Moody's Talks - Inside Economics - Tapering and Taxes

Episode Date: August 27, 2021

Bill Gale, Senior Fellow at Brookings Institute, joins Mark and Ryan to discuss Fed Chair Jerome Powell's speech and the big topic was fiscal policy. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics. We have a good podcast for you today. I'm as per normal, joined by Ryan Sweet, my colleague, who is head of real-time economics. It's good to see you, Ryan. How are you? I'm doing well. How are you doing, Mark? Good. I'm okay. We're missing our other colleague, though. Where's Mr. DeRides? He kind of has the AWOL on us. What's up with him? Well, you know he's on vacation. It's, what, 9 o'clock right now in Italy?

So he's probably one or two glasses of wine deep. Yeah. Well, you know, I thought when you went on vacation, you took your trusty microphone with you so you could do the podcast. But I guess I did. I mean, he's got to get on an airplane. I just had to get in a car. Yeah. Okay.

Well, we'll miss him today. He did email me this morning saying that he has his headset and he might be able to come next week. What? What? I mean, he's out for more than one week? What's that all about? He's out until like, mid-September. He's the Deputy Chief Economist.

I mean, Deputy Chief Economist can't just take off like that, you know, for two weeks. That means it's all on my shoulders. That's not a very good place to be. I'm pretty sure you approved his vacation. Oh, did I? That's right. I did. I got to pay more attention to that stuff, you know?

That's just, you know, not good, not good. Anyway, I'm sure he's having a lot of fun in Italy, a great, great place. And we're also joined by Bill Gale, Bill. Good to see you. Thank you. Nice to be here. Yeah. And Bill, before I introduce you formally, I just wanted to get Ryan's take on, or maybe I should introduce you formally right now. Hey, can I ask this? It seems like I've known you forever. But I can't recall when I first met you. Do you remember when we first met? Do you have any recollection of that? I sometime back in the 90s, but I don't remember. remember both because it was a long time ago and because we've interacted in a lot of different ways. Yeah. Well, you're the best. And you're at Brookings. You're the RJ and Francis Miller

chair in federal economic policy. So you're everything federal fiscal policy at Brookings. That's kind of sort of how I think of you. Do I have that roughly right? I technically, that's what the title covers. But obviously, a lot of people at Brookings care about fiscal policy. Yeah, I'm sure they do. Yeah, and you've been at Brookings for quite some time. 29 years, yeah. Wow. That's wonderful. But it's a great institution. It does such good work. It's been good for me. I like the ability to kind of do research when you've done to do research and engage in the policy stuff when you want to engage in the policy stuff. And there's a lot of

flexibility like that that comes in handy. And you're also an author. You wrote, a book in 2019 on the federal fiscal situation and gave some recommendations for policymakers. It seemed to be kind of sort of come into fruition here with the build back better agenda. Am I right about that? It feels like it. Yeah, interesting. I'd say the book had two main themes to it. One was that we needed to reform our spending and tax policy in the usual ways that people

talk about, more investment on the spending side, more efficient fare taxes on the rest of revenue side. The other theme of the book, probably the main theme of the book, was we need to pay attention to the long-term fiscal outlook. And of course, that's been totally ignored by current policymakers. And if anything, you know, with interest rates as low as they are, it's less of an urgent issue right now. But the spending, how we spend the money, how we raise the money is very salient and is very important. Well, we'll come back. We'll definitely come back to that. And I, you know, bit of a prep. So just to remind the listener, this conversation, the podcast really has two parts to it. Part one, we go over some of the economic statistics. We play a bit of a game and, you know,

I guess the other guy's statistics. And hopefully, Bill, you'll participate in that. You don't need to, but it would love to have you if you're interested. And then part two will go into the big topic, which is a fiscal policy. And, you know, obviously I have a lot to talk about there. There was two of the things I wanted to bring up. One, reading your bio, we're the same age, but you look a lot younger than me. So what the hell is going on? Is that just the lifestyle? What's going on? Is that good genes or what? It's got to be a boring lifestyle. Yeah. Ryan, would you concur? Doesn't he look a lot better than me? I mean, it's Moody's. That's the, that's the, this, Moody's is wearing me down, I think. Yeah, let's go with that. Let's go. Put me in a bad spot here. Yeah.

Yeah, the other thing I wanted to mention, you are married to Diane Lynn. Diane is a wonderful economist in our own right and just a very nice person. And I know you got married to her about the time you published the book, I believe, if I got the bio right. Yeah. Yeah, it was a busy three months in 2019. But, yeah, Diane is a great person and a great economist and just got a job as the policy head of a new select committee in the House, studying fairness and the economy. Oh, cool. Is that the Nancy, Speaker Pelosi put that together, right? Yeah, that is a great select committee. You know, it's funny, I get a call randomly every so often from a 202 number. And it seems to be a different 202 number every single time.

I can't quite figure it out. And it turns out it's Speaker Pelosi. She's just calling up to talk. And I've learned to always, you know, I never take any number except if it's a 202 number, I will now take that number because every time it's her. And she just wants to, you know, chat about different things. And she called about a year ago, it felt like a year ago. I might be not that long ago.

And she mentioned this select committee. And I thought it was a wonderful idea. And I think this is great. So this is going to focus on income and wealth, distribution, inequality, and the policy response to that. Do I have that right? That's the right. And how to keep the economy growing, but also address the whole panoply of fairness considerations and equity considerations that come up in the, in the,

policy debate. Hey, can I ask you a favor, Bill? Can you ask your wife if she would come on my podcast? Please. Okay, good. Yeah, I mean, yeah, please. Well, I suppose you're going to have to see how this thing goes, but, but assuming it goes reasonably well, I'd love to have her on. She'd be fantastic. I think she'd be a great guest. Yeah, absolutely. Fantastic. Okay, before we dive into things, Hey, Ryan, today, Chair Pal, Fed Chair Powell, gave a speech at Jackson Hall. That's the confab of Fed policymakers in Wyoming. They do this once a year. And what do you think of the speech?

