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Friday, April 3, 2020

How to Turn Corona Stimulus into Good Reform

Congress has passed the Coronavirus Aide, Relief and Economic Security Act, obviously better known under its CARES acronym. This bill is filled to the brim with new spending, something for which Congress is being abundantly criticized. I would normally be the first to agree, and there are undoubtedly reasons to question many of the spending items. Here are some examples assembled by Kimberly Strassel over at the Wall Street Journal:
The Forest Service gets $3 million for "forest and rangeland research," $27 million for "capital improvement and maintenance," and $7 million for wildfire management. The bill shovels $75 million t the National Foundation on the arts and the Humanities, $25 million to the Kennedy Center, an odd $78,000 "payment" to the Institute of American Indian and Alaska Native Culture and Arts Development. A water project in Utah gets $500,000.
She also reports $60 million for NASA and $8 million for the National Archives.

With all that in mind, though, there are some features in this bill that could actually prove to be platforms for promising future reforms. More on that in a moment; first, let us note that a good part of the spending for which Congress is being criticized is simply the result of us having an egalitarian, economically redistributive welfare state. Strassel explains that the CARES bill
throws $25 billion more at food stamps and child nutrition; $12 billion at housing; $3.5 billion to states for child care; $32 billion at education; $900 million at low-income heating assistance; $50 million at legal services for the poor and so on. This is a massive expansion of the welfare state, seemingly with no regard to the actual length of the crisis.
Strassel is correct, of course, although it is hardly a "massive" expansion. The American welfare state spends about $4 trillion each year, in view of which the extra money in the CARES act really only comes across as another spending-as-usual money infusion into the welfare state. 

The big problem is that we have a welfare state in the first place; once you have a welfare state, unfortunately people are going to change their behavior accordingly. If anything, the entitlement increases Strassel mentions are indicative of how necessary it is to roll back the welfare state and give Americans a path back to self reliance.

As mentioned, not all in this bill is troubling. There are two positive features in it. The first is the overarching policy goal, namely to pump liquidity into the American economy. This shows a sense of pragmatism that both Congress and the president deserve credit for. Their methods for getting the liquidity into the hands of families and businesses may be clumsy or even misguided, but the approach is overall correct. 

There is far less of this going on in Europe, where in many countries government focuses on balancing its budget and avoiding deficits. Members of the European Union are even constitutionally mandated to avoid so-called excessive deficits; in countries with government finances already in trouble, there are political convulsions over which policy priorities to make. The consequences for the economies across Europe may indeed turn out to be serious, especially in countries with single-payer health care systems. 

Congress and the president have not hesitated to turn on the liquidity pump. Again from a general viewpoint, this is actually a good approach. 

That said, the crisis also shows how absolutely necessary it is for Congress, once this crisis is over, to start working on re-aligning government spending with what taxpayers can afford. Back on March 15 I pointed to the serious risks for a debt crisis in the wake of more deficit spending, and on March 11 the Heritage Foundation issued a similar warning. They noted:
The fiscal situation for the United States government is grave. Even though the economy is healthy, the federal deficit is project to remain at $1 trillion in fiscal year (FY) 2021 and steady increase to $1.7 trillion in FY 2030. ... Spending on a subset of programs continues to grow much faster than economic growth, and once in every five dollars spent by the federal government is borrowed.
Indeed. The programs that Heritage refers to - which we won't discuss in detail here - are designed to grow not based on what taxpayers can afford, but based on the ideological spending parameters that are built into those programs. Bluntly: it is the ambition of these programs to redistribute money that drives spending, not the potential of the economy to fund them. Until we reform those programs, we will continue to have this problem with a structural budget deficit.

That is not to say deficits are universally abominable. There are exceptional times when deficits are needed. One of the authors of the Heritage piece, Paul Winfree, actually has a very good book on the subject: A History (and Future) of the Budget Process in the United States. He explains, e.g., how deficits originally were used as a wartime funding measure. The coronavirus crisis is a good reminder that we need to work our way back to a situation where deficits are indeed limited to exceptional circumstances.

If we do that, Congress and the president can concentrate all their efforts in a crisis on pumping liquidity into the economy. However, even there, Congress is limited in what it can do, in good part by its own habitual thinking. The stimulus-check program is a good example. On the one hand, the idea is - again - to put cash out in the economy; on the other hand, as again pointed out by the Heritage Foundation, this is a ham-fisted policy instrument:
Despite major dislocations, most Americans do not need direct government aid. Government supports should be targeted toward keeping people employed and supporting those who do lose their jobs due to the coronavirus crisis. At the same time, sending checks to all Americans (including those who have not lost their jobs) runs the risk of jeopardizing public health efforts if the intention is to encourage social distancing rather than going out into the economy to spend extra money.
On top of that, it will take the Treasury a good long time to get the checks out. Those who have a bank account registered with the IRS will get a direct deposit, but some estimates suggest that about 100 million Americans will get a check in the mail instead. With the IRS having the capacity to process 5 million checks per week, it will take until September before all the recovery-check cash has been pumped out in the economy.

