Sixteen years ago I wrote about problems with the U.S. Social Security System. The system promises a given pension upon retirement (a defined benefit) that is financed by a given payroll tax. It is not a pool of saving that is drown down at retirement. It is pay as you go. https://wcoats.blog/2008/08/28/saving-social-security/
When Franklin Roosevelt established it, average life time after retirement was only about two years. Today life expectancy in the US is 79 years, or 14 years of retirement pension payments for those retiring at age 65. This fact, plus the declining population growth rate, means that the workers being taxed to pay for the currently retired are shrinking relative to those already retired and receiving benefits. The worker to beneficiary ratio of 3.3 in 2005 is projected to fall to 2.1 in 2040. At that point wage taxes will not be enough to cover the current benefits promised at that time.
Various proposals have been made to address this problem. The wage tax could be increased. Retirement age could be increased (20% voluntarily work after retirement already). As people live longer many choose to work longer for more than just the extra income. Pension benefits could be indexed to inflation rather than to wage growth (which has been greater than inflation). But more recently I have proposed replacing Social Security and other safety net programs with a Universal Basic Income for every man, woman and child without exception. Such a remake of our social safety net would have a number of very good features. https://wcoats.blog/2020/08/20/replacing-social-security-with-a-universal-basic-income/
In these United States, power over each of us is passed up on a limited bases to our communities, to each state, and finally and ultimately to the Federal Government. Thus, each of our communities and states may free choose different levels of services. We Virginians may choose whatever level of services we are willing to pay for and the same for those of you in New York or Illinois. Deducting the state and local taxes that we pay for the service levels we choose from our federal income taxes passes on some of that financing to those in other states that might have choses less expensive service levels for themselves. Such deductions are a clear violation of the principles outlined above. Fairness and adherence to these principles requires that State and Local Tax deductions (SALT) from federal income taxes be zero. We are at risk of moving in the wrong direction.
Six years ago, Ito and I celebrated the 4th of July at the American Ambassador’s residence in Rome as the guest of our friend David Zimov (Economic Councilor at the American Embassy in Rome). It was a very fun event with lots of hamburgers and hot dogs, beer, and a concert by the US Marine Band. The cost of this extravaganza to us taxpayers was truly trivial compared to the cost of one day of our many wars (or our “special military operations” as Russia likes to call its wars). And the benefit to America in the form of international good will, far exceeds any American benefit from our wars, if there is any.
Janet Yellen’s upcoming trip to China will also cost a small drop in the bucket compared to sending the Sixth Fleet with a benefit for American security and wellbeing many times greater. At the same time, the US Senate continues to stall the confirmation of nominees to critical diplomatic positions. Go figure.
We seem to favor military spending over diplomacy to the detriment of our security and to our wellbeing more generally. In testimony before the UN Security Council Max Blumenthal recently stated that “The Biden Administration knows that ‘it is escalating a proxy war against the world’s largest nuclear Power. Why are we tempting nuclear annihilation by flooding Ukraine with advanced weapons and sabotaging negotiations at every turn?’ For those US officials who personally benefit financially, ‘a negotiated settlement to this territorial dispute means an end to the cash cow of close to $150 billion in US aid to Ukraine.’” https://expose-news.com/2023/07/03/us-officials-benefitting-from-ukraine-war/
When I noticed that the small handheld American flags we were all given at the Embassy’s 4th of July party was made in China (they had a very conspicuous “made in China” tag on the handle) the person sitting next to us was appalled. I explained to him why he should celebrate a feature of American life that has helped make us freer and more prosperous: 1. Our tax dollars were prudently spent in buying the cheapest flags; 2. The money the government saved could be spent on other government priorities (or—God forgive—returned to us taxpayers); 3. The American workers who otherwise would have been diverted to make these flags at higher cost; would remain in their current more productive activities raising our standard of living; 4. The larger volume of world trade strengthened America’s standing in the world. Though I don’t know how the American Embassy was able to avoid the shortsighted “Buy American” requirement, I was glad that it had.
