On Thursday, April 10, U.S. equity markets sold off sharply. The Dow was down by 1.62%, the S&P 500 declined by 2.09%, and the NASDAQ fell by 3.10%. Because the price of gold went up by 1.12% on the day, the declines were even greater in “real” (i.e., gold) terms: -2.71%, -3.17%, and -4.17%, respectively.
What happened that day? Well, among other things, 218 Republican congressmen signed their names at the bottom of a political suicide note drafted by Paul Ryan, by voting to pass his “Fiscal Year 2015 Budget Resolution.”
This vote, along with the Budget Resolution itself, dealt a major blow to Republican’s hopes for big gains in the November elections. From March 31, the day before Ryan’s budget plan was announced, to April 16, the advantage held by the Democrats in the “Generic Congressional Vote” opinion polls widened from 1.2 percentage points to 2.5 percentage points.
Right now, the Democrats are falling all over themselves to grab the lifeline that Ryan has thrown them. During the fall campaign, rather than being forced to try to defend the indefensible (i.e., Obamacare), the Democrats can focus attention on the Republicans’ budget plan, which amounts to performing surgery without anesthesia (big spending cuts without strong economic growth).
The Republican Party is known as “the stupid party,” and Ryan’s budget provides strong evidence for this appellation. His plan is strategically, conceptually, economically, and politically stupid.
A plan lays out a series of actions that are intended to achieve a goal. The goal is the most fundamental part of a plan. It must be logical, worthy, important, and correct. Ryan’s goal, balancing the budget, is none of these things. While Ryan calls his plan “The Path to Prosperity,” a better name would be: “The Path to Austerity;” or perhaps, “The Path to Blowing the 2014 Elections.”
Ryan’s plan fails strategically in its first sentence: “Washington owes the American people a responsible, balanced budget.” Ryan’s plan assumes that the most important goal of a budget plan is to eliminate the deficit. It is not. The most important objective is to maximize America’s prosperity.
Prosperity is about jobs and economic growth. Tellingly, while Ryan’s budget plan package includes 7 summary tables and 12 graphs, none of them mentions either jobs or economic growth. Instead, they focus remorselessly on spending, deficits, and debt.
The truth is that balancing the budget is much less important than maximizing our rate of economic growth (which will also maximize both total employment and wage growth). Republicans should always be willing to accept higher near-term deficits (e.g., by cutting taxes) in order to obtain faster economic growth. Here’s why this is fiscally, as well as economically and politically, sound.
A balance sheet has two sides, a left side for assets, and a right side for liabilities. Every business knows that assets are more important than liabilities. A company will gladly add debt, if the assets that it can acquire with the capital raised are worth significantly more than the debt incurred. No successful, growing company focuses on paying off its debt.
Ryan’s plan seems to assume that there is only one side to the federal government’s balance sheet, the right (liabilities) side. However, when asked to buy Treasury bonds, the financial markets look at both sides. And, American strength and prosperity is much more a function of the left (assets) side of the federal balance sheet than the right.
So, what is on the left side of the federal government’s balance sheet? Against what assets are the financial markets lending the U.S. money?
While our government owns some physical things (mainly land) that could be sold for cash, the major asset of the federal government is the present value of its future revenues. This, in turn, is equal to the present value of future GDP times the “tax take,” which is the percent of GDP that the government captures via taxation.
While it pays lip service to economic growth, Ryan’s plan is overwhelmingly about spending, deficits, and debt. This is the wrong focus. Achieving the fastest possible rate of economic growth should be the paramount objective of government budget policy.
This is because:
- The present value of GDP is exquisitely sensitive to the long-term rate of real economic growth.
- While the federal government may capture 18% of GDP, the states, the cities, and the people get to keep the remaining 82%.
- Both higher personal incomes and higher state and local tax revenues translate into less political pressure for federal spending.
- Even if your goal is only to cut spending, you need fast economic growth to create an environment where it is politically possible to cut spending. Growth must come first. Ronald Reagan understood this, even if present day Republican “leaders” do not.
