Cutting State Income Taxes Counterproductive to Prosperity, Racial Justice [feedly]

Cutting State Income Taxes Counterproductive to Prosperity, Racial Justice
https://www.cbpp.org/research/state-budget-and-tax/cutting-state-income-taxes-counterproductive-to-prosperity-racial

As states enter their 2021 legislative sessions, lawmakers in several states including Arkansas, Mississippi, Montana, and West Virginia are calling for cutting personal income taxes. This would sap revenues needed for an effective response to the COVID-19 pandemic and threaten states' recovery from the recession. And, by weakening state finances, it would undermine efforts to advance racial justice — just when growing understanding of the nation's shameful history of racism, as well as white supremacist opposition to American democracy itself, demand the opposite approach.

FIGURE 1

Cutting Income Taxes Would Likely Worsen Racial Inequities

MOST STATE TAX SYSTEMS ALREADY DEEPEN RACIAL AND ETHNIC INEQUITIES BECAUSE THEY ASK THE MOST, AS A SHARE OF INCOME, OF LOWER-INCOME HOUSEHOLDS, WHICH ARE DISPROPORTIONATELY HOUSEHOLDS OF COLOR.Most state tax systems already deepen racial and ethnic inequities because they ask the most, as a share of income, of lower-income households, which are disproportionately households of color.[1] In some cases, states have also used their taxing power to worsen the profound challenges facing people of color deliberately.[2] For example, Mississippi enacted the nation's first modern retail sales tax, during Jim Crow, in part to reduce property taxes and shift state taxes from (mostly white) property owners to consumers with little or no property to tax (many of whom were Black).[3]

Because most states' income taxes are progressive (meaning people pay higher rates on higher incomes), they foster at least some degree of racial equity in state tax codes; white families are three times likelier than Black and Latinx families to be in the top 1 percent, for example.[4] In contrast, regressive taxes — especially sales taxes and fees — fall more on low- and moderate-income people. This means cutting state income taxes can worsen racial inequities by disproportionately benefiting taxpayers at the top, most of whom are white. For instance, when North Carolina slashed personal income taxes in 2013, Black residents received only 10 percent of the tax cut, though they made up 22 percent of the state's population.[5] (See Figure 1.)

Cutting Income Taxes Hasn't Boosted State Economies in the Past

States that sharply cut income taxes in the past have reaped sharply lower state revenues, as common sense would predict, and the tax cuts have consistently failed to produce an economic boom. In the early 2010s, Kansas, Maine, North Carolina, Ohio, and Wisconsin cut personal income taxes by large amounts in hopes of boosting their economies. But all five saw slower growth in private-sector gross domestic product than the United States as a whole over the next few years, and four of the five saw slower growth in private-sector jobs.[6] (See Figure 2.) Kansas' massive income tax cuts wreaked so much havoc on the state's ability to pay its bills and save for the future, let alone invest in people and infrastructure, that lawmakers voted on an overwhelming, bipartisan basis to reverse them in 2017. [7] States that cut income taxes in the 2000s and 1990s didn't see much economic gain either.[8]

FIGURE 2

Other evidence indicates that raising income tax rates — in particular through targeted tax hikes on high incomes — doesn't harm states' ability to compete economically with their neighbors.[9] It's also worth noting that states without broad-based income taxes have higher sales and property taxes[10] and haven't enjoyed especially strong economic performance. The nine states with the highest top marginal income tax rates over the last decade saw their economies grow slightly faster, on average, than the nine states without income taxes, for example.[11]

More broadly, mainstream research finds that tax differences among states aren't the main driver of states' relative economic performance. Fifteen of 20 major studies published in academic journals from 2000 to 2018 that examined the broad economic effect of state personal income tax levels found no significant effects, and one of the others produced internally inconsistent results.[12] As a pair of university researchers described in a comprehensive literature review in 2018, "The vast majority of the academic studies that examined the relationship between state and local taxes and economic growth found little or no effect."[13]

Cutting Personal Income Taxes Doesn't Promote Small Businesses or Jobs

One reason state income tax cuts don't unleash economic growth is that they don't help small businesses to the degree often advertised. The vast majority of taxpayers are in no position to create a job, with or without a tax cut: only 2.1 percent of personal income taxpayers own a small business with any employees other than the owners. Also, most small businesses don't earn enough for tax cuts to make a crucial diff­erence. More than 8 in 10 small businesses have less than $50,000 in annual taxable income, so even eliminating the tax wouldn't come close to paying one full-time worker's salary.[14]

For entrepreneurs considering where to launch a company and create jobs, states' education systems, workforce talent, and general quality of life are much more important factors than tax differences, evidence suggests.[15]

Cutting Income Taxes Hinders Investments to Create Thriving, More Equitable Economies

Another reason income tax cuts don't unleash economic growth is that, since states must balance their budgets, they must offset the lost revenue by cutting support for schools, infrastructure, social services, and other building blocks of a strong economy.

