The Cruel Political Paradox of Deficit Reduction

By :: February 4th, 2014

I was chatting the other day with a fellow budget wonk who noted the cruel paradox of fiscal politics: When the economy is bad, deficits rise and the public support for reducing them grows. Yet a poor economy is the worst possible time to raise taxes and cut spending. By contrast, a period of strong growth is the best time to tackle the deficit. But when the economy is healthy, deficits normally fall and so does the political motivation for pols to do anything about them.

And as the Congressional Budget Office’s fiscal outlook released today shows, deficits are dropping like the proverbial stone. As the economy improves and the growth in health costs slows, the deficit is likely to continue to decline, at least for the next few years. CBO figures deficits will fall to just 2.9 percent of GDP in 2016, their lowest level since 2007. That’s far below their 9.8 percent peak in the depths of the Great Recession in 2009.

TaxVox-Feb-4-14-Fever-version

Despite this good news, we are hardly out of the fiscal woods. The national debt will continue to rise, and CBO warns that annual deficits will return to troublesome levels of around 4 percent of GDP by the early 2020s. But those predictions are unlikely to drive policy since they are both uncertain and far beyond the short-term vision of either the public or most pols.

You can see the turn in public opinion in a new poll by the Pew Research Center. The share of those who see deficit reduction as a top priority fell from 72 percent in January, 2013 to 63 percent in last month.  Eight in ten of those surveyed think strengthening the economy should be the nation’s top priority now.

Sagging interest in the deficit is no surprise. But it makes it very hard for lawmakers to make tough choices at the time the economy gives them the flexibility to do so.

You can see this in the evolving fiscal policy debate. My friend and I talked a couple of days after President Obama delivered his State of the Union Address. This was a speech where the president—who once spoke boldly about the need for a grand fiscal bargain—effectively ignored long-run budget issues.

And it isn’t just Obama. Congressional Republicans seem to have lost their stomach for fiscal combat as well. Stories circulating this morning suggest the House GOP wants to use the coming need to increase the nation’s debt limit to demand approval of an oil pipeline or repeal provisions of the Affordable Care Act that limit risk for health insurance companies. Whatever you think of these issues, insurance company risk corridors are a long way from a grand bargain.

Some of this has to do with Washington’s seemingly endless fiscal deadlock. Republicans simply will not consider any deficit reduction plan that includes new revenues. And Democrats won’t discuss changes in Medicare, Medicaid, and Social Security spending until taxes are on the table.

Thus it isn’t surprising that battle-weary pols have agreed to disagree—at least until the next election. Republicans may also be feeling less heat on fiscal issues as the clout of the anti-government tea party seems to be waning—another phenomenon driven in part by an improving economy.

But that begs the question: How do lawmakers tackle deficits when they should—at a time when the economy is strong and the flow of red ink slows to a relative trickle?

The answer may have emerged in the heated budget debates of 2011-2012 when some policymakers proposed combining a short-term fiscal stimulus with long-term deficit reduction. The idea died, another victim of the deep mistrust that has infected policy debates in the Capital. But it may ultimately be the solution to this troubling political paradox.

 

 

 

4Comments

  1. AMT buff  ::  8:23 pm on February 4th, 2014:

    “This was a speech where the president—who once spoke boldly about the need for a grand fiscal bargain—effectively ignored long-run budget issues.”

    I recall listening to his State of the Union speech after the 2010 election hoping to hear about a grand compromise. Nothing. This President has never invested a dime of political capital in anything more than nibbling at the problem. He even dropped the findings of his own commission like a hot potato. No politician wants to tell the voters that major pain is required, least of all a President who leads from behind whatever political cover he can find.

    “How do lawmakers tackle deficits when they should”

    Mancur Olson tells us that they cannot. Their incentive structure is wrong. Lying to the people that everything is OK is more politically profitable. A crisis is needed to end the lies and allow politicians to sell the necessary pain to voters.

    We don’t need to speculate. Argentina and other fiscally and morally bankrupt governments have shown us the way. You may believe that Americans are fundamentally different from Argentinians, but I doubt that. Human nature is universal, and the same structure will have the same results.

  2. Michael Bindner  ::  1:06 am on February 5th, 2014:

    In the long term, it is no longer health care but net interest that is out of control. To counter this growth, let us look at who benefits from net interest. While it is often fashionable to blame foreign governnments who use our bonds to back their currencies, they are not the biggest players – nor is the Federal Reserve. While it is dangerous to become part of overseas currency discussions, with the chance that possibly hostile governments might dump our debt (anyone see the new Jack Ryan movie?) the reality is that such a move would be suicide for the dumper rather than the dumpee. No other national will come across with that level of debt opportunity and the requisite cash to fund their currencies. A united European Union tax and debt scheme might come close, put we would have plenty of warning. If foreign debt holding were really a problem, enacting a Value Added Tax scheme or tarrif would be the way to kick some of that overseas funding stream back to US Coffers.

    The reality is, however, that most debt is held domestically – and mostly privately. The question then becomes whether it is held by state, city, union or corporate pension funds or accounts (neither is a problem), small U.S. investors (like my 10 year old daughter Cate – not a problem either), or large US investment funds held by individuals or groups who reside in the top tax brackets – say the 1% or even the top 20%. If it is the latter, the solution to our long term debt problems is rather easy – raise their taxes. If everyone invested in these brackets it might not be a problem – except for the interest repayment part (if they provide the money, it should be in taxes, not bonds). If investment is uneven among the upper class, however, then a tax increase on that class is ENTIRELY APPROPRIATE. Additionally, it WILL NOT damage growth. No one will miss any meals because they are paying higher taxes and buying less in Federal bonds. Indeed, the CEO and Investor Class is actually doing pretty well in this economy – even though no one else has been. Taxing them more in a down ecnomy will pull money out of the savings sector and into the spending sector. As long as we measure the health of the economy by consumer and government spending (for the most part), it is never a bad idea to raise taxes on the wealthy. That is what Ike did and he was absolutely right. I like Ike and how he dealt with debt. Economics has not changed since then – only the corruption of economists who take money from rich people and create garbage.

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