But with the combination of the deficit-financed tax cut and the similarly financed new budget deal, my morning papers are replete with articles about “ballooning deficits” and forthcoming new fights over the debt. This raises at least three interesting questions: are these higher deficits a problem, will politicians pay a political price for them, and what can be done to reduce the red ink?
My answers, which I fear may not be very satisfying: it depends, I doubt it, and higher taxes.
Are higher deficits a problem? Because deficits tend to be countercyclical — they go down when the economy goes up — our current fiscal policy is highly unusual. The deficit as a share of gross domestic product is expected to be around 4 percent to 6 percent over the next few years. In the past, when the unemployment rate has been as low as it is now (4.1 percent), that deficit ratio has been close to zero. It’s not unusual for the deficit to be the same as the unemployment rate in a downturn — they both got up to around 10 percent in the last recession. That’s very much as it should be, as extra government spending is need to offset the private sector demand contraction. But it’s very unusual at this stage of the expansion.
But “unusual” isn’t necessary bad. Brand-new estimates from Alec Phillips at Goldman Sachs finds that the impact on growth from fiscal policy should be about an extra 0.7 percentage points in 2018 and 0.6 points in 2019. Those are not huge numbers in this context, and if, as I believe to be the case, there’s still slack in the job market — some people and places that have yet to be reached by the recovery, now in its ninth year — then this new “fiscal impulse” could push the unemployment rate down even further. If unemployment falls to the mid-3’s by the end of this year, I strongly suspect the benefits of growth will find their way to those who’ve been left behind.
However, if we’re already at full employment — if the economy’s resources are essentially already fully utilized — instead of generating real activity (more jobs, higher real wages), we’ll just get more inflation and higher interest rates, which will slow growth. If inflation starts climbing quickly, the Federal Reserve will move from brake-tapping to brake-slamming, raising the benchmark interest rate it controls a lot faster than currently planned.
In other words, the answer to this first question is it depends on how full the economy water glass is. If it’s already at the brim, we’re just going to end up with spillage (inflation). If there’s room for more water, we’ll reach some people who deserve a slice of the pie (whoops — mixed metaphor overload! . . . my bad!).
Will politicians pay a cost for voting for higher debt? Typically, they haven’t, and I can’t see why this time should be different. If the economics turns out badly — glass is full, water spills out, etc. — perhaps, but I’d be surprised. Most polls show that people have learned to live with historically high debt levels, and who can blame them? Warnings of deficit doom have never come to pass. To the contrary, as noted, we’re currently living with high deficits and low unemployment.
But there’s another way that these deficits are unequivocally bad: I’ve had it with politicians telling us, in so many words, “You can have everything you want folks, and you never have to pay for it!” I’m afraid others fail to share my disgust, so again, there’s probably no political fallout from that construct.
The reason, of course, circles right back to the deficit, but with an important detour through tax policy. Most politicians’ basic understanding of fiscal policy these days comes down to this: They’re convinced their constituents don’t want to pay higher taxes, nor do they want to lose what the government currently provides for them. What policymakers intuit from this is that if you want to keep the people happy, just put everything on the debt. As long as the economy keeps growing faster than the cost of servicing the debt, we’ll be fine.
Until it all breaks down and we can no longer pay for the things we want and need given current revenue intake. Which raises the final point.
How do we get out of this jam? By ending the implicit ban on raising taxes. As Paul Van de Water points out here, and this is obvious based on our aging population alone, simply maintaining current services is going to require more revenue, not less. Add in our infrastructure needs, geopolitical risk, recessionary risks (it’s out there somewhere, folks!), climate, and more, and at some point, the current construct of “you can have X while paying for but a fraction of X” will mean either higher taxes or a lot less X.
On that point, you may be thinking: Why raise more tax revenue? Why not just cut spending? Don’t we have mandatory budget caps in place to do just that?!
Allow me to refer you to the new budget plan, which, for the record, is not all bad — there’s some useful spending in there. But almost every time we hit one of these budget impasses, they break through the caps and put the new spending on the deficit. The evidence is unequivocal: The political dynamics are such that cutting spending will not get us out of our fiscal quandary.
Dress it up any way you like, but here’s the reality: We either put new revenue on the table, or resign ourselves to ever larger deficits and debt.