I think the peak to trough decline is overwhelmingly likely to be worse than anything I’ve seen by a significant margin. Something like a third of the workforce is not going to be able to work during the current period of social lockdown. The people who can work now are the people who can work at home and the people that have to work outside. Economists are an example in the first category, ambulance drivers are an example in the second category. But a third of the people—the dental hygienists, people who work in bookstores, the people who sweep the floors in office buildings—who neither need to go outside nor are able to do their job from home—will suffer by no longer being able to do their jobs. And that’s an immense loss of labor input and of output.
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As an economist, I am normally enthusiastic when presidents or other political leaders emphasize the economic aspect of public policy issues. I am all for economic growth, cost benefit analyses, trade agreements, more flexible markets and prudent deregulation. Yet I am appalled by President Trump’s invocation of economic arguments as a basis for overriding the judgments of public health experts about battling the coronavirus pandemic.
In fact, as a matter of pure economics — even leaving aside moral considerations that should be taken into account — the president’s arguments are flatly wrong. When Trump tweets and says things like “we cannot let the cure be worse than the problem itself” or “you can destroy a country by closing it down” and raises the prospect of reversing measures taken to promote social distancing, he misunderstands the fundamental economic problem posed by the pandemic, as well as the most rational, economically sensible way to address it. In the end, economic growth and well-being would be harmed, not helped, by the course he is advocating.
It is an elementary confusion to believe that lost growth and lost jobs are primarily a consequence of social-distancing measures rather than the pandemic itself. There are currently more than 50,000 diagnosed cases in the United States; the number is doubling every few days. Perhaps some people would be traveling, shopping and eating out as usual if there were no prohibitions. But does anyone believe that ordinary life will continue if millions of Americans have the virus and our hospitals are overflowing? This is where we surely will be in a few weeks if we abandon social distancing.
I recovered over the past year from ruptured quadriceps tendon. At a certain point, sick of the braces that kept my knees rigid, I pressed my physicians to take them off. They responded by pointing out that taking them off prematurely would put at risk all the progress I had made. If I ruptured the tendons again, they said, I would have to start the whole process over — and from a worse starting point. Fortunately, I saw their point, managed my impatience and am doing well today.
The same logic applies to social-distancing policies. Prematurely abandoning or relaxing social distancing will be disastrous on both economic and health grounds. If restrictions are lifted prematurely, the result will be a follow-on pandemic surge. More people will die. What will the policy choice be then? If it is a return to restriction, starting from a much less favorable point and much more disease spread, then the cumulative economic loss will be greatly magnified. The costs we have already borne will have been totally in vain.
Indeed, as a matter of logic, overly temporary social distancing represents the worst of all policy alternatives. In the view of almost all experts, it would be a grave mistake to accept the full and rapid spread of coronavirus as inevitable. But if this is to be our strategy, there is no reason not to get on with it, rather than suffer the additional burden of temporary distancing.
Ending restrictions too soon and allowing a further disease spike carry a range of collateral risks and costs. When it is safe to take up old habits, will the public trust the advice of authorities who misled them? What extra uncertainty cost will be baked into all financial markets when it becomes clear that the federal government has offered false assurances on safety? Will other countries be willing to buy our goods when the United States has turned itself unnecessarily and against the advice of experts into an exporter of products?
The president has compared the challenge of pandemic to the challenge of war. But Americans do not fight wars for our freedom saying we can only keep going for another few weeks and then we will give up. Elevating temporary economic expedience over the long run health of the citizenry is a dangerous strategy. And we deserve better from our business community than demands to go back to selling when disease counts are still rising.
The president and the business leaders who urge him to abandon a public health orientation to pandemic policy are nonetheless correct to want to move through the current difficult period rapidly as possible. The right focus is not on false hopes. It is on realistic strategies that permit a targeted approach to reducing transmission. That means more testing, more contact tracing, and more and better facilities for those who need to be separated from others or treated.
There will come a time when we can gradually let up on current restrictions and help the economy in the process. It will be the moment when new case counts are no longer accelerating; when we have adequate measures in place to quickly catch and contain new outbreaks; and when we are confident that we are not endangering hard-won progress by impetuous actions.
While the Fed acted preemptively Tuesday, it is still too early to say much that is definitive about the economic threat from coronavirus. We do know, however, that this is one of the most dangerous and disruptive disease outbreaks since World War I.
Science and medicine have of course progressed massively since the 1918 Spanish flu. On the other hand, the world has nearly five times as many people now, and our interconnection is vastly greater, with 2.8 million people flying each day, in the United States alone, inside metal tubes with recirculating atmospheres. Large fractions of the world population live in places with little ability to carry out systematic health policies.
According to the Centers for Disease Control and Prevention, roughly one-third of the world’s population was infected with the deadly Spanish flu, and 50 million people died — about 3 percent of global population then and a mortality rate of about 1 in 10. Suppose with novel coronavirus the mortality rate turns out to be 1 percent and the disease reaches 10 percent of the world, so that fatalities amount to not 1 percent but 0.1 percent of the global population. The result would be more than 7 million deaths.
What we have seen so far has already had far-reaching economic effects. International meetings are being canceled. Shipments from Asia to the Port of Los Angeles are likely to be down by 25 percent in February. Financial markets, which are forward-looking, lost $6 trillion over six days before regaining some of the lost ground. It is close to an even chance the U.S. and global economies will go into recession in the next 18 months.
The questions in the current moment properly revolve first and foremost around public-health strategy. But there is much for economic policymakers to consider as well. Unfortunately, the tool that has received the most attention — monetary policy — is not likely to be very effective in a crisis of this kind, and the way it’s used could create problems down the road. It may on balance be desirable to cut interest rates — as the Fed voted to do Tuesday ― but the principal focus should be elsewhere.
Common sense offers the most important point. When, as in the 2008 financial crisis, output is dropping because consumers and businesses cannot afford to repay loans or get new ones, lowering interest rates and making more credit available is the natural and appropriate policy response. But when GDP falls because businesses cannot get components necessary to generate output, because quarantines limit people’s ability to work and because potential customers are rationally afraid to enter public spaces, then monetary policy is much less useful.
