At 03:24 26/12/2012, you wrote:
Subject: FW: Interesting item on government spending & future generations
Published on The Weekly Standard
(<http://www.weeklystandard.com>http://www.weeklystandard.com)
Accurate (and dire) though Christopher deMuth's
figures are concerning the financing of
tomorrow's nation-states (in short, the chances
are nil) there are two massive items of
information which he should be taking on board in
order to give a more well-rounded picture. One is
the remorseless decline in family size to less
than replacement in advanced countries. In 30/40
years' time this will rapidly reduce the
population as the present huge overhang of old
and infirm people increases somewhat and then dies away (literally!)
The other is that the existence, composition and
wide extent of shale gas has been known for the
past ten years or so, even though its
availability and full production cost has only
been confirmed in the last two or three. The
point is that it is so cheap that if a
nation-state government were to allow its
entrepreneurs full opportunity to exploit it
(subject to environmental safeguards) then it
would would turn an impossible task (paying off
its debt) into a practical one.
Keith
The Real Cliff
The staggering debt from decades of continuous
government borrowing is about to come due
Christopher DeMuth
December 24, 2012, Vol. 18, No. 15
It is important to understand that the fiscal
cliff is a charade. There are, to be sure, many
conscientious debt reformers working to avert
our proclaimed year-end epic fallââalong
with many cynics who are using the occasion to
advance pet projects that will make the debt
problem worse. But all concerned are working
within a fiscal system that has become seriously
pathological. The cliff is the latest expression of that pathology.
Just last year, the president and Congress
agreed by statute to (a) increase the federal
governmentâs public debt by more than $2
trillion (up to $16.4 trillion) and (b) begin
reducing annual federal spending by less than
one-tenth that amount starting in 2013. A
variety of temporary tax reductions, aimed at
spurring recovery from the Great Recession, were
also scheduled to expire in 2013. Now that the
new debt has been borrowed and spent, the
prospect of actually reducing our annual $1
trillion deficits by a significant amount is
regarded by all sensible people as a catastrophe
that must be avoided at all costs.
And what is to be done to stop the spending cuts
and tax increases? This monthâs partisan
positioning over raising taxes on the wealthy
masks a consensus, embraced by the leadership of
both parties, on two essential principles of
cliff-avoidance. First, the vast majority of
Americans who are middle class must be spared
any clear-and-present impositions: Their direct
income taxes must not be increased, and their
Social Security and Medicare benefits must not
be reduced any time soonââmeaning that any
reductions will be as contingent, and possibly
ephemeral, as last yearâs debt-reduction
accord. Second, the federal debt must be
immediately increased by yet another $2-3
trillion, with further increases of equal magnitude certain to follow.
These principles embody Americaâs de facto
fiscal policy since the early 1960s: continuous
government borrowing to pay for current
consumption. That policy was, in the first
instance, an unintended consequence of
Keynesianism, which proposed that government
shore up aggregate demand by spending more than
it taxed during economic downturns.
Previously, government borrowing had been mainly
for investments to secure or improve the
futureââexpenditures appropriately shared
with future generations. These included not only
physical infrastructure such as roads and water
systems but also wars (almost always
debt-financed) and national expansion (Jefferson
purchased the Louisiana territory mainly with
Treasury bonds, which Napoleon promptly sold at a discount).
Keynes introduced the idea that government could
legitimately borrow not only for production but
also for consumption. Just as a creditworthy
individual may take out a mortgage to purchase a
home with future earnings, so government could
borrow a share of tomorrowâs wealth to meet
urgent current needs. There had always been
cases, such as natural disasters, in which
governments had spent liberally, and if
necessary by borrowing, to sustain incomes in
the face of widespread emergency losses. Writing
in the 1930s, Keynes in effect generalized the
proposition to encompass economic emergencies of
the magnitude of the Great Depression. His
postwar apostles made refinementsââsuch as
âcountercyclical stabilizationâ and âthe
full-employment balanced budgetâââto
moderate more routine fluctuations in the business cycle.
These were important intellectual advances.
Although subject to many objections and
qualifications, they were admirable efforts to
respond to hardship and harness the modern
economy more tightly to individual well-being.
But, like many such advances, they emerged from
a particular milieu and then reshaped that
milieu in surprising ways. The Keynesian
nostrums were conceived in an era when the
balanced budget was the universally accepted
norm: They assumed that debts incurred during
depressions and downturns would be balanced by
surpluses during booms and upturns. And the
prospect of balance over the course of business
cycles seemed unproblematic during the
Depression, when the economy had been roaring in
the recent past, and during the three postwar
decades (through 1974) of bracing growth marred by only moderate recessions.
What was not foreseen was the effect of the
Keynesian proposition in the context of
practical politics. For it taught that
government officials, in weighing current
revenues and expenditures, should weigh the
needs of the known present against the resources
of an imagined future. But the present is always
cluttered with problems and difficulties, while
the future is an abstraction. The future is
also, in the progressive American mind, a more
prosperous and untroubled placeââespecially
if we can just get ourselves through todayâs
pressing exigencies. This manner of thinking
tended to dissolve the distinction between
investing for the future and borrowing from the future.