CNN reported today on the compromise bill to raise the Federal debt ceiling agreed between Biden and McCarty, saying that:” The Congressional Budget Office estimates the bill would reduce budget deficits by $1.5 trillion over the next 10 years, and reduce discretionary spending by a projected $1.3 trillion from 2024 to 2033.”
Language can be tricky. Debt and deficit are not the same. Reducing projected spending need not mean a reduction in actual spending. In fact, the package agree to by Biden and McCarthy will continue to increase the Federal debt (though at a slower rate than was proposed initially by Biden) and all categories of spending will continue to grow. Not only will they continue to grow, they will be growing from the abnormally high levels reached during the COVID pandemic.
If we really want all of these expenditures, we should, and will ultimately need to, raise taxes to pay for them. But do all of them pass the cost benefit test? Do all of them contribute to American wellbeing?
One Republican blind spot is defense spending (which, by the way does not include foreign aid to, for example, Ukraine). The defense budget for 2023 is 9.8% higher than in 2022 and is projected in the Biden/McCarthy package to continue to grow over the next two years covered by that deal. Our huge defense budget has resulted from (or encouraged?) American military adventurism that does not contribute to our security.
When semiconductors where invented in the U.S. in the late 1950 and began to replace vacuum tubes in electronic circuits, the world of electronic circuitry changed dramatically forever (from the computer I am composing this note on, to the mobile phone on which I might discuss it with you or the electronics in the car I might drive to meet you while listening to the radio these chips made possible, not to mention of submarines, planes, and satellites they empower).
American companies continue to lead the world in the design of the most sophisticate chips and semiconductor circuits. However, they have increasingly found it more economical to outsource their manufacture to facilities in foreign countries. Almost all the most sophisticated chips (still designed in the US) are now produced in Taiwan by TSMC, which produces about 56% of world output of semiconductors. Especially given the increasing suggestion, even by the President of the United States, that the U.S. might renounce its acceptance of China’s claim to Taiwan, such reliance on TSMC for our most advanced chips is an economic and security risk we should reduce.
What is the best way to reduce the risk of our heavy dependance on Taiwan’s supply of such Chips? The rest of this note briefly compares the market approach with the government (socialist/industrial planning) approach to reducing that risk.
American and other firms concentrated the manufacturing of the chips they designed and/or needed where it was cheapest to produce (and deliver) them. Where China violated the WTO rules of fair trade via state subsidies, importing countries are allowed by WTO rules to impose tariffs at levels designed to neutralize such artificial advantages. WTO rules also allow the use of tariffs to diminish the risk to national security of dependance on foreign supplies.
The opposite approach is for a government to subsidize the otherwise uneconomical manufacture of semiconductors (or whatever) in their own country. In the U.S., the CHIPS and Science Act of 2022 appropriated $280 billion in part to subsidize factories to produce such chips in the U.S. Why was so much needed to get firms to produce chips in the U.S.? “’It’s much cheaper to build the chips and the factories in Taiwan than it is in the United States,’ former Google CEO Eric Schmidt told Semafor. ‘Similarly, the workforce quality is not as good as it is in Taiwan.’” “Chip war-US-Taiwan”
The Biden administration’s industrial policy approach suffers all the well-known disadvantages of industrial policy. First, like China’s subsidies, it violates WTO trading rules, which the U.S. seems all too willing to do when it is the violator rather than someone else. Second, it, rather than market factors, must decide who gets the subsidies (and tax breaks), either by establishing the rules for access or by outright picking winners. Governments’ records at picking winners, especially picking technologies, have historically been poor compared with the search for profit by entrepreneurs, most of whom fail and quietly fade away without further cost or waste. Third, when governments pick winners, they establish an economic incentive for corruption by those seeking to be “picked”. Governments, like everyone else, tend to bend to such temptations.
