On Voodoo Economics, the Debt Ceiling Debate, and Hyperinflation
Bruce Bartlett, a Republican political appointee and domestic policy advisor to Ronald Reagan, points out that:
taxes were cut in 2001, 2002, 2003, 2004 and 2006.
It would have been one thing if the Bush tax cuts had at least bought the country a higher rate of economic growth, even temporarily. They did not. Real G.D.P. growth peaked at just 3.6 percent in 2004 before fading rapidly. Even before the crisis hit, real G.D.P. was growing less than 2 percent a year…
According to a recent C.B.O. report, they reduced revenue by at least $2.9 trillion below what it otherwise would have been between 2001 and 2011. Slower-than-expected growth reduced revenue by another $3.5 trillion.
Spending was $5.6 trillion higher than the C.B.O. anticipated for a total fiscal turnaround of $12 trillion. That is how a $6 trillion projected surplus turned into a cumulative deficit of $6 trillion.
Bartlett offers this killer chart as a summary of the numbers:
If you recall, it was George W. Bush’s father, GHW Bush, who, when campaigning against Reagan, called supply side economics’ claims that tax cuts pay for themselves Voodoo Economics. And Bush was proved right when deficits spiralled out of control and both Reagan and Bush were forced to raise taxes.
Alan Simpson, the Republican leader of Obama’s bipartisan deficit reduction commission, had this to say about Reagan:
Ronald Reagan raised taxes 11 times in his administration. I was here. I was here. I knew him. Better than anybody in this room. He was a dear friend and a total realist as to politics.
Yet, the Republicans of today are acting like none of this is true. Even Mitch McConnell, who has made more sense during the debt ceiling debate than others, has been heard spouting this stuff.
“There’s no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue because of the vibrancy of these tax cuts in the economy.”
Some of the Republicans even refuse to accept any debt ceiling deal that includes tax hikes when we can see that tax cuts were a main reason we have reached this point to begin with. To add insult to injury, the Bush tax cuts accrued disproportionately to the wealthy. The Tax Policy Center shows that 65 percent of the dollar value of the Bush tax cuts accrued to the top quintile, while 20 percent went to the top 0.1 percent of income earners.
If you want to talk about redistribution, there it is.
Again, some (Republican) Congress people refuse to rescind this monstrosity, holding the economy hostage via the potential for default. This is reckless in the extreme. It is the hallmark of a third-world, banana republic kind of political governance
My take: When you think about the currency debasement and inflation that leads to a hyperinflation that a lot of hard money types are worried about, debt and deficits alone don’t get you there. I know that Morgan Stanley reported that there is “no historical precedent” for exceeding total debt-to-GDP of 250% including the private sector without experiencing some sort of financial crisis or high inflation.
But, the reality is that it wasn’t just the debt, but the dysfunctional government that led to the hyperinflation. The benign outcome for a moderately functional system is the one we saw in Britain whereby the crushing post-World War II debt load was diminished by currency depreciation and inflation without a hyperinflation – wrenching and destructive but not catastrophically so.
The intransigence of those supporting Voodoo Economics and its debunked and bankrupt economic nostrums is prima facie evidence that the US political system is indeed dysfunctional. And so I say to my hard money friends, debt deflation is the flation to fear right now. This is the secular force from excessive debt. However, without changes to reserve currencies another crisis is inevitable and eventually the endgame will be a systemic government debt crisis in the western world.
First the deflation, then the inflation. A loss of faith in government and its ability to tax would be the precipitating factor. And as we watch the debt ceiling fiasco in astonishment, you are witnessing first hand evidence why.
There could be worse earworms than this:
https://www.youtube.com/watch?v=EoS52fVtVQM
We need something to displace the ever increasing mind numbing rhetoric as the deadline approaches.
I put up that video. Thank you for the tip. It was a good laugh.
Totally manufactured crisis, but a product of a crony dysfunctional democratic system in the hands of oligarchy. Also a bit ridiculous (tea party nuts) that a minority is holding hostage the whole population (the immense majority are in for tax hikes for the rich and not cutting medicare and other stuff, at least before other cuts are done).
