8/28/09 6:09 PMAmerican Medium-Term Fiscal Policy Going Forward...

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August 18, 2009

American Medium-Term Fiscal Policy Going Forward...

Bob Williams writes:

TaxVox: the Tax Policy Center blog: Rosanne Altshuler and I have argued in recent posts that

Washington will be hard pressed to close our ongoing budget gap with politically palatable tax

increases.... But what about the spending side of the budget?... [C]utting a dollar of spending

has pretty much the same effect on the deficit as raising another dollar in taxes. Let’s...

concentrate once again on 2012, the budget-window year with the smallest deficit--a mere $633

billion. The Congressional Budget Office’s baseline projects total 2012 spending of $3.4 trillion:

$1.9 trillion mandatory, $1.2 trillion discretionary, and $300 billion in interest paid to the

public.... [B]alancing the 2012 budget would require cutting a third of all mandatory spending

or more than half of discretionary outlays. That’s a tall order in the best of times....

[M]andatory spending... 40 percent pays Social Security benefits and another 30 percent covers

Medicare. If you protect them, you could zero out the rest--Medicaid, military and federal

retirement, and income support programs like unemployment compensation and Supplemental

Security Income--and just about balance the budget in 2012. You might squeeze some cost

savings out of Medicare, but just stop by your congressman’s town meeting to see how easy that

would be. Big cuts in Social Security benefits won’t happen either.

Cutting on the discretionary side... is unlikely to be any easier....

So let’s review the bidding. Politically feasible tax increases alone won’t solve the problem.

Neither will cutting spending. In fact, if history is any guide, we’re unlikely to do much of

anything on the outlay side. We will certainly have to slash the growth of healthcare to keep the

budget from spiraling totally out of control. But that’s likely to take the form of “bending the

cost curve” to get gradual savings over many years. In the near term, I suspect taxes will do the

heavy lifting. And that will require either major tax reform or tapping new revenue sources.

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I am having a hard time figuring out in which direction Mr. Williams is going. "Tapping new

revenue sources" sounds to me a lot like plain-old "tax increases" which are, he says, not "politically

feasible." Perhaps he means: "getting members of congress to vote for tax-law changes that cut taxes

on some of their constituents and raise taxes on others who don't notice until it is too late"? Seems

to me that that is not a recipe for good tax policy--that that is a recipe for raising taxes on

(politically) weak claimants.

And I have a hard time figuring out what Mr. Williams's destination is. Yes, I think that balancing

the (nominal) budget is a good thing--hell, I think balancing the ex-Social Security budget is a good

thing. You plan to balance the ex-Social Security budget and you are making (some) provision for

the aging of America while still setting the rest of the budget on a downward debt-to-GDP path

which leaves the government some fiscal headroom to deal with emergencies, and there will always

be emergencies.

But experience has taught us all that balancing the budget merely provides Republicans with an

opportunity to further unbalance the income distribution and widen inequality by enacting tax cuts

for the rich whenever they take power--and Republicans will take power again. As long as the

opposition to the Democratic Party is the current Republican Party, balancing the (nominal) budget

is an inappropriate goal. The appropriate goal for the budget is stabilizing the debt-to-GDP ratio.

Stabilizing the debt-to-GDP ratio requires running a primary surplus--a surplus of taxes over non-

interest spending--equal to:

PS = (r-g)(D/Y)

where r is the rate of interest on government bonds, g is the growth rate of the economy, and D/Y is

the debt to GDP ratio.

And while Bob Williams is right that we can't balance the budget over 2012-2015 with "politically

palatable" tax increases and spending cuts, we can stabilize the debt-to-GDP ratio--indeed, we do

stabilize the debt-to-GDP if congress is willing to lock itself into the box and enforce PAYGO on all

deviations from the CBO baseline:

8/28/09 6:09 PMAmerican Medium-Term Fiscal Policy Going Forward...

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For the next decade, perhaps the place to fight the budget fight and the line to hold is to insist on

real PAYGO.

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Brad DeLong on August 18, 2009 at 09:00 AM in Economics, Economics: Fiscal Policy, Obama

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big government conservative 21 million

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This is the legacy of our great Communist conspiracy, Reagan, lil Bush, and Dick "deficits don't matter" Cheney.

Posted by: Mattyoung | August 18, 2009 at 10:19 AM

The only way this present system will work out is with extraordinary growth accompanied by a continuation of

extraordinarily low interest rates.

You might like:

DeLong: Project Syndicate: Obama Has Lucked Out with Bernanke (this site)

You Cannot Hope to Bribe or Twist... (this site)

8/28/09 6:09 PMAmerican Medium-Term Fiscal Policy Going Forward...

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The probability of either one happening is low, and both at once, neglible.

Without those unlikely events we will have to recognize that we have moved into "all hat and no cattle" territory.

However, Afghanistan will live up to it's reputation as the reef upon which ships of state are broken.

Posted by: Neal | August 18, 2009 at 10:29 AM

Other revenue source: sales tax of 5% on out-of-state internet purchases. Bam.

Posted by: NE1 | August 18, 2009 at 12:31 PM

Another case of fallacy of composition...see below.

"Teaching the Fallacy of Composition: The Federal Budget Deficit

One of the most important concepts to be taught in economics is the notion of the fallacy of composition: what

might be true for individuals is probably not true for society as a whole. The most common example is the paradox

of thrift: while an individual can save more by reducing spending (on consumption), society can save more only by

spending more (for example, on investment). Another useful and very topical example involves the federal

government’s budget deficit. Politicians and the media often argue that the government must balance its books, just

like a household. If a household were to continually spend more than its income, it would eventually face

insolvency; it is thus claimed that government is in a similar situation. However, careful examination of

macroeconomic relations will show that this analogy is incorrect, and that it would lead to improper budgetary

policy. This example can drive home the fallacy of composition."

http://neweconomicperspectives.blogspot.com/2009/08/teaching-fallacy-of-composition-federal.html

Posted by: Economist | August 18, 2009 at 01:26 PM

I think you are right about keeping a deficit for a while because if you create a surplus the Republicans will just give

it away as a tax cut without applying it to the structural deficit.

What is interesting is how times change, but then they do not. In 1978 I was counsel to the House Judiciary

Committee, and the Republicans sought a balanced budged constitutional amendment. (Sort of like tying the

steering wheel to the armrest and driving the car forward, leaving you only to brake or accelerate.) I believe at that

time the deficit was some ridiculously low number--I'm thinking something in the $20 billions. The amendments

always left a loophole for military spending. The purpose was to starve the government, and give the minority more

power.

Later, in the 80's, social security was going to fail, and according to Greenspan, this change in the SS taxes would fix

the problem into the future. The future turned out to be a few years later, because the extra revenue from SS

increases was used to support tax cuts.

This stuff is so old. The only reason we repeat it is no one recalls the history of what was said and done in the past.

It's like every day we wake up and forget yesterday, but go on to repeat it.

Posted by: Bill | August 18, 2009 at 05:48 PM

I don't really think there's too much damage the GOP can do with a surplus these days. Because the only way we are

going to get a surplus is if the Democrats increase taxes on the wealthy. So there won't be a whole lot of room for the

GOP to make taxation more regressive.

Posted by: John Whitesell | August 18, 2009 at 06:47 PM

Just to check - this formula:

PS = (r-g)(D/Y)

expresses the primary surplus as a % of GDP?

Posted by: Oliver Rivers | August 19, 2009 at 12:29 AM

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