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Declining Deficits

Economic growth is the imperative, not budget cuts.

May 27, 2013, Vol. 18, No. 35 • By IRWIN M. STELZER
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The burgeoning deficit has stopped burgeoning, at least for now. So Republican plans to attack the profligate president and to use the debt ceiling as a weapon to get more spending cuts can be shelved. Conservative deficit hawks should turn to a more immediate and important task—devising policies that will help the economy to grow at a rate that ends middle-class malaise and gets the millions who are out of work back into the workforce.

Keynes: Heed him.

Keynes: Heed him.


The Congressional Budget Office, which only some 90 days ago forecast the deficit this fiscal year would hit $845 billion, has decided that $642 billion is the more likely total. Better still, the deficit is projected to be about 4 percent of GDP this year, down from 7 percent in the previous fiscal year, and reasonably close to a level that can be sustained if the economy grows as it should.

The lower-than-expected deficit comes partly from taxpayers having pushed dividend, capital gains, and other income they normally would receive in 2013 into 2012, to benefit from the Bush tax-cut rates that were due to expire. Taxes on that 2012 income are now flowing to the Treasury for a onetime gain. The other reason for the lower forecast is that the CBO now expects health care costs for the next few years to be lower than it had anticipated a few months ago. But, short on chagrin or embarrassment, it still says entitlement spending will consume half the budget by 2023.

There are important lessons here for Republicans whose new dinner and golfing partner is attempting to lure them into some grand bargain by which they give him higher taxes now, and he agrees to reduce entitlements after he has left office. It sails under the banner of tax reform.

Lesson One: Beware of forecasts, especially about the future. Mitt Romney based his campaign on forecasts that the economy would weaken and unemployment rise, and faced the monthly humiliation of reports about tens and hundreds of thousands of new jobs being created. Deficit forecasts are even more problematic: They are forecasts of a rather small difference between two very large numbers. A few percentage points’ revenue gain can produce a large swing in the deficit. Think about it this way. Assume you plan to spend $110, have income of only $100, and so face a deficit of 10 percent. Pick up a mere $2 (or 2 percent) in extra income, and the deficit falls from $10 to $8, a drop of 20 percent.

Lesson Two: Be wary of policies that promise pain now for gain at some future date. John Maynard Keynes, not a conservative but an economist with much to teach us, summed up the unwisdom of antagonizing the electorate by calling for entitlement cuts now to avoid a fiscal meltdown perhaps a decade hence: “It can seldom be right .  .  . to sacrifice a present benefit for a doubtful advantage in the future.” This is not “in the long run we are all dead” but a sensible statement of the need to weigh probabilities and to discount future gains: A hot fudge sundae now is worth more than a hot fudge sundae one year from now, especially if the promise of future delivery is as “ironclad” as most made in Washington.

Lesson Three: Beware the word reform, as in immigration reform and tax reform. Tax reform is the issue that now sets conservatives’ pulses racing. Because the deficit is a less compelling issue now that it is declining, and the battle over the debt ceiling has been postponed because it probably won’t be hit until October or November, and because House speaker John Boehner would very much like to avoid a showdown, with its charges of “default” and “government shutdown,” all Republican eyes have turned to tax reform. Not a bad thing, if they develop positions consistent with conservative principles.

They should, for instance, be certain that reforms labeled “revenue neutral” are not mislabeled. Barack Obama is no Ronald Reagan, Nancy Pelosi is no Richard Gephardt, and Harry Reid is no Bill Bradley. The odds that the Obama team will come up with reforms that don’t raise total taxes are just about zero, even if the increase isn’t discovered until after some bill running thousands of pages becomes law (cf. Obamacare).

Republicans should also take care that even if revenue neutrality is built into any reforms, those reforms don’t violate two important conservative principles: that civil society, which stands as an alternative to and buffer against bigger government should be preserved, and that home ownership is an important source of social stability.

The president made clear in his address to the graduates of Ohio State University that he has little use for the institutions of civil society, that he believes that government can provide all of the services that Americans might require, including some they don’t yet know they need. Which is one reason that he and what are now called “progressives” would “reform” down the charitable deduction. Never mind that the charitable deduction increases the willingness and ability of Americans to support some of the greatest universities and art institutions in the world, to donate to their churches and synagogues, to the fight against disease, and to a host of other good causes. Limits to deductibility of charitable contributions are, in essence, a tax on civil society. 

Charitable institutions provide alternatives to government institutions: Some provide direct relief from want, others enrich the culture, still others provide alternatives to government and government-friendly sources of information and scholarship. It is unsurprising that Obama and some of his constituent groups see these institutions and organizations as threats—charter schools frighten the trade union-government monopoly hold on education; think tanks produce critiques of government policies, some valid; churches provide alternatives to official morality on issues such as abortion and an alternative to the government welfare bureaucracy.

Then there is the mortgage-interest deduction. Tax reformers have the deduction of mortgage payments of less than the current limit of $1.1 million in their sights. Whether that limit is too generous is an open question, as is whether it should be restricted to only one home rather than being a limit on the total deductions for two. But what is not an open question is that reducing mortgage deductibility will make home ownership less attractive.

Yes, such a move would increase labor-force mobility as workers, who would be renters, find it easier to move to where the jobs are, and an artificial inducement to excessive investment in housing would be removed. But conservatives can nevertheless feel comfortable opposing the removal or even a reduction in the mortgage deduction since the deduction supports two conservative goals: It gives more people a stake in a stable society, and an incentive to maintain the housing stock in good order. As Larry Summers reminded us, no one washes a rented car.

Moreover, studies suggest that home ownership is associated (with varying degrees of statistical robustness) with lower crime rates, more active parent participation in community organizations, cleaner streets and parks, lower rates of school dropout and teenage pregnancy, and a host of other social advantages that are not fully reflected in the price of homes. They are, in economists’ jargon, externalities, justifying subsidies to encourage home ownership. Conversely, there are social costs to reducing the incentive to own a home: Is society better or worse off if a poor family receives a subsidy—which is what the mortgage deduction is—that enables it to get its kids out of some horrible neighborhood and into better surroundings?

Lesson Four: A presumption in favor of lower taxes should be just that—a presumption to be tested against the specific tax proposal being made. So before joining the chorus of those singing the praises of a cut in the corporate tax rate from 35 percent to, perhaps, 25 percent, it might be well to consider two things. First, very few companies actually pay the 35 percent rate. GE paid federal, state, local and foreign taxes equal to about 17.9 percent of its earnings over the past five years, FedEx 20.1 percent, Amazon 6.6 percent, and Ford 4.2 percent, according to S&P Capital IQ. This rather dilutes the force of the argument that this particular cut would increase the competitiveness of U.S. companies.

Second, these tax cuts would have to be paid for by some increases in order to be revenue neutral, even given dynamic scoring. And poised in the wings to argue for the offsetting increases are Democrats with redistributionist urges. Yes, reducing corporate tax rates might stimulate growth, but the nexus between the cuts and that growth should be clearer before establishing the need to find offsetting increases.

Enough of warnings. On to the main chore: finding policies that stimulate growth, and growth that will affect the lives of more than the much-derided 1 percent. Several such leap to mind, but that is for another day, after we hear from those who are relieved of the necessity of devoting their time to tackling a budget deficit that is shrinking, and entitlement spending that might, some day, perhaps need tackling.

Irwin M. Stelzer is a contributing editor to The Weekly Standard, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

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