New York Times | March 8, 2013
The sequester – the large, across-the-board cuts in federal government spending that began to take effect on March 1 and are scheduled to persist through the next decade – is a product of political stalemate and ideology cloaked in the language of fiscal responsibility. Despite what some of its champions proclaim, there is no economic justification for the sequester. It is the wrong medicine for what ails the economy now and the wrong cure for its future budgetary challenges.
As a result of a deep and lingering deficiency in aggregate demand, the United States economy is operating far below its potential. Real gross domestic product fell by 8 percent relative to its non-inflationary potential level in 2008 and has remained about 8 percent below the level consistent with its pre-recession growth rate ever since.
The gap between the actual and potential level of output means about $900 billion of forgone goods and services this year alone. This tremendous waste of productive potential is reflected in an unemployment rate of 7.9 percent, a higher rate than at any point in the 24 years before the depths of the 2008 recession, and a poverty rate of 15 percent, significantly above the average of the last 30 years.
High levels of unemployment impose substantial costs not only in terms of human suffering and forgone output now but also in terms of the economy’s productive potential in the future. The longer the economy operates below its current capacity, the slower the growth of its future capacity as a result of diminished risk-taking, forgone investment and the erosion of skills.
Besides its sheer size, what’s remarkable about the gap between actual and potential output is its persistence, despite a sustained and unprecedented effort by the Federal Reserve to boost demand and hasten the recovery. For more than five years, the Fed has held the nominal short-term interest rate near zero – its effective lower bound — with a promise to keep it there at least until the unemployment rate falls to 6.5 percent. The Fed has also been purchasing about $1 trillion of long-term government bonds annually. As a result of these actions, the nominal yield on the 10-year Treasury bond, a measure of the borrowing costs of the federal government, hovers around 2 percent, less than a third of its 40-year average, and both short-term and long-term interest rates are less than the rate of inflation.
In a speech earlier this week to the National Association of Business Economists, the Fed’s vice chairwoman, Janet Yellen, reaffirmed the Fed’s commitment to its bold accommodative policies until there is a “substantial improvement in the outlook for the labor market.”
Under current economic conditions, with significant unutilized resources, low inflation and highly accommodative monetary policy, contractionary fiscal policy has contractionary effects: spending cuts and tax increases reduce aggregate demand, choke job creation and dampen growth. In these circumstances, more deficit reduction is neither necessary nor wise; it is counterproductive. A more anemic recovery means less deficit reduction for any given set of fiscal policies.
Spending cuts at the local, state and federal levels have been powerful headwinds constraining growth during the last three years. And the headwinds are intensifying this year.
Taken together, the caps on discretionary spending imposed in 2011, the tax increases in the 2013 tax deal – especially the increase in payroll taxes that will trim household incomes by about $125 billion – and the sequester will cut about 1.5 percentage points from 2013 growth, consigning the economy to yet another year of tepid recovery and elevated unemployment. The sequester cuts alone will result in a loss of at least 700,000 jobs. And these arbitrary across-the-board cuts will inflict more damage on the economy than sensibly targeted cuts of the same magnitude.
Mr. Bernanke admonished Congress in his recent statement that monetary policy “cannot carry the entire burden of ensuring a speedier return to economic health.” Discretionary fiscal policy in the form of more debt-financed government spending is warranted and would be effective. Recent research finds that the multiplier for discretionary fiscal policy – the change in output caused by a change in discretionary government spending – is larger when interest rates are low and underutilized resources are available.
Indeed, under these conditions it is possible that increases in government spending will end up paying for themselves in the long run by speeding the recovery and stemming unnecessary losses in the economy’s future capacity. This possibility is the greatest for government spending in investment areas like research, education and infrastructure that generate sizable returns over time.
Mr. Bernanke also advised Congress that “not all tax and spending programs are created equal with respect to their effects on the economy,” and emphasized the importance of investments in work-force skills, research and development and infrastructure. Unfortunately, as a result of the caps on discretionary spending and the sequester, these areas will fall victim to significant cuts over the next decade.