How sensitive is the present value of GDP (and therefore federal revenues) to the rate of economic growth? Very, very, very sensitive. Consider the following:
Increasing our long-term real GDP growth rate by just 0.08 percentage points (from the CBO baseline of 2.15%) would do as much for federal finances as cutting federal spending immediately and permanently by 3.0% of GDP. (This would be equivalent to reducing this year’s outlays by more than $500 billion.)
Increasing economic growth by 0.5 percentage points (to 2.65%) would more than quadruple the present value of future GDP. At this higher growth rate, we could cut taxes in half, and still more than double the present value of future federal revenues vs. the CBO baseline.
Increasing our growth rate to 4.0%, which the U.S. averaged under the Bretton Woods gold standard (1947 – 1973), would increase the present value of future GDP by a factor of 125,000. This is not a misprint—we’re talking about 125,000 times more wealth, as the financial markets judge it.
OK, now let’s return to the Ryan budget.
They say that a picture is worth a thousand words. Below is the one graph that Ryan presents in the body of his plan document.
Now, if a private company published a plan with a graph like this, investors would assume that it was going out of business. No one would think that the company’s goal was faster growth.
The trajectory of U.S. debt held by the public in Ryan’s “Path to Prosperity” is no more viable or desirable than that of the “Current Path.” Both paths would lead to economic disaster, just a different kind of economic disaster.
The U.S. dollar is the currency of international trade, and the world monetary system runs on U.S. Treasury securities. Ryan’s plan calls for ripping the foundation out of the world’s financial structure, for the sake of, in essence, investing tax dollars in low-yielding U.S. Treasury bonds.
But wait! Chairman Ryan says that he does care about economic growth. Sorry, but this assertion is not supported by his plan document. For one thing, while it takes credit for producing higher growth, Ryan’s plan does not bother to present any GDP numbers. For this, one has to look to the CBO’s analysis of Ryan’s budget, “Budgetary and Economic Outcomes Under Paths for Federal Revenues and Noninterest Spending Specified by Chairman Ryan, April 2014.”
Based upon worksheet “13. Nominal GDP” of “45211-RyanSuppData-2.xlsx” (published by the CBO along with their report), Ryan’s budget plan would increase nominal GDP growth by 0.13 percentage points through FY2024. Because the CBO report does not suggest that Ryan’s plan would impact inflation, we must assume that the CBO believes that the Ryan plan would increase real GDP growth by the same amount.
So, Ryan’s plan would put the country through the fiscal wringer (and put many Republican candidates in danger of losing the November election) for the sake of squeezing out an additional 0.13 percentage points of annual growth between now and 2024. To present a plan that would increase economic growth by only 0.13 percentage points above the anemic CBO base case, when we are mired in the weakest economic recovery in American history, is to suggest that you don’t understand the problem.
Actually, Chairman Ryan doesn’t just suggest that he doesn’t understand the problem; he declares that he doesn’t understand the problem. The title of one of Ryan’s (unnumbered) “FY 2015 Budget Charts” (published along with his main document) reads, “Spending is the Problem.” No, Congressman, spending isn’t the problem. Slow economic growth is the problem.
During President Clinton’s two terms, real GDP growth averaged 3.89%, which was very close to the 3.86% that the U.S. averaged from 1790 to 2000. In contrast, from 2000 to 2013, real economic growth averaged only 1.76%. This was the slowest growth rate for any 13-year period since the Great Depression. Under Bush 43 and Obama, America moved 14.7 million jobs away from full employment.
If real GDP had grown at 3.89% for the past 13 years, the federal government would have run a $0.6 trillion surplus in 2013 (instead of a $0.6 trillion deficit), despite Obama’s wildly extravagant spending. And, of course, if President Bush had not made the policy errors that caused the slow growth (including standing idly by while the Federal Reserve trashed the dollar and the economy), there would never have been a President Obama, or an $847 billion “stimulus” program to run up the deficit.
Even more important than its effect upon the federal budget is the impact that the faster economic growth would have had upon family budgets. With 3.89% growth, 2013 real GDP would have been 31% higher ($22.0 trillion rather than $16.8 trillion). The nation would have been at effective full employment during the entire 13-year period. Spending on various welfare state benefits would have been much, much lower in 2013 than it actually was.
