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It’s the Spending, Stupid
Republican policymakers and strategists, most notably the “Reformicons,” have recently released numerous proposals for restructuring taxes. Many of the specifics may be sound and sensible. But the proposals are all a terrible mistake. My message to reformers is this: it’s the spending, stupid.
We live in an age of deficits. Any tax proposal will need to be revenue-neutral (and under static assumptions, because trust in economists is low). That means it will also be zero-sum: You can’t give one person a break without raising taxes for someone else. Good luck with that.
But deficits have two sides to them. The solution to our fiscal problems is the approach that politicians find most difficult: to cut spending. Our finances are a mess not only because our tax code is a mess, but because our spending is out of control.
Once spending is under control, and the budget is generating surpluses, it will be possible to restructure the tax code while reducing the overall tax level. A policy that generates losers will be much more palatable if, on average, taxes are going down.
Until then, the idea of restructuring taxes is pure fantasy.
Published in General
Exactly!
However, I’m afraid that the chances of controlling spending are not much better than the enactment of term limits for Congress.
I donno about you, but that looks like some controlled spending to me, ever since the GOP took the House in 2010. Their main goal needs to be to sustain this because every year of zero government growth is essentially a spending cut thanks to economic growth and inflation.
What’s going to be incredibly important is the test of 2017, assuming we win the presidency. Are we going back to Bush? Are we going to have to “catch up” with all those years of less spending on the military since it’s a “legitimate” area of government? I really hope not, but I won’t be surprised if that happens.
*The above chart includes state and local spending, but the story is no different on the federal level.
When projected spending, including Obamacare and entitlement spending, is taken into account, the picture is not so rosy:
I’m not sure where this site gets its projections from, but the trajectory is similar to CBO projections.
Mike H,
My problem is that I simply can no longer believe anything in the way of “information” that comes from our present federal government!
The way I see it, things that have been “pushed off into the future” don’t necessarily need to materialize, ever. Just don’t spend that money. They’ve been doing a good job with the actual spending every year so far, which is why I didn’t include the projection. It isn’t set in stone. It’s an accounting gimmick.
Spengler, I’m pretty much in line with your thinking.
A quibble: in theory, Congress can do a revenue-neutral, yet pro-growth reform of the tax code. That is, reduce the punishment of productive activity (work, investment), and increase the punishment of unproductive activity (consumption).
However, the political effort it takes to do this, (“Hey everyone, let’s reduce corporate income taxes, and increase the gas tax!”), is such that in practical terms, it would be better to focus on spending.
On the other hand, I am open to mixing tax reform with spending cuts. Say, cut the corporate income tax (which desperately needs to be done), and balance it with a spending cut.
SoS, do you have a link to specific proposals?
Sequestration has (somewhat) reined in discretionary spending, primarily military spending. But Social Security, Medicare, Obamacare, and other entitlement payouts are on autopilot. Unless and until Congress acts, that spending will materialize. That’s another reason why focus on tax proposals is a mistake — if Congress’s energy is focused there, it will not be focused on the long-term threats from automatic spending.
The two big ones are by Dave Camp and Mike Lee-Marco Rubio. (Robert Stein is also an important inspiration.) There have been numerous variants of the two approaches. The “tax wars” are generating lots of discussion at places like AEI and Forbes. It may be my misperception, but it seems that spending and entitlement reform is generating less discussion these days.
Separately, Charles Krauthammer recently proposed lowering the payroll tax and raising the gas tax as a revenue-neutral reform.
I am not on board for more tax cuts that are about burden shifting; especially more cuts that are more about getting in on the free sh** racket.
Yes, and moving forward, isn’t it true that the proportion of discretionary spending becomes less and less?
It sounds like entitlement reforms should come first, doesn’t it, SoS? Then spending and taxes? I’m obviously kicking this around as a total amateur.
Good point. The idea of “entitlements” also has two sides — spending and revenues. Democrats talk about fixing entitlements through tax hikes, and some GOPers don’t object. But here too, I think entitlement spending needs to be addressed before there can be any discussion of what is euphemistically referred to as “revenue enhancement”.
My personal preference would be to start with entitlement spending rather than discretionary spending. But either way, spending cuts need to come before we talk about tax reform.
Stability in the tax code would be beneficial for all, even if the rate schedules are stupid and the loopholes only benefit the crooked cronies. When I don’t know, from one year to the next, what my actual tax burden will be at my business then it becomes dang hard to plan ahead. Multiply that across industries and you have a huge amount of instability.
You all remember Cash For Clunkers? How car sales sank before the program, skyrocketed during, then crashed afterwards? Apply that lesson to capital equipment markets.
