Independent Courts, Independent Monetary Policy, why not Independent Fiscal Policy?

The US Supreme Court is independent from political influence.

The US Supreme Court is independent from political influence.

While always closely observed, rarely have landmark court cases been so politicized as the two gay marriage cases that went before the Supreme Court this week. You’ve probably noticed new profile pictures on Facebook and Twitter, timed apparently with the hope of swaying the court. Almost daily, another public figure expresses support for gay marriage. Most significantly, Pres. Obama has given his opinion on both cases, and has taken the unprecedented step of directing the Department of Justice not to defend DOMA in court.

The political nature of these court cases raises questions of how “independent” the US judicial system is. As a matter of law and tradition, courts in the US are not to be subject to undue political or partisan influence. This makes sense–if courts were not independent, then the role of the judiciary in “checking” the other branches of government would be undone. Judges might become extensions of the political system, appointed and paid only to justify their own party’s political positions.

Monetary independence is perhaps as important as judicial independence. Monetary policy concerns questions of the amount of money in the economy and is normally set by a central bank, over which the government may or may not have influence. Historically, governments with influence over monetary policy tend to show a very strong inflation bias, that is, they tend to favor increasing the money supply more than would be ideal, causing high long-run inflation (rises in prices of goods) and arguably worsening recessions. Put simply, they do this because expansions of money tend to benefit the government in power.

For this reason, the Federal Reserve, which sets monetary policy in the US, is independent from the government by law. Evidence shows that central bank independence really does go along with lower inflation, as in this data from the St. Louis Federal Reserve:

Long term inflation tends to be lower where central banks are more independent.

Long-term inflation tends to be lower in countries where central banks are more independent.

But while monetary policy is stable, fiscal policy in the US is messy. Fiscal policy concerns questions of taxes and spending. Currently, fiscal responsibility is shared by Congress and the President.

For years, the government has ignored experts who called for less drastic tax cuts, structural entitlement reform, and slower spending growth. Political self-interest has seemed to be responsible for such short-sighted policy. Tax cuts and new spending programs can always be sold to the public for votes, as can oversized stimulus spending, inefficient entitlement programs (Social Security and Medicare), and expansions to unemployment benefits. As a result, the US suffers from more debt, higher unemployment and lower economic growth rates than it otherwise would.

How could the US de-politicize taxes, spending and debt? While it would be very unpopular in Congress, there might be benefits to independent fiscal policy. This might work by giving an existing agency, like the expert-run Congressional Budget Office, independence and power to set mandatory long-run levels of tax revenue and spending, with the mandate to promote long-term economic prosperity. Congress could then decide which taxes to use to collect revenue and how to spend the money assigned to its authority. Perhaps the CBO might even have power to set specific tax rates or restrict spending in particular government programs.

If this agency had existed a few months ago, the government might have avoided the fiscal cliff as well as the sequester. An independent fiscal agency could also coordinate with the Federal Reserve. For example, during a recession, the Federal Reserve could engage in monetary expansion with the guarantee that the fiscal agency would not allow ineffective fiscal expansion. An independent fiscal agency would also be free from the influence of special interests that burdens Congress.

The main objection to this proposal would be that it removes accountability. (Similarly, people like Ron Paul are misguidedly arguing that the Federal Reserve should be more accountable to Congress.) But Congress has a terrible track record on fiscal issues. Fiscal independence would not involve a loss in accountability–on the contrary, Congress would be held accountable not only to donations or votes, but to the interests of the long run prosperity of the country.

Stephen Harper for President

No one could have predicted two decades ago how quickly the relative fortunes of the United States and Canada would change. In the early 1990s, the US was beginning a new decade of prosperity, while Canada was stagnant, stuck with perpetually low growth rates, a high long-term rate of unemployment, large fiscal deficits and a future pension crisis. Stock markets in the US set records and healthy exports pushed the value of the dollar ever higher.

Today, of course, Canada is the economic star. Few developed countries withstood the shocks of the Great Recession as well as Canada. It has improved against the US in nearly every important economic category, and continues to rise in various indices of human development, while the US has seen little progress in any area over the last decade or so.

There are of course many reasons for these trends, but here’s one:

Econ

This index is from a conservative think tank, the Heritage Foundation. It measures “economic freedom” by a number of different indicators, including trade freedom, labor freedom, business freedom and fiscal freedom (ie. freedom from taxes). It’s a good measure of the general attitude of a country toward “laissez-faire” economics. It’s clear that Canada has gone away from its old quasi-socialist image, while the US has seen a marked decline in economic freedom since the beginning of the recession.

