Exercise Fiscal Responsibility

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Dean Baker and Heather Boushey
In These Times, July 4, 2004

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A government should always be able to use its tax and spending policy to fight short-term economic difficulties.

The United States has just been through a quarter-century of economic mismanagement. It is important to keep this fact in mind when considering the budget priorities for the next Kerry administration (we hope), because the economy may intervene in ways that force a reconsideration of the best-laid plans.

Put simply, the large budget deficits of the Reagan administrations and the current Bush administration will make limiting the size of the deficit an unavoidable priority. While the Clinton-era stock bubble has largely deflated, the dollar bubble that the Clinton administration actively promoted persists, as does the huge (and growing) trade deficit—the inevitable result of an over-valued dollar.

The exact course of the dollar bubble is impossible to predict, but no economist believes that the United States will be able to continue to indefinitely borrow $650 billion a year (6.0 percent of GDP) from abroad. A falling dollar will lead to higher inflation and declining living standards because imported goods will become increasingly expensive, which will seriously complicate economic policymaking.

Finally, at some point, the housing bubble will burst. The timing of this collapse is unpredictable, but is likely to follow rising interest rates. There are good reasons for believing that it will collapse soon, but there also were reasons for believing it would collapse two years ago. The collapse of the housing bubble will not only decimate the construction industry, it will quickly end a massive wave of consumption fueled by mortgage refinancing and home equity loans. As a result, when the housing bubble does collapse, we will enter a recession, possibly a severe one.

Understanding this economic situation is important because it limits our ability to address pressing budget priorities. Most importantly, a government should always be able to use its tax and spending policy to fight short-term economic difficulties. For example, if the collapse of the housing bubble leads to a recession, the goal of deficit reduction (an important priority) should be temporarily abandoned in order to provide stimulus through new spending and tax cuts oriented at low- and middle-income families. In addition to deficit reduction, the other top priorities of the Kerry administration should be reining in an out-of-control defense budget and meeting a set of long-neglected social needs, most importantly by fixing the healthcare system and addressing the need for universal pre-kindergarten.

The size of the current deficit provides a real basis for concern even for those of us who are not deficit hawks. To fund the general budget (almost everything except Social Security and most of the Medicare program), the government currently takes in about $1,200 billion a year in revenue. The spending level is roughly 50 percent higher, or $1,800 billion a year. This deficit of $600 billion is equal to about 5.4 percent of gross domestic product (GDP). It is not necessary to balance the budget, but the deficit does have to be brought into a range of 3 percent of GDP to be sustainable. And the only way to reach that 3 percent is to implement tax increases and/or spending cuts in the range of $300 billion a year.

Taking back the Bush tax cuts goes a substantial portion of the way toward correcting this shortfall. Taking back the entire tax cut would raise close to $200 billion annually. Simply taking back the portion of the tax cut going to the richest 2 percent of families (as Sen. John Kerry has proposed) would raise close to $100 billion a year. Other progressive taxes, notably a tax on financial speculation, could go far toward bringing the deficit into line.

In addition, defense spending must be seriously readjusted in order to close the budget gap. The Bush administration has increased the annual defense budget by more than $110 billion (1.0 percent of GDP), with virtually no debate whatsoever. The pursuit of the war on terrorism is a recipe for endless interventions and ever-larger military budgets, but it would be difficult to claim it is making the country more secure. The Kerry administration will have to develop a serious defense policy, which should allow substantial savings, presumably getting the military budget down to levels comparable to those seen in the Clinton administration.

While the Kerry administration must get the deficits down to manageable levels, continued neglect of key social needs will be more harmful to the economy and society than a large deficit. Healthcare must be the top priority on this list. Already, nearly 70 million people go without health care insurance for at least some part of the year. This number is sure to grow as more employers drop coverage or, as is happening more frequently, drop coverage for dependents. Recent policy fixes, such as the expansion of Medicaid under the State Children’s Health Insurance Program (SCHIP), did little to stem the rise in the uninsured. There are indications that the expansion of SCHIP may have only persuaded many low-wage employers to drop coverage for dependents altogether and encourage their workers to sign their children up for SCHIP instead.

But the problem is not the uninsured. The problem is that the U.S. healthcare system is broken, which has led to rapidly escalating costs and deteriorating quality of care. The United States pays more than twice as much per person than the average for rich countries, yet its healthcare statistics rank near the bottom. Unless the system is repaired—along the lines of a universal Medicare system—costs will continue to rise and the number of people without insurance or with inadequate insurance will grow.

Fixing the healthcare system and extending coverage should save money, even in the short-run. For example, the country currently spends more than $200 billion a year on prescription drugs because the government gives drug companies patent monopolies. If drugs were sold in a competitive market, and the government funded research, the savings would be on the order of $120 billion a year. Savings on administrative costs and excessive doctors’ salaries also could more than offset the cost of covering the uninsured.

The other social need that desperately cries for attention is childcare. Most mothers now work outside the home. As a result, they need safe, enriching, and affordable childcare. Spending money to develop full-day pre-kindergarten, attached to the public school system, would not only aid parents juggling work and family, but it would help children succeed in school. Currently, only the lowest income children have access to subsidized childcare. Even the bulk of this group (around 85 percent) do not receive any funds Yet, difficulties accessing childcare—and especially pre-school—is a problem that is felt by families far up the income ladder.

One other problem that should not be neglected, even if it may not require large outlays, is global warming. The consequences of global warming for the planet are enormous. Restrictions on emissions of greenhouse gases will probably be more important than budget dollars in dealing with the problem. But some spending on developing clean technologies, as well as adjustment assistance for displaced workers, will be essential.

Finally, it is important to note one item that does not need addressing—Social Security. The program is completely solvent for the next 50 years, as a new report from the Congressional Budget Office just confirmed. Nonetheless, the business community and some in the corporate media establishment would desperately love to see Social Security attacked—apparently in the belief that it gives too much money to retired workers. The public should have their hatchets ready for any politician who tries to steal their Social Security benefits, otherwise the corporate media and wealthy campaign contributors will become powerful enough to gut the program.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site. Heather Boushey is a Senior Economist at CEPR.