Saturday, August 02, 2014

Kotlikoff versus Baker and Krugman

This past Thursday, Laurence Kotlikoff had a NY Times op-ed with two main points.  First, the infinite horizon U.S. fiscal gap is huge, and ought to be reported.  It stands at $210 trillion, and eliminating it would require an immediate, permanent 59% increase in federal revenues, or else an immediate, permanent 38% reduction in federal spending.  Second, we must immediately start raising taxes and/or cutting benefits in order to address it.  Indeed, "this is not just an economics problem.  It's a moral issue" - which he frames in terms of policy transparency, but surely with an underlying premise that it would be immoral to leave the full burden of policy adjustment to be borne by the members of future generations.

As unsurprising as Kotlikoff's column (if you know his views) are Dean Baker's and Paul Krugman's responses (if you know theirs).

First, Baker: all we learn from this is "why we should not use infinite horizon budget accounting.  Kotlikoff showed how this accounting could be used to scare people to promote a political agenda, while providing no information whatsoever."  E.g., if we just go out 75 years the fiscal gap is far more manageable.   And we could tame it by bringing healthcare costs per capita into line with those in other economically advanced countries, so why cut benefits? And Kotlikoff could / should have pointed out that the unfunded infinite horizon Social Security liability of $25 trillion, which he gives significant emphasis in the Times op-ed, equals just 1.4% of future income  (i.e., the present value of GDP in the infinite horizon forecast).

It seems to me that Baker is showing a different point than he thinks - that we can actually have reasoned debate about the numbers Kotlikoff wants to emphasize, rather than that we shouldn't use them because they will be misunderstood.  But moving on to Krugman, he agrees that the fiscal gap suggests that current policy is unsustainable and will have to change at some point.  "But why, exactly, is that something that must be done immediately?  If you state the supposed logic, it seems to be that to avoid future benefit cuts, we must cut future benefits.  I've asked for further clarification many times, and never gotten it."

But Krugman then answers his own question: "You can argue that it's better to avoid abrupt changes - to put things on a glide path to sustainability.  But that's a much weaker point than you might expect given all the cries of bankruptcy and crisis."

Fair enough.  But there's more to this point than Krugman says here.  In a 2006 book that has the admittedly Kotlikoffian-sounding title "Taxes, Spending, and the U.S. Government's March Towards Bankruptcy," I make a "smoothing" argument that goes beyond just avoiding abrupt changes.  Subject to other considerations such as macroeconomic policy and the aim of benefiting poorer relative to richer age cohorts, and leaving aside political economy issues, I argue that one should generally want to both announce and start implementing indefinitely sustainable policies ASAP.  Credible early announcement can provide greater certainty, and sharing the pain of course correction between all years can have "smoothing" benefits.  For example, suppose that your future healthcare benefits were going to be cut.  If all years are expected to be similar, and if "fat" tends to get eliminated before "bone," you'd probably prefer a 5% cut for all future years to no cut in some years and a 10% cut in others.

Let me add a word about that title, by the way, given that, even by 2006, I had moved further from the Kotlikoff camp and closer to the Baker-Krugman camp than I had been, say, in the late 1990s (although I remain fully in neither camp).  My preferred title was "The Use and Abuse of Fiscal Language."  My publisher, no doubt correctly, felt that this would not serve the book's prospects very well.  And while I discerned a "march towards bankruptcy," this was not nearly so much based on the types of numbers that Kotlikoff likes to cite (and which I agree should be included in public debate) as on pessimism about the capacity of the U.S. political system to handle tough policy choices of almost any serious or difficult kind.  Surely that pessimism remains as plausible as ever, whether or not government bankruptcy is the particular disaster that it's most likely to cause.

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