Ricardian Equivalence

From the Flow of Funds accounts, Corrections presents net private and net government savings, along with net total U.S. savings (click to enlarge).  Notice the mirror trends of net private and government savings as a percent of GDP.  

The graph certainly doesn't discount Ricardian Equivalence as a first-order effect:  households know that deficit spending means future taxes:  to smooth consumption, they save more  If true, this equivalence would suggest that financing government consumption through deficits or through taxation is equivalent, to a first order approximation:  households know net present value of taxation will rise and save for the event.

How Not to Write a Jobs Bill

New York Times editorial "How Not to Write a Jobs Bill" (February 11th, 2010) makes a reflexive claim about jobs and tax cuts that may not be valid. Specifically, the Times argues that tax cuts are unconnected to jobs. Further, it appears to support creation and maintenance of governmental jobs.

An $85 billion proposal put forward Thursday morning by Max Baucus, the chairman of the Finance Committee, and by Charles Grassley, the committee’s top Republican, scarcely began to grapple with the $266 billion in provisions for jobs and stimulus that President Obama proposed in his budget. It was not even in the same league as the modest House-passed $154 billion jobs bill.

Worse, about half of the proposal had nothing to do with new jobs. The single largest chunk, about $31 billion, went to renew expiring tax breaks that are generally useful but unrelated to jobs. Another $10 billion would renew an expiring Medicare payment formula so doctors wouldn’t face a pay cut

Harald Uhlig's 2010 Working Paper "Some Fiscal Calculus" suggests that in the long run, a discounted $2.60 is lost for every dollar the government spends, while tax cuts on labor offer up to $1.7 in gain. The relevant idea is that removal of distortionary taxes improve outcomes, while short-run multiplier benefits are temporary and small.

While time Times mentions tax cuts on labor, it focuses on fiscal aid to states and increasing the supply of government jobs. The Times demands more government jobs:

What senators don’t understand or choose to ignore is that state budget cuts mean layoffs. State and local governments are among the nation’s largest employers, responsible for 15 percent of the labor force, about the same share as the health care sector and far larger than manufacturing or the financial sector. Since August 2008, states and localities have eliminated 151,000 jobs.

From the perspective of Corrections, this may be good news for the economy. In "The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?" (March 2009) Federal Reserve Bank of Minneapolis Working Paper, Gonzalo Fernández de Córdoba and Timothy Kehoe, reporting that sharp productivity drops are a main contributer to depressions, write:

With banks and other financial institutions in crisis, the government needs to focus on providing liquidity so that banks can provide credit at market interest rates, and using the market mechanism, to productive firms. Unproductive firms need to die. This is as true for the automobile industry as it is for the banking system. Bailouts and other financial efforts to keep unproductive firms in operation depress productivity. These firms absorb labor and capital that are better used by productive firms. The market makes better decisions than does the government on which firms should survive and which should die.

Corrections suggests the same goes for one of the few employers whose labor productivity appears fundamentally disconnected from wages, and whose labor allocation is distorted by a labor force that is 36.8% unionized, a figure that is approximately the highest private sector union density ever reached, in the mid 1950's. Government job shrinkage appears to serve a double purpose: increase productivity in the long run as well as serve as a (Ricardian) tax cut in the short.

White House Changes Job-Count Rule

Time Magainze article White House Changes Job-Count Rule (January 12th, 2010) reports on the White House's change in accounting rules used for determining jobs created/impacted by the stimulus. Unfortunately, the accounting rule is as ludicrous as the first, though this is not noted by Time Magazine:

Despite mounting a vigorous defense of its earlier count of more than 640,000 jobs credited to the stimulus, even after numerous errors were identified, the Obama administration now is making it easier to give the stimulus credit for hiring. It's no longer about counting a job as saved or created; now it's a matter of counting jobs funded by the stimulus.

That means that any stimulus money used to cover payroll will be included in the jobs credited to the program, including pay raises for existing employees and pay for people who never were in jeopardy of losing their positions.

Of course, if that was the case, the proper way to create counted jobs in this program is to give a dollar to every existent job. This will cause nearly zero extra employment, as employers just use that dollar to pay employees and pocket their own dollar, while creating perhaps more than three hundred million jobs.

The ludicrous manner in which the rule has been changed is vastly more prone to counting dollars "cannibalized" by Ricardian Equivalence.

