Why is the U.S. headed for fiscal disaster (if it is)? - Part Three

The fiscal meltdown scenario that Len Burman and others posit as a significant possibility, and that I affirmatively believe will happen in the U.S. within the next 15 years, requires that financial markets fail to operate smoothly or efficiently.

Suppose the U.S. has rising default risk, and that the hypothesis that we will deal with it in a rational rather than a needlessly destructive way is growing continually less credible. Meanwhile, suppose our debt to GDP ratio is rapidly growing, and that so much of the debt is short-term (as Burman’s paper shows) that we have to keep rolling over an enormous percentage of it each year. Then what is the playout with efficient and well-functioning financial markets?

The answer is pretty clear. The interest rate that the U.S. has to pay starts rising. This sends a signal to U.S. politicians and voters that they have to change their ways. As they lack a good alternative, even with the serious defects in the political system that I alluded to in my prior post, the ship gradually turns, and there is absolutely no reason for a calamitous budget crisis – a fundamentally discontinuous event, akin to going 100 MPH despite the brick wall at the end of the alley and then suddenly smashing into it – ever to happen.

Of course, discontinuous market events, seemingly without sufficiently new information to trigger them, do indeed happen. The sudden collapse of a bubble is the key example here, and indeed is what people like me are positing when we predict at least the possibility of a horrendous crisis, in lieu of the smoother scenario with gradually rising interest rates.

As an aside before I get to the question of why there might be a bubble in the U.S. bond market that is at risk of exploding suddenly some day, what should the U.S. government do about the fact that its borrowing rate is currently so low? Here the optimists at yesterday’s Columbia session made a point that I (to a degree) think is correct.

Again, the interest rate that the U.S. government has to pay for borrowing seemingly should be high, yet we observe that it’s very low. If the pessimists are right and financial markets are wrong, the unduly low rate implies a wealth transfer, in expected value terms, from lenders to the U.S. government. Shouldn’t we exploit to the hilt by borrowing as much as we can on these terms? (At least, isn’t that the right answer if we don’t conclude instead, as the optimists may have meant to imply, that the markets must actually be right after all, in which case the wealth transfer would be illusory.)

The answer is yes – we should take advantage of it, if we can do so properly. Hence it might make sense to run current budget deficits even without the ongoing recession or any claim about the need for Keynesian stimulus. But here are 3 reasons why this does not imply that the current U.S. fiscal path, with its huge deficits currently and as far as the eye can see, makes sense:

1) Even if low interest rates would make large deficits currently rational even without the recession and Keynesian story, there is no good reason not to put the U.S. budget on a sustainable path by currently deciding on and announcing how it will be achieved. At a minimum, this would make the low interest rate environment more robust.

2) The rational borrowing story calls for using the money to make productive investments, which are much easier to find (the hurdle rate becomes lower) if we are borrowing cheaply. The usual buzz word one hears, of course, is infrastructure. Or the government could simply buy assets that offer it a higher return than it is paying due to the low borrowing rate, and profit from the spread (if all the political choice problems this poses could be solved). But none of this is happening. Instead, we are using cheap borrowing to fund current consumption.

3) Borrowing for current consumption, just like investing profitably, becomes more appealing if the interest rate is low. But the path we are on, by reason of doing it this way, makes no sense in terms of long-term consumption smoothing. Even with cheap borrowing, it doesn’t make sense to frontload the consumption as much as we are doing, by holding off entirely on the very painful tax and spending adjustments that (mere arithmetic tells us) are highly likely to be necessary soon.

OK, on to the question of how financial markets could be getting it so wrong. Should we instead assume that they must be getting it right, such as by rightly predicting that the U.S. political system will make the needed adjustments before things get ugly? Who should we believe, the financial markets or our lying eyes?

And this is where saying “What about 2008 and mortgages?” becomes, not just a cheap retort, but to my mind a convincing one.

What did we learn from the events of 2008? Not just that financial markets can sometimes get it wrong. We also learned a lot, the hard way, about how they operate.

There were plenty of people who knew and said before 2008 that you can’t keep making loans to people who cannot repay and count on perpetually rising home prices to keep the whole thing operating. All the underlying problems that came home to roost were public knowledge – for example, concerning the loan originators’ incentives and the rating agencies’ fee structure – and yet the right conclusions mostly were not drawn.

A few people saw what was happening. As a result of getting it right, if they were able to carry their short positions for long enough, they got rich. But they didn’t move the overall market until it was too late. And no penalty was suffered by the individuals who got it wrong, and who thereby (while accumulating huge fortunes) imposed huge losses on everyone else. And don’t think for a moment that this lesson wasn’t noticed by the people who are making the calls on Wall Street to this day.

