Off the fiscal cliff and into the abyss
Efforts to avert the fiscal cliff offer great drama, but won’t solve Washington’s budget woes and could precipitate another recession or worse.
The Budget Act of 2011 requires the president and Congress to agree on a nine-year $1.2 trillion deficit reduction program, or annual defense and nonentitlement outlays will be automatically cut $107 billion on Jan. 1. Also, the Bush tax cuts, payroll tax reductions and other assorted programs expire.
Altogether, $136 billion in annual spending reductions and $532 billion in additional taxes could trigger cataclysmic consequences for the economy. Unemployment would rocket past 15 percent, state government finances would collapse, homeowners would default on mortgages, and hundreds of banks would fail.
To avoid calamity, President Obama and House Republicans will likely agree to raise taxes on high-income Americans by $100 billion to $150 billion and curb spending an equal amount. However, those efforts will prove too little, and the economy may still skid into recession – driving down tax revenues and pushing up the budget gap again.
The annual deficit exceeds $1 trillion. Spending is up $1 trillion – outlays for Social Security, Medicare, Medicaid and other entitlements have increased by an amount equal to the entire 2013 defense budget.
By 2020, runaway entitlement spending will require shutting down the military or crippling many domestic spending programs to head off ballooning deficits.
With Americans living longer, the reasonable solution is to raise the Social Security retirement age to 70, and pattern U.S. health care after other national systems that better contain costs.
Democrats, hamstrung by unions, are loath to require Americans to work longer, and are too beholden to tort lawyers and the medical establishment for campaign support – hence, ObamaCare just throws more money into a broken system.
Republicans refuse to admit more competition won’t adequately slow rocketing costs.
Without raising the retirement age, effective price controls in health care and tort reform, federal spending and the national debt will jet into the stratosphere. Mounting interest payments, investor reluctance to buy U.S. Treasurys and consequent draconian cuts in spending will thrust the United States into the crisis now gripping Greece and Spain.
More immediately, tax increases and spending cuts threaten a second recession, because Obama and Congress failed to address dysfunctions that created the bubble and bust of the 2000s and make the economy perilously dependent on deficit spending.
A huge trade deficit with China and on oil continues, but the federal government is doing extra borrowing and spending to sustain domestic demand and modest growth. Obama and House Republicans indicate no interest in confronting China to force a more equitable trading relationship.
Slashing oil imports enough requires the president to permit more drilling in the gulf, off the Atlantic and Pacific coasts and in Alaska, and for Republicans to embrace alternative energy sources and aggressive conservation measures. Neither seems likely.
Absent changes in trade and energy policies to boost domestic demand and growth, budget deficit reduction is not possible without another long, hard recession. And absent genuine deficit reduction, the nation is headed for economic chaos by the end of the decade.
Peter Morici is a professor at the Smith School of Business, University of Maryland, and former chief economist at the U.S. International Trade Commission.