For Deficit Panel, Failure Cuts Two Ways

From The New York Times:

The latest Congressional failure to agree on a plan for balancing the government’s books could yield a surprising result: a sharp reduction in annual federal deficits, larger than anything contemplated by the special panel that reached its fruitless finale on Monday.

But the absence of an agreement also threatens to significantly slow growth in an already ailing economy by raising taxes on almost everyone while reducing government spending on almost everything.

Tax cuts passed in the Bush administration will expire at the end of 2012. By law, the panel’s failure triggers new caps on spending, cutting $1.2 trillion from the military, education, health care and other priorities over 10 years beginning next fall. The combined impact of higher tax rates and less spending would reverse the growth of annual deficits beginning in 2013, reducing by more than half the current $1.3 trillion gap between annual revenue and spending.

That has inverted the normal reality, in which spending rises inexorably unless Congress musters the political will to impose cuts. Now, although both parties say they are committed to more gradual approaches, an agreement is required to avoid the fiscal equivalent of shock therapy.

“There could be a bit of a silver lining,” said Rosanne Altshuler, an economist at Rutgers University who served on President George W. Bush’s 2005 tax reform panel. “It forces us to come to terms with cuts in areas that have been difficult to touch — the military and Medicare. We may not like how the cuts are going to be done, but we better start dealing with the fact that cuts are going to have to be made.”

The latest committee, created in August as part of a deal to let the federal government borrow more money, was charged with identifying at least $1.2 trillion in spending cuts over the next decade. Its failure forces the same amount of spending cuts, with half the money coming from the military budget.

The immediate economic impact depends first on investors, who must decide whether they are now any more concerned about the nation’s financial condition. Any increase in the interest rates that the government must pay would widen the deficit, as would any decrease in economic growth. But while stock market indexes fell sharply Monday, with the Dow Jones industrial average down 248.85 points, investors continue to pay for the opportunity to lend money to the United States. Two credit rating agencies, Standard & Poor’s and Moody’s, affirmed their ratings of United States debt securities on Monday and said the failure did not change their assessment of the government’s ability to pay its debts. Fitch, a third agency, said it was reviewing its ratings and hoped to make a conclusion by the end of the month. It said in August that a failure by the special committee would probably result in a negative rating.

A second, looming question is whether Congress will extend a payroll tax break for workers and continue supplemental benefits for the long-term unemployed, both scheduled to expire at the end of the year. The tax break reduces the amount that workers must pay for Social Security; the extended benefits provide support for 3.5 million Americans who have been out of a job for longer than 26 weeks. The government will spend about $168 billion on the two programs this year. Economic forecasters estimate that a decision to end the benefits would reduce the country’s economic growth next year by more than one percentage point.

The Obama administration had hoped to wrap extensions of both benefits into a broader agreement. It now faces the challenge of rescuing a smaller compromise from the ruins of the negotiations, with some Republicans in outright opposition and others demanding offsetting cuts in other federal spending.

President Obama plans to call for the extension of both programs in New Hampshire on Tuesday.

Representative Jeb Hensarling, a Republican from Texas on the special negotiating committee, said on “Fox News Sunday” that its members had been “laser-focused on trying to get success” on the payroll tax measure. But, he added, “the bigger tragedy is we have unsustainable debt that is threatening our national security, is threatening our jobs, frankly, and is threatening our children’s future.”

The decisions that must be made by the end of next year over the future of the Bush tax cuts and the reductions in spending are far larger, as are the economic consequences.

The Obama administration wants to extend most Bush-era tax cuts while restoring higher rates for higher incomes. Democrats say they will not strike any agreement on spending cuts without an agreement to raise new revenue. Mr. Obama repeated on Monday that he would veto any legislation extending all of the cuts. Republicans say they will accept nothing less.

A Moody’s Analytics report warns that failing a deal, the combined impact will amount to a “historically extreme” reduction in the deficit that could push the economy into recession. It notes that under current law, federal revenue would increase as a share of economic activity by 3.7 percentage points over 2012 and 2013 — the sharpest rise since 1969, when, Moody’s says, sudden tax increases “helped set off a mild recession.” Combined with the required budget cuts, the deficit would shrink to $510 billion from $1.3 trillion by 2013.

“You’re seeing a very rapid depletion of the budget deficit,” said Ben Garber, an economist with Moody’s Capital Markets Research Group who wrote the report. “You’re taking a weak economy and removing a large part of potential demand, which could be enough to tip us into recession.”

There is still plenty of time for Congress to unlock its self-imposed handcuffs and renounce frugality. Next year’s elections also could produce a clear mandate for one party to reduce deficits according to its priorities without any need for compromises. Partisans at both ends of the political spectrum said they welcomed the failure of the current talks as an opportunity to win just such a mandate.

Over the last month, conservatives feared that the committee would settle for cosmetic cuts. They now see an opportunity to secure larger reductions, without tax increases, to encourage faster growth.

Liberals hope the Occupy Wall Street protests have shifted political debate from an overriding focus on the long-term danger posed by the federal deficit toward a focus on unemployment, income inequality and other immediate economic problems.

“This committee was created at a very different time, when the dialogue was that our deficits were too big and unsustainable,” said Martin Hart-Landsberg, a professor of economics at Lewis & Clark College in Portland, Ore. “This failure gives us time to help educate and change that dialogue, to focus on job creation and the direction of the economy.”