Put Doomsday on the Schedule

Americans, like most citizens all over the world, resent paying taxes, but are fond of government programs that allow health care, education or science to flourish. The US is overextended, living beyond its means, and Congress is divided over how to ease the climbing debt: Liberal Democrats want to tax the rich, while conservative Republicans aim to reduce spending that help citizens. Congress has tried imposing self-controls – a ceiling on how much the federal government can borrow and automatic cuts that both sides detest – with little success. Instead, Congress displays an inability to invest in smart government programs and cut others, engaging in sensible tax and entitlement reforms. “Congress and the voters who send them to Washington should know that the uncertainty generated by this failure to legislate a compromise is already slowing economic growth,” argues economist David Dapice. He suggests that current economic difficulties are minimal compared with the devastation expected if the globe fails to prepare for climate change. By avoiding obvious problems, the US is losing influence. – YaleGlobal

Put Doomsday on the Schedule

Alternately imposing, ignoring debt ceilings and automatic cuts, Congress adds to global uncertainty
David Dapice
Monday, January 7, 2013

Divided US: Americans detest rising taxes and also cuts in government benefits; above, seniors demand spending cuts and, below, seniors urge protection of Medicare and Social Security, which account for about one-third of federal expenditures

MEDFORD: Most people are schizophrenic when it comes to government. They don’t like taxes, but do like benefits. The role of democratic political parties is to manage competing interest groups so they can pay fewer taxes and enjoy more benefits.  

For most US workers, there’s been little increase in real pretax pay and benefits for several decades. Growing medical costs and employer-paid benefits have absorbed most of the paltry increase in compensation that all but the most skilled workers receive. Gains in productivity have gone largely to the very top of income earners.

This is the background for the increasingly partisan politics in the US. The middle class is squeezed. It has a choice of a small-government and low-tax conservative Republican politics versus a tax-and-spend option favored by Democrats. It must be noted that Democrats only want to tax the rich more, but that’s inadequate. Either spending must be cut from planned levels or taxes on most people must increase substantially. Moderate politicians, especially Republicans, trying to straddle this divide have been defeated by their own party in primary elections or gone down to defeat in general elections.

Last year, Republicans in Congress nearly drove the US into bankruptcy by not approving a completely routine increase in the allowable federal debt unless onerous spending cuts were attached. Though Republicans only control the lower house, they need only 40 votes in the Senate to threaten a filibuster – effectively preventing a bill from coming to a vote. Historically, filibuster has been rarely used, yet Senate Republicans, the minority party, have used the threat many times. Because agreement over hiking the debt ceiling in 2011 was impossible, the Congress loaded a pistol filled with tax increases and automatic spending cuts detested by both parties and said that if somehow compromise wasn’t reached, they’d fire the gun, aimed at both the national and world economies. This self-imposed paralysis produced the so-called fiscal cliff.

Yet Congress has approved another set of short-term fixes rather than work on long-term tax or entitlement reforms, so the paralysis and threat to global markets will emerge once again in two months.

Congress and the voters who send them to Washington should know that the uncertainty generated by this failure to legislate a compromise is already slowing economic growth, by 1 to 2 percent of GDP at an annual rate. Companies are sitting on more than $1 trillion in cash and enjoy historically low borrowing rates, yet business investment remains sluggish. Consumers are boosting savings and cutting debt – partly to cure the hangover of excessive debt left over from five years ago but also because of uncertainty.

Besides postponing the immediate spending cuts for two months, the legislation raised income taxes for families earning more than $450,000 annually and social security taxes for everyone, but the overall deal adds $4 trillion to the federal deficit over the next decade.    

With the Bush era tax cuts maintained for all but high-income earners, that will boost GDP by 1.3 percent, according to the Congressional Budget Office. Reversing the planned spending cuts could add 0.8 percent just from the fiscal impact. Those two measures alone are expected to swing the economy back into slow growth. But reducing uncertainty would likely boost overall US growth back into the 2 percent range which, excluding recessions, is typical of average performance since 2000.

Instead, the Congress added to uncertainty, by postponing action on the automatic sequestration spending cuts for two months, at the same time when a decision is needed on hiking the debt ceiling, another artificial, self-inflicted limit that’s done little to encourage self-control.

The main point of short-run policy contention now revolves around what amount and type of budget cuts will be made. The Democrats, having won the presidency and gained seats in the Senate and House, are in no mood for big cuts. The Tea Party Republicans in the House of Representatives are fiercely committed to their vision of smaller deficits and lower taxes. Nonpartisan observers agree that both tax increases and spending cuts, including entitlement reforms, are needed to reach long-term fiscal sustainability. This also appears to be the position of President Obama, though it’s hard to tell what balance he would accept.

With federal spending accounting for more than 20 percent of GDP, which government programs are cut matter for businesses – will it be weapons spending and defense or health care and stipends for millions of seniors?

Republicans will have another chance to throttle or contain entitlement spending when the debt ceiling must be raised again in February. Their opposition to raising taxes makes it impossible to achieve fiscal sustainability without severe cuts to government spending, including entitlements and growth-boosting investments in infrastructure, training and research.  

Given the popularity of entitlements like Social Security and Medicare, the puzzle is how conservative House Republicans get re-elected. After all, they must run every two years. One answer is gerrymandered districts.  Every 10 years, states redraw congressional districts based on population and census reports, and urban Democrat-leaning voters have been concentrated among fewer districts. Most state governors are Republican, yet Democrats do the same to favor their candidates when they can. Solutions to this such as proportional representation in statewide elections are being discussed – which would benefit Democrats in some states and Republicans in others.

For now, the power of conservative House members leads to resistance to multilateralism, investment in foreign aid or free trade, a reversal of Republican positions in the past.

The irony is that despite congressional antics, the US economy is on the mend. The housing sector seems to have bottomed out and improved in most cities, eliminating one drag on the overall economy. Fewer mortgage holders are “underwater” – their mortgages worth more than their homes could sell for – and thus can refinance or relocate for better jobs. Delayed household formation in the past few years has led to pent-up demand, encouraging home buying, building, expansion and new purchases of durable goods. Older cars need replacement. Low loan rates make newer purchases easy.

If the Congress could agree to spend more on badly needed infrastructure and job training, the boost in output from higher demand and supply would reduce deficits over time. Adding tax reform to the mix and dealing with entitlements – especially government funding of medical care – would be welcome, indeed essential for longer-term sustainability.

Global warming is among other pressing challenges avoided by the US Congress. Few politicians have connected severe weather, including superstorm Sandy, which alone causing $60 billion of damage, excluding future mitigation measures, with global warming. Yet if there’s any hope of persuading China and India to participate meaningfully in capping global emissions – the two nations accounted for 95 percent of global emissions growth since 2000 – the US must impose something like a carbon tax.

Tax reform could push technology and consumption into sustainable directions. Americans have more to worry about than the fiscal cliff!  The United States and the rest of the globe have a hill to climb to avert climate problems much worse than any congressional nonsense. A carbon tax, currently a political impossibility, would add needed revenues and reflect the real cost of using fuel. But US politicians are not tackling reality.


David Dapice is associate professor of economics at Tufts University and the economist of the Vietnam Program at Harvard University’s Kennedy School of Government.

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