Cross-posted at Reports from the Economic Front.
The media continues to direct our attention to deficits and debt as our main problems. Yet, it does little to really highlight the causes of these deficits and debts.
The following two figures from the Center on Budget and Policy Priorities help to clarify the causes. It is important to note that the projections underlying both figures were made before the recent vote making permanent most of the Bush-era tax cuts.
Figure 1 shows the main drivers of our large national deficits: the Bush-era tax cuts, the wars in Iraq and Afghanistan, and our economic crisis and responses to it. Without those drivers our national deficits would have remained quite small.
Figure 2 shows the main drivers of our national debt. Not surprisingly they are the same as the drivers of our deficits.
Significantly, the same political leaders that scream the loudest about our deficits and debt have little to say about stopping the wars or reducing military spending and are the most adamant about maintaining the Bush-era tax cuts. That is because, at root, their interest is in reducing spending on non-security programs rather than reducing the deficit or debt.
Some of these leaders argue that the tax cuts will help correct our economic problems and thereby help reduce the deficit and debt. However, multiple studies have shown that tax cuts are among the least effective ways to stimulate employment and growth. In contrast, the most effective are sustained and targeted government efforts to refashion economic activity by spending on green conversion, infrastructure, health care, education and the like.
While Republicans and Democrats debate the extent to which taxes should be raised, both sides appear to agree on the need to rein in federal government spending in order to achieve deficit reduction. In fact, federal government spending has been declining both absolutely and, as the following figure from the St. Louis Federal Reserve shows, as a share of GDP.
In reality, our main challenge is not reducing our deficit or debt but rather strengthening our economy, and cutting government spending is not going to help us overcome that challenge. As Peter Coy, writing in BusinessWeek explains:
It pains deficit hawks to hear this, but ever since the 2008 financial crisis, government red ink has been an elixir for the U.S. economy. After the crisis, households strove to pay down debt and businesses hoarded profits while skimping on investment. If the federal government had tried to run balanced budgets, there would have been an enormous economy wide deficit of demand and the economic slump would have been far worse. In 2009 fiscal policy added about 2.7 percentage points to what the economy’s growth rate would have been, according to calculations by Mark Zandi of Moody’s Analytics. But since then the U.S. has underutilized fiscal policy as a recession-fighting tool. The economic boost dropped to just half a percentage point in 2010. Fiscal policy subtracted from growth in 2011 and 2012 and will do so again in 2013, to the tune of about 1 percentage point, Zandi estimates.
If we were serious about tackling our economic problems we would raise tax rates and close tax loopholes on the wealthy and corporations and reduce military spending, and then use a significant portion of the revenue generated to fund a meaningful government stimulus program. That would be a win-win proposition as far as the economy and budget is concerned.
—————————
Martin Hart-Landsberg is a professor of Economics and Director of the Political Economy Program at Lewis and Clark College. You can follow him at Reports from the Economic Front.
Comments 15
Ted_Howard — January 20, 2013
If I were Lewis & Clark College, I'd be embarrassed to have you on the economics faculty - you're ignorance is really remarkable.
