Cross-posted at Reports from the Economic Front.
Congress has finally agreed on a deficit reduction plan that President Obama supports. As a result, the debt ceiling is being lifted, which means that the Treasury can once again borrow to meet its financial obligations.
Avoiding a debt default is a good thing. However, the agreement is bad and even more importantly the debate itself has reinforced understandings of our economy that are destructive of majority interests.
The media presented the deficit reduction negotiations as a battle between two opposing sides. President Obama, who wanted to achieve deficit reduction through a combination of public spending cuts and tax increases, anchored one side. The House Republicans, who would only accept spending cuts, anchored the other. We were encouraged to cheer for the side that we thought best represented our interests.
Unfortunately, there was actually little difference between the two sides in terms of the way they engaged and debated the relevant issues. Both sides agreed that we face a major debt crisis. Both sides agreed that out-of-control social programs are the main driver of our deficit and debt problems. And both sides agreed that the less government involvement in the economy the better.
The unanimity is especially striking since all three positions are wrong. We do not face a major debt crisis, social spending is not driving our deficits and debt, and we need more active government intervention in the economy, not less, to solve our economic problems.
So what was the deal?
Before discussing these issues it is important to highlight the broad terms of the deficit reduction agreement. The first step is limited to spending cuts; discretionary spending is to be reduced by $900 billion over the next ten years. Approximately 35% of the reduction will come from security-related budgets (military and homeland security), with the rest coming from non-security discretionary budgets (infrastructure, energy, research, education, and social welfare). In exchange for these budget cuts the Congress has agreed to raise the debt ceiling by $1 trillion.
The agreement also established a 12 person committee (with 6 Democrats and 6 Republicans) to recommend ways to reduce future deficits by another $1.2-1.5 trillion. Its recommendations must be made by November 23, 2011 and they can include cuts to every social program (including Social Security, Medicare and Medicaid), as well as tax increases.
Congress has to vote on the committee’s package of recommendations by December 23, 2011, up or down. If Congress approves them they will be implemented. If Congress does not approve them, automatic cuts of $1.2 trillion will be made; 50% of the cuts must come from security budgets and the other 50% must come from non-security discretionary budgets. Regardless of how Congress votes on the recommendations, it must also vote on whether to approve a Balanced Budget Amendment to the Constitution. Once this vote is taken, the debt ceiling will be raised again by an amount slightly smaller than the deficit reduction.
Check out this flowchart from the New York Times if you want a more complete picture of the process.
Why is this a problem?
Those who favor reducing spending on government programs generally argue that we have no choice because our public spending and national debt are out of control, threatening our economic future. But, the data says otherwise.
The chart below, from the economist Menzie Chinn at Econbrowser, shows the movement in the ratio of publically held debt to GDP over the period 1970 to 2011; the area in yellow marks the Obama administration. While this ratio has indeed grown rapidly, it remains well below the 100% level that most economists take to be the warning level. In fact, according to Congressional Budget Office predictions, we are unlikely to reach such a level for decades even if we maintain our current spending and revenue patterns.
The sharp growth in the ratio over the last few years strongly suggests that our current high deficits are largely due to recent developments, in particular the 2001 and 2003 Bush tax cuts, the wars in Iraq and Afghanistan, and the Great Recession. Their contribution can be seen in this chart from the New York Times.
The effects of the tax cuts and economic crisis on our deficits (and by extension debt) are especially visible in the following chart (again from Menzie Chinn), which plots yearly changes in federal spending and federal revenue as a percentage of GDP (the shaded areas mark periods of recession). As we can see, the recent deficit explosion was initially driven more by declining revenues than out of control spending. Attempts to close the budget gap solely or even primarily through spending cuts, especially of social programs, is bound to fail.
Tragically, the debate over how best to reduce the deficit has encouraged people to blame social spending for our large deficits and those large deficits for our current economic problems. As a result, demands for real structural change in the way our economy operates are largely dismissed as irrelevant.
Recent economic data should be focusing our attention on the dangers of a new recession. According to the Commerce Department our economy grew at an annual rate of just 1.3% in second quarter of this year, following a first quarter in which the economy grew by only 0.3%. These are incredibly slow rates of growth for an economy recovering from a major recession. To put these numbers in perspective, Dean Baker notes that we need growth of over 2.5% to keep our already high unemployment rate from growing.
Cutting spending during a period of economic stagnation, especially on infrastructure, research, and social programs, is a recipe for greater hardship. In fact, such a policy will likely further weaken our economy, leading to greater deficits. This is what happened inthe UK, Ireland, and Greece—countries with weak economies that tried to solve their deficit problems by slashing public spending.
We need more active government intervention, which means more spending to redirect and restructure the economy; a new, more progressive tax structure; and a major change in our foreign policy, if we are going to solve our economic problems. Unfortunately for now we don’t have a movement powerful enough to ensure our side has a player in the struggles that set our political agenda.
