TCJA, the CARES Act, inflation, and the debt limit

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>> John Hurtley: This is the capitalism and freedom, the 21st century podcast where we talk about economics, markets, and public policy. I'm John Hurtley, your host. Today I'm joined by Kevin Hassetta, an economist who is a distinguished fellow at the Hoover Institution at Stanford University.

Kevin previously worked at AEI, where he was 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 the economic response of 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 Hassetta: It's great to be here, Jeff.

>> John Hurtley: 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 Hassetta: Yeah, actually, it was outside of Boston by quite a bit. I grew up in a town called Greenfield which is 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 Turner's Falls, which is the largest drop on the Connecticut river. It's a 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 papers first factory was in Turner's Falls, and there's this really famous tool company, the Greenfield tape and dye. So we had hydropower that made the economy great in the late 1800s and the early 1900s. And I grew up at a place where it was basically a ghost town.

All the factories had closed. Everybody was a distressed community type person, the kind of person that maybe Kaysen Deaton would write about and about, like, what happens when a factory closes? And so I sort of grew up wondering what happened to my town? Like, why is it that it went from being, like, the center of the economic universe for the US to being a ghost town.

And as a metric of the ghost town by the way, that Turner's falls actual burnout factories were used as a set. Like, they brought in cameras and everything for the video game fallout.

>> John Hurtley: Wow.

>> Kevin Hassetta: Yeah. So you can imagine when you're growing up and you're seeing this stuff and you're watching 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. A guy like Mark Kuperberg is a macroeconomist. Bernie Safran, who wrote the sort of ending column in the Journal of Economic Perspectives about 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 one of those people that don't exist anymore. I went straight to grad school. So right when I graduated from sophomore, I went to the university to Pennsylvania.

 

>> John Hurtley: Wow. It's amazing that you've seen the China shock and the effects of automation up close in your own hometown. So after graduating from Penn, where you were an Auerbach student, you were faculty at Columbia. You worked at the Federal Reserve Board of governors. You led economic studies at AEI.

And you're also chair of the board of academic advisors at the Economic Innovation Group, or EIG, where you helped conceive of the idea of opportunity zones, something that would later be written into law in the Tax Cuts and Jobs act, which was passed while you were there. I want to get a little bit.

While you were CEA chair in the early Trump years. I'm curious, 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? Notably, cut the corporate tax rate from 35% to 21%. Some of your most well cited work analyzes the impact of corporate tax rates on investment.

How did TCGA come together, and what do you think its legacy is here five years out?

>> Kevin Hassetta: Sure. Well, basically what happened was that we had a 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 we put together working groups to develop ideas and to model, what if we do this? What if we do that? 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 the political arena. But it began with a lot of careful study.

And as you mentioned, that 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 matter 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 four to $8,000.

And President Trump at this point at least, there's 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. He went out. And you might remember that 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. Anyway, but 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 4000. And so I think the tax cuts works about the way that we expected.

There was a big increase in their ratio of investment to capital stock, and that fed through to productivity and wages, just the way economic theory would say it would. Critics in the empirical evidence from what you wrote in the early nineties as well, with Jason Cummins and Glenn Humber looking at past tax reforms prior to that.

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.

>> John Hurtley: It's like the roman wrong.

>> Kevin Hassetta: Yeah, the way to think about a narrative approach is this goes back to my dissertation. 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 Brookings 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're doing is fundamentally wrong, because what happened in post war history, beginning with John F Kennedy, who's really underappreciated, brilliant supply side president, by the way.

 

>> Kevin Hassetta: 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.

>> John Hurtley: 70% until Reagan cut it again and I think there's another book, JFK conservative, too.

>> Kevin Hassetta: Yeah, he was a great man and a terrible loss for our country.

So anyway, so that 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 oomph to investment. And then if you take, if you're like naive 1970s macroeconomists 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 that investment tends to go up in times because 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, is like, how do we solve that? And what we did back then is that we decided that sort of endogenative 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 a power plant. And that our identifying assumption was basically that the cross section difference in the effect of a tax reform on this asset versus asset that asset, was, like, too mathematical for it to be endogenous.

Because the politicians surely wouldn't understand what effect they were 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 the whole bunch of times.

We found that the effect of the cost of capital on investment was about what the basic fundamental economic theory model, 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 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 if you pass a tax cut and then everybody's saying, we need to do this cause we're entering a recession, then you would call that an endogenous policy.

