Not Much Grade Inflation Here

The American Society of Civil Engineers (ASCE) has released its 2013 Infrastructure Report Card, and the overall grade has inched up from a D in 2009 to a D+ this year. The estimated amount required to address deficiencies (to get a grade of B) is $3.6 trillion by 2020. As this table makes clear, of the $3.6 trillion, only $2.0 trillion is likely to be funded, leaving a $1.6 trillion gap. That's an additional $200 billion per year for eight years.

A lot of the infrastructure we have is at the end of its useful life. We continue to be lucky rather than smart in avoiding widespread failure. This is an important report that should be read and appreciated in Washington. Like many other advanced warnings, it is likely to be ignored until the subject becomes an imminent crisis.

At one level, the inability for the federal government to oversee adequate infrastructure is just another in a long line of failures of government to effectively do the things that even a person who believes in limited government would agree that it should do. Many of these projects, like transportation, energy, parks, drinking water, education, and waste management, have characteristics of public goods.

At another level, the continued deficiencies in infrastructure are a missed opportunity. This is a subject I have been following for over five years, in the context of what policy makers should have done differently with fiscal policy as the Great Recession began.  In two op-eds in early 2008, one in the Washington Post and the other in the Ripon Forum, I pointed out the connection between capital projects and how to deal with economic downturns. The prevailing wisdom for what to do during a downturn was deficit spending to boost economic activity in ways that are "timely, targeted, and temporary." I thought this was short-sighted -- the right thing to do during a downturn is to advance forward capital projects that have already been planned over a window of several years. You can only do that if you have made those plans. Good luck with that in a Washington policy-making climate that cannot agree on anything constructive.

What is saddest about today's report is that we are no closer to having a well defined plan for replacing antiquated infrastructure or adding critical infrastructure than we were four years ago. I wish more people in Washington would have appreciated the following simple insight. The best reason to do infrastructure spending in a downturn is not because of some mythical Keynesian multiplier. The best reason to do it is because you have to do it at some point and the cheapest time to do it is in a recession, when both labor and capital are underutilized and available more cheaply than in business cycle upturns.

In fairness to the Obama Administration, key advisers recognized the need for more government spending as the depth of the Great Recession became more apparent. It started with a change in language, as Larry Summers dropped the "timely, targeted, and temporary" mantra in late 2008 and substituted "speedy, substantial, and sustained over a several-year interval." But it wasn't clear to me at that point that the Obama team had connected this to infrastructure when they designed the stimulus bill that passed as the American Reinvestment and Recovery Act in early 2009. Provisions for "shovel-ready" projects and an infrastructure reinvestment bank are fine, but what ASCE's report makes clear is that these efforts are too modest. Even as the connection was made to infrastructure and the Obama Administration joined what I referred to as the "build while it's cheap chorus," the sheer dollars being proposed were too small, even today, compared to what the ASCE estimates we need.


My favorite saying is, "The best time to plant a tree is 20 years ago. The second best time is today." With economic growth still tepid and unemployment still above 7.5 percent, let's hope the newest report card is enough to motivate a renewed effort in Washington to combine sound fiscal policy with proper oversight of public goods and address this growing problem.

Some Social Security Tweaks

Social Security is back in the news this morning as the Senate Democrats have produced their 10-year spending plan, a counterpoint to the plan released by the House Republicans earlier this month. Here's some language that caught my eye from today's Washington Post article:

While Democratic leaders are offering quiet support for Obama’s renewed campaign to strike a grand bargain with Republicans that would include cuts to Social Security and Medicare, a significant number of Democratic lawmakers are digging in their heels and vowing to protest any reduction in promised benefits. [emphasis added]

The appropriate word is "scheduled," not "promised." I've been over this before. Apart from the ability of the government to change the law at any time, there is no legal authority for some portion of these benefits to be paid after the Trust Fund is exhausted. The judicial system recognizes this -- beneficiaries have no legal standing to benefits other than what the law says at the time the benefits are payable. The press, and policy makers and analysts, would do well to choose their language accordingly. It's an easy mistake to make -- I used to do it myself.

The article then reports on an area of possible bipartisan compromise between the President and House Republicans. This alone should signal that it might be a bad idea:

Meanwhile, a growing number of Democrats have declared their opposition to a proposal that has emerged as Obama’s biggest selling point to Republicans: his offer to apply a less-generous measure of inflation to Social Security, resulting in slightly smaller annual cost-of-living increases.

I am in favor of using the most accurate measure of inflation possible to index the benefits of retirees for inflation. So yes, the change should be made, but the larger problem with Social Security benefits is that they do not rise in real terms at higher ages. The purpose of Social Security is to provide insurance against outliving one's means of support in retirement. That risk increases, dramatically for some people, at higher ages. Other sources of support, like private saving, may not be annuitized and may thus run out at advanced ages. An increasing age profile to Social Security benefits in real terms helps to offset the decline in other sources of support.

The reductions in future Social Security benefits should come in the initial benefits, not the way those benefits change over time. That would also improve incentives for older workers to stay in the labor force. But, of course, that would require agreement on principles of design, which seems very far removed from the realm of possibility in the current climate.

