At best, budget deal suggests decelerating anemic growth, labor market deterioration
Yesterday, my colleague Josh Bivens outlined the contours of this weekend’s 11th hour budget deal, concluding that Congress mostly monkeyed around with upper-income taxes—a politically contentious “fiscal cliff” component, but the least economically significant—leaving large swathes of scheduled fiscal restraint in place (or merely delayed a few months). For months, Josh and I have been arguing that the only real challenge facing Congress is the reality that the budget deficit closing too quickly—as it has been since mid–2010—threatens to push the economy into an austerity-induced recession. To this effect, “cliff” was a doubly misleading metaphor, as there was no single economic tipping point (underscored by President Obama signing the deal on Jan. 2, after the misguidedly hyped Jan. 1 “cliff plunge” had passed) and the legislated fiscal restraint was comprised of fully separable policies rather than an all-or-nothing dichotomy.
Viewed through the proper lens of avoiding premature austerity instead of compromising over tax policy for the top 2 percent of earners, Congress predictably failed to adequately moderate the pace of deficit reduction; short of sharply reorienting fiscal policy to accommodate accelerated recovery, U.S. trend economic growth will continue decelerating into 2013—slowing to anemic growth insufficient to keep the labor market just treading water.1 Absent substantial (seemingly remote) additional spending on public investment and transfer payments, the labor market will almost certainly deteriorate this year, regardless of what happens with sequestration and the pending debt ceiling fight.
I recently explained that the fiscal “cliff,” or rather, fiscal obstacle course debate was intrinsically fixated on maintaining anemic growth versus falling into a recession and deeper depression, not moving toward full recovery. As a rough compass, policymakers need to target real GDP growth above 2.2 percent (the Congressional Budget Office’s estimate of real potential economic growth over 2012–2022) if this depression is to eventually be ended. Trend economic growth for the first three quarters of 2012 registered only 2.1 percent annualized real GDP growth, which is below this benchmark, meaning that sustaining current economic performance would fail to make progress toward restoring full employment. And this budget deal—indeed expiration of the payroll tax cut alone—guarantees that current economic performance will not be sustained.
If all the major components of the fiscal obstacle course were “turned off,” (i.e., scheduled spending cuts repealed and tax increases prevented), we projected that real GDP would grow 3.1 percent in 2013. If, on the other hand, the current policy baseline were adhered to (in which the payroll tax cut and emergency unemployment benefits were assumed to expire and discretionary spending caps continue ratcheting down), we estimated the economy would decelerate to 1.4 percent real growth. And if the legislated fiscal contraction fully materialized (adhering to the current law baseline), CBO forecasted that real GDP would contract 0.5 percent in 2013.2 So how does the enacted deal stack up?
Problematically, the budget deal shrinks the projected budget deficit for 2013 relative to current policy, whereas the economic challenge at hand was moderating the pace of deficit reduction. The biggest economic drags in the fiscal obstacle course were the scheduled expiration of ad hoc fiscal stimulus and the Budget Control Act (BCA) of 2011, but these were only partially mitigated. What follows is an overview of major fiscal headwinds still pending for 2013:
- First and foremost, the expiration of the payroll tax cut is projected to reduce disposable income by $115 billion, shaving 0.9 percentage points from real GDP growth and lowering employment by nearly 1.1 million jobs relative to 2012 fiscal policy.
- The sequester was delayed for only two months, leaving a drag of 0.6 percentage points of real GDP if it materializes for the remainder of the year, or if the sequester is replaced with other spending cuts of a comparable magnitude (e.g., House Republicans voted to replace sequester cuts to the Department of Defense with deeper domestic cuts). This would mean a loss of 660,000 jobs relative to 2012 fiscal policy.
- The phase-one BCA discretionary spending caps will ratchet down, shaving 0.4 percentage points from real GDP growth and reducing employment by roughly 530,000 jobs relative to pre-BCA law.
- The Emergency Unemployment Compensation (EUC) program was extended, but only for a maximum duration of 73 weeks and to the cost of $30 billion in 2013, down from $39 billion in inflation-adjusted outlays for 2012 (when a maximum duration of 99 weeks was in effect for much of the year). Relative to 2012 fiscal policy, this implies a drag of 0.1 percentage points and 100,000 fewer jobs.
- The partial expiration of the upper-income Bush-era tax cuts (see Josh’s post) will shave less than 0.1 percentage points from real GDP growth and reduce employment by roughly 80,000 jobs, relative to 2012 fiscal policy.
- Downward revisions to discretionary spending caps and offsets paying for continuation of the Medicare “doc fix” would exert a slight additional drag.
Relative to fully mitigating the obstacle course components, these remaining drags imply 2.1 percentage points shaved off real GDP growth and more than 2.4 million fewer jobs in 2013. This suggests real GDP growth just above an anemic 1.0 percent for 2013. Relative to the 1.4 percent real growth we projected under current policy, the unaddressed bulk of pending sequestration cuts and the slight drag from partial expiration of the upper-income tax cuts exceeds the boost from continuing emergency unemployment benefits for up to 73 weeks. Even if the sequester is fully repealed without offsets—a best case policy scenario, but seemingly unlikely—real GDP growth of roughly 1.6 percent would be expected. Regardless, real growth rates anywhere in the range of 1.0 percent to 1.6 percent for the full year suggest deterioration in the already distressed labor market.
This debate was always about averting a recession in favor of maintaining anemic growth rates. That may have been accomplished by the budget deal, although much uncertainty surrounds sequestration and the statutory debt ceiling. But this bar for political horse-trading was always set appallingly low. The United States is still mired in a severe jobs crisis, and it’s a safe bet this jobs crisis intensifies in 2013 because of premature budget austerity and policymakers’ abdication of promoting full employment.
1. The decline in the headline unemployment rate masks that the labor market has largely been treading water. Ceteris paribus, adding 3.9 million unemployed workers “missing” from the labor force (for cyclical as opposed to structural reasons), the headline unemployment rate would be roughly 10 percent.
2. Growth projections for 2013 are all measured from 4Q2013 relative to 4Q2012, extrapolated from CBO’s Aug. 2012 economic baseline. CBO’s economic baseline reflects current law, and current policy and various policy scenarios are modeled from our à la carte menu of the major fiscal obstacle course components’ economic drags as well as CBO’s cost estimate of the American Taxpayer Relief Act (H.R. 8).