Tuesday, August 09, 2005

Federal budget analysis

It appears the Bush administration is making the same mistakes Reagan's did: Giving out tax cuts in a time of heavy military spending equates to a country in serious national debt. How can any conservative say the economy is getting better when our national debt is increasing yearly? Is this not another effort of a administration, any number of administrations, to hand out tax cuts on the basis of votes? Is it not a false sense of prosperous times, and one that will come back to hurt the economy, namely the people, sooner or later?

The annoying thing is this macro economist's article is from 1994! Those who do not learn from history will repeat history.

Note: This is a leftist economics text (see the last paragraph under the first link), so all interpretations are welcome, including conservatives.

Macro Economics
I. The BBA's Achilles' heel

It is generally understood that the BBA (Balanced Budget Amendment) would cause a tangle of definitional, accounting, legislative, judicial and federal/state/local-relations nightmares. But its real Achilles' heel can best be understood by looking at the federal budget's two functional components, as shown in the accompanying chart.

The Policy Deficit is controlled by the Congressional tax and spending policies which are the BBA's ostensible concern. But the HI-Unemployment (HI-UE) Deficit (the difference between the total deficit and the Policy Deficit), reflects the economy's growth rate and unemployment rate, which are controlled mainly by the Federal Reserve -- over which Congress now has no effective control.

When the Fed slows the economy and increase's unemployment to combat inflation, federal outlays for welfare, unemployment benefits and other means-tested entitlements automatically increase. But the biggest effect is the automatic nosedive of receipts from income and employment taxes -- much like the effect on laid-off workers and recession-hit businesses. A one percent change in unemployment automatically changes the HI-UE Deficit by more than most of the spending changes that Congress votes on -- nearly $60 billion a year in 1995, $80 billion in 2000.

Thus, contrary to the allegations of BBA and "smaller government" ideologues, most past deficits and resulting increases in federal debt have been caused more by Fed-induced revenue deficit than by "out of control" non-military deficit spending .

The BBA's requirement of a politically impractical 60% vote for a tax increase implicitly forces Congress to try to respond to every Fed-induced revenue reduction by an even greater reduction of current policy outlays. This would hardly facilitate stable businesslike management of the government.

Causes of past deficits.

Historically, the Policy Deficit has been caused mainly by Congress's political unwillingness to impose higher taxes to pay for higher military spending. The Policy Deficit was over 2% of GDP in the Korean War (1952-53), nearly 2% in the Vietnam War (1967-68), and varied between 2«% and 3«% during 1983-94 (when the military buildup over 1979 levels accounted for half of the total Policy Deficit). But the structurally endemic nature of the Policy Deficit since 1982 was also caused by the calculated "Reagan Revolution" political strategy of trying to "reduce the size of government" by cutting taxes and then pushing for cuts in non-military spending "to balance the budget." The renewed "Republican Revolution" now seems to be adopting this same strategy.

The HI-UE Deficit has been a serious problem mainly when governments have rejected an "activist" approach to managing the economy and abandoned full employment as a primary goal of national policy. The HI-UE Deficit reached temporary peaks of 3% of GDP in 1958 and 1960 (Eisenhower) and over 2% in 1970/71 (Nixon). But it became endemically high (over 1«%) only in 1974 when the OPEC cartel's first extortionist "oil tax" caused an economically- devastating worldwide inflation and ensuing recession -- and governments continued to rely primarily on "tight money" and high unemployment to combat the inflation. Since then HI-UE Deficits have accounted for 2/3 of the total increase in our national debt -- and the interest payments on it.

In fact, interest payments on the HI-UE debt are a key link between the HI-UE and Policy Deficits. If interest on the HI-UE share of the debt were included in the current HI-UE Deficit the Policy Deficit would now have a surplus of over $80 billion.

Why federal fiscal responsibility is fundamentally different from non-federal.

Households, businesses and state/local governments have little current control over their own income. But the federal government, through Fed monetary policy, has major control over not only its own income but also everybody else's. Governor Pete Wilson recently referred to his California as a "proud sovereign state." But states, counties and cities are not sovereign economically. In an integrated national economy, mismanaged policy in Washington can bring California to its knees along with everyone else.

