10 Questions: Who's Paying For The War?

(CBS)

Robert Hormats, an international finance expert at Goldman Sachs and former presidential adviser, has written a new book on how America pays for its wars—and he's the subject of this week's 10 Questions.

It is different in part because the war is easier to pay for than past wars. For instance at its peak World War II cost nearly 40% of GDP, the Korean War, 15%, and Vietnam 10%. This costs less than 1%. Also, American's were initially told that it would be short and cheap, so no sacrifice would be needed — and that Iraq's oil revenues would cover the costs of reconstruction after the war; all of these predictions turned out to be wrong. In addition, the administration was unwilling to alter fiscal policy to make room in the budget to pay for the war after it became apparent these were wrong; for example, in past wars there have been significant cuts in non-security-related spending programs, but in this war they have continued to increase along with earmarking (a.k.a. pork barrel spending).

2.You argue that sound financing of wars is necessary both in terms of funding a superior military, and also to sustain popular support for the war. How does the method of war funding affect the way the public feels about the war?

In past wars, Americans have been asked to sacrifice financially while U.S. troops were sacrificing on the battle field, which gave average citizens a sense of engagement or involvement in the war effort. That was certainly true in the two World Wars and early on in the Korean War. Of course, when a war becomes a stalemate or quagmire, as did Korea and Vietnam, large numbers of Americans become reluctant to make any sacrifices and want the government to find a solution so that human casualties and wartime spending can be brought to an end; that is what has happened in Iraq.

3. During Vietnam, President Johnson famously said America can afford "guns and butter"—meaning, expansive government at home and a vigorous war effort abroad. Was that true then, and is it true now?

It wasn't true then, largely because the cost of guns and butter increased significantly during the period of the Vietnam War and the deficit mushroomed. Today it is not as difficult, in part because this war is a far smaller portion of GDP than the Vietnam War and in part because the economy is growing and thus producing a flood of revenues. In addition, during Vietnam interest rates rose with high government borrowing and inflationary concerns; today, we can finance our deficit more easily, largely with foreign funds and competitive forces in the economy plus effective action by the Federal Reserve have reduced inflation and inflationary expectations.

4. You quote George Washington who warned against "ungenerously throwing upon posterity the burden which we ourselves ought to bear." The Bush administration says that their tax cuts—by strengthening the economy—actually have reduced the public debt. Is that a fair statement?

It is true that the tax cuts gave the U.S. economy a needed stimulus, but so did a long period of interest rate cuts by the Federal Reserve. Moreover, the US. private sector has become increasingly productive over the last couple of decades, in large measure because of the information technology revolution. But the public debt is still growing, because the government is still running deficits. And we cannot count on growth remaining robust indefinitely. Moreover, in the next decade, benefit payments for Social Security, Medicare and Medicaid will increase dramatically as more and more baby boomers retire and medical costs rise; that will lead to hedge budget deficits and/or big tax increases which will harm the economy and impost big debt burden on coming generations.
5. To what extent is America indebted to foreign governments—and what are the risks associated with that?

Debt to foreign governments is rising by roughly $700-800 billion annually. These governments for the moment are content to lend the U.S these lofty sums at reasonable interest rates, but that could change by, for instance, an act of terrorism that would shake foreign confidence in the U.S., cause the budget deficit to increase due to a drop in revenues and an increase in spending for reconstruction and retaliation; together these might cause foreigners to cut back on capital flows to the U.S. and given our enormous dependence would cause the dollar to plummet and interest rates to rise.

6. The administration has consistently argued that a growing economy is the best way to support the war—and that increasing taxes would hurt the economy. Is that what happened when previous presidents raised taxes in wartime?

During World War II taxes rose significantly but wartime spending pulled the U.S. out of the last phases of the depression and created a lot of jobs; taxes were increased during the Korean War as well but the economy still boomed. And the economy even grew after the tax increases in Viet Nam. I agree that a growing economy is important to support a war, but in most cases wartime spending has caused the economy to boom and led to large scale job creation. This war is not a very large portion of GDP, so its impact on growth is not very large, but it still gives certain industries a big boost. We should also remember that cheap foreign capital to finance this government's deficit and the war have also been helpful in sustaining growth, largely because it ahs given a big boost to housing by holding down mortgage rates.

