Larry Summers: ‘I’m concerned that what is being done is substantially excessive’

Former treasury secretary criticises the scale of Biden’s fiscal policy and warns it could lead to overheating and wasted resources

Martin Wolf

           © Leonie Woods


The world economy is struggling to escape the economic shock of Covid-19. 

During the worst of this pandemic, high-income countries provided a scale of fiscal and monetary largesse previously only seen in world wars.

No, however, after the election of Joe Biden as president, the US is proposing to do more than double down on already generous support. 

Is what the US administration doing well judged or excessively risky?

For its proponents, the idea of “going big” is designed, among other things, to rectify the mistakes, as they see it, of the Obama administration of 2009. 

They want this to be seen as a transformative political moment. But Lawrence (Larry) Summers of Harvard has criticised the approach as the “least responsible” in 40 years.

Summers is an influential economist and policymaker on the US centre left. 

He won the John Bates Clark medal in 1993 and has been chief economist at the World Bank, Treasury secretary under Bill Clinton and head of Barack Obama’s National Economic Council.

Summers has never been reluctant to court controversy as a thinker and policymaker. 

Notably, in 2013, he reintroduced into macroeconomic discussions the idea of “secular stagnation”, first used by the Keynesian Alvin Hansen in the 1930s.

He used the label to explain the combination of a long period of easy, or ultra-easy monetary policy, with weak demand and disappointing growth. 

He then became the leading economist arguing in favour of less reliance on monetary policy and more on active fiscal policy.

Now, however, Summers — a Democrat with his party back in power — is criticising both the scale and direction of the administration’s fiscal policies. 

Instead of applauding its boldness, he fears they will lead to significant overheating and waste of resources.

In discussion with Martin Wolf, the FT’s chief economics commentator, Summers explains why the new approach might go disastrously wrong. 

He agrees there is a strong case for a more aggressive approach to fiscal policy. 

But policy still needs to be grounded in economic realities and priorities — and these ones, he insists, are not.

If Summers is wrong, it will matter little. 

If he is right, the hopes for a transformative presidency are likely to end in catastrophic economic and political disappointment. 

It is an immensely important argument.

Martin Wolf: Let’s start with the current macroeconomic situation and, particularly, the legacy of Covid-19 and the arrival of Biden. 

His administration has already passed an enormous new fiscal stimulus of $1.9tn and is talking about a longer-term investment package of $3tn. 

Together, this is close to a quarter of gross domestic product.

You have been critical of these policies. 

Could you explain your criticisms? And how does this fit with your views on secular stagnation?

Larry Summers: I’m going to focus on the American policy path and not talk about where responsibility lies for that path. 

I think, in important respects, it lies with the Republicans and with those on the more extreme left of the Democratic party.

If you look at the economy at the beginning of this year, prevailing forecasts were that Covid would reduce wages and salaries to American households by $20bn-$30bn a month, with that figure declining over the year. 

So, that would be a $250bn-$300bn hole in wages and salaries over the course of the year.

So, I look at this hole and then I see $900bn of stimulus in the December package, $1.9tn of stimulus in the recently passed package and $2tn in the savings overhang, which is also likely to be spent. 

I see the Fed with its foot on the accelerator as hard as any Fed has ever done.

I see serious discussion of trillions of dollars more in fiscal stimulus, along with the explanation that this latest package is not temporary Covid relief, but a harbinger of a major transformation in social policy, which suggests that at least some of it will be continued indefinitely.

So, I look at that dwindling hole. 

Then I look at expenditures that aren’t hard to add into the multiple trillions, and I see substantial risk that the amount of water being poured in vastly exceeds the size of the bathtub.

That could manifest itself, as a much smaller period of excess did during the Vietnam war, in rising inflation and a ratcheting-up of inflation expectations. 

It could, as has often happened, manifest itself in the Federal Reserve feeling a need for a sharp and surprising increase in interest rates, and the subsequent deceleration of the economy into recession.

It could manifest itself in a period of euphoric boom and optimism that leads to unsustainable bubbles, or it could all work out well. 

But, it doesn’t seem to me that the preponderant probability is that it will work out well. 

So I’m concerned that what is being done is substantially excessive.

How does this square with my earlier views on secular stagnation? 