Moreover, this is all happening when the efficacy of monetary policy may already be largely exhausted. With 10-year U.S. rates approaching 1 percent, high uncertainty and limited room for cutting short-term rates, it is far from clear how much monetary moves can encourage economic activity, even without a pandemic.
There are also tactical issues to consider. The hardest moments for economic policymakers are when the power of the tool at their disposal is less than what is generally supposed. In such a circumstance, policy can function better as a potentially potent “sword of Damocles” than it would if its limited efficacy were laid bare. Closely related to this is the idea of never shooting your last bullet. And to the almost inevitable extent that it would appear political, a sharp move to easy money may undercut the Fed’s credibility.
Despite all this, Tuesday’s rate cut may nonetheless have been the right option, simply to avoid adding disappointment with the central bank to the current challenges. But the benefits of monetary pyrotechnics like Tuesday’s in the form of extraordinary timing and size of monetary moves have to be balanced against the alarm they may cause and the way they leave central banks exposed as lacking effective tools.
Much more attention should be devoted to economic policies better targeted at pandemic risk.
First, central banks should develop a facility to assure that credit is not cut off to key sectors of the economy, come what may. Steadily available credit is much more important than lower-priced credit.
Second, as huge excess capacity at major global ports suggests, this is a moment for less — not more — interference with trade flows. Though it may go against the president’s instincts, the United States should lead a global effort to reduce tariffs as a source of stimulus for the duration of the health emergency.
Third, planning should begin for fiscal expansion via federal budgetary investments in areas like the purchase of ventilators, videoconferencing equipment and distance-education technologies, all of which are directly connected to the coronavirus problem. And, of course, there is far more risk of spending too little on health research and production of health goods than in spending too much.
Fourth, international financial institutions’ failure to move to help the world’s poorest countries at a moment when they could suffer an AIDS-level catastrophe is scandalous. The United States should use its influence to assure that the International Monetary Fund, World Bank and regional banks step up on behalf of all nations, for all nations.
Just as the 2008 financial crisis upended the 2008 presidential election, coronavirus may upend this presidential campaign. 2008 was about money and the economy. This will be about money and life and death.
By Natasha Sarin and Lawrence H. Summers
Over the past year, the concept that corporations owe a responsibility to the broader society beyond their responsibility to their shareholders has flourished. The Business Roundtable renounced its earlier view that companies exist to serve stockholders and endorsed stakeholder capitalism last summer. BlackRock chief executive Larry Fink, whose firm controls $7 trillion in investable funds, expects a “fundamental reshaping of finance” and has vowed to vote against corporate directors insufficiently committed to serving interests beyond those of stockholders.
This year’s Davos meeting was centered on business’s responsibility to protect the environment. And there has been much celebration of recent corporate commitments, such as Microsoft’s promise to invest $1 billion to end or offset all of its greenhouse-gas emissions, present and past.
The most important stakeholder of U.S. corporations is the United States itself. Before any obligation to voluntarily reduce emissions, start charter schools or pay above-market wages should come an obligation to pay a reasonable share of income in taxes. Many of our most successful corporations have used accounting tricks, especially those involving sales of intellectual property to low tax jurisdictions, to avoid paying federal taxes.
A stunning story recently published jointly by Fortune and ProPublica credibly alleges that Microsoft avoided tens of billions in corporate tax liability by locating its profits in Puerto Rico on the advice of KPMG, and then waged all-out war against IRS efforts to hire strong counsel and gather information from key witnesses. (In a comment for the story, Microsoft said that it “follows the law and has always fully paid the taxes it owes”; the IRS’s audit efforts are ongoing.) Facebook is being investigated for its profit-shifting behavior, and in a number of years Amazon has paid no taxes. Companies such as Google, Netflix, Delta and General Motors pay a much lower share of their taxes in profits than the vast majority of successful small businesses.
As is so often the case, there is a major question here of whether the scandal is illegal things companies do, or the things that are legal. No doubt that much of the problem involves badly written tax laws that permit large-scale reduction in taxes below common-sense levels. But this goes only so far as a defense for companies that have lobbied and used campaign contributions to shape tax law. And apart from shaping the law, corporations that wish to be seen as good corporate citizens should refrain from pushing the envelope as they file their returns.
The issue here goes beyond corporate hypocrisy and even the significant revenue that could be collected from better tax laws and enforcement. With confidence in government and big business at a nadir, and global cooperation seen as harming ordinary Americans, a serious effort at restoring taxation would represent a substantial, economically rational response to populist and nationalist pressures. It is a legitimate source of outrage that a former senior Treasury official can assert — without apparent criticism from the corporate, tax bar or accounting communities — that the S in IRS stands for the “service” that the IRS should first and foremost provide to business taxpayers.
What should be done?
First, the tax code needs to be reformed. The United States should enthusiastically join the European-led effort to ensure that digital companies are taxed at reasonable rates, as long as the effort is expanded to cover other sectors where corporations from other countries dominate. And current approaches to the allocation of income across jurisdictions should be reviewed. For instance, ways to support Puerto Rico can be found without tax breaks for multinationals that exacerbate the federal deficit and do more for highly profitable but lightly taxed major corporations than they do for Puerto Rico.
Second, tax enforcement should be beefed up. It is a scandal that the share of large corporations that face corporate audits has fallen by half in the past decade. And the audits that remain are less aggressive, with the IRS almost 90 percent less likely to challenge companies’ tax liabilities than they were a decade ago.
Third, as in antitrust, Congress should make clear that it expects the IRS to hire and fully compensate top-flight legal and financial experts when bringing actions in tax matters. It is indefensible that star private litigators are only rarely used in tax matters and that it appears Microsoft was able to successfully challenge private counsel’s right to question their employees. Similarly, to improve effectiveness in enforcement, statutes of limitation should be extended and disclosure requirements increased.
