Fiscal Muddle

Michael Stephens | November 16, 2012

The fiscal cliff is very easy to explain.  What many in Congress and the press are saying we should do about it is more confounding.

If you were the sort of person who took expressions of policy preferences at face value, you would think that fiscal conservatives and deficit hawks would be ecstatic about this thing we’re calling the “fiscal cliff”—because contrary to our increasingly muddled popular dialogue, the fiscal event about which everyone is raising alarms is just a large and rapid reduction of the budget deficit (about $600 billion of spending cuts and tax increases scheduled for 2013).  Given the widespread deficit hysteria we’ve witnessed over the last few years, it is likely confusing to a lot of unsuspecting observers that so many in Washington and the mainstream press are dead set against this particular piece of deficit reduction.

The American public has been ill-prepared for this consensus.  We’ve been told, ad nauseum, that fiscal “stimulus” didn’t and doesn’t work.  But the case for fiscal stimulus is simply the flip side of a case against austerity that few seem to realize (or are willing to recognize) that they are making.

The reason for fearing that the fiscal cliff will go into effect and be kept in place through 2013 is that a large and rapid reduction of the deficit will likely send the economy back into recession (Suzy Khimm is right: there would be less confusion if we referred to this as an “austerity crisis“). In fact, many forecasts, including the Congressional Budget Office’s, may be underestimating how much damage this accelerated austerity will cause.  The Levy Institute has shown that for the CBO’s already glum growth forecasts to come true, there would have to be a large increase of consumption and investment funded by an explosion of private debt (and without this unlikely run-up of private debt, the fiscal cliff would be even more damaging to growth than the CBO estimates).

The growth-centered argument against the cliff is a thoroughly Keynesian argument.  Many who oppose the fiscal cliff are bending over backward to avoid being explicit about this, since it is an argument whose logic dictates not only that we should repeal the sequester, but that if we’re going to replace it with anything, it should be fiscal stimulus—higher deficits—rather than some other variety of austerity, otherwise known as a “grand bargain.”  If you’re against the fiscal cliff because you’re worried about growth, you should oppose a grand bargain, and should have opposed the fiscal austerity we’ve already enacted.  But, much like the Bush v. Gore Supreme Court decision, the current Keynesian-flavored arguments are somehow supposed to be logical one-offs that do not apply to circumstances outside of the fiscal cliff.

In that context, this moment has also been instructive in terms of revealing how few genuine deficit hawks there are.  Those who oppose the fiscal cliff but insist that it must be replaced by a different austerity package are having a hard time explaining why we ought to be in mortal fear of the cliff but full of hope for their preferred package of spending cuts.  Some have argued that the problem with the cliff is that it comes too soon, and that a deficit reduction package that is spread out over ten years would be preferable (since, according to this argument, the economy will then be healthy enough to withstand the hit).  This at least has the merit of being an earnest argument, but the problem is that it’s far from certain that the economy will be in good shape by 2014, or 2015, or whenever the cuts from a grand bargain are supposed to kick in.  If (a) you’re really serious about the growth-killing effects of austerity, and (b) some form of austerity is politically unavoidable, then the deficit reduction ought to be designed so that it is triggered only by particular macroeconomic conditions (unemployment falling below a certain level, for instance).*

But many who are rooting for replacing the fiscal cliff with a grand bargain aren’t really concerned about either growth or deficits.  This is the group that is telling us the fiscal cliff is not the right kind of deficit reduction because it doesn’t include “tax reform” (by which they mean tax cuts) or “entitlement reform” (which sometimes means cuts to Medicare, Medicaid, and Social Security, and sometimes not).**  When it comes down to it, these faux-hawks are willing to accept less deficit reduction as long as they get their tax cuts and preferred changes to entitlement programs.  It’s hard to avoid James Galbraith’s conclusion that this isn’t really about the budget deficit at all; that for many, the push for a “grand bargain” is really just another excuse to push for the same policies they have been advocating for decades, in good economic times and bad, in the presence of budget deficits and budget surpluses:  lower tax rates for upper income earners and the gradual dismantling of Medicare, Medicaid, and Social Security.

* To say nothing of the fact that trying to reduce the deficit under current circumstances is likely self-defeating.  If we send the economy back into recession, that alone will cause the deficit to grow (recall that most of the change in the budget deficit since 2007 is attributable to the recession), which will presumably only encourage louder calls for deeper cuts.  Rinse and repeat.  We will have voluntarily placed ourselves in what Greg Hannsgen and Dimitri Papadimitriou call a “fiscal trap.”

** If you’re paying attention to Beltway Rules, the $716 billion in Medicare cuts that were included in health care reform do not count as “entitlement cuts.”  Presumably, this is because they involve reducing overpayments to private insurers in the Medicare Advantage program.  You see, that’s cheating.  Real entitlement cuts require “hard choices.”  Translated, that means bravely standing up to the combined might of the poor and disabled and telling them the free ride is over.


5 Responses to “Fiscal Muddle”

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  1. Comment by Tyler HealeyNovember 19, 2012 at 10:50 am   Reply

    The Bush tax cuts have been insufficiently stimulative because they came with expiration dates. Permanent tax changes are more stimulative than temporary changes. People don’t make the sorts of changes in their behavior that would give the economy a boost unless they have confidence that today’s tax regime will be in place when the payoff from increased work, saving or investment is realized. Therefore, Democrats should support making the Bush tax cuts permanent, but they will not because they are deficit hawks.

    • Comment by Michael StephensNovember 19, 2012 at 3:18 pm   Reply

      Presumably a real deficit hawk would oppose extending any of the Bush tax cuts. Extending only the tax cuts for incomes below $250k (the D position) still represents a net increase in the deficit, compared with current law.

  2. Comment by Tyler HealeyNovember 20, 2012 at 10:52 am   Reply

    I stand corrected, Michael. Thanks.

    My concern with the Dems is that they’ll balance the budget and thereby cause a recession, just as they did in 2000.

    A recession at the end of Obama’s presidency could cause the election of Paul Ryan as president.

    • Comment by Michael StephensNovember 20, 2012 at 1:55 pm   Reply

      I’m not aware of any plans to attempt to balance the budget by 2016, but I agree that this would be economically suicidal (not to mention the fact that it would likely be self-defeating. Depressions have a way of massively increasing the deficit).

      And politically, it’s hard to find much evidence that there’s a payoff for genuine deficit reduction. I don’t even see compelling evidence that professional deficit scolds really care much about the deficit per se. Health care reform likely represents the most ambitious deficit-reducing entitlement reform in American history. But no one (least of all the self-identified centrists who claim deficit-reducing entitlement reform as a core issue) seemed to notice. Part of the problem is that talking about “the deficit” is often just a cover for other goals, like reducing the size of the welfare state. And health reform expanded the welfare state, so it doesn’t count.

  3. Comment by David Hillfinger — November 21, 2012 at 12:45 am   Reply

    This reminds me a lot of the speculation about the Clinton budget. There were many observers and economists on both sides of the bench saying what would happen.

    As much as we all want Greece and many European countries to reign in their debt, so it has to happen in the US. You cant expect to spend what you dont have, and it never to catch up to you.

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