Category: Economics

Immigrants from Hell

What immigration policies best serve the national interests of the United States?

Every country on the face of the earth has citizens whose intelligence, enterprise, and moral character range from 0 to 10. In poorly governed countries, we might call them “hell hole” countries, their best and brightest (the 8, 9, and 10s) often immigrate to more promising environments. The United States, with our constitution of liberty, has attracted a disproportionally large number of them. This is a dominant factor in the economic success of America and our spirit of individualism and enterprise. https://wcoats.blog/2010/06/10/a-nation-of-immigrants/

Just as individuals and companies compete in the market place to maximize the reward for their efforts (those who serve the public best, profit the most), so do the countries of which they are a part. When and if individuals and companies are given the chance to protect themselves from and restrict such competition they generally take it. Free (i.e. competitive) markets rarely offer such opportunities but governments often do. Governments claim to restrict competition to protect consumers or protect jobs from cheap foreign labor, etc. But more often than not government measures to interfere in the market are the result of political pressure to serve and protect special interests, what most of us would call corruption. Examples of government measures to protect companies or individuals from competition include: import tariffs, teachers’ unions that protect the jobs of bad teachers, excessive product safety standards that foreign competitors as well as domestic start-ups find hard to meet, and restrictive professional licensing through which medical doctors (to name just one profession) have limited who and what medical services can be provided.

The government’s regulation of who may immigrate temporarily or permanently is another area heavily influenced by individuals and companies seeking to protect themselves from competition. Subjecting American firms and workers to competition from foreign firms and workers (either from “cheap” foreign labor making it there and exporting to us, or immigrating and making it here), promotes long run economic growth.

Immigrants don’t take existing jobs from Americans; they create new jobs needed to pay for the consumption they add to the economy. While it is true that a firm can profit more with a monopoly by charging more by supplying less, the income of the nation as a whole suffers when supply is monopolized. Thus while worker and firm monopolies (e.g. the United Auto Workers, and uncompetitive steel manufacturers protected by import tariffs on potential competitors) will increase worker and firm incomes in the short run, the country would be poorer than otherwise in the long run. If we closed the border to trade all together, the country’s income would suffer considerably in the long run.

In this note I review a few immigration issues from the perspective of what policies best serve the national interest. By national interest I generally mean policies that best promote broadly shared economic growth. The self-selection of the best and brightest from around the world to immigrate to the U.S. in our earlier history clearly helped make us the prosperous nation that we are today. Our poorest citizens live better than the average citizen in many of the world’s poorer countries.

Attract the best and the brightest. To continue our past history of attracting the best and the brightest from around the world, our immigration policy should favor admitting the most talented and those with the work skills most needed. If we do not continue to attract and admit them they will go elsewhere boosting the economic fortunes of other (competitive) countries. “Immigration-is-practically-a-free-lunch-for-America”

Of the approximately one million foreigners given permanent residency each year about 70% are extended family members of existing permanent residents. These are the parents and grandparents and aunts and uncles of existing citizens or green card holders most of whom do not intent to work and/or do not have skills relevant to our labor markets. From a given total of immigrants the extended family preference crowds out workers. If we want to promote faster economic growth, we should pull the family preference back to the nuclear family (spouse and children) and keep or increase the total number of immigrants allowed each year thus increasing those coming to work.

Attract the best and the brightest. Similarly we should replace the existing green card lottery with merit based selection criteria (i.e. with H-1B visas, which are currently limited to 85,000 per year). The green card lottery, which provides 50,000 immigrant visas per year from countries with a low number of immigrants over the preceding five years, is meant to increase the diversity of countries from which people immigrate. Such country quotas, even if immigrants from each country are accepted on merit rather than luck, diminish the average skill levels from a global total without diversified country quota. A case might be made, however, that America’s interests are served by the good will gained when citizens of a large number of countries have a better chance of immigrating to the United States.

Help those displaced. While increased worker productivity increases our standard of living, it also causes some workers to loose their old jobs and to acquire the new skills needed for the evolving work place. While some of these dislocations come from the competition of global trade, most is the result of improving technologies that increase labor productivity and from changes in consumer tastes. These costs, which fall on a few for the benefit of many, must not be minimized or ignored.

Many of us are no longer such big risk takers as were our ambitious ancestors. We prefer a bit more security at the expense of increases in income. In any event we need to provide an effective and efficient safety net for those of us whose skills are no longer appropriate in the labor market while retraining for the new jobs that replaced the old ones. Very importantly, a public – private partnership should improve the targeting of training of new entrance into the labor force for today’s and tomorrow’s needs and to better support the retraining of those already in the labor force but in no longer needed occupations. This is a reasonable price to pay by the rest of us who benefit from the raising living standards of improving productivity.

Restore the rule of law. There are 11 to 12 million illegal immigrants living in the United States. It is not in our national interest to go on ignoring the law. But it would be devastating to our economy (to the firms that employ them) and to the personal lives and welfare of these people to expel them even if we had the military/police capacity to do so. So the laws defining their status must be changed. There is almost unanimous agreement that the Dreamers (those brought into the country illegally as minors) should be given legal status (permanent residency) but less agreement about citizenship. In my opinion, all illegal immigrants who have been here for more than say five years and have not been convicted of a felony should be granted permanent legal residency. However, to become citizens they should be required to go through the same process and procedures as anyone else applying for citizenship (though from their American residence). https://wcoats.blog/2017/02/12/illegal-aliens/

What is SALT really about?

Here is the proper way to understand the SALT issue—whether State and Local Taxes should be deducted from taxable income on which federal taxes are levied.

