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Stanford Economist John Taylor On The Deal Friday Night

Monday, April 11, 2011

HH: As promised, a few kind words for the budget deal. I’m joined by Professor John Taylor, who is the Mary & Robert Raymond professor of economics at Stanford. He’s also the George Schultz senior fellow at the Hoover Institution up at Stanford. He’s twice served on the President’s Council of Economic Advisors, former undersecretary of the Treasury as well, and last year, he received the Bradley prize for his achievements in the world of economics. Professor Taylor, welcome back, it’s good to have you on the Hugh Hewitt Show.

JT: It’s great to be here. Thank you.

HH: I have linked your blog over at mine, at, and you, I wanted to find someone who thought that the budget deal was just a great success. It looks like you do. Tell people why.

JT: I think it changed the direction of spending in Washington. A year ago, President Obama proposed a budget in the discretionary area. It called for an increase of $39 billion. What’s come out of this deal is a complete reversal. It’s falling by $39 billion, a minus 39, by the same measure. So that’s a pretty big change. No one would have predicted that a year ago. It’s a first step, to be sure. There’s a lot of way to go, but it’s, I think it’s significant. I think of it as a game changer. We’ll see in the end if the game does change, but if I think we look back on this, assuming things go well, this will be viewed as a game changer.

HH: Dr. Taylor, let me give you some of the objections from critics of the deal, and get your reactions to them. Number one, $39 billion dollars is real money, but given a trillion and a half dollar deficit, and a three and a half trillion dollar budget, it really isn’t. In the old days, it would have mattered. These days, it’s ten days of interest on the national debt.

JT: Those are good points, but you’ve got to start somewhere. And this is where we are in 2011. And the proposal at this point is, I think, more than anyone could have possibly expected before certainly last year. And to me, it establishes some credibility. In other words, now we want to go ahead and really do the heavy lifting. But you start somewhere, and you change the conversation from more and more spending to less and less spending, and emphasize, and this is going to help the economy. So I think of it as a first step. It’s like when you’re three touchdowns behind, you make a first down from fourth and two, and that brings you a chance at actually winning the game.

HH: Second objection, Dr. Taylor, is based upon both political critiques from people like Congressman John Campbell, a budget hawk, and investment gurus like Bill Gross, founder of Pimco, that we are very close to a Greece-like event, to a sovereign debt crisis in the United States, and that this just doesn’t go as fast as the urgency of the times require. Your response?

JT: I hope those sentiments are expressed loud and clear as we go into the 2012 budget debate. They’re very important. I don’t disagree. But now is the time to get those on the table, and so we get some action for 2012. That’s really where the budget under discussion is now. And already, you see, actually, the President’s budget was viewed by everyone as not even coming close. You have the Ryan budget taking $6 [trillion] off and plus, and now you have the President coming back with hopefully a new budget. So I think those points are very important, but they still should be made in reference to 2012.

HH: I’m talking with economist John Taylor, Professor Taylor one of the most esteemed economic forecasters in the United States when it comes to macroeconomics and monetary policy. Dr. Taylor, how much trouble are we in? Do you agree that we are within a year of a major fiscal crisis, and a, perhaps, debt crisis?

JT: We are in deep trouble now if we don’t change the situation. So I hesitate to put time frames like a year or two years. I don’t think anyone really knows. But it’s enough to be concerned and worried about. And I think that that is important to point out. But in addition to the crisis, fears of a crisis down the road, you have the fears of inflation would pick up if we don’t deal with this deficit and debt, the fears of higher interest rates, which would reduce investment even more than it is. So there’s many, many reasons, the fear of tax increases, which holds business back. All those things are out there, and I would add them to the list of a threat of a financial crisis to the reasons why we need to deal with this.

HH: In terms of the looming debate over the debt limit, A) is there any alternative to raising it, and B) what ought the Republicans to demand as another step forward along the lines of the one you’ve been describing, achieved last week?

JT: So I think they should demand a lot more, because there’s a lot more on the table now – 2012 and beyond. So there’s a lot more that will be under discussion. I think what people have to recognize is that the debt increase comes because of the past profligacy, the past spending more than we have. And so to stop that, you’ve got to stop it in the future, stop it starting today. That’s what the budget deal started to do. And that’s the way to really get the debt under control. And so I hope they get as much as possible out of it.

HH: They’re talking about spending caps down years, and a balanced budget amendment. You’ve been around Washington in these debates for a long time. Those sound like party platform paragraphs to me. Do they have any real teeth?

JT: The number one thing, and I think you’re quite right, the number one thing is to pass legislation that bring the spending down. And that can be like supplemented by, or enforced by the caps on spending, so that there’s some teeth put into it a little more. But number one is the legislation that brings the spending down. Number two are these caps that really enforce or articulate that strategy. And I think that mainly can be done through other legislative means. But in combination, they’re important to do. But the caps by themselves, without the really specific changes in programs, don’t mean much.

HH: A minute to our break, and then we’ll come back, Dr. Taylor. Except for Paul Krugman, who I know believes that this is overstated, is there many, are there many economists out there of achievement who believe that this sort of a debt burden is not an issue?

