Scott Sumner  

Charlie Brown and the GOP

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Compliance Costs of Federal In... Richer than Rockefeller?...

When growing up, I was frequently told that the GOP was the "small government" party. Back in the early 2000s, the GOP finally gained simultaneous hold of the Presidency, the House and the Senate, for the first time in my life. Now they could finally implement their small government vision.

Instead government spending started actually accelerating, rising at a faster rate than under Clinton. And it wasn't just the Iraq War, spending on domestic entitlement programs and Federal aid to education also rose rapidly.

After 2008, I was assured that Bush represented the old GOP, and that the new GOP really was a small government party. All the energy now resided in the Tea Party wing of the party. I remained skeptical.

Today a budget deal was reached that blows a huge hole in previous attempts to restrain government spending. While it's true that the GOP has only a small majority in the Senate, they are in the drivers seat in terms of ability to control spending due to the 2011 budget deal, which limited spending growth without an explicit Congressional override of the caps. But the GOP does not want to limit spending, and has now agreed to a massive override:

The Senate's top leaders announced Wednesday they have sealed agreement on a two-year budget pact that would shower both the Pentagon and domestic programs with almost $300 billion above existing limits, giving wins to both GOP defense hawks and Democrats seeking billions for infrastructure projects and combatting opioid abuse.

The agreement is likely to be added to a stopgap spending bill that passed the House on Tuesday and is aimed at averting a government shutdown Thursday at midnight.

The plan also contains almost $90 billion in overdue disaster aid for hurricane-slammed Texas, Florida and Puerto Rico.


This deal more than reverses any gains that came from the recent tax bill, which really did include some useful reforms. Don't assume that you are going to be able to hold on to profits from a highly successful business, just because the tax rates at this moment do not look too onerous. Investors now know that the US now faces a fiscal time bomb, and dramatically higher taxes are coming down the road.

Fiscal policy in 2018 may be the most irresponsible in all of American history. Massive and growing budget deficits at a time when the US is not at war, and late in a business cycle expansion. This is unprecedented territory.

One difference between a serious country and a banana republic is whether the political establishment, the so-called "very serious people", aka "grown-ups in the room", has the clout to prevent these sorts of mistakes.

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COMMENTS (25 to date)
E. Harding writes:

The number of Republicans in the Senate actually interested in keeping to Federal spending caps numbers one: his name is Rand Paul.
http://www.washingtonexaminer.com/rand-paul-outlines-opposition-to-republican-budget-key-to-tax-reform/article/2637764
"the so-called "very serious people", aka "grown-ups in the room","
are the ones who started this mess. They aren't going to end it.

"Fiscal policy in 2018 may be the most irresponsible in all of American history."
I can't disagree. This specific wave of fiscal extravagance started when Republicans took back the Senate in 2015.

Thomas Sewell writes:

@Harding,

I think you're giving the Senators too much credit for fiscal discipline. I'd rewrite that as:

"The number of Senators actually interested in reducing spending numbers one".

There's not much evidence anyone except Rand on either side of the aisle wants to spend less, they're mostly arguing about which specific things to waste more money on in order to please their compatible interests.

Scott Sumner writes:

Harding, Remember when groups like Simpson-Bowles were taken seriously in policy circles? That's the sort of thing I have in mind when I refer to the VSP. There no leadership today; no one is in charge of the government.

Mark writes:

"The Senate's top leaders announced Wednesday they have sealed agreement on a two-year budget pact that would shower both the Pentagon and domestic programs with almost $300 billion above existing limits, giving wins to both GOP defense hawks and Democrats seeking billions for infrastructure projects and combatting opioid abuse."

I'll reiterate something I'm fond of saying: that if a policy enjoys bipartisan support, that probably means it's twice as dumb as usual.

Shane L writes:

Here in Ireland the centre-right parties embraced stark, unpopular tax hikes and budget cuts during the economic crisis after 2008 when budget deficits soared. They were backed by the EU but opposed bitterly by a resurgent far-left, who made wild promises about ending austerity and even reversing it with expansionary fiscal stimulus. They could make such impossible promises because they had almost no chance of getting into government; it is very easy to promise things in Opposition.

In the United States, the party taking on the role of the wild, irresponsible Opposition is the Republican Party, and they are governing.

Alan Goldhammer writes:

Scott writes,

Remember when groups like Simpson-Bowles were taken seriously in policy circles? That's the sort of thing I have in mind when I refer to the VSP.

Nobody ever took S-B seriously. As a point of fact, some key Republicans voted against accepting the report and it did not get the necessary votes. It's pretty much been consigned to the dustbin of history.

robc writes:

The GOP is the stupid party.

They have always been such and have never been the party of small government.

Ravi Smith writes:

Scott,

I agree with you about the dysfunction, but differ as to the cause. In a federal separation-of-powers system, no one is ever really in charge. You are adding up local constituencies across state lines on an issue-by-issue basis. The New Deal Coalition was Tammany Hall writ large. Clientelistic political machines combined with ethno-religious bloc voting and coalition politics. The ethno-religious separatism broke down in the 1960s along with segregation in the South and the political machines collapsed after 1968. Today, the only groups able to mobilize and organize majorities in a majority of states are the rich interest groups with spread out workforces (finance, healthcare, real estate etc.)

