A Pareto optimal government policy would be for the federal government to subsidize clean energy technologies through the sale of government equity rather than through direct taxation or borrowing. In this way, the burden of risk is shouldered by those that choose to take risk rather than by taxpayers as a whole or worse.
As an engineer, I can appreciate building systems that are balanced and stable. In fact the goals outlined in the Humphrey Hawkins Act (1979) focus on balance and stability:
https://en.wikipedia.org/wiki/Humphrey–Hawkins_Full_Employment_Act
- Instructs the government to take reasonable means to BALANCE the budget.
- Instructs the government to establish a BALANCE of trade, i.e., to avoid trade surpluses or deficits.
- Mandates the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price STABILITY.
- a fixed foreign exchange rate
- free capital movement (absence of capital controls)
- an independent monetary policy
Currently, the federal government relies on two sources of funding - borrowing and tax revenue. And yet, everywhere else in the economy, three distinct types of funding are used - current income, borrowing, and the sale of equity shares. I believe that equity sold by the federal government addresses the wishes of all three parties.
Government equity would consist of fixed term, zero coupon, non-transferrable securities that would be redeemable in fulfilling a future tax liability. For instance, US Treasury sells a five year security with a 6% annual return. 5 years from now that security can be used to fulfill a federal tax liability.
Notice how this is different from a government bond. With bonds, tax payers as a whole make the interest payments on the bonds. With the equity as I have described, the owner of the security is ultimately responsible for his / her own returns on investment.
Notice that under law, this would not constitute borrowing by the federal government subject to limit set by Congress.
To borrow (in a legal sense) means to receive an asset from someone with the intent of returning that asset (with or without interest) at a future date. Obviously when money is borrowed, the exact same money (bills, coins, etc.) are not returned because money is fungible.
With government equity, money would be given to the federal government to purchase said equity, but no money would be returned by the federal government when the equity is redeemed.
In essence, the federal government would be selling tax breaks through the Treasury department - something that the Laffer curve Republicans can't seem to get their head around. In you want to cut taxes, then sell tax breaks that constitute a legally binding contract that cannot be undone by a future President / Congress.
The features of GEqty that distinguish it from GBond are (1) non-transferable, (2) not exercisable prior to maturity (T periods forward), (3) only useable for settling tax liabilities payable to the US government, (4) not a refundable tax credit.
These features MIGHT limit broad uptake of GEqty securities in the banking / insurance industry, but only because they are designed towards individual tax payers and companies outside the banking / insurance sector purchasing them. Mutual funds that hold tax deferred savings I would think would be interested in them though. Don't think of this as a financial instrument meant to be bought and sold by banks, insurance companies, and hedge funds.
Equity sold by the federal government has value to any productive US citizen that has a long lifetime of future tax liability. And as a hedge instrument for firms engaged in the production of goods, they have a lot of value.
If a firm or individual borrows at 4% nominal and has government equity returning 6% nominal, what is their after tax cost of debt service? Negative 2%? And so if a firm's / individual's after tax cost of borrowing can in fact be negative, why would it need to ever raise prices? (See zero bound for nominal interest rates).
The value of all future income tax receipts can be considered infinite absent armageddon, foreign conquerer, etc. under any non-zero tax rate. And so any notion of government equity negatively affecting the "solvency" of the federal government can be disregarded.
When equity is sold by the Treasury, the federal government does not TAKE from an individual. Instead, the individual is willing to forgo holdings of a liquid transferrable asset (money) for an illiquid asset that offers a risk bearing rate of return. The individual is willing to take risk, the same way that any purchases of corporate equity is willing to take risk. Whether the individual is made better off or worse off depends predominately on what that person does after taking that risk.
GEqty is a risk bearing asset and investors should be compensated for that risk. It is entirely reasonable that GEqty should offer a rate of return above the prevailing market interest rates for Treasury debt.
Suppose Treasury started selling equity that could not be purchased by the FOMC and the Fed continued to conduct open market operations. Under that scenario it is likely that the spread between interest rates on bonds purchased by the FOMC and the discount offered by the US Treasury on GEqty would widen.
One method of setting the discount rate on GEqty would be for the Treasury to set the rate of return offered on government equity equal to the output gap plus the potential / target real GDP growth rate. As output gap gets large (during recession), the Fed funds rate falls (dragging down bond yields) but the rate of return offered on government equity increases - see countercyclical tax policy.
