By Arnold Kling
Robert E. Rubin, Peter R. Orszag, and Allen Sinai make a case that our Budget deficits are not sustainable.
If one includes the cost of the recently enacted prescription drug benefit, assumes that discretionary spending keeps pace with inflation and population growth, that the growth in the fraction of taxpayers subject to the AMT is eliminated, and that all expiring tax provisions are made permanent, the federal government would face unified deficits averaging about 3.5 percent of GDP over the next 10 years. The unified budget deficit for 2004 through 2013, on this adjusted basis, would cumulate to about $5 trillion. Those deficits, furthermore, include the temporary cash-flow surpluses in retirement trust funds. Excluding such retirement trust funds, the projected deficits would be even larger…
From a libertarian perspective, Edward H. Crane writes,
The late 1980s and the 1990s also saw the rise of supply-side economics, which further undercut the GOP’s philosophical approach to governance. Don’t worry about all the nasty arguments about the proper role of government, the supplysiders argued. Just cut marginal tax rates and the economy will be spurred on to grow faster than government, thereby shrinking government as a percentage of GDP…Republicans, with a few notable exceptions, stopped talking about less government.
Rubin, Orszag, and Sinai explicitly reject one supply-side doctrine, which is that Budget deficits will not raise interest rates or crowd out private capital.
A reasonable range for the increase in interest rates for each percent of GDP in projected deficits is 30 to 60 basis points. Using that range, the implication is that the sustained adjusted projected deficits…which average about 3.5 percent of GDP…raise long-term interest rates by about 100 to 200 basis points compared to a balanced budget.
I myself have written that tax cuts without spending cuts are a form of harmful economic populism, and I share the concerns of Rubin-Orszag-Sinai as well as those of Crane.
For Discussion. After hearing Rubin speak, a friend who teaches finance (in fact, he is a co-author of some leading finance texts), emailed me with this question: “Where does this leave you in terms of investment strategy. Bonds look disastrous; stocks look questionable at best, especially if interest rates and inflation rise; TIPS bonds [inflation-indexed Treasury bonds] will tank if real rates rise. What’s left besides the money market?”