Focus on growth, not deficits, economists tell Obama

As US President Barack Obama comes under increasing pressure to prioritise deficit reduction, some 300 economists and civic leaders have issued the following statement urging him to stay the course of promoting growth and jobs.

Don't kill growth and jobs in the name of deficit reduction

IN the fall of 2008 the US and other major economies were in a free fall in the wake of a global financial crisis. Emergency stimulus policies here and around the world broke the fall, but brought us only part way to full recovery.

Today there is a grave danger that the still-fragile economic recovery will be undercut by austerity economics. A turn by major governments away from the promotion of growth and jobs and to premature focus on deficit reduction could slow growth and increase unemployment - and could push us back into recession.

History suggests that a tenuous recovery is no time to practise austerity. In the Great Depression, Franklin Roosevelt's New Deal generated growth and reduced the unemployment rate from 25% in 1932 to less than 10% in 1937. However, the deficit hawks of that era persuaded President Roosevelt to reverse course prematurely and move toward budget balance. The result was a severe recession that caused the economy to contract sharply and sent the unemployment rate soaring. Only the much larger wartime spending of the early 1940s produced a full recovery.

Today, the economy is growing only weakly. 7.8 million jobs have been lost in the recession. Consumers, having suffered losses in home values and retirement savings, are tightening their belts. The business sector, uncertain about consumer spending, is reluctant to invest in expansion or job creation, leaving the economy trapped on a path of slow growth or stagnation. Over 20 million American workers are now unemployed, underemployed or simply have given up looking for a job.

The President and Congress should redouble efforts to create jobs and send aid to the states whose budget crises threaten recovery by forcing them to lay off school teachers, public safety workers, and other essential workers. It also makes sense to invest in public service jobs- and in infrastructure projects for transportation, water, and energy conservation that will make our economy more productive for years to come.

Target what drives deficits. Don't fix what isn't broken

Austerity advocates confuse two different issues - short-term deficits generated by the recession and long-term projections of deficits and debt. Deficits rose last decade largely due to the Bush tax cuts and the unfunded wars and prescription drug programme, but they exploded as a result of the economic crisis. Once prosperity is restored, deficits will be reduced substantially. Over the long term, projections of rising deficits and debt are mainly due to one fundamental factor: rising health care costs.

Contrary to the claims of many deficit hawks, America does not have an entitlement crisis. America has a broken health care system. Efforts to reduce public sector costs without fixing the health care system, such as caps on Medicare and Medicaid spending or replacing them with vouchers, will undermine the effectiveness of these programmes, but won't fix the broken health care system. The health care reform bill passed earlier this year may be a first step towards repairing the health care system, but much more will need to be done.

Social Security has nothing to do with our current deficit. It is supported by its own dedicated payroll taxes (which were increased to build up a trust fund to cover the baby boomers' retirement). Social Security has actually reduced the unified budget deficit for most of the last three decades and will continue to do so for most of the next decade. Making sure Social Security is solvent for the next century should be dealt with separately from any process set up to address short- or long-term deficits, and can be accomplished with minor adjustments.

Restore fiscal responsibility, while investing in the future

The President's National Commission on Fiscal Responsibility and Reform has set a goal of reducing the Federal deficit to 3% of GDP by 2015. It is not clear that this arbitrary target can be met without damaging our recovery. In any case, the goals of economic policy must be far broader.

The most important question is this: What will drive economic growth, job creation and prosperity in the years to come? Conservatives argue that we should simply reduce deficits and wait for the next economic boom. But the last boom was built on a bubble, inflated by unsustainable household debt and financial speculation. If we focus merely on cutting spending and raising taxes, the economy could shrink again - or stay stuck in a permanently low level of growth and high levels of unemployment.

President Barack Obama has called on us to build a new foundation for the economy. This requires making investments vital to our future - in education and training, in research and development, in a modern infrastructure for the 21st century. It requires ending our addiction to oil, and capturing a lead role in the green industrial revolution, creating the next generation of green jobs.

