Another Voice on Dealing with the Deficit

E. J. Dionne is a pretty good political analyst. He comes from the port side of the political spectrum, but he can be thoughtful and, sometimes, insightful. This column makes a couple of points.

First, we shouldn't be crying so much about this year's deficit, or even next year's deficit. In the time-honored tradition of Lord Keynes, we're supposed to run a deficit during bad times. I like to think of the Keynesian principles as similar to those found toward the end of the book of Genesis. Pharoah has a dream in which seven fat cows are gobbled up by seven gaunt and starving cows. The prophet Joseph interprets this as meaning that seven prosperous years will be followed by seven years of famine. Joseph's prescription: Save up as much as possible of the produce of the good years as a provision against starvation in the lean years.

Second, we need to face the fact that we have a "structural deficit." That is, if you take all the things we are committed to buy, as a government, and all the sources of revenue available to the government, we will run a deficit even in good years. Our taxes are simply not high enough to cover the cost of all the things we want (Dionne's word: "need") government to do. Either we need to chop some beloved and well-regarded programs, or we need to raise taxes substantially to bring these two dynamics into balance.

Third, Dionne wants the federal government to adopt a provision common among the states: a capital budget. The idea is that we should not be borrowing in order to pay the ordinary expenses of government. Tax revenues, fees and imposts should cover the day-to-day cost of government services. We should be borrowing, as states and municipalities do, for capital expenditures, such as roads, buildings, bridges, airports, and rapid-transit systems.

In other words, we should balance the operating budget, and run a deficit only on the capital side. That's a good idea, but there are several problems with it. First, based on the experience of California and other states, I'd say that it's pretty easy to reclassify routine expenditures as being somehow capital costs. The motivation to do so is always present; it's always easier to borrow to pay your bills than it is to raise taxes.

The second problem with the capital budget idea is that governments tend to commit to more projects than are financially sustainable. Suppose we have $1 billion to spend on highways, but we want $20 billion in highway construction. Okay, if we borrow $20 billion from investors by selling bonds, we only have to pay $1 billion per year in interest and administrative costs. Look, Ma, I just multiplied my money by 20 times! But, if you do this year after year, eventually the debt service costs (interest and administration) rise to equal the amount of your annual borrowing, and then, after 20 years, you have to pay back the principal of the loans. So, in year 21, you have to pay back the $20 billion you borrowed in year one, and you have $20 billion in charges for your borrowings from years 2-19.

Third, the interest charges on your debt have to take priority over all other spending. I know, there have been instances of defaults on sovereign debt in the past. Even respectable countries such as Russia and Argentina have defaulted on their debt. But I don't think the people of California would enjoy the consequences of default one bit. That's part of the problem with the Federal government now. The service on the existing debt is around half a trillion dollars a year. That's a lot of money, and it has first call on our revenues.

There is another column from Thursday's Washington Post on a similar topic, and I'll post it soon.