Austerity [sic] Is In The Air
2024 08 26
Austerity, as Noah Smith likes to call it [and I don’t[1]] is in the air. Sam Harsimony at Splitting Infinity uses calculus to examine the limits of
Deficit Spending in Growing Economies Like a lot of analyses, this focuses on what can be done not what should be done, almost as if deficits were good in themselves, but subject to constrains. I do not deny some of this can be useful. Constraints are and the principles behind the constraints can give guidance to the “should.”
The place to start is to ask what patterns of spending and taxation maximizes NPV. The complete answer clearly is an optimization problem with multiple equations that I am not capable of modeling. But I have an intuition for some of the results of the solutions and factor that will impinge on the results.
One factor is the NPV of expenditures.[2] Higher NPV mean more borrowing can be optimal. Even here there is simultaneity as governments can borrow enough to affect the discount rate of the NPV and the amount borrowed depends not only on expenditure but on revenues. Still a good rule of thumb ought to be that deficit should be less than the Σ(expenditures with NPV>0). Roughly, governments should borrow only to invest _meaning_ expenditure that generate future income, although not necessarily fiscal revenue. Linking government borrowing to investent rests on the assumption that funds lent to the government would otherwise be lent to investors for projects with NPVs. Borrowing by government in excess of expenditures with NPV > 0 means shifting resources from higher to lower yielding uses.
But Harsimony is not alone. Dylan Matthews at Vox says The US Government Has to Strt Paying for Things Again
heinously attributing his new-ish concern to age and admitting that in the 2010’s he embraced deficits. That was, no joke, an error in principle. Deficits in excess of Σ(expenditures with NPV>0) shift resources from investment to consumption. They slowed growth in the 2010’s and they slow growth today. I will grant Matthews this much; the damage was smaller when interest rates were lower. Additionally, in a period of low interest rates and especially during recession and high unemployment 2008-2019 when the marginal costs of some expenditures is less than their market price (the laid off policeman) the Σ(expenditures with NPV>0) is much greater than today. I'd even guess that during at least the early Obama's Presidency Σ(expenditures with NPV>0) was greater than deficits.
But the criterion for deficits (which are neither “good” nor “bad”) does not change, just the parameters that are used to calculate the NPV.
Oh, BTW, Matthews, even deficits that DO exceed Σ(expenditures with NPV>0) just slow growth. THEY DO NOT CAUSE INFLATION. The Fed causes inflation, and disinflation, and recessions, and recoveries. Deficits, for an independent Fed (something we cannot take for granted if Trump wins the presidency) that has a Flexible Average Inflation Target, just produce higher interest rates.
Fortunately, Matthews puts his concern with “debt” into 5 policies for addressing “debt” (bad framing, but let’s let that pass) in a Harris Administration.
· First: use tax hikes or spending cuts to offset any new spending or tax cuts…
o No, to MORE THAN offset … Remember the aim is deficits that do not exceed of Σ(expenditures with NPV>0)
· Second, take growth seriously…expanded green cards for immigrants with science and engineering degrees seems like a no-brainer…funding for scientific research boosts productivity
o Yes, and reduce trade restrictions and reform regulation so that regulations pass cost benefit tests, too.
· Third: the coming tax fight in 2025 should be used to raise revenue, not just avoid losing it…Taking the debt at all seriously means that whoever’s in office next year needs to pay for whatever part of the Trump cuts they want to keep…
o Yes. Tax so that deficits do not exceed of Σ(expenditures with NPV>0) But we can also reduce the inefficiencies in taxation, the dead weight losses by:
§ Eliminating taxes on business income. Impute business income to owners’ personal incomes and tax it there
§ Shifting the progressive income tax toward a progressive consumption tax.
§ Taxing net emissions of CO2 and other negative externalities
§ Substitute partial tax credits for “deductions from income for favored kind of consumption – mortgage interest, chartable contributions, healthcare costs.
· Fourth: Social Security should be addressed, not punted…Democrats will push to pay for the program by raising taxes on high earners; Republicans will push for benefit cuts. Either way, the gap needs to be filled…
o And the WAY to address it is with a VAT to replace the wage tax. The VAT is better because it is a consumption, not an income tax so depresses investment less. The VAT also removes the distortion that makes employing labor more costly than employing capital or other inputs. And a VAT is probably easier to manage so as to keep the trusts funds it finances in balance.
· Fifth and finally, Congress needs to work to ensure that per-person health spending stays roughly constant.
o No for the reasons Noah points out. The marginal expenditure on health-care > marginal benefit from health-care. Unless the benefit increases, we should spend less. And Noah is right that the key to this is breaking the link between health insurance and employment. Besides opening up ways to reduce costs, breaking the link is another way to remove the distortion that makes employing labor more costly than employing capital or other inputs.
[1] “Austerity” is usually associated diminished expectations.
[2] A more sophisticated analysis would allow for and NPV in which the discount rate I related to a social time preference that is separate from the marginal productivity of capital.
[Standard bleg: Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail. I would welcome comments on these views.]
Image Prompt: Muscular horse labeled “GROWTH” pulling a cart with a large load labeled “DEBT”
You need to fix the Splitting Infinity link at the beginning.
> "The Fed causes inflation, and disinflation, and recessions, and recoveries."
I think this is a dangerous sentence that's too easily taken out of context. Monetary policy, or even expected monetary policy, causes these things, a policy which the Fed has the most control of in the modern era, but hardly the only control over. As well as some supply policy.
> "Second, take growth seriously…expanded green cards for immigrants with science and engineering degrees seems like a no-brainer"
Often these people pay significantly less for their degrees than people do in the US. This can make them more than competitive with native trained scientists and engineers both for jobs, and for housing in the high cost of living locations where many of the science and engineering jobs are. This is more an argument for reforming our tertiary education funding system than for preventing these people from immigrating, but it's a counter-point not often stated by those like Matthews who bring it up.
> "§ Eliminating taxes on business income. Impute business income to owners’ personal incomes and tax it there"
I don't understand the mechanics of how this works for publically traded corporations. Or whether business income that is retained by the business will be taxed while the business retains it? If it is not taxed, then businesses are highly incentivized to retain income rather than disburse it (except through means which allow tax write offs).
> "§ Shifting the progressive income tax toward a progressive consumption tax."
Do examples of this exist that I could look at?
> "o And the WAY to address it is with a VAT to replace the wage tax."
This is interesting. Would it allow everyone to receive the same SS income, regardless of their personal incomes throughout the years?
The rhetoric of austerity is full of both-sideism, which in practice translates into lots of pressure for spending cuts and little if any for tax hikes.
Interestingly in this context, the Biden-Harris proposals for substantial tax increases ($5 trillion is routinelly mentioned) seems to be forgotten when pundits describe her as "policy light"