From the pages of February 1996

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The Balanced Budget Ploy

By Edward S. Herman

 

The Republican drive for a balanced budget, and the alleged extreme urgency of this objective, is a ploy that covers a barely hidden agenda. The phrase “balanced budget” resonates well with the American public and has great symbolic value for a propaganda campaign. Unbalanced budgets and deficits sound immoral and menacing, hinting at extravagance and imminent bankruptcy. Mainstream commentators rarely point out that corporations and households regularly unbalance their budgets when they borrow money to buy plant and equipment (business firms) or cars and homes (households); these borrowers, but not government, are allowed to distinguish between capital budgets and current accounts.

The real aims of the push for a balanced budget are two-fold: to constrain macro-policy and prevent its use in ways that would increase pressures on the labor market and threaten inflation, and to scale back the welfare state.

The fear of inflation and aversion to tight labor markets on the part of the corporate and financial community can be read almost daily in the market's negative reaction to announcements of drops in unemployment or of wage settlements favorable to labor. “Favorable” changes are manifestations of stagnation, as in “U.S. stock market surges on signs of economic slowdown” (Financial Times, February 16, 1995). The economic policy objective agreed on at a recent G-7 gathering was “sustainable non-inflationary growth,” an inhumane standard met quite satisfactorily by the now familiar “jobless growth,” and whose sustainability is threatened only by outbursts such as that exhibited recently by French workers. The powers that be are also quite clear that the battle against inflation is never really won, and that, in the words of Bank of International Settlements president Wim Duisenberg, “It would be regrettable, to say the least, if central banks' new policy approaches to controlling inflation were undermined by policy failures elsewhere [he mentions specifically, fiscal policy]” (Financial Times, June 13, 1995).

On the other main policy objective, scaling down the welfare state, it should be clearly understood that this is not an attack on “government” as such, as that would include corporate welfare, which conservatives often separate in their minds from the terrible word government, and which the Republicans intend to preserve or even enlarge (the military establishment, the police-prison complex, and those civil functions helpful to the corporate community). In fact, during the Reagan era, while important steps were taken to undermine the welfare state, the federal budget still expanded in size as the growth of the acceptable forms of government activity plus the increase in interest payments on the skyrocketing national debt more than offset the welfare state cutbacks.

The indirectness of the attack on a full employment policy and the welfare state is dictated by the fact that, despite the flood of propaganda on the horrors of budget deficits, the public consistently indicates in polls that they don't want the budget to be balanced at the expense of Medicare, economic growth and jobs, or damage to poor children. (A December 1994 NYT/CBS poll showed that only 9 percent favored cuts in spending for poor children; 47 percent favored an increase, and 39 percent no change; an October 1995 NYT/CBS poll showed 2-to-1 opposition to the Republican Medicare cuts to “save” Medicare and balance the budget.) It has therefore been necessary not only to establish the balanced budget as a symbol of rectitude, but also to downplay the public's preferences, pretend that the desperate financial straits of “entitlements” justifies the budget attack, and ignore the ways in which the budget could easily be balanced at the expense of the monied interests instead of ordinary citizens. The mainstream media have cooperated by focusing on political winners and losers, and addressing only episodically the real issues and interests at stake.

 

Reagan Tax Cuts and Deficits

There is a curious contrast between the current Republican devotion to balanced budgets and the willingness of Reagan-era Republicans to produce spectacularly unbalanced budgets. Reagan, of course, claimed a devotion to the balanced budget and sharply criticized Jimmy Carter for his (retrospectively, modest) deficits; but once in office Reagan produced, by deliberate action, a huge structural deficit via the deep tax cuts of 1981-82. (A structural deficit is one that exists even at high levels of employment, because of tax-expenditure policy decisions that result in tax revenues falling short of planned expenditures.) Of course the deficits were rationalized by means of “supply side economics,” which forecast a surge of output based on the new work and investment incentives of lower tax rates; but this was nonsense believed in only by a few supply side fanatics.

The design of those pulling Reagan's strings was similar to that of Gingrich's string pullers: namely, getting wages and inflation under control, cutting back the size of the welfare state, reducing business taxes (and regulatory burdens), and increasing the flow of funds to the Pentagon and its contractors. A very important part of the 1981-82 plan was to get taxes down in order to make it difficult to reconstitute the welfare state later. Historians of that budget process state that “From the beginning of the battle, both sides knew that the real stakes were constraining the government in the future” (Joseph White and Aaron Wildavsky, The Deficit and the Public Interest, University of California, 1989). With low tax rates and a structural deficit, greater outlays to serve ordinary citizens would require either raising tax rates or increasing the size of the deficit (assuming of course that we wouldn't want to tamper with “national security”). Then, in the future, if the deficit and unbalanced budget can be demonized, the welfare state will be easy to contain and possibly even erode further.