Boomerang kids: recession sends more young adults back home

Christian Science Monitor article "Boomerang kids: recession sends more young adults back home" (November 24th, 2009) makes a claim that is neither backed up by empirical evidence nor necessarily by economic theory. The article suggests that America's youth will pay for today's government borrowing tomorrow.

But some analysts say the youngest generations are being hit twice by this recession: once up front with the tough labor market, and again later as they’ll pick up a big share of the taxpayer costs of government programs to rescue the economy. This year’s stimulus spending package and other strategies by presidents before Obama have involved buoying the economy with borrowed money. [Emphasis added].

Parents care about their children. If government agents are acting against the wishes of the elderly and transferring money from their children to them in the form of government debt, then parents are free to transfer it back to their children in other forms--such as paying for their children's rent (allowing them to move home). It is possible for the introduction of Social Security to have no impact at all--parents who are getting more than they and their children desire can transfer their income back to their children. So too with all government spending programs. Of course, as with all government spending programs, deadweight loss is added, as offspring will be taxed in the future.

Nonetheless, the central point remains: it is unclear that children are the ones being harmed by taxes that have to be paid 40 years in the future.  If parents have their children's budget constraints in their preferences, then it could simply be this generation that pays for future taxes through monetary transfers now.  These transfers can come in the form of educating children, or allowing them to move back home.

The Wrong Side of History

New York Times opinion editorial "The Wrong Side of History" (November 18th, 2009) submits social security as a successful reform that paves the way for programs like public health care:

Indeed, these same arguments we hear today against health reform were used even earlier, to attack President Franklin Roosevelt’s call for Social Security. It was denounced as a socialist program that would compete with private insurers and add to Americans’ tax burden so as to kill jobs.

and

In hindsight, it seems a bit ridiculous, doesn’t it? Social Security passed, and the republic survived.

Yet we can say that Social Security is an inefficient savings mechanism that made the old better off at the cost of at least one future generation. Furthermore, it remains unclear whether or not social security will indeed survive the next eighty years of negative population growth, as a pyramid-shaped payment scheme requires more dollars from fewer individuals. The full story of social security will be told in the next eighty years. We might additionally correct the article, noting that private savings in America fell when social security was imposed--savings is a form of private insurance, and social security, an inefficient savings mechanism, has surely competed with it.

A Stimulus That Could Save Money

New York Times article "A Stimulus That Could Save Money" (November 17th, 2009) misses the forest for the trees.

The one highly visible success of the stimulus program has been the cash-for-clunkers program. It induced a boom in vehicle sales this summer that clearly would not have happened otherwise.

Presumably, the article is referring to the large increase in car sales during the Summer of 2009. Cars are a durable good, last around a decade, and cost around $28,000. With an average rebate of $4100, a 14% average price decrease, we should expect individuals who were going to replace next year to intertemporally displace their purchases to the Summer of 2009.

But this is just shifting purchases and is by no stretch of the imagination expansionary in the long run--what we gain now in sales is taken out of sales in the future. It was foolish to draw sales nearer to today at the expense of tomorrow in a negative sum game--far from a success.

Turn America into a nation of savers

The Christian Science Monitor's opinion editorial "Turn America into a nation of savers" (November 9th, 2009) wishes for the U.S. savings rate to go up.

Deciding that America needs to save, Mr. Cramer advocates government spending:

For the next few years, we should expect the federal government to continue to spend more than it takes in. This will be a good thing as it solves the troublesome "paradox of thrift," where reduced economic prosperity leads to sudden declines of consumer spending, which accounts for two-thirds of the economy.

But once the economy recovers, a high savings rate still will be essential to financing the investments American business must make to improve efficiency and avoid the looming prospect of inflation. And the more Americans of all classes save, the less dependent the country becomes on foreign creditors to buy our debt.

1) This article implies that savings are good. No course in economics would dare to make such a claim. If not saving makes people happy, then they shouldn't save!
2) The existence of a "paradox of thrift" is not clear. A fall in consumption and increase in savings will cause both prices to go down and interest rates to go down, both of which encourage consumption. Unless we believe in a multiplier, there's no paradox.
3) Ricardian Equivalence should take place when it comes to simultaneous government spending and consumer saving. The governmental budget constraint is the aggregate consumer budget constraint.

The only Paradox of Thrift that Corrections can see is the Paradox of consumers spending more (as individual taxes raise) while saving more (as individual bank accounts rise).