America Is Having the Wrong Fiscal Argument

The question should be whether to cut the deficit right now, not how
By Jeff Madrick
Source: The Harper's Magazine

This week’s agreement on the fiscal cliff is disappointing. Although President Obama can claim victory on such important measures as extending unemployment insurance for the long-term unemployed, he agreed to raise the income threshold for the tax hikes he sought from $250,000 to $450,000. Most important, he failed to secure an agreement to mitigate future social-spending cuts, meaning Social Security and Medicare will still be on the table in the next few months. This leaves the Republicans in a position to once again employ brinksmanship when it comes time to raise the debt ceiling, which could be as soon as mid-February. At that time, they may well succeed in their demands for serious and unnecessary social-spending cuts.

It’s more than a little unfortunate that the United States was boxed into the fiscal-cliff situation in the first place. That the nation is adopting a contractionary policy with an unemployment rate of nearly 8 percent is absurd. And that there is such a widespread consensus — accepted by the media as simple common sense — that substantial deficit reductions must be made in 2013 to solve a deficit problem that won’t begin seriously until in the 2020s, is a question for future historians and maybe psychologists. Even the current compromise, which rescinds the payroll tax cut and includes significant tax breaks for others, takes significant spending power out of an economy that is too weak withstand the move.
The fiscal cliff, recall, was effectively imposed on America by Republicans who in 2011 threatened to cause an unprecedented default on U.S. debt by not raising the legal debt limit. At the time, an agreement to reduce sharply the budget deficit across ten years was put in place, intensifying the pressure to cut social-program (and military) spending. The central battle now is whether deficit-cutting should be weighted toward higher taxes or sharp cuts in social spending — but it should be about whether deficit reductions of $4 trillion to $5 trillion over ten years are necessary at all, especially if they’re to start now. We have already seen caps placed on valuable social programs, including on the National Institutes of Health, on subsidies for low-income housing, and on college loans, which all told amount to about $1.5 trillion in future spending reductions.

Deficit-cutting under the current circumstances is bad economics, according both to theory and to historical precedent. Austerity economics are palpably and tragically failing in Europe, yet the same types who urge austerity on Greece, Italy, Portugal, Spain, and even France — not to mention the non-Eurozone giant, Britain — are also urging it in broad consensus in America. And they are succeeding. Dedicated to their polite even-handedness, meanwhile, the media have tended to blame both sides and to assume unquestioningly that deficit reduction is required, rather than identifying the clear culprits responsible for sustaining our economic mess. These culprits are not evenly distributed across the political spectrum. In order of importance, they are:

First and foremost, the small-government, tea-party Republicans who have been working for an economic policy driven by ideology and a hatred of most social policies. True, small-government ideologues — there are a few — would also seek to cut the military, but this group’s target is solely what it thinks of as the nanny state.

Second are the self-appointed “common sense” centrists, who agree that the federal deficit is our biggest problem, and thereby lend credibility to the right-wing extremists. These are the seemingly serious and purportedly moralistic practitioners of the anti-Keynesian austerity economics that are failing so badly in Europe. They include the powerful Campaign to Fix the Debt, which has aggressively signed up supporters across political and racial spectrums, and the Concord Coalition, as well as the Committee For a Responsible Federal Budget, which is financed by investment-banking billionaire Pete Peterson. But it is dominated by CEOs, almost all of whom have massive retirement funds and health-care benefits, yet demand cuts in Social Security, Medicare, and Medicaid.

Their great public-relations tool is the budget-balancing committee appointed by President Obama and led by Clinton Administration official Erskine Bowles and Republican former senator Alan Simpson. With heavy support from the groups mentioned above, the conservative document this group produced has come to be seen as the common-sense middle ground. Alarmingly, it calls for federal spending to be capped at 21 percent of GDP, the average since the 1970s, in order to control the deficit. Such an average cannot accommodate an aging population, rising health-care costs, and new public investments. It would require sharp cuts in social spending. The press nevertheless seems to trust the document and Simpson and Bowels are paid handsomely by deficit hawks, reportedly led by Peterson, to make speeches around the country in support of their views.

Third is the Congressional Budget Office, which is almost never mentioned as a partisan in the debate because it is legally bipartisan, answerable both to Democrats and Republicans. This distinction is almost meaningless. The CBO’s economics are utterly neoclassical, which means it is conservative, in that it almost always favors less government spending.

Its projections generally assume that high budget deficits will crowd out private investment and slow economic growth. This is simply biased economics. It also presumes that higher taxes reduce the incentive to work — a dubious conjecture at current levels of taxation, to say the least.

Guided by such assumptions, the office frequently arrives at questionable conclusions. For example, its long-term projections have suggested broadly that it would have been better to go over the fiscal cliff than to arrive at the sort of compromise reached this week. In its long-term outlook, the CBO claims that had the drastic spending cuts and tax hikes of the fiscal cliff gone into force, the economy would have bounced back robustly from an ensuing modest recession with 9 percent unemployment. Unemployment would thereafter have fallen to nearly 5 percent, and that federal deficits as a percentage of GDP would have fallen sharply, to 2 percent or so between the late 2010s and 2022. (The CBO’s assumption here is that the recession would lead to lower interest rates and rapid capital investment — that economies are basically self-adjusting, a profoundly conservative notion.)

The fiscal-cliff compromise, by contrast, will in the CBO’s eyes lead to bigger deficits and ultimately higher taxes, therefore robbing the economy of growth. Deficits would rise to 4 or 5 percent, and debt as a percent of GDP will soar. This is austerity economics, pure and simple. If you read the fine print, the CBO provides alternative projections based on milder assumptions about the impact of deficits — assumptions that in my view are much closer to the truth. But the “central’ projections, which are alarmist about the size of the deficit, are the ones the office publishes, and the ones Congress, fiscal hawks, and most of the media take at face value. Economic absurdity, as I say. America badly needs a shadow CBO that publishes more realistic projections, unconstrained by neoclassicism.

President Obama may have been able to make a better deal, but the Republicans are formidable enemies thanks to their numbers and their refusal to compromise. Obama made a mistake when he joined the deficit hawks so enthusiastically back in 2009. It is probably too late to change course — the great social programs inspired by the New Deal are now at stake.