The old “tax cuts pay for themselves” justification for cutting the tax rates of the wealthy is back:

despite a host of Republican economists telling them otherwise, Republican policymakers can’t resist arguing that tax cuts pay for themselves. That’s the old voodoo economics.

There’s no evidence that tax rates have ever come close to paying for themselves at tax rates such as the US imposes, so it’s a justification without merit. In fact, there’s no evidence that the Bush tax cuts had any effect on growth at all (see here too). The claim that tax cuts are self-financing is snake oil, and if the press was doing its job any politician saying this would immediately be labeled as a fraud (Ryan’s budget proposal makes this claim). Yet it lives on.

Just for fun, did you know that deficits more than pay for themselves?

Suppose the nation needs a key piece of infrastructure, a public good the private sector has trouble providing for itself. If the government puts the infrastructure into place through deficit spending, it will increase private sector growth for as long as the infrastructure remains in place, i.e. until it wears out (it could be replaced, but I want to focus on a single project). If the extra tax revenue from the higher economic growth rate covers maintenance costs, the cost of the project, and then some, then the project more than pays for itself. It won’t cost taxpayers a dime. In fact, it will save them money.

The problem, of course, is that just as in the private sector it is very unlikely that the economic growth rate would increase enough to actually generate sufficient revenues to cover the costs - it would take a substantial increase in economic growth to do that (into the Pawlenty zone of infeasibility).

Let me emphasize that this says nothing about whether a project benefits society. The tax revenue a project generates through increased growth is different from the economic benefits of a project. In some cases there is little relationship between revenue and benefits, so whether a project generates sufficient tax revenue to pay for itself says nothing about whether it is worthwhile to society. That’s not a test of private sector projects — the requirement is simply that the benefits exceed the costs — and the same is true for public sector projects. For example, providing public parks may not do much for growth, and they may generate little if any revenue, but they can still be a net positive when willingness to pay for parks is compared to the actual taxes that are collected.

A broader point here is that tax cut proponents often point to the private sector benefits of a tax cut, the increased growth, tax revenue, employment, trickle down benefits, etc. that supposedly occur. But they rarely look at what is lost from cutting public spending to pay for the tax cut (or, if spending isn’t cut, the costs of the deficit that is created — deficits Republicans profess to fear so much due to their very high costs). If what is lost in the public sector from cutting spending (or from creating a long-term budget problem) is more than what is gained in the private sector, then even though it may be possible to point to private sector gains, overall the tax cut was harmful.

I’m not arguing that every cut in taxes and spending would result in a net loss to society. There are certainly areas where government spending could be cut (and other areas, like health care, where we could get net positive returns from expansion). But we should at least consider what we give up when we cut spending (or increase the deficit) to pay for tax cuts, something those who argue for tax cuts as the solution to any and all of the nation’s economic problems rarely rarely do. If, for example, the cost is important social programs or key pieces of infrastructure, then society may very well end up worse off.

Four shows newly posted to my radio archives:

June 11, 2011 Vincent Reinhartat the Council on Foreign Relations on Greece and the political trick of austerity (thanks to the CFR for allowing broadcast; full event here) •Greg Grandin, author of Fordlandia, on all the great political developments in South America

June 4, 2011 Another Hoover interview: Morris Fiorina on American public opinion and the nonexistence of the “culture war” • And in non-Hoover content, Yanis Varoufakis updates the Greek and EU crises

May 28, 2011 Hoover Institution special. Two interviews from my week as a Hoover media fellow. Paul Gregory on Russian politics (Putin vs. Medvedev) •Terry Moe on school “reform” (i.e., charters, testing, unionbusting, etc.)

May 14, 2011 Deepa Kumar, author of this article, on political Islam [The last 20 minutes of the broadcast version of this show was devoted to fundraising for KPFA. This has been excised for the web version. But if you like what you hear, please donate.]

And now the show has a new Facebook page: Behind the News, with Doug Henwood.

I had a radio interview not too long ago on cyclical versus structural unemployment, and in rereading some old posts on the topic I came across this statement from Brad DeLong:

Let us remember what structural unemployment looks like. The economy is depressed and unemployment is high not because of slack aggregate demand generated by a collapse in spending, but instead because “structural” factors have produced a mismatch between the skills of the labor force and the distribution of demand.

