# Ryo Ishida: Japan’s Hometown Tax Payment System as an Analog for a Public Contribution System

One of the ideas I consider the most important is the idea of a public contribution system that expands the nonprofit sector instead of expanding the government beyond the current substantial levels of government in rich countries. (See my bibliographic post “How and Why to Expand the Nonprofit Sector as a Partial Alternative to Government: A Reader’s Guide.”) My former student and University of Michigan PhD Ryo Ishida pursued this idea in his dissertation, and I am pleased to have a guest post from Ryo today on an aspect of the Japanese tax system that provides relevant empirical evidence for the design of a public contribution system–perhaps in part by illustrating what not to do.

Japan’s Hometown Tax Payment System is not about a large tax incentive for donations to private sector activities that can provide a partial substitute for government activities, but a large national tax incentive for donations to local governments. It enhances voluntary contribution to local governments.

Note that this post is his personal opinion and does not necessarily reflect the opinions of the organizations to which he belongs.

Hometown Tax Payment System in Japan — Individuals and Corporations

1. The Introduction of Hometown Tax Payment System for individuals.

The Hometown Tax Payment System (HTP System hereafter), or Furusato-Nozei System in Japan is a system introduced in 2008 that aims to encourage individuals to donate to local governments, i.e. municipalities and prefectures [1]. Before the implementation of HTP system, individuals who had donated could only enjoy taxable deductions. However, under the HTP system, individuals who donated more than 2,000 yen (approx. USD 20) can have their national and local income tax reduced drastically. The amount of tax credit a taxpayer can enjoy is the amount of donation minus 2,000 yen and is capped based on the individual’s income [2]. Roughly speaking, the upper bound of tax credit one can enjoy is approximately proportional to one’s taxable income. A detailed calculation is explained in [2]. If one’s donation is lower than the calculated upper bound, you may see that the taxpayer can enjoy almost a 100% tax credit. In such a case, one might see that this system is equivalent to a tax-transfer system, where one can shift a portion of her tax liability to local governments the taxpayer chooses. Roughly speaking, under the HTP System, a taxpayer can pay a portion of her tax liability to her hometown instead of paying it to the local government where she resides. Note that, although the HTP system is named “furusato (hometown)”, individuals are allowed to donate not only to their actual hometowns but also to any municipalities and prefectures. As a result, donations to devastated areassurged in 2011 after the Tohoku Earthquake.

This HTP system has attracted attention. The Economist [3] described the response as “overwhelming.” Although the amount of donations started at 8 billion yen (approx. USD 800 million) in 2008, it grew to 14 billion yen (approx. USD 1,400 million) in 2013, 39 billion yen (approx. USD 3,900 million) in 2014, and 165 billion yen (approx. USD 1.65 billion) in 2015 [4].

Brockmann et al. (2016) [5] stated that the HTP System is an immaterial tax rewards system that mitigates the nuisance of paying taxes. An immaterial tax rewards system includes a system that allows taxpayers to allocate a portion of their tax liability to a designated purpose, such as the Spanish system that allows taxpayers to allocate 0.7% of their tax liability to churches, charitable organizations or state organizations [5] or Hungarian Percentage Philanthropy that allows them to allocate 1% or 2% of their tax liability for a charitable purpose [6]. Although restricted to contributions to local governments, the HTP System might seem to be similar to Spanish or Hungarian system. However, there is a key difference between them, which makes the HTP System unique to Japan.

2. Rewards for Contributors. Although the Hungarian system was referred to when introducing the HTP System [7], a prominent feature in the HTP System is that many local governments reward the contributors by sending gifts, such as regional goodies. In a newspaper article posted on Jan 31, 2016 [8], it was noted that growing number of local governments reward contributors, with survey evidence showing that 84% of local governments rewarded contributors by sending gifts in autumn 2015 where 52% of them had done so in autumn 2013. Another newspaper article on Jun 18, 2016 [9] reported that, in 2015, the total value of these gifts was 63 billion yen (approx. USD 6,300 million) and postage costs were 4 billion yen (approx. USD 400 million) while total donations were 165 billion yen (approx. USD 1.65 billion). Therefore, it deduced that approximately 40% of donations were used for gift-related expenses. Hashimoto and Suzuki (2015) [10] explained that contributors may obtain financial gain under HTP System, by providing an example that a taxpayer may get 48 thousand yen as gain if she donated 100 thousand yen, enjoyed a 98 thousand yen tax credit, and obtained a gift whose value was 50 thousand yen. Then, a natural question could be whether such gifts attract individual contributions empirically. Nishimura et al. (2016) [11] reported that gift is certainly a positive determinant for individual contribution though there are several other positive determinants, such as availability of credit card transaction or local government’s explicit explanation about how to use contributions.

There are pros and cons for such rewards. For example, the Ministry of Internal Affairs and Communications surveyed local governments’ opinions about the HTP System [12]. In this report, although 668 local governments perceive that HTP System enables local governments to advertise themselves, 286 local governments have concern about competition in gift rewards. One media editorial on May 16, 2016 [13] claims that the HTP System fosters new industries in local area, while another media editorial on Jan 31, 2016 [14] argues that too much competition in gift rewards deviates from original purpose of HTP System. Taking into account this situation, the Ministry of Internal Affairs and Communications asked local governments in 2015 to refrain from sending expensive gifts and cashable gifts [15], and some local governments abolished rewards or reduced the value of gifts [9].

Gifts are not the only spur for contributions. A spate of revisions to the system sought to encourage individual donations.

3. The Hometown Tax Payment System, Past and Present. When the HTP System was introduced in 2008, the maximum tax credit one could enjoy was one’s total donation minus 5,000 yen. This system was revised in 2011 so that the maximum tax credit became the total donation minus 2,000 yen. Although the increase in donations in 2011 can mainly be attributed to the Tohoku Earthquake in Mar 11, 2011 [10], this systemic revision should theoretically have increased individual contributions.

In 2015, the HTP System was revised again. First, the upper bound of the tax credit, which is positively related to one’s income, was approximately doubled. Second, certain people became exempted from tax reporting even if they donated under HTP System. The first of these reforms increased the financial incentive for contributions, while the second encouraged contributions by simplifying procedures.

4. The Hometown Tax Payment System for Corporations. In 2016, the HTP System was expanded to corporations. Even under the previous system, donating corporations enjoyed a tax deduction and thus could reduce their tax payment by about 30% of the value of their donations. Under the HTP System for corporations, donating corporations enjoyed an additional 30% tax credit. Therefore, under the HTP System for corporations, donating corporations could reduce their tax liability about 60% of the value of their donations. A Corporation could contribute to local governments except for designated rich local governments and local governments where it had its headquarters. Before receiving this donation, local governments must clearly specify how they would use such donations and receive the national government’s approval. The HTP System for corporations is different from that for individuals since gifts or financial rewards from local governments receiving donations to the donor corporations are prohibited [16][17]. I am eagerly awaiting the evidence on how this change will affect corporate donations.

5. Conclusion. Although the HTP System has attracted attention, comprehensive treatments in English, especially for economists, are rare. An exception is an article in Japan Times [18], but it did not mention the HTP System for corporations nor did it mention the surge of donations in 2015, because the article was published on Oct 20, 2014. Annual statistics for the HTP System are currently available on the Ministry of Internal Affairs and Communications website [4]. I hope many economists take an interest in this Japanese experiment in tax policy.

Notice: This article is only for research purposes. The views expressed herein are those of the author and do not necessarily reflect the opinions of the organizations to which the author belongs. Any remaining errors are solely the responsibility of the author. Contact information: rrishida137035@gmail.com.

References

[1] Webpage of Ministry of Internal Affairs and Communications in Japan, http://www.soumu.go.jp/main_sosiki/jichi_zeisei/czaisei/czaisei_seido/furusato/about/ , in Japanese, retrieved on August 14, 2016

[2] Webpage of Ministry of Internal Affairs and Communications in Japan, http://www.soumu.go.jp/main_sosiki/jichi_zeisei/czaisei/czaisei_seido/furusato/mechanism/about.html , in Japanese, retrieved on August 14, 2016

[3] The Economist (April 18, 2015) “Japan’s rural regions Hometown dues”

[4] Webpage of Ministry of Internal Affairs and Communications in Japan, http://www.soumu.go.jp/main_sosiki/jichi_zeisei/czaisei/czaisei_seido/furusato/archive/ , in Japanese, retrieved on August 14, 2016

[5] Brockmann, Hilke, Philipp Genschel, and Laura Seelkopf (2016) “Happy taxation: increasing tax compliance through positive rewards?” Journal of Public Policy 36 (3), pp. 381-406

[6] Török, Marianna (2004). “Percentage philanthropy: an overview” In Percentage Philanthropy, edited by Marianna Török and Deborah Moss. Hungary. NIOK Foundation.

[7] The Tax Commission (2009), Webpage of Cabinet Office, http://www.cao.go.jp/zei-cho/history/2009-2012/gijiroku/zeicho/2009/__icsFiles/afieldfile/2010/11/22/21zen8kai16.pdf , in Japanese, retrieved on August 17, 2016

[8] Mainichi Shimbun newspaper (2016), http://mainichi.jp/articles/20160131/k00/00e/040/114000c , in Japanese, retrieved on August 17, 2016

[9] Nikkei Shimbun newspaper (2016), http://www.nikkei.com/article/DGXLASFS17H6H_Y6A610C1NN1000/ , in Japanese, retrieved on August 17, 2016

[10] Hashimoto, Kyoji, and Yoshimitsu Suzuki (2015) “Verification of Hometown Tax Payment System,” 72nd Annual Conference of the Japan Institute of Public Finance, in Japanese

[11] Nishimura, Yoshitomo, Tomoko Ishimura, and Nobuo Akai (2016) “Analysis about Incentive of Hometown Tax Payment System,” 24th Annual Conference of the Japan Association of Local Public Finance, in Japanese

[12] Webpage of Ministry of Internal Affairs and Communications in Japan, http://www.soumu.go.jp/main_sosiki/jichi_zeisei/czaisei/czaisei_seido/furusato/file/report20151023.pdf , in Japanese, retrieved on August 17, 2016

[13] Nikkei BP (2016), http://www.nikkeibp.co.jp/atcl/tk/PPP/030700027/042800003/?P=1 , in Japanese, retrieved on August 19, 2016

[14] Mainichi Shimbun newspaper (2016), http://mainichi.jp/articles/20160131/k00/00e/040/114000c , in Japanese, retrieved on August 19, 2016

[15] Webpage of Ministry of Internal Affairs and Communications in Japan, http://www.soumu.go.jp/main_content/000351771.pdf , in Japanese, retrieved on August 17, 2016

[16] Website of JTB, https://furu-po.com/business , in Japanese, retrieved on August 17, 2016

[17] Website of Cabinet Secretariat, http://www.kantei.go.jp/jp/singi/sousei/meeting/tihousousei_setumeikai/h28-01-14-siryou4-1.pdf , in Japanese, retrieved on August 17, 2016

[18] Japan Times (2014), “Hometown ‘tax’ donations system catching on,” http://www.japantimes.co.jp/news/2014/10/20/reference/hometown-tax-donations-system-catching/#.V7R_C5iLTIU , retrieved on August 17

# Narayana Kocherlakota Advocates Negative Rates and Criticizes the Conduct of US Fiscal Policy

On March 25, 2015, Narayana Kocherlakota sat in my office at the University of Michigan; we talked especially about negative interest rate policy. (See my preface to “Yichuan Wang on Narayana Kocherlakota and coauthors’ “Market-Based Probabilities: A Tool for Policymakers.”) He has since emerged as a major presence on Twitter; you can get a sense of this from my storified Twitter discussion with him: “Narayana Kocherlakota and Miles Kimball Debate the Size of the US Output Gap in January, 2016.” But don’t miss the chance to go to Narayana’s Twitter homepage as well.

