The Progressive Caucus’s sensible approach to sequestration: Prioritizing jobs and growth

Congressional Progressive Caucus (CPC) Co-Chairs Rep. Keith Ellison (D-MN) and Rep. Raúl Grijalva (D-AZ) have introduced the Balancing Act of 2013 (H.R. 505) which presents an evidence-based approach to two imminent challenges actually facing policymakers: preventing what is intentionally terrible budget policy from taking effect, and preventing budget policy from exacerbating the jobs crisis and counterproductively delaying a return to full employment.

Broadly speaking, their bill would replace the entirety of the pending automatic “sequestration cuts”—now legislated to commence March 1—with $948 billion in progressive revenue (much of which was proposed in the CPC’s budget fiscal 2013 alternative, the Budget for All) coupled with $276 billion in near-term economic stimulus, paid for with $278 billion in cuts to spending by the Department of Defense. Replacing the sequester with revenue would bring net spending cuts and revenue increases roughly to a 1:1 ratio, and the DOD spending reductions would bring nondefense and defense discretionary spending cuts to a 1:1 ratio (measuring deficit reduction since the start of the 112th Congress, notably $1.5 trillion in discretionary spending cuts and $633 billion in policy savings from the lame duck budget deal). And most critically, the bill would balance deficit reduction with near-term measures boosting growth and employment, while making the composition of deficit reduction less economically damaging than scheduled.

With Congress having voted to suspend the statutory debt ceiling until May 19—preventing, for the time being, the threat of sovereign default being used to extract spending cuts—the next big budget and economic policy fight will be over sequestration, which the American Taxpayer Relief Act of 2012 (i.e., the lame duck deal, or ATRA for short) merely prevented for two months. Under current law, the Budget Control Act (BCA) of 2011 still requires the Office of Management and Budget to sequester (i.e., cut) $948 billion of government spending, split between defense and nonexempt domestic programs, over the next decade. Remember, the sequester was designed to be so politically unpalatable and damaging (as a share of GDP, the scheduled cuts are frontloaded—a terrible design for economic recovery and programmatic implementation) that it would force the since-disbanded Joint Select Committee on Deficit Reduction to compromise on more sensible deficit reduction. Clearly, that never happened.

But as we have previously explained, ATRA left in place sizable fiscal headwinds for 2013 by inadequately mitigating the two largest biggest economic drags among the major components of the fiscal obstacle course—the expiration of ad hoc fiscal stimulus and the BCA. The payroll tax cut was allowed to expire, emergency unemployment benefits were extended (but at a shorter duration and smaller economic boost than for most of 2012), and the first BCA phase of discretionary spending caps were entirely unaddressed. Relative to fully mitigating the fiscal obstacle course drags, the trajectory for federal fiscal policy implies a drag of between 1.5 percentage points and 2.1 percentage points, depending on whether the sequester materializes or, if avoided, the degree to which and when it’s repeal is offset. Adjusting from CBO’s August 2012 economic forecast, this would imply anemic real GDP growth of 1.0 percent to 1.6 percent—estimates consistent with those of Goldman Sachs, among others—suggesting renewed deterioration in the distressed labor market, as trend real growth rates of 2.0 percent to 2.5 percent are needed just to keep the unemployment rate treading water.

Just as austerity measures can easily scuttle a depressed economy’s recovery, increased spending to boost demand is the most effective policy lever for accelerating growth. The Balancing Act would boost growth by investing $150 billion in near-term surface transportation infrastructure, $10 billion to establish an infrastructure bank, $55 billion in K-12 school modernization and rehiring teachers, and $61 billion to reinstate the Making Work Pay (MWP) tax credit for 2013. These are all cost-effective job-creation measures with fiscal multipliers (the amount of economic activity generated by year’s end per dollar spent) exceeding 1, meaning that this would actually reduce the debt-to-GDP ratio next year.1 Increasing public investment is a no-brainer in the midst of a jobs crisis and during a period of near-record low financing costs (it’s largely self-financing in the near-term and public investment is a key driver of long-term productivity growth). Reinstating MWP would cushion the impact of expired payroll tax cut for lower- and middle-income households—at half the cost of the payroll tax cut because of its more progressive phase-in and phase-out rates.

