Tag: Inflation

The Progressive Democratic Autopsy Does Not Go Far Enough

The progressive left has produced its own autopsy of the Democrats’ 2024 presidential loss. Some of it is useful. Much of it is predictable.

This post is about the progressive RootsAction autopsy, not the separate DNC/Rivera report later released by the Democratic National Committee. The RootsAction response was more progressive and self-confirming than the Rivera report.

The Rivera report appears more serious on voter groups Democrats lost and on the party’s failure to listen. But both reports still leave important questions underdeveloped, especially inflation, immigration, Biden’s governing coalition, Gaza cross-pressures, and the cultural alienation of working- and middle-class voters.

The RootsAction report is right that Democrats paid a price for President Biden’s decision to seek reelection and then withdraw only very late in the process. Biden ended his campaign on July 21, 2024, after a debate performance that intensified existing doubts about his age and capacity, leaving Democrats only a few months to define a new nominee and make the case against Donald Trump.

The report is also right that Democrats had a problem with younger voters. The RootsAction autopsy identifies “losing young voters,” “voter disenchantment,” Biden’s late withdrawal, working-class erosion, and Gaza as central reasons for Harris’s defeat. Tufts’ CIRCLE analysis found that young voters still favored Harris overall, but shifted right compared with 2020. AP reported that young men moved significantly toward Trump after a campaign that deliberately appealed to masculine identity through podcasts, sports, and nontraditional media.

So the progressive autopsy is not wrong about everything.

But it still seems to confirm progressive priors more than it confronts the hardest lessons of the election.

It wants Democrats to conclude that they lost because they were not progressive enough, not populist enough, not aggressive enough on Gaza, and not sufficiently mobilizing of the party’s base. Even if some of that were true, which I doubt, it does not explain the whole story. Most importantly, it ignores the issues that many working- and middle-class voters were actually reacting to: immigration disorder, inflation, cultural alienation, and the sense that Democrats were more comfortable speaking the language of elite progressivism than the language of ordinary Americans.

Biden’s Late Withdrawal Hurt Democrats

I agree with the progressive critique on this point: Biden’s decision not to withdraw earlier hurt Democrats.

Voters had serious doubts about his age and capacity long before the debate made those doubts impossible to dismiss. By waiting so long, Biden denied his party a normal primary process, denied voters a real choice among alternatives, and denied the eventual nominee the time needed to build a durable campaign identity.

The RootsAction report calls Biden’s decision to run again, and his refusal to step aside until late in the process, one of the central causes of the Democratic loss. That is fair.

But that explanation has limits. Biden’s late withdrawal hurt Democrats. It did not create all of the underlying problems Democrats faced. A stronger nominee might have performed better, but even a stronger nominee would have had to defend the record and rhetoric of the Democratic Party as voters experienced it.

That is where the progressive autopsy becomes much less persuasive.

The Young Male Problem Democrats Need to Understand

Democrats also appear to have a real problem with young men.

This should not be reduced to a crude claim that all young men are reactionary or that Democrats should imitate the online right. But the problem is real enough to deserve more serious attention than it often receives.

Many young men hear progressive rhetoric about privilege, identity, and DEI less as a call for fairness than as an accusation aimed at them personally. They are told they are beneficiaries of an unjust system at the same time many of them are struggling economically, socially, educationally, and professionally. That is not a recipe for political loyalty.

A healthy political party should be able to say two things at once: discrimination is real, and alienated young men are not all villains.

Too often, progressive rhetoric leaves no room for the second half of that sentence.

This does not mean Democrats should abandon equal opportunity or stop opposing discrimination. It does mean they should rethink language that sounds less like fairness and more like collective blame. A party that talks constantly about inclusion cannot afford to make a large group of voters feel preemptively excluded.

Trump exploited that opening. Democrats should ask why the opening existed.

Gaza Was Not the Main Problem for Most Voters

The progressive left is especially focused on Gaza. There is no question that Gaza mattered deeply to some voters, especially younger voters, progressive activists, Arab Americans, Muslim Americans, and some voters in Michigan. More than 100,000 Michigan Democratic primary voters cast ballots for “uncommitted,” a protest vote widely understood as a rebuke of Biden’s handling of the Israel-Hamas war.

But it is much harder to believe that the central lesson of 2024 is that Democrats failed because they did not tilt far enough toward Gaza activism.

