The Deficit Inferno

No one likes to face up to the need to cut back on their lifestyle. Governments and families alike rightly recognize the process of fiscal sacrifice as a wrenching one. The process of dealing with cutbacks in any sector can be fractious, contentious and notoriously short-sighted, as we all are tempted to put off until tomorrow what we would rather not do today.

Many of us who have high hopes for the public sector actually see the silver lining in the deficit cloud. A fiscal crisis can force a very healthy reexamination of programs, priorities and operations. While often too painful to address in normal times, inefficient work rules, program designs and benefit formulas can be reformed. Unfunded promises can be curtailed and rationalized. And perhaps governments might emerge from this difficult period in healthier shape than they were before.

But such are the dreams of reformers like myself. The process of dealing with deficits are rarely this high-minded or straightforward. Instead, we see a process that is pockmarked with resistance, privilege and short-sighted decision-making. The actual process of fiscal sacrifice has never really been charted and varies considerably across governments. But it resembles the stages of grieving for losses more than we would like to admit.

I want to lay out what I will call the inferno of deficit reduction. I would suggest that governments facing fiscal gaps go through stages of budgetary recognition and decision-making. I would caution that this is not based on empirical surveys but rather on a long view of observations over many episodes of fiscal retrenchment at all levels of government.

Denial. Often, initial deficit projections are ignored or even fudged. At the federal level, we heard under President Bush that deficits did not matter in a growing economy. In the Obama era, we hear some suggest that deficit reduction is trumped by the need for greater stimulus and that the resulting economic growth will help the budget bounce back. Denial is a strategy that stresses the risk of taking action versus the risks of letting deficits accumulate to daunting levels.

Temporizing. Once policymakers acknowledge the need for some response, early actions are often designed to be temporary and superficial, typically failing to address the deeper drivers of deficits on the spending and tax sides of the budget. Temporizing strategies not only typically fail to definitively solve the problem but often can make it worse for others. Examples of strategies at this stage include:

• Cost shifting to the future: Shifting costs forward is accomplished by such strategies as pushing off paydays or other liabilities to the next budget year or selling off buildings and other assets that will yield healthy cash revenue today at the price of mortgaging the future in the form of lease payments or foregone toll revenues or user fees.
• Cost shifting to other sectors: When faced with hard choices, there is strong temptation to solve fiscal problems by passing costs down to other levels of government or the private sector. After all, from the government's standpoint, such costs are essentially "free". California officials have attempted to hijack highway revenues formerly allocated to local governments to help fill the state's budget hole. Payments to local governments are often among the early victims of budget cuts at the state level.
• Short-term expediency: Often the early response to deficits focuses on one time measures or short-term cuts that do little or nothing to affect the long-term trajectory of spending. Actions such as furloughs are a classic example. The sale of government assets are another one-time savings that are short-term focused -- this strategy carries the additional risk of tempting decision-makers to book additional longer-term spending commitments against one-time revenues. All of these actions are premised on the notion that the deficit is a passing phenomenon -- that the sun will once again shine and the government can return to business as usual when the fiscal storm clouds pass.
• Administrative cuts: These actions achieve real savings and play to our collective bias against bureaucrats. Actions such as wage freezes, hiring freezes and suspensions of training and travel, hang on the low-hanging branches of the deficit reduction tree. Unlike the category above, these initiatives can achieve longer-term savings by lowering the baseline of spending for the future. And they may or may not prompt agencies to scrub their operations for efficiencies. However, if this does not happen, administrative cuts will simply need to be restored in the future in one way or the other. President Clinton, for instance, cut 270,000 federal employees without cutting any major program commitments -- the result was a spike in the number of private contractors used to replace these people.
• Fraud, waste and abuse: While offensive to be sure, going after government waste is a false mirage in the inferno of deficit reduction strategies. While some savings can undoubtedly be achieved, they are simply not sufficient to close multibillion dollar fiscal gaps facing state and federal governments. It turns out that significant progress in reducing waste often requires additional spending on government staff or other difficult steps. For instance, the federal "tax gap" is over $300 billion, with much of this caused by small businesses and independent contractors who fail to report their incomes. The most effective way to solve this problem would be to require those who employ contractors to withhold taxes, just like employers do with wages -- a prospect that is guaranteed to be stopped by the powerful small business lobby.

Realization. Once governments proceed through the denial and temporizing rings of the deficit inferno, they often will be forced to acknowledge the actual magnitude of the fiscal gaps they face. A key step in this process of fiscal awareness is recognizing that deficits stem not from temporary shortfalls caused by short-term economic factors or other passing events but rather have their roots in longer-term structural forces that must be addressed. The failure to address structurally caused deficits by sustainable and permanent changes in revenues and spending will consign governments to a politically damaging cycle of repetitive budget cuts and tax increases, eroding the credibility of the leaders themselves.

Structural reforms. Structural changes in spending include reforms that promise to bend the cost curve for government commitments and operations. Pension reforms extending minimum retirement ages and sentencing guidelines decriminalizing certain drug offenses are two recent structural reforms being discussed as necessary to close daunting fiscal gaps. Revenue reforms to extend sales taxes to services and remote Internet sales are two such steps on the tax side.

Foresight and prevention. The final ring in the deficit inferno is the stage I will call preventative actions. In this stage, federal and state officials actually exercise foresight to mitigate and prevent future fiscal problems from burdening future taxpayers and public officials. Examples of actions here include the provision of funding for unfunded pension liabilities and setting aside a portion of revenues for a rainy day fund. While such foresight is difficult indeed to do in the teeth of a fiscal crisis, nonetheless policymakers have risen to this high standard at federal, state and local levels of government in the past. Recently, for instance, in the midst of significant budget deficits, Michigan set aside significant new funds to shore up funding for future pension commitments. Those governments reaching this last ring of the inferno may or may not gain the appreciation of current voters, but future taxpayers and voters alike will have good reason to applaud them for having the foresight to balance both current and future generations in hard times.