America’s Path to Fiscal Conservatism

The new Republican majority in the House of Representatives has decided to make substantive policy changes on many issues. Among the most contentious is the so-called debt ceiling, a statutory instrument requiring Congress to balance its budget every year.

There are many reasons why Republicans should challenge the status quo regarding the debt ceiling. Most importantly, it has been monumentally ineffective in preventing Congress from piling up more debt. The new Speaker of the House, Kevin McCarthy, has earned a strong mandate from the new Republican majority to scrap old habits and pursue a new, more fiscally conservative policy direction.

Though long overdue, this ambition is welcome. The big question is how Republicans would actually implement fiscal conservatism: should they treat the debt ceiling as a hard line on government spending, or should they part with it altogether? 

A Range of Reform Ambitions

Many experts and commentators want to weigh in on the debate over what to do about the federal government’s almost $31.5 trillion big pile of debt. At last, the nation’s attention is turning toward one of the most overlooked threats to America’s future. If Congress and the president fail to properly address the debt and the deficits, the U.S. economy will inevitably be subjected to a fiscal crisis, quite possibly of Greek proportions. 

That said, Congress is rapidly running out of time. As I predicted back in early December of last year, the annual cost of the debt—interest that Congress has to pay its creditors—will likely exceed $1 trillion this fiscal year. Now, the St Louis branch of the Federal Reserve has posted numbers that show my forecast to be almost prudent by comparison.

In short, the United States is sailing into dangerous waters: with runaway costs for the debt, it is only a matter of time before the U.S. government finds itself in the crosshairs of the world’s next fiscal crisis. Given the risks of such a crisis, it is essential that Congress gets its debt fix right the first time. If it fails, the repercussions for the American people will be enormous—and they will be exploited by radicals who support the so-called modern monetary theory, MMT. Its consequences, in turn, are critical to the long-term survival of  whatever country is subjected to them; it was MMT that caused the unmitigated economic and social disaster known as Venezuela.

With so much at stake, fiscal conservatives who wish to end America’s endless budget deficits will only get one chance to implement their reforms. To get everything right the first time, they must start with one clear and concise question: why do we want to balance the government budget?

The answers to this question range from practical to principled. At the practical end, we find Michael Strain with the politically influential, right-of-center American Enterprise Institute, AEI. In a recent article, Strain set one specific practical goal for all policy reforms related to the federal budget deficit: avoid a default. He urged the Democrats in Congress and President Biden to work with the new Republican majority in the House on a deal to control the federal debt. Specifically, Strain said, Democrats

should acknowledge the more widely shared Republican argument that federal spending has reached problematic levels … and they should then find some spending that can be cut.

Strain elaborated on his practical point in a January 30 podcast. He shows only scant interest in spending reform, suggesting that if interest rates decline again, such reforms become “less necessary.” 

Another recent contribution to the debate over the federal debt comes from The Debt Dispatch, a publication by the libertarian Cato Institute. Their ambitions are only modestly stronger than those of the AEI. On February 1st, Romina Boccia and Dominik Lett explained:

High and rising debt slows growth, crowds out private investment, limits the government’s ability to respond to unforeseen emergencies, and elevates the risk of a sudden fiscal crisis where investors would lose confidence in U.S. Treasury bonds.

On January 10th, Boccia wrote:

Federal debt is at economically damaging levels and growing at an unsustainable rate. Additional deficit spending threatens to make inflation worse and burden the economy by misallocating resources from higher-growth projects toward politically-directed spending.

She also called for Congress to make generic spending cuts and “adopt responsible, pro-growth fiscal policy.” In lieu of spending-reform specifics, the Cato Institute elevates one fiscal policy goal above all else: balance the budget. This means that once they get to spending-reform specifics, their policy recommendations will be conditioned by the goal to balance the budget.

The Heritage Foundation, a conservative think tank, has already produced its own reform agenda. While not explicitly aligned with conservative principles, their package of reforms sets a clearly ambitious goal:

The cost and regulatory burdens of the federal government harm our nation, injecting politics into the most important aspects of American civil life and eroding communities and liberty. Further, the unsustainable financing of major benefit programs and the current debt level will, left unaltered, force a crippling tax burden that would rob the U.S. of cherished economic vitality.

This is the most far-reaching statement on fiscal conservatism of these three think tanks. To demonstrate that they are committed accordingly, Heritage presents 229 specific policy reforms, most of which have a distinctly conservative ideological profile. 

Get the Priorities Right

The deficit-addressing reform proposals from the AEI, Cato, and Heritage are indicative of where the debate on America’s debt problem is going. They are dots along a line, from

• The AEI and its practical approach, which is located close to the political center, via 
• The Cato Institute’s generic, supply-side-inspired ambition to close the budget deficit with economic growth, to
• The Heritage Foundation and its overt fiscal conservatism.

