The so-called Super Committee, predictably, has failed in its task to reduce the deficit by $1.2 trillion or any other meaningful amount. As a consequence, mandatory across-the-board cuts in defense and discretionary spending will go into effect. The fallout from these events will have many dimensions, both political and economic.
However, the failure to reach an agreement actually means little in terms of the impact on the deficit in the short run. This is because the legislation that established the Super Committee also provided for mandated automatic cuts in the event the committee fails to reach an agreement. These cuts will now kick in and will approximately equal the cuts the committee was charged with recommending. Of course, the distribution of those cuts across programs will be quite different. Regardless, the overall impact on the cumulative budget deficit is largely cosmetic. The effort hardly constitutes a serious attempt to address our fiscal problems. This is because the cumulative deficit over what was the ten-year target time horizon for the committee will likely be in excess of $10.5 trillion.
But we also shouldn’t delude ourselves into thinking that even the mandated across-the-board cuts will actually go into effect. These cuts aren’t scheduled to begin until 2013, which is well after the 2012 election, when a new Congress will be in place. That new Congress will not be bound by any commitments or decisions made by the current Congress, so everything is now effectively on hold and is fair game for the next time around. It has even been suggested by some commentators that, from a political perspective, the failure to reach a consensus may be optimal. Each party can blame the other, and the president has removed himself from the fray and can thus disavow any responsibility. Furthermore, the new Congress can simply eliminate and/or significantly modify any cuts before they go into effect.
The positions of the respective political parties to this debate are ideological but with some validity. Republicans want to limit the size of government and have chosen to do so through insisting on a revenue constraint that requires spending cuts. One look at Europe shows what happens when governments consume too large a proportion of GDP. Democrats want to fill the deficit hole by increasing taxes on higher-income groups and thereby maintain as many entitlement programs as possible. A second look at Europe shows how angry voters can become when current entitlement benefits are either threatened or cut.
The negotiations between the two sides have been muddied by arguments about the distribution of the tax burden and fear mongering over the impact that cutting entitlement programs will have. All of this, however, is both sad and infuriating when one considers what is at stake for the nation and its economic wellbeing.
A few facts about the deficit are critical in understanding the problem and what needs to be done. First, it should be recognized that the current $1.5 trillion deficit for 2011 is likely to be a temporary aberration due to the recession and stimulus spending that will soon cease. Revenues should increase and expenditures decline as the economy recovers and spending programs subside. Second, OMB’s longer-run budget projections and analysis make it clear that the current budget paths for both Social Security (one of the key programs that have been the subject of intense fear mongering) and discretionary spending (including defense spending) don’t represent critical budget problems and can be managed without necessarily increasing the budget deficit. Third, the key budget problem is the prospective growth in healthcare entitlements which threaten to grow almost without bound. Fourth, unlike Social Security and many other benefit programs, the healthcare problem is a prospective problem because of the prior commitments to coverage that have been made to future recipients. Thus, unlike the European situation, trimming back prospective payments by changing the payout structure does not entail cutting back on benefits that U.S. recipients are currently receiving. Finally, failing to come to grips with the prospective program costs commits taxpayers to a continual series of serial tax increases and expansion of government’s share of GDP.
So what needs to be done? First, we have argued previously, spending needs to be capped and brought into line with revenues. Had the Super Committee reached this conclusion, its time would have been well spent. Second, the allocation of those costs across income classes is a separable issue that should not be folded into the discussion of whether the budget should be balanced. While “who is to pay” is an important issue, if spending were to be limited to 19% of GDP or so, then the extent of progressivity in the tax system and issues surrounding simplification and rationalization could be more rationally addressed in a revenue-neutral context. Third, the current discussion should not pretend that changing the tax code – whether it be through closing loopholes and incentives or through substituting a flat tax or sales tax – even if it is revenue neutral, isn’t increasing taxes. Those who lose deductions or who must pay sales taxes that were not paid previously (read “voters”) will certainly see their taxes increase. Hiding tax reform behind a revenue-neutral posture is confusing macro tax policy with micro distributional tax policy. Any change in the tax structure will change the distribution of the tax burden, thereby increasing taxes for some while reducing them for others. Introducing that discussion into the determination of whether the budget should be balanced/and or reduced only needlessly introduces class and intergenerational risk sharing issues into the discussion. Typically such considerations have proven to be counterproductive.
For financial markets and investors, the Super Committee’s failure means an additional year or two of market uncertainty, until after the election takes place and it is decided which party will control the White House and the new Congress. It will then take at least another year before the budget and spending issues are on the table again. In the meantime, we will experience at least one and possibly two more contentious rounds of debate on the debt ceiling. In the short run, the Super Committee’s failure has probably already been priced into markets, but volatility will surely be with us for the next year and a half or more. This is not what we should expect from our government.