I looked at the global economy and, indeed, at the US economy during the pre-Covid period and what I saw was that, at near-zero real interest rates, there was a quite substantial gap between private savings and investment, driven by demography, cheap capital goods, inequality and technology.

That substantial gap meant a deflationary tendency, one towards sluggishness and for savings to flow into existing assets and create asset bubbles. 

So, I felt that savings absorption was a central macroeconomic problem and the order of the problem was 3 or 4 per cent of GDP at very low interest rates that themselves carry substantial risks.

Now, when we’re talking about fiscal stimulus totalling 14 per cent of GDP in its first round, when we’re also talking about extraordinary monetary measures, structural effects of Covid — notably a large savings overhang — it seems to me that we are way overdoing the requisite response.

I always thought of economics as a quantitative field and when I hear people talk about why this is the right thing to do, they say things like “we really need to go big”, or “the 2009 stimulus was too small”.

It seems to me one needs to link the scale of the problem with the magnitude of the response. 

I look at the response and I look at the scale of the problem and I can’t see how it adds up.

There’s not much argument that the 2009 stimulus, in retrospect, was too small. 

It was 4 to 5 per cent of GDP over a couple of years, so it was 2.5 per cent of GDP in the first year, against a gap that was 6 or 7 per cent of GDP and growing, so it was perhaps a third or half of that gap.

Today’s stimulus is above 10 per cent of GDP in the face of a gap that is 3 or 4 per cent of GDP. 

Relative to the gap, this stimulus is already of the order of five or six times as large as in 2009. 

Not even the most extravagant critics of the 2009 stimulus have suggested it should have been six times as large.

I would say one other thing. 

In 2009 there was an important argument in which the people who were, in general, more progressive in their beliefs stressed that — in addition to responding to the macroeconomic situation — it was essential, in Rahm Emanuel’s phrase, “not to let a crisis go to waste” and take advantage of this opportunity to do deep structural things.

That’s why, in the 2009 stimulus, there were important investments in electronic medical records, new green venture capital and research-type measures, extending broadband and infrastructure repair and investment. 

What’s striking about today is that all of the trillions of dollars — all of it — does not include a penny directed at building back better.

I could have been comfortable with a headline figure well in excess of $1.9tn if it had been a large-scale, multiyear programme of public investment responding to our deepest societal concerns. 

But that’s not what this is.

It transfers to state and local governments that don’t have any new budget problem, according to the latest figures. 

It’s paying people, who have been unemployed, more in unemployment insurance than they earned when they were working. 

It’s giving cheques to families in the 90th percentile of income distribution.

It doesn’t seem prudent on resource allocation grounds, as well as being problematic on macroeconomic grounds.

MW: Assume you are correct. So we get huge excess demand in the US. 

One plausible consequence is a widening of the current account deficit, possibly associated with a large rise in the dollar as monetary policy is driven to tighten. 

This could, given the scale of borrowing around the world denominated in dollars, be followed by the sort of debt crisis we saw in the early 80s.

Should we be thinking about such international ramifications of the programme you’re discussing?

LS: I very much share your apprehensions. 

The reason I haven’t articulated a fuller set of views is that I find myself ambivalent between two adverse scenarios.

One is what I would call the Reagan deficits scenarios — a temporary boom, rising current account deficit, increased protectionism, a strong dollar and magnification of the debts of others.

The other risk is what I would call the pre-Bretton Woods scenario or the Carter administration scenario, in which the sense that a country is printing its currency indiscriminately, in conjunction with the substantial accumulation of debt, leads people to be more reluctant to hold it.

I guess if I can see a plausible scenario for a very strong dollar and for a very weak dollar, it’s logically possible that the forces will balance themselves, at least over time. 

Of course, Latin America’s experience would suggest that the pursuit of reckless policy could lead to a scenario like yours, followed by a currency collapse.

There’s a term I coined when I was in the Treasury, iatrogenic volatility. 

Iatrogenic illness is when you go into a hospital and you catch an infection there. 

Iatrogenic volatility is when policymakers, whose role is to stabilise markets, destabilise them with their actions.

I think there is a risk of that taking place. 

But I don’t have the conviction to predict in what direction and with what timing it will happen.

MW: Let’s suppose I were [Treasury secretary] Janet Yellen. 

Her argument might be that this stimulus might create some excesses in the short-run. 

But that will be a temporary shock.

We believe — she might say — that the elasticity of labour supply in the US is actually much greater than you and most other economists believe. 

