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September 26, 2005
Intertemporal government budget constraints (or, how to pay for a hurricane)
Mark Thoma spots a debate between Senators Grassley and Harkin, both of Iowa about whether to pay for Katrina rebuilding using tax increase or spending cuts. In case it's not obvious to you who is on which side, read here. I want to address Mark's comments.
First, during the recovery period itself, there is no need to do either, something Grassley seems to implicitly acknowledge elsewhere in his remarks. If the goal is to stimulate the economy during this period, then deficit spending (borrowing) is needed. Offsetting spending on hurricane relief with reduced spending elsewhere or increasing taxes does not provide any short-run stimulus. Arguments about long-run economic growth and tax rates are being mixed up with arguments about the level of GDP in the short-run. Once the economy has recovered, then it’s time to pay the bills. At that point either an increase in taxes or decrease in spending can be used in theory since both reduce the deficit, though in reality tax increases will be needed since spending cuts alone cannot solve our deficit problem. This is where growth considerations come into play and, though there are certainly pockets of fat in government, cuts in spending large enough to dent the deficit will reduce essential spending on infrastructure and social insurance programs and harm rather than enhance our long-run growth prospects and economic security.
I don't totally disagree with Mark. Here's where I take issue with it. I don't find the long run growth argument all that compelling. Unless you can convince me that the government spending being cut is something that enhances aggregate supply as opposed to aggregate demand, then the long run multiplier is probably pretty close to 1. Not to mention the fact that you're just trading one type of spending for another.
If we're talking about one time events, then I can set up a simple opportunity cost question about whether disaster relief is a higher priority right now than a bridge to nowhere in Alaska. (But I wouldn't argue for permanent cuts to Medicaid on that basis.) Permanent tax increases probably wouldn't be necessary. Small spending cuts spread out over time, combined with short term deficits will plug the hole.
But if we're talking about permanent changes and asking for more Homeland Security or FEMA spending then the cuts in other programs would have to be permanent. Cutting the fat out of one highway bill won't be enough. In that case, I would want there to be a real debate about priorities. A tax increase might be more politically realistic in that case, especially if Congress deadlocks over priorities (almost guaranteed).
Of course, using 9/11 as a precedent, I'd be wary of using Katrina as a justification for large, permanent increases in spending. (I'm just sayin'.)
So here's a case where it makes a lot of sense to think about the problem in the context of an intertemporal budget constraint, no matter what your view of the appropriate size of government. Whether this most recent fiscal demand is a one time thing or a permanent shift in priorities is more important to me right now than whether to increase taxes or cut spending. Indeed, the answer to the former would inform my opinion on the latter.
Posted by William Polley at September 26, 2005 1:07 AM
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