Sunday, November 23, 2014

Mitt Romney and America’s Four Deficits

BERKELEY – The United States is beset by four deficits: a fiscal deficit, a jobs deficit, a deficit in public investment, and an opportunity deficit. The budget proposals put forward by presidential candidate Mitt Romney and his running mate, Paul Ryan, could reduce the fiscal deficit, but would exacerbate the other three.

To be sure, Romney and Ryan have failed to provide specifics about how they would reduce the fiscal deficit, relying on “trust me” assertions. But the overarching direction of their proposals is clear: more tax cuts, disproportionately benefiting those at the top, coupled with significantly lower non-defense discretionary spending, disproportionately hurting everybody else – and weakening the economy’s growth prospects.

Despite 30 months of private-sector job growth, the US still confronts a large jobs deficit. The unemployment rate remains more than two percentage points above the “normal” rate (when the economy is operating near capacity). Moreover, the labor-force participation rate remains near historic lows.

More than 11 million additional jobs are needed to return the US to its pre-recession employment level. At the current pace of recovery, that is more than eight years away. In the meantime, persistent high unemployment reduces the economy’s growth potential by robbing today’s workers of skills and experience.

When weak aggregate demand causes the economy to operate far below its potential, cuts in government spending enlarge the jobs deficit. Indeed, in his recent speech in Jackson Hole, Wyoming, US Federal Reserve Chairman Ben Bernanke warned that such cuts significantly inhibit job creation.

Without revealing which programs he would reduce, Romney promises to slash federal spending by more than $500 billion in 2016, capping it at 20% of GDP thereafter. He also promises an immediate 5% cut in non-defense discretionary spending in 2013, on top of the huge cuts already scheduled to take effect. And he has ruled out additional temporary fiscal measures aimed at job creation, like President Barack Obama’s proposals for additional grants to states and additional infrastructure spending.

Romney acknowledges that large spending cuts, along with the scheduled expiration of tax cuts at the end of this year, could throw the economy back into recession in 2013. But he vows to steer the economy from the fiscal cliff by extending the tax cuts enacted under George W. Bush, doubling down with a further 20% across-the-board cut in income-tax rates and cutting the corporate rate from 35% to 25%.

With the possible exception of the extension of the Bush-era tax cuts, these changes would take considerable time to implement. Even when enacted, their near-term effects on job creation would be minimal. An across-the-board reduction in tax rates performs poorly in terms of budgetary effectiveness (the number of jobs created per dollar of foregone revenue). Payroll-tax relief and spending on programs like food stamps and unemployment compensation are much more effective.

Romney overstates his tax proposals’ long-term growth effects as well. Reducing individual tax rates and taxes on savings and investment at best fosters modest increases in employment, work effort, and income. Despite the Bush-era tax cuts, the 2001-2007 expansion was the worst of the post-war period in terms of investment, employment, wage, and GDP growth. Job creation and growth were much stronger following President Bill Clinton’s tax increases in the 1990’s.

Moreover, if all of Romney’s additional tax cuts were financed in a revenue-neutral way, as he promises, only the composition of taxes would change; the overall tax share of GDP would not. There is no evidence that this would significantly boost growth, as Romney claims.

Based on what Romney has told us, we can conclude that his plan would exacerbate the public-investment deficit as well. Romney’s vow to cap federal spending at 20% of GDP by 2016, while maintaining defense spending at 4% of GDP and leaving both Social Security and Medicare unchanged for those 55 or older, implies exempting more than 50% of government spending from cuts for the next decade. So, to hit the 20% cap, spending on everything else would have to be slashed by an average of roughly 40% by 2016 and 57% by 2022.

Everything else includes government investments in three major areas on which growth and high-wage jobs depend: education, infrastructure, and research. These areas account for less than 8% of federal spending, and their share has been declining steadily. Under Romney, it would plummet to new lows.

Everything else also includes spending on programs that help low-income families, like food stamps, student grants, and Medicaid. The Center on Budget and Policy Priorities finds that almost two-thirds of the Ryan budget’s spending cuts would come from such programs. Romney offers few specifics, but simple arithmetic shows that his plan would require even deeper cuts in these programs than Ryan’s plan would.

Meanwhile, Romney’s plan would actually increase taxes on middle-income families. His plan would pay for lower income-tax rates by eliminating tax deductions like those for charitable giving and mortgages, while maintaining tax preferences for saving and investment. But there are not enough tax breaks for the rich to cover another 20% reduction in their income-tax rate. That is why the nonpartisan Tax Policy Center found that Romney’s plan would cut overall taxes for households with incomes above $200,000, but would require an average annual tax increase of at least $2,000 for households with incomes between $100,000 and $200,000.