Yesterday, February 9, 2016, Narayana posted: “Negative Rates: A Gigantic Fiscal Policy Failure,” arguing quite explicitly for negative interest rates. Narayana writes about moving to negative interest rates. In his words:

1. It would facilitate a more rapid return of inflation to target.
2. It would help reduce labor market slack more rapidly.
3. It would slow and hopefully reverse the ongoing and dangerous slide in inflation expectations.

So, going negative is daring but appropriate monetary policy.

Narayana then goes on to criticize low levels of government investment given very low interest rates. This is an issue I have written about more than once, in a way generally sympathetic to Narayana’s point:

I don’t come down in exactly the same place as Narayana, though. As I noted to John Conlin, who pointed me to Narayana’s post, I tend to think that monetary policy should be used to stabilize the economy, not fiscal policy. Once monetary policy does its job, if the medium-run natural rate of interest is still low, then we should undertake more government investment. (See “The Medium-Run Natural Interest Rate and the Short-Run Natural Interest Rate.”) And we should undertake crucial government investments even if interest rates are high after the economy recovers. But it is just too hard to time government investment effectively in order to stabilize the economy.

Monetary policy has a lag of 6 to 12 months in its effects. Even so, it is much nimbler than government investment. Private investment and imports and exports can’t turn on a dime; hence the 6 to 12 month delay in the effect of monetary policy. But government investment typical takes even longer than that to turn around.

Using monetary policy as it should be used, aggregate demand is no longer scarce. Monetary policy can provide all the firepower needed. But fiscal policy can still play a role. Fiscal policy is most helpful in economic stabilization under two circumstances:

1. When (as is not the case for government investment) it can move faster and act faster in its effects than monetary policy, or

2. When monetary policy is somehow constrained.

Other than automatic stabilizers, which are extremely helpful, but not enough by themselves, the one type of fiscal policy that acts fast is fiscal policy that affects household consumption which can realistically change within a matter of days. Some might think of tax rebates in this regard, but I have argued at some length that tax rebates are a strictly dominated policy in “Getting the Biggest Bang for the Buck in Fiscal Policy.” In brief, I argue that the ratio of stimulus to ultimate addition to the national debt is much more favorable for lines of credit from the government than tax rebates. For example, it is not unreasonable to think that, since much of it would be repaid, a $2000 line of credit from the government would ultimately cost the government about as much as a$200 tax rebate. But a $2000 line of credit is likely to provide a much stronger impetus to consumption than a$200 tax rebate.

As for constraints on monetary policy, the zero lower bound is crumbling all around us. After that the most important constraint on monetary policy is the fact that so many European countries share their monetary policy in the euro zone. For these countries, fiscal policy–or if you want to call it that, credit policy of the sort I talk about in “Getting the Biggest Bang for the Buck in Fiscal Policy”–can be very helpful in adjusting the overall level of macroeconomic stimulus to different needs from one country to another in the euro zone. There may also be a place for government investment as a countercyclical tool in the euro zone. But given vigorous monetary policy, it might well be that government investment, even in the euro zone, might best be directed at medium to long-run considerations rather than short-run considerations. My posts bulleted above address some aspects of those medium- to long-run considerations.

Note: Also, don’t miss my contribution to long-run fiscal policy as laid out in “How and Why to Expand the Nonprofit Sector as a Partial Alternative to Government: A Reader’s Guide.”

