"The Tarp is a fiscal straitjacket"

This comment by Jeffrey Sachs in the Financial Times is broader than its title suggests. It says that the US should not run willy-nilly into enacting massive spending plans in haste. Sachs makes two core points: a lot of compromises are being made that will render big chunks of the plan ineffective and/or wasteful, and that the focus is strictly on Doing Something, Now, and the intermediate term effects are given nary a thought. If the plan merely reduces the amplitude of the downturn (likely) at the cost of hamstrung future performance, have we really come out ahead?

Obama’s willingness to compromise is serving him badly here. The Reagan Administration fought hard for what it wanted, and got about 75% (of course, the easy 75%, the tax cuts and defense spending, but not other budget cuts). Obama is willing to settle for less, and was too quick to offer the tax cuts as a compromise, which has merely emboldened the Republicans to seek even more, targeted to the affluent. Today, the Senate Appropriations Committee added $70 billion to the stimulus package in the form of alternative minimum tax relief, which will aid households earning from $100,000 to $500,000.

That is most decidedly NOT stimulus. The experience of the Bush tax rebate, which was spread across more income brackets, was that (according to a detailed analysis by Gary Shilling) over 80% was saved. A similar outcome is a given with higher income cohorts.

Admittedly, Sachs is a controversial figure. He devised the shock therapy approach used by the IMF for hyperinflation and transition from controlled economies, and later in the Asian crisis. The approach has vocal opponents (and many of the loudest are the ones who lived through it). Some of Sachs’ neoliberal/cold water Yankee mindset comes through in this piece. But Sachs more recently has argued for targeted aid for the poorest nations, contending that they are in a poverty trap, and assistance to get them to a higher level of agricultural productivity could give them the boost they need to overcome chronic deprivation.

Whether you agree with all of Sachs’ argument, his caution about undue haste is well founded and is consistent with the worries of other macroeconomists such as Willem Buiter.

From the Financial Times

:

The US debate over the fiscal stimulus is remarkable in its neglect of the medium term – that is, the budgetary challenges over a period of five to 10 years. Neither the White House nor Congress has offered the public a scenario of how the proposed mega-deficits will affect the budget and government programmes beyond the next 12 to 24 months. Without a sound medium-term fiscal framework, the stimulus package can easily do more harm than good, since the prospect of trillion-dollar-plus deficits as far as the eye can see will weigh heavily on the confidence of consumers and businesses, and thereby undermine even the short-term benefits of the stimulus package.

We are told that we have to rush without thinking lest the entire economy collapse. This is belied by recent events. The spring 2008 stimulus package of $100bn (€76bn, £71bn) in tax rebates was rushed into effect in a similar way and we now know it had little stimulus effect. The rebates were largely saved or used to pay down credit card debt, rather than spent. The $700bn troubled asset relief programme bail-out was also rushed into effect and its results have been notoriously poor.

The Tarp has not revived the banks or their lending, but it has supported a massive transfer of taxpayer wealth to the management and owners of well-connected financial institutions. Some of those transfers – as in the case of Merrill Lynch using its government-financed sale to Bank of America to enable $4bn in bonuses last month – are beyond egregious. Yet the US is now inured to corruption and in such a rush that even billions of dollars of public funds shovelled into Merrill’s private pockets in broad daylight barely merited a day’s news cycle.

The most obvious problem with the stimulus package is that it has been turned into a fiscal piñata – with a mad scramble for candy on the floor. We seem all too eager to rectify a generation of a nation saving too little by saving even less – this time through expanding government borrowing. First it was former US Federal Reserve chairman Alan Greenspan’s bubble, then Wall Street’s, and now – in the third act – it will be Washington’s.

The White House and Congress have stated an amount – $825bn to be spent mostly over two years – on top of a deficit that is already projected to reach $1,186bn in fiscal year 2009 without the stimulus package. Many of the details of allocating the $825bn are being left to Congress with the aim of reaching a bipartisan consensus. The result is shaping up to be an astounding mish-mash of tax cuts, public investments, transfer payments and special treats for insiders.

What we need is a medium-term fiscal framework, one that lays out an anticipated schedule of taxes and spending consistent with the needs of the economy and government functions. Rather than soundbites about ending pork-barrel projects or scouring the budget for waste, or about the relative multipliers of tax cuts versus spending increases (both of which depend on expectations about the future, a point mostly overlooked in the debate), we should be reflecting on certain basic fiscal facts, the most important of which is that the US government faces huge and potentially debilitating structural deficits as far as the eye can see.

