Wednesday, July 13, 2011

Resolving current fiscal imbalances in the US

Boyes points to one of the approaches that could be used to bring about current US federal fiscal balance - tax policy. The related approach is government spending. The third approach is to monetarize the imbalance through inflation.

The current fiscal imbalance has been decades in the making. Beginning with the Great Society, politicans of both parties followed the predictable path of reaping current benefit (reelection via expansion of the social welfare state) while deferring inevitable costs related to the benefit. One might well argue that the acceleration of the imbalance took place on the Republican watch, but the real issue is, assuming sincere commitment to changing the imbalance, what actions can be taken?

I would argue that before considering scenarios for reducing the imbalance it is incumbent to keep in mind the forces that public choice reveals - politically "easy" actions will take place before politically "dangerous" actions. And secondly, it is obvious that an imbalance that accumulated over a 50 year period will not be significantly reduced in a single year or single term of Congress.

That said, I would also suggest that if I read Douglass North and his colleagues correctly, the informal institutional matrix of beliefs, norms and conventions shape the formal institutional matrix. That being the case, public policy, particularly on an issue as important as taxes, government spending and the value of the dollar cannot run contrary to public opinion.

This being the case, the vast majority of the American public supports the social welfare state as it exists in the US and would oppose significant change to social security, medicare and medicaid. The Pew Foundation survey of public opinion revealed that Americans prefer tax increases to spending cuts.

The conundrum for policy makers, interested observers and economists is what to do in the face of this constraint. If the survey is correct and is a representation of the informal institutional framework of society, efforts that conflict with this set of beliefs will be unsuccessful.

The least worse option, it seems to me, is to align federal spending and taxes rather than to use inflation to monetarize the deficit. In plan English, tax increases are preferable to inflation.

I write this not advocating tax increases, rather from my belief that there is virtually no support for the alternative - steep reductions in social security, medicare and medicaid. A back of the envelope analysis confirms that, the cuts necessary in these 3 programs to reduce the deficit significantly are so large as to both be unacceptable to the public and to be disruptive (think Greece) to social stability.

In thinking about this one might attach consequences to various future courses of action:

Scenario 1 - no meaningful action toward fiscal balance using the budget. If no significant changes are made to tax and spending at the federal level this leaves only the action of inflation to resolve the imbalance.

Scenario 2 - meaningful government spending cuts to all categories of the federal budget without a change in taxes. As Boyes points out, the regime uncertainty resulting from state action has a tendency to cast a long and dangerous shadow over government activity. Given the track record in Washington, I wonder how long this scenario would need to continue in order to overcome the uncertainty that seems institutionalized in government activity. Certainly more that one policial cycle would need to transpire to provide authentic belief by the players in the US economy - both domestic and international.

Scenario 3 - a repeat of the recent past.

I have made consist efforts to find optimism in my view of our emergent order in the US, the evolution of the government and the financial imbalances that seem to be a consequence of Leviathan seem, in the past, to have generated sufficient innovation that the resulting creative destruction is Schumpeterian rather than Marxian. That said, I wonder what the future holds.

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