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Principles and Guidelines for Deficit Reduction Joseph E. Stiglitz | The Roosevelt Institute December 2, 2010, Working Paper No. 6

Principles and Guidelines for Deficit Reduction In the next few weeks, the United States will be focused on deficit reduction. Analytically, the task of deficit reduction is simple: cu!ing expenditures and raising taxes. Politically, the task of deficit reduction is enormously difficult, for each cut in expenditure or increase in taxes hurts someone, and typically, some powerful group. Each, pursuing its own interests, has led the country into what is widely viewed as an untenable position. The hope is that a National Commission would devise an acceptable framework for shared sacrifice. It is more likely that that will be the case if there is an enunciated set of criteria against which we can judge proposals. Different individuals may put more or less weight on different criteria, but behind them all is one core principle: at the head of the list of reforms are measures which increase both efficiency and equity; unacceptable are measures which decrease efficiency and equity. A few statistics provide some guidance to these deliberations. Median income has declined by some 5% over the past decade—and was even in decline before the recession. Poverty has increased from 11.9% in 1999 to 14.3% in 2009.1 Median income of males with only a high school education has decreased some 13.5% from 1999 to 2009, as measured in 2009 dollars.2 The upper 1% of Americans accounted for an average of some 22% of the nation’s taxed income during 2004-2008. 65% of the income growth during the Bush expansion was captured by the top 1% of families.3 Given the enormous increase in inequality that has occurred in the United States over the past three decades, any measure that harms those at the bo!om should also be unacceptable, and measures that impose undue burdens on the middle class should receive careful scrutiny. There is a further principle which should guide deliberations: what ma!ers is not the deficit itself or the short-run national debt, but long-run levels of the national debt. The country should be looking at its national balance sheet. Debt reflects only the liability side. In assessing the economic strength of a firm, no one would look just at its liabilities; they would also look at its assets. The single-minded focus on deficits and short-run debt is thus fundamentally misguided.

Spending on assets (investments in education, technology, and infrastructure) thus may improve the country’s strength. By the same token, there is no magic number, like 21% of GDP, that represents the appropriate size of the federal government. If new public investment opportunities open up, the share of government might increase; if there has been a period of underspending on public investments, returns will be high, and so subsequent levels of government spending as a share of GDP may be high.! This conclusion is reinforced by the observation that what ma!ers for debt sustainability is not the absolute value of the debt but the debt-GDP ratio. Spending that increases debt but simultaneously (over the long run) increases GDP can lower the debt-GDP ratio.

Elaborating the Principles: guidelines for deficit reduction These general principles have some direct implications, providing some seven guidelines, which should guide proposals for deficit reduction as we strive for equity as well as efficiency and growth. 1. Public investments that increase tax revenues by more than enough to pay back the principle plus interest reduce long-run deficits. 2. It is be!er to tax bad things (like pollution) than good things (like work). _________________________________________________________ Joseph E. Stiglitz is Senior Fellow and Chief Economist at the Roosevelt Institute, University Professor at Columbia University in New York, and chair of Columbia University's Commi!ee on Global Thought. He is also the co-founder and executive director of the Initiative for Policy Dialogue at Columbia. In 2001, he won the Nobel Prize in economics for his analyses of markets with asymmetric information, and he was a lead author of the 1995 Report of the Intergovernmental Panel on Climate Change, which shared the 2007 Nobel Peace Prize. He was chief economist and senior vice president of the World Bank from 1997-2000. In 2008, he was appointed by French President Nicolas Sarkozy to chair a Commission on the Measurement of Economic Performance and Economic Progress. The views and opinions expressed in this paper are those of the author and do not necessarily represent the views of the Roosevelt Institute, its officers, or its directors.