I’d like to elaborate on this post more soon with more detail (and fun graphs), but the topic of fiscal policy and continuing federal budget deficits has been on my mind lately. My thoughts are:
- The economy is operating close enough to full potential that any Keynesian deficit-financed stimulus would potentially be counterproductive at this point. Similarly, continued annual deficits increasingly run the risk of crowding out private sector spending as resources are used to fuller capacity. If crowding out were to occur, interest rates would almost certainly rise, hurting growth. Though economic slack does remain, we should be increasingly cautious about running large-ish deficits in the coming years.
- Our long-term debt sustainability issues (which are our actual problems) certainly are not helped by short-term debt accumulation. Though acceptable in times of economic downturn and during recovery, short-term debt accumulation is less acceptable when an economy is both growing and has almost returned to near full operating capacity. If we continue to run structural (e.g. cyclical = 0) deficits, as we have for the past four decades, even in good times, our capacity to deal with the coming surge of entitlement spending will be greatly diminished. In many ways, though, we’re already too late on this regard.
- It might even be optimal to try to run a balanced or even more than balanced (e.g. surplus) budget for a few years. Normally, the rule-of-thumb is that, in the long run, annual debt growth (which roughly equal annual deficits) must be equal to or less than annual economic growth in the long-run (indicating that even balanced budgets are technically required for sustainability). Though this is now the case at the moment, our current deficit of around 3% of GDP is only small enough to about stabilize our debt/GDP ratio of around 75%, not reduce it. And arguably, reductions in debt/GDP would be preferable soon to give us more room for the coming entitlement spending and any future recessions we might encounter (and also to reduce the risk of a debt crisis).
- At the very least, we should continue to try to reduce our structural budget deficits while promoting long-term government investments (for example, in infrastructure, R&D, etc.). At the present time, further fiscal stimulus would seem inappropriate; the window for action has passed.
- Reduction of budget deficits is not only about timing, but rates of change (which is where the calculus comes in). Any plan must not just offer targets and amounts, but how quickly those targets and amounts are to be achieved and any feedback loops that might ensue
- None of the presidential candidates offers a viable long-term deficit reduction/debt stabilization plan, which is appalling. Indeed, many (especially Trump and Sanders) would dramatically increase our rate of debt accumulation in a very unsustainable way. Though many candidates offer proposals for productive spending, both that spending and, more crucially, the coming increase in mandatory program spending should be at least partially paid for, via tax increases or spending cuts. None elaborate on such a plan.
In my world, the government would:
- Enact reforms to mandatory programs (e.g. Social Security, Medicare, Medicaid) that progressively reduced benefit growth and raised more dedicated revenue (for example, by increasing the payroll taxes’ income cap)
- Reduce wasteful spending in the form of corporate subsidies (e.g. agricultural, fossil fuel), DOD procurement waste, redundant programs (for example, many overlapping government assistance programs)
- Raise general revenue (via reductions in excludability of health insurance from taxation, gradual phase-out of mortgage interest deduction, caps on deductions/deductability of some items, etc.)
- Modestly raise spending on direct R&D and R&D tax credit, transportation (highway) funding, job training programs
A more detailed discussion of the fiscal situation and solutions I would endorse will follow soon. But I thought it would be good to write down my general thoughts on the matter.