Assume that taxpayer 1 (Jack) in state A and taxpayer 2 (Mary) in state B both have earned incomes of $150,000 each. If Uncle Sam needs to raise $60,000 each year from its income tax and applies a flat tax on each taxpayers’ total income, it would need to impose a tax rate of 20% (150,000+150,000=300,000*0.2=60,000). Each taxpayer would pay $30,000 in federal taxes.

Assume that Jack chooses to buy an expensive car costing $100,000 while Mary makes a more frugal choice and buys a $40,000 car. No one would think that they should be allowed to deduct the cost of their cars from their incomes for purposes of their federal income tax, but what if they could? Jack would now have $50,000 in federally taxable income (150,000-100,000) while Mary would have taxable income of$110,000 (100,000-40,000). To raise the same $60,000 needed by the Feds, the federal tax rate would need to be increased to 37.5% (50,000+110,000=160,000*0.375=60,000). Of the $60,000 in federal tax revenue, Jack would pay $18,750 (50,000*0.375) and Mary would pay $41,250 (110*0.375). Not only does Jack get a better car but he also pays less taxes. In fact, this tax treatment subsidizes Jack’s expensive car to the amount of $11,250 (30,000-18,750). This is likely to lead Jack to buy a more expensive car than he would have chosen if spending only his own money. Clearly that would be neither fair nor economically efficient.

Replace “car” in the above example with “state government expenditures”. Jack may well choose to have (and pay the higher taxes to finance) more extensive state government services than does Mary. That is fine as long as you are free to choose whether you live in state A or state B. But should Mary be forced to pay (subsidize) some of Jack’s tastes for larger state government expenditures? Surely not, but that is exactly what allowing tax payers to deduct their SALT from their taxable income for federal tax purposes does. Eliminating that deduction would restore fairness and remove any artificial inducement for larger state expenditures. In this way, every one would be free to support the level of state spending they are willing to pay for.

SALT—More press nonsense on tax reform

The elimination of State and Local Tax (SALT) deductions from the proposed tax reforms working their way through Congress has become a hot topic. Fine, but please keep the discussion honest. Sadly my local newspaper, The Washington Post, is not setting a good example: “In-towns-and-cities-nationwide-fears-of-trickle-down-effects-of-federal-tax-legislation”

First a word about tax reform vs tax reduction. We are now in the 9th year of economic recovery, one of the longest on record. It won’t go on forever. Ideally the Federal government’s budget should balance its expenditures and revenue over the business cycle. That allows for aggregate demand stimulating deficits during business downturns. These deficits result from so called automatic stabilizers—the fall in tax revenue from the fall in taxable income plus increased transfer payments to the unemployed. But a cyclically balanced budget also requires budget surpluses during the business expansion phase. The U.S. economy is now fully employed (in fact, unfilled vacancies exceed those looking for work). The Federal Reserve has finally increased inflation to its target rate of 2%. We should now have budget surpluses to make room for the deficits that will follow during the upcoming downturn.

But our fiscal situation is much worse than that. The large increase in “entitlement” expenditures for my greedy generation as we retire (greatly increasing unfunded social security and health benefits) will push our fiscal debt held by the public, now at 77% of our Gross Domestic Product (GDP), to over 150% of GDP within 30 years if current laws remain unchanged. See the figure below.

Taxes will either need to be increased (not reduced) or entitlement expenditures reduced (which means increased less than current law provides). My point is that reducing tax revenue at this time is irresponsible without at least matching expenditure cuts. The proposed tax reforms now in congress would increase the debt by $1,500 billion dollars over the next ten years on a static forecast basis, meaning without taking into account the increased growth and thus tax revenue that might result from the tax reforms, which no one expects to wipe out all of the static forecast of $1,500 billion.

Fed debt      Congressional Budget Office forecasts

While it is irresponsible to cut tax revenue at this time, it is highly desirable to reform how that revenue is raised. The existing taxes distort the economy and thus reduce our incomes in a number of ways. They grant favors to many special interest groups via allowing them to deduct specific expenditures from their taxable incomes (i.e. from the tax base). These so called tax subsidies encourage activities over what the private economy would otherwise under take. One very damaging example is the deduction of interest payments by businesses and individuals, which has encouraged excessive borrowing and indebtedness. The most popular of these is the mortgage interest deduction by homeowners. This tax subsidy benefits homeowners relative to renters, i.e. it benefits the wealthier at the expense of the poor. How well meaning middle and upper income American’s can justify this with a straight face is beyond me.

But what about the SALT deductions? By eliminating such deductions, i.e. by broadening the tax base, the same revenue can be raised with a lower tax rate. Other things equal (such as revenue), lower tax rates are good because they influence taxpayer decisions less. For example, companies are more likely to invest in the U.S. rather than abroad if the corporate tax rate is reduced from its current 35%, virtually the highest in the world, to 20%, which is closer to the rate in most developed countries.

Reducing tax subsidies to state and local governments is also good because it reduces an artificial encouragement for larger state and local government expenditures. If Californians are willing to pay more state taxes for larger state expenditures they are welcome to do so. But there can be no justification for transferring federal tax revenue from states with lower expenditures and matching taxes to California and other high spending states. To a large extent the existing SALT deductions transfer income from poorer states to wealthier ones. Who can support that with a straight face?

How information is presented can have a significant effect on how it is understood or viewed. How did Renae Merle and Peter Jamison of The Washington Post (see link above) report the proposed elimination of the SALT deduction? They reported that, “In San Diego County, the elimination of what is commonly called the “SALT” deduction could affect about a third of households, said Greg Cox, a member of the board of supervisors. The average middle-income resident would lose a $16,000 deduction.” They failed to note that the third of households affected are the wealthiest third. According to CNBC: “More than half of taxpayers who are earning $75,000 and above claim SALT deductions on their federal income tax returns as do more than 90 percent of taxpayers who make $200,000 or more.”

share of SALT

Furthermore, the figure $16,000 is misleading in two respects. The loss of a $16,000 deduction would increase taxes for a single person earning $200,000 annually by $5,280 at the current tax rate of 33%. However, broadening the tax base by eliminating the SALT and other deductions allows raising the same revenue with a lower tax rate. To measure the actual tax impact both effects must be combined. Current congressional proposals are to reduce the rate for the above person to 25%, which would result in an increased tax of $4,000. None of this would affect the poor directly. I assume that Renae Merle and Peter Jamison were just careless rather than letting their biases get the best of them, but you can make your own judgment.

