Deficit Hawkery as Farce

The Economist

Deficit hawkery as farce
Feb 1st 2011, 17:44 by M.S.

I'M HAVING trouble writing about the GOP effort to reach a compromise over whether to cut $100 billion out of the 2011 budget, or just $50-60 billion. My problem is that I can't really write about the advantages or disadvantages of one or another version of the cuts when the entire enterprise appears completely senseless to me. The notion, apparently, is that continuing unemployment and slow growth in America are caused by the federal budget deficit. So shrinking the deficit by $50-60 billion will presumably lead to faster economic growth and renewed hiring. Yet exactly one month ago, these same Republican leaders eagerly agreed to a tax-cut package that raised the federal deficit for 2011 by over $400 billion. Even if there were a plausible argument that unemployment and lethargic growth today stem from the current budget deficit, any impact congressional leaders hope to see from their spending cuts will add up to no more than noise around the edges of their tax cuts.

Even more confusingly, there is no plausible argument that current unemployment or slow growth stem from the federal budget deficit. The mechanism through which budget deficits can lead to unemployment and slow growth is the bond market: government borrowing raises interest rates, which makes credit more expensive for businesses. But the 5-year treasury bond is under 2%, and the most recent auction had a bid cover of almost 3 times. Unsurprisingly, with interest rates low, the cost of credit ranks low on the list of businesses' chief concerns. Those who acknowledge that deficits don't seem to be driving up the cost of credit, but still want to blame deficits for the poor economy, have pointed to business uncertainty over potential future tax increases to cover government debt. But how does enacting an $800 billion two-year tax cut and then cutting $50 billion or even $100 billion in spending assuage business uncertainty about future debt? In any case, the main reason businesses are not expanding is that they are worried about lack of demand from consumers and other businesses, who are still deleveraging from the debts they built up during the 2000s and the collapse in their asset values during the financial crisis. Karl Smith noted last week that the public-debt and private-debt figures are largely mirror-images of each other, and that government budget deficits are healthy in a deleveraging economy because government is essentially taking on private debt and paying lower interest rates on it. But even if you find fault with that perspective, how can you argue that cutting government spending this year will raise demand or growth, or lower unemployment, within the next year or two?

The idea that cutting several tens of billions of dollars out of the federal budget right now will improve the economy makes no sense. There are no doubt some government programmes that aren't worth what we're spending on them. It's always a good idea to cut programmes that aren't worthwhile. Such cuts have nothing to do with the current state of the economy, one way or the other. America faces a long-term debt problem on the order of trillions of dollars, mainly as a result of rising health-care costs and their impact on the Medicare and Medicaid budgets. Rising Social Security obligations and huge defence expenses also play a role. And a very large role is played by the fact that federal taxes in the United States are set at a level that consistently, throughout the business cycle, brings in less revenue than the government spends, by somewhere over 2% of GDP. To ensure the long-term health of the economy and the government, Congress will need to begin to demonstrate that it can enact and stick to long-term spending limits and tax hikes that will close the budget gap on those kinds of scales. I simply don't understand what GOP leaders are trying to accomplish by frantically trying to slash a few tens of billions of dollars out of this year's budget at the last minute, just after they've cheerily approved a whopping tax cut. Bond markets are not worried about the creditworthiness of the American government right now; to the extent that they may get worried, it will be because of trillion-dollar Medicare obligations and $800 billion defence budgets. They won't be reassured because Republicans manage to cut a few hundred million dollars out of the Corporation for Public Broadcasting. If Republicans want to convince people they know how to close the budget deficit, they need to propose major long-term cuts in some mixture of Medicare, Medicaid, Social Security, and defence, as well as major tax increases.

That still wouldn't have anything to do with what the US economy needs over the next year or two. But at least it would make sense as a long-term strategy. What the GOP is doing now is frenziedly cutting often worthwhile small programmes because they can't face the political consequences of taking on entitlements and defence or proposing tax hikes, and it's very hard for me to take the charade seriously.