In rough numbers, the US federal tax system collects about 18 per cent of gross national product, while the total of just five categories of public spending – Social Security (retirement and disability), health (Medicare, Medicaid), veterans’ benefits, defence and homeland security and interest payments – eat up about 18 per cent of GNP. Yet government has more to do – for example, providing the justice system; help for the poor and unemployed; science and technology research; energy systems, transport and other infrastructure; diplomacy and international aid; natural hazards mitigation; training; and the future costs of financial clean-up. Let us add in the fact that state and local governments are broke and need increased federal transfers, and that America’s ageing population, broken healthcare system and growing underclass all require increased fiscal attention. We currently pay for all of this, if we do so at all, by borrowing from China and from the future.

If the present stimulus package is adopted without a medium-term plan, it will go the way of the earlier stimulus package and the Tarp, yet also put the US into a fiscal straitjacket that could paralyse public sector action in critical areas for a decade or more to come. This is especially true if we allow further tax cuts during a time of fiscal haemorrhage, or give into “bipartisan” demands to make the Bush tax cuts permanent, even for the rich, as seems increasingly likely.

There are many valuable things proposed in President Barack Obama’s spending plans – such as the sums to be spent on energy, healthcare and education – but these should be incorporated into medium-term strategies rather than a grab bag of hasty short-run spending. The tax cuts that he is likely to approve in the stimulus package, and the extension of Bush-era tax cuts if that comes to pass, could close the door to these longer-term programmes; haphazard spending on these vital programmes could do the same.

Perhaps Mr Obama should reflect on the fact that the Clinton-era boom began in 1993 with tax rises and a congressional rejection of a fiscal stimulus package. This time, there is certainly a cyclical case for deficit- financed public spending, but accompanied by phased-in tax increases to provide proper financing of crucial government functions in the medium term.

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16 comments

  1. Steve

    Sachs says some reasonable things, but talking about the long view on a US political issue is naive. Just as CEOs of public companies live quarter to quarter, US politicians live election to election, and they look to buy as many votes as possible through short-term initiatives (spend or cut taxes today). The long term will be somebody else’s problem. US voters want to know what their elected officials are doing for them right now–for them personally, of course. So, the US will continue lurching from crisis to crisis, spending too much, taxing too little, taking care of all the buddies of the Congress and Administration, until the Minsky ponzi finally explodes.

    US politicians love critics who take the long view, because that kind of opposition is impotent.

  2. cap vandal

    There is some protectionist language in the bill regarding only using US produced steel, etc.

    That combined with the salvo regarding currency manipulation is not a good sign if the goal is to avoid replaying the 30’s.

    I’m wondering if that includes or excludes severstalna.

    http://www.severstalna.com/

    That’s what $150/oil will do — allow the Russians to take over and control critical industries like steel. If oil hadn’t collapsed, maybe we could have sold them GM.

  3. pj

    Your understanding of the politics is mistaken. It’s the Democrats, not the Republicans, who want alternative minimum tax relief. The AMT hits Democratic strongholds overwhelmingly — New York, California.

    Obama hasn’t compromised with Republicans on anything yet. Nor will he. His attitude was well captured when he told Republican congressmen, “I won.”

    Finally, tax relief is a stimulus even if it is saved. To have the Treasury borrow $1 trillion from abroad at 0.2% annual interest, transfer it to Americans, who save it after which it pays down debt from abroad at 8.2% annual interest saves the country $80 billion per year in interest expense.

  4. Anonymous

    Mr. Sachs says: “Yet government has more to do – for example, providing the justice system; help for the poor and unemployed; science and technology research; energy systems, transport and other infrastructure; diplomacy and international aid; natural hazards mitigation; training; and the future costs of financial clean-up. Let us add in the fact that state and local governments are broke and need increased federal transfers, and that America’s ageing population, broken healthcare system and growing underclass all require increased fiscal attention. We currently pay for all of this, if we do so at all, by borrowing from China and from the future.”

    I find it quite refreshing that the liberals are finally staring at the end game of socialism. They thought you could tax productive people and assets infinitely, either directly or through govt borrowing. Certainly none believed that we could run into terminal constraints on their grand scheme so soon.

