Kevin Hassett (Former CEA Chairman and Hoover Institution Distinguished Fellow) joins the podcast to discuss his career, the legacy of the Tax Cuts and Jobs Act (TCJA), including corporate tax reform and opportunity zones, the Trump administration's response to COVID-19 in the CARES Act, inflation, and the ongoing debt limit standoff.
Jon: “This is the Capitalism and Freedom of the 21st Century podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Today, I'm joined by Kevin Hassett, an economist who is a Distinguished Fellow at the Hoover Institution at Stanford University. Kevin previously worked at AEI, where he is the Head of Economic Studies, and he recently served as Chairman of the Council of Economic Advisors in the Trump Administration from 2017 to 2019, and then returned in 2020 after the COVID-19 pandemic outbreak as the Senior Advisor to Head of the Economic Response at the Administration to COVID-19. He's also very highly cited in the public finance literature and has written some of the most cited empirical papers on corporate taxation. Welcome, Kevin.”
Kevin: “It's great to be here, Jon.”
Jon: “So, Kevin, I want to talk a little bit about where you grew up. You grew up in Boston, and you're also quite the athlete. How did you first get interested in economics?”
Kevin: “Yeah, actually, I lived outside of Boston quite a bit. I grew up in a town called Greenfield, which is right sort of on the Connecticut River, where Vermont meets New Hampshire meets Massachusetts, just about. And I grew up in a town that was previously great. It's right next to Terns Falls, which is the largest drop on the Connecticut River to serious waterfall. And so, it was basically the hydroelectric center of American industry. And there were all these factories that used to be there when they had a huge competitive advantage because they could generate power with the waterfall. And so, for example, International Paper's first factory was in Terns Falls. And there's this really famous tool company, the Greenfield Tabernacle. So, we had hydro power that made the economy great in the late 1800s and the early 1900s. And I grew up in a place where it was basically a ghost town. All the factories closed. Everybody was a distressed community-type person, the kind of person that maybe a case in Deaton would write about, about what happens when a factory closes. And so, I sort of grew up wondering, like, what happened to my town? Like, why is it that it went from being, like, the center of the economic universe for the U.S. to being a ghost town? And the metric of the ghost town, by the way, the Terns Falls actual burnout factories were used as a set. Like, they brought in cameras and everything for the video game Fallout.”
Jon: “Oh, wow.”
Kevin: “So you can imagine, like, when you're growing up and you're seeing this stuff and you're watching, you know, your sister's friends graduate high school and not get a job and so on. Then when I went off to college, I was just, like, super curious about economics. And then I found when I took the classes at Swarthmore that the professors were really wonderful. Like, Mark Kuperberg is a macroeconomist. Bernie Safran, who wrote the sort of ending column in the Journal of Economic Perspectives about, like, what people should read that's interesting this month, at the very dawn of that journal. And so, I was surrounded by incredibly talented economists, and it really lit a fire under me. And so, I went. I'm one of those people who, like, don't exist anymore. I went straight to grad school. So right when I graduated from Swarthmore, I went to the University of Pennsylvania.”
Jon: “Wow. It's amazing that you've seen the China shock and the effects of automation up close and near in your hometown. So you were, after graduating from Penn, where you were an Aurovac student, you were faculty at Columbia. You worked at the Professor Board of Governors. You led economic studies at AEI. And you were also chair of the Board of Academic Advisors at the Economic Innovation Group, EIG, where you helped conceive the idea of opportunity zones, something that would later be written into law in the Tax Cuts and Jobs Act, which we passed while you were there. I want to get a little bit, while you were TA chair in the early comp years, I'm curious, like, let's get into the Tax Cuts and Jobs Act a bit. Can you tell us a bit about what it was like, the conception of it? You know, it normally cut the corporate tax rate from 35% to 21%. Some of you are most qualified to work. It analyzes the impact of corporate tax rates on investment. How did the whole, how did it come together, and what do you think its legacy is here now five years out?”
Kevin: “Sure. Well, basically what happened was that we had a, you know, group that included at the time Gary Cohn and Steven Mnuchin and myself and Mick Mulvaney were the main sort of economic team in the White House at that time. And, you know, we put together working groups to develop ideas and to model what if we do this, what if we do that. We presented the president with options and then began negotiations with people on the Hill. And we could sort of say, we want this and this. And they would say, well, you can't have that, but what about this thing? And the negotiations were pretty complex. Like, in order to get Marco Rubio's vote, we had to expand the child credit probably more than we wanted to at the beginning and so on. But the thing evolved in, you know, the political arena. But it began with a lot of, you know, careful study. And as you mentioned, a big chunk of the study was on the impact of the corporate tax cuts that we were advocating and the impact, especially, of those tax cuts on American workers, which is a literature that I think really kind of began with a paper that Aparna Mehta and I wrote a while ago that showed that corporate tax cuts help blue-collar workers. And President Trump actually really embraced the result from our paper, which was that corporate tax cuts lift blue-collar wages quite a bit. And we did a lit review at the CEA when we put out our estimates of what would happen if we passed the tax cuts that said that the typical wage would go up in three to five years by $4,000 to $8,000. And President Trump, at this point, at least just one time in his life where he was being cautious, he said, let's not take the high number. Let's take the low number. And he went out, and you might remember the $4,000 improvement in wages was like one of the main points, selling points that he cited over and over in speeches. And it was attacked by a lot of people who thought the effect seemed too large but hadn't actually read the literature to see that it was an empirically based thing. A lot of false things were said. One left-wing economist said that we are only citing papers that weren't peer-reviewed, and then we went back and put a star next to the peer-reviewed papers. And I think there were like a dozen of them or something like that that had the effect. So anyway, if you go back and look at what happened afterwards, we basically had two presidents, Bush and Obama, where there really was almost no wage growth whatsoever over that entire period. And the wage that we targeted and did the $4,000 estimate for increased by a little more than $6,000 up until right before COVID. And then if you look when President Trump left office, then the increase even after the COVID recession was north of $4,000. And so, I think the tax cuts worked about the way that we expected. There was a big increase in the ratio of investment to capital stock, and that fed through to productivity of wages just the way economic theory would say it would. Critics—”
Jon: “In the proof of evidence from what you wrote in the early 90s as well with Jason Cummings and Glenn Humble looking at past tax reforms prior to that.”
