The changes being proposed to federal tax and spending are aligned with past
· A globally coordinated minimum corporate tax, applied on a country-by-country basis, which will be a crucial step forward in countering the incentives for profit shifting and base erosion.
· The elimination of loopholes that allow high income individuals to recharacterize labor income and escape tax on capital gains.
· A permanent expansion of the Earned Income Tax Credit to childless workers and an extension of the higher, refundable child tax credit which together will be instrumental in reducing poverty.
· Increased funding for the
It is worth highlighting that many of these tax and spending changes will directly support working mothers (who have long made up a large share of the poor and were hard hit by the pandemic ) and disproportionately help black and Hispanic families.
The size and ambition of the proposed fiscal packages is admirable. However, a better targeting of policies would further strengthen their impact on macroeconomic and distributional outcomes. Specifically, as the appropriations process moves ahead, more could be done to:
· Phase out tax credits at lower levels of household income.
· Prioritize spending toward programs that have the biggest impact on productivity, labor force participation, reducing poverty, and facilitating the shift to a low-carbon economy.
· Fully eliminate step-up basis, lower the threshold for paying the estate tax, eliminate the 199A passthrough deduction, and reformulate the business tax as a cashflow tax.
Reorienting the administration's tax and spending proposals in this way would likely imply a slower (but more sustained) demand impulse, create a bigger boost to aggregate supply, and, in so doing, lessen the near-term risks posed by a sustained upswing in inflation. In this regard, the administration's commitment not to raise taxes on households earning under
· Increasing the
· Scaling back poorly targeted tax expenditures such as the income tax exemption for employer-provided health care, the capital gains tax exemptions for individuals selling their principal residence, and the deductibility of mortgage interest and state and local taxes.
· Aligning the combined (i.e., corporate plus personal) top statutory rate on capital income with the top marginal rate on labor income (which would imply taxing dividends and capital gains received by taxable entities at around 20–25 percent). Doing so would also help lessen the extent to which pass-through entities face a preferential tax rate.
The combination of the new monetary policy framework and the economic boost from fiscal stimulus should be self-reinforcing. The flexible average inflation targeting helps increase the demand impact of the fiscal support by providing more accommodation. At the same time, the large fiscal boost increases the likelihood that inflation gathers enough momentum to sustainably exceed 2 percent (something that the
In the coming months, the ongoing rapid pace of recovery and expectations of additional fiscal support will necessitate a shift in monetary policy. As discussed above, the reopening of the economy will create considerable unpredictability in PCE inflation during the next several months, making it very difficult to divine underlying inflationary trends. At the same time, presuming staff's baseline outlook and fiscal policy assumptions are realized, policy rates would likely need to start rising in late-2022 or early-2023 (with asset purchases starting to be scaled back in the first half of 2022).
Managing this transition—from providing reassurance that monetary policy will continue to deliver powerful support to the economy to preparing for an eventual scaling back of asset purchases and a withdrawal of monetary accommodation—will require deft communications under a potentially tight timeline. Mitigating the risks of market misunderstandings, volatility in market pricing, and/or an unwarranted tightening of financial conditions (with all the negative spillovers to the global economy that such outcomes would entail) will require the
Risks to the Outlook
The principal risk facing the
There are downside risks to the outlook from the potential that
A surge in underlying inflation in the
In the event that these upside risks to inflation are realized, monetary policy will need to adapt quickly. If realized inflation moves higher but medium-term inflation expectations are well-anchored, the premium will be on communicating clearly that the changing environment calls for a withdrawal of monetary accommodation. However, the anchored inflation expectations will provide room for maneuver, allowing these policy adjustments to take place along an orderly timeline (i.e., similar to that already incorporated into staff's baseline outlook). While this would imply a somewhat larger, more prolonged inflation overshoot, inflation should still return to the longer-run target relatively quickly. On the other hand, if there are unambiguous signs that inflation expectations have become de-anchored, monetary policy would quickly need to change tack, accelerating the reduction in asset purchases and even having to consider raising policy rates before net purchases have been brought to zero. This would likely create an abrupt shift in financial conditions and risk premia with negative implications at home and abroad. Clearly, it will be difficult to distinguish, in real time, between these two potential out-of-baseline risk scenarios, especially when there is substantial noise from the expected idiosyncratic and transitory shifts in a range of prices.