That reminded me of a point I’ve been meaning to make. With all the talk about whether our unemployment problem is cyclical or structural (it’s mostly cyclical), many people are looking at measures of mismatches to assess how much of the problem is structural. But care needs to be taken in the interpretation of mismatch numbers. Here’s why.

Suppose that you run a business in Town A and you need someone to run a complicated piece of equipment. Unfortunately, the size of your town is relatively moderate, and there are no qualified job applicants available. You have advertised the job for weeks, but no takers. This sounds like a classic case of structural unemployment — there is a need for workers with a different skill set — but it may not be a structural problem.

Suppose also that the economy is in a recession, and business has not been good. Because of that, you can’t offer a very high wage. It turns out that in the very next town, Town B, there is a qualified worker who was laid off due to a business failure caused by the recession, but at the wage you are offering the worker is not willing to move. The worker has a job and is surviving, though the pay is much less than before and the worker is underemployed — the worker is mismatched — but the family is getting by.

However, if things were better — if the economy was humming away at full employment — the employer in Town A could offer a higher wage and induce the worker in Town B to move. If so, then this unemployment is cyclical, not structural. There is a mismatch, but the mismatch is driven by lack of demand.

The point is that when we talk about structural unemployment, we assume aggregate demand is not the problem. Thus, structural unemployment must be measured under an assumption that demand is sufficient to return us to full employment. Structural unemployment is driven by changes in tastes, technology, etc. that produce geographic, skill, or other mismatches that prevent reemployment. For example, if there is a change in tastes that causes the demand for hula hoops to fall and the demand for skateboards to increase, or a change in technology that causes the demand for typewriters to fall and the demand for word processing software to increase, then we have to move workers and other resources out of hula hoop and typewriter production and into the skateboard and word processing businesses. That will take time if there are geographic, training, or other barriers that prevent the quick translation of resources from one use or one place to another. Note, however, that the problem is not lack of demand. People want more skateboards and word processors than they currently have, so that unlike the example above where higher demand and the higher wages that come with it cause the worker to move and eliminate the mismatch, an increase in demand won’t fix the problem. If an increase in demand will fix the problem, as in the example above, then it’s not a structural problem.

The bottom line is that to measure structural unemployment in a recession, it’s not enough to simply survey the labor market and count the mismatches. You have to know if those mismatches would persist at a level of demand consistent with full employment. To the extent that the mismatch problem is due to lack of demand, and wages and prices that are too low to induce resource movements to their best use, the problem is cyclical, not structural.

In recent, years, the U.S. has undergone what political scientist Jacob Hacker calls “The Great Risk Shift“. Hacker explains this concept succinctly on his website as follows:

For decades, Americans grew both steadily richer and steadily more secure. They received health and retirement benefits and stable jobs from employers. Social Security, Medicare, and other public programs stepped in when employers would or could not. But over the last generation, this public-private framework of security has unraveled, leaving Americans newly exposed to the harshest risks of our turbulent economy: losing a good job, losing health care, losing retirement savings, losing a home—in short, losing a stable financial footing. Increasingly, Americans find themselves on a financial tightrope, without a safety net if they slip. Bankruptcy rates are skyrocketing, and more people don’t have health insurance or secure retirement benefits. Meanwhile, family incomes fluctuate up and down three times as violently today as they did in the early 1970s. At bottom, what my research shows is simple and frightening: Families are now facing up and down swings that rival the most volatile stocks.

To summarize, American institutions have increasingly put the risk on individuals, and off of large corporations or the state. The clearest example of this sort of risk shift might be trends in retirement accounts. In the mid-20th century, in addition to social security, many Americans paid into “defined benefit” pensions. These pensions were guaranteed to provide a certain amount of income upon retirement. In the last few decades, employers have shifted away from these pensions and towards “defined contribution” accounts, where employees are guaranteed nothing except some tax benefits and perhaps matching contributions. In other words, employees, not employers, now bear the risks of stock market fluctuations and the like.* Similarly, health care plans increasingly cover only a fraction of health care costs (e.g. 70%) and thus require people to pay substantial portions of their (highly variable) health care costs, a pretty straightforward example of “risk shift”. One year, you might owe nothing. Another year, you might owe tens of thousands of dollars and be forced into bankruptcy. Having health insurance no longer shields you from as much of the risk of unexpected health care costs as it used to.

