Ed Dolan's Econ Blog

The Budget Deal: What We Have Left Undone

Making fiscal policy is never going to be easy, but it would be easier if we broke the process down into a logical sequence of steps. Here are those steps, as I see them:

  1. Decide how large a government we want in terms of government purchases and transfer payments. Any such number will necessarily have to be a political compromise, because not everyone will agree, but the result should be consistent with inescapable realities such as demographic trends.
  2. Agree on a set of budget procedures for prioritizing line items within the constraint imposed by (1), and then follow the agreed procedures.
  3. Determine the tax revenue needed to support the desired level of spending. This amount should be consistent with long-term considerations of sustainability.
  4. Agree on a set of rules for adjusting spending and revenue over the business cycle. The rules should allow for a prudent amount of cyclical stimulus and restraint as appropriate, while maintaining consistency with decisions (1) and (3).
  5. Agree on a tax structure that collects the amount of revenue required by (1), (3), and (4) in a way that is consistent with efficiency (broadest feasible base, lowest feasible marginal rates) and fairness (another political compromise).

Which of these five steps did Congress accomplish in 2012? Not one of them.  That conclusion will hold whether or not the House approves the last-minute stopgap measure passed by the Senate on New Year’s Eve.

In the consensus view, two things are holding back the recovery. One is the fear of an “austerity bomb”—a dose of British-style front-loaded austerity early in 2013, when what the economy really needs is a fix for its long-run inability to manage its budget. The other is sheer uncertainty—how many kilotons of fiscal TNT? Will it be all cuts? If so, which programs will be hit? If revenue is to rise, how much will come from structural tax reform and how much from increases to marginal rates? The New Year’s deal does nothing to answer these questions. All it does is to ensure that we go through the whole exercise again at another midnight a couple of months from now.

So here’s a resolution for the Honorable Members of the incoming Congress: Let’s do in the New Year those things which we left undone in the old. All five of them.

3 Responses to “The Budget Deal: What We Have Left Undone”

nelswightJanuary 1st, 2013 at 12:55 pm

We can only hope someones listening, or at least have their heads at the proper end of their alimentary canals.

Bryan WillmanJanuary 1st, 2013 at 1:34 pm

The failing of this proposal is that it treats government spending and tax policy as economic topics focused on things like "well being" and "optimal growth" and "competitiveness of society over time" and "maximizing individual opportunities and incentives across society." In spite of my views being fundamentally different from what I perceive yours to be, you and I could negotiate good solutions to this in a few days.

But those aren't what government spending and tax policies are about. Some large part of them are about "punishing winners" and other forms of resdistribution for it's own sake. Some part of them seem to be about creating "dependents" sure to vote for those who create the dependency. Other large sets are designed to address a problem by having "government fix it" rather than having government enable and support citizens fixing it. This sometimes backfires.

And of course, various forms of vote-buying and cronyism. So even #1 is a non-starter, even though it would be wise policy, because it's not what the political process is actually about.

Bryan WillmanJanuary 1st, 2013 at 1:39 pm

Part II – but if we're going to talk about a dreamworld where policy is driven by sensible lines of thought like Ed Dolan proposes, let's add one more point:

Regardless of where a person is on the economic spectrum, the total implicit marginal tax rate across fed/state/local taxes/benefits should always be reasonable. In particular, the marginal "cost of working" should never be infinite nor higher than say 50%.

It makes no sense to tell a retired person that working to supplement their social security income is pointless, because the tax hit associated with a small amount of revenue will make their hourly return very small or even negative.

It makes no sense to tell a single mother with housing assistence that getting a job, even a reasonably well paying one, is net loss, because the sudden total loss of housing benefits will exceed her net income gain from the job.

We must never ever, at any level, punish people for working or saving. Phase benefits out? Sure. Phase marginal rates up? Sure. But the *total* of those effects should always be restrained (to, say, 50%.)

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