Friday, January 11, 2013

What is the debt-ceiling really about?

An interesting public choice question facing us (America) at this time, is the apparent inability to reverse course and undo the establishment of multiple voting and lobbying constituencies once they have been created - many of whose members do not pay taxes (example many entitlement recipients). This is what Romney was referring to in his 47% comment. Once these power groups have been created and receive benefits in excess of the (perceived and actual) payments they make, the likelihood of their members voting to cut expenditures for these benefits diminishes over time. Crudely expressed, when a majority receives benefits from a paying minority (in power terms, if not in numbers), there appears to be no going back if we are to rely on the normal majoritarian democratic process. The article reproduced below from today’s WSJ, suggests something may be missed in the above analysis. It prompted me to think things through to the ultimate implications. 

In essence, a welfare-dependent-majority situation is one that is not static; it gets worse over time and the growing costs, and the hardships imposed on a growing number of taxpayers, must eventually cause some kind of reform – either that or a complete fiscal collapse. To be sure, a welfare majority does make expenditure reform much more difficult. At the very least, it suggests that things have to get pretty bad before any kind of reform initiative is likely to have any traction. Current events in Europe bear witness to this. It is a  consideration of the constitutional status of the debt-servicing, expenditure-appropriation process that clarifies the situation we face.

Contrary to popular conception, entitlement expenditures are not constitutionally entrenched. They can be cut anytime Congress decides to pass legislation to that effect, or anytime Congress fails to appropriate money for them. On the other hand, as explained by the article below, government debt payments (principle and interest) are so entrenched by the 14 Amendment, Section 4 of the Constitution. This means that if Congress fails to raise the debt ceiling, thus preventing new government borrowing, the existing debt still has to be paid. In the absence of being able to borrow in order to pay for its expenditures, the government would then have to prioritize and decide what to cut in order to pay interest and principle due on the debt or increase revenue by raising taxes. So the question becomes, will the Congress continue to approve debt-ceiling increases ad infinitum? If not, then the government will have to face its budget constraint and make cuts or consider even more tax increases – one can imagine the blood that will flow in that debate. Of course, using tax increases to solve this problem also has a limited range of effectiveness. At some point the Laffer curve will kick in – higher tax rates will bring in less revenue as tax-constrained incomes put a crimp in income generation through value-creation. At that point expenditure cuts have to be relied on.

On the other hand, if Congress simply continues to raise the debt-ceiling, the economic consequences will be dire, and bad things will start to happen at an accelerating rate. The deficit and the debit will become a larger and larger multiple of the revenue coming in. A number of things are likely to happen, though the timing and the sequence cannot be predicted. With a greater portion of the debt being financed by the Federal Reserve, bank reserves will continue to rise (even though they stand at unimaginably high levels already). As the economy continues to recover (in spite of the dysfunctional polices of the last four years), the banks will begin making loans, market interest rates will rise, and the money-supply will rise. This, in turn, implies an exploding increase in the interest payment due on newly borrowed debt, and widespread price inflation. Americans are historically very antagonistic to both interest rate increases (which will wallop the stock markets) and, even moreso, high levels of inflation. 

At that point, who knows? Will we have a Carter to Reagan type situation again? Or will it have to get much worse before any pendulum swing-back can be expected? I guess we will find out.