# John Stuart Mill on Why a Free People, to Stay a Free People, Should Do Many Things Outside of Government

The other side of it is I think we should expand the charitable deduction, so if you make $10 billion and you want to give 90 percent of it away, you can give it away with your name on it so it enhances your prestige, but give it away and you should be able to deduct it. Q: So we would more aggressively redistribute income from the top? A: From selfish people at the top who don't want to give it away. You could turn into Bill Gates or an Andrew Carnegie. I think that's OK. Instead of just taxing people—saying, "We're just taking the money, and you'll go to jail if you don't turn it over"—we can find a better way. I have reserved for the last place a large class of questions respecting the limits of government interference, which, though closely connected with the subject of this Essay, do not, in strictness, belong to it. These are cases in which the reasons against interference do not turn upon the principle of liberty: the question is not about restraining the actions of individuals, but about helping them: it is asked whether the government should do, or cause to be done, something for their benefit, instead of leaving it to be done by themselves, individually, or in voluntary combination. The objections to government interference, when it is not such as to involve infringement of liberty, may be of three kinds. The first is, when the thing to be done is likely to be better done by individuals than by the government. Speaking generally, there is no one so fit to conduct any business, or to determine how or by whom it shall be conducted, as those who are personally interested in it. This principle condemns the interferences, once so common, of the legislature, or the officers of government, with the ordinary processes of industry. But this part of the subject has been sufficiently enlarged upon by political economists, and is not particularly related to the principles of this Essay. The second objection is more nearly allied to our subject. In many cases, though individuals may not do the particular thing so well, on the average, as the officers of government, it is nevertheless desirable that it should be done by them, rather than by the government, as a means to their own mental education—a mode of strengthening their active faculties, exercising their judgment, and giving them a familiar knowledge of the subjects with which they are thus left to deal. This is a principal, though not the sole, recommendation of jury trial (in cases not political); of free and popular local and municipal institutions; of the conduct of industrial and philanthropic enterprises by voluntary associations. These are not questions of liberty, and are connected with that subject only by remote tendencies; but they are questions of development. It belongs to a different occasion from the present to dwell on these things as parts of national education; as being, in truth, the peculiar training of a citizen, the practical part of the political education of a free people, taking them out of the narrow circle of personal and family selfishness, and accustoming them to the comprehension of joint interests, the management of joint concerns—habituating them to act from public or semi-public motives, and guide their conduct by aims which unite instead of isolating them from one another. Without these habits and powers, a free constitution can neither be worked nor preserved; as is exemplified by the too-often transitory nature of political freedom in countries where it does not rest upon a sufficient basis of local liberties. The management of purely local business by the localities, and of the great enterprises of industry by the union of those who voluntarily supply the pecuniary means, is further recommended by all the advantages which have been set forth in this Essay as belonging to individuality of development, and diversity of modes of action. Government operations tend to be everywhere alike. With individuals and voluntary associations, on the contrary, there are varied experiments, and endless diversity of experience. What the State can usefully do, is to make itself a central depository, and active circulator and diffuser, of the experience resulting from many trials. Its business is to enable each experimentalist to benefit by the experiments of others; instead of tolerating no experiments but its own. Update: This post engendered a lively Facebook discussion, which you can see here # Discounting Government Projects Image source: February 4, 2014 speech on “The outlook for the New Zealand economy,” by Graeme Wheeler, Governor of the Reserve Bank of New Zealan During my three weeks in New Zealand as a Visiting Research Fellow of the New Zealand Treasury helping New Zealand get closer to developing national well-being indices (see 1,2,3), I learned of the New Zealand Treasury’s current custom of using an 8% per year real discount rate for evaluating government projects (including “social projects”). That custom makes no sense to me; I wrote a series of emails to New Zealand Treasury officials explaining why. They took me up on my offer to give a presentation on this issue. You can see the Powerpoint file I used here, though I didn’t have time to cover the abridged version of the presentation I had given a year ago at the US Congressional Budget Office on capital budgeting that I appended after the discussion about discounting. Below, I have copied out the text of the emails I wrote, after subtracting some identifying information at the beginning of the first email. As usual when I talk to officials of government agencies, I am telling you what I told them and what I recommended, but–to maintain a certain degree of confidentiality–remarking only in the most general terms about their reactions. The distinct emails are marked by Roman numerals. To understand these emails, you need to know that New Zealand has a sovereign wealth fund called the Superfund. Also, it is good to have a sense of the yield on New Zealand government bond: I have a graph showing the nominal yield above, and a graph comparing the nominal to the real yield below. I. There is an extremely strong argument against using an 8% real discount rate in evaluating government projects. I think the argument below can be sharpened to become institutionally relevant. Basically, an 8% real discount rate makes no sense to use unless the New Zealand government is actually getting an 8% real return on funds that it saves. It is not enough for someone to claim that the New Zealand government theoretically could get an 8% real return on funds it saves when that is not true or is only theoretical because the New Zealand government would never actually do that with funds saved by not doing a project. The argument here also dovetails nicely with a presentation I gave at the Congressional Budget Office a little over a year ago on capital budgeting, that I would be happy to give here next week some time in addition to my other talk if there is interest. (I attached the Powerpoint file.) Here is the argument against the 8% real discount rate used for assessing government projects in more detail: (1) On the face of it, such a high discount rate is hard to square with the much lower government borrowing rate, which in simple cases clearly implies a benefit from borrowing to fund the project if the project has a net present value that is positive given that government borrowing rate. What is going on? (2) Historically (perhaps back in the 1970s) the 8% per year real discount rate was motivated by the expected return on the stock market, and the idea that government projects are risky investments. But it is important to look beyond this superficially plausible set of words to the underlying logic, which doesn’t hold up. (3) The underlying logic of the 8% per year real discount has to be that the opportunity cost of a project is that the money could be put into the stock market (say a diversified international fund) if it weren’t used for the project. This logic requires (a) that if funds weren’t used for the project that it is in fact realistic the funds would be added to the Superfund and (b) that the extra funds in the superfund would be earning an 8% per year real return. (4) To the extent that there is a great reluctance on the part of the government to invest extra funds in the Superfund, that tends to indicate some combination of either (a) for various political or institutional reasons it is not realistic that the extra funds will be added to the Superfund or (b) the risk-adjusted return that is expected if the extra funds were added to the Superfund is much less than 8% per year in real terms. In either case, an 8% per year real return is not a relevant rate at which to discount government projects. This is easy to show in two models: (a) where the flows of funds into the Superfund (the government’s sovereign wealth fund) are fixed in a way that is exogenous to projects undertaken among the projects now being discounted at 8%; (b) where the government is rationally indifferent on the margin between investing more in the Superfund and paying off some of the debt, which then makes the interest rate on the debt the relevant one because it is in this model equivalent to a risk-adjusted return on money in the Superfund. (5) Some might argue that the riskiness of government projects hasn’t been adequately included in the discussion above. That is true, but the risk in government projects is quite different from regular stock market risk, so the risk adjustment must be done in another way. A good method of risk adjustment for projects is to think seriously of the real dollar value they will have dependent on the level of real consumption in the economy. One virtue of thinking about the adjustment this way is also that it provides a reminder that the dollar value of the flow of benefits from many projects will tend to increase in the future simply because trend increases in per capita income will raise the willingness to pay for those benefits. II. Just to be clear, my view is that (a) all projects that are better than putting the money in the Superfund should be done, and (b) if someone claims that a project is worse than putting money in the Superfund, then money should be put in the Superfund instead, and © if a project looks better than paying off some of the debt by buying bonds–or, almost equivalently, good enough that borrowing at the bond rate to do it looks like a positive present value–it should also be undertaken UNLESS the government is willing to issue additional bonds to put more money in the Superfund invested in risky assets. Like Roger Farmer, I have argued that many, many governments should in fact be expanding their sovereign wealth funds (like the Superfund) by borrowing at the quite low interest rates that are possible for financially sound governments these days. Borrowing at favorable rates to better fund the Superfund (which I am assuming would invest the extra funds in a diversified international portfolio of risky assets) is indeed quite a good “project” in its own right and so should set a substantial hurdle for other projects to meet but (1) certainly not as high as an 8% real return, assessed almost as if that were a safe return and (2) if borrowing or using other available funds to better fund the Superfund is ruled out of court for any reason, that “project” of better funding the Superfund (and thereby implicitly investing in a diversified international portfolio of risky assets) cannot rationally be used as a comparison to set a high hurdle rate for other projects. To argue that borrowing to better fund the Superfund should in fact be taken seriously, let me point out several other advantages to it, beyond the fact that it is a relatively high return “project”: (i) If the accounting separates the Superfund from the rest of the government debt, then better funding the superfund makes it possible to point to the amount of bonds the government has issued to remind people of the liability the government has taken on to pay pensions in the future out of the Superfund (and whatever else the Superfund is committed to in the future). This reminder of the liability the government has taken on can be quite helpful. (ii) Because it makes sense for a small open economy such as New Zealand’s to be investing in an internationally diversified portfolio of risky assets, better funding the Superfund will generate capital outflows that are likely to cause some depreciation in the New Zealand dollar. Some opinions suggest the New Zealand dollar is to strong to begin with, so that might be a good thing. (iii) The issuance of additional government bonds could raise safe interest rates. As long as this is taken into account in calculating the returns to the “project” of borrowing to invest in an internationally diversified portfolio of risky asset, that “project” is still a good idea in terms of the overall government budget. For the private economy, it will lead to a safe interest rate that better reflects the the costs and benefits of various actions that New Zealand actually faces vis a vis the rest of the world. One interesting side effect of a higher safe interest rate is that land prices are likely to fall somewhat. (iv) The choice between investing only in broadly based ETF’s and doing more actively managed diversified international investments is a hard one. However, on one end, even simply by its choice of ETF’s New Zealand could have a good effect on corporate governance around the world. On the other end, if the dangers of rent-seeking and corruption can be avoided, there may be a way to, say, use more actively managed international diversified investments as a way for New Zealanders to learn more about technologies in the companies they invest in, for example. Note in all of this that other projects that are actually better than investing internationally are being undertaken, after a full assessment of all the costs and benefits of those projects, including how those costs and benefits are correlated with high levels of per capita consumption or low levels of per capita consumption. III. Note that all these arguments boil down to saying that one can argue quite sincerely that if someone claims that despite meeting the present value test according to the government borrowing rate that a project is less good than investing internationally in risky assets, it implies that one should be investing internationally in risky assets, NOT necessarily that the project should not be undertaken (though one would have to reassess after investing internationally in risky assets as appropriate). If investing internationally in risky assets is ruled out, then the simpler present value test relative to the borrowing rate is the right one. IV. Thoughts on how to frame a rule for the evaluation of projects in relation to their intertemporal dimension–and in relation to their interpossibility dimension given that outcomes are uncertain: A. It is appropriate to use the government borrowing rate to evaluate the intertemporal dimension of projects … B. PROVIDED that the ever-present option of adding more funds to the Superfund is enrolled in the list of possible projects to be evaluated. Actually, this option of adding more funds to the Superfund is a number of different projects, since adding the first$1 billion dollars is a different proposition from adding the 101st additional $1 billion; if adding the first$1 billion is actually undertaken, then adding the 2d $1 billion must be added to the list of projects to be evaluated and compared with other projects. C. The simplest application of the (real) government borrowing rate as a discount rate is when the (real) dollar value of of benefits and costs is certain. But this is uncommon. How should one deal with uncertainty? Here is my suggestion: 1. The strong assumptions needed to use a market risky rate to adjust for risk definitely do not hold. This is for many reasons, but the simplest is to say that the kinds and details of risks entailed by government projects tend to be different from the kinds and details of risks entailed by private projects. Hence, market risky rates should not be referred to at this stage. Provision B expresses well the primary and big way in which market risky rates are relevant. 