Doing the math on deficit reduction. By Matthew Yglesias

www.slowboring.com

Doing the math on deficit reduction

Matthew Yglesias

12 - 15 minutes

As I’ve written before, there’s something perverse about the fact that so much elite energy was expended 10 years ago on the search for a fiscal grand bargain when deficit reduction was macroeconomically inappropriate, but now that the time is right for deficit reduction, that energy has largely vanished.

House Republicans have sort of returned fiscal issues to the forefront with their debt ceiling tactics. But by limiting the discussion to domestic discretionary spending, they have — in important ways — really not. Last winter, I think the White House expected that the GOP would propose an all-cuts approach to fiscal policy that would inevitably feature cuts to Social Security and Medicare, since it’s obviously crazy to try to do a cuts-oriented approach to balancing the budget while exempting the two largest and fastest-growing programs. And then when Republicans did that, Biden would hit them hard with the reality that this is unpopular and counter-offer his own more balanced approach, the way Obama did. This would recapture the political upside of Obama’s fiscal politics, but it would be even better because now it actually makes sense to do balanced deficit reduction.

What happened instead is that when Biden brought this up at the State of the Union, Republicans loudly denied any intention to cut the largest and fastest growing non-defense programs as part of their plan to balance the budget by cutting only non-defense programs.

This is shrewd politics; they’re not going to let Dark Brandon zap them with his laser eyes.

But it doesn’t make sense on the merits, to the point that GOP fiscal policy now just consists of a mix of tax and spending policies that would make the deficit larger. They are trying to obscure that by linking the spending side of their demands to the debt ceiling (dramatic!) while leaving the tax part to the side as an agenda to be enacted in the event of a 2024 victory. But precisely because the deficit does matter in the contemporary full employment economy, it’s important to look at this on the merits — and it’s clear their ideas don’t make sense.

More generally, though, the numbers show that enacting substantial deficit reduction is genuinely quite hard. The American population is aging, and the cost of providing people with health care is rising faster than overall incomes. So keeping things the same in terms of senior citizens’ expectations requires changing a lot in terms of taxation and the American military’s global role. To expand the welfare state, you need even more change. Alternatively, you could try to change expectations in terms of commitments to retirees. But either way, in a political system that’s biased toward the status quo — and with an electorate that is itself biased against policy change — it’s not possible to avoid change.

I think the Committee for a Responsible Federal Budget has been unduly indulgent of congressional Republicans’ approach to the debt ceiling, which you can see if you use their Debt Fixer interactive.

Republicans want to cut non-defense discretionary spending back to fiscal year 2022 levels and then cap growth from there at 1% (nominal) per year. On the dubious theory that Congress would stick to that cap for a decade, that reduces the deficit by $1.6 trillion. They also want to reverse the Biden administration’s student loan actions, which is good for $610 billion in deficit reduction. And then they have their work requirements proposal. I’ve argued before that this will not generate additional work, but it will cause people to lose health care and nutrition benefits due to red tape, which CRFB thinks will reduce spending by about $130 billion. That’s good for about $2.38 trillion in deficit reduction over a 10-year time span, which is a lot.

But CRFB estimates that a full extension of the Tax Cuts and Jobs Act, which Republicans are also pushing for, would reduce revenue by $2.820 trillion.

I asked a sophisticated artificial intelligence model whether this combination of proposals makes the national debt higher or lower, and they reported that debt gets higher when you reduce revenue by more than you cut spending.

So Republicans aren’t even offering an unbalanced or unduly mean-spirited approach to deficit reduction, they’re offering a fiscal mix that would make the deficit higher.

What’s more, the biggest spending cut here by far is the quasi-fake idea of “capping” the growth in discretionary spending so that it keeps up with neither population growth nor inflation. This is just a kind of time-consistency dodge, where the Congress of 2023 asserts that the Congress of 2029 is going to settle for much lower levels of public service provisions, without saying how that’s going to work or why future people will find it acceptable. Brian Riedl from the Manhattan Institute says “past experience shows that discretionary caps have a shelf life of — at most — 3-4 years before they are obliterated. And the deeper the initial cuts, the sooner caps are repealed. Which is why the 10-year figures aren't ‘real.’”

It’s inherently difficult for present Congress to bind the hands of future Congresses. But when Congress makes changes to the tax code or to non-discretionary programs, it is at least changing the default, which has a big influence on the future course of events. Discretionary spending needs to be appropriated by Congress each year, so promises about future discretionary spending levels are largely fake.

The Biden administration’s official budget proposal is the opposite. Instead of proposing to cut spending, he wants to raise it. And instead of proposing to cut taxes, he wants to raise them — by a lot. Biden also favors some significant spending cuts, mostly coming from defense ($200 billion) and from more aggressive efforts to push down prescription drug prices ($205 billion). The upshot is that even with $2.8 trillion of proposed new spending, Biden’s budget proposal would reduce the deficit by about $2.7 trillion, before considering the $300 billion in reduced interest costs.

A $5 trillion tax increase is not a political no-brainer, but you can see here the outline of the policy debate the White House would like to have.

    Without touching Social Security and Medicare, the GOP is unable to identify enough spending cuts to generate even $1 of deficit reduction consistent with their tax pledges.

