Streetwise Professor

January 28, 2010

It’s the Spending, Stupid

Filed under: Economics,Politics — The Professor @ 9:25 pm

Most public policy debates, e.g., healthcare, focus on the deficit.  As I said in a post some time ago, that’s a red herring.  What really matters is the amount of spending.  The deficit just relates to the Fram Oil Filter challenge: you can pay me now, or pay me later.  The first order issue is how much you spend and whether you spend it wisely, not how you finance it.  Deficits are correlated with bad outcomes to the extent that deficits are correlated with wasteful spending.  Spending badly and paying for it with a tax today so that it is deficit neutral is no better than spending badly and paying for it with taxes later.

Ed Lazear, whom I TA’d for some time around the Trojan War, makes the point quite nicely in a WSJ oped today:

The recent growth in spending has been camouflaged by a focus on deficits. Budgets and proposed legislation, like that on health care, are being judged not by their impact on spending and taxation, but by their projected effect on the deficit. Equal increases in spending and taxes reduce economic growth, even if they do not alter the deficit.

So the rhetoric surrounding the health-care bills misses this point. Were they to pass, it would mean more spending, more taxes and less growth. Both the White House and Congress have discussed fiscal responsibility in terms of the bills’ effect on the deficit, not the amount of spending.

The health legislation that looked likely until Massachusetts voted last week included about $1 trillion in new spending, $500 billion in promised Medicare cuts, and slightly more than $500 billion in increased taxes. If the Medicare cuts were to materialize, then the bill would reduce the deficit because tax increases exceed net new spending.

But even if the Medicare cuts were realized, the policy would contribute to the growing size of federal spending and the budget, which, when financed, is the major impediment to economic growth. Arguments over whether the legislation would increase or decrease the deficit or whether it would bend the “cost curve” down or raise it are secondary as far as economic growth is concerned. The largest impact comes from levying over $500 billion of new taxes to pay for the increased spending.

Despite all the talk about deficits, the irony is that we are in little danger of eliminating or reducing the federal deficit. Mr. Obama’s target is to lower the deficit to 4% of GDP by 2013. That is twice the level of the Bush deficit in the average year and larger than any Bush-year deficit. During President George W. Bush’s term, the ratio of federal spending to GDP averaged 20%. Mr. Obama’s budget aspires to reduce the spending ratio to 23% by 2013 from 24% today.

. . . .

Let us pay close attention to the president’s message. But let us not be confused by promises of jobs, coupled with fiscally responsible sounding language that masks the underlying irresponsibility of budget decisions. Proposals that increase taxes and spending, even if they do not increase the deficit, will place a substantial burden on our recovering economy and on future economic growth.

Just so.

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