Everything Should Not be on the Budget Cutting Table: The Case for Expanding Public Investment

The International Monetary Fund recently scolded the U.S. government for running large budget deficits. Leaving aside the absurdity of cutting deficits when unemployment is still extremely high, it’s clear that at some point – as joblessness declines toward 5 percent – deficit reduction will need to begin in earnest. But the real question is how to do that. There’s a risk that the Washington economic class – grounded as they are in 20th century neo-classical economics — will fail to balance the twin imperatives of fiscal discipline and public investment.

Indeed the common refrain that has become the new “group think” in DC is that “everything should be on the table” when it comes to addressing the debt. For example, the Bipartisan Policy Center’s Debt Reduction Task Force says, “everything should be on the table.” Even President Obama, who has at least rhetorically talked about the need for increases in public investment and fought to include public investment in the stimulus, now says that everything should be on the table. Other groups echo this intellectually easy, but intellectually simplistic, position. Pete Peterson’s Concord Coalition likewise calls for “applying budget discipline to all parts of the budget.” The New America Foundation’s Committee for a Responsible Budgetsupports a budget freeze on all discretionary spending. For these budget hawks, subsidies to farmers to produce crops that aren’t needed fall in the same category as funding for the National Science Foundation to advance science and technology critical to our nation’s future: they both cost money and both should be cut.

The Government’s Role

But there are some things that governments do – on the tax and spending sides – which drive productivity, spur innovation, improve health, clean up the environment and create other benefits that most certainly should not be on the table. The National Commission on Surface Transportation Financing (which I had the honor of chairing) recently highlighted a federal highway and transit funding gap of nearly $400 billion over the next five years. Increased federal support for highways and transit would lead to significantly greater societal benefits (reduced traffic congestion, higher productivity) than the costs in revenues. Yet some groups wave the budget red flag to oppose expanded infrastructure investment, even if increased user fees, such as the gas tax, pay it for. As ITIF has demonstrated, increasing the Research and Experimentation Tax Credit from 14 to 20 percent would return $9 billion more to the Treasury than it would cost. And as ITIF and the Breakthrough Institute have shown, solving climate change requires significant increases in federal support for clean energy innovation, but the benefits (saving the planet) are massive.

If neo-classical-inspired budget hawks want everything to be on the table, liberal Keynesians want to put practically nothing on the table, except higher taxes on the wealthy and business. For example, economist Jamie Galbraith would take entitlement reform off the table. His solution: pray the Chinese keep lending us money. Likewise, Jeff Faux, founder of the liberal Economic Policy Institute argues that, “The deficit projections no more reflect a crisis of “entitlement” overspending than they reflect a ‘crisis’ in any other category of spending, like military spending or agricultural subsidies. Sensible governance understands that the fact that a program area is expanding does not make it the source of fiscal imbalance. But with entitlements off the table, you can’t solve the government’s fiscal problems simply by raising taxes on the rich.

All Spending Is Not the Same

What’s behind this widespread unwillingness to prioritize investment? Budget hawks fear that sparing one item from the chopping block will only validate the demands of interest groups to exempt their pet programs. In addition, many adhere to a neo-classical economics perspective, which holds that government plays a negligible role in economic growth and should be neutral with regard to private sector activity. In the purest form of this thinking, everything is on the table, because nothing is more important than anything else. To paraphrase Michael Boskin, a neo-classical Bush I economist, a dollar of public investment on computer chips has the same societal value as a dollar spent on potato chips. But government should be anything but neutral. Science and infrastructure funding is more valuable than farm subsidies. Government support for research in computer chips is more valuable than support for potato chips.

For liberals, reducing spending on entitlements will not only harm working Americans, but will also reduce economic growth, since Keynesian doctrine holds that growth comes from increasing aggregate demand – meaning pump more money into the economy, period.

In contrast, an innovation economics approach to the budget distinguishes between spending on consumption and spending on investment. For innovation economics advocates, all spending (either on the tax or expenditure side) should be on the table, and all investment (on the tax and expenditure side) should be off the table.

Tax, Cut and Invest

The last time Washington paid attention to deficits was in the first Clinton term. At that time PPI Vice President Rob Shapiro wrote a series of reports with the title, “Cut and Invest.” The notion was that we should cut unnecessary spending and use a significant share of the savings to invest in the nation’s future, including education, infrastructure and research. That was the right message then and it is the right message now. Although today, such a report might be best titled, “Tax, Cut and Invest.” To solve the budget deficit in a way that enables the significant increases needed in investment, we need to raise some taxes, cut some spending and increase some investment.

The general outline should look like this: On the tax side, we should let the Bush tax cuts on the wealthy expire, including: dividend taxes, estate taxes (above a certain modest size) and top marginal rates. We should increase the gas tax by at least 15 cents a gallon (and index it to inflation) and at the same time institute a carbon tax. We should consider a border-adjustable business activity tax. We should eliminate the home mortgage interest deduction. (Home ownership has many societal benefits, but as we see from other nations without these large tax incentives, nations can get high levels of home ownership without wasteful subsidies.)

On the spending side, we need to deal with entitlements, including: progressive indexing of Social Security benefits and increasing the retirement age, continued health care reform — particularly focused on driving innovation to cut costs and cutting entitlements to farmers — farm subsidies. This should be a gradual process to spread the pain over time.

And most importantly, we should significantly expand investments. We need to expand investments in education and training, science and research, technology (including, but not limited to clean energy) and physical infrastructure. In order to ensure that companies in the U.S. are globally competitive and create jobs here at home, we need to expand corporate tax expenditures. For example, create a new corporate competitiveness tax credit that would include a much more generous credit for research and development, and a credit for business investments in workforce training and new capital equipment, especially software. Making these investments will cost money in the short run. But they will also generate returns to the economy and the government in the long term. In economic downturns, successful corporations don’t cut key investments because they know that these investments are vital to gaining market share and competitive advantage in the moderate term. Governments should think the same way.

So let’s stop talking about putting everything on the table and instead recognize that not only do investments need to be off the table, they need to get more from what’s on the table.