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WEALTH OF NATIONS
Dealing With A Fiscal Emergency
Predictions of fiscal doom have rarely looked as plausible as they do now.
The public debt stands at nearly $8 trillion and within 10 years, according to Congressional Budget Office projections, it will be more than $14 trillion. Getting to that second figure in one piece depends on two things. Some optimistic economic assumptions need to hold, and investors need to be willing to lend the government another $6 trillion. Taking either of these things for granted would be foolish.
Almost everybody in Washington agrees that the fiscal outlook is scary. Almost everybody says that something must be done. But the options for confronting the problem come down to spending cuts or tax increases, and as soon as you mention either, an embarrassed silence descends.
The politicians are not as worried as they say they are. And the same is true of the public. If you believe the polls, voters are more anxious about public borrowing than their politicians are -- but not so worried as to welcome a rise in taxes (their own taxes, I mean) or cuts in Social Security or Medicare. They may be nervous about policies that would add to the fiscal problem -- hence their hesitation over health care reform -- but meaningful subtractions from the problem are a different matter.
Can anything be done? We have been here before. Washington has a time-honored procedure for such cases. Rather than thinking about entitlement reform or tax reform, it thinks about process reform. In the 1980s there was Gramm-Rudman, which set a schedule of targets for the budget deficit and imposed automatic spending cuts, or "sequesters," if the targets were breached. In the 1990s, there was "pay-as-you-go." Essentially, this regime said that Congress had to match measures that increased the budget deficit with cuts in other spending or increases in revenues. That system expired in 2002 but was reinstated in 2007 -- in good time for the fastest growth in the budget deficit the country has ever seen.
These regimens did not solve the problem, but at their best they helped. Warren Rudman, co-architect of the Gramm-Rudman law, famously called his measure "a bad idea whose time has come." He meant that its response to a failure to hit deficit targets was deliberately stupid, and therefore indefensible: Just cut spending across the board, the law said, regardless of the consequences. This stupidity was the key. Gramm-Rudman was a fiscal doomsday machine. If the law required unacceptably damaging sequesters to happen automatically, Congress would not dare go there, and lawmakers would strive to cut the deficit instead.
Rather than thinking about entitlement reform or tax reform, Washington thinks about process reform.
Up to a point, Gramm-Rudman worked. Deficits fell as a share of gross domestic product during the late 1980s. The law gave a push to a big deficit-reduction package in 1990. The system that followed it, involving caps on discretionary spending and "paygo" rules, helped (along with a vigorous economic expansion that boosted revenues) to restrain the deficit during the Clinton years. Congress learned to game the various systems by exempting certain kinds of spending or by allowing creative accounting of one kind or another. But deficit control was mostly better with both of these measures than without.
Unfortunately, the paygo framework that Congress reintroduced in 2007 has been rendered all but null by emergency exemptions and the imaginative use of annual or supplemental appropriations. It would be wrong to quarrel with this spending; the recession made it necessary.
In one way, a system like Gramm-Rudman -- which aims to reduce the deficit gradually over time -- would make better sense in current circumstances than year-by-year paygo rules. Even so, its deliberate lack of flexibility would be a drawback at a time when the economy's prospects are so uncertain.
Locking the economy into a predetermined path of fiscal tightening might apply the brakes too abruptly if the recovery falters. You could build in mechanisms to take account of that, but get-out clauses of this sort would widen the opportunities for gaming and defeat the system's brutal simplicity -- its main attraction.
A group of Democratic senators is exploring another approach. They are calling for a special legislative process that would make it harder to stop or amend deficit-reducing measures. One idea is to have a bipartisan panel of lawmakers and administration officials come up with a deficit-reduction plan, which would then be fast-tracked to a final vote. Committee chairmen, especially in the House, are understandably opposed to the idea because it would usurp their powers.
Though process reform has been a qualified success in the past, the risk is that it becomes a kind of displacement activity: something to talk about instead of cutting spending and raising taxes.
And the rules stick, in any case, only if soaring public borrowing is seen as an overriding problem. Despite all the statements to the contrary, that sense of urgency is lacking -- partly for the good reason that slashing the deficit immediately, with the economy still weak and unemployment still rising, would indeed be a bad idea.
It is asking a lot of politicians and voters to grasp these two ideas simultaneously: The budget deficit had to rise dramatically because of the recession, but steps to make it fall dramatically once the economy revives are indispensable. The discussion about where to find the savings and how to raise revenues needs to start now -- not least, to signal to the government's creditors that the issue is going to be addressed. Democracies are wired for procrastination, and this country's more than most. Preparing the United States to face this challenge may be President Obama's greatest test, which is saying something. He has not even begun to try.
One temptation he and his advisers need to resist is believing that deficit hawks are exaggerating the danger. Certainly, Republican fiscal conservatives are hard to take seriously when you consider their recent record in office. Why weren't they worried about deficits before? The consistently hawkish, on the other hand, can be dismissed for saying what they always say. Their predictions of fiscal doom were wrong in the past: In the end, the calamities they predicted never happened. They have a point, a skeptic might say, but let's not get carried away. There is no great hurry to put things right.
I think we may look back on this temporizing as a mistake as serious as leaving subprime mortgages unregulated, or letting big banks operate with wafer-thin capital reserves. Predictions of fiscal doom have rarely looked as plausible as they do today. Compared with previous periods of stress, the situation is worse now in several ways.
Predictions of fiscal doom have rarely looked as plausible as they do now.
First, public debt is projected to rise far higher than in those earlier episodes -- even if the economy stages a respectable and sustained recovery. For any given level of interest rates, the burden of debt interest will be correspondingly higher as well. Current policies imply a permanent budget deficit of more than 3 percent of GDP, even after years of steady economic growth, according to the administration's optimistic assumptions. Many independent analysts say that the gap is likely to be bigger than that unless programs are cut and taxes are raised -- and Obama has ruled out a tax increase for all but the rich. In short, the numbers are worse.
Second, creditors are going to lose their traditionally ravenous appetite for U.S. government debt. Long-term interest rates are currently low, which says that the government has no difficulty at present in borrowing. But this can change abruptly, as other countries have discovered.
The United States has grown accustomed over the years to an extraordinary fiscal privilege -- the ability to borrow, seemingly without limit, in its own currency. How long the global capital market will extend this favor is very much in question. China is the biggest creditor, and its hunger for dollars is beginning to look sated. Beijing has no interest in starting a run on the dollar; because it owns so much dollar-denominated debt, China would be the main loser. But it is pressing gently to dethrone the dollar as the global reserve currency, and the markets know that when (not if) this happens, America's borrowing privileges will be curbed.
Third, the tax code is in worse shape than before -- less able to raise the revenue required without harming the economy. For a while after 1986, when the United States last undertook comprehensive tax reform, the country had a fairly simple system, with relatively low income-tax rates applied to a relatively broad base. Over the years, the system has grown in complexity, and the base has been nibbled away by exemptions and deductions. The result is an income-tax system that requires moderately high rates to raise puny amounts of revenue. Balancing the books on the back of this degraded system would be almost literally impossible -- even if Obama were willing to raise taxes for the middle class.
An optimist could call this last point an opportunity, not a constraint. Washington will have to tackle comprehensive tax reform. The question is when. Process reform is all very well, but Congress needs to start talking about revenues too -- and the sooner the better.