The National Tax Journal asks for views on a recent proposal from Len Burman to limit tax expenditures.   My answer:   I couldn’t agree more.

With regard to the politics, one would have to see whether the phrase “cut tax expenditures” polls more like the phrase “cut expenditures,” which I assume polls well, or like the phrase “raise taxes,” which of course polls horribly.  I have no idea.  But at least there is a hope of breaking through the mindless artificial “Taxes versus Spending” rhetoric that dominates Washington.

With regard to the merits of the idea as economic policy — in a context where strong measures to reduce the budget deficit will be necessary in coming years — Burman is completely right.   Most tax expenditures tend by nature to be distortionary.   Many of them are convoluted ways of making what would otherwise be a subsidy look like a tax deduction.

Agreeing to the general principle of limiting tax expenditures is easier than agreeing to all the detailed implications.   Looking at the list of the actual 12 largest tax expenditures would give most people pause.   But much less so for economists.    The only one on the list that gives me serious pause, personally, is #7:  the “charitable deduction (other than education and health).”   But the top two deserve to be cut, as part of a larger fiscal package, not just because they would save a lot of money, but also to get economic incentives right.  Those top two are the exclusion for employer-sponsored health insurance and the mortgage interest deduction.

A proposal to eliminate the mortgage interest deduction would of course get zero support in Congress, because it is political suicide with middle class voters.   A more moderate proposal to freeze the amount of the deduction would also be unpopular.  The same with four other pro-housing tax expenditures out of Len’s list of 12:    deduction for property taxes, exclusion of net imputed rental income, capital gains exclusion on home sales, and property tax deduction.   All politicians and voters (excluding economists) continue to believe that public policy should tilt in favor of home ownership.   Notwithstanding the recession that began with the sub-prime mortgage crisis of 2007, economists have not made even a dent in popular perceptions, with our arguments against artificially tilting the field away from rental housing and the rest of the capital stock, which is what you do when you tilt toward owner-occupied housing.   That the bias is toward high leverage in home ownership makes it worse.  To take another example, whatever happens ultimately to Fannie Mae and Freddie Mac, they certainly won’t be abolished.    Americans believe too strongly in the dream of home ownership to absorb fully the point that you are not doing a family a favor if getting them into their own house means burdening them with debt that they will probably not be able to repay.

“Political impossibility” is not a reason not to try.  After all, our country will not get through the next few decades, fiscally, unless we make some “politically impossible” changes.   But I emphasized the housing issue in the preceding paragraph to make a different point.   Almost all commentators on the financial crisis, whether from the left or right, talk as if the causes of the crisis are obvious and our leaders are idiots for not having acted to fix the problem ahead of time.  Needless to say, those on the left blame the right, for deregulation, and those on the right blame the left, for moral hazard.   And yet there is still zero support for fixing the housing policy parts of the problem, on which economists have almost unanimous agreement (and did ahead of the crisis).

[Comments  can be posted on the SeekingAlpha site.]

At first glance, the job numbers of the last week seem to offer a mixed and confusing picture.   On the one hand, today’s headline from the Bureau of Labor Statistics certainly sounds like good news:  the unemployment rate finally dropped below 10.0% — to 9.7%.   On the other hand, today’s establishment survey of employment, which most of the time is a more reliable measure than the unemployment rate, still shows job change numbers that are negative.   Furthermore, recent numbers on claims for unemployment benefits have been discouraging.   

To reach an overall evaluation, one must take a longer-term perspective. Even the job loss reported in the establishment survey for January can be interpreted more positively:   it is less than 1/30th of the rate at which job losses were running one year ago, in January 2009.   (See the chart below, which presents 3-month averages of employment changes over the last two decades.)  The best way to sum up all the labor market numbers in recent months, both positive and negative, is they have been within measurement-error-distance of zero, roughly flat.  That may not sound great, but it is a big improvement relative to what came before.

It is inconvenient, but common, that the labor market and the rest of the economy send conflicting signals.

