Arguments for and Agains Governtment Deficit
"[An] excellent, comprehensive, and illuminating book. Its analysis, deftly integrating considerations of economics, constabulary, politics, and philosophy, brings the issues of 'balanced budgets,' national saving, and intergenerational equity out of the area of religious crusades and into an loonshit of reason.…A magnificent, judicious, and balanced treatment. It should exist read and studied not just by specialists in fiscal policy but by all those in the economic and political community."—Robert Eisner, Journal of Economic Literature
"By conceptualizing budget deficits as 'taxation lag'—the spending of coin by regime before information technology has been acquired through taxation—Shaviro directs u.s. toward issues of generational brunt-shifting, macroeconomic performance, and the size of government.…Shaviro is unusually honest well-nigh the difficulties that have left these conflicts unresolved. …A sobering assay."—Kirkus Reviews
"The writer's groundwork as a legislation attorney shows in his insightful analysis of political gamesmanship and the unintended consequences of legislation. Shaviro'southward history, economics, and political analysis are right on the marking. For all readers."—Library Journal
Do Deficits Matter?
Daniel Shaviro
Few topics in American politics are more than discussed and less understood than the federal upkeep deficit. We frequently hear that deficit reduction is vital to our prosperity, but we rarely hear why this might be and then. The arrears is blamed for all manner of economic ills, ranging from loftier involvement rates to unemployment to the merchandise arrears to the low rate of national saving to low productivity growth—whichever seems most crucial at the moment—merely fiddling attention is paid to why it might have whatever of these effects.
The near unanimity in public discourse well-nigh the evil of deficits might seem to advise that economists are similarly unanimous. In fact, even so, they disagree fundamentally well-nigh whether deficits affair, and, if and so, then why. They have been debating these issues for more than 2 centuries, with consensus occasionally emerging but not persisting. Over the past twenty-v years, the deficit fence among economists has grown increasingly discordant, reflecting the issue'south increased prominence, the growing size of reported deficits, and the collapse of 1960s Keynesianism.
Despite the scope and intensity of this contend, no ane has ever published a serious, comprehensive study of budget deficits' economic and political significance. Economists more often than not practice not focus on more than than one or ii of the principal issues that we volition see deficits pose, nor do they explore the relationships between the problems. They likewise mainly ignore the question of how deficits affect the level of federal spending, although this is a key part of the national political argue. Moreover, their work is often marred by partisanship of the Left or the Right, or by the impulse to stake out a public stance like a campaigning politician—frequently equally the foundation of one's academic career—and then to stick to it at all costs, ignoring or disparaging all contrary arguments and prove.
For the commencement time in ii centuries of deficit debate, this volume unifies the varied strands of the economic and political science literature, and draws definite, balanced, and inter-related conclusions regarding all of the main issues that upkeep deficits present. The journey has many stages, and will take us in a number of different directions. I therefore offer the following summary of my assay and conclusions.
one) Purely equally a descriptive matter, why do Americans care so much nearly budget deficits? The United States has a history of unusual business organization about federal (although not land) budget deficits, going back to the earliest days after adoption of the Constitution. Other industrialized nations generally have not shown similar levels of business organisation, even when they have had comparable or greater budget deficits (or outstanding national debt) relative to their economies.
Our deficit fixation results in part from equating government debt with an individual's or household'south debts, which generally could not abound for decades at a time without raising a serious prospect of default. In addition, deficits are a deeply rooted symbol in American history, the significant of which has inverse over time, just that continually relates to distrust of the national government. The historical lineage from Thomas Jefferson'southward denunciations of the deficit to those of H. Ross Perot should warning u.s.a. to the cultural conditioning that needs to be left to i side for purposes of clear analysis.
two) Are the national government's debts properly analogized to those of an individual or household? People frequently exaggerate the analogy, although it is not wholly misplaced. The main distinction is that the federal government, with its power to raise taxes and print money, faces less default risk than would a household that regularly spent more than it took in. In addition, our debt is mainly internal: owed by American taxpayers to American bondholders (two groups that overlap).
