Very Different Visions of Fairness

By temperament and habit I tend to see people as more alike than different. Thus I was struck by how dramatically different Washington Post columnist E. J. Dionne, Jr. sees the world than I do when he was discussing false choices. I think that it is worth illuminating and exploring this difference for what it implies about the nature and role of government we each want.

In his column Monday Dionne quoted himself from a book he had written twenty years ago:

“Women who take time off from their careers to care for young children are routinely ‘punished’ by having their opportunities for promotion reduced,” I wrote. “Is it ‘feminist’ or is it ‘pro-family’ to suggest that this practice is unfair? Is it ‘feminist’ or ‘pro-family’ to contend that this practice shows how little value society really places on the work that parents do?”[1]

I am sure that he finds nothing shocking in these words (or he wouldn’t have quoted them) but I do. Why is it that someone who leaves the labor force for a few years is “punished” by “having their opportunities for promotion reduced?” It is not because they are women or because they are rearing children, because the same would be true for a man (or woman) serving in the Peace Corps for a few years. It is, of course, because to a very large extent companies promote on the basis of productivity (competence, experience, effort, etc). Some of these capacities are gained from actually working (on the job experience) such that a 40-year-old worker who was with the company (or in a particular profession or line of work) for twenty years is likely to be more productive (i.e. worth paying more) than one that took out five years for the Peace Corps (or whatever).  In a competitive market economy companies that do not behave this way will lose out to those that do. In a perfectly competitive economy companies are forced by competitive survival to ignore race, sex, family relationship, or any other factor than productivity.

Dionne takes for granted that this practice, when it results in delayed promotion for a young mother (rather than the Peace Corps volunteer), is unfair and asks whether calling it such is feminist or pro-family (hence the false choice he is discussing). He adds that this practice (promotion based on productivity) “shows how little value society really places on the work that parents do?” By society he presumably means the employers who promote based on productivity, or does he mean a society that would allow employers to do this?

What is the alternative Dionne has in mind? The corrupting seniority system of the civil service would not over come this “unfairness” because time off would reduce seniority. Somehow employers would have to be prevented from basing promotion on productivity in the case of women who take a few years off to raise a family. They might be shamed out of it (social pressure), but the competitive market place that has given us such a high standard of living would punish them for such behavior. The law might forbid such unfairness to mothers. Because the market place will punish firms that promote less productive workers whether the law requires it or not, such a law would create a strong incentive for firms to avoid hiring women in the first place (an unintended consequence).

Mr. Dionne is clearly advocating a society in which employers are expected to promote workers on the basis of how much “society” values them and their non/extra work activities rather than on the basis of their value to the firm (productivity and hence their contribution to our material standard of living).

An example of such a society was the American South in the first half century after the end of slavery. Firms were expected to hire and promote blacks in accordance with social expectations, which looked down on blacks. Mr. Dionne would certainly disagree with the social values that discriminated against blacks but it is an example of how a society functions when it attempts to impose its (the dominate segment’s) non-economic values into economic processes. While racial and ethnic prejudices seem imbedded to some extent in human nature (we would rather hire a cousin than a stranger), competitive market forces work against giving much scope to such biases. Prejudice has a cost in the market place.

Leaving the labor market to raise a family or to service in the Peace Corps is laudable. In the case of raising a family it is essential to the survival of mankind. But it is a personal choice. The person making that choice does so knowing that there will be career consequences. I don’t want to over simplify. The experience of raising a family or of servicing in the Peace Corps may help develop capacities that will promote productivity when the person returns to the labor force. But evaluating that is best left (can only properly be left) with the employer whose bottom line is at stake. Employers can and will make mistakes but at least, unlike bureaucrats administering rules, they have a financial incentive to get it right.

