Tag Archives: fiscal rules

The Republican Campaign to Shift the Blame for the Sequester To Obama: If You Don’t Want It, Pass a Simple Bill To End It

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John Boehner Obamaquester

It appears increasingly likely that the Congressionally mandated severe and across-the-board budget cuts, known as the sequester, will begin on March 1.  Serious negotiations are not underway, Congress is only back in session now after having been gone for most of the past two weeks, and public statements are not focused on negotiating an agreement but rather on shifting blame.  Should the sequestration budget cuts go into effect, not only will critical federal functions be suspended, but the sudden cuts in spending levels will likely push the country back into recession.  As was noted in an earlier posting on this blog, cuts in Government spending were already the primary cause for a fall in GDP in the fourth quarter of 2012 (according to the initial estimate, which may be revised).  More broadly, had government spending been allowed to rise following the 2008 downturn as it had during the Reagan presidency following the 1981 downturn, we would now likely be at full employment.

The situation is serious, but the new assertion by the Republican leadership that the sequester is there only at the insistence of Obama is almost farcical.  As part of this campaign, Speaker Boehner has staged events for the cameras such as that pictured above, behind a podium labeled with the hashtag “#Obamaquester”, and in front of a clock marked as “Countdown to #Obamaquester”.  Boehner is now asserting that the sequester is only there due to “the president’s demand”, and he refers to the cuts as “the president’s sequester”.

Even some of Boehner’s Republican colleagues find it absurd to try to blame Obama for the sequester.  For example, Representative Justin Amash, a conservative Republican from Michigan (who voted against the bill that set up the sequester mechanism) said:  “I think it’s a mistake on the part of Republicans to try to pin the sequester on Obama.  It’s totally disingenuous.  The debt ceiling deal in 2011 was agreed to by Republicans and Democrats, and regardless of who came up with the sequester, they all voted for it.  So, you can’t vote for something and, with a straight face, go blame the other guy for its existence in law.”

With these new assertions from Boehner and similar assertions from colleagues such as Congressman Paul Ryan (the Republican Chair of the Budget Committee in the House), it may be of interest to review briefly the history of how the sequester mechanism came to be:

