Tuesday, July 12, 2011

The Debt Ceiling Debate in Plain English

First off, what exactly is the debt ceiling? Most people seem to think it's a license for the federal government to take on deeper debt, but Bruce Bartlett has the clearest explanation I've read:

The debt ceiling is a cap on the amount of securities the Treasury can issue, something it does to raise money to pay for government expenses. These expenses, and the deficit they've wrought, are a result of past actions by Congress to create entitlement programs, make appropriations and cut taxes. In that sense, raising the debt limit is about paying for past expenses, not controlling future ones. For Congress to refuse to let Treasury raise the cash to pay the bills that Congress itself has run up simply makes no sense.

Failure to raise debt ceiling will mean:

Despite this, the GOP has insisted that any vote to raise the debt ceiling be accompanied by huge cuts in federal spending and they are adamantly opposed to raising any taxes to increase federal revenues (this extends to ending any existing tax cuts as well). On June 23, House Majority Leader Eric Cantor (R, VA) walked out of the talks due to the inclusion of some revenue increases. There was then some talk about returning to the earlier plan involving $2 trillion in budget cuts, but again, the GOP was insistent that no new revenues be included in the package while Democrats were adamantly opposed to cuts in Medicare, Medicaid and Social Security.

On July 7, Obama changed the equation. According to the Washington Post,

Obama and Boehner have emerged as the most enthusiastic proponents of a big deal that would save as much as $4 trillion over the next decade by overhauling the tax code and tackling all the major drivers of federal spending, including the Pentagon and health and retirement programs.

However, resistance to revenue increases in the proposed package led to abandonment of the idea by the GOP.

Today, Obama announced that Social Security payments would be delayed if the debt ceiling was not raised, and 470 CEOs of many of America's largest corporations signed a statement urging Congress to end the impasse. This afternoon, Senate Minority Leader Mitch McConnell (R, KY) announced a new plan to give the President authority to raise the debt ceiling himself. Congress would then be free to vote on a resolution of disapproval, which the President could then veto, after which President Obama would raise the debt ceiling in three increments over the next year. Essentially, this would pass responsibility for raising the debt ceiling to the President and would draw attention to the raise throughout 2012, an election year. As Kevin Drum put it, "This is possibly the most juvenile, most buck passing, most transparently mendacious proposal I can recall from any party leader in recent memory."

What’s behind the political battle over the debt ceiling?

Since most people’s eyes glaze over when the subject is economics, here’s a plain English explanation of the ideas and interests underlying the debt ceiling debate.

Does Deficit Reduction Stimulate the Economy?

1. Would it be safe to say that progressives believe that if the government spends money, the economy will be stimulated and grow, and more people will have jobs?

Well, not just that it spends money, but that it does so in targeted ways. According to Mark Zandi, chief economist at Moody's, the most effective government spending to counteract a recession is food stamps & unemployment insurance (see chart below). Why? Because people who get that aid need it, so they spend the money right away & it starts circulating through the economy.

Zandi found that among the least effective government spending would be the Bush tax cuts (see chart below). Why? (i) The Bush tax cuts were never targeted to boost the economy. They were set up, quite literally, to reward Bush's biggest donors (i.e., fat cats). (ii) Nobody spends money they don't need to in a recession. Our natural tendency is to hunker down. Do rich people have to spend the money they get in tax cuts? No. Do they? No. Ergo, no additional money circulates through the economy, so it doesn't grow.

2. Government spends on people, people spend money, other people receive that money, the economy is stimulated. This is good.

Basically, yes. In economic terms, government spending in a recession starts the process. The rest of the process you mention is called the multiplier effect.

3. Republicans believe that we have to reduce the deficit by cutting government spending in order to reduce the deficit because we have to reduce the deficit because....you get the point.

Republicans SAY they believe that, but they're the ones who created 90% of the current deficit, directly or indirectly, in the first place. They held an extension of unemployment insurance hostage over their demand for continuation of the Bush tax cuts at the end of 2010, further deepening the deficit. And they're now insisting that (a) no taxes be raised to reduce the deficit and (b) any increase in government revenues via elimination of tax loopholes be offset by additional spending cuts. So there's no reason to take seriously any statements they make about their supposed concern about the deficit. They love deficits. So if they're not concerned about the deficit, what are their ulterior motives for all the posturing?

