Conservative Economist Inadvertently Makes the Case for More Government Spending

That's not what his book intended to say, but it's the unmistakable conclusion.

Photo Credit: Shutterstock, Copyright (c) ChameleonsEye

Gene Steuerle is not a standard right-winger who believes that a dollar in the pocket of a middle class or poor person is a dollar that could be in the pockets of the rich. He is a serious budget analyst who has done important work on tax and budget issues for more than three decades. He sees the deficit as a problem precisely because he sees it as having a negative impact on poorer children in both the present and the future. This is why, apart from the great title, his new book Dead Men Ruling, is worth reading. He sets out the deficit hawk case about as well as anyone can.

Steuerle's basic point is that the commitments we have made in the budget to mandatory spending programs, most importantly Social Security, Medicare, and Medicaid, plus interest on the debt, will soon take up nearly all of the federal budget. This means that the electorate in twenty or thirty years will have almost no control over how their tax dollars are spent. They will not have the discretion to spend more money on infrastructure, education or other areas they might consider priorities. Their tax dollars will already have been committed to the big three mandatory programs.

While there is little dispute as to the basic numbers (Steuerle uses projections from the Congressional Budget Office) there are several fundamental issues concerning his framing of the issue. First, the country's main economic problem in the recent past and the foreseeable future is a lack of demand, or "secular stagnation" to use the term that folks like Larry Summers and Paul Krugman prefer.

If this seems unconnected to Steuerle's budget concerns, then you need to think more closely. The central problem of Dead Men Ruling is overcommitted resources. The country can't pay to educate our kids or maintain our infrastructure because we are spending so much caring for our elderly.

However, the secular stagnation argument is 180 degrees in the opposite direction. This is an argument that we have millions of people unemployed because we don't have enough demand in the economy. In this story, the best thing we could do is spend more money, ideally in productive areas like educating our kids and improving our infrastructure.

If the secular stagnation story is right, then our problem is that our deficits have been too small, not too big. The failure to spend more investing in the future was due to political obstacles to deficit spending, either from a misplaced concern about deficits or a positive dislike of government spending in areas that benefit large segments of the population.

There is obviously a lengthy debate in the economics profession on this issue, but a few points are instructive. Inflation has been stable or drifting downward for virtually all of the last three decades. This is not consistent with an economy that is up against supply constraints.

Second, countries with much larger debt burdens than the United States have little problem borrowing in international financial markets. Italy, with a debt burden of almost 140 percent of GDP, was able to borrow long-term at less than a 2.8 percent interest rate in the summer of 2014. Japan, with a debt burden of more than 240 percent of GDP, was able to borrow at less than a 0.6 percent interest rate. This suggests that the United States, with a debt to GDP ratio of less than 80 percent, is quite far from reaching any borrowing limits.

Third, as a practical matter the countries that have reduced their deficit the most since 2010 have seen the worst employment performance. This implies that if the United States had spent large amounts of money investing in the future, it would have paid both short-term employment dividends and long-term growth dividends.

If the U.S. economy has been faced with a persistent shortfall in demand then we really are not constrained in our spending. That could change at some point in the future, but there is no obvious reason that it should. Furthermore, if there is some substantial spur to growth (e.g. a sharp reduction in the trade deficit), it will lead to a boost in tax revenue and reduction in payments for many transfer programs, directly improving the budget picture.

That should not sound far-fetched to anyone who remembers the last time ran budget surpluses in the late 1990s and early 2000s. In 1996, the Congressional Budget Office projected a deficit of 2.5 percent of GDP for 2000. Instead we had a surplus of roughly the same amount, meaning a shift of 5 percentage points of GDP (at $850 billion in the 2014 economy). This shift was not brought about by any tax increases or spending cuts, the Clinton tax hike and Clinton and Gingrich spending cuts were already incorporated into the 1996 projections.

The reason for the large shift from projected deficits to actual surpluses was more rapid growth and a sharp reduction in the unemployment rate. CBO had projected a 6.0 percent unemployment rate for 2000; in fact the rate was 4.0 percent. In short, CBO can be taken by surprise on these things. (It was taken by surprise in the opposite direction with the collapse of the housing bubble in 2008.)