That claim may be emotionally satisfying to parts of the progressive left. It is not a convincing explanation of the broader working-class and middle-class erosion Democrats experienced. Most voters were not living politically in foreign-policy protest politics. They were living with grocery bills, rent, immigration anxiety, cultural conflict, and frustration with a party that seemed surprised by voter concerns it should have seen coming.

Nor is it obvious that more pro-Gaza rhetoric would have been a net political winner. Democrats may have lost some voters because the Biden administration was too supportive of Israel for their taste. But they also risked losing other voters, including Jewish voters, pro-Israel Democrats, moderates, and voters alarmed by the tone of some campus protests, if the party had moved further in the other direction. A Forward poll taken during the campaign found that Jewish voters trusted Harris more than Trump to handle the Israel-Hamas war, but also saw Trump as more supportive of Israelis. That captures the tension Democrats faced.

In other words, Gaza was not a one-way political problem.

The progressive left counts the voters Democrats lost over Gaza. It is much less interested in counting the voters Democrats might have lost by sounding naïve, hostile, or morally confused about Israel.

For most Americans, the question was not whether Democrats had adopted the correct activist position on Gaza. The question was whether Democrats understood the country they were governing.

Immigration Was a Self-Inflicted Wound

Immigration is one of the most obvious issues the progressive autopsy underplays.

Working-class voters are not wrong to want a humane immigration system and a secure border. Those goals are not contradictory. They are the basic requirements of a functioning country.

Democrats spent too long treating border concerns as if they were merely a cover for xenophobia. That was politically foolish and substantively wrong. A country that cannot credibly manage its border will lose public trust, including trust among voters who support legal immigration and humane treatment of migrants.

AP VoteCast found that Trump tapped into deep economic anxiety among voters, and AP’s broader VoteCast work showed immigration and the economy were central issues in the 2024 electorate. That should not have shocked anyone. When voters believe the governing party has lost control of a basic function of government, they tend to punish that party.

Democrats can object to Trump’s cruelty, dishonesty, and demagoguery on immigration. They should. But opposing Trump is not enough. They also need a policy that persuades ordinary voters that the government can be compassionate without being naïve. They needed to come to that conclusion before it became politically obvious that they were only doing it because they had to do something.

That failure helps explain why Democrats lost in 2024.

The “They/Them” Ad Worked Because It Hit a Real Vulnerability

One of Trump’s most effective attacks was the “Kamala is for they/them, President Trump is for you” ad. The ad was ugly. It was designed to exploit cultural resentment. But Democrats should resist the temptation to dismiss its effectiveness as merely evidence of voter bigotry.

The ad worked because it told a simple story: Democrats are focused on a narrow set of elite cultural concerns; Trump is focused on you.

That story was unfair in many ways. It was also politically potent.

PBS reported during the campaign that anti-transgender political ads were dominating the airwaves, with ads supporting Trump attacking Harris over transgender issues. Some postelection analysis, including discussion of Democratic super PAC testing, suggested the “they/them” attack was among Trump’s more effective ads, though there was disagreement about how large its effect was.

The point is not that transgender Americans should be treated as political scapegoats. They should not be. The point is that Democrats had no clear answer when Republicans framed them as more concerned with the language and priorities of progressive activists than with the everyday concerns of ordinary voters.

That is a political problem.

The right answer is not cruelty. It is clarity. People of good will can address the real concerns of transgender Americans without appearing so open-minded that their brains fell out. The deeper problem is that progressives are often so busy signaling virtue to one another that they forget there are potential allies who can be persuaded if their concerns are treated with respect rather than derision. Democrats should defend the equal dignity of every American while also being willing to say no to unpopular, poorly defended, or symbolically extreme positions that most voters do not share.

This is where Democrats often confuse moral seriousness with activist maximalism. A humane society should protect vulnerable people from harassment, discrimination, and cruelty. But voters are also entitled to expect boundaries, prudence, and ordinary language. When Democrats cannot make those distinctions clearly, Republicans will make the distinctions for them — and not kindly.

A party that cannot make those distinctions will keep giving Republicans material for ads like that.

The Inflation Mistake Democrats Don’t Want to Own

The progressive autopsy is especially weak on inflation.

It is right that inflation badly hurt working- and middle-class voters. But it largely treats inflation as something Democrats failed to message properly or failed to blame sufficiently on others. That is too convenient.

