CPEG’s Ron Baiman on the Impending “Fiscal Cliff”: Washington has it Backwards.

The so-called “Fiscal Cliff” is Mostly Good, the Bad Part about it is that it would Reduce the Fiscal Deficit!

Why is it that just after an election where reducing the job deficit was universally acknowledged to be our absolute first priority, mainstream Washington has immediately pivoted to making reduction of the federal fiscal deficit its number one concern?

OK, this is (in part) a rhetorical question. We all know that the impeding “fiscal cliff” is driving this immediate concern, though the “fiscal cliff” itself is in large part a direct product of the misguided fiscal “deficit hysteria” that has gripped Washington.1 The question now is what to do about it.

The answer is first to get our priorities in order: 1) Reducing our jobs deficit is our absolute most pressing problem. 2) This calls for an immediate increase in the fiscal deficit and for deep and far reaching economic restructuring so that more well paid jobs in the U.S. are supported by any given level of domestic demand. 3) Finally, as a distant third priority, eventually if and when world demand for dollars falls (it shows no sign of this currently) and after successful restructuring or it will increase our jobs deficit, we will need to reduce our long run federal fiscal deficit. Mainstream Washington seems to have put 3) first, and mostly dropped 2), which is critically important for 1), altogether.

How can we best address our most immediate needs? Going over the so-called “fiscal cliff” would accomplish a degree of, long overdue, necessary economic restructuring: a progressive tax increase that impacts the highest income households the most, and large cuts in defense spending) that would appear to be politically otherwise very difficult to achieve. Moreover the biggest macroeconomic downside of the “fiscal cliff,” the $560 billon cut that it would make in the 2013 federal deficit, would appear to be most easily addressable, and in ways that would further the key goal of reducing the jobs deficit, after going over the cliff.2

After the cliff “reboot”, the political will to cut taxes for middle and lower income households will likely strongly re-assert itself. Similarly, one would expect that there would be much political will to reverse the most egregious fiscal cliff cuts in social spending, such as the $26 billion cut in extended unemployment insurance, especially if this was restored as part of a deal to reverse some of the cuts in defense spending.3 These changes would be fiscal deficit expanding and thus serve the number one priority of reducing the jobs deficit. Thus going over the fiscal cliff would likely be better for the economy than a pre-“fiscal cliff” “grand deal” with its misplaced priorities of reducing the fiscal deficit and, at least partly, reversing the beneficial economic restructuring that would be accomplished through the “fiscal cliff”. The underlying political economic rationale for this view is outlined below.

Ten “Fiscal Cliff” Conclusions

The hard fact is that our economy is currently dependent on the roughly $1 trillion federal deficit for demand equal to about 1/15th of our $ 15 trillion GDP. And this is at a time when current demand for goods and services is so lacking that there are roughly 19.4 million (about 14.5% of the 133.8 million officially Employed Americans) fewer full-time equivalent jobs than there are people who would like to work. Moreover, 5.0 million, or 43% of the 11.7 million officially unemployed, have been unemployed for 27 weeks or longer with the average length of unemployment of 40.2 weeks, a number that is double that of any prior post-war recession.4

Conclusion 1: Even though we are pumping up our economy by injecting “extra demand” equal to about 1/15th of its total output, our economy is not generating anywhere near the number of jobs necessary to harness the productivity (and provide the income) necessary for broad based sustainable prosperity.

Conclusion 2: Our number one priority should be to find a way to generate these needed jobs.

Conclusion 3: Our economy needs more “pumping up” from deficit spending to create these jobs.

Conclusion 4: Unless we want to again blow up a massive private deficit (as we did during the “balanced budget” late Clinton years), this deficit spending will have to come from the public sector.5 As states and local governments cannot generally run large operating budget deficits, this public sector pumping up of the economy will have to come from the federal government. Ergo: Our current economy needs more, not less, federal government deficit spending.

Conclusion 5: Reducing the federal deficit is not an “accounting problem” but rather an “economic dependency” problem.

Conclusion 6: If we want to reduce our economic dependency on deficit spending (which we will have to do at some point when world demand for dollars falls, though we don’t seem to be anywhere near this point judging by current record low interest rates for U.S. Treasury Bills and the relatively high exchange rate for the dollar), we will have to radically restructure our economy.

Conclusion 7: This will require: a) reducing the demand “leaking out” of our economy to the rest of the world by expanding our exports and reducing our imports without reducing our GDP (that is we need to cut our persistent “full employment” trade deficit”), and/or
b) increasing the number of productive jobs and level of domestic income generated at each level of private and public spending.