Thus, federal fiscal responsibility also requires federal economic responsibility -- with much more systematic coordination of all our economic policy tools. By ignoring the HI-UE Deficit and putting the Policy Deficit in a straight-jacket the BBA would make businesslike economic management impossible.

II. There is a better way than the BBA to achieve real fiscal responsibility

2) Recognize that the key economic responsibility of fiscal policy is to maintain stable low real interest rates -- by "counter-cyclical" adjustments of the federal budget's deficit or surplus to maintain a stable balance between the economy's total supply and demand for credit.

"Cyclical" fluctuations of borrowing, particularly consumer credit, home mortgage borrowing and business credit to finance the capital investment needed to meet these credit-financed fluctuations in consumer demand, are key factors in continuing the "business cycle."

* Excessive total borrowing, federal and non-federal combined, as in 1994, drives up interest rates and increases the Policy Deficit through interest on the federal debt. In addition, excessive consumer borrowing tends to cause inflationary market conditions in credit-financed sectors such as houses and cars, thus causing the Fed to slow the whole economy and increase the HI-UE Deficit.

* Insufficient total borrowing, as indicated by abnormally low real interest rates as, in 1980 and 1992-93, makes it difficult for the Fed and the banks to maintain a recovery rate of money growth, and thus increases the HI-UE Deficit. In this case a temporary increase in the Policy Deficit would tend to reduce the HI-UE Deficit.

Thus, how fast the present Policy Deficit can be appropriately reduced depends mainly on the national credit balance, as indicated by short-term real interest rates. Because total borrowing is now excessive, with short-tern rates about 2% above their historical norms, faster reduction of the Policy Deficit would be economically appropriate -- by either spending cuts or tax hikes. For instance, now would be an ideal time to eliminate the inappropriate tax deduction for interest on non-housing-related home equity loans. It would also be an ideal time for an energy tax -- to help reduce our dangerous dependence on foreign oil and reduce the huge trade deficit which matches our federal budget deficit.

But any kind of tax cut now would be economically inappropriate. Fed Vice Chairman Alan Blinder says that the Fed is likely restrict economic growth even further if the Republican "smaller government" ideologues repeat the Reagan era fiscal irresponsibility by combining tax cuts with another military buildup.

III. The Philosophical and Political Context

The Preamble of the Constitution says that one of the purposes of the Constitution and the federal government is to "promote the general welfare." Thus the government has two choices:

* an "activist" philosophy to prevent problems and help people by long-run "framework" planning to create the kind of social-economic, full-employment environment in which businesses, workers, consumers and investors everywhere can have maximum confidence to plan further ahead in pursuit of the American Dream without having to call on government for the kind of assistance which tends to concentrate power in Washington;

* a "laissez-faire" philosophy which permits the traditional "business cycle" and free-enterprise profit motive to work without interference -- until things fall apart (like the savings and loan debacle), and then reluctantly and inefficiently yield to public demands for the government to "pick up the pieces."

Conservative opposition to the goal of full employment.

After WW II, Congress passed the "Em ployment Act of 1946." Although it is often referred to today as "the full -employment act" conservatives forced Congress to take the "full" out of the title because they recognized that if an "activist" government accepts effective responsibility for maintaining stable full employment growth it would require many "interventions" in the economy which are opposed by those who know how to profit from "the business cycle" and from the absence of effective legislation protecting the general welfare. The H/H Act kept "full " in its title and set specific economic goals, but conservatives made sure that it had so few real teeth that it has been largely ignored.

The "size of government" issue.

Undoubtedly, some supporters of the BBA either really believe it would help reduce the deficit or don't realize that there are more effective means of doing that. But for some conservative ideologues the most basic purpose of the BBA is to "reduce the size of government" by putting artificial pressure on Congress to reduce non-military federal spending, even when that clearly diminishes the national welfare. When they were pushing the BBA in 1936 they were really trying to prevent FDR, whom they hated ideologically, from mobilizing the full powers of the government to get us out of the Great Depression. In 1982 they pushed it in support of the Reagan Revolution. Now they are using the general public discontent with the results of past government mismanagement of the budget and the economy to gain public support for the BBA. But if the public fully realized the nature and implications of the BBA's basic ideological purpose, it is doubtful if many would support it.