If these policies are enforced, the Congressional Budget Office projects that discretionary spending will fall to 5.5 percent of G.D.P. by 2023, more than three percentage points below its 1973-2012 average, with nonmilitary outlays falling to 2.7 percent of G.D.P. compared with a 40-year average of 4 percent.
The economy needs less rather than more deficit reduction in the near term. But less deficit reduction also means more debt accumulation over time. Even with the sequester and the discretionary caps, federal debt held by the public is projected to recent Congressional testimony remain around 75 percent of G.D.P. during the next decade, compared with an average of about 40 percent between 1960 and the 2008 recession.
A large and growing government debt relative to the size of the economy has several negative potential consequences. Most important, when the economy is operating at capacity, it crowds out private saving and investment, reducing the capital stock, productivity and wage growth. It puts upward pressure on long-term interest rates and increases the cost of servicing the debt. It weakens investor confidence in the debt, heightens the risk of a financial crisis and reduces the government’s budgetary flexibility to address future, unexpected shocks.
The economy needs a long-run plan of revenue increases and spending cuts to put the federal budget on a sustainable path that will stabilize and reduce gradually the debt- to-G.D.P. ratio. Congress should jettison the sharp, front-loaded and arbitrary sequester cuts that will harm the recovery and work on such a plan.
Unfortunately, the political stalemate and ideology that produced the sequester appear to rule out this approach at least for now. Perhaps when the sequester’s costs become apparent, Congress will be forced back to the negotiating table.
Forbes | February 26, 2013
Barring an unexpected breakthrough agreement between the Democratic Senate and the Republican House, the federal budget will be subjected to a sequester which will reduce discretionary spending by about $86 billion in calendar 2013.
That $86 billion is only a bit more than 10% of the “fiscal cliff” that faced the country at the end of the year. It’s a painful cliff, but not a large one. The American Taxpayer Relief Act resolved most the cliff problem, but the Congressional Budget Office (CBO) says that the sequester will reduce short-term growth in an already slow economy. On the other hand, no sequester at all would mean an even greater reduction in long-term growth.
The worst feature of the sequester is that it is the wrong way to reduce spending. The cuts are mandated across-the-board in most discretionary spending areas. The good programs will be cut along with the bad. The most hard-hit casualty will be the Defense Department (DOD). It can stand cuts, but they need to be carefully selected. The sequester does not select. The sequester meat-axe slices muscle along with the fat.
It is hard to believe that allegedly smart people could have agreed to such a device. The President and the leaders of both houses signed off on the sequester in the belief that because it was so bad it would force them into a compromise deficit/debt reduction plan despite their philosophic disagreements.
As it seems to be turning out, our representatives’ philosophic disagreements are more precious to them than the health of the nation’s economy. Republicans want to protect tax rates and Democrats want to protect entitlement programs. They would prefer the sequester, admittedly smaller than the tax cliff, to any form of compromise.
The moment of truth is only a week away. Most odds-makers believe the Sequester will actually occur. However, the policymakers do have other choices: (1) they could postpone it, in hopes of making a later deal (2); they could trash the sequester, and sacrifice long-term growth for another short-term fling; (3) they could give the Executive Departments leeway to make the cuts where best tolerated; or (4) they could live with the sequester for a few weeks or months, and then holler “uncle” and opt for (1) , (2), or (3) above.
This writer believes that the sequester will happen. However, when airport security lines triple, the national parks open later and close earlier, and our military tours abroad are extended, there is a good chance that Congress will begin to rethink the problem, particularly with respect to DOD. If so, at that point, it is critical that Congress replace a dumb cut with a smart cut of equal value, rather than deferring or repealing the sequester.
Our debt is already high. CBO sees it going higher rather than stabilizing under the most likely budget scenarios over the next 10 years. The President’s budget drives the debt ratio up around 80% in 10 years. That’s one reason why cancelation, or deferral, of the sequester would be unwise. Over 10 years, the sequester would save well over $1 trillion. Another reason is that it makes no sense to swap short-term faster growth for long-term reduced growth.
If no comprehensive compromise (one with total 10-year reductions of Bowles-Simpson proportions) is in sight, it is better to accept the stupid cuts of the sequester than to postpone deficit/debt reduction plans again. The best plan would be smart cuts. The sequester is a distant second choice, but, clearly, it is better than nothing.