While the prospect of involuntary default is remote in the The states at present, we face a problem that is a lesser version of it: that of policy sustainability, or our ability to meet current commitments that are not quite as definite as the pledge to accolade government bonds. Current fiscal policy is likely to prove difficult to sustain—not only because of the growing national debt, but because of the expected long-term insolvency of Social Security and Medicare. Fiscal policy changes may result in disappointing expectations that our nowadays financial policy encourages people to concord. Yet more and more than people realize that our fiscal policy must and will alter. The main problem posed past policy unsustainability is the shock and dislocation that result when expectations must change also fast.
3) What issues do federal budget deficits raise, apart from concern nigh default and policy sustainability? The first issue is generational equity, or concern about unduly benefiting current generations at the expense of futurity generations. The second issue is what macroeconomic effects deficits generally have. At i time, they were lauded by Keynesians as the cure for recession or even significant unemployment, based on the merits that they increased current consumer spending and thereby stimulated the economy. Today, the same causal claim leads many to condemn deficits as a cause of the low rate of national saving. The third issue concerns their furnishings on the size of the national government. Some supporters of limited government identify arrears spending as a major cause of undesirable regime growth, and therefore advocate the adoption of a balanced upkeep amendment to the U.South. Constitution.
Each business rests on a common causal claim: that arrears spending reduces the perceived (whether or not the bodily) cost of government spending to current consumers and voters, thus inducing them to feel wealthier. They therefore swallow more, exit less for subsequent generations, and have a higher level of regime spending than they would have otherwise. Earlier discussing the accuracy and significance of this causal merits, we must expect more advisedly at how deficits are divers and measured.
iv) Is the budget deficit a meaningful economic measure? The budget deficit would seem well-nigh probable to have these claimed furnishings if information technology were a meaningful economical mensurate. Unfortunately, it is not—although there is a meaningful underlying phenomenon, which it mismeasures, about which the above claims can be fabricated.
The upkeep deficit's main shortcoming is that information technology is calculated on the ground of cash flow, rather than economic accrual. Suppose that an private kept his books under the rules that the federal authorities uses to measure out the budget deficit. If he managed to purchase a million dollar home for only a thousand dollars, he would seem to have acted imprudently, since, in the year of buy, he would take increased his deficit. This transaction would be treated identically to losing a thousand dollars at the racetrack. If he instead sold a million dollar home for a thousand dollars, or agreed to pay someone a million dollars next year in exchange for a chiliad dollars today (assuming that this was not classified equally a loan), he would have achieved arrears reduction, at least under some versions of the measure, and thus would seem to have acted prudently.
While inaccuracies of this kind may accept mattered little at one time in American history, that fourth dimension has passed. Today, a cash flow measure creates systematic, non just random, mismeasurement, for three main reasons. Kickoff, information technology encourages ignoring the approach of unfunded future spending commitments, as under Social Security and Medicare. Second, it encourages legislative responses that, over the long term, are meaningless or even make the regime's fiscal posture worse. "Fume and mirrors" policy changes, or those that reduce deficits in the brusque term while increasing them for "out years" beyond the estimating window, accept been a feature of all major deficit reduction initiatives in Washington. Third, to the extent that fiscal policy affects economic behavior via its impact on perceived wealth, the long-term elements of such policy that the deficit ignores may matter. Unless people are highly myopic, their expectations regarding how much the government volition pay or take from them in the futurity should touch on their current beliefs.
5) How could nosotros better describe the underlying fiscal policy that deficits mismeasure? Given the deficit's economic inaccuracy as a cash flow measure, we need a new vocabulary to describe the underlying phenomenon of having spending accrue before taxes. I will use the term tax lag to depict a fiscal policy (such equally our present one) in which, over the long term, (a) tax revenues will be inadequate to pay for government spending absent a policy change and/or (b) younger generations and future generations will cease up paying for authorities spending on behalf of older individuals and electric current generations. The word lag is appropriate because, over the long term, no government spending is free; information technology all must and will exist paid for by someone. Even if the national debt is never repaid, taxpayers comport information technology economically over time by perpetually paying interest on the debt. Nor would defaulting on our debt obligations eliminate the price of paying for authorities spending. Default would only shift the cost from taxpayers to bondholders—operation, in consequence, as a sometime tax on the latter.
