The three biggest economic policy problems of our time

As I see it, governments and central banks are currently facing three major economic policy problems.  First, there is the problem of how to manage the economy when interest rates are stuck at zero.  Second, there is the problem of how to deal with rapidly rising debt levels.  Third, there is the problem of how to deal with rising income inequality.  What is interesting is that in each of these problems, public finance economists are likely to play a key role in finding the solution.

When interest rates are stuck at zero, central banks can no longer manage the ebbs and flows of the business cycle by changing interest rates, so they will need a new policy tool to fulfill that role, and one likely candidate is to give central banks some control over fiscal policy.  Central banks can probably muddle through if interest rates remain at zero temporarily, but if this is a permanent problem, then it does probably make sense to start figuring out how the central bank might gain some control over government finances by sending out direct payments to individuals.  This is one key example where public finance economists are going to have to work together with macroeconomists to build a whole new policy framework that gives the central bank the ability to fulfill one of their primary functions over the long term going forward into the future by incorporating tools that come from fiscal policy.

Over the next several decades, governments are also going to have to worry about rising levels of debt whether this is due to dramatic new economic shocks like the housing bubble or the pandemic, or because interest rates are stuck at zero and governments need to run persistent budget deficits just to keep the economy performing at potential.  If the first problem had the public finance economists bailing out the macroeconomists by giving central banks some control over fiscal policy, the second problem has the macroeconomists bailing out the public finance economists by having central banks buy up lots of government debt through quantitative easing.  If interest rates remain stuck at zero as debt levels continue to rise, central banks will likely be doing a whole lot of QE during that time as well, so that even if debt levels go up, much of that debt will be held by central banks.  If central banks continue to roll over that debt in perpetuity and promise to buy more debt if there threatens to be a run on government debt, than it could be the central banks that keep governments from experiencing a debt crisis.  That means on both of these first two problems, public finance economists and macroeconomists are going to have to work together so that both of these highly critical economic problems can successfully get resolved.

In many rich countries (especially the English speaking ones), there has also been a persistent trend of growing income inequality, and public finance economists will likely play a key role in resolving this problem too.  Tax policy will clearly play a big role, as declining marginal tax rates on the rich is likely one of the causes, and increasing marginal tax rates on the rich is one of the likely solutions as well.  Figuring out how to make sure the rich pay their fair share in taxes will likely be left to the tax policy experts, and they might play a key role in deciding how that tax money gets distributed as well, since that could involve expanding tax refunds for low and middle income people.  

That puts public finance economists at the heart of all three of the major economic problems governments and central banks currently face, and I remember the time when I was beginning my career in public policy and had to decide on my application for a research assistant position at Brookings what field I wanted to go into.  I chose budget and tax policy as my preferred field and after I started working on the topic I was always struck how important those issues really were, since tax policy experts routinely dealt with proposals with costs in the trillions and even a billion dollars was just considered a rounding error.  What was especially surprising to me was how few people there were working on tax policy issues at the time, and now public finance economists are even more important than ever.  If people are trying to figure out how to have a big impact on the world, public finance as a field is a good place to start, and tax policy should be one key aspect that young public finance economists should also give special attention to learning. 

Kevin Carey's plan for higher education

Kevin Carey published his plan for reforming our higher education system in the Washington Monthly recently, and there is a lot to like in his proposal.  His plan consists of three major reforms.  First, the federal government would provide a $10,000 per student subsidy for every college that agreed to a transparent pricing system for tuition that made it free for those from families making less than $75,000 and charged only $10,000 for those from families making above $250,000.  Second, he would require any college participating in this system to accept credits from any other college in the system.  Third, he would reduce tax subsidies for charitable donations to colleges with large endowments.  

Biden offers his own plan to provide free tuition at public colleges for students from families making less than $125,000, but his plan has some serious problems that I describe in an earlier blog post, and Keven Carey's plan addresses many of those.  First, Carey's plan would not require states to pony up one-third of the money, which would avoid another patchwork of participating states as happened with the Medicaid expansion in Obamacare.  Second, Carey would have individual colleges decide whether or not to participate, rather than having the state government arrange a deal to have every public college in the state participate.  This would allow some private colleges to participate if they want, and some public colleges to not participate if they prefer that as well, and would get rid of the dynamic where the subsidies for an entire state could hinge on every public college in the state adhering to a number of strict rules.  Third, Carey's plan would get rid of the tuition cliff, where Biden would have students from families making less than $125,000 get free tuition, but students from families making $125,001 could be charged full tuition.  Carey smooths out this transition by ramping up the tuition colleges could charge starting with families making $75,000 all the way up to $250,000.  

One of the advantages of Carey's plan is that it provides a boost in funding to colleges that charge little tuition.  Many colleges charge less than $10,000 in tuition so the $10,000 subsidy would allow them to reduce tuition to zero for everyone if they wanted, and still spend more on a student's education.  At the same time, it would allow expensive colleges to opt out, which would provide for some independence, but comes at the cost of doing little to reduce tuition or making pricing more transparent at the schools that need it the most.  Plus, because those expensive colleges would now be competing with colleges who did get some major subsidies by participating and dramatically reduced tuition as a result, those expensive colleges would face substantial pressures to reduce education spending on their own students in order to attract them to their school.  Clearly, spending more on low tuition colleges is something that is badly needed and often overlooked, but putting price pressure on schools that do not participate might decrease education spending on our best students, which is something we would probably like to avoid.  

I would propose changing his proposal slightly, where schools would either get half of their net tuition revenue in federal subsidies or $10,000 whichever is higher (up to say $25,000), and could charge up to $10,000 or half of their net tuition revenue (up to say $25,000) which ever is higher.  This would encourage some of the more expensive colleges to opt in, which would spread the dramatic tuition discounts to a wider range of schools, and impose some pricing transparency on the schools that need it the most, while also relaxing some of the competitive pressures to reduce spending on those schools who now decide to participate.  The most elite colleges could still opt out and not be subject to the requirements of the federal government, which would still allow for some independence.

As far as Carey's other proposals, making it easier to transfer credits would be very worthwhile, but I am not sure the effect would be quite as transformative as he suggests.  He also proposes eliminating the charitable deduction for donations to colleges with big endowments, and it is useful to point out that Biden's tax plan would reduce the generosity of those deductions already for high income households, which is probably a good idea.  Biden's plan allows for some tax subsidy for donations to colleges, which I also support, but perhaps the full deduction could be allowed for donations to low endowment schools in an effort to spread the wealth beyond a few elite colleges.  Carey would also propose having participating colleges charge the same for in state and out of state students, which is another good idea that is often overlooked.  Charging different prices for in and out of state students distorts decision making among some of our best students (especially for those with few in state options), and provides no overall advantage to the country once every state decides to do it.

In his article, Kevin Carey provides a very useful proposal to reform our higher education system.  It is not perfect, and I would make some tweaks around the edges, but fundamentally, his plan is much more sound than the plan to provide free tuition for those from families making less than $125,000 that Biden proposed.  He specifically addresses some of the major shortfalls of Biden's plan and provides other useful ideas that would make our system of higher education even stronger.  The article is definitely worth a read, and should be getting more attention in our current debate over higher education.