What did he say? First of all, can you summarize for the listener what he said? And what was your take on the speech? Yeah, I think there's a few bold points and takeaways. First is they're going to likely taper their 120 billion monthly asset purchases later of this year. So we were kind of debating should we stick to our baseline of January or move it to December. I think with Powell's comments today, we got to move it to December. Not a big change in the forecast. It's only one month. But that's pretty much the ground that he broke on the tapering.

He pulled it off really well. There wasn't a big market reaction because everyone was focused on what he was going to say about tapering. But I think what was a little bit surprising was he was very doveish just overall in his comments. You know, he's really really, doubling down on the transitory acceleration and inflation. And he gave, you know, a litany of explanations why, you know, a lot that we've talked on the podcast, the reopening the economy, supply chain issues. He thinks the global disinflationary pressures that have been around for 25 years are going to emerge again, that, you know, we don't have this regime shift in inflation dynamics. And he was established on the labor market. I mean, he acknowledged that we're

making progress, but, you know, we have a long ways to go. And, you know, he acknowledged, we're making progress, but, you know, And, you know, he is committed not to raise interest rates until the economy's close to or at full employment. And I think he did a really good job. I think what was most important. What you saw on the market reaction is that he divorced balance sheet policy through tapering with raising interest rates. And I think Bernanke didn't do as well of a job in 2013. And that's why we got that tapered tantrum. Oh, that's interesting.

Yeah, you make a good point. He made an explicit statement saying that what we're doing with. QE quantitative easing, the tapering has nothing to do with the timing or the trajectory of future rate increases. I mean, he was very explicit about that. Yeah, exactly. That was really, really important. And I think he did a really good job. Yeah.

Hey, Bill, I know you're a fiscal policy expert, but do you pay attention to what the Fed's doing? Did you look at what Powell did today? Yeah, I do. And the reason, the reason, too, is that, you know, Congress is often acting these big fiscal packages, and the question is, is that a good idea or is that politically motivated? And then you look at what the Fed's doing. I think you're going to assume the Fed is very largely dominated by economic considerations, not by political considerations. So if the Fed is pushing on the economy, continuing to push on the economy, even when they know that Congress is passing these big packages, I think that

helps reinforce that what Congress is doing is basically right. Got it. Got it. So what do you think? Are they on the right track here in terms of policy, monetary policy? I, you know, the idea that we're going to keep pushing now, but we're going to get strict later is a common theme in fiscal policy. It often never happens. I'm not doubting Powell's veracity or anything like that.

but they've been buying assets for a long time. And if they start slowing that down and reversing that, that would be a big change. It's not quite, I'll believe it when I see it. I mean, I believe that's what Powell wants to do. But sometimes it's easier said than done. Yeah, I saw Larry Summers. I didn't actually read the op-ed.

I just got a text saying he wrote a piece critical of the Fed that they're being too slow, I think, to wind down QE. I think that was his, the gist of it. He's obviously very nervous about inflationary pressures, which will come back to in the context of the fiscal policy and the build back better agenda. So, okay. I mean, Summers's argument fits with Bullard.

You know, Bullard's been pounding the drum that he wants to start now. And he's president of, he's president of... St. Louis Fed, right. Okay. Sorry about that. And he wants to end it by the end of the first quarter. That's too aggressive. If Powell came out and hinted at that, you would have seen a much bigger reaction in the bomb.

That would have set off alarm bells right and left. And the Fed's balance sheet wasn't inflationary. So when they taper, it's not going to be disinflationary. Right. So in our baseline, most likely outlook, we have long had the first move towards tapering in January of 2022. in the first rate hike, first short-term rate hike in, I believe, March of 23. So now you're saying, given everything that's going on here in the speech, probably December of 2021, right? And do we change our timing for the first rate hike from March of 23, or are we sticking to that?

We could bring it forward to January, 2023, but I think you started to see. Oh, really? So, oh, so, Ryan, you're changing your forecast. Bill, we've had a long-running bet about the timing of the first rate hike. And I had to beat Ryan down to get to March. And now he says, January. Am I hearing that right? Is that right, Ryan? Hey, when the facts change, you know, change your opinion.

Exactly. I just would do that just to be internally consistent with what Powell's saying. He's saying a long time between the end of taper and the first rate hike in a year is a pretty long time in the world of central banks. Yeah, got it. Okay. Anything else on the Fed before we move on to the statistics that you want to bring on? I think we covered it. Okay. Okay. Statistics. All right. Since we're down, Chris, Ryan, I'm going with you. I'm going to go easy on us, please. You know, we're getting old. Well, this one's not going to be fair to Bill. But this is very easy for you. Okay. It captures the week all in one number, 5.7%.

5.7%. Okay. It's not GDP. I don't think it's anything to do with income or consumer spending, which came out today. Let's say it started off. It started off at 7.2%. So it's come down. Really? So 7.2 is now 5.7. Bill, do you have any idea what that would be? I was going to guess GDP, but you just said not. GDP is GDP. Oh, is it? Oh, is it? Oh, it is it gross domestic income or no?

It's gross domestic product for the third quarter, our tracking estimate. Oh, I. So we have this high-reaching GDP model. Yeah. This week we've got a lot of data that is source data for GDP. It feeds into this model. We were at 7.2% and, you know, given, durable goods orders, the decline in real consumer spending in July.

Advanced inventory data was a little bit softer. All that broader tracking estimate down. So what did you say was 5-7, you said? Yep, 5-7. 5-7. So strong. Yeah. Oh, that's a little disappointing because we, before today, I think you were at 6.5 for Q3, right?

