Toward a Different Fiscal Future

[Vegas]

http://online.wsj.com/article/SB1000...168889076.html

Moody's Investors Service's warning last week that the AAA credit rating of the United States is in jeopardy raises fresh concern about the nation's fiscal health. The question to ask about the president's eye-popping budget, also rolled out last week, is whether it prepares the country for its future—or shackles it to past decisions that our leaders would rather not confront.

President Obama's blueprint gave us a federal budget deficit for fiscal year 2010 of $1.6 trillion, about 10.6% of GDP. While one expects bigger budget deficits in a downturn, the administration expects the deficit and debt buildup to persist. By 2013, it forecasts that deficits will bring about a debt-to-GDP ratio of 72%, unprecedented in our experience except during a major war.

The problem is spending. Despite Mr. Obama's words about restraint, the new budget proposes more spending—1.8% of GDP for 2011 to be precise—and a higher level, roughly one percentage point of GDP higher, in subsequent years.

Debates about the budget traditionally revolve around these numbers. There is another way to look at the federal budget, however, and that is to focus on its effect on our economic health, not just the government's fiscal health. Focusing on economic health means setting our sights on productivity growth—our future living standards.

To understand what this means, consider the famous "kitchen debates" between Soviet President Nikita Khruschev and Vice President Richard Nixon in 1959 about the merits of capitalism and socialism. Nixon famously pointed to color television as a milestone in American innovation. The Soviet leader replied by trumpeting his nation's lead in rocket thrust. The issue resurfaced in the televised 1960 presidential debates, when Sen. John F. Kennedy attacked Nixon for wanting to lead a nation No. 1 in color TV, but not in rockets.

Nixon's response was essentially nothing. But the correct response was obvious: The nation with the higher present and future productivity growth—the U.S.—could lead in both color TV and rockets.

Today our productivity growth is imperiled by the anti-investment tilt of the president's budget plan for escalating federal debt. Even conservative estimates of effects of federal debt on interest rates (by Eric Engen of the Federal Reserve and me in the 2004 National Bureau of Economic Research Macroeconomics Annual) suggest that the last Obama budget blueprint would lead to a one-percentage-point rise in Treasury interest rates as the economic recovery takes hold. The consequence—lower business investment and real GDP 4% lower than it would otherwise be by the next presidential election—compromises our future.

But there is more bad news. The Congressional Budget Office (CBO) estimates that, without policy changes, by 2050 spending on Social Security, Medicare and Medicaid alone would be 10 percentage points of GDP more than today. Total federal spending would exceed 30% of GDP. ObamaCare would only exacerbate the problem. This means government spending for national defense, education, research and other priorities would be dramatically constrained.

This brings us to the reason we need a real budget debate today: Tax increases cannot plausibly make these problems go away. If taxes were increased sufficiently to accommodate the CBO's projected increase in entitlement spending, long-term U.S. GDP growth rates would be reduced between a half and a full percentage point (an estimate derived from widely cited research by Mr. Engen and Jonathan Skinner of Dartmouth), unacceptably lowering our future living standards. This would be equivalent to erasing all the "growth dividend" gains of the great productivity boom of the 1990s.

[BoredWithNoSB]

As soon as any politician on either side is willing to tackle the blue hairs, I'll start listening to their high and mighty act.