INSIDE ECONOMICS

Mark Zandi:       Welcome to Inside Economics. I'm Mark Zandi, 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?

Ryan Sweet:       I'm doing well. How are you doing, Mark?

Mark Zandi:       Good. I'm okay. We're missing our other colleague though. Where's Mr. deRitis? He kind of is AWOL on us. What's up with him?

Ryan Sweet:       Well, you know he's on vacation, and it's, what, 9:00 right now in Italy?

Mark Zandi:       Oh, that's right.

Ryan Sweet:       So he's probably one or two glasses of wine deep.

Mark Zandi:       Yeah. Well, I thought when you went on vacation, you took your trusty microphone with you so you could do the podcast, but I guess-

Ryan Sweet:       I do. He's got to get on an airplane. I just had to get in a car.

Mark Zandi:       Yeah, okay. Well, we'll miss him today.

Ryan Sweet:       He did email me this morning saying that he has his headset, and he might be able to come next week.

Mark Zandi:       Well, he's out for more than one week? What's that all about?

Ryan Sweet:       He's out until the end of September.

Mark Zandi:       He's the deputy chief economist. Deputy chief economists can't just take off like that for two weeks. That means it's all on my shoulders. That's not a very good place to be.

Ryan Sweet:       I'm pretty sure you approved his vacation.

Mark Zandi:       Oh, did I? That's right. I did. I got to pay more attention to that stuff. That's not good. Not good. Anyway, I'm sure he's having a lot of fun in Italy. Great place. We're also joined by Bill Gale. Bill, good to see you.

Bill Gale:             Thank you, nice to be here.

Mark Zandi:       Yeah. 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 remember when we first met? Do you have any recollection of that?

Bill Gale:             Some time back in the '90s, but I don't remember, both because it was a long time ago and because we've interacted in a lot of different ways.

Mark Zandi:       Yeah. Well, you're the best. 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?

Bill Gale:             Technically that's what the title covers, but obviously a lot of people at Brookings care about the fiscal policy.

Mark Zandi:       Yeah, I'm sure they do. Yeah, and you've been at Brookings for quite some time.

Bill Gale:             29 years. Yeah.

Mark Zandi:       That's wonderful. It's a great institution. It does such good work.

Bill Gale:             It's been good for me. I like the ability to kind of do research. [inaudible 00:02:58] do research and engage in the policy stuff when you want to engage in the policy stuff. There's a lot of flexibility like that that comes in handy.

Mark Zandi:       You're also an author. You wrote a book in 2019 on the federal fiscal situation and gave some recommendations for policymakers that seem to be kind of sort of coming to fruition here with the Build Back Better agenda. Am I right about that? It feels like it.

Bill Gale:             Yeah, interesting. As 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, fair taxes on the 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. Of course, that's been totally ignored by current policymakers. If anything, 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.

Mark Zandi:       We'll definitely come back to it. We had a 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 guess the other guy's statistics and hopefully, Bill, you'll participate in that. You don't need to, but would love to have you if you're interested. Then part two, we'll go into the big topic, which is of fiscal policy. You obviously have a lot to talk about there.

                              There was two other things I wanted to bring up. One, reading your bio, we're the same age, but you look a lot younger than me. What the hell is going on? Is that just the lifestyle? What's going on? Is that good genes or what?

Bill Gale:             It's got to be a boring lifestyle, yeah.

Mark Zandi:       That's funny. Ryan, would you concur? Doesn't he look a lot better than me? It's Moody's. Moody's is wearing me down, I think.

Ryan Sweet:       Yeah, let's go with that. I'm in a bad spot here.

Mark Zandi:       Let's go with that. Yeah. The other thing I wanted to mention, you are married to Dianne Lynn. Dianne is a wonderful economist in her own right, and just a very nice person. I know you got married to her about the time you published the book, I believe, if I got the bio right. Yeah.

Bill Gale:             Yeah, it was a busy three months in 2019, but yeah, Dianne is a great person, great economist, and just got a job as the policy head of a new select committee in the House studying fairness and the economy.

Mark Zandi:       Oh cool. Is that the... Speaker Pelosi put that together, right?

Bill Gale:             Yes.

Mark Zandi:       Yeah. That is a great select committee. It's funny, I get a call randomly every so often from a 202 number. It seems to be a different 202 number every single time. I can't quite figure it out. It turns out it's Speaker Pelosi. She's just calling up to talk, and I've learned to always... 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 chat about different things. She called about a year ago. It felt like a year ago. It might be not that long ago, and she mentioned this select committee. I thought it was a wonderful idea. I think this is great. So this is going to focus on income and wealth distribution and equality and the policy responses. Do I have that right?

Bill Gale:             That's right, how to keep the economy growing, but also address the whole panoply of fairness, considerations, and equity considerations that come up in the policy debate.

