Cutting The Deficit: A Bipartisan Joke

Share on FacebookTweet about this on TwitterShare on LinkedInShare on Google+Share on RedditPrint this pageEmail this to someone

President Obama’s proposal to cut the deficit by x trillion dollars over ten years is just another punch line in the serial joke that our political machinery has been telling us for too long: that somehow, deficits will be “cut” in ten years, while tax cuts and spending increases (the jobs bill, for example) are needed immediately.

OK, cutting taxes and increasing spending are politically expedient. We love to receive handouts—spanning the entire spectrum from the homeless guy down the street to Goldman Sachs, GE, and AIG, and even Silicon Valley stars like Solyndra and Tesla.

Raising taxes and cutting spending and are painful procedures. People get upset. Consumption might edge down. Companies that have gotten fat on handouts get in trouble. Wall Street blows up again. So we defer it. Meanwhile, the deficit hovers around $1.5 trillion, year after year, 40% of the federal budget, 10% of GDP. Gross national debt has reached 100% of GDP—after Obama signed the debt-ceiling law, it jumped $238 billion in one day. Next year, it will flirt with 110%, and the year after with 120%. Neither Obama’s proposal nor anything that has emerged from Congress addresses that fiasco. They’re talking about making micro adjustments years down the road. That’s a tired joke. And we’ve stopped laughing long ago.

US-National-Debt

$15 trillion will be added to our gross national debt over the next ten years if deficits continue to pour at the current rate, doubling it to $30 trillion. Even if $3 trillion in cuts were to see the light of the day, gross national debt would still increase to $27 trillion. A catastrophic situation. And the scary graph will look a heck of a lot scarier.

And worse: Ten-year budget forecasts are ridiculously optimistic. A little over ten years ago, a “surplus” had conveniently been forecast for the next ten years. Now, when we look back, we see that the surplus was ephemeral, and that a deficit rose from it like a mushroom cloud. Since then, the deficit has become structurally embedded in our economy. Like an addictive drug, red ink is now required in ever greater quantities to eke out puny rates of growth, and in the future, even $1.5 trillion of red ink may not suffice.

The solution isn’t more deficit spending. The solution is to get off the drug. And to get off now. Due to the sheer magnitude of the deficit, both tax increases and spending cuts have to be on the table. For those who want to balance the budget via spending cuts alone: You’d have to cut 40% out of every government program, including defense and intelligence, congressional salaries (good luck), highways, entitlements, bridges to nowhere, bailouts, etc. Hardly possible. But a good part could be cut, and the rest will have to be dealt with through tax increases.

There will be no free lunches. Since government spending adds directly to GDP (consumption + investment + government spending + exports − imports), any cuts will lower GDP. Taxes, which are not part of the formula, have a more complex relationship to GDP. Raising taxes on those who spend their entire income will lower consumption, and thus GDP, while raising taxes on those who spend only a portion of their income may not have a measurable impact on GDP. However, if taxes are perceived as confiscatory at the upper end, it will lead to perverse effects. It’s vital that our tax code be seen as fair, where everybody pays their share, and changes to it should take that into account.

One of the primary reasons we even have this huge deficit is, you guessed it, the Fed. It has been the great enabler. So that the Treasury could sell its trillions of new debt at near-zero yields, the Fed printed money and monetized the debt. In doing so, it insulated the government from the tough discipline of the capital markets. Now, there no longer is any market-based incentive to address the deficit problem because Congress knows that the Fed will print us “out of trouble.”

But the costs of printing money have been steep. Income streams from bonds, CDs, savings accounts, etc. have been demolished, inflation in goods and services is rising, yet real wages are declining. This insidious combination is one of the forces behind the impoverishment of the American middle class, which in turn, is one of the reasons why the economy can’t take off.

Share on FacebookTweet about this on TwitterShare on LinkedInShare on Google+Share on RedditPrint this pageEmail this to someone

  6 comments for “Cutting The Deficit: A Bipartisan Joke

  1. nickel
    Sep 20, 2011 at 3:16 am

    OK, so let's say we do cut gvt spending and hike up taxes. How will that *not* send an already tottering economy into a recession? The last one pushed maybe 10 million Americans into joblessness. Do we need 10 more? How will government revenues and expenditures fare with more businesses suffering and closing, and more people unemployed or on food stamps?

    Greece is into austerity, and its economy is collapsing faster than forecast, making its deficit situation ever worse (cf http://www.reuters.com/article/2011/09/01/us-greece-imf-eu-idUSTRE7804V720110901). The government slashes spending, this sends businesses and wage earners reeling, and the deficit just gets worse. How do we know we would not get into such a depression spiral?

