The President’s fiscal policy is based upon a flawed health care premise, and the flaws are becoming apparent to a wider audience.

The Administration’s fiscal strategy is to increase short-term spending (and not just on health care) and more than offset those spending increases through long-term reductions in federal health care spending.

In theory this strategy could work, but by ducking painful policy choices on health care reform that would actually reduce long-term health care spending, the President and his team have placed their health care and fiscal policy strategies in jeopardy.

Flaw 1: The arithmetic is nearly impossible.  These bills start by increasing federal health spending 10-15% by creating a new entitlement.  That digs a huge hole before beginning to address the existing fiscal problem.

Flaw 2: As it becomes increasingly more difficult to pass health care reform legislation, the Administration is lowering the bar to say such legislation must not increase the long-term deficit (rather than must reduce it).  But to make their fiscal policy case, the Administration needs to be able to demonstrate that health care reform will reduce long-term deficits.

Flaw 3: The Administration has not recommended policies that would actually reduce long-term federal health spending.  When experts (like CBO) point this out, the Administration misrepresents the analysis and repeats their claims of long-term savings.

As CBO has dismantled this argument, it has placed health care legislation in jeopardy.  In addition, the lynchpin of the President’s fiscal policy case is buckling.

Flaw 4: The Administration says the long-term savings will exist, but the savings are too nebulous to be precisely scored.  What, then, do they plan to display in next year’s President’s budget if they are successful?  At some point someone would have to attribute specific long-term budgetary effects to an enacted health care reform bill.  You can’t just hand-wave past this problem forever.  It will catch up to you.

Challenge 1: I challenge the Administration to publish their own estimate of long-term budgetary savings from any of their long-term proposals.  (They can’t because their professional estimators agree with CBO.)

Let’s watch how NEC Director Dr. Larry Summers struggled with these flaws yesterday on NBC’s Meet the Press with host David Gregory.

SUMMERS:  That’s why the president has made health care a central issue in long-term deficit reduction.  It’s going to be the largest part of the federal, the federal budget.  … So we’re going right at the deficit, but we’re going at the issue that’s measured in the hundreds of billions of dollars, federal dollars, which is federal health care spending.  And that’s the big fight the President’s committed to.

…

GREGORY:  The difficulty of deadlines being missed and more public opposition to health care leads to the question of whether or not the president is losing the economic argument, that is the argument that health care is essential as an economic fix.

SUMMERS: It is essential as an economic fix. It’s essential because of how much of the federal budget health care represents. It’s essential because it’s so important for the competitiveness of American businesses. You know, for some of the automobile companies, the health insurance companies are actually their largest supplier. And it’s essential to slow the growth of health costs if American families are going to see rising wages that rise ahead of inflation. So it is essential.

Flaw 5: CBO says the House bill would increase the budget deficit over the next ten years.  They’re $239 B short.

Flaw 6: CBO says the House bill will result in bigger and ever-increasing deficits in the long run.  This is because the bill starts with a huge spending increase, and then offsets fast-growing health spending increases with slow-growing tax increases.

Flaw 7: While health cost growth is a huge and growing federal budget problem today, it’s actually not the largest source of growth for the next 15-20 years.  Demographics and aging of the population is.  To address this one needs to change the demographic parameters of Medicare, Medicaid, and Social Security.  By ignoring demographics, the Administration can punt on Social Security reform (which Speaker Pelosi definitely does not want to do.)  But even if health reform legislation achieved the President’s stated goals, the benefits would build very slowly over time.  We would still have to address the medium-term demographic cost driver.

Flaw 8: Dr. Summers is right that we need to slow health cost growth “if American families are going to see rising wages that rise ahead of inflation.”  That is why rising health costs do not harm the competitiveness of American businesses.  They hurt the workers at those businesses.  In addition, the health insurance mandates now trumpeted by the President and Speaker would raise premiums costs for most Americans.

Let’s return to Mr. Gregory and Dr. Summers:

GREGORY: That’s a very important point, and yet the CBO, the Congressional Budget Office, has looked at this, a nonpartisan actor in this debate, and has said there is a shortfall in paying for it even over the first decade, and that shortfall grows in subsequent decades.

As you look at these health care plans, do there have to be fundamental changes if you’re going to avoid adding to the deficit down the line?

SUMMERS: CBO said that about one of the bills that’s passed, one of the committees. This is why the discussions are continuing. No bill is going to move forward that is not over the first 10 years scored by the CBO as budget neutral.

