Robert Kuttner

A perverse austerity plan

By Robert Kuttner
November 23, 2010

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THE UNEMPLOYMENT rate remains stuck at close to 10 percent. Meanwhile, despite low interest rates, banks are reluctant to lend and businesses are hesitant to invest. Mortgage foreclosures keep rising and real estate values falling. And with the federal stimulus petering out, state budgets anticipate more service cuts and layoffs.

Yet to read the newspapers and watch TV news and talk shows, you would think the top menace facing the country is the projected federal budget deficit in 2020.

The two chairs of President Obama’s bipartisan fiscal commission, Democrat Erskine Bowles and Republican Alan Simpson, are promoting an austerity package that would begin cutting public outlay in less than a year. The panel is due to report December 1.

Just for good measure, a private deficit commission chaired by former GOP Senator Pete Domenici and Democratic deficit hawk Alice Rivlin is going the official panel one better, proposing $5.9 trillion in tax hikes and spending cuts over eight years, compared to the $3.8 trillion proposed by the president’s panel.

Economic masochism has become the national fad, when the real issue is restoring economic growth. According to Bowles, if we don’t act soon to rein in the deficit, the economy is on “a path of absolute disaster.’’ Excuse me, but the disaster is here and has nothing to do with projected future deficits.

There are three huge flaws in the austerity program.

First, in a deep and prolonged slump, the economy needs more public outlay, not less, to make up for a paralyzed private economy. With depressed consumer spending, reduced business investment, weak banks, and declining property values each dragging the other down, standard economics dictates that only government demand can step into the breach.

During the Great Depression, the economy got stuck in a similar downdraft. Though weak growth returned by 1934, unemployment was still stuck above 12 percent on the eve of World War II. It was the massive wartime deficits (peaking at 28 percent of GDP compared to less than 9 percent today) that finally produced strong recovery.

Postwar leaders, unlike today’s deficit hawks, were wise enough not to panic about the large war debt (twice today’s size relative to the economy) but continued such public investments as the GI bill, low-interest home loans, and the interstate highway system. Rather than suffering an austerity scheme that would have made debt loom larger, the postwar boom enabled the economy to grow its way out of debt.

The second flaw is the timing and composition of the proposed deficit reduction plan. Just as after World War II, we need a long-term path to a lower debt. But hikes in taxes and cuts in spending should begin only when the economy is back at full employment, not next year. And the proposed mix of tax increases and spending cuts in the Bowles-Simpson plan is grotesque.

Everything is supposed to be on the table, but repealing the Bush tax cuts for the wealthy is not part of the proposed package. Nor are other notable increases in taxation of the best-off. Two thirds of the deficit-reduction would come from cuts in spending, and the proposed revenue increases would mostly hit the middle class.

A third flaw is the inclusion of Social Security cuts. Social Security has nothing to do with the current deficit, and is in surplus for the next 27 years. If we want to balance the projected long-term Social Security accounts after 2037, the best way is to get more people working and wages growing again, since Social Security is financed by taxes on payrolls.

The deficit hawks have not plausibly explained the connection between belt-tightening and recovery. Supposedly, we need to show our resolve to lower the debt years down the road, in order to give businesses confidence. But let’s get real: business is failing to invest because of lack of demand, not because of worries about deficits in 2020.

Commentators are clucking that the commission may deadlock because its Republicans won’t raise taxes and its Democrats won’t cut spending. We should only be so lucky. If the commission fails, we can get back to the real economic business of promoting a robust recovery.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is “A Presidency in Peril.’’