I don’t believe either in hyperinflation or high (two cipher) inflation yet. But I believe in cost-push inflation and no-growth, this means gradual deflation with the unusual stimulus by governments to keep the system functioning. It’s too early yet and we are ‘slow learners’ but eventually it wouldn’t be strange if ‘job guarantees’ and MMT-like policies (even if by other names) would be applied. All the mantras of the last era are going to fall apart even if we need temporal defaults, entire countries defaulting (Greece) or recessions and high unemployment increasing because austerity is dominating mantra.
I think this political crisis is just a charade and if they push to hard it will backfire on them with outrage from the public (and this will happen both in USA and Europe). I don’t think the oligarchs and creditors can push too far without the system falling apart.
To get to hyperinflation, first you have to destroy productive capacity, then spend like mad. The Teapublicans seem committed now to destroying capacity wherever they can through a forced political deflation that will follow a debt downgrade.
The base Tea Partyers feel justified because they are as disgusted with the financial oligarchy as anyone on the left. They have watched major financial disaster after disaster result in more difficult straits for themselves and their kids while financial oligarchs amass through the devastation ever great empires with direct feeds to the fiat money creation powers of the state.
These people, I think, don’t understand the systemic fragility of the non-financial economy adequately to anticipate the level of disruption a downgrade would cause, but because everything has always been made better through crisis for finance the Tea Party base is inclined to dynamite the whole financial system if that is what it takes.
Once finance is liquidated, if they succeed, however it will take down the WalMarts, GEs and Monsantos in its wake. This liquidation of productive capacity will actually create the conditions for a hyperinflation where a desperate government, trying to re-start commerce through spending will arrive at the right solution too late. May saner minds prevail.
The Tea Party do not have a clue. The problem is that assets are still in a bubble because of QE. Add in the intransigence over tax raising which would not affect most of them except in their dreams yet they will not allow those that benefited most from the bubbles to pay their fair share. Sometimes I think let them implode the economy and see what happens. Until they realise that the economy is very different from how households budget then they might just be a hindrance. A collapsing economy might also clear the government of the Tea Party next election.
At this point I think, tactically and politically, is better a temporal default (I don’t think it will happen though) and a default in Europe.
Only then some mantras will be destroyed and panic will oblige governments to act. It’s better now than later, because right now there still is a lot of excess capacity in the economy so we can afford some real deflation and demand destruction (but things could get very bad in some european periphery countries and some american states).
But in some time, with gradual decline of the economy, this could lead to a desperate political and social situation where eventually currency collapse could happen and the whole global economy would blow up with all the dangers it would carry (wars, protectionism, conflict, etc.).
So let the tea nuts have their little party, a bit of deflation and gold rise (a short bubble in gold would be good too, meaning rapid rise in price and strong correction after that), then they will be politically wiped out and we can still save democracy in the western world and get some deep political and economical reforms. But if we continue on this path we could eventually lose democracy.
As a European I think that the US political system is clearly dysfunctional at this point in time. Default by the US would be a political decision not an economic one. Defaults by the eurozone periphery are essential for them to get their economies on to a sustainable path. The same for some US states. That also applies to the vast majority of americans. They need to have their debts written down to a sustainable level or they will go bust at some point. Until the publics finances are better the economy will very weak. Force MBS to take huge losses if necessary. If this destroys the MBS market that can only be a good thing.
As for losing your democracy. It has already been lost. Citizens United ended US democracy. You now have a plutocracy and who ever they want will run the US.
Just a short note, not very relevant: I’m European too (Spanish btw), I also think there is a strong lack of democracy in much of Europe (actually one of the few really democratic regimes is Switzerland). A lot of European countries (specially including my own) need a deep political reform, the crony partitocracies we have are poisoning.
But I think obviously that what is happening in USA is very important for Europe and the world in general, and at this point and from what I read on blogs like this and see on the Internet a temporal default would serve them better in the long run. Also while we have dysfunctional political systems, we still have some sort of democracy and the system can be reformed, but as this depression progresses, I think the chance of serious political regime change increases.
P.S: Agreed that writedowns are necessary, at least to a point, specially in the private sector. But not necessarily in the public sector (except maybe Greece unless an huge tax reform and enforcement is done on the rich), this is just a matter of institutional structure of the EMU/EU.