But the President’s — in addition to insisting on budget neutrality, which we didn’t use to do, the President’s doing another important thing. It’s what we’ve called a belt-and-suspenders approach. There’s some things — how we pay drug companies, for example — where you can do the accounting very accurately and you can see what happens to the deficit.

There are other things, encouraging — encouraging preventive care, taking the whole reimbursement system out of politics — where it’s much more difficult to do the exact calculation.

And so the CBO doesn’t give us any credit for them even though most people would say that, over time, they’re likely to have some benefit. And so we’re doing both sets of things. And so I think we’ve got a lot of basis for being optimistic that, whatever the CBO says, it’s going to end up better. But we’re being very conservative. That’s why it’s belt-and-suspenders. We’re not taking any account of that second set of changes, the preventive care and all of that.

This is the most fiscally responsible approach to introducing a major structural change in the economy that’s ever been pursued. If you look at what happened with Medicare; if you look at what happened with prescription drugs; if you look at what happened when food stamps was introduced, there has never been this degree of careful scrutiny of long-run — long-run cost impacts.

And it’s right because the center of this has to be containing health care costs, otherwise it’s not going to work for most families.

Flaw 9: CBO did not say that it’s difficult to calculate how much the President’s “IMAC” Medicare commission would save.  CBO said, “enacting the proposal, as drafted, would yield savings of $2 billion over the 2010-2019 period … in CBO’s judgment, the probability is high that no savings would be realized … Looking beyond the 10-year budget window, CBO expects that this proposal would generate larger but still modest savings on the same probabilistic basis.”

Challenge 2: I challenge the Administration to produce three experts who would say that the specific IMAC legislative language offered by the Administration would produce significant long-term budget savings.

Flaw 10: While the Administration asserts that providing more information by itself would significantly slow the growth of health spending, most (all?) health experts say you also have to change incentives.  Here’s CBO:

Other approaches – such as the wider adoption of health information technology or greater use of preventive medical care – could improve people’s health but would probably generate either modest reductions in the overall costs of health care or increases in such spending within a 10-year budgetary time frame.  Significantly reducing the level or slowing the growth of health care spending would require substantial changes in those incentives.

The Administration’s health care reform and fiscal policy strategies are based on flawed premises.  When neutral and non-partisan referees like CBO point out these flaws, both strategies collapse.  The damage to the President’s health care reform effort is evident.  I think the damage to his fiscal policy strategy will soon become apparent as well.

(photo credit:  Collapsed by Martin Cathrae)

The Administration’s flawed health care argument threatens their fiscal policy strategy

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. CBO Director Elmendorf destroys a core Presidential health care argument
2. Dr. Krugman telegraphs the Left’s long-term fiscal strategy
3. A health care fallback strategy, or merely a messaging shift?

President Obama is scheduled to hold a press conference tomorrow (Wednesday) evening at 8 PM EDT.

I hope the questions are better than the one asked by Jeff Zeleny of the New York Times at the President’s 100-day press conference on April 30th:

During these first 100 days, what has surprised you the most about this office, enchanted you the most about serving in this office, humbled you the most and troubled you the most?

In case any members of the White House press corps are looking for more rigorous questions focused on economic policy, I offer the following for your consideration.

Economy

1. The U.S. economy has lost 2.64 million jobs since you took office.  The unemployment rate is 9.5% and rising.  The good scenario is one in which the unemployment rate begins to decline early next year.  The Vice President said your Administration misread the economy.  You said you had incomplete information when proposing the stimulus.   Yet you have said you would not change anything about the stimulus if you could.  If the facts have changed, why doesn’t it make sense to change your policy?
2. Last month’s jobs report was the first since you took office that was worse than the prior month.  Do you think the economy is getting stronger or weaker right now?  If the next jobs report gets still worse, will you re-evaluate the need for a change in fiscal policy?
3. Do you maintain your promise not to allow taxes to be raised on people earning less than $250,000 per year?  Will you insist that health care legislation conform with this commitment?
4. Chrysler and GM have exited bankruptcy.  Are U.S. taxpayers done subsidizing these firms?  What is your exit strategy from taxpayers owning much of GM and Chrysler?
5. You proposed spending money from the TARP to prevent foreclosures, help small businesses, and to buy toxic assets from banks.  In June CBO said they had found no evidence that any money has been spent for any of these programs.  How many foreclosures have been prevented, how many small businesses have received loans from, and how many toxic assets have been purchased?