Supply-chain disruptions mattered. Energy markets mattered. The war in Ukraine mattered. Federal Reserve policy mattered. But Democrats should also admit that Biden-era fiscal policy helped increase inflationary pressure. I have seen little persuasive evidence that inflation was caused by corporate pricing policies, as the RootsAction report asserts, that cannot be explained by ordinary market conditions. The simpler explanation is also the more economically plausible one: demand was pushed up while supply was still constrained.

The impulse behind the transfers was politically understandable. The country had just been through a pandemic. Millions of households had experienced economic disruption. Democrats wanted to prevent hardship, sustain demand, and avoid repeating the too-slow recovery that followed the Great Recession.

But policy has to be judged not only by its intentions, but by its timing and consequences.

By 2021, the problem was no longer simply inadequate demand. Supply chains were still disrupted. Production capacity was constrained. Labor markets were unsettled. In that environment, aggressive transfers risked increasing demand faster than the economy could increase supply. More dollars were chasing goods and services that could not be produced or delivered quickly enough.

That is a classic recipe for inflation.

Federal Reserve research has emphasized that post-pandemic inflation reflected the interaction of supply and demand forces. A 2025 Federal Reserve paper summarized the evidence by noting that demand factors became more relevant in 2021 and 2022, while supply factors also remained important. New York Fed research likewise estimated that aggregate demand shocks explained a large share of model-based inflation from late 2019 through mid-2022, with fiscal stimulus contributing significantly to that demand effect. San Francisco Fed research found that global supply-chain disruptions also contributed substantially to the run-up in inflation.

This does not mean that every dollar of inflation was caused by Biden’s policies. It was not. But Democrats too often spoke as if inflation were something that happened to them, rather than something their own policy choices helped aggravate.

Voters noticed the prices. They noticed the explanations. And they were not wrong to conclude that the people in power seemed surprised by an outcome that should have been easier to anticipate.

Inflation is not an abstract statistic to most voters. It is the grocery bill. It is rent. It is a car payment. It is the feeling that even a decent raise does not get you ahead. For working- and middle-class voters, inflation feels like betrayal by the governing class, especially when that class appears to dismiss their concerns as temporary, technical, or exaggerated.

Pointing to lower inflation numbers as success only exacerbated the political problem. People were upset because prices were so much higher than they had been, not merely because the current rate of inflation remained too high. Bringing the rate of inflation down was a real success, but failing to realize that was not what people were upset about was politically obtuse.

That is why the inflation mistake matters so much. It was not just an economic problem. It was a trust problem.

Biden Ran as a Moderate but Governed with the Progressive Coalition

Another issue the progressive autopsy avoids is the gap between Biden’s 2020 campaign image and the governing coalition that emerged afterward.

Biden won in 2020 largely as a reassuring, experienced, moderate Democrat. Many voters did not choose him because they wanted a progressive transformation of American politics. They chose him because they wanted Trump gone and because Biden seemed normal, decent, and comparatively centrist.

But once in office, Biden often governed as if the progressive wing had to be appeased at every turn. That does not mean every Biden policy was progressive or that progressives got everything they wanted. They did not. But the administration’s language, staffing, and policy instincts often seemed more aligned with activist priorities than with the moderate image Biden had projected in 2020.

That created a problem of expectations.

Some voters who supported Biden as a stabilizing centrist felt they had instead gotten a party preoccupied with immigration permissiveness, DEI rhetoric, aggressive spending, and cultural issues they did not understand or share.

The progressive autopsy treats this as a failure to mobilize the base. Centrists and independents should see something else: a failure to respect the voters who gave Biden his winning coalition in the first place.

The Working-Class Message Democrats Missed

The common thread is not that Democrats should become Republicans. They should not. Trumpism remains reckless, dishonest, divisive, and institutionally dangerous.

The lesson is that Democrats need to stop assuming every loss proves they should move further left.

Working-class voters did not need a lecture on ideological purity. They needed a party that understood their daily pressures. Many concluded that Democrats had been foolish on immigration, overly absorbed in DEI rhetoric, culturally distant, and at least partly responsible for inflation that hurt them badly.

AP VoteCast found that voters focused on the economy broke strongly for Trump, reflecting deep anxiety about an economy that, despite growth, many voters felt was not meeting the needs of the middle class. That finding should discipline every post-election theory. If an autopsy does not take inflation, affordability, immigration, and cultural alienation seriously, it is not really an autopsy. It is a factional argument.