The national debt tripled during the Reagan years (1981-88), growing from $906 billion to $2.6 trillion. Collaborating with the dominant Republicans in carrying through the Reagan budget policy were the New Democrats, who are the Democrats closest to Republicans in responsiveness to corporate demands. The Reaganites and New Democrats enacted the huge tax cuts of 1981-82 without assurance that expenditure cuts would be forthcoming to control the deficit if supply side economics failed -- the risk of really massive deficits was one they were quite willing to take. Keith Bradsher's attempt to make the deficits an equal responsibility of both parties (“Partnership In the Deficit,” NYT, December 3, 1995) is thus wrong and deceptive: it was carried out on Republican initiative and plan, and the deficits had the element of intentionality described above (to constrain future civil expenditures); and Bradsher fails to note that supportive Democrats were the New Democrats, who followed Reagan in 1981 and now follow Gingrich in the newfound devoted concern over deficits.

In 1981-88, scaling down the welfare state, while increasing the military budget and giving tax relief to the long-suffering rich, produced sizable current deficits. Interestingly, as Max Sawicky has pointed out, social entitlements in the Reagan era were in surplus, and the only unfunded source of the deficit was the military buildup and the growth in interest payments to service that debt (Roots of the Public Sector Fiscal Crisis, Economic Policy Institute, 1991). In 1995-96, the attack on the welfare state could be renewed by selling the deficit as a terrible threat, and by blaming it on social budgets, while quietly continuing to reward the same rich constituents who had benefited from the Reagan counterrevolution. Now, instead of a fraudulent supply-side economics and an equally fraudulent huge Soviet military threat justifying large deficits, there are fraudulent claims about intergenerational warfare and an explosion of entitlements that must be brought under control to save our children. In fact, the only non-military and non-corporate entitlements threat to the budget lies in the explosion of medical costs, whose solution rests entirely on a reform of the U.S. health care system that the Republicans and New Democrats refuse to make.

 

Deficits and the Business Community

But doesn't the business community hate deficits? The answer is: yes, but sometimes they must be tolerated for higher ends; and at other times (like now) they must be made overwhelmingly important to facilitate the achievement of other ends. Reagan's deficits were acceptable because he was doing so many “good” things (deregulating, attacking unions, turning public property over to robber barons as fast as possible, cutting business taxes, increasing the military budget, and making a credible start in decimating the welfare state). The leaders of the National Association of Manufacturers, for example, who were “thrilled to get rid of Carter, wanted help from the new administration on environmental and other regulatory issues...rallied to the president's side with uncharacteristic fervor” (White-Wildavsky). Business would have preferred a balanced budget even then, but you can't have everything. The U.S. business community is strongly ideological, but at the same time remarkably opportunistic and prone to “immediate gratification.” Its members hate politicians and government, but use them for their own ends when needed without batting an eyelash over “principles.”

The business community's double standard on deficits is well illustrated by the contrasting judgments of Walter Wriston, former CEO of Citicorp, on the threat of deficits during the Carter and Reagan eras. Carter, though he tried hard to placate business, and did nothing of consequence of a populist nature, was still a Democrat and, like Clinton, made threatening (if unimplemented) promises to ordinary citizens. In 1978, with Carter in office, Wriston asserted that federal deficits were “diverting available capital from productive private investments to finance public expenditures. Only a reduction in the federal deficit would reverse this trend.” In 1988, with market-friendly Reagan in office, Wriston stated that “no family I know expenses its home” -- that is, charges the full sum borrowed to current expenses, instead of writing it off with monthly payments. And he pointed out that if we separate the federal capital expenditures from regular expenses, Reagan's operating budget was near balance. This distinction, which apologizes for the Reagan deficits, Wriston did not see fit to make for Carter's smaller deficits.

This double standard is only comprehensible on the assumption that Wriston does not regard large budgetary deficits as a major problem that cannot be offset by the uses to which the deficits are put and the merits of the larger package of benefits provided. More generally, we may note that while the business community expressed concern about deficits in the Reagan years, its complaints, and the reactions of the bond market, were muted and “conservatives” in politics, economics, and the media never got too agitated over deficits even as they soared. Only with the election of Clinton did the market and conservatives recognize again the importance of deficits and their “threat” to future generations.

 

The Cost of Budget Deficits

The primary real cost of budget deficits is absorbed not by future generations but by those who lose out in the current transfer of resources to those favored by the government tax and spending decisions. When Reagan cut the taxes of his business and affluent constituency, raised only social security taxes, enlarged military outlays, and cut back welfare and low income housing budgets, the enlarged deficit had immediate and powerful effects. The burden on, and losses to, the lower 80 percent was realized then and there, as were the substantial gains to the business community and wealthy.

Won't the debt have to be paid back, and won't these interest and principal payments beggar future generations? The answers are: no and no. The debt won't have to be paid back -- it will be rolled over indefinitely, and the interest payments will be a shrinking proportion of the national income as income grows, unless the debt grows faster than the national product (or interest rates rise).