What changed? In the mid-1990s, Canada’s new government under Liberal Prime Minister Jean Chrétien and Finance Minister Paul Martin began slashing spending, eliminating the federal deficit within a few years. Later, they sharply reduced tax rates, including the corporate tax rate. In 1997, they revamped the Canada Pension Plan, partially privatizing it and cutting benefits. This tight attitude toward fiscal policy has remained the standard at the federal level to this day.

In the US, things began to change in the early to mid-2000s. The Bush tax rate cuts were too deep and too quick, and federal spending began to ramp up with the war in Iraq and many new federal spending projects. The United States’ approach to the 2008 downturn was unfortunate: fiscal spending ballooned and was spent in some of the least effective places. Canada’s approach was much more sensible.

If this narrative could be boiled down to one thing, it’d be the leaders each country elected. Martin, Chrétien (both Liberals), Stephen Harper (the current Conservative Prime Minister) and Bill Clinton (Democratic) are fiscally pragmatic, economically literate leaders. Harper even has a Master’s degree in economics. Presidents Bush and Obama, on the other hand, are not. Electing a Harper-style president wouldn’t be an economic panacea for America (especially with a gridlocked Congress), but it could mean the difference between poverty and prosperity for millions of people.

Today’s post was shorter; this week has been a busy one. If you haven’t had the chance, please read through some of my older entries!

Good People, Bad People, and People who Disagree with You

Alan Grayson questioned Paul Ryan's motives this week, after Ryan proposed his budget to Congress.

Alan Grayson questioned Paul Ryan’s motives this week, after Ryan proposed his budget to Congress.

Earlier this week, Paul Ryan proposed a federal budget that, among other things, would repeal the health care act passed in 2011 (“Obamacare”) and balance the budget, mainly through spending cuts, by 2023. The reaction to this proposal was varied, mostly critical, and often enough within the bounds of civility. One of Ryan’s fellow congressmen, however, went beyond criticism of the bill, bluntly accusing him of sinister motives: “He wants poor people who get sick not be able to see a doctor … He wants them to die.”

Alan Grayson has pronounced judgments like this before, and has gained celebrity among some progressives who see his frankness as moral clarity. In the world of such extreme partisans–and they are not found only on the left–there is good, and there is evil, and when views conflict, the first cannot compromise with the second.

This Manichaean worldview is bigger than politics, of course. When I spent two years in Oregon on a religious mission, I was unhappy to discover that many people I talked to believed that the world, and most people in it, are generally bad. The world seemed to them so full of selfishness and violence that there was no way it could belong to benevolent beings. Almost always, however, these people I talked to didn’t describe themselves as bad. In their hearts, they wanted everyone to be better off. If there was a button to be pressed that would end human suffering, they would of course push it, and gladly.

The really odd thing is that these people I talked to also didn’t describe others they knew as bad. If it came to examples, they usually had to resort to vague groups of people (racists, wealthy bankers, abortion doctors, etc.), or else to public figures they had never met. Somehow in their experiences with others, they had only rarely come across one of this majority of people who apparently were evil. I’ve done the thought experiment myself–in the last week, I can’t think of anyone I’ve talked to who I would say is evil. Even in the last month, no one comes to mind. I have to go back quite a while to be able to think of someone whose heart was really hateful, and who consciously did evil things, knowing they were wrong. Even when I think of those I know who have done very morally questionable, or even criminal, things, I can’t call them evil. They’ve made serious mistakes, but they want to be good.

I don’t know how much of the world thinks that humanity is generally bad. But if I could generalize what I’ve talked about to people in general, it’s that we give a much greater benefit of the doubt to those we have met in person than to those we haven’t. It seems that when looking at the world in general, we tend to see it in utilitarian terms. In other words, if a politician or a large business does something harmful, or offers a political opinion that could have harmful effects, then we start to think of that person or group of people as bad; intentions and context don’t matter very much. But when looking at people within our personal social sphere, our mindset seems to change to one that is more virtue-based and context-sensitive. Of course your friend isn’t a bad person because his views on gay marriage, immigration or health care are different from yours. You disagree on some things, but you know you have a lot of common moral ground.

This is where politics comes back in. I think one reason politics are so divisive is that they are distant from us. Politicians aren’t friends or family; we’ve never sat down at a meal with them, or taken a class with them, or called them to ask a favor. So they can just be “talking heads” with opinions–and if they hold the wrong opinions, then they’re probably bad people. Mass media has allowed us to know about people we don’t know. Our intuitive, sympathetic side can’t make it through the impersonal screen and so our Manichaean, utilitarian, well-intentioned but destructive side takes over.

I don’t think very many people really think that humanity is bad. People may say they believe it in their moments of hyper-rationalist philosophizing, but I don’t think they do. Our conscious reasoning doesn’t very often overpower the truth that lies deeper, in our intuitions, in the parts of our mind that actually determine how we act. The people around us are good people who want the best for themselves, their family and everyone else. But like us, they’re fallible, they don’t understand everything, and so disagreements are inevitable. What a tragedy it would be to spend our time questioning their motives, convicting them of the same crime of ignorance that we commit.

