Good News and Bad News in Debt Limit Deal

Let’s give our political leaders credit for reaching an agreement on the debt limit. After years of cutting taxes and raising spending, reducing the medium-term debt is clearly a step in the right direction. But it is only the first step of a long journey, and it is a problematic one at that.

The new budget deal comes in two main parts. The first imposes cuts in discretionary spending of almost $1 trillion over the next decade. The second creates a congressional commission that, by the end of the year, would offer a plan to cut entitlements and “reform” (as opposed to “raise”) taxes and reduce future deficits by $1.5 trillion. Congress would vote up or down on the plan and if the plan failed, a cut in federal spending would be enacted to save that amount. The cut would be split 50-50 between defense and everything else, except Social Security, Medicaid, and Veterans’ benefits. Medicare would be limited to a 2 percent programmatic cut, which would be placed directly on providers, not beneficiaries.

The Deficit and the Economy

The $3 trillion in savings over the next 10 years will put a dent in the overall debt picture but is nowhere near enough to solve the whole problem. That’s not a criticism—it would have been too much to expect the whole problem to be solved all at once—just an assessment. We are not out of the woods, though we may be a little closer to finding a path.

One has the feeling, especially given that the final agreement was a complete capitulation by Democrats (more on that below), that the whole drive-the-economy-to-the-point-of-crisis approach could have been avoided. It certainly should have been. By stringing the negotiations to the very end, our elected leaders created enormous and wholly gratuitous uncertainty, at a time when the economy could not afford it. They may have created lasting damage to the economy by shaking the foundational belief that the U.S. obligation to pay its debts is totally sound.

The extended debate about fiscal policy also detracted attention from policies that could help the economy now as it limps along with sluggish growth, high unemployment, and extremely high long-term unemployment.

Who Pays?

An even bigger problem is the deal itself.  The deal is all spending cuts and no tax increases.  In practical terms, that means the burden of closing the gap will be placed on poor and middle-class households, rather than high-income or wealthy households.  It’s true that the second part of the deal involves the potential for tax reform, but the Republicans have been united in their “no new taxes” pledge and the Democrats accommodated them both directly, in requiring no new taxes, and indirectly, in stating that the trigger mechanism, in case the Commission’s report is not enacted, will be all spending cuts and no tax increases.

It does not seem fair or reasonable to impose virtually the entire cost of this part of the fiscal burden on poor and middle-class households, but that is exactly what this bipartisan act of Congress and the White House does. Without tax increases in either part of the current deal or in the foreseeable future, there is no way to get the well-off to pay anything close to their fair share of the fiscal burden. The top 1 percent own 33 percent of the wealth and receive about 15 percent of the income in the country. These shares have risen over the past 30 years. They are being asked to bear none of the burden of closing the fiscal gap.

News flash: rich people don’t get direct spending from the government. Instead, almost 100% of the burden will be borne—via spending cuts—by the poor and the middle-class. Low- and middle-class households have seen stagnating or declining earnings over the past few decades, and they have been hit hard in the Great Recession by the housing market collapse and the job market collapse. Now, they are being asked to shoulder—via spending reductions—all of the fiscal reduction agreed to so far. To paraphrase Tevye in Fiddler on the Roof, such households might be wondering why policymakers “couldn’t choose someone else once in a while.”

The Politics of the Deal

And that leads directly into the remarkable politics of the situation. The deal that was enacted is, politically, a complete capitulation by the Democrats. There are no tax increases as part of the initial trillion-dollar package. That package is all spending cuts, which was the original Republican position.

It’s particularly notable that the deal is all spending cuts when public opinion clearly wanted a mix of tax increases and spending cuts. In just the most recent example of this fact, a July 18-20 CNN/ORC International poll showed that almost two-thirds of respondents preferred a deal with a mix of spending cuts and tax increases. Only 34% preferred a debt reduction plan based solely on spending reductions. Also, the plan that was enacted was significantly to the right of the Gang of Six proposal and the Bowles-Simpson commission. It’s as if the two parties each started out on their own 25 yard line. The Dems moved to the 50 yard line, while the R’s moved back to their own goal line. Then the agreement was settled on the Republican’s 25 yard line, right where the Republicans started.

The proposal to enact the new commission’s policies or enact an automatic trigger virtually guarantees no new taxes because the automatic cuts are all on the spending side. The Obama administration’s defense of this is, in Gene Sperling’s words, quoted by CNN: “You want to make it hard for them just to walk away and wash their hands. You want them to say, if nothing happens, there will be a very tough degree of pain that will take place.” While I have affection and respect for Sperling, and his comment reflects a sound strategy, that strategy has nothing to do with the actual outcome in this case. If the Democrats wanted the Republicans to bear “pain” or to pay attention to a “reform or else” situation, they would have been well-advised to include tax increases in the “or else” part. It is certainly not going to be easier to negotiate with the Republicans when the do-nothing alternative is all spending cuts.

What Next?

The good news is that a default crisis was averted, though it could have been averted much more easily, and that a deficit reduction plan has been put in place. The bad news is that the plan imposes the full cost of deficit reduction on low- and middle-income households, gives the wealthy a free pass, and bodes poorly for future negotiations, which, like it or not, will require tax increases or draconian cuts in entitlements.