The IRS will not even start mailing checks until deep into May. By that time this regulatory disruption of the economy will be over.

The lack of precision and timing in the stimulus, together with the addition of new deficit spending, tells us loud and clear in what direction we need to move as we go forward from here. A crisis like this would not invite, let alone require, government intervention if the private sector were financially fully self reliant. In other words, the best crisis mitigation is that which families and businesses can manage on their own.  

Which brings us to the one promising feature of the CARES act: the 401(k) withdrawal feature. It allows for a withdrawal of up to $100,000 or 100 precent of the balance, whichever comes first, without the usual early-withdrawal penalties. To encourage repayment of the withdrawal, reports Forbes, "employees can repay the distribution within three years without regard to annual contribution limits for their 401(k) plans". Furthermore, "the repayment does not need to be made all at once". 

On the other side of the equation, if the balance is not repaid within three years there is a tax bill waiting for the amount withdrawn. While that bill can be paid over three years, it still looms as a dark cloud over many families making a withdrawal now.

It would be bad for the economy with a major hike in tax liability three years from now. It was necessary for Congress to construct the 401(k) withdrawal this way, simply because of what the plan is designed to do. To avoid this unintended consequence, Congress could take the opportunity to make two reforms that would preempt this future cold tax shower:

1. Convert the 401(k) into a general income security account

There have been several proposals for reforms that would allow families to build financial security on their own terms, including family leave and adverse events such as the coronavirus crisis. My good friend Rachel Greszler has a list of good reforms to keep paid family leave within the private sector; the present situation should be a source of inspiration for structural reforms to what is now a fragmented landscape of financial-security legislation. Why not turn the 401(k) into an account - for lack of better word - where individuals and families could deposit pre-tax earnings and defer any tax payments until withdrawal. Call it ISA, income security account. There would be no penalty for "early withdrawal" as the account would be used for more purposes than retirement. 

This reform could also include an unemployment-insurance feature, attaching the purchase of a pre-paid credit line specifically for jobless situations. 

2. Roll the SALT deduction into an ISA

It was the right thing to do to limit the ability of taxpayers to deduct state and local income taxes from their federal tax bill. Separate jurisdictions should act as separate jurisdictions; the SALT deduction has de facto been a federal subsidy to states with high personal income taxes. That said, the deduction cap has given many families a higher tax burden, and it has hit small business owners filing under the personal income tax. The SALT deduction could be reinstated as a shared-deduction feature for any deposits into the ISA.

Suppose a family owes $20,000 in state income taxes. Today's SALT feature permits the deduction of half of that amount. Suppose the family deposits $10,000 into their ISA. This money would now be deducted, half of it from their federal half tax, half from their state income tax. In other words, their SALT would effectively amount to $15,000 but would come with an additional, state-specific deduction.

There are, of course, problems with this feature, one being that it does not apply if you live in a state without an income tax. This is, however, a problem already today with the SALT deduction. Furthermore, this could encourage states to innovate with their own state tax structure; one option for states that collect property taxes is to tie an ISA deposit to their property-tax bills. The state share of the property tax - where collected - is usually a fairly small share of total tax revenue. In Nevada, e.g., the state property tax is responsible for only 3.5 percent of total state tax revenue. In other words, converting some of the state share of property taxes into a fully deductible ISA deposit is a realistic option with limited impact on state finances.

Together, these two reforms would create an account that allows families more flexibility in meeting their own financial needs, not just in times of crises but for life events in general. By making this reform now, Congress could convert the future tax bill, now accruing from CARES-act related 401(k) withdrawals, into special deductions related to ISA deposits. This special deduction could be spread out over the three years now being granted 401(k) owners for payment of deferred, withdrawal-related taxes. 

In short: what is now a dark cloud of higher taxes hanging over our future could become a boost in family savings and a surge in financial independence for America's hard-working families.

Wednesday, April 1, 2020

Forecasting under Uncertainty

The old phrase that there are lies, damn lies and statistics, was originally coined as a reminder to users of quantitative information to learn to actually disseminate numbers before throwing them around. 

Tuesday, March 31, 2020

Friday, March 27, 2020

Let Sanity Prevail

Professional experts can make a big difference for the better. They can also make catastrophically bad contributions if they choose to be irresponsible with how they go about their business.

Monday, March 23, 2020

Millennial Frugality Gives Hope to America

The generation that had to google how to use a wrench is growing up and becoming good, old Americans. The Millennials are in fact reviving some of the most essential character traits of our country.