The dog’s breakfast of a deal that “resolved” the fiscal cliff fell far short of expectations. In the hours after it passed, deficit hawks at the Committee for a Responsible Federal Budget and the tag team of former Senator Alan Simpson and former Clinton White House chief of Staff Erskine Bowles all expressed disappointment in a bargain that was anything but grand. Senate Republicans gritted their teeth to accept a small increase in taxes on America’s highest-earning households while Senate Democrats made permanent the bulk of the Bush-era tax cuts. A number of tax provisions that hark back to the 2009 fiscal stimulus law were extended, as were unemployment benefits, thus delivering a modest income boost to a large number of low-income households. But the Social Security payroll tax cut, a Republican-backed replacement for the more narrowly targeted Making Work Pay tax credit that was part of the stimulus law, which benefited a wide range of affluent households as well as families of more modest means, was allowed to lapse. Long-term spending levels, meanwhile, were left largely untouched, which is why rebellious House Republicans came close to scuttling the delicately constructed compromise.
One group that offered at least two cheers for the deal were deficit doves, who believe that premature fiscal consolidation poses a grave threat to America’s sluggish economic recovery. Paul Krugman, the prominent economist and popular left-of-center New York Times columnist who never shrinks from apocalyptic pronouncements, was almost pleased to see that the deal avoided any serious spending cuts and that it entailed relatively modest near-term tax increases.
There is a coherent approach to reconciling the concerns of deficit hawks and doves, which has been championed by former Senator Pete Domenici and former Clinton budget director Alice Rivlin of the Bipartisan Policy Center’s Debt Reduction Task Force. Essentially, it entails addressing the federal government’s structural budget deficit — the gap between revenues and spending levels when the economy is humming along at its “normal” pace — while allowing for substantial deficits so long as the economy is in recovery mode.
There is one market democracy that has embraced something like the grand bargain American budget reformers have in mind, yet it has been widely panned as a poster child for the evils of fiscal austerity. Since 2010, Britain has been ruled by a coalition government that unites the center-right Conservative Party with the center-left Liberal Democrats. Faced with a tanking economy and a budget deficit of 11 percent of GDP on entering office, and constrained by public spending levels that reached 47.7 percent of GDP under the previous Labour government, the coalition committed itself to a course of slow and steady deficit reduction. The hope was that this fiscal consolidation would signal that Britain was serious about getting its public finances under control, and that this in turn would encourage growth. Yet Britain’s economic performance has been disappointing, and a growing chorus of critics insists that fiscal consolidation is to blame.
Before we turn to the fiscal consolidation debate, it is worth noting that Britain’s economic performance has also been downright confusing. The unemployment rate is 7.8 percent, roughly in line with the U.S. rate. It is also true, however, that Britain’s employment rate, i.e., the number of Britons who have a job, has recovered faster. But according to the GDP numbers, the U.S. economy is recovering, albeit slowly, while Britain’s economy is teetering on the edge of recession. Indeed, British GDP remains 3 percent smaller than it was in 2008. Normally we’d expect GDP and employment levels to go hand in hand, but that hasn’t been the case in Britain. Because employment levels have remained fairly robust while measured GDP has not, measured productivity has actually declined over the last year. One possibility is that Britain’s GDP is currently being underestimated, but the coalition is certainly not counting on that rosy scenario.