The New Congress and Economic Growth—Posner’s Comment

Becker makes the important point that growth in the deficit, because of an increased gap between government spending and tax revenues, is tolerable if GDP grows faster; for it is not the absolute size of the deficit, but its relation to the size of the economy, that is important. And there are, as he says, a number of reforms that would result in faster economic growth, including tax reforms and a rational immigration policy. And spending could be cut—just placing social security and Medicare on a means-tested basis would do wonders.

But there are two questions to ponder. One is whether reforms aimed at increasing economic growth (rather than reducing spending) would be likely to increase that growth by a large enough margin to make a growing deficit shrink as a percentage of GDP. I am skeptical. Americans are lightly taxed by international standards and the rate of formation of new businesses normally is very high. Small businesses are currently having trouble borrowing but that is a consequence of the continuing weakness of the banking system rather than of anything to do with the tax system, and the financial system is likely to revive before tax reform could be implemented. The higher tax rates of the Clinton years seem not to have inhibited economic growth. It would be great if the immigration laws were changed to encourage more immigration by high-IQ foreigners and also by wealthy ones, but, again because of the continuing weakness of the U.S. economy, the demand for skilled immigrants is at present weak.

There may also be a practical ceiling on the rate of economic growth of a mature, highly complex economy. Maybe at a growth rate above 3 percent, labor and materials shortages create bottlenecks and inflation that make it prudent for the Federal Reserve to push up interest rates in order to slow down growth. If this is right and if taxes are cut and spending rises, it is hard to see how the annual deficit can be kept from rising by more than 3 percent. It is illuminating to compare the increase in the national debt during the Presidency of George W. Bush—a period in which Congress (until 2007) and the Presidency were highly pro-business—with the increase in GDP during that period. In 2002, the debt increased by 5.5 percent and GDP by 1.3 percent. The corresponding figures for 2003 were 6.2 percent and 1.4 percent; for 2004, 5.7 percent and 3.4 percent; for 2005, 3.7 percent and 2.6 percent; for 2006, 3.4 percent and 2.9 percent; for 2007, 3.6 percent and 2.8 percent; for 2008, 5.0 percent and 2.0 percent; and for 2009, 5.5 percent and 2.6 percent. Since then of course the gap has widened, but that is because of the economic crisis. We would feel great if we were back in the Bush economy! Yet in every year of Bush’s Presidency, the deficit grew faster than GDP. That may be the “new normal.”

The second question (which relates to the hypothesis of a new normal) is the political realism of economic reforms that would increase the growth rate or reduce the deficit. As I have argued previously, both political parties seem to have converged on a policy of high spending and low taxes. The Democrats want even higher spending than the Republicans do, and the Republicans want even lower taxes than the Democrats do, but these differences should not blind us to the realization that neither party has serious plans for reducing the annual increases in the deficit. I do not see this changing in the new Congress. If the Republicans had won control of the Senate, they would be under pressure to produce legislation that the President would sign, lest the new Congress be accused of being a “do-nothing” Congress—the accusation that won Truman the Presidency in 1948. But since the Republicans do not control Congress, an oppositional stance is attractive. And it is more difficult for Obama to compromise with Republicans than it was for Clinton, because Obama is more liberal than Clinton was and the Republicans are more conservative today than in the 1990s.

The status of the dollar as the international reserve currency, and the mercantilist policies of countries like China and Germany, will enable us to finance our growing deficit, and thus postpone the day of reckoning, for some time. But at some point the wheels may start coming off the chassis.

Still, life is full of surprises. The prospects for the United States looked grim in the 1970s and bright for Japan. Then Reagan was elected and the sky cleared here, and then the Japanese housing and banking bubbles burst and Japan entered the long period of economic stagnation in which it still finds itself. Maybe we’ll get lucky again.

Comments

[Jack]

A thoughtful and well reasoned essay but a few questions remain.

On lack of GDP growth per deficit dollar, I'd argue that one of the mistakes was that of "spending" too many dollars on upper income tax breaks as those in the higher brackets have little propensity to spend the marginal increase. We can see this effect w/o a "study", while the strapped middle class or lower income person will shoot off to the mall with even a small tax rebate -- new shoes for Jr, a trip to see grandparents, etc. the much larger check coming to the upper income home is likely to go in the bank.

