Katrina Relief & Ricardian Equivalence
Credit should go to conservatives like Andrew Samwick who object to Bush’s free lunch philosophy:
If we can handle it now, why weren’t we handling it before? Why does rebuilding New Orleans compete favorably with this unspecified set of least useful programs, but not funding Social Security personal retirement accounts? Or the new Medicare prescription drug benefit? Or simply lowering the debt burden on future generations? But I digress. If we have decided that rebuilding New Orleans to the tune of $200 billion is a national objective (and I haven’t seen nearly enough debate on that subject in the Capitol), then we ought to fund it by reducing our consumption of everything else. The simplest way to do that would be to impose an income tax surcharge that funds the rebuilding over a given period … Taxes may be bad, but deficits are surely worse. What’s the explanation for why future generations should have to pay for this one, too?
The only attempt to rationalize Bush’s call for even larger deficits seems to come from this proponent of Ricardian Equivalence:
The mistake he is making is forgetting the Friedman idea that the burden of government is not what it taxes but what it spends. Once President Bush (and Congress) decide to spend $200 billion to rebuild New Orleans it becomes our burden, how they finance it is irrelevant. The government has only two options, it can raise taxes by $200billion or issue $200billion in debt (I suppose it could do some combination of the two), and either way the present value of the liability is the same no matter how they finance it. The future generation argument is a red herring; if Andrew Samwick is worried about it he can simply buy a treasury bond representing his children’s share of the debt and gift it to them. When their bill comes do they can sell the bond to pay for it. If Andrew does not have the money to buy the bond then he would not have the money to pay for the tax increase.
Jacob’s Ricardian Equivalence argument is not inconsistent with Andrew Samwick’s argument as both are predicated on the realization that there is a long-run government constraint. Jacob is assuming that all members of my generation have been saving our tax cuts so we can bequest the funds to our grandchildren who will have the responsibility for mailing in very large checks to the Treasury in the future.
We heard the same argument a generation ago when Reagan cut taxes but kept spending high. Yet, consumption rose during the 1980’s. It is a fair point that consumption as a share of GDP did not decline during the more fiscally responsible 1990’s. As our first graph shows, the Bush tax cuts have been consumed not saved.
On the nature of Bush’s spending spree, let’s have Fareed Zakaria step up to the microphone:
President Bush explains that he will spend hundreds of billions of dollars rebuilding the Gulf Coast without raising any new revenues. Republican leader Tom DeLay declines any spending cuts because “there is no fat left to cut in the federal budget.” This would be funny if it weren’t so depressing. What is happening in Washington today is business as usual in the face of a national catastrophe. The scariest part is that we’ve been here before. After 9/11 we have created a new government agency, massively increased domestic spending and fought two wars. And the president did all this without rolling back any of his tax cuts—in fact, he expanded them—and refused to veto a single congressional spending bill. This was possible because Bush inherited a huge budget surplus in 2000. But that’s all gone. The cupboard is now bare. Whatever his other accomplishments, Bush will go down in history as the most fiscally irresponsible chief executive in American history. Since 2001, government spending has gone up from $1.86 trillion to $2.48 trillion, a 33 percent rise in four years! Defense and Homeland Security are not the only culprits. Domestic spending is actually up 36 percent in the same period. These figures come from the libertarian Cato Institute’s excellent report “The Grand Old Spending Party,” which explains that “throughout the past 40 years, most presidents have cut or restrained lower-priority spending to make room for higher-priority spending. What is driving George W. Bush’s budget bloat is a reversal of that trend.” To govern is to choose. And Bush has decided not to choose. He wants guns and butter and tax cuts. People wonder whether we can afford Iraq and Katrina. The answer is, easily. What we can’t afford simultaneously is $1.4 trillion in tax cuts and more than $1 trillion in new entitlement spending over the next 10 years. To take one example, if Congress did not make permanent just one of its tax cuts, the repeal of estate taxes, it would generate $290 billion over the next decade. That itself pays for most of Katrina and Iraq. Robert Hormats of Goldman Sachs has pointed out that previous presidents acted differently. During World War II, Franklin Roosevelt cut nonwar spending by more than 20 percent, in addition to raising taxes to finance the war effort. During the Korean War, President Truman cut non-defense spending 28 percent and raised taxes to pay the bills. In both cases these presidents were often slashing cherished New Deal programs that they had created. The only period—other than the current one—when the United States avoided hard choices was Vietnam: spending increased on all fronts. The results eventually were deficits, high interest rates and low growth—stagflation.
Following-up on Robert Hormat’s point about FDR raising taxes during World War II, our second graph shows the consumption/GDP ratio from 1929 to 1950. While the increase in defense spending did crowd out investment, part of the brunt was borne by a drop in consumption. Bush’s free lunch philosophy seems to be to tell the current generation to go ahead and consume more as the Federal government spends more. As a result, our national savings is very low, which means we are pursuing anti-growth policies under the umbrella of free lunch “supply-side economics”.