But if they're passing a tax cut because somebody just ran for president arguing for tax reform or something, then maybe that's an exogenous policy. And they find a 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 I think that when you've got replication, like Caballero 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 that so much of the economics profession is just basically a pure partisan democratic profession now. That even though the literature quite decisively said that the effects would be what CEA was reporting, that we were being attacked in an ad hominem fashion often by economists from all over the country who hadn't clearly read the literature.

And that was a disappointment for me, because I think that it's really important for economists to read the literature and then give it honest take. And the fact that there are papers in the last four or five years in the very top journals, the American Economic Review and the Quarterly Journal of Economics and so on.

That confirm our results from way back when, and that we were actually citing papers from the top journals and then being accused of being unprofessional. And so I suggest that our profession runs the risk of going off the rails the way the rest of society has and becoming divorced from science and unconnected to data.

 

>> John Hurtley: And it's just so fascinating. You were there at the very beginning of the credibility revolution. Your papers with Glenn Hubbard and Jason Cummins looking at tax reforms as natural experiments, looking at the effects on investment, and sort of testing this hypothesis about Q theory of investment. That was written even before the card Kruger famous minimum wage paper, I think, around that same time.

So I think it's fantastic work, and I certainly have my own biases toward well identified studies. But I feel like there was a very very early in this, what has since been a tidal wave of complete change in the profession from sort of not well identified theory and empirical work.

Certainly in macro and in public finance to a field now, and labor economics and public finance are almost entirely. Entirely heavily well identified applied micro fields, and I think you helped set that scene change.

>> Kevin Hassetta: And thank you. And I would actually like bring in another paper too that I wrote with Jason Cummins and Steve Oliner.

That is 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, how do I come up with an idea of a paper?

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 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 for human beings that you could have a tax policy that does this or that to our labor income. And then we could respond to it 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 necessarily know that economics is going to be helpful for understanding what people do, because people aren't 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 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 that 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. It was published, peer reviewed paper in the American Economic Review, that's also been, I think, maybe even more influential than that paper that was coauthored with Jason Cummins and Steve Oliner.

And it was very much related because one of the things that people did, in addition to looking at tax policy is that 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 a firm, you could buy a hot dog stand for $1 but you could sell it on the market for $2.

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 it would get back to market price, had to be driven down to $1. The way that would happen is we'd have a lot more hot dog stands.

The hot dog salesmen would be competing with each other, their profits would go down, and so that's the Tobin's Q. 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, took an enormous amount of abuse from other academics who 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, and 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, Bob Shuler won the Nobel Prize for talking about how there's 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, and then everybody goes down 5%, and then they go up 5%.

And so if you try to predict 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 gonna find that the Tobin's Q has no effect. And so, what we did in the paper was, we say, okay, so we got to come up with a way to basically sift out the measurement error fluctuation in the stock market, and then estimate the impact of Tobin's Q, basically controlling for that.

And we got the very clever idea, which actually was kinda 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 firm is basically a discounted present value of how much money we think that they're going to be able to pay shareholders of the future 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'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 of earnings, and then they tell you what the long run growth is. Estimate the present value of earnings, or dividends, really, for firms, based on what analysts say, and then you actually observe the expectations. 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 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, I became very, very convinced that, okay, so we're doing it a different way. So we've talked about two other different ways, ow we've got another one where we did it with Tobin's Q, and we also found that it worked for that. And so 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 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. Just anticipate that someone might be saying that if we were 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, okay, I'm going to have an investment tax credit in January, and it's October, then what can happen would be everybody's like, okay, well, I'm going to wait till 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 waits to see.

Is you need to say, okay, well, if we have expensing, which is like 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.

And so, one of the things that happened, though, is that we made the expensing retroactive to October or maybe September, I forget which month. But the corporate tax rate reduction, which was at the time originally a proposal, was a 20% 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%, which it was, then if I buy a dollar a machine, then I get 35 cents of a tax benefit. But if the tax rate is 21% and I spend a dollar on a machine, then I only get 21 cent tax benefit.

And so we have 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 in the fourth quarter right after the tax cuts passed, is there's 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 gonna go down in the first quarter, and then we're going to have all these news stories about how our tax cuts failed because the newspapers.

This is too complicated, in effect, for the guys who cover the economy. So, I thought for sure that was gonna happen, but actually it stayed high. And in the models that Alan Aurebach and I developed a long, long time ago about how to think about the effect of taxes on investment, that 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 it 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 inaccurately to January 1. 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 care about free enterprise as far as I could tell.

