The 10-year budget framework that President Barack Obama released in February, called “A New Era of Responsibility,” is as much a philosophy of government as a fiscal action plan. Gone is the Ronald Reagan view that “government is not a solution to our problem; government is the problem.” Obama rightly sees an expanded role for government in allocating society’s resources as vital to meeting the 21st century challenge of sustainable development.
The scientific discipline known as public economics describes why government is needed alongside markets to allocate resources. These reasons include: the protection of the poor through a social safety net; the correction of externalities such as greenhouse gas emissions; the provision of “merit goods” such as health care and education that society deems to be essential for all of its members; and the financing of scientific and technological research that cannot be efficiently captured by private investors. In all these circumstances, the free-market system tends to underprovide the resource in question—whether income support for the poor, abatement of carbon emissions, low-cost primary health care, or R&D for renewable energy.
After a decade of macroeconomic instability, Reagan came to office in 1981 on a platform of shrinking the public sector to free resources for market-based allocation. Federal revenues and outlays remained relatively unchanged as a share of national income from 1981 to 2008, at around 18 percent of gross domestic product (GDP) for revenues and around 21 percent of GDP for outlays. The U.S. ran budget deficits during most of that period, with a long and chronic stalemate between those who would raise taxes and those who would cut spending. By and large, the public resisted cuts to spending programs but also resisted calls for tax increases.
The result is in strong contrast with Europe, where both taxes and spending are notably higher. Counting all levels of government (federal, state, and local), government revenues in the U.S. are about 33 percent of GDP, compared with 45 percent in Europe; spending stands at 38 percent of GDP in the U.S. and 46 percent in Europe. Yet because U.S. taxes are even lower than spending as a share of GDP, U.S. deficits are chronically higher. The main predictions of public economics are also supported. The U.S. lags behind Europe in several areas where public spending makes a vast difference: U.S. health outcomes are worse (for example, lower life expectancy with a much more costly private system); U.S. poverty is much higher; U.S. educational outcomes are worse (poorer outcomes in science, math, and functional literacy); and public infrastructure is superior in many European countries (for example, better mass transit and broadband penetration).
Obama’s budget plan properly focuses on areas that public economics identifies as priorities and where the U.S. discernibly lags behind many parts of Europe: health (the costly private U.S. system yields a lower life expectancy), education (worse science, math and functional literacy), public infrastructure (for mass transit and broadband, for example) and research and development (especially on sustainable energy). The emphasis is on public-private partnerships (PPP), combining public financing and private sector delivery. Among other major efforts, the PPP model will be used to promote the next generation of electric automobiles (plug-in hybrids, all-battery and fuel cells), a smart grid to tap renewable solar and wind energy in a resilient and efficient national network, and the testing of carbon-capture and sequestration at coal-fired power plants.
Obama’s vision of an expanded federal role is on-target and transformative, but the financing will be tricky. This year’s deficit will reach an astounding $1.75 trillion, or 12 percent of GDP, as a result of a collapse of tax revenues, bank bailouts and stimulus spending. Under the plan, the government debt held by the public will balloon from 40.8 percent of GDP in 2008 to 65.8 percent in 2013, a level that will weigh heavily on the budget for years.[break]
Obama’s budget plan aims to reduce the deficit to 3 percent of GNP by 2013, and to level off till 2019. This deficit is relatively large, but even that target will be very difficult to achieve and sustain as planned. With significant increases in entitlements spending and higher interest payments on the rising public debt, the plan is to cut the deficit mainly through higher taxes on the rich, reduced military outlays for Iraq and Afghanistan, new revenues from auctioning carbon-emission permits and, finally, a squeeze on non-defense discretionary spending as a share of GDP (which is programmed to decline from 4.7 percent in 2010 to 3.2 percent in 2019). Such a squeeze on non-defense spending seems unlikely—and indeed undesirable—at a time when government is launching several much-needed programs in education, health, energy and infrastructure.
The truth is that the U.S., like Europe, will probably have to raise new revenues by a few percent of GDP if government is indeed to carry out its vital roles in protecting the poor, promoting health and education and building a modern infrastructure with 21st century sustainable technology. Ending the Bush-era tax cuts on the rich certainly is merited, but further taxing the rich much beyond that will come up against political and practical limits. Within a few years, we’ll probably see the need for new broader-based taxes, perhaps a national sales or value-added tax such as those widely used in other high-income countries. If we continue to assume that we can have the expanded government that we need but without the tax revenues to pay for it, the unacceptable build-up of public debt will threaten the well-being of our children and our children’s children. No parent, or citizen, should find such an approach acceptable.
This story was originally published with the title "Paying for What Government Should Do"