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What Jack Lew Can Learn From the Europeans

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By Daniel Hanson

Newly minted Treasury Secretary Jack Lew’s trip to Europe this week has to be a curious spectacle for the Europeans. The Secretary is spending his time in Europe meeting with European leaders, encouraging them to move away from a focus on austerity and toward a focus on growth.

The situation is ironic since, with Lew as a senior budget negotiator over the past four years, the US has failed to achieve meaningful deficit reduction, to restart growth, and to pass a budget. Indeed, while Europe struggles under the burden of debt, Mr. Lew would do better to learn from the Europeans rather than lecturing them.

Consider his background

Mr. Lew was head of the president’s Office of Management and Budget during a period in which the Administration failed to work with Congressional leaders to pass a budget and succeeded in securing a downgrade of US government debt when Congress gridlocked on the debt ceiling in the summer of 2011. During this period, National Economic Council Chairman Gene Sperling and Lew invented the much-maligned sequester and convinced Congressional leaders to sign on.

As President Obama’s Chief of Staff during 2012, the Administration was confronted with a self-imposed “fiscal cliff” of $600 billion in spending cuts and tax increases set to take effect on January 1, 2013. Despite a year of negotiations, Congress and the President only reached a deal after the deadline had passed that included $175 billion in direct tax increases, a postponed implementation of the sequester, and cronyism handouts to rum producers, NASCAR race tracks, and electric scooter producers.

In both roles, Lew advocated for, designed, and implemented anti-growth, pro-austerity measures of the type he is now scolding the Europeans for pursuing. Mr. Lew has been in the unenviable position of navigating between a vitriolic Congress and a stubborn president, but faced with multiple trillion dollar deficits, Lew has supported raising taxes and cutting short-term discretionary spending – the type that supports investment growth – without touching longer term entitlements.

But Europe is not the US

European crisis countries have historically spent much more on entitlements than the US. According to the OECD, Italy’s entitlement programs have averaged 26 percent of GDP since 2000, while Spain’s have consumed 23 percent of GDP. In 2012, Greece and France both spent twice as much as the US on health care and old-age entitlements per senior citizen.

Spending of this variety has made huge portions of the European population dependent on government assistance for day-to-day living, which in turn makes the pain of fiscal austerity deeper. Unemployment and poverty are the hallmarks of a beleaguered southern Europe struggling with budget cuts and tax increases.

Meanwhile, European governments have neglected their discretionary budget duties, underfunding transportation, education, defense, and other priorities as they are forced to choose between social programs and longer run investments. One report from the European Commission, for instance, estimates that surface transportation in the euro area is underfunded by at least €1 trillion.

A longer term lesson of the European debacle is that expansive and expanding social safety nets are not sustainable forever. Large European budget deficits have precipitated a debt crisis that demands governments spend less money in the short term. Government coffers in many European nations are empty, forcing hard and painful decisions about who gets paid by the government in the very immediate and salient future.

Heading down the same path

This is in stark contrast to the US, which currently faces a long-term budget problem, but no short-term crisis. With the yield on 10-year Treasuries at 1.75 percent, investors are lining up to finance a federal deficit that will fall below $1 trillion this year for the first time in five years. Unlike Spain, Greece, Italy, and other European debtors, the US fiscal position is sustainable for the time being.

But in the long run, exploding entitlement commitments will swallow up larger and larger shares of GDP here, just as they have in Europe. Under current law, spending on Social Security, Medicaid, Medicare, and Obamacare subsidies will consume every dollar of tax revenue by 2045, and by 2085 these programs will consume $0.25 out of every $1.00 produced in the US economy. Strangely, the primary reason these projections are unrealistic is because the Medicare and Social Security Trust Funds that finance these expenditures will likely go bankrupt long before these outcomes emerge.

Despite this, Lew has repeatedly lobbied for policies that cut short-term spending while exempting the long-term entitlement challenges that are the primary drivers of our debt. If using Europe as a guide, Lew should understand that a small amount of pain in these programs today can save lots of pain later, since tiny changes today can drastically alter the trajectory of future spending. Cuts to out-year outlays for Medicare and Social Security can go a long way toward promoting fiscal sustainability and closing the fiscal gap.

While Lew is in Europe, he should survey the wreckage wrought by decades of misguided entitlement policy. High unemployment, dysfunctional budgeting, painful austerity, and more are the reward for Europe’s entitlement largess. Rather than chiding Europe for the cuts they must make, Lew should return to Washington with ways to reform entitlement systems in a sustainable and responsible manner.

Daniel Hanson is an economics researcher at the American Enterprise Institute.