How could a bubble market in U.S. government bonds persist when the lenders are in effect making a gift (though without charitable intent) by buying and holding bonds at an interest rate that is too low given the true (actual or implicit) default risk? The main answers to this question include the following:

(1) Some big players in this market, such as the Chinese government, are willing to make the gift because from their perspective it isn’t one. Rather, it simply is part of the cost they have to pay to achieve purposes of their own. The Chinese government is subsidizing imports to stimulate its economy during a period of massive rural to urban transition that contributes to their preexisting post-Tianenman Square eagerness to avoid political unrest. Other big players, such as from the oil states, likewise have economic incentives other than as investors, and may be serving their own institutional interests whether or not those of their nations in the long run.

(2) The flight to quality creates a winner-take-all contest for the laurel of safest asset. And for now the dollar wins, because what else is there? The Euro looks even worse. But the winner of this beauty contest can suddenly and unpredictably change, potentially leading overnight to a panicked rush away from dollars and dollar-denominated assets.

(3) Even among conventional market actors, the massive inefficiencies in financial markets that we saw in 2008 are still there. These guys are not pricing U.S. government default risk in their models (or rather they are running short-term models in which it’s zero), just as they weren’t properly pricing scenarios of nationwide real estate price drops. It simply isn’t how either they or they models operate. Irrational? Socially yes, but at the individual actor level probably no. Keep in mind – these guys are betting other people’s money under poorly designed incentive compensation schemes under which they get rich too fast to care much if their careers end up being shortened when the crunch hits. In short, the Berle-Means problem of agency costs from the separation of ownership from control operates on the manager side, while collective action problems hamstring responses on the investor side. And just as in 2007, this encourages massive disregard of tail risk, or what would happen to one’s seemingly extra-normal returns when the bottom finally drops out.

In other words, we have a financial system in which, notwithstanding Adam Smith’s invisible hand, no one has the right incentives, and getting it right does not bring a sufficiently sure or proximate reward.

What is going to happen when the Chinese finally have to change course, and/or the dollar loses its first place rank in the safest-asset competition, and/or the other market actors finally start pricing the risk of U.S. government default in their investment models? This can rapidly lead to a self-reinforcing feedback loop, in which the need for a higher interest rate raises the likelihood of U.S. government default, which triggers the need for a still higher interest rate that triggers a still greater likelihood of default, until there’s no price at which anyone is willing to lend.

What happens then is anyone’s guess, but we just may get to find out some day. Lucky us.

Why is the U.S. headed for fiscal disaster (if it is)? - Part Two

The political story behind expecting a U.S. fiscal disaster is that nothing like the benign story of the Brookings and AEI experts designing the best available compromise solution to restore sustainability will ever be allowed to happen. Instead, the doomsayers (including me) say, we’ll refuse to turn off the road to a budgetary disaster until it’s too late, even though the fixes would be much less bad than permitting the disaster to occur.

For possible details of the disaster, see the Burman paper. Or think about Greece’s problems today, only worse since we’d be dragging down the entire world economy with us. Possible details might include a very rapid 25% decline in output, Weimar Germany-style hyper-inflation, wipe-out of millions of people’s life savings, very slow recovery, and little significant economic growth for a generation. Plus all the political fallout that such a state of affairs might entail – think Weimar Germany again, only this time the loonies who took over large countries or regional rivals in various global hotspots would have nuclear weapons.

But back to the question of why the disaster would be allowed to occur. One of the strange things about the fiscal crisis is that everyone knows it’s out there. The Tea Partiers could be interpreted as worrying about it, although their solution is to cut taxes while retaining all government spending that they like (which is about 99% of the overall federal budget, although they seem to think that it’s 5%). But I’ve been talking to “lay” people in the hundreds about this issue for 15 years (having published books about it in 1997 and 2007), and I have yet to find anyone who was surprised or didn’t already know about it.

So why doesn’t our political system deal with it? Why would Obama be committing political suicide (above and beyond anything of the sort he’s accomplished already) if he seriously tried to take this issue on, rather than agreeing to massive tax cut extensions? (My hopes from the panel he’s empowered are quite limited, though I will probably be more sympathetic to the entitlements changes they might propose than most commentators on the left. And the panel is certain, I gather, not to address the tax side of the ledger in any serious way at all.)