Since 1929 the relative size of the federal government has been greatly increased by four factors: the Great Depression, World War II, the Cold War, and excessive unemployment most of the time. All of these might have been avoided by a more effective "activist" federal government with more vision to understand what was needed to prevent those catastrophes and better leadership to help the public understand what needed to be done.

If "size of government" is measured by the amount of current spending, and if the self-financing Social Security system, other pension programs and Medicare and Medicaid are excluded, then the great bulk of policy budget spending goes for current military spending and the interest cost of previous HI-UE Deficits and deficit-financed military spending. In this perspective, the best way to "reduce the size of government" is to eliminate the HI-UE Deficit by managing the economy for stable full employment, reforming and strengthening the United Nations so that it could take over a good share of America's national defense and foreign military responsibilities, and enacting a universal, effective, cost-conscious and largely self-financing (like Social Security) national health-care system . Everything else is marginal.

World Socialist
On January 6, the Congressional Budget Office (CBO) issued new projections showing that the cumulative deficit between 2004 and 2013 would reach $2.3 trillion. But this is generally acknowledged to be an understatement.

A study by the Center on Budget and Policy Priorities issued on February 1 noted that if likely or virtually certain costs, left out of the CBO projection, were added back in then the deficit projection for the next 10 years rose to $5.2 trillion.

The Center’s analysis made it clear that the budget blowout is not due to increases in domestic spending but is the result of the Bush tax cuts—aimed primarily at the wealthy—and increased spending on the military and “homeland security.” As a result of the tax cuts, revenues in 2004 will total only 15.8 percent of GDP—the lowest level since 1950—and will only average 17.1 percent of GDP over the coming decade, lower than average levels for every decade in the second half of the twentieth century.

In January 2001 estimates from the CBO showed surpluses for the 10-year period to 2011 totalling $5 trillion. Now it is estimated that there will be a deficit over the same period of $4.3 trillion. According to the Center’s report, approximately 35 percent of this $9.3 trillion turnaround is due to the tax cuts made by the Bush administration. Another 28 percent is due to increased spending, more than two thirds of which arises from increased costs for the military, homeland security and the “war on terrorism”. Only one-twenty-fifth of the new spending represented the increased costs of domestic programs outside of homeland security. The remainder of the turnaround was accounted for by over-optimistic estimates by the CBO in 2001.

What others are saying at American Progress
The White House predicted recently that the budget deficit would drop to $333 billion, $94 billion less than expected, and continue falling for the next four years to $162 billion in 2009. In light of recent tax changes, increases in defense spending, and the war in Iraq, this declaration startled many and caused numerous Wall Street analysts to warn of over-excessive optimism. The Bush administration attributed the drop to supply side economics, as an auspicious sign that his tax cuts are paying for themselves. Others pointed out that "triple-digit deficits for as far as the eye can see" were not a cause for celebration. Furthermore, the prediction does not take into account the costs needed for Iraq past the next year and excludes full funding for programs such as job training and Medicare. Even nonpartisan firms such as Goldman Sachs warned of the accuracy of these numbers. Here is a sampling of what America is saying about the budget deficit.

Jackson, Mississippi - The Clarion-Ledger
July 18, 2005 - Editorial

"Putting a positive spin on the latest federal budget deficit figures, President Bush is claiming his economic policies are cutting the growth in the deficit by $100 billion. …

"That sounds good, but wait a second. The annual mid-year report didn't say the budget deficit was cut; it said it was less than expected by $100 billion. So, how high is it?

"As it turns out, this year's budget deficit will 'drop' from what was anticipated as the largest budget deficit ever.

"In fact, with this new "drop," the budget will be the third largest deficit in history, at $333 billion, following the two previous records under Bush last year and the year before."


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