Beyond the macroeconomic questions, there also are some fundamental issues about what constitute commitments made by dead men. Steurele restricts his list to the main entitlement programs, however the government makes many other commitments that can be comparably binding. For example, the decision to go to war in Iraq committed the government to hundreds of billions of dollars in veterans benefits, including large payments to veterans who were permanently disabled as a result of the war. It also arguably locked in large amounts of additional military spending as politicians find it difficult to just walk away from the turmoil created by a war they had supported. Tough on crime laws imply the same sort of future spending commitment for incarceration and the criminal justice system more generally. If these costs are included then our kids might be even more constrained than Steurele indicates.

Fortunately there are some aspects to the situation that point in the opposite direction. First, it is not clear that the public views taxes for all purposes as interchangeable. Specifically, there is reason to believe that the public views taxes that pay for Social Security as being qualitatively different than other taxes.

This is not just a legalistic argument about the definition of the Social Security trust fund. Social Security was set up to be a distinct program and there is evidence that the public sees it this way. The National Academy for Social Insurance did a poll asking respondents to choose between various proposed cuts to the program as compared to raising the payroll tax. A substantial majority preferred raising the payroll tax to any of the proposed cuts. It is unlikely that a majority would have supported higher taxes more generally.

Of course taxes for social insurance programs have been raised a great deal over the last five decades, going from 3.0 percent of GDP in the early 1960s, to roughly 6.0 percent of GDP in the last decade. While this increase has been largely offset by declines in corporate income taxes and excise taxes, it is unlikely that reductions in these other taxes made voters more willing to tolerate higher payroll taxes. (This point applies even if we allow that most of these taxes would be passed on to workers in lower real wages. It is implausible that workers distinguish between an increase in real wages due to productivity growth and an increase due to a cut in corporate income taxes. If the former does not make them open to higher taxes then it is unlikely the latter would either.)

To make this point another way, if Social Security had been privatized, then the money committed to the program would not be included at all in the budget. This money would instead be going to private accounts. This would mean a larger percentage of the budget would be under the discretion of current voters. That translates into a big improvement in the Steurele-Roper Fiscal Democracy Index, which measures the share of the federal government not committed to the big three programs, even though current voters would not control any larger share of the total economy's output.

If voters actually perceive their payments to Social Security as distinct from their other payments to the government, then this is not really money that is available for other purposes. There can always be questions of timing and minor reallocations, but we can't think that we will support any substantial portion of the general budget from money designated as Social Security contributions.

This brings us to Medicare-Medicaid side of the big three. The rising costs projected for these programs are in part driven by aging, but also by projections of excessive growth in health care costs. While Steurele puts the payments for seniors front and center in his analysis, arguably the payments to health care providers are what really deserves center stage on the national agenda.

The United States pays more than twice as much per person for its health care as the average for other wealthy countries with nothing to show for it in terms of outcomes. We do not get better care than people in Germany, Canada, or France, we just pay much more for the care we get. The main reason is that our providers - doctors, drug companies, medical equipment companies - get paid twice as much as providers in these other countries.

Rather than looking to take away benefits from seniors, it might make more sense to bring payments to providers in line with the payments in the rest of the world. (My preferred route is increased trade. If Medicare beneficiaries had the opportunity to buy into more efficient systems elsewhere, splitting the gains with the government, it would make more people aware of how inefficient our health care system is.) This is of course an extremely difficult battle. All of these groups have enormous political power which they will use to combat any effort to cut their incomes. Of course retirees and future retirees also have substantial political power, as Steurele knows quite well.

It seems the real issue is which group you choose to fight. The projected growth in health care programs will lead to serious budget problems as well as difficulties in paying for health care in the private sector. We can either cut back the public sector programs that disproportionately benefit seniors or bring our health care costs in line with costs in the rest of the world. The latter route would offer benefits not only for the budget but for the economy as a whole as the albatross of a broken health care sector would no longer be a drag on economic growth.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). His most recent book is Plunder and Blunder: The Rise and Fall of the Bubble Economy. He also has a blog, Beat the Press.

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