The passage of President Clinton's budget, marked by its one-half trillion in deficit reduction, is already restoring respect for the administration. Clinton will be tempted to move on to other issues. The urgent need to make good on health care reform and the generally sour nature of budget discussions will add to this impulse.
But the administration should resist the temptation to rush off the playing field, for two reasons. First, there will be a retrospective debate over the budget that may be more important politically than all the arguments leading to its enactment. Second, over the longer run, sad to say, unacceptably slow economic growth remains likely. Since economic growth, not legislative success or failure, will determine the ultimate judgment on Clinton, he needs to prepare ground for the next wave of budget and economic policy reform.
Republicans and some deficit "hawks" are already framing the retrospective debate. In a recent New York Review of Books, economist Benjamin Friedman argues that the package wasn't daring enough, that it should have cut spending more and raised taxes much more sharply on the middle class. Friedman focuses on the fact that the nominal deficit will start to rise again in 1997, and that even at the bottom the deficit "will still absorb more than half of the nation's net saving." Old supply-siders, for their part, are having a field day with the high ratio of (mainly progressive) tax increases to spending cuts. When the economy fails to grow, they will blame it on diminished work incentives for the rich.
It would be fatal to concede to either criticism. On the contrary, the president should insist that this package represents a once-for-all attack on the deficit. The budget should be portrayed as a full and fair test of the argument that financial markets and private investors will respond to credible deficit reduction by cutting interest rates and raising private investments. The deficit hawks have, in fact, been given their wishes. They must not be allowed to frame the retrospective debate and thereby escape responsibility for the results.
The president has ably defended the tax/spending balance. The simple fact is that excessive tax cuts, not excessive spending increases, caused the deficit; the dependent poor did not get rich under Reagan. It is also true that the tax increases have more credibility than spending cuts. Outside of Social Security, spending cuts are only projections and promises, whereas tax increases, once enacted, are law, and a future Congress would have to override the president's veto to repeal them. For this reason, Clinton's willingness to bite the tax bullet ought to be a major force in driving down long-term interest rates--if those who argue that tough and credible deficit reduction is the key to economic recovery are correct.
The present package deserves a fair chance to work (or not work) in practice. To assure that it has the best chance, the president and administration must keep the Federal Reserve on the team. Some members of the Federal Reserve Board wish to display their independence by raising interest rates in response to an inflationary threat, real or imagined. The administration should resist. It should not even be drawn into an argument over whether inflation threatens, since to do so is to concede the contingent policy position of the hard-liners. The present responsibility of the Federal Reserve is to support growth and deficit reduction by keeping interest rates low, come what may.
If economic growth remains unsatisfactory, say below 3 percent at an annual rate, then responsibility should be laid where it belongs: first, on Republicans in Congress who blocked the president's original growth package; second, on the unwillingness of the Federal Reserve to bring interest rates down far enough to offset the contractionary effects of deficit reduction; third, on the weakness of the theory that deficit reduction alone will revive growth.
The original two-track strategy combined a short-term growth package with long-run deficit reduction. With only half of that program enacted, growth will likely remain slow. Some may suggest a new (and larger) stimulus package, timed for best effect in 1995-1996. As economics, this position has merit. But coming as the president faces reelection, it would receive intense resistance from Republicans in Congress and from the press, revive unpleasant memories of an early defeat, and perhaps provoke the Federal Reserve to jump ship and raise interest rates sharply. A second stimulus package is probably a political non-starter.
Further constraints on the administration's margin of fiscal maneuver may be imposed by Congress. Renewed future-year spending caps have already been agreed to. A balanced budget amendment is also possible, unless the administration defuses it. All this too would militate against a discretionary fiscal expansion in 1995-1996.
The administration is unlikely to find other engines of growth. The gains from steps to revive private bank lending through regulatory relief--much talked about in the early days--are likely to prove illusory. Likewise, a global growth strategy, though potentially a vital contributor to domestic growth, is not a short-term solution, particularly when Europe's economy is stagnant and Japan's political climate is in disorder.
Therefore, despite the arguments made above against a new stimulus package, some other form of direct fiscal action may be the only practical way to break the economy out of stagnation. The question then becomes how to broach such steps in the political climate that now exists. The only answer requires bold and permanent changes in the terms of reference of fiscal discussion.
It must become possible for the administration and Congress to act on needed investments without having to run a gauntlet of balanced budget arguments, arbitrary spending caps, and charges of political opportunism. And this can only happen if the administration goes beyond recent efforts to recast the rhetoric of fiscal policy ("investment-led growth") and moves to recast the actual legal and political framework on which fiscal policy is made.
Four steps come to mind:
Capital Budget. The administration should begin to plan such a budget for, say, Fiscal Year 1996 or 1997. Allowing that some $200 billion of expenditures can properly be placed in the capital category, this single step would do wonders toward educating the American public on the dual nature of fiscal and economic responsibility. More important, it would permit the president to initiate capital projects with bond finance while presenting a balanced operating budget in normal economic times.
Infrastructure Bank. Congress has developed many variations on this idea, which would establish a revolving fund for state and local infrastructure projects. Here again, such capital projects, which spur development and support growth, should not be hostage to artificial and politicized federal budget constraints. An infrastructure bank would give the president more flexibility in capital spending, without derogation to the authority of Congress to set the operating terms of the bank.
Expanded Earmarking. Social Security (and also highway programs) has been isolated politically in part because dedicated revenues lock in long-term political commitment to them. Earmarking can get out of hand. But in health care, the idea of a national budget financed by a dedicated and stable tax source warrants close examination; it may be the only way to win acceptance for effective cost control and stop health care costs wreaking havoc with the rest of the budget.
New Framework for Fiscal-Monetary Coordination. A full reexamination of fiscal policy ought to include a review of institutional links between the president and the Federal Reserve. Moreover, the president must find new ways to use fiscal and incomes policy levers--such as, perhaps, allowing discretionary presidential control over annual cost-of-living adjustments--to signal inflation expectations to the private economy and relieve pressure on the Federal Reserve to be the only dutch boy at the anti-inflation dike. Now may not be the time to implement major changes, but a discussion of these issues should be on the agenda.
While dealing with the budget aftershocks, Clinton must indeed turn to meet his commitments on health care and other matters. He cannot assume that the economic orthodoxy behind the budget will pay off either for the American people or for himself. He must therefore begin now to prepare for the day when the effects of the present package are clear and the political climate may become receptive to larger reforms in the conduct of budget and economic policy.
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