Mark Zandi:       Hey, can I ask you a favor, Bill?

Bill Gale:             Sure.

Mark Zandi:       Could you ask your wife if she would come on my podcast?

Bill Gale:             I will do that.

Mark Zandi:       Please. Okay, good. Yeah. Yeah. Please. Well, I suppose you're going to have to see how this thing goes, but assuming it goes reasonably well, I'd love to have her on. She'd be fantastic.

Bill Gale:             I think she'd be a great guest. Yeah.

Mark Zandi:       Yeah, absolutely. Fantastic. Okay. Before we dive into things though, hey, Ryan, today Chair Powell, Fed Chair Powell gave a speech at Jackson Hall. That's the confab of fed policymakers in Wyoming. They do this once a year. 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?

Ryan Sweet:       Yeah, I think there's a few bullet points and takeaways. The first is they're going to likely taper their 120 billion monthly asset purchases later 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 forecast. It's only one month, but that's pretty much the ground that he broke on the taper and 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 the tapering.

                              But I think what was a little bit surprising, he was very dovish just overall in his comments. He's really doubling down on the transitory acceleration of inflation, and he gave a litany of explanations why, a lot that we've talked on the podcast, 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 we all have this regime shift in inflation dynamics, and he was dovish on the labor market. He acknowledge that we're making progress, but we have a long ways to go. He is committed not to raise interest rates until the economy is close to or at full employment.

                              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, so tapering with raising interest rates. I think Bernanke didn't do as well of a job in 2013, and that's why we got that taper tabled.

Mark Zandi:       Oh, that's interesting. Yeah. You make a good point. He made an explicit statement saying that what we're doing with QE, quantitative [inaudible 00:09:14] the tapering has nothing to do with the timing or the trajectory of future rate increases. He was very explicit about that. Yeah. Markets like that.

Ryan Sweet:       Exactly. That was really, really important. I think he did a really good job.

Mark Zandi:       Yeah. Hey, Bill, i' know you're a fiscal policy expert, but do you pay attention to what the fed's doing? Di you look at what Powell did today?

Bill Gale:             Yeah, I do, and the reason too is that Congress is often enacting these big fiscal packages, and the question is is that a good idea, or is that politically motivated? 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 what 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.

Mark Zandi:       Got it. Got it. So what do you think? Are they on the right track here, in terms of policy, monetary policy?

Bill Gale:             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 voracity 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 changes. It's not quite, "I believe it when I see it." I believe that's what Powell wants to do, but sometimes it's easier said than done.

Mark Zandi:       Yeah. I saw Larry Summers. I didn't actually read the oped. 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 QOE. I think that was the gist of it. He's obviously very nervous about inflationary pressures, which we'll come back to in the context of fiscal policy and the Build Back Better agenda. So okay.

Ryan Sweet:       Summers's argument fits with Bullard. Bullard has been pounding the drum that he wants to start now, and [crosstalk 00:11:24]

Mark Zandi:       He's president of-

Ryan Sweet:       St. Louis Fed.

Mark Zandi:       St. Louis Fed, right. Okay, sorry about that.

Ryan Sweet:       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 [inaudible 00:11:36]. That would have set off alarm bells right and left. The Fed's balance sheet wasn't inflationary, so when they taper, it's not going to be disinflationary.

Mark Zandi:       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, in the first short-term raid 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?

Ryan Sweet:       Mm-hmm (affirmative).

Mark Zandi:       Do we change our timing for the first rate hike from March of '23, or are we sticking to that?

Ryan Sweet:       We could bring it forward to January 2023, but I think you start to see-

Mark Zandi:       Oh really? Oh, so Ryan, you're changing your forecast. Bill, we've had a long-running bet about the timing of the first rate hike. I had to beat Ryan down to get to March, and now he says January. Am I hearing that right [inaudible 00:12:35]? Is that right, Ryan?

Ryan Sweet:       Hey, when the facts change, you got to change your opinion.

Mark Zandi:       Exactly.

Ryan Sweet:       I would do that just to be internally consistent with what Powell is saying. He's saying a long time between the end of taper and the first rate hike, and a year is a pretty long time in the world of central banks.

Mark Zandi:       Yeah, got it. Okay. Anything else on the fed before we move on to the statistics that you want to bring up?

Ryan Sweet:       No, I think we covered it.

Mark Zandi:       Okay. Okay. Statistics. All right. Since we're down Chris, Ryan, I'm going with you first. What's your statistic? Go easy on us, please. We're getting old.

Ryan Sweet:       All right. Well, this one's not going to be fair to Bill, but this is very easy for you.

Mark Zandi:       Okay.

Ryan Sweet:       It captures the week all in one number. 5.7%.

