Democracy in Deficit

by on March 6, 2011 at 7:08 am in Economics | Permalink

Here is my New York Times column, which most of all explains what a prophetic thinker James Buchanan has turned out to be (and I thank Brad DeLong for reminding me of this, though he may not agree with my argument).  This excerpt is not the main point, but it hints at how Austrian business cycle theory and Keynesian theories of fiscal illusion might be integrated:

The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they’re holding in a money market account.

The field of behavioral economics analyzes imperfections in market decision-making, but the biggest practical problems often involve our inaccurate perceptions of what the public sector is up to and how much it will affect us.

In this case, the sorry truth is that our savings aren’t worth as much as many of us think, and a rude awakening is coming. One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches.

In terms of driving sectoral shifts, and mismatching AD shocks to what the data call for, there is this:

Yes, some laudable cost controls on Medicare are embedded in the new health care law, but they’re not enough. Most likely, we will end up making other spending cuts that won’t solve our fiscal problems – and in areas that could instead benefit from Keynesian employment stimulus. These kinds of knee-jerk, poorly reasoned decisions are what happens when fiscal illusion reigns.

I also borrow Alex's point that we have not developed a workable Keynesian politics.

What to do?  Time is no longer on the side of good.  I suggest that we confront the nation's fiscal difficulties as soon as possible.  That means both tax hikes and spending cuts, though I prefer to concentrate on the latter.  Nonetheless it is naive to think spending cuts can do the job alone, and insisting on no tax hikes drives us faster along the path of fiscal ruin.  The time for the Grand Bargain is now, it will only get harder:

Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run.

Here is a relevant post from Matt Yglesias.  Here is an Andrew Sullivan post on debt as a moral issue.  Here is a Jonah Lehrer post on how behavioral considerations, in particular loss aversion, make public sector debt harder to limit.

Just An Australian March 6, 2011 at 3:15 am

Looks like it's already too late from over here.

RD March 6, 2011 at 3:48 am

Don't swallow the leftist line about tax hikes being necessary, going back to 2008 levels of spending is now considered a draconian cut. Of course the political incentives are against large cuts, but we need some people using common sense about the real problem.

E. Barandiaran March 6, 2011 at 4:05 am

Tyler, albeit focused on New York state, today NYT editorial http://www.nytimes.com/2011/03/06/opinion/06sun1….
makes clear how wrong you are by pointing to illusion as the cause of the fiscal crisis. As a public choice scholar, you should know better: it's not an economic illusion, it's a political reality. Your column avoids the reality that the NYT editorial details (for the details of California's fiscal crisis see http://reason.com/archives/2011/02/16/farewell-my….
And to make your column even more banal you conclude with a call to Obama (It's 3 AM and you call Obama!). I'm sure Jim Buchanan, Gordon Tullock and all public choice scholars are laughing at your conclusion.

Constant March 6, 2011 at 4:49 am

Nonetheless it is naive to think spending cuts can do the job alone, and insisting on no tax hikes drives us faster along the path of fiscal ruin.

That is not at all clear, unless by "us" you mean government. If that's what you mean, then yes, of course, both tax hikes and spending cuts will improve the government's finances. But every tax hike merely shifts a given financial negative from the government to the taxpayer. If by "us" you mean "government and people", then a tax hike doesn't reduce our overall financial situation, since it merely shifts money from one account to another without increasing the amount of money in the sum of both accounts.

Meanwhile, by "us" I mean people minus government. From this point of view, it's not at all clear that a tax hike is a good idea, since a tax hike is a net financial negative (for the people minus government). From the point of view of the people minus the government, one could, of course, argue that a financially distraught government is an unstable government and we benefit from stability – or some such thing. So the real issue, from the point of view of the people minus the government, is governmental collapse. But this is far from a simple matter of arithmetics. Whether it is better to let the government collapse earlier, or to keep it on life support and let it collapse later and, in all probability, much more catastrophically (since delays in collapse tend to increase the catastrophe of collapse), is a question that is not at all answered by "better it collapse later".

beezer March 6, 2011 at 5:49 am

I don't see evidence that progressive tax rates have any negative effect on robust economies. They do, however, have a positive effect on curtailing deficits.

My take is that dynamics other than taxes are far more important in determining the health of economies. Taxes are of secondary or tertiary importance. First investment, then savings, then debt reduction. That's the order of things.

We didn't invest and we didn't save but we did grow our debt. Private debt that has been transferred into public debt. The cure is investment, then savings, then debt reduction. Stop obsessing over tax cuts. Establish reasonable, progressive tax tables and then forget them.

Lord March 6, 2011 at 6:04 am

Debt is wealth for it will never be repaid, only rolled over. Whatever cannot be sold will be bought by the Fed. There are dangers to overindebtedness and this weakens us over time, but never will it be abrupt for us as there is literally nothing else to buy. But if you want to solve it, solve current account imbalances, debt is merely a necessary artifact from them.

We don't really have a political problem, we have a Republican problem, because Republicans don't believe in balanced budgets, only tax cuts. They have been in charge for most all this period and have led us to where we are now. Only by the Democrats leaning back and letting Republicans rediscover sound policies will we make progress and that may take a long while yet.

