Guns, Butter, and Retired Boomers

Robert Reich and Glenn Hubbard debate how to address impending budget deficit issues. This is somewhat long, but worth it:

Big Issues - Guns, Butter and Retired Boomers: How Do We Pay for It All?, WSJ (free): This is the first of three online debates ... The federal budget deficit is the topic ... Joining the debate are Robert B. Reich, who was secretary of labor in the Clinton administration, and R. Glenn Hubbard, who served as chairman of the Council of Economic Advisers for two years under President Bush. ...

MR. WESSEL begins the debate: Has the federal government bitten off more than it can chew by reducing tax rates ... and subsequently -- despite the costs of responding to 9-11, fighting the war in Iraq, rescuing and repairing New Orleans and environs and expanding Medicare to cover prescription drugs? Is current fiscal policy sustainable ...?

MR. HUBBARD: The U.S. economy... is in excellent shape, and it can absorb the tax changes, military and homeland security changes, and disaster relief. Two points are in order, though: More restraint is needed to ensure that domestic spending growth does not continue, and tax reform is needed to codify pro-growth policy that can raise the revenue required to fund the federal government. The problem is not the next three or even five years; the problem is the long-run fiscal picture. ... [T]he Medicare expansion without substantial reform of the system was unwise fiscal policy. The current Social Security and Medicare systems are on an unsustainable path. In both cases, sound fiscal reform should involve slower benefit growth for high-income households. ... accompanied by reform of health-care markets. The bottom line issue is less guns v. butter today (the next three to five years) than whether the butter will crowd out guns tomorrow ... or indeed whether the butter itself will be affordable on the same terms tomorrow.

MR. REICH: Undoubtedly yes. But we should distinguish between deficits that occur when the economy has lots of unused capacity ... and deficits that become part of the long-term structure of the federal budget. If the tax cuts and spending increases ... at the start of the administration were temporary and stayed temporary, there'd be little to complain about. In fact, they might have helped get the American economy moving. But the administration wants to make the tax cuts permanent. And much of its new spending ... will go on for years. ... This isn't sustainable over the long haul and I don't think it's sustainable even over the next five years.

MR. HUBBARD: I agree wholeheartedly with Bob that dividing the timeline of fiscal worries into two parts -- short-run and long-run is important. I also agree that we must distinguish between running deficits when the economy is not at full employment versus when it is (read now). Tax cuts that add to the nation's productive capacity include reductions in the tax burden on saving and investment and reductions in marginal tax rates on entrepreneurial activity. ... The near-term tax debate should be about tax reform so that we can maximize ... pro-growth policy. On the spending side, a strong case can be made for continued basic research support and support for individualized training programs. What often goes under the heading of investment -- highways, for example -- is a tougher case to make from an economic perspective.

Where Bob and I disagree regards his characterization of "tax cuts that mostly benefit the wealthy." Reductions in the taxation of saving and investment show up in current tax distribution analysis as benefiting savers -- generally well-to-do savers. Yet, over the long run, those tax changes raise capital accumulation, productivity, and wages. ... It is hard to imagine what tax changes ... would add more to the nation's productive capacity.

MR. REICH: I'm not adverse to tax cuts on savings and investment, but in my view the growth we get from such tax cuts is far less than the growth we get from well-targeted public investments in education at all levels, on health care .., infrastructure, and basic research and development. ... Over the long term, capital flows to places around the world where it can get the highest return -- either because production is very inexpensive there, or because of natural resources located there, or ... because people there are enormously productive. And they're productive because they have high skills, good health, good infrastructure linking them together, and an excellent scientific base from which to draw.

Obviously, we can't do it all. We can't extend the tax cuts and at the same time carry out all the public investments that are necessary -- while at the same time we fight wars in Iraq and Afghanistan, build up homeland security, give the middle class some relief from the Alternative Minimum Tax, and dole out Medicare drug benefits (not to mention the rest of Medicare) to early boomers. Deficits do matter, and choices do have to be made. I'm skeptical of claims that continued tax cuts on capital gains and dividends have such a hugely positive effect on the economy ... This recovery ... is weaker than the average post-World War II recovery.... So I see no reason to extend them. ...

MR. WESSEL, Moderator, asks: On taxes, do either of you believe that a significant tax increase is either wise or inevitable either in President Bush's term or in the first term of his predecessor? If so, what tax and on whom? And on spending, what one or two things would you have the government spend more ... on? And what one or two things would have the government spend less ... on?

MR. REICH: ...I don't anticipate any concerted move by this administration to tame the deficit ... unless bond markets get so rattled by the size of pending deficits that the White House is forced to come up with something. .... That will ... leave a fiscal mess for the president's successor... What would I have the government spend more on, notwithstanding the above? Early-childhood education. The evidence is clear and compelling that these expenditures provide very large social returns... I'd also have the government spend more on K through 12 in poor communities .... I'd even be in favor of a progressive voucher system, ... What spending to cut? Start with subsidies and tax breaks directed to specific companies and industries ... "corporate welfare." ... Also, get rid of all earmarked spending on specific projects. It's pork. ... We need a capital budget that establishes clear priorities for infrastructure spending. Medicare savings are possible ... I'd also amend the new Medicare drug benefit to allow the government to use its huge bargaining power with pharmaceutical companies to push down costs.

MR. HUBBARD: Let me echo Bob's call for a reduction in corporate subsidies and earmarked spending projects. ... I think the administration is missing an important opportunity to talk ... about the enormous looming entitlement liabilities and the large implicit flow deficits ... that go with them. If we cannot bring these deficits ... under control, we will have to raise taxes, with significant adverse consequences for economic growth. I do not believe that a significant tax increase is wise or inevitable. ... I say this because I believe we should and will scale back the growth in the entitlement programs that are the clear and present fiscal danger. I would like to see the government spend more on basic research and on training (because our employment policies are outdated) -- but these $$$ are not large in the context of the overall federal budget. ... [T]he real area for spending restraint is the entitlement programs.

Re: Bob's second reply: Blanket spending increases on health care, infrastructure, and education strike me as unwise. Our goal for health care should be to improve value ... The evidence on the effectiveness of infrastructure spending is, to put it mildly, mixed, ... Even with education, ... structural reform is a bigger deal here than a cry for more money. ...

MR. REICH: I'm not suggesting "blanket spending increases" ... To the contrary, I'm urging more and better-targeted spending in these vital areas. ... As to health care, I'd recommend that the federal employee's health insurance system be made broadly accessible and affordable to all small businesses wishing to enroll their employees -- thereby giving the federal system far more bargaining leverage with providers and drug manufacturers, while at the same time enrolling a large portion of Americans currently without health care. This would be a first step toward a single-payer system.

As to entitlement spending, and contrary to what we've heard from the White House, Social Security isn't the biggest entitlement problem. It's Medicare. ... The reason Medicare spending is rising so quickly -- apart from the aging of the population -- is double-digit increases in annual health-care expenditures across the economy. So the key to containing Medicare is streamlining our whole health-care system. That's a big enough topic for a discussion all its own.

MR. HUBBARD: I couldn't agree with you more on Medicare being the more significant problem and that reform of health care markets is central. ...