The federal government sells equity (as I describe it) and uses the proceeds to retire debt. Is this good public policy from:
1. A trade balance perspective?
2. An independent central bank perspective?
3. An economic incentive perspective?
4. A productivity perspective?
As a practical matter, it would make the most sense for the Treasury to sell ladders of the securities that I describe. For instance, Treasury sells a ladder of securities with maturities from 1 to 30 years, each year a portion of the security can be used to discharge the tax liability for that year.
Yes, during a year when an individual is un-employed / underemployed the gains would not be realizable (hence the equity nature of the security), but I don't think it is realistic to presume that none of the gains for all years 1-30 are realizable unless the owner of the securities is either deceased or permanently disabled. Of course the owner should be permitted to "roll over" his equity to a future year up until the point that he perishes. The important part is that the "incentive for the owner to work for a living" incorporated into the government equity is preserved.
The reason for the non-transferability has to do with overlapping generations and the natural rate of interest. Illiquid government liabilities have a tendency to raise the natural rate of interest and real growth rate.
Another "feature" of government equity is that Treasury can sell equity on demand rather than as a function of deficits.
It is a common misconception that government debt is a "result" of deficits. Instead, deficits place a limit on the amount of government debt that can be sold by Treasury.
Suppose the US Treasury did sell government bonds on demand - what would happen? Every bank with access to the Fed's discount window would be jumping over themselves to borrow short from the Fed, lend long to the federal government, and collect the spread. The Ponzi limit on government debt would be reached overnight and the only thing government would be spending tax revenue on is interest payments.
Contrast that with government equity as I have described it. A private bank borrows from the Fed short term and buys a bunch of government equity. They can't resell it (because it is non-transferrable) and the gains a bank realizes are limited to it's own future tax liability.
The only reason that bonds need to be liquid is that the federal government cannot realistically sell them on demand. Finally, even 30 years out is an arbitrary length of time. With a working age starting at age 18 and end just past the age of 65, 50 year laddered government equity is certainly within the realm of possibility.
"My experience teaches me this: Men and nations do act wisely when they have exhausted all the other possibilities." - Abba Eban (1979)
Have all the other possibilities (debt monetization, dollar devaluation, etc, etc.) been exhausted yet?
Treasury sells equity, private investor buys equity from Treasury, Treasury uses money from private investor to retire government debt held by Federal Reserve. Monetary aggregates and federal debt fall irrespective of the wishes of the central bank.
I understand tax farming and previous attempts at it, but that is not what I am describing.
You probably know who Daniel Ellsberg was, but aside from his infamy with the "Pentagon Papers" he also has a decision theory named after him:
https://en.wikipedia.org/wiki/Ellsberg_paradox
"Ellsberg's findings indicate that choices with an underlying level of risk are favoured in instances where the likelihood of risk is clear, rather than instances in which the likelihood of risk is unknown. A decision maker will overwhelmingly favour a choice with a transparent likelihood of risk, even in instances where the unknown alternative may produce a larger utility. Given a particular set of choices in which each choice carries known and varying levels of risk, people will still prefer choices with calculable risk, even in instances with a lower utility outcome."
In a nutshell, Mr. Ellsberg postulates that people care more about self directed success than absolute returns on investment. I would rather push my own boat into the lake to take my chances at fishing rather than pay a charter boat and professional to do the fishing for me.
And that is what the equity I describe offers - a chance for the individual to improve his / her returns on investment because of his / her own productive capacity - not because he / she picked the right stock or mutual fund to invest in.
From the Government's perspective, GEqty is a better financing option than GBonds and the reason is that the underlying risk is born by the individual purchaser rather than taxpayers as a whole. Even today, the federal government sells a mix of short term T-Notes and longer term GBonds.
I assume you remember George Bush's pledge - "Read my lips, no new taxes" which he subsequently reneged on? The reason he had to reneg on that promise is that the interest payments on government debt (both T-Notes and Bonds) were consuming a growing portion of available tax revenue. Those payments are guaranteed by the 14th amendment and as such, subsume all other forms of government spending.
The federal government is not an investment bank looking to profit off of the voting public. The point is the difference in incentives between GEqty and T-Bills / GBonds.
When you purchase equity shares of individual companies, are you speculating or are you investing in a productive enterprise?
With T-Bills / GBonds, the owner of the security barely has to lift a finger to collect his / her return on investment. With GEqty, the owner of the security must have some form of taxable income (via wages or other earned income) to see any benefit. And so when an individual purchases GEqty, they are "speculating" on their own future income derived from a productive purpose and associated tax liability.