Kevin: “Right. So, it's very, very similar to the response of previous tax cuts or the economy to previous tax cuts. So again, there was an old literature that I participated in, which we could talk about if you'd like. And then there's a modern literature where people use a narrative approach to find the effect of tax cuts on the economy, a narrative approach. Yeah, the way I think about a narrative approach is—this goes back to my dissertation even—that when I started studying corporate taxes when I was in grad school, then everybody believed that the cost of capital, which is the channel through which taxes affect corporate investment, had no effect. Everybody thought the estimate of the effect of the cost of capital was zero. And the Bookings papers were filled with papers that documented that that was true. But when I looked at what they were doing, it struck me that what they were doing was fundamentally wrong because what happened in post-war history, beginning with John F. Kennedy, who was a really underappreciated, brilliant supply-side president, by the way. But what happened was—”
Jon: “He couldn't lower a whole book. Indeed. JFK and the Reagan Revolution.”
Kevin: “That's right. That's right. And the point is just that he introduced the investment tax credit back then, which sort of became accelerated depreciation or expensing.
Jon: “And he cut the top rate, too.”
Kevin: “And he cut the top rate.”
Jon: “70 percent until Reagan cut it again. And I think there's another book, JFK Conservative, too.”
Kevin: “He was a great man and a terrible loss for our country. So anyway, what would happen would be that we'd have a recession, and then people would basically take a play out of the JFK playbook and say, well, we should have an investment tax credit. And then we'd get out of the recession, and then they'd say, well, we don't need it anymore. And so, what would happen would be in recessions, we actually had tax policy that stimulates investment. And outside of recessions, we had tax policy that doesn't add extra hope to investment. And then if you're like naive 1970s macroeconomist writing for the Brookings Papers, then you just run the regression. You just correlate tax policy and investment, and you find that you get the wrong sign. The investment tends to go up in times because the investment goes up, if there's a general economic boom and goes down in a recession, it tends to go up in times when there's no tax subsidy for it. And that was the puzzle that I sort of set myself with my co-authors when I was in graduate school. It's like, how do we solve that? And what we did back then is that we decided that that sort of endogeneity of policy, the fact that it was responding to recessions, surely is like a big effect for the aggregate number. But there's a different cost of capital for every type of asset that depends on its asset life and depreciation rules and so on. And so, the cost of capital for a car will be different than the cost of capital for, you know, a power plant. And that, you know, our identifying assumption was basically the cross-section difference in the effect of a tax reform on this asset versus that asset. That asset was, like, too mathematical for it to be endogenous because the politicians surely wouldn't understand, you know, what effect they're having through all the formulas that Alan Auerbach and I derived. And so, therefore, we can actually look at the correlation and it would be meaningful. And when we did that in a series of papers that have now been cited a whole bunch of times, we found that the effect of the cost of capital on investment was about what, you know, the basic fundamental economic theory model of the Cobb-Douglas production function would predict. And that was that literature. Subsequently, Ricardo Caballero at MIT tried it a different way, found about the same effect. But then there was this really innovative literature by Christie and David Romer, started by them but then absolutely, you know, expanded into numerous papers by authors from all over the world where they basically said, well, one way to tell whether something is like an endogenous policy or exogenous policy is to look at the floor debate and what does Congress think they're doing, and so... And so, if you pass a tax cut and then everybody's saying, we need to do this because we're entering a recession, then you would call that an endogenous policy. But if they're passing a tax cut because, you know, somebody just ran for president arguing for tax reform or something, then maybe that's an exogenous policy. And they find that when they look only at the exogenous variation, so they're fixing this effect that I noticed when I was in grad school, then they get about the same estimates that we got. And so, so I think that when you've got, like, replication, like, Cavalier doing it a different way, and then the modern narrative approach doing it a different way, as you do something lots of different ways that each have a plausible story behind them and you get the same answer, then you should start to have a great deal of confidence in that answer as a scientist. And for me, like, the disappointment of the economic debate at that time is there's so much of the economic profession is just, you know, basically a pure partisan democratic profession now, that even though the literature quite decisively said that the effects would have, that the effects would be what CDA was reporting, that they were being attacked, you know, in an ad hominem fashion, often by the Congress from all over the country, who hadn't clearly read the literature. And, you know, that was a disappointment for me, because I think that, you know, it's really important for economists to read the literature and then give an honest take. And the fact that, you know, there are papers, the last four or five years of the very top journals, the American Economic Review and the Quarterly Journal of Economics and so on, that confirm, you know, our results from way back when, and then you're actually citing papers from the top journals and then being accused of being unprofessional. And so, I'd, you know, suggest that our profession runs the risk of, you know, going off the rails the way the rest of society has and becoming, like, divorced from science and unconnected to data. “
Jon: “And it's just so fascinating. You were there at the very beginning of the credibility revolution. You know, your papers with Glenn Hubbard and Jason Cummins, looking at tax reforms as natural experiments and looking at the effects on investment and sort of testing this hypothesis about a Q theory of investment. That was written even before the, you know, Carter Cooker paper. I think it was around that same time. So, I think, you know, it's, it's fantastic work. And I certainly have my own biases towards well-identified studies. But I feel like that was very, very early in this, or since then, you know, a tidal wave of complete change in the profession from sort of not well identified theory and empirical work, certainly in macro and public finance, to a field now, you know, labor economics and public finance are almost entirely heavily well-identified applied macro fields. And I think this, you helped set that changing.”