Back in September when I analyzed the Heritage plan in detail, I described it as a surprisingly detailed list of tangible ideas for conservative-minded reforms to the American welfare state. I also noted that their reform ideas aim to change the fiscal trajectory of federal spending. 

This last point is crucial. It draws a dividing line between different motives for balancing the budget. On one side are policy ideas that make budget balancing the primary goal and accompany it with a secondary, non-ideological goal. In Cato’s case, this goal is to stimulate economic growth but to do it as a side effect of balancing the budget. With their emphasis on a balanced budget, we can refer to the AEI’s and Cato’s reform ideas as ‘fiscal responsibility.’

On the other side, we have ideas, inspired by fiscal conservatism, that place an ideological goal first and budget balancing second. 

The difference between fiscal responsibility and fiscal conservatism becomes visible when we try to put them both to work. Consider Figure 1, which is a simple schematic of the trends in government spending, G, and tax revenue, T. The lines are drawn purposely to depict a permanent budget deficit, i.e., with G exceeding T:

Figure 1

Let us try fiscal responsibility first, which means that we prioritize budget balancing and try only secondarily to achieve other goals. Following the AEI and the Cato Institute, we use spending cuts to close the budget gap; the nature of the spending reductions will be dictated by the first-order priority, namely to eliminate the budget deficit.

One of the practical consequences of this priority is that we pick spending cuts that reduce the deficit sooner rather than later. Once we have narrowed down the list of spending cuts that take us to this mile marker, we now pick the ones that can also stimulate economic growth. 

Since an upfront reduction in spending, immediately visible (at least by fiscal-policy standards), is preferable to any slower alternative, we will exclude in the first selection spending reforms that would be better for economic growth over time. Since they are not fast enough in closing the budget gap, they are discarded already at the first step. 

The practical fiscal effect will be as follows:

Figure 2

The new spending trajectory, G1, is inevitable. The spending reform retains all the cost drivers in public spending, i.e., the variables that dictate spending growth over time. These cost drivers are built into every program dispensing entitlement benefits—cash or in kind—and have three components:

• A demographic that is considered eligible for the benefit;
• A benefit, i.e., cash, goods, or services; and
• A value of the benefit.

To take an example, the federal government runs a tax-paid program called Medicaid, which provides health care for low-income families. Its demographic is every man, woman, and child who, among other criteria, has earnings below a legally stipulated income threshold. 

The benefit is a list of medical services, which lists what the demographic has the right to, and, by omission, what they cannot expect to be provided with. The value of the benefit is the remuneration that Medicaid pays out to health care providers for treating patients enrolled in the program. 

Health care costs increase over time along a predictable but steady trajectory defined by, among other things, the size and growth of the eligible demographic. It is also affected by the overall cost of producing health care in the economy. Based on these criteria, Congress appropriates a certain amount of money per Medicaid-covered medical service, in practice the value of each benefit provided. 

To avoid an erosion of the quality and quantity of benefits, and to maintain its roster of citizens entitled to the benefits, Congress has to increase spending every year. The factors driving this annual cost increase are in place prior to the spending cut in Figure 2, and remain intact after the spending cut has been executed. This is the reason why, once the cut has taken effect, the G1 trajectory of government spending is approximately parallel to the original trajectory, G. 

Since nothing has happened on the revenue side, the T trajectory remains unchanged. As a result, the AEI-Cato priority of budget balancing above the specific design of spending reforms allows the deficit problem to resurface again after a short intermission.

Suppose instead that we prioritize spending reforms because they are conservative in nature, not primarily because they balance the budget—while not unintended, the latter is a welcome side effect of the former.

A conservative reform changes the spending trajectory of entitlement benefit programs. In some cases, such as social welfare, the redesign of the program could alter the parameters of all three aforementioned components. Hypothetically:

• The demographic could be limited by stricter income criteria, e.g., that a person must have lost his means of self-support;
• Benefits could be confined to a set of goods and services that guarantee a subsistence-level but dignified standard of food, clothing, housing, transportation, and health care;
• The values of benefits could be restricted on an in-kind basis.

These are admittedly strict, perhaps overly strict criteria for benefits reform in a conservative spirit. The point with them is not so much to make actual suggestions about reform to the American welfare state as to illustrate what it means to break the trajectory of government spending from Figure 1. 

In terms of the reforms proposed by the Heritage Foundation, this new path of reforms finds its way into their idea for a new benefits system in Social Security, the American retirement benefits system. By proposing a flat-benefits model, they put the spending of the program on a ‘flatter’ path into the future. 

If applied generally, this reform principle would have the effect on government outlays illustrated by G2 below:

Figure 3

Once the growth parameters of government spending have been changed, there will be room for the federal government to ease the tax burden as well. The adjustments to taxes could even be done in such a way that they allow for a small portion of government revenue to be used to regularly pay down the enormous government debt.

By putting conservatism first, and the balanced budget second, the new Republican House majority could be successful in both reducing the burden of government and putting conservatism to work for the American people. Just as they were elected to do.