ME.
Professor, you might be pleased to learn that Erskin Bowles, former Chief of
Staff for President Bill Clinton and Democratic Co-Chairman of the national
bipartisan Debt Reduction Commission was at Iowa State University a few weeks
ago. He was in town to celebrate the installation of ISU's new President,
Steven Leath, who considers Bowles to be a mentor. Bowles presented a
lecture on fixing the federal government's $16 trillion debt. There was
an audience of 500 people who gathered in ISU's Memorial union to hear his
message: "If political leaders fail to take bold steps to address the
nation's fiscal problems, the U.S. could become a second-rate power," he
said.
BF. Not to be outdone, we had former Senator Alan Simpson in Manhattan at
Kansas State University to present a Landon Lecture last year. He was the
distinguished Senator from Wyoming who served as Republican Co-Chair of the
national bipartisan Debt Reduction Commission. He said the same things in an
even more colorful manner. Unfortunately, their report has been out for
nearly two years, and gathered a lot of dust while confrontational politics
took over Washington. Not much has been done, until recent weeks. However
their framework for moving forward may still be useful after the election.
The "Farm Bill" uncertainty is now being trumped by the much
larger uncertainty if our economy falls off the "fiscal cliff" that
everyone is talking about. If Congress and the President do nothing after the
election, the U.S. economy could be expected to fall back into recession next
year because of the tax increases and automatic budget cuts.
ME. Exactly right. The Congressional Budget Office (CBO) estimates
that if the current law remains in place, the annual budget deficit will fall
by $502 billion between Fiscal Year 2012 and Fiscal Year 2013. Good news
you think-that is only one shoe dropping. The other shoe is the tax increases
and across the board spending cuts are expected to create a 2-4% drag on GDP
growth-and that likely puts us back in a recession. The "Bush-era
tax cuts," reduced income taxes by reducing tax rates, reduced the
marriage penalty, repealed limitations on personal exemptions and itemized
deductions, expanded refundable credits, and modified education tax incentives.
They also reduced estate tax liabilities by increasing the amount of an
estate exempt from taxations and by lowering the tax rate. A
two-percentage point reduction in the Social Security payroll tax is also set
to expire at the end of 2012 and a number of additional temporary tax
provisions known as tax extenders will expire at the end of 2012. If
these tax provisions are allowed to expire on December 31st, the annual deficit
is expected to decline by $400 billion.
BF. Don't forget the $109 billion in automatic spending cuts that were
agreed to as part of the Budget Control Act of 2011. That is more than $1
trillion in deficit reduction over ten years. These cuts were imposed by the
same legislation that set up the Congressional Super-Committee on the Budget
and it was agreed to by a majority of House and Senate and signed by the
President on August 2, 2011. The automatic spending cuts are the fall
back position that takes effect because the Super-Committee failed to recommend
a set of budget and revenue adjustments that could be approved by Congress.
So now we have the automatic spending cuts that become effective January
3, 2013, unless Congress approves an alternate plan during the "lame
duck" session. These cuts include the federal share of extended
benefit payments for unemployment and temporary emergency unemployment
benefits, payments to physicians under Medicare that are to be reduced by 27%,
cuts to the defense budget and other discretionary parts of the federal budget
that are not held harmless.
ME. Well the federal budget deficit has exceeded $1 trillion in each of the
last three years and it is expected to exceed that level for FY2012.
So on one level, the bitter medicine of Congress doing nothing
allows the annual trillion dollar budget deficit to be cut by about half with
the $502 billion in revenue increases and expenditure cuts. The automatic
balancing formula is approximately $4 dollars of tax increases for every $1
dollar of spending cuts. This would be the worst "tea party"
nightmare that could be conceived--a $3,500 average tax increase per household.
It would cause heart burn and tax increases for 90 percent of
households-- including middle income folks who both Presidential Candidates are
apparently now courting for the general election. On the other hand, it
would take us back to the level of taxes that were in place when Bill Clinton
was President. At that time, we had a stronger economy with a federal
budget that was balanced.
BF. You forget we are in the longest weak recovery from a recession in
modern history. All it takes for the stock market to plummet is a little
bad news from the European debt situation. The $400 billion tax increase
of the "fiscal cliff" times ten equates to the ten year $4 trillion
deficit reduction target that Congressional leaders and the President have been
using as they work on an alternative combination of spending cuts and revenue
increases. The only reason we might go over the cliff would be if the partisan
bickering continues after the election to prevent compromise across the isle.
Normally, we would expect a honeymoon after the election for the
President--whomever that may be. However, all bets are off with this
Congress. If party leaders decide their party doesn't get enough credit
for solving the problem, they may not kick the can down the road, even if it
causes a recession.
ME. Bowles suggested that the nation's deficit problems are centered on five
issues that must be resolved: (1) healthcare spending, (2) defense spending,
(3) reform of the tax code, (4) solvency of Social Security, and (5) a rapid
escalation of the nation's debt because of compound interest. We are
currently spending $250 billion a year on interest. But if interest rates
recover to levels that would be expected during a healthy economy--like the
1990s--the federal interest payments would likely be $650 billion annually.
That is more than the defense budget. Just like over-extended household
budgets, interest payments could easily become overwhelming due to too much
debt.
BF. We might expect the Senate and House Ag Committee farm bills with their $23
to $35 billion in spending cuts to be considered as part of the compromise
agenda being worked on by a bipartisan group of Senators. Will House leaders be
willing to compromise on some tax increases to avoid the larger tax hikes that
occur with no action? Who knows. As Senator Simpson likes to say, Congress is
giving 2 year-old's a bad name. A third possibility is to postpone all
decisions a year to allow for revamping the tax code.
* Edelman is professor of Economics at Iowa State University and Flinchbaugh is
emeritus professor of agricultural economics at Kansas State University.
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