The ultimate solution IMO is to have the initiative and referendum at the federal level. This reduces the 'transaction costs' of our political system by making it easier to organize people around a specific issue. It would probably allow us to reduce inequality and the size of government, both of which stem from the massive rent-seeking that has occurred since the collapse of the political machines in 1968.

Justin D writes:

This is very irresponsible. When unemployment is 4.1%, the budget should be in surplus by several tenths of a percentage point of GDP. Instead, the deficit is 3.4% of GDP and rising. We need a fiscal package which reduces spending and increases taxes by a combined 4% of GDP, $800 billion in year 1 and $9 trillion over a decade (and that's before considering the impact of recently enacted tax reform).

Philo writes:

Fiscal alarmists have been talking this way for decades: "the US now faces a fiscal time bomb, and dramatically higher taxes are coming down the road." But what actually comes "down the road"? Not higher taxes, just more debt.

The urge to cry that "the sky is falling" is an inherent feature of human psychology (examples myriad!), but the cry usually turns out to be unjustified.

Scott Sumner writes:

Alan, That's sort of my point, isn't it? That sort of report used to be taken seriously, but no longer is. Remember the Greenspan Commission?

Philo, This time is different. The debt ratio is on an unsustainable path, which was not true in the past.

Justin D writes:

Philo, we truly are being more irresponsible than in the past.

At the end of FY2007, the US unemployment rate was about 4.7%, we were in the middle of a war costing about 1% or so of GDP, tax rates were lower (more room to hike them), and the deficit was 1.1% of GDP. Expected nominal GDP growth was 5%.

At the end of FY2017, unemployment was 4.2%, military spending and domestic spending was a much smaller share of GDP (less to cut), and the deficit was 3.4% of GDP. Expected nominal GDP growth is closer to 3.5%.

On top of this, we have now cut taxes, and are blowing out spending. The deficit might well rise to 5% of GDP at one of the best economic climates of the past 50 years. From there, we will have the other half of the baby boomers retiring pushing up costs, slow productivity growth restraining tax revenue, and of course future economic cycles. It's not out of the question that the U.S. deficit levels will be higher than Obama's were as a % of GDP for a garden variety recession, let alone a severe economic collapse.

If the budget deficit is 7% on average with 3.5% nominal GDP growth, then we are on trend for the debt ratio to hit 200% of GDP (and in practice, it will continue to rise so long as interest rates are meaningfully positive). It simply isn't sustainable.

Philo writes:

@ Justin D:

If it truly is unsustainable, it will not be sustained. That does not mean we cannot do it this year (and even next year, and maybe even . . .).

Mark writes:

Scott, in saying this: "Investors now know that the US now faces a fiscal time bomb, and dramatically higher taxes are coming down the road."

Are you referring to Ricardian equivalence? That investors will pull back in anticipation of future taxes, negating the benefits of the tax bill? Do you think only investors will do this, or consumers as well?

Because inasmuch as Ricardian equivalence holds, the deficit spending amounts to a surreptitious tax and it shouldn't have pro-cyclical effects. Conversely, to the extent that Ricardian equivalence doesn't hold, everyone will still enjoy their tax cuts... until the inevitable crash induced by the deficit spending. I guess what I'm asking is, aren't Ricardian equivalence and the business cycle inducing/exacerbating effects of deficit spending mutually exclusive?

Lastly, do you think the current unemployment rate is below the natural rate of unemployment? In an undergrad econ class I recall being taught that the natural rate of unemployment (if there is such a thing) was thought to be around 5%. Assuming that hasn't changed much since then, significantly below 5% unemployment over an extended period of time (like now) seems like a sure indicator that markets are indeed'overheated.'

Alan Goldhammer writes:

Justin D writes,

If the budget deficit is 7% on average with 3.5% nominal GDP growth, then we are on trend for the debt ratio to hit 200% of GDP (and in practice, it will continue to rise so long as interest rates are meaningfully positive). It simply isn't sustainable.
How do you explain why Japan isn't an economic basket case. their debt ratio has been well over 200% for almost a decade?

Jon writes:

The real shame in the military is no one seems to pick the low hanging fruit ... such as the 20B / yr spent on air conditioning in Iraq and Afghanistan. You might wonder how it is that the AC is so expensive...

- lightweight barrack style construction
- wide spread use of AC in forward locations which requires more convoys which require air support for protection.

But the real problem isn't with the program spending which really has been shrinking. It's the non program spending: social security(20%), Medicare (20%), safety net (13%) retirement benefits for military and federal employees (7%)

How do you get that on the table ? Trump is right that the best strategy is getting back to 3% growth. How do we get there?

Justin D writes:

@Philo,

Yes, but getting off an unsustainable path, especially after years of delay, can be very painful, and there's no compelling reason for large deficits right now.