    I'm not a know-it-all, I don't know what should be done! Would declaring bankruptcy be better? Or austerity so the budget is balanced, coupled with bankruptcy so as to be relieved from the debt burden?

  2. Sep 20, 2011 at 2:10 pm

    Nickel, thanks for your comments and thoughts. You put your finger on the problem: there aren't any easy solutions. But if we keep going along our current trajectory, our system (print and borrow to generate a tiny bit of GDP growth … with lots of money for the few, real wage declines for the many) will eventually blow up. This, historically, can take different forms and remains unpredictable. To prevent it, we need to fix our system now.

    For specifics, check out some of my other posts, particularly those that deal with the Fed, for example http://www.testosteronepit.com/home/2011/8/26/dear-ben-please-print-us-more-money.html ) and those that deal with our trade deficit, for example http://www.testosteronepit.com/home/2011/7/25/our-chinese-bay-bridge.html Thanks again.

  3. Sep 24, 2011 at 1:19 am

    It's even more complex and difficult that that, I think.
    Certainly the problem as you outline it here is real enough, but there's another pressing dimension to the whole thing; resources.
    At some point we have to seriously begin (we should have begun in earnest a generation ago at least, but, well, 'nuff said) the multi-generational task of re-tooling our modernity for a different resource/energy future. The days of having a "healthy" economy based on progressive acquisition are at an end, and the modernity we have manufactured for ourselves is simply too energy intensive to be sustainable – it's not just that we can't afford to maintain it economically (and we can't) it's also that it is unmaintainable by reason of planetary imperatives.

    So – what we are currently doing we cannot afford to continue doing, and what we need to do (a massive re-tooling of infrastructure at almost every level) is beyond our economic capacity by reason of too much debt.
    What is likely to happen is that it will all get much worse, as the desperate sluicing of what remains of the public treasure is sluiced into ever more spectacular attempts to shore up an essentially insolvent private financial sector. Just in time for energy (and water, don't forget water) sources to become dicier and more expensive to extract from.
    A perfect storm, really.

  4. nickel
    Sep 25, 2011 at 12:54 pm

    Wolf,

    I read the posts you suggested. I kind of agree with what you describe. The Western world is hemorrhaging jobs due to the offshoring of… well everything, from manufacturing in China or Indonesia or Vietnam to IT or call centers or medical diagnostic in India or China. And that means incomes stagnate, high-paying job opportunities dwindle, know-how leaves the country, households need to borrow to keep up, the tax base erodes. That hurts, on that, we agree.

    I am not sure about the inflation screed though. No one wants hyper-inflation, of course, but deflation has its troubles too. But, but let's say the Bernanke does print money. More money supply, therefore, inflation, right? But we are in a context in which people default on their mortgages, financial institutions go bankrupt, and their mortgage-backed securities, and esoteric swaps and other exotic assets are all going up in smoke. This is money destruction. Is there more money being created by central banks than money destroyed by defaults? I don't know. Do you?

    But really, my question is: how do we set in course conditions for an economic recovery? Revaluing the yuan would help, but it's not the only currency, and corrections won't move fast enough to make a difference soon. What else? Tariffs against low-wage countries? That's an economic heresy if there is one, and yet…

    And regarding deficits… things that cannot go on forever, don't. So if the deficit is out of control and beyond tackling, well then why not do the sensible thing and default? An orderly bankrupcy, and the guys dumb enough to loan to irresponsible borrowers take a hit for their stupidity, and lose a fraction of their money. Why is that a bad idea?

    Let me know…

  5. David
    Jul 6, 2012 at 7:22 pm

    The problem needs a bit of outside the box thinking and a lot of political leadership. First, we need to take back control of the country from the banks. The banks are there to serve us, not the other way around. The Fed's usurpation of the power of coinage should be revoked. That is a governmental function, not a banking function, despite what the banking industry says. No bank should be allowed to use fractional reserve accounting of assets. That is fraud and should be prosecuted as such.

    Once the power to create money is firmly back in the government's hands, they can eliminate the interest on the national debt by replacing bonds and notes by non-interest bearing currency. With the interest expense firmly under control it becomes possible to cut spending and raise taxes sufficiently to close the deficit.

    At some point it's in the nation's best interests to back the currency by some combination of hard assets (your choice, it really doesn't matter as long as a dollar represents more than just a politician's promise to limit their creation.)

  6. Wolf Richter
    Jul 7, 2012 at 4:35 am

    David – I agree with your first paragraph.

    Your second paragraph and on: if the government had a balanced budget, it wouldn’t need to issue new debt or currency. Or let’s say, in periods of growth, even minor growth, it would have a surplus, and in periods of recession if would have a deficit. Over time, the budget would be balanced or have a slight surplus so that existing debt could be paid down. Then the whole issue would go away. And money would retain its value.

Comments are closed.