Deficits, Taxes & Shared Pain

I’m not an economist, but I played one in college–well enough to know that if you put 100 economists in a room, you’ll get at least a dozen inconsistent theories (and the makings for a really exciting cocktail party!). I believe there is no economic basis for choosing between spending cuts and tax increases. As Matt Dowd pointed out on This Week today, there is no empirical evidence for favoring either. Any hit to economic growth will occur as a result of eliminating debt financing itself, regardless of the source of deficit reduction. The real issue is purely political: who will bear the inevitable pain and when? If we don’t deal with the deficit now, the pain will be deeper and more widespread when America’s financiers ratchet up rates and the federal low-interest debt bubble bursts.

I could rail forever about these issues, but I will keep my main points brief:

1. Tying deficit reduction to the debt ceiling is stupid. I don’t even know why the debt ceiling exists. The need to borrow inevitably flows from a failure to collect enough revenue to pay approved expenses. There should not be a second vote required to pay the bills after the government has already approved the expense in the annual budget. The Republicans’ use of the solvency of the United States of America to extort fiscal policy initiatives they could not pass during budget negotiations should be a criminal offense.

2. The federal government must find a more mature way to compromise now to achieve the deficit reduction everybody agrees must occur. We are borrowing money at zero interest to finance current expenses, but unless we magically return to a budget surplus, that debt will have to be refinanced in the future, inevitably at higher interest rates. We are building a federal debt bubble that is exactly like the home mortgage bubble. The Fed is creating a gigantic adjustable-rate mortgage on America’s future, and when China and Japan insist on higher rates, the bubble will explode. The United States will not default; it will use powers no homeowner has in his arsenal: the government will either raise taxes dramatically or print money, triggering massive inflation. Inflation is the equivalent of a tax on wealth, and Americans’ real net worth will plummet. So take the pain now and cut the deficit, or take the pain later through massive inflation. There will be pain.

3. The only real deficit reduction question is who will bear the pain, and the obvious answer is everybody. Whether senior citizens have to pay more out of pocket to cover their medical care or basic needs or higher income Americans pay more taxes, that money will be removed from the economy and is likely to have similar impact on economic growth. Intuitively, it seems to me that there would be a greater impact from taking money away from poor and middle class people because they would surely have spent the money, whereas the wealthy are more likely to stash it in a savings account where it won’t stimulate any growth (especially when banks are afraid to lend). (I never understood the argument that taxing a doctor, lawyer, major league athlete or pop star at 39% instead of 35% would somehow impair job creation.)

But even if we assume every dollar has the same impact on economic growth, there is no difference between a domestic spending cut and a tax increase. The decision is pure political jockeying among representatives of different interest groups, the rich, the middle class, the poor, and the elderly. My thoughts on wealth distribution have been documented in a prior post: Wealth Distribution, The Law of the Jungle, & Seeds of Revolution. But in the spirit of compromise, surely any reasonable solution will include some combination of spending cuts and tax increases.

4. Republicans are saying President Obama has not presented a specific plan. Well, presenting the specifics would be kind of pointless when the Republican position has been that they will not compromise no matter what details are presented. That said, the President supports the report of the bipartisan deficit reduction panel (Simpson-Bowles) which presents numerous options to choose from to reach different levels of deficit reduction. When the Republicans show up ready to compromise on taxes, both sides can pick their pain right off the Simpson-Bowles menu. If they don’t compromise, the massive inflation triggered by the bursting of the debt bubble in a few years will destroy all that wealth they’re protecting so vehemently, anyway.

What’s your opinion?