The Fiscal Myth

by: Robert Kuttner

As President Obama gets closer to making his deal with the Republicans on the budget, the most important thing to keep in mind is that the fiscal cliff is an artificially contrived trap. Were it not for the two Bush wars and the two Bush tax cuts and the House Republican games of brinksmanship with the routine extension of the debt ceiling, there would be no "fiscal cliff."

Rather, there would be a normal, relatively short-term increase in the deficit resulting from a deep recession and the drop in government revenues that it produces. When the economy recovered, the deficit would return to sustainable levels. In the meantime, these deficits are necessary and useful to maintain public spending as a tonic to the economy.

In addition, there are two entirely extraneous questions that do not belong in this debate -- whether Social Security requires any long-term adjustment to assure its solvency, and if so, what kind; and how to restrain the long-term growth in Medicare spending.

In fact, if we get can get back to full employment, there is no Social Security crisis, because Social Security is financed by taxes on payrolls. In the Clinton era, when we had full employment, the crisis kept receding. If we want a little extra insurance, we can lift the cap on income subject to payroll taxes.

Medicare spending is a long-term problem that requires major structural reforms. Reducing benefits or raising the eligibility age in the heat of an artificially contrived fiscal crisis is the wrong way to proceed. Obama's Affordable Care Act will keep Medicare at roughly its present level of spending relative to GDP -- too high, but not an imminent catastrophe.

The strategy of the right-wing has been to blur these several distinct issues into a single grand fiscal crisis, the better to reduce government spending and especially to cut Social Security and Medicare. The right-wing, in this case, is a two-headed beast. The Republican right-wing is mainly interested in defending tax cuts for the rich and reducing social spending generally, while the deficit hawks of the center-right want to achieve budget balance and weaken Social Security and Medicare. And since Social Security and Medicare are phenomenally popular, so much the better for the Republicans if they can trick the Democrats into sharing responsibility for the deed.

A further piece of mischief is the premise that we somehow need a 10-year budget deal that reduces the projected deficit by something like $4 to $5 trillion. We don't. What we need is an economic recovery. If we get a recovery with something close to full employment, the deficit naturally comes down as revenues to and current levels of public spending are entirely sustainable -- especially if we go back to the pre-Bush tax levels on the wealthy.

So if we limit the debate to the real subject at hand -- namely how to avoid a massive fiscal contraction next year when all the Bush tax cuts expire, President Obama holds a very strong hand. He has made it clear that he will not tolerate extending the Bush tax cuts for the top 2 percent at a cost of cutting back valued government outlays for everyone else. But he does want to extend the lower tax rates for the bottom 98 percent.

This puts the Republicans in the position of allowing everyone's taxes to increase in order to preserve the cuts for the top two percent. Not a happy position politically. And Obama has said he is willing to play hardball -- let the economy go "over the cliff" of a general increase in rates in order to force the Republicans to back down.

The Republicans have been tying themselves in knots in order to find other sources of additional revenue to plug the budget gap so that they can keep their pledge to Grover Norquist never to increase tax rates. (Funny how the Norquist pledge is a one-way ratchet. Republicans can vote to cut tax rates on the premise that the economy needs the temporary stimulus, but then if they vote to restore the old rates they are in violation of the pledge. You can see where this leads.)

But there is just not enough money for this budget deal unless a rate hike on the rich is part of the package. Restoring the pre-Bush tax rates on the top 2 percent would raise about $1.2 trillion over a decade. Raising capital gains rates to those of ordinary income and closing other loopholes that benefited mainly the wealthy would raise at most less than another trillion.

Even with those tax hikes, Obama and the Republicans would be more than $2 trillion short of the stated goal of cutting the deficit by at least $4 trillion over a decade.

And there is where the deeper mischief of the $4 trillion goal and its relation to Social Security and Medicare comes in. Neither party wants significant budget cuts in the next year or two, when the recovery is too fragile to stand even a smaller fiscal contraction. So the Republicans, Obama and the Democratic budget hawks like Erskine Bowles and retiring Budget Committee chairman Senator Kent Conrad all want to "back-load" the spending cuts -- have them bite late in this decade.

It just happens that Social Security and Medicare cuts fill that bill perfectly. Cut social insurance several years from now, and you delay the political outcry until Obama has left office. You also delay the fiscal impact, and you leave room for a bit of other government spending.

But cutting Social Security and Medicare for the sake of an arbitrary and needless budgetary reduction of $4 trillion and as a "solution" to an entirely contrived fiscal crisis is bad policy. It is bad economic policy and worse social policy. And for Democrats, it is dumb politics. If Republicans want to be the ones to attack America's two most valued social programs, Obama should let them go right ahead -- until they march off their own fiscal cliff.

And if the president is too determined to get a deal to appreciate what a strong hand he has, then it is up Democrats in Congress and the progressive community outside Washington to make sure that Obama doesn't follow Republicans off their cliff.