I have noted before that two of America’s best-known economists, Paul Krugman and Joseph Stiglitz, both Nobel Prize winners, are in extreme disagreement on the causes and implications of and remedies for, America’s inequality crisis. Both are politically progressive, but their disagreement is profound and fundamental. Quite literally, it affects what they think about how a modern capitalist market economy like the U.S. economy works and grows. Of course, they agree that our federal government is part of the economy, and that what it does and doesn’t do matters a great deal. Neither of them is intellectually even close to the insensible libertarian economic ideology. But I am prompted to publish this short post today because of Paul Krugman’s Op-ed in this morning’s New York Times (8/21/2015), “Debt is Good” (here). Krugman’s worldview is considerably different from that explained in detail Stiglitz more than two years ago in his book The Price of Inequality, and also more recently in a New York Times Op-ed (4/14/2014): “A Tax System Stacked Against the 99 Percent, (here).
In “Debt is Good,” Krugman re-emphasizes the arguments about public debt he has been making for a long time:
Believe it or not, many economists argue that the economy needs a sufficient amount of public debt out there to function well. And how much is sufficient? Maybe more than we currently have. That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.
I know that may sound crazy. After all, we’ve spent much of the past five or six years in a state of fiscal panic, with all the Very Serious People declaring that we must slash deficits and reduce debt now now now or we’ll turn into Greece, Greece I tell you.
But the power of the deficit scolds was always a triumph of ideology over evidence, and a growing number of genuinely serious people — most recently Narayana Kocherlakota, the departing president of the Minneapolis Fed — are making the case that we need more, not less, government debt.
Krugman argues that government debt can do useful things, like pay for needed infrastructure improvements, and that a time of extremely low interest rates is a good time to borrow. Beyond that, he concurs with the idea that “having at least some government debt outstanding helps the economy” because “the debt of stable, reliable governments provides ‘safe assets’ that help investors manage risks, make transactions easier and avoid a destructive scramble for cash.”
Now, in principle the private sector can also create safe assets, such as deposits in banks that are universally perceived as sound. In the years before the 2008 financial crisis Wall Street claimed to have invented whole new classes of safe assets by slicing and dicing cash flows from subprime mortgages and other sources.
But all of that supposedly brilliant financial engineering turned out to be a con job: When the housing bubble burst, all that AAA-rated paper turned into sludge. So investors scurried back into the haven provided by the debt of the United States and a few other major economies. In the process they drove interest rates on that debt way down.
We need to take a close look at this perspective: There is certainly some false ideology behind the view that more government debt is always tolerable, and that centers around the idea, promoted for more than the last one-half century by Paul Samuelson, that the U.S. economy will always grow itself out of decline and, once at full, optimal employment and running on all cylinders, will not have to worry about government debt. That fantasy is based on a lot of assumptions that don’t pan out, like perfect competition, perfect efficiency, continuing full employment, and so on — and notably, it takes no account of the drag on growth caused by the ever-increasing concentration of income and wealth at the top, and the increasing inequality caused by the interest on the debt itself. It further assumes responsible debt management by the government, and that has been lacking since 1980.
Indeed, the debt has grown continuously since 1980, in response to tax cuts at the top of the income ladder. The debt was needed to replace revenues lost due to the tax cuts for the wealthiest taxpayers, and it has effectively financed those cuts. Now, over forty years later, the total of the national debt has grown to over $18 trillion, and the federal government is running deficits every year, so the debt is growing. The holders of the U.S. debt have what is known as a “perpetual annuity,” because none of the principle is being repaid, but they collect continuously accruing interest.
Even though interest rates are low today, the question is, with the national debt at over $18 trillion and growing, and interest obligations on the existing balance compounding exponentially, don’t we have to worry about, at some point, stopping the bleeding? I addressed my concerns in this area in detail in an earlier blog post (“Inequality and Debt, Dysfunctional Forecasting, and the Discomfort Zone on the Left” (here). and in letters to the editor of the Albany Times Union (“Reinstating higher tax levels crucial,” 1/21/2015 (here); “Tell truth about interest on debt,” 8/19/2014 (here).
