Democracy in Deficit

Here is my New York Times column, which most of all explains what a prophetic thinker James Buchanan has turned out to be (and I thank Brad DeLong for reminding me of this, though he may not agree with my argument).  This excerpt is not the main point, but it hints at how Austrian business cycle theory and Keynesian theories of fiscal illusion might be integrated:

The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they’re holding in a money market account.

The field of behavioral economics analyzes imperfections in market decision-making, but the biggest practical problems often involve our inaccurate perceptions of what the public sector is up to and how much it will affect us.

In this case, the sorry truth is that our savings aren’t worth as much as many of us think, and a rude awakening is coming. One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches.

In terms of driving sectoral shifts, and mismatching AD shocks to what the data call for, there is this:

Yes, some laudable cost controls on Medicare are embedded in the new health care law, but they’re not enough. Most likely, we will end up making other spending cuts that won’t solve our fiscal problems – and in areas that could instead benefit from Keynesian employment stimulus. These kinds of knee-jerk, poorly reasoned decisions are what happens when fiscal illusion reigns.

I also borrow Alex's point that we have not developed a workable Keynesian politics.

What to do?  Time is no longer on the side of good.  I suggest that we confront the nation's fiscal difficulties as soon as possible.  That means both tax hikes and spending cuts, though I prefer to concentrate on the latter.  Nonetheless it is naive to think spending cuts can do the job alone, and insisting on no tax hikes drives us faster along the path of fiscal ruin.  The time for the Grand Bargain is now, it will only get harder:

Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run.

Here is a relevant post from Matt Yglesias.  Here is an Andrew Sullivan post on debt as a moral issue.  Here is a Jonah Lehrer post on how behavioral considerations, in particular loss aversion, make public sector debt harder to limit.