Even more insidiously, Keynesian borrowing
raised the prospect of providing the electorate
as a whole with higher current benefits than
taxes to fund those benefits. Whatever the
future may hold, it will certainly be populated
by many people who are not voters
todayââthe younger generation and the yet
unborn. Todayâs debts will be repaid by some
or all of them, in one way or
anotherââthrough higher taxes or lower
benefits to accommodate payments on the loans,
or through loan defaults, or through the partial
default of inflation. When clever economists
assure politicians that more government debt is
unworrisome because âwe owe it to
ourselves,â they are using the soothing
collective âweâ to gloss over all the
contentious tasks of allocating burdens and
benefits among competing interests and
constituencies that are the stuff of practical
politics. (âWhat do you mean âwe,â
Kemosabe?â) At any point in time, politicians
will be happy to relax the resource constraints
on their own choices and leave greater
constraints for their successors to deal with.
These political dynamics quickly left formal
Keynesianism in the dust. In the 52 years since
1960, the federal budget has been in balance or
surplus only five times (although the deficits
before 1975 were mostly small); the cumulative
deficits have far exceeded the surpluses, and
there has been no correlation of fiscal balances
to economic cycles. Each new year has brought
its own unique and compelling reasons for
borrowing just a little bit more for a little
while longerââwith the effect of shifting
consumption further ahead of production from
every new baseline. Even the economic expansions
of the mid-1960s and mid-1980s were treated not
as opportunities for budget surpluses but
instead as evidence that deficit stimulus was
working. The exceptional surplus years of
1998-2001 may be chalked up to the steely
discipline of President Clinton or Republican
Congresses (or to the virtues of divided
government and the dot-com bubble), but it
should be noted that they began as a
surpriseââClintonâs 1998 budget proposed
a deficit and projected deficits through 2002.
Now there is more to the story, and a twist in
the plot. Following the stagflation of the
1970s, liberal Keynesianism was joined by
conservative, anti-Keynesian âsupply-side
economicsâ as a new force for debt expansion.
Supply-side theory rejected aggregate demand
management and emphasized microeconomic
incentives, especially the tendency of high
marginal tax rates to suppress economic growth
and, to a degree, government revenues. Once
again, an important intellectual advance
acquired a life of its own. In the journals and
newspaper op-eds, tax cutting was advocated to
promote economic production, but in the hands of
politicians it acquired additional
purposesââincluding, eventually, promoting debt-financed consumption.
Ronald Reagan and Jack Kemp were authentic
supply-siders, but they and other Republicans
understood that tax cutting could serve an
electoral purpose as well: In response to the
big-spending Democrats, the GOP could turn the
tables and offer lower taxes rather than
purse-lipped fiscal restraint. Then, a few years
into Reaganâs first term, another purpose
appeared. The administration had been much more
successful in cutting taxes than cutting
spending; while the economy was recovering
smartly, deficits and debt were growing steeply.
What were limited-government conservatives to do?
I was working at the White House and OMB in
those years, and was party to many a late-night
argument over two divergent strategies.
âStarve the Beastâ held that the public
would tolerate only so much deficit
spendingââso cutting taxes would at some
point restrain spending as well. âServe the
Checkâ held that the only way to limit
spending was to charge its full price at retail:
Set taxes at an average of 20 percent of
individual incomes and we would discover whether
the public really wanted federal spending of 20 percent of national income.
Reagan went with âStarve the Beast.â As a
loyalist, I will note that, after inflation was
tamed and the economy rebounded, he was still
engaged in a huge defense buildup that he
regarded as an investmentââto abolish the
Soviet Union. That turned out rather well, but
it also turned out that the publicâs tolerance
for high debt and deficits was much larger than
anyone had supposed. Today, one would have to
say that tolerance is unlimited so long as the
public is faced with abstract numbers in
newspaper headlines rather than tangible consequences.
Nevertheless, tax cutting and âno new taxesâ
became increasingly embedded in Republican
electoral strategy. As they did, they took leave
of supply-side economics just as completely as
demand stimulus had taken leave of its Keynesian
origins. Indeed, tax reductions for the masses
(but not for the wealthy and corporations)
became a matter of bipartisan consensus and
competition. Through the tax legislation of the
1980s, 1990s, and 2000s, progressively greater
numbers of Americans had their income taxes
reduced or were removed from the rolls
altogether, and many credits and deductions were
added for a variety of favored activities, from
children to childcare to energy-efficient appliances.
The transformation of fiscal policy was
accompanied byââand, no doubt, was in some
significant degree caused byââa larger
transformation of American politics and
government. Beginning in the 1970s, the old
establishment hierarchies of the political
parties and Congress were displaced by more
decentralized, populist, freewheeling forms of
decision-making. Critically, the congressional
finance, ways and means, and appropriations
committeesââpreviously imperious
gatekeepers for federal taxing and
spendingââwere among the unhorsed. Into the
vacuum came legions of well-organized interest
groups with newfound abilities to secure
targeted transfer payments and tax preferences.