Mark Zandi:       5.7%. Okay. It's not GDP. I don't think it has anything to do with income or consumer spending, which came out today.

Ryan Sweet:       But say it started off at 7.2%, so it's come down.

Mark Zandi:       Really? So it was 7.2. it's now 5.7. Bill, do you have any idea what that would be?

Bill Gale:             No, I was going to guess GDP, but he just said no.

Mark Zandi:       GPD-

Ryan Sweet:       It is GDP.

Bill Gale:             It is?

Mark Zandi:       Oh, it is? So is it gross domestic income or no?

Ryan Sweet:       It's gross domestic product for the third quarter, our tracking estimate.

Mark Zandi:       Oh. Oh, what's it down to?

Ryan Sweet:       So [crosstalk 00:14:09] GDP model, and 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 given [inaudible 00:14:20] goods orders, the decline in real consumer spending in July, the advanced inventory data was a little bit softer. All that brought our tracking estimate down. So we're becoming a little bit soft.

Mark Zandi:       So what did you say it was? 5.7 you said?

Ryan Sweet:       Yep, 5.7. still strong.

Mark Zandi:       Yeah, oh, that's a little disappointing, because before today, I think you were at 6.5 for Q3, right?

Ryan Sweet:       Yeah, we went from 7.2 down to 6.5. now we're at 5.7.

Mark Zandi:       That's a big come-down. Wow. Interesting. And that-

Ryan Sweet:       And this is incorporating all the data pre-surge in COVID, this recent wave.

Mark Zandi:       So do you think delta is playing a role here in-

Ryan Sweet:       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.

Mark Zandi:       Sure. So you're-

Ryan Sweet:       We could be going further south.

Mark Zandi:       Oh okay. So you think when Q3 is all said and done, it could be even lower than 5.7? That's interesting.

Ryan Sweet:       Yeah, I think it's going to be closer to five.

Mark Zandi:       Okay. Hey, before we move on, and I have a statistic, and I know Bill does as well, wanted to ask you about next week's employment report, because I'm sure we'll talk about that. Bill, you don't know this, but Ryan is... I'm not exaggerating at all here, he is probably the most accurate, in terms of forecasting the real-time statistics. So he looks at all the other information data. He has models, and he will give you an estimate of what he thinks each of these statistics will be. Actually, I think Market Watch tracks your accuracy, and you're always at the top of the list, in terms of accuracy.

                              He always nails this employment number. I know it's a little early, and you don't like to tell us your number before you have all the data in, but what are you... Last month, we got almost a million jobs.

Ryan Sweet:       Correct.

Mark Zandi:       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?

Ryan Sweet:       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. Just like in July, I dropped it from our employment models for August. A lot of that other alternative labor market [inaudible 00:16:42] that I track has been coming in weak. The early consensus is for total employment, the net change to be 700,000. I'm taking under. I'm going to be below that.

Mark Zandi:       Oh okay. Something close to a half million you think?

Ryan Sweet:       Yeah, probably closer to that.

Mark Zandi:       Okay, interesting. Well, I'm sure as you get more data early next week, that might change.

Ryan Sweet:       Yeah, it could change. ADP we don't have and a few other things.

Mark Zandi:       Okay, so Q3 seems to be delta is having an impact. It's starting to-

Ryan Sweet:       Yeah, it will show up in the labor market statistics, because we really got a big surge during the payroll reference period, and not necessarily that businesses were laying off workers, but they were probably slowing the return to the office. I think in the end on the margin, it's likely going to be visible there.

Mark Zandi:       Got it. Okay. So Bill, you get this game? It's pretty simple, right?

Bill Gale:             Yeah, it is.

Mark Zandi:       You try to look as smart as you can. You want to give us a statistic that is not a slam dunk, but we have a fighting chance of getting, something like that. I know that's a lot of pressure do you have a statistic for us?

Bill Gale:             Let me [inaudible 00:17:54] with 55%.

Mark Zandi:       55%? Is it fiscal policy related?

Bill Gale:             It's tax related.

Mark Zandi:       Oh, it's tax related? 55%. Well, it's not the effective tax rate. Would it be the top marginal rate if Build Back Better agenda gets everything they want?

Bill Gale:             It might be, but that's not what I had in mind.

Ryan Sweet:       Mark's great at these... He'll throw a number out there, and it could be that, just so he can go back and say, "I knew it."

Mark Zandi:       That's plausible though, right Bill? [inaudible 00:18:33]

Bill Gale:             Yeah, especially if you add in state taxes and stuff like that.

Mark Zandi:       Exactly. Yeah, yeah, but that's not what you meant. So 55% tax related. Is it 55% of people pay taxes or don't pay taxes or some that pay income tax?