As a member of the NBER Business Cycle Dating Committee, I get asked whether we are ready to call officially an end to the recession.   Although the Committee looks at many indicators in reaching its decisions, the most important overall are measures of output, particularly quarterly GDP.   GDP shows growth turning from negative in the first half of 2009 to positive in the 3rd quarter of the year, and now strongly positive in the 4th quarter.  That suggests that the trough will probably turn out to have been in the middle of last year. 

Beyond output, the monthly indicators that are most important to the Committee are probably those that come from the labor market. Here is how I personally read the overall picture of the labor market that has emerged recently (refer again to the graph): 

·        the employment loss was especially bad in this recession, whether viewed in absolute terms or relative to the output decline (8 million jobs lost, in the BLS revisions that are probably the most important news in today’s report); but

·        the recovery time in jobs does not appear to be lagging behind output any more than was the case in the preceding two recessions — and perhaps less.   The worst job loss this time occurred around the time of the worst negative GDP numbers – the very beginning of 2009, as opposed to waiting until GDP growth actually turned positive, as in the preceding two recessions.   Yes, it is painful that labor market losses have, at best, not ended until a half-year after the end of output losses.  Nevertheless, as I count, that still appears to be a shorter lag than in the famous “jobless recoveries” following the recessions of 1990-91 (job losses ended 11 months after the trough) or 2001 (they did not end until 21 months after the trough).

The bottom line is to reinforce the verdict of most economists: that the recession very likely ended sometime in 2009.    At this point the main thing that the NBER Committee must watch out for is the small risk that the economy could be hit in 2010 by a sudden new downturn, as the changes start to diminish;  but a real double dip recession (which might in theory count as a continuation of the same recession as 2007-09), seems increasingly unlikely.

Employment changes, monthly data, January 1990-January 2001.   Source: Bureau of Labor Statistics.

            As Chile’s President Michelle Bachelet prepares to hand over power to her newly elected successor, she remains extraordinarily popular.  It is worth reflecting on the fiscal aspects of her term in office, as Chile has important lessons for other countries struggling with fundamental long-term budget problems, which includes a lot of countries right now.

             As recently as June 2008, President Bachelet and her Finance Minister, Andres Velasco, had the lowest approval ratings of any President or Finance Minister, respectively, since the return of democracy to Chile. (See graphs below.) There may have been multiple reasons for this, but perhaps the most important was popular resentment that the two had resisted intense pressure to spend the receipts from copper exports, which at the time were soaring along with world copper prices.  One year later, in the summer of 2009, the pair had the highest approval ratings of any President and Finance Minister since the return of democracy.  Why the change?  

         It was not due to an improvement in overall economic circumstances:  in the meantime the global recession had hit.  Copper prices had fallen abruptly.  (Chile’s economy is dependent on this metal, which constitutes as much as 3/4 of its exports.)   But the government had increased spending sharply, using the assets that it had acquired during the copper boom, and thereby moderating the downturn.   Saving for a rainy day made the officials heroes, now that the rainy day had come.   Chile has achieved what few commodity-producing developing countries have achieved:  a truly countercyclical fiscal policy.  

Source for charts:
Eduardo Engel, Christopher Neilson & Rodrigo Valdés, “Fiscal Rules as Social Policy,”  Commodities Workshop, World Bank, Sept. 17, 2009.

            Some credit should go to previous governments, who initiated an innovative fiscal institution.  But much credit should go to Bachelet and Velasco, who enshrined the general framework in law and abided by it when it was most difficult to do so politically.  (They introduced a Fiscal Responsibility Bill in 2006, which gave legal force to the role of the structural budget, and created a Pension Reserve Fund and a Social and Economic Stabilization Fund, the latter a replacement for the existing Copper Stabilization Funds.)   

            Chile’s fiscal policy is governed by a set of rules.   The first one is a target for the overall budget surplus (originally set at 1 % of GDP, then lowered to ½ % of GDP, and again to 0 in March 2009).    This may sound like the budget deficit ceilings that supposedly constrain members of euroland (deficits of 3 % of GDP under the Stability and Growth Pact) or like the occasional U.S. proposals for a Balanced Budget Amendment (zero deficit).    But those attempts have failed, because they are too rigid to allow the need for deficits in recessions, counterbalanced by surpluses in good times.  The alternative of letting politicians explain away any deficits by declaring them the result of slower growth than expected also does not work, because it imposes no discipline. 