The Government We Deserve | February 20, 2013
In last week’s State of the Union speech, President Obama put great emphasis on expanding early childhood education. He’s not alone in recognizing the vital role of education as the launching pad for 21st century growth. George W. Bush wanted to be known as the “education president,” and so did his father, George H.W. Bush.
Many governors have similar aspirations. Jerry Brown, for instance, has gotten headlines for his efforts to restore the California university system to its former high status. State support for higher education has fallen dramatically there, particularly as a share of the budget and of Californians’ incomes but also in real terms. Brown even supported a tax increase to try to reverse this trend.
While I strongly support these types of effort, right now pro-education governors and the president are fighting a losing battle. Their new initiatives merely slow down their retreat against a health cost juggernaut.
California isn’t much different from many other states. The college bound and their parents witness this declining state support in the form of ever-rising costs and student debt. Less recognized is the fall in academic rankings of the nation’s leading public universities, such as many of the formerly extolled California universities and my own alma mater, the University of Wisconsin–Madison.
State support of education hasn’t just declined at postsecondary schools. In recent years, legislators have assigned K–12 education smaller shares of state budgets as well. During the recession, teachers were laid off and not replaced in many states. Efforts to expand early childhood education have also stalled, although the president’s initiative may give it some temporary momentum.
Federal spending policies only reinforce the longer-term anti-education trend. An annual Urban Institute study on the children’s budget suggests future continual declines in total federal support for education as long as current policies and laws hold up.
Education spending will continue to decline as long as health costs keep rising rapidly and eating up so much of the additional government revenues that accompany economic growth. The figure below, prepared by National Governors Association (NGA) Executive Director Dan Crippen and presented by his deputy, Barry Anderson, at a recent National Academy of Social Insurance conference, tells much of the state story: health costs essentially squeeze out almost everything else.
These rising health costs don’t just place a squeeze on government budgets; they also are one source of the paltry growth in median household cash income over recent decades.
Within states, health costs show up primarily in the Medicaid budget. As the NGA numbers demonstrate, recent federal health reform did little and is expected to do little to control these state costs, despite large, mainly federally financed subsidies for expanding the number of people eligible for benefits.
With populations aging, state and federal governments now also face demographic pressures to increase their health budgets. Large shares of the Medicaid budget go for long-term and similar support for the elderly and the disabled. This budgetary threat also extends to revenues as larger shares of the population retire, earn less, and pay fewer taxes.
The next time someone tells you that we should wait another ten years to control health costs because we’ll be so much smarter and less partisan then, remind him or her that this procrastinating implicitly advocates further zeroing out state and federal spending on education—and the children’s budget more generally. Presidents and governors will never succeed with their education initiatives until they stop the health cost juggernaut in its tracks.
CNN | February 16, 2013
This week the president faced the American people to talk about, among other things, the budget. He said the right things. During his State of the Union address on Tuesday night, he drew a link between responsible fiscal policy and the important issues of jobs, the middle class and economic growth. He emphasized the need for fiscal responsibility.
He pointed out that while some savings have been accomplished, there's still much to be done. But his objective of saving another $1.5 trillion falls well short of what is needed to put the debt on a sustainable path. A recent analysis by the Committee for a Responsible Federal Budget found that a minimum of $2.4 trillion in additional savings is needed to achieve that basic goal.
He acknowledged that compromise will have to drive negotiations and that no one will see a deal come together exactly as they would choose. But when it comes to specifics, the president continues to take the easy way out, instead of using the platform that he alone has to help the country understand both what's at stake and what it will take. It's relatively easy to talk about things like scaling back tax loopholes for corporations and the well-off, asking the rich to pay more as part of Medicare, and providing fewer subsidies to drug companies. But it will take more than that.
Instead of just replacing or retooling the blunt sequester, we do need to find savings from defense. We also need to put Social Security on a path toward solvency and the sooner we do it the better. We should protect those who depend on the program, and running from the financial imbalances it faces does just the opposite.
