In the Nation's Interest
The FOMC on the Approach; a Cry of ‘Uncle’ on Tax Reform
Macroeconomists aren’t particularly fond of the metaphor of the “soft landing” for the economy, because the economy never lands; it just keeps flying along forever (we hope). Well, if the Federal Open Market Committee (FOMC) is not maneuvering in a landing approach, they are at least attempting a fairly abrupt simultaneous change of altitude, course and speed. And the financial markets seem to be hunched over in the passenger seats nervously clutching the small paper bags.
I have seen some plaintive columns and Wall Street analysis pieces saying that all the markets want from the Federal Reserve is a little certainty. Experimentally, based on the most recent experience, the markets want that certainty as a cue for them to freak.
Last year, the FOMC ventured an estimate of the date when they would begin to unwind their “quantitative easing” policy, and the markets tanked. Last week, new Federal Reserve Board Chair Janet Yellen (full disclosure, a fellow graduate school econ department alum and former work colleague) gave a specific time interval as to what might constitute a “considerable time” for interest rates to be held at their current extraordinarily low level, and again the markets flinched.
Nothing much has changed from last year to this year. The economy remains in a long slog out of the deepest pit into which it has fallen since the Great Depression. From the outset, the only uncertainty was just how extraordinarily long that slog would be. Now, as was true a year ago, all decisions of the FOMC will be data-driven. The FOMC will seek to prepare the markets for the likely course of policy. But the members will not commit to any specific change of policy one year ahead of the fact, as some market players apparently believe they just did. Anything can happen over one year. The FOMC will jealously guard the opportunity to see every scrap of data before they act. Suggestions to the contrary based on the most recent press conference misread how the FOMC does its business.
However, even with that understood, the market environment around FOMC decisions will remain volatile. There is a great deal of trading centered around the Fed’s as-low-as-you-can-go interests rates, and no one wants to be caught holding the bag when that policy changes. The FOMC’s best course would be to convey the clearest possible sense about the economic conditions that would lead to the first increase in the target Federal Funds rate, which will occur at some point beyond the end of the tapering of quantitative easing purchases. However, the FOMC should convey that sense without advance reference to specific dates, because subsequent unexpected data could change previous estimates of the right time for the policy transition. With that accomplished, the first increase of the Federal Funds rate would not be a surprise, and investors would have begun to make their accommodations before that event transpired.
Some have argued to hurry the increases of interest rates, on the ground that savers have suffered from prolonged low rates. There is no doubt that the extended period of low interest rates has imposed costs. The problem is that the dire state of the economy left no realistic alternative.
With respect to the Fed’s policy choices going in, the consequences of their policy actions, and the quandary of getting out, the financial crisis has put the Fed in one impossible position after another. And the Fed has carried even more of a burden because the Congress and the President have given no sense of fiscal policy coherence and continuity. The total absence of fiscal policymaking has left every Fed decision even more exposed and more controversial, bearing total responsibility for both sides of its dual mandate of price stability and economic growth. That, plus the nearly unprecedented nature of the problems before it, has left the Fed with challenges that will be most difficult to meet. We should be most thankful if our central bankers manage to keep the plane in the air – especially given that they never will enjoy the relief of landing.
It was clear a few weeks ago that House Ways & Means Committee Chairman Dave Camp (R-MI) had taken on a monumental task in putting forward a “trial balloon” proposal for tax reform. There were equally clear indications early this week that Chairman Camp’s balloon was sitting on the ground – whether because it never managed to gain any altitude, or because it attracted the kinds of potshots that such experimental flights tend to do.
A number of “permanently temporary” provisions of the tax law – the so called “extenders” – expired at the end of 2013. Among the more than four dozen provisions are the tax credit for research and experimentation, expensing of limited amounts of business investment, and numerous subsidies for particular forms of energy. In the past, those provisions have continued in the law on a temporary basis, in some instances with multiple expirations or near-expirations followed by further temporary extensions. A hopeful explanation of this behavior pattern is that those provisions are in effect getting tryouts, and will be permitted to join the team on an indefinite basis if they perform well. A cynical interpretation is that each periodic expiration forces the Congress to consider a tax bill – recalling that tax bills may originate only in the House, which has high hurdles for bills to reach the floor – which gives legislators an opportunity to fundraise over the extension bill that therefore appears every year or two.
Chairman Camp had pronounced that he would consider the extenders only in the context of comprehensive tax reform. That made sense, in that it would broaden the discussion beyond temporary re-enactments, and perhaps encourage tradeoffs and consolidations of similar provisions to result in a simpler, more-efficient tax law. It would perhaps end the once-every-few-years ritual of reconsidering, again, the same lineup of expiring provisions, yet another time. (The preceding sentence was pre-approved by the Department of Redundancy Department, in the spirit of the current subject matter.) However, Chairman Camp’s determination would stand up, of course, only if the Congress would actually consider tax reform legislation before the expiration of the extenders would itself have extended so long as to become intolerable.
Well, earlier this week, Chairman Camp joined Senate Finance Committee Chairman Ron Wyden (D-OR) in planning free-standing consideration of the extenders that expired at the end of last year. That could be read as an admission that the prospects for comprehensive tax reform this year are mighty low.
To be sure, Chairman Camp has put a much more optimistic face on his decision, talking about a step-by-step process of tax reform, with separate action on particular provisions as individual steps in the overall process. But tax reform arguably is much more amenable to an apparently more difficult “big bang” than to a superficially simpler journey of a thousand steps. Tax reform, as best understood (and as embodied in the Tax Reform Act of 1986), is a multi-participant bargain in which just about everyone gives up some tax preferences in exchange for universally applicable reductions of tax rates. If you try to cut that deal in small pieces, then some people are asked to give up their tax preferences first, while others get to wait until later. Those persons called upon to go first rightfully will ask whether they are in fact being asked to go alone, and whether others will in fact fulfill their share of the bargain later. Those arguably valid concerns would tend to undermine consensus, and I would not bet on tax reform happening in slices. It will come in one big bang, or not at all.
So action on the extenders may be tax reform crying “uncle,” at least for this year. It is too bad, both for tax reform’s own sake, and for the contribution that tax reform could make toward a comprehensive budget solution.