We will pull a large number of workers into the labour force. 

This will pull up wages. 

That will squeeze profits, which will be fine, because profits are very high.

Yes, maybe, inflation will get up to 3-3.5 per cent but the Fed will look through that and expect a return to lower inflation. 

And, our future spending plans — this $3tn, or whatever — are going to be covered by taxes. 

You are far too worried about something we need to do to give confidence back to Americans, jolt us out of the Covid-19 recession and improve the conditions for many workers who have given up.

Why would you say this is wrong?

LS: I’d make these points.

First, no one was advocating a programme of this magnitude last December. 

This was not anyone’s economic analysis. 

So, the argument might be right — but it was not an argument anyone had come to before it became politically expedient.

Second, there’s much discussion that suggests you can’t measure the GDP gap but, gosh, employment is 10m people lower than it might otherwise have been, so there’s got to be enormous slack.

Covid-19 has wrought colossal changes in the global economy. 

In this monthly series, leading FT commentators hold in-depth, solutions-focused conversations with the world’s top economists about what the recovery will look like

As a rough calculation, if employment is 10m people short, that’s about 6 per cent of the labour force and, it appears, those who are not employed have wages of perhaps 60 per cent of the average worker. 

In terms of the shortfall in effective labour input, you’re at 60 per cent of 6 per cent, which is about 3.6 per cent.

So, in employment terms that gets you to just about the same gap that you come to in terms of more traditional estimates. 

You also don’t see the Fed or others substantially revising upwards their estimates of potential GDP.

Third, the view that this is only temporary expenditure sits uneasily with two other things that the proponents like to say. 

One is that this is a new era in progressive policy, with a different attitude towards government and public policy, and that there’s a lasting legacy of structural improvement.

That would suggest that the spending was going to continue over some very substantial interval, in which case relying on its transience may not be such a good idea, even before you get to the question of future spending and investment.

The other thing that Paul Krugman and others who have defended this programme argue is that households are going to save part of the money that’s provided to them. 

I, too, think it’s likely that half this money will be spent this year and a quarter of it will be spent next year and the year after.

Yet, you still have to ask what is the magnitude of the fiscal stimulus and what is the magnitude of the cumulative gap over the next several years? 

It is hard to make that arithmetic work out even over that period.

There is a serenity that, yes, inflation may rise for a time but it will return and expectations will not become unanchored. 

Of course, when it’s explained that the Fed has an entirely new paradigm, that this is an entirely new paradigm of fiscal and social policy, it’s a bit hard to understand why expectations should remain anchored.

So, we’re seeing an episode that I think differs both quantitatively and qualitatively from anything since Paul Volcker’s days at the Fed, and it stands to reason that would lead to significant changes in expectations.

Let me put it in a different way and it’s sort of ironic. 

The bet that we can do this is a bet on secular stagnation being even more true than I had supposed. 

For this to be right, the long-term demand gap has to be far larger than I had imagined.

I don’t think that, until recently, the principal criticism of my views on secular stagnation was that I was very much underestimating its force. 

So I find it not a preponderant probability.

MW: The implication of your view of the macroeconomics would seem to be that taxes have to be raised permanently because the administration’s ambitions are for permanent increases in spending, some of it on investment but quite a bit on current spending. 

If you were asked how should we raise the taxes to pay for this, what would you advise them to do?

LS: I have written for years in favour of increased public investment. 

An additional point that I think is under-appreciated is that whatever values you have, the reality is that a larger fraction of our population is going to be aged in the future and the relative price of things, like education and healthcare, has also increased very dramatically relative to the price of things like television sets. 

This means the public sector has to be bigger, to deliver on the same values.

The fact that we have more inequality, that support for opportunity and redistribution are central fiscal responsibilities and that we’re moving into an increasingly dangerous world with more international obligations, mean that whatever you thought the right share of government was 20 years ago, you should favour a substantially larger one today, unless your values have changed. And I do.

So, yes, the US would definitely be better off with a larger government and that is going to require larger taxes. 

I think the administration is entirely correct in its view that the place to begin looking for higher taxes is with those who have been most fortunate over the last decades.

The measures that I would favour would be, first, a very substantial increase in the tax-enforcement effort.

Second, there were very substantial and inappropriate excesses in the Trump tax cuts. 