  1. The sequester’s origin came from the strategic decision by the key Republicans in Congress in early 2011 to use the routinely required authorization to raise the public debt ceiling as leverage to force through drastic cuts in the budget.  Eric Cantor, the then new Republican House Majority Leader, was the principal architect and proponent of the strategy, which he proposed in January 2011 at a closed-door retreat of Republican congressional members in Baltimore.  He was soon stating publicly that the Republican controlled Congress should not approve an increase in the debt ceiling without drastic spending cuts.  
  2. What this meant was that they would hold the economy hostage to their budget demands, as a refusal to raise the debt ceiling would force the US to default on its debt.  While speeches and pontificating are routine whenever Congress has had to approve an increase in the nominal public debt ceiling, never before had such demands been attached to this approval.
  3. And default on the US public debt would be serious.  US Treasury Bonds are held as risk-free assets both in the US and around the world, and are indeed the foundation of the modern international monetary system.  The impact of default on such assets cannot be predicted with certainty, as it has never happened before, but the consequences could quite possibly throw the global economy into a downturn that would make the 2008 collapse look mild. 
  4. [As an aside:  While I am not a lawyer, the constitutionality of a refusal by Congress to raise the debt ceiling (and hence force a default on the public debt) looks to me to be questionable.  The Fourteenth Amendment to the Constitution (passed in 1866, following the American Civil War) reads in its Section 4:  “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”  In their oath of office, Congressmen pledge to uphold the Constitution.  They cannot then take actions (or defer taking action) which would violate the Constitution by forcing a direct default on the public debt.  However, as noted above, I am not a lawyer, and obtaining such Congressional approval for increases in the debt ceiling has been customary since substantial borrowing needs developed during World War I.]
  5. As the country was coming increasingly close to breaching the existing debt ceiling in July 2011, negotiations were underway at many levels in Washington.  I will not try to review them all here, but the most senior were direct negotiations between Obama and Speaker Boehner.  These talks broke up when Boehner was not able to convince his Republican congressional colleagues to support an approach that included even a relatively small share of revenue increases along with larger expenditure cuts.  In fact, Boehner had to reverse himself twice from tentative agreements he had reached with the President, as he could not get backing from sufficient numbers of his Republican colleagues in Congress.  At the time, Boehner stated publicly that the President had negotiated in good faith.  But in his op-ed piece in the Wall Street Journal this month, Boehner now says the opposite, and asserts the talks failed because the President had reversed his position.
  6. As the deadlines approached and it became clear that agreement would not be possible on a specific set of spending cuts and revenue increases, Jack Lew, then the head of the Office of Management and Budget in the White House (and soon likely to be US Treasury Secretary), suggested consideration of a mechanism that had been used in the 1980s, in budgetary negotiations during the Reagan term.  In its final form and as passed by Congress, the mechanism established a Joint Committee made up of 12 members of the Senate and Congress (split evenly between Republicans and Democrats), who would by a certain date (November 21, 2011) develop a plan to achieve $1.2 trillion in deficit reduction (over 9 years) through a combination of spending cuts and revenue increases.  If the Joint Committee could not reach agreement, an automatic cut in spending of $109 billion per year over nine fiscal years (FY2013-21) would be required, split evenly between Defense and non-Defense programs.  These automatic across-the-board cuts were known as the “sequester”, and were deliberately crude and draconian to serve as an inducement to the Joint Committee to reach an agreement on more palatable means to achieve a similar reduction in the deficit.
  7. The mandate of the Joint Committee was to reach agreement on measures that would reduce the deficit by $1.2 trillion over ten years.  Such measures could include both spending reductions and revenue increases.  And the revenue increases could be achieved not only by raising tax rates, but also by closing tax loopholes, cutting expenditures that are implemented via tax subsidies, and/or broadening the tax base.  But the Joint Committee never reached an agreement, as Republicans refused to agree to any revenue measures at all.
  8. At the time, Boehner, Paul Ryan, and other Republicans praised the sequester mechanism as a means to force what they were seeking.  Boehner famously said in a CBS interview on August 1, 2011, that he had gotten “98%” of what he wanted.  Ryan emphasized and praised the sequester mechanism in an interview on Fox News on August 1.  Following his recent reversal now to criticize the sequester, a YouTube video was even put together showing a series of Ryan statements over the years in favor of sequester mechanisms (including this one specifically) and statutory spending caps.  And a Power Point presentation put together by Boehner when he made the case to his Republican colleagues to vote in favor of the bill that established the sequestration mechanism, makes clear his approval of it at the time.
  9. Obama, in sharp contrast, had always wanted a clean bill authorizing an increase in the public debt ceiling, without additional conditions added on.  It is indeed rather absurd to think that Obama would want to see a bill passed that would deliberately tie his hands.  Obama had proposed alternative approaches to reducing the deficit, including in his FY2013 budget (in great detail) and during the negotiations with Boehner.  Obama still stands by these proposals.  But while the Republicans assert that Obama has not offered any such plans, the issue is rather that the Republicans have rejected the plans Obama has offered.
  10. Jack Lew only suggested the option of the sequester mechanism as a fallback if no agreement is reached, late in the negotiations when it became clear that agreement on a specific set of spending cuts and revenue increases would not be possible.  But Obama and Lew would have greatly preferred a clean bill without any such conditions.  It is absurd to say, as Boehner now does, that the sequester mechanism is there only because it was something Obama “insisted upon in August 2011”.

The automatic sequester will cut government expenditures by $85.3 billion over the remainder of the fiscal year, from March 1 to September 30, 2013.  If nothing is done, there would be further cuts of $109.3 billion in each of the next eight fiscal years to FY2021.  The $85.3 billion cut over seven months would be equal to roughly 1% of the seven month GDP.  With a multiplier of two, this would by itself drive down GDP by 2% from what it would be otherwise.  The Congressional Budget Office estimates that the US economy is producing at about 5 1/2% below what it potentially could be producing at full employment.  An additional 2% reduction would be significant.