Updated January 10, 2013, 7:12 p.m. ET
Rivkin and Casey: The Myth of Government Default
The Constitution commands that public debts be repaid. There is no such obligation to fund entitlement programs.
Three false arguments, pushed hard by the Obama administration and accepted on faith by the media and much of the political establishment, must be laid to rest if the American people are to understand the issues at stake in the federal "debt ceiling" debate.
The first is that Congress's failure to raise the debt ceiling—the amount of money the federal government is authorized to borrow at any given time—will cause a default on the national debt. The second is that federal entitlement programs are constitutionally protected from spending cuts. The third is that the president can raise the debt ceiling on his own authority.
To take up the first canard: Contrary to White House claims, Congress's refusal to permit new borrowing by raising the debt ceiling limit will not trigger a default on America's outstanding public debt, with calamitous consequences for our credit rating and the world's financial system. Section 4 of the 14th Amendment provides that "the validity of the public debt of the United States, authorized by law . . . shall not be questioned"; this prevents Congress from repudiating the federal government's lawfully incurred debts.
The original concern of this provision was to guarantee the integrity of federal debts incurred during and immediately after the Civil War (while the debts of the Confederacy were nullified permanently), and to ensure that a newly "reconstructed" Congress—to which the Southern states were readmitted—would not reverse these decisions. However, the amendment's language was not limited to the Civil War-related debts. In Perry v. United States (1935), the Supreme Court made clear that the provision "indicates a broader connotation" protecting the nation's debts as a whole.
This means that a failure to raise the debt ceiling—to prevent new borrowing—does not and cannot put America's current creditors at risk. So long as this government exists, and barring a further constitutional amendment, those creditors must be paid.
Nor are they at risk in practice, since the federal government's roughly $200 billion in tax revenue per month is more than sufficient to service existing debts. If the executive chose to act irresponsibly and unconstitutionally and failed to make any debt payments when they come due, debt-holders would be able to go to the Court of Federal Claims and promptly obtain a money judgment.
These basic facts should inform any credible decisions by credit-rating agencies in establishing the government's creditworthiness. Significantly, these agencies have traditionally acted favorably when heavily indebted countries have not defaulted on their debt but cut deeply their public spending.
Second, despite White House claims that Congress must raise the debt ceiling to pay the bills it has incurred, the obligations protected as "debts" by the 14th Amendment do not include entitlement programs such as Medicare and Social Security. These programs are not part of the "public debt," which consist of loans that are made to the federal government through bonds and similar financial instruments. Entitlement programs are instead political measures that are fully subject to the general rule that one Congress cannot, by simple legislation, prevent a future Congress from making cuts.
This fundamental and vital distinction is clear from both the text and the drafting history of the 14th Amendment's Section 4. The wording of the section was revised before its enactment and ratification to replace the term federal "obligations" with that of "debts," a far more narrow (and manageable) category.
The distinction was recognized by the Supreme Court in Flemming v. Nestor (1960), which involved the power of Congress to modify Social Security benefits. The court noted that entitlements and "contractual arrangements, including those to which a sovereign itself is a party, remain subject to subsequent legislation by the sovereign."
Congress can reduce a wide range of payments to various beneficiaries at any time by amending the statutes that authorize them or simply by failing to appropriate sufficient funds to pay for them. Nor does Congress have any legal or constitutional obligation to borrow money to pay for entitlements.
Third, assertions, most recently made by Nancy Pelosi, that the president can rely on Section 4 as a pretext for raising the debt ceiling by himself are manifestly incorrect and constitutionally dangerous. Section 4 grants no power whatsoever to the president—instead, the 14th Amendment grants Congress the "power to enforce, by appropriate legislation, the provisions of this article."
More fundamentally, this argument—which has been tentatively advanced and then tentatively withdrawn by the White House, both during the 2011 debt-ceiling battle and in the last several weeks—is contrary to the language, structure and history of the Constitution.
Like the British Parliament before it, Congress controls the power of the purse—the authority to raise taxes, borrow money and direct how revenues are spent. In particular, Article I, Section 2, grants to Congress the power "to borrow money on the credit of the United States." There is no similar grant to the president. Any effort by the chief executive to borrow money without congressional action would be every bit as injurious to our constitutional system as presidentially ordered taxation.
True enough, the "debt ceiling" is not a constitutional requirement. Congress could choose instead—as used to be the case during most of our history—to vote separately on the issuance of each federal debt instrument. However, nowhere in the Constitution is the president authorized to borrow or spend money without congressional action, except insofar Congress itself may permit.
Once these false arguments are cleared away, the real issue in the debt-ceiling debate becomes clear: the proper level of federal spending. Should Congress fail to increase the debt ceiling as much as the president wants, the effective result would be major government spending cuts, with payments on public debt excluded.
This is tough medicine and not to be administered lightly. If Republicans are serious about winning this debate, they must strive to convince the American people that such spending cuts are necessary, given President Obama's openly articulated unwillingness to implement any meaningful spending cuts other than defense and his clear preference for limitless borrowing.
Whether they can succeed in this task is unclear. But the public must at least be allowed to ponder these vital issues without being misled by false claims involving debt default, the nature of federal obligations, and which branch of government is in charge of the public fisc.
Messrs. Rivkin and Casey are partners in the Washington, D.C., office of Baker Hostetler LLP and served in the White House and Justice Department during the Ronald Reagan and George H.W. Bush administrations.
A version of this article appeared January 11, 2013, on page A13 in the U.S. edition of The Wall Street Journal, with the headline: The Myth of Government Default.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Tuesday, January 1, 2013

Taxation, fairness, inequality, poverty and the confusion of language in modern discourse.

