The headlines this week were devoted to the high-stakes drama in D.C. that led to (literally) an 11th hour deal to avert a federal government shutdown and an $38 billion spending cut for 2011-2012. But the real news was that the 2012 Presidential election was effectively thrown to the Democratic incumbent (who also announced the launch of his campaign this week) when the leading fiscal policy visionary on the Republican side issued his long-term plan for the role of government over the next ten years. Congressman Ryan’s plan is so extreme in its proposed cutbacks on health insurance coverage and so regressive in its proposed reform of income and corporate taxes that it leaves most of the American political spectrum open to President Obama for the taking. He will no doubt begin the journey to this vast expanse of political turf with his speech on Wednesday.
Ryan’s plan has been much discussed in the press. It calls for a privatization of Medicare, with drastic reductions in funding. The key will be in how this funding reduction is distributed, and there is no indication that it would be done in a progressive way. This the major fault line of the plan, that it would put an even greater burden on the poor and middle class in accessing health care than is the case today. The plan calls for reducing the income tax on the richest individuals and corporations to the extremely low level of 25%. Finally, the projected effect of the plan on budget deficits hinges on wildly unrealistic assumptions that have already been questioned by the Congressional Budget Office.
We are in such a moment of political frenzy over the fiscal deficits that we often forget two basic economic fundamentals about deficits. The first is that deficits are not a function simply of spending levels but mainly of economic growth rates, since it is these that largely determine revenues. The second is that shrinking deficits generally reduce the economic growth rate and slow the creation of jobs.
There is no reasonable economic case for cutting the budget deficit in the short run because while the hemorrhaging of the labor market seems to be over, there are only small signs of an upturn in employment. The $38 billion cuts in this weeks budget deal will only hurt, although the cuts are not large enough to make a big difference (0.25% of GDP). Over the recent period of GDP growth the unemployment rate remains just below 9%. More important is that the decline in the unemployment rate is swamped by the increase in discouraged workers who are not counted among the unemployed.
What is the economic case for deficit cutting in this environment? There are two lines of argument, both related to the stress that public borrowing puts on capital markets. The first is that fiscal deficits raise interest rates. There is no evidence to support this case. Both short-term and long-term rates remain at historic lows. The bond market is simply not showing signs of a lack of confidence in the U.S. Treasury as the budget cutters would lead us to believe. The second argument is that public spending “crowds out” private investment. Given the weakness of corporate spending over the last few years, this one at least is plausible. The problem is that the most significant determinant of investment spending by the private sector is expected future profitability usually tied to expected future rates of economic growth. Most studies by economists, thus, find that public spending serves to “crowd in” private spending because it spurs economic growth. There remains a case for improving the corporate sector’s access to credit, but this should be addressed through financial regulation, not fiscal restraint.
The Ryan plan would exacerbate the economic problems of our day–slow growth and high inequality. The good news is that the plan is a political disaster for the right. Either the Republicans will have to back away from the Ryan plan — which, given their aversion to tax increases, will translate into larger budget deficits – or, the Republicans will make the plan a centerpiece of their platform, in which case they are ceding most of the political spectrum to President Obama. Like all incumbents before him, Obama is not concerned with his base or those on the left of the political spectrum. He will govern not even from the center, but from right of center (see, for example the Simpson-Bowles deficit commission recommendations), since this allows him to capture a big part of the centrist vote and everything to its left.
While those on the left may not be able to count on President Obama to support a standard left-wing fiscal agenda of expanding entitlements and a progressive tax reform, they can expect that the administration will trumpet the results of the CBO analysis of the Ryan plan. Once the implications of the plan are clear to the American public, the extreme nature of this vision will be apparent.
I understand the politics of the deficit, national debt and the unfunded liabilities issues; but I would like to understand more about workable economic solutions to these problems short term and long term that will return the U. S. economy to full employment without eroding our purchasing power. Do you have opinions on which solutions will work best, and why? To use an everyday analogy, I feel as though the United States is like lobster that has been placed in large pot of cold water on a gas stove with the burners turned up high. We feel comfortable as the temperature rises and are likely to be cooked before we acknowledge what is happening and do something meaningful about it. Perhaps President Obama will offer his solutions tomorrow.
Hi Michael. I am not affiliated with this website or post author in any way. But I happened to read the article, happened to see your comment, and would like to put forward an answer to your question.
