May 24, 2013
Crying sequestration wolf
As if having learned from the fable of the boy who cried wolf, the US public does not believe that Washington will actually enforce the draconian budget cuts due to take effect starting on March 1. As there is little time to discuss meaningful budget cuts, President Obama and Congressional Republicans will likely agree to extend the deadline for the sequestration. As a result, the threat of the sequestration will be further diminished and US citizens might forget that the fiscal deficit remains a real problem.
The US managed to have fiscal surpluses in the last years of the Clinton administration, but the Bush administration’s tax cuts and spending increases — including the wars in Iraq and Afghanistan — turned the surpluses into a growing deficit. When the government introduced a stimulus package after the 2008 crisis, the deficit skyrocketed. In Obama’s first term, the deficit increased by more than US$4.5 trillion, to US$16.4 trillion. The total debt now stands at US$16 trillion, slightly more than GDP. A good portion of that debt is held by the Social Security trust fund and some of it is held by the Federal Reserve. Still, the debt held by the public is close to US$10 trillion, 63% of the GDP.
Most economists argue that there was no choice but to incur in debt to help jump-start the US economy after the 2008 crisis. The slow recovery since then has hurt tax revenues and has forced the government to keep funding several programmes. Initiatives to curb government spending have been criticized by those who argue that by investing in jumpstarting the economy now, the government will foster economic growth, which will facilitate future tax revenues and shrink the relative size of the debt.
Still, most independent analysts agree that the US must do more to improve its fiscal balance. The failed negotiations to avert the fiscal cliff in late 2012 resulted in a tax increase on the very wealthy that Republicans had adamantly opposed. Democrats wanted a larger tax increase, but the new tax revenues that kicked in on January 1 will make the 2013 fiscal deficit fall below US$1 trillion for the first time since the 2008 crisis.
Other tax increases and spending revenues will be needed to put the fiscal house in order. Though the end of US military presence in Iraq and the reduced presence in Afghanistan have eased pressures on military spending, the fact that many local communities depend on defence contracts and that the Armed Forces directly and indirectly provide employment to millions of US citizens has made it difficult to cut the defence budget. Many other social programmes and subsidies are also popular in different areas. Politicians who advocate budget cuts normally work hard to save the subsidies and benefits that favour their constituencies. As a result, little progress can be made in adopting drastic budget cuts. Any tax increase will have a negative impact over the sector that gets a new tax. Tax increases are popular with some groups, but those adversely affected by new taxes normally rally strong support in Congress to resist tax hikes. As the marginal benefits of spending cuts and tax increases are small for the nation as a whole, but the costs of any changes in taxes and spending are borne by specific sectors, there will always be a more vocal opposition than popular support for a specific change. The public wants lower spending and higher taxes as a general principle, but support for spending cuts and tax increases decreases drastically when details are made public.
The sequestration conundrum exemplifies that while politicians gain popularity by advocating fiscal discipline, they gain little when they get down to specifics. Committing to spending cuts is popular, but when the spending cuts are spelled out, support for the policy decreases. President Obama is specifying some unpopular spending cuts to put pressure on Republicans in Congress to further extend the sequestration deadline. Since polls anticipate that Republicans will be blamed more than Obama for the spending cuts, everyone expects the Republicans to cave in and grant the White House additional time to negotiate specific cuts that will need to be made. Since the expiration of the Bush tax cuts is already ancient history, the White House wants to associate needed spending cuts to additional tax increases as a balanced way to reducing the deficit.
Three days before the sequestration deadline, every politician in Washington is crying wolf and blaming the other side, but the public no longer believes the threat. Unfortunately, some of the fiscal deficit threat is indeed real — though not as urgent as to be dealt with this week. As politicians have transformed a long-term debate into short-term threats of a looming fiscal crisis, the general public is paying less and less attention to the entire debate. Because they no longer buy the argument that the fiscal deficit is a do or die problem for this week, Us citizens mistakenly increasingly believe that the deficit is not a problem at all.