Krugman Illustrates Caplan’s Point

In January 2019, co-blogger Bryan Caplan wrote:

The theory of market failure is a reproach to the free-market economy.  Unless you have perfect competition, perfect information, perfect rationality, and no externalities, you can’t show that individual self-interest leads to social efficiency.*  And this anti-market interpretation is largely apt.  You can’t legitimately infer that markets are socially optimal merely because every market exchange is voluntary.

Contrary to popular belief, however, market failure theory is alsoa reproach to every existing government.  How so?  Because market failure theory recommends specific government policies – and actually-existing governments rarely adopt anything like them.

What we also often see and, depressingly, even usually see, is that economists who are pro-government intervention to fix market failures have a much lower standard for the government than they have for the market. So the odds are that avoiding the specific government policy being proposed would get us closer to the optimum than implementing the government policy.

A case in point is Paul Krugman and his views on the recent $1.9 trillion spending bill. In Benjamin Wallace-Wells, “Larry Summers versus the Stimulus,” March 18, 2021, Wallace-Wells makes that point, although I’m not sure that that’s his intention.

Wallace-Wells, describing a recent debate between Krugman and Larry Summers about the Biden spending plan, writes:

Krugman asked, rhetorically, which elements of the package Summers would cut. Not the public goods, like vaccination and funds for school reopening, and surely not the needed income support. What was left was the part that members of Congress had most vociferously demanded: the aid to state and local governments (which Krugman agreed probably exceeded the fiscal need) and the checks to people who had not much suffered. Krugman said, “The checks, which are the least-justifiable piece in terms of standard economics, are also by far the most popular, and I don’t think we can entirely disregard that.”

Put aside the fact that the funds for school reopening are almost certainly not justified because the risks to students and teachers are so low. Notice what even Krugman admits. First, that the aid to state and local governments is too much, even by his standards. Second, the checks to people who hadn’t suffered much, which are a huge part of the package, are the “least-justifiable piece in terms of standard economics.” And what’s Krugman’s justification for those payments? That they are “by far the most popular” and, for that reason, we can’t “entirely disregard that.”

In short, in order to get hundreds of billions in spending that Krugman thinks are justified, he is willing to have the government spend other hundreds of billions for things that are not justified. Such is the nature of many, perhaps most, economists’ advocacy of government policy.

Note: The picture above is of a Rube Goldberg machine, which is what I think a lot of government policy is like. There is one difference. The Rube Goldberg machine always worked.


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The Damage Yet to Come from the “Stimulus”

In my previous Defining Ideas article, “An Unnecessary ‘Stimulus’ ” (March 5), I laid out why the about-to-be-passed $1.9 trillion federal spending bill was unnecessary. I also pointed to a few major spending items in the budget that were clearly unjustified, such as the unneeded bailout of state and local governments. But I didn’t point out that the bill will also cause harm in the long run. The harm will be of two kinds. The first is in the realm of ideas: many people will learn the wrong lessons from the spending. The second is in the realm of policy and the effects of policies: dependence on government and irresponsibility will increase, and economic freedom and long-run economic growth will fall.

This is from David R. Henderson, “The ‘Stimulus’ And The Damage Yet to Come,Defining Ideas, March 18, 2021.

At a distance, the $1.9 trillion measure is awful; up close, it’s ugly.

Another segment:

A major piece of the spending bill is a $3,600 annual tax credit for each child under age six and a $3,000 tax credit for children ages six to seventeen. The credit is, in tax speak, “refundable.” Normally one can get a refund only of something one has paid. But the term “refundable” is now widely used to describe a tax credit that goes to someone who otherwise would have a tax liability that is less than the credit. For some people, these tax credits will amount to a huge increase in their income. And the tax credit is granted regardless of whether the recipients work. Thus, the measure undoes, to some extent, the highly successful welfare reform of the mid-1990s, passed by a Republican Congress and signed into law by Democratic President Bill Clinton. Economist Scott Winship of the American Enterprise Institute points out that a non-working mother with three children could get $10,800 a year, as well as food stamps and Medicaid. That’s not a lot, but it would reduce her incentive to get married and/or to get a job.

Washington Post columnist Greg Sargent, in an op-ed titled “The GOP scam is getting worse—for Republican voters. A new study shows how,” March 8, 2021, finds puzzling the fact that all Republicans in Congress voted against the bill even though the tax credit would help a lot of low-income people in the states they represent. I don’t find it puzzling at all. In fact, given how dismal the performance of Republicans in Congress has been this century, it’s slightly heartening. Why would so many Republicans vote against a bill that helps so many of their constituents? Could it be that they actually believe some of their own rhetoric, the rhetoric about keeping people off welfare and not having them depend so much on the federal government? Maybe.