On the issue of stimulating the economy, you're arguments are laughable. It's embarrassing a professor of economics would even make them. Firstly, the issues of tax cuts vs. spending cuts is not simple. Anybody who says it's simple and could write it off with one link has no business discussing this issue. Since you decided to give the issue such little-attention, I won't waste my time educating you. I'll simply say the one study you cite is laughable. If we took the methodology of this study seriously, you would assume the US could could eliminate all unemployment by just hiring everyone no-questions-asked and we'd have a productive, prosperous society. Apparently you missed the day in econ 101 when they taught "crowding out." Whether I spend my $1 or the government spends my $1 that it took from me via lump-sum tax doesn't make a difference for aggregate statistics (though it matters for welfare). If government and private sector jobs are substitutes (and realistically they are) and if government finances its expenditures with taxes - then there is no effect. You are just changing the composition of employment and output. With distortionary taxes, government hiring has negative effects. In other words, the study you link to to is complete garbage. Given the theory, your evidence says absolutely nothing about the validity of public spending. All it proves is that the government didn't burn the tax money it got. The evidence for this prediction is ample, Algan-Cahuc-Zylderberg (2002) in Economy Policy is the most respected study. Honestly, the prediction of long-run crowding out is completely uncontroversial in the literature. Whether these predictions apply in the short-run under specific circumstances is a different story, but it's not nearly as clear cut as you believe. Also, the evidence for the productivity for government spending isn't particularly strong. The estimates are all over the map. The general consensus is the estimates used by Baxter-King (1993) in their seminal paper. We generally treat the elasticity of productivity of public capital as 0.05, which isn't especially high. Many studies even suggest negative productivity effects like Evans & Karras (1994) in the Review of Economics & Statistics. This actually isn't that surprising, because most people confuse average productivity with marginal productivity. It's true that an economy with roads will have great productivity of private capital than an economy without roads, but that does not imply an economy with already reasonably functioning roads gets significant productivity gains from repairs. Health care & education are notorious for failing to increase private capital productivity - at the margin. Core infrastructure is really the only thing that raises the productivity of private inputs. Also, on green energy, I doubt this will do anything for productivity unless the energy production is so much more efficient. The evidence for productive gains in green energy isn't there. You'll mostly be redistributing energy production from traditional means into green production, without significant growth effects. It will be better for the environment, but not for the economy really.
Also, to cite Mark Zandi as a source immediately disqualifies you as an economist. We know what Mark Zandi is doing. He's using one of those god-awful 1970s large-scale macroeconometric models. It's obvious he's just using a linear stochastic difference equation system with no cross-equation restrictions. The Lucas Critique already taught us why these models were garbage and useless for policy analysis. The fact a professor of economics apparently doesn't know what the Lucas Critique is, is just astounding.
On the issues of budget deficits, reasonable people are more concerned with long-term budget. I'm not opposed to tax increases, though my preferences is to first move to an optimal tax code without so many distortions so we can raise more revenue with causing significant economic harm. Non-military/non-Medicare spending can be dealt with relatively easy, a little cut here and a little tax increase there. However, we are going to have to cut Medicare. Whether you decide to ration care by careful management like they do in other countries or decide to ration care by savagingly cutting the program doesn't make much difference. It will have to be done, however. The tax base simply isn't large enough to support this programs future expenditures. To even come close you'd have to go to a European tax model and drop the desire for progressively and impose large labor taxes on everybody and a consumption tax. I personally would love to see a reduction in defense spending, but you can't really create a long-term plan for that. Nobody can "plan" for wars and conflicts decades in the future. The only way to get long-term defense spending reductions is through a change in the attitude of the populace about the desirability of these endeavors.
Finally, I'm a utilitarian. I'm in favor of redistribution and would favor countercylical government spending if the evidence supported that it worked (the evidence, theoretical and empirical, is very, very mixed). Progressives hurt their cause when they live in a magical world where marginal tax rates don't matter or where they dramatically exaggerate the available evidence on the success of government interventions. If we can't make a realistic case for government intervention, by pointing to serious evidence and admitting that, yes, government actions do have a lot of negative consequences, but, in the end, are still worthwhile - then we have nothing to offer.
Alison — January 20, 2013
I'm confused about the third graph, of federal expenditure as a percent of GDP. It seems like the chart shows that quantity as going up over time, not down.
MPS — January 20, 2013
I'm not going to bother with a careful reading of this post but I will say that to look at forward-looking deficits and blame them on "Bush-era" tax cuts is no longer appropriate. We now have Obama-era tax cuts. Although Republicans were happy to go along, Democrats were insistent on extending these cuts for most people, when they otherwise would have expired.
decius — January 21, 2013
Nice cherry-picking on the deficit figures. You cleverly manage to imply that those five categories make up most of the federal budget, rather than a tiny fraction of it.
If my mortgage is $1500/month and my income is $2000 short of my expenses, it is both true and false to say that my mortgage payment is 3/4 of my shortfall if I have $5000 gambling losses.
Come back with a little bit less agenda, and you will be taken seriously by those outside of your echo chamber.
The Causes Of US Deficits And Debt… « The Internet Times — February 1, 2013
[...] this is rather unsurprising and I will decline comment as to the cause as it is not necessary. Here. ▶ No Responses /* 0) { jQuery('#comments').show('', change_location()); [...]