That is the problem with the progressive report. It identifies some real wounds, but it avoids others because those wounds implicate progressive assumptions.

What a Serious Autopsy Would Say

A serious Democratic autopsy would say something like this:

Biden should have stepped aside earlier.

Democrats had a real problem with young voters, especially young men.

Gaza mattered to some voters, but it was not a significant reason most working- and middle-class voters moved away from Democrats.

Immigration disorder badly damaged the party’s credibility.

The “they/them” ad worked because Democrats had allowed themselves to be defined by unpopular cultural signals.

Biden-era fiscal stimulus was understandable in motive but excessive or poorly timed given supply constraints, and it contributed to inflationary pressure.

Biden ran as a moderate but governed too often as the head of a coalition trying to placate progressives.

And working-class voters concluded, not irrationally, that Democrats did not understand their lives.

That is the autopsy Democrats need. It is also the autopsy many progressives do not want.

The Centrist Lesson

For centrists and independents, the lesson is simple: voters are not ideological props.

They are allowed to have mixed views. They are allowed to want legal immigration and border security. They are allowed to support equal rights while resisting cultural coercion. They are allowed to appreciate government help during a crisis while objecting to inflation afterward. They are allowed to worry about discrimination and also dislike DEI rhetoric that sounds accusatory or unfair.

Good policy must be economically efficient, fair, respectful of personal freedom, and politically realistic. That standard is harder than slogans. It requires tradeoffs. It requires listening. It requires admitting when your own side made mistakes.

Trump has been a terrible president across so many different dimensions, and his personal conduct should have made him easy to defeat. Democrats’ failure to do so says something very powerful about the Democratic Party.

The progressive autopsy asks Democrats to believe that the party mostly failed because it lacked the courage to move left.

The evidence suggests a more uncomfortable conclusion: Democrats lost many voters because they stopped hearing them.

And a politics that cannot hear voters clearly will keep misunderstanding the country.

Should Inflation Be the Dominant Election Issue in 2022?

Both Republicans and Democrats talk about inflation. Neither has anything useful to say.

A number of political analysts have observed that inflation has displaced other issues as the dominant issue in this election cycle. That may well be true, but should it be?

The left at first tried to dismiss inflation as transitory. When that was clearly false, some said inflation is not that harmful. When voters clearly appeared to believe that inflation matters, the left switched to “it’s not our fault,” citing high levels of inflation in many other countries and blaming supply chain disruptions and Russia’s war against Ukraine.

The last of these has at least a little bit of merit, but there are many low inflation countries that suffered from these same problems. The unifying feature of economies with high inflation is loose monetary and aggressive fiscal policies to combat the Covid induced recession.

Republicans certainly share the blame for loose monetary policy. Political pressure from both parties has encouraged the Fed to keep interest rates far too low for far too long. Other countries have experienced a similar dynamic to varying degrees. Democrats bear most of the blame for just how aggressive fiscal policy has become, but Republicans share some of the blame for actions taken during the Trump administration.

Democrats say that Republicans complain about inflation but offer no solutions. On that the Democrats have a point. The Democrats offer solutions, that aren’t solutions. The “Inflation Reduction Act” was about climate change subsidies. Most economists agree its role in terms of inflation will be minimal. Student loan forgiveness is a wealth transfer. If unfunded through tax increases on someone, student loan forgiveness will just make inflation worse in the long term. Price controls on drug prices, like all price controls, just make markets less efficient. Real reform here would require U.S. drug companies that receive U.S. patent protection grant “most favored nation” status to U.S. consumers. Under this rule drug companies would be free to set prices, but they could not charge any U.S. consumer, including Medicare, any more than the least expensive price they charge outside the U.S. This would be good public policy, but it has nothing to do with inflation.

What is inflation?

Remember, inflation is a rise in the general price level. Higher or lower prices for individual commodities are not inflationary or deflationary. For example, in the absence of accommodating monetary policy, higher energy prices just mean lower prices for other goods (or recession, but that requires a much longer discussion).

What would help?

So what should both parties be saying on inflation. First, it is a serious problem. Second, the Fed is doing the right thing by raising interest rates, and we (the politicians) will avoid pressing the Fed to back off before the job is complete. Third, if elected we (the politicians) will not make the Feds job harder by cutting taxes or increasing spending.

What role should inflation play in the mid-term elections?

