Debtors' Prison

Check out this article about the sources of our current fiscal nightmare. The author takes the difference between the 2001 projections for the years 2009-2012 versus the current projection for those years, and attributes the causes of the swing. As he breaks down the causes, they are:

- 37% due to the global recession – 33% due to policies enacted in the Bush Administration (tax cuts, new entitlements) – 20% due to affirmative decisions by the Obama Administration to continue policies begun in the Bush Administration (the war in Iraq, the war in Afghanistan, tax cuts on families earning under $250,000/year, the TARP) – 7% due to the stimulus bill – 3% due to the other spending items on the Obama Administration agenda

I agree with Conor that blame is not the issue – but attribution is important. If we have massive, structural deficits, we need a structural solution. Complaining about waste is not a structural solution. Categorically opposing any new spending because of the deficits is even worse – spending on initiatives that will generate long-term returns is the sort of spending we should be doing, so if (and it’s a big if) government spending were going up in “good” areas, we shouldn’t be opposing that; we should be looking to reduce spending in “bad” areas – meaning, areas that are less productive.

The Obama Administration has two big talking points about the deficit and how they are going to bring it under control.

The first is that health care reform will do it. This claim is, at best, highly speculative. The main evidence to back it up is that other countries spend less than we do and get comparable (or, in some cases, better) health outcomes. But it does not follow that by enacting politically plausible reforms we would actually move our health spending meaningfully in their directions. Other countries pay doctors a lot less than we do; other countries spend much less on end-of-life and beginning-of-life care; other countries spend much less on medical innovation (and free-ride on our greater spending in this area); other countries tolerate significant limits on the freedom of their citizens to purchase private insurance or see physicians privately. I do not forsee health care reform in America changing any of these. That doesn’t mean it isn’t worth doing. We could probably do a great deal to improve labor market competitiveness by making insurance more portable (which some kind of public health insurance option would do as well). We could surely get better health-care options with better incentives to deliver good preventative care. I’ve just very skeptical that any of these things will wind up saving us a lot of money. At the least, I think it’s imprudent to assume that they would.

The second is that an economic recovery will do it. If 37% of the swing from surplus to deficit is due to the recession, then presumably 37% of the problem solves itself. No? No. Because a great deal of the growth of the past decade turns out to have been based on illusion, not true growth in productivity, there is good reason to suspect that our true sustainable rate of real growth is lower than was projected at the end of the 1990s. Moreover, there is this huge mountain of private sector debt to pay off. That will require reductions in consumption and increases in savings. That will depress growth for years, if not decades. Prudently, we should be assuming a real rate of growth significantly below the trend of the past 25 years for the next 10 years at least.

Then there’s inflation. This is the Obama Administration talking-point that they don’t talk about, but it is clearly government policy to create inflation. Inflation transfers wealth from creditors to debtors. Inasmuch as the government is a major debtor, it benefits from inflation. As nominal growth goes up, so will nominal revenues, shrinking the size of the national debt as a percentage of GDP. The trouble is, interest rates will go up substantially in anticipation of inflation (as they are already doing), which makes borrowing much more expensive. So while the debt as a percentage of GDP may go down, it won’t stay down, as interest on the debt balloons and begins to take over the federal budget, and we wind up borrowing more principal to, in effect, pay interest on the debt we already owe. (We’ll have other problems, much more serious ones, if we actually create a dollar crisis, but this budgetary problem will exist even if the inflation gambit works.)

So, if none of these talking points are adequate, what are possible components of a structural solution?

1. Raise the retirement age.

Modest increases in the age of first eligibility for full benefits under Social Security would rapidly move the program back into surplus. Such an increase absolutely will have to happen at some point; there’s just no way to keep taxing a relatively smaller proportion of workers to support a relatively larger proportion of retirees. Something’s got to give, and if we don’t want senior citizens trying to survive on inadequate annual incomes, we’re going to have to raise the retirement age. Doing it now would change the long-term budget projections right now, when everybody is focused on them, and would hopefully give us a respite from rising interest rates.