John Thacker March 6, 2011 at 6:26 am

I don't see evidence that progressive tax rates have any negative effect on robust economies.

"Any" negative effect? Even those studies that suggest the effects are small, like those of Saez, suggest a small negative effect.

This is one of the areas where economics disagree about the size of the elasticity, though that makes a lot of difference as to whether any benefits outweigh costs. There was a a paper of Prescott's that MR covered that suggested that marginal tax rates made a big difference on robust First World economies, a paper that compared different countries. Domestically, Feldstein has generally found a large effect from cutting marginal tax rates (while eliminating deductions), whereas Saez has found a small effect.

Hieronymus Goat March 6, 2011 at 6:35 am

Brownian-Ratchet Bureaucracy plus Hedonistic Populism, enabled by advanced technical, financial, and exploitative wizardry.

The system is so escaped from reality, the only resolution may be catastrophic collapse.

ziel March 6, 2011 at 6:57 am

'a wildly inexperienced coke head' – Two term governor of the second largest state
'a wildly inexperienced draft dodger' – Two term governor of a small state and chairman of the highly influential DLC
'a wildly inexperienced intelligence agency head' – Seriously?
'a widely experienced B-movie actor' – 9 years president of SAG and two term governor of the nation's largest state

vs.

'wildly inexperienced community organizer' – Two term state senator and U.S. senator for two years.

C'mon prior_approval – that was pretty lame.

Slocum March 6, 2011 at 7:28 am

Nonetheless it is naive to think spending cuts can do the job alone, and insisting on no tax hikes drives us faster along the path of fiscal ruin.

This is a political, not economic judgement on Tyler's part — that a majority won't accept the necessary cuts. But I think it's much less politically feasible to imagine enacting VAT (which, in the past, has been Tyler's preferred approach). That's an idea that practically demagogues itself (A EUROPEAN-style Tax! A regressive, HIDDEN tax on EVERYTHING you buy! A tax that will hit the savings of RETIREES the hardest –people who 'worked hard and played by the rules' who were taxed when they earned and saved the money and are now going to be hit by a REGRESSIVE, EUROPEAN, HIDDEN TAX on EVERYTHING when they try to spend the money).

Republicans are so married to 'no new taxes' and Democrats to 'higher taxes only for the rich', that a VAT (or any other new broad-based tax) seems out of the question. So I can much more easily imagine spending cuts eventually getting bipartisan approval with only nominal tax increases included in the bargain.

Loren Gatch March 6, 2011 at 7:51 am

"In the United States, at least, Keynesian economics has failed to find the necessary political institutions to enact and sustain a wise version of the theory."

This is correct, but deeply disingenuous. A generation of convervative intellectuals who never liked the welfare state to begin with, and partisan opponents practicing starve-the-beast political nihilism, have assured our current governability crisis. It's no accident that the deficit crisis began in the early 1980s.

Keynesianism is like a once-livable house now abandoned in foreclosure, with feces smeared on the walls by its former occupants and its copper wiring ripped out by vandals.

AC March 6, 2011 at 8:46 am

As a net taxpayer, I don't see why I should particularly prefer higher taxes now over default. A default would be a better lesson in the importance of fiscal sustainability, and while it would be a big deal for the government, wouldn't affect me any more (probably less) than a serious budget-balancing program. Any reason why we, as citizens, have an incentive to bite the bullet?

John Thacker March 6, 2011 at 12:19 pm

There have been only two Democratic presidents in the past 30 years and the only time we lowered the deficit in real terms was under Clinton.

True enough, but that's still no better a track record than the record of Republicans holding Congress, in number of years or percentage of the time.

If balanced budgets are deflationary and bad, and debt is not a problem when the economy was weak, what exactly is the problem with the Republican deficits, in your view, particularly since they increased when the economy was bad?

If balanced budgets are a bad way of dealing with a current account deficit, then does that mean that the surpluses under Clinton were a bad thing? We had a current account deficit then. Once again, I can't tell if you think that the deficit being lowered was a good thing or a bad thing.

The only thing I think is that your assumption is that deficits caused by government spending cause no problems, but deficits caused by tax cuts are terrible. You're the very mirror image of a spendthrift Republican. Democrats like you do as much to "teach the Republicans that frugality is for fools" as Democrats have done to Republicans. Democrats like you are the ones who caused frugality-focused Republicans to be tarred with the "tax collector for the welfare state" moniker.

freemansfarm March 6, 2011 at 2:48 pm

Virtually no mention of the cost of out of control military spending and the other costs associated with maintaining a world wide empire. The true annual "defense" budget (counting the "special" appropriations for the ongoing wars, military directed foreign aid, spending by other agencies directly attributable to the military ((eg much of the dept of energy)), veterans' benefits, "homeland security," counterterrorism costs hidden as "law enforcement," intelligence, etc, is over a trillion dollars a year. Cut this down to size.

Then we have the Bush tax cuts. Get rid of them.

