Debt Digest | Trump’s Trade and Investment Policy Goals Are Contradictory
Links & Fiscal Facts
Here are this week’s reading links and fiscal facts:
Medicaid spending reductions are both fiscally necessary and sound policy. The Washington Post’s Jacob Bogage highlights a new Congressional Budget Office (CBO) report showing that the House Energy and Commerce Committee cannot achieve $880 billion in savings (as instructed in the House budget resolution) without reducing spending on Medicare, Medicaid, or the Children’s Health Insurance Program (see the graphic from the New York Times below). However, reducing spending on these programs isn’t just necessary to meet this target—it’s good policy. For example, the committee could exceed its savings goal by adopting two commonsense Medicaid reforms that President Obama previously supported. Two proposals by the Paragon Health Institute, limiting the Medicaid provider tax scam and equalizing reimbursement rates between traditional (children, seniors, pregnant women, and people with disabilities) and expansion (able-bodied adults) enrollees, could generate $600 billion and $500 billion in savings, respectively. Notably, Economic Policy Innovation Center’s Paul Winfree points out that these are not cuts but rather a slowdown in spending growth—with Medicaid still growing by 3 percent annually.
Government spending should be included in GDP calculations. Elon Musk and Commerce Secretary Howard Lutnick recently argued for excluding government spending from GDP calculations. Cato’s Jai Kedia explains why this is misguided: “Their statements suggest that GDP, as constructed, obscures the government’s flaws because wasteful increases in G simply result in artificially increased Y (output) with no other effects. This is a mistaken view of macroeconomics. Wasteful activity from the government can and does appear in the GDP as constructed. Economists have long documented the “crowding out” effect. That is, in response to misallocated government resources (such as Mr. Musk’s hypothetical cars versus DMV example), private consumption and investment can fall below their optimal values. As a result, an increase in G can be coupled with significant decreases in C or I, resulting in reduced overall GDP. And removing G from the reported national accounts will make it harder for people to account for the waste.” If Mr. Musk and Mr. Lutnick want to isolate the government spending portion of GDP, that’s simple math (see the figure below). However, as Kedia points out, they should “leave GDP calculations alone”.
Trump’s trade and investment policy goals are contradictory. Phil Gramm, a former chairman of the Senate Banking Committee, and Donald Boudreaux from the Mercatus Center argue that the Trump administration’s policy to simultaneously push for lower trade deficits and higher foreign investments is inconsistent as “Trade deficits and capital surpluses are two sides of the same coin.” They illustrate this with an example: “If Japanese tech-investing firm SoftBank fulfills its Dec. 16 commitment to invest $100 billion in the U.S., as SoftBank acquires dollars to fund the investment, the value of the dollar will rise relative to what it would have been without the investment, the cost of U.S. exports will rise, the cost of U.S. imports will fall, and the country’s trade deficit will rise.” Gramm and Boudreaux urge Trump and Congress to focus on responsibly extending the pro-growth tax cuts and not fixate on trade deficits. For more on this, read this piece from Cato’s Adam Michel.
Two GOP senators are pushing back against the harmful current policy baseline. Semafor’s Burgess Everett reports that at least two Republican senators, Bill Cassidy (R-LA) and Todd Young (R-IN), have concerns about using a current policy baseline to extend the 2017 tax cuts. While Cassidy isn’t a hard no, he said he wants to choose the option “most likely to keep 30-year mortgage rates down, keep car note rates down.” Meanwhile, Young is “pushing for the most fiscally responsible approach to ensure sustained economic growth.” Using a current policy baseline—which assumes the 2017 tax cuts are permanent and ignores their extension costs—would be one of the least fiscally responsible choices and would likely push interest rates higher as debt explodes. Cassidy’s and Young’s leadership will be important in stopping this “fiscally irresponsible gimmick that avoids tough political choices to saddle Americans with trillions more in debt.” Last Thursday, I joined the Committee for a Responsible Federal Budget to discuss the risks of using a current policy baseline. Watch the full event video below.
ChatGPT on the threat of fiscal dominance. Mercatus Center’s Tyler Cowen shared ChatGPT’s response to his question on the fiscal theory of the price level. ChatGPT explained that the price level can depend on the present value of future primary surpluses relative to debt, in addition to a central bank’s monetary policy. And when a government approaches insolvency, it may face political and economic barriers to hiking taxes or cutting spending, making the fiscal theory of the price level more relevant. In that scenario, ChatGPT adds, “Monetary policy may become subordinate or even impotent because the central bank might be compelled to accommodate the government’s fiscal needs (e.g., by monetizing debt).” Dominik Lett and I have previously warned of this possibility: “If Congress leaves spending corrections to the last minute, legislators may perceive the draconian fiscal consolidation necessary to bring debt under control as less desirable than monetizing the debt. In such a scenario, printing more money might become the easiest or only politically feasible way out.” Read Cato’s Populism and the Future of the Fed for a deeper dive into the threat of fiscal dominance.
