Toward a More Resilient Europe

By Poul M. Thomsen Europe, like the rest of the world, faces an extended crisis. An element of social distancing—mandatory or voluntary—will be with us for as long as this pandemic persists. This, coupled with continued supply chain disruptions and other problems, is prolonging an already difficult situation. Based on updated IMF projections released last […]

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Fiscal Policies for a Transformed World

By Vitor Gaspar and Gita Gopinath The ongoing COVID-19 pandemic has already prompted an unprecedented fiscal policy response of close to $11 trillion worldwide. But with confirmed cases and fatalities still rising fast, policymakers will have to keep the public health response their No. 1 priority while retaining supportive and flexible fiscal policies and preparing […]

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Reopening Asia: How the Right Policies Can Help Economic Recovery

by Chang Yong Rhee For the first time in living memory, Asia’s growth is expected to contract by 1.6 percent—a downgrade to the April projection of zero growth. While Asia’s economic growth in the first quarter of 2020 was better than projected in the April World Economic Outlook—partly owing to early stabilization of the virus […]

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The Great Lockdown through a Global Lens

By Gita Gopinath The Great Lockdown is expected to play out in three phases, first as countries enter the lockdown, then as they exit, and finally as they escape the lockdown when there is a medical solution to the pandemic. Many countries are now in the second phase, as they reopen, with early signs of […]

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Bill Whalen and David Henderson Conversation

On June 4, my Hoover colleague Bill Whalen interviewed me about my latest article for Hoover’s Defining Ideas, “Just Say No to State & Local Bailouts,” June 3. I had heard and seen a talk by Bill on Zoom a week earlier and was impressed with his deep knowledge of California politics. His show is titled “Area 45.”

The interview was really a conversation, something I prefer to a standard interview. Bill has a charming personality, with just the right amount of humor.

In the first 20 or some minutes I make the case that I made in my article, in response to Bill’s questions. But he also raised an issue I hadn’t addressed in my article: whether on grounds of emergency aid, California’s state government should be given a bailout. I said no and I said why.

Some highlights from the rest of the conversation:

23:20: Why I worry that Senate Majority Leader Mitch McConnell will go along with some kind of bailout.

36:00: My case for bonds instead of tax increases. (My first choice, of course, is budget cuts.)

37:10: Why, if the feds do bail out California’s government, I would prefer aid with no strings over aid with strings.

38:30: States going their own way on coronavirus policy and why that’s important.

41:00: Related to what’s directly above: The states as laboratories of democracy and why that’s so important.

41:27: Why economists and other social scientists are almost orgasmic about the forthcoming data.

45:20: Eat the rich.

45:40: I’m seeing it as rich people saying “eat the rich.”

 

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What does it mean to say a debt is “unsustainable”?

I often warn against countries running up excessively large public debts. Some people interpret my worry as a prediction of a future financial crisis, perhaps including default and/or very high inflation. They point out that countries such as Japan have run large deficits for many decades, with interest rates on long-term bonds remaining near zero. So are these worries overblown?

For developed countries with their own currency my actual fear is not outright default, or even hyperinflation. Rather I fear that an excessively large public debt will eventually force painful changes in fiscal policy, such as benefit cuts or more likely large tax increases. The most efficient fiscal policy is one that smooths tax rates over time, as high taxes are a drag on the economy.  Furthermore, the effect of tax increases is not linear. A doubling of the tax rate will lead to a roughly fourfold increase in the deadweight loss, without even doubling tax revenue.

By the mid-1990s, Japan’s budget deficits were on an unsustainable path while the US budget deficits were still on a more sustainable path.  At this time, Japan had a 3% national sales tax whereas the US had no national sales tax.  Both countries had overall tax burdens that were below average for developed countries.

In 1997, Japan raised its national sales tax to 5%.  In 2014 they raised the tax to 8%.  In 2019 they raised the tax to 10%.  These increases were intended to address the debt problem.  Meanwhile the US continued to have no national sales tax.  Thus the very thing I was worried about did actually occur in Japan.  Furthermore, more tax increases are almost certainly on the way.  Unfortunately, the US budget deficit situation also became unsustainable during the late 2010s, due to a highly expansionary fiscal policy.  Thus the US is likely to be forced to raise taxes (or cut benefits) in future years.

To summarize, it is true that Japan is likely to be able to avoid default on their public debt.  But this does not mean that those who warned the deficits were unsustainable were wrong.  Indeed, Japan was forced to repeatedly raise taxes precisely because the path of the public debt was unsustainable without future tax increases.

PS. The FRED data site shows net debt for Japan (blue line) and gross debt for the US (both as shares of GDP.)  So the actual gap is even larger than it appears:

 

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Just Say No to State & Local Bailouts

Why is the HEROES bailout so much greater than the states’ losses? Simple: State governments would likely use a large part of the bailout money to make up for shortfalls in their funds for state government pensions. In April, Illinois Senate Democrats, for example, asked Congress for a bailout of over $40 billion, $10 billion of which would go the state pension fund. A famous Illinois politician, Rahm Emmanuel, famously said “You never want a serious crisis to go to waste.” His fellow Illinois Democrats’ motto could be “Never let a crisis go to waste when you can use it to subsidize waste.”

This is from my latest Hoover article, “Just Say No to State & Local Bailouts,” Defining Ideas, June 3.

Another excerpt:

Governor Newsom, in a May 17 interview with CNN’s Jake Tapper, asserted that the $54 billion budget deficit the state government is facing “is a direct result of the impact from the coronavirus pandemic and not because of existing financial troubles.” Close but no cigar. There are three problems with this statement.

First, in claiming that California’s government would have a $54 billion deficit, Newsom contradicted the California’s Legislative Analyst’s Office (LAO). That office, which has a stronger incentive to tell the truth than the governor has, estimates that the budget deficit will be a much more manageable $18 billion to $31 billion. The $18 billion estimate is based on a U-shaped recession, with the recovery starting this summer. In case you think that’s too optimistic, the LAO’s U-shape assumes that economic activity stays “below pre-recession levels well into 2021.” The $31 billion estimate assumes an L-shaped recession, with the economy in recession well into 2021 and gradual recovery not beginning until the second half of 2021. Now that’spessimistic! In 2019, California’s gross state product was $3.2 trillion. Of course, it will be lower this year. But I point that out to note that the pessimistic $31 billion deficit is only about one percent of last year’s gross state product.

Second, although much of the budget deficit is due to the pandemic, a large part is also due to Newsom’s extreme lockdown, which he began on March 19. In attributing the deficit to the Covid-19 disease, Newsom, like many politicians and pundits, failed to distinguish between the voluntary social distancing measures that people undertook before the lockdown and the lockdown itself. Those voluntary measures certainly reduced economic activity, with the decline in spending on restaurants and bars being one of the main ways that happened. But the Newsom lockdown went much further, causing a closure of many retail outlets that people would have still been inclined to patronize, albeit with social distancing. In short, part of the economy’s decline is on Newsom.

If you want to know the third reason, read the whole article.

Thanks to Eileen Norcross of the Mercatus Center at George Mason University for a helpful conversation and for providing some good links to state data on budgets.

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