2. Any adjustment for the risk in the cost and benefits of a government project in real dollars needs to be serious about asking “How will the costs and benefits change depending on how high the level of per capita consumption is?” Sometimes the answer to this question may depend on why per capita consumption is high or low in a future situation, but often a reasonable answer can be given simply by considering the likely benefits and costs in more or less prosperous possible futures. A simple example of variation in the real dollar value of a project is that the willingness to pay for most non-market goods goes up when people have more money from which to pay. 3. It is also essential for good project evaluation that the overall upward trend in per capita GDP be realistically taken into account. For example, since on average the future is likely to be more prosperous than the present, we can anticipate that on average, the willingness to pay in real dollars for then current non-market goods is likely to be higher in the future than in the present. 4. Projects that provide benefits that are just as high in real dollar terms in bad financial situations where dollars are more precious as in good situations where dollars are less precious (which can be discounted quite simply at the government borrowing rate) are more valuable than otherwise similar projects that provide benefits that are high in real dollar terms primarily when dollars are also less precious and provide benefits that are lower when dollars are very precious. This should be assessed. 5. In assessing the extent to which the typical project which evinces benefits with higher willingnesses to pay in good financial situations than bad should be marked down in attractiveness relative to a simple discounting of its expected real dollar benefits by the government borrowing rate, there is a serious discussion to be had about what level of risk aversion should be applied. As someone who has devoted a significant part of my career to studying and thinking about risk aversion, I want to insist that much is unknown here and that a simplistic application of the level of risk aversion that seems to be implicit in some particular financial market (without regard to all of the conflicting evidence about risk aversion in other markets and other decisions) is inappropriate. I think it is best for the government to make its own, separate determination of an appropriate level of risk aversion to apply based on a vigorous internal debate about this very issue, which should involve philosophical considerations and a wide range of survey data on people’s preferences as a counterpoint to market data. I would be delighted to be involved in such a debate. (I have a presentation or two in my back pocket on this, but consider presenting them less urgent than the one on capital budgeting that is a strong complement to the series government discount-rate memos I have been sending by email.) Based on what I know, I would apply a risk aversion curvature in per capita consumption of not more than 2. # Quartz #63—>VAT: Help the Poor and Strengthen the Economy by Changing the Way the US Collects Tax Here is the full text of my 63d Quartz column, “VAT: Help the poor and strengthen the economy by changing the way the US collects tax,” now brought home to supplysideliberal.com. It was first published on June 8, 2015. Links to all my other columns can be found here. If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice: © June 8, 2015: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2020. All rights reserved. Despite a hard first quarter, someday soon the US economy may be in a position where it needs people to save more instead of spend more. Economists will start talking about the importance of having people save to provide funds for investment instead of the importance of having people spend to generate enough demand that investment is worthwhile. A few weeks ago, I pointed out in “How Increasing Retirement Saving Could Give America More Balanced Trade” how increasing the saving rate can also raise net exports, in a way that has a long-lasting positive effect on jobs. And I pointed out how a regulation making saving something automatic people have to opt out of, instead of something they have to opt into, could dramatically raise the saving rate. A change in our tax system could also raise the national saving rate: shifting from taxing income to taxing only the part of income that is consumed, while exempting the part of income that is saved. The clean, well-tested way to tax consumption rather than income is to use a value added tax or VAT. A VAT tax is like a sales tax on final sales to households that is collected gradually all along the way as goods and services are produced. It is structured so that the buyers in business-to-business transactions are motivated to check that the sellers are paying the tax—which makes it much harder to cheat on than other taxes. Most rich, well-run countries other than the US use a value added tax. And though it is much harder to compare saving rates accurately across countries than one might think, most of those other countries seem to have higher saving rates than the US. In saying all of this about a VAT tax, I am only repeating the conventional wisdom, which I think in this regard is by and large on target. But there is another aspect of the conventional wisdom about a VAT tax that I think is totally off target: the idea that a VAT tax hits the poor especially hard. Part of this misconception comes from the simple fact that measuring how progressive or regressive a tax is by the fraction of income paid in taxes at different levels of income is already sneaking in the idea that income is the right basis for taxation—exactly the question that is at issue. Measuring how progressive or regressive a tax is by the fraction of consumption paid in taxes at different levels of consumption would give a different picture. The other part of this misconception is that typical measures of progressivity or regressivity ignore the other side of the ledger: the government assistance that people are given at different levels of income or consumption. Ignoring that side of the ledger slips in an assumption about how government assistance would be affected by a VAT tax that seems wrong to me. (Here I am counting Social Security and Medicare as government assistance since people don’t have individual Social Security or Medicare accounts and the government can change the level of benefits at any time.) To think about how taxing consumption taxes rich and poor consider this question: “Who can afford to spend more than they earn from their job?” People who absolutely can’t afford a given level of spending will ultimately fall so deeply in debt that outside forces will stop them from spending so much. So they may pay more taxes on their consumption now, but will pay fewer taxes later. So it is the consumption people can afford that matters for consumption taxes over the long haul. There are two basic ways you and your immediate family might be able to afford to spend more than you earn from jobs: have a pile of your own wealth to draw on for consumption or have someone else give you money to spend. Other things equal, having a pile of your own wealth to draw on for consumption makes you richer; so that side of things makes a consumption tax–such as a VAT–progressive. If someone else is giving you money to spend when you don’t really need it, that counts as being rich in a spongeing sort of way. Or to put it better, although ignoble, the ability to convince other people to let you sponge off of them is its own form of wealth. On the other hand, if someone is giving you money to spend because you really do need it, they should realize that the amount of money you need has to be grossed up enough to get the same amount of goods and services even after paying the VAT. In particular, if the someone giving you money to spend is the taxpayer, through the government, whatever dire need motivated the taxpayer to help you out is a need for a given amount of goods and services, and the dollar value of the government assistance should of course be grossed up enough to buy the same amount of goods and services even after paying for the VAT. Since consumer price indices are usually calculated including VAT taxes, this could happen through the standard process of cost-of-living adjustments. Notice that the government receives the VAT taxes paid on goods purchased with money from government assistance. So grossing up the government assistance to pay the VAT tax is just shuffling money from one government account to another and isn’t an unsustainable drain on the government budget. Of course, the shift to a VAT tax could be used as an excuse to cut the amount of goods and services provided as government assistance. That would be regressive. But analytically that should be considered a shift to a VAT tax in the more neutral assistance-preserving way described above plus a cut in government assistance. The VAT tax itself should not be blamed for this effective cut in government assistance. But in the flawed accounting all too often used, the VAT tax is blamed for this unmotivated and far from inevitable cut in the effective level of government assistance. What I have laid out is not the end of the story; there are many other issues in the transition to a value-added tax—for example, while lowering income taxes on 401(k) distributions would keep those who saved that way under the old tax system whole, something needs to be done to honor at least in spirit the promise to those who saved in a Roth plan that after paying taxes on that saving up front, they wouldn’t be taxed later on. But the basic story is that a value-added tax is progressive when the accounting is done right and the shift to a VAT tax is not used as an unwarranted excuse to cut the effective level of government assistance. This shouldn’t really come as any surprise, since governments in many countries that intend to do a lot more redistribution than the US use a value-added tax. # Marcus Nunes on Changes in Real GDP Growth Following Changes in the Government Spending to GDP Ratio → # Dylan Matthews: Think the poor don’t pay taxes? This chart proves you very wrong. → This is a very nice chart showing that taxes overall are remarkably close to proportional. One of the things that suggests to me is that a much simpler tax system that had people paying a proportional tax such as a VAT tax, coupled with a lump-sum transfer to the poor, would not be such a big change after all. We probably cause a lot of distortions by pretending to have a progressive tax system instead of admitting that we have a mostly proportional tax system and optimizing it. # Yichuan Wang: Reflections on Reinhart and Rogoff--Why Time Series Are Not Enough → # The Wrong Side of Cobb-Douglas: Matt Rognlie’s Smackdown of Thomas Piketty Gains Traction I have been impressed with Matt Rognlie ever since our discussion in “Sticky Prices vs. Sticky Wages: A Debate Between Miles Kimball and Matthew Rognlie.” Matt also had a guest post here: “Matt Rognlie on Misdiagnosis of Difficulties and the Fear of Looking Foolish as Barriers to Learning.” I posted a link to Matt’s paper “A note on Piketty and diminishing returns to capital” when I say Tyler Cowen’s post on it. Now I am glad to see it making its way into the consciousness of journalists with “Wealth inequalityNIMBYs in the twenty-first century” in The Economist, and Greg Ferenstein’s piece “A 26-year-old MIT graduate is turning heads over his theory that income inequality is actually about housing (in 1 graph).” The key graph is shown above: there is no upward trend in capital’s share once housing rents are accounted for. The production of housing services is, of course, mostly provided by the house itself, which is counted as capital. So housing services have a capital’s share close to 1. So if the weight of housing goes up, it will drive up the overall share of capital, including the production of housing services. But there is no reason from the graph above to believe that the production function for goods and services other than housing services is on the side of Cobb-Douglas that Thomas Piketty needs–a direction in which a much higher amount of capital would be associated with only a slightly lower rate of return. (See my post “The Shape of Production: Charles Cobb’s and Paul Douglas’s Boon to Economics” for my effort at an intuitive treatment of the logic for why Cobb-Douglas leads to a constant share for capital and for labor.) Matt cites a large body of micro-empirical work suggesting that the elasticity of capital-labor substitution is quite a bit below the Cobb-Douglas level of 1, so that things are on the wrong side of Cobb-Douglas for what Thomas Piketty wants. There are some subtle arguments involving other adjustments that mimic a higher elasticity of capital-labor substitution that could make things look closer to Cobb-Douglas in the aggregate. But it still looks as if in the aggregate, when