'Game over' for the 30-year fiscal wars By: David Stockman

'Game over' for the 30-year fiscal wars
By: David Stockman
February 24, 2010 06:03 AM EST

The Obama budget is a rank fiscal cop-out. While calling for budget discipline, it proposes no meaningful tax or spending changes for the next 10 years — a virtual fiscal lifetime. The administration is thus wagering that its projected $9 trillion of new bond issuance over the coming decade won’t go bump in the night, ever.

Not to be outdone in the eyes-wide-shut department, New Hampshire Sen. Judd Gregg, speaking for Republicans, duly sounded the fiscal alarm, too. Puffing himself up to deliver a loud call to action, he urged a “game changer” while neglecting to mention a single concrete policy action that might make a difference. Only in the U.S. Senate are people paid to utter such brazen platitudes.

The truth is that it’s “game over” with respect to the nation’s fiscal predicament. We are hurtling irreversibly toward a budgetary crack-up that will generate the mother of all crises in global bond and currency markets.

Admittedly, there is no shortage of blueprints that could forestall this Judgment Day. Earnest scribblers such as young Rep. Paul Ryan (R-Wis.) have proposed innovative ways to drastically shrink entitlements; and the mountain of new tax revenues needed to pay our bills is not hard to specify.

We could start with a transaction tax on Wall Street’s fevered money-spinning. Add a 3 percent consumption tax on Main Street to go with Obama’s plan to soak the rich. Soon, you have a half-trillion-dollar boost to the nation’s depleted revenue base.

But none of this has a remote chance of passing. In declaring “game over” on his own career last week, Sen. Evan Bayh (D-Ind.) finally outed the reasons why. The nation is ensnared in the maw of “brain-dead ideology,” Bayh said, and it is utterly ungovernable on the fundamental issue of public finance.

The calamity ahead is deeply rooted in more than the Obama stimulus stampede of recent months or the eight years of Bush fiscal debauchery preceding it. The real problem has been gestating for 30 years — as the essential ingredients for successful fiscal governance were eviscerated.

The first casualty was the disappearance of competition between the Democrats and Republicans on the budget’s bottom line — the fiscal deficit (or surplus). This was the result of a remarkable transformation of fiscal policy ideas over the half-century between 1932 and the early 1980s.

During the 1932 campaign, Franklin D. Roosevelt actually tried to “out-Hoover” the incumbent president in his ardor for a balanced budget. But FDR then led the Democrats permanently into the “deficits don’t matter (much)” camp — embracing the spending curatives of the New Deal.

Roosevelt’s defection from fiscal orthodoxy left the field open for the mainstream Republican Party of Wendell Willkie, Everett Dirksen and Gerald Ford to perennially campaign for a balanced budget, preserving a countervailing force in fiscal governance.

Indeed, as a backbencher in the late 1970s, I vividly recall House Speaker Thomas P. "Tip" O’Neill’s smoking-hot irritation whenever Republicans began beating the anti-deficit tom-toms. After all, the speaker needed only to look over his side of the House and wonder how many would be casualties in the next election if red ink became too effervescent.

During the Reagan era, this balance of political force disappeared. Aside from charlatans such as Arthur Laffer, Republicans didn’t desert straightaway to the “deficits don’t matter” camp. Instead, they embraced a more insidious proposition: that deficits disappear on their own if doused with enough economic growth from tax cuts and deregulation.

Never mind that there was never any budgetary math to support this fiction. The profound consequence was that after the GOP also abandoned the old-time religion, the inherent fiscal profligacy of American interest-group democracy was given free rein.

Indeed, lacking any coherent fiscally conservative opposition party, the nation’s finances have succumbed to the raw, parochial imperatives of organized lobbies and hometown industry. These primal political forces now heap fiscal largesse on clunker cars, random homebuyers, farm-belt ethanol plants and Wall Street bankers with bipartisan equanimity.

The second casualty has been the notion of sound public finance. The budget is now treated like a subservient stepchild of macroeconomic stimulus and hyperactive growth management.

Republicans have become tax-side Keynesians, ready, in good times and bad, to juice the national economy with every manner of tax-cut and subvention that K Street denizens concoct. Republicans have locked arms with their spending-side Keynesian brethren among the Democrats who, in turn, long ago made a convenient discovery that economic growth and jobs can always be deemed to lag below alleged “full employment potential” — justifying an endless procession of fiscal stimulants. The only debate now is over the mix of tax versus spending giveaways.

While this crude “Keynesian consensus” is an enemy of fiscal stability, it might be a tolerable trade-off if it actually led to sustainable prosperity and jobs. But the Washington conceit that activist monetary and fiscal policies do any good has been thoroughly discredited. Two epochal macroeconomic calamities have proved the case.