The optimists think the political system will deal with it non-catastrophically in due course, and is just waiting for a clearer crisis. One point to the contrary is that dealing with it demonstrably gets much costlier and more painful if you wait. But the second point to the contrary, which is utterly unprovable in advance but happens to be my belief, is that our political system has reached the point of being unable to deal rationally with crises even though it used to have some such capacity. On this one, we’ll simply have to wait and see who’s right – the optimists, or the people like me who have become pessimists.

One reason no one will fix it in advance of a direr crisis, even though everyone knows the problem is looming, is the underlying chicken game. I used to think of this mainly in terms of the parties. Suppose that Democrats and Republicans both know that a mix of spending cuts that the Democrats especially dislike and tax increases that the Republicans especially dislike will eventually be needed. What’s more, both sides know that they will have to make a handshake deal on the package, as one side acting alone would get politically crucified. You don’t want to be the first to flinch and offer a deal, because you are hoping to have the ultimate concessions be as much on their side, and as little on your side, as possible. But at some point one side must flinch and the other side reciprocate, or else we all go over the cliff. Chicken games can end catastrophically, although this requires miscalculation.

Back in the 1980s, the chicken game was why legislative staffers such as me when I was at the Joint Committee on Taxation sometimes had to work late. House and Senate negotiators over a big tax bill would wait until the last minute to make a deal because they wanted to minimize their own concessions. But apart from hasty drafting and needless loss of sleep the social cost was low. Why should it end up so much worse, with everyone going over the cliff, in the future budgetary scenario?

The answer that pessimists such as myself would make is that U.S. politics has fundamentally changed for the worse. There are many reasons why things are different today than they were in the 1980s (and to a lesser degree the 1990s), but perhaps the key one, to me, is that the Republicans have gone stark raving mad. (Plenty of conservatives would agree with this diagnosis, by the way – try asking Bruce Bartlett and David Frum.)

Why have the Repubs gone stark raving mad? It’s easy to blame individuals – say, Newt Gingrich and Grover Norquist. Or to cite contingent historical events – e.g., the first President Bush makes a brave and wise budgetary compromise in 1990, and this costs him the 1992 election because the Republican right retaliates. But I suspect there are deeper sociological forces at work here, relating to how white people above a certain age have responded to modernization, demographic changes in U.S. racial composition, etcetera, and that you therefore have to look from a historical and sociological perspective rather than at particular politicians and their tactics. But that’s clearly beyond my personal expertise.

Anyway, how do we know that U.S. politics has fundamentally changed? We really don’t know this for sure – and indeed it was a point of disagreement at the Columbia seminar on Burman’s paper yesterday. But Burman’s personal experience in Washington over the last 20 years matches my own in concluding that it has.

We’ve never had the fundamental rejection of modern science by a major political party that we now have today. So it’s hard to see why they’d stop – indeed, to date they haven’t – at also rejecting arithmetic, which is all you need to say that the budget numbers don’t add up over the long term, under plans they'd tolerate (and could actually get enacted) no less than under current policy.

And since so much of this is about chicken games, I should add that one side’s provocations can lead to the other to up the ante. There are people on the left out there using the phrase “catfood commission” to defame what might be reasonable efforts to restrain entitlements growth while protecting elderly people on the bottom of the income distribution. And the Democrats saw that Clinton’s hard work in helping create the budget surplus simply gave Bush a bigger wallet to blow on his friends and his causes. So they will not be in any rush to try that again.

The chicken game goes beyond the political parties to individual voters, however. Why does everyone, while realizing that we have a problem, stand ready to vote out any politician who proposes to do anything serious about it? One way of thinking about the answer – apart from people who simply hope the adjustment can be postponed until they are no longer on the scene – is in terms of a chicken game. I should resist any changes which take some of the solution out of my hide, because there are always alternative solutions available that would take less from me and more from someone else.

One last point about the politics is the following. I’ve been suggesting so far that U.S. politics used to be “normal” and capable of making hard decisions, but has now become abnormal or aberrant and has lost its ability to do so. I happen to think that’s pretty true. But perhaps this gets things backwards, in a sense. Maybe our political system’s ability to deal with these problems in the 1980s and 1990s was exceptional and unusual, not the current inability that pessimists such as me posit.

There’s lots of convincing political science work to the effect that the political system should be expected to fail in dealing with this stuff. Think of the Virginia school public choice Leviathan literature, or the work of Alberto Alesina & others about how political factions’ short-term incentives can lead them to play dangerous budgetary games. Sometimes I almost get the sense that one could logically prove that the budgetary accomplishments of the 1980s and 1990s couldn’t have actually happened. Sure, as the saying goes, it worked in practice, but not in theory. How can we explain the good things that happened without resort to unconvincing clichés about leadership, people who cared about the national interest, etcetera?

