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Tuesday, July 5, 2011

DEBT LIMITS AND POLITICS

 
 
The clock keeps ticking towards the forecast August 2, 2012 point when the nation's debt will exceed the legal limit. So far, negotiations between the Obama Administration and Senate Democrats and the Republican leadership in the House of Representatives have resulted only in stalemate. A failure to pass legislation to raise the governments legal limit for federal debt would, most economics and financial experts agree, create market conditions for U.S. debt instruments, which would range from highly negative to disastrous, with significant ripple effects throughout the domestic and international economies.

The political stalemate, in simple terms, involves the ideological divide over the solution to the long term financial health of the nation. Obama and congressional Democrats believe that budget deficits and their impact on the ever growing federal debt can only be reduced by a combination of spending reductions and revenue increases i.e. taxes. Republicans, including many elected with the help of the "smaller government" Tea Party activists in 2010, reject the notion of any tax increases outright and demand much higher levels of spending reductions than the Democrats are willing to approve. The Republicans have said there will be no debt limit increase without an agreement for significant spending reductions.

The situation is like an impending train wreck while the engine crew argues about which side rail to take. It is thus ripe for compromise. The danger is the current "game of chicken" might go on to long for a compromise to be constructed by the statutory dead line.

The President has admitted that spending must be brought under control but his past proposals have been woefully inadequate given the astronomical character of the numbers involved. Obama is a compromiser by nature as the previous continuing resolution to keep the government running without a budget has shown. In that compromise, Obama agreed to extend the current tax rates of the so called "Bush tax cuts" and to several billion dollars in spending cuts. Republicans should remain strong in their demands for more significant spending cuts. However, the enormous numbers involved also should make it obvious that revenue increases must also play a part if the deficits and debt are ever to be reduced.

Now is not the time for a full scale redesign of the federal tax code which is indeed needed. But the President's 2010 Bipartisan Commission on Fiscal Responsibility and Reform contains some suggestions which the House Republicans should, and could, agree to while still adhering to their basic philosophy of "no tax increases", if accompanied by the Commission's ideas on spending reductions. The President and congressional Democrats have largely disowned the Commission's report, largely because of their suggestions on reforming entitlements (Social Security and health care), and the Republicans have essentially ignored it. But it could, in part offer a way out of the current debt increase stalemate. Here is an excerpt from the Commission's final report.

 First, on spending:
"Over the past decade, base discretionary spending (excluding war costs) has grown by 34 percent in inflation-adjusted dollars (64 percent in nominal dollars), and the President’s Fiscal Year 2011budget projects it to grow by an additional 6 percent to $1.26 trillion in 2015. In order to bring down the deficit, Washington will have to rein in discretionary spending."

"RECOMMENDATION 1.1: CAP DISCRETIONARY SPENDING THROUGH 2020. Hold spending in 2012 equal to or lower than spending in 2011, and return spending to pre-crisis 2008 levels in real terms in 2013. Limit future spending growth to half the projected inflation rate through 2020." 
Under the Commission proposal, discretionary spending would be frozen at 2011 levels.
The estimated budget saving for discretionary spending only are 1 trillion, 760 billion dollars through the year 2020.

On taxes:
"Lower rates, broaden the base, and cut spending in the tax code.

"2.1.2 Dedicate $80 billion to deficit reduction in 2015 and $180 billion in 2020. In additional to reducing rates, reform must be projected to raise $80 billion of additional revenue (relative to the alternative fiscal scenario) in 2015 and $180 billion in 2020. To the extent that the dynamic effects of tax reform result in additional revenue beyond these targets, excess funds must go to rate reductions and deficit reduction, not to new spending. "The Commission's recommendations need not be addressed in their totality as part of the debt limit discussions but these key portions offer a sensible place to start meaningful negotiations. "Tax expenditures" refer to legal deductions in the current tax code. Many of these deductions are referred to as "loopholes" and their elimination should not be identified collectively as "tax increases". When combined with lower tax rates, the reform both simplifies the tax code and makes it more efficient. The point is that the huge spending cuts demanded by the Republican negotiators will not be accepted by the Democrat controlled Senate unless accompanied by some revenue enhancement which could be made both ideologically more palatable and which make good sense in the form of reduced deductibles and lower rates.


The current head banging demagoguery by the President and the by the congressional leadership on both sides just makes this vital legislative action more difficult and further enhances the current level of cynicism by the public on the willingness and ability of their elected officials to serve the public interest. The President's current job approval rate stands below half, at 47.5% and the Congress's job approval is practically off the bottom of the chart at 17.2%. This latest exercise in political an ideological obstinacy is just another example which explains these numbers.

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