under control. In Great Britain, too, leading Conservatives have recently proved willing to raise taxes and attempted to limit future spending.

The United States is very different in this respect. There, leading politicians who choose to call themselves “fiscal conservatives” – such as Paul Ryan, now the Republican Party’s presumptive vice-presidential nominee to run alongside presidential candidate Mitt Romney in November’s election – care more about cutting taxes, regardless of the effect on the federal deficit and total outstanding debt. Why do US fiscal conservatives care so little about government debt, relative to their counterparts in other countries?

It has not always been this way. For example, in 1960, President Dwight D. Eisenhower’s advisers suggested that he should cut taxes in order to pave the way for his vice president, Richard Nixon, to be elected to the presidency. Eisenhower declined, partly because he did not particularly like or trust Nixon, but mostly because he thought it was important to hand over a more nearly balanced budget to his successor.

The framework for US macroeconomic policy changed dramatically when the international monetary system broke down in 1971. The US could no longer maintain a fixed exchange rate between the dollar and gold – the cornerstone of the postwar Bretton Woods system. The arrangement collapsed because the US did not want to tighten monetary policy and run more restrictive fiscal policy: keeping US voters happy was understandably more important to President Nixon than maintaining a global system of fixed exchange rates.

Ironically, however, rather than undermining the predominant international role of the US dollar, the end of Bretton Woods actually boosted its use around the world. Much has been written, and many hands wrung, about the dollar’s decline over the last four decades, but the fact remains that holdings of US dollar assets by foreigners today are vastly greater than they were in 1971.

This turns out to be a mixed blessing, because it has allowed the US to become less careful about its fiscal accounts. Foreigners now hold roughly half of all US federal government debt, and they are willing to hold it when it yields a very low return in dollars (and even when the dollar depreciates).

In fact, whenever the world looks unstable, investors want to hold more dollar assets – even when the US is the cause of the instability. When big US banks are in trouble or Americans are having another debilitating political fight over their public finances, global investors scramble into US Treasuries. Last year’s congressional showdown over the federal debt ceiling may have cost the US its AAA sovereign rating with Standard & Poor’s, but the federal government’s borrowing costs are actually lower now than they were then.

What has America done with this opportunity – arguably the lowest-cost funding in the history of humankind? Not much, in terms of productive investment, strengthening education, or maintaining essential infrastructure. But the US has done a great deal in terms of adopting tax cuts that boost consumption relative to income and lower government revenue relative to expenditure. This is the lasting legacy of the “temporary” tax cuts adopted by George W. Bush’s administration in the early 2000’s.

And Americans have shifted greatly toward political philosophies – on the right and on the left – that regard public debt merely as a distraction. Or, as former vice president Dick Cheney put it, “Reagan taught us that deficits do not matter” – meaning that Ronald Reagan cut taxes, ran bigger deficits, and did not suffer any adverse political consequences.

Ryan and members of the Tea Party wing of the Republican Party undoubtedly want to cut the size of the federal government, and they have articulated plans to do this over several decades. But, in the near term, what they promise is primarily tax cuts: their entire practical program is front-loaded in that direction. The calculation is that this will prove politically popular (probably true) while making it easier to implement spending cuts down the road (less obvious). The vulnerability caused by higher public debt over the next few decades is simply ignored.

For example, Ryan supported George W. Bush’s spending spree. He also supports maintaining defense spending at or near its current level – resisting the cuts that were put in place under the Budget Control Act of 2011.

The assumption here – unstated and highly questionable – is that the US will be able to sell an unlimited amount of government debt at low interest rates for the foreseeable future. There is no other country in the world where fiscal conservatives would want to be associated with such a high-stakes gamble.

Read more from our "Fiscal Cliff Notes" Focal Point.

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    1. CommentedMoritz G€d1g

      Stop feeding the Troll (Gary Marshall)! Do not reply. If it one day works vote him down. He has the time and stamina to repeat himself over and over again. He will not respond to reason.

    2. CommentedJohn Wiederspan

      Mr. Marshall, your personal attacks (Joseph Stieglitz=rotten socialist innards) do nothing to aid in the rebuttal of a position. All too often certainty blinds us to other viewpoints. The only time a person learns (grows intellectually) is when they are confronted with something entirely new or something that contradicts what they already believe to be true. They see they need to change their frame of reference. After being involved in economics for almost 40 years, the one thing I know is that economics (like politics )will always exist and there will always be disagreements on how it should be conducted.