the real interest rate goes down, it goes down fast enough that the overall gross rental rate of capital goes down proportionally faster than the amount of capital relative to output goes up. The title of Greg Ferenstein’s piece is a bit misleading. Capital’s share is an important issue and capital overall is certainly central to Thomas Piketty’s story, but as for inequality, as Matt says in his conclusion, “Inequality of labor income, for instance, is a very different issue–one that remains valid and important.” It is good news if a lot of wealth and inequality is about housing, because we have known for a long time how to deal with wealth inequality from at least the land component of the value of housing: Henry George’s idea of a tax on land values that Noah Smith talks about, for example, in his Quartz column “This 100-year-old idea could end San Francisco’s class war.” Land taxes are typically much less distortionary than taxes on any other form of capital. So to the extent that inequality is about high land values, it doesn’t run into the issues I talked about in my post “Is Taxing Capital OK?” It does make sense, however, to have provisions in land tax policies to give to developers some of the increase in the value of land engendered by their activities when others want to be near some new development–just as we would want to make sure that developers pay some of the costs of the reductions in the quality of life nearby when others don’t want to be near some new development. The post “Charles Lane on Thomas Piketty and Henry George” discusses some of these issues. “Henry George and the Carbon Tax: A Quick Response to Noah Smith” discusses how some of the logic of a land tax extends to natural resources. Land-price-based inequality can also be addressed by loosening restrictions on building. C.R. in the Economist writes in the article about Matt: “Policy-makers should deal with the planning regulations and NIMBYism that inhibit housebuilding and which allow homeowners to capture super-normal returns on their investments.” Let me explore the logic behind this. Land prices are pushed up when regulations require that land be used in a high ratio to construction in creating housing. That is zoning and other regulations that limit housing density enrich landowners. Above, I wrote that developers should have to pay some of the costs of reductions in the quality of life nearby when higher density is unpleasant to live nearby–say by blocking out the sun. In an earlier version of this post, I actually made the serious mistake of saying they should pay for the reduction in “land values” from development nearby. But that is wrong by a cost-benefit test. Suppose a particular housing development is neutral for the quality of life nearby. Then it would still reduce the values of land nearby by providing more housing competition. This is not a social loss but rather a shift in wealth from landowners renters and future buyers of land, which reduces inequality. So a key conceptual issue for appropriate land policy is to not think of everything that reduces neighboring land values as a bad thing, but to distinguish when (and how much) it brings down land prices by reducing the quality of life nearby from when (and how much) it brings down land prices by providing additional housing competition. # Finding Out the Truth about Infrastructure Projects Along with Noah Smith, I write in favor of infrastructure investment in “One of the Biggest Threats to America’s Future Has the Easiest Fix” and followed that up with “Capital Budgeting: The Powerpoint File.” But I am frustrated by my inability to tell from the news how which particular infrastructure investments are a good deal from the standpoint of solid cost-benefit analysis, and which are just meant to be salient shiny baubles for voters–or perhaps worse, meant to be ways to get money into the pockets of campaign contributors or into the pockets of workers being paid more than a free-market wage. It is very, very easy for the government to pay more than it should for an infrastructure project, given that every dollar it spends is someone’s income. And it is very easy to be drawn to a shiny new light rail system, for example, when a better bus system would be a much more cost-effective solution–or to be drawn to building a new road, when fixing the potholes on existing roads is a better investment. I was reminded of this frustration by reading Holman Jenkin’s Wall Street Journal op-ed “The Infrastructure Medicine Show and tweeted the following, which is the question I want answered: Is there any way to establish an independent think tank to make trustworthy analyses of infrastructure projects? http://t.co/irk8xkVpmF — Miles Kimball (@mileskimball) February 4, 2015 # Quartz #55—>Righting Rogoff on Monetary Policy Link to the Column on Quartz Here is the full text of my 55th Quartz column, “Righting Rogoff on Monetary Policy,” now brought home to supplysideliberal.com. This column was first published on December 15, 2014. Links to all my other columns can be found here. If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice: © December 15, 2014: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2017. All rights reserved. This column is meant to back up my tweet: Ken Rogoff is wrong when he says the BOJ’s Kuroda has done “whatever it takes” monetary policy for Japan: http://www.project-syndicate.org/commentary/japan-slow-economic-growth-by-kenneth-rogoff-2014-12… One other note: Ken sent a nice reply to the email I sent him about my work on eliminating the zero lower bound, soon after I sent it. After the text of the column, which focuses primarily on monetary policy, you can see the text of an update to my companion post, which revisits in greater depth Carmen Reinhart and Ken Rogoff’s research on the effects if government debt on economic growth. Carmen Reinhart and Ken Rogoff’s 2010 academic paper “Growth in a Time of Debt” was influential in giving policy-makers the impression that higher levels of government debt would lead to slower economic growth. In Spring 2013, University of Massachusetts Amherst graduate student Thomas Herndon and his faculty coauthors Michael Ash and Robert Pollin announced that they had discovered a spreadsheet error marring Reinhart and Rogoff’s work. News of that error led to a broader reevaluation of Reinhart and Rogoff’s claims. My own embarrassment at having relied on Reinhart and Rogoff’s claims led me to examine their claims closely myself, in two Quartz columns coauthored with University of Michigan undergraduate Yichuan Wang. We found no evidence in Reinhart and Rogoff’s data that national debt slows down economic growth at all. Indeed, after taking into account past growth rates, many economies have grown surprisingly fast despite high levels of government debt. As Reinhart and Rogoff’s claims fell apart, they came under particular criticism for allowing policy-makers to believe they had conclusive evidence that higher government debt slowed down growth at the same time their more cautious words to their fellow economists indicated that they knew the evidence at best only suggested such a view, pending further analysis. Between Reinhart and Rogoff, it was clear this criticism was directed primarily at Rogoff, in view of his greater stature and influence with policy-makers. Despite his mistakes in badly overstating the evidence that government debt retards growth, Ken Rogoff is a brilliant economist, who has greatly advanced many areas of economics and has a deep concern for real-world economic policy. So it is disappointing to see his analysis of Japanese economic policy limited so sharply by conventional wisdom in his recent Project Syndicate article “Can Japan Reboot?” Indeed, Rogoff makes an unforced error in that article that is every bit as consequential for economic policy as his errors in relation to debt and economic growth. Rogoff writes: My own view is that the “three arrows” of Abenomics 1.0 basically had it right: “whatever it takes” monetary policy to restore inflation, supportive fiscal policy, and structural reforms to boost long-run growth. But, though the central bank, under Governor Haruhiko Kuroda, has been delivering on its side of the bargain, the other two “arrows” of Abenomics have fallen far short. This is wrong. Both the Bank of Japan and Ken Rogoff know that “whatever it takes” monetary policy goes beyond anything the Bank of Japan has done. Governor Kuroda has not been delivering on his side of the bargain. “Whatever it takes” monetary policy would involve cutting the interest rates determined by the Bank of Japan below zero. The fact that paper currency, according to current practice, earns a zero interest rate causes serious complications, but the Bank of Japan knows, at a detailed level, how to implement a negative interest rate on paper currency, too. I know the Bank of Japan knows how to do it because I went to the Bank of Japan in June 2013 to explain the details in an official seminar, to both staff economists and high Bank of Japan officials, and returned in August 2014 to remind them. On this, my second visit, I spoke about “Portfolio Rebalancing in General Equilibrium” in my official seminar, but I used that visit as an opportunity to talk about negative interest rates in side conversations. And before the financial crisis that precipitated the Great Recession, I spent enough time in residence at the Bank of Japan that I have many friends among the staff economists at the Bank of Japan who have followed my work on negative interest rates closely. I know that Ken Rogoff appreciates the power of negative interest rates to provide economic stimulus because he has advocated adding negative interest rates to the monetary policy tool kit for exactly that purpose himself. And when I realized from his May 2014 Financial Times opinion piece in that vein of his advocacy of negative interest rates, I emailed him to let him know of my efforts to work out details of implementing negative paper currency interest rates to make deep negative interest rates practical now, instead of a decade or two from now. Thus, Ken Rogoff’s characterization of current Japanese monetary policy being willing to do “whatever it takes” is not just an error, but an unforced error. The most likely reason Rogoff made the error is because he is too quick to assume the existence of political constraints on monetary policy in Japan. While they may exist today, they could be swept away tomorrow, if Japan’s economy falls deeper into the mire. To my mind, it is the responsibility of an economist giving serious advice to point out what can and should be done even if that may not be politically feasible at the moment. Of course, one should then go on to give the best advice one can within whatever political constraints exist at the moment, as I did when I gave my opinion to the Bank of Japan that quantitative easing would be more powerful if they focused their asset purchases on risky assets. But progress is ill served if economists fail to point out areas where a government should try to expand the range of what is politically possible. Many economists explain the benefits of free trade, for example, even when the tide of politics is running toward greater protectionism. And many economists explain the benefits of dramatically more open immigration, even when the tide of politics is running toward greater immigration restrictions. Indeed, while Ken Rogoff has not yet shown the courage of his convictions in his public advice to Japan about monetary policy, he does show the courage of his convictions in tough words about Japan’s immigration policy. He writes: There has been no significant progress on supply-side reforms, especially on the core issue of how to expand the labor force. With an aging and shrinking population, Japan’s government must find ways to encourage more women to work, entice older Japanese to remain in the labor force, and develop more family-friendly labor policies. Above all, Japan needs to create a more welcoming environment for immigrant workers. That is all good advice. While immigration policy can, for the most part, be cleanly separated from monetary policy, monetary policy and fiscal policy are unavoidably intertwined. Rogoff has this to say about Japan’s recent and possible future increases in its consumption tax: The timing of the April 2014 consumption-tax hike (from 5% to 8%) was also unfortunate. It would not have been easy for Abe to postpone the move, given that it had been locked in place by broad-based political agreement before he took office. But the government could have engaged in more aggressive fiscal stimulus to counteract the hike’s short-term effects. Instead, two successive quarters of negative growth have had a dispiriting psychological impact. … Mind you, Japan’s outsize government debt and undersize pension assets are a huge problem … It is clear from these passages that Rogoff wants lower taxes to stimulate the economy (or to keep from creating a drag on the Japanese economy), but worries about the effect of lower taxes on the already supersized national debt of Japan. But if Japan supercharged its monetary policy with negative interest rates, the fiscal drag from higher consumption taxes would be overwhelmed by the monetary stimulus, so that Japan’s tax policy could be focused on the long-run issue of stabilizing its debt level. In “Can Japan Reboot,” Ken Rogoff presents himself as someone despairing of the potential for better monetary policy to dramatically improve the situation in Japan, and therefore turning to supply-side measures as the main hope for getting the Japanese economy back on track. In my view, Japan can dramatically improve both its monetary policy and its supply-side policies. I have heard the argument that tight monetary policy can foster supply-side reform by holding an economy hostage until politicians enact the supply-side reforms they know their economy needs, but I don’t believe it. (Fortunately, Rogoff makes no such claims.) Instead, good monetary policy, by keeping the economy at the level of output consistent with stable prices reveals and highlights supply-side issues that need to be addressed. When people believe, with good reason, that bad monetary policy is part of what ails the economy, it is not surprising that they underestimate the need for supply-side reforms such as loosening immigration restrictions and making it easier for new, innovative firms to enter old, jaded markets. Repairing monetary policy clears the way for repairing the underlying ability of an economy to produce the goods and perform the services that enrich people’s lives with material abundance. In both the reinforcement he