Health care

1. You have insisted that health care reform “bend the cost curve down.”  CBO Director Elmendorf says the bills being debated would instead raise the health care cost curve and would increase long-term budget deficits.  Will you continue to insist that health care reform not increase the deficit?
2. Your Administration has said that health care reform is the key to addressing our long-term budget problem.  Yet you have adopted a lower standard, that health care reform legislation simply does not make our deficit problems worse.  If health care reform leaves the unsustainable budget situation unchanged, and since CBO says your budget would result in nine trillion dollars of new debt over the next decade, then how else do you propose to deal with the projected explosion of government debt over the long run?
3. You have said transparency is a top priority.  Yet you are calling on Congress to pass a trillion-plus dollar spending bill before CBO has had time to estimate its full effects.  In addition, your Administration is delaying release of the new economic projections and deficit estimates until after Congress votes on this massive new spending bill.  Will you commit now that you will not ask Members of Congress to vote on this massive new spending commitment until your Administration has met its legal obligation to provide an updated economic forecast and deficit projection, and until CBO has provided Congress with transparent and complete analysis of the bill?
4. On June 15th you said, “If you like your health care plan, you will be able to keep your health care plan.  Period.  No one will take it away.  No matter what.”  Yet CBO says these bills would cause a few million Americans who now have employer-provided health insurance to lose it, as their employers would try to push costs and people onto taxpayer-subsidized programs.  Last Thursday in New Jersey you seemed to redefine your promise when you said, “When I say, ‘If you have your plan and you like it, … what I’m saying is the government is not going to make you change plans under health reform.”  And at your televised forum, you said, “If you are happy with your plan, and if you are happy with your doctor, we don’t want you to have to change.”  Do you believe your first promise was too strong?
5. In a February 2008 debate with then-Senator Clinton you opposed an individual mandate to buy health insurance.  In that debate you said, “In some cases, there are people who are paying fines and still can’t afford it, so now they’re worse off than they were.  They don’t have health insurance and they’re paying a fine.  In order for you to force people to get health insurance, you’ve got to have a very harsh penalty.”  Now you are supporting a bill that would force people to buy health insurance, and that CBO says would still result in eight million people not having health insurance and paying higher taxes.  How do you explain to those eight million uninsured people why you now support the mandate and “very harsh penalty” they would have to face, and which you opposed during the campaign?
6. Experts across the policy and political spectrum say that repealing or limiting the tax exclusion for employer-provided health insurance is a good way to bend the health cost curve down.  Some powerful unions oppose this change.  Your position has so far been ambiguous.  Do you think this change would be good policy?  Are you willing to support it if it attracts Republican votes?
7. Your party controls the White House, has a 38+ seat margin in the House, and has the 60 Senate seats needed to overcome any filibuster.  How can Republicans be holding up health care reform?
8. Most members of Congress who oppose these health care bills argue they have a better way of reforming health care, such as the Ryan-Coburn bill.  Why is it fair to accuse them of defending the status quo?  Can you name a Member of Congress who has explicitly argued for the status quo, rather than just arguing against your preferred alternative?
9. You campaigned against Washington special interests and have accused them of attempting to block health care reform.  Yet your Administration has negotiated and supported deals made behind closed doors with some of these same interests, and you have announced those deals here at the White House flanked by Washington lobbyists representing HMO’s, drug companies, hospitals, doctors, unions, and nurses.  How is this consistent?

Energy & Climate change

1. The Indian government told Secretary Clinton that India will not agree to limit its carbon emissions.  The Chinese have sent the same signal.  Are you willing to sign a new climate agreement that does not contain binding commitments by China or India to reduce or slow the growth of their emissions?
2. Does it make sense for the U.S. to impose higher energy costs on American workers and manufacturers if the two largest developing economies are unwilling to slow their emissions growth?  Won’t that just disadvantage American workers with little reduction in future global temperatures?
3. If the Senate cannot pass a cap-and-trade bill this fall, will you ask Congress to send you a smaller clean energy technology bill before you go to the global climate change discussions in Copenhagen this December?
4. Do you support the expansion of nuclear power in the U.S.?  If so, what are you doing to encourage it?  And where are you going to store the nuclear waste, given the strong opposition of Senate Majority Leader Reid to storing it in Nevada’s Yucca Mountain?