Bill Gale:             That's actually close. The Tax Policy Center, we estimated that 61% of people did not pay federal income tax in 2020, but yeah [crosstalk 00:18:59]

Mark Zandi:       Okay. Ryan? That was pretty close, but that's not it. I don't get the cigar, obviously.

Ryan Sweet:       That was good. That was another good one. I'm pressed with that one.

Mark Zandi:       Oh man, I got it. 55%. Do you have any clue, Ryan? You want to take a crack at it?

Ryan Sweet:       No, I don't know. Can you give us a hint without giving it away?

Mark Zandi:       Yeah, can you do that?

Bill Gale:             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.

Mark Zandi:       Holy mackerel.

Ryan Sweet:       All right. Never again can you tell me I picked statistics that we were never going to know.

Mark Zandi:       Right. Right. Wait, wait. Can you repeat that? That was-

Bill Gale:             More than half of farm income and sole proprietorship income is not reported to the IRS, and therefore no taxes are paid on it. 55% is not reported.

Mark Zandi:       That is fascinating. How much revenue do you think would be generated if it was reported?

Bill Gale:             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 off shore and stuff like that. But the rate of evasion is very high for sole proprietorships and farmers, because there's no third party transaction. 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, and more than half of that income is not reported, according to the IRS.

Mark Zandi:       In the Build Back Better agenda, there's a fair amount of funding for the IRS to try to raise tax compliance. Presumably, they would also go after the self-proprietors and farm income as well as kind of the high rollers, the wealthy households?

Bill Gale:             Yeah, the emphasis the last few years has been on EITC recipients where people are evading taxes there, it's mainly because the filing requirements are complicated, and the wrong parent claims the kid and stuff lie that, but this is the sole proprietorship and the farm stuff, the wealthy offshore stuff, this is accidental evasion that just happens to go in the tax payer's favor every time. There's huge potential for the IRS to raise revenue here.

Mark Zandi:       Interesting. Well, I think I deserve some [inaudible 00:21:42] here. I got-

Bill Gale:             Absolutely.

Mark Zandi:       I got numbers that were close. Okay. I got a statistic. This is more geared I think towards Ryan. I'm going to give you two statistics that are related. First is 9.2%. Do you need a hint, Ryan, or do you know right off?

Ryan Sweet:       No, it's corporate profits, second quarter.

Mark Zandi:       Yeah. Yeah, because you wrote this release. I was reading your analysis of the GDP report. So I would 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. They were up 9.2% over Q1, quarter to quarter, not annualized, just a one quarter increase. Profits are surging. It's pretty amazing.

                              If you look at total corporate earnings in Q2 at an annualized rate, 2.7 trillion dollars, that's almost a half trillion dollars more than it was pre-pandemic. It's going skyward. Just another statistic, 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% annualized. That's a pretty heady rate of corporate earnings growth.

                              Okay, this is the harder one, Ryan and Bill. Again, related to corporate earnings, but I think a very interesting statistic, 14.3%.

Ryan Sweet:       Is that corporate profit margins?

Mark Zandi:       That's pretty good. That's pretty good, but not exactly what I had in mind, but it's highly correlated and related to what I do have in mind. It's the share of national income accounting for corporate earnings. So 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 eight, so that's in the middle of recessions like the financial crisis. The highest it ever gets is about 14.3%. So corporate earnings, they're booming.

                              so I guess to some degree, what's going on in the equity market is supported by what's going on with regard to fundamentals with corporate earnings and obviously low interest rates. But to-

Ryan Sweet:       What do you think is the best way to look? Because my default is always to look at corporate profits as a share of GDP. Right? I wonder if I should also be looking at it as a share of national income.

Mark Zandi:       Well, they're similar, right? GDP, national income.

Ryan Sweet:       They're going to be [inaudible 00:24:47] the paths are going to be [inaudible 00:24:48]. Yeah.

Mark Zandi:       Yeah, it's pretty consistent. The actual levels are a little bit different, but they're very, very consistent. But that gives me reason to be optimistic about a couple things, macro economic things. One, that businesses are going to continue to be able to invest, and they're focused on productivity growth because of rising labor and other costs. So that augers well. It also augers well, I think, for inflation too, doesn't it? If margins are wide, earnings are strong, then they can absorb some of the cost increases and higher labor costs that they might face. I don't know. Bill, do you have any views on that, any perspective on that?

Bill Gale:             It's interesting in the context of the 2017 tax reforms, which cut corporate rates. I don't know enough about the aggregate statistics to say, but there's a lot of action with shifting of income and shifting of expenses after the act. I would guess there's some daylight in thinking about how the 2017 tax deck might have influenced that number.

Mark Zandi:       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.

Bill Gale:             I see.

