Barry Eichengren: What’s the Problem With Protectionism?

What's the Problem With Protectionism?

Barry Eichengren: 

BARRY EICHENGREEN

Barry Eichengreen is Professor of Economics at the University of California, Berkeley; Pitt Professor of American History and Institutions at the University of Cambridge; and a former senior policy adviser at the International Monetary Fund.

PORTO – One thing is now certain about the upcoming presidential election in the United States: the next president will not be a committed free trader. The presumptive Democratic nominee, Hillary Clinton, is at best a lukewarm supporter of freer trade, and of the Trans-Pacific Partnership in particular. Her Republican counterpart, Donald Trump, is downright hostile to trade deals that would throw open US markets. Breaking with modern Republican tradition, Trump envisages a 35% tariff on imported cars and parts produced by Ford plants in Mexico and a 45% tariff on imports from China.

Economists are all but unanimous in arguing that the macroeconomic effects of Trump's plan would be disastrous. Repudiation of free and open trade would devastate confidence and depress investment. Other countries would retaliate by imposing tariffs of their own, flattening US exports. The consequences would resemble those of the Smoot-Hawley Tariff, enacted by the US Congress in 1930 and signed by an earlier, disgraced Republican president, Herbert Hoover – a measure that exacerbated the Great Depression.

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But just because economists agree doesn't mean they're right. When the economy is in a liquidity trap – when demand is deficient, prices are stagnant or falling, and interest rates approach zero – normal macroeconomic logic goes out the window. That conclusion applies to the macroeconomic effects of tariff protection in general, and to the Smoot-Hawley Tariff in particular. This is a point I demonstrated in an academic paper written – I hesitate to admit – fully 30 years ago.

Consider the following thought experiment. President Trump signs a bill slapping a tariff on imports from China. This shifts US spending toward goods produced by domestic firms. It puts upward pressure on US prices, which is helpful when there is a risk of deflation.

But then President Xi Jinping retaliates with a Chinese tariff, which shifts demand away from US goods. From the standpoint of American consumers, the only effect is that imports from China (now subject to tax) and their US-produced substitutes are both more costly than before.

Under normal circumstances, this would be an undesirable outcome. But when deflation looms, upward pressure on prices is just what the doctor ordered. Higher prices encourage firms to raise production and households to increase their spending. They also reduce the burden of debts. And because inflation is still too low, owing to depressed macroeconomic conditions, there is no need for the Fed to raise interest rates and offset any inflationary effects of the increase in spending.

To prevent this thought experiment from being misconstrued, I want to be clear: there are other, better ways of raising prices and stimulating economic activity in liquidity-trap conditions. The obvious alternative to import tariffs is plain-vanilla fiscal policy – tax cuts and increases in public spending.

Still, the point about tariffs is important. Just as tariff protection is not a macroeconomic problem in deflationary, liquidity-trap-like conditions, freer trade, the economist's familiar nostrum, is not a solution. Those seeking a cure for the current malaise of "secular stagnation" – slow growth and sub-2% inflation – shouldn't claim too much for the beneficial macroeconomic effects of trade agreements. And they shouldn't invoke the old saw that Smoot-Hawley caused the Great Depression, because it didn't. False claims, even when made in pursuit of good causes, do no one any good.

But Smoot-Hawley did have a variety of other damaging consequences. First, it disrupted the operation of the international financial system. Free trade and free international capital flows go together. Countries that borrow abroad must export in order to service their debts. Smoot-Hawley and foreign retaliation made exporting more difficult. The result was widespread defaults on foreign debts, financial distress, and the collapse of international capital flows.

Second, trade wars fanned geopolitical tensions. The French Chamber of Deputies was outraged by American taxation of French specialty exports and urged an economic war against the US. The UK taxed imports from the US while giving special preferences to its Commonwealth and Empire, angering Hoover and his successor, Franklin Delano Roosevelt. Canadian Prime Minister Mackenzie King warned of an outbreak of "border warfare," diplomacy-speak for deteriorating political relations. Efforts to stabilize the international monetary system and end the global slump were set back by these diplomatic conflicts.

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Worse, US, British, French, and Canadian leaders were at one another's throats at a time when they should have been working together to advance other common goals. After all, economic policy aside, there was an even greater threat in the 1930s, namely the rise of Hitler and German re-militarization. Unilateral resort to trade restrictions, by making diplomatic cooperation more difficult, complicated efforts to mobilize a coalition of the willing to contain the Nazi threat.

Tariff protection may not be bad macroeconomic policy in a liquidity trap. But this doesn't make it good foreign policy – for Trump or anyone else.

John Case
Harpers Ferry, WV

The Winners and Losers Radio Show

7-9 AM Weekdays, WSHC-Listen Live, Shepherd University

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Bernstein: Whats UP with wages?