One explanation I’ve offered in previous writing is that it related to the Downsian dynamic to compete for the median voter. Reagan and O’Neill could compete as well as cooperate by showing the people in the center, “I’m as reasonable as he is” (which also helped them both to hold off rival leadership claimants).

But U.S. politics is much less Downsian than it used to be. E.g., Republicans don’t exactly get nominated these days by showing their primary constituencies that they are the true centrists who can win in November. There are a lot of institutional reasons why the Downsian rush to the center has abated. E.g., “natural gerrymandering” at the state level from sorting into blue and red states. The way money and interest group politics has played out lately. But one factor that I regard as important is what I call differential turnout elasticity.

One reason Repubs don’t always face Downsian pressures to head to the middle, even once they have been nominated, is that for every vote they gain in the center by convincing median voters that they are a better fit than the Democratic candidate, they lose 3 votes on the right wing fringe by dampening enthusiasm such that their prospective voters stay home. With voter turnout being so low, and with the particular dynamics of a far-right group that has to be enthusiastic or they’ll stay home, the Downsian dynamic which produced budget compromises is simply far less operative than it used to be.

Anyway, I can’t prove we’re headed for disaster on the ground that politicians and their incentives have changed. But I think we are. And I know that many informed observers of the political system agree that it is radically different today than it was 20 years ago, even if we can’t entirely figure out why it happened or agree as to what diagnoses are most plausible.

Against this view, economist types on the optimist side of the debate think they have a trump card. They say: What makes you think you’re smarter than the financial markets? The market obviously doesn’t see a problem – that’s why interest rates for U.S. government bonds are currently so low. The market still defines U.S. Treasuries as risk-free. So it evidently has determined that things are going to be just fine in the end. And since that reflects informed people betting real money – as opposed to you pessimist blowhards, who are just pontificating – they have got to be right.

Needless to say, this view might have been a bit more convincing before 2008. We now have a snappy retort: Yeah, this is the same market that did such a great job evaluating subprime default risk.

But this is a good place to end this post, at the moment of transition to my recent realization that there’s a crucial onion layer inside the politics (just as the politics is inside the demographic & technological layer), relating to how financial markets function. I will save that topic for my next follow-up post, most likely in the mid-afternoon or else tomorrow (as just now the tennis court and farmer's market are beckoning).

Why is the U.S. headed for fiscal disaster (if it is)? - Part One

Len Burman’s paper, “Catastrophic Budget Failure,” presented yesterday at Columbia Law School’s tax policy colloquium, describes how the end game of U.S. fiscal unsustainability could potentially play out. Short version: it might not be pretty.

Also, the paper shows that, with a couple of reasonable assumptions, such as about how interest rates might start to rise about ten years from now in response to the U.S. fiscal situation, the line showing our debt to GDP ratio might turn highly vertical by the early to mid 2020s, which really isn’t that far off.

I had thought I was done for now writing about fiscal issues, for a couple of reasons. The first is that I thought I had pretty much worked through my understanding of the very complex and multi-faceted issues raised. The second is that I get the sense sometimes that the market has spoken, in the sense that my input on these issues is less noticed and valued than on issues closer to my known professional specialization. People out there seem to think I’m more worth reading on, say, corporate or international tax policy or fundamental tax reform than on the long-term budget issues, for which they turn purely to economists.

Now, I don’t actually agree with this judgment – I think that my analysis of the budget issues is very good (if I may say so), and gets to the core of the issues as only the very best work by economists does, while also featuring a different mix of qualities (e.g., no number-crunching, but more value added on the normative and political science aspects). But people have their expectations, and I certainly don’t feel slighted in general by the market out there. Apparently, just as people don’t especially want a synth album from Neil Young, so they don’t seem to want this sort of stuff as much from me. Fine, so be it.

But I’m nonetheless tempted to write again about these issues, perhaps in Tax Notes or some such thing. So whether or not that happens (as I’d hate to take more time off from my ongoing and much-delayed international tax book), here are some rough preliminary thoughts as prompted by last night’s discussion at Columbia.

My understanding of why the U.S. might face a fiscal disaster has gone through 3 stages. First I understood it as a demographic problem, which I soon saw included as well a path-of-technology aspect. Then I came to understand it as more fundamentally a political problem. Finally, with help from Len’s paper, I’ve come to see it as perhaps even more fundamentally a problem of how financial markets (mal)function. But each new interpretation supplements rather than supersedes the prior ones.

