B-School Profs: Fixing the Deficit

Posted by: Louis Lavelle on August 8, 2011

With the country teetering on the brink of default, Congress and President Barack Obama in the last month have debated the U.S. budget and deficit ad nauseam, reaching a deal to raise the debt ceiling but leaving the U.S, still facing the possibility of a double dip recession. It was enough to terrify Wall Street and give equity markets abroad a case of the jitters. Anyone watching the negotiations unfold in Washington, D.C. was probably thinking that businesspeople might have better answers than politicians.

When Congress returns from the August recess, it will have to hash out the particulars, taking action on at least $1.5 trillion in deficit reduction measures to be recommended by the new Congressional “supercommittee.” While Congressional members are off explaining their meltdowns and tantrums to those in their districts, Bloomberg Businessweek asked top business school professors to weigh in about where they would cut spending and how they would raise revenue to help grow the ailing U.S. economy. Here is what some of them had to say:

Murray Weidenbaum, professor of economics at the Washington University in St. Louis’ Olin Business School and chairman of the Council of Economic Advisers under President Ronald Reagan, says Congress should cut farm, energy, and aviation subsidies, among others, to start. He argues, for example, that farm subsidies often lead to the need for other subsidies, such as those necessary to help developing countries compete against low-cost U.S. farm exports. “Most of the subsidies the government provides are for special-interest groups that do not need them,” he adds.

What Weidenbaum calls “nice-to-have programs,” such as Housing and Urban Development (HUD), should be eliminated because they produce low-priority stuff, he says. In addition, Weidenbaum would closely consider grants the government offers, such as one encouraging states to have employees take sabbaticals, and get rid of the unnecessary ones. Finally, if it were up to Weidenbaum, he would tax Americans. “They ought to make a strong effort to reduce tax loopholes for the rich and middle class,” he says. Specifically, he said he would consider eliminating the deduction for home mortgage interest and taxing the fringe benefits that companies offer employees.

No one is pretending that budget cuts are easy, says Nejat Seyhun, professor of finance at the University of Michigan's Ross School of Business, who adds that people probably will not like his suggestions. He would have government cut back on healthcare and Social Security. "By not providing automatic raises [in benefits] with the rise is the cost of living and postponing the retirement age, you will encourage people to stay in the workforce longer," he says. Prescription drug plans, Medicare, and Medicaid are the biggest drain and biggest growth areas in the United States, says Seyhun. Over the next four to five years, he adds, healthcare expenditures will make the biggest contribution to the deficit. Overall, he suggests cutting back on spending especially in these areas, increasing the tax base, and eliminating tax deductions.

Others agree that healthcare expenses are crippling the U.S. economy. Larry Van Horn, executive director for Health Affairs and associate professor of economics and management at Vanderbilt University's Owen Graduate School of Management, says it is mathematically impossible to keep up with the ever-growing costs of Medicare and Medicaid. In addition, he would tax the health insurance that companies provide to employees, which he estimates could bring in $2.5 trillion over the next 10 years. "We have an insatiable appetite for healthcare, but we have a limited willingness to fund it," he says. "We've kicked the can down this road for the last 25 years, and we've run out of time."

Instead, Medicare and Medicaid should cover catastrophic services as opposed to unlimited services, says Van Horn. For example, he says that a year's worth of Medicare payroll deductions for 17 taxpayers would be needed to pay for one knee or hip replacement, which costs about $20,000. Multiply that by the 400,000 replacements that happen each year in the United States, he adds, and you need more than 6.5 million taxpayers to cover those expenses. "You can spend what you bring in," says Van Horn. "But if you can't bring in the money, you can't keep spending."

Still, no one is saying that growth will be unharmed by major cuts in spending. Peter Rodriguez, senior associate dean for degree programs at University of Virginia's Darden School of Business and a former student of Fed Chairman Ben Bernanke when he was a professor at Princeton University, says budget cuts will in some way influence growth even if they are necessary. His suggestions are to cut into future projects, such as infrastructure repair, rather than cutting current jobs, and taking a look at the government's own role. "Every bureaucratic office can run leaner," he says. "It's easier to put more pressure department by department rather than cutting something entirely." In addition, a decrease in military spending would take significant pressure off the budget without hurting local economies much, adds Rodriguez.

Like everyone else, Rodriguez agreed that a combination of cuts in spending and closing tax loopholes to generate revenue would have been the ideal plan. For now, though, new taxes are off the table. While Seyhun is glad that Congress and the President averted default, he feels the proposed $1.5 trillion sum for cuts is "peanuts." "The reduction in spending that Congress is planning is not a big deal," says Seyhun. "It's postponing the problem. It's postponing the solution."

--Francesca Di Meglio

Reader Comments

Ryan A

August 8, 2011 5:02 PM

A great article from a bunch of folks who spend all day crunching the numbers.

Terrill noe

September 12, 2011 10:48 AM

The American dream for the middle class has been a home. Valuations have gone down. Selling without loss is difficult in this environment. So what happens, these people say take the deduction away. Any ideas on the housing market. Renting sure sounds good.

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