Neither party is saying anything like that. So from my perspective, inflation is not an issue for the mid-terms. Maybe it should be, but it certainly does not help me decide on who to vote for. In any case, we will have divided government for the next two years, even if the Republicans gain both the House and the Senate, since Biden is President. Divided government means that we are unlikely to see either tax cuts or major spending legislation. That may be the best we can hope for since it will make the Feds job easier.

If not inflation, what issues should drive the election?

Vote on abortion rights, there are clear choices to choose from, no matter where you stand. Vote on preserving democracy and election integrity, there are clear choices. Vote on America’s commitment to NATO and the defense of Ukraine against Russia, there are clear choices. Vote on climate change or energy security, there are clear choices.

But please don’t vote on inflation. There is no party that offers a good answer here.

What is in the “Inflation Reduction Act” of 2022? Is it a Good Thing?

Truth in Labeling

First, let’s all admit the “Inflation Reduction Act” of 2022 (IRA) has virtually nothing to do with controlling inflation. Whatever its merits or failures are, they are not about controlling inflation. The name of the act is shameless marketing. The non-partisan Congressional Budget Office estimated the Act’s effect on future prices to be between +0.1% and -0.1%. Some news sources have been referring to the IRA, more accurately, as the climate, health care, and tax act or something similar. Although a number of economists support this legislation, I am unaware of any serious economist who believes that the IRA will have a meaningful impact on inflation. However, for simplicity I will refer to it as the “IRA,” but don’t be fooled.

Climate Legislation

The IRA has a number of subsidies, tax credits, and regulatory incentives to encourage faster adoption of electric and hydrogen cars. It has incentives for rapid development of solar, wind, and nuclear power. It also provides for subsidized loans to encourage consumers to buy various kinds of equipment to reduce their use of energy and/or carbon emissions. Finally, it includes subsidies to make existing energy production, including fossil energy, cleaner.

The Bargain with Manchin

In order to get this package of incentives past Sen. Joe Manchin (D) of West Virginia, Sen. Chuck Schumer (D-NY), the Democratic Majority Leader in the Senate, had to facilitate additional fossil fuel production through promises about federal lease sales and facilitating future build out of energy infrastructure. The fulfillment of these promises is dependent upon separate legislation that could not be passed as part of the reconciliation process. This energy infrastructure legislation faces threats from both the right and the left.

If Sen. Manchin’s quid-pro-quo for supporting the IRA, a separate bill facilitating faster build out of energy infrastructure is passed, that would be a good thing. If it fails because of resistance from progressive environmentalists, we should expect to see a new Republican senator from West Virginia in a few years. If it fails because of mean-spirited resistance from Republican senators, maybe we will end up with two Democratic senators from West Virginia.

Are the Climate Provisions Good Public Policy?

None of the climate change legislation in the IRA is especially bad and some of it may be good, but all of it is suboptimal when compared to a carbon tax and tariff system. Such a system would not only be more efficient in reducing green house gas emissions, it would also have provided a new source of government revenue. If the government did not turn around and spend those additional funds on new programs but simply used them to reduce the deficit, this approach might actually reduce inflation. (But that is a more complicated issue best addressed elsewhere.)

Are the IRA’s climate provisions better than nothing? The climate change provisions, while suboptimal, will encourage the deployment of electric vehicles and electric vehicle infrastructure. These climate change provisions will also encourage the development of solar, wind, and nuclear energy production which will all certainly play a part in addressing climate change in the long run.

We can only hope that, in the not too far distant future, these kinds of credit and subsidy approaches will be replaced by a broad based carbon tax and tariff approach. If this happens, the capital investments encouraged by the IRA will not have been wasted. Unfortunately, the costs of these investments will be born disproportionately by the general taxpayer rather than carbon consumers. In addition, uncountable other activities that would have contributed to reducing carbon emissions under a broad based tax and tariff plan will have been passed over by focusing on a few governmentally favored solutions.

Health Care Legislation

Extending Subsidies Under the Affordable Care Act

The IRA would extend, for three years, the Affordable Care Act subsidies that were included in the 2021 American Rescue Plan. Subsidies are wealth transfers. They are not anti-inflationary. The right level of subsidy for health care insurance is a legitimate area for debate. I would be more inclined to support larger subsidies for ACA premiums, if they were matched with higher deductibles and co-pays. For more on this question visit the Centrist Independent Voter’s policy position on Health Care.

