The political economy of debt and deficits


The Niskanen Center’s namesake, William Niskanen, is known to categorically reject the “starve the beast” theory of spending cuts. Cutting taxes, Niskanen argued, does not automatically lead to spending cuts over time. On the contrary: in the short term, deficit financing reduces the cost of government programs as experienced by the public, creating a “tax illusion” that increases the demand for larger spending over time – a conjecture that Niskanen pursued. . empirically test.

The failure of the “starve the beast” strategy is now well known, and yet that did not stop Congress from passing a deficit-funded tax cut in 2017, with the promise that it will be paid for by future rights reforms. As a result, the US federal deficit has exceeded one trillion dollars. This historically unprecedented level of public debt in peacetime was made possible by unusually low interest rates, but also by an equally unprecedented ebb in the political clout of budget conservatives on both sides of the aisle – and all. this before the Covid-19 pandemic.

Democratic debt deficit

The argument for fiscal sustainability has always looked to the future. As economist Herbert Stein’s famous “law” says, “a trend that cannot last forever will not.” And yet budget hawks have tended to wage the final battle, either by seeking politically untenable cuts to popular agendas, or by insisting on procedural tricks in the budget process that are routinely removed or easily played out. These two approaches are victims of what economists call the problem of “temporal inconsistency”, which is only a technical way of saying “today’s actions, tomorrow’s regrets”.

A deep appreciation of the political economy of debt and deficits, as captured in concepts like fiscal illusion and time consistency, can help differentiate between those who care about fiscal sustainability. and those who use fiscal sustainability as an excuse for widespread austerity. Understanding policy incentives is also essential for designing fiscal rules that work as well in practice as they do in theory – a challenge our colleague at the Niskanen Center, Ed Dolan, noted in his 2021 report, “Rules for Sustainable Fiscal Policy ”.

Unfortunately, the contemporary debate largely neglects the political dimension of deficit financing in favor of purely macroeconomic considerations. Consider the insolvent pension funds that the Biden administration’s US bailout bailed out to the tune of $ 86 billion. Such a large and unconditional transfer of wealth to union interests was only possible because of deficit financing, which separated the link between the benefits and costs of the bailout, thus blunting the ability of voters to assess the situation. compromise in the here and now. In contrast, similar union pensions in Denmark – Bernie Sanders’ model of socialist paradise – are fully funded by law. In fact, all of the major welfare states in Scandinavia ensure that future obligations are funded and with some relation to the recipient’s ability to pay, including through significant value-added taxes. They do this not in a spirit of austerity, or with the exclusion of taxes on the rich, but rather as a crucial aspect of good and honest government, ensuring that the public gets all the government they want and is willing to pay – but No more.

Freed from having to make difficult choices, lawmakers are free to pursue timely reforms that reward politically favored interests with minimal resistance. The rationale for the link between spending and funding is democracy, not austerity – ensuring that public tax claims are fully deliberated and justified in light of other public priorities. In the future, the interminable deficit funding of new programs therefore risks allowing interminable waves of rent-seeking by providers of goods and services whose costs are sick.

The above is an excerpt from Cost Disease Socialism: How Subsidizing Costs While Restricting Supply Drives America’s Fiscal Imbalance, and is part of our Captured Economy of Cost Disease series exploring the political economy of debt and deficits. It is made possible through the support of the Peter G. Peterson Foundation.

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