A debt deal that solves the wrong problem

August 2, 2011

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.


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Thank you, Mr. Summers, for this refreshing and balanced viewpoint on the current economic situation we face. It seems clear that Congress and the President are not working together very well for the prosperity of all Americans. The political maneuvering over the debt limit these last couple of weeks brought the Democrats to their knees. It was all they could do to keep a devastating withdraw of Government support from pulling the rug out from under this stalling economy. Until all parties can get behind reasonable efforts to solve the jobs crisis, partisan ideology on behalf of the few will continue to trump doing the right thing for the American worker.

Posted by LEEDAP | Report as abusive

True that Larry.

Posted by coyotle | Report as abusive

What we learned is that the incentives of members of Congress do not lead them to work together constructively. Traditionally, they have larded up financial measures order to get them passed. And they were doing this 200 years ago. This time, a bunch of people thought they would try to mix things up by trying to shut the system down, but that idea’s pretty much like a Vietnamese monk setting himself on fire as a protest. Now, even the Tea Party is back to the same old lard-it-up approach. Sen. Rand Paul is apparently advocating not renewing the gasoline tax, which is set to expire September 30. Two questions here: First, how do you factor the lost revenue into the recent deficit reduction deal. Second, why? Sen. Paul says that it would be an economic stimulus by making gasoline cheaper. It’s comical that he fails to realize that the price of gasoline is set by the law of supply and demand and not by the government. Getting rid of the gasoline tax would not change the price of gasoline, because the supply of gasoline and people’s need for it would be unchanged. It would simply transfer what is currently the government’s cut to whoever is currently paying the tax to the government. Why is that a good idea? It’s just the Tea Party way to increase the Federal deficit by larding up fiscal legislation — they want to do it by eliminating taxes as opposed to writing checks. That’s not a real difference.

Posted by Bob9999 | Report as abusive

Ok, regardless of your politics, are you having trouble visualizing what the debt “looks like”? Here’s something you should see to put it into perspective: http://usdebt.kleptocracy.us/

Posted by elusivesolution | Report as abusive

Larry, there are a lot of tricks available in how we determine “spending cuts”. You mentioned the baseline, and also there is the inflation assumptions baked into whatever baseline is used, and all the other assumptions. The, you have a government accounting system that is pitiful. Apart from a few wonks at the GAO, no one has any details on what anything costs. Ideally you’d want to cut the cost of things like hiring people, processing grants and contracts — not direct checks that go out to people. But our government has never paid any attention to this. See article in Harvard Business Review on this point.
http://blogs.hbr.org/cs/2011/07/what_the _us_government_can_lea.html

Posted by bogemin | Report as abusive

I’m still waiting for a chart of GDP, not Percent Change in GDP, that demonstrates how we are still in a hole relative to four years ago.

There should be a distinction between “recovering” and recovery or recovered.

Also, as Summers and every other economist of his ilk know that the breakeven point on growth is not zero GDP, but somewhere in the range of three to five percent, or even the Council of Economists optimistic (but unfounded) 2.75%.
Then, we would have some useful facts.

Posted by ptiffany | Report as abusive

Thank you Mr. Summers.

Now, please tell us how the GDP will henceforth be measured with real numbers as prescribed by EuroStat and not the GAAP nonsense that every US entity has been using until now.

We’re all adults here….. :)

Posted by Juergen12 | Report as abusive

I’m confused why temporary tax cuts are still pushed. Doesn’t economic theory, as well as recent evidence from the Bush and Obama administrations, suggest non-permanent changes in income largely get saved?

Posted by TinyOne | Report as abusive

In eliminating the Bush cuts we should adjust income brackets, both for individuals and corporate, to account for inflation. For example I would raise the limit of 15% corporate to $ 100K (It has been at $ 50K for over a decade).

Subsidizing unemployment or lowering the employment tax, does not create jobs, only gives the consumers some $ to spend, but looks to me like a subsidy, a present, not a strategy to create jobs.

Taxing outsourcing would be an easy way to create revenues and create jobs at the same time, is just fair.

Posted by robb1 | Report as abusive

A deal that solve no fiscal, economic, trade, unemployment problems.

But it solves the political Russian roulette, one-upmanship civil war in DC. This is why the 3 civil war parties involved called it a Win-Win-Win.

Posted by TomKi | Report as abusive

This is an article that will be referred back to in a year’s time…along with the many other (majority) economists’ voices, warning of the dire economic consequences that are practically certain to result from going after government spending with a scythe (while wearing a long, hooded robe). What a potential default threatened to do in weeks, Congress has legislated for it to occur over several months. Don’t congratulate the Republican House majority and “Tea Party” for this achievement…they’re already busy slapping their own backs – talking about an election year resume item. Rarely does the term ‘wait and see’ carry so much foreboding.

