A five-part plan to cut the deficit, narrow inequality, and strengthen the economy—and why special interests would block it.

Commentaries on economics and technology.
Dec. 6 2010 4:54 PM

This Budget Would Never Pass

A five-part plan to cut the deficit, narrow inequality, and strengthen the economy—and why special interests would block it.

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Happy co-workers. Click image to expand.
If we eliminated special treatment of capital gains taxes, would that benefit those who work for a living?

In the aftermath of the Great Recession, countries have been left with unprecedented peacetime deficits and increasing anxieties about their growing national debts. In many countries, this is leading to a new round of austerity—policies that will almost surely lead to weaker national and global economies and a marked slowdown in the pace of recovery. Those hoping for large deficit reductions will be sorely disappointed, as the economic slowdown will push down tax revenues and increase demands for unemployment insurance and other social benefits.

The attempt to restrain the growth of debt does serve to concentrate the mind: It forces countries to focus on priorities and assess values. The United States is unlikely in the short term to embrace massive budget cuts, à la the United Kingdom. But the long-term prognosis—made especially dire by health care reform's inability to make much of a dent in rising medical costs—is sufficiently bleak that there is increasing bipartisan momentum to do something. President Barack Obama has appointed a bipartisan deficit-reduction commission whose chairmen recently provided a glimpse of what their report might look like.

Technically, reducing a deficit is a straightforward matter: One must either cut expenditures or raise taxes. It is already clear, however, that the deficit-reduction agenda, at least in the United States, goes further: It is an attempt to weaken social protections, reduce the progressivity of the tax system, and shrink the role and size of government— all while leaving established interests, like the military-industrial complex, as little-affected as possible.

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In the United States (and some other advanced industrial countries), any deficit-reduction agenda has to be set in the context of what happened over the last decade:

  • A massive increase in defense expenditures, fueled by two fruitless wars, but going well beyond that;
  • Growth in inequality, with the top 1 percent garnering more than 20 percent of the country's income, accompanied by a weakening of the middle class—median U..S household income has fallen by more than 5 percent over the past decade, and was in decline even before the recession;
  • Underinvestment in the public sector, including in infrastructure, evidenced so dramatically by the collapse of New Orleans' levees; and
  • Growth in corporate welfare, from bank bailouts to ethanol subsidies to a continuation of agricultural subsidies, even when those subsidies have been ruled illegal by the World Trade Organization.

As a result, it is relatively easy to formulate a deficit-reduction package that boosts efficiency, bolsters growth, and reduces inequality. Five core ingredients are required.

First, spending on high-return public investments should be increased. Even if this widens the deficit in the short run, it will reduce the national debt in the long run. What business wouldn't jump at investment opportunities yielding returns in excess of 10 percent if it could borrow capital—as the U.S. government can—for less than 3 percent interest?

Second, military expenditures must be cut—not just funding for the fruitless wars, but also for the weapons that don't work against enemies that don't exist. We've continued as if the Cold War never came to an end, spending as much on defense as the rest of the world combined.

Following this is the need to eliminate corporate welfare. Even as America has stripped away its safety net for people, it has strengthened the safety net for firms, evidenced so clearly in the Great Recession with the bailouts of AIG, Goldman Sachs, and other banks. Corporate welfare accounts for nearly one-half of total income in some parts of U.S. agro-business, with billions of dollars in cotton subsidies, for example, going to a few rich farmers—while lowering prices and increasing poverty among competitors in the developing world.

An especially egregious form of corporate special treatment is that afforded to the drug companies. Even though the government is the largest buyer of their products, it is not allowed to negotiate prices, thereby fueling an estimated increase in corporate revenues—and costs to the government—approaching $1 trillion dollars over a decade.

Another example is the smorgasbord of special benefits provided to the energy sector, especially oil and gas, thereby simultaneously robbing the treasury, distorting resource allocation, and destroying the environment. Then there are the seemingly endless giveaways of national resources—from the free spectrum provided to broadcasters to the low royalties levied on mining companies to the subsidies to lumber companies.

Creating a fairer and more efficient tax system, by eliminating the special treatment of capital gains and dividends, is also needed. Why should those who work for a living be subject to higher tax rates than those who reap their livelihood from speculation (often at the expense of others)?

Finally, with more than 20 percent of all income going to the top 1 percent, a slight increase, say 5 percent, in taxes actually paid would bring in more than $1 trillion over the course of a decade.

A deficit-reduction package crafted along these lines would more than meet even the most ardent deficit hawk's demands. It would increase efficiency, promote growth, improve the environment, and benefit workers and the middle class.

There's only one problem: It wouldn't benefit those at the top, or the corporate and other special interests that have come to dominate America's policymaking. Its compelling logic is precisely why there is little chance that such a reasonable proposal would ever be adopted.

This article comes from Project Syndicate.

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Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University.  The paperback version of his latest book, Freefall: Free Markets and the Sinking of the Global Economy,with a new afterword, was published in October.