Bowles-Simpson would lead to a weaker America — with slower growth and a more divided society

Stiglitz on Bowles-Simpson:

Bowles Simpson recommendations represent, to too large an extent, a set of unprincipled political compromises that would lead to a weaker America — with slower growth and a more divided society.

In a white paper written for the Roosevelt Institute, I explain the principles that should underlay deficit reduction and what a deficit reduction package consistent with these could look like.

The ballooning of the deficit since the crisis struck has understandably moved deficit reduction to the center of the debate. But the best way to reduce the deficit is to put America back to work.

Overwhelmingly, the deficit increase has been caused by the enormous shortfall between the economy’s potential and actual output. Even as growth has resumed, the “output gap”—reflecting in high unemployment—has persisted. The Bowles-Simpson recommendations, if adopted, would constitute a near-suicide pact: Growth would slow, tax revenues would diminish, the improvement in the deficit would be minimal.

What matters for sustainability is the debt to gross domestic product ratio — and that likely could worsen. This is what we have seen in the similarly poorly designed austerity measures of Greece, Latvia and Ireland; and in earlier such measures in Argentina and East Asia. The International Monetary Fund seems to have learned the lesson — but not the Bowles-Simpson Commission.

With monetary policy demonstrably ineffective in pulling us out of our malaise, fiscal policy is only recourse to putting America back to work. Fortunately, we can simultaneously stimulate the economy now and reduce the deficit in the medium term.

Years of underinvestment in the public sector—in infrastructure, education and technology—mean that there are ample high-return opportunities. Tax revenues generated by the higher short- and long-term growth will more than pay the low interest costs, implying significant reductions in deficits. Any firm that could borrow at terms similar to those available to the U.S., and with such high return projects, would be foolish to pass up the opportunity.

So, too, increased progressivity of the tax system—shifting the burden from low and middle income Americans, who have seen their incomes decline, to upper income Americans, the only group in the country that has prospered for the last decade—would have double benefits. The shift would stimulate the economy in the short run, and reduce the growing divide in the country in the long run. 

With a quarter of all U.S. income going to the upper 1 percent, and America’s middle class actually facing lower incomes than a decade ago, there is only one way to raise more taxes: Tax the top. 

A corollary of this inequality is that slight increases in the taxes at the top can raise large amounts of revenue. Just making the tax system fairer and more efficient at the top—eliminating the massive corporate welfare hidden in the tax system and the peculiar provisions that allow the speculators and bankers who helped cause the crisis pay far lower taxes than those who work for their income—would go a long way toward deficit reduction. 

The Bowles-Simpson Commission is correct in pointing to the middle class tax expenditures, which encourage excessive spending on health care and housing. But eliminating these provisions should not be considered part of a deficit reduction package. If they were eliminated, the hard-pressed middle class should be protected by corresponding reductions in tax rates. 

Moreover, the commission seems insensitive to the consequences of even making commitments today to reduce mortgage deductions in the future – no matter how gradually phased in. Housing prices would fall further; more Americans would see their homes go underwater; there would be more foreclosures, and the ever-suffering middle class would face even more suffering. 

The Bowles Simpson Commission is correct in one conclusion: At the core of the country’s long run deficit and debt problem are soaring health care costs. The commission recognized that it had not adequately dealt with this crucial issue. If U.S. health care costs were comparable to those of European countries, which provide better health care to more citizens at lower costs, our long term deficit would be under control. 

But the commission did not point out the implications of attempting to curb costs of the public system for the aged and poor, without reforming that for rest of the economy. Inevitably, it would mean that the poor and aged would face rationing. They could not compete for the health care services. 

In short, redesigning tax and expenditure programs could promote faster economic growth in both the short run and long; increase equity and opportunity, and lower the national debt, and the debt/GDP ratio even more.

In my report, I outline the low-hanging fruit that could easily exceed the $4 trillion dollar target set by the Bowles-Simpson Commission. For example: (a) The Cold War ended more than two decades ago, but we continue to spend tens of billions on weapons that don’t work against enemies that don’t exist. Fruitless wars have not increased our security and our military’s credibility. Rather, they have undermined both. 

We could have more security with less spending. The commission recognized this — but didn’t go far enough. Congress and the Obama administration have not gone far enough either. 

(b) The health care reform bill did little to eliminate the trillion-dollar giveaway to the drug companies, resulting from restrictions on the ability of government (the largest buyer of drugs) to negotiate prices. In contrast to every other government in the world. While much more can, and should, be done to control health care costs, this little change would make a big difference. 

Eliminating corporate welfare, both that hidden in our tax systems and in the hidden give-aways of our country’s natural resources to oil and gas and mining companies; eliminating the unjustifiable and harmful tax breaks for speculators and companies that keep their money out of the country, and taxing activities that generate large negative externalities—whether the environmental pollution that threatens our health and our children’s future, or the financial transactions that brought out country and the world to the brink of ruin—could all easily generate trillions of dollars in revenues. At the same time, they could also create a fairer society, a cleaner environment, and a more stable economy. 

Deficit reduction is important. But it is a means to an end — not an end in itself. We need to think about what kind of economy, and what kind of society, we want to create; and how tax and expenditure programs can help achieve those goals. 

Bowles-Simpson confuses means with ends, and would take us off in directions which would likely be counterproductive. Fortunately, there are alternatives that could do more for deficit reduction, more for putting America back to work now and more for creating the kind of economy and society we should be striving for in the future.