States need adequate revenues in good times to pay for investments that promote long-term growth, such as by knocking down long-standing barriers to opportunity. States also need adequate revenues in bad times such as the COVID-19 recession, to help families and small businesses stay afloat and limit short-term harm, especially for people of color and struggling communities. Without adequate revenues, states will be hard pressed to advance antiracist policies needed in the wake of the pandemic to address structural barriers that limit states' economic potential, such as the massive disparities in wealth and incomes and persistent racial discrimination.[16]

Instead of cutting income taxes, states can help create stronger, more equitable economies by raising taxes on high incomes. This can generate substantial revenue, disproportionately from white taxpayers,[17] for public investments that improve schools in communities of color, repair often-neglected water systems and other public infrastructure in these communities, increase family incomes, dismantle racist and sexist barriers to innovation and opportunity,[18] and otherwise help build an economy whose benefits are widely shared.

TOPICS: 

State Budget and Tax

End Notes

[1] Institute on Taxation and Economic Policy, "Who Pays? 6th Edition," October 2018, https://itep.org/whopays/. In 45 states, lower-income households pay a larger share of their income in state and local taxes than high-income households.

[2] Michael Leachman et al., "Advancing Racial Equity With State Tax Policy," CBPP, November 15, 2018, https://www.cbpp.org/research/state-budget-and-tax/advancing-racial-equity-with-state-tax-policy.

[3] Michael Leachman, "Mississippi Governor Irresponsibly Proposes to Repeal State's Income Tax," CBPP, November 30, 2020, https://www.cbpp.org/blog/mississippi-governor-irresponsibly-proposes-to-repeal-states-income-tax.

[4] Cortney Sanders, "State Millionaires' Taxes Can Advance Racial Justice," CBPP, March 15, 2019, https://www.cbpp.org/blog/state-millionaires-taxes-can-advance-racial-justice. At the other end of the income spectrum, 22 percent of the nation's households are Black or Latinx, but they make up 28 percent of the nation's poorest households.

[5] The 2013 tax cuts reduced the taxes of the highest-income state residents by 1.5 percent of their income, on average, but by just 0.1 percent of income for the lowest-income North Carolinians, according to the Institute on Taxation and Economic Policy. See Leachman et al., op. cit.

[6] CBPP, "Big Cuts in State Income Taxes Not Yielding Promised Benefits," updated February 21, 2018, https://www.cbpp.org/research/big-cuts-in-state-income-taxes-not-yielding-promised-benefits.

[7] Michael Leachman, "A Kansas Wake-Up Call for Other States Considering Big Income Tax Cuts," CBPP, February 23, 2017, https://www.cbpp.org/blog/a-kansas-wake-up-call-for-other-states-considering-big-income-tax-cuts.

[8] Four of the six states that cut personal income taxes significantly in the 2000s saw their share of national employment decline after enacting the cuts. And, in the 1990s, states with the biggest tax cuts grew jobs during the next economic cycle at an average rate only one-third as large as more cautious states. Michael Leachman and Michael Mazerov, "State Personal Income Tax Cuts: Still a Poor Strategy for Economic Growth," CBPP, updated May 14, 2015, https://www.cbpp.org/research/state-budget-and-tax/state-personal-income-tax-cuts-still-a-poor-strategy-for-economic.

[9] Of the eight states (including the District of Columbia) that enacted lasting "millionaires' taxes" from 2000 to 2018, seven had per capita personal income growth at least as strong as their neighbors after raising taxes; six had growth in private-sector gross domestic product about as good as or better than their neighbors; and five added jobs at least as quickly as their neighbors. Wesley Tharpe, "Millionaires' Taxes a Smart Way for States to Invest in Their Future," CBPP, February 7, 2019, https://www.cbpp.org/blog/millionaires-taxes-a-smart-way-for-states-to-invest-in-their-future.

[10] Nicholas Johnson and Erica Williams, "Without A State Income Tax, Other Taxes Are Higher," CBPP, March 22, 2012, https://www.cbpp.org/sites/default/files/atoms/files/3-22-12sfp.pdf.