            Under the Chilean rules, the government can run a deficit larger than the target to the extent that:
(1) output falls short of potential, in a recession, or
(2) the price of copper is below its medium-term (10-year) equilibrium,
with the key institutional innovation that there are two panels of experts whose job it is each mid-year to make the judgments, respectively, what is the output gap and what is the medium term equilibrium price of copper (also the same for molybdenum).   Thus in the copper boom of 2003-2008 when, as usual, the political pressure was to declare the increase in the price of copper permanent thereby justifying spending on a par with export earnings, the expert panel ruled that most of the price increase was temporary so that most of the earnings had to be saved.  This turned out to be right, as the 2008 spike was indeed temporary.    As a result, the fiscal surplus reached almost 9 % when copper prices were high.  The country paid down its debt to a mere 4 % of GDP and it saved about 12 % of GDP in the sovereign wealth fund.    This in turn has allowed a very substantial fiscal easing since 2008, when the stimulus was most sorely needed.

            Any country, but especially commodity-producers, could usefully apply variants of the Chilean fiscal device.  Given that many developing countries are prone to weak institutions, a useful reinforcement of the Chilean idea would be to codify the details legally, and to give legal independence to the panels.    There could a requirement regarding the professional qualifications of the members and laws protecting them from being fired, as there are for governors of independent central banks.   The principle of a separation of decision-making powers should be retained:  the rules as interpreted by the panels determine the total amount of spending or budget deficits, while the elected political leaders determine how that total is allocated.   This may be just the sort of reform needed in so many countries where the politicians have repeatedly proven themselves unable to maintain long-term fiscal discipline.  

[Earlier version posted at RGE Monitor.]

The National Journal asks for reactions to a recent blog post by Greg Mankiw regarding the reasons why US investment has fallen sharply. 

I agree with Greg that the dominant empirical fact about investment is its procyclical volatility (the main reason investment has been depressed for the last two years is that the economy has been depressed), and also that the recent credit crunch made it worse.   But I don’t agree with a third item on his list: “the policy environment seems adverse to business.”   As in many areas, it is when we get to the politics that I disagree. 

Greg cites trade policy, fiscal imbalances, and energy costs, in support of his proposition that the current policy environment is anti-business.    Let’s consider each of the three.

Trade.  I wasn’t happy in September when the White House put tariffs on imports of Chinese tires.  But President Obama, despite the pressures of the most severe recession since the 1930s, has yet to succumb to any protectionist measures as big or as blatantly in violation of international trade agreements as were Ronald Reagan’s quotas on Japanese auto imports or George W. Bush’s tariffs on steel imports, in response to the 1981-82 and 2001 recessions, respectively.  (Greg, of course, was the Chair of Bush’s Council of Economic Advisers.)

Budget.   Most of us think that the $787 billion fiscal stimulus and the distasteful banking rescues were minimal necessary responses to the recession.   But let’s address the serious question of the bleak longer term fiscal outlook. It is known to those who look carefully at the budget numbers that Obama’s recent actions are a distant 5th on the list of contributors.      #1 in the long term (by far) are the future costs of Social Security and Medicare, the approach of which we have been watching for several decades.    #2 are the long term effects of Bush’s tax cuts.   A close #3 are the effects of Bush’s spending increases (including foreign wars and the expansion of Medicare benefits, among other things).    #4 is the loss of tax revenues from the recession that began December 2007.   A distant #5, as I say, is the recent fiscal stimulus.  (The banking layouts are being repaid, usually with a high return for the Treasury – as the Administration had predicted, to critics’ ridicule.)   I believe that as the recovery becomes better established Obama will, as he says, take much more serious steps than his predecessor in the direction of long-run fiscal consolidation.   But only time will tell. 

Energy costs.  Greg Mankiw in fact believes that a system of energy taxes or cap-and-trade would increase the efficiency of the economy, even though it would raise the relative price of energy.  (This is all the more true if the comparison is to past policies of subsidizing oil and other fossil fuels.)   Greg founded the Pigou Club on this principle, and I heartily congratulate him for it. 

