The Budget Deal: A First, Wobbly Step

By :: August 1st, 2011

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.

Let’s give our political leaders credit for reaching an agreement. 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 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 the final agreement was a complete capitulation by Democrats – and 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 ill afford it. They may have created lasting damage to the economy by shaking the foundational belief that theU.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, while it is limping 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, no tax increases. In practical terms, that means that 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, 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 what a bipartisan act of Congress and the White House just did. 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, 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 policy makers “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 that the deal should only involve spending cuts.

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 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.

19Comments

  1. Joe Perez  ::  7:13 pm on August 1st, 2011:

    You make some good points, but do you really believe the deal was a “total capitulation”? Ezra Klein has a good summary of some of the advantages for Democrats, and while they may seem slight they are actually quite strategic. Later this year, even if there is no deal with the Republicans, we will see massive defense cuts. By the end of Obama’s first term, he can enact an end to the Bush tax cuts, resulting in a much bigger tax increase than has been contemplated by any compromise this year. Democrats may have lost a battle, but they’ve set themselves up to win the war.

  2. Mark Condon  ::  8:26 pm on August 1st, 2011:

    I enjoyed reading your piece, Mr. Gale. As to the claim that Democrats can still win the “war”, as the first comment suggests, I have my doubts. I suspect Obama will only let the Bush tax cuts expire at the end of next year if he is a lame duck. I cannot see how that would be a victory for Democrats, unless you think a Republican president might be more progressive than Obama. (That may not be out of the question, given Obama’s track record.). If Obama wins a second term, I suspect the economy will still be very weak, thanks in part to this budget deal. He will want to again “negotiate” with the Republicans to extend some tax cuts for lower income households. Republicans will insist on an all or nothing approach, Obama will cave, and the Bush tax cuts will remain in place, because to let them expire will be viewed as too painful economically. In other words, Republicans will continue to use the same tactics that bring victory in every battle. Lose every battle, and Democrats have eventually lost the war. I suspect Ezra Klein is giving too much credit to Democrats, who have a good track record of snatching defeat from the jaws of victory.

  3. BIG JAKE  ::  8:36 pm on August 1st, 2011:

    “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.”

    How high, Mr. Gale, does the marginal tax rate have to be so we no longer have to hear liberals like yourself whine about fairness? Is it simply a 100% rate after some arbitrary figure like one million dollars? The irony is that your concerns about fairness are just empty rhetoric as you indulge in your own material wealth while so many others suffer in this country and around the world. You do not have the courage to truly live your life helping the needs of the less fortunate… Your concern is merely a means to enrich yourself. A modern day sophist.

  4. Andre 3000  ::  8:47 pm on August 1st, 2011:

    @BigJake.

    How about 39 percent after 250K and 42 percent after a million?

    Still ridiculously low compared to other OECD countries. Plus if tax rates for earnings up to 250K are kept at current levels (they probably shouldn’t be,) wealthy taxpayers will reap that benefit as well. That seems like a reasonable start.

  5. Zach  ::  9:17 pm on August 1st, 2011:

    Mr. Gale-

    Your Urban Institute colleague provides a good perspective on why the deal is so skewed, and ultimately ineffective for the long run economic needs of the country. Are you compelled by this explanation?

    http://blog.metrotrends.org/2011/08/costs-and-benefits-matter-debt-ceiling-debate/

  6. New Economic Times › Bill Gale on the Debt Ceiling  ::  10:00 pm on August 1st, 2011:

    […] TaxVox » Blog Archive » The Budget Deal: A First, Wobbly Step. This was written by John Irons. Posted on at 10:00 pm. Filed under Uncategorized. Bookmark the […]

  7. Will Liley  ::  10:13 pm on August 1st, 2011:

    The article’s point was almost entirely political: do you really think entitlement programs neeed no reform? For example,Social Security (and Medicare and Medicaid) could immediately be rendered less of a huge drain on the budget just by pegging the COLA increase to wholesale price inflation, rather than to wages (which have historically outstripped inflation). The idea that the budget can be brought back towards balance without such entitlement reform is a fantasy, so why treat them as a “third rail”?

  8. Michael Bindner  ::  2:45 am on August 2nd, 2011:

    Unless the deal has hidden language extending the Bush tax cuts, its a win for Obama, since there is nothing else that “must pass” given the fact that the House is churning out appropriations bills under open rules. If the Senate acts on these quickly, it will prevent any kind of shutdown – that is the key.

    My analyis of this situation is that the Tea Party (or the GOP if you like) got punk’d.