Trade

1. The top Democrat and Republican on the Senate Finance Committee have called for you to submit to Congress for their approval the signed Free Trade Agreements with U.S. allies Colombia, Panama and South Korea.  Why have you not submitted them to Congress?  When will you do so?
2. At the G20 and G8 Summits you joined other leaders in renouncing protectionism and committed to concluding the Doha Round of global trade talks.  What steps are you taking to roll back protectionist measures the U.S. has taken, such as Buy America, and what concrete steps are you taking to advance the Doha Round?

The President and Congress are considering changes in economic policy that would have massive effects if adopted.  I hope the White House press corps asks rigorous questions that can better inform the economic policy debate.

(photo credit: whitehouse.gov)

20 questions for the President’s press conference

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. The President’s press conference: climate change
2. The President’s press conference: health
3. Six month economic policy status update

Everyone wants to know when the U.S. economy will start growing.  I will focus on a related question:  when will the stimulus law begin to have a significant positive effect on U.S. economic growth?  And could it have come sooner if the Administration had done something different?

I believe the Administration made an enormous mistake in its legislative implementation of the stimulus.  As a result, the boost to GDP will come six to nine months later than it needed to (maybe more).  Given the President’s desire to do a large fiscal stimulus, and given his policy preferences, he could have had a different bill that would have been producing significant GDP growth beginning now, rather than in the middle of next year.  That’s a huge mistake with real consequences for the U.S. and global economies.

To illustrate this point, let me classify four types of fiscal stimulus:

1. a permanent tax cut;
2. a temporary tax cut;
3. one-time checks to people independent of their tax liabilities; and
4. increased government spending through federal and state bureaucracies:  infrastructure, energy spending, etc.

There is of course a fifth option:  no fiscal stimulus law.

If you’re going to do a fiscal stimulus (big if), the best kind is a permanent tax cut.  It is effective, efficient, and fast:

• effective – People spend a large proportion of a permanent tax cut.  This is derived from Milton Friedman’s “permanent income hypothesis.”
• efficient – People spend their own money on themselves, so they waste very little of it, and they spend it on things that matter to them.  Again, see Milton Friedman.
• fast – Checks are delivered quickly, and people spend most of their own money soon after they get the check.

This was part of the short-term logic behind the 2003 tax cut, which we designed to foster both short-term and long-term economic growth.  I also have a strong general policy preference for lower taxes rather than more government spending, but that’s a separable question from how it works as short-term stimulus.

In 2008 we knew we could not get a Democratic Congress to enact a permanent tax cut.  Q:  Do you then go for a temporary tax cut, or do nothing?  The President thought the risks of an economic slowdown in 2008 were significant enough that it made sense to pursue a (second best) temporary tax cut with the Congress.

Like the 2003 law, the 2008 law got the bulk of its short-term GDP boost by advancing tax refunds from the year to come, and delivering them as checks from the IRS to taxpayers.  As in 2003, the checks were delivered to taxpayers in the summer (mid-June to early-August), and consumers immediately started spending a portion of their rebates.

Because the 2008 law was a temporary tax cut, taxpayers spent a smaller proportion of it than anyone would have liked.  While designing the law, we assumed about 1/3 would be spent, and much of that fairly quickly.  The rest would be saved, which is also good but doesn’t help short-term GDP growth.  Economists agree that GDP in Q3 and Q4 of 2008 was higher than it otherwise would have been because of the 2008 stimulus law.  It was efficient, fast, yet only partially effective, with a smaller GDP boost than we would have liked:

• efficient – People were again spending their own money on themselves.  You get very little waste, and people know what they want and need.
• fast – Checks were delivered quickly, and much of the spending that did occur happened in Q3, with some in Q4, and with very little left by Q1 of 2009.
• only partially effective – Because it was a temporary tax cut, people saved a lot of their checks, as we expected.  Still we got a GDP bump in Q3 and Q4, and in retrospect we certainly needed it.

The 2008 law was mostly (2) from my list above – a temporary tax cut.  Some of the money went to (3), checks to people who didn’t pay income taxes.  This was necessary to reach a compromise with a Democratic Congressional leadership that placed a high priority on the distributional effects of the law.  Speaker Pelosi insisted that poor people who owed no income taxes still get “rebate” checks, and that high-income taxpayers get nothing.  So the 2008 stimulus law was mostly (2) with a little bit of (3).

