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Federal budget policy to spur economic growth

Douglas W. Elmendorf

I spoke today to the National Association for Business Economics about changes to federal budget policy that would spur economic growth.

I began by asking, economic growth for whom? The traditional answer of “economic growth for the country as a whole” stems from a view that growth in total output and income will generate growth in incomes for most people. But that view has been wrong in the past few decades: The rising tide has not lifted most people’s boats very much. Therefore, we should focus on spurring income growth for lower- and middle-income people.

The five-part agenda I proposed was the following:

First, maintain federal investment as a share of GDP.
Under the current caps on discretionary spending, federal nondefense investment in infrastructure, education and training, and research and development soon will be smaller relative to GDP than at any time in at least 50 years. That is not forward-looking, growth-oriented budget policy. Cutting those federal investments will reduce total output and income relative to what they would otherwise be; to maintain those investments, we should raise the caps on nondefense discretionary spending.

Second, reform the tax code to increase the efficiency of business investment.
The current tax code distorts businesses’ decisions regarding asset types, industries, organizational forms, and geographic locations. Reducing those distortions would boost future incomes. Therefore, we should enact revenue-neutral and distribution-neutral tax reform that increases the efficiency of business investment.

Third, encourage innovation.
Some of the key policies we should adopt are not primarily budget policies, such as increasing immigration of high-skilled people and improving the patent system. Other important policies are budget policies, such as providing robust funding for research and strong support for STEM education.

Fourth, reduce federal debt relative to GDP, but do so only slowly.
It would be prudent to reduce the debt-to-GDP ratio gradually over the next few decades. However, a further decline in the deficit in the next few years would hurt the economic expansion; in my view, a rush to “normalize” fiscal policy has been the biggest policy error during the economic recovery.

To spur income growth for lower- and middle-income people, restraining federal debt by cutting their benefits or raising their taxes would be counterproductive. We should avoid significant cuts in benefits targeted at lower- or middle-income people—as well as significant across-the-board cuts in benefits, such as boosting the eligibility age for full Social Security benefits—and instead increase means-testing of Social Security and Medicare benefits and raise taxes on the affluent. (My blog post last month addresses this issue at greater length.)

Fifth, reduce uncertainty about future budget policy.
To improve decision-making by businesses, households, state and local governments, federal officials who are managing programs, and the Congress, we should avoid shutdowns and debt-ceiling threats, avoid short-term extensions of expiring policies and continuing resolutions for appropriations, and address (rather than defer) long-term issues, such as entitlement policies, tax policies, and policies to address climate change.

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