Add these two together, and we would go a long way towards closing the defecit and paying down the debt.

But no, these are "impossible." And why is that? Not because we have a "community organizer" as President, but because the other Party (the one that gave us the nepo boy coke head alcholic drunk driver who thought that God talked directly to him as President) refuses to even consider these options. They are not even on the table.

No, we just can't afford Social Security and Medicare/Medicare. There just isn't enough money for that. Or, apparently, for State and local services either. But there is plenty of money to launch futile military offensives in Kandahar, and to have military bases everywhere from Tashkent to Timbuktu. And to retain tax cuts that mostly benefit the wealthy.

There is no "fiscal" crises. There is a political crises. We now have one major political party that is committed to destroying our social compact. We have a Supreme Court which has sanctified the use of organized wealth to determine political results. We have by far the largest economy in the world. We could easily afford to have a cradle to grave, social democratic welfare state. We don't have one because the rich have purchased one political party, and are well on there way to purchasing the other, to ensure that their already opulent and luxorious style of life becomes even more so, and that their lust for unbridled power succeeds.

Yancey Ward March 6, 2011 at 4:39 pm

We already know how this ends- it ends with a reset in default. This has always been the outcome, and there is absolutely no evidence we have learned anything from history- just witness Cowen's column and most of the comments above. The only question is who dies before it occurs. I used to think the system would outlive me (44), but I now doubt it makes it beyond 2025.

dirk March 6, 2011 at 7:32 pm

I'm trying to imagine what would happen if Republicans and Democrats got in a room determined to solve the problem, horse traded until they solved it and then came out of the room and announced to the public the solution, which involves reductions in Medicaid, Medicare and Social Security and raises taxes. Would the public stand for it — or would we have riots in D.C.? I suspect the latter. So what solution won't lead to rioting?

I have a proposal which is slightly radical. Congress forms a suicide pact. After they announce the reductions in Medicaid, Medicare and Social Security and raised taxes, which they say they did for the good of the country, they one by one set themselves on fire to prove how serious they are. They die martyrs, the public finally understands the gravity of the situation and the necessity of the cuts and taxes, and nobody riots. America and democracy is saved.

Adam March 7, 2011 at 5:35 am

How can debt be a problem is a fiat currency???

There necessarily has to be a deficit for the private sector to have money. Unless we've moved back onto a gold standard.

Some unreal stuff here.

Yancey Ward March 7, 2011 at 10:29 am

Adam,

Ask Zimbabweans. There is an illusion that people have no alternatives to using that exact fiat. You debase it enough, and people stop using it at increasing rates. There is a deep history on the death of fiat currencies. So, yes, there can be a problem.

freeemansfarm March 7, 2011 at 12:43 pm

Cerise

"Lol @ freemans-'if I explain my values to you one more time, maybe you will change yours'-farm."

In other words, the majority of the country, which favors taxing the rich, maintaining the "entitlement" programs, and cutting defense, and NOT being the world's policemen, should change their "values" to suit those of the tiny group of the wealthy, and the foreign/defense policy establishment, which supports a huge military, low taxes and cuts to the safety net. And which uses its money and its flag waiving to get its way.

And why is it OK for folks like the author of this article to try to impose his values, but not me?

According to him:

"Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run."

So even that's not good enough. Yes, he proposes to raise taxes too, but he "prefers" to "concentrate" on spending cuts. So we must be even more draconian in cutting the safety net. Yep, the poor and middle class are just going to have to tighten their belts and "share in the sacrifice," while the super wealthy go on living high on the hog and we squander our resources on a futile, destructive and morally bankrupt foreign policy. But that's just peachy keen, right?

Anything else, like, ya' know, democracy, would be my forcing others to "change" their "values."

Lord March 7, 2011 at 6:57 pm

@Thacker
Deficits averaging less than the long run growth rate of the economy are not bad. It is only when they exceed this that they become bad. Since they will be higher in bad times, they need to be lower in good ones.

Republicans increased the debt even during good times, and not by small amounts. Balanced budgets are not the best way of dealing with current account deficits, actually dealing with them is. Facing up to them. Addressing currency manipulation. Not looking for free lunches. Balanced budgets did help under Clinton because we were growing and could withstand their deflationary side effects. The current account deficit was much lower under Clinton at the same time. Modeled Behavior has an excellent post on how deficits have been driven by tax cuts and a weak economy, not spending. Balancing the budget means making the tough choices and bringing revenues and spending into line. The only choices Republicans want to make are tax cuts which are in the opposite direction and meaningless cuts. It has won them elections though, so the public doesn't much care and they know that. Since they aren't interested in the deficit, picking up trade could be more productive. That moniker is applied by Republicans to Republicans, those not interested in balanced budgets to begin with.

Adam March 8, 2011 at 3:34 am

Bill Mitchell responds

"In the context of a federal government (such as in the US) the use of the term “unfunded” in relation to anything is meaningless. Such a government is never revenue constrained because it is the monopoly issuer of the currency. In that sense it doesn’t have to put a dollar away to spend it."
http://bilbo.economicoutlook.net/blog/?p=13738

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