Deficit spending CAN be fiscally responsible. Here's how.
The deficit only keeps growing if we spend more than we bring in from tax revenue – but tax revenue depends on the nation's economic health.
I’m traveling all this week for work, so I probably won’t be blogging at my usual frequency. But I had to say at least something about this week’s big fiscal policy development.Skip to next paragraph
'EconomistMom' (Diane Lim Rogers) is Chief Economist of the Concord Coalition, a non-partisan, non-profit organization which advocates for fiscal responsibility, and the mom of four (amazing) kids to whom she dedicates her work. She’s been blogging since Mother’s Day 2008.
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The Bipartisan Policy Center’s (BPC) debt reduction plan was unveiled on Wednesday morning and is a good example of why pursuit of “fiscal responsibility” need not be in conflict with other economic goals, contrary to how opponents of fiscal hawkish policies like to portray them.
First, additional deficit spending can be fiscally responsible. How is that not an oxymoron? Because the fiscal outlook is only unsustainable if the debt grows faster than the economy. There are two variables in that comparison, both affected by policy choices. The debt grows each year by the size of the annual deficit, the difference between spending and revenues. But how the particular spending and revenue policies affect economic activity in turn affect how fast the economy grows. In other words, exactly how we spend and how we tax matters beyond how much we are spending and how much we are taxing (collecting in revenue), in determining what is winning this race between the debt and the economy.
In Wednesday’s New York Times, David Leonhardt makes the point that all else constant, a stronger economy reduces the budget deficit–that “one way to trim [the] deficit” is to “cultivate growth.” In an economy with high unemployment, even deficit-financed policies can produce an economic benefit (greater economic activity with more income to tax and less need for government safety net spending) that outweighs the economic cost (increase in the deficit which may increase borrowing costs and reduce national saving), provided that the deficit spending has high (and fast) economic “bang per buck.” Short-term deficit-financed stimulus is most likely to produce that high “bang per buck” when the policies follow the “three Ts” of being timely, (well) targeted, and temporary in nature.
As David explains, the plan put together by the BPC debt reduction task force actually includes a temporarily large increase in the deficit with a major new fiscal stimulus (emphasis added):
“Some politicians and economists present a false choice: reduce unemployment or stabilize the debt,” argues a new bipartisan deficit plan that will be released Wednesday, the second such plan to come out in the last week. As Alice Rivlin, a Democrat who oversaw the writing of the plan with Pete Domenici, a Republican, put it: “We can do both. We can put money in people’s pockets in the short run and trim government spending in the long run.” .
The plan calls for a one-year payroll tax holiday for employers and workers, costing $650 billion. But remember that’s a one-time sum, while the needed deficit cuts will be hundreds of billions of dollars a year. Relative to those cuts, a payroll tax holiday — or more spending on roads and bridges, as President Obama favors — is a rounding error. And, of course, putting people back to work has its own benefits.
Admittedly, that is a very big additional one-year stimulus and might be considered going overboard. (Today at my event at the Boston Fed, Mark Zandi said he thought it was more than necessary.) But if a payroll tax holiday (full or partial) is considered more effective stimulus than, say, temporarily extending the various parts of the Bush tax cuts, why not consider substituting the payroll tax holiday (or any other more effective fiscal stimulus) for the Bush tax cuts, rather than just piling it on?