Now fast forward to January of 2009, when President Obama proposed an enormous fiscal stimulus.  The President’s mistake was in largely deferring to Congress on the composition of the stimulus bill. Rather than allowing Congress to pump hundreds of billions of dollars through slow-spending and inefficient bureaucracies, the President should have insisted that Congress instead send all the funds directly to the American people and let them spend it quickly and efficiently.  Given his policy preferences, he could have directed a large share of those funds to poor people who don’t pay income taxes.  He could have again mislabeled these payments as “tax cuts,” or just correctly labeled them as one-time entitlement payments.  I would not have liked that policy, but it would have generated a faster macroeconomic boost than what he allowed Congress to do instead.

Let’s compare the two scenarios.  The enacted 2009 stimulus is:

• effective (eventually) – Most of the spending through government bureaucracies will (eventually) increase GDP.  Some of the funds transferred to State governments will be used to offset State spending or tax cuts that otherwise would have occurred, so there’s a loss.  But clearly the proportion of the $787 B that will eventually increase GDP will be high, and much higher than if all the funds were given to individuals and families.
• inefficient – It will be inefficient in two senses.  The spending represents the policy preferences of legislators (and all their ugly legislative deals and compromises), rather than the choices of hundreds of millions of Americans who presumably know better how they would like money spent on them.  The spending will also be wasteful, and we are starting to see signs of this in the press.
• s-l-o-o-o-w – CBO says that $25 B of spending had gone into the economy by May 22nd.  That’s less than 4% of the total budgetary impact of that bill.  Other news reports suggest that about $40 B is in the economy if you include the revenue side.  Remember that almost all of the 2008 stimulus was in private hands by August 1.  We will get very little GDP boost from fiscal stimulus in Q3 of 2009, and not much in Q4 either.  The stimulus will begin to ramp up in Q1 of next year, and be in full swing by Q2 and Q3 of 2010.

Had the President instead insisted that a $787 B stimulus go directly into people’s hands, where “people” includes those who pay income taxes and those who don’t, we would now be seeing a stimulus that would be:

• partially effective but still quite large – Because it would be a temporary change in people’s incomes, only a fraction of the $787 B would be spent.  But even 1/4 or 1/3 of $787 B is still a lot of money to dump out the door.  The relative ineffectiveness of a temporary income change would be offset by the enormous amount of cash flowing.
• efficient – People would be spending money on themselves.  Some of them would be spending other people’s money on themselves, but at least they would be spending on their own needs, rather than on multi-year water projects in the districts of powerful Members of Congress.  You would have much less waste.
• fast – The GDP boost would be concentrated in Q3 and Q4 of 2009, tapering off heavily in Q1 of 2010.

Why did the President not do this?  Discussions with the Congress began in January before he took office, and he faced a strong Speaker who took control and gave a huge chuck of funding to House Appropriations Chairman Obey (D-WI).  I can think of three plausible explanations:

1. The President and his team did not realize the analytical point that infrastructure spending has too slow of a GDP effect.
2. They were disorganized.
3. They did not want a confrontation with their new Congressional allies in their first few days.

I think the Administration now recognizes this problem.  Last month when they released a CEA paper “Estimates of Job Creation from the American Recovery and Reinvestment Act of 2009,” the paper danced around the timing of job growth and government outlays in 2009 and 2010.  Tips for reporters:  (1) ask the Administration to give you OMB estimates of quarterly cash flows for the stimulus law, and (2) ask them to give you the quarterly GDP and job growth estimates behind this CEA paper.  I know the first one exists, and I’d bet heavily the second does as well.

Fortunately, CBO Director Doug Elmendorf just gave a presentation titled “Implementation Lags of Fiscal Policy” to the IMF’s conference on fiscal policy.  All of the following data are from his presentation.

The final 2009 stimulus law broke down like this:

The problem is that only 11% of the first line (discretionary spending) will be spent by October 1 of this year.  In contrast, 31-32% of the entitlement and tax cuts lines will be out the door by that time.  (I have questions about the speed of the entitlement part.  The bulk of that is Medicaid spending, and it’s not clear to me that a Federal payment to a State means the cash is immediately flowing into the private economy.)

If we extend our window to October 1, 2010, then less than half the discretionary spending will be out the door, while almost 3/4 of the entitlement spending and all of the tax cuts will be out the door and affecting the economy.  The largest part of the stimulus law is therefore also the slowest spending part.  This is fine if you’re trying to increase GDP growth over the next 2-4 years.  If you’re going for short-term GDP growth, it makes no sense.