When I use the term tax lag, the reader should go on in mind that I am describing the relative timing of taxes and spending, rather than anything absolute about taxation. I could simply every bit easily refer to spending acceleration. Tax lag tin be reduced through policy changes either on the revenue enhancement side or on the spending side of the federal budget. On the revenue enhancement side, ane can increase the extent to which futurity necessary taxes are specified and/or increment taxes on current generations and older individuals. On the spending side, one can reduce planned present or future spending, in detail that on behalf of current generations and older individuals.
The most intuitively obvious manner to measure changes in tax lag would be through what I phone call the economic accrual budget arrears (equally singled-out from the greenbacks menses budget arrears that we currently use). This measure—which I mean just as a thought experiment—would focus on economic accrual over time, rather than cash menstruation, by taking account of expected future revenues and outlays at their interest-adapted present value. Suppose that at the beginning of the fiscal yr, the national debt stood at $2 trillion, and the present value of all expected time to come budget deficits stood at $3 trillion. Revenue enhancement lag would therefore full $5 trillion in present value terms at the outset of the year. (This would be the "economic accrual national debt.") Next, suppose that during the fiscal yr, there was a $100 billion greenbacks-flow budget arrears, and the present value of all expected future deficits rose by $150 billion. The economic accrual budget deficit would equal the sum of these two amounts, or $250 billion, as the nowadays value of our revenue enhancement lag would have increased by that corporeality to $five.25 trillion in the course of the financial year.
The measure out, as I accept described it thus far, would still be too cash flow-oriented in a critical respect. It would fail to distinguish betwixt expenditures that create durable authorities avails, and those that are immediately consumed. Recall my before point that spending a thousand dollars to purchase a business firm is quite dissimilar from spending that amount at the racetrack. To the extent feasible, one would want to adjust the economic accrual budget deficit to employ standard principles of accrual bookkeeping for regime expenditures. At a minimum, expenditures that created lasting government assets would be deducted over their estimated useful lives, rather than in the year of the expenditure. I might too want to consider adjusting for fluctuations in the value of regime avails (at least those plausibly held for auction, if not, say, the Lincoln Memorial), and ignoring government asset sales that merely convert property to cash.
Still, even if i could make these adjustments, another problem would arise. Suppose that Congress in 1998 enacted a head revenue enhancement of $l,000 per yr, to employ starting in 2050 to each developed American, and remain in force equally long as needed to pay off all public debt and eliminate all funding shortfalls in Social Security and Medicare. This enactment probably would non modify one'southward view of our electric current financial policy, whether considering it seemed frivolous or considering the bottom line, the fact that taxes ultimately will pay for today'south spending, was already implicit. This suggests two problems with the economic accrual upkeep arrears. The more trivial one is that the prepare of tax and payment rules currently on the books is less important, for some purposes, than the fix of rules that actually, credibly found our electric current policy. The more central problem is that what really matters well-nigh taxes and spending, at least distributionally, is who pays for and receives them. A tax on younger generations in l years may be quite different than a tax on us today, even if the taxes have the same present value.
Responding to these problems in measuring tax lag, the economist Laurence Kotlikoff has proposed a new measurement system to supervene upon the cash flow budget deficit that, while less intuitive than the economic accrual budget arrears, provides more meaningful information. He calls it generational accounting. Its near important innovation, beyond employing principles of economic accrual, is that it compares expected taxes to expected outlays by age group, rather than providing a single overall measure of tax lag. Generational accounting involves calculating the estimated lifetime cyberspace taxation payment and lifetime net taxation rate for the average fellow member of an age group—those built-in, say, in 1930, 1960, 1990, or the hereafter—bold the continuation of current policy (except that hereafter generations are accounted to make upwards all the long-term revenue shortfalls). The lifetime net tax payment is the backlog of taxes paid over transfers received, computed on a lifetime basis in present value terms from nascence. The lifetime net tax charge per unit is the lifetime internet tax payment, divided by estimated lifetime income.