Spain has different problems, particularly with local corruption and the cajas. A lot of the political problems can be resolved with party funding reforms. I think that a cap on contributions of €1000 from combined union contributions, party fees, donations and business donations would eliminate the influence of the rich. Enforce it with long prison sentences.
I think that fast and deep cuts in asset values is better long term. If all the homes in Spain were to fall further the banks could not foreclose everyone. It might create opportunities for the young to have a home of their own, there are certainly plenty of homes available.
I do agree that write downs of private debts are essential. It will also reduce the burden on the tax payer who would not need to support the economy for so long. Greece and Ireland will have to default to save their economies.
Just a quick note here. Obviously, this post is about phony deficit hawks talking about cutting deficits today and promoting tax cuts as if tax cuts pay for themselves. Tax cuts don’t pay for themselves and it’s ridiculous that we are hearing people say that they do when this has been debunked numerous times due to the situation on the ground over the last 30 years. It’s crazy – and a clear sign of ideology, the kind that is causing a huge dysfunction.
Yes but you have the Tea Party and GOP still spouting this nonsense. That cuts pay for themselves is still coming out of the UK Conservatives. That is why I think that the UK is doomed for now. But facts do not matter to the GOP. They run on blind faith.
https://www.aei.org/docLib/20101227-Econ-WP-2010-04.pdf
37 year Study Shows Spending Cuts, Not Tax Increases, Best for Debt, Growth, Bond, Stock Markets
The typical consolidation that failed relied on 47 percent spending cuts and 53 percent tax increases.
The typical consolidation that succeeded consisted of 85 percent spending cuts and 15 percent tax increases.
The “most wildly successful” efforts by nations, as Brooks put it, went into tax cut territory: Finland in the late 1990s, pointed out by Biggs and Hassett as a model of successful consolidation, had 108 percent spending cuts along with modest tax cuts.
Regarding which cuts : “Specifically, reducing transfer programs and government wages were the most beneficial to growth, according to the 36 year study.”
No real surprise there really. How would cutting waste jeopardize growth? (Federal workers earning double their private counterparts).
Fiscal consolidation can produce wealth effects on growth because of lowered expectations of future tax liabilities and the positive effect on real interest rates.
This is now termed the “expectational view” of fiscal consolidations and contrasts with the Keynesian belief that a fiscal consolidation will reduce aggregate demand and GDP.
Nobody rationally objects to waste but there has been huge amounts of waste in US military procurement alone. Yet very little is done about it. Why? Because the beneficiaries pay backhanders to politicians in lobby funds.
Also it looks like an austerity budget will be passed at some point, it will not be long before we see if this theory works. Though Ireland has made huge spending cuts and it is still in recession for three years. Then the Baltic nations have also tried it. With only one nation looking like it succeeded, yet it is a fraction of the size of the state of New York. So how can it be compared to an economy the size of the US. They also managed to keep unemployment payments low because they had mass emigration of a scale that would mean tens of millions of americans going to work aboard, many never to return again. So it looks like that theory is as good as trickle down. Lowered expectations of future taxation are a complete nonsense. In fact that theory was discredited more than twenty years ago. Nothing like spouting claptrap and reporting it as fact.
Expectational view is as useless as efficient markets hypothesis. Expectations of future taxes are only applicable if there is a permanent government. Governments change and even change policy depending on the conditions. So why make plans for a future tax hike that might never happen? Also many corporations hold their profits offshore till some idiot politician suggests a tax amnesty.
Efficient markets hypothesis is also bunkum. Goldman Sachs made its fortune on knowing facts before others. Why do you think that the big banks spend so much on High Frequency Trading? To get an advantage over the rest of the market. The same applied to many of these toxic products that destroyed the banking system. The reason we had a credit crunch was that no one knew where the toxic debt was. So much for efficient markets.
Then you have to consider the other factors which enabled these so called successes to actually work. None happened when all it’s trading partners were following the same austerity policy.
This post is not about whether tax cuts or spending increases are better for growth. Nor is it about whether in the present circumstances tax increases or spending cuts are better. It is about whether tax cuts pay for themselves via growth. They do not as Bartlett has demonstrated.
