Cut-and-Invest Is a Death Trap

If Obama is re-elected as president, there are indications that his administration will try to work with the lame-duck Congress to pass a “grand bargain” to reduce long-term deficits, in order to avert the “fiscal cliff” created by the expiration of George W. Bush’s ten-year tax cuts together with the steep automatic cuts devised last summer in order to provide lawmakers with an incentive to negotiate. As part of this national conversation, some neoliberals are likely to revive an old phrase from the 1990s: “cut-and-invest.” The idea is classic Clintonian triangulation—progressives can increase public investment in R&D and infrastructure, and at the same time prove to the business and financial community that they are serious about deficit reduction, by cutting entitlements for the elderly.

Here, for example, is the Progressive Policy Institute in January of this year, “Why Obama Needs to Cut and Invest”:

If benefits for the elderly are deemed untouchable, then Congress will have to either raise taxes on everyone, including working families, or cut domestic spending to the bone, or both. Domestic spending (including defense) has already borne the brunt of the spending cuts agreed to last year. It is only 12% of the budget, but it includes all the key public investments progressives should be for – in infrastructure, education and workforce skills, science and technology – not to mention public health and safety and measures to alleviate poverty. To shield entitlements from cuts is, in effect, to give priority to retirees’ consumption over strategic investments in a more prosperous and equitable society.

Cut-and-invest is no doubt appealing as a bumper sticker slogan to Democratic office-seekers, particularly those trying to appeal to wealthy donors who favor more public investment but who don’t want their own taxes to go up significantly in order to reduce the federal deficit. But “cut-and-invest” is a bad idea, in terms of both politics and policy.

In terms of politics, there is simply no significant constituency in the electorate, as opposed to a segment of the tiny political donor elite, for a combination of increased public spending on R&D and infrastructure to be funded by significant cuts in Social Security, Medicare, and Medicaid. The votes are simply not there. Indeed, pushing the “cut-and-invest” theme would probably undermine voter support for increased public investment to enhance the nation’s long-term productivity. If voters are told that the country cannot afford both public investment and entitlements for the elderly, most will likely prefer to sacrifice government spending on R&D and infrastructure in order to avert cuts in Social Security and Medicare.

In terms of practical policy, cut-and-invest is just as flawed. The premise is that government spending is fungible, so that revenues saved by cuts in Social Security and Medicare can somehow be translated into higher spending on R&D and infrastructure. But how is this miraculous transubstantiation of entitlement cuts into higher public investment supposed to occur?

Social Security has its own dedicated revenue stream, the payroll tax, and Medicare has two, a payroll tax and also general revenues. No serious person can believe that Social Security and Medicare payroll taxes will be diverted to fund public investment projects, even in the unlikely event that a political coalition formed to support slashing spending on the elderly in order to fund more public investment.

Presumably the cut-and-invest crowd does not really intend to divert Social Security and Medicare payroll revenues to bridge and port projects and the Defense Advanced Research Projects Agency. Rather, it must be presumed that they seek to increase room for discretionary spending on R&D and infrastructure, while leaving overall revenue at the same level, by cutting entitlements. Note that, in this scenario, “cut-and-invest” requires new taxes, or increases in existing taxes, to fund the increase in discretionary spending that compensates for the decline in entitlement spending.

The political calculus thus gets even worse. The proposal is not only to cut entitlements for the elderly, but also to raise taxes to fund more infrastructure investment and R&D out of federal discretionary spending. “I’m going to cut your Social Security and Medicare benefits, and at the same time I’m going to raise taxes on you to pay for bridges, ports and scientific experiments.” Now there’s a formula for political suicide waiting to be embraced by a kamikaze candidate.

The fundamental problem with the cut-and-invest gimmick is that it accepts the conservative myth that federal spending is too high or at its limit, so that progressives, if they want more spending for one favorite program, must kill another of their favorites. The truly progressive answer is that we can have both generous spending on the elderly, once all-payer price controls and other delivery reforms reduce excess prices in the U.S. medical sector, and at the same time have more money to spend on R&D and infrastructure.

Most of the money for public investment should not come from discretionary spending. Instead, public investment should be funded chiefly by public borrowing.

A basic rule of municipal finance holds that while the operating expenses of government, including social insurance and other safety net programs, should be funded out of annual taxes, long-term borrowing is appropriate for investments with high up-front costs that improve long-term productivity—not only municipal sewage systems and public school buildings, but also, in theory, basic science research and infrastructure. Borrowing for capital improvement projects need not contribute to a government operating budget deficit if they are off-budget, as they are even in states which have balanced budget amendments. In the case of increased federal public investment, the debt can be either federal debt, the debt of federally-backed agencies like a national infrastructure bank, or, less directly, municipal debt like the short-lived Build America Bonds that is subsidized by the federal government. Investors in public investment bonds can be repaid over time either out of general tax revenues or out of dedicated revenues, like tolls on roads or perhaps royalties on IP resulting from federally-funded research.

The cut-and-invest school to the contrary, there is no need to choose between social insurance and public investment. Whatever form the social insurance system takes—the efficient, low-cost form of universal social programs favored by most liberals, or the inefficient, middleman-enriching, costly form of vouchers and tax credits pushed by libertarians and neoliberals—the current costs of the system should be paid for completely out of current taxes. At the same time, public investment for the most part should be funded by debt, to be repaid by some combination of modest and sustainable debt service taxes or tolls, royalties and user fees.

We need not choose between cut-and-invest and tax-and-spend. We should tax-and-spend for social insurance and borrow-and-invest for public investment.

Michael Lind is Policy Director of the Economic Growth Program at the New America Foundation and author of Land of Promise: An Economic History of the United States.