Recommendations for successfully navigating the fiscal obstacle course
Yesterday, my colleague Josh Bivens and I released a paper, Navigating the fiscal obstacle course, intended to offer a realistic blueprint—one that accounts for the constraints regrettably imposed by the current political climate—for how policymakers should navigate the so-called “fiscal cliff” of legislated spending reductions and expiring tax cuts scheduled for 2013. At its core, the fiscal cliff reveals the macroeconomic reality that budget deficits closing too quickly—thus public debt accumulating too slowly—will, if left unaddressed deep into 2013, push the U.S. economy into an austerity-induced recession. Contrary to the misplaced but pervasive inside-the-Beltway hand-wringing of recent years about rising public debt, this outlook implies that big budget deficits and rising public debt have been sustaining growth and economic recovery in recent years. The only way for policymakers to successfully navigate the scheduled fiscal restraint is to substantially moderate the pace of deficit reduction while the economy remains depressed—meaning for several years at minimum.
FULL ANALYSIS FROM EPI: Budget battles in the lame duck and beyond
Our recommendations build on our analysis from a recent paper, A fiscal obstacle course, not a cliff, which argued that “cliff” is a terrible metaphor because it implies a false dichotomy; we prefer “obstacle course” as the numerous separable policies should be weighed on their economic and budgetary impacts, which we decomposed as an “à la carte” menu for interested parties. Accordingly, we propose a package of policies that would jettison economically ineffective measures while fundamentally reorienting fiscal policy in order to support job creation—i.e., increasing near-term budget deficits relative to current policy.
We previously concluded that expiration of the remaining temporary stimulus—notably emergency unemployment benefits and the payroll tax cut—and implementation of Budget Control Act (BCA) spending cuts pose the biggest impediments to growth, respectively; we propose cost-effectively mitigating these drags. We also propose allowing the upper-income Bush-era tax cuts and recent estate tax cuts to expire on schedule as we concluded these are the least supportive of jobs of all the fiscal obstacle course components and most starkly fail cost-benefit analysis. Lastly, we concluded that small economic drags from raising taxes—particularly on upper-income households—can easily be more than offset with efficient, temporary fiscal support that trades bigger near-term deficits and greater economic growth for medium– and long-run deficit reduction.
Our blueprint would direct half the savings from allowing the upper-income Bush tax cuts to expire (roughly $600 billion over the next decade) to finance cost-effective fiscal stimulus, mostly over the next three years. Our top priorities for job creation are: emergency unemployment benefits; aid to state governments; infrastructure investment; investing in teachers and school modernizations; and a targeted tax rebate to cushion the expiration of the payroll tax cut in 2013. These investments would make fiscal policy more supportive of recovery over 2013—2015, while leaving another $600 billion in revenue as a down-payment on long-run deficit reduction, all relative to current policy.
Our blueprint would boost economic growth by 1.7 percentage points and generate more than 2 million jobs in 2013 while reducing the 10-year budget deficit by $651 billion, relative to current policy. Notably, our approach would also avoid another sharp fiscal contraction in 2014 similar to the one currently facing Congress; emergency unemployment benefits would be extended for three years, aid to states would be gradually wound down, and infrastructure spending would gradually ramp up. This blueprint’s recommendations are weaker medicine than what is needed for a rapid return to full employment, but they would accelerate recovery while meeting the misguided but pervasive political constraint that near-term economic support be paired with a down payment on longer-term deficit reduction.
Accelerating recovery relative to current policy is critical, because the current policy baseline assumes that much of the pending fiscal contraction does materialize: notably, it assumes the payroll tax cut and emergency unemployment benefits expire and discretionary spending caps (the first phase of the BCA) continue to ratchet down, collectively shaving 1.7 percentage points from real GDP growth in 2013. Policymakers and the media have largely ignored these drags, fixating instead over the expiring Bush-era tax cuts and pending automatic “sequestration” BCA cuts, but these account for less than one-third of the economic drag scheduled for 2013. Sequestration does pose a big risk to growth and we recommend that it be repealed, as is widely assumed Congress will do and is baked into the current policy baseline. Extension of the Bush tax cuts is also baked into the current policy baseline, but while the tax cuts loom large in budgetary terms, they offer little economic support. Successfully navigating the obstacle course requires mitigating economic drags outside an extension of current policy, particularly the expiring stimulus.
Fortunately, policymakers clamoring to “avoid going over the cliff” are making fundamentally Keynesian arguments—whether explicitly or implicitly—and are acknowledging the need to moderate the pace of deficit reduction in order to support jobs. Ecumenical concern about the fiscal cliff—found on both sides of aisle—has finally put policymakers on a more productive trajectory, pivoting back to prioritizing job creation over near-term deficit reduction, which is inherently at odds with moving back toward full employment.
Rapidly restoring full employment—which should be the top policy objective—would take more than simply reshuffling components of the fiscal obstacle course, the intentionally limited focus of our paper. Closing the output gap (the barometer for restoring full employment) would take something on the order of $700 billion worth of deficit-financed stimulus in 2013 alone, relative to current policy, with more needed in subsequent years to prevent an even bigger subsequent fiscal obstacle course. But even working within perceived political constraints, fiscal policy can be reoriented to be more supportive of jobs and sustaining recovery. Diverting savings from the policies least supportive of jobs to those most supportive of jobs is the most sensible way to expand near-term budget deficits while meeting the constraint that stimulus be paired with a down payment on long-term deficit reduction.