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The Sharp Pencil Test

Time for a real growth agenda

Jun 13, 2011, Vol. 16, No. 37 • By LAWRENCE B. LINDSEY
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It’s easy to get caught up in the details of the political battle of the day over the nation’s economic and fiscal health—after all, that’s what we do in Washington. Unfortunately, many of our decision-makers and opinion leaders possess the skills required for political infighting in greater abundance than the capacity for thoughtful analysis. Their focus on the fight and on winning the 24-hour news cycle has produced a country that designs policy for tactical political advantage and not for the efficient use of scarce resources. As a consequence we have dug a deep hole that will be difficult to escape from. As bad as things may seem, our country’s actual long-term economic and fiscal situation is even worse than Washington’s political class recognizes.

The Sharp Pencil Test

Start with economic growth. The president’s budget assumed 3.1 percent growth this year and 4 percent next year. It now looks like the first half of this year will produce a number just over 2 percent, and there is no evidence that growth is going to accelerate. Since the recession formally ended in the second quarter of 2009, growth has averaged just 2.8 percent, a little over half the average of 4.6 percent in the two years following the typical recession since World War II. The reasons are partly structural, but many government policies aggravate the economy’s structural weaknesses. The effect on the budget can be profound. Each percentage point of slower real growth increases the cumulative budget deficit by $3.2 trillion over ten years. Even if growth meets current projections, federal debt per capita will rise from $19,000 in 2008 to $68,000 in 2020.

Then there is the problem of interest rates. Right now, thanks in large part to Federal Reserve policy, Uncle Sam can borrow at an average cost of just 2.5 percent. The average borrowing cost over the last three decades was 5.7 percent. Our debt is now $14 trillion and scheduled to grow to $25 trillion by the end of the decade. If interest rates normalize over that period, the added interest costs in 2021 alone will be $800 billion—more than 20 times the mere $37 billion in budget cuts that tore up Congress in March. It would take virtually all of the cuts in the Ryan budget just to cover that added interest, much less to start bringing down the national debt. Unfortunately, the Fed is now in a fiscal box. A normalization of interest rates would break the Treasury. Hence, a normalization of rates really can’t happen—we are stuck in a world in which the Fed must keep rates artificially low in order to prevent a budget disaster.

Government policies to “stimulate” growth have not done so. Everyone except flacks for the White House knows that the 2009 stimulus package failed miserably to produce the promised results. But even if you buy the White House’s argument that the $800 billion package created 3 million jobs, that works out to $266,000 per job. Taxing or borrowing $266,000 from the private sector to create a single job is simply not a cost effective way of putting America back to work. The long-term debt burden of that $266,000 swamps any benefit that the single job created might provide. 

This is an example of a program failing the Sharp Pencil Test. If you sit down and do a back of the envelope calculation of the program’s costs and benefits, there is no way to conjure up numbers that allow it to make sense. But the stimulus bill is hardly alone. What we need to do is take a sharp pencil to all of our programs—and to our tax code—and redesign them in a way that brings maximum benefit at minimum cost. 

For a case study in the failure of political program design, consider Obamacare. It is widely, if privately, acknowledged across the political spectrum that Obamacare will have to be reformed before it takes effect in 2014. Recall how it became law. On the day before Congress’s Christmas break in 2009, Senate majority leader Harry Reid called a bill to the floor that had been cobbled together behind closed doors with last-minute agreements penciled in the margins. Several Democratic senators stood and said they thought the bill wouldn’t work, but they were going to vote for it in order to allow it to move to a conference committee with the House, where the inconsistencies of complex bills are typically ironed out. But before the conference committee could do its work, Scott Brown won the Massachusetts Senate election, and there were no longer the 60 votes the Senate would need to pass the conference bill. So the House had to accept the Senate bill virtually unchanged. To get over thorny issues like abortion funding, Obama had to sign an executive order since the bill couldn’t be reopened.

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