Kevin: “And thank you. And I would actually like to bring in another paper, too, that I wrote with Jason Cummins and Steve Ulmer, that is a completely different story. And I think it's a really interesting one. And I think it's a completely different story. But I think that it highlights sort of the evolution that you're talking about. And it's another case that I think is a nice example for people in graduate school who are thinking about, like, how do I come up with an idea of paper? And then, and then so basically, if you look at a paper, then wonder why the result exists, then the thing that made me go into the natural experiment paper and develop natural experiments was that ultimately, in a prior belief that could be wrong, that the responsiveness to tax policy for companies can't be zero. And the reason I thought this was actually that I think that, like, for human beings, that, you know, you could have a tax policy that does this or that to our labor income. And then we could respond to it, you know, the way homo economicus would, the way a purely rational economically trade person would, or we could respond to it the way a mentally ill person does or somewhere in between. And there's nothing that's going to make us not exist anymore. And so, humans, I sort of came into it with almost like a belief that I'm never going to study consumption behavior, because I don’t, I don't necessarily know that economics is going to be helpful for understanding what people do, because people aren't like put out of business if they don't do the right thing. But a business, suppose you have two businesses, one that responds rationally to tax policy, the way economic economists model it, and the other one that doesn't, then the one that doesn't should be run out of business. And so, if we're looking at businesses, then it ought to be the sort of Darwinian forces make it so that they act in response to the tax cuts the way I sort of believed that they did. And so, I started to wonder, well, if it's not zero, what are they getting wrong? And that's where we got the story that you and I just said. But there was another one of those that basically became a paper, this published peer-reviewed paper in the American Economic Review that's also been, I think, maybe even more influential than that paper because it was co-authored with Jason Cummins and Steve Older, and it was very much related because one of the things that people did, in addition to looking at tax policy, is they looked at Tobin's Q. And Tobin's Q, for those who haven't studied it, is just if you take the market value of the firm and divide it by what it would cost to rebuild the firm, then if the market value, as in like what it's worth if you could buy it in the stock market, is way above what it would cost to build such a firm, then somebody could come in and replicate that. So, suppose that a firm, you could buy a hot dog stand for a dollar, but you could sell it on the market for two dollars, then you would buy hot dog stands and sell them until you basically got so that the market price was equal to what it cost to buy a hot dog stand, right? So, you'd get back to a market price that had to be driven down to a dollar. The way that would happen is we'd have a lot hotter dog stands, the hot dog salesmen would be competing with each other, their profits would go down, and so on. So that's the Tobin’s Q model. Well, at the same time, when I finished the cost of capital thing, and I really understood that, okay, now I think the cost of capital mattered. And by the way, it's incredibly controversial at the time to the enormous amount of abuse from other academics. We could talk about that as well, that they really invested in the old way of doing things. So, in this case, I'm thinking, okay, well, if the cost of capital matters, the way I say it, so firms are responding rationally to that. Well, there's this other end of the literature, completely different thing, where people look at the effect of Tobin's Q on investment. We just talked about why it should have an effect. If Tobin's Q is way bigger than one, then there ought to be more investment. And yet they were finding zero coefficients on Tobin's Q, and why is that? And then I looked at it and basically decided that there's a problem with the measure that people were using for Tobin's Q, which is just that the stock market has a lot of noise, right? In fact, you know, Bob Shiller won the Nobel Prize for talking about how there's like excess volatility in stock markets, because they respond to things other than fundamentals. They could get panicked today about maybe the risk of a new bank failure, and so on. So, everybody goes down 5%, and then they go up 5%. And so, if you try to predict like the investment behavior of a typical company with the stock market, which is fluctuating wildly, then unless investment behavior of companies like their property, plant and equipment investment fluctuates wildly, then you're going to find that the Tobin's Q has no effect. And so, what we did in the paper was to say, okay, so we got to come up with a way to, you know, basically sift out the measurement error fluctuation in the stock market and then estimate the impact of Tobin's Q, you know, basically controlling for that. And we got the very clever idea, which actually was kind of given to me in an econometrics class when I was in grad school by a brilliant econometrician named Robin Sickles. And the idea was that the stock market value of the FIRB is basically the present value, a discounted present value of how much money we think that they're going to be able to pay shareholders in the future or present discounted value of dividends, which is related in a way to the present discounted value of earnings or profits that they make, because in the end, they're going to pay the profits out to shareholders. And so that that's the thing that the market is supposed to be estimating. And our idea was, well, we have all these analysts that follow stocks, and then they tell you what their future earnings are going to be. And they give you a great deal of detail, they give you like the next five-year earnings, and then they tell you what the long run growth is. So, you can estimate the present value of earnings, or dividends, really, for firms based on what analysts say. And then you actually observe the expectation. So, you don't have to do any fancy rational expectations, econometrics, because you have like the expected future profits, which is what should affect the investment. And we found that when we did that, this is the really cool thing, that not only did we find like a Q effect that was like far away from zero, but it was almost exactly the same effect we got from looking at the natural experiments for tax cuts. And so then once again, you know, I became very, very convinced that okay, so we're doing it a different way. So, we've talked about two other different ways. Now we've got another one where we did it with Tobin's Q. And we also found that it worked for that. And so, you know, I'm highly confident that the analysis that we put in to designing the corporate tax cuts and the Tax Cuts and Jobs Act was based on an enormous amount of very careful science that's been peer reviewed, and widely cited. And, you know, I'm not surprised that what we saw in the data afterwards was exactly what we predicted, because it was based on so much hard evidence. The one last thing I'll say without filibustering is that there are people who say that the investment effect didn't happen. You've seen that. And so maybe some of our listeners have been exposed to those arguments. And I just want to respond to that and just anticipate that someone might be saying that if we were here taking questions. That basically what happened was that, and this was actually my doing, because I had been studying all these other tax reforms, that there's a problem that if I say, OK, I'm going to have an investment tax credit in January and it's October, then what can happen would be everybody's like, OK, well, I'm going to wait until January to invest. So, I get like a big tax credit. If I, do it in January right now, I get nothing. And so, what you need to do when there's an uncertain tax policy that might happen in order to not kick your economy potentially into recession because everybody wants to see, is you need to say, OK, well, if we have like, you know, expensing, which is like an investment tax credit, then it'll be retroactive to today, the day that we announce here's our bill. And so therefore, there's no reason for you to wait till January when the new tax law might come in. And so, you're not doing some kind of weird, massive distortion. So, one of the things that happened, though, is that we made the expensing retroactive to October, maybe September, I forget which month, but the corporate tax rate reduction, which was, you know, at the time, originally a proposal was a 20 percent rate reduction, was not backdated to the first time we announced it. And so, everybody expected, especially once the bill was passed, that the corporate tax rate would drop quite a bit in January. And so, the thing then is that if you buy a machine and you expense it, then the value of that expense is you subtract it from your profits before you pay tax. And so, if the tax rate is 35 percent, which it was, then if I buy a dollar machine, then I get 35 cents of a tax benefit. But if the tax rate is 21 percent and I spend a dollar on a machine, then I only get 21 cents tax benefit. And so, we had this quarter where people got a much bigger tax benefit actually before the tax cuts technically happened, because they were looking backward and the rate was coming in January. And so, what happened is the fourth quarter, right after the tax cuts passed, is there was this incredible investment boom because of this, because people saw that they had like a timing advantage to whack it into the fourth quarter while they could deduct it at 35 instead of 21. And so, you got this big surge in investment. And then it stayed, I thought it was going to go down in the first quarter, and then we're going to have all these news stories about how our tax cuts failed because of the newspapers. It's too complicated an effect for the guys that cover the economy. And so, I thought for sure that was going to happen, but actually it stayed high. And in the models that Alan Auerbach and I developed a long, long time ago about like how to think about the effect of taxes on investment, then what happens is the level of investment jumps. And so, you get much more investment than you need to offset depreciation of existing capital. And then the capital stock gradually grows up to be consistent with the new level investment, and for the investment to capital ratio equal to depreciation. And so, investment jumps and then stays there is what the model says should happen. And so, what happened was that in the fourth quarter we got the investment jump, and then it kind of stayed there and grew a little bit from there. But because the jump was in the fourth quarter, you see a lot of like partisan Democratic economists say that there wasn't an investment effect because they treat the control group, they add the fourth quarter to the control group, and say, well, let's look before and after the tax cuts, and then they date the tax cuts, you know, inaccurately to January 1. And so that's, but the argument I've seen that the tax cuts didn't have an effect, which I've even seen, by the way, at places you wouldn't expect, like the American Enterprise Institute, which used to actually, you know, care about free enterprise as far as I could tell. But at these places, they tend to make mistakes like that, like to do the control group inaccurately.”