Read the whole thing.




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How much should we borrow?

A commenter directed me to a Noah Smith post that begins as follows:

One of the most important questions in macroeconomics is one that economists have curiously chosen not to study. That question is: “How much can the government safely borrow?”

In my view, this is the wrong question.  The right question is: How much should the government borrow?

The term “safely” is quite vague.  Safe from what?  From default?  From hyperinflation?  From future tax rates that are punishingly high?

In contrast, we have a great deal of research on the optimal level of public borrowing.  In a 1979 JPE paper, Robert Barro argues that the budget deficit should fluctuate in such a way as the minimize the long run deadweight cost of taxation.  Here is the abstract:

A public debt theory is constructed in which the Ricardian invariance theorem is valid as a first-order proposition but where the dependence of excess burden on the timing of taxation implies an optimal time path of debt issue. A central proposition is that deficits are varied in order to maintain expected constancy in tax rates. This behavior implies a positive effect on debt issue of temporary increases in government spending (as in wartime) a countercyclical response of debt to temporary income movements, and a one-to-one effect of expected inflation on nominal debt growth. Debt issue would be invariant with the outstanding debt-income ratio and, except for a minor effect, with the level of government spending. Hypotheses are tested on U.S. data since World War 1. Results are basically in accord with the theory. It also turns out that a small set of explanatory variables can account for the principal movements in interest-bearing federal debt since the 1920s.

Can we safely borrow as much as we are currently borrowing?  I’d say yes.  Should we be borrowing as much as we are currently borrowing?  I’d say no.  After all, I don’t think anyone in their right mind expects a “constancy in tax rates” in the coming decades.  Tax rates are going to increase.

PS.  If you don’t believe that tax rates are set to increase, consider today’s news:

House Republicans voted to allow their members to request dedicated-spending projects, known as earmarks, following that same move by Democrats, in a positive sign for President Joe Biden’s hopes for a bipartisan infrastructure bill.

So remind me, which one is the party that favors small government?


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An Unnecessary “Stimulus”

In two Defining Ideas articles in 2009, “Who’s Afraid of Budget Deficits? I Am” and “Furman, Summers, and Taxes,” I criticized Lawrence Summers and Jason Furman, two prominent economists who worked in the Obama administration, for their dovish views on federal debt and deficits. They had argued that we shouldn’t worry much about high federal budget deficits and growing federal debt. Of course, that was before the record budget deficit of 2020. Now even Summers is worried. In two February op-eds in the Washington Post, Summers argues against the size and composition of the Biden “stimulus” bill.

Summers makes a solid argument, on Keynesian grounds alone, that the proposed $1.9 trillion spending bill is much too large. He also, to his credit, digs into some of the details of the bill, pointing out how absurd they are. Had Summers looked at more details, he could have made an even stronger case against the measure. For instance, one major provision of the bill, the added unemployment benefits through August, will actually slow the recovery. And other provisions of the bill, like the bailout of state and local governments, are bad on other grounds. The fact is that this is not your father’s or your grandmother’s run-of-the-mill recession. It was brought about by two things: (1) people’s individual reactions to the threat of Covid-19 and (2) politicians’ reactions, in the form of lockdowns, to the same threat.

These are the opening two paragraphs of my latest article for Defining Ideas, “An Unnecessary ‘Stimulus’“, Defining Ideas, March 5, 2021.

And the ending:

First, the economy is recovering. In January, the International Monetary Fund predicted that real GDP will grow by 5.1 percent in 2021. Possibly that’s because the IMF understands that this is not a typical recession. The slump we’re in was due initially to people’s fear of the virus, a fear whipped up by Dr. Anthony Fauci and others. But now it’s due mainly to lockdowns. As the percent of the US population that has had COVID-19 rises and the number of people vaccinated rises, we are getting closer to herd immunity. Then people will feel even safer going out and governments will have fewer excuses to keep their economies locked down. We can all become Florida or Florida-Plus. That will all happen without any stimulus bill.