Rather than paying hundreds of billions of American taxpayer’s money for more costly Made in American products, imposing tariffs on imported chips sufficient to reflect the existing sole source risk would leave it to the market to find the best alternative and more diversified sources (India, Korea, Japan, Viet Nam, etc.). The full cost of lower living standards from industrial policies will only be felt in the longer run. “The slippery slope”
The same economic forces and arguments apply to slowing or preventing further global warming. A carbon tax reflecting the global warming externality of carbon producing activities leaves to the market the search for the best technologies for reducing carbon emissions without loss or with minimal loss of output.
Beyond defining and protecting property rights, most governments dip into the private market for one reason or another (e.g., national defense) to some extent. In doing so, they reward (e.g., subsidize) or penalize (e.g., tax) specific firms and/or industries. These firms have a MUCH stronger incentive to protect their interests than do the general public with regard to these activities. As a result of this asymmetry, firms spend more (fight harder) to protect their privileges than do the general public to protect a fair and competitive marketplace. As a result of these incentives, government privileges tend to grow over time and are hard to reverse. Governments keep getting bigger and bigger. Worse yet, if taxes do not match these increases in government costs, i.e., if the government borrows to finance them, these asymmetric incentives are even stronger.
These realities are now being confronted by the Republican Party as it attempts to agree on which government budget items to cut in order to reduce the fiscal deficit without raising taxes. As Steve Clemons reported in this morning’s Semafor Principles: “When Speaker Kevin McCarthy only has four votes of wiggle room in passing GOP legislation, the corn caucus can be as powerful as the Freedom Caucus. After a proposed repeal of biofuels subsidies prompted a rebellion by Midwestern lawmakers, leadership is making changes to a bill they presented as non-negotiable”
The Chips Act of 2022 provides an even costlier example that will be almost impossible to get rid of. The Act provides $52 billion in manufacturing grants and research investments and establishes a 25% investment tax credit to incentivize semiconductor manufacturing in the U.S.” It makes financially attractive what was on its own an inefficient and costlier way to acquire these produces than buying them abroad. It makes us poorer as do other “Buy American” requirements.
Especially now with a labor shortage (we should increase legal immigration), moving workers to subsidized areas means taking them away from producing what the market found more profitable. It reduces overall output and our standard of living. If we insist on producing our own tanks and airplanes for national security reasons, that is a cost we should probably bare. But for 5G phone service, Tik Toc, steel from Canada, or whatever???? Tell your congressman to stop subsidizing these special interests. And if they are really justified by national security, pay the cost properly with tax revenue.
While I will not hold my breath, I am thrilled to see the introduction of H.R.25 – FairTax Act of 2023 in the House of Representatives by Rep. Carter Earl L. “Buddy” (R-GA-1) on January 9.
“This bill imposes a national sales tax on the use or consumption in the United States of taxable property or services in lieu of the current income taxes, payroll taxes, and estate and gift taxes. The rate of the sales tax will be 23% in 2025, with adjustments to the rate in subsequent years. There are exemptions from the tax for used and intangible property; for property or services purchased for business, export, or investment purposes; and for state government functions.
Under the bill, family members who are lawful U.S. residents receive a monthly sales tax rebate (Family Consumption Allowance) based upon criteria related to family size and poverty guidelines.” “Fair Tax Act of 2023”
I have written a great deal about taxation, a necessary feature of government spending, and how to make it fair and economically neutral (minimal distortion of the allocation of resources in our economy). Income taxation—especially corporate income taxation—fail these tests. A universal consumption tax passes them. It is especially suitable for our globalized world where companies produce and sell in many countries. “Tax reform and the press”“The corporate income tax”
But the issue of fairness is somewhat in the eyes of the beholder. I have also supported a Universal Basic Income (UBI), in place of our many safety net transfers including Social Security. “Our social safety net” Not only does a UBI better fit American’s strong commitment to individual liberty and choice, but when combined with a flat consumption tax it produces a progressive impact on income that satisfies my notion of fairness. “Replacing social security with a universal basic income”
As I understand the new (actually a return to the old) and improved House rules, after consideration by the House Ways and Means Committee, the bill will be debated on the floor of the full House. This is a giant step in a very good direction.