Romney’s budget plan would also make the federal tax-and-transfer system considerably less progressive, thereby worsening income inequality, which is already at its highest level since the Great Depression. Rising income inequality fuels a growing opportunity deficit for children born into poor and middle-income families, reflected in disparities in educational attainment by family background, and a decline in intergenerational mobility. Under Romney, the opportunity deficit would widen, robbing the country of future talent and productivity.

Romney has provided few details about his deficit-reduction plan. But, based on what he has revealed, we know that it would increase the jobs deficit, the investment deficit, and the opportunity deficit, with negative consequences for future growth and prosperity.

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    1. CommentedPartha Sarkar

      While a lot of media coverage and political rhetoric has been exhausted on Public debt (fiscal deficit), what is more important for the reduction of other three deficits mentioned in the article is the high private debt and continued deleveraging by private companies and households since the financial crisis. This trend is sure to continue in near long term and hence there is little hope that aggregate demand is going to go up any time soon. This in turn will translate to current high unemployment numbers close to 8%.

      FED’s QE measures in recent times have tried to address this loss of aggregate demand through their policy of monetizing private sector debts (buying MBS). These measures arguably had low to no success rate in terms of getting the economy on track. What is required is prudent fiscal policies and tax reform, just one of the many required fiscal policy changes, has received highest public scrutiny and attention.

      Mitt Romney’s tax policies, as presented, are incomplete and fail to answer many of the key questions. When it comes to Corporate taxes, it is true that 35% corporate tax is one of the highest in the world but it is also true that the marginal tax rate for all companies in S&P 500 is 32.8%. (Source: nytimes article). Also the article reports “Of the 500 big companies in the well-known Standard & Poor’s stock index, 115 paid a total corporate tax rate — both federal and otherwise — of less than 20 percent over the last five years”. So there are tax loopholes which allow these companies to pay way lower marginal tax rates than the stipulated 35%. Thus without clarifying how many of the current loopholes in the tax code would be closed, this proposed tax reduction statement is vague.

      Also it is questionable, whether only lowering income taxes, capital gains and dividend income taxes(leaving carried interests and other exquisite taxes outside of scope), without accompanying structural reforms in labor markets, increased infrastructure spending, reduction of bureaucratic red tape and education reform, will spur economic growth and aggregate demand. In absence of better business and investment environment any surplus money from tax relief in the hands of households would be directed to deleveraging.

      Another fundamental question that needs to be answered related to the argument “lower taxes means higher investment / better employment” is the behavior of rent seeking by investors, speculators and financial institutions. A small example of this is between July 2012 and present the DJIA has rallied to pre-crisis 2007 levels. However the real earnings for the DJIA components have not moved up significantly. So an individual investor have benefited from the FED intervention more than anything and his investments have not contributed to increase in real output.

      Thus a lot of this political rhetoric from both sides of the great divide remains inconclusive in proving their ability to bring things back to normal (if we think that 2007 economic indicators with big asset bubbles were the normal).

        CommentedPartha Sarkar


        You are spot on that any tax reform has to be revenue neutral especially in these fiscally constraining times. But revenue is only one side of the coin. The other side to taxes is “perverse incentive” factor which encourages some behaviors while discouraging some others. For example high excise on tobacco and alcohol is used to reduce the negative externalities on health. Similarly reducing marginal corporate tax rates while closing loopholes can not only be achieved in revenue neutral way but the will also provide added incentives to corporations with huge cash on books of offshore subsidiaries, to repatriate a lot of that money. Another example of perverse incentive that springs to mind is if the Bush tax cuts expire, the huge differential in the Dividend Income tax rate and Capital gains tax rate (43% vs. 24%) would not only distort investment decisions by individuals and dividend payout by firms but will also affect the supplementary retirement income of seniors. So any tax reform debate in my opinion should be bipartisan and exhaustive to consider all the implications.

        Again, you are correct on the partisan nature of the economic policies and I think a big reason for that is “Supply side” policies would need structural reforms, which the polity tries to shy away from. The US economy has reached a threshold where the Real Assets to Financial Assets ratios is about 3 to 7. Also historically over last 30 years Financial Assets with long stream of expected future cash flows have outperformed the Real Assets. This was due to credit expansion as the Expected Future Cash Flows from these instruments were discounted by interested rate and yield spread. As interest rates went down yield spreads became thinner making long maturity and leverage highly lucrative. Now the interest rates cannot go any lower and inflation is at 2%. So can stocks or bonds be expected to yield their historic 7 – 8%? Also post crisis and with technical innovation most Financial Intermediaries are left with excess capacity and increased productivity making it difficult for them to absorb more people in their workforce. This is evident from Banks slashing employees regularly.