Hmm GDP "Growth" itself during the Bush era has me wondering. Whatever the reason/fault "gdp" grew on a frantic housing boom fueled by fraudulent and very profitable banking practices. None of which could be deemed healthy growth nor a foundation for future gains. Capitialism based on wrong (warped, false and fraudulent) signals is bound to be inefficient, as we see with scarce resources "invested" in too many homes, of the wrong size, in the wrong place, that are obsolescent energy hogs to boot.

What real growth would we get if we backed out the faux "growth?" Hard to say, but even the term "jobless recovery" and more folks falling below the poverty line, followed by the consequent meltdown and tremendous levels of unemployment gives us an estimate of zero to negative.

Posner uses terms like "pro business" for Bush era policies. Oh? I'd think the thoughtful observer would expect "pro business" policies to be those that promote a healthy and honest competitive environment that rewards efficiency, good management and wise use of scarce resources.

My intent here is not "Bush bashing" but to analyze the recent path to give us a clue to the direction ahead as we are clearly in a transitional time of many problems with few or at least very tough to adopt solutions.

One thing is certain; we are accumulating far too much debt, debt levels so staggering they'll freeze out useful government programs as the cost of debt service becomes "another military". It will be interesting to see how the incoming "low tax purists" react when they come to the unavoidable conclusion of having to raise taxes.

Ha! In closing I liked this last:

Still, life is full of surprises. The prospects for the United States looked grim in the 1970s and bright for Japan. Then Reagan was elected and the sky cleared here, and then the Japanese housing and banking bubbles burst and Japan entered the long period of economic stagnation in which it still finds itself. Maybe we’ll get lucky again.

Ha! Mostly no one saw that coming at the time, and though, to me, the fraudulent excesses of our "bankers" seemed apparent 5 years ago without sophisticated computers or and insider's view. If we are to believe what we're told "no one" saw that coming either, while the "S&L crisis" was seen for a decade before anything was done.

Ha! so with all the computers at the Fed and on WS, the CBO, in academia we see no further ahead than driving with a muddy windshield ......... and have no brakes?

[Jack]

Whoops! I meant "Becker" uses terms like "pro business" for Bush era policies.

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Small businesses are currently having trouble borrowing but that is a consequence of the continuing weakness of the banking system rather than of anything to do with the tax system, and the financial system is likely to revive before tax reform could be implemented.

[Jake]

When did Posner start drinking from Krugman's teapot?

That aside, Posner should know better than to indiscriminately assert that "Americans are lightly taxed by international standards." If Posner believes this to be true (and it is not), he ought to reconcile his position with the perverse tax incentives that the U.S. creates by imposing comparatively punitive corporate tax rates on U.S. companies, with a surcharge for repatriating their foreign earnings.

Posner likewise misses the mark in urging that "it is more difficult for Obama to compromise with Republicans than it was for Clinton, because Obama is more liberal than Clinton was and the Republicans are more conservative today than in the 1990s." It is more apt to say that Republicans today are no more conservative than they were in the 1980s.

Understandably Posner ends his post with positive memories of Ronald Reagan's presidency. Were he still with us, Reagan would have the good sense to give Obama a memorable spanking.

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"Americans are lightly taxed by international standards..."

Americans are also the most prosperous nation amongst almost 200. But it's just a coincidence folks! Let's ignore it and join the rest of the world! If we make a mistake we can always return to lower taxation, can't we?

[Jack]

"Greece?" Are you weighing in, in favor of our paying for the needless wars ginned up? Other???

[Jack]

Jake -- Right, If we add Fed taxes and our exorbitant H/C costs together and compared them to Canada, the UK or Europe we'd likely be paying more. But then! We have this fine military which takes 35% of the budget and the "supply side" debt to service.

As mentioned the UK recently chopped their much smaller military by a reported 8%, I wonder if anyone will dare to make a similar reduction in ours?

