John McCain's Economist Explains How Huge National Debt Threatens U.S. Freedom and Prosperity

Douglas Holtz-Eakin believes that America’s national debt “is a grave problem that threatens our very freedom and prosperity.”

Yet Holtz-Eakin — an economist in the Bush White House and adviser to the presidential campaign of John McCain — believes the most urgent order of business is for the lame-duck session of Congress and President Obama to make this year’s deficit larger, by extending the Bush-era tax cuts.

“A full sunset of the Bush tax cuts would be a severe shock to the economy,” he tells Aaron Task and me in the accompanying video. Letting income and capital gains tax rates return to their pre-2001 levels could lower annual economic growth by 1.4 per cent. “And given how poorly we’re growing, we run the risk of a double dip.” (On Tuesday the Commerce Department reported that, in the third quarter, the economy grew at a 2.5 per cent annual rate, higher than previously reported.)

Holtz-Eakin is confident that a deal will be struck in the next few weeks to avert substantial increases in tax rates. Here’s why: “A majority of those in the House and the Senate favoured a full extension of all of the tax cuts for some period. And there’s nothing that happened in the midterms that should reverse that basic predilection.”

Second, the Obama White House should recognise that an economic slowdown is the greatest threat to the president’s re-election plans. “They have no interest in risking that,” Holtz-Eakin says. Extending all the tax cuts for some period of time is both the economically and politically rational thing to do.

I can’t help but think that Holtz-Eakin’s optimism might be a triumph of hope over recent experience. First, it assumes that political players will act in an economically rational manner. Second, consider the experience of the past two years. A deal on taxes would require the Republican leadership and a big chunk of the GOP rank-and-file to vote for legislation that President Obama is willing to sign. But over the past two years, Congressional Republicans have generally held fast in united opposition — even on issues and legislation they had supported in the past. Politically, it has worked out extremely well for them. What incentive do they have to start cooperating now, especially when they’ll have much more power in a few weeks? Meanwhile, lame-duck Democrats, many of whom were forcibly retired by voters earlier this month, don’t have much incentive to hand Republicans a victory on their way out the door.

Regardless of what ultimately happens with taxes in 2011, the newly constituted Congress and the White House will face a tough chore in coping with the deficit. Holtz-Eakin believes it is incumbent on President Obama to submit a budget early next year that will begin to come to grips with the large deficit.

“These problems require presidential leadership,” he says. “Thus far he has put out two budgets that show us going down the path of a fiscal spiral. Come February he will have to put out a budget that doesn’t.” (In fact, the budget deficit actually fell in fiscal 2010 from fiscal 2009. And the budget submitted for fiscal 2011  — which started in October 2010 — shows deficits falling over the coming years.)

Holtz-Eakin finds the recent proposals from Erskine Bowles and Alan Simpson, co-chairs of the president’s Deficit Commission, to be “enormously helpful.” Even though the mixture of spending cuts and tax increases (or elimination of tax breaks) has been panned on both sides of the aisle, Holtz-Eakin believes the mix — roughly three dollars of spending reductions for every dollar of increased taxes — is appropriate. “You can’t pretend that if you just raise taxes on rich people that it’s going to be fine,” he says. “And you don’t solve this by chopping foreign aid and getting rid of waste, fraud, and abuse.”

Ultimately, Holtz-Eakin believes that letting a portion of the tax cuts expire won’t materially improve the budget deficit. “Our deficit problems are on the spending side, period. You can’t tax your way out of them. You cannot grow your way out of them.”

The structural mismatch between government revenues and expenditures is something Holtz-Eakin knows from experience. He was director of the Congressional Budget Office when Congress approved the expensive Medicare prescription drug entitlement — with no funding mechanism.

Daniel Gross is economics editor and columnist at Yahoo! Finance.

This post originally appeared at Yahoo! Finance and is republished with permission.

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