Allowing Medicare to “Negotiate” Drug Prices

For those of you who think that the IRA fights inflation by controlling health care costs, please remember subsidies and price controls do not lower prices. Subsidies and price controls simply hide costs or shift them to other consumers or to the taxpayer.

Giving the government the ability to “negotiate” prices with drug companies is really just a kind of price control. In this case, the government’s ability to “negotiate” arises because it can forbid drug companies from charging more than the government’s offered price for the drugs. Without that, the government’s offer to pay, say $100/dose, might be met with “fine pay what you want, but we (the drug companies) are going to charge the patient $500.” The government “negotiation” only works because it can prevent the drug company from charging the patient any more than the government offer.

This is not to say that giving Medicare the ability to negotiate prices with pharmaceutical companies is a bad thing. Within limits, it might be a good thing. But follow the process through. (I am ignoring co-pays here for simplicity.) Let’s assume that Medicare says that it will only pay $100 for a given drug and the drug company is forbidden from selling the drug to Medicare patients for any more than $100. The drug company has a number of choices, it can: 1) accept that price and produce as much as is demanded at that price; or 2) it can accept that price, but limit the amount of the drug that it produces, creating shortages and possibly black markets; or 3) it can simply refuse to sell the drug to Medicare patients at all.

The challenge for the government is to figure out the price that will induce the drug company to provide the amount demanded at that price. This is not always an easy thing to do, but it can be done. The challenge for the drug company in these negotiations will be to persuade the government that, absent a higher price, the company will choose option 2 or 3 above.

The drug company also has a choice to make about investments in research on future drugs. Drugs that are likely to face enormous demand, if successful, may well be developed normally even in the face of possible limits on prices imposed by Medicare. But research on drugs with more limited potential demand may simply not receive funding. This has been the case pushed by the pharmaceutical industry, and it has at least a little bit of merit. If the government uses its power under the IRA aggressively, it may lower the price on drugs in the short run, but choke off the supply of many new drugs in the future.

International Equity in Funding Drug Research

For a long time, U.S. consumers have been providing benefits to drug consumers in other countries. The highly profitable market in the U.S. encouraged the development of new drugs and Canadian, European and other consumers benefited by being able to buy those drugs at substantially lower prices. The best policy for Medicare, in the long run, might be to demand “most favored nation status.” That would mean that drug companies could not charge Medicare patients any more than the lowest price that they charge in any other developed country. This will discourage U.S. drug companies from offering drugs at heavily discounted prices outside of the U.S. Most favored nation treatments will, therefore, not result in U.S. consumers paying the current heavily discounted prices that many non-U.S. customers now get. It will result in higher prices outside of the U.S. and lower, but equivalent, prices in the U.S. In this way, the burden of supporting the development of future drugs will be more equitably shared across the developed world.

Capping Out-of-Pocket Drug Costs for Medicare Recipients

Similarly, capping out-of-pocket costs for those on Part D of Medicare does not curb inflation. It simply shifts the costs of these drugs to others. How does that happen? Drug companies confronted with the out-of-pocket cap will simply raise the premium for all those insured under their plans. This is not collusion. It will be driven by the underlying economics in the presence of the cap. The losers will be those people who opted for low cost “catastrophic coverage” plans and were never confronted with the need for expensive drugs. In the face of higher premiums, some people may forego Part D drug plans altogether. Is this good public policy? I don’t know; I much prefer the current situation in which individuals can choose the amount of risk they are willing to take.

The provisions for capping out-of-pocket costs are a wealth transfer plan between various low and middle income people. The only unambiguously bad thing about this plan is that it will probably discourage some people from carrying any Part D drug coverage.

Tax Law Changes

Without the changes in the tax law incorporated in the IRA, it could have been called the Inflation, Climate, and Health Care Act. If the spending on climate and health care incorporated in the IRA had not been accompanied by higher tax revenues, it would have constituted stimulative fiscal policy. Stimulative fiscal policy, in the face of a fixed monetary policy, is inflationary. If one accepts the wisdom of the climate and health care aspects of IRA, one has to conclude that increasing tax revenues was a good idea. But what about the way in which tax revenues were increased? Did those make sense, relative to other alternatives?