Jon: “Fascinating. And I mean, it's interesting to hear just about all the evidence that sort of goes into, you know, showing the effects of corporate tax reductions on investment and talking about the narrative approach and talking about Tobin's Q and future cost of capital and using past reforms as netbook experiments, all early part of the credibility revolution, and you were a key part of that. It's amazing. Very few scholars, I think, get to both write seminal work in some field like you have in public finance and actually gone into policy and implemented that, you know, thinking about like Ben Bernanke, for example, who just won the Nobel Prize this past year, you know, wrote a lot about depressions and, you know, the Great Depression, and a lot about, you know, finance and the macroeconomy, and he certainly was there to apply a lot of his academic wisdom as Ped Chair, so I think it's almost analogous in the case of public finance with your career. I want to talk a little bit about some of the other aspects of DICJA, or the Tax Cuts and Jobs Act, which was passed just at the end of the first year of the Trump administration when you were Chair of the Council of Economic Advisers. What do you think the legacy is so far of Opportunity Zones? You know, we saw a lot of other things in the legislation as well. There were some changes in personal tax rates, some changes in capping the mortgage interest deduction, but I think the Opportunity Zones were one of those things that was really new, and certainly something that you had helped conceive well before, certainly, that tax reform was being considered, and before we even sort of knew Trump was president when the Innovation Results were first conceived. So, I'm curious, you know, looking sort of five years on, what do you think about the state of Opportunity Zones?”
Kevin: “Yeah, so, you know, Jared Bernstein and I, way back the day, wrote the first paper on Opportunity Zones. It was published by the Economic Innovation Group.”
Jon: “Jared Bernstein, who is now the nominated new Chair of the Council of Economic Advisers under the Biden administration.”
Kevin: “And a genuinely, you know, authentically good person who I disagree with on some policies, obviously agree with him on others like Opportunity Zones, but he and I are viewed, you know, there's a Ph.D. candidate right now named Harrison Wheeler at the University of California, Berkeley, that has a paper on Opportunity Zones. And in the beginning, he basically says that Jared and I invented it, and it's sort of pretty much true as an academic matter, although we had other friends that were helping us think about what to do. But the original thought was based on game theory, and I know we want to talk a little bit about the debt limit struggle at the end of this. There's a lot of game theory there, too, but I spent a lot of time playing with game theory. I didn't find a lot of applications for it, really, until the Opportunity Zone paper. But they had, in the past, Jack Kemp pushed the idea of like an enterprise zone. And the idea was that if you had like a tax benefit for putting a business in a distressed community, then maybe you could get businesses to do that. And he, you know, Jack Kemp was absolutely beloved in the African-American community because he obviously like he made the number one focus of like helping other privileged folks or people who are discriminated against with economic policy. But the enterprise zones didn't really work. And so, it's very similar to like, well, wait a minute. It seems like they ought to work. And so first, is the evidence wrong? And then you look at the evidence, and none of the evidence looks right. They really didn't work. And so, I didn't have like I did with the Tax Cuts and Jobs Act an opportunity to say, oh, they just got the econometrics wrong. They absolutely do work. But, no, the enterprise zones really didn't work.”
Jon: “Now, with Opportunity Zones, like how are they different? Like so the idea is that it's essentially a tax break for real estate developers, if they develop floors for anybody to invest.”
Kevin: “You and I want to start a brewery. I know we talk about that a lot. Given our beer consumption, we could probably fund it ourselves.”
Jon: “As long as that is built in the brewery or a real estate construction project occurs in one of these lower income zones.”