[11] Carl Davis, "Another Reason to Tax the Rich? States with High Top Tax Rates Doing as Well, if Not Better, than States Without Income Taxes," Institute on Taxation and Economic Policy, September 23, 2020, https://itep.org/another-reason-to-tax-the-rich-states-with-high-top-tax-rates-doing-as-well-if-not-better-than-states-without-income-taxes/.

[12] Wesley Tharpe, "Raising State Income Tax Rates at the Top a Sensible Way to Fund Key Investments," CBPP, February 7, 2019, https://www.cbpp.org/research/state-budget-and-tax/raising-state-income-tax-rates-at-the-top-a-sensible-way-to-fund-key

[13] Dan S. Rickman and Hongbo Wang, "U.S. State and Local Fiscal Policy and Economic Activity: Do We Know More Now?" August 7, 2018, https://mpra.ub.uni-muenchen.de/88422/1/MPRA_paper_88422.pdf.

[14] CBPP, "Tax Cuts Don't Boost Small Business Employment," https://www.cbpp.org/sites/default/files/atoms/files/5-11-15sfp-fact_4.pdf.

[15] In a survey of the founders of many of the country's fastest-growing firms, only 5 percent cited low tax rates as a factor in deciding where to launch their company. Endeavor Insight, "What Do the Best Entrepreneurs Want in a City? Lessons from the Founders of America's Fastest Growing Companies," February 2014, p. 6, https://issuu.com/endeavorglobal1/docs/what_do_the_best_entrepreneurs_want.

[16] Erica Williams and Cortney Sanders, "3 Principles for an Antiracist, Equitable State Response to COVID-19 — and a Stronger Recovery," CBPP, May 21, 2020, https://www.cbpp.org/research/state-budget-and-tax/3-principles-for-an-antiracist-equitable-state-response-to-covid-19.

[17] Cortney Sanders, "State Millionaires' Taxes Can Advance Racial Justice," CBPP, March 15, 2019, https://www.cbpp.org/blog/state-millionaires-taxes-can-advance-racial-justice.

[18] Wesley Tharpe, Michael Leachman, and Matt Saenz, "Tapping More People's Capacity to Innovate Can Help States Thrive," CBPP, December 9, 2020, https://www.cbpp.org/research/state-budget-and-tax/tapping-more-peoples-capacity-to-innovate-can-help-states-thrive.

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The Trump Administration’s Health Care Sabotage [feedly]

The Trump Administration's Health Care Sabotage
https://www.cbpp.org/research/health/the-trump-administrations-health-care-sabotage

President Trump bookended his Administration with efforts to repeal the entire Affordable Care Act (ACA) — first through legislation and, after that failed, through the courts. Late in 2020 the Trump Administration and Texas attorney general's office, with the support of 17 other Republican state attorneys general, argued before the Supreme Court that it should strike down the entire ACA as unconstitutional. If it does, some 21 million people would become uninsured, and millions more could be charged more or denied coverage altogether because they have a pre-existing condition or would lose other important protections.

Along with pushing for full ACA repeal, President Trump also took administrative actions throughout his time in office that caused people to lose coverage or made coverage less comprehensive or less affordable. Despite strong economic growth and falling unemployment between 2016 and 2019, the number of people without health insurance coverage rose by 2.3 million, including over 700,000 children. This is likely due in large part to the following and other Trump Administration actions to undermine the ACA and Medicaid.[1] The Trump Administration:

Made It Harder for Eligible People to Get Coverage

• Slashed consumer outreach and enrollment assistance. The Centers for Medicare & Medicaid Services (CMS) slashed funding for outreach by 90 percent and for the navigator program's enrollment assistance and outreach by more than 80 percent. These cuts alone caused an estimated 500,000 to 1 million people to lose coverage.
• Discouraged immigrants and their family members from enrolling in coverage. The Trump Administration issued immigration rules in 2019 that severely restricted family-based immigration to the United States and created a climate of fear among immigrants and their family members. This led many people to forgo Medicaid or marketplace coverage and other assistance programs for which they were eligible, likely contributing to uninsured rate increases among Hispanic adults, Hispanic children, and children who were not born in the United States.
• Encouraged over-verification in Medicaid and the marketplaces. The Trump Administration pressed states to add burdensome paperwork requirements and other complexity to their systems for verifying Medicaid coverage. This likely caused low-income people — among them eligible children with complex health care needs — to lose coverage and forgo needed medical care, with some states seeing large Medicaid enrollment declines for both children and adults. Likewise, the Administration added new paperwork and verification requirements in the marketplaces, for example making it harder for people to enroll mid-year through special enrollment periods and harder for some very low-income people to enroll at any time.

