Tuesday, February 5, 2013

Scary Sequester

Last week, we were reminded of what happens when a fragile economy is given too much austerity. Today on Capitol Hill, we have another reminder. Take it away, CBO (Congressional Budget Office)!

“[E]conomic activity will expand slowly this year, with real GDP growing by just 1.4 percent,” according to CBO’s projections. “That slow growth reflects a combination of ongoing improvement in underlying economic factors and fiscal tightening that has already begun or is scheduled to occur-including the expiration of a 2 percentage-point cut in the Social Security payroll tax, an increase in tax rates on income above certain thresholds, and scheduled automatic reductions in federal spending. That subdued economic growth will limit businesses’ need to hire additional workers, thereby causing the unemployment rate to stay near 8 percent this year, CBO projects.”

In other words, intentional efforts to reduce annual deficits and stabilize the debt are working. But if you retrain your gaze from the government’s balance sheet to the real economy, you’ll see the impact of that austerity is fewer people working and slower growth. According to CBO, the recovery won’t really pick up steam until next year, and the economy won’t have recovered until the end of 2017, when it will reach its output potential, and unemployment will fall to 5.5 percent.

On one hand, we're doing a great job at deficit reduction. But when it comes to putting more Americans back to work, we've been harming our own economic recovery by fixating on all this austerity. Earlier today, Goldman Sachs economist Alec Phillips specified just how dangerous (even more) austerity can be.

“Sequestration, spending caps, and reduced war spending will together reduce real federal consumption and gross investment by 11% over the next two years,” writes Phillips. Ouch. That’s a very big drop in a very weak economy.

“This is a large decline in historical context, but it is not without precedent,” Phillips continues. “This would mark the third decline in the last 50 years; the first occurred around 1970, after Vietnam War spending had peaked, followed by another around 1990 as military spending declined following the end of the Cold War and multiple rounds of spending caps were enacted.”

Even if there’s precedent for this kind of a drop, there are at least three reasons to be particularly concerned about it happening now. First, the previous periods of austerity that Phillips mentions were primarily driven by the end of major wars. That meant that a lot of that spending was not directly raising living standards in the United States, and so its absence didn’t have the kinds of consequences of, say, the sequester. Second, this graph misses the significant tax-side austerity we’re engaged in, with the expiration of the payroll tax cut and the high-income tax increases from the fiscal cliff deal serving as an additional drag on growth. And third, the economy remains unusually weak by historical standards, and this kind of fiscal drag is going to make it that much harder to recover.

Remember this: When we divest from our economy, economic activity falls. And when too much of that happens and the private sector can't make up for that level of lost investment, the economy contracts. That's the result of austerity. And that's why there's this constant threat of a "double dip recession".

While balancing the budget is typically a laudable goal, it shouldn't be a priority when an economy is barely emerging from a deep recession and too many people are still out of work. Again, pulling money out of the economy is the last thing we should be talking about. Yet Congressional Republicans keep demanding this nonsense in order to placate their crazed "tea party" base.

Because President Obama is worried about the harmful economic effects of "The Sequester" (aka "The Fiscal Cliff" redux), he wants to replace it with a more sensible budget that won't throw our economy back into recession. And while some Republicans have recently declared their love for "The Sequester", others are particularly worried about the heavy military cuts that will occur under "Sequestration". That's why some Capitol Hill watchers think there's at least a chance another fiscal deal can be reached.

So far, President Obama and Senate Majority Leader Harry Reid have been quite skillful in averting complete economic disaster as they've diffused Congress' manufactured crises. Nonetheless, Main Street has had a more difficult (than necessary) recovery as a result of the austerity that's been allowed to happen. And at this point, Wall Street may not want to see any more austerity implemented.

So there's pressure on Congress and the President to reach another fiscal deal. Can it be done? Harry Reid thinks so.

Asserting that “the American people” are on his side, Senate Majority Leader Harry Reid, D-Nev., told me during an exclusive interview for “This Week” that any that deal reached between Republicans and Democrats to avoid the looming sequester must — “without any question” – include revenue.

“The American people are on our side. The American people don’t believe in these austere things. We believe that the rich should contribute. We believe we should fill those tax loopholes — get rid of them, I should say. And that’s where we need to go,” Reid said. “And I’ve got a pretty good fan base for that: the American people. Republicans, Democrats, and Independents.”

Reid confirmed his position on revenue would apply to any deal put into place to avert a government shutdown or lift the debt ceiling as well. This puts him directly at odds with Senate Minority Leader Mitch McConnell, R-Ky, who said earlier this month on “This Week” that the ”tax issue is finished,”But Reid — invoking the GOP’s 2012 presidential candidate Mitt Romney —suggested a deal could include such things as the elimination of oil and gas subsidies, or what he called “low hanging fruit.” The Nevada senator also pushed back when I asked if he was sidelined during the so called “fiscal cliff” negotiations, telling me he played the “bad cop” during that period.

Again, the current makeup of "The Sequester" is just way too much austerity unleashed all at once. Congress needs to craft an alternative deficit reduction plan that won't overly harm economic recovery. We'll have to wait & see if Reid & Obama can overcome this next fiscal hurdle.

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