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A Fiscal Proposal Both Keynes and Reagan Could Support

Thursday, May 30, 2013

The Left says the government should spend more, but the Right says it should spend less. It sounds like an ideological standoff, but there is common ground.

The growing list of executive-branch scandals in recent weeks and months, along with the bipartisan backlash they’ve generated, seem to confirm a point the political Right has been making: government does some things well, but, especially when one or more bureaus are allowed to run without a leash, government can not only be inefficient and incompetent, it can become counterproductive and dangerous. In short, at least a few agencies and bureaus within the government are making it look more and more like the “beast” that some on the right have been warning about.

In the meantime, the Congressional Budget Office informs us that the federal deficit is shrinking. As one would expect, the shrinking deficit is helping to slow the growth of the debt-to-GDP ratio (federal debt as a share of the economy, a widely employed indicator of a nation’s debt level). Figure 1 shows not only the rapid increase in debt-to-GDP beginning with the 2008 financial crisis, but also hints that measure has recently begun to steady. The Congressional Budget Office projects that the ratio of publicly held debt to GDP will level off at around 72 percent within three years.

Conover Percent 

Why the Deficit Is Shrinking

Today, the deficit is decreasing due to the combined effects of leveled-off federal spending and increasing revenues. Figure 2 compares total federal revenues and spending, clearly showing the disruption caused by the sudden recession brought on by the 2008 financial crisis, as well as today’s shrinking deficit. Although spending has essentially returned to its pre-crisis trend line, the underperforming economy (the “output gap” I’ve discussed before) is still keeping tax revenues below potential. Nonetheless, even a modest uptick in the economy’s growth rate boosts revenues.

 Conover Debt Ratio

But the shrinking deficit begs a question: is it good or bad news? As usual, that depends on whether the liberal Left or the conservative Right is giving the answer. However, close examination of both sides’ arguments reveals some potential common ground for a mutually beneficial, bipartisan approach to the budget.

Is a Smaller Deficit Good News or Bad News?

On one side, the Keynesian Left is lukewarm about the decreasing deficit. According to Bloomberg Businessweek, “Keynesian economists say that the deficit is narrowing too quickly, curtailing growth and threatening to derail an economy that grew a tepid 2.5 percent in the first quarter.” In his 2012 book, End this Depression Now!, Paul Krugman concluded that “in a deeply depressed economy ... we need more, not less, government spending.” In short, if we want to revive the economy, we need more government spending.

At least a few agencies and bureaus within the government are making it look more and more like the ‘beast’ that some on the right have been warning about.

The conservative Right, on the other hand, is guardedly optimistic about the decreasing deficit because they prefer deficit reduction driven by spending cuts, not tax increases, and because they think the cuts should be deeper and happen sooner. A recent article in Forbes dubbed this a pro-growth strategy: “Spending cuts are actually pro-growth ... that is why they were one of the four planks of Reaganomics.”

Both sides know that reviving the economy requires boosting economic growth, but they present us with a paradox: to boost growth, those on the Left say the government should spend more, but those on the Right say it should spend less. In other words, the Right is saying we should starve the government beast, while the Left is saying we should feed it more rapidly.

That sounds like an ideological standoff. Believe it or not, however, there is some common ground.

Some Common Ground for a Bipartisan Approach

The Keynesian Left prefers more government spending, especially “investment” spending that yields benefits long into the future — even if investment spending requires larger fiscal deficits. The conservative Right, although it favors smaller deficits, tends to look back nostalgically on the Reagan years, even though those were years of rapid increases in peacetime military spending and large fiscal deficits.

The common ground is this: if (a) the Left could somehow admit that effective defense spending is actually an “investment” in war prevention (as opposed to war-making), and (b) the Right could somehow admit that effective war prevention spending truly is “investment” that justifies near-term deficits to prevent costly future wars, there’s hope for a bipartisan fiscal agreement with benefits for both sides. The Left would get the “Keynesian” spending boost it desires, and the Right would get the Reaganesque national security boost it desires. If the Keynesians are correct that more government spending will create jobs, and if the Reagan conservatives are correct that defense is the wrong thing to cut, then such a bipartisan proposal to boost our war-prevention capacity will yield rewards for both the Left and the Right.

The seeds for finding that common ground are already in place, but whether those seeds will be able to grow in today’s distracted and politically charged atmosphere is unclear. We already employed the Keynes-Reagan formula successfully during the Reagan years; why not once again?

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy.

FURTHER READING: Steve Conover also writes “Two Budgets, One Point of Agreement, and a Third Way,” “The Tea Party and the Debt Ceiling vs. Economic Growth,” “The Left’s Flip-Flop on the Bush Tax Cuts,” and “Is Government Really 'The Solution'?” James Pethokoukis goes “Beyond Spending Cuts and Deficit Reduction” and asks “Is the Cost of Servicing U.S. Debt Really Ready to Explode?

 

 

Image by Dianna Ingram / Bergman Group

 

 

 

 

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