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These eight changes will greatly facilitate making the needed budgetary responses to the recession and the 9/11 terrorist bombing.
In the 2000 election campaign both parties promised to put Social Security (SS) and Medicare baby-boom surpluses in a "lock box" and not raid them for non-SS purposes. But that promise was broken, even before the 9/11 terrorist attack, by the recession and President Bush's budget-busting tax cut -- which he has so far refused to rescind as a fiscally responsible response to the new situation. Congress now seems ready to "do what it takes" to repair the attack damage, win the "war" against terrorism and recover the economy, without much concern about how it will be paid for. Since Bush seems to have little interest in addressing, or even acknowledging, the aspects of US foreign policy that have fueled Arab/Muslim anger, that war and its costs are likely to escalate sharply. The SS lock-box promise seems out the window, and budget forecasts now see the SS surplus again financing non-SS deficits, as before 1998. As the federal funds rate approaches zero the Federal Reserve seems to be losing control of the economy.
Adding to this discouraging prospect, the Democrats, timidified by the demand for "bipartisan national unity," have refrained from demanding cancellation of Bush's future tax cuts, or effectively opposing his star wars chimera, and have even offered to cut back on their own proposals for much needed education and other social investment spending, while Bush proposes to take advantage of the crisis to win even more tax cuts for business and the wealthy under the banner of "fiscal stimulus." It would be a real tragedy if this crisis leads to a repetition of the Reagan/Bush fiscal irresponsibility of the 1980s that quadrupled the federal debt and its interest burden on taxpayers. That would be very expensive "collateral damage" from the terrorist attack.
This article suggests that the best way to prevent this outcome would be to use this crisis to make long-needed basic reforms in how we deal with budget and Social Security finances -- fiscally and economically sound changes that will make both of them easier to understand, easier to manage, and less vulnerable to political shenanigans.
The FY 2001 pre-attack budget provides a useful example of the value of this "dual budget" appoach. Merely excluding the roughly $70 billion budget cost of the extra 1% unemployment (whch Congress could not control), would have changed the CBO-projected $9 bllion non-SS operating budget deficit (which was financed by raiding the SS baby boom reserves) to a $61 billion Policy Budget surplus -- enough to end the supposed "fiscal straightjacket" with less partisan wrangling, and without raiding the $162 billion SS baby-boom surplus.
As most people now realize, Fed monetary policy largely controls the whole economy's growth rate and unemployment rate. The standardized Stabilization Account provides a valuable measure of the budget cost of the recessions that the Fed causes ("to control inflation"), or inadvertently permits. This budgetary cost of recession unemployment has been one of the largest causes of public debt buildup. Even during the fiscally irresponsible Reagan/Bush 1980s, it accounted for more than half of total deficits. Thus, to prevent long-run federal debt buildup, it's most important to get the economy back to full employment before its basic productive capacity has been further diminished by layoffs, bankruptcies, financial disorganization and postponed investment -- which create the supply conditions for inflationary pressures during recovery.
What about Federal spending? The disruptive across-the-board "austerity" federal spending cuts advocated by some "smaller government" ideologues would clearly be counterproductive, both economically and budget-wise. But in a (hopefully) short recession like this, trying to use increased federal spending as "fiscal stimulus" isn't much better because it is too slow to get started and almost always ends up inappropriate in amount and timing.
However, a recession is an appropriate time to initiate badly needed but long-postponed public investment spending that is evaluated on its own merits -- schools, high speed rail, computer bike paths, bridges, wind farms, universal public health service, higher salaries for teachers and nurses, to name a few (cf. the post 9/11 Economic Policy Institute Briefing Paper, "Addressing the Nation's Needs...").