        CommentedGary Marshall

        Hello John,

        What am I to learn or how do I grow intellectually from economic principles that are currently being refuted by the collapse of governments in Europe, in Asia, and perhaps soon in the US?

        What reasonable argument can be made for the inordinate squander of funds stripped from the hardworking individuals that earned them and doubtless would have employed them to far better purpose?

        Were I back in the 1500 and 1600's would I have grown intellectually by mastering the erroneous geocentric theory?

        This whole rotten enterprise of government squander is coming to a remorseless end. A new form of economics is coming that shall clear all that overgrown and suffocating brush, rendering the soils of economics once again fertile.

        If all these laurelled economics thinkers have is a defense of an obsolete, ridiculous, and derelict theory, then what lesson is there save futility?


    3. CommentedJohn Wiederspan

      Hello Mr. Marshall, All viewers of this web site should be grateful you saw fit to reveal the path of economic wisdom to the former chief economist of the IMF. It must be intellectually comfortable; knowing with certainty your understanding of economics is comprehensive and true. With the irrefutable economic counterpoint to Mr. Johnson, he may be tempted to leave the profession. It is obvious your academic/private sector education/experience lends itself to an advisory position in any public or private organization. Their gain would be our loss.

        CommentedGary Marshall

        Hello John,

        I will just add that the accountants obtain a a near perfect grasp of the proof and its implications within minutes of seeing it. The comments of one fellow in particular have kept me going these last 12 years.

        The economists never do get it.


        CommentedGary Marshall

        Hello John,

        Thanks for the comment. I am usually told I am nuts, and I am still expecting you to fire with a hell of a nasty barrage.

        I see you are retired, which means you have far more years in this business than most of us. Since this is so, your comment means a lot more to me than you realize.

        Its easy to convince young people there is a far better way of doing things. But it is difficult to show those well grounded in the knowledge. Thanks for letting me know there is hope.

        I used to attend economics conferences and give my little speeches, with the few attending looking on with the most bizarre looks. I don't bother anymore. But the effort did elicit a solid proof.

        Gary Marshall

    4. CommentedGary Marshall

      Hello Mr. Johnson,

      The US Government, any government is in deficit to the whole of its expenditures. Why? Because it doesn't generate any revenues of its own. It merely hands the bill for its public expenditures to the taxpayer, or borrows in the name of the taxpayer.

      So it does not really matter what the portion funded by taxes is and what portion is funded by borrowing. Its all deficit.

      Obviously, you have no idea that tax cuts will lessen the penalty placed upon worthy economic activity, spurring more. George Bush Jr. performed this miracle as did Ronald Reagan. Government revenues soared. Unfortunately so did government expenditures. But the way is clear.

      When you get rid of your narrow and erroneous beliefs regarding government, its finances, and its ability to aid the economy with wise investments, perhaps then you will not appear to be as obtuse as you do.


        CommentedGary Marshall

        Hello James,

        I shall ask the same questions.

        Is Solyndra us? Is the rotten NYPD us? Is the shabby state of our public school system us? Are the bailout packages for so many Wall Street bankers us? How about all those subsidies to every politicians' favored friend, relative and business; Are they us too?

        Does this plundering of the people for the absolute worst in public services enable commerce to succeed and enrich the nation?

        I may not understand economics very well, but if the worst of human beings can strip hard working people of their fruits to enrich, not the commonweal, but the noxious government and their parasitic friends with near impunity, then who really does?

        Is this government by the people for the people?

        Try saying something intelligent, would you?


        CommentedJames Edwards

        Taxes are the forced confiscation of other peoples' money
        The Government is us."

        The government is created by the people for the whole society. Roads, bridges and all forms of transportation that enables commerce to succeed, funding of public schools and defense comes from the very tax you despise and unfortunately you seem to be a libertarian with no understanding of economics.

        CommentedGary Marshall

        Hello Jimmy,

        Taxes are the forced confiscation of other peoples' money.

        "The Government is us."

        Really. Is Solyndra us? Is the rotten NYPD us? Is the shabby state of our public school system us? Are the bailout packages for so many Wall Street bankers us? How about all those subsidies to every politicians' favored friend, relative and business; Are they us too?

