Cutting Long-Term Deficits Alone Won’t Fix the Economy

Cutting Long-Term Deficits Alone Won’t Fix the Economy

April 27, 2011

Washington is mesmerized these days with the two parties’ various stratagems to turn the deficit debate to their own advantage.   But all this political maneuvering may carry a big cost for Americans, as it sidelines any serious action on our larger, more immediate economic problems.  The U.S. expansion is in some danger today, but not from the deficit projections for 2015 and 2020.  The economy continues to grapple with structural problems that have led to a decade now of weak job creation and stagnating incomes. Beyond that, we also face strong economic undercurrents coming from rising energy prices, the prospect of another financial shock from Europe’s growing sovereign debt difficulties, and the gathering economic aftershocks from Japan’s terrible disasters. And while the two parties in Congress scheme and struggle over deficit plans, the party (and person) most likely to win next year will be the one that uses the debate over spending and taxes to credibly address jobs and incomes. 

A deficit debate designed to do that would look and sound very different from today’s charges and countercharges.   For example, it would certainly include steps of some kind to stem home foreclosures and stabilize housing prices, because those are key factors for rebooting consumer spending and business investment. With the bottom 80 percent of Americans owning just 7 percent of the country’s financial assets, home equity has long been the only significant asset held by the most Americans – and the sharp decline in the value of most people’s home equity has left average Americans poorer on top of their long-stagnating incomes.  Until home values turn up again, most people will continue to hold back on family spending, which in turn will continue to dampen business investment.  And without strong business investments in technologies and other capital, most workers’ incomes can’t rise.

The deficit debate already includes a ready but very wrongheaded response to housing, namely cutting back on the mortgage interest deduction. Yes, it would raise some revenues; but it also would further depress housing values.  Instead, we should figure out the best way to help people keep their homes out of foreclosure – for example, a temporary, two-year program of bridge loans to people facing foreclosures. And if we do it right, it could even help us out with the long-term deficit:  For example, Washington could make itself the priority lender for repayment if a homeowner loses the house anyway or, if a later sale produces capital gains, taxpayers could claim a small share of those gains.

The President’s deficit plan does include gestures towards the country’s larger economic challenges, in his insistence on modest funding increases for education, infrastructure, and research and development.  But those increases aren’t enough to move the needle on jobs and incomes, and so they’re also not enough to inspire broad support for smart public investment.  To have a shot at doing both, these initiatives have to touch most Americans.  For example, for less than a few hundred million dollars – almost chump changes these days – Congress could provide grants to community colleges to open their computer labs on the weekends to any adult who wants free training in computer and Internet skills.   We also could ensure that this investment would more than pay for itself.  For example, those who use the service could be required to return the favor to taxpayers, by paying an extra one or two percent income tax on increases in their incomes in the following two or three years.

The economy’s crying need to upgrade its infrastructure – from roads and highways, to city-wide wifi and a smart energy grid – also could be used to jumpstart job creation, and not just with temporary jobs at large construction companies.  Since new and young businesses are the strongest engines of job growth, we could set aside 20 percent of the funding for these projects for newly-formed businesses that would then provide hundreds of goods and services for the projects.  This kind of provision could stimulate the formation of thousands of new businesses, and the taxes on their profits and on the incomes of their new workers would go the deficit.

We also could stimulate job creation more directly while raising revenues at the same time.  Multinationals today keep overseas some $1 trillion in profits from their foreign operations, in order to avoid high U.S. corporate taxes.  We could let them bring back those funds at a lower tax rate, if they expand their U.S. workforces.  For example, any multinational that increases its U.S. workforce by 5 percent could bring back 50 percent of their foreign earnings at the preferential rate – or bring back 60 percent of those earnings in exchange for a 6 percent increase in their U.S. employees.  And, yes, it should ease the deficit since otherwise, most of those earnings will remain abroad indefinitely, and so untaxed here.  And on top of that, the new jobs generate income that also will produce additional revenues. 

Whether or not you like these particular approaches, they provide a glimpse into how far off-target the current deficit debate has veered.  The only economic justification for reducing any deficit is that doing so will in some way produce better times; and in this time, that especially means more jobs and higher incomes.  Unhappily, any current debate about how to produce those better times has been hijacked by Paul Ryan’s radical plan to cut every program that Republicans have ever disliked, and by the tempting target it offers Democrats. 