I am skeptical that investment is currently depressed by perceptions of an anti-business climate.    But if the average businessperson does in fact have the perception that recent Democratic administrations have been worse for business than Republican administrations, I suggest setting aside campaign rhetoric and looking at actual history.   Start with the fact that, in the graph in Greg’s blog post, investment growth was substantially higher during the Clinton Administration than during the Reagan or Bush Administrations.   Investment will recover when the economy does.

“Should Central Banks Target Asset Prices?”   That is the question addressed by the current symposium in The International Economy (2009, no.4).

My answer: 

Alan Greenspan was right to raise the question “How do we know when ‘irrational exuberance’ has unduly escalated stock prices?”, which is what he actually said in 1996.    But he was wrong to conclude subsequently that monetary policy should ignore asset prices (or even that it should take asset prices into account only to the extent that they contain information about future inflation, as the Inflation Targeters would have it).    More specifically,
(1) Identifying in real time that we were in a stock market bubble by 2000 and a real estate bubble by 2006 was not in fact harder than the Fed’s usual job, forecasting inflation 18 months ahead;
(2) Central bankers do have tools that can often prick bubbles; and
(3) The “Greenspan put” policy of mopping up the damage only after run-ups abruptly end probably contributed to the magnitude of the bubbles ex ante, while yet being insufficient ex post to prevent the crisis from becoming the worst recession since the 1930s.    All three points run contrary to what was conventional wisdom among monetary economists and central bankers a mere two years ago.

As Claudio Borio and Bill White at the BIS pointed out before the financial crisis, many of the worst economic collapses of the last 100 years have occurred after excessively easy monetary policy had shown up in asset prices but not in inflation: US 1929, Japan1990, East Asia 1997, and now the US 2007.

A final point: “Targeting asset prices” is the wrong phrase.  The word “target” (for example, with respect to the money supply, exchange rate, or inflation) implies a number, or at least a numerical range.   I don’t know anyone who thinks that the central bank should contemplate setting a numerical range for the stock market.   Rather, the claim, which I think the evidence now supports, is that central bankers would be well advised to monitor prices of equities and real estate and to speak out, and eventually to act, on those rare occasions when asset prices get very far out of line.

(To post a comment, go to the SeekingAlpha version.)

The international press reports, “At Climate Talks, Danger to Free Trade Mounts.”

The Copenhagen negotiations have essentially failed to include, among the many topics covered, one that will be critical in the coming years:   the question of import tariffs or other trade penalties that individual countries apply against the products of other countries that they deem too carbon-intensive.    Such border measures are already in EU and US legislation (the Waxman-Markey bill, not yet passed by the Senate).    Properly designed, they could turn out to be the missing instrument needed to get each country to cut emissions without fear of others taking unfair advantage, via leakage.   More likely, national politics will turn them into protectionist barriers.

Actions taken multilaterally would probably make the difference as to whether border measures are used for good or ill.  Here is my personal ranking of five possible scenarios.

1. Best choice — a system of multilateral sanctions as part of a new “Copenhagen Protocol” or other treaty, following the precedent of trade sanctions in the Montreal Protocol on Stratospheric Ozone Depletion.

     2.   Next-best choice — national import penalties adopted under multilateral guidelines:

• (i) Measures can only be applied by participants in good standing.
• (ii) Judgments to be made by technical experts, not politicians.
• (iii) Interventions in only a ½ dozen of the most relevant sectors.

   3. Third-best choice — no border measures at all.

   4.  Fourth choice — each country chooses trade barriers as it sees fit.

   5.  Worst choice: national measures are subsidies to adversely affected firms, which may take the form of free emission permits (as is contemplated in EU provisions).    These do nothing to limit carbon leakage.  They function simply as bribes to those industries lucky enough to receive them, in return for political support.

I am writing from Copenhagen, the site of the 15^th Conference of Parties to the UN Framework Convention on Climate Change.     If one were to judge by outward appearances, the prospects look dim for a meaningful global agreement by the end of the week.   

