When Deficit Reduction Poses as Fiscal Expansion
After watching Donald Trump win the presidency in 2016 with promises of unfinanced tax cuts, defense spending increases, and yet-to-be-seen trillions of dollars for infrastructure projects, the Democratic party is in no mood to take up fiscal restraint. Instead, the candidates competing to take on Trump in 2020 are trying to outdo each other with promises of sweeping new federal benefits and spending programs, with only the very rich on the hook for higher taxes.
Two of the Democratic party’s respected economists, Jason Furman and Larry Summers, seemed to lend their voices to this new direction for fiscal policy in an essay in Foreign Affairs. Their message, at least at first glance, was that deficit worries are overblown and should not stand in the way of a new era of government activism to combat inequality, climate change, and other social ills. In other words, they seemed to side with Democratic party activists who say there’s no harm in widening budget deficits now if the result is a higher standard of living and more security for those with the lowest incomes.
Furman and Summers were bolstered in their argument by Olivier Blanchard, former Chief Economist of the International Monetary Fund (IMF), who dedicated his address as outgoing president of the American Economic Association to the subject of deficits and debt in an era of ultra-low real interest rates. Blanchard observed that nations with real economic growth exceeding the real rate of interest can run larger deficits than in previous eras because interest on the debt will not push annual borrowing to unsustainable levels. His argument came with conditions, most importantly that a nation would need to run something close to balance in the primary budget (which excludes interest payments on accumulated debt) for the annual deficits not to become a major problem.
All of this seemed to suggest that the Democratic presidential candidates pushing for new unfinanced spending initiatives would have some credible economists bolstering their case.
But a closer reading of the Furman-Summers article reveals a different position. After much nodding and posturing regarding the urgent need to address poor health care and education for lower-income households, the authors endorse a rather conventional fiscal position: pay-as-you-go. They want new federal spending to be offset with tax hikes, or other spending reductions. That pretty much rules out Medicare for All.
To be sure, a pay-as-you-go framework would allow deficits to widen substantially over the coming years based on current law, but at least it would prevent elected leaders from making the problem worse. The Congressional Budget Office (CBO) projects the primary budget deficit will widen from 1.4 percent of GDP in 2029 to an average of 3.1 percent of GDP over the ten-year period 2039 to 2048. In 2048, federal debt will have climbed to 152 percent of GDP, up from 78 percent this year.
Recently, Furman and Summers issued a clarification to their earlier essay, and moved even further away from a fiscal expansion posture. The two now suggest that, in addition to paying for new spending, a responsible fiscal position would need to close the financing gaps in the Social Security and Medicare Hospital Insurance (HI) trust funds, with a combination of tax hikes and spending cuts. They would prevent using the savings from a trust fund rescue package to finance other federal spending, which means the added revenue and lower spending in Social Security and Medicare would reduce the government’s overall budget deficit.
As it happens, the Boards of Trustees for Social Security and Medicare have just issued their annual reports. They show both program’s trust funds headed toward insolvency soon. Eliminating the combined Social Security and Medicare HI trust fund deficit would require tax hikes and spending cuts equal to about 1.3 percent of GDP over seventy-five years. Thus, if implemented soon, the Furman-Summers proposal would lower projected deficits over the next decade, expected to average 4.4 percent of GDP, by about one-third, which is substantial. In dollar terms, that’s equivalent to more than $3 trillion. And, unless they change the character of Social Security by adopting highly progressive taxation, some of that deficit reduction would involve real sacrifices by middle-income households.
The Furman-Summers essays leave an impression of conflicted instincts. On the one hand, they don’t want to be viewed as throwing cold water on Democratic spending ambitions. Indeed, they go out of their way to create the impression that they favor moving aggressively in the same direction as party activists. On the other hand, they realize that abandoning all fiscal restraint is the wrong policy. In the short run, of course fiscal expansion will boost economic growth. But the U.S. economy is already at full employment and still growing at a strong pace. There’s no justification for fiscal stimulus in the short-run. Indeed, widening the deficit now would only make it harder to run larger deficits when the economy really does soften or fall into recession.
Further, over the medium and long-run, there’s no credible evidence suggesting countries with high accumulated debt do better than those which manage their finances more prudently. In fact, there’s strong evidence pointing in the opposite direction. One recent study of advanced economies found periods with high levels of public and private debt slow economic growth by as much as 1 percentage point annually. CBO and other forecasters build into their models lower long-term growth from higher accumulated levels of public debt.
The U.S. is running large deficits today and accumulating debt at a rapid pace. The federal government will soon be paying substantial amounts annually just to service the accumulated debt, even with low interest rates. This is all occurring while the economy is quite strong. Now is the right time for sensible medium and long-term fiscal consolidation, not expansion. Furman and Summers certainly know this, which is probably why they call for deficit reduction even as they create the impression that they favor something else.
James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.