The SALT deduction cannot be justified on either economic or fairness grounds, but there is sadly a good chance congress will cave in to the pressure from the wealthier states to keep it or at least some of it.

 

 

 

Tax reform and the press

I have written several articles about the need for serious tax reform in the U.S. and set out the basic principles of good tax law accepted by most economists. “US Federal Tax Policy”, Cayman Financial Review, Issue 16, Third Quarter 2009. https://works.bepress.com/warren_coats/47/  Cayman Financial Review, July 2013

Taxing consumption is best, but if income is taxed, it should be broadly defined and taxed uniformly. Income tax reform should follow the mantra “broaden the base and lower the rate” for the revenue needed to finance whatever the government spends. The main dispute tends to focus on whether and how progressive the tax rate should be. I favor a flat rate as the fairest and simplest regime. This means that a person with twice the taxable income would pay twice the tax. Many others favor a progressive rate—a marginal tax rate that increases with income—, which means that someone with twice the taxable income might pay 3 or 4 times as much in taxes. In 2016 the “top 1%” by income paid over 50% of all federal income tax revenue collected and the top 20% paid 84%.

I raise this issue because any judgment of whether a reduction of the top U.S. marginal tax rate from its current 39.6% to 38.5%, as currently proposed by the U.S. Senate, increases or decreases the fairness of the system depends on whether you consider 39.6% fair or too high or too low. I consider it too high and a reduction to 38.5% too little, so I would say that the tax reform is unfair to the top income groups by not lowering the top tax rate enough. The press almost uniformly refers to any cut in the top rate as favoring the rich (rather than reducing discrimination against the rich).

But what prompted this note was the blatant bias reflected in the following Washington Post article that claims to report the winners and losers in the current Senate tax reform proposals. Winners-and-losers-in-the-Senate-GOP-tax-plan   In the losers column the article states the following for the poor:

“The poor. More than 70 million Americans don’t make enough money to have to pay federal income taxes. Many of those people currently receive money back from the government because they qualify for refundable credits. Under the Senate plan, those credits aren’t going away, but they also aren’t growing. On top of that, the plan raises America’s debt, which will likely require cost cuts somewhere down the line. Republicans have proposed sizable cuts in the past to some safety net programs used by the poor.”

According to the author of the article, Heather Long, the poor lose because they don’t gain anything!!! Seventy million of them don’t pay taxes to begin with so there is not much that tax reform can do to lower their taxes. The existing tax credit paid to these people will remain but is not increased. Thus Heather concludes that the poor are losers because they didn’t gain anything. I agree with Heather’s implicit objection to the plan’s increasing the federal government’s debt, but avoiding that would require higher taxes for someone and has nothing to do with making the poor worse off that I can see.

Any tax reform that is revenue neutral (unfortunately this one will increase the debt by 1.5 trillion dollars over ten years.) necessarily increases taxes for some while lowering them for others.  It should not be judged by whether it will result in President Trump paying more taxes or less, as some press would have it.  It should be judged by whether the resulting realignment of tax obligations is fairer and economically more efficient (neutral). Sadly it is rarely discussed in these terms.

Sound Money

Philadelphia Society Address on Oct 14, 2017

Introduction

Sound money is a necessary but not a sufficient condition for a healthy economy. How can we best achieve and maintain it?

For almost two hundred years the gold standard did a good job of producing sound money but its weaknesses ultimately led to its abandonment and exchange rates were allowed to float.

The movement in the 1980s to independent central banks with a stable price level mandate, such as an inflation target, delivered several decades of sound money—this was called the great moderation. But is came at the expense of increased exchange rate volatility and asset bubbles.

We need to return to a monetary regime with a hard anchor. But money fixed in price to a single commodity, such as gold, will not provide as stable a value as a price fixed to a larger basket of goods.

The discretion of the central bank to control the supply of money should be replaced with market determination of the money supply. To achieve this money should be issued under currency board rules. Specifically the public should be able to buy all of the currency they want at the currency’s official prices and redeem any of it they no longer want at the same price.

The Gold Standard

The essence of the gold standard was the obligation of the issuer of gold backed money to redeem it for gold at an officially fixed price. This limited the amount of money that could be issued.  The United States set the price of fine gold at $19.49 per ounce in 1791 and raised it to $20.69 in 1834. The Gold Standard Act of 1900 lowered it slightly to $20.67.  In 1934, Congress passed the Gold Reserve Act, which raised the price of gold to $35 an ounce and prohibited private ownership of gold in the United States.  Lyndon Johnson’s guns and butter deficit spending over heated the U.S. economy, which raised doubts about the U.S.’s ability to honor its gold commitments. By late 1971 the U.S. no longer had enough gold to honor its redemption commitment, and President Richard Nixon suspended the U.S. commitment to buy and sell gold at its official price. Yet, an official price remained, and was raised to $38.00 per ounce in 1971 and to $42.22 in 1972. In 1974, President Ford abolished controls on and freed the price of gold, which rose to a high of $1,895 in September 2011 before falling back to $1,304 this morning (October 14, 2017). More importantly, as gold has never been very representative of prices in general, prices of goods and services on average in the U.S. rose 500% over the 45 years since Nixon closed the gold window.