Above all, American society was becoming more
affluent, more educated, and olderââand
more concerned with issues of health, amenity,
and income insurance. Nicholas Eberstadt of the
American Enterprise Institute and others have
documented the remarkable shift in the
composition of federal spending from the 1970s
to todayââfrom traditional public goods
such as national defense and physical
infrastructure to social insurance (especially
Social Security, Medicare, and unemployment
insurance), welfare programs, and many other kinds of transfer payments.
These profound changes might have been
manageable if they had been accompanied by
old-fashioned budget balancing that obliged
government officials to make hard choices among
competing interests. Instead, the concurrent
discovery of the political magic of continuous
public borrowing produced something not only new
but financially addicting: government as an
engine for debt-financed consumption. In
retrospect, a key turning point came in the
expansion of Medicare to cover prescription
drugs. A drug benefit was added during
Reaganâs last year in officeââbut it was,
at his insistence, âbudget neutral,â funded
entirely by program taxes and premiums, and it
proved wildly unpopular. Following a senior riot
in the streets of Chicago, aimed at Ways and
Means Committee chairman Dan Rostenkowski, the
program was repealed a year later. George W.
Bush and the Republicans learned the lesson
well. Their 2003 Medicare drug benefit, costing
more than $60 billion annually, was funded
mainly (more than 75 percent) by new government
borrowing. That proved very popular.
The era of prolonged and growing government debt
since the mid-1970s has corresponded with slower
and more volatile economic growth as measured by
per capita GDP, median and average incomes, and
total-factor productivity. This will present an
interesting chicken-and-egg question for
economic historians: Did the
debt-for-consumption project eventually slow
rather than stimulate economic growth, or did
slowing growth have other causes, and inspire
government to increase borrowing in an effort to
sustain accustomed levels of income growth? But
for nowfollowing the Bush and Obama economic
stimulus and financial bailout programs of
2007-2010, the stupendous annual deficits of
President Obamaâs first term, and the
continuing neglect of the huge financial
imbalances of our Social Security and Medicare
programs, and with the prospect of
trillion-dollar deficits for the foreseeable
futureââwe can say with assurance that our
national debt has become an impediment to growth
and is going to crush the economic expectations of many Americans.
The federal governmentâs public debt is now
about 75 percent of annual GDP and growing
rapidly, and already more than 100 percent if
one includes the Treasury Departmentâs
intra-government debts to Social Security and
other programs. These amounts put us in the
range where, historically, government debt has
seriously depressed economic growth and risked
sovereign defaults and wrenching fiscal
contractions, even when interest rates were low.
But our true indebtedness is much higher than
that, much higher than our peak debt during
World War II, and not far behind that of the
crisis-wracked EU. Accounting for the chasm
between projected Social Security and Medicare
payments and revenues (which the governmentâs
official debt figures unfortunately ignore) puts
the federal debt at more than five times GDP.
Generational accounting suggests that future
generations will be paying nearly all of their
lifetime incomes in taxes, which obviously cannot happen.
Calculations such as these point to the real
harm of financing current consumption with
ever-increasing public debt. Substantial
segments of the population become accustomed to
levels of government benefits that cannot be
sustained. With time, an inheritance of
continuous stimulus can be withdrawn slowly,
permitting private adjustments and, with luck,
resumed economic growth. But the longer the
stimulus continues, the greater the likelihood
that personal expectations will be shattered by
an emergency that an insolvent government is no
longer in a position to respond to. That will
certainly mean widespread losses and hardship,
and perhaps political instability as well, and,
worst-case scenario, temptations for Kirchner-style confiscations.
It is remarkable that, in our current straits,
and with the demographic clock running out on
the graduated reforms to our entitlement
programs that nonpartisan think tanks have been
propounding for decades, the government has
shifted its stimulus machinery into overdrive.
With the economy still shaky, we are warned, now
is not the time to begin consolidating our
debts! With interest rates so low, we would be
fools not to borrow trillions more while the
getting is good! With the states $7 trillion in
debt and maxed out on private borrowing,
Washington needs to be doing more not less! This
is what a pathological fiscal system sounds like
when debt stimulus no longer stimulates and its options are running out.
The fiscal cliff will be avoided, or not. We
face two other challenges that are much more
serious and nearly as immediate. The first is to
begin contingency planning for the coming debt
crisisââwhich may arrive as early as next
year, when California is the first of our
bankrupt states to apply for a massive uploading
of debt to the federal government. The second is
to establish institutions of public finance with
a fair chance of disciplining rather than
placating the populist pressures of contemporary
politics, and of right-sizing our middle-class
welfare state to acceptable levels of middle-class taxation.
These institutional tasks can hope to succeed
only after we have developed a new public
rhetoric of fairness. It should be a matter of
acute national embarrassment that our leaders
can pretend to be redistributing from wealthy to
average citizens when, in fact, they are
redistributing in far greater measure from the
young and unborn. Our rhetoric must teach that,
although government borrowing is appropriate for
certain purposes, the routine redistribution of
wealth from future generations to ourselves is
undemocratic, corrupting, and ultimately
impoverishing. We donât need to wait for a
deadline or a crisis to take this intellectual leap.
Christopher DeMuth is a distinguished fellow at the Hudson Institute.
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