Tax reform also will require tackling popular, yet expensive and inefficient, tax breaks -- from the health care exclusion to the home mortgage deduction -- if we truly want to overhaul our outdated and anti-growth tax code. Reforming the tax breaks for the rich and well-connected is a must, but it's not enough to really fix a tax code that hemorrhages more than $1 trillion in forgone revenues a year.
The bottom line is deficit reduction is difficult, the president knows that, and he should start an honest dialogue with the American public about what it will take to help move the issue forward.
The emphasis he put on the issue this week was encouraging, but the proof will be in how he leads going forward. In recent fiscal negotiations, we have been locked in a game of you go first, no you go first between the two parties when it comes to how they would get specific on entitlement and tax reform. The risk is that both will find it too politically convenient to hide behind the easy pieces of taxing the rich and discretionary spending caps--both of which have been enacted, and neither of which are sufficient to fix the problem—instead of focusing on the real issues of entitlement and tax reform.
Only the president can start this honest dialogue. If he steps forward and starts putting real specifics on the table for some of the hard choices and uses his platform to explain to the country why it is so important not to duck from these issues as we work to get the economy back on track, his speech will have been a great start to a serious effort. Otherwise, it will be just a lot of empty words.
Politico | February 15, 2013
The continual fiscal brinkmanship of the past two years — in which policymakers go from crisis to crisis, avoiding catastrophe at the last moment and providing nothing more than usual “small ball” solutions that fail to address our underlying structural problems — has ground all progress to a halt.
The failure to get our debt under control, reform our Tax Code and put our entitlement programs on a fiscally sustainable course is robbing us of the ability to invest in our future and will leave us without the resources we need to meet other challenges facing our nation. And moving forward will be out of our reach as long as we continue to “pass the buck” on the debt crisis. It is critical that leaders in both parties come together in an honest and meaningful way to put our fiscal house in order if they have any hope of addressing the other challenges and opportunities that we face as a nation.
Congress could barely come to agreement on a last-minute, short-term compromise on the fiscal cliff at year’s end. All Washington has managed to do since our commission submitted its report is the easy stuff. Through a combination of the work done in the continuing resolution, the Budget Control Act and the pitiful revenue deal at year end, Washington has capped discretionary spending without being specific on what it will actually cut, and it has raised taxes on the rich. It has done nothing to reform the Tax Code or reduce the rate of growth of health care spending to no more than 1 percent above the rate of growth in the economy. Nor has it done anything to make Social Security sustainably solvent. This is the hard stuff that must be done to finally put our nation’s fiscal house in order.
An agreement large enough to complete the job may seem out of reach. However, looking at where the parties were in the negotiations last year, it seems clear that it is possible to reach agreement on a plan if both sides are willing to go beyond their comfort zones and come to a principled compromise.
President Barack Obama and Speaker John Boehner originally made substantial progress toward a comprehensive deficit reduction plan that could have gotten us most of the way. Importantly, these negotiations focused beyond the near-term crisis, with real discussions on structural entitlement reforms as well as comprehensive tax reforms. Both sides identified potential areas of agreement: using chained CPI to index both spending programs and the Tax Code with protections for low vulnerable populations; identifying additional savings from defense and domestic discretionary programs and unjustified subsidies; and finding savings in mandatory programs that can and should be included in a comprehensive deficit reduction plan.
That last round of negotiations should be the starting point for the next round — however, both sides will have to go further.
The president deserves credit for putting forward Medicare savings in his budget and offering further entitlement savings in the negotiations, but he and his fellow Democrats must be willing to do more to reform our entitlement programs. Reaching an agreement to achieve the amount of savings necessary to slow the rate of growth in health care to no more than 1 percent above the rate of growth in the economy will require a combination of Republicans and Democratic ideas for achieving savings from those programs.
For health savings, we’ll have to look at everything from increasing premiums for well-off beneficiaries to reducing reimbursements to providers and drug companies to modernizing cost-sharing rules to tort reform. We will also need to reorient incentives to change the delivery of care and make adjustments to reflect the aging of society. In short, it will require taking on favored and well-entrenched constituencies across the health care system. Remember, health care is the largest single driver of our future debt.