NPR debate: Are The Rich Taxed Enough?

At the link above there is a broadcast of a debate I heard today that prompted this post.
Robert Reich is insufferably smug, though he is smart. He has these rock-solid views on economic policy and he is not even a trained economist - though, goodness knows, that may be an advantage these days - but not in his case. And on the other side they have two ineffective spokesmen in Art Laffer and Glen Hubbard. Mark Zandy, arguing against the proposition, is fair and intelligent, but, in my opinion, sadly wrong where it counts. So frustrating.
Everyone tries to use history (historical statistics) to support his case. The problem (I repeat again) is the irremediable uncertainty that attaches to the attribution of cause and effect in the interpretation of historical events and eras. I see the economic growth that occurred during the Clinton administration resulting from the momentum of the Reagan era reforms (as limited as they were), and in spite of the increase in taxation that occurred. Reich opines confidently that raising taxes did no harm to economic growth and value creation and may have done some good. There is no way to resolve this kind of disagreement. One can offer coherent theories for each - and other interpretations besides.
So what's left? Well faced with this uncertainty one has to appeal to values! We have to decide where, in our ignorance, we want to put the burden of proof. Who should bear the burden of proof - those advocating an activist economic policy or those opposing it? In the former case, it would have to be shown beyond a high level of doubt that higher taxes on the rich DO NOT harm economic growth, productivity, etc. In the latter case, to effectively oppose it, it would have to be shown that higher taxes DO so harm these things. The policy adopted absolutely depends on where you put the burden. So how to decide?
A couple of things that could have been mentioned in this debate.
1.       At the very top it should be clearly stated that taxation is an inherently coercive act. There is no escaping this. Taxes are compelled under the threat of forcible extraction or incarceration. Taxes are an aberration in a free and peaceful society. This should dramatically color the burden of proof requirement. Those who favor more and higher taxes, on anyone rich or poor, should have to overcome a fundamental moral objection to coercion. If taxes are a necessary evil, then they should be kept to a minimum, continually examined and increased only under the weight of a powerful argument to do so. Absent the ability to prove the absolute necessity of increased taxes such a proposal should fail, just as any proposal to further increase coercion should fail unless some very compelling overriding purpose can be discerned.
2.       Why this preoccupation with inequality of earnings? All these misleading numbers about how it has increased? Why is inequality a problem? Surely poverty is the problem, not inequality. Anti-poverty programs are not the same thing as anti-inequality programs. We need to get this straight before we can discuss policy. If everyone in America earned a minimum of $1million in today's purchasing power, and the richest earned $1billion, would that be a problem? If the answer is Yes, then what is the norm, the value, that is informing that answer? Envy, resentment? How does one defend distribution policies without bringing in resentment, albeit dressed up in respectable terms? These are unworthy norms, destructive values, for which we chastise our children. How have they become part of respectable national policy?
3.       So, inequality should not have been part of this debate. Maybe poverty, but not inequality of earnings. That being said, the focus then shifts to how best to tackle the question of poverty and one has to note the grossly ineffective anti-poverty programs of the last sixty years and the fact that there is now a “poverty industry” in the US – a huge sector of the economy devoted simply to serving the poor, and thus maintaining poverty. There is simply no denying that there is a huge public sector constituency that has a vested interest in the maintenance of poverty. (They have achieved a lot of mileage simply by continually redefining it).
4.       What the hell does "fairness" mean? Why on earth would anyone consider it fair that someone with greater earnings which they came by in a legitimate way, should pay a higher proportion in tax. If I earn $100 and pay 10% in tax, I pay $10. If I earn $200 and pay 10% in tax, I pay $20. I earn more I pay more, in direct proportion to my increased earnings. Seems very fair to me. Fairness, as justice, is about treating people equally regardless of who they are, rich or poor. (The Talmud teaches that the rich are entitled to equal justice and should not be victimized because of their advantages.)
Armchair second-guessing is easy. I probably could not have come up with all of this spontaneously. But given preparation time, surely Hubbard and Laffer could have done better. I can think of a number of “Austrian types” who would have.