US Income Inequality: Taxes Aren’t the Problem

A few weeks ago I wrote a post about the ineffectiveness of the minimum wage to reduce poverty, in response to President Obama’s proposition, in his State of the Union address, to raise it. Obama was addressing a concern of his, as well as many others’, that the poor aren’t getting what they deserve in America, while the rich are getting much, much more.

While I believe strongly in free markets and opportunities to prosper, there’s truth to this characterization. Real income appears to have stagnated for the poorest 40% over the last few decades, while the top 20%, and especially the top 1%, have made incredible gains.

There’s a new kind of culture war in the United States, and it’s about money. The Occupy movement wasn’t a group of economists promoting more progressive taxes or expanded social programs–it was mostly indignant young people, expressing their outrage at the misdeeds of the wealthiest 1%. In the Occupiers’ view, this isn’t an academic issue; this is a moral struggle, with lines clearly drawn between the greedy and the just.

I do not share the Occupiers’ worldview, but the feelings that motivate them are at some level universal. You might experience the same moral horror when you hear how much more CEOs are paid than their employees, or when it is reported that very wealthy investors seem to pay so little in taxes. People don’t necessarily want everyone to be equally rich, but we are averse to inequality–and when inequality appears to violate our expectations of just reward for effort and ability, we want an explanation.

The best simple measure of income inequality is probably the Gini coefficient. The higher a country’s Gini coefficient, the less equitable the distribution of income. The OECD (a group of wealthy industrialized countries) publishes Gini data for its member countries, using income before taxes and transfers, and after. Because taxes and transfers (transfers are government programs that transfer money to people, usually the poor) are designed to redistribute income to some degree, the Gini coefficient is higher before they are applied. Here’s the data for OECD countries in the late 2000s, minus a few of the countries less comparable to the United States, and Ireland, which didn’t have pre-tax data.

init

The first observation to make is that before taxes and transfers, the US is among the least equitable countries. But it is not the worst. Perhaps surprisingly, Italy, the UK, Israel and Germany all have higher pre-tax, pre-transfer Gini coefficients. I won’t get into the reasons for the United States’ high pre-tax inequality in this post. After taxes and transfers, however, the US is the least equitable. Here’s a graph of the difference between pre- and post-tax and transfer Gini coefficients for each country:diff

It appears from this data that tax policy and social spending in the US is relatively ineffective at reducing poverty compared to other countries. While this isn’t a perfect measure of the power of fiscal policy to bring about equality, it’s probably a good clue. Most of the discussion around income inequality in the US has centered around taxation. A relatively mundane effort to raise the top marginal income tax rate in the US recently became a major political battle.

But inequality probably isn’t a taxation story. The US has the highest corporate tax rate in the developed world (and among the highest when average effective rates are considered), relatively high capital gains taxes and a progressive income tax system. By some measures, the US actually has the most progressive tax system in the world, because such a high proportion of its tax revenue comes from rich people. Since the Bush tax cuts, the average effective tax rate paid by the lowest 20% of income earners has fallen to 1%. The next lowest 20% pay just under 7%. Most of the taxes the poor pay are payroll taxes; it’s been well reported that just under half of Americans don’t pay any federal income taxes.

This suggests that much of the inequality problem in the US can be explained by government policy on transfers. Historically, the US has had significantly lower public social expenditures than other countries. Since 2008, however, public expenditures on social programs have risen to be in line with other OECD countries. Including private social spending, the US now spends more per person than nearly every other OECD country. The data can be found here.

The biggest trouble, in my very informal analysis of US social spending, is probably in the way the money is spent. Whereas many OECD countries have established forms of basic income or direct transfers, most of US social spending is in the form of health spending and old age spending (ie. Medicare, Medicaid, and Social Security). More recently, there has been a great deal of money spent on unemployment benefits. Without getting into lengthy detail, there’s evidence that these programs are relatively inefficient at alleviating poverty, partly because so many of their funds are directed to recipients who aren’t rich, but also aren’t poor.

One alternative to these old-fashioned programs is direct cash transfers (ie. giving money to poor people). Historical experience, however, tells us that Lyndon B. Johnson-style welfare programs did very little to alleviate poverty and reduced economic incentives. In my minimum wage post, I suggested that the negative income tax or a similar scheme might be a way to establish a basic income while preserving incentives to work. A negative income tax system might sound like an almost socialist idea (although it was originally proposed by famously capitalist Milton Friedman), but with its administrative simplicity and fiscal efficiency, it’s one of the few major anti-poverty proposals I’ve heard that would not require tax rises.