Generational bookkeeping thus direct addresses which age groups win and lose under fiscal policy, and sheds light on such policy's likely sustainability. According to Kotlikoff, lifetime net tax rates take been rising throughout the twentieth century, and at present stand at astronomical levels for future generations—more than 84 percent under current policy, according to his most recent information.
Unfortunately, whatever long-term economic accrual measure involves conceptual and computational difficulty. In calculating futurity years' tax and spending levels, what fix of policies should we assume volition be followed? How confident tin nosotros be in whatsoever long-term economic and demographic forecasts? Should mere expectations of benefiting in future years from government spending programs exist distinguished from explicit public debt? Can nosotros actually determine the incidence, within a multi-generational household, of government taxes and transfers?
While these problems reduce generational accounting's practical value—especially given estimating games in the existent world of partisan politics—it remains conceptually superior to the cash menses budget arrears. Generational accounting requires extensive assumptions, just at least it sets forth a meaningful economical concept. Moreover, it addresses an important gap in current understanding. While political debate has moved in the management of focusing on long-term economic accrual (every bit through multi-year deficit forecasts and debate nigh the long-term solvency of Social Security and Medicare), information technology has tended to ignore the generational implications of alternative policies.
Still, despite the importance of focusing on long-term accrual and on who pays what, discussion of the cash-flow budget deficit is non wholly without value, as long as nosotros proceed its limitations in mind. Major deficit reduction initiatives in Congress oft would reduce tax lag, fifty-fifty if they also include smoke-and-mirrors elements. Ane could fifty-fifty debate that the deficit has particular advantages equally a guide for public political discourse, despite its conceptual flaws, considering of its greater salience and symbolic heft.
6) What aspects of government policy do even long-term financial policy measures ignore? So far, the discussion has been limited to fiscal policy, which concerns greenbacks flows to and from the authorities. This focus is incomplete, since greenbacks transactions correspond merely a part of total government activeness. Both in-kind benefits from government spending, and the diverse in-kind benefits and burdens resulting from authorities regulation are similar in principle to cash subsidies and tax levies. Yet they generally are ignored in discussions of fiscal policy, for no better reason than that they are hard to measure and allocate to specific individuals or groups.
I could contend that just every bit the cash flow budget deficit is not a truthful economic mensurate because it ignores long-term accrual, then generational accounting is not a true economic measure out because information technology ignores the value of in-kind benefits and burdens imposed on different age groups by authorities policy. Consider Kotlikoff's finding that lifetime net taxation rates have been ascension over time. If this were wholly an antiquity of government growth that could increment the value of in-kind public appurtenances and services, it might have piddling significance. The claim that 1 tin can meaningfully evaluate fiscal policy separately from all other regime policy is essentially an "all else equal" merits (or promise)—although perhaps not an unreasonable one.
7) All else equal, does tax lag actually have the generational, macroeconomic, and size-of-government effects that accept been attributed to upkeep deficits? This is an empirical question, which turns on whether tax lag actually causes people to feel wealthier and regard regime spending as less costly than they would if taxes were accruing at the same rate as spending. The argument against tax lag's having this effect begins from the observation that rational private borrowers recognize that borrowing money generally does not make them wealthier, but only gives them current cash against a future, interest-bearing accuse. If people mostly took this view of public debt—because it, in the aggregate, a charge on their current wealth since it implies college hereafter taxes, including interest on the deferral—and then tax lag would fail to increase their perceived or actual wealth.