Encouraged States to Cut Coverage

• Took coverage away from people who didn't meet work requirements. The Administration released guidance in January 2018 that encouraged states to take Medicaid coverage away from people who weren't working or engaged in work-related activities for a specified number of hours each month. Where implemented, these policies terminated or threatened health coverage for 20 to 40 percent of those subject to them; meanwhile, studies of Arkansas' policy found it increased uninsured rates, worsened access to care, and did not increase employment. Federal courts struck down CMS' approval of demonstrations that included work requirements in several states. The Supreme Court has agreed to hear the Trump Administration's appeal of the courts' decisions.
• Imposed premiums on people in poverty. The Trump Administration gave states unprecedented authority to require people in poverty to pay premiums for their Medicaid coverage, in spite of extensive research showing that premiums significantly reduce coverage for low-income people. For example, in October 2018, it approved a Wisconsin demonstration requiring some people with incomes as low as $500 per month to pay premiums to keep their coverage.
• Threatened coverage for HealthCare.gov enrollees. In November 2020, the Trump Administration approved an unprecedented ACA waiver under which Georgia plans to exit HealthCare.gov without creating an alternative state marketplace, requiring its residents to enroll in marketplace coverage exclusively through private brokers and insurers. Tens of thousands of Georgians could lose comprehensive coverage under this fragmented and confusing system. On January 14 the Administration finalized a rule that lets other states make the same harmful change without even requiring a waiver.
• Invited state "block grant" demonstrations. The Trump Administration issued guidance in January 2020 inviting states to apply for demonstrations that would convert their Medicaid programs for adults into a form of block grant, with capped federal funding and new authorities to cut coverage and benefits. This guidance could have led to state policy changes resulting in large coverage losses and reduced access to care. In its final days in office, the Trump Administration approved an unprecedented Tennessee demonstration project that incorporates several policies from the guidance. It creates a financial incentive for Tennessee to restrict access to care for Medicaid enrollees, while offering the state a federal "slush fund" that it can use to supplant state spending with no benefit to Tennesseans needing Medicaid coverage.

Cut Financial Assistance

• Raised costs for millions with marketplace or employer plans by changing insurance payment formulas. In April 2019, the Administration finalized a rule changing the formula for how premium tax credits are updated each year. In 2022, the formula change will raise premiums, after tax credits, by almost 5 percent for millions of marketplace consumers by cutting their premium tax credits. Based on the Administration's own estimates, the rule change will likely reduce coverage by over 100,000 people in 2022.
• Other cuts to premium tax credits. In April 2017, the Trump Administration finalized a regulation letting marketplace insurers reduce the value of coverage provided in marketplace silver plans, on which premium tax credits are based. This likely reduced the value of premium tax credits for millions of people.

Weakened Consumer Protections

• Expanded subpar health plans. In October 2018, the Trump Administration finalized a regulation expanding the availability of so-called short-term health plans, which are exempt from benefit standards and protections for people with pre-existing conditions. The new rules define short-term plans as those lasting less than a year, up from three months under the previous rules, and let insurers extend them for longer. The Administration also changed rules to expand the availability of association health plans, which are also exempt from many ACA standards. Expanded availability of these subpar plans exposes consumers to new risks and raises premiums for those seeking comprehensive coverage — especially middle-income consumers with pre-existing conditions.
• Weakened standards for access to care in Medicaid. The Trump Administration significantly weakened standards for access to care for Medicaid enrollees who receive care through both the managed care and fee-for-service systems. In November 2020, the Administration finalized a rule undermining key sections of the managed care rule. In July 2019, it proposed to rescind the access rule entirely (though this change was not finalized).
• Restricted access to qualified family planning providers. The Trump Administration rescinded guidance in January 2018 that affirmed Medicaid's "free choice of provider" provision, which allows beneficiaries to receive family planning services from all qualified providers of such services. It then approved state proposals preventing qualified family planning providers, in particular Planned Parenthood, from participating in Medicaid's family planning program if they also provide abortions. This policy significantly limits access to care in many places.
• Attempted to gut anti-discrimination policies. In June 2020, the Trump Administration finalized a rule gutting anti-discrimination protections for LGBTQ+ people, women, people with limited English proficiency, and people with disabilities. Among other things, the rule eliminated specific non-discrimination protections based on sex, gender identity, and association and removes requirements ensuring that people with limited English proficiency can get important information about their health care and coverage. Within days, the Supreme Court issued a historic decision that undercuts the Trump Administration's changes, yet they are likely to create confusion and fear, causing people to delay or avoid seeking medical attention or health coverage.