Mark Zandi:       And then of course after tax profits. I think there's always data issues, measurement issues, but I think it's a relatively economically pure, as best as you can, estimate of what's going on. Obviously it can be revised as they actually get more tax return data, which is pretty lagged. But nonetheless, pretty significant gains and corporate earnings. So a very positive development.

                              Okay, so let's talk fiscal policy. A lot obviously to talk about here. I want to ask you, Bill, just first up what do you think of the fiscal policy response to the pandemic? 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 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. 

                              For context, if you go back to the financial crisis, you consider the Recovery Act, that was the stimulus under Obama that was passed in February of '09 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 do you consider the policy response? Do you think it was a good thing, bad thing? What's your perspective on that?

Bill Gale:             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. Some of it was kind of what a friend of mine calls 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 crisis in early 2020, what else could they have done? I give them... It's fun to criticize Congress, and it's easy, but I give them high points on acting quickly, acting in a very expansive, both in terms of dollars an in terms of the scope of the interventions, I can't imagine what it would be like without the stimulus, the unemployment, the PPP. Those things, granted, they could have been designed better, but you just don't have that kind of time.

                              So I feel like generally, they have done the right thing, and this infrastructure package that's moving through I think is also generally the right thing. We've had net federal... I consider this as a statistic, but it's too fuzzy. But net federal capital investment and infrastructure was pretty close to zero from the mid '90s to the end of last year. 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.

Mark Zandi:       Net capital investment meaning after depreciating of the stock.

Bill Gale:             Yeah.

Mark Zandi:       Basically we're going nowhere with public infrastructure.

Bill Gale:             Yeah. In the '90s, for example, one way the budget got balanced was a big cut in infrastructure spending. It just never really recovered after that.

Mark Zandi:       As you say, it was kind of a, it was called spaghetti policy? I think that's a pretty apt description. Of all of the elements of that spaghetti, were there some aspects that stand out as being particularly good policy and some that stand out as being 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?

Bill Gale:             I think that's a great question. 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 [inaudible 00:31:12], but I think it's helped a lot of people. I think it's actually helped in the 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 those kind of policies have real effects on people's lives.

                              The craziness of this all is our health insurance system, where you have a pandemic, and people have their job, their health insurance through their jobs. You have a pandemic that was right when people need health insurance, and they lose their jobs because of the pandemic. So they loose health insurance. So I think they got a lot of things right, but there's certainly a lot more work that could be done.

Mark Zandi:       I can attest to your point about non-profits. I'm the lead director of a large CDFI, 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. The help we receive from the federal government through not only PPP, but other avenues have been very, very important, allowing us to help the community. So I agree with you. That's something that I think is really important that has not gotten any attention in all the conversation. Very, very important.

Bill Gale:             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.

Mark Zandi:       Yeah. Interestingly, a fair amount of the CARES money, they went to the states. The states had some flexibility to do 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 under-served communities, and they don't work 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 pay for all your loan losses," which was just amazing, really very important. Allowed us to continue to extend our 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. 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 is 3.5 trillion. What do you think about that piece of legislation? How do you view that?

Bill Gale:             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 childcare is infrastructure or not. I just want to focus on whether it's a good idea or not. I think it is. So we need to... Yeah, if you're thinking of infrastructure essentially as government investments that make the private sector work better, that type of thing would qualify.

                              You mentioned my wife Dianne 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. The American Family Plan is essentially an effort to get women back to work. I just think that's a really interesting way to look at the different proposals. There was some debate early on in the administration about whether to go the traditional route for [inaudible 00:35:17] to go to a family route first.

Mark Zandi:       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 there's two pieces of legislation. One is around traditional infrastructure. One is around social infrastructure, education and childcare and healthcare and housing and climate change, those kinds of things.

                              One of the concerns is it's going to lead to undesirably high inflation, 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, maybe even go back into a recession. Do you have a sense of that? Are you worried about the inflationary aspects 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.

Bill Gale:             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. 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. They don't have to be immediate. They can be 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.

Mark Zandi:       Yeah. I agree with you. Ryan, do you have any views on that, in terms of the inflationary impacts? I know you've thought about that a little bit.

Ryan Sweet:       Yeah, I'm not worried about the inflationary impact. 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 it all where you're going to get all this infrastructure spending when the economy is approaching full employment. So that's not going to be too much of a concern for me.

Mark Zandi:       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 four trillion. That's on top of the five trillion we've already 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. 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.

                              Of course the other criticism of this is that it's going to raise taxes, and that's a big deal. 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. I know you recently, Bill, wrote a paper, a 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 tax this year. I was curious, perhaps you could just summarize what those results were and what it means for the current policy debate around the Build Back Better agenda?