On the tax side, Republicans must be willing to acknowledge that more revenue will be needed as part of an agreement to meet our deficit-reduction goals, but those revenues need not be generated by “tax increases” but through comprehensive tax reform that broadens the base and lowers rates. The Tax Code is riddled with more than $1 trillion of annual tax breaks — most of which are just government spending in disguise. By reforming them, we can reduce individual and corporate tax rates in a way that keeps the Tax Code progressive while promoting economic growth and reducing the deficit at the same time.
If both sides move as one beyond their comfort zone on health and tax reform, those changes could be combined with the other spending cuts discussed in the negotiations last December to produce a package large enough to stabilize and begin to reduce our debt as a share of the economy.
Even with such a package, however, further steps would be needed to ensure long-term fiscal sustainability in light of the major demographic and health care pressures expected in the coming decades. Social Security will still need to be reformed to achieve sustainable solvency over 75 years; though these reforms could be gradual and designed to protect the most vulnerable. We will also need to continue implementing reforms of the health care system as we learn more about which policies are effective in controlling costs. We need to keep the pressure on to take further action to reduce health care spending if the policies we enact now are not sufficient to limit the growth to a sustainable level that grows no faster than GDP plus 1 percent.
The events over the past few weeks have demonstrated that neither party will be able to deal with this problem on its own and that any solution will require a bipartisan agreement based on principled compromise. Our generation created this mess, and it’s our generation’s responsibility to clean it up together. We do not have the time or the luxury of leaving this problem for the next generation to solve. If America is to compete successfully in this global economy, the time for responsible action is now. One thing is certain, if our generation does not solve this problem we created, the brute force of the markets will, and that will not be a pretty sight.
The Hill | February 2, 2013
The president says he is going to spend the first few months of his second term traveling the country attacking Republicans.
The Republican members of Congress had said they were going to spend the beginning of the new Congress taking a hostage they could not shoot, the debt ceiling, and thus continue on their now well-worn path of self-immolation. A confrontation on that issue still looms.
All this leads one to ask: Isn’t there a better way? The answer, of course, is yes.
What is causing all this dysfunctionality in Washington? Is there a way forward that does not involve the chaos theory our government is functioning under?
The core problem is that we are trying to learn how to deal with a government that arose in a time of plenty — when our nation had its largest generation in history, the baby boom generation, engaged in the work force. Now, that generation is moving out of the workforce and into the role of the recipient.
We are taking 70 million people who made up the most productive and wealth-generating group in the nation’s history, and moving them from pulling the wagon to being in the wagon. This transfer, coupled with the massive explosion in the possibilities and costs of healthcare, has created an untenable fiscal situation.
The president seems to have concluded that he does not need to come up with substantive policies to address this looming crisis so long as he just creates an atmosphere of class warfare, claims all things can be cured by raising taxes on a small percentage of Americans and blames the Republicans for failing to agree to abdicate to this policy.
The Republicans have responded by claiming that spending is the sole villain causing our fiscal crisis. They seek to force reductions in spending by threatening actions that in the end they cannot take, such as going over the fiscal cliff or defaulting on the nation’s debt obligations. Actually taking such actions would — quite rightly — destroy the party’s credibility in the eyes of most Americans by doing fundamental harm to the future of the country they claim to want to protect.
There is a path forward. It is just not either of the ones that the primary players have identified. It is a path that does not require brinkmanship governance; nor does it require either side to sacrifice its core beliefs.
The president wants to push forward with his signature program on healthcare, and raise revenues to fund it. He also wants to aggressively use government to seek redress for what he and his cadre of Harvard reformers believe to be the inherently unjust nature of many aspects of our nation.
Republicans want to bring down the cost of government and put us on a path to fiscal solvency by restraining spending. They also want government to be much less intrusive in the day-to-day lives of Americans.
The latter goals of the two parties rather aggressively diverge. They can and will continue to be points of great contention. But they are not at the core of our deficit and debt problem.
It is the first part of the goals of the two parties that can be made to overlap. We can get this debt and deficit down through an agreed path that both parties should be able to live with.