Study after study demonstrates that America has a huge 'public investment deficit' in areas vital to our economy. Some estimates suggest a shortfall in public investment of as much as $500 billion a year. As long as we have unacceptably high unemployment, outlays for additional investment can be deficit-financed. But once we achieve a robust recovery, our country should continue to pay for productive public investment, while acting to bring down public deficits. This will require new revenues.

We must have the confidence to forge our future. At the end of World War II, the US was burdened with debt that totalled over 120% of GDP. But we made the investments vital to a new economy - the GI Bill, housing subsidies, the interstate highway system, the conversion of military plants, and the Marshall Plan. We ran annual deficits over most of the next three decades and the debt grew in absolute size, but the economy and the broad middle class grew faster. By 1980, the debt had been reduced to barely 30% of GDP. The better way to reduce the deficit as a percent of GDP is to increase GDP.

Even with a growing economy, increased investment and deficit reduction will require new sources of revenue, new priorities and a crackdown on wasteful subsidies.

Below are a range of measures which could be used to reduce the deficit and finance needed investments. Not all signers endorse every one of these options:

Any effort to cut spending should address the military budget, which consumes over half of discretionary spending. Much of our huge military spending is devoted to weapons designed to counter a Soviet Union that is no more. Defence experts estimate we could achieve significant Pentagon savings - in the range of $100 billion per year - while still sustaining the most powerful military in the world. We can use funds freed up to invest in new manufacturing industries that make our nation more secure.

Second, we should cut back the massive amounts wasted on outmoded subsidies - billions to the oil industry, to wasteful farm subsidies, and tax loopholes benefiting a few, with little productive return.

On the revenue side, in an era of Gilded Age inequality, progressive tax reform is long overdue. Revenue for reducing deficits and increasing investment can be raised by making taxes more progressive and by taxing activities we want to discourage. Some examples:

* A small tax on financial transactions (e.g. 0.025% on credit default swaps) would reduce high volume speculation and would produce revenues of about $177 billion per year.

* The Wyden-Gregg corporate loophole-closing proposals produce $1.078 trillion over 10 years.

* Taxing hedge fund managers' 'carried interest' income as regular income gains $3 billion per year.

* End special tax treatment of capital gains income. Revenue: $480 billion over 10 years.

* A 5.4% surcharge on high incomes (passed by the House) produces $500 billion over 10 years.

* A carbon tax would help reverse climate change. Revenue: $500 billion over 10 years.

* End Bush tax cuts for people making more than 250k. Revenue: $678 billion over 10 years.

* One version of a progressive estate tax on large fortunes would generate $50 billion per year.

Any value-added tax that amounts to a regressive sales tax on the working middle class should not be part of this package. There may be a future case for a VAT, perhaps to fund progressive social programmes or replace even more regressive taxes, but not for deficit reduction.

Take the high road to fiscal balance

There are two alternative paths to long-term fiscal balance.

The less desirable path is austerity economics: government sharply cuts spending long before full employment is reached; production stagnates; revenues decline. We might reach budget balance but at a lower level of economic output, with increased taxes on working Americans and reduced public services.

The alternative high-road path would increase public spending financed by deficits for a year or two, until unemployment is definitely on a downward trend and GDP is rising rapidly. We then collect more revenues from a stronger economy. By identifying investments vital to our future, and paying for them with targeted spending cuts and progressive tax reforms, our country provides the basis for new private-sector investments that help fuel growth, generating greater revenues while reducing the deficit. The benefit of this second path is that government moves towards a reduction in annual deficits and a lowering of the debt-to-GDP ratio, at a higher level of economic output, while building a new basis for long-term prosperity.                 

This statement, which was publicly released on 16 September, was co-authored by Robert Borosage and Roger Hickey of the Institute for America's Future, Dean Baker of the Center for Economic and Policy Research, and Robert Kuttner of The American Prospect and Demos. It has been endorsed by over 300 economists and civic and labour leaders.

*Third World Resurgence No. 240/241, August-September 2010, pp 16-17