America's Deficit Hysteria is Taking a Toll on State Governments

To follow economic news these days is painful.  It seems that each thing you read is worst than the last.  So in an effort to keep my sanity I have watched quietly as the eurozone dismantles itself.  Perhaps a combination of fatigue and an insular Atlantic has me pacified.  But as whatever mental disease that compels the leadership of Europe these days spreads across the pond, I'm once again obliged to pen a few words in protest.

The State of Minnesota shut its doors last Thursday as a result of an impasse over its $5 billion budget gap.  Minnesota is not alone as most states in the union, in varying degrees, currently face budget crises.  According to  the Center on Budget and Policy Priorities 42 states project budget shortfalls for FY 2012.  These gaps range from 2.4% to 37.40% of their respective general fund budgets, with most states hovering around a median of 11.5%.  States with budget deficits are projected to total over $100 billion in FY2012.  While that sum is better than the current fiscal year deficit of $131 billion, states expect to be in the red for the foreseeable future.

To deal with this issue states are faced with the choice of raising taxes, cutting spending, or a combination of both.  Unlike the federal government, states cannot generally run deficits in perpetuity.  They must balance their budgets or run surpluses.  Usually tax increases are ruled out immediately and for good reason.  We are in the midst of a recession and raising taxes drains spending power from the economy, which only serves to prolong the misery.  Of course, there are other ways to raise taxes that don't have that effect - like increasing marginal tax rates on income and capital gains - but those are often immediately discarded from debate as "socialist" and "unamerican."  They are not, but that is a subject for another post.  So any kind of tax increase is off the table, leaving only spending cuts.

While it seems to be the weapon of choice for governments, spending cuts are often worse than tax increases, especially at the state level.  Typically there is not much fat to trim from state budgets before you cut into the meat.  Take for instance Nevada who ranks the highest in terms of deficit as a proportion of its overall budget.  Below is a snapshot of how Nevada divides its spending pie.  Notice the two largest pieces of the pie are expenditures on education and human services (health care, elderly assistance, employment services, mental health services and programs for families and children).  Now since Nevada has a large budget gap to close - more than 37% of its budget - it has no choice but to look for opportunities to cut spending on education and human services, as they account for 60% of the state's total spending.  You won't find those savings by streamlining the finance / administration sector.

Source:  Nevada Open Government

Cuts to education and health services not only have an immediate, negative impact on the economy, as layoffs and furloughs translate into less demand, but they also limit the ability of the state to meet its long-term social and economic goals: mainting a healthy and well-educated workforce.  What is most appalling is the fact that states are being forced to hollow themselves out to deal with temporary, cyclical budget shortfalls.  These deficits, in large part, are a consequence of the Great Recession.  They have nothing to do with the normal function of each states' budgets and priorities, but rather the reduction in tax revenues and increase in unemployment benefits as jobs disappear from a contracting economy.  As unemployment remains high and federal support to states runs dry, these states are resorting to drastic measures to remain solvent in the short-term.

The massive layoffs, government shutdowns and liquidation of entire "right-sizing" of school districts around the country is completely avoidable.  That is the great tragedy.  The farce is that Washington believes it needs to behave like individual states, member countries to the EU (read:  Greece), or even individual households.  The rhetoric these days is all about balancing the budget or running surpluses, rather than providing liquidity to states to keep them in the black during the recession.  Absolute madness!  Worse, the POTUS is so committed to convincing us that he's just as austere as the next guy that he keeps playing the same old "fallacy of composition" record, hoping that this time it will sell:

"Government has to start living within its means, just like families do.  We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs." ~ Barack Obama, July 2nd 2011 Radio Address (h/t Krugman)


The president is wrong.  The federal government does not face the sort of funding constraints that individual states, businesses or households do.  Nope, they are the issuers of the currency in use by those entities, and as such can never run out of dollars.*  Federal spending is only limited by political will and the sort of inflation an economy experiences as it nears full employment.  With this in mind, the president should instead spend his political capital reminding the polity that incumbent upon the federal government is a responsibility to the states, that during periods of cyclical budget crises they will be extended the liquidity necessary to keep the doors open and resume their long term development strategies.  