If I contemplate buying a piece of expensive machinery, will I have to depreciate it over 15 years, 2 years, or some other schedule? A bit of such stimulus was set to expire at the end of 2012, so we had a mad scramble from our customers to buy new utility vehicles to get the more aggressive 2 year schedule, which then depressed sales all through 2013. Of course Congress passed a “temporary” extension the next year, then again in 2014, but this constant tinkering threw my entire industry into chaos – you can’t make long-term amortization projections when the tax code is uncertain beyond the next 6 months.
Right now the incentive in Congress seems to be more temporary incentives, patches, fixes, and other such nonsense. Leave it alone, get the budget under control, then work on real long-term reform.
Agreed.
Whenever Republicans propose tax cuts, they must battle Democrats’ propaganda about Republicans serving wealthy donors and big corporations while hurting the poor (which is true, but more true of Democrats than of Republicans). Strategically, Republicans would be better off leaving the tax code untouched for a while (unless they are seriously about a fundamental and irrevocable overhaul) and focusing on spending issues.
I say “spending issues” rather than “spending cuts” because the core problem is as much how spending is prioritized as how much is spent. If we can’t get voters to recognize the former, we won’t get them to acknowledge the latter.
Changes to entitlement spending are difficult to enact partly because there are reasonable disagreements over specific policies and partly because so many voters refuse to give up their “unsustainable” freebies (which have proven sustainable so far, thanks to Uncle Sam’s magic piggy bank).
Changes to discretionary spending, on the other hand, should be easy. Republicans wouldn’t have to be very competent to convince voters that all the laughable investments we have heard every week of our lives (grants for absurd studies, for example) could be cut without crippling police and fire departments everywhere. If we could get people accustomed to the idea of reducing spending and shifting funds from frivolous programs to essential programs, then we might make more headway toward truly significant cuts.
Sadly, even that seems too high a bar while Republicans can’t even kick Sesame Street out into the realm of private industry.
The central challenge in convincing voters on budgetary reforms is that our government’s budget is an abstraction. If a person is out of money, the consequences are obvious. If a government is out of money, and it happens to be the most influential government in the world, then life goes on as before.
One can only hear the word “unsustainable” for so many years before one begins to doubt its meaning.
Or, you know, we could just continue to cut taxes while spending like drunken sailors and hope for the best. That’s the American way.
I’m not sure how the things suggested here are any more realistic than the things suggested by the GOP and others.
You’re saying “focus on spending for entitlements”. Ok. Is reducing entitlements going to be an easier and more politically acceptable thing to do, then reduce discretionary spending? Or do tax cuts?
Keep in mind that the one time this Congress tried to tackle one entitlement program: that being a US military one…it was the Right that exploded in anger. Apparently, even a tiny cut to a greatly bloated US military budget (a large part of which is not about military spending, but about entitlements and other benefits within the military) was unacceptable.
And of course, the argument used was: we’re special! Ok, you’re special. But everyone thinks they’re a special case. The elderly are “special”. The poor are “special”. The children are “special”. Everyone on the dole is “special”.
So cutting entitlements is about the last thing that is going to happen.
A big part of the tax reformers’ case is that getting the tax system “right” (though the definition of that is subject to debate) would unleash economic growth. Higher growth would lead to higher revenues (not to mention better standard of living). The higher revenues would ease or eliminate the deficit.
In other words, they argue that if we fix the tax system, we don’t need to worry about our spending problem. But past experience makes it hard to imagine that higher revenues would not lead to ideas about new ways to spend those revenues….
As far as spending: spending doesn’t have to be financed by taxes. There’s also debt. Given that the interest rates for US government debt, it would be pretty…irresponsible…to not use debt financing at a much heavier level. The interest rates are realistically negative.
I know “debt” is a “bad word” for many “conservatives”. But it’s basic finance. When the cost of debt is low, you do debt.
So I’m not sure I see very many “serious” discussions here across the board, certainly not be economists. I just see policy wonks and politicians (with no clue on what they’re talking about) with political agendas, doing what they always do.
Basic financial management is that you use debt to finance investment, not operations. Our debt is unaffordable because it is being used to finance operating deficits generated by transfer payments, as opposed to activities that lead to future growth. A case could be made for more debt if the operations were healthy.
Ok.
So let me be the devil’s advocate here for a second and see where it takes us.
1) Why do we care about “deficits”? A “deficit” doesn’t reflect an inability to cover spending. A deficit reflects what;s left over after taxes. Well, there’s debt for that. And if debt is gained at interest rates which are essentially zero, or realistically negative, than what’s the problem?