Human dignity is the central focus of a fascinating new book written by Tom Palmer and Matt Warner Development with Dignity–Self-determination, Localization, and the end to Poverty. They spotlight the treatment of every person with the dignity due all people as a critical factor in unleashing the innovation and entrepreneurship that has dramatically raised the standard of living to virtually the whole world over the last three hundred years after thousands of years of no progress. The book is rich with interesting examples.
Palmer and Warner argue that the top-down approach of most development agencies and aid projects of “teaching them how we do it in our developed countries,” often fails as a result of overlooking and/or ignoring the knowledge and ways of social organization found in the local communities aid is meant to uplift. Such knowledge is important to understand where the problems are and what is working well in a community. Any improvements must start from there and be embraced by the people we want to help. The IMF calls this “ownership.” It must start with treating every individual with dignity.
A wonderful example of the importance of understanding and building from local knowledge and practices is provided by Jennifer Brick Martazashvili and Ilia Martazashvili in their recent book on common law property rights in the villages of Afghanistan: “Land, the State, and War –Property Institutions and Political Order in Afghanistan.” They argue very convincingly that the common law traditions of many Afghan villages can provide satisfactory property rights until there is a central government that can be trusted and has sufficient administrative capacity to administer the registration of legal land titles.
Both books reflect an attitude toward individuals and the importance of their agency for prosperous, liberal societies. I am struck by the similarity of attitudes in the above approaches to development aid and our approaches to social welfare in the United States. Our Federal, State, and local governments provide a wide range of programs to assist the poor or temporarily unemployed. The food stamp program, for example, epitomizes the attitude that people “on the dole” can’t be trusted to make their own decisions about how to use such assistance. I don’t want to ignore the fact that there are people we shouldn’t trust to make their own decisions (drug addicts, the emotionally unstable, etc.). But the view that government can make better decisions about how food aid should be used than the hungry who receive it is at the heart of the Palmer – Warner discussion about the importance of dignity.
Those of us who support Universal Basic Incomes (UBI) are on the side of those who believe that most people know better than government bureaucrats or even well-meaning social workers what their needs are–i.e., how best to spend their money. UBI payments are made to every person with no strings attached. Unlike current unemployment assistance and other safety net programs UBI would not diminish the financial incentive to work, though the incentives to work include more than just money. With a UBI any additional income from work is kept. The UBI is not reduced by work. See my: “Our Social Safety Net”
Pilot tests of the impact on recipients and on their incentives to work are being carried out in a number of countries and cities with generally very promising results. A two year pilot that was recently concluded in the Washington DC area is typical:
“Placing money into people’s hands without restrictions empowered them to address their needs, program administrators said, and removed the typical layers of bureaucracy and eligibility requirements that can frustrate recipients and hamper the effectiveness of aid efforts. The study’s quantitative and qualitative data showed that “participants often struck a thoughtful balance between addressing immediate survival concerns like paying rent and longer-term concerns like accumulation of debt,” analysts concluded. Recipients surveyed for the study, which was released Thursday, reported lower rates of mental health stressors and food insecurity than people with comparable incomes in the District and nationally.” “Guaranteed basic income-dc-poverty thrive”
When Universal Basic Incomes are combined with the replacement of income taxes (both individual and corporate) by a flat consumption tax, the result is a nicely progressive tax rate relative to income. See rough estimates here: “Replacing Social Security with a Universal Basic Income” It also simplifies the process of financing the government expenditures that we want.
Trusting the choices of individuals about their own lives doesn’t mean that we (government or private institutions) shouldn’t offer information to help inform and guide their choices. But it does mean that we do not make those choices for them. We give them the dignity with which free societies can and have flourished.
Prices of many goods and services have increased in recent months. Are these increases permanent or temporary or will they continue rising in the future? Before exploring those questions, it is important to understand the measures of inflation we are considering. What is the current rate of inflation in the United States? U.S. inflation in September was 3.0% (Compound annual rate of change for Consumer Price Index without food and energy prices over the month of September), or 4.0% (percent change from a year ago) or 5.4% (percent change from a year ago including food and energy prices). What does it mean if this is temporary or long lasting?