The economist Robert Barro asserts that people actually view tax lag this manner. Thus, he would expect a $100 billion electric current year tax reduction (holding government spending constant) not to bear on current consumption behavior or take any systematic impact. This claim—called Ricardian equivalence for economist David Ricardo who outset described it—suggests that tax lag is largely irrelevant because people make offsetting adjustments. In effect, they put the amount of whatsoever deferred tax in a dedicated banking concern account to pay the tax when it comes due, rather than regarding information technology as giving them extra money to spend—fifty-fifty if they do not await it to come due during their lifetimes. Barro derives this claim from a "rational expectations" framework in which people, acting without systematic error, pursue stock-still goals regarding how much wealth to transfer to their children net of deferred taxes, and thus achieve whatever end result they adopt without regard to whatever government policies that neglect to alter the "opportunity gear up."
If Barro were right, then politicians could, with relative impunity, propose massive electric current tax increases to eliminate tax lag, leaving the question of spending levels to be debated separately. Yet fifty-fifty the barest familiarity with contemporary politics shows that this is false. Voters more often than not punish politicians who propose current tax increases, plainly not agreeing with the Ricardian argument that the timing of taxation has no event on its perceived electric current level. We also fail to observe other apparent implications of Ricardianism—for instance, equal frequency of budget deficits and surpluses, or any trend of large families to prefer current taxation increases based on the view that their share of the revenue enhancement burden will grow over time as they divide into multiple households. All this suggests that increasing tax lag does tend to increase perceived wealth, leading to the claimed generational, macroeconomic, and size of government effects.
8) What should we recollect of tax lag's generational effects? Many argue that shifting our tax burdens to future generations is immoral. The question is non actually one of wealth transfer, which is pervasive and inevitable between generations in any event (equally whenever parents spend money on their children or go out bequests). Rather, the effect is better put in terms of rising lifetime net tax rates. Laurence Kotlikoff argues that a norm of "generational residual" requires avoiding any increase in the expected lifetime net tax rates for future generations relative to those on current generations.
I find this norm unpersuasive. The existent outcome is the overall distribution of lifetime consumption between succeeding generations. This, in plow, depends less on fiscal policy than on present generations' overall charge per unit of saving and productivity of investment, along with decisions within the household concerning such matters equally child care, educational investment, and the charge per unit of divorce. In that location is no apparent reason why government fiscal policy, which is merely i component of everything nosotros do that affects our descendants, should exist generationally "balanced." Even the narrower claim that reducing revenue enhancement lag, by increasing national saving, would shift lifetime consumption in the right direction, may not exist correct. For example, if technological advances cause people fifty years from now to exist wealthier than we are—only as we are wealthier than people fifty years ago, and they are wealthier than people fifty years earlier however—then changing fiscal policy to benefit future generations would corporeality to playing Robin Hood in contrary. While per capita societal wealth is not certain to continue increasing, our inability to predict the time to come makes it hard to know what generational policy would be best.
1 might ask: even if some increase in lifetime net revenue enhancement rates is justifiable, isn't a projected 84 percent charge per unit for futurity generations far too loftier? Here the reply might be yeah if such a rate were actually possible. Fifty-fifty Kotlikoff agrees, still, that it is not. Rather, this projected rate reflects a computational convention, under which he estimates the implications of electric current policy (although it may be certain to change) by assigning the entire unprovided-for net tax burden to hereafter generations. He does this both because some arbitrary assumption is needed (since current policy does not tell u.s. how tax lag volition be addressed), and as a rough indicator of where our current fiscal policy is headed. A staggering lifetime net tax charge per unit for futurity generations mainly indicates a sustainability problem for current policy, suggesting that some of the as yet unprovided-for net tax brunt will have to be borne, in the end, by members of present generations.
9) What should we think of tax lag'south macroeconomic effects? Again, tax lag tends to increase current consumption relative to saving. While many condemn this effect on the footing that the current charge per unit of national saving is too low, it is hard to be certain. What is the optimal rate of saving? No one knows. The whole bespeak of saving, rather than consuming, is to brand possible greater future consumption. Yet the choice between present and future consumption presents a hard tradeoff, and neither is to exist preferred automatically. In whatever example, while saving helps to promote long-term economic growth, such growth probably depends more than, in the cease, on technological developments than on the precise level of capital accumulation.