Yeah, we went from 7-2 down to 6-5. now we're at 5-7. That's a big come-down. Yeah, wow, interesting. And this is incorporating all the data pre-surge in COVID, this recent wave. So do you think Delta is playing a role here? No, not yet. Not in the tracking estimate, because this is using mostly data through July.

And COVID cases really didn't start to surge until early August. Oh, so you could be going further south. Oh, okay. So you think when Q3 is all said and done, it could be even lower than 5.7. That's interesting. Yeah, I think it's going to be closer to 5. Okay. Hey, before we move on, and I have a statistic and I know Bill does as well, I wanted to ask you about next week's employment report, because I'm sure we'll talk about that. Do you, Bill, you don't know this, but Ryan is, and I'm not exaggerating at all here.

he is probably the most accurate in terms of forecasting the real-time statistics. So, you know, he looks at all the other information data. He has models and he will, you know, give you an estimate of what he thinks each of these statistics will be. And actually, I think MarketWatch tracks your accuracy and you're always at the top of the list in terms of accuracy. And he always nails this employment number. So, and I know it's a little early and you don't like to tell us to your number before

you have all the data in. But what are you, last month, we got almost a million jobs. Correct. We got almost a million jobs in June. What do you think it's going to be this month? Do you think the Delta is going to have its fingerprints on this data? Yeah, so this month is going to be tricky because you had that big drop in unemployment insurance benefits, but you have seasonal adjustment issues. And just like in July, I drop it from our employment models for August. A lot of the other alternative labor market data that I track, has been coming in week. The early consensus is for total employment,

the net change to be 700,000. I'm taking the under. I'm going to be below that. Okay. Something close to a half million? You think? Yeah, probably closer to that. Okay, interesting.

Well, I'm sure as you get more data in the next early next week, that'll be. Yep. It can change. I mean, ADP we don't have and other things. Okay. So Q3 seems to be, Delta is having an impact.

It's coming, it's starting to. Yeah. it will show up in the labor market statistics because we really got a big search during the payroll reference period. And not necessarily that businesses were laying off workers, but they were probably slowing the return to the office. So I think in the end, on the margin, it's likely going to be visible there. Got it. Okay.

So, Bill, you get this game? You say that it's pretty simple, right? I mean, you try to be as look as smart as you can. You want to give us a statistic that is, you know, not a. a slam dunk, but not as like, we have a fighting chance at getting, you know, something like that. So I know that's a lot of pressure. So do you have a statistic for us? Let me go with 55%. 55%. And is it fiscal policy related? It's tax related. Oh, it's tax related? 55%. Well, it's not the effective tax rate. Is it the top, is it the top,

mark, because would it be the top marginal rate if build back better, Jen, it gets everything they want? It might be, but that's not what I had in mind. Mark's great at these, he'll throw a number out there. Yeah, it could be that, just so we can go back and say, I knew it. That's plausible though, right, Bill? That, I mean, that might say, especially if you had in state taxes and stuff like that.

Exactly. Yeah, yeah. That's probably not. That's not what you meant. So 55% tax related. Is it 55% of people pay taxes or don't pay taxes or something to pay income tax? That's actually close. The tax policy center, we estimated that 61% of people did not pay federal income tax in 2020. Okay. Ryan, that was pretty close, but that's not it. That was another good one.

I don't get the cigar. I don't get the cigar, obviously. Oh, man, I got it 55%. Do you have any clue, Ryan? You want to take a crack at it? Can you give us a hit without giving it away? Yeah, can you do that? It is the share of sole proprietorship income and farm income that is not reported to the federal government,

and hence has taxes evaded on it. Holy mackerel. All right. Never again. Can you tell me I picked a statistic that we're never going to know. Wait, wait, wait. Can you repeat that? More than half of farm income and.

sole proprietorship income is not reported to the IRS and therefore no taxes are paid on it. That is fascinating. It's not reported. How much revenue do you think would be generated if it was reported? Overall evasion is according to the IRS commissioners on the order of a trillion dollars a year. That is revenues that are not paid. It's tricky to estimate because you're estimating something that's not there and a lot of it is very high income and offshore and stuff like that. But the rate of evasion is very high for sole proprietorships and farmers because there's no third party transaction.

Like when you work, your firm withholds wages, sends it to the government. And when you file your taxes, the government already knows what your wages are and how much taxes you've paid. Whereas a farmer or sole proprietorship, there's nothing like that. There's no extra reporting. So it turns out that that makes a big difference. more than half of that income is not reported according to IRS. And in the build back better agenda, there's a fair amount of funding for the IRS to try to raise tax compliance. And presumably they would also go after their self-proprieters and

farm income as well as kind of the high rollers, the wealthy households. Yeah. The emphasis, the last few years, has been on EITC recipients where people are evading taxes there is mainly because the filing requirements are complicated and the wrong parent claims the kid and stuff like stuff like that. But this is the sole proprietorship in the farm stuff, the wealthy offshore stuff. This is, you know, accidental evasion that just happens to go into taxpayers' favor every time. And there's huge potential for the IRS to raise revenue here. Interesting. Well, I think I did. are, you know, some plaudits here. I got, I got numbers that, you know, were close. Okay,

I got, I got a statistic and this is more geared towards, I think, towards Ryan. And I'm going to give you two statistics that are related. First is a 9.2%. 9.2%. And I, do you need to hit Ryan or do you know right off? No, it's corporate profits. Second quarter. So, yeah, because you wrote this release. I was reading your analysis of the GDP report. So I'd be a little surprised. I knew that was going to be a bit of a slam dunk.

So just for the listener, corporate profits in the second quarter came out with this GDP release that we got on Thursday. And they were up 9.2% over Q1, quarter to quarter, not annualized, just a one quarter increase. and profits are surging. I mean, it's pretty amazing. I mean, there were, if you look at total corporate earnings in Q2 and an analyzed rate, $2.7 trillion. It's almost, you know, a half trillion dollars more than it was pre-pandemic. I mean, it's going skyward.

