Recipe for recovery: Short-term spending and long-term saving

Sounds easier said than done, but maybe there are sound fiscal options that Congress hasn't considered.

Mark Lennihan/AP Photo/File
This February 2010 file photo shows the National Debt Clock in New York. Economists argue that Congress must find a way to incorporate short-term economic stimulus with long-term deficit reduction.

In his latest wailing on the failure of politics to produce wise fiscal policy (on any front it seems, lately), Ezra Klein describes what would be the ideal policy were it not for the screwed-up politics (bolding added):

Short-term stimulus spending need not conflict with deficit reduction. A fairly serious injection of funds — say, $300 billion over the next two years — could be paired with twice as much deficit reduction in the three years following the spending. Few economists, I think, would argue against the combination of short-term spending and longer-term deficit reduction if they believed the deficit reduction was certain. But the American political system has a lot of trouble making unpopular choices and some trouble sticking to those choices once they’re made. This is where you might expect a bloc of deficit hawks to step into the middle of the legislative debate with a proposal pairing spending in 2011 with savings beginning in 2014, but we’ve seen no such thing

I still maintain I know the answer–or at least one pretty good possible answer–to the riddle: How can we find such a policy that Ezra describes as “pairing spending in 2011 with savings beginning in 2014?” My answer is to extend only the Obama-proposed portions of the Bush tax cuts only temporarily, with a call for revenue neutrality relative to current law (i.e., sticking to the CBO baseline level of revenues) beyond that one or two years. If policymakers think they can do better than simply reverting back to Clinton-era tax policy (still not such a bad option in my opinion), they can work on fundamental tax reform to achieve the revenue-neutral (or better) goal.

If we’re serious about deficit reduction and the “checkpoint” quantitative (and shorter-term) goal of the President’s fiscal commission to get deficits as a share of the economy down to 3 percent by 2015 (versus 4 percent under the President’s budget proposals), then one way to get there is to stick to the current-law level of revenues. But that doesn’t necessarily mean sticking with current tax law itself. Saying that tax policy could be anything as long as it raised the same amount of revenue under current-law policies is exactly how tax economists set up any mental exercise in fundamental tax reform. And when we tax economists go through such careful thinking of what tax policy is supposed to do and how its efficiency and fairness could be improved, we always think about the definition of the tax base–how broad and how neutral it is–well before we obsess over tax rates. And when we think of ways to broaden the tax base and make it more neutral and more efficient, it seems the first item on all our lists (whether we be liberal-leaning or conservative-leaning tax economists), is to eliminate or at least reduce the single largest “tax expenditure” in the federal budget–the exclusion from taxation of employer-provided health benefits (worth about $250 billion a year).

So the beauty of the “stick to current-law revenue levels by 2015” goal is that it would serve many purposes. It would: (i) allow the short-term stimulus provided through the tax cuts to continue temporarily, (ii) achieve the fiscal commission’s goal of the 3 percent of GDP deficit in 2015, (iii) set up the motivation for revenue-neutral, base-broadening fundamental tax reform, which would in turn (iv) likely lead to some reduction in the employer-provided health exclusion which would both turn a revenue-neutral reform into a revenue-gaining one over time (because the costs of the exclusion grow over time with health costs) and would be consistent with the goals of health-care reform (to bring down costs by reducing excess demand), and thus (v) improve longer-term (and not just 2015) fiscal sustainability from both the tax side and health spending sides of the budget.

And earlier this morning, Ezra linked to this IMF blog post by Olivier Blanchard and Carlo Cottarelli on the “Ten Commandments for Fiscal Adjustment in Advanced Economies.” I look over this list of “commandments” and think that a tax policy change of the type I’m describing here–where we don’t just stick to current-law revenue levels by just not doing anything, but use the fiscal commission’s goal to motivate thoughtful tax reform–would obey all of them (or at least be consistent with all of them).

And I don’t mean to suggest this is a cure-all for our long-term fiscal woes, because it’s not. We need to reform the big entitlement programs, too (and even cut “waste, fraud, and abuse” wherever we can find it), because otherwise even a much more efficient tax system still won’t be able to “keep up.” But in my mind tax reform holds a lot more promise than people (even the policy experts) seem to be acknowledging. I think it’s even a more promising solution accounting for the messy politics. So I hope the President’s fiscal commission starts talking about it–often, clearly, and enthusiastically.

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