"The final re****t card can now be written on the fiscal management of
the Bush administration, the primarily Republican Congresses since
2001 and the Federal Reserve Chairmen of the period."
" One's only regret in writing it is that no grade lower than F has
been discovered."
anyone besides me remember "It's the economy, stupid!" ???
..d
===========================
The Bear's Lair, by Martin Hutchinson
The trillion dollar deficit
February 04, 2008
Martin Hutchinson is the author of "Great Conservatives" (Academica
Press, 2005) -- details can be found on the Web site
www.greatconservatives.com
It was revealed Thursday that the George W. Bush administration
intends to present a budget showing deficits of $400 billion for each
of the fiscal years to October 2008 and October 2009, at a time we are
close to an economic peak. Given a normal recession, that means the
next "trough" deficit will probably be over $1 trillion. The final
re****t card can now be written on the fiscal management of the Bush
administration, the primarily Republican Congresses since 2001 and the
Federal Reserve Chairmen of the period. One's only regret in writing
it is that no grade lower than F has been discovered.
Budgetary management in a democracy is damn difficult, to be fair. The
voting public gets only the most vague and generalized benefit from
spending cuts, while the affected lobbies and interest groups are
energized to their maximum squawking intensity by the idea that their
precious budget handouts or tax reliefs might be removed. On the other
side, tax cuts are inevitably skewed towards the wealthier taxpayers,
since they pay most of the tax in the first place, but no amount of
electoral juggling can lead the wealthy to form an electoral majority.
If taxation and government spending had no economic effect, as people
believed between the 1950s and the 1980s, and elections determined the
share of output retained by the state, the equilibrium political state
would be something like Sweden, in which the state takes around 60% of
Gross Domestic Product and doles it out in an egalitarian manner in
health, education, pensions, disability payments and other benefits.
The private sector would be limited to food and consumer goods in
which there was no plausible rationale for state management (even
alcohol is a state monopoly in Sweden, for example, and is
inordinately expensive).
However in practice, increasing the size of government damages
economic output, in three ways. First, resources are diverted from the
economically optimized (by the price mechanism) private sector) to an
area where decisions are made on a political basis, so are generally
nowhere near economically optimal. Second, increasing marginal tax
rates is subject to a severe law of dimini****ng marginal returns on
the supply side. At low rates a small increase will produce only
modestly less than would be expected by a linear analysis, but a high
marginal rate, above 40% or so, or a sharp increase has repeatedly
been shown to be counterproductive in terms of revenue raised, often
producing a reduction in revenue where an increase had been expected.
Third, institutions that are subject not to the disciplines of the
market but to the imperfect controls of a large government bureaucracy
become corrupt, and that corruption, which is pro****tionate to the
resources controlled, represents pure loss of output to the economy as
a whole.
Thus even in honest pious Scandinavia the big government nirvana has
been proved sub-optimal, and in a country with a US or Mediterranean
level of graft it would quickly descend into chaos. The problem is
then that the adverse economic effect of a large public sector is
inchoate and diffuse, whereas the forces tending to enlarge it are
ever-present and powerful. The Founding Fathers, almost all of them
wealthy men, were very aware of this problem and attempted to limit
the expansion of the federal government, partly by making the income
tax unconstitutional. 19th Century economists helped by establi****ng a
consensus that budget deficits were bad, thus limiting the ability of
government to grow without inflicting immediate pain upon the
taxpayers.
However in the early 20th Century, the progressives, economically more
or less illiterate but appalled by the sight of nouveau riche
businessmen consuming conspicuously, removed these barriers. First
they passed the Sixteenth Amendment, allowing an income tax. Then they
discovered the joys of Keynesian economics, which de-linked revenues
and expenditures, allowing budget deficits and spending to be
justified as economic "stimulus" whenever the economy was performing
at less than 105% of capacity. Control of the Federal Reserve System
enabled them to remove the short-run monetary constraints that had
previously prevented over-expansion, and the road to larger government
was cleared. The Great Depression and intermittent wars fueled the
increase; expansions of government that would have been impossible in
peacetime were justified as emergency measures, and then embedded in
the system, so as to persist after the emergency ended.
By the late 1970s the economic costs of ever-increasing government had
become obvious both in Britain and the United States, and the
political consensus in favor of it was defeated by two determined
leaders, Margaret Thatcher and Ronald Reagan. That defeat was only
tem****ary however, as demonstrated by the failure of their successors
John Major and the Bush family and the rise to prominence of supposed
"Third Way" leaders in Tony Blair, Bill Clinton and, as it turned out,
George W. Bush.
Blair and Clinton discovered simultaneously that much of the cost of
increasing government could be disguised for many years, if it was
done gradually and combined with an excessively loose monetary policy.
