Benn Steil

Geo-Graphics

A graphical take on geoeconomic issues, with links to the news and expert commentary.

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Showing posts for "Fiscal Policy"

Buffett Wants to Pay Higher Taxes—on Less Than 1% of His Income

by the Center for Geoeconomic Studies
The U.S. Tax Code: Poorly Designed, but Progressive

In a now-famous August 14, 2011 New York Times op-ed, billionaire Warren Buffett called for tax rates to be raised “immediately on taxable incomes in excess of $1 million, including, of course, dividends and capital gains.” The key word here is “taxable.” In Buffett’s case, his taxable income is a mere 0.9% of his income held within Berkshire Hathaway, of which he owns 22%. His share of its 2010 pre-tax income was $4.2 billion dollars, taxes on Read more »

The Payroll Tax Cut and U.S. GDP Growth

by the Center for Geoeconomic Studies

Breaking Down 2011 U.S. GDP Growth

U.S. annualized real GDP growth of 1.2% through Q3 2011 was driven by personal consumption, accounting for 91% of it.  Yet only 44% of personal consumption growth was driven by higher incomes.  The other 56% was accounted for by unsustainable items: a decline in savings (36%) and the payroll tax cut (20%).  The latter will expire in two months time unless Congress acts to extend it again. Read more »

Does “More Europe” Mean More Pro-Cyclical Fiscal Policy?

by the Center for Geoeconomic Studies

Europe's Pro-Cyclical Fiscal Policy

“It is time for a breakthrough to a new Europe,” German Chancellor Angela Merkel said on November 9th.  “That will mean more Europe, not less.” Merkel wants a stronger fiscal union with strict controls on eurozone national budgets.  Yet to date EU fiscal policy, such as it is, has meant ill-considered pro-cyclical spending programs – as shown in the graphic above.  Greece was and is a large recipient of EU transfers, yet those transfers collapsed by 1.3% of Gross Domestic Product (GDP) after it was forced to cut back on its contributions to EU-subsidized projects in an effort to slash government spending.  This additional fiscal squeeze hurt growth; Greek GDP fell an annual average of 3.5% in 2009 and 2010.

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The BRIC Twist Didn’t Work

by the Center for Geoeconomic Studies

China, Russia, and Brazil Bond Buying, 2009-11

On September 21st the Fed announced that it would be selling $400 billion in short-term Treasurys and buying $400 billion in longer-term Treasurys to replace them – a maneuver titled “Operation Twist.” Atlanta Fed president Dennis Lockhart explained what it would mean for the economy: “It means lower interest rates – a lower cost of borrowing – across a whole spectrum of loan maturities.” Is he right? Well, China, Russia, and Brazil have conducted their own version of Operation Twist over the past several years, replacing roughly $330 billion in short-term Treasurys with long-term ones. The 10-year Treasury rate went sideways over that period, as shown in the figure above. Whereas the BRIC* Twist may have put some modest downward pressure on longer-term rates, other factors overwhelmed it. Don’t expect much from the Fed’s similar-sized version.

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The Dangerous Mirage of Washington Deficit Plans

by the Center for Geoeconomic Studies

The rapidly approaching August 2nd deadline, as proclaimed by the U.S. Treasury, for raising Congress’s self-imposed debt ceiling is producing a flurry of deficit-reduction plans – or, more accurately, plans for having plans.  Whereas a U.S. default triggered by a failure to raise the debt ceiling is the worst possible way to address the country’s unsustainable deficits, as it would cause borrowing rates to soar and pummel growth prospects, raising the debt ceiling without a credible deficit-cutting agreement still poses real risks of imminent, damaging market turmoil.  This is because of the regrettable but real power of the credit ratings agencies, whose downgrade pronouncements trigger automatic selling and purchase-restriction directives hardwired into public and private investment fund guidelines.  S&P has announced that it needs to see a $4 trillion deficit reduction commitment over 10 years—consistent with stabilizing U.S. debt as a percentage of GDP—in order to sustain the United States’ AAA rating.  Speaker Boehner’s plan aims at only $3 trillion in cuts; Senator Reid’s plan at $2.7 trillion.  Rep. Ryan’s plan is, from a practical perspective, meaningless, as its big spending cuts don’t materialize until well after 10 years.  President Obama’s budget also falls well short of the mark, relying on wildly optimistic near-term growth forecasts to juice the GDP denominator (see the Geo-Graphic here).  As the spending graph above-left shows, both Ryan and Obama set the country off on a path of much higher spending than the average over the past 50 years.  In short, debt ceilings and ratings agencies may be stupid inventions, but they will drive us into a major economic crisis if Congress doesn’t take serious action now.

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Retirees Are America’s Same Old Problem

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In a major speech on April 13th laying out his blueprint for reducing America’s long-term debt burden, President Obama drew a sharp contrast between the outlook today and the much rosier one a decade ago. In 2000, he claimed, “we were prepared for the retirement of the Baby Boomers.” Yet whereas the national debt burden today, at around 65% of GDP and rising fast, is much higher than it was in 2000, the long-term fiscal path the nation was on was as unviable then as it is today. This is illustrated starkly by the figure on the left. The driver of the sharply rising debt curves was, and still is, retirees – and specifically two programs to care for them, Medicare and Social Security, as shown by the bars in the figure on the right. President Obama is surely right to draw attention to the challenge of funding retiree entitlements. He is on less firm ground, however, in suggesting that the last Democratic administration had a handle on this. 2000 was no Golden Age of preparedness for our Golden Years.

