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December 19, 2006
Is Pay-As-You Go A Good Idea?
Democrats are taking sides in what is shaping up as one of the party's biggest divides -- its identity on economic issues.
The brewing debate has been overshadowed by the national focus on Iraq. But at stake is the legacy of Bill Clinton and his treasury secretary, Robert Rubin, who in the 1990s redefined the formerly protectionist, free-spending party as a champion of free trade and balanced budgets. That "establishment" view now is under challenge from party populists and organized labor, who have been emboldened by gains in last month's elections to press their case against globalization and fiscal austerity.
My own leanings are probably no secret to anyone who reads this blog on a regular basis -- I'm solidly in the "free trade and balanced budgets" camp. But there is at least one counterpoint about which I might have some sympathy:
While liberal groups believe they have the party establishment on the defensive on trade, they complain that on budget and spending issues, fiscal conservatives have the upper hand. That stems in large part from Democrats' 2006 campaign promise to restore a "pay as you go" budget rule, which would require that any new spending, or tax cuts, be accompanied by offsetting revenue increases or spending cuts to avoid widening the deficit.
Robert Borosage, co-director of the liberal Campaign for America's Future, objects that by insisting on a pay-as-you-go approach Democrats are tying their own hands as they turn toward addressing "decade-old pent-up demands" for domestic spending.
Republicans, he says, never worry about deficits when they cut taxes. "What pay-go says is that the nation's first priority is the budget deficit, and that's just not true," Mr. Borosage says, citing instead the war in Iraq, global warming, energy dependence and trade deficits as bigger problems than the budget shortfall. "When you have a national crisis, you spend the money."
I'm a fan of pay-go rules, but there is a reasonable case to be made for the proposition that deficits have their place. Tom Sargent explains:
Robert Lucas and Nancy Stokey, as well as Robert Barro, have studied this problem under the assumption that the government can make and keep commitments to execute the plans that it designs. All three authors have identified situations in which the government should finance a volatile (or unsmooth) sequence of government expenditures with a sequence of tax rates that is quite stable (or smooth) over time. Such policies are called "tax-smoothing" policies. Tax smoothing is a good idea because it minimizes the supply disincentives associated with taxes. For example, workers who pay a 20 percent marginal tax rate every year will reduce their labor supply less (that is, will work more at any given wage) than they would if the government set a 10 percent marginal tax rate in half the years and a 30 percent rate in the other half.
During "normal times" a government operating under a tax-smoothing rule typically has close to a balanced budget. But during times of extraordinary expenditures—during wars, for example—the government runs a deficit, which it finances by borrowing. During and after the war the government increases taxes by enough to service the debt it has occurred; in this way the higher taxes that the government imposes to finance the war are spread out over time. Such a policy minimizes the cumulative distorting effects of taxes—the adverse "supply-side" effects.
Or consider policies that have short-term costs but long-run benefits. Think growth-promoting free trade policies that nontheless displace some domestic jobs and production today. Or, perhaps, a health-care program (prescription drug benefit?) that immediately raises spending, but offers the promise of better health and less expensive remedial treatments down the road. In cases such as these, you might think that because the benefits accrue to future taxpayers it would be sensible to have them bear some -- maybe even most -- of the costs as well. And that is exactly the nature of deficits -- they shift the tax burden from today to tomorrow.
That is also, of course, the problem. You might have noted the "under the assumption that the government can make and keep commitments " clause in the Sargent quotation above. That is one big "if" in this discussion. And you might suggest that it would be awfully easy for a government to claim that there are big future benefits to some set of policies, even when said benefits are suspect or highly speculative. Or you might reasonably argue that the burdens of future taxation are already inappropriately skewed to future generations (and getting more so by the minute).
For all these reasons, I lean to the pay-go solution. But the contrary view is at least worth considering.
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