        Of course, adding 20 million private sector jobs is a complete failure. Having less people working today than 4 years ago is a massive success. That's how any complete moron sees it. Congrats to you. Your parents must be so proud of their son.

        Maybe next week you can argue the virtues of socialism to all those fine European governments that thrive under big, squandering, corrupt government.

        The public school system proves its worth once again.


        Commentedjimmy rousseau

        Oh gary, so much nonsense. The government doesn't generate any revenues? Then what are taxes? Your whole view of government is skewed because you forget that we have government of and for and by- the people. The government is us.
        Bush and Reagan never had success with trickle down theories, it remains truly 'voodoo' economics
        Get your facts straight

    5. Commentedmohamed elnoby ali ahmed

      To retain the voters are happy that the principles of Nixon is like a drug that should wake them community and knows what must be done and we will be in trouble bigger and bigger, but why all this and roads ahead is clear and in spite of the dollar's decline, but it is required can be classified these things contrastingas classified by former Federal Reserve governor in things inconsistent perplexing puzzle

    6. CommentedGeoff Robinson

      Has anyone heard of Hauser's Law? No matter what tax rates have been since WWII, federal tax collection has stayed between a narrow band, usually around 19%. Higher in booms. Lower in recessions.

      So without that bit of information, we get the assumption that higher tax rates give you higher tax revenue automatically. And that assumption is no slam dunk.

      Spending restraint is what brings budgets into balance. And that's pretty much it. My guess is that those who feel that taxes should be raised to balance the budget are also the people who feel that government has the first priority and should be given priority over the monetary needs of citizens. Extra revenue that comes in gets spent just as fast, so it won't produce lower deficits.

        CommentedGary Marshall

        Hello James,

        Would you please show me spending restraint by government when times are good!

        How about a tax cut? Would not lessening the penalty on productive and worthy economic activity not move the economy in the right direction?


        CommentedJames Edwards

        You may be correct that spending restraint will bring the budget into balance however when the economy is in a downturn especially a depression, it is counter-cyclical and makes it much worse in the short term. Every policy maker know something needs to be done however each have argued that their approach is right and everyone else is wrong. In a good times we can undertake spending restraint without harming the growth process.

        CommentedGary Marshall

        I have Geoff. And many of your present economists, devoted to socialist principles and blind to everything else, will reject it without sense or reason.


    7. CommentedPaul A. Myers

      Additional comment:

      Today money flows out of Europe and other regions to the US as a "haven." When Europe stabilizes and other regions develop deeper pools of credible liquidity, then the US bond market becomes less attractive.

      Once international investors start to diversify out of the US and into other credible international investment alternatives, pressure on US interest rates may intensify much faster than many "wise men" now think.

      As the rest of the world gets healthier, the US will get sicker!

    8. CommentedMark Pitts

      There is little difference between the two parties when it comes to opposing higher taxes.

      In 2010 Obama and the Dems actively supported a 2-year extension of the Bush tax cuts. Now Obama favors a further extension, except for the “rich.”

      But the tax on the rich is all but irrelevant when it comes to taming the deficit. For example, the revenue from the Buffet Rule would only cover ¼ to ½ % of the deficit each year.

    9. CommentedPaul A. Myers

      This is the most perceptive column on the real political dynamic underlying America's current political paradigm that I have read this election season. A large proportion of American voters simply hate taxes and almost all of the political contributions flowing to Republicans come from wealthy people who have a single issue: lower taxes, particularly on investment income. Elected Republicans, rain or shine, year-in and year-out, vote with single-minded determination against taxes. It is the meta-issue of the modern Republican party.

      From 1980 to 2008, 85 percent of the net additions to the US public debt were made by Republican administrations. The Reagan-Bush era over 12 years 1980-1993 more than tripled US national debt.

      If Romney wins, where does this go? What will happen?

      I remember back to the Carter years when the interest rate on the US government long bond skyrocketed and the price went into a free fall. The Congress insisted on throwing Carter's Fed chairman Warrent Miller overboard--that weekend! Then they went for Volcker. They wanted the biggest gun they could find--right now.

      When the interest rate of the US debt starts to go up, first Congress will bring the Fed chairman for a good chewing. But once that is seen as futile by the markets, then political retreat will turn to panic and then pell mell retreat.