Floating Exchange Rates and Inflation Targets

When Nixon closed the gold window he also imposed wage and price controls, which lasted for three years. The dollar no longer had a “hard” anchor. It was no longer redeemable for anything and new policies were needed to regulate its supply. Over this period the Fed implemented monetary policy via adjustments in the overnight interbank lending rate (the Fed funds rate) in light of, among other things, its objectives for the growth of monetary aggregates. When wage and price controls were finally lifted the CPI increased a staggering 12% in 1974.

In the face of the Fed’s persistent over shooting of its narrow and broad money target ranges and the entrenching of higher and higher inflation expectations in wage and price increases, Federal Reserve Board Chairman Paul Volcker led the Board and the Federal Open Market Committee (FOMC) on October 6, 1979 in a dramatic change in the Fed’s approach to implementing monetary policy by shifting to an intermediate, narrow money target, operationally implemented via a target for non-borrowed reserves. The new approach required the Fed to relax its Fed funds rate targets and it increased the band set by the FOMC for the Fed funds rate from 0.5% to 4%. However, the fed funds rate rose temporarily to over 22% and GDP fell by over 2% in 1982—actual and expected inflation were reversed and fell below 2.5% by 1983. The new approach had defeated inflation but it was not easy to implement and by the end of 1989 the Fed abandoned it for the more traditional fed funds rate targeting.

At about the same time radical innovations in the development of monetary policy rules were launched by the Reserve Bank of New Zealand, which came to be known as explicit inflation targeting. An inflation target provides a clear and explicit rule that permits flexible operational approaches to its achievement. Given Friedman’s long and variable lags in the effect of monetary policy on prices, setting monetary operational targets (almost always the equivalent of a fed funds rate) must be based on the best model assisted forecast of its consistency with the inflation target one to two years in the future. A longer target horizon provided more scope for smoothing any output gap (employment). Full transparency of the policy and the data and reasoning underlying policy settings is required to gain the benefits of the alignment of market inflation expectations with the policy target.

The RBNZ’s development and adoption of inflation targeting was an important development in the pursuit of rule based monetary policy with floating exchange rates that accommodated flexible implementation. It swept the world of central banking. While the Fed did not adopt explicit inflation targets until 2012, it clearly pursued an implicit inflation target long before that.

Monetary stability, defined as price level stability, improved significantly, but exchange rate volatility increased. The Great Moderation of the 1990s and early 2000s that resulted from more stable domestic prices was followed by the Great Recession. The Great Recession of December 2007 to June 2009 highlighted the failure of inflation targeting to take account of asset price bubbles and “inappropriate responses to supply shocks and terms-of trade shocks”.[1]

What followed can only be described as a nightmare (largely because of the over leverage and other weaknesses in the U.S. financial system). After properly and successfully performing its function of a lender of last resort and thus preventing a liquidity-induced collapse of the banking system, the Fed went on to undertake ever more desperate measures to reflate the economy. These Quantitative Easings (QEs)—quasi-fiscal activities—have been widely discussed and have contributed little to economic recovery.[2]

The conclusion from the above history is that monetary policy is being asked to deliver more than it is capable of delivering. Central banks are generally staffed by very capable people, but they can never know all that they need to know to keep the economy at full employment as employers and jobs keep changing. The quality of forecasting models has greatly improved in recent years, but they remain unreliable. The policy strategy and intentions of the Fed and other inflation targeting central banks have become admirably transparent, but given the uncertainty of its next policy actions, markets remain spooked by every new data release and speech by Fed officials. Yet inflation in the U.S. and Europe remain below the 2% targets of the Fed and of the ECB.

Despite the huge increase in the Fed’s balance sheet, which banks are largely holding as excess reserves at the Fed, monetary growth in the U.S. averaged only about 5.5 to 6% over the past four years or about the same as its long run average (for M2). My assessment of the slow pace and modest size of the economic recovery in the U.S. is that regulatory burdens have discouraged investment while many internet related investments continue to drive down costs of many economic activity (a sort of unrecorded productivity increase).  Easy money is once again inflating asset prices (stocks and to a lesser extend again real estate).  But who knows for sure?

The idea that central banks can micro-manage monetary conditions to smooth business cycles is a conceit. In my opinion, central banks have given their price stability mandates their best shot and failed. The successful, countercyclical management of the money supply with floating exchange rates is simply beyond the capacity of mortals.

Return to a Hard Anchor

The Fed should give up its management of the money supply and return to a system of money redeemable for something of fixed value – a so-called hard anchor for monetary policy. This means linking the value of money to something real and managing its supply consistent with that value (exchange rate). Such regimes do not magically overcome an economy’s many and continuous resource allocation and coordination challenges, but by providing a stable unit in which to value goods and services and to evaluate investment options, and sufficient liquidity with which to transact, such regimes facilitate the continuous adjustments private actors need to make for an economy to remain fully employed and to grow.

But fixed exchange rate regimes, including the gold standard in one of its forms or another, have historically had their problems as well. These problems generally reflected one or the other of two factors. The first was the failure of the monetary authorities to play by the rules of a hard anchor, which is to keep the supply of money at the level demanded by the public at money’s fixed value. The pressure to depart from the rules of fixed exchange rates generally came from fiscal imbalances or mistaken Keynesian notions of aggregate demand management. However, even when central banks aimed actively to match the supply of its currency to the market’s demand with stable prices it proved beyond their capacity to do so.

The second source of failure came from fixing the value of money to an inappropriate anchor. When the exchange rate of a currency is fixed to another currency or to a commodity whose value changes in ways that are inappropriate for the economy, domestic price adjustments can become difficult and disruptive. Fixing the exchange rate to a single commodity, as with the gold standard, transmitted changes in the relative price of gold to prices in general, which imposed costly adjustments on the public.