January 15, 2021

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EPI: The U.S. economy could use some ‘overheating’: Biden’s relief and recovery plan meets the scale of the economic crisis [feedly]

The U.S. economy could use some 'overheating': Biden's relief and recovery plan meets the scale of the economic crisis
https://www.epi.org/blog/the-u-s-economy-could-use-some-overheating-bidens-relief-and-recovery-plan-meets-the-scale-of-the-economic-crisis/

Key takeaways:

• President-elect Biden's recently announced relief and recovery plan is highly unlikely to cause economic "overheating"—and it would be a sign of its success if it did.
• Economic "overheating" generally means large and prolonged increase in inflation and/or interest rates, but the U.S. economy has run far "too cold" for decades, largely due to the enormous rise in income inequality redistributing income to richer households that save most of their income. Unless inequality is substantially reversed, economic overheating is highly unlikely.
• Even when the unemployment rate was 3.7% in 2019, there was no sign at all of economic overheating. Any relief and recovery plan would have to push the unemployment far beneath this for an extended period of time before any real overheating could happen.
• Common metrics that deficit hawks often point to as evidence of economic overheating are not convincing.
  • The debt service burden is actually historically low in recent years due to the too-cold economy of recent decades.
  • The overall ratio of federal debt to GDP would actually likely be lower years from now if Congress passed the Biden plan, because such plans would increase GDP.

Recent proposals for large-scale fiscal relief and recovery from the economic effects of COVID-19 have drawn criticism that they could lead to "overheating" of the U.S. economy. These criticisms should be ignored. Proposals under discussion—including Biden's economic plan introduced tonight—are highly unlikely to lead to any durable uptick in inflation or interest rates (the normal indicators of "overheating") and even if they did, these higher interest rates and inflation would be a welcome sign of economic healing, not something to worry about.

Warnings about economic "overheating" normally mean that growth in spending by households, businesses, and governments (known as aggregate demand) will outpace growth in the economy's productive capacity—the stock of potential workers and capital that can be used to produce goods and services to satisfy aggregate demand. When demand growth outpaces growth in the economy's productive capacity, the result can be upward pressure on inflation (too much demand chasing too few goods and services, which drives up prices). In normal times, the Federal Reserve is the nation's inflation guard dog, and if upward pressure on inflation threatens to move it durably above what the Federal Reserve has announced as its inflation target (2%), the Fed will raise interest rates to slow growth in aggregate demand. The overheating concern is often directed at any deficit-financed fiscal plan, as the Biden relief and recovery plan appropriately is.

But profound changes in the U.S. and global economies over the past generation have made it much harder to "overheat" the economy and, in fact, have made a too-cold economy the bigger problem. Most notably, the huge rise in inequality has redistributed income to wealthier households that are much more likely to save it than spend it. All else equal, this has slowed aggregate demand growth and made it less necessary for the Fed to raise interest rates to fight off inflation driven by overheating (sometimes this chronic demand shortfall is called "secular stagnation," sometimes it is referenced as the "falling neutral rate of interest," but the upshot is clearly that demand growth is running too cold).

Some quick numbers to make the point: Between 1979 and 2000, the main interest rate controlled by the Fed averaged over 7%. Since 2000 it has averaged 1.7%, and since 2007 less than 1%. Overheating has become a far less pressing problem for the U.S. economy, even if too many economic observers and policymakers haven't fully realized it.

The 2019 labor market—the last year before the COVID-19 shock—also illustrates how hard it is to overheat the modern U.S. economy. The unemployment rate averaged 3.7% that year, the lowest level since 1969. Normally, this unemployment rate would be low enough to make economists worry that empowered workers would demand wage increases in excess of the economy's ability to deliver them, leading to wage-driven inflation. However, wage growth actually slowed in 2019, but for mostly good reasons: The high-pressure labor market was drawing in less experienced and credentialed workers who normally have more trouble finding steady work, and adding these lower-paid workers to wage data mechanically slowed measures of average wage growth. And yet, even as these workers were added to the workforce and wage growth slowed, productivity—or how much income is produced in the economy overall by an average hour of work—grew faster, expanding the economy's ability to produce goods and services and dampening inflationary pressures. This rise in productivity as labor markets tightened was predictable and provided a built-in check against overheating. In turn, core inflation in 2019 didn't accelerate measurably at all.

The Fed itself has been far more worried about too-low inflation than overheating in the last decade. They have stressed that their inflation target should not be interpreted as a hard ceiling above which inflation is never allowed to go. Instead, they have clarified that the 2% inflation target is a "flexible average inflation target" over time. Practically, this implies that long periods of inflation below 2% should be made up by extended periods above 2% before interest rates are raised. Given that inflation spent most of the past 14 years well below this target, it would take a relatively long period of inflation significantly higher than 2% before the Fed would begin steadily raising interest rates.

