Meat Loaf famously said that “two out of three ain’t bad.” By this standard, President Obama’s fiscal year 2014 budget, released Wednesday, ain’t bad. It certainly makes more sense than most of what passes for serious fiscal discussion in Washington. But it doesn’t do all that is necessary to boost U.S. growth—now or in the future.
The best economic-growth plan would be built around three elements: an ambitious public-investment agenda; serious measures to broaden the tax base and pare entitlement benefits for well-to-do retirees—not for now, but over the long term; and reforms to resolve festering issues from the 2008 financial meltdown. The president’s plan has versions of at least the first two elements. It moves beyond mindless austerity by offering up new public investments. It also uses a sensible mix of new revenues and entitlement changes to restore long-term fiscal sanity. Equally important, the budget phases in those changes down the road when the economy (we hope) will be stronger.
To appreciate why continued austerity would be economically reckless, just review the economic data for 2012. The United States did grow faster than most other advanced economies. But that’s only because the euro zone has been back in recession since mid-2012, France and Britain barely grew at all last year, with rates of 0.1 percent and 0.2 percent growth, respectively, and Germany expanded less than 1 percent. So, the United States looks good with 2.2 percent growth for 2012—even though it slumped to 0.4 percent in the final quarter. Among the major developed economies, only Australia (3.3 percent) outpaced America in 2012.
Given this environment, a budget’s first mission should be to strengthen growth. In short, there is no economic basis at this time for any short-term spending cuts or tax increases, especially on top of our own continuing, mindless sequester. Under certain special conditions, austerity can stimulate output in a weak economy—namely, when inflationary expectations and interest rates are high. But those conditions have nothing to do with the current state of the economy. The case for austerity, then, is simply politics. The continuing calls from conservatives to slash federal programs merely mask their fervid preference for small, weaker government.
The pressing issue here is not some notion of the optimal size for the federal government, but how to best use the federal budget, right now, to promote healthy growth. One part of the answer is to double down on the president’s plan to expand public investments. These cover goods and services that support productivity and innovation across all industries and companies—mainly, education and training, modern infrastructure from roads to broadband networks, and basic scientific research. When economists add up all of the benefits, they usually find that on average, public investments produce higher returns than private investments do. Moreover, smart public investments also stimulate more private investment. Yet, a recent study by the European Central Bank also found that America now lags behind in this sphere: across 17 advanced economies, we now rank 12th in our public investments as a share of GDP.
A budget dedicating an additional 1 percent of GDP to these investments, then, should boost growth in the short run and strengthen the factors that drive growth over the long term. That could mean more support for reforms to improve secondary education, reduce financial barriers to higher education, and provide retraining for any adult who wants it. It could mean renewed public support to develop light-rail systems across metropolitan areas and improve roads, ports, and airports. This is also the right time economically to more actively promote technological frontiers with more support for basic research. It’s also a good time to take the less costly step of reviewing federal regulation with an aim to lower barriers to new business formation. New and young businesses are reliable sources of jobs and competition, and those elements, in turn, stimulate higher business investment, particularly in new technologies.
While austerity makes no economic sense today, slowing entitlement spending over the long term seems clearly necessary. With Social Security providing at least 90 percent of the incomes of more than one-third of retirees, pension reforms should focus on some form of means testing. A good template to contain health-care spending is more elusive. The easy way politically would be to continue to cut payments to doctors, hospitals, and clinics. But over time, this approach almost certainly will end in shortages and long queues for treatment. For a sounder strategy, start with the half dozen or so provisions of the Affordable Care Act calculated to slow rates of health-care spending. A bipartisan effort to strengthen those measures, perhaps with malpractice reforms to entice conservatives, would be a good place to start.
Unfortunately, even all these initiatives won’t ensure strong growth, at least not by themselves. Economic history teaches us—if only we’d listen—that the recoveries that follow financial crises are always slow and bumpy, unless policymakers directly resolve the distortions that brought about those crises. In our case, many of the distortions in finance and housing linger on. We need to get financial institutions to divest themselves of their remaining toxic assets and, equally important, further limit the impulse of these institutions to operate like hedge funds. Until such changes come to pass, Wall Street will not focus sufficient resources towards supporting homegrown business investment.
The challenge in housing is as difficult politically, though technically less complicated. Across the nation’s five largest mortgage holders at the end of 2012, almost 12 percent of all mortgages were in serious trouble. Some 6.5 percent of mortgages were delinquent, another 1.6 percent were in bankruptcy proceedings, and 3.6 percent were in foreclosure. So long as these rates remain so abnormally high, housing values will be weak—and the primary asset of most American households will languish. A sensible approach would be a new federal program to help people avoid home foreclosures by drawing on temporary government bridge loans—much like student loans—made available until the job market recovers.
This year’s budget debate will likely follow a now familiar script in which the president offers his plan, which is promptly met with partisan invective and followed by personal attacks from all sides. For average Americans to see their economic prospects improve any time soon, the president and his allies have to forgo the partisan fights and instead use the budget to initiate a new national conversation, focused on the challenges and changes necessary to get the economy back on track.