What's UP with wages?

July 12th, 2016 at 10:16 am

Source: Fed Up campaign

I stumbled on three, count 'em, pieces on wage growth in the papers this AM.

–Catherine Rampell on recent wage growth and how it might help the incumbent party keep the White House.

–Starbucks says the tight job market is leading them to increase compensation.

–JPMorgan Chase's Chairman Jamie Dimon is giving his employees a raise.

Check out this paragraph from the piece on Starbucks (my bold):

Starbucks said Monday that it is preparing to give pay increases of at least 5 percent to all of its U.S. store workers and managers, a move aimed at shoring up the coffee giant's ability to attract and retain employees in a steadily improving labor market.

I know it's common sense, but this is precisely the nub of the argument I've been making for years, and with extensive evidence. In an economy like ours, with very low union representation, tight labor markets are the working person's best, if not only, friend when it comes to bargaining clout.

Yes, education matters, of course. There's long been a very steep gradient of wage levels by educational attainment. But even some college-educated workers (e.g., younger grads) have experienced flat real wage trends. NY Fed datashow that the median real annual earnings for recent college grads hasn't gone up much since the 1990s, and even the 75th percentile of earnings is now just back to where it was 15 years ago. Elise Gould et al get the same finding for hourly pay of young grads.

And just yesterday I focused on the importance of very low unemployment for low-wage black workers.

So, all this is truly good news, but let's keep it in perspective. First, there's no evidence of wage-push inflation, either in real life or in expectations. Are such pressures building? Perhaps, but as I and others have shown, it's actually hard to link wage pressures to prices in recent years. Inflation remains "well-anchored" even in tighter job markets, so we shouldn't assume anything near full wage/price pass-through.

Second, a lot of what's driving real wage gains is uniquely low inflation. That's not taking anything away from all the above positive news, and no question, another driving factor has been faster hourly wage growth as a function of the tighter job market. But it does mean that as inflation normalizes—e.g., as oil prices regain their footing or shelter prices continue to mount in parts of the country—weekly paychecks won't go as far, i.e., unless hourly wages or weekly hours accelerate to offset the higher prices.

Here's what I mean. The figure below decomposes real weekly earnings into its component parts over 2012-14 and 2014-16. The dot shows the percent growth in real weekly earnings in each period, and it shows a nice, welcome acceleration, from 1% to 3.3% (weekly paychecks are up $30 a week in real $'s over the past couple of years). About a quarter of that acceleration comes from faster hourly wage growth, but the lion's share comes from much slower price growth, which slowed from 3.4% in the first bar to 1.1% in the second one.

So, yeah, there's some wage growth out there, both nominal and real, as you'd expect given that we're working our way towards full employment. But we're not there yet, and many working families have a lot of ground to make up. If today's stories stick and multiply, this progress should continue, which would be a very good thing. Remember, it took seven years of expansion to get here. Let's hang out here for awhile!

Source: BLS

 

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Categories: Jobs, New Posts, Wages | 2 Comments »

1. Smith says:

   July 12, 2016 at 2:04 pm

   This doesn't pass the smell test, because the next likely President (Clinton) already is running on $12/hour, New York and California are phasing in $15/hour, and Starbucks is paying well less than those amounts for most of it's workers and will be even after a 5% raise.
   http://www.indeed.com/cmp/Starbucks/salaries

   Dimon, as another comment elsewhere noted, couldn't write about wages without changing of the definition of the word "minimum". It means least. Instead he claims to be raising the minimum in a range of $12.00 to $16.50. Translating that back into English, he's raising the minimum to $12. Orwellian, and deceptive, the Times editors should not allowed this misuse of language. The media are enablers of the 1%.

   How tight is the job market when workforce participation fell the last 12 months, and as many as 500,000 (a half million) dropped out unrelated to demographics of an aging population.

   To repeat, in 1994, the workforce participation rate was 66%, the population over 65 years of age was 12.5% and most surprisingly, and the unemployment rate was 6%. Today, participation is 61%, over 65 population 15%, and unemployment 5%.

   Another thing worth mentioning is Dimon in passing remark promoting the myth that education is the answer to getting ahead and higher wages. Unfortunately there is already a surplus of over educated high skills workers, who take jobs from low skills works, in occupations that don't require college degrees. This also accounts for flat wages for college level occupations since the year 2000 and higher levels of unemployment for those less educated. Calls for infrastructure spending don't address this problem, and neither does free public college.

John Case
Harpers Ferry, WV

The Winners and Losers Radio Show

7-9 AM Weekdays, WSHC-Listen Live, Shepherd University

Sign UP HERE to get the Weekly Program Notes.

