Unless President Obama drastically changes his goals and his tactics, the current round of budget negotiations can only lead to deeper spending cuts. Here's why.
The Two Roads to Fiscal Balance. Before we explore why the politics of budget cutting now favor the Republicans, let's keep in mind the economics: There are two possible roads to improved fiscal balance. Let's call them Road A and Road B. (By fiscal balance, I mean getting down a deficit that keeps the debt ratio stable, let's say 2 percent of GDP.)
Road A requires stringent cutting of the budget, which slows economic growth and gets us to fiscal balance at a relatively lower level of economic output. This, after all, was the widely touted danger of the original fiscal cliff -- too much deficit cutting too fast, pushing the economy back into recession.
Road B targets higher deficits for a few more years, uses public investment to stimulate a stronger recovery -- and the improved growth rate reduces the deficit ratio over the next decade. We get to fiscal balance a higher level of economic output. That's what happened during and after World War II, when the debt ratio was 120 percent of GDP in 1945 (compared to 72 percent today) and declined to under 30 percent by the late 1970s thanks to the postwar boom.
Unfortunately, Road A is the preferred path of all Republicans, much of the mainstream media, the business elite, the Fix the Debt campaign, and half the Democratic Party, including the Obama White House.
Road B is embraced by most of the Congressional Democratic Party, economists like Paul Krugman and Joseph Stiglitz, the labor movement and think tanks like the Economic Policy Institute, Demos, and the Center on Economic and Policy Research (and the lessons of economic history.)
Due to the previous actions and pronouncements of the Obama Administration and pressure from Republicans, Road A -- severe budget cuts that will worsen a lingering economic slump -- is the path that we are on. And unlike in the first round of the fiscal cliff negotiations, when Republicans grudgingly agreed to hike taxes on the top one percent, the tactical advantage now lies with the Republicans.
The Budget Cuts Baked into the Cake. When President Obama appointed the Bowles-Simpson Commission in 2010, and then agreed to the terms of the Budget Control Act of 2011, he reinforced the conventional wisdom that the road to recovery is paved with deficit reduction. At one point in the bargaining with Speaker John Boehner, Obama was willing to cut both Medicare and Social Security.
As recently as his introduction of Jack Lew as his nominee for treasury secretary last week, Obama praised Lew for having delivered budget balance while President Clinton's OMB director, reinforcing yet again the image of balanced budgets as an economic holy grail. And when Obama made his New Years deal to hike taxes just on the top one percent, he left a huge hole -- to be filled with spending cuts.
The Budget Control Act of 2011 has already cut domestic spending by $1.5 trillion over a decade. Even without further cuts, this will cut non-defense discretionary spending from just under 6 percent in 2009 to less than 2 percent by the end of this decade -- a two-thirds cut. That includes everything else the government does (except social insurance and food stamps) -- everything from flood control to education aid to anti-poverty programs. So the budget cuts already agreed to will cut domestic spending rates back to those of the early Eisenhower years.
It Gets Worse: the Tax Deal. Restoring taxes on just the top one percent got only about 12 percent of the Bush tax cuts back. Nobody expected taxes to be increased back to the Clinton-era rates on everyone, but the revenue gain was far more meager than anticipated by the White House budget planners.
Obama's budget for fiscal year 2013 assumed that tax hikes on everyone earning over $250,000, not $450,000 and closing other loopholes would, produce revenue gains of $1.433 trillion over a decade. But the actual New Years deal produced only about $600 billion. So the hole is close to a trillion dollars bigger than Obama assumed. According to the Congressional Budget Office, the net effect of the deal, which left lower tax rates intact on the bottom 99 percent and extended other tax breaks, is to increase the projected deficit by $4 trillion over ten years.
In his own proposed budget for 2013, Obama proposed deep cuts in domestic spending, even without this deal. In Obama's own budget, discretionary domestic would fall from 5.8 percent in 2009 to 3.1 percent in 2011 and just 1.8 percent in 2018. He proposes to spend less on education than George W. Bush did. And this is just the starting point from which Republicans will demand further cuts.
In submitting the fiscal 2013 budget, Obama's Office of Management and Budget rather heroically assumed that growth would rebound to 2.7 percent for 2012 (it will be just over 2 percent), to 3.0 percent this year, and 4.1 by 2015. Since the recession hit, all of the growth projections by OMB and CBO have been overly optimistic, and these are, too.
At various points in budget negotiations, the president has talked of $2.50 in spending cuts for every dollar of tax hikes, or, more recently, a dollar of cuts for every dollar of tax increases. In the New Years deal, he did he insist on all tax increases and no spending cuts. But that partial deal was just the first step in ongoing budget talks. If you believe, as the president and his treasury secretary-designate, Jack Lew do, that we need deeper deficit cuts, those cuts will come out of reduced spending.
The Tactical Tilt. Having gone back on their pledge not to raise taxes on anyone, the Republicans are now loaded for bear. The vote on taxes temporarily split Boehner's caucus, cheering progressives, but Congressional Republicans are now united on the proposition that the next round has to be spending cuts -- big cuts.
Indeed, this demand is the one thing that holds their Caucus together.
In the New Years bargaining, Obama had the upper hand: If the Republicans blocked the deal, taxes would rise on everyone because of the expiration of all the Bush tax cuts. But in the next round if Congress fails to act, the Sequester of automatic cuts hits -- $110 billion this year and $1.1 trillion over a decade. So this time, unless Obama is willing to play a much tougher bluffing game than in the past and let the Sequester take effect if necessary, the Republicans can wait for Obama to move toward their position.