Second, the $1.9 trillion bill represents government taxing us or our children in the future to spend money in places where we the people have chosen not to spend it now. The bill is, in essence, a huge instance of central planning with government officials’ preferences overriding ours. The bill, for example, contains $28 billion for transit agencies, $11 billion in grants to airports and airplane manufacturers, and $2 billion in grants to Amtrak and other transportation. How does the government know that those are the right amounts? What if, as I predict, when the pandemic and lockdowns end we will still have fewer people wanting to ride transit because they and their employers will opt for a hybrid model of some at-home work and some in-office work? The effect of this misallocation of resources won’t necessarily show up in GDP because GDP measures government spending at cost rather than at value. But this spending will make us somewhat worse off. It’s far better to rely on people having the freedom to make their own allocations.

If the government gets out of the way, the economy will recover. Maybe it takes an outsider to see that and to say that. I just did.

Read the whole thing.


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When is fiscal stimulus appropriate?

Greg Mankiw recently presented a graph showing that the US is doing much more fiscal stimulus than other big economies during the Covid crisis, even as a share of GDP:

I was struck by the big difference between the US and major European economies such as Germany, France and Italy.  According to mainstream macroeconomic theory, the Eurozone economies should have been doing far more fiscal stimulus than the US.

The standard model suggests that monetary policy should steer demand during normal times.  According to this view, there might be two situations where fiscal stimulus is appropriate:

1. If a country lacks an independent monetary policy.

2. If a country is stuck at the zero bound, and monetary policy is ineffective.

Both the US and the Eurozone have near-zero short-term rates.  In contrast to the Eurozone, however, longer-term rates are well above zero in the US.  So the case for monetary policy ineffectiveness is stronger in the Eurozone.

The US has an independent monetary authority that can provide stimulus when needed.  Individual Eurozone countries lack such an authority, and thus might benefit more from fiscal stimulus.

This is not to suggest that I believe Eurozone countries should have done more fiscal stimulus.  I’m skeptical of the efficacy of fiscal stimulus, and countries without an independent bank have less margin for error in terms of avoiding a debt crisis.  Rather my point is that for whatever reason, developed countries are not following the playbook suggested by the standard model of fiscal policy.  The US would be expected to do far less fiscal stimulus than the Eurozone countries.

PS.  For those interesting in long run debt sustainability issues, I strong recommend David Beckworth’s podcast with Ricardo Reis.  It’s a bit technical, but highly informative.



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Mitt Romney’s Expensive and Unfair Child Allowance

Co-blogger Scott Sumner argues for, without quite endorsing, Senator Mitt Romney’s proposal for a large child allowance. I won’t lay out the specifics of Romney’s proposal in detail because Scott has already done it and the Tax Foundation has provided even more details.

I will point out that the budget cost of the plan, all else equal, is estimated to be about $229.5 billion annually. While that might not sound like a lot in this time of trillion-dollar spending programs, it is a lot.

Of course, not all else is equal. If Romney got his way, the child care tax credit would be eliminated, which would save $117 billion annually, leaving $112.5 billion as the net cost. He would also reform the Earned Income Tax Credit, saving $46.5 billion annually, driving the net expenditure for his plan down to $66 billion.

He would come up with the $66 billion by increasing taxes in three ways and cutting two other spending programs.

While the Tax Foundation did an excellent job of analyzing the provisions of the Romney plan, it did make one error. The analysts, Erica York and Garrett Watson, state:

Romney estimates eliminating the SALT deduction would result in $25.2 billion in annual savings through 2025.

But eliminating the SALT deduction doesn’t save money: it costs money. It costs taxpayers who will lose the deduction. Of course, York and Watson may be quoting Romney and so it may be Romney’s mistake. But it is a mistake.

Note also that the child allowance starts phasing out for single taxpayers with income about $200,000 and for married, filing jointly taxpayers with income above $400,000, at a rate of $50 per $1,000 in income. That implies that very high-income people, virtually all of whom are already in a fairly high federal tax bracket, will see their marginal tax rates increase by 5 percentage points. That’s if they have 1 child. And if they have 2 children, their marginal tax rates will be 5 percentage points higher over an even larger range of income than the Tax Foundation’s graph shows.

Most of these high-income people will be in a 35 percent tax bracket. This phase-out increases their marginal tax rate by 14.3 percent (5 is 14.3 percent of 35). The efficiency loss, also called deadweight loss (DWL), from taxes is proportional to the square of the tax rate. So the 14.3 percent increase in the marginal tax rate doesn’t increase DWL by 14.3 percent. It increases it by 30.6 percent. (Take 0.4 squared divided by 0.35 squared and you get 1.306.) That’s a large increase.

And why all this? Why does it make sense to subsidize people having children?