The Costs of Monopoly: A New View [feedly]

The Costs of Monopoly: A New View
http://economistsview.typepad.com/economistsview/2016/07/the-costs-of-monopoly-a-new-view.html

James Schmitz:

The Costs of Monopoly: A New View, The Region, FRB Minneapolis: Economists overwhelmingly agree that the actual costs of monopoly are small, even trivial. This consensus is based on a theory that assumes monopolies are well-run businesses that limit their output in order to drive up prices and maximize profit. And because empirical studies have found that monopolists do not restrict output or raise prices by very much, most economists have concluded that monopolies inflict relatively little harm on the economy.

In this essay, I review recent research that upends both the theoretical and empirical elements of this consensus view.² This research shows that monopolies are not well-run businesses, but instead are deeply inefficient. Monopolies do drive up prices, as conventional theory suggests, but because they also reduce productivity, they often ultimately destroy most of an industry's profits. These productivity losses are a dead-weight loss for the economy, and far from trivial.

The new research also shows that monopolists typically increase prices by using political machinery to limit the output of competing products—usually by blocking low-cost substitutes. By limiting supply of these competing products, the monopolist drives up demand for its own. Thus, in contrast to conventional theory, the monopolist actually produces more of its own product than it would in a competitive market, not less. But because production of the substitutes is restricted, total output falls.

The reduction in productivity exacts a toll on all of society. But the blocking of low-cost substitutes particularly harms the poor, who might not be able to afford the monopolist's product. Thus, monopolies drive the poor out of many markets.

Outline

In this essay, I first review the standard theory of monopoly that contends it inflicts little harm, and then I introduce a new theory that refutes that view. In this new theory, groups within monopolies act as both adversaries that reduce productivity and allies that eliminate substitutes. The new theory thus demonstrates that monopolies in fact cause substantial economic harm, and that harm falls disproportionately on people with fewer financial resources.

I then provide several historical examples of monopolies from my own research and that of others. I'll discuss monopoly subgroups in their role as adversaries in the sugar, cement and construction industries. I'll discuss monopoly subgroups acting as allies in the dental and legal industries. But I want to emphasize that in all monopolies, subgroups engage in both roles. I'll also take a fresh look at a familiar example of a monopoly, U.S. Steel, showing how subgroups acted as both adversaries and allies. These few examples are illustrative only and provide a narrow glimpse of a far broader economic phenomenon: Monopolies are prevalent in the U.S. (and international) economy. ...

Skipping forward to the summary and conclusion:

For decades, the theoretical understanding and empirical analysis of monopoly have themselves been monopolized by a dominant paradigm—that the costs of monopoly are trivial. This blindness to new theory and analysis has impeded economists' understanding of the actual harm caused by monopoly. Rather than inflicting little actual damage, adversarial relationships within monopolies have significantly reduced productivity and economic welfare. And in many industries, subgroups within monopolies collaborate to eliminate competition from low-cost substitutes. This lack of competition in the marketplace has a disproportionate impact on poor citizens who might otherwise find low-cost services that would meet their needs.

I've described this as a "new" theory, but in truth its roots go back decades, to the ideas of Thurman Arnold. Arnold ran the Antitrust Division at the Department of Justice from 1938 to 1943, taking aim at a broad range of targets, from automakers to Hollywood movie producers to the American Medical Association.¹⁰ He argued that lack of competition reduced productivity and that monopolies crushed low-cost substitutes, hurting the poor. Arnold supported his arguments through intensive real-world research. He and his staff undertook detailed investigations of monopolies, examining the on-site operations of many industries and documenting the productivity losses and destruction of substitutes caused by monopoly.

Arnold began his work at a pivotal time—in the midst of the Great Depression, just after the United States had experimented with the cartelization of its economy. Faith in competitive markets had reached such a low that cartels and monopolies were thought to be, perhaps, better alternatives. His work and ideas played a big role in reinvigorating confidence in competitive markets. He mounted an aggressive campaign to protect society from monopoly. The campaign had two parts: forceful prosecution of monopoly through the courts, accompanied by an array of speeches and articles to educate the general public about its costs.

Economists gradually forgot Arnold and his ideas, convinced by Harberger's empirical work and the introspection of economists, leading to, for example, the logic provided by Stigler and others. Scholars and regulators who studied monopolies focused on prices alone and found little to worry about.

But as shown by the research reviewed in this essay—and an expanding body of empirical work—the problems caused by monopoly are significant, and still pervasive. My hope is that this paper will open a new era of discussion about monopoly and its costs, and ultimately lead policymakers to encourage greater competition for the benefit of all.

 -- via my feedly newsfeed

CBPP: Louisiana Blazing Trail for Streamlined Medicaid Enrollment [feedly]

Louisiana Blazing Trail for Streamlined Medicaid Enrollment
http://www.cbpp.org/blog/louisiana-blazing-trail-for-streamlined-medicaid-enrollment

Louisiana has earned lots of attention for jump-starting Medicaid enrollment of more than235,000 people on July 1, the first day of its Medicaid expansion.  Less celebrated but also important, it's the first state to use a recent option to enroll SNAP (formerly food stamp) participants in Medicaid while avoiding duplicative paperwork for state workers and consumers. 

