A guest post by Benjamin Cole
Well, if a Martin Wolf can call for permanent QE by all Western governments, and if a John Cochrane can suggest the U.S. Federal Reserve should completely liquidate the U.S. national debt, than I guess my USE-ME program is worth trotting out as well. I mean anything goes these days, no?
Universal Solution Extraordinaire for Modern Economies (USE-ME)
In a nutshell, at least in the United States, it goes like this: Cancel all payroll taxes, and have the central bank print up the money and put it into the Social Security and Medicare trust funds.
Oh, I know, the right way to do that is to have the U.S. Treasury issue bonds, and then the Fed buys the bonds, through the QE program. Then Treasury puts the Fed-money into the Social Security trust fund. Okay, keep the charades if that helps.
I do have a worry and this is that USE-ME will cause too much deflation.
Payroll taxes (also called “FICA taxes” for Federal Insurance and Contributions Act) are huge deal in the American workforce, big wedge between worker and employer, and major disincentive to both.
The U.S. government levies now about $1 trillion a year in FICA-payroll taxes.
And the FICA taxes fall most heavily upon “ordinary” businesses and employees. That is not left-wing blah-blah, it is an indisputable fact. The FICA taxes apply only to the first $113,700 of wages, and are now 15.3 percent, split between employer and employee.
So, what happens when the cost of employment suddenly falls 15.3 percent for most employers, under my USE-ME scheme?
If we assume some competition in the American economy, such large labor cost reductions will be deflationary, although they will be the so-called “good” deflation rhapsodized by many who are obsessed with price indices. Call them supply-side tax cuts.
The worry comes from this: Unit labor costs have been flat in the U.S. for a long time; about up 1 percent a year since 2000. Thus, a 15.3 percent cut in labor costs would likely deflate unit labor bills for a long time. With deflation in labor costs, it is hard to forecast any inflation in the U.S., no?
Really Pour on The QE
Of course, the U.S. hardly experiences any inflation now, what with the PCE deflator running at 1.6 percent and falling, well below the Fed’s putative 2 percent target.
The USE-ME payroll tax cuts in combination with already-wimp inflation would require the Fed to show steely resolve in the printing of more money, just to reach its 2 percent target, let alone make it an average.
My back of the envelope guess is that under USE-ME the Fed would have to buy perhaps $85 billion in Treasury bonds a month—which happens to be exactly enough to offset the lost FICA tax revenues, and keep the Social Security-Medicare system full to the brim.
If after USE-ME the Fed still does not hit the 2 percent inflation target, then Fed Chief Yellen would have to up the ante, and pay down the national debt too, ala John Cochrane. Maybe also buy another couple hundred billion of Treasuries every year.
Prosperity Will Be Tough
I concede, it will take some time and extended prosperity to get inflation back up to the 2 percent average target, if the U.S. implements USE-ME, but I think Americans can take it.
My guess is the U.S. GDP will have to expand by up to 20 percent in real terms, maybe as it did from 1976 through 1979—back when there was no Internet, less foreign trade and the top MTR was 70 percent. And did I mention capital is abundant now, but wasn’t then?
Under USE-ME, we will endure a swelling workforce, and new investment in plant and equipment to handle the strong sales. The robust U.S. economy may strengthen the dollar, another deflationary side-effect, and that may require even more QE. There will be no relief for the Fed, not for years. The Fed printing plants will be in the red zone 24/7.
There is a long road ahead under my USE-ME plan, of higher labor participation rates, higher per capita incomes, and even higher corporate profits, as we pay down the national debt.
“I have nothing to offer you but blood, toil, sweat and tears, ” said Winston Churchill, master wordsmith in a time and place that needed both.
And so I paraphrase.
“I have nothing to offer you, but Fat City.”