But at these places that they tend to make mistakes like that, like to do the control group inaccurately.

>> John Hurtley: Fascinating, and I mean, it's so interesting to hear just about all the evidence that sort of goes into showing the effects of corporate tax reductions on investment. And talking about the narrative approach and talking about Tobin's Q and use your cost of capital and using past actual reforms as natural experiments, all early part of the credibility revolution, and you were a key part of that.

It's amazing, and I think 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. Thinking about, like Ben Bernanke, for example, who just won the Nobel Prize this past year wrote a lot about depressions and the Great Depression and a lot about finance and the macroeconomy.

And he certainly was there to apply a lot of his academic wisdom as Fed chair. So, I think it's almost analogous in the case of public finance with your career. I wanna talk a little bit about some of the other aspects of TICJA, 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 Advisors, what do you think the legacy is so far of opportunity zones? 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 while before certainly tax reform was being considered. And before we even sort of knew Trump was president when the economic innovation group was first conceived. But I'm curious looking sort of five years on here, what do you think about state of opportunity zones?

 

>> Kevin Hassetta: Yeah, so, Jared Bernstein and I, way back in the day, wrote the first paper on opportunity zones. It was published by the Economic Innovation Group. And Jared Bernstein, who's now the nominee.,

>> John Hurtley: Or soon to be the new chair of the Council of Economic Advisors under the Biden administration.

 

>> Kevin Hassetta: And a genuinely, 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 that there's a PhD candidate right now named Harrison Wheeler at 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 wanna 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, but 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.

The idea was that if you had a tax benefit for putting business in a distressed community, then maybe you could get businesses to do that. And he, Jack Kemp was absolutely beloved in the African American community because he obviously, he made the number one focus of, like, helping underprivileged folks or know people who are discriminated against with economic policy.

But the enterprise zones didn't really work. And so, it's very similar to, well, wait a minute, it seems like they ought to work. And so is, first, is the evidence wrong, and then you look at the evidence, and the evidence looked right. They really didn't work, and so I did with the Tax Cuts of Jobs Act, an opportunity to say, they just got the econometrics wrong.

They actually do work, but no, the enterprise owners really didn't work.

>> John Hurtley: Now, what opportunity zones, like, how are they different? So, the idea is that it's essentially a tax break for real estate developers if they develop.

>> Kevin Hassetta: Or not real estate, anybody.

>> John Hurtley: For anybody who invests.

 

>> Kevin Hassetta: You and I wanna start a brewery, I know we talk about that a lot. Given our beer consumption, we could probably fund it ourselves.

>> John Hurtley: As long as that is built-in that brewery, or real estate construction project occurs in one of these lower income zones.

>> Kevin Hassetta: Yeah, so basically, the idea is that when I invest or when you invest, for the most part, what I do is I put my money in vanguard and index funds and things like that cuz I'm an economist.

That's what economists do. But the way to think about the way a typical human being who wants to invest is that they give their money to a professional firm. Is it 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, put a tire store in Anacostia, in DC, and get an enterprise credit. But then, you got a tire store, and then, what are you gonna do? And if you sold the tire store and then didn't, put the money in a gas station in Anacostia, then you'd have to get the tax credit back in some cases, and so on.

And so, it's very, 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, 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 the key idea is that you have qualifying investments, which are investments in distressed communities, and that 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 radically reduces the complexity of encouraging the flow of capital to distressed communities. So, we had the view that that could be a game changer, because if you look at poor places versus rich places, the big reason poor places are poor is that they don't have enough capital.

And if we could 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 was the idea of opportunity zones. And, I said game theory before I referred to it, is that I think the problem with the enterprise zone is that it had a bad equilibrium, where what happened is that I was thinking about putting a tire 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'd have all sorts of problems with crime. And I just, and so I would really wanna do that. If you would wanna do it, too. But the, if you look at how treacherous the incentives were, and sometimes, for example, you had to, the workers who worked in your tire factory had to be in the distressed community, too.

And so, if one of your workers moved across Pennsylvania Avenue to over near RFK stadium and get outside of the distressed community, then you would lose your tax credit. There was all this kinda stuff. And so, there was a bad equilibrium where I didn't go because I kinda knew you weren't gonna go.

And, what we wanted to do is create a positive equilibrium where everybody's going, because everybody knows everybody else is gonna 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, very new. The opportunity zones weren't really finalized until almost 2020. And so, that we need data through probably 2024 or 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 basically said, well, we can't really look for effects necessarily on employment yet, necessarily, because if you're gonna build a. You and I are gonna put a brewery in someplace, we gotta get all the permits, we gotta build the building, and.

