Fiscal policy in an era of austerity.

• Author: Schizer, David M.
• Position: Age of Austerity

1. THE NEED FOR A POLICY AGENDA TO PROMOTE ECONOMIC GROWTH A. Deleveraging Hangover for Consumers B. Ballooning Government Deficits C. Intense International Competition D. Promoting Economic Growth II. UNCERTAINTIES AND CHALLENGES WITH A KEYNESIAN STIMULUS A. Dueling Models and Multipliers B. The Challenge of Identifying "Shovel Ready" Projects C. The Problem of Politically-Motivated Projects D. The Costs of Deficits III. TACKLING PROBLEMS OF SUBSTANTIVE LAW: THE EXAMPLE OF CUTTING CORPORATE TAX RATES A. Addressing a Broad Range of Problems B. The Case Study of Corporate Tax Reform IV. TACKLING PROBLEMS OF PROCESS: PROMOTING BETTER FISCAL DECISIONMAKING A. Problems of Information and Political Incentives B. Institutional Strategies to Promote Better Fiscal Decisions 1. Disclosure and Outside Fiscal Watchdogs 2. Institutional Reform 3. Hard Budget Constraints CONCLUSION We face a time of stagnant economic growth, severe unemployment, massive budget deficits, and an increasingly competitive global economy. These daunting challenges are the legacy of a number of unwise policy decisions in both the public and private sectors. Although the good news is that unsound policies can be changed, the bad news is that no single step will do the trick. It is a challenge to rely on monetary policy when interest rates are near zero. There also is uncertainty--and a heated debate among economists--about the effectiveness of a Keynesian stimulus. One thing we know is that a stimulus is quite difficult to execute effectively. For example, it is a challenge to identify "shovel ready" projects that contribute to long-term economic growth, particularly on short notice.

   There is no uncertainty, though, about the need to address a broad range of specific problems contributing to our economic woes. We have to promote economic growth and fiscal stability over the long term. To do so, we should reform our housing and mortgage markets, our entitlement programs, our tax code, and much more. A short Article for a special issue cannot delineate all the challenges Congress is facing or provide definitive guidance about how to address them. As an illustrative example, this Article emphasizes the perils of maintaining the highest corporate tax rate in the Organisation for Economic Co-operation and Development (OECD) in a competitive global economy. Cutting our corporate tax rate would encourage businesses to invest and hire more employees, while also reducing incentives to engage in wasteful tax planning and to shift taxable income and jobs overseas.

   In addition to the problems with our substantive law, we also face problems of process that undercut our government's effectiveness. An important (and familiar) one is that politicians are consistently tempted to accommodate organized interest groups, especially if the costs of these favors can be quietly passed on to the general public. This is all the more true if special interest deals can be financed with deficit spending, so that the bill will not come due until long after our current political leaders have retired. Various measures can constrain this familiar political dynamic, and this Article sketches three strategies as illustrative examples. First, we should make the costs of special interest deals more visible through better budgetary accounting. Second, we should enlist specific institutions within our government to target waste and pork. For example, we should empower special House and Senate committees to cut particular budget items or, alternatively, to sever them from the rest of the budget and subject them to a separate public vote. Third, we should create stronger institutional barriers to deficit spending. Scarcity focuses the mind, so that our leaders will have greater incentive to reject initiatives that are not cost-justified.

   Part I of this Article lays out the relevant economic challenges and calls for a broad agenda to promote economic growth. Part II outlines difficulties and uncertainties with a Keynesian stimulus. Part III surveys a few substantive challenges that require our attention and, as an example, shows the importance of cutting corporate tax rates. Part IV discusses the need to reform our budgetary process.