Posted by commenter84 | Report as abusive

The best way for the federal government to generate jobs is to hire people to work for the federal government. Often times these people will produce worthless research and shuffle papers, which harms the economy in the long run. Another way to motivate job creation in the US is through tariffs. Finally, lending standards can be eased and loans can be made directly to students and entrepreneurs to create jobs.

Posted by M.C.McBride | Report as abusive

If they don’t get demand increased by increasing employment, so as to get the economy expanding, we’re looking at another Great Depression within a couple of years. Europe is actually worse.
Watch the outstanding, Oscar nominated, 2010 documentary ‘INSIDE JOB’ to see how Larry Summers and his banking buddies were instrumental in creating this mess, and how banks have even corrupted academia.

Posted by Discovery451 | Report as abusive

It is interesting to note what Vladimir Putin stated yesterday:”That the USA is like a parasite living off the rest of the world”. It is time that ambitious plans (read Iraq, Afghanistan, maybe a play on Iran) be stopped thereby saving billions.

Posted by Laidback | Report as abusive

“The Hippocratic Oath applies in economics as well as medicine …”

If only economists felt that way in 1947 when they pushed the U.S. to draft and sign the Global Agreement on Tariffs and Trade. If they did, we wouldn’t be in the fiscal mess we find ourselves in today.

Posted by Pete_Murphy | Report as abusive

What most Americans seem to fail to understand is that the ruling class lives in a post-national world. Patriotism is useful to them in the way that religious faith has been useful to the Church for milennia: as a means of controlling and exploiting the populace. Government officials, Wall Street, and the senior officers of large, multinational corporations have no use for or interest in promoting a healthy and strong America. More than 2/3 of economic growth comes from developing nations today; this is where the owners of our government make their money now. We the people of the US are here to serve them, and all decisions made by them will be in their interests, not ours. Rest assured, these interests do NOT coincide.

Expect to see politicians continuing to wrap themselves in the flag, appealing to the baser, partisan instincts of Joe Sixpack, while continuing to rip us all off and flee the country at the moment when we finally wake up and decide to take it back.

Posted by JackMack | Report as abusive

Why would anyone listen to this rehashed Wall Street hack who is part of the problem rather than the solution? Like Colin Powell after his shameful UN presentation on WMDs, Larry Summers ought to hide away for a few years and contemplate the damage he has done to the American people. Flash to Summers: your policies don’t work!

Posted by Medusa | Report as abusive

Big budget cut will worse economy and budget deficit will increase finally. 10 yrs treasury bond yield reached at 2.7% historical low level. It means bond market is not afraid of US default at all.
Government can finance at cheap cost 2.7%. We should issue government bond and stimulate economy, create more jobs.

Posted by MasatoshiKubo | Report as abusive

I think this is a pretty fair analysis, with the one omission pointed out by a previous post, which is that ending the wars would save a whole pile of money.

Without revenue increases (which I am FOR, but which will not likely be forthcoming), the single largest thing we can do is reduce defense spending. Pulling back on the offensive front and retrenching to enhance intelligence efforts and defend against cyber-attacks can save an enormous expenditure, short-term. We can count on future attacks, but in the meantime we can “sharpen our spears and rebuild our walls” at a much lower cost than forward deployment.

Posted by AllForLight | Report as abusive

Mr. Summers, you are a disgrace. You are in fact responsible for much of what has occurred within our economy and our financial system. Shame on you. How can a man of your supposedly high intellect be so wrong? You, your beliefs and your policies are completely based on an ever increasing debt laden society in which the government commands and controls. Well you guys really screwed this one up. Why is it so hard for you to realize that loose lending policies result in failure, every single time? The effects of excessive debt is an elementary concept to understand. Then you just ignore the wrong decisions you guys made and allowed the failed institutions to live on until the next failure occurs, which has arrived by the way.

Posted by TechX85 | Report as abusive

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Sounds like he has learned Bernanke`s double-speak gooblygook down pat. A whole lot of verbiage that says nothing.

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End the wars, end the bush tax cuts, lower the corporate tax rate and eliminate all loopholes. DO NOT provide incentives for companies to outsource, provide incentives to insource. IT’S NOT THAT COMPLICATED!

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Posted by It’s all about the jobs | JavedanTV | Report as abusive

I live in Australia.My property shares are trading at a return of over 10% dividend.Yet they continue to fall.The latest debt ceiling deal just puts off the financial day of reckoning.The fact is that America must increase the tax burden on the wealthy.The tax structure in Australia is fair.People who earn more should pay much more tax.Social Justice should not be a casualty of economic mismanagement and greed within the finacial system.

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