Fiscal Follies

President-Elect Obama is planning to convene a "fiscal responsibility summit" some time in February, the Washington Post
has reported. Obama floated the idea at a conversation last Wednesday
with Post editors, specifically flagging Social Security and Medicare.

The rhetoric and framing of the problem are distressingly similar to
efforts of the newly formed Peter G. Peterson Foundation, Robert
Rubin's Hamilton Project, and the Concord Coalition, and kindred groups
that seek to define long term budget discipline as the Republic's top
economic problem. The Peterson Foundation was founded last year, with a
pledge of over a billion dollars out of Peter G. Peterson's own
personal fortune. Peterson hired the former U.S. Comptroller General,
David Walker, as the new foundation's president. Walker has taken his
road show to foundation executives and other opinion leaders, trading
on his bipartisanship and record as a former public servant of

Another of the fiscal hawks, Maya MacGuineas, who runs the Committee
for a Responsible Federal Budget, has joined with the Peterson
Foundation and the Pew Charitable Trusts to create a Peterson-Pew
Commission on Budget Reform. This follows on an essentially similar
Brookings-Heritage Fiscal Seminar. The trouble with all of these
efforts is that they all point in the same direction. But beneath the
fiscal high-mindedness lurks a very conservative agenda, to cap the one
part of American's patchwork system of social insurance that actually
delivers reliable benefits. I wrote about an earlier skirmish between
relatively liberal and more conservative budget hawks last September in
the Prospect (Obama versus the Fiscal Fear-Mongers).

The Peterson Foundation's basic storyline goes like this:

Government is fundamentally "broken" because of $56 trillion in
"unfunded liabilities." Generations to come will be stuck with the
bill, because "we" have been irresponsible in allowing "entitlements"
such as Medicare and Social Security to make promises that they can't
keep without bankrupting the economy. Too many of the beneficiaries of
social insurance programs are either elderly or affluent, at the
expense of needier people. The poster children for the story line are,
well, children. Supposedly, if we reined in Medicare and Social
Security, there would be more to spend on other social needs such as
housing, children's programs, and other anti-poverty efforts. You can
read the Peterson Foundation's pitch for yourself at

Just about everything in this story is wrong. I recently had the
pleasure of debating Eugene Steuerle, Vice President of the Peterson
Foundation, before an audience of New York foundation executives. Here
is an abbreviated rebuttal.

For starters, the supposed $56 trillion conflates real debts on
which interest is being paid with projected future outlays taking a
worse case scenario. The current public debt is about $6.3 trillion or
about 40 percent of GDP. (The national debt, which includes money that
one government agency owes to another is over $10 billion.) The public
debt was far higher--over 100% of GDP--at the end of World War II, yet
the economy began a 25 year boom and the debt ratio quickly came down.

Why? All that debt ended the Great Depression. Wartime spending, as
a side effect, put people back to work, recapitalized American
industry, invested in science and technology, and created pent up
demand for consumer goods. The debt was paid down rapidly after the

The situation today is similar. We could easily tolerate a ratio of
public debt that peaked at, say 70% of GDP, well below the WWII peak,
if that's what it took to avert a second great depression. And then we
could start paying it down once recovery came, as we did after the war.
My own view is that we need expanded public spending to avert a
depression, about a trillion dollars a year for two years; and most
economists think that Obama is at risk of aiming too low, not too high.
Obviously, increased deficits and debts in the short run are preferable
to a second great depression.

The Peterson Foundation's second sleight of hand is the effort to
conflate Social Security and Medicare. Social Security's projected
deficit is within the statistical margin of error--about one-third of
one percent of GDP over 75 years. And Social Security, which is
financed by taxes on wages, would have huge surpluses if the wage share
of productivity growth hadn't been shrinking for the past thirty years.
If we could restore decent wage growth, Social Security's much
exaggerated problems would vanish.