 

>> John Hurtley: Home prices to some degree, I guess. I know there was some very early work that was done, I think, by Ed Glazer and David Wessel, that found that there weren't any home prices, home price increases in opportunity zone areas, but only looking one year out, I think.

 

>> Kevin Hassetta: And, probably a year before they were even in effect, which is another thing we'll talk about, Wessel, at the sort of extremely, I would say, idiosyncratic, anti-opportunity zone sentiment amongst America's left, where they're basically 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 and then 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 we find really big effects of these. If you also, like the funds themselves, report how much money they've raised. And, I think this year, it's pretty likely we're gonna cross $100 billion, has been raised to invest in America's distressed communities.

And so, if you're social justice warrior inequality, dude, I'm kinda Rawlsie, 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 cuz I grew up in the place that was used for the set for Fallout, the video game of post-apocalyptic America.

And so, I really.

>> John Hurtley: China is kinda shock.

>> Kevin Hassetta: It wasn't the china shock that killed us. It was like it was electricity spreading. So, you didn't need to have a waterfall or electricity. They had an electricity advantage cuz of the waterfall of hydropower.

>> John Hurtley: So, technological disruption.

 

>> Kevin Hassetta: Technological disruption is what sort of really harmed our community. But, yeah, so I think that in the permitting activity, you could see big effects. You could see that already. I think there's 50 billion headed towards distressed communities, and it's got to climb into about 100 billion this year is an estimate, 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 gonna go there. If you actually look, the whole problem is that these places are starved with capital.

So, if we can identify that much capital is going to the community, that if you're gonna say that it has no effect, then you've gotta have a pretty complicated story for why. 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, how is it that you can go to places where the marginal product of capital, as we economists call it, should be pretty high? Cuz there's not a lot of capital, and then you send 50 billion in capital to these places, and then it doesn't have an effect.

As soon as you're finding a result like that, if you're an honest scientist, start to wonder, jeez, why is it that doesn't have an effect? It seems that's 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, that 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 kinda 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 it updated 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 gonna allow you to build a business.

And so, you're gonna have to knock stuff down. Down and put stuff up and get the permits and so on. And so it could be they don't work. 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 vehemence 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, 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 much needed capital and jobs and so as to those places. The Joint Tax Committee estimated that the total cost of opportunity zones would be $1.5 billion over ten years for taxpayers. So imagine if I told you, for 1.5 billion of taxpayer dollars over ten years, I can get you 50 billion in capital flowing to distressed communities.

Would you take the trade? And who wouldn't? 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.

>> John Hurtley: Those are excellent points on helping those least among us, which I think the, certainly the intention of opportunities. I wanna 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 reached the US, and so it was spreading like crazy. And you joined the White House as a senior advisor to head the economic response to COVID.

And that included a lot of things like scrambling to pass these coronavirus relief bills, the CARES Act, which is sort of the broader economic support relief that was passed. That included a lot of things like these economic impact payments, a couple thousand dollars, stimulus checks.

>> Kevin Hassetta: I was running the team that moved ventilators.

I mean, anything that was data driven, that wasn't involved in basically epidemiology. So we weren't in any way guiding Tony Fauci, but anything that influenced moving ventilators to here or there, anything that was really data dependent. Our team working with Palantir, actually, we built a massive data operation to manage that.

I didn't intend to do this. It's not like that I've always had the ambition of there being an 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 that the President and Jared decided that.

Jared Kushner, 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.

>> John Hurtley: Australia.

>> Kevin Hassetta: I was in the outback of Australia.

>> John Hurtley: You got a call.

 

>> Kevin Hassetta: I got a call, yeah. And I flew back from the outback and went right to the White House and started right away.

>> John Hurtley: March 2020.

>> Kevin Hassetta: 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.

We made a lot of good calls. And Jason Furman had a really interesting tweet. And he's really upped his game lately in the sense that I got to say that his analysis is really always worth looking at and sometimes worth agreeing with, but always very thoughtful. And he basically said, if actually look at GDP, what we 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 and GDP, and we've returned to the trend. Granted, we've got a lot of problems going forward, like the debt, which you and I will talk about a little before we're done. And that was debt financed in a way that was necessary given that we shut the economy down.

But the economic policies that, if you had told me when I did the first estimate that GDP growth in the second quarter was going to be -32% 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 gonna 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 Wyden at Senate Finance and his staff worked really closely with us at the White House to make sure that we had, like, thought carefully about the emergency and what the right economic response to it would be.