On net, we estimate that these stimulus measures would boost real GDP growth by 1.0 percentage point in 2013, increasing nonfarm payroll employment by over 1.2 million jobs for the year, relative to current policy. These calculations, however, ignore any near-term economic drags from cutting defense spending and (lesser drags) from progressive revenue increases due to data limitations (there is no year-by-year CBO cost estimate). But these pay-fors have the advantage of minimizing near-term fiscal headwinds because progressive revenue increases are, per dollar, the least economically damaging option for deficit reduction and the DOD cuts would presumably be back loaded. Based on proxy phase-in rates, the combination of progressive revenue increases and DOD cuts might reduce the net stimulative impact by 0.2 percentage points real GDP growth and roughly 270,000 jobs, again relative to current policy.2 But that would still mean a net boost of 0.8 percentage points to growth and nearly 1 million additional jobs by the end of 2013. This would likely reorient federal fiscal policy from slowing growth to the point of a deteriorating labor market to actually boosting trend growth for the year (based on our estimate of 1.6 percent real GDP growth without sequestration).

Note also that the current policy baseline used in the above calculations assumes sequestration will not occur, which is by no means guaranteed. Should sequestration take effect for the remainder of 2013, we estimated it would slow growth by 0.6 percentage points and reduce employment by 660,000 jobs—and outcome that the Balancing Act would ensure against.

Deficit reduction should take a back seat to restoring full employment, period: if depression and cyclical budget deficits persist, contrary to CBO’s forecast, the fiscal outlook deteriorates markedly and trillions of dollars of actual income and potential future income will be forgone. But if political constraints dictate otherwise, weighting the composition of budgetary savings heavily toward progressive revenue and coupling savings with near-term stimulus spending is the evidence-based second best approach. The Balancing Act would accelerate growth and lock in more efficient, less economically damaging deficit reduction than that enacted to date, while stimulus spending would actually improve the debt-to-GDP ratio. That’s as sound as Congressional budget policy gets these days.

1. According to Moody’s Analytics chief economist Mark Zandi, the fiscal multiplier is 1.44 for infrastructure investment, 1.31 for general aid to state governments (i.e., funds for rehiring teachers), and 1.18 for MWP.

2. Year-by-year progressive revenue increases are modeled from the bill’s stated ten-year total using the implicit phase-in rate for upper-income tax provisions from OMB’s Mid-Session Review of the president’s budget request for fiscal 2013. Year-by-year DoD cuts are modeled from the ten-year total using the implicit phase-in rate for base DoD cuts from the CPC’s Budget for All. Fiscal multipliers of 0.35 and 1.4 are assigned, respectively (Zandi’s estimate for extending all the Bush tax cuts—an intentionally conservative estimate—and general government spending, respectively).

