Greg Ip

Articles by The Economist’s U.S. Economics Editor

America’s deficit: Confronting the monster

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At last, plans are appearing to cut America’s deficit. But will politicians and the public embrace them?

Nov 18th 2010 | Washington, dc

[Greg Ip] BARACK OBAMA and his Republican opponents have spent much of the past month sniping at each other, but on November 15th they suddenly found themselves agreeing. Mitch McConnell, the leader of the Senate Republicans, called for a ban on earmarks, the pet projects politicians like to pop into spending bills. Mr Obama, who also wants a curb on them, quickly applauded.

A cynic would say that such agreement was easy, since the stakes are so low. Earmarks attract plenty of bad press, but the money is trivial—less than 0.5% of federal spending. On the more pressing question of how to close America’s gaping deficits, Democrats and Republicans remain far apart. Only a week before, the chairmen of a bipartisan commission set up by Mr Obama in February to find ways to get the deficit down floated a proposal focused on cutting spending. Republicans liked this, but Nancy Pelosi, the Democrats’ leader in the House of Representatives, called the idea “simply unacceptable”.

This sound and fury, however, may signify something important. The two sides are no longer arguing over whose taxes to cut or which entitlements to expand, but whose taxes will rise and which entitlements will shrink. It may all come to naught; or it may signal the dawn of a new age of austerity, similar to the era of tax increases and entitlement cuts that prevailed from 1982 to 1997.

America’s budget deficit in the fiscal year that ended on September 30th stood at $1.3 trillion; at 9% of GDP, the second-largest since the second world war. (Fiscal 2009 was the biggest.) That figure reflects the effects of the recession and the temporary stimulus, both of which will fade. The real problem is the future. On current policies the Congressional Budget Office (CBO) reckons that the federal debt, now 62% of GDP, will hit 87% by 2020. Add in state and local-government borrowing, and the total approaches 110%.

According to the IMF, America’s structural deficit and the growth in its debt over the medium term are among the worst in the rich world. The United States also stands out for its lack of any plan to deal with this. Germany has passed a balanced-budget constitutional amendment. Britain’s coalition government has launched an ambitious four-year plan to slash its massive deficit. Nicolas Sarkozy, France’s president, has finally triumphed in a bruising battle to raise the pension age.

America has a good and a bad excuse for its inaction. The good one is that the economy isn’t ready. Economic growth in the second half of this year has been a painful 2% at an annual rate. The unemployment rate, at 9.6%, remains near its peak. The effects of the stimulus are wearing off, so fiscal policy now veers towards contraction. If taxes rise or spending falls immediately, the economy could slide back into recession, as happened in Japan in 1997.


Giveaway and takeaway

But there is also a bad reason for delay: America’s political culture is unused to austerity. The country’s fiscal policy alternates between “giveaway” and “takeaway”, says Gene Steuerle, a Treasury official in the 1970s and 1980s and now a scholar at the Urban Institute, a think-tank. From 1946 to 1981 was an era of giveaway: entitlements expanded, most notably with Medicare and Medicaid in 1965, and taxes were cut, most famously in Ronald Reagan’s first year in office, in 1981. In 1982, however, fiscal policy flipped to takeaway. Mr Reagan’s tax cuts and defence build-up, compounded by the 1981-82 recession and sky-high real interest rates, produced record structural deficits. Pete Domenici, then a junior Republican senator, remembers going to the White House with other Republicans in 1982 to talk to Reagan about the deficit. He recalls the president’s stunned disbelief when he told him that he could run up more debt than all his predecessors combined.

The full article is linked here.

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Written by gregip

November 18, 2010 at 4:18 pm

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