Balance may be good politics, but it’s bad economics
Despite the unprecedented explosion of the federal debt during his first four years in office, President Obama acknowledges that something must be done to halt deficit spending. Throughout the election campaign and since, Obama has insisted that a “balanced” approach is necessary. By “balanced” he means a combination of increased revenues and reduced spending.
Balance implies relatively equal amounts of each — a dollar of new revenue combined with a dollar of reduced spending yields $2 less deficit in the current year. Once this combination of new revenue and spending cuts allows for a balanced budget, the government can cut another dollar from spending and collect another dollar in taxes and make a $2 payment against the national debt.
Of course, the same results could be accomplished by making no cuts to spending and increasing tax revenues by $2, or by cutting $2 from spending and maintaining tax revenues at existing levels, or by any combination of spending cuts and increased revenues that combine to net $2. So why does the president insist on balance?
Well, it turns out he doesn’t. The last-minute fiscal cliff deal is anything but balanced — by most estimates the ratio of new tax revenues to spending cuts is 40 to 1 or higher. House Speaker John Boehner is now saying balance requires offsetting future cuts in spending and Senate Minority Leader Mitch McConnell insists there will be no more talk of increased tax revenues, but both should know that they and their Republican colleagues have been suckered. Obama got much of what he wanted and Republicans got scarcely anything of what they wanted. That deal is done.
The president will demand balance in the next deal as well, because balance has nothing to do with economics and everything to do with politics. Balance is what savvy political negotiators seek. Give $1 and get $1. And if you’re really good, give $1 and get $2. But give $40 and get $1? That’s a wipeout. That’s what Alabama did to Notre Dame. And in politics, as in football, the next game starts with the score 0-0. Notre Dame doesn’t get to start the next game with a 28-point lead. Nor do Republicans begin the next round of negotiations with Democrats agreeing to $39 of spending cuts before talking about another dollar of new tax revenues.
Some economists will suggest that a balance between tax increases and spending cuts is necessary to avoid another recession that they say would result from too quickly eliminating the stimulative effects of government spending. But there is little evidence, beyond the administration’s and Paul Krugman’s assertions to the contrary, that the gusher of federal spending over the past four years has done anything to stimulate the economy. More importantly, there is strong evidence (including from Obama’s former top economic advisor Christina Romer) that marginal rates higher than about 33% do not yield higher revenues. It turns out that taxpayers are not robots.
But if you just keep saying something over and over again, as the Obama administration is prone to do, it turns out that many people start believing it, even in the absence of any supporting evidence. In July 2011, Gallup reported that adults split 50/32 in favor of deficit reduction entirely or mostly via spending cuts versus the “balanced approach.” By November 2012, the split was 45/40 in favor of the balanced approach.
Yet there is no reason to believe a balance between spending cuts and tax increases will get the nation any closer to a balanced budget or allow the federal government to start paying down its enormous debt. In fact, there is persuasive evidence that raising tax rates will yield little if any increased revenue. Higher tax rates encourage investment in tax avoidance and thus discourage investment in economic growth, which is the only surefire way to increase tax revenues.
The only reason to seek a balance between spending cuts and tax-rate increases is to garner enough votes from both sides of the political aisle to achieve agreement. Whether the nation’s fiscal crisis will be ameliorated by whatever agreements a balanced approach yields going forward depends on the extent to which fiscal conservatives in both parties are willing to tip the balance in favor of spending cuts. From an economic perspective, the last thing we need is balance.
Jim Huffman is the dean emeritus of Lewis & Clark Law School, the co-founder of Northwest Free Press and a member of the Hoover Institution’s De Nault Task Force on Property Rights, Freedom and Prosperity.