Becker makes the important point that growth in the deficit, because of an increased gap between government spending and tax revenues, is tolerable if GDP grows faster; for it is not the absolute size of the deficit, but its relation to the size of the economy, that is important. And there are, as he says, a number of reforms that would result in faster economic growth, including tax reforms and a rational immigration policy. And spending could be cut—just placing social security and Medicare on a means-tested basis would do wonders.
But there are two questions to ponder. One is whether reforms aimed at increasing economic growth (rather than reducing spending) would be likely to increase that growth by a large enough margin to make a growing deficit shrink as a percentage of GDP. I am skeptical. Americans are lightly taxed by international standards and the rate of formation of new businesses normally is very high. Small businesses are currently having trouble borrowing but that is a consequence of the continuing weakness of the banking system rather than of anything to do with the tax system, and the financial system is likely to revive before tax reform could be implemented. The higher tax rates of the Clinton years seem not to have inhibited economic growth. It would be great if the immigration laws were changed to encourage more immigration by high-IQ foreigners and also by wealthy ones, but, again because of the continuing weakness of the U.S. economy, the demand for skilled immigrants is at present weak.
There may also be a practical ceiling on the rate of economic growth of a mature, highly complex economy. Maybe at a growth rate above 3 percent, labor and materials shortages create bottlenecks and inflation that make it prudent for the Federal Reserve to push up interest rates in order to slow down growth. If this is right and if taxes are cut and spending rises, it is hard to see how the annual deficit can be kept from rising by more than 3 percent. It is illuminating to compare the increase in the national debt during the Presidency of George W. Bush—a period in which Congress (until 2007) and the Presidency were highly pro-business—with the increase in GDP during that period. In 2002, the debt increased by 5.5 percent and GDP by 1.3 percent. The corresponding figures for 2003 were 6.2 percent and 1.4 percent; for 2004, 5.7 percent and 3.4 percent; for 2005, 3.7 percent and 2.6 percent; for 2006, 3.4 percent and 2.9 percent; for 2007, 3.6 percent and 2.8 percent; for 2008, 5.0 percent and 2.0 percent; and for 2009, 5.5 percent and 2.6 percent. Since then of course the gap has widened, but that is because of the economic crisis. We would feel great if we were back in the Bush economy! Yet in every year of Bush’s Presidency, the deficit grew faster than GDP. That may be the “new normal.”
The second question (which relates to the hypothesis of a new normal) is the political realism of economic reforms that would increase the growth rate or reduce the deficit. As I have argued previously, both political parties seem to have converged on a policy of high spending and low taxes. The Democrats want even higher spending than the Republicans do, and the Republicans want even lower taxes than the Democrats do, but these differences should not blind us to the realization that neither party has serious plans for reducing the annual increases in the deficit. I do not see this changing in the new Congress. If the Republicans had won control of the Senate, they would be under pressure to produce legislation that the President would sign, lest the new Congress be accused of being a “do-nothing” Congress—the accusation that won Truman the Presidency in 1948. But since the Republicans do not control Congress, an oppositional stance is attractive. And it is more difficult for Obama to compromise with Republicans than it was for Clinton, because Obama is more liberal than Clinton was and the Republicans are more conservative today than in the 1990s.
The status of the dollar as the international reserve currency, and the mercantilist policies of countries like China and Germany, will enable us to finance our growing deficit, and thus postpone the day of reckoning, for some time. But at some point the wheels may start coming off the chassis.
Still, life is full of surprises. The prospects for the United States looked grim in the 1970s and bright for Japan. Then Reagan was elected and the sky cleared here, and then the Japanese housing and banking bubbles burst and Japan entered the long period of economic stagnation in which it still finds itself. Maybe we’ll get lucky again.