Friday, November 18, 2011

What Is the Least Bad Outcome for the Supercommittee Debacle?

-- Posted by Neil H. Buchanan

In yesterday's post, I discussed the impending failure of the so-called supercommittee to fulfill its purpose -- to propose a ten-year deficit reduction bill that would be fast-tracked through Congress. If the committee does fail, current law -- which could change at any moment, as I discussed yesterday, and as I will explain further below -- says that there will be automatic "trigger cuts" affecting spending on both nondefense and defense programs.

My analysis was mostly backward-looking, because I used the post as an opportunity to explain how a failure by the supercommittee would be worse than a counterfactual history in which we had never created the supercommittee in the first place. The debt ceiling deal in early August 2011 was clearly a bad idea at the time, and it is now clear that it was even worse than we thought -- especially if the supercommittee tries to pretend that it did not fail, by putting together a deal that no one will take seriously and that includes phantom tax revenues.

Paul Krugman's NYT column today weighs in on the supercommittee's bleak prospects, taking a forward-looking perspective (with which I agree). He argues that we should be happy to have the supercommittee fail, not because it will validate the view that the August debt ceiling deal was terrible policy (although Krugman's other writings indicate that he would not disagree with my view on that question), but because "success" by the supercommittee would lead to bad results.

Krugman offers three reasons (not in the order that I am discussing them here) to be happy about the supercommittee's near-certain failure. First, he argues that the economy will be harmed by further spending cuts (or, I would add, non-progressive tax increases), because spending cuts directly cause job losses. Second, he argues that the economy's current position is so bad that cutting spending could actually make the deficit go up, because the consequences of the weakening of the economy (lower tax revenues, and higher safety net spending) would swamp the magnitude of the initial cuts themselves. (Today's column only mentions this argument in passing. For those interested in a numerical analysis supporting that conclusion, Krugman ran through some numbers in a blog post in mid-2010.) Third, he points out that any progress on deficit reduction now will surely be reversed should Republicans return to power, as they will use any deficit reduction now to justify high-end tax cuts later. Therefore, the net result will not be to reduce the long-run deficit picture, but merely to transfer money from Social Security, Medicare/Medicaid, and other nondefense programs to what we now know as "the 1%."

Krugman does not, however, ask whether the automatic trigger cuts might be worse than anything the supercommittee might extrude. Taking this possibility into account cuts against the conclusion that the supercommittee's failure would be a net positive, but not enough to justify rooting for the supercommittee to succeed. Allow me to explain.

Comparing the trigger mechanism with potential supercommittee "success" involves comparing the size of the automatic cuts versus the size of any supercommittee cuts. As I said in yesterday's post, the debt ceiling deal that created the supercommittee gave it the task of finding $1.5 trillion in deficit reduction. One could simply argue, therefore, that the trigger cuts would be better than committee "success" because an economy with 9% unemployment would suffer greater damage from an extra $300 billion in cuts (which would almost surely be composed of spending cuts that harm the middle class and poor).

As it turns out, however, the trigger is only pulled if the supercommittee fails to come up with $1.2 trillion, not $1.5 trillion, a difference of $300 billion. The $1.5 trillion target is thus legally toothless, even though it is the number that is officially the committee's target. (There is an effect on the size of the increase in the debt ceiling, as explained here.) If failure is defined as not proposing $1.2 trillion in cuts, however, then there is no top-line difference between the trigger cuts and what the committee must do to be deemed a success.

Yet even by that standard of success, perhaps surprisingly, the effect on the overall economy is still likely to be worse if the committee succeeds, because it will surely propose cuts that are highly imbalanced, cutting nondefense spending much more than defense spending (if it cuts the latter at all). In what way is this a worse outcome (other than as a matter of distributive justice)? Estimates of the economic impact (both in jobs and GDP) of changes in spending show that defense spending is the least stimulative type of spending (that is, it has a smaller multiplier than does nondefense spending). Therefore, the trigger cuts are likely to be less harmful to the economy in its weakened state.

But what if the committee's success is essentially a sham? In other words, what if the supercommittee avoids the trigger by passing something that does not really involve $1.5 trillion (or even $1.2 trillion) in cuts, but everyone acts as if their proposal meets the statutory requirement? From a straight Keynesian perspective, is this not potentially better than both the trigger and what might be called "honest success" by the committee?

This, however, is where I -- even though I am keenly aware that we are all dead in the long run -- base my conclusion on the prediction that any immediate benefit of smaller budget cuts would be swamped over time by something else. (By the way, Krugman's final argument -- that any cuts will be reversed by Republicans over time -- is not responsive to the possibility under discussion here. If he is concerned about the net redistributive effect over time, he would still be happier with a sham bill, because it would reduce the amount of money being shoveled upward.) The forward-looking part of my argument in yesterday's post was that everyone outside of Congress would see through a sham bill, and the effect of this would be to harm confidence now and going forward, which would likely have harmful effects on financial markets and the real economy.

I do not believe in the Confidence Fairy, who promises to more than offset spending cuts with increased investment spending and hiring by businesses, but I certainly understand that businesses can and do respond badly to political developments that lead reasonable people to believe that the political system is broken. Within very short order, therefore, the political system would be required to come up with an even bigger set of spending cuts to regain the confidence of the business class, which is (misguidedly) obsessed with deficit reduction.

Finally, what about the possibility of changing the law to allow the trigger cuts to be smaller -- making failure less consequential? In that scenario, the committee's failure would be a good thing, but simply because the magnitude of the cuts would be smaller. In that way, failure by the committee would have a numerical impact similar to "sham success" in reducing spending (and thus harming jobs). For precisely that reason, however, the symbolic effect of the failure is the same: a momentary reprieve that would surely be followed immediately by calls for even bigger make-up cuts.

In the end, then, a straight-up failure by the committee -- without shams, and without back-door legislation to reduce the consequences of failure -- actually looks better than the alternatives. Genuine success would cause too much damage to jobs and GDP, and weaseling out will further intensify calls for disastrous austerity measures. The political discussion will surely involve a freak-out no matter what, but the better outcome really does involve allowing the committee to fail outright, at which point everyone will move on to the next battle.

1 comment:

toryburchflats said...

Estimates of the economic impact (both in jobs and GDP) of changes in spending show that defense spending is the least stimulative type of spending (that is, it has a smaller multiplier than does nondefense spending). Therefore, the trigger cuts are likely to be less harmful to the economy in its weakened state.Windows 7 ultimate product Key
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