In its simplest terms it involves an agreement to adjust entitlements through changes that do not result in near-term impacts of great significance — but which lead to dramatic long-term changes that make them affordable for the country and the next generation which has to pay for them.
Taking this long-view approach would allow the parties to leap over the short-term fights regarding Obamacare and lock in place policies that will ultimately lead to a fundamental correction in course.
The second part of the agreement is an all-out commitment to produce fundamental tax reform. The template for this is already in place, via the Simpson-Bowles Commission. It gives both sides what they need in a dramatic and effective way: Much lower rates for Republicans and progressivity for Democrats. Such an approach would, in all likelihood, also produce a lot more revenue through growth and the elimination of special deductions and exemptions.
Both sides could back this approach. Instead of the president hitting the campaign trail and the Republicans picking procedural battles, the two sides could actually work together and make the country work too.
TaxVox | February 1, 2013
In one of the more dangerous fiscal developments of recent months, some on the left are defining successful deficit reduction as merely stabilizing the federal debt at about 70 percent of Gross Domestic Product by 2022. While there is no magic target, this one is far too modest and threatens to leave future fiscal policy perilously constrained.
Under current assumptions this goal can be achieved with combined reductions in spending growth and/or increases in taxes of $1.4 trillion over the 2014-2022 period, far less than the total deficit reduction provided by the 2011 Budget Control Act (BCA), which resolved the 2011 debt ceiling debate, and the American Taxpayer Relief Act of 2013 (ATRA), which recently avoided the fiscal cliff.
Richard Kogan of the Center on Budget and Policy Priorities, supported by Martin Wolf of the Financial Times makes the case for more modest deficit reduction. The editorial page of the Washington Post shares my concern that their goals are dangerously modest.
Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022. If not, it will be the longest period without a decline in the recorded history of U. S. business cycles. Add a modest stimulus to the recession-driven reduction in tax revenues and increases in social spending and the debt-GDP ratio would top 100 percent in the blink of an eye. But it is harder to argue for a stimulus with the debt already soaring, and without one, a future recession would be more severe than necessary.
However, let us say that for some period before or after 2022 the economy is cruising along a full-employment path at a steady rate of growth. The deficit associated with stabilizing the debt-GDP ratio at 70 percent of GDP is more than 10 percent higher than that consistent with a 60 percent ratio – the limit chosen by the drafters of the Maastricht treaty that created the Euro. That is a significant increase in the rate at which we are depleting our nation’s wealth. The damage to the standard of living cumulates over time and that does no favor to our children and grandchildren.
Kogan and Wolf assume that the discretionary spending caps imposed by the BCA through 2021 will be enforced successfully (Kogan assumes that the BCA’s spending sequester will be cancelled.) The caps imply that discretionary spending will fall to the lowest level relative to GDP since World War II. They would also require both defense and nondefense outlays to grow less than the rate of inflation from 2014 to 2021, after already falling considerably from the levels inflated by the stimulus and the recession.
The biggest risk is that it will be impossible to maintain defense at such low levels. Mali shows that the war on terror is far from over. While the Chinese defense budget is now only about one-quarter of ours, it is growing explosively. Is it reasonable to expect ours to continue to decline in real terms, even if theirs approaches ours by 2021?
In nondefense, population growth will be putting upward pressure on spending for programs like education, infrastructure, national parks, etc, etc. Although nothing is irreversible in the budget, true reforms in Social Security, Medicare, and Medicaid have a better chance of lasting than arbitrary caps on discretionary spending that do not specify individual program cuts. The BCA, however, excludes Social Security and Medicaid from cuts and includes only modest reduction in payments to Medicare providers.
I would think the left would back more aggressive deficit reduction, if only to lower the risk of a sovereign debt crisis. It is, after all, the poor who are being most devastated by high unemployment in Ireland, Portugal, Spain and Greece and by arbitrary cuts in public pensions and social programs.
Sovereign debt crises occur at all manner of debt-GDP ratios and are impossible to predict, but it is hard to believe that a higher ratio does not increase the risk to some degree. It is sobering to note that in 2008, just before their crises, the net debt to GDP ratio in Spain was less than 31 percent and in Ireland less than 25 percent.