These historical weaknesses of monetary regimes with hard anchors can be overcome by choosing better anchors and by replacing central bank management of the money supply with market control via currency board rules.

Currency board rules give control of the money supply to the market—to the public. As an example, a strict gold standard operated under currency board rules would increase the money supply whenever the public wanted more and was willing to buy it with gold at the fixed gold price of a dollar. If the public found it held more money than it wanted it would redeem the excess for gold at the same price.

I led the IMF teams that established the Central Bank of Bosnia and Herzegovina with currency board rules, and it functions in exactly this way. It has no monetary policy other than issuing or redeeming its currency for Euro at a fixed exchange rate in passive response to market demand. It has worked very well. I was also involved in establishing currency board rules for the Central Bank of Bulgaria, which has also enjoyed stable money ever since.

The hard anchor should not be just one thing. The relative price of any individual good or commodity will vary relative to prices in general. Thus a small representative basket of goods should be chosen for the anchor. Earlier proposals for broader baskets suffered from the assumption that buying and redeeming the currency should be against all of the items in the basket. That would be cumbersome and storage and security would be costly. Currency board rules should provide for indirect redeemability, by which the currency would be purchased with or redeemed for designated AAA securities (e.g., U.S. Treasury bills) at their current market value.

Exchange Rate Volatility or a Global Currency

A major cost of the current system of floating exchange rates with inflation or other targets is the uncertainly and wide swings of exchange rates. Over the last decade the USD/Euro exchange rate varied over 40 percent. The classical gold standard was associated with a flourishing of foreign trade in part because the gold standard was a world currency, which there for eliminated exchange rate risk. There would be considerable benefit to world trade, economic efficiency, and growth if all or most countries adopted the same hard anchor for their currencies. The International Monetary Fund’s SDR already exists for this purpose but would need to be modified in several important ways in order to operate under currency board rules and to change its valuation basket from a basket of currencies to a basket of goods.

Conclusion

Experience with monetary regimes with floating exchange rates has been mixed. Almost all major currencies have become more stable in the last three decades but at the expense of increased exchange rate and asset price volatility. The United State, as well as most other countries, would benefit from a return to a monetary system with a hard anchor, but fixed to the value of a small basket of goods rather than to just one, and whose supply is determined by the public’s demand via issuing and redeeming it indirectly for a liquid asset of comparable value according to currency board rules. The benefits of such a system would be increased the more widely it was adopted. One of the virtues of the gold standard was that it was global.

Reference

Warren Coats, “Real SDR Currency Board”, Central Banking Journal XXII.2 (2011), also available at http://works.bepress.com/warren_coats/25

________________, “What’s Wrong with the International Monetary System and How to Fix it?” April 20, 2017. https://works.bepress.com/warren_coats/38/

Jeffrey Frankel. “The Death of Inflation Targeting”. Project Syndicate, May 16, 2012.

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[1] Jeffrey Frankel. “The Death of Inflation Targeting”. Project Syndicate, May 16, 2012.

[2] See for example, Warren Coats, “US Monetary Policy–QE3” Cayman Financial Review January 2013.

Abuses of Government regulation

Government is essential for a vibrant, growing economy. It provides and enforces the property rights and rules of the game (e.g., contract enforcement) within which entrepreneurs operate. It is, or should be, the referee of the game rather than a player.

There is often pressure from established firms for government regulations to have a role beyond establishing a transparent and level playing field in order to favor or protect these firms from unwanted (by them) competition. Requiring the U.S. government to buy what it needs from American firms is such an example. If the products and services of American firms were better and cheaper than those of foreign firms, there would be no need for such a law. As it is, it often means that taxpayers must pay more for their government than would be the case if it procured on a purely competitive basis. The extra cost must either divert government spending from other things or divert household incomes via an increase in taxes.

Two examples of such abuse are currently in the news—the Jones Act and the Boeing dispute with Bombardier.

The Jones Act, adopted in 1920, requires that all goods shipped between American ports must “be carried on ships built, owned and operated by Americans…. A 2012 study from the New York Federal Reserve found that shipping a container from the US East Coast to Puerto Rico cost $3,063. But shipping the same container on a foreign ship to the Dominican Republic nearby cost only $1,504. More broadly, the island loses $537 million per year as a result of the Jones Act.” “Jones-Act-hurts Puerto-Rico”

The Jones Act, formally called the Merchant Marine Act of 1920, was adopted to protect our merchant marine industry—thousands of sailors, ship builders, and their owners and operators. They were not competitive with foreign shippers without such protection. So Puerto Rico and all of the rest of us buying the goods shipped pay higher prices than necessary. If American cargo ships were forced to compete with foreign operators, then some—but not necessarily all—of them would fail and take jobs producing things that were competitive. Those that survived such competition would be the better for it, as would we. Senator John McCain introduced a bill in 2015 to repeal the Jones Act permanently, which we should all support. Buy American is a loose, loose, requirement. “Buy-American-hire-American”

“Mr. Trump’s big mistake has been his handling of the Jones Act.… First he said he would not suspend it as he did for Texas after Harvey and Florida after Irma. ‘A lot of people that work in the shipping industry . . . don’t want [it] lifted,’ he said. Well, duh. A lot of people don’t like competition. But that’s hardly a good argument for blocking it.