        So to get the Economy back on track Real Growth is the only available option. But that is constrained by Fiscal deficits and High debt to GDP ratios. Supply Side reengineering is the only available option but would need strong commitment from Polity and Electorate.

        CommentedG. A. Pakela

        Nice comment Partha. I believe that more efficient tax policies would work independently of the other reforms that you mentioned. The overall tax on capital returns should be "revenue neutral," that is as close to what is needed to support government spending and account for low or negative tax rates on lower income individuals and households. However, given that corporate income is taxed twice, the effective tax on capital returns is closer to 50%. True, there are many loopholes, but it is the rate on the marginal investment that determines whether it will be undertaken or not.

        Also, your point on household deleveraging is spot on. We used to be able to count on the public to take on ever more debt to support their spending. We have clearly reached the end of the ability of consumers to take on more debt. Decreasing the cost of capital at the margin at least offers hope that increased investment will drive more employment and corresponding consumption. Demand-side policies seem to be ineffectual. I am not exactly sure why there is an ideological and partisan element as to which policies are favored, or why "supply-side" seems to be the province of conservatives.

    2. CommentedG. A. Pakela

      This is yet another example of a highly rated Ph.D economist resorting to the kind of ideological, opinionated, sloppy thinking that would result in an economics student being verbally crucified in the class room.

      How is it that reducing the cost of capital by lowering marginal tax rates, maintaining the 15% rate on capital gains and dividends and lowering the corporate tax rate to 25% will not result in more investment and hiring? Resorting to comparing the economic results in the Bush administration to that of the Clinton years is simplistic and anecdotal. After all, President Clinton did not have to contend with a stock market that lost half of its value after the dot com bubble burst, a recession that started when he took office, the 9/11 tragedy which profoundly impacted the airline and transportation industry, and the dramatic increase in cost of oil throughout the decade.

      As economists say, "all other things being equal...," there can be no doubt we were better off with lower taxes on capital than higher taxes. To suggest otherwise is to deny that the law of supply and demand applies to capital and labor.

      I do agree that lower taxes on capital will result in a higher concentration of income. However, you cannot accumulate that wealth without reinvesting the returns to grow the business, thereby producing more goods and services,hiring more people and increasing demand. Why should we care that others get rich from our good fortune?

    3. CommentedKofi Jackson

      Mitt Romney is a nighmare personality. The future of the capitalist world is the Swedish model, everything else is anti-progressive.

    4. CommentedElizabeth Pula

      Excellent article. So it seems that Romney and Ryan are proposing to take most cuts from only a specific 8% of proposed Federal annual spending budget. This 8% amount is the amount that includes most if not all of any federal spending that actually contributes directly to support citizens of the nation. At the same time, the tax changes proposed by Romney and Ryan will significantly increase the annual tax burden of only citizens earning less than $200,000 annually. To me, there are definite negative implications then for any continuance of financial survival for the majority of US citizens (taking a long-thought-leap- with generalized conclusions). Even if Romney and Ryan win this coming election, God sure isn't going to lift a finger to support the majority of US citizens. Are the Democratic party proposals any better if a Republican majority Congress does not support any Democratic proposal- just because, and primarily only because a proposal is a Democratic plan? Can Obama really propose any effective alternatives? Who, bottom line, really pays what percentage of taxes. How much tax revenues are really essential to support the Federal "public good" expectations of citizens within the nation? How balanced are "public good" expenditures from one state to another within the nation? Perhaps if there were significant reductions in salaries within corporations of top corporate individuals, and significant reductions in salaries of members of Congress, and significant reductions in ALL entitlements, such as pensions, paid personal expenses etc. etc. etc. to members of Congress(families and friends), then there may be a higher allocation than "less than 8%" of the Federal budget for general expenditures to improve opportunities for the majority of US citizens.