 -- via my feedly newsfeed

Dollars and Sense: The July/August Issue Is Out! [feedly]

The July/August Issue Is Out!
http://dollarsandsense.org/blog/2016/07/the-julyaugust-issue-is-out.html

The July/August issue of Dollars & Sense is out! We fell a bit behind because of our recent office move. But the issue has now been sent out to e-subscribers and the print edition is at the printers.

We have posted three articles from the issue online already:  Josean Laguarta Ramírez's Enforcement of Puerto Rico's Colonial Debt Pushes Out Young Workers, John Miller's A Clintonomics Sequel, and Alejandro Reuss's An Historical Perspective on  Brexit.

(Alejandro's take on Brexit, along with the two-part article the first part of which is our current cover story, have some similarity in perspective to a piece by Dani Rodrik that is making a splash recently, The Abdication of the Left, from Project Syndicate.)

Here is the editorial note from the July/August issue, with a review of the contents:

Out of the Frying Pan …

Life in capitalist society, in "ordinary" times, is no picnic. It's more like a fish fry—and we're the ones in the pan.

Rob Larson, in the second part of his study of the economics of information, shows the relentlessness of capitalist corporations in controlling the information we see about them, in a range of arenas: from advertising, to corporate public relations, to influence over the organizations—mass media and credit rating agencies—that are supposed to render independent judgment of them.

Suzanne Schroeder continues along those lines, arguing that the problems of private credit rating run deeper than the conflicts of interest laid bare by the recent financial crisis (for example, the outrageous granting of top "AAA" ratings to mortgage-backed securities and the like). Rather, the problem is that the standard methods of credit rating rely on the assumptions of an inherently stable and self-correcting capitalist economy. A solution, Schroeder argues, requires not only an alternative approach to credit rating, but also a reorientation of government policy to "stabilize an unstable economy."

Of course, these are not ordinary times, and all of the contradictions and outrages of capitalist society are amplified.

José A. Laguarta Ramírez's article about Puerto Rico's debt crisis points to its roots in colonialism. Subordinate to the U.S. government politically and to U.S. corporations economically, Puerto Rico is now mired in "odious debt"—neither incurred freely by its people nor used for their benefit. Meanwhile, legislation just passed by the U.S. government will impose harsh austerity and an undemocratic "oversight" board. Laguarta Ramírez suggests that the solution to the crisis lies in the direction of repudiating the debt, which in turn points in the direction of political independence.

D&S co-editor Alejandro Reuss looks at the eurozone crisis. The structure of the monetary union deprived member countries of the means to respond individually, and did not institutionalize ways to respond collectively (like automatic fiscal transfers to the hardest-hit areas). This faulty structure, Reuss argues, was not just an accident, but a result of the long-range neoliberal turn of economic policymaking in Europe—in which the mainstream social democratic parties are seriously implicated. The most recent twist, the UK's "Brexit" referendum, is a nationalist and nativist reaction to the crisis of internationalized capitalism—to which the left must answer with a new socialist internationalism.

Arthur MacEwan addresses the question of whether we're staring into an abyss of long-term economic stagnation. There are good reasons, he notes, to think of economic stagnation as an inherent problem in capitalist economies, rooted in "over-accumulation": Profit-making in one period gives capitalist enterprises the means invest in expanded plant and equipment, and the expanded capacity means more goods and services can be produced—sometimes more than people are able and willing to buy. MacEwan, however, also points to more particular causes of the current stagnation, and argues that a solution requires government policies to reduce inequality, maintain demand and employment, and invest in new infrastructure.

With each new piece of news—the Puerto Rico debt crisis, the Brexit vote, the victories of the right in Latin America and Europe—it seems like we're going from the frying pan into the fire. But consider each of the problems described above—the chronic and the acute. For each, there are solutions, and it comes to us to organize and fight for them.

Yes, we're going into the fire. But what will emerge from the flames?

 -- via my feedly newsfeed

Economic Trends: Can We Ignore the Alarm Bells the Bond Market Is Ringing? [feedly]

Economic Trends: Can We Ignore the Alarm Bells the Bond Market Is Ringing?
http://www.nytimes.com/2016/07/12/upshot/can-we-ignore-the-alarm-bells-the-bond-market-is-ringing.html

The financial media tend to report breathlessly about what the stock market did yesterday. But savvy economic analysts have always known the bond market is the place to look for a real sense of where the economy is going, or at least where the smart money thinks it is going.

And right now, if the bond market is correctly predicting the economic path ahead, we should all be terrified.