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Is the President’s Budget Credible?

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“We’re not going to be running up the credit card anymore,” President Obama announced in introducing his 2012 budget.  That would suggest spending less.  But what is striking about the president’s actual budget math is how reliant it is on growth assumptions, rather than actual cuts in spending.  His Office of Management and Budget estimates robust growth of 4.4% in 2013 and 4.3% in 2014.  These assumptions are, however, significantly in excess of private sector “blue chip” consensus forecasts.  Private forecasts are 1.4 percentage points lower in 2013 and 1.5 percentage points lower in 2014.  If the private forecasts are used instead of the political ones, the president’s projected deficit average for 2013 to 2021 would have to be marked up from 3.3% of GDP to 4.3%.  That means about $1.75 trillion more added to the national debt.  Since 1976, the OMB has overestimated growth in the year after the budget by a substantial 0.5%.  This compares with private forecaster upside bias of only 0.1%.  In the case of the president’s budget, however, there is reason to suspect that the bias gap will actually be much larger.  This is because when the OMB and private forecasts differ widely (defined as being greater than 1.4 percentage points), the OMB’s upside bias rises to a full 1%.  In short, the president’s budget relies on rosy growth forecasts just to set the country on a path to lower but still unsustainable deficits.

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Can the U.S. Cut Defense Spending?

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“There’s only one way to [fix America’s long-term budget problems],” said President Obama’s fiscal commission co-chair Alan Simpson. “You dig into the big four, Medicare, Medicaid, Social Security, and defense.” In shying clear of Medicare, Medicaid, and Social Security in his 2012 budget proposal, the president took a bow to the formidable political challenge posed by the first three. But what about defense, which accounts for a whopping 22% of Federal expenditures? In spite of the ups and downs in the global peace index, history suggests that cuts in nominal defense spending are just as hard to achieve. As the yellow line in the top figure shows, nominal defense spending almost never falls. Declines in defense spending as a percentage of GDP have historically been accounted for by inflation or real GDP growth – not by spending cuts. The fiscal commission’s report called for $34 billion in nominal defense cuts between 2012 and 2013, a time-period during which the president’s budget calls for increases. But even the president’s much more modest brand of fiscal discipline looks oversold. His budget projects strong economic growth in the medium term, but if private growth forecasts are more accurate he will need to do the politically impossible – actually cut nominal spending – in order to achieve the real cuts implied by his budget. Read more »

Luck of the Irish Hinges on Banks

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The EU-IMF Irish bailout gives Ireland a window of opportunity to solve its problems, but how large a window is it? Although the €85 billion headline number appears to be very large, at over 50% of Irish GDP, the funds must be benchmarked against what they are being earmarked for. €50 billion is tagged for public finances, which will cover two years of public debt refinancing and deficits. This provides a significant window for Ireland to achieve fiscal improvement. However, the window provided by the €35 billion tagged for banking sector recapitalization is much smaller. Over €34 billion of foreign deposits fled Irish banks in September 2010 alone. Over the past two years, Irish banks’ balance sheets have shrunk by over 9%, while their funding reliance on the European Central Bank has increased from 5% to 9% of total liabilities. This suggests that any Irish bailout plan, to be credible enough for the markets, must ensure that the Irish government ceases adding bank debt to its public debt. That will almost surely involve a restructuring – that is, a significant partial default – on the bank debt. Such a restructuring, however, will raise a slew of new bailout questions, since German, French, British and other European banks holding Irish bank debt may themselves require public assistance to remain acceptably capitalized. Read more »

Greek Drachma: Not an Option

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On April 26th, Standard and Poor’s downgraded Greece’s credit rating, and Greek sovereign credit default swaps (CDS) climbed to 825 basis points – far higher than before the IMF and European Council of Ministers announced a support package. The Greek crisis is clearly unresolved. Some have argued that if Greece had never switched from the drachma to the euro it would have been able to pursue a fiscal policy that fit its domestic needs without depending on international capital markets. Yet Greece consistently relied on non-drachma debt issuance well before it adopted the euro in 2001. In the six years before joining the euro, only 27% of Greek debt was issued in drachma. At the end of 2000, just before Greece joined the eurozone, 79% of its outstanding debt was already denominated in euros, and a mere 8% in drachmas. Even if Greece had remained outside the eurozone, its dependence on euro borrowing would only have increased. A falling drachma would merely have brought the current crisis to a head earlier by accelerating the rise in Greece’s debt-to-GDP ratio (think Iceland). The fact that the euro is not an “optimum currency” for Greece, or any other eurozone country for that matter, is not the main problem. That problem is excessive foreign borrowing, a problem with which Greece has struggled since the early 19th century. Read more »