When society (a much overused word) values and benefits from activities that are not rewarded in the market place, they are likely to be undersupplied. Attempting to remove this gap between public and private benefit is challenging and fraught with risks of doing more harm than good. Nature has provided men and women with a strong desire to procreate and raise successful families. But most societies, and certainly ours, have encouraged that propensity and the social benefit of an educated and law-abiding citizenry by, for example, subsidizing elementary education. But we interfere with the efficiency of a competitive labor market at our peril.

[1] E. J. Dionne, Jr. “The real value of false choices”, The Washington Post, April 25, A15

Thinking about the Public Debt

The U.S. Federal Government spent $1.7 trillion dollars last year more than its tax revenue. It had to borrow that amount. This increased the outstanding public debt of the Federal government to 14.2 trillion dollars or 96 percent of GDP. This includes that part owned by the Social Security trust fund and the Federal Reserve but does not include the unfunded liabilities of Medicare, Medicaid and Social Security, which will add an additional $46 trillion to the deficit in present value terms over the next 75 years.

This year’s federal deficit is expected to be 1.4 trillion. Interest payments on this debt are forecast to be $287 billion this year (almost 8% of total outlays) and are expected to grow to three or four times that over the next decade as the stock of debt grows and interest rates rise.

This is not sustainable. Without spending cuts and/or tax increases this amount will not only continue growing without end but will increase as a share of GDP until bond holders are no longer willing to trust the government’s ability to pay the interest required. At that point they will dump U.S. Treasuries and the U.S. will be forced to default. Standard & Poors has already downgraded its “credit outlook” for the U.S. to negative.

All of this is by now well-known as is the fact that there is no longer any choice about the need to cut spending and/or raise taxes. But that is just the beginning of the search for responsible and effective governance by our representatives here in Washington. It makes a big difference which expenditures are cut and which taxes are raised. The deficit will fall and our ability to finance it will increase with the growth of our output/income. Specific spending cuts and tax increases effect income growth differently.

The job of our political representatives is to determine what the government should be doing within the set of things it is permitted to do by the Constitution and the resources the public wishes to make available. Their job is to carefully and wisely set priorities on the use of the limited resources available to them.

David Ignatius provides one of many examples that I strongly agree with: “Today, the United States is allocating about $110 billion annually for the Afghan war, about $3.2 billion for military and economic aid to Pakistan, and about $0.15 billion in special assistance to help Egypt’s democratic revolution. In terms of U.S. national interests, those spending levels don’t make sense. The pyramid is upside down.”[1]

The budget for the Defense Department in 2010, including our several wars, was $664 billion while the State Department (including all foreign aid) was $52 billion.  We have the best fighting machine the world has ever seen and rather mediocre diplomatic capabilities. Better and more extensive use of diplomacy and less use of drones and lesser-guided bombs can often produce better results (improved security for the U.S.). Spending more to develop well-trained (history, culture, language) Foreign Service officers and less to manufacture more munitions might be a good idea. It is hard to imagine that spending less on DOD and more on DOS wouldn’t improve our security for less money.

All spending should pass a strict cost benefit analysis but setting a cap on total spending relative to GDP (e.g., 18 or 19 percent) would be a useful disciplining tool for forcing more careful prioritization. So we must cut deeply but not evenly. We can and should spend less and get more benefit by better prioritizing what is really important to our safety and quality of life. This will not be an easy debate.

The same must be said for taxes. Not all taxes have the same effect on the economic growth that lifts our standard of living and makes a given debt easer to service. And not all taxes are equally fair.  So while the revenue generated by taxes should match the level of government spending over the business cycle, how that revenue is raised is as important as how it is spent.

The primary standards for judging tax systems are neutrality and fairness. Neutrality means that the tax does not distort business and spending decisions so that the allocation of investment and economic resources are not distorted. A neutral tax damages economic growth less than, say, a tax that falls largely on investments. A neutral income tax, for example, treats all sources of income the same.

If tax revenue is raised in ways that do not discourage economic growth, income growth itself will increase tax revenue and reduce a given debt as a share of national income (an indicator of the government’s ability to services it). The arguments in favor of the most neutral possible tax structures are well-known and broadly accepted by economists across the political spectrum. The tax base (whether income or consumption) should be comprehensive making the marginal tax rate as low as possible.