* For those unacquainted with the operational facts of modern US finance this claim may come as a shock.  If so, please see this primer on Modern Monetary Theory (MMT)

Network Science, Facebook and Economics

In their critique of orthodox method, heterodox economists are faced with the burden of offering alternatives.  By stressing the importance of tradition, consequence and interconnectedness, we agree to the task of accounting for them.  One quest that emerges from this seeks to identify the network of social connections that constitute our environment.  To whom are we connected?  How do we affect the decisions of others?  What goods flow between which connections, and why did they do so at all?

In order to find appropriate methods for addressing these questions I've spent a deal of time lately reading the literature on network analysis. The idea is that if you have a list of nodes - e.g. friends, colleagues, etc. - and a list of their connections, you can begin to see the structure of the network.  For instance, two friends may have a set of common friends, who in turn may have common friends, and so on.  When we think of the degrees of separation, we are referring to the structure of the network.

Out of curiosity I decided to analyze my facebook friends network.  Using netvizz I extracted a graph file that contains my lists of nodes and edges (connections).  Then I imported that into Gephi and ran a few tests on the data.  First, I ran an algorithm that determined the degree of connectedness of each node.  The degree measure is simply the number of connections to other nodes per node.  Next, I sized each node relative to its degree, making larger nodes visible as the most connected.  Then, I ran the force atlas algorithm to distribute the nodes in a manner that makes the network visually meaningful.  Finally, I ran a modularity test.  This detects distinct communities in the network, based upon a neighborhood of mutual connections.  Oh, and I got rid of the names for the sake of anonymity.  Here's what I discovered:

Immediately you'll notice that there about 9 main color groups.  These are the communities that were discovered in the modularity test.  I was pretty amazed at how accurately it identified the communities in my actual friendship network.  For instance, all purple, red, yellow and peach nodes went to my high school.  But, only the purple nodes graduated in 2002, while the red group was in my class of 2000.  Further still, the yellow group singles out the people I knew in high school since middle school.

Overall my facebook network is well connected.  With exception of a few "islands" of friends most of my friends have direct friendships with other friends of mine.  In particular, this network has an average path length of 2.087:  on average people in my network are within 2 degrees of separation.  Each friend is connected to 11 of my other friends on average.

There are four friends in particular that stand out as being much more connected than the group as a whole:  the largest of green, purplish-blue, dark blue and peach.  Their respective degrees are  58, 42, 50, 53.  This isn't terribly surprising given that each of these are my closest friends.  What this graph infers and my experience confirms, is that each of these well connected nodes is my connection to its respective color group.  My large green friend is well connected to my friends from Western, and indeed is responsible for our introduction.  Similarly, my large purple friend is connected to 42 of my high school and family friends.  And the large blue and peach friends are brothers.

The islands of friends share in common no connection to the larger group of high school, family and WWU friends.  They are entirely representative of discontinuous breaks in my past experience.  For instance, the small turquoise pair of friends is drawn from a set of friends I know from my days in the army.  Similarly, that rather lonely set of friends to the right are from Kansas City.  This is not to say that these friends are friendless; they aren't in their respective networks!  They simply don't share too many common friends from previous stages of my life.

This little exercise is exploratory and does not make any substantial claims.  However, some observations may be drawn from these results.  Primarily that distribution matters when we theorize about the structure of the social systems.  In economics, how individuals are connected in social networks plays a part in the flow of resources through the network.

The much more difficult task of identifying and parsing the data from which to develop structural models of the economy remains.

An Open Letter to the Tea Party

Dear Tea Party:

We come in peace.  Normally we are pitched in total disagreement over most political issues, ranging from taxes to the role of the state in economic affairs, and so on.  Those differences probably won't be resolved in the short-term, if ever.  But, I submit that there is one cause that we can mutually support:  uniting to check TSA's new approach to traveler screening, and perhaps working to abolish the agency altogether.