But keep in mind that the Policy Budget is a "full-employment" budget, where spending must normally be matched by appropriate tax revenue. For instance, the estimated $40 billlion Federal spending planned for repair of the attack damage, and for anti-terrorist protection and war, will undoubtedly help stimulate recovery -- as would almost any other federal spending. But since it will probably continue long after we should have recovered from this recession, it should not be treated as deficit-financed fiscal stimulus. Like any other Policy Budget disaster relief spending, it should be financed, if necessary, by increased taxes -- in this case, preferably by whatever reduction is needed in Bush's budget-busting long-run tax rate cuts. Even the much needed reforms of the unemployment insurance and other "safety net" programs -- to include not only those laid off because of the terrorist attack, but also the millions who are not now covered at all -- should also be treated this way. However, because their recession-induced benefit increases are automatically reflected in the Stabilization Account, only their basic adminstrative costs compete with other, tax-financed, social spending in the Policy Budget.
This analysis also applies to indirect federal spending through revenue-sharing grants to state and local governments (including funds based on local unemployment rates, to prevent recession-hit localities from having to cut back on their own spending), grants to private businesses and non-profit organizations, and "tax expenditures" (the cost of "tax incentives").
The U.S. is a wealthy country, now taxed at a much lower rate than most other industrial countries. We can well afford to catch up with them in public infrastructure and public services, and pay for it responsibly with appropriate Policy Budget higher taxes -- particularly the conservation-inducing energy taxes that could have prevented a lot of trouble if President Clinton could have gotten them eight years ago. Let's use this crisis as an opportunity to bring the nation together, non-partisanly, on rebuilding America. Plans for these "nation-building" expenditures should be included in the revised 2002 Policy Budget,
Bush and other "smaller government" conservatives say that individual taxpayers know better how to spend their money than the government does. But this crisis has shown how false this unpatriotic idea is. Now is the time to frontally challenge it. The needed public expenditures could do much more for America, as a nation, than the multi-million-dollar mansions and yachts, the $100,000 cars and $5000 designer dresses and other baubles that have been financed in recent years by bloated stock gains. If Bush and the "smaller government" conservatives refuse to join this "crusade" on a non-partisan basis, the Democrats should make this issue a key plank in their 2002 and 2004 campaigns.
Why tax cuts for fiscal stimulus? Fed Chairman Alan Greenspan and former Clinton Tresury Secretary Robert Rubin stressed in their 9/25 testimony before the Senate Finance Committee that temporary tax cuts, appropriately designed in timing and amount, are more effective fiscal stimulus than legislated changes in spending or permanent tax rates. In a 9/30 New York Times article, Rubin said the key criteria should be "a substantial effect in the short term, the greatest impact for the money, and no cost in later years." A long-run-expensive capital gains tax cut and/or a permanent corporate income tax rate cut would violate these criteria. Any violation of the third criterion would be considered fiscally irresponsible by the bond market and tend to increase long-term interest rates. He concluded that "To increase demand, the most effective measures would be tax rebates to low and middle-income working people -- including those who pay Social Security taxes but not income taxes -- who have the highest propensity to spend." And these people especially deserve the fiscal stimulus tax cut now because they were short-changed in the preceding boom. Part of it will undoubtedly go to pay off consumer debt -- preventing bankruptcy, evictions and homelessness. But most will go for consumer goods, thus preventing further business layoffs and cutbacks in business investment plans. This will complement the expanded unemployment benefits going to those still working.
Why FICA withholding taxes? Instead of administratively inflexible and expensive mailed checks, the needed rebate could be carried out more simply, precisely, flexibly and effectively by a temporary reduction of FICA withholding tax deductions. Administratively, this could be done most quickly and inexpensively by a Treasury e-mail or fax notification to all computerized-payroll employers (presumably the Treasury has their addresses) stating the needed reduction. It could even be done by a simple press release. (The Treasury could compensate employers for the small cost of making this adjustment by an appropriate reduction in their total FICA return.) Making the cut in a round-dollar amount, the same for all workers, might be more stimulus-effective and administratively simple than as a percent of wages. And instead of needing to "wait a couple of weeks more" for the economic "dust" (and layoffs) to settle, this adjustment could be initiated immediately, with, say, a $100 a week bigger paycheck, because its amount could be changed as often as needed. If Republicans argue that this FICA reduction should also apply to the employer's contribution, this should be resisted because, like other business tax cuts, it would not be as cost-effective, in terms of economic stimulation, as the same amount in worker paychecks.