“Under pressure, he finally said he would suspend the Jones Act for Puerto Rico—but only for 10 days, a meaningless gesture.” Mary A. O’Grady FEMA’s-foul-up-in-Puerto-Rico

Boeing’s claim that Bombardier’s C Series CS100 commercial jet, built in Canada and Ireland and being purchased by Delta in the U.S., is competing unfairly because of government subsidies is murkier than the Jones Act case and raises a different issue for the renegotiation of NAFTA, which is now underway. While it is undeniable that Bombardier receives financial assistance from the Canadian government in a variety of ways, so does Boeing (from the U.S. government). Boeing is the single largest beneficiary of the loan subsidies provided by the U.S. Import-Export Bank (nicknamed in Washington the “Bank of Boeing”) to help foreign airlines finance their purchases of Boeing aircraft. “Boeing-took-a-foreign-firm-to-task-over-subsidies-critics-say-boeing-gets-help-too”

In response to Boeing’s complaint, the Commerce Department has announced that it intends to impose a staggering 219% tariff on the Canadian plane. Strangely Boeing did not even compete for Delta’s business and has no aircraft that competes with the Bombardier plane. Sorting out the claims and counter claims will be complicated. Which plane builder has benefited more from their governments’ help? What would constitute a level playing field in the international competition to sell these airplanes?

Canadian Prime Minister Justin Trudeau threatened that “his government might cancel a previous proposal to buy Boeing F-18 Super Hornet fighter jets.” In addition, “Bombardier employs about 4,000 people in Belfast, many of whom work on the CS100.” Britain’s, Prime Minister Theresa May “tweeted that it was ‘bitterly disappointed’ by the proposed tariff….   British Defense Secretary Michael Fallon said that he would not cancel an existing deal to buy eight spy planes and 50 Apache helicopters from Boeing but that the slight would hurt Boeing in future competitions.”

These are the sorts of tit for tat trade wars can grow out of, to the detriment of everyone. Like most other trade agreements, the NAFTA (North American Free Trade Agreement) has established a dispute resolution mechanism to evaluate and settle such disputes. Bombardier-vs-Boeing-skip-to-chapter-19. Such disputes are adjudicated by independent dispute resolution panels. “Chapter 19 [of NAFTA] offers exporters and domestic producers an effective and direct route to make their case and appeal the results of trade-remedy investigations before an independent and objective binational panel. This process is an alternative to judicial review of such decisions before domestic courts.” http://www.naftanow.org/dispute/default_en.asp

The Trump administration is now renegotiating NAFTA with Canada and Mexico. “U.S. Trade Representative Robert Lighthizer has… suggested having the nation’s own courts hearing the disputes.” Canada-says-hard-no-on-Trump-change-to-nafta-dispute-resolution.

Take a deep breath and step back. We want Canada’s challenge to our proposed 219% tariff on Canadian airplanes adjudicated in our own courts? How can we imagine that this would be acceptable? Would we agree to our challenge to a Mexican tariff on American cars sold in Mexico being settled in a Mexican court? Have we become such big bullies that we can even suggest such an outrageous approach? Trade should be as fair as possible within the terms of any trade agreement and disputes should be resolved as impartially as possible. We and the rest of the world benefit from the increase in trade that results.

Taxing the Wealthy

The administration has “backed a tax plan that analysts say would greatly benefit the wealthy.” I want to unpack that and take a closer look at what it might mean.

“The Trump tax plan drops the top bracket from 39.6 to 35 percent, and allows for the possibility of a 25 percent top rate through a pass-through entity.” The Washington Post Fact Checker

I want to explore two questions. Would the proposed income tax changes reduce the taxes paid by the average wealthy tax payer (say the top ten percent, who in 2016 paid 80% of all income taxes)? Would that be a good thing or a bad thing and in what ways should we judge that question?

To evaluate the impact on taxes paid by dropping the marginal tax rate from 39.5 to 35 percent we must also take into account the increase in taxable income resulting from broadening the tax base (eliminating some of the existing deductions from taxable income such as State and Local Taxes and interest paid on other than mortgage debt, etc). The conventional wisdom of tax reform is to lower the rates and broaden the base. This can be done in amounts that leave tax revenue unchanged (revenue neutral). Whether the wealthy pay more or less from the proposed modest drop in the tax rate will depend on how successful congress is in fighting off the special interest groups that will try to preserve their special interest deductions.

There are two other important considerations when evaluating the revenue impact of a rate cut. To the extent that lower marginal tax rates encourage greater investment, the economy will grow more than otherwise. This is an additional way in which the tax base is increased and with it the tax revenue generated from whatever the tax rate might be. While there is no case in which the economy grew fast enough to recover all of the revenue lost from cutting the rate, faster growth generally recovered some of it. But a bigger revenue boost can also come from the wealthy repatriating more of their income held abroad to be taxed in the U.S.

But let’s assume, all things considered, that lowering the marginal tax rate for the wealthy reduces the taxes they pay. Is that a good or a bad thing? Leaving aside the point above about increasing economic activity in the U.S., what should the standard of judgment be of what is fair? Obviously people with more income should pay more taxes but how much more? If current tax rates (and deductions) are unfairly high for the wealthy, then lowering them is a good thing. If they are unfairly low, they should be raised. In short, it is not necessarily appropriate to say that something that lowers the taxes paid by the wealthy is a bad thing. The core question is thus: what is our standard of fairness?

Tax burdens are generally discussed in relation to the share of ones income paid in taxes. Rather than comparing the fairness of a millionaire with an income of $5,000,000 paying $1,000,000 in taxes with the average American family income of $50,000 paying $10,000, we look at the tax burden in relation to the share of ones income paid in taxes. In the preceding example, both the millionaire and the average family are paying 20% of their incomes in taxes. In fact, the average share of income paid in taxes of the top 10% of income earners was almost 20% in 2012 while the bottom 50% (most of whom paid no federal income taxes) was 3.3%. A flat tax rate (same marginal rate for everyone), which means that a person with twice the income pays twice the tax, is my standard of fairness. Many others believe that it is fair for the rates to be progressive (higher marginal rate for higher incomes).