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[John]

Posner shows deep senility and madness, writing

There may also be a practical ceiling on the rate of economic growth of a mature, highly complex economy. Maybe at a growth rate above 3 percent, labor and materials shortages create bottlenecks and inflation that make it prudent for the Federal Reserve to push up interest rates in order to slow down growth. If this is right and if taxes are cut and spending rises, it is hard to see how the annual deficit can be kept from rising by more than 3 percent. It is illuminating to compare the increase in the national debt during the Presidency of George W. Bush—a period in which Congress (until 2007) and the Presidency were highly pro-business—with the increase in GDP during that period. In 2002, the debt increased by 5.5 percent and GDP by 1.3 percent. The corresponding figures for 2003 were 6.2 percent and 1.4 percent; for 2004, 5.7 percent and 3.4 percent; for 2005, 3.7 percent and 2.6 percent; for 2006, 3.4 percent and 2.9 percent; for 2007, 3.6 percent and 2.8 percent; for 2008, 5.0 percent and 2.0 percent; and for 2009, 5.5 percent and 2.6 percent. Since then of course the gap has widened, but that is because of the economic crisis. We would feel great if we were back in the Bush economy! Yet in every year of Bush’s Presidency, the deficit grew faster than GDP. That may be the “new normal.”

There are no "limits" to growth. China just built a 16 story hotel in 6 days. There are merely limits of vision and imagination.

Obviously, cutting taxes doesn't work. Why? because it leads to wasteful consumption and under investment in R & D

as the world become more complex, gathering information becomes more expensive and complex. Read Lewis, The Big Short. Government must become bigger, to keep up with the information flow, and better. Look at all the silos that lead to 9/11

How can a limited government gather enough information to make intelligent choices? Take nuclear energy, for example. Making capital investments and safety decisions in both r&d and plant and equipment is extraordinarily complex.

How can a small, limited government do the job? It can't

[Deeptee]

With so many Americans adopting outright the bigger better government mentality, it is questionable whether America will be able to sustain 1-2% growth rates, not Posner’s mediocre hope for 3%.

It is amazing how many Americans totally misinterpret China’s growth and derive exactly the opposite conclusions. Add to that the sizable number of Americans who HOPE that CHANGE to lower incentives to produce will create more prosperity, and you realize how a majority has now formed that makes America’s fate of decline all but sealed, save a few brief intermissions.

The average Chinese individual, once 95% owned by government, and thus producing a per capita GDP that was 3% that of the average American, has now finally found some new limited freedom whereby he is now only 50% owned by government. As a consequence, he is now springing up from decades, if not centuries of oppression to a new equilibrium point. An equilibrium point where he is poised to become perhaps as much as 50% as productive as the Average American. While he will not be able to reach or surpass American per capita GDP, unless he is given more freedom, remember that a China where each Chinese produces even just ½ of what the average American produces will already be an economy twice as big as the United States. Add to that India, Brazil and a host of other countries for a total of 3 billion people whose citizens now finally have some limited economic freedom and are thus also springing up towards a new equilibrium growing at 5-8%, and you see how quickly Americans are going to be marginalized as the dominant economic power; especially when Americans are now moving in exactly the opposite direction under the we HOPE that CHANGE to more government will be better.

Today, the American middle class is indeed very high class by worldwide standards. But make plans, because the days of descent into worldwide averagedom are finally here. By turning against the most productive amongst them, in class warfare, the American middle class will soon find itself in a true middle class position: The worldwide average.

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[R.B. Ling]

Only 55% of all Americans pay income taxes.

Income tax increases will bring some additional revenue in the very short term, however not proportional to the tax increase (though the CBO uses fairy tale static forecasting and thus typically assumes that higher taxes will not change incentives to earn whatsoever). Furthermore, the ever so slight change in growth rate, caused by increased taxation, has the nasty tendency to compound over the years and thus, in anything but the short term, negate any additional revenue from the extra income taxes.

The bottom line is that since it impossible to balance the budget by taxing the rich alone, time has come for the middle and lower class to also pay to feed the beast that they worked so hard to create. So be prepared. Look for value added taxes and/or other direct and indirect consumption taxes that will inevitably bring the middle and lower classes more and more into the tax paying pool. There is no other way to feed the beast. You wanted it, you got it!