Budget-wise, this adjustment should be treated as an "off budget" addition to the Stabilization Account deficit, rather than a reduction in the SS baby-boom surplus.
Greenspan and Rubin estimated that the economy would probably need $40-60 billion more short-term fiscal stimulus.
Now let's put some real numbers on the potential FICA reduction. If 130 million workers get an initial $100 more in the first week's paycheck (October 15th?), that would provide an immediate $13 billion shot-in-the-arm of economic stimulus -- enough to be noticed both by the individual households and the economy, but not enough to cause problems. If, in two weeks, the "confidence-lifting" psychological effect is still inadequate, the weekly rebate could be doubled. But if the $100 rate continued for four weeks, that would be $56 billion -- in the ballpark of the Greenspan/Rubin suggestion for the total needed. However, it is likely that, in the context of this confidence building overall recovery program, less would be needed and the amount could be tapered down.
Reconciling Fiscal and Economic Responsibility: Coordinating Monetary and Fiscal Policy
Although the actual relationships tend to be obscured by flawed economic theories, most people understand "intuitively" that "new money" -- growth of the money supply -- finances economic growth. In fact, each dollar of new money (checking accounts and currency -- "M1") multiplies total income and spending by many times the original amount, as it circulates around the economy from borrower/spenders to businesses to their employee-spenders, etc. -- a monetary multiplier effect". But in a credit-money system like ours, new money is created only by banks, in the process of making loans. Thus, if the economy's total credit-worthy demand for credit (total borrowing by governments, consumers and business) falls so far that banks have to use whatever reserves the Fed gives them to buy Treasury bonds rather than consumer and business loans, they say that trying to make loans to create new money then is "like pushing on a string," and short-term interest rates can fall close to zero. In fact, the "real" (inflation-adjusted) US federal funds rate for inter-bank overnight loans is already close to zero -- as in Japan.
Therefore, to be most efficient, a pro-active increase in the Stabilization Account deficit should be viewed in a credit-flow perspective, as a complement to Fed monetary policy. In effect, the new money that the Treasury borrows from the banks to finance the FICA tax cut, in turn finances the "monetary multiplier" increase in consumer spending. Thus, the economically most appropriate amount of federal deficit would increase the economy's total demand for credit just enough to counter recession-induced "pushing on a string" credit conditions. Then the Fed can work with the banks to increase the money supply (M1) at an adequate recovery rate without pushing the Fed Funds rate so low as to cause a precipitous decline in the dollar exchange rate. If appropriately timed, before financial relationships get this far out of control, the needed amount of Stabilization Account deficit could actually be far less than suggested by the above FICA reduction calculation. (Cf. "Monetary and Fiscal Policy Sunshine Act")
(Note: In this article, the term "baby-boom" is used with SS surpluses and reserves as an explicit political reminder of this vital purpose of the large and rapidly-growing SS trust fund.)
Just as for private pension funds, SS's large and rapidly growing interest earnings on its investments are vital for its long run financial health. But when SS is permitted to invest only in Treasury bonds, the Treasury's interest payments to SS are, in effect, a large taxpayer subsidy of SS that greatly reduces the non-SS budget surplus. The present unified budget scam effectively hides this cost the same way it hid the pre-1998 non-SS deficits -- by subtracting SS interest receipts from the Treasury's total interest payments. This way, the cost will become evident only after 2020 when the Treasury has to find the money to pay off the interest-financed SS bonds. Permitting SS to invest in private debt securities would "privatize" this interest cost and correspondingly increase the non-SS Policy Budget surplus. It would also protect SS surpluses from being raided for non-SS purposes far more effectively than the flimsy "lock box" promises, and would make the SS trust fund seem more "real" to those who doubt SS's future.