Kevin: “Right. Yeah, so basically the idea is that when I invest or when you invest, for the most part, you know, what I do is I like put my money in like Vanguard and index funds and things like that because I'm an economist. That's what economists do. But the way to think about like the way a typical human being who wants to invest invests is that they give their money to a professional firm, whether it's a private equity firm or a mutual fund company or something, and then they go out and invest. And so, Jared and I decided that the problem with the sort of old-fashioned approach to this was that you could like put a tire store in Anacostia in D.C. and get an enterprise credit. But then, like, you got a tire store, and then, you know, what are you going to do? And if you sold the tire store and then didn't like put the money in a gas station in Anacostia, then you'd have to give the tax credit back in some cases. And so, it's very like illiquid. And so, the first thought that we had was that what we need to do is make it so that I can put my money in a fund, like the Vanguard Index 500, but not that, but like a private equity fund. Like a private equity fund that invests in distressed communities and the fund can build a business in Anacostia and then sell it and then build a business in Camden, New Jersey and then sell it and then go to North Philadelphia and build it and then sell it and it's not a taxable event until I take my money out of the fund. And that was like the key idea is that you have like qualifying investments which are investments in distressed communities and you have qualifying funds which basically do the qualifying investments and the incentive is for individuals to put their money in the funds and then for the funds to go around and invest and it like radically reduces the complexity of encouraging the flow of capital for distressed communities. So, we had the view that that could be a game-changer because if you look at like poor places versus rich places, the big reason poor places are poor is that they don't have enough capital. Yet if we can get capital to flow to these places then we could potentially really change a whole bunch of lives of the most distressed people in America. And so that's that was the idea of opportunity zones and I said game theory before I referred to it is that I think the problem with like the enterprise zone is that it had a bad equilibrium where what happened is that I was thinking about putting an entire factory at Anacostia but I would really if I was the only one who did it then it would still be such a distressed community that I have all sorts of problems with crime and I just you know and so I would really want to do that if you would want to do it too. But then if you look at like how treacherous the incentives were and sometimes for example you had that the workers who worked in your tire factory had to be in the distressed community too and so like if one of your workers moves you know across the Pennsylvania Avenue to hover near RK Stadium and get outside of the distressed community then you would lose your tax credit you know it's a there was all this kind of stuff and so there was like a bad equilibrium where I didn't go because I kind of knew you weren't going to go. And what we wanted to do is create a positive equilibrium where everybody's going because everybody knows everybody else was going to go and to do that we thought that this fund structure would do that and it's really proven to be true and I think the best paper on this is this paper by Harrison Wheeler it hasn't gone through peer review yet because you have to understand the data is very new the opportunity zones were really finalized until almost 2020 and so that we need you know data through probably 2024-25 to really do science although I got to say that what Wheeler's done is really impressive what he did is he went around and you know basically said well we can't really look for effects necessarily on like employment yet necessarily because if you're going to build it before you and I are going to put a brewery in some place we got to get all the permits we got to build the building and you know.”
Jon: “I guess and there were some very early works that was done I think by a major individual that found that there weren't any home prices, home price increases, opportunity zone areas, but only looking one year out I think.”
Kevin: “And probably a year before they were even in effect and so which is another thing we'll talk about Wessel at the sort of extremely like I would say idiosyncratic anti-opportunity zone sentiment amongst America's left where they're basically like dying to show they don't work so much so that there are all these people that have written premature papers saying they don't wait and it had strong conclusions based on incomplete data but the point is just that if you look at permit activity where we can get data that's really almost real-time then you know we find really big effects of these if you also like the funds themselves report how much money they've raised and you know I think this year it's pretty likely we're going to cross a hundred billion dollars that's been raised to invest in America's distressed communities and so if you're a social justice warrior, inequality dude, I'm kind of a Rawls-y and I care most about people at the bottom which is why I work so hard on opportunity zones. You say where did that come from? Well, it's because I grew up with the place it was like used for the set for Fallout the video game of post-apocalyptic America and it's I really you know care about.”
Jon: “The China shock.”
Kevin: “And it wasn't the China shock that was like it was electricity spreading so you didn't need to have a waterfall or electricity. They had an electricity advantage because of the waterfall hydropower.”
Jon: “Technological disruption.”
Kevin: “Technological disruption is what like sort of really harmed our community but yeah so I think that in the permitting activity you know you can see big effects you can see that like already I think there's 50 billion heading towards the distressed communities and I think climbing to about 100 billion this year is the whisper estimate that I have and so we're starting to get evidence that a massive amount of capital went there and the thing I got to say is that if capital goes to a distressed community it wasn't going to go there like if you actually look the whole problem is that these places are starved of capital so if we can identify that much capital is going to the community that if you're going to say that it has no effect then you know you've got to have a pretty complicated story for like first why would smart investors do it if it's not going to have a positive return which requires basically that you improve those neighborhoods and then why how is it that you can you know go to places where you know the marginal product of capital this week you kind of was called it should be pretty high because there's not a lot of capital and then you send you know 50 billion in capital these places and then it doesn't have an effect you know that you have all of these places, and then it doesn't have an effect. You know, as soon as you're finding a result like that, you've got to, if you're an honest scientist, start to wonder, oh, jeez, why is it that that doesn't have an effect? It seems so contrary to what I would expect. But the thing is that I think I know why people like Wessel do it. And I don't have a very high regard for his book. It is that Trump did it. It was part of Trump's Tax Cuts and Jobs Act, because it turns out that Trump really did care a lot about distressed communities and basically giving people a second chance, letting people out of prison, sending capital to distressed communities. He did a lot of stuff that normally people on the left would embrace. But since he did it, and he's such a controversial character, then they just have to hate it because he did it. And if you look at the things that Trump did that Biden has reversed, it's kind of like if Trump did it, they've reversed it. And so I think that these troubled political times that we're in have had a big effect on the opinions of people who should try to return to being scientists and scholars and stop being partisans. And I think the opportunity zone space is one of those spaces. Now, but that being said, as I said before, it's like 2024, probably before we have enough data so that we can form firm conclusions, given that these things are relatively new and given that if you go to a distressed community, there aren't a lot of, for example, buildings that are going to allow you to build a business. And so, you're going to have to knock stuff down and put stuff up and get the permits and so on. And so, it could be they don't work. You know, there's like now I think evidence that suggests like the permit data that they are having an effect, and also just the data that just adds up how much money is in the funds. But maybe it ends up not having a big positive effect on the lives of these people. But if that's true, though, I would say, and this is the thing that I don't know, it's something that one should consider when one looks at the evidence of the critics. The intent of the policy is to go to the places in America with the most distress, where if you're a kid born there, you know, Raj Chetty has shown us that you've got a very low likelihood of achieving the American dream and to fix those places, to help those places by sending, you know, much needed capital and jobs and services to those places. The Joint Tax Committee estimated that this, the total cost of opportunity zones would be one and a half billion dollars over 10 years for taxpayers. So, imagine if I told you for one and a half billions of taxpayer dollars over 10 years, I can get you 50 billion in capital flowing to distressed communities. Would you take the trade? And like who would? And so, these people who are indignant and angry about opportunity zones, you know, need to get over it and need to get a life because, you know, it's an attempt to help the people who are most in need in our country. And if they don't work, then we should make another attempt, not condemn the attempt.”