Even the business community didn’t ask for a reduction in corporate rates to 21 per cent. 

A serious programme of corporate tax reform could surely raise over $1tn over the next decade.

Third, a variety of changes associated with capital gains tax would raise $0.5-1tn.

In all, I think one could raise close to $4tn over the next 10 years with measures that would be desirable in terms of having a more just and more level tax system, and that’s where the conversation should start.

Ultimately, I think society is going to require larger revenues and it is going to be necessary and appropriate to raise taxes, not just on the top 1 per cent of the population but more broadly.

And I think that would be the right thing to do, even if there were not macroeconomic concerns over overheating.

MW: Finally, a long time ago, we used to associate the Republican party with a “balanced budget” view. 

That has clearly gone out of the window. 

Is the same thing now happening to the Democrats? 

Is the implication of your analysis that no political force in America nowadays wants to offer fiscal rectitude?

LS: Imputing a tradition of serious fiscal concern to Republicans has been wrong for 40 years. 

Republicans have been deficit hawks whenever Democrats have wanted to spend money on helping people who are disadvantaged. 

And then going back to the Reagan tax cuts, through the Bush tax cuts and the Trump tax cuts, whenever there was an opportunity to cut taxes for high-income people.

In the 1990s, substantial amounts of business investment were being inhibited by high costs of capital. 

So I pushed the idea that bringing deficits down and crowding in private investment was an attractive growth strategy.

In the context we’ve had for the last decade, when cost of capital was not a meaningful constraint on investment, one needs to think quite differently about deficits. 

So, I don’t think anybody should believe the things that were believed in 1993, because the world has changed in important ways.

But, in many ways, today’s situation is a bit like the 1960s. 

It was then hoped that the laws of economic arithmetic could be suspended and that it would all work out. 

That experiment didn’t work out well for Lyndon Johnson, economically, and it didn’t work out well for the Democratic party, politically. 

I think there is a significant risk that something of the same kind will happen today.

Biden’s Cradle-to-Grave Government

His latest $1.8 trillion plan rejects the old social contract of work for benefits.

By The Editorial Board

President Joe Biden speaks on the North Lawn of the White House on April 27. PHOTO: STEFANI REYNOLDS/POOL/ZUMA PRESS


The progressive hits keep coming from the Biden Administration, and the latest is the $1.8 trillion American Families Plan introduced in broad strokes on Wednesday. 

It’s more accurate to call this the plan to make the middle class dependent on government from cradle to grave. 

The government will tell you sometime later, after you’re hooked to the state, how it will force you to pay for it.

***

We’d call the price tag breathtaking, but by now what’s another $2 trillion? 

Add $2 trillion or so each for the Covid and green energy (“infrastructure”) bills, and that’s $6 trillion of new spending in 100 days. 

That doesn’t include the regular federal budget of more than $4 trillion a year. 

No worries, mate, the Federal Reserve will monetize the debt.

But the cost, while staggering, isn’t the only or even the biggest problem. 

The destructive part is the way the plan seeks to insinuate government cash and the rules that go with it into all of the major decisions of family life. 

The goal is to expand the entitlement state to make Americans rely on government and the political class for everything they don’t already provide.

The White House talking points pitch this in the smothering love of the welfare state: “making care affordable”; free medical and family leave; “free education”; two years of “universal pre-school”; “invest in the care workforce.” 

Subsidies and millions of new care givers, all licensed and unionized, will nurture you through the challenge of earning a living and raising a family.

One question to ask is: Haven’t we tried this before? 

What is Head Start if not government pre-school education and child care? 

Weren’t school lunches and the Women, Infants and Children program supposed to prevent child hunger? 

Food stamps, welfare checks, child-care subsidies and a supplement to earned-income, plus public housing. 

Weren’t all of these programs and more from previous decades supposed to end poverty?

Why did the trillions of dollars spent on those programs fail? 

And if they didn’t work, why do we need more?

For the candid answer, listen to Rahm Emanuel, the Chicago Democrat who explained the political calculation this week to the Washington Post: “Once everyone’s in, all the parents want in. 

Then it’s not a poor person’s program or a poverty program. 

It’s an education program. . . . That to me, that is essential. 

It changes the center of gravity once it’s for everybody.”

So much for the “safety net” to prevent poverty. 

This is now about mainlining benefits to middle-class families so they become addicted to government—and to the Democratic Party that has become the promoting agent of government.