Bill Gale:             Sure. So the results have looked at revenues, GDP growth, patterns of investment, patterns of business formation, wage changes, international profit shifting before and after the '17 act and found very little evidence of supply-side effects. 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 got raised, not just whether taxes go up or not. I think closing loopholes in the income tax could go a long way toward raising revenues without hurting the economy. There was a lot of options to raise taxes. 21% is probably too low for the corporate tax, so on. I just think the political prospects for raising taxes are ridiculously weak. We can't get people to wear masks. How are we going to get their representatives to support tax increases? But conceptually and empirically, I think there's plenty of room to raise revenues.

Mark Zandi:       So just to pick on one number, the top marginal corporate rate prior to the Trump tax cuts, which were implemented at the start of 2018, was 35%. That was the top marginal rate. The Trump tax cuts lowered that to 21. In your thinking, what is a reasonable place for that marginal rate? So it kind of strikes the balance between, "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 is the sweet spot. Do you have a sweet spot in mind?

Bill Gale:             I would say 25 would be easy to achieve without creating any significant damage. Remember, we went down by 14 points, and we didn't get reinvestment 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. Then they got paid out to shareholders. If we're willing to reform the base as well as raise the rate, then I would say we could go to 28% and move to a cash flow base, which basically means you just let people [inaudible 00:41:59] all investment, and you eliminate interest deductions.

                              TCJA moved in that direction, as 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. Then when you go to the... The benefits are going to a cash flow base is that the effective tax rate on new investment is zero, even if the statutory tax rate is positive. So you could raise the rate a little more with the adjustment to eh base. But I think it's really important, again, that we focus on the base adjustments and not just the rate adjustments.

Mark Zandi:       Remind me, in the Build Back Better proposal, are they moving in that direction? I can't quite remember.

Bill Gale:             No. No. There's no talk about changing the base in the regard that I just mentioned there. They're very interested in the international provisions and tightening them up, but there's no discussion of going to a cash flow [inaudible 00:43:02].

Mark Zandi:       Right. So you think it make some sense to raise, 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?

Bill Gale:             I do, yes. 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.

Mark Zandi:       Yeah. Before we move on, let me just ask one more thing just to 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 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 on the margin. Maybe some econometrician somewhere down the road could tease that out, but it's not obvious. It's certainly not a slam dunk. What's the intuition behind that? Why is that? Why didn't we see an impact?

Bill Gale:             The best argument I've heard is that 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 cost of capital and past investment responses. 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 at the last 15 years has been lower than one would have expected. People attribute this to rising market power, rising concentration in key markets.

Mark Zandi:       Could also be just low rates and low returns. Who cares? If you're lowering the cost of capital, and the cost of capital is already on the floor. I can-

Bill Gale:             Yes, yes. Absolutely. Oddly enough, I have a paper that says exactly that. It's like if the discount rate is zero, then the expensing is the same as depreciation, right?

Mark Zandi:       Exactly.

Bill Gale:             So it could be the low interest rates are an indication that there aren't great investment opportunities. So it could be that too.

Mark Zandi:       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 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, is going to have larger deficits and debt. Just feels like that's where we're going to land.

                              In fact, if you look at the budget resolution that was passed by the Senate and I think was passed by the House, 3.5 trillion over 10 years, only 1.75 trillion in revenue. So that means an increase of 1.75 trillion in the 10-year budget deficit. That's not inconsequential. That's 175 billion a year. What, that's seven, eight tenths of a percentage of GDP. That's meaningful. Does that bother you? Would you vote for that legislation or would you not vote for it because of the size of the deficit?

Bill Gale:             I would vote for it. I think the analogy is somebody that has long-term health problems, but also has short-term emergency needs. Maybe emergency is too strong, but 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 think low interest rates are critical to this. The interest rate is zero, which is not much of an exaggeration. A dollar of deficit today is a dollar of debt 10 years from now. Right? Or 12 years from now, sorry. If the interest rate is 6%, a dollar of debt now is $2 12 years from now. So low interest rates don't mean that debt is costless, but it makes debt a lot less expensive than it otherwise could be.

                              That's just an important consideration. Interest rates have come down so far for so long. The tips rate is negative. The 10-year tips rate is negative right now. The 10-year nominal yield on treasuries is, I don't know, one and a half or less than that.

Mark Zandi:       135.

Bill Gale:             135. That actually makes a difference. When the price of something goes down that much, and the optimal thing is to buy more, the world is saying, "We want more treasury debt."

Mark Zandi:       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 a radius of two, three miles. I'm sure I can find an infrastructure project that has a higher return than, say, a 30-year bond at 2%. It seems like why wouldn't we do that?

Bill Gale:             Right. 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 circle would-

Mark Zandi:       That's your urbanite coming out there, Bill. I'm sure I can find projects in North Dakota too that have a higher return than 2%, especially when the net capital investment has been zero for 30 years.

