February 07, 2003
Arnold Kling Tries to Calm Me Down

Unfortunately, Arnold Kling doesn't quite succeed. I believe that he is too optimistic. He writes:

If [DeLong] is correct, and GDP growth for the next 25 years is, say, 1 percent higher per year than the conventional forecast, then even with the rise in entitlement spending the ratio of total Federal spending to GDP will remain about where it is today. The deficits will go away, too...

But one percent faster real GDP growth does not leave federal spending unchanged. A lot of government services require that bureaucrats be paid salaries: their salaries rise as fast as GDP per worker rises. Still more government programs--Social Security, unemployment insurance--are keyed not to an absolute poverty standard but to people's wage levels. These programs' costs will rise as fast as real GDP rises (minus an adjustment for Social Security equal to the number of years since retirement for the recipient of the weighted-average Social Security dollar times the average wedge beween wage growth and CPI growth). My rule of thumb--from my days at the Treasury--is that a 1% increase in real GDP reduces the federal program spending share of GDP in the long run not by 0.02% of GDP but by only 0.008% of GDP.

If it were 0.02%, then Arnold would be completely right. Over fifty years faster growth by 1% per year for fifty years would reduce the 2050 program-spending share of GDP by 5% points, and reduced interest owed on the reduced debt from smaller earlier deficits would more than wipe out the projected proposed-budget-policy 2050 deficit. We wouldn't have a federal budget problem--at least not in this half century.

But with 0.008% of GDP, I think that growth 1% per year faster than the OMB baseline--even for fifty years--doesn't save us. At least, my sensitivity analysis run got us to a 2050 proposed-budget-policy federal deficit of 7.2% of GDP (instead of the OMB baseline estimate of 17.5%). We would have a big federal budget problem--one we didn't have last year, one created by this current round of proposed tax cuts.

Now Arnold is partly right: the difference between a deficit of 17.5% of GDP and one of 7.2% of GDP in 2050 is pretty large potatoes.* So if you believe (as I do) that the OMB baseline lowballs likely GDP growth over the next half century, then you should be much more optimistic than is Chapter 3, "Stewardship" of the 2004 Budget Analytical Perspectives. Instead of panic, terror, and dismay, only alarm and anxiety are called for.

But then you think that the proposed-policy-budget numbers don't contain any allowance for the costs of war with Iraq, of any future wars, and of reforming the Alternative Minimum Tax. You wonder what other misestimates are contained in the budget materials that we haven't caught yet. (I still haven't seen a good number on the revenue losses from expanded tax-preferred savings program. Nor have I dynamically scored the effect of the shift in the deficit path on economic growth. There's only one of me.) And I find myself back in a state of panic, anxiety, and dismay again.


*Moreover, in the fast-growth optimistic scenario that I think more likely, we could pay Social Security beneficiaries all the benefits they would receive in the conventional-baseline scenario and more and still not have a deficit in this half century...

Posted by DeLong at February 07, 2003 11:15 AM | Trackback

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Let's play. Given the Administration tax cuts, we can use an S&P index fund for a taxable account and avoid dividend taxes and even cut our capital gains tax liability by applying "deemed" dividends to any eventual sale. We can buy 30,000 dollars of corporate bonds a years in addition and set them away in a tax free IRA. We also have our 401K tax free accounts. So, we are headed for a tax free investment program and since we have enough income will take full advantage of it. We can look forward to our tax bracket declining and having no estate tax to fret about. [We like fresh air enough to probably resist taking a 50% tax deduction on a Lincoln Navigtor.] Hmmmm....

The alternative minimum tax will have to be fixed for all. Hmmmm....

Where is the magic walk on the supply side that will pay for this? Where?

Posted by: anne on February 7, 2003 11:54 AM

bureaucrats be paid salaries: their salaries rise as fast as GDP per worker rises.

Meaning there is no possibility of better productivity?

Still more government programs--Social Security, unemployment insurance--are keyed not to an absolute poverty standard but to people's wage levels. These programs' costs will rise as fast as real GDP rises (minus an adjustment for Social Security equal to the number of years since retirement for the recipient of the weighted-average Social Security dollar times the average wedge beween wage growth and CPI growth).