JT: Not very many. There’s a distinguished economist who’s studied it. Ken Rogoff is a professor at Harvard who’s written about it extensively, Carmen Reinhart, a colleague of his has written about it, and her work, joint work together. So there’s quite a bit out there. You know, there’s not many who try to say the debt’s not a problem. I think that’s almost irresponsible right now.

HH: I’ll be right back with Dr. John Taylor, a professor at Stanford University, founder of the Center On Economics there as well as one of the leading authorities on these matters in the United States. When we come back from break, we’ll talk about the tax package that is being formulated even as we speak. And Professor, one more question before the break. In terms of raising taxes at this point, you mention bad idea across the board, correct?

JT: Bad idea. Bad idea. We want to get growth. The problem is not taxes. It’s spending. So focus on the problem, and make sure that we’re doing this to improve the economy.

HH: Have you been following the Gang of Six conversation in Washington, D.C?

JT: No, that’s pretty private, as far as I can tell. I know it’s existing, but hopefully, they’ll come up with something. But I think a lot of that is behind closed doors.

– – – –

HH: Dr. Taylor, the Gang of Six allegedly has on the table four different kinds of big tax hikes. The first is a return to Clinton era marginal rates, which the President will probably call for on Wednesday night. Then there is the limiting or elimination of the home mortgage interest deduction, the limiting or elimination of the charitable deduction, and the removal of the cap on the Social Security tax at whatever it is right now, $106,000, I’m not sure. What do you make of those four ideas? Which is the worst of them, and which is the least worst of them?

JT: The worst is anything that raises what we call the marginal tax rate, the tax on an extra dollar of income. So those are the worst. So you mentioned income tax and you mentioned payroll tax. Those are the worst. I think any ideas of base broadening is, for example, in the Ryan proposal, should be accompanied by lowering the marginal tax rates. And to the extent that that’s what they’re talking about in the Gang of Six, lowering marginal tax rates, is very, very important to do.

HH: The home building industry, and I have represented them for twenty years, and I will be fighting against the home mortgage interest deduction curtailment as hard as I can, as long as I can, has made the argument that there is no upper end housing market. There’s just a housing market. And to truncate this deduction will be to impact an already weak sector. What’s your assessment, Dr?

JT: Well, it’s certainly a weak sector. Let’s face it. You know, I think there’s some advantages here to, at least as we get through this budget 2012, to just make it clear that we’re not going to be raising taxes. We do not need to raise taxes. That will create some certainty for businesses when they’re hiring, or in the housing industry, some certainty. We’re just going to leave it alone for a while. Look at the real serious part of the tax code, the increased growth. But in the meantime, get this spending growth down without any increase in taxes, which you certainly can do.

HH: When you were on the Council of Economic Advisors, or when you were undersecretary of the Treasury, did you ever imagine a debt load this large of $14 trillion and rising at this rate, John Taylor?

JT: No, there’s always fears that somehow policy will get in this mess. I think that there were, in this fight I go back a long time. In the 70s, we’re running into these kinds of problems with high inflation and high interest rates and high unemployment. Things got a lot better in the 80s and 90s, and then recently, we’re moving back in this direction. And I think we need to get back to what I would call sound fiscal policy, sound monetary policy. And that’s the things that I’m dreaming about.

HH: And what does the, what kind of inflation threat do you see out there, given the Fed’s still incredibly liquid approach to the debt?

JT: There is a…the threat is that they’re not going to be able to undo all this liquidity in time. And they won’t be able to start taking the corrective actions. I think they already could be raising interest rates just a little bit to get started with this. They’re not going to do that. But the hope is that they don’t wait too long, and we get into one of these boom-bust cycles again with inflation picking up, and then they have to put on the brakes too late, and then we have another recession.

HH: How much stock, we’ve got about two minutes left, how much stock do you put into consumer confidence, Dr. Taylor? And what’s it telling you about the fragility of our economy?

JT: I think of consumer confidence as kind of lagging what’s going on in the economy. I think if you look at the business confidence, the decisions of businesses to invest, that, to me, is really more crucial, because the more businesses invest, the more you’ll see that jobs are created, whether it’s in the housing business, or whether it’s non-residential construction, or it’s simply business equipment. So it’s those business expectations at this point are important. I think the consumer expectations will follow as the economy picks up.

HH: Let’s conclude by talking about the Ryan plan, which has really set the table for this debate. If that were passed, in near complete form, what would its impact be on the United States’ fiscal health?

JT: It would be a tremendous improvement. First of all, it would bring spending as a shared GDP, I think that’s a good measure, from 24-25% down to, like, 19.5-20%. So it’s a big change. It brings us back to where we were before this big spending binge. And that’s how you get the debt down. And then later on, the debt comes down, actually, instead of exploding where it’s going now, it would be contained and actually get back down to zero.

HH: And what do you, as a long time observer, last question, what do you think the odds are of getting it through?

JT: It’s going to be very tough. There’s the House is going to vote for it later this week. Let’s assume they’re going to do that. But then you’ve got the Senate and you’ve got negotiations, and you’ve got the White House all pushing in the other direction. So I’m positive about the deal on 2011, and that’s a step in the right direction. So if that momentum can build up, and then you have people out there around the country expressing their concerns, then we’ll make some progress. But it is very tough.

HH: John Taylor, thank you.

End of interview.

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