That said, it is entirely unreasonable to refuse to raise the debt ceiling unless all of the consolidation is in the form of spending cuts. This stance is not only outside of the mainstream, the intransigence is causing much greater potential damage than any differential this stance seeks to address.
That said, I have nothing against tax cuts. If people want stimulus and they say 100% tax cuts and zero percent spending increases, fine. Why not?
What is not clear to me is that fiscal contraction is expansionary. The AEI has an ideological axe to grind and is not an impartial source of information. The IMF reaches different conclusions about fiscal contractions short term benefits while noting the longer-term benefits of deficit reduction. This is a more nuanced and balanced report:
https://pro.creditwritedowns.com/2011/07/fiscal-consolidation-slows-growth.html
“fiscal consolidation typically reduces output and raises unemployment in the short term. At the same time, interest rate cuts, a fall in the value of the currency, and a rise in net exports usually soften the contractionary impact.
Consolidation is more painful when it relies primarily on tax hikes; this occurs largely because central banks typically provide less monetary stimulus during such episodes, particularly when they involve indirect tax hikes that raise inflation. Also, fiscal consolidation is more costly when the perceived risk of sovereign default is low. These findings suggest that budget deficit cuts are likely to be more painful if they occur simultaneously across many countries, and if monetary policy is not in a position to offset them. Over the long term, reducing government debt is likely to raise output, as real interest rates decline and the lighter burden of interest payments permits cuts to distortionary taxes.”
But Edward, are you of the opinion that we should avoid fiscal consolidation now that the economy is so weak because of the effects that it would have on aggregate demand? Putting aside for a moment the question of whether or not it is politically feasible for a government to shrink itself (without this consolidation being enforced by the bond market), it seems clear to me that it is desirable, for the economy at large, to eliminate all non-essential public services, even if this means an increase in unemployment and a fall in aggregate demand, because it will speed up the process of reallocating labor and capital towards more productive ends.
I only ask for clarification here, because I heard you on RT America yesterday make the point that cutting spending now will deepen the recession (which is true), but wasn’t sure if you thought that this was a bad idea for the time being.
Demetri, it’s a good question. If I were able to make recommendations, this is what I would do.
The premise is that while we don’t want excessive cutting in the short-term, high unemployment and large government deficits are unsustainable and that the current level of expenditure on Medicare, Social Security and Military spending is also undesirable.
So I would recommend austerity-light for discretionary spending, which is in line with what the Obama Administration has proposed. But I would counter that by adding a jobs and training program. The net effect over the short-term would be higher deficits. Over the medium-term it would be lower unemployment and lower deficits.
As to long-term deficit reduction, I think there are four pillars.
1. Austerity light on discretionary spending: cutting unwanted and unnecessary programs in the short-term. TYhe net effect would be an immediate and permanent reduction in expenditure.
2. Tax reform: flatten personal tax rates with higher personal deduction. Equalize tax rates for earned income, corporate taxes, capital gains and interest carry so as to prevent tax arbitrage over a 7-year time horizon. Closing of tax loopholes, more aggressively, over 5 years . A run-off of the mortgage interest deduction (similar to Reagan’s run-off of credit card interest deductibility), less aggressively over 10 years. A run off of agricultural, pharma, oil, nuclear, alternative energy and other corporate subsidies, much more aggressively over 3-5 years. The net effect of which would be a medium-to-longer-term gain in revenue.
3. Cut military spending. Get out of Iraq, Afghanistan and Libya. Stop the drone wars. Reduce troops stationed abroad in places like South Korea, Japan and germany or receive compensation from those governments for the military protection. Increase border and terrorist security within the US. The net effect would be a large reduction in medium-to-longer term expenditure.
4. Raise the age of social security and medicare to 67 for people under 50 or 55. But Increae social security benefits and Increase the FICA exemption from 106,800 to 250-500,000 at a reduced FICA rate depending on the revenue impact starting in 2015-16. Consider means testing Medicare from 2015-16. Allow drug importing from Canada and the EU for Medicare immediately. Consider allowing compensation to physicians with private practices in the EU or Canada for Medicare. Net effect: Medium-to-long term revenue gain, long-term expenditure reduction.