After the Johnson-Nixon policies of guns, butter and easy money, we got a decadelong scourge of soaring inflation in the price of commodities, goods and money during the 1970s, along with stunted economic growth. Then came the even more egregious Greenspan-Bush-Bernanke orgy of fiscal and monetary promiscuity, and an even greater inflation. This time, it was in asset prices, followed by a devastating financial collapse and long-lasting economic damage from the bubble era’s rampant malinvestment and debt burdens that still remain to be liquidated.

The current bipartisan consensus that we need either another round of tax cuts, per the GOP caucus, or a Pelosi-Reid spending barrage to jolt the macro-economy out of its hangover from the last stimulus is, therefore, badly mistaken.

Both unreconstructed Keynesians, such as Paul Krugman, and closet Keynesians, such as Ben Bernanke, would have us believe that, 15 months ago, aggregate demand suddenly sprung a giant leak that must be plugged with fiscal and monetary injections to private spending.

But after the Panic of 2008 there was no mysterious demand leakage — just the final exhaustion of a 30-year borrowing binge by households and businesses. So “counterfeit demand,” based on unsustainable borrowing that had swelled the boom economy, has now been irrevocably dissolved. This means that honestly measured gross domestic product is lower than before, and the nonbubble job count is about 20 million fewer (counting part-time and discouraged workers) than previously reported. Permanently adding trillions to an already staggering national debt, to re-create spending and jobs that were an illusion in the first place, hardly constitutes sound economic policy.

The collateral damage to the fiscal policy process from this Keynesian consensus, however, is palpable. At 15 percent of GDP, Federal receipts are at their lowest since World War II, yet both parties pile on jobs, housing and investment tax credits that further dismantle the revenue base. Similarly, spending is at an all-time high of 25.5 percent of GDP, yet white-elephant stimulus projects, such as high-speed trains that local taxpayers would never pay for, push the spending ratio ever higher.

Principles of sound public finance condemn bond issuance equal to 40 percent of outlays and 10 percent of national output under almost any circumstance short of enemy invasion. Moreover, lead times for the massive tax and spending changes needed to alleviate this are three to five years.

But with both parties in thrall to the Keynesian consensus, the necessary remedial policy actions might never get started. Politicians are on an endless treadmill, chasing near-term fiscal stimulants that invariably block the way to longer-term fiscal reform.

The third casualty of the past 30 years is bipartisan fiscal disarmament. In May 1981, the Reagan White House, where I was budget director, proposed a constructive reform of Social Security early retirement that could have been the opening gambit in taming the monstrous growth of non-means tested social insurance programs.

It was not to be. The next day, the Democrats ignited a firestorm of protest, and on the third day, the initiative was rechristened the Schweiker Plan — after the hapless HHS secretary who got stuck with it. Then and there, social insurance became inviolate — the third rail of politics. Now, the two main programs — Social Security and Medicare — are projected to cost $1.2 trillion, or 8 percent of GDP.

Once the Democrats decreed that the entitlements of even the wealthiest one-third of the retirement population were sacrosanct, they became the “high-tax party.” There was no place else for them to go.

In the coming budget year, for example, an additional $650 billion will go to means-tested programs and unemployment benefits, $500 billion to domestic appropriated programs, $800 billion to national security and $200 billion to interest. But Democrats wouldn’t cut the safety net; can’t abide even a freeze on domestic discretionary programs; must pay the interest, and are now the war party, responsible for every dime of the defense bills.

For the 28 years through the 2008 election, the Democrats ducked their responsibility to come out of the closet for high taxes on everyone. They did this by denying their own fiscal math with the fraudulent claim that repeal of “trickle-down” tax giveaways to the rich would solve the problem. Now they are in the White House, and propose a budget that eliminates every vestige of the Bush tax cuts for the rich. No one should whine about ending them. But this generates the grand sum of $50 billion three years from now, when the annual budget gap is expected to be upwards of $2 trillion — 40 times more.

Presumably, this first Obama budget was meant to be “change you can believe in.” But on the core issue of tax disarmament, it is the same old fiscal fakery you should fear. It marries-up the long-standing Democrat ban on middle-class entitlement cuts with a new proscription on tax increases for households earning less than $250,000 a year — the entire middle class. Not even the fiscal sleepwalkers of the Bush era managed to proclaim a set of budgetary postulates so at odds with reality.

Helping to sugarcoat the unreality of the Obama budget is the noxious convention of 10-year budget projections when there is no economic visibility for 10 months — or even 10 weeks.

Nonetheless, administration officials blather on about saving $1 trillion from the upper income-tax increases, $100 billion by closing corporate tax loopholes on off-shore income and $40 billion each from hitting energy companies and the carried-interest income of hedge fund operators.

