Very Good News

At least that’s what the markets are telling us.   But that’s mostly relief that there won’t be a fiscal/debt train wreck on Tuesday.  I’m more interested in the details.  This is the PR put out by the White House tonight:

  • Removes the cloud of uncertainty over our economy at this critical time, by ensuring that no one will be able to use the threat of the nation’s first default now, or in only a few months, for political gain;
  • Locks in a down payment on significant deficit reduction, with savings from both domestic and Pentagon spending, and is designed to protect crucial investments like aid for college students;
  • Establishes a bipartisan process to seek a balanced approach to larger deficit reduction through entitlement and tax reform;
  • Deploys an enforcement mechanism that gives all sides an incentive to reach bipartisan compromise on historic deficit reduction, while protecting Social Security, Medicare beneficiaries and low-income programs;
  • Stays true to the President’s commitment to shared sacrifice by preventing the middle class, seniors and those who are most vulnerable from shouldering the burden of deficit reduction. The President did not agree to any entitlement reforms outside of the context of a bipartisan committee process where tax reform will be on the table and the President will insist on shared sacrifice from the most well-off and those with the most indefensible tax breaks. 

I don’t care much about the debate over “revenues” and “cuts.”  When read a document like that I see:

Blah, blah, blah, blah, entitlement and tax reform, blah, blah, blah, blah, tax reform will be on the table, blah, blah, blah, blah.

It’s all about entitlement and tax reform, the rest is just window dressing.  Of course I’m glad the defense budget will fall, but given how bloated it is and how deeply in debt we are, that was a given.  The good news is that there will be a commission that will produce some real reforms.  How do I know that?  Because economics isn’t a zero sum game.  There are $100 bills lying all over the place if the commission cares to pick them up.  The only way to get an agreement is to make it a positive sum game–otherwise the two sides are too far apart.  We’ve already seen both Simpson-Bowles and the Gang of Six promote major tax reform, so it doesn’t take a rocket scientist to predict the commission’s proposal will be bold—I’m taking 1986 bold.

The Asian markets are soaring because there is an end to the uncertainty, but I think the likely reform package will also be good in the longer term for the US equity markets.  At a minimum they have to do something about the US corporate income tax, which I believe is now the highest of any industrial country.  I’d look for a ten percentage point cut there, which would clearly boost equities.

Of course all this assumes the compromise will pass.  If not, then . . . well . . . nevermind.


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27 Responses to “Very Good News”

  1. Gravatar of johnleemk johnleemk
    31. July 2011 at 19:21

    Intrade doesn’t seem to be hopeful about the compromise, Scott. As of this writing, it puts the odds of the debt ceiling being raised by end of August at 27.0%: http://intrade.com/v4/markets/contract/?contractId=749123

  2. Gravatar of Morgan Warstler Morgan Warstler
    31. July 2011 at 19:35

    Um Scott, the reason we had to see Obama eat it on this, was so we could have tax reform.

    There’s a very real chance that the Super Congress is going to be a full blown tax reform deal.

    And if Obama had gotten tax loopholes closed as revenue, Democrats would be far less likely to go a full Monty on tax reform…. deep down they LIKE picking favorites.

    Sure the rate will be lower, but what we’re after is a corporate tax system that has no loopholes, which INSTANTLY is a massive win for SMBs – it’s like they not only get to pay less, but their competitors the Fortune 100 have to pay more.

    Jobs boom juice ready to squirt everywhere. Money in the pocket of the Tea Party.

    Right in there after Rick Perry takes over.

  3. Gravatar of Ram Ram
    31. July 2011 at 19:44

    johnleemk,

    I think that’s because the Intrade contract pertains to whether the debt ceiling is raised to $15.1 trillion or more before the end of August. The plan seems to involve raising the debt ceiling in a series of increments, the first of which may be less than $15.1. So the fact that the price of that contract declined substantially when the deal was announced suggests that traders actually think the odds of the debt ceiling being raised are substantially higher now.

  4. Gravatar of johnleemk johnleemk
    31. July 2011 at 19:51

    Ram,

    I thought it might be something like that. Interesting. I thought Obama promised he’d veto any bill which threatens to broach the debt limit issue again in the near future. I guess he and/or the markets are confident that this compromise won’t let that happen.