Fourth, no matter how much enforcement is enhanced and the tax code reformed, there will still be efforts to play the audit lottery and take unreasonable positions. Strong actions including treble damages, removal of privileges for attorneys and accountants to practice before the IRS and direct financial penalties on executives should be considered as means to discourage efforts to push the envelope. The case for taxpayer privacy is far less compelling with respect to public corporations than it is for individuals. Some sunlight on how companies allocate income across jurisdictions could also be an effective disinfectant.
Fifth, anyone who is concerned with business being seen as constructive — such as the Roundtable, large institutional investors or presidents and their treasury secretaries — should work to change the law to eliminate the most egregious shelters and make clear that they are prepared to name and shame companies that don’t meet their obligations.
Justice Oliver Wendell Holmes famously said, “Taxes are what we pay for a civilized society.” Any company that wishes to be thought of as a good citizen needs to join the effort to combat corporate tax avoidance. No issue is more important to restoring the legitimacy of our economic system.
Lawrence H. Summers is a professor at and past president of Harvard University. He was treasury secretary from 1999 to 2001 and an economic adviser to President Barack Obama from 2009 through 2010.
Natasha Sarin is an assistant professor of law at the University of Pennsylvania Law School and an assistant professor of finance at the Wharton School.
www.larrysummers.com
Lawrence H. Summers, former U.S. Treasury Secretary, dismisses Former Federal Reserve Chairman Ben Bernanke’s optimism for central bankers in a recent speech to the American Economic Association. He spoke with David Westin on “Bloomberg Wall Street Week.” (Source: Bloomberg)
January 7, 2020
Few economic virtues are more universally applauded than thrift.
Going back at least to Ben Franklin, Americans have equated greater thriftiness with greater worthiness. Progressives decry the limited saving and wealth accumulation of middle-income families and express alarm over the widely reported “fact” that 40 percent of Americans cannot come up with $400 in an emergency. Conservatives applaud thrift as an aspect of self-reliance and propose ideas such as health-savings accounts to help families prepare for emergencies. Moderates believe universal social insurance programs such as Social Security and Medicare, which they label as entitlements, should be modest or even curtailed out of fiscal prudence.
In the current economic context of extremely low interest rates, however, these views are more wrong than right. The federal government should provide more, not less, social insurance. If it did, the result would be reduced inequality, a more secure middle class and a stronger economy.
The immediate financial insecurity of the middle class has been exaggerated. That frequently cited 40 percent figure comes from a Federal Reserve survey asking how individuals would meet an unexpected $400 expense. About 60 percent said they would meet the expenditure by dipping into cash or its equivalent, which in turn is the basis for the claim that 40 percent of families would have to borrow on credit cards or from family members. But the same Fed survey found that 85 percent of adults could meet a $400 expense while still paying all their bills.
The real challenges that keep middle-class families up at night are retirement, economic dislocation and supporting their children as they go to college and then buy a first home. These cost far more than $400 and are not best met by personal saving. Rather, a generous and well-functioning society in which Social Security meets retirement needs, appropriate unemployment and wage insurance programs cushion economic shocks, adequate public funding holds down college costs, and health insurance has generous coverage would greatly reduce the need for most households to save.
It is highly inefficient to rely on individual saving rather than universal public programs to deal with life’s contingencies. Social Security, for example, pays out close to 99 percent of the revenue it collects in benefits. In contrast, individuals saving for retirement or the proverbial rainy day can over a lifetime dissipate as much as 20 percent of their savings in commission payments to financial institutions. Similar, and probably greater, efficiencies are associated with government provision of other forms of insurance.
There is the further point that self-reliance is an especially implausible way to deal with catastrophes such as disability or the loss of a good-paying job without the availability of an alternative. Genuinely preparing for such contingencies would involve building up a large nest egg at a substantial cost in terms of current consumption. Meanwhile, the feared contingencies never arise for most people. That’s why pooling risk through insurance is the best strategy.
All of this has always been true. What makes this an especially propitious time to expand, rather than contract, government-provided social insurance is the current macroeconomic environment. After adjusting for inflation, the interest rate on safe debt securities is essentially zero.
Suppose the government expands Social Security by raising taxes on payrolls by, say, 2 percentage points and pays the proceeds to the retired generation, then continues this policy indefinitely. The generation currently retired would get a windfall gain. And each subsequent generation would earn a return on the taxes it pays equal to the economy’s growth rate, which is well above rates of interest.
The combination of the economies available from having the government provide insurance services, plus the return premium made available by such pay-as-you-go finance, makes public programs the right way to strengthen the middle class. This becomes even more true once it is recognized that, as long as initiatives are financed at least in substantial part from highly progressive taxes, the result will be to reduce inequality.
And finally there is the observation that more social insurance, even if fully paid for by contributions, will raise demand in the economy by reducing households’ need to save. By increasing normal interest rates, this will push the economy forward and contribute to financial stability.
The clear verdict: We don’t need fewer entitlements for the American middle class. We need more.
By Natasha Sarin and Lawrence H. Summers
November 17, 2019
While there’s plenty of disagreement about how the money should be used, almost everyone involved in public-policy debates agrees that it would be good if the federal government could collect more revenue without raising tax rates or reducing tax deductions or credits.
It should be indisputable that investment to make sure all citizens meet their tax obligations is desirable. Such investment would raise substantial revenue, as well as increase economic efficiency and help redress growing inequality: Our rough estimates suggest that at least 70 percent of the “tax gap”— defined as owed but uncollected taxes — comes from underpayment by the top 1 percent. This contributes to legitimate concerns that our tax system unfairly advantages the elite.
Our new analysis suggests that better-focused audits, raising Internal Revenue Service enforcement to previous peak levels, investing in information technology and broadening earnings reporting could raise more than $1 trillion in the next decade, primarily from very high-income taxpayers. This well exceeds the revenue benefit of raising the top individual rate to 70 percent.
Some basic facts about tax compliance and enforcement:
Extrapolating from the most recently available IRS information, the tax gap will be more than $7.5 trillion over a decade. You only need to close 15 percent of this gap to raise $1 trillion.