During the same 10 years, however, GDP is forecast to total $200 trillion! So, all this faux populist sound and fury against tax malefactors amounts to a rounding error — just one-half of one percent of GDP — compared to the problem, that is 10 percent of GDP.

The Democrats’ political cowardice on tax disarmament is exceeded only by the GOP’s pusillanimity on spending cuts.

Republicans foreswore any appetite for entitlement cuts decades ago. But they managed to keep banging the pans about overspending in the tiny 12 percent slice of the budget covering domestic appropriations. Under the somnolent fiscal regime of George W. Bush, however, the GOP dropped even this frail budgetary weapon faster than a French army rifle. Specifically, budget authority for the domestic discretionary programs that President Obama would now freeze was $262 billion in 2000 and had risen by 60 percent, to $420 billion, in Bush’s final budget for 2008.

Thus, after 6.5 percent compound growth over eight years, without a single veto in the last redoubt of the budget where Republicans were even willing to whisper about budget cuts, the GOP has adopted unilateral disarmament on spending as party policy. So the persistent, vicious campaign by Republican politicians and party organs against tax increases in any way, shape or form gives the concept of mendacity a whole new definition.

The nation is hurtling toward a budgetary doomsday because the tax-and-spending policy disarmament of both parties over the last 30 years has rendered it fiscally ungovernable. In the context of this debilitating political affliction, Obama’s new deficit commission has about as much chance of success as the Aussie lads at Gallipoli.

The final casualty of the 30-year fiscal stalemate has been the addiction of policymakers to Rosie Scenario — the long-range economic forecasts that assume average growth rates that are never reached.

Admittedly, as a participant in the 1981 Reagan fiscal plan, I was complicit in Rosie’s debut. The lesson learned by later policymakers, however, was not, as it should be, that wishful thinking backfires, but that unwarranted hope springs eternal.

Thus, the Obama budget assumes real growth of nearly 4 percent per year in an economy still listing from the collapse of a 30-year debt spree. More improbably, it assumes nominal GDP grows by 6 percent annually for five years — though the world economy is caught in a powerful deflationary downdraft, and nominal U.S. GDP has not grown at anything close to a 6 percent rate since early 2006, before the day of reckoning arrived.

The laws of compound arithmetic extract a painful toll when these numbers are reset to more realistic values. Nominal GDP could easily grow at only 3 percent, meaning the size of the U.S. economy forecast for 2015 is overstated by $2.5 trillion and Federal receipts by $500 billion annually — while spending is probably understated by several hundred billion more. Thus, adjusted to real-world assumptions, the White House budget projects a $1.5 trillion deficit out as far as 2015, and $10 trillion of incremental bond finance in the interim.

A while back, when Tiny Tim Geithner told a group of Beijing students that Washington would get its fiscal house in order over the next five years, they guffawed. It is no wonder.

The U.S. economy is comprised of an aging, debt-burdened population which manufactures little that is competitive in today’s over-capacitated global economy. In fact, we are down to 8 million manufacturing production jobs in an economy with 150 million workers. Such an economy must drastically cut spending and ramp-up savings and reinvestment to ever regain a healthy footing. That means public-sector savings in the form of budget surpluses, along with higher household savings rates than we have had for decades.

Given these imperatives, you might wonder where our befuddled Treasury secretary came up with the notion that 3% of GDP deficit as far as the eye can see — even if honestly calculated — is good enough. The obvious answer is that he came up with that dubious proposition while flying by the seat of his pants — just like he did in giving $180 billion to the claimants of AIG.

A fiscal doomsday looks certain, therefore, because the actions required to avoid it are beyond the capability of our ungovernable fiscal process. A minimum structural change in the Federal budget equal to 5 percent of GDP, or $800 billion per year, is needed.

The Obama budget shows that taxing the rich brings in $100 billion. Another $200 billion can be raised by means-testing Medicare and Social Security, cutting the top one-third by an average of 40 percent. The inescapable fiscal math is that we would need at least a 3 percent national sales tax to extract $300 billion per year from Main Street.

As for the remaining $200 billion, there is an elegant supply-side solution. It is said that if you want less of something, tax it more. Owing to the Fed’s fantastical money printing spree, Wall Street has been transformed into a high-frequency trading casino, which accomplishes little except to extract ill-gotten rents from the nation’s households and businesses. A “Tobin tax” on every stock, bond, commodity and derivative transaction, whether done on an exchange or over the counter, would do no economic harm and might even shrink a financial economy that is bloated beyond reason.

Of course, there is not a chance that such robust measures will be adopted. After 30 years of evisceration, the ingredients for successful fiscal governance are gone. The current drift toward doomsday is likely irreversible.

David Stockman, a director of the Office of Management and Budget under President Ronald Reagan, is writing a book about the financial crisis “The Triumph of Crony Capitalism.”