Bill Gale:             Yeah, fair enough. Fair enough.

Mark Zandi:       I'm just guessing. I'm just guessing. Anyway, but okay. All right. Look. There's got to be a limit to this, right? No? Where does this kind of thinking end, or does it not end until it ends? Meaning we keep running large budget deficits because it makes economic sense to do so, until interest rates rise, and then you don't. Is that kind of the logic?

Bill Gale:             If people say the dumbest things about which way interest rates are going to go, the second dumbest conversation is how much fiscal space to we have? Nobody knows. You look at Japan, and they've got enormous debt.

Mark Zandi:       Hold on. Wait, Bill. Wait. Wait, Bill. I think Ryan knows. I do. I think Ryan knows. Ryan, do you know, or am I just-

Ryan Sweet:       Right how much fiscal space we have?

Mark Zandi:       Fiscal space, you don't know?

Ryan Sweet:       I agree with Bill. We estimate it, but there's an enormous uncertainty around it.

Mark Zandi:       Okay. 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, anything related to Markets or institutions. I got to know him really well, because around the GSEs, I 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? What makes sense? Sorry, I didn't mean to interrupt.

Ryan Sweet:       And Damien is a perfectionist.

Mark Zandi:       That too. He is a perfectionist. That is true.

Bill Gale:             It's just so hard to know, and it depends on so many things. It could turn on a dime. Right now though, it looks like we're nowhere near what our fiscal capacity is.

Mark Zandi:       Okay, so you're saying to me, "Mark, don't worry. Don't go crazy. Don't do stupid things, and you want things that have a good social return, but 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 under-investing for so long." That's kind of sort of what you're saying to me. 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 sort of what you're saying.

Bill Gale:             I am. Yeah. To put it slightly differently, let's make good spending choices and good tax choices, and keep an eye on interest rates. Market is going to tell us when they think the debt situation is getting out of control.

Mark Zandi:       Right. Well, 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. Hopefully we have the politically will at that point to listen to what the [inaudible 00:52:24], but maybe it makes sense. Maybe policymakers, lawmakers, politicians can't connect the dots in the mind of the electorate that we got to do something unless interest rates rise, because otherwise, it's hard for it to resonate with people. If deficits mean a bad economy, well, how exactly, if it's [crosstalk 00:52:44]

Bill Gale:             Right, right. Exactly. So if policymakers 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. So you need some sort of external thing like interest rates rising or financial crisis or something. We need something that puts their backs against the wall and makes them have to deal with it. Right now, there isn't anything like that.

Mark Zandi:       Yeah, it's kind of sort of like what happened in the early '90s, right? Bill Clinton, Treasure Secretary Rubin, he could point to the 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." Once you make that visceral connection, you can do something politically with it.

Bill Gale:             Right, and I think interest rates were something like 5 or 6% at that point. That's just a huge qualitative difference.

Mark Zandi:       Yeah. Okay. Well, let me ask you this. We've been talking about the United States. What about overseas? 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."?

Bill Gale:             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 US had, in two ways. One is the dollar is 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.

                              If you look at Japan, for example, does have control over its own monetary policy, and it 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 debt independence.

Mark Zandi:       Yeah. I wonder if we, somewhere down the road here on the other side of the pandemic, when the economy starts picking up interest rates start... Ultimately at some point, they are going to rise, presumably, that we might not have some kind of fiscal, global fiscal event, kind of sort of like European debt crisis after the financial crisis where all of a sudden, oh my gosh, can countries service all the debt they accumulated during the pandemic? Because every country on the planet did what we did and borrowed a boatload of money, used that to help support their economy through the pandemic. So I worry about that.

Bill Gale:             A similar thing happened in World War II, worldwide I mean. Countries managed... Well, the US managed to transition particularly well, but there was not a lot of entitlement spending back then. The budget was mainly discretionary spending, the defense spending came down, but now we've got Social Security and Medicare rising, creating a lowest [inaudible 00:56:22] the deficit up over time. So something's got to give, but when and what it is is an open question.

Mark Zandi:       Right, and definitely it's going to be Ryan's problem, not ours, Bill, I'm pretty sure. Yeah. Hey, I know our time on the podcast is coming to a close, but before we end, I did want to get, because you are such a world expert in tax policy, you've been thinking about this deeply. I know you've 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 a lightning round take on different types of tax proposals that have been in and out of the public discourse and just get your take on it. Does that sound okay? Would that be okay?

Bill Gale:             Sure.

Mark Zandi:       You good with that? Okay. Wealth taxes. So what do you think about wealth taxes?

