On Deficit Commission Proposals

November 10, 2010

Senator Alan Simpson and Erskine Bowles appeared to have largely ignored economic reality in developing the proposals they presented to the public today.

The country is suffering from 9.6 percent unemployment with more than 25 million people unemployed, underemployed, or who have given up looking for work altogether.  Tens of millions of people are underwater in their mortgage and millions face the prospect of losing their home to foreclosure.

This situation is not the result of government deficits, contrary to what Mr. Bowles seemed to suggest at the co-chairs’ press conference today.  The downturn was caused by the bursting of an $8 trillion housing bubble.  This bubble was the basis of the construction and consumption demand that drove the economic expansion through 2007.

The large government deficits are the only factor sustaining demand following the loss of this bubble wealth.  If today’s deficit were smaller, we would not be helping our children; we would just be putting their parents out of work.  Simpson and Bowles somehow think they have covered this concern by delaying their cuts until fiscal year 2012, 11 months from now.  Virtually all projections show the unemployment rate will still be over 9.0 percent at the point when the Simpson-Bowles cuts begin to slow the economy further.  This leaves the economy like a plane with one engine already out and Simpson Bowles prepared to knock out the other engine as well.

The failure to understand current deficits contributes to a misunderstanding of the debt burden.  For example, Simpson and Bowles raised fears of an exploding debt reaching 90 percent of GDP by the end of the decade.  There is no reason that the Fed can’t just buy this debt (as it is largely doing) and hold it indefinitely.  If need be, the Fed can use other tools at its disposal to ensure that this expansion of the monetary base does not lead to inflation.

This creates no interest burden for the country, since the Fed refunds its interest earnings to the Treasury every year.  Last year the Fed refunded almost $80 billion in interest to the Treasury, nearly 40 percent of the country’s net interest burden.

This means that the country really has no near-term or even mid-term deficit problem, just paranoia being spread by many of the same people who led the economy into its current disastrous situation.

Over the longer term, the country is projected to face a deficit problem but this is almost entirely attributable to the projection that private sector health care costs grow at an explosive rate.  This projected growth rate of health care costs would eventually lead to serious budget problems in addition to leading to enormous problems for the private sector.  However, the underlying problem is the broken health care system, not public sector health care programs.  For some reason, though, Simpson-Bowles never directly addresses these of the health care system.

Simpson and Bowles apparently never considered a Wall Street financial speculation tax (FST) as a tool for generating revenue.  This is an obvious policy-tool that even the IMF is now advocating, in recognition of the enormous amount of waste and rents in the financial sector.  Through an FST, it is possible to raise large amounts of revenue, easily more than $100 billion a year, with very little impact to real economic activity.  The refusal to consider this source of revenue is striking since at least one member of the commission has been a vocal advocate of financial speculation taxes.  It is also worth noting that Mr. Bowles is a director of Morgan Stanley, one of the Wall Street banks that would be seriously impacted by such a tax.

Finally, it is striking that the co-chairs felt the need to address Social Security, even though it was not part of their mandate.  The commission’s mandate was to deal with the country’s fiscal problems.  Since Social Security is legally prohibited from ever spending more than it has collected in taxes, it cannot under the law contribute to the deficit.  Their proposal would cut benefits for tens of millions of middle class workers who are overwhelmingly dependent on Social Security for their retirement income.  It would also raise the retirement age for lower income workers who have seen little increase in life expectancy.

While there are some positive items in the report (it would limit the mortgage interest rate deduction and get rid of the deduction for cafeteria benefit plans), it suffers from the fact that the co-directors never reflected on their basic economic assumptions.  It is hard to avoid the conclusion that this exercise was a waste of time and that we should go back to having Congress determine our budgets through the normal process rather than secret commissions.

Dean Baker is an economist and Co-director of the Center for Economic and Policy Research, in Washington, D.C.  This letter was published by CEPR on 9 November 2010 under a Creative Commons license.  This statement was first published by CEPR on 10 November 2010 under a Creative Commons license.

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