Back in April, we discussed Jeremy Nalewaik’s work on the relative virtues of GDP(I) vs. GDP(E). Generally speaking, we rely on GDP(E) to measure the amount of economic activity, i.e., we tally up total expenditures. Yet in theory, we should also be able to tally up all of the income generated by the economy’s activity. Nalewaik and his colleagues Boragan Aruoba, Francis Diebold, Frank Schorfheide, and Dongho Song have argued that GDP(I), or GDI, appears to offer a more accurate picture of the state of the economy. Justin Wolfers has done a great deal to draw attention to GDI, and he recently wrote a short post on a recent divergence between the GDP(I) and GDP(E) numbers:
In the three months through September, GDI grew at an annualized, inflation-adjusted rate of only 1.7 percent, compared with 2.7 percent for GDP. Historically, when we’ve seen divergences like this, it has been more common for the GDP estimate to be revised toward the GDI estimate. So future revisions are likely to show that GDP growth was a bit weaker than the current optimistic headlines suggest.
Perhaps more strikingly, GDI in the second quarter of 2012 shrank at an annualized, inflation-adjusted rate of 0.7 percent. Together with the disappointing third-quarter number, this suggests that over the past two quarters, real GDI has grown at an annualized rate of only 0.5 percent. By contrast, the headline GDP data have grown at an average rate of 2.0 percent over the same period. We don’t know which is right, but there’s good reason to fear that the pessimistic data are closer to the truth.
The vulnerability of the economy has implications for the fiscal cliff negotiations. Matt Yglesias recommends that congressional Republicans accept President Obama’s proposals for fiscal stimulus, including an extension of the payroll tax holiday, and his proposed cuts to entitlement expenditures while offering a deduction cap that will generate $800 billion in revenue rather than the $1.6 trillion in revenue from high-earning households he is requesting:
Tell him he can have his stimulus and he can even have higher tax revenue if he really wants it, but that the price is giving up his obsession with higher rates. Is he more interested in soaking the rich or in creating jobs? I don’t think Obama says no to a deal like that, and if he does lots of sensible liberals (like this guy) will call him out on it.
The GDI numbers make this argument more plausible. There are, however, a number of potential objections, e.g., the American Jobs Act (AJA) is problematic for a number of reasons and it is unclear which of its provisions will stay or go. For example, the AJA includes “Buy American” restrictions, difficult-to-enforce new employment regulations, and transfers to state and local governments that are in danger of becoming an open-ended commitment to federalizing the financing of the public sector workforce in high-cost, low-efficiency jurisdictions.
And of course conservatives are concerned about making a revenue concession of any size in the absence of firm commitments on the structural reform of Medicare. One crucial problem, however, is that Republicans have contributed to making structural Medicare reform for current beneficiaries and those near the retirement age politically toxic.
All that said, two thoughts come to mind: the case for the extension of the payroll tax holiday seems relatively sound, and it is unlikely to have the downsides of the various other AJA provisions cited above; the second is that the best strategy for the congressional GOP on taxes might be to back a law that extends all of the Bush-era tax cuts but the high-income rate reductions, as Rep. Tom Cole (R-OK) has proposed. This is, for me at least, a bitter pill to swallow as I am a defender of the high-income rate reductions, but as a legislative strategy, this approach has the advantage of serving as a non-endorsement of the scheduled increase. If the Obama administration endorses a deduction cap as part of a swap, in contrast, the GOP will have affirmatively endorsed higher revenues in exchange for entitlement proposals that are underwhelming.