It might be shocking to many Conservatives out there, but Progressives support the protection of individual liberty.  We differ in our interpretation of how liberty should be maximized, and what forces serve to undermine them, but we strongly value the rights of the individual.  Our major disagreements stem from differing views of how the economy works, so it is natural to derive divergent interpretations of the economic consequences of liberty. 

However, government intrusion into the right to privacy is largely devoid of economic interpretation.  Progressives and Conservatives alike see the common erosion of freedom at the hand of the TSA.

So my proposal is simple.  Let us unite and work to strip away the authority of TSA.  We should mobilize our separate bases to pursue the same goal.  Progressives and Tea Party Conservatives, as activists, are poised to shake up the Establishment from the Left to Right. If we do this together we can force some legislation to unravel some of the mess that is the TSA.  Who knows, maybe we'll break apart the Deparment of Homeland Security as well.

After that we never have to cooperate again.  We can resume our disagreements as long as they exist.


Sincerely,

Progressives

Concerned about #socialsecurity? Arm yourself with knowledge.

If you hear anybody say that we need to cut Social Security, Medicare, Medicaid, (or any program for that matter) because they are going to bankrupt America, they either don’t understand how public finance works or are simply lying to you!  Most likely they are lying, but I’ll give them the benefit of the doubt ‘cause I’m a nice guy:)

This post dismantles the central argument behind SS privatization or reform: the US will not be able to afford those programs in the future, so we should take measures to cut them now.  Once that argument dissolves we are left scratching our heads wondering, “So why do we want to do away with those programs?”
Short answer:  so that Wall Street can package up our already secure national pension system and sell it back to us, at a premium, but without the assurance that it was originally designed to provide.

Arm yourself with the facts regarding Social Security and public finance.  Things are going to get ugly in the politics of public spending.  There will be a torrent of misinformation, designed to dupe you into cutting of your nose to spite your face. 

My exchange between @loadedorygun explained

Thoughtful policy debates are difficult.  Doing so 140 characters at a time is even more difficult!

Over the last day or so I’ve (@greenm1981) gone back and forth with the Twitter arm of the progressive blog loadedorygun.net, on the subject of deficits and taxes.  My original intent was to point out that progressives need to avoid the deficit when speaking about social and economic policy.  Public finance is one of the most misunderstood subjects in politics and economics, and the Left is not exempt from that characterization.  But, it is my fault for choosing to engage this misunderstanding in a tweet.  My bad.
At the same time, we cannot ignore the power of social media in overcoming binding myths and promoting ideas that generate progress.  So it is sort of a catch-22.  What follows is an attempt to clear the air as to a misunderstanding that has emerged between @loadedorygun and myself.

I hold a lot of respect for the blog loadedorygun.net, and in the past they have been very influential in bringing about my own political awareness.  I follow them on twitter so that others might be indirectly exposed to their message.  I agree that government should serve to promote equality, well-being and social justice.  My disagreement, however, is based upon my understanding of how taxes and deficits work at the federal level.
The left has long embraced the myth that taxes finance government spending, that deficits are inherently bad, and that it makes for sound fiscal policy to pursue balanced budgets.  And for good reason, “the deficit” as it stands in the modern political discourse virtually guarantees that any politician with serious ambition, needs to humble before that old time religion.  Ironically, Democrats in their desire to show themselves as responsible keepers of the public coffers, amplify the rhetoric of fiscal austerity in a futile attempt to prove they are the not the party of profligate waste.

All of this rhetoric is predicated upon the notion that since the federal government is constrained by what it receives in taxes, or what it can raise by selling bonds, that cutting taxes ties the hands of government to engage in socially useful activities.  Cutting taxes, while offering some stimulus in the short run, only reduces the prospect of long term goals such as single-payer health care, clean energy infrastructure projects, full employment policys, etc.