Just another statistic, you know, the year-over-year growth is obviously inflated because a year ago we were in the middle of the pandemic and corporate profits got nailed. So year over year doesn't really give you any sense of what's going on underneath. But if you look at growth over the past two years, so go back to Q2 2019 and look at the growth rate, it's about 8, 9 percent, you know, annualized. I mean, that's a pretty heady rate of corporate earnings growth. Okay, this is the harder one, Ryan, in Bill. Again, related to corporate earnings.

But I think a very interesting statistic. 14.3%. 14.3%. Is that corporate profit margins? That's pretty good. It's pretty good, but not exactly what I have in mind, but it's highly correlated related to what I do have in mind. It's a share of national income account for corporate earnings.

So, you know, similar kind of concept. 14.3% is at the high end of the range back to World War II. So if you go back to World War II, look at the share of national income that is going to corporate earnings. On average, it's about 11%. The lowest it ever gets is about 8. So that's in the middle of recessions like the financial crisis. The highest it ever gets is about 14.3%. So corporate earnings are, they're booming.

So I guess, you know, to some degree, what's going on in the equity market is supported by, you know, what's going on with regard to fundamentals with corporate earnings and obviously low interest. rates. But do you think it's the best way to look? Because I normally, my default's always to look at corporate profits as a share of GDP. But I wonder if I should be also looking at it as a share of national income. Well, they're similar, right? GDP national income. Pass are going to be similar. Yeah. Yeah, it's pretty, you know, pretty consistent. You mean, the actual levels are a little bit different, but they're very, very consistent. But, you know, that gives me reason to be optimistic about a couple things, macroeconomic things. One, that businesses are going to continue to be able to

invest and they're focused on on productivity growth because of, you know, rising labor and other costs. So that, you know, augurs well. And it also augurs well, I think, for inflation, too, doesn't it? I mean, if margins are wide, earnings are strong, then, you know, they can absorb some of the cost increases in higher labor costs that they might face. I don't know. Bill, do you have any views on that, any perspective on that? It's interesting in the context of kind of the 2017 tax reforms, which cut corporate rates. And I don't know enough about the aggregate statistics to say, but there's a lot of action with shifting of income and shifting expenses after the act. And I would guess there's some daylight in thinking about how the 2017 tax act might have influenced that number.

Yeah, I think that's kind of top line economic profits, and then they get before tax profits, and that's where all the shenanigans can start kicking in, and then, of course, after tax profits. So I think, you know, there's always data issues, measurement issues, but I think it's a relatively economically pure, you know, as best as you can, you know, estimate of what's going on. Obviously, it can be revised as they actually get more tax return data, which is pretty lagged. So, but nonetheless, you know, pretty significant gains. in corporate earnings, so a very, very positive development. Okay, so let's talk fiscal policy and a lot, obviously, to talk about here.

And I wanted to ask you, Bill, just first up, what do you think of the fiscal policy response to the pandemic? I mean, you know, obviously a lot has been done by my calculation, and maybe you've done your own, that if you towed up all of the fiscal support provided to the economy since the so-called cares, Act back in March of 2020. That was the first fiscal package, emergency package, to help the economy navigate through the pandemic, all the way up to the American Rescue Plan, which was the package that was of emergency spending and some tax breaks in March of this year, comes to almost $5 trillion. In fact, a little over $5 trillion, which is about 25% of GDP.

That's massive. You know, for context, if you go back to the financial crisis, you consider the recovery. Recovery Act. That was the stimulus under Obama that was passed in February of 2009, that was instrumental in getting the economy out of that recession. And then a little bit of stimulus after that before things became kind of flipped because of political reasons and we went into austerity. You add up all the fiscal support during the financial crisis about 10% of GDP. So this response was pretty massive. How would you rate it? How would you, how would you, how do you consider the policy response? Do you think it was a good thing, bad thing? What would, what,

What's your perspective on that? I think the very high level perspective is that they did the right thing. They went big. They went fast. They went in a lot of different areas. I mean, some of it was kind of what a friend of might call spaghetti economics, which is you take everything, you throw it up against the wall and you see what sticks. But I think given the severity and the immediacy of the creation of the creation.

crisis in in early 2020, I mean, what else could they have done? They, they, they, I, so I give them, I mean, it's fun to criticize Congress and it's easy, but I give them high points on, on acting quickly acting, you know, in a very, uh, expansive, uh, both in terms of dollars and in terms of the scope of the interventions, uh, you know, I, I can't imagine what it would be like, where will it be like without, you know, the stimulus, the unemployment, the PPP. I mean, those things, granted, they could have been designed better, but, but, you know, you just don't have that kind of time.

So I feel like generally they have done the right thing. And, you know, this infrastructure package that's moving through, I think is also generally the right thing. I mean, we've had sort of net federal, this was, I consider this as a statistic, but it's too fuzzy. But net federal capital investment in infrastructure was pretty close to zero from the mid-90s to the end of last year. And, you know, that just can't be an optimal situation. We have this crumbling infrastructure and the needs. I don't know if they're doing exactly the right infrastructure targets, but the, notion that we needed to invest, I think is absolutely right.

Net capital investment, meaning after depreciating of the stock, we basically were going nowhere with public infrastructure. Yeah. In the 90s, for example, one way the budget got balanced was a big cut in infrastructure spending, and it just never really recovered after that. As you say, it was kind of a spaghetti, it was called spaghetti policy. I think that pretty apt description. Of all of the elements of that spaghetti, were there some aspects that kind of stand out as being particularly good policy and some that stand out as being, you know, not as good?