Jon: “Those are excellent points on, you know, helping those at least among us, which I think the, certainly the intention of opportunity zones. Fast forward just a little bit to COVID and the Trump administration's response to COVID. So, you left the White House in 2019 after you finished two years as chair of the Council of Economic Advisors, but then you returned in 2020 right after COVID had started or sort of reached the US and sort of was spreading like crazy. And you joined the White House as a senior advisor to head the economic response to COVID. And, you know, that included a lot of things like scrambling to pass these coronavirus relief bills, the CARES Act, which is for the broader economic support relief that was passed. That included a lot of things like these economic impact payments, you know, a couple thousand dollars stimulus check.”
Kevin: “I was running the team that moved ventilators, you know, I mean, anything that was data driven and that wasn't, you know, involved in, you know, basically epidemiology. So, like we weren't in any way like guiding Tony Fauci, but anything that like influenced like moving ventilators to here or there, anything that was really data dependent, our team, you know, working with Palantir, actually we built a massive data operation to manage that. And yeah, I mean, I didn't intend to do this. It's not like, you know, I've always had the ambition of there being a national emergency and me being in the White House. In fact, I was in the outback in Australia and got a call from the White House. President Jared decided that because we had worked so well together when I was at the CEA and it was such a national emergency, they asked me if I would drop everything I was doing and come back. I was in the outback in Australia. I got a call. Yeah. And I flew back from the outback and went right to the White House and started right away.”
Jon: “It was March in 2020.”
Kevin: “It was March in 2020. Early March. Yeah. And yeah, it was a very, very difficult time, but I think that we made a lot of under extreme distress really, right. We made a lot of good calls and Jason Furman had a really interesting tweet and he's really up to his game lately in the sense I got to say that his analysis is really always worth looking at and sometimes worth agreeing with, but always very thoughtful. And, and, and he basically said, you know, if actually look at GDP, what we've forecasted GDP for GDP today before COVID that we've kind of returned to the trend. And so, we had the biggest drop since the great depression in GDP and we've returned to the trends. Now, granted, we've got a lot of problems going forward, like the debt, but you and I will talk about a little before we're done. And that was financed debt financed in a way that was necessary given that we shut the economy down. But the economic policy is that if you had told me when I did the first estimate, the GDP growth in the second quarter. It’s going to be minus 32 percent. You can remember me saying that on TV before the number came out, because it's based on a lot of math. I was terrified that that was going to cause a financial panic and a Great Depression. And the fact that we were able to go from there to we're back on trend, here we are just a little bit later, I think is one of the great economic policy accomplishments in economic history. And I can finally say, too, that it's one that is nonpartisan, that Ron Lydon at Senate Finance and his staff worked really closely with us at the White House to make sure that we had thought carefully about the emergency and what the right economic response to it would be. And then there was bipartisan support that I don't think that a single Democrat or Republican voted against this thing. So, imagine, President Trump's a pretty controversial guy. I guess that's not a controversial statement. And he's even getting impeached. And he passes all these stimulus bills with, you know, 100% support from Democrats. And it was because basically Democrats and Republicans in the emergency worked well together. And the credit for getting back to trend is not just, you know, ours from our team, but really everybody. And that, I think, is like, again, one of the great economic policy accomplishments of our lifetimes, that we could turn off the economy at a minus 32% quarter and then not have the whole thing in mind.”
Jon: “Well, I suppose like one other question here. I feel like we have in this period, we have this massive relief. We had first this massive pandemic, which would have stopped the world in many respects. We had a significant drop in GDP in the U.S. and many countries around the world. In fact, most in the first few quarters of 2020. And then there was this significant surge of stimulus that occurred or relief, depending on how you sort of look at it, in the U.S. that amounted to things like very generous unemployment insurance, things like the Paycheck Protection Program, PPP, which were forgivable loans to businesses, ideally smaller businesses. There were stimulus checks that we mentioned, this whole gamut of stimulus. And then there were sort of successive iterations of different bills that would either send more checks or fill out PPP. Or in the case of sort of the more recent Biden administration, things like the AARP, for example, which also sort of gave $200 billion to public pension funds. And certainly there's been a lot with also on the environmental side of the so-called Inflation Reduction Act and producing or creating electric vehicle tax cuts. Thank you for all this stimulus that has occurred. And the return of inflation, we've seen inflation in the U.S. peak at around 8%. It's fallen to around 5% now, which is the headline measure. And we're starting to see inflation sort of subside a little bit around the world, but it's still very elevated to what degree do you think that all that spending over the period of a couple years post-pandemic is related to this uptick in inflation versus, say, other sort of leading stories, say, largely supply chains or monetary policy?”