The demographic and technological problem – Everyone knows about this bit. Rising life expectancies, baby bust after the baby boom, etcetera. The technological piece is that the long-term U.S. fiscal picture wouldn’t be nearly as bad, despite the plummeting worker to retiree ratios, if healthcare weren’t growing faster than GDP for technological as well as demographic reasons.

In theory, it’s ambiguous whether advances in medical technology should on balance make healthcare more expensive or less. E.g., for every costly new procedure that makes a previously untreatable problem something we can handle at great expense, there may also be a cost-saving innovation. E.g., you take a daily pill and, as a result, don’t need open heart surgery next year.

In practice, however, technological advances have unambiguously had the net effect of making healthcare more expensive, not less. Why is this? It could be something about the technological “space” at the frontier of current knowledge into which our R&D innovators are currently advancing. But it also could have a lot to do with the innovators’ incentives in a healthcare world in which consumers have only limited cost-consciousness due to tax-favored employer-provided healthcare, Medicare, Medicaid, etcetera.

I often quote Brad DeLong’s statement in a blog entry some years back to the effect that liberal economists think the big problem in healthcare is adverse selection while conservative economists think it’s moral hazard (i.e., consumers’ lack of cost-consciousness), to which I add (I don’t recall if Brad did) that the unfortunate thing is, both are right. The liberal economists like to point to evidence that consumers in healthcare don’t act quite the same as when buying a car or a breakfast cereal, seemingly weighing against the relevance of the conservative economists’ diagnosis. But I think the case that the latter (as well as the former) group is right is strengthened if you look at healthcare dynamically over time in terms of where the innovators find it profitable to go. When they won’t get rewarded for cost-saving to the same degree as for new treatments, you get the moral hazard story in full force.

This won’t change unless incentives in the healthcare sector do. Which I don’t see happening any time soon, though this of course gets us into the political story.

OK, that’s the demographic and technological piece. But the reason I no longer see that as the core problem (albeit a key precondition) could be summarized as follows. While current policies place us on an unsustainable path, all we have to do is change them. How could we do that? Well, here’s one easy way. Take one serious, principled liberal economist with healthcare and budgetary expertise, and one, serious, principled conservative economist. Say, perhaps someone at Brookings or Urban plus one of the good people at AEI. Give the pair of them full staff back-up for estimates and the like, and give them 2 weeks to come up with an answer that they have agreed to between themselves, and that the politicians then promise to implement. They could easily do it.

The end result wouldn’t be pretty (it would have changes that no one at any point along the political spectrum actually liked, in that we’d be forced to confront the nasty empirical fact of scarcity), but there would be no fiscal crisis. But this is not going to happen, because our political system doesn’t operate this way.
But one last point on the healthcare front before moving on to politics. This hypothetical compromise might lead to people more often NOT getting the best available healthcare in 20 years than they do today. But the best available healthcare in 20 years may be so much better than what we currently get (for technological reasons), that you’d have people getting much better healthcare than us absolutely, just worse than us relative to what is contemporaneously available.

OK, on to politics. But this blog entry is so long already that I think I’ll end it here and post a follow-up that continues the analysis, hopefully some time later today.

Video of the NYU Forum on extending the Bush tax cuts

Here it is, more than an hour long but not without some amusing moments. Includes brief commentary on 1980s vs. 70s and 90s pop music, and on rejecting science versus rejecting arithmetic.

Revised paper

Kim Clausing and I have posted on SSRN a revised version of our paper, "A Burden-Neutral Shift from Foreign Tax Creditability to Deductibility?"

While generally similar to the previous draft, we've cleaned up a few problems and tried to make the analysis and motivation clearer.

NYU Forum on extending the Bush tax cuts

As expected, a good session (and with high student attendance) reflecting considerable agreement between Diane Lim Rogers, Alan Viard, and myself.

Brief excerpt from my introductory remarks:

"I see 3 key facts for today’s discussion. First, we’re either in recession or just out of it with a danger of severe relapse. Either way, unemployment is much too high. So I believe the economy needs further stimulus if it can be done effectively. Allowing tax rates to increase would be the opposite of stimulus. But extending the tax cuts is poorly designed stimulus, and concern about the state of the economy would only support extending the tax cuts temporarily.

