The Vicious Cycle of Fiscal Incoherence

As recent developments illustrate, we are in a vicious cycle of fiscal incoherence: our leaders speak cynically, if not dishonestly, about our fiscal problem, fueling public ignorance that presents more opportunity for our leaders to speak cynically and dishonestly, fueling even more public ignorance.

Such ignorance can only impede efforts to convince Americans, in the near future, to accept the bitter medicine of deficit reduction in order to reduce the risk of fiscal calamity and strengthen the economy for the long term.

On Monday, we learned from the latest “Congressional Connection Poll” (a joint project of the Pew Research Center and National Journal) that 66 percent of Americans believe last year’s stimulus bill increased the federal deficit. Duh! Of course it did. It was supposed to do so in the interest of reviving the economy. That’s basic arithmetic.

Meanwhile, just 35 percent of Americans said the bill kept unemployment from getting worse while just 29 percent said it helped state and local governments avoid layoffs and budget cuts. But, in fact, the nonpartisan Congressional Budget Office says unemployment would be as much as nearly two points higher this year without the bill. Meanwhile, the bill’s aid to state and local governments clearly helped prevent even more layoffs and budget cuts than those cash-strapped governments were forced to enact.

Because times remain tough, with unemployment high and the recovery shaky at best, we should not be surprised by public skepticism that government’s actions of the last two years have worked as intended.

But many Americans have moved beyond skepticism to outright, if incoherent, anger at government.

“Just 22% say they can trust the government in Washington almost always or most of the time, among the lowest measures in half a century,” the Pew Research Center reported last spring. Favorable ratings for Congress are at their lowest point, 25 percent, in at least a quarter-century, while just 38 percent believe the federal government has a positive impact on their lives and 30 percent actually view the government as a major threat to their freedom.

So, confusion and anger about the federal government is deep and widespread. Americans don’t know what government does and – based on what they think it does – they are frustrated and fearful.

Why? Well, perhaps it starts with the way policymakers describe the nation’s fiscal problem and what’s needed to fix it.

At one level, this is nothing new. Policymakers have long pretended that we could merely eliminate “waste, fraud, and abuse” and solve our fiscal problem.

Making matters worse, however, President Obama has pledged not to raise taxes on anyone earning up to $250,000 a year – that is, 98 percent of taxpayers. Even less credibly, leading Republicans pretend we can keep cutting taxes and still fix the problem.

Unfortunately, such intellectual hide-and-seek extends to the realm of leading budget experts, as witnessed by Martin Feldstein’s column in the Wall Street Journal this week on “tax expenditures” – the collection of deductions, credits, and other write-offs that enable individuals and businesses to significantly reduce their effective tax rates.

To be sure, Feldstein was right about a few things. Tax expenditures now cost the government at least $1 trillion a year in lost revenue, they represent a form of spending through the tax code, many of the write-offs are unjustified, and we should examine tax expenditures as part of future deficit-cutting efforts.

But, alas, Feldstein went on to confuse as much as to enlighten.

In his first paragraph, he describes tax expenditures as “a wide range of spending including education, child care, health insurance, and a myriad of other congressional favorites.” Two paragraphs down, he says that the congressional Joint Tax Committee has identified, for instance, “more than a dozen tax-based programs that subsidize education and training.”

It all seems like the tax-based version of “waste, fraud and abuse.” In fact, tax expenditures are something quite different.

Like the spending side of the budget, which is dominated on the domestic side by programs that people clearly support (Social Security, Medicare, and Medicaid), tax expenditure are dominated by a few key write-offs that are extremely popular and, politically speaking, very tough to scale back.

Specifically, the two most costly tax expenditures by far are the tax-free benefit of employerprovided health care and the home mortgage interest deduction, according to the Office of Management and Budget.  Following behind, in descending order of cost, are the tax-free treatment of 401(k) plans, the deduction for charitable contributions, the deduction for state  and local taxes, and other popular provisions.

That’s not “waste, fraud, and abuse,” at least not the way people understand the term. Those are provisions that people support and would be very reluctant to part with under almost any circumstance.

Feldstein knows that. Perhaps that’s why he did not tell us forthrightly about the composition of tax expenditures. Such candor might have raised too many hackles about his proposal to scale them back.

At some point, however, the American people must come to grips with fiscal reality. The costliest programs on both the spending and tax sides of the ledger are the ones that people care about. Those are the ones that policymakers will have to scale back in order to restore fiscal sanity.

Suggestions to the contrary, whether by top elected officials or leading economists, only feed public ignorance – and set the stage for a public backlash against any effort to address the deficit head-on.

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