Comments 41
John Kordich — August 2, 2011
That is a LOT of money that will be cut from "security". (I believe it's around $800billion in the most likely case?)
In my opinion, it's probably worth it.
I'd rather live in a libertarian's no-tax dream (with no government programs) than in an oppressive empire that bombs villages on a daily basis.
Anonymous — August 2, 2011
So, rather than pass an interim increase while the debt deal is worked out, and then pass the final increase after the deal is worked out, we... pass an immediate increase and make the final increase contingent on future actions?
I have to wonder: is the $1.2T in 'automatic additional cuts' designed to be so unpalatable to everybody that whatever comes out of the deficit committee is clearly superior, since we did give a minority power to force it to happen via filibuster. I have no doubt that the "No new [repeal of] tax [cut]s" crowd will be glad to further manipulate truth when they say that the "bill is still in debate" as the deadline passes.
And in the meantime, the FAA reauthorization bill is tabled another month. ~75,000 people are furloughed without pay, funding for airport maintenance fails to appear, and some aviation taxes go uncollected while the expenses that they cover continue to accumulate.
I'd like to see a "The president can keep congress in session until they have voted on every bill before them" constitutional amendment.
Anonymous — August 2, 2011
Wow, this is a surprisingly one-sided post for Sociological Images - since when did this blog become a political forum rather than a discussion about sociology?
"We do not face a major debt crisis, social spending is not driving our deficits and debt, and we need more active government intervention in the economy, not less, to solve our economic problems."
Yrro Simyarin — August 2, 2011
I thought this was a sociology blog, not a left-wing economics blog. Should I simply link to reason.com for the opposing argument and call it a day?
George — August 2, 2011
This blog post is so biased it's a self parody.
I especially like the part immediately below the plot showing the ratio of debt to GDP. The text blames this on tax cuts and the wars in Iraq and Afghanistan, when the plot clearly shows that the ratio increases precipitously in 2008 after the bailouts and TARP.
The closing statement calling for "active government intervention" doesn't even attempt to make an argument. I am fairly sure this is due to the dearth of evidence supporting such a course of action.
Kat — August 2, 2011
IMHO this post would have been better if it had only consisted of the NY Times pic with a "Discuss" underneath, potentially also with a second pic on which income brackets benefited from the Bush era tax brackets.
Anonymous — August 2, 2011
I don't understand the complete denial of taxes. It's not even just an anti-tax position, it's like they want to shut out any understanding of how taxes work at all.
"we aren't earning as much as we spend, so we have spend less!"
Or earn more! Mr. Boehner, don't you know basic arithmetic? Are TeaPrrrtiers actually happy that public services are going to be de-funded just so they can stand by tax cuts?
This doesn't make any sense!
Andrew — August 2, 2011
Lots of people assume this is a left-leaning or left-wing post.
However, I would disagree.
While there may be multiple arguments to every story, not all arguments are equally valid.
I'm certain that if a "left" individual went on a debate and laid out a case for the world being round, none of us would give believe the opposite view point, that the world is actually flat. And that would have nothing to do with the "left" individual.
Obviously when it comes to economics and politics, left and right start getting intermixed.
However, data is data and historical evidence is historical evidence. If the consensus of all of the data points that the "left" position is actually TRUE and CORRECT, then that position should not be considered a "left" position, but rather a "Factual" position.
The right side of the media has done an amazing job in the past few decades of painting the media as a whole as "left". In the end there were only two options for actual media: Report the news and be called "left wing media" by those who *really are* right-wing media, or offer an opposing view point in ALL arguments, even those that are, to any reasonable person, completely lacking of all merit.
The reaction to this situation is similar. There are very few actual economists who feel that the bush tax cuts actually helped the economy. The truth is, based on actual evidence (As shown above), that they did not help the economy. Other historical data will show that higher tax rates for wealthier individuals, with the money spent on social programs, actually does help the economy.
Those truths fall into line with the democrats platform more than the republicans (although, the republican party pre-Reagan had absolutely no problem with that line of thought), so whenever it's presented as it has been here, people who disagree with the politics of it call it "left", which marginalizes the facts and figures and truths contained within.
Gilbert Pinfold — August 2, 2011
"more spending to redirect and restructure the economy; a new, more progressive tax structure; and a major change in our foreign policy."
One out of three ain't bad. The last point I agree with. Higher taxes, well ho-hum... nothing new there from the left. But I shudder to think what is actually meant by 'redirect and restructure the economy.' Not Green Jobs and other unicorns, surely?
AlgebraAB — August 2, 2011
"While this ratio has indeed grown rapidly, it remains well below the
100% level that most economists take to be the warning level. In fact,
according to Congressional Budget Office predictions, we are unlikely to
reach such a level for decades even if we maintain our current spending
and revenue patterns."