So "automatic stabilizers" are a myth? They only work one way -- toward higher govt spending?

Posted by: George Zachar on February 7, 2003 11:58 AM

Where indeed. I get it!

February 4, 2003

Aid to Poor Faces More Scrutiny
By ROBERT PEAR - NYT

President Bush's budget proposes new eligibility requirements that would make it more difficult for low-income families to obtain a range of government benefits, from tax credits to school lunches....

Brad - How many school lunches do we need to deny to pay for the tax free dividends from GE due Jack Welch? Do the math. Sorry Jack.

Posted by: anne on February 7, 2003 12:05 PM

Speaking of tax plans, apparently the Administration is now laying the blame for the apparently dead in the water savings account plan on Paul O'Neill

http://www.washingtonpost.com/wp-dyn/articles/A42236-2003Feb7.html

Reading this article gave me more insight into the mindset of the Bush administrations economic honchos.

1) If Paul O'Neill wrote the savings plan, and you guys did not agree with it, and you fired Paul O'Neill, why go with it as a centerpiece of the budget?

2) If you include an entire chapter in the ERP talking about Glenn Hubbard's vision for a country with a consumption based tax system instead of a income tax system, then would anybody believe that a proposal to reduce savings taxes could really be attributed to Paul O'Neill and not Glenn Hubbard?

3) If it really was Glenn Hubbard's plan, why did the president not talk about it at the SOTU, and why did no one, including the congressional delegation of your own party have any clue about what this plan was? Did you really think that such a significant proposal need not be exposed to the light of day for its merits to be debated before deciding to throw it into the budget??

They never cease to amuse

Posted by: achilles on February 7, 2003 08:33 PM

Sorry, the Paul O'Neill part appears in this story

http://www.washingtonpost.com/wp-dyn/articles/A38036-2003Feb6.html

the article in the earlier post describes the ERP.

Posted by: achilles on February 7, 2003 08:36 PM

>>Meaning there is no possibility of better productivity?<<

Little concerning bureaucrats, I am afraid.

>>So "automatic stabilizers" are a myth? They only work one way -- toward higher govt spending?<<

Close your eyes, George, and picture an upward sloping line (we're in a log-linear axes base) with swings around this trend. In other words, entitlements follow up on growth (otherwise retirees, say, would keep sliding down the income distribution) and inflation (otherwise, the real value of these entitlements would evaporate over time).

But, of course, in times of recession unemployment benefits payment will increase, while tax collection will decrease (without having to cut tax rates since taxable income dips). This is the "automatic stabilizer" part of the budget.

In the case of Professor DeLong's worries, and the corresponding projections, this discussing has little to do with making a judgement about whether social programs and other federal budget items should, or should not, be allowed to increase over time. The political economy of Social Security, given that the block of the baby boom's voters is about to retire (and to need healthcare), makes it highly unlikely that we'll be able to reform these programs. Reform is at this point politically suicidal.

Posted by: Jean-Philippe Stijns on February 7, 2003 10:18 PM

this discussing has little... => the discussion has little... sorry

Posted by: Jean-Philippe Stijns on February 7, 2003 10:23 PM

Brad

If ever your hopeful projections for productivity growth had better be right, they had better be right if even half the Administration tax cuts are enacted. Hopefully we can anticipate GDP growth at 4% or more going forward, though the consensus among analysts is 3%. Funny, the optimists on the economy really do not buy the productivity growth increase when forecasting possible GDP growth.

Posted by: anne on February 9, 2003 09:04 AM

Meaning there is no possibility of better productivity?

Little concerning bureaucrats, I am afraid.

Think consumer banking, where lots of employees use rules and accounting to make decisions and track information. There's no reason govt workers handling food stamps can't enjoy the productivity gain of Citibank employees handling cash, for example.

entitlements follow up on growth

If you assume that entitlements are an essentially constant %/GDP, your statement makes sense. Viewing today's welfare state as a maximum instead of a constant or minimum alters one's conclusions.

Posted by: George Zachar on February 9, 2003 02:12 PM

Um, but George, a retirement program that pays each generation the same fraction (30%, whatever) of their pre-retirement income is a "constant," for all intents and purposes.

Posted by: Jason McCullough on February 9, 2003 08:00 PM
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