In addition, GEqty allows monetary policy to operate independently of Treasury since monetary policy operates within the debt markets. If government is using GEqty for it's financing operations, then changes in monetary policy have no ill effects on the government's fiscal position. The Secretary of the Treasury should not be one to engage in policies that undermine the independence of the central bank. The only way she / he can possibly do this is through the sale of equity. And if the Treasury Secretary is able to take the funds obtained from the sale of equity and retire existing government bonds - how is this not a fair gamble from both a government finance perspective and an independent monetary policy perspective?
The most elaborative example I can give is this:
An economy is composed of 100 people all paying the same amount in taxes and all owning the same quantity of government bonds. If all 100 people quit their jobs, where does the money come from to make the interest payments on those bonds?
A second economy is composed of 100 people all paying the same amount in taxes and all owning the same quantity of government equity. If all 100 people quit their jobs, then no returns are paid on the government equity holdings.
I presume that you are familiar with performance incentives built into a lot of professional sports contracts (start every game, run for 1000 yards, hit 30 home runs, etc.). These can be considered contingent contracts - you get paid, but only if you achieve the agreed upon target goal.
That is exactly what I am describing - a contingent contract sold by the Treasury where the target goal is for you to remain fully employed and have an associated tax liability.
My rationale for referencing the Ellsberg Paradox goes this way:
When a person purchases corporate equities he / she faces a multitude of unknown risks including future demand for the companies products, future financing needs for that company, future compensation due to employees, future price swings in materials that the company requires for production, potential future corporate malfeasance (fraud, product liability, etc.), and a whole host of unknown risks.
When a person purchases equity from the Treasury as I have described it, the only risks the person must consider are their own future employment and tax liability.
And so even though a person may obtain better expected utility from purchasing corporate equities, he / she may still elect to purchase equity from the Treasury given the opportunity because the risks are better understood by that person.
From the Wikipedia article:
"...people intrinsically dislike situations where they cannot attach probabilities to outcomes...favouring the bet in which they know the probability and utility outcome..."
If I purchase government equity, I have a better handle on the probability of my bet being successful and the utility I gain from a successful bet.
If she (Janet Yellen) actually believes in central bank independence, then there is a strong probability. If she is just parroting what every other central banker has said then there is little to zero probability.
Judging by her recent comments saying that the federal debt ceiling should be eliminated, I would say she is just parroting what she has heard around the water cooler.
The central bank / FOMC would be precluded from purchasing government equity - see Federal Reserve Open Market Operations here:
https://www.federalreserve.gov/aboutthefed/section14.htm
In addition, changes in the discount rate set by the Federal Reserve (set administratively) would have no direct effect on the rate of return offered by Treasury on the equity that it sells.
The similarity between my description of government equity and U.S. Savings Bonds is notable. The significant difference being the incentives involved in purchasing and holding savings bonds and the incentives in purchasing and holding government equity.
The power delegated specifically to Congress under the US Constitution is the power to borrow (US Constitution Article 1, Section 8). Equity sold by the US Treasury would not constitute borrowing any more than equity shares sold by GE, or Microsoft, or any other corporate interest constitutes borrowing.
Back in 1997 when he was Treasury Secretary, Robert Rubin authorized the sale of TIPS and inflation indexed bonds.
If Robert Rubin can sell TIPs, then Janet Yellen can certainly sell equity.
One asset of the US government is the tax revenue that they collect. And the equity that I propose is in fact a claim on that tax revenue.
And besides all that, even if you don't want to call it equity and instead call it forward tax contracts (FTC's) or some other acronym, the point remains that because what I describe would not constitute borrowing by the Treasury and because what I describe would offer no cash settlement, the FTC's would not infringe on any Constitutional power given to Congress.
Meaning (unlike TIPs), Janet Yellen (or some other Treasury Secretary) could sell them without Congressional approval.
Can we agree that the securities that I am describing would not be considered to be borrowing and would not be subject to the debt limit set by Congress?
In lay terms, to borrow means to receive some good with the expectation of returning that good (possibly with interest) or a fungible equivalent at some point in the future. If I borrow a $100 bill, I am expected to return $100 in money at some point in the future. Because money is fungible I am not expected to return that exact same $100 bill.
Notice with the securities that I am describing, money is used to purchase the security, but no money is returned when the security reaches maturity. Instead the security is used to fulfill a tax liability. Hence no borrowing has occurred.
