In his latest column, Paul Krugman sheds his worry-free attitude about spiraling debt levels while arguing for more spending now.
Recent disappointing data on hiring and retail sales back up Krugman's main point "” the jobless rate is too high and the recovery too tepid to start tapping the fiscal brakes. But the Nobel winner backed away from his earlier suggestion that the U.S. could wait for a decade to start cutting spending.
Now, noting that the deficit is projected to fall to 4% of GDP in 2014, Krugman says: "Unfortunately, that's not enough."
Even so, there's a big inaccuracy in Krugman's "Now and Later" column, which might help explain why he has been so complacent about deficits.
He writes: "The Congressional Budget Office, in its analysis of President Obama's budget proposals, predicts that economic recovery will reduce the annual budget deficit from about 10% of GDP this year to about 4% of GDP in 2014."
Not exactly. CBO's projection of a narrower deficit reflects much more than "economic recovery." It also factors in the ramping up of tax hikes on higher earners, corporations and the 95% of working families who benefited from Obama's Making Work Pay tax cut.
Including $50 billion in new taxes tied to health care reform, those tax increases would amount to $250 billion in 2014, according to White House estimates. So under today's tax levels, deficit forecasts would approach $1 trillion in 2014, not the $724 billion projected by CBO.
Add in the expiration of stimulus spending on infrastructure and other areas whose timing is not necessarily linked to recovery, and the 2014 deficit under current policy would be higher still.
The bottom line is that Krugman seems to underestimate just how hard it will be to get deficits down to that 4% of GDP range "” even if growth holds up well in the face of aggressive budget curbs.
Congress has already cast aside some of the White House tax increases "” such as limiting tax write-offs with a top rate of 28% on itemized deductions. Unwinding Obama's $60 billion Making Work Pay tax cut "” a centerpiece of his campaign "” also looks iffy.
The difficulty of near-term spending cuts and tax hikes, especially if the recovery slows, underscores the need for aggressive budget reforms that will begin to pay off in the next few years.
One big problem here is that the passage of ObamaCare, after a wrenching debate, has already tapped the low-hanging fruit of health care savings.
All this suggests that necessary intermediate-term budget savings will be hard to come by and that public intellectuals such as Krugman should be doing their best to facilitate a climate where bipartisan budget progress can be made.
Perhaps with that in mind, Krugman is advocating a 5% value-added tax, but even that would fall far short of a budget cure. Factoring in some likely exemptions such as education, autos, groceries, housing and health spending, the Tax Policy Center says a VAT of that scale could raise $161 billion in 2012, or about 0.9% of GDP.
The top federal income tax rate would rise from 37.9% to 43.4%, including employer and employee Medicare taxes, while the top long-term capital gains rate would jump from 15% to 23.8%.
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