I think these proposals are largely in line with Simpson-Bowles, which liberals don’t like. So they would be difficult to implement by a Democratic President. But the goal is to protect the economy over the short term by not introducing excessive cuts and promoting jobs while cutting significantly in defense and entitlements along with other tweaks to the tax code and discretionary spending. Why the President didn’t follow through on Simpson-Bowles, I don’t know. But it is probably because his base was outraged and he wants to be re-elected.
The US budget is on an unsustainable course and deficits must be reduced to manageable levels. Any cuts should not interfere with the recovery as the majority of deficits today are based on unemployment from the downturn. Cuts should be aimed at reducing (but not eliminating) the deficit, starting in 2105-16 and especially for the years beyond 2021.
I just finished reading your “ideology, economics, and the compatibility of Chartalists and Austrians”
Taking what I just read in conjunction with your response to my question, I gather that your only real objection to the “let the chips fall where they may” austrian approach laid out by Mises and others is that we are too far down the rabbit hole of counterpart liability and overall debt to allow this sort of organic reset. In your view, allowing for bankruptcies at this stage in the game, after decades of artificially low rates and massive malinvestment will lead to a depression so deep that civil unrest, war and destruction are sure to follow.
I agree that a total reset would be destructive at this stage, even though I would have advocated one in years prior, before the debt reached such excessive levels. However, what type of deficit reductions are we talking about here (how many 100’s of billions would we be able to cut with your proposals)? Also, when you say “any cuts should not interfere with the recovery as the majority of deficits today are based on unemployment from the downturn” you mean that a drop in tax receipts caused by the recession is to blame for the rise in the deficit?
Lastly, how can the economy begin to grow productively and sustainably again without liquidating significant amounts of debt (including raising the interest rate, or allowing it to rise naturally to a level more reflective of free market money supply/demand dynamics)? It seems to me that we will never have a recovery so long as we do not have a major liquidation in debt, which means bankruptcies, and also a push close to civil unrest.
Your proposal makes sense (including military spending), but this hardly appears to be austerity-light. Any significant cut in military spending would be heavy duty cutting. This is why I am asking for a dollar figure form you.
Have you written any previous pieces where you go into the specifics of your such proposals?
Thanks for your time in responding.
Any competent administration should be trying to run most efficiently at all times regardless. Though I suspect that much of the hypothetical waste is illusory and less than a couple of percent of the budget at most.
As for tax reform I agree except for a flattening of the tax curve. It should be steepened with the objective of raising revenue to eliminate the deficit as fast as possible. Then once balanced then they can be levelled out but to be reversed if ever the accounts go into deficit above a certain level. All levelling will do transfer the burden on to the middle classes.
Subsidies and loophole should be scrapped as fast as possible. That will reduce expenditure.
I mentioned cutting military spending before and you said that was unlikely. With military spending making up a sizeable proportion of the overall spending to not cut it would be foolish. Also on a pure stimulation effect it is the least effective of any government spend.
I do agree about social security but most of all end the contribution caps.
You can get the same effect by raising the personal exemption and flattening. The point is to simplify.
Also, I am not looking to raise revenue except via the effect that reduced tax arbitrage has in adding revenue. We could design the tax simplification to be tax neutral but it would still raise more revenue because of reduced tax arbitrage vehicles.
My point was that taxes fell because of the recession. So raising them would help initially. Closing off one huge part of the equation seriously limits you in terms of reform. Also such taxes are likely to be cut in future by one administration or another. Though savaging services means that the welfare net that the middle classes think will be there when trouble hits them will be gone. Though since the US is in a race to the bottom in terms of impoverishing their electorate just so that billionaires can keep their tax payer subsidised jets does give the impression of a highly dysfunctional society.
I think we’re in general agreement, but again, I am opposed to any tax increases, especially because they could be unnecessarily recessionary right now. Better to concentrate on jobs and reducing private sector debt. That said, I think you’re right that any tax harmonisation would see capital gains, corporate income and carried interest tax rising to the level of personal income. The wonks can figure out what is the tax neutral level if you were to double the personal exemption, say. But I bet you could lower the personal rate if you were to do this.
One way where I depart from the MMT prescriptives is taxes. I don’t see managing the macro economy via taxes as a good viable option to reduce inflationary pressures. Taxes are too political to tinker with on a constant basis. And I don’t think it’s realistic to expect politicians to effectively steer an economy to begin with. Having more robust automatic stabilisers are better as shock absorbers.
