Glory be, the funks on me: Pay as you grow

[Winslowalrob]

The Democrats' economic policy

Pay as you grow

Jun 16th 2007 | NEW YORK

From Economist.com

Getting back in shape?

Hulton

IF DEMOCRATIC politicians had a theme song, it would be “Those Were the Days”. After years of war, budget deficits, and middle-class wage stagnation, Democrats are promising a return to the sunny Clinton years, when peace prevailed and a rising tide lifted all boats. Vote Democrat, runs the subtext, and erase the colossal mistakes of the past two elections.

Nowhere is this clearer than on the issue of fiscal policy. Polls show that voters no longer regard the Republicans as the party of solid fiscal responsibility. When George Bush took office government outlays were 18.5% of GDP; by 2006 they were 20.3%. Most of the extra has been discretionary spending, with military costs up by a third.

The Democrats have promised a change. Early after taking over Congress they instituted a procedural rule mandating pay-as-you-go (PAYGO): any new tax cuts or increases in government programmes, such as Medicare, must be paid for with new revenue or cuts elsewhere. Democrats say they would like to make the rule a law, if only Mr Bush could be counted on not to veto it.

The implicit promise, echoed by various presidential hopefuls, is that more frugal fiscal policy, and a more balanced budget, will produce the same rapid growth in GDP, employment and tax revenue that graced the Clinton economy.

The Democrats have put forward a budget resolution that projects a slight surplus by 2012 as tax revenues rise and spending falls. But the real tests are ahead. PAYGO must withstand expensive projects, such as a farm supplement dear to mid-westerners.

Congress also needs to fix the Alternative Minimum Tax (AMT), a system originally designed to catch rich people who otherwise found ways to pay little or no income tax. With fewer deductions and a flat rate, it pushes up the tax bill for those caught in its grasp. Bracket creep means that now includes people with incomes of $75,000—comfortably off, but not the wealthy finaglers the tax was designed for.

So far Congress has passed temporary fixes. Democrats now say they want a permanent solution, either an adjustment of brackets and deductions or an outright repeal. But just keeping AMT at current levels, where it hits about 4m taxpayers, would cost $40 billion in 2007 alone, rising thereafter, according to the Tax Policy Centre. Democrats are weighing various plans to finance a repeal (full or partial), by levying surcharges on some high earners. But this may solidify their tax-and-spend image.

Yet they have one weapon: the surprising strength of tax revenues, which have cut the budget deficit far quicker than anyone expected. The latest projections from the Congressional Budget Office show a budget deficit perhaps as low as $150 billion (though it could be as high as $200 billion) at the end of the year, just over 1% of GDP—less than at the end of Mr Clinton’s first term.

Even if the deficit narrows it is doubtful if America will relive the 1990s boom. Mr Clinton's supporters credit much of that decade's growth to his deficit-reduction plan. By cutting government demand for capital funds were freed for private investment, boosting productivity and expanding the economy, and tax revenue.

These days, however, America is awash with capital from foreign savers. Analysts may be heard complaining that there has been too much capital around of late, producing a credit bubble—one that is now deflating, taking economic growth with it. (Rising bond yields also hint that foreigners’ enthusiasm for American assets is waning.) On Tuesday June 12th, Larry Summers, Mr Clinton’s treasury secretary, indicated that, because of this, he did not expect a burst of growth from deficit reduction this time.

He believes, nonetheless, that cutting the deficit is a good idea, because America’s government borrowing abroad poses other economic risks. And there is no reason, other than lack of political will, that America should be running deficits at this point in the business cycle. Politicians are storing trouble for future taxpayers in order to fund consumption today.

But the biggest problem may not be the current deficits (economic growth and inflation may erode the value of today’s debt). More important, future taxpayers will have to deal with unfunded liabilities of Medicare and Social Security, which will leave gaping structural deficits. By the latter part of this century Medicare alone is projected to cost 11% of GDP if left unchecked—over half of current federal tax collections.

Neither presidential candidates nor Congress have come up with a solution. The most serious attempt may be Hillary Clinton’s proposal to concentrate spending on evidence-based medicine and preventative care. That sounds laudable, but it is unclear whether it would deliver the massive savings needed. More drastic measures, like rationing, may yet need to be considered.

My smirk was so damn big when I read this you could see it from outer space. Americans, at least according to the polls, no longer regard the Republicans as fiscally responsible? Took them long enough to realize it, but man that cracked me up. I also rather enjoyed an old Economist blog detailing how Silicon Valley libertarians were starting to vote Democrat because they felt that the Democrats had managed to become closer representatives of classically liberal ideals. In any case, I sense a strong year for the Democrats in 2008 if they can show that they know more about economics than the Republicans .