    But people are quite trainable and we respond to incentive well. Three or four generations of increasingly socialist rhetoric and policy have finally broken down our barriers to dependency. Why save for retirement, we have the government for that. Just go on a debt binge, there’s always that government safety net. Why become an American entrepreneur and fight the bureaucrats, environmentalists, labor unions, tax man, regulators, tort lawyers, etc., etc., etc. Just another worker ant putting in 80 hour weeks to support the grasshoppers.

    This is Atlas Shrugged with a twist; the producers in our society didn’t walk away, they just joined the other side. Now time to get about the business of gnawing the last bits of tender meat from the carcass of capitalism.

  5. Anonymous

    “That combined with the salvo regarding currency manipulation is not a good sign if the goal is to avoid replaying the 30’s.”

    I challenge the assertion that today’s situation is comparable to the 30’s. In the 30’s, America was the trade surplus exporter. Raising domestic tarrifs was probably like shooting one’s own self in the foot. The actual impact of the 30’s tarrifs are cloudy, at best.

    In today’s world, trade regulation to counteract mercantilism may be exactly the club that is needed. The laissez faire economic adjustments have been subverted.

    I prefer Bernanke’s solution that Americans should modify their purchases of imported goods. Oh, that’s allready happening by force majeure. Gee ! whocouldanode.

  6. Jimmy T

    It is quite clear to Washington that the only politically acceptable solution is to either grow out of the current banking and debt crisis, or failing that, inflate our way out. Both require massive shift of private debt to public liabilities. Congress and the Fed both believe that ultimately, its the foreigner holders of US government debt who would be paying. As an American, that is the only reason why we should accept the solution of exchanging private for public debt, because push comes to shove, the US would have to default and the Chinese would end up paying. The Chinese have understood this but are either very hopeful or very naive or have no choice.

  7. sjc

    locust, research “Puritanism”.

    How does a Yankee spell program “programme”? Must have been the British editor.

  8. freude bud

    It’s a bit rich to be lectured about being “inured” to corruption by the very man whose shock therapy recommendations in Russia basically ensured the establishment of a kleptocratic society.

    He appears to think that this prescription is not likely to have similar results elsewhere.

    But he feels bad about Africa … surely targeted aid there isn’t subject to corruption concerns.

    Grrrrrrrrrrrrr!!!!!!!

  9. john bougearel

    spot on freude bud

    where do the shock therapists get off?

    The reason he feels bad about Africa is b/c they havent set up a central bank there yet. Once they can establish a do-some-ill-good central bank to help out there with foreign injections of capital, they are one step away from being inured with debt they can’t possibly repay.

    Just another Zimbabwe target for future hyperinflation

  10. john bougearel

    more disconcerting at home are the huge transfers of wealth regarding TARP in all its morphologies.

    It makes me sick.

    Buiter was too kind to MER and co. Thain raised more than $30 billion of capital from private investors with false reassurances that each raise would be the last they would need throughout the 1st half of 2008. In September 2008, he runs for cover into BAC’s arms. At the end of 2008, MER discloses more than $21 billion in losses for 2008 and $15 billion in bonuses – all this not only at taxpayer expense but that of private investors as well being told nothing but tall stories at best.

  11. Anonymous

    I don’t see anything wrong with saving. If spending only amounts to status quo then manufactures should adjust to it.

    If consumers decide to go from lavish to frugal then maybe government(s) should to.

    Spending for the sake of spending got us into this mess.

  12. Prachawan B

    “He devised the shock therapy approach used by the IMF for hyperinflation and transition from controlled economies, and later in the Asian crisis.”

    May I suggest humbly that you review your understanding of the Asian financial crisis. The “shocked therapy” prescribed by the IMF was not the same applied to Bolivia and Poland recommended by Sachs (and by the way, Sachs was not an adviser to the IMF as you might have hinted in your article, he acted as advisers to the Bolivian and Polish government). The key point in the IMF’s asian prescription was to raise interest rates to stem capital outflow, which led to widespread banks and otherwise healthy company with no foreign loans failing. Sachs and Stiglitz (and much later Krugman) were to point out that the countries which rejected this IMF doctrine, such as Malaysia and HK, had to sacrifice far less socially and economically to stabilize than those who were forced by the IMF to raise interest rates.

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