If you were king for a day or a week, would you have done some things differently here than actually the way they ended up? I think that's a great question. I mean, I think the unemployment boost was important, especially in a situation where, we're telling people you need to get out of the economy so we can deal with this. You want to make it possible for them to do that. That's kind of a relief policy rather than a stimulus policy. I think PPP, I know people have grumped about it and some, but I think it's helped a lot of people. I think it's actually helped in a non-profit sector a lot, which is a story I don't think has been told that much.

I think the eviction moratorium was important. I'm sad to see the Supreme Court overrule it. But, you know, those kind of policies have real effects on people's lives. And the craziness of this all is our health insurance system where you have a pandemic. And well, people have their job, their health insurance through their jobs. You have a pandemic. It was right when people need health insurance. and they lose their jobs because of their pandemic.

So they lose health insurance. So I think they got a lot of things right, but there's certainly a lot more work that could be done. You know, I can attest to your point about nonprofits. I'm the lead director of a large CDFI, a community development financial institution. We're headquartered in Philly. That's our hometown,

but we make investments all over the country, healthcare centers and affordable housing and community centers, that kind of thing. And the help we received from the federal government, that through not only PPP, but other avenues have been very, very important allowing us to, you know, help community. So I agree with you. That's something that I think is really important that has not gotten any attention, you know,

in all the conversation. Very, very important. Yeah, a lot of those institutions don't have a lot in the way of reserves. And so they got nailed when they just had to shut down for a couple months. Yeah, I mean, interestingly, a fair amount of the CARES money, you know, they went to the states. The states had some flexibility to do with what they want, what they thought best with the money. In the state of Pennsylvania said to all the CDFIs, we're a financial institution. We extend credit to projects that are

in underserved communities and they're, you know, they're, they don't work, you know, with market interest rates. So it's subsidized. But it allowed us to, pay for all our loan losses. So the state of Pennsylvania said, hey, use this money to to pay for all your loan losses, which was, you know, just amazing, you know, really very, very important. A lot of us to continue to extend out credit. So very, very important legislation. I did notice, Bill, when you talked about the infrastructure plan, which you're very positive about, You didn't mention the social infrastructure plan, which is much larger. I mean, the infrastructure plan, I think, adds $550 billion in additional money to infrastructure

bipartisan. The social infrastructure plan is kind of making its way through the Senate and the House's $3.5 trillion. What do you think about that piece of legislation? How do you view that? Well, it's breathtakingly large, but I think it's going after stuff that is important. I don't want to get caught in debates about whether, you know, child care is infrastructure or not. I just want to focus on whether it's a good idea or not.

And I think it is. We need to, you know, if we're thinking about, if you think of infrastructure essentially as government investments that make the private sector work better, that type of thing would qualify. You mentioned my wife, Diane, earlier. She had what I thought was a brilliant observation, which is that the infrastructure, the conventional infrastructure plan, is essentially an effort to get men back to work. And the American family plan is essentially an effort

to get women back to work. And I just think that's a really interesting way to look at the different proposals. And there was some debate early on in the administration about whether to go, the traditional road first or to go to a family route first. You know, one of the criticisms of the plan, both the infrastructure plan and the traditional infrastructure plan and the social infrastructure plan and the so-called American Families

plan. I know there's a lot of plans here. It's a little confusing. But, you know, there's two pieces of legislation. One is around traditional infrastructure. One is around social infrastructure, education and child care and health care and housing and climate change, those kinds of things. The one of the concerns is it's going to lead to undesirably high inflation,

you know, juice up the economy so much that it overheats. Undesirably high inflation. Fed has to respond. Higher interest rates, kind of a classic business cycle, may even go back into recession. Do you have a sense of that? I mean, are you worried about the inflationary aspects of, of what's being proposed here. That would be another,

I know we're picking on Larry Summers, but that's another area of concern that he has, that this will be inflationary. Summers, as I recall, actually favored the investment side of these things in terms of increasing the long-term productivity and capacity of the economy, and it was more the consumption-oriented things

that he was worried about. But there's all these good structural reasons to invest in workers and infrastructure. And they don't have to be immediately. They don't have to be immediate. They can be kind of medium-term plans so that both the investment aspect of them and the medium-term aspect of them would moderate the inflation concerns, I think. Yeah, I agree with you. Ryan, do you have any views on that in terms of the inflationary?

I know you've thought about that. Yeah, I'm not worried about the inflationary impact. I mean, first with the infrastructure bill, the traditional one, that's going to be spread out over a few years. So it's not like we're front-loading at all where you're going to get all this infrastructure spending when the economy's approaching full employment. So that's not going to be too much of a concern for me. Okay. All right. I did want to ask around the deficit implications of all of this.

You said breathtakingly large. It's a lot of money. $3.5 trillion plus $500 billion, we're up to $4 trillion. That's on top of the $5 trillion we've already kind of borrowed here. Now, in these proposals, depending on which one you look at, but if you look at the president's original Build Back Better Agenda proposal, he has tax increases to help pay for it, not over the 10-year budget horizon. And I should be clear that $3.5 trillion is over a 10-year budget horizon,

but over a 15-year budget horizon, more or less, something like that. cut. Do you do what, and of course, the other criticism of this is that it's going to raise taxes, and that's a big deal. You know, that's going to be very negative for the economy, wash out any of the benefits from the higher spending and the other tax breaks in the proposal. And I know you recently, Bill wrote a paper piece for Brookings looking at the Trump tax cuts, which I think in the way I thought about it was highly informative in terms of how we should think about the proposals to raise taxes here. I was curious, perhaps you could just summarize what those results were and what it means for the current policy debate around the bill back, better agenda.

Sure. So the results looked at revenues, GP growth, patterns of investment, patterns of business formation, wage changes, international profit shifting. after before and after the 17 Act and found very little evidence of supply side effects. And so that suggests that there's room to raise taxes or create new taxes without destroying the economy. I think a lot of attention should be paid to the structure of the taxes that get raised, not just whether taxes go up or not. So I think, you know, closing loopholes in the income tax could go a long way toward raising revenues without hurting the economy. And I mean, there was a lot of options to raise taxes.