The Carried Interest Provision

One thing that was stripped from the bill at the insistence of Sen. Kyrsten Sinema (D-AZ), was the taxation of capital gains as ordinary income in the case of private equity managers. Taxing capital gains at a lower rate than ordinary income makes sense on a number of grounds that I won’t go into here. However, the carried interest compensation that private equity managers receive is much more analogous to ordinary income than it is to a capital gain on an investment. I think leaving the carried interest provision in the act would have improved the IRA.

Minimum Corporate Income Tax

Progressive Democrats love to rail against large corporations that pay no or little taxes in some years. They rarely mention the reasons why these corporations pay low taxes. The reasons for low or no taxes can include massive losses accumulated over years. These corporations may also have lowered their taxes by taking advantage of tax credits and accelerated depreciation supported by the very same progressive Democrats. To fix the offensive optics of large corporations paying low taxes in some years, the IRA provides a “book” based minimum tax system.

To understand this, one must realize that Generally Accepted Accounting Principles (GAAP) differ from the accounting rules used to calculate corporate income taxes. Reported corporate income is calculated using GAAP. Taxes are based using a different set of rules that generally result in lower taxable income because of things like accelerated depreciation and tax credits. I have not read the details of the bill, at this time, but I am guessing that, like the Alternative Minimum Tax for individuals, the Corporate Minimum Tax allows firms to roll forward their Alternative Minimum Tax payments as credits for future years. In large part, this results in front loading tax revenue, increasing it in the near term but lowering it in the future. If one focuses on the first ten years following adoption (as many analysts do), this aspect of the act will overstate the amount of revenues raised.

In response to complaints that the alternative minimum tax would hurt manufacturing, the Democrats allowed “manufacturers” to retain accelerated depreciation. This of course means that corporations must maintain essentially three sets of books. One set based on GAAP for SEC reporting purposes, one based on the regular tax code, and one based on a complicated hybrid of GAAP and tax accounting rules.

This is all incredibly complicated and largely pointless. In fact, the minimum corporate tax undermines the effectiveness of many of the tax credits included in the IRA to help on climate change.

Taxation of Stock Buybacks

The IRA includes a 1% excise tax on stock buybacks. Stock buybacks used to be considered a tax efficient way for corporations to return money to shareholders. It was tax efficient because it returned money to shareholders in the form of capital gains rather than as dividends which were taxed as ordinary income. Now that corporate dividends are typically treated as Qualified Dividends for tax purposes and receive the same treatment as capital gains, this is a moot point. Progressives, like Sen. Elizabeth Warren (D-MA), continue to complain about stock buybacks for reasons that elude me. All this accomplishes is to push corporations to return money to shareholders in the form of dividends. I expect that the Democrats are counting the revenue from this tax as part of their fiscal restraint. In all likelihood, there will be little to no revenue raised by this tax.

Fossil Fuel Taxes

The IRA imposes a number of taxes on fossil fuels. Some of these may make sense, but they are definitely suboptimal when compared to a broad based carbon tax. Some of these taxes are reasonable apart from their climate effects, such as making permanent an excise tax on coal mining that is the chief source of funding for the Black Lung Disability Trust Fund.

Additional Funding for the IRS

The IRA provides some funding to improve the audit capabilities of the IRS. I think this is a good thing, although some of the money will be wasted on ensuring compliance with the new Corporate Alternative Minimum Tax.

Obviously, we need to carefully monitor the IRS to ensure that it does not use its considerable powers to target political enemies. Nevertheless, our tax system is dependent on voluntary compliance and a robust audit capability helps to encourage that voluntary compliance.

Are the Tax Law Changes Good Public Policy?

In terms of taxation, I would have preferred a broad based carbon tax and tariff approach. Absent that, I would have preferred they leave in the carried interest provisions and accomplished the rest of the revenue gain with an across the board increase in all marginal tax rates both personal and corporate.

The best that can be said for the tax policies in the IRA is that these taxes finance the subsidies and tax credits in the act with some kind of tax revenue. That is at least better than the half hearted attempts to claim fiscal neutrality in the original Build Back Better plan.

The Bottom Line

If I had been presented with the IRA and told that I had a choice between it and nothing, I would have supported it. It is sad that it is our only choice.

Invitation for Comments

Finally, I have not had time to read the entire act and this analysis was prepared based on a number of summaries of the act. If the reader is aware of any inaccuracies, please let me know by commenting below. If there are any aspects of the IRA not mentioned here that you would like to address, please do so in the comment area below.

Inflation: What Should the Fed Do and How Far Should It Go?

