On the “Political Economy” of Fiscal Policy
November 15th, 2009 . by economistmomI’m just back from Denver, where in the opening session on “Dealing with the Fiscal Outlook” of the National Tax Association annual conference, I had been tasked with discussing the “political economy” of the problem. I started by saying I didn’t know where to begin; there’s such a gulf between what’s perceived as politically “smart” and what’s economically wise. I know many of this blog’s readers think I was way too generous in my post about OMB director Peter Orszag earlier this week, when I suggested by the title of my blog post that Peter was getting “specific” on the “tough choices.” But what I actually said was (emphasis added):
the Administration well understands the biggest (and specific) ways in which fiscal policy can affect the budget outlook over the next ten years– and it’s not health care reform (which is much more about the much longer-term outlook).
Note that I said I think the Obama Administration understands that the extension of the Bush tax cuts are the biggest policy decision affecting the ten-year budget outlook–i.e., they understand their budget adds $2 trillion to the ten-year deficit by choosing to deficit finance most of the Bush(/Obama) tax cuts. I didn’t say they were admitting it as their Administration’s choice (rather than just the Bush Administration’s “fault”). They’re not admitting it because their political calculus is that blaming the Bush Administration for the fiscal irresponsibility of the Bush tax cuts, while willfully continuing most of those same, still fiscally-irresponsible tax cuts beyond 2010 (to avoid having to say that taxes will come up), is a win-win strategy. In terms of the economics, of course, it’s hypocritical.
In fact, I complained at that tax conference session that the health care reform debate well illustrates how any fiscally-responsible parts of policies that politicians are now willing to offer have a kind of gauzy, soft-focus quality to them. Any tough choices remain vague and off to the future. I said something like “what the politicians seem most willing to do [to reduce the deficit] are things that we least know how to do.” Because if we don’t know how yet to do it, then we can’t spell it out very clearly now, can we? Things like “bending the health cost curve” by as-yet-unspecified-by-that-future-commission Medicare savings. Sounds like it could just be cutting out waste that no one values–or at least it doesn’t sound specifically like a cut to anyone’s specific Medicare benefits. But reducing the deficit by raising taxes? Well, we know lots of specific ways to do that to have more immediate impact (just look at CBO’s budget options that feed into Concord’s Federal Budget Challenge), so politicians couldn’t possibly propose any of them, because those would be very specific proposals that could be very clearly spelled out to people, with easily identifiable winners and losers (a la Joint Committee on Taxation or Tax Policy Center distributional tables).
In the Q and A part of our session, I was asked: what will finally get the politicians to start doing the right thing and actually making those truly tough, fiscally-responsible policy choices (rather than merely putting off those vague, off-in-the-future choices)? And I said that unfortunately, it will probably take the next economic crisis–the tangible evidence that our economy has reached its breaking point because of our fiscal irresponsibility, when lenders stop being so willing to keep lending to us and interest rates and inflation appear soon headed to intolerable levels.
And coincidentally, EconomistMom reader (and frequent commenter) “AMTbuff” sent me his very intriguing (and distressing) political economy thought: that who is in charge when that crisis happens is important–in fact so important that policymakers may have the incentive to let or even spur on that crisis while the economy’s on their watch. From AMTbuff’s email to me (which quotes Bill Gale from the video of the student summit we held in Denver last month), emphasis added:
At the Colorado fiscal summit sponsored by the Concord Coalition, Bill Gale said something (listen at the 39-minute mark of the video, also embedded in the economistmom post) that I’ve believed for some time:
Q: How much of extension of Bush Tax cuts is justified on short term economic grounds vs. longer-term, and if’s not justifiable on longer-term grounds, why not?
Bill Gale: This is the epitome of the lack of stopping digging that’s going on. I mean the debate in the 2008 campaign was about who had the bigger tax cut, not about who was going to raise taxes and pay for the fiscal gap. That’s not even the right debate to be having. It’s like they need to meet at the 50 yard line, and they’re each in the end zone running the opposite way.
And the stop digging point is really important. Washington isn’t even at the point where they say “OK let’s sit down and solve this.” They’re still at the point where they say “Gee, when we do sit down and solve this, everyone is going to take a hit. Therefore our goal right now is to get as much as we possibly can now in tax cuts and spending so that when the big negotiation has to happen we start from a position of lower taxes or more spending.”
So it’s a politically calculated thing that’s going on, but it’s extraordinarily dysfunctional. But don’t think that people in Washington don’t get it and don’t understand what they’re doing. In fact it’s exactly the opposite. They know exactly what they’re doing: They’re setting up their initial positions so that when that big budget summit or negotiation happens, that they can keep as much as they want.
Now I’m not defending that, I’m just telling you don’t assume that just because they look like idiots that they actually are idiots. They actually know what they’re doing.