But, government does not spend tax money.  Rather, they spend by crediting their reserve account at the Fed, which is then debited by the account of the recipient of federal expenditures, such as veterans on the GI Bill or recipients of Social Security.  Further, before dollars can be collected as taxes, they must enter the financial system through federal spending.  In essence, the federal government creates money by spending.  This ability to spend without prior reserves is common to governments that have sovereign control of their currency.  In other words, they issue money that is not pegged to an external currency, and their debts are denominated in their own currency.  Countries under these conditions (US, Japan, Australia, Canada, UK, etc.) are never cash constrained; they cannot go insolvent.  States within the US, or member countries of the EU, do not enjoy this freedom to spend without constraint.  But, the federal government does.
So then what about inflation?  Why do pay taxes at all?  The conventional wisdom that “printing money” creates inflation is a myth, and is not grounded in theory or experience.  Inflation occurs when the price of inputs in the production process (oil, steel, labor, etc.) increase due to efforts to increase corporate profits, or because of some event that restricts their normal production (Hurricane Katrina).  Inflation also occurs when the economy comes up against its real limits of production at full employment, in which case it is demand led.  In today’s economy inflation is not a real concern; unemployment of both labor and capital is very high!

Taxes serve two functions.  First, taxes destroy money.  Taxes remove purchasing power from the economy.  A progressive tax structure serves to regulate demand in such a way that reduces the tendency for incomes and wealth to flow towards the richest households, leaving the purchasing power of most households intact.  Also, a progressive tax structure has what economists call a “countercyclical” effect on the economy:  it dampens both booms and busts by removing an increasing amount of purchasing power in the former, and a decreasing amount of purchasing power in the latter.  This is especially true if the progressive tax is on incomes.

Second, taxes create demand for the currency.  When the federal government levies a tax it gets to choose the terms which serve to settle that tax.  In the US taxes are only payable in dollars, therefore we demand dollars so that we can meet our tax liability.  This process has been developed by a school of monetary scholars under the banner of Chartalism.  This approach contrasts sharply with the conventional, ahistorical story that money emerged from barter.  Unfortunately, there is no anthropological evidence for this claim and it only persists out of convention.

Ok, so what?  My description of how taxes and spending work at the federal level exposes what has come to be an inversion (or perversion?) of the relation between the deficit and economy.  The deficit - the difference between tax revenues and spending - is a means to an end.  The end I have in sight, as do Progressives, is full employment and social justice.  But in politics, the deficit has become an end in itself.  All of our policy goals are subsumed to whether it results in a reduction of the deficit, or at least having a neutral effect.  This inversion of means versus ends results in Progressives taking the stance that tax cuts are not good in this economy, or that it will make it impossible to afford larger agendas.  This is misguided.
Tax cuts, at the federal level, increase aggregate demand.  Surely, cutting top marginal tax rates on high income earners or extending estate tax cuts have a negligible effect compared to direct job creation.  But, not all taxes are the same.  Payroll taxes - medicare and social security - are regressive taxes on income.  They are not necessary to fund those programs and their continued presence shifts the burden of taxation from the rich to the poor.  Suspending all payroll taxes immediately would increase purchasing power of all wage earners.  And, cutting payroll taxes would reduce the level of wage inequality, immediately.  Since payroll taxes are split between the wage earner and the employer, employers would see an immediate relief as well.
To be clear, for the sake of stability and equality the top marginal rates on income need to go back to their post-WWII rates, or at least their post-Kennedy rates.  And we need a hefty estate tax so that you can’t create a tendency towards dynastic wealth accumulation.  We also need to push for a federal job guarantee program, that places the government as “employer of last resort.”  There is no better way of achieving full employment and we can afford it.

But, if the Left wishes to retain any power in government it ought not pursue a tax increase of any kind!  Until those that wish to find employment are presented with the opportunity, and until the middle class sees a substantial tax decrease, any attempt to raise the top marginal rates will be used like a weapon.  Not seeing any effect on their earnings, middle class voters will accept the lies that the Dems raised their taxes, and they will turn even further to the Right.
If you suspend payroll taxes, create jobs directly, you will see a reduction of the deficit to follow, because more jobs means more tax revenue.  Only after that will there be the political capital to pursue more progressive goals.