Agreement is difficult in Washington, particularly in the current political environment.  But if Boehner, Ryan, and others now hold to the view that the sequester is a bad idea, there is a simple solution.  All that they would need to do would be to pass a simple bill which revokes it.  Obama would certainly sign it.  The budgetary mechanism would then revert to the standard process, and that standard process could be followed to determine whether certain public expenditures should be cut and by how much, and whether revenues should be increased by closing loopholes, cutting tax subsidies, raising rates, or some other approach.

But there is nothing that requires the sequester mechanism.  If Boehner, Ryan, and the others do not want it, they can pass a simple bill to end it.

Resolving the US Fiscal Deficit: Understanding the Causes, and What to Do Now

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The US came close to defaulting on its public debt in August 2011, when Congressional Republicans refused to raise the debt ceiling unless their demands were met.  And the public discussion and what was presented in the press accepted the view that to bring the US budget dynamics back to a sustainable path would require drastic cut-backs in federal expenditures.  Of necessity, it was said, this would have to include drastic cut-backs in important social support programs, which would devastate the lives of many who were struggling to get by.  Not surprisingly given these presumptions, the deficit and debt issues are still not resolved.

Actually, the issue is not that difficult, at least for the next decade.  While there will, indeed, be long term problems that need to be addressed in the US budget dynamics, these will not arise until the 2020s and 2030s.  They will stem at that time from rising medical costs coupled with an aging population, and will need to be addressed by health system reform (which the Obama reforms start to address, but do not go far enough).  But as will be shown below, the issue through at least 2022 would be fully addressed provided one allows the Bush tax cuts to be phased out (and under current law, they are due to expire), leading us back to tax rates under which the economy performed quite well during the Clinton years.

One first needs to understand what led to the current budgetary problems, problems which (due to Congressional brinkmanship) almost led to the US Government defaulting on its debt last summer.  One can then work out alternative scenarios for the fiscal accounts, to examine “what if” questions to see the impacts of certain policy decisions.  These are worked out below, using numbers made available by the Congressional Budget Office, in its recent, January 31, 2012, report titled “The Budget and Economic Outlook:  Fiscal Years 2012 to 2022”.  The calculations were somewhat complex to work out (it is especially important to include the feedback from higher or lower fiscal deficits on the future interest payments then due on the resulting debt; many analysts ignore this).  But I was then surprised by how quickly the fiscal accounts would stabilize provided only that the Bush tax cuts were phased out.  Not more is needed.

We can start with the fiscal accounts based on the historic actuals between fiscal years 1972 and 2011, and then (for 2012 to 2022) as projected by the CBO under its current policy scenario.  The current policy scenario (which the CBO calls its “Alternative Fiscal Scenario”) assumes that the Bush tax cuts will be renewed and that the “automatic” spending reductions mandated under last year’s Budget Control Act will not in fact happen (and also that compensation of doctors under Medicare is kept as now rather than being cut:  but this is minor).  The resulting fiscal accounts look like this:

One sees here the deterioration in the accounts during the Reagan presidency, as revenues were cut (the Reagan tax cuts) and outlays were increased (defense expenditures) leading the public debt to GDP ratio to almost double during the Reagan and Bush I years, from 26% in 1981 to almost 50% in 1993.  Outlays were then reduced and revenues increased during the Clinton years, reducing the deficit and in fact leading to a surplus by 1998.  The public debt to GDP ratio fell sharply.  Bush II then cut taxes sharply soon after taking office in 2001 and increased outlays, leading back to deficits, and the public debt to GDP ratio started to rise again.

Revenues then fell sharply in 2008 and especially in 2009 as a result of the 2008 economic collapse as well as tax cuts aimed at stimulating the economy.  Outlays rose in the downturn to cover increased expenditures on unemployment compensation and similar support programs, as well as a consequence of the Obama stimulus measures enacted in response to the sharpest downturn the US had faced since the Great Depression.  Under the CBO projections going forward, outlays are expected to remain well above revenues, leading only to a gradual fall in the deficit.  The public debt to GDP ratio then explodes, reaching 94% of GDP in 2022 and still rising.

