Why Spending Cuts Aren’t the Answer

The question isn’t how much the government spends, it’s the rate of return on that spending.

The nonpartisan Congressional Budget Office projects that President Obama’s recently proposed budget will cause the national debt to double over the next ten years. Deficits aren’t an immediate problem, since the economy is in the midst of the deepest downturn since the Great Depression. In fact, most economists argue that we should be running even bigger deficits in the short run. But most economists also agree that we need to bring deficits under control in the long run.

There are only two ways to do that—by cutting government spending and by raising taxes. Cutting wasteful spending would obviously be a good thing. Every president promises to do this. Yet federal spending has continued to grow in every administration, and there are good reasons for believing that spending cuts won’t be the answer this time, either.

Government programs have constituents. On the rare occasions when programs get cut, they are typically not the ones that deliver poor value, but rather those whose constituents have the least power to object. For example, the Bush administration, self-proclaimed enemies of government waste, cut the Energy Department’s program for rounding up poorly guarded nuclear materials in the former Soviet Union, the National Science Foundation’s budget for basic research, rehabilitation programs for injured veterans, and nutritional assistance programs for poor mothers of small children. Each of these programs was delivering good value for the money.

Although it is extremely hard to cut existing programs, it is easier to avoid launching new ones. But much of the new spending proposed by the president is for public investments with high rates of return. Failure to make these investments will actually make us poorer. For instance, if the government borrowed a trillion dollars at 4 percent and invested the money in projects with an annual return of 7 percent, we’d actually be richer each year by $300 billion than if we hadn’t made those investments. And because investment in the public sphere has been neglected for decades, there are thousands of shovel-ready projects with extremely high rates of return.

A specific example: Because a handful of low-clearance bottlenecks currently make it impossible to ship double-decker cargo containers along the northeast rail corridor, these containers must be carried by trucks. The result is bumper-to-bumper truck traffic along I-95, which has diverted a growing volume of truck traffic 200 miles west onto I-81. According to one study, the cost of eliminating the rail bottlenecks would be $6 billion, and the benefits would be more than $12 billion, not even counting the value of reduced greenhouse gas emissions. Failure to make investments like that would not be a smart move.

Of course, there is other wasteful spending that should be cut. But much of that spending occurs because legislators feel pressure to enact programs that benefit campaign contributors. If we really want to attack that kind of waste, we’ll first have to make substantial progress with campaign finance reform. In the meantime, our best bet for curbing deficits is to raise additional revenue.

But proposing new taxes has always been the third rail of American politics. The key to solving that problem lies in shifting the focus of what we tax. Our current system taxes many beneficial activities, such as saving and new job creation. We could raise all the revenue we need by shifting to a system that taxed only harmful activities. I mentioned taxes on congestion in yesterday’s post. I’ll discuss additional examples in future posts.

Author: Robert Frank

Robert H. Frank is the Henrietta Johnson Louis Professor of Management and Professor of Economics at Cornell's Johnson Graduate School of Management and the co-director of the Paduano Seminar in business ethics at NYU’s Stern School of Business. His “Economic View” column appears monthly in The New York Times. He is a Distinguished Senior Fellow at Demos. He received his B.S. in mathematics from Georgia Tech, then taught math and science for two years as a Peace Corps Volunteer in rural Nepal. He holds an M.A. in statistics and a Ph.D. in economics, both from the University of California at Berkeley. His papers have appeared in the American Economic Review, Econometrica, Journal of Political Economy, and other leading professional journals. His books, which include Choosing the Right Pond, Passions Within Reason, Microeconomics and Behavior, Principles of Economics (with Ben Bernanke), Luxury Fever, What Price the Moral High Ground?, Falling Behind, The Economic Naturalist, and The Darwin Economy, have been translated into 22 languages. The Winner-Take-All Society, co-authored with Philip Cook, received a Critic's Choice Award, was named a Notable Book of the Year by The New York Times, and was included in Business Week's list of the ten best books of 1995. He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought. He was awarded the Johnson School’s Stephen Russell Distinguished teaching award in 2004, 2010, and 2012, and its Apple Distinguished Teaching Award in 2005.