Disease in drag as diagnosis: The conservative attack on sound public finance.

by: Paul Rosenberg

Tue Dec 28, 2010 at 15:00

First, here's DeLong's rules (with some shorting that cuts out some interesting, but not essential details in #4 and #5):

Five Rules for Public Finance: And so now we have arrived at five rules for public finance:

(1) The government must do whatever is necessary in order to make sure that people have confidence it will pay back its debts.

(2) You really ought to have budget balance over the business cycle. It is fine to run cyclical deficits in times of high unemployment, but you really should balance them with surpluses when the economy is in a boom.

(3) That implies Milton Friedman's Pay-as-You-Go principle that he set out in his late 1940s framework for fiscal and monetary stability: whenever the government takes on a mission to do some long term spending program, it also needs to match that by imposing some tax large enough to fund the spending. Changes in government spending plans over time should be accompanied by changes in taxes so that when politicians make decisions and when voters evaluate politicians there is no gaming the system.

(4) You need to keep plenty of headroom in your debt capacity in normal times. In normal times you should aim to keep your debt-to-GDP ratio fairly low. There will come emergencies and opportunities during which you will want to increase your debt-to-GDP ratio. Remember 1803: Thomas Jefferson was president and Napoleon I was about to become Emperor and was willing to sell French "rights" to the entire Louisiana territory. The United States had plenty of debt capacity and could easily afford to borrow--and Jefferson did. Thus we have a United States that doesn't end at the Mississippi river but instead continues all the way on from the Atlantic to the Pacific Coast. The War of 1812, Civil War, World War I, World War II--in all of them we were very grateful that we started with a low national debt-to-GDP ratio. The government wanted to fight these wars for reasons that it thought were sufficient. It was able to borrow in order to build the armies and navies and air forces to fight them, It could not have done that if the debt to GDP ratio was really high. The Great Depression and the current Great Recession--we want to respond to them by deficit spending as well....

(5) But that does not mean that countries should not borrow except in emergencies. It is perfectly okay for a government to borrow and run up its debt when it is undertaking projects that are going to primarily benefit future generations.Taxing the citizens of the East Bay and San Francisco right now to pay for the entire reconstruction of the Bay Bridge seems unfair--the new Bay Bridge will still be there and be earthquake-safe 50 years from now. People who are going to move into the San Francisco area 40 years from now will benefit from the bridge. They should pay some part of the cost. Thus you should finance infrastructure projects that build up productive capacity through borrowing and debt.

You should also finance current spending through borrowing and debt if you think the future is going to be a lot richer than the present....

So here we have our five rules for public finance.

And now here's the conservative critique:

A Right-Wing Conclusion: I want to close this lecture by making a right wing argument that these five rules are inconsistent and we have to drop one of them.

This right-wing argument is one that back when I was your age I pooh-poohed as nonsensical and simply silly. But it is 30 years later. I at least feel a little bit wiser. It's not that I believe this right-wing argument completely. But it has much more force with me than it did 30 years ago.

The argument comes from Nobel Prize-winning James Buchanan. He pointed out two generations ago that he didn't think that these rules were politically sustainable. If you try to enunciate the principal that cyclical deficits in downturns are good and permanent structural deficits are bad--that is just too complicated for the political system to process. If you tolerate and approve of cyclical deficits to fight downturns, Jim Buchanan argued, then you're setting the political stage for permanent structural deficits because politicians will be eager to grab the argument that the deficits that they want to run are actually good for the economy.

Allow cyclical deficits, and you make permanent large structural deficits likely. They will slow growth by crowding out investment. They might eventually lead to an erosion of confidence in the government's ability to pay back its promises--and so lead you down the road to Mad Max.

Actually, the structural deficit/structural deficit is not inherently too difficult for the political system to process.  This was not an objective assessment of historical reality, but a strategic assessment of political vulnerability, and one that Ronald Reagan proceeded to begin exploiting to the hilt in order to destroy the welfare state, and thus return the majority of the citizenry to a state of permanent want, which conservatives have always thought to be the morally proper order of things.  

After the 30 years of deliberate Republican fiscal irresponsibility, running huge deficits due to massive reductions in progressive taxation at the national level (while state and local taxes remained hugely regressive, and regressive payroll taxes were also significantly increased), they are positioned to move their long-term attack on the welfare state into its next phase. But it was never the political system in and of itself that couldn't tell the difference between structural and cyclical deficits.  That was never the real story of what was going on.  It was just the conservative cover story--nothing more.

Misleading the public on fiscal policy--among many other things--was always a key aspect of conservative strategy.  The problem wasn't the system, but conservative's ability to game the system. And the solution wasn't to give up on sound fiscal thinking, but to strengthen the truth-orientation (aka "reality-based orientation") of the political system.

This is, in short, just another chapter in the age-old dispute between liberals and conservatives.  Conservatives--living on Kegan's Level 3--say that we're doomed because of the nature of the cosmos and ourselves. Liberals--living on Kegan's Level 4--say, "Wait a minute. There's an app for that."  And if not, Radicals--living on Kegan's Level 5--will come along and invent one.