Last Sunday, I read an article in the New York Times by Catherine Rampell entitled “A Way to Overcome Debt” in which the solution to America’s federal debt problem was the judicious use of spending cuts using Canada in the 1990’s as an exemplar. I decided to deconstruct the article to see if the body of the piece supported the conclusions.
The first thing that I do is look at the background of the reporter, not as an ad hominem attack but to get a sense if possible of their stance on the issue. Her formal bio at NYT is:
Catherine Rampell writes about economics for The New York Times, where she served as the founding editor of the Economix blog. Under her stewardship the blog was honored with an award from the Society of American Business Editors and Writers. She has also received the Weidenbaum Center Award for Evidence-Based Journalism and is a Gerald Loeb Award finalist. A lifelong theater nerd, she regularly contributes to The Times's arts coverage, too.
Before joining The Times, Catherine wrote for the Washington Post editorial pages and financial section and for The Chronicle of Higher Education. She grew up in South Florida (the New York part) and graduated from Princeton.
From other sources at Princeton, she graduated majoring in Anthropology and was a legacy student whose mother graduated from the same alma mater in 1975. In a piece that she wrote for the Princeton newspaper:
In my time at Princeton, I remember a student body that seemed hyperaware of socioeconomic distinctions — and in many cases the need to show off, and pursue, wealth. Some of it had to do with the clubs, but a lot of it had to do with clothes and shopping and career choices. Signifiers like popped shirt collars, a brand logo, or a pair of men’s pastel pants were cues of some form of superior breeding (until many such signals, like the popped collar, were adopted by “the riff raff,” of course).
I conclude that she arrived at the economic desk as an preppy ingénue without preconceptions from previous encounters with economics but having a certain naiveté about her sources.
In the first paragraphs of her article she lays out her basic premise that the painless solution to the debt woes is economic growth and quotes Dean Maki, chief US economist at Barclays Capital:
The most obvious choices (to the debt crisis) are a painful reduction in spending, unpalatable tax increases, higher inflation or default. None of that would be necessary if we could indeed restore economic growth. Citizens would become richer and pay more taxes. Et voila! – a painless way out of debt.
Unfortunately during the Bush years the American debt doubled during a period of strong economic growth due to two wars, tax decreases for the rich and the drug payment supplements for seniors. If you look at the graph below from Mother Jones, you’ll see that most of the increases in income during both low growth and high growth periods of the last thirty years went to the most affluent portion of society who have numerous avenues for tax avoidance if not tax evasion. The highest marginal rate for the wealthy in the sixties was 90% while today the highest marginal rate is about 27%. From the USAtoday:
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| source: Mother Jones |
Not the best day to report this, but the IRS says 1,470 millionaires paid no federal income taxes in 2009.
Where did the money go? Tax "expenditures" (otherwise known as deductions, write-offs, subsidies or loopholes), charities, municipal bonds and tax payments to foreign governments, according to a recent IRS report …The nonpartisan Tax Policy Center reported last month that 46% of American households (known as "units") actually will not pay federal income taxes for this year nor will receive refunds. That's because of low incomes, credits for children or other dependents, or exemptions.
Besides ignoring the expenditure side of the balance sheet, note that the economist, Dean Maki, says nothing about increasing corporate taxes considering that GE which had profits of $13 billion paid no taxes but instead received a tax credit of $3.2 billion. One of the major shifts in government revenues since the fifties has been the shift from corporate to personal taxes so the approximately two trillion in corporate profits which the companies are currently sitting on has had no effect on reducing the public debt.
The next part of the story is about Ireland. From the NYT article:
Before its economy crashed, Ireland was a star of this sort of debt reduction…largely because the economy was very strong.
This story is really about shifting public debt to private debt and particularly to the mortgage debt of citizens. Ireland has the lowest corporate tax rate in Europe (15%) and a very well educated population due to a low cost, high quality school system so many corporations flock to Ireland which of course is an EU country with open access to the rest of Europe so it was a kind of tax arbitrage. The government decreased its debt by taxing the citizens who had increased their wealth through one of the largest housing bubbles in the world. In effect public debt was transferred to private debt and would ultimately fail as the real estate boom came to its inevitable end. She quoted Carmen Reinhart who is a senior fellow at the Peterson Institute for International Economics on Ireland. This is where you have to be careful about your sources. From the Naked capitalism website:
In the US, the brass-knuckle leader of the effort to convert the tattered remnants of the left to the conservative cause is the long standing entitlement foe, billionaire Blackstone Group co-founder Pete Peterson. His Peterson Foundation provides funding for a large array of organizations, including initiatives at his think tank, the Peterson Institute. We’ve discussed various Peterson efforts on this blog: the Peterson Foundation’s “America Speaks” program, which used a series of faux town hall meetings with openly manipulative facilitators to try to deliver focus group type results depicting broad-based willingness to cut entitlements to reduce the budget deficit. That plan backfired, not only failing to deliver the desired Potemkin consensus, but also generating bad press for its ham-handedness.
The next part of the NYT piece is a glowing account of Canada’s debt reduction policies starting in 1994.
The paragon of thoughtful, growth minded fiscal consolidation is Canada … Policy makers subsequently pared down Canada’s debt level from one of the highest in the Group of Seven to the lowest. Since Canada cut federal fat judiciously, it reduced its debt without much harm to growth.