But, please, read on before panicking. There's a lot more to the story.

The stock market can rise and fall for all sorts of reasons, and sometimes for no apparent reason at all. But the bond market, where trillions of dollars change hands and long-term interest rates are determined, is steadier (normally). Its prices are generally tied closely to the outlook for growth and inflation over the years ahead.

The long-term interest rates that currently prevail across all the major advanced economies are consistent with a disastrous economic future. Taken at face value, they imply that the smart money expects inflation will remain extraordinarily low for years to come, and that growth will stay so weak that central banks won't be able to raise rates for years. It is a shift that has accelerated since Britain's vote on June 23 to leave the European Union, but one that has been underway for years.

Look at the current shape of the American "yield curve," the chart of how rates compare for short, medium and long-term bonds. It implies a 60 percent chance of a recession in the next year based on historical patterns,according to Deutsche Bank analysts. Long-term interest rates hit record lows last week — which is to say the lowest in the 227-year history of the United States.

Prices for inflation-protected bonds suggest that consumer prices will rise only about 1.4 percent a year through 2021 — and only 1.5 percent in the five years after that. They suggest that not only is the Federal Reserve unlikely to find conditions that warrant an interest rate increase in the remainder of 2016, but also that there is only about a 50 percent chance of a rate increase in 2017.

Across other major advanced economies, the signals sent by bond prices are even worse. Ten-year bonds are now offering negative interest rates in Germany, Japan, Switzerland, Denmark and, as of Friday's close, the Netherlands. That means buyers of these securities will get fewer euros, yen, Swiss francs or Danish kroner back than they invested, a development without precedent in hundreds of years of financial history.

Continue reading the main story

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But that phrase "taken at face value" is doing some heavy lifting here. There are reasons to think that current prices are reflecting idiosyncrasies in the supply and demand for safe assets, rather than a conviction among global investors that very bad times are ahead.

Many of the purchasers of government bonds do so not because they find the returns offered compelling but because they have to. Insurers face regulators who may require that they do so. Pension funds seek to offset long-term obligations with safe assets of similar duration. Banks buy bonds to comply with rules limiting how much risk they can take.

In the last few years, central banks have become the biggest buyers of bonds. The Federal Reserve's program of quantitative easing — buying bonds to try to stimulate the economy — ended in 2014, but the European Central Bank and the Bank of Japan are just getting going; the E.C.B. is buying 80 billion euros' worth of securities a month.

So you have a strong demand for bonds coming from institutions that are willing to buy at almost any cost — they are inelastic, in economic terms.

Continue reading the main story

Continue reading the main story

Interest Rates Are at Lowest Level in U.S. History

Last week, long-term Treasury rates fell to a new low.

Yield on 10-Year Treasury Bond

%

10

5

0

1.36%

1800

1820

1840

1860

1880

1900

1920

1940

1960

1980

2000

2016

Gray line represents average since 1790

Source: Global Financial Data through 2015; Federal Reserve for 2016

Then on the supply side, governments have not exactly been issuing vast supplies of new bonds, for reasons involving anti-deficit domestic politics. The value of outstanding German general government debt was $1.8 trillionat the end of 2015, for example, down from $2 trillion a year earlier.

Whatever you think of the wisdom of using government deficits to try to prop up a faltering economy, governments for the most part simply are not responding to very low interest rates and depressed economies by radically increasing deficit spending and thus increasing the supply of bonds.

So rising demand for bonds that is largely indifferent to price (even a willingness to buy the bonds at a certain loss) along with pretty much fixed supply combines to drive up prices, which in the bond market means driving down rates.

And even though the United States isn't the prime driver of this — the Fed has ended its Q.E. program, and American debt outstanding continues to rise — the bond market is sufficiently global that it's an important part of the story.

When German and Japanese bonds are offering negative returns, the 2 percent or so that United States Treasury bonds were offering earlier this year looked extremely attractive. Essentially the United States has imported this very low interest rate environment from overseas, even though the domestic economy is in pretty good shape and the Federal Reserve had been planning interest rate increases.

So even though in normal times bond prices give useful information about the likely path of inflation and growth, this might be an instance when those indicators are less useful.

Among the evidence that the recessionary signals out of the bond market are wrong? If bond prices are an unreliable yardstick, we can look to other markets that may be flawed, but are at least flawed in different ways.

And those other markets are not flashing recession warnings at all: The United States stock market closed on Monday at a record high; indexes of future stock market volatility are quite low; and oil prices, after a furious rally since the winter, have mostly held onto their gains.

So how much of the drop in interest rates can we really pin on these supply-and-demand factors in the market for bonds, as opposed to a genuine shift in investors' expectations about the future? Roberto Perli, an economist at Cornerstone Macro, has tried to disentangle the parts of the puzzle.

