Severe Deficit Reduction will Cause Another Recession

The "Fiscal Cliff": Congressional Budget Office foresees Recession due to Planned Deficit Reduction

The bipartisan, highly regarded Congressional Budget Office recently released an important budget assessment. If the massive reductions in the federal government deficit go forward, as planned, CBO projects the country will fall back into a recession.

To understand the CBO report, first recall what is scheduled to happen in January, 2013. To do so, we need to go back to 2011 when Congress enacted budget cuts (the “sequestration”) that will shrink the federal government deficit by $1.2 trillion dollars over the next 10 years. Under this plan, starting in January, 2013, federal spending will be reduced by over $100 billion each year compared to what it would have been otherwise. In addition, numerous tax cuts are scheduled to expire on December 31, 2012, that will raise tax payments in 2013. These include the Bush tax cuts of 2001 and 2003 that primarily benefited the wealthy and the 2011 payroll tax cut enacted to stimulate the economy. Taken together, the spending reductions plus the higher tax payments will reduce the deficit by over $700 billion in 2013 compared with 2012.

Reducing the deficit by such a huge amount will further weaken an already weak economy. Less government spending means less government purchasing. It also means layoffs of workers who, at least until they find a new job, buy less. As demand for goods and services falls, firms produce less and also lay off workers. The CBO notes that the rise in unemployment and reduction in incomes – both driven by the large deficit reduction – will generate a fall in tax revenues and an increase in government spending on items such as unemployment insurance.

Overall, CBO projects that the economy will shrink in the first half of 2013 and cautiously notes, “such a contraction … would probably be judged to be a recession.” During the second half of the year the economy is projected to grow, giving an average growth rate of just 0.5% for the year. (By comparison, in 2010 and 2011 the economy grew by 3.0% and 1.7%, respectively.

To reduce the harmful short-run impact of the huge deficit reduction while also promoting the long-term health of the economy and the nation, CBO suggests a two-part strategy. First, Congress should increase spending (do fewer cuts) in 2013 and extend some tax cuts so the deficit in 2013 is not reduced so drastically. Second, Congress should enact additional policies, and maintain and strengthen those already in place, to reduce the deficit later in the decade.

But which planned tax changes and spending cuts should be delayed?

CBO does not recommend which spending cuts should be revoked or tax cuts extended in order to avoid another recession. But the choices are clear for people who care about fairness and seek a world where everyone has abundant life and shares in the resources that God provides for all of us.

Tax cuts: The people who most need their tax cuts extended are lower- and middle-income folks who have received little benefit from the past 30 years of economic growth. This means the payroll tax cut should be extended, and the Bush tax cuts should be maintained for lower- and middle-income households. The Bush tax cuts must be ended for upper-income and wealthy households.

Spending: In recent years, Congress has repeatedly cut funding for discretionary social programs and general government functions. Most of the additional cuts in these areas, scheduled to happen in 2013, should be permanently suspended. On the other hand, military spending has risen rapidly over the past decade, up 48% adjusted for inflation, to well over $500 billion per year. This figure does not even include “supplemental” funding for the Iraq and Afghanistan wars, over $100 billion per year. The planned 2013 cuts in military spending (some $55 billion) would reduce expenditures to the level of 2007, adjusted for inflation. These cuts should go forward. Also see this excellent assessment of military spending from the National Priorities Project.

There will be enormous pressure on Congress to do just the opposite: 1) to cut the military less and continue with or even increase the planned cuts on social programs and core government functions, and 2) to preserve all the tax cuts or at least all the income tax cuts which are more beneficial to the wealthy than cuts in the payroll tax. People of faith need to pressure Congress to make sure this doesn’t happen.

Upper-income households and especially the wealthy have benefited enormously from the economic policies and trends of recent decades. They should pay more in taxes and the income tax cuts they received during the Bush administration should be ended. Cuts in payroll taxes, on the other hand, are more beneficial to lower- and middle-income workers and should be the first tax cuts to be extended. Spending cuts should target the military, the area of the federal budget that has seen remarkable growth in the past 10 years and a type of federal spending that is least effective in creating jobs.

By reducing some planned spending cuts and extending some tax cuts, the deficit will be larger in 2013 than under current law. This is good. Hopefully the country will avoid another recession and the economy will continue to gain strength. Creating a robust economy – one where people are working and wages are high – is the best way to shrink a deficit.  


Also see Jackie Calmes in the New York Times: Recession possible if impasse persists, budget office says 

 

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Ms. Edith Rasell, Ph.D.
Minister for Economic Justice
700 Prospect Ave.
Cleveland,Ohio 44115
216-736-3709
raselle@ucc.org