These trends are disturbing, but they also present an opportunity or method for rethinking our social institutions. We can ask, how can we shift risks back onto larger institutions more capable of handling them? Hacker has focused a lot of attention on retirement, unemployment and health care costs, which are logical and hugely important places to start. But we can also extend the same logic into other arenas. Think, for example, of student loans.

Student loans are a big topic of conversation, at least among academics, as they are one of the causes and consequences of the rising cost of college. For-profit educational institutions, like the University of Phoenix, feed off of student loans (without necessarily providing much in return), while more traditional universities rely on student loans to help cover their increasing costs.** Student loan debt is difficult if not impossible to get rid of in bankruptcy, and for students who fail to get high paying jobs can present a serious financial burden, especially unsubsidized private loans. One solution to this problem, so far with only limited uptake, are so-called “human capital contracts”. The NYT had a short piece on the topic: Instead of Student Loans, Investing in Futures. The piece discusses a small private company called Lumni which has so far provided financing to about 1900 students in the US and Latin America along these lines:

Sneider’s dream was to attend college so he could become a nurse and serve his community. To do so, he needed $8,500 — a sum that is close to the average annual income in Colombia. … Here’s the deal that Lumni struck with him: In exchange for $8,530 in financing, Sneider agreed to repay 14 percent of his salary for 118 months after he graduated. At that point, regardless of how much he has paid, his obligation terminates.

So instead of agreeing to repay a fixed amount, Sneider agrees to pay a fixed percentage of his income. For Lumni, the loan still rates to be profitable – much like an insurance system, as long as most loan-recipients end up with decent jobs, Lumni has priced the agreements so that it comes out ahead. If there’s a big recession, on the other hand, and many graduates can’t find decent jobs (like, oh.. the past three years) Lumni would lose money but the individuals themselves would still be above water (or at least not worrying about missing a loan payment in addition to everything else). Lumni bears the risk:

What this means is that the students who have the biggest problems benefit the most. And, in effect, those who decide to become investment bankers end up subsidizing the ones who decide to become social workers. Since a good society needs many different roles fulfilled, everyone benefits.

In other words, you run the great risk shift backwards. But here’s the thing, Lumni is a small private company which can only extend loans to a handful of people. And it faces regulatory and enforcement issues – how do you tell how much money someone makes? Etc. On the other hand, the federal government is already deeply enmeshed in the student loan business, and the figuring-out-how-much-you-make-and-taking-part-of-it business (i.e. federal income tax). So why not have the federal government offer such programs? Offer students a deal: we pay your tuition, you agree to pay a higher tax rate when you graduate. If you graduate, and become a social worker and make $30k/year, it costs you very little. If you get a job on Wall St. and rake in the big bucks, you pay a bit more. If there’s a big recession and graduates can’t find jobs, the government takes a hit but the graduates have less to worry about. If there’s a boom, the government makes a bit more than planned. Income-linked student loans (we really need a catchy name) would provide a way for the government to assume more of the risk of student loans, while still expecting to make a small profit (or break even), but in a countercyclical fashion. And because the federal government already has extensive experience and bureaucracy set up for administering loans, and for collecting taxes, it wouldn’t require a giant institutional leap to implement.***

If nothing else, income-linked, federally funded (or not) student loans provide a nice example of a policy that explicitly seeks to reverse the great risk shift.

* Recent UM B-School PhD Adam Cobb is doing interesting work on this history.
** There has been a ton of discussion of these topics all across the media and internet, from the Chronicle of Higher Education to the New York Times. I highly recommend OrgTheory’s discussion of these topics as one entry point.
*** This statement may be more than a little optimistic. No program is ever simple to implement. But at least it’s plausible this one could be relatively feasible.