Sounds good and the Canadian government did reduce some of its expenditures but this wasn’t the reason for the decrease in debt. A lot of the federal debt was consciously accepted in order to keep the country united after the Quebec secessionist movement where the Quebec provincial government demanded its “loot” as the price for not separating and since the other provinces wanted their fair share, there was an increase in federal revenue sharing which had a causal effect on the run up in debt. Also the interest rates were very high in the early nineties due to a deliberate policy by the department of finance to end the inflationary bubble culminating in 1989 by monetary policy so the government was paying a high rate of interest on its debt and this kept rolling over. At the same time that the budgetary cuts went into effect the interest rates declined drastically due to government policy and America which was our largest trading partner went into a boom cycle because of the tech bubble and a decrease in post cold war defence spending. To say that expenditure reduction led to a federal debt decrease is being disingenuous.
The next paragraph claims that America between 1945 and 1985 had its debt drop from 142% to 33% and the same decrease in the 1990’s because it became richer – “most economists attribute it primarily to rapid growth.” The facts are correct but it leaves out a lot of contributory events such as the massive investment in infrastructure during the fifties such as the interstate highway system, the massive increase in population caused by the baby boom and the tech bubble in the 1990s. Then we get “Companies can worry less about being surprised by, say, higher taxes, and proceed to hire new workers.” Companies aren’t hiring because they’re worried about more taxes but because there isn’t any demand and this is caused by a lack of liquidity in the economy. As I said in an earlier post, small business owners are pawning their personal items because they can’t get lines of credit from the banks and they have to increase their cash reserves as collateral and to pay their current employees. Most of the federal cash to the major banks in the two Quantitative easement episodes went to the bank’s counter parties in other countries or straight back to the treasury when the banks got paid a guaranteed profit by borrowing from the fed at zero interest and loaning it back by buying treasury bonds at 3%.
Next in the NYT article we read:
More manageable debt also helps to keep interest rates low, which is generally good for growth. What’s good for growth is generally good for the debt.
I'm glad that she said generally because the interest rate for institutions is effectively zero and growth is lousy. I’m sure you’ve also noticed that your credit card interest rate hasn’t declined from its usurious heights and the fees haven’t been circumscribed. Just because the interest rates at the heights of the economy are low doesn’t mean that main street gets a better deal. She ends with a caveat that “countries that undertake fiscal consolidation in the midst of a crisis can end up paying even more later.” True and that’s why Canada that wasn’t in a crisis but in a debt problem caused by its own political expediency came out on top. The last sentence in the piece was “American policy makers might learn a thing or two from Canada’s patient, hysteria-free pruning.” Ok. Here’ a quote from chapter 12 of Naomi Klein’s, The Shock Doctrine ( I found this book stuffed between C.N. Banwell’s, Fundamentals of Molecular Spectroscopy and Pablo Neruda’s, “Twenty Love Poems and a Song of Despair.” I’m going to have to sort out my book collection one of these days but it does give an indication of my eclectic mind.) :
The phase “debt wall” suddenly entered the vocabulary. What it meant was that, although life seemed comfortable and peaceful now, Canada was spending so far beyond its means that, very soon, powerful Wall Street firms like Moody’s and Standard and Poor’s would downgrade our national credit rating from its perfect Triple A status to something much lower. When that happened, hypermobile investors, would simple pull their money from Canada and take it somewhere else safer. The only solution, we were told, was to radically cut spending on such programs as unemployment insurance and health care.
Sound familiar? And after the cuts were made, the current Canadian federal spending on these items is still far above the current American spending on these items before the future proscribed cuts. In conclusion, the article's issue's solution as espoused by the writer systemically eliminates any other possible approaches to decreasing the debt as being outside the boundaries of discourse and maintains the current center right policy position of the NYT. I’ll end with a quote from Naked Capitalism about a Ferguson/Johnston article:
Now just ask the obvious question that a citizen or politician who had any choice would before embarking on the austerity route to budgetary consolidation: What are the chances that the policy will work? That is, actually reduce the deficit while also stimulating growth?
The striking fact that emerges from their [Alberto Alesina's and Silvia Ardagna's] tables is the meager number of successes. They indentify 107 separate cases of major fiscal contraction in the OECD between 1970 and 2007. Only 26 of these 107 qualify by even their Rube Goldberg definition as leading to “growth.” Now also set aside all qualms about definitions and whether countries were booming or in recession when they started cutting the budget. Just focus on the overarching pattern: Only nine of those “growth” cases actually achieved major reductions in debt to GDP ratios. That shouts out a demoralizing result: that 92% of the time countries tried fiscal contraction; it did not lead to growth with big reductions in debt to GDP ratios. We are not surprised that even a recent IMF study has now repudiated Alesina and Ardagna’s core argument. As Ireland is now discovering, the royal road to reducing debt to GDP ratios runs elsewhere. Arguments that current levels of debt to GDP profoundly threaten future U.S. economic growth are mere assertions crying out for empirical evidence. They should carry no weight in national policy debates.
Don’t expect anything from the Obama team. From the Brad DeLong blog:
Stock market down 17% in two and half weeks while the bond market has reduced the yield on the Ten-Year Treasury from 3% to 2.35%, and break-even five-year inflation has fallen from 2.1% to 1.7%. I think that is a very loud wake-up call for Mr. Obama--that it is long past time for him to stop talking about how surrendering to Republicans on long-run spending priorities will bring the confidence fairy who will then gift us with a strong recovery and start actually doing his job…when I (Brad DeLong) talk to their (Obama’s) staffs, the message I hear is not "we were wrong about how the world works, and are rethinking the issues from the ground up to figure out what to do" but instead "we were unlucky: our policies were good".
I have to say that there is a mystery associated with Pawlenty — but not about the candidate. Instead, the question is why pundits continue to represent him as a smart, qualified guy. On economics, he has been awesomely clueless — making gross factual errors, demonstrating on repeated occasions that he doesn’t understand anything about monetary economics, etc.. (My favorite was the rant against “fiat money“). Maybe there are some subjects on which he isn’t an embarrassing ignoramus, but I’ve yet to see them.
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