The upshot of this examination of the 2019 economy is that a relief and recovery plan could—and should—push the unemployment rate substantially lower than what prevailed pre-COVID before it was clear that the Federal Reserve would be hesitant to even begin raising interest rates. With that said, it is far from clear that even the admirably ambitious Biden plan would push the unemployment rate far beneath its 2019 level anytime soon. Because the chronic demand shortfalls of the last decade or more have led to historically low interest rates, they have significantly eroded one standard measure of the burden of federal debt: interest payments on this debt expressed as a share of overall gross domestic product (GDP). Despite a large rise in the overall debt as a share of GDP (more on this below) in recent years, falling interest rates have kept the debt service burden historically low. In fact, adjusted for inflation, the debt service "burden" is negative, meaning that investors are paying the Federal government for taking on its debt. Too often, commenters mistakenly treat this low debt service burden as a lucky fluke that could reverse any day. But it's not a fluke, it's the outcome of the bigger problem of the chronic shortfall in demand—a problem that was been with us (and growing) for decades and that will only be clearly solved when policymakers address its root causes, such as growing income inequality.

Those looking to whip up fears about federal debt often point to another (less informative) measure: the overall ratio of federal debt to GDP. Despite common claims, this measure tells us nothing about how "sustainable" the federal debt is, since it is entirely a backward-looking measure (i.e., the current stock of debt tells us only about deficits run in the past that resulted in this debt but tells us nothing about the likely trajectory of debt or GDP going forward). But setting aside this measure's irrelevance for debt sustainability, it is far from clear that the Biden relief and recovery plan will even increasethis measure in the medium term. What happens to the ratio depends on both the numerator (debt) and the denominator (GDP). If additions to debt are used to finance spending and investment and relief measures that raise GDP, then this will serve to reduce the debt ratio. The Biden plans will indeed raise GDP— the evidence showing that deficit-financed spending undertaken during times of economic distress boosts growth is huge and incontrovertible. This extra GDP growth will in turn boost tax revenues, which will put some downward pressure on debt growth relative to the status quo—that is, a nontrivial part of these spending and relief measures will be self-financing. In fact, when assessing the various influences together as a whole, it is highly likely that the debt ratio five years from now would be lower because the Biden relief and recovery plan will lead to a much faster recovery than if we hadn't acted.

The possibility of a lower debt ratio emerging due to the relief and recovery plan is not, obviously, the reason to undertake this. The plan should be undertaken because the U.S. economy remains deeply damaged, people are suffering, and it's time policymakers made a labor market with plenty of jobs and sustained upward pressure on wages a top priority. But the likely prospect of this package actually reducing the debt ratio just shows how misplaced typical anti-deficit arguments are in this time.

We've suffered from a too-cold economy for far too long—it's time to turn up the heat, a lot. To its credit, the Biden relief and recovery plan aims to do this.

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Dean Baker: On the Biden BILL: Debt and Deficits, Yet Again [feedly]

Debt and Deficits, Yet Again
http://feedproxy.google.com/~r/beat_the_press/~3/ZkvVHVCMHkA/

With a Democrat in the White House, the season of the deficit hawk has returned. So, it's worth going through the old arguments just to remind everyone that the best response to these people is ridicule.

It looks like President Biden will propose a robust stimulus package of well over $1 trillion. According to press accounts, the package is likely to include another check for $2,000. (I believe it is supposed to $1,400 above the $600 in the last package.) It is likely to include a refundable child tax credit that will do much to reduce child poverty.

It will also include money to state and local governments to make up massive pandemic induced shortfalls. There will also be money for mass transit and a down payment on green new deal programs. Biden also plans to increase the subsidies provided in the Affordable Care Act, to make its insurance more affordable. And, he is likely to ask for a reduction in the age of Medicare eligibility.  

In other words, this will be a really big deal. And, it will cost money. Biden will propose tax increases on the rich and corporations, but there is little doubt there will be a large increase in the deficit and the debt. So should we be worried?

The immediate issue is the deficit. The deficit hawks will be screaming that the Biden package will over-stimulate the economy, leading to rising interest rates and inflation. There is some truth to these claims, but we have to think clearly about what is at issue.

Interest rates have been extraordinarily low following the pandemic shutdown as the Federal Reserve Board sought to use the power it had to boost the economy. It set short-term interest rates to zero and brought the long-term interest rate on Treasury bonds down to 0.5 percent. Long-term rates have crept up over 1.0 percent, both due to economic recovery and the expectation that Biden will have a robust rescue package.