The 100% level you cite is arbitrary. What matters is not just the debt-to-GDP ratio but also the trajectory of the economy as a whole. The rate at which the public debt is growing must be compared to the rate at which the economy is growing and the rate at which revenues are growing. Thus, Spain, at a debt-to-GDP level of ~50%, is in trouble because even at that level economic growth can't keep up with the debt. In contrast, Germany, at a debt-to-GDP level of ~70%, is in relatively good shape thanks to its robust economic growth and its goal of enacting a balanced budget by 2014.
I'm also curious which CBO source you're citing. I'm looking at the CBO's 2010 Long Term Budget Outlook and under the 'alternative fiscal scenario,' the US's debt-to-GDP ratio will reach 109% in 2025. The 'alternative fiscal scenario' is one of two scenarios that the CBO lays out. However, the 'alternative fiscal scenario' assumes that the Bush tax cuts will be extended while the other scenario does not. As you know, those tax cuts have in fact been extended.
A 100%+ public debt will have real ramifications. Essentially, as Generation Y enters its prime working years it will be financing a public debt almost on par with the public debt that was used to finance World War II. Except, instead of fighting a global war, the money will be used to finance the basic standard-of-living for Americans.
That brings up the next problem. World War II was temporary. Financing a standard-of-living that we can't afford is presumably not. So where will it end? And, will the rest of the world continue to finance our lifestyles indefinitely? In return for what?
Its these "endgame" questions that are provoking anxieties. The US has no model for promoting economic growth, at least not one that isn't fueled by ever-increasing public debt. Agriculture rests on subsidies. Manufacturing will continue to leave the U.S. in net terms as long as global wage inequalities persist (and a correction of global wage inequalities would likely mean lower wages for US workers, which is clearly unpalatable to many here). Essentially, our prosperity depends on the global strength of our financial sector and its ability to import capital to fuel debt-based consumer spending. The rest of the world is increasingly becoming cognizant of the fact that were it not for the dominance of the US greenback and were it not for Wall Street/London's dominance of global financial markets, the US economy would not be able to provide anything close to the current standard-of-living it offers the US populace. Thus you have Putin calling the US a "parasite" and nationalist leaders in Latin America calling for an end to dollar hegemony. Thus you have average Americans worried about ANY kind of debt-based spending in the absence of a solid model for future growth.
Offer the American populace a solid, detailed plan for how the US is going to retool itself in this new era of increased global competition and they will surely agree to more debt and increased social programs. So far no one, left or right, has been able to offer that.
marta-maria — August 3, 2011
Spend, spend spend.....has to stop! Ful stop!
[links] Link salad for a midweek | jlake.com — August 3, 2011
[...] The Deficit Deal: We Got Taken — I really expected better from Obama. Unfortunately, I’m stuck voting for him in the next election, as the alternatives are unimaginably worse. [...]
CTD — August 3, 2011
Looks like someone's never heard of Hauser's Law.
http://online.wsj.com/article/SB10001424052748703514904575602943209741952.html
You'll simply never collect more than 18.5% of GDP as revenue for any extended period (and you'll never break 20% except for red hot bubbles) no matter what you do. Higher taxes, lower taxes, taxing the rich, taxing corporations... it doesn't matter.
The Science of Kissing; A Look At the Deficit Deal; And Much More… « Welcome to the Doctor's Office — August 3, 2011
[...] THE DEFICIT DEAL: WE GOT TAKEN by Martin Hart-Landsberg, [...]
Sally — August 4, 2011
While on the whole I agree with the economic analysis provided here, pulling in "the UK, Ireland and Greece" at the end to try and prop up an already well-made argument is disingenuous and inaccurate.
"Slashing public spending" is not what brought the Irish economy down. In fact, Ireland's current budget public spending -- public servant salaries and social welfare provisions -- is still among the most generous in Europe. The problems with our capital public spending -- in particular a sorely neglected health service -- existed even during the boom in our economy, when we had one of the highest GDP figures in the Eurozone. What happened to trigger our financial collapse was poor government regulation, a dishonest banking sector and corrupt political ties with property development. After a drastically ill-advised decision on the part of the Irish government to guarantee the banks, we're now in a black hole of debt to the EU Central Bank and the IMF, with no one willing to lend on the international markets.
But even if you didn't know that, a quick glance over the last few Irish government budgets should amply demonstrate that services have not been "slashed". Our university education is still free; our social welfare is still generous; our health service remains as dysfunctional as it was during the boom. I agree that government investment in the public sector is vital, but Ireland never made many of the crucial infrastructural investments you suggest even when we did have the money. Public spending cuts are not what crippled the Irish economy. We were heading for a fall before the global economic crisis anyway through bad financial management.
Just because people now handily associate the word "Ireland" with "scary financial collapse" doesn't mean you can throw it in wherever you like to make your argument look better.
Matt Seegz — August 7, 2011
I think this blog post needs to seriously take a look at how this economic situation is going to impact the Robotnik population.