21% is probably too low for the corporate tax, so on. And I just think, you know, I mean, the political. prospects for raising taxes, you know, are ridiculously weak. We can't get people to wear masks. You know, how are we going to get representatives to support tax increases? But conceptually and empirically, I think there's plenty of room to raise revenues. So the, just to pick on one number, the top marginal rate, corporate rate prior to the Trump tax cuts, which were implemented at the start of 2018 was 35%. That was the top marginal rate. Trump tax cuts lowered that to 21.

You know, in Europe thinking, what is kind of a reasonable place for that for that marginal rate? Is it so that it, you know, it kind of strikes the balance between, you know, I need some revenue. I don't want to do any real damage to the economy. All else being equal, yeah, it'll be a negative. but not to the degree that this becomes a real problem. There's somewhere in between 21 and 35 that, you know, is the sweet spot.

Do you have the sweet spot in mind? I would say 25 would be easy to achieve without creating any significant damage. You know, remember, we went down by 14 points, and we didn't get the investment surge. We didn't get the profit-shifting surge. We got a bunch of repatriations, but then that was because of the, change in law and then they got paid out to shareholders. If we're willing to reform the base as well as raise the rate, and I would say we could go to 28% and move to cash flow base,

which basically means you just let people expense all investment and you eliminate interest deductions. TCJA moved in that direction. We have expensing for equipment for the next five years and they limited interest deductions. But at this point, they might as well just go all the way. And then when you go to what the benefits are on your cash flow base is that the effective tax rate on new investment is zero, even if the statutory tax rate is positive. And so you could raise the rate a little more with the adjustment to the base.

I think it's really important, again, that we focus on the base adjustments and not just the rate adjustments. Remind me in the buildback better. proposals. I mean, are they moving in that direction? I can't quite remember. No, no. There's no talk about changing the base in the regard that I just mentioned. They're very interested in the international provisions and tightening them up. But there's no discussion of going through a cash flow tax. All right. So you think it makes some sense to raise, you know, given the constraints, the political constraints, to raise the top marginal rate, to generate some revenue to help pay for this package of proposals that are being

put forth. You feel comfortable with that? I do, yes. I think, you know, I don't think we should panic about debt and deficits right now, but we should get policies in place that start dealing with the issue. Yeah, before we move on, let me ask one more thing. Just try to provide some intuition around the result that you came to. That is, Trump tax cuts don't appear to have significantly affected or increased long-term investment. Therefore, you know, it's not going to benefit productivity.

It's not going to benefit the long run growth rate of the economy. It may, but it's, you know, on the margin. Maybe some kind of attrition somewhere down the road can tease that out. But it's not obvious. It's certainly not a slam. MDunk. What's the intuition behind that? Why is that? Why aren't we, why didn't we see an impact? The best argument I've heard is that the, the, given the change in the cost of capital, the IMF has a study that says that the investment response was muted relative to the change in

the cost of capital compared to past changes in the cost of capital, past investment responses. And the argument would be that increasing market power, increasing concentration has given firms more oligopoly control in markets and made it less essential that they invest more. There's been this general trend that investment the last 15 years has been lower than one would have expected. And people attribute this to rising market power, rising concentration in key markets. Could it also be just low rates and low returns? I mean, you know, who cares? I mean, if, you know, you're loaning the cost of capital and the cost of capital is already on the floor.

I mean, there's, I can't. Yes, yes, absolutely. And oddly enough, I have a paper that says exactly. Yeah. Yeah. If it, if the discount rate is zero, then the expensing is the same as depreciation, right? Exactly. And so it could have be, it could be the, you know, low interest rates are an indication

that there aren't great investment opportunity. So it could be that too. Right. Okay. So let's now, we're kind of putting the pieces of the puzzle together here. We talked about the build back better agenda and you kind of sort of like, you know, where it's headed, talked a little bit about potential revenues. But it feels like at the end of the day, if we get a piece of legislation through Congress

and signed by President Biden, it is going to have larger deficits in debt. It just feels like that's where we're going to land. And in fact, if you look at the budget resolution that was passed by the Senate, I think it was passed by the House, 3.5 trillion over 10 years, only 1.75 trillion in revenue. So that means a one point seven, increase of $1.75 trillion in the 10 year budget deficit. That's not inconsequential. That's, you know, 175 billion a year. That's what? That's a seven, eight, seven, eight tenths of a percent of GDP. That's, you know, meaningful. Does that bother you? Would you vote for that legislation or would you not vote for it because of the size of the size of the? the I would vote for it. And I think the analogy is somebody that has long-term health problems, but also has sort of short-term emergency needs. Maybe emergency is too strong, but, you know, has health issues that need immediate addressing. You go ahead and address the issues in the short-term, even though they might affect the long-term outcome. I mean, I think in low-term, Low interest rates are critical to this.

The interest rate is zero, which is not an exaggeration, not much of an exaggeration. A dollar of debt today costs, a dollar of deficit today is a dollar of debt 10 years from now, right? If the interest rate is 12 years from now, say, if the interest rate is 6%, a dollar a debt now is $2 12 years from now. And so it doesn't, low interest rates don't mean that debt is costless, but it makes debt a lot less expensive than it otherwise could be. And that's just an important consideration. Interest rates have come down so far for so long. The tips rate is negative. The 10-year tip

rate is negative right now. The 10-year nominal yield on treasuries is like, I don't know, one and a half or less than that. One-35. One-three-five. And so, you know, that actually makes a difference. When the price of something goes down that much, the optimal thing is to buy more. I mean, the world is saying we want more treasury debt. Yeah, the way I kind of make that visceral for people is I say, look, I can put a map of the United States on my wall over here, take a dart, throw it anywhere on the map, draw a circle around it, maybe with the radius of, you know, two, three miles. I can, I'm sure I can find an infrastructure project that has a higher return than, say, a 30-year bond at 2%.