The issue of whether Republicans will block the debt increase is a sideshow. In the end, they won't. This is one place where Obama has drawn a line in the sand; editorial opinion is firmly against Republicans playing cute with the debt ceiling; and business elites who supported Republicans in the 2011 election are now warning Republicans not to mess with securities markets.
But the main show is pressure to cut spending, using the cudgel of the Sequester; and here both the arithmetic and the tactical situation are on the Republicans side. Unless, that is, Obama changes his stance on the deficit and the recovery.
He could easily point to the jobs numbers, which are feeble, the need for massive public investment in the aftermath of Superstorm Sandy, more public outlay to prepare for future storm surges -- declare that additional deficit reduction is a bad idea until we get a stronger economy.
According to the Office of Management and Budget, if we make no more further spending cuts beyond the ones that Obama has already proposed or accepted, the deficit declines to 3.9 percent of GDP in 2014 and 3.4 percent in 2015. Given the weak economy, that's about as fast a pace of deficit reduction as we can stand, maybe even too fast. If we raise taxes on the rich by closing more loopholes and use the proceeds for public investment, the economy will grow at an even faster rate and the deficit will come down faster.
The only spending cuts that Obama should even consider in the upcoming talks are in three areas: changes in the Medicare drug program to allow the government to bargain with drug companies for bulk discounts (as the VA system does), something explicitly prohibited by the privatized "Medicare" drug program sponsored by President Bush; other efficiency gains in Medicare and Medicaid that do not reduce necessary health care; and cuts in military spending. All other cuts in domestic outlay should be off the table.
But cuts in those categories do not add up to enough money to produce the $4-5 trillion scale of deficit reduction that the President has previously embraced, on the premise of Road A. That's why he needs to shift to Road B.
CBO's Voodoo Economics. One oddity in this story is the refusal of the generally respected Congressional Budget Office to recognize that drastic cuts in deficits in a still weak economy would slow the rate of recovery. If you look at CBO's different scenarios for the years after 2013, they assume that the economy would return quickly to normal even in the face of deep budget cuts.
CBO calculates that even if Congress had repealed all of the Bush tax cuts, causing a massive fiscal contraction, "The pace of economic expansion will average 4.3 percent from 2014 through 2017," and unemployment will fall to 5.7 percent by 2017.
This assertion is just preposterous and contradicts CBO's own one-year analysis of the fiscal cliff. When CBO was asked to "score" the impact of the so-called fiscal cliff of massive cuts occurring in a single year, CBO correctly recognized the contractionary impact of abrupt cuts, warning that it would the economy back into recession.
But this was in a situation when both Republicans and Democrats in a divided Congress were eager, for their own reasons, to have CBO emphasize the catastrophic impact of the cliff.
While CBO is ostensibly technical and non-political, it operates in a political cauldron. If CBO's model recognized the plain economic reality that a slower path to deficit reduction -- less budget cutting -- would stimulate higher growth, Republicans would have a fit.
No less a figure than Olivier Blanchard, chief economist of the International Monetary Fund, recently published a very brave technical paper in which he calculated that the budget cutting imposed on European nations by the EU leadership and his own IMF were having three times the contractionary affects assumed by the models. That's why the more that Greece, Portugal, Spain and Ireland cut their budgets, the more their deficits increase -- because the austerity raises unemployment and slows the economy.
CBO director Doug Elmendorf should display some of Blanchard's professional and political courage.
Splitting the Progressive Community. One consequence of Obama's embrace of more deficit-reduction than is sensible economics is to split the progressive community.
Some, like Robert Greenstein of the Center on Budget and Policy Priorities, have been willing to accept some cuts in Social Security through a revised cost-of-living formula. Greenstein's premise is that adjustments to Social Security are needed anyway, and that if some of the pain does not come out of social insurance programs then even more cuts will have to come from programs for the poor.
Others, such as the AFL-CIO have tried to hold the line and press the Administration to commit to no cuts in social insurance or other domestic spending, other than at the expense of drug companies and other vendors who abuse the system.
The broader problem is that if Obama agrees to program cuts, then advocates for different programs will be played off against one another, fighting to preserve relative crumbs. The solution is to hold the line against cuts altogether -- by revising the premise about the need for deficit reduction in a weak economy.
Tapping Obama's Courage. Here's the puzzle. President Obama has displayed real political courage and strategic mastery on issues like defense and immigration. He pulled out of Iraq and is pulling out of Afghanistan. The State Department under Hillary Clinton has been as much as we could expect in a mainstream liberal president.
Obama faced down his critics and took some real risks in backing the insurgency in Libya without committing American ground troops. He showed that he could be audaciously hawkish when necessary in approving the raid to kill Osama bin Laden, and courageously dovish in his risky appointment of Chuck Hagel as defense secretary, defying the Israel lobby. Just today, we see him leading on comprehensive immigration reform.
But on budget issues, Obama has been just dismal. One can only conclude that he is in bed with the wrong people -- those who believe that the road to prosperity is through austerity.
There are two things that could change this pattern for the better. Obama could realize that his own legacy is at stake if the economy stays stuck in second gear because of fiscal austerity. Or the progressive community could unite around the proposition that Democrats in Congress should vote for no budget deal that includes any further cuts in domestic spending or social insurance, other than greater efficiencies in health programs.
If those two things happen, and Obama uses his eloquence to educate public opinion on how the budget and a depressed economy actually interact, the tactical advantage and economic high ground just might shift to the President.
Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos.
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