The Sequester-Posner

The “sequester” is an ingenious (though, it seems, unlikely to be successful) device for forcing a compromise between President Obama (and Democratic legislators) and the Republican members of the House of Representatives. The federal deficit is too large—everyone agrees about that. Obama wants to cut it by a combination of tax increases and spending cuts. The Republicans want to cut it by spending cuts alone—larger spending cuts than Obama wants, larger because the cuts must do all the work, with no assist from higher tax revenues. The Republicans can’t make up their minds whether they hate taxes more, or deficits more, though taxes and deficits are interrelated. 

The sequester imposes steep cuts across the board, though not proportional cuts—for example, the military cuts are the steepest, and the entitlement cuts the shallowest. No effort was made to distinguish between essential federal agencies with no significant bloat, such as the Federal Aviation Administration and the Food and Drug Administration, and the federal agencies that either have unimportant functions or are overstaffed and the federal grant programs that are just interest-group handouts. But arbitrariness of the sequester is essential to its efficacy as a device for pressuring the opposing sides to compromise. The cuts would impose real hardship on government workers and beneficiaries of government spending. The sequester resembles a game of chicken. 

A majority of House Republicans believe that the federal government is simply too large, must be shrunk radically, and realize that it will be shrunk by a dollar less every dollar in additional tax revenues. Suppose the government spends 10 percent more than it should. If there is no tax increase, government spending must simply be cut 10 percent to achieve the desired shrinkage. But if tax revenues are raised by 10 percent, government must be shrunk by 20 percent in order to achieve a net reduction of 10 percent in government expenditures, and a spending cut of that magnitude would undoubtedly produce a severe recession. 

From a deficit standpoint, tax revenues are as good a device as spending cuts; a 10 percent increase in tax revenues has the same effect on the deficit as a 10 percent reduction in spending. But the radical Repulicans are less concerned about the deficit than about the size of government. Hence their adamant opposition to tax increases. 

So I must consider whether the federal government is indeed too large. I don’t think so. Nor have the House Republicans, to my knowledge, provided evidence or reasons for thinking it is. We need to distinguish between two kinds of “excessive largeness” in government. One is excessive bloat—too many government employees and, what often goes with that, excessive regulation of the private sector. Bloat in the sense of overstaffing is characteristic of all large organizations, public and private, and reflects imperfect control of large organizations by their managers, or in short “agency costs.” There probably isn’t much that can be done about that. And although excessive regulation is a problem, the financial crisis of 2008, from which we are still suffering the aftershocks, was caused not by excessive regulation but by insufficient regulation by the Federal Reserve, other banking regulators, insurance regulators, the SEC, and private regulators such as the rating agencies and FINRA (Financial Industry Regulatory Authority). 

The other kind of “excessive largeness” in government is spending. Major spending programs include Medicare, Social Security, Medicaid, and other welfare programs; support of research; subsidy programs such as farm subsidies and ethanol subsidies; the financing of infrastructure, such as the interstate highway system; environmental expenditures; the cost of the military; the cost of regulatory agencies such as the Food and Drug Administration, the SEC, and the EPA; the cost of law
enforcement and the judiciary; tax expenditures (for example, the subsidization of charity); and national security intelligence (the CIA and the multiple other intelligence agencies). None of these programs is easy to cut. Many of them should not be cut; in that category I would put (along with environmental expenditures, including measures to deal with global warming, and basic regulatory functions) the military and national security intelligence. We live in a very dangerous world, in which the usual geopolitical threats have been enhanced by the rise of international terrorism; and our allies are of limited dependability and resources in dealing with security matters. Much that passses for “waste” in the defense budget is a rational response to profound uncertainties concerning current and future threats and current and future capabilities of potential enemies. 

Medicare and Social Security are bound to grow as a function of increased longevity, and Medicaid as a function of increasing economic inequality. Some reforms seem attractive and even feasible, but the best and simplest would involve tax increases rather than spending cuts: higher Medicare and Social Security taxes for the affluent, and higher copays for Medicare (copays for government health insurance are a form of taxation). That are many subsidy programs, such as agricultural subsidies, that should be eliminated, but they are protected by powerful interest groups. 

All in all, then, the opportunities for spending reductions are limited. Therefore if the deficit is to be reduced, it will have to be reduced mainly by imposing higher taxes, whether in the form of higher rates on income tax or—what is a superior solution because it is more efficient than higher marginal tax rates, which are distortionary—tax reform mainly in the form of reducing deductions from income
tax. The problem is that the main deductions, such as mortgage interest, charitable contributions, and state and local taxes, are extremely popular. And so there may be no feasible alternative to higher rates. Fortunately, slight percentage increases in marginal rates can generate large increases in tax revenues; and the negative effects of slightly higher marginal rates— effects on emigration, work effort, investment choices, movement of money overseas, concealment of income, and schemes of tax avoidance—are likely to be modest. An increase in the marginal income tax rate from 35 to 75 percent would have dramatic negative effects; an increase from 35 to 40 percent on high-income taxpayers (say $200,000 and up), coupled with taxing capital gains, dividends, and interest at the same rate as ordinary income, probably not. 