Enforcement effort — as reflected in the share of gross collections reinvested in the IRS — has declined by approximately 35 percent over the past decade, and the decline has been disproportionate for corporations and millionaires: In 2011, more than 12 percent of individuals making $1 million or more annually were audited; last year, only 3.2 percent were. Audit revenue declines proportionally to the declining audit rates.
At present, recipients of the earned-income tax credit — all of whom have incomes below $50,000 — are about as likely as those making $500,000 or more to be audited.
Only 5 percent of taxpayers earning above $5 million are audited — even though IRS data demonstrates that an extra auditor-hour spent on their returns raises almost $5,000 on average.
Fewer than 1 percent of corporate returns were audited in 2018 — even though corporate audits on average raised nearly $1 million in additional revenue.
The IRS invests less than a quarter as much in information technology as major banks and still relies on systems from the 1960s. Pilot projects suggest payoff rates on strategic IT investments could approach 50:1.
When third-party income reports exist to compare to individual tax returns, income is correctly reported more than 95 percent of the time. Almost all income earned by individuals who make $200,000 or less annually gets reported in this way. But without such substantiation, between 17 percent and 55 percent of income goes unreported (and so untaxed) — and more than two-thirds of the income of those who earn $10 million or more falls into this category.
There are more facts in this vein. But these should be sufficient to demonstrate that there is plenty of low-hanging fruit in the area of tax enforcement.
What is the overall potential? In a study released this weekend, we conservatively priced out a program of increased auditing, IT investment and greater third-party reporting. We estimated that it would be possible to close 15 percent of the tax gap by spending approximately $100 billion on additional enforcement, as would be necessary to return the IRS to its historical scale. Every $1 that is spent would generate more than $11 in greater tax collection.
Congressional scorekeepers have suggested more modest revenue potential from investment in enforcement; however, our study shows these differences can be reconciled. Their approach is based on a program that is more modest in size (only a quarter as large as our proposed restoration of enforcement effort to previous peak levels) and scope (we consider the revenue potential of targeting audit resources on high-income individuals, as well as increasing information reporting). Critically, the Congressional Budget Office does not account for deterrence effects, which Treasury Department reports suggest greatly magnify the revenue gains from increased enforcement.
Why is the federal government leaving so much money on the table? Part of the answer is that there are powerful interests that want to maintain a system that facilitates evasion.
Likely more important, though, are congressional budget procedures. Historically, it was common for congressional leaders faced with last-hour budget gaps to rely on substance-less “tax compliance initiatives” to plug holes. The practice became discredited, and revenue from increased enforcement came to be excluded from budget scoring.
What’s counted counts. When credit is not given for the revenue that will be collected from increased enforcement spending, it can hardly be surprising that tax compliance is neglected.
Restoring the IRS budget would, we believe, pay for itself many times over. It would also create a more progressive tax regime: At a time when working people pay their taxes in full, because of withholding, it would be reassuring for the tax law to be equally well-enforced on high-income earners.
Assuring compliance to the maximum extent feasible is not where tax reform should end, given the many problems with the current system and our need for significantly greater revenue. But it is where it should begin.
Natasha Sarin is an assistant professor of law at the University of Pennsylvania Law School and an assistant professor of finance at the Wharton School.
Campaign arithmetic is always optimistic, but errors are highly consequential with respect to a program that on some measures is eight times as large as the Trump tax cut. Warren estimates the revenue potential of increased Internal Revenue Service enforcement as being about 65 times as large as the Congressional Budget Office’s enforcement proposal. The University of Pennsylvania’s Natasha Sarin and I have been working to make the case that the CBO is far too pessimistic in its estimates of the potential for better enforcement to generate revenue. But the most optimistic scenario we can envision is still more than $1 trillion short of the Warren estimate.
Further, Warren’s plan would double the 3 percent tax on wealth over $1 billion that she has already proposed. Many experts believe the Warren wealth-tax revenue estimates are too high, perhaps by a factor of two, because they overestimate the wealth of the very rich and, as Sarin and I have argued, underestimate potential avoidance. Whatever the merits of these arguments, it is hard to see a defense for assuming — as the Warren proposal does — that wealth taxes can be doubled with no impact on avoidance, or that annual capital gains taxes can be levied without reducing the wealth tax base. The estimates are also infected by erroneous transcription of the CBO’s 10-year growth estimates and by a general failure to take account of interactions between the different tax measures proposed.
Second, there will be large labor market effects: Warren’s plan will discourage hiring, particularly of low-skilled workers, by firms that currently provide generous benefits. These firms will face the most burdensome taxes when they increase hiring and will gain the greatest cost savings by laying off workers. In addition, workers’ incentives to take jobs will be dulled because they will no longer be compensated with health benefits (which will become available regardless of what they do). There are further potential economic perversities as well: To cut costs, firms will be incentivized to get below the 50-employee threshold and scale back on current health benefits. And all the efforts that employers have engaged in to contain costs and to encourage prevention will become pointless.
Third, the combined tax impact of Warren’s various plans is extreme. While the case for more tax progressivity is compelling, and each of the Warren measures can be defended in isolation, there is the concern that their cumulative impact may be excessive should, as the Warren campaign repeatedly claims, they be borne only by the very wealthy. Here is a suggestive comparison: The total after-tax adjusted gross income of all those earning more than $1 million or more, as last reported by the IRS in its Statistics of Income publication, was under $1.1 trillion. The sum of all the new taxes on the wealthy proposed by Warren is of comparable magnitude: adding together around $310 billion a year in new wealth taxes; $330 billion a year in corporate taxes from her new proposals and her previous real corporate profits taxes; $240 billion a year from her new capital gains and finance tax proposals; at least $90 billion from her across-the-board 14.8 percent taxes of labor and investment income; and $190 billion in increased compliance. This totals nearly $1.2 trillion — more than millionaires’ total after-tax income.
Of course, this calculation is an oversimplification. Different taxpayers are situated differently and will be affected differently by any set of proposals. There will be tax collections from those who are not middle class but still earn less than $1 million a year. There are sources of “income” that will be taxed under the Medicare-for-all proposal that do not show up in current adjusted gross income — unrealized capital gains or corporate retained earnings, for example. On the other hand, it’s highly problematic given the avoidance and other bad incentives likely to result, to be anywhere in the ballpark of confiscatory taxation of high-income taxpayers.