Bill Gale:             A wealth tax can be thought of as an equivalent to an income tax. So if the rate of return is 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 rate of return is only 2%, all of a sudden their wealth tax is equivalent to a 50% capital income tax. So low interest rates make wealth taxes more distortionary than they would otherwise be.

Mark Zandi:       Got it. So wealth taxes, probably not such a great idea, particularly in the context of very low interest rates.

Bill Gale:             Yeah. There are these administrative issues as well. It's just not going to happen.

Mark Zandi:       Okay, got it. Carbon taxes. Obviously there's a carbon boarder adjustment tax proposal embedded into the Build Back Better agenda to generate some revenue. European Union is thinking about a carbon border adjustment tax. There's different flavors of carbon taxes. What do you think of carbon taxes?

Bill Gale:             Well, first thing, the "border adjustment" is really a tariff. It's not a full border adjustment. It doesn't subsidize exports. It just taxes imports. The low interest rate scenario we've been talking about makes carbon taxes even more attractive than they have been in the past. 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 adds further to that.

Mark Zandi:       Got it. So carbon taxes make sense, and particularly in a low-rate environment because of the discount rate effect on benefits and cost out into the future. Yeah, got it. How about investment incentives for businesses? What do you think of those? Different types of tax credits to try to incent businesses to do different things?

Bill Gale:             Yeah. All the capital and saving incentives we have, whether it's tax deferral for 401Ks, or expensing for business investments, or preferential capital gains treatment, they all get muted as the interest rate goes to zero. There'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.

                              The mortgage deduction, for example. If mortgage rates go to zero, there's no interest payments, there's no deduction. So low interest rates sort of change how we think about tax policy.

Mark Zandi:       Got it. This goes back to our previous conversation about why the Trump tax cuts may not have worked as much as... No one really thought they were going to be a game-changer, but there's no evidence they had any impact whatsoever. That might be... What about consumption taxes? How do you think about consumption taxes?

Bill Gale:             Oh yeah, I should have mentioned that. The difference between a consumption and an income tax also shrinks, because they think 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 difference. 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.

Mark Zandi:       So wealth taxes are out. Investment incentives are out. Carbon tax is definitely in, and you're kind of a fan of consumption taxes?

Bill Gale:             Yeah.

Mark Zandi:       Got it. Particularly in a low-rate environment.

Bill Gale:             Yeah.

Mark Zandi:       Got it. Got it. Hey, Ryan, so you got Bill Gale here, world class fiscal policy expert, tax policy guy. What one question do you want to ask him? And not is he a Boston... Who plays in Boston?

Ryan Sweet:       Yeah, a Red Sox fan.

Mark Zandi:       Red Sox fan, the Red Sox. You're not a Red Sox fan, are you, Bill? Please.

Bill Gale:             No.

Mark Zandi:       Thank god. Yeah.

Ryan Sweet:       Well, one thing I was wondering, this is a question I get all the time from our clients is does the high debt to GDP ratio in the US act as a ceiling for interest rates? Because right now, interest payments as a shared GDP is 1.6%, which is low historically. But as interest rates start to rise, particularly in our baseline, we have steadily rising over the next few years. Is there kind of a threshold where we can't raise interest rates any further, or our interest payments just get too large?

Bill Gale:             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. There's kind of a well-developed theory that higher debt causes interest rates to rise, but at the same time, from the Fed's perspective, raising interest rates will impose bigger costs the bigger debt is in the economy. 

                              Again, I don't want to venture a guess on what the limit is, but I think it's really important, and I've learned from Larry Summers and Jason Furman on this, really important to think that we're in a different macro era than we have been 10 or 20 or 30 years ago. Those of us in Mark's age and my age who were raised on inflation concerns and high interest rates have to be rethinking what we learned.

Mark Zandi:       We'll end this way, Bill. Just a cautionary note. One we change our views, it's all over. It's going to change the world.

Bill Gale:             Right, right. Yeah. We're like the people that come into the stock market after the rallies, right?

Mark Zandi:       It's all over. Things are going to change again.

Bill Gale:             That's right. That's also right.

Mark Zandi:       So anyway, hey, I want to thank you for taking this time with us. It's Friday afternoon. I know you probably would like to get to a ball game 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 Dianne. Bill, hey, can you put in a good word for me? Because I'm going to send her an email trying to get her on my podcast.

Bill Gale:             I will do that. I will do that. Thank you for having me on. It's a really interesting discussion.

Mark Zandi:       Absolutely. To the listener, thank you for participating. I did want to point out that, again, if you... We want to have podcasts that are of interest to you. If you have a topic that you'd like us to tackle, we'd like to know. So go to Economy.com. Go to the Inside Economics part of that. You'll see it right at the top. Let us know. We take that very seriously, and want to be talking about subjects that are of interest to you.

                              So with that, thank you so much. We'll call this a podcast. Take care now.