    If Obama gets serious about vetoing any tax cut extension with high rate cuts extended, he can’t be stopped. Since he has exacted 2.2 Trillion in cuts, all he has to do is make sure that the deal applies these to preserving the child tax credit at $1000 (or go higher with it) and the 10% tax rate. Everything else can expire.

    Chained CPI should probably be dropped by the committee. If the real issue with Medicare is Parts B and D being underfunded, the proper revenue source is premuium hikes, offset by an increase to Social Security benefits – which should be paid for by increasing the payroll tax or by lifting (or eliminating) the income cap. The latter is especially attractive if, instead of means testing or changing bend points, the employer contribution was credited equally (without regard to the size of the employee contribution). Do that and bend points can be eliminated.

    Finally, it is fashionable in tax simplification to say the AMT is being eliminated. In truth, the rest of the tax code is being eliminated, with the excpetion of tax subsidies for the poor and a slightly lower rate for the middle class. In truth, the AMT becomes the tax code, although no one will admit it.

    As to the economy, right now the FDIC and the Federal Reserve are considering the impact of the Fed buying Freddie and Fannie. If they do this, even partially, and start doing principal adjustment on these loans (which they quietly did with the other mortgage backed securities they held), it will bring the economy out of its tailspin.

  9. Michael Bindner  ::  2:46 am on August 2nd, 2011:

    Actually, no enactment is necessary. He can just let them all expire and balance the budget in one fell swoop.

  10. Nancy Irving  ::  7:39 am on August 2nd, 2011:

    How high? You talk as if tax rates for the highest income groups have been rising, when in fact they have been trending down for the past half century.

  11. Ralph H  ::  10:04 am on August 2nd, 2011:

    “An even bigger problem is the deal itself. The deal is all spending cuts, no tax increases. In practical terms, that means that the burden of closing the gap will be placed on poor and middle-class households, rather than high-income or wealthy households.”

    If the problem is that we are borrowing 40% of all spending, we have to cut the spending. To take that off the table because it disproportionaly affects poorer folks means we will never solve the problem. I view the legislation as a first step, and (more importantly) a resolution of the debt limit cap crisis.

    It is foolish to try to revise taxes in a few weeks. Lets try to do it right, with incentives to grow the economy, and eliminate as many prefences as possible. I doubt we can do it as I see Mr Obama does not really want to tackle a hard issue, especially if it increases taxes on his favored class (low and moderate income). The GOP might agree to tax reform, but only if rates go down — difficult to do if we want to increse revenues. My guess is the only way to increase revenues is to let the Bush cuts expire, and that would mean all the cuts.

  12. Secondary Sources: Paychecks, Debt Deal, Middle Class Pain – Real Time Economics – WSJ  ::  10:50 am on August 2nd, 2011:

    […] […]

  13. BIG JAKE  ::  2:34 pm on August 2nd, 2011:

    So what other OECD countries do is the arbiter of what is “fair”?

    Regardless, can we agree that your proposed changes make no material difference on the long run budget situation and Medicare, as we know it, will have to be ended? They true trade-off is what you hint at in your “they probably shouldn’t be” parenthetical… the current welfare state with dramatically higher taxes for everyone or ending Medicare and Social Security as know them.

  14. BIG JAKE  ::  2:35 pm on August 2nd, 2011:

    Grade F. Failure to answer the question.

  15. Cfwade  ::  4:19 pm on August 2nd, 2011:

    Let me get this right…the rich don’t pay their fair in taxes. Ah, i see, it must be the bottom %50 that pay. No, wait they don’t pay any federal income tax now do they! Fair share my ass! Whats fair?? Should the top 10% pay everything to keep a bloated bureaucracy going! Give me an effing break!

  16. Tom Laughington  ::  4:54 pm on August 3rd, 2011:

    NUTS !

    The writer is simply NUTS !

  17. Paolo Romanacci: E Tu Democrats: The Bloody Toga of the Middle Class  ::  6:27 pm on August 8th, 2011:

    […] Many have already begun lifting the bun and indeed it is ugly. According to William Gale of the Tax Policy Institute, "The deal is all spending cuts, no tax increases. In practical terms, that means that the burden […]

  18. Paolo Romanacci: E Tu Democrats: The Bloody Toga of the Middle Class | Politimo | PoliticalParades.com  ::  6:29 pm on August 8th, 2011:

    […] Many have already begun lifting the bun and indeed it is ugly. According to William Gale of the Tax Policy Institute, "The deal is all spending cuts, no tax increases. In practical terms, that means that the burden […]

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