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Deficit spending CAN be fiscally responsible. Here's how.

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Seth Perlman / AP / File

(Read caption) Protesters participate in a tax day tea party Illinois State House in Springfield, Ill., April 15, 2009. The Bipartisan Policy Center recently released a report arguing that additional deficit spending can be fiscally responsible, because the fiscal outlook is only unsustainable if the debt grows faster than the economy.

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I’m traveling all this week for work, so I probably won’t be blogging at my usual frequency. But I had to say at least something about this week’s big fiscal policy development.

The Bipartisan Policy Center’s (BPC) debt reduction plan was unveiled on Wednesday morning and is a good example of why pursuit of “fiscal responsibility” need not be in conflict with other economic goals, contrary to how opponents of fiscal hawkish policies like to portray them.

First, additional deficit spending can be fiscally responsible. How is that not an oxymoron? Because the fiscal outlook is only unsustainable if the debt grows faster than the economy. There are two variables in that comparison, both affected by policy choices. The debt grows each year by the size of the annual deficit, the difference between spending and revenues. But how the particular spending and revenue policies affect economic activity in turn affect how fast the economy grows. In other words, exactly how we spend and how we tax matters beyond how much we are spending and how much we are taxing (collecting in revenue), in determining what is winning this race between the debt and the economy.

In Wednesday’s New York Times, David Leonhardt makes the point that all else constant, a stronger economy reduces the budget deficit–that “one way to trim [the] deficit” is to “cultivate growth.” In an economy with high unemployment, even deficit-financed policies can produce an economic benefit (greater economic activity with more income to tax and less need for government safety net spending) that outweighs the economic cost (increase in the deficit which may increase borrowing costs and reduce national saving), provided that the deficit spending has high (and fast) economic “bang per buck.” Short-term deficit-financed stimulus is most likely to produce that high “bang per buck” when the policies follow the “three Ts” of being timely, (well) targeted, and temporary in nature.

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