Kevin: “You know, I think that what happened, and this is, I think, underappreciated by people, especially, you know, partisans who want to rewrite history, is that there was bipartisan agreement that I think intellectually was led by our team that no one knew what was going to happen. I mean, you could look back at COVID and say, oh, I knew it was going to be this. I knew we were going to have 10 waves and stuff like that. But Fauci and Birx were saying in March that we needed 15 days to stop the spread. And then, like, Italy went up and went down. And so, then they were saying, OK, so we're going to be like Italy. And let's try to get to the end as fast as possible. And, you know, they basically were saying that it was going to go up and it was going to go down and it wasn't going to be that, you know, that eventful. And, in fact, Fauci, I can remember telling us in the Oval that they would be gone by summer because it's going to be like the flu season if nobody gets the flu in the summer. Nobody's going to get COVID in the summer. He absolutely 100% said that in the Oval to us. And so, but we didn't really know. A lot of uncertainty. And so, what we agreed to with the Democrats was let's, well, we know we're going to be shut for the next month or mostly shut. So, let's do a bill that gets us through the next month. And then let's talk. Like, are we going to do another month? Or are we better? So that we right-size the response. And so, I think if we go back. And so, I think if we go back and count the interim measures, that we had five bills. I think it's by count vote. Might be wrong, might be four. And there were times so that we did something that would build a bridge to the other side. You hear me say that on TV all the time. And then we got to the other side, and then we'd say, OK, so where do we got to build a bridge to DALL? And so, I think that what happened is that by December, after the election, that we had basically about right-sized the response, that we had filled the hole. And you can see that, because GDP growth was up enough so that we pretty much recovered the 32% that we lost. Inflation hadn't taken off when President Biden came into office. Inflation was very low. But President Biden had a challenge. And the fog of war is a nasty thing. And they had a serious fog of war problem in that January that must be, for their economic critics, must be paid attention to. And that is that there was like the new variant cases were skyrocketing. We had more cases, I think, in the January that he took office than we had had yet in the month, or it was close. We could pull up the charts and look. And he basically, at one point, I was on TV, and somebody said, well, do you think we're going to need another stimulus? And I said, well, yeah, if you look at how bad the cases are right now, I guess one could expect that there might be more lockdowns and so on. Forget about whether lockdowns would make sense, but just they're probably going to happen. And so probably you need another stimulus. And President Biden, one of the first things he did when he was in the Oval Office was specifically cite me by name and say, Trump's guy who manages this for him says we need another stimulus. And at that point, I didn't think so. But then what happened was that we found out that the vaccines were making it so that it wasn't as big a health issue. It was a milder variant and it takes Congress a long time to do anything. And so, by March, it was clear that what we feared in January wasn't going to happen. And moreover, it was clear that the bill that they were pursuing was not guided by the build a bridge to the other side, let's go a month or two at a time, but rather it was guided by, like, you got a new president, and Democrats control Congress, and they want to have a Christmas tree, just like everybody of every party does. Like, once they get to do everything they want, because they control Congress and the White House, then they put in everything they always wanted to do, like big, big green subsidies and so on. And so, they passed this thing that was way too big, and they did so on a partisan basis. And so, think about it. Like, President Trump passed all these bills with, like, unanimous consent from Democrats. President Biden comes in promising to heal the country and instantly has a Christmas tree bill that doesn't get a Republican vote. And it was humongous. It was way too big because the January spike had gone back. In January, he was right to start to devise a stimulus, but in March, they were wrong to pass it. And that's what set off inflation, because if you dig a hole that's a shovel full deep, and then you put the shovel full back, then the hole's gone. And that's why we were going a little bit at a time, because we didn't know. And so, we didn't know, like, how much dirt we were going to have to put back in the hole. But they knew that they didn't have to do any more shoveling. They were on the other side, and they used it as an excuse to inflate the economy. And that's one of the big policy errors, I think, of our lifetimes, because we're going to pay the price of higher inflation for a long time.”
Jon: “I’m curious, when you think about the whole so-called transitory inflation narrative that was being promoted by largely the press, I'm curious, think about this counterfactual world where, say, President Trump was re-elected, and he was serving in 2021 and experienced the same inflationary uptick that President Biden did in May of 2021 and successfully increased. Do you think that the response from the media would have been different had that inflationary uptick occurred during a hypothetical conflict in the White House?”
Kevin: “Of course, yeah. That's right. Yeah, of course, it would have been Trump's irresponsible spending destroys America, or something like that.”
Jon: “Rather than supply chain.”
Kevin: “Yeah, the transitory supply chain. You've got to understand that what happened is that we mailed checks to people that were printed, or mailed money to people, and the money was printed by the Fed. So, it's like a helicopter drop. And so, that kind of thing always causes inflation. That's why John Cochran and I wrote right at the beginning, right as the bill was being passed, in Biden's first few months in office, that inflation was going up. I said back then it was going to be probably at least 7% this year based on some math I did. It was sort of right about then, that year. And it was based on the following simple analysis. Suppose that I'm an economy and all I do is I make apples. And I've got 10 apples a year is what I get out of my apple tree. And they sell for a dollar apiece. And so, I've got $10 and 10 apples. And suppose that I don't have time to plant a tree because it takes a while. And then the government says, you know what? To make people better off, we're going to spend $11 on apples this year. But you only have 10 apples. So, the supply is constrained because you don't and you can't. It takes a while for an apple tree to grow. So, if you spend $11 on apples, then what's going to happen is that the price of the apples is just going to go up. And so, you're going to have inflation. And so, if you're going to have a massive increase in spending, then you have to have some reason to expect that supply will be able to respond. Now, one way supply can respond is if you have like a large share of the things you buy. It's like from the global economy and you're just a little country and so on. And so, you know, you're not necessarily going to get the full, you know, 11-apple effect, we could call it. But it was really easy to do the math that would show that the supply couldn't possibly keep up with the demand that they're pushing through because there was so much. And that's where really the Cochrane Asset article about how inflation is about to lift off really came from. It was like from, you know, simple math that, you know, anybody who took a first semester macro class, you know, undergraduate macro class should have been able to do. And again, you know, to his credit, Jason Furman did this right at the same time we did and said the same thing that we said and has been like a really like an honorable former CEA chair who goes out there and sort of says what he thinks the truth is regardless of the partisan impact. And I really respect that a lot. But, you know, when you're in the White House and you just pass this bill and it's a big mistake, then it puts everybody as a messenger, you know, into a difficult spot. And I think that, you know, probably a lot of people thought that it was transitory for reasons that I'm not sure I don't understand. But I don't think people were lying when they said that they thought it was transitory. I think that they did. You know, we know that people at the Fed thought it was transitory at the beginning because they moved way too late.”
Jon: “And I don't think there are any media or certain people who are trying to hold water for the Biden administration.”
Kevin: “Oh, for sure. That's true, too. Right. Because the point is, just again, to go back to your question, you know, I had a CEA and I came out when we saw like inflation at 7% and I said, don't worry, it's transitory. Or for the Biden administration? Oh, for sure, that's true, too. Right, because the point is, just again, to go back to your question, if, you know, I had at CEA and I came out when we saw, like, inflation at seven percent, and I said, don't worry, it's transitory, then, you know, there would have been, I mean, you know, I used to do the White House press conferences, and they'd be like, put your hands up, put your hands up, no, no, wait a minute, wait a minute, won't be me, you know, that's what would have happened, right? Yeah, how could you say that? It's just, you know, and then they would have found the Democrats to say, you know, this Nobel Prize winner says it's, you know, it's a permanent negative shock, and that's what, you know, but that's democracy, that's what democracy should be. I love it when that happens, and you're a Republican in the White House, because that's where democracy comes from, is, you know, people should say harsh things about you all they want, they should be able to question you as hard as they want, and you should answer them, but we've got an administration that's in denial, the press allows them to be in denial, and a president whose hiding in the basement, you know, and so we don't really have an honest conversation about all these things.”
