Thursday, September 15, 2016

John Cochrane's testimony before the House Committee on Budget

JC's testimony is very interesting - with lots of good ideas about how to increase the economy's growth rate.  Here is the link.

Here are some excerpts.
Sclerotic growth is our country's most fundamental economic problem.2 From 1950 to 2000, our economy grew at 3.6% per year.3 Since 2000, it has grown at barely half that rate, 1.8% per year. Even starting at the bottom of the recession in 2009, usually a period of super-fast catch-up growth, it has grown at just over 2% per year. Growth per person fell from 2.3% to 0.9%, and since the recession has been 1.3%. 

I'm here to tell you the most plausible answer is simple, clear, sensible, and much more difficult. Our legal and regulatory system is slowly strangling the golden goose of growth. There is no single Big Fix. Each market, industry, law, and agency is screwed up in its own particular way, and needs patient reform. 

Economic regulation, law and policy all slow growth by their nature. Growth comes from new ideas, new products, new processes, new ways of doing things, and most of these embodied in new companies. And these upend old companies, and displace their workers, both of whom come to Washington pleading that you save them and their jobs. It is a painful process. It is natural that the administration, regulatory agencies, and you, listen and try to protect them. But every time we protect an old company, an old industry, or an old job, from innovation and competition, we slow down growth. 

Regulation is too discretionary --you can't read the rules and know what to do, you have to ask for permission granted on regulators' whim. No wonder that the revolving door revolves faster and faster, oiled by more and more money.

Regulatory decisions take forever. Just deciding on the Keystone Pipeline or California's high speed train --I pick examples from left and right on purpose --takes longer than it did to build the transcontinental railroad in the 1860s. By hand.

Regulation has lost rule-of-law protections. You often can't see the evidence, challenge witnesses, or appeal. The agency is cop, prosecutor, judge, jury and executioner all rolled in to one. [And, a Congressman pointed out during the discussion, recipient of collected fines.]

Most dangerous of all, regulation and associated legal action are becoming more politicized. Each week brings a new scandal. Last week10, we learned how the Government shut down ITT tech, but not the well-connected Laureate International. The IRS still targets conservative groups11. The week before, we learned how the company that makes Epi-pens, headed by the daughter of a Senator, got the FDA to block its competitors, Congress to mandate its products, and jacked up the price of an item that costs a few bucks to $600. This is a bi-partisan danger. For example, presidential candidate Donald Trump has already threatened to use the power of the government against people who donate to opponents' campaigns.12

Congress can take back its control of the regulatory process. Write no more thousand-page bills with vague authorizations. Fight back hard when agencies exceed their authorization. Insist on objective and retrospective cost benefit analysis. Put in rule-of law protections, including discovery of how agencies make decisions. Insist on strict timelines --if an agency takes more than a year to rule on a request, it's granted.

The real health care problem is not how we pay for health care, but the many restrictions on its supply and competition.13 If hospitals were as competitive as airlines, they would work darn hard to heal us at much lower --and disclosed! --prices. If the FDA did not strangle new medicines and devices, even generics, prices would fall.

Rather than guarantee bank debts, and unleash an army of regulators to make sure banks don't risk too much, we should instead insist that banks get their money in ways that do not risk crises, primarily issuing equity and long-term debt. Then banks can fail just like other companies, and begin to compete just like other companies.14

"The planet is dying, control carbon!" "Your crony energy boondoggles and regulations are killing the economy!" Well, that argument is not getting us anywhere, is it? The answer is straightforward: A simple carbon tax in exchange for elimination of all the growth-killing, intrusive, cronyist, and ineffective micromanagement. We can continue to argue about the rate of that tax, but it will both reduce more carbon, and increase more growth, than the current ineffective policies --and stagnant debate. 

In many social programs, if you earn an extra dollar, you lose a dollar or more of benefits. Many programs have cliffs, especially in health care and disability, where earning one extra dollar triggers an enormous loss. Even when one program cuts benefits modestly with income, the interaction of many programs makes work impossible.15 No wonder that people become trapped. We need to fix these disincentives.

It is important to limit Federal spending. However, we tend to just limit the appearance of spending by moving the same activities off the books. Off-the-books spending does the same economic damage. Or more.

For example, we allow an income tax deduction for mortgage interest, in order to subsidize homeownership. From an economic point of view, this is exactly the same thing as collecting higher taxes, and then sending checks to homeowners. It looks like we're taxing and spending less than we really are. But from an economic growth point of view, it's the same thing.

