A debt deal that solves the wrong problem
By Lawrence H. Summers
The opinions expressed are his own.
At last Washington has reached a deal that raises the debt limit and averts a default that would have been a national embarrassment and an economic and geopolitical catastrophe. The forces shaping the deal and the deal itself are multifaceted–and so is the right reaction to it. Mine has a number of elements.
Relief. There will be no first default in U.S. history; no economy-damaging short-run austerity; no attack on the nation’s core social protection programs or on universal health care; and no repeat of the last month’s shabby spectacle for at least 15 months. All of this was in doubt even a week ago as Congressional intransigence threatened to make the problem of acceptably raising the debt limit insoluble. The Hippocratic Oath applies in economics as well as medicine and so it is no small thing for the Administration to have reached an agreement that does no immediate harm. It may well be that no better agreement was achievable given the political dynamics in Congress.
Cynicism. An objective observer would predict larger U.S. budget deficits in the outyears than he or she would have predicted a few months ago. The economic forecast has deteriorated (see chart below), and it is reasonable to estimate that even a half-a-percent reduction growth averaged over 10 years adds well over a trillion dollars to the national debt in 2021.
Despite claims of spending reductions in the $1 trillion range, the actual agreements reached so far likely will have little impact on actual spending over the next decade. The deal confirms the very low levels of spending already negotiated for 2011 and 2012, and caps 2013 spending about where most would have expected this Congress to end up. Beyond that outcomes are anyone’s guess—the reality is that Congress votes discretionary spending annually and the current Congress cannot effectively constrain future actions. True, there are caps and sequester threats present in the debt limit legislation, but these are virtually certain to be reformulated in 2013 so the reality was and still is that discretionary spending going forward will largely reflect the will of future Congresses.
Remarkably for a matter so consequential the agreement that the Supercommittee will seek to reduce the deficit by $1.5 trillion comes without any agreement on what the baseline is from which the $1.5 trillion is to be subtracted. Is the $1.5 trillion from a baseline that includes or excludes the Bush tax cuts? Includes or excludes tax extenders and the annual AMT fix? These and other similar questions are unresolved at this moment.
Baseline arguments are mind-numbing but highly consequential. Perhaps a current-law baseline will be employed, assuming a phaseout of the Bush tax cuts, in which case there will be no motivation to assure repeal of the high-income tax cuts because it will not count toward the goal. Perhaps, and more likely, in an effort to make deficit reduction easier a baseline following current policy will be adopted. This would treat the nonextension of the Bush high-income tax cuts as a $1 trillion tax increase—hardly a likely outcome given the probable composition of the Supercommittee.
Economic Anxiety. The United States’s current problem is much more a jobs and growth deficit than an excessive budget deficit. This is confirmed by the fact that a single bad economic statistic more than wiped out all the stock market gains from the avoidance of default and the fact that bond yields reached new lows at the moment of maximum apparent danger on the debt limit.
On the current policy path which involves a substantial withdrawal of fiscal stimulus when the payroll tax cuts expire at the end of the year, it would be surprising if growth was rapid enough even to bring unemployment down to 8.5 percent by the end of 2012. With growth at less than 1 percent in the first half of the year, the economy is now at stall speed—with the prospects of adverse shocks from a European financial crisis that is decidedly not under control, spikes in oil prices, and confidence declines on the part of businesses and households. Based on the flow of statistics, the odds of the economy going back into recession are at least 1 in 3 if nothing new is done to raise demand and spur growth.
If these judgments are close to correct, relief will soon give way to alarm about the United States’s economic and fiscal future. Among all the machinations ahead, two issues stand out. First, the single largest and easiest method of deficit reduction available is the nonextension of the Bush high income tax cuts. The President should make clear that he will not accept their extension on any terms. Clarity on that trillion-dollar point, along with very modest entitlement reform, will be sufficient to hit current deficit reduction targets.
Second, it is essential that the payroll tax cut be extended and further measures such as infrastructure maintenance and unemployment insurance extension be taken to spur demand. There is still time to confirm Churchill’s maxim that the United States always does the right thing after exhausting all the alternatives.