If prices remain where they are today after the 5.4% increase from a year ago, inflation going forward would be zero even though the cost of living would be permanently higher. If inflation is long lasting it means that prices will continue to rise for some time (years). What are the factors that influence the future behavior of prices? What should we expect in the U.S.?
The price of a good or service increases when its demand exceeds its supply and similarly for prices in general (when aggregate demand exceeds aggregate supply). As prices are measured in a country’s currency, supplying too much of the currency (generally when the money supply grows more rapidly than the supply of goods and services) causes its value to fall (i.e., prices in the country’s currency to rise).
On the cost side, firms will hire workers and pay them a particular wage (and related benefits) when it adds more to the company’s income than it costs, which includes the cost of the tools they use (capital). Workers will accept a job when its benefits (pecuniary and nonpecuniary) are the best they can find. The inflation expected by the employer and the employee over the period of the wage contract is an important factor in determining what will be offered and what will be accepted.
Because of changes in consumer demands, worker preferences, halving of work visas for immigrants, and supply chain disruptions, labor markets are temporarily in turmoil. September unemployment in the U.S. was 7.674 million while there were 10.4 million job vacancies. Employers are raising wages in an effort to fill those vacancies. As reported by Scott Lincicome: “Goldman Sachs analysts saw a ‘perfect storm of factors that have significantly reduced the supply of workers who are currently looking for jobs at the same time that labor demand—as measured by job openings—has risen to an all-time high.’ This includes… state and federal benefits, early retirements, severely restricted immigration, a switch to self-employment, fear of COVID, and a geographic mismatch between unemployed workers and available jobs. Combined, these factors account for most of the missing workers out there.” “What if the labor shortage isn’t transitory?”
In short, the labor force has shrunk just as the demand for output is increasing. This excess demand for workers is driving up labor costs and thus pushing up output prices. If the 5 or 6 percent price increase experienced over the present year is expected to be temporary, i.e., if prices are expected to return to their level a year ago, because the supply of labor returns to its pre-pandemic level, wage increases should be temporary as well, falling back to their pre pandemic level and growing thereafter on average with labor productivity plus the 2% inflation target of the central bank once there is full employment and better labor market balance.
More likely, if the inflation is expected to be temporary, i.e., the current 5 to 6 percent inflation stops but prices remain at their increased level, wages will remain at the increased level, but their real (inflation adjusted) value will fall back to their original level. In other words, if these higher prices are expected to be “permanent,” the nominal wage increases now being experienced will not result in any increase in real wages and the worker short fall might remain.
While some of those who withdrew from the labor force will probably return, it is not likely to fully satisfy the demand for various reasons (early retirement, fall in immigration, etc.). Filling (or attempting to fill) the remaining labor shortage will require additional wage increases (unless the public’s demand for goods and services falls–see below). In that case, firms will plan to pass on their higher cost of labor to their customers. If we, the customers, can continue to pay the higher prices, the inflation will continue. Expectations of higher prices and or inflation will be realized.
The Covid-19 pandemic caused a sharp fall in output and thus to most people’s incomes. The government provided extraordinary financial support to temporarily fill the resulting income gap. Such support did not increase the output of goods and services or even prevent their decline but rather temporarily redistributed income from those saving it to avoid hunger and defaults on rents, mortgages, and other financial obligations by those who lost it. “The new covid-19 support bill” Because personal incomes were substantially maintained while actual output fell, personal savings rates increased dramatically and continue to be well above pre pandemic levels.
The Federal Reserve pitched in by buying up huge amounts of the resulting government debt increasing its balance sheet from $3.5 trillion in February 2020 to $6.3 trillion in August 2021 (measured by the monetary base, M0). This fueled an increase in board money (M3–M0 plus bank deposits and similar liquid assets of the public) from $15.5.0 trillion in February 2020 to $20.8 trillion in August 2021. This increase, though substantial, was significantly less than the increase in M0 (which almost doubled) because the Fed paid interest to banks for keeping the new base money with the Fed (excess reserves) rather than lending it to the public, by paying banks interest on all bank reserves kept with the central bank.
