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The Economics of the Ryan Budget



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A mini-furor has arisen over the Heritage Foundation’s analysis of the Ryan budget — see, for instance, this Paul Krugman post. Unfortunately, they have aimed their criticisms at the wrong target, the Ryan budget. Time to clear up the confusion.

The facts are that House proposals for tax reform, Medicare reform, Medicaid reform, job-training reform, and so forth should be judged on their policy merits — and reasonable people will doubtless disagree. Similarly, the budget implications (the revenues, spending, deficits, and debt) are based entirely — I repeat: ENTIRELY — on the Congressional Budget Office’s economic assumptions and baseline projections. No smoke. No mirrors. Just the official, non-partisan numbers.

It is true that Heritage took those proposals and budget implications and generated its own analysis of the economic implications. Again, one may disagree with the particulars, and I don’t blame Paul Krugman for doing so. However, the notion that there are beneficial feedbacks is a no-brainer.

Take the CBO, for instance. In its analysis of the Ryan budget, the CBO concluded:

To the extent that marginal tax rates on labor and capital income would be lower as a result, future output and income would be greater in the long term, all else being equal. Moreover, because the proposal would reduce federal debt relative to the extended-baseline scenario, less private saving would be absorbed by federal borrowing—which would also tend to boost future output and income. Therefore, GDP and national income would probably be higher in the long term under the proposal than under the extended-baseline scenario.

That’s right. The Ryan budget would provide beneficial impacts on economic growth because it lowers marginal tax rates, controls spending, and reduces debt.

This does not represent new thinking by the CBO. Back in the old days — think when Bill Clinton was president — a consensus arose that the economy responded to sensible debt policies. Reflecting this commonsense notion, the CBO included budgetary feedbacks (a “fiscal dividend”) from policies that generated economic benefits.

For example, in An Analysis of the President’s Budgetary Proposals for Fiscal Year 1996, the CBO wrote:

Those simulations assumed that the budget would be balanced smoothly over the next seven years, following the illustrative path laid out above. Moreover, they assumed that the policy actions would be on the outlay side of the budget rather than on the revenue side. The broad conclusions apply, however, to many other ways of reaching balance, provided that those methods do not involve changes in marginal rates of taxation on saving, on the return from capital or on labor. [underline added]

Long-term rates drop more than short-term ones, on the assumption that the policies undertaken to balance the budget will put the long-term fiscal outlook on a more sustainable path than is possible under current policies.

The key insight is that beneficial policy changes directly improved the budget outlook, but also improved financial market conditions and economic performance. The latter two impacts have feedbacks so that the budget outlook is also affected. Notice that a premium was placed on “those methods do not involve changes in marginal rates of taxation on saving, on the return from capital or on labor.” Put differently, good policy should be reflected in budget projections.

This week witnessed a seminal moment as the House Budget Committee began work on a resolution that centers its efforts at debt reduction on entitlement reform (reduced spending) and tax reform (lower marginal tax rates). To date, progressives, liberals, and other defenders of the broken status quo have resisted efforts to control spending on grounds that it would endanger the economic recovery. They have opposed sensible entitlement and tax reforms as attacks on the poor, giveaways to the rich, or some combination of both. While this might be an effective political strategy, it does nothing to resolve our debt problem.

Now they are choosing to attack a third-party analysis that has nothing to do with the proposals themselves.

Only a decade ago, it was agreed that precisely these changes were the best for economic growth. With so many millions of Americans desperately seeking a job, why not acknowledge this again? Only a decade ago, it was agreed that spending restraint and growth were the best route to fixing a broken budget. With a dangerous sea of red ink facing the nation, why not acknowledge this again? The current strategy of more federal spending, more federal regulations, and more government in general has failed to fix the economy. In fact, this strategy will only accelerate the crisis.



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