Hoover Daily Report

The Time for Spending Cuts Is Now

via Wall Street Journal
Friday, February 11, 2011

The old bromide that citizens elect presidents for protection from other people's congressmen was reversed last November when a Congress was elected for protection from the president. This week House Republicans have been debating how to cut the ballooning budget. After ramming through an expansion of federal spending to levels not approached since World War II, President Obama is now calling for still more spending, with a renewed emphasis on infrastructure, that he claims will create jobs and economic growth.

Let's put this in perspective: With the Congressional Budget Office (CBO) now projecting a federal budget deficit this year of $1.5 trillion, Mr. Obama is on course to add as much debt in one term as all 43 previous presidents combined. Not surprisingly, the rating agency Standard & Poor's is warning of a Treasury downgrade.

Yes, the president is calling for a freeze on nondefense discretionary spending (18% of the budget). But this would leave that spending more than 20% higher than already- elevated 2008 levels, where Republicans would like to return. The freeze also cements in place a huge expansion of government originally sold as a temporary, emergency response to the economic and financial crisis.

Mr. Obama's Budget Director Jacob Lew asserts that the president has made tough choices, pointing to $775 million of proposed cuts—but that's one-tenth of 1% of nondefense discretionary spending. The Obama administration and its supporters dubiously claim higher spending will quickly strengthen the recovery and generate jobs, and that any "draconian" cuts would derail the recovery. Higher spending, deficits and debt are future problems, they argue, and even then higher taxes (especially on "the rich") won't harm the economy.

But government spending generally does little to boost the economy. Exhibit A is the failed 2009 stimulus bill, the president's American Recovery and Reinvestment Act (ARRA).

The strongest case for stimulus is increased military spending during recessions. But infrastructure spending, as the president proposes, is poorly designed for anti-recession job creation. As Harvard economist Edward Glaeser has shown, the ARRA's transportation spending was not directed to areas with the highest unemployment or the largest housing busts (and therefore the most unemployed construction workers). Indeed, last September Wendy Greuel, the City of Los Angeles controller, shocked the country when she revealed that the $111 million in ARRA infrastructure money her city received created only 55 jobs—that's a whopping $2 million of federal stimulus per job created.

Why is this so? Modern, large-scale public infrastructure projects use heavy equipment and are less labor-intensive than they were historically (WPA workers digging ditches with shovels in the 1930s). Federal transportation stimulus spending was $4 billion in 2009, leaving two problems with claims of "shovel-ready" projects: shovels and ready.

The nation certainly has public investment needs, but federal infrastructure spending should be based on rigorous national cost-benefit tests. Most local officials are happy to have the rest of the country pay for spending on virtually any project, however modest the local benefits. Even so, several states have rejected high-speed rail subsidies as requiring unwise state spending despite the subsidies. California's estimates, for example, have soared.

Moreover, how will we pay for all this new spending? The CBO's 10-year projection sees the possibility of the debt-to-GDP ratio rising to an astounding 100%. Several recent studies (detailed on these pages in my "Why the Spending Stimulus Failed," Dec. 1, 2010) conclude that: 1) such high debt would severely damage growth, so fiscal consolidation is essential; 2) fiscal consolidation is likely to be far more effective on the spending than the tax side of the budget; and 3) substantially higher tax rates and spending cause permanent drops in income that are many times larger than the temporary fall caused by the recession. Thus, spending control is vital before debt levels or tax increases risk severely damaging growth for a generation.

In the 1980s and '90s, federal spending was reduced by more than 5% of GDP to 18.4% in 2000—a level sufficient to balance the budget at full employment and allow for lower tax rates. It was a remarkable period of growth, and there's no reason we can't repeat that success. In addition to rolling back ObamaCare and rolling up remaining TARP and stimulus funds, spending control should include these major reforms:

Consolidate, eliminate, defederalize and, where feasible, voucherize with flexible block grants. I pointed out in 2007 that 42% of federal civilian workers were due to retire in the coming decade. Replacing half of them (with exceptions for national security and public safety) with technology could improve services and save hundreds of billions of dollars. Beyond the savings, it would make necessary services more efficient. For example, the federal government's many separate job-training programs should be consolidated and voucherized to enable citizens to obtain commercially useful training.

Adopt successful business practices where possible. For example, consolidating IT infrastructure, streamlining supply chains, using advanced business analytics to reduce improper payments, and switching from expensive custom code to standardized software applications could save more than $1 trillion over a decade while upgrading and improving federal support and information services.

Gradually move from wage to price indexing of initial Social Security benefits. This would eliminate the entire projected Social Security deficit without cutting anyone's benefits or raising anyone's taxes. Also, raise the retirement age over several decades, preserve early retirement and disability, and strengthen support for the poorest. On Medicare, former Clinton Budget Director Alice Rivlin and House Budget Committee Chairman Paul Ryan propose gradually moving to fixed government contributions to purchase insurance, for large savings and more informed care.

The immense growth of government spending and soaring public deficits and debt are the major sources of systemic economic risk, here and abroad, threatening enormous costs by higher taxes, inflation or default. The problem is not merely public debt. A much higher ratio of taxes to GDP trades a deficit problem for sluggish growth. In recent decades, the large advanced economies with the highest taxes have grown most slowly. And the high-tax economies did not have smaller budget deficits. Rather, higher taxes merely led to higher spending.

Elected officials too often ignore long-run costs to achieve short-run benefits. But government policies can neither revoke the laws of arithmetic nor circumvent the laws of economics. The time to start reducing spending is now.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.