"Second, we are on an unsustainable fiscal path, with projected spending way ahead of projected revenues. Taxes WILL have to go up. Spending growth – in particular healthcare-related – WILL have to slow. Otherwise, we’ll eventually have a fiscal crisis, potentially leading to both a severe depression and hyper-inflation, that will make what happened two years ago look like a walk in the park

"Given our unsustainable fiscal path, I’d say it verges on insanity to consider extending ANY of the rate cuts more than temporarily, unless the extension is financed (and then some) by other changes that include raising taxes in some other way instead. Yet the Democrats and Republicans both want to extend unsustainable tax cuts, and only disagree about the top bracket.

"Third, in the last 20 years, there has been a big change in U.S. wealth distribution. In particular, if you go not just to the 99th percentile but to the upper portion of that, you’ll observe substantial relative gains compared to everyone else. Why this happened & how bad it is (if it’s bad at all) is disputed, as well as what if anything to do about it. [But addressing this, however important for its own sake, is not going to be more than a small part of addressing the fiscal gap problem.]

As Diane (see here) and Alan (see here) both blog, I look forward to reading their comments, if any, about the session, and may perhaps cross-link and extend the colloquy.

Cheerful discussions of the long-term U.S. budget situation

As I've previously mentioned, at tomorrow's Forum at NYU Law School, Diane Lim Rogers, Alan Viard, and I will be discussing the budgetary insanity of extending some or all of the expiring Bush era individual tax cuts. I will post my introductory remarks shortly after the event.

Then on Thursday, Len Burman will be presenting a paper at our rival (?) law school to the north, entitled Catastrophic Budget Failure.

One nice thing about this paper is that it goes through some possible scenarios for the eventual catastrophic U.S. budget failure that current U.S. political trends - far more than simply prevailing economic, demographic, or technological trends - suggest to me is verging on inevitable. When the crunch comes, the credit markets may simply seize up, with the U.S. unable to borrow at any interest rate, and the U.S. economy may rapidly shrink by 25% (a la the Great Depression, but with hyper-inflation to boot).

Here's the conclusion: "Continuation of current patterns of taxing and spending would cause U.S. debt levels to reach unprecedented levels. The CBO (2009b)calculates that debt would reach 100 percent of GDP by 2023 and 200 percent of GDP by 2038. As bleak as those projections are, they do not reflect likely macroeconomic feedback effects. Including the effects of rising debt on interest rates and economic growth, the debt-to-GDP ratio will increase even faster.

We fear, however, that a far worse scenario may be in our future. It is possible that interest rates will not respond significantly to rising debt levels for many years — because of a bubble in financial markets or because foreign lenders have an incentive to fuel our imports by enabling our large budget deficits. This cannot go on forever and when the bubble bursts, the consequences for the United States would be a severe recession or depression with a significant probability of hyper-inflation. Since the United States is so large relative to the world economy, catastrophic budget failure would likely create economic carnage around the world, which could feed back to deepen and lengthen our own economic decline.

Unfortunately, given current knowledge, it is impossible to predict when or even if such a budget crisis could occur or exactly how it would play out. However, the possible consequences are so severe that avoiding it should be a high priority. The solution is relatively straightforward: cut spending, especially for entitlements, and raise revenues to stabilize and eventually reduce debt as a share of the economy."

Unintended ambiguity?

On my way back to NYU after my lunch talk at St. John's earlier today, I saw a parked car with two bumper stickers. The first said "No drilling." The second said, "No farms, no food."

Reading the second one in light of the first one, I wanted to tell the car owner, Hey, I hate drilling too, what with BP & the Gulf and all that, but do you really want to do away with all farms and food?

Talk today at St. John's University Law School

I'm heading to Queens, NYC shortly to give a lunch talk at St. John's University Law School, based on my just-published paper (with Doug Shackelford and Joel Slemrod) Taxation and the Financial Sector.

I've given talks on this paper and posted the slides before. But, as I've shortened and clarified them for today, in good part by downplaying issues (such as retributively motivated bonus taxes) that are much less of-the-moment now than when we were writing the paper, I'll post a pdf of the revised slides here.

UPDATE: The session went well. Much of the discussion focused on financial transactions tax (a.k.a. turnover tax or Tobin tax) versus financial activities tax (falling on extra-normal financial institutions profits, on the view that they're either rents or else correlated with tail risk that creates negative externalities). I'm more sympathetic to the latter and think it worth exploring further, though this appears these days to be politically unlikely.

But the high point personally for me came shortly before the talk, when one of the faculty members in attendance (whom I hadn't met before) handed me a copy of Getting It to sign, and told me (as have several other readers) that it had given him a delightful day over the summer and made him laugh out loud at numerous points.

Ding dong, the wicked witch is dead

When the Yanks finally get eliminated in a given year, I feel more relief than enjoyment. It makes the rest of the post-season more relaxing and fun, but I still can't forget the astonishing terms of MLB "competition" these days.

