Warren Buffett’s recent op-ed in the New York Times is making a stir because it calls for a minimum tax on high incomes above $One million annually. But I was much more interested in some deficit targeting he proposes which exposes his ignorance about the sectoral financial balances model of macro-economics, and reveals him as a deficit hawk whose advice, if followed would be unsustainable and lead the United States into another deep recession. I’ll comment on a couple of paragraphs in Buffett’s op-ed.
Our government’s goal should be to bring in revenues of 18.5 percent of G.D.P. and spend about 21 percent of G.D.P. — levels that have been attained over extended periods in the past and can clearly be reached again. As the math makes clear, this won’t stem our budget deficits; in fact, it will continue them. But assuming even conservative projections about inflation and economic growth, this ratio of revenue to spending will keep America’s debt stable in relation to the country’s economic output.
So, our goal ought to be running deficits of 2.5% and this is Warren Buffett’s idea of fiscal responsibility. Now here’s an accounting identity from macroeconomics, called the Sectoral Financial Balances (SFB) model in which the economy is divided into three sectors, and in all the balances are financial flows over a period of time:
Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0.
There’s plenty of empirical evidence showing that the real world interpretation of this identity works. But, there’s NO negative evidence refuting it.
Now, let’s say that the income of the private sector exceeds the amount it pays to the other two sectors by 6% of GDP, so that the private sector has a surplus. And let’s say that the income of the foreign sector in dollars exceeds what it spends on US goods and services by 4% of US GDP, leaving it with a surplus, and the US with a current account (trade) deficit, then what does the formula say MUST happen to the Government balance?
Government spending will have to exceed its income from taxation by 10%. That is, it will have to run a deficit of 10% to support the foreign surplus and the domestic savings. i.e. 6% + 4% + (-10%) = 0.
Now, what happens if we refuse to let the deficit be 10% of GDP, and that we either cut Gov spending or raise taxes to make that happen? Let’s say we want to hit Warren Buffett’s target, so that we try to force that -10% to become Buffett’s – 2.5% of GDP. Then we have choices.
We can force a zero trade balance, by refusing to import more than we export. But that still leaves us with the need to DECREASE the private balance surplus from 6% to 2.5% of GDP to get the Federal budget to a deficit 2.5%. This is a decline of 3.5% of GDP in savings the private sector might have had, if Mr. Buffett’s deficit target was, say, – 6% of GDP.
There are other options here of course. We could leave the foreign sector balance where it is at 4% of GDP, and decrease the private sector balance to -1.5%, of GDP, actually increasing the private sector’s debt by 1.5% of GDP. But, do we really want to do either of these first two options or anything in between?
I really don’t think so. Do you? Why would we want a policy that would impoverish the private sector over time, or minimize its accumulation of nominal wealth? Is this really consistent with the public purpose?