  • benjclaassen

    Tax and Spend
    This is a favorite description of our US government from fiscal conservatives. More correctly, tax, borrow and spend—until a cry for deficit reduction occurs. Deficit reduction means to get a closer match between tax collections and spending so as to borrow less than last year. Political voices (hard to call them leaders) do different math on the problem. GOP tea party math is geared to cutting spending where they do not like it – call that “social programs”. DEMO Math may agree to some cuts but sees social spending and stimulus spending as actually yielding a deficit reduction.
    Economists are writing the story from both directions. Austerity measures in math 1 lower the deficit. It is simple, just spend less! In math 2, we see that the government money that would be cut is in virtually everyone’s paycheck. A soldier gets paid and his dollars show up in many more pay checks – a barber for his hair cut, a clerk for checking his groceries, retail stores where he bought his video games and his music. Drastic government austerity would remove money from every paycheck and could cause a meltdown of the whole economy. Math 2 may say that stimulus spending is a miracle. If the dollar moves along enough, the tax taken from the many paychecks is more than the new spending.
    More exact math shows that each cycle in domestic spending pulls income tax money out of each paycheck and the total income tax for many cycles is not enough to cover the stimulus spending. Each spending cycle also includes money sent to a foreign government to pay for oil or to pay for a worker in China. Money leaves the system and flows to illegal drug smugglers and is laundered to be spent in foreign countries while incurring no tax liability. My guess is that some of the cash money for drugs comes from earned income tax credits and black market sales of food stamps. This exported money displaces money for a US paycheck.
    Only the creation of private sector jobs adds new taxes that are not driven mostly by government spending. The cash to support these jobs can come from less spending on foreign products or the export of American goods and services to countries that have dollars to spend. Some would say that a tax cut adds spending money that creates a new job; however, the tax cut adds to the deficit and is no different than borrowing money for a stimulus package.
    A drain on the economy occurs when “spending money” decreases. A worker may have to pay a higher amount for goods and services that provide him with no higher value. A $3-gallon of gasoline provides the same value as a $4-gallon and one less dollar is available for other domestic purchases. Since most people are dependent on cars for moving around, gasoline price is very inelastic. People keep buying almost the same amount of gasoline even when prices increase. A medical procedure that costs more each year can be automatically supported by increased health insurance rates. If a person feels that some medical procedure is needed, the price will not matter. They will spend the money even if they face bankruptcy to pay for the procedure. Particularly in old age, the procedure may not even add value in an extension of good health and life. As these costs grow without limit, there will be less money to buy other things.
    In many cases, the government spending on “social programs” has no mechanism to cap the total spending. The programs respond with cash during setbacks to the economy in which more people ask for support and less tax is collected. These programs have the potential to create a “runaway train” in the deficit. The programs have no feedback loop to compare the cost with the value. We can picture that these programs can suck the “spending money” from everything else or create an open checkbook with endless borrowing to pay the cost.
    To repeat, only the creation of private sector jobs adds new taxes that are not driven mostly by government spending. Jobs that we all would call a private sector job are not equal in supporting economic growth. As more jobs are ultimately supported by the runaway train, the deficit grows and the US becomes less productive, less competitive and less able to generate real new cash from exports.
    A clever slogan is, “cap and trade”. As refers to carbon emissions and the certain science of global warming, cap and trade means that a limit (cap) is set for green house gas emissions and the “rights to emit” are traded in an open market. This approach asks each owner of a source that emits green house gases to define the value for him to emit and be willing to buy extra allowances if his perceived value exceeds the cost of the allowances. The “cap and trade” system would end the freedom to emit unlimited green house gases for free with no regard to environmental impacts. The point of this digression is that the government spending in the runaway train programs needs some kind of cap and trade that caps total spending and adds a cost/benefit feedback loop.
    We have reached the roadblock. The elected leaders and individual citizens do not want to accept either kind of cap and trade. Magical thinking of “spend more in a stimulus” or “just stop spending too much”, are on the front page. Powerful people who are getting the cash flow keep their candidates in office. Hard choices are not open for discussion. At this moment, gasoline prices are headed up. To our credit the US is becoming more fuel efficient and importing less oil; however, each extra dollar spent for gasoline will slow the economic recovery. Each dollar cut for austerity will also cost jobs. Each lost job has the potential to move more people to ride the runaway train. Uncapped medical costs, insurance rates, food stamp allowances, earned income tax credits, and unemployment payments prevent any deficit reduction and also make the US less competitive in creating real jobs.
    Hard choices need to cap the total cost of government programs in belt tightening that will lower the deficit or more correctly cap the deficit. Well designed program changes can retain some value for those who really need assistance. An incentive to work will result when the safety net life style is not as desirable as a minimum wage working lifestyle. Stimulus spending to improve the US productivity has the potential to create real private sector jobs in which goods and services sell at competitive prices in world markets. Better education has the potential to have fewer minimum wage jobs or higher minimum wages.
    Each year as a person ages he lives with more uncertainty for the future. The aging baby boomers will create a swell of elderly people. Good health is a goal for everyone. Allowing medical providers to be honest with patients about future benefits from costly medical procedures is one way to help to cap the costs, particularly for the last months of life. Food and housing will be needed for poor people, the disabled and the elderly. As money is short some quality of life declines must be accepted. A redefines safety net life style will be needed to cap costs. Politically, it is hard to make these changes; economically, these changes are unavoidable.