Historical experience is that the public will not be willing to hold these larger amounts of money for ever. They will eventually attempt to spend them down to their traditional (normal) levels, thus adding to aggregate demand for goods and services (and inflationary pressure).
Eventually, the demand for goods and services (aggregate demand) must fall to match real output, or output must rise to match demand. But if the Federal Reserve continues to print money faster than its real value is being inflated away, the inflationary process will continue or accelerate. Similarly, if the government continues to redistribute income from those with a lower propensity to consume (generally higher income families with a higher savings rate) to those with a higher propensity to consume (generally lower income families that save little), aggregate demand will remain excessive perpetuating inflation.
Historically, hyperinflation episodes invariably exploded in the collapse of the currency. “Hyperinflation in Zimbabwe” Turkey has come closest to a high inflation “equilibrium.” From the mid 1980s to the end of the 1990s Turkey’s inflation rate varied between 80 and a 120 percent. A high inflation “equilibrium” would be characterized by nominal interest rates and wage rates that fully incorporate the ongoing expected rate of inflation in order to preserve the appropriate real (inflation adjusted) rates. Interest rates in Turkey in this period generally exceeded 100%, as did wage growth.
In its most recent World Economic Outlook, the International Monetary Fund stated that: “In settings where inflation is rising amid still-subdued employment rates and risks of expectations de-anchoring are becoming concrete, monetary policy may need to be tightened to get ahead of price pressures, even if that delays the employment recovery.” “World Economic Outlook-October 2021”
As stands out clearly from the increasingly but unevenly rising inflation in the 1970, the process of increasing inflation is not linear (see the chart above). As inflation increased, the Federal Reserve tightened monetary policy (raised interest rates to slow monetary growth) to slow inflation, causing real output to slow or decline. Policy then eased prematurely, and inflation and the expectation of higher inflation took off again, each time reaching a higher peak (until Paul Volcker stepped on the breaks and ended the game in 1979-80–the exciting year I worked at the Federal Reserve Board).
The Federal Reserve is smarter today than it was in the 1970s and has the tools to prevent the acceleration of inflation and the unhinging of inflation expectation. But the excess money balances and personal saving are very large and the government’s seeming willingness to run up unprecedented deficits create a powerful inflationary head wind. The tightening of monetary policy that will be needed (sooner rather than later in my view) will reduce the Fed’s purchases of Treasury debt and increase interest rates. Higher interest rates will increase government spending for debt service on its very large stock of debt, which will further increase government borrowing and debt or require cuts in spending for other programs. This must be added to the economic challenges of confronting climate change, the continuing recovery and adjustments from the Covid-19 pandemic, the deepening and destructive partisan divide that is stifling Congress, and the growing lack of public trust that drives it.
Whether our current inflation is temporary or longer lasting depends on how quickly and decisively the Federal Reserve tightens monetary policy and how quickly people go back to work. Whether the U.S. economy and the government’s large stock of debt continue to enjoy safe haven status around the world depends heavily on whether our government brings its spending and tax policies under better control.
Many people who lost their jobs because of Covid are not able to pay their rent until they return to work. What should we do about it? Most landlords will work out an arrangement for deferred rent with tenants that are otherwise trustworthy. Most overdue debts are handled this way. But a case can be made, and has been made, for temporary government assist. Where you think the money should come from to bridge the income gap tells a lot about your general attitudes toward our market economy. When renters lose their incomes and stop paying their rent, they are passing on part of that loss to their landlords.
The income supplement to out of work renters can come from the general taxpayers (us) or from landlords. Investing in real estate is one of the primary ways in which lower middle-income families build wealth and move up the ladder. They should not be the ones to bear the cost of this assistance. The CARES Act and subsequent programs was meant to share this burden more fairly, but its disbursements seem to have been slow. The eviction moratorium, in addition to being illegal, is immoral.
Warren's space 