  5. Gravatar of cassander cassander
    31. July 2011 at 20:47

    Unfortunately, I have as little faith in the Democratic commitment to entitlement reform as you do in the Republican commitment to cutting spending. And I have faith in neither party when it comes to tax reform. A simple tax code means less opportunity for graft.

  6. Gravatar of Andy Harless Andy Harless
    31. July 2011 at 21:16

    There are $100 bills lying all over the place if the commission cares to pick them up.

    Sure, if the commission had carte blanche. But the problem is that Congress has to vote on whatever the commission proposes. Sequestration leaves a lot of $100 bills on the street, but Congress doesn’t have to vote explicitly to leave them there. In order to avoid sequestration, the proposal has to say not just, “Pick up the $100 bills,” but “Pick up the $100 bills and take responsibility for the cuts that are going to be made (and would have been made anyway).” Democrats won’t vote to cut entitlements. Republicans won’t vote to raise revenues. What this deal does is throw some more $100 bills on the street on top of the ones that are already there, and none of them are going to be picked up.

  7. Gravatar of Morgan Warstler Morgan Warstler
    31. July 2011 at 22:23

    Andy, there are 87 Tea Party congressman, who as I read it, will only accept this deal BECAUSE they realize they can force the GOP to do tax reform.

    Tax reform is – again by my read – more important than cutting spending. Because immediately after you get tax reform, you can got back to cutting spending.

    Tax reform = money in pocket of Tea Party, so I expect it is far more important to the GOP than anything else.

  8. Gravatar of Joe Joe
    1. August 2011 at 00:29

    Why not someone propose the elimination of the entire corporate income tax plus an equal reduction in military spending + corporate subsidies.

    How could the republicans say no?

  9. Gravatar of Rien Huizer Rien Huizer
    1. August 2011 at 02:47

    Amazing people, Americans

  10. Gravatar of Bonnie Bonnie
    1. August 2011 at 03:32

    There are some pretty dead-set on getting a balanced budget amendment and won’t accept anything less. This deal isn’t that much different from the Boehner or Reid plans, with the exception of more cutting, that didn’t pass the Senate. It is just another form of punting and having someone else deal with the problem, as we have had commissions and debt reduction triggers before and they seem to always get ignored. If I had a vote on this though, I would probably take it because there is something to be said for not ending up like General Lee at Gettysburg, and living to fight another day; as an aside from my opposition to the BBA, which won’t solve the problem either.

  11. Gravatar of John Thacker John Thacker
    1. August 2011 at 04:38

    President Obama chose not to embrace Simpson-Bowles when it came out, instead doing the typical Washington way of rejecting without completely rejecting; i.e., calling for another commission.

    That may have made political sense, because he forced the Republicans to come up with their own long-term plan on their own, which naturally was easy to attack politically because any large plan will be. Hard choices and all that.

    However, it shrank the amount of time until the deadline. By the time the President was willing to accept the basic reform framework of Simpson-Bowles, it was too late to get anything big, so this proposal for a commission with a deadline with teeth is the best way to achieve something.

  12. Gravatar of Scott Sumner Scott Sumner
    1. August 2011 at 05:10

    johnleemk and Ram, Thanks for the Intrade info.

    Morgan, I thought you’d be pleased.

    Andy and Cassander, I’m more optimistic that you guys.

    Joe, Good idea, but it won’t happen.

    Rien, In a good or bad way?

    Bonnie, I haven’t followed the BBA debate. Are they talking about balancing over the cycle? That would make sense.

    John, That sounds like an accurate assessment of what happened.

  13. Gravatar of johnleemk johnleemk
    1. August 2011 at 05:28

    Scott,

    Krugman has a column up today on the compromise: http://www.nytimes.com/2011/08/01/opinion/the-president-surrenders-on-debt-ceiling.html

    A friend posted this on Google+ calling it the most depressing Krugman column she’s ever read. My response:

    *

    I don’t agree at all with this Republican nonsense about balancing the budget, but this is possibly the most irritating Krugman column I have ever read.