Finally, what of the economic and financial effects of Warren’s proposals? A place to start is by thinking about the potential impact on the stock market. The market is valued as investors’ claim on future corporate earnings, which the Bureau of Economic Analysis estimates are about $1.8 trillion this year. As a result of all the tax claims just described, the Warren program would reduce investors’ claim on these earnings. Recognizing that some of these taxes fall on salary income or non-corporate business, it is reasonable to estimate that investors will pay an extra $500 billion to $600 billion in taxes related to corporate profits. Then, Medicare-for-all proponents cite a severe hit to health industry profits, currently on track to be over $200 billion this year. Then, there will be the broader impacts of overhauling regulation, often to serve vital social interests, in initiatives such as banning fracking and reforming the energy industry, stepping up financial regulation, a major increase in antitrust enforcement and the regulation of technology companies, and filling corporate board seats with labor representatives. It is hard to see an argument that investors’ claim on profits would fall less than a third. The figure could be considerably greater.
Because of abnormally high valuations, along with increased uncertainty and volatility, loss of business confidence and selling pressure from those in distress, the market would likely fall more than proportionally to earnings. Accurate market predictions are impossible and will in any event depend not on what is proposed but on what the market expects will actually take place. There is, however, the real risk of economic contraction following a sharp market decline, especially given that the current very low level of interest rates puts the Fed in a weak position to pursue counter-cyclical policy.
For decades, I have emphasized that corporate profits and the market do better when progressives are in power and have dismissed conservative fear-mongering about progressive policies.
This time seems different. Judged relative to gross domestic product, the Medicare-for-all program dwarfs the federal spending hikes of the New Deal and the Great Society. Presidents Franklin D. Roosevelt and Lyndon B. Johnson emphasized that their new benefits would be paid for by contributions from their middle-class beneficiaries. With Warren’s plan, it is the combination of vast new entitlements with total reliance on the top 1 percent for revenue that puts us in uncharted and, I fear, dangerous territory.
Governments should borrow more to stave off secular stagnation
October 11, 2019
New IMF managing director Kristalina Georgieva’s first speech makes bracing reading for the global financial community as it gathers this coming week in Washington for the annual IMF and World Bank meetings. Ms Georgieva noted that while two years ago growth was accelerating in 75 per cent of the world, the IMF now expects it to decelerate in nearly 90 per cent of the global economy in 2019 to the lowest level in a decade.
This shift into reverse comes as central banks in Europe and Japan have embraced negative interest rates and investors expect further rate cuts from the US Federal Reserve. Bonds worth more than $15tn are trading with negative yields.
If the primary problem were on the supply side, one would expect to see upward price pressure. Instead, despite loose fiscal and monetary policy, central banks in the industrialised world have as a group fallen well short of their inflation targets for a decade and markets project that this will continue.
Europe and Japan are engaged in black hole monetary policy. Without a major discontinuity, there is no prospect of policy rates returning to positive territory. The US appears to be one recession away from entering the same black hole. If so, the whole industrialised world would be providing at best negligible and often negative returns to risk-free savings and falling short of growth and inflation targets. It would also have to maintain financial stability amid increased incentives for leverage and risk-taking.
All this requires new thinking and new policies, much as the rapid inflation of the 1970s forced a reset back then. Once economies are in the monetary black hole, central banks that focus on inflation targeting will be ineffectual in hitting their immediate goal and unable to stabilise output and employment. The policy action has to shift elsewhere.
Today’s core macroeconomic problem is profoundly different from the problem any living policymaker has seen before. As I have been arguing for some years now, it is a version of the secular stagnation — chronic lack of demand — that terrified Alvin Hansen during the Depression. In today’s global economy, private investment demand is manifestly unable to absorb private savings even with negative real interest rates and limited restraints on financial markets. That is why even with burgeoning government debt and unsustainable lending, growth remains sluggish and below target.
Since 2013, when I first argued that we were seeing more than simple “economic headwinds”, interest rates have been much lower, fiscal deficits have been much larger, and leverage and asset prices have been much higher than expected. Yet growth and inflation have fallen short of forecasts. That is exactly what one would expect from secular stagnation: a chronic shortage of private sector demand.
What is to be done? To start it would be helpful if policymakers acknowledged this week that the policy problem is not smoothing cyclical fluctuations or preventing profligacy. Rather the fundamental issue is assuring that global demand is sufficient and reasonably distributed across countries.
The place to start is by dampening down trade wars — deeds, threats and rhetoric. Trade warriors think they are participating in zero-sum games globally with one country gaining demand at the expense of another by opening markets or imposing protection. In fact trade conflicts are negative-sum games because there is no winner to offset the demand that is lost when uncertainty inhibits and delays spending decisions.
Given the risk of a catastrophic deflationary spiral, central banks are probably right to attempt to ease monetary conditions. But diminishing returns have surely set in with respect to monetary policy and there is risk of doing real damage to the health of the banks and other financial intermediaries.
Most important governments need to rethink fiscal policy. Government debt or government support for private debt is needed to absorb savings flows. With real rates near zero or even negative, the cost of debt service is very low and low rates can be locked in for decades. That means that the debt levels that were prudent when rates were at 5 per cent no longer apply in today’s zero interest rate world. Governments that run chronic surpluses are failing to do their part to support the global economy and should be the object of international scrutiny.
There are other possible interventions. Increasing pay-as-you-go public pensions would reduce private saving without pushing up deficits. Public guarantees could spur private green investments. New regulations that prompt businesses to accelerate their replacement cycles will increase private investment. Measures to create more hospitable environments for investment in developing countries can also promote the absorption of global saving.
Spurring sound spending is the antidote to secular stagnation and monetary black holes. It should be an easier technical problem to solve and much easier to sell politically than the austerity challenges of earlier eras. But problems cannot be solved until they are properly diagnosed and the global financial community is not there yet. Hopefully that will change this week.
