How to Cut the Deficit: Boost Good Spending, Reduce the Bad

Last Updated Dec 2, 2010 7:09 PM EST

One of the wonderful things about Washington is that words there can mean anything. Take "austerity." Depending on your political persuasion, it can stand for the kind of stern fiscal discipline needed to whip the U.S. economy back into shape, or it can represent a ginormous financial giveaway.

Case in point. Most congressional Republicans claim to oppose extending jobless benefits because it adds to the federal deficit. Yet these same lawmakers also favor extending the Bush tax cuts to the richest Americans, a move that would add considerably more to the deficit than offering a few more weeks of financial assistance to the people who need it most. Austerity in action? Hey, consult your dictionary.

Here's another concept that denizens of the nation's capital are now torturing beyond all recognition: "spending." The Obama administration's deficit commission has, of course, been inveighing for weeks about the evils of government spending and about the urgency of belt-tightening. That's why the group's recipe for balancing the budget consists of 75 percent spending cuts and only 25 percent of measures to boost tax revenue.

Politicos like Sen. Judd Gregg, R-N.H., endorse across-the-board spending cuts. Others, such as Rep. Paul Ryan, R.-Wis., want to ratchet up the campaign by eliminating some entitlement programs altogether. Some Democrats also recklessly fan the flames. Here's what North Dakota Sen. Kent Conrad, who like Gregg and Ryan sits on the debt commission, recently had to say:
Anyone watching the spreading debt crisis in Europe -- in Ireland, Portugal and Spain -- understands the threat we face is real.
With all due respect to Portugal, to equate its economy with that of the U.S. makes about as much sense as slashing the deficit by extending tax cuts for Warren Buffett.

There are two major problems with trying to reduce the deficit by blasting away at spending. First, the American public sensibly opposes major cuts to vital federal programs, complicating the politics of wielding the axe. For all the hubbub over deficit reduction, in other words, the effort is already falling into chaos. Second, cutting spending while the economy flirts with double-dipness is plumb crazy.

Very simply, when aggregate economic demand is waning, spending is essential. The key is to boost federal funding for programs that foster long-term growth -- education, technology, infrastructure -- while lowering it in areas that policy types politely refer to as "not growth-enhancing." In the latter category, I'd include what amounts to massive government subsidies for agribusiness and for pharmaceutical firms, which are allowed to bilk Medicare for billions of dollars.

Another area ripe for much larger expenditure cuts than have been proposed is defense. As The New Republic's Gregg Easterbrook recently pointed out, since 2001 the defense budget has grown 68 percent -- excluding the cost of fighting wars in Afghanistan and Iraq. The result:
The U.S. defense budget is now about the same as military spending in all other countries combined
So much for the post-Cold War peace dividend. By contrast, investing in public works is an excellent way to generate growth. Economist Joseph Stiglitz, who has joined a group of other liberal economists and other wonks in offering their own deficit plan, offers three reasons why:
(a) There has been underinvestment for years, so the returns on investment are high; (b) The interest rate at which government can borrow is at record low levels; and (c) Because the economy is operating significantly below capacity--and is likely to continue to do so for years to come--there are significant multiplier effects, with each dollar of such spending generating as much as 1.5 to 2 times the spending in increased output.
How do you tell wise public investment from the wasteful, non-growth enhancing kind? Easy, Stiglitz says. If spending lifts tax revenues by more than what a program costs, including the cost of principle and interest, you're in business. Because over the long-run such investments ultimately reduce the deficit.

There are other ways to curb deficit besides taking a cleaver to entitlements and cutting off unemployment benefits. Here's a simple one that is certain to prove overwhelmingly popular on Main Street, if not on Wall Street: a financial transactions tax. Imposing a 0.5 tax on securities trades would raise upwards of $353 billion per year, which could be directed toward federal jobs training or, yes, eventually paring the debt. And by marginally raising trading costs, it also would have the salutary effect of discouraging speculation.

Unsurprisingly, given the banking industry's clout in Washington, the Deficit Commission ignored this commonsense proposal. Instead, we get a political theater of the absurd that stands basic economic principles on their head. That's not austerity -- it's madness.

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    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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