For many of the people who want to cap or privatize Social Security,
the supposed concern for its deficit is an ideological assault
masquerading as a fiscal anxiety. The conservatives who wanted to
privatize Social Security showed no comparable fiscal worry when the
three Bush tax cuts consumed a budget surplus that might have been
applied to Social Security trust funds.

Medicare does face a serious shortfall, but as Henry Aaron of the
Brookings Institution keeps pointing out, you can't seriously talk
about Medicare without addressing the dysfunctional health system to
which Medicare is attached.

Here, too, this is really an ideological and philosophical argument,
not a fiscal or a technical one. No reform is possible if we keep the
present health system, with its wasteful misallocation of scarce
resources, in which money goes to procedures that are profitable rather
than those that are most cost-effective medically, and in which private
insurers take out 20 or 25 cents of every premium dollar.

America now spends 16 percent of our GDP on health, and the number
of uninsured and under insured rises every year, in tandem with the
costs. Other advanced countries manage to insure everybody for less
than ten percent of GDP. They have better health outcomes than we do,
because health outlays are efficiently targeted. We have more rationing
than any other nation, and we have the most pernicious kind of
rationing - rationing based on the private ability to pay for good

The present path leads inexorably to cost-containment via further
reductions in coverage. It leads to capping Medicare by turning it into
a voucher, and a worsening of the two class health system, with more
cost-shifting to patients and even less efficient allocation of scarce
health resources. And it leads to further stresses on primary care
doctors, who have been subjected to a speed up in the number of
patients they see and a reduction in compensation, leading to a
deterioration in care.

It is unconscionable to speak of the Medicare imbalance as primarily
as a problem of cost. It is a problem of a dysfunctional system, which
can only be resolved by shifting to a universal system that saves money
by financing health coverage universally and socially. If we shift to a
universal system, we could easily cover everyone for far less than 16
percent of GDP, and have net savings to the economy as well as better
quality care.

As for poster-children, when progressives fight for more funding for
kids, or housing, or higher wages, or to plug the other gaps in social
policy, the Petersons of the world never seem to materialize.

Those who warn about public spending increasing deficits and debts
often deliberately confuse two entirely distinct issues. First, how
large a share of the entire economy should be invested and spent
socially; and second, how large a deficit is wise. Before the current
crisis, public spending had been running at about 20 percent of GDP,
and revenues had been fluctuating between 16 and 18 percent. The
difference is the deficit. Once the crisis is behind us, I would like
to see federal spending rise to about 25 percent of GDP; and I would
like to see the federal budget at, or very close to balance, over the
business cycle. We can do that by increasing taxes on people like Pete

Given what financial deregulation has done to the economy, it's
revealing that people like Peterson have spent three decades warning
about impending fiscal collapse, but have not said word one about the
far more serious risks of the kind of market fundamentalism that built
their fortunes.

What crashed the economy? It sure wasn't the national debt or worry about "unfunded liabilities."

So, just how will President Obama define fiscal responsibility, who
will he choose to showcase, and to what end? It will be interesting to
see whether his fiscal summit features people like Pete Peterson, David
Walker, and Robert Rubin, and lends credence to their story--or whether
he also gives the floor to their critics.

You can understand why, as matter of fiscal tactics, Obama would
need to signal that it is possible and necessary to rely on large
deficits in 2009 and 2010 to avert a recession, and then to get serious
about fiscal discipline over the next decade once the economy has
returned to decent growth. He needs to argue this to reassure the Blue
Dogs in his own party, to win over some Republicans, and to get support
of opinion leaders for his recovery strategy.

But there is more than one road to fiscal discipline. One entails
gutting the few program that have survived the rightwing assault on
social insurance. The other involves filling in the appalling gaps in
social insurance and achieving fiscal balance by restoring the
principle of taxation based on the ability to pay.

Once again, our new leader, who has inspired so much hope and who so
wants to be a post-ideological president, needs to grasp that these are
deeply ideological questions. To pretend otherwise is to allow the
conservative version of the story to govern by default.

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