(end of Bill Gale quote)
I think Bill is exactly right, meaning that the mission of the Concord Coalition is hopeless. There will be no grand compromise in advance of the big crisis. We’ll have to wait until the market will no longer buy Treasury debt before action occurs. Yet I fear that the problem is even more serious than Bill says. I used to believe that the party in power when the crisis hits would be outcast for decades, much as the Republicans were after the Great Depression. This may be true, but now I realize that the party in power during the crisis will be able to dictate the terms of accommodation to reality. This is crucial to the long-term trajectory of the government’s role in our lives. To a staunch partisan, this is a hill worth dying on.If I am correct that being in power when the crisis hits is crucial, it behooves the party in power to precipitate the inevitable crisis before they lose power. Therefore enacting policies which are objectively fiscally insane might be perfectly rational.
Let me pause to let this thought sink in. I’ll repeat it: If the crisis is inevitable, why not make sure that the crisis arrives when we are in power, so that we can make the radical changes we favor, rather than letting the other guys make the radical changes that they prefer?
The preceding logic is, I believe, irrefutable. I would prefer to be wrong. Am I? –AMTbuff
This is an amazing and terrifying political economy theory. What do you all think of it? Is AMTbuff onto something?
It’s an interesting line of thinking and not one that hasn’t crossed my mind from time to time. I do agree with the substance of Bill’s quote although I’m not sure it’s a conscious thought about negotiating strategy. It could be but my suspicion is that few in Congress think in a long term fashion and therefore it’s unlikely.
On AMT’s quote, I don’t think it’s as clear as he? puts it. Let me illustrate.
Let’s assume that I am planning to precipitate a crisis in order to control the repsonse to that crisis. I have two things I need to be concerned about. First, I need to be worried about the stability of the policy prescriptions that I would put in place. If this is a jump on the hand grenade game, meaning I get to put my preferred solution in place but then I will be out of power to 10+ years, I need to be concerned that I can put things in place that will last through the cycle.
The problem with this is it flies in the face of the history of the country. Just take marginal tax rates as an example. Down under Reagan/Bush, up under Clinton, down under Bush43, up (on the horizon) under Obama. Thus, one would need to be concerned with stability and whether the short-term policy change can be enshrined in the long-term. I wouldn’t be overly confident of this were I the party precipitating the crisis.
The second issue would be the nature of the majority during the crisis. We had quite a good crisis (though not insolvency) heading into 2009. Despite the nature of the crisis, it has been quite difficult for democrats to implement their preferred policies. Health care is struggling and the stimulus, by all accounts, was a compromise solution relative to what liberals really wanted (makes me shudder to think about it). So without a dominant majority, it is at least uncertain how much freedom to move politicians would have. Further, you’d have to count on politicians committing political suicide en masse to move outside of centrist solutions.
So while it might be a hill worth dying on, you might die without taking the hill and get Pickett’s charge or Little Round Top instead (sorry I love Civil War history). Thus, my conclusion is that the calculus is too cloudy to have a party precipitate a crisis in order to drive a solution.
Let me then turn to the second part of the discussion — is Concord’s mission hopeless? My answer is it’s not hopeless but Concord is pushing on the wrong levers to solve the problem. Were I looking for long-term solutions, I would be pushing on three levers.
1. Efficiency/waste — clearly the lowest cost approach to finding balance is eliminating inefficiency and waste. Government doesn’t know how to eliminate inefficiency and waste. A process to do this and an approach to incentives that provides the basis to sustain it is clearly step 1.
2. Structural change (probably constitutional) — part 2 needs to be an approach that changes the process for managing spending and taxes. I think there are many ways to do this that need to be discussed and debated, potentially to include a balanced budget amendment, a line item veto, more direct democracy on the amount of spending, or greater limits on Federal power.
Any of these would be a hard hill to climb but working on the root causes is better than trying to get balance within an inherently unbalanced system.
Sorry all for the very long post but it’s a complex issue and one that has been on my mind for quite a while as well
Sorry, I forgot the third lever.
3. Change in the process of talking about spending/taxes. Think about this as the CBO scoring process. It is fundamentally broken and consistently gamed by Congress. This needs to be changed and the public needs to be educated on what’s going on here.
Re: AMT’s If the crisis is inevitable, why not make sure that the crisis arrives when we are in power, so that we can make the radical changes we favor, rather than letting the other guys make the radical changes that they prefer?
First, the validity of the premise is not at all clear to me. It’s possible that the “party” “in power” would not be able to get “the radical changes” “the party” favors (meaning heavily tilted toward solutions on the mainstream or far end of “the party’s” range on the ideological spectrum). They may be constrained and held closer to the center by “moderates/centrists” within the party. Or the public could shift heaviliy toward the view that the crisis occurred because of that party’s policies, thus forcing that party toward — or perhaps beyond — what had previously been the center, or just tossing them out of power in favor of the party (and/or independents) that offers a different approach (and either tossing them out before they can enact much/any of their “solution”, or reversing their “solution” via the new legislators and administration).