    You don’t need government spending to prop up the economy; it’s textbook economics that fiscal and monetary stimulus are interchangeable, so Obama just needs to appoint more aggressive monetary policymakers to the Fed (something he’s been very slow to do, and something Krugman needs to call him out on more). It’s also rich of Krugman to, in the same breath, criticise spending cuts and criticise restraint in levying taxes — the Republicans aren’t the only ones playing politics here.

    Fiscal austerity for its own sake in a depressed economy is stupid, of course. But the US, like most Western/developed countries, faces some serious problems with excessive deficit spending that are only going to grow worse with time — old age entitlements drive government spending everywhere. (The US also has serious issues with its defence spending, but that’s nothing compared to Medicare, which Obama’s healthcare reform did nothing to address.) This isn’t radical right-wing rhetoric — it’s public economics as taught in pretty much every American institution of higher education, Princeton included.

    Budget deficits need to be sustainable in order to continue — as Krugman points out, it’s cheap to borrow now, but it won’t be cheap to borrow forever. And when you have to refinance the debt incurred now ten, twenty years down the road, you’ll be hit with expensive rates on a huge mass of debt (the US debt has exploded in recent years). The status quo isn’t sustainable.

    The Republicans are being stupid about all this, of course. But Krugman’s column isn’t any less politicised or maniacally partisan than they have been, unfortunately.

  14. Gravatar of B B
    1. August 2011 at 06:26

    Brad DeLong has a very short post on the debt-ceiling deal:
    “A first guess: -0.4% off of fiscal 2012 real GDP growth, with an unemployment rate in November 2012 0.2% above the baseline.
    http://delong.typepad.com/sdj/2011/07/the-debt-ceiling-deal.html

    By now we should all be familiar with this picture:
    http://www.economics21.org/files/updated%20unemployment%20stimulus%20graph.png

    So I wrote a short comment asking him what his baseline was. Predictably my post still hasn’t cleared moderation. So does anyone have an idea what the baseline is and how plausible Brad’s claim of -0.4% less real growth in FY2012 because of this deal?

  15. Gravatar of Rien Huizer Rien Huizer
    1. August 2011 at 06:50

    Scott,

    In both ways, as you would expect. Foreigners develop a strange fascination with them, maybe because they live under conditions that do not exist anywhere else.The place seems to grow on you And yes, I would be biased toward the good way..Besides, for a politics hobbyist there is no contest.

  16. Gravatar of johnleemk johnleemk
    1. August 2011 at 07:47

    And now Romney comes out to oppose the compromise… http://mittromney.com/press/2011/08/mitt-romney-statement-debt-ceiling-deal

  17. Gravatar of W. Peden W. Peden
    1. August 2011 at 07:52

    Let’s hope that this mistake from Romney paves the way for Jon Huntsman 2012. One can dream!

  18. Gravatar of Scott Sumner Scott Sumner
    1. August 2011 at 08:17

    johnleemk, Yes, and let’s not forget how apocalyptic he was about the tiny Bush deficits.

    B, It’s all pure guesswork.

    Rien, Yes, it is certainly entertaining politics, I’ll give you that.

    johnleemk, A disappointing decision by Romney, but I guess he figures that given his moderation on monetary policy, global warming, health care, he has to do some demagoguery somewhere. And this won’t tie his hands as president.

  19. Gravatar of Gabe Gabe
    1. August 2011 at 08:55

    The government expansion since 1977 has been rather dramatic IMO. Every facet of the central government has expanded. Sure the governemnt has “privatised” a couple of areas, but they have massively expanded regulation in all of those areas to create additional barriers to entry for the benefit of corporate-state facism…this is hardly a sign of progress towards laissez faire.

  20. Gravatar of johnleemk johnleemk
    1. August 2011 at 08:56

    W. Peden,

    Amen!

