Greg Mankiw on the Deficit

Broken record alert: Another post on the deficit ahead. Wouldn’t you rather look at funny pictures of cats? Why do I keep writing these? (Hint: The other side keeps writing them.) You have been warned.

Greg Mankiw, noted economics textbook author and former chair of Bush 43’s Council of Economic Advisers, has an op-ed on the deficit that is relatively sensible by the standards of recent debate. He points out that modest deficits can be sustainable, that taxes will probably need to go up, and that a value-added tax is a plausible option. He also points out that Obama’s projections are based on optimistic economic forecasts that very plausibly may not pan out, and that Obama’s main deficit-reduction strategy is to kick the problem over to a deficit-reduction commission, which are valid criticisms.

Unfortunately, his bottom line seems to be throwing more rocks at President Obama, under the general Republican principle that since he’s the president, everything is his fault:

“But unless the president revises his spending plans substantially, he will have no choice but to find some major source of government revenue. Ms. Pelosi’s suggestion of a VAT may be the best of a bunch of bad alternatives. Unfortunately, in this new era of responsibility, the president is not ready to face up to the long-term fiscal challenge.”

Mankiw, not I, brings up the comparison between Bush 43 and Obama:

“From 2005 to 2007, before the recession and financial crisis, the federal government ran budget deficits, but they averaged less than 2 percent of gross domestic product. Because this borrowing was moderate in magnitude and the economy was growing at about its normal rate, the federal debt held by the public fell from 36.8 percent of gross domestic product at the end of the 2004 fiscal year to 36.2 percent three years later. . . .

“[Mr. Obama’s budget] fails to return the federal government to manageable budget deficits, even as the wars wind down and the economy recovers from the recession. According to the administration’s own numbers, the budget deficit under the president’s proposed policies will never fall below 3.6 percent of G.D.P. By 2020, the end of the planning horizon, it will be 4.2 percent and rising.”

What’s missing from this comparison? First, the economic growth of 2005-2007 was at best a mixed blessing, as we now know, driven by an unsustainable and ultimately catastrophic credit bubble. Second, and more importantly, the comparison leaves out the long-term trend . . . wait for it . . . Medicare.

Here’s my favorite chart again, from the 2008 CBO Budget and Economic Outlook.

figure1-4.gif?w=700&h=258

In 2007, Medicare, Social Security, and Medicaid cost 8.9 percent of GDP (see Table 3-1). By 2018, they were already projected to grow to 10.8 percent of GDP; extrapolating forward at constant growth rates, by 2020 they would grow to about 11.3 percent — an increase of 2.4 percentage points over 2007. That, in one number, is the difference between Bush 43 and Obama. (Ongoing patches to the AMT — something that Obama includes in his projections that Bush did not — also grow to $150 billion by 2018, or another 0.7 percent of GDP.)

Did Bush 43 do anything about this looming problem? No, because one conservative aspiration since Ronald Reagan has been to crimp government by crippling its finances (“starving the beast”). If Bush had actually reduced the size of government to match his tax cuts, in true conservative fashion, we would face less of a long-term deficit problem now.* But whether by accident or design, it turned out to be politically advantageous to kick the problem down the road and therefore make it harder for his successor to govern.

Now, this doesn’t change the fact that it’s Obama’s problem now, and it’s his responsibility to do something about it. But Obama realized that the long-term deficit is a health care problem, while Mankiw doesn’t even use the word “health” in his op-ed on the deficit. If we don’t slow the growth of health care costs, there is no real solution to the deficit problem; the only way out from the budget perspective will be slashing Medicare, but that doesn’t solve the problem — it just shifts it onto individuals. And Obama spent much of the last year pushing for health care reform with major cost-cutting components,** attracting support from some Republican health experts (though not from any Republican Congressmen). Now, it would be meaningful to criticize Obama for having the wrong ideas about how to control health care spending, as a few Republicans have done. But to say he’s not up to the challenge without mentioning health care misses the real point.

Still, it’s true that Obama could put forward a more aggressive deficit reduction plan. If I were king, my plan would include modest increases in the Medicare eligibility age, a whole bevy of health care cost reduction initiatives, modest tax increases (pushed out into the future and made contingent on economic recovery) such as eliminating the cap on the Social Security tax and reinstating the estate tax, and bigger tax increases that would kick in if health care cost savings failed to materialize. But in our current political climate, that would be political suicide for any president and would have zero chance of passage. I’m skeptical about the deficit commission, too, but we have collectively backed ourselves into a position where neither party can afford to even propose the necessary steps on its own.

The political problem is that there’s no politically palatable way to solve the long-term deficit problem. The Republican strategy, after (almost) killing health care reform, is to attack Obama for not having a long-term solution, daring him to propose one so they can then attack him for raising taxes. Yes, that’s the way the game is played. That doesn’t change the fact that it’s a game.

* Bush did make an attempt to reform Social Security. But even if we assume he had managed to stop the growth of Social Security completely, the growth in Medicare, Medicaid, and the AMT fix would by themselves account for the difference between the 2005-2007 deficits and the projected 2020 deficit.

** The Senate health care bill only reduces the deficit by a little by year ten, because the CBO gives it very little credit for its cost-cutting measures, particularly the delivery system reforms. It is fair for the CBO to give those reforms little credit, since they are unproven. But it is also important to remember that there is no proven way to reduce health care costs (Paul Ryan’s plan reduces government expenditures reliably, but it is no more proven to reduce actual health care costs), so the only way to have any chance to reduce health care costs is to undertake the kind of experimentation proposed by the Senate bill.


Originally published at The Baseline Scenario and reproduced here with the author’s permission. 

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