HOW TO PAY FOR HURRICAINE CLEAN-UP

COMMENTARY BY MICHAEL MEEROPOL on WAMC RADIO, October, 2005.

IN TODAY’S COMMENTARY, ECONOMIST MICHAEL MEEROPOL PROPOSES A WAY TO FINANCE THE FEDERAL EXPENDITURES TO CLEAN UP AFTER HURRICANES KATRINA AND RITA.

When President Bush addressed the nation in the wake of the Katrina catastrophe he correctly recognized a Federal responsibility to help people whose lives had been devastated by both the hurricane and the failures of government.

Federal Expenditures are estimated at $200 to $300 billion dollars and that’s not counting the clean up after Rita.

Pundits and politicians have immediately taken the position that this increased spending poses a grave danger if it raises the Federal budget deficit.[1]

I want to argue a contrary position.

In addition, I want to make a modest proposal.

I submit that the assertion that a federal budget deficit is always a bad thing is the equivalence in economics of stating that the earth is flat.[2]

“We are mortgaging our children’s future!” is the warning from those who demonize deficits.

Mortgages, in fact, are not bad things.

When we buy a house we usually take out a mortgage. Most individuals borrow and every business borrows.

Individuals borrow to go to college, to buy a house, to buy a car, to get through a short rough patch. Businesses borrow to invest and to expand.

If you borrow, go to college or expand your business [pause] and are rewarded with a decent income the burden of repayment is “worth it.”[3]

But say the critics – letting government borrow lets government waste your money.

NOT IN THIS CASE.

The government will actually be investing in our future when it re-builds buildings, repairs roads, reconnects and repairs electric utilities and urban water and sewer lines in response to the horrific damage caused by the recent hurricanes and the government’s initial failures after Katrina.[4]

Don’t get me wrong. The government does waste money. The recent highway bill was full of “pork”

Similarly, since 2001 tax cuts have reduced the percentage of GDP taken in by the Federal Government from 20.9% to 16.8% projected for 2005.[5]

A good chunk of that reduction was in tax cuts which disproportionately benefited very high income individuals and have had no measurable impact on savings and investment.[6]

My fear is that because deficit spending has been so demonized, we will forget that borrowing in order to rebuild is an essential investment, and thus there will be great pressure to pay for hurricane clean-up by reducing spending elsewhere in the budget – for example, by cutting Medicaid.

That would be a bad thing.

So now I make my modest proposal.

Just as during World War II the US ran a gigantic budget deficit and urged all citizens as part of their patriotic duty to buy “War Bonds”[7]

I propose that the Federal Government immediately announce that the Treasury will be issuing $300 billion in new 10-year inflation-adjusted Treasury Bonds in denominations as low as $100.[8] All citizens will be encouraged to invest in these Hurricane Bonds. The revenues will be used to clean up and rebuild the areas and lives ravaged by Katrina and Rita. I believe that given this opportunity, our people will respond as strongly and patriotically as did the Greatest Generation during World War II.[9]

MICHAEL MEEROPOL is PROFESSOR AND CHAIR, DEPARTMENT OF ECONOMICS, WESTERN NEW ENGLAND COLLEGE in SPRINGFIELD, MA. HE IS THE AUTHOR OF SURRENDER, HOW THE CLINTON ADMINISTRATION COMPLETED THE REAGAN REVOLUTION.



[1] On October 1, the new Fiscal Year will begin. As of mid August, the Congressional Budget office was estimating a budget deficit of $331 billion. This will undoubtedly prove too low because it was based on an expectation that the Federal Government would take in more revenue in September than it spent, in other words, that for one month it would actually run a surplus. The CBO acknowledged in a September 6, Monthly Budget Review that: “The devastation wrought by Hurricane Katrina will affect federal spending and revenues in September, but with only one month left in the fiscal year, the net impact on the 2005 deficit is likely to be small. Although additional funds have been appropriated and the Federal Emergency Management Agency is providing substantial aid to victims of the storm, many of the bills will be paid in October or later. Other effects in September will include delays in the collection of estimated taxes and reduced spending for some federal benefit programs because of delays in submitting or processing claims.”
(Go to www.cbo.gov and click on “Monthly Budget Review”). By the early part of October, the CBO will have listed on its web site the actual budget deficit for Fiscal 2005.

I would caution all readers not to focus on the absolute size of the Budget Deficit. The important number is the RATIO of government borrowing to total Gross Domestic Product (GDP) because that actually measures the IMPACT of the borrowing.

Looking at the total overall Federal Budget, as of September, 2005, the CBO was projecting a total Federal Expenditure of $2473 billion. $300 billion is over 10% of that and represents approximately 2.7% of GDP (which will be in the neighborhood of $11 trillion on October 1). Assuming only half of that money is spent in fiscal 2006, and nothing else happened to the rest of the budget, that would raise the ratio of the deficit to GDP from approximately 3% at the end of Fiscal 2005 to 4.3% in Fiscal 2006. This is not the highest ratio since World War II – during the 1980s, the government borrowed more than 5% of GDP a number of times. Nevertheless, there is fear expressed that such a significant increase in federal borrowing will have a negative impact on interest rates and business expectations in general. For details on this and other deficit related issues, see Meeropol, SURRENDER: 19-21; 129-141; 162-165; 170-176; and the endnotes on 282 and 291.

