The recent rise in interest rates may mark the first sign that the chickens of Washington’s fiscal recklessness are coming home to roost, as investors worry that huge budget deficits in the coming years will threaten not just recovery from today’s recession but longer-term economic growth as well
Top federal policymakers are responding. Federal Reserve Chairman Ben Bernanke recently urged the White House and Congress to get serious about deficit-cutting, and President Obama’s senior economic advisors signaled a renewed commitment to the goal.
White House Budget Director Peter Orszag said that, despite the private hopes of many lawmakers, President Obama will insist that Congress fully offset the up-front costs of reforming the health care system. In addition, he said, the administration will soon recommend further steps to begin reducing soaring deficits, such as by strengthening the long-term finances of Social Security.
That’s a good start. If policymakers do not act, current deficits will send interest rates even higher (and, thus, threaten economic growth), increase our dependence on China to buy our debt and reduce government’s ability to meet basic needs.
But, for Congress, deficit-cutting is about taking political risks. Lawmakers must raise taxes, cut spending or both, which will anger powerful constituencies. On Capitol Hill, Obama’s key proposals to finance health reform and begin to reduce the deficit are all in trouble, suggesting the tolerance for risk is quite low
So, here’s the question: What will motivate today’s lawmakers to reduce deficits to economically manageable levels?
Over the years, presidents and Congresses have addressed budget deficits for one of three reasons: 1) they were morally opposed to red ink; 2) they worried that the economy would suffer if they did not act; or 3) the public demanded that they do so. None of those factors is present at the moment
Moral aversion: For most of U.S. history, Americans and their leaders looked askance at public debt.
Until Roosevelt’s New Deal, Washington ran annual surpluses far more often than deficits. And when it did run deficits, it was usually for one of only two reasons – a slow economy drained revenues, or the government needed to spend more to fight a war. Once the economy recovered or the war ended, the government would generate a surplus and pay off the debt of the previous period.
Since the 1930s, when Keynesianism provided the intellectual fodder for more routine deficits, Washington has run deficits far more often than surpluses (although usually at economically manageable levels).
Economic panic: After President Reagan pushed tax cuts and a big defense build-up through Congress in the early 1980s, the deficit exploded – rising from $79 billion in 1981 to $208 billion just two years later.
Lawmakers of both parties panicked, fearing such deficits could generate soaring interest rates, skyrocketing inflation, even economic collapse. Because both parties had much to lose – Republicans ran the Senate, Democrats ran the House – they spent much of the ensuing years taking steps to chip away at deficits or, at the very least, ensure that they didn’t get much worse.
In virtually every year, policymakers raised some taxes and cut some spending. The elder George Bush, who won the presidency in 1988, even broke his “no new taxes” pledge to secure a big deficit-cutting agreement with Congress two years later.
Then, with the job of deficit-cutting not yet finished by 1993, economic panic morphed into political necessity under President Clinton.
Political necessity: Clinton assumed office after a campaign in which a third-party candidate, Ross Perot, garnered 19 percent of the vote by speaking forcefully about just one issue – the budget deficit.
Clinton, who had promised to cut the deficit in half during that same campaign, felt compelled to act quickly. By mid-1993, he had pushed his own package of tax hikes and spending cuts through Congress.
Now, Washington again faces the prospect of exploding deficits. But, when it comes to fiscal policy, policymakers have little in common with their predecessors. They have no moral aversion to deficits, no sense of economic panic over them and no political imperative to force action.
So they need a reason to act. Well, here’s one:
Treasury Secretary Timothy Geithner recently had to beg China’s rulers to continuing buying our debt. That leaves us beholden to a rising power that wants to challenge our pre-eminence on the world stage.
Does anyone think that’s good for the United States of America?