    Without taxing the middle class, Biden is able to identify $3 trillion worth of deficit reduction that is consistent with his ambitions to expand the welfare state.

    If challenged to generate $3 trillion in deficit reduction, Republicans would obviously need to propose cutting Social Security and Medicare benefits. 

If you could get Republicans to write down a proposal consistent with (3), and then have a head-to-head referendum in which voters chose between the Biden Plan and the GOP plan, I think the Biden plan would very likely win. That’s the debate Biden wants.

And it’s a perennial source of legitimate grievance among Democrats that the press and deficit hawk groups tend, if anything, to treat the GOP as more focused on deficit reduction when in practice they are not proposing deficit reduction at all once you consider the tax side of the ledger. I think the Biden White House has squandered a lot of credibility with fiscal hawk types by following up a stimulus that deliberately erred on the side of being too big with an expansive student loan forgiveness initiative that has no tax offset. Still, the fact is that Biden is proposing significant deficit reduction and Republicans are proposing modest deficit expansion.

As the last true believer in modern monetary theory, my criticism of Biden’s tax proposals is that he’s very focused on generating headline revenue numbers rather than thinking about macroeconomic impacts.

If the reason we care about deficit reduction is that we are worried about interest rate hikes and the investment side of the economy in a full-employment economy, then doing all this capital taxation isn’t ideal. Obviously the point is that Biden wants to avoid any kind of tax on the middle class, and true to my popularist convictions, I won’t criticize him for staying in the political safe zone. By the same token, Republicans are trying to avoid unpopular cuts to Medicare and Social Security. The dream, though, has always been getting a bipartisan deal going on fiscal policy and then, because bipartisan deals are popular, including a bunch of unpopular stuff in it. What kind of stuff?

These are my principles:

    You want to avoid harming poor people.

    You want to target things with negative externalities, if you can.

    Since this is make-believe and we’re ignoring politics, you want to be fearless about hitting the middle class.

Looking through the CRFB’s options, my favorite tax hikes are:

    Eliminate the mortgage interest deduction ($330 billion)

    Limit the charitable deduction ($460 billion)

    Eliminate the state and local tax deduction ($1,490 billion)

    Institute a cap on the health insurance tax exclusion ($700 billion)

    Financial transactions tax ($970 billion)

    Carbon tax ($880 billion)

    Increase cigarette and alcohol taxes ($170 billion)

    Restore the estate tax to 2009 levels ($370 billion)

    Increase the gas tax by 15 cents, then grow it in future years ($310 billion)

That adds up to $5.68 trillion in deficit reduction, all on the tax side. Spending-wise, here are some CRFB ideas that are distributionally progressive:

    Repeal Biden student debt plans ($600 billion)

    Slow Social Security benefit growth for the top 50% of earners while increasing benefits for the lowest earners ($70 billion on net)

    Increase Medicare premiums for high-income beneficiaries ($210 billion)

    Rejigger Medicare cost-sharing ($160 billion)

    Reduce prescription drug costs ($270 billion)

    Reduce Medicare provider payments ($350 billion)

That’s $1.6 trillion in spending cuts without touching defense, discretionary spending, or programs for poor people. That’s not to say those things need to be categorically sacrosanct in the course of a political negotiation. It looks right now like Biden is prepared to make significant concessions on non-defense discretionary spending which, if it happens, conservatives will claim as a huge victory and progressives will howl over in agony. The truth is non-defense discretionary got a big boost in last year’s appropriations in part precisely because the negotiators anticipated the post-midterms Congress demanding cuts. So while the details of this absolutely do matter, there is also an element of theater to it. The real action is on the entitlement side, and I think there’s a menu of proposals here that would curb inflation while holding people of modest means harmless — in effect boosting their incomes.

As I’m writing all this down, it seems so improbable that I don’t even know what to say.

And yet when I tally it all up, it comes to $7.28 trillion worth of deficit reduction — and while that’s a lot, it’s not quite enough to stabilize the debt:GDP ratio. That would require about $8.1 trillion in deficit reduction over the next 10 years. It’s not that this is impossible. I deliberately didn’t do anything with military spending or with domestic discretionary cuts that Republicans like and I didn’t use any of Democrats’ favorite tax-the-rich policies. But I didn’t do that in part because there’s also a bunch of stuff that Democrats (welfare state expansion) and Republicans (more tax cuts) are champing at the bit to do, so I kind of wanted to leave each party’s distinctive partisan agenda available.

On some level, it doesn’t matter. This is my own exercise and I’m free to come up with whatever parameters I want.

I’m inclined to say that if you stuck to these deficit reductions but also made pro-growth policy changes in terms of immigration, housing, and energy, you’d be in fine shape. And certainly the best possible way to reduce the debt:GDP ratio is through economic growth. The basic point, though, is that the current budget deficit is, in fact, very large, and reducing it by a substantial amount requires some very large policy changes. Republicans right now seem to have successfully branded themselves as “guy who’s worried about the large deficit” even though their proposals would actually make the deficit larger. The Biden White House is much, much closer to sound terrain here in the sense that their number has the right sign next to it. But it’s still too small to stabilize the national debt, and my effort to do high-minded wonky stuff also fell short. Nobody likes to admit that there are hard problems in the world, but the combination of population aging and the resurgence of geopolitical competition is very challenging.