October 9, 2019
The economic geography of the United States is central to our most serious economic social and political problems. And yet it is a subject that receives only the episodic attention of federal policymakers and initiatives that are far too small to have a meaningful chance of success.
By almost any measure, U.S. citizens no longer share a common lived experience. Men age 25 to 54 in Arlington, Va., have a 5 percent chance of being without work. Men in Flint, Mich., have more than 35 percent chance of that. Life expectancies across states differ by more than five years — more than the impact of doubling all cancer rates. Intergenerational mobility differs by a factor of more than two across regions of the country. Areas with high rates of joblessness also have high rates of depression and pessimism about the future, and low rates of confidence in U.S. institutions.
The regional economies that comprise the United States used to be converging. Mississippi is still the poorest state, but its relative income is much higher than it was a decade ago. Studies done toward the end of the 20th century often found that city and state unemployment rates were not correlated from one decade to the next. No longer. Recent work suggests that in regions where work was in short supply in 1980, joblessness may have gotten even worse over the subsequent generation. The same is true of all the various indices of social distress.
Why? Part of the answer is migration between cities and states has fallen sharply in recent decades, in part because of problems in the housing market. It may also be that migration has become less effective in fostering economic mobility than economists suppose. Outmigration from troubled areas tends to disproportionately remove those area’s most able and catalytic residents. There is also the consideration that outmigration reduces the demand for new construction and the value of housing wealth, which in turn reduces spending.
Perhaps most important, weak economic performance coupled with outmigration sets the stage for what might be called fiscal-space death spirals. Just when the need to train and retrain workers for jobs outside traditional industries expands, the capacity to fund community colleges and other training institutions declines. Just as it comes to seem most important to attract new businesses, the capacity to fund first-rate schools and necessary specialized infrastructure is most circumscribed. It cannot be an accident that Northern Virginia, one of the most economically vibrant areas in the United States, could afford to attract Amazon (Amazon founder and chief executive Jeff Bezos owns The Washington Post), or that Rust Belt cities, with their many pension and other liabilities, struggle to hold on to the businesses they have.
A look at an economic and political map of the United States, or that of almost any other industrial country, for that matter, points up the political stakes in deteriorating economic geography. The areas where distress is greatest and opportunity is least provide disproportionate support for candidates advocating populist nationalist policies that seek to close off the rest of the world, to demonize immigrants and to resist the inclusion of minority groups.
What is to be done? Traditional approaches have involved tax incentives for investments in distressed places. It hasn’t worked well, as the tax incentives have often gone to projects with little real development content or that would have happened anyway. In any event, the investment has been small relative to the scale of the problem.
Here are some larger ideas that should be thought through carefully. Perhaps the federal government should levy punitive taxes on the receipts from targeted local tax incentives. This would stop the zero-sum competition between localities, and give more disadvantaged communities a fairer chance to compete.
The federal government could also announce plans to provide extra support to public education and community colleges in areas where joblessness is high or has recently risen. There is no reason investment in the next generation should suffer most where current pain is greatest.
Because interest rates are so low that there is limited room for them to be reduced, the response to the next recession will inevitably be focused on fiscal policy. Policymakers should design it keeping clearly in mind that the economic multiplier will be greatest, and the inflationary impact least, where the economy lags most.
These may or may not be the best ideas for enabling people wherever they live to share in U.S. economic progress, and they are no substitute for addressing inequality more directly. But it is hard to see how we can bring about enduring improvement in the nation’s condition without addressing the needs of the tens of millions of Americans who live in places that are failing to catch up with the rest of our country.
It is hard for me to think about carrying on my career as an economist without Marty Feldstein.
I first met Marty in 1973, 46 years ago, when he hired me as part of his flotilla of a dozen or so research assistants. Read more
The Business Roundtable recently announced a major policy change declaring that the purpose of a corporation is not just to serve shareholders (its official position since 1997) but “to create value for all our stakeholders.” At a time of considerable disillusionment with U.S. capitalism, this is a significant statement that could signal meaningful change in the operation of the American economy. Certainly the recognition by leading chief executives that they need to look beyond the narrow metric of their stock price is to be welcomed.
But there are some questions that Business Roundtable members will need to wrestle with going forward. This is crucial, because initiatives of this kind can be not just ineffective but also counterproductive if they weaken the impulse to address problems through government policy.
First, who will watch CEOs going forward? Under what authority do CEOs have the role of declaring the purposes of the corporations as broader than just shareholders, when they were appointed by boards of directors representing shareholders? It’s legendary that whenever you serve multiple masters, you serve none. With shareholders disempowered and no other form of vigilance empowered, how will the risk that stakeholder capitalism becomes an agenda of CEO empowerment be avoided?
Second, will the roundtable act on its professed principles? For example, I have no idea whether recent grievances against General Electric, Boeing or Johnson & Johnson are warranted, but if they are valid, they represent blatant violations of the roundtable’s principles. Will companies or CEOs ever be forced to leave the Business Roundtable? How will this be adjudicated?
Third, while the statement references communities, consumers and customers, what role does the United States have as a stakeholder for roundtable companies? Are roundtable companies that act according to the group’s principles supposed to be indifferent between locating new plants in the United States and other countries? What obligation are roundtable companies now under not to subvert American democracy with campaign contributions or extensive lobbying operations? What is their obligation to speak out against presidential words or deeds that undermine the United States’ standing in the world or offend core values of their employees or customers?
Fourth, is it as clear as the Business Roundtable seems to assume that standing up for stakeholders is the right thing to do in a dynamic economy? Consider, for example, a firm debating whether to relocate some or all of its operations out of super-prosperous, fully employed Silicon Valley to a disadvantaged area to reduce labor costs. On “shareholder” grounds, this would likely be desirable. Its employee stakeholders would likely object. Yet I would argue that broad American egalitarian values would be well-served by the move. We generally celebrate disruptive innovation such as digital photography, but it often comes at the expense of some employees and customers with traditional skills and tastes. How are stakeholder capitalists supposed to decide about pursuing disruptive innovation?