When Biden puts his proposal on the table, it is likely to push interest rates higher and they will rise further when we actually see the spending taking place. This should not bother us. We more typically have seen long-term interest rates in the 4-6 percent range and considerably higher in the decades of the 1970s and 1980s.

We saw interest rates first plummet in the Great Recession before recovering modestly in the recovery. They then plummeted again with the shutdown. Suppose interest rates return to the 4-6 percent range we saw before the Great Recession. What's the problem?

Interest rates in this range would have been considered normal, or even low, prior to the Great Recession. Higher interest rates will have some negative effects. We will see less construction, mortgage refinancing will slow sharply, and there will be a modest falloff in public and private investment. The dollar will also likely rise. This will make U.S. goods and services less competitive internationally, leading to a somewhat higher trade deficit.

These downsides are real, but if we are engaged in useful spending, like reducing child poverty, rescuing state and local governments so that they can maintain vital public services, slowing global warming, extending health care coverage, then these costs seem minor by comparison. In any case, it is hard to understand how having the same interest rates we saw in the 1990s and pre-Great Recession 00s is supposed to be a major catastrophe.

There is also the issue that we might see higher inflation. This also needs a big "so what?" The Fed sets a target of 2.0 percent inflation. This is supposed to be an average, not a ceiling. We have not hit this target since before the Great Recession. (The measure targeted by the Fed is the core Personal Consumption Expenditure Deflator (PCE), which is consistently 0.2-0.4 percentage points lower than the Consumer Price Index we more often see mentioned in the media.)

Suppose the inflation rate increases by 1.0 percentage point. The core PCE increased by 1.4 percentage points over the last year. A 1.0 percentage point increase puts us at 2.4 percent. This is totally consistent with the Fed's target of a 2.0 percent average inflation rate. (We can debate whether the 2.0 percent target is even appropriate, but let's ignore that for now.)

If we continue to push the economy too hard, we can see inflation rise further, hitting rates that should trouble us. But there are no models that show inflation just jumping from a modest level to more worrisome levels, barring some sort of catastrophe like a climate disaster or war. The Fed is totally prepared to take steps to slow the economy if inflation threatens to be a problem.

In short, there seems little basis for concern that too much spending will create a dangerous inflationary spiral. In addition to the valuable goals that will be furthered by this spending, we also can see the economy move back to full employment, with workers enjoying increased bargaining power.

As I and others (including Fed Chair Jerome Powell) have frequently argued, low unemployment disproportionately benefits the most disadvantaged in the labor market. The sharpest gains in employment and wages will be seen by Blacks, Hispanics, the less educated, people with disabilities, and people with criminal records. This is a really huge deal for those concerned about inequality and racial justice.

The Hit to the Stock Market

There is one issue with higher interest rates that should be noted. If long-term interest rates rise even back to pre-pandemic levels, it could lead to a substantial decline in the stock market. One of the reasons the stock market was so strong in 2020 was that there were few alternative options for investors. With long-term interest rates under 1.0 percent, the return from holding government bonds was extremely low. Also, investors took a risk of large capital losses on their bonds if interest rates rise. If the interest were 2.5 percent or 3.0 percent, holding bonds looks much better. Also, there is much less risk of a capital loss due to further rises in interest rates.

With bonds becoming a more attractive alternative, many investors will switch from stocks to bonds, putting downward pressure on stock prices. It wouldn't be unreasonable to see a 20 or 30 percent drop in stock prices. While the Donald Trump whiners will be screaming bloody murder, more serious people need not be concerned. The vast majority of stock is held by the richest of the population, with close to half held by the top one percent. A drop in stock prices would mostly be hitting the wealth of the relatively affluent and the very rich.

We should think of stock prices as being like wheat prices. A drop in wheat prices is bad news for wheat farmers, but for the rest of us, it might mean lower bread prices. We should think of the stock market the same way. Lower stock prices are not necessarily bad for the economy (they can be if the drop is due to a plunge in the economy), but they are bad news for the wealth holdings of the very rich.

Of course, not everyone who owns stock is rich. Plenty of middle-class people own stock. Also, pension funds are heavily invested in the stock market. While we may not be happy to see these folks take a hit, there are two points to keep in mind.

There was an extraordinary run-up in stock prices in the years following the Great Recession. If the market were to fall 20, or even 30, percent, investors would still be looking at a pretty good return in the last decade. They have little grounds for complaint.