Democrats are enamored of this principle of “universality” because it has worked to sustain the popularity of Social Security and Medicare, despite their failing finances. 

But those programs promise benefits in return for work across a lifetime. 

The Biden New Deal isn’t a deal at all. 

Most of its programs are free handouts on the model of the 1960s Great Society.

The new pre-school entitlement will go to all families, as would free community college. 

The tax-credit expansion to $3,600 per child in the Covid bill, which Mr. Biden wants to make permanent, is on top of the other welfare subsidies. 

The Biden plan also makes permanent an expansion of ObamaCare subsidies for more affluent adults, eliminating the subsidy cap that was 400% of poverty. 

A new paid family leave entitlement will be an incentive for companies to drop leave benefits that already cover most workers.

All of this adds up to healthy guaranteed annual income largely untied to the social contract that requires work, which is the real path to independence and self-respect.

***

The White House is also less than honest about how it will pay for all this. 

Its short answer is that more taxes on the wealthy and more IRS audits are enough. 

But that doesn’t come close.

The permanent child-tax credit expansion would cost $1.6 trillion over 10 years, according to our friends at Cornerstone Macro. 

The White House says it only costs $420 billion, but that’s because it only includes four years through 2025. 

The new entitlements ramp up slowly but explode in the later years, while the tax increases are immediate and won’t raise the revenue they expect.

That’s especially true of the increase in the top tax rate on capital gains to 43.4%, which would lose money by all historical experience. 

The White House tries to get around this by eliminating the step-up basis for paying capital gains at death, meaning an heir would pay the tax based on accrued value over a lifetime. 

This is a back door addition to the current death tax rate of 40%.

The White House also predicts that unleashing thousands of new IRS agents will find $700 billion in unpaid tax bills. 

But this prediction is based in part on old IRS data, before the 2017 tax reform that removed many tax loopholes, especially in the corporate tax code. 

The only benefit of the IRS audit army is that its $700 billion bogey replaces what would be another tax increase.

The new taxes are destructive, but their impact will take time to be felt as the post-pandemic economy soars. 

The GOP shouldn’t ignore the taxes and spending. 

But a more potent political target may be the bill’s tripling down on a welfare state that disdains the dignity of work and seeks to make Americans the wards of government.

Biden’s Infrastructure Plan: Who Are the Winners and Losers?



The American Jobs Plan (AJP) proposed by President Biden on March 31 would spend $2.7 trillion and raise $2.1 trillion dollars over the 10-year budget window of 2022–2031, according to the Penn Wharton Budget Model (PWBM), a nonpartisan initiative that analyzes the economic impact of public policy proposals.

The AJP’s tax and spending provisions would increase government debt by 1.7% and reduce GDP by a quarter percentage point by 2031, the study projected. By 2050, however, government debt would fall by 6.4% and GDP would decrease by 0.8%, according to its estimates.

“The decline in GDP isn’t necessarily going to mean that we are worse off as a society,” Alex Arnon, associate director of policy analysis at PWBM, said in an interview on the Wharton Business Daily radio show on SiriusXM. (Listen to the podcast at the top of this page). Much of the spending is to keep existing infrastructure in running condition and to provide insurance against unforeseen setbacks, he added.

“A lot of the investments [will be] in resilience, and as a form of insurance against, say, catastrophic climate change or a future pandemic,” Arnon continued. “Those investments in the most likely outcome don’t pay out in full [if] things go okay. But if we get unlucky and things turn out much worse than we expect, we’ll be glad we have that insurance.” Some benefits of those investments are not captured in GDP measurements, such as “better roads, safer and faster trains, or more regular bus services,” he added.

Taking the Long View

While the AJP does not specify any spending plans beyond 2029, PWBM has assumed that the proposal would not increase federal outlays in 2030 and beyond, and that its business tax provisions continue past the budget window.

The study assessed the impacts beyond the 10-year budget window, extending up to 2050, in order to remove the “big bias” that a shorter window would entail, PWBM faculty director Kent Smetters said at a press conference where he released the study’s findings. The estimates “would not look favorable” in a 10-year window, especially since public spending on infrastructure projects such as bridges would have “a longer-run path” before they begin to pay off, said Smetters, who is also a Wharton professor of business economics and public policy. “We want to give a fairer comparison by going more long-run.” Smetters is

In addition to Arnon, the PWBM team that conducted the analysis includes Marcos Dinerstein, economist; Jon Huntley, senior economist; and John Ricco, associate director of policy analysis, under the direction of Richard Prisinzano, director of policy analysis and Efraim Berkovich, director of computational dynamics.

