Why I Didn't Sign the Deficit Letter

By Joseph E. Stiglitz
Politico
March 28, 2011
http://www.politico.com/news/stories/0311/52027.html

I was asked to sign the letter from a bipartisan group
of former chairmen and chairwomen of the Council of
Economic Advisers that stresses the importance of
deficit reduction and urges the use of the Bowles
Simpson Deficit Commission's recommendations as the
basis for compromise.

The letter's signatories believed that their support
would show that there was a core to scientific economics
that crosses ideological boundaries. While I agree there
is a core set of principles to which all card-carrying
economists would (or should) subscribe - resources are
limited, incentives matter - I did not sign.

I believe the 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.
_____________________

Joseph E. Stiglitz served as chairman of the Council of
Economic Advisers under President Bill Clinton. He was
chief economist of the World Bank from 1997 to 2000 and
was awarded the Nobel Memorial Prize in Economic
Sciences in 2001. His most recent book is "Freefall:
America, Free Markets and the Sinking of the World
Economy."

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