Fifth, what role does the roundtable imagine for public policy? The idea that companies should be run for the benefit of stakeholders is a powerful one. But for it to work, companies that practice stakeholder capitalism must be protected by law from excessively ruthless competition from companies run only in shareholders’ interests.
If the Business Roundtable is serious about stakeholder capitalism, and if responsible firms are to flourish and spread their benefits, it will not just decree principles according to which its firms will operate but will also push for laws and regulations that support firms’ ability to stand up for their stakeholders. These might include minimum-wage and benefits requirements and broader mandates to protect companies that want to do right by their workers from those competing companies that are ruthlessly pursuing shareholder interests. Or they might include rigorous restrictions on advertising and promotion practices, so firms who are honest and transparent are not placed at a competitive disadvantage. Or universally high capital standards on financial institutions, so that imprudent willingness to take on risk cannot be a competitive advantage.
Most CEOs want to do the right thing by all their stakeholders, and most shareholders want to support them in being responsible. But in a world of fierce competition, good intentions are not enough. All companies do right some of the time. Some companies do right all of the time. But even the Business Roundtable should know that all companies do not do right all of the time. That is why a serious Business Roundtable program in support of stakeholder capitalism will include legislation and regulation.
Martin S. Feldstein was a great economist who changed the world through research, teaching, public service, hundreds of op-eds in these pages over 40 years, and leadership of the National Bureau of Economic Research.
Marty, who died Tuesday, June 11, at 79, didn’t lack for recognition. He earned the American Economic Association’s John Bates Clark medal and then its presidency, chairmanship of President Reagan’s Council of Economic Advisers, numerous honorary degrees, and memberships in prestigious scholarly and policy groups.
It was all well-deserved and has been well-chronicled in his obituaries. For me, though, Marty’s death isn’t merely the loss of an economics superstar; it is the loss of a mentor and friend who, through his teaching, generosity of spirit and example, made possible everything I have been able to achieve professionally. Countless others can say the same about him, in their own ways.
I met Marty in the summer of 1973 when he decided to take a chance on hiring a disheveled college sophomore as his research assistant. Marty was infinitely patient with my many questions about his research and remarkably tolerant of my inability to keep straight his data on international social-security comparisons.
Working for him, I saw what I had not seen in the classroom: that rigorous and close statistical analysis of data can provide better answers to economic questions, and possibly better lives for millions of people. A doctor can treat a patient. An economist, through research or policy advice, can improve life for a population.
Marty was appointed president of the NBER in 1977—a position he held for more than 30 years. The NBER became my professional home and occasionally my literal home as I slept near its computer terminals. In Marty’s work and what he created at the NBER, I can recognize many things that seem commonplace today but were new at the time. A network of hundreds of economists collaborating, debating and sharing data made far more progress than even geniuses working alone. More important, Marty’s research showed how data about individuals from the census, tax records or hospitals—information then rarely used by economists—could provide sharp answers to questions about policy.
At the time Marty was publishing more papers in top scholarly journals every year than most economists produce in a lifetime. I read them avidly and saw new frontiers open up for my generation of economists to study. Before Marty, public-finance economists had focused on who paid tax checks and who received government benefits, and on mathematically elegant abstract models of taxation. Marty persistently argued that it was also crucial to consider the incentive effects of tax and benefit programs. In the process he set the agenda for decades of research and contemporary debates on dynamic scoring and tax and social-insurance reform.
During his career Marty taught introductory economics to more than 10,000 undergraduates. The best economics course I ever took was taught by Marty. I learned from him what good and generous teaching is all about. I was one of dozens of graduate students whom he allowed to be listed as co-authors on studies of his design. On hundreds of occasions over the years, I was privileged to be a guest at the Feldstein home, where Marty and his wife, Kate, entertained students and junior colleagues.
Marty was a magnet for talent. I had the privilege of serving on his staff when he chaired the CEA. Marty didn’t care that I was a Democrat or that Paul Krugman was as well. That staff also included Greg Mankiw and Larry Lindsey, who went on to senior positions in Republican administrations. Marty cared about people’s economic analysis, not their political affiliation. That is why he mentored stars like Jeffrey Sachs and Raj Chetty, who disagreed with him on many questions, and why I so enjoyed working with him as he made valuable contributions to President Obama’s Economic Recovery Advisory Board.
I learned an important lesson about integrity in government from Marty’s service at the CEA. He was a powerful advocate for the Reagan administration’s agenda of lowering marginal tax rates and cutting government spending. But he wasn’t a deficit apologist and introduced into the public discourse ideas like “twin” budget and trade deficits and the adverse effects of anticipated future deficits.
For Marty, economics was a calling, never an intellectual game or a political tool. He represented the best in our profession and brought out the best in all those whose lives he touched. It has been the privilege of my professional life to follow in Marty Feldstein’s wake. Rest in peace, my mentor.
The Federal Reserve will over the next several months make monetary policy decisions that are as consequential as any it has made since the financial crisis and Great Recession of 2007-2008. The temptation in a highly uncertain and politicized environment will be to move cautiously. Yet this would be a grave error in the current context, where a recession could be catastrophic and the odds of one beginning in the next year, while still less than 50-50, now appear significant and increasing.
While the headline number for first-quarter growth in gross domestic product (GDP) was a robust 3.1 percent, the details of the report suggest much weaker prospective growth. Jason Furman has highlighted that the gap between GDP as reported and the conceptually equivalent GDI, (gross domestic income) measure is now at its highest level since the onset of the Great Recession.
Moreover, the components of GDP that have predictive powerfor future growth are running at less than half the total GDP growth rate. Little wonder that most forecasters’ expectations for second-quarter growth are well below 2 percent. Other grounds for concern include weak reports from business on spending intentions, trade-war uncertainty and yield curve inversions —traditional predictors of recessions.
The best way to take out recession or slowdown insurance would be for the Fed to cut interest rates by 50 basis points over the summer and by more, if necessary, in the fall. A serious recession anytime in the next few years would encourage populism and polarization at home, and reduce American influence and strength in the world as well as damaging the global economy. It is clear in retrospect that the Fed was too slow in responding to gathering storms during 2008 as the Great Recession took hold and in 2000 when the Internet bubble collapsed.
