November 18, 2017

Economix Blog: Simon Johnson: The Flaw in Obama’s Budget Approach

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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

From the White House, we need a clearer articulation of what the federal government does and why this makes sense. Instead, the president has allowed the debate to become dominated by excessive paranoia about deficits and by extremist demands to shrink government in a radical and inappropriate manner.

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This tension reflects the three ways to think about medium-term fiscal policy — the relationship between government spending and revenue over the next decade or two. You can figure out the budget deficit that it is possible to finance by selling government bonds, and use this as your basic constraint. Or you can stipulate the maximum acceptable level of government revenue as a percentage of gross domestic product, and work out the implications of that. Or you can define what government should do, and figure out how to finance these activities in a responsible manner.

The first way of thinking becomes paramount when countries have any form of serious fiscal crisis. For example, in some parts of Europe today — what is called the euro zone periphery — the market appetite for government debt is very limited. As a result, the governments have to think hard about the deficits that they can finance through any combination of assistance from other governments — either directly or through an indirect mechanism, such as the International Monetary Fund — and through the market.

All countries need to pay some attention to the sustainable level of government deficit (this is a flow, best thought of as the difference between government spending and revenue in a year). This is what adds up to government debt (a stock of outstanding obligations at any point in time, for example at the end of the year). But countries also differ considerably in the extent to which market pressures force them to make bringing down the budget deficit a priority.

Greece and Portugal have a fiscal crisis. They need to cut spending or raise revenue in a hurry. (Of course, if their euro zone neighbors are willing to be more generous, that will make their fiscal adjustments less painful.)

The United States does not need to take any such actions on a precipitate basis. The demand for its government debt around the world remains high. Despite the extreme assertions — or wishful thinking — from apocalyptic commentators, reports of the death of United States Treasury obligations have been greatly exaggerated.

Chinese officials like to announce that their country intends to develop its currency, the renminbi, as a reserve asset available to investors in a way that will rival the United States dollar. No doubt this is their intention, but achieving this goal is not so easy.

First China needs to reform its financial sector, then it must increase the protections afforded to overseas investors. When the going gets tough, who will get the rainy-day cash you stashed in China – you or the Chinese authorities?

The second view of budgets holds that it is of paramount importance to cap the size of the federal government budget relative to the economy. Republicans on Capitol Hill discuss a potential cap of around 17 or 18 percent of G.D.P. — and a significant number of them would like to enshrine this limit in a constitutional amendment.

A major problem with this approach is that the United States population is aging. As this demographic shift occurs, if we maintain social insurance — Social Security and Medicare, primarily — at or close to current levels, there is a natural tendency for government transfers to increase relative to the size of the economy.

This is not because of any sinister plot, but rather some simple mathematics. We insure each other, fairly modestly, against outliving our assets or our families’ ability to support us. As we expect to live longer today than did people in the past, we each expect to receive more benefits (this is a statement about probabilities; of course, we do not know which of us will live to be 95 or require what kind of medical attention when we reach 85).

This is an insurance policy, mediated by the government, the value of which has increased — and we should pay higher premiums.

If we pay more in and receive more when we retire, this will increase government revenue and increase government spending. But if you cap government revenue at 17 or 18 percent of G.D.P., that cannot happen. If that cap really binds, the value of social insurance per person must shrink over time.

The recent budget prepared by Paul Ryan, Republican of Wisconsin and chairman of the House Budget Committee, would make drastic cuts in Medicaid, Medicare and other programs in order to reduce the budget deficit to zero by 2023 without increasing taxes. This budget merges insistence on immediately eliminating the budget deficit — as if this were Greece — with a strong desire to shrink the size of government.

The third approach is to figure out what you want government to do — in terms of defense, social insurance, infrastructure investments, assistance for poor children and anything else. Once you know that, you know how much revenue you need — and you should also figure out the least distorting way to raise revenue. (Or you can increase taxes on activities that you want to discourage, like smoking, for example, because of how that affects people’s health and drives up health care costs for everyone.)

When there is a budget deficit — as in the United States today — this can be brought under control in a responsible and measured manner. Limiting government spending while ensuring a broad tax base is entirely consistent with achieving robust economic growth over the coming decades.

But who talks about the budget in those terms? The recent Senate budget proposal contained some elements of this alternative approach, but it’s hard to say that this framing of the budget issues came through loud and clear.

Unfortunately, President Obama, in his budget proposal unveiled on Wednesday, did not reinforce the need to think first and foremost about what we want government to do. Rather than laying out any kind of vision for what the government should do over the next decade or two, the president put forward what he asserts is a viable compromise with the Republicans — some tax increases and some cuts to Social Security (by changing how cost-of-living adjustments are calculated, the real value of future pensions would be reduced).

I sincerely doubt that such a compromise is possible — Congressional Republicans have dug in too deeply against higher taxes, in terms of higher rates and any package of measures that would produce a net increase in federal government revenues relative to the size of the economy.

People who don’t like social insurance — or perhaps just dislike any role for government — have been preparing for this moment for a long time. They have spent many years trying to convince people that there is an immediate fiscal crisis and that government must shrink.

Social insurance is under severe political pressure. The House Republicans want to phase it out for many people — and President Obama appears willing to acquiesce.

The White House should instead focus on explaining to people how social insurance works – and why it offers irreplaceable value. There was no affordable private health insurance for 85-year-old Americans before Medicare was created. And there will be none when Medicare is swept away.

Article source: http://economix.blogs.nytimes.com/2013/04/11/the-flaw-in-obamas-budget-approach/?partner=rss&emc=rss

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