This scenario is pretty grim and is clearly not sustainable.  Hence the agreement by all that something needs to be done.  But first it is important to see why the fiscal situation deteriorated so much since 2001, when Bush II took office.  There were two main reasons:  the Bush tax cuts, and the decision to fight major and lengthy wars in Iraq and Afghanistan without taking any step whatsoever to pay for them other than through borrowing.

Of these two, the Bush tax cuts are the more important.  The CBO estimates that the Bush tax cuts will lead to reductions in collected tax revenues of about 2.5% of GDP each year going forward (up to 2020 when the losses are projected to rise a bit to 2.6%, and then to 2.7% of GDP in 2021 and 2022).  Over a twenty year period, and considering also the resulting higher public debt and hence the interest due on this higher debt, this is huge.

The unfinanced wars in Iraq and Afghanistan have also been costly.  Based on CBO estimates, the wars have cost on average 1.0% of GDP each year between 2003 and 2011, and will decline only modestly in 2012 and 2013.

Using the CBO data, one can then calculate what the fiscal picture would have been, and what it would then be expected to be, had the Bush tax cuts never been passed, and had the Iraq and Afghan wars not been started (or, in terms of the impact on the deficit and the debt, had they been paid for by current taxes rather than borrowing).  Under this scenario the budget is in surplus and debt falls rapidly until the shock of the 2008 crisis.  And the deficit and the debt then stabilize quickly after that shock:


Note the scale here is different from that in the figure above.  With just these two changes, and leaving all else as before (including the economic collapse of 2008, even though some have argued it would not have then been so severe), the fiscal deficit diminishes and becomes a surplus by 2020, and the public debt to GDP ratio levels off and then starts to fall by 2014/15.  (Note for those not familiar with such dynamics:  The debt to GDP ratio can fall even while the public accounts are in a modest deficit because of GDP growth, which increases the denominator in the debt to GDP ratio.)  The public debt to GDP ratio peaks at 35% of GDP, well below what it reached during the Reagan / Bush I period.

Putting the two scenarios together on one figure allows for easier comparison:

All is the same until 2001, so this focusses only on 2001 to the projected 2022.  Revenues are always substantially lower as a result of the Bush tax cuts.  Outlays are always higher, for two reasons:  the costs of the Iraq and Afghan wars, and then, growing over time, due to outlays for interest on a growing public debt as a result of the deficits.  Deficits are always substantially higher with the Bush tax cuts and wars, and worsen over time due to growing interest expenditures.

And the impact on the public debt to GDP ratios is particularly stark:

The cause of the fiscal mess we are in is therefore clear:  without the Bush tax cuts and the unfinanced Iraq and Afghan wars, the fiscal accounts would not have worsened so much in the 2008 economic collapse, and would soon be back on a sustainable path.  This is taking all else as equal, including all other revenues and expenditures, as well as overall economic growth.  While it is certainly fair to note that all else would likely not then have been equal, there is no evidence to support the Republican argument that higher taxes (without the Bush tax cuts) would have stifled economic growth.  Without the Bush tax cuts, one would have had tax rates as they were during the Clinton years, when the economy grew well.  Why would taxes have suddenly become such a problem?  And growth during the Bush years was in fact quite poor (and terrible if one measures it by growth over his two full terms, with the 2008 collapse at the end of his second term).  The lower taxes under the Bush tax cuts did not lead to better growth than what the US economy achieved during the Clinton years.  It was far worse.

It is also fair to note that while the above may help us understand better the causes of the current fiscal mess, it does not by itself tell us how to solve the mess.  We cannot change the past.  But it does point out that re-establishing prior tax rates would be a clear place to start.  And it turns out that by themselves they would be more than enough:

This scenario assumes that the Bush tax cuts will be phased out starting in 2014 (and not earlier, as the economy has not yet fully recovered from the 2008 economic collapse), with 50% phased out in 2014 and 100% phased out from 2015 and onwards.  This, by itself, puts the economy on a stable and sustainable fiscal path.  The public debt to GDP ratio peaks in 2014 and then starts to fall, and the fiscal deficit falls steadily if slowly, to just 1% of GDP by 2021.  Revenues stabilize at about 21% of GDP and outlays at 22% of GDP.