They were assisted providentially by the Internet communications
revolution, which allowed an increasing pro****tion of the world's
consumer goods to be produced in low wage economies at declining costs
- this prevented the surge in consumer price inflation which would
otherwise have been inevitable.
Bush came to office promising a reduction in the size of government
and in particular a tax cut, both traditional Republican policies
strengthened by Reagan's success in the 1980s. Instead Bush, recently
described by his former chief speechwriter Michael Gerson as a "large-
hearted man" -- at least with other people's money - indulged in an
orgy of feel-good social policy. Notably there was the "No Child Left
Behind Act" of 2001, which vastly increased the federal government's
intrusion into education without noticeable positive results and the
Medicare Part D of 2003, which was also hugely expensive since it
lacked effective cost controls. The largeness of Bush's heart even
extended to his Congressional colleagues, whom he allowed to carry on
veto-free in an orgy of ****k-barrel spending and outright corruption
without precedent in the history of the Republic.
Even Bush's tax changes had little or no supply side effect. His 2001
bill lowered top rates of tax only modestly, while including so many
sops to populism that its effect was at best that of an equivalent
sized Keynesian stimulus. In 2003 he passed a genuinely supply side
measure, reducing the top rate of personal tax on dividends to 15% and
thus their total taxation to around 50% from the exorbitant cor****ate
plus personal rate of 61% they had previously borne. Even then, he did
it wrong; he should have made dividends fully tax deductible at the
cor****ate level, which would have leveled the playing field between
different types of investors and removed almost all the incentives to
business tax evasion. If he had done that, paying for it by capping
the deductibility of home mortgage interest at around $10,000 per
annum, and perhaps closing a few other cor****ate tax loopholes, he
would have truly have increased the value and productivity of US
business, while quelling the speculative boom in housing that is
proving so unbearable to unwind.
Now Bush is running into the next downturn proposing a mindless
Keynesian fiscal stimulus, with an unrealistic economic forecast of
almost 3% economic growth in 2008 and 2009 and deficits in those years
at close to record levels. Since the swing in the budget deficit from
2000 to 2004 was over $600 billion, and the US economy is bigger now,
it seems inevitable that the bottom of the recession will see a
federal budget deficit of over $1 trillion, with all the financing
difficulties and economic distortions that will cause. In short,
whatever the size of George W. Bush's heart, it is clearly bigger than
his brain.
As the primary season has proceeded, we are beginning to see into the
future. The picture is not entirely negative. On the Republican side,
the likely winner is John McCain, a man with innumerable drawbacks and
unpleasantnesses but one pretty solid virtue: he appears to be more
fiscally responsible than the in***bent, harking back beyond the
supply-side showboating of the 1980s (which was always to some extent
smoke and mirrors as far as fiscal balance was concerned) to the
successful budget-trimming Presidency of Gerald Ford. McCain's
solution to soaring medical costs is to reduce them through increased
competition; his solution to expanding the military is to reduce the
gold-plating and log-rolling in the Pentagon. Faced with a trillion
dollar deficit, his likely solution would be to cut back spending
sharply and impose a swingeing tax increase; faced with inflation
rocketing into double digits his likely solution would be to fire Ben
Bernanke. One can live with such an approach, uncomfortable though it
would be.
On the Democrat side, the picture is less clear. Hillary Clinton, the
front-runner, appears to have her husband's vice of sharp practice
without his virtue of fiscal prudence. While she might save some money
in Iraq she would spend all of it and more on social programs. Faced
with a trillion dollar deficit, her twin solutions would doubtless be
to impose a tax increase that was as redistributive as possible,
albeit with loopholes for her campaign donors, and to hire Wall Street
to push the envelope of deficit financing techniques through
securitizing the Wa****ngton Monument. Double digit inflation would be
pushed into the future and blamed on others, as it was from 1973-79.
Then there's Barack Obama. On the surface, his policies are almost as
expensive as Clinton's, though he might be more determined in reining
back overseas military adventurism, thus achieving a larger saving
there. On the other hand, his principal economic advisor Austan
Goolsbee is a senior business professor at the University of Chicago,
so presumably has a good economic grasp. Interestingly, Obama has now
been endorsed by Paul Volcker, in 1979-87 the only really useful Fed
Chairman ever, who killed (but alas not permanently, thanks to his
feckless successors) the double digit inflation of the 1970s. Assuming
Obama listens to his advisors and the most eminent of his sup****ters
one can thus have some confidence that his solutions to a trillion
dollar deficit and double digit inflation would be intelligent, but
not what they would be.
Looks like a two out of three chance for a decent solution, or
thereabouts. But even minimally competent and forward-thinking
economic management, in both the administration and the Fed, would
have avoided the problems in the first place.
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