  21. Gravatar of Andy Harless Andy Harless
    1. August 2011 at 11:13

    Morgan,

    If the Tea Party wants tax reform, how come the Republicans weren’t willing to accept tax reform as part of the deal during the negotiations? The current deal makes it very hard to do the “cut rates and broaden the base” kind of tax reform, because it uses a current law baseline, which means that rate cuts are basically off the table for the super-committee: making the Bush cuts permanent (i.e. leaving rates where they are in 2011-2012) would be a huge increase in the deficit that would have to be offset with huge reductions in tax expenditures. What is the chance that the committee (either party, for that matter) is going to sign off on such huge “tax increases” for some people? The only other possibility is to cut tax expenditures and then hope (or have some sort of gentleman’s agreement) that the Bush cuts will be made permanent later. But I can’t see the Republicans signing off on moderate cuts in tax expenditures (which many will call tax increases) without a credible commitment on rates.

  22. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. August 2011 at 12:07

    As usual, Keith Hennessey is the most lucid analyst:

    http://keithhennessey.com/2011/08/01/bca-strategy/

    ——————quote——————-
    An additional 10% cut to defense discretionary is deep, and many Republicans will intensely want to avoid it. At the same time, an additional 8% cut in nondefense discretionary will freak out many Congressional Democrats and the White House, and they will intensely want to avoid it. I think the depth of both cuts are so deep, and the difference between -10% and -8% is small enough, that it confers no relative advantage in the Joint Committee. Democratic negotiators will be just as desperate to avoid 8% domestic discretionary cuts as Republicans will be to avoid 10% defense cuts.

    This means that all Republicans need to do is call the President’s/Democrats’ bluff on tax increases, threaten to allow the pain of the trigger hit both sides, offer $1.5 T of entitlement spending cuts, and wait.

    $2 trillion of spending cuts is big for Congress but small relative to our underlying fiscal problems. If this bill becomes law and if the fall Joint Committee process is successful, the remaining spending problem will be more than an order of magnitude larger than this accomplishment. If you think this summer has been painful or dread the battle of this fall, you ain’t seen nothin’ yet. Wait until Congress wrestles with the big stuff.

    Three times in the past year Congressional Republicans have played brinksmanship with the President and come out ahead: the December 2010 tax rate fight, the Spring 2011 CR fight, and now the Summer 2011 debt limit fight. They have a game plan that has delivered multiple incremental wins so far, and a playing field that favors them for the Fall 2011 Joint Committee fight. In a balanced Washington they have successfully leveraged a debt limit increase to cut spending and not raise taxes.

    For these reasons I am fairly optimistic this bill provides an opportunity for another incremental win this fall. If I’m right, it also establishes a pattern for when the debt limit expires in 2013.
    ——————-endquote——————–

  23. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. August 2011 at 12:19

    Btw, I hope this:

    ‘Republicans] have successfully leveraged a debt limit increase to cut spending and not raise taxes.’

    makes Ben Crain smile.

  24. Gravatar of Scott Sumner Scott Sumner
    1. August 2011 at 17:41

    Gabe, I don’t agree, i think the government has cut MTRs, deregulated and privatized since 1977–although I’ll admit the trend has been much stronger in most other countries.

    Patrick, Thanks, that’s a good analysis.

  25. Gravatar of Kevin Donoghue Kevin Donoghue
    2. August 2011 at 00:50

    Scott,

    What markets are telling us that this is good news? Right now I can’t see what market you’re referring to.

  26. Gravatar of Morgan Warstler Morgan Warstler
    2. August 2011 at 10:09

    Andy I suspect the battering ram is cuts to Medicare providers, and cuts to the Federal workforce.

    On the other side is the difference between FORTUNE 1000 tax rates and SMB tax rates.

    I think that is the average small business man (Tea Party voter) is seeing his tax rates decline, while GE is suddenly forced to pay real taxes – no more green spiffs, no more nothing…

    If the average monied investor sees capital gains increase while the top rate on salary goes down – with no loopholes….

    If the CBO scores that as tax increase, the Tea Party WILL NOT CARE.

    Imagine tax policy that robs the top 1% and gives it to the small businessmen all over America – I think that passes in a heart beat.

  27. Gravatar of Scott Sumner Scott Sumner
    12. August 2011 at 11:45

    Kevin, The price change right after the announcement is the market response. That was positive.

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