The problem is that US business has shaken out much of the labour already, the fact that no one is rehiring is down to the fact that there is not enough domestic demand to justify any investment. Then add in the possibility of supplying that demand from offshore so why invest in the US? The US consumer how ever is still overloaded with debt. If their debts were wiped out then their cash flow would improve immensely basis that they are not paying debt or interest. Without such debts they could be shopping again. That would create domestic demand to an extent that business investment would be restarted.
As for government debt that would be minimised if people were free of debts. So that is why I think that higher interest rates to force bankruptcies on those who would go bankrupt over the next decade trying to cope is the best solution. Without those debts they would be in a much better position. it will shrink the banking sector to a much more sustainable size. It will also free up borrowers to actually borrow again. This time to higher rates which will eliminate much of the bubble activity.
Demetri,
This is not a formal proposal of any sort. I’m just telling you what the major issues are. These suggestions would cut hundreds of billions from the budget starting in 2016 and ramping up to trillions by 2021.
Austerity is reckless because it is pro-cyclical. So I am not proposing any major cuts to discretionary spending in the short-term. If you re-read what I said, that’s why I call the discretionary cuts ‘austerity light’ countered by an INCREASE in spending on jobs and job-related automatic stabilizers. That would INCREASE the deficit over the short-term.
The meat of what I am talking about is entitlements and military spending.
And, no, the economy cannot grow until the writedowns are taken. When the next recession comes, it would be nice to see nationalization, seizure and bankruptcy instead of bailouts and writedowns in the banking sector, and job support from government. This would be wrenching but not nearly as wrenching as having the government let the chips fell where they may.
The major difference between what I am saying and what most Austrians would say is that I believe in supporting the economy counter-cyclically and cushioning the fall. See these three 2008 posts as a point of reference:
https://pro.creditwritedowns.com/2008/12/confessions-of-an-austrian-economist.html
https://pro.creditwritedowns.com/2008/12/what-does-mises-say-about-trying-to-stimulate-the-economy-out-of-recession.html
https://pro.creditwritedowns.com/2008/12/a-brief-philosophical-argument-about-the-role-of-government-stimulus-and-recession.html
Personally if you are going to have an increase in job related automated stabilisers why not raise taxes to pay for it. Raise an extra $2 trillion this year. Spend the lot on highly stimulative programs like jobs programs and welfare, and each year as the economy recovers cut that spending as it it so no longer needed. As the this is reduced it will completely eliminate the deficit.
I am against tax increases. It’s better to have the deficit until it is closed by job growth. Again, harmonising tax rates and having high personal deductions will achieve tax progressively without increasing the tax rate on personal income. This would also incent the right behavior by corporations and aid job growth since the low tax rates on capital gains and carried interest incent job cuts so that the rich can arbitrage their income into those areas making keeping headcount down important to lower their overall tax bill.
I can support the idea of equalising tax rates for all sources of income as tax arbitrage is a huge incentive in this crisis. Though if you are to reduce the deficit it should be by levelling up, not by levelling down. That will raise extra funds to lower the deficit. If done the other way around I can see the super rich getting another 90% of the adjustments, with nothing getting to those that need help.
I read all three posts, but there are links to many more that I would like to read before I comment much further.
You have a great grasp of austrian economics, as i’m sure you already realize, which is what makes your nuanced approach so interesting and worthy of further study.
Furthermore, in numerous other posts, you devote ample time to pointing out the intoxicating and corrupting effect of providing a government/central bank with monopoly control over the issuance of currency and credit, so you clearly do not gloss over the very real threats inherent in such a system.
Clearly, you have assessed the landscape and come away with the conclusion that a strictly austrian approach to this problem would be unacceptably catastrophic, and therefore, you hope that politicians and policy makers can work together in smart ways to provide just the right amount of stimulus, and in the right areas, to both prevent a catastrophic liquidation (that could lead to untold political and social turmoil, including all-out war), as well as retain the functionally valid social programs in society (education, healthcare, etc.)
This clearly comes down to trust and confidence, something that you have written about before.
You produce really good stuff man. I should have been reading this blog much earlier.
Thanks