Director Elmendorf drills down further into discretionary spending and shows that defense spending happens quickly, highways and water extremely slowly:

• If you allocate $1 to defense spending, 65 cents has been spent within one year.
• If you allocate $1 to highway spending, 27 cents has been spent within one year.
• If you allocate $1 to water projects, only 4 cents has been spent within one year.

In fact, the infrastructure spending in the stimulus law will peak in fiscal year 2011, which goes from October 1, 2010 to September 30, 2011.  That’s too late from a macro perspective.

The Director further points out that the 2009 stimulus law created many new programs.  This slows spend-out, as it takes time to create and ramp up the new programs.

The Administration has made much of working with federal and state bureaucracies to find “shovel-ready” projects to accelerate infrastructure spending.  All of my conversations with budget analysts suggest this claim is tremendously overblown, and Director Elmendorf asks, “Is this practical on a large scale?”

The 2009 stimulus law will increase U.S. economic growth.  But the actuals are matching the budget analysts’ projections for the speed at which that effect will occur.

I would not have liked a stimulus law that would have given cash to people who didn’t pay income taxes.  But from a macroeconomic perspective, we need the faster economic growth now.  Had the President and his team insisted on giving money to people (taxpayers or not) rather than to bureaucracies, we would be seeing a huge growth spurt in Q3 and Q4 of this year.

It is sad that instead we have to wait until the middle of next year because the White House deferred to Congressional desires to spend on infrastructure.  This strategic mistake was avoidable, and the recovery will be delayed because of it.

Will the stimulus come too late?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. A bipartisan economic booster shot
2. A “second stimulus”?
3. Stimulus 2008: a need for speed

There’s a lot to say, so I’m going to break this up into three big parts.

1. what the President proposed;
2. why the President proposed it; and
3. today’s bipartisan agreement, and why we support it.

1.  What the President proposed last Friday

Here are the President’s remarks from last Friday.  They’re short and well worth reading, and they contain a lot of substantive content.

To put it simply, the President proposed that Congress pull the fiscal policy lever to increase economic growth (GDP) this year.  You’ll remember (or not) from your macroeconomics course that there are two basic governmental tools for addressing the short-term economic picture.  The Federal Reserve has a monetary policy lever, and the Congress has a fiscal policy lever.  The Federal Open Market Committee pulled their lever on Tuesday, by cutting both the federal funds rate and the discount rate by 0.75 percentage points (experts say “75 basis points”).  We studiously refrain from commenting on the Fed and its tools.

Last Friday the President described the shape of an effective growth proposal.  He did this instead of laying out a detailed proposal, in part at the request of Congressional leaders on both sides of the aisle, to allow them some flexibility in their negotiations.  It appears to have worked.

To actually increase GDP in the near term, an effective growth package must be:

• Big enough to move the needle on a $14.5 trillion economy.  The President proposed a package that’s 1% of GDP, or about 145 billion dollars in 2008.  That’s 50% — 100% bigger than what Congress has been discussing for the past two weeks.
• Immediate.  This means (i) Congress should pass legislation immediately.  (ii) Policies with immediate macro effects are better than those with lagged effects.
• Based on tax relief.  Individuals, families, and businesses will react quickly (and more effectively) if they are deciding how to spend more of their own money.  Government bureaucracies react slowly.
• Broad-based.  Many were emphasizing “targeted.”  In contrast, we think policies should be neutral and distort decisions as little as possible.  We have a macroeconomic focus on sectors of the economy, like increasing consumption and business investment.  This is in contrast to those who implicitly have a microeconomic focus on particular constituencies in American society.  There’s also a difference in philosophical approach, between helping the American economy as a whole, to benefit everyone, and helping those parts/members of the American economy that someone deems to be “most in need of assistance.”  (In retrospect, some were also using “targeted” to refer to the income distribution of tax relief.  In this respect, we think that the compromise announced today addresses their concerns.)
• And temporary.  As a general matter, we prefer long-term policy changes, especially on the tax side.  In this case, our policy focus is insuring against drops in GDP growth without significantly raising the national debt.  That necessitates short-term and temporary policy changes.  (It also dramatically increases the chances of a bipartisan legislative success.)

The President also described a couple of things that move in the wrong direction.  To be effective, a growth package must not:

• Raise taxes.
• Waste money on federal spending without an immediate positive effect on GDP growth.