Curious as to the source of my radical interpretation of public finance?  Here are some great sources for a more technical reading:
levy.org
neweconomicperspectives.blogspot.org
moslereconomics.com

Wasted Capital

President Obama’s recent call for the establishment of a new national infrastructure plan only reinforces my frustration with contemporary American politics.  My frustration arises from the stark realization that we have a political system that virtually assures that in each election, at all levels of government, we are lucky enough to choose between Coke and Pepsi.  When your favorite brand is winning in the polls you tend to forget that product differentiation rules in politics, as efficiently as it determines our choice between California Pizza Kitchen or the Cheesecake Factory for dinner.

Fortunately, I’m not here to rant about politics.  Instead, I’ll offer a critique of the economic merit behind the President’s transportation proposal.  Before we get too far I’d like to disclaim that I fully support the rapid expansion of modern transportation infrastructure in the US.  We badly need to both repair our current stock of aging infrastructure and invest in infrastructure that offers real choice in transcontinental travel.  Every day that passes without a high-speed rail system in this country is another opportunity for the airline industry to find new, innovative ways to suck the life out of America.  For example, this “saddle” seat might become the new coach class standard if the FAA approves them as safe for implementation.  The airport experience is already dehumanizing enough with the TSA’s “freedom-enhancing” procedures; further cost saving innovations on the part of the airline oligopoly need not offer the icing on the cake.

I don’t object to Federal investment in transportation infrastructure, only the level and method of financing.  On Labor Day, Obama called for Congress to front-load $50 B in seed money for the establishment of an “infrastructure bank” that will fund future transportation projects.  This new bank will nest under the Department of the Treasury and will function as a public-private partnership.  According to Michael Hudson, the initial seed money will provide the necessary incentive to invite a flow of funds from the investment houses in Wall Street to the infrastructure bank, thus allowing the private sector the “opportunity” to rebuild America.  The public side of the “partnership” enters into the equation in the event the bank goes insolvent.  Therefore, the usual risk associated with massive, public-works projects - the sort of risk that prices the entrepreneur out of such enterprise - is reduced to a level consistent with a firms profit expectations.
When private capital serves as the source of finance for investment, the resultant assets - highways, railroads, streetcars, etc. - are expected to yield a stream of payments over their lifetime.  In the case of infrastructure, revenue takes the form of user fees - tolls, taxes, fares, etc.  Prima facie, user fees seem like a fair method of spreading the burden of public finance amongst those who benefit the most from its service.  After all shouldn’t those that choose to use the infrastructure pay for its cost?  Wait to answer that question until you’ve considered that we are dealing with private ownership of a natural monopoly, which in the absence of a functional and effective regulatory framework results in the user being taxed with monopoly prices.  Before it fades from our collective memory, with a little help of revisionist history, let us recall the price people paid for their natural monopoly services from the likes of Enron, Vivendi and Bechtel.  Corporations are only beholden to their shareholders managers; there’s no guarantee that monopoly profits will translate into expenditures on maintenance and investment.
Hudson points to the likelihood that property values will increase as a result of the “right-of-way” implied by new transportation infrastructure.  The increase can be thought of as a windfall capital gain that accrues to those that hold land along the new or modified route.  In addition to user fees, the difference between the ex ante / ex post land value provides yet another opportunity for Wall Street to reap private gains from public activity.

To anticipate the reader’s thoughtful counter-critique:  “Sure, we all hate Wall Street, but what choice do we have?  We need to do something about our aging infrastructure, we need to promote greener transportation solutions, and we need more jobs!  Since we can’t continue to borrow money from the Chinese that our grandchildren will have repay, relying on private investors to fund these programs is sound finance.”  Before we can move the discourse over policy questions of this nature, we need to settle a few fallacies, which serve as hurdles to a sensible understanding of the problems of the day.

