Great Nations Pay Their Bills

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Great nations pay their bills.

That, I believe, is what this debate boils down to. That is what our founding fathers would tell us if they saw us toying so dangerously with the federal budget and the debt ceiling.

The national debt has always been controversial. The current government shutdown is only the latest episode in a long history of divisive debates over paying the nation’s bills.

Consider, for example, what John Adams’s wife Abigail wrote to her daughter Mary in 1792: “I firmly believe, if I live ten years longer, I shall see a division of the Southern and Northern states, unless more candor and less intrigue, of which I have no hopes, should prevail.”

She wasn’t talking about slavery. She was talking about government debt. And she wasn’t alone.

“With the South filled with debtors and the North creditors,” says the historian Ron Chernow, Thomas “Jefferson feared the country would break apart along sectional lines.”

You have to admit, that really puts things in perspective. Today’s debate may be polarized, but no one seriously expects half the nation to secede because of it. And yet, in the early days of the American experiment, that’s how controversial the national debt was.

After the American Revolution, the new government had a lot of bills to pay. Fighting the mighty British Empire wasn’t cheap. The federal government had racked up $54 million in unpaid bills, and the states owed another $25 million.

There were many in Congress who believed that the government should default on its debt rather than pay the bills. They knew that they’d have to raise taxes to pay the bills, and they believed that taxing and spending were the first steps toward monarchy.

Sounds familiar, no?

George Washington disagreed. During the war, Washington had marveled at the British army’s seemingly inexhaustible supply of money. A great military, he believed, depended on the government’s ability to spend as much as necessary, and that required tax revenue and solid credit — two things that were sorely lacking on the American side.

By the end of the war, investors were fed up with the Americans. The new state governments had refused to collect enough taxes to pay the interest on the debt they had accumulated. The financier Robert Morris warned Washington that investors “who trusted us in the hour of distress are defrauded.” It’s “madness,” he lectured, to “expect that foreigners will trust a government which has no credit with its own citizens.” He begged the federal government to begin collecting taxes to repay their loans.

“With respect to the payment of British debts,” Washington concluded, “I would fain hope…that the good sense of this country will never suffer a violation of a public treaty, nor pass acts of injustice to individuals. Honesty in states, as well as in individuals, will ever be found the soundest policy.”

In other words, when a gentleman gives his word, he honors it. Great nations pay their bills. He did not, however, have an easy time convincing Congress of that.

In his first State of the Union, Washington declared that “an adequate provision for the support of the public Credit is a matter of high importance to the national honor and prosperity.” A few days later, his Treasury Secretary Alexander Hamilton proposed to Congress that the federal government not only raise enough taxes to pay off its debt but also to pay off all the states’ debts as well. Even more controversial, he suggested that they pay the entire face value of the debts, not the low prices that they were currently selling for in the market.

James Madison rose in the House of Representatives to denounce Hamilton’s proposal. It would reward speculators who had purchased the government bonds from hapless war veterans, he argued, and create a dangerously large Treasury bureaucracy.

In the end, Hamilton won, but not before creating many enemies. The investors who stood to gain from his policy lived mostly in the industrial North, while the indebted landowners of the South were suspicious of bankers and their “paper assets.” The debate over Hamilton’s proposal was the beginning of a rift that eventually led to our modern political parties.

Not long after Congress approved Hamilton’s plan, government bonds tripled in value. “The progress of public credit is witnessed by a considerable rise of American stock abroad as well as at home,” boasted Washington.

Still, radical dissenters tried to thwart this goal. In western Pennsylvania, a group of outraged farmers rebelled violently against the new tax the government had placed on whiskey, a product created from their grain. But Washington wouldn’t stand for it. If “a minority…is to dictate to a majority,” he warned, “there is an end put at one stroke to republican government.”

Apropos wisdom for today, wouldn’t you say?

Eventually, the Whiskey Rebellion was quelled, and all the debts were paid off — state and federal — at face value. The American government went on to become the most trusted investment in the world. To this day, it is widely considered the crowning achievement of Hamilton’s career — and one of the most important acts of this new nation.

Our credit is our reputation. It is our word. It is, quite literally, our bond with the investors of the world. To abuse it is not only to invite economic disaster; it is, more importantly, to sever the promise our forefathers made to us and the promise we make to the world. When other nations are in distress, they turn to us. We are the beacon in a sea of uncertainty. We are the deep pockets when all others have gone empty.

We are a great nation. Let’s start acting like it.

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This op-ed was published in today’s Huffington Post. An abbreviated version was published in the South Florida Sun-Sentinel.

Government Isn’t the Problem…and Austerity Isn’t the Answer

I have a friend who witnessed about half of the Supreme Court arguments on the Affordable Care Act. When he walked out of the courtroom, he wasn’t surprised to find a sea of people protesting the law. What did surprise him was how many of the protest signs were anti-Europe. Apparently, the protestors were worried that universal health insurance was the path to “becoming European” and all the nefarious consequences that implies.

If asked for their opinion on government spending to stimulate the economy, I imagine they’d give roughly the same answer.

But the truth is that fiscal irresponsibility has little to do with Europe’s current crisis.

Just before the recession hit, the European governments with the highest public social spending (relative to the size of their economy) were France, Austria, Belgium, and Germany — none of the so-called “PIIGS” nations that are in trouble. In fact, many conservatives have anointed Germany as the role model that its neighbors should emulate.