And then that there was bipartisan support, 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 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 ours from our team, but really everybody. And that, I think, is, again, one of the great economic policy accomplishments of our lifetimes, that we could turn off the economy, have a -32% quarter, and then not have the whole thing unwind.

 

>> John Hurtley: Well, I suppose one other question here. So in this period, we have this massive relief. We had first this massive pandemic which stopped the world in many respects. We had a significant drop in GDP in the US 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 US, it 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 the seamless 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 up PPP. Or in the case of sort of the more recent sort of Biden administration, things like the ARP, for example, which also gave $200 billion to public pension funds.

And certainly there's been a lot with. Also on the environmental side, with the so called Inflation Reduction Act and producing or creating electric vehicle tax credits. I'm curious, just with all this stimulus that has occurred and the return of inflation, we've seen inflation in the US peaked at around 8%.

It's fallen to around 5%. Now. This is just a headline measure. 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 of years post pandemic is related to this uptick in inflation versus, say, other sort of leading stories, largely supply chains or monetary policy?

 

>> Kevin Hassetta: I think that what happened, and this is, I think, underappreciated by people, especially 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. So you could look back at COVID and say, I knew it was gonna be this I knew we were gonna have ten waves and stuff like that, but Fauci and Birx were saying in March that we needed 15 days to stop the spread.

And then Italy went up and went down and so then they were saying, okay, so we're gonna be like Italy, and let's try to get to the end as fast as possible. So they basically were saying that the thing was gonna go up and it was gonna go down and it wasn't gonna be that eventful.

And in fact, Fauci, I can remember telling us in the oval that the thing would be gone by summer because it's gonna be like the flu season if nobody gets the flu in the summer. No, he's gonna get COVID in the summer he absolutely 100% said that in the oval to us, but we didn't really know a lot of uncertainty, and so what we agreed to with the Democrats was, well, we know we're gonna 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 gonna do another month or are we better so that we right size the response? And so I think if we go back and count, like the sort of interim measures that we had five bills, I think is by count, but I might be wrong, might be four.

And they were timed so that we did something that would, like build a bridge to the other side, you heard me say that on tv all the time, and then we got to the other side, and then we'd say, okay, so where do we got to build a bridge to now?

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, you could 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 a 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 gonna 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 made sense, but just they're probably gonna 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 is specifically cite me by name and say, Trump's guy who manages 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 gonna happen, and moreover, it was clear that the bill that they were pursuing was not guided by the bill to 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, the Democrats control Congress and they wanna 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 the 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 unanimous consent from Democrats. President Biden comes in promising to heal the country and instantly has a Christmas 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 that's what set off inflation, because if you dig a hole that's a shovelful 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 we didn't know, we didn't know how much dirt we're gonna 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 that's one of the big policy errors, I think, of our lifetimes, because we're gonna pay the price of higher inflation for a long time.

>> John Hurtley: I'm curious what you think about the whole so called transitory inflation narrative that was being promoted by largely the press.

I'm curious, like, let's think about this counterfactual world where, say, President Trump was reelected and was serving in 2021 and experienced the same inflationary uptick that President Biden, 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 had occurred during a hypothetical transit?

 

>> Kevin Hassetta: Of course yeah, that's right, yeah, of course it would have been Trump's irresponsible spending destroys America, or something would have been.

>> John Hurtley: Rather than supply chain.

>> Kevin Hassetta: Mister Henry, transitory supply chains yeah, the transitory supply chain you got to understand that what happened is that we mailed checks to people that were printed the money was or mailed money to people, and the money was printed by the Fed.

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, the inflation was going up. I said back then it was gonna be probably at least 7% this year based on some math I did, it was sort of right about then that that year.

And it was based on the following simple analysis that suppose that I'm an economy and all I do is I make apples, and I've got ten 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 ten apples.

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 gonna spend $11 on apples this year but you only have ten apples, so the supply is constrained because you don't, you can't, like, it's gonna take a while for an apple tree to grow.

And but if so, if you spend $11 on apples, then what's gonna happen is that the price of the apples is just gonna go up you could have inflation, and so if you could 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 could respond is if you have like, a large share of the things you buy is like, from the global economy, and you're just a little country and so on and so you're not necessarily gonna get the full. 11 apple effects, we could call it, but it was really easy to do the math that would show that supply couldn't possibly keep up with the demand that they were pushing through, cuz there was so much.