Actually, it's worse, because it adds unfairness and inefficiency. Suppose a colleague proposes a bill to you: The U.S. Treasury will send checks to homeowners, but high income people get much bigger checks, as will people who borrow a lot, and people who refinance often and take cash out. People with low incomes, who save up to buy houses, or don't refinance, get a lot less. You would say, "You're out of your mind!" But that's exactly what the mortgage interest deduction achieves!

Mandates are the same thing as taxing and spending. Many European countries tax a lot, and then provide services, like health insurance. We mandate that employers provide health insurance. It looks like we're taxing and spending less, but we're not. A health insurance mandate has exactly the same economic effects as a $15,000 head tax on each employee, financing a $15,000 health insurance voucher. 

The economic damage of taxation is entirely about "marginal'' rates --if you earn an extra dollar, how much do you get to enjoy it, after all taxes, federal, state, local, sales, estate, and so forth. Economics has really little to say about how much taxes people pay. The economists' ideal is a tax system in which people pay as much as the Government needs --but each extra dollar earned is tax-free. Politics, of course, focuses pretty much on the opposite, how much people pay and ignoring the economically-distorting margins.

Thus, if you ask 100 economists, "now, forget politics for a moment --that's our job --and tell me what the right tax code is, with the only objective being to raise revenue without distorting the economy,'' the pretty universal answer will be a consumption tax --with no corporate tax, income tax, tax on savings or rates of return, estates, or anything else, and essentially no deductions.

A massive simplification of the tax code is, in my opinion, as or more important than the rates --and it's something we're more likely to agree on. America's tax code is an obscenely complex cronyist nightmare.

For example, that's why I favor, and you should seriously consider, eliminating the corporate tax. Corporations never pay any taxes. All money they send to the government comes from higher prices, lower wages, or lower returns to shareholders --and mostly the former two. If you tax people who receive corporate profits, rather than collecting taxes from higher prices and lower wages, you will have a more progressive tax system.

But more importantly, if you eliminate the corporate tax, you will eliminate the constant stream of lobbyists in your offices each day asking for special favors.

The claim that infrastructure spending will lift the economy out of its doldrums lies on the "multiplier" effect, that any spending, even wasted, is good for the economy. That is a dubious proposition, especially when the task is to raise the economy by tens of trillions, over decades.

Modern infrastructure is built by machines, and not many people; even less people who do not have the specialized skills. A Freeway in California will do little to help employment of a high school dropout in New York, or a middle-aged mortgage broker in New Jersey. Neither knows how to operate a grader.

The problem with infrastructure is not lack of money. President Obama inaugurated a nearly trillion dollar stimulus plan 8 years ago. His Administration found out there are few shovel-ready projects in America today. They're all tied up waiting for historic review, environmental review, and legal challenges.

The problem with infrastructure is a broken process. Put a time limit on historic, environmental, and other reviews. Require serious, objective, and retrospective cost-benefit analysis. Repeal Davis-Bacon and other contracting requirements that send costs soaring. If the point is infrastructure it should be infrastructure, not passing money around. You ought to be able to agree on more money in return for assurance that the money is wisely spent. 

The biggest danger that debt poses is a crisis.

Debt crises, like all crises that really threaten an economy and society, do not come with decades of warning. Do not expect slowly rising interest rates to canary the coalmine. Even Greece could borrow at remarkably low rates. Until, one day, it couldn't, with catastrophic results.

Now, bond investors are willing to lend to the US government so long as they think someone else will lend tomorrow to pay off their loans today. When they suspect that isn't true, they pull back and interest rates spike.

But our large debts leave our fiscal position sensitive to interest rate rises. At 100% debt to GDP ratio, if interest rates rise to just 5%, that means the deficit rises by 5 percentage points of GDP, or approximately $1 Trillion extra dollars per year. If bond investors were worried about sustainability already, an extra trillion a year of deficits makes it worse. So they demand even higher interest rates. Debt that is easily financed at 1% rates is not sustainable at 5% rates and a catastrophe at 10% rates --if you have a large debt outstanding.

This is a big part of what happened to Greece and nearly happened to Italy. At low interest rates, they are solvent. At high interest rates, they are not.

Debt crises are like an earthquakes. It's always quiet. People laugh at you for worrying. Buying insurance seems like a waste of money. Until it isn't. 

The easy answers are straightforward. Sensible reforms to Social Security and Medicare are on the table. Fix the indexing, improve the incentives for older people to keep working. Convert medicare to a premium support policy.

The harder problems are those less recognized. Underfunded pensions, widespread credit guarantees, and explicit or implicit too big to fail guarantees add tinder to the fire. Dry powder and good credit are invaluable.

Above all, undertake a pro-growth economic policy. We grew out of larger debts after World War II; we can do that again.

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