In addition, because there is no cash settlement, no spending unauthorized by Congress occurs when I redeem the security through the Treasury / IRS in fulfilling a tax liability.
Finally, it is already legally acceptable for the Internal Revenue Service to accept goods other than money in fulfillment of a tax liability - see:
https://www.treasury.gov/auctions/irs/index.html
Our system of laws protects any contract entered into by two willing parties (not just those legislated by Congress). And so in my mind, if Treasury sells FTC's and I purchase them, then our Congress and Judiciary would be bound by law to protect and honor those contracts as long as they don't infringe on the powers granted to Congress.
It remains an open question whether FTC's sold under one President / Treasury Secretary would be binding under a future President / Treasury Secretary. Meaning could Treasury sell FTC's under one President and then have the IRS refuse to accept them in discharging a liability under another President? Again, I would think that our system of laws protects contracts despite who or what party occupies the White House.
Chapter 31 of Title 31 of the United States Code authorizes the Secretary of the Treasury to issue United States obligations, and to offer them for sale with the terms and conditions that the Secretary prescribes. So the Treasury Secretary (under broad authority granted by CFR) can sell equity (forward tax credits) as I describe.
A Treasury Secretary might be "forced" into doing such a thing.
It is entirely within the framework of the Constitution for the US Congress to vote yes on a spending bill, then vote no on any legislation designed to pay for that spending (debt / borrowing limit increase - no, tax increase - no, coinage of money - no).
Under that scenario, it falls upon the Executive Branch of government under Article II, Section 3 to execute the legislative action of Congress:
https://constitution.congress.gov/browse/essay/artII_S3_1_3_1/
"...he shall take Care that the Laws be faithfully executed."
My government equity has merit because it may be the only option available to a Treasury Secretary facing a divided Congress that wants to spend, but does not want to tax or borrow to pay for it.
Part of the problem (I think) is that people believe that "United States obligations" as mentioned in Subpart A, 356.0 of Chapter 31 of Title 31 in USC are always the result of government borrowing.
The tax credit forward contracts (equity) that I describe would be considered obligations of the United States in that the Internal Revenue Service would be obliged to accept them in discharging a tax liability, but would not be considered to be borrowing / debt subject to limit under Article 1, Section 2 of the Constitution.
https://www.cnbc.com/2021/09/28/congress-must-raise-the-debt-limit-by-oct-18-yellen-warns.html
“We now estimate that Treasury is likely to exhaust its extraordinary measures if Congress has not acted to raise or suspend the debt limit by October 18,” Yellen wrote."
https://home.treasury.gov/news/press-releases/jy0390
"Congress must address the debt limit immediately."
The debt ceiling serves a number of purposes. Yes, the debt ceiling gives a legislature the opportunity to pause and reconsider it's commitments to financial expenditures. The debt ceiling also prevents an unscrupulous Treasury Secretary / Executive Branch of Government from selling government bonds on demand.
And if you think that can't happen please see the Solomon Brothers scandal:
https://en.wikipedia.org/wiki/Salomon_Brothers
"In 1991, U.S. Treasury Deputy Assistant Secretary Mike Basham learned that Salomon trader Paul Mozer had been submitting false bids in an attempt to purchase more treasury bonds than permitted by one buyer during the period between December 1990 and May 1991."
With government bonds sold on demand, a bank / multiple banks with access to the Fed's discount window could purchase a sufficient quantity of bonds (borrow short from the Fed, lend long to Treasury) such that the Ponzi limit would soon be reached.
The limit on government debt that can legally exist is referred to as the Ponzi limit.
Ponzi finance (aka a pyramid scheme) is illegal under federal law. When the total interest expense owed by a federal government exceeds the total amount of revenue that it receives, the federal government would be making interest payments on it's existing debt with new debt issuance, which would be a violation of federal law (yes federal government employees are not above the laws they are sworn to protect).
Provided B(t) is bounded, i.e., 0 ≤ B(t) < ∞, the level of debt:GDP is not an issue, but the interest expense relative to government revenue is always an issue.
GDP = Nominal GDP
TR% = Taxes and other government revenue expressed as a percentage of GDP
B = Quantity of government bonds
I% = Average annual interest
GDP * TR% > B * I% - Under the no Ponzi condition, this is always true
What should be obvious is that when the federal government sells equity (FTC's) as I have described it, the Ponzi condition can never be breached irregardless of the term structure or the offered rate of return for that equity.