First, the notion that we have to make tough choices between borrowing from the Chinese and saddling future generations with debt, or foregoing the subsequent investment from deficit financing and living with unemployment is a false choice fallacy.  The fallacy is constructed by presenting two possible choices, each diametrically opposed to the other, and suggesting that a choice must be made.  The fallacy is exposed once we consider that not only is there a range of possible choices beyond the ones presented, but that the original options are themselves misleading.  For instance, deficit financing operates as the Treasury issues bonds for sale to the financial system, most notably the Federal Reserve.  Since there is no limit to the amount of T-bills the central bank may purchase from the Treasury, because there is no cash constraint, then it makes no sense to say that China’s willingness to purchase those bonds limits the ability to engage in deficit finance in the future.  If the US wants to issue bonds the central bank will accommodate.  While the Chinese may prefer to hold reserves in US bonds it is important to note that those bonds are denominated in dollars, not RMB, so the likelihood of default approaches zero.  Furthermore, bond issue is not the only way to engage in deficit spending.  The Treasury may simply credit the bank accounts of those it wishes to contract from.  However, that is a wholly separate discussion on public finance which demands its own forum.  For our purposes here, let’s just assume the government needs to sell bonds to raise money for its purchases.  For those curious about that process, there has been a thorough treatment here, here, here and here.

This leads nicely into my second point that the popular media, and so the conventional wisdom, consistently mistakes budgetary for economic costs.  Almost daily we are reminded of the dollar cost of the bailout, health-insurance reform, the social security trust fund, and a host of other “wasteful” entitlement packages.  These figures, in total, measure in the trillions and when subject to compound growth present an untenable future for the US economy.  The misconception lies in the complete absence of any mention of economic costs and benefits associated with such policy.  For example, when Paul Volcker refers to returning to an era of “sound finance” he speaks of a balanced budget economy.  All current tax receipts should offset all current outlays.  Or better, tax receipts should exceed outlays in the current period until such time that the deficit approaches zero.  Yet, when we are in the midst of rather severe recession, characterized by high and persistent unemployment, the economic costs of lost output dwarfs the nominal benefit of paying down the deficit.  The result is that the future is far less productive than its potential, thereby reducing growth and income for our future generations.  In this sense, “sound finance” is nothing but a “beggar thyself” policy.
At this point the chorus usually rings, “Bah, Keynesians believe you can get something for nothing.  You can have your cake and eat it too!  Every sensible businessman knows that only through parsimony, gumption, and a little luck does wealth accrue!”  But, businessmen know well that investing during a period of slack demand and rampant joblessness is a quick way to go broke.  Consider this statement from the Chief Economist at Goldman-Sachs:

“One important reason why we expect the economy to remain weak is that the household sector is likely to deleverage its balance sheet further. This will require households and the private sector more broadly to run a large financial surplus, which will keep demand weak unless offset by substantial fiscal (and monetary) stimulus…..The still-high ratios of debt and debt service to disposable income suggest that the household sector and the private sector more broadly will need to continue running financial surpluses in coming years. Unless fiscal and monetary policy provide a strong counterweight, this is likely to imply only sluggish growth, with risks tilted to the downside.” (zero hedge) via Mike Whitney at Counter Punch

So households aren’t spending because they’re paying down debt and saving, in anticipation that things aren’t going to get better anytime soon.  Let’s help “lull their disquietude” by announcing a revised plan to hire every unemployed person willing to work, to build a network of 21st century infrastructure, and to complete the project within ten years.  We can do this without paying Wall Street a dividend; without wasting real and political capital.  We can do this right now.

A Different Perspective on Deficits

In this brief, L. Randall Wray and Yeva Nersisyan explain why much of the hysteria over the federal deficit is misplaced.  They conclude by offering that if we are to promote a prosperous and democratic future for the US then we need to get past some myths that hamper our ability to engage in fiscal activity that serves a stable posture for growth.  They sum up their intent nicely in the final passage of the brief:

“We accept that there are real differences of opinion regarding the proper role of government in the economy. Some would like to see the functions of government curtailed; others would like to see them expanded. These are legitimate political stances. (italics added for emphasis)  

What is not legitimate is to use fear over deficits to restrain government from achieving the public purpose that is democratically approved. A debate that is freed from the constraints imposed by myths about how government really spends would allow us to move forward to gain consensus on the public purpose the American people expect government to pursue.”