He estimates that about three-quarters of the drop in American Treasury yields since the start of the year is because of a decline in the "term premium," or the compensation investors demand for tying up their money over many years. This is largely attributable to those supply-and-demand factors. He attributes about one-eighth of the drop to investors' perception that the Fed will raise rates more slowly for any given economic circumstance than they had assumed at the start of the year.

He attributes only one-eighth of the drop to an actual belief among bond buyers that the economy will grow more slowly in the years ahead than they had thought at the start of 2016.

There is good news in that as well as bad. The good news is that most of the drop in long-term interest rates is being driven by things that have little to do with the underlying strength of economic growth. The bad news is that some portion of the drop really is being driven by more pessimistic economic views, at a time a great deal of pessimism is already baked in.

The bond market right now is like a speedometer that is miscalibrated and therefore unreliable. It may be less useful than usual, and is not to be interpreted literally — but it's still telling us something. And that something is that we should be worried about the possibility the world is in a nasty deflationary economic trap that won't get better anytime soon.

 -- via my feedly newsfeed

Steps to Building State Economic Opportunity [feedly]

Steps to Building State Economic Opportunity
http://www.cbpp.org/blog/steps-to-building-state-economic-opportunity

Tax Policy

The 2008 recession brought deep declines in state revenue, but now some of that revenue is starting to return. In this article, Erica Williams of the Center on Budget and Policy Priorities discusses forward-looking steps states can take to improve their economies now and in the future.

By Erica Williams

Erica Williams is Deputy Director of State Fiscal Research with the Center on Budget and Policy Priorities' State Fiscal Policy division. Since joining the Center in 2009, her research has focused on tax and spending limits and other anti-tax threats, state EITC developments, poverty, cuts to state services, and immigration.

Decisions made in states every day profoundly affect future economic stability and opportunities in communities across the country. States face a fundamental choice: provide the resources required for public investment in schools, transportation, health care, safe communities, and other building blocks of economic health—or cut taxes while skimping on public investment, which contributes to the concentration of economic gains among the richest households and limits opportunity for the broad majority.

When the recession hit in 2008, record-breaking declines in state revenue brought deep, job-killing cuts to schools, health care, and other key services that people depend on every day. Now, as revenue returns, states have the opportunity to invest in their economies and meet rising needs by eschewing crippling tax cuts and, instead, instituting fiscal policies that can help create jobs now and prime states for long-term, broadly shared prosperity.

California, Minnesota, and Massachusetts stand out as leading examples of states that have recently taken forward-looking steps to improve their economies now and in the future. These states are pursuing measures consistent with the recommendations found in " A Fiscal Policy Agenda for Stronger State Economies," a recently released Center on Budget and Policy Priorities report that offers a roadmap for creating and sustaining thriving communities and stronger economies. The agenda lays out five main steps states should begin to take today to build future economic security.

1. Target Public Investment to Boost the Economy, Now and in the Future

States can build a strong foundation for economic growth and promote jobs that enable people to get ahead by investing in areas such as education, public transportation, roads, and water and sewage systems—things that businesses and communities rely on heavily. These investments can create jobs in the short run and improve economic growth and job quality in the long run.

•   Strengthen education:Reinvest in education at every level, from high-quality preschools to college and customized job training, to prepare a workforce that can compete for good-paying 21st century jobs.
•   Invest in infrastructure:Reverse the serious decline in state investment in transportation, water treatment, and other forms of infrastructure (see Figure 1). These investments are key to creating jobs and promoting longer-term economic vitality, as they help businesses get their goods to market and increase productivity. Now is an especially good time to invest, given low interest rates for the borrowing that states can use to finance infrastructure projects.
•   Support entrepreneurs:Help startups and young, fast-growing firms already located in the state to survive and grow instead of cutting taxes and trying to lure businesses from other states with ill-advised tax breaks. The vast majority of jobs are created by businesses that start up or are already present in a state—not by out-of-state firms that relocate or branch into a state.
•   Spend wisely: Make careful, informed decisions by reviewing spending areas that may not be meeting intended goals, such as economic development subsidies; tax credits, deductions, and exemptions; and contracting practices. Such decision-making could free up resources for other priorities.

2. Help Struggling Families Share in Prosperity

State policymakers should help struggling families meet basic needs and avoid cutting supports that ease hardship. They also should reform policies in areas such as immigration and criminal justice that carry unnecessary economic costs, with the goal of helping more people participate more fully in the economy.