Conclusion 8: The later will require: a) redirecting public spending toward a large scale federal jobs program and toward sectors with very high employment to spending ratios that happen to also be very productive and environmentally sustainable like: education, health, human services, and many types of “green” jobs6; and cutting public spending with low employment to spending ratios like defense spending and business tax breaks for companies that are growing most of their jobs outside of the U.S., b) empowering unions and raising minimum and living wages to reduce income inequality and increase the proportion of demand for current goods and services generated at each level of overall aggregate income, and c) making our (state, local, and federal) tax system progressive , (overall taxes in the U.S. are now on-net regressive in all but one state -Vermont)7 and more conducive to employment growth by directing them toward households with high income and wealth, and toward financial speculators, neither of whom spend a large share of their earnings on current goods and services. Only through this kind of “radical restructuring” of the U.S. economy can we achieve long term, broad based, and sustainable prosperity.8

Conclusion 9: Through the “fiscal cliff” we accomplish some of this necessary long term restructuring. We should allow these “restructuring” aspects of the fiscal cliff to occur by: a) Letting the Bush and other tax cuts lapse (ideally taxes on middle and lower income would not be increased but it seems politically impossible to let some cuts and not others lapse), b) Allowing the $65 billion in “sequestrations,” i.e. automatic cuts in military spending and spending programs occur (Social Security and Medicaid are not impacted, and Medicare benefits cuts are limited to 2%) and $26 billion cut in funding for extended unemployment insurance occur.9

Conclusion 10: It appears likely that the deficit can be best increased again, and in ways that support restructuring and restore the most egregious cuts in social spending, after the “fiscal cliff” occurs. For example, allowing middle and lower income taxes to increase, will likely immediately (if not sooner) engender the political will in both parties to cut taxes for these groups – so that allowing all the Bush tax cuts to increase will eventually achieve the goal of just allowing taxes on the wealthy to be increased. Similarly it appears likely that there will be greater political will (though probably less likely given the Republican majority in Congress) to restore the most egregious cuts in social spending after going over the cliff. The biggest macroeconomic problem with the “fiscal cliff” is that it reduces the federal deficit by much more than the requisite macro-economic restructuring that could sustain this level of federal deficit reduction. But the “fiscal cliff” appears to be largely beneficial in its radical “restructuring” of taxing and spending.

Recommended Political Course of Action: Go Over the “Fiscal Cliff” and Work to Implement an Ex-Post Expansion of the Fiscal Deficit Back to and Beyond it’s Pre-“Fiscal Cliff” Level.

Politically it appears that the best course of action is to embrace the “fiscal cliff” as a mostly positive tax and spending “restructuring reform,” while working to off-set its negative deficit-reduction impact through ex-post reversals of the middle and lower income tax increases, and ex-post deals to off-set the most harmful social spending cuts. Ideally these measures would be supplemented by further “deficit increasing” and “restructuring increasing” employment generating policies like the jobs, income inequality reduction measures, and other programs outlined above.


1. Most notably: “The Budget Control Act of 2011”.
2. See: http://www.cbpp.org/cms/index.cfm?fa=view&id=3788.
3. Op. Cit.
4. All data are from BLS October 2012 Household Survey. The 19.4 million figure includes 11.7 million who are officially part the Labor Force and Unemployed, 3.5 million who want a job but are not currently counted as part of the Labor Force, and 8.3 million who are working a part-time for economic reasons and so are roughly 1/2 Unemployed leading to a “full time equivalent” unemployment increase of approximately 4.1 million. On the plight of the long term unemployed, see: http://www.nytimes.com/2012/11/02/business/economy/lingering-unemployment-poses-long-term-risk.html?pagewanted=all. See also the CPEG October jobs report at: http://www.cpegonline.org/2012/11/08/commentary-on-the-october-2012-bls-jobs-report/#more-366.
5. See: http://www.cpegonline.org/multimedia/DeficitLinkages.ppt.
6. See: http://www.cpegonline.org/reports/jobs.pdf.
7. See: http://www.itepnet.org/whopays3.pdf. Based on this 2007 data, Illinois is the third most regressive of all the states, and the most regressive of the 43 states that have some form of state income tax.
8. CPEG reports and working papers at: http://www.cpegonline.org.
9. See: http://www.cbpp.org/cms/index.cfm?fa=view&id=3788.

Image: FreeDigitalPhotos.net

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