You know, it seems like, why wouldn't we do that? Right. I mean, that's particularly true, I think, in urban areas. The politics of infrastructure are always that you have to build something in North Dakota or Wyoming if you want to build something in New York. But I think, at least for the densely populated areas, I'm pretty sure that that circle would. That is, you know, that's your urban. coming out there, Bill,

I mean, if I can find projects in North Dakota, too, that have a higher return than 2%. Yeah. Especially when the net capital investment has been zero for 30 years. Yeah, fair enough. Fair enough. Yeah, I'm just guessing. I'm just guessing.

Anyway. So, but okay, all right, look, there's got to be a limit to this, right? No? I mean, where does this kind of thinking end? Or does it not end until it ends? meaning we keep running a large budget deficit because it makes economic sense to do so until interest rates rise and then you don't. Is that kind of the logic?

You know, if people say the dumbest things about which way interest rates are going to go, the second dumbest conversation is how much fiscal space do we have? Nobody knows. I mean, you look at Japan and they've got. Wait, wait, Bill. I think Ryan knows. I do. I think Ryan knows. Ryan, do you know? Or am I just? What, how much physical space we have? A physical space. Do you don't know? No, because I agree with Bill. I mean, we estimate it, but there's an enormous uncertainty around it.

Hey, Bill, I want to tell you this before you move on. So we hired a great economist, Damien Moore. Damien, I don't know if you know the name, but Damien was at CBO. He was their guy who did all the financial economics, you know, anything related to markets or institutions. Like I got to know them really well because around the GSEs, you know, do a lot of work around Fannie and Freddie, and he did a lot of the budgeting around Fannie and Freddie. Anyway, he's been working on a fiscal space paper now for two years. He's very reluctant to release anything.

I think for the sentiment you just expressed, how do you do it? I mean, what makes sense. So sorry, that was, I didn't mean. And Damien's a perfectionist. That too. He is a perfectionist. That is true. I mean, it's just so hard to know.

And it depends on so many things. And it could turn on a dime. Right now, though, it looks like we're nowhere near what our fiscal capacity is. Okay. So you're saying to me, Mark, don't worry. You know, don't go crazy. You don't do stupid things. You don't want things that have a good social return.

But, you know, deficits, not. that big a deal. We can live with them. In fact, to some degree, that might be good economic policy because we've been underinvesting for so long. That's kind of sort of what you're saying to me. And we'll know when it doesn't make economic sense again, and we'll have the ability to pivot and show that fiscal discipline when we need to when interest rates are high. That's kind of what you're saying. And, yeah, if I put it slightly differently, let's make good spending choices and good tax choices and keep an eye on interest rates. And if we, you know, market's going to tell us when they think that situation is getting out of control.

Right. Well, you know, I, just as an observer of the bond market for a long time, not a very good forecaster of the bond market, admittedly, but as an observer, it moves pretty damn fast. So I think we'll know pretty quickly when enough is enough, you know, so hopefully we have the political will at that point to, listen to what the bomb mark. But maybe that makes sense. Maybe it makes sense. Maybe, you know, policymakers, lawmakers, politicians can't connect the dots in the mind of the electorate that we've got to do something unless interest rates rise. I mean, because otherwise, it makes no, it's hard to, for it to resonate with people. Deficits mean a bad economy. Well, how exactly, you know? Right, right. Exactly. And so like policymakers are, are,

even if they wanted to do something about it, they wouldn't have the public support to do it. The public doesn't like deficits, but they don't like spending cuts or tax increases even more. And so you need some sort of external thing like interest rates rising or financial crisis or something. You need something that puts their backs against the wall and makes them have to deal with it. And right now there isn't anything like that. Yeah, it's kind of sort of like what happened in early 90s, right? Bill Clinton, the Treasury Secretary of Rubin, he could point to the bond market, so-called bond market vigilantes.

And he said, look, if we run deficits, we're going to have much higher interest rates and we're going to be paying more on our interest, more interest than we are going to be spending on our military. And once you make that kind of visceral connection, you can do something politically with it. Right. And I think interest rates were something like 5 or 6% at that point. And that's just a huge, you know, a huge quality of difference. Yeah.

Okay. Well, let me ask you this. We've been talking about the United States. What about overseas? I mean, is it even this argument on steroids because they're at negative interest rates? So they should be flat on the accelerator. Don't worry about it, you know? Yeah, I don't quite understand the negative interest rates.

But the concern with other countries' deficits is. they don't have the exorbitant privilege that the U.S. have in two ways. One is the dollars to the world currency, and two is we print our own currency, whereas the European countries use euros. They don't really have control over their individual monetary policy. And that, if you look, Japan, for example, does have control over its own monetary policy. and that issues debt in its own currency. So a number of people have pointed to that independence

as being helpful for us in managing our debt and being a problem for countries that don't have that independence. Yeah, I wonder if we, you know, somewhere down the road here on the other side of the pandemic, when the economy starts picking up interest rates start, you know, ultimately at some point they are going to rise, presumably, that we might not have some kind of fiscal, global fiscal event, you know, kind of sort of like the European debt crisis after the financial crisis,

where all of a sudden, oh, my gosh, can country service all the debt they accumulated during the pandemic? Because every country on the planet did what we did, and bought a boatload of money, used that to help support their economy through the pandemic. So I worry about that. I mean, a similar thing happened in World War II. And, you know, worldwide, I mean, and countries managed, well, the U.S. managed transition particularly well, but there was no entitlement spending back then.