In addition to these principals, the President suggested that a growth package should try to increase consumption (70% of our economy) and business investment (11%).  The President said that to be effective, a growth package must:

• Include tax incentives for American businesses to invest (especially small businesses).
• Include “direct and rapid income tax relief” to increase consumer spending.

2.  Why our economy needs a booster shot

Here is a memo from the Chairman of the President’s Council of Economic Advisers, Dr. Edward Lazear.  It goes into more substantive depth than I will do here.

Our view of where the economy is now

booster shot [boo-ster shot] (n)         An additional dose of a vaccine needed to “boost” the immune system.

You don’t get a booster shot when you’re sick.  You get it when you’re well, but you’re concerned you might get sick.  It’s a preventive measure to reduce the chance that you get sick.

Let’s start with three simple but critically important facts:

1. The single most important indicator of a healthy economy is how many people are working.  The unemployment rate is now 5.0%.  While that’s up quite a bit from 4.7% in the prior month, 5.0% unemployment is still a very good number.  Lots of Americans are working, and that’s good.  Today’s unemployment rate is below where it was (on average) in each of the last three decades.
2. The U.S. economy is growing, albeit slowly.  We had a strong 3rd quarter last year (GDP +4.9%).  But private sector projections for both Q4 of last year and Q1 of this year fluctuate around +1% (with a big error margin).  That’s a significant slowdown, and it’s slower than we would like.  (Silly but important reminder:  “slowdown” does not equal “recession.”  Slowdown means slow growth.  Recession means negative growth.  Rule of thumb:  a “recession” is two successive quarters of negative GDP growth.  And for the technicians, yes, the NBER’s definition is actually more complex than this.)
3. The President’s economic advisors and most private sector forecasts expect the economy to continue to grow this year, albeit slowly.  The most likely scenario is slow GDP growth through the first half of 2008.  Most also predict that growth will accelerate somewhat in the second half of the year.

It’s easy to miss these three facts, because much of the press coverage has glossed over them and instead covered the possibility of worse economic scenarios.

Future downside risks provoke economists inside and outside the Administration to recommend an economic booster shot.  Most economists raise housing problems and financial markets issues as the greatest near-term threats to continued economic growth.  Many also point to the economic drag of expensive oil.

While much of the policy and legislative discussion in the Fall was about housing finance (mortgages), the principal macroeconomic issue is the actual houses themselves.  Fast-rising house prices created an incentive for builders to keep putting up new houses beginning in 2003, and inventories built up.  When a manufacturer has lots of products in its inventory, it slows down the manufacture of new goods.  The same has happened, quite dramatically, in the housing sector.  Builders aren’t building because there’s a big supply of unsold houses on the market (with significant regional differences).

As long as housing inventories remain high:

• since supply exceeds demand, prices of new and existing houses will decline (by how much is highly uncertain); and
• builders won’t build many new houses; so
• the “residential construction” component of GDP will shrink; and therefore
• a shrinking housing sector will cause slower overall economic growth.

These adjustments in the housing sector will take some time.  We need to make sure that policy in Washington doesn’t make this problem worse.  We are also watching carefully to see whether problems in the housing sector bleed over into consumer spending.  This could happen in one of two ways:

1. If your home is worth less, you have less overall wealth.  The evidence shows that you then spend less (maybe 1 or 2% of the decline in your wealth).  This is the “wealth effect”.
2. If your home is worth less, you might be less confidence about the economy as a whole, and this might cause you to spend less.

It’s important to understand that the President’s proposal from last Friday was about the U.S. economy as a whole, and his proposal focused on consumer spending (70% of the economy) and business investment (11%).  The housing sector needs to adjust, and we can have a greater effect with fiscal policy on consumption and business investment, through the policy direction outlined by the President last Friday.

To summarize:

• Our economy is growing, albeit slowly.
• We think the economy will continue to grow, albeit slowly.  We are not predicting a downturn.
• There are risks to that growth projection, especially from housing, the financial markets, and high oil prices.
• The President proposed that Congress quickly enact legislation to address these risks.

3.  Today’s bipartisan agreement, and why we support it.

A short while ago House Speaker Nancy Pelosi (D-CA), House Republican Leader John Boehner (R-OH), and Treasury Secretary Hank Paulson announced their agreement on a growth package.  The Speaker said she intends rapid legislative action in the House.

Here’s a useful summary, followed by our evaluation of how this agreement fits with the principles the President offered last Friday.

