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November 29, 2009

Economist's View - 3 new articles

"Will the Obey Plan End the War?"

If people had to pay for the cost of the war with an explicit, dedicated tax for that purpose, would they still support it? I think it's a good idea to make clear what the war costs - e.g. the $11 billion per month the war effort costs would pay for a lot of health care and other domestic needs - but I'm not sure that raising taxes during a recession (or during the inklings of a recovery) is a good idea.

The economic effects of a tax increase are one of the worries, though the size of those effects depends upon where the burden falls. If the Bush tax cuts didn't do much to help middle and lower class income and employment -- and I don't see any strong evidence that they did -- it's hard to see how reversing such taxes would have much of an effect either. But the tax surcharge proposal is broad-based, everyone would face higher taxes not just the wealthy, and the effects of a broad-based tax change might be larger. Why take a chance when the job market doing so poorly?

The main worry for me is not the size of the debt or the economic consequences (though the latter is of concern), it's the political message that raising taxes right now would send. Raising taxes to pay for the war would send the message that the federal debt is such a large problem we have to implement a tax surcharge even while the economy is struggling to recover from a recession. That is the opposite of the message I think we should be sending -- the economy and labor markets still need more help -- and it's hard to imagine how to get that help after sending a message that the debt is so worrisome.

We do have debt problems down the road, and rising health care costs are the driving force behind the budget trajectory. We will need to address this problem. In addition, we should pay for the wars and the stimulus package when the economy is on better footing. Thus, I would support legislation that raises taxes (or cuts "wasteful" spending, though good luck with that) to pay for these items at some point in the future. That would highlight the cost of the war without simultaneously sending a message that the budget problem is urgent, so urgent that it ties our hands from doing anything more. It would also blunt the inevitable "tax increases will kill jobs" objection that is sure to come.

So yes, let's raise taxes now to pay for these things, but the tax changes shouldn't take effect until the economy surpasses some metric for health -- unemployment falling below a particular number could be one trigger -- or it could come at some date certain in the future, e.g. two years from now, (assuming that gives the economy enough time to regain more solid footing).

If I thought that the Obey tax surcharge plan would actually end the war, or stop it sooner, I might see this differently. But it seems to me that highlighting budget problems now would be more likely to affect funding for needed social programs such as food stamps and unemployment compensation than it would be to affect the war effort.

I'm curious to hear your thoughts on this:

Will the Obey Plan End the War?, by Bruce Bartlett, Commentary, Forbes: In recent years, Republicans have been characterized by two principal positions: They like starting wars and don't like paying for them. George W. Bush initiated two major wars in Iraq and Afghanistan, but adamantly refused to pay for either of them by cutting non-military spending or raising taxes. Indeed, at his behest, Congress actually cut taxes and established a massive new entitlement program, Medicare Part D.
Bush's actions were unprecedented. During every previous major war in American history, presidents demanded sacrifices from rich and poor alike. As Robert Hormats explains in his 2007 book, The Price of Liberty: Paying for America's Wars, "During most of America's wars, parochial desires--such as tax breaks for favored groups or generous spending for influential constituencies--have been sacrificed to the greater good. The president and both parties in Congress have come together … to cut nonessential spending and increase taxes."
During World War II, federal revenues roughly tripled as a share of the gross domestic product (GDP) and the number of people paying income taxes expanded tenfold, from 3% of the population in 1939 to 30% by 1943. In 1940, a family of four needed close to $80,000 of income in today's dollars before it paid any federal income taxes at all. By the war's end, it saw its effective tax rate rise from 1.5% to 15.1%. (Today such a family only pays a federal income tax rate of about 6%.) But taxes weren't the only way the war was paid for. Spending on nondefense programs was cut almost in half, from 8.1% of GDP in 1940 to 4.4% in 1945.
Even during wars closer in magnitude to those in which we are presently engaged, significant sacrifices were made. In 1950 and 1951 Congress increased taxes by close to 4% of GDP to pay for the Korean War, even though the high World War II tax rates were still largely in effect. In 1968, a 10% surtax was imposed to pay for the Vietnam War, which raised revenue by about 1% of GDP. And there was conscription during both wars, which can be viewed as a kind of tax that was largely paid by the poor and middle class--young men from wealthy families largely escaped its effects through college deferments.
However, Bush and his party, which controlled Congress from 2001 to 2006, never asked for sacrifices from anyone except those in our nation's military and their families. I think that's because the Republicans understood, implicitly, that the American people's support for the wars in Iraq and Afghanistan has always been paper thin. Asking them to sacrifice through higher taxes, domestic spending cuts or reinstatement of the draft would surely have led to massive protests akin to those during the Vietnam era or to political defeat in 2004. George W. Bush knew well that when his father raised taxes in 1990 in part to pay for the first Gulf War, it played a major role in his 1992 electoral defeat.
Consequently, Republicans resolved to fight our wars on the cheap and with deceptive cost estimates. On the eve of war in December 2002, Office of Management and Budget (OMB) director Mitch Daniels claimed that the war in Iraq could be fought at a total cost of $50 billion to $60 billion. Indeed, Bush even fired his top economic adviser, Lawrence Lindsey, for saying publicly that the war might cost between $100 billion and $200 billion.
Of course, both Daniels and Lindsey grossly underestimated the actual cost. According to a recent report from the Congressional Research Service (CRS), the wars in Iraq and Afghanistan have cost close to $1 trillion thus far. That is exactly what economists not on the White House payroll expected. (See this December 2002 report from the American Academy of Arts and Sciences.)
In his 2008 book, What a President Should Know, Lindsey said that lowballing the cost of the war was a "tactical blunder" because it allowed Bush's enemies to claim that he lied us into war. But at the same time, Lindsey acknowledges that the administration never rose to "Churchillian levels in talking about the sacrifices needed." He also says that asking for sacrifice in the form of spending cuts and tax increases would have served the important purpose of involving the American people in the war effort. As it is, war is largely out of sight and out of mind.
According to the CRS, the marginal cost of continuing the Iraq and Afghanistan wars is about $11 billion per month, with no end in sight. Although there has been some decline in spending for the Iraq war, it has been more than offset by the rising cost of the war in Afghanistan. According to OMB director Peter Orszag, it costs about $1 million per year per soldier in the field, so adding 30,000 additional troops in Afghanistan, as President Obama is expected to do next week, will cost another $30 billion per year.
The White House has given no indication of how it plans to pay for expanding the war in Afghanistan. More than likely, it will follow the Bush precedent and just put it all on the national credit card. But at least some members of Congress believe that the time has come to start paying for war. On Nov. 19, Rep. David Obey, D-Wis., introduced H.R. 4130, the "Share the Sacrifice Act of 2010." It would establish a 1% surtax on everyone's federal income tax liability plus an additional percentage on those with a liability over $22,600 (for couples filing jointly), such that revenue from the surtax would pay for the additional cost of fighting the war in Afghanistan.
It's doubtful that this legislation will be enacted. But that's not Obey's purpose. He will probably offer it as an amendment at some point just to have a vote. Republicans in particular will be forced to choose between continuing to fight a war that they started and still strongly support, or raising taxes, which every Republican in Congress would rather drink arsenic than do. If nothing else, it will be interesting to see those who rant daily about Obama's deficits explain why they oppose fiscal responsibility when it comes to supporting our troops.
Obey makes no secret of his motives. He knows that deficits need to be reduced at some point and this will put pressure on spending programs he supports. "If we don't address the cost of this war, we will continue shoving billions of dollars in taxes off on future generations and will devour money that could be used to rebuild our economy," Obey explained in a press statement.
He is not alone in his fear that war presents a threat to the Democratic agenda. As Boston University historian Robert Dallek told Obama at a White House meeting earlier this year, "war kills off great reform movements." He cited the impact of World War I in ending the Progressive Era, World War II in killing the New Deal, the Korean War in terminating Harry Truman's Fair Deal program and the Vietnam War in crushing Lyndon Johnson's Great Society.
At this point, Republicans are probably nodding in agreement. If it takes wars to end ill-conceived social programs, then that's another argument in favor of continuing the Iraq and Afghanistan campaigns. But that's a very short-sighted view because, as essayist Randolph Bourne once put it, "war is essentially the health of the State." Historians Robert Higgs and Bruce Porter, among others, have documented the pernicious effect of war on the size and scope of government. It creates a ratchet effect in which taxes and spending grow and civil liberties are restricted permanently, because when war ends, we never go back to the status quo ante.
If it takes the threat of a tax increase to get people to think seriously about whether it's worth continuing to fight wars far from home--wars that have only the most tenuous connection to the national interest--then it's a good idea. History shows that wars financed heavily by higher taxes, such as the Korean War and the first Gulf War, end quickly, while those financed largely by deficits, such as the Vietnam War and current Middle East conflicts, tend to drag on indefinitely.
If Americans aren't willing to follow John F. Kennedy and "pay any price, bear any burden, meet any hardship" to fight a war, then we shouldn't be fighting it.

"Dangers of an Overheated China"

Tyler Cowen:

Dangers of an Overheated China, by Tyler Cowen, Commentary, NY Times: ...Several hundred million Chinese peasants have moved from the countryside to the cities over the last 30 years... To help make this work, the Chinese government has subsidized its exporters by pegging the renminbi at an unnaturally low rate to the dollar...; additional subsidies have included direct credit allocation and preferential treatment for coastal enterprises.
These aren't the recommended policies you would find in a basic economics text, but it's hard to argue with success. ... Those same subsidies, however, have spurred excess capacity... China has been building factories and production capacity in virtually every sector of its economy... Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. ...
Regional officials have an incentive to prop up local enterprises and production statistics... Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.
Put all of this together and there is a very real possibility of trouble. ... What will the consequences be ... if and when the Chinese economic miracle encounters a major stumble? A lot of Chinese business ventures will stop being profitable, and layoffs and unrest will most likely rise. The Chinese government may crack down further on dissent. The Chinese public may wonder whether its future lies with capitalism after all, and foreign investors in China will become more nervous.
In economic terms, the prices of Chinese exports will probably fall, as overextended businesses compete to justify their capital investments... American businesses will find it harder to compete with Chinese companies, and there will be deflationary pressures in both countries. And ... the Chinese ... may have less to lend to the United States government. ... The United States will face higher borrowing costs, and its fiscal position may very quickly become unsustainable.
That's not so much a prediction as a very possible contingency, and we should be prepared for it. For now, we should avoid two big mistakes. The first would be to assume that just because borrowing costs are now low, we can postpone fiscal responsibility and keep running up the tab — with the aid of Chinese lending, of course. The history of financial crises shows that turning points can come swiftly...
The second mistake would be to demand too many concessions from the Chinese. What we see in the numbers today are a growing China... Yet there's a real chance that, soon enough, Chinese economic weakness will be a bigger problem than was Chinese economic strength.

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