In summary, the Bush tax cuts enacted in 2001 and 2003 (and extended in 2010 for two further years, through 2012), plus the costs of the unfinanced Iraq and Afghan wars, have undermined the US fiscal accounts, to the extent they are now unstable and lead to explosive growth in debt.  Had these decisions not been taken, the fiscal accounts would be quite stable, even with the extraordinary measures that were necessary (and the decline in fiscal revenues received) due to the economic collapse of 2008 and the then slow recovery.  But even with the debts incurred due to the Bush tax cuts and his unfinanced wars, the fiscal accounts can be put on a sustainable path simply by phasing out the tax cuts starting in 2014.

The Proposed European Balanced Budget Rules: “How to Create a Depression”

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In these days where conservative orthodoxy has gone so far to the extreme right, it is encouraging to see a prominent conservative economist point out what should be obvious:  that adoption of stringent fiscal rules for balanced budgets by Eurozone members, as are being emphatically pushed by Angela Merkel and other Eurozone leaders, could easily cause an economic contraction turn into an economic depression.

Professor Martin Feldstein of Harvard, a prominent establishment figure, has made this point in his posting yesterday on the Project Syndicate web-site here.  The argument is clear and easy to understand, and should be read in its entirety.  I have copied below some of the key sections.  And Professor Feldstein is not a liberal economist:  he was Chairman of the Council of Economic Advisers under President Reagan, was the long-time head of the National Bureau of Economic Research, and was a prominent adviser to President George W. Bush, including as a proponent of Bush’s plan to privatize Social Security.

While the point being made by Professor Feldstein should be obvious, it appears that Eurozone members will soon adopt such balanced budget rules, and some have already adopted variants.  Germany is pushing strongly, and the members are currently in no position to oppose what Germany wants.  Yet implementation of contractionary policies in an attempt to cut fiscal deficits caused by an economic contraction will put economies on a path to depression.  And similar rules are being pushed for the US by prominent Republicans and especially by Tea Party activists.

It is a formula for turning a downturn into a depression, as was done in the 1930s.

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How to Create a Depression

2012-01-16

European political leaders may be about to agree to a fiscal plan which, if implemented, could push Europe into a major depression.

…

[With the adoption of the Euro] the only countercyclical policy available to France [or any Eurozone member] is fiscal: lower tax revenue and higher spending.

While that response implies a higher budget deficit, automatic fiscal stabilizers are particularly important now that the eurozone countries cannot use monetary policy to stabilize demand. Their lack of monetary tools, together with the absence of exchange-rate adjustment, might also justify some discretionary cyclical tax cuts and spending increases.

…

The European Union’s summit in Brussels in early December was intended to prevent such debt accumulation in the future. The heads of member states’ governments agreed in principle to limit future fiscal deficits by seeking constitutional changes in their countries that would ensure balanced budgets.

…

The most frightening recent development is a formal complaint by the European Central Bank that the proposed rules are not tough enough.  Jorg Asmussen, a key member of the ECB’s executive board, wrote to the negotiators that countries should be allowed to exceed the 0.5%-of-GDP limit for deficits only in times of “natural catastrophes and serious emergency situations” outside the control of governments.

If this language were adopted, it would eliminate automatic cyclical fiscal adjustments, which could easily lead to a downward spiral of demand and a serious depression.  If, for example, conditions in the rest of the world caused a decline in demand for French exports, output and employment in France would fall. That would reduce tax revenue and increase transfer payments, easily pushing the fiscal deficit over 0.5% of GDP.

If France must remove that cyclical deficit, it would have to raise taxes and cut spending. That would reduce demand even more, causing a further fall in revenue and a further increase in transfers – and thus a bigger fiscal deficit and calls for further fiscal tightening. It is not clear what would end this downward spiral of fiscal tightening and falling activity.

If implemented, this proposal could produce very high unemployment rates and no route to recovery – in short, a depression. …