But my main disagreement with AMT’s theory exists even if we assume, arguendo, that his premise is valid, and even if we assume (although it’s untrue) that once a party’s “solution” is enacted, it can’t be (or is highly likely to be) subsequently reversed if power shifts to others. Under those (dubious) assumptions, only noble, selfless political leaders who put the interests of the nation above their political careers would prefer that the crisis hit on their watch. Why? Because any solution means broad-based, very unpleasant/painful sacrifice, which hasn’t happened yet (albeit in pre-crisis times) precisely because imposing broad-based sacrifices is such a political net loser, meaning a ticket out of office. Amid the aforementioned crisis, the “party” “in power” must impose or at least try to impose some actual, realistic solution with these broad-based sacrifices, while those out of power can posture and protest and offer the mere pretense of an alternative “solution” that works better politically, meaning (in that context) quite possibly a ticket to office. Thus, power will quite possibly shift, and assuming the problem remains, it will become their problem and they’ll have to actually impose or seek to impose actual, realistic solution, and from there it’s anyone’s guess where we end up (although one needs to bear in mind the coming very substantial growth in seniors as a percentage of the population and the facts that they vote disproportionately and care so much about their entitlements, all of which places some bound on reductions in projected spending).
So I think that, at best, AMT’s theory holds in the fictitious world of a Congress and White House filled with noble, selfless political leaders. More likely, it would be the (real world) politicians’ worst nightmare for the crisis to happen on their watch. Much better to be in the minority barking about how the “party” “in power” mess up and protesting the outrageous, unacceptable sacrifices they are imposing (or at least seeking to impose) on the good American people who “didn’t cause this mess”, championing the cause of “the people” against those “out of touch elites” in Washington (this stuff almost writes itself).
If we created the SAFE Commission and all that ended up resulting for now were (1) a better understanding (in Washington and elsewhere) of approaches to a solution and related trade-offs, and (2) establishment of some process (and experience with the process) for reaching a Grand Compromise when a crisis hits, that alone would make it worth creating the SAFE Commission.
When we also consider the possibility that the SAFE Commission could help better inform member of Congress, move the needle on public opinion toward some realistic solution, and provide some political cover for politicians to act responsibly, and considering that there is little downside to giving the SAFE Commission a shot, it seems clear to me that we should support creation of the SAFE Commission.
Yeah, yeah, I know. Commissions often end up accomplishing little/nothing, and politicians sometimes use them as a diversion to avoid taking action while creating the appearance of action for some bit of time, but at worst in this case it would mean that it delays for a year or so some hypothetical, sudden courage and irresistible urge in Washington to act fiscally responsibly, so there really very little opportunity cost, and the resources devoted to it would be minuscule relative to the budget and relative to the size of the problem and the value of reaching a solution even a bit sooner rather than later. So the upside potential far outweighs the downside cost and risk.
Brooks,
I have no issue with a the SAFE commission in theory although I’m not so sure about the current legislation. My worry is less about whether politicians will hide behind it as an excuse for doing nothing (they will) and more about whether the commission will actually look at the structural causes of the problem and attempt to address those as opposed to treating the problem as an accounting exercise to get to balance.
The latter approach (which seems closer to the current legislation to me) is doomed to fail in the medium to long terms since efficiency, incentives, and the structural issues will not be addressed in a way that limits the ability of future legislative and executive branches to recreate the problem.
Steve,
If you don’t mind covering ground you’ve probably already partially covered on other threads and this one, can you elaborate (and/or link to your comments elsewhere) on what you see as the “structural causes of the problem”, and by solutions to this “structural problem” do you mean your #2 above?
I think that YOU are on to something. There is no evidence that any politician will be honest and explain the hard choices.
What is hard, probably impossible to predict, is what the trigger will be.
Sure Brooks,
To put it simply, there needs to be a structural change in the way we budget that creates a greater probability of long term stability. Examples, ranging from weak to strong would include a line item veto, some sort of Constitutional limitation on transfer payments (e.g., Constitutional means testing), or a balanced budget amendment.
I’m sure there are more ideas that others could come up with but my general point is we need to put limitations on the process to prevent Congress from taking us right back to the current situation post any “grand compromise”
Steve,
I, too, would like very much to see budget process improvements to stay on a responsible course once one is set per some “grand compromise”. I probably won’t think of all of them right now, but a few I’d like to see:
- Getting entitlements off auto-pilot and set each year just like the discretionary budget.
- At least generally treating tax expenditures as the spending that they are.
- A strong, statutory, comprehensive PAYGO in both houses. “Strong” meaning requiring some substantial supermajority to override or repeal it (I realize that a future Congress can repeal or override the law requiring the supermajority, but at least that creates another hurdle perhaps adding to the cost side of their political calculations). “Comprehensive” meaning including everything in the budget, excluding nothing.
- Once a course has been set for deficits and debt-to-GDP ratios over time, require some supermajority in both chambers of Congress to exceed the targets beyond a specified amount.
I just finished Reinhart & Rogoff’s very impressive This Time is Different: Eight Centuries of Financial Folly. (Only $17 at Amazon, I learned too late).
My brief, digested, in-a-nutshell review of its data, analysis, conclusions and lessons to be learned, regarding the issues commonly discussed here:
We’re doomed.