•   Enact or strengthen state EITCs: State lawmakers can boost the earnings of families working hard for low pay by enacting or increasing state Earned Income Tax Credits (EITCs). State EITCs build on the success of the federal EITC by keeping working parents on the job and helping families make ends meet. Twenty-six states and the District of Columbia have enacted state EITCs (see Figure 2).
•   Improve state support for families struggling the most: States can protect and better administer supports for those in the greatest economic need. These supports include cash assistance, subsidies for child care and transportation, and free school meals. States also should help families to enroll in SNAP—the federally funded food assistance program that lifts 10 million people out of poverty—as well as protect families with housing vouchers from discrimination and help them move to higher-opportunity neighborhoods.
•   Expand Medicaid: Through health reform, states can extend Medicaid coverage to people with annual incomes up to 138 percent of the federal poverty line—about $17,000 for an individual. This increases the number of people with insurance, protects families against health-related financial shocks, and keeps people healthier and able to work, which helps struggling residents and the state economy.
•   Reform criminal justice policy: States can save millions of dollars without endangering public safety through reforms such as effective addiction treatment instead of incarceration for people convicted of drug-related crimes or using sanctions instead of prison time for violations of technical conditions of parole, such as missing a meeting with a parole officer. These reforms also reduce the rate of people returning to prison and enable marginalized residents to participate more fully in the economy.
•   Improve immigrant policies: State policymakers can bring more immigrants into the mainstream economy, build a more educated and productive workforce, and enable immigrants to contribute to their fullest potential.

3. Avoid Ineffective Strategies and Gimmicks That Can Weaken a State's Economy

Several states have enacted or considered deep income-tax cuts that give the biggest benefits to large, profitable corporations and people with the highest incomes. Others have weighed budget restrictions that would severely limit public investment. Such policies fail to produce promised economic benefits and squander revenue that states could otherwise use to lay a strong foundation for future economic growth through public investment in high-quality schools, infrastructure, and other areas (see Figure 3).They also make it harder for states to save for a rainy day or respond to emergencies.

•   Avoid costly income tax cuts:Proposals such as replacing the state's income taxwith a higher, broader sales tax would sharply raise taxes for low- and middle-income households and threaten a state's ability to maintain services necessary for a strong economy. Other proposals would eliminate or deeply cut income taxes for individuals and businesses without replacing the lost revenue, forcing drastic cuts in services such as schools, transportation, and public safety.
•   Avoid costly corporate tax cuts: Large corporate tax breaks typically have a negligible impact on economic growth. Most are zero-sum at best: if a state cuts a tax, it generally has to make an offsetting cut to services to keep its budget balanced; the spending cut likely reduces demand in the economy, which counteracts any stimulative benefits of the tax cut.
•   Reject arbitrary spending limits: Strict formulas to limit revenue and spending, like Colorado's " Taxpayer Bill of Rights" (TABOR), are gimmicks that hamstring a state's ability to adapt to changing needs. Every state that has considered a TABOR since Colorado adopted it in 1992 has rejected it because it requires massive reductions in support for schools, health care, safe communities, transportation, and environmental protection.
•   Reject supermajority restrictions: Requiring a two-thirds legislative vote to raise revenue, instead of the simple majority required for other legislation, makes it harder for states to protect public investments during recessions. The resulting cuts can cost jobs and weaken economic recovery. They can also cause legislative gridlock when a small minority of lawmakers holds a tax measure hostage to expensive pet projects, making it harder to enact policies that serve the state as a whole.

4. Improve Fiscal Planning to Protect Investments That Promote Long-Term Economic Growth

States can better plan for the future through budget impact analyses that are professional and credible, and instituting mechanisms that trigger mid-year changes when needed to keep the state on course (see Figure 4). Policymakers need accurate information about the cost of spending- and tax-related proposals to make sound decisions. Without it, they may be more likely to adopt proposals that cause serious fiscal problems.

•   Employ best practices in budget planning: States routinely put at risk some of their highest priorities—educating children, maintaining a healthy and trained workforce, and caring for the elderly, for example—by failing to employ proven budget methods. Getting a stronger grasp of likely revenue and the cost of providing core services would help states have the necessary resources. It also can reduce businesses' uncertainty about future funding levels and tax rates.
•   Strengthen "rainy day" funds:Rainy day reserve funds help states offset revenue drops during economic downturns. In hard times, states can tap them to preserve public investment that promotes economic growth and sustain the state's demand for private-sector goods and labor. States without such funds should create them; states with overly tight restrictions on their use should reform those laws.
•   Institute "pay-as-you-go": In an improving economy, many policymakers are tempted to cut taxes or enact new programs that are not sustainable without significant new revenue. States can protect themselves by adopting a requirement that policymakers fully offset over a five-year period the cost of spending increases or tax cuts.

5. Raise Revenue Needed for Economy-Boosting Investments

Discussions by policymakers about strengthening the economy often center on tax cuts, despite overwhelming evidence of their negligible impact on creating jobs or promoting broad prosperity. States should pursue new revenue when necessary and modernize their revenue systems for the long term.