The budget was mainly discretionary spending. Defense spending came down. but now we've got Social Security, Medicare, rising, you know, creating a lowest level, you know, pushing the deficit up over time. And so something's got to give, but when and what it is is an open question. Right. And definitely it's going to be Ryan's problem, not ours, Bill. I'm pretty sure. Yeah.

Yeah. Hey, I know our time on the podcast is coming to a close. Before we end, I did want to get, because you are such an world expert in tax policy, you've been thinking about this deeply. I know you just wrote a paper that you're going to present at the National Bureau of Economic Research here in a month or so around tax policy in a low-rate environment. I wanted to get your take on kind of a lightning round, you know, take on different types of tax, proposals that kind of have been in and out of the public discourse and just get your take on it. Does that sound okay?

Would that be okay? Sure. You go with that. Okay, wealth taxes. So what do you think about wealth taxes? A wealth tax can be thought of as like an equivalent to an income tax. So if the rate of returns 5%, and the wealth tax is 1%. It's equivalent to a 20% income tax on capital income.

So as the rate of return comes down, say the greater turns only 2%, all of a sudden, then wealth taxes equivalent to a 50% capital income tax. So low interest rates make wealth taxes more distortionary than they would otherwise be. Got it. So well tax is probably not such a great idea, particularly in the context of very low interest rates. Yeah. I mean, there are these administrative issues as well.

It's just like to happen. Okay, got it. carbon taxes. Obviously, there's a carbon border adjustment tax proposal embedded into the build back better agenda to generate some revenue. The European Union is thinking about a carbon border adjustment tax. There's different flavors of carbon taxes. What do you think of carbon taxes? Well, first thing, the border adjustment, quote unquote, is really a tariff. It's not a full border adjustment. It doesn't subsidize exports or just taxes imports. The The low interest rate scenario we've been talking about makes carbon taxes even more attractive

than they have been in the past. And the reason is that the costs are up front, the benefits are in the future. With low interest rates, you don't discount the future benefits very much. So the benefits rise relative to the costs as interest rates decline. So there's all these good reasons independent of interest rates to adopt carbon taxes, but lower interest rates even, you know, adds further to that. Got it. So carbon taxes make sense, and particularly in a low rate environment because of the

discount rate effect on benefits and costs out into the future. Yeah, got it. How about investment incentives for businesses? What do you think of those, you know, different types of tax credits to try to incent businesses to do different things? Yeah, all the capital and saving. incentives we have, whether it's, you know, tax to 401Ks or expensing for business investments or preferential capital gains treatment, they all get muted as the interest rate goes to zero.

And it's just a lot of the policies we have are based on the idea that we're going to have fairly high interest rates, and therefore there's a big subsidy. In mortgage interest reduction, for example, if mortgage rates go to zero, there's no interest payments, there's no deduction. And so low interest rates sort of change how we think about tax policy. Got it. And this goes back to our previous conversation about why the Trump tax cuts may not have worked as much as even no one really thought they were going to be a game changer. But, you know, they were even, there's no evidence they had any impact whatsoever.

What about consumption taxes? How do you think about consumption tax? Oh, yeah, I sort of mentioned that. The difference between a consumption and an income tax also shrinks because they think of the big difference is the treatment of saving. the interest rate is zero, the return on saving is zero, and so it's not that big of a, big of a difference. I generally the difference between a pure income tax and a pure consumption tax is very small.

The difference between a pure consumption tax and the system we have is enormous, but that's because the system we have is nothing like a pure income tax. So wealth taxes are out, investment incentives are out, carbon tax is definitely in, and you're kind of a fan of consumption taxes. Yeah. Got it. In a particularly in a low rate environment. Yeah. Got it.

Hey, Ryan, so you got Bill Gale here, a world class fiscal policy expert tax policy guy. What one question do you want to ask him? And not, is he a Boston? He's in Boston? Who are this guy? Red Sox fan. Red Sox fan, the Red Sox. You're not a Red Sox fan, are you, Bill? No. Please. Thank God. Yeah. Well, one thing I was wondering, and this is a question I get all the time from our clients is, you know, does the high debt to GDP ratio in the U.S. act as a ceiling for interest rates? Like, is there, because right now, like interest payments as a share of GDP is 1.6%, which is low historically. But if interest rates start to rise, particularly in our baseline, we have them steadily. rising over the next few years, is there kind of like a threshold where we can't raise interest

rates any further or our interest payments just get too large? Yeah, this is a variant of the fiscal space question, I guess. There's an interesting dynamic that as public and private debt goes up relative to GDP, it's more costly for the Fed to raise interest rates. So it's, it, there's a kind of a well-developed theory that higher debt causes interest rates to rise, but at the same time, from the Fed's perspective, and then raising industries will impose bigger costs, the bigger debt is in the economy. So, again, I don't want to venture, I guess, on what the limit is. Right.

But I think it's really important, you know, and I've learned from Larry Summers and Jason firm on this, really important to think that we're in a kind of a different macro era than we have been, you know, 10 or 20 or 30 years ago. And those of us in Marx age, in my age, who are raised on inflation concerns and high interest rates have to be rethinking what we learned. You know, the one that will end this way, Bill, just a cautionary note. Once we change our views, it's all, you know, it's all over. It's going to change it. Right, right. Yeah, we're like the people that come into the stock market after the rally. It's like all over.

Things are going to change again. So anyway, hey, I want to thank you for taking this time with the site. It's Friday afternoon. I know you probably would like to get to a ballgame or a barbecue or have a beer or, I don't know, have a gin and tonic, whatever you do. But thank you so much. And give my best to Diane. And Bill, hey, can you put in a good word for me?

because I'm going to send her an email, you know, trying to get her on my podcast. I will do that. I will do that. Thank you for having me on. It's really interesting, discuss it. Absolutely. And to the listener, thank you for participating. I did want to point out that, again, if you, we're looking for, we want to have

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We'll call this a podcast. Take care now.