DELL: What fiscal pain?

Budget-cutting misery is more imagined than real

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Fundamental reforms necessary to resolve the nation’s long-term fiscal gap equitably and efficiently would produce large gains for little pain. In 1984, New Zealand abolished its large, unsustainable farm subsidies all at once. As expected, the plan was met initially with protest marches on Parliament and organized resistance by farmers. Nevertheless, only 1 percent of commercial farmers were forced to leave the land as a result of the new policy. Soon after the elimination of subsidies, the agricultural sector began growing faster than the rest of the economy, and it has been growing steadily since. In 2001, Alistair Poulson, chairman of the New Zealand Federated Farmers, advised farmers in other countries to “get off the subsidy gravy train as soon as possible.”

In 1996, congressional Republicans were attacked for their efforts to cut welfare spending. After reforms were enacted, welfare rolls fell by more than 50 percent, yet the poverty rate did not rise as some had predicted. Until the recent recession, the poverty rate remained lower following welfare reform than at any point in the previous 17 years. The 1996 reforms also produced an increase in health insurance coverage among noncitizen immigrants as a result of Medicaid eligibility cuts, according to a study completed by Harvard economist George Borjas.

In 1993, Canada faced an unemployment rate of 11.4 percent and a federal debt-to-GDP (gross domestic product) ratio of 67 percent. (Ours is 93 percent.) Led by its Liberal Party, Canada began to reduce federal spending in absolute terms, including spending for “sacred cow” programs such as employment insurance. Federal spending fell from a high of 17.5 percent of GDP in 1993 to just 11.3 percent in 2001, and by 2010, Canada had reduced its federal debt-to-GDP to 27 percent. Counter to the predictions of Keynesian models, Canada’s real GDP growth averaged a healthy 3.4 percent annual rate from 1993 to 2006.

Economist David Henderson suggests that Canada’s budget-cutting experience reinforces the lesson from the more extreme U.S. experience after World War II. Between 1945 and 1947, federal spending was cut from 41.9 percent of GDP to 14.7 percent. Yet the unemployment rate over that period stayed below 3.6 percent, and real GDP grew by 9.6 percent. According to Mr. Henderson, “The postwar bust that so many Keynesians expected to happen never did.”

Concerns about deep or lasting pain caused by spending cuts are misplaced. To spend is to tax. Most government spending hinders its recipients and damages the economy. Past reforms suggest that people of working age adjust quickly to the withdrawal of government spending. Also, only a small share of government spending benefits poor citizens, and thus substantial cuts - at least $400 billion from current annual discretionary spending - can be made without affecting them.

A total resolution of our $202 trillion fiscal gap ideally would entail two additional fundamental reforms. First, many economists favor, as the ultimate pro-growth tax reform, a flat tax on aggregate consumption (e.g., the FairTax) to replace the current Internal Revenue Service tax code. Such a reform would produce much gain for little pain. A 2006 study concluded that only the wealthiest would pay a higher percentage of their remaining lifetime resources in taxes than they do under the current regime. The greatest benefit would be to workers with low lifetime earnings, largely because of the effects of a FairTax prebate and elimination of regressive payroll taxes. The FairTax would spur economic growth, encourage new hiring, promote health insurance portability while controlling costs, put our entitlement programs on a more sound financial footing and stop subsidizing our overuse of debt.

Second, many economists argue for the long-term conversion of Medicare into a voucher system (or “premium support” system like that proposed in Rep. Paul Ryan’s Path to Prosperity) that would offer future seniors a fixed payment and allow them to pick their coverage from a range of private insurance options. This change would not require reducing Medicare benefits to current beneficiaries. Because everyone knows Medicare in its current form cannot be sustained for future retirees, the pain from program withdrawal for them is hypothetical. Mr. Ryan’s vouchers likely would be larger for the poor and sick. Those who would have to pay more out of pocket would be the rich and healthy.

Although our large, unsustainable fiscal gap demands fundamental reforms, most politicians do not advocate them because they reduce political leverage for future campaign support. But that and the prospect of pain should not stop the rest of us from insisting that politicians free us from the economically toxic policy mistakes of the past.

Robert Dell is a commercial real estate banker in Atlanta. He is co-author of the forthcoming book “Back From Serfdom: A Republican New Deal for Pragmatic Democrats.”

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