•   Pursue focused tax increases: For example, policymakers can raise taxes on the highest-income households and profitable corporations (those best able to afford the higher tax and least likely to spend substantially less as a result) by adjusting income tax rates, altering certain tax breaks for these groups, or reinstating taxes on inherited wealth. Experience doesn't support claims that these kinds of tax increases will drive significant numbers of affluent people to other states.
•   Improve tax collections: States can do a better job of collecting taxes due under current law. For example, the failure of catalogue or Internet sellers to collect and remit state and local sales taxes costs states billions of dollars each year. States also can nullify a variety of tax-avoidance strategies employed by large multistate corporations by adopting " combined reporting," which treats a parent company and its subsidiaries as one entity for state income tax purposes (see Figure 5).
•   Modernize state revenue systems: States can halt the erosion of their sales taxes and improve their long-term ability to invest in public priorities by updating antiquated tax systems ill-suited to the 21st century economy and broadening the sales tax base to include more services. For example, many states primarily levy sales taxes on tangible goods, even though services such as video streaming—which didn't exist when sales taxes were first enacted—make up a growing share of consumption.

States Paving the Road to Broadly Shared Prosperity

California and Minnesota have pursued a number of policy measures laid out in our fiscal policy agenda to build their economies. The results? Both states have improved their education systems—boosting their future prospects—while maintaining strong economic growth.

Minnesota continues to enjoy strong state finances, California voters will likely vote in November on extending the temporary personal income tax increases they approved four years ago, and another state—Massachusetts—will ask voters to decide the fate of a new measure to raise income taxes to pay for needed investments in transportation and education.

Minnesota raised income tax rates for its wealthiest residents in 2013 to address a gaping budget shortfall and make investments that matter. For example, the increase enabled the state to make a number of promising education investments. These include helping more low-income families afford preschool programs for their children, extending kindergarten to a full day in all public school districts, and offering college scholarships to more low- and middle-income residents. The state also was able to give a boost to working families struggling to get by with an increase in its EITC in 2014.

The sound decision to raise revenue in 2013 continues to pay off. This year, the state registered a $900 million budget surplus. Lawmakers' work this year reflects the choice to make investments that truly matter rather than squander resources on poorly targeted, unaffordable tax cuts. For example, rather than adopt a proposal to cut back the state estate tax, they chose to improve the state's working family and child and dependent care tax credits to buoy those struggling to make ends meet. As part of the package, Minnesota would become the first state and the second jurisdiction (behind Washington, D.C.) to do what Congress has debated for several years to no avail—expand the EITC for workers without dependent children, many of them young and just getting a toehold in the workforce. Altogether, the Working Family Credit would put $49 million back into the pockets of nearly 400,000 working families and individuals. The governor supported these provisions but pocket-vetoed the tax package over an unrelated technical fix. There's still a chance that lawmakers will be brought back for a special session to make that fix and adopt these measures.

California voters in 2012 temporarily raised income tax rates for the wealthiest residents, as well as the state's sales tax, and dedicated the new revenue to education, which the state had cut deeply after the recession hit. Those changes helped California raise annual K-12 funding per student by $ 1,800, as of 2014-15, and better target those dollars to communities with the greatest need, likely improving the state's workforce down the road. As in Minnesota, the brighter revenue picture that has endured since the tax increases allowed California the resources to broaden the economic recovery for deeply struggling workers and their families by creating its first-ever state EITC in 2015.

Because the 2012 tax increases were temporary, voters will likely be called upon this November to extend the income tax rate increases to sustain the progress made. If voters approve the measure, it would extend the tax increasefor another 12 years. If they don't, revenue available for education and other essential investments in California's communities would fall by more than $8.5 billion by 2020.

Massachusetts voters will decide in the fall whether to raise individual income taxes on incomes over $1 million, with the additional revenue funding greater investments in education and transportation. As previously noted, these public investments will benefit the state's economy and facilitate more widely shared prosperity.

Massachusetts is one of the country's most unequal states in terms of wealth and income, and the gap has widened in recent decades. Incomes at the top have soared, leaving a larger gap between the state's wealthiest and its middle- and lower-income families. The state's tax system is unfair and exacerbates this problem. The top 1 percent of non-elderly taxpayers in Massachusetts pay much less in state and local taxes as a share of their income than middle- and low-income people. Raising income taxes for people with incomes over $1 million would help address this fundamental unfairness.

Although opponents will likely argue that raising taxes for the highest income earners will cause them to flee the state, harming the state economy, that claim doesn't hold water, as noted above. State after state has found that the revenue generated for schools and other services by such an increase more than offsets any revenue lost if some rich people move out.

Notably, since raising taxes, both Minnesota and California's economies have grown faster than the nation as a whole (see Figure 6.)

As the CBPP has written, state income tax levels have very little to do with state economic growth rates. Focused income tax increases can provide revenue to improve schools and other public services that form a strong foundation for economic growth.

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