U.S. Federal Reserve Bank

Inflation is about Monetary Policy

Inflation appears to be at the top of everyone’s mind lately. That is understandable given that current inflation rates are at 40 year highs. It is likely to play a major role in determining the outcome of the 2022 mid-term elections, despite the fact that there is much bi-partisan blame to be parceled out for the current high rates of inflation. There are, also, a lot of silly proposals on the table for combating it, e.g. price controls and gas tax holidays. There are also some ideas that may be reasonable policy suggestions, in their own right, but have nothing to do with inflation, e.g. lowering tariffs, allowing Medicare to negotiate some drug prices, or facilitating more domestic energy production.

Milton Friedman, a Noble prize winning economist famous for his work on monetary theory and policy, said that “inflation is always and everywhere a monetary phenomenon.” Things like supply chain problems, higher oil and gas prices, Russia’s invasion of Ukraine, the rapid snap back from the Covid 19 induced recession, and aggressive fiscal policy did play a role. They helped to kick start the current inflation, but in the absence of accommodating monetary policy they would not have caused persistent inflation.

The Theory

In theory, all of the above would have resulted in some things becoming more expensive. Absent monetary accommodation, these price increases would have been accompanied by declining prices for other goods and services. If those price declines did not materialize, because of “sticky wages and prices” we would have seen a recession until the under-employment of labor and other resources forced a relative price adjustment.

Evidence Backing the Theory

Those who think this is just theory should take a look at the inflation rates in Switzerland. The inflation rate in Switzerland (3.4%) is about half that of the rest of Europe (8.6%), yet virtually all of the litany of other factors listed above were present for Switzerland. What is different? Switzerland does not use the Euro and Switzerland’s monetary policy is not controlled by the European Central Bank (the European version of the Fed). Also of note is Turkey, which runs its own, extremely loose, monetary policy and has an inflation rate of 78.6%.

The History: The Fed, The Energy Crisis, and Monetary Policy in the 1970’s

In the 1970’s the Federal Reserve Board attempted to avert a recession, in the aftermath of that decade’s oil price shocks, by expanding the money supply. The idea was to produce just enough inflation so that wages and prices for non-energy intensive goods could decline in real terms (but stay constant in nominal terms) while prices in energy intensive industries could increase in real and nominal terms. Done just right this results in mild inflation and no recession. Sadly, the strategy is nearly impossible to execute properly. The problem is that inflation, once started is devilishly difficult to stop. The result was the “stagflation” of the 1970’s, high inflation and low growth. It was not until Paul Volcker really put the screws to the system, in the early 1980’s, and drove interest rates over 20%, that inflation was finally crushed.

What Should the Fed Do Now?

The policy solution is straight forward, if somewhat distasteful. The Fed needs to reduce the rate of growth of the money supply and quickly raise real interest rates with all of the tools it has at its disposal.

Calculation of Real Interest Rates

Real interest rates are the difference between the nominal interest rate and the expected rate of inflation.

The 10 Year Real Interest Rate

In calculating real interest rates it is important to subtract an estimate of inflationary expectations rather than a historical inflation rate, like the CPI, from current interest rates. The problem with using calculated measures of inflation, like the Consumer Price Index (CPI), is that they are backward looking and the current interest rate is forward looking. If we use the current nominal yield on 10 year Treasuries of 2.9% and the Federal Reserve Bank of St. Louis’ estimate of average inflationary expectations over 10 years of 2.34%, the real 10 year interest rate is 0.56% (2.9 minus 2.34), or nearly zero.

The Short Term Real Interest Rate

If we use the New York Fed’s estimate of 12 month forward inflationary expectations of 6.8%, the real short-term (one year) interest rate is -3.8% based on the current nominal yield on Treasuries of about 3%.

However you look at it, real interest rates, despite recent Fed action, are still either extremely low or significantly negative.

What Should the Target Be?

How high should the Fed push real interest rates? Reasonable people can disagree about the target and the speed for getting there. My own preference would be to see real short-term (1 year) interest rates at about 1-2% and long term (10-30 year) real rates of 3-4%. Getting there will require nominal interest rates in the high single digits or possibly higher. I am not sure what the appropriate speed should be to reach this target but I am sure that it is faster than the Fed is currently moving.

Will this Mean a Recession?

Maybe, but the longer we wait before trying to bring inflation down, the deeper and longer lasting the recession will be. We have already waited too long.