"America's Latest Phony Fiscal Crisis"

Former chief economist for the IMF, Simon Johnson @ Bloomberg:

In most countries that experience a fiscal crisis, there is no ambiguity about the situation. 

The government is unable to sell debt at a reasonable interest rate. This probably coincides with a broader shift out of domestic assets, as smart investors read the writing on the wall or in the newspapers. The currency collapses and, often, inflation accelerates. The government is forced to slash spending and, cap in hand, asks for help from the world’s least popular ambulance service: the International Monetary Fund.

British burn White House - War of 1812

No part of this description fits the modern U.S. Rates on government debt are very low, the currency isn’t depreciating rapidly and inflation seems stable. There is no imaginable circumstance under which the U.S. would need to borrow from the IMF. Yet this great land of innovation has undeniably invented its unique kind of fiscal crisis.

Or, to be more precise, we have reinvented the uniquely American way of ruining our fiscal affairs. At the beginning of the 19th century, Thomas Jefferson was obsessed with the idea that debt was bad and that the U.S.’s obligations -- inherited mostly from the War of Independence -- must be eliminated at all costs. (Jefferson himself had had some bad personal experiences with debt.)


Jefferson, James Madison, and their colleagues in the Democratic-Republican Party also wanted to shrink the size of the federal government, a reaction to the agenda of Alexander Hamilton and the Federalists.

Smaller Navy

In 1801, when Jefferson became president, the U.S. government embarked on a policy of cutting federal spending, including for the military. The Navy, in particular, suffered years of neglect or, in modern terminology, “lack of readiness preparation.”

What any economy needs by way of publicly provided goods varies with income level and stage of economic development. But the U.S. has always needed a robust military that is capable of protecting the country. And that’s not what remained after more than a decade of cuts in the early 1800s.

Unfortunately, the American fiscal way -- then as now -- was to combine excessive expectations with inadequate revenue. As a result, the dominant war-hawks faction in Congress sought and achieved a confrontation with Great Britain. It pitted the world’s biggest navy against a depleted fleet in a sorry state of repair. The contest wasn’t even close.

As a direct result, the British were able to trash Washington and burn the White House. The U.S. government didn’t default, or even come close. The fiscal crisis was a failure to deliver the public goods -- defense -- that the nation needed and expected.

Fast-forward to today. We have a budget deficit because revenue has been allowed to fall behind government commitments. This is the net result of the George W. Bush tax cuts, two foreign wars and the unfunded expansion of Medicare. Then, a financial crisis cratered the economy and further pushed down tax revenue while increasing unemployment and poverty. And, looking at decades ahead, health-care costs (not just Medicare) threaten to undermine competitiveness or even sink the economy.

So how does the political system respond? Most recently, with a sequestration program of across-the-board spending reductions that undermine military readiness and cut essential programs that help poor children. And now, with a budget proposal from House Republicans that slashes Medicaid, about half of which goes to protect the health of poor children.

Does this make any sense? No, but there is likely to be a lot more of this in our immediate future.

Tax Resistance

Republicans are dug in very hard against raising taxes. I testified before the Joint Economic Committee of Congress last week, and the discourse was much more cordial and constructive than it had been in recent years. Still, I sincerely doubt the House Republicans will budge in their opposition to raising revenue.

Meanwhile, in December, the Obama administration decided not to press its main advantage, which was the expiration of the Bush tax cuts. The drama over the so-called fiscal cliff at the end of last year was the right moment to put additional revenue on the table; this happened, but only to a small and insufficient degree.

At the hearing, Senator Amy Klobuchar, a Minnesota Democrat who is vice chairman of the committee, said Medicare should be able to negotiate the price of prescription medicine, which could save hundreds of billions of dollars over 10 years. This idea will soon be gaining traction. How could any reasonable person keep this off the current budget table (unless they work for Big Pharma)?

More broadly, we need to confront and limit health-care costs (not just Medicare and Medicaid). Cutting government support for health care and shifting the burden onto families will have one clear and unavoidable impact: less care and less good care for poor people and their children.

The U.S. needs a strong defense. And that includes helping a generation out of poverty, up the education ladder, and into the middle class.

We must look at how the world is changing and recognize threats, including those from North Korea, Iran and terrorism (including the cyber kind). We need the government to help organize and pay for our protection, and that includes our data networks.

But we must also address the poverty all around us. Income inequality has increased over the past three decades. Many families thought they were making sensible decisions for the future, only to see their jobs move overseas and their human capital lose value. The housing boom-bust and recent recession have exacerbated these problems. The social-insurance system is already stretched very thin.

Cost Shifting

Shifting health care costs from the government to the private sector doesn’t help anyone. I agree with the Congressional Budget Office that doing so would probably increase overall health-care costs (as a percentage of gross domestic product and as a percentage of your total income). The effect of raising the Medicare eligibility age to 66 or 67, from 65, would be similar -- creating a new group of people, ages 65 or 66, who can get insurance only at a high price.

Americans need to have a more honest and open conversation about what we want to achieve as a nation -- and how to use our government’s fiscal policy, in a responsible manner, to reach these goals.

Congress should end the sequestration and replace it with a more sensible process of determining how big the federal government should be (in terms of spending as a percentage of GDP) and how to pay for that.