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In the two and a half months between the election and this week’s inauguration of President Barack Obama, America’s public policy debate has been focused on prospective budget deficits and what can be done to reduce them.
The concerns are partly economic – there is a recognition that debts cannot be allowed to grow indefinitely faster than incomes and the capacity to repay them. Then there is a moral dimension in terms of not unduly burdening our children. There is also the global and security dimension, with the concern that the excessive build-up of debt would leave the US vulnerable to foreign creditors and without the flexibility to respond to international emergencies.
Economic forecasts are, of course, uncertain. Yet there is a great likelihood that, in the next 15 years, debts will rise relative to incomes in an unsustainable way if no action is taken beyond the 2011 budget deal and the end-of-year agreement to prevent the nation tumbling over the “fiscal cliff”. So even without the risk of self-inflicted catastrophes – failure to meet debt obligations or government shutdown – it is entirely appropriate to focus on reducing prospective deficits.
Those who argue against a further concentration on prospective deficits on the grounds that – contingent on a forecast that assumes no recessions – the debt to gross domestic product ratio may stabilise for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.
Reducing prospective deficits should be a priority – but not an obsession that takes over economic policy. This would risk the enactment of measures such as pseudo-temporary tax cuts that produce cosmetic improvements in deficits at the cost of extra uncertainty and long-run fiscal burdens. It could preclude high-return investment in areas such as infrastructure, preventive medicine and tax enforcement that would, in the very long term, improve our fiscal position.
Economists have long been familiar with the concept “repressed inflation”. When concern with measured inflation takes over economic policy, and drives the introduction of price controls or subsidies to hold down prices, the results are perverse. Measured prices may not rise, so the appearance of inflation is avoided. But shortages, black markets and enlarged budget deficits appear. The repression is unsustainable and, when it is relaxed, measured inflation explodes as in the case of the Nixon price controls during the early 1970s.
Like repressing inflation, repressing budget deficits can be a serious mistake. Yet – just as corporate managements judged only on a single year’s earnings take perverse and ultimately harmful steps – government officials in the grip of a budget obsession repress rather than resolve deficit problems.
When arbitrary cuts are imposed, agencies respond by deferring maintenance, leading to greater liabilities later. Or compensation is provided in the form of promised retirement benefits that are less than fully accounted for, with the ultimate burden on taxpayers increased. Or measures such as the recent Roth Individual Retirement Arrangement legislation are enacted, encouraging taxpayers to accelerate their tax payment while reducing present value.
As important as avoiding the repression of the budget deficit is ensuring that focusing on it does not come at the expense of other, equally real deficits. Interest rates in the US and much of the industrialised world are now remarkably low. Indeed, in real terms the government’s cost of borrowing has been negative for as long as 20 years. No one who travels from the US can doubt that we have an enormous infrastructure deficit. Surely, even leaving aside any possible stimulus benefits, current economic conditions make this the ideal time to renew the nation’s bridges and roads. Such investments, borrowed at near-zero real rates of interest, need not increase debt ratios if their contribution to growth raises tax collections.
Infrastructure deficits are only the most salient of the deficits facing the US. Nearly six years after the onset of financial crisis, we are living with substantial jobs and growth deficits. Consider this: an increase of just 0.15 per cent in the growth rate maintained over the next 10 years would reduce the debt to GDP ratio in 2023 by about 2.5 percentage points. That is an amount equal to the much-debated end-of-year tax compromise. Increasing growth also creates jobs and raises incomes.
By all means, let us address the budget deficit. But let us not obsess over it in counterproductive ways – nor lose sight of the jobs and growth deficits that will ultimately have the greatest impact on the way this generation of Americans lives and what they bequeath to the next.
The writer is Charles W. Eliot university professor at Harvard and a former US Treasury secretary