AMERICA´S SUCCESS DEPENDS ON A SOUND FISCAL REGIME / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

America’s success depends on a sound fiscal regime

Robert Rubin

July 28, 2011

Our country cannot afford politics as usual at a moment of such vital import for now and for the longer term. Many Americans have experienced great hardship since the recession began; unemployment has become long-term for large numbers, with potentially permanent damage through loss of skills; and current economic conditions could well remain stressed for an extended time due to the strong headwinds we face. Policy decisions can make a real difference to these conditions, for better or for worse.


Looking to the longer term, we could well be at an historic crossroads. With our dynamic culture and other strengths, we should succeed if we meet our policy challenges. If we don’t, we will likely languish.


The issues we face are complex and there are very different views about what to do. But policy makers who operated on facts and analysis, not ideology and politics, who worked to find common ground and who made politically tough decisions could reach enough agreement to ameliorate our shorter term duress and position us for longer term success. The key is the political will of our people and our leaders.


It is imperative, for both the nearer term and the longer term, that we meet the deficit commission’s goal of $4,000bn of deficit reduction over roughly 10 years, which would first stabilise and then begin to reduce our debt to gross domestic product ratio. That programme must include room for public investment in areas critical to our economic future, a balance of revenue increases and reductions in all categories of spending that enables the government to provide the services and safety net that most Americans expect (albeit with appropriate reform), and an effective date two or three years from now to allow time for recovery to hopefully take hold.


The argument against raising taxes during a recession is a red herring given the deferred effective date, and in any case would apply equally to spending cuts. Opponents of President Bill Clinton’s 1993 deficit reduction programme also said that the tax increases – almost entirely on the most affluent – would lead to recession or worse. Instead, we had the longest economic expansion in the nation’s history – in part because of the confidence created by sound fiscal conditions – with massive job creation, widespread income increases, and ultimately the first fiscal surplus in 30 years. That notwithstanding, the ideological opposition to revenue increases continues, creating deeply counter-productive pressure on programmes critical to our economic future and the economic security of our people.


It is delusional to think that our fiscal problems can be solved predominantly by cutting non-defence discretionary spending, which can be roughly defined as the regular functions of government apart from defence, social security and the healthcare programmes. The numbers simply won’t work – the Congressional Budget Office estimates that on a realistic appraisal of our current policy outlook, our deficit will be 7.5 per cent of GDP in 2021, and non-defence discretionary spending is roughly 4.4 per cent of GDP today. Moreover, the damage to our economic future from focusing predominantly on non-defence discretionary spending (which includes education, infrastructure and the many other aspects of public investment) would be enormous.


A serious deficit reduction programme could be attached to increasing the debt limit, which is an absolute imperative, given the effects not doing so could have on market risks and on confidence in our political system. At the very least, the debt limit should be raised without harmful conditions.


Meanwhile, work must continue toward accomplishing the full fiscal objective. As many specifics as possible could be set now, with guidelines for the rest that are concrete and structured to be as hard to evade as possible in future years.


Such an approach would greatly reduce the severely dangerous bond and currency market risks of our current fiscal trajectory. Those risks are more likely to materialise in the longer run but market psychology is unpredictable and disruption in the shorter term cannot be ruled out.


Moreover, our current unsound fiscal outlook is likely to increasingly undermine business and consumer confidence, both by creating uncertainty about future economic conditions and policy and by symbolising a broader inability to manage our economic affairs and provide effective governance. Conversely, the 1993 deficit reduction programme showed how strongly a sound fiscal programme can improve confidence, which in turn increases investment and hiring.

Because of the corrosive effects of our fiscal outlook on confidence, which will worsen as our debt to GDP ratio deteriorates, I do not believe a healthy recovery can begin without a sound fiscal regime.


Serious longer-term deficit reduction would also make a temporary stimulus safer and more effective, by countering the market risks and adverse confidence effects that could be associated with additional deficit measures. Linked to such a fiscal programme, a temporary stimulus, such as continuation of the payroll tax holiday and of the unemployment insurance extension, could well be warranted to combat the paucity of demand.


Without serious deficit reduction, the balance of effects of a temporary stimulus is a much harder question. We do need additional demand, especially with the increasing incidence of long-term unemployment and the fiscal drag in 2012 from the end of the current stimulus. The risk is that the political system could be seen as unable to address the difficult issues of serious deficit reduction, but able to act only on providing lower taxes or increasing programmes. That could possibly become the straw that breaks the camel’s back on market psychology. And business and consumer confidence could be further undermined, partly offsetting the stimulus and possibly with more lasting effects. Moreover there are real issues about whether a stand-alone stimulus would be likely to have an ongoing benefit, given our unsound fiscal underpinnings and other headwinds, and whether it will pay for itself, even over time. The points here are not dispositive either way on a free standing stimulus, but simply show that the decision is not simple or one-sided.


For the longer term, our success – and avoidance of unsatisfactory performance – depends on a sound fiscal regime. That regime would prevent an otherwise virtually inescapable market and economic crisis, create an interest rate environment conducive to growth, buttress confidence, and provide the resources for essential public investment, economic security and national defence, which would otherwise inevitably be significantly under-funded.
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The writer was was US Treasury Secretary from 1995 to 1999 and is co-chairman of the Council on Foreign Relations