2) Your’s is a good argument for why we should not finance the government through taxes, but through debt ;) Debt has a build-in mechanism for increasing or decreasing it’s use: interest rate.
The more you spend, the more the debt markets are going to increase your interest rate, if they expect that you’re spending more than you should. Hence, disincentivizing more spending.
Tax revenue can be used to pay off interest on debt, but that’s it. That way, the government cannot have a “guaranteed source of revenue”, but must go to the “markets” to get its money.
It’s a self-regulating mechanism.
That’s an overstatement of the reality. The proposal conservatives objected to was not merely that the military budget be cut but that it be cut by an amount equal to all non-military cuts combined. In other words, the military was singled out when Republicans were supposed to be negotiating a “bipartisan” action with Democrats. The military budget could indeed withstand cuts, but that specific deal seemed to many Republican voters like an unnecessarily lopsided trade.
The key to overcoming the “special cases” of voters is to cut the funding of all programs and agencies simultaneously.
No, it certainly isn’t. Debt is used to finance operations to a very large extent, in most firms.
No what I was talking about there wasn’t simply the military spending cut.
What “the right” opposed in that instance was cuts to some military benefits: cost of living adjustment and some health care benefits, if I recall correctly.
Overall those were all pretty tiny cuts, but the “right” made specifically the argument that they were “special” and those “benefit” programs could not be touched.
They were asking specifically for special treatment. And this, despite the fact that other Federal employees had gone through cuts to benefits the year prior as well. But the “right” said: not for our guys!
Well, excuse me, but you can’t be championing “entitlement reforms” when you say “not for us” and when you say “no cuts to the military” which has one of the biggest entitlement programs.
Entitlements would be my preference, but it’s not the only way. Discretionary spending spiked in 2009 with the stimulus, and then the ballooned spending level became the new baseline. Sequestration has been a real step forward, but there is still plenty of room. The stimulus was about $1Tn, and the deficit is about $1Tn. A return to 2008-level spending would not be draconian and would bring us far toward balance.
It’s true that spending cuts are politically more difficult than promising a free lunch from tax reform. Nonetheless, zero-sum spending cuts will lead to a opportunities for positive-sum reforms, whereas zero-sum tax reform is a dead end.
And I don’t disagree one bit.
But this is 100% a political will problem, not a deficit, tax, spending problem. If they wanted to get spending to 2008 or 2007 levels, it’s not going to be hard to do. It will be politically hard to do.
Which is why I said that this is simply a “battle” being fought by policy wonks and politicians with agendas in mind. It’s got little to do with any “economic” argument any of us can think of.
Well, yes. I was not questioning the economic wisdom of tax reform. I was questioning the political wisdom of pursuing tax reform now, prior to establishing spending discipline.
In most large firms, yes. Those are firms with ongoing innovation, investment in which is determined by their forecast ability to exceed a hurdle rate. Their debt is managed globally, often to a target debt-equity ratio. (In small firms, the approach is necessarily different, typically more like my assertion.) Even though public/government entities can large, it’s not clear that this approach can apply to them. What is their equity capital? How do you measure total capital? If the government were to measure its financials like a business, I think it would consider itself imprudently leveraged.
Of course the comparison isn’t straight forward. But that’s irrelevant. The relevant part is that when debt is cheap, it’s not a smart idea to forego it. That applies to firms, governments or individuals.
Especially when the interest rates are essentially zero, and realistically negative. People are paying you take their money.
So the bigger question here is: why are we worried about the “deficit”? It doesn’t mean very much, in isolation.
You’re right that spending is the real key here, but the level of spending impacts the interest rates for debt. So debt has a build in corrective mechanism: it’s risk adjusted.
Taxes aren’t. Taxes are purely political in nature.
Milton Friedman used to say that it doesn’t matter whether you finance the government through taxes or through debt. And I agree with that. But he said he preferred taxes to debt because they place a political limit on spending. Sure, but not so if only the top 20% of people are paying any taxes. If taxes are flat, or they impact everyone proportionally, sure he’s right. But that’s not what we have in the US.
So at this point, I’d much rather have deficits than taxes. The deficit currently is financed by debt which costs us “nothing”. Taxes on the other hand have opportunity cost associated with them.
PS: The cost of debt for firms is mainly dependent on cash flow. Of course, a lot of other things too. Innovation or investments make the firm “riskier”, increasing the cost of capital. What that means for the level of debt…depends.
PPS: So I would agree that “tax reform” is the way to control spending, but only if the tax reform is aimed at flattening and broadening the tax rate. That way, you get a build-in mechanism to control spending. Other stuff, only leaves it up to the political process to decide. Which means all you’ll get is more “taxes for the rich” and “tax cuts for the middle class”. More of the same.