Confessions of a Supply-Side Liberal

Last week, on Monday, May 14, I was one of ten outside academics invited to present a briefing to the Board of Governors of the Federal Reserve on the topic of consumption. All of the Governors, Eric Engen, the Federal Reserve Board economist who had organized the briefing, and all ten academics were seated around the gigantic oval table where the Federal Open Market Committee (FOMC) makes monetary policy decisions. Bob Hall, a Stanford Professor who is one of my favorite macroeconomists, was the moderator.

In my ten-minute presentation, I proposed an addition to the toolkit of fiscal policy: “Federal Lines of Credit” or FLOC’s. Here is the idea. Imagine that the economy is in a recession and the President and Congress are contemplating a tax rebate. What if instead of giving each taxpayer a $200 tax rebate, each taxpayer is mailed a government-issued credit card with a $2,000 line of credit? ($4,000 for a couple.) Even though people would spend a smaller fraction of this line of credit than the 1/3 or so of the tax rebate that they might spend, the fact that the Federal Line of Credit is ten times as big as the tax rebate would have been means it will probably result in a bigger stimulus to the economy. But because taxpayers have to pay back whatever they borrow in their monthly withholding taxes, the cost to the government in the end–and therefore the ultimate addition to the national debt–should be smaller. Since the main thing holding back the size of fiscal stimulus in our current situation has been concerns about adding to the national debt, getting more stimulus per dollar added to the national debt is getting more bang for the buck.

I have a new paper that spells out the argument in greater detail. It has the same name as this post. Here it is: “Getting the Biggest Bang for the Buck in Fiscal Policy.”

In Europe right now, the corresponding National Lines of Credit would be even more helpful. In my paper “Getting the Biggest Bang for the Buck in Fiscal Policy” I write:

Austerity and traditional fiscal stimulus can only be reconciled by the difficult two-step of spending more or taxing less now while promising to spend less or tax more in the future. By contrast, it is perfectly possible to combine an immediate or relatively-quickly-phased-in austerity program with the issuance of large national lines of credit to counteract the negative aggregate demand effects of the austerity program. (Some countries may be close enough to being shut out of credit markets themselves that they might need an outside loan to be able to provide national lines of credit to their citizens.) Politically, these lines of credit could be explained as a way to cushion the blow of an austerity program on household budgets as well as providing macroeconomic stimulus.

I stayed in D.C. the rest of the week to work with my coauthors Claudia Sahm and Brendan Epstein and talk to other economists I know there. Tuesday, the day after the briefing to the Board of Governors of the Federal Reserve System, I got a call from Bill Greider, a columnist at The Nation who has taken a special interest in the Fed. (He has written a book about the Fed, Secrets of the Temple, and many articles about the Fed, including the recent article “The Fed Turns Left” about the Fed’s support for fiscal stimulus.) Bill Greider said he had heard about my Federal Lines of Credit proposal the day before and wanted to interview me. Late Wednesday afternoon I walked from the Federal Reserve Board to Bill’s office on K Street. For well over an hour, he interviewed me and kept me well entertained with his avuncular style in his unkempt office. If he writes anything based on that interview, I will make sure to post the link.

As an Economics professor, thinking about public policy is a big part of my job, both in teaching and research. The work of the ivory tower has given me some distance from the rough-and-tumble of daily political debate, but has called on me both to face the enduring dilemmas of public policy and to identify areas where technical solutions are available, but not generally understood.

As for areas where technical solutions are available but not generally understood, one of the most important is in stabilization policy. It does not seem to be generally understood that there is no shortage of powerful tools to revive both the U.S. economy and the world economy. This is true despite (A) short-term interest rates already being close to zero in the U.S. and many other countries and (B) most countries not being able to afford to add much to their national debt. I will post on this point soon.

Among the enduring dilemmas of economic policy the most important is the conflict between efficiency and equity. In calling myself a supply-sider I am saying that I believe the harm to the productive performance of the economy caused by taxes and regulations is serious (though seldom serious enough that a reduction in taxes would raise revenue). In calling myself a liberal, I am saying that in addition to an attachment to the liberty, limited government, constitutionalism, and rule of law emphasized by Classical Liberalism, I hold to a view based on both classic Utilitarianism and contested elements of modern economic theory that, generally speaking, a dollar is much more valuable to a poor person than to a rich person, and that therefore, there is a serious benefit to redistribution that must be weighed against the serious distortions caused by the usual methods of redistribution.

Economists have identified two numbers that are central in governing the size of distortions caused by taxes and the benefits of redistribution:

Tax distortions are governed in important measure by the the consumption-constant elasticity of labor supply. The consumption-constant elasticity of labor supply measures how much less workers want to work when what they earn is taxed, but the tax revenue is recycled back to them in one form or another of government benefit they can get regardless of how little they work. Matthew Shapiro and I argue in our paper “Labor Supply: Are the Income and Substitution Effects Both Large or Both Small?" that the consumption-constant elasticity of labor supply is large. Even leaving aside the decision of whether to work or not and just focusing on how many hours to work, we found a consumption-constant elasticity of labor supply equal to one and a half.
The benefits from redistribution are governed by what I will call the degree of inequality aversion. In a research project that began in 2005 but is still ongoing, Fumio Ohtake, Yoshiro Tsutsui and I put some extra questions on the University of Michigan Survey of Consumers (the survey behind the Reuters/University of Michigan Consumer Sentiment Index). We asked the people answering the survey first "It is often said that one thousand dollars is worth more to a poor family than to a rich family. Do you agree?” Over 90% of everyone agreed. Then we went on to ask them questions such as this: "Think of two families like yours, one with half the income of your family and one with the same income as your family. Which would make a bigger difference, one thousand dollars to the family with half your family’s income or four thousand dollars to the family with an income like yours?“ More than half of everyone answering the survey said that $1000 would make a bigger difference for the poorer family than $4000 for a family at their own income level. As analysis ably assisted by Daniel Reck and Fudong Zhang confirms, this implies a degree of inequality aversion above two. An inequality aversion of two would mean that if you double someone’s income the value of an extra dollar will drop to a quarter of what it was. So $4000 to the family with twice the income looks like $1000 did to the family with the lower income. The short summary is that most people believe that dollars are worth a lot more to the poor than to the rich when they are asked in a context not immediately connected to public policy. But the public policy implications of this belief are dramatic when coupled with a view that making a net positive difference in people’s lives overall (added up across people) is a legitimate goal of public policy.

Perhaps because of cognitive dissonance, it is common for people to either believe (a) that tax distortions are serious and redistribution is of questionable value OR (b) redistribution is valuable and the distortions induced by taxes are small. My belief is that (c) tax distortions are serious AND redistribution is valuable. That makes me a supply-side liberal.