Fiscal Policy Options for Bush’s Second Term

I had hoped to write this post for Roger Altman and Gene Sperling as they advised President-elect John Kerry on how to reverse George W. Bush’s fiscal mess. Two recent discussions pose the problems facing President Bush in his second term.

Daniel Gross of Slate writes:

The fiscal record of the past four years has been one of unmitigated—and seemingly intentional—irresponsibility. A Republican Congress working with a Republican president created the massive new Medicare prescription-drug entitlement, passed a new, subsidy-crammed farm bill, committed hundreds of billions of dollars to war efforts, and loaded up on pork-barrel spending. Meanwhile, taxes were reduced—on wage earners, investors, and companies. The end result: We collected about the same amount of taxes in fiscal 2004 as we did in fiscal 1999. But we spent 34 percent more. The total national debt has risen 30 percent in the past four years…Freed of the need to run for re-election, will Bush act more fiscally responsible in a second term? Wishful thinking. This crowd literally doesn’t have a clue when it comes to fiscal matters. Bush actually believes he has restrained Congressional spending, Cheney believes deficits don’t matter, and most members of the Bush economic team can’t—or won’t—speak truth publicly.

Jonathan Weisman writes:

President Bush signaled yesterday that he would add personal investment accounts to the Social Security system, simplify the tax code without raising taxes and cut the budget deficit in half, all before he leaves office in 2009. Ambitious as those promises are, they may be mathematically impossible, budget and policy analysts say…But in an independent analysis of that budget, the nonpartisan Congressional Budget Office concluded it would not fulfill that promise. The deficit in fiscal 2004, which ended Sept. 30, was $413 billion. Under Bush’s plan for spending and taxes, the deficit would be $258 billion in 2009. If anything, that may understate the size of the deficit in coming years because it does not include any additional costs for the wars in Iraq and Afghanistan. The Pentagon is expected to seek an additional $70 billion early next year. Moreover, the president’s budget does not include the cost of a Social Security reform plan that includes the personal investment accounts Bush is demanding…To cope with the cost of his agenda, Bush said he would impose “spending discipline” on Congress and spur economic growth to boost tax revenue. But he has also made it clear he would not cut defense or homeland security spending, and he has promised more spending for education. The remaining spending at Congress’s discretion — transportation, law enforcement, veterans, agriculture, housing, health research, space exploration and national parks — totaled $346.5 billion in 2004, not much less than the budget deficit. Eliminating all nondefense, non-homeland security spending may not be enough to balance the budget and cover the cost of the president’s Social Security plan.

Indeed, Bush’s record of fiscal recklessness gives little hope that he has the political courage to address the fiscal mess his first term created. But as a member of the loyal opposition, here are a few thoughts just in case someone in the Administration cares to listen.

First, one needs to recognize the magnitude of the problem. With the General Fund deficit exceeding $600 billion a year, a return to surpluses will not occur simply from faster growth. Sure it is true that all the White House cheerleading about how strong the economy supposedly is belies the fact that we are still far from full employment. But most of the dismal forecasts of rising deficits assume we return to full employment eventually. And the free lunch supply-side notion that tax cuts without spending cuts will lead to some growth miracle is simply wrong as this form of long-term fiscal stimulus lowers savings and investment.

Conservatives often say we should trim government spending and are often not that impressed that “discretionary” spending is only $350 billion when they can point to total Federal spending running near $2.4 trillion. Of course, Federal government purchases are only $800 billion with about $550 billion of that being defense purchases. I guess we can hope for another peace dividend, but it seems that Bush’s approach to the war on terrorism precludes that anytime soon. And sure there may be some DoD pork, but isn’t one of the Bush-Cheney goals to further increase this pork?

That leaves nondefense purchases (around $250 billion) and transfer payments. And yes, the Tom DeLay crowd has added to nondefense pork as they have likely shortchanged other domestic priorities. In Weisman’s list of “transportation, law enforcement, veterans, agriculture, housing, health research, space exploration and national parks”, how much can we realistically expect Federal spending to be reduced when priorities are being unfunded and the DeLay crowd still wants to curry favor with certain special interest groups.

As far as the $1.6 trillion in transfer payments, around $600 billion goes to interest on the debt and Federal revenue sharing with the lion’s share of the rest going to expenditures from the Trust Funds such as Social Security. If we reduced Federal revenue sharing, then the burden of financing state and local responsibilities such as education and law enforcement would require state and local tax increases.

So it is no surprise that Alan Greenspan has suggested reducing Social Security benefits. But his suggestion is a far cry from at least what I understand Bush’s privatization plan envisions. Let’s imagine that Bush’s plan involves reducing benefits and payroll contributions by the same amounts in present value terms. Such a plan would not affect the General Fund deficit and could temporarily increase the unified deficit. OK, I blasted Kathleen Hays’s comments Saturday agreeing with Robert Barro’s long-term focus on Federal finances but the same long-term focus would suggest Bush’s private privatization plan does not lower the long-term deficit problem. Greenspan’s suggestion rather is to cut benefits without reducing payroll taxes, which is effectively a tax increase on labor.

Bush is proposing some “revenue-neutral” tax simplication, which by definition would not lower the deficit. It would tax some more as it taxes others less, but Bush is being quite vague on who would pay more. Of course, Bush’s tax record of tax law changes has been ones that made the tax code even more complicated and easier for the tax attorneys to design means to evade. And under Bush’s lack of leadership – the IRS has less resources to enforce the more complicated tax code.

At the end of the day, however, spending cuts will not generate significant reductions in the deficit so someone will have to pay more in taxes eventually. But can we count on the Republican Party having the backbone to actually propose tax increases or will they do what they did over the 1981 to 1992 period – defer the problem until a Democrat is finally President?