“The fact that we are pulling resources out of the private sector in order to make these investments in public capital [will hurt] future outputs.”–Alex Arnon

Funding for the AJP is planned from higher business taxes, including an increase in the corporate tax rate to 28%; a minimum tax on corporate book income (income firms publicly report on financial statements); and a higher tax rate on foreign profits of U.S. companies. Other funding is planned by removing tax preferences for fossil fuels and tax deductions for certain types of foreign income.

The original Biden campaign proposal called for spending on public infrastructure, R&D, workforce training, affordable housing, and caregiving. It later added an additional $400 billion in clean energy tax credits.

The PWBM model treated individual components of those spending outlays as either public investments or as transfers. Public investments, totaling $2.1 trillion of the AJP, include new spending on transit infrastructure, R&D, and domestic manufacturing supply chains. Investments in such “public capital” enhance the productivity of private capital and labor. Transfers, totaling $600 billion, include spending on affordable housing access and on home- and community-based care.

Crowding out Private Investment

New spending on either public investments or transfers, if financed through increased federal deficits, has the indirect effect of crowding out private investment. “That crowding-out effect reduces growth in the capital stock and thus GDP,” the study noted.

According to PWBM, the tax provisions in the AJP have two direct economic effects: decreasing firms’ incentives to invest and disincentivizing saving by households. “The revenue raised by these tax provisions has the indirect effect of decreasing government deficits and thus crowding in private investment,” it stated.

“In isolation, raising the statutory corporate tax rate is expected to increase corporate investment in the near term. However, that positive effect is reversed when an increase to the corporate rate is combined with the AJP’s proposed minimum tax on book income, which reduces the value of depreciation deductions — in turn increasing the tax wedge on investment. The plan’s international tax provisions also increase the overall tax burden on corporate income.”

Those tax provisions have a cascading effect: The increase in corporate tax rates lowers the after-tax return on equity investment, the study noted. As a result, “households, facing lower after-tax returns, save less which in turn decreases investment and the capital stock.”

“The fact that we are pulling resources out of the private sector in order to make these investments in public capital [will hurt] future outputs,” Arnon said. “The tax increases fall [almost] entirely on corporations, and they are a significant negative for investment and therefore for economic growth over the long run.”

Although the plan’s public investments increase the productivity of capital and labor, that productivity boost is not enough to overcome additional crowding out of capital due to increased government deficits, PWBM stated. By 2031, the AJP’s spending provisions alone would increase government debt by 8.16%, and decrease capital stock by 1.17%, and GDP by 0.25%. By 2050, all of those would fall: government debt by 4.72%, capital stock by 1.46% GDP by 0.33%.

Those funding estimates are on the conservative side because PWBM did not measure the potential impact of other tax proposals in the AJP. They include increased tax enforcement against corporations, denial of expensing for offshoring jobs, and the creation of a tax credit for onshoring jobs. The Biden administration also plans to push other countries to increase their corporate taxes.

Backtracking on Minimum Corporate Tax

The AJP includes a new form of minimum tax based on book income, but with some modifications. That is in sharp contrast to the 2017 Tax Cuts and Jobs Act, which repealed the corporate alternative minimum tax.

Some of the motivation there for the Biden administration might be to target corporations that may over-report book income, or what they publicly report, to attract investors, while underreporting taxable income to lower their taxes, said Arnon. “It’s trying to balance those incentives. The thinking is it will encourage corporations to be more accurate in their reporting of both incomes.”

Compared to the corporate minimum tax requirements that existed prior to the Tax Cuts and Jobs Act, the AJP proposal “is even more complicated and creates even more strange incentives,” Arnon noted.

Treasury secretary Janet Yellen last week also called for a global minimum corporate tax rate to prevent corporations from fleeing to lower-tax or tax-free regimes. Such a global tax could help prevent the type of “race to the bottom” that has been underway, Yellen said in a speech to the Chicago Council on Global Affairs.