1. THE NEED FOR A POLICY AGENDA TO PROMOTE ECONOMIC GROWTH

   The U.S. economy has taken a beating since 2008. Median household income has fallen to 1996 levels, and 22% of American children are living in poverty, the highest level since 1993. (1) As of January 2012, the jobless rate remained above 8%, (2) and almost half of the nearly thirteen million Americans classified as unemployed have been out of work for more than six months. (3) The jobless rate is even higher among young people and minorities (for example, 38.5% among African-American teenagers). (4) If we also count people who have given up looking for work (2.8 million), (5) and people working only part-time because they cannot find full-time jobs (8.2 million), (6) the overall unemployment rate in the United States is 15.1%. (7) The economic recovery has been sluggish; we need to create 125,000 jobs per month just to accommodate population growth, (8) but in the summer and fall of 2011 we often fell short of even that threshold. (9) The human costs are staggering. Meanwhile, growth has slowed so that our gross domestic product (GDP) grew by only about 1.5% in 2011. (10) After nine quarters of recovery, aggregate output is still not back to its level before the financial crisis. (11)

   1. Deleveraging Hangover for Consumers

      The crisis--and the bleak economic conditions that followed-were triggered by the bursting of the U.S. housing bubble. Encouraged by low interest rates, consumers borrowed money to buy homes they could not afford. Financial institutions lent recklessly, rating agencies blessed the packaging of these flawed loans for investors, and government regulators silently stood by or actively encouraged these practices. (12) Representative Barney Frank was not alone, as he famously put it, in "want[ing] to roll the dice a little bit more in this situation towards subsidized housing." (13) But when it became clear that securitized mortgages were riskier than the market thought, storied financial institutions collapsed, triggering a financial panic and recession.

      We are still living with the hangover from this excess. Most recessions have "typically sowed the seeds of their own recoveries," Ben Bernanke observed, "as reduced spending on investment, housing, and consumer durables generates pent-up demand." (14) But this recession is different because it was "associated with both a very deep slump in the housing market and a historic financial crisis." (15) Banks with weak balance sheets are less likely to lend, (16) consumers with underwater mortgages have less money to spend, and businesses that otherwise would sell to them have to cut back. In short, deleveraging is a painful and slow process. (17)

   2. Ballooning Government Deficits

      Meanwhile, government debt reached record levels. There has been a sea change since 2000, when the U.S. government ran an $86-billion surplus. (18) During the Bush Administration, two wars, a tax cut, and undisciplined federal spending took us from a $32-billion deficit in 2001 to a $641-billion deficit in 2008. (19) During this period, the federal budget went from $1.86 trillion to $2.98 trillion, and the outstanding indebtedness of the U.S. Treasury increased from $3.3 trillion to $5.8 trillion. (20) During the first three years of the Obama Administration, these numbers skyrocketed, as tax revenues fell during the recession and government spending increased dramatically. The federal budget for 2011--$3.819 trillion (21)--is 28% larger than 2008; it represents 25.3% (22) of the nation's GDP (up from 20.7% in 2008). (23) The projected deficit for 2011, $1.645 trillion, represents 43% of the federal budget and nearly 11% of GDP, (24) a level not seen since World War II. (25)

      The deficit is more than 2.5 times larger than in 2008. Meanwhile, the Treasury debt held by the public has grown to more than $10.2 trillion, (26) which is more than 50% larger than in 2008. The national debt held by the public is now about 67% of the gross domestic product, compared to 40% in 2008 and the 37% average over the past four decades. (27) At the same time, the budgets of state and local governments have been under great strain as well. (28)

      The proliferation of government debt is not confined to the United States. Anxiety about unsustainable debt levels in the European Union has cast a shadow over the global economy. In 2010, the deficit in Greece represented 10.6% of GDP; in Ireland, it was 31.3%; in the U.K., 10.3%; and in Spain, 9.3%. (29) Twelve member states had government debt ratios of higher than 60% of GDP in 2009. (30)

      A further fiscal challenge in the United States is the need to meet a broad range of other government obligations, including Social Security and Medicare. These entitlement programs for retirees are funded with taxes on those who are still working. Costs increase with life expectancies and the price of medical care. At the same time, there will be fewer workers to bear this burden as the population ages. (31) As a result, these programs are projected to run massive deficits in the coming years. (32)

   3. Intense International Competition

      Meanwhile, another source of pressure on the U.S. economy-and, in particular, on job creation--is global economic competition. The weakening of the dollar has strengthened our exports, but the United States still is running a large trade deficit. (33) Although the economic downturn has been global, some countries have bounced back more quickly. In contrast to the U.S. economy, which grew at 2.9% in 2010, China grew at 10.3%, India grew at 9.7%, Brazil grew at 7.5%, and Mexico grew at 5.5%. (34) It is well understood that we operate in an increasingly global economy, in which the competition for capital and jobs is...