Who will pay for the government spending? 

Jay Powell, the Federal Reserve chairman, says we need more of it. Financial markets and Main Street alike are counting on it. The Democratically controlled House of Representatives wants trillions of dollars more in Covid-19 relief spending right away, while the Senate and the White House want to pretend that the pandemic will pass sooner than many experts think, and that we can somehow put a pause on more federal aid. The next stimulus package is already becoming political. But a deeper question that I’m pondering is how we will pay for the larger government programmes needed in the years ahead, and the new social contract that most of us believe will come.

As Ed and I outlined in our note last week, it’s clear that the pandemic is putting steroids on all the troublesome structural economic trends of the past several decades, from rising inequality to technology-based job disruption. This will go higher up the food chain, and much of it will be permanent (meaning that certain categories of jobs are likely to disappear forever). I thought former Clinton labour secretary Robert Reich got it pretty much right a few days ago when he wrote about four new classes of workers born out of the Covid-19 era — the remotes, the essentials, the unpaid and the forgotten.

The first two categories will have work; the last two won’t, which roughly squares with the numbers in the NBER paper I flagged last week, predicting that 42 per cent of those being laid off won’t have jobs to come back to. The big question: what to do about this? The answer — bigger government — seems obvious. These people will have to be retrained for new types of work, and in the meantime, provided with longer term unemployment benefits, given some form of free healthcare, and so forth. To those who would argue that this won’t inevitably require a bigger state intervention, I’d simply point out that the number of unemployed Americans now far exceeds the population of Australia. The idea that those people simply have to go it alone isn’t sustainable from either an economic or a social stability standpoint.

So, if we assume a bigger government, we must ask: how is it paid for? And there, we get into one of the most deep and interesting economic debates of the moment — do we print money, tax wealth, or do some combination of both? There are those that would say it’s too early to ask such questions when we are still in the midst of firefighting. But I think it’s quite important (especially for Democrats) to begin thinking about them now, because the answer must shape policy from the first day of what (fingers crossed) will be a new administration. 

Modern Monetary Theory, or debt monetisation in which central bankers and the Treasury work more closely together, with the Fed essentially backstopping government spending plans, is one option. I’m spending some time trying to learn more about this idea at the moment (including reading this interesting Lance Taylor piece about it on the INET website). As Swampians know, I’ve been somewhat sceptical about MMT, not so much because I fear an immediate issue with inflation (I think we are actually in for a few years of deflation) but because I fear the undermining of the dollar and of the US as a safe haven by political agendas on both the right and the left. As a well-known venture capitalist told me recently in a conversation on the topic: “You can get away with anything if you are credible.” Not so much if creditors feel you aren’t.

That said, I’m not naive enough to think that central bank policy hasn’t become more political over the years anyway. As I wrote in my first book, Republicans and Democrats alike have often left the Fed to deal with economic growth since the 1980s because they didn’t want to make tough choices between various interest groups. That’s why we’ve had asset-driven growth rather than income-based growth, because monetary policy can only accomplish the former (readers shouldn’t take this as a criticism of central bankers, most of whom are among the wisest and most competent public servants around, but rather of our economic system and its assumptions).

Still, if we don’t monetise debt and deficits, there’s really only one other way to bridge the gap — we must raise more tax money to pay for social programmes. That’s politically tricky. The rich, funny enough, don’t like to be taxed. But I would argue that higher taxes on capital should be a crucial part of any major new government spending programme. This is part of what must be a new risk and reward calculation. Debt monetisation holds both promise and risk for the nation as a whole; in fact, one could argue that it’s especially risky for people who own the most dollar assets, since they are likely to decline in value should it go badly. But it’s abstract, complicated and difficult to explain to the public.

Higher taxes on capital, on the other hand, are quite easy to understand and I’d argue quite fair, particularly given where moral hazard has taken us politically in the last decade. Think about which people and entities will come out of this crisis with the most wealth — they will be remotes and the companies that employ them, many of which will be in data and software-rich areas, as well as certain parts of the financial sector. If I were crafting tax policy for Democrats, I’d start by upping the capital gains rate, and also look at California’s plans for a digital dividend tax and how it might be made national.

Ed, would you agree?

Recommended reading 

• On the note of who should be taxed, don’t miss Naomi Klein’s takedown of New York’s “Screen New Deal”.

• In The New Yorker, Siddhartha Mukherjee looks at the intersecting problems of just-in-time supply chains and the American medical system.

• And the FT has several terrific pieces this week, from a deep dive on collateralised debt obligations, which might become the “financial weapons of mass destruction” of this crisis, to a thoughtful piece by former Indian central banker Raghuram Rajan on which businesses should fail and which should be supported, to Robin Wigglesworth’s wise take on the Fed’s war and whether it could become a monetary Vietnam. From Ed, read the definitive indictment of Trump — an FT Weekend front cover must read.

Edward Luce responds

Rana, you’re asking the right questions. I don’t think the answer needs to be very complicated. Washington should equalise capital gains and dividend tax with the income tax rate, remove tax deferrals for leverage, purge loopholes in the corporate tax code and impose an escalating carbon tax. Some of this would raise revenue. Other reforms, such as swapping a carbon tax for the employer-paid social security tax, would be fiscally neutral but highly efficient. We should tax “bads”, such as carbon, and remove taxes on “goods”, such as jobs.

In the short term, there is also a role for government-guaranteed employment along the lines of FDR’s Works Progress Administration. Some of this could be in the form of mass training for the 300,000 contact tracers that will be needed to help ease lockdowns. Such skills would be fungible for other kinds of work. 

I’m not sure I really understand Modern Monetary Theory. There’s an element of hocus-pocus that makes me suspicious. I do understand that the US Treasury can raise 10- and 30-year funds at close to zero interest rates. America has second-world infrastructure. Not upgrading it now, at these almost free borrowing costs, would be an unforgivable opportunity cost.

The basic equation is simple. Coronavirus will deepen the secular stagnation malaise that Larry Summers wrote about. In the absence of private sector demand, the public sector must fill the gap. Whether politics will permit common sense to prevail is another matter. That is not how Mitch McConnell sees his role. 

Your feedback

And now a word from our Swampians . . . 

In response to Wall Street is having a good plague:
“Democratic capitalism needs to be reconfigured to increase the output of goods and services and income across the broad middle. A good model is to look at FDR’s New Deal that used the social insurance principles of risk reduction to make people more productive and the economy more reliable. A change in the mix of middle-class consumption towards more public goods delivering healthcare, education, transportation, and housing against a backdrop of environmental adaptation — the big public good of the future — should be undertaken.” — Paul Myers, accountant, Corona del Mar, California

“Inequality is the real virus that will destroy America. And Trump is a painful symptom — not the cause. Far worse than him will follow without fundamental changes to a system that has been hijacked and controlled by the rich to serve our own purposes. And don’t apologise to FT readers — we need saving from ourselves. History has shown (repeatedly) that extreme inequality does not end well for the ruling classes!” — Chris Millerchip, publisher, Rye, New York

Source: Economy - ft.com