First, most conference participants have been put through an experience that seems designed to convince them that global warming may not be such a bad idea after all:  a registration system that requires waiting in long lines in freezing temperatures.  (Wait times commonly reported this week vary from one hour for China’s negotiator to 8 hours for other participants, such as prominent NGO leaders.  Even 9 or 10 hours.)    
 
Second, there has been little convergence of positions.  The views expressed here cover the same fantastically and unbridgeably wide range as they did at the time of the Kyoto meeting 12 years ago.   At one end of the spectrum, developing countries are still asking for reparations - African delegations boycotted Monday’s meetings;  and demonstrators are still very confused about who they should be trying to persuade and how.   At the other end of the spectrum, the climate change deniers are also represented here.  Recent opinion polls show that the percentage of skeptics among the fickle American public has risen very recently, even though the scientific evidence for anthropogenic warming continues to mount.   (For some reason, many find it easier to deny science than to make any of the less indefensible arguments available to critics: that global warming wouldn’t be all bad, or that cutting emissions enough to prevent it would be too expensive, or that the U.N. is not a competent instrument, or that geo-engineering would be a cheaper approach.)    

Most importantly, the impasse between the rich countries, notably the United States, and the poor countries, notably China, remains.   That, of course, is why world leaders acknowledged some months ago they would not be able to agree in Copenhagen on a successor treaty to the Kyoto Protocol
 
Many here, however, take hope from the idea that President Obama would not have committed to come to Copenhagen at the end of this week if the White House did not have reason to expect to be able to achieve at a higher level an interim understanding that goes beyond the positions that the negotiators until now have been instructed to take.

My own plan for how to break the impasse has been detailed in this blog before. (The paper is now published, in a book co-edited by Joe Aldy and Rob Stavins).   The proposal can be boiled down to a couple of bare essentials:

Stage 1: 

• Annex I countries commit to the post-2012 targets that their leaders have already announced.
• Others commit immediately not to exceed BAU, thus precluding leakage.

Stage 2: 

• When the time comes for developing country cuts, targets are determined by a formula designed so each is asked only to take actions analogous to those already taken by others before them. Developing countries could agree now to the principle, without yet agreeing to specific parameters.

(To post comments, go to the Roubini Global Economics version of this post.)

Question from the National Journal: “President Obama and his team said recently that the fiscal 2011 budget will represent a credible effort to reduce budget deficits and put the federal government on a path toward “sustainable” deficits …How would you alter taxes and spending to achieve (or at least pursue) that goal? ”

Here are my ten proposals to move the budget back to a sustainable path (like the one it was on until January 2001):

First, auction off most greenhouse gas emission permits, rather than giving them away to firms (which would confer windfall profits). This is what President Obama originally proposed last February, but it is not in the congressional climat change legislation.

Second, raise the gas tax. Among the benefits, besides raising revenue, would be reducing traffic congestion, accidents, pollution, the trade deficit, and dependence on Mideastern oil.

Third, cut agricultural subsidies to rich farmers and agribusiness, saving money and improving economic efficiency. This is another measure that Obama proposed when he first took office, but that was rejected by Congress.

Fourth, continue to cut expensive weapons systems that the military doesn’t want, but have in the past been been kept because the suppliers are in the districts of influential congressmen.  President Obama and Defense Secretary Gates have, amazingly, managed to do this with the F22.

Fifth, end manned space exploration. We don’t need it. Spend half the money on useful science instead, including research on energy and medicine (and unmanned space exploration).

Sixth, let George W. Bush’s tax cuts for the rich expire as under current law. Of course the Bush plan to eliminate the estate tax completely in 2010 and have it bounce back to its 2001 level thereafter is absurd.  We should instead level out the taxable threshold at some reasonable estate size: a few million dollars, something high enough to de-legitimize the hysterical stories about inheritors supposedly being forced to sell their small farms or small businesses to pay the tax.  (Use some of the revenue in these proposals to fix the Alternative Minimum Tax once and for all. And, in the meantime, continue Obama’s return to honesty in budget accounting regarding the costs of AMT, wars in Iraq and Afghanistan, tax cuts, etc.    Bush’s habitual trick of purposely understating such costs in future budgets allowed him to pretend that we could afford his profligate fiscal policies, which in turn added far more to the national debt than the current recession measures have added.)