@Alan,

Several reasons. Most importantly, the Yen is a fiat currency which gives Japan more flexibility than a nation such as Greece, and moreover, it's important that markets also understand this. Second, Japan has a lot of assets, therefore its net debt is substantially lower than the gross debt, closer to 100% of GDP (I've seen estimates that range from 90% to 120%). I suspect that Japan doesn't look drastically different from other developed countries when considering net debt and all unfunded future liabilities. Third, government bond yields have been very low for a long time, most recently negative for much of the curve.

I'll allow that if Japanese government bond yields remain zero or negative, they can in theory increase their debt relative to GDP forever, though that strikes me as a precarious position. What if circumstances eliminate that source of cheap funding? Yes, the BOJ can buy bonds to hold down interest payments, but if it is forced to do that, inflation will shoot through the roof.

My baseline expectation is that Japan and America do not have debt crises over the next several decades, but it would be extremely painful if they do. It's simply prudent risk management to avoid building up financial imbalances if possible.

Scott Sumner writes:

Mark, Taxes can have both demand and supply side effects. In my view the supply side effects are trivial, due to monetary offset. So I'd focus on the supply side effects. Expectations of future tax increases can dampen current investment.

I don't know where the natural rate of unemployment is right now. If I had to guess I'd say about 4.3%

Scott Sumner writes:

Update: I meant the demand side effects are trivial, due to monetary offset. (I thank David Henderson for pointing out that error.)

LK Beland writes:

We all remember the Obama "pivot" on deficits, that culminated in the Simpson-Bowles report.

The GOP didn't want to hear about it, mostly because of their strict policy of giving no bi-partisan wins to Obama.

Alec Fahrin writes:

The willingness of "conservatives" to defend Trump's 6% of GDP deficit flabbergasts me. Republicans always spend more money and never bring down the deficit to sustainable levels. Democrats are the fiscally responsible party, and anyone who questions that needs to look at the deficits during the first fiscal year of each administration, and the final year.

My father defended the donor relief bill with the absurd "starve the beast" argument. Do people not get that nothing is free?

Either way, I am a firm believer that all money that is spent is eventually paid back (with interest). Either directly through higher future taxes or indirectly through private capital crowding out, efficiency costs, and worse public goods/services.

There is an efficiency argument of course. Some conservatives assert that deficit spending is okay if matched with tax "reform".

Yet, do conservatives now believe that the government spends the citizens' money better than the citizens themselves? Those dollars don't just appear without cost in the government's lap.

Alec Fahrin writes:

Alan Goldhammer,

Your Japan example is true. Japan has a huge debt/GDP ratio and they have not collapsed.

But you ignore a very important fact...
Why did Japan develop this ratio? Well, economic stagnation and the government having to spend its way out of the stagnation.

Now, what happens when a government spends an enormous share of GDP for decades on end? More economic efficiency?
Well, the private sector gets to spend less of the GDP. Unless you are a socialist (and even then), that most likely drives down economic efficiency levels.

Why could Japan afford this spending?
Taking money away from the consumers, mostly. The consumption tax was nonexistent in 1988. Now it is 14%. Japanese consumer spending per capita is the same level it was in 1996.
Imagine your people still consuming the same amount they did 21 years ago? Americans would go into a revolution.

Oh, and Japan's high debt ratio means that it cannot effectively stimulate the economy in the next recession. Add up the decades of economic underperformance caused by this immense level of government spending, and you get a society that is depressed, childless, and rapidly dying out.

Finally, stop trying to compare a homogenous and socially stable nation like Japan to the USA. Their inequality rate is hilariously low compared to our's. Japan has about 1 crime for each of our 10.

Thomas Sewell writes:

@Alec,

Democrats in Congress aren't fiscally responsible, ever. They continually vote for increased spending.

Republicans in Congress are sometimes fiscally responsible, but only when there is a Democratic President. As soon as they are "governing", 90% of them forget all about deficits.

If you want to compare the increase in debt between administrations, you need to blame who is in control of Congress, which actually appropriates money and changes tax laws.

Check the numbers and relate it to Party control and you'll find that the only time the deficit and debt was on a downward slope was when we had a GOP Congress and a Dem President.

Mark writes:

Alec,

This budget was the result of a bipartisan deal, and much of it (including beefed up infrastructure, education, etc. spending) is to obtain democratic support.

If the Democrats were firmly opposing this, you’d have a point; instead, they’re using what influence they have to make it even worse.

To borrow Lewis Black’s theory of politics (excluding the profanity): one party enthusiastically declared “I’ve got a really bad idea!”, and the other responds, “but I can make it even worse!”

Alec Fahrin writes:

Thomas, Mark,

I must admit I exaggerated. A better way to state this is that the Democratic Party does not campaign on "small government" and "low taxes". They openly admit to supporting big government. This bill is not hypocritical for them.

Also, the argument that "congress carries all the blame" is absurd. The President signs the bill and negotiates it.

If you were a fiscally conservative president, you would not sign a bill that expands the deficit by another $300 billion after signing a bill that already will expand it by $150 billion a year.

Remember that Reagan raised taxes three times during his presidency. The budget deficit/GDP ratio averaged 3% during his second term.

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