gave to policy makers more worried by the effects of debt on economic growth than by the disastrous human consequences of the persistent worldwide slump, and in his current advice to Japan, Ken Rogoff has erred in the direction of making it easy for people who believe a questionable conventional wisdom to continue in that belief. Economists concerned with real-world economic policy should aim higher. It is all well and good to give a verdict on current policy controversies, as they have been framed by politics as usual. But those who know there is a better way need to say so, with patience and tenacity. Update December 19, 2014: Although the main point of my column is to emphasize the importance of putting negative paper currency interest rates in the monetary policy toolkit now rather than a decade or two from now (with particular urgency for the European Central Bank and the Bank of Japan), I know that for many readers, the reprise of the Spring 2013 media furor about Carmen Reinhart and Ken Rogoff’s work is equally salient. Personally, I believe eliminating the zero lower bound is much more important as whether debt lowers economic growth even when it doesn’t cause a debt crisis, but the issue of debt and growth does need to be addressed as well. I had a chance to read Ken Rogoff’s and October 2013 FAQ http://scholar.harvard.edu/rogoff/publications/faq-herndon-ash-and-pollins-critique. Substantively, I think this is a good response to the Thomas Herndon, Michael Ash and Robert Pollin paper (linked there) that started the media furor in Spring 2013. But my own substantive concerns are not those. They are the concerns that Yichuan Wang and I detail in our two Quartz columns and two other posts on Reinhart and Rogoff’s work: In my view, these posts by Yichuan Wang and me are a good example of how, in Clay Christensen’s terms, the disruptive innovation of the economics blogosphere is beginning to move upscale and challenge traditional economics outlets such as working papers and journal articles. I hope that, taken as a whole, what I write on my blog puts things in the context of the literature, and—through links—gives the kinds of references that are rightly considered important for academic work. In any case, for me the major source of the not inconsiderable number of references I have had in my academically published work come from other people telling me about work related to my own. The same thing happens online. I deeply appreciate the many links people send me in tweets and in more private communications. Although it is natural for an individual blog post to be be much less complete than a working paper or journal article, I hope to achieve a reasonable balance between breadth and depth in this blog as a whole. And of course, the relative difficulty of putting mathematical equations in Tumblr means I will choose the working paper format once the number of equations needed to make a point exceeds a certain threshold. To repeat, although Thomas Herndon, Michael Ash and Robert Pollin’s paper definitely piqued my interest and Yichuan’s interest and so led to our analysis of Carmen Reinhart and Ken Rogoff’s postwar data, I am critical of the substance of Carmen and Ken’s work based on my work with Yichuan, not based on the work of Thomas Herndon, Michael Ash and Robert Pollin. In relation to our own critique of Carmen and Ken’s work, let me make three substantive points: 1. Nonlinearity. In our last piece on Reinhart and Rogoff’s work, http://blog.supplysideliberal.com/post/55484991854/quartz-25-examining-the-entrails-is-there-any 2. Yichuan and I look nonlinearly at how different levels of debt are related to growth beyond what one would expect from looking at past growth alone. It would be nice to have more evidence total, but on its face, the hint has a higher growth rate after controlling for past growth at a 90% debt to GDP ratio than at a 50% debt to GDP ratio. And we do suggest that what little evidence there is in the data suggests that, say, 130% debt to GDP ratio is associated with lower growth beyond what would be predicted by past growth than a 90% debt to GDP ratio, though a 130% debt to GDP ratio and a 50% debt to GDP ratio give about the same level of growth beyond what would be predicted by past growth alone. On theoretical grounds, it seems plausible to me, though far from an open-and-shut case that high enough debt levels would cause problems for economics growth. That thinking has led me to argue persistently that monetary stimulus is better than fiscal stimulus because it does not raise national debt. See for example my post “Monetary vs. Fiscal Policy: Expansionary Monetary Policy Does Not Raise the Budget Deficit.”But exactly how high that is matters a lot when people can’t be convinced of the virtues of negative interest rates so that fiscal stimulus remains an issue. I consider the nonlinear smoother result that (given what power there is in the postwar data set) the line is the same at a 130% debt to GDP ratio as at a 50% debt to GDP ratio, even after correcting for “illusory growth” on the part of Ireland and Greece as painting a considerably different picture than someone would get from reading Carmen Reinhart and Ken Rogoff’s, or Carmen Reinhart, Vincent Reinhart and Ken Rogoff’s work. 3. Is controlling for past GDP growth appropriate? In my view, yes. I consider the past income growth controls important because countries that are generally messed up are likely to have both high debt and low growth. That doesn’t mean the high debt causes low growth. Most of the discussion has focused on reverse causality, but I consider the positive correlation across many dimensions of bad policy to be another big issue. I worry that the past income controls would make it hard to detect whether or not debt overhangs are followed by long-lasting low-growth periods, as Carmen, Vincent and Ken argue. But without some other way to control for the many, many other possible bad policies besides debt (which goes beyond the kind of growth accounting regressions that Ken’s FAQ document points to as strong evidence in favor of the view that debt might slow growth) this seems to me to point toward genuine empirical agnosticism about whether debt lowers growth as the right conclusion. (Theoretical arguments are a different matter.) 4. Does the prewar data strongly bolster the case the debt slows growth? Here, it depends on what the question means. The prewar data were not as readily available as the postwar data, so Yichuan and I did not analyze them. And so I don’t know what they say, once subjected to the kind of empirical exercises I would like to subject them to. I would love to see an analysis like the one the Yichuan and I did on the postwar data applied to the prewar data. That said, the prewar data may answer the question of whether a given debt level lowered growth under the gold standard, or with prewar institutions that were weaker than current institutions. So I have my doubts about how much guidance it can give to policy now. Monetary policy in particular, had advanced dramatically since the pre-World War II era, even before the ongoing revolution against the paper currency standard. Did Carmen and Ken overstate their case? While I feel confident that Yichuan’s and my substantive critique has not been adequately addressed, I am much less confident about claims I made in “Righting Rogoff on Japan’s monetary policy” about how policy-makers interpreted Carmen and Ken’s work (and how they could have been expected to have interpreted it, given what was written). Ken’s FAQ document points to the 2010 Voxeu article “Debt and Growth Revisited” as something that could have provided more balance to policy makers in interpreting Carmen (and Vincent) and Ken’s work. Because policymakers might be more likely to read a Voxeu article than an academic paper, this Voxeu piece is an important touchstone for whether Carmen and Ken overstated the strength of the empirical evidence in favor of the idea that high public debt slows down growth in the range that was relevant to policy in the last few years. The issue I have with the Voxeu article “Debt and Growth Revisited” is that it never mentions the fact that the normal standard of establishing causality in economics is to find a good instrument, or some other source of exogeneity or quasi-exogeneity. In other words, the inherent difficulty of establishing causality in this kind of data is never mentioned. Here is how strongly Carmen and Ken suggest in their Voxeu article “Debt and Growth Revisited” that there is causal evidence despite the highly endogenous nature of the data: Debt-to-growth: A unilateral causal pattern from growth to debt, however, does not accord with the evidence. Public debt surges are associated with a higher incidence of debt crises.9 This temporal pattern is analysed in Reinhart and Rogoff (2010b) and in the accompanying country-by-country analyses cited therein. In the current context, even a cursory reading of the recent turmoil in Greece and other European countries can be importantly traced to the adverse impacts of high levels of government debt (or potentially guaranteed debt) on county risk and economic outcomes. At a very basic level, a high public debt burden implies higher future taxes (inflation is also a tax) or lower future government spending, if the government is expected to repay its debts. There is scant evidence to suggest that high debt has little impact on growth. Kumar and Woo (2010) highlight in their cross-country findings that debt levels have negative consequences for subsequent growth, even after controlling for other standard determinants in growth equations. For emerging markets, an older literature on the debt overhang of the 1980s frequently addresses this theme. … … We have presented evidence – in a multi-country sample spanning about two centuries – suggesting that high levels of debt dampen growth. I appreciate the note of uncertainty in the sentence Perhaps soaring US debt levels will not prove to be a drag on growth in the decades to come. But I feel that for the typical policy maker reading the Voxeu article, this note of uncertainty is largely cancelled out by the next sentence: However, if history is any guide, that is a risky proposition and over-reliance on US exceptionalism may only prove to be one more example of the “This Time is Different” syndrome. The phrase “if history is any guide” phrase in particular suggests that the historical evidence gives some clear guidance, and the sentence as a whole points to an interpretation of “Perhaps soaring US debt levels will not prove a drag on growth in the decades to come” as simply making a bow toward random variation around a regression line rather than expressing any uncertainty about what the causal regression line for the effect of debt on growth says before other random factors are added in. In any case, saying “Perhaps soaring US debt levels will not prove to be a drag on growth in the decades to come” is not the same as if Carmen and Ken had said Of course further research could overturn the suggestion we find in the evidence that high debt lowers growth, and there are always many difficulties with interpreting historical evidence of this kind. Of course, there is always the possibility that Carmen and Ken said almost exactly that, in a forum that most policy makers would have noticed, but one that Idid not notice. (My own reading is ridiculously far from comprehensive.) If so, I would love to get a link to it. Ideally, I would like to see the main text of Ken’s FAQ document collect in its main text all the details (including of course venue or outlet and date) about all the strongest caveats and cautions against overreading that Carmen, Vincent and Ken wrote about their work. One extremely important note that the FAQ document does have is this quotation from Reinhart, Reinhart, and Rogoff (2012), “Public Debt Overhangs: Advanced-Economy Episodes since 1800.” (Journal of Economic Perspectives, 26(3)): This paper should not be interpreted as a manifesto for rapid public debt deleveraging exclusively via fiscal austerity in an environment of high unemployment. Our review of historical experience also highlights that, apart from outcomes of full or selective default on public debt, there are other strategies to address public debt overhang, including debt restructuring and a plethora of debt conversions (voluntary and otherwise). The pathway to containing and reducing public debt will require a change that is sustained over the middle and the long term. However, the evidence, as we read it, casts doubt on the view that soaring government debt does not matter when markets (and official players, notably central banks) seem willing to absorb it at low interest rates – as is the case for now.” This suggests to me that Paul Krugman went overboard in his criticism of Carmen and Ken—at least before he backed off somewhat. I am not up on all the details, but it is my understanding that some of Paul Krugman’s stronger criticisms against Carmen and Ken in terms of providing intellectual backing for austerity might have been better leveled against other influential economists, such as Alberto Alesina. But I would need a lot of help to know whether such criticisms were even appropriate for other influential economists such as Alberto. For the record, the current Wikipedia article on Alberto Alesina says: In October 2009 Alesina and Silvia Ardagna published Large Changes in Fiscal Policy: Taxes Versus Spending,[3] a much-cited academic paper aimed at showing that fiscal austerity measures did not hurt economies, and actually helped their recovery. In 2010 the paper Growth in a Time of Debt by Carmen Reinhart and Kenneth Rogoff) was published and widely accepted, setting the stage for the wave of fiscal austerity that swept Europe during the Great Recession. In April 2013 some analysts at the IMF and the Roosevelt Institute found the Reinhart-Rogoff paper flawed. On June 6, 2013 U.S. economist and 2008 Nobel laureatePaul Krugman published How the Case for Austerity Has Crumbled[4] in The New York Review of Books, noting how influential these articles have been with policymakers, describing the paper by the ‘Bocconi Boys’ Alesina and Ardagna (from the name of their Italian alma mater) as “a full frontal assault on the Keynesian proposition that cutting spending in a weak economy produces further weakness”, arguing the reverse. Thus, Wikipedia conflates Carmen and Ken’s views with those of Alberto Alesina and Silvia Ardagna. But just as Carmen and Ken’s views should not be conflated with Alberto and Silvia’s views, neither should my views be conflated with Paul Krugman’s. Soon after Thomas Herndon, Michael