Given that monetary policy operates with substantial lags and that downturns develop momentum once they start, monetary policy delay is always problematic when recession is a risk. For several reasons, slow Fed action would be especially dangerous in the current context.
First, markets currently expect rate cuts, so failure to deliver would be a negative surprise; it would have direct adverse effects and raise questions about whether the Fed is adequately sensitive to economic conditions. After the Fed unnecessarily raised rates last December, market gyrations and economic anxiety were contained when Chairman Jerome Powell signaled a dramatic change in policy, but the agitation illustrated what can happen when the Fed disappoints.
Second, the Fed normally cuts rates by a cumulative 5 percentage points in response to recession, and with rates now below 2.5 percent there is nothing approaching that amount available. Allowing a recession with inadequate firepower to confront it risks “Japanification” — a situation where interest rates are permanently pinned at zero and deflationary pressures take hold. The Fed will be able to do too little in combating the next recession, so it is especially important that it’s not too late.
Third, and perhaps most important, unlike the normal situation where the benefits of supporting the economy need to be weighed against the risks of allowing inflation, we are now in a situation where the Fed needs to accelerate inflation to meet its 2 percent inflation target. Core inflation on the Fed’s preferred indicator has come in at 1.6 percent over the last year and 1 percent over the last quarter. Moreover, market expectations as reflected in Treasury index bonds are for inflation on the Fed’s preferred measure to remain in the 1.5 range even over a 30-year horizon and to be even lower over shorter horizons. There is the further point that with a 2 percent inflation target, inflation during good times should run above 2 percent to compensate for its lower level during recessions.
Sometimes the Fed should worry that overly easy policy will lead to complacency in financial markets. In light of recent volatility in the markets and with the possibility of more adverse surprises on the trade front, this is not such a time.
If rate cuts by the Fed are seen as a capitulation to President Trump, this sort of pressure may be counterproductive, even apart from any long-term consequences. It would be tragic, though, if a lack of institutional self-confidence and a focus on appearances kept the Fed from doing what is best for the economy.
By Anna Stansbury and Lawrence H. Summers
The Washington Post
May 31, 2019
Sen. Marco Rubio (R-Fla.) recently released a thoughtful report highlighting a substantial issue in the American economy: the steady decline of American private investment.
The trend, Rubio contends, is the result of shareholder capitalism and corporate short-termism. In other words, business decision making has shifted toward “delivering returns quickly and predictably to investors, rather than building long-term capabilities through investment and production,” as he writes in his analysis. Read more
On Monday, China announced new tariffs on $60 billion of U.S. exports, and the United States threatened new tariffs on up to $300 billion of Chinese goods. These actions were cited as the principle reason for a decline of more than 600 points in the Dow Jones industrial average, or about 2.4 percent in broader measures of the stock market. With the total value of U.S. stocks around $30 trillion, this decline represents more than $700 billion in lost wealth.
This was not an isolated event. Again and again in the past year, markets have gyrated in response to the state of trade negotiations between the United States and China.
The market sensitivity to threats and counter-threats in the trade war is quite remarkable. Monday’s announcement by the Chinese, for example, would be expected to raise China’s tariffs by about $10 billion. Much of this will show up as higher prices for Chinese importers, and some of it will be avoided by diverting exports of goods such as liquid natural gas to other markets, so the impact on U.S. corporate profits will be far less than $10 billion. Meanwhile, U.S. tariffs are likely to raise corporate profits as higher import costs push some business to domestic producers.
There is the further consideration that reasonable market participants should not have entirely discounted the possibility of tariff increases Monday and that there surely remains some chance a trade deal will be reached. So, in fact, the market should not even have moved in full proportion to the change in corporate profitability associated with new tariffs.
There is a revealing puzzle here. Events whose direct impact on corporate profits is a few billion dollars seem to be driving market fluctuations that change the total value of corporations by hundreds of billions of dollars. To be sure, there would be many ways of refining my calculation of the profit impact to recognize various feedbacks, and certainly the imposition of tariffs increases uncertainty, which in general depresses markets. But with any plausible calculation of the direct impact of tariff changes on profitability or uncertainty about profitability, it is not possible to justify the kinds of changes in market value we observed Monday or on many other days when there was news about the status of the U.S.-China trade negotiations.
Part of the answer to the puzzle, I suspect, lies in markets’ tendency to sometimes overreact to news, especially in areas where they do not have long experience. This idea is supported by the tendency illustrated by the market’s Tuesday rally, which took place without any particularly encouraging U.S.-China developments.
A larger part of the answer probably lies in the idea that the current trade conflict is a possible prelude to a far larger conflict between the two nations with the largest economies and greatest power for as far as can be foreseen. When it appears less likely that a conflict over well-defined and ultimately not-that-difficult commercial issues can be resolved, rational observers conclude that it is also less likely the United States and China can manage issues ranging from 5G wireless technology to North Korea, from the future of Taiwan to global climate change, and from the management of globalization to the security architecture of the Pacific region.
A world where relations between the United States and China are largely conflictual could involve a breakdown of global supply chains, a splinternet (as separate, noninteroperable internets compete around the world), greatly increased defense expenditures and conceivably even military conflict. All of this would be catastrophic for living standards and would also have huge adverse effects on the value of global companies.
It is, I suspect, the greater risk of catastrophic medium-run outcomes, rather than the proximate impact of trade conflicts, that is driving the outsize market reactions to trade negotiation news.
This carries with it an important lesson for both sides: It is risky to turn the pursuit of even vital national objectives into an existential crusade. Rather, even when nations have objectives that are in conflict, it is important to seek compromise, to avoid inflammatory rhetoric and to confine rather than enlarge the areas where demands are being made. Establishing credibility that promises will be kept and surprises will be avoided is as or more important with adversaries as with friends.
As the Trump administration carries on the trade negotiations, and as the presidential campaign heats up, Americans will do well to remember that there is no greater threat to the success of our national enterprise over the next quarter-century than mismanagement of the relationship with China. It is not just possible but essential to be strong and resolute without being imprudent and provocative