“[The AJP is] much more aggressive in terms of seeking out and making sure we tax every dollar of corporate profits, regardless of where it’s earned.”–Alex Arnon

Taxing Foreign Income

The AJP’s proposal to collect more taxes on the foreign profits of U.S. corporations represents “a huge change” from the existing tax regime, said Arnon. He noted that while the Tax Cuts and Jobs Act “massively overhauled the system of international taxation,” the Biden administration wants to scrap all of that and replace it with a new system. “[The AJP is] much more aggressive in terms of seeking out and making sure we tax every dollar of corporate profits, regardless of where it’s earned.”

Taxing foreign profits of U.S. corporations could backfire by prompting them to either relocate overseas, get acquired by a foreign company, or do inversions. “This is probably the single biggest uncertainty in what the plan would actually end up doing,” said Arnon. “The proposed new taxation of foreign profits increases the incentive [for a U.S. corporation] to complete an inversion [by getting] acquired by a foreign corporation [in a lower-tax country].” Taxing foreign profits would increase the value of an inversion for a corporation with substantial international operations, he added.

The Biden administration plans to prevent those inversions with penalties for corporations that go headquarters shopping overseas. “They will use regulatory means, essentially, to ensure that corporations cannot just ditch the U.S. purely for tax reasons,” said Arnon. He recalled that after “a wave of inversions in the mid-2000s,” new rules put in place by the Obama administration and the Tax Cuts and Jobs Act “dramatically reduced the incentives to invert, and we did see a significant slowdown in inversions.”

“Those inversions all but ended after 2017 as reform lowered the top corporate rate to 21% from 35% and moved the U.S. closer to a territorial tax system in which income is taxed where it is earned,” The Wall Street Journal said in an editorial, citing research by Dan Clifton of Strategas Research Partners. In the three years after the passage of the Tax Cuts and Jobs Act (2018–2020), companies repatriated $1.6 trillion from overseas to the U.S., a sharp increase from the $495 billion repatriated in the three years prior to the tax cuts, the data showed.

Those tax provisions have a cascading effect: The increase in corporate tax rates lowers the after-tax return on equity investment, the study noted. As a result, “households, facing lower after-tax returns, save less which in turn decreases investment and the capital stock,” the PWBM report noted.

“Despite the decline in government debt, the investment-disincentivizing effects of the AJP’s business tax provisions decrease the capital stock by 3% in 2031 and 2050,” the study stated. “The decline in capital makes workers less productive despite the increase in productivity due to more infrastructure, dragging hourly wages down by 0.7% in 2031 and 0.8% in 2050.”

Put another way, that means “workers will have less capital to work with and less high technology because of the negative effect on investment,” said Arnon.

Not an Easy Passage

With its controversial proposals, the AJP is expected to face challenges as it makes its way through Congress. “We can already see different groups lining up to take aim at specific provisions,” Arnon noted. “I fully expect that if we do see any kind of final legislation, it’s not going to look exactly like this.”

The AJP is a work-in-progress, and its final shape would depend on the challenges it faces in Congress and modifications the Biden administration may incorporate. One big change came on April 8, when PWBM’s release of its study coincided with a report in The Wall Street Journal that the Biden administration plans to raise the income threshold for its proposed minimum corporate tax to $2 billion from its campaign proposal of $100 million. 

“The change will lose revenue and increase short-term deficits,” said Smetters. PWBM will assess the potential impact in future studies, he added. 

How to Stop the Poverty Pandemic

Experience shows that innovative and evidence-based approaches, when executed well, can dent poverty. With the COVID-19 pandemic threatening to reverse hard-won global gains, the need for policy-relevant research, and for scaling effective solutions, has never been more urgent.

Lindsay Coates, John Floretta


WASHINGTON, DC/CAMBRIDGE – Globally, extreme poverty is increasing for the first time in 20 years. 

Although some poor countries are now receiving COVID-19 vaccines, the pandemic is set to drive nearly 150 million people into extreme poverty by the end of 2021, reversing decades of progress.

Within the space of just weeks, the COVID-19 pandemic fundamentally altered how billions of people carry out their day-to-day lives. 

To understand the sheer scale of these effects, there is no better guide than a map.

But the world has a huge opportunity to help prevent this outcome, and not only through more generous aid and vaccine distribution. 

Lower-income countries also need assistance in adapting and scaling more robust social protection and livelihood programs. 

Such initiatives build resilience, enabling people to weather future economic crises. 