 

 

 

Comments

[Thomas Rekdal]

The size of the current budget deficit--apart from the contribution of increases in the growth of entitlement spending--is not alarming in itself. Normal economic recovery should erase it, even if Rogoff and Reinhart are correct in believing that the recovery may take longer than most people expect.

Growth in the size of government surely must be part of the problem, because the more things government attempts to do, the more interest groups (such as AARP and the farm lobby) will organize to affect the outcome, usually in ways that benefit themselves more than others. But underlying this political dysfunction (if that is the right word) lies a deeper impasse rooted in the lack of consensus on two basic questions: How much of the nation's resources should be devoted to the old, the sick, the poor, and the unemployable; and who should pay for it--those presently alive and voting, or generations yet unborn?

These are moral questions not easily amenable to compromise. Indeed, I do not expect to see them compromised until the bond market forces some sort of accommodation. It is anyone's guess what that will look like, but it will be certain to confirm Joseph de Maistre's observation that every people gets the government it deserves.

[Terry Bennett]

As for the central question being posed, I agree that the effects can be absorbed relatively innocuously, unless there is a deliberate effort by government actors not to do so. This sort of thing happens all the time in private companies, even large ones. The board of directors simply says to the various division managers (analogous to federal government Cabinet members), "We are forecasting revenues to be down 3% in the coming year, so we're reducing everybody's budget 3%. Plan accordingly, and pass the word down to your reports. Cut spending on non-essential projects within your department, push for more efficiency, prioritize, drag your feet on some spending allocations, etc." This is what managers do, in the private sector. It's not particularly difficult. Every budget contains a certain amount of optimism toward the future, which can be scaled back if you find you can't afford it right now.

The 12/31 sunset of the Bush tax cuts was poised to deliver to the Democratic Party exactly what they wanted: higher taxes. I do not understand why they compromised, given their Senate majority and holding of the Presidency.

The 3/1 trigger is poised to give the Republican Party exactly what they want: lower spending. I do not see where they have any incentive to negotiate around the sequester.

Under the system our Constitution dictates, the people from the various states get to send Representatives to Congress. It seems that a majority of people in some states (to wit, the red ones) feel it is important that the federal government spend less, and they keep rewarding the Representatives who vote for lower spending by re-electing them. Until Democrats wrest a House majority and 60 votes in the Senate, this intransigent anti-spending contingent is going to keep doing what they are doing: enacting their agenda of making the federal government spend less. The President can decry their lack of intelligence, patriotism, and even sportsmanship, but the President is unpopular with the people who vote for anti-spending Congressmen, so this noise only helps them get re-elected. What seems to mystify the Democratic Party and the President is that large numbers of people in this country disagree with them, and want the federal government to spend less, and are going to keep voting for Representatives who work to accomplish that goal for them.

[Neilehat]

Terry, The "Red" States desire a smaller Federal Government and plan to downsize it by reducing Federal expenditures across the board and across the Nation. Fine. We'll start by eliminating all Federal Funding and Services to the "Red" States and leave them to their own devices. Now how much would that save on the Federal Budget? The "Reds" don't want to pay, the "Reds" don't want to spend, then they don't get to play.

I can hear the screams and howls rising now all across the "Red Nation". Which by the way doesn't represent the National majority - Thank God...

[Terry Bennett]

Neilehat - let me think about that. Some sort of opt-out plan may actually work.

[Terry Bennett]

Neilehat - I've been giving it the old GED try... Alas, the principle problem with citizens of red states choosing not to pay into federal programs and not avail themselves is mobility. A person can put in a career in a low-tax red state, then retire in a blue state and get the services. If it is set up at a personal level, where an individual chooses not to pay into Social Security, then wealthier people will choose not to participate and this will leave the poor to support the poor - unlikely to be viable. While there are work-arounds for these problems, ultimately it looks a lot like a dead end, and politically it's a nonstarter in any case.

I would also point out that (a) I am merely observing and not endorsing the Republican strategy, (b) an opt-out plan would seem to go against the impetus of some of your earlier posts, and (c) the blue vs. red debate in fact so particularly persists exactly because neither side has a sufficient majority, which was my original point. Recently a Democrat told me, "Once the sequester goes into effect, everyone will realize that it's the Republicans' fault for not compromising." This sentiment is oblivious to the fact that for some 40-plus percent of the electorate, "fault" is not an apt word. Those voters are enthusiastically saying, "Go ahead, sequester, and force lower spending. We will re-elect you."

As a general matter, I think the government spends money unintelligently, and I agree with the premise that it needs to be reined in. However, I would have preferred to see the cuts revised to target more obviously expendable line items. It turns out the government saves money unintelligently too.