Scott Sumner  

"Fund" and games with fiscal policy

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I recently did a post suggesting the new political divide in the world is not small and big government, but rather open and closed societies. A new Bloomberg article reminded me about how far to the left the GOP has moved on issues like federal spending and the deficit:

Donald Trump on Tuesday proposed a plan to rebuild U.S. infrastructure that costs "at least double" the amount that Hillary Clinton has floated, in what would amount to a massive new government program.

Asked on Fox Business Network how much he'd spend, the Republican presidential nominee said, "Well, I would say at least double her numbers, and you're going to really need more than that. We have bridges that are falling down. I don't know if you've seen the warning charts, but we have many, many bridges that are in danger of falling."

Clinton's plan, which is estimated to cost $275 billion over five years, calls for setting up a national infrastructure bank to help fund large-scale projects, an idea that President Barack Obama advanced only to see it stall for lack of Republican support.

Trump was vague when asked how he'd pay for his much larger plan.

"We'll get a fund. We'll make a phenomenal deal with the low interest rates," he said.

So that's at least $110 billion/year, but "we'll get a fund". In fairness, the federal budget is awfully big, so this single item is not that dramatic a change---unless viewed in context:

1. Trump opposes cuts in Medicare and Social Security. This means that these programs will rise rapidly as a share of GDP.

2. Trump wants to eliminate Obamacare, without denying health care to low-income people. To me, that suggests a bigger Medicaid program. Again, it will rise as a share of GDP.

3. Trump wants to rebuild the military.

4. Trump wants to do much more for veterans.

5. Trump wants a more aggressive war on terror, and war on drugs.

6. Trump wants a big beautiful wall on the southern border.

Now let's talk about the deficit. In the past, candidates who proposed such big spending increases were usually Democrats (although, ex post, the GOP often increased spending too). The Democratic proposals generally involved tax increases. Trump favors:

1. A massive tax cut for affluent taxpayers, bringing the top rate down to 25%. That's the lowest top rate since the 1920s, when federal spending was 3% of GDP.

2. A massive cut in corporate taxes, with the top rate falling to 15%.

3. Removing 75 million lower income people from the tax role. Instead the IRS will send them a letter saying, "I win"

4. Eliminating the estate tax.

And we already have a pretty big deficit for the 7th year of an expansion. Trump has also promised to pay off the entire national debt in 8 years. I'm not quite sure whether that includes the "fund" that will pay for all of this infrastructure spending, maybe someone can ask him.

If you combine this with Hillary's long laundry list of programs, what can we infer? I think it's fair to say that fiscal policy is likely to become highly expansionary over the next decade. I suppose that might not be the case if divided government continues, but even then I'm not so sure a grand "deal" won't follow the election. The same is occurring in places like Britain, where the new "Conservative" government is moving away from austerity. Japan's conservative government is also doing fiscal stimulus, although the fine print suggests it's pretty small. (On the other hand, Japan's baseline deficit is large, even before the stimulus.)

In New Keynesian models an increased expectation of future fiscal stimulus is expansionary right now, unless offset by monetary policy. Since we see no evidence of fast NGDP growth in the bond markets, I think it's fair to say that either people don't expect fiscal stimulus, or they think the Fed will offset it. My hunch is that the Fed will raise rates enough to keep inflation from exceeding 2%, and hence any fiscal stimulus will not be expansionary.

Here's more evidence that the gap between the parties on government spending is shrinking:

Rory Cooper, a Republican strategist who opposes Trump, called his proposal "essentially the Obama stimulus argument" and added in a Twitter post, "Half trillion tax dollars toward mythical projects to 'create jobs.' Nearly every Republican member of Congress voted against this in 2009."
I don't mean to suggest that there are no areas where infrastructure spending is needed. I do worry though that if you look at policy areas one at a time (college debt, universal pre-school ed., infrastructure, clean energy, etc., etc., you end up with lots of programs that seem nice in the abstract, but at a cost that adds up to a real burden on the debt. Right now interest rates are low. But what if we boost the national debt to 200% or 300% of GDP, and rates rise?

HT: JonathanH

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COMMENTS (11 to date)
SG writes:

Uh oh Scott, you've started talking about Trump on EconLog...

ThaomasH writes:

But the correct way is to evaluate both the costs and benefits of proposed programs. A lot (I do not know just how much) infrastructure can be justified as self financing, NPV>0 (and an infrastructure bank seems like reasonable way to get to that kind of rule). Opinions differ on how much of Sec. Clinton's list would make sense if financed with higher taxes, especially if the taxes were progressive consumption taxes rather that taxes on income.

I'm not impressed that we are in the 7th year of the "recovery" so long as NGDP is still below its pre-crisis trend.

Njnnja writes:

I wish you hadn't left that last sentence as a rhetorical question. What do you think will happen when rates go up?

I think it could only mean one of two things: 1) that there is expected inflation or 2) the creditworthiness of the US has declined. But since we can always print dollars we can't default, so the real fear of #2 is that if we were having trouble paying our debt we would print so much that it inflates away the dollars worth. Which is just inflation, so there is really only one way rates could go up: expected inflation.