Given that, for most people, prosperity requires a decent paying job, it is odd that Ryan calls his plan the “Path to Prosperity.” It is hard to imagine that the meager 2.58% real growth rate that Ryan’s plan would produce through 2024 would do much for either employment or family incomes.
During the first 4.5 years of Obama’s so-called “economic recovery,” real GDP increased at a rate of 2.35%, while America actually lost ground (by 1.3 million FTE jobs) with respect to full employment. While Ryan’s promised 2.58% growth rate is higher than this, it is hard to see how it could put much of a dent in our employment shortfall, which was 14.9 million FTE jobs as of the end of March.
What Ryan is offering is a far cry from the 4.57% growth rate of the first 18 quarters of the Reagan recovery, which produced strong growth in both jobs and family incomes.
Perhaps even more alarming than Ryan’s pathetically low growth target is how clueless he seems to be about what actually produces economic growth—or even what it would take to actually cut spending.
Strange things happen when people go to Congress. Men that were previously strong Christians begin worshipping the CBO as if it were some kind of number-spewing golden calf. This seems to be what has happened to Chairman Ryan.
Federal spending is a negative for economic growth, but, in terms of impact, this factor runs a distant fourth behind monetary policy, tax rates (especially on capital), and regulations. However, because the CBO seems to give growth credit only for deficit reduction, Ryan’s plan focuses on that as a source of economic expansion. Unfortunately, the CBO’s model provides very small growth increments in return for large (and politically unacceptable) spending cuts.
The Ryan budget does mention tax reform as a potential source of higher growth, but the plan itself does not propose a tax reform program, and does not take credit for any increase in growth as a result of tax changes.
Again genuflecting before the CBO, Ryan talks of “…revenue-neutral fundamental tax reform.” “Revenue neutral” means, “revenue neutral under the CBO’s static scoring methodology.” As a practical matter, this means, “tax reform that could never actually be enacted.”
Static-revenue-neutral tax reform will produce losers as well as winners, and the losers will always band together to defeat the proposal. “Pro-growth” tax reform can only happen if Republicans are willing to defy the CBO, and propose a net tax cut. Ryan’s budget plan seems to be saying he is not willing to take on the CBO in this way.
However, as important as tax reform is, it is not as important as monetary reform, which would force the Federal Reserve to stabilize the dollar in terms of something real, and stop them from manipulating interest rates.
America has now suffered through more than 40 years of monetary chaos. The Fed’s efforts at economic central planning via a discretionary monetary policy have severely impacted U.S. (and world) economic growth. If the U.S. economy had grown as fast during the past 40 years as it had over the 183 years prior to that, GDP would be 63% greater today, and we wouldn’t be spending our time talking about deficits, debt, and inequality.
So, Ryan’s budget plan does not even mention the nation’s single largest obstacle to prosperity, the out-of-control Federal Reserve. Other than that, it’s great.
The Ryan budget plan is all about cutting spending, but even in this arena, it fails—both economically and politically. The Medicare reforms he proposes will spawn another round of Democratic campaign ads showing Republicans throwing old people off cliffs.
There are two points that the Republicans have to understand if they want the voters to give them full control of government again:
- At growth rates that are normal for America (3.5%+), all of the financial problems of Social Security and Medicare disappear, with no tax increases and no benefit cuts.
- Only scientific progress can “bend the cost curve” for Medicare. We must mobilize to find cures for Alzheimer’s, cancer, and diabetes.
Unfortunately, the Ryan budget plan doesn’t mention either of these points. Instead, it surrenders to the Washington “conspiracy against economic growth,” and then proposes tackling our entitlement problems via various “cost shifting” exercises.
There is a streak of righteous fiscal masochism in today’s Republican Party. The belief seems to be that we have (fiscally) sinned, and we must do (austerity) penance. This translates into Republican candidates calling for huge (although always unspecified) spending cuts, as well as balanced budget amendments. While this approach may play well in some Republican primaries, it will prove deadly in all too many general election campaigns.
Paul Ryan’s budget plan represents a suicide note for the Republican Party, because it offers austerity rather than growth. This November, the Republicans will either present themselves as the party of economic growth, or they will lose a number of winnable races.