The impact on global activity from the rapid
Gaining From Trade
The administration has underscored the need for a “worker-centric” trade agenda that ensures that global trade benefits Americans as workers and wage-earners, not just as consumers. In pursuing these objectives, a removal of the obstacles to free trade would help support
It is of significant concern, therefore, that many of the trade distortions introduced over the past four years remain in place. In particular, tariffs have been kept on imported steel and aluminum, washing machines, solar panels, as well as a range of goods imported from
The entanglement of trade and currency issues over the last four years—including investigations into currency-based countervailing duties on
Finally, there is a clear need to address longstanding global trade and investment distortions in areas such as tariffs, farm subsidies, industrial subsidies, and services trade. The
Financial Stability Concerns
Systemic financial stability risks appear close to the historical average. However, the very accommodative financial conditions are encouraging continued risk taking and facilitating rising leverage in the nonbanks and corporates. The banking system appears to be in a strong position but leverage in nonbanks has increased and life insurance companies and hedge funds are exposed to lower-rated corporate debt. Fundamental shifts in the
The housing market appears to be on a vigorous upward path which could raise financial stability concerns in the event of a reversal. Mortgage debt, though, has grown by a modest amount (around 5 percent year-on-year) and lending has been concentrated in households with high credit scores. Nonetheless, given the importance of housing for the broader economy, the buoyancy of the residential real estate market bears careful watching.
The unfolding pandemic revealed important shortcomings in the functioning-under-stress of systemically important
The Challenge of
As the pandemic effects recede, policymakers will have to cope with simultaneous, ongoing transitions that include:
· A pandemic recovery that likely creates lasting shifts (in the
· A move to a low-carbon economy that will necessitate a significant reallocation of labor and capital (e.g. away from fossil fuels and heavy industry and toward renewables) and, potentially, a very different set of skills.
· A demographic transition whereby 22 percent of the population will be over-65 by 2040, the number of Americans over-85 will double by 2035, and the population will be increasingly racially diverse.
· Digitalization and other evolving technologies that will remake both production and consumption in unpredictable ways.
The longstanding flexibility and innovativeness of the
Instead, a multi-dimensional policy approach will need to be developed to support rising living standards for all Americans and prevent workers from becoming disenfranchised or detached from the labor force. A more effective social safety net and broader healthcare coverage will help. So too will increased investments in vocational and academic education. Greater spending on public investment can raise labor productivity and help improve living standards. However, other strategies may well be needed. These could include regional development initiatives to facilitate the transition. There may be a need to subsidize labor mobility (especially if newly created jobs are in areas where the cost of living and housing is higher). Efforts will be needed to ensure schools and colleges are equipped to provide students with the basic technical and critical thinking skills needed for a fast-changing economy. Also, immigration policies will need to be re-examined to ensure there is the right supply of skills needed to meet the demands of the newly created jobs.
A Greener Economy
The administration's new impetus to reduce greenhouse gases represents a critical, and very positive, change of direction. While many of the steps that will be needed to achieve the administration's climate goals have yet to be defined, the broad scope of the plans that have already been articulated (and the significant investments that are expected to be made), if realized, will jump-start the transition to a low carbon economy. However, it will be costly and difficult to achieve the administration's climate objectives without a greater focus on carbon pricing. In particular, a new federal carbon tax would need to be an indispensable component of the administration's climate strategy. Such a carbon tax could be combined with sectoral-based policies to tilt incentives away from carbon intensive activities. As political support is being built for a carbon tax, regulatory actions could be strengthened to increase disincentives for greenhouse gas emissions.
Announced efforts to reduce implicit subsidies for the fossil fuel industry are important. However, a similar approach is needed for the agro-industrial sector (which accounts for 10 percent of total