My point is that it is wrong to conclude that any reduction in the taxes paid by the wealthy is good or bad unless we have first agreed on the standard of fairness and whether existing tax payments exceed or fall below that standard.

It is important to note also that there are many other taxes that people pay. While most America families pay no federal income taxes, they do generally pay wage (social security) taxes, sales taxes, property taxes and other taxes. “The Principles of Tax Reform”

 

A Basic Human Right

Hunter-gatherers freely traded what they produced (gathered) for what they needed but did not produce. The story is well known (except by Peter Navarro, an energy and environmental policy analyst masquerading as Trump’s trade expert). By specializing in what they did best (hunting) and trading their bounty with those better at producing the other things hunters needed, total output was greater and every one was better off. The right to sell what we produce for what we need/want but don’t produce is, or should be, a pretty fundamental right. It is called free trade.

Historically governments have interfered with this right to protect the markets of special groups otherwise unable to compete. These trade restrictions and tariffs reduced total output making everyone (except those protected) worse off. Recognizing the general harm done by trade restrictions, most countries have negotiated mutual reductions in these restrictions. These have taken the form of bilateral and regional and global multilateral trade agreements.

The Trans-Pacific Partnership (TPP) was one of the most recent efforts to expand trade and its income rising benefits. It was negotiated over an eight year period among 13 Pacific Rim countries and in addition to expanding trade would have deepened U.S. leadership in setting trade standards in the region. Steve Bannon rejoiced when President Trump withdrew the United States from the agreement, claiming that all future agreements would be bilateral. President Trump thereby potentially gave standard setting leadership in the area to China. Not very smart.

Candidate Trump had also promised to scrap the North American Free Trade Agreement (NAFTA) with Canada and Mexico, calling it the worst trade deal of all times (a rather crowded category). President Trump wisely decided to renegotiate it instead. It has been updated several times since it was originally signed and another round can potentially make it better still. In fact, many of the good features of the now discarded TPP are being incorporated.

If we remove existing restrictions on purchasing Canadian lumber and millwork products, for example, fewer trees will be cut down in Washington and Oregon. In exchange Canada will reduce its tariffs and other restrictions on American cars, equipment, and food product sales to Canada. Production will be more efficient and incomes will rise both here and there.

As competitive advantages shift with freer trade and product and manufacturing innovations, some workers will need to shift to new areas of work and may need new skills. Public policy should facilitate and ease the adjustment burdens of these shifts, but it is important to recognize that these shifts arise mainly from improving productivity and not from increases in cross border trade. Most of us export our labor to a domestic company (our employer) and import everything we need (paid for by our labor export). But most of those imports are from domestic companies and service providers not from so called foreign trade. The era of the self sufficient farm families ended long, long ago. https://wcoats.wordpress.com/2017/07/23/the-balance-of-trade/

President Trump may well oversee the negotiation of a better NAFTA (better for all three countries involved). Unfortunately his style of leadership in this area—baseless claims of great harm to American workers from existing trade agreements—provides a very misleading message to the American worker and public in general. He creates a negative atmosphere around the right of each of us to sell what we make to whom ever we choose and to buy what we need from whomever we choose. The world has benefited enormously from freer trade and the increases in worker productivity it has made posible. This is a huge understatement. President Trump does us all a great disservice by characterizing trade in negative terms.

Finally (?): Healthcare Reform

What are the problems with our universal healthcare system (no one is denied the care they need “Health-care-plan-B”) that Congress is trying to fix? At the broadest level America’s health care costs much more than it should for the results it delivers and the distribution of its financing is neither efficient nor equitable. Six years ago Democrats made the mistake of sneaking through the Affordable Care Act without significant debate. This year Republicans committed the same error but failed to pass a law. This provides congress (thank you Senator McCain) with the opportunity to fashion a healthcare reform law the proper way (open committee hearings, etc.).

A new attempt to reform the system would no longer be restrained by the limitations of a budget law that limited what earlier attempts were able to do. In particular a new law should address the factors that drive up the cost of medical care in the U.S. These include relaxing legal limitations on who can provide what services and how they may be performed, requiring that the cost of services be transparent and requiring stronger incentives for customers (patients) to care about cost when choosing medical treatments. “Heath-care-reform-fatigue”

How medical services are paid for influences the incentives of both suppliers of these services as well as the users to seek and provide the most cost effective options. Medical services are paid for by patients (because they are uninsured, or pay deductibles or copays), insurance premiums, or taxpayers. Each provides its own set of incentives for choosing what is delivered. When patients pay for the services they have a financial incentive to choose the option with the highest benefit-cost ratio. When third parties pay for medical services, (insurance companies or government) they must impose choices that patients, in consultation with their doctors, would otherwise make.

Some commentators have complained that third party payers, whether a single payer (government) system or many insurance companies, introduce rationing. However, all scarce goods and services are necessarily rationed. The relevant issue is how they are rationed, whether on the basis of the preferences of patients or the judgment of the third party payer of what is reasonable.

To the extent that medical costs are paid for by taxpayers, the incidence of such financing depends on and is determined by the structure of the government systems of taxation. In the U.S. these are currently unfair and inefficient and in bad need of reform quite independently of the issues of healthcare delivery. Medical insurance financing is complicated by the ill advised post World War II tax incentive for employers to provide and help pay for medical insurance. This practice establishes insurance pools (the firms employees) that generally mix the number of healthy and sick policyholders in a representative way. The very purpose of insurance is for the healthy to share the costs of the sick and thus reduce the financial burden of medical surprises. Most Americans with health insurance buy it through their employers’ plans.

