On budget plans

I already covered the Ryan budget proposal back in March, calling it hypocritical and in certain parts unrealistic. I praised some aspects of his taxation reform proposals, but I didn’t approve of his expenditure side reforms, particularly concerning defence spending, and have fully aligned with what Ron Paul had to say on the Ryan budget, calling it disappointing in which it continues to assume that “the federal government should [more or less] continue to do everything it is currently doing”, and that Congress should learn to “stop trying to run the world, run the economy and run our lives”. Five months later the Ryan budget is again the focal point of attention due to Paul Ryan's nomination for Vice President by Mitt Romney, the Republican challenger to President Obama in the 2012 US Presidential elections. This resulted in many economists and political commentators having once again repeated their main points from five months ago on what this budget can and cannot do. And so will I. 

The most recent well devised summary of the Ryan proposal compared to other available budget plans is offered by the Bipartisan Policy Center (BPC). They came up with the following graph comparing the debt and deficit reduction plan of 5 different budgetary scenarios. However, the expected results at the end of the decade are based purely on the given calculations. Meaning that it doesn't take into account whether or not the proposals are realistic in their assumptions, nor can the graph show if any cuts or revenues raised are actually attainable. In that sense I favour the Bowles-Simpson proposal (it’s not perfect but it goes a long way in realistically resolving some of the country's crucial issues – I covered their proposal briefly earlier in February).

In a nutshell, what Ryan is trying to do is the following; 

Ryan's proposal, noted simply as "Proposal", compared to CBO's extended-baseline scenario and the alternative fiscal scenario, would increase debt after the first decade reducing the deficit down to 2%, but real benefits wouldn't be visible for another 30 or 40 years, no matter how unrealistic this sounds (there is a number of unforeseen issues and circumstances that may arise until then. Even 10-year forecasts sometimes sound too implausible to be taken seriously).  

His budget includes a couple of laudable proposals such as the government-funded voucher system that incentivises buying private health insurance for over 65-year olds (even though this still doesn’t solve the problem, it’s a step in the right direction), or his tax system overhaul. In the previous blog I praised the idea to reduce marginal tax rates for US companies, which are currently the highest in the world. In the same time an emphasis must be to exclude all the existing exemptions, giveaways, and rebates which only create jobs for accountants and lawyers. These ultimately only benefit the big corporations who are able to find an exemption, while small businesses almost never do and will end up paying the full burden. Not to mention the amount of revenues which is lost this way. Indeed, Mr Ryan proposed to scrap six different rates of income tax and replace them with only two bands. This is one of the centrepieces of his proposal – by doing away with exemptions and closing loopholes he plans to pay for the tax cuts he wishes to move forward on US companies and high income earners.

Here’s the tricky part. His critics claim that he never states which specific exemptions he would get rid of, nor how he plans to offset the reduced revenue from tax cuts by broadening the tax base. A lot of politicians use the term “broadening of the base” as a favourable economic policy but none of them really know what this means and even less how to do it in the right way. The best way would be via a flat tax rate, which would close any possibility of a loophole and make the tax easily collectible and easily enforceable. The broadening of the base comes along gradually as less and less businesses find it profitable to deviate on paying taxes. Along with this effect, a flat tax creates a simple and competitive tax system which attracts foreign investments and initiates the creation of more businesses in the economy. Another important step in that direction is increasing political stability, economic freedom, and doing away with any constraining regulation (the US is strong in the first condition, weakening in the second, and severely disrupted in the third). Then the base can be called broadened and the stream of revenues is increased. However I doubt this is what the Ryan budget proposal would achieve even if his idea is, broadly speaking, similar.

The Economist makes a good point on that perspective: 

"Until he is more specific, the fear must remain that the Republicans will deliver the spoonful of sugar but not the medicine, as they did under George W. Bush. If that happened, the deficit would balloon, just as it did under Mr Bush. And, with the top rate of income tax falling from 35% to 25%, the rich would benefit while spending cuts hit the poor disproportionately." 

This is what gives the Democrats the biggest edge in that debate; the Ryan plan is unrealistic, and would only benefit the rich. They do have a point there. 

"Mr Ryan was also wrong to vote against the proposals of the Bowles-Simpson deficit commission, which he did on the grounds that it wanted to close the deficit partly through an increase in tax revenues. He believes that the gap should be closed wholly through spending cuts. Because Mr Ryan, in true Republican fashion, wants to increase spending on defence, everything else—poverty relief, transport infrastructure, environmental protection and education, for instance—will have to be squeezed intolerably." 

Cutting all discretionary spending (food stamps, environmental protection, infrastructure and education) apart from defence will give President Obama a lot of easy targets. Especially on one particular point in which after the first decade the Ryan budget would continue into cutting discretionary spending relative to GDP down to 3.5%, which does sound implausible since only defence spending (something in which no Republican dares to touch), is currently at 4% of GDP. 

Serious institutional and structural reforms require hard, well-defined solutions and a broad-based, nation-wide support. Because of political stubbornness, the US lost that chance last August after the debt ceiling debate. Now everyone is just waiting for the November elections, but the country cannot afford to be in a standstill that long. Ideology is playing too high a role in US economic policy which is producing a grim outlook for the country. US is the perfect example of how good politics doesn’t necessarily translate into good policies.