Tax lag'southward effect on the choice betwixt current consumption and saving also matters in Keynesian theory, where one tin can moderate recessions by making people feel wealthier, thus offsetting fearfulness-induced reductions in consumer spending. Nonetheless, although Keynesianism has rebounded from its apparent intellectual collapse in the 1970s, even most Keynesians now recognize that the case for an actively countercyclical fiscal policy is extremely weak. The main bug are systematic misuse by politicians pursuing short-term political goals, and undue lag in implementing fiscal policy changes. Keynesian fiscal policy should be purely automatic rather than discretionary, as when unemployment benefits ascension and income tax revenues decline during a recession.
ten) What should we recollect of tax lag'due south size-of-government effects? Again, tax lag tends to increment authorities spending by reducing its perceived price. While this does not testify that, on residue, the federal government spends besides much, there is much to exist said for such a view. Political and regulatory processes oftentimes atomic number 82 to bad and wasteful policy due to their structural problems, such equally the power of special interest groups, politicians' and bureaucrats inappropriate incentives, and voters' low information.
Nonetheless, fifty-fifty if by reducing revenue enhancement lag, one could reduce the number of dollars the government spends, a smaller and ameliorate government might not result. For one matter, the size of government and the level of harm from bad policies, correlate only very roughly, if at all, with the number of dollars that the government spends. For another, political pressures might mainly lead to a reduction in good rather than bad spending. For a third, reducing taxation lag might simply yield changes in the course of authorities activity, with regulatory mandates replacing explicit taxes and spending. This has already happened to some extent in recent years. Therefore it is not clear that reducing tax lag would atomic number 82 either to a genuinely smaller regime, or to one whose policies, when misguided, did less harm.
The foregoing discussion suggests that, while taxation lag is of import and needs to be better understood, the appropriate response to it is unclear. Only on size of government grounds exercise its effects seem conspicuously undesirable, and even there reducing it might not reach much. This suggests skepticism virtually enacting a balanced budget amendment (BBA)—the peachy political result concerning tax lag in recent years—even disregarding the budget deficit'south shortcomings as a measure.
Such skepticism is enhanced when one examines the BBA'south probable course, as in the version nigh adopted by Congress in 1995. This version of the BBA would probably be grossly ineffective, even on its own terms, for two main reasons. First, information technology allows a 60 percent supermajority in both houses of Congress to authorize deficits of any size, and for any reason. While this flexibility has some virtues, in practice it might lead to increased budget deficits! Supermajority requirements may increase the amount of logrolling that is necessary to gather a winning coalition. Second, the proposed BBA has no built-in enforcement mechanism. Information technology merely states that unauthorized deficits should non occur. Any enforcement legislation that was adopted to fill this gap would lack the constitutional condition of the BBA itself, and thus probable neglect to provide a binding constraint.
In the end, the most pressing business organization raised by electric current tax lag relates, not to the three main long-term issues that I have identified, but to the relatively short-term, prudential issue of policy sustainability. If, as seems likely, nosotros cannot long pay for everything that electric current fiscal policy seems to hope—to a higher place all, due to the probable long-term insolvency of Social Security and Medicare—and so our policy must change, and eventually volition alter. Forth the way, however, at that place may be disruption and severely disappointed expectations unless the shift to a sustainable policy is made gradually, with broadly distributed impact, and in a reasonable, well-explained fashion. The sooner the shift to a sustainable policy is made, the less disruptive it is likely to testify.
Copyright observe: Excerpt from pages i-12 of Practice Deficits Matter? by Daniel Shaviro, published by the University of Chicago Press. ©1997 by Daniel Shaviro. All rights reserved. This text may be used and shared in accord with the off-white-use provisions of U.S. copyright law, and it may be archived and redistributed in electronic form, provided that this entire notice, including copyright information, is carried and provided that the University of Chicago Press is notified and no fee is charged for access. Archiving, redistribution, or republication of this text on other terms, in any medium, requires the consent of the University of Chicago Press.
Daniel Shaviro
Do Deficits Matter?
©1997, 344 pages, iii tables
Cloth $29.95 ISBN: 978-0-226-75112-2
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