Punch Drunk on Dumb Justifications for Stimulus

I am a Sheila Bair fan. I have been for the better part of the five years since the financial crisis hit. (Here's an example.) I wish the national Republican Party would line up behind (most of) the approach she lays out in her New York Times op-ed yesterday. Here's the meat of it:

I am a capitalist and a lifelong Republican. I believe that, in a meritocracy, some level of income inequality is both inevitable and desirable, as encouragement to those who contribute most to our economic prosperity. But I fear that government actions, not merit, have fueled these extremes in income distribution through taxpayer bailouts, central-bank-engineered financial asset bubbles and unjustified tax breaks that favor the rich. 

This is not a situation that any freethinking Republican should accept.

She's absolutely right. To varying degrees, almost everyone on the so-called Left would agree with her sentiments, I suspect.

I think she makes two errors in the rest of the op-ed that are typical of current discourse, even among smart folks.The first is the very next sentence:

Skewing income toward the upper, upper class hurts our economy because the rich tend to sit on their money — unlike lower- and middle-income people, who spend a large share of their paychecks, and hence stimulate economic activity. 

When the rich "sit on their money," they are lending it to people who want to use it for some economic activity. They drive down the cost of capital for people who want to borrow it to invest. That investment creates economic activity. There is nothing less virtuous about this than having low- and middle-income people spend most of their disposable income. But after five years of policy makers and pundits concocting justifications for the government to enact policies to promote spending, spending, spending, I suppose it is not a surprise to read this muddled thinking.

The second error is this notion that a first order issue, or any issue that Republicans should spend their time on, is major overhaul of the tax code. Fundamental tax reform would take years of bipartisan cooperation. We cannot even manage a week of it. And if we could muster the cooperation, we should use it to address the fact that we don't raise enough revenue to cover our expenditures rather than the various ways in which we don't raise it. But even is the political issues could be solved, there are problems with the economic elements of what she proposes.  Here's what she writes:

For instance, as part of renewed fiscal discussions over sequestration, Republicans should put fundamental tax reform on the table and make it our priority to end preferential treatment of investment income, which lets managers of hedge funds pay half the tax rate of managers of shoe stores.

[...]

If we eliminate this and other unjustified tax breaks, we can produce enough new revenues to lower marginal rates and reduce the deficit, according to both the Simpson-Bowles and Domenici-Rivlin debt-reduction plans.

In the first paragraph, she's writing about the carried interest loophole. I agree, wholeheartedly, that that loophole should be closed, along with any corporate tax loopholes we can find. But it is a far cry from closing those few obvious loopholes to the tax expenditures required to meaningfully reduce the deficit. The CBO is quite clear on this matter -- to make a real dent, you have to go after the big tax expenditures. They are, in order of foregone revenue, the exclusion of health insurance premiums from income and payroll taxes, the net exclusion of pension contributions and earnings from taxable income, and the deduction for mortgage interest on owner-occupied housing. None of these three are the exclusive playground of the rich. If she's serious about this idea, she needs to mention those tax policies by name.

In a future post, I will share some additional thoughts on what to make of proposals to curb the use of tax expenditures.

The Republicans Have Done Their Job?

My op-ed on the fiscal grand canyon in Sunday's New York Daily News topped the list of Must Reads on yesterday's broadcast of Morning Joe.


Listen carefully to what Scarborough says around 6:40 of the clip.  I think you are going to hear it a lot in the coming months.  He says, "Taxes were increased in the House of Representatives … The Republicans have done their job."  Earlier, he says, "Taxes have been raised ... That card has been taken off the table." You can bet the Republicans will use a similar talking point to fight any future tax increases.

The tendency for public discussion -- and future partisan talking points -- to not distinguish between a small, targeted tax increase that raises inadequate revenue and the broader tax increase back to Clinton-era tax rates that would have raised a lot of revenue is the reason why Obama should have held out for as much new revenue as going over the fiscal cliff would have produced.  He could then have negotiated with the Republicans on how much additional spending or tax relief to offer to mitigate the threat to short-term economic activity.

The Fiscal Grand Canyon

With the benefit of hindsight, I think the adoption of the "massive fiscal cliff" metaphor for our fiscal policy challenge was a bad idea.  I think Ben Bernanke introduced it to motivate action -- 10 months in advance -- to improve fiscal policy.  But what was meant to suggest urgency actually led to unnecessary panic.  A clear statement by a newly re-elected Obama in November that unless the Congress sent him a thoughtful bill to sign, the tax code would simply revert would have been a much better course of action.  The Republicans would then have to specifically introduce legislation to achieve their objectives.  The sad story of the last two years is that they have been able to get Obama to acquiesce to their demands without having to actively promote their agenda through legislation.  In this case, Obama really did hold all the cards, and yet almost all of the Bush tax cuts have been made permanent. 

Not to be outdone by Chairman Bernanke, I introduce the phrase "fiscal grand canyon" in an op-ed in the New York Daily News today.  We certainly jumped out of the frying pan and into the fire.  The key excerpt:

Unfortunately for Obama, he signed away the opportunity to pursue an ambitious second-term agenda when he signed this legislation.

In this era of partisan disagreement, we can expect congressional Republicans to oppose any new idea the White House may propose on the grounds that it costs more money and the budget is already projected to be in large deficit.

Enjoy!