Monday, April 18, 2011

Starving the Beast

The strategy of cutting taxes in order to force spending reductions has been called "starving the beast." It did not really work in the Reagan Administration, as the budget deficit went up from about $50 billion at the end of the Carter Administration to the $200 billion range. Domestic programs were, in general, not cut, but defense spending was increased. Those who believe the government should be smaller can at least argue that, during the Reagan Administration, no major new domestic spending programs were initiated. During the George W. Bush Administration, starving the beast by tax cuts also did not result in lower government spending. Indeed, spending went up as military action was initiated and a prescription drug benefit was added to Medicare, among other factors.

Currently, in face of the large short-term and projected long-term budget deficits, the starving the beast strategy appears to be bearing fruit. While the actual expenditure cuts for the current fiscal year seem to be much smaller than initially advertised when the deal averting a government shutdown was announced, the House Republicans will keep pushing and the Obama Administration now takes the position that government spending should be cut, along with some tax increases that most Republicans oppose, in order to reduce the deficit.

Of course, the current budget deficit over which there is much hand wringing is not only the result of the Bush tax cuts, but also the recession and subsequent sluggish economy and the waging of two, perhaps now three, wars. There is also a long-term budget deficit outlook which is in large measure the result of an aging population and escalating medical costs.

Initially the tax cuts were argued to be well-timed, because they countered a recession that was developing when Bush took office. But once taxes are cut, it seems there is never a good time to raise them, even if the economy recovers. At least one former Bush official indicated pleasure publicly that the Obama Administration had to forego letting the tax cuts expire for even on the wealthiest in the compromise last year. (The estate tax was reinstated for amounts over $5 million for 2011 and 2012, but the effect of this differs among large estates, since in 2010, when there was no estate tax, some heirs are subject to capital gains taxes.)

I suspect that the Republicans are in danger of overplaying their hand. They claim that the voters gave them a clear mandate to reduce spending in the 2010 election. I am not so sure. I am reminded in this connection of the "townhall" style debate between Bill Clinton and George H.W. Bush. A member of the audience asked a question related to the deficit. I don't remember exactly what it was, but literally taken, it did not make much sense. President Bush appeared flummoxed about how to answer it, because he took the question literally. Clinton decided that the question was really about the recession and made it clear he was concerned about that. His answer appeared to satisfy the questioner. Most observers believe that Clinton won that debate.

In other words, during periods of economic distress, the budget deficit can serve as a stand-in for what ails us. That does not really mean that voters want spending cut, because many of those spending programs have constituencies that benefit from them. They also don't want taxes raised, unless it is on the "man behind the tree," as the saying goes. What voters really want is for economic prosperity to return.

The Republicans argue that the "road to prosperity" runs through keeping taxes low and reducing government spending. They argue that the stimulus program failed. What they seem to be saying is that government spending can never jumpstart the economy, only tax cuts can do that. Many economists, though, would disagree with the relative efficacy of spending increases and tax cuts during a recession.

The argument that the stimulus failed is similar to the argument I have heard repeated many times that the New Deal did not get us out of the Depression; it was World War II that did that. Old-fashioned liberals counter, though, that the Roosevelt Administration was not aggressive enough in its spending programs and that World War II, though entered into for other reasons, economically served as an enormous stimulus program financed by the issuance of government securities. Currently, Paul Krugman and others argue that the reason the results from the stimulus program were not more dramatic is that it was not big enough, not that it was undertaken, as some would argue.

The Administration, which seems resigned to accepting budget cuts, is betting that the current recovery proves to have traction, and that the economy improves over the next two years even as the government contracts somewhat. They cannot be confident of that; in fact, no one knows, but that is the bet they are forced to take. In fact, the Administration will want to take credit for any deficit reduction initiatives that are undertaken. The Administration, though, will resist the type of overhaul of the Medicare program that Paul Ryan has proposed. President Obama's recent speech on budget issues made this clear. It was in part an unapologetic defense of the New Deal and the Great Society.

While the Obama Administration is attempting to make a virtue out of political necessity, the message the Republicans are sending to the electorate is more muddled. During the Bush Administration, they expanded Medicare without much seeming concern with how to finance this expansion. During the health care debate they argued that Medicare was being cut and that this was a bad thing. Now, they are arguing that it should be effectively privatized for those under 55 and made much less generous. It is certainly possible that whoever the Republican nominee is in 2012 will want to distance himself from the House Republicans in the general election.

I am somewhat surprised that Ryan took on Medicare while not addressing Social Security. He could have proposed some changes to Social Security that at least would have pushed out the date of projected insolvency of the trust fund as a first step. The Medicare issue is more difficult, because it cannot really be addressed without considering the entire health care system in the U.S., not just programs related to those over 65. It is also extremely emotional, since it eventually involves end-of-life issues.

Ryan has to know that his proposal for Medicare is not going to be enacted. As the saying goes, "politics is the art of the possible." He has succeeded in getting the issue a lot of attention, but I am not sure where he goes from here.

What seems to have happened is that for the short-term, the starving the beast strategy will serve to cut some government spending. The outlook for dealing with the long-term deficit outlook is not as clear. While there seems to be a political consensus developing that this should be addressed, there is no consensus on how to do it. If something is done, there will have to be proposals other than the Ryan plan. Ryan himself may well have marginalized himself in this debate, at least when it begins to matter, by proposing something that he is unlikely ever to garner anything approaching majority support.

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