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Wednesday, April 25, 2007

Democrats and Deficits

Brad Plumer on whether the Democrats should pursue fiscal austerity first and foremost, or whether the deficit should give way in favor of important objectives such as health care, inequality, and addressing climate change:

Democrats obsess over deficits, by Bradford Plumer, TNR Online: ...For the past six years, Democrats have savaged the Bush-era GOP for running up the national debt with reckless spending. Pelosi has promised that the Democratic Congress will insist on fiscal responsibility. ... But not everyone's thrilled with this return to Clinton-era austerity. Two weeks ago, a handful of liberal policy wonks gathered at an Economic Policy Institute (EPI) forum, titled "Beyond Balanced Budget Mania," to address this very issue. Joseph Stiglitz, the Nobel Prize-winner who once headed up Bill Clinton's Council of Economic Advisers, was invited to give the keynote.... The purpose was to persuade Democrats that they could spend responsibly without sacrificing liberalism at the altar of fiscal rectitude. It's hardly a radical notion. But that doesn't mean it's anywhere near catching on.

Stiglitz ...[is] using his former insider status in the Clinton administration to try and steer liberals away from "Rubinomics"--the view that Clinton offers an enduring model for Democrats because he followed the advice of Robert Rubin in the early '90s by raising taxes, slashing spending, and bearing down on the deficit in order to gain Wall Street's confidence.

Those moves appeared to have helped bring down interest rates in the years that followed and usher in a decade of high economic growth. But, Stiglitz cautions, "One should not think of that as a normal situation." In part, he argues, Clinton and Rubin were blessed with special economic circumstances ... that don't exist today. At present, with the housing market sagging, employment middling, and a possible recession on the horizon, Stiglitz argues that Keynesian-style deficit spending may be a better remedy. In addition, problems such as "growing inequality, the health care crisis... energy and climate change" may require a fair bit of money to address. "If this money is well spent," Stiglitz adds, "it does make sense to do that--even if it led to a greater deficit." It's an old tune that liberal Clintonites such as Robert Reich were humming in the early '90s. But it may sound catchier this time around, given that a growing number of economists are doubting that a Rubin-style policy focus on growth alone can benefit all Americans.

None of the participants at the EPI event suggest that the Democrats should just go wild and spend, spend, spend ... But Stiglitz points out that the current deficits aren't harmful just because they're deficits; they're harmful because Congress is borrowing money specifically to fund a needless occupation in the Middle East and massive tax cuts for the wealthy that have done little to boost the economy. Whereas deficit hawks tend to worry about ... borrowing... Stiglitz would prefer they ask, "What is it borrowing for?"

The conventional case against budget deficits is that the government has to borrow private money that could be used more productively elsewhere; as the econ textbooks put it, deficits "crowd out" private investment. But several panelists point out that this takes a too-dismal view of government, which can sometimes invest more usefully than the private sector. ...[P]olicies geared toward early childhood--preschool, child care--pay off massively in the long run. ...[O]utlays for infrastructure and research have historically played a driving role in the U.S. economy, but that such spending has drooped since the Reagan years. While it's satisfying to tweak conservatives by pointing out that Clinton restrained domestic spending more effectively than George W. Bush, such restraint has real costs...

Of course, the elephant in the room is the long-term budget situation, especially once the Baby Boomers start retiring in about five years and entitlement spending begins to balloon. But,... this "crisis" is fueled entirely by the rapid rise in health care spending--by Medicare and Medicaid. Focusing on drastic cuts to food stamps or Social Security, as entitlement hawks at, say, the Wall Street Journal propose, misses the point. Only an overhaul of the country's health care system ... will alleviate the problem. ...

To some extent, the party has backed itself into a corner by carping so loudly about the Bush administration's prodigal ways. And, while many hope that ending the Iraq war--which now costs nearly $200 billion per year--will provide a "peace dividend" for future domestic spending, that's probably too optimistic....[O]nce the war ends, most of that money will go toward repairing a military that's at the breaking point (not to mention treatment for wounded vets). That's doubly true so long as Democrats want to expand the Army's strength and avoid cuts to the Pentagon's budget.

A key question is whether Democrats will continue the posture they adopted through much of the '90s, when, cowed by Newt Gingrich's success, they followed his lead in backing spending cuts and praising deficit-reduction as an end unto itself. ... Perhaps Dems still don't have the votes--or the popular support--to do anything else. But, as Stiglitz notes, "there is a wide agenda facing our society--important priorities that need to be addressed that will require expenditures." Democrats can hardly make that case so long as they obsess about deficits. ...

Greg Anrig has one response to this. From TPM Cafe:

On the Same Team, by Greg Anrig, Jr.: The ongoing debate among progressives about where reducing federal deficits should rank on the policy priority list is completely legitimate, but denigrating Clinton’s 1993 budget agreement is wrong-headed and counterproductive. Remember that every last Republican in Congress, along with some blue-dog Democrats, voted against the legislation entirely on the basis that its tax increases would purportedly send the economy into a tailspin, kill jobs, make deficits even worse, destroy investment markets, and a host of other calamities concocted by the fertile minds of Newt Gingrich and Wall Street Journal editorialists.

Any future Democratic president who attempts to raise revenues, whether for deficit reduction or any of the initiatives on the admirable wish list of the Economic Policy Institute, will be subjected to the same fear-mongering litany. And the most effective response will be to describe how after those alarms were raised in 1993, nothing but good economic news followed. It’s a really bad idea for liberals to help the right out by suggesting that the 1993 budget agreement had nothing to do with the prosperity that followed – especially when it also happens not to be true. ...

Obviously, no one knows what would have happened had just one more Democrat in either the Senate or the House voted against the 1993 bill. But we do know that every last horror that opponents said would arise from raising taxes did not occur. Just the opposite. That history will be an essential touchstone for future Democratic presidents, regardless of the extent to which they may worry about deficits. So we should be venerating that history, not unjustifiably trashing it.

I can't argue that an increase in taxes will not have negative consequences for the economy. There are special cases where that is true, but in general increasing taxes will slow the economy. It's true that the effect on the economy will depend on initial conditions so that the costs can be large or small, but the costs will be there.

It's what you do with the money that matters. What I can argue is that the benefits from using the tax dollars for things such as health care, infrastructure, or other important objectives provides benefits that exceed the costs from increasing taxes, including any reduction in output. Thus, when the economy is in a state where there are highly beneficial government projects waiting in the wings and taxes that can be increased without causing substantial costs, i.e. if the benefits exceed the costs, then deficits should not be an obstacle to putting those projects in place. Focusing solely on the cost side - whether the economy will slow at all as the result of the tax increase - without focusing on the benefits from what is done with the increased tax collections misses an important part of the equation.

That is why I would oppose deficit reduction for the sake of deficit reduction presently. What are the benefits from decreasing the deficit? There do not appear to be large gains from the usual channel, i.e. from lowered interest rates and less crowding out since interest rates have been insensitive to deficits recently, and there's no evidence that growth would be strongly affected. So it is not clear to me what large economic benefit would result from reducing the deficit, but there may be large costs in terms of the programs we have to give up in the pursuit of fiscal austerity. Thus, reducing the deficit brings no great benefit presently, has large potential costs, and for me is easy to oppose on that basis. And going in the other direction the costs and benefits are reversed. There are lots of beneficial things we could do with more revenue, and though increasing taxes would have costs, it's unlikely those costs would be large enough to offset the expected benefits if we are careful to limit the spending to projects that are expected to produce a high return.

    Posted by on Wednesday, April 25, 2007 at 10:42 AM in Budget Deficit, Economics | Permalink  TrackBack (0)  Comments (37)

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