      I also interpret that "Federal monies" are being allocated within other categories to specific interests that only benefit specific corporate interests that specific members of Congress support, primarily to maintain their political career and personal entitlements. So what is the annual percentage of Federal monies that can be allocated to Congressional salaries, retirement benefits? What are the monies that support programs/expenditures that specifically benefit those connected to Congressional members (active or retired), and specific corporations? Is this percentage a more significant percentage of the annual Federal budget? Shouldn't the majority of the expenditures of the Federal budget actually be ONLY for the direct support of US citizens, and not just Congressional members and associates(I'm either presuming or assuming that the monies amount to well over less than 8% of the annual Federal budget)? What should the monies be used for? Are the main reasons for Federal expenditures Defense and Support of the nation, especially the citizens? The members of Congress and associates should be volunteering their time to their nation and the citizens that they supposedly represent as members of the Congressional House and Senate. Most Congressional members are extremely wealthy, or became extremely wealthy after terms in Congress. Why should these positions be paid positions? Presently, I interpret that the members of Congress, and perhaps the Presidency and Judiciary, expect all other citizens to donate all time and efforts to support any kind of Federal government representation, even a totally irrelevant representation. The present kind of representation is definitely not in the best general welfare interests, or the for-profit interests of the majority of US citizens or the US, as a nation.

    5. CommentedPaul A. Myers

      There is a surplus! The US is making huge tax expenditures to the top .1% of one percent so that the "wealth creators" are in surplus. Can good times be far behind?

      Sheldon Adelson is announcing a gigantic development project in Madrid Spain (your tax dollars at work!).

      Next January, the US Senate is going to come back with the political balance of power held by senators elected by Karl Rove's Crossroads PACs. Reactionaryism in the Senate has been made national rather than rooted in individual state politics. So the Republican senators will all be beholden to Karl Rove. So now we will have government by stooges of Karl Rove. (Remember how well it worked when he had his stooge in the Oval Office!)

      Now if Mitt can just win, then we'll let the Happy Talk Roll!

    6. CommentedMark Hayes-Newington

      Whatever ones political priorities, why is it that the overspending, underperfoming economies of the US and UK (and others) believe the one cost that cannot be reduced is the military. God knows there is little point in invading either country, and since we seem incapable of managing our own domestic budgets to effect why would we want to use our military to widen the influence of self evidently in effective economic management?

        CommentedPaul A. Myers

        The US reduced its military by 30 percent after the Cold War. Most likely, starting next year, the US will start another 30 percent reduction since a lot of Army and Marine divisions will no longer be needed since further invasions of Moslem countries will probably be off the agenda.

        This outcome was foreordained by the first Bush administration when it (1) passed large tax cuts (2) significantly increased the pay and benefits of military personnel, particularly career personnel, and (3) passed a trillion dollar unfunded prescription drug benefit. Numbers will drive the force reduction.

    7. CommentedBurk Braun

      Apart from the fact that neither Romney's nor Ryan's proposals perform in net any explicit deficit-cutting, (and due to their quite explicit tax cuts seem to make this deficit far worse), this piece buys into the Republican frame that the fiscal deficit is bad.

      It isn't. The deficit is the only thing between us and a depression, and needs to continue just as long as we have net trade and savings deficits, and high unemployment. It presents no long-term problem, either, whether in solvency terms (we owe this money to ourselves, we print it ourselves, and bond holders are savers anyway), nor in inflation or funding terms. When inflation is a problem, we can then address it with deficit cuts and all will be just fine. This is basic MMT economics.

    8. CommentedMark Pitts

      Surely the professor is being facetious when she compares the Bush years to Clinton years to argue that tax cuts are ineffective stimulus.

      If she believes her own example, she must conclude that tax increases are in fact an economic stimulus.

      Similarly, she must recommend that we immediately move to deregulate financial services since this is what Clinton did. (Clinton ensured that derivatives would not be regulated and he revoked Glass-Steagall).

      A single comparison proves nothing.

      Why not choose other examples? Why not look at the recovery after 1982 when Reagan cut taxes?

        CommentedThomas Haynie

        Actually this might be the case. It’s not highly scientific but using numbers from I put together a list of almost 30 developed nations comparing their highest marginal corporate tax rates and unemployment levels . The scatter plot and regression analysis suggests a negative relationship. Taxes down and unemployment up. Or put differently raising taxes lowered unemployment. At least in this single slice of time. In the future I may check other periods or even, given time create a long term trend of the R^2 value to look for times/conditions that low taxes may be more significantly linked to high employment. This does not address how that tax revenue is spent.

        CommentedA. T.

        By Reagan's tax cuts you mean when the national debt exploded, both in absolute terms and as a percentage of GDP?

        It would actually be in-keeping with the author's point – it is impossible to cut taxes, cut the deficit, and engineer economic growth all at the same time.