And that's where really the Cochrane asset article about how inflation's about to lift off really came from. I was from simple math that anybody who took a first semester macro class, undergraduate macro class, should have been able to do. And again, 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 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 when you're in the White House and you just passed this bill that's a big mistake, then it puts everybody who's a messenger into a difficult spot.

And I think that 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. We know that people at the Fed thought it was transitory at the beginning, cuz they moved way too late.

And I don't think they're being partisan.

>> John Hurtley: Media in part, or there were certain people who were trying to hold water for the Biden administration.

>> Kevin Hassetta: For sure, that's true, too, right? Because the point is, just, again, to go back to your question, if I had beten at CEA and I came out when we saw inflation at 7%, and I said, don't worry, it's transitory.

Then there would have been, and I used to do the White House press conferences and be, but chairman has it, but chairman has it. No, no, wait, wait a minute. Me, me, that's what would have happened, right? Yeah, how could you say that? And then they would have found the Democrats and say, you know what, this Nobel Prize winner says, it's a permanent negative shock.

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, 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 who's hiding in the basement. And so, we don't really have an honest conversation about all these things.

>> John Hurtley: But group think 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 point by point. Sort of CPI sub components of, look at used car prices that are skyrocketing, and so forth.

And I think that sort of justified this pause or not raising interest rates on the Fed side of things. Ultimately, until March of 2022, a year later after the uptick in inflation was first showing signs, but by October of 2021, it was very clear that 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 spending versus supply chains were responsible, and often there isn't a monoclosal reason. But it's interesting how strongly people like to deny any kind of influence from spending at all, it's very interesting.

Speaking of spending and debt, I wanna get your take here on the debt limit. There's currently a big debt limit debate in DC right now about whether or not there should be a clean debt limit increase. That is, the debt limit being increased without any other considerations or anything else to change the future path of debt.

These debt limit ceilings have been part of law for quite some time. Typically every time we near them, they get raised. And ten years ago there was pretty significant debate around a similar deadline ceiling standoff that resulted in S&P downgrading us debt. 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 US equities at the time, and it actually caused US treasury to rally, which is somewhat counterintuitive, given that S&P was down grading US debts. We're in this new sort of debt limit ceiling standoff, and CVS prices on US debt are higher than what they were even ten years ago.

So the probability, or what the market thinks about the probability of there actually being some form of default is actually higher than it was ten years ago. Now, you're not in favor of a clean debt limit raise, unlike some other Republican economists who say 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 Hassetta: Yeah, and first you have to understand that the debt limit, it goes actually back to the 19 teens. It used to be, by the way, going back all the way, 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.

Let's say we're gonna borrow money to build a bridge, then we borrow some money to build a bridge, and then Congress would have, they borrow money to build a bridge act. And then what happened is in the 19 teens, they decided this is getting out of control, and so let's just have a debt limit.

This sort of applies to everything. And 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 US history have been dirty. There's a Congressional research service study on the history of these, which I commend people, if you Google it, you'll find it right away, that shows basically what happened each time. And if you look at it, the majority of debt limit increases that passed with a Democratic Congress and a Democrat in the White House were dirty.

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 position right now that we shouldn't negotiate, we shouldn't include other policies is ignoring a long history of this being basically a vehicle by which policy compromises are made. And so the debt limit has been a really good thing because it's helped constrain the growth of government and introduce good policies like the cigarette tax came and a debt 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 gotta pass it or you're in default.

And so the majority party gets a little bit of power, and so what's happening right now is you got all these Nobel Prizes. Surprise, 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. So it's astonishing to me that that's 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 sort 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 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 because they didn't agree, they didn't come up with something. And so the idea that it's McCarthy's fault if you default 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 gotta allow for the fact that there's gonna be extreme positions taken because they're negotiating and they're gonna 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 think tank inside Washington people who basically don't want Republicans to have any power at all, apparently.

 

>> John Hurtley: Fascinating, well, thank you so much, Kevin, for these amazing thoughts on so many topics, from tax policy to the Covid-19 stimulus response, the debt limit. Thank you so much for joining us.

>> Kevin Hassetta: Thank you.

>> John Hurtley: Our guest was Kevin Hassett, a distinguished fellow at the Hoover Institution at Stanford University and former chairman of the Council of Economic Advisors.

This is the Capitalism and Freedom in the 21st Century podcast where we talk about economics, markets and public policy. I'm John Hartley, your host. Thanks so much for joining us.