There are many different ways for the US to increase revenue and/or cut spending. If we can decide on a package of specific revenue increases and/or specific spending cuts that puts us back in the black, we’ve solved our problem.
Interestingly, in modern US politics one of the two major political parties has specifically taken one of our two major avenues to the solution (revenue increases) off the table. Due to dogmatic ideological beliefs, they’ve consistently supported decreasing revenues (tax cuts), which obviously moves us deeper into our problem and forces us to make even harder choices. Specifically, the massive “Bush Tax Cuts” increased our yearly deficit and thus also our total national debt by a gigantic amount of money. These cuts were deemed irresponsible in the long term by their original designers and were set by law to expire, but we’re now seeing politicians fighting tooth and nail not only to prevent the lawful expiration but to also cut taxes even further than these already-historical-lows.
Sorry for the tangent, but it is good to understand the context when imaging solutions to a problem. In our case, we can look at all the available solutions and come up with a package that we think is wisest, but we must keep in mind that an entire sector of potential solutions, revenue increases, will be fought against tooth and nail by one of the two major political parties.
So, on to solutions. The following tool is great:
http://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html
You’ve probably already seen it and used it. There are other similar tools on the web, but they all include roughly the same potential options and roughly the same overall dollar figures. When you sit down and use one of these tools you will likely be struck by two surprises. One, the magnitude of the problem is truly gigantic – so gigantic that it is hard for a person to truly comprehend. Two, it is actually not that difficult to solve the problem as long as you are willing to make drastic cuts to one or two large ticket items.
I consider myself a classical Conservative. I have a dim view of human nature, oppose utopian policy making, and advocate pragmatic policy that helps the largest segment of Americans possible. Let me share with you the specific boxes I tick on the NYT tool to fix our budget problems. You may be surprised to hear what options I put together to completely fix the problem:
1) Reduce nuclear arsenal and space spending (not necessarily a total waste of money, but not wise when we are pinching pennies)
2) Reduce military size to pre-Iraq levels and remove troops from Asia and Europe
3) Reduce our troop count in Iraq and Afghantistan to 30,000
4) Enact medical malpractice reform (very small dollar amount realized, but hey, its still a good idea)
5) Reduce tax break for employer-provided health ensurance (a massive distortion of the market for health insurance)
6) Reduce social security benefits for those with high incomes
7) Return the estate tax to Clinton-era levels
8) Allow the Bush tax cuts only for those who make over $250,000 a year to expire (as already dictated in law)
9) Adjust the payroll tax upwards a bit to cover the same percentage of wages it was originally intended to cover
10) Add a new top tax bracket for people making over $1 million per year (i’d like to add more tax brackets in between and above as well, but no option is given in the tool for this)
11) Eliminate tax loopholes similar to Bowles-Simpson
12) Eliminate the mortgage deduction and other similar deductions for high income earners
13) Install a carbon tax (as proposed originally by conservative think tanks 20 years ago)
There you go. Honestly, I don’t think any of the options I’d choose are extreme. Every option on the table comes with benefits and drawbacks. My method is simply to select any option that restores military spending or tax revenue to roughly Clinton levels (or better yet, Reagan levels, but that was not an option in the NYT tool). I think the Bush detour into unneeded wars and irresponsible tax cuts was dangerous and the primary cause of our problems right now. You can clearly see this when you use a budget tool like the one linked above.
One item not included in the NYT tool is to roll back Medicare Part D, the largest domestic spending item passed in the last couple decades. I don’t think it was wise to increase Medicare spending so greatly and needlessly while the original program itself is in danger of cuts. Why does one major political party first pass something like Medicare Part D while it is in full control of the white house and congress, and then advocate massive cuts to the original core of Medicare several years later? I don’t know. It is hard to answer such questions about motivation. But I can say with certainty that no cuts to Medicare or Social Security are necessary if you are simply willing to roll back recent military spending and recent massive tax cuts and benefits for the wealthy.
I hope you find this info interesting. I’m sure you will disagree with many of my policy stances, but I hope we can all at least agree that the problem is very solvable and the only question is about our priorities as a nation. Do we want to keep military spending and tax rates on the wealthy at historical lows while taking apart social programs for the middle class, or do we want to roll back military spending and tax cuts for the rich to Clinton (or, god forbid, even Reagan) levels? We all have to make this choice for ourselves and we’ll see the argument being played out in politics over the next few years.