Yes, huge, long-term deficits do matter economically.  If history is any guide – as it usually is in economics – we have two to three years to enact a credible glide path to more sustainable levels of federal borrowing for the following decade.  That’s what Washington did in the 1980s and again in the 1990s, and it helped create tens of millions of jobs and, especially in the 1990s, healthy income gains.  The task is harder today, because the economy in this period doesn’t deliver jobs and rising incomes the way it used to.  That calls for two steps.  First, protect existing jobs and incomes while the economy remains fragile and vulnerable to the outside shocks, by foregoing more cuts in this year’s deficit.  And second, use the deficit debate to advance initiatives that address what Americans truly and properly care about, which is their jobs and their incomes.

President Obama Wins the First Round with Paul Ryan

April 14, 2011

Yesterday’s presidential address on fiscal policy was a very striking scene. The venue was a small auditorium at George Washington University. Invitations went out just two days earlier; and with so little notice, GWU students made up more than half of the audience. Former Democratic economic policy officials — myself and perhaps 10 others — directors of Democratic-allied policy shops, and a smattering of CEOs and senior Senate staffers filled up another row.  Just before the President took the stage, his economic team filed in — Bill Daley, Tim Geithner, Gene Sperling, Jack Lew — along with Vice President Biden and his new chief-of-staff, fresh from directing the Simpson-Bowles Deficit Commission.  Alan Simpson and Erskine Bowles were there too, along with other Commission members — here’s what added drama to the scene — including Representative Paul Ryan, this year’s Republican guru on the budget sitting uncomfortably in the first row. The moment the President finished — without exaggeration — Ryan bolted for the exit. Perhaps he suspected that the President’s plan is smarter, fairer, more balanced and more credible than his own.

Both blueprints would reduce deficits by $4 trillion over the 10 (Ryan) or 12 (Obama) years, but the real difference lies in revenues. The Congressman would give away another $1 trillion in new tax cuts to high-income Americans and business, while the President would collect an additional $1 trillion in revenues. The consequent $2 trillion difference explains how the President, unlike Ryan, can stabilize federal debt as a share of GDP while preserving the basic guarantees of Medicare and Medicaid.  And there was one telling moment during the speech which demonstrated how new revenues change the choices that Americans face with the debt: The President was interrupted by applause only once, and it was when he said, “They [Republicans under Ryan’s plan] want to give people like me a $200,000 tax cut that’s paid for by asking 33 seniors each to pay $6,000 more in health costs. That’s not right. And it’s not going to happen as long as I’m President.”

Obama’s plan, then, recasts the issue from the GOP choice between spiraling debt and drastic cuts in Medicare, Medicaid and all domestic spending, to a new choice between higher taxes on the top one or two percent of Americans and preserving health care coverage for elderly and low-income people while also controlling the debt.  That choice can be cast even more starkly: Control the debt by forcing seniors to pick up two-thirds of their own health care costs by 2030 (CBO’s estimate of the impact of Ryan’s plan) or deny wealthy Americans their most recent and future tax cuts.  If you believe the polls, Americans today overwhelming favor President Obama’s priorities over Representative Ryan’s.

With his additional revenues, the President still has to find $3 trillion in spending reductions.  One big chunk of cash would come from broadening and strengthening the cost-control measures in his signature health care reforms; including, reimbursing hospitals and doctors based on results rather than volume and authorizing a new federal board to mandate rather than merely recommend the use of proven, cost-saving approaches to treating Medicare patients. He also calls for a new version of an old budget mechanism, from the late-1980s, which would trigger automatic, across-the-board cuts in domestic spending whenever the deficit exceeds a certain level.

In the end, OMB number crunchers believe that these and other measures would shave $2 trillion from spending over 12 years, and the lower deficits would save another $1 trillion in interest payments on the debt.

President Obama’s approach also allows him to preserve the substantial new public investments in education, infrastructure, clean energy and basic R&D which he called for in his latest budget.  By putting together a plan to control deficits while increasing public investments — the “cut-and-invest” approach championed by Bill Clinton in the 1990s — he assumed an optimistic, can-do attitude that recalls Ronald Reagan. And the implicit contrast with the Republican “the sky is falling” recipe of large sacrifices may serve his reelection nearly as well as it did Reagan’s.

These choices will not be resolved anytime soon.  GOP leaders immediately rejected the President’s blueprint.  Yet, they and their Democratic counterparts know full well that any resolution will require real compromises that include both additional revenues and some paring of entitlements. They also know, based on the deficit struggles of the 1980s and 1990s, that it will likely take several years for both sides to find and comfortably claim some common ground.