[2] Some of the most extreme arguments include the view that deficit spending creates inflation. To refute this all you need to do is examine the history of the 1980s when the federal deficits were quite large and inflation remained quite low. The more measured and acceptable argument within the economics profession is that when the government runs a deficit and borrows from the pool of national savings, the rise in interest rates ends up reducing the amount that private investors can borrow from the same pool. The economists say that government borrowing “crowds out” private borrowing. The problem is that with the ability of all borrowers to borrow from all over the world, there is no evidence, again from the 1980s, for any national crowding out in the US. Similarly, despite much rhetoric to the contrary, the reduction of deficits and the brief period of surpluses during the 1990s cannot in any way be judged the cause of the rather short-lived “Clinton boom.” Most people now give a lot of credit to the stock market bubble and the over-investment in information technology (miles of fiber optic cable were laid that have never been used). For details see Robert Pollin, CONTOURS OF DESCENT.

As I stated in SURRENDER (on p. 21) the desire to balance the budget has nothing to do with the alleged damage done by budget deficits but in fact is based on the alleged damage done by government expenditure. Balancing the budget and demonizing deficits is a MEANS TO AN END – the end is to reduce the impact of government on the economy.

[3]Of course it is essential that the borrowing be successful. If you take on a mortgage on a house that falls down the day you move it, you are stuck with the mortgage and have no house! If a business takes out a loan, buys a bunch of machines that don’t work and therefore gains no income, of course their debt is a burden. However, if the investment (either a college education or a business expansion) is successful, then the increased income stream more than pays for the interest and principal burden of taking on the debt.

[4]Unlike businesses or individuals, it is a bit harder to identify “success” for a government investment. In fact it is actually unclear what parts of the federal government’s budget actually constitute investments. The Bureau of Economic Analysis divides federal purchases of goods and services into current consumption (wages and salaries of all government employees including the military) and gross investment. In the second quarter of 2005, out of the $868.2 billion spent on goods and services, $106.3 was identified as investment, which was further broken down into structures, equipment and software. However, virtually every dollar spent on education by government is also an investment into our future yet none of that shows up in the “gross investment” column unless it actually constructs a school or a library or a laboratory.

But even if we were to successfully identify the part of the budget that could be identified as investment, unlike in a personal investment like a college degree or a business investment like a new machine, there is no dollar payback that can be measured. The success of a government investment occurs through the increased growth in the productivity of the citizens and businesses in the economy. When the government repairs a road, trucks break down less frequently! Thus, the key to the success or failure of government investments can only be judged in terms of the long term growth in the economy. Successful investments by government raise tax revenues in the future making it possible to pay interest on the debt out of these increased revenue streams. That is why, despite the very large Reagan era deficits of the 1980s, the percentage of GDP spent on interest went from 1.7% in 1979 to 3.1% in 1989 (see Surrender, p. 329). According to the latest figures from the Bureau of Economic Analysis, total government interest payments in the second quarter of 2005 totaled $342 billion and with GDP near $11 trillion, that represents 3.1% of GDP just as in 1989. This is again a good reason to ignore absolute numbers when expressing concern about government spending, whether it be on interest or anything else and focus on the ratio of that spending to GDP.

[5]This information is also available from the Bureau of Economic Analysis (www.bea.gov).

[6]It is important to get this information correct. It is true that certain elements of the tax cuts that have occurred since 2001 led to significantly reduced tax burdens for some middle income people. Of particular note is the $1000 child tax credit (up from $600) which for a family with, say, four children living a middle class life style, could lead to virtual elimination of the federal income tax burden. However, when all the actual dollars of reduced revenue to the Treasury is counted, the largest amount of tax reduction (which translates into a rise in after-tax income) went to individuals earning very high incomes. For details see Robert Pollin CONTOURS OF DESCENT – especially pp. The most significant example of course involves the elimination of the Estate Tax which represents over time close to 55% of all the benefits from the 2003 tax reduction bill. Because so few estates are subject to the tax, this entire benefit accrues to the top 2% of the wealthiest individuals in the country.

The evidence is clear that between 2001 when the first tax cut was enacted and 2005, there has been a very sluggish recovery in investment since the recession began. Meanwhile, personal savings has actually fallen in absolute dollar amounts between 2002 and 2004, and investment as a percentage of GDP went from

[7]In 1942, the Federal Government borrowed 14.8% of GDP. By 1945 the government was borrowing 22% of GDP. The national debt stood at $235 billion at the end of World War II and was LARGER than the economy’s Gross Domestic Product (= great than 100% of GDP). By contrast, even at the end of the decade of large peacetime deficits under Ronald Reagan, the national debt was $2.2 trillion which represented only 41% of GDP. (The number $2.2 trillion represents debt held outside the government – the debt held by government agencies like the Social Security Administration would make the national debt seem higher …).

Much of the $235 billion borrowed during World War II was in large denomination T-bills sold to banks and insurance companies but much of it was financed by smaller denomination “WAR BONDS” sold to the public – even in numbers as low as $10.

[8]I propose low denominations so ordinary citizens can buy them. However, lots of $10,000 and even $1 million could be sold so rich people could also advertise their personal patriotism.

[9]At this point some critics of my proposal will be complaining: “Aren’t people already giving very generously to private charities? Shouldn’t that be what we encourage people to do?” My response is quite simple. Private money raised for the victims of Hurricane Katrina has supposedly topped $1.3 billion according to the Washington Post on September 29, 2005. Let us heroically assume that by the end of the year, the private fund raising will be so successful that this number will TRIPLE. That would leave $3.9 billion. That pales to insignificance before $300 billion. However, the government can raise that amount immediately because people will have the satisfaction of making a significant contribution AND being rewarded for it with a riskless rate of return.