7. The president has gotten a lot of flack for calling on Americans to go shopping after 9/11 rather than asking for a bigger kind of sacrifice. Is that a fair criticism—and, if so, what should he have asked Americans to do?

It is half fair and half unfair. He was correctly saying that Americans should not let the terrorist threat disrupt their normal lives. That was an important message. But he also had the opportunity at that time to call on Americans to make important changes for example, A Roosevelt or Wilson, or a Truman or an Eisenhower, might well have told American that we are about to enter a long war on terrorism so we need to cut non-essential domestic programs; instead the y increased rapidly after 9/11 and their was no message of restrain from the president and no vetoes or vote threats. And he could have submitted a bold energy plan to reduce oil important from the Middle East that do not happen either, it is often said that "9/11 changed everything." Well, it didn't change fiscal policy — for the better and it didn't change energy policy at all. These were badly missed opportunities for leadership.

8. You've said that 9/11 didn't change very much in terms of our fiscal policy. Defense and homeland security spending rose a bit, but that's pretty much it. What do you think should have changed?

Several things should have changed: Our leaders in Washington should have put forward a proposal for as bold energy policy to reduce dependence on imported oil, which would cut down vulnerability to an interruption of oil imports and reduced the flow of funds to a number of countries and groups that are hostile to American interests. They also could have cut back on a series of non-essential domestic spending programs to make room in the budget for that additional spending for the war on terrorism and to better engage the American people in that war by encouraging at least a small measure of sacrifice of their parts, rather than create the impression that security is free and nothing needs to change in fiscal policy to pay for it.

9. Can America afford its entitlements programs, Iraq, the war on terror, and to fund its social and economic priorities for the foreseeable future?

No. Reform of entitlements is needed because on their current trajectories they are not fiscally sustainable. This needs to be done in a way that endures that those who needs such benefits receive them, but that those in upper income groups who can pay more into such programs or don't need the full array of benefits do not get them.

Also, the president and Congress need to be sure that the national security budget is cleansed of programs begun in an earlier era but which are not relevant today, while new programs and approaches to deal with current and future security challenges are adequately funded. And our leaders need to ensure that all other aspects of the budget are structured in a way that sharply cuts non-esentail spending, including earmarks that divert funds from more vital national functions. They must also see to it that the tax system provides sufficient revenues to make certain that the nation's finances are sound, which means that whatever deficits exist remain manageable in size over the long-term.

To candidly address these problems, America's political leaders need to recognize that a future financial problem exists if our government and nation are to keep faith with our elderly and those who need support for good healthcare, and to have the resources needed to protect the nation's security, while maintaining sound finances. We cannot count on growth to generate the revenues to meet all these need; tough policy changes and significant reforms will also be needed.

10. Has the president been sufficiently frank with the American people about the costs of the war? And why do you think the American people would be more supportive of the war if they knew the full extent of the cost?

At the outset of the war the administration and many in the Congress believed that it would be short and cheap — and much of it would be paid for by Iraqi oil. These were all wrong. And as costs grew they were paid for by "emergency supplemental" appropriations requests, which skirted the normal budget process, which cost it credibility.

Early in the war, which at its outset had relatively strong popular and congressional support, Americans might have been willing to check a box on their tax returns to ensure that the troops had proper body armor or that their families were well taken care of. But as disenchantment with the war grew, and support gave way to anger that so many mistakes and been made and so many expectations and predictions and turned out to be wrong,
I do not believe that any measures on the fiscal side could have preserved support. But I do think there is still an argument for candor in telling Americans the true costs of any war and asking them to make some sacrifices at home while the troops on the battle field and their families are making big sacrifices. And as the war on terrorism — to prevent another attack or respond to one should it occur — goes on, a candid discussion with Americans as to how to pay for it is certainly in order.