Even so, the President’s speech will have more immediate consequences, because it may well make the GOP’s position on the debt limit politically untenable. They no longer can argue credibly that they have to hold the full faith and credit of the United States hostage, in order to force the President to get serious about the debt.  The country now has a choice, and the Republicans can no longer say, our way or no way, when it would risk pushing up U.S. interest rates and possibly shaking the global economy. The current impasse over debt limit will be resolved with some face-saving commitment by both sides to begin negotiating in good faith.

Why Big Banks Want Americans to Pay More for Everything

April 7, 2011

Once again, the nation’s big banks are working hard to have their own way with some of the most consequential issues before Congress. Tucked into the small print of Paul Ryan’s budget plan for 2012 and beyond are provisions to roll back the key regulatory steps taken to make another financial meltdown less likely, especially higher capital requirements tied to the riskiness of a bank’s investments. That’s not their only fight these days: They also are trying to roll back a critical debit-card reform enacted last year and just now about to go into effect. If they succeed — and the Washington airwaves are saturated with ominous ads calling for the rollback — it could cost many Americans nearly as much as what they have at stake in the ongoing squabbling over the 2011 budget.

The bipartisan debt and credit card reforms passed last year put the first real limits on how much the card networks and the large banks that issue nearly all cards can charge merchants when a consumer pays with a debit card. These charges are called “swipe fees,” and while they apply to all credit card as well as debit card transactions, the 2010 swipe-fee reforms apply only to debit card transactions. But if they save consumers as much as economists estimate, these reforms could well be extended to all credit card transactions too. And that could save the average American household some $230 per-year.

This is worth dwelling on, because it involves an ostensibly free market which, behind the curtain, a few huge companies actually manage to a significant degree — and now, behind the scenes, they’re also trying to manage the legislative process.

The facts, in a nutshell, are as follows. Merchants pay the three credit and debit card networks that account for some 80 percent of all charges a fee for every transaction using one of their cards that ranges from 1.5 percent to about 3.2 percent of the value of the transaction. A fee at some level makes perfect sense, since people buy more when they can charge or debit it, which benefits the merchants. But there’s no real economic basis for the actual levels of the fees. Less than 20 percent of the fees go to cover the actual costs of transaction for the banks and the credit card networks. Most of the rest goes to the four big banks that account for nearly 70 percent of all card transactions, with some going into higher profits and some for the advertising and rewards programs used to attract more customers.

We studied these fees last year. We found that in 2008, merchants paid swipe fees totaling some $48 billion. Those costs were tacked on to the price of everything they sold – clothing, computers, gasoline, restaurant meals, airline tickets, medications and so on. Moreover, the credit card networks forbid merchants from charging anyone using their cards a higher price to cover the fee, than those who pay cash. So, everyone pays for the swipe fees in higher prices every time they buy anything, whether or not they even use a credit or debit card.

We found that 56 percent of the swipe fees paid by merchants get passed along in higher prices, which in 2008 came to about $26 billion or $230 per-household. This year, it will be more, because we’re all charging more. And if the swipe fees were limited to the actual costs of processing debit and credit card transactions, plus normal profits, the lower prices for everything would expand real demand enough to create nearly 250,000 more American jobs.

In truth, the credit and debit card system operates more like a cartel than a genuine market. The fees are set by three companies that together account for 95 percent of consumer charges and two-thirds of business charges — Visa, MasterCard and American Express. Their actual customers are the banks that issue the cards, because the more cards are issued, the more swipe fees are generated. Moreover, four banks account for 70 percent of all cards and charges: JP Morgan Chase, Bank of America, Citigroup, and American Express (all of which, by the way, also collected taxpayer bailouts).

Since each of the networks and each of the banks account for a good slice of any merchant’s business, merchants have little option but to deal with them — again, much like a cartel. So, merchants can’t put normal market pressures on the networks and the banks to lower the fees by exiting the system. And since the networks forbid merchants from charging different prices based on whether a customer uses a card or cash, consumers have no incentive to pressure the networks and banks to lower their fees by using cash instead.

This not only produces higher prices, but higher prices that are applied in particularly unfair ways. More than half of all lower and moderate-income Americans don’t carry credit or debit cards at all. Yet they pay the higher prices along with everyone else. And most middle-class Americans with credit or debit cards pay higher prices to finance rewards programs largely restricted to more affluent card users.

So, last year, Congress gave the Federal Reserve authority to set rules for the swipe fees on debit card transactions. When Australia did much the same to cover both credit and debit cards, swipe fees there fell to 0.50 percent — and the system continued to work fine. The new rules are nearly ready to be issued here, and that’s what the banks and credit card networks are working so hard to stop. It will be another political test of whether big finance really can get anything it wants from Washington, regardless of the cost to everybody else.