The Congressional Budget Office, in its Update to the Budget and Economic Outlook: 2014-2024, August 2014 (here) warned (p. 2):
The persistent and growing deficits that CBO projects would result in increasing amounts of federal debt held by the public. * * * The large and increasing amount of federal debt would have serious negative consequences, including the following:
* Increasing federal spending for interest payments,
* Restraining economic growth in the long term,
* Giving policymakers less flexibility to respond to unexpected challenges, and
* Eventually increasing the risk of a fiscal crisis (in which investors would demand high interest rates to buy the government’s debt.
In its February 2014 outlook (here), CBO stated: “Over the next decade, debt held by the public will be significantly greater than at any time since just after World War II. With debt so large, federal spending on interest payments will increase substantially as interest rates return to more typical levels” (p. 7).
CBO’s projections for the growth of debt interest, relative to federal budget items, is alarming: “Net interest,” that is interest paid out by the federal government net of interest collected from various sources, was expected to more than triple from 2014 to 2024, “the result of both projected growth of federal debt and a rise in interest rates.” (February report, p. 3 In the February report, net interest was projected to rise from $233 billion in 2014 to $880 billion in 2024. In the August update, these projections were reduced slightly, from $231 billion to $799 billion.
Leaving aside forecasting issues, and CBO’s failure to model the effect of increasing income and wealth redistribution on growth, the growth of net interest is swamping federal discretionary expenditures. Over the entire period, the defense budget is more than one-half of all discretionary spending, and it was projected in both the initial and revised Outlook to grow from $594 billion in 2014 to $716 billion in 2024. Under the initial projection, net interest would exceed the entire defense budget by 2021, and under the reduced projection of net interest, it would roughly equal the defense budget by 2022.
It is inconceivable, in these circumstances, that the federal debt could be considered “safe assets,” and the CBO’s concerns about a fiscal crisis materializing seem very real. Referring to the Crash off 2008, Krugman said: “When the housing bubble burst, all that AAA-rated paper turned into sludge. So investors scurried back into the haven provided by the debt of the United States and a few other major economies. In the process they drove interest rates on that debt way down.” Why should investors apply different standards to U.S. government debt? What would it take, we have to wonder, for the national debt to turn into sludge?
Stiglitz has a much more realistic perspective on all of this. He warns about the dangers of excessive debt, and recommends a series of reforms to halt the redistribution of income and wealth to the top, a process which, after all, has resulted in growing bubbles of student debt, automobile debt, general consumer debt and more home mortgage debt. In his 2014 Op-ed, Stiglitz stated:
What should shock and outrage us is that as the top 1 percent has grown extremely rich, the effective tax rates they pay have markedly decreased. Our tax system is much less progressive than it was for much of the 20th century. The top marginal income tax rate peaked at 94 percent during World War II and remained at 70 percent through the 1960s and 1970s; it is now 39.6 percent. Tax fairness has gotten much worse in the 30 years since the Reagan “revolution” of the 1980s.
Of course the issue of the progressiveness of America’s taxation, from top to bottom, is more complicated than just the top rate, but the work done by economists Emmanuel Saez, Gabriel Zucman, and Thomas Piketty, among others, has made it clear that income is concentrating very high within the top 1%, and even high within the top 0.1%. Consequently, the top marginal FIT rate has enormous consequences for growth. By 2014, the wealth of the top 1% had increased by more than $20 trillion since the inauguration of the Reagan revolution. All new income produced by any stimulation more federal borrowing might provide, in current circumstances, is simply ending up in the top 1%.
It appears to Krugman, apparently, that we must choose between increasing the money supply even more or increasing the progressiveness of taxation, and noting the intransigence of the wealthy and their GOP spear carriers, he has evidently opted to argue for the former. But the income and wealth is being siphoned off at the top and removed to offshore havens or sunk into expensive mansions, yachts, private airplanes, rare works of art, and real estate, all at rapidly inflating prices. The velocity of money is substantially slowed as it is kept pout of the hands of people who need it and would spend it.
There is no alternative but to reform the tax system significantly, to increase its effective progressiveness. For everyone’s sake, we need to appreciate that taxing the rich is not only the best option, it is the only workable option left.
JMH – 8/21/2015