Okay, they lost to the Rangers despite having used their vast financial superiority to take away the Rangers' best two pre-Hamilton hitters (A-Rod and Teixeira). For next year, they will take the Rangers' best pitcher (Lee). Plus, the two winningest teams in the rest of MLB will each lose its best outfielder, and the Yanks will get to decide which of those two (Crawford or Werth) they prefer.

So it's a bit like knowing that Sauron has been defeated, but that his spirit will re-form shortly and be stronger than ever. Plus, via the free agent draft he's going to add Aragorn along with his pick of Legolas or Gimli.

New publications, part 2

Also forthcoming in the December 2010 issue of the National Tax Journal, and offered here for your convenience despite the incalculable* harm to my SSRN download rating, is my solo piece, "Rethinking Foreign Tax Creditability." Available here.

*Incalculable by me at any rate, though probably extremely small.

UPDATE: I will be giving a lunchtime talk concerning this paper at Rutgers Camden Law School on Monday, November 8. Possibly followed by a 4 pm talk to students (if any show up) on Getting It.

New publications, part 1

"Taxation and the Financial Sector," which I co-authored with Doug Shackelford and Joel Slemrod, will be coming out shortly in the December 2010 issue of the National Tax Journal.

Though this might cost me SSRN downloads (the coin of the realm these days in legal academia), a convenient PDF version of the final article is available here.

UPDATE: I should have added that I'm giving a lunchtime talk about this paper at the St. John's University School of Law this coming Monday, October 25.

Expansionary fiscal austerity?

I often disagree in various respects with Dean Baker. For example, I'm more of a deficit hawk under non-recessionary circumstances, and more inclined to cut entitlements growth as a part of the long-term adjustments that are needed to avoid a major fiscal disaster.

But I very much like and am in sympathy with this piece, which does a good job of rebutting recent arguments that fiscal austerity in current circumstances could actually aid economic recovery.

This is going too far

I wanted to refer to the Mad Tea Party in a subchapter heading of my book in progress on U.S. international taxation. Having in mind, of course, the scene in Alice in Wonderland. But if I did this, too many readers would assume it was a contemporary political reference.

For now I can't do it, but let's hope the problem is temporary.

I've already used Rube Goldberg; not even worth considering at this point whether I could pair the two references.

Disappointing discovery of the day

The Earl of Sandwich may have invented (or more likely popularized) the meal item named after him because he was working so hard as a Cabinet minister, rather than because he was gambling around the clock.

Forum on the Bush tax cuts: official link now posted

The NYU Law School website now has a live-action link concerning the October 27 Forum at which Diane Lim Rogers, Alan Viard, and I will be the invited speakers (though with plenty of audience discussion) on the topic "Congress Revisits the Bush Tax Cuts: Who Should Pay Taxes, and How Much?"

If you're potentially interested in attending, just scroll down to October 27 and click on the event title for more information.

Invidious rhetoric directed at fellow hominoids

While at an academic tax conference last weekend, I experienced the frisson (a word I've never actually used before, either in speech or writing) of coming across a lively-sounding quote from my own past work that I had completely forgotten writing.

The paper we were discussing at the conference concerned overlaps between programs designed by different Congressional committees, and it cited a paper of mine from some years back that discusses the effective marginal tax rates that can apply to poor individuals from federal and state income and other taxes plus income-based phase-outs of TANF, Food Stamps, Medicaid, the EITC, rental vouchers, etc. In many ranges, as I showed, the effective marginal tax rate for a given rise in income may plausibly exceed 100% for many people. I suggested that this couldn't be a good design feature, and that it presumably reflected lack of conscious coordination of the programs (among other factors).

But the line that I still don't recall writing (though it sounds like me), and that the paper we were discussing quoted, goes something like: This MTR structure looks like it was designed by a drunk, or perhaps a chimpanzee.

But I know how to do the decent thing when I'm in the wrong. So, even though there were none in the room, I made sure at the conference last weekend to apologize to the chimpanzees.

Expiring tax cuts - early notice of NYU Law School event

Readers in the NYC area may be interested in an upcoming event that I've been helping to organize at NYU Law School, to take place of Wednesday, October 27, from 12:20 to 1:50 pm. Every week in this slot, we have a "Forum," aimed mainly at law students, discussing various legal topics of professional or intellectual interest. A typical session has about 30 minutes of panel discussion, followed by an hour of Q & A with the audience. On October 27, the topic will be the expiring tax cuts for individuals.