The national debt shouldn't be paid back at all except in times when a budgetary surplus would be desirable macro-policy, as collecting taxes in excess of expenditures to reduce the debt is highly deflationary. Rational fiscal policy calls for deficits when an expansionary stimulus is desirable, surpluses and debt reduction only when fiscal constraints are called for in a full employment and inflationary situation. The interest payments on the debt do require tax collections that could affect economic incentives and redistribute income in undesirable ways; but as most of the debt is owned by U.S. taxpayers (approximately 80 percent), and the interest payments require tax collections of only 2-3 percent of GDP, the overall tax burden is not great and a progressive tax structure can minimize any regressive redistribution effects.

Future generations might also be damaged by current deficits if they “crowded out” private investment in favor of government outlays less socially productive; the government's borrowing to fund its deficit would raise interest rates and compete away the private savings that might otherwise flow into private investment, and would thus reduce the rate of investment and productivity growth. So goes the standard argument.

But the crowding out effect rests on a number of dubious assumptions. First, and most important, it assumes that the system is at full employment, a standard Chicago School and pollyannaish assumption that has filtered into mainstream economics and ideology. If there is significant unemployment and unused resources, the government deficit will not only not crowd out private investment, it may crowd it in by increasing effective demand and thereby stimulating private investment. That “crowding in” is far more important than crowding out is shown by a number of studies that have found a positive relationship between government deficits and rates of private investment and economic growth. Economist Robert Eisner, for example, has found a positive correlation between size of deficits and rates of real output growth, and he maintains “that involuntary unemployment due to a lack of aggregate demand or purchasing power is a fundamental fact of our economy, as confirmed by these effects of deficits” (The Misunderstood Economy, Harvard Business School, 1993).

A very good case can be made that the great enlargement of government spending from the 1930s onward, and the so-called automatic stabilizers built-in by unemployment compensation and progressive tax structures, really underwrote private investment thereafter and in a sense served as a global “crowding in” stimulus to private investment. (Adding to this, of course, was the huge direct and indirect government stimulus to private investment through enormous research subsidies and government contracting for computers and military hardware.)

Other dubious assumptions of the crowding out view are that investment is sensitive to the rate of interest and that the latter is more important than expected sales in inducing investment. Again, studies have pointed to the preeminent importance of sales expectations and the weak relationship between interest rates and investment (Steve Fazzari, Investment and U.S. Fiscal Policy in the 1990s, Economic Policy Institute, 1993). This suggests the greater potency of the “crowding in” effects of government deficit spending than the investment inducing effects of interest rate declines associated with reductions in deficits, confirmed by empirical studies such as Eisner's.

Another assumption of crowding out theorists is that government uses of resources are inferior to those of the private system. In fact, with the long neglect of public capital, “the payoff in GNP growth from an extra dollar of public capital is estimated to exceed that of private capital by a factor of between two and five” (David Aschauer, Public Investment and Private Sector Growth, Economic Policy Institute, 1990). Ironically, the worst misuses of government deficits occurred in the Reagan-Bush years of massive escalation of military outlays. It is testimony to the perverse and anti-social character of the business community and its intellectual-pundit epigones that it was the Reagan era deficits that were treated benignly; deficits that would fund investments in humane and productive human and public capital (public education, job training, public transportation) are the ones that produce their concern over crowding out and intergenerational warfare.

The Reagan era was a testing ground for the crowding out effects of government deficits on private investment and the investment stimulating effects of falling interest rates. The huge Reagan deficits should have crowded out private investment. It is true that real business investment levels in that period were modest. But the deficits did not crowd out the provision of funds to business -- hundreds of billions were made available, but were used for mergers and leveraged buyouts rather than real investment. Thus there was no crowding out of funds, and the theorists' assumption that funding availability to the private sector would have productive consequences (in contrast with government spending) was shown to be unwarranted. Furthermore, steady interest rate declines 1982-88 failed to ignite a boom in real capital investment. This and the later weakness of investment may well be related to the stagnation of incomes for the majority of the population.

 

Conclusion

The Clinton-Republican agreement to work toward a balanced budget in seven years will be hurtful in two major ways. First, it will force a deflationary budget policy on the overall economy and reduce the government's flexibility in using the budget for contra-cyclical policy. Given the weakness of effective demand stemming from downsizing, the rise of unemployment, underemployment, temp work, insecurity, and stagnant incomes for the majority, the budget plan will further stagnationist tendencies.

Second, serious damage will be imposed on the majority (and on future generations as well) by the choices being made by the Republicans and Clinton in shrinking the budget. The partners have agreed to preserve a Cold War military budget and to stint on public and human capital. Instead of investing in urban development and renewal, the partners are putting money into the police and prisons. Apart from its fearsome inhumanity, these priorities will waste human capital and expend resources in treating symptoms. The market and its spokespersons are making cruel and short-sighted choices that will come back to haunt them. They do this under the fraudulent cover of the urgency of a balanced budget.

Edward S. Herman is a regular contributor to Z Magazine.