By Lawrence
H. Summers
The opinions expressed are his own.
At last Washington has reached a deal that raises the debt
limit and averts a default that would have been a national embarrassment and an
economic and geopolitical catastrophe. The forces shaping the deal
and the deal itself are multifaceted–and so is the right reaction to it.
Mine has a number of elements.
Relief. There will
be no first default in U.S. history; no economy-damaging short-run austerity;
no attack on the nation’s core social protection programs or on universal
health care; and no repeat of the last month’s shabby spectacle for at least 15
months. All of this was in doubt even a week ago as Congressional
intransigence threatened to make the problem of acceptably raising the debt
limit insoluble. The Hippocratic Oath applies in economics as well as
medicine and so it is no small thing for the Administration to have reached an
agreement that does no immediate harm. It may well be that no
better agreement was achievable given the political dynamics in Congress.
Cynicism. An
objective observer would predict larger U.S. budget deficits in the outyears
than he or she would have predicted a few months ago. The economic
forecast has deteriorated (see
chart below), and it is reasonable to estimate that even a
half-a-percent reduction growth averaged over 10 years adds well over a
trillion dollars to the national debt in 2021.
Despite claims of spending reductions in the $1 trillion
range, the actual agreements reached so far likely will have little impact on
actual spending over the next decade. The deal confirms the very
low levels of spending already negotiated for 2011 and 2012, and caps 2013
spending about where most would have expected this Congress to end up.
Beyond that outcomes are anyone’s guess—the reality is that Congress votes
discretionary spending annually and the current Congress cannot effectively
constrain future actions. True, there are caps and sequester threats
present in the debt limit legislation, but these are virtually certain to be
reformulated in 2013 so the reality was and still is that discretionary
spending going forward will largely reflect the will of future Congresses.
Remarkably for a matter so consequential the agreement
that the Supercommittee will seek
to reduce the deficit by $1.5 trillion comes without any agreement on what
the baseline is from which the $1.5 trillion is to be subtracted. Is the
$1.5 trillion from a baseline that includes or excludes the Bush tax cuts?
Includes or excludes tax extenders and the annual AMT fix? These and
other similar questions are unresolved at this moment.
Baseline arguments are mind-numbing but highly
consequential. Perhaps a current-law baseline will be employed, assuming
a phaseout of the Bush tax cuts, in which case there will be no motivation to
assure repeal of the high-income tax cuts because it will not count toward the
goal. Perhaps, and more likely, in an effort to make deficit reduction
easier a baseline following current policy will be adopted. This would
treat the nonextension of the Bush high-income tax cuts as a $1 trillion tax
increase—hardly a likely outcome given the probable composition of the
Supercommittee.
Economic Anxiety. The United
States’s current problem is much more a jobs and growth deficit than an
excessive budget deficit. This is confirmed by the fact that a single bad economic
statisticmore than wiped out all the stock market gains from the
avoidance of default and the fact that bond yields reached new lows
at the moment of maximum apparent danger on the debt limit.
On the current policy path which involves a substantial
withdrawal of fiscal stimulus when the payroll tax cuts expire at the end of
the year, it would be surprising if growth was rapid enough even to bring
unemployment down to 8.5 percent by the end of 2012. With growth at less
than 1 percent in the first half of the year, the economy is now at stall
speed—with the prospects of adverse shocks from a European financial crisis
that is decidedly not under control, spikes in oil prices, and confidence
declines on the part of businesses and households. Based on the flow of
statistics, the odds of the economy going back into recession are at least 1 in
3 if nothing new is done to raise demand and spur growth.
If these judgments are close to correct, relief will soon
give way to alarm about the United States’s economic and fiscal future.
Among all the machinations ahead, two issues stand out. First, the single
largest and easiest method of deficit reduction available is the nonextension
of the Bush high income tax cuts. The President should make clear that he
will not accept their extension on any terms. Clarity on that
trillion-dollar point, along with very modest entitlement reform, will be
sufficient to hit current deficit reduction targets.
Second, it is essential that the payroll tax cut be
extended and further
measures such as infrastructure maintenance and unemployment insurance
extension be taken to spur demand. There is still time to confirm
Churchill’s maxim that the United States always does the right thing after
exhausting all the alternatives.
Lawrence H. Summers is the
Charles W. Eliot University Professor at Harvard and former U.S. Treasury
Secretary. He speaks and consults widely on economic and financial issues.
Source : Reuters
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