Two other points.

First, although Scott Sumner says that the proposal will increase equity, he doesn’t define equity. But implicit in his discussion is the idea that equity is synonymous with income equality or, at least, reduced income inequality. That’s not my view. My view is that people are treated equitably when other people don’t take their stuff. Romney would tax people more when they live in high-tax states and thus lose their deduction of state and local taxes. That’s not fair. (I think, along with Scott, that the SALT deduction should be zero, but in return, marginal tax rates for high-income people should be cut.)

Second, what happened to Romney’s fear, which he once had, of the deficit. The budget deficit is huge this year and, although it will likely be lower next year, it is set to be at least $1 trillion annually for a long, long time. We should be looking at paring down “entitlements” such as Social Security, Medicare, and Medicaid, not adding new ones.


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Olivier Blanchard on monetary offset

This tweet identified the real issue:

People often talk about the risk of economic overheating, but that seems unlikely.  TIPS market participants seem to agree, as that market also forecasts close to 2% inflation going forward.

The actual risk is that a very large fiscal stimulus package will not stimulate the economy (at the margin), as the Fed will offset the effect. (Just as the Fed offset fiscal austerity in 2013).  Instead, we will merely add to the national debt.

Given low interest rates, there’s a respectable economic argument for a slightly higher steady-state budget deficit, and some of the fiscal package may be useful.  But quickly dumping $1.9 trillion into the the economy is almost certainly not a policy that minimizes the long run deadweight cost of taxes.  I’d encourage policy makers to take a deep breath and think about their long run objectives.  What are they actually trying to accomplish, and what’s the most cost effective way of getting there?

And think at the margin.

PS.  I began blogging on monetary offset back in 2009.  Expect to see a lot more discussion of this issue in the years ahead.


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Government Support Is Vital as Countries Race to Vaccinate

By Vitor Gaspar, Raphael Lam, Paolo Mauro, and Mehdi Raissi The COVID-19 pandemic is accelerating in many countries and uncertainty is unusually high. Decisive government actions are necessary to ensure swift and extensive vaccine rollouts, protect the most vulnerable households and otherwise viable firms, and foster a durable and inclusive recovery. Most countries will need […]

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Top 10 Blogs of 2020

By IMFBlog Welcome to 2021. Before we step too far into the new year, the editors at IMFBlog invite you to reflect on what the world went through in 2020. As much as we would like to turn the page on 2020, navigating a course forward through still uncertain times entails using all we’ve learned […]

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Newt Gingrich’s Numeracy Problem

And Trump’s and the Dems’ arithmetic problem.

$2,000 * 200 million does not = $2,000.

$2,000 – $600 does not equal $2,000.

Newt Gingrich tweets:

If Senate Republicans fail to bring up the $2000 payment as a clean vote they run a real risk of losing the two seats in Georgia. This is an 80% issue. People get it. Billions for the banks, billions for big companies, but we can’t find $2000 for everyday Americans.

If the proposal before the Senate really were to give $2,000 to everyday Americans, no one would be raising an objection because $2,000 divided by, say, 200 million everyday eligible Americans is way, way below 1 penny each.

Everyone understands that it’s $2,000 per “everyday American.” With about 200 million Americans qualifying, that’s $400 billion.

So if we were to rewrite Newt’s tweet honestly and accurately, it would read something like:

If Senate Republicans fail to bring up the $2,000 payment as a clean vote they run a real risk of losing the two seats in Georgia. This is an 80% issue. People get it. Billions for the banks, billions for big companies, but we can’t find $400 billion for everyday Americans.

Sounds a little different, doesn’t it?

And remember how Trump objected that $600 was way too low an amount to have the government give eligible people and $2,000 was the right amount? Well, they got the $600. So if Trump really believed what he said, and if the Democrats believed what they said they believed, he and they should have pushed for an extra $1,400, not an extra $2,000.

Newt’s tweet also shows the difference between those of us who want to have gridlock and divided government in order to restrain government and people who want divided government simply because they want the Republicans to be the majority party in the Senate.

Many of us want gridlock because we fear what a Democratic House of Representatives, a Democratic Senate, and a Democratic president will do. One of the main things many of us fear is that they will spend hundreds of billions of dollars more than if the Republicans won the Senate and restrained the Democrats’ spending. But if Mitch McConnell caves so that the feds spend an extra $400 billion and the Republicans win in Georgia, they will have nullified a huge part of the reason for having the Republicans win in Georgia.


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