America’s fiscal-political trap

The systemic flaws in United States governance make long-term policy to address its cavernous deficits impossible, says Godfrey Hodgson.
Godfrey Hodgson
22 December 2010

The sharpest political arguments in Washington towards the end of 2010 have centred on taxation. Barack Obama faced a choice that highlighted a legacy of the George W Bush administration in granting “the wealthy” (defined as those with over $250,000 in annual income) substantial tax cuts, which amounted on average to over $100,000 a year for each person involved. This substantial advantage had to be abandoned or renewed by December 2010. Most of Obama’s fellow Democrats strongly preferred the former option as part of an effort to tackle the country’s enormous public deficits and reintroduce a modicum of equity to the tax system.

In the event, on 6 December 2010 the president agreed with congressional leaders - among whom Republicans are more numerous and assertive than before after the mid-term elections - to extend the tax breaks. The wider package contains some “progressive” measures too, but liberal Democrats are furious with President Obama for being too quick to concede on this point; as a result, the president’s standing - a matter of almost obsessional concern among both supporters and opponents within the Washington beltway - has been further damaged.

The noise and passion of the tax debate, as well as the artillery of argument mustered on both sides, have been as impressive as any such contest in Washington. At the same time, the intense preoccupation with this single issue is emblematic of the short-term focus of the American federal government, a feature exacerbated by the relentless two-year rhythm of (presidential / congressional / state) elections.

The sheer concentration of energy and attention here is arguably distracting, even damaging; for it leaves little if any room to address the serious long-term matter at stake, namely the prospects for the federal deficit as a whole, and the consequences of these for domestic politics and America’s standing in the world.

This larger question is both inescapable yet constantly evaded in the everyday high politics of Washington. Most serious analysts of the federal deficit argue that its inexorable growth and resulting impacts on debt are so serious as to threaten (by 2030, or at latest 2040) the three pillars on which the power of the United States rests: the tranquillity of its domestic political system, its position as a superpower capable of defending its interests and brokering international order, and its ability to guarantee some modicum of surety for the international economy as consumer and lender of last resort.

The context

How has it come to this? For well over a century, all the United States’s money-related bills originated in the committee on ways and means of the House of Representatives, a body modelled on the arrangements of the 18th-century House of Commons in London. But in 1921, Congress passed the Budget and Accounting Act, which empowered the president to send a draft budget to Congress and equipped him with a bureau of the budget (its name was later changed to the office of management and budget [OMB]). The change was so fundamental that many scholars even claim that this act in effect created the modern presidency.

The revised system lasted until 1974, when Congress - provoked by President Nixon‘s refusal to spend monies appropriated by Congress for purposes he did not approve of - passed the Congressional Budget and Impoundment Control Act. This set up the congressional budget office (CBO) as (in some measure) a rival of the president’s OMB.

In this context, what is different today is the scale rather than the fact of the deficit. The US has balanced its budget on only twelve occasions since 1929, most recently in the four years of Bill Clinton’s second term (1996-2000). But until Ronald Reagan’s administration (1980-88), the government usually ran small and manageable deficits (the obvious exception was the wartime years, 1941-45, when the deficit reached and narrowly passed 20% of gross domestic product [GDP]).

The deficit began to widen when Reagan - against vociferous warnings from his budget director, David Stockman - combined deep tax cuts and increased defence spending, while imposing only modest limits on domestic expenditure. After it gradually was made more manageable, the deficit exploded under George W Bush’s second administration (2004-08), which combined substantial tax-cuts, increases in domestic expenditure, and runaway expenditure on the wars in Iraq and Afghanistan as well as on “homeland security”.

The twist is that President Obama sees himself as a “deficit hawk”, even saying that he wants to limit the structural deficit to 3% of GDP (in fiscal year 2010-11 it is predicted to run at over 8%). In the longer term, almost all experts predict that the public debt will amount (on varying assumptions) to anything between 200%-600% of GDP.

Two commissions have recently addressed this problem. The Bowles-Simpson commission on fiscal responsibility - led by a former White House official in the Bill Clinton administration, Erskine Bowles, and former Republican senator Alan Simpson - reported on 10 November 2010; it recommended that a proportion upwards of 75%-80% of debt-reduction could come from cuts in government spending, with the balance from increased taxation. The co-authors were highly praised for the imagination and seriousness of their proposals, but they failed to carry a quorum of their own committee’s members with them.