Business income taxation double taxes the same income (by the business and again by the shareholders as individuals) and introduces wasteful and risky corporate behavior in their effort to minimize the tax. Everyone agrees that the corporate profits tax in the U.S. should be lowered more in line with the rates in other countries, but in fact the corporate tax should be abolished. It raises only modest revenue and causes great damage. I favor complete reliance on a flat comprehensive consumption tax (VAT) because it does not tax saving and thus encourages more investment and growth, is simpler to collect and is fairer. [2]

There is less agreement about what is fair. Everyone agrees that the rich should pay more taxes than the poor but how much more. Actually, under the existing tax code those with incomes in the top 1 per cent paid 40 per cent of all income tax revenue in 2006 and earned only 22 per cent of all income, the top 10 per cent paid 71 per cent and the bottom 50 per cent less than 3 per cent.

President Obama thinks that this is not progressive enough and wants to tax high income families even more and the Republicans think it is already too progressive both in terms of fairness and in discouraging investment that promotes faster growth.

A “flat” income tax, the same marginal tax rate for everyone with incomes large enough to pay taxes at all, is the most neutral rate structure when applied to a comprehensive income (or consumption) base. But it is also a good benchmark for discussing fairness. A flat rate means basically that someone with twice the income pays twice as much tax. I consider that fair, but of course our existing rate structure increases with income so that tax payments would more than double when income doubles. Increasing marginal rates is a rather open field. Where should you stop? Clearly our tax system needs to be made more neutral and more fair. The debate over how to do that will not be easy either.

[1] “Time to up the ante on Egypt”, The Washington Post, April 20, 2011, A17.

[2] Warren Coats, “U.S. Federal Tax Policy” , Cayman Financial Review, July 7, 2009

Libya: Further down the slippery slope

It is not easy to find the right balance between our relationships with sometimes repressive and always undemocratic (in the narrow sense of voting) regimes in the Middle East and the dissidents among their citizens who criticize them. But statecraft and diplomacy are the right tools not military force (e.g. drones). Defense Secretary Gates said as much when cautioning against imposing a no fly zone in Libya a week before we under took them. Now the pundits are chattering that we have not done enough. Gaddafi is still there. President Obama is inarticulately and ineffectively trying to resist further sliding down the slippery slope to another messy engagement with another Muslim country. But the odds are against him. When will we ever learn, when will we ever learn.

The Washington Post published two thoughtful op-eds on the subject today that are well worth reading.  The first by Michael Chertoff and Michael V. Hayden is called: “What happens after Gaddafi is removed”. The other by Sarah Sewall and Anthony Zinni is called: “The military interventions we don’t plan for–those to protect civilians”

Notes from Nanjing

French President Nicolas Sarkozy chairs the G-20 this year and has focused on the reform of the international monetary system. I was invited by the French Finance Minister and the central bank Governor to join the High Level G-20 Seminar in Nanjing March 31 on that subject as one of the lead speakers (of which there were quite a few). The G-20 is the group of industrial and emerging market countries that has replaced the G-7 industrial countries as the lead forum for global economic policy coordination. This meeting was attended by the Finance Ministers and Central Bank Governors of the G-20 countries or their deputies, heads of international financial organizations (like the IMF), and some academics like me.

The Nanjing meeting was opened by Vice Premier of the Peoples Republic of China (PRC), Wang Qishan, and French President Sarkozy. For this opening session I was seated next to a Germany delegate who was kind enough to explain to me who various people around us were and what was going on. The opening was delayed for an hour waiting for President Sarkozy to arrive. The President was grandstanding the Deputy Governor explained to me. “Don’t you find it strange,” he asked, “that the Vice Premier rather than the Premier is opening the meeting and doing so in front of the French and EU flags with no PRC flag?” “Well, yes, that is very strange.” I replied. “This is because,” he continued, “the Chinese government didn’t really want such a meeting in China. The issue of the exchange rate of the Chinese currency would have to come up. It was agreed, however, that the China Center for International Economic Exchanges (CCIEE) would host the seminar on behalf of the PRC. So no Chinese Premier and no Chinese flag.” I should always be lucky enough to sit next to a German.

