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With the Bush administration’s sights trained on Iraq, problems on the home front remain to be addressed. Wall Street is hitting 15-year lows, corporate scandals have jarred investor confidence, and a weak market has Americans worried about job security. In Washington, Congress continues its spending spree as members race to finalize spending bills before the November election. Surpluses are a thing of the past, with the federal deficit pushing $160 billion and counting. A recent poll found a majority of Americans have serious concerns about the U.S. economy and believe that heightened foreign policy concerns have come at the expense of sound economic policies here at home.
The deficit spending in the current economic downturn may be business as usual in Washington, but it raises important questions about fiscal policy and the lack of willpower in Congress. In many ways, the return of deficits serves as a reminder that government spending continues to be a problem for the economy. In fact, the recent surpluses resulted not from any government attempts to reign in spending; rather, the surpluses were a byproduct of a booming economy that generated higher than expected tax revenues for all levels of government. As evidenced by the federal deficit and the fiscal crisis in the states, government at all levels continues to spend at an alarming rate that promises to place a significant burden on taxpayers, now and in the future.
Typically, policy analysts have focused on the deficit when evaluating fiscal policy. When the federal government runs a deficit, spending outlays are greater than revenues. To bring the budget into balance, spending must be reduced or taxes increased. One of the problems with this approach to policy is that eliminating the deficit becomes an end in itself, overshadowing the larger question of the appropriate size and scope of government. Consequently, deficit hawks are often amenable to tax increases as a means to address the deficit. While additional taxes may bring the budget into balance, they also transfer additional resources to the government, at the expense of private businesses and consumers. And increasing taxes to fill a gap in the government’s accounting ledger does nothing to evaluate the long-term sustainability of government policies.
Excessive focus on the deficit is problematic for other reasons as well. In particular, there is little economic theory underlying federal accounting and what should or should not be included when calculating deficits. Government debt is an ill-defined concept and different definitions can generate different fiscal outlooks. Perhaps the most notorious example is Social Security, and the debate whether it should be off-budget or on-budget. Both Social Security and Medicare have been identified for the long-term liabilities they pose for the government. But the government spends money on many more programs as well, and they may pose future liabilities as well, particularly as demographics change over time.
Economic tools have been developed that provide additional insights into fiscal policy. One innovative approach is “generational accounting” developed by Laurence Kotlikoff, Jagadeesh Gokhale, and others. Generational accounting provides insights into the sustainability of fiscal policies as well as who bears the burden for government spending. Briefly, generational accounting rises above the accounting questions of how to calculate the deficit and examines the broader question of government spending and who pays for it. Governments spend money and issue debt; ultimately this must be paid back—either by today’s taxpayers or future taxpayers. What current taxpayers do not pay is a legacy they leave to the next generation of taxpayers. When evaluated over time, it quickly becomes evident that current fiscal policies are not sustainable.
The findings of this analysis are sobering. Economists have calculated a “lifetime tax rate” for each generation, with the current generation’s tax rate equal to 33 percent. Mr. Gokhale has estimated that the government will spend $31.5 trillion to meet its current obligations, but the current generation will pay only $22.1 trillion in taxes over their lifetime, which leaves a debt of $9.4 trillion This overhang is a huge burden on the next generation. In fact, Gokhale predicts that the next generation will face a lifetime tax rate of nearly 50 percent if the government is to meet its spending obligations. This raises serious questions about the inter-generational fairness of current government spending. In many ways, today’s generation is living large at the expense of future generations. If the next generation wants as much out of government, they must be prepared to pay a substantially higher tax bill.
While not perfect, generational accounting raises an important caution about excessive federal spending. As government obligations grow, so does the burden on the next generation. Additionally, the longer reform is delayed, the more it costs to pay down the costs of government. Nonetheless, Congress continues to spend at a record pace. The war on terrorism has provided an excuse and cover for more congressional spending. Yet as Mortimer Zuckerman notes, “Only a third of the entire $91 billion increase in annually appropriated funds has been spent on homeland security and national defense; the rest goes for everything from highway construction to farm subsidies.”
Generational accounting lays bare a number of problems with Washington’s spending habits, from the need to reform programs such as Social Security and Medicare sooner rather than later, to a more accurate depiction of the impact today’s spending will have on future generations. With economy in the doldrums, Americans are rightly concerned about the domestic economy. Spending policies that, at best, shift the burden to future generations will do little to improve the long-term fiscal outlook or long-term economic growth. In addition to addressing threats from abroad, President Bush cannot ignore the home-grown dangers of domestic policies that continue to push government spending higher.