Wednesday, July 20, 2011

Crises can make for bad decisions

Economists deeply divide over whether the best solution to the United States’ fiscal woes is to cut spending, raise taxes, or a combination of both. This lack of theoretical consensus has complicated the political debate and already begun to lead to poor decisions.

For example, Congress recently cut the budget of the Securities and Exchange Commission (SEC) by more than $200 million. What appears a potential sensible budget reduction is in fact just the opposite. The SEC funds its budget by imposing fees on financial firms. Reducing the SEC budget is at best fiscally neutral for the U.S. Treasury. However, the SEC annually contributes hundreds of billions of dollars to the U.S. Treasury in the form of penalties and fines collected. Reducing the SEC budget will curtail enforcement and almost certainly reduce Treasury revenues.

Who benefits from the reduction? The financial firms that the SEC monitors and regulates do because they will pay lower fees (by law, the SEC cannot charge more than it spends). How did the U.S. get into its current quagmire? In large measure, the problem stems to an under regulation of large mortgage firms.

Meanwhile, the driver of the U.S. economy, consumer spending, remains significantly depressed. The auto industry seems likely to sell 28% fewer vehicles this year than in 2001. Home sales are about the same as at the low point in the crisis. More and more consumers face a cash crunch at the end of each month, unable to ease their situation with debt.

Some government spending eases the plight of the consumers, e.g., reducing the payroll tax. Other government spending, though well intentioned, has proven ineffectual, e.g., the tax credit for first time home buyers resulted in increased sales prices for some homes but failed to reduce the backlog of houses on the market.

Dramatic reductions in government spending to balance the budget will most likely see a repetition of what happened when Herbert Hoover was president: the Great Depression. Consumers don’t have money to spend. Business is spending cautiously, waiting for increased demand to justify additional hiring and capital expenditures. That leaves only government to help the economy emerge from its current travail.

Two fundamental principles, both with strong ethical dimensions, which should shape U.S. government responses to current problems, are sustaining the economy in the short-run with spending and balancing the budget in the longer-run to ensure fiscal stability. Government spending in the short-run appropriately expresses communal concern for the most vulnerable (children, the elderly, the ill, etc.). Balanced budgets in the longer-term expresses a commitment that this generation not prosper by imposing a diminished prosperity on the next.

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