The other point is that if we look at the annual returns to stockholders from dividends and share buybacks, there is little reason to think they would be hurt. If we look at a company like Apple or Walmart, their profits are likely to be just as good, or possibly even better, with a robust Biden rescue package. This means that on annual basis, these shareholders will be getting just as much money with lower stock prices as do with the current high stock prices. They have a loss of wealth, but their income from their stocks should be little affected.

Long and short, we should not be worried if we see a stock market correction in the next year or two. We need to worry about employment, wages, and other factors affecting the living standards of the bulk of the population. A drop in the stock market need not be a cause for concern.

 

The Debt and our Children

Perhaps the most pathetic argument against an ambitious rescue package is that the debt will be an enormous burden on our children. This argument usually begins and ends by pointing out that the debt is a really large number. (It is.) But throwing out a really big number doesn't tell us anything about the burden of the debt.

This is measured by the interest we pay. Last year, we paid $338 billion in interest, this year we are projected to pay $290 billion. Measured as a share of GDP, last year our interest payments came to around 1.6 percent, this year's payments are projected at 1.4 percent. By comparison, in the early and mid-1990s (a very prosperous decade) our interest burden was over 3.0 percent of GDP.

But even the 1.6 percent figure overstates the actual burden. The Federal Reserve Board currently holds trillions of dollars of government debt. The interest paid on the debt held by the Fed is refunded right back to the Treasury. Last year the Fed paid $88.5 billion to the Treasury, reducing the true interest burden by 0.4 percentage points, which leaves the interest burden at only slightly above 1.0 percentage point of GDP.

The deficit hawks rightly point out that if interest rates rise then the burden will be greater, but this ignores two points. First, interest rates are only likely to rise very much if inflation increases, in which case inflation will be eroding the real value of the debt and the burden on our children.

The other point is that higher interest rates will only gradually raise the interest burden. Much of the debt outstanding is long-term, which means that we will only see higher payments when a ten-year or thirty-year bond expires. So the idea we will suddenly be facing a crushing interest burden doesn't make any sense.

 

Debt Burden and the Burden of Government-Granted Patent and Copyright Monopolies

The deficit hawks not only exaggerate the burden of deficits and debt, they are not honest about them. Direct spending is only one way in which the government pays for things. It also pays for services by offering patent and copyright monopolies. By my calculations, these government-granted monopolies cost the economy over $1 trillion a year in higher prices for drugs, medical equipment, software, and other items.

This is a real burden that swamps the interest payments that the deficit hawks tell us will impoverish our children and grandchildren. I have never seen any economist other than myself make this point, so I will try to explain the issue in a way that even an economist can understand.

Suppose the government were to spend another $90 billion a year on developing prescription drugs, replacing what the industry currently spends. (This is in addition to the $45 billion we spend annually through the National Institutes of Health and other governmental agencies.) This $90 billion would be added to other spending and would add to the debt, with an implied future interest burden.

Suppose that to cover this spending, the government raised taxes on prescription drugs to cover the future interest cost. While the taxes will mean future deficits would be lower, they don't change the fact that the additional spending has added to our debt.

Instead of paying for the development of new drugs with direct spending, we pay for the development of new drugs by granting patent monopolies. These monopolies effectively allow drug companies to impose a tax on prescription drugs. It makes no sense to say that the interest we pay on the debt from direct government spending is a burden, but the patent rents that drug companies are allowed to collect are not a burden. In the case of prescription drugs alone, I calculated the burden in the form of higher drug prices to be close to $400 billion a year.

I'm not raising this point to say that our debt burdens are even higher than the deficit hawks claim, I'm raising the issue to make the point that our debt burden really doesn't tell us anything about the hardships we are imposing on future generations.

We will hand down a whole economy and society to future generations. If we had zero national debt, but massive amounts of patent and copyright rents, it would be hard to claim that we had served them well.

But the issue goes much further. If we fail to educate our children, with more than one-sixth growing up in poverty, we have not done well by future generations. If we leave them a decrepit infrastructure, we will not have served future generations well. And, if we destroy the natural environment by not arresting global warming and destroying the country's natural beauty, we will not have been fair to our children.

In short, the debt doesn't really measure anything. Highlighting the debt is a way for people with a political agenda to oppose spending that they don't like. It is not an honest complaint and doesn't deserve to be treated as such.

We should have a serious debate of whether the specific items being put forward by President-Elect Biden are a good use of resources. They will surely be grounds for real criticisms. But the complaint that they will add to the debt should simply be laughed out of the public debate.

The post Debt and Deficits, Yet Again appeared first on Center for Economic and Policy Research.

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