Even if you measure all government spending in the middle of the crisis, there is no correlation between a country’s public spending and the interest rates on its sovereign debt (which is the key indicator of financial distress).

From 1999 to 2007, the European government with the highest budget deficit (again, relative to economic output) was Slovakia, hailed by conservatives for its flat tax. France’s budget deficit was about as big as Italy’s, and Germany’s was close behind. Spain and Ireland actually had budget surpluses.

Besides, if government spending were the problem, then the crisis should be over by now. The EU and the IMF have forced the PIIGS nations to slash public expenditures — and the recession has only gotten worse.

Compare that strategy with what happened in the United States, where we took the opposite approach and increased public expenditures.

In the fourth quarter of 2008, real GDP contracted at an annual rate of 8.9 percent in the U.S. In January 2009, nonfarm employment declined by over 800,000. That was the lowest point both statistics — growth in economic output and jobs — would reach.

On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act (ARRA), better known as the “stimulus” package.

In the first quarter of 2009, real GDP contracted by 6.7 percent. In February 2009, nonfarm employment losses were closer to 700,000. The recession was clearly not over, but the bleeding had slowed.

On March 6, 2009, the Dow Jones reached its cyclical low of 6,626.94. The next day, it began a strong recovery.

By the third quarter of 2009, when the stimulus money was starting to be spent, the economy was growing again. By March 2010, job growth was positive again. (Job growth always lags behind economic output.) By February 2011, two years after Congress passed the ARRA, the Dow Jones cleared 12,000.

Clearly, the ARRA was the turning point. Its passage was the beginning of the end of the Great Recession.

Coincidence? Perhaps.

But isn’t it odd that none of the critics’ predictions came true? They warned that interest rates would skyrocket with the government borrowing so much money. Instead, interest rates plummeted. They warned that inflation would soar. Instead, it’s been low and stable.

And that’s not all. Several economists have measured the effect of the stimulus since it was spent. Two Dartmouth researchers, for example, compared jobs growth in each state and county to the amount of stimulus funds spent in that state or county. They found that every dollar spent on the poor yielded two dollars in increased economic output, and every dollar spent on infrastructure yielded $1.85 in output.

Another study compared jobs growth in each state to the amount of federal Medicaid matching funds spent in that state. They found that each dollar spent yielded two dollars in output. A similar study found that the ARRA “created or saved about 2 million jobs in its first year and over 3 million by March 2011.”

So it’s no surprise then that Europe continues to flounder while America continues to grow. You can’t beat a recession by cutting government spending. Even Mitt Romney said so.

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This op-ed was published in today’s South Florida Sun-Sentinel.

Reader Request: Do Lower Tax Rates Lead to Higher Tax Revenue?

A reader asks: If low tax rates lower income to the Treasury and cause deficits and lower economic growth, how do you explain how we ran deficits with a 70 percent top marginal tax rate in the 1970s and we ran surpluses for 1998-2001 with a 39 percent top marginal tax rate with almost identical average GDP growth for the periods? Doesn’t this fact give significant credence to the supply-side argument that lower tax rates increase tax revenue and cause surpluses?

Professor Chandra Mishra made roughly the same argument in our debate over the Bush tax cuts. I didn’t address it in my op-ed because I didn’t expect a tenured professor to advocate such a widely discredited position.

First, a clarification: I never said that “low tax rates…cause…lower economic growth.” On the contrary, the economic evidence indicates that tax cuts have a slightly positive effect in the short run.

In order for tax cuts to increase tax revenue, however, they would have to have such a large effect on economic growth that it outweighs the effect of the lower rates. Taking a smaller percent of a bigger number can yield more than taking a bigger percent of a smaller number, given the right numbers. At a certain point, if you keep raising taxes, people will stop working because it isn’t worth the effort. If enough people stop working, economic output decreases, and tax revenue shrinks despite higher rates. If you like graphs, you can visualize that “tipping point” as the top of the “Laffer curve,” named after economist Arthur Laffer who helped popularize the concept in the 1970s:   Continue reading “Reader Request: Do Lower Tax Rates Lead to Higher Tax Revenue?”

Chandra Mishra Rides Astride a Trojan Horse

When Professor Mishra and I debated the Bush tax cuts a few weeks ago, we agreed to limit the debate to income taxes, but the Professor went a bit off-topic. He spent half his op-ed talking about corporate taxes, and I didn’t get a chance to respond.

Until now.

First, let’s see what I’m responding to:

A high corporate tax rate moves jobs overseas. Currently American companies are sitting on more than $2 trillion of cash overseas, which is used for hiring and investments in foreign operations.

The United States has the second highest corporate tax rate in the world. Two things we must do to spur job growth and expand the taxpayer base in the America: Cut the corporate tax rate from 35 percent to 20 percent, the median tax rate for the developed countries, and eliminate the taxes on repatriation of foreign earnings.

Wow. Every sentence there is either wrong or very misleading.   Continue reading “Chandra Mishra Rides Astride a Trojan Horse”

How to Discover the Truth with Statistics

Regular readers may remember my post, “How to Lie with Statistics,” where I criticized ASU economist Richard Rogerson for misleading the public with bad math. I showed the nonsense in his claim “that raising taxes will turn us into a bunch of lazy old Europeans.”

Since I’m going to be writing about taxes a lot this week, now is a good time to show how a responsible statistician approaches this issue. The following is a summary of two excellent posts by University of Arizona political scientist Lane Kenworthy.   Continue reading “How to Discover the Truth with Statistics”