Republicans believe several different things that underlie what they say they believe about the economy, all of them wrong:

a. The smaller the government, the greater the individual freedom. Conversely, the bigger the government, the greater the encroachments on individual freedom: This sounds straightforward. In fact, it has deep roots in American culture, having been expressed directly by Thoreau in the early 19th century. More recently, Friedrich Hayek enunciated it when he predicted that the development of Britain's National Health Service (universal health care to you & me) would turn the UK into another Soviet Union. His prediction obviously was wrong, but that didn't stop conservatives from continuing to believe it with their typical fervor. There are lots of other problems with this (what measure is used to determine the size of government? i..e, how do we know if a government is too big or too small?), but limits of space & time preclude further elaboration.

b. Tax cuts pay for themselves by increasing economic activity: Reagan tried it with huge tax cuts in 1981. The enormous resulting deficits led him to pass 8 consecutive tax increases (yes, increases), but nobody in the GOP seems to remember that part of the story. Bush, as we know, gave us the closest thing to a pure scientific test of this we're ever likely to have: With the GOP in control of all 3 branches of government, he passed enormous tax cuts & didn't subsequently offset them. He had the worst economic growth record of any president since Hoover. Conversely, Clinton raised taxes & had the biggest economic expansion in our country's history. So much for tax cuts stimulating growth. Again, the evidence has had no influence on GOP thinking.

c. Starve the beast: Grover Norquist famously said he wanted to shrink government to a size that would enable him to "drown it in a bathtub." Again, see Bush. He cut taxes, waged two wars without paying for them, & passed the Medicare Part D unfunded mandate. Money was drained from the Treasury, but did government shrink? No, it grew. The only president to preside over a shrinkage in the size of government was Clinton, who raised taxes, as previously noted. Again, no correlation backing up the claim, and no acknowledgment of the fact by the GOP.

Lastly, remember who funds their campaigns. The GOP always knows which side their bread is buttered on.

4. Obama believes that we have to reduce the deficit by cutting government spending because ________?

See my answer to #7 below.

5. Obama wants the economy to be stimulated because if more people have more money they will vote for him. Also theoretically he does actually want people to have more money.

One would think...

6. Does Obama think that cutting the deficit is going to stimulate the economy?

I guess he must, but I don't know.

7. Does deficit reduction stimulate the economy?

For an economy stuck in a severe recession? Hell, no. See #1 above. Just as there's a multiplier effect, there's also a negative multiplier effect. Think about it like this: As rain falls on crops, the water circulates into the soil, around the roots of plants, and the plants are fed, enabling them to grow. Imagine what happens when there's a drought. Water no longer circulates, plants are not fed, and they die.

Right now, not enough money is circulating through the economy--at least, not to ordinary people (the banks have oodles of the stuff--much of it from the bailouts--but they're not issuing much credit, businesses are not expanding & hiring, unemployed people are not making ends meet, so they're not spending, so there's little demand, so businesses aren't expanding & hiring, rinse & repeat). Since interest rates are near zero, the Fed can't lower interest rates any more to stimulate the economy. And the consensus in Washington is that we don't dare--no, no, no--do further stimulus spending to boost the economy. So we're stuck.

All deficit reduction will do in this context is remove more money from an economy that already has too little circulating through it. Take a look at what's happening to public service employees. State employees are being laid off right & left. All of them have families, most have houses, cars, bills to pay, etc. but there's no money to be had. All this is creating enormous strain on state budgets because the demand for Medicaid is going through the roof due to all these people becoming unemployed. So what are the GOP & now Obama talking about? Making enormous cuts to the federal budget (including aid to the states, which is already failing to meet the exploding need). But all the Very Serious People to whom Obama seems to be listening in DC make 6- or 7-figure salaries. None of them know anybody who's unemployed, I'd venture to guess. Economists have declared the recession over (that's the recession defined in technical terms, not in terms of what's actually happening to ordinary people). So I guess Obama thinks that if the technocrats say it's over, it's over, & it's time to start reducing the deficit. Now that I think of it, this brings to mind a recent thread about epistemic closure among conservatives that appeared in blog posts by Henry Farrell, Julian Sanchez & some other smart people. But obviously, conservatives are not the only ones susceptible to that dynamic (of course, reasonable people may disagree about whether Obama is a liberal, a conservative or something else).

One Final Note

As Kevin Drum and others have remarked tonight after Mitch McConnell's plan was announced, it seems that the GOP may have boxed themselves in with their insistence on drastic budget cuts with no revenue increases under any circumstances. Speaker of the House John Boehner himself told fellow House Republicans earlier today that they were going to lose leverage steadily as the August 2 deadline drew nearer. Judging by McConnell's announcement, that leverage may be ebbing more quickly than they'd anticipated. It's always a stretch to try to read the minds of others, and some of my comments above may go further in that direction than the evidence supports. Whether Obama is a fool or a genius (or both) is probably best evaluated with greater temporal and emotional detachment than I possess. My own perceptions of him are susceptible to changes in the political winds so I'm probably well advised to restrict my analyses to the economics and politics of the issues at hand. That said, I do think that allowing the entire debate over the budget to take place on GOP terms--i.e., with a focus on the deficit rather than on job creation--is a huge unforced error on Obama's part. We still don't know how the whole debt ceiling debate will play out; nor do we know what will happen vis a vis the deficit. But it's hard to see how we get from our current situation of high unemployment and low job growth to one that returns our economy to health. This short-term deficit obsession is a detour that doesn't help us get where we need to go, and may actually make the situation far worse.

An earlier version of this was cross posted at http://www.greaternycforchange.org/?p=676.

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