Jon: “Groupthink matters, though, in the sense that you had this narrative about transitory inflation that was so deeply ingrained in that economic policy community at the time, and so much so that I think it influenced forecasting, which I think was certainly no longer based in really any kind of econometric models, but just sort of looking at this, you know, point by point sort of CPI sort of components of, oh, look at these car prices that are skyrocketing, and so forth, and I think that sort of justified this pause, and or not raising interest rates on the Fed side of things, ultimately until March of 2022, a year later after this sort of uptick inflation was sort of first showing signs, but by October of 2021, it was very clear that, you know, shelter prices were going up, this was not just a used car story, that there was something that wasn't transitory, and now there's still debates over to what degree, you know, spending versus, you know, supply chains were responsible, and often there isn't a monoculturalism, but it's interesting how strongly people like to deny any kind of influence from Spain at all, it's very interesting. Speaking of spending and debt, I want to get your take here on the debt limit, there is currently a base debt limit debate in DC right now about whether or not there should be a clean debt limit increase, that is the debt limit be increased without any other considerations or anything else to change the, you know, future path of debt, these debt limit ceilings have, you know, been sort of part of a lot for quite some time, typically every time we hear them, they get raised, and 10 years ago there was pretty significant debate around a similar to ceiling, debt limit ceiling standoff that resulted in S&P downgrading U.S. debt, some many argued that it wasn't really a justified thing, but they did it, and I remember it caused a massive market sell-off in U.S. equities at the time, and it actually caused U.S. It's a rally, which is somewhat counterintuitive, given that, yes, a similar increase in U.S. debt, but I'm curious, we're in this new sort of debt limit ceiling standoff, and CES prices on U.S. debt are higher than what they were even 10 years ago, so the probability of what the market thinks about the probability of there actually being some form of default is actually higher than it was 10 years ago, now you're not in favor of a clean debt limit raise, unlike some other Republican economists who say, yeah, this is wrong, there should be a clean debt limit raise, just like the ones prior to it, I'm curious if you could speak to your position on how we should approach the debt limit.”
Kevin: “Yeah, and first you have to understand that the debt limit goes actually back to the 19-teens, it used to be, by the way, going back all the way to the Revolutionary War, that every time we borrowed, then we had to say it was for a specific project, and that had to be approved by Congress, and so we're going to say we're going to borrow money to build a bridge, and then we borrow some money to build a bridge, and then Congress would have to borrow money to build a bridge act, and then what happened is the 19-teens, they decided this is getting out of control, and so let's just have a debt limit that sort of applies to everything, and you know, subsequently the debt limit has had to be increased a whole bunch of times, and you have a history of debt limit political negotiations, and there are clean debt limit increases and dirty debt limit increases, and a clean increase is one where it's only the debt limit, and a dirty is one where it includes policy compromises, and the majority of debt limit increases in U.S. history have been dirty, that we, there's a Congressional Research Service study on the history of these, which I commend to people, if you google it, you'll find it right away, that shows, you know, basically what happened each time, and if you look at it, you know, the majority of debt limit increases that passed for the Democratic Congress and the Democrats in the White House were dirty, and President Biden, when he was in the Senate, voted four times for debt limit increases that were tied to spending cuts, there was one dirty bill only that he voted against, and he gave a floor speech explaining that he was voting against it because the debt limit increase wasn't tied to bigger spending cuts, and so President Biden's in this position right now that we shouldn't negotiate, we shouldn't include other policies, is sort of ignoring a long history of this being basically a vehicle by which policy compromises are made. And so, the debt limit is on that being a really good thing because it's helped constrain the growth of government and introduced good policies like the cigarette tax came in at that limit increase. And so, the position that you should have a clean one is really, if you think about it, what the debt limit does is it gives the minority party a little power. Because if you don't pass it, it doesn't go up, and that's a really bad thing. You've got to pass it or you're in default. And so, the minority party gets a little bit of power. And so, what's happening right now is you've got all these Nobel Prize guys, and surprisingly, again, like people at AEI, saying you should have a clean debt limit. But the clean debt limit position is really that, okay, so the Republicans have a little bit of power. They should give it up for free, even though the Democrats would never do that. And so, it's basically like I don't want Republicans to have a say in what policy this is. It's astonishing to me that that's like the message of the American Enterprise Institute that I used to love so dearly. But that's their message. But it ignores history, but it also sorts of blames Republicans if something goes wrong, which is sort of illiterate economically in the sense that the game itself is fully symmetric. And so, you've got the things you want. Say, if you're Biden White House, I've got the things I want if I'm Mr. McCarthy. If we don't agree to something, then it's terrible for financial markets. But if we don't agree, then it's not McCarthy's fault. It's not Biden's fault. It's both of their fault. Maybe because they didn't agree. They didn't come up with something. And so, the idea that it's McCarthy's fault if he defaults presumes that the virtuous thing to do is to pass a debt limit with no other policy changes. But the majority of time, Congress has attached policy changes to it. And moreover, the policy changes that have been attached to debt limit increases have been virtuous. And so, I think that it's just the conversation. I understand politicians posturing. You've got to allow for the fact that there's going to be extreme positions taken because they're negotiating and they're going to come to a deal at the last minute. That's what always happens. But the idea that it's irresponsible or demented to negotiate over the debt limit and to ask for policy changes to come with it is just not defensible. And yet it's the position of most of the media and many sort of think tank inside Washington people who basically don't want Republicans to have any power to fulfill their intent.”
Jon: “Fascinating. Well, thank you so much, Kevin, for these amazing thoughts on so many topics from tax policy to the COVID-19 response to the debt limit. Thank you so much for joining us.”
Kevin: “Thank you.”
Jon: “Today, our guest was Kevin Hassett, a distinguished fellow at Hoover Institution at Stanford University and former chairman of the Council of Economic Advisers. The Capitalism and Freedom of the 21st Century podcast, where we talk about economics, markets and public policy. I'm Jon Hartley, your host. Thanks so much for joining us.”