Also, the equity being described can be considered a "public" good in that it is both non-rivalrous and non-exclusionary. The equity is non-rivalrous in that the gains / losses on the investment are limited to the individual purchaser for that equity (privatized gains and privatized losses). The equity is non-exclusionary in that the Treasury can sell equity on demand rather than as a consequence of deficits.
I realize that this does not exactly fit the Samuelson definition of a public good with regards to exclusive goods (goods that are only limited to paying customers). Instead, the equity being described can be considered non-exclusive because it can be sold on demand to any customer that wishes to purchase it. Under a strict Samuelson definition, Social Security, Medicaire, and other government insurance programs can all be considered exclusive goods since money is used to "purchase" enrollment in those programs.
One example of an exclusive good is a movie ticket. The ticket is exclusive not because money is paid to purchase the ticket, but because of the limited number of seats available for viewing the movie.
One possible method for Treasury to set the discount rate offered on equity is a comparable parallel to the Taylor rule for monetary policy.
Monetary Policy (Taylor Rule):
i(t) = Nominal Fed Funds rate
pi(t) = Inflation rate
pi'(t) = Target inflation rate
y(t) = RGDP growth rate (dY(t)/Y(t))
y'(t) = Target RGDP growth rate (dY'(t)/Y'(t))
r'(t) = Equilibrium real interest rate
B(t) = Quantity of government bonds
P(t) = Price level
TR% = Prevailing tax rate
i(t) = pi(t) + r'(t) + alphapi * ( pi(t) - pi'(t) ) + alphay * ( y(t) - y'(t) )
Two problems with the Taylor rule:
Problem #1 - 1. During deflation and / or falling real GDP, i(t) must go negative which it can't do.
Problem #2 - A high enough i(t) puts monetary policy in conflict with fiscal policy for an indebted government ( TR% * Y(t) * P(t) < i(t) * B(t) ).
And so we need a fiscal policy rule that addresses both the potential for deflation and fiscal concerns. Enter government equity combined with a modified Taylor rule.
Fiscal policy (Restly rule):
EQ(t) = Quantity of government equity outstanding
d(t) = Discount rate offered on government equity
da(t) = Realized (actual) rate of return on government equity
d(t) = alphay * ( y'(t) - y(t) ) - Fiscal policy rule
i(t) = pi(t) + r'(t) + alphapi * ( pi(t) - pi'(t) ) - Modified Taylor monetary policy rule
Notice:
1. Changes in the interest rate i(t) are no longer tied to changes in Real GDP Y(t) - monetary policy focuses solely on the inflation rate.
2. Any discount rate d(t) offered by Treasury, TR% * Y(t) * P(t) is always greater than or equal to da(t) * EQ(t) because the equity can only be used to fulfill a tax liability (no cash settlement by the Treasury) - Problem #2 solved.
3. The discount rate d(t) offered by Treasury can move independently of monetary policy changes in i(t) set by the Federal Reserve.
4. While the interest rate i(t) can never go negative, the net of i(t) - d(t) can certainly go negative - Problem #1 solved.
Condition #1 - Deflation and depression (falling prices and falling y(t)) - Interest rate i(t) falls, Discount rate d(t) rises
Condition #2 - Deflation and positive real growth (falling prices and rising y(t)) - Interest rate i(t) falls, Discount rate d(t) is unchanged
Condition #3 - Inflation and positive real growth (rising prices and rising y(t)) - Interest rate i(t) rises, Discount rate d(t) is unchanged.
Condition #4 - Inflation and negative real growth (rising prices and falling y(t)) - Interest rate i(t) rises, Discount rate d(t) rises.
Regarding the natural rate of interest (Equilibrium Real Interest Rate), it is important to understand what interest actually is. Interest in finance and economics is not strictly the cost of money or borrowing. It is the cost of time associated with any non-instantaneous transaction.
If I buy a car on the lot today, I may pay $30,000 for that car. If I buy the exact same car that won't be delivered to me for another two years I will only pay $28,000. In effect I am charging interest even though legally the car dealership has not borrowed from me.
In overlapping generations economic models with frictionless intergenerational transfers the natural rate of interest will tend to fall because one person's lifetime (80 years) becomes lifetimes spanning hundreds or even thousands of years. Time becomes less scarce and so the cost of that time (interest rate) falls.
And so there is likely a positive feedback loop between da(t) - Realized Rate of Return on Government equity and r'(t) - Equilibrium Real Interest Rate, where simply by having the federal government sell non-transferrable securities in the form of Government Equity, this will cause the Equilibrium Real Interest Rate to rise.
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