Which sounds a lot like "fiscal policy is expansionary when it is so irresponsible that it literally forces an expansionary monetary policy by making it impossible to pay the debt any other way." This makes President Trump's plan to default on the debt to "get a better deal" seem almost same. But it would (eventually) give us an expansionary monetary policy (like Zimbabwe!)

Brian Donohue writes:

Again, Trump shows conventional politicians: "You wanna see pandering? I'll show you some real pandering."

This is the greatest hits of pandering from across the political spectrum.

Is Trump trying to teach us that all politicians are shameless panderers, and he's just exaggerating to make it obviously ridiculous and unmistakable? That, in essence, he's taking the standard political playbook and pumping it up with steroids? Like proposing a $25 minimum wage to illustrate the stupidity of a $15 minimum wage?

Maybe not, but I like to think so.

BC writes:

Quick question on fiscal sustainability/responsibility: Do deficits and debts matter or just gross spending? Doesn't a nation's fiscal health depend on its *aggregate*, i.e., public plus private, debt? If so, then it seems to me that debt that arises from spending is much different from debt that arises from tax cuts since taxes merely transfer debt between public and private. For example, holding income and (private plus public) spending constant, each dollar of tax cuts increases public debt but decreases private debt (or increases private savings) by a dollar, thus leading to no net increase in public plus private debt. On the other hand, holding income, taxes, and private spending constant, each dollar of increase in public spending increases total debt by a dollar. A government that spends 15% of GDP and collects only 10% in taxes seems more fiscally responsible than one that spends 25% of GDP and collects 25% or even 30% in taxes.

The Sumner household's finances are unaffected by transfers between Scott's and his wife's bank accounts, which are like taxes and tax cuts. (I'll let Scott say whether he or his wife is the government in his house.) On the other hand, if Scott or his wife spends money, then that will decrease their household's aggregate savings, regardless of whether such spending is "paid for", i.e., leveling a tax, by transferring money from one spouse's account to the other's.

B Cole writes:

Trump is pandering. Although a heroic infrastructure programme resulting in the world's most beautiful airports might not be such a bad idea. We also live in a strange time in which fiscal outlays can apparently be financed by QE or helicopters and not result in inflation. It makes sense to take advantage of this aspect of the modern economy to either pay down debt or build something of lasting value to our society rather than the F-35 jet.

Scott Sumner writes:

SG, But I avoided using the term 'lunatic'.

Thaomas, You said:

"so long as NGDP is still below its pre-crisis trend."

We will never return to that trend.

Njnnja, Yes, but I'd rather avoid the Zimbabwe solution.

BC, There's more to it than that. Debt should be managed in such a way as to minimize the deadweight cost of taxes over time.

Jay writes:

Is it really fair to say that just because Trump has these ideas, that the GOP as a whole has moved to the left on these? No matter what musings come out of his mouth, all of these ideas would have to come from congress and it isn't obvious to me they've moved left or right on these issues at all thus far and should Trump get in they'd probably go right not left.

Matthew Waters writes:

"But what if we boost the national debt to 200% or 300% of GDP, and rates rise?"

As I'm sure Scott knows, it should be either "real interest rates" or rates adjusted by NGDP. If both interest rates and NGDP growth rates go up by 2%, the percentage of interest going to GDP should be the same.

But I think probably countries like Japan, US and France can sustain 200% debt/GDP levels. First-world liberal democracies have a much more stable production base. Third-world countries who default on their debt or have hyperinflation also have worse Rule of Law, institutions, etc. which ultimately endanger sustainable GDP.

The UK in the 70's may be the best example. Roughly, the leftist policies had been shown to become completely unsustainable. So the UK elected Margaret Thatcher while third-world countries would tend to double-down on unsustainable policies.

So I see high debt/GDP in first world countries being sustainable. Not that I'm happy about high debt. High interest costs are ultimately a generational transfer, where future generations pay the interest for today's spending. If government spending on infrastructure or free college is so good, taxpayers today should pay for it. Not taxpayers of the future.

Matthew Waters writes:

"Quick question on fiscal sustainability/responsibility: Do deficits and debts matter or just gross spending? Doesn't a nation's fiscal health depend on its *aggregate*, i.e., public plus private, debt?"

Private debt should be between two market participants, where the creditor is holding the bag.

Public debt is the responsibility of all taxpayers and a nation as a whole, no matter what. The government defaulting on the debt has far worse repercussions than somebody defaulting on their credit card. If the debt is *not* defaulted on, then *all* taxpayers have to either pay down the bonds or pay interest in perpetuity.

Anyway, if you're curious: here is the balance sheet for the entire United States. Total assets owned by US citizens is around 1,000% GDP while total liabilities are valued at 700% GDP. Most financial/private debt are what Americans owe to other Americans.

Scott Sumner writes:

Jay, I agree that Trump is just one part of the GOP. But I think his success in the primaries indicates that there is a lot of support among the GOP for a big government approach.

Matthew, Good point. I was assuming the case where interest rates rise more than inflation, just as they fell much more sharply than inflation over the past few decades.

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