The most serious problem with the existing American health insurance system is for those not receiving insurance from an employer (or those changing employers and needing to establish new insurance policies). These people must use the so-called private market for which the Affordable Care Act established the insurance exchanges. The cost of insurance purchased in this private market depends on the mix of healthy and sick people that sign up. Employer provided plans are essentially mandatory for a firm’s employees (and enjoy a tax subsidy) and thus result in a well mixed (sick and healthy) risk pool. Private market plans were made mandatory by the ACA but with a penalty for remaining uninsured that was so low that large numbers of young healthy people choose not to join. Thus private market plans were increasingly populated by the sick (and those expecting that they were likely to become sick). This undermines the cost sharing the insurance exists to provide and thus drives up the premium cost. The simple cure for this problem is to make healthcare insurance mandatory as originally proposed by the Heritage Foundation.

Mandatory healthcare insurance should cover every health service for which society believes financial assistance should be given. It undermines the purpose of insurance to allow policy holders to pick and choose which services will be covered. Premiums might very with age, lifestyle choices that effect health (such as smoking or obesity) and the choice of the level of deductions and copays but policy holders should not be able to opt out of services society intends to provide and finance one way or another even if they never expect to need them. The issue of preexisting conditions would not arise when insurance is mandatory and policies are not linked to individual employers. “Health-care-in-America”

The individual policyholders’ choices of the level of deductions and copays (but not the scope of services covered) would determine the division of financing between patients and third party payers. In addition, government (the voting public) would choose the extent to which the cost of medical services would be taken over by taxpayers as a result of government financial assistance to the poor. A further policy option is whether the cost of catastrophic health care needs would be lifted from insurance premiums and paid for by taxpayers via a reinsurance plan. But the cost of medical services that must be paid over all (by patients, insurance premiums, or tax payers) can be greatly reduced by taking those measures that will lower the cost of these services in the first place.

Hopefully this time around congress will entertain open public discussion of all of these issues so that the public will understand the purposes and tradeoffs of the policies ultimately adopted.

The Balance of Trade

President Trump has regularly called for bilateral trade balances with our trading partners. Though he prudently gave up his campaign promise to declare China a currency manipulator on his first day in office because of China’s large trade surpluses with the U.S., he more recently criticized Germany’s even larger surplus. The Trump administration’s objectives in renegotiating the North American Free Trade Agreement (NAFTA) published July 17th also call for reducing U.S. bilateral trade deficits with Mexico and Canada. Economists recognize these objectives as nonsensical, but it might be worthwhile to spell out to the broader public (if not to Trump’s protectionist White House wing) why that is so.

Let’s start with the U.S. trade balance with the rest of the world. As we pay for what we import with what we export, we would generally expect a balance between imports and exports over time, just as we expect a rough balance between our income and expenditures over time. But uniquely in the case of the U.S., we need to have a deficit (imports exceeding exports) paid for with U.S. dollars, because the rest of the world holds and uses our dollars to finance many international transactions. The dollar is the world’s primary international reserve currency and our trade deficit is the primary means by which we supply them to the rest of the world.

This is an over simplification, however, because dollars are also supplied to the rest of the world via our capital account, i.e. Americans investing abroad. At the end of 2016 Americans had invested about $24 trillion USD equivalent. However, the rest of the world had invested over $32 trillion USD in the U.S. Roughly $5 trillion of this net investment in the U.S. of $8 trillion represented official foreign exchange reserves held by foreign governments in U.S. dollars out of total foreign exchange reserves of about $8 trillion.

Something also needs to be said about the relationship between foreign holdings of dollars and changes in those holdings. Any increase in the demand for foreign exchange reserves by foreign governments, something that tends to happen naturally as economies grow, must be met by the balance of payments deficits of the countries supplying those reserves. Thus the U.S. trade deficit last year (2016) of about $500 billion USD more or less reflects the addition to the dollar reserves of foreign governments.

So the use of the U.S. dollar in foreign exchange reserves implies that the U.S. will have, and need to have, a balance of trade deficit of a similar amount. But let’s simplify and assume that U.S. trade with the rest of the world is balanced (zero trade balance as well as zero current and capital account balances), perhaps because the U.S. dollar is replaced in international reserves by the SDR as I have long recommended. See my: Real SDR Currency Board What about the trade balance with Mexico and Canada? Should we want and expect each bilateral trade relationship to be balanced?

The error of such thinking can be easily illustrated with a simple, hypothetical example. Assume that within NAFTA the U.S.’s comparative advantage is in manufacturing all the pieces that make up an automobile and growing wheat, Mexico’s comparative advantage is using its “cheap” labor to assemble those pieces into cars, and Canada’s is growing and milling lumber. Assume that that is all they do that crosses their borders. The U.S. sells its car parts to Mexico, which puts them together and sells the cars to the U.S. and Canada. The value of the parts sold to Mexico is less than the value of the cars (which incorporates the parts from the U.S.) Mexico sells to the U.S. so that on net the U.S. has a trade deficit with Mexico. The U.S. sells wheat to Canadians buying a lesser value of lumber in return and Canada sells its lumber to the U.S. and to Mexico buying a few cars but of less value. Looking at bilateral trade balances, Mexico has a surplus vs. the U.S. and a deficit vs. Canada. Canada has a surplus vs. Mexico just sufficient to cover its deficit vs. the U.S. These bilateral deficits and surpluses are not a problem because the U.S. has a trade balance vs. Mexico and Canada combined and indeed with all of the rest of the world. The same is true for Mexico and Canada. What really matters is whether the value of a country’s exports to the rest of the world match and thus pay for the value of its imports from the rest of the world. As someone noted, no one worries that you have a large trade deficit with the grocery store as long as your total spending everywhere is covered by your income (the sale of your labor to your employer).

Being the eternal optimist, I trust that there are enough people in the Trump administration that understand that seeking bilateral trade balances with each and every country would be a terrible mistake to keep him from trying to do so.