And collaborations between enterprising non-profits and researchers can help guide the way.

Careful, high-quality research to evaluate the effectiveness of specific social policies and programs in different contexts has increased markedly in the past two decades. 

A particularly rigorous approach known as randomized evaluation employs a methodology similar to that of medical trials to assess the real-life effects of promising innovations.

This research has identified a range of effective measures to reduce extreme poverty, including schemes to enroll more girls in school, help the unemployed find jobs, and support voters in making more informed election choices. 

The tremendous value of this research was recognized in 2019 when the Nobel Memorial Prize in Economic Sciences was awarded to three of its pioneers, Abhijit Banerjee and Esther Duflo of MIT and Michael Kremer of Harvard.

A vivid example of how social policy research-and-development collaborations can make a real difference to those whose livelihoods have been upended by the pandemic is the Graduation Approach, whose effectiveness Banerjee and Duflo have studied. 

Established and led by BRAC, the largest NGO based in the Global South, the Graduation Approach involves a holistic sequence of interventions that are evidence-based, highly adaptable to local contexts, and designed to meet the multidimensional needs of people in extreme poverty.

Graduation participants are provided with an income-generating asset such as a cow, a sewing machine, or a cash transfer. 

In addition, they receive wraparound support for the following 18-36 months, including training on how to generate income from the asset, life skills coaching, consumption support, access to a savings account, and links to government assistance.

BRAC previously collaborated with a team of economists from the London School of Economics on a randomized evaluation to study the Graduation program’s impact on poverty in rural Bangladesh. 

The results were impressive: the move to self-employment increased the poorest participants’ earnings by an average of 37% over four years. 

But could the approach be effective and scaled in other contexts?

To answer this question, nonprofits working in seven countries, from Pakistan to Peru, were trained to run the program while rigorous evaluation continued. 

Researchers from MIT’s Abdul Latif Jameel Poverty Action Lab (J-PAL) and Innovations for Poverty Action conducted six concurrent randomized evaluations in each country. 

These coordinated studies found the Graduation Approach to be one of the most effective of the evaluated programs for helping people propel themselves out of extreme poverty.

In nearly every country, Graduation program participants improved their economic outcomes. 

They successfully launched small businesses, and their increased income led them to explore other ways to make money. 

Participants also reported improved psychological well-being, including an increased sense of hope. 

A follow-up study published in November 2020 found that these positive effects persisted for up to ten years after the program ended.

To date, BRAC has reached more than 2.1 million households in Bangladesh, where the program originated, with a “graduation” rate of 95%. 

As of 2018, more than 100 organizations in nearly 50 countries have piloted or implemented Graduation programs.

The Graduation Approach’s worldwide expansion and proven ability to break the cycle of extreme poverty shows that designing innovative programs, collaborating with researchers to test them rigorously, and establishing trusted partnerships with governments can result in great strides toward scaling up the most effective schemes. 

High-quality research demonstrating the Graduation Approach’s effectiveness across contexts helped BRAC, J-PAL, and other partners convince donors and governments that the model can help vulnerable people create sustainable livelihoods and make social protection policies more inclusive and effective.

As BRAC scales Graduation globally through direct implementation and with partners, it has identified important lessons that can inform similar efforts. Above all, adherence to the key underlying principles driving a program’s impact is essential, while also adapting the model to each context. 

An ethos of learning and critical self-evaluation is central to program success, as Graduation’s 20-year evolution in Bangladesh has shown. 

And by examining a program’s effects on different population groups and continuing to tweak and test its components, like the size and type of livelihood packages provided, we can continue to leverage research to empower people in extreme poverty.

The scale of the Graduation Approach after years of iteration and evaluation points to areas where philanthropy and aid can be especially useful. 

These include investment in social policy innovations, rigorous evaluation of whether and how they work, and partnerships with governments to apply globally sourced knowledge to their own programs.

Our experience shows that innovative and evidence-based approaches, when executed well, can dent poverty. 

With the pandemic threatening to reverse hard-won global gains, the need for policy-relevant research, and for scaling effective solutions, has never been more urgent.


Lindsay Coates is Managing Director of BRAC’s Ultra-Poor Graduation Initiative.

John Floretta is Global Deputy Executive Director of MIT’s Abdul Latif Jameel Poverty Action Lab (J-PAL).