The Rivlin-Domenici commission - led by the former congressional budget director, Alice Rivlin, and the former Republican chair of the Senate budget finance committee, Pete Domenici - reported on 17 November 2010. It suggested that debt-reduction must come equally from spending-cuts and tax increases.

But even were the reports of such commissions to be accepted politically, the process of implementing them would face a major institutional obstacle: namely, that the constitutional plan and historical development of the American system make it harder for the United States than for other democratic governments to tackle long-term imbalances between revenue and expenditure.

The gridlock

There are, in this light, three specific reasons for the growth of the deficit problem and the sclerosis in face of it.

The first is constitutional. A prime minister in most parliamentary systems can set a budget and know that, in all but the direst of crises, it will become law. A president in the structure operating in the US has no such assurance.

The second is that the situation has been complicated by the weakness of party authority in Congress. A pernicious system of “earmarks” has grown up - in  effect, private appropriations granted by Congress to its members for favourite projects (known as “pork” for their districts or states), often agreed as a result of a near-corrupt process of “log-rolling” (or trading of favours).

The third and most important reason for the sclerosis - and the hardest factor to remove - is political. This is the acute ideological polarisation of Congress and its attendant political tribes.

Democratic politicians regard entitlement programmes such as social security (the American state-pensions system), Medicare (for the old) and Medicaid (for some of the poor) as near-sacrosanct; any president who dares to touch them can expect fierce political denunciation. Republican politicians are committed to tax cuts, both for ideological and political motives: as a means of handing out money to their relatively wealthy supporters, and (according to the tenets of supply-side economics) as a way to ensure an economic-growth effect as wealth “trickles down” from rich Republicans to poor Democrats. With no or minimal consensus on fundamentals, any serious negotiation on deficit-reduction is soon mired in deadlock.

The warning

The congressional budget office is charged with the difficult task of being non-partisan in the service of the most partisan Congress for many decades. In June 2010, the CBO predicted that tax-rates would have to rise if the deficit was not to get out of control. “Those rising rates”, it reported, “combined with the tax provisions of the recent health care legislation, would push total revenues to 23 percent of GDP by 2035 - much higher than has typically been seen in recent decades - and to larger percentages thereafter. At the same time, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt - activities such as national defence and a wide variety of domestic programs - would decline to the lowest percentage of GDP since before World War II.”

The CBO has subsequently offered two contrasting scenarios, carefully noting that these are not predictions. The first is predicated on the assumptions that George W Bush-era tax-cuts would be reversed, and that tax rates would therefore rise; and the cost of entitlements would also rise, so that expenditure on national defence (and on the modernisation of infrastructure) would have to be drastically cut. At the very least, presidents would then simply be unable to afford to undertake an invasion of (say) Iraq or Afghanistan, or even to become involved in confrontation with (say) Iran.

The second scenario assumes that tax-cuts will not be reversed (that is indeed the outcome, until 2012 at least, of the agreement President Obama reached with the Republicans). In that case, says the CBO, “debt would reach 87 percent of GDP by 2020...After that, the growing imbalance between revenues and non-interest spending, combined with spiralling interest payments, would swiftly push debt to unsustainable levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2025 and would reach 185 percent in 2035.”

There is more. The consequences of large budget deficits would be to reduce saving, raise interest-rates, increase borrowing from abroad, cut domestic investment and lower income-growth. Congress would be less able to respond to economic downturns. The probability would increase of a fiscal crisis in which investors would lose confidence in the government's ability to manage its budget, and the government would thus have to pay much more to borrow money.

The pattern, as envisaged by the United States Congress’s own official advisers, is all too easy to recognise. It is America as Greece, Ireland or Portugal, constrained by the jaundiced eyes of international bond-markets.

The United States has certain advantages over those European invalids. Its economy is resilient. The dollar is the leading international reserve currency. The credit-rating agencies are American, not Irish or Greek. And the politicians may yet see the precipice ahead and draw back, even at the cost of abandoning cherished beliefs.

Still, in view of these ominous fiscal projections, Americans (and others) have to ask a tough question: whether the United States’s ability to fulfil the functions its citizens expect - from guaranteeing them one of the world’s highest living-standards to projecting its power abroad - will by the mid-21st century be seriously impaired. The problem is that, even when the answer is negative, the American political system has at present no way of responding.

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