MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

YOU DECIDE: How should we pay for Katrina and Rita?

By Dr. Mike Walden
North Carolina Cooperative Extension Service

The total bill for the federal government's share of the rebuilding on the Gulf Coast necessitated by hurricanes Katrina and Rita isn't in yet, but it will be huge, perhaps $250 billion or more. By some measures, it will be the single biggest reconstruction effort in the nation's history.

What should be the federal role in the reconstruction?

Some say the private sector should take the lead; others question whether the Gulf Coast should be rebuilt to its previous level. Nevertheless, I think there's an overwhelmingly likelihood the federal involvement will be significant and costly. So the question then becomes how we pay for it.

Essentially, there are three options: increase federal taxes or federal borrowing or cut other federal spending programs. Each includes pluses and minuses.

Increasing taxes means taking more money out of private hands and putting it in government's. This transfer alone will slow economic growth because there will be less money for private businesses and households to spend. Yet countering this reduction will be the additional business activity caused by the rebuilding.

So in this scenario, the nation would be trading one type of spending for another. Of course, the Gulf Coast and nearby regions would see a net gain in spending at the expense of other regions.

Presumably, the reconstruction would be limited, although still measurable in years. If the tax route were followed, this would argue for a temporary tax increase. Federal taxes would increase by a limited amount and for a limited duration until the rebuilding effort is complete.

Such a tax plan has one big advantage. With the private sector knowing the higher taxes were temporary, long-range investment and spending plans are minimally affected.

The second option is increased federal borrowing, which adds to the federal deficit and national debt. Although many think more government borrowing leads to higher interest rates, there is little evidence it does. The major financial impact is that increased borrowing implies higher taxes later.

On the other hand, a case can be made for borrowing to pay for at least a part of the reconstruction program. Borrowing makes economic sense when used to pay for long-lasting projects. Then both current and future households and businesses, all of which benefit from the project, pay for it.

In the case of the Gulf Coast, transportation and port infrastructures are long-lasting investments that will benefit local and national citizens for years to come. Borrowing to repair the damage to these projects can be economically logical.

For many, the most appealing option is the third: reducing other federal spending. It mirrors what most households and businesses would do when faced with an unexpected expense. Federal programs would be prioritized and those with the lowest priority reduced to pay for the Gulf Coast spending.

There's one problem with this approach: the need to prioritize. Elected officials often have difficulty reducing spending programs because behind every program lies a constituency that wants to keep it. Selecting specific programs for cutbacks is sure to spark protracted political fights.

However, one potentially viable option is across-the-board cuts. Here, every program takes the same percentage reduction, and all constituencies share the pain equally.

Hurricanes Katrina and Rita did an incredible amount of physical and human damage, and we're just now beginning to tally the toll.

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Dr. Mike Walden is a William Neal Reynolds Professor and extension
economist in the Department of Agricultural and Resource Economics of North
Carolina State University's College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic outlook and public policy.
His You Decide column is provided every two weeks by the Department of
Communication Services. Earlier You Decide columns are available on the Web
at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at
http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html