Seventh, encourage hospitals to standardize around national best-practice medicine – to pursue the checklist that minmizes patient infections and to avoid unnecessary medical tests and procedures – using levers such as making Medicare payments conditional on these best practices. This is another part of the Obama plan.   (Don’t pursue the logic of radio talk show propaganda, which labels even modest government involvement in health care as “socialism,” because that logic would require dismantling veterans’ hospitals, which provide good medical care relatively efficiently, even before it would require dismantling Medicare.)

Eighth, limit or eliminate the tax-exemption for employer-paid health insurance (as proposed by Senator McCain), at least the Cadillac plans which are very expensive but don’t even pay off in health results (as proposed by Senator Kerry).

Ninth, ideally, eliminate the tax deductibility of mortgage interest too. I realize proposing this would be political suicide. Congress and the public are still virtually unanimous in wanting to tilt the playing field in favor of owner-occupied housing and against rental housing and the rest of the capital stock, notwithstanding that such policies contributed to the housing bubble and crash.

Tenth, to save Social Security, raise the retirement age (just a little), tax higher incomes (just a little), and progressively index benefits for future retirees to price inflation, rather than to wage inflation (just a little).

(To post comments, go to the Roubini Global Economics version of this post.)

The economy has been on a roller coaster ride since the cyclical peak of December 2007. (See illustration.) The gradual slide of early 2008 turned into a terrifying freefall in the last quarter of 2008 (after the Lehman Brothers bankruptcy) and the first quarter of 2009. Now the train is probably at the bottom of the roller coaster valley.

The Index of Leading Economic Indicators, represented by the first car in the train, was this morning reported to have risen for the seventh consecutive month in October. Similarly, consumer confidence is substantially improved relative to February (though it, like all economic statistics, has experienced some bumps in the ride). The important middle cars, which represent measures of aggregate output, probably reached bottom in the early summer, and then started back up.  The BEA’s advanced estimate for GDP growth in the third quarter was 3 ½ % .

The jobs measures are lagging well behind the rest of the train, as usual.
Among three key labor market measures, the hours worked series has apparently reached the bottom. Employment is still falling, though thankfully not at the very rapid pace of a year ago. The unemployment rate brings up the rear; people in that car are understandably unhappy.

My response:

I do think that measures such as the Contingent Convertible Bonds would be a useful step.  Some argue that it would be hard to know when to invoke the contingency clause.  It strikes me that this argument largely vanishes when one realizes that the clause would of necessity be invoked by the time we got to the stage of a Bear Stearns or Lehman Brothers bankruptcy. CoCos would not go very far in themselves toward comprehensive reform of the financial system, if that is the goal.  But then no single policy measure would do that.  I agree with Gillian Tett: “In theory, I think that CoCos certainly could be a useful additional to banks’ tool kits. However, in practice, the contagion risk suggests it would be dangerous to rely too heavily on an exclusive diet of CoCos for any policy ‘fix’.” 

Two related issues are of much bigger import.   First, is it a feasible goal to eliminate, credibly, the problem “too big to fail” or “too interconnected to fail,” thereby eliminating the critical moral hazard problem?  My suspicion is that this is not an achievable goal, when push comes to shove, ex post, in a crisis; and if I am right, then it is very important that we don’t return to the rhetoric of claiming “no bank is automatically too big to fail” and so fail to regulate and collect insurance from the banks ex ante.   This would just exacerbate the moral hazard problem.   Commercial banks are like river banks  in this respect.

Second, would the legislation that is offered by Senator Chris Dodd be a better approach to financial reform than alternative proposals, or even than the status quo?     While the 1,000+ page Dodd bill undoubtedly has some good things in it (the principle of a Consumer Protection Agency in lending is probably at the top of the list), I believe it would be very damaging overall. The major reason is that it would seriously undermine the power of the Fed to set fully-informed monetary policy in normal times and to respond effectively in times of crisis.  It seems that Barney Frank understands these things much better.