Ash and Robert Pollin’s paper came out, I wrote in Quartz: Unlike what many politicians would do in similar circumstances, Reinhart and Rogoff have been forthright in admitting their errors. (See Chris Cook’s Financial Times post, “Reinhart and Rogoff Recrunch the Numbers.”) They also used their response to put forward their best argument that correcting the errors does not change their bottom line. Given the number of bloggers arguing the opposite case—that Reinhart and Rogoff’s bottom line has been destroyed—it is actually helpful for them to make their case in what has become an adversarial situation, despite their self-justifying motivation for doing so. And though I see a self-justifying motivation, I find it credible that Reinhart and Rogoff’s original error did not arise from political motivations, since as they note in their response, of their two major claims—(1) debt hurts growth and (2) economic slumps typically last a long time after a financial crisis—the claim that debt hurts growth is congenial to Republicans, while the claim that it is normal for slumps to last a long time after a financial crisis is congenial to Democrats. The results from the fairly straightforward data analysis that Yichuan and I did made me somewhat less sympathetic to Carmen and Ken. Nevertheless, I think they spoke and wrote in good faith. Errors of omission are a different issue, and there we all stand condemned, in a hundred different directions for each of us. It is from the perspective that we all stand condemned for errors of omission of one type or another, that I hope my words in “Righting Rogoff on Japan’s monetary policy” are taken. I also urge you to distinguish carefully between simply reportingone side of the Spring 2013 debate about Reinhart and Rogoff’s work, and things I say on my own behalf: principally that Ken does not challenge policy-maker conventional wisdom as much as I would like to see. Carmen and Ken literally did not have time enough to defend themselves adequately back in Spring 2013. Now that the dust has cleared, I would be glad to see them do more to tell their side of the story. This update is my effort to make up for some of my own errors of omission when I wrote “Righting Rogoff on Japan’s monetary policy.” In particular, I thought wrestling with Ken’s FAQ document was the least I could do to give a little more voice to Carmen and Ken’s side of the story. (To the extent that you were persuaded by Thomas Herndon, Michael Ash and Robert Pollin’s paper, or were persuaded by unjustified accusations of bad faith on Carmen and Ken’s part, you should take a close look at that FAQ document.) # Quartz #54—>The National Security Case for Raising the Gasoline Tax Right Now Link to the Column on Quartz Here is the full text of my 54th Quartz column, “America’s national security case for raising the gasoline tax right now," brought home to supplysideliberal.com. It was first published on December 5, 2014. Links to all my other columns can be found here. At this writing, this is one of my most popular Quartz column ever. You can see a list of my most popular columns here. If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice: © December 5, 2014: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2017. All rights reserved. The world is a dangerous place. The Russianannexation of the Crimea and invasion of Eastern Ukraine behind tissue-thin pretenses has set Europe on edge. Hard-line factions in Iran are working to sabotage talks to rein in Iran’s nuclear program, in counterpoint to dark words from Bret Stephens in the Wall Street Journal speculating that the Obama administration has accepted the inevitability of an Iranian atom bomb. Meanwhile the Islamic State has carved out large chunks of Iraq and Syria for its grim caliphate. And China, despite its growing economic problems amidst its periodic saber-rattling, is still on track to besting the US in the overall size of its economy, simply because it has four times as many people as the US. (While GDP per personmatters for many international comparison it is total GDP that matters most for military strength.) To deal with the long-run danger of Chinese dominance, the best strategy is to bring more people into the American fold, as I wrote in “Benjamin Franklin’s Strategy to Make the US a Superpower Worked Once, Why Not Try It Again?” But to shrink the more immediate threats from Russia, Iran, and ISIS down to size, there is another remedy: low prices for oil. Russia’s and Iran’s economies survive economic sanctions as well as they do because of oil revenue. Iran has plenty of money to enrich uranium and build missiles because of oil revenue. And the Islamic State earns millions of dollars a day from smuggled oil to help fund its murderous operations. Lowering the world price of oil puts less money in the hands of our enemies. More subtly, lowering the world price of oil may help undercut or prevent dictators that may become our enemies in the near future. Economists and political scientists have noticed the “natural resource curse” in which many countries have dysfunctional politics because of natural resources. In a country without many natural resources, people are the main source of wealth; they have to be handled with care by rulers or they won’t produce much wealth. But in a country with oil, controlling the oil fields is enough to control most of the wealth of the country, and provides enough funds to buy off the people without giving them freedom, or to pay soldiers to intimidate the people. Fortunately, the world price of oil has just fallen dramatically. On November 28, 2014, the Wall Street Journal began its editorial “The New Oil Order” with these words: America’s unconventional oil boom continues to yield major benefits—economic and geostrategic. The latest evidence is OPEC’s decision on Thursday to defy expectations and maintain its current oil production target despite the steepest price decline since the 2008-2009 recession. The price of Brent crude, the global oil benchmark, plunged as a result to about$70 a barrel, continuing its decline from a peak of nearly $116 in June. Here, the Journal appropriately gives much of the credit to the fracking boom in the US. In addition, the world’s economic troubles have reduced the demand for oil. And the rulers of Saudi Arabia realize (better than most Americans) that low oil prices are a way to weaken its rival Iran. What can we do to keep the price of the oil that Russia, Iran and the Islamic State are selling as low as possible? ## 1. We can keep the fracking boom going …and open the way for building the pipelines needed to ship oil and natural gas from point A to point B. ## 2. We can pour more money into solar power research On November 19, I saw a talk by former Energy Secretary and Nobel Laureate Steven Chu at a (natural gas and oil-funded) conference in Doha, Qatar. He said solar power is close to being cheaper than conventional energy sources even without subsidies. (See also Ramez Naam’s Scientific American article “Smaller, cheaper, faster: Does Moore’s law apply to solar cells?”) Already, solar panels are cheap enough that installation costs are becoming the biggest issue. And there, German firms have figured out how to bring installation costs down far below installation costs in the US. Pushing solar power faster along the path it is already going could do a lot to keep oil demand from pushing prices up as the world economy improves. ## 3. We can increase gasoline and oil taxes and devote the proceeds to rebuilding our military to combat the new national security challenges that confront us Gasoline and oil taxes raise the price of oil to consumers, but they also lower the price of oil to producers like Russia and Iran—especially if we convince our allies to raise their gasoline and fossil fuel taxes as well (which they might be willing to do, even though for many, their gasoline taxes are much higher than ours already). A basic principle from Economics 101 is that at the end of the day, taxes affect all players in a market, whoever officially pays them. For oil what that means is that although higher gasoline and oil taxes would involve some sacrifice from US consumers and US producers for the sake of national security, they are also taxes that, at the end of the day, are paid in a real way by US enemies. One way to make an increase in gasoline and oil taxes easier to swallow is to phase those taxes in over time. Economic theory predicts that credible future gasoline and oil taxes will bring down the price of oil now. If everyone knows and believes gasoline and oil taxes will increase over time, the value of keeping oil in the ground to sell it in the future will be lower, so that oil is more likely to be put on the market now—at a lower price. And down the road, if solar power continues to get cheaper—and new ways to store power get cheaper, too—those gasoline and oil taxes in the future won’t be as painful as they would be now. For too long, the US and many of its allies have either ignored the dangers of the world and turned inward, or have been drawn into fighting wars against dictators or terrorists funded by oil riches. One of the best ways for the US and its allies to support the valiant men and women who fight and die to defend the free world and to keep those parts of the world that are struggling towards freedom from descending into chaos is by taking high oil revenues out of our enemies’ war chests. Technical Note: In light of the title, I should point out that, from an efficiency standpoint (without regard to politics), there may no justification for phasing in a gasoline tax increase slowly. If a national security externality were like an environmental externality, that externality should ideally be reflected in the tax rate right now. But the national security externality is actually a pecuniary externality, so it would take some nontrivial reasoning to figure out whether or not there is any justification for phasing a gasoline tax in. It is an optimal taxation problem in which money in the hands of certain parties counts negatively. Syndication: I am pleased that this column was syndicated here to another Atlantic Company website as well: Defense One. Here is a screen shot: # The New Republican Majority Should Keep Doug Elmendorf as Director of the Congressional Budget Office As Diogenes dramatized with his lamp, it is not easy finding an honest man. That is especially true when it comes to honesty in the face of strong political pressures. Doug Elmendorf is that rarity. If he is willing to continue as Director of the Congressional Budget Office (CBO), where honesty is especially needed, the new Republican majority would be well-advised to keep him on. They should remember that it was the CBO under Doug that pointed out what a budget-buster an early incarnation of Obamacare was. (Of course the final version was not cheap either–something the CBO under Doug also pointed out. You can see what I have to say about Obamacare here.) And it was the CBO under Doug that gave the estimate that raising the minimum wage as much as some proposed would cost half a million jobs, when the party line among many Democrats is that raising the minimum wage won’t cost any jobs at all. (You can see what I have posted so far about the minimum wage here: 1,2,3,4. I definitely lean against a higher minimum wage, but I am still debating all of the issues in my mind.) David Lawder makes the same case in the Reuters article “Republicans weigh big changes at U.S. budget referee agency.” One of the key issues is “dynamic scoring.” Dynamic scoring is when the changes to tax revenue induced by changes in economic behavior are included in calculations–an area where impartiality in doing the calculations is especially important because of the judgment calls that need to be made. The CBO has already done some dynamic scoring in unofficial estimates. Here are some key excerpts from David Lawder’s reporting: The budget math used under dynamic scoring has long been a goal for Republican lawmakers, including the incoming chairman of the House Budget Committee, Representative Tom Price, and the current chairman, Paul Ryan, who next month will take over the tax-writing House Ways and Means Committee. … “What we’re simply striving for is accuracy in score keeping,” Ryan told Reuters in a recent interview. “We know for a fact that it is not accurate or prudent to ignore the effects of economic growth on policies we make in Congress.” … “I’ve always said that Doug Elmendorf has done an extremely good job at CBO,” Price said. “My complaint, my concern about CBO is not about the individual at the lead of CBO, my concern is the rules under which they operate.” … … several prominent conservative economists have backed Elmendorf, arguing that Republicans would gain more credibility by keeping the former Clinton administration economist. … “If you’re going to go with dynamic scoring, Elmendorf is a great guy to implement that,” said Michael Strain, deputy director of economic policy studies at the conservative American Enterprise Institute. “It would be harder to accuse Republicans of putting their thumb on the scale” if he stays. To everything said above about dynamic scoring, let me add that I think Doug Elmendorf is the right person to implement disciplined capital budgeting to the CBO. I have in mind the approach I advocated when I visited the CBO this past May. (See my post “Capital Budgeting: The Powerpoint File.) I know Doug well. Doug is a Harvard PhD classmate of mine, a coauthor on "Taxation of Labor Income and the Demand for Risky Assets” and a friend. So I can’t claim to be unbiased. But everything I am saying about Doug Elmendorf, others are saying as well. Bleg: It may be important to write again on this topic. So I would be grateful for links and information relevant to the argument for keeping Doug as Director of the CBO. # Jon Hilsenrath, Brian Blackstone and Lingling Wei on Monetary Policy: Low Rates and QE "Didn’t Cause the Hyperinflation or Obvious Asset Bubbles that Some Lawmakers and Critics Feared" The well known gap between the Wall Street Journal news pages and editorial pages is well illustrated today in this passage from the article “Central Banks in New Push to Prime Pump” by monetary policy reporters Jon Hilsenrath, Brian Blackstone and Lingling Wei: The Fed pursued low-rate, QE experimentation for half a decade. It pushed U.S. short-term rates to near zero in December 2008 and promised to keep them there for long periods. Convinced that wasn’t enough, it then launched several rounds of bond purchases that helped push its portfolio of securities, loans and other assets from less than$900 billion to more than \$4 trillion.