2. Cut defense spending.

We currently spend more than 4% of GDP on defense. Defense is overwhelmingly the largest discretionary spending item in the budget, representing about 50% of the total. It is also largely unproductive; we get some productivity gains from technological developments that originate in defense spending, but nothing resembling what we’d get if we spent that money (publicly or privately) with an actual goal of productive investment. To make a real difference to the budgetary picture might well require a quite radical rethinking of America’s defense posture, and hence its foreign policy. But it might not. We could probably radically downsize our nuclear force – unilaterally, if need be – with almost no implications for our foreign policy. A great deal of what the Air Force does is prepare to fight enemies that, currently and for the foreseeable future, don’t exist. I would like to see someone (The Atlantic Monthly, say) put together a panel with the following mandate. You have to cut the military budget by 40%. You have no political constraints. How would you do it, and what would be the implications for American foreign policy?

3. Reform the tax code.

The United States has one of the highest corporate tax rates in the world, and brings in less revenue (percentagewise) than countries with much lower rates. We have an income tax that is riddled with deductions that undermine its purported progressivity, and we rely on increasingly steep progressivity to justify every additional change to said code. A 1986-style reform that eliminated many deductions and lowered rates would not only be a likely booster of the economy, but would probably raise revenue – certainly on the corporate side. Any such reform on the income tax side would need to eliminate or phase out the mortgage interest deduction. This would seem to be spectacularly ill-timed given the poor state of the housing market, but in fact reflating the housing bubble would make our economic problems worse, not better; we need to tackle the overleveraged homeowner directly, not by means of asset-price inflation. Meanwhile, redirecting capital away from housing and towards more productive endeavors is exactly what we want to do.

4. Enact a value-added tax.

A VAT is the most efficient revenue-raiser out there. We are going to absolutely need more revenue to close the structural budget gap. We are not going to get there through spending cut alone. If we have to raise taxes, we should do it in ways that are least economically damaging. If I had my druthers, I’d go for a higher VAT and scrap the payroll tax, which is economically destructive, and bring Social Security on-budget. But regardless, we’re going to need more revenue, and this is the least destructive way to raise it.

5. Sell land.

The government of the United States still owns a lot of land – about 30% of the national territory. Most of it is not parkland. Some of it might just find buyers if put on the private market. The three biggest components of Federal spending are: entitlements, defense, and interest on the debt. A one-time substantial paydown of the debt with the proceeds from sale of assets could make a material contribution to reducing the budget gap precisely because it would reduce the amount of interest due annually. (Of course, we’re doing the opposite right now, not shedding assets but acquiring them, albeit these are mostly equities like AIG and GM rather than real estate.)

Obviously, there are a bunch of smaller-ticket measures that would be win-win if they could be enacted. Agricultural subsidies, for example, are economically wasteful, ecologically destructive, actually hurt many small farmers, exacerbate poverty in less-developed countries; clearly, cutting them would be a good idea, and would save money as well. And I’m sure there are other big-ticket items I haven’t listed or thought of that could make a difference. But my point is: we really do need big-ticket items to make a difference. The hole is enormous. Debating the Obama spending proposals is almost beside the point if we don’t tackle the big-ticket issues.

Or, rather, debating them the wrong way is sort of beside the point. What’s the right way? The only way out of our hole is to become a more productive economy. That means some combination of working harder and working smarter. So the right question to ask is whether a given spending line-item is going to make America more productive – and how much more productive relative to spending that money in another way (or, not spending it at all and reducing the debt instead).

We do need to be talking about restraining spending, don’t get me wrong. To return to the Obama Administration’s favorite talking point, health care: if getting control of health care spending means making tough choices (like paying doctors less, or denying end-of-life care in some circumstances) as well as win-win choices (like better preventative care), then you need a political context that makes it possible to discuss choices in those terms. If you are spending money on everything in sight because we “can’t afford not to” then you do not have the right context for such a discussion. But by the same token, if the debate is about austerity versus stimulus, I think stimulus is going to win every time, until the bond market forces a reappraisal. So we need to change the terms of the debate, and that means changing them in ways that may well let some of the Obama Administration spending proposals in (if they do plausibly improve productivity).