Evan Soltas
Mar 11, 2015

High Polarization, Big Deficits

The right reason to disapprove of fiscal deficits and high government debt is that they lead to a waste of resources. By driving up interest rates, the government's need to finance itself crowds out the private investment that would make us all better off.

Although that logic isn't in play now -- interest rates are not a problem, and there is no crowding-out -- there's good reason to think that, in an era of political partisanship and closely-contested elections, fiscal deficits will be a serious and persistent problem for the United States.

The reason comes from Albert Alesina and Guido Tabellini. (And also from Torsten Persson and Lars Svensson.) Let's say there are two parties with very different conceptions of what government should do, and they run against each other periodically in democratic elections. When they come to power, they want to put their policies in place and remove the other's policies, but both have their ability to implement their policy visions constrained by the the ability of the government to finance itself through taxes and borrowing. The party out of power has no say.

That is, as much as parties might want to, say, give everyone endless amounts of money through either tax cuts or government spending, they can't do that, because eventually the crowding-out hurts the government more than whatever gain is derived from putting their political vision into practice.

In this kind of world, what do parties do? They produce persistent fiscal deficits, even though everyone would be better off if the government balanced its budget. Why? Since parties know it is likely they will not be in power in the future, and thus will have no direct ability to keep their policies in place, they want make it harder for their rivals to repeal their policies and put in their own.

The way to do this is to leave the budget in deficit. The tax-cuts party can't cut taxes because the deficit is already large, and for the same reason, the spending party can't increase spending. As Alesina and Tabellini put it, "government debt becomes a strategic variable used by each policymaker to influence the choices of his successors."

These explanations were put forward in the late 1980s, when the U.S. fiscal deficit ballooned under Reagan. "I'm not worried about the deficit," he quipped in 1984, "It's big enough to take care of itself."

In fact, it's interesting how well the strategic-deficit story fits U.S. history since the Second World War.

From the Great Depression until the Reagan revolution, the ideological gap between the two parties was relatively small. Furthermore, legislative elections were not close: Democrats held onto the House of Representatives for all but two years from 1930 until 1994. Then it all changed. Polarization has grown since the 1970s, and control of Congress has switched back-and-forth. We've entered into the political world envisioned by Alesina and Tabellini, as my graph shows:

And, from the Congressional Budget Office, here are historical and forecasted deficits as a percentage of GDP:

So the story fits: More or less balanced budgets from the 1940s to the 1970s, and then structural budget deficits from the 1980s onward, with the outlier of the Clinton administration.

I would be pretty interested to see if anyone has tested the predictions of this model rigorously. One could, without too much trouble, gather data on the ideological polarization between the major political parties across democracies, the competitiveness of their elections, and fiscal deficits.*

Updating the Alesina and Tabellini story shows that, at least for the U.S., they got it right. The rise of political polarization and competitiveness has moved the U.S. from a balanced-budget democracy to a democracy with a structural fiscal deficit.

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* Boris Shor, a professor at Georgetown, had two comments on this point. First, measuring polarization in parliaments is not quite as easy. (My comment: Use geographic polarization as a proxy, with the logic that if there are sharp political divisions by region, there are likely sharp political divisions.) Second, Shor suggests, one could look at U.S. states, where good measures of statehouse polarization exist, but then it becomes challenging to think about fiscal deficits, because of balanced-budget requirements at the state level.