Fiscal follies in America and beyond [Archives:2005/821/Business & Economy]

March 3 2005

By J. Bradford DeLong
Those of us who know that long-run fiscal imbalances are likely to end in disaster – high inflation, deep recession, financial crisis, or all three – scratch our heads in bemusement at the priorities of George W. Bush and his administration. The Social Security “crisis” that he wants to spend his political capital on “resolving” ranks no higher than third among America's fiscal problems in urgency and seriousness – and at a time when these problems have grown into a profound threat to global economic stability.

America's gravest fiscal problem is the short- and medium-run deficit between tax revenues and spending. This deficit is entirely of Bush's own creation, having enacted – and now seeking to extend – tax cuts that are not cuts at all, because they merely shift the burden of fiscal consolidation onto future generations.

The second most serious problem is the looming long-term explosion in the costs of America's health care programs. This is also partly Bush's doing, or, rather, not doing, as his first-term policy on health spending was to do virtually nothing to encourage efficiency and cost containment. Instead, he enacted a Medicare drug benefit that promises to spend enormous amounts of money for surprisingly little in the way of better health care.

Surely a more competent administration would be worried about addressing these more severe and urgent fiscal problems. Let's pretend that the United States had such a government. What would it do?

Dealing with the short- and medium-run deficit would be fairly straightforward: decide how large a share of GDP the federal government should take up, set spending at that level, and set taxes so that the budget is balanced (or so that the debt-to-GDP ratio is not growing) over the business cycle. Determine whether, overall, you would rather have in the medium term a federal government that spends, say, 16%, 20%, or 24% of GDP – and on what.

What is not straightforward is how to address the imminent explosion of health-care costs. In fact, projections of rapidly rising Medicare and Medicaid spending in the US – and similarly rapidly-rising governmental health care expenditures elsewhere in the developed world – are not so such a problem to be solved as the side effects of an opportunity to be grasped.

The opportunity stems from the fact that our doctors and nurses, our pharmacists and drug researchers, our biologists and biochemists are learning to do wonderful things. Many of these things are, and will be, expensive. Many of them will also be desirable: longer, healthier, and higher quality lives as we learn more about the details of human biology. Federal health-care spending will grow very rapidly over the next two generations because the things that health care money will be spent on will be increasingly wonderful, and increasingly valued.

But it will be difficult to grasp fully this opportunity. It is highly likely that desired health expenditures will be enormous for some things and trivial for others. This calls for insurance. The problem is that private insurance markets do not work well when the buyer knows much more about what is being insured than the seller. Obviously, one's health is an area in which private information can be very private indeed.

This is, of course, why state-run health-care systems came into being. But replacing private insurance with public insurance has its own problems: consider the parlous circumstances in which Britain's National Health System finds itself, the result of generations of politically driven underinvestment in health care.

Moreover, the overall level of spending is likely to be large. That means that without (and even with) state-run health-care systems, the rich will be able to afford more and better care than the poor.

To what extent do we accept a world where the non-rich die in situations in which the rich would live? To what extent do we hold on to our belief that when it comes to saving lives, medical care should be distributed on the basis of patients' needs, not their wealth? Where and how would we tax the resources to put real weight behind egalitarian principles?

Sharply rising health-care costs will probably confront governments throughout the developed world with the biggest economic policy issues they will face over the next two generations. The Bush administration has yet to realize this, but other governments are not thinking hard enough, either.

At best, they are seeking ways to keep health-care spending from rising, as though the genie of medical progress can be forced back into the bottle. Instead, governments should embrace the promise of wonderful innovations in health care, and ask how fast spending should rise, and how that rise should be financed.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and was Assistant US Treasury Secretary during the Clinton Presidency.