Deficits for Stimulus Were OK. But Now?

President Bush and Senator Kerry should mimic Presidents Reagan and Clinton by advocating tax reforms and the reduction of long-term deficits.

Although the economic figures remain a little tentative, it's fair to say that Bush's budget deficits have successfully re-inflated the U.S economy. At this point, the recovering U.S. and world economies are benefiting. Combined with ultra-low interest rates, the deficits helped prevent an extended recession. Fears of deflation -- a worrisome drop in prices accompanied by economic stagnation -- are almost gone, even in the most affected economies, like Japan's.

In fact, strong economic growth, especially in East and South Asia, is causing new inflationary pressures. In the longer term -- assuming trade remains relatively unrestricted -- Asian economic growth will boost global productivity and incomes. But the U.S. shouldn't take low inflation for granted.

The huge swing into budget deficits in the U.S. -- accomplished via short-term tax cuts and spending increases -- deserves some credit for the global economic improvement this year.

Now, the emphasis must shift to structural reforms and re-balanced budgets. Looking forward, continued large deficits will hurt the economic prospects, driving up inflationary expectations and, ultimately, interest rates.

It's time for the Bush Administration to give up on its misguided zeal to make tax cuts permanent. Tax cuts to be implemented in 2006 or 2010 have little to do with current economic growth. Or future economic growth, for that matter. But foregoing some of them could help the budget a lot.

The supply-side theory that small changes in future tax rates will change investor and entrepreneurial behavior is vastly overstated. In fact, the worrisome deficit outlook is probably more likely to retard future growth, now that recession and deflation fears have abated.

President Bush should quit complaining about Senator Kerry and present a coherent, responsible economic policy for the next four years. The right choices would be to reform the over-complicated U.S. tax code and to significantly reduce the federal deficit. That will mean rescinding tax cuts now that they are no longer necessary for economic stimulus.

Under Bush or Kerry, the biggest problem for the next 5 or 6 years will be insufficient revenues. Tax reform would be a way to combine popular simplifications of the tax collection process with unpopular revenue increases.

After 2010, the main problem isn't revenues, it's spending.

With short-term deficits under control, we could re-address entitlement reforms, so that budget problems will not paralyze the government -- and the economy -- once the huge baby-boom generation starts to retire and demand entitlement benefits.

Obviously, it will take leadership from the Democratic side of the aisle -- historically the protectors of entitlements -- to make progress on entitlement reform. Senator Kerry should be open-minded about long-term Social Security and Medicare fixes. At the least, he should instruct his campaign to refrain from the usual "scare" rhetoric on entitlements.

The first priorities of the next president should be tax reform and deficit reduction. Deficit reduction will require rolling back tax cuts -- preferably in the context of tax reform -- and trimming "discretionary" spending.

But scaling back Congressional appropriations won't be nearly enough to bring the budget back into balance in the long run. And raising future taxes is not a viable solution. Taxes would have to keep going up and up to match ever-increasing entitlement costs.

We will need sufficient revenue increases now, and a significant slowdown in entitlement spending later.

Links:
Centrists.Org Summer Economic Update -- Moderate Growth and Slowly Improving Labor Markets (July 9, 2004)

Centrists.Org Where Will the Deficit Go From Here? New Long-Term Budget Projections (June 3, 2004)

Posted by Jeff Lemieux at July 14, 2004 01:19 PM