While typically a mainly in-house event, I've been told that non-NYU people, such as those who might attend a session of our Tax Policy Colloquium, are welcome. (But they should probably send me word that they are interested, so I can make sure the front desk at the law school has their names.)

Our panelists will be Diane Lim Rogers of the Concord Coalition, Alan Viard of the American Enterprise Institute, and myself as moderator and discussion facilitator. It's possible we'll be adding one more speaker, depending on a particular individual's availability. But Diane and Alan alone should make this a great event. Among other virtues, they are both intellectually honest but have different points of view.

Here's the event description that we'll be officially disseminating shortly:

"CONGRESS REVISITS THE BUSH TAX CUTS: WHO SHOULD PAY TAXES, AND HOW MUCH?

"The United States tax system is on a collision course with reality. Experts on the left and right agree that the U.S. is on an unsustainable fiscal path, and it is difficult to deny sharply increasing income inequality. Yet the only debate between Democrats and Republicans regarding the expiring Bush era tax cuts is whether to repeal those cuts for the very highest income tax bracket. Will this work as a long-term answer? What about the mushrooming budget deficit? Or income inequality? We have a remarkable panel of experts to address these issues – and plenty of time for your questions! Please join us for what promises to be a terrific forum."

And here's a more detailed event description that we won't be disseminating officially, as reliable sources told me it sounded too wonky or geeky (I'm not sure which, as said sources were being polite to me):

"Tax rate cuts for individuals that were enacted in 2001 will expire at the end of this year, unless and until Congress acts. This would cause all taxpaying individuals’ income tax rate brackets to rise back to their pre-2001 levels, with the top rate rising from 35 percent to its prior level of 39.6 percent.

"Both the Obama Administration and Congressional Republicans agree that all of the expiring rate cuts, other than that for the top bracket, should be extended indefinitely. Thus, the only dispute in Washington concerns the expiring top bracket rate cut, which the Republicans but not the Administration want to extend.

"Despite this tax-cutting consensus, however, responsible experts on both the left and the right generally agree that the U.S. is on an unsustainable long-term fiscal path, and that this is likely to lead to significant tax increases at some point soon, even though neither party is currently willing to address this issue.

"The question of what to do about the expiring tax cuts also is complicated by the fact that the U.S. economy is currently (at best) just out of a severe recession, with a threat of relapse, and with persistent, extremely high unemployment levels. It also is complicated by differing views about U.S. income inequality, which has increased over the last twenty years by reason of the relative gains enjoyed by people in the 99th percentile (and particularly its upper reaches)."

Peter Diamond's Economics Nobel

Nice to see him get it; well-deserved; insert here all-too-predictable (shame that it has to be) snark about Senate buffoons who have placed a hold on his Fed nomination because they think he's not up to their high economics standards.

Random book recommendation

For reasons not worth going into here, I recently recommended to a friend one of my favorite books, Saki's The Unbearable Bassington.

Her review: "I thought it was great. Sad, funny, psychologically acute, and beautifully written."

I'll repeat that recommendation here, if only because (a) it's such a great book that not many people know about, and (b) Saki, a.k.a. H.H. Munro, is under-appreciated on Facebook (just as he is elsewhere). Only 7 "likes" on his Community Page, and no page for The Unbearable Bassington (hands down his best work, in my view).

Closest literary sibling to Saki: Oscar Wilde. But Bassington is much sadder than anything Wilde wrote before his destruction, and clearly better than anything he wrote other than (of course) The Importance of Being Earnest and (perhaps) Dorian Gray.

Conflicts of interest

This article from the Chronicle of Higher Education raises important questions about the incentive structure that many economists and law profs, if writing about issues that business groups care about, face these days. To be sure, it's a matter of broad-ranging entrepeneurial choice how one directs one's academic efforts. The important point, however, is that conscious hypocrisy is not needed for the incentive structure (including side rewards) facing academics in a given field to matter greatly.

I should emphasize that I don't mean to endorse this article's critique of any particular individual, be it Larry Summers or any of the others named. Given the non-monetary rewards we seek in academics (prestige, the enjoyable aesthetics of doing good intellectual work, etc.), the rewards of taking a side that proves lucrative may often be inframarginal even if one isn't surprised to end up reaping them. And there may be plenty of other biases out there as well, some pointing in different directions.

But the issue of potentially reaping enormous rewards for analysis that ends up suggesting a pro-business-constituency bottom line is out there, too big and potentially significant NOT to be discussed even though the discussions may prove quite awkward because they can get ad hominem.