The policies didn’t cause the hyperinflation or obvious asset bubbles that some lawmakers and critics feared. The fact that the U.S. economy is now doing better than Europe’s or Japan’s suggests the policies helped boost growth, although the degree of support is a matter of great disagreement among economists.

I fully agree with that assessment. I disagree with two other places in the article where they quote Eswar Prasad and Liaquat Ahamed without quoting any contrary views. Here are my contrary views.

Jon, Brian and Lingling write:

Global economic weakness creates a dilemma for the U.S. If the Fed pulls away from easy money as other central banks ramp up money-pumping policies, it could drive up the value of the U.S. dollar, straining U.S. exports. It also could put downward pressure on U.S. inflation and on commodities prices, which are typically denominated in dollars.

Eswar Prasad, a Cornell University professor and former International Monetary Fund economist, said those developments would make it harder for the Fed to move ahead on rate increases.

This is not a dilemma for the US at all. What happens in the rest of the world matters a great deal for the US economy; the greatest dangers the US economy faces in the next few years are bad news about how other nations’ economies are faring. Given this stake we have in the world economy, when the rest of the world is struggling with low aggregate demand and the US central bank is thinking of raising interest rates to rein in aggregate demand, the thing one should hope would happen is that the countries that are struggling depreciate their currencies to boost their aggregate demand, while the US tolerates appreciation of the dollar to rein in its aggregate demand at that juncture rather than reining in aggregate demand by raising interest rates. In other words, when the world as a whole still needs more monetary stimulus, it is good thing for the Fed to stay relatively stimulative, while exchange rate movements are allowed to help steer that stimulus to other countries that need it most.

## Liaquat Ahamed’s Views: “Central banks have done about as much as they can”

Liaquat Ahamed articulately expresses an idea that sounds plausible, but is wrong. Here is the quotation from Jon, Brian and Lingling’s article:

“Central banks have done about as much as they can,” said Liaquat Ahamed, author of “Lords of Finance,” which documented the mistakes global central bankers made before and during the Great Depression.

I have been taking many of the Wall Street Journal monetary policy reporters to task before for this error:

(I recently updated my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” to add a “News and Trends” section for posts likes this.)

Until central banks have employed negative interest rates, including negative paper currency interest rates (implemented by a time-varying paper currency deposit fee), they have not done all the monetary stimulus they can.

Of course, it is possible to have too much monetary stimulus. So there are indeed situations in which a central bank has done “all it can” in the sense that more monetary stimulus would be a bad thing. And in the long run, standard models (which I essentially agree with) imply that a central bank can only affect inflation, not real economic activity. (See my post “The Deep Magic of Money and the Deeper Magic of the Supply Side.”

Applying these principles to current events, a central bank can reasonably be said to have “done all it can” to foster economic growth in only two situations:

1. Additional monetary stimulus would create a genuine danger of a serious, undesirable increase in inflation (that is greater than the danger of too little monetary stimulus).
2. The central bank has done all it can to raise equity requirements to a level that will make the financial system safe, but has failed in these macroprudential efforts, so that additional monetary stimulus would create a serious danger of a bubble that would endanger the financial system.

One might argue that the first case applies to the Bank of England or to China’s central bank, but it does not yet apply even to the Fed, and is nowhere close to applying to the European Central Bank or the Bank of Japan.

No central bank has yet qualified for the second case. I have written two Quartz columns on monetary policy and financial stability:

And I address some of the key issues in my all-time most popular blog post so far: “Contra John Taylor.”

The Fed actually has a great deal of authority over equity requirements that it has not fully used yet. On equity requirements, see my recent post “The Wall Street Journal Editorial Board Comes Out for a Straight 15% Equity Requirement” and other posts in my Finance and Financial Stability sub-blog. Of just Quartz columns about equity requirements, see these two:

## Liaquat Ahamed’s Views: Supply-Side Reform, not Monetary Stimulus

The account of Liaquat Ahamed’s views continues:

Japan, he said, is burdened by a highly inefficient domestic economy, and Europe by a fragmented and fragile banking system. Pumping cheap credit into these economies won’t directly fix those problems, he said. “They may be just copying the U.S. when they have different problems,” he said. “The world has relied too much on central banks.”

Supply-side reforms are crucial, but as I wrote in my slate article “Governments Can and Should Beat Bitcoin at Its Own Game” about empowering monetary policy by eliminating the zero lower bound:

… every time one set of problems is solved, it allows us to focus our attention more clearly on the remaining problems. It is time to step up to that next level.

People sometimes argue that good monetary policy will distract governments from pursuing supply-side reforms. But because optimal monetary policy keeps output close to its natural level, it would actually make supply-side issues much more salient, since only supply-side forces change the natural level of output.

Fostering long-run economic growth is a many-sided issue. Writing this post inspired me to add a “Long-Run Economic Growth” sub-blog link to my sidebar. I had some difficulty categorizing posts. I didn’t want to duplicate what I had in my “Long-Run Fiscal Policy” and “Education” sub-blogs too much, but included some of my favorite posts in those categories. And I consciously included many posts about things that could contribute to economic growth correctly measured, even if they wouldn’t contribute to GDP as currently measured.

## Monetary Policy vs. Fiscal Policy vs. Credit Policy

Jon, Brian and Lingling continue, in what may also be a reflection of Liaquat Ahamed’s views:

In the U.S., Fed officials have been frustrated that they were being relied on to spur growth while the Obama administration and Congress feuded over fiscal policies that slowed growth in the short-run without addressing projected long-run budget deficits.

My view is that monetary policy is exactly what we should be using to keep GDP at its natural level. And except for our unfortunate policy of imposing a zero lower bound on interest rates with the way we now handle paper currency, that would work well. On the issue of monetary vs. fiscal policy, these two posts are a good start:

Overall, in the absence of a zero lower bound, I don’t see traditional fiscal policy (beyond automatic stabilizers) as a good way to deal with fluctuations away from the natural level of output.

However, credit policy, which lies somewhere between monetary and fiscal policy, can have a useful role to play in stabilization, simply because National Lines of Credit to consumers can have a faster effect on aggregate demand than interest rate changes (which typically take 6-12 months to have their effect). Here is what I wrote in my academic working paper “Getting the Biggest Bang for the Buck in Fiscal Policy” (pp. 3, 9):

… for the sake of speed in reacting to threatened recessions, it could be quite valuable to have legislation setting out many of the details of national lines of credit but then authorizing the central bank to choose the timing and (up to some

limit) the magnitude of issuance. Even when the Fed funds rate or its equivalent is far from its zero lower bound at the beginning of a recession, the effects of monetary

policy take place with a significant lag (partly because of the time it takes to adjust investment plans), while there is reason to think that consumption could be stimulated quickly through the issuance of national lines of credit. …

… A big advantage of national lines of credit is that, once triggered, the details of spending are worked out through

the household decision-making process, which is relatively nimble compared to corporate and government decision-making processes.

## Conclusion

The bottom line is that the conventional wisdom about monetary policy (on the left as well as on the right) is somewhat off target. To the extent that what people say seems reasonable, it is in important measure a self-fulfilling equilibrium: because the conventional wisdom is what it is, only certain policies are thinkable, and therefore what is said in the conventional wisdom makes sense. The concept of the Overton window is very helpful here. There is great value in working to expand the Overton window of policies that can be discussed among “very serious people” rather than just arguing about policies within the Overton window.

# Quartz #53—>Why You Should Care About Other People's Kids as Much as Your Own

Link to the Column on Quartz

Here is the full text of my 53d Quartz column, “Why you should care about other people’s kids as much as your own,” now brought home to supplysideliberal.com. It was first published on October 12, 2014. Links to all my other columns can be found here.

This column doesn’t just say we should care, it gives a plan for getting there. In particular, how we handle long-run fiscal policy can make a big difference to the level of altruism in our nation.

If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice:

The remarkable popularity of Danielle and Astro Teller’s essay “How American parenting is killing the American marriage” points to an incipient backlash against the cult of parenthood.

But if there is going to be a backlash against the cult of parenthood, I hope it is the right backlash. To me, the problem here is not at all the elevation of child rearing. After all, those who are children today really are the future of our species and our civilization, as I wrote in my Christmas column last year: “That baby born in Bethlehem should inspire society to keep redeeming itself.” What deserves a backlash is the elevation of my child or your child over everyone else’s children, and over all the adults who hold things together and move things forward until those who are now children are ready to run things.

Among the middle-aged, the most common type of thoroughgoing selfishness is not “Me, me, me,” but “my, my, my” on behalf of a precious daughter or son. But isn’t this just human nature? Isn’t it just tilting against windmills in the grand tradition of Don Quixote to inveigh against the extreme favoritism people exhibit towards their own children? Actually, no.  As adult human beings, how many children we care about, and how much, is a curiously malleable aspect of our personalities. People love their adopted children dearly. And it is hard to coach a soccer team, be a Cub Scout den leader, or run a math club without starting to care about the kids one works with.

Growing up, I was often told “You love those whom you serve.”  That is a true principle of psychology. If you help someone out without too much of an ulterior motive, parts of your brain outside the localized glow of consciousness start trying to make sense of why you are being so nice. A handy explanation for your subconscious to turn to is that whoever it is means something to you. And this process of what in economists’ jargon would be called “developing a new altruistic link” works even if you know full well that it is happening. I remember when bargaining with the head of my department over the terms on which I would serve (a now completed term) as director of our Masters of Applied Economics program knowing that I had to be ready for a situation in which I would come to care about those students, even though I didn’t know them yet.

Community and religious organizations that get people involved in helping others—especially when they get people involved in helping others who are in especially bad situations—do a lot to help generate new altruistic links that make the world a fairer, more benevolent place in ways that come easily to us, psychologically, after getting over the initial hump of dealing with someone new. Strangers become friends. And our friends’ problems become our own.

Even government policy can help. Paying taxes does very little toward making us care about those who are helped from those tax revenues. But if, instead of raising taxes, we insisted that those who are comfortable contribute a substantial amount to a charity of their choice, as I advocated in my column “Yes, there is an alternative to austerity versus spending: Reinvigorate America’s nonprofits,” we would care more. And caring more, we would be likely to volunteer our time as well as giving money. And best of all, our children would see us helping other people’s children, and learn early on that loving others—even beyond our own families—is what brings us to the highest level of our own humanity.

# Reihan Salam: Miles Kimball’s Quixotic but Interesting Tax Proposal

Link to Reihan Salam’s National Review essay "Miles Kimball’s Quixotic but Interesting Tax Proposal"

I was pleased to belatedly run across Reihan Salam’s discussion of my proposal to provide key public goods with a minimum of tax distortion by expanding the non-profit sector rather than expanding government. In Reihan’s article, “Miles Kimball’s Quixotic but Interesting Tax Proposal,” Reihan says it might not curtail growth in government spending, but then continued:

What Kimball’s proposal does do, however, is address the normative demands made by egalitarians for higher taxes on the affluent (the notion of paying your fair share) while not directly addressing this structural dynamic. This is arguably a feature of Kimball’s proposal and not a bug, as it undermines the most potent case for higher taxes (the rich should bear more of the burden of making the investments we need to help vulnerable people flourish) without effectively rewarding public sector inefficiency.

Unfortunately, as Kimball would surely acknowledge, this proposal is wildly unrealistic, in no small part because it would drive a shift in resources from the public sector to civil society organizations that will embrace a wide variety of business models, not all of which will be incumbent-friendly. And over time, one assumes that incumbents will work to stymie empowering innovations in this space that prove threatening. That doesn’t change the fact that Kimball’s proposal is extremely interesting.