The Agenda

Debt Ceiling Deal—Less Than Meets the Eye

My stated preference has long been for a clean debt ceiling hike. Failing that, I wanted to see a debt ceiling deal that contained as little policy as possible, or at least very little bad policy. This deal meets those criteria, and I am satisfied.

The deal includes a lot of spending cuts, but it’s important to understand how backloaded these cuts are. The headline figure is $2.5 trillion in cuts over ten years, but less than 1 percent of those cuts will come in FY 2012. The near-term fiscal changes are so small that they will matter very little for the economy. The long term changes will be subject to revision by future Congresses and will hopefully come when the economy is healthier—and the parts that do go into effect will probably not be that different from whatever fiscal adjustment we were going to have to enact sooner or later.

There are two parts of the spending cuts in this package that really do matter. One is the cuts that will apply in Fiscal Year 2012. There probably won’t be very big; there will be $22 billion in spending cuts compared to the baseline for 2012, or about 0.15 percent of GDP. (That’s out of the $1 trillion in cuts that will be agreed upfront.)

A “Super Committee” will be charged with finding a further $1.5 trillion in deficit reduction, and we can expect that the cuts it recommends will again be backloaded. (Indeed, if the Super Committee deadlocks, we will go to an automatic “trigger” process which involves no cuts at all until FY 2013). Discretionary spending cuts that come out of the Super Committee process will again be subject to the whims of future Congresses. Any changes to mandatory spending that come out of the Super Committee are more likely to be sticky—that’s the second part of the cuts that matters—but I’ll believe we’re getting meaningful entitlement reform when I see it.

So, liberals who are upset that this deal is destimulative, or who expect it to tank the economy, are off base. Suzy Khimm cites a study finding that a 1 percent of GDP fiscal consolidation implies a 0.5 percent reduction in GDP after two years—or a reduction in the growth rate of 0.25 percent each year. That points to a hit to annual GDP growth of roughly 0.04 percentage points from the FY 12 changes in this plan—an effect that will be impossible to pick up amidst the noise.

The consolidations get larger in later years. But an eventual fiscal consolidation is inevitable—we can’t run deficits over 5 percent of GDP forever. If the economy remains terrible in 2014, it is likely the cuts will be delayed.

Finally, I would note that the president called for a “balanced” approach to fiscal adjustment, and this is one. We now have $2.5 trillion in automatic, scheduled spending cuts* over the next 10 years. That comes on top of $2.8 trillion in automatic tax increases that are already scheduled through the year 2022, due to the expiration of the Bush tax cuts at the end of 2012. Indeed, Republicans have a good case that the automatic deficit reduction plan is not balanced but a bit tax-heavy.

I brought this up on Twitter today, and I got a lot of harrumphing from Democrats. There’s no way President Obama will ever let the Bush tax cuts expire, they say—he’ll get rolled again, just like he did in 2010.

To that, I have two responses. First, it’s not our fault you nominated this guy. Second, I’m not sure what good a balanced trigger as part of this compromise—one that included automatic tax increases, not just spending cuts—would have done, under this view. President Obama already has an automatic tax trigger that liberals believe he is afraid to use. What good would giving him a second trigger do?

I, personally, believe that Obama will play hardball on the Bush tax cuts in late 2012, assuming he gets reelected. Both the politics and the policy will be very different than when he agreed to a full extension in 2010. Having already been re-elected, he’ll be free to break his promise not to raise taxes on people making less than $250,000 (or, perhaps I should say, break it again, since he’s already raised cigarette taxes).

On the policy merits, if the economy is on sound footing in 18 months, a large fiscal consolidation will be called for. If we’re still in the mire, Obama can agree to another short-term extension. Once the economy is healthy and interest rates are rising, I expect that Obama will put his foot down, Republicans will refuse to do a middle-class-only extension, and most of the Bush tax cuts will expire.

Of course, if Obama is defeated in 2012, all bets are off. But then, if Republicans take full control in Washington in January 2013, they will be able to set the fiscal agenda anyway—the fact that this deal passed won’t do much more to weaken Democrats’ hands.

So, aside from raising the debt ceiling—which is very important—I think most everybody is overstating how much this deal matters. It is possible that we will get some good entitlement reforms out of the Super Committee, which will be a nice bonus on top of the debt ceiling increase. If not, for all the Sturm und Drang, this deal will have been a lot like a clean hike in the ceiling, which is fine with me.

*The mandate of the Super Committee will be to find $1.5 trillion in deficit reduction, not necessarily just spending cuts. I disagree with claims that the Super Committee is institutionally blocked from recommending tax increases. However, as a political matter, I believe that if the Super Committee recommends tax increases, the House of Representatives will most likely reject its recommendations.

This post was written before the release of the text of the compromise bill, and originally stated that my estimate of the size of FY 2012 cuts assumed no change from John Boehner’s Budget Control Act. Now that text has been released, and matches the spending levels from the original Boehner bill, that caveat has been removed.

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