The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Anti-Deficit Hysteria?


Many writers, including the consistently sharp Chris Hayes of The Nation, are decrying what they see as anti-deficit hysteria. My sense is that anti-deficit hysteria is not a fair characterization of the political mood. Rather, many citizens are concerned about long-term fiscal imbalances, and some of us have been worried about these long-term fiscal imbalances for a long time. Chris writes:

First, the facts. Nearly the entire deficit for this year and those projected into the near and medium terms are the result of three things: the ongoing wars in Afghanistan and Iraq, the Bush tax cuts and the recession. The solution to our fiscal situation is: end the wars, allow the tax cuts to expire and restore robust growth. Our long-term structural deficits will require us to control healthcare inflation the way countries with single-payer systems do.

Let’s parse this: one could just as easily say that the entire deficit for this year would vanish if we sharply decreased federal entitlement spending. That said, it is clear that the ongoing wars in Afghanistan and Iraq are very expensive. And it is also true that the Bush tax cuts — which were explicitly temporary — have reduced revenues. It’s certainly possible that some of the capital gains tax cuts generated enough new economic activity to offset as much as half of the revenue loss, but there was a revenue loss. Yet it’s not clear that sharply increasing taxes is an effective strategy for restoring robust growth. Indeed, we have good theoretical and empirical evidence that, as Arpit Gupta recently observed, that the tax increases will hinder growth over the long term:

A clever resolution is suggested by a set of papers by Raj Chetty, an economist at Harvard. Chetty points out that the micro estimates rely on instantaneous adjustment to higher tax rates, and typically focus on short durations after law changes. However, a variety of factors may combine to make the behavior responses to tax cuts a more long-run effect. People face costs in switching jobs or entering the job force. They may simply be unaware of tax changes or lazy. Any of these plausible frictions are compatible with large long-term effects of tax cuts that are difficult to capture in micro data.

This distinction is important, because policymakers are generally interested in the economy-wide and durable impacts of tax increases, rather than their short-term impacts. Macro estimates, which use economy-wide data, may be better suited to answer this question.

In a separate paper, Chetty and coauthors develop new techniques to capture broader responses to taxation while looking at firm-level data in Denmark. They are able to obtain a set of estimates that suggest that the work disincentives of taxes, properly computed, are closer to the higher macro estimates (though lower than some estimates Prescott prefers). These figures would suggest that a sizable portion of the Europe-America income difference can be accounted for by differences in marginal tax rates.

One can see why those who favor a sharp expansion of government expenditures would focus on the revenue side rather than the spending side. The last sentence in Chris’s paragraph is particularly worthy of note:

Our long-term structural deficits will require us to control healthcare inflation the way countries with single-payer systems do.

Of course, it could also mean that we should control healthcare inflation the way Singapore does, with universal catastrophic coverage that has proven far more effective than the single-payer system in Canada. Towers Watson summarizes the system as follows:

The key to Singapore’s efficient health care system is in its emphasis on the individual to make a significant contribution towards their own healthcare costs. With this focus, the Government has been able to maintain a relatively low level of public expenditure on health for many years with the major burden put on individuals and/or their employers.

The use of compulsory savings (that is, the Medisave account) has been very successful as the main source of private funding for hospital expenses.

Another key focus of the Government has been to ensure that overall health expenditure does not fall victim to the significant inflationary pressures that have been evident throughout the world. This has been achieved by actively regulating the supply and prices of healthcare services in the country. [Emphasis added.]

Conservatives will like the first part and liberals might like the second. The point, however, remains: Canadian-style single payer has been consistently outperformed by the Singapore model of HSAs and catastrophic coverage. Moreover, the Canadian system is now under intense strain.

What we’re dealing with is a values clash: some of us want households to enjoy higher disposable incomes, others want to generously fund public services. 

Among those who want households to enjoy higher disposable incomes, incidentally, are those who favor more redistribution, e.g., higher Social Security benefits for less affluent seniors, an expanded EITC,  and other cash transfers. Medicare is only a weakly redistributive program, in contrast. Others want households to retain more of their earned income, with the understanding that this will spur an increase in work effort that will generate more economic growth. This is a big and significant difference. Yet the higher disposable income side is united nevertheless in wanting individuals and families to control a larger slice of the economy than government at all levels.    

Later in the column, Chris suggests that anti-deficit hysteria is comparable to the climate that led up to the invasion of Iraq. I’ll let you be the judge of that. I made a similar argument about the health reform debate, so I’m certainly not against the analogy in every instance. My guess is that we’ll be hearing more of it rather than less. I used it during the health reform debate to suggest that we were moving very quickly to pass a measure that we didn’t fully understand, a position that has been vindicated by new revelations regarding controversial provisions in the new health law, and new findings from Medicare’s chief actuary regarding its likely trajectory. On deficits, it’s an open question whether we’ve been rushing into any rash action without a deliberative process.

It seems that the unfolding conversation about debt and deficits has been happening in very deliberative fashion. It hasn’t been led by the White House and its allies. In fact, it’s been sparked by grassroots anger and outrage, which isn’t necessarily a bad thing in my view. Indeed, one could say that the conversation about debt and deficits has been exactly the opposite of the conversation about Iraq — elites have been responding to public outrage rather than driving it. This is potentially discomfiting for self-described populists allied with the White House, who insist that Tea Party activists and rank-and-file voters concerned about debt and deficits are not truly representative of the wider public. 

I’ll just observe that concern about public debt has a very clear basis in reality, as Reinhart and Rogoff suggest:

The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies. 

Granted, this doesn’t mean that this year’s deficit constitutes a crisis. What it does mean is that we have to weigh the benefits of expanding the public sector against the costs of either increasing public debt or burdening households with higher taxes.

Many populists, including Chris, are very enthusiastic about the idea of sharply increasing the tax burden on affluent households. But as Ruth Marcus of the Washington Post has argued, there are limits to this strategy:

I’m all for a more progressive tax code. But consider: The Tax Policy Center examined what it would take to avoid raising taxes on families earning less than $250,000 a year while reducing the deficit to 3 percent of the economy by decade’s end. The top two rates would have to rise to 72.4 and 76.8 percent, more than double the current level. You don’t have to be anti-tax zealot Grover Norquist to think this would be insane. 

One could then note that marginal tax rates did exceed 70 percent for a time in U.S. history. This was also a time when more compensation came in the form of fringe benefits, masking inequality and magnifying the power of large, hierarchical organizations.  


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