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Avoiding the Austerity Trap

The garden of the economy needs more than pruning.

Oct 18, 2010, Vol. 16, No. 05 • By MATTHEW CONTINETTI
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Republicans better sign up for yoga class between now and the start of the 112th Congress. They have a difficult balancing act ahead of them, and the performance will require incredible dexterity.

Avoiding the Austerity Trap

The Gipper went for growth

On one side is the public’s reasonable expectation that the next Congress will restrain the growth of government and strive to put America’s fiscal house in order. On the other side is the public’s equally reasonable expectation that the next Congress will help improve the economy. No matter how well the Republicans do in 2010, they can expect to be repudiated in 2012 if they fail at either task (or both).

What might trip up the GOP? It’s not that the public’s demands are impossible to meet. It’s that belt-tightening all too easily becomes an unhealthy obsession. Numbercrunching is a valuable skill, but it also has a tendency to crimp the political imagination. So Republicans must be careful as they trim expenses. Otherwise they’ll fall into the austerity trap.

In the austerity trap, Republican congressmen get so outraged over earmarks to fund studies of the mating patterns of red-bellied newts, they neglect legislation that would foster long-term growth. Deficit anxiety causes conservative lawmakers to rule out sensible policies like a payroll tax cut. A myopic focus on government spending causes Republican leaders to short-change the defense budget and renege on America’s global responsibilities. The entitlement nightmare frightens GOP candidates into framing their economic agenda in strictly negative terms.

In the austerity trap, you lose tactical battles over spending while passing up strategic opportunities to promote economic growth. You mistake thrift for an end in itself, rather than a means to a prosperous, virtuous society. Plunge deep enough into the trap, and you become the tax collector for the welfare state. This isn’t new; the GOP’s been caught in the austerity trap before. During the wilderness years from 1960 to 1980, voters elected Republicans only to clean up the messes left behind by liberal Democrats.

The good news is that the trap is easily avoidable. Why? Because fiscal responsibility and economic growth aren’t mutually exclusive. They are interdependent. Rolling back nondefense discretionary spending to pre-TARP levels, as the Republicans propose in their Pledge to America, will free up capital for private investment and dispel the uncertainty about the future that clouds the business community. Adopting a simple formula to contain spending (such as the inflation-rate-minus-one-percent rule put forward by Stanford’s Edward P. Lazear) would bring predictability and responsibility to the budget process.

Tackling the entitlement problem, moreover, will reassure investors that America isn’t hurtling at light speed toward a currency crisis. Tossing Obamacare onto the scrap-heap and replacing it with policies that emphasize portability, choice, and competition will reduce the health care price inflation that threatens to destroy the federal budget. Best of all, limited government not only brings economic benefits. It improves character by fostering independence, responsibility, risk-taking, and self-respect.

The best place to combine fiscal rectitude and pro-growth economics is the tax code. After repealing Obama-care, the second agenda item for the new GOP Congress is extending current tax rates. Then, go for tax reform.

It’s been almost 25 years since Ronald Reagan and a Democratic Congress closed tax loopholes while lessening the tax burden. Yet in the years following the 1986 tax overhaul, both Republicans and Democrats wasted no time carving out exemptions that favored the wealthy and well connected. Another bite at the reform apple is long overdue. We’re happy to report that the White House seems open to significant changes in the tax code; the president’s commission on tax reform, chaired by Paul Volcker, issued a report in August that recommended lowering the corporate tax rate while eliminating corporate welfare.

Another plan worth considering comes from Harvard’s Martin Feldstein, who estimates that reducing tax “expenditures”—subsidies and credits—by 2 percent of GDP would shave trillions off the projected national debt. Many of these loopholes could be closed immediately, with -others, like the perverse mortgage-interest deduction, reduced over time. What’s more, this approach could be combined with counter-vailing reductions in marginal tax rates.

The Feldstein plan preserves incentives to work, invest, and save, all while removing the eddies in the tax code that divert capital to unproductive uses. A simpler tax code not only would benefit taxpayers, it would make America a more attractive place for foreign investment. And where there’s investment, jobs are sure to follow.

A prosperity agenda doesn’t stop at reduced spending and reform of entitlements and the tax code. It encompasses support for free trade, deregulation that promotes competition, and a consistent habit of tending the garden of the economy so entrepreneurs can grow and thrive. If you want to defeat the debt without resorting to punishing inflation or punitive tax increases, growth is the only option. Bring prosperity to America, and the debt problem fades away. Austerity, by itself, is not enough. To the contrary: It’s a trap.

—Matthew Continetti


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