House Bipartisan Leadership Growth Plan Agreement

What it does:

• Part I:  Personal Tax Relief ($103 B)
  • Cut the 10% tax rate in 2008 to 0% for the first $6,000 (individuals)/$12,000 (couples) of taxable income
  • Maximum rebate: $600 (individuals)/$1200 (couples)
  • Minimum (refundable) rebate check:  $300 (individuals)/$600 (couples)
  • Eligible if earned income > $3,000 (subject to income limits below)
  • Rebate phases up from $300 to $600 for those with taxable incomes ranging from $3,000 to $6,000
  • Additional refundable tax credit of $300 per child for those who otherwise receive a rebate
  • Full rebates/credits are available to those with adjusted gross income (AGI) < $75 K (individuals)/$150 K (couples)
  • Total rebate (including child credit) phases out above $75K/$150K (by 5% of AGI above those levels, until eliminated)
  • Relief provided via rebate checks sent ASAP after enactment (estimated starting date = 60 days later)
  • Examples:
    • Single parent with two children, earned income of $4,000 (has no current income tax liability).
      • Individual rebate = $300
      • Child tax credit = $600
    • Single parent with two children, AGI = $38,000, taking standard deduction.
      • Individual rebate = $450
      • Child tax credit = $600
    • Married couple with two children, AGI = $48,000, taking standard deduction.
      • Individual rebate = $800
      • Child tax credit = $600
    • Married couple with two children, AGI = $80,000 (assuming tax liability greater than $1,200).
      • Individual rebate = $1,200
      • Child tax credit = $600
• Part II:  Business Investment incentives (~$50 B)
  • Accelerated bonus depreciation of 50% in 2008
  • Increased expensing for small business (§179 limit raised from $125 K to $250K)

The agreement would also increase the conforming loan limits for Freddie Mac, Fannie Mae, and the Federal Housing Administration.

Why it is good:

• Effective: The package addresses the two major components identified by the President as essential to promoting near-term growth:  boosting consumer spending and business investment.
• Timely: The personal tax relief will begin to stimulate consumer spending and additional economic growth within about 60 days of enactment.  The business incentives will spur investment throughout 2008.
• Temporary: The package will provide immediate relief to the economy without turning away from policies to promote long-term growth and to balance the Federal budget.
• Rewards Work: Individuals must have earned income to receive the $300 rebate check.
• Broad-based: Rebates will reach 117 million households.
• Neutral: The package allows individuals and businesses to decide how best to use the relief provided.

What it does not do:

• The package does not raise taxes.
• The package is not a collection of spending programs; it does not include any government outlays beyond the minimum rebate check and refundable child tax credit.
• The package does not contain wasteful provisions that would spend money slowly, failing to meet near-term economic objectives.
• The package does not contain lender bailout provisions that would interfere with ongoing and necessary corrections in the housing sector.

I want to return to the criteria the President laid out last Friday, to see how the bipartisan agreement matches up.

1. Big The President proposed 1% of GDP, or about $145 B.  This package is about $153 B. 
2. Immediate We got a bipartisan agreement in the House even faster than we expected, thanks to the excellent work and leadership of Secretary Paulson, Speaker Pelosi, and Leader Boehner. 

   We hope for quick legislative action, and similar bipartisan support in the Senate.  TBD

   We anticipate advance refund checks could start being delivered about 60 days after the President signs the bill into law.  TBD

3. Based on tax relief The entire package is done through tax relief, excepting one mortgage-related provision (that does not affect spending).  The refundable aspects of the tax relief technically count as spending.  But the other spending items (which we opposed) are all excluded from this agreement. 
4. Broad-based It is very important to us that the government not pick particular constituencies as more “deserving” of tax relief.  The agreement largely meets that test. 
5. Temporary Every provision in this bill is effective only for 2008.
6. Don’t raise taxes. 
7. Don’t waste money on federal spending without an immediate positive effect on GDP growth. 

You can see why the President is strongly supporting this bipartisan agreement.  He said a short while ago, ““Because the country needs this boost to the economy now, I urge the House, and the Senate, to enact this economic growth agreement into law as soon as possible.  We have an opportunity to come together, and take the swift, decisive action our economy urgently needs.”

A bipartisan economic booster shot

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. The Economic Report of the President
2. Stimulus 2008: a need for speed
3. Enacting President Bush’s stimulus proposal