Under the pre-attack lock-box promise, it was planned to use SS surpluses to pay off the entire public portion of the national debt, something that was expected to inconvenience monetary policy management, private pension funds and other aspects of the financial market. This reform would make it unnecessary to push the pay-down that far.
One advantage of carrying out this reform now is that the interest rate "spread" between Treasury and private bonds and mortgages is much higher than usual. So the SS trust fund, which can afford to take a longer-run perspective than most private investors, can benefit from the higher rates at the same time that its security purchases tend to help housing and other industries by reducing the rates for private borrowers.
These are not mere smoke-and-mirror gimmicks. These reforms are fundamental conceptual changes that increase the "transparency" (understandability) of the SS and budget systems, reduce the incentive for short-run political gamesmanship in budget making, and facilitate real fiscal and economic responsibility. Keeping recession-induced deficits out of the Policy Budget helps prevent "fiscal cynicism" -- the impression that "the deficit" is so large that there is no longer any use trying to honor the SS lock box promise.
By helping to clarify the distinction between public debt and the national debt (which includes Treasury debt to SS as well as the public), these reforms would expose the basic misconception that Treasury borrowing from the SS trust fund to pay down the public debt also reduces the total national debt. They would also help throw more light on a fact conveniently ignored by the privatizers -- that the overall social and economic "burden" of retiree benefits on future workers, and the effects on financial markets, will be much the same whether the anticipatory prior financial saving is through Social Security or through private pensions and 401(k)s.
How these reforms would facilitate financing post-attack spending increases and fiscal stimulus without raiding SS surpluses. A retrospective pre-attack 2001 Policy Budget could have had a surplus of up to $167 billion, compared to the the CBO-reported non-SS deficit of $9 billion, because it would have excluded the following key items:
This shows that the pre-attack supposed "fiscal straight jacket" was as much a fiction of inappropriate accounting rules as the supposed 2038 "bankruptcy" of the SS trust fund.
That doesn't mean that this much additional spending (or tax cuts) would have been fiscally responsible. It merely means that:
Now, let's apply these considerations to the real present post-attack problem with the proposed new budget and SS framework:
If needed for a comprehensive compromise agreement that includes putting back on the table some of the Democratic spending initiatives now on hold, it would be possible to raise additional funds by selling perhaps half of SS's present Treasury bonds and replacing them with private mortgages and bonds. That would further reduce our national debt and benefit the private capital market.
The need to resist Bush fiscal irresponsibility. In an 8/24 news conference Bush referred to the "fiscal straightjacket" his tax cut and the recession had imposed on Congress as "incredibly positive news" -- because it would halt growth of the federal government -- except for his proposed military increases. This says that Bush's "smaller government" philosophy measures the size of government by the amount of non-military spending. But it is worth noting that the Reagan/Bush regime -- which the current Bush seems to be imitating -- greatly increased the "size of government" not only by its large increase in military spending but also by the huge slice of interest cost that its fiscally irresponsible fourfold increase in federal debt added to later budget pie charts.
The budget framework of these reforms will make it easier to demand fiscal responsibility of Bush and the Republicans, and also provide the Democrats with better bargaining power for the inevitable compromises. Moreover, keeping recession-induced deficits out of the Policy Budget helps prevent "fiscal cynicism" -- the impression that "the deficit" is now so large that there is no longer any use trying to honor the SS lock box promise. It keeps the balanced-budget target viable and keeps the means of reducing the Stabilization Account deficit in focus.
If the Democrats allow the Republicans to use this crisis to wipe out the SS surplus and run big non-SS deficits, as during the 1980s, they can kiss goodbye to their hopes for more social spending, and will have no platform on which to run a winning campaign in 2002 and 2004. If they push these budget reforms through now, history could well look back on them with the same approval it now looks back on Clinton's hard fought 1993 fiscal "revolution." If the Republicans block them, that will provide another plank to run on in 2002 and 2004.
The CBO should prepare at least a preliminary 5-year projection on this new basis as quickly as possible, as a basis for responsible Congressional budget discussion before adjourning this fall.
Written: September 12, 2001
Last revised: October 8, 2001