      The Congress of the United States will be seen to have lost all control over the public finances of the United States.

      Most likely Congress will raise taxes and cut spending in a matter of weeks if not days. No program will be spared, few oxen will not be gored.

      The American people will have gotten what they have voted for. And that is what Romney is offering.

    10. CommentedProcyon Mukherjee

      I think the script is pretty repetitive, America has chosen to take a path that will allow higher levels of debt to be sustained for protracted period of time and the rates would continue to be at an all time low. I am not aware of any economic theory that could vindicate such a denouement that higher access to money and need of money (liquidity) could continue to draw a downward pressure on interest rates for any amount of time; interest is the reward for not parting with money and the liquidity preference precludes the inherent belief that interest rates would increase at some point of time.

      Simon has covered the more important part of the puzzle, which is investment, that is grossly lacking and lack of investment at high levels of liquidity is a clear indication that preference for speculative outlets of capital takes precedence over locking it in fixed assets, specially at a time when no clear signal is visible on the direction the economy could be headed in the near or medium term. By tax breaks, or by increasing the money supply, precious little had been achieved to increase sustained consumption and/or the velocity of money; the correlation of velocity and unemployment rate is pretty straight forward, with high correlation coefficient.

      The last part, we need to see is the conservative approach to government, where government is reduced to a ‘host’ and almost every activity performed by it is brought under the scanner and then activities and functions are cherry-picked to allow private participation. This approach has become the current fad of our times, with many consequences, unintended included.

      Procyon Mukherjee

    11. Commentedjames durante

      Does it really matter? Whether we increase taxes slightly and cut spending significantly or cut taxes significantly and "drown government in a bathtub," the end result is the same" more for the rich and less for the poor. Can we all just agree that that is precisely the purpose of a capitalist economy? At least we would gain a little clarity.

      "Yea, for capitalism; we're all on the side of the rich!" Let's start from that premise and all the bromides, Clinton/Obama moderate for the rich and Romney/Ryan wackos for the rich, will make more sense.

      What is true of party politics in the U.S. is true of economists. As Gore Vidla noted, "There is one political party in this country, and that is the party of money. It has two branches, the Republicans and the Democrats, the chief difference between which is that the Democrats are better at concealing their scorn for the average man."

    12. CommentedJohn Wiederspan

      I consider myself a fiscal conservative and do not support cutting taxes. The label has been hijacked by the Grover Norquist crowd, but that doesn't make it correct. Since the late 70's, I have advocated action on the spending side to minimize deficits and growing debt. Pete Peterson, Concord Coalition, entitlement "reform" study groups, Simpson-Boles, and the Band plays on. Contrary to the Supply-Side Myth, there has never been proof that lowering tax rates (after you pass 40%) stimulates anything. "Starve the beast", "Trickle Down", Pamper the "Job Creators"; please, the voting public doesn't like paying taxes, any cuts in programs that effect them and they claim to dislike the growing debt. Corrective fiscal actions will not be taken because the majority of voters would not approve.

    13. CommentedStephen Stanley

      This is actually a counter-argument to the "I did it myself" crowd. It is government spending that enables the entrepreneur to develop his company. Name it, education, the Internet, roads, much of technology, public funding at minimum developed it if not outright built it. This comes to the good old fashioned idea of investment. Giving money to insolvent banks is not investment, building roads is. Tax cuts for the rich is not investment in the future, providing kids a world-class education is. Investing in Solyndra is not a good investment of public funds, research into better solar cells is. The legacy of tax cuts is the US falling behind its competition and crumbling of our hard-won infrastructure.

        CommentedJ. S. Renau

        Regardless of the public and private infrastructure in place, there is a crucial element in this recent "You didn't do that" meme that is discounted by progressives -- the notion of risk. The entrepreneur bears the enterprise risk alone, not government. This notion of risk should garner more respect and acknowledgement, because without it, there is no private enterprise, no job creation, and ultimately, no prosperity.

    14. CommentedA. T.

      Responsibility typically means doing less of what you enjoy. Fiscal responsibility, therefore, must mean buying fewer things that you enjoy buying. The government 'diet' proposed by Ryan, on the other hand, is no greens and all bacon. It is, indeed, "exceptional" to call it responsible or conservative.