The general rule is: Look for an “increased taxes and spending reduction”, “compromise” package between political liberals and conservatives in the next year. Tax increases will then become permanent (including VAT and other consumption taxes that bring the middle and lower class into the taxation pool) and then spending cuts are forgotten after a few years. Repeat cycle every 5-10years ever increasing all tax rates by a few percentage points each time (when is the last time sales taxes went down?). Become a middle of the pack medium prosperity country in 1-2 generations.

[Jack]

Deeptee: Korea was another nation that enjoyed very high rates of growth. Of course there situation was much like that of China after MFN was passed. That is a very small and hungry economy had access to our VERY large and established consumer base.

It's tempting to extrapolate a past growth rate to the future, but as is the case with many of our large corporations it's a LOT tougher to double the gross or net, of a GE, GM or other behemoth.

Consider, for the US to have an 8% GDP growth rate would require (.08 X $14 trillion) more than an additional trillion worth of product year after year. I'm sure we could rise to the occasion on the production side, though as Posner points out there'd be shortages, bottlenecks and the price of oil likely going through the roof.

But WHERE would we sell trillions more in products? There's certainly needs in a world with 6 billion people, but the number of units sold at US prices will be small.

China, may well be running into a STIFF headwind soon as well. Their internal policies are creating an R/E bubble that would make our own look like a bubble from a child's bath tub toy and it appears that the US is not alone in no longer tolerating currency value games.

[Jack]

John another great post! Indeed! In say 1960 the FDA had penicillin to consider, today? thousands of complex drugs? And Deeptee? The "right" simply has to get over the idea that "government" produces nothing.

RB Ling: It's indeed unfortunate that the tax burden distribution is not more as it was in the 50's and 60's, but! problem is that of stagnant wages for most while those in the topmost tiers have garnered all of the gains of increased productivity. It's simply math that even with a progressivity that IS too low today, that those receiving a huge fraction of the income will also bear a similarly large percentage of the tax burden. Can't really be any other way.

As for slipping in some Forbesian or "Chicago School" "flat tax", VAT or the darling "consumption tax" we are forewarned and will not tolerate regressive schemes when incomes are so utterly out of whack.

Lastly? the key to "unleashing" US capitalism IS getting rid of cronyism and I've some (slender) hopes that the teabaggers brought enough idealism with them to root it out and try to kill it off. Our aging nation is dying of corruption and stagnation NOT over taxation.

[John]

Jack,

Glad to see that someone has some sense around here.

Mostly, this blog is Posner's idea to cutoff a serious inquiry into his personal responsibility for what has happened. It is good offense is the best defense in spades

Along with Easterbrook and Scalia, Posner has been one of the principal architects of promoting fraud, by letting the crooks go free.

Our economy started going down hill with Central Bank of Denver, the aiding and abetting case, which destroyed trust, which is different from confidence.

here is an excellent discussion of the destruction of trust

http://www.washingtonsblog.com/2010/11/economy-will-not-recover-until-economic.html

Posner and Easterbrook have been rowing the oars since DiLeo.

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[Jack]

John --- good article. On a slightly different tack, it seems "economists" and pundits largely ignore the new home industry having tanked from 2.5 million starts down to less than 400k starts today. At something like 4 full time jobs per new home, plus what most folks spend when the move to a new home the number of primary and secondary jobs lost is enormous and the lost income dwarfs the measly $70 billion/year that upper income folk would pay if the utterly unaffordable Bush tax cuts for those over $250k are allowed to revert to the rates current during the Clinton era boom.

"They ought to be impeached for this case.Decatur Ventures, LLC v. Daniel, 485 F. 3d 387 - Court of Appeals, 7th Circuit 2007, in which they held that a home buyer, duped into buying an overvalued house, could not sue the appraiser who made it all possible"

......... Interesting. Here in Alaska where the 1984 R/E collapse in "oil patch" states was much like the national situation today, I know of a realtor who was imprisoned on the basis of "a realtor's assessment of value" which I never thought anyone took seriously.

With the amount of outright fraud throughout the "banking" system replete with the savvy derivatives designers all of a sudden becoming dumber than Enron execs our prison should be tossing out minor drug offenders to make room for "our" financiers.

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