After the long wait, President Sarkozy delivered an excellent opening speech. He is an impressive performer. His several references to “my friend Tim,” while nodding to U.S. Treasury Secretary, Timothy Geithner, sitting in the front row, seemed perfectly natural and effective.

Nanjing is famous as the capital of the Ming and several other Dynasties and for its food. The food of each region of China is distinct. I can’t really explain the differences but the food here in Nanjing is very good. During the Seminar luncheon I sat next to the Finance Minister of Japan, who complimented me on my chopstick skills. I explained that I had been using them from childhood. On the rare occasions that my parents could afford to take us out for dinner, we went to a Chinese restaurant (they were cheaper). Thus Chinese restaurants were very special in my mind and like all kids I was eager to learn all that I could, including how to use chopsticks.

My own session was chaired by Christian Noyer, Governor of the Bank of France, and moderated by George Osborne, Minister of Finance of the U.K (Chancellor of the Exchequer as they call it in the U.K.). Following strict instructions from Ito and Ken Weisbrode, I informed Mr. Osborne that his wife’s novels were much enjoyed by some of my friends, though I had never read one myself. He was pleased and informed me that her next one would be out soon. During our session Minister Osborne replied to a procedural question with the remark that “As is often the case, the British are operating under the instructions of the French.” Delicious.

My presentation on the SDR, the International Monetary Fund’s reserve asset, was made sitting directly across the table from Dominique Strauss-Kahn, the Managing Director of the IMF and Robert Mundell, a friend and a Nobel prize winner in economics. I could not have wished for a better audience for my three-minute summary of my radical suggestions, which you can find here:

I was sitting next to Kevin Warsh, a Governor on the Board of Governors of the Federal Reserve System (the U.S. central bank), and while waiting for our session to get underway I could not resist telling him about a dinner I had with my friend Randy Kroszner, who was also a Governor on the Fed’s Board of Governors at the time.  I met Randy at a Belgian restaurant on MacArthur Boulevard in Washington that he wanted to try Tuesday evening September 16, 2008 after his meeting with the Federal Open Market Committee. Lehman Brothers had declared bankruptcy the day before and I was eager to talk to Randy about it. Around 9:00 pm I received a CNN news alert on my Blackberry that the Federal Reserve had saved AIG that day with a $85 billion injection that gave the Fed an 80% equity interest. My jaw dropped. “Randy,” I asked, “how could you sit there all evening and not say a word about this.” He looked uncomfortable and said, “I am afraid that I still can’t comment because I don’t know if CNN is reporting from a Fed Press Release or a leak.” If ever anyone was leak proof it is Randy.

Despite the 12 hour time difference, I was wide awake until the afternoon session on surveillance (no offense Ted Truman, your presentation was very good). The next day, April 1, we were taken sightseeing. We climbed the 391 steps to the Mausoleum of Sun Yet-sen to see his tomb. Each step represented one million Chinese of the population as it was at the time of his death (obviously some time ago). I noticed that our police escort car was a Buick (probably made in China).

The food here in Nanjing is excellent as are our rooms and conference facilities outside the city in the Purple Palace Hotel at the foot of the Purple Mountains. The roads are equally modern and beautifully designed and built. From a distance I can see the modern skyscrapers of the city surrounded by a 600 hundred old 25 kilometer long stone wall. The city was founded 2,500 years ago. Most of the villages, which is where the majority of Chinese still live, remain very poor. But increasingly the hundreds of millions of Chinese in the major cities live in surprisingly modern and vibrant housing and surroundings. Most people visiting china are shocked.