Spending Cuts Loom Large as Budget Debate Continues

by Patrick Lester, 1/15/2013

Resolution of last year's "fiscal cliff" fight was achieved in the first few hours of the new year with a tax package that made permanent 82 percent of the Bush-era’s tax cuts. This may have made a "grand bargain" on the deficit that balances tax and spending provisions much more difficult to achieve and heightened the likelihood of more spending cuts.

According to the White House, the new law – called the American Taxpayer Relief Act (ATRA) of 2012 (H.R. 8) – will reduce the deficit by $737 billion over the next ten years (2013-2022), an amount that includes over $600 billion in new tax revenue and $104 billion in reduced interest on the debt. But this amount is overshadowed by $1.7 trillion in spending cuts (including interest savings) that had already been enacted as part of the Budget Control Act of 2011. Overall, spending cuts in the two packages outweigh revenues by more than 2-1.

Shortly after he signed the latest bill, President Obama said that revenues were still on the table. "Now, if Republicans think that I will finish the job of deficit reduction through spending cuts alone ... without asking also equivalent sacrifice from millionaires or companies with a lot of lobbyists, et cetera, if they think that's going to be the formula for how we solve this thing, then they’ve got another thing coming. That's not how it’s going to work. We've got to do this in a balanced and responsible way. And if we're going to be serious about deficit reduction and debt reduction, then it’s going to have to be a matter of shared sacrifice—at least as long as I'm president."

Unfortunately, making most of the Bush-era tax cuts permanent has also removed most of the incentive for congressional Republicans to negotiate further on revenues. On Jan. 6, Senate Republican leader Mitch McConnell (R-KY) told ABC's George Stephanopoulos, "The tax issue is finished, over, completed. That's behind us." Soon afterward, a spokesperson for House Speaker John Boehner (R-OH) told BNA, “We regard the issue as settled.”

The two parties have long held different budget priorities, so their latest positions are not new or surprising. The enactment of ATRA, however, has changed their respective leverage. Before ATRA, congressional Republicans faced being blamed for the expiration of all of the Bush-era tax cuts if they did not come to an agreement on rates for upper-income taxpayers, and even then, House Republicans were badly split over the issue. Now congressional Republicans have little incentive to negotiate, possibly excepting those few who care deeply about defense spending or tax reform, and even in the latter case, they have indicated that they would only support tax reform that was revenue-neutral.

The president's leverage has been further undermined by his unwillingness to play hardball in negotiations over the fiscal cliff, which was never the danger that some thought. If negotiations had extended a few weeks into January, the associated across-the-board spending cuts (called sequestration) and tax increases could have been managed and mitigated for a short period of time by the administration. The president's unwillingness to take a stronger stand on the fiscal cliff has undermined his position on continued budget negotiations going forward, when he will have less leverage than before.

Now most of the president's leverage lies in his ability to make his case directly to the American people. So far, according to a recent poll by the Pew Research Center, he seems to be winning that battle. He will have additional opportunities to make his case in the weeks ahead, including at his State of the Union Address in February.

Winning the battle for public opinion, however, may not be enough. In the 2012 election, five-sixths of House Republicans took more than 55 percent of the vote in their districts. Most House Republicans are less worried about public pressure from the president than about a potential primary challenge.

“At the end of the day, the only poll that matters is the one in people’s districts. I’m focused on the people in my district," Rep. Tim Griffin (R-AR) told the National Journal. "National polls include people in Nancy Pelosi’s district, Henry Waxman’s district.... I don’t work for them, and I’m not real worried about the national polls.”

Looking Ahead

So how will these changed political circumstances affect the budget going forward?

Congressional Republicans appear ready to use three coming decision points to force additional cuts in spending. The first is a vote to raise the debt ceiling, which will be needed by mid- to late-February to avoid a possible default on the federal debt. The second is a new deadline for across-the-board cuts from sequestration, which was delayed until March 1 by ATRA. The third is an omnibus spending bill, which must be enacted by March 27 to avoid a federal government shutdown.

Most of the media attention has focused on the debt ceiling. However, a default on the national debt could trigger a financial crisis at least equal to that in 2008, and this undermines its plausibility as a point of leverage. No party would want to be seen as responsible for the economic chaos that would ensue. A more credible threat is the one least spoken about – the omnibus budget bill. House Republicans may pass such a bill, but with considerable spending cuts attached, and dare Senate Democrats and the president not to go along with it.

It is too early to know with any certainty what spending cuts will be considered, but the best indication can be found in the deal that was developing in mid-December between House Republicans and the president before it was shelved. That deal included $400-600 billion in cuts in health care entitlement spending over ten years (mainly in Medicare, including means-testing benefits and a possible increase in the eligibility age for Medicare to 67). It included another $200-300 billion in non-health-related entitlement cuts. It included a change in how the consumer price index would be calculated, for an additional savings of $130-200 billion, much of which would affect Social Security benefits. It also included another $100-300 billion in cuts to discretionary spending (for programs like education, environmental protection, and defense), possibly including savings from winding down the war in Afghanistan.

Total cuts might be in the range of $1 trillion over 10 years, which would be enough to lift the debt ceiling for a year under the House Republican policy (called the Boehner rule) of matching any increase in the debt ceiling with a package of equal or greater spending cuts. The package might also be used to justify canceling sequestration.

Such cuts would be far from ideal. Preventing them from occurring will require a concerted effort to educate the public about their impact and also about better revenue-based solutions, such as imposing a financial transaction tax on high-speed stock traders – an option that by itself could reduce volatility in the financial markets and achieve more deficit reduction than all of the spending cuts combined.

The Perils of Austerity

One important issue receiving insufficient attention in the ongoing budget debate is the impact that further deficit reduction might have on the economy. According to market analysts, the just-completed deal will trim anywhere from 1 to 1.75 percent off of U.S. economic growth this year. Enacting further spending reductions, especially to the extent they occur this year, would weaken the economy even further.

Despite this, on Jan, 14, President Obama proposed reducing the deficit by an additional $1.5 trillion, closely mirroring a recent analysis by the Center on Budget and Policy Priorities (CBPP) that indicated that another $1.4 trillion in savings would be enough to maintain federal deficits and the public debt at about 73 percent of GDP. In each case, most of these savings could be achieved by replacing the sequester, slated to begin March 1, with a deficit-cutting package of equal size.

But CBPP's own analysis shows that these additional cuts are not necessary, at least not immediately. CBPP's preferred option, which is similar to the president’s, is shown in the red line in the graph below. However, the yellow line just above it reflects what would happen if no further budget reduction was achieved and sequestration were simply canceled. Under this option, the debt still declines as a share of the economy (although not as quickly) until about 2018, when it begins to reverse. While it may be necessary to address increasing deficits at that time, the intervening delay would give the economy further time to strengthen.

CBPP chart

Recent developments in international economic thinking reinforce this alternate view. Last fall, the International Monetary Fund (IMF), which has long been noted for imposing austerity on developing nations in return for economic assistance, released a report calling its own austerity policies into question. The report found that the IMF's economic forecasts were consistently too optimistic for countries that pursued austerity programs, including reduced public spending and increased taxes, and too pessimistic for other countries that pursued stimulus policies.

U.S. policymakers ignore these lessons at their peril. With the U.S. economic recovery still in its infancy and the economy only beginning to absorb the impact of the most recent round of deficit reduction, now may not be the time for additional budget cuts.